The scene was the Grand Ballroom of the Rydges Hotel, at Sydney’s World Square, a venue considerably grander by name than by nature.
The occasion: the meeting of the LM First Mortgage Income Fund where unitholders gathered in utter dismay at how their fees were still going through the roof while their life savings remained frozen.
They were also there to vote on a change to their fund’s constitution, a change which might finally permit them to escape from this gruesome investment with a few meagre dollars still intact.
Alas, they were further dismayed to find that the meeting had somehow suddenly become non-binding. This was now a meeting about a meeting. If all went well at this meeting, unitholders would get the chance to cast their binding vote for a change to the constitution at another meeting in three months time.
“Where is Peter Drake?” demanded one irascible proxy-holder. It was a most excellent question. The mysterious Peter Drake is surely the Scarlet Pimpernel of the Australian funds management industry.
Owner of $3b empire
Having arrived in Australia from his native New Zealand at age 18 to make his fortune, the elusive Drake had done just that. Now ensconced in a $30 million mansion on the Gold Coast – with no less than nine toilets – Drake is chairman, chief executive and sole owner of the “$3 billion” LM empire.
Apart from a soft profile or two in the Queensland press you won’t find much more about the elusive Drake from public materials. According to the local rags he had redeveloped a $4 million block of land adjacent to his four-storey mansion on Mermaid Beach into a skateboard park for his kids.
He is also executive director of the ill-fated LM First Mortgage Fund and, as chief executive of the fund’s “Responsible Entity”, had written to investors, urging them to vote “yes” to changes to the fund’s constitution to enable a “liquidity mechanism”.
Unfortunately, he didn’t front up in person. His investors are hurting badly. This fund once boasted a big yield and nearly $1 billion in assets.
Now, of the $513 million in loans left at least $441 million are in default.
Feeding management fees
What income the fund does enjoy from its chronically impaired loan book goes to feed LM’s unconscionably high management fees, not to mention the 15 per cent to 18 per cent interest on a loan desperately struck with Deutsche Bank to refinance and stay alive.
LM’s original lender Commonwealth Bank – also the banker for the woebegone City Pacific – bailed a couple of years ago, though clients of Commbank’s financial planning division remain locked in the fund for the bare-knuckled ride.
The whole affair is a morass of related party transactions with director-related entities and the plaintiff law firms are circling hungrily. In fact, this fund is so distressed that it seems one of the only things it can count as an asset is a $7.8 million loan to none other than a related party of Peter Charles Drake himself.
The principal on that loan, incidentally, did not get paid down last year.
In the absence of the enigmatic Drake, yesterday’s meeting was chaired by a fellow called Angelo who was so composed in the face of investor outrage and high sarcasm that he either did this sort of thing a lot, or was just a natural.
“Whats the point of having a vote if its not conclusive, not binding?” demanded one irate unitholder.
“There was always going to be two meetings”, said Angelo smoothly. Angelo is not a director of the fund but apparently occupies the position of chairman of the LM First Mortgage Income Fund compliance committee.
As such, Angelo really ought to cast his eye over the suitability of his fund assigning $31 million of loans to other LM related parties at an interest rate of just 7 per cent while poor old investors are footing the 15 per cent to 18 per cent interest bill on the loan to Deutsche Bank.
In any case, the debonair and unflustered Angelo was flanked at the head table by LM’s numbers man Grant Fisher and marketing director Francene Mulder, who did most of the talking.
Francene often called on the lawyer from Ashurst, especially during the first half an hour of the meeting, which was entirely chewed up by debate over the need for a meeting at all, as there was only going to be another meeting in three months to ruminate over the same issue.
“I don’t see the point in voting at all,” proferred the crusty John Macdonald, a lawyer holding proxies for disgruntled clients. “You already know (from the proxies) that 98 per cent of people are voting yes”.
Francene Mulder kept explaining that the reason there would be another meeting was due to “consultation with our advisors and investors” whose identities were kept in the dark.
The LM lawyer sprayed a bit of legalese about. “The vote today is subject to further conditions that come into effect.”
Another proxy-holder, Paul Howard, pointed out that management would still have to keep selling property anyway to extinguish its loans and hopefully return what value remained to unitholders, if any, so the next meeting would be “pointless” as well.
At that meeting, investors would only be asked to vote again on a ‘liquidity mechanism’ which would divide up the properties into those for sale and those for holding.
There is a general suspicion among unitholders that the properties in the “hold pool” might be superior to those in the “sell pool”.
After all, something had to pay the lavish management fees. While the performance of the fund had turned from plain deplorable to downright harrowing, management had the hide to hoist its fees from $9 million to $11 million.
