March 31, 2008

Insert to article - Opes: Leveraged investors be warned (By Alan Kohler)

Scott Francis adds: If you are unlucky enough to have money exposed at a prime broker then the advice above should be taken immediately. If you are among the majority of investors who have steered clear of the affair, here's a guide to what's happening

The basic details of this story are that Opes Prime was a stockbroking firm that is now in receivership. Opes Prime is a "prime broker", which differs somewhat from the retail stockbroker that a mum and dad investor would use. One definition of a prime broker is:

A broker which acts as settlement agent, provides custody for assets, provides financing for leverage, and prepares daily account statements for its clients, who are money managers, hedge funds, market makers, arbitrageurs, specialists and other professional investors.

Opes Prime's website confirms that the core part of its service revolves around security lending and equity finance (ie, margin lending), stating that "investors use Opes Prime for our securities lending and equity financing expertise" (ie, margin lending).

At a practical level, what we are seeing is that Opes Prime was involved in offering aggressive equity (sharemarket) financing and security lending. Aggressive borrowing to invest in shares is a great strategy during a strong market, but highly problematic during a time when markets have fallen in value by 20-25%, with some stocks falling much more than this.

Many of the clients of Opes Prime were involved in borrowing to invest, which begs the question why did they not do this through a simple margin loan? The answer lies in the list of stocks to which Opes Prime clients have been attracted: Admiralty Resources, Hedley Leisure and Austin Group. These are not stocks margin lenders would usually lend against, deeming them too risky.

A prime broker offers a way to aggressively borrow to invest in shares like this. Even for shares that a margin lender does offer borrowing against, a prime lender is likely to lend with more aggressive loan-to-value ratios. The website confirms this, boasting that Opes "can offer finance on all listed securities". A retail margin lender would tend to only offer loans to companies in the market's top 100-200 stocks.

The financial damage done through the Opes Prime collapse is that to offer its aggressive margin loan facilities, client portfolios were offered as security against bank loans with ANZ and Merrill Lynch, who are owed a reported $1.1 billion secured against $1.3 billion of shares. Effectively this means that client portfolios have now been taken over by ANZ and Merrill Lynch and are being sold down to repay their loans.

The administrators of Opes Prime, Ferrier Hodgson, explains this by saying that "preliminary investigations indicate that the financiers to the group hold sufficient capital securities to cover their position in full". Translated, that means that there are enough shares in client portfolios for ANZ and Merrill Lynch to sell them and get their money back. The news for clients is not so promising. "At this stage it is too early to estimate the realisable value of Opes Prime's assets to meet client claims."

There has been a spectacular array of corporate collapses over the past two years. Westpoint, Fincorp and Australian Capital Reserve are all property development mortgage trusts that have collapsed. City Pacific, another property development mortgage trust, is at the very least wrestling with liquidity problems and has suspended redemptions for 180 days. Basis Capital is a hedge fund that has collapsed, with Absolute Capital and Macquarie Fortress Notes also under financial pressure. The MFS Premium Income Fund has suspended all income payments and redemptions.

The comments by one Opes Prime client, Jason Shugg (detailed in today's Herald Sun newspaper), are instructive. Shugg says he was put into the investment by a stockbroker. He says he was never told that that he didn't own the shares and that Opes would have ownership. This misunderstanding highlights the commonality between many of the investors hit by these collapses. They didn't fully understand the investments or investment structures they were involved in.

Similarly, did Wespoint investors fully understand that their investments were "secured" against property development projects run by related parties and usually with second mortgages? And has every investor really understood what happens in a hedge fund like Basis Capital? Similarly, did Opes Prime investors understand that they did not really own their share portfolios and that they were secured against Opes's loans to ANZ and Merrill Lynch? My suspicion is that as in the case mentioned earlier, many did not.

The key difference between the loss suffered by investors in Westpoint and Basis Capital and Opes Capital is that the Westpoint and Basis Capital collapses were a failure of the underlying assets, whereas Opes Prime is more a failure of financial structuring. Even though, no doubt, many of the shares held by Opes Prime clients were sound, it was the fact that Opes Prime clients had signed their shares over as security that sees those shares in the process of being liquidated, and the Opes Prime clients waiting to see what is paid to them as "unsecured creditors".