CHAPTER 10
CASE STUDY IN CREDIT MANAGEMENT:
CELTAINER LIMITED
TABLE OF CONTENTS
10.1 REFERENCE INFORMATION
10.2 BACKGROUND TO THE ACCOUNT
10.2.1 COMPANY HISTORY
10.2.2 BACKGROUND TO THE FACILITY
10.3 CHRONOLOGY
10.4 COMPLIANCE WITH POLICIES AND PROCEDURES
10.4.1 INITIATION OF THE FACILITY
10.4.2 APPROVAL OF FACILITY
10.4.3 SECURITY
10.4.4 HINDSIGHT OVERVIEW
10.4.5 ADVANCEMENT OF FUNDS
10.4.6 MANAGEMENT OF THE ACCOUNT
10.4.7 MANAGEMENT OF NON-PERFORMING FACILITY
10.4.8 CREDIT INSPECTION
10.5 OTHER MATTERS IDENTIFIED IN THE INVESTIGATION
10.5.1 EQUITY ACQUISITION
10.5.2 "WINDOW DRESSING"
10.5.3 "LOOK AT SELLING SHARES"
10.5.4 CONDUCT OF AN OFFICER OF CELTAINER LTD
10.6 REPORT IN ACCORDANCE WITH TERMS OF APPOINTMENT
10.6.1 TERMS OF APPOINTMENT A
10.6.2 TERM OF APPOINTMENT C
10.6.3 TERM OF APPOINTMENT E
10.7 RECOMMENDATION ON FURTHER INVESTIGATION OR ACTION
10.8 APPENDICES
A Summary of Movements in the Facility
B Chronology of Events During the Life of the Loan
10.1 REFERENCE INFORMATION
The following information on the facility for Celtainer Ltd (In Liquidation) is set out for reference purposes:
REFERENCE INFORMATION Account Name . Celtainer Ltd (In Liquidation) Directors at 13 July 1987
(ie date of referral of facility to Lending Credit Committee for approval)
. Mr S O Lundgren; . Mr K B Godson;
. Mr A F Swain;
. Mr A Reinli; and
. Mr C J Atkins. (also Secretary)
Industry Sector . Light Engineering Facility Type . Commercial bills; . Overdraft;
. Multi-currency loan; and
. Trade finance line.
In addition the Bank had an equity holding in Celtainer of 900,000 25c "B" class shares at an initial cost of $0.52M. At 31 March 1991 the market value of these shares was zero.
Principal Outstanding at 31 March 1991 . Overdraft $M 3.00
Unrecognised Income at 31 March 1991 . Overdraft 0.20 Provision for Loss at 31 March 1991
. Overdraft 3.00 Estimated Loss at 31 March 1991
. Loss on equity holding . Overdraft
0.52 3.00
10.2 BACKGROUND TO THE ACCOUNT
10.2.1 COMPANY HISTORY
Digitec Pty Ltd was incorporated in South Australia in 1972. Its principal business was the design and manufacture of specialised products mainly for the shipping and mining industries.
In 1985 it changed its name to Celtainer Pty Ltd and following a change in status it became Celtainer Ltd. In 1986, the company was listed, for the first time, at the Adelaide Stock Exchange. The company is now in liquidation.
10.2.2 BACKGROUND TO THE FACILITY
Early in 1987 the activities of the Company came to the notice of Mr C B Taylor, the Bank's Manager, Corporate Marketing and Finance, whose responsibilities and activities included "targeting all South Australian based companies that were listed on the Main and Second Board of the Adelaide Stock Exchange." ()
Mr Taylor maintained an information file on any such company which was not at that time a client of the Bank. He gathered information on the Company, from various sources, including (but not limited to) press reports, and from Todd Partners, Stockbrokers, (which included analysis of the publicly available financial information relating to the Company). It was noted in the initial information which came to the attention of the Bank, through Mr Taylor, that the Company had reported a profit of $0.486M in the period of 6 months to December 1986, and had a turnover in that period of $3.2M.
In April 1987, Mr Taylor and other officers of the Bank invited the Managing Director of Celtainer to lunch. In the discussion which took place, the Bank was informed that:
"... on current sales and demand for product line, Celtainer projects export sales of $100.0M per annum by 1990. Expansion program due to commence and some debt requirements will be sought." ()
After that meeting, Mr Taylor spoke with the Secretary of Celtainer, Mr C J Atkins, about the borrowing requirements of the company, and, in the course of that conversation, Mr Atkins indicated that Celtainer was looking for "equity placement" ().
