Key Points:

The Nathans Finance story is a shocker, an absolute scandal. It is arguably even worse than Bridgecorp and Hanover Finance because investors' money has disappeared into thin air, mostly overseas, whereas at least the latter two lent their money to high risk property developments that have plunged in value.

Where did Nathans Finance's money go and why are a number of regulatory and enforcement agencies investigating the failed company?

The Nathans Finance story begins in November 2000 when Vending Technologies, which has subsequently changed its name to VTL Group, listed on the NZX following the sale of 7.5 million shares to the public at $1.00 each.

After the issue John Hotchin, the brother of Mark Hotchin, and Mervyn Doolan owned 33.2 per cent each, Gary Stevens and Roger Moses 4.1 per cent each, with the public holding the remaining 25.4 per cent.

The public paid $7.5 million for their 25.4 per cent stake whereas the founding shareholders had a net contribution of just $500,000 for their 74.6 per cent holding.

VTL's directors were Richard Janes (chairman), Doolan, Hotchin and Elizabeth Coutts. Hotchin was executive director of operations and Doolan the chief financial officer.

According to the prospectus, "VTL was established to acquire, manufacture and sell vending machines for convenience foods and to manage and service those machines. Over time the intention is to retain ownership of an increasing proportion of machines."

In July 2001 VTL established Nathans Finance as a fully owned subsidiary. The use of this name was a clever play on the well-established Auckland business family and it enabled the new company to take advantage of the former Nathan (without the s) Finance branding. Nathan Finance had changed its name to Nationwide Finance and is now part of Allied Nationwide Finance.

The use of old names, or offshoots of old names, has been an unfortunate development in recent years as it gives the impression that a company has been around for a lot longer than it has.

The original directors of Nathans Finance were Janes (chairman), Doolan, Hotchin and Warren Larsen, the former chief executive of the New Zealand Dairy Board. Larsen had also joined the VTL Group board.

VTL exceeded its forecast earnings for the first two years but the June 2003 year result showed that the company was beginning to struggle. By this stage Coutts and Larsen had resigned and the company was converting itself from an owner and operator of vending machines in Australasia to a franchisor, mainly in Australia and the United States.

In the June 2003 year companies and interests associated with Hotchin and Doolan sold VTL shares for a total consideration of $2.26 million.

In July 2003 VTL approved the purchase of NZ Vending Investments for $2.3 million. The principal vendors were Hotchin and Doolan.

Shortly afterwards Janes resigned and the VTL board then consisted of the company's four original shareholders, Stevens (chairman), Hotchin, Doolan and Moses.

VTL's operations became increasingly difficult to understand and its performance began to wane. The company had a net loss of $9.8 million in the June 2005 year followed by net earnings of $2.3 million the following year even though it had negative operating cash flow of $2.1 million for the latter period.

VTL reported a loss of $5.9 million for the six months to December 2006, Nathans Finance was placed in receivership on August 20, 2007 and VTL Group suffered the same fate on November 5, 2008.

Two of the most notable features of the Nathans Finance receivership are the dreadful state of its loan book and an anticipated repayment to secured debenture holders of just 10c or less in the dollar.

The accompanying table shows the book value assets and liabilities of Nathans Finance on the day PricewaterhouseCoopers (PWC) was appointed receivers.

A finance company borrows money from the public, mainly in the form of secured debentures, and should lend it to parties that have a strong business model with the ability to pay 100 per cent of the loans back.

According to Nathans Finance's last prospectus it had "a robust credit assessment process" and provided "loans to a broad range of commercial entities".

These comments were made even though, according to PWC, $170.8 million or 97 per cent of its total loans of $176.1 were to related parties, mainly VTL.

Where did the $162.3 million of loans to VTL Group, other VTL Group companies, master franchisee and franchisee in the accompanying table disappear to? What were they secured against?

At least as far as Hanover Finance and Bridgecorp are concerned there is land and developments in Queenstown, Matarangi and Fiji, but there is virtually nothing left at Nathans Finance. The company's vaults are almost empty except for the stench of foul air.

Did VTL ever make a genuine profit? Did Nathans Finance lend money to master franchisees who then used this money to pay VTL and the listed company was able to report a big profit on this money go round? What did the master franchisees obtain from VTL in return for these payments?

There is nothing in the kitty as far as VTL is concerned as it now has virtually no assets and has negative shareholders' funds of $135.3 million.

There are a number of additional observations about Nathans Finance and VTL including:

* VTL ran Nathans Finance from both an administration and governance point of view. This created huge conflicts of interest.

* Staples Rodway's Hamilton office was auditor to Nathans Finance and VTL. Did this organisation have the expertise to audit a complex group that had most of its activities in Australia and the Northern Hemisphere?

* Nathans Finance capitalised most of the interest payments that were due from VTL. This inflated the finance company's earnings as its cash flow statements revealed that the company had large operating cash deficits.

* On July 12, 2007 - 10 days after Bridgecorp was placed in receivership - Nathans Finance chairman Roger Moses wrote an extraordinarily optimistic letter to the company's investors. Amongst the points he made were: "All our loans are secured. We do not have any unsecured loans. The security for our loans is normally in the form of a first charge over the assets of the borrower or over real property (or both), as well as personal guarantees, where the borrower is a company."

* Chancery Finance, which is also 100 per cent owned by VTL, was placed in liquidation late last year owing investors $17.5 million. Very little of this will be recovered.

* The $3.7 million of related party loans on the asset side of the balance sheet appears to comprise loans to Sally Hotchin and Joanne Doolan, wives of the directors. Some of these were capitalised interest loans.

It beggars belief that a public issuer which promotes its "robust credit assessment process and strong level of corporate governance" has 97 per cent of its loans to related parties and, when it goes bust, very little of these loans are secured against real assets or are recoverable.

There are a number of enforcement agencies investigating Nathans Finance including the Securities Commission - which is bringing prospectus charges against Doolan, Hotchin, Moses and Donald Young - the Serious Fraud Office, the Ministry of Economic Development's National Enforcement Unit and the US Securities & Exchange Commission.

The least that Nathans Finance investors deserve is a thorough investigation by all these agencies and a full explanation as to where their money has vanished.

Disclosure of interest: Brian Gaynor is an executive director of Milford Asset Management.
bgaynor@milfordasset.com