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Banksia: Anatomy of a "ponzi" scheme ~ "City Pacific, returns were illusory"

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Pacific First Mortgage Fund [CP] by Andrew Griffin: "I say the returns were “illusory” because the distributions that resulted from the ‘accounting income’ were largely funded not by income earned from the loans but from new money invested in your fund by new investors and this is the very definition of a Ponzi, or pyramid, scheme --funding existing investor’s distributions with new investor’s money. 

Why was it hidden? Why did they not stop it? Because once this became known there would be no more new investment in the Fund the cash flow would stop and it would collapse --the unitholders were not important, your only role was to be it's ‘iron lung’, you unknowingly kept them alive. As a thank-you CP stripped the last remaining cash out of the Fund with a $50m loan to itself in March 2009. I cannot imagine what would have happened if they were still the manager of your Fund.

--To be clear, the reduction in the value of your units that was hidden from you by clever accounting treatment and a single dodgy revaluation exceed $315m, or 36 cents per share."

--another problem from the lack of third party scrutiny[= ASIC], --was that City Pacific was able to significantly deviate from responsible lending practices. This ‘deviation’ resulted in a variety of negligent and potentially fraudulent practices including a preponderance of loans being made to “related” parties, loans being made without due and proper consideration, loans being made against arbitrarily inflated values and loans that were defective or by virtue of poor documentation, simply unenforceable.

_______________________________________________________________

Pacific First Mortgage Fund - Meeting of Unitholders 1 September 2010 Brisbane

The State of the Mortgage Fund Market

Since being appointed to manage your Fund, we have invested a huge amount of resources in ascertaining the state of the Fund and its assets. With the benefit of this knowledge, we are now in a position to speak frankly with you in relation to the Fund. The fact is your investment has been decimated by the global financial crisis as well as City Pacific’s gross mismanagement.

So today, whilst I will give you an insight into the state of the Fund, and how it has been mismanaged in the past, I also want to focus on what we can do in the future to try to recover past losses.

To commence, it is important to understand how your Fund differs from many other first mortgage funds.

Unlike all mainstream mortgage funds City Pacific marketed the Fund directly to the public as offering high returns backed by first mortgages. They spurned marketing the Fund through professional advisor networks which meant they were able to avoid any need to have the fund rated by independent ratings agencies such as Mercer, Morningstar, Standard & Poor, Lonsec or van Eyk. As such, City Pacific avoided the independent scrutiny of both the ratings agencies and the advisor networks. An independent scrutiny embraced by all mainstream mortgage funds as a valuable marketing tool but avoided by City Pacific for fear of exposure.

City Pacific was then largely left unchecked in investing the Fund in risky assets, marketing the Fund on the basis of unrealized, illusory returns, administering the Fund without adhering to proper lending practices and exploiting the Fund for the benefit of City Pacific’s own balance sheet through a series of related party deals.

I say the returns were “illusory” because:

• They were a result of accounting treatment. To be precise nearly $150m, or 17% of the original value of the Fund, was actually interest owed by developers that had no ability to pay that interest. That $150m was never a real asset of your Fund. The effect of this was that the ‘true’ value of your units was already down by 17% to 83 cents;

• And secondly, the distributions that resulted from the ‘accounting income’ were largely funded not by income earned from the loans but from new money invested in your fund by new investors. This is the very definition of a Ponsi, or pyramid, scheme. Funding existing investor’s distributions with new investor’s money. The distribution of new capital this way depressed the value of your units even further.

Another problem I mentioned resulting from the lack of third party scrutiny was that City Pacific was able to significantly deviate from responsible lending practices. This ‘deviation’ resulted in a variety of negligent and potentially fraudulent practices including a preponderance of loans being made to “related” parties, loans being made without due and proper consideration, loans being made against arbitrarily inflated values and loans that were defective or by virtue of poor documentation, simply unenforceable.

I will refer to a couple of loans for your information to illustrate points throughout this course of this address. The first is Asset 23, pictured below.

