Deposit guarantee companies test NZ market

In what is perhaps yet another sign of just how buoyant the housing market, a new form of financing deposits has emerged, the deposit bond or guarantee.

Thursday, October 9th 2003, 10:19AM

by Jenny Ruth

In what is perhaps yet another sign of just how buoyant the housing market, a new form of financing deposits has emerged, the deposit bond or guarantee.

A home-grown company, Deposit Bond, has been operating since April last year and its business is secured by the "AAA" rated Great Lakes Reinsurance in Britain which is ultimately owned by Munich Reinsurance. Now another, Deposit Power, which is ultimately owned by the recently listed Promina has opened for business in New Zealand after first establishing a business in Australia where it has operated since 1989.

Essentially, they offer potential residential property buyers the option of paying a relatively small fee to have their deposits guaranteed, rather than having to pay it in cash, until settlement date.

However, the two aren’t really competitors because each is chasing very different markets.

David Parker at Deposit Bond, which he jointly owns with merchant banker Martin Reesby, says his company’s niche in the market is in providing "long bonds" or guarantees of deposits on development properties, usually ones sold off the plan before building starts, for terms which typically range from one to 2 ½ years.

By contrast, Keith Levy at Deposit Power is offering such guarantees on sales of existing residential property for terms up to six months or "short bonds."

Reflecting the different market niches, the fees each company charges range from 1.2% of the deposit amount for Deposit Power, equivalent to a 2.4% annual interest rate, up to between 6.5% and 7% for Deposit Bond, reflecting the greater risk the latter faces.

What both companies share is that they both demand their customers provide proof of their ability to settle the relevant transaction when due.

In both cases, the guaranteeing company still has to make good on the bond if their client defaults and then try to recover the money from the client.

Parker says his company’s services allow a developer to go ahead with a project in the certainty of a number of sales. In fact, developers usually pay the cost of the bond to make it easier to sell their projects.

He says his company has been involved in providing bonds on 65 developments to date with the largest bond it has provided being on a $3.5 million apartment. Typically, his firm will provide bonds on anywhere from 30% of units in a development up to 70%.

While some similar schemes in Australia have resulted in tears – developers providing their financiers with "bogus" bonds – Parker says his firm offers the protection of its backer’s "AAA" credit rating.

Banks have come to see his firm as complementary rather than as a competitor because a typical deposit of, say, $30,000 on a $300,000 apartment means the same amount of paper work as the eventual loan without the same payoff and because the capital adequacy requirements on such deposits are double that of a loan secured by a mortgage.

For the client, buying such a bond means not having to break existing investments until settlement.

Essentially, the same goes for Deposit Power’s clients who are typically selling an existing house to buy another. While they can prove the ability to settle, they don’t necessarily have the cash up front, Levy says.

One possible snag his company faces in New Zealand is that real estate agents are usually paid their commissions from the deposits rather than having to wait until settlement, as most Australian agents do.

Levy says agents in Victoria operate the same way as those in New Zealand and his company has been able to persuade them that using a bond allows buyers into the market sooner than if they had to sell their existing house first before making a bid on another. "It brings qualified buyers into the market quickly" and can mean the agent securing a higher price than would otherwise be possible, he says.

Levy argues that when the housing market inevitably does turn down, agents are likely to be even more willing to support his company as it may help provide sales opportunities that may not otherwise be available.

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