CHAPTER 8
CREDIT AND ITS MANAGEMENT: GUIDELINES, POLICIES, PROCESSES, PROCEDURES AND ORGANISATIONAL DELIVERY MECHANISMS
TABLE OF CONTENTS
8.1 INTRODUCTION
8.1.1 SCOPE OF THIS CHAPTER
8.1.2 PLAN OF THIS CHAPTER
8.2 BACKGROUND: FACTORS INFLUENCING THE BANK'S MANAGEMENT OF CREDIT
8.2.1 THE STATE BANK OF SOUTH AUSTRALIA ACT, 1983
8.2.2 THE RESERVE BANK OF AUSTRALIA
8.2.3 ECONOMIC CLIMATE
8.2.4 DEREGULATION OF THE BANKING INDUSTRY
8.3 GUIDELINES AND DIRECTIONS FOR THE CONDUCT OF THE LENDING BUSINESS
8.3.1 INTRODUCTION
8.3.2 THE STRATEGIC PLANS
8.3.3 THE PROFIT PLANS
8.3.4 THE EXECUTIVE COMMITTEE
8.4 ORGANISATION AND STRUCTURE OF CREDIT MANAGEMENT
8.4.1 INTRODUCTION
8.4.2 THE BOARD
8.4.2.1 Ambit of Authority
8.4.2.2 Capacity of the Board to Control Lending
8.4.2.3 Round Robin Decision Making
8.4.2.4 The Chief Executive Officer
8.4.3 BOARD SUB-COMMITTEE
8.4.4 LENDING CREDIT COMMITTEE
8.4.5 OTHER LENDING AUTHORITIES
8.4.6 OVERSEAS LENDING AUTHORITIES
8.5 CREDIT MANAGEMENT POLICIES AND PROCESSES
8.5.1 INTRODUCTION
8.5.2 INITIATION OF LOANS
8.5.2.1 Definition
8.5.2.2 Policies
8.5.2.3 Processes
8.5.2.4 Assessment of Policies and Processes
8.5.2.5 Conclusion
8.5.3 APPROVAL OF LOANS
8.5.3.1 Definition
8.5.3.2 Policies
8.5.3.3 Processes
8.5.3.4 Assessment of Policies and Processes
8.5.3.5 Conclusion
8.5.4 LOAN SECURITY
8.5.4.1 Definition
8.5.4.2 Policies
8.5.4.3 Processes
8.5.4.4 Assessment of Policies and Processes
8.5.4.5 Conclusion
8.5.5 HINDSIGHT OVERVIEW
8.5.5.1 Definition
8.5.5.2 Policies
8.5.5.3 Processes
8.5.5.4 Assessment of Policies and Procedures
8.5.5.5 Conclusion
8.5.6 SETTLEMENT OF LOANS
8.5.6.1 Definition
8.5.6.2 Policies
8.5.6.3 Processes
8.5.6.4 Assessment of Policies and Processes
8.5.6.5 Conclusion
8.5.7 MANAGEMENT OF LOANS
8.5.7.1 Definition
8.5.7.2 Policies
8.5.7.3 Processes
8.5.7.4 Assessment of Policies and Processes
8.5.7.5 Conclusion
8.5.8 MANAGEMENT OF NON-PERFORMING LOANS
8.5.8.1 Definition
8.5.8.2 Policies
8.5.8.3 Processes
8.5.8.4 Assessment of Policies and Processes
8.5.8.5 Conclusion
8.5.9 CREDIT INSPECTION
8.5.9.1 Definition
8.5.9.2 Policies
8.5.9.3 Processes
8.5.9.4 Assessment of Policies and Processes
8.5.9.5 Conclusion
8.6 THE ORGANISATION, STRUCTURE, POLICIES AND PROCESSES AT WORK
8.6.1 PRELIMINARY OBSERVATIONS
8.6.2 COMPARATIVE ANALYSIS - A SUMMARY
8.6.2.1 Loan Antecedents
8.6.2.2 Initiation of Loans
8.6.2.3 Approval of Loans
8.6.2.4 Security
8.6.2.5 Advance of Funds or Settlement
8.6.2.6 Hindsight Overview
8.6.2.7 Management of Performing Loans
8.6.2.8 Management of Non-Performing Loans
8.6.2.9 Credit Inspection
8.6.2.10 General
8.7 REGARDING THE CONDUCT OF THE BUSINESS
8.7.1 QUALITY OF THE (PROPOSED) BUSINESS
8.7.2 REPORTING OF RELEVANT INFORMATION
8.7.3 QUALITY OF DECISION MAKING
8.7.4 CONFLICTS OF INTEREST
8.7.5 COMMUNICATION BETWEEN DIVISIONS/DEPARTMENTS
8.8 THE BOARD AND THE DISCHARGE OF ITS DUTIES
8.9 THE CHIEF EXECUTIVE OFFICER
8.10 GENERAL CONCLUSIONS
8.10.1 GUIDELINES AND DIRECTIONS FOR THE CONDUCT OF THE LENDING BUSINESS
8.10.2 ORGANISATION AND STRUCTURE
8.10.3 POLICIES AND PROCESSES
8.10.4 THE ORGANISATION AND STRUCTURE AT WORK
8.11 REPORT IN ACCORDANCE WITH TERMS OF APPOINTMENT
8.11.1 TERMS OF APPOINTMENT A
8.11.2 TERM OF APPOINTMENT C
8.11.3 TERM OF APPOINTMENT D
8.12 APPENDICES
A Executive Committee
B The Board of Directors
C Lending Credit Committee
D Lending Credit Committee (Graph)
E Corporate and International Banking - Delegated Lending Authorities Record of Changes
F Detailed Analysis of Individual Loan Files
G Compliance with Policies, Systems and Processes
8.1 INTRODUCTION
This Section of the Report deals with how the Bank managed credit risk in the period under review by this Investigation.
The management of credit risk denotes the processes of initiating, approving, controlling, and recovering, loans provided by the Bank to its customers.
It should be noted that I have not included, in this Report, any report of my investigation and findings in respect of the Bank's provisioning for bad and doubtful debts.
The policies and processes relating to provisioning, and the establishment of adequate provisions, are critical aspects of the management of credit risk. However, provisioning is, in a real sense, a distinct element of credit risk management, relating as it does to the adequacy of the Bank's financial statements.
The Bank's provisioning - including the role of the Bank's Board of Directors and of Management -will be included as an aspect of my Report in respect of the external audits of the Bank pursuant to my Term of Appointment B.
Prudent credit risk management by a bank requires the formulation of, and adherence to, policies and procedures calculated, among other things, to assist in management of the counterparty risk in lending, and to protect the Bank from an over concentration of lending to a particular company or group of companies, to a particular industry, or to a particular geographic region. Responsibility for monitoring the concentration of risk in a banks' loan portfolio should be taken by the most senior levels of bank management. This function of the credit management process, ie concentration risk, whilst discussed where relevant in this Section of the Report, is more fully examined in Chapter 5 - "The Management of the Bank Group's Diversifiable Credit Risk".
This Chapter is relevant first, to Term of Appointment A, which requires that I:
"... investigate and inquire into and report on:
(a) what matters and events caused the financial position of the Bank and the Bank Group as reported by the Bank and the Treasurer in public statements on 10th February 1991 and in a Ministerial Statement by the Treasurer on 12th February 1991;
(b) what were the processes which led the Bank or a member of the Bank Group to engage in operations which have resulted in material losses or in the Bank or a member of the Bank Group holding significant assets which are non-performing;
(c) whether those processes were appropriate;
(d) what were the procedures, policies and practices adopted by the Bank and the Bank Group in the management of significant assets which are non-performing;
(e) were those procedures, policies and practices adequate;
(f) whether adequate or proper procedures existed for the identification of non-performing assets and assets in respect of which a provision for loss should be made;
(g) whether the internal audits of the accounts of the Bank and Beneficial Finance Corporation Ltd ... were appropriate and adequate; and
(h) ... any possible conflict of interest or breach of fiduciary duty or other unlawful, corrupt or improper activity on the part of a director or officer of the Bank or a subsidiary of the Bank, or any possible failure to exercise proper care and diligence on the part of a director or officer of the Bank or a subsidiary of the Bank."
It is also relevant to Term of Appointment C, which requires that I:
"... investigate and inquire into and report, with reference to the above matters, whether the operations, affairs and transactions of the Bank and the Bank Group were adequately or properly supervised, directed and controlled by:
(a) the Board of Directors of the Bank;
(b) the Chief Executive Officer of the Bank;
(c) other officers and employees of the Bank;
(d) the Directors, officers and employees of the members of the Bank Group."
Finally, it is relevant to Term of Appointment D(a), which requires that I:
"... investigate and inquire into and report, in relation to the matters set out in paragraphs A and B above, whether the information and reports given by the Chief Executive Officer and other Bank officers to the Board of the Bank:
(a) were under all the circumstances, timely, reliable and adequate;"
(Paragraph B referred to above relates to the external audits of the Bank and is to be the subject of a separate report).
Approval and management of loans are separate line functions in each of the Bank's three business divisions, that is to say:
(a) Personal and Business Banking.
(b) Commercial and Rural Banking.
(c) Corporate and International Banking.
An initial investigation of loan portfolios of each of these divisions indicated that the incidence of non-performing loans in both the Personal and Business Banking and Commercial and Rural Banking divisions was significant numerically, but not in dollar terms. In dollar terms, the relative incidence of non-performing loans was significantly greater in the Corporate Banking area than in any other division of the Bank. For that reason, in accordance with my Terms of Appointment, the Investigation has focused on the management of credit in the Corporate and International Banking division, later referred to by the Bank as the Corporate Banking division, in which substantial non-performing loans have been identified.
8.1.1 SCOPE OF THIS CHAPTER
The scope of this Chapter is to:
(a) provide the reader with an understanding of the factors which influenced the Bank's management of credit;
(b) examine the Bank's general guidelines and directions for the conduct of its lending business;
(c) examine the organisation and structure of the credit management process within the Bank; and
(d) describe and assess the appropriateness of the Bank's policies and processes in regard to credit management.
The six loan case studies in the Chapters which follow demonstrate specific weaknesses in the Bank's credit management process. They also evidence certain departures by officers and directors of the Bank from the Bank's credit policies and processes. The transactions referred to in the six case studies contained in the following Chapters were selected from the nineteen non-performing loans analysed by the Investigation having regard to a number of factors. I have set those factors out in Section 8.6 of this Chapter. As will be evident from reading this Section of the Report, I have been conscious of the matter of client confidentiality. Any matter that has been referred to by name is already in the public domain as a result of the insolvency or other public comment regarding the entity concerned.
8.1.2 PLAN OF THIS CHAPTER
Section 8.2 - Background: Factors influencing the Bank's Management of Credit: This Section briefly refers to those external factors which influenced the Bank's lending operations; to the State Bank of South Australia Act 1983 ("the State Bank Act") which governed the operation of the Bank; briefly to the influence of the Reserve Bank of Australia; and to the general economic climate during 1984-1991, which, together with the deregulation of the banking industry had significant consequences for the Bank.
Section 8.3 - Guidelines and Directions for the Conduct of the Lending Business: This Section discusses the major internal factors which influenced the Bank's lending operations, ie the strategic plans and profit plans which were prepared by management and accepted by the Board. It also examines the role of the Executive Committee.
Section 8.4 - Organisation and Structure of Credit Management: This Section introduces the formal structure of the Corporate Banking division's lending activities. Within this structure were certain delegations which ceded responsibility to the Board Sub-Committee, Lending Credit Committee, and specified line management on the basis of monetary lending limits.
Section 8.5 - Credit Management Policies and Processes: This Section describes and assesses the Bank's policies and processes in relation to the management of credit risk. The credit risk management process has been divided into eight stages for the purpose of analysis.
Section 8.6 - The Organisation, Structure, Policies and Processes at Work: Describes the evidence examined by the Investigation, from the examination of loan files, regarding the actual conduct of the credit risk management process.
Section 8.7 - Regarding the Conduct of the Business: Describes some important features of the credit risk management function, within the Bank, including the general nature and quality of the loans granted, reporting, the quality of decision making and intra-Bank communication of information.
Section 8.8 - The Board and the Discharge of its Duties: Describes and evaluates the role and performance of the Board in respect of credit risk management.
Section 8.9 - The Chief Executive Officer: Describes and evaluates the role and performance of the Bank's Chief Executive Officer in respect of credit risk management.
Section 8.10 - General Conclusions: Describes in detail my Findings and Conclusions regarding the Bank's management of credit risk.
Section 8.11 - Report in Accordance with Terms of Appointment: This Section provides my Report in answer to the relevant Terms of Appointment.
8.2 BACKGROUND: FACTORS INFLUENCING THE BANK'S MANAGEMENT OF CREDIT
8.2.1 THE STATE BANK OF SOUTH AUSTRALIA ACT, 1983
The State Bank Act does not specifically restrict or control the credit activities of the Bank. The Act does, however, impose some limitations on the engagement by the Bank in activities connected with the provision of credit.()
By virtue of the State Bank Act, the Bank is empowered to lend monies and to borrow monies in any way that the Board approves as being appropriate.()
By Section 18(1) of the State Bank Act, the Board is authorised to delegate to the Chief Executive Officer any of its powers or functions. By Section 18(2), the Chief Executive Officer is authorised to delegate any of his powers or functions under the Act.
The statutory powers of delegation enable the Board and the Chief Executive Officer to establish business structures appropriate to the business of the Bank, with such delegated authorities as they may deem appropriate, and without limitation on the holder of the delegated authority.
8.2.2 THE RESERVE BANK OF AUSTRALIA
The Bank was not strictly speaking subject to the supervisory control of the Reserve Bank of Australia. The Reserve Bank does not have authority to control State banks to the extent to which they carry on operations within the boundaries of their respective states of domicile.()
It is important, however, that a bank take into account, when determining its credit management policies, the requirements of the Reserve Bank of Australia (hereafter called "the Reserve Bank"). The relationship between the Reserve Bank and the State Bank is considered in detail in Chapter 15 - "The Relationship with the Reserve Bank of Australia" . For the purposes of this Chapter, it is sufficient to note the following aspects of that relationship and of the Reserve Bank's prudential supervision requirements:
(a) The Bank is not, and at no time has been, legally subject to Reserve Bank prudential supervision. But it has had voluntary arrangements with the Reserve Bank in that regard, and developed and implemented its prudential policies after considering the Reserve Bank's prudential standards.
(b) The Reserve Bank's prudential supervision is not intended to immunise banks from the risk of loss, from the economic cycle, or from mistakes of their managers. The Reserve Bank's approach is based on the view that the prime responsibility for the prudent management of a bank's business lies with that bank's management. The Reserve Bank seeks to satisfy itself that individual banks follow management practices that limit risk to the prudent levels determined by management, and that those standards are observed and kept under review.
(c) With the statutory objectives of ensuring the stability of Australia's financial system, and of protecting the depositors of banks (but not their shareholders or owners), the Reserve Bank has, since January 1985, developed a set of general prudential guidelines against which to assess a bank's operations. Through statistical collections, consultations, and assessment of a bank's risk management systems, the Reserve Bank monitors each bank's performance. In addition, a bank's external auditors report annually to the Reserve Bank on the observance of prudential guidelines, on the effectiveness of management systems, and on the reliability of the Bank's statistical returns. The first complete report from the Bank's external auditors to the Reserve Bank was for the 1988-89 financial year.
Two features of those Reserve Bank supervision processes are specifically relevant:
(a) The first is the Reserve Bank requirement that banks keep their large credit exposures under close review so as to avoid undue concentration of risk. In May 1986, the Reserve Bank introduced a requirement that banks submit to it, on a quarterly basis, a return identifying the number and amount of credit exposures in excess of 10 per cent of capital.
(b) Second, and more significantly for present purposes, is the Reserve Bank's request that banks advise of their credit management policies. In respect of the State Bank, this aspect of the supervision arrangement was, in due course, supported by the report to the Reserve Bank by the Bank's external auditors, which amongst other things, was intended to confirm to the Reserve Bank that management systems to control, monitor, and limit, credit risk were adequate and being observed. In that context, it is worth noting the following events:
(i) In April 1986 the Reserve Bank asked the Bank to describe the Bank's credit management policies.
(ii) In May 1986, the Bank provided that description of its credit policies and control mechanisms. That explanation was periodically updated, the last such update being in May 1988.
(iii) The Reserve Bank thereafter relied on its consultations with Bank management and (eventually) on the reports from Bank external auditors to satisfy itself that the Bank's credit management policies and internal control systems were being observed.
This aspect of the Bank's operations, and the involvement of its external auditors, is further considered in Chapter 15 - "The Relationship with the Reserve Bank of Australia" and in a later Report on the external audits of the Bank.
8.2.3 ECONOMIC CLIMATE
The period 1984-1991 was characterised by rapid economic growth. In particular, the period was associated with rising property prices and a booming equities market. These markets were fuelled by an abundant supply of credit, which created buoyant economic conditions. By comparison, the early 1980's was a period of recession. That recession did not dampen inflationary expectations. Those expectations were unleashed in earnest when a growth cycle began in 1983.
The stockmarket crash of 1987 increased the investment of capital in property, and created a surge in commercial real estate values. During this period and until about the end of 1989, investment decisions were frequently based on anticipated continuing increases in asset values (ie speculation), and not sufficiently on basic economic and business tenets.
During 1984-1991, there was an unprecedented growth in private business debt. Businesses became much more highly geared, interest coverage ratios decreased, and borrowers became more exposed to interest rate movements and to a fall in asset values.
The subsequent recession has created a myriad of problems for banks in general, and for those exposed to the property sector in particular. In the years between 1984 and 1990 the Bank lent heavily to commercial property investors and entrepreneurs. Those loans were at the high end of a bank's acceptable scale of risks. That level of risk was aggravated by the fact that the Bank did not have other substantial good quality corporate exposures (not dependent on changes in property values) with which to "dilute" its exposures to speculators and property investors. The Bank's aggressive corporate lending on commercial property created an imbalance in its portfolio.
The subsequent recession has also proven problematic for borrowers lacking reliable cash flow, who became accustomed to selling assets in order to service or repay debts, and who were thus dependent for their economic survival upon the maintenance of inflationary expectations and the upward movement in asset values.
8.2.4 DEREGULATION OF THE BANKING INDUSTRY
Deregulation of the Australian banking industry commenced in the early 1980s with the adoption by the Federal Government of the report of the Campbell Committee of Inquiry into the Australian financial system. The Campbell Committee proved to be a catalyst for Australian trading bank mergers. Those mergers resulted in the formation of four major banking groups, that is to say the Commonwealth Bank of Australia, Australia and New Zealand Banking Group, Westpac Banking Corporation, and National Australia Bank.()
The various State banks did not initially at least, seek to compete nationally with the major trading banks. They sought to bolster their positions in their respective State of domicile, and to become regional banks in order to meet the expected increase in competition for assets and profits in the deregulated banking environment, which gained momentum in 1985-1986 with the introduction of foreign bank licences.
The State Bank of South Australia, on its establishment on 1 July 1984, through its Board and Chief Executive Officer, sought to respond to the emerging competitive banking environment. The Bank set out actively to seek new corporate clients and market share before the entry of the newly licensed foreign banks.
The Bank's established client base was largely in the retail, housing, and small business sectors. The Bank did not have experienced corporate banking staff or systems to support its aggressive approach to new business.
A further impediment encountered by the Bank was its location in South Australia, where few major Australian or international companies are domiciled. Its base in South Australia limited the Bank's access to substantial and financially sound companies with strong credit ratings.
In seeking to grow and to expand the Corporate banking base, the Bank encountered the prospect of lending extensively to less substantial and less creditworthy companies. The limited opportunities of the South Australian market for corporate banking motivated the Bank's expansion into interstate and overseas markets.
Deregulation led to an increase in the availability of financial services and credit in Australia. It was accompanied by, and contributed to, the growth in business debt noted in the preceding Section of this Chapter.
8.3 GUIDELINES AND DIRECTIONS FOR THE CONDUCT OF THE LENDING BUSINESS
8.3.1 INTRODUCTION
This Section of the Report describes and assesses the extent to which guidelines and directions for the conduct of lending business emanated from the Bank's planning processes. It also comments on the Executive Committee's role in this regard.
8.3.2 THE STRATEGIC PLANS
As part of the overall planning structure of the Bank, Strategic Plans were prepared each year. At its very first meeting on 28 June 1984, the Board resolved() on the concept of a five year strategy plan. The Board's resolution contemplated that an annual profit plan would arise out of the approved strategy plan. The Strategic Plans covered a rolling five year period. Matters relating to strategic plans have been dealt with in some detail in Chapter 4 - "Direction Setting and Planning" of this Report. The discussion in this Section, therefore, is by way of background only, and is restricted to identifying those parts of the strategic plans that may have influenced the Bank's management of credit in the area of corporate lending.
Whilst five year strategic plans were prepared annually, the Bank's actions suggest that the Bank was primarily driven in its management by the budgets contained in its annual profit plans (to which I refer below).() The Strategic Plan was the document which sought to map out the strategy of the Bank for the ensuing five years. The process of preparation of this plan was not formally documented. Indeed, a noticeable change in its make-up is evident in the period under review. Plans prepared in later years were less detailed and less comprehensive than those prepared for the earlier years. The plans were prepared by a Strategic Planning department. A draft plan was considered (and approved for submission to the Board) at an annual planning conference of senior Bank officers.
A predominant feature of the strategic plans prepared in each of the years from 1984 to 1991 was the focus on asset and profit growth. Aggressive targets were set for each year. Part of this projected growth in the Bank's asset base included an anticipated growth in the assets of the Corporate and International division. Aggressive as those growth targets were, they were in fact exceeded, and substantially exceeded, by actual growth. The Bank's actual growth, both in absolute terms and in comparison with that of other publicly owned banks in Australia, is vividly illustrated by the following tables:
|
State Bank of South Australia Key Financial Information as at 30 June |
||||||||
|
1991 |
1990 |
1989 |
1988 |
1987 |
1986 |
1985 |
1984 |
|
|
Net Interest Income |
213,027 |
273,284 |
223,905 |
172,276 |
147,608 |
133,513 |
114,578 |
|
|
Operating Revenue |
342,306 |
414,168 |
355,264 |
250,571 |
204,917 |
176,151 |
148,656 |
|
|
Doubtful Debt Expense |
1,186,921 |
168,446 |
56,566 |
14,541 |
7,700 |
5,474 |
7,635 |
|
|
Operating Profit |
14,035 |
35,879 |
78,527 |
55,474 |
40,819 |
33,625 |
28,098 |
|
|
Operating Profit After Tax |
(21,749) |
35.879 |
78,527 |
55,474 |
40,819 |
23,031 |
16,976 |
|
| Dividends Paid to South Australian Government | ||||||||
|
Financing Authority |
21,026 |
24.093 |
88,101 |
46,000 |
31,250 |
9,839 |
5,852 |
|
|
Total Assets |
20,190,896 |
17,299,775 |
12,688,205 |
9,532,151 |
6,846,287 |
5,470,740 |
3,429,952 |
2,682,985 |
|
Total Liabilities |
18,900,720 |
15,951,052 |
11,375,480 |
8,560,003 |
6,276,407 |
5,079,483 |
3,074,931 |
2,516,501 |
|
Net Assets |
1,290,176 |
1,312,725 |
1,312,725 |
972,148 |
569,880 |
392,257 |
355,021 |
166,484 |
|
Growth in Bank Assets |
||
| Bank |
1984 |
1990 |
| State Bank in South Australia |
2,683 |
17,300 |
| State Bank in New South Wales |
5,787 |
18,382 |
| State Bank of Victoria |
7,512 |
n/a |
| Rural and Industries Bank of W.A. |
2,311 |
8,271 |
| Commonwealth Bank |
14,730 |
59,391 |
The Strategic Plans did not address in detail how the growth in assets was to be achieved, nor how the management of credit was to be controlled. From 1987 onwards, reference was made in the plans to both information systems and the need for better risk and prudential management. The emphasis in the plans, however, remained on new business rather than on risk management.
8.3.3 THE PROFIT PLANS
As part of the overall planning within the Bank, profit plans were prepared each year. They were prepared by the Bank's Planning department for submission to the Executive Committee. The profit plan was based upon input from line management and the Group Finance division, and was reviewed and approved by the Executive Committee before being presented to and approved by the Board.
These plans have been commented upon in some depth in Chapter 4 - "Direction Setting and Planning" of this Report. The discussion in this Section, therefore, is by way of background only and is restricted to identifying those features of a profit plan that may have influenced the Bank's management of credit in the area of corporate lending.
As noted in the preceding Section, more importance would appear to have been attached by Bank management to the annual Profit Plan than to the Strategic Plan.() The Profit Plans for each of the years 1984-1985 to 1990-1991 budgeted for a substantial growth in assets. These budgets were surpassed by the actual growth in assets. Indeed, in 1987-1988, actual growth in assets exceeded projected growth by 100 per cent.
Challenging profit growth targets were set in Profit Plans in all but the final year, 1990-1991, the budget for which suffered from the anticipation of increased bad debts.
As with the strategic plan, the profit plans, whilst consistently projecting aggressive asset growth targets, did not address in detail the obstacles to successful achievement of such growth. The need for better information, for effective information systems, and for skilled personnel to manage and control the expanding corporate loan portfolio, were addressed in general terms; as early as 1985-1986, the following was noted as a risk:
"... our people resources may not be sufficient for the period of rapid growth and dynamic change ahead." ()
However, little if any attention was drawn to the particular need to manage and control credit risk. The focus, rather, was upon the asset growth objectives of the Bank:
"... the Bank will lend as much money as borrowers seek, provided it is at market rates of interest. Therefore in the asset class "Loans" the Plan is based on an agreement as to what is the maximum level of lending likely to be achieved." ()
"... Corporate will be undertaking a much heavier call programme on potential clients in 1985/86. The team will be looking to an increased draw down on facilities approved." ()
Generally, the profit plans failed to identify how this projected growth was to be prudently achieved and how it was to be controlled from a credit management viewpoint.
Profit plans for later years did make express reference to the management of risk, including portfolio or diversifiable credit risk. The 1988-1989 Profit Plan, observed that group strength would be bolstered by "close scrutiny of Global Risk Management". The 1989-1990 Profit Plan referred to the establishment of a data base to better evaluate Global Risk exposure. Indeed, in the introductory address to the Board within the 1989-1990 Profit Plan, Mr T M Clark noted that:
"The establishment of Global Risk Exposure Management will create a more coherent environment for controlled lending and risk assessment."
8.3.4 THE EXECUTIVE COMMITTEE
The Executive Committee functioned as the senior management organ of the Bank. It was however never formally constituted by the Board, and the Board did not formally delegate any powers to the Committee. The Committee was not created or expressly contemplated by the Act. It met first on 21 March 1984 before the Bank had formally come into existence.() The Board never subsequently expressly() ratified the existence of the Executive Committee, which was brought into existence by the Chief Executive Officer.
The role, functions, and powers of the Committee were never defined. It received minutes of the Interest Rates Committee and the Lending Committee.() The Committee was to be chaired by the Chief Executive Officer or, in his absence, by one of the General Managers.() It originally met weekly, but in later years met fortnightly. Constitutionally, the Executive Committee was merely the alter ego of the Chief Executive Officer, a committee whose purpose was to advise the Chief Executive Officer as to the discharge by him of his statutory and other duties. For these reasons, none of the statements made in the preceding paragraph are intended to imply that the mode of constitution of the Committee was in any sense defective or unauthorised. The Chief Executive Officer had implied authority to create the Committee, define its powers, and regulate its business, as he should see fit from time to time. The Chief Executive Officer was not bound by its decisions: he had an express power of veto.()
As I have said, the Executive Committee did not have a formal charter. In practice, it considered the whole range of issues relating to the management of the Bank. It did not have any formal powers. It made recommendations to the Board. It was essentially the management committee of the Bank. According to the former Group Managing Director, the business of the Executive Committee was:
"... to implement the policies agreed by the Board;
to consider and make recommendations as to what sort of future policies and strategies might be appropriate; and
to review the operations and the performance of the State Bank Group." ()
During 1984-1991, a total of 23 individuals were members of the Executive Committee at one time or another. In 1987 and 1988, membership peaked at 16 individuals, being either Chief Managers or General Managers. At other times, membership was set at seven. Membership of the Executive Committee represented all functional areas of the Bank. Appendix A lists the members of the Executive Committee from 1984 to 1991.
The Executive Committee meetings were minuted. The minutes were then formally adopted at the following meeting. The Lending Credit Committee minutes were tabled at each meeting for noting. Occasionally, general comments were made in respect of a particular credit application. This was the exception rather than the rule.
The minutes of the Executive Committee meetings record the subjects discussed, and the papers and recommendations made, by various operational areas within the Bank. The minutes also record the attendees at each meeting, but do not state if any member agreed or disagreed with any particular motion or recommendation. Decisions were generally required to be made by consensus.()
Many of the members of the Executive Committee were also members of the Lending Credit Committee. The following is a list of officers who were members of both committees:
| (a) | Mr T M Clark | 1984 - 1991; (ex offcio) |
| (b) | Mr J B Macky | 1984 - 1991; |
| (c) | Mr T L Mallett | 1986 - 1991; |
| (d) | Mr D C Masters | 1984 - 1990; |
| (e) | Mr K S Matthews | 1984 - 1989; |
| (f) | Mr G S Ottaway | 1984 - 1988; and |
| (g) | Mr S G Paddison | 1985 - 1991. |
The minutes of the Executive Committee disclose that it considered many issues and subjects which normally would have been the responsibility of line managers. Such subjects were, however, discussed in the Executive Committee, which then delegated the particular responsibility to the functional manager.
The Executive Committee formulated broad policy directions for the Bank, and recommended to the Board that those policies be adopted. As noted above, it comprised the Chief Executive Officer, along with senior line and support department executives. It is questionable whether the majority of its members were equipped by training or experience for the important role of advising the Chief Executive Officer on matters of senior level management. Many of the senior executives of the Bank in the period 1984-1985 were drawn from the merged banks. They had risen through the ranks of retail and personal banking within the merged banks. Although the position changed after 1986, in the period 1984-1985, the Bank infrequently recruited externally when filling senior positions. (Corporate Banking may have been an exception to this proposition).() On this topic, the reader is referred to Chapter 23 - "Internal Audit of the State Bank" of this Report. Few senior managers in the Executive Committee had a background in corporate finance and lending.
The Committee exercised no useful control over lending or over credit-related activities. Whilst it was perceived as the decision-making centre of the Bank, it in fact occupied too much of its time on trivial matters, and was handicapped by an excessively large membership.()
8.4 ORGANISATION AND STRUCTURE OF CREDIT MANAGEMENT
8.4.1 INTRODUCTION
The Bank was formed on 1 July 1984 as a result of the merger of the State Bank of South Australia and the Savings Bank of South Australia. The merger was effected upon the proclamation of the State Bank of South Australia Act, 1983. The State Bank Act confers broad powers on the Bank to market a diverse range of financial services.() The Board, amongst other things, is required by the Act to "act with a view to promoting - (a) the balanced development of the State's economy" and "(b) the maximum advantage to the people of the State".() No substantive restrictions were placed on the Bank Board by the Act. The then Premier stated that the Bank was to be free to operate as a commercial entity in a competitive environment.() The Bank's Mission Statements restated the organisation's understanding of its charter and purpose.
This Section describes and discusses the State Bank's organisation and structure of credit management and how various lending authorities were implemented and delegated.
8.4.2 THE BOARD
8.4.2.1 Ambit of Authority
The Bank Board was required to administer the Bank's affairs in accordance with accepted principles of financial management with a view to achieving profit.() The State Bank Act vests governance of the Bank in the Board.() The Board was empowered to delegate various responsibilities to Management.()
The members of the Board of Directors of the Bank were appointed on 28 June 1984 by the Governor-in-Council pursuant to the provisions of the State Bank Act for various terms ranging from one year to five years.() The Board met in advance of the date of commencement of the Act. At its first meeting on 28 June 1984, the Board resolved:
"The Board is not to be seen as a "rubber stamp" to endorse all actions and recommendations of Management without question." ()
The Board at that meeting passed a series of resolutions and adopted a number of recommendations relating to the conduct of the Bank's lending business. First, the Board created a series of delegated lending authorities and thus conferred on officers and committees part of its powers in relation to loans to customers. Secondly, the Board adopted a series of prudential limits and guidelines to operate in conjunction with its lending authorities. As far as concerns delegation of its lending powers, the Board authorised a sub-committee (in terms which I set out below) to transact part of the business of the Board in relation to lending in certain circumstances; in addition, the Board delegated its power to approve loans below a certain ceiling to the Lending Credit Committee and to individual officers of the Bank. It was through the Lending Credit Committee that most of the major credit decisions of the Bank came to be made.
By way of illustration of the effect of these resolutions as to lending authorities and prudential limits, at the commencement of trading by the new Bank on 1 July 1984, Board approval was required of all loan facilities greater than $2.5M() and of any exposure to a single entity or industry in excess of 20 per cent of the Bank's "risk assets." ()
The Board thus created, in 1984, and subsequently revised from time to time, a structure of delegated lending authorities, by virtue of which it devolved on various committees and officers of the Bank authority to commit the Bank to lending transactions. These lending authorities are referred to in more detail in Sections 8.4.3 to 8.4.6 and 8.5.3 of this Chapter of the Report, in conjunction with Appendix C.
The low initial ceilings on delegated lending authorities implied that the Board would be actively involved in the Bank's lending. The Board, however, in fact chose to exercise little control over lending. Ultimately, it created such a high ceiling on the delegated lending authority of the Sub-Board that the full Board rarely considered loan applications on their merits.() By the late 1980's, the delegated lending authorities of the Sub-Board and other lending organs were at such a level that most applications for loans to customers fell inside a delegated lending authority. To the extent to which lending proposals came before the Board, they did so for "noting" or "confirmation" only. The Board delegated control over lending by permitting the Sub-Board to operate as a lending institution within the limits of its delegated lending authority from time to time and by permitting the Sub-Board to act in non-urgent circumstances, contrary (as I shall show in Section 8.4.3 of this Chapter) to the terms of the resolution creating the Sub-Board.
8.4.2.2 Capacity of the Board to Control Lending
The membership of the Board of Directors of the Bank and a statement of the formal qualifications of members appear in Appendix B. The Board was composed of individuals drawn from various sectors of the business community, from the professions, and from the public sector. Mr Clark was the only Board member who had any previous commercial banking experience, and even that experience was limited, both in scope and in time, before he joined the Bank.
The Board's lack of experience and inability to cope with the volume of information presented to them is commented upon by J P Morgan in its review of the Bank's credit policies and procedures as follows:
"Most Board members are not bankers and do not have lending expertise. As described above, the credit submissions and precis are long, onerous to read, and require substantial time. Therefore we believe Board members are being asked to approve matters for which they may lack time and expertise." ()
This conclusion was subscribed to by certain past and present directors who have noted in a submission to the Investigation:
"...
(c) Board papers which were required to be read by the Directors prior to Board meetings were voluminous. It was not unusual for the Board to receive documents which would stack in a pile to approximately four inches in height. It was the experience of most Directors that those papers took between eight and 12 hours to read carefully. The Directors have expressed the view on several occasions that they felt they were "swamped with data". The papers were not only voluminous but often technical in nature.
(d) It was the experience of the Board that the Board papers were usually optimistic in statistical forecasting and extremely positive in nature. As a result of this, it was difficult for any Board member to identify the downside of any proposal put to the Board and to question that proposal effectively.
(e) The papers received by the Board prior to a Board meeting included a Monthly Operating Review, Quarterly Operating Review (4 per year), Executive Committee Minutes, Lending Credit Committee Minutes, Proposals (usually lending) to the Board for Approval, and Information Papers for Noting.
(f) It was the experience of the Board that the Lending Credit Committee Minutes and Executive Committee Minutes were printed in a short and blunt style. They usually gave few reasons for a decision reached at the meeting and in most cases stated only the decision without explanation." ()
The reference in sub-paragraph (c) of this submission to "papers ... technical in nature" implies that Board members experienced difficulty in comprehending papers of a technical kind, including papers which employed the use of technical language. This implication is borne out by analysis of the conduct of the Board of such lending business as it was required to transact, that is lending business which fell outside delegated lending activities. It is also borne out by resolutions of the Board. For example, in October 1985, the Board noted that:
"Some Directors were experiencing difficulties in clearly understanding proposals put before them because of the use of technical language in the papers. Department heads were to avoid the use of technical language in Executive and Board papers wherever possible.
