CHAPTER 39
MORTGAGE ACCEPTANCE NOMINEES LIMITED
TABLE OF CONTENTS
39.1 INTRODUCTION
39.1.1 REFERENCE INFORMATION
39.1.2 OVERVIEW
39.1.2.1 Introduction
39.1.2.2 The Nature of Beneficial Finance's Operating Joint Ventures
39.1.2.3 The Mortgage Acceptance Nominees Joint Venture
39.2 THE ESTABLISHMENT OF THE JOINT VENTURE
39.2.1 INTRODUCTION
39.2.2 INITIATION OF THE JOINT VENTURE
39.2.3 APPROVAL OF THE JOINT VENTURE BY THE BOARD OF DIRECTORS
39.2.4 SUMMARY AND CONCLUSIONS
39.3 THE STRUCTURE, MANAGEMENT AND OPERATIONS OF THE JOINT VENTURE
39.3.1 THE MANAGEMENT STRUCTURE
39.3.2 FUNDING OF THE JOINT VENTURE
39.3.3 THE PERFORMANCE OF THE JOINT VENTURE
39.3.4 THE LOSSES IN RESPECT OF MORTGAGE ACCEPTANCE NOMINEES
39.3.5 A HINDSIGHT REVIEW BY BENEFICIAL FINANCE
39.3.6 SUMMARY AND CONCLUSIONS
39.4 FINDINGS AND CONCLUSIONS
39.5 REPORT IN ACCORDANCE WITH TERMS OF APPOINTMENT
39.5.1 TERM OF APPOINTMENT A
39.5.1.1 Term of Appointment A(b)
39.5.1.2 Term of Appointment A(c)
39.5.1.3 Term of Appointment A(d)
39.5.1.4 Term of Appointment A(e)
39.5.1.5 Term of Appointment A(h)
39.5.2 TERM OF APPOINTMENT C
39.1 INTRODUCTION
39.1.1 REFERENCE INFORMATION
| REFERENCE INFORMATION | ||
| Account Name | Mortgage Acceptance Nominees | |
| Industry Sector | Real Estate and Bloodstock finance | |
| Facility Type | Loans and finance leases | |
| Principal Outstanding
at 28 February 1991 |
$109.0M | |
| Provision for loss at 28 February 1991 | $10.2M | |
39.1.2 OVERVIEW
39.1.2.1 Introduction
Mortgage Acceptance Nominees was an operating joint venture between Beneficial Finance and Mortgage Acceptance Corporation Ltd. The joint venture provided finance to the real estate and bloodstock industries.
The joint venture was essentially a partnership between Beneficial Finance and Mortgage Acceptance Corporation. Beneficial Finance held its interest in Mortgage Acceptance Nominees through its off-balance sheet entity, Kabani Pty Ltd.
This Chapter deals principally with the establishment of the joint venture, and with the key deficiencies in the structure, management and control of Beneficial Finance's participation in the joint venture. My Report in respect of Mortgage Acceptance Nominees has been restricted for reasons of confidentiality, and because of a possible legal dispute. The restructuring of an operating joint venture is described in greater detail in Chapter 33 - "Case Study in Credit Management: Pegasus Leasing".
39.1.2.2 The Nature of Beneficial Finance's Operating Joint Ventures
Beneficial Finance entered into operating joint ventures as a method of expanding its core financing business into specialised, niche markets in which it lacked both expertise, and an established reputation and clientele. The strategy was that Beneficial Finance would provide its strong financial backing, either in the form of direct funding or by guaranteeing loans to the joint venture by other financiers, to a partnership with a small specialist financier with expertise in a niche financial market. With Beneficial Finance's financial strength, the partner would use its skills and expertise to grow a profitable business from which both would benefit. As stated in a paper prepared by the Investment Banking division in October 1989, the "basic premise" of the joint ventures was "Beneficial Finance has the financial strength and the joint venture parties have the expertise." The Report stated that Beneficial Finance often had total responsibility for funding the joint ventures:
"... the strong growth of some of the joint ventures was not anticipated, and given that none of the joint venture partners have the financial capacity to support the growth they were achieving through continual capital injections to maintain gearing at acceptable levels, there has been an expectation that Beneficial will provide the additional funding required. Whilst Beneficial can choose to limit the funds lent, as there is no legal requirement to provide all funding, it is our objective to not restrict profitable growth of the joint venture. However, notwithstanding this objective, considerable difficulty is being experienced in attracting non-recourse external borrowings with existing joint venture gearing levels." [Emphasis added]
That summary accurately describes the funding and growth of the Mortgage Acceptance Nominees joint venture.
39.1.2.3 The Mortgage Acceptance Nominees Joint Venture
Mortgage Acceptance Corporation was a mortgage broker. Its business consisted of identifying businesses in need of finance, and then identifying a financial institution that would be prepared to provide that finance. It earned its income from bringing together businesses needing funds, with lenders prepared to provide those funds. In some cases, Mortgage Acceptance Corporation would provide temporary loans, called bridging finance, to the businesses until a lender could be found. It specialised particularly in arranging finance for businesses in the real estate and bloodstock industries. Mortgage Acceptance Corporation was controlled by an entrepreneur who, for confidentiality reasons, I will call Mr Green.
