CHAPTER 38
EQUITICORP RECEIVABLES
TABLE OF CONTENTS
38.1 INTRODUCTION
38.2 NEW ZEALAND RECEIVABLES
38.2.1 HISTORY AND STRUCTURE
38.2.2 PURPOSE OF THE ACQUISITION
38.2.3 CHRONOLOGY OF EVENTS
38.2.4 FINANCIAL PERFORMANCE
38.2.5 COMPLIANCE WITH PROCEDURES
38.2.5.1 Review of Receivables
38.2.5.2 The First Tranche
38.2.5.3 The Second Tranche
38.2.5.4 The Third Tranche
38.2.5.5 The Approval Process
38.2.5.6 Other Matters
38.3 AUSTRALIAN RECEIVABLES
38.3.1 HISTORY AND STRUCTURE
38.3.2 PURPOSE OF THE ACQUISITIONS
38.3.3 CHRONOLOGY OF EVENTS
38.3.4 FINANCIAL PERFORMANCE
38.3.5 COMPLIANCE WITH PROCEDURES
38.3.5.1 Approval of the Acquisitions
38.3.5.2 Review of the Portfolios
38.4 FINDINGS AND CONCLUSIONS
38.4.1 NEW ZEALAND RECEIVABLES
38.4.2 AUSTRALIAN RECEIVABLES
38.5 REPORT IN ACCORDANCE WITH TERMS OF APPOINTMENT
38.5.1 TERM OF APPOINTMENT A
38.5.2 TERM OF APPOINTMENT C
38.5.3 TERM OF APPOINTMENT E
38.1 INTRODUCTION
In the period between January and March 1988, Beneficial Finance acquired five portfolios of receivables, ie loans, from various Equiticorp companies. Four portfolios were located in Australia and had a total book value of $165.8M. The fifth portfolio was located in New Zealand and had a book value of approximately $NZ 100.0M.
The New Zealand portfolio, which comprised approximately forty loans, has sustained significant losses. The poor performance of the portfolio has, in part, been influenced by events occurring after the acquisition, such as difficulties in the New Zealand property market, and the collapse of the Equiticorp Group of Companies. The final position with respect to the quantum of these losses is yet to be determined, as certain amounts may be recoverable in the course of the administration of Equiticorp's affairs. There are, however, other factors including internal management processes that have, in my opinion, contributed to these losses, and these are discussed in this Chapter.
In a property market, which it was anticipated could deteriorate, it was of fundamental importance for a prudent purchaser of receivables to ensure that the borrowers had the capacity to repay the loans, that the loans were adequately secured, and that commercially realistic valuations of the securities were obtained. Management deficiencies occurred in respect of each of these matters. Further, management proceeded to acquire the portfolio without presenting a firm recommendation on the investment to the Board after such recommendation had been requested. It was put to me by the Board members() that they questioned management over the acquisition and received reassurance. This discussion on such an important matter was not documented in the minutes which, if it took place, reflects poorly on reporting practices.
I have examined the acquisition of the New Zealand receivables in the first Section of this Chapter. In Chapter 26 - "Dealings between the State Bank and Equiticorp" of my first Report, I have reported on a series of transactions between Equiticorp and the State Bank which occurred between late 1987 and March 1988. In my opinion, what occurred in the process of this New Zealand acquisition may be explained by, or at least understood in the context of, the timing of these transactions, and the pressure by Equiticorp for quick settlement.
The four portfolios of receivables acquired in Australia have been profitable. Nonetheless, in the course of examining these transactions, certain matters have been revealed about the acquisition process which I am required, by the Terms of my Appointment and the provisions of Section 25 of the State Bank of South Australia Act 1983, to report. The most significant is that the Beneficial Finance Board did not approve any of the transactions, although the total amounts involved in each acquisition were clearly outside the delegated authorities of management. As the Australian portfolios were acquired in three successive transactions, the Board had the opportunity to question management's use of delegated powers and to require that a detailed recommendation be approved by it, prior to commitment. But the Board did not do so, supporting the view of management that as individual loans in each portfolio would have been within management's delegated credit limits, the acquisition of portfolios valued at between $47.0M and $63.8M was within their authority. For reasons stated in this Chapter, I reject this submission.
The second matter is that the haste with which the two transactions to acquire the second, third and fourth portfolios were negotiated and concluded, compromised the review process. Review of the second portfolio to be acquired was commenced before, but effectively not carried out until after, settlement of the contract to purchase, and no proper pre-acquisition review was undertaken of the third and fourth portfolios. Whilst no loss resulted from the lack of full pre-acquisition review of these portfolios, it was a risk which a prudent financier, particularly one lent monies by the public and other creditors, ought not to run. Further, the history of dealings between the State Bank and Equiticorp, which I discuss in Chapter 26 - "Dealings between the State Bank and Equiticorp", may explain why this occurred.
I have examined the Australian acquisitions in the second Section of this Chapter.
38.2 NEW ZEALAND RECEIVABLES
38.2.1 HISTORY AND STRUCTURE
In March 1988, Beneficial Finance acquired a portfolio of receivables comprising some forty accounts with a book value of approximately $NZ 100.0M from Equiticorp Financial Services Ltd and Equiticorp Finance Group Ltd. These companies were subsidiaries of Equiticorp Holdings Ltd. For the purpose of this Section on the New Zealand receivables, I shall use the term "Equiticorp" to refer to each of the above named companies.
In early February 1988, Mr J A Baker and Mr G S Ottaway, General Manager, Corporate and International, State Bank, visited New Zealand to conduct a preliminary evaluation of the portfolio. Beneficial Finance management had been informed of the opportunity by Mr T M Clark, the Bank Group Managing Director. The Bank had an interest in the proposal, as it was suggested that the Bank provide financial support to Beneficial Finance for the acquisition. The fact that Mr Clark introduced this acquisition to Beneficial Finance and the relationship between the State Bank Group and Equiticorp is referred to further in Chapter 26 - "Dealings between the State Bank and Equiticorp".
Details of the proposed acquisition were provided to the Beneficial Finance Board by Mr Baker in a letter dated 9 February 1988. After informing the Board of his visit to New Zealand with Mr Ottaway with the objective of evaluating a portfolio of "33 real estate secured loans totalling $NZ 100.0M", Mr Baker continued:
"The loans were generally of good quality and are typical of Australian Finance company real estate receivables. However, because of the likely downturn in the NZ real estate market and the timing factor involved, we concluded that some recourse to Equiticorp will be necessary. The opportunity arises because Equiticorp has recently acquired NZ Steel and is rationalising certain of its finance activities to reduce overall gearing ...
Pricing will be
|
Customer Rate Say |
22.0% |
|
Cost of Funds |
17.0 |
|
Gross Margin |
5.0% |
|
Beneficial - Minimum |
3.5 |
|
Equiticorp - Recourse/Admin |
0.5 |
|
Balance 50/50 Benfin/Equiticorp |
1.0 |
|
Gross Margin |
5.0% |
On an annual basis, Beneficial would earn net revenue of $NZ4.0M assuming the receivables level is maintained ... Details of the 33 loans are contained in Attachment A.()
Equiticorp NZ typically lends up to 80% of cost plus interest on construction loans. Securities range from CBD properties in Auckland/Wellington to tourist related properties in non-major city areas. Lending policy has been to rely on close historical knowledge of the borrower's capacity and the security margin. Analysis of cash flow capacity in the files inspected was not strong. Credit loss experience has been excellent; albeit in a growth market."
The structure of the proposed acquisition was also outlined by Mr Baker as follows:
"To meet the timing objective and to comply with NZ foreign investment requirements, the following purchase/funding package has been arranged:
|
Co (NZ Co) formed with 100 NZ $1.00 shares with ownership - |
|
|
Beneficial Finance (or subsidiary) |
24% |
|
Equiticorp Finance Group Ltd |
38 |
|
BNZ Nominees (or similar) |
38 |
|
Senior BNZ executive or NZ panel |
|
|
100% |
Beneficial will have an option to purchase balance of the shares (76%) on receipt of Overseas Investment Commission approval.
Bank of New Zealand to lend NZ Co $NZ100M for six months at 0.5% points over the Commercial Bill Rate (approximately 16.5% at present).
NZ Co acquires the receivables from Equiticorp for $NZ100M (book value) which yield approximately 22.0% per annum on a variable interest rate basis.
Equiticorp Holdings Ltd (shareholders funds at 30/9/87 $NZ647M) will guarantee any losses up to $NZ10M on a partial recourse basis and manage receivables on behalf of Beneficial for at least six months.
Security to BNZ will be
Charge over NZ Co
Guarantee from Beneficial Finance
Letter of Credit from State Bank of South Australia for
$NZ20M to support the guarantee of Beneficial."
The Board discussed this proposed structure at a specially convened meeting on 10 February 1988. The Board contemplated that a different structure might be required. The minutes record:
"Consideration was given to the shareholder structures to be used in each of the transactions. It may be necessary to involve a SBSA owned company to hold a portion of the shares so that they are not Beneficial subsidiaries for Trust Deed purposes. The SBSA involvement could also assist in developing funding lines in New Zealand utilising Japanese and other banks."
The minutes further state that the Board contemplated the use of an off-balance sheet entity to acquire the portfolio:
"The need to work out what will be the effect of the various off-balance sheet operations having to come on-balance sheet in the future is to be urgently reviewed by Management."
The company used for the acquisition was Ravlick Holdings Ltd ("Ravlick"), a New Zealand shelf company which Beneficial Finance acquired through its off-balance sheet structure. The paid up capital of Ravlick was $NZ 100.00 comprising 100 shares of $NZ 1-00 each. As envisaged by the Board, the structure of the shareholdings and the shareholders was different from that which was set out in Mr Baker's proposal. The shares were held as follows:
(a) 48 per cent by Beneficial Finance;
(b) 48 per cent by Kabani Pty Ltd (an off-balance sheet entity of Beneficial Finance); and
(c) 4 per cent by Thomson Simmons Nominees Pty Ltd.
The directors of Ravlick appointed in February 1988 were Mr Baker, Mr E P Reichert, General Manager, Corporate Services, and Mr G L Martin, Manager, Business Development, Corporate Services.
Although Beneficial Finance owned less than 50 per cent of Ravlick's share capital, Mr Baker was a director of both companies and the other two directors of Ravlick were employees of Beneficial Finance. The directors of Kabani Pty Ltd were appointed by Beneficial Finance. I am satisfied that Beneficial Finance had the capacity to exercise control of Ravlick for reasons that I have stated in Chapter 41 - "Management and Financial Information Reporting". The Beneficial Finance Board had a responsibility in respect of the transaction, because Beneficial Finance was undertaking to procure the loan to Ravlick for the purchase.
Mr Baker has informed my Investigation that this structure was adopted in order to circumvent restrictions in the Trust Deed under which Beneficial Finance operated from time to time.()
For purposes of this Chapter, it is sufficient to state that the Trust Deed provisions imposed certain restrictions on the activities of Beneficial Finance and its subsidiaries. These matters are discussed in Chapter 41 - "Management and Financial Information Reporting" referred to above. Ravlick was placed within the Beneficial Finance structure so as not to fall within the definition of a "guaranteeing subsidiary" as defined in the Trust Deed.
The agreements between Ravlick and Equiticorp were:
(a) Management Contract dated 1 March 1988.