Not long afterwards an invitation was extended by Celtainer for the Bank to take equity in the Company. () The precise terms of the invitation are not known, and are unimportant. On 25 June 1987, Mr Taylor wrote to SVB Day Porter, Stockbrokers, seeking their advice on an equity investment by the Bank.() On or about 6 July 1987, Mr P E Miller, the Bank's Senior Manager, Corporate Administration visited the premises of Celtainer, together with Mr G Day and two investment analysts (of SVB Day Porter), and had further discussions with the Managing Director of Celtainer.
The Diary Note prepared by Mr Miller in connection with that visit is of some importance. It reveals, more explicitly than earlier documents, the fact that the Bank was simultaneously looking to provide substantial credit facilities to Celtainer Ltd, and to making an equity investment in that Company.()
Some time between 6 and 13 July 1987, SVB Day Porter provided the Bank with written advice with respect to Celtainer. This document was prepared by the investment analysts employed by SVB Porter. It was entitled "Investment Memorandum" and dealt, inter alia, with the background of the Company, its Directors, its capital structure, its manufacturing and design activities, its Trading Activities, its Profitability, its Worth, and details of trading in its shares. It concluded with comments and conclusions including the following:
"A maximum entry price of 66 cents represents a price/earnings multiple of 8.4 times estimated 1986/87 earnings and 5.1 times projected 1987/88 earnings - well below current market averages for any sector. We believe the stock has an upside potential to around $1.40 within the next 12 months or so, based on a price - earnings rating of 11 on projected 1987/88 earnings.
An investment in Celtainer at 60-66 cents would appear to have excellent capital growth potential in the short to medium term and represents an attractive opportunity to secure a holding in a thinly traded, tightly controlled company with a sound longer term future." ()
Arising from these initial discussions, the Bank received a credit application from Celtainer. Concurrently, the Bank began to take steps toward acquisition of equity in Celtainer.
A written proposal dated 13 July 1987 ("the Proposal") was then prepared for consideration by the Bank's Lending Credit Committee. It was prepared by Mr Taylor and his subordinate staff, and was endorsed as "supported" by another Bank officer. As to that "support", that officer said in evidence before me, on 12 February 1992, that the exercise of that function meant that he:
"... would have inquired of the person submitting the paper, that he had made due inquiry and due analysis of (the profit and loss projections of Celtainer)." ()
It is clear, that as the "supporter" of the Proposal, that officer did not personally review the supporting analysis, or personally scrutinise the factual basis of the information provided by Celtainer.
In essence, the Proposal recommended the grant of credit facilities totalling $2.75M secured by:
(a) a First Registered Debenture over all assets and including uncalled capital of the Company and its subsidiaries;
(b) a First Registered Mortgage over the Company's commercial property at Royal Park; and
(c) a negative pledge by the Company that:
(i) Its net tangible worth not fall below $3.5M;
(ii) Its total liabilities not exceed 75 per cent of its Total Tangible Assets; and
(iii) `A' Class shareholding of Mr S O Lundgren not to be depleted without written consent of the Bank.
The said credit facilities were recommended to be extended subject to certain `conditions precedent' including:
(a) "Provision of audited financial accounts of Celtainer Ltd and its subsidiaries as at 30/6/87 and such being satisfactory to the Bank. Alternatively, an investigating accountant's report by a recognised accounting firm appointed by the Bank and to substantiate assets and liabilities disclosed in balance sheet 28/2/87"; and
(b) A licensed valuer's opinion being obtained disclosing an `open market' value of not less than $0.65M of the Company's real estate. ()
The Proposal also recommended acquisition of 1 million shares in Celtainer Ltd at 5 per cent less than current market price. Such an investment involved expenditure of approximately $0.627M and would have made the Bank the holder of 7.1 per cent of the issued capital of Celtainer.
The Proposal itself was five pages in length. It followed the established standard format, and included descriptive segments (eg the facilities proposal, the equity proposal, the terms, security and fee structure), and as well expressions of opinion on future developments (eg the Safety Assessment and General Comments, which listed, without comment, advantages and disadvantages of the transactions).
No useful purpose would be served by repeating in full the advantages/disadvantages of the transactions stated in the Proposal. I draw attention, without comment at this stage, to two of the matters stated. First, the document refers to, and is entirely consistent with, a corporate charter on the part of the Bank to be involved with and to assist South Australian industry. (Several of the written submissions received by me, including that of the Bank refer to this matter.) Secondly, the author of the proposal warned, in listing the disadvantages of the transactions:
"...
3. Heavy reliance on Mortgage Debenture and outwardly moving Gearing Ratio.
4. Company is relatively immature when viewed against the business cycle. 1986/87 is the first profit turnaround.
5. Assessment is based on future outlook as historical results do not inspire financial confidence." ()
In so far as the Proposal to the Lending Credit Committee concerned equity acquisition, it did little more than to describe the equity acquisition transaction, and to repeat some of the factual material and the basic opinion as to the future value of the shares in Celtainer which were contained in the SVB Day Porter Investment Memorandum. The Proposal did not contain any further assessment of the investment opportunity beyond that stated in the Investment Memorandum.