Beneficial Finance was one of the financial institutions invited by Mortgage Acceptance Corporation to provide loans to its clients, and Beneficial Finance was appreciative of the opportunities. Before the proposal to establish a joint venture in June 1988, Mortgage Acceptance Corporation introduced business totalling $15.0M to Beneficial Finance's Parramatta branch, and made loans as the agent of Beneficial Finance under a Principal and Agency Agreement. The Managing Director of Beneficial Finance, Mr J A Baker, described Mortgage Acceptance Corporation as a "very strong new business referee" at the Beneficial Finance Board of Directors' meeting on 27 May 1988. Indeed, so impressed were the Management of Beneficial Finance that, in May 1988, it agreed to establish a joint venture with Mortgage Acceptance Corporation.
The joint venture was established, and commenced operations, before a submission to establish the joint venture was presented to the Beneficial Finance Board of Directors. When a submission seeking approval for the joint venture was submitted to the Board at its meeting on 24 June 1988, it was rejected. Nevertheless, the basic elements of the joint venture, particularly the management of loan accounts by Mortgage Acceptance Corporation, were left in place, without the knowledge of the Board of Directors.
A further submission to establish the joint venture was presented to the Board at its meeting on 25 November 1988, and approved. The fact that the joint venture had been established, and commenced operations before the Board meeting on 24 June, was not adequately disclosed to the Board in either June or November.
Such conduct by management, in settling transactions prior to the Board meeting at which the proposal was to be considered, demonstrates an attitude that the Board would "rubber stamp" management's recommendations. In the event, management's expectation was wrong. The approval eventually given in November 1988 was given retrospective effect by management to include the business conducted from June 1988.
The joint venture grew rapidly, and by 30 June 1989 had total assets of $88.9M. By 30 June 1990 total assets were $97.3M, including $27.0M funded by the State Bank under the Reverse Principal and Agency Agreement.
Beneficial Finance provided the great majority of the funding for the joint venture, with the exception of the business written by the joint venture as a sub-agent of Beneficial Finance under the State Bank of South Australia Reverse Principal and Agency Agreement, and a $4.5M loan from the State Bank relating to a particular receivable.
I have examined the Reverse Principal and Agency Agreement in detail in Chapter 33 - "Case Study in Credit Management: Pegasus Leasing". Shortly stated, in legal form the Agreement appointed Beneficial Finance as the agent of the Bank for the purpose of writing tax-effective finance leases, which are a form of lending. The Agreement authorised Beneficial Finance to appoint sub-agents. Although the legal form of the Agreement was that of a principal and agency arrangement, in substance, however, the Agreement was a funding arrangement, and was used as such by Beneficial Finance to fund some of the activities of its joint ventures, including Mortgage Acceptance Nominees.
By 30 June 1990, Beneficial Finance's loans to the joint venture totalled $74.8M. When combined with the funding provided by the Bank pursuant to the Reverse Principal and Agency Agreement, the total Bank Group exposure was at that time $101.8M. There had effectively been no capital contributed to the joint venture by either partner.
Despite the rapid growth of the joint venture and Beneficial Finance's exposure to it, no joint venture agreement was executed by the partners. Beneficial Finance did not impose any prudential limit on its exposure to the joint venture, and did not exercise effective control over its operations. Although Beneficial Finance had authority to approve all large loans made by Mortgage Acceptance Nominees, the effective day-to-day control of the joint venture's activities was in the hands of its joint venture partner.
The Mortgage Acceptance Nominees Joint Venture experienced significant problems with respect to a major real estate loan to a borrower that, for confidentiality reasons, I shall refer to as "Hotel Pty Ltd", and more recently with its bloodstock loan portfolio. In July 1990, Beneficial Finance decided to wind down its joint venture operations. Real estate lending by the Mortgage Acceptance Nominees joint venture ceased in June 1990, and bloodstock financing ceased in October 1990. The joint venture has not been profitable, and, in May 1991, a State Bank internal audit found that 63.4 per cent of its portfolio was in arrears. As at 28 February 1991, the exposure of Beneficial Finance, including its off-balance sheet companies, and of the State Bank, to Mortgage Acceptance Nominees and related parties, was $109.0M, and a specific provision of $10.2M was raised.
I have been informed by Beneficial Finance that a dispute had arisen in respect of the termination of the joint venture. Accordingly, as required by my Terms of Appointment, I have excluded from my Report any matters that may have a direct bearing upon any possible litigation.
39.2 THE ESTABLISHMENT OF THE JOINT VENTURE
39.2.1 INTRODUCTION
Mortgage Acceptance Corporation, incorporated in 1984, carried on business as a finance broker, specialising in arranging real estate finance in Sydney. The company was controlled by Mr Green. The business involved introducing businesses that needed finance to lenders who might provide it, receiving brokerage fees for that service. Mortgage Acceptance Corporation would sometimes provide bridging finance to the businesses until a lender was identified and provided the needed finance.
In the course of its business, Mortgage Acceptance Corporation had introduced business totalling about $15.0M to Beneficial Finance's Parramatta branch, principally in the form of real estate and construction loans. In April 1986, Mortgage Acceptance Corporation entered into a Principal and Agency Agreement with Beneficial Finance, pursuant to which it made loans as agent for Beneficial Finance.
Mortgage Acceptance Corporation had also borrowed from Beneficial Finance, although the Beneficial Finance Board was apparently cautious about the extent of Beneficial Finance's exposure. For example, in September 1985 when the exposure to the Mortgage Acceptance Corporation Group stood at $6.34M, the Board requested a list of the personal assets of its shareholders, and a reconciliation of the net worth of the Group and of the guarantors of the loans. On 29 October 1985, the Board reviewed the net asset position of the shareholders of the Group, and resolved that "no incremental transactions are to be approved at this stage."
