Treasury's five options for SCF, ForBarr's "exhaustive efforts" & bidder's non-existent capital

By Gareth Vaughan

Registrar of Companies Neville Harris thought receivership for South Canterbury Finance (SCF) could prove an expensive option and suggested the struggling company could be incorporated into the statutory management of owner Allan Hubbard.

This is revealed in a raft of information released by Treasury in response to Official Information Act (OIA) requests received by the Treasury and the Minister of Finance relating to SCF's participation in the Retail Deposit Guarantee Scheme, including the company's default and triggering of a NZ$1.6 billion payout under the Crown guarantee.

The documents show Harris raised this in a meeting on July 27 that was also attended by the Treasury's John Park, the manager of the guarantee scheme,  and Brian McCulloch.

The documents show that Treasury noted that in the absence of a recapitalisation proposal for SCF that warranted Crown support (i.e. the fiscal benefits were sufficiently material in comparison to the policy risks associated with such an intervention) SCF was expected to fail by the end of August due to liquidity issues or covenant breach when its existing trust deed waiver expired.

Receivership 'expensive'

After a Companies Office update on the statutory management of Hubbard and Aorangi Securities,  Harris said receivership of SCF might prove an expensive option, including as a result of limitations on the ability of the Crown to be assured that the process would deliver the highest value outcome.

"NH (Neville Harris) indicated that it would be feasible to extend statutory management to incorporate SCF if that were considered appropriate and that may offer the potential for an improved outcome," the notes say.

Treasury staff pointed out, however, that while nothing uncovered in investigations had suggested there were grounds for statutory management, it was not for it to recommend statutory management. That responsibility rested with the Companies Office  and/or Securities Commission.

The documents also show that at a meeting on August 3 a Reserve Bank official also raised the question of whether statutory management would be better than receivership if SCF did fail.

Park again reiterated Treasury had seen nothing in its investigations to suggest statutory management was warranted and that any decision to recommend it was up to the Companies Office  and/or Securities Commission rather than Treasury.

SCF was placed in receivership by its trustee Trustees Executors on August 31. Hubbard, and associated entities were placed in statutory management by the Government on June 20 at the recommendation of the Securities Commission. The Serious Fraud Office is now investigating Hubbard.

The documents also show recommendations for an SCF related provision against the retail deposit guarantee scheme in the June year Crown accounts. The total recommended was NZ$665 million, being the Crown’s Share of the loss given default of NZ$559 million plus an allowance for interest of NZ$106 million.

Treasury's five options

Here is a link to the five resolution options considered by Treasury and analysis of a proposal declined and a letter from SCF's adviser Forsyth Barr covering its efforts to save the company.

Treasury outlined five resolution options considered. Two were pre-failure ones and three "post failure" receivership ones.

1) Investor "purchases" good bank (SCF), and equi ty assets. Crown owns and actively manages bad bank (Newco).

2) Investor "purchases", good bank (SCF), bad bank (Newco) and equity assets. Crown makes upfront payment to investor for expected credit loss in bad bank.

3) Standard receivership with normal payout process.

4) Standard receivership with full payout (Crown objectives recognised in conduct of the receivership). Ultimately this was the option chosen.

5) Receivership & purchase/active Crown management of all assets of SCF.

In the resolution options document Treasury notes that based on the indicative proposals discussed with SCF, Treasury’s preliminary view is that the fiscal costs under recapitalisation would be between NZ$20 million to NZ$80 million lower than the costs under receivership, excluding post-default interest costs.

Uncertainties abounded

"However, the recapitalisation proposals discussed with SCF do not currently provide immediate contractual certainty over the actual fiscal cost to the Crown. Key uncertainties include:

• In the event the Overseas Investment Office (OIO) approval is not received for the sale of (SCF subsidiaries) Scales and Dairy Holdings (both have significant rural land holdings), the Crown
would be required to purchase these assets at current book value;

• The size and composition of the “Bad Bank”, and therefore the Crown’s expected loss in relation to Bad Bank, will not be settled until 31 December 2010.

Crown support for any recapitalisation proposal would raise important policy risks with the potential to adversely influence business incentives, including:

• Changing the incentives upon firms, both within the guarantee and outside of it to seek private sector solutions ahead of government ones;

• Raising fairness issues, including why the Government has stepped in to prevent SCF from defaulting, when it has allowed other entities to default.

Bid offered no new capital or ongoing funding line

A letter from an un-named external consultant from Tim Robinson Ltd, asked to give an opinion on an offer for SCF's assets, dated September 1 notes: That the un-named bidder was not undertaking to introduce new capital to SCF, or to secure new funding lines.

"In my view, while acknowledging that there is a great deal of uncertainty over recoveries to the Crown in a receiver-managed process, it is likely that the Crown’s net financial position would be materially worse under the proposal when loss of tax revenue is taken into account," the consultant adds.

Also see the related letter from KordaMentha.

Forsyth Barr's "exhaustive" search

In its letter dated August 30, Forsyth Barr says the recapitaisation process had been an exhaustive and protracted one. Both it and Hubbard had approached or received approaches from a wide range of national and international parties.

"We are confident that any potential investor in SCF has had more than adequate opportunity  to express their interest and complete a transaction  over the past year," Forsyth Barr says.

Wide role for KordaMentha

The papers also shed light on KordaMentha's role.

"KordaMentha contines to inspect SCF at the Crown’s request," Treasury notes.

"The scope of the inspection includes; a full discounted cash flow model of the expected loss to the Crown under receivership, the expected loss to the Crown under the potential 'recapitalisation' proposals, and an audit of it debenture register (to speed up any payout that may be required). In addition, key 'trip up' event are being monitored (liquidity, covenant compliance etc)."

Treasury also said a number of parties doing due diligence on SCF as they considered helping to recapitalise the firm were at different stages. But to avoid receivership, a recapitalisation
proposal would require binding heads of Agreement by the 20th of August.

'SCF’s Trustee waiver expires on 31 August 2010 and in the absence of an agreed recapitalisation proposal by that date, SCF’s Trustee is expected to give notice of default on that date and SCF will enter receivership if this occurs. In addition, SCF is also expected to run out of cash on or about 31 August 2010."

"Further compounding issues include the inability to raise debenture funding due to Alan and Jean Hubbard and “associated Hubbard entities” being under statutory management and the constant barrage of negative press surrounding SCF."

Furthermore the documents say: "Internally, SCF appears to have accepted that with out a recapitalisation SCF will fail on or about the 31st of August 2010."

In the same document Treasury says it is considered probable that SCF will default under the existing Crown Guarantee on or about 31 August 2010 and therefore a provision is required.

Meanwhile in another document Park says KordaMentha was contracted to do due diligence on SCF's assets to make sure Treasury was well placed to assess any "concrete proposals" it was presented with from potential SCF "white knights." Kordamentha had also been contracted to provide advice on how the Crown’s interests could be protected in the event of a receivership, with the firm looking at  the receivership process and asset realisation strategies.

Separately, Treasury recommended to Finance Minister Bill English on August 3 that a proposal from an unnamed investor to support SCF to the tune of NZ$50 million provided the benefit of the Crown guarantee was extendedf to the investor, be rejected.

(Updates add further detail).