Hirst feels the heat as Bendigo investors
Print Adel Ferguson | July 13, 2009
Article from: The Australian
WHEN news erupted last week that the Bank of Queensland was facing legal action over its owner-manager model, it gave angry shareholders in some of Bendigo and Adelaide Bank's 238 community lenders food for thought.
Six former NSW franchisees decided to take action against BoQ and various officers, alleging the owner-manager model is flawed. At Bendigo Bank, a few shareholders in some poorly performing community banks are looking at ways to get their own back.
It comes as Bendigo, already under pressure to protect its $615 million exposure to 8200 customers who poured money into the collapsed Great Southern managed investment scheme, is struggling with funding pressures related to the global financial crisis and the government guarantee on wholesale funding.
It also comes as the market questions the $1.37 billion goodwill sitting on its balance sheet from the acquisition of Adelaide Bank less than two years ago.
The bank closed off its accounts on June 30, but not before making a sharp revision to its full-year earnings back in April, citing overall funding pressures and factors relating to its 2007 Adelaide Bank merger. It was Adelaide Bank that exposed it to managed investment schemes such as Great Southern. [/B]It is a mess that Bendigo's newly appointed chief executive Mike Hirst will have to deal with. Less than two weeks into the top job, Hirst has received letters from investors refusing to pay principal and interest on loans taken out to finance investments in Great Southern managed investment schemes. He will also receive letters from interested watchers about the community banks.
In the case of the $615m loans owed by Great Southern investors, Bendigo faces years of messy legal action and negative publicity. In the case of the community banking model, only time will tell how it all pans out. Right now, the message from the bank is that the model works, most shareholders are happy, it has 70 campaigns under way and expects to open 20 branches this financial year.
But behind the spin the picture is not so pretty for many of the struggling community branches. The way the model works is the 238 community banks operate under a franchise arrangement, in which the local community owns and operates a branch and the bank provides all the infrastructure and support. The community company and Bendigo split the branch revenue 50-50, and the community branch pays 100 per cent of the expenses, including an annual franchise fee.
Bendigo doesn't readily separate the earnings of the community banks, the number of loans it has made to the community banks, or whether that has increased in the past 12 months. But a retired auditor, who asked not to be named, has taken it upon himself to study the performance of all the franchises to ascertain the true state of affairs.
His findings are illuminating. Total funds raised over the 10 years to June 30, 2008, was $112m, revenue collected by Bendigo was $116m in the year to June 30, and $112m for the banks, against total profit of $20m. Loans to community banks from Bendigo was $10m.
The investigation also revealed that 14 of the banks were basket cases, with negative equity, 32 had poor working capital and many relied on Bendigo & Adelaide Bank loans to stay alive. They include Augusta (Margaret River), Dimboola, Donnybrook/Capel, Edenhope, Flemington, Fremantle, Homebush in NSW, Kingsway, Mt Gambier, Mukinbudin, Narrandera, Pingelly/Brookton, Robe and Wyong.
It found that over 100 community banks that opened before 2006 had lost a good portion of their equity raised, while all but 23 branches made a profit for 2008. Another 40 that opened between 2006 and 2008 made a loss, though some had only opened in the last year.
According to Bendigo, the number of community banks that achieved net profit before tax at June 2008 was 115, and of those 46 had fully recovered the initial equity put in by shareholders to create the bank. Of the 115, 71 recorded a profit of $100,000 or less.
Bendigo naturally argues that the model works. It argues the strategy was in response to a vacuum created by the withdrawal of bank branches from "hundreds of Australian communities in the 1990s", its spokesman says.
"Community Bank has never been promoted (look at any prospectus or go to any community meeting) as a high capital growth venture, where 'equity' and 'NTA' defines it success," a spokesman says.
But the small profit made by Bendigo from the community banks, despite the fees and 50 per cent revenue it takes from the banks, goes a long way to explaining why the big four abandoned many areas: they are too small, make too little money for the effort involved and make internet banking a much cheaper option.
Robe Community Bank, which was created in 2003 -- six years ago -- is one of many that are yet to make a profit, never mind pay a dividend. Robe Mayor William Peden, a shareholder in the Robe Community Bank, wrote to former chief executive Rob Hunt on numerous occasions outlining his concerns. The bank retaliated by taking out full-page ads in the local paper.
Peden claims Robe Community Bank has lost $699,000 over the first five years of the franchise while Bendigo made a gross profit of $683,000 from the operation over the same period.
Peden says that in the 2002 prospectus for the Robe branch, the worst-case scenario predicted a loss of $77,000 in the first three years. In the year to June 2008, five years into the bank's life, it made a loss far worse than the worst-case scenario of $89,000. "We were told in the prospectus by the chairman of the community bank that investing in the community bank has solid prospects of generating positive returns for investors. The chairman then said: 'I commend this investment to you.' He didn't say it would be 'a donation with no return', which is what it has become," Peden says.
In light of the litigation that has erupted between the Bank of Queensland and a number of franchisees over alleged misrepresentation of running a bank as a viable business, it wouldn't be a big leap to think Bendigo could face a few issues.
But the bank thinks not. Nor is the bank concerned about its $615m exposure to Great Southern through its 8200 customers. In a statement to the ASX on Friday, it warns borrowers that they have to keep paying back their loans despite the managed investment scheme's collapse. "We have loaned money invested with us by depositors and shareholders and they have every reason to expect us to pursue our rights."
Indeed. The only fly in the ointment, and it could end up being a very big and irritating fly, is the loan assignments. Some of the loans were issued by Great Southern Finance and subsequently "sold" or assigned to Bendigo.
Some lawyers have been hired to try to build a case that the actions of Great Southern Finance rendered the loan transactions unlawful, either on its own behalf or on behalf of Bendigo. If they are successful, it could get ugly for Bendigo. Either way, it faces a lot of bad PR and litigation in the next few years. To put it into perspective, Bendigo has a $40bn loan book, and $615m represents about 1.5 per cent of that book. If Bendigo is forced to write off $100m in bad and doubtful debts from the MIS schemes, it would effectively wipe out the group's cash earnings. Between tough credit markets, the Great Southern exposure and potential problems brewing in community branches, Hirst has his work cut out for him.
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