Mr E P Reichert, the Chief General Manager of Beneficial Finance's Structured Finance and Projects division, said in evidence to my Investigation that although Mortgage Acceptance Corporation did default in respect of its loans from Beneficial Finance, the loans were eventually repaid.()
39.2.2 INITIATION OF THE JOINT VENTURE
In his evidence to my Investigation, Mr T Waller, a manager in Beneficial Finance's Corporate Services division, said that the Managing Director, Mr Baker, and Mr Reichert, who was Chief General Manager of the Corporate Services division, held discussions over a number of months with Mr Green regarding a possible joint venture.()
On 27 May 1988, Mr Baker told the Beneficial Finance Board of Directors that Management was considering the possibility of establishing a joint venture with Mortgage Acceptance Corporation. Mr Baker described Mortgage Acceptance Corporation and Mr Green as being "very strong new business referees to Beneficial Finance".
Without waiting for Board approval, Mr Baker and Mr Reichert immediately took steps to establish the joint venture. On 30 May 1988, Beneficial Finance acquired a 50 per cent interest in a newly incorporated company, Mortgage Acceptance Nominees, and Mr Baker and Mr Reichert became directors of the company. The minutes of the Mortgage Acceptance Nominees Board of Directors' meetings record that a Board meeting of the newly appointed directors was held in Sydney on the same day, 30 May 1988. The minutes of meeting record that two directors nominated by Mortgage Acceptance Corporation, including Mr Green, and Mr Reichert and Mr Waller of Beneficial Finance were present, and that:
"It was resolved that Mortgage Acceptance Nominees would act solely in the capacity of Nominee or Manager of a joint venture between Mortgage Acceptance Corporation and Beneficial Finance. The terms and conditions of such joint venture are to be mutually agreeable between both joint venturers, and are to be formalised into writing as soon as conveniently possible."
In his evidence to my Investigation, Mr Waller said that he could not remember attending any such meeting in Sydney. Mr Waller did not deny that an agreement in the terms stated in the minutes existed, but thought that the minutes might have documented the resolution of a meeting that was not in fact held.()
The minutes of the meeting of Beneficial Finance's Joint Venture Committee held on 16 June 1988 record that a submission to form a joint venture with Mortgage Acceptance Corporation was to be presented to the Board of Directors.
On 24 June 1988, a special submission dated 15 June 1988, prepared by Mr Waller, was presented to the Board of Directors of Beneficial Finance, seeking approval for Beneficial Finance to enter into the joint venture with Mortgage Acceptance Corporation. The submission stated that the joint venture would essentially be a partnership, with Mortgage Acceptance Nominees Ltd acting as nominee for the partners, who would contribute equally to the capital of the joint venture, and would share profits and losses equally.
The special submission recommended that the joint venture be established to conduct "a successful mortgage banking operation", concentrating in the areas of mortgage finance and thoroughbred partnerships, because it provided:
"(a) an opportunity to further diversify into the mortgage banking market that attracts high quality clientele;
(b) an additional profit opportunity, especially in the area of equity positions; and
(c) the development of a relationship with a party well known to Beneficial management."
It was proposed that:
(a) the company would not act as a broking house, but rather would act as a lender in its own right;
(b) each partner would contribute $0.25M of capital to the joint venture;
(c) initially, accounting records would be maintained by Mortgage Acceptance Corporation; and
(d) although Beneficial Finance would raise funds for the joint venture, the long term objective was to fully capitalise the venture so that it could raise funds in its own right.
The submission projected, however, that by December 1988, the joint venture would have total assets of $85.0M, funded by Beneficial Finance, and have capital of only $0.5M. That represents a gearing ratio of 99.4 per cent, or a debt to equity ratio of 170:1. No information was provided regarding the financial position of Mortgage Acceptance Corporation or Mr Green, and it was not proposed to take guarantees from Mr Green in respect of Beneficial Finance's loans to the joint venture. The submission stated that the joint venture was to be established for a six month trial basis:
"At this particular point in time, Mr Green is extremely cautious about entering into a joint venture with Beneficial Finance. As such, it has been agreed that we will enter into a joint venture on a six month basis."
The submission disclosed that the nominee company had already been acquired, and stated that the estimated profit of the joint venture for the seven months from June 1988 to December 1988 (inclusive) was $0.3M. The submission projected that, by 30 June 1988, just six days after the submission was presented to the Board, the joint venture would have loan receivables of $35.0M, and stated that "volume generated to Beneficial Finance in May was approximately $8.0M."
If that information can be regarded as hinting that the joint venture had already commenced operations, that possibility was apparently not raised at the meeting, because the Board of Directors refused to approve the submission. The minutes of the meeting record that:
"After detailed consideration, it was resolved that we should not proceed with the proposal. Concern was expressed that the proposal was being submitted on the basis of a six months trial, which indicated some uncertainties by both parties. It was considered that we should seek to overcome current problems of servicing in Sydney, and continue to deal with Mortgage Acceptance Corporation on a selective stand-alone basis. When the relationship has developed and improved, the matter can then be resubmitted for consideration." [Emphasis added]
In attendance at the meeting were Mr Reichert, who was described in the minutes as "representing Mr Baker" who was overseas, and Mr J Graham, who was General Manager, Finance and Operations. Mr Reichert said in evidence to my Investigation that the Board's decision not to proceed was:
"... partly prompted by a request from Mr Green to have six month honeymoon, and the Board was not happy with that arrangement to the extent that there was no long term commitment. Mr Green's request, I guess, was prompted on the basis that he had a few relationships in the past with some other bankers, that was concerned not to put all his business into the joint venture until such time as, he was assured that the comfort was there on both parties' side to deal with one another ... Another factor involved in the lead up to that is that the Board would have been aware that there had been a problem with a loan. He ultimately paid, but it had been overdue for a substantial period." ()
In fact, business had already been transacted by Beneficial Finance and Mortgage Acceptance Corporation before 24 June 1988, in anticipation of the approval of the joint venture by the Beneficial Finance Board of Directors. The rejection of the submission by the Board put the joint venture into limbo.
