Sparse information released on Geneva debt-for-equity proposal as noteholder attacks 'gravy train'

By Gareth Vaughan

A dissident Geneva Finance subordinated noteholder is encouraging fellow noteholders to vote against the company's latest proposed debt-for-equity swap, effectively Geneva's third capital reconstruction within three years, saying there's no benefits for them in backing the plan and not enough information available on why they should vote "yes" ahead of the scheduled March 31 vote.

Tony Boswell, a subordinated noteholder who says his original NZ$500,000 holding has been reduced to NZ$225,000 through a previous debt for equity swap, is concerned the proposal if successful, could leave Geneva's management led by managing director David O'Connell, trustee Covenant Trustee Company, and directors Peter Francis, O'Connell, Robin King and David Smale, as the only winners.

"Everyone else is just paying and losing," Boswell said. "The longer it drags out, the longer that gravy train continues."

Boswell, who says he supported Geneva's first capital reconstruction in May 2008 but opposed last year's one, says he's in touch with some other noteholders. Boswell stood unsuccessfully for the Geneva board alongside former senior Westpac manager June McCabe and the then Shareholders' Association chairman Bruce Sheppard in 2008. Boswell says he now has no interest is getting elected to the board and the only reason he did three years ago was to look for the best ways of selling Geneva's assets and repaying depositors. 

What especially irks Boswell is a dearth of information on the alternative option to the debt-for-equity proposal suggested in the 13 page independent expert report from Northington Partners, which is a wind-down of the consumer credit and small to medium business lender over four years.

"The information we’re given in terms of a cost of wind up is very limited," says Boswell.

"The Northington report says in a wind up there’ll be nothing left for noteholders but there’s nothing to support that."

Geneva needs to stay within Reserve Bank rules

Geneva says it's proposing the debt for equity swap because it needs more equity to avoid the possibility of dropping below the Reserve Bank's 8% minimum capital adequacy ratio under Non-Bank Depositor Regulations, which would probably trigger receivership. The company says its directors have explored several other options including new equity investments, a merger with other financial institutions and continuing to market its property holdings, which are its headquarters in Auckland's Mt Wellington and an 11% stake in Hamilton's Angelsea Medical Properties, for sale.

The finance company says if the subordinated notes are converted to equity, its prospects of breaching the Reserve Bank rule will diminish. Alongside saving NZ$587,000 in annual interest payments to noteholders, a possible securitisation programme and other debt raising opportunities, its business plan is "feasible," Geneva says.

"While there can be no assurance of the future value of the shares, the directors believe that the share price will rise once the company returns to profitability," Geneva says.

It posted a NZ$900,000 loss in the six months to September 2010. Geneva's shares were sitting at 5 cents each on Friday.

Managing director staying mum

Boswell, who says he has 16 years experience as a commercial banker including 14 years at Westpac and two years at ASB plus a Post Graduate Diploma in Banking from Massey University, said he emailed O'Connell seeking further detail on Monday and received a phone call from him on Friday.

Boswell says O'Connell said he wasn't going to provide the information Boswell had sought, suggesting he trust management's assessment.

"I have a finance background, and I just can’t come to any resemblance at all similar to what they’re coming up with," Boswell said. "I’d love to see what kind of modeling they’ve used."

He said he was worried Geneva was "trying to get votes on a fear emotion rather than a rational decision" where subordinated noteholders were properly informed.

Approached for comment on the debt-for-equity swap and its alternatives by Interest.co.nz O'Connell said he'd rather not comment.

"We’re right in the middle of making it happen and our major priority is simply to make it happen," said O'Connell. "I think the proof of these things is in the pudding."

"We’ve found historically our best way of dealing with matters is to deal directly with investors and that’s how we prefer to deal with them." See Geneva's notice of meeting here and prospectus here.

Independent report writers' 'limitations'

Northington Partners, which was hired by Covenant, notes the scope of its report was "far more limited" than was often the case for reports of this nature. It says the scope was limited to:

"A determination of what further payments of interest and principal (if any) noteholders would be likely to receive in the event that Geneva is either placed into receivership or wound down by current management commencing on April 1, 2011."

Based on its review of Geneva's financial modeling, Northington Partners says noteholders would be "very unlikely" to receive any payments of outstanding principal or accrued interest under the wind-down scenario. The firm projects a NZ$5.2 million shortfall in net assets in a wind down scenario. Northington Partners estimates Geneva will have cash of NZ$2.1 million at March 31, gross loan receivable of NZ$83.6 million with a NZ$29.7 million provision and adjustment.

