Amongst the numerous investment funds and financial institutions falling victim to the global credit crunch, one that surely need not and should not have succumbed was New Zealand-based MFS Pacific Finance Limited.



Starting life in New Zealand in 1999 as a subsidiary of ASX-listed MFS Limited (now known as Octaviar Limited), an early venture saw the Company take over the name and management of several underperforming Waltus property funds, later followed by an offer of Debenture Stock and Unsecured Notes to the New Zealand public through a registered prospectus. From the outset the Company made clear that funds raised were primarily destined for lending in the broadly diversified Australian property market, with the same interest rates offered in either AUD or NZD reflecting a significant proportion of second or even third mortgage lending. Figures to 30 September 2007 show one third of such lending as lying behind first mortgage advances from MFS Limited's own flagship Premium Income Fund, indicating a common interest between mortgagees. Cash raised in NZD but lent as AUD was hedged back to the New Zealand currency.

Over the next few years, MFS Pacific worked diligently to establish itself within the mainstream New Zealand finance company sector with restructuring in early 2007 placing MFS Pacific Finance under NZX listed MFS New Zealand Limited (38 of total assets as a fee in exchange, the Put Option became commercially as well as legally based.

This formal agreement effectively gave MFS Pacific Finance investors legal recourse to the full financial resources of MFS Limited, in support of both Secured Debenture Stock and Unsecured Notes. By mid 2007 the level of parent MFS Limited shareholder funds had reached a massive A$1.5 billion. No wonder the relatively generous fixed interest rates on offer of 9.25 unsecured, attracted widespread support.

MFS Pacific Finance became a significant partner and supporter of financial events around New Zealand, being on hand at major seminars and conferences. Company briefings were open and frank, personnel appeared well informed and competent.

The company seemed to take constructive criticisms on board - such as early disposal of the maligned Waltus name. Details of security type, missing from early communications, were added to later prospectuses. Early attempts to evaluate the Company's liquidity were originally answered by production of a complicated combined line and bar chart purporting to show an excess of assets over liabilities spread over time but, which to this observer at least, seemed to indicate the opposite. However, later financial statements displayed the assets and liabilities maturity profile in the standard tabular format common in New Zealand registered prospectuses with an overall receivables excess over liabilities of about 2.6 from October 2007 to A$4 in early January 2008 but this was generally in line with the broad ASX losses over the same interval, so little justification for the ensuing rout can be found here. Markets don't just suddenly react savagely to news that has already been widely known for months.

Further confusion seems to have been generated by suitor City Pacific first showing interest in merging with or acquiring certain financial assets from MFS Limited, then withdrawing, then showing renewed interest, only to withdraw again. City Pacific appears to have problems of its own.

Also, and although flagged in general terms earlier, a Board proposal in early January to address debt by raising A$550 million from shareholders while splitting the company in two must have contributed to dissatisfaction, it does not fully explain the sudden share price collapse.

No, what really hit out of left field in mid January - vital information unknown previously to the market - was that large shareholders, including Directors, were facing margin calls on shares effectively purchased on deposit, margin calls they were unable to meet. This news appears to have unnerved other substantial holders who quickly joined a rush for the exits. As every highly leveraged property owner knows, a modest fall in the market can wipe out ones equity. Margin traders of shares face the same fate but here the financier, or margin lender, usually demands immediate payment to make good any of the finance provider's losses. Failure to meet such demand may result in immediate sale or confiscation of the leveraged security to limit losses, this being the norm rather than the exception. The decline of MFS Limited shares over several months, in line with market sentiment, was obviously sufficient to trigger margin calls. Dumping of huge volumes on the market, including notifiable directors' holdings, did the rest.

CEO Michael King's conference call on 18 January, following two days of trading halt, was intended to present the separation and cash raising issues but instead oversaw a massive volume of trades, approaching 120 million shares compared to normal volumes between one and five million, and a 69 sale of Stella Group for A$1.3 billion equivalent, effectively values that arm at just over $2 billion, compared to A$2.5 billion evaluated by analysts earlier. Hence total shareholders' funds could take a half billion dollar hit from that one item alone. Nevertheless and even if remaining assets were all to be written down by 50 p.a. interest to debenture holders over the next 20 months.

Lessons

Unfortunately MFS Pacific Finance is beyond rescue as an operating unit in its original form and its passing is a genuine loss to the New Zealand finance company sector. In addition to offering investors currency diversification, MFS Pacific carried the potential to set a new benchmark of financial support for finance company borrowings through the "Put Option". To date no other parent/subsidiary relationship of companies listed on the New Zealand Debentures Exchange has instigated a similar enforceable guarantee. Perhaps the new "Global Credit Crunch" reality will empower investors to demand just that.

In addition, as more intricate trading mechanisms such as margin trading, stock borrowing and short selling evolve, it becomes clear that disclosure of such potentially dangerous practices must become a mandatory requirement imposed by stock exchanges or legislation if markets are to be open and informed. Private investors have quite enough risks to contend with, without the secret avarice of their own company's directors and executives exposing them to even more.

But while the mandatory objective may prove an optimistic goal in the short term, ordinary shareholders and fixed interest investors alike can take their own action immediately, wasting no time in sending the "totally unacceptable" message loud and clear to directors and executives where margin trading is concerned.