Allco Finance Group: the leasing empire GFC finished off

By the time Allco Finance Group's shares were suspended from the ASX in early 2008, the company had become something of a test case for how spectacularly wrong structured finance could go in the wrong hands at the wrong moment. The group had been, at its peak, one of Australia's more ambitious financial engineering outfits: a leasing and asset-finance conglomerate with aircraft, ships, rail equipment and property wrapped inside structures of considerable complexity. Then the Global Financial Crisis arrived, credit lines tightened, and the whole architecture fell apart.

The administrators' reports and the subsequent court proceedings make one thing plain. This was not a simple story of a company caught flat-footed by a once-in-a-generation financial shock. The seeds of the collapse were planted well before Lehman Brothers filed for Chapter 11.

What Allco Finance Group actually was

Allco grew out of the Allco Equity Partners and Allco Finance structures developed in Sydney through the 1990s and into the 2000s. Its core business was asset leasing, principally aircraft, but the group expanded aggressively into a broader financial services model. It managed a range of listed and unlisted investment funds and took significant stakes in other listed entities, including Rubicon Europe Trust, Rubicon America Trust, and, most consequentially, Allco HITS (Hybrid Infrastructure Trust Securities), along with a prominent stake in the listed airline lessor and acquirer, Allco HIT.

The group's listed parent, Allco Finance Group Limited, sat above a web of related entities. Fees flowed from the managed funds back to Allco. Allco's own debt sat partly against assets held across those funds. It was a structure that worked tolerably well when asset prices were rising and credit was cheap. It was not designed for a world in which credit markets froze and asset values fell simultaneously.

The GFC hits and the share price collapses

Through late 2007 and into 2008, Allco's share price deteriorated sharply. In early 2008, reports emerged that Allco's founder and key executive, David Coe, had borrowed money against his personal Allco shareholding from the company itself. It was a related-party arrangement that, once disclosed, unnerved the market considerably. At this point I'd note that the precise terms and legal characterisation of that arrangement were subsequently subject to litigation; the Federal Court proceedings are the appropriate place to look for authoritative findings rather than the contemporaneous press coverage, which was not always precise.

What is well established is that Allco's share price fell from above $10 to below $2 in the space of a few months. Attempts to refinance the group's debt came to nothing. The board, by then substantially reconstituted, appointed Ferrier Hodgson as voluntary administrators in March 2008.

The administrators go in

Voluntary administration is a process under the Corporations Act in which an outside professional takes control of a company's affairs, investigates its position and reports to creditors. Creditors then vote on whether the company should sign a Deed of Company Arrangement, return to its owners, or be wound up. The voluntary administration process is meant to give a breathing space, and the regulator, ASIC, oversees the registered liquidators and administrators who run it. For a more recent example of the mechanism in action, see how administration saved an airline.

Ferrier Hodgson's subsequent reports to creditors painted a picture of a group whose complexity made even basic asset-and-liability reconciliation time-consuming. The managed funds Allco operated were separate legal structures; their assets were not available to Allco creditors in the direct sense. What the administrators were working with was the parent entity's own balance sheet, and that balance sheet carried substantial debt against assets, including fund management businesses, whose value had fallen materially and whose income streams had become unreliable.

Total creditor claims across the various Allco entities ran to several billion dollars, by the administrators' reckoning. Secured creditors included major Australian and international banks. Unsecured creditors, including holders of subordinated notes and retail investors in some of the structured products, faced the prospect of receiving cents in the dollar, if that.

The Deed of Company Arrangement that eventually emerged delivered very little to unsecured creditors. That is a matter of record in the creditors' reports.

Related-party questions and the litigation that followed

The related-party issues at Allco attracted regulatory and legal attention well beyond the administration itself. ASIC commenced investigations, and civil proceedings were eventually brought in the Federal Court of Australia against a number of former Allco directors and officers. The proceedings alleged, among other things, breaches of directors' duties in connection with the company's affairs in the period leading up to its collapse.

I want to be careful here, and readers should be too. The allegations made in legal proceedings are allegations. The Federal Court proceedings resulted in findings against certain defendants on certain grounds; other claims were not established. The judgments are publicly available and are the correct reference point for anyone wanting to understand precisely what was and was not found.

