Market News 31 May 2010 

Just add water. Water is life.

With due respect to flooded areas, the past two weeks of rain have been fantastic for NZ. I hope the storage and re-distribution governors are making progress.

Water is the source of value for our largest industry, via the land and production unit (could we just call it a cow? - Ed)

Water is also a necessary substance for our second largest industry, tourism.

The amount of water has been good for our health (longer sleeps in the weekend) and catching up on recorded television events (Monaco F1).

Contrary to expectation I have enjoyed the recent run of weather.

Investment Opinion

Teaching the teachers - I would like to have seen Oscar Kightley on the Committee that developed the Code of Professional Conduct for Financial Advisers.

A recent quote from him is compelling. When asked about his Shortland Street experience he replied - 'The impact it had on my career was huge. There are no schools that teach you those skills'. I feel the same way about my experience from time in financial markets. I know this is also true for many of my peers.

Oscar's quote got me thinking about the teachers who will present our compulsory courses required to meet the Code's new minimum competence test.

With all due respect I doubt any teachers will have spent much, if any, time in financial markets making the content theory based. The outcome could be like letting my son free on the road, alone, with only his driving theory complete.

In my experience most teachers (and nurses - Ed) are underpaid. Financial markets incomes are usually significantly higher than those in teaching. Given the choice teachers with a passion or skill for finance would be working in the finance industry, not teaching on the subject.

We completely endorse the need for competence, but question whether you achieve it in this industry via an exam paper.

I shall always recommend that people seek financial advice firstly from those who display integrity (or have reliable references to this affect), secondly from those with experience in financial markets, and finally from those who meet a qualification test. All of the above is ideal. The rest should be avoided.

I remain concerned that the new compulsory school work will result in the retirement of many of NZ's best and most experienced financial advisers. They will be replaced by a less experienced group who complete the school work.

The Code is about to be finalised. We are grateful to the committee for its efforts.

SOE - We are reading more about our SOE's looking to invest offshore. I am having a hard time making sense of this. It is not sticking to their knitting, it is not helping our capital markets to develop and we have witnessed plenty of mistakes with offshore investment.

I read an article that presented the idea that it was necessary to increase returns on capital for the government. As a tax payer I would be more accepting if it was a low risk option but I doubt that is the case.

The NZ Government declined the recommendation from the Capital Markets Development Task Force to partially list SOE's and allow the public to invest. This suggests they wish to retain 100% ownership.

Credit rating agencies enhance ratings where a business is significantly influenced by the government (ownership or regulatory affect).

On the basis of the conditions above I wonder why the government doesn't simply guarantee the senior debts of an SOE, reduce the capital invested and thus increase the returns on capital without increasing investment risks offshore?

How about we take the capital reduction and apply it to Kiwibank for greater returns?

Kiwibank shares - Commentary opposed to the idea of selling shares in Kiwibank is usually encouraged by those who chant - 'don't sell our stuff'.

With respect to Kiwibank the idea is not to 'sell the stuff' but to ask for more investment to help Kiwibank grow. Either the government needs to put more money in or invite the others to do so. So let's have that debate.

Our capital markets need to expand, for the sake of our economy and to provide investors with more opportunities. Listing Kiwibank shares has the potential to achieve three goals at once (bank growth, support our economy, increased investment opportunity).

Why does Kiwibank need more capital?

For every $1 that Kiwibank wishes to lend they must have an average of 8 cents of their own capital. 

Home mortgages require less capital support (4 cents per $1 loaned) relative to business loans (8 cents per $1 loaned). 

Last year the bank had $355m of equity and around $8.5 billion of loans (mostly home mortgages). The recent perpetual preference share issue of $150m allows the bank to grow a little more but if they want to push into the business loan sector they'll need more capital, more quickly.

I was not in favour of Kiwibank when Jim Anderton proposed it. However, I am happy to declare that my view has been proved incorrect and Anderton's correct. I am now very pleased he pushed the business to the start line.

It would be poor governance to stop the bank from growing in the face of public support and an economic need. 

Let's provide the bank with the capital it needs, whether from government or new public investors.

What's the message? - The US has a 30 year bond (called Treasuries) on issue. They currently offer a yield 4.24% which to a Kiwi eye looks like a poor option for a long term investment. 

However, this is the biggest financial market in the world and this bond yield is the distilled opinion of hundreds of thousands, possibly millions of investors. 4.24% is considered appropriate at present.

So what are the messages this is sending us?

One message might be that investors expect low or no inflation for a very long time.

Another message may be that investors expect similarly low returns on other investments, such as shares or property, over a long time frame. 

Perhaps it means that the world’s investors do not expect consumers to increase demand for goods and services to fire up inflation?

Perhaps it just reflects a huge demand from investors willing to ignore returns to simply park money in the safest asset they can find?

None of these possibilities paint a picture of a world with a belief in strong economic prospects.

Experience in financial markets teaches you to ask - 'what isn't the market considering?' - to try and understand possible unexpected outcomes. For now I find it hard to argue with the markets conclusions.

A rising gold price, but a falling oil price, is consistent with market concerns being expressed through very low long term interest rates.  

Investment News

St Laurence – Stock & Share continue to write to different groups on the STL register making offers to buy STL debentures at prices that are extremely low and in our view is a waste of time for investors.

All such offers belong in the rubbish bin or fire place. Indeed we believe any unsolicited offer should prompt investors to seek advice. If they choose not to get such advice the only logical alternative is the rubbish bin rather than to accept an offer without knowledge.

We will lose money on our STL investments but we do not want someone else to profit from them at our expense.

Our advice – wait for the receivers report on value due in the weeks ahead.

Mobil - appears to want out of our markets too, which would be great news for Infratil (Shell / Greenstone). They have just sold off their 300 outlets in Australia.

Meanwhile BP and their image are also a little distracted in the Gulf of Mexico.

I wonder if Greenstone will sneak through and claim 50% market share in NZ?

Infratil - I noticed another 'win' for Infratil over the weekend. The regulated pricing caps are being 'eased' on electricity sold in Queensland with the state government allowing a 13% increase in the pricing of electricity.

Queensland has been a growth state for Infratil Energy Australia but until price caps were removed they were not prepared to allocate much capital to building their business in this state.

The price increases being allowed by the Queensland state government suggest profit margins can now rise and thus investment in new generation can occur. There will be good reason to compete for more retail customers again.

Victoria and South Australia have unregulated electricity pricing and have been successful 'hunting grounds' for IEA. It'll be nice if Queensland ultimately joins this less regulated pricing environment.

Rural Portfolio Capital - will go down as one of the quickest receivership/liquidations in history. Aside from the loss, the rapid clean up is refreshing after a failure.

47 cents per $1 invested was paid out last Friday. The trustee stated that perhaps another 1.25 cents will be repaid. 

They should be able to pay this full amount because the remaining $228,000 looks like plenty to pay the trustee, the receiver and the brokers who sold the shares. I estimate the broker will have been paid about $70,000 for their part leaving a healthy balance for the others.

This should all happen quite quickly as there appears little more needs to do be done.

With the benefit of hindsight I sit here wondering why Rural Portfolio Investments, their brokers and our trustee didn't discuss buying put options (right to sell) on their PGW shares at a price that provided a higher level of capital protection for RPC lenders?

