If anyone is interested, this is part of a recent Lonsec review...

If anyone is interested, this is part of a recent Lonsec review dated 11 March.

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• The primary reasons for the recommendation downgrade to Redeem are the deterioration in the estimated net asset value supporting the $1 unit price, the continuing uncertainty regarding MFS Limited and the impact this will have on the PIF (due to interdependencies between the PIF and other parts of MFS), and the decline in the risk return profile of the Fund relative to cash.

• Approximately 16% of the Fund is invested in other MFS entities, some of which have also suffered significant market value declines (or are currently suspended from trading) and some of which, like the PIF, are also dependent to varying degrees on MFS Limited for support. These entities include MFS Living and Leisure (ASX:MPY), MFS Pacific Finance (NZ Finance Company) and MFS Diversified Trust (ASX:MFT). This, together with the dramatic widening in credit spreads (fall in price) of the credit assets of the Fund and the sell off in the listed property trust sector has resulted in a deterioration of the Gross Asset Value (GAV) of the PIF.

• The PIF has a loan facility with Royal Bank of Scotland (RBOS) used to manage liquidity which is limited to 20% of GAV. In late 2007 a number of asset backed investments and mortgage loans were funded from the RBOS facility. MFS has advised Lonsec that at the time it was anticipated that this would be an interim use of the facility as a large number of loans were due to be repaid in late March 2008 (and needed to be replaced). However, the aforementioned increase in redemption requests, coupled with a decline in market value of listed MFS assets, property trusts and credit market assets has meant that the RBOS facility has not been repaid as originally intended and now represents greater than 20% of GAV. As a result, Lonsec has been informed that the PIF is in technical non-financial breach of its covenants with RBOS with respect to the gearing level specified in the PDS. Thus far, RBOS continue to be supportive of the MFS PIF and to Lonsec’s knowledge has not exercised its security rights with regard to PIF assets, however given the situation outlined above, this possibility cannot be ignored.

• The MFS PIF has a $50m support facility from MFS Limited which Lonsec has been informed has been activated (but not yet received). One potential use of this facility is to support the Fund’s $1 unit price. At the time of writing Lonsec has been informed that the estimated NTA including the $50m support facility (assuming a realisation of assets in the next 12-18 months) is approximately $0.95 (*see footnote 1). However without the assumption of the use of the $50m facility, the NTA is lower. Given that many other parts of the wider MFS group appear to be also reliant on MFS Limited for some form of support, in Lonsec’s opinion there is a significant risk that the $50m may either not be forthcoming or may only be advanced in part. Regardless, even if the full amount is ultimately extended to the PIF it is evident from the estimated NTA figure of $0.95 that it is unlikely to be of sufficient size to offset existing losses.

• Given the heritage of the PIF, 40% of the Fund is invested in mortgage loans. The bulk of MFS’s mortgage loan book is secured against property sectors that are not targeted by mainstream managers, including vacant land (around 30% of the mortgage loan book) and residential property development (around 19% of the mortgage loan book). In Lonsec’s opinion this exposes the Fund to significant development and construction risk. Whilst this type of lending is allowable under the Fund’s PDS and has been undertaken for some time, Lonsec has been informed that the principal value of loans classified as ‘non –complying’ or ‘complying under arrangement’ now represents around 25% of the mortgage loan portfolio (or around 15% of the total portfolio). In Lonsec’s opinion, this is an unacceptably high figure.

• The PIF has two loans to MFS Living and Leisure (ASX:MPY) which were originally due to be paid by 31 March 2008. In early February MPY negotiated to extend repayment of the loan to 30 May 2008, pending sale of various assets by 1 March. These loans have in recent weeks been fully drawn to $67m. On 5 March 2008 it was announced that the sale of these assets to Village Roadshow had fallen through. Whilst it is feasible that another buyer may emerge, in Lonsec’s opinion this latest development casts significant doubt as to whether these loans will be repaid when they fall due.

• The PIF also has holdings in a number of other assets which have declined significantly in value or are at some risk. These include holdings in Macquarie Fortress Notes, and unsecured notes in MFS Pacific Finance.

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