city pac the short

This is why I am short City Pacific:

We all know about the sudden and brutal force that took MFS through to oblivion. City Pacific could be on the verge of suffering the same fate. You must remember that in the weeks leading up to MFS’s demise, they were in talks to join hands (sale, merger or otherwise) with City Pacific!

City Pacific is “one of Australia’s largest non-bank loan providers with $5 billion in mortgage assets under advice, comprising $1 billion funds under management in City Pacific First Mortgage Fund, City Pacific Income Fund, City Pacific Managed Funds and City Pacific Private Fund, a residential loan book of $3.3 billion and commercial mortgage assets under management of $800 million.”

This is the company’s own description of itself, and should put it fare and square within the eye of the current storm occurring in financial markets – and in the marks of all good short players.

With regards to their development loan book, for example, they have disclosed that 80% of their $1.1 billion in loans (lent by City Pacific First Mortgage Fund, but managed by City Pacific) have interest capitalised for the term of the loan. They also state that the current Loan to Valuation Ratio across the book is at 69%. Lending money with capitalised interest is a dangerous sport: If the interest payable on the loan is capitalised, this means that the developer is only going to pay the interest owing on the loan when the property is completed and sold. If the property market slows, this means that the loan (and its interest) will not be paid until the property can be liquidated. This provides the potential for their loan book, and in particular, the LVR of the book to blow out very quickly. Furthermore, if the relevant developer can not sell the development stock, then they are not going to be able to pay the loan back, and interest (and principal) is only recoverable if the property is sold at the right price and in a timely manner – both being very difficult to achieve if the market slows.

With regards to the relevant City Pacific funds that are advancing the loans, these are likely to be moving into a very difficult period, and therefore, may struggle to pay the required management fees etc to the head company, City Pacific. It would seem that growth potential for the company would only come at a significant increase of the current level of risk the company is exposed to.

It is unclear as to the breakdown of how City Pacific funds its relevant operations. Disclosures refer to a $200 million securitisation facility through Westpac, and that they have “institutional funding lines” in place in conjunction “with some of the largest domestic banking institutions”. It is highly likely that in the current environment, any such institutions would be taking a very close look at any exposure that they have in relation to these funding facilities. Furthermore, in the current ‘credit crisis’ environment, it is unlikely that further credit would be extended beyond existing facilities in place.

If there is any disclosure of loan defaults, funding difficulties, investor redemptions etc to the market, then City Pacific are likely to suffer a brutal blow to their ability to raise any further funding from investors or institution – and probably see a run on their funds in the form of investor redemptions.

It is likely that this is a particularly precarious time for City Pacific. They are due to report profits and dividend this month. Also, they are due to settle on their Marina Cove purchase for $49 million. This is a JV with the Raptis Group – which has been in the course of the last year or so, putting up buildings faster than they can be sold in the South East corner. As one property veteran recently said, Jim Raptis has a nack for going big at the peak of the cycle (ie like now) – and has been bust twice before?!!

The current situation with the shareprice may also see an MFS-type situation where investors that have margin loans become forced sellers of the stock. As was seen with the dumping of MFS stock owned by Michael King and Paul Manka, when director’s shares are secured on margin, if the share price falls as with MFS’s shares, then this could potentially add “fuel to the fire”, so to speak.

City Pacific is a constituent of the ASX 200, and therefore many margin lenders (and Contracts for Difference providers) allow investors to leverage into the stock. According to the 2007 Annual Report for City Pacific, the largest shareholder is a company called Maldon Pty Ltd. ASIC records show that this company is associated with City Pacific CEO, Phil Sullivan. However, more interestingly ASIC records show that this company has fixed and floating charges registered in to the National Australia Bank, St. George Bank, and the dead give-away, Leveraged Equities Limited. It is highly likely that Maldon Pty Ltd’s ownership of City Pacific stock is leveraged. This makes it a potentially dangerous situation if/when the share price falls.

With regards to the recent director buying, this can hardly be called ‘support’ for the stock. The amount of stock bought was absolutely puny for these guys: Sullivan bought only 16,214 shares; Stone bought 20,000 shares; and Swan and Donaldson only bought 14,000 and 7,500 shares respectively. Between the 4 directors, and for rich-listers like Sullivan and Stone, $153k of shares can hardly be called support for their stock! Especially given that, for example, Stone’s relatively puny parcels were at an average price of $2.39!

I note with interest that since the company’s announcement mid January that they are going to report a strong profit, the share price has continued its long downward trend. OK, bad market, but in summary, the market doesn’t believe them. This is similar to announcements from other companies that the market simply does not believe in any more… Al la MFS, Allco et al.

If you own this thing, sell; if you want to get on the short side use CMC or Macquarie Prime.

Do your own research, and understand that this is just a personal opinion…