Perhaps our market is just too small for such deals. This deal is now over.

Fairfax - has written to remaining holder of the redeemable preference shares prior to the 15 June 2010 maturity date. Technically Fairfax are exercising their right to 'call' back and repay the securities.

The letter asks holders to sign a transfer form and return with a holder statement. This seems a waste of time to us and this is confirmed by the final paragraph of the letter which states:

'If the registrar does not receive the abovementioned documents from you by 15 June 2010, it will execute a transfer form on your behalf'.

Repayment will clearly be made on 15 June 2010.

GG Interest? - It is possible that investors in failed finance companies may receive interest up until the day the government repays an eligible investor. At least that is the case if you read recent comments from Matt Lancaster, trustee for Vision Securities Ltd.

This possibility all depends on trust deeds and interpretations of them, however, a story last week has the Treasury apparently accepting the trustees view that, with respect to VSL, interest accrues until principal is repaid (regardless of who makes the payment).

This is not what we expected and we suspect not what the Treasury wanted!

We suggest that you do not budget on this but it may be an unexpected positive development. Mind you, the Treasury might react by stating they are buying the obligations, not repaying them, thus negating the trustees position.

I have always found that I can rely on time to yield the answer.

We think investors should be very happy about the presence of the GG and not get too concerned about the finer points of interest in the remaining days between any failure and the recovery our an investment.

NZF Group - Excellent news. The securitisation market may be gradually re-opening and has supported NZF Group with the sale of $100m of their Residential Backed Mortgage Bonds (RMBS). 

RMBS securitisation is (briefly speaking) the bundling of many residential mortgages into a single pool, then selling bonds that represent different risks within that pool.

Imagine a layer cake represents the pool of mortgages. The icing on top represents the strongest tranche to invest in with usually 3-4 more layers below that in weakening credit order for investors to consider. 

Each layer of the cake offers a different risk and thus a different reward. (unless its a banana cake with no layers and appears to be a confused structure - Ed)

This is great news for NZF and represents the wholesale funding we felt they were best to pursue. It is also very healthy to see securitisation markets re-emerging as a source of funding.

Access to this funding is now a function of Westpac's ongoing commitment to NZF and to the securitisation market. We hope they are long term supporters.

SCF - Standard & Poor has surprised South Canterbury Finance by cutting their credit rating to B+, down from BB citing concerns about liquidity. 

It would be a surprising outcome if a company with a government guarantee could not borrow money. If Matt Lancaster's opinion (above) is correct, about interest being guaranteed until principal is repaid, then SCF is the best risk versus reward investment available for one year in NZ.

If longer term deposits would provide comfort to S&P then investors planning to extend their deposit are encourage to decide sooner, rather than later. This will provide more evidence of investor support.

Sandy Maier should also be drafting the letter to holders of his 'auto extend' bonds (SCF030) explaining that SCF will retain their investment for another year, until 8 October 2011 under the extended GG.

If S&P concerns prove correct, and SCF fails as a result of insolvency, the price of SCF's bond maturing in 2012 (SCF010) should rise rapidly. Let's keep an eye on that one.

Maier has confirmed that the credit rating change does not impact on the government guarantee for SCF investors.

Credit Margins - the price of risk is rising again, which shouldn't be surprising given the huge increase in market volatility recently.

In other words, the rewards sought are going up for accepting the same level of risk. 

I hope this will help to again lift long term interest rates back above 7% for investors, even if underlying interest rates remain low.

Princes Wharf Hotel Bonds - investors should have received a letter explaining that a proposal will be delivered to them by July. The proposal will ask investors to vote on a two year extension to the bonds.

ASB Bank has agreed to extend its funding on the condition that bond holders also agree and that the building is sold by September 2012.

I ponder the notion that bond holders should agree too but seek a rising interest rate for each half year that passes without the hotel being sold.

Bond holders now carry a relatively high level of risk given that the level of equity in the hotel is low. Certainly much lower than before. Accordingly the potential returns for bond holders should rise.

Babcock & Brown - We called Deloitte in Sydney for an update on their pursuit of Directors and executives of B&B.

They explained that they have received all of the documents sought from the company. 

The liquidator and legal teams are studying the documents and by August plan to begin public examinations (formal questioning in court) of the directors and executives.

Deloitte hope to communicate with B&B investors in four to six weeks to update them on the situation.

Deloitte has a useful website which investors may wish to bookmark for monitoring progress.

I haven't budgeted on any repayment from this process but like Tony Gavigans efforts with Feltex we applaud Deloittes efforts to investigate the B&B failure more deeply to confirm whether or not rules were broken.

Fidelity - No sooner do I open my mouth and gain confidence than the markets have a hugely volatile week resulting in losses for this fund! 

The fund is now at risk of not having sufficient cash held to pay the July interest payment. If they do not it will accrue and compound until January 2011. This is a frustration to investors and to the manager who hoped to avoid this sort of occurrence again.

The rising volatility in markets is a double edged sword though because it increases the income available for the Fidelity Bond fund (managed by Tyndall). They have displayed the skills to recover from these knocks and we'll give them time to do so again.

The bonds traded at 12% last Wednesday, a gross price of $96.90 per $100. If no more interest is paid between now and maturity the return on such a purchase would be 1.20% p.a.. Put differently, the minimum return is 1.20% p.a. with an upside of 12% p.a.

Accordingly, along with the capital protection from Westpac, we discourage investors from selling these bonds at current pricing.

Ever the Optimist - NZ enjoyed its first annual trade surplus in nine years last year. Exports are up and imports are down a little. We look like we are getting the message as a nation and wish to earn more than we spend, which is a state of mind that must be retained.

Investment Opportunities

SHELL (Aotea Energy) - Infratil is considering a bond issue by Aotea Energy to repay bank funding used when they purchased Shell NZ.  If they confirm a bond issue, we expect it to be long term (five or six years) and to arrive in about a months time.

In preparation we encourage investors to read the excellent report provided by Infratil which discusses details surrounding the Shell NZ business.

A very long serving (now retired) staff member of Shell contacted us after reading the above report and describes it as the best summary of the business he has read including reports available whilst employed! He was impressed by the successful strategy of identifying and developing the busiest sites and having market share rise as a result. He plans to invest in the pending bond issue.

We will continue to build a mail list in the expectation of a bond issue from this business. If you would like to be added to this list please contact us by phone, email or the website. 

Secondary Market - If you have spare cash to invest and would like some ideas from the markets please email your portfolio to us and we will be happy to offer suggestions.

Property Trusts - still offer attractive yields to investors. Unit pricing appears to reflect all the worst news markets can discover.

What they may have lost with respect to tax deductions many investors have gained with PIE tax rates falling to 28%. Investors seeking higher returns (above 8%) from a relatively stable asset price should consider this sector closely.

Michael Warrington Senior Consultant Projects Resources Limited

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Market News 24 May 2010 

There must be thousands of New Zealanders who have completed 75 hours of community work recently.

I'll wager that a large portion of them have lost at least $37,500 during the past two years. 

Yet I am certain that none feel as cheerful as Mark Bryers looked when he left court last week?

In this particular case I suspect the public holds little or no respect for either the justice system or investment laws that allow such an outcome.

Maybe there are more serious charges yet to come for Mr Bryers and maybe they’ll have much more significant penalties. We hope so.