Its term liabilities are listed as NZ$24.2 million owed to BOS International Australia, debentures worth NZ$28.5 million and subordinated notes, held by about 75 investors, worth NZ$4.4 million.

Under the capital reconstruction proposal, noteholders will receive 20,000 ordinary Geneva shares for every NZ$1,000 of outstanding sub-note principal. This is based on an issue price of 5c per share. Based on the number of Geneva shares currently outstanding, noteholders will be left holding just over 50% of all shares on issue should the proposal - requiring support from noteholders owning at least 75% of the subordinated notes on issue, succeed.

The noteholders will receive interest up to March 31. Geneva is also offering stockholders the option of subscribing for additional shares by swapping their debenture principal repayment worth about NZ$4.86 million due on March 31, 2015, also at 5c per share.

What Northington Partners couldn't consider

Interest.co.nz asked Northington Partners director Greg Anderson, whose signature appears on the independent report, how unusual it was to have such a narrow scope set for a report and whether his firm had considered turning down the opportunity to do the report given this narrowness. Anderson said ultimately the scope of the report was the trustee's decision.

"We pointed out when we were first given the scope that this was fairly limited," says Anderson. "Basically from our point of view it was ensuring that the trustee understood our view that the scope was narrow and was happy to proceed on that basis."

He says Covenant did understand and clearly was prepared to continue.

So just how narrow was the scope compared to previous reports Northington has compiled?

"I think the scope speaks for itself on that," says Anderson. "The things we haven't considered, which we have covered off in other reports, are listed in the report."

In the report Northington Partners says it hasn't addressed several factors noteholders should consider when deciding whether or not to approve the deal. It says these include:

- The consequences for Geneva and the noteholders in the event the sub-note exchange isn't approved, which includes a likely receivership or managed wind down;

- Options available to the company as an alternative to the sub-note exchange and the likelihood that any of these options could be successfully implemented;

- The share value used to determine the number of shares that noteholders will receive in exchange for their sub-notes if the sub-note exchange is approved;

The short-term prospects for the market price and liquidity of Geneva's shares, and the potential for noteholders to sell the shares issued to them pursuant to the sub-note exchange; and

- The likelihood that Geneva's medium - long term plans will be achieved if the sub-note exchange is approved, and the potential future value of the shares issued to noteholders pursuant to the sub-note exchange.

Asked whether he could provide any more information for investors on the Geneva wind down option, Covenant managing director Graham Miller said no.

"Unfortunately we are not in a position to provide additional forecast information," Miller said. "The Northington Report does comment on the company’s financial modeling over the relevant period. The report also comments on the key assumptions used by the company in its modeling. The report then reaches its own conclusion. We have no reason to question that conclusion."

And Anderson said nor could he provide more detail on the report's conclusion of a NZ$5.2 million net asset shortfall in a wind up scenario, as it wasn't his place to do so if the trustee wasn't prepared to.

Trustee 'doing whatever company tells it to?'

Given the tough economic conditions and Geneva's ongoing capital shortages since 2008, Miller was also asked whether it might simply be a better option to wind Geneva down or put it in receivership.

"Geneva is paying its debts as they fall due under the terms of the current moratorium," Miller said. "Their concern is the lack of head room in its capital ratio. Any wind up and sale of the book will very likely result in further loss of value and the noteholders (who may become shareholders) would be the next to miss out after shareholders."

Meanwhile, Boswell questions whether Covenant is acting in the best interests of investors saying, in his opinion, it appeared to be doing whatever the company tells it to do.

"I don't feel like I have any protection at all from a trustee," Boswell says, suggesting Covenant was also favouring shareholders over depositors.

"Under current management (the future outlook) is probably bleak because the track record is terrible and in their own words suggests they don’t see the economic outlook in the immediate future improving at all. So if they can’t give some reason why things should be different, I think they’ll be the same. The only winners out of this (debt-for-equity swap proposal) are the CEO getting his $500k and the directors getting their directors fees," Boswell says.

Geneva's annual report for the year to March 2010 shows O'Connell received salary, bonus and "other" remuneration totalling NZ$388,000. He has also received a loan of NZ$273,711 that paid interest of 8% up to September 30, 2007 but has been interest free since October 1, 2007.

Miller says Covenant doesn't agree that it, as trustee, has been working for the board rather than depositors.