The Board Secretary to oversee the Board's request." ()
Again, in June 1986, the Board resolved as follows:
"Directors again asked that all Board papers be purpose written and avoid excessive use of bank terminology. Diagrams should be included wherever appropriate. It was decided the Board Secretary would prepare a Glossary of Terms used throughout the Bank for Directors' information." ()
Many members of the Board lacked the experience necessary properly to fulfil their responsibilities in relation to supervision of the lending activities of the Bank. Certain past non-executive directors of the Bank have accepted that "the Board had a responsibility to exercise an independent judgement (that is to say, independent of Management) in relation to all credit assessment matters".() I agree with this proposition. Certain past non-executive directors of the Bank have also submitted to me that they "lacked the qualifications and experience to make determinations on the appropriate nature of financial information to obtain from borrowers. They had sufficient understanding of the credit assessment process to know that information relating to security and the ability to repay both principal and interest was essential". However, to categorise specific classes of information was, it was submitted, beyond what can be required of non-executive directors.() I am satisfied that the former non-executive directors' lack of experience in relation to lending impeded them in the discharge of their responsibility to exercise the requisite independent judgement. This lack of experience was compounded by the manner in which information was presented to the Board. As often as not, lending submissions which reached the Board did not facilitate useful analysis.
8.4.2.3 Round Robin Decision Making
The integrity of the decision-making process within the Board in relation to lending applications was adversely affected by usage of the "round robin" approval process.
In the course of the Investigation, it became evident that on a number of occasions decisions had been made by the Directors via an informal method which was referred to within the Bank as a "round robin" consultation of Board members.
A round robin was a vote on a lending or acquisition proposal in which a number of directors were circularised with a written proposal and requested by Bank officers individually to assess the merits of the proposal, to form a view on the proposal without attending a Board meeting, and to relay that view by telephone to a nominated Bank officer. The stated purpose of the process of round robin consultations was to provide a mechanism to enable the Board to make decisions quickly on urgent proposals.
Round robins were, as I have said, conducted by distributing the relevant proposal to each member of the Board who was presently within Australia, endorsed with the name and telephone number of the Bank officer who was to serve as the contact person. Typically this person was one or other of the Chairman of the Lending Credit Committee, the Group Managing Director, or the head of one of the line divisions. Board members would review the proposal, and would then phone the contact person to indicate their attitude to the proposal. The contact person would tabulate the results of his or her discussion with each Board member, and would usually forward this information to the Board Secretary for documenting.
No rules or policies were ever adopted, by the Board, or by management, regulating when a decision could be made by the Board or sought by Bank staff, using a round robin. In practice, for the most part, the Chairman of the Lending Credit Committee decided when to use the procedure. Round robins were generally used with proposals which required a very rapid response. For lending proposals where there was not the same degree of urgency, an ad hoc meeting of the Board sub-committee or full Board would be convened. In the State Bank's round robin process, there were no formal rules regulating how directors' comments were to be recorded, or whether or how they were to be passed on to the other directors. By their nature, round robins required rapid responses. This meant that Board members did not have a lot of time to consider the issues raised in the proposals.
The number of proposals circularised by round robin varied over the years, reaching a peak in 1987. At the Board meeting of 17 December 1987, five different proposals were presented for "confirmation" which had been previously dealt with by round robins. These proposals were for:
(i) An increase in Group facilities for XYZ Limited from $80.0M to $180.0M to enable a $100.0M foreign exchange facility for the switching of spot dealing transactions in various currencies.
(ii) An increase in facilities for PQR Limited from $43.25M to $73.25M to fund share purchases.
(iii) Reinstatement of $50.0M of a previously approved $65.0M facility for Equiticorp Tasman Ltd.
(iv) The purchase by the Bank itself of a portfolio of loan receivables from Equiticorp Australia for $150.0M.
(v) Provision of an underwriting facility of $150.0M to an unnamed company as part of a syndication of $1.0B.
These examples confirm that many proposals which were the subject of a round robin led to decisions regarding significant amounts of money.
Differing points of view have been expressed about the status of affirmative Board responses expressed via the round robin process. The management of the Bank viewed the round robin process as providing an approval of a proposal. Mr K S Matthews, former Chief General Manager, and former Chairman of the Lending Credit Committee, stated that the Board was being asked actually to approve a proposal by the use of the round robin process.() This view is amply borne out by the conduct of Bank officers subsequent to round robin consultations recorded in Bank files perused by the Investigation. Some of those consultations are referred to elsewhere in this Report.
Certain former directors of the Board have submitted to the Investigation that the round robin process did not involve a resolution of the Board or the approval of particular proposals, but that rather it simply involved a process in which directors were asked to express a view as to how they would vote on the proposal when it came before the Board at a meeting.() I cannot accept this.
Their submission to me was:
"1. That the "Round Robin" procedure was not a final procedure but merely gave "indicative" approval and was always subject to confirmation by the full Board of the Bank at a later stage.
2. Accordingly, Section 12(6) did not apply to the "Round Robin" procedure and there was no need for all Directors to express in writing their concurrence in the proposed resolution.
3. That the only resolutions of the Board which were binding on the Bank were those which were passed at a full Board meeting as distinct from a "Round Robin".
4. That therefore all Board business was lawfully and regularly transacted and in particular all statutory procedures were adhered to." ()
I accept only the second of these submissions. I reject the other submissions, first and fourth principally for the following reasons.
First, Board members are on record as having voiced their displeasure with the round robin process. The Minutes of the Board meeting in December 1987 contain the first recorded protest against use of the round robin procedure:
"A number of Directors expressed concern that round robin approval was sometimes given to extremely complex proposals that they considered should be dealt with at a duly constituted Board meeting where further explanation could be obtained more readily if required. It was agreed that where appropriate, a Board meeting would be constituted in lieu of a round robin approval." ()
The use of the word "approval" in this Minute is consistent only with the view that, on this occasion, the Board considered the round robin process to involve the approval of proposals and thus the transaction of business. Secondly, in April 1989 the following is recorded:
"Round Robin Lending Proposals
Directors expressed concern that on occasion there was inadequate time to consider lending proposals circulated in this manner and that there was not the opportunity to discuss these proposals with other Directors. In addition when Directors telephoned the contact point, comments made by other Directors were not always passed on.
It was considered that one of the major competitive advantages of the State Bank was the ability to respond quickly and this round robin mechanism allowed lending proposals to be approved quickly.
It was agreed that where a Round Robin Loan Approval was made, any comments made would be recorded and passed on to ensure that all Directors were aware of the views of other Directors." ()
Again, the language of the minutes is inconsistent with the proposition that the round robin process did not involve the approval of proposals. And the mere fact that directors expressed concern at the procedure is evidence that the directors were conscious that the round robin process involved approvals and resolutions, and that those approvals and resolutions were being, or might be, acted upon by management before the relevant approval or resolution was "confirmed" at a Board meeting.
In explaining their views on the round robin process, certain past and present Board members expressed their concern about the practical problems of implementing Section 12(6):
"Mr Barrett, who was Chairman at the time [July, 1984], reminded the Board that Section 12(6) required the concurrence, in writing, of all Directors entitled to vote and that this could cause practical difficulties. As a result, the Board did not rely on Section 12(6), but chose instead to allow the distribution of written material to all Board members (on matters calling for urgent decision only) with a request that they telephone their views to the Board Secretary (or other designated person)." ()
I fully accept that the round robin procedure did not invoke, and was not intended by the Board to invoke, sub-section 12(6).
In order to review the State Bank's use of round robins, the Investigation examined three specific proposals that were circularised by round robin. Presented below is an overview of each of the proposals and the events surrounding what was, I am satisfied, their approval.
(i) Equiticorp - The round robin was conducted on the weekend of 30 and 31 May 1987. The proposal was to increase the Bank's commitment from $50.0M to $250.0M to assist Equiticorp to finance the purchase of shares in Monier Ltd. The total commitment of $250.0M represented a figure in excess of 50 per cent of the Bank Group's capital base. In the event of take-up by Equiticorp, the Bank was planning to reduce its exposure within a short period of time by selling down some of the commitment. The Reserve Bank of Australia was advised by Mr Matthews of the transaction on 1 June 1987 and it "counselled strongly against...entering into this transaction." () By the time the next Board meeting was held on 25 June 1987, Equiticorp had taken up the commitment and the Bank had sold down its exposure so that the remaining exposure was less than 30 per cent of the Bank Group's capital base. The Board Minutes do not contain an explicit confirmation of the round robin approval. The present Board secretary, Ms Kotses, has been unable to locate any record of the way in which Directors voted on this proposal.()
(ii) Newco Pty Ltd - The round robin was conducted on 11 December 1987. The proposal was to provide a $150.0M underwriting facility as part of a syndication of $1.0B to assist in the purchase of the total share capital of an unnamed company. The Board confirmed the round robin decision at its meeting on 17 December 1987.
(iii) Adelaide Steamship Co Ltd - On 23 March 1988 the Board had, I am satisfied, approved an extension of facilities to Adelaide Steamship for a further twelve months and had increased these facilities from $45.0M to $80.0M. This approval was obtained via a round robin only one day before the Board meeting of 24 March 1988. The Board Paper notes that only four directors were contacted in this round robin. A second round robin was conducted in relation to an Adsteam facility on 12 May 1988. This time the proposal was for the approval of a progressive increase in facilities from $80.0M to $196.0M to refinance an existing investment in Royal Insurance PLC. Adelaide Steamship had acquired a 6 per cent shareholding in the Royal Insurance PLC and wished to refinance the investment off balance sheet on a more cost effective basis. The Board confirmed this round robin decision at the Board meeting of 26 May 1988.() As indicated in the Chapter on the Adsteam Group, it has not been possible to determine when either of these approvals was communicated to Adsteam. For the reasons stated in Chapter 9 - "Case Study in Credit Management: The Adsteam Group", it is highly probable, and I am satisfied, that Adsteam was informed of approval before the Bank Board meeting. The Bank has, however, produced no evidence as to when the approval was communicated.
I am satisfied from these sample transactions, and from the contemporaneous documents to which I have referred, that both management and the Board viewed the round robin process as an acceptable method for actual decision making, and not merely, as has been submitted, as a means for eliciting an indication from the Board as to how it would vote at a subsequent meeting. Decisions taken as a result of a round robin process were acted upon as if they had been taken at a duly convened meeting of the Board at which a quorum had been present. Certainly, the evidence of Mr Matthews() supports this inference. The inference is strengthened by the behaviour of the Bank in implementing decisions taken by round robin, in advance of confirmation of those decisions by subsequent Board meetings, and by the language of the directors in complaining about the frequent use of the round robin process. While the Board confirmed the round robin decision at the next Board meeting, the relevant transaction was, in many instances, beyond the point where the round robin decision could realistically have been reversed without the Bank being exposed to liability for a breach of a contractual undertaking. I am further satisfied that, by virtue of Sections 13 and 14 of the Act, which I set out below, the Bank would have been bound by a round robin decision upon that decision being communicated to the applicant borrower as an actual approval of the Board.
The Implications of Round Robin Consultation
In my opinion, the process of round robin consultation employed by the Bank Board raises issues of serious concern.
First, the legality of the process and its outcomes is open to question. Section 12 of the State Bank of South Australia Act provides as follows ():
"...
(3) No business shall be transacted at a meeting of the Board unless a number of Directors that exceeds one-half of the total number of Directors is present at the meeting.
(4) Each Director present at a meeting of the Board shall be entitled to one vote on any question arising for decision at that meeting and, in the event of an equality of votes, the person presiding at the meeting shall be entitled to a second, or casting, vote.
(5) The Board shall cause accurate minutes to be kept of its proceedings.
(6) If all Directors entitled to vote on a proposed resolution express, in writing, their concurrence in the proposed resolution, it shall become a resolution of the Board notwithstanding that it has not been passed at a meeting of the Board".
Furthermore Sections 13 and 14 of the Act state ():
"...
13. No act or proceeding of the Board is invalid on the ground of a vacancy in the office, or a defect in the appointment, of a member of the Board."
"14. (1) The Board is the governing body of the Bank and has full power to transact any business of the Bank.
(2) Anything done by the Board in the administration of the Bank's affairs is binding on the Bank."
The round robin process involved a series of telephone discussions between a Bank officer on the one hand and members of the Board (individually) on the other. On no occasion analysed by the Investigation was a record found of contact between directors themselves in the course of a round robin. Such a series of telephone conversations, the directors making up their minds individually, independently, and in isolation, could not, on any view, be said to be a meeting of directors. The Board could lawfully transact its business only at a meeting or (other than at a meeting) pursuant to sub-section 12(6).
In the light of sub-section 12 (6) of the Act, a round robin consultation could be a valid Board process only if it related to a proposed resolution and if all directors entitled to vote indicated concurrence in writing to the proposal.
Secondly, as a deliberative process of the Board, round robins were deficient. The Investigation has revealed that not all directors, or even all available directors, were contacted in regard to each proposal subjected to round robin consultation. Moreover, there is no evidence to confirm that all round robin "votes" were accurately recorded. In fact, the system presented opportunities for manipulation, since it lacked the checks and balances associated with sound internal control procedures. Although no evidence of any abuse of the round robin consultation process has been found, it is sufficient to state that, in my opinion, it was unsound, as participating directors were entirely reliant upon the contact person at the Bank charged with recording responses to a round robin doing so accurately, and communicating any views expressed by other directors fully and correctly to each director in turn.
Thirdly, the round robin approval mechanism subverted the due process of the Board. The evidence available to the Investigation indicates that round robins could, in effect, be used to reach majority decisions, without a quorum of directors being required to vote on a proposal. Bank personnel conducting a round robin could select participants in a round robin from among available directors - there was no requirement that all directors be contacted in regard to any single proposal. Bank personnel could, for example, decide to refrain from contacting a particular director entitled and available to vote, for the reason that the director was known to be unlikely to favour a particular proposal.
The round robin process was thus flawed. I am satisfied that, in acquiescing in its continued use, the Board failed adequately and properly to direct, supervise and control the affairs of the Bank. Further, the absence of either a sound legal basis for, or sufficient internal control over, the process amounted to a failure to meet the standards required for the prudent management of the Bank's affairs. The Board expressed its discomfort with use of the method of round robin consultation. Directors were aware that it did not conform, and it was not intended by them to conform, with sub-section 12(6) of the State Bank Act. Yet the Board did not direct that the practice be terminated.
This aspect is commented upon by certain past and present directors as follows:
"(a) When the matter of urgent decision-making was first raised at a Board meeting in 1984, reference was made to the State Bank of South Australia Act, 1983 in particular Section 12(6) which provided for urgent Board decision making between meetings. Mr Barrett, who was Chairman at the time, reminded the Board that Section 12(6) required the concurrence, in writing, of all Directors entitled to vote and that this could cause practical difficulties.
(b) As a result, the Board did not rely on Section 12(6), but chose instead to allow the distribution of written material to all Board members (on matters calling for urgent decision only) with a request that they telephone their views to the Board Secretary (or other designated person). The item would then be placed on the Agenda of the next Board meeting for confirmation of the "round robin" decision so that it became a decision of that Board meeting and not a resolution under Section 12(6).
(c) In general, the Board was hesitant about round robin approvals believing that there was no substitute for open discussion at the Board table. Therefore, telephone approvals were not encouraged as a matter of principle but the Board accepted that on some occasions, where the matter was urgent, they could be utilised.
(d) These arrangements continued satisfactorily for some years. However, in approximately 1987, the use of round robin decisions for approval of loan proposals increased in frequency. This was despite the Board's direction that they ought to be used only at times of genuine urgency.
(e) Dissatisfaction with this state of affairs was raised by Board members and in one instance, Mr Simmons forwarded a letter to Mr Ken Matthews dated 4th June 1987, advising of his concern at the frequent use of round robin decisions (Annexure 14). A copy of that letter was sent to the then Board Chairman, Mr Barrett, who also expressed his concern about the growing frequency of the practice. In addition, Minutes of Board Meetings of 17th December 1987 and 17th April 1989 also record concern on the part of the Board in respect of this procedure. (Annexure 15).
(f) It was the Board's experience that such a procedure did not allow the Board:
(i) time to properly consider the matter;
(ii) to discuss with, and determine the view of, the other Board members." ()
These submissions are not wholly borne out by analysis of lending transactions scrutinised by the Investigation. For example, in relation to the Somerley transaction(), there was an occasion when a "round robin" decision was not listed for "confirmation" at a subsequent Board meeting, but was acted upon as a resolution of the Board. A similar situation arose in relation to an approval of a facility to the Adsteam Group.() In any event, the Board collectively managed its own business. It could, if genuinely dissatisfied with "round robin" decision-making, have brought "round robin" discussions to an end. Its members could have refused to take part in them. I am satisfied that, in relation to the lending business of the Bank, the Board lacked the experience, information, and, on occasions when it utilised the round-robin procedure, the appropriate forum, in which to make properly considered decisions.
8.4.2.4 The Chief Executive Officer
It is convenient at this point to make mention of the Chief Executive Officer of the Bank (initially styled Managing Director and later Group Managing Director), Mr T M Clark. By Section 16 of the State Bank Act, the Chief Executive Officer was responsible for the management of the Bank, subject only to the control of the Board. The Chief Executive Officer did not have a delegated lending authority in his own right. He was at times a member of the Lending Credit Committee, but he had no personal responsibilities or power in relation to specific credit applications. Being responsible for the management of the Bank, however, the Chief Executive Officer was responsible, in broad terms and among other things, for the due formulation and implementation of satisfactory credit policies. That responsibility was never eroded in any way by resolution of the Board. It is my opinion that Mr Clark neither discharged, nor effectively delegated, his responsibilities in respect of credit policies.
In his submission to the Jacobs' Royal Commission, Mr Clark has asserted that the approach which he followed in building up management personnel and structures involved his carrying out the following activities (subject in each case to Board approval):
"...4. To co-ordinate the activities of the Bank through the Planning Process and through the appropriate committees.
5. Subject always to Board control, to manage most of the Bank's operations through these committees and put important matters of policy and administration (including major loans and/or acquisitions) up to the Board ...." ()
Mr Clark has informed the Investigation that it was at his instigation that the Lending Credit Committee was composed of what were believed to be experienced and able banking executives, and that, as the Bank grew, he always endeavoured to improve the quality of staff. He submitted that it was at his instigation that lending examiners were recruited and introduced into the Bank to train staff and to monitor lending within the branch structure, and that it was at his instigation that the Bank conducted training and development in credit within the Corporate and International Banking and Business Banking divisions.() There is, however, no indication in the materials produced to the Investigation - and Mr Clark did not submit - that he took any initiative whatsoever with a view to either the formulation or the implementation of appropriate credit policies and risk management procedures within the Bank. Given the growth which the Bank was undergoing in the period from 1984 to 1991, when Mr Clark was Chief Executive Officer, and the clear need for that growth to be accompanied by suitable credit risk management policies and procedures, I have formed the view that this was a serious dereliction of duty on his part.
8.4.3 BOARD SUB-COMMITTEE
The first reference to the Board Sub-Committee was made at the Board meeting of 28 June 1984. At that meeting, the Board approved two papers (84/10 and 84/12) which dealt with lending delegations in terms that are not entirely consistent. By resolution Minute 84/12:
"It was proposed that urgent decisions be considered by a Board Sub-Committee of any two Directors and the Chairman of the Credit Committee, with decisions referred to the next Board meeting for ratification. (emphasis added) A quorum for meetings [that is to say, Credit Committee meetings] would be four, of whom one must be a General Manager or the Chief Executive, who shall receive agendas and minutes of all meetings and attend whenever possible."
By its contemporaneous approval of a second paper(), the Board resolved that:
"With lending, the Board is to delegate to Management a lending discretion of $2.5m. This discretion will not be exercised by the Chief Executive, but by the Loans Committee chaired by a General Manager.
The Loans Committee will overview delegations within this $2.5m throughout the organisation.
...
The Board would approve all loans over $2.5m and when urgency is required this would be done by a Sub-Committee of two Directors who would approve the loan subject to confirmation at the next Board Meeting.
The Board would receive monthly, for information, brief details of all loans made during the month between $0.5m and $2.5m.
With extensions to loans, this would be approved by the Board when the exposure was taken over $2.5m, or with existing exposures of $5m or more, extensions of $250,000 or more would be approved by the Board."
This situation remained largely unchanged throughout the review period, with the qualification that the monetary ceiling on the lending authorities devolved to the Board Sub-Committee was increased periodically, as was the case with all other delegated lending authorities. The delegated lending authority of the Sub-Board increased rapidly and substantially: first, to $40.0M in August 1985; secondly, to $50.0M in July 1987; finally to $60.0M on 22 December 1988.
The Bank Board had authority under Section 18(1) of the Act to constitute sub-boards or sub-committees and, in particular, to prescribe a quorum for two for such Sub-Boards. It was desirable, however, that resolutions constituting Sub-Boards clearly define the power to be delegated by the Board. I have commented in the Case Study on Collinsville on the confusion and uncertainty surrounding the charter and authority of the Board sub-committee.() That confusion and uncertainty stemmed from ambiguities in the resolution constituting the Board Sub-Committee. The resolution, for example, does not make it clear whether, in the case of urgency, the authority of the Board Sub-Committee was binding on the Bank or - what is less likely - was merely provisional. The Board had probably intended, in passing that resolution, that the Sub-Board would, in cases of urgent applications, have final authority to approve credit applications and to commit the Bank to specific transactions.() What is clear is that the Board Sub-Committee was given no authority to approve loans, except when some urgency was involved. This requirement of urgency was never rescinded by the Board. By 1989, at the latest, employees of the Bank had come to regard the Board Sub-Committee as a discrete lending institution within the Bank.
Employees of the Bank were of the view that the Board Sub-Committee had authority to approve loans without reference to the Board in non-urgent circumstances, and that decisions of the Sub-Board in favour of lending proposals were valid whether ratified or confirmed by the Board or not.() For example, Mr R L Wright - a member of the Lending Credit Committee - has submitted to the Investigation that it was always his understanding that the Board Sub-Committee was formed to consider urgent proposals which could not await a normal Board meeting. Mr Wright further believed that the decision of the Sub-Board was binding on the Bank, and that the proposals approved by it were subsequently presented to the Board merely for noting and confirmation.() This view is reasonably open on a reading of the first minute which I have set out above (minute 84/12). The second minute (84/10) which I have set out, however, indicates that decisions of the Sub-Board were merely provisional and were not intended to bind the Bank unless and until confirmed or ratified by the Board.
In addition, officers of the Bank had come to regard the Board Sub-Committee as being authorised to meet merely to expedite consideration of loan applications, whether the circumstances were truly pressing or not. I was also informed that it was common for the Sub-Committee to act in non-urgent circumstances.() In these respects, the Board Sub-Committee was acting beyond its authority.
The tables in Appendix E demonstrate the increases in delegated lending authorities given to the Board Sub-Committee. Decisions made by the Board Sub-Committee were tabled before the Board for "confirmation" or "noting" (but not, to use the language of resolution 84/12, "ratification"), at the next Board meeting. No formal minutes were kept of Board Sub-Committee meetings. Meetings were held on an ad-hoc basis.
It is a matter for regret that minutes were not kept of Board Sub-Committee meetings. In practical terms, as I have indicated, the Sub-Board was transacting part of the lending business of the Bank. In practical terms, for the reasons set out above, its decisions became immediately binding on the Bank because they were communicated to applicants as being approvals of loans. Further, the Sub-Committee was reviewing decisions of the Lending Credit Committee, whose meetings were minuted. Given the magnitude of the loans which it was, in practical terms, approving, minutes should have been kept of Sub-Board meetings.
It has been submitted to the Investigation by one of the Bank's directors, Mr R E Hartley, that he began to notice a deterioration in the seniority and quality of the Bank officers in attendance at Board Sub-Committee meetings:
"... Prior to 1990, Mr T Marcus Clark, Mr S Paddison or Mr M Hamilton would usually attend the meetings, but by 1990, often these persons were absent. Thus applications for loans, sometimes for very large amounts, were being put to a Board Sub-Committee by increasingly junior personnel. The quality of the papers was sometimes poor, as was the ability of management to answer even basic questions about the applications.
As a result of this, Mr Hartley expressed his concern at a Board Meeting and the practice of having Senior Bank Officers present at meetings of the Sub-Committee was reinstated. Mr Hartley says that this experience alarmed him and that it indicated to him:-
(i) that senior management did not appear to be involved in or interested in major credit applications; and
(ii) the relatively low calibre of personnel directly below Paddison and Hamilton." ()
I cannot wholly accept this. First, at the factual level, Mr Hartley was appointed to the Board in 1987. Mr M G Hamilton was appointed to the Bank on 3 July 1989. So far as the Investigation's perusal of Bank papers go, Mr Hamilton never attended a Sub-Board meeting. In any event, Mr Hamilton had no lending experience in banking circles. Mr Clark frequently attended in his capacity as a director. The Chairman of the Lending Credit Committee was required to attend. Frequently line personnel attended. Secondly, if Mr Hartley or any other member of the Board was genuinely concerned at the functioning of a particular Sub-Board meeting, the Board member had it within his or her power to remedy the situation by voting against a particular lending proposal. That would have sealed the fate of a defective or inadequately presented lending submission. The Investigation has encountered no instance of a Sub-Board rejecting an application. Given that the Board placed significant reliance on the deliberations and recommendations of the Board Sub-Committee, it is a major cause for concern that a deterioration of the kind said to have been observed by Mr Hartley in the quality of personnel assisting the Board Sub-Committee could occur.
Equally, despite the considerable uncertainty inherent within the terms of the resolution by which the Sub-Board was constituted, the Board never sought, after 1984, to alter the powers, constitution, or mode of operation, of the Sub-Board. Indeed, as I have observed in the Case Study on Collinsville, there is reason to think that members of the Board did not acquaint themselves with the terms of the resolution creating the Sub-Board. This proposition is exemplified by a number of facts. First, the Board actually conferred a delegated lending authority on the Sub-Board: if the Sub-Board were merely a Committee of the Board, with no power to give a final and binding approval to a lending submission, the concept of a lending authority would be otiose. Secondly, lending submissions were invariably and routinely referred to a Sub-Board if they fell above the delegated lending authority of the Lending Credit Committee. Board members, I am satisfied, did not require, as a condition of transacting business at a Sub-Board, to be persuaded that urgency was involved in a particular proposal.() Certain former non-executive directors of the Bank have submitted to me that:
"...(k) In the majority of instances, where the sub-committee had been convened, a paper was subsequently presented to all Board members prior to the forthcoming monthly Board meeting and consideration was given to the proposal by the full Board and, if appropriate, the full Board, after due consideration, would approve the proposals. It is, therefore, not correct to state that:
"The Board effectively abdicated control over lending by permitting the sub Board to operate as a lending institution." (page 22).
(l) It was always possible for the full Board at a forthcoming meeting to reject a proposal put to a Board sub-committee rather than confirming or ratifying the previous "approval in principle" registered by the sub-committee:
(m) By using the sub-committee procedure it was envisaged that the non-executive directors, who considered the proposal at first instance, could request additional information on behalf of their colleagues at an early stage in order that the Board requirements could be satisfied
(n) It was never intended by the Board that the full Board meeting would simply rubber stamp the sub-committee's approvals. It was not to be, and was not, a simple bureaucratic or administrative confirmation. This intention was clearly known to management as the Board insisted that a paper outlining the proposal to the sub-committee be duplicated (and sometimes further information required in it) to all directors prior to the forthcoming Board meeting where it would be presented by the relevant General Manager, and would receive due consideration.
(o) It was only after the full Board had given its approval to the proposal, that management could proceed to advance funds to the client.
(p) Accordingly, the sub-committee never had the power to give final approval to a lending proposal and no non-executive director who sat on such a sub-committee ever considered that in giving "approval in principle" he or she had given authority to management to advance funds." ()
I am not persuaded by these submissions.
The composition of the Board Sub-Committee was fluctuating and unpredictable. Its meetings were short. The Investigation's analysis of its decisions has led me to be satisfied that it served no useful purpose. Indeed, I am satisfied that it was an unsafe institution. Its meetings were convened on short notice. Generally, members would have had an inadequate time in which to consider what were often complex lending submissions. Yet the business was transacted nevertheless. The Board Sub-Committee was assisted by the presence of the Chairman of the Lending Credit Committee. That person may have been unaware of fine details of the lending submission and of the merits of the underlying proposal. The Investigation has not encountered a single instance where a Board Sub-Committee rejected a loan application. This may be thought to suggest a pre-disposition on the part of Board members, when sitting as members of the Board Sub-Committee, to approve loan proposals because they had been recommended for approval by the Lending Credit Committee, who were perceived to have expertise in relation to lending. The former non-executive directors of the Bank have submitted to the Investigation that decisions of the Board Sub-Committee were not binding on a full Board, and that the Sub-Committee never had the power to give a final approval to a lending proposal, and further that no non-executive director that sat on such sub-committee ever considered that in giving "approval in principle" he or she had given authority to Management to advance funds.() I have already set out my reasons for disagreeing with the first component of this assertion. If members of the Board, when attending Sub-Board meetings, considered that their decisions had no binding status unless and until approved by the full Board, then there was a real danger that those persons would not bring a necessary degree of scepticism and analysis to the transaction of the Sub-Board's business. Board members sitting as a Board Sub-Committee may themselves have had no lending experience and expertise.
8.4.4 LENDING CREDIT COMMITTEE
Created at the inception of the Bank on 28 June 1984, the role of the Lending Credit Committee (now known as the Group Credit Committee) was described as follows:
"It is proposed that the Committee will meet as appropriate to process loan applications and a quorum will be 4; one of the General Managers or the Chief Executive must be present.
Loans in excess of $2.5M will be referred to the Board for decision, but when urgent decisions are needed a Sub-Committee of any two Directors will meet with the Chairman of the Credit Committee. Their decision will go forward to the next Board Meeting for ratification.
Half-yearly reviews of loan quality will be undertaken by the Committee. In this regard any instalment loan above $50,000 on which instalments are in arrears in excess of three months, or any other advance in excess of arrangements by $25,000 or more for a period exceeding one month, will be reviewed by the Committee. Following this half-yearly review a report will be made to the Board." ()
By its resolution adopting this proposal, the Board resolved that the Credit Committee would "undertake half-yearly reviews of loan quality, and a report will be presented to the Board". The Board further resolved that future appointments to the Committee would be approved by the Board.() In my opinion, the charter of the Lending Credit Committee was not satisfactory. First, it did not precisely define the monitoring role to be undertaken by the Committee in relation to the Bank's loan transactions. Secondly, it did not clearly demarcate where, as between the Board, the Chief Executive Officer, and the Committee, responsibility for supervision and surveillance of the Bank's lending policies would lie. In the absence of a clear delegation of authority by it, such responsibility and authority would remain with the Board.
As a matter of construction of the resolution which I have set out, the principal functions of the Lending Credit Committee were: the approval of lending applications which fell inside its delegated lending authority; the consideration of other applications with a view to their recommendation to the Board; and the conduct of reviews of irregular loans; and the reporting thereon to the Board. In the absence of an explicit delegation, constitutionally speaking, the Board, including the Chief Executive Officer, retained general responsibility for the lending operations of the Bank; namely the responsibility to manage concentration risks and exposures; the duty to ensure adherence to the lending policies of the Bank; and responsibility for the creation of procedures for the due reporting and provisioning of bad and doubtful debts. Furthermore, the Lending Credit Committee was not equipped with personnel or a support staff to enable it autonomously to carry out the responsibilities which were expressly vested in it. That, too, was unsatisfactory.
The former non-executive directors of the Bank do not accept the conclusions in the preceding paragraph. They have submitted to me that:
"... there was explicit responsibility given to the Lending Credit Committee and that at the meeting of 26 June 1984 there was a substantial discussion which clarified the charter, and furthermore, half yearly reviews of loan quality were undertaken by the Credit Committee. This delegation was made to the Credit Committee by the Board via the Chief Executive Officer. Furthermore, the former non-executive directors dispute the conclusion that they retained general responsibility for the lending operations of the Bank and have pointed to the resolutions of the Board at its meeting of 28 June 1984 which resolved among other things:
"Accordingly, the role of the Board is as its name implies, a Board of Directors, and in considering the proceedings of the Board, emphasis is to be placed on determining and directing matters of policy. The execution of this policy is the role of the Chief Executive Officer and the Staff of the Bank."" ()
I am not persuaded by these submissions.
When the Board, in June 1984, created the Lending Credit Committee, the Board should have ensured that the Lending Credit Committee was unambiguously charged with responsibility for monitoring the Bank's prudential guidelines; with responsibility for broader aspects of asset management; and with responsibility for the Bank's exposure to lending risks generally. It was simply inconceivable that the Board might undertake these tasks. Nevertheless they were not delegated by the Board to the Lending Credit Committee, or to any other entity in the Bank.() At its meeting in June 1984, at which the Lending Credit Committee was constituted, the Board also constituted an Asset/Liability Management Committee which was empowered "to manage the interest spread and assets and liabilities side of the Balance Sheet to ensure that the Bank is safely funded and invested". It is clear on a reading of the minutes as a whole that, as between these two committees, it was the Lending Credit Committee which was required to monitor loan quality. The Asset/Liability Management Committee was disbanded in 1987. On 22 September 1988, the Board resolved that the Asset and Liability Management Committee be formally re-constituted.()
The Merger Advisory Group established in May 1983, recommended to the Bank Board, on 28 June 1984, the composition of the Lending Credit Committee and its Delegated Lending Authority. The Board fixed the membership of the Lending Credit Committee in 1984, and conferred on that Committee authority to consider all loan proposals over $1.0M and up to $2.5M. The Board further stated that the Managing Director, or a General Manager, must form part of the quorum of four.
At some stage during the 1987/1988 year, the requirement that the Managing Director or a General Manager be present was dispensed with. ()
Decisions made by the Lending Credit Committee were noted at a subsequent Board meeting. The Executive Committee received the Lending Credit Committee papers and its minutes for information.
Strictly speaking, changes to the membership of the Lending Credit Committee were required to be approved by the Board. This policy, however, was inconsistently applied. New members were appointed on an ad hoc basis from time to time, without formal resolution by the Board.
In practice, the Lending Credit Committee received a reasonably detailed submission on a particular lending proposal for the purposes of approving it, if within its authority, or recommending it to the Board or Sub-Board, if outside the Lending Credit Committee's authority. The Sub-Board received a copy of the Lending Credit Committee submission. By contrast, the Board in, practice, received a summary of the proposal presented by a representative of Corporate Banking division. The Lending Credit Committee was also required to identify and manage non-accrual accounts. In practice, it involved itself also in recommending appropriate provisions.()
The tables in Appendices C and D detail the membership of the Lending Credit Committee, as at the end of each financial year until 30 June 1990. The tables reflect the changes in the Delegated Lending Authority of the Lending Credit Committee, from time to time, as set down by the Bank Board.
It is evident from the minutes that there was a core group of executives who were regular attendees at meetings throughout the period under review. The bar chart appearing in Appendix D illustrates the membership of the Lending Credit Committee during the entire period under review. There were nineteen individual members who variously held the titles of Chief Manager, General Manager, or Chief General Manager.
In the four year period to 30 June 1988, the members of the Lending Credit Committee who most frequently attended its meetings were:
(a) Mr T M Clark (ex-officio);
(b) Mr J B Macky;
(c) Mr D C Masters;
(d) Mr K S Matthews (Chairman);
(e) Mr G S Ottaway; and
(f) Mr V R Pfeiffer.
The following three executives frequently attended Lending Credit Committee meetings, although they were not members throughout the entire four year period, which ended on 30 June 1988.
(a) Mr J T Hazel;
(b) Mr T L Mallett; and
(c) Mr S G Paddison.
During this period the total assets of the Bank increased from $3.142B to $11.0B. The true extent of problem loans written by the Bank had not yet emerged.