(b) Factoring Agreement (undated but I infer executed on 1 March 1988).
(c) Second Factoring Agreement dated 15 March 1988.
(d) Agreement Amending Management Contract dated 15 March 1988.
(e) Guarantee between Equiticorp Holdings Ltd and Ravlick.
The acquisition proceeded in two parts with settlement of the first tranche of receivables on 1 March and the second tranche on 15 March.
The terms of the acquisition were summarised in a memorandum from Mr J C Mudge, Credit Manager, Beneficial Finance to Mr Reichert on 14 April 1988. Mr Mudge has informed my Investigation that he prepared the memorandum as an aid to his own understanding of the arrangement, in the absence of any detailed facility description. Mr Mudge described the arrangement entered into with Equiticorp as follows:
"Legal Structure
The relationship is governed by three documents viz:
(a) factoring (assignment) agreement between Equiticorp Finance and Ravlick;
(b) management contract between Beneficial, Equiticorp Finance and Ravlick;
(c) guarantee of obligation of debtors under and right to purchase assigned receivables between Equiticorp Holding and Ravlick.
Factoring Agreement
This effects the assignment of the receivables and under it we have the right to notify the borrowers of the assignment at any time. [Prior to the assignment of the receivables it was not open to Beneficial Finance to contact the borrowers.]
Funds collected by Equiticorp on Ravlick's behalf are to be held in a Trust account and accounted for on each monthly settlement date. Where Equiticorp is late in transmitting funds a rate of 25% applies.
The covenants under the document include current insurance cover of property held as security and enforceability of securities. The document also allows us access to inspect relevant books and records maintained by Equiticorp.
The agreement is to continue beyond the duration of the management contract and guarantee until all receivables have been paid.
Management Contract
This defines Equiticorp's role as Ravlick's agent in managing the receivables.
Whilst the management fee is currently set at 0.5%, it is subject to review at the end of 6 months when a contract is due for renewal.
The agreement requires Equiticorp to pay to Ravlick all interest due on the designated monthly settlement date even if such payments have not been paid by the borrower. Equiticorp is entitled to retain any such arrears when recovered, together with penalty interest thereon.
Whilst there is a provision for Equiticorp to pay out or provide substitution of such defaulting receivables, it is totally at their discretion.
Any payments of principal are to be made immediately to Ravlick's Trust Account. The agreement allows, but does not require, any such payment within the first 6 months to be used to acquire other Equiticorp receivables.
Should the receivables fall below NZ$98M within six months of purchase, Equiticorp is to offer replacement receivables to maintain a minimum balance of NZ$98M. If during the same period the balance exceeds NZ$100M then Equiticorp is to fund the excess at a rate equal to the average rate earned during the past month on the current receivables eg further drawdowns under construction facilities.
Beneficial undertakes to obtain funding at the lowest cost possible from the BNZ or other sound financial institutions.
On each monthly settlement day, Ravlick is to pay on the following priority:
(a) 3.5% per annum of the principal amount of the receivables to Beneficial as a fee out of which Beneficial will be required to meet guarantee fees to SBN (State Bank of New South Wales) and the Bank.
(b) 0.5% per annum (calculated as above) to Equiticorp as a management fee.
(c) The balance remaining, if any, is to be divided equally between Beneficial and Equiticorp.
The above fees are to be paid from the net yield of the receivables which can be defined as the difference between the interest earned (on the principal amount of the receivables managed by Equiticorp including interest arrears funded by Equiticorp) and the cost of funds from BNZ and paid by Ravlick to support the receivables.
Renewal of the management agreement can be effected by giving one month's notice on expiration of the initial six months term. The full term of such agreement cannot exceed 24 months. It is noted that the terms of some of the assigned receivables exceed 24 months.
Guarantee
The document states that Equiticorp Holdings guarantees the punctual payment of all moneys due and payable by the borrowers. The guarantee is enforceable upon a default occurring and continuing for 30 days.
Equiticorp is to meet such demand even if Ravlick has not made demand on the borrower or commenced any other action to remedy the default.
The guarantee is limited to a maximum amount of NZ$10M net of any amounts recovered by them from defaulting clients."
38.2.2 PURPOSE OF THE ACQUISITION
The motive for Beneficial Finance's acquiring these receivables was set out in Mr Baker's letter to the Board of 9 February 1988:
"Beneficial's strategic plan has identified New Zealand as an overseas target, but in recent years any opportunities have been passed because of either a goodwill element or unrealistic price/earnings ratios. The October 1987 sharemarket crash will cause more than a ripple effect in the New Zealand economy and special opportunities now exist for Beneficial to enter the NZ market without paying any goodwill factor. In fact, margins/profits should be excellent."
A second, and unrelated, proposal that Beneficial Finance acquire assets from, and shares in, a company conducting a merchant banking style operation in New Zealand was also set out in the same letter. It is unnecessary to refer further to this matter.
Mr B D Barton, Company Secretary of Beneficial Finance, was not in favour of the proposal, as he set out in a note written to Mr Baker on 10 February 1988. He considered that the acquisition of the portfolio would "stretch" Beneficial Finance's limited management resources. Mr Baker acknowledged his view, but did not reconsider his recommendation to proceed with the acquisition.
"Question: Would you agree that this is, as he (Mr Barton) says in the last paragraph, a memorandum that records his lack of enthusiasm, almost rejection of the proposal?"
Mr Baker: "I know Bruce had concerns about us growing too fast, diversifying into New Zealand, and the points he raised in many cases were quite valid, and needed to be addressed. In the case of (the other proposal), of course, we didn't go ahead with that, because we weren't satisfied with the quality of the receivables. But we did have a direction from the Board to go to New Zealand. It was part of our strategic plan and this was regarded as an ideal opportunity to enter that country." ()
38.2.3 CHRONOLOGY OF EVENTS
I take up the history on Tuesday 9 February 1988 when Mr Baker in his letter to the Board stated:
"While the proposals included in this paper have been developed with considerable haste, we will ensure close supervision by External Legal Counsel and Price Waterhouse."
The reference to Price Waterhouse is made in relation to another unrelated proposal.
Mr Baker concluded:
"Any comments from interstate directors would be appreciated by telephone or fax. A meeting of available Adelaide directors has been scheduled for 3pm on Wednesday February 10 in the Beneficial Board room to enable all comments relating to strategy, loan quality etc to be reviewed prior to our visit to New Zealand on Thursday."
The meeting of the Beneficial Finance Board took place on Wednesday 10 February at 3-00pm. Present were Mr L Barrett (Chairman), Mr K D Williams (Deputy-Chairman), Mr Baker, Mr Clark, Mr K S Matthews and Mr D W Simmons. Two senior executives of Beneficial Finance, Mr Reichert and Mr Martin, together with Mr Barton, were also in attendance.
The minutes record that Mr Baker advised directors of the responses received from the directors who were absent, namely, Mr N Barrell, Mr R D Malcolmson, Mr R P Searcy and Mr J D Studdy. It is noted that "they raised a number of queries but were generally supportive of the strategy outlined in the letter". After Mr Clark declared his interest as a "director of Equiticorp New Zealand" the minutes record that the following views were expressed by the Board:
"The importance of obtaining commercially realistic valuations was stressed. Mr Martin advised that arrangements had been made for a highly regarded commercially street smart valuer to review the securities with the Beneficial Management. The end use on completion position, including tenancy arrangements are to be checked. If there is any doubt on particular transactions, they should be excluded. Construction deals are to be carefully checked.
The Equiticorp guarantee for losses up NZ$10.0M should be increased to NZ$15.0M or NZ$20.0M if possible but should not be taken into account in assessing whether particular transactions should be accepted by the Company. We should err on the side of conservatism. The Managing Director considered that not enough emphasis had been given to assessing the cash flow on these deals and this detail will be carefully checked".
Later the minutes record:
"The Managing Director advised that he had discussed the possible acquisitions with the South Australian Under-Treasurer who will advise the Premier. Official approval will be sought if we proceed with the acquisition."
The minutes, on the acquisition of the Equiticorp receivables, conclude:
"The Board approved the recommendation that Messrs Baker, Reichert, Yelland and Martin proceed on a visit to New Zealand to further the negotiations to enable firm recommendations to be submitted to the Board."
The meeting closed at 4-00 pm.
On 10 February 1988, Mr Baker wrote to Mr P J Hutchinson, Executive Director of Equiticorp, confirming the intention to purchase the receivables, subject to final evaluation and satisfactory legal clearance.
Between 11 and 29 February 1988, the portfolio was reviewed by both the Beneficial Finance representatives visiting New Zealand and its external legal advisers. I examine the extent of this review later in this Chapter under the heading "Compliance with Procedures".
Equiticorp proposed that settlement occur during the week ended 19 February 1988. Settlement occurred later because of difficulties in finalising funding, in completing the pre-acquisition reviews, and in drafting legal agreements.
On 26 February 1988, the Beneficial Finance Board was given a verbal report on "negotiations currently being held in New Zealand." Present at that meeting were all of the members of the Board except Mr Baker who was in New Zealand and Mr Malcolmson who was absent with leave. Mr Macky (an alternate director for Mr Clark), Mr M Chakravarti, General Manager Commercial of Beneficial Finance and Mr J G Graham, General Manager Finance and Operation Services of Beneficial Finance, together with Mr Barton, were also in attendance. The minutes record that it was reported:
"Some difficulties existed regarding to (sic) acquisition of a portfolio of real estate receivables for $NZ100.0M from Equiticorp. There were problems with the Bank of New Zealand funding line and it is more likely that our exposure will be reduced to $NZ70.0M with funding support from State Bank of SA and State Bank of NSW."
On 1 March 1988, settlement of $NZ 69.2M of receivables occurred which I shall describe in this Chapter as the "first tranche". The reduced value (ie from $NZ 100.0M) of receivables assigned to Ravlick was due to Equiticorp's inability to provide more receivables, acceptable to Beneficial Finance, which could be checked within the time limit for settlement.
On 7 March 1988, Equiticorp provided details of a further $NZ 30.3M of receivables which it intended Ravlick to acquire. I refer to these receivables as "the second tranche".
On 12 March, Mr G J Yelland, General Counsel, Beneficial Finance, wrote to Nicholson Gribbin, Beneficial Finance's solicitors in New Zealand advising that:
"... The assignment of a further NZ$30 million worth of receivables from Equiticorp to Ravlick is due on 29 March."
the letter continued:
"Equiticorp have advised that unless the further NZ$30 million is paid by 16/3/88 (Wed) they will find the money elsewhere.
We have not yet accepted all of the securities offered making up this NZ$30 million. Mr Baker wants to settle within the timeframe given by Equiticorp (ie 16/3 or, better still, 14/3). Obviously neither BNZ/SBN (State Bank New South Wales) nor Beneficial Finance will be in a position to settle by then."
In order to meet the Equiticorp deadline, Beneficial Finance advised that Ravlick was prepared to settle by that date on the basis that it had fourteen days to reject any of the receivables as being unsuitable should this prove to be the case.
On 14 March, Mr Yelland instructed Nicholson Gribbin to proceed with settlement on 15 March 1988. The next day settlement on the second tranche occurred upon the condition (ie right to reject) stipulated by Beneficial Finance.