In his evidence to my Investigation, Mr Baker said that business was transacted with Mortgage Acceptance Corporation in June 1988. Although he was unsure of the arrangements pursuant to which that business was done, he said that it eventually became joint venture business. He said:
"I do not know whether actually the joint venture did the business or whether it was done on Principal and Agency or what, but I do know that business was booked in June 1988 and settled, and I think subsequently somehow got brought into the joint venture. It was not done with my authority, and indeed it seems that I was away, but I think that Erich Reichert was involved in approving settlements of some sort." ()
Shortly after the Board of Directors rejected the joint venture proposal, a credit submission was circulated to all directors seeking approval for a loan of $27.6M to be made by Mortgage Acceptance Nominees to Hotel Pty Ltd, to purchase a hotel complex in Sydney. The submission was approved by a quorum of four directors on 29 June 1988. Pursuant to Beneficial Finance's policies and procedures, large loans by its joint ventures had to be approved in accordance with Beneficial Finance's loan approval authority system. The credit submission plainly stated that that Mortgage Acceptance Nominees was a joint venture between Beneficial Finance and Mortgage Acceptance Corporation.
In his submission to my Investigation, Mr Reichert said that:
"The fact that the "joint venture" operated between May and November was known to be the case. My understanding is that Beneficial Finance was to obtain 100 per cent of net income, less brokerage, until Board approval was obtained. I am sure that correspondence exists to support this position, and that documentation would be the authorisation for management to process transactions."
The minutes of the Beneficial Finance Board of Directors' meeting held on 29 July 1988 record that Mr Baker advised the Board that the arrangements were as described by Mr Reichert in his submission to my Investigation. The minutes state:
"Mortgage Acceptance Corporation Ltd: The Managing Director advised that a 100 per cent interest had been taken rather than the proposed joint venture company with Mortgage Acceptance Corporation. A brokerage arrangement had been entered into with regard to business introduced to the company by Mortgage Acceptance Corporation."
The reference by Mr Baker to a "100 per cent interest" apparently meant that Beneficial Finance owned all of the business that was to be conducted by Mortgage Acceptance Nominees. The Board Papers for the meeting record that the high level of new loans made by the New South Wales branch during the month was the result of business introduced by Mortgage Acceptance Corporation. Mortgage Acceptance Nominees was not included in the Joint Venture Quarterly Report presented to the Board at that meeting, or indeed in any of those Reports until April 1989.
Although Beneficial Finance took 100 per cent of the risks and benefits of the business that had been intended to be joint venture business, it continued to hold only half of the shares of Mortgage Acceptance Nominees. A search of the register of members of that company revealed that of the six issued shares in 1988, three were held by Mortgage Acceptance Corporation, and three by Beneficial Finance. The registered ownership of the shares held by Mortgage Acceptance Corporation was not transferred to Beneficial Finance, pending resubmission of the joint venture proposal to the Board in accordance with its decision on 24 June 1988. In effect, following the rejection of the proposal by the Board, the name of Mortgage Acceptance Nominees was used to identify the business being booked by Beneficial Finance, but the company itself was dormant.
Beneficial Finance's Monthly Management Reports in respect of Mortgage Acceptance Nominees, provided to the Executive Committee of Beneficial Finance in September and October 1988, did not describe Mortgage Acceptance Nominees as being a joint venture. The September 1988 Management Report stated that:
"The Year-To-Date loss of $0.12M has been established since trading began in June. Pleasing factors include the level of income generated from the Construction and Development portfolio of $0.12M at a yield rate of 14.78%. This rate is in addition to a prospective profit share of $1.5M (minimum) on the Hotel Pty Ltd transaction (as early as December 1989), and a payment of establishment and commitment fees. The Commercial Finance portfolio has also contributed $0.2M at a yield rate of 22.48%. The SBSA Reverse P&A portfolio result is subject to investigation, however, a loss provision of $16,000 has been deducted from the margin. Other provisions totalling $90,000 have detracted from the initial result of 1988."
The October 1988 Management Report did state, however, that:
"The Construction and Development portfolio continues to strongly support the joint venture with a current yield of 16.42% from income amounting to $0.47M." [Emphasis added]
Despite the fact that Beneficial Fiance owned the business, the loan portfolio was managed by Mortgage Acceptance Corporation. There was, at that stage, no written joint venture agreement between the joint venture partners setting out their respective rights and obligations, and no written agreement in respect of the management of the business by Mortgage Acceptance Corporation.
39.2.3 APPROVAL OF THE JOINT VENTURE BY THE BOARD OF DIRECTORS
In rejecting the proposal to establish the joint venture in June 1988, the Board of Directors had invited Management to resubmit the proposal when the relationship with Mortgage Acceptance Corporation had further developed and improved. On 25 November 1988, another submission was presented to the Beneficial Finance Board of Directors seeking approval for the establishment of the joint venture. All the directors were present at the meeting. The submission stated that:
"A proposal to commence a joint venture on the basis of a six month trial period with Mortgage Acceptance Corporation was considered by the Board in June 1988. A decision on the joint venture was deferred for six months.
Since then, Mortgage Acceptance Corporation have introduced business totalling $66.0M to Mortgage Acceptance Nominees Ltd (a company owned one hundred per cent by Kabani Pty Ltd), and have acted in the role as account managers. This proposal now seeks to formalise this interim arrangement."
