Taking Stock 1 May 2025

AT a time when fund managers and investors are cautious about the robustness of sharemarkets, attention logically turns to debt markets - bank deposits, bonds etc.

New Zealand can be grateful that the practice of buying into private credit loans is rare in our country, and generally restricted to these whose wealth can absorb large losses, or to those who control other people’s money. Bank deposits and the bond market here look robust.

A relatively new concept, private credit is usually offered by very large-scale fund managers, like BlackRock or Apollo, based in the USA or UK, where they arrange funding that main street banks prefer to decline.

Private credit, now a trillion US dollar sector, steps up when companies either cannot borrow from banks, will not accept the conditions of bank loans, or have no other choice.

The arrangers of the lending facility often provide the money and then on-sell chunks of the loan to other fund managers, to wealthy individuals, or, most often, to pension funds.

The likes of Apollo or BlackRock will retain some part of the loan to ensure the loan is managed, and that the borrower is supervised.

Fees result; handsome fees.

Generally the loans are to aspirational or troubled companies.

Default rates are rising to a level so far estimated at 1%, but according to BlackRock likely to settle between 2% and 4% this year. To me that forecast seems optimistic.

The additional margin priced into the private credit lending, compared to high grade lending, has risen from 2.5% to 4.5%.

Despite highly favourable repayment lenience, such as interest rate holidays, around 20% of private credit loans were "classified" last year. That is corporate speak for loans "under scrutiny," not performing as planned.

By comparison, US banks "classified" 3.2% of loans.

Private credit is not the same as high-yield bonds. Bonds have liquidity in a visible market and are high yielding if the credit rating of the company is at the lower range, say BBB, as opposed to AA.

By contrast, private credit is an opaque area of lending, often targeting high-risk lending to those who are buying out competitors.

When Elon Musk sought to buy Twitter he borrowed tens of billions, the banks unwisely participating in this transaction.

At least that arrangement was transparent, the Musk bonds selling at a painful discount almost from day one.

They now sell around 97c in the dollar, yielding 11% returns after failing to attract bids at just 70c in the dollar in 2022. The banks will be mightily relieved. They owned six billion of these securities. 

At the time of the Musk transaction, I was reminded of the gullibility gap between sage investors and high-risk investors, a gap that had been discussed in New Zealand when Telecom made its superbly timed exit from the now obsolete Yellow Pages (YP).

The consortium that bought YP was, as you would expect, led by a pension fund, managed by those without vested interest. At the time an NZ sales group rang our office and advised that the transaction would be funded by a huge bond offer to retail investors.

“How much would you want to reserve for your clients?” we were asked.

As you might surmise, the answer was “nil”.

The offered interest rate might have been extreme, but the risk of failure was obvious as by then most could see that the internet was excavating the ground below the Yellow Pages.

Much of the private credit now being rolled over and offered to pension funds and wealthy investors displays very similar characteristics to the Yellow Page transaction.

Whatever the truth about bank people the fact remains that the banks have a fantastic database, a very high level of real capital, and a future characterised by high, sustainable profits providing they do not walk into the traps set by struggling companies, or by greedy profit targets.

Private credit has grown to its extreme size based on banks not being willing to lend indiscriminately, and reacting to risk by demanding highly prescriptive covenants, imposing discipline, and even handbrakes, on aspirational risk-taking businesses.

When equity market valuations became extreme, and the flood of printed money was leading to improbably frequent merger and acquisition proposals, the private equity managers and hedge funds needed to find avenues for the high returns on which their bonuses depend.

Hedge funds might have turned to currency speculation, or to shorting different sectors.

Private equity turned to private credit.

Perhaps some of this “credit” was to salvage the very same companies in which the manager had invested other people’s capital. We will discover, probably this year, whether that strategy was pouring other people’s money into deals that could not be salvaged.

It is of comfort to me that those individuals I know to have invested into private credit deals, chasing double figure returns, can afford to write off any losses.

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IT is precisely because of the undeniably high risk of failure in financial markets - think debt levels, household debt, high risk merger and acquisition prices, high multiples of assumed future earnings in equity markets - that I remain perhaps the sole fan of former Reserve Bank governor, Adrian Orr. Perhaps I am the president of a club of one.

Let me back off this position first.

Orr was most unwise to accept some of the conflicting social engineering ideas of Ardern and Robertson and he should have campaigned against the converting of his board to people with no or precious little relevance to central banking. The knowledge of, and empathy for, central banking of Ardern and Robertson could have been written in lipstick on the wings of an aviating sow.

Orr should have been stronger on opposing inappropriate populists being appointed to trading banking directorships. He should have opposed any Crown underwrite of private finance companies.

But his merits far exceeded these errors.

Orr understood that the global financial markets rest on the tip of the nose of a crocodile, and may do so for years.

Having led the country's biggest investment fund, he had active networks that made global risk readily understood and discussed.

He knows what banking failures do to a society and an economy. He was not appointed to be “popular”, or political, or patient with “gotcha” media, themselves often with political bias.

Under his leadership, the banks operating in New Zealand were forced to increase capital and to prepare for a global event that could – could - be catastrophic. It may be averted. It may not. He understood.

Global debt levels might have been the trigger of his concern.

Never before has so much debt existed, relative to income, either at sovereign or household levels.

His response - to virtually double the capital requirements of banks - was an earthy, practical response, possibly the only option if governments around the world continued to prioritise re-election rather than solve the problems that begin with perpetual fiscal deficits.

