FINANCE : Another DFC! – Do we really need one?

The continuing impacts of the Global Financial Crisis on the New Zealand banking system and the collapse of dozens of finance companies are still fresh in our minds. Some experts, therefore, wonder how growing companies will find enough credit to continue operating without modern-day equivalent of the Development Finance Corporation. Let’s consider that.
 On October 2 1989 the Reserve Bank of New Zealand decided that the financial state of the DFC had deteriorated to the point that it had become problem of systemic importance to our financial sector that required the imposition of statutory management. The reverberations of the decision spread quickly through local and global markets and created headlines in the financial press that would continue for long time. 
The decisions taken that day and throughout the subsequent restructuring impacted on the finance sector for years. The DFC’s collapse influenced the financial mechanisms used few months later to assist the BNZ through series of similar troubles; affected the regime still used today to supervise our largely Australian-owned banking sector; and impacts the discussion around salvaging today’s finance company wrecks.
On October 1 last year, accounting firm PricewaterhouseCoopers and lawyers Bell Gully hosted panel discussion to look back and put the events of 20 years earlier in perspective. Both firms had, in earlier incarnations, been deeply involved in the restructuring of the DFC.
Panellists included David Caygill, the then Minister of Finance; Don Brash, Governor of the Reserve Bank throughout all the years of the statutory management; Fran O’Sullivan, the journalist most closely identified, both locally and internationally, with the breaking story and its subsequent media coverage; and John Waller, the last of the DFC statutory managers.
The audience included key representatives from the Reserve Bank, commercial banks, former DFC directors and executives, lending and treasury staff, the National Provident Fund (the majority owner at the time of the failure), lawyers, accountants and other professional advisors, Treasury, the Securities Commission, and other Crown entities. It was an unparalleled opportunity to examine what actually happened and assess the continuing impact of the event.
One of the persistent issues that arises out of the experience is the continuing claim that the financial sector needs another DFC. The reasons usually advanced include: filling development finance role that is not fully served by current market players; supporting key sectors of growth economy; and, to better achieve range of policy objectives. The issue hung over the room in October, and provoked considerable commentary and debate. We were even assured that there are “live” discussions within Government to examine the case for “second DFC”.
Several participants raised practical issues: 
• The decade of the 1980s was time when rules governing capital adequacy were in their infancy. It would be much more difficult today to assemble sufficient capital to successfully operate an entity of the size and scope required to fill an analogous place in our current economy.
 • Funding, then and now, would largely have to come from overseas wholesale markets. There exists considerable doubt that counterparties could be found in today’s highly competitive global market to provide sufficient liquidity to fund new entity, at least without extensive and continuing government support.
 • Even if funding could be found, current risk assessment and risk-based pricing would make the costs prohibitive.
• Finally, even making heroic assumption that all these hurdles could be jumped, assembling the people and skills required to do the job would be almost impossible.
 But all these arguments are mechanical “how to” issues and miss the point. Does the DFC experience help make the case for the “need” for another such institution? Is there any indication that the market was failing to provide the type of finance that was central to the rationale of the purpose and mission of the DFC? 
These sorts of questions are hard to prove conclusively because the financial environment of 1989 is not equivalent to that of 2009. But, with the benefit of the 20/20 hindsight that the recently re-assembled group possessed we can make an educated guess. 
The DFC had extensive lending, derivative, and equity exposures to thousands of growing companies across New Zealand’s economic spectrum. The aggregate amounts were found by the authorities to be of national significance: “systemic” in the language required by Reserve Bank legislation to justify statutory management. It was big portfolio, and included great deal of developmental lending.
So, what happened when the DFC lending window closed abruptly 20 years ago? If the market was failing and unable or unwilling to provide credit to the companies being shut out by the DFC, more or less dramatic chaos should have resulted. Undoubtedly many borrowers collapsed or suffered. Some, of course, would have met that fate in any event – that is likely, known, and accepted outcome for not insignificant number of borrowers needing development finance. 
The “stand still” powers of statutory management allowed time and opportunity for the skilful use of restructuring, price signals, receiverships, and litigation in hundreds of cases, managed and supported by what ultimately became very skilled cadre of DFC executives and advisors. The economy continues to benefit in significant ways from the experience of these ex-staff and from many of the companies which survived the collapse.
But ultimately the resolution of the DFC was not question of statutory management mechanics or personal skills. The restructuring would have failed if the wider market lacked the appetite and capacity to absorb displaced DFC customers. 
History shows that customers were absorbed swiftly, virtually seamlessly, and almost completely by other financial intermediaries. The restructure was signed little more than year after the collapse; within another year the bulk of the DFC’s book had been shifted to other institutions and the vast majority of DFC exposures were settled and creditors paid. 
There is scant evidence to support case that the original DFC was needed because the markets of the day failed to support the sort of development finance that DFC was doing at the time. Anyone attempting to use history to support case for new DFC will ultimately have to ignore the facts, postulate changed world, or look elsewhere to try and make the point.

Sandy Maier is chief executive of South Canterbury Finance, an independent chairman and director of number of companies. He moderated last October’s panel discussion.

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