CEO’s Address 1Asset 23, which comprises a total of 900ha on the Gold Coast hinterland, was acquired by the borrower in several stages until the entire property holding was amalgamated in late 2005. The Fund had lent $17m at this stage at 50% gearing (i.e. the borrower contributed 50% equity and the Fund provided 50% by way of debt). The property was revalued in March 2006 and, based on some ridiculous assumptions that some future rezoning would occur (needless to say it never did), the valuation doubled to $65m. The Fund also allowed an increase in gearing to 80% ... for non income producing vacant rural land ... and subsequently lent another $38m to the borrower. The total loan was now $55m. None of this money was used to improve the property. It remained a large rural landholding. We have no idea what the borrower did with the

$38m. But we do know that this borrower had other loans from the Fund that were failing. But rather than take action, which would have meant, telling Unitholders that there were significant impairments in the mortgage portfolio, City Pacific “rectified” this problem with another revaluation of Asset 23 in June 2008. Surprise, surprise, based on even more outrageous assumptions of rezoning (needless to say they too never happened) the value doubled again to $130m. This enabled City Pacific to ‘pretend’ that their borrower was not in any default. Un-repaid loans from that borrower went on to cause significant loses to the Fund that could have been stopped earlier and if so, the bulk of these losses avoided. To be precise losses from this borrower were nearly $165m, or 19% of the original value of the Fund!

To be clear, the reduction in the value of your units that was hidden from you by clever accounting treatment and a single dodgy revaluation exceed $315m, or 36 cents per share.

Why was it hidden? Why did they not stop it? Because once this became known there would be no more new investment in the Fund the cash flow would stop and City Pacific as a developer (ASX listed) would collapse. The Unitholders were not important. Your only role was to be City Pacific’s ‘iron lung’. You unknowingly kept them alive. As a thank you City Pacific stripped the last remaining cash out of the Fund with a $50m loan to itself in March 2009. I cannot imagine what would have happened if they were still the manager of your Fund.

2 CEO’s Address

So your Fund has a very different profile to other mortgage funds. And whilst other funds were challenged by falling values post the GFC, your Fund was decimated. Your Fund’s remaining assets comprise large and complex loans unsupported by the borrowers who generally have fled the country, gone into receivership or administration or declared themselves bankrupt. The remaining mortgage securities were, and remain, highly speculative, incomplete and fraught with problems. I will, however, address the assets of the Fund shortly.

So it would appear, on the face of it, to be a very simple process for Balmain Trilogy to follow as manager of your fund. Nail up some “For Sale” signs and get you your money back, or what’s left of it, as quickly as possible. But we also know that most of you want us to maximize your recovery, even if it takes longer. It is wto achieve these goals ...both speed of recovery and amount of recovery... that is the very essence of the New Strategy.

I would like to make it clear for the record that our sole aim as your manager is to recover as much of your original investment as we can as fast as we can. If anyone doubts our commitment I would like to remind you of what we have achieved in our first year.

What Have We Achieved

• Steadily realised those Fund assets where a fair market value could be obtained and recovered $135m for the fund in the first 10 months;

• Reduced the Fund’s finance facility with the CBA from $91.8 million to $30 million and now have their consent to a further 2 year term and their consent to commence unlimited redemptions to Unitholders;

• Increased the Fund’s cash position from $9 million to $42.2 million as at 30 June 2010 which enables us to make the first payment to Unitholders of $35m in October this year.

• Reduction in management fees from $30m in 2008 and $25m in 2009 to $8.3m in 2010 – a 67% reduction - see charts below;

• Reduction in related party loans from $200m in 2008 and $80m in 2009 to nil in 2010; • Established an Investor Committee, appointed by an independent auditor, which has provided

valuable feed back to Balmain Trilogy over the last 12 months;

• Provided an unprecedented level of information in respect of the assets to Unitholders, tempered only by the very real need to protect Balmain Trilogy‘s ability to realize the value of the assets. We do not want every developer in Australia to know our hand before it is played!;

• Completed an extensive legal and asset review of all Fund to establish work-out strategies for each of the assets and draft statements of claim against entities that have caused the Fund harm;

• Appointed an independent custodian (Trust Company) and an independent registrar (Computershare) to ensure Unitholder protection;

• We have taken control of all of the warts-and-all assets of the Fund to ensure appropriate remediation prior to sales or development commencing;

• Vigorously pursued borrowers and guarantors including related parties of the previous manager (City Pacific Limited) for amounts owed to the Fund;

CEO’s Address 3

• We have micro-managed the process of procurement of re-zonings and development approvals on the vast number of rural landholdings which comprise the Fund’s assets;

• Rectified significant legal and/or physical defects in the assets of Fund including rectification of defective mortgages;

• Identified specific Fund assets that can be developed to significantly increase value of the Fund;

 

http://www.balmaintrilogy.com.au/pdf/BTI%204512%20CEO%20Address.pdf

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Comments

  • doyla66
    doyla66 Wednesday, 31 October 2012

    Good one, Andy. I wonder if ASIC knows what a Ponzi is?

  • doyla66
    doyla66 Wednesday, 31 October 2012

    Now we have another issue uncovered, fraudulent valuations!
    Which valuers would come up with such a valuation for that rural property? Independent valuations?
    Aren't they liable also?

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