Investment Opinion

Commerce Commission - I am all for our regulators becoming more involved in challenging poor form but after reading their recent findings on credit card fees I raised my eyebrows and thought 'there must be a better use of their resources than this'.

In an environment where reducing debt is encouraged high interest rates and fees for failing to meet obligations should encourage a change in consumer behaviour. They shouldn't require the ComCom to step in on their behalf.

The terms were part of our agreement to access the credit. The consumer has a lot of choice and can easily avoid the fees being assessed. ComCom criticising banks by arguing that a $25 fee is too high for late payment by a borrower (via credit card) strikes me as missing the wood amongst the trees.

I would be happier if they spent their allocation of our taxes on those misusing capital, and mis-representing facts than helping those behaving poorly with too much debt. Irongate - It's just an opinion, but I expect Irongate will repay its bonds maturing on 15 July 2010. It is too important not to, on several counts.

They have been buying back their own bonds on market, which indicates bank approval for this use of cash surpluses. There are $28.9m bonds on issue but Irongate now own about $1.4m of these leaving $27.5m to repay.

They recently sold the shares they held in National Property Trust, representing 8.85% of NAP, to raise $7.5m cash. However, the NZX release states that they didn't sell of their NAP shares. The declaration stated they still own 1.03% of the company.

Recent trading data for the bonds shows only two or three buyers. Irongate is one and I think I know the other two. Everyone else is sitting hoping to be repaid. 

I think they'll be satisfied and recent sellers may not be.

I know that nothing is certain in the world of investment, but...

Disclosure - I own a few and will keep them until maturity.

Invest in Dairy - market commentators and investors often describe the difficulty in finding investments in our largest industry, dairying. We were discussing in the office an opportunity that exists right now. 

South Canterbury Finance owns about 33.5% of Dairy Holdings Ltd, a significant South Island dairy farming business. This asset does not fit comfortably on a finance company balance sheet under the new regulations for Non Bank Deposit Takers. However, with analysts discussing the potential for a milk price next season of $8 per KgMS (Milk Solids) it may yet prove to be a jewel in the equity of SCF.

Further North the receivers are trying to sell the heavily indebted Crafar dairy farms. They currently have a conditional deal on the table but will still consider other bids.

Is there not a glaring opportunity for Dairy Holdings to arrange the largest float of 2010, offering out SCF's shares, raising new equity, buying the Crafar farms?

This achieve milestones for three different groups in one move. SCF would receive cash equity in return for the sale of its shares in Dairy Holdings. The receivers would sell the Crafar farms (to politically acceptable local ownership). finally, the NZ public would gain investment access to dairy farming returns.

As an aside the Capital Markets Development Task Force and the NZX would also be very satisfied with this outcome. After I wrote these words I heard Federated Farmers on the radio calling for NZ to buy the Crafar Farms.

Perhaps Sandy Maier could put in a call to a couple of significant NZX brokers and to KordaMentha to discuss the idea. Maybe the NZ Super Fund could underwrite an offer to the public? 

He'll have to act fast if he likes the idea.

NZX - given the importance of capital markets to our economy the NZX is an important cog in its role of capital raising and exchanging ownership of securities.

A person that I consider to be an industry friend resigned from the NZX recently. What caught my attention was that he was the next in a long line of people who have left the NZX during recent months.

You may recall from recent comments that I quite like the prospects for success that are available to the NZX, but you cannot execute a strategy without key staff. Even a monopoly bus service cannot leave the depot without a driver.

It is quite common to have employees who disagree with their employer over decisions or direction. An employee can be wrong in their strongly held view or perhaps they do not have all the facts. However, when many of the team start putting their wallet where their mouth is and resign, it implies to me there are problems at the leadership level.

I know two of the NZX directors reasonably well. I am pleased about their presence on the board. I hear very good comments about two other board members. So governance appears to be very strong.

Therefore I can only conclude that the CEO, Mark Weldon, may have a weakness with respect to leadership of people. Perhaps we expect too much of a busy person whose focus seems to be strategic.

He has delivered significant progress for the business in recent years but this success could slow significantly if staff turnover results from a weakness in leadership.

Disclosure - I own a few shares and will keep them, but I am disappointed by recent developments.

Investment News

Budget - A well received strategy by all accounts. I am certainly impressed by the volume of changes adopted from the the Tax Working Group recommendations. 

I am convinced that the Hon. Bill English noticed how much fun I was having the day I read the TWG report (refer to Market News archive 8 March 2010 - boating, beach, sunshine) he felt it only fair that all of NZ should find such pleasure from the document. (that's a longer bow than Robin Hood's - Ed)

The government is beginning the recommended process of broadening and flattening the tax base of NZ and I think there is more to come. 

The property sector has seen the arrival of more tax impact and negative affects on their net income. I think this situation will expand in coming years, hopefully excluding the 'family home'.

Capital gains tax is already an obligation on those who trade properties with the intention of profit. Armed with property ownership registry information I suspect that IRD will increase compliance monitoring in this area.

S&P declare that NZ has sound public finances and it supports our current 'AA+' credit rating. It's a nice position to be in when you observe Europe from the sidelines.

Unlike the respect shown for the wise men of the TWG the government has ignored our advice and not aligned PIE tax rates with trusts and the top personal tax rate (now 33%). The PIE regime leaves one tax loophole for highly paid investors to reduce some tax to the 28% corporate level.

Perhaps the government decided it was better to encourage more savings (via PIE vehicles) than to remove the benefits and thus recover the $30-40m of tax we estimated was available.

Retired investors should enjoy increases in their income which will be a welcome change. A couple receiving national super and income from 250,000 invested should experience an increase of about $1,200 per annum (2% increase to National super plus reduced personal tax rates). This is equivalent to earning interest on an additional $20,000 capital. Some of this will be needed for offsetting the GST increase.

From an investor perspective we think this has been a good budget too, especially for those in shares and fixed interest investments. Growth investments will benefit from the lower corporate (and PIE) tax rate and possibly higher growth rates following the tax cuts. Fixed interest investors will benefit from lower personal tax rates. We expect withholding tax rates to fall, in line with the new personal tax rates.

RBNZ - is likely to increase the OCR shortly but it will not be in response to GST. They are more interested in underlying trends and will look through the one off's like GST increases. That is of course conditional on businesses not taking advantage of a landscape to make further subtle price increases.

SCF - has received $15.5m more equity from George Kerr interests and they have announced $202 million in repaid loans. Don't get too excited about the scale of loan repayments.

The time frame is since the start of 2010 (4 months) which represents only $50m per month. SCF has about $1.3 Billion of non property lending (60% of the business) and loan terms we believe average about 24 months. On this basis we would have expected monthly repayments to be not less than $50m anyway. 

This doesn't leave that many, if any, impaired loans having been repaid or sold at a discount to third parties.

Reducing the size SCF's lending book is vital so we applaud the progress but we suspect they need it to reduce at that same rate every month, for the next 18 months, to position the business at a manageable size by late 2011.

Ideally, by December 2011, SCF will have completely exited its property development loans, isolated non-core assets, increased equity and retained profitable consumer and business lending of around $750m.

These are small steps in the right direction but there's still a lot of hard work to do.

SCF #2 - has approached all investors with deposits maturing between now and October 2010. They are making an attractive offer to these investors if they agree to extend their deposit now.

