Part 7: Paying depositors when institutions failed

The Treasury: Implementing and managing the Crown Retail Deposit Guarantee Scheme.

7.1
In this Part, we discuss:

7.2
In summary, despite the number of finance company failures in the two years before the Scheme was introduced, the Treasury was surprised by the March 2009 failure of a finance company accepted into the Scheme. Because the payout was not expected nor adequately planned for, some aspects of the first payout process could have been improved. However, the Treasury learned from the first payout and managed later payouts effectively and efficiently.

7.3
The Treasury was well prepared for the South Canterbury Finance payout and provided comprehensive analysis of the advantages and disadvantages of the various options that were available. Because of this, the Treasury secured an effective outcome that significantly reduced the liability that the Crown would otherwise have faced. In our view, the Treasury chose the best available option for paying out South Canterbury Finance’s depositors.

The first payout under the Scheme

7.4
A number of finance companies in the Scheme experienced difficulties. Problems in finance companies ranged from poor management and excessive related-party dealings to poor quality lending decisions and not enough capital or liquidity (because of the long-term and illiquid nature of their loans, finance companies often did not have enough short-term funds to repay depositors).

7.5
The first institution to fail under the Scheme was Mascot Finance, which was placed in receivership on 2 March 2009. Another small institution, Strata Finance Limited, failed in April 2009. A further six institutions failed under the Revised Scheme in 2010. Only one institution, Equitable Mortgages Limited, has failed under the Extended Scheme. Equitable Mortgages Limited was placed in receivership in November 2010.

7.6
Figure 17 provides details of the payments made to institutions that failed while covered by the Scheme.

Figure 17
Institutions that have failed while covered by the Crown Retail Deposit Guarantee Scheme

Institution Date of failure Amount
paid*
$million		 No. of
depositors		 Months taken
to complete payout
Mascot Finance Limited 2 March 2009 70.0 2,494 20
Strata Finance Limited** 23 April 2009 0.5 17 20
Vision Securities Limited 1 April 2010 30.0 967 8
Rockforte Finance Limited 10 May 2010 4.0 66 4
Viaduct Capital Limited 14 May 2010 7.6 88 4
Mutual Finance Limited 14 July 2010 9.2 329 2
Allied Nationwide Finance Limited 20 August 2010 131.0 4,094 3
South Canterbury Finance Limited 31 August 2010 1,580.3 30,404 0
Equitable Mortgages Limited 26 November 2010 140.2 3,852 Not applicable
TOTAL
1,972.8 42,311

Source: The Treasury.

Note: As at 30 June 2011. The Treasury expects to pay out a further $37.3 million.

* Includes interest payments after the institution failed and ineligible deposits. Note that some small payments remain outstanding because some deposits are yet to mature and some depositors cannot be traced.

** Most eligible depositors were paid on 4 June 2009.

7.7
Under the Scheme, the Crown committed to pay depositors 100% of their eligible amount up front. This was to facilitate quick payment to depositors. The alternative would be to wait for the receivership process to be finalised and for the Crown to make up any shortfall after the failed institution’s assets had been sold. The Crown would participate in the receivership process to recover as much as it could from the sale of the institution’s assets. The receivership process takes a lot of time, so the payment process was instead designed so that depositors would not have to endure lengthy delays before they received their funds.

7.8
During interviews, we were told that officials in the Treasury were thinking about and discussing their planning for payout processes in late 2008 and early 2009. However, there is no documented evidence of this planning. There is evidence that planning for possible Scheme payouts was under way in February 2009. In particular, the Treasury and the Reserve Bank met on 23 February 2009 to “brainstorm” the payout process and failure scenarios.

7.9
When Mascot Finance failed in early March 2009, the Treasury needed to quickly implement a payout process. Several Treasury officials said that they were surprised by Mascot Finance’s failure and that the Treasury was fortunate a larger institution had not failed, given the Treasury’s lack of established payout and communication processes.

