VOLUME SIX
THE MANAGEMENT OF CREDIT: CASE STUDIES

 

 

CHAPTER 9
CASE STUDY IN CREDIT MANAGEMENT: THE ADSTEAM GROUP

 

 

TABLE OF CONTENTS

9.1 REFERENCE INFORMATION
9.1.1 SCOPE OF THE INVESTIGATION

9.2 BACKGROUND TO THE ACCOUNT
9.2.1 COMPANY HISTORY AND STRUCTURE
9.2.2 BACKGROUND TO THE FACILITY

9.3 CHRONOLOGY

9.4 COMPLIANCE WITH POLICIES AND PROCEDURES
9.4.1 INITIATION OF FACILITIES
9.4.2 APPROVAL OF FACILITIES
9.4.3 SECURITY
9.4.4 HINDSIGHT OVERVIEW
9.4.5 ADVANCE OF FUNDS
9.4.6 MANAGEMENT OF FACILITIES
9.4.7 MANAGEMENT OF NON-PERFORMING FACILITIES
9.4.8 CREDIT INSPECTION

9.5 OTHER MATTERS IDENTIFIED BY THE INVESTIGATION
9.5.1 ASSESSMENT OF RISK
9.5.2 INDUSTRIAL EQUITY EXPOSURE AND PRUDENTIAL LIMITS
9.5.3 INCLUSION OF WOOLWORTHS IN THE INDUSTRIAL EQUITY REPORTING
9.5.4 AVAILABILITY OF FINANCIAL INFORMATION
9.5.5 APPROVAL OF INDUSTRIAL EQUITY FACILITIES

9.6 REPORT IN ACCORDANCE WITH TERMS OF APPOINTMENT
9.6.1 TERMS OF APPOINTMENT A
9.6.2 TERM OF APPOINTMENT C
9.6.3 TERM OF APPOINTMENT D

9.7 RECOMMENDATION ON FURTHER INVESTIGATION OR ACTION

9.8 APPENDICES
A Adelaide Steamship Company Limited Group Structure as at 30 September 1990
B Summary of Movements in Facilities
C Summary of Adelaide Steamship Company Group Exposures 1984-1990

 

 

 

9.1 REFERENCE INFORMATION

 

The following information on facilities advanced to the Adelaide Steamship Company Limited Group of Companies is set out for reference purposes:

Note: Neither the Adelaide Steamship Company Limited Group of Companies as a whole nor the individual entities which can be considered to comprise that Group appear in the list of Non-Productive Assets at 31 March 1991 reported to the Board. The Loans were not classified by the Bank as non-performing until 26 April 1991.

9.1.1 SCOPE OF THE INVESTIGATION

The exposure to the Adelaide Steamship Company Limited Group of Companies was complex. A large number of different facilities were made available to the individual entities which can be considered to comprise that Group. As the Group expanded and reorganised subsequently to June 1984, the facilities made available to the Group were changed. In addition, the Bank had exposures to certain companies which became members of the Group before they became associated with Adelaide Steamship Company Limited.

The Investigation of the Bank's exposures to entities which can be considered to comprise the Adelaide Steamship Company Limited Group of Companies has been restricted to the decision-making and approval processes of the Bank in relation to changes in facilities which were made available to the Group, and to the reporting of the Bank's exposures to the appropriate level of management within the Bank.

The most significant credit decisions were the responsibility of the Lending Credit Committee and the Bank Board. The Investigation's primary source of information regarding those decisions has been the papers presented to each of those bodies, and the minutes arising from their meetings.

The Investigation did not examine any of the files relating to Petersville Sleigh Limited or Industrial Equity Limited ("Industrial Equity") which are held in the Bank's Sydney and Melbourne offices. Only Lending Credit Committee and Board Papers relating to those companies which are kept in Adelaide were examined by the Investigation.

 

9.2 BACKGROUND TO THE ACCOUNT

 

9.2.1 COMPANY HISTORY AND STRUCTURE

The Adelaide Steamship Company Limited ("Adelaide Steamship Company") was formed in 1875 to operate cargo and passenger ships in the Australian coastal trade. In the early 1970s, Adelaide Steamship Company commenced a program of diversification, both by acquisition and expansion, and, by 1990 the company, along with its principal subsidiaries and associates, operated in a wide range of industries which included retailing, manufacturing, real estate, food, and wine.

The group structure of Adelaide Steamship Company and its principal operating subsidiaries as set out in its 1990 Annual Report is included as Appendix A to this Chapter of the Report. The Appendix indicates the group structure only at 30 June 1990. The structure was at all times fluid and evolving.

The relationship between Adelaide Steamship Company and those entities which can be considered to be associated with it was carefully structured so as to avoid, in many instances, establishing a parent-subsidiary relationship in terms of the Companies Code that was in force for the greater part of the period covered in this Report. While direct and indirect shareholdings traceable to Adelaide Steamship Company may have indicated that Adelaide Steamship Company was entitled to ownership of shares in excess of 50 per cent of the issued capital of certain companies, Adelaide Steamship Company adopted the view that it was not required to consolidate those companies for financial reporting purposes under the Companies Code. In this Chapter of the Report, the term "Adelaide Steamship Company Group"/"the Group" means Adelaide Steamship Company and those entities which can be considered as having been associated with it, being, in large part, those named in Appendix A.

During 1990, the Adelaide Steamship Company Group was the subject of a number of adverse media reports. Many of these concerned its level of debt.⁽⁾ The criticism in the press also related to the uncertainties arising from the numerous cross share-holdings which existed within the Group, and to the fact that Adelaide Steamship Company was not required by the Code to prepare consolidated financial statements covering companies in which Adelaide Steamship Company or one or more of its subsidiaries held less than 50 per cent of the issued ordinary share.

The media reports and certain published financial analyses generated a lack of confidence in the Adelaide Steamship Company Group. Concern was aggravated by the Group's attempted takeover of Industrial Equity Ltd ("Industrial Equity"). As a result of the lack of confidence in the Adelaide Steamship Company Group, the share prices of the listed companies in the Group fell sharply. Companies in the Group suffered a liquidity crisis in mid-1990. The liquidity crisis resulted from the inability of individual companies in the group to negotiate extensions of or the replacement of a significant portion of their bank credit facilities, being facilities due to mature during the second half of 1990, and from their failure to sell sufficient assets in a declining market to achieve necessary reductions in debt levels. The Adelaide Steamship Company Group's difficult financial situation was exacerbated by its acquisition through Dextran of Industrial Equity. Banks exposed to the Group decided to take action. The Bank was, I am satisfied, one of the first Banks to act in reducing facilities to the Adelaide Steamship Company Group. Many lenders to the Adelaide Steamship Company Group were also lenders to Industrial Equity, and thus their potential lending or prudential limits were breached upon the Adelaide Steamship Company takeover of Industrial Equity. This resulted in those financial institutions seeking to reduce their overall exposure to the now expanded Adelaide Steamship Company Group. The further adverse media reports which followed this conduct on the part of financial institutions, together with the concurrent lack of market confidence and falls in share prices, made it impossible for the Adelaide Steamship Company Group to negotiate replacement Bank facilities.⁽⁾

This gave rise to the formation of a "Banking Group". It consisted of the Australia and New Zealand Banking Group Limited, the Commonwealth Bank of Australia, the National Australia Bank Limited, Westpac Banking Corporation and the Bank of America. It was to represent the interests of the 109 banks and other entities exposed to the Adelaide Steamship Company Group.

On 14 December 1990, the Banking Group appointed Price Waterhouse to monitor the cash flows of the Adelaide Steamship Company Group. The Banking Group also generated restructuring and rescheduling proposals for the Adelaide Steamship Company Group.

International Pacific Securities Ltd was also appointed by the Banking Group to monitor the Adelaide Steamship Company Group's performance, and to provide independent advice to the Banking Group. This appointment was superseded by the appointment of Bankers Trust Corporate Finance Limited ("Bankers Trust") as lead advisers to the Banking Group for the purposes of the Adelaide Steamship Company Group restructuring and refinancing arrangements.

It being the fifth largest lender to the Adelaide Steamship Company Group, the Bank set up an internal working party to consider whether the Bank should press for membership of the Banking Group. The working party concluded that membership of the Banking Group was not warranted.⁽⁾ It was considered that the level of information provided by the Banking Group and by Price Waterhouse, future cash flow and asset divestment monitoring reports, and the Bank's direct communication with the Adelaide Steamship Company Group, would enable the Bank to make informed judgments about its risk exposure, without having to commit further resources or having to court additional risks, eg interim fundings and adverse publicity.

On 20 December 1990, the Bank Board approved in principle the Adelaide Steamship Company Group restructure and rescheduling of existing facilities to a common maturity date of 31 December 1991 (the "Standstill Arrangement") as proposed by the Banking Group.⁽⁾ Lenders representing 93 per cent of the total debt owing by Adelaide Steamship Company accepted those proposals by the due date of 31 December 1990.

The purpose of the Standstill Arrangement was to:

(a) permit the orderly sale of assets to aid debt reduction;

(b) enable the merger of Adelaide Steamship Company, David Jones Limited ("David Jones"), Tooth & Co Limited ("Tooth") and Industrial Equity into a single company with an independent board;

(c) attract additional equity; and

(d) refinance existing debt by the maturity date.

The arrangement was able to be terminated at any time by a majority of 75 per cent of the banks by lending volume.

In addition, the four major Australian banks agreed jointly to provide a stand-by facility of up to $100.0M (Group wide) to assist in meeting liquidity problems. This was allocated, as to $60.0M, to David Jones and $40.0M was to be shared between Adelaide Steamship Company and Tooth.

The original facilities granted by the Bank to the Adelaide Steamship Company Group were unsecured. Terms and conditions that were standard for all borrowings by the Adelaide Steamship Company Group were employed. The facilities were, after April 1990,⁽⁾ supported by cross-company guarantees and indemnities between each operating entity and its subsidiaries, but were not inter-group, ie they did not permit recourse to the assets of other operating entities and their subsidiaries.

In addition to using negative pledges, Adelaide Steamship Company also covenanted in favour of the Bank not to permit ordinary shareholders' funds to fall below a specified minimum. Initially, this was $270.0M.⁽⁾ At that stage, there were two additional covenants, namely that the borrower's total liabilities (actual and contingent) were not to exceed 65 per cent of total tangible assets, and secured liabilities were not to exceed 40 per cent of total tangible assets.⁽⁾ By 1988, the minimum shareholders' funds stipulated for under the standard negative pledge was $500.0M.⁽⁾

The rescheduled facilities again included similar cross guarantees, but those guarantees were now supported by fixed and floating charges over the assets and undertakings of the borrowers and their subsidiaries. The only exceptions were those wholly owned subsidiaries of David Jones by which the major trading operations were conducted; in those cases, charges over the shareholdings in those subsidiaries only were taken. This exceptional category was created to ensure continuity of supply from creditors. No "pooling" or "consolidation" of the assets of the whole Adelaide Steamship Company Group would be allowed.

The security documentation was not to become effective until all parties, including the borrowers, had signed. By 27 March 1991, three banks were still not committed to the Banking Group's proposals. The banks had been informed that adverse Stock Exchange announcements, including large losses and write-downs, were due to be made on the afternoon of 29 March 1991. All banks were asked to sign security documentation in the hope that execution by the majority of banks would persuade the three outstanding banks to commit to the proposals, thus increasing the protection given to all lenders. Execution was effected on behalf of the Bank on 27 March 1991, by its attorney in Canberra.

On 2 May 1991, an urgent meeting of all lenders was called by the Banking Group. The unanimous approval of lenders to Adelaide Steamship Company, Tooth and David Jones was required for a Contractual Moratorium in order to make available to David Jones stand-by facilities to enable it to meet ongoing interest obligations. Those obligations had been deferred since 30 April 1991.

The meeting was informed that one bank still refused to sign the David Jones documentation and, therefore, the Directors would be in breach of their fiduciary duties if they signed the security documentation, given their knowledge of the financial position of David Jones. As a result Adelaide Steamship Company, Tooth and David Jones were unable to meet the documented Performance Milestones (timetable of events) associated with their proposed merger. A Contractual Moratorium was proposed in order to provide the necessary documentary changes to the agreed Performance Milestones so as to avoid an Event of Default which might have led to a "fire sale" of assets.

At the meeting on 2 May 1991, unanimous support "in principle" was given by the lenders. On 13 May 1991, the Banking Group advised that all lenders had formally agreed to the proposals to which I have referred, and had provided authority to execute the documents.

The documentary changes thus approved deleted the Performance Milestones, which had become impossible to achieve, and simply required:

(a) a business plan to be presented to all lenders for consideration on or by 30 September 1991; and

(b) certain amounts arising from asset sales to be deposited by each company in its Asset Proceeds Accounts by 31 December 1991.

The business plan was to be formulated by Bankers Trust in conjunction with the relevant companies, and was to include refinancing and group restructuring proposals for Adelaide Steamship Company, David Jones, Tooth and Industrial Equity. The plan required approval by the majority of lenders (75 per cent by volume), but no disapproving lender was committed to continue its then existing facility past the existing documented standstill termination date. Failure to provide the business plan would constitute an Event of Default.

This change effectively gave the Adelaide Steamship Company Group additional time to explore all available options with a view to extracting the maximum value out of each company's assets in a timely, though controlled, manner, without triggering an untimely Event of Default.

As all conditions had then been satisfied, the Standstill Agreement became effective as and from 14 May 1991. Asset sales by the Adelaide Steamship Company Group were proceeding, and business plans had been drawn up for each entity in conjunction with Bankers Trust.⁽⁾

Proceeds from asset sales were being paid into an Asset Proceeds Account for each company. The companies were then allowed to draw upon these Asset Proceeds Accounts up to a set limit, defined as the "working capital retention amount". This had been set for each company. No company was allowed to draw beyond this limit. All other working capital requirements had to be funded from ongoing operations.

9.2.2 BACKGROUND TO THE FACILITY

The Bank's involvement with the Adelaide Steamship Company Group began in June 1984, when a facility of $10.0M was granted to Adelaide Steamship Company.⁽⁾

By August 1985, when David Jones purchased John Martin Retailers Limited ("John Martin"), these facilities had grown to $35.0M.⁽⁾ John Martin's already had facilities from the Bank totalling $37.0M.⁽⁾ The aggregate exposure of the Bank to the Adelaide Steamship Company Group was thus taken to $72.0M.

Over the next three years, facilities extended to Adelaide Steamship Company progressively increased. The two largest increases were:

(a) the provision, in March 1988, of a $35.0M (GBP 14.0M) letter of credit facility to Adelaide Steamship Company to support an issue of preference shares by Adelaide Steamship (UK) Limited; and

(b) the provision, in May 1988, of a $115.0M (GBP 46.0M) Deferred Interest Facility to Buckley & Nunn (Antiques) Pty Limited ("Buckley & Nunn") which was a joint venture company owned by Adelaide Steamship Company and David Jones, to finance the Adelaide Steamship Company Group's investment in Royal Insurance PLC, a blue chip insurer registered in the United Kingdom. This facility was attributed to Adelaide Steamship Company as the borrower's obligations under it had been guaranteed by Adelaide Steamship Company.

In August 1988, the Bank approved a new facility of $20.0M to Petersville Sleigh Limited ("Petersville Sleigh"). This brought the facilities granted to the Adelaide Steamship Company Group to the following levels:

Entity	Direct $M		** Indirect $M
Adelaide Steamship Company	* 196.0		60.0
David Jones	55.1		-
Petersville Sliegh	20.0		-
	271.1		60.0

In 1989, two events significantly increased the Bank's exposure to the Adelaide Steamship Company Group:

(a) a joint venture company, Vaniro Pty Limited ("Vaniro") was, in January 1989 set up between David Jones and National Consolidated Limited ("National Consolidated") to hold a substantial investment in National Australia Bank Limited. The Bank provided a facility of $150.0M to finance this investment. It simultaneously recorded contingent risk exposures against David Jones and National Consolidated, both of which provided guarantees in relation to the borrowing; and

(b) in November 1989, Adelaide Steamship Company announced the acquisition of Industrial Equity through Dextran Pty Limited ("Dextran"). Industrial Equity and its subsidiaries Southern Farmers Group Limited ("Southern Farmers Group") and Woolworths Limited ("Woolworths") had been customers of the Bank since the mid 1980's. Shortly before the purchase of Industrial Equity by Dextran, Industrial Equity Group had direct facilities from the Bank totalling $86.0M and indirect facilities totalling $60.0M. The acquisition by the Adelaide Steamship Company Group of Industrial Equity Ltd created a situation where loans to the Adelaide Steamship Company Group exceeded the prudential limits set by the Bank's policies at the time. The Bank was powerless to prevent this.