You are encouraged to get advice before accepting the offer. Investors should be sure to hold enough cash, be happy with 12-15 month investments and to not over-invest.

You are free to handwrite your brokers name into the broker box and return directly to SCF to avoid missing the deadline.

Downer EDI - holders of bonds issued by Downer EDI (Works) should be pleased by last week’s news about new long term contracts. 

The new A$300m contract to maintain state highway 5 has a duration of three years, finishing beyond the maturity of the two bonds issued in NZ. 

The company has been focusing on generating recurring income. They have added A$1 billion of such revenue since February and are in the running for up to A$3.5 Billion more over coming months.

Downer appears to be an example of a company on a path to success. Sadly whilst this is good news for bond holders it also means banks will start competing with the public by agreeing to lend to Downer in future! 

I hope the management remember who was there for them when borrowing money wasn't so easy.

Shell - all Infratil investors (shares and bonds) are presumably becoming focused consumers at SHELL stations. There is now a financial incentive for them to do so!

Bans - Germany is to ban 'naked' short selling of government bonds and shares in financial institutions (banks and insurers). 

Before you imagine that we, of the financial markets membership, are at our most confident that prices will fall when we are naked, allow me to explain.

'Naked short selling' occurs where a market participant starts with no investment position at all, then sells something they do not have. They hope the price will fall, at which point they will buy the item back for a profit. Unless of course they get it wrong and the price rises and the result is a loss, on the investment they never really had.

For fun I shall call the alternatives 'clothed selling' which are allowed. 

If you already own something then you are entitled to sell it (exit the investment). 

If you already own something that you wish to keep, but fear falling prices, you may wish to sell a very similar product to protect against anticipated price declines, you may do so (Hedging). 

Finally, you may wish to invest in one product where you expect stable or rising prices (say green apples) but sell another product where you anticipate falling prices (say, red apples), you may do so (Spread trading).

So, for a while, the German government will not tolerate selling something you do not own without good reason. In line with an eighties tune, 'the only way is up'. At least that is the case if you value your banking or broking licence. 

This action has upset financial markets and increased volatility (unexpected action). The German government will not stop prices from falling but they hope to stop attacks on companies by others with much larger wallets and a significant tolerance for risk.

This decision is not fair, or balanced, but I learnt from my parents early that this would be the case in life. They have been proved correct more times than I can remember so today's announcement is no surprise to me.

Fear is escalating again and regulators want control earlier this time.

Ever the Optimist - A dairy analyst recently commented that they believe $8.00 per KgMS for farmers is possible in the coming season. That would be outstanding for NZ. Their forecast was presumably prior to the kiwi dollar falling against the USD last week.

Investment Opportunities  

SHELL (Aotea Energy) - Infratil confirmed at their recent annual meeting they are considering a bond issue by Aotea to repay bank funding. 

Pricing will be impacted by the fact that banks are increasing their willingness to lend. However, we expect any bond issue to be long term (five or six years) which is beyond the banks preferred loan terms.

In preparation we encourage investors to read the excellent report provided by Infratil which discusses details surrounding the Shell NZ business.

Investors can get an early insight into the Shell NZ business, its assets, market share, revenue, profit margins, and cash flow.

We will continue to build a mail list in the expectation of a bond issue from this business. If you would like to be added to this list please contact us by phone, email or the website. 

Secondary Market - If you have spare cash to invest and would like some ideas from the markets please email your portfolio to us and we will be happy to offer suggestions.

Michael Warrington Senior Consultant Projects Resources Limited

Footnote: Giovanna, Linda, Edward, Lynette, Diana, Brian and I would like to thank those who did bring in morning tea following the court case!

We would further like to compliment Chris with respect to his commitment, honesty and dignity during the trial against Bob Jones. It has been a valuable experience for all of us.

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Market News 17 May 2010

 

It was hundreds and thousands when I was at school.

Now it's billions and trillions. It may as well be Squillions because this is a term my children use and it will be their generation that pays for all this.

Europe and the IMF has approved 750 Billion Euro (NZ$1.3 Trillion) to assist European countries in financial difficulty. By far the most interesting part of the story is that it only took days to approve. They must have been very concerned about the possible collapse of their monetary union.

It's nice to see Europe put out its chest and warn financial markets 'there shall be no failure'. At least, not on my watch.

So what does 1 trillion look like?

I was trying to put this story in perspective for my 8 year old son, Toby. (don't justify your weaknesses by blaming your son - Ed)

A pineapple lump has a volume of 5mm x 25mm x 20mm = 2500mm3 (0.0000025m3). 

The Westpac stadium in Wellington has a surface area of 48,000m2. 1 trillion pineapple lumps would fill the stadium to the height of the floodlights!

Investment Opinion

Alert - In mid 2008 we wrote a special warning to clients about the need to be extremely careful with their investing in the months that followed. We didn't contemplate just how nasty the following months would become. We couldn't have.

The problems, exposed in 2007 and brought into the clear light of day in 2008, were born out of excessive debt, an inability to service that debt and insufficient security for the debt.

Most of that debt still exists or has been written off. A lot of the debt has changed from private hands to public hands.

The level of debt being accumulated by governments currently can in most cases be serviced by tax payers but it is becoming a serious concern and must have a dampening affect on those economies with the most debt.

The point here is that whilst this is not 2008 tensions are rising again and we feel the need to encourage a heightened level of caution again when investing.

Protect your assets and protect your income.

I read a quote recently that sums up the situation nicely - 'Risk now wears big boots and is stomping on everyone'.

Greece - So if it was that urgent that Europe approve and EUR750 billion loan, what does that teach us about their economies?

The financial markets measure of volatility (VIX) has exploded again. An excess of fear has returned to the world of finance.

If governments keep issuing more bonds to fund fixes, and if this leads to some governments defaulting on those obligations they will undermine the notion of a risk free investment product. Maybe there isn't such a thing.

Servicing debt and avoiding default requires the collection of enough tax. Governments will only collect enough tax if 1) their economy grows, 2) the tax rates go up, or 3) government spending is cut. Any combination could also occur but it will be very hard to achieve economic growth while increasing tax and reducing spending.

One remaining lever is to maintain very low interest rates for a long time. This helps the economy and may keep the cost down on the enormous volumes of debt that exist.

If deflation starts to emerge, I wonder if governments will increase land taxes and capital gains taxes to avoid the rich getting richer? They are clearly the group that can still afford to borrow money cheaply to buy discounted assets.

Europe has a dilemma on its hands.

Budget - The Budget will be read this coming Thursday. The government has made it clear they will make various tax changes which will, in turn, impact on the way people invest.

As is becoming the norm, content is progressively released early to prepare people and the avoid the shock value that I recall from my time in financial markets during the nineties.

You can already imagine the howls of discontent from unions as they react to a budget that calls for fiscal restraint which will impact on government employees. Perhaps the unions cries should be muffled by last week's news that Spain has cut wages for government employees by 5%?

Mind you, if the government plans to cut back in one area they'll either need to increase spending in another or hope that private industry is about to grow fast enough to replace any spending they remove.

NZ has the luxury to be able to manage such changes. Many nations, such as Greece, Spain, Portugal, and the UK, are in a very difficult position of having to make cuts to government spending at a time when the private sector is not strong enough to fill the void. Commentators are very concerned that this situation will result in the recession returning and a risk of deflation.