As stated above, the funding of the acquisition was by way of $NZ 100.0M provided by the Bank of New Zealand to Ravlick. The State Bank provided a guarantee for $NZ 20.0M in favour of the Bank of New Zealand. The State Bank of New South Wales provided a guarantee for $NZ 50.0M in favour of the Bank of New Zealand. In order for settlement of the second tranche to proceed, Beneficial Finance provided $NZ 30.0M of additional security to the Bank of New Zealand. Whilst the provision of a guarantee was referred to in Mr Baker's proposal to the Board, the amount of the guarantee was not stated, and therefore the provision of this guarantee was not approved by the Board on 10 February, and the Board was uninformed about the additional exposure to Equiticorp.
On 16 March 1988, Nicholson Gribbin completed their inspection of security documents for the second tranche of receivables. On the same day Beneficial Finance commenced reviewing the receivables in the second tranche. Extensions were obtained to the original fourteen day limit until 5 May 1988.
On 25 March, at its normal monthly meeting, the Beneficial Finance Board was informed that $NZ 100.0M of receivables had been purchased. All directors were present at the meeting. Mr Macky, Mr Graham and Mr Barton were also in attendance.
In addition to being informed of the actual structure of the share holdings in Ravlick to which I have already referred, the Board was informed that:
"... based on a 3% margin [the receivables] should contribute $3.0M per annum to gross profit".
The minutes record that, apart from declaring again his interest as a director of Equiticorp, Mr Clark:
"... also expressed his appreciation to the Beneficial staff involved in arranging the transaction."
It has been submitted to me by Mr Clark that he informed the Board that he had been requested by the Board of Equiticorp to convey to the Beneficial Finance Board the appreciation on the part of the Equiticorp Board that the transaction had been handled in a professional manner by Beneficial Finance staff. Mr Clark states that it was not an expression of appreciation of the transaction itself.
The minutes on this matter conclude:
"This could lead to a growing business relationship between Equiticorp New Zealand and Beneficial Finance."
On 5 May 1988 Beneficial Finance rejected $NZ 5.9M of receivables assigned in the second tranche, and exchanged these for one receivable valued at $NZ 4.4M.
On 28 September 1988, further receivables were offered to Ravlick in accordance with the management agreement, which required Equiticorp to provide further receivables if the balance fell below $NZ 98.0M within six months of the receivables being acquired. The minutes of the meeting of the Beneficial Finance Board on 29 September 1988 record the possibility of acquiring further receivables from Equiticorp. Mr Matthews, a director of Beneficial Finance, was absent from this meeting. It is not recorded what management told the Board. The next day a further $NZ 16.0M of receivables were assigned to Ravlick to maintain the value of the portfolio at about $NZ 100.0M ("the third tranche").
On 22 January 1989 the Equiticorp group of companies was placed in receivership.
38.2.4 FINANCIAL PERFORMANCE
I set out in the following table the number, total value on acquisition, average value, and anticipated average gross yield of the assigned receivables. The four receivables that were acquired on 15 March 1988 and subsequently declined by Ravlick have been omitted from the analysis.
|
No of |
Total |
Average |
Average |
|||||||||||||
|
1st tranche |
- 01/03/88 |
19 |
69.2 |
3,462 |
23.1 |
|||||||||||
|
2nd tranche |
-15/03/88 |
20 |
24.9 |
1,310 |
22.4 |
|||||||||||
|
- 05/05/88 |
1 |
4.4 |
4,352 |
22.3 |
||||||||||||
|
40 |
98.5 |
2,462 |
||||||||||||||
|
3rd tranche |
- 30/09/88 |
20 |
16.0 |
798 |
21.2 |
|||||||||||
|
60 |
114.5 |
1,924 |
||||||||||||||
The above information was provided to my Investigation by Beneficial Finance.
This table indicates that, as at 5 May 1988, when the initial acquisition was effectively completed, the value of the portfolio was approximately $NZ 100.0M and the anticipated yield exceeded the yield of 22 per cent per annum noted in Mr Baker's proposal dated 9 February 1988. With the exception of one loan settled in the second tranche, all of the loans in the first and second tranches were secured by first or second mortgages over real estate. The exception was the loan to a Company which I shall refer to for present purposes as "X Ltd". In my opinion, apart from this loan, the investment criteria set out in the proposal to the Board were achieved for these two tranches. In the case of the loan to X Ltd when this receivable was accepted, Ravlick had evidence that a mortgage security was in place. On 28 April 1988 Mr Mudge, who was responsible for the credit assessment of the second tranche (but not the first tranche) wrote to Mr B Walsh of Equiticorp regarding this receivable stating that this loan:
"... will be reconsidered subject to our solicitors confirming their satisfaction with additional security in the form of a second registered mortgage over the property at ... Christchurch and ranking behind a $6 million first registered mortgage."
On 9 June 1988, Mr D P Paget, a director of Equiticorp Finance Group Ltd, replied:
"... We have now taken further security for the receivable referred to above being a Deed of Guarantee and Indemnity from ... Ltd supported by a second registered mortgage over Certificates of Title ... (Canterbury Registry).
In consideration of you at our request continuing to hold the receivable referred to above rather than requiring us to repurchase the same, we hereby:
1. Transfer, set over and assign to you absolutely the guarantee and indemnity and memorandum of mortgage from ... Ltd and the full benefit thereof;
2. Acknowledgment (sic) and agree that the terms and conditions of the management contract dated the first day of March 1988 as varied by the agreement amending management contract dated fifteenth day of March 1988 and the terms and conditions of the second factoring agreement dated the fifteenth day of March 1988 are incorporated into this assignment and apply to the guarantee and indemnity and the memorandum of mortgage.
We shall forward the original guarantee and indemnity and registered mortgage to you as soon as they are available."
Mr Mudge has informed my Investigation that this letter was sent to Nicholson Gribbin who did not inform Beneficial Finance that they had not received the mortgage.
Ravlick did not receive those documents, and, on 2 December 1988, some six months later, required Equiticorp to repay the facility under the terms of the factoring agreement. Equiticorp requested, and was granted leave to extend the deadline for repayment until 27 January 1989. Equiticorp went into receivership on 22 January 1989 before the amount was repaid. Even accepting Mr Mudge's submission, in my opinion, Beneficial Finance ought, at least, to have made specific inquiries of Nicholson Gribbin about whether the security had been received and instructed the solicitors to follow it up. The responsibility for the supervision of these receivables was transferred progressively to the Southstate staff based in New Zealand commencing in June 1988. The evidence available to my Investigation does not enable me to determine who, within the personnel in New Zealand, was responsible for following up this matter.
In the case of this particular receivable, the security was, therefore, limited to various guarantees from Chase Corporation Limited ("Chase Corporation"), a debenture charge over X Ltd's receivables due from Chase Corporation, a factoring agreement and shares in the Company owning the property. On the collapse of Chase Corporation this latter security proved to be the only security of potential substance. Given my Terms of Appointment, it is not appropriate for me to investigate the question of Mr Paget's knowledge at the time he made the representations in his letter of 9 June 1988.
With respect to the third tranche, the anticipated yield was below the yield of 22 per cent per annum for the receivables in the first and second tranches. Whilst the cost of funds may have reduced, thereby not reducing the margin, there is no evidence that the yields and margins were considered by Beneficial Finance personnel as part of any due diligence assessment of these receivables. Mr Baker has informed me that a change of the rate would not have warranted a further submission to the Board for approval, although it represented a variation from the terms of the original submission. More importantly, seven of the loans in the third tranche were not secured by real estate. In my opinion, on this basis, the tranche did not satisfy the criteria set out in the proposal to the Board of 9 February 1988.
The portfolio as a whole suffered difficulties in that a number of borrowers experienced financial problems. The first borrower to which this comment applies, had a receiver appointed in June 1988. By 29 March 1989, twelve borrowers were either in receivership, liquidation, or some other form of statutory management. The principal cause of these appointments was the collapse of three major New Zealand groups of companies. Six of the borrowers were directly related to these groups.
The number of borrowers experiencing difficulties and the short period of time following settlement in which this occurred, in itself, suggests that the pre-acquisition information about the borrower's financial strength was inadequate. Mr Baker had already noted, on his preliminary inspection of Equiticorp's files, that analysis by Equiticorp of the borrowers' cash flow capacity was "not strong". Mr Mudge has informed my Investigation that he was precluded, in his review of the second tranche of receivables, from speaking to the borrowers by the terms of the arrangements between Beneficial Finance and Equiticorp which prevented disclosure, at that time, of the proposed factoring of the receivables. This restricted the analysis which Beneficial Finance staff could perform and placed greater reliance upon the security evaluation. The borrowers' financial circumstances were also aggravated by the rapidly deteriorating economic conditions.
Beneficial Finance incurred losses in relation to the portfolio, both as a result of writing off amounts due and by way of interest foregone. It is not possible to determine precisely the total losses which will be suffered in relation to these receivables, as this will depend on the amounts eventually realised on the security for certain of the individual receivables which were unsold at 12 February 1991.
I set out in the following table the number of loans which are performing and non-performing and their values, the amounts written off principal, and the amount of interest foregone on the non-performing loans. As will be seen from the table, not all of the non-performing loans have been retained by Ravlick. One account was transferred to another company within the State Bank Group, Southstate Corporate Finance Ltd, and three receivables (and securities over real estate) were transferred to a property trust ultimately controlled by the State Bank.
|
|
|
Amounts |
Interest |
||||||||||
|
Performing Accounts |
43 |
55.5 |
- |
- |
|||||||||
|
Non-Performing Accounts |
|||||||||||||
|
Retained by Ravlick |
13 |
47.1 |
12.4 |
3.5 |
|||||||||
|
Refinanced |
1 |
2.9 |
0.5 |
- |
|||||||||
|
Transferred to property Trust |
3 |
9.0 |
- |
0.8 |
|||||||||
|
Total Non-Performing |
17 |
59.0 |
12.9 |
4.3 |
|||||||||
|
Total Portfolio |
60 |
114.5 |
12.9 |
4.3 |
|||||||||
These figures do not include losses relating to the additional expenses incurred in managing the portfolios.
I set out in the following table a summary of the losses sustained on individual receivables. Subject to one exception, I have not identified the individual borrowers in order to protect the confidentiality of their relationship with Beneficial Finance (new State Bank).
|
Losses on the New Zealand Portfolio |
||||||||||
|
First |
|
Loss |
Interest |
|||||||
| A |
2.9 |
0.5 |
- |
|||||||
| B |
9.0 |
- |
- |
|||||||
| C |
5.7 |
- |
0.8 |
|||||||
| D |
5.1 |
2.3 |
1.4 |
|||||||
| E |
2.5 |
0.4 |
- |
|||||||
| F |
2.2 |
0.8 |
- |
|||||||
| G |
3.4 |
- |
- |
|||||||
| H |
1.9 |
- |
- |
|||||||
| I |
4.9 |
- |
0.4 |
|||||||
|
37.6 |
4.0 |
2.6 |
||||||||
|
Second |
||||||||||
| J |
0.7 |
0.2 |
0.1 |
|||||||
| K |
0.7 |
- |
- |
|||||||
| L |
7.6 |
4.5 |
0.9 |
|||||||
| M |
4.4 |
- |
0.5 |
|||||||
|
13.4 |
4.7 |
1.5 |
||||||||
|
Third |
||||||||||
| N |
3.7 |
3.7 |
- |
|||||||
| O |
1.1 |
0.5 |
0.1 |
|||||||
| P |
3.0 |
- |
- |
|||||||
| Q |
0.3 |
0.2 |
- |
|||||||
|
8.1 |
4.4 |
0.1 |
||||||||
|
Total |
59.1 |
13.1 |
4.2 |
|||||||
* This loan was to Ararimu Farms Investments Limited, a company associated with Mr A Hawkins. The affairs of this company are already in the public domain.