The submission reported that, as at October 1988, Mortgage Acceptance Nominees' assets totalled $66.0M, and that it had made a profit before tax of $54,000 in the five months to October.
The proposed structure of the joint venture was similar to that proposed in June 1988, except that Beneficial Finance was to contribute 51 per cent of the total capital of $0.5M, and Mortgage Acceptance Corporation 49 per cent. The submission projected that by June 1989, the joint venture's lending would total $202.0M, as follows:
|
"Lending |
Five months |
Forecast to |
Total $M |
|||||||
|
Secured real estate |
*55 |
96 |
151 |
|||||||
|
Leasing, breeding partnerships |
11 |
40 |
51 |
|||||||
|
66 |
136 |
202 |
||||||||
|
includes a managed loan of $11.0M" |
||||||||||
Again, the submission did not provide any information regarding the financial position of Mortgage Acceptance Corporation or of Mr Green, and did not propose that any guarantees would be obtained from them in respect of Beneficial Finance's loans to the joint venture.
The approval of the joint venture by the Board of Directors is recorded in the minutes of meeting as follows:
"The Chief Executive of the joint venture is to be Mr Green of Mortgage Acceptance Corporation, who has been a significant introducer of good quality business to Beneficial. Mortgage Acceptance Corporation will be contributing capital of $245,000 to the joint venture. Beneficial's holding of 51% of the issued capital will be through Kabani Pty Ltd."
The credit submission was prepared by Mr Waller, who said in his evidence to my Investigation that the information for the submission was provided to him by Mr Reichert.()
The approval of the joint venture was given retrospective effect to May 1988. In the words of the credit submission, the approval served to "formalise the interim arrangement". The audited accounts of the joint venture for the period ended 30 June 1988, signed by Mr Baker on 15 December 1988, stated that the joint venture had commenced business on 3 March 1988, and that as at 30 June 1988 had total assets of $11.7M, and had incurred a loss of $40,137.
The audited financial statements of Mortgage Acceptance Nominees for the financial year ended 30 June 1989 gave a slightly different date, stating that "the joint venture commenced business operations on 30 May 1988."
39.2.4 SUMMARY AND CONCLUSIONS
In my opinion, the circumstances and events relating to the establishment of the Mortgage Acceptance Nominees joint venture were highly irregular and unsatisfactory. Management committed Beneficial Finance to the joint venture, and allowed it to commence operations, before approval of the venture was sought from the Board of Directors.
When a submission was presented to the Board, it was rejected. Despite that, Mortgage Acceptance Corporation continued to act as account manager. Mr Baker said in his evidence that the joint venture commenced operations without Board approval because:
"... prior to June 1988 when settlements took place, those members of management, including Mr Reichert, anticipated approval and the deals were done and settled. When they did not have Beneficial Board approval, things were basically in limbo on some form of management basis until such time as it got approved by the Board. I can remember being upset by what had happened." ()
Mr Baker did not believe that it was a matter that needed to be disclosed to the Board:
"I did not think so at the time because I thought it was just a technicality. I mean, Beneficial had the security for the money they had lent, so I did not think there was any risk. And accounts were audited 30 June anyway, if that is any justification really, I suppose, but the money had been lent on first mortgages."()
Mr Baker was not at the 24 June 1988 meeting at which the first submission was presented to, and rejected by, the Board of Directors. Mr Reichert was, however, and in my opinion he should have informed the Board that the joint venture had already commenced operations.
While I accept Mr Reichert's submission to my Investigation that he did not act alone, he was, as the Chief General Manager of the Corporate Services division, the officer most directly responsible for what can only be regarded as a quite fundamental breach of proper procedures. Beneficial Finance was exposed to the risks of a loan portfolio managed by Mortgage Acceptance Corporation, without a joint venture or any other agreement in place. That exposure arose before the approval of the Board was sought, and continued despite the express rejection of the proposal by the Board.
39.3 THE STRUCTURE, MANAGEMENT AND OPERATIONS OF THE JOINT VENTURE
39.3.1 THE MANAGEMENT STRUCTURE
The submission presented to the Board on 25 November 1988 described the proposed structure of the joint venture as follows:
"The Joint Venture entity will be Mortgage Acceptance Nominees Ltd ("MANL"), with Kabani holding 51 per cent of the issued share capital and Mortgage Acceptance Corporation the balance.
Four directors are to be appointed to MANL, of whom two will be from Beneficial (Mr J Baker who will act as Chairman, and Mr E Reichert), and two from Mortgage Acceptance Corporation Ltd. As long as Beneficial supply funding to MANL, the Chairman will have a controlling vote. Profits are to be shared equally."
The submission stated that although Beneficial Finance was already engaged in bloodstock financing through Pegasus Leasing, there would be no conflict with that business because Mortgage Acceptance Nominees "lent in larger tranches to quality high net worth individuals with large disposable incomes (QCs, barristers, partners of large accounting firms, etc)". The Joint Venture business was said to "target high quality business with low loan to security ratios".
The proposed administration of the joint venture was described in the submission as follows:
"Beneficial will provide accounting services and access to use of computer systems. Mortgage Acceptance Corporation will supply premises and staff to the Joint Venture. Appropriate fees will be charged to MANL for recoupment of costs incurred by the respective parties. Marketing, credit approval and settlement of transactions, delinquency control and account management will be the responsibility of the Joint Venture. The Chief Executive of the Joint Venture, who will be Mr Green, will have a delegated approval authority subject to countersigning by Beneficial at subsequent Board meetings within pre-determined lending policy. We envisage that a resident Investment Banking division employee will have a reasonably large involvement with the approval process."