I am hoping our government will take a few bold steps forward with this budget.  

Investment News

Amortising premiums - Some investors declare they'll be very pleased if their perpetual investment from a bank pays them a high yield then repays after five years. I don't think most investors would be so happy.

Once you get your money back it needs to be reinvested to continue generating an income.

If you paid a capital price premium (more than $100 per $100) then the premium must be amortised over the remaining life of the investment for only $100 will be repaid by the bank. Accordingly investors receive a better outcome if they can amortise a price premium over 7 - 10 years rather than five.

Contrary to media attention most of these securities are trading at a price premium.

BNZ and Kiwibank hinted at the opportunity to repay after five years. Rabobank made it clear they will not repay prior to the 10th year. Already we have an inconsistency which is a condition financial markets don't like.

The ability to repay 'early' solely for the benefits of re-borrowing the money at a cheaper price is a one sided sword that is detrimental to investors. It was this behaviour that resulted in investors owning securities with ever decreasing credit margins but now they are not being offered ever widening margins! 

Witness Motor Trade Finance perpetual notes. In their first generation I recall this investment paying a credit margin of 4.50%. Now in its third generation it offers a credit margin of 2.40%. It is time for a fourth generation and a credit margin above the original but investors are not being offered such 'fairness'.

I would prefer it if all banks helped develop a market consistency and sought to repay and refinance perpetuals at the tenth year, subject to being financially able to do so.

Viaduct Capital - has been placed in receivership and some of their depositors will now make claims for repayment from the government (Treasury). This is the business that lost the use of the government guarantee last year when the Treasury withdrew it based on information they were clearly very unhappy about. 

We complimented Treasury at the time and repeat it now.  The GG is distorting the investment landscape enough without it being extended to businesses that do not deserve the assistance it offers.

SCF - is writing to investors with maturities pending over coming months offering them the chance to extend that deposit now at 8.25%. They have written to maturities in May and June so far.

If you have a maturity later in the year and would like to extend your maturity date by up to a year at 8.25% I am sure they would be happy to hear from you.

The best way to process such an agreement would be to call SCF on 0800 808 117 and ask them to extend the offer to you. This would result in offer documents being mailed out for completion.

NZSIF - The retail investment into Morrison & Co's Public Private Partnership vehicle reached $41m by the close. They may be a little disappointed not to have exceeded $50m but when this cash is combined with wholesale money plus the $100m from the NZ Super Fund they'll have plenty to pursue projects offered by Treasury.

Many people told us that the long time frame put them off a little. Given the minimal liquidity available for this investment I can understand this concern for investors closer to or in retirement.

However, the modest volume also suggests to me that there are less people fearing strong inflation than I expected. The inflation adjusted pricing pursued by this investment looked attractive to me.

Once the fund makes progress, and displays the success they expect, I would expect Morrison & Co to offer the public another chance to invest in this asset type with a second fund.

Dorchester - in contrast to Non Bank Deposit Takers failing under the GG Dorchester is showing real potential to return almost $1 to its debenture investors without the assistance of the GG.

DPC has issued a proposal to exit moratorium if debenture investors will accept an exchange from their previous investments to several new assets either owned or issued by DPC.

Chris will discuss this on Thursday.

National Property Trust - It will be hard to argue that St Laurence Funds Management has done a poor job with NAP after learning that one of NZ's largest institutional investors has just bought a substantial percentage of the company. ACC has increased its stake in NAP to 9% and this is after a 30% increase in the value of the shares during the past year.  If SLFM was a poor manager, why is ACC buying more units?

Investment Opportunities  

SHELL - In preparation for the bond issue we hope to see, it would be very useful for potential investors to read the excellent report provided by Infratil which discusses details surrounding the Shell NZ business that they purchased.

Investors can get an early insight into the Shell NZ business, its assets, market share, revenue, profit margins, and cash flow.

Shell NZ has been re-named Greenstone Energy Holdings Ltd on the companies register, which in turn is owned by a vehicle named Aotea Energy Ltd. This path tracks, as you would expect, up to Infratil and the Guardians of the NZ Superannuation Fund. 

We are interested in which name might be used when the company borrows money, however the name is incidental to the decision to lend or not. We are interested in the financial strength of the business.

May is almost over so perhaps we'll have to wait another month.

We will continue to build a mail list in the expectation of a bond issue from this business. If you would like to be added to this list please contact us by phone, email or the website. 

Secondary Market - If you have spare cash to invest and would like some ideas from the markets please email your portfolio to us and we will be happy to offer suggestions. We see the secondary market as having an interesting menu of strong, long bonds.

Chris is back in the office, free of what was a three year project. He plans to be in Hawkes’ Bay soon, Nelson (Friday before Queens Birthday) and Christchurch (June 15 & 16) before taking some leave to be with his extended family in Malta in July. I suspect he and Giovanna will enjoy this break, but they have a new issue to face.

Chris sister, after attending the Jones trial in support of Chris last week, had a serious car accident a few hours after the trial and is in critical condition at Hutt Hospital. Chris may be unavailable at short notice until her condition improves.

I am in Hamilton/Tauranga until Wednesday.

Michael Warrington Senior Consultant Projects Resources Limited

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Market News 10 May 2010 

Governments of the world are discussing the introduction of new environmental taxes and carbon trading schemes to save a few micrograms of pollution per person each year. It might even be milligrams.

And then BP spills a massive volume of oil into the Gulf of Mexico.

That's perspective for you.  

Investment Opinion

Weak Governments? - have governments of the mature democracies been too soft in recent decades and not honest with themselves and the public?

I have been pondering the thought that true democracy governments seem to be incapable of delivering difficult messages to their populations. They typically offer the opposite message as if managing the country is an endless cycle of ever improving outcomes, thus guiding us into our current economic state.

The competition by each political party, in successive elections, to 'give more' contributes to fiscal deficits. Some may conclude that this looks like buying votes.

Is it any wonder that a growing proportion of our population live beyond their means?

Greece is currently in the hot seat with respect to owning up to is poor governance and excess. That hot seat will be well used over the next five years by a long queue of governments.

Governments must become willing to present honest messages to the public, including the difficult messages. The public must learn to accept those messages and not simply vote for those throwing the most money around.

Lenders will seek out these governments as their preference. 

Interest rates on loans for governments with poor fiscal discipline will increase, relative to those governments with good fiscal discipline. 

At some point the lenders will decline to lend at any price. Then that nation has no option but to default on its obligations.

The notion of sovereign debt being 'risk free' is not an absolute truth. I am comfortable with the description for many nations but let's not forget failures by Argentina and Russia, recently, or Germany, Spain and even the Confederate States of America in previous centuries.

Next time you vote look for honesty, not cash.

Greece - whilst on the subject of Greece, their government voted in favour (about 62%) of the tough fiscal conditions demanded by those offering the US$110-120 Billion of funding. So it seems they shall receive the money and fears of imminent default have been removed. I guess I should shout our office lunch.

However, this doesn't make the debt go away. The enormous mountain of debt remains to be climbed. It is just a few months further away now.

What to do with the Mortgage? - The brief answer is easy. Pay it off. 