The Proposal annexed 3 substantial documents. The first two were entitled "History Sheet -27/8/87" and "Security" respectively. They are obviously documents prepared by Bank staff. The third was the Investment Memorandum of SVB Day Porter.
The History Sheet contains information on the capital structure of the Company, its trading activities, its worth, and a commentary in relation to these matters.
The "Security" annexure listed the assets (other than real estate) of the Company, as valued in it's unaudited balance sheet to 28 February 1987, and, in the case of the Company's real estate, as valued at 30 June 1985.
The written Proposal, as a whole, presented Celtainer as a company which had, in the recent past, operated at a moderate loss, but which had more recently returned to profitability; which was "quite sound" and had prospects in its future manufacturing and trading activities which were likely to expand in the near future; and which could provide adequate security for advances by the Bank of approximately $2.75M (made up of an overdraft facility, commercial bills, a multi-currency loan and a trade finance facility of $0.75M). ()
The Proposal was considered, on 15 July 1987, by the Lending Credit Committee. The Committee approved lending totalling $2.75M, subject to conditions requiring, amongst other matters, the monitoring of cash flow projections, which had been made by Celtainer, and verification of compliance with the negative pledge requirement that the net worth of Celtainer be not less than $3.5M. The advances on this loan were not made until December 1987. In the period between approval by the Lending Credit Committee and the making of the initial advance, the financial position of Celtainer deteriorated to the extent that its activities were unprofitable. Neither the deterioration in its financial position nor the deterioration in its profits were detected prior to the Bank advancing funds to Celtainer, because there was a failure, on the part of the Bank, adequately to verify the net worth of Celtainer, and there was no verification of its cash flow and profitability for the period July 1987 to December 1987. The account became problematical almost immediately, although it was not classified as "non-performing" until March 1989.
Although Celtainer continued in business until 1990, it did so only with the continued support of the Bank and another substantial investor. In September 1990, that investor advised the Bank that it would no longer provide support for Celtainer, whereupon it was obvious to the Bank that Celtainer could not satisfactorily service the loan and its security was inadequate. The Bank immediately appointed a Receiver. Celtainer has since been put into liquidation.
The acquisition of shares in Celtainer, at a cost to the Bank of $0.52M (approximately), was made after only superficial examination of the merit of that acquisition by the Lending Credit Committee which, although expressing satisfaction with the acquisition, recommended consideration of the matter by the Equities and Underwriting Group of the Bank. That Group did not consider the merit of the acquisition. Purchase of the shares took place on the mistaken belief by the Bank officer involved that the Lending Credit Committee recommendation was all that was required, and that the merit of the acquisition had been thoroughly assessed. The acquisition was never approved by an authorised delegate of the Board. As at 31 March 1991, the shares were worthless.
10.3 CHRONOLOGY
Appendix A of this Chapter of the Report contains a summary of movements in the facility.
Appendix B sets out a detailed chronology of events in respect of the facility.
10.4 COMPLIANCE WITH POLICIES AND PROCEDURES
Chapter 8 - "Credit and its Management: Guidelines, Policies, Processes, Procedures and Organisational Delivery Mechanisms" of this Report details the lending policies and procedures that applied over time within the Bank.
The initiation of the loan to Celtainer, and the approval of that loan, both took place in 1987, as did settlement of the loan. As noted in Chapter 8, substantial changes occurred in the policies and procedures of the Bank in March 1988, when new practices and procedures were implemented for the first time. Accordingly, the initiation, approval and settlement stages of the Celtainer credit transaction occurred prior to the implementation of those new processes practices and procedures. This Chapter therefore deals with those stages of the credit transaction not with a view to describing non compliance with established procedure nor to allocating degrees of culpability to the relevant bank officers and employees, but rather with a view to illustrating the errors capable of being made when the established procedures are inadequate.
The following Section does not descend to detail with respect to compliance with procedures introduced in March 1988 with respect to Hindsight Overview, Management of Loans, Management of Non-Performing Loans and Credit Inspection. That is because those procedures and processes were largely concerned to detect problem loans, and to implement special arrangements thereafter to avoid loss. The Celtainer account was recognised as problematical, in March 1988, whereupon monitoring of it outside of the normal processes was assumed. There was no need to proceed through the stages designed to detect problems - the problem was well recognised.
This section of this Chapter is therefore largely descriptive of what occurred, and contains my criticism of it having regard to the matters which I am required to investigate.