Although these arrangements were described in the submission, no joint venture agreement documenting the arrangements for the conduct of the joint venture was signed by the partners.
Mr G J Yelland, Beneficial Finance's legal counsel, told my Investigation that to the best of his knowledge, no joint venture agreement was executed either at the commencement of operations, or later. The absence of such executed agreement was raised on a number of occasions at Mortgage Acceptance Nominees' Board meetings. The Beneficial Finance Board was not made aware that no formal joint venture agreement had been signed by the parties.
The administrative processes of the joint venture were addressed in about March 1989. An internal audit report dated 17 March 1989, covering the lending operations of the joint venture, gave the operation an overall rating of "Satisfactory +". Nevertheless, the following specific points were made:
(a) formal policies should be adopted for bloodstock lending and real estate lending;
(b) no standing written instructions were issued to valuers;
(c) a proper securities register had not been maintained;
(d) independent valuations were not obtained for two bloodstock leasing transactions totalling $2.0M;
(e) pre-settlement conditions were not satisfied on a $4.2M loan before an advance of funds was made; and
(f) loans to bloodstock partnerships were considered as secured when, in reality, they were unsecured.
The report noted that Mortgage Acceptance Nominees had only recently been provided with Beneficial Finance policies and procedures.
The matters raised in the internal audit report were addressed at a meeting the Board of Directors of Mortgage Acceptance Nominees on 30 March 1989. So far as I have been able to determine, that was the first meeting of the Board since the inaugural meeting on 30 May 1988. Thereafter the Board met quarterly. At the 30 March 1989 meeting, the Mortgage Acceptance Nominees Board resolved to:
(a) produce a strategic plan for the joint venture;
(b) add to the product range;
(c) finalise a joint venture agreement, which was "near completion";
(d) establish policies relating to the granting of bloodstock leases; and
(e) establish approval limits for loans made by the joint venture.
In accordance with its policies in respect of joint ventures, Beneficial Finance was to approve loans made by the joint venture above certain limits. The limits above which Beneficial Finance approval was required after June 1989 were:()
|
Credit Risk Limits |
||
|
Single |
Cumulative |
|
|
Bloodstock Leasing |
1,500 |
2,000 |
|
Bloodstock Partnership Loans |
50 |
N/A |
|
Real Estate |
2,000 |
2,500 |
The Board of Directors of Mortgage Acceptance Nominees was comprised by four, and later six, members, with half being appointed by Beneficial Finance, and half by Mortgage Acceptance Corporation. The practice of equal Board representation was not followed at all times, however, as during 1990 Mortgage Acceptance Corporation had three representatives as directors, and Beneficial Finance only two. Subsequently, Beneficial Finance had four Board members, and there were three representatives from Mortgage Acceptance Corporation. Mr Baker was the Chairman of the Board of Directors of Mortgage Acceptance Nominees until August 1990.
The day-to-day operations of the joint venture were the responsibility of Mortgage Acceptance Corporation. The joint venture employed no staff of its own, but instead utilised Mortgage Acceptance Corporation's staff, paying a management fee to Mortgage Acceptance Corporation for their services.
Beneficial Finance provided legal and accounting services to the joint venture, and produced monthly management accounts. It also assisted with loan management services through its Structured Finance and Project division and Investment Business division until May 1990, and through its Australian Business division and Asset Management division from that date.
39.3.2 FUNDING OF THE JOINT VENTURE
The submission approved by the Board of Directors in November 1988 had stated that the joint venture partners would contribute capital to the joint venture totalling $0.5M, with Beneficial Finance to contribute 51 per cent. The minutes of meeting of the Mortgage Acceptance Nominees Board held on 20 June 1989, however, stated that, as at that time, no capital had been contributed by either party, pending the signing of the joint venture agreement. Even then, the capital was then to be obtained from the accumulated profits of the venture itself.
The minutes record that:
"... following finalisation of the joint venture agreement, $0.5M would be distributed to the venturers in proportion to their entitlement under the joint venture agreement. The funds are to be re-invested as equity in the joint venture."
Mr Baker said in his evidence to my Investigation that the provision of equity in this manner was contrary to the usual Beneficial Finance policy, and that he has been unable to explain why such an arrangement would have been permitted() even though he attended the meeting as Chairman, and signed the minutes.
Beneficial Finance provided all of the finance for the joint venture, with the exception of the business written by the joint venture as sole agent of Beneficial Finance under the Reverse Principal and Agency Agreement, and a $4.6M loan from the State Bank relating to a particular receivable. Beneficial Finance also granted substantial loans to Mortgage Acceptance Corporation, the joint venture partner.
Despite this, Beneficial Finance did not establish a prudential limit on its exposure to the joint venture. Mr S Spadavecchia, Beneficial Finance's General Manager Special Projects, told my Investigation that, to the best of his knowledge, no overall lending limit was applied by Beneficial Finance to the Mortgage Acceptance Nominees joint venture. In my opinion, the adoption of a joint venture structure with its management vested in a third party, with no joint venture agreement or limit on Beneficial Finance's exposure, constituted an arrangement that failed to adequately protect the interests of Beneficial Finance.
39.3.3 THE PERFORMANCE OF THE JOINT VENTURE
An operating report() presented to the July 1989 meeting of the Beneficial Finance Board of Directors reported that the joint venture's assets totalled $106.0M, and that the year's profit was $2.4M, including $2.0M from a single transaction:
"The year's profit result of $2.4M, being $2.0M better than budget, was an excellent result, and was boosted by the $2.0M profit share taken up on the facility to Hotel Pty Ltd. The result is after establishing provisions for losses of $0.383M. Sales for the year reached $100.0M, and with the substantial margins locked in on thoroughbred receivables, the year ahead will again see sizeable profits achieved."