By April 1990, the Bank's exposure to the Adelaide Steamship Company Group had become:

Entity	Direct $M		Indirect $M
Adelaide Steamship Company	* 165.0		60.0
David Jones	54.0		0.5
Petersville Sliegh	20.0		5.0
Industrial Equity	** 67.0		7.0
Vaniro	150.0		-
	456.0		72.5

* Subject to fluctuation in GBP

** Subject to fluctuation in USD

The Vaniro facility was fully repaid on 16 July 1990. In the Bank's papers which record the increase in facility levels beyond $400.0M, all of these exposures are regarded as "stand alone."⁽⁾

In February 1990, correspondence between Mr S Pyper, Manager Corporate Banking, and Mr P F Mullins, Chief Manager Corporate Banking,⁽⁾ indicated Mr T M Clark's desire that the Bank cancel all unsecured lines to the Adelaide Steamship Company Group over the next twelve months. Such cancellation would have been possible only either on maturity of a facility or in the event of a default. A further memo from Mr D C Masters, General Manager Corporate Banking, to Mr S G Paddison, Chief General Manager Australian Banking, dated 23 March 1990, indicates that the Bank's desire not to do business with the Adelaide Steamship Company Group on a negative pledge basis had been communicated to Adelaide Steamship Company and that a full review of alternatives was to be performed. Some small facilities which had expired were cancelled between February and April 1990.⁽⁾ The progressive reduction of facilities was proposed in a submission dated 20 June 1990, to the Lending Credit Committee. That submission was approved by the Lending Credit Committee at meeting 59A/90 on 20 July 1990. In July 1990, the Bank Board approved a strategy of reducing exposure to the Adelaide Steamship Company Group by cancelling certain facilities as they matured.⁽⁾

At December 1990, when the lending banks agreed upon the Standstill Arrangement for the Adelaide Steamship Company Group, facilities still outstanding were as follows:⁽⁾

Entity	Direct $M		Indirect $M
Adelaide Steamship Company	* 181.5		13.2
David Jones	54.0		-
Petersville Sliegh	20.0		-
Industrial Equity	** 59.9		-
	315.4		13.2

* Subject to fluctuation in GBP

** Subject to fluctuation in USD

The indirect facility represented forward foreign exchange contracts which had not yet matured. This was reduced gradually to zero as those contracts matured.

According to a credit precis, submitted to the Group Credit Committee, and to the Bank Board, dated 16 April 1991 by Corporate Finance, the Bank's exposure to the Adelaide Steamship Company Group had, at that stage, been reduced to the following:

Entity	Outstanding Liability $M		Existing Limit $M
Adelaide Steamship Company	* 171.0		171.0
David Jones	51.0		54.0
Petersville Sliegh	20.0		20.0
Industrial Equity	** 39.9		59.9
	281.9		304.9

* Subject to fluctuation in GBP

** Subject to fluctuation in USD

With the exception of the exposure to Industrial Equity, the facilities became subject to the Group restructure and debt rescheduling proposals under which security was to be taken.

At the meeting of the Bank Board held on 26 April 1991, the Board approved provisions of $65.0M against the exposure to Adelaide Steamship Company and $18.4M against the exposure to David Jones.⁽⁾

The level of these provisions was determined by assessing the Bank's potential recovery from Adelaide Steamship Company and each of its associates, separately, on the following basis:

(a) The operating assets and businesses within each Adelaide Steamship Company associate were valued in the light of historical financial performance and projected earnings performances as reviewed by Price Waterhouse. "Downside", "base", and "upside", case valuations were then ascribed after applying comparative industrial price/earnings multiples. The downside case was generally based upon the existing depressed earnings performance;

(b) Investments in non-associate companies were identified, and written down to current market value; and

(c) A series of models were developed to mirror the "Asset value flow through"⁽⁾ structure of the Adelaide Steamship Company Group, assessing the value of each associate's cross-shareholdings at a given time.

The provisions made were based upon the downside case, calculated by the process described above. This was perceived to be prudent so long as the security documentation was not effective. Two banks were still not committed at this point. A reduction in provisions was to be considered as soon as the security documentation became effective.

No provision was proposed against the Industrial Equity exposure, as the Bank's calculations estimated a significant capital return to shareholders.

The downside case for Petersville Sleigh revealed an "at worst" break even scenario for lenders and creditors but, given the number of well known brands and good cash flow generating businesses within Petersville Sleigh, a cash return nearer to the base case was envisaged. Hence, no provision was proposed in relation to Petersville Sleigh.

Loans to the Adelaide Steamship Company Group, although classified as significant credit risks, have continued to perform in the sense that all interest payments have been met. The Bank, however, ceased taking interest to profit from the date at which the provisions were made, even though it is still receiving interest due. Receipts are being credited against the clients' exposures.

Exposure to the Adelaide Steamship Company Group was managed through Bank offices in Adelaide, Melbourne and Sydney. The Melbourne office was responsible for Petersville Sleigh whilst, except for Southern Farmers Group, Sydney looked after the Industrial Equity exposures. Mr Pyper, Manager Corporate Banking, and domiciled in the Adelaide office was responsible for the exposures to Adelaide Steamship Company, David Jones and Southern Farmers Group. Mr Pyper was also responsible for collating reviews of the Adelaide Steamship Company Group companies so that they could be presented to senior management for consideration.

 

9.3 CHRONOLOGY

 

Appendix B of this Chapter of the Report contains a Summary of Movements in the facilities available to the Adelaide Steamship Company Group.

Appendix C of this Chapter of the Report sets out a summary of the exposures at 30 June and 31 December each year from 1984 to 1990.

 

9.4 COMPLIANCE WITH POLICIES AND PROCEDURES

 

Chapter 5 - "The Management of the Bank Group's Diversifiable Credit Risk" and Chapter 8 - "Credit and its Management: Guidelines, Policies, Processes, Procedures and Organisational Delivery Mechanisms", of this Report provide details of the lending policies and procedures that applied within the Bank.

The following Section identifies and comments upon departures that occurred from those policies and procedures of the Bank which should have been followed at each stage of the loan cycle.

Other departures from the Bank's policies and procedures were noted by the Investigation. These were of a minor nature, and do not warrant mention in this Report.

9.4.1 INITIATION OF FACILITIES

The scope of the review of these facilities did not include a detailed review of compliance with policies and procedures relating to the initiation of facilities.

9.4.2 APPROVAL OF FACILITIES

The review of these facilities identified four major changes to the facilities which warrant mention in this Chapter of the Report.

(a) Letter of Credit Facility

In March 1988, Adelaide Steamship Company required a three year GBP 14.0M ($35.0M) letter of credit facility to support an issue of preference shares by Adelaide Steamship (UK) Limited to National Westminster Bank PLC. This facility was to support the obligation of Adelaide Steamship (UK) Limited to redeem the preference shares in 1991 or earlier. One effect of the proposed facility would be to nearly double the Bank's then drawn down exposure to Adelaide Steamship Company.

On 23 March 1988, the Lending Credit Committee,⁽⁾ agreed to recommend this proposal to the Bank Board for approval. The minutes show that the Committee members present at this meeting were Mr Clark, Mr T L Mallett and Mr Masters. The quorum for the Lending Credit Committee was defined by the Bank Board, which stated that a:

"... quorum for meetings would be four, of whom one must be a General Manager or the Chief Executive."⁽⁾

Accordingly, the Committee members present at the Lending Credit Committee meeting on 23 March 1988 did not constitute a quorum. For that reason, that Committee's purported approval of the facility was irregular. The Chairman of the Committee on that occasion, Mr Clark, as Chief Executive Officer of the Bank, had a particular duty to ensure that all organs of the Bank act validly and within the limits of their authority. He should not have permitted the Committee's recommendation to go to the Board.

For the reasons given above, on the basis of the facts which I have found and the documents to which I have referred, I am of the opinion that the members of the Lending Credit Committee referred to above failed to exercise proper care and diligence in recommending that the Bank Board approve the letter of credit facility to Adelaide Steamship Company. Members of the Committee should have ensured that a quorum was present at the meeting before conducting any business, and, in the absence of a quorum, those members should not have made their recommendation to the Bank Board. In particular, the Chairman, whose obligation it was to ensure that the meeting was conducted regularly and properly, and to ensure that business was transacted validly, should not have permitted the proposal to go to the Bank Board.

The proposal for this letter of credit facility was put before the Bank Board at its meeting the following day, 24 March 1988. The paper⁽⁾ presented to the Board by Mr Masters, Chief Manager, Corporate Banking notes that:

"... as Adsteam [Adelaide Steamship Company] required urgent approval of the L/C facility by 23/3/88, Directors were contacted by telephone. The approving Directors were:

L Barrett Chairman

D W Simmons Deputy Chairman

A G Summers

T M Clark Chairman, Lending Credit Committee".

It is not clear that all directors "entitled to vote" on the proposal were contacted. I infer that only the four named directors were contacted. If that were so, there was a departure from the requirements on Section 12 of the State Bank of South Australia Act 1983, ('the Act") as I indicate below. The minutes of the Bank Board meeting of 24 March 1988 indicate that the Board approved the letter of credit facility of $35.0M. The Investigation could not determine when approval was communicated to Adelaide Steamship Company, but in light of Mr Masters' recorded comment that:

"Adsteam [Adelaide Steamship Company] required urgent approval...by 23/3/88"

it is highly probable that Adelaide Steamship Company was informed of approval on that day, that is before the Bank Board meeting on 24 March 1988. Otherwise there would have been no need to contact directors by telephone on 23 March 1988.

It is important to note that the letter of credit facility of $35.0M made available to Adelaide Steamship Company on, in all probability, 23 March 1988 was a transaction which, according to the Bank's policies and procedures, and the then levels of delegated lending authorities, required the approval of the Bank Board. The State Bank of South Australia Act, 1983 provides (Section 12) that business can be transacted by the Board either:

. at a meeting of the Board at which more than one half of the total number of directors is present; or

. other than at a meeting of the Board, if all directors "entitled to vote on a proposed resolution express, in writing, their concurrence in the proposed resolution." ⁽⁾

The Bank has not produced to the Investigation any evidence to indicate that Mr L Barrett, Mr D W Simmons, Mr A G Summers and Mr Clark expressed in writing their concurrence in the decision to approve the letter of credit facility to Adelaide Steamship Company on 23 March 1988. There having been no adherence to the procedures prescribed by sub-section 12(6) and there having been no direct, simultaneous telephone contact between Board members, there was no valid meeting of directors. I am satisfied that business of the Bank was transacted in the course of the telephone conversations on 23 March 1988. That business was not transacted at a Board meeting. Nor was the transaction properly recorded in accordance with sub-section 12(6). The purported approval of the facility was thus irregular.

The Proposal concerned the granting of a $35.0M letter of credit facility to support an issue of preference shares. Certain Directors were contacted by telephone in order to obtain their approval for this proposal. It is not at all clear that the approving Board members in fact received Mr Masters' paper, but I shall assume that they did receive it. It is unlikely that they would have been given sufficient information upon which to base their decision or had sufficient time in which to consider the Proposal. The paper submitted to the Board contained inadequate financial information, as was common in the case of proposals relating to Adelaide Steamship Company. By way of example, the most recent information in the proposal as to trading performance was 9 months old. There was no financial information at all as to the proposed borrower, a subsidiary of Adelaide Steamship Company. There was no material on the capacity of that borrower to repay the debt. At the same time, as the Board Paper⁽⁾ noted, the funding was provided not merely unsecured, but at reduced funding margins; eg, the line fee on a Commercial Bill Acceptance was reduced by one-half to 0.20 per cent. The lending being unsecured, the borrower's financial position generally, and, in particular, its capacity to service and repay the loan, was material to a proper consideration of the proposal. The paper should not have been approved in the absence of information as to the borrower's position. In this respect, the affairs and transactions of the Bank were inadequately directed and controlled by the Board.

In addition, it was an exercise in tokenism on the part of Mr Masters to contact Mr Clark in his capacity as a member of the Board. He had been a member of the (irregular) Lending Credit Committee which had recommended the Proposal to the Board. He could hardly be said, in the circumstances, to be bringing an independent mind to the proposition.

The former directors of the Bank Board have submitted:

(a) That the "Round Robin" procedure was not a final procedure but merely gave "indicative" approval and was always subject to confirmation by the full Board of the Bank at a later stage.

(b) Accordingly,Section 12(6) did not apply to the "Round Robin" procedure and there was no need for all directors to express in writing their concurrence in the proposed resolution.

(c) That the only resolutions of the Board which were binding on the Bank were those which were passed at a full Board meeting as distinct from a "Round Robin".

(d) That therefore all Board business was lawfully and regularly transacted and, in particular, "all statutory procedures were adhered to."⁽⁾

I have set out in Chapter 8 - "Credit and its Management: Guidelines, Policies, Processes, Procedures and Organisational Delivery Mechanisms" of this Report my reasons for accepting the second of these submissions and for rejecting the other components of the submission.

The non-adherence to Section 12 was a procedural flaw. I am not able to conclude that, had the proposal been put to the Board in the ordinary way, it would have been declined or, in the alternative, approved on different terms. Nor have I concluded that the Board's approval of the proposal was intrinsically imprudent.

For the reasons given above, on the basis of the facts to which I have referred, I am of the opinion that:

. Mr Barrett, Mr D W Simmons, Mr Summers and Mr Clark failed to adhere to Section 12 of the State Bank of South Australia Act, 1983 in that they transacted business other than at a meeting of directors yet failed to express in writing their concurrence in a resolution that was dealt with otherwise than at a meeting of the Board; and

. Mr Barrett as Chairman of the Board failed properly and adequately to direct, supervise and control the affairs, operations and transactions of the Bank in that he permitted business of the Bank to be transacted other than at a meeting of directors and other than as contemplated by sub-section 12(6). It was the duty of the Chairman to ensure that Board business was regularly and lawfully transacted and, in particular, that statutory procedures were adhered to. In this instance, the provisions of the Act were not complied with.

(b) Buckley & Nunn

In May 1988, Adelaide Steamship Company applied for facilities to be made available to Buckley & Nunn, a joint venture company owned equally by Adelaide Steamship Company and David Jones, which was to acquire Adelaide Steamship Company's investment in Royal Insurance PLC, a blue chip company registered in the United Kingdom, for a consideration of GBP 165.0M. National Australia Bank Limited and Westpac Banking Corporation had already agreed to provide facilities of GBP 80.0M and GBP 50.0M, respectively. The Bank's initial participation of GBP 35.0M ($87.5M) was contemplated to grow to an approved limit of GBP 46.0M ($115.0M) over the three year period, due to deferral of interest payments over that period.⁽⁾ The Lending Credit Committee minutes record that the application was deferred by the Lending Credit Committee at Meeting No. 359 on 10 May 1988. The Chairman of the Committee, however, endorsed the lending submission `approved', although in what circumstances does not appear.

The Directors' approval of this Proposal to grant a deferred interest facility of $115.0M to Buckley & Nunn was sought using the round robin method on 11 and 12 May 1988. The Directors who "recorded their approval" ⁽⁾ were Mr Barrett, Mr D W Simmons, Mr W F Nankivell, Mr R P Searcy, Mrs M V Byrne and Mr R E Hartley. The approval was confirmed at a Board meeting on 26 May 1988.

The Bank has produced to the Investigation no evidence as to when the approval was communicated to Adelaide Steamship Company. A memorandum to the Board of Directors from Mr K S Matthews, Chairman, Lending Credit Committee, dated 11 May 1988 stated that:

"An early decision is now sought from Directors to allow the Bank to convey its answer to Adsteam [Adelaide Steamship Company] by no later than 13th May 1988 as requested."

It is, therefore, highly probable - and I conclude - that Adelaide Steamship Company was informed of approval on 13 May 1988, that is, before the Bank Board meeting on 26 May 1988.

The granting of a facility of $115.0M required the approval of the Bank Board.

I refer to my previous remarks on Section 12 of the Act. The Bank has not produced to the Investigation any evidence to indicate that the Directors who responded to the Proposal to grant a deferred interest facility of $115.0M to Buckley & Nunn expressed, in writing, their concurrence in the proposed resolution. This is disquieting for the reason that the Proposal, as approved, was to increase Adelaide Steamship Company's borrowing from the Bank by some 150 per cent.

The aforementioned memorandum from Mr Matthews to the Board of Directors requested that:

"Directors please convey their approval or otherwise to this transaction to either the undersigned (210 4333) or Peter Mullins, Chief Manager, Corporate Banking (210 4665) as soon as possible, but by no later than 12 noon on 12 May 1988."

A list of the Bank's directors has been written on this memorandum with either "yes" or "o/seas" against each. Two directors are noted as having been "o/seas" (Mr R D E Bakewell and Mr Summers).⁽⁾ This would imply that the Directors who responded to the Proposal did so by telephone or personal contact. It also implies that those directors noted as being "o/seas" did not express, and were not asked to express, their "concurrence in" the proposal. If that were indeed so, there has been a further departure from Section 12. Sub-section (6) authorises the Board to transact business other than by means of a meeting if:

"... all directors entitled to vote on a proposed resolution express, in writing, their concurrence in the proposed resolution ..."

For the purposes of this sub-section, a director is "entitled to vote", if he is not disqualified from doing so by Section 11. A director remains "entitled to vote" notwithstanding that he may be absent from Australia. If it were to happen that a director (not disqualified by Section 11) were absent from Australia or were otherwise incommunicado, then the sub-section 12(6) procedure cannot be invoked. In the case of this particular facility, I am satisfied that one (or more) directors who were "entitled to vote" was (or were) not asked to express and did not express, in writing, concurrence in the proposal. Section 12(6) was not, therefore, availed of. There was no meeting of the Board. I am satisfied that business of the Bank was transacted in the course of the telephone conversations on 11 and 12 May 1988. That business was not transacted at a Board meeting. Nor was the transaction of that business properly recorded in accordance with sub-section 12(6). Therefore, the approval of the facility was irregular. It was not regularised by anything in Section 13.