From the above table it can be seen that the quality of the loans deteriorated with each succeeding tranche. In respect of the third tranche more than 25 per cent of the balance outstanding on the receivables when acquired was subsequently written off.
38.2.5 COMPLIANCE WITH PROCEDURES
38.2.5.1 Review of Receivables
As the acquisition of this portfolio involved a small number of high value loans, in my opinion, it was essential to review each receivable. This in fact was the approach adopted by Beneficial Finance.
As I have already mentioned, Mr Baker had stated in the proposal to the Board on 9 February 1988, that Equiticorp had not analysed the borrowers' cash flows in depth, and a down turn in the New Zealand real estate market was anticipated. These two factors should have indicated to Beneficial Finance the potential for higher than normal levels of default by the borrowers. Further, Equiticorp was having difficulty in providing loans of a quality acceptable to Beneficial Finance, which was the reason for the initial acquisition of receivables being valued at only $NZ 69.2M. In my opinion, security values, therefore, would be crucial to the review particularly if the existing evaluations had been performed when the property market had been more buoyant.
After the meeting of the Beneficial Finance Board on 10 February 1988, Mr Baker, Mr Reichert, Mr Martin and Mr Yelland went to New Zealand to conduct the pre-acquisition review process. This review was divided into a number of separate areas of responsibility. Mr Baker acted as overall co-ordinator and team leader. Mr Yelland was responsible for legal aspects of the review and for liaising with Nicholson Gribbin, the New Zealand firm of solicitors which acted as Beneficial Finance's solicitors in the transaction. Mr Reichert was responsible for reviewing the individual loan files maintained by Equiticorp. Mr Martin was responsible for reviewing the properties which represented the security for individual receivables. To assist him, a New Zealand property consultant, Mr N F Oldfield, of Oldfield Hurst and Will Property Consultants Ltd, was engaged.
The documentary evidence presented to my Investigation on the review process consists of copies of correspondence between personnel from Beneficial Finance, Equiticorp, Nicholson Gribbin, and other parties involved in the transaction; schedules of receivables, annotated by members of the Beneficial investigation team with a variety of comments applicable to individual receivables; and individual loan files for each receivable, which principally contained documents in relation to the management of that receivable and do not directly relate to the investigative work done in relation to the particular receivable prior to its acquisition by Ravlick.
Interviews conducted with various personnel suggest other material may or would have been created. Mr Baker has stated that there would have been notes concerning individual receivables.()Mr Reichert has stated that there were one to two page summaries in the second tranche. Mr Mudge has told me that they were given to Mr Reichert. Neither Beneficial finance nor the Bank has yet located these documents, despite searches on behalf of my Investigation. The problem has been compounded by files and documents being sent to the New Zealand office as part of the transfer of responsibility for the management of the portfolio. It has been submitted to me that further inquiries of staff in New Zealand may yield some information about the location of further documents. I am, however doubtful, that this would prove fruitful, given the "working" documents which have already been produced in response to searches.
The lack of certain records relating to the acquisition, in the circumstances of this case, is a matter of deep concern. The minimum records required to be maintained should have recorded the reasons why each receivable was accepted. These should have noted any representations made by the vendor, and would have provided the basis for any claim against the vendor should this have been required. A report summarising the results of all aspects of the inquiries should have been produced. There is no evidence that one was made. Mr Baker cannot recall whether a written report was produced or not.() The lack of such report casts doubt on the quality of decisions made by personnel who were not familiar with the detailed stages and results of inquiries.
I consider that the management of Beneficial Finance ought to have ensured that at least those records to which I have referred in the preceding paragraph were made and retained, together with the notes and summaries concerning individual receivables. Despite the problem of moving offices, I conclude that insufficient care has been taken to retain the latter records, assuming that such records were, indeed made.
It is possible from the available evidence to determine in broad terms what was done in relation to the review of the first and the second tranches.
38.2.5.2 The First Tranche
The only analysis of the first tranche of the portfolio consists of a schedule drafted by Mr Yelland, which shows, for each account: its location; the amount outstanding; the limit of the facility; the expiry date of the facility; the interest rate applied; and whether the facility was a fixed or variable interest rate facility. The schedule also provided space for comments on each loan, and for an indication as to whether loan agreements, certificates of title, and mortgages or debentures, were present when Mr Yelland reviewed Equiticorp's files. This analysis was, in fact, a "check-list" prepared in relation to each receivable, and was not an overall analysis of the profitability and security of the portfolio. Because the records maintained were incomplete it is not possible to conclude whether any overall analysis that was performed was conducted in a satisfactory manner.
Mr Baker's statement, in the proposal to the Board dated 9 February 1988, that analysis of cash flow capacity in the files inspected was "not strong", indicates that the files did not contain sufficient information on which Beneficial Finance management could safely base judgements on the capacity of borrowers to meet their obligations. A prudent prospective purchaser should, in these circumstances, have required more information to be produced by the vendors or, if this was not practicable, take some other compensating precaution. I have already reported the practical difficulty of obtaining such information when the vendor required that the factoring arrangement was not to be disclosed to the borrower prior to the purchase of the receivables.
The evidence available to my Investigation contains no comparison of the pricing policy of the vendors with that of Beneficial Finance. It is arguable, however, that in this situation such a comparison would not be useful. Beneficial Finance did not lend in the New Zealand market, and its pricing policies for the Australian market would not necessarily have been relevant for the New Zealand market. I do not consider, therefore, that any failure to perform comparison of pricing policy was a serious matter. Of greater relevance would have been the overall margin which it was anticipated would be received from the portfolio, the ability of borrowers to meet their obligations, and the security backing of the receivables making up the portfolio.
The provision of Beneficial Finance staff to manage the portfolio was not of immediate concern at the time of acquisition because Equiticorp was to manage the portfolio for the first six months. Mr Barton, of Beneficial Finance, had expressed his concern about the Company "stretching" its management resources in his memorandum to Mr Baker to which I have already referred. Mr Baker has stated that he was aware of these concerns, but considered that Beneficial Finance either had, or could obtain, sufficient management resources to manage the portfolio in New Zealand. The number of loans and their nature support his view.
Mr Baker has informed me that all the loans had to be "acceptable as regards credit/security etc". The available documentary evidence does not, however, record the basis for acceptance of each receivable. The available evidence includes reports from Beneficial Finance's property consultant which refer to individual loans. The Beneficial Finance Board had told management at the meeting on 10 February 1988 to "obtain commercially realistic valuations". The reports from the property consultant did not comprise valuations of the individual properties, but consisted of general comments concerning the properties and, in some cases, comments on valuations previously prepared for Equiticorp. In my opinion, these reports do not constitute "commercially realistic valuations". Mr Mudge has informed me that the advice of the Board was not communicated to him. It has been submitted to me that, as Mr Martin told the Board that a "highly reputable and commercially street wise valuer would review the securities with Beneficial Finance management", the Board was "on notice" formal valuations would not be obtained.() From the evidence of the minutes, I am unable to conclude that the Board had in contemplation the type of review which was performed. If management is unclear about the Board's intention, the matter should have been clarified and unambiguously expressed on the record.
The available evidence demonstrates that the reviews uncovered some serious problems concerning individual receivables. These problems were sufficient for Beneficial Finance to reject eleven of the original thirty three accounts representing over $NZ 31.5M in value of receivables from the original portfolio presented to it in early February 1988, and a further four accounts representing $NZ 5.9M from the second tranche settled on 15 March 1988.
The review of the legal implications of the transaction was covered by Nicholson Gribbin who were appointed to advise Beneficial Finance. The solicitors were responsible for obtaining Overseas Investment Commission approval for the establishment of Ravlick in New Zealand as a foreign owned company, reviewing the security documentation for each receivable, providing advice on stamp duty in relation to the transaction, and providing advice on the contract for acquiring the receivables. No problems have emerged since the acquisition in relation to these matters. This aspect of the pre-acquisition review was conducted satisfactorily.
A significant step in the pre-acquisition review process that Beneficial Finance personnel did not perform was a review of Equiticorp's ability to meet its guarantees. In my opinion the pressure being exerted by Equiticorp for early settlement, due to its need for funds following the purchase of New Zealand Steel, should have caused Beneficial Finance to be particularly cautious in its evaluation of this aspect of the transaction. This opinion is reinforced by concern which Mr Baker had about the position of Equiticorp. He has stated to my Investigation:
"I think with the benefit of going to New Zealand I perhaps felt that they weren't travelling as well as they had been telling us, but I had nothing at all indicated to me that they wouldn't be good to back up any contingent liabilities they had. They were dealing with the New Zealand Government and once again Tim Clark was still sort of happy and everything was gung ho about the transaction." ()
Nevertheless, the shareholders funds in Equiticorp Holdings Limited, as at 30 September 1987, namely $NZ 647.0M, were set out in the proposal of 9 February. Although this figure should not have been relied upon by Beneficial Finance as a measure of Equiticorp's worth in early 1988, which could well have been reduced after the October 1987 share market crash, the Beneficial Finance files contain a copy of Equiticorp Holdings Limited's consolidated balance sheet, as at 31 January 1988, which showed shareholders' funds of $NZ 565.9M. This had been sent by facsimile to Mr Baker on 7 March 1988. Mr Baker has stated to my Investigation that he did not review Equiticorp's financial position, relying in lieu on the favourable impression of Equiticorp's performance which he gained from Mr Clark. Mr Clark has submitted that any favourable impression of Equiticorp's performance received by Mr Baker from him pre-dated the October 1987 share market collapse and in that event, Mr Baker could no longer rely upon the impression. There is, however, no evidence that Mr Clark at any time subsequent to October 1987 indicated that any favourable impressions regarding Equiticorp previously indicated by him were no longer appropriate. I consider, however, that, given the size of the guarantee of $NZ 10.0M in relation to the balance sheet of Equiticorp Holdings Ltd, it was unlikely that an investigation of Equiticorp's financial position would have led Beneficial Finance, and, in particular, Mr Baker, to conclude that the company would be unable to meet its obligations under the guarantees.
A more significant matter, to which I have already referred, was the absence of a mechanism within the State Bank Group to limit exposure to one company or group of companies. This matter was examined by me in detail in Chapter 5 - "The Management of the Bank Group's Diversifiable Credit Risk" of my first Report.
38.2.5.3 The Second Tranche
The work conducted on these receivables consisted of individual reviews of each receivable offered to Beneficial Finance. The reviews were conducted in Adelaide and New Zealand by Mr Mudge, and the results were provided to Mr Reichert.
Mr Mudge obtained a further report from the same property consultant which had looked at the property securing the first tranche. He also inspected a number of the properties but, for reasons previously given, I do not consider that the consultant's comments comprise valuations which the Board had required Mr Baker, Mr Reichert and Mr Martin to obtain.