10.4.1 INITIATION OF THE FACILITY
Relevant facts relating to the general preparation and content of the Proposal are stated above.() I am of the opinion that the Proposal was deficient and irregular in the following respects:
(a) The financial information available with respect to Celtainer included cash flow projections and profit projections. Those estimates were relevant to assessment of the capacity of Celtainer to service a loan and to repay it. Any inconsistencies between those estimates would have provided reason to suspect that the estimates were unreliable. There was an inconsistency in those estimates. The `payments to creditors' in the cash flow projection was $0.828M lower than the equivalent item (`purchases') in the profit projection. This matter ought to have been noted and significance attached to it. No significance was attached to it.
When this matter was put to the officers who prepared and `recommended' the Proposal they each submitted in a written reply:
"The total figure for `payment to creditors' in the cash flow projections is $3,938,750.00. The total figure for `purchases' in the profit projections is $4,767,000.00. As the difference between these two figures is $828,250.00, I assume these are the figures referred to in your letter and report. The significance which you seem to attach to the difference between the two figures is, with respect, misplaced. There is nothing untoward in the figures being different as they represent different items and timing and can be easily explained. One would expect the `payments to creditors' figure to be less than the `purchases' figure in every company which operates on deferred purchase terms and with increasing sales growth. Assuming, for example that the company operated on 90 day trading terms, the figure of $828,000.00 difference is entirely consistent with such terms, representing as it does 18 % of the value of goods purchased during the year..."
This explanation is implausible. My reasons for that conclusion are two fold. First, it is to be noted that an examination of the Celtainer projections (ie the cash flow projection and the profit projection) reveals that the figures for payments are constant throughout the year with the exception of the immediate post-Christmas holiday period, and therefore the difference cannot be accounted for as being due to timing in an expanding business. The figures, in both cases, forecast a constant purchases figure/payment to creditors. The figures do not show "... increasing sales growth ..." as the Bank officers allege. Secondly, if the flow of payments is constant (as was the prediction), a deferred payment practice would not cause the figures to vary greatly and indeed, possibly not at all, except perhaps at the beginning, or at the end, of the accounting period - where payments might be made out of the usual pattern, for tax or other purposes.
In my opinion, an examination of the documents containing the estimates, and the application of common sense, justifies the conclusion that the difference between these figures should have been noted by a competent analyst who was carefully examining the documents and significance ought to have been accorded to this discrepancy. The discrepancy is ground for suspecting that the figures presented may not have had a sound factual basis.
The submissions of the officers concerned confirm, by inference, that no significance was placed by them on the fact that the figures for payments were different in the cash flow projections and profit projections.
The fact that the discrepancy was either not noted, or not considered significant, would explain why this specific matter was not brought to the attention of the Lending Credit Committee.
The Proposal contained neither comment on the degree of examination and/or analysis exercised by the Bank officers on those projections, nor comment concerning their reliability. The General Comments - Downside/Disadvantages section of the Proposal contained the statement "Assessment is based on future outlook as historical results do not inspire financial confidence". This statement certainly did not amount to a clear warning that profit estimates had not been analysed or verified so far as was possible. Nor did it amount to an acceptance of responsibility for reliability of the estimates.
Accordingly, I consider that the Proposal was deficient in that:
(i) in the preparation of the proposal, a relevant matter was not considered significant; and
(ii) the Proposal did not contain a warning with respect to the reliability of information.
(b) Prior to submitting the Proposal to the Lending Credit Committee, the officers responsible for its preparation made no attempt to inspect the banking records of Celtainer.
They suggest, in their written submissions to me, that it would have been contrary to the interests of the Bank to request the client's consent to seek information from the existing banker to Celtainer, because that banker would have been alerted to competition emanating from the Bank. I agree that an intending financier would not, in other than exceptional circumstances, ask for the consent of an intending borrower to approach that borrower's existing financier. This may well explain why no enquiry was directed to the bankers, but does not explain why "the records" of Celtainer were not examined.
The failure to seek this information may have been because a decision was taken not to obtain it. Such a decision might have been made because the Bank officers thought that Celtainer was potentially a good customer, and worth pursuing in order to obtain its business. In such circumstances, it might have been thought undesirable to ask Celtainer for its past banking records lest that cause annoyance to the potential customer. If that was the case, the failure to obtain and inspect those documents was not so much the result of lack of due diligence as the result of an error of judgement arising from a decision, policy, or ethos, within the Bank, whereby the pursuit of market share was insufficiently tempered by reasonable and prudent credit assessment practices.
An alternative is that no one thought to ask Celtainer for its records. If this were the case, then, in my opinion, there was a lack of due diligence.
In my opinion, thorough assessment of credit risk involves consideration of past banking activities of the borrower, such information being obtained from the borrower itself, at least unless the borrower consents to do otherwise. Accordingly, the matter should have been considered as part of the preparation of the Proposal. The Proposal should have stated either that Celtainer had previously kept within its Banker's limits, or that it had not done so.