In the period 1 July 1988 to 28 February 1991, when the total assets of the Bank increased from $11.0B to $21.0B, the members of the Lending Credit Committee who most frequently attended meetings were:
(a) Mr T M Clark (ex-officio);
(b) Mr J B Macky;
(c) Mr T L Mallett;
(d) Mr D C Masters;
(e) Mr K S Matthews (Chairman until his resignation in June 1990);
(f) Mr P F Mullins;()
(g) Mr G S Ottaway (Deputy Chairman);()
(h) Mr S G Paddison;
(i) Mr V R Pfeiffer; and
(j) Mr R L Wright.
It is apparent from the lists which I have set out that a majority of the Lending Credit Committee were line managers, that is to say, in charge of the Lending divisions of the Bank. It is, in my opinion, wholly inappropriate for a credit committee to be dominated by individuals whose junior staff are responsible for bringing lending submissions before the Committee whose members had, by virtue of adoption by the Bank of its strategic plan and annual profit plans, a firm personal objective of meeting asset growth in the division for which the particular member is responsible, in particular periods. Members of the Lending Credit Committee should have been drawn from a division or divisions of the Bank independent of, and autonomous from, business divisions.
There is a real danger that line managers will have a predisposition (because of this commitment to meeting profit plan objectives) to approving lending submissions without adequate scrutiny of the genuine merits of the submissions. What was lacking from the Bank's credit approval structure, at Lending Credit Committee level and below, was a procedure under which lending decisions would be rigorously and objectively analysed by a person not having a commitment to asset growth for its own sake. There was no institution or procedure within the Bank which permitted or required lending decisions to be scrutinised by reference solely to prudential considerations. All officers of the Bank who participated in lending decisions at Lending Credit Committee level and below were motivated either wholly or partly by the corporate desire for growth in assets. It is abundantly clear that this was a major failing within the lending structures of the Bank prior to 1990. In forming this conclusion, I have also had regard to the fact that many members of the Lending Credit Committee, in the period under review, were participants in a bonus scheme, or were otherwise entitled to bonuses, which reflected the growth, in a particular year, in loans written by the division of which the officer was a senior manager.
It is also evident from the above lists that, for the period under review, the Lending Credit Committee comprised a large number of different individuals. Membership fluctuated in two senses; first, the number of attendees at meetings ranged from three (in breach of its charter) to seven; secondly, members did not attend - and were not required to attend - every meeting. Strictly, it was a misnomer to describe the Lending Credit Committee as a committee. A consequence of this situation was that the accountability of individuals was weakened. Indeed, certain of the members may not have developed the skills required to perform the Committee's lending function adequately. In commenting upon the limitations of the Lending Credit Committee, J P Morgan in their review of the Bank's Credit Policies and Procedures stated the following:
"It is constituted of a "revolving door" of individuals who do not consistently review all credits. This can give rise to abuses (e.g., stacked committees), individuals participating who have little interest in the procedures, and some participants who may not have well developed credit expertise. All members of the GCC have other day-to-day responsibilities and may not have time to review a large quantity of credit submissions in any depth.
We believe this system stifles accountability. So many people are part of the approval chain that responsibility can be attributed to any part of the organisation. Junior account managers assume any errors will be caught by senior managers. Senior managers assume a problem will be caught before it gets to them. Everyone assumes CQ [scil "Credit Quality"] managers will address critical issues and bring them to everyone else's attention.
In our interviews we repeatedly heard comments to the effect that the process was circumvented by someone appealing to a higher manager. This occurred when it was feared a given manager or CQ manager might raise an objection to a transaction." ()
It is quite clear that the Lending Credit Committee was not a Committee in the strict sense, but rather a fluctuating group of individuals. In the submission of the State Bank of South Australia to the Auditor-General, reference is made to concerns expressed by Executives, including:
". Lending Credit Committee was too transactions oriented rather than focusing on broader asset quality/portfolio risk considerations; also Lending Credit Committee, by the nature of its operations, did not promote individual accountability; ..." ()
Serious reservations were also expressed in relation to the Lending Credit Committee by Mr T L Mallett, General Manager Treasury and International, in a memorandum to the Managing Director, dated 4 May 1989:
"For some time I have been concerned about the effectiveness of our Lending Credit Committee. This concern does not centre around the commitment of the individuals who play a role in it, but rather the attitudes that have been built into the Bank because of it and the difficulty of anybody to have a decision making role with no responsibility (other than a feeling of responsibility to the bank as a whole) for the real impact of their decisions.
Because of the membership structure of Lending Credit Committee, there has been considerable inconsistency in Lending Credit Committee decisions. Well illustrated by numerous re-submissions to Lending Credit Committee (with no material change in the application), on the basis that a different quorum may be/will be present. The inconsistency in Lending Credit Committee decisions has been very specifically covered by Executive Vice Present, U.S.A., Chief Manager, London and Chief Manager, Corporate.
I believe the history of the Lending Credit Committee centres around the Managing Director's wish that no individual should have a discretion exercised alone and without some form of independent review. I also believe that Lending Credit Committee in the years 1985 and 1986, served the growing Bank very well. It provided an opportunity to "educate" diverse members of the Bank's management team into some areas of the Bank's total risk portfolio. It however arguably did not in any way protect the Bank from making bad lending decisions."()
More than one regular attendee at meetings had no corporate lending experience. In reality, those members attended merely to make up a quorum.() Some members did not retain papers circulated to members. Thus, they were unable personally to monitor the Bank's lending practices, and to ensure compliance with its procedures, except by casting a vote at a particular meeting; they were individually unable to monitor either compliance by line personnel with conditions of approval set by the Committee, or exposures to a particular borrower or group of borrowers. Equally, there was no expectation that they would undertake these monitoring tasks. Members personally were not subjected to that duty. In addition, the Committee sought to make decisions by way of consensus. That must inevitably have weakened the sense of personal responsibility which attendees felt. The Committee often itself resolved difficulties and inadequacies in submissions, rather than rejecting a submission and requiring its re-submission in different form. Furthermore, members of the Committee were, by and large, division managers interested in ensuring growth in the Bank's assets; they must for that reason, as I have said, have had a predisposition in favour of approving lending submissions.()
I am satisfied that, as a consequence of the manner in which it was convened and of its lack of accountability, the Lending Credit Committee did not adequately fulfil its defined role in the assessment of loan applications. Nor is there evidence to demonstrate that the Lending Credit Committee effectively addressed its responsibilities as regards half-yearly reviews and related reports to the Board in relation to loan quality.
I should add that there was another fundamental weakness in the way in which the Lending Credit Committee was constituted. As I have said, members of the Committee were senior line managers. They served on the Lending Credit Committee as an adjunct to their ordinary duties, which, I assume, generally involved a full time commitment, and which I accept must have been quite onerous from time to time. Thus, their service to the Lending Credit Committee was merely both part-time, and secondary to their principal managerial responsibilities. It was an inevitable consequence of this that Lending Credit Committee members, at least at certain times, would not always have had adequate free time within which to analyse lending proposals.
It is clear in retrospect that the weekly workload imposed upon the members of the Lending Credit Committee was excessive, having regard to the other duties of its members. The number of credit papers considered by the Committee in meetings at which for, example, the Collinsville transaction was considered was:
| Date |
Number |
| 20 July 1989 |
4 |
| 21 November 1989 |
20 |
| 5 December 1989 |
16 |
| 30 January 1990 |
17 |
| 7 August 1990 |
6 |
| 21 August 1990 |
13 |
| 8 January 1991 |
32 |
| 21 February 1991 |
12 |
| 6 August 1991 |
4 |
| 22 October 1991 |
14 |
The maximum number of credit papers which one former member of the Committee could recall being presented to any one meeting of the Lending Credit Committee was 38. Lending Credit Committee members had line management responsibilities, and were, in many instances, unable to consider credit submissions in the course of their working day. Credit papers were, I was informed(), usually received late on Friday afternoons for consideration in time for the Lending Credit Committees meetings at 8:45 a.m. on the following Tuesday. Inevitably credit papers were often examined after hours and at weekends, and imposed considerable demands on Lending Credit Committee members' time. There was, I am satisfied, a fundamental weakness in the Bank's credit process arising from the involvement of Credit Committee members in a "part-time" capacity.
The Bank now has a small team of full time personnel who discharge the role previously performed part-time by the Lending Credit Committee.()
8.4.5 OTHER LENDING AUTHORITIES
The system of delegated lending authorities which was in place within the Bank operated so as to give individuals in positions of responsibility authority to make credit decisions on transactions up to a designated maximum dollar amount. Delegated lending authorities were conferred on offices rather than on officers personally. The titles or positions within the Corporate Banking division on which delegated lending authorities were conferred were those of:
(a) General Manager;
(b) Chief Managers;
(c) Senior Managers; and
(d) Managers (in limited situations).
Officers in each of these positions were in fact given three different lending authorities depending on the type of credit decision being made. That is to say, different delegated lending authorities applied to:
(a) decisions to approve or decline new loan facilities;
(b) decisions to approve or decline renewals (ie continuation) of existing facilities; and
(c) decisions to approve or decline applications for increases in existing facilities.
Appendix E to this Chapter summarises the delegated lending authorities held by officers in the Corporate Banking division at various times in the period under review. Appendix E contains three tables, respectively reflecting the three different types of credit decision listed above.
As an example, it can be seen from Appendix E that, on 30 June 1990, a Chief Manager in the Corporate Banking division was authorised to approve:
(a) new loan facilities to a maximum credit limit of $2.0M;
(b) renewals of existing facilities to a maximum credit limit of $5.0M, provided that the borrower satisfied the following conditions:
. all arrangements approved had been honoured;
. no material deterioration in financial position was evident; and
. no deterioration in security was evident, and risk assessment was the same, or better than, when the original exposure was approved.
If any of these conditions were not satisfied, the Chief Manager could not approve the renewal. (A facility of up to $5.0M which did not satisfy any of the above conditions required approval by the General Manager); and
(c) increases in existing facilities of amounts not exceeding $0.25M. If the total increased exposure exceeded $2.0M, the increase was required to be reported for confirmation as follows:
. $3.0M to $10.0M Lending Credit Committee; and
. Over $10.0M Board of Directors.
I have formed the view that the delegated lending authorities applicable in the Corporate Banking division were generally too low.() Although one might consider that to impose tight restrictions on the value of loans capable of being approved by individuals is a prudent measure, in fact this can have material negative effects.
First, it limits the degree of responsibility of a particular lending officer and results in a loss of accountability by those individuals who should be capable of making more substantial credit decisions. Responsibility for a lending decision should remain with the officer who recommended the proposal for approval.
Secondly, it imposes an excessive workload on higher credit approval organs, and thus results in a deterioration in the quality of the credit decisions made (and other functions performed) by those higher authorities.
The adverse effects of inappropriately low delegated lending authorities were inflicted upon the Bank. Some were identified by Mr Mallett in his memorandum to the Managing Director, dated 4 May 1989:
"The internal assessment prior to Lending Credit Committee's consideration, deteriorated to a salesmen job on the basis that if the deal is not alright then for sure Lending Credit Committee would decline it. A further step has then evolved in that if the deal goes bad, a documented response from Corporate Banking has been "its Lending Credit Committee's problem they approved the transaction".
What I would like to concentrate on is a credit approval process that ensures that responsibility rests entirely with the people managing and monitoring the facility. I am also conscious of a Bank wide philosophy that no individuals have discretions. I believe that this scenario would actually tighten our lending approval process (the downside could possibly be that it will slow down our asset growth eg marginal deals are unlikely to be approved, as they are at this time)." () [Emphasis Added]
Notwithstanding that memorandum, no significant improvement to this situation had been achieved by early 1991, when J P Morgan noted:
"Our opinion is that the dollar amounts (of the delegated lending authorities) are too low at most levels. This results in too many layers of management becoming part of the lending decision, which limits accountability. Further, the limited authority results in what appears to be too many decisions being made at the Group Credit Committee and Board levels." ()
Whilst the delegated lending authorities applicable in the Corporate Banking division were too low, it would not have been prudent significantly to increase the delegated lending authorities without also implementing controls calculated to ensure the quality of the credit decisions made by individuals, such as independent credit inspections and hindsight overviews by peers. These controls were not, however, introduced into the Corporate Banking division until towards the end of 1990 (refer to Sections 8.5.5 and 8.5.9). Delegated lending authorities were, as I have said, revised from time to time by the Board. It is impossible to discern in the Board Papers and minutes any rationale for these revisions. The Board would appear never to have directed its attention to the appropriateness of the authorities which it was conferring. Even the anomalously high authority conferred on the Chief General Manager, International, escaped recorded comment by the Board. Certain of the former non-executive directors of the Bank have, however, submitted that the Board did consider the issue of the high delegated lending authority conferred on the Chief General Manager, International, and were advised by the Chief Executive Officer of the Bank, Mr Clark that the authority was necessary on account of the time differences under which the Bank's international operations functioned.()
8.4.6 OVERSEAS LENDING AUTHORITIES
Overseas lending authorities were established to assist in the efficient and expeditious processing of lending proposals by overseas offices of the Bank situated in London, New York and Auckland. No such authorities were established for the Hong Kong office, as all approvals for lending proposals from this source were dealt with directly from Australia.
London Office Credit Committee
The London Office Credit Committee was established on 23 January 1986. On it was conferred a delegated lending authority of GBP 500,000 (or equivalent in other currencies) with the proviso that, in the absence of the Chief Manager, London, the ceiling was reduced to GBP 250,000 (or equivalent in other currencies).() Both the submissions to the Board and the Board's resolution adopting that submission proposed that the "... discretion to apply to one entity or group of entities where beneficial ownership exceeded 40 per cent". This rider may have been intended to incorporate, by reference, the Bank's prudential guidelines on exposures to individual borrowers or groups of borrowers.
The membership of the London Office Credit Committee comprised:
(a) Chief Manager, London (Chairman);
(b) Senior Manager, Corporate Treasury;
(c) Senior Manager, Capital Markets;
(d) Financial Controller; and
(e) Senior Manager, Operations.
In the absence of the Chief Manager, London, the Senior Manager, Corporate Treasury assumed the role of the Chairman. A quorum of three was required.()
Facilities approved were reviewed by the London Office Credit Committee on an annual basis, or more regularly if there was any evidence of deterioration in the quality of the credit. It was also a requirement that any deterioration in lending be promptly reported to Head Office.
Meetings were held as required. Minutes were required to be taken, but were in fact not made until about December 1988, almost three years after its establishment.
New York Office Credit Committee
The New York Office Credit Committee was established by resolution of the Board on 27 October 1988, with a delegated lending authority of USD 2.0M (or equivalent in other currencies) with the proviso that, in the absence of the Executive Vice President, USA, the ceiling was reduced to USD 1.0M (or equivalent in other currencies). Once again the Board resolved that "... in both cases, the discretion to apply to one entity or group of entities where beneficial ownership exceeds 40 per cent."() I again interpret this policy to be intended to preclude loans in excess of the ceiling to one entity, or group of entities as defined by the Bank's prudential guidelines.
The New York Office Credit Committee comprised:
(a) Executive Vice President, USA (Chairman);
(b) Vice President, Corporate;
(c) Vice President, Credit;
(d) Vice President, Administration and Operations; and
(e) Vice President, Treasury.
In the absence of the Executive Vice President, USA, the Vice President, Corporate, assumed the role of Chairman. A quorum of three was required.
Meetings were held as required. Minutes were taken.
Auckland Office Credit Committee
The Auckland Office Credit Committee was approved by the Board on 25 May 1989, with a delegated lending authority of NZD 3.0M (or equivalent in other currencies) with the proviso that in the absence of the Chief Manager, New Zealand the ceiling was reduced to NZD 1.5M (or equivalent in other currencies). Again the prudential policy limit was that, in both cases, the discretion applied to one entity or group of entities where beneficial ownership exceeded 40 per cent.()
The Auckland Office Credit Committee comprised:
(a) Chief Manager, New Zealand (Chairman);
(b) Senior Manager, Banking;
(c) Senior Manager, Operations; and
(d) Treasury (Chief Manager plus two others).
In the absence of the Chief Manager, New Zealand, the Senior Manager, Banking assumed the role of Chairman. A quorum of three was required. Meetings were held as required. Minutes were kept.
Credit proposals which exceeded the overseas office credit committees were forwarded to the Chief General Manager, International or to the Lending Credit Committee as appropriate. As to the exposures of these three off-shore branches as of 31 March 1991, I direct the reader to Chapter 19 - "The Overseas Operations of the State Bank." ()
8.5 CREDIT MANAGEMENT POLICIES AND PROCESSES
8.5.1 INTRODUCTION
This Section of the Report describes and assesses the Bank's policies and processes in relation to the approval, and subsequent management, of the loans made by the Corporate Banking division in the period under review. The policies and processes of Corporate Banking division were selected for analysis for two connected reasons. The first was that, as I show below, Corporate Banking generated most of the Bank's non-performing loans, numerically and in dollar terms. The second was that, the Bank having developed from two retail banks, its retail lending policies and processes were relatively well-developed.
The credit management process denotes the implementation of policies and procedures for:
(a) the evaluation and approval of loan facilities;
(b) monitoring compliance by customers with the terms and conditions of loan agreements;
(c) monitoring the financial position of customers with a view to detecting significant developments which may affect the recoverability of the loan by the Bank; and
(d) taking appropriate corrective action in the event of non-compliance by the borrower or in the event of a deterioration in prospects of recovering a loan.
This Chapter describes and assesses the Bank's credit management policies and procedures by reference to eight stages (or tasks):
(a) initiation of loans;
(b) approval of loans;
(c) loan security;
(d) hindsight overview;
(e) settlement of loans;
(f) management of loans;
(g) management of non-performing loans; and
(h) credit inspection.
The following sub-sections deal with each of these eight stages of the credit management process. In each case, the Investigation's attention has been focused on the policies and processes within the Corporate Banking division. Only passing reference is made to the other divisions.
The principal sources of information as to the credit management policies and procedures which existed in the Corporate Banking division are the various lending manuals which were developed and introduced during the period under review by this Investigation. It may be helpful at this point to provide the reader with a brief history of these manuals:
(a) The initial policies and procedures manual for the Corporate Banking division was a collection of internal memoranda dated from 1985 to 1987, most of which were sequenced and assigned a reference number. Until March 1988, policies and procedures continued to be communicated principally by memoranda within the division.
(b) In March 1988 brief policy guidelines were introduced entitled "Corporate Banking, Policy Guidelines on Reporting Procedures". This document contained a number of broad statements and specific directions in regard to the lending process and indicated that:
"The policies and procedures set out herein are given to form a base by which Managers and Senior Managers can develop their own style of account management". ()
Reference was made in the March 1988 guidelines to a forthcoming manual:
"A comprehensive manual will be prepared over coming months to expand the contents herein." ()
(c) This "comprehensive" manual was released in September 1988 and was entitled "Credit Policy Manual".
(d) In or about October 1989, a more detailed manual was introduced bearing the title "Corporate Banking Division Accounting Policies and Procedures". A number of the policies and processes articulated in it have since been updated and remain in use. This manual operated on a loose-leaf system. This has made this Investigation's task of identifying which policies and procedures were in place at particular dates a difficult one. When Sections were inserted or replaced, the year and month were noted on each new page. A substantial Section of this manual entitled "Credit Policies and Procedures" is dated March 1990.
(e) At its meeting on 23 November 1989, the Board of Directors had noted the decision of the Executive Committee to approve the establishment of a major internal project team to redevelop the Australian Banking credit process. At its meeting on 26 October 1989, the Board had requested a paper detailing procedures being adopted for the restructure of the Credit Quality Section and loan approval procedures within Australian banking. Independently, Corporate Banking division had determined a need for a major overhaul of the credit quality process within Corporate Banking division. The Board Paper, produced to the Board in November 1989,() noted that it had been agreed at a meeting of Corporate Banking division and other Bank division executives that the division's current credit process was inadequate for the Bank's future needs. The Board Paper noted it had been further agreed, that, to achieve the objective of restructuring credit processes, a radical restructuring of the Bank's current credit processes, at all levels, was necessary.
(f) Also dated March 1990 are a series of documents entitled "Group Credit Policy Statements". These were initial drafts of policy statements intended to be later included in the "Group Credit Manual". A number of policy statements in the series were not completed in the period under review by this Investigation and were still to be issued when the "Group Credit Manual" was introduced in March 1991.
(g) The "Group Credit Manual" was only partly complete when introduced in March 1991. The index to the Manual recorded that a number of policy and procedure statements were still to be issued. It is intended by the Bank that this document have application throughout the State Bank Group and for that reason it contains a number of high level policies, together with certain detailed operational procedures common throughout the State Bank Group. The manual states that each division is to use it to develop a Local Credit Manual by interpreting and transposing the contents, taking into account the local business environment.
I do emphasise that the criticisms which appear in the following pages are directed to the Bank's credit policies as on foot prior to 1 March 1991. The Bank has informed the Investigation that its guidelines, policies, and procedures, in relation to the management of credit, were completely overhauled following the introduction of its two volume Group Credit Manual in March 1991. That manual, I have been informed, is constantly being reviewed and updated by the Bank. In subsequent pages, I have briefly referred to specific guidelines, policies, and procedures, which the Bank has informed me have been modified since February 1991. In view of my Terms of Appointment, it has not been appropriate for me either to investigate, or to form or express a view on, the credit management guidelines, policies and procedures currently applied within the Bank. For these reasons, nothing in the following pages is intended to be either a criticism or an evaluation of any aspect of the guidelines, policies, and procedures, of the Bank as on foot since 1 March 1991.
The memoranda and manuals issued before March 1991 provide evidence as to the policies and processes which existed at various times. The case studies which follow in Chapters 9-14 provide evidence of the extent to which these policies and procedures were complied with in the period prior to 1 March 1991.
8.5.2 INITIATION OF LOANS
8.5.2.1 Definition
Initiation of loans denotes the process of instigating new business; obtaining data in relation to a prospective borrower, and the preparation of a credit submission which provides a particular lending organ with the background to the transaction, the proposed structure of the loan facility; analysis of the proposal (including assessment of any valuation), and the justification for recommending the transaction.
8.5.2.2 Policies
The first statement of policies relevant to the initiation of loans by the Corporate Banking division was contained in the Credit Policy Manual published in September 1988. The Credit Policy Manual emphasised the importance of evaluating the prospective borrower's cash flow and repayment ability:
"Credit quality must always take precedence over exploitation of business opportunities. Put simply, safety of principal and assurance of repayment within the allotted time frame have priority over the profit on the transaction. One cannot charge an interest rate high enough to compensate for a loan that cannot be collected." ()
...
"Lending to a borrower on a secured basis is usually meaningless on its own. This type of financing must be premised on the borrowers viability as a going concern with adequate cash flow. Loans to otherwise weak borrowers should not be disguised as secured lending." ()
...
"Do not regard security as a substitute for repayment - loans must be repaid from the flow of cash."
The Corporate Banking Division Accounting Policies and Procedures Manual, introduced in October 1989, and progressively updated, added further emphasis to the importance of the prospective borrower's ability to service and repay the proposed loan:
"Adequate ability to service any loan should be the core of a submission." ()
...
"Submissions must detail the sources of funds to cover:
. interest serviceability,
. programmed reductions, and
. capital repayment."
...
"Security should be looked upon as a comfort factor with repayment ability being of paramount importance in assessing any lending proposals."
In March 1990, a policy statement was issued which addressed the responsibilities of officers and, in particular, the responsibilities of the recommending officer:
"The recommending officer is responsible for the preparation of an analysis of the customer's financial position and the transaction in sufficient detail to make it clear why the risks inherent in the credit are acceptable to the Group. The recommending officer is accountable for such recommendation and is responsible for clearly identifying all the positive and negative features of the credit".()
Another policy statement, issued in March 1990,() dealt specifically with the process of credit risk assessment. It provided specific guidance on, amongst other things, the information to be gathered and the matters to be considered in the assessment of credit risk. It also provided direction on establishing the potential maximum credit exposure which the Bank should accept in providing a customer with a particular type of credit facility.
8.5.2.3 Processes
No formal processes for the initiation of loans by the Corporate Banking division have been identified prior to July 1986. In July 1986 a document entitled "Proposed Format and Guidelines for submissions, to the Lending Credit Committee"() was introduced. It required that all submissions include information under the following headings:
| (a) | introduction; | (i) | fee structure; |
| (b) | directors; | (j) | estimated earnings; |
| (c) | major shareholders; | (k) | borrower details; |
| (d) | facilities | (l) | financial summary; |
| (e) | terms of arrangement; | (m) | safety assessment; |
| (f) | purpose; | (n) | general comments; |
| (g) | security; | (o) | clonslusion; and |
| (h) | repayment ability; | (p) | recommendation. |
This document provided basic instructions as to the information which should be gathered and included in submissions, but did not provide guidance as to how this information should be analysed. For example, under the heading "repayment ability", the following instructions are given:
"3 year comparative profit and loss figures, identify take out source if not from profits. Latest figures not to be over 6 months old. Interim figures may be unaudited."
At this time, (July 1986), there were no dedicated computer systems to support the loan initiation process. Lending submissions were initially hand written, and subsequently typed for presentation. Occasionally, computer spreadsheets, not in fixed format, were utilised to assist preparation of the financial analysis of borrowers' accounts and financial statements.
On 9 October 1986, Mr D C Masters (Chief Manager, Corporate Banking) circulated a memorandum to Senior Managers, Corporate Managers, Corporate Officers, and Analysts, on the topic of preparation of Lending Credit Committee and Board Papers. It differed somewhat in content from the prescriptions in the July document to which I have referred. Mr Masters' memorandum stated:
"Frequent requests have been made for uniformity in the presentation of the above papers; and a standardized model has been supplied to you for this purpose.
Over recent weeks this model has been frequently departed from and Board Dockets presented have exceeded the two pages (maximum - three) requested.
This memo. is given to further expand upon previous requests made and to advise that in future, dockets which are not prepared in the standard format, will not go forward to L.C.C. or Board until they comply.
PREPARATION OF L.C.C. PAPERS
These are to be prepared as a two part submission:-
. Part 1
Two (maximum - three) pages are to be prepared as the Board Docket. This part is to contain all relevant facts concerning the borrowing in the briefest detail. Attachment "A" sets out the requirements of this paper.
. Part 2
Is to be comprised of (sic) all supporting material to allow the Lending Credit Committee to fully check the lending assessment. This should comprise:-
Annexure A History Sheet on Company
Annexure B Financial Analysis and Balance Sheet Notes, Cash Flows, Projections etc.
Annexure C Security Appendice showing details of security to be taken, lending margins extended, insurance etc.
It is a further requirement that any papers which are considered to be a (sic) complicated structure, must have a diagrammatic chart attached explaining the transactions. Such transactions are also to be supported by the Chief Manager, before being distributed to L.C.C. members. Straightforward proposals are to be supported by a Senior Manager before being distributed to L.C.C.
All Board Dockets must have the initials of the Chief Manager before being forwarded to the Board Secretary.
As stated earlier, the Secretary of the Lending Credit Committee has been instructed that proposals submitted, which do not conform to the above requirements, will be returned to the writer for correction before going forward to L.C.C. or Board."
The pro forma submission which accompanied this memorandum required, among other things, the following:
"GROUP EXPOSURE
Only to be shown where Bank has additional group exposure other than detailed above.
...
FEE STRUCTURE [Explicit]
- Estimated Earning to Bank
[ To be a one line statement, with amount, not a complicated formula ]
SECURITY
Brief summary of type, market value and lending margin (detailed Annexure to be provided to L.C.C.).
- Safety Assessment
[ Brief statement as to adequacy and acceptability etc.]
REPAYMENT ABILITY - brief statements covering:-
- Projected Income/Budget Figures
- Interest Cover/Servicing Ability
- Repayment Capacity
[ Supporting evidence, cash flows and detailed analysis to be attached for L.C.C.] ..." [Emphasis Added]
The Credit Policy Manual introduced in September 1988 provided some general guidance relevant to the loan initiation process, as follows:
". Make certain that the loan has a productive purpose and verify repayment sources and terms before the loan is committed. Ask yourself if anything could go wrong that would jeopardise repayment.
. Obtain both current and past financial statements and related supporting data.
. Pay close attention to the basic ratios of credit, including the trend in profitability, turnover and liquidity.
. Understand the borrower's trade cycle and how cash is derived.
. Satisfy yourself about the borrower's continuing ability to generate cash from operations.
. Check trade reactions. The trade often detects trouble faster than Bank lenders.
. Be satisfied with the borrower's financial controls."()
The Corporate Banking Division Accounting Policies and Procedures Manual developed the initiation of loans process in a number of significant ways:
(a) Detailed guidance notes were provided in relation to the financial analysis that should be performed prior to approving a loan.() In particular, standard forms were introduced for the purpose of presenting financial information pertinent to the customer, and to guide basic assessment procedures, including the calculation of relevant financial ratios and forecasts of cash flows.()
(b) Detailed processes were introduced relating specifically to the approval of unsecured loans.() These processes included:
(i) review of the submission, with particular attention focused upon:
. quality and integrity of management;
. track record and future prospects of the business;
. borrower's capital base;
. ownership structure; and
. quality of co-lenders.
(ii) constructing and negotiating covenants to support the facility; and
(iii) preparation of an Undertaking/Covenant Compliance Sheet to assist with the monitoring of covenants.
(c) Specific instructions were given regarding the submission of papers to the Lending Credit Committee and the Board.() Whilst papers submitted to the Lending Credit Committee were required to be fully completed in terms of promulgated instructions, policies and procedures, the Bank restricted the volume of information which was to be provided to the Board:
"Papers should be two pages where possible with a maximum of three pages and must be initialled by the Sectional Senior Manager." ()
I accept that it is not an easy task, in formulating general lending processes, to strike the correct balance between the supply of excessive detail to, and the withholding of material information from, an approving unit.
There was also a requirement that all presentations to the Lending Credit Committee or above include suitable "Funds" and "Cash Flow" statement analysis.()
Further guidance relevant to the initiation of loans was provided in March 1990, with the release of Group Credit Policy Statement No 4, "Credit Risk Assessment", which addressed the process of initiation of loans in three stages:
(a) establishing the potential maximum credit exposure;
(b) gathering and analysis of financial and other relevant information; and
(c) safety assessment.
In determining the potential maximum credit exposure, consideration was to be given to:
(a) the "credit limit" as defined in GCPS-13();
(b) the customer's ability to service the payment of interest and fees; and
(c) additional potential exposure over and above the amount of the "credit limit".
The gathering and analysis stage required consideration of the following aspects of a proposal:
(a) a customer's ability to repay and service the loan;
(b) the ratio of debt to equity;
(c) security;
(d) a customer's ability to implement strategies so as to ensure that it could meet its obligations;
(e) the economic and political conditions likely to be relevant during the life of a facility;
(f) the role and position of the customer in the industry;
(g) a customer's knowledge and management expertise; and
(h) the use (where appropriate) of advice from independent external experts/consultants.
The third stage, that of safety assessment, involved consideration of whether further security may be required so as to offset a weakness in one of the areas of the proposed exposure.
Responsibility for the implementation of these processes rested with the Account Manager.
8.5.2.4 Assessment of Policies and Processes
In my opinion, the formal policies and processes for the initiation of loans were inadequate in that:
(a) prior to the introduction of the Credit Policy Manual in September 1988, there was no policy or process to ensure that loan proposals would not be recommended on the basis solely or principally of the security offered by the applicant, and without due consideration of the applicant's ability to service and repay the debt;
(b) prior to the introduction of the Credit Policy Manual, there were no policies or procedures requiring an analysis of a prospective borrower's cash flows as a standard procedure in the preparation of a credit submission, in order to assess the borrower's repayment ability;
(c) directions were not given to Managers calculated to ensure that they performed sensitivity analysis of cash flow projections provided by customers, nor was any guidance given as to how such sensitivity analysis should be done;
(d) prior to the introduction of the Credit Policy Manual, directions were not given to Managers calculated to ensure that they obtained sufficient information, and performed appropriate analysis, to enable them properly to assess all the risks inherent in a proposed loan; and
(e) prior to March 1990, the responsibilities of Managers preparing credit submissions were not defined, so that the extent of their accountability was not made clear prior to this time.
The lack of a requirement that cash flow analysis be performed was noted by the Board in early 1990, and resulted in a letter being sent by Mr Hartley, Director, to Mr S G Paddison on 5 July 1990, in the following terms:
"What worries me is that, in assessing proposals, management still appear pre-occupied with profitability forecasts and the various ratios, interest cover, etc, associated with profit. Yet the events of the last year or so have shown that profit is only a concept, a book entry ... The only true measure is cash flow." ()
Mr Paddison responded to Mr Hartley by letter dated 12 July 1990 agreeing with his concerns.
It has been submitted to the Investigation on behalf of Mr R P Searcy that he, in addition to Mr Hartley, required "cash flow analysis on transactions that were brought to the Board". Mr Searcy was not able to remember on what specific occasions he sought such a cash flow analysis.
Between February and April 1991, J P Morgan conducted a review of the Bank's credit policies and procedures. J P Morgan was critical of the Bank's lack of focus on cash flows and the emphasis placed on security,() and of the standard of credit submissions in general:
"They do not contain enough analysis, and they do not sufficiently identify the risks of the credit. Projections, or any forward thinking, are seldom included. When they are, they are typically those of the customer. Little critical comment on the assumptions is included, nor is sensitivity analysis of the assumptions performed." ()
The Bank has informed the Investigation that it has sought to address these criticisms, and that the goals of the Bank in relation to credit management now include the following:
(a) ensure credit appraisal and credit origination contain appropriate checks and balances;
(b) place appropriate emphasis on repayment ability from cash flow;
(c) use a rigorous common credit risk grading system applied consistently across all of the Bank Group;
(d) define clear job descriptions, functions, accountabilities, and objectives, for all positions;
(e) require personal responsibility, accountability, and "credit ownership", such that originating officers are held personally accountable for the quality of the credit which they originated and managed.()
In relation to the conclusions set out above under the heading "Assessment of Policies and Processes", the Bank has submitted that its current Credit Manual does not place undue emphasis on the value of security proffered by a customer, but rather lists a number of other relevant considerations, including the customer's ability to meet obligations and potential obligations to the Bank and to other creditors as they fall due; that an analysis of the prospective borrower's cash flow is a mandatory part of the credit origination and approval process; that the Credit Manual now contains detailed guidelines in relation to the preparation and reporting of cash flow analysis; that the Credit Manual contains guidelines and procedures necessary to ensure that appropriate sensitivity analyses are performed; that officers involved in credit origination and approval must obtain sufficient data and perform analyses adequate to an assessment of all the risks in the proposal; and that the Manual now sets out in detail the procedures which Bank officers should follow in discharging that obligation.()
8.5.2.5 Conclusion
I have formed the opinion that the Bank's formal policies and processes in respect of the initiation of loans were inadequate in the period reviewed by this Investigation.
The inadequacy of the Bank's policies and procedures for the initiation of loans is made evident by several of the loan case studies examined by the Investigation. For example, the initiation of loans was found to be deficient in:
(a) the Interwest/Somerley Pty Ltd facility (Chapter 13 - "Case Study in Credit Management: Somerley Pty Ltd") in that;
(i) the report projecting the value at completion of the project for which the Bank's funding was sought was not adequately considered or analysed; and
(ii) the proposal which recommended the buy-out of other First Tier syndicate members, and thus an increase in the Bank's exposure, was incorrect and misleading in certain material aspects.
(b) the REMM Group Ltd facility (Chapter 14 - "Case Study in Credit Management: The REMM Group") in that;
(i) no detailed analysis of the REMM Group Ltd's financial position was found in the Bank's files; and
(ii) no comprehensive feasibility study was undertaken. The study, to the extent to which it was carried out, was inaccurate.
(c) other transactions examined by this Investigation, in that;
(i) in three cases no cash flow analysis was prepared;
(ii) in two cases no sensitivity analysis was undertaken; and
(iii) in one case, where the value of a broadcasting licence was fundamental to the security available to the Bank, and to a balanced and diligent assessment of the facility as a whole, no consideration was given to the effect which a deterioration in revenue would have had on the value of the licence. In addition, by reason of statutory restrictions on transfer of that broadcasting licence, it was doubtful that the Bank would ever be able to become the beneficial owner of, or to dispose of the beneficial interest in, the licence. Thus, for practical purposes, the Bank's lending was unsecured.
8.5.3 APPROVAL OF LOANS
8.5.3.1 Definition
Approval of loans denotes the decision-making process associated with the approval or rejection of a proposed loan facility, including both the initial approval at the time of inception of the facility, and any subsequent renewals or extensions of a facility.