For the reasons given above, on the basis of the facts to which I have referred, I am of the opinion that:

. Mr Barrett, Mr D W Simmons, Mr Nankivell, Mr Searcy, Mr Hartley and Mrs Byrne failed to adhere to Section 12 of the State Bank of South Australia Act, 1983 in that they transacted business other than at a meeting of directors yet failed to express in writing their concurrence in a resolution that was dealt with otherwise than at a meeting of the Board; and

. Mr Barrett, as Chairman of the Board, failed adequately and properly to supervise, direct and control the affairs, operations and transaction of the Bank in that he permitted business of the Bank to be transacted other than at a meeting of directors and other than as contemplated and permitted by sub-section 12(6) with the result that the provisions of the Act were not complied with.

(c) Vaniro

In January 1989, the Bank approved the granting of a facility of $150.0M to Vaniro, a joint venture company set up between David Jones and National Consolidated. This facility was sought and obtained to finance an investment in National Australia Bank Limited ("National Australia Bank"), and was secured by a first registered charge over shares in that Bank. Additionally, unlimited guarantees were obtained from David Jones and National Consolidated to cover interest shortfall and any principal shortfall resulting from the Bank's need to realise the National Australia Bank shares. As a result of this, the Bank recorded indirect exposures of $20.0M against each of David Jones and National Consolidated.⁽⁾ This proposed facility was not implemented.

In February 1989, the customer requested that the terms of the proposed facility be varied. Specifically, at the customer's request, the guarantees to be executed by David Jones and National Consolidated were amended so as to cover only interest. This was a significant change. In exchange, the approved asset/security ratio was lowered from 75.6 per cent to 65 per cent and, in addition, security top-up conditions were implemented.⁽⁾ The Bank's recorded indirect exposures against David Jones and National Consolidated were reduced from $20.0M to $10.0M each as a result of the variations in the guarantees.⁽⁾

The submission to the Board relevant to this variation noted that the approved facility was reduced to $135.0M. The Board Minutes record that, although the facility had been reduced, the variation of the facility needed to be approved by the Board:

"... as it was not the Bank's normal practice to lend on this basis". ⁽⁾

It has been submitted to the Investigation that the Board Minutes are inaccurate in recording this statement as to the Bank's practice as the reason why the variation submission was referred to the Board. The submission to the Investigation was that the revised proposal was submitted to the Board because the structure of the transaction had changed from that previously approved in January 1989, and the amount involved in the transaction was outside the Lending Credit Committee's delegated lending authority. It was submitted that the Bank had no policy that non-recourse facilities could be approved only by the Board.⁽⁾

The variation by way of reduction of the facility from $150.0M to $135.0M coupled with a restriction in the ambit of the David Jones and National Consolidated guarantees was approved by the Board on 23 March 1989.⁽⁾ This variation increased the risk to the Bank. In order to compensate for the increased risk, the Bank increased its margins and fees by some 50 per cent as against its pricing of the first proposed facility. The Bank recognised that the underlying risk of the transaction was against the continued value of the National Australia Bank shares.

Vaniro accepted this revised structure on 5 May 1989. Only two weeks later, on 19 May 1989, a paper dated 17 May 1989 was put before the Lending Credit Committee at meeting 35/89, stating that Vaniro had requested a reinstatement of the full $150.0M limit, in view of the recent increase in National Australia Bank share prices. The "top-up conditions" were made more favourable to the Bank. Members of the Lending Credit Committee present at this meeting were Mr G S Ottaway, Mr Masters, Mr Mullins, Mr V R Pfeiffer and Mr R L Wright. The Committee recommended the increase to the Board.

In recommending this increase for approval by the Board, the Lending Credit Committee noted (p 5-6) that draw down of the facility would be on the basis that the value of the National Australia Bank shares provided a minimum of 150 per cent cover and that current prices gave a cover of 145.8 per cent. Under the top-up arrangements, restoration of the 150 per cent cover (by way of provision of additional National Bank shares) was required within ten business days if cover fell below 145 per cent. Cover did fall below 145 per cent throughout a period in July 1989.⁽⁾ ( This did not, however involve a breach of the terms of the facility. The shares recovered value within the relevant 10 day periods provided for in the security documents, so that the top-up arrangements never became enforceable. In addition, the Investigation has been informed that at all material times the Bank held information to the effect that the Adelaide Steamship Company Group's shareholding in the National Australia Bank was significantly higher than the shares that were to be the subject of the Vaniro facility and thus ample top up security was available. It is not, however, clear that Vaniro had either ownership of or legal control over these additional National Australia Bank shares or a legal right to compel them to be made available to the Bank. The additional shareholding of the Adelaide Steamship Company Group would have been relevant if the transaction had involved recourse to Adelaide Steamship Company.)

The revised facility was approved by the Board on 25 May 1989. Members of the Board present at this meeting were Mr Barrett, Mr D W Simmons, Mr Bakewell, Mr Hartley, Mr Nankivell, Mr Searcy, Mr Summers and Mr Clark. The loan was drawn down on 21 June 1989. Security on draw down was approximately 36.7M National Australia Bank shares at $6.26 (approximately 153 per cent to cover), which differed from the 32,940,721 shares at $6.64 quoted in the Lending Credit Committee paper of 17 May 1989.

The Bank, having previously reduced the facility from $150.0M to $135.0M, in conjunction with a variation of the guarantees executed by David Jones and National Consolidated which removed their liability to make good a default in repayment of principal, should not have reinstated the facility on the basis of a rise in share prices only three months later without requiring the guarantees to be further amended so as to cover the principal component of the loan, as originally proposed. This rise in share price could have been only temporary. At the time when the recommendation for approval was made by the Lending Credit Committee, the share price was not sufficiently high to give the cover required under the new top-up arrangements⁽⁾. I have had regard to the fact that the Bank's security was to be, not a fixed number of National Australia Bank shares, but rather a number of shares reflecting the price of National Australia Bank's shares from time to time. Thus, I am not to be taken as expressing a view that the loan facility to Vaniro was unsafe. It was properly and adequately secured. It was maintained and repaid within arrangements.

I now mention a procedural matter relevant to this re-arrangement in facilities. The paper presented to the Lending Credit Committee on 23 January 1989, when the facility was first being considered by the Bank, asserted that this transaction "can only be regarded as a low risk transaction".⁽⁾ The submission to the Board by Mr Mullins described the transaction as involving "minimal risk".⁽⁾

This assessment was repeated in the annual review of the facility which was presented to the Lending Credit Committee at its meeting 30/90 on 24 April 1990. The minutes of that meeting, however, record that:

"Members considered the description of the facility as a low risk transaction may have been inappropriate, comfort was taken from the strength of the asset ... and the sound nature of David Jones Ltd. and National Consolidated Ltd." ⁽⁾

The paper presented to the Board on 26 April 1990 for the purpose of presenting the annual review to the Board and which was prepared by Mr T Parsons, Senior Manager, Corporate Banking and Mr Mullins, Chief Manager Corporate Banking, was dated 23 March 1990. It also stated that:

"This transaction ... can only be regarded as a low risk transaction." ⁽⁾

The Investigation has not been able to ascertain which Committee member or members asserted that "the description of the facility as a low risk transaction may have been inappropriate". No evidence has been found in the Bank's papers which indicates that the comments made on 24 April 1990 by the Lending Credit Committee, which were relevant to the Board's decision, and which, on the face of the minutes, expressed the views of the whole Committee, were communicated to the Bank Board. These comments should have been relayed to the Board in the written submission to the Board.⁽⁾ In expressing this view, I have had regard to many submissions to the Investigation to the effect that both Lending Credit Committee and Board Minutes were not always either comprehensive, or wholly and strictly correct, and that they did not contain a full and detailed summary of the presentation to, and deliberations of, the Committee or Board.

There should have been a procedure in place within the Bank which ensured that comments such as those made by the Lending Credit Committee were passed to the Board before the Board made their decision on the Credit Proposal.⁽⁾ In the absence of a formal procedure, Mr Ottaway, as Chairman of the Lending Credit Committee meeting on 24 April 1990, should have taken steps to ensure that the Lending Credit Committee's comments were relayed both to the Bank Board before its meeting on 26 April 1990, and to Mr Parsons and Mr Mullins, for formal communication to the Board.

Neither of the authors of the Board submission (Mr Parsons and Mr Mullins) was present at the Lending Credit Committee meeting on 24 April 1990. They may, therefore, have been unaware of the tenor of the Lending Credit Committee deliberations. Mr Ottaway was not present at the Board meeting. Mr Clark, Mr Matthews, Mr Paddison, Mr Hamilton and Mr Mullins were present. None of those had been present at the Lending Credit Committee meeting. Mr Mullins spoke to the Board Paper at the Board meeting. I fully accept that the assertion in the Board Paper was the considered view of Mr Mullins, and that there were reasonable grounds for holding that view. I also accept that the Board had sufficient material in the Board Paper to make up its own mind whether the assertion as to risk was either accurate or appropriate or otherwise.

Lending Credit Committee minutes of meetings held on 9 and 20 April 1990 were produced at the April 1990 Board meeting. The minutes of the meeting of 24 April 1990 were, however, not produced, possibly because they had not then been prepared or possibly because they were prepared after the deadline for Board Papers. It is regrettable that the Board was not informed of the Lending Credit Committee comments. It is also regrettable that Mr Mullins and Mr Parsons were not told of the Lending Credit Committee comments. In the circumstances, however, I attribute no responsibility to any particular officer of the Bank for this failure to relay information to the Board. I add that no detriment flowed to the Bank out of this series of events. The facility was maintained within arrangements, and there is no reason known to the Investigation why the annual review should not have been approved by both the Lending Credit Committee and the Board.

As I have said, on 22 February 1989, the Lending Credit Committee approved a variation in the facility granted in relation to Vaniro. The minutes record that only three members of the Committee were present at the meeting and that:

"Mr G. S. Ottaway and Mr R. L. Wright indicated their approval of the proposal Ex POST FACTO." ⁽⁾

I interpret this to mean that those two officers did not attend the meeting or take any part in its deliberations, but that subsequently, they indicated support for the Proposal. In the circumstances, there was no valid meeting of the Lending Credit Committee. The conduct of those present in transacting business and the conduct of Mr Ottaway and Mr Wright in subsequently attempting to participate in a meeting of the Committee was quite irregular and most unsatisfactory. The Investigation has been informed⁽⁾ that ex post facto approvals were an accepted practice on the part of Committee members, and that no loans "approved" by an inadequately attended Committee were implemented prior to the approval by a quorum. I accept the factual components of this submission. Nevertheless, members of the Lending Credit Committee were required to meet. At meetings, if business was to be validly transacted, a quorum was required to be present at all times. If a quorum was not present, then such business as was transacted was irregularly transacted. The mere fact that one or more persons eligible to attend meetings of the Committee may later have indicated approval of a particular lending proposal does not retrospectively supply a quorum, and cannot retrospectively regularise the invalid transaction of business.

(d) Variation of Industrial Equity Facility

On 18 January 1985, a Board sub-committee comprising Mr Barrett (the Chairman of the Board), Mr Clark (Managing Director) and (purportedly) Mr P E Byrnes (Chairman of the Lending Credit Committee) resolved to approve a dilution of the negative pledge covenants given by Industrial Equity. The Lending Credit Committee at its meeting, No. 37, had approved the dilution.

Mr Barrett disclosed a conflict of interest.⁽⁾ I infer that he was aware of the prescriptions in sub-section 11(1)(b) of the Act, and that accordingly, he did not vote on the Proposal or "take part in any deliberations" on the proposal.⁽⁾ For reasons given in the Collinsville Chapter, there was no effective meeting of a Sub-Board on this occasion in relation to this particular proposal. First, there was no urgency. Secondly, on Mr Barrett's withdrawal, there would have been no quorum, Mr Byrnes not being a member of the Board and, therefore, not a member of the Sub-Board. Mr Clark had been a member of the Lending Credit Committee. It was quite inappropriate for him to have participated in the Sub-Board meeting both for that reason and for the reason that he was not independent of the officers of the Bank.

9.4.3 SECURITY

The scope of the review of these facilities did not include a detailed review of compliance with the Bank's policies and procedures relating to security.

9.4.4 HINDSIGHT OVERVIEW

The scope of the review of these facilities did not include a detailed review of compliance with the Bank's policies and procedures relating to hindsight overview.

9.4.5 ADVANCE OF FUNDS

The scope of the review of these facilities did not include a detailed review of compliance with the Bank's policies and procedures relating to the advancement of funds.

9.4.6 MANAGEMENT OF FACILITIES

The review of these facilities did not include a detailed review of compliance with the policies and procedures of the Bank relating to the management of the facilities. Instead, it focused upon:

(a) the action taken by the Bank on several occasions when the Adelaide Steamship Company Group acquired an existing customer of the Bank;

(b) whether or not the Bank treated exposures to companies within the Adelaide Steamship Company Group as a group exposure for prudential purposes; and

(c) how these exposures were reported.

The Bank's exposure to the Adelaide Steamship Company Group has consistently been one of the largest in the Bank's corporate lending portfolio. Consequently, the manner in which the Bank's prudential policies were applied and monitored is of significance.

The appropriateness and adequacy of the Bank's prudential policies themselves is discussed in Chapter 5 - "The Management of the Bank Group's Diversifiable Credit Risk" of this Report.

The Bank's prudential policies comprised two key planks:

(a) credit limits were to be applied to any one entity or "group" of entities; and

(b) a definition of a "group" was formulated for the purposes of aggregation of exposures.

Shortly after it commenced operations, the Bank fixed an exposure limit in the following terms:

"1. Exposure, both actual and contingent, to any one entity, not to exceed 20 per cent of the capital base of the Bank at any time (This is to exclude the Public Sector).

At the present time, this would allow exposure of $28.0M to any customer." ⁽⁾

The Bank's policy regarding the definition of a "group" for the purposes of aggregation, set in February 1985, was that:

"The definition of a group be based on the premise of 40% or greater ownership." ⁽⁾

The paper submitted to the Board in connection with its review in February 1985 contained the following comments:⁽⁾

"EXISTING POLICY

...

In assessing whether an associated or related account falls within a "group", the determining factor, under current policy, is whether or not that account is subject to the control of another entity. Control, by our definition, is broadly defined as the ability to give direction to management.

REASON FOR REVIEW

The very nature of this exposure limit put in place for prudential purposes requires a strongly conservative attitude. It is, however, considered that we must give due cognizance to both practical and, to a lesser extent, competitive pressures in deciding our policy and be prepared to review its impact, as is necessary, to protect both our position in the market place and the viable soundness of our corporate base.

...

PROPOSED NEW POLICY

In considering a new policy it is fully recognised that we have to some extent met market pressures in exposure levels by setting our "base" as 20% of our shareholders funds, and no change is proposed in this area. It is proposed that our current level of exposure $30 million, be increased to $33 million in line with our current capital base.

It is now suggested that we should remove the area of subjective assessment in our "group" exposure policy to an objective definition, and provide greater flexibility in the area of dealing with major corporates.

It is therefore proposed that we look to varying and expanding our existing policy on the following basis:-

(I) The definition of the group be based on the premise of 40% or greater ownership.

(II) Full Board will consider a higher level of exposure, maximum 30% of shareholders funds ($50 million) for "blue chip" corporate groups e.g., as a general rule this would involve the top corporates in Australia usually enjoying a credit rating of AA or better (refer attached appendix for entities meeting this requirement).

(III) Full Board will consider proposals for the Bank to take on corporate risk on the basis that the risk can be sold down to place exposure within prudential guidelines within a period of six months. In this instance a dollar figure is not proposed so as to allow any proposal of merit to come before the Board.

(IV) Full Board will allow management to place before it proposals of an exceptional nature, which fall outside prudential guidelines when management considers that there are benefits and extenuating factors that warrant a "one-off" decision.

...

POLICY I

Our main protection in this area is the duty owed to minority shareholders to fully protect their interests. The prime concern of legislation and the courts being to ensure that the rights and assets of the minority shareholders are not detrimentally treated by the controlling shareholder.

...

POLICY II

The intrinsic value of the company can by our examination be assessed as to whether it is affected by a "take-over". The logic in this scenario is perhaps illustrated as follows:-

State Bank has exposure to S. A. Brewery $30m

B. Seppelt & Sons $15m

The lending to both companies has been based on the `value' and standing of the companies concerned. Under present policy we would need to require that approximately $15m of our lines be repaid, a loss of good business. Despite the fact that the only aspect that has changed is the names on the Shareholders Register, Assets, profits, management etc. are unchanged. Naturally, should it become apparent that the takeover target's intrinsic strength is being eroded by inter-company lending, asset sell-off etc., we would need to reassess our position with a view to reducing exposure. It is considered that policy guidelines are required to allow us to give consideration to each individual case that falls within these general definitions.