In Audit Report No 350, dated 13 December 1989, the internal auditors of Beneficial Finance questioned the prudence of recognising its $2.0M share of the "success fee" in respect of the Hotel Pty Ltd transaction in the accounts of Beneficial Finance. The other partner, Mortgage Acceptance Corporation, had not recognised its share of the fee as income, because of doubts about the recoverability of the fee, which was to be received in September 1989. Management of Beneficial Finance who reviewed the auditors' report did "not support" the comment, stating that "it was a matter for the Mortgage Acceptance Nominees Board, it was totally justified at the time", and that the fact that Mortgage Acceptance Corporation had not included its share in its income was "irrelevant". The $2.0M included in Beneficial Finance's income in 1989 formed part of its "record" profit for that year.
As I have noted, the total assets of the joint venture increased rapidly to total $88.9M by 30 June 1989. In 1990, however, the venture began to experience financial problems, recording a loss of $7.3M for the year ended 30 June 1990. The loss resulted in a deficiency of assets to liabilities of $5.3M as at 30 June 1990.
The risk to Beneficial Finance was clear. In April 1990, Beneficial Finance had advanced $0.7M to Mortgage Acceptance Corporation, and took a charge over Mortgage Acceptance Corporation's interest in the joint venture. In October 1990, Beneficial Finance sought to improve its security further by advancing a further $0.6M to Mortgage Acceptance Corporation, taking a registered mortgage debenture charge over the assets and undertakings of Mortgage Acceptance Corporation, and obtaining personal guarantees from Mr Green. The submission to the Beneficial Finance Board, requesting approval for the further advance of $0.6M, said that:
"... if we reject the application the applicant will fail, and we will realise a loss on our direct exposure, and have little chance of recovering it or the MANL shortfall."
At about the same time, deficiencies in the management of Mortgage Acceptance Nominees were beginning to emerge. An Internal Audit Report for the joint venture, dated 13 June 1990, covered the period from 1 February 1989 to 15 April 1990. This Report gave an overall rating of "Satisfactory" to the joint venture, but raised a number of significant points regarding the quality of the management of the joint venture's loan portfolio:
(a) eight out of the fourteen bloodstock partnership transactions reviewed were incorrectly approved;
(b) validity of security documentation was not certain with respect to the approximately 200 accounts settled on 30 June 1989. The Report stated that:
"... the emphasis was on ensuring the accounts were settled and in the absence of a proper settlement authorisation function, controls over the checking of the execution and completion of the documents were considered to be inadequate.";
(c) in three out of the six real estate accounts reviewed, there was no demonstration of loan serviceability;
(d) Beneficial Finance's procedures in relation to valuations were not adhered to by the joint venture;
(e) management accounts of 30 April 1990 appeared to be incorrect, as unacceptably low margins were being derived; and
(f) a joint venture agreement had not been signed.
On 11 July 1990, a report was produced on two joint venture loans to "CD Pty Ltd", and the Hotel Pty Ltd transaction. In relation to the first of these, which was a two-stage development project, the Report noted that advances had been made in excess of approval limits, and that changes to the terms of the loan should have been referred to the Beneficial Finance Board for approval, but had not.
Two Internal Audit Reports dated 17 May 1991 encompass operations up to February 1991.
The first of these internal reports covered lending, securities, collections, and administration. The conclusion of this Report was that overall controls of the joint venture were unsatisfactory. In particular, the Report stated that approval procedures and post settlement conditions were not complied with on a number of facilities, and there were serious problems with collections.
The second Internal Audit Report concluded that "the quality of asset and account management by BFCL over MANL is unsatisfactory," and referred to a number of instances where defects identified in earlier Internal Audit Reports had not been rectified. It also pointed out a number of further serious matters not mentioned before:
(a) Security over advances by Beneficial Finance to Mortgage Acceptance Nominees had been obtained only as a result of Beneficial Finance's providing further funds to Mortgage Acceptance Corporation to finance the completion of Mr Green's personal residences.
(b) An advance of $0.6M to Mortgage Acceptance Corporation, in October 1990, was based on insufficient information with regard to security values, and the loan might require a provisioning;
(c) Although Mortgage Acceptance Nominees had advanced $29.4M funded by the State Bank under the Reverse Principal and Agency Agreement, there was no formal Sub-Agency Agreement between Beneficial Finance and Mortgage Acceptance Nominees. This jeopardised the recovery of any losses on these accounts from the joint venture; and
(d) Loss provisions in relation to fourteen accounts required review.
Given the current high level of arrears and apparent problems in enforcing security, particularly in relation to bloodstock lending, it is apparent that Mortgage Acceptance Nominees' procedures with respect to the joint venture activities were not adequate.
The joint venture also experienced problems with the Beneficial Finance accounting system used to record and manage receivables. These problems were first identified in mid 1989, and, as at 28 February 1991, remained unresolved. I have reported on this matter in Chapter 36 - "Treasury and the Management of Assets and Liabilities at Beneficial Finance" of this Report.
Having regard to these various Internal Audit Reports and other documents that I have examined, I am of the opinion that there were serious ongoing weaknesses in the stewardship of the Mortgage Acceptance Nominees joint venture, and that, although those weaknesses should have been known to those senior managers of Beneficial Finance who were associated with this transaction, no effective remedial action was taken.