8.5.3.2 Policies
I have already referred in Section 8.4 to the Bank's system of "delegated lending authorities". The system of delegated lending authorities existed from the Bank's inception and operated continuously throughout the period under review by this Investigation. The only significant changes were revisions from time to time to the ceilings of the delegated lending authorities. Such changes to ceilings were made by the Board and communicated to the relevant lending authorities by way of internal memoranda.
Appendix E to this Chapter provides a historical summary of the delegated lending authorities applicable to the Corporate Banking division.
Some guidance on the application of delegated lending authorities was contained in the document entitled Corporate Banking Policy Guidelines on Reporting Procedures which was issued in March 1988:
"Facilities may only be approved if firstly recommended for approval by an officer immediately subordinate to the approving officer.
Unsecured facilities must be approved by the Chief Manager, General Manager, Lending Credit Committee or Board of Directors"()
This document then outlined the delegated lending approval authorities that had been approved by the Bank Board on 23 July 1987.
In addition to conferring delegated lending authorities in respect of new loan facilities, the Board conferred increased delegations for the renewal of loans and for increases in existing facilities. As I have noted in passing at para 8.4.5, however, the use of extended delegations was restricted:
"The use of extended delegation is subject to:-
. Account must have been approved or reviewed within twelve months prior to the date the increase is sought
. Existing facilities are being conducted in a satisfactory manner
. Security/Risk Assessment has been fully considered, with no deterioration evident since approval or first review, and increased exposure is deemed quite safe
. Brief details of increase in facilities under extended delegations are reported as under for confirmation:
$3M to $10M - Lending Credit Committee
Over $10M - Board of Directors"
The Credit Policy Manual of September 1988 noted the increased delegated lending authorities that had been approved by the Board on 28 April 1988. There was no change to the use of extended delegations other than by way of increasing the limit of the aggregate exposure requiring confirmation by the Lending Credit Committee or the Board from $3.0M to $5.0M, to be reported as follows:
"$5M to $20M Lending Credit Committee
Over $20M Board of Directors" ()
In March 1990, Group Credit Policy Statement No 1 delineated the responsibilities of a loan approval officer:
"The approving officer is accountable for personal credit decisions and is responsible for:-
(i) undertaking a full assessment of the risks attaching to the credit and being satisfied that these are acceptable to the Group;
(ii) (where applicable), ensuring that, after approval, the credit memorandum is submitted for Hindsight Overview and that any corrective action required by the overviewer is taken at the earliest practicable opportunity" ()
In regard to controlling the concentration of risk in the Corporate Banking division's loan portfolio, the policies first documented were as follows:
". In general, the exposure limit to any entity is 20% of shareholders' funds.
. Full Board will consider a higher level of exposure, maximum 30% of shareholders' funds for `blue chip' corporate groups. As a general rule this would involve the top corporates in Australia usually enjoying a credit rating of AA or better.
. Full Board will consider proposals for the Bank to take on corporate risk on the basis that the risk can be sold down to place exposure within prudential guidelines within a period of six months.
. Full Board will allow management to place before it proposals of an exceptional nature, which falls outside prudential guidelines when management considers that there are benefits and extenuating factors that warrant a `one-off' decision.
. Contingent liability exposure at any one time is not to exceed 100 per cent of `risk assets' ie all loans and investments, excluding liquids and shareholdings."()
"Offshore exposure limits are as follows:
. New Zealand-AUD1000 million, interchangeable between direct and contingent liabilities, with a maximum of AUD500 million in direct facilities
. Other countries (except Australia and NZ)
- Direct - 20 per cent of Bank total assets
- Contingent - 20 per cent of Bank total assets
- Swap - 20 per cent of Bank total assets" ()
"Exposure to any industry, including contingent liability exposure is not to exceed 20 per cent of risk assets. Risk assets are all loans and investments, excluding liquids and shareholdings".()
"Exposure both actual and contingent to any one account/group is limited to 20 per cent of the Bank's capital base. The aggregate exposure limit to the South Australian Financing Authority, combining both direct and contingent risks, is to be not more than 100 per cent of total Bank capital resources.
The general maximum exposure to any single entity is AUD60 million. In exceptional circumstances applications may be submitted to Full Board for limits to a single entity exceeding AUD60M, but in any case not exceeding AUD100M.
Where the Bank provides facilities to a group of companies, in which single entities within the Group have individual limits, then the maximum of the combined facilities may not exceed AUD150 million".()
The Accounting Policies and Procedures manual introduced in October 1989() effected a number of significant changes to the policies outlined above, namely:
(a) maximum exposure to a single corporate entity increased to 30 per cent from 20 per cent;
(b) the general maximum exposure to any single entity of $60.0M was no longer referred to; and
(c) the maximum exposure to a single entity or group of companies that may be approved by the Board was increased from $150.0M to $250.0M.
I interpose that the stipulation which I have set out to the effect that the Board was authorised to approve a maximum exposure to a single entity or group of companies to a limit of $250.0M is not borne out by Board Minutes. To that extent, the Accounting Policies and Procedures Manual introduced in October 1989 would appear to be unauthorised.
8.5.3.3 Processes
The loan approval process began at the point when a credit submission was completed by a Manager with a positive recommendation. The Manager who prepared the credit submission directed the credit submission to the appropriate level of the credit approval hierarchy for either approval or a supporting recommendation. Credit submissions were able to be approved only if first recommended by an officer immediately subordinate (in the credit approval hierarchy) to the approving officer. In the Corporate Banking division, the hierarchy consisted of:
(a) Managers;
(b) Senior Managers;
(c) Chief Managers; and
(d) General Manager.
Senior Managers and above had delegated lending authorities.
Proposed loans which were greater in size than the General Manager's delegated lending authority continued further up the credit approval hierarchy, which, strictly speaking, and depending again on the size of the proposed loan, consisted of the Lending Credit Committee, the Board Sub-Committee and the Board. (For reasons given in the report on Collinsville (Chapter 11 - "Case Study in Credit Management: The Collinsville Stud Group"), the Board Sub-Committee was, and was perceived within the Bank as being, a lending organ of the Bank). In cases where the proposed transaction fell outside the delegated lending authority of the Lending Credit Committee but within that of the Board Sub-Committee, and where the Board Sub-Committee resolved to approve the loan, the proposed transaction would go before the Board for "confirmation" only. In those circumstances, the Board Sub-Committee was the ultimate credit approval organ within the Bank. In cases where the proposed transaction fell outside the delegated lending authority of the Lending Credit Committee and also outside that of the Board Sub-Committee, and where the Board Sub-Committee was resolved in favour of the loan, the proposed transaction would go before the Board for approval. In these circumstances, the Board was the ultimate credit approval organ within the Bank and the Sub-Board was, like the Lending Credit Committee, merely a recommending organ.
As an example of how that latter process worked, a loan proposal for a facility requiring Board approval would pass through the following decision-making steps:
(a) Manager or Senior Manager - prepared credit submission and makes recommendation.
(b) Lending Credit Committee and Board Sub-Committee - endorsed credit submission with a supporting recommendation.
(c) Board - gave final approval.
No particular documentation was associated with the loan approval process. Generally, only the outcome of lending decisions was recorded, rather than the deliberations of the lending organ by which a loan was approved. Minutes were kept of Lending Credit Committee meetings, but not of Sub-Board meetings. Minutes of Board resolutions relating to loan applications rarely record the substance of any debate which may have occurred on a particular proposition.
In late 1989 or early 1990, a Credit Quality Section, independent of the Bank's business units, was established. Amongst its responsibilities, the Credit Quality Section was required to review credit submissions for all "... medium, large and maximum credits" and, if satisfactory, approve and recommend that the credit be reviewed at the next level of authority. (By "maximum credits" is meant loans requiring approval by the full Board itself.)
8.5.3.4 Assessment of Policies and Processes
In my opinion, the formal policies and processes in regard to the approval of loans were inadequate in that:
(a) Prior to establishment in late 1989 or early 1990 of the Credit Quality Section, there was no review of credit decisions by a source independent of the business unit which sponsored the loan application. Accordingly, no strictly independent review was formally required to be carried out of the credit judgements being made by managers.
(b) The use of extended lending delegations on existing facilities weakened the control of the authority which had originally approved the facility by enabling a subordinate authority to approve increases. It was somewhat irrational for the Bank to have a series of delegations under which an officer could approve an increase in a facility in a sum larger than the ceiling on his or her original delegated lending authority. I say this particularly because it will often happen that a customer seeks an increase in a facility because the customer is encountering difficult financial conditions or is otherwise not operating to budget. For that reason, a bank should generally closely scrutinise applications by customers for increases in facilities. That scrutiny should be applied by the original approving organ.
(c) The responsibilities of officers recommending and approving loans were not stated until March 1990, so that the extent of their respective accountability was not made clear prior to this time.
(d) the levels of the delegated lending authorities were inappropriate. This required too many decisions to be made by the Lending Credit Committee. In a memorandum to Mr Paddison dated 27 October 1989, Mr Masters said:
"The present delegations and LCC process are outdated and as a result I believe credit approval is not getting proper due diligence. LCC papers for the meeting of last Tuesday (24th October 1989) totalled 26 submissions with 384 pages of material ... I am sure LCC members could not properly absorb the volume." ()
(e) the Lending Credit Committee should have been more concerned with broader asset quality issues. Furthermore, the involvement of the Lending Credit Committee in credit decisions removed accountability from individuals.
(f) there was no separation of responsibility within the Corporate Banking division between credit/marketing and credit assessment/approvals. This was raised by the Board as a concern in mid-February 1990.() Officers in divisions of the Bank other than Corporate Banking also discharged both marketing and credit assessment and approval duties. In the case of the Collinsville loan, in particular, this combination of incompatible duties led to imbalanced lending submissions being made. In fairness to the Bank, I do add that it was an invariable practice within Australian banks in the 1980's for business officers to have a credit function, and to have, as one of their duties, the preparation and recommendation and, to a certain level, the approval, of loan applications. I do not, therefore, level adverse criticism at the Bank simply because it adopted this practice. The Bank does, however, attract adverse criticism on the ground that it failed to erect necessary checks and balances within its credit approval process. I have already referred to the fact that members of the Lending Credit Committee were drawn from line divisions and that, in the period under review, no autonomous and independent unit of the Bank scrutinised loan applications before they were approved. It was the combination of three factors: first, the delegation of credit functions to business officers; secondly, the composition of the Lending Credit Committee; and thirdly, the absence of an independent credit unit, which made the Bank's lending structure unsafe in the period under review. The merging of business and credit functions in a single office is not unacceptable if accompanied by appropriate checks and balances such as credit inspection and hindsight overview.
The unsatisfactory features of the merger in one individual of the authority to originate and approve loans has been acknowledged by the Bank:
"There was some separation between origination and approval especially for larger transactions but approval below Board level was very much driven by the line divisions." ()
The Bank has also submitted that separation of responsibility between origination and approval of loans is now a reality, but is still at a very basic level. Further, the Bank has submitted that the credit management system of the Bank has now been streamlined, first, to ensure that a minimum number of employees or groups of employees are involved in the credit approval process, and, secondly, clearly to define the accountability of individual officers in relation to credit decisions. In particular, the Investigation has been informed that the Bank's current Credit Manual makes it clear that all delegators of credit authorities are required to ensure that any authority delegated to an officer below the delegator in the credit approval chain is appropriate to the delegate's capabilities and experience. The Group Credit Committee (the successor to the Lending Credit Committee), the Investigation has been informed, has been disbanded.
The Bank has informed me that credit inspection processes and portfolio managed processes have been established by the Bank with a view to periodically measuring the quality of a total portfolio management by individual Bank officers against the minimum requirements and standards stipulated for in the Manual; that the responsibilities of loan approval officers, at all levels, are now clearly set out in the policy and procedural Sections of the Manual; in relation to delegated lending authorities, that the scope of the various delegated credit authority types are now clearly set out in the Group Credit Manual; and that accountability for credit policy and credit approval and recommendation has been assumed by an office entitled Head of Credit which is divorced from the major line functions of retail and business/corporate banking within the Bank. The Bank has submitted that its new assessment procedures, - the independent hindsight review required by its current Credit Manual, the higher degree of emphasis on the accountability of approving officers, and the credit inspection process which it has established in combination - will achieve the result that it is no longer correct to state that the policies and processes of the Bank, in relation to the approval of loans, are able to be circumvented or violated.()
I also wish to make it clear that I direct no criticism to the concept or functioning of the Credit Quality Section. It is simply a reform which has come too late.
8.5.3.5 Conclusion
I have formed the opinion that the Bank's formal policies and processes in respect of the approval of loans in the period reviewed by this Investigation were inadequate.
The inadequacies of the policies and processes for the approval of loans became evident on scrutiny of several of the loans examined by the Investigation.()
8.5.4 LOAN SECURITY
8.5.4.1 Definition
Loan security denotes those policies which influence the quantum and quality of security obtained by the Bank from its customers, and the processes involved in valuing, documenting, perfecting, registering and discharging, securities held by the Bank.
8.5.4.2 Policies
The Corporate Banking division's loan security policies were formulated in writing, for the first time, in March 1988() and then only in the briefest of terms:
"Full details of Corporate Banking's security requirements will be provided at a later date, but in summary the policy is as follows:
. Acceptable security must be taken to secure all loans except where the lending is approved by the General Manager - Corporate and International Banking, the Lending Credit Committee or the Board.
. "Security must not be released, which supports borrowings unless approved by Chief Manager - Corporate Banking, General Manager - Corporate and International Banking, the Lending Credit Committee or the Board depending upon the level of debt and delegated authority.
. Where the Bank relies upon a Registered Mortgage Debenture for its primary security, the Balance Sheet must be audited to substantiate the assets being relied upon therein, or a partial audit certificate is to be supplied to the Bank, certifying that the assets as stated have a fair and realistic value.
. All assets taken as security, which may be in danger of loss must be insured, and an appropriate cover note/policy held prior to settlement.
. All security must be perfected in absolute terms and be enforceable before any draw-down of facilities is made. Advances made without security being in place will be viewed seriously."
The Credit Policy Manual introduced in September 1988, provided minimal guidance as to Corporate Banking division's loan security policies. It merely listed several important reminders in relation to asset-based lending, including:
". The asset's market value, currency and value at liquidation must be realistically appraised by knowledgeable persons. Even if there is a will to sell assets, there has to be a readily identifiable and measurable market.
. If at all possible, the security should be held in the bank.
. The security should give the bank a privileged position vis a vis all other creditors and be in a form that permits unconditional disposal at the bank's sole discretion.
. Do not wait too long to take and/or sell security.
. If you think you will ever have to take security, do so immediately; do not just secure the right to it." ()
and in relation to negative pledge lending:
"If lending against negative pledge covenants, they must provide the Bank with adequate means for controlling the loan and provide mechanisms for the Bank to act quickly if the company commences to go into decline." ()
The Corporate Banking Division Accounting Policies and Procedures Manual added significant detail to the processes in relation to loan security but did not specifically refer to policies in this area.
8.5.4.3 Processes
The Bank's general procedures for security documentation and valuation are comprehensively outlined in three documents:
. State Bank Instruction Manual Volume 14: Securities Procedures;
. State bank Instruction Manual Volume 15: Securities Documents; and
. State Bank Instruction Manual Volume 16: Valuations and Insurance.
These three manuals were introduced in 1985, and were progressively updated by removing and replacing superseded sections. The manuals had application uniformly throughout the Bank.
In 1985 and 1986, Corporate Banking division's managers needed to be reminded on a number of occasions that these manuals applied to them:
"In dealing with Guarantees generally, Corporate Managers should comply where appropriate with the provisions contained in the Manual of Instructions Section 1516." ()
and
"Section 1411 of the Manual of Instructions sets out the procedures relating to recording and custody of securities and these instructions will in future be strictly observed." ()
The Policy Guidelines on Reporting Procedures, issued in March 1988, referred to the use of Security Appendices with loan submissions:
"All security held for a customer must be fully detailed on the Security Appendices, which must be updated whenever a change occurs." ()
I infer from this that the Security Appendices were in use as a standard document for the recording of security details by March 1988.
Within the Corporate Banking Division Accounting Policies and Procedures Manual (introduced in October 1989) there were a number of significant developments in the security process:
(a) Procedures were introduced to establish a minimum standard of quality and reliability in valuation reports obtained by the Bank.() This included establishing a panel of valuers in each State on the basis of professional expertise and level of professional indemnity cover. It also provided a list of accepted standards with which every valuation report should conform.
(b) Detailed instructions for the completion of the Security Appendix were provided.()
(c) The security item details required for various types of security were specified.
8.5.4.4 Assessment of Policies and Processes
In my opinion, the formal policies and processes of the Bank, prior to 1 March 1988, in regard to security were inadequate in that:
(a) despite the substantial growth of the Corporate Banking division from 1984 through to 1987, policies on loan security were not introduced until March 1988;
(b) the policies introduced in March 1988 and September 1988 provided only broad directions, whereas, given the size and complexity of loans made by the Corporate Banking division, detailed and specific directions were needed;
(c) there was no policy requirement that a legal opinion be obtained (whether from the Bank's Legal department or from external solicitors) on proposed security arrangements for particularly complex transactions (); and
(d) until approximately September 1990, the Bank did not establish a panel of valuers for performing independent security valuations, and did not instigate procedures to ensure that valuation reports obtained by the Bank were of a minimum standard.
The Bank has informed me that its procedures in relation to the assessment and monitoring of loan security are now addressed in its Group Credit Manual and that all policies relating to security are now ultimately under the control of the Head of Credit, major policy revisions being referred to the Board for its consideration and approval. The Group Credit Manual, I am informed, now contains detailed instructions to relevant Bank officers in relation to the assessment of loan security. In addition, the Bank has informed the Investigation that the topic of retaining external solicitors is under review, as is the topic of policies directed to the procuring of valuation reports, and to the standard of those reports.
8.5.4.5 Conclusion
I have formed the opinion that the policies and processes in regard to loan security in the period reviewed by this Investigation were inadequate.
The inadequacies of the policies and procedures for loan security are made evident by scrutiny of several loan case studies examined by the Investigation. For example, processes for loan security were found to be deficient in:
(a) the Collinsville Stud Pty Ltd facility (Chapter 11 - "Case Study in Credit Management: The Collinsville Stud Group"), in that the Legal department were not advised of increases in an overdraft facility for which only limited security was held;
(b) other case studies examined by the Investigation in that;
(i) in one case, the signing of a new lease agreement was not followed up, thus weakening the Bank's security; and
(ii) in another case there was inadequate monitoring of security covenants; had covenants been adequately monitored it is possible that the Bank's exposure to losses would have been reduced.
8.5.5 HINDSIGHT OVERVIEW
8.5.5.1 Definition
Hindsight overview is a process which was introduced by the Bank to strengthen the credit decision-making process, a process whereby credit decisions made were reviewed shortly after approval by an independent authority higher in the credit approval hierarchy.()
8.5.5.2 Policies
The concept of hindsight overview was introduced to the Corporate Banking division in or about March 1990. It is described in detail by Group Credit Policy Statement No 9 "Overview of Credit Decisions". It was seen as:
"... an essential function within the credit assessment process." ()
The responsibility of the overviewer was to draw attention to, and comment on, any weaknesses considered to exist in the approved submission or in the approval process, and, if appropriate, to require that corrective action be taken if practicable. Hindsight overview is not calculated to review specific credit decisions as such. Its purpose is to enable the overviewer to review the judgment of the initial decision-maker, and the extent to which that decision-maker was complying with the Bank's policies, processes, and procedures, in approving the credit application which is the subject of overview.
8.5.5.3 Processes
The application of the hindsight overview process was initially described in point form in Clause 2 of Group Credit Policy Statement No 9.() In summary, the critical features of the process are:
(a) Hindsight overview to take place within two business days after approval of a particular loan.
(b) The overviewer does not have a right to veto the loan approval, but may require the approving officer to take corrective action, such as:
(i) incurring no further credit to a particular customer or customer group;
(ii) reducing the Bank's exposure; and
(iii) improving the security position.
(c) Minimum trigger levels for hindsight overview were established, based on the value of the loan approval, and the risk grading of the customer.
(d) Loan approvals for customers graded higher than 5B in terms of Group Credit Policy No 8 "Risk Grading of Customers", and with a total credit limit less than $0.1M were not required to be overviewed. (In Corporate Banking division, these exclusions would rarely have applied.) Details of the system of risk grading of customers is to be found in Section 8.5.7 of this Chapter (ie "Management of Loans").
The concept of hindsight overview applied only to loans approved by individuals, and not to lending submissions approved by the Lending Credit Committee, Sub-Board or Board. The overview process was undertaken by an individual, and not by a committee.
8.5.5.4 Assessment of Policies and Procedures
In my opinion the fact that the hindsight overview process was not introduced by the Bank until early in 1990 highlights inadequacies in the credit management process prior to this time, in that:
(a) There was no system of independent credit inspection. Certain officers within the Bank who held delegated lending authorities also had a marketing role. In that state of affairs, independent credit review by an officer with a power of veto was essential.
(b) There were no procedures calculated to ensure that officers responsible for approving loans at various levels of authority had the requisite skill and experience to make such credit decisions reliably.
(c) There were no policies and procedures on foot calculated to ensure that officers responsible for approving loans at various levels of authority were exercising reasonable judgments and having due regard to the credit policies of the Bank.
8.5.5.5 Conclusion
In my opinion, the policies and procedures of hindsight overview, once they were introduced, were adequate. It is regrettable, however, that the hindsight overview process was not introduced until early in 1990. In addition, given the limited sanctions capable of being invoked by the overview officer and the two-day buffer period, the process was really directed to the identification of the errant decision-maker, and does not itself provide an adequate check on the intrinsic quality of lending decisions. The process must be accompanied, as it now is, by credit quality review.
In my opinion, the lack of scrutiny or control over the quality of the credit judgments exercised by the holders of delegated lending authorities within the Corporate Banking division prior to 1990 was a significant weakness in management's overall control of the division's lending activities.
8.5.6 SETTLEMENT OF LOANS
8.5.6.1 Definition
Settlement of loans denotes those processes following credit approval through to the advance of the Bank's funds to the customer.
8.5.6.2 Policies
The Corporate Banking Division Policy Guidelines on Reporting Procedures dated March 1988 made the following statement:
"All security must be perfected in absolute terms and be enforceable before any draw-down of facilities is made. Advances made without security being in place will be viewed seriously." ()
No other evidence of policies in relation to the settlement of loans has been identified in the period under review.
8.5.6.3 Processes
In April 1986, under cover of a memorandum from Mr N E Gillespie, Manager Corporate Administration(), the Corporate Banking division staff were issued with a pro forma document entitled "Settlement Guide" which was to be completed for each new facility and loan review. The document required authorisation by a Manager or by a more senior officer. Essentially, the Settlement Guide was a one page checklist of settlement actions divided into three groups:
(a) Authorisations and Legal;
(b) Registers and Records; and
(c) Miscellaneous - including reference to special conditions that had been noted and complied with.
When the Corporate Banking Division Accounting Policies and Procedures Manual was introduced in October 1989, the Settlement Guide continued to be utilised as a procedural guide.()
8.5.6.4 Assessment of Policies and Processes
In my opinion, the formal policies and procedures in relation to the settlement of loans were inadequate, in that:
(a) prior to March 1988, no policies were issued to ensure that managers were clearly aware of their obligations prior to releasing the Bank's funds to a customer;
(b) the policy formulated in March 1988 referred only to the need to have security in place. It did not explicitly require that all loan documentation be fully completed, checked, and vetted, prior to the release of funds in order to ensure that the documentation accorded with the terms of the loan approval;
(c) there was no requirement that legal practitioners be involved in the settlement of particularly large or complex transactions, or in other situations where the Bank's staff may have lacked sufficient expertise to ensure that all documentation was complete, adequate, and conformed with the terms of the approval; and
(d) given the size and complexity of the loans often handled by the Corporate Banking division, the one-page check list of settlement procedures was not sufficient to ensure that errors or omissions would not occur in this critical process.
8.5.6.5 Conclusion
I have formed the opinion that the policies and procedures in relation to the settlement of loans in the period reviewed by the Investigation were inadequate.
I have not, however, become aware of any specific instances in which these inadequacies directly resulted in a material loss to the Bank.
8.5.7 MANAGEMENT OF LOANS
8.5.7.1 Definition
Management of loans denotes the ongoing monitoring and control by the Bank of loan accounts which are being conducted in accordance with approved terms and conditions, and of those loans which are classified by the Bank as "Irregular," but have not yet reached the stage of being classified as "Non-Performing".
8.5.7.2 Policies
When the Bank was first established, its basic policies in regard to managing corporate loans involved:
(a) annual review of all accounts(); and
(b) identification of any accounts which exceeded the approved credit limit by more than a specific sum ($25,000)() with a view to taking appropriate action.
In terms of annual reviews, there were policies which delegated responsibility for approving the renewals:
"1. Renewal of Facilities Where -
(a) All arrangements approved have been honoured.
(b) No deterioration in financial position is evident.
(c) No deterioration in security is evident and risk assessment is same or better than when original exposure was approved.
Loans $0 - $2.0M
Extension approved by a Senior Manager, Corporate.
Loans in excess of $2m - $5m
Extension approved by Chief Manager, Corporate Banking.
Loans in excess of $5m - $15m
Extension approved by General Manager, Corporate Banking.
Loans in excess of $15m
Extension approved by Lending Credit Committee.
2. Renewal of Facilities Where -
(a) Arrangements made have not been honoured, or
(b) Financials show deterioration, from previous year, or
(c) Security has deteriorated from original approval, or since last annual review.
Loans $0m - $5m
Renewal approved by General Manager, Corporate Banking.
Loans in excess of $5m - $10m
Renewal approved by Lending Credit Committee.
Loans in excess of $10m
Renewal approved by Board." ()
In February 1986, the policy of identifying accounts which exceeded their credit limit was extended by the establishment of procedures which required daily reporting of accounts in excess of authorised limits.() The mechanics of this policy are discussed under "Processes" in this Section.
In March 1988, the Corporate Banking Division Policy Guidelines on Reporting Procedures further developed the policies for managing corporate loans, particularly with the following comment:
"It is emphasised that the underlying strength of a Corporate Banker is his relationship with his/her client, in that he/she could be close enough to the client to detect problems before they manifest to a point where difficult decisions are necessary." ()
This is the first documented reference to a policy of actively monitoring the performance of customers, rather than relying on annual reviews and reporting of credit excesses. There were several other new policies introduced by this document:
. "An extension of the annual review for a period of one (1) month beyond the expiry date must be approved by the Chief Manager, Corporate Banking or General Manager, Corporate and International Banking.
. Annual reviews, extended beyond one month, which are outside the delegation of the General Manager, Corporate and International Banking are to be reported in the Quarterly Operating Review, following the accounts in excess beyond $25,000.
. Reviews of fees charged is (sic) to form part of the review and should be increased where:
. The credit has deteriorated from original approval; OR
. Customer is a nuisance account, and time taken in management of the account is well in excess of the return being achieved; OR
. Where this is a general movement in the market place which should be passed on to the customer.
Managers/Senior Managers have total discretion to charge additional fees for any transaction which will increase the revenue to the Bank."
The delegated authorities for the approval of annual reviews were unchanged from the levels set in November 1985.()
In September 1988, the Credit Policy Manual provided some guidance to assist with early detection of weakened credit.() This may be seen as a development of the policy of actively monitoring the performance of customers to identify timeously any deterioration in the quality of the credit. Factors to be considered included:
(a) the effects of inflation on the customer's business;
(b) changes in management or the objectives of the business;
(c) leverage and financial factors; and
(d) external factors - such as any adverse industry information and changing technology.
The Credit Policy Manual also set forth the delegated authorities for approval of annual reviews. These remained unchanged from the levels set in November 1985.()
In October 1989, the Corporate Banking division's policies in regard to annual reviews were condensed to two points:
"1. Facilities are to be reviewed annually and review dates stipulated in all correspondence with clients. All security items to be physically inspected annually by an officer from Corporate Banking except where security is held by "Corporate Securities" Section.
2. Annual review of Australian corporates with facilities booked through any overseas offices but managed by Adelaide, will be conducted by Corporate Banking. Confirmation of reviews are to be forwarded to Overseas Offices on completion." ()
In regard to the appropriate response in situations where customers exceeded authorised credit limits, the following policy was promulgated:
"The view is taken that if we grant an excess it must be on the basis that we are in fact approving a temporary arrangement and if this is so we should formalise same. If not, then dishonour must take place.
When temporary limits are to be granted for a period exceeding one month, appropriate establishment fees are to apply." ()
Group Credit Policy Statement No 1 stated the responsibilities of each customer/account controller,() and, directed that he or she was responsible for the continued safety of loans under the management or control of the officer and, in particular, that their responsibilities included:
"(i) regularly monitoring the customer's financial position and the effect of external influences thereon;
(ii) ensuring that the loan was conducted within the approved terms and conditions and that any deviation was remedied as soon as possible or reported to the appropriate level in the credit approval chain; and
...
"(v) ... assessing/reviewing the risk grading at the time of new/increased credit risk exposure and at annual review and also in the light of events which may occur."
The policy of evaluation of the risk profile of customers was enhanced by the following documents:
(a) Group Credit Policy Statement No 8 "Risk Grading of Customers", dated April 1990 provided for the grading of all customers on a scale of 1-8 according to the degree of risk of default. The following grade descriptions are particularly relevant:
Grade 5a - Sound major corporates with conservative balance sheets and good profit history. (AAA rated companies or equivalent).
Grade 5b - Strong financials and good history but less quality than 5a.
Grade 5c - Sound but with tendency for weakness to develop. Gearing slightly higher than industry average, cash flow less certain.
Grade 5d - Weakening financials, poor trend, possible problems unless managed well.
Grade 5e - Limited financial strength, vulnerable to market conditions, unreliable cash flow, doubtful or second class security.
Grade 6 - Non-performing loans.
Grade 7 - Non-accrual loans.
Grade 8 - Account provisioned.
(b) Group Credit Policy Statement No 3 - "Managing Higher Risk Customers", March 1990, which stated, amongst other things, the appropriate steps to be taken on down-grading a customer to Grade 5c or lower, in terms of Group Credit Policy Statement No 8 as outlined above. In particular, a formal corrective action plan was to be prepared by the account manager.
(c) Group Credit Policy Statement No 12 - "Credit Watch Accounts". This document introduced a mechanism which enabled recognition and reporting of situations where information of an inferential or non-quantifiable nature indicates material adverse implications for the future credit risk grade. Such information, the Statement noted, could include:
(i) takeover/merger;
(ii) corporate restructure;
(iii) industry restructure;
(iv) movements in share price of listed company;
(v) failure of client's major supplier/customer; and
(vi) litigation by or against client.
8.5.7.3 Processes
The policy of reporting an account operating in excess of its credit limit was initially supported by a process whereby a schedule was prepared as at the third Wednesday of each month detailing all accounts which were at levels more than $25,000 in excess of arranged limits.() This schedule was known as the "Monthly Excess Return" and was required to be submitted to the Chief Manager, Corporate Banking, within 5 days of its scheduled preparation date.
In February 1986, a memorandum() introduced procedures requiring a daily reporting by Managers of all accounts in excess of arrangements. This daily "Excess of Limits Report" was to be submitted to each Section's Senior Manager and, where appropriate, to the Chief Manager for approval/confirmation of excesses. Other procedures prescribed by this document included:
(a) assessing whether the facility was adequate, or whether an increase in the limit was justified and should be reviewed;
(b) advising the customer in writing of its excess position, and that penalty provisions would be applied;
(c) advising the branch of excesses on a weekly basis; and
(d) continuing to report monthly all accounts more than $25,000 in excess of limits.
In terms of the processes which supported the policy of conducting annual reviews, some limited guidance was given by Mr Gillespie's memorandum of 6 November 1985:()
"Reviewing Officers should note that prior to completion of a review personal contact with the customer must be made. This will not apply where we are a participant in a syndicated facility.
Reporting of reviews is to be by way of schedule showing name, amount and new extension date to be provided to Lending Credit Committee and must include situations where the amount of extension exceeds our General Manager's delegated lending authority."
More guidance was provided in regard to the processes supporting the policy of annual reviews in March 1988 by the Corporate Banking Division Policy Guidelines on Reporting Procedures:
". Financial data used to perform the review should not be older than six months.
. Review is to cover both past performance and future prospects.
. Security is to be re-assessed and updated as at each annual review, in particular RM Debenture annually audited and quarterly management reports certified correct by directors.
. Annual reviews are to be spread throughout the year as far as is possible taking into account financial reporting dates of the Company/Group."
The policy of monitoring customer performance, as opposed to annual reviews, was supported by procedures which required up-to-date particulars to be maintained in a series of files:
(a) Advance File - containing all the files and other information listed below;
(b) Facilities File - fully detailing the Bank's exposure to the customer/group on Form 32000-2;
(c) Diary Note File - a record of all visits, arrangements, discussions and information regarding the customer;
(d) Correspondence File;
(e) Financials - with current financials;
(f) Security Appendix; and
(g) Special files as necessary for particular customers, for example, certificates relating to negative pledges.
The Corporate Banking Division Accounting Policies and Procedures Manual provided further instructions for the reporting of accounts in excess of arrangements(), as part of procedures calculated to ensure the monitoring of the loan portfolio for potential bad debts. Key documents were identified as the Daily Excess Return (Form PBD01) and two monthly Irregularity Returns.
The Daily Excess Returns were required to highlight instances where insufficient security was held, when arrangements were not honoured, where limits had expired, and so on. The completed form was sent to the Senior Manager, and, if outside his delegation, forwarded to a higher authority to deal with the excess. The credit approver's decision on the appropriate course of action for the excess was to be advised immediately and confirmed in writing. Records of excesses and of the resolution of excesses were to be kept on file.
For the purposes of the "Irregularity Returns", irregularities were defined as:
"... any deviation from the approved terms and conditions of a facility, including excesses over approved and formally recorded credit limits, drawings without arrangements, deductions (sic) not made, security/covenants not maintained. ..." ()
Irregularities were divided into two categories:
(a) Category 1: "All irregularities other than credit facilities or credit limits overdue for review/renewal"; and
(b) Category 2: "All irregularities due to credit facilities or credit limits being overdue for review/renewal".
Category 1 irregularities were to be reported immediately if there was a remedy available to the Bank, in the exercise of which time was of the essence (eg dishonour of a cheque) or where immediate action was necessary to protect the safety of the Bank's exposure.
Category 1 irregularities could be waived by the Account Controller (ie Manager) if within that person's delegated lending authority. Otherwise, such an irregularity was required to be reported to the appropriate level within the credit approval chain.
The monthly Irregularity Returns were transmitted to the Division's General Manager or, at the General Manager's discretion, to an independent credit officer. The two Irregularity Returns were required to detail:
(a) All Category 1 irregularities beyond the Account Controller's credit approval discretion and greater than $25,000.
(b) All Category 2 irregularities where the customer's review/renewal is overdue more than one month.
8.5.7.4 Assessment of Policies and Processes
In my opinion, the formal policies for the management of loans in the period under review were inadequate in that:
(a) Prior to March 1988, Managers were not directed to monitor the performance of their customers. Instead, they performed an annual review of each customer, and otherwise examined only customers who exceeded approved credit limits. This approach did not enable timely identification of weakening credits in order to forestall potentially adverse consequences for the Bank.
(b) Whilst the Credit Policy Manual of September 1988 directed Managers to monitor the performance of their customers there was inadequate direction as to how this should be done.
(c) The responsibilities of Managers in relation to the monitoring of customers were not defined until March 1990, so that in the preceding period the extent of a Manager's accountability was not made clear.
(d) The lack of definition of responsibilities, and the lack of guidance as to methods of monitoring customer performance, had the consequence that the actual level of active monitoring of customers varied from manager to manager and was generally conducted haphazardly. This deficiency was identified by JP Morgan:
"Our sense from file reviews and interviews is that monitoring has been carried out haphazardly at best. It is also not clear whether active monitoring procedures, even though they are now spelled out, have been adopted by all Managers." ()
and
"Unless the account manager understands the severity of the situation, he is not likely to report the problems. Thus, the deterioration is likely to worsen before anyone begins to worry about it." ()
(e) Prior to March 1990, when Group Credit Policy Statement No 3 "Managing Higher Risk Customers" was released, no policies or procedures were established to direct Managers as to the appropriate remedial steps to be taken in response to an identified weakening credit situation, such as the preparation of a formal corrective action plan.