POLICY III

Business opportunities will present themselves from time to time where it would be to the Bank's best advantage to take on a level of corporate risk outside prudential guidelines. This would mainly be the case in an underwriting situation or a syndication mandate, which was not on a best endeavours basis. The position can also arise where we wish to be seen to be supporting a major South Australian entity or project, and therefore take on exposure in the public eye. In all cases the recommendation of management will be based on a confident ability to sell down that portion of risk outside our prudential guidelines.

This particular scenario is illustrated by our involvement with the Southern Farmers Group, an entity and loan syndication where it is to our advantage to maintain our lead management status and be seen to be supporting a major S.A. corporate, however, it is a credit risk that falls under option I and III, and our total exposure should be reduced to within our 20% guideline. The proposed policy would allow us to take on (underwrite) the exposure pending a syndication (silent or otherwise) of the risk. Naturally, the underwritten position would only be considered when management is confident in its ability to sell down.

The Board's resolution on this proposal was in the following terms:⁽⁾

"...

It was considered that the existing policy supported a conservative attitude, whereas due cognizance should be given to both practical and competitive pressures in deciding policy with a willingness to review its impact, as necessary, to protect the Bank's market share. The exposure policies of the A.N.Z. Banking Group and the State Banks of New South Wales and Victoria were illustrated for comparison.

No change was sought to the 20% of shareholders' funds as the base for exposure. However, it was proposed that the current level of $30m be increased to $33m in line with the current capital base.

IT WAS RESOLVED that in order to provide greater flexibility when dealing with major corporates -

. The definition of `Group' be based on the premise of 40% or greater ownership;

. The Board would consider a higher level of exposure to a maximum of 30% of shareholders' funds ($50m) for `blue chip' corporate groups, i.e. as a general rule this would apply to those top Australian corporates enjoying a credit rating of AA or better;

. The Board would consider proposals for the Bank to take on corporate risk on the basis that the risk can be sold down to place exposure with (sic) prudential guidelines within a period of six months. In this instance, a dollar figure was not proposed so as to allow any proposal of merit to be submitted to the Board;

. The Board would allow Management to submit proposals of an exceptional nature, which fall outside prudential guidelines, when it is considered there are benefits and extenuating factors that warrant a `one-off' decision; and

. Proposals requiring an urgent decision under the guidelines set out above would be considered at extraordinary meetings of the Board at times determined by the Chairman."

I do not criticise the adoption, by the Board, of a rule requiring the aggregation of loans to two companies where one holds a 40 per cent interest in the other. 40 per cent was an appropriate and a prudent threshold. It was more strict by 10 per cent than the Reserve Bank threshold at the time. It was not, however, made clear by the proposal or the resolution how the 40 per cent policy for groups should be applied, particularly where a subsidiary (or 40 per cent owned associate) itself owned 40 per cent of another company. The policy, as formulated, was too simple and rudimentary to deal with this type of corporate arrangement. The hypothetical other company could be either included in or excluded from the "group" depending upon one's interpretation of this policy.

For example, if company A owns 80 per cent of company B which in turn owns 45 per cent of company C, companies A and B clearly form a group under the Bank's policy, as do companies B and C. A's indirect interest in C being less than 40 per cent, it is not clear whether C should be regarded as part of the group to which A belongs, for the purposes of the Bank's policy. In other words, it was not clear whether an exposure to C should, in terms of the Bank's policy, be aggregated with other exposures to A and to other, directly owned, members of the A group.

As was well publicised at all material times, the structure of the Adelaide Steamship Company Group was complex. The complexity derived largely from the number of companies in the Group, from the shareholding structures of "Sub-Groups" and from the existence of cross-shareholdings between companies in the Group. In addition, members of the Group were shareholders in a number of joint venture companies, together with outside parties.

As noted above, the Bank's 40 per cent ownership policy was uncertain in its effect. Adelaide Steamship Company and David Jones, however, each owned more than 40 per cent of the other and, therefore, should have been viewed as a group for prudential purposes under the policy. Ownership of other group companies was more complicated. Petersville Sleigh, for example, was owned 8.7 per cent by David Jones and 49.4 per cent by Tooth at 30 September 1988. Tooth itself was owned 43.73 per cent by David Jones. Adelaide Steamship Company's own effective shareholding was, therefore, less than 40 per cent, but Petersville Sleigh was still owned, in aggregate, as to 58.1 per cent by companies associated with Adelaide Steamship Company.

Despite the complex structure, it is clear from the depiction of the group structure in Appendix A of this Chapter, that more than 50 per cent of each major company was collectively owned by various members of the group. Furthermore, the major companies, including those to which the Bank provided facilities, had common directors, namely Mr K W Russell, Mr J G Spalvins and Mr M J Kent. Market perception of the companies, as evidenced by comments in brokers' reports made available to the Bank from time to time, was therefore of a group under central control.

A strong case can be made for viewing a company such as Petersville Sleigh as part of the Adelaide Steamship Company Group for prudential purposes. It had common directors with Adelaide Steamship Company. More than 50 per cent of its issued shared capital was held by companies which were clearly members of the Group.

It is pertinent to note that one of the earliest of the Bank's papers on the establishment of prudential policies stated that:

"In assessing whether an associated or related account falls within a "group", the determining factor, under current policy, is whether or not that account is subject to the control of another entity. Control, by our definition, is broadly defined as the ability to give direction to management." ⁽⁾

By virtue of the Board's adoption of this paper in February 1985, this "subjective approach" was replaced by the "objective definition" of 40 per cent ownership.

The Bank has not produced to the Investigation any evidence tending to show that the Bank's management or Board monitored the Bank's total exposure to members of the Adelaide Steamship Company Group in the light of the Bank's prudential policies. Certain past directors of the Bank have submitted that "they did consider the Bank's total exposure to members of the Adsteam [Adelaide Steamship Company] Group particularly in the light of the Bank's prudential policies but that they allowed themselves to be persuaded by management's recommendation that each member of the Adsteam [Adelaide Steamship Company] Group could be considered on a "stand alone basis"." ⁽⁾ Group Risk Management reports of large exposures did usually aggregate exposures to members of the Adelaide Steamship Company Group but, for credit assessment purposes, members of the Group were considered on a stand alone basis. Details of exposures to all members of the Group were not always provided in credit proposals presented to the Lending Credit Committee and the Bank Board.

As I have observed in passing, the facilities granted to the Adelaide Steamship Company Group were unsecured, using terms and conditions that were standard for borrowings by members of the Adelaide Steamship Company Group. Members of the Adelaide Steamship Company Group offered similar terms and conditions to all lenders. After April 1990, the facilities were supported by Cross Company Guarantees and Indemnities between each operating entity and its subsidiaries, but were not inter-group, ie they did not permit recourse to the assets of other operating entities and their subsidiaries. For example, under facilities granted to David Jones and its subsidiaries, the Bank had no recourse to Industrial Equity and its subsidiaries. This was the Bank's primary reason for not aggregating exposures to Adelaide Steamship Company Group members for credit assessment purposes.

Where a bank is lending to one of a group of connected companies, whether the borrower is a subsidiary or an associate (as those terms are used in common parlance, and in the applicable companies legislation), it is sound banking practice to carry out a full review of the borrower's operations and financial position to determine whether the borrower company is financially independent or is, by contrast, reliant upon income from one or more group or associated companies. Where there is such reliance, it would be prudent for a bank, when deciding whether to approve a facility or when reviewing a facility, to aggregate the intended or reviewed facility with exposures to group or associated entities, whether or not the lender had, or was proposed to have, recourse to the group or to the associated companies. The Bank has produced to the Investigation no evidence that such a review was carried out for any member of the Adelaide Steamship Company Group.

The manner in which certain lending decisions were made by the Bank on applications by Adelaide Steamship Company is open to criticism. Of particular note is the continual failure fully to analyse the Bank's total exposure to the Adelaide Steamship Company Group and the failure clearly to state how the Bank's prudential policies applied to the Adelaide Steamship Company Group. Each borrower was usually regarded separately. Rights of recourse were recorded only against certain parties (rather than against the total assets of the combined Group). The nature of the interlocking shareholdings between the various members of the Group, however, meant that the failure of any one company could have a consequential effect flowing through to other members of the Group. The fortunes of Group members were inextricably linked. This was particularly so where a significant component of a borrowing company's assets was an investment in another member of the Group. A prudent and careful banker would have focussed on the total exposure of the Bank to the Group in assessing particular loan applications and when reviewing facilities.

The following table highlights the departures from the Bank's prudential limits resulting from failure on the part of the Bank's lending organs to aggregate facilities extended to members of the Adelaide Steamship Company Group:

Date	Prudential Limit (Based on Percentage of shareholders’ funds)* $M	Total Exposure (see Appendix C) $M	Excess Over Prudential Limits $M
30.06.86	78.5	97.0	18.5
31.12.86	78.5	100.0	21.5
30.06.87	114.0	100.0	-
31.12.87	114.0	110.1	-
30.06.88	194.4	311.1	116.7
31.12.88	194.4	330.1	135.7
30.06.89	262.5	515.6	253.1
31.12.89	393.8	559.5	165.7
30.06.90	401.6	528.5	126.9
31.12.90	401.6	328.6	-

* Shareholders funds as computed by the Bank from time to time.

I have already set out the text of the Board resolution by which the Board adopted a prudential policy in 1985. In terms of that policy and, indeed, even in the absence of express words to that effect, the Board had, and would at all times have retained, a reserve power to depart from a policy which it itself prescribed (including prudential policies) on such occasions, and for such reasons, as it might in its commercial judgement see fit. For this reason, there was nothing unlawful or unauthorised in the Board's permitting loans to the Adelaide Steamship Company Group to exceed 20 per cent of shareholders' funds. The question simply is whether it was prudent and advisable in the circumstances, for the 20 per cent ceiling to be exceeded in relation to the Adelaide Steamship Company Group from time to time.

From February 1985 until October 1989, the prudential limit based on 30 per cent of shareholders' funds was relevant only in the case of blue chip companies, ie those defined by the Bank as being companies "... enjoying a credit rating of AA or better." ⁽⁾ Adelaide Steamship Company itself, in general terms, had a ratings history from Australian Ratings of BB- in January 1984, BBB in February 1985 and BB+ from January 1986 to March 1989.⁽⁾ It, therefore, was not blue chip in terms of the Bank's policy. The prudential limit against which exposures to the Adelaide Steamship Company Group should have been assessed was 20 per cent of shareholders' funds. The prudential limits shown in the above table are, therefore, based on a ceiling upon 20 per cent of shareholders' funds until October 1989, at which time the policy was changed. The limits shown for 31 December 1989 and 30 June and 31 December 1990, are based upon a limit of 30 per cent of shareholders' funds.

Certain former directors of the Bank, in their written submissions to me, have stated "that they considered Adsteam [Adelaide Steamship Company] to be "as good as blue chip" and falling within the exception provided in the Bank's prudential guidelines." They have pointed to the standing that Adelaide Steamship Company then enjoyed in the Australian equity market. I am nevertheless of the view that the decision to regard Adelaide Steamship Company as a suitable case for exception from the 20 per cent ceiling was imprudent and hence inappropriate.⁽⁾

In January 1989, a Proposal to the Board from Corporate Banking contained a rather revealing sentence as to Corporate Banking's attitude to the prudential limit of 40 per cent:

"Group Exposure

The Bank consolidates exposure where beneficial ownership in another company exceeds 40 per cent. Under Reserve Bank (RBA) Guidelines of 50 per cent ownership, the above [ie facilities to Adsteam [Adelaide Steamship Company], David Jones Ltd, NCL and Vaniro] are regarded as separate public companies and hence our exposures, need only to be reported on an individual basis to the RBA." ⁽⁾

The same submission then contained a calculation based, not on the Bank's prudential limits, but on the Reserve Bank of Australia limit,⁽⁾ and, in calculating the impact of the proposed variation of facilities on the prudential limits, the submission (by Mr Mullins) did not include the intended loan of $150.0M to Adelaide Steamship Company on account of Vaniro.

In addition to the prudential limits, which were based upon percent of shareholders' funds, the Bank's policies specified absolute limits for exposures to groups of companies. In September 1988, the policy stated that:

"Where the Bank provides facilities to a group of companies, in which single entities within the Group have individual limits, then the maximum of the combined facilities may not exceed AUD150 million." ⁽⁾

In October 1989, those limits were revised:

"Where the Bank provides facilities to a group of companies, in which single entities within the Group have individual limits, then the maximum of the combined facilities may not exceed AUD 250M." ⁽⁾

It is evident from the table above and from these extracts from the Bank's policies, that the Lending Credit Committee and the Board over a number of years approved increases in facilities that, on a group exposure, exceeded both the prudential limits based on percentage of shareholders' funds and the absolute limits set for any one group of companies.

The policies on prudential guidelines did allow the Board to exercise its judgement and approve facilities which exceeded the limits set by the guidelines. For example, the policy set in February 1985 stated:

"Full Board will allow management to place before it proposals of an exceptional nature, which fall outside prudential guidelines when management considers that there are benefits and extenuating circumstances that warrant a "one-off" decision." ⁽⁾

This was re-affirmed by the policies adopted in October 1989.

The minutes of the Lending Credit Committee, and of the Board, in relation to loans approved in departure from these guidelines contain nothing to indicate that the Board or management considered that the credit facilities advanced to the Adelaide Steamship Company Group satisfied these criteria.

Lack of grouping also affected the approval process in terms of the authorised delegated lending authorities. By not grouping the entities, it was possible to have the Lending Credit Committee approve facilities which, on a group basis, would require Board approval. This actually occurred when the Lending Credit Committee approved a facility of $20.0M to Petersville Sleigh on 31 August 1988. This approval was within the Lending Credit Committee's delegated lending authority, if Petersville Sleigh was regarded as a stand-alone customer. If Petersville Sleigh had been treated as part of the Adelaide Steamship Company Group, Board approval would have been required.

In my opinion, the Lending Credit Committee wrongly resolved the issue of how the Bank's prudential policies (particularly the definition of a "group" for prudential purposes) should be applied to the Adelaide Steamship Company Group. In my opinion, the Bank Board erred in accepting management's recommendations regarding the issue of how the prudential policies (particularly the definition of a "group" for prudential purposes) should be applied to the Adelaide Steamship Company Group. The Committee and the Board continued to approve new and increased or extended facilities which, on a Group basis, exceeded the Bank's prudential limits. The Committee and the Board proceeded upon the basis that, by virtue of the structure of the facilities and of the associated negative pledges, cross-company guarantees and indemnities, exposures to each member of the Adelaide Steamship Company Group could be assessed and approved in isolation. Even as late as June 1990, Corporate Banking regarded the arguments in favour of treating Tooth, David Jones, Petersville Sleigh and National Consolidated as individual entities to be equally strong as those which favoured consolidation⁽⁾.

Three specific examples of approvals given with little or no consideration of the Bank's prudential policies are set out below.

(a) Buckley & Nunn

As I have already said (Section 9.4.2(b)), in May 1988, Adelaide Steamship Company applied for a deferred interest facility to be made available to Buckley & Nunn, a joint venture company, owned equally by Adelaide Steamship Company and David Jones. The Bank's initial participation of GBP 35.0M ($87.5M) was contemplated to increase to approximately GBP 46.0M ($115.0M) over three years, due to the agreed deferral of interest over that period.

At the time of the application, existing direct facilities to Adelaide Steamship Company and David Jones were $81.0M and $55.1M respectively. Indirect facilities available to Adelaide Steamship Company were $60.0M. The David Jones facilities were noted in the papers presented to the Lending Credit Committee and the Bank Board as being on a stand alone basis.

The Lending Credit Committee⁽⁾ and Bank Board⁽⁾ approvals in May 1988 were expressly given on the basis that total outstandings under all facilities at any one time would be maintained within the Bank's prudential limit on exposure to any one client (stated to be $175.0M).

A paper was presented to the Lending Credit Committee on 31 May 1988 which set out the way in which the facilities could be managed against the stated prudential limit of $175.0M.

This paper ignored the facilities to David Jones, which were noted as being on a stand alone basis. It concluded that the combination of the direct facilities (of $81.0M to Adelaide Steamship Company and the initial exposure of $87.5M to Buckley & Nunn) fell within the stated prudential limit of $175.0M. It further concluded that the outstandings under the direct and contingent facilities needed to be managed against that limit of $175.0M only until 30 June 1988, when the Bank's capital base would increase sufficiently to overcome the problem of breaching the limit.

The Bank's prudential policies in force at that time stated that the maximum credit limit that could be granted to any one customer or group was 20 per cent of shareholders' funds or 30 per cent of shareholders' funds for "blue chip" companies. "Blue chip" was defined by the Bank as AA rated or better.⁽⁾ Adelaide Steamship Company was not blue chip under this definition at the time of the approval and, therefore, should have been monitored against the limit of only 20 per cent of shareholders' funds. The limit of $175.0M quoted in the papers presented to the Lending Credit Committee and to the Board approximated to the 30 per cent limit. The Adelaide Steamship Company Group was, therefore, being measured against the wrong limit. 20 per cent of shareholders' funds was only $114.0M. At 30 June 1988 this increased to $194.4M.

