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South Canterbury Finance paid almost twice fair value for debt ridden Dairy Holdings stake, Reserve Bank says
By Gareth Vaughan
The NZ$75.7 million price South Canterbury Finance (SCF) paid for a 33.5% stake in Dairy Holdings Ltd from its majority owner Allan Hubbard last year was almost twice as much as it was worth, according to Reserve Bank analysis.
In a swathe of correspondence released by the Reserve Bank relating to SCF, Douglas Widdowson, an adviser on domestic deposit taking oversight at the central bank, tells John Park, Treasury's manager of the Crown retail deposit guarantee scheme, in an email that, the sale price was "probably inflated." A report attached to the email argues the price paid should have been just NZ$42 million rather than NZ$75.7 million.
This is based on a Reserve Bank valuation of Dairy Holdings of NZ$125 million as opposed to the NZ$225 million the Hubbard-SCF deal valued the business at, which according to a September 3, 2009 email from the Reserve Bank's Andrew Hemphill had NZ$340 million of bank debt.
Widdowson says the transaction led the company to technically breach some of its banking covenants and notes it would probably leave SCF worse off from a capital ratio point of view, and would require the injection of additional capital to ensure that the entity's capital ratio remained the same.
"The transaction transferred cash from SCF, and moved assets into the company that were readily realisable for supporting the company, and in some instances would leave the company more vulnerable to additional calls for funds,' Widdowson writes.
The report attached to Widdowson's email reviewed and criticised the pricing methodologies used by Dairy Holdings and an un-named expert.
"The effect of using my pricing methodology is to reduce the capital injection from the stated NZ$40 million to NZ$2 million," Widdowson says.
"The impact on SCF's capital ratio under the new NBDT (non-bank deposit taker) regime will be negative because the shares, at their true value of NZ$42 million, will be risk weighted at 600%."
Land and buildings value 'materially' overstated
The expert's report had "materially" overstated the current value of land and buildings by reducing them by just 1.5% from the May 2008 market peak. Dairy Holdings itself had trimmed them by 8%, but Widdowson argued even this was not conservative enough, and in his calculations he assumed a 22.5% fall.
He also questioned, but used the expert's current liabilities figure of NZ$3 million. Widdowson pointed out this was down from NZ$11.3 million a year earlier, looking low for a company under "extreme financial pressure" that would presumably be trying to make maximum use of trade and other miscellaneous sources of finance.
Dairy Holdings' valuation also ignored a NZ$37 million increase in debt liabilities during 2009.
Meanwhile, the email from Hemphill sent to Widdowson and another Reserve Bank staff member Andy Wood, outlines trading banks exposure to Dairy Holdings. Commenting on a report on SCF by Treasury's adviser KordaMentha, Hemphill says Dairy Holdings, owner and operator of 58 South Island dairy farms producing 1.5% of New Zealand's total milk production, isn't cashflow positive as previously thought. Dairy Holdings' website shows it is New Zealand's largest single privately owned supplier to Fonterra.
"At best the forecast for 2010 is breakeven, at worst a NZ$8 million loss," he writes.
He notes a NZ$45 million ANZ loan facility held by the Hubbard controlled SCF parent Southbury Corporation.
"There is a suggestion that SCF are indirectly funding this commitment," Hemphill says. "Assume failure of SCF will have a domino impact on ANZ facility."
An ANZ spokeswoman declined to comment.
In total Widdowson noted NZ$340 million of total bank funding in Dairy Holdings from "three majors" and Rabobank. He refers to a NZ$100 million Australian loan book with no detail known on its performance, and also says related party loans are nearer NZ$250 million, well up on the NZ$190 million disclosed to the Reserve Bank.
"The NZ$100 million standby facility provided by BNZ and (ASB's parent) Commonwealth Bank of Australia has already effectively been withdrawn by advising they will not honour any drawdown due to a technical breach of the covenants," notes Hemphill.
Meanwhile, Widdowson also notes a NZ$21 million SCF facility provided to PGG Wrightson and says a NZ$50 million facility to Silver Fern Farms may have been repaid.
Separately, a Reserve Bank report on SCF's position in the rural lending market noted it provided just 0.7% of total rural lending. Of its reported NZ$300 million rural exposure, half was attributed directly to farming the rest was farm related in areas such as the transport of farm related products. Of the NZ$150 million of direct farming exposure, about NZ$80 million was concentrated in Canterbury and the lower South Island.
According to KordaMentha figures, SCF's rural portfolio comprised about 200 loans with 80% worth less than NZ$1 million.
SCF bought the one-third stake in Dairy Holdings in a related-party transaction with its main shareholder, Hubbard's Southbury.
SCF receiver works through ownership issues
Hubbard, was placed in government enforced statutory management on June 20 this year. SCF collapsed into receivership on August 31, with McGrathNicol appointed receiver.
McGrathNicol has appointed Goldman Sachs to advise it on the sale of Scales and Helicopters NZ, two other businesses SCF bought from Southbury, and Deutsche Bank to assist on the sale of SCF's core financial services operations. However, McGrathNicol managing partner Kerryn Downey recently told interest.co.nz there would be no quick sale of the Dairy Holdings stake.
"We're working through certain issues regarding the nature of some of the statutory documentation, or the documentation regarding the various ownership interests,” he said.
“And till we’ve been through some of that documentation we’re not really quite ready to offer our shareholding.”
Hubbard remains a Dairy Holdings director.
SCF related party loans and other entities associated with Hubbard including Aorangi Securities, Hubbard Management Funds and several charitable trusts, are now under investigation by the Serious Fraud Office.
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