39.3.4 THE LOSSES IN RESPECT OF MORTGAGE ACCEPTANCE NOMINEES
The losses in 1991 relate to the suspension of interest on a number of its accounts, and, as at 28 February 1991, $32.5M, or 34 per cent by value of Mortgage Acceptance Nominees portfolio, was in arrears. In May 1991, the State Bank's internal auditors reported that 63.4 per cent by value of the joint venture portfolio was in arrears. Further specific provisions were noted in the joint venture management accounts for the months of April 1991 and May 1991, as follows:
"Further specific provisions have been provided for and backdated to June 1990.
April 1991 $6,685,000
May 1991 $7,003,000"
"Specific provisions which were provided for in the current year but had to be reversed and backdated to June 1990:
May 1991 $0.890M"
39.3.5 A HINDSIGHT REVIEW BY BENEFICIAL FINANCE
At the meeting of the Beneficial Finance Board held on 30 November 1990, a paper titled "Lessons Learned from Joint Ventures"() was provided to the Board. The paper had been prepared by Management at the Board's request. The minutes of the Board meeting stated that:
"Following a review of Beneficial's involvement in various joint ventures, action was being taken to withdraw or wind down all joint ventures as quickly as possible within the constraints imposed by the Joint Venture Agreements."
With respect to the Mortgage Acceptance Nominees joint venture activities, the Board Paper includes the following key indicators which, whilst not exhaustive, demonstrate where, in the opinion of Beneficial Finance's Management, Beneficial Finance went wrong in its relationship with Mortgage Acceptance Corporation:
(a) no written Joint Venture Agreement was finalised;
(b) management of the joint venture was directly controlled by joint venture partner;
(c) the joint venture's loan portfolio was characterised by high arrears/weak collections;
(d) financial support was provided to joint venture partner by Beneficial Finance;
(e) the joint venture's products were outside Beneficial Finance's normal approval criteria; and
(f) no prudential limits were set on Beneficial Finance's exposure to the venture.
39.3.6 SUMMARY AND CONCLUSIONS
In my opinion, the monitoring and control of Beneficial Finance's participation in, and funding of, the Mortgage Acceptance Nominees joint venture was highly unsatisfactory in a number of respects:
(a) No written joint venture agreement was ever entered into between Beneficial Finance and Mortgage Acceptance Corporation. Nor was a sub-agency agreement entered into in respect of the State Bank Reverse Principal and Agency Agreement.
(b) Mortgage Acceptance Corporation did not contribute any capital to the joint venture, other than its share of profits totalling $0.245M. Beneficial Finance effectively provided all of the funding for the joint venture. Beneficial Finance was, as well, a lender to Mortgage Acceptance Corporation, and did not obtain any guarantees from Mr Green in respect of its exposures until new loans were made to Mortgage Acceptance Corporation in 1990. In those circumstances, Beneficial Finance bore almost the entire risk associated with the joint venture's loan portfolio, which grew to total $106.0M.
(c) No prudential limit was placed on Beneficial Finance's exposure to the Mortgage Acceptance Nominees joint venture, despite the fact that:
(i) in practical terms, it bore the risk of losses; and
(ii) it was already heavily exposed to the real estate industry and, through Pegasus Leasing, had an exposure to the bloodstock industry.
39.4 FINDINGS AND CONCLUSIONS
Beneficial Finance management commenced the operation of the Mortgage Acceptance Nominees Joint Venture in June 1988, without obtaining approval from the Board. The terms of the joint venture had not, in June 1988, been sufficiently defined for the form of a joint venture agreement to have been entered into by Beneficial Finance. There is no evidence of such matters as lending policies, systems, and procedures, having been settled with the co-venturer by this time.
By proceeding with the joint venture before approval was granted, management had usurped the function of the Board to decide on the investment and, in my opinion, thereby potentially compromised their advice tendered to the Board in November 1988. Mr Baker and Mr Reichert are the officers principally at fault.
Beneficial Finance management negotiated, and recommended, the joint venture. Management of the joint venture activities was vested in Mortgage Acceptance Corporation, and Beneficial Finance had no day-to-day control. The respective rights and obligations of the parties to the joint venture were unclear, as they were never formalised by a written agreement. Perhaps the only certainty was that, if there were significant losses, they would be borne by Beneficial Finance.
39.5 REPORT IN ACCORDANCE WITH TERMS OF APPOINTMENT
39.5.1 TERM OF APPOINTMENT A
39.5.1.1 Term of Appointment A(b)
The processes which led the Bank and Beneficial Finance, a member of the Bank Group, to engage in operations which have resulted in material losses and in the Bank and Beneficial Finance holding significant assets that were non-performing include the processes described in this Chapter.
39.5.1.2 Term of Appointment A(c)
For the reasons described in this Chapter, those processes were inadequate.
39.5.1.3 Term of Appointment A(d)
The procedures, policies and practices adopted by Beneficial Finance in the management of significant assets that are non-performing include those described in this Chapter.
39.5.1.4 Term of Appointment A(e)
For the reasons described in this Chapter, those procedures, policies and practices were not adequate.
39.5.1.5 Term of Appointment A(h)
In my opinion, Mr Baker and Mr Reichert failed to exercise proper care and diligence in that they facilitated and permitted Beneficial Finance to participate in the joint venture before seeking to obtain the approval of Board of Directors, and to continue to so participate after such approval was refused.
39.5.2 TERM OF APPOINTMENT C
For the reasons described in this Chapter, in my opinion the operations, affairs and transactions of Beneficial Finance were not adequately or properly supervised, directed and controlled by Mr Baker and Mr Reichert.