A History Lesson - Co-lending in the PFMF: A Shell Game
http://www.colonialfirststate.com.au/prospects/CityPacific_update4_20080828.pdf [page 6]
"Co-lending arrangements - On 18 March 2008, City Pacific announced it had entered into a $100 million co-lending agreement with Fortress Credit Corporation (Australian) II Pty Ltd (Fortress). The agreement provides that Fortress will co-lend approximately $100 million with the Fund in a range of first mortgages currently held by the Fund.
The co-lending arrangement allowed the release of up to $100 million back to the Fund along with a reduction of the Fund’s investment in those mortgages, which was used to continue the investment objectives of the Fund.
The co-lending agreement provides Fortress with priority ahead of the Fund for the repayment of its principal in a manner similar to the existing bank facility referred to above under the heading ‘Finance Facility’.
City Pacific may enter into other co-lending arrangements where it considers it is in the best interests of investors. Any new arrangements will be advised to investors."
In 2008 when things when pear-shaped for the (then) City Pacific First Mortgage Fund (CPFMF), the CBA was pressuring City Pacific Limited to pay down the (then) $240m facility provided to the CPFMF - can you believe it, $240m?
Good ol' Fortress come along and co-lent with the CPFMF to the tune of $100m - believe it or not, many punters were relieved. Duh ! They actually thought that having Fortress as a co-lender was better than having a bank facility - Duh (again) ! What was the essential difference between a co-lending institutional lender and a bank facility? geez, nothing !
The reality was that both had their lendings secured by fund assets - both Fortress and the CBA were guaranteed return of their capital, then fund would cover the shortfall.
But many thought a co-lender took on risk, but it didn't - just like a bank, it protected its investment.
City Pacific didn't reduce the fund's obligations to guarantee debt, it simply shifted debt from the bank to the institutional lender. Heck, City Pacific actually foreshadowed that more such arrangements might be made. That's unbelievable given the fund was frozen at the time the statement containing the above excerpt was made.
Fortress bought out a number of mortgages and continued lending (just as Citypac would do), and just like the bank, the fund secured Fortress' lending (capital and interest) against loss.
See, from an accounting point of view, the fund's gross assets are assessed, and then any bank loan (and other liability) is subtracted from that amount to obtain net assets (which are attributable to unitholders). It doesn't matter to the bank how many assets are sold to pay back the facility (and interest), but it matters to unitholders.
In a falling market, more assets are necessarily sold in order to pay back a facility - this is exactly the same with co-lending arrangements. The only difference is that the bank facility value forms part of the accounting process while the co-lending value only rates a mention in a note in the accounts.
However, the effect of a debt, whether it's on or off balance sheet is identical, and for unitholders, the risk is also identical. But investors didn't seem to 'cotton on' to this fact. In fact, when spruiking about debt, Citypac didn't always mention the impact of Fortress' loan, rather it focused (to the delight of the ignorant) on the pay down of $100m of the CBA facility.
http://www.colonialfirststate.com.au/prospects/CPL0001AU_1.pdf (created 16 September 2009)
"The Fund’s finance facility has been reduced by half down to $120 million. This finance facility
represents a ratio of 12% of debt to assets in the Fund."
Why is this excerpt important? Well, because there's no mention of the fund's obligation to the institutional lender, Fortress for the $100m of co-lender Fortress engaged in. In truth, the level of obligation hadn't changed one iota - simply put, $100m had shifted off balance sheet but remained secure at the risk of the fund.
Just another event in the life of a managed investment scheme.
(Both documents disclose what investors in the CPFMF (now Trilogy's PFMF) were told back there in 2008)
And the devastation continues along with Trilogy:
http://moneymagik.com/three_part_trilogy_funds_management_tragedy.php