(f) The lack of definition of managerial responsibility, and the failure to prescribe remedial measures for weakening borrowers, had the consequence that situations of deteriorating credit risk were responded to according to a Manager's judgement. Given that the Manager responsible for monitoring a particular loan was often the same Manager who had initially recommended the loan for approval - there was no separation of these responsibilities - there was often an unwillingness to recognise deteriorating situations and to take remedial action. The JP Morgan study found:
"In monitoring clients, it seems that many account managers have not been willing to recognise deteriorating situations and have further been unwilling to take action when they do acknowledge deterioration." ()
This conclusion is borne out by the Investigation's scrutiny of non-performing loans. The Bank has acknowledged that it originally lacked both policies and a framework for the major credit functions, including credit review and problem resolution(). By early 1991, however, when JP Morgan performed its review, the situation had improved to the extent that JP Morgan reported:
"The concept of credit monitoring ... is appropriate in most regards. Regrettably, procedures are not in place throughout the organisation. Some procedures have only recently been adopted in some areas." ()
The Bank has informed me that criticisms levelled at it in relation to management of loans have now been addressed, and that the Group Credit Policy Manual now clearly allocates and defines responsibility for the day-to-day management of risk assets. In particular, a customer/account controller is required to engage in regular monitoring of the customer's financial position, and of the effect of external influences on it; and to review, at least annually, the customer's credit limits, monitoring, where applicable, the value of security continually, and assessing or reviewing the risk grading of the customer and taking all appropriate action. The requirement of continual monitoring applies irrespective of the risk grading of the particular customer. The current Manual, I have been informed, also defines in detail the actions to be taken by the customer/account controller when he or she determines that a customer should be allocated an increased credit risk. These actions include the establishment of a formal action plan, the recommendation of an appropriate provision and the preparation of a credit paper to be submitted to the Business Unit Executive, Head of Credit or the Board Credit Committee as determined by the size of the exposure and the delegated credit authority. In addition, there are now in place policies and procedures for the production and direction of standardised and periodic credit risk reports based upon common risk grading and early warning structures.()
8.5.7.5 Conclusion
I have formed the opinion that the Bank's policies and procedures for the management of loans in the period reviewed by the Investigation were inadequate.
The inadequacies of the policies and procedures for the management of loans were made evident in the case of several of the loans examined by the Investigation. Details of these inadequacies are to be found in the analyses in Chapters 9 to 14 (inclusive) of this Report.
8.5.8 MANAGEMENT OF NON-PERFORMING LOANS
8.5.8.1 Definition
The management of non-performing loans denotes the process of identifying and controlling those accounts which are classified as "non-performing". It also includes the management of loans classified as "non-accrual", these loans having deteriorated to a condition worse than non-performing.
This Section also covers the process of provisioning for doubtful debts, which is dealt with under a separate sub-heading.
8.5.8.2 Policies
The terms "non-performing loan" and "non-accrual loan" were first defined by the Corporate Banking division in March 1988:
A "non-performing loan" was defined as:
"A non-performing loan is any facility which is:
(i) More than 30 days overdue in meeting a scheduled repayment.
(ii) Has been in excess of approved facilities, more than 30 days, and it would require a major restructuring of facilities to rectify the situation and such restructure would clearly be outside the Bank's normal lending policy.
(iii) Security has deteriorated to a level that the Bank's lending is outside normal lending policy and top-up security cannot or is not provided.
(iv) Non-compliance with Negative Covenants.
(v) Any other accounts which have an adverse trend or factor which cannot be rectified in the short term (30 Days or less) and which places the Bank's advance at some risk if not rectified." ()
A "non-accrual loan" was defined as:
"A non-accrual loan is defined as any advance on which interest is being accrued but is not debited and taken to profit.
Any advance/facility is to be automatically classified as non-accrual if it is 90 Days or greater past due date in the payment of:
. A scheduled principal reduction, and facilities have not been restructured to cater for same.
. Interest, or
where it is assessed that the accruing interest may not be collectible, or the repayment of the principal sum is in doubt, and a specific provision to cover the estimated loss is deemed necessary.
The structure and verbiage of the above definitions changed slightly after March 1988, but the essential ingredients of each definition have remained unchanged. In March 1990, the definitions were expressed as follows:
(a) Irregularities (ie deviations from approved terms and conditions of a facility) were divided into two categories:
Category 1 - "All irregularities other than credit facilities or credit limits overdue for approval";
Category 2 - "All irregularities due to credit facilities or credit limits overdue for review/renewal".()
(b) Non-Performing loan:
"Any Category 1 irregularity which has continued without remedy beyond 30 days constitutes a non-performing loan." ()
(c) Non-Accrual loan:
"Any advance on which interest is being accrued but not debited and taken to profit constitutes a non-accrual loan. Advances are classified non-accrual:
(i) automatically if 90 days or more past due date for payment of
. interest, and/or
. scheduled principal reduction
(ii) as soon as it becomes evident upon assessment that either
. accruing interest and fees may be uncollectible
. repayment of principal is in doubt
. specific provision for principal loss is needed." ()
Initially, prior to use of the classifications "non-performing" and "non-accrual", the Bank did not have a policy of separately classifying potential problem loans as they were identified. Instead, a review of the entire loan portfolio for potential bad debts was conducted on a quarterly basis.() The suggested criteria for identifying corporate loans at risk of default were as follows:
(a) Where 1st Class Security is held - Advances in excess of 80 per cent of Bank valuation of security, and the account is irregular.
(b) Where 2nd Class Security is held - Advances in excess of 60 per cent of Bank valuation of security, and the account is irregular.
The Lending Credit Committee was required to review all potential bad debts fitting the following descriptions:
(a) instalment loans above $50,000 on which instalments are in arrears in excess of three months;
(b) advances in excess of approved arrangements by $25,000 or more for a period exceeding one month; and
(c) any account on which the Bank could face a possible loss of $25,000 or more.
The Senior Manager was to be advised immediately of defaults by borrowers, or where the Manager suspected that the borrower was in financial trouble or intended to default.() Where necessary, the Senior Manager was required to refer the account to the Chief Manager with a recommendation regarding the action to be taken.
A memorandum, circulated in July 1986, dealt specifically with the appointment of a Receiver and Manager.() The responsibility for appointing a Receiver lay with the General Manager, Corporate and International.
In March 1988, the policy of classifying bad and doubtful accounts into three categories -Irregular, Non-Performing and Non-Accrual - was introduced.()
The Credit Policy Manual of September 1988 further addressed the subject of non-performing loans:
"The non performing classification remains in place until it is superseded by a more severe loan quality classification (eg non-accrual) or the facility is brought back within arrangement.
In some circumstances, rearrangement may take the form of altering the loan to another type of normal commercial arrangement but different from the original terms and conditions of the advance. This is acceptable as a return to normal advance status.
The classification of a non performing loan does not immediately require the loan to be placed on a non accrual basis. It does however require that this option be investigated. Similarly a non performing loan will not necessarily expose the Bank to a potential loss. Nevertheless, its potential loss status must be assessed at this time.
If the loss of either principal or interest is a possibility, the loan should be placed on a non accrual basis immediately and if appropriate a specific provision should be recommended for the advance. Clearly recognition of a non performing loan is the "warning sign" which should be a signal for the Branch/Department and Credit Quality Section to commence special management of the advance and if necessary recovery action." ()
The Credit Policy Manual also addressed non-accrual loans and the policies for provisioning:
"At the time of classification the loan must be reviewed for any anticipated loss and a recommendation made through Credit Quality Section to Lending Credit Committee that:
(a) a specific provision be allocated; or
(b) no provision be made.
The recommendation will be based on the difference between principal outstanding and the realisable security value. Except in very unusual circumstances any non accrual loan would be the subject of recovery action. Where loss of principal/interest was anticipated, recovery action would be instigated by Credit Quality Section in co-operation with the Branch/Department.
Allocation of a specific provision will act as a reinforcement mechanism to assist Credit Quality Section to focus on advances which require close scrutiny and management.
Recommendations for specific provisions and write-offs are reported at Executive Committee and Board level, with the Bank's Lending Credit Committee reviewing potential losses for agreeing specific provisions." ()
In March 1990, Group Credit Policy Statement No 3 addressed the immediate and subsequent remedial actions that the Bank should take when a customer is classified as non-performing.()
The Bank's basic policy in this regard may be summarised thus:
"In establishment of an appropriate action plan, it is necessary to consider any longer term advantages or disadvantages resulting therefrom. Whilst the attraction of expeditious settlement on a less than full recovery basis can be considerable, a course of action yielding this result must be measured against the prospects for enhanced recovery (and increased uncertainty of recovery) that may result from a longer term strategy." ()
Group Credit Policy Statement No 3 also introduced a policy concerning the need for a Group perspective on the control of higher risk customers.() The policy postulated the need for a "controlling point" to ensure that the State Bank Group's overall best interests were served where several entities within the State Bank Group were exposed to a single customer group in financial difficulty.
8.5.8.3 Processes
Initially, prior to use of the classifications "non-performing" and "non-accrual", the policy of identifying potential bad debts relied on a process whereby Managers completed a "Potential Bad Debt" report on a quarterly basis.() The decision whether a Potential Bad Debt report was required or not was the Manager's, based on his/her assessment of whether it was likely that a loss may accrue to the Bank. The Senior Manager was advised only if a borrower actually defaulted, or the Manager suspected the borrower may default.
From March 1988, non-performing loans were identified monthly and separately identified on the Monthly Excess Report.() In addition, a Bad and Doubtful Debts return was to be prepared quarterly and include details of all non-performing loans with an excess of more than $25,000 for more than one month. It was in January 1990 that the first non-accrual report was presented to the Board. In my opinion, this was wholly unsatisfactory. The Board should have set up, at an earlier stage, a procedure under which non-accrual loans were reported to it. It could not possibly make a genuine provision without detailed knowledge of all non-accrual accounts and the amount involved in each account that had been classified non-accrual. At its meeting on 23 March 1989, one of the members of the Board expressed concern that, given the growth of the Bank and the Bank Group, it would be important "to continue to ensure that information in relation to the Group exposure was available for management purposes". According to the minutes, "Directors were advised that the Bank was giving a high priority in continuing to develop its Group Global Risk Management techniques in order that it could accurately assess its group risk". ()
It has been submitted to me by certain past directors of the Bank that, in late 1988, they requested that they be provided with a full non-accrual report on a regular basis, but that they were advised by management, and, in particular, by Mr Matthews and Mr C W Guille, that the system at that stage was unable to produce such a regular report; that new systems were being implemented; and that such a report was likely to be produced in early 1989.()
Upon an account being classified as non-accrual, the Manager was to prepare a full report for the Chief Manager, Corporate Banking, detailing the circumstances. Such report was required to advise the potential loss, if assessable, and recommend whether a specific provision should be made or set. In addition, all non-accrual loans were to be listed in the Monthly Operating Review.
The procedures for reporting non-performing and non-accrual loans were redefined in Group Credit Policy Statement No 11 in March 1990 but no substantial changes from the procedures established in March 1988 were made.
Group Credit Policy Statement No 3 listed a series of steps to be taken upon a customer being downgraded to Grade 5c or lower (in terms of Group Credit Policy Statement No 8 "Risk Grading of Customers"). Non-Performing is Grade 6 and Non-Accrual is Grade 7. The specific actions to be considered include:
(a) reduction of the Group's exposure to the customer, and prevention of increased exposure;
(b) relaying to all other entities and divisions within the Group known to have contact with the customer or related entities notice of the downgrading;
(c) review of all documentation, including facility letters, loan agreements, and other security documents relating to the customer, and checking such documents for correctness and completeness;
(d) action to ensure that the debt does not become statute barred;
(e) re-assessment of financial statements (having regard to the possibility of a distress sale of assets);
(f) revaluation of any security held;
(g) examination of the potential preferred position of other banks, lenders and creditors;
(h) review of recent security arrangements (including the Group's) with a view to determining whether any such security falls within a voidable preference period;
(i) in certain circumstances, careful consideration of whether there could be any implications for the Group arising from the principles which have flowed from Court judgements; and
(j) re-examination of the ability and willingness of guarantors to meet their obligations; and
(k) seeking advice and assistance where there is a need for special expertise, either from within the Group or from an external source.
Having taken the above steps as considered appropriate by the Account Controller (ie Manager), a corrective action plan with target dates was required to be established. Such an action plan may involve:
(a) a restructuring program;
(b) obtaining additional financial support from creditworthy parties;
(c) realising security;
(d) obtaining new or additional security;
(e) re-negotiating the terms and conditions, or duration, of existing credit facilities;
(f) seeking the support of appropriate government agencies;
(g) seeking takeout by another financial institution;
(h) encouraging changes in management where incumbents have demonstrated inability or unwillingness to take necessary action; and
(i) requiring the sale of the business.
If corrective actions did not have the desired results, then consideration was required to be given to last resort solutions such as:
(a) bankruptcy;
(b) other legal action; and
(c) compromise settlement with the customer.
8.5.8.4 Assessment of Policies and Processes
In my opinion, the formal policies and processes for the management of non-performing loans in the period under review were inadequate, in that:
(a) Prior to March 1988, there were no policies requiring the classification of loans as "non-performing" or "non-accrual". The "suggested criteria" for identifying potential bad debts were vague and resulted in haphazard reporting and treatment of problem loans. Without strict criteria for identification, the recognition of problem loans was able to be deferred.
(b) Prior to March 1990, there were no policies or processes dealing with the corrective actions that should be taken when a loan became non-performing.
(c) Prior to March 1990, there were no policies or procedures in relation to the level of additional monitoring which should be applied to non-performing loans - for example, monitoring the customer's cash flows on a weekly or monthly basis.
(d) Prior to March 1990, the responsibilities of Managers in relation to the identification and regularisation of non-performing loans were not defined, so that the extent of their accountability was not made clear.
(e) There was not, prior to the formation of the Group Asset Management division in or about March 1991, a separate Section of the Bank responsible for handling problem loans and resolution of doubtful loans.
(f) Responsibility for managing non-performing loans remained with the line managers in the division which had originally recommended or approved the facility. In the absence of the appropriate checks and balances, this was highly unsatisfactory. In situations where a Manager has had a long association with a customer prior to the loan becoming non-performing, there can often be reluctance on the part of the Manager either to acknowledge the severity of the situation or to enforce corrective measures.
In the opinion of JP Morgan, the Bank's approach to managing non-performing loans has been influenced by a "culture" which:
"... has encouraged nurturing of customers, even those who are not prepared or able to repay their loans" ()
and
"Account managers must be brought to understand that bank capital must be protected, not the interests of customers."
The Bank has informed me that it has taken steps to improve its management of non-performing loans. In particular, non-performing and non-accrual loans are now separately classified in reports that are presented quarterly to the Board indicating portfolio analysis by risk grade; and the Group Credit Policy Manual now clearly establishes the procedures and actions to be taken by a customer/account controller where a loan has been downgraded to "D" or below. Those procedures include preparation of a detailed review of the customer's financial situation and a formal corrective action plan, the establishment of an appropriate provision for the debt, and the preparation of a credit paper. The Bank has also submitted that the responsibilities of customer/account controllers in relation to identifying and taking action on non-performing loans are clearly set out in its Group Credit Policy Manual and that the Bank's newly created Group Credit division engages in random portfolio reviews, and has, among its duties, that of monitoring and reporting to the Board on risk concentration and portfolio quality.()
8.5.8.5 Conclusion
I have formed the opinion that the policies and processes in regard to the management of non-performing loans in the period under review were inadequate.
The inadequacies of the policies and procedures for the management of non-performing loans became evident in several of the loans examined by the Investigation. For example, the management of non-performing loans was found to be deficient in five cases in which there was an undue delay in the recognition and classification of a loan facility as non-performing or non-accrual, and four other cases in which proper corrective actions, including (for example) additional close monitoring of the customer's cash flows, were not implemented after the loan was classified as non-performing or non-accrual.
8.5.9 CREDIT INSPECTION
8.5.9.1 Definition
Credit inspection is the process of sampling a set of credit files, with the principal objectives of uncovering deficiencies of the credit management function by assessing the adequacy and effectiveness of credit systems and controls, and of auditing compliance with prescribed policies and procedures.()
8.5.9.2 Policies
Policies associated with the process of credit inspection were first introduced in Corporate Banking division in August 1990, when the Credit Inspection Procedures Manual was released.() A Group Credit Inspection Policy Statement had been drafted at that time but had not been formally approved. The Investigation has been informed that the delay in implementation of the credit inspection procedures was a consequence of the distraction of senior staff from matters relevant to credit inspection and, in particular, the deterioration of many of the Bank's customers which occurred at about that time. This policy statement was subsequently issued in the Group Credit Manual dated 1 March 1991.()
Two purposes were identified as underlying the credit inspection process:
"- to provide an assurance to Management and the Board that the Bank's statutory and regulatory obligations are being met; and
- to provide a service to Management which may be used as part of the process of improving management control." ()
Numerous objectives of the credit inspection process were identified, the more significant being:
(a) assessment of the quality of the Bank's credit risks independently of line management;()
(b) ensuring that all high risk customers are identified;()
(c) assessment of the extent of compliance with Bank credit policy and Management directives;()
(d) identification of significant management weaknesses, and any other circumstances which might give rise to material losses;()
(e) determination of whether management systems for the control of credit risk are adequate, and are operating efficiently;() and
(f) assessment of whether adequate systems and controls are in place to ensure compliance with statutory or regulatory requirements.()
The scope of the responsibilities of the credit inspection function were clearly stated,() as were those responsibilities to which credit inspection did not extend:
"Credit Inspection is not a substitute for day to day management control, safety assessment of customer exposures and overview of a Business Unit's lending portfolio; it is a further stage in Management's credit control process."
The Credit Inspection Procedures Manual outlined the credit inspection policies in concise point form as follows:
"1.4.1 All credit inspections are to be planned, performed and reported in accordance with the minimum standards set out in this Manual, as supplemented by local procedures and requirements and the inspecting officer's knowledge and judgement. There should also be adequate evidence maintained to justify the scope of work undertaken and support the findings reported.
1.4.2 The results of all credit inspections are to be reported fully and completely on an `exception' basis, and include comment on significant actual or potential losses identified in the course of the inspection or omissions or failures to comply with Bank credit policy in respect of any type of customer exposure.
1.4.3 All credit risks on the books of the Bank together with off-balance sheet risks assumed on behalf of customers and limits approved for the taking of such risks will be inspected in accordance with the approach incorporated in this manual.
1.4.4 The credit inspection process will be carried out by suitably qualified credit inspectors who will operate with the maximum degree of independence of judgement and without the influence of line management.
1.4.5 Credit inspection will be carried out by physical examination of files and other records at the unit where such files and records are normally maintained.
1.4.6 Credit inspections will be carried out at intervals which may vary in accordance with differing levels of assessed risk within the frequency requirements set by Management and/or the Board.
1.4.7 Credit inspections will be carried out by detailed examination of individual accounts and compliance testing of internal control systems.
1.4.8 Credit inspections will be carried out in accordance with minimum standards set by Senior Management as agreed from time to time.
1.4.9 No Inspector should inspect a set of accounts for which he/she has held management responsibility until a period of two years has elapsed since the date of his/her departure.
1.4.10 No inspecting officer should inspect the same set of accounts on more than two consecutive occasions." ()
8.5.9.3 Processes
The processes which supported the credit inspection policies were set out in substantial detail in the Credit Inspection Procedures Manual of August 1990. Specific procedures for the conduct of each credit inspection became matters for the determination of the Head of Credit Inspection.() A number of common stages in the process are, however, identifiable:
(a) Gaining an understanding of the current business environment, including a review of:
(i) lending portfolio;
(ii) current economic, political, and business, environment;
(iii) management structure, staffing and skills, required;
(iv) major changes since the last inspection;
(v) views of Business Unit/division management; and
(vi) previous credit inspections, group audit reports, external audit letters.
(b) Establishing the scope of the Inspection.
(c) Interviews with relevant line management.
(d) Consultation with internal and external auditors.
(e) Reconciling customer exposures.
(f) Determining an appropriate sampling approach.
(g) Conducting inspections of selected customer files.
(h) Maintaining working papers.
(i) Assigning gradings for quality of customer exposures, and quality of credit administration.
(j) Producing a credit inspection report.
The frequency of credit inspections and priorities was to be established by agreement between the Chief General Managers, Australian Banking and International Banking and the Head of Credit Inspection, in consultation with internal and external auditors.() As a general rule, however, each Business Unit was to be subject to credit inspection annually, with interim inspections undertaken as considered appropriate.
8.5.9.4 Assessment of Policies and Processes
In my opinion, the credit inspection policies and processes, once they were introduced, were adequate.
It is regrettable, for the following reasons, that credit inspection procedures were not introduced until August 1990:
(a) the objectives of credit inspection, as previously described, were not achieved by any other policies or processes on foot prior to August 1990;
(b) although the Bank had an internal audit Section, its activities in the area of credit quality were closely circumscribed; and, therefore
(c) the Board and senior management had only minimal assurance that credit policies and procedures were being complied with and that systems to control credit risk were effective.
My comments on the limitations imposed on the Internal Audit function is a matter of audit risk assessment as discussed in Chapter 23 - "Internal Audit of the State Bank" of this Report.
Whilst the policies and processes formulated for credit inspection were, in my view, adequate, the resources provided to carry out the function were initially inadequate. JP Morgan noted:
"We are quite sure that, if the Credit Inspection function is to work as planned, there are not enough resources dedicated to this task." ()
The Bank has also submitted that it is only recently that the credit inspection function has been properly resourced.()
8.5.9.5 Conclusion
I have formed the view that the Bank's credit management policies and processes, in the period under review by this Investigation, were inadequate in that the Credit Inspection function was not established until in or about August 1990 and then was not given adequate resources to enable the function to be adequately performed.()
8.6 THE ORGANISATION, STRUCTURE, POLICIES AND PROCESSES AT WORK
8.6.1 PRELIMINARY OBSERVATIONS
One of the major tasks undertaken by the Investigation was an inquiry into specific non-performing loans written by the Bank. The Investigation did not analyse all non-performing loans written by the Bank. Rather, the Investigation was supplied by the Bank with a list of non-performing loans as of March 1991. The Investigation selected a sample of 19 from the list of loans supplied by the Bank, after performing some initial testing of information supplied by the Bank, which proved to be accurate.() The Investigation then chose six of the sample of 19 non-performing loans to be investigated in more detail than the remaining 13. The analysis of those six loans had, as its objectives, the demonstration of: first, the application or non-application by Bank officers of guidelines, policies, and procedures, laid down by the Bank; secondly, the absence of clearly described rules in relation to certain aspects of lending; and thirdly, other conclusions of the Investigation in relation to the Bank's lending policies.
In selecting the six non-performing loans which are reported upon in detail in Chapters 9 to 14 (inclusive), the Investigation had regard first and foremost to the Terms of Appointment. In particular, I have had regard to the need to preserve confidentiality in the Bank's affairs. As a corollary of this, I have had regard to the need that existing and future customers of the Bank be confident that their affairs and dealings with the Bank will not be disclosed to the public save in special circumstances. Secondly, I have had regard to the need and to the stipulation in my Terms of Appointment that I not prejudice the course of future civil or criminal proceedings. Thirdly, I have had regard to the need to avoid, as far as practicable, prejudice to, and interference with, the ongoing operations of the Bank and the Bank Group. Finally, I have had regard to the public interest in publication of the results of my Investigation. I have weighed, against the desirability of preserving confidentiality in the Bank's affairs, the legitimate expectation of the public generally that the results of my Investigation into the Bank will be made generally available to the citizens of South Australia, so that they be accurately and adequately informed of my findings and conclusions, and of the reasons in support of those findings and conclusions. I have had regard to these four considerations, not only in selecting the six transactions reported upon in any following Chapters, but also in selecting information that should be reported upon in the confidential Section of this Report. In selecting that information, I have also been mindful of the need not to delete crucial information from the published report or to so dismember it that it became imbalanced, misleading, or uninformative.
Having regard to those and other matters, the six customers and groups of customers named in the following Chapters were selected because they were either in liquidation or receivership, and it was generally a matter of public notoriety that they were in liquidation or receivership; because either there had been substantial press coverage in relation to their dealings with the Bank, or their dealings with the Bank had been, by some other means, well and truly ventilated in the public domain prior to publication of this Report, so that publication of the anticipated contents of the Report would not be detrimental to relations between the Bank and those customers, or between the Bank and its other customers, present and future. I also had regard to the following factors:
(a) the need to assess the quality of the Bank's lending decisions and, where lending quality was unsatisfactory, to demonstrate which matters, events, and circumstances, led to poor lending decisions being made by the Bank and to poor management of loans;
(b) the size of the loans;
(c) the desirability of reviewing various types of loans in order to test the general applicability of specific conclusions across more than one area of lending activity (viz Consumer, Commercial, Corporate);
(d) the materiality of the loss expected;
(e) the possibility of breach of prudential guidelines and, incidentally thereto, the geographic location of the borrower, the branch of the Bank by which the loan was made, and the field of activity of the borrower;
(f) the possibility of fraudulent activity;
(g) potential conflicts of interests which affected decisions made by the Bank.
Particular loans were selected for detailed examination based on a methodology which involved:
(a) Review and consideration of information (viz listings of non-performing loans) obtained or assembled during the `Preliminary Investigation Phase'.
(b) Review and consideration of additional information acquired and assessed subsequent to the `Preliminary Investigation Phase' (viz Policies, Systems and Processes).
(c) Establishment of a computerised data base of non-performing loan information, recording specific data relative to each non-performing loan (viz Client Details, Loan Facility Type, Movements in Loan Facility, Security details).
The reports on the six selected non-performing loans comprise Chapters 9 to 14 (inclusive) of this Report. A summary of issues and conclusions contained in those reports and in the unpublished reports is provided in a later Section of this Chapter.
It will be noticed that all but one of the loans reported upon in detail in Chapters 9 to 14 (inclusive) were loans made within the Corporate Banking division of the Bank. This bias in favour of Corporate Banking arose because most of the major non-performing loans entered into by the Bank were in fact written by the Corporate Banking division. The exceptional loan reviewed in depth by the Investigation was the loan to the Collinsville Stud group of companies. That loan was investigated for reasons including that it was the largest non-performing loan written by Retail and Business Banking, because it accounted for a major proportion of the non-performing loan portfolio of Retail and Business Banking, and because the loan in a sense was hybrid in that, whilst approved by management in Retail and Business Banking, management of the loan was taken over by Corporate Banking, late in 1990, as a result of a management restructure within the Bank.
As noted above, the detailed analysis of the non-performing loans of the Bank also covered 18 loan facilities associated with Corporate Lending. Although the selection of the non-performing Corporate loan facilities was based on a methodology that recognised exposures of significance, geographic and industry sector spread, and other important considerations, issues and conclusions drawn from the analysis may not be indicative of all non-performing Corporate loan facilities of the Bank. Loan facilities differ in nature and have been initiated at differing times. The general supervision exercised over loans has been influenced by changes in Policies, Systems and Processes and the involvement of different Bank officers.
In my opinion, the analysis reveals that credit assessment and management of those corporate loan facilities was deficient. For that, and other reasons, the preceding sections of this Chapter have focused on the Corporate Banking area of the Bank.
In the Chapters which follow, detailed information is set out on the six selected non-performing loans. The information includes the nature and amount of the loan facility or facilities; a loan history; a chronology; an assessment of the quality of management of the facility; conclusions as to compliance or non-compliance by Bank officers with the Bank's policies, systems and processes; and lastly, specific conclusions. Each transaction was analysed with an eye to each of the eight stages of the credit management process identified in Section 8.5 of this Chapter. For the most part, the analysis and assessment process undertaken by the Investigation in relation to selected non-performing loans involved the evaluation of the conduct of Bank officers and of decisions by the Board of Directors in respect of each of the critical components of the lending process, with a view to determining the adequacy of that conduct, and the extent of compliance with prescribed policies, systems, and processes.
Each report on a non-performing loan is preceded by a table which sets out the salient financial detail, in particular:
(a) principal outstanding, by which is meant the total value of loans as at 31 March 1991 which in most cases includes all fees and charges accrued to that date;
(b) provisions for loss, that is to say, the amount by which the facilities are written down in the Bank's books of account;
(c) unrecognised income, that is to say, the amount of interest charged against the facilities, but not brought to account in the Bank's books; and
(d) estimated loss, that is to say, the Bank's estimate of the likely financial consequences of the transaction to the Bank, on the worst case prognosis reported to the Bank Board.
None of the Bank's figures have been independently audited. The financial tables in each of the following six Chapters reflect the Bank's assessment of its financial position, and not that of the Investigation.
In general terms, the Investigation ascertained, from its review of policies, systems, and processes, in relation to the Bank's lending areas of activity, that, in respect of consumer lending, the Bank's processes were well and clearly developed and documented; that in respect of commercial lending, its procedures in relation to loans to the rural sector were well documented; but that, in relation to its most important sector of activity, corporate lending, the Bank's procedures were neither well structured, nor properly documented.
Preliminary Investigations by the Inquiry
As part of a `Preliminary Investigation Phase' directed at obtaining an initial understanding of the Bank Group organisation structures and financial activities, information relevant to the non-performing loan portfolio of the Bank was gathered and analysed. That information included listings of non-performing loans and credit facilities against which specific loss provisions had been raised.
Specific Investigations
The `Preliminary Investigation Phase' provided an information base for the initiation of the `Specific Investigation Phase' which incorporated specific assignments with respect to non-performing assets, namely:
(a) The review, documentation and evaluation of Policies, Systems and Processes in the Bank's principal areas of lending activity, namely consumer, commercial and corporate.
(b) The identification, selection and subsequent detailed analysis of specific non-performing loans, including the degree of compliance with the Bank's approved Policies, Systems and Processes.
Analysis indicated that the significant non-performing loan exposures were in the Bank's Corporate Lending area, and that principal exposures were in the sectors of construction, property, and finance (intrastate, interstate and overseas).
Nineteen loans were selected and subjected to detailed analysis. They had a combined "Principal Outstanding" of $961.9M at 31 March 1991. They cover various geographic locations and industry sector exposures. The loans selected represents 35.6 per cent of the amount outstanding for the non-performing loans identified by the Bank.
In essence the analysis involved:
(a) an extensive examination of the loan facility files, with particular emphasis directed to the evaluation of the critical elements of the loan transaction, including compliance with Policies, Systems and Processes;
(b) where appropriate, discussions with relevant Bank officers;
(c) establishment of loan facility investigation files containing relevant photocopy documentation extracted from the Bank's loan files, notes of discussions with Bank officers, and working papers;
(d) where considered warranted, interviews on oath with relevant Bank officers, and others;
(e) production of a comprehensive report providing the following information:
(i) Loan Facility client details and financials;
(ii) Background to the Loan Facility;
(iii) Movements in the Loan Facility;
(iv) Chronology of Events during the Life of the Loan Facility;
(v) Full discussion of the loan cycle (namely critical events in the loan transaction) including evaluation of compliance with approved Policies, Systems and Processes; and
(vi) Investigation comments and conclusions.
8.6.2 COMPARATIVE ANALYSIS - A SUMMARY
The detailed comparative analysis of the nineteen loans reviewed by the Investigation (and set out at Appendices F and G) has revealed what I regard as serious inadequacies in the Bank's credit management systems and processes. Although many of those inadequacies are referred to at Section 8.5 of this Chapter, it is appropriate to report on them in the context of the comparative analysis of those nineteen selected loans.
The following part of the Chapter uses basically the same eight stage analysis that the Investigation used in Section 8.5.
To protect client confidentiality the entity names that have been included are those that are the subject of the case studies in Chapters 9 to 14. It should be noted that the analysis of the loans to the Adsteam Group and to the REMM Group did not embrace all eight phases of the loan process referred to in Section 8.5 of this Chapter. Rather, those two loans were examined principally from one of those perspectives only, that of "Management of Loans", in the case of Adsteam, and "Initiation of Loans" in the case of REMM. With the exception of the loans to the Adsteam Group and to the REMM Group, all other loans have been analysed in relation to all eight phases of the loan cycle in a manner similar to those set out in Chapters 9 to 14 inclusive. As will be seen from the contents of this Section of this Chapter, all nineteen transactions have been used as the basis for findings and inferences as to the conduct by the Bank of its lending business. The Bank's files in relation to the fourteen facilities which are referred to in Appendix F but not reported upon in detail in the following six Chapters have been examined by the Investigation applying the same methodology as that brought to bear on those loans reported upon in Chapters 9 to 14 inclusive. For a combination of reasons, however, including that of client confidentiality referred to above, those fourteen loan transactions and the customers involved in them will not be referred to by name in this Chapter in support of specific conclusions.
8.6.2.1 Loan Antecedents
Of the nineteen loans reviewed, nine were facilities that were either fully or partially transferred from another financial institution to the Bank. In most of these cases, it is not evident from the Bank's files why the business was transferred to the Bank. In the case of Collinsville, bank officers may have been given reasons (which are recorded in the Ayers Finniss Information Memorandum referred to in the report on Collinsville) as to why the business was being transferred from the existing credit provider (Elders Rural Finance) to the Bank. For reasons given in the report on Collinsville, however, there are grounds for thinking that those reasons were not accurate or, if they were accurate, that they were pro tanto not complete.
In the case studies that were analysed in the course of the Investigation, there is only one case of a transferred facility, ie Collinsville, where there is clear indication that the company was already experiencing cash flow difficulties before the facilities were transferred to the Bank. Two other borrowers, however, had a history of losses before their facilities were transferred to the Bank. In the case of the Somerley loan, Interwest was, unbeknown to the Bank, encountering cash flow difficulties prior to the settlement of the syndicated loan in which the Bank was a participant. The Bank's subsidiary, Beneficial Finance, was aware of Interwest's financial difficulties and, as is indicated in the report on Interwest, disclosed certain of those difficulties to the Bank prior to settlement of the first tier syndicated loan. Nevertheless, both the Bank and Beneficial Finance consummated the syndicated loan transaction. This topic is more fully examined in Chapter 13 - "Case Study in Credit Management: Somerley Pty Ltd".()
8.6.2.2 Initiation of Loans
(a) Inadequate Gathering and Analysis of Financial Information
In the case of all but one of the loans reviewed, it was found that the gathering and analysis of financial information, including budgets and cash flow forecasts, was inadequate for one or more of the following reasons:
(i) the analysis of future cash flow projections was not done thoroughly;
(ii) sensitivity analyses were not performed on projected revenue or expenditure;
(iii) significant points were missed completely; for example, the projected cash flows supplied by the customer showed cash flow deficits or funding requirements in excess of the debt finance being sought; yet there was no analysis in the lending submission of how these shortfalls were to be covered;
(iv) where a company had only recently commenced business and therefore had no credit history, no additional effort was made to assess the attainability of the budgets presented to the Bank;
(v) budgets and cash flow forecasts provided by potential customers were simply accepted without question; there was no attempt to verify the reasonableness of these forecasts in the light of industry or economic conditions;
(vi) the required ratio analysis was either not done, or only briefly stated, without any commentary on adequacy or trends; and
(vii) in some cases - for example, loans to members of the Adsteam Group and to another large corporate borrower - loans were made despite a refusal on the part of the borrower to furnish projected financial information of the kind usually elicited from a borrower by the Bank.
It is appropriate to record that, in a number of instances, Bank officers interviewed by the Investigation asserted that appropriate analyses had been conducted, despite the fact that the Bank's files contained no evidence of such analyses. If such analyses were in fact performed, it is obviously regrettable that those important papers were not retained.
(b) Ability to Service the Loan
In three cases it was found that ability to service the loan had not been fully addressed. In five cases it was found that the source of the ultimate repayment of the principal at the end of the loan period had not been considered. Indeed, in two cases, it was found that the ability of the intending borrower to repay the principal to be borrowed from the Bank was not analysed at all. In one of these cases, the Bank's officers asserted to the Investigation that cash flow details had been obtained from the intending borrower, but these were not retained on the file, and so were not available to the Investigation. Furthermore, the file contained no evidence of an analysis of these cash flows having been performed by officers of the Bank. This compounded the failure of the Bank to direct attention to the source of repayment of the principal to be advanced to the borrower. Each of the two loans to which I have last referred was approved by the Lending Credit Committee.