7.10
Once the Treasury was aware of the pending failure of Mascot Finance, it quickly responded to ensure that the payout process was as smooth as possible. The Treasury planned a media statement to reassure eligible depositors that they would receive 100% of their entitlement and to provide details of the step-by-step process on the Treasury’s website. This information was released the day the receiver was appointed.

7.11
The Treasury made claim forms for simple claims available within a few days of Mascot Finance’s failure. All claim forms were available within a few weeks. The Treasury also set up a free-call telephone number to handle queries from depositors. The process for claiming was:

  • Depositors submitted a completed Notice of claim form to the Treasury (with all supporting information).
  • The Treasury sent an acknowledgement that it had received the claim.
  • The Treasury checked the institution’s records and directed any queries to claimants.
  • The Treasury made payments as requested (either by cheque or directly to a bank account) and provided a final statement to the depositor.

7.12
By all accounts, processing payouts for Mascot Finance was complicated and the Treasury quickly realised that it would require additional resources. It engaged PricewaterhouseCoopers (PwC) to help in processing claims. A contract between the Treasury and PwC was signed on 10 March 2009 for services until 30 June 2009, providing both on-site and off -site support.

7.13
Issues that complicated the claims processing included:

  • complex eligibility criteria – as discussed in Part 5, an unintended consequence of the Scheme’s design was the need to meet complex depositor eligibility criteria, which created processing difficulties;
  • incorrect claim forms – many investors submitted the wrong claim form for their circumstances, which required follow-up with the claimant; and
  • payment of interest – the Treasury received a ruling from the High Court on 27 August 2009 that it had to pay interest after the date of failure until the claim was paid. The Treasury had not anticipated this. The decision had significant implications because it meant that claimants could delay submitting their claim form to continue to receive high interest payments. The guarantee deeds did not limit the interest to be received or set a deadline for submitting a claim form.

7.14
Despite these complications, the payments were timely. The first payment was made on 9 April 2009. By 30 June 2009, 78% of payments had been made.

7.15
The second failure, in April 2009, was a very small institution (Strata Finance Limited) that had only 17 depositors and was in the process of winding down. The institution’s failure was triggered by a failure to pay a depositor on the maturity date. With the small number of depositors, the payout process was a much smaller task than for Mascot Finance. The Treasury handled it internally. The Treasury sent claim forms directly to each depositor in May 2009, and most eligible depositors were paid on 4 June 2009.

Outsourcing the processing of claims

7.16
Despite its success, the Treasury’s experience with Mascot Finance highlighted the need for a more robust payout solution. Using the Mascot Finance model, it would have taken too long to process payouts for a large institution. The Treasury prepared a comprehensive analysis document (undated, but entered in the Treasury’s document management system in August 2009) detailing the costs and risks associated with the various options considered. The Treasury explored three options:

  • fully outsourcing the payout process;
  • continuing to process payouts in-house; or
  • a combination of the two processes.

7.17
Because of potential NBDT failures and the Scheme’s limited term, the Treasury did not see that an in-house capacity was practical or cost-effective. It favoured a single service provider over multiple providers because of the cost efficiencies of a single provider and the minimisation of potential duplication and inconsistency. Further, it favoured an end-to-end arrangement to ensure efficiency and clear responsibilities and deliverables. The Treasury decided that outsourcing the end-to-end payout process to a single service provider was the best option.

7.18
The Treasury then analysed the capacity, credibility, and experience of three potential providers. These providers were scored against a comprehensive list of requirements, sub-criteria, and key risks in the payout process. The Treasury also
analysed the cost of two potential providers, considering the payout for a small and a large institution.

7.19
The Treasury carried out appropriate due diligence checks of possible service providers. It met a number of potential outsource providers in August 2009 and also met with potential receivers to discuss the payout process. The Treasury decided to outsource claims processing to Computershare. It also decided to investigate a refined in-house process for smaller NBDTs, but this never eventuated because of the success of the Computershare arrangement.

7.20
The Business Management Team (which makes resourcing decisions) agreed to appoint Computershare on 11 September 2009. The contract was structured in two stages. The initial stage was to prepare adequate processes and systems. (This initial engagement was confirmed on 5 November 2009.) The second stage was processing claims. The final services agreement between the Treasury and Computershare was signed on 19 July 2010.

