When the cracks appeared

BY TIM HUNTER

For a finance company, confidence is everything – and South Canterbury Finance had it in spades.

In late 2008 at the company's annual meeting in Timaru, owner and then chairman Allan Hubbard was relaxed and joking with investors as he led them through his presentation. A beacon of mainland rectitude amid the gloom of so much financial carnage, his comments on the crisis had the wisdom of experience from a man raised in the Depression.

"We'll get through it better, but it's going to last a year or so, isn't it," he told Press reporter Alan Wood. Unknown to the public at the time, South Canterbury had already been under heightened surveillance by its trustee for more than six months.

In practice, this meant the company was required to provide seven-day cashflow projections on a daily basis and report to trustees executors every week.

After appointing receivers yesterday, trustee Yogesh Mody explained the reason for its alarm two years ago: "A regular review of their financial statements showed us they were under financial pressure at that time. More specifically, we were becoming increasingly concerned about the quality of the loan assets amid a period of general financial dysfunction."

By June 2009, under heightened scrutiny from its trustee, South Canterbury was a giant among finance companies. Its total assets were $1.98 billion and its operations had spread well beyond Canterbury to encompass the whole country.

Founded in 1926, the firm built a reputation for conservatism with its sheer longevity – an impression actively cultivated by Hubbard after buying into the business in the 1950s.

But after decades of relatively unremarkable performance, South Canterbury began to grow at astonishing speed.

In just five years between 2003 and 2008 it tripled in size and its owner's shareholding was worth, on paper, well over $200 million. There are generally two ways of fuelling such high-speed growth – grabbing market share or taking on more risk, and it would appear South Canterbury did both.

Unlike most of the finance companies to fail thus far, its lending was relatively diverse. Where the likes of Bridgecorp, Hanover and Capital & Merchant were focused almost exclusively on property development, at South Canterbury there were loans to farmers, manufacturers, hoteliers, shopkeepers, builders, fishermen – the full range of commercial finance.

But in its headlong search for growth the company had also embraced the property development rush – by mid-2008 about 40 per cent of its lending was described as "property and business services", up from 20 per cent five years earlier. As the property bubble burst, those loans began toppling over and the pressure went on South Canterbury to maintain its reputation.

An early public sign of its struggles came from Greg Ninness at the Sunday Star-Times, who last June highlighted a huge surge in related party loans in the six months to December 2008 from $62.2m to $170.2m.

Related party lending – where a company lends money to entities controlled by its owners or directors – was a common characteristic of failed finance companies and is rightly regarded as an indicator of deeper troubles. Yet this pillar of South island probity was indulging in complex asset-shuffling with its own shareholder Southbury Group and other related interests, including the purchase of "various farming properties" from an unnamed related party for $67.2m.

South Canterbury chief executive Lachie McLeod dismissed concerns about these loans, saying: "Some of our related party lending is the best lending we know."

He was wrong.

A month later in July South Canterbury warned of a loss of $37m for the year to June – its first since 1934 – after having to write off $58m in bad loans, mainly on property development. The disclosure led Standard & Poor's to place its credit rating on negative watch, citing heightened risks from the related party exposure and concern that the company would use up precious cash buying investments such as farms.

It wasn't long before the news got worse. The rating downgrade arrived in August, forcing South Canterbury to repay US$100m it had borrowed from overseas institutions, and the loss, when it came, was $69m.

If there was a point when Hubbard's idiosyncratic approach to business became more of a weakness than a strength, this was it.

As loan write-offs grew and South Canterbury's need for capital grew more desperate, Hubbard was forced to reach out for new investors. After a "wider capital raising" was flagged in an October prospectus, market sources indicated their misgivings about the way it was being run.

"This is the problem with South Canterbury," said one. "It's a tangled web of Hubbard-sells-things-to-Hubbard. If Hubbard was Eric Watson there'd be a massive uproar about all these related party deals."

South Canterbury Finance was the public part of a large and intertwined private empire of holding companies, farms, trading businesses and other finance companies. Apart from Hubbard himself, no-one really knew how the pieces fitted together.

Accounting statements have since revealed intricate accounting transactions designed to shore up South Canterbury's balance sheet, circular deals with lenders and Hubbard paying interest for some borrowers himself.

South Canterbury insiders told of a hard-copy ledger, kept separate from the finance company's computer records, in which Hubbard tracked loans he administered personally.

Statutory managers, appointed to take charge of Hubbard's interests in June, have since revealed Hubbard's cavalier approach to record-keeping. Millions supposed to be invested by his funds management business simply do not exist, and funds were borrowed from investors and lent at zero interest by one of his unregistered charities.

The appointment of troubleshooter Sandy Maier as CEO in December suggested Hubbard, who is said to have liked to be the one in the controlling seat, knew a clean-up was essential.

But it came too late. Confidence had gone.

MONEY TRAIL

South Canterbury's asset growth:

30/6/2005 - $ 1.02 billion

30/6/2006 - $1.29 billion

30/6/2007 - $1.59 billion (under NZ GAAP)

30/6/2008 - $1.60 billion (under NZIFRS)

30/6/2009 - $1.98 billion

30/6/2010 - $2.35 billion

- © Fairfax NZ News