Cash flow forecasts are an important source of information for use in assessing the customer's ability to service the requested facility. In the period reviewed by the Investigation, lending organs in the Bank, when considering the risk of a transaction over-emphasised the existence of security to be taken by the Bank when considering the risks of a transaction. Cash flow should have been, but was not, looked at as the primary source of repayment of funds, with realisation of security as a secondary source only.
It was common, in cases where ability to service the facility was considered by Bank officers proposing a loan, that there was insufficient information in the hands of the Bank and in the lending submission upon which the Bank's lending organs might make an informed decision. This was a result of shortcomings, in such analysis, of financial information and cash flow forecasts as did appear in the lending submission. Equally, there were cases where no industry analysis was carried out by those proposing a loan.
(c) Loans to Weak Customers
In a number of instances, loans were made by the Bank to companies or groups of companies which were showing signs of financial strain. The Collinsville Stud Group was such an entity. Equally, in the case of Halwood, the Lending Credit Committee acquiesced in the extension of foreign exchange facilities up to $40.0M to Halwood in January 1989, despite a series of adverse press comments on Halwood originating in April 1988. In October 1988, the Bank resolved to extend a $73.0M facility to Blanche, a subsidiary of Halwood, acknowledging that there had been a deterioration in Halwood's financial health.
(d) Defective Analysis of Security
In two instances, the Investigation identified misconceptions, on the part of Bank officers sponsoring loan submissions, as to the subject matter of security to be taken by the Bank, and as to parties against whom recourse might be had in the event of default. The loan to Buckley & Nunn, reported upon in the course of my report on Adsteam,() is such a case. A fundamentally similar misconception occurred in the case of a lending submission in relation to a proposed facility in favour of a different customer. The submission, which was approved by the Lending Credit Committee and by the Board Sub-Committee, postulated that the Bank would have recourse against a party with whom it was not entering into any contractual relationship whatsoever.
(e) Credit Assessment
Another important indicator of ability to service a loan is credit assessment, both of companies and often their directors, and of any individual or company which guarantees to support a facility. In six cases it was found that no credit assessments had been performed. A number of these cases involved loans to private companies. In these cases, failure to carry out an appropriate credit assessment was inexcusable.
(f) Valuations and Confirmation of Asset Values
In the case of seven of the loans reviewed, the initial appraisal of the value of security to be taken was either not on file when the file was produced to the Investigation, or was inadequate. In particular, sensitivity analysis which took into account a downturn in the business or economy was rarely performed. Valuations provided by the customer were often accepted with little analysis or scrutiny. Insufficient rigour was brought to bear on financial and other information provided to the Bank by applicants for loans.
In the case of the loan to Collinsville, the Bank's officers accepted, without sufficient scrutiny, the reasonableness of a substantial upward revaluation by Collinsville of current assets of the borrowing group.() In the Somerley/Interwest transaction, the Bank accepted, without question, a valuation prepared by an external valuer, when that valuation had attracted considerable criticism from Beneficial Finance on the grounds, inter alia, that it was internally inconsistent, and had arrived at a valuation on an inappropriate basis.()
The Bank's officers failed persistently to have regard, in analysing valuations, to the "boom and bust" or cyclical nature of the Australian economy. This pattern of behaviour continued even after the 1987 stock market crash. The Bank paid no heed to the lessons of the 1982-1983 recession, or to the earlier rapid decline in commercial property values which had occurred in 1973-1976 with dire consequences for credit providers exposed to the commercial property sector. The lending submissions analysed by the Investigation demonstrate that Bank officers commonly failed to direct attention to the stability of the value of assets to be secured in favour of the Bank. It is axiomatic to prudent lending that, when considering the likely outcome of forced realisation of any security, the lender have regard (when deciding whether or not to advance funds) to the ease with which the security will be able to be realised, and, in particular, to the following specific considerations: first, to whether the security can be taken into possession and ownership by the lender; secondly, to whether the security can lawfully be sold by the lender; and thirdly, to the existence of purchasers of the assets proposed to be secured in favour of the lender, to the size of the class of possible purchasers, and to whether their activity in the marketplace is continual or merely intermittent.
There were many instances where the Bank's officers failed to have regard to this axiomatic proposition. First and foremost, in the case of a loan on the security of a broadcasting licence, the Bank's officers failed to have regard to statutory restrictions on dealings in, and ownership of, the licence, which restrictions intrude on the ability of a secured lender to take over, and to sell beneficial ownership of the licence. In another case, the Bank's security included a Crown lease. The lease contained a power on the part of the lessor (a Crown instrumentality) to forfeit the lease and re-enter in the event of the tenant committing such a breach of a security transaction that the mortgagee became entitled to take possession of the tenant's interest in the lease. This power of forfeiture and re-entry made the tenant's interest in the lease wholly useless as security. Effectively, therefore, the security in both these instances was quite precarious. The Bank should not have lent without a full investigation of statutory and contractual restrictions on, or obstacles to the realisation of its security.
In the case of the Somerley transaction, the Bank's officers should have known that Australian based institutions had not, since the property crash in the mid 1970's, been major buyers of hotels. The Australian institutional market lacked, in 1988 and 1989, the investment and capital base to provide "take-outs" for hotel projects then under development. The direct consequence of this was that any buyer of the hotel which was to be constructed by Somerley with funds provided by the Bank would , in all probability, be a foreign interest. This immediately should have prompted the Bank to consider the stability of the Federal Government's foreign investment restrictions. It must be considered to be a perennial possibility that a Federal Government will preclude the acquisition by foreign entities of real estate in Australia, either wholly or in particular sectors.
Foreign investment restrictions also became relevant in relation to the Collinsville Stud loan, once that loan became irregular. It soon became apparent to the Bank that no purchaser of the secured properties would be found within Australia. It then became necessary for an approach to be made to the Foreign Investment Review Board for an indication of its attitude to a sale to a foreign interest of the secured properties.
In conclusion, it can be said that, when a decision is made to extend credit on security, all matters relevant to the ability of the lender to realise its security should be fully and comprehensively examined. In particular, where the security is, or includes, a statutory interest, licence, or title, and the statute under which the interest or licence has been granted imposes restrictions on dealings in, or on ownership of, the interest or licence, then lending on such interests is imprudent in the absence of support from other assets which are readily realisable. Equally, where loans are made on real estate, it is imprudent for the lender not to consider the availability, domestically, of potential purchasers of the secured property. Failure to do so creates the spectre of the Bank needing to run the gauntlet of Foreign Investment Review Board approval on attempting to realise its security. In several of the transactions analysed by the Investigation, these canons of prudence were ignored.
In one case, the valuation was provided by a firm in which the customer was a partner. This fact was not recorded in the Bank's files until more than four years later. The Bank took no steps to ascertain that the valuer was disinterested and independent. The Investigation has been informed that at least one former member of the Board can recall on several occasions emphasising to management, in the course of deliberations by the Board on a particular lending proposal, that valuations provided in verification of the value of a proposed security should be undertaken or commissioned by the Bank, and that it was inappropriate for such valuations to be provided by the customer.() (In reporting that submission, I am not to be taken as agreeing that such valuations necessarily have to be commissioned by a bank rather that its customer).
The Investigation scrutinised only one transaction involving a loan where the primary security was to be a registered debenture over the assets of a private company. It was the Bank's policy at the material time that, where a registered debenture was to be relied upon by way of primary security, the borrower's balance sheet must be audited, or a partial audit report supplied to the Bank confirming asset values. In the case analysed by the Investigation, no audit was conducted of the borrower's balance sheet to substantiate the value of the assets being relied upon, nor was a partial audit report supplied to the Bank confirming that the assets as valued in the borrower's financial statements were fairly and reasonably valued. The values furnished by the customer were relied upon without question, although they were based on an unaudited balance sheet. In a case of this kind, not only the lending submission should not have gone forward, but it should not have been approved, as it was, by the Lending Credit Committee.
(g) Notes of Interview
It was a requirement of the Commercial and Rural Lending department at all material times that interviews be held with prospective clients. Seven Commercial loans were reviewed. In three of those cases no documentation of initial meetings was found. Moreover, there was one Corporate loan which was introduced through Ayers Finniss where no record of meetings between the Bank and Ayers Finniss was found on the Bank's files. I have commented in the course of the report on Collinsville that the failure of Bank officers to make and retain notes of interviews with the customer before loan approval may materially disadvantage the Bank should it decide that its officers were the victims of non-disclosure of information.()
(h) Incompatible Duties
A fundamental flaw in the Bank's procedures for initiation of loans was that the duty of assessing information provided by applicants, and the duty of preparing loan submissions fell to be discharged by officers with a credit marketing role. In combination with the composition of the Lending Credit Committee, and given the absence of an independent credit inspection unit from the chain of credit approval between the points of origination and of final approval, this flaw, which was structural, resulted, in a number of instances, in the preparation of lending submissions which were imbalanced, which contained exaggerated assertions of the strength of the borrower, which treated topics only incompletely, or which omitted treatment of matters relevant to a reasonable and balanced assessment of the proposal. Because of the structure and composition of the Lending Credit Committee and the fact that loan applications went direct to it, necessary checks and balances were missing prior to 1 March 1991 and, as a result, no scrutiny was brought to bear, on loan applications by a division of the Bank independent of those business divisions which were bent upon asset growth.
I give a number of examples of imbalanced submissions of the kinds to which I have referred. Such a submission was found in the original lending proposal in relation to the Collinsville Stud.() In a second case reviewed by the Investigation, the Bank had in its possession information at the time of an application for an increase in facilities which indicated that, based on financial information forthcoming from the customer itself, the customer was in financial decline. That is to say, the financial information supplied to the Bank by the customer indicated, first, a failure to meet budgeted profits before tax; secondly, and in relation to a later period, reductions in budgeted profit before tax; and thirdly, and in relation to a still later accounting period, a budgeted loss before tax. Nevertheless, despite having that information which indicated a consistent downward trend in the profitability of the customer, the particular lending division proposed to the Lending Credit Committee (after the third period to which I have referred) a substantial increase in facilities. The lending submission did not draw to the attention of the Lending Credit Committee, or to the Board, the downward trend evident on the face of the customer's financial statements.
8.6.2.3 Approval of Loans
Structurally, as I have concluded in Sections 8.4 and 8.5 of this Chapter, the Bank's lending mechanisms were defective. One consequence of the way in which the Bank had organised its lending approval process was that there was insufficient accountability for decisions. In addition, insufficient rigour and analysis were applied both to the preparation of and to consideration of lending submissions. More importantly, the Lending Credit Committee was not, as I have said, structurally well-equipped to discharge its role. Its membership was drawn from line divisions, when it should have been divorced from those divisions. It had too many members. Its members had onerous duties apart from consideration of lending submissions.
Initial approval of loans was, in a procedural sense, generally satisfactory. At the substantive level, however, the approval of large loans by the Lending Credit Committee and the Sub-Board left a lot to be desired. One instance of exceeding prudential limits was found, along with two instances in which the Lending Credit Committee exceeded its Delegated Lending Authority on group exposures.
I have commented at length, in the course of my report on Adsteam, on the Bank's departures from its prudential limits and from its manipulation of self imposed restrictions by the use of what I consider to be transparently specious reasoning.() In one other case investigated, it was found that a facility recommended for approval by the Lending Credit Committee involved a breach of the Bank's prudential guidelines in respect of industry concentration. The subsequent submission to the Board, flowing from Lending Credit Committee recommendation, failed to include reference to the Bank's exposure to the industry as detailed in the submission to the Lending Credit Committee. That being so, it is likely that the Board did not consider the Bank's exposure to that particular industry before approving the facilities. The Investigation also identified three transactions, in the course of which individual Bank officers exceeded their delegated lending authority.
In providing facilities to Celtainer Ltd, the Bank agreed to make an equity investment of approximately $520,000 in that Company in addition to providing debt finance. The approval of this investment decision was referred to the Bank's Equity Group. The Equity Group, however, thought that the Lending Credit Committee would approve the investment at the same time as the loan, and thus refrained from approving the investment. In any event, the Equity Group's approval authority was limited to $300,000. There is no evidence that this investment was ever formally or duly approved by either lending organ.
Both the Lending Credit Committee and the Sub-Board often approved lending submissions which were manifestly deficient. For example, in the case of one loan analysed by the Investigation, a cash flow analysis was missing from the submissions to the Lending Credit Committee, to the Sub-Board, and to the Board. Cash flow analysis was required by the Bank's procedures. The approval by the Lending Credit Committee and the Sub-Board of lending submissions lacking cash flow analysis was a failure of duty on the part of the members of the Lending Credit Committee. In 1986, a sizeable loan ($20.0M) was extended to Halwood Corporation Limited (formerly known as Hooker Corporation Limited) as part of a syndicated financing facility. The financial information in the possession of the Bank did not include any projections of profit or cash flow critical to enabling the Bank to assess Halwood's capacity to service the syndicated facility, which was to be in the range of $75.0M to $100.0M. In 1987, the Bank made a further advance to Halwood as a participant in a syndicated facility under which Halwood borrowed $US 107.0M. The loan arose out of a lending submission approved by the Lending Credit Committee which contained no information as to projected profits or cash flow of Halwood.
Furthermore, where information as to cash flow was received by and relied upon by the Bank, it was often inherently improbable, yet accepted without rigorous scrutiny. The information provided by the Collinsville Stud group falls into this category. In one other case analysed by the Investigation, it was found that projected profit and loss information supplied to the Bank was insufficiently analysed, and failed adequately to address existing cash flow. In this particular instance, the borrower's information projected a threefold increase in sales, but no information was produced by the borrower to support such a projection, nor does the Bank's file indicate that the validity of those projections was questioned.
A number of instances were noted where, in the case of loan submissions which complied with the Bank's procedures, the merits of the applications were so weak that the applications should not have been proposed and recommended by management, and the Bank's lending organs should not have approved the proposed loans..
8.6.2.4 Security
(a) The Bank's policies required that an Extended Loanable Amount be calculated for all loans by multiplying the value of the security by an appropriate ratio which reflected the Bank's lending margin. The resultant amount is not necessarily the maximum amount the Bank will lend, but is considered to be a prudent guideline.
In six cases, the amount advanced by the Bank exceeded the Extended Loanable Amount. In some cases, the excess was considerable. In the case of the $73.0M facility extended to Blanche (a subsidiary of Halwood) the project cost was 100 per cent debt funded. The Bank's value of the project on completion was $78.1M. Applying the Bank's criteria, the extendable loan amount was $54.67M. The funding agreed to be provided by the Bank was, therefore, almost $20.0M in excess of that permissible under the Bank's lending guidelines.
(b) In a number of instances, the Bank lent effectively without security by way of procuring negative pledge covenants from the borrower. The loans to the Adsteam Group of Companies were usually of this kind. Equally, some of the loans to Halwood and its subsidiary and associated companies were secured merely by negative pledge. I am aware that in the 1980's, lending by way of negative pledge was extremely common, but the Bank should have participated in facilities secured merely by negative pledge only with caution and then only in connection with loans to customers with the highest credit ranking and in whom the Bank had, by virtue of previous dealings, a great deal of confidence.
(c) It also came to the notice of the Investigation that, on occasions, the Bank advanced funds on a limited recourse basis. The Somerley transaction was of such a kind. Loans by way of non or limited recourse finance impose great demands on credit originators and account controllers, and should also be entered into only with caution.
(d) In three cases the security actually taken differed from that detailed in the credit proposal. No formal approval of these changes to security arrangements has been produced to the Investigation by the Bank. I am satisfied therefore that in these cases procedural irregularities occurred.
8.6.2.5 Advance of Funds or Settlement
Two major problems were noted.
(a) Advance of funds occurred in five of the sample of nineteen loans before security was perfected. The bank was, therefore, unsecured from the time of settlement to the time at which security was obtained. In one case, security was not obtained until fourteen months after the initial drawdown even though approval was given subject to obtaining security. In another case, security was effectively not taken at all.
(b) Approvals of loans often set pre-conditions to drawdown; for example, the obtaining or confirmation of information or the making of certain commitments by the customer. In the case of six loans, it was found that these pre-conditions were not met before funds were advanced. In some instances, no records have been kept justifying settlement in the absence of satisfaction by the customer of all pre-conditions. In two instances, one of them being Collinsville, funds were advanced on the security of uninsured assets whilst other conditions as to insurance were outstanding.
It is also worth noting that, in one case, the letter offering facilities was sent to the prospective client before a credit submission was prepared.
In two instances, the advance of funds was preceded by inappropriate or inadequate letters of approval or finance facility agreements. I have commented, in some detail, in the report on Collinsville on the inadequacy of the Bank's letter of offer of 21 July 1989.() In one other case analysed by the Investigation, it was found that a provision in the facility agreement was simply impossible to be complied with, or satisfied by the borrower. That created a situation where the facility agreement, as a whole, was possibly unenforceable. A further case was identified where lending covenants were drawn in a form entirely inappropriate to the borrower's line of business. This points to the desirability of the Bank's prescribing a policy in relation to the issue of letters of approval, in respect of substantial transactions, to the effect that all letters of approval in relation to loans above a certain threshold be vetted by officers of the Bank's Legal department before being forwarded to the customer.
Equally, the Bank's approval of facilities extended to private companies was often inadequate, in that the Bank did not routinely insist on personal guarantees in support of loans to what were essentially family businesses. The provision of guarantees by an entire board, or at least by a majority of a board of a private company or an unlisted public company, will enable a lender to influence a debtor in a way which is not possible in the absence of guarantees, and may lead to the board of a debtor acting with greater caution in incurring debts and in attempting to comply with its lending obligations.
8.6.2.6 Hindsight Overview
The Hindsight Overview procedure was introduced in October 1989 in relation to all approvals other than those to customers "with credit risk grades A, B or C where total limits are less than A$100,000". It is not clear whether "where ... A$100,000" qualifies C only or A, B and C. But I construe the clause as meaning that all loans less than $0.1M to customers classed as A, B or C in quality do not attract overview. As I have indicated in passing in the course of Chapter 8, Hindsight Overview was introduced in Corporate Banking in about March 1990.()
Of the loans reviewed by the Investigation, many were established before the Overview process was introduced. Where Hindsight Overview did occur, it was not consistently applied to all credit decisions. It was sometimes performed after the two business day time limit. Two instances were found, in relation to the same loan, where overview did not occur because the Chief General Manager, Australian Banking, was on leave. One would have expected that an alternative reviewer would be nominated to cover his absences from duty.
8.6.2.7 Management of Performing Loans
(a) The principal characteristic of the management of the loans reviewed (before they became non performing) was that procedures were usually not carried out promptly. This held true, in particular, of the following procedures:
(i) taking action to rectify excesses over approved limits;
(ii) reporting excesses on accounts to the appropriate level of management;
(iii) downgrading or reclassifying loans to non-performing status; and
(iv) performing annual reviews.
In the case of nine of the loans reviewed, at least one of these procedures had either not been performed at all, or had not been performed promptly.
(b) Delegated Lending Authorities apply, not only in relation to the initial approval of facilities, but also in the ongoing management of those facilities, ie in approving extensions, increases, and changes to facilities.
Seven instances where Delegated Lending Authorities were exceeded were noted in relation to the management of loans. Five such cases related to the extension of facilities, one related to an increase and extension, and the other related to a verbal agreement given to a client to increase that client's facility by $100,000.
In the case of three loans, no formal approval of extension to facilities could be found on the Bank's files as produced to the Investigation. In spite of this, in one case, the client had been informed of an apparent approval.
(c) When annual reviews were performed, they were generally of an adequate quality. There seemed, however, to be a reluctance to question the reasonableness of budgets and cash flow forecasts provided by the customer (as noted in Initiation of Loans). In some instances, annual reviews were not adequate to protect the Bank, and reviews should have been carried out at more frequent intervals.
(d) As has been noted, in the case of the Adsteam Group, an annual review was deferred when, in all the circumstances, it should have been accelerated or preceded by a preliminary annual review.()
(e) Certain other irregularities or breaches of procedure were noticed in relation to loans whilst they were performing. In a number of cases, it was found that monitoring by Bank officers of compliance by the borrower with covenants and conditions of the loan was inadequate. For example, it was found that, on occasions, the Bank staff failed to maintain a covenant compliance sheet, and failed promptly, or at all, to report breaches of covenants and conditions to a lending organ within the Bank when seeking an extension, increase, or annual review, of a facility. In addition, cases were identified where Bank officers failed either to monitor, or to make due and proper inquiry into, the degree of compliance by the borrower with terms and conditions of lending. In a number of instances, merely superficial inquiry was made of the borrower as to its compliance with terms and conditions of loans from the Bank; no endeavour was made to corroborate information from the borrower.
A related incident occurred in connection with a facility to Halwood. In March 1989, an officer of Corporate Banking was required to certify compliance by Halwood with its negative pledge covenants. The compliance sheet and associated memoranda to the Lending Credit Committee reported that the negative pledge covenants had been complied with solely on the basis of publicly available information. No information had been sought from, or provided by, the company as to its compliance with its negative pledge covenants and conditions.
In several instances of loans examined by the Investigation, there was evidently a failure to monitor the financial health of the borrower. I have commented, in the course of my report on Collinsville, on the seeming indifference of Bank officers to the fate of Collinsville Stud's attempts to obtain equity in the months between July 1989 (when the Bank's funds were advanced) and December 1989, when a substantial facility granted by the Bank was expected to be repaid.()
(f) In many instances, insufficient information was stored on the Bank's files and the degree of monitoring of customer performances was haphazard.
8.6.2.8 Management of Non-Performing Loans
(a) When a loan is identified as non-performing, the Bank's policies stipulated that a review of the customer's financial position should be performed, that security documentation should be reviewed to ensure that it was in order, and that the value of that security should be reassessed. In the cases of seven of the sample loans, one or more of these reviews had not occurred.
(b) The Bank's policies required that an Action Plan be formulated for non-performing loans. In six cases no action plan had been drawn up by the time of review by the Investigation.
(c) As with the management of performing loans, information was not always reported to appropriate levels of management in time. This occurred even when management had specifically requested that they be informed of developments. Such delays were specifically noted in seven of the loans reviewed. The most important deficiencies in these respects were, first, failure by Bank officers to have non-performing loans declared non-accrual and recognised as such by the Lending Credit Committee, and, secondly, failure to recommend a provision where loss became a real possibility.
Similarly, timely action was not taken on many loans. References to the need to take action were found on many files, mainly in the form of internal memoranda or handwritten comments, but these were rarely followed by definitive action. Four specific cases were identified where there had been concern expressed on the files but no action taken. In only one of these cases was the Bank part of a syndicate which made independent action more difficult.
(d) It was a policy of the Commercial and Rural Lending department, at all material times, that actual performance should be monitored against budget for all customers whose loans had been classified non-performing. Such monitoring was not done for three of the seven Commercial and Rural loans reviewed.
(e) It became apparent to the Investigation, in the course of review of the non-performing loan transactions scrutinised by it, that one common feature of the Bank's management of non-performing loans was that officers who had sponsored the original lending submission remained in charge of the account after it became non-performing. There are manifest disadvantages in permitting this, in the absence of either random account monitoring by an independent credit unit, or fail-safe procedures for the generation of reports on irregular loans. The sponsoring officer may feel a certain reluctance to admit to a mistake (if for example it is found that an imprudently large amount has been extended to the customer) or may feel a form of loyalty to the customer which countervails against the employee's duty to the Bank. Or the lending officer simply may not be able, in an objective sense, to form an accurate assessment of the magnitude of the problem confronting borrower and lender. The Bank's policies and procedures at the time of the loans reviewed by the Investigation were inadequate. They should have, but did not have the consequence that, on an account becoming irregular, a division of the Bank apart from the division which sponsored the loan approval took control of the irregular transaction.()
8.6.2.9 Credit Inspection
The credit inspection policy was introduced only in August 1990. The policy required that "any sample must incorporate the review of:
(a) "All customers with aggregate credit exposure of A$1M or more; and
(b) All customers graded D (increased risk) or below".
All loans reviewed, except one, qualified for inspection on the basis of size alone. Credit inspection reports were found on only the five files.
8.6.2.10 General
The Bank's procedures for administering credit facilities required the completion of a number of forms. These include:
(a) Specification of Securities Form;
(b) Establishment Record;
(c) Credit Assessment Form;
(d) Settlement Guide;
(e) History Sheet; and
(f) Arrears Report.
In the case of eleven of the facilities reviewed, one or more of these forms was either missing or incomplete. This would indicate a general disregard of procedures.
8.7 REGARDING THE CONDUCT OF THE BUSINESS
8.7.1 QUALITY OF THE (PROPOSED) BUSINESS
It is extremely difficult to assess the quality of the business offered to the Bank on the basis of a sample of loans, which have subsequently proved to be non-performing. Proposals for credit facilities usually presented the prospective customer in a positive manner and, as noted above under Initiation of Loans, the possible demerits of a proposal were often not considered in the presentations. In addition, there was usually a lack of analysis of the proposal on file, and it is, therefore, difficult to make an independent judgement on the merits of most of the proposals.
Five of the loans which were examined related to property development, and another related to the financing of a commercial rental property. Of these six, four customers were large established corporations in the property business, one was a partnership of experienced South Australian developers, and the sixth comprised persons already known to the Bank. These proposals were approved during the boom in the property market in the late 1980s. On the basis of prices prevailing at that time they probably would have appeared viable. The Bank could never have predicted the severity of the downturn in the market and its resulting effect upon these loans. In my opinion, however, had sensitivity analyses been performed, had the Bank restricted itself to lending only up to the recommended lending margin for property based transactions, and had the Bank recognised its growing exposure to the property market, these losses might have been lessened.
Three of the facilities examined had been provided to companies, or divisions of companies, which had been in existence only for a short period of time. They therefore had no borrowing history. Whilst two of these facilities performed satisfactorily for some time before experiencing difficulties in a falling market, the third was clearly in difficulty within three months. Although it is evident that the Bank had no past history upon which to base a decision in these cases, it is not clear that it ever questioned the assumptions underlying the projected results of these companies.
Similarly, facilities were provided to two companies which had a recent history of losses. Again, there is no indication that the Bank questioned the ability of the customer's managers to restore profitability.
8.7.2 REPORTING OF RELEVANT INFORMATION
Four instances were found in which information of significance to the decision making process was not reported to the appropriate level of management.
In one instance, one of the directors of the borrowing company had been employed by that company for his expertise in one aspect of its business. A diary note of a discussion between an officer of the Bank and an employee of Beneficial Finance (the conversation occurring before the Bank decided to lend money to the company) noted that Beneficial Finance was no longer interested in doing business with the borrowing company as several deals written by the particular director for an entity related to Beneficial had left Beneficial Finance "in a sticky situation". Despite this information, a loan proposal was put to the Lending Credit Committee which reported on this particular director's "considerable knowledge" which was "held in high regard". No mention was made of Beneficial Finance's past experience of this person, as relayed to the Bank's officers who should have pricked up their ears on receiving such information.
In the case of a second loan in November 1990, Corporate Banking prepared a paper to be put to the Lending Credit Committee noting its concern over the recent valuation of the security held. Corporate Banking considered that the valuation was outdated and exaggerated, and Corporate Banking further commented that there was no ready market for the security. This paper, the contents of which were material to the decision making process, should have been but was not sent to the Lending Credit Committee.
In the case of the facility extended to Collinsville:
(a) An overview of the facility, which was prepared and submitted to the Board in June 1990, omitted to mention that the loan had been causing problems for the previous six months, and that the company had inadequate cash flow to service the loan since drawdown of the loan. It was misleading in that it implied, contrary to the fact, that the borrower was making part payment of its interest commitments.()
(b) In addition, the Collinsville facility became irregular early in January 1990. It remained irregular thereafter. In terms of the Bank's policies it should have been declared to be non-accrual at some stage in either April or May 1990. As it turned out, however, it was not until 16 August 1990 that a recommendation was made to the Lending Credit Committee that the loan be treated as non-accrual. That particular recommendation in fact came about at the insistence of the Lending Credit Committee itself, and not by virtue of compliance by members of line division with the Bank's policies.()
Finally, one loan involved the use of an off balance sheet company of the Bank Group, Kabani Pty Ltd, as an intermediary in the security arrangements. The involvement of this Company was not brought to the Lending Credit Committee's attention until some thirty months after the loan was approved, nor was the intention to enter into a Participation Agreement with Beneficial Finance mentioned. The ramifications of these security arrangements were thus not addressed by the Lending Credit Committee at the time when it was considering the lending submission. Subsequently the Bank has had to take legal advice as to the effectiveness of the security documents.
It was also found in relation to this last mentioned transaction that, at the time when the loan was approved, no mention was made of the existing exposure of Beneficial Finance to a group of companies of which the borrower was a part. The same defect was noted in connection with the Somerley transaction. It was ascertained by the Investigation that lending proposals, prepared by officers of Corporate Banking in relation to Somerley, did not inform the Bank's lending organs that the Bank had an existing exposure to Somerley and that Beneficial Finance, which was to be a second mortgagee over the property of which the Bank was to be a joint first mortgagee, also had exposures to Somerley and to another party involved in the relevant transaction.
I have commented, in the course of my Report on Somerley, on the imprudence of the Bank lending concurrently with a subsidiary. In the case of the Somerley transaction, the Bank failed to accord sufficient weight to the aggregated risk confronted by the Bank Group.() The Bank and Beneficial Finance also jointly extended funds to Halwood. I now set out certain details of this lending.
On 1 November 1988, the Bank's Lending Credit Committee considered a proposal that $33.0M be advanced to Halwood. The proposal had its origin in an invitation from Beneficial Finance to participate with Beneficial Finance in a joint funding package to enable the construction of Stage 1 of the development of the Henry Waymouth Centre in Waymouth Street, Adelaide. Beneficial Finance was to be the prime lender on the construction project. Stage 1 of the project comprised acquisition of the subject land and costs of construction of 13 storey office tower together with a car park comprising 680 spaces. A second stage was planned comprising two further office towers. It was proposed, however, that Stage 2 not proceed until a major tenant had been secured.
The lending proposal to the Lending Credit Committee noted that provision of funds for Stage 2 would be precarious, as construction was to occur during a period of potential over-supply of lettable office space in the Adelaide central business district area. Under the arrangement proposed to the Bank by Beneficial Finance, the Bank was to provide $33.0M of the total $47.0M costs of development of Stage 1, together with the purchase price of the Stage 2 land. Beneficial Finance was to fund the developer's remaining requirements. In addition, Beneficial Finance was to provide what was described as risk underpin to the Bank to the extent that Beneficial Finance would underpin 30 per cent of the total funds advanced by the Bank at all times other than when Beneficial Finance itself advanced funds, in which case 30 per cent of the total joint funds advanced would be underpinned.
The Bank was to have first claim to any proceeds of sale. The facility to be provided by the Bank was to be a cash advance facility with bill reliquification. Interest costs and fees were to be capitalised from within the facility limit which was for a term of 18 months. The facility was to be non-recourse to Halwood, except that Halwood both gave a guarantee that the project would be completed and provided a guarantee in relation to cost overruns and interest cover beyond the total estimated project cost ($37.7M). This proposal was approved by the Lending Credit Committee.
In my opinion, the approval of this proposal by the Committee involved lack of due care and diligence. Repayment of the loan advanced by the Bank was dependent entirely on Halwood's ability to sell Stage 1 on completion. The lending proposal itself acknowledged that the project was being constructed for completion at a time of potential over-supply of lettable office space in the Adelaide central business district. The amount to be advanced was substantial. The facility was non-recourse. Total Bank Group exposure to Halwood (including the amount to be advanced by Beneficial) was $193.5M upon the loans being extended to Halwood by the Bank and by Beneficial Finance. The loan was especially structured in the way adopted for the purpose of evading the negative pledge covenants which governed Halwood's main borrowings. In particular, because Halwood was not itself to be the borrowing entity, it was considered that the transaction would not put it in breach of negative pledge covenants.
In addition, the Lending Credit Committee did not direct its attention to whether the intended facility should be aggregated with other debts due to the Bank by Halwood and by its subsidiary and associated entities for the purposes of the Bank's prudential guidelines.
Repayment of this facility was dependent exclusively on Halwood's ability to sell the project on completion. Halwood had informed the Bank that it had not yet considered how it would sell the complex. Despite this, and despite the projected over-supply of office space, the Bank considered it more important to support the development of the building "to indicate faith in the Adelaide central business district" rather than see the project abandoned by the developer. In so acting, the Bank acted recklessly.
8.7.3 QUALITY OF DECISION MAKING
The quality of decision-making by individual management, the Lending Credit Committee and the Board, is highly dependent upon the information available to the decision-maker at the time of the decision. As noted above, relevant information was sometimes not reported. In many cases, events associated with the on-going management of exposures were not reported to appropriate levels of management on a timely basis. Senior management were, therefore, unaware of certain potential problem loans until after they had become serious problems. The decisions in these circumstances were thus reactive rather than pro-active, in determining the course to be taken in managing these loans.
A number of instances of imprudent decisions have been found:
(a) Proposals for credit facilities for two particular companies were each initially rejected by the Bank. In the case of one, this was due to concerns over the repayment ability of the customer. In both cases, however, the proposal was subsequently resurrected and approved. There is no indication, in either case, that the borrower's circumstances had altered sufficiently significantly to warrant such a change in assessment.
(b) A proposal to provide credit facilities to an ex-director of Celtainer Ltd cited a Letter of Comfort from a major shareholder of Celtainer Ltd as security for the loan. The Bank's Legal department advised that this Letter was not binding upon the issuer. The Bank nevertheless lent with only the Letter as security, noting "we will have to trust their commitment". Whilst the letter was, in fact, subsequently honoured, it was, in my opinion, extremely imprudent of Bank officers to advance funds in the face of such advice from the Bank's Legal department.
(c) A number of imprudent decisions were identified by the Investigation in relation to the Somerley loan. First, the Lending Credit Committee authorised a bridging facility into Somerley at a time when Beneficial Finance was extending second mortgage finance to the borrower over the same security. The consequence was that the aggregated exposure of the Bank Group on the project, which was funded by a limited recourse loan, was an inappropriately high 89 per cent of the total syndicated borrowings. Secondly, the Lending Credit Committee and the Board subsequently approved participation by the Bank in a first tier syndicate knowing that Beneficial Finance was to be a second tier lender against very fine margins, in circumstances where it was foreseeable that conflict would arise between the interests of the Bank and the needs of Beneficial Finance. Equally, the later decision of the Bank to acquire the interests of the other first tier syndicate members through Beneficial Finance was imprudent for the reasons given in the report on the Somerley loan.
Decisions regarding the reclassification of accounts and the making of provisions were often not made in good time. In four loans reviewed, there were late decisions to classify the account as Non-Accrual. In four others, concern over the state of the account was recorded on file, but no action was taken to rectify identified problems with the account. In one case, as previously noted, the Bank was part of a syndicate and, therefore, its ability to take independent action was restricted. The Collinsville facility was one in which a senior officer of the Bank, Mr Ottoway, omitted to treat the facility as non-accrual because of a misinterpretation of Bank policy.()
8.7.4 CONFLICTS OF INTEREST
Of the loans reviewed, points worthy of note under this Section arose in five instances. In two, relationships and dealings caused the Investigation grave disquiet. Nevertheless, the evidence available to the Investigation did not enable me to conclude that particular Bank officers were improperly afflicted by a conflict of interest and duty at material times, or, if they were, that their interest somehow influenced decision-making within the Bank. The Bank does need to formulate and monitor both clear guidelines on material and pecuniary interests, and policies calculated to prevent or reduce the risk that junior officers will be improperly influenced, in the course of decision-making, by the existence of friendship or other personal relations between a borrower (or someone interested in a borrower) and a senior officer of the Bank.
8.7.5 COMMUNICATION BETWEEN DIVISIONS/DEPARTMENTS/SUBSIDIARIES
The following specific instances of communication difficulties were found.