7.21
The services provided by Computershare included managing a help desk and telephone hotline, setting up a claimant database (after reviewing and reconciling claimants with the institution’s register), sending and processing claim forms, and forwarding payments to each depositor. The register could take up to two months to prepare, putting pressure on other aspects of the process.

7.22
The Treasury retained oversight of the payout process. It met regularly with Computershare, received weekly reports, reviewed a sample of payment files, approved all payments, approved all decisions to decline payments, and processed the complex claims. The Treasury, with Computershare, prepared detailed business rules and checklists to clearly set out the payment process and to help in applying the eligibility criteria. The Treasury also spent time training Computershare staff . Learning from its experience with Mascot Finance, Computershare sent the correct claim form to each depositor after it had confirmed their details (avoiding the problem of the depositor sending in an incorrect form).

7.23
All preparation under the first stage was completed by March 2010. Computershare was then ready to process claims if a financial institution covered by the Scheme failed. As part of its preparation, in November 2009, the Treasury requested details of the debenture registers for institutions most likely to fail. This helped to identify any data quality issues before an institution failed.

7.24
The first payout under the outsourced arrangement was for Vision Securities Limited (Vision Securities), which was placed in receivership on 1 April 2010. The contract between the Treasury and Computershare was not yet final (because of delays in preparing service standards and other documentation). However, this did not affect the claims processing for Vision Securities, which was carried out under a Statement of Work required for each individual claims payout.

7.25
All payouts after Mascot Finance and Strata Finance Limited used the Computershare outsourcing model.

Paying the depositors of South Canterbury Finance Limited

7.26
South Canterbury Finance was placed in receivership on 31 August 2010. Its failure triggered the guarantee under the Revised Scheme: the deed for the Extended Scheme was signed, but the Scheme had not yet started.

7.27
Although the payout process had been set up and had proven to be efficient, the failure of South Canterbury Finance presented additional challenges. Some of these were administrative. Others were because of how the Scheme was designed.

7.28
The Treasury expected claims and payout processing for South Canterbury Finance depositors to be large and complex. The finance company had more than 30,000 depositors and a large deposit base of more than $1.6 billion. The Treasury was also concerned that significant additional costs would arise from interest payments, particularly if depositors deliberately tried to maximise their interest payments under the guarantee.25 The interest rates paid on South Canterbury Finance’s investments were high relative to other investments, so the interest payments after the company failed could have been significant. Although the Crown had paid interest to depositors for all the earlier failures, they had been smaller institutions and the payout process was efficient.

7.29
The Treasury’s close monitoring of South Canterbury Finance in the months leading up to its eventual failure provided ample warning and an opportunity to analyse and consider alternative payout approaches. In the month before South Canterbury Finance’s failure, the Treasury carried out a lot of planning. It analysed extensively the options to simplify the payout process and reduce the Crown’s liability. The Treasury prepared a paper for Cabinet on 26 August 2010, setting out its analysis to reduce costs if South Canterbury Finance failed.

7.30
Accordingly, the Treasury announced several decisions on 31 August 2010. These included that:

  • eligible and ineligible depositors would be fully paid out on the first day of the receivership; and
  • the Crown would pay certain other organisations owed money by South Canterbury Finance (“prior ranking charge holders”) so that the Crown would become the first-ranked creditor.

7.31
On 31 August 2010, the Crown paid the trustee of South Canterbury Finance $1.8 billion, with both the Treasury and trustee co-operating to promptly repay all depositors (once an up-to-date register was available). Negotiations with the trustee included a requirement for the trustee to also use Computershare, under a separate agreement. The Treasury continued to oversee the payments made.

Repaying eligible and ineligible depositors

7.32
The decision to repay all depositors of South Canterbury Finance, regardless of any previous eligibility criteria, was in response to anticipated difficulties in assessing eligibility criteria and concerns about the interest payments that would accrue as claims were processed. Assessing the eligibility of individual depositors would have been an enormous administrative task.