The pre-existing direct and indirect exposures to Adelaide Steamship Company at the time of the approval totalled $141.0M, and were thus already in excess of the prudential limit for any individual customer. For this reason alone, the facility of $115.0M to Buckley & Nunn should not have been approved in May 1988.

In addition, the Bank's prudential policies defined a group on the premise of 40 per cent or greater ownership. As Adelaide Steamship Company owned more than 40 per cent of David Jones, exposures to these two customers should have been aggregated when comparing total exposure to prudential limits. This was not done by the Bank when the proposed facility to Buckley & Nunn was considered.

The Deferred Interest Facility granted to Buckley & Nunn was transferred to Adelaide Steamship Company as from 7 April 1989.⁽⁾ Lending Credit Committee members present at the meeting, on 10 May 1988, at which the facility of $115.0M to Buckley & Nunn was approved, were Mr Matthews, Mr Ottaway, Mr Masters, Mr Pfeiffer and Mr Wright. The members of the Lending Credit Committee (apart from Mr Ottaway) have submitted to the Auditor-General⁽⁾ that:

"Specific security had been taken so that there was no increased exposure to Adsteam [Adelaide Steamship Company]. The first recourse was this security if Buckley and Nunn were in default. The Lending Credit Committee believed that this did not need to be recorded as an exposure to the Adsteam [Adelaide Steamship Company] Group as the Bank did not have any recourse in the transaction to Adsteam [Adelaide Steamship Company]."

I accept that this belief was held by those members, and I accept the factual components of the submission. Nevertheless, I reject the submission. True it is that the Bank had taken specific security for this loan, the security being the Royal Insurance shares to which I have referred at Section 9.4.2(b). Nevertheless, the borrowing company was a directly held subsidiary of Adelaide Steamship Company. For that reason, there was an increased exposure to Adelaide Steamship Company. It did not matter that specific security had been taken. In addition, the submission that "the first recourse" was against the security reflects a view with which I cannot agree. It is a view which has been criticised by JP Morgan, in its review of the Bank's credit policies and procedures⁽⁾ and which has, since February 1991, been disavowed by the Bank and is a view which, I am satisfied, has contributed to the Bank's participation in many of the non-performing loans investigated by the Inquiry. A lender's first recourse is, in practical terms, always against the borrower and the borrower's income. A lender must regard the liquidation of security as his last recourse rather than his first recourse. The mere fact that security is taken does not mean that a loan is without recourse to the borrower. The mere fact that security was taken, even coupled with the fact that the Bank had no contractual right of recourse against Adelaide Steamship Company, did not warrant the conduct of the Lending Credit Committee in failing to aggregate the proposed exposure to Buckley and Nunn with existing exposure to the Adelaide Steamship Company Group.

Directors present at the Board meeting, of 26 May 1988, which confirmed the approval of this facility, were Mr Barrett, Mr D W Simmons, Mr Bakewell, Mrs Byrne, Mr Hartley, Mr Nankivell and Mr Searcy. These directors, with the exception of Mr Bakewell, had already recorded their initial approval of this facility on 11 and 12 May 1988 (see Section 9.4.2 (b) of this Report).

For the reasons given above, on the basis of the facts which I have set out, I am of the opinion that the members of the Lending Credit Committee referred to above failed to exercise proper care and diligence, and the members of the Bank Board referred to above failed adequately and properly to supervise, direct and control the relevant operations, affairs, and transactions of the Bank in approving the deferred interest facility of $115.0M to Buckley & Nunn, in that:

(a) they measured the total exposure to the Adelaide Steamship Company Group against the wrong prudential limit;

(b) they did not aggregate exposures to David Jones and Adelaide Steamship Company as required by the Bank's prudential policies; and

(c) they recommended and approved respectively additional facilities of $115.0M to a customer whose existing facilities already exceeded the maximum credit limit which could be granted to any one customer under the Bank's prudential policies.

(b) Petersville Sleigh

On 31 August 1988, the Lending Credit Committee⁽⁾ approved the establishment of a $20.0M Revolving Cash Advance facility for Petersville Sleigh. Committee members present at the meeting were Mr Ottaway, Mr Masters, Mr Wright, and Mr I R Tucker. This was the first direct banking relationship between the Bank and Petersville Sleigh; an earlier transaction between them merely involved the Bank's participation in a syndicated sale and leaseback arrangement, under which the Bank's exposure was protected by a letter of credit from Westpac.⁽⁾

As I have noted, the Bank's prudential policy regarding the definition of a "group" for the purposes of aggregation, adopted in February 1985, was that:

"... the definition of a group be based on the premise of 40% or greater ownership."

At 30 September 1988, Petersville Sleigh was owned as to 49.4 per cent by Tooth and as to 8.7 per cent by David Jones. On the same date, Tooth was owned 43.73 per cent by David Jones⁽⁾ and as to 26.9 per cent by Petersville Sleigh itself;⁽⁾ and David Jones was owned 47.01 per cent by Adelaide Steamship Company.⁽⁾ Under the Bank's prudential policy, therefore, Tooth was part of the David Jones group and David Jones was, in turn, part of the Adelaide Steamship Company Group. The Lending Credit Committee paper, which was prepared by Mr P Davenport, Corporate Analyst, and recommended and supported by Ms J M Cartmer, Senior Corporate Manager, and Mr J V Henderson, State Manager, Victoria and Tasmania, multiplied out the various shareholdings to arrive at an effective holding by Adelaide Steamship Company of only 23.1 per cent in Petersville Sleigh. On this basis, the Bank officers concluded that Petersville Sleigh exposures need not be aggregated with other Adelaide Steamship Company Group exposures, even though:

"... PSL [Petersville Sleigh Ltd] effectively comes under the Adsteam [Adelaide Steamship Company] umbrella from an operational point of view ...".⁽⁾

In its safety assessment, the lending proposal advanced the proposition that "... risk ... is considered minimal ..." for reasons including the reason "... that PSL is part of the Adsteam [Adelaide Steamship Company] Group ....".⁽⁾

I disagree with the conclusion in the credit submission that, in the circumstances, Petersville Sleigh exposures did not need to be aggregated with other Adelaide Steamship Company exposures. The Board's policy on aggregation may have been insufficiently explicit, but it should not have been construed so as to permit the process of multiplication carried out by the proponents of the submission. In approving this unsecured facility on a stand alone basis, the Lending Credit Committee did not comply with the Bank's prudential policy on the grouping of exposures. The minutes noted that "PSL is a member of the Adsteam [Adelaide Steamship Company] Group ...." ⁽⁾ They noted the sentiment quoted above, and the artificial calculation of Adelaide Steamship Company's shareholding in Petersville Sleigh. The Committee ignored the fact that, at 30 September 1988, 58.1 per cent of Petersville Sleigh was owned by members of the Adelaide Steamship Company Group, who had common Board members, namely Mr Spalvins, Mr Kent and Mr Russell. Whilst the Bank's policies and procedures did not require identification of common directorships, this was a further indication that Petersville Sleigh had close ties to the Adelaide Steamship Company Group.

I further note that, in a lending submission dated 5 January 1987, which was approved by the Lending Credit Committee on 13 January 1987, one of the factors listed in favour of the proposal was the strong consolidated profit performance of the Adelaide Steamship Company Group (page 4). Annexure "C" to that proposal treated Petersville Sleigh as a member of the Adelaide Steamship Company Group. To the same effect was the lending proposal of 20 January 1989 by way of annual review and recommended increase in facilities. Annexures "A" and "B" to that proposal treated Petersville Sleigh as a member of the Adelaide Steamship Company Group. That same paper also noted that Adelaide Steamship Company had been able to acquire effective control of associates through the acquisition of substantial minority interests.

In addition, on the first occasion when the Lending Credit Committee approved a facility in favour of Petersville Sleigh,⁽⁾ the Lending Credit Committee had noted that:

"... PSL is a member of the Adelaide Steamship Group."

The same proposition was found in the proposal to that meeting of that Committee.⁽⁾

A subsequent Board Paper,⁽⁾ submitted in April 1989 (which was prepared and supported by Mr Masters), suggested again that the Bank did recognise the strength of the central control of the Adelaide Steamship Company Group, despite comments regarding the lack of effective ownership of Petersville Sleigh by Adelaide Steamship Company itself. This paper (as did page 4 of the lending submission of 29 August 1988 to which I have referred) stated, on page 2, that:

"... the management of Petersville Sleigh Ltd is autonomous, however the influence of the Adsteam [Adelaide Steamship Company] management adds support to this proposal."

The paper correctly treated the influence of Adelaide Steamship Company management as a relevant factor. Consistency of reasoning required that Petersville Sleigh be treated as a member of the Adelaide Steamship Company Group for prudential purposes. The Lending Credit Committee minutes of 11 April 1989⁽⁾ (by which this paper was recommended to the Board) treated Petersville Sleigh as an "associate company of Adsteam [Adelaide Steamship Company]" (Page 7).

In later years, without any change in shareholding or management arrangements in relation to Petersville Sleigh, Corporate Banking was to say:

"Due to the level of cross shareholding between major associate companies, namely, David Jones, Tooth, Petersville Sleigh...Adsteam [Adelaide Steamship Company] has in our opinion significant influence over these companies and operate [sic] as an economic unit with unified management. It therefore could be said that it meets the characteristics for consolidation of the accounts." ⁽⁾

The same manipulation of shareholding data, and inconsistent use of information as is found in the August 1988 Proposal, was found in the 1989 annual review Proposal from Corporate Banking Melbourne to the Lending Credit Committee,⁽⁾ and in a lending Proposal dated 1 February 1989, approved by Lending Credit Committee meeting 9/89 held 7 February 1989. Time and again it is asserted, for the purposes of risk minimisation within a safety assessment in a proposal, that Petersville Sleigh was controlled by Adelaide Steamship Company; the same fact is persistently denied for the purposes of consideration or application of prudential limits.

Since Petersville Sleigh was not treated as an Adelaide Steamship Company Group company, the Lending Credit Committee decision on 31 August 1988 to approve the Revolving Cash Advance facility was not referred to the Board. At that time, approval of a facility of $20.0M was within the Lending Credit Committee's delegated lending authority. Had it been treated as a group company, Board approval would have been required. The facility having been treated as already approved by a Sub-Board, it was before the Board on 27 April 1989 merely "for confirmation".⁽⁾

This approval was not communicated to the Bank Board until the Board noted the minutes of the Lending Credit Committee meetings held, between 11 August and 13 September 1988, at the Board meeting on 22 September 1988.

For the reasons given above, on the basis of the facts to which I have referred, I am of the opinion that the members of the Lending Credit Committee referred to above did not properly construe and apply the Bank's policy on aggregation of exposures to companies in that:

(a) they did not aggregate the Revolving Cash Advance facility of $20.0M granted to Petersville Sleigh with other exposures to the Adelaide Steamship Company Group as was required under the Bank's prudential policy, nor did they adequately consider the strength of Petersville Sleigh's connection with Adelaide Steamship Company, even though it was commented upon in the credit proposal; and

(b) as a result, they approved a facility of $20.0M to Petersville Sleigh which, had it been aggregated with other Adelaide Steamship Company Group exposures, was in excess of their delegated lending authority, and should have been approved by the Bank Board.

(c) Vaniro

In January 1989, the Bank granted a facility of $150.0M to Vaniro, a joint venture company, owned in equal shares by David Jones and National Consolidated. The facility was secured by a first registered charge over National Australia Bank shares owned by Vaniro, and by guarantees from David Jones and National Consolidated. (I have already referred in passing to this facility at Section 9.4.2 (c)).

Although Vaniro's ownership was noted in papers presented to the Board and the Lending Credit Committee, the Bank considered this exposure very much as a "stand alone" facility.

The Bank's prudential policy stated that ownership by one company of 40 per cent or more of the share capital of a second company was to constitute those companies a group. On this basis, the facility to Vaniro should have been aggregated with existing exposures to David Jones, and thus Adelaide Steamship Company, for the purposes of prudential management.

The initial facility of $150.0M was recommended by the Lending Credit Committee, at its meeting number 5/89 (comprising Mr Ottaway, Mr Masters, Mr Pfeiffer, Mr Wright and Mr Mullins), on 23 January 1989. Directors present at the Board meeting on 26 January 1989, when approval of the facility was given, were Mr Barrett, Mr D W Simmons, Mr Bakewell, Mr Nankivell, Mr Searcy, and Mr Clark.

The proposals presented to the Lending Credit Committee and Bank Board at these meetings did not give any details of the Bank's exposure to other members of the Adelaide Steamship Company Group. An amendment to the Adelaide Steamship Company and Buckley & Nunn facilities was also approved at these meetings.⁽⁾ The papers supporting these proposals did show the Bank's exposure to other members of the Adelaide Steamship Company Group, but the papers produced to the Investigation by the Bank contain nothing to indicate that the Lending Credit Committee and the Bank Board ever considered that they should aggregate the exposure to Vaniro with these other exposures for prudential purposes. Similarly, the minutes of the Lending Credit Committee and Board do not contain clear and explicit justification for not aggregating these exposures.

Certain former members of the Lending Credit Committee have submitted to the Investigation that that loan to Vaniro was, and could reasonably be regarded as, standing outside the Bank's prudential policies for a number of reasons. First, the Bank had no contractual right of recourse against members of the Adelaide Steamship Company Group for the principal sum advanced by the Bank. Secondly, the Bank had taken security for its loan. Thirdly, the top up conditions upon which the security was granted, together with the ability of the Bank to sell the secured shares should those top up conditions not be complied with, had the consequence that it was most unlikely that the Bank would ever exercise any recourse against the guarantors and equally unlikely that the Bank would ever exercise recourse against Vaniro itself.⁽⁾

It has also been submitted to the Investigation that:

"It was the Bank's view that the Vaniro transaction was "stand alone" from the Adsteam [Adelaide Steamship Company] Group and therefore should be excluded from any aggregation for Group exposure purposes.

The basis for this view was that the Vaniro facility was non-recourse to the Adsteam [Adelaide Steamship Company] Group for principal repayment. Vaniro was a single purpose company established as the vehicle for David Jones and National Consolidated's investment in NAB.

The safety of the Bank's exposure to Vaniro was linked inextricably to the value of the NAB shares held as security and the Bank's ability and right to act quickly to realise part or all of the security to protect the Bank's position, if necessary. It was not an assertion that it was "stand alone" merely because the Bank took security.

While not very common, non-recourse financings or asset based loans of various types have always been an accepted part of Banking.

The Bank's safety assessment of the Vaniro proposal considered past price movements of NAB shares both prior and subsequent to the October 1987 stock market "crash" and future trading projections.

The liquidity of the "Blue chip" shares and the Bank's ability to act quickly to realise them, were also factors considered in establishing the security lending margin and the timeframes allowed for restoration of the security margin, either by provision of additional share security or reduction of the debt.

The Bank also had carried out its own credit assessment of NAB. It should be mentioned that the Adsteam [Adelaide Steamship Company] Group was looking to refinance its investments in the three major banks at that time. It was the Bank's preference to refinance the NAB shares in lieu of (shares in two other major banks).

It should be noted that with the 150% security cover, taken the NAB share price would have to have fallen by 33 1/3 % before the loan would only have had a dollar for dollar security cover. In the October 1987 share "crash" the decline in NAB's share price was only 25%.

To exercise recourse against Vaniro would have been futile as it was a single purpose company whose only asset was the Bank's security. The contingent exposures to National Consolidated and David Jones were recorded against those companies." ⁽⁾

In addition, the former non-executive directors of the Bank have submitted that "the reason why the Vaniro facility was not aggregated with Adsteam [Adelaide Steamship Company] exposures was because the security held in the NAB shares was considered good enough in its own right and the likelihood of any of that security being eroded was so remote that only a contingent exposure needed to be recorded." ⁽⁾

Having decided that the exposure to Vaniro was to be considered on a stand-alone basis, the Lending Credit Committee and the Bank Board adhered to that approach throughout the term of the facility. The minutes of the Lending Credit Committee record that:

"Members noted the strong arguments in favour of the independent recording of exposures of the above facilities particularly the Adelaide Steamship, Buckley & Nunn and the David Jones facilities. It was recognised that the overall Group direct exposure, when all exposures were consolidated, does not exceed $300.0M."⁽⁾

The "strong" arguments are not recorded, but I take it that they are substantially the same as those referred to above.

In subsequent credit papers, summaries of exposures to other members of the Adelaide Steamship Company Group were given, but only the contingent risks relating to Vaniro were listed, that is to say $20.0M (and later $10.0M) against each of David Jones and National Consolidated, in recognition of the guarantees given by those companies. The full exposure of $150.0M to Vaniro was not shown in these summaries.

While I accept that there is some force in the arguments noted above, I am nevertheless of the opinion that the exposure should, for prudential purposes, have been aggregated with other Adelaide Steamship Company exposures.