Thorough investigation of security documentation and consideration of the merits of acquiring further receivables from Equiticorp were in the circumstances particularly important. This was because Equiticorp had experienced difficulty in providing receivables that satisfied Beneficial
Finance's requirements. On 22 February 1988, Mr Hutchinson, a director of Equiticorp, had written to Mr Martin, by facsimile and stated:
"... Have found some more transactions ... but starting to scrape the barrell now for "trouble-free deals"."
In his letter to Beneficial Finance of 7 March 1988, Mr Hutchinson stated:
"... The majority of receivables have been evaluated by you and your colleagues and to make up the required $30M you will note the size of the proposed receivables has reduced substantially. We are finding it difficult to provide you first class receivables of $1.0M+ secured by real estate."
Beneficial Finance was, therefore, on notice that these receivables in the second tranche, and any further receivables offered by Equiticorp, were likely to be both smaller loans and not necessarily of first class quality. The latter letter indicates that, should the receivables have proved unsuitable, it would be difficult for Equiticorp to find suitable replacements.
Nonetheless, settlement occurred at Equiticorp's insistence on 15 March 1988, nearly a fortnight earlier than originally planned. Beneficial Finance had not had time to complete the pre-acquisition reviews. A warning from Nicholson Gribbin was addressed to Beneficial Finance in the following terms:
"With regard to the receivables purchased, we reiterate our advice that if you wish to settle today we will not have had time to obtain appropriate Land Transfer Office and companies office searches to verify that the securities represented to us by Equiticorp in fact exist. Furthermore, we advise that we have not conducted any investigation of the financial terms and conditions of the receivables to be purchased since we do not regard this as our responsibility. Unless we hear from you to the contrary we shall assume that you are happy to proceed to settlement on the basis that we have not had sufficient time to verify that the securities represented by Equiticorp in fact exist and on the basis that we have conducted no investigation of the financial terms and conditions of the receivables to be purchased."
Nicholson Gribbin also warned of three named loans, one which had been previously rejected, a second which had been in arrears with interest capitalised, and a third which was backed by security which also supported a loan in the first tranche. I have not identified the particular borrowers to protect their interests. These three receivables were all acquired by Ravlick in the second tranche. The documentary evidence presented to my Investigation does not specifically indicate why each of these receivables was accepted by Beneficial Finance. Ravlick suffered no loss on these accounts, which were all repaid in full by 30 November 1988. There may, therefore, have been reasons why Nicholson Gribbin's concerns were unwarranted which were revealed on subsequent investigation, or Beneficial Finance may just have been fortunate in that no losses occurred.
In my opinion, this process of settlement before completion of the pre-acquisition review procedures was plainly imprudent and hence inappropriate, having regard to the sums of money involved. In particular, there are indications from Mr Hutchinson's correspondence that this haste to complete the transaction in accordance with the vendors' wishes left Ravlick, and therefore Beneficial Finance, exposed to risks that it was purchasing receivables of insufficient quality, and that this fact was known to Beneficial Finance. The adequacy of the underlying security was also questionable, and the position may well have been that Beneficial Finance was actually providing substantial funds that were unsecured. It is my opinion that, in authorising the settlement of this transaction prior to the completion of proper due diligence procedures, Mr Baker failed to exercise proper care and diligence.
38.2.5.4 The Third Tranche
The Investigation has been informed that the receivables in this tranche were reviewed by staff in Beneficial Finance's office in New Zealand, which had been established by September 1988. Mr Reichert has stated that each of the loans was reviewed individually, and approved pursuant to the credit authority delegated to a credit committee of Beneficial Finance management.() To the extent that this may imply that each receivable was the subject of a formal credit application, I very much doubt whether this occurred. No such applications have been located by Beneficial staff in the course of my Investigation. Given a lack of documentary evidence, I am unable to form any view about the review of this tranche. My doubts (referred to above) therefore remain.
38.2.5.5 The Approval Process
In the proposal dated 9 February 1988, Mr Baker had sought approval from the Beneficial Finance Board to acquire the portfolio. On 10 February 1988, the Board accepted a recommendation that management proceed to New Zealand to further conduct negotiations to enable firm recommendations to be made to the Board. There is no evidence that approval to acquire the portfolio was given at the meeting of the Board on 26 February. Mr Baker has submitted that the minutes dated 26 February indicate that management (Mr Chakravarti was Acting Managing Director in Mr Baker's absence) informed the Board that at least $NZ 70.0M was to settle. He states that the Board probably would have been informed that settlement was imminent, but I have no evidence that this occurred. He argues that, on the basis the Board members knew, and did not dissent when informed that "negotiations (were) currently being held in New Zealand", he was not acting contrary to the wishes of the Board. But I do not agree that the minutes which I have previously cited go as far as Mr Baker submits. Mr Baker has acknowledged to my Investigation that no approval was given by the Board before Beneficial Finance proceeded to acquire the portfolio.() At its next meeting on 25 March, the Board was informed that the acquisition of $NZ 100.0M of receivables had taken place.
Management and, in particular, Mr Baker failed to comply with the Board's direction to bring a firm recommendation to the Board after further investigation. Mr Baker has explained his reasons for this conduct to my Investigation:
"Question: So you still don't accept that your actions were contrary to what your Board requested you to do.
Mr Baker: The general request and impression and direction I got from the Board was consistent with what we did. Now, the fact of the matter is they asked for another recommendation. Obviously events have overtaken that piece of (sic) written document. I mean, it just didn't work that way. We wouldn't do anything contrary to the Board knowingly or anything like that. We would - we had the Board's support and everything else to get into New Zealand and to buy some good business. I mean, that was what we were for."
I infer from this statement that Mr Baker proceeded with the acquisition because he believed that the Board supported the proposal in its general outline, as set out in his letter of 9 February, and because it accorded generally with the strategy of Beneficial Finance to enter the New Zealand market. In my opinion, this general support did not justify his proceeding with the acquisition without a firm recommendation being presented to the Board and approved. By entering into, and settling, this transaction, Mr Baker must either have misunderstood the Board, or disregarded the direction from the Board. It is unlikely that a person in his position would have misunderstood the Board. It is my opinion that, in committing Beneficial Finance to purchase the receivables on 10 February, Mr Baker acted in disregard of the direction of the Board and thereby breached his duty to the company and that he acted improperly. Mr Baker has submitted that "during the period 10 February to March"() he had discussions with Mr Clark and possibly Mr Barrett about progress with the matter.() Mr Baker also suggests that because the Bank was involved in the funding of the acquisition, credit proposals may have been initiated, and other Beneficial Finance directors with the Bank, including Mr Ottaway, Mr Macky and Mr Matthews may have been aware that the matter was proceeding to settlement. Nevertheless, whether some others knew, or not, did not alter his duty to the Beneficial Finance Board to submit a firm recommendation and have it approved.
When Mr Baker was asked by my Investigation whether the Board ever identified the apparent failure of management to bring a firm recommendation back to the Board for its consideration and decision, he responded:
"Mr Baker: No, no. They didn't work like that. I mean, they were a Board that understood that you had to get on and do things and we always tried to comply with whatever the Board's wishes were. To say that we've, you know, done something deliberately against it is just not right. It never happened that way." ()
Mr Matthews has, however, informed my Investigation that when the acquisition was reported to the Board at its meeting on 25 March 1988, he recalls that "appropriate questions were asked of management and the assurances given by management were such that the Board was comfortable with the transaction proceeding".() I acknowledge that an absence of any record in the minutes cannot lead necessarily to an inference that the matter was not discussed. But accepting what was put to me by the former Non-Executive Directors of Beneficial Finance(), two issues remain. First, the Board accepted management's decision and secondly, it did not report the discussion in the minutes. It is open to me to infer from what Mr Matthews has said that the Board retrospectively approved the transaction. On the matter of approval to acquire receivables generally, it was submitted to me by management that it had authority to make such an acquisition under delegated credit approval powers. The former Non-Executive Directors of Beneficial Finance supported this interpretation of the delegations.() For reasons which I discuss in the next Section on the Australian receivables, I reject it. In my opinion, the Board had the responsibility to decide whether or not to invest $NZ 100.0M as proposed. Further, on this occasion, management had expressly requested Board approval to acquire the receivables in the proposal dated 9 February. And the Board's response on 10 February indicates the Board intended to make the decision on the acquisition. Accordingly, in my opinion, Mr Baker's conduct was in excess of his powers, and the Board ought to have censured him. Further, the Board ought not, in my opinion, to have been so easily reassured. The former Non-Executive Directors have submitted that they did not know that "commercially realistic valuations" (assuming the Board intended proper valuations) had not been obtained, nor() did they know of the warning in Nicholson Gribbin's letter, nor() of Mr Barton's concerns about management resources.() I accept the Board's submission. In my opinion however, the Board ought to have required a detailed recommendation as it had originally directed, before deciding that it was "comfortable" with the transaction proceeding. I would expect that a public company that had been lent substantial sums of money by the public and other creditors would have ensured that approval was properly given and documented for a commitment of such magnitude, if for no other reason than to ensure accountability to the auditors of the company's commitments.
The minutes of meeting of the Board on 29 September 1988 make only brief reference to the third tranche. The minutes record:
"Top up of the NZ$82 million receivables acquired from Equiticorp to the NZ$100 million level was also being considered."
It was put to me by the former Non-Executive Directors of Beneficial Finance that no approval by the Board was required for the acquisition of the third tranche as the expenditure fell within the terms of the original contract of purchase.() But the Board was not informed that seven of the loans were not secured by real estate.
I accept the submission, but I have been unable to determine who, within management, was responsible for deciding to accept these receivables. It may well be that this transaction occurred "by default". In any event, the absence of documentary evidence of authority to settle indicates a serious deficiency in the administrative procedures.
38.2.5.6 Other Matters
Mr Matthews, has informed my Investigation he considered the Board believed that it was the responsibility of management of Beneficial Finance to acquire receivables generally within the parameters set out in the proposal of 9 February 1988, and "the general parameters of the business that the company did".()
As I have previously stated, a number of receivables, particularly in the third tranche, were not secured by real estate. Losses have been incurred on a number of these receivables, for example, the loan to X Ltd and the loan to the companies associated with Mr A Hawkins for $3.7M in the third tranche. The latter loan further varied from the parameters in the proposal in that its yield was 19 per cent per annum and was one of two loans purchased having a yield lower than 20 per cent per annum. These receivables were not within the criteria set out in the proposal to the Board.
I have already mentioned that the Board requested management to obtain a higher guarantee from Equiticorp, if possible. Following the Board meeting on 10 February 1988, Mr Baker wrote to Mr Hutchinson:
"... Subject to final evaluations and satisfactory legal clearance etc, we confirm that we intend purchasing NZ$100 million of receivables from Equiticorp Finance Group Limited with settlement possibly next week.
(f) We will require:
(1) Guarantee from Equiticorp Holdings Ltd for NZ$10 million.
(2) Cash flow cover from Equiticorp Finance Group Limited in event of late payment but Equiticorp may elect to substitute alternative performing receivables with similar yield subject to Beneficial's acceptance of the credit."
Mr Baker cannot recall why he apparently did not attempt to increase the guarantee. Nor can he recall why he wrote to the vendor confirming the $NZ 10.0M guarantee on the same day as the Board meeting at which he was instructed to seek, if possible, an increase in the level of the guarantee. He has suggested that Equiticorp may have been concerned about its level of contingent liabilities which would be increased by such guarantee, or that he had been able to negotiate an improvement in the terms of the guarantee but not its quantum.()
The failure to increase the guarantee level and the variation in the terms of the guarantee were not minuted as reported to the Board at the Board meeting on 25 March 1988.