In making these findings for the reasons outlined in Section 10.4 above, I am not concerned to attach blame to the officers who prepared and supported the proposal. The practices and procedures in place at the relevant time did not provide adequate guidance with respect to analysis of information. The result, which is so clearly evidenced in this matter, is that whilst the Proposal had the appearance of a document prepared after careful investigation and judgement, it was a superficial document, and in some respects inadequate. I am reinforced in this conclusion by the submission I received in connection with this transaction, from the Bank.
On behalf of the Bank, its Solicitors submitted that:
"... the Bank accepts that the initiation ... of the transaction was inadequate." ()
In the submission accompanying that letter, the Bank explained that the Instruction Manuals which it maintained when these transactions were initiated (and at other times not presently relevant):
"... had limited applicability to more complex `corporate' transactions e.g. involving multiple lending products, company groups, negative pledge, lending etc.
The history of specific "Corporate" policies and procedures is not clear until March 1988 ... Prior to this time it seems that specific "Corporate" policies were manifested in various memos - not necessarily integrated or comprehensive - issued on an ad hoc basis by the department's senior management." ()
Accordingly I consider that there was inadequate guidance in this matter to those bank officers whose duty it was to prepare Proposals for consideration by the Lending Credit Committee.
In my opinion, there is no reason to doubt these statements made by the Bank. My Investigation in connection with Celtainer confirms the correctness of the submission of the Bank in this respect.
(c) The processes, practice and procedures, ie the system, insofar as it concerned the preparation of the Proposal, was deficient and defective by reason of the following matters. When one examines the processes, procedures, practices, and policies, of the Corporate Banking department, as evidenced by the Celtainer transactions, to the stage of submission of the Proposal to the Lending Credit Committee, the following observations may be made:
(i) The Bank had a corporate ethos of seeking to assist South Australian based industry.
(ii) This lead to the Bank seeking out South Australian based companies in order to do business with them. Celtainer was one such company.
(iii) Bank officers concerned with this task were aware that they had to attract the customer, and to entice it away from its existing banker, and they were prepared to do so. Thus, they were involved in a competitive `marketing' exercise.
(iv) Concurrently with the marketing activity, the Bank assessed the credit worthiness of the client, and, in this instance, the merit of an equity investment as well. That assessment of credit risk was made, or supervised or both by the same officer as was involved in the `marketing' exercise.
(v) The analysis of credit worthiness was not a well defined or controlled process within this department. There were no applicable manuals or substantial guidelines to be followed in transactions of this particular kind.
(vi) The requirement that the Proposal be endorsed both by the officer `recommending it' and as well by the officer `supporting' it, whilst giving the appearance of an analysis by two persons, was an inadequate quality control mechanism. There was no analysis and detailed consideration of the document by the officer `supporting'.
(vii) As a consequence of the two matters noted above, the accuracy and adequacy of analysis was entirely dependant on the capacity and diligence of the person recommending the Proposal.
(viii) Bearing in mind the corporate ethos and the marketing function of the officer recommending the Proposal, he may well have been influenced, at the time of making his analysis, by a pre-disposition to `do business' if possible, and, if his impression during the marketing exercise was that the company looked sound, his analysis might not have been as probing as the circumstances warranted.
In my opinion, the analysis of credit risk was not as probing as it should have been, in that no significance was attributed to the discrepancy in payments shown in the cash flow and profitability estimates (as discussed above).
(ix) The content of the Proposal had the capacity greatly to influence the decision of the Lending Credit Committee. Yet the form of the Proposal contained no certification with respect to the identity of the analyst; no indication of the extent of the analysis; and, most importantly, no statement of responsibility for the correctness of the information contained in it. The Bank's records do not contain a clear acceptance of responsibility for the correctness of the information submitted to the Lending Credit Committee, or a clear warning that the information was unreliable.
(x) Thus, no-one checked the analysis, in detail, before it was submitted to the Lending Credit Committee. The Proposal contained no warranty that the information and assessment contained in it had been checked and was accurate, and no clear warning that it had not been checked or was likely to be inaccurate. Thus, if there was to be consideration of the accuracy of the analysis, that had to be done orally at the Lending Credit Committee meeting. The way in which the system worked meant that it was most unlikely that the matter would be raised at the Lending Credit Committee meeting. That is because the Proposal contained no material which would cause the Committee members to question the material; the person recommending the Proposal was unlikely to volunteer that his work to that stage was incomplete or of poor quality; and the Committee did not see it as its function to examine the minute detail of the financial analysis presented to it.()
For the above reasons, it must be concluded, and I find, that the system, to the stage of submission to the Lending Credit Committee did not require or enforce a thorough and independent assessment of risk nor a clear and comprehensive presentation of the same to the Lending Credit Committee which was the designated decision maker. The system allowed significant scope for errors to be made in the assessment of lending risk, and, for these errors to remain undetected.