In my opinion, this transaction would not have been undertaken if Vaniro had truly been an independent entity. It is my opinion that the involvement of the Adelaide Steamship Company Group significantly influenced the Bank's decision to approve this loan. I infer this from the Bank's own papers and in particular from the following passages:

"This transaction represents a unique opportunity to further expand our relationship with the Adsteam [Adelaide Steamship Company] Group ... with only a nominal increase in risk exposure." ⁽⁾

"The Adsteam [Adelaide Steamship Company] Group has now sought an alternative borrowing on a non recourse basis." ⁽⁾

"It was not the Bank's normal practice to lend on this basis." ⁽⁾

Consistency and forthrightness of approach required, for the purposes of the Bank's prudential policies, that the Vaniro facility be treated as a loan made available to the Adelaide Steamship Company Group. The conduct of the Bank's lending institutions in treating the facility as stand alone was inconsistent, and an oblique and overt departure from the Bank's own policies.

For the reasons given above, on the basis of the facts to which I have referred, I am of the opinion that the members of the Lending Credit Committee referred to above failed properly to construe and apply the Bank's prudential policies, and the members of the Bank Board referred to above failed adequately and properly to supervise, direct, and control, the relevant operations, affairs, and transactions, of the Bank, in that they did not aggregate the exposure to Vaniro with other exposures to the Adelaide Steamship Company Group, as required by those policies.

(d) Infringement of the Limit by Acquisition of a Borrower

Where an existing Bank customer acquired another company which was also a customer of the Bank, the Bank's total exposure to the new or enlarged group would have increased by force of circumstances outside the Bank's control. If the total exposure to that group of customers then exceeded the Bank's prudential lending limits, it was difficult for the Bank to respond, except by requesting a renegotiation of existing facilities. In the absence of default, the Bank could not unilaterally terminate facilities, or initiate a reduction in approved limits. Upon maturity of a facility, however, the Bank could choose not to renew it or, if it chose to renew, could renew to a reduced ceiling.

If an acquiring company (being a customer of the Bank by which monies were owing to the Bank) had sought finance from the Bank to fund an acquisition which would result in the Bank having an exposure beyond prudential limits to a newly constituted group, the Bank would have been in a position to reject the application for finance. The Investigation has not seen any such applications for finance from the Adelaide Steamship Company Group. When the Adelaide Steamship Company Group acquired existing Bank customers, the Bank was faced with total exposures beyond prudential limits arising from transactions which were beyond its control. The only options available to the Bank, at that stage, were to refuse any further applications for finance and to refuse to renew maturing facilities.

On two occasions during the period 1984-1991, Adelaide Steamship Company or Adelaide Steamship Company related companies acquired control of existing customers of the Bank.

(a) Acquisition of John Martin by David Jones

The acquisition of John Martin in August 1985, by David Jones, increased exposure to the Adelaide Steamship Company Group by $37.0M to $72.0M.⁽⁾ The Lending Credit Committee minutes of meeting 69, on 23 July 1985, when the Bank first took over John Martin's banking arrangements, noted that this acquisition would give a total "Adsteam [Adelaide Steamship Company] connection" exposure in excess of the prudential limit of $40.0M (page 2). This was the absolute limit for any single entity or group unless specific Board approval for a higher limit was held. According to the Committee minutes, members of the Committee, in deciding that aggregation was not called for, were influenced by three considerations: namely, the fact that there was no recourse to Adelaide Steamship Company on the John Martin exposures; that the Adelaide Steamship Company facility itself permitted direct recourse only to that company; and that David Jones had guaranteed the John Martin's debt.

Lending Credit Committee members present at the meeting on 23 July 1985 were Mr Byrnes,⁽⁾ Mr Ottaway, Mr Masters, Mr Pfeiffer, Mr Tucker, Mr Wright, and Mr D E Hosking.

Had these two exposures been treated as loans to a group, as they should have been under the Bank's prudential policy, specific Board approval would have been required for this level of exposure. At its meeting on 25 July 1985, the Bank Board simply noted the increased total exposure to the Adelaide Steamship Company Group; they were requested to approve only the new facilities to John Martin's ie a mix of facilities totalling $37.0M.⁽⁾ These departures from the prudential limits were quite knowing: the Lending Credit Committee minutes and Board Paper⁽⁾ noted that John Martin's had been "sold to the David Jones Group", that David Jones was "controlled" by Adelaide Steamship Company and that a consequential number of significant advantages were inherent in the proposal.

As I have said, the Bank's prudential policy allowed exposures to "blue chip" corporates in excess of the $40.0M limit. Blue chip was defined as a company "usually enjoying a credit rating of AA or better". According to the Australian Ratings report of 19 December 1984, an extract of which was attached to the policy paper,⁽⁾ Adelaide Steamship Company had a rating of BB+ and David Jones a rating of BBB+. These companies were thus not blue chip under the Bank's definition, and accordingly, the combined exposure should not have exceeded $40.0M. The Bank relied upon the fact that there was no recourse to Adelaide Steamship Company on the John Martin's transaction, and vice versa, to justify the approval of each exposure on a stand alone basis. On this basis, each exposure was less than $40.0M and therefore within the prudential limits. In real terms, this facility took exposure to the Adelaide Steamship Company Group to $70.0M.

Members of the Lending Credit Committee have submitted to the Investigation that, as there was no recourse to Adelaide Steamship Company under the proposed arrangement, the Lending Credit Committee was entitled to consider that the facilities were separate, as a matter of interpretation of the Bank's prudential policy.⁽⁾ I do not accept that this interpretation was reasonably open in the circumstances, and refer back to the submission of certain former non-executive directors as to their reason for resolving to treat the facilities separately.⁽⁾

In response to concerns raised by the Board at its meeting on 25 July 1985,⁽⁾ the Managing Director gave assurances that management had assessed the impact upon the Bank's resources of the facilities to be made available to John Martin, and that management were confident the account would be given the attention required. These "concerns" were not specified in the Board Minute. Members of the Board present at this meeting were Mr Barrett, Mr K J Hancock, Mr Clark, Mr Bakewell, Mr Searcy, Mr D W Simmons, Mr K Smith, and the Hon Donald W Simmons. The Board noted (page 6) that "the exposure to the Adelaide Steamship Group totalled $64.0M".

In a sense, one can understand the process of rationalisation indulged in by the members of the Lending Credit Committee. Both John Martin and Adelaide Steamship Company were very substantial locally based enterprises. John Martin was a very prominent retailer in the city of Adelaide. Adelaide Steamship Company was being offered credit lines by the country's private banks and by other lending institutions. One can understand that, in the period of two to three years after its establishment, the Bank would be particularly keen to procure the business of these enterprises and keep it, if practicable. Nevertheless, these facts did not warrant departures from policies as important as prudential limits.

For the reasons given above, on the basis of the facts to which I have referred, I am of the opinion :

(a) that the members of the Lending Credit Committee referred to above failed properly to construe, and apply, the Bank's prudential policies; and

(b) that the members of the Board referred to above failed adequately and properly to supervise, direct, and control, the relevant operations, affairs, and transactions, of the Bank

in approving (in the case of the Board) and in recommending for approval (in the case of the Lending Credit Committee) the facilities of $37.0M granted to John Martin. This exposure should have been aggregated with existing exposures to Adelaide Steamship Company, according to the Bank's prudential policies.

Three months later, on 21 November 1985, a proposal by way of annual review was put to the Board, and to the Lending Credit Committee, by Mr Masters with a view to increasing exposure to Adelaide Steamship Company by $15.0M. This proposal noted the existing exposure to John Martin and the basis on which it was to be treated as stand alone from Adelaide Steamship Company, but commented (page 1):

"The above two exposures (Adelaide Steamship Company and John Martin Retailers Ltd) whilst being combined for our global exposure are viewed as two distinct lending proposals for internal lending assessment".

It would be normal practice to treat aggregation of exposures consistently whatever the nature of the reporting. Whilst not specifically referring to the stand alone basis, the Board approved the increase "on terms set out in the paper". There was no recourse to Adelaide Steamship Company on the exposure to John Martin. First recourse was to John Martin. Secondary recourse was to David Jones under David Jones' guarantee. These were the three reasons given for treating the exposures to Adelaide Steamship Company and David Jones on a stand-alone basis. The Lending Credit Committee had noted and relied upon these reasons, adding that the Board on 28 July 1988 had considered David Jones Ltd "as being good for [$37.0M] in their own right" (page 1).

The Lending Credit Committee also noted⁽⁾ (page 2) that:

"... the exposure of $50.0M to Adsteam [Adelaide Steamship Company] is a result of new Bank policy guidelines which require Foreign Currency Dealing `Spot' trading transactions (current limit $15M) being extended from 15% to 100%".

The minutes also record that, on the Adelaide Steamship Company facilities being increased to $50.0M, the Bank's exposure to "Adelaide Steamship Company Group" would be $87.0M, some $47.0M in excess of the prudential limit.

Only 20 per cent of the exposure to Adelaide Steamship Company related to foreign currency transactions. Even ignoring the "new" guidelines, loans to Adelaide Steamship Company itself exceeded the prudential limit, and were unsecured. The reasons advanced for defying the guidelines are wholly insufficient, both alone and in combination.⁽⁾

Mr Masters' proposal of 21 November 1985 continued:

"Naturally, Adsteam [Adelaide Steamship Company] exposure is direct to that company and whilst it exceeds on $40M prudential limit this is due to a change in policy in the calculation of Spot Rate Exchange Exposure.

Company previously had a dealing limit of $15M for Spot transactions and $35M for forward exchange contracts. These were both extended at 20%, thus giving an exposure of $10M against the Company. New policy guidelines now require Spot transactions to be extended at 100% resulting in a $10M increase in Foreign Exchange Dealing exposure limits".

This information is not borne out by the Bank's papers. Only $10.0M of the facilities granted to Adelaide Steamship Company were for foreign exchange dealing purposes⁽⁾. Nor is there any logic in the reasoning. One major (although implicit) premise in the reasoning is that because a policy is "new" it is deserving of no adherence. In short, what Mr Masters is apparently suggesting is that the Bank, in its administrative arrangements, ignored the introduction of the new rule on Foreign Exchange dealing exposure limits. Another feature worthy of mention is that, as part of the Annual Review noted by the Lending Credit Committee and the Board in November 1985, the line fee charged to Adelaide Steamship Company on the commercial bill facility was reduced by one-half to 0.25 per cent. Finally, Mr Masters' paper noted (page 4) that John Martin Retailers Ltd had become a wholly owned subsidiary of David Jones Ltd in the year under review.

The reasoning set out above was found in the cognate submission by Mr Masters to the Board.⁽⁾ It continued to permeate the Bank's attitude to departures from the prudential guidelines on successive applications by Adelaide Steamship Company for increases in facilities⁽⁾.

In my opinion, the Board should have explicitly repudiated the reasoning, found in submissions to it, against aggregating these various exposures. Its approval of the submissions which contained that reasoning clearly encouraged the wholesale evasion of the Bank's limits which later occurred.⁽⁾

In 1988, the reasoning summarised above continued to appear in proposals to the Board in juxtaposition with assertions that:

"John Martins is now an integral member of the Adsteam [Adelaide Steamship Company] Group structure." ⁽⁾

This attitude of defiance of the prudential limits was aggravated, in that instance, by the facts that the submission was based on inadequate information in relation to David Jones, that material relating to John Martin showed a loss in the previous year, and that trading figures summarised in the submission were "significantly distorted by inter-company transactions" in a way not elaborated in the submission. The capacity and the tendency of members of groups of companies to engage in non-arm's length transactions is one reason why grouping rules are an integral component of prudential limits. The Bank's comments imply that the Bank did recognise that there was a group exposure under its prudential policies but chose to disregard it for the purposes of credit assessment. This flies in the face of the primary purpose of prudential limits which is to limit a Bank's vulnerability to any one customer or group of related customers.

(b) Acquisition of Industrial Equity by Dextran

In November 1989, Adelaide Steamship Company bid for Industrial Equity through Dextran, a company owned in equal shares by Adelaide Steamship Company, David Jones and Tooth. By 20 November 1989, Dextran had acquired 50.9 per cent of Industrial Equity's shares. Subsequently it gained 100 per cent ownership.

Under the Bank's policy that 40 per cent ownership should constitute a group, it was not clear whether Dextran should be considered to be part of the Adelaide Steamship Company Group for prudential purposes. Dextran's three shareholders were, however, all part of that Group. In future years, the Bank did refer to Dextran and its subsidiary Industrial Equity as part of the Adelaide Steamship Company Group.

In July 1989, the Bank had on foot direct facilities to Industrial Equity and its subsidiaries, Southern Farmers Group and Woolworths, totalling $85.9M, and indirect facilities totalling $60.0M. Those facilities continued on foot through to, and beyond, November 1989. Exposure to other Adelaide Steamship Company Group companies totalled approximately $485.0M in November 1989.

No paper was submitted either to the Board or to the Lending Credit Committee to draw their attention to the fact that the Bank's exposure to the Adelaide Steamship Company Group would increase significantly as a result of this acquisition or to the fact - known, as I shall show, to Corporate Banking - that a consequence of the acquisition was that Adelaide Steamship Company was taking on an excessive debt burden.

The report of Group Exposures greater than $20.0M at 31 December 1989, which formed part of Group Risk Management's quarterly reporting to the Board, failed to include Industrial Equity exposures under the Adelaide Steamship Company Group. In fact, the Industrial Equity total was reported separately as $29.0M. This excluded Southern Farmers Group facilities, which were still shown as part of the exposure to the Brierley Investments Group, the previous owner of Industrial Equity. This report to the Board was prepared by Mr N Newman, Head of Risk Information Systems, Global Risk Management, supported by Mr C Guille, General Manager, Global Risk Management, and presented by Mr Matthews.

The report of Large Exposures prepared for the Reserve Bank at this date also excluded any exposure to Industrial Equity or Southern Farmers Group from the Adelaide Steamship Company total (although this omission was not identifiable without viewing source documents since these reports do not identify individual exposures by customer name). I express no criticism of Mr Newman and Mr Guille in this regard. They were, I am satisfied, reliant upon receipt of information from Corporate Banking⁽⁾ or from the Lending Credit Committee, in connection with preparation of their reports. Their role at the time, upon receiving information, was merely to collate it and compile a report in a certain form. They did not (and they were not required to) review or investigate the accuracy of information relayed to them. Since January 1990, Group Risk Management's role has changed. That division now undertakes portfolio analysis, reviews of individual large exposures, reviews of the economy, and reviews of economic factors which may affect the operations of businesses and customer groupings.

The report of large exposures was not an appropriate vehicle by which to relay to the Board and to the Lending Credit Committee the two facts to which I have referred namely, that the Bank's exposure to the Adelaide Steamship Company Group was about to increase, as was Adelaide Steamship Company's debt burden. A specific paper from Corporate Banking was required in the circumstances. The Bank's officers recognised that:

"When IEL [Industrial Equity] was acquired in late 1989 it was clear that the Adsteam [Adelaide Steamship Company] Group would need to undertake a significant asset rationalisation and sales programme over the ensuing two years to reduce its overall debt to a more acceptable and sustainable level." ⁽⁾

Yet the Bank's officers did not, on this account, bring forward - as they should have done - the annual review of Adelaide Steamship Company's facilities. They sought, in April 1990, to defer it. The deferral proposal⁽⁾ to which I refer below did not express the sentiment extracted above. This was quite unacceptable. In my opinion, the officers managing the account should, in December 1989 (when an annual review was due), have prepared a preliminary annual review disclosing and containing comment on the effects, on the Bank and on Adelaide Steamship Company, of the Adelaide Steamship Company bid for Industrial Equity. If Bank officers considered that circumstances warranted it, that preliminary review might have sought deferral of a full or thorough annual review.

It has been submitted to the Investigation on behalf of Mr Mullins that the following were the reasons why the annual review was deferred. A full credit submission on Adelaide Steamship Company was approved by the Board on 26 October 1989. During that presentation, it was submitted, Mr Mullins informed the Board that an Adelaide Steamship Company Group bid for Industrial Equity was anticipated in the near future. It was further submitted that Mr Mullins informally discussed with the Board the Dextran bid and the Adelaide Steamship Company Group's plans to rationalise its activities at the Board's meetings in November and December 1989 and thus that the Board was aware that the Bank's exposures to Industrial Equity and Southern Farmers Group would need to be grouped with other Adelaide Steamship Company Group exposures if the bid proceeded and succeeded. The Adelaide Steamship Company Group acquisition of Industrial Equity through Dextran was not finalised until March 1990. The Adelaide Steamship Company Group had not finalised its rationalisation plans and asset sales programs which it had indicated would follow upon the acquisition of Industrial Equity. During the period from October 1989 to March 1990, it was submitted, no major Bank Group facilities were due to expire and no events of default occurred. Thus, the Bank was unable significantly to reduce its exposure to the Adelaide Steamship Company Group and correspondingly, it was submitted, a review in the period October 1989 to March 1990 would have achieved little other than to point out the obvious. It was considered preferable to defer the review until some of the uncertainties had been resolved, and the Bank had sufficient information to complete "a meaningful assessment" of the Bank's overall position. It was further submitted that senior executives were kept informed of developments during this period, that the Bank maintained regular contact with Adelaide Steamship Company, and that the Group's exposures were under constant review during this period.⁽⁾

The Bank has produced to the Investigation no evidence tending to show that the Lending Credit Committee and the Board received any papers dealing with exposure to the Adelaide Steamship Company Group after the acquisition of Industrial Equity and until 24 and 26 April 1990 respectively, five months after the acquisition.