7.33
Under the simplified repayment criteria, all that was required was for the depositor to be on the register of debt securities at the date of the company’s failure. The relaxing of eligibility criteria resulted in payouts to depositors who would have otherwise been ineligible. This included related parties, financial institutions, depositors with deposits of more than $1 million, trusts, and non-tax residents/citizens.

7.34
To implement this full payout, the trustee was nominated as the eligible creditor. This allowed the Crown to pay the trustee in full instead of depositors making a claim to the Treasury and the Crown repaying amounts to individual depositors. Under this payout method, interest to depositors ceased to accrue on the date that the trustee was paid.

7.35
In the 26 August 2010 Cabinet paper, the Treasury estimated that interest payments to depositors if South Canterbury Finance failed would be between $170 million and $240 million or more under the standard payout arrangements. This range reflected assumptions about how many depositors might delay making claims and how long they might take to lodge their claims. The Cabinet paper also contained the Treasury’s estimate of the net saving to the Crown of an early full payout with the trustee nominated as the eligible creditor. The net saving to the Crown of the early full payout was estimated at about $109 million.

7.36
The decision to pay “prior ranking charge holders” gave the Crown control over the payout process. This allowed for an orderly and well-managed receivership that minimised the cost to the Crown. Prior ranking charge holders could otherwise have appointed their own receiver, which might have resulted in longer processes, more complicated receivership processes, and, ultimately, additional Crown losses. Taking this step was estimated to cost no more than $175 million, which the Crown received back in full by February 2011.

7.37
The Treasury also announced that changes to the eligibility criteria would also apply to any other guaranteed companies that failed (including those that had already failed). Paying out previously ineligible depositors was a controversial decision and an about-turn in policy, because many depositors would benefit from the guarantee who were not originally intended to do so.

7.38
The decision to extend this change to institutions that had already failed under the Scheme was based on a cost-benefit analysis and was an attempt to manage issues of “precedent and fairness.” The saving to the Crown was the overriding factor in the decision. The Treasury had calculated that quickly paying all depositors (eligible and those previously ineligible) through the trustees was administratively sensible and would cost about the same as continuing to pay interest to individual eligible depositors until their claims were fully settled.

7.39
At the time of the South Canterbury Finance failure, payments had not been made to any of the depositors in the preceding four failures (as registers were still being verified) and around 75% of payments due had been made to the depositors of Vision Securities (which failed in April 2010). Interest would have been payable for these claims (which would have taken time to process).

7.40
Eliminating the need to assess eligibility resulted in faster payments to depositors. Payment from the Crown to the trustee enabled it to make payments to South Canterbury Finance’s bond holders on 23 September 2010 and to its debenture holders and depositors on 20 October 2010.

7.41
The remaining Vision Securities payouts and payouts for depositors with other failed institutions were also able to be processed more quickly.

Paying depositors under the Extended Scheme

7.42
Under the Extended Scheme, paying interest after an institution failed was explicitly excluded as part of the guarantee deed. Interest was paid only up to the date of the failure.

7.43
Because the interest problem was adequately dealt with under the Extended Scheme, any payouts made under the Extended Scheme would be subject to the full eligibility criteria. This differed to the original Scheme, which relaxed the eligibility criteria to hasten payments and avoid the interest payments.

7.44
One institution has triggered the guarantee under the Extended Scheme. Equitable Mortgages, which had about 4000 eligible depositors and $178 million in deposits, failed. With no ability to misuse the Scheme and maximise interest payments, and with the Extended Scheme’s requirement that claim forms be received within 180 days, claim forms arrived early. The Treasury continued to use Computershare to process the payments.

7.45
The Treasury had introduced tighter and more complex eligibility criteria for the Revised Scheme and the Extended Scheme. For example, under the original Scheme, joint deposit holders were eligible if one of the joint deposit holders was eligible. However, for the Revised and Extended Schemes, both joint deposit holders needed to be eligible (with some exceptions). Other revisions were also made for the Extended Scheme (such as a lower cap). These tighter criteria and other revisions meant changed business rules, and a higher proportion of claims for Equitable Mortgages were classed as complex. This led to greater interaction between the Treasury and Computershare. In other respects, the payout process was similar to earlier payouts.

