Thursday, 25 September 2008

Sub prime MIS

Few would have thought 12 months ago that granting mortgages to a few borrowers who couldn’t afford the repayments, would lead to such world wide turmoil. But it was more than just a few borrowers. It was a few million.

The mortgage providers bundled the mortgages together and transferred them to other lenders. They were then repackaged, given an attractive credit rating, then on sold to investors and super funds all round the world. The investors thought they were buying a highly rated bond with an interest rate better than bank deposits, when in fact they were buying a collection of mortgages to borrowers with a high possibility of default.

Default is what occurred. With a large level of defaults, a lot of houses hit the market at once. House prices plummeted. Invertors’ bonds became worthless. The only recourse for investors was to sue those who sold the toxic product. But firms like Lehman Brothers declared themselves bankrupt. In Victoria alone it is estimated that local governments and other semi government bodies have lost $30m in this way.

We are now witnessing the same phenomena in our MIS industry.
The flood of money into MIS schemes in the last 10 years or so has largely come from borrowed funds. Providing finance to a MIS investor allowed the investor to buy Woodlots with little or no cash up front, and then get a tax refund of approximately $4,000 for every $10,000 invested. Financial planners were regarded as modern day alchemists able to create gold from nothing. It was only going to cost a few hundred dollars per month over a few years to repay the loan. No worries. However it may turn out to be fool’s gold.

Most loans to investors were bundled up (or securitised) in much the same way as the sub prime mortgages and transferred to other lenders and investors. So there are a lot of people out there who own little more than a collection of loans used to purchase Woodlots. What happens if loan defaults occur, say if the Woodlot owner suddenly realises that the amount owing on the loan far exceeds the value of his underlying Woodlot, due to the yields falling well short of those indicated in the prospectus. The investor may then decide to renege on the loan.

Default is now occurring. Great Southern Limited (GSL) wrote off $38m in amounts lent to investors in their latest interim financial statements for the period ended 30th June 2008. And these were the loans that GSL still had on their balance sheet, those which hadn’t been bundled up and transferred to other lenders. It would be coincidental if all the bad loans were on GSL’s books. The other lenders who participated in the pass-the-parcel game will surely be experiencing an increased level of defaults.

The level of defaults will no doubt increase when Woodlot owners realise the current value of their investment. Possibly to head off investor concern at their imminent poor returns, GSL has proposed buying back Woodlots from 6 of their tree projects (1998 to 2003). GSL only values a 1998 Woodlot at $2,576 (the investor paid $3,000 plus GST 10 years ago). GSL is proposing to issue 2342 GSL shares @$1.10 each (=$2576) as consideration. But with the current market price for GSL share being only 40 cents, the current market value of a 10 year old Woodlot is only $1,000.

When other investors see this, they may decide to default on their loans. They may get sued by the lenders, but they may in turn sue the MIS promoters who sold them the rubbish in the first place. I’m sure there are lawyers who have chased ambulances in the past, who may be willing to take instructions from aggrieved investors.

If the investors accept shares for their Woodlots the market value of the GSL shares at the time will be assessable income. If they subsequently sell the shares at a loss, the capital loss may not be able to be offset against the income gain. Quite a dilemma.

GSL and Gunns have both indicated problems with securitised loans which will inhibit future MIS investors. GSL has also indicated that future MIS projects will concentrate on high end value plantations, which is the first acknowledgment, albeit implicit, that what they have been selling to date has been low end value rubbish.

On 19th Sept, Environinvest, a MIS company operating in Victoria appointed an Administrator because of trading difficulties. Three days later, Receivers were appointed to arrange an orderly burial. As more distressed asset sales occur, the market price of those assets will fall.

Gunns too are trying to sell $170m worth of trees in an effort to raise more money. So the market price for trees might come under a little more downward pressure in the coming months.

Not only have MIS promoters relied on overly optimistic yield projections (GSL’s first 6 crops will average only 60% of initial estimates) but investors have excessively relied on debt. Worse still is the money that has been diverted from the public purse merely to finance a few private benefits. Booms are usually followed by busts, and this is what is now occurring.

It beggars belief that the shapers of our destiny have contemplated building a downstream processing industry that requires large public investment on such shaky MIS foundations.

What have all the guardians of the public purse been doing? All levels of Government have encouraged the excesses, and then turned a blind eye to the ensuing problems as they surfaced. Surely ASIC has enough information on the final yields from Woodlots to seriously question whether the promoters are running an investment scheme that they specifically warn about on their website. The ATO have grown weary at the literalism shown by MIS promoters in conducting their schemes, but there is now clear evidence of major breaches by MIS managers of ATO Product Rulings which investors have relied upon.

And then there’s Private Forests Tasmania, missing somewhere in action. In cases of market failure resulting partly from the lack of pertinent information to investors, there has always been a strong case for someone to provide independent info on yields etc. Such info has been difficult to obtain and it is only with GSL starting to harvest their crops, that data is becoming available. And hopefully the secondary market provisions allowing MIS investors to sell after 4 years will also send much needed price signals to the market.

Surely now is the time to start designing a more sustainable plantation industry, one that coexists with native forests and traditional farming.


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