The same minutes record that the anticipated margin and profit from the receivables was to be 3 per cent or $NZ 3.0M per annum. This was a reduction from the level set out in the proposal to the Board namely 4 per cent. Whether a discussion about this occurred and formed part of the "assurances" of management is not recorded.
The minutes of 10 February 1988 referred to management obtaining official approval from Treasury for the acquisition, should it proceed. It was not a legal requirement that this approval be given. Nonetheless, it was a clear representation by Mr Baker that it would be sought. Beneficial Finance has been unable to locate documents giving such approval. It is not minuted that the Board inquired whether approval had been sought when it was informed, on 25 March, that the receivables had been acquired. Whilst no adverse inference can be drawn from the absence of reference in the minutes, silence on such important matters reflects adversely on reporting procedures.
38.3 AUSTRALIAN RECEIVABLES
38.3.1 HISTORY AND STRUCTURE
In January and February 1988, Equiticorp Finance Ltd, Equiticorp Leasing Pty Ltd and Equiticorp Commercial Ltd, which were all subsidiaries of Equiticorp Holdings Ltd, sold four portfolios of receivables to Beneficial Finance. In this Section, I shall use the term "Equiticorp" to refer to each of these companies. The first acquisition was of receivables in South Australia, the second was of receivables in Western Australia, and the third comprised portfolios of receivables located in New South Wales and Victoria. To the extent that Equiticorp's offer referred to Tasmania too, I shall include it in my reference to the Victorian portfolio.
A description of the portfolios was provided to the Beneficial Finance Board on 25 March 1988 in Special Submission 229 as follows:
|
SA |
WA |
NSW and Victoria |
|
|
Settlement date |
15.01.88 |
03.02.88 |
26.02.88 |
|
Net balance |
$47.0M |
$63.8M |
$55.0M |
|
Premium paid |
$0.5M |
$0.5M |
$0.25M |
|
Number of recievables |
3,334 |
5,121 |
5,579 |
|
Average size of recievables |
$15,000 |
$12,500 |
$10,000 |
The acquisition of the receivables was undertaken using two subsidiaries of Beneficial Finance's off-balance sheet company, Kabani Pty Ltd, namely, Dynour Pty Ltd and Gaimop Pty Ltd.
The structure of the South Australian acquisition was different from the other two acquisitions. It was structured in two stages. The reason for this method and a description of the first stage were set out in a letter from Mr Baker, Managing Director of Beneficial Finance, to the Board dated 29 December 1987:
"... Because of uncertainty in Stamp Duty liability arising from a draft Bill before the South Australian Parliament, an outright purchase is not possible, and the transaction will be structured as follows:
1. Beneficial will fund an off-balance sheet company which will make a loan (secured by the receivables) to Equiticorp Financial Services Ltd. Refinancing via State Bank or Ayers Finniss will be considered early in 1988.
2. Beneficial will assume responsibility for all account maintenance functions, including computer masterfile maintenance, collective follow-up etc.
3. Beneficial will manage the cash flow on Equiticorp's behalf and apply funds against principal reductions and interest payments on the funding line, and retain the balance as a management fee."
The first stage was effected, on 15 January 1988, by Dynour Pty Ltd, which lent to Equiticorp about $47.0M, being the balance owing on the receivables. Beneficial Finance provided the funds to Dynour Pty Ltd by way of loan. Security was by way of charge (in favour of Beneficial Finance) over the receivables. Beneficial managed the receivables, and applied the moneys received from the borrowers against interest and principal due by Equiticorp on the loan from Dynour Pty Ltd, retaining the balance as fees. Beneficial Finance was totally responsible for losses on the receivables, except those arising from unenforceable documentation.
The second stage of the acquisition involved Dynour Pty Ltd entering into a Call Option Agreement in consideration of paying a sum of $0.5M to Equiticorp. This sum was the price for the portfolio. By the terms of this agreement, Dynour Pty Ltd could purchase the portfolio at any time. Dynour Pty Ltd was also required by Equiticorp to enter into a Put Option Deed. For consideration of $10-00, if certain events happened, particularly, if Dynour Pty Ltd was liable to pay stamp duty of less than a specified amount on the transaction, Equiticorp could require Dynour Pty Ltd to purchase the portfolio. The second stage was implemented on 29 June 1988, when the terms of the Call Option Agreement were varied to enable Dynour Pty Ltd to exercise the option in favour of a nominee. The option was exercised, on that day, in favour of Gaimop Pty Ltd.
The other three portfolios were acquired outright, in part by Gaimop Pty Ltd, and in part by Beneficial Finance.
The reason for both companies being involved was explained in Special Submission No 229 of 25 March 1988, to the Beneficial Finance Board as follows:
"... 2. Structures
WA, NSW, Vic
Wherever possible, receivables have been purchased by a subsidiary of Kabani Pty Ltd to facilitate a "re-financing" process similar to the Luxcar securitization plan. This will allow receivables to remain off-balance sheet and income to be booked as fees. Approximately $50M of the $118M in these States will be off-balance sheet, and it is possible that the remainder may be treated similarly, pending final legal advice.
SA
Because of a draft Bill currently before the South Australian Parliament, stamp duty liability is not clear. Pending resolution of this - which may take another couple of months, we have acquired the gross cash flow in return for a loan for the principal balance outstanding. The full amount can be taken off-balance sheet, and the consumer ledger may be taken by SBSA."
The implications of the use of off-balance sheet entities are referred to in detail in Chapter 41 - "Management and Financial Information Reporting" of this Report. For present purposes, it is sufficient to observe that Beneficial Finance decided to use an off-balance sheet entity in order to facilitate a "refinancing" process or on-sale of the receivables by way of securitisation.
The terms and conditions of sale of the Western Australian portfolio included a guarantee by Equiticorp of part of the portfolio, namely, twenty seven receivables. If these receivables were not recoverable by Beneficial Finance, Equiticorp agreed to repurchase them. The risk of loss on repayment of the remainder of the receivables rested with Beneficial Finance.
The guarantee by Equiticorp was considerably wider for the New South Wales and Victorian portfolios. The reason was stated by Mr Chakravarti, General Manager of Beneficial Finance, in his letter to Mr Clark dated 25 February 1988:
"To avoid the onerous and expensive process of evaluating a multitude of consumer loans, we have proposed, and Equiticorp has accepted, that Equiticorp will indemnify us on all accounts in arrears greater than 90 days at date of settlement. In addition, Beneficial's losses on the remaining portfolio will be restricted to 1%, with any incremental losses shared between the two parties on a 50-50 basis."
The Guarantee and Indemnity Agreement, dated 26 February 1988, varied the above only to the extent that Beneficial was to absorb the first $0.45M of losses on the receivables rather than 1 per cent of the value of the portfolio. By using vendors' guarantees in such manner, Beneficial Finance was relying upon the vendors' representations and financial strength rather than itself assessing the quality of the assets prior to purchase.
38.3.2 PURPOSE OF THE ACQUISITIONS
The Board was first informed of the intention to purchase the South Australian portfolio on or around 30 December 1987 by the letter from Mr Baker to which I have already referred. The letter concluded:
"... In summary we are acquiring a well spread portfolio that is attractively priced and can be effectively managed by our South Australian operation."
From the terms of the letter the motives for purchasing the portfolio were:
(a) to acquire non-real estate assets at attractive margins; and
(b) to gain access to a new customer base with the hope of deriving new business in the future.
The minutes of meeting of the Beneficial Finance Board on 29 January 1988, in relation to the acquisition of the Western Australian portfolio, recorded:
"Beneficial has hired some staff from Associated Midland (Equiticorp) ... to manage the accounts and to build on the new business opportunities."
The reasons for this acquisition are the same as for the South Australian portfolio.
The purpose of the acquisition of the New South Wales and Victorian portfolios was more restricted. In the letter to Mr Clark dated 25 February 1988 already referred to, Mr Chakravarti stated:
"Beneficial will be managing the portfolio (sic), but with a view to running it down at respective maturities."
These portfolios included a large number of consumer credit transactions and were of smaller average value than were the receivables in the other portfolios. This business was less complementary to Beneficial's existing operations. I am satisfied on the available evidence that this third acquisition was not intended to contribute significantly to new business.
38.3.3 CHRONOLOGY OF EVENTS
I have referred, briefly, to deficiencies in the pre-acquisition review process prior to the second and third acquisitions and the matter of approval of the transactions. In order to understand my comments and conclusions, I have set out the history of all of the acquisitions, commencing with the South Australian portfolio.
In October 1987, Mr Clark, who was a director of Beneficial Finance and of Equiticorp Holdings Ltd, advised Mr Baker of the possibility of acquiring receivable portfolios from Equiticorp.
Between October and December 1987, Mr P H Poulton, Divisional Product Manager, Commercial Services division, Beneficial Finance, received information supplied by Equiticorp in relation to the South Australian portfolio and conducted a review of the portfolio. This review consisted of financial analyses of the portfolio aimed at calculating the financial implications of the acquisition for Beneficial Finance and establishing a purchase price.
On 21 December 1987, Mr Baker wrote to Mr A Cox, Managing Director of Equiticorp Australia Ltd, offering to acquire the South Australian portfolio subject to certain conditions including:
"...
(b) Satisfactory audit by Beneficial of all deals with net balance in excess of $100,000 and a random sample of all other deals. In relation to the former, Beneficial may refuse to accept credit risk on unsatisfactory credits.
(c) Satisfactory review of all delinquent accounts."
On 23 December 1987, the terms of Mr Baker's letter were verbally accepted by Mr Cox on behalf of Equiticorp.
On 29 December 1987, Mr Baker wrote to the Beneficial Finance Board advising of the intention to purchase the portfolio. I have already referred to the description of the structure of the purchase in the letter. Mr Baker stated that the expected gross yield on the receivables would be 17.96 per cent per annum and that 1.28 per cent of accounts were more than thirty days in arrears. He described the composition of the receivables as:
|
"Commercial purchase |
$16 million |
|
Leasing |
$12 |
|
Real Estate |
$ 6 |
|
Other Secured |
$ 6 |
|
Consumer Lending |
$ 7 |
|
$47 million (3,300 accounts)" |
Management had not set criteria in terms of which types of loan or borrower would or would not be acceptable.
On 2 and 3 January 1988, a team of Beneficial Finance staff conducted a detailed review of the South Australian portfolio. On 4 January 1988, a formal Heads of Agreement between Equiticorp and Beneficial Finance was signed by Mr Baker for Beneficial Finance.
On 5 January 1988, the Beneficial Finance Board purportedly met and resolved to lend Gaimop Pty Ltd and Dynour Pty Ltd a total of $113.0M. These moneys were sufficient to finance the acquisition of both the South Australian portfolio and the Western Australian portfolio. The minutes of meeting of the Board record that Mr Barrett (Chairman), Mr Baker and Mr Barton, Company Secretary, Beneficial Finance, were present. The minutes were signed by the Chairman. Mr Baker, when examined upon oath for the purpose of this Investigation stated:
"It would have been a paper meeting."
