Secured debenture or term deposit?
- Neville Giles, HANOVER GROUP LIMITED
A bank term deposit is perceived to be the absolute safest investment there is, but fixed interest investors are invariably trying to generate a return that ‘beats the bank’. The implied assumption is that they are willing to take on more risk in order to generate a higher return. But what are the characteristics of a secured debenture and how does this compare with a bank term deposit?
The first issue to note is that banks are not risk-free. Banks, whilst among the safest of investments, do carry a degree of risk that people need to be aware of when making a term deposit. Since the mid-1970s there have been nearly 120 systemic bank crises in 45 countries around the world.
For example, Barings Bank in the UK was wiped out in a matter of weeks by the losses of a one derivates trader in Singapore. The most recent example close to home was the BNZ which ran into difficulties in 1990 and had to receive a cash injection from the Government not once but twice! A compounding factor is the fact that the large New Zealand banks are all Australian owned so that difficulties in their home market may have repercussions for term deposit holders here.
The notable difference between a term deposit and a secured debenture is the security. A term deposit is unsecured meaning that in the event of default, customers are unsecured creditors of the bank and will be paid back only after secured creditors and bond holders have received their monies. This contrasts with secured debentures which are generally first ranking in their security. In the event of default, the debenture holders are the first to be repaid by the receiver (subject to any permitted prior charges, if any) and the receiver has a first call on the assets of the company. So while the risk of default may be lower for a bank, the chance of recovery if default does occur may be higher for a finance company.
Examining the security alone does not take into account the different financial strength of the companies. The entire finance company industry has assets of around $14 billion compared with ASB Bank which has assets exceeding $43 billion alone. This is reflected in credit ratings with most of the banks being rated AA or AA- by the international rating agencies whereas finance companies are generally rated BB to BBB. This is the main reason why debentures pay higher rates than term deposits – it reflects the balance between risk and return.
Investors should be fully informed when making an investment which is why the type of security held should be taken into account when comparing the interest rates offered by banks and finance companies.
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