2008 should have alerted borrowers to accelerate repayments. Low interest rates in 2009 should have enabled larger capital repayments. 2010 will see the beginning of interest rate increases, especially for short term mortgages, which is the final reminder to increase ones capital repayments.

If a borrower happens to be playing the higher risk game of only a floating rate or very short term mortgage (say 5.75%) then as a minimum they should be using the savings to repay extra capital too (mortgage size x about 2%). 

If global economic conditions continue to improve short and long term interest rates will begin to rise more quickly.  

The best escape from a rising mortgage cost  is capital repayment. The Risk versus Reward See-Saw - Picture a see-saw that monitors investor behaviour. At one end is a sign 'low risk, low reward' and at the other end we find 'high risk, high reward'.

Over recent months there has been a shift by investors away from the 'LOW' end back toward the 'HIGH' end. I doubt we have passed the fulcrum but the change is significant.

Some investors remain in the 'must be government guaranteed' corner but they are now the minority. 

You'll recall that we believe the government guarantee of third party's is distorting the investment landscape and we look forward to its departure. Investors seeking government guarantees will soon only have government bonds as a choice with yields between 3% - 6% (more for longer). To enhance this script on the subject I have loaded an image to our website to display how quickly attitudes have been changing. Click here to view a chart of investment volumes in Kiwibonds (issued by the government).

Note the massive rise in demand for Kiwibonds from mid 2008 and now the equally rapid decline. You'll be aware that investors have been receiving much higher returns with government guarantees than are available from Kiwibonds. Mind you, even this later point highlights investor desire, or need, to find higher yields.

Non Bank deposit takers are reporting as many as 50% of depositors are now agreeing to invest outside the terms covered by the government guarantee. Some may not even seek the extended GG.

These are healthy developments.

Goldman vs The People - The CEO of Goldman Sachs, Lloyd Blankfein, has decided to take a 'get stuffed' approach to the claims being made against it by the US government and its agencies.

This may simultaneously be a legally correct but politically stupid position to take. I do not say naive for I am quite certain Blankfein is not naive.

Blankfein is unlikely to be driven by the purity of justice either. I suspect he is proceeding on the basis that his clients are those with vast amounts of capital who benefit from Goldman's presence, not the wider public who share their opinion with Goldman's but not their money!

He perhaps realises that the largest donors to the political parties will all be major participants in capital markets and that they will have a sharp eye on property rights and justice.

I wonder if the US government will remember who elected them rather than who paid for it when they decide what actions to take? Share Indices - are beginning to look a little sick and the direction over the next two weeks is important in our view. 

Friday's movements were exceptional. Some have blamed the price falls on computer initiated sell orders but whilst this may be true the fact is the market had insufficient buyers to match up against the sellers at the time.

The falling market initially generated more sellers fearing they had missed the turn in the market, than buyers believing cheap investments were available. The rush for the door by the majority exposes the lack of conviction in the bullish commentaries circulated by most players during recent months.

Share markets have had a fabulous run, but now look over bought, and need to pull back to lower levels and discover if this attracts new investors or not. On Friday those buyers were tentative, not confident.

The market's concerns are also witnessed by a return to a rapidly rising gold price. Last month Gold was US$1120 per ounce, but today it is US$1200. 

Where the Euro was recently touted as another reserve currency for those who are over exposed to the USD it is now looking quite unloved. I suspect it is this money which is heading for gold, rather than back to USD.

If you want a snap shot image of how extreme markets have been over the past 15 years relative to previous decades take a look at this chart. It is entirely reasonable to describe how the Dow Jones could fall to a visible long term trend line around 6,000 - 7,000.

In my opinion the explosive growth of the Dow Jones between 1995 and 2000 was partly due to growth in real loans but mostly relates to explosive use of unregulated derivatives (for more leverage).

Regulators are seeking to have derivative activity captured in a clearing house (single settlement point) so volumes and net risk position can be disclosed and then governed.

Banks' ability to offer real loans will depend on the amount of equity capital each bank has. Loan losses, including any defaulting government bonds, will reduce that equity and thus reduce the ability to lend. Expect banks to remain cautious.

The point is that credit growth seems most unlikely to us. In fact it is possible that credit supply may shrink further. So if share markets were inflated by credit over the past 15 years and the source of inflation is now being removed, the market value must decline.

Lower access to credit and rising real interest rate costs will have a significant impact on the valuation of all investments.

We never put it away, but we may need to re-polish the advice to focus on 'Strong, Long, and Liquid' fixed interest investments. 

If you are feeling uncomfortable with your exposure to shares following last weeks moves, this should alert you to the likelihood that you should sell some.

Investment News

Code of Professional Conduct - we have loaded our submissions on the draft code to our website.

The Code Committee has made very good progress but we have pointed out that in our opinion there remain a few requirements that aren't consistent with the purpose of the Financial Advisers Act 2008.

It's in their hands now and a final Code will be produced after the Financial Service Providers (pre implementation) Bill is passed. Once passed investment advisers can apply for registration (FSP) and authorisation (FAA) for the new regime which begins on 1 December 2010.

GPG Delay – Last week Sir Ron Brierley indicated that investors will need to wait a little longer for the return of value proposed last year.

Market conditions are not conducive to the sale of certain assets.

That sounds a bit like ‘moratorium speak’ to me.

Set aside mortgage - I wonder if NZ lenders will start looking over their shoulders following a recent legal decision in Australia. 

The court has set aside a mortgage because the lenders committed an unconscionable act by approving the mortgage whilst knowing the borrower had little hope of being able to service the loan.

Does anyone else think of Blue Chip in NZ when they read this story?

St Laurence - We need to amend our advice regarding the offer from Stock & Share Pty to buy debentures issued by St Laurence.

Previously we described that its best use would be as a fire starter. A client has called to us say she tried, but it failed to offer any value in its new role as a fire starter too.

Evidence that the offer from Stock & Share is of very poor value indeed, regardless of perspective.

New advice: If they supplied a return envelope, send their documents back to them (unsigned) along with any other junk mail you no longer require on the kitchen bench.

Strategic Finance - receiver has said they expect to announce a sale of the SFL loan book by late June. Until that point they will not comment on the value they see within the business.

This may well lead to a prompt 'tidy up' of SFL but I would suggest investors do not get too excited with the news.

If the successful buyer pays cash for the loans the value received will be a significant discount to perceived future values and will confirm a loss for debenture holders and, therefore, a total loss for holders of subordinated notes and perpetual preference shares.

If the buyer uses equity to pay for the loan book SFL investors will become subordinated investors in another business that may itself be in weak condition.

Avoid false hope. Wait for facts from the receiver.

Bonus Bonds - one caller was concerned following my comments last week about the retirement of the gentleman who managed the Bonus Bond fund.

There is no reason to be concerned. Bonus Bonds are one of the strongest funds in NZ with respect to the quality of its assets. The ANZ banks also provides very strong governance for the fund.

The only concern holders of Bonus Bonds should have is whether they win each month!

I apologise if others misunderstood.

US Bond yields - A month or so ago I was watching US 10 year government bond yields closely. They were threatening to rise above a point that may have indicated a new trend for rising yields.

Last week's Greek drama and falling share markets has resulted in a rush to low risk assets again, which includes government bonds. This increase in demand is forcing yields lower again.

You may remember me saying, that where US yields go so to do we. Investors should take advantage of last weeks lift in yields following NZ's strong employment data.