While there is some force in the submissions which I have summarised above, they do not, in my opinion disclose sufficient reason as to why no management report was prepared until 19 April 1990. On 19 April 1990, Mr Parsons and Mr Mullins presented to the Lending Credit Committee a request to extend (that is, defer) the annual review of the Adelaide Steamship Company Group, which usually occurred in December/January, to 30 June 1990:

"... due to the uncertainties with the IEL [Industrial Equity] acquisition and subsequently the need to include IEL [Industrial Equity], SFG [Southern Farmers Group] and Woolworths Limited facilities in the Adsteam [Adelaide Steamship Company] Group". ⁽⁾

Although there were indications (page 3 of the proposal dated 19 April 1990) that three of the major Australian trading banks were prepared to continue to provide facilities to the Adelaide Steamship Company Group, the increasing exposure to the Adelaide Steamship Company Group, and its continuing takeovers and acquisitions, required that the Bank maintain a close watch on the Group, and on the Bank's exposure to the Group. To defer the annual review in the face of such significant changes to the Group and the Bank's exposure to the Group, was not an action of a prudent banker.

The proposal that the annual review be deferred set out all facilities available to members of the Adelaide Steamship Company Group, and commented upon the renegotiation of negative pledge agreements and financing of the Group. These matters, along with proposed asset sales, litigation, and completion of the Industrial Equity takeover would appear to be the "uncertainties" referred to above. The Proposal to the Lending Credit Committee noted that Adelaide Steamship Company had been informed that the Bank was reluctant to extend the facilities on a negative pledge basis. The Proposal to the Lending Credit Committee asserted that "Corporate Banking has taken appropriate actions to protect the Bank's position." It did not indicate explicitly what those actions were. At the same time, the Lending Credit Committee reviewed and extended the Vaniro facility⁽⁾. The Lending Credit Committee recommended the deferral of the annual review to the Board. The Bank Board subsequently approved the deferral.

At the time of the actual annual review in July, Industrial Equity was included in the full list of Group exposures.

Members of the Lending Credit Committee, who recommended the deferral of the annual review to the Board, have informed the Investigation that they agreed to a deferral due to the fact that it was indicated to the Committee by management that it would take some time to collate the information necessary to perform a thorough review, and that the Adelaide Steamship Company Group account was so complex that it could not reasonably be expected to be prepared for annual review in a short period of time. The Bank's lending to the Adelaide Steamship Company Group was, in some instances, as a member of syndicates; any proposed changes to the terms and conditions of those syndicated loans would have been required to be discussed with other syndicate members. It was submitted to the Investigation that the annual review was deferred because the members of the Lending Credit Committee wished to ensure that all relevant information had been obtained, and to satisfy themselves that the annual review would produce accurate results, and that deferral of the annual review for six months was therefore, not unreasonable.⁽⁾ I have accepted this submission. By the time the deferral submission reached the Lending Credit Committee, the proposed deferral period had, in any event, almost run its course.

For the reasons given above, on the basis of the facts to which I have referred, I am of the opinion that senior management erred in their decision to seek a deferment of the annual review of the Adelaide Steamship Company Group's and in failing, prior to 19 April 1990, to report in writing on the anticipated effects of the Industrial Equity acquisition upon the Bank's exposure to that Group. Senior management should have ensured that a review was performed as soon as possible which identified the uncertainties and risks to which the Bank was exposed, with an update to be presented as soon as the uncertainties were resolved.

9.4.7 MANAGEMENT OF NON-PERFORMING FACILITIES

Adelaide Steamship Company Group facilities were not classified as non-performing until 26 April 1991, when it was ascertained that there was a risk of non-recovery of principal. Interest was still being paid as it became due at that time.

9.4.8 CREDIT INSPECTION

The scope of the review of these facilities did not include a detailed review of compliance with the policies and procedures relating to credit inspection.

 

9.5 OTHER MATTERS IDENTIFIED BY THE INVESTIGATION

 

I am of the opinion that there were certain other deficiencies in the Bank's procedures as detailed below:

9.5.1 ASSESSMENT OF RISK

The deferred interest facility of $115.0M which was granted to Buckley & Nunn in March 1988 was supported by an unlimited guarantee from Adelaide Steamship Company and a negative pledge from Buckley & Nunn. The facility financed Buckley & Nunn's holding in Royal Insurance PLC.

In December 1988 a paper was submitted to the Lending Credit Committee stating that in order:

"... to reduce Adsteam's [Adelaide Steamship Company] contingent liability it is proposed that the Bank's risk assessment be against Royal Insurance PLC (ie. non recourse to Adsteam [Adelaide Steamship Company]). Adsteam [Adelaide Steamship Company] would provide a guarantee to meet any shortfall in security." ⁽⁾

The paper also concluded that:

"Relocation of this risk exposure to Royal Insurance PLC will allow the Bank to expand its relationship with this valued Corporate client, at the same time maintain our prudential requirements."

This paper was put before the Lending Credit Committee for "an indicative response".⁽⁾ The Lending Credit Committee members were not agreed on the treatment of the exposure as proposed. A decision was deferred.⁽⁾ Committee members present at the meeting were Mr Matthews, Mr Mallett, Mr Masters, Mr Pfeiffer, Mr Wright, and Mr Mullins.

While this proposal should have referred to taking security directly against the value of the Royal Insurance PLC shares (rather than against the Royal Insurance itself, which would have been impossible), the Bank could not hold a guarantee from Adelaide Steamship Company and consequently state that there was no recourse to Adelaide Steamship Company on this transaction.

This proposal implicitly contemplated that the Bank should take security over the Royal shares (as later occurred with National Australia Bank shares pursuant to the Vaniro transaction). Even if security had been taken over the shares, the ultimate risk of a shortfall in security would still have rested with the Adelaide Steamship Company Group because of Adelaide Steamship Company's guarantee. By restructuring the facility in this way, Adelaide Steamship Company's aim of reducing its contingent liability would have been achieved but, from the Bank's point of view, the exposure to the Adelaide Steamship Company Group would have remained unchanged. There was no conceivable benefit to the Bank in the variation proposed. The Proposal contemplated that the Bank would lend in excess of the security value of the subject matter.

Although they deferred the decision, the members of the Lending Credit Committee referred to above clearly misunderstood the nature of the risk associated with this transaction. The proposal to assess the risk against Royal Insurance PLC instead of Adelaide Steamship Company should have been declined immediately. The Bank could not lend to an Adelaide Steamship Company Group company, hold a guarantee from Adelaide Steamship Company and consistently assert that there was no recourse or exposure to the Adelaide Steamship Company Group.

9.5.2 INDUSTRIAL EQUITY EXPOSURE AND PRUDENTIAL LIMITS

In January 1985, the Board approved an increase in the Southern Farmers Group facility from $24.4M to $40.0M. Existing Southern Farmers Group borrowings were not secured.⁽⁾ Industrial Equity borrowings of $15.7M were secured only by guarantees.⁽⁾ Southern Farmers Group was 64 per cent owned by Industrial Equity. The Industrial Equity Group exposure thus increased to $50.7M. That exceeded the existing prudential limit of $30.0M. This was noted by the Board, which recognised the necessity to sell down the exposure to the existing limit. The same paragraph of the Board Minutes of its meeting on 24 January 1985, however, stated that:

"... a paper seeking alteration to the prudential exposure limits will be submitted at the next Board meeting".

The lending submission⁽⁾ in fact contemplated that this submission, on altered prudential limits, would accompany the lending submission. This would imply that the prudential exposure limits were to be increased in order to accommodate the exposure to the Industrial Equity Group. The former non-executive directors of the Bank have accepted that a review of the prudential exposure limits was requested, in part, in order to accommodate the exposure to the Industrial Equity Group.⁽⁾

It should be noted that this occurred before Industrial Equity was acquired by the Adelaide Steamship Company Group.

At the following Board meeting, on 13 February 1985, the Bank's prudential limits were increased⁽⁾ to an absolute limit of $33.0M for any single entity or group or 30 per cent of shareholders' funds (at that time a limit of $50.0M) for "blue chip" companies. In December 1984, Australian Ratings had classified Industrial Equity as A rated; this was not "blue chip" under the Bank's definition under which a "blue chip" company was one "usually enjoying a credit rating of AA or better". Industrial Equity group exposure should not have exceeded $33.0M until July 1985, when the limit for companies which were not blue chip increased to $71.0M (based on the criterion 20 per cent of shareholders' funds). The increase in the Southern Farmers Group facility was, therefore, a contravention of the Bank's prudential limits.

Members of the Bank Board present at the meeting at which the increased facility to Southern Farmers Group was approved were Mr Barrett, Mr Hancock, Mr Clark, Mr Nankivell, Mr Searcy, Mr D W Simmons, the Hon Donald W Simmons, and Mr Smith.⁽⁾

In September 1985, the Board approved an increase in the prudential exposure limit of the Industrial Equity Group to $52.78M, to enable the Bank to participate to the extent of $8.0M in a syndicated letter of credit facility.⁽⁾ The new facility was for repayment in instalments, the first repayment (25 per cent) to be made at the end of the third year of the facility, and the final instalment to be made at the end of the fifth year.

Industrial Equity had refused to supply budget projections to the Bank. This should not necessarily have lead the Board to refuse an application by a borrower such as Industrial Equity. A prudent banker, however, when confronted by a refusal by a company such as Industrial Equity to provide budget projections, should have sought some compensation or quid pro quo, for example, some improvement in the proffered security position, an identification of a specific repayment source, more current financial information, or an increase in the Bank's lending margin or fees. The most recent financial information known to the Bank in this instance was 9 months old. The loan was to be unsecured, except by guarantees. The underpinning of $30.0M, contemplated in the Board decision of 27 June 1985 (when the Board had approved participation in a syndicated facility in favour of Southern Farmers Group), to be made in three months had not been completed - only one half of that amount had been underpinned. In those circumstances, the Board's decision to create an exception to its prudential limits is difficult, if not impossible, to justify. Indeed, even by January 1986, when the Board approved the annual review of the Southern Farmers Group facilities, no additional underpinning had been arranged.⁽⁾ The Lending Credit Committee subsequently authorised variation of the letter of credit facility to entitle Industrial Equity to defer all repayments of principal to the fifth year of the loan.⁽⁾

For the reasons given above, on the basis of the facts to which I have referred, I am of the opinion that members of the Board referred to above failed adequately and properly to supervise, direct, and control, the operations, affairs, and transactions, of the Bank, in that they approved increased facilities to the Industrial Equity group which exceeded prudential limits. This conclusion is not directed to Mr Barrett and Mr Nankivell who, at the relevant meetings, declared an interest in the resolutions to which I have referred and, I am satisfied, did not vote on those resolutions.

9.5.3 INCLUSION OF WOOLWORTHS IN THE INDUSTRIAL EQUITY REPORTING

Lending Credit Committee paper 363/88, the annual review of the Industrial Equity group dated 18 May 1988, asserted in an Annexure that Industrial Equity already owned "40% (controlling interest)" ⁽⁾ of Woolworths' shares. At this time, the Bank had an exposure to Woolworths of either $11.5M drawn to $3.5M, or simply $3.5M.⁽⁾ The Bank's documents do not clearly evidence the position.⁽⁾ This annual review was presented by Mr B J Parker, Senior Corporate Manager, and supported by Mr C H Andrew, State Manager, New South Wales, Corporate Banking. Lending Credit Committee members present at the meeting on 24 May 1988 at which the annual review and extension of facilities were approved, were Mr Matthews, Mr Ottaway, Mr Paddison, Mr Mallett, Mr Masters, Mr Macky, Mr Wright, and Mr Pfeiffer.

The Bank's prudential policies stated that 40 per cent or greater ownership was to constitute a group for prudential purposes. The exposure to Woolworths should, therefore, have been included as a group exposure in the Bank's reporting of facilities available to the Industrial Equity group. (The exposure was, not in fact, included until the annual review dated 31 May 1989, some months after Industrial Equity had gained 100 per cent ownership of Woolworths.) Members of the Lending Credit Committee thus approved the annual review of the Industrial Equity Group, without being informed of the Bank's exposure to Woolworths.

These events occurred before Industrial Equity was acquired by the Adelaide Steamship Company Group.

For the reasons given above, on the basis of the facts to which I have referred, I am of the opinion that Mr Parker and Mr Andrew failed properly to interpret and apply the Bank's policies relating to aggregation of exposures in recommending and supporting an annual review of the Industrial Equity Group which failed to include facilities to Woolworths as part of the total exposure to that group. The Bank's prudential policies should have been robustly interpreted and applied, and the exposure to Woolworths should have been included.

Mr Andrew and Mr Parker have disputed this conclusion. They have submitted that the History Sheet, which was "Annexure A" to the Lending Credit Committee Paper, and which (as I have said) asserted that Industrial Equity owned "40% (controlling interest)" of Woolworths, was not, and was never intended to be, part of the body of the Lending Credit Committee Paper. Their submission was that the History Sheet was intended to be part of an overview of Industrial Equity's strategic interests only, and was not intended to give a true and accurate indication of grouping. The History Sheet was, they submitted, a document which was required by internal procedures to be attached to the Lending Credit Committee paper, and that it was prepared by a credit analyst. They have further submitted that Industrial Equity's shareholding in Woolworths at the time of preparation of the Lending Credit Committee Paper was not 40 per cent but rather 39.8 per cent. They accept that Bank policy required grouping if shareholding was 40 per cent or greater. They do not accept that a belief about a level of shareholding is grounds for grouping.⁽⁾

Whilst I accept that the shareholding of Industrial Equity in Woolworths at the relevant time was 39.8 per cent and not 40 per cent, I do not accept that this has the result that the Woolworths exposure should not have been grouped with the exposure to Industrial Equity. The Bank's prudential policies should have been applied and adhered to having regard to their substance and purpose rather than with strict literalness. Such an approach was fundamental to proper management of the Bank's affairs. In the application of such important policies, there was no room for mathematical niceties. The authors of the paper should have, at the very least, rounded up the relevant shareholding . Had they done so, the threshold for grouping would have been achieved.

Furthermore, the simple fact is that the History Sheet Annexure "A" put forward the fact that Industrial Equity had "a 40 per cent (controlling interest)" in Woolworths as a fact favourable to the Industrial Equity interests, and thus a fact in favour of approval of the annual review. The attachment of the History Sheet to the credit paper was an adoption of its contents. In addition, Mr Parker and Mr Andrew have accepted that the Industrial Equity interest was "effectively a controlling one irrespective whether the interest was 39.8 per cent or 40 per cent".⁽⁾

For the reasons given above, on the basis of the facts to which I have referred, I am of the opinion that Mr Parker and Mr Andrew failed properly to interpret and apply the Bank's policies relating to aggregation of exposures in recommending and supporting an annual review of the Industrial Equity group which failed to include facilities to Woolworths as part of the total exposure to that group. The Bank's prudential policies should have been robustly interpreted and applied, and the exposure to Woolworths should have been included.

9.5.4 AVAILABILITY OF FINANCIAL INFORMATION

Lending Credit Committee paper 76/85 stated that:

"In accordance with its corporate philosophy, IEL [Industrial Equity] will not disclose its objectives to Financiers, thus budget projections are not available."

Additionally, there are no cash flow forecasts or budget analyses in credit proposals relating to Adelaide Steamship Company, David Jones or Petersville Sleigh. The Investigation understands that information, other than publicly available information, was provided only to the major banks by these companies. This forced the Bank to rely on published, outdated information as a basis for its safety and repayment assessments.

A prudent and diligent banker should be aware of the purpose for which facilities are granted, and should demand prospective information in order to assess the viability of the proposal and to determine whether cash flows will be sufficient to service the debt and repay the principal advanced.

Members of the Lending Credit Committee have submitted to the Investigation that:

"Adsteam [Adelaide Steamship Company] (as was the case with most publicly listed companies in the 80's) did not provide budgets or cash flow forecasts to any banks, including the major banks, prior to April 1990 and that for the Bank to have insisted upon the provision of cash flows in the competitive environment that existed in the later half of the 1980's would have placed the Bank in an uncompetitive position in the banking market." ⁽⁾

The Investigation has received expert advice inconsistent with the submission that Adelaide Steamship Company did not provide budgets or cash flow forecasts to any banks, including the major banks, prior to April 1990. The advice to the Investigation has been that cash flows were obtained by certain other banks lending to companies which were members of the Adelaide Steamship Company Group. I do accept, however, that all bankers, prior to April 1990, experienced difficulty in obtaining a consolidated financial statement in respect of the Adelaide Steamship Company Group. For that reason, a prudent banker would have been more diligent in obtaining accurate and precise details of individual companies within the Group to which loans were proposed. In any event, the Bank, in my opinion, should have insisted upon the provision of cash flow forecasts consistently with good banking practice, and no departure from basic prudent lending principles can be justified by reference merely to considerations of competition. Standards should not be compromised in the interests of mere competitiveness. In expressing this view, I have had regard to the fact that, while the Bank did not have access to cashflows or budgets for the Adelaide Steamship Company Group, it did have regular access to Adelaide Steamship Company's computer-generated report of Bank facilities, which showed the committed facilities of each lender to the Adelaide Steamship Company Group, the expiry date of each facility, and current usage levels, and that from these reports, the Bank was able to ascertain that Adelaide Steamship Company generally maintained committed undrawn Bank facilities in excess of $1,000.0M which provided a significant liquidity back stop in the event of any unexpected deterioration in the income of the Adelaide Steamship Company Group.⁽⁾

I do not mean to say that refusal by a public company such as Adelaide Steamship Company to furnish budget projections should necessarily and of itself, lead to a credit provider's declining a loan application. In my opinion, however, a prudent banker confronted with a refusal by an applicant for a loan to provide cash flow forecasts and budget information should, as I have said, seek some compensation or quid pro quo for advancing the loan in the absence of that kind of information, for example, an improved security position, identification of a specific repayment source, more current financial information, or an increase in the Bank's lending margins. A proper and balanced lending decision without the benefit of budget projections is more difficult than with it.