Communications about the payout process

Failures and claim processes

7.46
One of the objectives of monitoring institutions was to anticipate any failures and allow preparations to be made for communicating with and paying depositors. The first two failures under the Scheme occurred before the monitoring process was set up. There was limited early warning. However, for other failures under the Scheme, the Treasury was aware that a failure was approaching and planned the necessary responses.

7.47
Mascot Finance triggered the guarantee on 2 March 2009. The Treasury released details of the company’s failure and the accompanying payout process:

  • A media statement was issued on the day of the failure, assuring eligible depositors that they would receive 100% of their money back. It provided a free telephone helpline during business hours for depositors wanting further information and directed depositors to the Treasury’s website for further details.
  • A Claims Frequently Asked Questions (Claims FAQs) and a Step by Step Claims Process guide were also released on 2 March 2009. Both provided useful and clear information about what depositors needed to do to make a claim.
  • A claim form for individual depositors was available on the Treasury’s website on 5 March 2009, with other claim forms (for trustees, corporations, and joint holders) following from 13 March 2009 to 23 March 2009. Updates to these forms were completed by 14 April 2009.

7.48
The Treasury answered queries from depositors by email or by telephone. The Treasury set up a dedicated web page about Mascot Finance, providing contact details and the claim forms for download, as well as a link to the Claims FAQs. The Claims FAQs were updated on 1 April 2009 to clarify that interest would be paid after the date of failure (based on the High Court ruling). The Step by Step Claims Process was amended on 9 July 2009 to remove references to the receiver and refer to claim complexity only in the context of payment timing. The web page was updated in September 2010 about the decision to pay all depositors (including those previously ineligible). Further updates were made in October 2010 and on 10 December 2010 to advise that payments to all Mascot Finance depositors had been completed.

7.49
An equivalent amount of communication about the payout process for Strata Finance Limited was not necessary because there were only 17 depositors. However, the Treasury also set up a dedicated web page for Strata Finance Limited, similar to that created for Mascot Finance’s depositors.

7.50
By late 2009, the “questions and answers” web pages had comprehensive information on claims and failures. On 25 February 2010, the Claims FAQs were incorporated into the “questions and answers”.

7.51
The Treasury was better prepared for the company failures that occurred in 2010 (starting with Vision Securities in April 2010 through to South Canterbury Finance in August 2010). The extensive “questions and answers” were in place, and the Treasury had prepared a Crisis Response Plan that set out the steps and responsibilities for the payout process. With the heightened monitoring of institutions, there was enough warning of impending failures for web pages and communications to be prepared well in advance. A media statement on 19 July 2010 also provided detail on the process for repayments.

7.52
Each company failure had a dedicated web page and toll-free telephone number for enquiries. The Treasury issued a media statement on the date of failure, directing depositors to this information. The dedicated web pages were frequently updated to provide information on the Treasury’s progress, the reasons for any delays, changes to eligibility or payment of interest, expected dates for receiving letters, and expected payment dates. A specific “questions and answers” page was also provided on the dedicated web page (as well as the general listing).

7.53
On 12 October 2010, the general “questions and answers” were updated to reflect the changes to the Extended Scheme. There has been one failure under the Extended Scheme. For this payout, the disclosure regime has been similar to those in 2010, with regular updates provided on the progress towards payout.

7.54
In our view, the communications about company failures under the Scheme provided clear, timely, and comprehensive information to depositors on the process for making a claim and receiving a payout. In 2010 in particular, web pages were frequently updated to provide depositors with a good understanding of the Treasury’s payout process and progress, and when depositors could expect contact or payment.

7.55
Although the information about Mascot Finance was clear, timely, and comprehensive, it was not regularly updated as often as was the case for later payout processes. Depositors could have benefited from more regular updates on payment progress. Moreover, there was no communications plan in place before Mascot Finance’s failure. However, the Treasury learned from Mascot Finance’s failure. The Treasury had improved information and a Crisis Response Plan to apply for the later company failures. The Crisis Response Plan included the necessary tasks and the timing for those tasks in the event that an institution failed.