Taxes - Reinvesting some of its recent successes (energy and cash), the IRD is now training its guns on the tobacco industry for perhaps using financial transactions to reduce tax obligations. Three cheers for the IRD. I am sure the public will be happier to pay their own taxes if they witness zero tolerance by the IRD for avoidance by major businesses operating in NZ.

Ever the Optimist - It's hard to argue against the very positive news last week that, simultaneously, employment is up AND unemployment as a percentage is down. This reinforces the likelihood that the RBNZ will begin to increase short term interest rates in June. Long term interest rates increased following the employment data because it was much stronger than expected. 

Investment Opportunities  

SHELL - we will continue to build a mail list in the expectation of a bond issue from this business (in New Zealand, now owned by Infratil). If you would like to be added to this list please contact us by phone, email or the website. 

SECONDARY MARKET - In our opinion a few fixed interest investments have reached pricing that makes sense again for investors to consider.

Goodman Property Trusts 5 year bond, issued last year, is again offering yields above 7.50%;

Quayside perpetual preference shares, paying 10% until next March then reset at the three year benchmark plus 1.70%. This is a good credit margin for a council backed security. 

Fidelity Bonds with capital protection (Westpac), maturing in 3 years, offer a possible yield of 11% currently. The return is dependent on not missing any future interest payments, which is a risk, but currently the fund value is well above the level needed to pay July's interest.

I will be in Hamilton on Monday 17 May and Tauranga on Tuesday 18 May. If you would like an appointment please call or email us at the office.  

Michael Warrington Senior Consultant Projects Resources Limited Footnote: Chris is away this week, but will be back next Monday, hopefully with a strong reason to shout morning tea!  

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Market News 3 May 2010 

Washing was clearly a risky subject to tackle! 

Wives seem to have been grateful. Husbands’ less so.

Who'd have known there was a tutorial available on YouTube. Mind you, I learned how to change the clutch on my trail bike there too. 

Note to self - 'see YouTube for further professional development'.  

Investment Opinion

Greece - this story continues its troubled journey, down a slippery slope. We keep watching to see if someone will offer them a metaphorical ice axe, before they reach the edge. The riots over the weekend suggest a frightening proximity to the edge.

Stop Press: Overnight Greece has been offered $120 Billion of support. We’ll read the detail this week and comment later.

Last week the country's credit rating was downgraded to BB+. It might hold at that level if they actually gain funding support from stronger nations and the International Monetary Fund (IMF). If this doesn't happen the credit rating may continue sliding, toward D.

As the pressure rises the public of Greece and of potential lender nations are voicing their anger, as we forecast a year ago; civil unrest, trade wars, hopefully not real wars.

Sharemarkets appear, thus far, to be unconcerned about the situation in Greece. This of course excludes the Greek market which is one of only two on the planet to be down, year to date!

Whilst I think world share markets are a little over confident, it is the consolidated view of hundreds of thousands of participants.

This story, about excessive debt (about 35,000 per person in Greece), has further to run yet. It is current. Watch it closely. What happens in Greece may well redefine Europe and the European Monetary Union.

Energy Sector - We continue to be very comfortable with clients investing in the energy sector. The fundamental dominance enjoyed by the major generators and the high cash flow (monthly) through their business should be comforting.

I was prompted to review electricity pricing recently wondering if recent pricing still supported the new, more expensive wind farms. The answer was yes, currently, but only after several months of trading at pricing below the marginal cost of building those wind farms.

An industry friend provided me with pricing data at one of the 'zero' nodes (Haywards hub prior to line loss when delivered) to review.

The price movement over the past seven years looks a little like a heart rate monitor ranging between $30 - $80 per Megawatt hour, with a few spikes as high as $300. The past six months has seen a rise from $25 to $100 per MWh, with slight falls in the past week (hardly surprising given the rain down south - Ed).

Below $75 per MWh the incentives to build new generation are low, but without new generation 'brown out' risk exists as consumption of electricity grows. 

It's this 'Catch22' situation that appeals to me as an investor. If we don't build more generation pricing will rise but we risk running short of electrons. If we build more generation we need pricing to be reliably above about $75 per MWh to justify the investment.

At the end of the service chain is the consumer (retail and wholesale) who needs the product and must pay for its delivery.

Certainly for holders of bonds in the energy sector (generators and lines companies) there is a very strong cash flow available and a good opportunity to deliver net profits by the borrowers.

Investment News

Official Cash Rate - The Reserve Bank has left the OCR at 2.50% but the tone of their statement is clearly evolving to broadcast the imminent beginning to a rising interest rate environment, albeit slowly, as we have been expecting.

This caught markets by surprise, a little, and thus interest rates increased following the statement.

We have a government budget shortly which will influence Dr Bollard's next forecasts, with a special eye on the likely changes to consumer behaviour from GST increases and personal/corporate tax cuts.

The next full Monetary Policy Statement is on 10 June. It is likely rate hikes will begin at this point unless the Greek government defaults on its debts and thus undermines confidence surrounding other weak nations.

Regardless of Dr Bollard’s actions greater returns for fixed interest investors will still be achieved from longer terms.

GST Survey - I received a copy of a GST survey carried out by one of the major accounting software providers last week. It is clear that most businesses are accepting of, and ready for, an increase in GST.

They perceive few problems following a GST increase and expect only marginal changes to sales volumes.

However, one item that will raise the eyebrow of Dr Bollard is the intention of 36% of respondents to increase pricing by 2.50% - 5.00% more than the GST increase.

The main reasons given are to recover or increase profit margins that have suffered during the past two years. 

This provides another reason for buying that necessary item before the GST increase, rather than shortly thereafter, but only with surplus cash!

Government Bonds - The NZ Debt Management Office has agreed to increase the volume of government bonds it will issue in response to demand from domestic institutions.

Government bonds have been increasing in yield relative to other bonds and they have reached the point of being relatively cheap in the eyes of those institutions. Banks are the largest domestic buyers of government bonds for their liquidity books (used as collateral if they borrow cash from the Reserve Bank).

In light of the concerns surrounding a few European governments I imagine offshore investors are also buying more NZ government bonds.

All of this suggests that we will have no trouble funding the current fiscal deficits until the government returns to surpluses.

A senior staff member from the NZDMO attended a government funding conference in Paris recently. He told me, with a smile, that the representatives from Greece needed a 'stadium' to host those seeking an update on their situation. 

By contrast the level of comfort with NZ government debt meant our story could be explained over coffee and a handshake. Let's keep it that way.

Whitcoulls - holders of Whitcoulls bonds (now REDGroup) should be very pleased with the company’s recent results.

REDGroup has clearly benefited from purchasing BORDERS and recent Dymock closures suggest that REDGroup (Whitcoulls) is winning on the competitive landscape for books and stationary.

The companies interest cover ratio has been rising (a good thing) and the gearing (debt) ratio declining (another good thing). They have stayed inside the progressively tightening banking covenants throughout the life of the bonds.

Their financial performance is a credit to the company during a period that includes two very nasty economic years.

Repayment of the NZ subordinated bonds on 15 December 2010 looks very likely to me. Unless you need cash urgently I see little point in selling bonds at the current discounted pricing on the market.

If REDGroup happen to progress with a float of shares, before maturity, bond holders will be offered discounted access.

