KEY POINTS:
Many finance company investors, particularly those who entrusted their savings with Mark Hotchin and Eric Watson, face a major decision. They must resolve whether a moratorium or a receivership is the best option when their finance company cannot meet its repayment obligations.
This is not an easy assessment but a number of important factors have to be taken into account:
* The integrity and competence of the directors and senior management. This is a critical consideration because the existing directors and management usually remain in control under a moratorium whereas all decisions are made by the receiver in a receivership.
* The expected shortfall between money owed and recovered. The expert view is that a receivership is the preferred option when the shortfall is expected to be large.
* The long-term viability of the distressed company's business model. Finance companies with large shortfalls are unlikely to have viable business models.
National Finance 2000, which was the first finance company failure in May 2006, was a clear receivership decision because the board and management were poorly regarded. In addition the return to date has been only 40c in the dollar and it didn't have a viable model.
The second receivership, Provincial Finance, could probably have been a moratorium as the board and management had performed well in the past, 82.5c in the dollar has been repaid to investors and it had a reasonable chance of being viable in the longer term.
Bridgecorp was a clear receivership because of its poor-quality board and management, the large expected shortfall and a business model that had always been suspect.
When considering the future structure of Hanover Finance, and its 100 per cent-owned subsidiary United Finance, the first consideration must be the quality and integrity of the board and management.
Both companies have two independent directors, Chairman Greg Muir, who was appointed in February 2006, and Sir Tipene O'Regan, who joined in August 2004. The other directors are Mark Hotchin and Bruce Gordon.
One of the longest running concerns regarding Hanover and United has been the large amount of loans to companies associated with Hotchin and Eric Watson, the indirect 50/50 shareholders through the Hanover group of companies.
As at December 31, 2007, Hanover and United had $81 million of loans to companies associated with Hotchin and Watson, representing 10.9 per cent of total loans and advances. Most of these were to Hotchin and Watson's external property development interests. All these loans were due to be repaid by June 30 although media reports indicate that these related party loans may now be in excess of $81 million.
Related party loans by public issuers should be completely banned or the exact details should be spelt out in the prospectus with a full copy of the original loan agreement available to view on the Companies Office website.
The information regarding Hanover Finance's related party loans is woefully inadequate. The prospectus states that "all transactions with related parties have been entered into in the ordinary course of business" and the specific interest rate has not been disclosed.
Why did the two independent directors allow Hanover and United's loans to companies associated with Hotchin and Watson escalate from $26.5 million to $81.0 million in the 18 months ended December 31, 2007?
What is the exact position of these loans at present?
If investors wish to support a moratorium for Hanover and United they should insist that two new, strong independent directors be appointed, the board should have a clear majority of independent directors and all related party loans be repaid. If not, a full copy of these related loan agreements should be made available for inspection.
The second factor, which is the expected shortfall in the event of a receivership, is difficult to assess because of limited information.
The third, which is the viability of Hanover and United's business model, is an interesting one.
The two finance companies are almost totally reliant on retail investors for their funding. The meltdown of the finance company sector, Hanover and United's failure to repay investors on time and the destruction of the Hanover brand makes it difficult to see where the companies will fund their activities in the future, particularly as the large domestic banks won't touch them.
Hotchin's lavish new home, one of Auckland's most expensive, won't endear him to retail investors, particularly as he has failed to meet his repayment obligations to them.
In addition the property development sector, where most of the lending is focused, faces a bleak future.
When these three criteria are taken into account the arguments in favour of receivership seem to be stronger unless Hanover and United can develop different, and more viable, business models.
Receivership experts believe that investors should receive the same return under a moratorium as a receivership. Receiverships are slightly more expensive but they should generate higher recoveries to compensate for this.
The big difference between a moratorium and receivership is the ability of the owners to inject more capital and this is where Hotchin and Watson come in. If they contribute more capital, as they have said they will, then the returns under a moratorium could be higher than under a receivership. But how much should they contribute?
First of all they should repay all related party loans.
Secondly, the $28 million dividend paid by Hanover Finance in the six months ended December 2007 should be returned and additional capital of approximately $20 million injected.
The accompanying table shows that Hanover Finance paid dividends of $101.4 million in the 30 months ended December 2007 even though the company was facing major funding problems, particularly since the Bridgecorp collapse just over a year ago.
The top line shows the operating cash flow, which is the difference between all operating income, mainly interest received, and expenditure, predominantly interest paid.
The second and third lines are the most revealing with the loans data showing that Hanover Finance was a strong net lender until June 2006 but its lending book has contracted sharply since then. The company had a positive inflow of investor funds up to December 2006 but a huge outflow since then, particularly in the six months ended December 2007.
The company was due to repay $260 million to investors in the six months ended June 2008 and, given the low rollover rate, its outflow to investors during this period was probably in excess of $200 million.
Why did Hanover Finance pay a dividend of $28 million in the six months ended December 2007 when it was experiencing a massive outflow of cash to investors?
The other issue investors have to take into account when considering a moratorium or receivership is their quest for justice or revenge. Under the Receivership Act the receiver is obliged to report offences to the police, Serious Fraud Office, Securities Commission, Companies Offices and/or NZX.
This is the main reason why Rod Petricevic and Robert Roest of Bridgecorp appeared in the High Court this week.
There is far less chance of Court action under a moratorium.
Thus it comes down to the simple question of how much Hotchin, Watson and the Hanover group of companies are prepared to inject into Hanover Finance and United Finance - in addition to the repayment of all their related loans and the return of the latest $28 million dividend - to avoid a receiver's scrutiny.
Disclosure of interest: Brian Gaynor is an executive director of Milford Asset Management.
