KEY POINTS:
The first substantive announcement by Bridgecorp's receivers was a dreadful reality check for investors. It clearly demonstrated that the company's high-profile advertising campaign, called "minimising the risk", was misleading and should have been dubbed "invest in Bridgecorp and maximise your risk".
The announcement indicated that John Waller and Colin McCloy of PricewaterhouseCoopers were surprised and shocked by the poor condition of Bridgecorp's loan book. They believe that investors will receive between 25c and 74c in the dollar with a payout closer to the bottom estimate looking more likely.
Bridgecorp's returns to investors, on a per dollar basis, will be lower than Provincial Finance, Western Bay Finance and possibly National Finance, three finance companies which failed last year.
Directors, management, auditors and the trustee will be unhappy with the receiver's statement that "in the course of our analysis we have identified a number of matters which may give rise to breaches of the Securities Act", and "we will refer these matters to the Securities Commission".
This places a great deal of pressure on the commission to undertake a comprehensive and quick inquiry into Bridgecorp. It needs to assess the role of directors, management, auditors and trustees and take a close look at the rules and regulations regarding advertising to determine whether extremely high-risk financial institutions should be allowed to project a low-risk image to the investing public.
Bridgecorp had total assets of $595 million at June 30, $393 million of which was classified as its loan book. These loans, which were mostly to property developers, were predominantly secured over second, third or lower ranking mortgages and securities. One cannot get much riskier than this.
In addition, interest on most of these loans was received only when the loans were repaid. However, interest was included as revenue over the course of the loan, which meant that reported earnings were usually much higher than cash flow.
Bridgecorp totally understated its non-performing loans because bad loans are usually identified when interest payments are missed and Bridgecorp's borrowers paid interest only at the end of a loan period.
Bridgecorp's problems are best summed up by the troubled Momi Bay project near Nadi, Fiji.
Gary Urwin, a Bridgecorp director, originally bought the concept from an American developer. His plan was to build a large resort including residential accommodation, a Ritz Carlton Hotel, golf course and marina.
The development ran into problems for a number of reasons including difficulties with the local landowner, an uncompromising approach by the Fiji tax authority and the poor state of the road from the main highway. Bridgecorp blames the problem on the December 5, 2006 coup although sources in Fiji indicate that work on the project had slowed considerably before then.
Urwin was due to repay the loan and interest, which totalled $47.7 million, by December 31, 2006.
The accounts for the six months ended December 31, 2006, which were signed by chairman Bruce Davidson and chief executive Rod Petricevic on March 30, stated: "The directors of the company are of the opinion that the development will proceed to completion albeit with a delayed timetable, the extent of which delay the directors are unable to ascertain at present. Dependent on the political and governmental situation in Fiji, it is anticipated the loan will begin to be repaid within 6 to 12 months of balance date."
This loan was worth $51.1 million at June 30, indicating an interest rate of just over 14 per cent a year. The Momi loan raises a number of important questions including: * Why was it still included at full value on December 31 when neither interest nor final payment had been made by due date, the project was incomplete and had come to a standstill?
* Was accrued interest included in the Income Statement for the six months ended December 31, 2006?
* Was the board's objectivity impaired because the loan was to a related party of a director?
* Why was the interest rate only 14 per cent for such a high-risk loan?
* Why didn't management, directors, the auditors or trustee warn the investing public that the company's biggest loan was at risk?
Bridgecorp's auditors are PKF, a chartered accountancy group in Sydney, Australia. It is totally unsatisfactory for an Australian-based firm to audit Bridgecorp, particularly as the finance company was a high-risk entity that needed carefully monitoring.
PKF's last audit was completed on November 10 and signed off on December 21. How could the auditors sign off on the Momi loan when the project was incomplete and work had ceased on the project?
The role of Covenant Trustee, Bridgecorp's trustee, is also relevant. Trustee organisations monitor finance companies through a reporting regime that ensures the management and directors of these entities adhere to the terms of the trust deed, investment statement and prospectus.
The Bridgecorp prospectus states that the trustee has a statutory duty to "ensure that the assets of the charging group that are, or may be, available are sufficient or likely to be sufficient to discharge the amounts of the securities on the maturity date".
According to Securities Commission chairwoman Jane Diplock, "the work of trustees in relation to debt securities is of particular interest. They are able to monitor issuers' performance very closely, and can intervene on behalf of investors at an early stage, before more serious problems arise". New Zealand has five authorised statutory trustee corporations established under an act of Parliament: New Zealand Guardian Trust; Perpetual Trust; Public Trust and New Zealand Permanent Trustees, part of the Public Trust group; and Trustees Executors.
Covenant Trustee Company can also act as a trustee by authority of the commission.
Covenant has been the trustee of three of the four finance companies placed in receivership in the past 15 months. As noted in the accompanying table, investors in the three failed finance companies monitored by Covenant will get far less money back than Provincial Finance, which was supervised by Perpetual Trust. This indicates that Covenant has been far slower to anticipate problems.
In light of this, the role of Covenant has to be seriously questioned. Why didn't it anticipate Bridgecorp's problems? Why did it allow Bridgecorp to give the impression that over 60 per cent of its loans were insured by Lloyd's of London when only a tiny proportion of its loans, in dollar terms, were covered? Why did it allow the company to continue to represent the Momi loan as full value? Why does the commission continue to allow Covenant to act as a trustee when it has such a high failure rate?
The unwillingness of the regulatory authorities to investigate and comment on finance company failures is frustrating. Waller and McCloy wrote in National Finance's first receivers' report, dated July 9, 2006: "In light of the poor recoveries to investors we have referred the events leading up to receivership to various authorities for investigation."
In the latest report, dated December 2006, Waller and McCloy stated: "We continue to co-operate with various government authorities who are conducting investigations."
It is particularly important that the role of trustees be identified and clearly explained as there is little doubt that investor losses in Bridgecorp would have been materially lower if Covenant Trustee had recognised the company's loan problems earlier.
* Disclosure of interest: Brian Gaynor is an investment analyst and strategist at Milford Asset Management.