Loan management fees
Finance costs were up 35 per cent, legal fees rose sevenfold, auditor’s fees were up (Ernst & Young), custodian fees were up (LM), advisor commissions were steady (financial planners) and there was even a $5.4 million “loan management” fee to the “responsible entity” – an entity also 100 per cent owned by the mysterious Peter Drake.
But wait! Isn’t loan management part of the ordinary course of everyday business for a mortgage fund?
Doesn’t LM, like its Gold Coast confreres City Pacific and Equititrust, merely lend its investors’ funds to property developers at a higher interest rate and clip the ticket on the interest rate differential? Isn’t making property loans to property speculators “core business”?
Evidently not, at least as far as LM is concerned. Had Peter Drake, the chief executive of the “responsible entity”, been available for comment he might have been able to explain the extra $5.3 million slug on top of the egregiously unwarranted 20 per cent rise in management fees.
Sadly, he was “on LM business overseas”, advised Francene Mulder, and therefore not available. Perhaps they don’t have telephones in the wilds of “overseas”, wherever that might be.
We duly lodged a request with Francene for a chat with the elusive Drake – a meeting about a meeting about a meeting, if you like. But our hopes of an audience with the founder of “the global pathway to Australian investment solutions” were dashed as the hours passed and a new day broke.
Ben Wilmot, the Financial Review property reporter who also had the privilege to cover yesterday’s proceedings, confided after the two and a half-hour non-binding meeting that he had been trying to contact Peter Drake for five years, to no avail.
One unit-holder, John McConchie, told the meeting how he had made an application to redeem his investment in May 2008 but was “knocked back”.
“It’s been four years that we have been seeking to redeem,” he said. “We reinvested interest for nine years. You have made a lot of money out of us … and we have paid tax”. McConchie was told his application had been made during the “discretion period” as management was about to freeze the fund.
Naturally it would not have been in the “interests of unitholders” for McConchie’s funds to have been released.
“Now we are paying for your lawyers as well,” interjected the boisterous John Macdonald, still hot on the theme of hefty fees and unnecessary meetings.
“I’m not getting any younger. We want our money back,” said McConchie.
“I hope you’ve got a funeral bond!” quipped Macdonald.
Headed for the courts
Like its Gold Coast counterparts City Pacific and Equititrust, LM is headed for the courts.
Insolvency litigators Piper Alderman are investigating the changes to the fund constitution. Under the Corporations Act, management can only change a constitution if it is in the best interests of unit-holders.
Over the years, the constitution of the LM First Mortgage Income Fund has been altered to increase the fund’s leverage. The loan to valuation ratio started out at 66.6 per cent (was this a sign?) and was increasingly raised to 85 per cent.
It is inconceivable that a fund – touted by its promoters LM as a conservative option for retail investors – could justify lifting the gearing to 85 per cent during the biggest property boom in Australian history.
The evidence is, in any case, mirrored in the impending wipe-out of the loan book, now roughly 90 per cent in default.
Four other LM funds are frozen too, as the mysterious Drake continues to jet about raising money overseas, either without a telephone or too shy to use it. And compounding the mess for investors, another three of LM’s funds have cross unit-holdings in the flagship fund.
It is extraordinary that this situation could have been allowed to develop in the first place. And, in typical Gold Coast mortgage fund style, the more pear-shaped things went for investors, the higher the fees went for the managers.
LM expenses last year ballooned to $114 million from $32 million the year before.
“Will there be any money left in the fund after all the experts have had a go?” asked Macdonald, before leaving the meeting early, muttering a few words of contempt.
City Pacific, whose once-$1 billion mortgage fund was frozen in March 2008, now limps along under new managers Balmain Trilogy. Half a billion in losses shared by its 10,000 investors.
Late last month, on behalf of Balmain, Maurice Blackburn filed a suit in the Federal Court against the company and its former offices for failing to lend properly.
Equititrust class action
Then there’s Equititrust, where Piper Alderman is also working up a class action to recover $100 million in losses and $72 million in “manifestly excessive” payments made to its managers.
The Equititrust RE went into liquidation, having appointed Richard Albarran from Hall Chadwick who now has his licence back after suspension.
The entire sector has been a wipeout, a disgrace, and worse, a disaster which has affected mostly elderly people who needed these savings to fund their twilight years.
Instead of getting returns, they now suffer losses. Billions are gone. The reason they bought in the first place was based on property, “bricks and mortar”, a solid investment, said the promoters.
Few realised then that they were buying high-risk loans to property developers, not to mention loans to associates of their own fund managers.
Michael West established michaelwest.com.au to focus on journalism of high public interest, particularly the rising power of corporations over democracy. Formerly a journalist and editor at Fairfax newspapers and a columnist at News Corp, West was appointed Adjunct Associate Professor at the University of Sydney’s School of Social and Political Sciences. You can follow Michael on Twitter @MichaelWestBiz.