(a) The loan to the Collinsville Group resulted from an Information Memorandum prepared by Ayers Finniss. This document contained cash flow projections which had been checked only perfunctorily by the Ayers Finniss staff. I have found that a detailed review of these projections was not performed by Bank officers. They relied on the information supplied by Ayers Finniss on the ground that it was a subsidiary of the Bank.() In that case, Ayers Finniss was bound by obligations of confidence to its client, Collinsville Stud, not to make disclosure of information to the Bank. Its position as both a wholly-owned subsidiary of the Bank and a merchant banker retained by an intending customer of that Bank, to act at arm's length to the Bank, was riddled with incipient conflict. Furthermore, in connection with the same transaction, it transpired that the terms of the retainer given by Collinsville Stud to Ayers Finniss (that is to say, the amount of equity in Collinsville which Ayers Finniss was to seek, and the basis upon which the equity was to be sought), changed fundamentally between the date of approval of the loan by the Bank and the date of settlement. Ayers Finniss did not, and was not entitled to, relay this information to the Bank notwithstanding that it affected the entire substratum upon which the Bank's approval had been procured.()
(b) As already mentioned, the Bank made an equity investment in one of its customers, Celtainer Ltd. There is no evidence on file to show that this investment was formally approved, apparently because of a lack of communication between the Equities Group, the Corporate department, and the Lending Credit Committee.
This lack of definition of responsibilities continued after the initial investment. The Corporate department apparently thought that the Equities Group was monitoring the investment, but did not provide them with any information on Celtainer because it was purporting to maintain a "chinese wall" between the departments. The Equities Group decided that this was a strategic investment, not a trading investment, and that responsibility for the monitoring of this investment lay with the Corporate department.
(c) In the case of the Somerley transaction, Beneficial Finance had grave concerns about the reliability and factual premises of the valuation report which, to its knowledge, had been produced to the Bank, and was being relied upon by the Bank in its own assessment of whether or not to extend funds. The substance of those concerns in relation to the valuation was not, so far as the Bank's files reveal, disclosed to the Bank, nor indeed, was the existence of those concerns relayed to the Bank, until after the Bank's funds had been advanced.
(d) In June 1988 Beneficial Finance Corporation sold down to the Bank part of its funding of a development on the Gold Coast. When problems arose with this facility, Beneficial Finance Corporation and the Bank appeared to spend more time and effort in contesting who was to pay the interest owing to the Bank than in attempting to find a possible solution to the problem of the loan.
(e) Not only were there difficulties of communication within the Bank, and as between different entities in the Bank Group, but the Bank also seemed to lack the facility to digest information in the public domain and act upon it. For example I have, in the course of reporting on Somerley, commented on the Bank's acceptance, without scrutiny, of a valuation prepared by Colliers. Before the Bank settled its participation in the First Tier Syndicate loan to Somerley, the Melbourne Herald carried a report of the speech delivered by the Managing Director of the hotel division of Colliers.() The speech, as reported, sounded a note of caution as to the viability of hotels then under construction and planned for construction in Australia and indicated that the hotel market was approaching saturation point. The speaker's remarks were directly relevant to and cast doubt upon the accuracy, at the time of the speech, of the assumptions which underpinned the valuation report to which I referred in paragraph 4. Whilst a copy of the relevant press clipping was on the Bank's file, there is no indication that the Bank took any notice of this prognosis by a senior officer of Colliers. At the very least, the information was of sufficient materiality to warrant it being relayed to the Lending Credit Committee for reconsideration of the Bank's participation in the syndicate.
8.8 THE BOARD AND THE DISCHARGE OF ITS DUTIES
I am satisfied that the Bank Board failed sufficiently to control and oversee an orderly development of credit processes within the Bank. The Board was aware that the Bank was growing at a rate faster than its competitors, but it did not resolve, at any stage, to create the necessary structural accompaniments to this growth. The former non-executive directors of the Bank have submitted to me "that they sought assurances, at the consideration of every Strategic Plan, Profit Plan and Annual Report from management that, despite the outstanding growth of the Bank's assets, the Bank was capable of directing, controlling and managing such growth. Those assurances were given on each occasion".() Notwithstanding those assurances, the Board had, and expressed, knowledge of deficiencies in the Bank's credit processes. For example, at its meeting on 24 July 1986, the Board noted:
"The quality of some Corporate Lending proposals indicate that the Lending Officers concerned have not fully developed the special skills necessary to identify information which may lack integrity. Directors recognised the rapid business growth in this area and suggested there was a need for specialist training in financial analysis of Corporate Banking proposals." ()
Nothing would appear to have emerged from this observation. Certainly, from 1989, Board members more frequently expressed concern as to the Bank's ability to manage its exposures and its growing business. For example on 23 February 1989, a Director expressed concern at a Board meeting at the occupancy level of central business district properties, not only in Perth, but also throughout Australia generally, and was reportedly advised (by whom does not appear) that the Bank was currently reviewing its exposure to central business district development, and that a paper on the topic had in fact been considered by the Lending Credit Committee. The Board was told that the paper considered by the Lending Credit Committee had indicated that the Bank was not over exposed in the area of central business district real estate. It was recorded that, after a further review to provide additional detail, the paper would be re-submitted to Lending Credit Committee and subsequently to the Board for the information of directors.()
On 17 April 1989, a number of directors expressed further concern at a Board Meeting at the rate of growth of the Bank and the ability of staff to cope with the pressures caused by this growth. The minutes record that directors were advised that the Bank was currently undertaking a major review of its organisational structure, in conjunction with a firm of external management consultants and, in addition, that external consultants had been engaged to review the structure of Corporate Banking. The Board was informed that these reviews were being carried out to ensure that the Bank had appropriate personnel to meet the demands of the Bank's operations.() At the meeting of the Board on 26 July 1990, the Directors are recorded as having expressed their concerns that Bank officers responsible for the operational and strategic management of the Export Park project had insufficient real estate management and marketing expertise. The Board is recorded as having been informed that "a property "workout" Section would be established in the Corporate Banking division to provide expertise in this area".()
Finally, at its meeting on 14 November 1990, while the board was resolving on an internal restructure, the Chairman of the Board advised the Board that he had recently met with the external auditors of the London branch, who had expressed concern over the Bank's operations at its London branch. In addition, the Chairman is recorded as having advised the Board on that occasion, that the Bank of England and the Reserve Bank of Australia had commented that the Bank's London portfolio had a high level of exposure to the United Kindgom property market. Another member of the Board observed that London's over exposure to the property market suggested that supervision of the Bank's London operations from Adelaide was inappropriate, and that this in turn reflected on International Division management. The Board member questioned what effect perceived errors in judgement by International Division managers would have on other managers in the organisation. The Board is recorded as having been given certain assurances as to the competence and supervision of the relevant Bank officer.()
It was not until November 1989 that the Board actually passed a resolution requiring a review of the Bank's credit quality processes and procedures. The Board was on notice well before November 1989 that all was not well with the Bank's lending processes and procedures. Again, I give but two examples.
At its meeting on 26 November 1987, the Board had received a review paper from the Finance and Planning department, dated 18 November 1987, for information. The paper() reported that a review had been conducted of all loans for which a specific provision for write-off of greater than $50,000 had been made. The loans had been analysed with a view to determining the cause of the write-off. The review paper did not state who had conducted the analysis, but it would appear to have been carried out by Bank officers, as opposed to external auditors or consultants. The paper noted that the Bank had offered a number of training courses in the lending area; that a Commercial Lending Section had been created to focus commercial lending activity in a centrally based Section; and that a Lending Examiners Section had been created in the Retail Lending department. It was reported that some write-offs were due to inadequate valuations and that, in consequence, much tighter guidelines had been put in place to cover the use of external valuers. It was also reported in the review paper that several problems had arisen from imperfect and inadequate security having been taken; this problem was proposed to be overcome by training well before November 1989.
It was clear from this paper that all was not well with the Bank's lending processes and procedures. What was not clear from the paper was whether inquiries had been conducted to ascertain whether the identified defects were more widespread in the Bank's lending portfolio. It was noted that, in Retail Banking division, substantial losses had been incurred because of "extremely poor account management". Some officers had been removed from their positions, and Retail Banking had created an internal disciplinary committee. No positive corrective steps were proposed. It was also reported that some losses had flowed from failure to place accounts on a non-accrual basis sufficiently early, and that that had been the result of a lack of clear policy guidelines covering non-performing and non-accrual loans. The paper noted that a major policy revision was currently being "defined" to improve performance in that area. The paper foreshadowed introduction of a mandatory classification scheme for non-performing and non-accrual loans. The paper further foreshadowed implementation of an automated non-performing loans reporting system in Retail Banking division. Finally, the paper noted that it was anticipated that the tightening of policy guidelines, the expected economic downturn resulting from the collapse of equity markets, and the introduction of the new reporting system in Retail Banking division, would increase the recognised need for specific provisions by $2.0M above current budget estimates.
For purposes of preparation of the paper, the authors of the paper had analysed 38 loans. In the course of the analysis, 16 incidents of poor lending decisions were identified, 12 of inadequate valuations, 11 of imperfect security, 11 of inadequate security, 7 of poor account management, and 18 of failure to place on non-accrual. These are alarming statistics. Given that the paper was a review paper presented merely for information, the Board was not required to resolve to direct any action with a view to improving the Bank's credit processes. The paper implied that management had well in hand the task of rectifying the problems identified in the paper. The Directors are recorded as having noted the report. The matter was the subject of little discussion.
More or less contemporaneously, Board members received a memorandum from Mr Clark dated 13 November 1987. In the memorandum, the Managing Director of the Bank informed the Board (and members of the Executive Committee, to which the memorandum was also addressed) that it was his view and that of the Chief Economist of the Bank:
"that we are heading into very difficult times which will not correct quickly.
State Bank is well prepared for a difficult future but will be faced with customers getting into financial difficulties, increasing non-accrual accounts, increasing bad debts and challenges in meeting our lending targets with high quality loans.
While we anticipate several difficult years ahead of us there will be opportunities. We will actively seek out these opportunities but assess them very conservatively assuming:
. The continuing decrease in the stock market,
. The decrease/collapse in certain areas of the property market,
. Extremely difficult conditions in certain agricultural areas,
. The decline in the Australian economy,
. The reduced status of Australia in the International scene."
I comment on the materiality of this memorandum in Section 8.9 of this Chapter.
The second example arose in March 1989, when the Bank's loan to the National Safety Council of Australia became a matter of concern. The Board discussed the loan at a special meeting on 1 April 1989. At the meeting, the Board resolved, among other things, that a Committee of the Board be formed to examine details of the transaction. That Committee later completed a review which included an internal lending audit of "selected corporate files".() The findings of the review included the following:
"REVIEW FINDINGS
In summary the conclusions of the review are as follows.
. There is no particular reason to doubt the soundness of the Bank's credit assessments. Indeed in some areas Beneficial Audit Team has commented that the assessments have been very appropriate.
. There is however clear evidence that the administrative detail, completeness and consistency of the process that surrounds credit assessment and account management has not kept the pace (sic) with the Bank's growth and is deficient in a number of areas.
. The Bank is clearly stronger at handling traditional loans as opposed to more innovative lending instruments. In some of the latter instances lending deficiencies have been found.
. In general, loan and security documentation was adequate although in specific instances significant deficiencies have been uncovered. Some of these deficiencies result from the age of the security documentation, in other instances they result from lack of management follow-up of specific items of the security administration.
. No effective audit process exists for Corporate Banking.
. In some areas risk assessment is not accompanied by the level of "risk boxing" necessary to properly manage all manageable loan risks.
. There is evidence that the Corporate Lending Department has been understaffed in both the marketing areas of the department and in some of the administration and back office areas also.
. Communication of concerns from Account Managers through to Board has not always been effective and in some cases has been deficient.
SPECIFIC ACTIONS
As a response to these general concerns the following action has been proposed by management.
1. Complete review of the current lending approval structure, including the role of Lending Credit Committee and the Board in the overall credit decision making chain (intended for presentation to the July Board).
2. A redefinition, extension and general tightening of the Lending Credit Committee submission format.
3. A more explicitly defined and broadly based process of establishing loan conditions during the loan approval process.
4. The development of a revised organisation structure within Corporate Banking and in associated departments (e.g. Audit, Legal) that segments responsibility and management for security documentation and settlement tasks.
5. A clarification of the authorities to approve variations in loan conditions, loan securities and a definition of responsibility for explicit account monitoring tasks to be developed.
6. The establishment and staffing of a corporate audit function.
7. The development of an annual review processing and management system (computer based) to ensure that all account monitoring and annual review is conducted within the approved timeframes.
8. Attention to and training of Corporate Lending staff in the "boxing of risks" identified during assessment process and the proper establishment of loan conditions to contain those risks.
9. Specific guidelines regarding such matters as seeking current financial information, treatment of capitalised interest, treatment of significant client events etc..
10. Development of more formalised Lending Policy Manuals."
The reforms mooted in this paper took up to 12 months to implement.() In the meantime, business continued to be written, and to be approved by the Board, as usual. Given its statutory and contractual/fiduciary duties to the Bank, the way in which it had structured the Bank's lending organisation, the role which it had reserved to itself in the lending process, its knowledge after 1987 of defects in the lending process, its knowledge of the swift growth of the Bank and its approval of the extreme growth in corporate lending by the Bank, the Board had a specific responsibility actively to intervene in relation to development within the Bank of appropriate credit policies and procedures. The Board did not intervene until 1989. There is no evidence to indicate that the Board ever specifically delegated responsibility for implementing effective and adequate credit processes. But, by its inaction, the Board effectively left matters of that kind to the Managing Director, prior to April 1989. After April 1989, as I have indicated, the Board both expressed concern as to the Bank's credit processes and took active steps to ensure that those processes were reviewed. Pending that review, however, the Board did not endeavour to restrict the volume of business which the Bank was writing. It disengaged itself almost wholly from some aspects of the practical business of banking. The Board, I am satisfied, failed properly and adequately to direct, supervise, and control, the affairs, transactions, and operations of the Bank. It failed adequately and properly to oversee the activities of the Chief Executive Officer. It failed to set proper priorities for the Bank's management. It failed to direct management to implement appropriate checks and balances to the Bank's asset growth, and, in particular, to the growth in volume and character of the Bank's corporate lending.
8.9 THE CHIEF EXECUTIVE OFFICER
The Chief Executive Officer of the Bank, Mr Clark, also attracts criticism for the inadequacies in the development of appropriate credit processes and procedures within the Bank. As I have observed, by virtue of Section 18(2) of the State Bank of South Australia Act, Mr Clark was, subject to the control of the Board, responsible for the management of the Bank. Until November 1989, when the Executive Committee approved the establishment of a project team to redevelop the Australian Banking divisions credit processes, Mr Clark neither effectively discharged, nor effectively delegated, his duties in relation to management of the Bank's lending and in relation to management of its credit risks. In this respect he was, in my opinion, in serious breach of duty.
I have previously referred to Mr Clark's memorandum to the Directors and the members of the Executive Committee, dated 13 November 1987, in which he warned the Board that the Bank was heading into very difficult times which would not correct quickly. In that memorandum, as I have indicated, Mr Clark asserted to the Board that "State Bank is well prepared for a difficult future". That statement, in so far as it related to the Bank's credit assessment processes and its level of provision, was positively misleading. The memorandum foresaw quite accurately that the Bank would "be faced with customers getting into financial difficulties, increasing non-accrual accounts, increasing bad debts and challenges in meeting our lending targets with high quality loans". Nevertheless, the memorandum contemplated an increase in the Bank's lending.
It is incomprehensible that Mr Clark, knowing of the defects outlined in the November 1987 review paper and having foreseen difficult years ahead for the Bank, should have failed, as I am satisfied that he did, to take positive steps in 1987 or 1988 to ensure, not only a thorough review of the Bank's level of general provisions but also a review of its credit quality processes and, indeed, that he should not have in the interim, restricted the Bank's level of lending.
Mr Clark should, in 1987 or early 1988, have promptly taken or directed action to remedy those shortcomings in the Bank's credit processes which were identified in the review paper of 18 November 1987, to which I referred in Section 8.8. By contrast, Mr Clark neither took, nor directed, specific remedial action. Some ten months went by before a rudimentary Credit Policy Manual was prepared, in September 1988. In the meantime, no modificiations were suggested, or directed, by Mr Clark to the Bank's lending policies, processes or procedures. Lending business continued to expand, despite the coincidence of the stock-market crash, Mr Clark's memorandum of November 1987, and the results of the review to which I have referred. In the light of his memorandum of November 1987, it is incomprehensible that Mr Clark can have failed, as he did, to insist on the immediate formulation and adoption of stricter and more rigorous lending policies and procedures. He should have ensured that the Bank's processes were such that only the quality assets referred to in his memorandum were able to be the subject of loan approvals by the Bank.
Equally, when the Bank's involvement in the NSC crisis stimulated the Board as a whole to constitute an ad hoc review Committee, Mr Clark failed to take any initiatives. He did not take any steps positively to accelerate implementation of the reforms proposed by the Committee. He did not take any interim steps to restrict Bank lending until the reforms were on foot. He did, however, in July 1989, instruct Mr Paddison to cause a review to be undertaken of twenty five of the Bank's larger non-performing loans, and to review credit reporting within the Corporate Banking division.()
8.10 GENERAL CONCLUSIONS
The preceding Sections of this Chapter of the Report have discussed and examined:
(a) the background factors that influenced the Bank's management of credit;
(b) the guidelines and directions for the conduct of lending business;
(c) the organisation and structure of the Bank's credit management process;
(d) the Bank's policies and procedures concerning the credit management process.
(e) in broad terms, specific transactions which have resulted in material Bank losses;
(f) the conduct of the Board and the Chief Executive Officer of the Bank in relation to credit risk management;
(g) the functioning and efficacy of the Lending Credit Committee;
(h) in broad terms, the extent to which lending policies and procedures were adhered to by officers of the Bank.
Having considered all of these matters, and based on the assessments, analyses and conclusions, expressed in this Chapter, a summary of my major conclusions, opinions, and findings, is provided below.
8.10.1 GUIDELINES AND DIRECTIONS FOR THE CONDUCT OF THE LENDING BUSINESS
The guidelines and directions for the conduct of the lending business and the constraints thereon should, in normal circumstances, be dealt with as part of a bank's planning process. The extent to which these issues were addressed in the Strategic Plans, in Profit Plans, and by the Executive Committee, was inadequate in that:
(a) Whilst the Bank's plans focused on asset and profit growth, insufficient attention was paid to constraints upon achieving these targets, and, in particular:
(i) the need to enhance information systems; and
(ii) the need to ensure appropriate human resource skills.
(b) insufficient attention was paid to the means by which the desired growth was to be achieved. In particular:
(i) there were no internally published procedures for limiting risk by way of defining maximum exposures to any particular industry or sector; and
(ii) lending criteria were insufficiently defined.
8.10.2 ORGANISATION AND STRUCTURE
The organisation and structure of the Bank's credit management processes were inadequate in that:
(a) The Board:
(i) lacked the necessary experience properly to fulfil its obligations, so far as concerned credit management;
(ii) failed sufficiently to control and oversee an orderly development of credit processes;
(iii) neither effectively delegated, nor effectively discharged, its statutory powers in relation to lending;
(iv) did not receive, and did not insist on receiving, information in such a form that it could both fully comprehend it and safely use it as the basis for wise and practical decisions;
(v) due to the use of "round robin" decision making processes, was on occasions denied an appropriate forum in which to discuss and assess loan applications. In the case of loans to Adsteam and Halwood, the Board approved unsecured loans during "round robin" telephone calls. In the case of the Somerley transaction, the "round robin" resolution was never formally confirmed; and
(vi) by failing adequately to define the monitoring role to be undertaken by the Lending Credit Committee and by failing to create a clear demarcation line between the duties of the Lending Credit Committee and the Asset/Liability Management Committee, failed to ensure that an appropriate organ of the Bank was unambiguously charged with responsibility to monitor the Bank's prudential guidelines, to supervise broader aspects of asset management, and to monitor exposures to lending risks generally.
(b) The Board Sub-Committee:
(i) did not have either a well defined role or a clear perception of its powers and functions;
(ii) was not strictly a Committee at all, but rather a fluctuating group of individuals;
(iii) was an unsafe and unsatisfactory institution which, in practice, served no useful purpose;
(iv) accepted papers and submissions, on short notice, that were of variable quality;
(v) frequently acted beyond its authority, in that it purported to approve loans which required full Board approval, in circumstances where no urgency was identifiable; and
(vi) made major credit decisions without due regard to the quality of the information presented for consideration, and deferred excessively to the perceived expertise of the Lending Credit Committee, and of the officers responsible for preparing the submissions.
(c) The Chief Executive Officer, Mr Clark:
(i) in the period between 1984 and November 1989, neither effectively discharged, nor delegated, his duties in relation to formulation of lending policy, processes, and procedures, and in relation to management of its credit risks, and in this respect, he was, in my opinion, in serious breach of duty.
(d) The Lending Credit Committee:
(i) was unsatisfactorily constituted by the Board. The Board did not define the monitoring role to be undertaken by the Committee. The Board did not create a demarcation line, as between the Board (including the Chief Executive Officer) and the Committee, or as between the Lending Credit Committee and the Asset/Liability Management Committee, so as to allocate responsibility for supervision and surveillance of the Bank's lending and lending policies;
(ii) was hampered in the discharge of its duties (so far as loan approvals were concerned) by the large number of individuals admitted to membership, its workload, and the manner in which the Committee operated;
(iii) on occasions transacted business in the absence of a quorum;
(iv) failed adequately to review and report upon loan quality on a half yearly basis, and failed to give direction to the Bank's lending. Members of the Committee were unable personally to monitor the Bank's lending practices, and to ensure compliance with its procedures, except by casting a vote at a particular meeting; they were individually unable to monitor either compliance by line personnel with conditions of approval set by the Committee, or exposures to a particular borrower or group of borrowers. Equally, there was no expectation that they would undertake these monitoring tasks. Members personally were not subjected to that duty;
(v) sought to make decisions by way of consensus. That must inevitably have weakened the sense of personal responsibility which attendees felt;
(vi) comprised, by and large, division managers interested in ensuring growth in the Bank's assets; they must for that reason, as I have said, have had a predisposition in favour of approving lending submissions;
(vii) comprised a number of persons who lacked experience and expertise in Corporate Banking;
(viii) was poorly structured and inadequately supported; and
(ix) was defectively constituted in that:
. the Committee was predominantly constituted by individuals drawn from the Bank's lending divisions who had an interest in the Bank's corporate achievement of asset growth; and
. the Committee was not assisted by any institution or division within the Bank which was able to scrutinise lending applications by reference solely to prudential considerations.
What was lacking from the Bank's credit approval structure, at Lending Credit Committee level and below, was a procedure under which lending decisions would be rigorously and objectively analysed by a person not having a commitment to asset growth for its own sake. There was no institution or procedure within the Bank which permitted or required lending decisions to be scrutinised by reference solely to prudential considerations. All officers of the Bank who participated in lending decisions at Lending Credit Committee level and below were motivated either wholly or partly by the corporate desire for growth in assets. It is abundantly clear that this was a major failing within the lending structures of the Bank prior to 1990. In forming this conclusion, I have also had regard to the fact that many members of the Lending Credit Committee, in the period under review, were participants in a bonus scheme, or were otherwise entitled to bonuses, which reflected the growth, in a particular year, in loans written by the division of which the officer was a senior manager.
(e) Regarding Other Lending Authorities:
(i) the levels of delegated lending authorities applicable to officers in the Corporate Banking division were inappropriately low. This created the potential for a loss of accountability by line management in relation to credit decisions, for the reason that most loan applications received by Corporate Banking lay beyond the delegated lending authority applicable to officers in Corporate Banking. Those officers who sponsored submissions to the Lending Credit Committee did not need to accept responsibility for the approval of loans by that Committee; and
(ii) as line management had insufficient delegated lending authority, an excessive number of credit decisions fell to be considered by the Board and the Lending Credit Committee.
8.10.3 POLICIES AND PROCESSES
The formal policies and processes concerning the credit management process on foot prior to 1 March 1991 were inadequate in material aspects, including:
(a) Initiation of loans, in that the policies and processes:
(i) did not ensure that loan proposals were prepared and recommended solely, or principally, on the basis of the applicant's ability to service and repay the debt. Rather, excessive weight was given to the value of the proposed security;
(ii) did not require as a standard procedure an analysis of the prospective borrower's cash flows;
(iii) did not ensure that sensitivity analysis was performed where necessary, particularly with regard to cash flow projections, and to forecasts provided by prospective borrowers;
(iv) did not ensure that Managers obtained sufficient data and performed analysis adequate to an assessment of all the risks in a proposal; and
(v) did not formally establish the responsibilities of Managers preparing credit submissions.
(b) Approval of loans, in that the policies and processes:
(i) did not, before early in 1990, provide for any independent review of the quality of credit decisions;
(ii) did not formally define the responsibilities of loan approval officers;
(iii) did not set delegated lending authorities at appropriate levels, resulting in an excessive number of credit decisions being considered by the Lending Credit Committee. Accountability for credit decisions was removed from individuals;
(iv) did not establish a credit review or Lending Credit Committee, whose members were devoted full time to a consideration of loan applications and other matters relating to credit management and credit policy. As a consequence, members of the Lending Credit Committee, in the period 1984 to 1990, must from time to time have had an inadequate opportunity to peruse and analyse lending submissions forwarded to the Committee; and
(v) were able to be circumvented or violated.
(c) Loan security, in that the policies and processes:
(i) were not introduced, by way of any published policy statements, in the Corporate Banking division until March 1988;
(ii) were not, given the size and complexity of loans made by the Corporate Banking division, sufficiently detailed or specific;
(iii) did not formally require professional independent legal assistance to be obtained on complex matters; and
(iv) did not ensure that valuation reports obtained by the Bank were of a minimum standard of quality and reliability.
(d) Management of loans, in that the policies and processes:
(i) did not, prior to March 1988, direct managers continuously to monitor the performance of their customers, and watch for early signs of deteriorating credit risk;
(ii) did not provide specific direction as to how Managers should monitor their customers or define the responsibilities of Managers in this regard, with the result that monitoring was carried out haphazardly;
(iii) did not, prior to March 1990, direct Managers as to the appropriate remedial actions to take when a weakening credit situation was identified;
(iv) did not separate the responsibility for account monitoring from the loan initiation and approval roles, so that there was often an unwillingness by Managers to recognise deteriorating credit situations or take remedial action. I do accept that it will not always be practicable to separate the functions of loan initiation/approval and monitoring, but , where these functions are merged in a single officer or division, they should be accompanied by appropriate checks and balances, such as the establishment of a Credit Inspection Unit, and clear guidelines calculated to trigger off the intervention of an autonomous credit watch unit once objective signs of customer deterioration become known to the Bank. As I have indicated, the Bank's Group Credit Manual is now intended to create these checks and balances.
(e) Management of non-performing loans, in that the policies and processes:
(i) did not, prior to March 1988, establish a system such that non-performing or non-accrual loans were separately classified and treated;
(ii) did not, prior to January 1990, require that reports on non-accrual loans be presented regularly to the Bank Board. From March 1988, non-performing loans were identified monthly and separately identified on the Monthly Excess Report. In addition, a Bad and Doubtful Debts return was to be prepared quarterly and include details of all non-performing loans with an excess of more than $25,000 for more than one month. It was in January 1990 that the first non-accrual report was presented to the Board. In my opinion, this was wholly unsatisfactory. The Board should have set up, at an earlier stage, a procedure under which non-accrual loans were reported to it. It could not possibly make a genuine provision without detailed knowledge of all non-accrual accounts and the amount involved in each account that had been classified non-accrual;
(iii) did not, prior to March 1990, describe the actions that should be taken when a loan became non-performing, such as additional monitoring of a customer's cash flows and performance against budgets;
(iv) did not, prior to March 1990, define the responsibilities of Managers in relation to identifying and taking action on non-performing loans;
(v) did not, prior to March 1991, establish a separate Section of the Bank, independent from the business units responsible for approving loans, responsible for handling problem loans and the resolution thereof.
8.10.4 THE ORGANISATION AND STRUCTURE AT WORK
In the course of its investigation into, and review of, the 19 non-performing loans to which I referred in Section 8.6 of this Chapter, the Investigation encountered disturbingly frequent departures from prudent lending practice and from the Bank's self-imposed lending procedures. I have, in Section 8.6, set out, in some detail, the findings and conclusions of the Investigation in relation to those loans, and I invite the attention of the reader to those findings and conclusions. It is not appropriate here that I repeat point by point the conclusions and findings expressed in Section 8.6 or the conclusions and findings found in each of the following six Chapters of this Report. Suffice to say that the Investigation identified irregularities, breaches of procedure, and imprudent conduct or imprudent decisions, in relation to each of the eight phases of lending activity identified in Section 8.5. In many respects, these delinquencies were a function of the structure and organisation of the Bank's credit processes. Additionally, and more specifically, they were a function of the fusion in individual officers of marketing roles and lending powers and responsibilities; of the loss of accountability which flowed, as I have demonstrated, from the ambit of the role of the Lending Credit Committee in relation to Corporate Banking division; of the obsession with asset growth and of the Bank collectively according a higher priority to growth itself as opposed to growth in quality assets; of insufficient discipline and of insufficient regard to the cyclical nature of the Australian economy; and they were a function of both collective and individual lack of acumen and lending maturity.
In my overall assessment, a common theme of the inadequacies described above is that the Bank placed little importance on the implementation of adequate credit policies and procedures in the period from its inception until about late 1989. Given that in this period the Bank's total assets grew from $3.1B to more than $15.0B, such an indifference to the quality of credit management was extremely imprudent.
Some attempt was made in March and September 1988 to formulate basic credit policies for the Corporate Banking division, but the need for fundamental improvements to the credit management process was not addressed in earnest until 1989. It was only in November 1989 that the Credit Quality Project Team was established, and given the task of developing a new credit philosophy, culture, and credit management system. This resulted in publication of the Group Credit Manual (albeit not complete) on 1 March 1991.
So far as concerns the overall management of its lending business, I am satisfied that the two principal factors which have caused the financial position of the Bank, as reported by the Bank and the Treasurer in public statements on 10 February 1991, and in a Ministerial Statement by the Treasurer on 12 February 1991, were, first, the quality of lending decisions made within the Bank, and, secondly, the process for the identification of bad and doubtful debts. The poor quality of lending decisions made by officers and institutions within the Bank in the period under review was partly a consequence of the non-existence of policies, partly a consequence of the inadequacy of policies which did exist, partly a consequence of non-compliance with policies, and partly a consequence of a culture within the Bank which created a pre-disposition to lending money without an adequate assessment of the credit worthiness of the borrower. Furthermore, the Bank's policies were not only often inadequate, they were often flouted by Management, and, in some instances, by the Board itself. Shortcomings in policy formulation, coupled with non-adherence to such policy as had been prescribed, made the reported financial position of the Bank inevitable.
The poor quality of lending decisions made by officers and institutions within the Bank was compounded by the failure of the Bank properly to monitor the quality of the loan business which it had written. That failure led to a failure on the part of the Bank adequately to make provision against bad and doubtful debts. These various factors reacted synergistically.
The Bank has, in its submission to this Investigation, admitted:
"The problems with the SBSA credit process started from the early days of the new Bank. In its desire for growth, and to prove itself as an increasingly significant player in the Australian financial market, the Bank focused too much on the deal and not sufficiently on repayment, security and portfolio considerations." ()
The matters investigated by the Inquiry, as reported upon in this Chapter, provide ample confirmation of this assessment on the part of the Bank.
8.11 REPORT IN ACCORDANCE WITH TERMS OF APPOINTMENT
As directed by paragraphs A, C and D(a) of my Terms of Appointment, I have investigated and inquired into matters relating to the Bank's management of credit. Having regard to the evidence to which I have referred in this Chapter and for the reasons set out in this Chapter, I hereby report that, in my opinion:
8.11.1 TERMS OF APPOINTMENT A
(a) The matters and events which caused the financial position of the Bank as reported by the Bank and the Treasurer in public statements on 10 February 1991, and in a ministerial statement by the Treasurer on 12 February 1991, included the conduct by the Bank of its lending business and in particular the quality of lending decisions made by the credit organs within the Bank and the process for the identification of bad and doubtful debts.
(b) The processes which led the Bank to engage in operations which have resulted in material losses or in the Bank's holding significant assets which are non-performing, (as the case may be) included the lending processes and procedures of the Bank on which I have commented in this Chapter.
(c) Those processes were inappropriate, for the reasons given in this Chapter.
(d) The procedures, policies, and practices, adopted by the Bank in the management of significant assets which became non-performing are those set out in this Chapter of this Report.
(e) Those procedures, policies, and practices, were inadequate, for the reasons given in this Chapter.
(f) Inadequate and improper procedures existed for the identification of non-performing assets.
8.11.2 TERM OF APPOINTMENT C
The operations, affairs, and transactions, of the Bank were, in the respects identified in this Chapter, inadequately and improperly supervised, directed, and controlled, by:
(a) The Board of Directors of the Bank.
(b) The Chief Executive Officer of the Bank.
(c) The other officers and employees of the Bank to whom reference has been made in this, and in the succeeding six Chapters of this Report.
8.11.3 TERM OF APPOINTMENT D
The information and reports given by the Chief Executive Officer and other bank officers referred to in this and the succeeding six Chapters of this Report were not, under all the circumstances, timely, reliable, or adequate.
8.12 APPENDICES
APPENDIX A
|
MEMBERS |
30 Jun 1984 |
30 Jun 1985 |
30 Jun 1986 |
30 Jun 1987 |
30 Jun 1988 |
30 Jun 1989 |
30 Jun 1990 |
30 Nov 1990 |
| G D Abbott |
Member |
member | ||||||
| J A Baker |
Member |
Member |
Member |
Member |
Member |
member | Resigned Aug 90 | |
| P E Byrnes | member | member | ||||||
| T M Clark | member | member | member | member | member | member | member | member |
| K L Copley | member | member | member | member | member | |||
| R S Dent | member | member | member | member | member | |||
| C W Guille | member | member | member | |||||
| M G Hamilton | member | member | member | |||||
| D Hammond | member | |||||||
| J T Hazel | member | member | member | member | member | |||
| J B Macky | member | member | member | member | member | member | member | member |
| T L Mallett | member | member | member | member | member | member | ||
| J D Malouf | App. Oct 90 | |||||||
| D C Masters | member | member | member | |||||
| K S Mathews | member | member | member | member | member | member | ||
| G S Ottaway | member | member | member | member | member | |||
| S G Paddison | member | member | member | member | member | member | member | |
| V R Pfeiffer | member | member | member | |||||
| K P Rumbelow | member | member | member | member | member | |||
| S Stone | member | |||||||
| S G Targett | member | |||||||
| I R Tucker | member | member | member | |||||
| G N White | member | member | member | member |
Note: The Annual Report of the State Bank of South Australia for each of the years 1985 through 1990 show an Organisational Structure except for the 1988 year.
Source: Annual Reports - State Bank of South Australia for the Period 1985 - 1990 and Bank records.
THE BOARD OF DIRECTORS
APPENDIX B
|
MEMBERS |
QUALIFICATION |
30 Jun 84 |
30 Jun 85 |
30 Jun 86 |
30 Jun 87 |
30 Jun 88 |
30 Jun 89 |
30 Jun 90 |
28 Feb 91 |
30 Jun 91 |
| R D Bakewell | B Sc. (Econ) |
Appointed 24/04/85 |
Director |
Director |
Director |
Deputy Chairman |
Deputy Chairman |
Resigned/ Reinstated |
Retired 30/06/91 |
|
| L Barrett | OBE,FCA,ACIS,FTCL,FAIM |
Chairman |
Chairman |
Chairman |
Chairman |
Chairman |
Retired 30.05.89 |
|||
| T M Clark | MBA (Harvard) |
Managing Director |
Managing Director |
Managing Director |
Managing Director |
Managing Director |
Grp Managing Director |
Grp Managing Director |
Resigned 09/02/91 |
|
| Prof K J Hancock | B A,PhD,FASSA |
Deputy Chairman |
Deputy Chairman |
Deputy Chairman |
Resigned 31/12/86 |
|||||
| W F Nankivell | B AgSc,RDA,JP |
Director |
Director |
Director |
Director |
Director |
Director |
Director |
Resigned |
|
| R P Searcy | B Ec,FCA |
Director |
Director |
Director |
Director |
Director |
Director |
Director |
Resigned |
|
| D W Simmons | LLB |
Director |
Director |
Director |
Deputy Chairman 26/02/87 |
Deputy Chairman |
Chairman 01/07/89 |
Chairman |
Resigned |
|
| Hon D W Simmons | DFC,BA,BEc,AVA |
Director |
Director |
Director |
Died 28/08/86 |
|||||
| K Smith | ARMIT,GRMIT,FAIM |
Director |
Director |
Director |
Resigned 23/01/87 |
|||||
| Mrs Molly Byrne | OAM |
Appointed 26/02/87 |
Director |
Director |
Director |
Resigned |
||||
| R E Hartley |
Appointed 26/02/87 |
Director |
Director |
Director |
Resigned/ Reinstated |
Re-appointed 28/02/91 |
||||
| A R Prowse | B Com, M Sc |
Appointed 01/07/90 |
Resigned/ Reinstated |
Re-appointed 28/02/91 |
||||||
| A G Summers | RDA,AAIV |
Appointed 6/02/87 |
Director |
Director |
Director |
Resigned |
Note: Australian Board of Advisors was appointed on 1 July 1990 and included Sir Sydney Schubert QLD, Sir Lawrence Govam NZ, R Donald Malcolmson MBE Vic, and John B Studdy AM NSW who was appointed 1 September 1989. All were terminated with effect as of 31 March 1991.