Orr is fiery. So what? He is impatient with those who cannot do the calculus, or even the arithmetic. So what?

He would never have electorate appeal. His bedside manner is gruff.

Rightly, he does not care much about what unaccountable media people might write, yet, inexplicably, he graciously allowed even self-employed social media people to attend official functions.

He was accountable for solving problems and building protection against what he could see were dangerous possibilities, caused by a highly imbalanced world. Controlling inflation and ensuring banks were robust made up 99% of his agenda, if one ignores all the political stuff.

In many ways he was, and knew he was, the smartest person in the room.

Somebody has to be the smartest person in the room. I expect a CEO to be this person.

He largely ignored those who had previously worked in the Reserve Bank, had strong opinions, but had left, and now live amongst the bottom feeders in social media, who share their views with those in the media to whom central banking is a rather mysterious concept.

All of his tasks require a strong man.

Orr has now left his job. He is too young, too experienced, and too vital to disappear onto some riverbank, to fish for trout, ride his bicycle around the bays or write blogs to a tiny audience.

If the world is going to have a coterie of Trumps, it will need the likes of Orr to stand in their way.

His replacement, Christian Hawkesby, is a highly intelligent, socially mellow man with an impressive range of experiences. 

One hopes he too can stand tall, as does Jerome Powell, the chairman of the US Federal Reserve.

The last thing the world needs is mousey central bankers bullied by politicians with a hidden agenda.

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IF all timetables are met in July the NZ government will underwrite bank deposits, finance company deposits, and those of credit unions and building societies, to a level of $100,000 per investor, per deposit.

An investor may use multiple banks and finance companies to chase the highest returns without risk, up to the $100,000 figure per person, per bank.

Oddly, there is no signal that banks can offer higher deposit rates that do not attract the guarantee, instead passing on the cost of the guarantee to clients.

If there were such an opportunity for a higher rate I would assess the bank and potentially take the higher rate.

In my opinion the scheme has erred egregiously in offering guarantees to private finance companies, building societies and credit unions.

At the very least, such munificence ought to be offset by fees payable to the Crown to reflect real risk. Fees ought to be equal to what an insurance company would charge for such a guarantee.

In the case of virtually all NZ finance companies that seek retail funding, that fee would be around 5%.

Instead, the Crown will charge around 0.2%, and only a little less to the much more sustainable banks.

Investors can chase risk with impunity, using the taxpayer guarantee as a free backstop.

One must hope that Hawkesby’s leadership puts heavy emphasis on micro-managing any non-bank that is eligible for the guarantee and is particularly harsh on adjudicating whether their directors and managers are fit and proper people.

Prior to the 2008 finance company debacle I would have met at least 100 directors and managers.

Pitifully few would be judged as fit and proper people and many who gave no signs of being unfit or improper proved to be spineless and incompetent when the markets subjected them to pressure. The Crown bonfired more than two billion dollars.

Hawkesby, one hopes, has enough back street wisdom to be fierce in protecting taxpayers from such people.

$2 billion equals a Dunedin hospital.

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TWO billion dollars also equals the current expected benefit to the Crown if the Central Otago proposed gold mine at Bendigo/Ophir proceeds, mines gold, and sells it at existing prices.

The gold price has surged for several reasons, the biggest being global central bank buying to hedge against falling confidence in fiat currencies like the US dollar.

Another major influence has been retail buying in China and India, where gold is more revered than bank deposits.

Nobody, least of all me, can foretell gold prices, though Goldman Sachs tries.

It forecasts the gold price will rise by a further 20% in the next 12 months.

If New Zealand chose not to produce gold in the current pricing environment, it would be an outlier.

The Bendigo/Ophir project planned by Santana Minerals will file its consent application within the next eight weeks. The Environmental Protection Agency (EPA) will review the application to ensure it addresses all issues relevant to the environment.

A Fast-track panel, including a representative of the Central Otago District Council, will then assess the proposal, weighing economic benefits against environmental concerns. The EPA has 15 days to review what will be literally hundreds of pages of environmental information. If it finds the application has not addressed all relevant issues, it may decline to forward it to the Fast-track panel.

The Fast-track panel will have no more than six months to make a decision on any application handed to it by the EPA. One would hope that the Fast-track panel would process applications efficiently. Six months sounds like a very lengthy deliberation.

If the project proceeds and if the gold price remains elevated, the Cromwell town and its surrounding areas will celebrate.

Support for the plan is high, as illustrated at a recent A&P weekend in Wanaka, where Santana directors and staff manned an information centre. Support recorded exceeded opposition by a ratio of around 197 to 3.

Santana shareholders, which on a small scale (1.25%) includes my family, will be paying attention to what will be one of the first projects subject to the Fast-track legislation. 

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Travel

Auckland (Albany) – 2 May – Edward Lee

Palmerston North – 6 May– David ColmanWellington – 7 May – Edward Lee

New Plymouth – 9 May – David Colman

Nelson – 12 May – Chris Lee (FULL)

Blenheim (pm) – 13 May – Chris Lee (One appointment time available)

Auckland (North Shore) – 26 May – Chris Lee

Auckland (Ellerslie) – 27 May & 28 May am – Chris Lee

Please contact us if you would like to make an appointment to see any of our advisers.

Chris Lee

Chris Lee & Partners