"The trustee would not be doing its job if it did not allow the noteholders the opportunity to consider this proposal," says Miller. "The company is currently not in breach of its trust deed, and so even if this proposal does not go ahead, it remains a going concern. The directors have, however, expressed their concerns going ahead."

S&P lowers credit rating to "CC"

Meanwhile, credit rating agency Standard & Poor's (S&P) has cut its long-term counter party credit rating on Geneva to 'CC' from 'CCC' and placed Geneva's ratings on creditwatch with negative implications. S&P's description of a"CC" rating suggests a company that's "currently highly vulnerable."

S&P credit analyst Peter Sikora said the move reflected S&P's view there there was a high likelihood Geneva's subordinated noteholders will agree to the debt-for-equity exchange at a level less than par. This would  see Geneva's ratings lowered to 'SD' (selective default on some obligations).

 S&P has also lowered its insurer financial strength rating on Geneva's captive insurer, Quest Insurance Group., to "CC' from 'CCC" and placed Quest's rating on creditwatch with developing implications.

"After the exchange is completed, it is likely that the rating on Geneva and Quest would be raised to a level no higher than a 'CCC' rating category following further review of the group," Sikora said.

"Standard & Poor's view is that should investors and shareholders reject the plan, there is a high chance of Geneva being forced into receivership. Accordingly, the 'CC' rating on Geneva would remain on creditwatch with negative implications and transition to 'D' when the company is formally placed in receivership. The 'CC' rating on Quest would also remain on creditwatch but the direction revised to negative."

Moratorium and two previous capital restructures

Geneva subordinated noteholders backed a moratorium - as opposed to winding the company down or appointing a receiver - that ran from November 2007 till April 30, 2008. They received all their interest monthly during this period at an average rate of 13.25%.

Then in May 2008 subordinated noteholders agreed to convert 55% of their subordinated notes to equity at a price of 36.492c per share. In the following two years the noteholders received all their interest on their remaining 45% of subordinated notes at an average rate of 13.25%.

Then, in late 2009, Geneva says a "real risk" emerged that it wouldn't be able to refinance or extend its NZ$35 million bank loan from BOS, which was due to mature on April 30 this year. The company therefore reached a deal to pay off BOS in half-year installments with the final installment due on March 31, 2015. Subordinated noteholders were, therefore, asked to extend the term of their investment out 30 months to dates between October 31, 2013 and April 30, 2015.  The noteholders again threw their weight behind Geneva's plan and have continued to receive monthly interest payments - on the 45% of their original noteholding they retain - at 13.25%.

"My note was $500,000," says Boswell. "I’ve already given them $275,000, which is gone and now they’re basically going to say 'we’d like the other $225,000 as well Tony.' I don’t seem to be getting a lot for it (and) it’s a little bit soul destroying."

If the company needs an extra NZ$5 million, Boswell says it should price the shares at a level where people with a risk appetite will buy them.

"Obviously at 5c a share people won’t because the only way they’re able to sell them at 5c a share is to try and force them onto reluctant shareholders or people who don’t really want them. But if you make them 1c a share, would people who have got a risk appetite then say, 'well yes we’ll have them.' If that’s the case you might even be able to say ‘those of you with notes and debentures, if you wish you can take up that share offering using some of your debentures and notes'."

'Sell the assets and repay depositors'

Boswell says an alternative option Geneva could look at is seeking a buyer for its assets, primarily its loan book, and use the proceeds to repay depositors.

"I look at some of the other finance companies out there who have done that and it’s not a mission impossible, it has been done quite successfully by others with similar sorts of books. It could be done again but there needs to be a willingness to do it."

Consumer finance companies that have been tipped into receivership include National Finance 2000, Provincial Finance and Western Bay Finance, which were all placed in receivership between May and July 2006. They either have, or are expected to, return 48%, 92.2% and 82% of investors' money, respectively. See our Deep Freeze List for full finance company receivership details.

In a 2008 report on Geneva's first capital reconstruction proposal, Northington Partners estimated operating costs from a receivership at between NZ$33 million and NZ$37.3 million leaving between NZ$114.1 million and NZ$142.2 million available for distribution to stockholders and BOS.

As for the new capital reconstruction proposal, Boswell says noteholders' remaining position will be knocked down the peaking order in a wind up situation to the same as that of a shareholder.

"It’s hard to see what benefit there would be for a noteholder to say 'yes' and I can’t actually see one."