What the proceedings did establish, at least in part, was that the governance of Allco in the period before its collapse raised serious questions about whether the board had adequate information about, and control over, significant financial transactions involving related parties. The Australian Securities and Investments Commission, in its public statements on the matter, characterised the conduct at issue as involving a failure of basic director obligations. The Federal Court's findings gave that characterisation some judicial support, though again the specifics require careful reading of the judgments rather than summary characterisation.

Corporate collapses of this kind can also generate litigation that runs for years. The longest-running corporate litigation in Australian history shows how long the aftermath can last.

The managed funds and their investors

One aspect of the Allco story that deserves more attention than it typically receives is what happened to the investors in Allco's managed fund vehicles. The Rubicon trusts, and the various Allco-managed infrastructure and property funds, were separate from Allco Finance Group itself, but they were tied to it operationally through management agreements, and in some cases the group held or had pledged interests in those funds as security for its own borrowings.

When Allco collapsed and the management agreements terminated or were transferred, the funds lost their manager. Investors who had put money into those vehicles found themselves holding interests in orphaned, often illiquid funds whose assets were being wound down. Some recovered something meaningful over time. Others did not. The experience was not dissimilar, in its broad outlines, to what happened to investors in Storm Financial's margin-lending structures, though the mechanisms were quite different. If you want to understand how related management structures can amplify the damage of a single corporate collapse, the Storm Financial story is instructive reading alongside this one.

Aircraft and the asset leasing book

Allco's aircraft leasing business was, in some respects, the most tangible part of the group. Physical aeroplanes sitting in hangars across the globe are harder to obscure in a set of accounts than fee income from a managed fund. The leasing book was ultimately disposed of through the administration at values that reflected the distressed-sale context; buyers who came in during the administration period were, as tends to happen in these situations, not paying top dollar.

The broader aviation leasing market has changed considerably since 2008, with a small number of large global lessors, SMBC Aviation Capital, AerCap and similar, consolidating the industry. Allco's Australian ambition in that space is largely a historical footnote now.

What Allco tells us about the pre-GFC era

Allco was not the only Australian financial group to construct elaborate fund-management and leasing structures in the mid-2000s and find that the whole thing became unmanageable once liquidity disappeared. You can draw a line between Allco and other GFC-era Australian casualties. ABC Learning used a not-dissimilar model of acquisition-and-listing-of-managed-assets, and collapsed in the same year. The pattern is worth understanding.

The common element is a business model that depended on continuous access to cheap capital to fund acquisitions, and on asset price appreciation to maintain the apparent value of what had been acquired. Management fees flowed from the funds back to the manager, creating an incentive to grow assets under management regardless of whether the underlying assets were priced sensibly. When credit tightened, the model had no defensive capacity.

In my view, the structural problem at Allco was not primarily the GFC. The GFC was the stress test; the failure was built into the architecture years before Lehman filed. A group carrying that much short-term debt against long-duration, illiquid assets, with governance structures that did not give the board clear visibility over related-party transactions, was going to face a crisis. The only question was which external shock would trigger it.

For more context on Australian corporate failures of this period, the Great Australian Collapses archive is a reasonable starting point. The HIH Insurance collapse from earlier in the decade, examined in our HIH piece, involved different mechanics but raised some of the same questions about board oversight and the limits of external audit in complex financial structures.

The aftermath: lessons not entirely learned

Ferrier Hodgson's reports, ASIC's proceedings, and the Federal Court judgments together constitute a fairly thorough post-mortem on Allco. The material is publicly available. What is harder to answer is whether the lessons stuck.

The managed-fund model that Allco exemplified, an ASX-listed manager sitting above a constellation of listed and unlisted vehicles, extracting fees and using the consolidated entity's balance sheet to support the structure, did not disappear after 2008. It evolved, became somewhat more conservatively capitalised in the immediate post-GFC period, and in various forms remains a feature of Australian financial markets. The specifics of Allco are history. The structural tensions it exposed are not.

Creditors lost billions. Retail investors in the associated funds lost considerably. A handful of individuals faced lengthy and expensive litigation. And the aircraft kept flying, operated by someone else.

— Ray Petrakis, Corporate Collapses & Insolvency