He agreed that the meeting of the Board would never actually have been held.()
Mr Baker stated that the minutes of so-called paper meetings would have been put in the directors' folders to be approved at the next full meeting of the Beneficial Finance Board. Mr Baker said:
"It was a practice that had been fairly long established, I think, in Beneficial, but it would normally be the sort of transaction, either a lending or a borrowing going on, to satisfy the request of an outside party." ()
He continued:
"... Mind you, I think both those companies (Gaimop Pty Ltd and Dynour Pty Ltd) were within the Beneficial group. Whether that excuses it - I don't know that that is quite as bad as showing it to an outside bank, but there would have been occasions I am sure where that would have happened."
It was put to me by the former Non-Executive Directors of Beneficial Finance that Mr Barrett met with Mr Baker on 5 January 1988.()
No evidence has been made available to the Investigation of any other member's response to the proposed acquisition, nor has Mr Barrett indicated a response by other members.
On 15 January 1988, settlement on the acquisition arrangement of the South Australian portfolio occurred. Whilst Beneficial Finance did not obtain legal ownership of the receivables for which it paid full price (until the option was exercised), it nevertheless accepted the credit risk on the portfolio from that date.
On 20 January 1988, Mr Cox of Equiticorp advised Mr Baker of the price requested by Equiticorp for the Western Australian portfolio. On 28 January 1988, Mr Baker informed Mr Poulton, Mr F R Horwood, and Mr Yelland, all being employees of Beneficial Finance, in a memorandum that, at Equiticorp's request, settlement of the second portfolio would occur "early in the day" on 3 February 1988.
On 29 January 1988, the Beneficial Finance Board was advised at the monthly Board meeting, of the acquisition of the South Australian portfolio and that a second portfolio in Western Australia would be acquired in early February 1988. The minutes do not record any comment or direction by the Board to management that approval of the acquisitions by the Board was required.
On the same day, Mr Poulton wrote a memorandum to Mr Chakravarti and Mr Baker setting out the results of his analysis of the Western Australian portfolio, including expected gross yields and level of losses, expressed as a percentage of the value of the receivables. This memorandum noted that the portfolio was less attractive than the South Australian and that this justified Beneficial Finance negotiating a lower premium than had been paid for $47.0M of receivables in the South Australian portfolio. Purchase of the portfolio was settled on 3 February, and a detailed review of the portfolio was commenced by Beneficial Finance personnel.
On 18 February 1988, Beneficial Finance was offered the New South Wales and Victorian portfolios by Equiticorp in a facsimile from Mr Cox. A note dated, 18 February 1988, stated that Equiticorp wanted settlement prepared by Friday, 26 February. Purchase of the New South Wales and Victoria portfolios was settled on 26 February without any detailed review by Beneficial Finance. The Board was informed of this acquisition and settlement at its normal monthly meeting held on that date. A summary of the three acquisitions was presented to the Board on 25 March 1988 in Special Submission 229. The last stage of the transactions was completed with the exercise of the option to purchase the South Australian portfolio, to which I have already referred, on 29 June 1988. The vendor companies were placed into receivership on 22 January 1989.
38.3.4 FINANCIAL PERFORMANCE
As I have already mentioned, Mr Poulton provided Mr Baker with an analysis of the expected gross yields and level of losses, expressed as a percentage of the value of the receivables and the margins for each portfolio. This analysis was performed prior to the acquisition of each portfolio to assess its profitability. The anticipated margins were higher for each successive acquisition, namely 3.71 per cent, 4.75 per cent and 6.5 per cent respectively. The South Australian portfolio had the smallest number of consumer loans whilst the New South Wales and Victorian portfolios had the highest number of consumer loans. Consumer loans are normally written at a higher margin than commercial loans.
After acquisition, the Beneficial Finance Board received quarterly reports on the performance of the portfolios. These were discontinued after the report relating to the period ended on 31 January 1989, which was presented at the Board meeting on 24 February 1989. The three reports produced disclosed the following yields and losses as a percentage of average net receivable balances:
|
Gross Yield of Portfolios |
||||||||||||||||||
|
Portfolio |
Actual |
Actual |
Actual |
Beneficial Finance |
||||||||||||||
|
South Australia |
18.72 |
* |
19.50 |
17.96 |
||||||||||||||
|
Western Australia |
18.33 |
* |
18.94 |
18.00 |
||||||||||||||
|
New South Wales |
19.25 |
* |
20.93 |
19.40 |
||||||||||||||
|
Victoria |
20.49 |
* |
20.28 |
19.40 |
||||||||||||||
|
Total |
18.99 |
* |
19.67 |
|||||||||||||||
|
Losses as a Percentage of Average Net Receivables |
||||||||||||||||||
|
Portfolio |
Actual |
Actual |
Actual |
Beneficial Finance |
||||||||||||||
|
South Australia |
- |
0.36 |
0.47 |
0.50 |
||||||||||||||
|
Western Australia |
- |
0.26 |
1.03 |
0.50 |
||||||||||||||
|
New South Wales |
- |
2.20 |
1.67 |
1.42 |
||||||||||||||
|
Victoria |
- |
0.49 |
0.62 |
2.00 |
||||||||||||||
|
Total |
- |
0.69 |
0.94 |
1.08 |
||||||||||||||
On the basis of this evidence, I consider that the actual performance of the portfolios, generally, was consistent with Beneficial Finance's expectations, although the Victorian portfolio performed better than expected.
38.3.5 COMPLIANCE WITH PROCEDURES
38.3.5.1 Approval of the Acquisitions
The acquisitions were made without first being considered and approved by the Beneficial Finance Board. In his letter to the Board of 29 December 1987, Mr Baker stated:
"As all individual receivables are within delegated credit limits, we do not believe that Board approval is specifically required."
The former Non-Executive Directors of Beneficial Finance support Mr Baker in his interpretation of management's powers to approve the transactions.() On the evidence available to me, in my opinion, this interpretation of delegated authority was misdirected. The Board had defined, from time to time, the limit of authority of managers and committees of management of Beneficial Finance and of the Board, constituted by less than the full number of directors, to approve credit transactions. These limits were increased in January 1988 by the Board, as set out in Special Submission No 225. The authority of a credit committee of management of Beneficial Finance was then increased to $5.5M for single transactions, and $7.5M for cumulative exposure to individual borrowers. All proposals above $20.0M for either a single transaction or involving cumulative exposure were then required to be approved by a meeting of the Board comprising all available directors. Each of the three acquisitions exceeded the latter designated limit by more than two-fold.
Taken to its logical conclusion, the interpretation adopted by Mr Baker would have authorised him to purchase portfolios of loans of unlimited aggregated amount provided that individual loans were within delegated limits - a situation, which in my opinion, is inconsistent with the responsible delegation of authority by any Board.
Mr Baker's interpretation ignored fundamental differences in the level and intensity of credit reviews for individual loans of between $10,000 and $15,000 and for the acquisition of "portfolios" which were valued at between $47.0M and $63.8M. Individual credit transactions were approved under an established process of checks and counter checks. By contrast, when a portfolio of receivables was acquired, a sample only of the individual receivables generally was reviewed and even those selected for review were not subjected to a structured approval process equivalent to that applying to new loans. Furthermore, proposed new loans were fully reviewed before being approved by Beneficial Finance, whereas Beneficial Finance was committed to the acquisition of the receivables in the case of the second and third transactions before review was completed or undertaken.
Mr Baker, in his letter to the Board, continued:
"However, in view of the total transaction size and the nature of the funding, we would appreciate any comments next week."
Mr Baker has stated, to the Investigation, that he would have expected approval by the Board to be required for each acquisition.() He did not, however, directly request Board approval before the first acquisition, nor did management submit a proposal, and request approval, before the second and third acquisitions.
38.3.5.2 Review of the Portfolios
The three acquisitions occurred over successively shorter periods of time. The South Australian transaction spanned approximately three months. The Western Australian transaction was concluded in fourteen days although Beneficial Finance was aware of the possibility of being offered the portfolio before 20 January 1988. The acquisition of the New South Wales and Victorian portfolios spanned eight days between formal offer and settlement, although some discussion and review in relation to the portfolios had taken place during approximately the preceding ten days. Mr Baker has stated, to my Investigation, that he regarded the decreasing amounts of available time as an opportunity to negotiate a better price for the portfolios.()
The minutes of meetings of the Board, on 29 January and 26 February 1988, do not record that any question was raised by the Board about whether there had been adequate time for review of the portfolios, and whether reviews had taken place, prior to settlement.
There were no standard procedures promulgated by Beneficial Finance for conducting reviews of portfolios of receivables. Mr Poulton has informed my Investigation that, in his experience within the finance industry, there had been only a very limited number of major acquisitions of portfolios of receivables, and, because each acquisition was different, a company could not establish standard procedures to be followed.() Each transaction was, therefore, addressed on a one-off basis.
The reviews of the South Australian and Western Australian portfolios were each conducted by a team of Beneficial Finance staff with experience in the type of receivables being reviewed and included a Beneficial Finance lawyer. The only significant difference between Beneficial Finance's review of these two portfolios is that the review of the latter was conducted after settlement. Whilst this could have exposed Beneficial Finance to the risk of loss if the portfolio had proved to contain unsuitable credit risks, Mr Poulton has informed me that Beneficial Finance had access to information prior to settlement which satisfied him of the adequacy of the portfolio. In particular, Beneficial Finance had been able to review Equiticorp's computer records in relation to loan accounts and the portfolio's trends, and two members of Beneficial Finance staff who previously had been employed by Equiticorp in Western Australia, one as the manager, had provided information about the portfolio.()
These two reviews comprised the following steps.
The Beneficial Finance team reviewed Equiticorp's lending criteria for each type of receivable and checked recent transactions to ensure that they complied with Equiticorp's criteria. No specific comparison with Beneficial Finance's lending criteria was made.
Equiticorp's pricing policy in respect of the individual loans was not considered on a loan by loan basis. The detailed review of loan files should, however, have revealed any major discrepancy on loan pricing between Equiticorp and Beneficial Finance.
Beneficial Finance's State Managers in South Australia and Western Australia were involved in the reviews of the portfolios in those States to assess the adequacy of resources, in terms of staff numbers and technical abilities, to manage the receivables to be purchased.
The Beneficial Finance team reviewed all of the receivables valued at over $0.1M, all receivables in arrears over the previous twelve months or currently, all receivables with a payment stream other than monthly, certain types of receivables (eg agricultural) and, in respect of the Western Australian portfolio receivables conducted through a particular broker, and all loans to borrowers engaged in the mining industry, as well as a random sample of other receivables. In the case of both South Australia and Western Australia, approximately 15 per cent (ie 500 and 769 respectively) and 50 per cent of the value (ie $23.0M and $32.0M respectively) of the receivables were specifically reviewed. These reviews covered the adequacy of checking of credit references by Equiticorp, the extent of financial analysis conducted on the borrowers and the assessment of their capacity to pay, the value of securities including any guarantees, and the analysis of potential methods of recovering advances if the borrower experienced difficulty in repaying the loan. In respect of the larger loans (ie over $0.1M) one team member was deputed to check their delinquency history, the quality of collection activity by Equiticorp and the collection records, and the monitoring of confirmation of insurance cover on the securities supporting these loans.