The Bank, as lender, is entitled by virtue of its position as such, and by virtue of custom in the credit industry, to demand information of such a kind. In addition, Officers and Directors owed to the Bank, and to its shareholders, a duty to demand such information rather than accept unsubstantiated assurances and historical information from an intending borrower. If the borrower refuses to supply such information, the sensible course for a prudent and diligent banker is to refuse the application for finance. The provision of cash flow forecasts was also a specific requirement of the Bank's lending policies and procedures.

The Bank deprived itself not only of cash flow projections but in many instances, because of the dearth of information as to past results procured by the Bank, lending proposals contained speculation and inference, rather than specific factual information.⁽⁾

The Investigation reviewed all papers submitted to the Lending Credit Committee and the Board at the meetings referred to in Appendix B of this Chapter for the period from 1984 to 1990. It was found that, in 1990, some papers did contain cash flow forecasts for the Adelaide Steamship Company Group.⁽⁾ In the period 1984-1989, however, only three papers contained any reference to cash flow forecasts or budgets. These were the papers in respect of Industrial Equity which were presented to the Lending Credit Committee at their meetings on 14 July 1988 and 6 and 15 June 1989.

Members of the Lending Credit Committee who approved proposals which did not contain cash flow forecasts or budgets for the period 1984-1989 were Mr Byrnes, Mr Clark, Mr Pfeiffer, Mr K P Rumbelow, Mr Matthews, Mr Ottaway, Mr Masters, Mr Tucker, Mr Wright, Mr Mallett, Mr Macky, Mr Hosking, Mr J T Hazel, Mr Paddison, Mr Guille, and Mr Mullins.

Members of the Board who approved these proposals over the same period were Mr Barrett, Mr Hancock, Mr Clark, Mr Nankivell, Mr Searcy, Mr D W Simmons, Mr Smith, Mr Bakewell, the Hon Donald W Simmons, Mrs Byrne, Mr Summers, and Mr Hartley.⁽⁾

In addition, support for most facilities granted to the Adelaide Steamship Company Group relied on the companies' compliance with negative pledge covenants. I acknowledge that it was generally accepted banking practice in the 1980's for banks in Australia to lend to public companies by way of negative pledge. The use of negative pledge covenants as a substitute for security, however, requires careful and frequent monitoring of the companies' financial performance to confirm compliance with the covenants in place. So far as the Bank's files indicate, compliance with covenants by the Adelaide Steamship Company Group was confirmed by the Bank, at the date of a review or when an increase was requested, using certain publicly available information - this, in the main, consisted of the Annual Report, or the six monthly report to the Australian Stock Exchange. In addition, Adelaide Steamship Company and its associated companies provided to the Bank (along with other banks) half yearly compliance certificates. These certificates were reports by directors referring to all loan terms and conditions and lending ratios for each six monthly accounting period. They were provided generally within 100 days of the end of the relevant accounting period and were based on audited accounts. The certificates were checked for authenticity and accuracy upon receipt.

For the reasons given above on the basis to the facts to which I have referred, whilst I extend no criticism to members of the Lending Credit Committee or to the members of the Bank Board in relation to the availability to the Bank of financial information and in relation to the conduct of the Bank in extending credit to the Adelaide Steamship Company Group in the absence of cash flow forecasts and budgets, I do adhere to the view that the Bank should, in its dealings with Adelaide Steamship Company prior to April 1990, have insisted upon the provision of budgets and cashflow forecasts.

9.5.5 APPROVAL OF INDUSTRIAL EQUITY FACILITIES

In August and October 1987, the Bank Board approved increases to the facilities available to Industrial Equity of $20.0M and $100.0M, respectively.⁽⁾ The second increase was granted on the basis that $60.0M of the increase would be sold down to a third party. These matters occurred before Industrial Equity was acquired by Adelaide Steamship Company.

In both cases, the Directors were consulted using the "round robin" method which was later confirmed at a Board meeting. Eight of the Bank's nine directors (Mr Barrett, Mr Bakewell, Mr Nankivell, Mr D W Simmons, Mr Searcy, Mrs Byrne, Mr Summers, and Mr Clark) responded to the first of these proposals on 10 and 11 August 1987. Only six responded to the second proposal on 8 October 1987. Those six were Mr Barrett, Mr Bakewell, Mr Nankivell, Mr Searcy, Mr Summers and Mr Clark. I am satisfied that on these occasions the Board transacted business by telephone and resolved to approve the lending submissions, and that Industrial Equity was informed of the approval of these increases before the subsequent formal Board meetings which confirmed them. Otherwise there would have been no need to consult the Directors by the "round robin" method. Both of these increases were transactions which required the approval of the Bank Board. My interpretation of the State Bank of South Australia Act, 1983 Section 12, along with the views of the former directors as to the meaning of that provision, and my reasons for rejecting those views, is found in Chapter 8 - "Credit and its Management: Guidelines, Policies, Processes, Procedures and Organisational Delivery Mechanisms" of this Report.

The Bank has produced to the Investigation no evidence tending to indicate that these Directors had expressed their concurrence in writing with the proposed resolutions within the meaning of sub-section 12(6) of the Act. I am satisfied that no meeting of directors was convened for the purpose of approving these facilities. Thus, for the reasons which I have already given, the Board did not regularly approve these proposals.

For the reasons given above, on the basis of the facts to which I have referred, I am of the opinion that:

(a) Mr Barrett, Mr Bakewell, Mr Nankivell, Mr D W Simmons, Mr Searcy, Mr Summers, Mr Clark, and Mrs Byrne, failed to adhere to Section 12 of the State Bank of South Australia Act, 1983 in that they transacted business other than at a meeting of directors, and failed to express in writing their concurrence with a resolution that was dealt with otherwise than at a meeting of the Board; and

(b) Mr Barrett, as Chairman of the Board, did not properly and adequately direct, supervise, and control, the affairs, operations, and transactions of the Bank in that he permitted business of the Bank to be transacted other than at a meeting of directors, and he failed to ensure that all Directors entitled to vote on the resolution expressed in writing their concurrence with the resolution, as contemplated by sub-section 12(6) of the Act, with the result that the provisions of the aforementioned Act were not complied with.

 

9.6 REPORT IN ACCORDANCE WITH TERMS OF APPOINTMENT

 

As directed by Terms of Appointment A(a) to (f) (inclusive), A(h), C and D, I have investigated circumstances that occurred over the period from June 1984 to March 1991 surrounding certain facilities granted to the Adelaide Steamship Company Group of companies.

For the reasons given elsewhere in this Chapter of the Report, on the basis of the facts which I have set out and on the basis of the documents to which I have referred, I am of the opinion that:

9.6.1 TERMS OF APPOINTMENT A

(a) So far as concerns the "Approval of the Facilities":

(i) The Lending Credit Committee comprising Mr T M Clark, Mr T L Mallett, and Mr D C Masters, failed to exercise proper care and diligence in approving the letter of credit facility to Adelaide Steamship Company, in that they failed to ensure that a quorum was present at the committee meeting of 23 March 1988 before transacting the business of that meeting.

(ii) Mr L Barrett, Mr D W Simmons, Mr A G Summers, and Mr T M Clark, when asked to approve the letter of credit facility to Adelaide Steamship Company, failed to adhere to Section 12 of the State Bank of South Australia Act, 1983 in that they transacted business other than at a meeting of directors and failed to express in writing their concurrence with a resolution that was dealt with otherwise than at a meeting of the Board.

(iii) Mr L Barrett, as Chairman of the Board, failed adequately and properly to supervise, direct, and control, the affairs, transactions, and operations, of the Bank in that he permitted business of the Bank to be transacted other than at a meeting of directors, and other than as contemplated by sub-section 12(6), with the result that the provisions of the State Bank of South Australia Act, 1983 were not complied with.

(iv) Mr L Barrett, Mr D W Simmons, Mr T M Clark and Mr A G Summers failed adequately and properly to supervise, direct, and control, the affairs and transactions of the Bank in that they were requested by telephone to approve, and they did approve, the letter of credit facility of $35.0M to Adelaide Steamship Company without sufficient information upon which to base their decision.

(v) Mr L Barrett, Mr D W Simmons, Mr W F Nankivell, Mr R P Searcy, Mr R E Hartley and Mrs M V Byrne, when asked to approve the deferred interest facility of $115.0M to Buckley & Nunn, failed to adhere to Section 12 of the State Bank of South Australia Act, 1983 in that they transacted business other than at a meeting of directors, and failed to express in writing their concurrence in a resolution that was dealt with otherwise than at a meeting of the Board.

(vi) Mr L Barrett, as Chairman of the Board, failed adequately and properly to supervise, direct and control the affairs, transactions and operations of the Bank in that he permitted business of the Bank, namely a resolution to approve the deferred interest facility to Buckley & Nunn, to be transacted other than at a meeting of directors, and other than as contemplated and permitted by sub-section 12(6), with the result that the provisions of the State Bank of South Australia Act, 1983 were not complied with.

(vii) The Lending Credit Committee, comprising Mr K S Matthews, Mr D C Masters and Mr P F Mullins, failed to exercise proper care and diligence in approving a variation in the facility to Vaniro, in that they failed to ensure that a quorum was present at the Committee meeting of 22 February 1989 before transacting the business of that meeting.

(b) So far as concerns the "Management of the Facilities":

(i) The Lending Credit Committee (comprising Mr K S Matthews, Mr G S Ottaway, Mr D C Masters, Mr V R Pfeiffer, and Mr R L Wright) failed to exercise proper care and diligence, and the Bank Board (comprising Mr L Barrett, Mr D W Simmons, Mr R D E Bakewell, Mrs M V Byrne, Mr R E Hartley, Mr W F Nankivell, and Mr R P Searcy) failed adequately and properly to direct and control the operations, affairs and transactions of the Bank in approving the deferred interest facility of $115.0M to Buckley & Nunn in that:

. they measured the total exposure to the Adelaide Steamship Company Group against the wrong prudential limit;

. they did not aggregate exposures to David Jones and Adelaide Steamship Company as required by the Bank's prudential policies; and

. they approved additional facilities of $115.0M to a customer whose existing facilities already exceeded the maximum credit limit that could be granted to any one customer under the Bank's prudential policies.

(ii) The Lending Credit Committee comprising Mr G S Ottaway, Mr D C Masters, Mr I R Tucker, and Mr R L Wright, did not, in approving the Revolving Cash Advance facility to Petersville Sleigh, properly construe and apply the Bank's policy on aggregation of exposures, in that:

. they did not aggregate the Revolving Cash Advance facility of $20.0M granted to Petersville Sleigh with other exposures to the Adelaide Steamship Company Group as required under the Bank's prudential policy, nor did they consider the strength of Petersville Sleigh's connection with Adelaide Steamship Company, even though it was commented upon in the credit proposal;

. as a result, they approved a facility of $20.0M to Petersville Sleigh which, had it been aggregated with other Adelaide Steamship Company Group exposures, was in excess of their delegated lending authority, and should have been approved, if at all, by the Bank Board;

. the Lending Credit Committee (comprising Mr G S Ottaway, Mr D C Masters, Mr V R Pfeiffer, Mr R L Wright, and Mr P F Mullins) when first asked to approve a facility of $150.0M to Vaniro, failed properly to construe and apply the Bank's prudential policies, and the Bank Board (comprising Mr L Barrett, Mr D W Simmons, Mr R D E Bakewell, Mr W F Nankivell, Mr R P Searcy, and Mr T M Clark) failed adequately and properly to supervise, direct and control, the relevant operations, affairs, and transactions of the Bank in that they did not aggregate the exposure to Vaniro with the exposures to the Adelaide Steamship Company Group as required by those policies;

. the Lending Credit Committee (comprising Mr P E Byrnes, Mr G S Ottaway, Mr D C Masters, Mr V R Pfeiffer, Mr I R Tucker, Mr R L Wright, and Mr D E Hosking) failed properly to construe and apply the Bank's prudential policies, and the Bank Board (comprising Mr L Barrett, Mr K J Hancock, Mr T M Clark, Mr R D E Bakewell, Mr R P Searcy, the Hon Donald W Simmons, Mr D W Simmons, and Mr K Smith) failed adequately and properly to supervise, direct, and control, the relevant operations, affairs, and transactions, of the Bank in approving (in the case of the Board), and in recommending for approval (in the case of the Lending Credit Committee) the facilities of $37.0M granted to John Martin at the time of its acquisition by Adelaide Steamship Company. This exposure should have been aggregated with existing exposures to Adelaide Steamship Company according to the prudential policies; and

. senior management erred in deciding to seek a deferment of the annual review of the Adelaide Steamship Company Group and in failing prior to 19 April 1990 to report in writing on the anticipated effects of the Industrial Equity acquisition upon the Bank's exposure to the Adelaide Steamship Company Group.

(c) So far as concerns "Other Matters Identified in the Investigation":

(i) The Bank Board (comprising Mr K J Hancock, Mr T M Clark, the Hon Donald W Simmons, Mr R P Searcy, Mr D W Simmons, and Mr K Smith) failed adequately and properly to supervise, direct, and control, the affairs and transactions of the Bank, in that they approved increased facilities to the Industrial Equity group in January 1985 which exceeded the Bank's prudential limits.

(ii) Mr B J Parker and Mr C H Andrew failed properly to interpret and apply the Bank's policies relating to aggregation of exposures in recommending and supporting an annual review of the Industrial Equity group which failed to include facilities to Woolworths as part of the total exposure to that group. The bank's prudential policies should have been robustly interpreted and applied, and the exposure to Woolworths should have been included.

(iii) Mr L Barrett, Mr R D E Bakewell, Mr W F Nankivell, Mr D W Simmons, Mr R P Searcy, Mr A G Summers, Mr T M Clark and Mrs M V Byrne, when asked to approve increased facilities for Industrial Equity, in August and October 1987, failed to adhere to Section 12 of the State Bank of South Australia Act, 1983 in that they transacted business other than at a meeting of directors, and failed to express in writing their concurrence with a resolution that was dealt with otherwise than at a meeting of the Board.

(iv) Mr L Barrett, as Chairman of the Board, failed adequately and properly to supervise, direct, and control, the affairs, transactions, and operations, of the Bank in that he permitted business of the Bank namely resolutions to increase the facilities available to Industrial Equity, to be transacted other than at a meeting of directors, and he failed to ensure that all Directors who were entitled to vote and who voted, expressed in writing their concurrence with the resolution, with the result that the provisions of the State Bank of South Australia Act, 1983 were not complied with.

In reference to my findings and conclusions in relation to Section 12, I refer the reader back to the submission of the former directors of the Bank in relation to sub-section 12(6) of the State Bank of South Australia Act, 1983 and to my reasons for rejecting those submissions.⁽⁾

9.6.2 TERM OF APPOINTMENT C

For the reasons which I have given, and in the respects which I have set out in Section 9.6.1, the operations, affairs, and transactions, of the Bank in reference to the Adelaide Steamship Company Group of Companies, were not adequately and properly supervised, directed, or controlled, by the Board of Directors of the Bank, or by the Chief Executive Officer of the Bank, or by the other officers of the Bank whom I have named.

In expressing this criticism, I note the limited tenure on the Board of the Hon Donald W Simmons, Mr K J Hancock, Mr A G Prowse and Mr K Smith. The Hon Donald W Simmons passed away on 28 August 1986. Mr K J Hancock resigned from the Board on 31 December 1986. Mr K Smith resigned from the Board on 28 February 1987. Accordingly, any general reference in the text of this Chapter to the Board of Directors in relation to a period subsequent to those dates is not intended to be a reference to either of those former directors. Mr A G Prowse was appointed to the Board on 1 July 1990.

9.6.3 TERM OF APPOINTMENT D

For the reasons which I have given, and in the respects which I have set out in Section 9.6.1, the information and reports given by Bank Officers to the Bank Board were not, in all the circumstances, timely, reliable or adequate, nor were they sufficient to enable the Board adequately to discharge its functions under the Act.

 

9.7 RECOMMENDATION ON FURTHER INVESTIGATION OR ACTION

 

I recommend that each of the matters dealt with above should be the subject of administrative action within the Bank to ensure proper supervision and competence in understanding and executing the lending policies and procedures of the Bank.

 

9.8

APPENDICES