City Feels Heat As Inflows Slow And Redemptions Rise
The Age
Saturday February 23, 2008
The balance-sheet numbers show that City Pacific is not in particularly sound shape at the moment.
CITY Pacific is trying to buy the MFS Premium Income Fund in a deal that would give the foundering MFS some cash and deliver City some $700 million in assets. But this deal is more about survival, or at least buying time, if the latest City Pacific accounts are any guide.Time is running out. Although City declared a 12% rise in interim net profit to $27.5 million yesterday, a closer inspection of its accounts suggests any claim to profitability is bold, if not brazen.For a start, it is cash flow-negative to the tune of $20 million. That's for the half-year. It burned $48.8 million in cash last year and is borrowing more money, much from related parties, to fund the cash burn.In fact, the notes to the interim accounts show the developer has drawn down $98 million of its $100 million bank facility, so it seems City Pacific might need MFS more than MFS needs City Pacific.As City has more than $1 billion in small investors' savings in its mortgage trusts - which it on-lends to property developers - this would appear to be a critical situation, especially as the company has just deconsolidated the mortgage trusts from the parent balance sheet.For the sake of these investors, it is worth quoting the latest accounting manoeuvre from the notes to the accounts: Note 3:"City Pacific is responsible entity for certain registered managed investment schemes which fund registered mortgage loans primarily through the issue of units to investors."Of these schemes, City Pacific previously consolidated City Pacific First Mortgage Fund and City Pacific Income Fund on the basis that City Pacific had exposure to the majority of the risks and rewards of the funds."As a result of the directors of City Pacific resolving that the company would no longer provide the funds with financial support in the event of a loss so as to maintain unit holder distribution rates, and both funds subsequently issuing amended Product Disclosure Statements, City Pacific no longer has exposure to the majority of the risks and rewards of either fund."They were deconsolidated on December 1, which makes it hard to work out what is going on, but a few things are clear.According to PDS disclosures for the mortgage funds, one fund has $326 million of loans falling due from property developers at the end of next month. Another $707 million is due at the end of the year. Over on the City balance sheet, receivables have jumped from $63 million to $138 million. That's money due in from property developers this year, and property developers are doing quite as nicely as they have been.City has been lending money at rates above 20% - high risk in other words - and last year's accounts showed some $100 million of loans were in default. On the other side of the ledger, current liabilities are $126.5 million, of which $102 million take the form of interest-bearing loans due this year.Moving right along to the income statement, distributions to unit holders (mortgage trust) fell from $45 million to $38 million, which suggests retail investors are not rolling over their investments. Interest expense is up 56%, reflecting City's increased borrowings. Capitalised interest is recognised as income.All up, it appears redemptions to the funds are on the rise, the pace of inflows is slowing, cash is down to $2.5 million, the latest debt facility is virtually exhausted and City is looking to reduce its exposure to the mortgage trusts via deconsolidation.When City was proposing to take over MFS for $1.3 billion a few weeks ago, it was certainly not talking about $1.3 billion in cash. Rather, it was scrip, but any examination of the accounts would indicate this scrip is not worth as much as City reckons it is.The marketing guff attached to the numbers claims "strong business model continues to drive growth". Each to their own, but this observer certainly would not be advising his mother to participate in this exciting opportunity, let alone anyone else's mother. City is now in a two-week exclusivity period with MFS. It is believed any deal would take the form of some cash up front from City plus some instalments to be paid on the performance of MFS Premium Income Fund (PIF) over the next couple of years. The word is less than $10 million cash and up to $50 million, contingent on PIF performance.Even a $2 million cash payment up front would seem to be a stretch, so if City gets this deal done it may well be contingent on a capital raising. Indeed, if the deal does get done, it would deliver Phil Sullivan and his troops time as the PIF assets could be used to satisfy City's own obligations.PIF is similar to City in that it gets retail investors' money in the door and then lends it to property developers, including itself (MFS).It raised $770 million and has $3 million cash left. The $700 million-odd in property development assets will price at a discount, as the related party stuff, that is the developments done by MFS, are frozen.The projects are all yet to be completed and there is a bit of exposure to the shaky MFS Living and Leisure.Still, PIF contributed some $16 million to MFS last year in interest on the loan book to developers, so Sullivan and his colleagues at City would love to get their hands on this cash flow and meld PIF's assets into City. PIF's 11,000 unit holders would also bolster City's retail base.City Pacific and its faithful are in for a white-knuckled ride over the next few weeks and months, and ironically, although MFS may be in suspension, it may also have the upper hand in negotiations.
© 2008 The Age