Source: State Bank of South Australia Board Meeting Minutes for the Period 1984 -1991
THE BOARD OF DIRECTORS
APPENDIX B.2
(The Board was restructured in February 1991)
|
MEMBERS |
QUALIFICATION |
30 Jun 84 |
30 Jun 85 |
30 Jun 86 |
30 Jun 87 |
30 Jun 88 |
30 Jun 89 |
30 Jun 90 |
28 Feb 91 |
30 Jun 91 |
| R D Bakewell | B Sc. (Econ) |
Appointed 24/04/85 |
Director |
Director |
Director |
Deputy Chairman |
Deputy Chairman |
Resigned/ Reinstated |
Retired 30/06/91 |
|
| N R Clark | B Com, AASA,FAIB |
Appointed Chairman 27/02/91 |
Chairman |
|||||||
| I E Webber | B E, M.Aut.E,CIT,FAIB |
Deputy Chairman |
Deputy Chairman |
|||||||
| J Glidden | B Sc,B Econ |
Appointed Director 04/04/91 |
Director |
|||||||
| M S Shanahan |
Appointed 28/02/91 |
Director |
||||||||
| E C J Johnson | B Econ, DipBus,AAIB,FAIM |
Appointed Group Managing Director 01/06/91 |
Group Managing Director |
|||||||
| R E Hartley |
Appointed 26/02/87 |
Director |
Director |
Director |
Resigned & Reappointed 27/02/91 |
Director |
||||
| A R Prowse | B Com, M Sc |
Appointed 01/07/90 |
Resigned & Reappointed 27/02/91 |
Director |
Source: State Bank of South Australia Board Meeting Minutes for the Period 1984 - 1991
LENDING CREDIT COMMITTEE
APPENDIX C.1
EFFECTIVE 29 JUNE 1984
|
NAME |
POSITION |
BANK TITLE |
| P E Byrnes | Chairman | General Manager, Corporate & International Banking |
| T M Clark | Ex-Officio | Managing Director |
| D C Masters | Member | Chief Manager, Corporate Banking |
| K S Matthews | Member | General Manager, Retail Banking |
| G S Ottaway | Member | Chief Manager, Finance |
| V R Pfeiffer | Member | Chief Manager, Retail Lending |
| K P Rumbelow | Alternate | Chief Manager, Administrative Services |
| I R Tucker | Alternate | Chief Manager, Branch Banking |
|
Quorum: Managing Director or a General Manager must be in quorum of four. Delegations: To be advised to Managing Director for confirmation. Urgent decisions by Board Sub-Committee require two (2) directors and chairman of LCC. Minutes: Distributed to Executive Committee members for information. Membership: Future appointments to be approved by Board. |
||
Note: Delegated Lending Authority: $1.0 M to $2.5 M
Source: Board Minute 84/10 & 84/12, 28 June 1984
LENDING CREDIT COMMITTEE
APPENDIX C.2
EFFECTIVE 30 JUNE 1985
|
NAME |
POSITION |
BANK TITLE |
| P E Byrnes | Chairman | General Manager, Corporate & International Banking |
| T M Clark | Ex-Officio | Managing Director |
| J T Hazel | Member | Chief Manager, Foreign Exchange and Money Market |
| D E Hosking | Alternate | Chief Manager, International Banking |
| J B Macky | Alternate | Chief Manager, Planning |
| D C Masters | Member | Chief Manager, Corporate Banking |
| K S Matthews | Member | General Manager, Retail Banking |
| G S Ottaway | Member | Chief Manager, Finance |
| V R Pfeiffer | Member | Chief Manager, Retail Lending |
| K P Rumbelow | Alternate | Chief Manager, Administrative Services |
| I R Tucker | Alternate | Chief Manager, Branch Banking |
| R L Wright | Alternate | Chief Manager, Administration Corporate & International |
|
Quorum: Managing Director or a General Manager must be in quorum of four. Delegations: To be advised to Managing Director for confirmation. Minutes: Distributed to Executive Committee members for information. Membership: Future appointments to be approved by Board. |
||
Note: Delegated Lending Authority: $2.0 M to $5.0 M increased on 28 February 1985
Source: Board Minute 85/56, 28 February 1985
LENDING CREDIT COMMITTEE
APPENDIX C.3
EFFECTIVE 30 JUNE 1986
|
NAME |
POSITION |
BANK TITLE |
| T M Clark | Ex-Officio | Managing Director |
| J T Hazel | Member | General Manager, Treasury and Capital Markets |
| J B Macky | Member | General Manager, Information Systems & Subsidiary Co. |
| T L Mallett | Member | Chief Manager, International Banking |
| D C Masters | Member | Chief Manager, Corporate Banking |
| K S Matthews | Chairman | Chief General Manager |
| G S Ottaway | Member | General Manager, Corporate & International Banking |
| S G Paddison | Member | Chief Manager, Retail Banking |
| V R Pfeiffer | Member | Chief Manager, Retail Lending |
|
Quorum: Managing Director or a General Manager must be in quorum of four. Delegations: To be advised to Managing Director for confirmation. Minutes: Distributed to Executive Committee members for information. Membership: Future appointments to be approved by Board. |
||
Note: Delegated Lending Authority: $2.0M to $5.0M
Source: Board Minute 85/56, 28 February 1985
LENDING CREDIT COMMITTEE
APPENDIX C.4
EFFECTIVE 30 JUNE 1987
|
NAME |
POSITION |
BANK TITLE |
| T M Clark | Ex-Officio | Managing Director |
| C W Guille | Member | Chief Manager, Personnel |
| J T Hazel | Member | General Manager, Treasury & Capital Markets |
| J B Macky | Member | General Manager, Information Systems & Subsidiary Co. |
| T L Mallett | Member | Chief Manager, International Banking |
| D C Masters | Member | Chief Manager, Corporate Banking |
| K S Matthews | Chairman | Chief General Manager |
| G S Ottaway | Member | General Manager, Corporate & International Banking |
| S G Paddison | Member | General Manager, Retail Banking |
| V R Pfeiffer | Member | Chief Manager, Retail Lending |
|
Quorum: Managing Director or a General Manager must be in quorum of four. Delegations: To be advised to Managing Director for confirmation. Minutes: Distributed to Executive Committee members for information. Membership: Future appointments to be approved by Board. |
||
Note: Delegated Lending Authority: $2.0M to $10.0M increased on 28 August 1986
Source: Board Minute 86/285, 28 AUgust 1988
LENDING CREDIT COMMITTEE
APPENDIX C.5
EFFECTIVE 30 JUNE 1988
|
NAME |
POSITION |
BANK TITLE |
| T M Clark | Ex-Officio | Managing Director |
| J B Macky | Member | General Manager, Group Information Systems |
| T L Mallett | Member | General Manager,Treasury and International |
| D C Masters | Member | General Manager, Corporate Banking |
| K S Matthews | Chairman | Chief General Manager |
| G S Ottaway | Deputy Chairman | General Manager, Group Services |
| S G Paddison | Member | General Manager, Personal and Business Banking |
| V R Pfeiffer | Member | Chief Manager, Retail Lending |
| I R Tucker | Member | Chief Manager, Branch Banking |
| R L Wright | Member | Chief Manager, Institutional Banking |
|
Quorum: Any four members can form a quorum. Delegations: To be advised to Managing Director for confirmation. Minutes: Distributed to Executive Committee members for information. Membership: Future appointments to be approved by Board. |
||
Note: Delegated Lending Authority:
- $3.0M to $15.0M increased on 28 July 1987; and
- $3.0M to $20.0M increased on 28 April 1988.
Source: Board Minute 87/204, 23 July 1987; and
Board Minute 88/94, 28 April 1988.
LENDING CREDIT COMMITTEE
APPENDIX C.6
EFFECTIVE 30 JUNE 1989
|
NAME |
POSITION |
BANK TITLE |
| T M Clark | Ex-Officio | Group Managing Director |
| J B Macky | Member | General Manager, Group Information Systems |
| T L Mallett | Member | General Manager, Treasury and International |
| D C Masters | Member | General Manager, Corporate Banking |
| K S Matthews | Chairman | Chief General Manager |
| P F Mullins | Member | Chief Manager, Corporate Banking |
| G S Ottaway | Member | General Manager, Group Service |
| S G Paddison | Member | General Manager, Personal and Business Banking |
| V R Pfeiffer | Member | Chief Manager, Personnel and Business Lending |
| I R Tucker | Alternate | Chief Manager, Branch Banking |
| R L Wright | Member | Chief Manager, Institutional Banking |
|
Quorum: Any four members can form a quorum. Delegations: To be advised to Managing Director for confirmation. Minutes: Distributed to Executive Committee members for information. Membership: Future appointments to be approved by Board. |
||
Note: Delegated Lending Authority: $3.0M to $25.0M increased on 22 December 1988
Source: Board Minute 88/504, 22 December 1988
LENDING CREDIT COMMITTEE
APPENDIX C.7
EFFECTIVE 30 JUNE 1990
|
NAME |
POSITION |
BANK TITLE |
| T M Clark | Ex-Officio | Group Managing Director |
| J T Hazel | Member | Chief General Manager, Financial Services |
| J B Macky | Member | Chief General Manager, Group Management Services |
| T L Mallett | Member | Chief General Manager, International Banking |
| D C Masters | Member | General Manager, SA/NT Corporate and Commercial |
| P F Mullins | Member | Chief Manager, Corporate Banking |
| S G Paddison | Member | Chief General Manager, Australian Banking |
| R L Wright | Member | Chief Manager & Project Leader, Wholesale & Credit Review |
|
Quorum: Any four members can form a quorum. Delegations: To be advised to Managing Director for confirmation. Minutes: Distributed to Executive Committee members for information. Membership: Future appointments to be approved by Board. |
||
Note: Delegated Lending Authority: $3.0M to $25M since 22 December 1988
Source: Board Minute: 88/504, 22 December 1988
LENDING CREDIT COMMITTEE
APPENDIX D
(Established 28 June 1984 to 28 February 1991)
| memberS |
1984 |
1985 |
1986 |
1987 |
1988 |
1989 |
1990 |
'91 |
||||||||||||||||||||||||||||||||||||||||||||
|
SEP |
DEC | MAR | JUN | SEP | DEC | MAR | JUN | SEP | DEC | MAR | JUN | SEP | DEC | MAR | JUN | SEP | DEC | MAR | JUN | SEP | DEC | MAR | JUN | SEP | DEC | FEB | ||||||||||||||||||||||||||
| P E Byrnes | ||||||||||||||||||||||||||||||||||||||||||||||||||||
| T M Clark | ||||||||||||||||||||||||||||||||||||||||||||||||||||
| C W Guille | ||||||||||||||||||||||||||||||||||||||||||||||||||||
| M G Hamilton | ||||||||||||||||||||||||||||||||||||||||||||||||||||
| J T Hazel | ||||||||||||||||||||||||||||||||||||||||||||||||||||
| D E Hosking | ||||||||||||||||||||||||||||||||||||||||||||||||||||
| J B Macky | ||||||||||||||||||||||||||||||||||||||||||||||||||||
| J D Malouf | ||||||||||||||||||||||||||||||||||||||||||||||||||||
| T L Mallett | ||||||||||||||||||||||||||||||||||||||||||||||||||||
| D C Masters | ||||||||||||||||||||||||||||||||||||||||||||||||||||
| K S Matthews | ||||||||||||||||||||||||||||||||||||||||||||||||||||
| P F Mullins | ||||||||||||||||||||||||||||||||||||||||||||||||||||
| G S Ottaway | ||||||||||||||||||||||||||||||||||||||||||||||||||||
| S G Paddison | ||||||||||||||||||||||||||||||||||||||||||||||||||||
| V R Pfeiffer | ||||||||||||||||||||||||||||||||||||||||||||||||||||
| K P Rumbelow | ||||||||||||||||||||||||||||||||||||||||||||||||||||
| S J Stone | ||||||||||||||||||||||||||||||||||||||||||||||||||||
| I R Tucker | ||||||||||||||||||||||||||||||||||||||||||||||||||||
| R L Wright | ||||||||||||||||||||||||||||||||||||||||||||||||||||
Note:members of the Lending Credit Committee held variously the titles of Chief Manager, General Manager and Chief General Manager and represented the Retail and Corporate and International Banking Divisions and Treasury.
Source: Lending Credit Committee Meeting Minutes for the Period 1984 - 1991
CORPORATE AND INTERNATIONAL BANKING
APPENDIX E
DELEGATED LENDING AUTHORITIES RECORD OF CHANGES
|
Date of Change |
Board Sub-Committee $'000 |
Lending Credit Committee $'000 |
Chief General Manager Inter'l $'000 |
General Manager Inter'l $'000 |
General Manager Corporate $'000 |
Chief Manager Corporate & Inter'l $'000 |
Senior Manager $'000 |
Corporate Manager $'000 |
| 21/05/85 |
5,000 |
2,000 |
2,000 |
500 |
250 |
|||
| 25/08/85 |
5,000 |
2,000 |
2,000 |
1,000 |
500 |
250 |
||
| 28/08/86 |
40,000 |
10,000 |
3,000 |
3,000 |
1,500 |
500 |
250 |
|
| 28/07/87 |
50,000 |
15,000 |
3,000 |
3,000 |
1,500 |
800 |
250 |
|
| 28/04/88 |
50,000 |
20,000 |
5,000 |
5,000 |
2,000 |
1,000 |
1,000 |
|
| 22/12/88 |
60,000 |
25,000 |
5,000 |
5,000 |
2,000 |
1,000 |
1,000 |
|
| 17/10/89 |
60,000 |
25,000 |
16,000 |
5,000 |
5,000 |
2,000 |
1,000 |
1,000 |
| 06/12/90 |
60,000 |
25,000 |
5,000 |
5,000 |
2,000 |
1,000 |
1,000 |
DELEGATED LENDING AUTHORITIES FOR THE REVIEW OF FACILITIES RECORD OF CHANGES
|
Date of Change |
Board $'000 |
Lending Credit Committee $'000 |
Chief General Manager Inter'l $'000 |
General Manager Inter'l $'000 |
General Manager Corporate $'000 |
Chief Manager Corporate & Inter'l $'000 |
Senior Manager $'000 |
Corporate Manager $'000 |
| 21May85 a)
b) |
>10,000 |
>15,000 10,000 |
15,000 5,000 |
5,000 |
2,000 |
|||
| 25Jul85 a)
b) |
>10,000 |
>15,000 10,000 |
15,000 5,000 |
5,000 |
2,000 |
|||
| 28Aug86 a)
b) |
>10,000 |
>15,000 10,000 |
15,000 5,000 |
5,000 |
2,000 |
|||
| 27Jul88 a)
b) |
>10,000 |
>15,000 10,000 |
15,000 5,000 |
5,000 |
2,000 |
|||
| 5Dec89 a)
b) |
>10,000 |
>15,000 10,000 |
30,000 5,000 |
15,000 5,000 |
5,000 |
2,000 |
||
| 17Sep90 a)
b) |
>10,000 |
>15,000 10,000 |
30,000 5,000 |
15,000 5,000 |
5,000 |
2,000 |
||
| 6Dec90 a)
b) |
>10,000 |
>15,000 10,000 |
30,000 5,000 |
15,000 5,000 |
5,000 |
2,000 |
a) All arrangements approved have been honoured, no deterioration in financial position is evident, no deterioration in security is evident and risk assessment is same or better than when original exposure was approved.
b) Arrangements have not been honoured, or financials show deterioration from previous year, or security has deteriorated from original approval, or since last review.
DETAILED ANALYSIS OF INDIVIDUAL LOANS FILES
APPENDIX F
|
MANAGEMENT |
|||||
|
INITIATION |
APPROVAL |
SECURITY |
ADVANCEMENT |
PERFORMING |
NON-PERFORMING |
|
A LTD |
A LTD |
A LTD |
A LTD |
A LTD |
A LTD |
|
CELTAINER |
CELTAINER |
CELTAINER |
CELTAINER |
CELTAINER |
|
|
COLLINSVILLE STUD |
COLLINSVILLE STUD |
COLLINSVILLE STUD |
COLLINSVILLE STUD |
COLLINSVILLE STUD |
COLLINSVILLE STUD |
|
B LTD |
|||||
|
HALWOOD CORPORATION |
HALWOOD CORPORATION |
HALWOOD CORPORATION |
|||
|
- ASPENAIR PTY LTD |
- ASPENAIR PTY LTD |
ASPENAIR PTY LTD |
|||
|
- BLANCHE PTY LTD |
BLANCHE PTY LTD |
||||
|
C LTD |
C LTD |
C LTD |
C LTD |
||
|
INTERWEST (SOMERLEY) |
INTERWEST (SOMERLEY) |
INTERWEST (SOMERLEY) |
|||
|
D LTD |
D LTD |
D LTD |
D LTD |
||
|
E LTD |
E LTD |
E LTD |
E LTD |
E LTD |
E LTD |
|
F LTD |
F LTD |
F LTD |
F LTD |
F LTD |
|
|
G LTD |
G LTD |
G LTD |
G LTD |
||
|
H LTD |
H LTD |
H LTD |
H LTD |
H LTD |
H LTD |
|
I LTD |
I LTD |
I LTD |
I LTD |
||
|
J LTD |
J LTD |
J LTD |
J LTD |
J LTD |
|
|
K LTD |
K LTD |
||||
|
L LTD |
L LTD |
L LTD |
L LTD |
L LTD |
|
|
M LTD |
M LTD |
M LTD |
M LTD |
M LTD |
M LTD |
|
MANAGEMENT |
||||||
|
ACCOUNT NAME |
INITIATION |
APPROVAL |
SECURITY |
ADVANCEMENT |
PERFORMING |
NON-PERFORMING |
| A LTD | . No detailed cashflows presented with application to LCC;
. no sensitivity analysis undertaken of advertising revenues; and . failure to assess means by which loan principal would be repaid. |
. Actual exposure in May 1989 of $116.2M exceeded Bank's policy of $100.0M absolute cashing or 20% of shareholders' funds, if less. |
. Security of $0.152M released without notification to LCC or the Board. |
. No settlement guide produced;
. equity commitment pre-condition waived after funds drawn down; and . Lending Credit Committee pre-conditions either not satisfied or outcomes not communicated to LCC. |
. Breaches of certain facility conditions and covenants not reported to LCC and Board on a timely basis;
. history sheet not maintained in relation to facility; and . downward trends in borrower's profit forecasts not critically reviewed from submission to submission. |
. Although customer rated a category 5c risk in February 1990, increase in facility proposed to LCC;
. notwithstanding customer down grading to category 5c, security not revalued until September 1990 and loan-to-value ratios calculated by reference to June 1989 figures until August 1990; . security evaluations not notified to Board for six weeks after revaluations completed and potential conflict of interest on the part of the valuer not queried by LCC or Board; and . further loan of $3.0M made in January 1991 not approved by the Board. |
| CELTAINER LTD | . Credit application contained no assessment of borrower's ability to repay the loan, nor was the term specified;
. no assessment of borrower's cashflows and budgets, which were inconsistent in some respects; . Celtainer's business was heavily dependent upon a single customer; and . inappropriate facility structure resulted in overdrawing of limits. |
. No evidence that security documents were duly stamped. |
. No settlement guide produced; and
. analysis of financial statements of Celtainer for year ended 30 June 1987 was flawed. Celtainer did not satisfy loan covenant when money advanced, implying that it should not have been lent. |
. Overdraft facility excesses were largely offset against unused trade finance line - assessed as a low risk line. Until re-allocation of facility limits in March/April 1988, overdraft excess should have been reported to a higher authority;
. no evidence of monthly monitoring of negative pledge covenants; . Celtainer was not notified of overdraft excesses, nor were penalty provisions invoked; . exposure monitoring was hampered by late delivery of financial information by Celtainer; and . when original facility formally amended in 1990 existing multi-currency line of $1.2M which should have been deleted was overlooked. |
. Overdraft excesses approved after exposure classified as non-performing were improperly authorised; and
. no formal corrective action plan, as required by Bank policy, was established. |
|
| COLLINSVILLE STUD GROUP | . Notes of initial interview were not kept by the Bank;
. no examination of cashflow projections by the Bank - reliance was placed on Ayers Finniss Information Memorandum, which did not contain a rigorous analysis of Collinsville's cashflow projections; . detailed cashflows and balance sheets were not presented to the LCC, nor were material asset revaluations explained; . no ratio analysis of the Group was performed; . security information was not included on form of application; |
. Decision to place $2.0M overdraft facility in name of Collinsville Stud and not Ambia Pty Ltd exceeded delegated lending authority of the officer concerned and should have been approved by Board Sub-Committee. |
. Security obtained differed from what was specified in the letter of offer, without approval having been given to the alteration; and
. valuations of asset securities included two parcels of land which were not in fact obtained as security. |
. Although required by the letter of offer, keyman and livestock insurance were either not effected until some months after settlement (in the case of keyman insurance) or at all (in the case of livestock); and
. utilisation of funds was not in accordance with the approved submission. |
. Board was not notified of increased exposure to the Group, and decisions to permit increased exposure exceeded delegated lending authority of officers concerned;
. crucial information was withheld in reporting to the Board in June 1990; . livestock insurance not effected, resulting in an uninsured exposure of up to $20.25M; and . no top-up security was sought when facility security became inadequate in January 1990. |
. information was not supplied to the LCC in August 1990 which, had it been provided, would have caused the facilities to be classified as non-accrual, rather than non-performing; and
. a provision for loss should have been made at June 1990. |
| COLLINSVILLE STUD GROUP
(CONT'D) |
. other formalities not completed on Application and Specification of Securities forms; and
. no external credit assessment performed on companies in the Group. |
|||||
| B LTD | . B Ltd had no track record against which to compare its cashflow projections and profit and loss forecasts;
. relevant information about a key B Ltd executive was not brought out in initial submission to LCC; and . net lending Margin of Security was calculated at $2.4M - below proposed loan of $5.0M. |
|||||
| HALWOOD CORPORATION LIMITED (including)- BLANCHE PTY LTD
- ASPENAIR PTY LTD |
Halwood. No evidence that the Bank received an Information Memorandum from the State Bank of New South Wales or that financial data was subject to analysis by the Bank;
. no evidence of independent verification of Societe Generale Information Memorandum; and . listing of directors of the borrower not included in syndicate submission. Aspenair . Major shareholders not disclosed. |
Halwood. No consideration of the means for withdrawing the facility in line with the Bank's policy on negative pledge lending; and
. advances to Hooker Fidelity Trust in June 1988 and to Aspenair Pty Ltd in February 1989 should have been confirmed by the Board due to the overall level of group exposure. |
Halwood
. Security of HCL debenture stock did not meet the required lending margin for such stock. No evidence that the stock was ever received. Blanche . The lending margin for Australia's Centre facility was greater than permitted by Bank policy - an HCL guarantee was accepted as adequate to cover the shortfall in security. Aspenair . Same comments apply as to Blanche facility in regard to Boulevard Burnside financing. |
Blanche. Bank advanced more than $9.0M before Blanche had obtained vacant possession of land; and
. security documents not forwarded to the Bank until four months after initial facility drawdown. Aspenair . Security and related documents were not received by the Bank until six weeks after the initial drawdown of the facility. |
||
| C LTD | . Initial information provided by State Bank of New South Wales not subject to independent verification or review by the Bank; and
. no review undertaken of the basis upon which car park lease valuations had been prepared. |
. The Bank's security was not perfected when loan advanced;
. review of car park lease valuations in 1989 and 1990 would have indicated a decline in the value of loan security; and . registered first mortgage between borrowers and "X" Pty Ltd was not adequately evaluated. |
. Although the Bank was aware of poor results for the car park in June 1989, the August 1989 valuation was not queried, nor was an independent valuation commissioned. |
. Loan downgraded to 5d in June 1990, but the Bank did not know that base rental had remained at $3.5M and was not $7.0M. |
||
| INTERWEST - SOMERLEY |
. No compliance with the standard bank practice of ensuring security valuation at both market and liquidation values. |
. Approval for continued participation in the syndicated loan should have been obtained from the LCC - it was outside the delegated lending authority of the General Manager, Corporate Banking. |
. Contrary to Bank policy, a provision for loss was not established until four months after recognition of a possible loss. |
|||
| D LTD | . Analysis of the borrower's cashflow and profit and loss statements indicates that the company did not have sufficient cashflow to service its borrowings;
. contrary to Bank policy, a registered mortgage debenture was taken as primary security without an audit of asset values shown in the company's balance sheet; . in a direct departure from Bank processes, no industry analysis was performed on the facility; . no assessment of company management and its operations was made; . the degree of analysis applied to financial information was less than required by Bank process; and |
. Bank policy requiring assets used as security to be insured against loss was not adhered to. |
. Category 1 irregularities should have been reported to General Manager, Corporate Banking in January 1990. No report was made until May 1990, in contravention of established processes; and
. diversion of funds by the borrower in contravention of loan covenants was not notified on a timely basis to senior management. |
. A provision for loss was not made until November 1990 although the conditions necessary to raise a provision existed at 30 June 1990;
. irregularity in the facility was not reported to the LCC for ten months from its first occurrence; . the LCC was not informed of or asked to approve the appointments of a Receiver and Manager in May 1990; and . the facility should have been classified as non-accrual in June 1990; it was not so regarded until August 1990. |
||
| D LTD (CONT'D) |
. no evaluation was undertaken of the current market value or liquidation value of any assets over which security was held. |
|||||
| E LTD | . No documentation supporting initial advance of $0.45M, other than Application for Advance;
. integrity of financial information in the application not checked by reference to signed audited accounts; . ratio analysis was limited; . establishment record not prepared; . no external credit assessment was prepared on group companies or directors; and . Specification of Securities form is incomplete and there is no evidence that insurance cover was checked. |
. Incomplete file records and no Credit Assessment form located; and
. no indication as to why the Bank had been requested to offer the facilities in lieu of the Company's usual banker, Westpac. |
. Incomplete corporate records held on file and section 230(8) certificates not provided until December 1988;
. no evidence of stamping of security documents in Specification of Securities form; and . upstamping was not timely and the borrower in any event regularly exceeded its credit limits. |
. Monies were advanced for the purchase of "Y" Pty Ltd in October 1987, but relevant security documents were not executed until December 1988. A similar anomaly occurred with the advance to purchase "Z" Pty Ltd;
. no file copy of approval letter, either for initial advance or the assumption of Westpac facilities; and . no evidence of involvement at settlement by Securities Section. |
. No evidence that detailed reviews were undertaken of financial information supplied by the borrower;
. the borrower regularly exceeded authorised facility limits through February 1989, suggesting that the loan could have been classified as non-performing earlier than it was; . 1988 Credit Review should have been actioned earlier and referred to LCC for ratification; . no review of insurance policies undertaken until June 1990; and . loan files were incomplete and poorly maintained. |
. Tardy implementation of policy requiring that no further excesses be permitted on irregular accounts and that interest margins be increased;
. classification as a non-accrual loan did not occur in accordance with policy; . no detailed action plan on file in July 1991; . no submission exists on file dealing with the loan or its likely outcome; and . although around $4.8M remains outstanding, financial statements are not expected from the borrower for 1991. |
| F LTD
G LTD |
F Ltd. No credit paper prepared when loan initially approved;
. no assessment of F Ltd's financial position or ability to repay loan principal; and . no independent valuation of a yacht offered as loan security. G Ltd . No assessment of the Company's ability to repay principal;. financial position of loan guarantors was not fully established; and . no review of cashflows was prepared. |
F Ltd
. Approved facility exceeded Bank's lending margin. G Ltd . Calculation of extended loanable value was erroneous;. receivable did not eliminate inter-company balances; . advance to security ratio was wrongly understated; . finance lease liabilities were not considered until brought on balance sheet by introduction of new accounting standards; . non-standard lending margins were applied to trade receivable; . lending margin was lower than the approved facility; and . mortgage debenture was improperly |
F Ltd
. Loan was approved on the basis of security being obtained, but was advanced on an unsecured basis. Security was not obtained until the first annual review of the loan. G Ltd . Guarantees were changed from unlimited joint and several to proportional to shareholding in the company subsequent to initial approval but prior to letter of offer to G Ltd. |
F Ltd. No annual review was performed in 1990; and
. Manager, Commercial Advances approved a facility increase outside his approval limits. G Ltd . Facilities due for annual review in February 1988 were extended in March 1988 to April 1988; no evidence that the annual review was conducted. |
F Ltd. Account frequently operated outside approved limits;
. facility was not reviewed when classified as non-performing; and . no action taken to review file until after Retail Credit Inspection in April 1991. |
|
| H LTD | . No initial interview notes maintained as a record of preliminary discussions;
. financial information provided by the borrowers not properly considered or independently verified; . no ratio analysis undertaken; . establishment record not properly completed; . no external credit assessment performed on the prospective borrowers; . specification of securities forms deficient, especially in detailing insurance cover; and . no consideration of the effect of a downturn in the property market or of poor tenancy mix at borrower's shopping centre. |
. No Credit Assessment form located; and
. no consideration as to why financing being transferred from another bank. |
. Not formally determined that parties offering security legal capable of doing so;
. specification of Securities forms do not evidence timely stamping; . overdraft facility for $20,000 granted in November 1987 was unsecured; and . exceeding of facility limits did leave the Bank vulnerable to being under-secured. |
. The Bank did not receive executed securities for two weeks after settlement on the Malvern shopping complex;
. no evidence of a check that rates and taxes had ben paid to the settlement date; and . some documents which should have been reviewed by Securities section not held on file. |
. Financial information provided by borrowers not reviewed in detail, nor was information checked for substantiation;
. loan should have been classified as non-performing at an earlier stage; and . files do not show when loan was to be regarded as non-performing. |
. Insufficient pressure was put on the borrowers to service the loan. Reliance was placed on eventual sale of the property to cover principal and interest;
. procedures applicable to the management of irregular accounts were not invoked on a timely basis; . regional office was not provided with regular Arrears reports; . the loan was classified as non-accrual later than Bank procedures required; . no detailed action plan noted on file at 18 June 1991; . situation has been allowed to deteriorate while new equity is sought; |
| H LTD
(CON'D) |
. no evidence of a review of budgeted and actual cashflows; and
. no file record of likely outcome of a falling property market. |
|||||
| I LTD | . No evidence in the Specification of Securities form that security documents were stamped;
. facility draw downs were not accompanied by regular upstamping; and . there is a lack of correspondence between security taken and what was approved by the Board. |
. Settlement guide cannot be located. |
. Facility extension requests were approved by the Group Credit Committee when they should have been approved by the Board; and
. no History Sheet has been maintained for the account. |
. Status of stamping of securities and the consequences of under-stamping have not been considered; and
. no evidence that provision of $5.0M against this account has been ratified by the Board. |
||
| J LTD | *. Guarantees were based upon unsubstantiated and outdated financial statements provided by the directors;
. no independent valuations of security offered; . limited value in cashflow and financial projections prepared; and . no long term forecasts were prepared to support the ability of the borrower to repay the loan. * Procedure manuals had not been issued - comments are related to perceived weaknesses supported by review of manuals issued subsequently. |
*. Deed of priority recorded as executed in favour of the Bank cannot be found;
. permitted lending margin exceeded in December 1988 when facilities were extended; . security for overdraft and interest accounts is under-stamped; and . specification of Securities forms were not completed. |
*. Funds advanced before security documents and guarantees had been signed;
. insurance confirmations not held for all periods in which advances were made; and . there is no evidence that some conditions precedent to advancement were satisfied. |
. No annual reviews after 1987 of either insurance cover or security valuations;
. interest capitalisation was back dated to 1 October 1990, but doubt as to authority to do this; . feasibility of revised cashflows provided in support of overdraft facility increases was not ascertained; and . excessive reliance was placed upon the personal worth of the guarantors. |
. Account graded as Grade E yet no action plan prepared for the account;
. no evidence located concerning the size of the provision approved by LCC; . no arrears reports advised to Regional Office even though a loss was expected; . no formal valuation of loan securities made since December 1987; and . No action taken to enforce the security or guarantees. |
|
| K LTD | . Inadequate verification of the customer's financial ability to service the borrowing; and
. specification of Securities forms were not properly completed. |
. Letter of offer was issued by an officer without authority to do so. |
||||
| L LTD | . Personal details of most directors omitted from submission of 13 June 1988;
. non-disclosure of the role of Kabani Pty Ltd to the LCC; . ability of the borrower to repay not analysed in the context of a stoppage or deferral of redevelopment; . limited financial analysis of the group; . borrower advised of valuation required to support the loan prior to valuation being prepared; and . the Bank's exposure only to the customer was noted in the submission; the exposure of Beneficial Finance was ignored. |
. The Board reviewed the application without reference to the exposure of Beneficial Finance. |
. No evidence that company constituent documents had been reviewed to ensure capacity existed to charge assets, although may have been done by Beneficial Finance which co-ordinated loan securities; and
. specification of Securities forms cannot be located and details of stamping of documents are piecemeal. |
. Initial monitoring was left to Beneficial Finance, but as Bank's monitoring increased co-operation between Beneficial Finance and the Bank in regard to the account reduced;
. from February 1989 to May 1989 the term of the facility was extended, apparently without approval. This was repeated in November/December 1989 and July/September 1990; . LCC approved a facility increase in 1989 without Board ratification, as the Bank's procedures required; and . as a problem loan, the October 1990 request for extension should have been referred to the Board for approval but was not. |
. Independent review of security documents should have been done earlier; and
. files do not evidence any consideration of the Bank's role in advising loan default. |
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| M LTD | . No independent assessment was made of key customer personnel;
. financial information received from the customer was not independently verified or critically analysed to determine ability to repay either from the project or other income sources of borrowers; . tenancy problems inherent the project were not considered with by the Bank or sufficiently by its valuer; |
. No credit assessment form located;
. no effort made to find out why National Australia Bank, which financed land purchase, was not involved in financing the development; . economic and industry specific considerations were not taken into account; and |
. Specification of Securities forms do not evidence timely stamping of securities; and
. no evidence that mortgage documents stamped to a particular value. |
. Funds were advanced prior to the perfection of securities; and
. funds were advanced in accordance with work completed, but reports to the Bank did not advise of construction difficulties or likely overruns until December 1989. |
. No critical analysis of financial information provided by the customer;
. no critical assessment of budgeted against actual costs; . dispute between architect and developers was not monitored or its possible impact assessed; and |
. No analysis done of the borrowers' financial positions to assess their ability to contribute additional capital to project completion or to meet loan repayment commitments;
. additional financing was approved in March 1990 even though project was then financed at close to market value and the Bank know of borrowers; weakening cash position; . effects of a falling property market were not fully appreciated; |
| M LTD
(CONT'D) |
. no consideration of the risk inherent in a downturn of the property market;
. limited use of ratio analysis to assess project viability; and . specification of Securities form not wholly completed. |
. reservations expressed by Lending Examiner in May 1990 were seemingly ignored. |
. proper annual reviews were not performed. |
. contrary to policy, no monthly review of budgeted against actual cashflows was done;
. no High Risk Credit Reports nor a Credit Paper recommending risk down grading were prepared; . no action plan had been prepared to 5 July 1991; and . the provision raised is inadequate. |
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