10.4.2 APPROVAL OF FACILITY
The Lending Credit Committee was the designated delegate of the Board for the purpose of approval of a lending transaction of this size.()
Each of the members of the Lending Credit Committee involved with the approval of this particular lending transaction submitted that:
"The role of the Lending Credit Committee in relation to Credit Proposals, was to decide upon the merits of the Proposal as a whole based on the information submitted to it by the Proposer and Supporter of the Proposal. It was not the role of the Lending Credit Committee to manually check the accuracy of the figures in the Proposal. Checks on the reliability of the figures provided by the customer and a sensitivity analysis of the customers cashflow etc were carried out by the Account Manager responsible for that particular account." ()
As the ultimate decision maker with respect to the lending transaction, the Committee would have been required to consider the following matters:
(a) the ability of the customer to service the loan;
(b) the ability of the customer to repay the loan;
(c) the adequacy of security in the event that the customer did not repay the loan and charges on it;
(d) whether the lending was in breach of prudential guidelines by reason either of over exposure to a particular customer, or of over exposure to a particular sector of the economy; and
(e) other matters.
It is noteworthy that the Proposal contained information which is relevant to the factors identified immediately above. It is also noteworthy that neither the Proposal, nor the Annexures to it, provided sufficient information to enable members of the Lending Credit Committee to make a detailed sensitivity analysis, or any substantial analysis at all, of the reliability of the figures presented in connection with both the future cash flow and future profit of Celtainer. The Lending Credit Committee was, in effect, presented, in connection with the assessment of ability to service the loan and assessment of the ability to repay the loan, with the barest of information ie a projection of profits, details of assets and liabilities of the kind found in the balance sheets of a public company, and some estimate of the available security. Anything more than this, the members of the Lending Credit Committee would have had to obtain by way of oral presentation from the person presenting the Proposal.
The Proposal was distributed to the Lending Credit Committee before it met on 15 July 1987.
The minutes of that meeting record that an oral report of `background' to the application was made by Mr Taylor and that the following matters were discussed or noted by the Committee on 15 July 1987:
(a) details of the equity investment;
(b) reference to the fact that SVB Day Porter had given a favourable report with respect to equity acquisition;
(c) "Members were satisfied with the credit risk noting the profit performance in 1986/87 and the positive future outlook for added growth, given the demand for the company's product ..."
(d) "It was agreed that the advances should be subject to monthly monitoring of cash flow projections in view of the fluctuations in the value of the Australian dollar and that there should be no constraints on the sale of the equity investment if agreed to by the Bank's Equities Group"; ()
(e) "Decision;
Facilities of $2.75M approved subject to monthly monitoring of cash flow projections. The proposal for an equity investment of $0.627M recommended to the Bank's Equities Group for approval on the understanding that there will be no constraints on the sale of the equity investment by the Bank."(18).
It cannot be doubted that the Committee members placed great reliance in making their decision upon the estimate of profits made by Celtainer, and as stated in the Proposal.() They had to do so in order to assess the ability of the customer to service the loan and to repay it.
It would be wrong, however, to conclude that the members of the Lending Credit Committee simply accepted the profit figures and made a decision on them. It would be wrong to do that because the Proposal contained conditions precedent to the making of the loan, one of which was:
"Provision of audited financial accounts of Celtainer Ltd and its Subsidiaries as at 30/6/87 and such being to the satisfaction of the Bank. Alternatively, an Investigating Accountant report by a recognised accounting firm appointed by the Bank and to substantiate assets and liabilities disclosed in balance sheet 28/2/87." ()
Moreover, the minutes of meeting disclose that the Committee expected monthly monitoring of cash flow projections before advances were made.
In my opinion, the condition precedent did not provide any useful criteria on which to decide whether the audited accounts were to "... the satisfaction of the Bank". Nor did it specify who was to make the assessment. Nor did it specify what was to occur if there was variance between the situation as presented in the Proposal, and the situation appearing in the audited accounts. In these respects, from a management perspective, the condition precedent was inadequately expressed.
In effect, what the Lending Credit Committee did, by making its decision in this form, was to say "we accept that if these cash flow and profit projections are reasonable then the credit risk is acceptable - but the facts have to be verified". By simply accepting the cash flow projection and by imposing a condition precedent, which was far from specific, the Lending Credit Committee approved the recommendation only `in principle'. The matter then proceeded back down the chain of command (and control) to a subordinate officer who had to make the decision to proceed, and that officer had to make that decision without any clear direction as to how it was to be made. Moreover, the decision-making function was remitted to a subordinate who was, in the discharge of it, outside of the control of the Lending Credit Committee.
Accordingly, by approving the recommendation, the Lending Credit Committee effectively circumvented the procedure which had been laid down by the Board, ie, that loans of this size had to have the consideration and approval of the Lending Credit Committee.