Disclosure – I own a few of the bonds.

Rural Portfolio Investments - has announced that they cannot remedy the breach of a bond covenant (pre fund the next interest payment). The trustee is now involved and it seems likely that the security for the loans will be sold or perhaps distributed to holders of the redeemable preference shares.

The PGG Wrightson shares (46.7m), NZ Farming Systems Uruguay (10m) and cash of $742,000 equates to about 50 cents in the dollar repayment.

Some holders have been selling for values below 50 cents recently on the market. We believe the best advice is to wait, rather than sell for less than 50 cents of value.

This failure has the potential to be 'tidied up' in months, not years.

Disclosure - I own a few of these securities too and hope they distribute the shares and cash to us rather than selling the shares to only deliver cash.

Elephants & Dragons - Did you spot the story about two Indian companies being in the running to win a major contract (hundreds of millions) from Telecom?

No Commission - Australia has confirmed it is to head down the path of banning commission for financial advisers. The NZ government has elected not to take this step but given our regulators propensity for copying Australia and the UK there is an air of inevitability lurking.

In NZ disclosure is the key requirement. If advisers fail to disclose their income to customers commissions will be banned here too. I agree with the disclosure issue absolutely but on the commission banning I happen to think this would be a short sighted political move.

Watch the resounding silence in Australia as their financial advisers react to the ban. They will turn away, smile and rub their hands together because they will earn a lot more money from annual fees charged against client portfolios.

If we charged 1% per annum on all of the money our clients invest through us our income would be uncomfortably high. Small wonder some advisory firms like the annual fee model.

St Laurence - It became clear last week that STL management and Board no longer saw eye to eye with Perpetual Trust. They have fought for the whole 16 months of the moratorium.

STL made a direct approach to its investors with a proposal to try and exit the moratorium, on the basis they would soon fail to meet its terms. Perpetual Trust reacted by immediately placing STL into receivership.

STL directors may have argued that the trustee was not adding to the opportunity to extract value for investors. 

The trustee has argued that investors will benefit from its supervision and independent management (receivership). PT also stated 'This is a very clear case where the interests of stockholders will be served by removing the current directors and management from the process of recovering monies for investors'. They cannot argue this point without having serious concerns about the people involved.

We look forward to the trustee explaining their position in more detail.

However, we do feel that if a business fails to meet the terms of a moratorium, that it had a hand in designing, it is probably time for a new person to 'take the wheel'.

We look forward to hearing the receiver’s independent view of asset values. Chris will comment further on this in Taking Stock this week.

Note - holders of St Laurence debentures have been approached with an offer to buy their debentures for 8 cents on the dollar. In our opinion this offer belongs in the rubbish bin. We await a realistic opinion about value from the receiver in coming weeks.

Note: Irongate is not in receivership and continues to operate as before, meeting its obligations.

UDC - Does not currently have the extended government guarantee. Given UDC's strong owner, governance and credit rating it is clear they have not applied for the extension. It would surely be granted the same day if they applied.

UDC does not need the extended GG and frankly I think they should NOT apply. It would be a poor statement about our investment community if they felt it was necessary for UDC to have the extended GG.

By glaring extension we would be disappointed if any NZ bank applies for the extended GG. They do not need it.

It would be very poor form if any bank 'breaks rank' and applies for the GG in an effort to reach their 'core funding ratio' (retail and long term funding targets set by the Reserve Bank).

Indeed, I think the public's reaction should be to move away from a bank if they feel they still need the support of a government guarantee. 

Regulation - The Hon Simon Power has announced NZ will have a single Financial Markets Authority to consolidate industry oversight. It is an excellent concept. 

Now we await more detail on legislative support and funding available to the FMA and confirmation that its constitution will encourage a proactive stance.

I do hope commentary about the FMA doesn't focus on the impossible question of 'can they fix the past'. 

The government, through Simon Power, has introduced significant changes to improve the financial landscape with a particular focus on protecting the public. 

All deposit businesses are now regulated by the Reserve Bank, the Financial Adviser Act strengthens the advice framework and the new FMA should result in focussed oversight of the industry.

These changes don't improve a person's integrity but they significantly reduce the opportunity to mislead the public.

Fidelity - The fund manager (Tyndal) continues the impressive performance in restoring the position of these bonds to a point of financial surplus, thus trying to protect the future interest payments for bond holders.

Excluding the period in late 2008, the peak of the global financial crisis, the investment has added value almost every month.

The current market pricing displays a level of uncertainty which is understandable. However, shortly this discount will be unwarranted as the funds surplus grows.

As at 30 April the fund has enough cash to pay the next two interest payments. The fund remains exposed to profit and loss potential from interest rate movements.

Disclosure - I hold a few of these bonds and plan to keep them.

The Warehouse - in a small timing victory for investors, the interest rate on The Warehouse bonds has been set at 7.37%, a little higher than indicated previously.

Kiwibank - is continuing to be the darling bank of the public. The significant support for its recent issue of perpetual securities reminded us of the goodwill they enjoy from the public. 

This goodwill is further highlighted by the success in its funds management area. 

Lead by their 'energetic' and experienced head of wealth, Tracey Berry, Kiwibank is enjoying significant growth in funds under management from their customers. Last quarter Kiwibank had the second largest net inflows of $60.4m into managed funds.

I seldom think advertising tells me a story as it really is, but currently I think Sam Neil's advertisements are precisely what is happening for Kiwibank.

Will Shell tap into this same nationalistic vein?

Ever the Optimist - Fonterra increasing the pay out to $6.10 per kilogram of milk fat solids is excellent news for the NZ economy, especially the regions. 

Their success is a significant part of why we also enjoyed a healthy trade surplus in March with exports rising, above $4 Billion and happily, our imports declined.

China is now a bigger export customer for NZ than America. We must continue this path and become a nation of net savers. May we keep up this progress.

More from the Optimist - Buyers, who can afford to settle(!!), bought all apartments offered by a receiver in Queenstown last week. 

The prices seem very realistic between $300-$500,000. The buyers were from the usual catchment of Queenstown, Otago, Southland, Australia and a few from other international locations. 

This is a very healthy development in a market where early failures had signaled the arrival of property problems nationwide.

Also, in Paraparaumu Beach, in the apartments above the offices we bought, several apartments sold at auction for $327,000 – 350,000. They originally sold for $520,000. Again the sale prices look realistic in today’s climate.

Investment Opportunities

Time for a breather.

 

Kiwibank - Closed last week. Thank you very much to the many who participated. Chris and I planned to invest in this issue but ultimately did not do so as it would have resulted in some clients missing out.

Those clients who missed out on allocation have had their cheques returned and will be given priority in the anticipated bond issue from Shell NZ.

Public Infrastructure Partnership Fund - Also closed last week. Thanks to these investors too. We look forward to the development of this Public Private Partnership investment space. If this initial fund proves successful we expect to see more opportunities for the public to invest.

Disclosure - Chris and I invested in this fund.

SHELL - we will continue to build a mail list in the expectation of a bond issue from this business (in New Zealand, now owned by Infratil).

If you would like to be added to this list please contact us by phone, email or the website. 

I will be in Hamilton on Monday 17 May and Tauranga on Tuesday 18 May. If you would like an appointment please call or email us at the office.  

Michael Warrington Senior Consultant Projects Resources Limited

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