Communications about the extent of repayments

7.56
In each media statement to announce that an institution covered by the Scheme had failed (other than the statement for Mascot Finance), the Treasury provided an estimate of the number of depositors and the total deposits for the institution. The initial announcement was followed by a number of media statements that provided updates on the payments made and those that were outstanding (on 19 July 2010, 6 September 2010, and 8 December 2010). The media statement on 8 December 2010 detailed the total amounts paid for each of the eight failures that had occurred. Details of the failures, net costs, and the gross payouts to investors were also provided in the month-end and year-end financial statements of the Government.

7.57
In our view, the information about each failure under the Scheme was timely and comprehensive. A list of institutions that had failed is clearly available on the Treasury’s website, along with links to the media statement about the failure (which provided details on the estimated deposit amounts covered by the Scheme), the web page for that institution (which was updated as payments progressed), and the media statements on payments progress.

Informing the Minister of Finance about failures and payouts

7.58
As well as information for the public, the Crisis Response Plan required the Treasury to provide details of each failure to the Minister through a Treasury Report or aide-memoire. These were to provide details on the institution’s history, monitoring, default details, amounts of deposits, number of depositors, and likely outcomes. We have not seen any of these documents (other than for South Canterbury Finance).

7.59
Although we have not seen the documents, we know from other documents that the Minister received a Treasury Report on the Mascot Finance failure on 27 February 2009 (in the week before the failure), as well as an aide-memoire on 10 March 2009, which set out a step-by-step outline of the application process and the plans for the Mascot Finance payout. The Treasury also provided the Minister with updates as part of the fortnightly financial system issues meetings. The disclosure to the Minister for Mascot Finance was before the Crisis Response Plan was prepared.

7.60
The Crisis Response Plan required Treasury officials to notify the Minister. It also required the Minister’s press secretaries to be notified, and they were to tell the local member of Parliament if the failed institution had a concentration of investors in that member’s constituency. We have not seen evidence that this aspect of the Crisis Response Plan was applied.

7.61
In our view, the Minister was well informed about company failures and expected payouts.

Our views on the payout process

7.62
In our view, the Treasury learned valuable lessons from its experience with the Mascot Finance payout and applied this knowledge to improve the payout processes. Using Computershare was effective and made the payout process efficient. The Treasury was well prepared for the South Canterbury Finance payout and provided comprehensive analysis of the advantages and disadvantages of the various options that were available. As a consequence, the Treasury secured an effective outcome that provided significant savings to the Crown.

7.63
The payout process was adversely affected by unintended consequences of some aspects of the Scheme’s design, namely the payment of interest after an institution failed and dealing with complex eligibility criteria. If these issues had been explicitly provided for at the outset, the payout process would have been significantly simplified. However, the Treasury learned lessons from the Scheme’s design and made sure that, in the Extended Scheme, there were no interest payments after an institution failed and there was an explicit deadline for submitting claim forms. Complex eligibility criteria continued to be a feature of the Revised and Extended Schemes.

7.64
The payout process could have been improved by contingency planning for possible payouts in the early days of the Scheme. We have not seen evidence of any formal planning of proposed payout methods before the failure of Mascot Finance in 2009. Ideally, the arrangement with Computershare would have been in place at the start of 2009. The Treasury told us that it could not have done so because the arrangements with Computershare reflected what the Treasury had learned from the payouts after Mascot Finance failed.

7.65
In our view, having a provider broadly prepared for processing payments, even if finer details were yet to be determined, would have been better than having no arrangements in place. If South Canterbury Finance had failed in mid-2009, the Treasury would have been caught unprepared and the effort to achieve an effective payout solution would have been significant. We consider that the Treasury took too long to finalise the Computershare agreement and should have done this earlier than its effective date of July 2010.

25: If South Canterbury Finance had failed under the Extended Scheme, there would have been no interest payments to make because they were explicitly excluded when the Scheme was extended.

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