Members of the Lending Credit Committee might well say "Well we expected that if the accounts were materially different from the accounts presented to us, advances would not have been made or that the matter would have come back to us". Be that as it may, the point which must be made is that the approval given by the Lending Credit Committee did not require that the accounts should be in conformity with the projections, and did not require that the matter be re-submitted to the Committee if the accounts were not in accordance with the projections. The recommendation, and the approval, left it to someone else to decide whether or not advances would be made. At the point of acceptance of the recommendation, and by means of the inadequate and confusing condition precedent, the Lending Credit Committee lost control over the lending decision.
I do not imply any specific lack of judgment or lack of due care in the process of exercising judgment by the members of the Lending Credit Committee. It may well be that the members recognised the inadequacy of the information which was being submitted to them. It was the system which was at fault. Either the proposal was submitted to the Lending Credit Committee before it should have been, or, alternatively the system in operation was so loose as to enable a decision to be made "in principle" on inadequate information, with the fundamental decision then being transferred to someone else, who was then burdened with the duty to examine the situation, and the duty to make a decision which, properly, ought to have been part of the considerations of the Lending Credit Committee.
In short, in my opinion, the deliberations of the Lending Credit Committee, and the form in which it approved the Proposal, left the fundamental decision as to whether or not this loan should be made to a body other than the designated body. It does not help to characterise this decision as an abrogation of responsibility or as something else. The point is that the designated decision-maker did not, in the end result, make the decision. The decision was ultimately made by someone at a lower level, and, as will be discussed below, by someone who had insufficient training and experience to make it. The way in which the Lending Credit Committee conducted itself facilitated the circumvention of the system, which had been put in place in order to ensure proper lending credit decision-making.
10.4.3 SECURITY
I am of the opinion that no departures from the approved procedures of the time occurred in relation to the security phase concerning this facility.
10.4.4 HINDSIGHT OVERVIEW
No Hindsight Overview was undertaken in relation to this loan when it was first approved (in July 1987) because the process had not been implemented by that time.()
10.4.5 ADVANCEMENT OF FUNDS
The Lending Credit Committee's approval was, as discussed above, subject to a number of conditions. These conditions were not all clearly laid down in a resolution or decision of the Committee, and had to be extracted from both the Proposal and the `decision' stated in the minutes of the Lending Credit Committee meeting of 15 July 1987. The following pre-conditions for advancement of funds which were required by the Lending Credit Committee are relevant for present purposes:
(a) Monthly monitoring of cash flow projections was required (see Lending Credit Committee decision - stated in its Minutes of Meeting);
(b) The condition precedent to the loan required either audited accounts to 30 June 1987 "... being to the satisfaction of the Bank" or alternatively an accredited statement of assets and liabilities as at 28 February 1987 (see the Proposal);
(c) The negative pledge was required, and the Bank had to verify compliance with it - in effect - that net tangible worth of Celtainer would not fall below $3.5M (see annexure "B" to the Proposal and the Proposal).
The financial analysis, prior to draw down, was not undertaken until four and a half months after the decision of the Lending Credit Committee. It was prepared by Mr C C Ritchie, a Corporate Analyst and contained the endorsement `recommended by' Mr B J Parker, Corporate Manager. It was incorporated into a Diary Note dated 19 November 1987, and was submitted to Mr A Kloot, Senior Manager Corporate Banking.
Mr Ritchie submitted to me:
"... at that time I had been with the Corporate Department for two years and had received very little technical training and guidance from the Bank in respect of Corporate Banking. Many of the departments policies and procedures were fragmented, deficient, inconsistently applied and in respect of some aspects of Corporate Banking no policies and procedures existed.
At the time I performed the analysis I understood that the method of calculation that I used was the same as that commonly used by the Bank for such calculations. I had received no training in tax effective accounting. ... In performing the analysis of Celtainer's audited financial statements I submit that I performed my duties to the best of my capabilities, skills and knowledge of the time." ()
In his submissions to me, Mr Parker, who "recommended" the analysis, made comments which are, for all practical purposes, identical to those made by Mr Ritchie, in so far as they concern departmental policies and procedures. Mr Parker had, at the time, been in the Corporate Banking department for only two years. Mr Parker submitted, in connection with the preparation of the analysis, that he was acting under constraints of "... inadequate training, guidance and lack of resources." ()
There can be no doubt that the analysis which was performed in November 1987, and which formed the basis of the decision to advance funds, was inadequate in two respects:
(a) There was no actual monitoring of cash flow, as required. This was a serious defect. Had there been a monitoring of cash flow it would have been observed that the period from July to November 1987 was one of incredible difficulty for Celtainer due to a number of factors, and that the Company had sustained losses in this period. The down turn in business, seen against projected business, was dramatic. (As was revealed early in 1988, sales of the major production line of Celtainer were only 40 per cent of budgeted sales of that item - gross profit margin had fallen from 30 per cent to 13 per cent, an increase of overheads above budgets had occurred, and extraordinary items of cost were being experienced).()
(b) Errors of principle were made in the process of verifying compliance with the negative pledge. The negative pledge requiring that net tangible worth should not fall below $3.5M was scrutinised by Mr Ritchie. In the process, neither he nor Mr Parker observed and/or appreciated the significance of a qualification to the audited accounts for the period ended 30 June 1987. The consequence of this qualification was to reduce group profits, if tax effective accounting standards were applied. Furthermore, neither Mr Ritchie nor Mr Parker removed, for the purposes of assessment of net tangible worth, intangible assets such as the deferred cost of development and flotation. Had tax effective accounting standards been adopted and had the net tangible worth of the Company been assessed properly, it would have been observed that, as at 30 June 1987, on the audited accounts, Celtainer could not comply with the negative pledge.