Beneficial Finance consulted external legal advisers about stamp duty on the acquisitions, assignability of receivables, and associated security and credit legislation. This advice was used as the basis of the drafting of the agreements. Beneficial Finance also requested its solicitors to conduct searches to confirm that there were no prior charges created by Equiticorp over the receivables being acquired. Beneficial Finance made a similar request of its solicitors prior to acquiring the New South Wales and Victorian portfolios. Beneficial Finance's solicitors advised that they were not able to do this in the time permitted them by Beneficial Finance prior to the settlement of any of the acquisitions.
Apart from the time constraints, in the case of the South Australian portfolio, there was a further complication, namely, that the appropriate vendor companies from amongst the Equiticorp group were not identified to Beneficial Finance (a wrong company having been named by Equiticorp) until just prior to settlement. The failure to perform this step, namely, checking for prior charges, exposed Beneficial Finance to risk of loss if the vendors' warranties about prior charges of the receivables were later found to be incorrect.
In respect of the New South Wales portfolio, only a brief review of a minor proportion, 1 per cent (ie approximately 50) and 21 per cent of the value (ie approximately $11.55M) was conducted by Beneficial Finance. Mr Poulton has stated in my Investigation that the review of the Victorian portfolio was similar to the New South Wales portfolio. Despite thorough searches of files produced by Beneficial Finance to my Investigation, no documentary evidence of even a superficial review of the Victorian portfolio has been uncovered. As I have already mentioned(), the basis of the offer by Beneficial Finance to purchase these two portfolios was that no credit review would be undertaken as it was too "onerous and expensive to evaluate a multitude of consumer loans". Although the absence of documentary evidence of even a brief review of the Victorian portfolio does not necessarily mean that no such review was conducted, that inference is open to be drawn. If that were the case, this lack of review exposed Beneficial Finance to the risk of loss if the portfolio did not match the representations of the vendors. This was emphasised to Beneficial Finance in a letter from Thomson Simmons & Co, Beneficial Finance's solicitors, dated 4 March 1988, which stated:
"... We have recommended in these transactions that the portfolio should be inspected prior to settlement so as to increase the probability of detection of problems with the portfolio prior to completion of the transaction. Completion of the transaction without such an inspection increases the level of risk for your company."
With respect to the New South Wales and Victorian portfolios, Beneficial Finance relied upon Equiticorp's guarantee of all losses on accounts on which payments were more than ninety days in arrears and to share equally losses over and above a total of $0.45M to protect it from the risk of excessive loss if the portfolio turned out to be of poor quality. Equiticorp guaranteed some twenty seven accounts in the Western Australian portfolio.
Mr Baker has stated in my Investigation that no specific investigation was conducted into the ability of Equiticorp to meet its guarantees. He has stated that he was aware of the financial position of Equiticorp in Australia from his attendance at meetings of the Australian Finance Conference and from his reviews of their published accounts. This knowledge led him to believe that Equiticorp was of sufficient standing to meet its commitments. He has also stated that the position of Mr Clark gave him comfort as to the financial strength of Equiticorp.()
The Lending Credit Committee of the State Bank had, however, recorded at its meeting on 19 January 1988, that:
"... short term liquidity of the Equiticorp Group is currently being affected by the withdrawal of funding lines to New Zealand Steel owing to the change in ownership."
Mr Baker has stated that he was aware of the withdrawal of funding lines to New Zealand Steel and that he probably read the minutes of that Committee meeting. Whilst it would have been prudent to make some specific enquiries on this matter, on the evidence available to the Investigation, acceptance of Equiticorp's ability to meet its obligations was not an unreasonable assumption. The more important issue is that no mechanism existed within the State Bank Group to identify "concentration risks" associated with a group of companies dealing with the State Bank Group.
38.4 FINDINGS AND CONCLUSIONS
38.4.1 NEW ZEALAND RECEIVABLES
Approval to acquire the portfolio of New Zealand receivables was sought in the proposal to the Board of 9 February 1988. The Board required further negotiation and a firm recommendation to be put to it for decision. Notwithstanding the Board's direction, on 10 February 1988, Mr Baker agreed to the purchase, subject to final evaluation, and legal clearance. I am satisfied the transaction was settled by management in two stages ie on 1 March and 15 March 1988, and that settlement was undertaken without a firm recommendation having been provided to the Board, and its formal approval obtained.
There is nothing in the minutes about Mr Baker's conduct in relation to the Board's direction on 10 February. I am satisfied that the Board did not censure him nor express concern about his conduct. I do not accept that management had delegated authority to acquire the receivables. In my opinion, it was the Board's responsibility to authorise the transactions and record the decision. The Board should have censured Mr Baker and established a monitoring procedure to ensure that its powers were not, in future, usurped. In not doing so, the Board, in my opinion, failed to properly supervise, direct, and control, the activities of management.
Beneficial Finance conducted a review of the New Zealand receivables prior to the acquisition. Despite this, Beneficial Finance incurred substantial losses within a relatively short period after the acquisition. The inferences are open that either the due diligence process was not conducted as thoroughly as was necessary or it was decided to accept the risks rather than reject the receivables. The nature and timing of the emergence of the losses, with the appointment of receivers and statutory managers within a relatively short period after the acquisitions, indicates that these borrowers may not have been financially viable when the receivables were purchased. A proper analysis of the borrowers' financial position was restricted because Beneficial Finance officers were unable to contact borrowers before the purchase of the receivables. The fact that, after losses arose, some securities did not realise sufficient funds to repay the outstanding balances and interest, indicates either, that for the type of loan and borrower, security cover was not adequately addressed, or that the values declined after the acquisition of the portfolio. The timing of the losses supports the former inference being drawn but the deterioration in the economic conditions and property market was a significant factor.
Due to the absence of records, I have been unable to determine what analysis of the borrowers' cash flow capacity was performed, what recommendations were made in the light of the results, and what reasons were expressed in support of those recommendations. For the same reason, I have been unable to form a firm opinion who, within the management of Beneficial Finance, decided what advice would be obtained about security values, and what reasons were advanced in support of recommendations to purchase individual receivables.
With respect to the third tranche acquired in New Zealand, I have been unable to form an opinion who, within the management of Beneficial Finance, authorised the settlement of receivables which were not all secured by real estate. This is most unsatisfactory as it was a condition of acquisition that all receivables be secured by real estate. Further, the largest single loss in this tranche was on a loan not secured by real estate to a company associated with Equiticorp.
Mr Baker authorised settlement of the second tranche without the review process first being completed even though Equiticorp had warned of its difficulty in providing receivables which were satisfactory to Beneficial Finance, and Mr Baker had himself formed the view that the financial analysis by Equiticorp of the borrowers' cash flow capacities was weak. A right to reject loans and substitute others is of little protection if the vendor is unlikely to be able to satisfy the purchaser's criteria.
Based on all of the evidence available to me, and for the reasons as stated in this Chapter, I am of the opinion that:
(a) Mr Baker acted in breach of his duty as a director of Beneficial Finance in disregarding the direction of the Board by proceeding to acquire the receivables without presenting a firm recommendation to the Board for approval.
(b) Mr Baker failed to exercise proper care and diligence in authorising settlement of the second tranche of receivables prior to the completion of review of those receivables.
In the context of the review of this transaction, I was hindered in my Investigation by my being unable to examine all of the documents which I would have expected to have been brought into existence, or which persons who were interviewed in the course of my Investigation have mentioned.
In my opinion, proper records relating to the acquisition of the receivables were not maintained and safeguarded by management of Beneficial Finance. Based on the evidence available to me, I am unable to form a firm opinion that this failure constitutes a breach of applicable companies or taxation legislation. That is a matter for investigation by the appropriate authorities.
It has been reported to my Investigation that creditors of those companies in the Equiticorp Group which were involved in this acquisition may be repaid their debts in full. As matters stand at the present time, Beneficial Finance has suffered material losses on this transaction.
38.4.2 AUSTRALIAN RECEIVABLES
The members of the Beneficial Finance Board were invited by Mr Baker, in his letter of 29 December 1987, to advise him of their comments about the proposed acquisition of the South Australian portfolio of receivables. Mr Baker has informed the Investigation that no comments were received, but Mr Barrett has put to me that he and Mr Baker met on 5 January 1988. There is no evidence of any other members of the Board responding to Mr Baker's proposal, nor has Mr Barrett indicated that there was any response.
The former directors have submitted that management had authority under delegated credit approval limits to acquire the portfolio and their approval was not required. The same submission is made in relation to the second and third acquisitions of receivables. As I have already stated, I reject this interpretation of delegated powers as being inconsistent with the responsible delegation of authority by any Board.
Further, having regard to the fact that Beneficial Finance was being committed to expenditure of $47.0M, $63.8M and $55.0M respectively in the three transactions, in my opinion, the Board members ought to have exercised their own independent judgement about the merits of the investments. The absence of evidence of response from the Board, apart from the alleged meeting on 5 January, leaves it open to question whether they turned their minds to these matters and the extent of consideration undertaken by them.
In my opinion, the Board should have realised that it was required to authorise these transactions and management exceeded their authority. The Board failed to recognise that this had occurred, and, accordingly, did not recognise the need to adopt appropriate reporting and monitoring procedures to ensure that management did not, in the future, exceed their authority. In my opinion, in this matter the Board failed to properly supervise, direct, and control, the management of Beneficial Finance in these transactions.
I have discussed the matter of "Paper Meetings" in Chapter 40 of this Report.
38.5 REPORT IN ACCORDANCE WITH TERMS OF APPOINTMENT
38.5.1 TERM OF APPOINTMENT A
In the course of this Investigation, I have investigated and inquired into matters relating to the processes which led to Beneficial Finance engaging in the acquisition of five portfolios of receivables, ie loans, from various Equiticorp companies, as directed in Terms of Appointment A(a), A(b) and A(c). Having regard to the evidence and for the reasons indicated in this Chapter, I report that, in my opinion, the processes which led to Beneficial Finance engaging in the acquisition of those receivables were inappropriate.
I have also, as directed by Terms of Appointment A(h), investigated and inquired into any possible failure to exercise proper care and diligence on the part of a director or officer of Beneficial Finance and report that, in my opinion, the Managing Director (Mr Baker) did not exercise proper care and diligence, with reference to his authorisation of the settlement of the second tranche of New Zealand receivables.
38.5.2 TERM OF APPOINTMENT C
As directed by Term of Appointment C, I have also investigated and inquired into matters relating to the supervision, direction and control of the operations, affairs and transactions of Beneficial Finance. Having regard to the evidence and for the reasons indicated in this Chapter, I report that, in my opinion, the operations, affairs and transactions of Beneficial Finance, with reference to the acquisition of the portfolios of receivables from the various Equiticorp companies, were not adequately or properly supervised, directed or controlled by Mr Baker (Managing Director) and the Beneficial Finance Board.
38.5.3 TERM OF APPOINTMENT E
As directed by Term of Appointment E, having regard to the evidence and for the reasons indicated in this Chapter, I report that I am of the opinion that the failure of Beneficial Finance management to maintain and safeguard proper records relating to the acquisition of the portfolio of New Zealand receivables may have constituted a breach of applicable companies or taxation legislation. I am of the opinion that this matter should be further investigated.
I further report, that, in my opinion, Mr Baker acted improperly and was in breach of his duty as a director in disregarding the direction of the Board by proceeding to acquire receivables without presenting a firm recommendation to the Board for its approval as he had been directed.