South Canterbury Finance collapsed because Allan Hubbard was far too popular and didn't have the skills to run a large financial organisation.
Hubbard was placed on a large pedestal by investors and money flooded through the doors of his Timaru office, yet he continued to run the finance company, and most of his other operations, in an old-fashioned way.
SCF was a slow and inevitable train wreck and investors should be grateful that the Crown bailed them out instead of blaming politicians and regulators for Hubbard's demise.
SCF was the country's 10th largest finance company in 1991 with total loans of only $45 million. Six years later it had loans of $167 million and had jumped to seventh place ahead of Fisher & Paykel Finance, Medical Securities and Motor Traders Finance.
This analysis begins in 1999 when the company had borrowings of $277 million and loans of $265 million. The accompanying table shows these borrowing and loan figures over the next 10 years with the five columns on the right, which contain the company's loan exposure by sector, adding up to the total net loans column.
By June 2004, SFC was the country's second largest finance company, after only UDC Finance, but its strong growth phase had just begun. In the next four years total borrowings surged from $660 million to $1.6 billion and loans from $576 million to $1.3 billion. A cult-like status developed around Hubbard and he was swamped by an avalanche of money from enthusiastic investors.
Fast-growing financial organisations have to be carefully organised in terms of management systems, credit analysis, information technology and proper reporting and accounting standards. There also need to be strict rules regarding related party transactions when organisations attract large sums of money from the public.
The first two statutory management reports, which covered two of Hubbard's non-SCF activities, clearly demonstrated that he continued to run his businesses in an old-fashioned way. Accounting records were poor, credit analysis was inadequate and there were far too many related party transactions for a major financial institution. These are persistent problems in the country's financial sector and SCF is no exception.
Why do Hubbard's supporters excuse him for these poor business practices when they would be appalled if their local Kiwibank branch manager kept poor accounting records, recorded customers' financial information in hand-written note books and lent their money to his family members with little credit analysis?
SCF's flawed business strategies came to the fore in the June 2009 year after the Government guarantee system was introduced in October 2008. Many finance companies took advantage of this scheme to reduce their risk, and strengthen their business, but SCF pressed harder on the accelerator and acted as if the global financial crisis was a mirage.
In the year ended June 2009 total borrowings surged by $418 million, from $1.6 billion to $2.1 billion, while total gross lending increased by $308 million, from $1.4 billion to $1.7 billion.
The $1.3 billion and $1.6 billion in the accompanying table are after impairments of $28 million and $78 million respectively. In other worlds, SCF grew its loan book by a record $306 million in the June 2009 year and $143 million, or 47 per cent of this, went to property-related activities.
This demonstrates the moral hazards associated with government guarantees. Prudent businessmen would have pulled in their horns and reduced their high risk lending but SCF, which took huge advantage of the guarantee scheme to grow its business, acted as if there was no financial crisis and the property boom would continue.
The SCF debacle shows that the Government should have insisted that all companies covered by the scheme be required to reduce, not aggressively increase, their loan book.
SCF was heading full speed towards a brick wall as it continued to increase its exposure to high risk property developments, with most of its loans on a capitalised interest basis.
Meanwhile, it was inevitable that borrowers would be reluctant to roll over their loans to SCF once the Government guarantee expired, notwithstanding Hubbard's cult-like status. Investors slowly lost confidence in Hubbard over the past 18 months as they realised he had problems, mainly because he had dramatically increased his exposure to the troubled property development sector.
In the 10 years ended June 2009, SCF's net lending increased 6.2 fold yet its lending to the property and business services sector surged 32.0 times. Property has also been the company's major problem in terms of write-offs as 34.8 per cent of its property loans were impaired as at December 31, 2009, compared with only 8.5 per cent of all remaining loans.
SCF's cash resources rapidly depleted as investors wanted their money back. Over the past 18 months the company's cash resources plunged from $322 million in December 2008 to $123 million in June 2009 and just $22 million in December 2009.
Most investors wanted to leave the company before the Government guarantee expired and on December 31 a staggering $1.877 billion, or 99.2 per cent of the company's total borrowings of $1.892 billion, were due to be repaid within the following 12 months.
Unfortunately poor management and inadequate information technology systems have been a recurring theme in the financial sector and this was a feature of the 1980s sharemarket boom and bust. There was a huge increase in sharemarket trading during that period and brokers struggled to stay on top of the situation, mainly because of woeful management, inadequate planning and poor accounting systems.
Many market participants went bust and there was a huge reduction in the number of stock brokers, as there has been with finance companies in recent years.
At the end of 1987 there were 15 stock broking firms operating in Auckland and a further 12 in Wellington. There are now only 11 between Auckland and Wellington. Many of the major broking houses are now overseas-owned.
The Bank of New Zealand was another example of poor management during the 1980s boom and it was acquired by Australian interests for well below its current value.
The finance company sector will probably end up in the same situation as the stockbroking industry today, namely far fewer participants with most of the major ones overseas- owned.
The surviving finance companies will obtain a much higher percentage of their funding from wholesale sources, instead of retail investors, and they will be better managed with more effective information technology systems and credit analysis.
However, the sector will employ fewer people and it will have lower risk lending strategies. This will curtail high-risk property development projects until new sources of funding are developed.
The contraction of the stock broking industry and the finance company sector, with the fire sale of the BNZ, are all directly related to poor management, particularly during boom periods.
Poor management should never be condoned, as it is by Allan Hubbard's more vocal supporters, because it destroys wealth, reduces employment and transfers ownership from New Zealand to overseas interests.
Based on this assessment it would not be a surprise if most of Hubbard's cherished assets are sold to overseas interests, at low prices, over the next year or so.
* Disclosure of interest: Brian Gaynor is an executive director of Milford Asset Management.