In my opinion, there is no doubt that the analysis, as a whole, was grossly defective. Regard should be had to the submission made by the officers concerned, with respect to the inadequacies in their training, and in the lack of guidelines for them to carry out the task in question. I have no reason to doubt either of them when they say that they carried out their tasks to the best of their skill and ability. Once again, it is very much the case that `the system' was at fault.
Careful observation of the Diary Note prepared by Mr Ritchie, which contained his financial analysis, reveals that it purports to be a discussion of events only up to 30 June 1987. Accordingly, it should have been obvious to anyone reading that document that cash flow monitoring, for the period July to November 1987, had not been done.
The analysis prepared by Mr Ritchie, and recommended by Mr Parker, was then submitted to Mr Kloot, Senior Manager Corporate Banking.
It appears, from the records which I have examined, that Mr Kloot wrote, on the bottom of the written analysis prepared by Mr Ritchie:
"We have no option but to proceed as they have fulfilled the requirements laid down. However, everything must be in place before we assume the debt.
This is the Co's first good performance - I was not party to the original approval and I am still sceptical about their long term prospects. Hopefully I will be proved wrong." ()
Mr Kloot was wrong when he considered that all of the requirements for lending had been met. He was wrong in that a correct assessment of net tangible worth would have revealed that the actual net tangible worth was less than the amount required by the negative pledge. Worse than that, he was wrong in the sense that the original decision, which had been made back in July, had required a monitoring of cash flow and no monitoring of cash flow had occurred. I do not suggest any lack of care on the part of Mr Kloot, because the Diary Note submitted to him contained neither mention of the fact that monitoring of cash flow was required nor sufficient detail for him to check the verification of compliance with the negative pledge.()
On the basis of Mr Kloot's approval, the preparation for settlement and draw down subsequently took place. The security documents were then prepared, and were signed on 25 November 1987.
Settlement on the transaction took place on 1 December 1987. It is noteworthy that that settlement was in markedly different terms from that actually approved by the Lending Credit Committee. Whereas that Committee had approved of a facility involving an overdraft of $0.2M, and a multi-currency loan of $1.2M, the overdraft facility was increased at draw down to $0.8M and the foreign currency advance reduced to $0.6M. This was necessary in order to accommodate a larger payout to the previous bankers of Celtainer. It will be observed that by increasing the overdraft and reducing the foreign currency advance by the same amount, the overall facility made available by the Bank was the same as that approved by the Lending Credit Committee. The form was different.
Had the Lending Credit Committee been confronted in July with the true facts (as they were by November 1987), and had that Committee exercised the judgment of a prudent banker after due diligence, would it have approved credit to Celtainer on the terms which were actually approved in July?
In my opinion, the answer to this question is that the Lending Credit Committee almost certainly would not have approved the loan at all, and certainly would not have approved it on the terms which were in fact approved. The fact is that, in the intervening period between July and November 1987, the financial and trading affairs of Celtainer deteriorated so seriously that a decision to extend credit on those terms would have been unthinkable. The situation reached by November 1987 was that the profit projection and cash flow projection of Celtainer had not been achieved, and had been shown to be grossly erroneous. Moreover, the form of security which was required could not have been provided as the net tangible worth, at 30 June 1987, was less than that specified in the conditions which were approved, and that situation deteriorated still further between July and November 1987. Finally, the trading pattern of the company had slumped back into a loss making situation.
The immediate cause of the erroneous decision in November 1987 was the failure of Mr Ritchie to examine the affairs of Celtainer in connection with the period July to November 1987, and the failure of Mr Kloot to ascertain that he had not done so and/or to ascertain that this was required and/or he himself was to consider that this was necessary. The underlying causes however, and, in my opinion, it is the underlying causes which are important, were failures of `the system'. These are identified as follows: