Market News 28 July 2014

Sacre Bleu, you are in trouble when the Japanese think you are heading down the same path as them, economically speaking!

Japanese investors have become very active in buying French government bonds convinced from their own experience that the debt of a country where the central bank is battling deflation represents a winning bet.

Japanese investors bought 14 billion Euros of French bonds in May alone, equal to more than 60 percent of the government’s new issuance that month. Talk about dominating a market.

When one agrees to make an investment, putting money at risk, it increases the credibility of the opinion or investment forecast, relative to those who are not putting money at risk.

This development should not make the French government, nor the European Union, feel very good about the Japanese predictions for European economics.

INVESTMENT OPINION

Heartland – The defensive story issued by Motor Trade Finance last week caught my attention for the same reason that my ‘really?’ antenna vibrates when my children become extraordinarily defensive about a situation or adamant about the ‘facts’.

MTF announced that it had been approached by Heartland New Zealand Ltd (HNZ) who had the intention of trying to acquire the MTF business, or perhaps its loans, thus expanding HNZ’s very successful vehicle lending business.

Within the negotiations HNZ was keen to understand the implications of a recent court case that MTF lost in 2013, a case that MTF is now appealing. MTF appears to have been reluctant to share the updated information relating to this case.

Clearly MTF weren’t enamored by the HNZ approach and certainly not the references to contingent liabilities on the MTF balance sheet that surely must now exist following the court findings, thus far.

The Court found that some of MTF’s fees were “unreasonable” under the Credit Contract and Consumer Finance Act 2003 but MTF was cleared of misleading behaviour under the Fair Trading Act 1986. MTF is appealing the guilty finding, but interestingly the Commerce Commission is also appealing against the court’s FTA judgment!

The case brought related to one of MTF’s many lending sources (Sportzone Motorcycles) but its finding will apply far more widely.

I doubt the Commerce Commission will enjoy success under its appeal, based on Justice Toogood’s comments: ‘I am satisfied that the claim is misconceived and can be dismissed without detailed analysis’ and further ‘there is no evidence that any borrower suffered or was likely to suffer loss or damage by the representation that the lender was seeking to recover costs in establishing and maintaining the loan account.’

I ponder whether this Commerce Commission’s appeal action on this case is indicative of a wider vindictive approach to its role as regulator?

MTF earns about $10 million each year in fees, according to recent accounts, and this judgment places at risk a reasonable proportion of its historical fees collected (Court may insist on refunds) and a significantly large proportion of its future fees (now no longer chargeable).

I understand that three years of such fees would be exposed to the court’s finding last year; which one might well describe as a contingent liability now, or part thereof.

The Judge ordered the parties to meet and discuss the quantum of a potential agreement following his judgment, so he clearly introduced a contingent liability.

However, MTF half year report quotes the following on the matter:

‘No provision has been recognised in respect of this contingency as the impact, if any, cannot be reliably measured’.

Three years fees (approximately $30m) plus lost interest (approximately $2.7m at 4.50% p.a.), reduced by some factor that might deliver a ‘quantum’ sought by the Judge, is a large potential liability in anyone’s language, more so if it equates to about 80% of a business’s equity as an amount of this scale would do.

My definition of MTF equity includes the ordinary shares plus retained earnings, but excludes the perpetual preference shares ($39m) that are ‘debt’ in my language and rank ahead of ordinary shareholders.

I guess the reason for recording no contingent liability rests with not wanting to weaken ones negotiating position in court, or commercially. Fair enough, from one perspective, but if you were a shareholder you would be rather concerned to be told that the majority of a business’s equity and likely 30% of future revenues was currently at risk.

You might also be pretty keen to hear more from MTF directors about this risk and about the potential of any takeover offers to secure the future of an investment.

HNZ must have felt that MTF shareholders did not have full disclosure from MTF’s management or directors because the media articles imply that MTF shareholders are being approached directly for discussions about the situation. Some MTF shareholders (8.10% of them) have called for a special shareholder meeting to address the situation.

The intention seems to be to hold this special meeting prior to the appeal court date of 16 November 2014.

HNZ investors will likely watch this story from a perspective of ‘potential expansion’ whilst MTF shareholders will be watching from a perspective of ‘contingent liability’ (ironically) and all will be revealed in the fullness of time. (subject to a suitable level of disclosure – Ed)

All finance businesses in NZ will be watching it closely with respect to the level of fees they are allowed to charge a borrower when extending a loan to them. On this matter, and for the purpose of assisting readers or their children who may be borrowing money, the court stated:

‘Applied to this case, that approach (allowing fees on variable costs only) does not allow the imposition of fees to recover costs which are not closely relevant to the particular transaction but which are merely referable to the general business of selling motorcycles or of lending money.’

‘Taking that view does not mean that general business overheads are not recoverable. For Sportzone as the seller of the motorcycles, general overheads which may not be recovered by fees in a credit transaction are recoverable in the purchase price. For the finance company, the general overheads for the business of lending are recoverable in interest.’

‘The finance company MTF has allocated virtually all of its company overheads to the fees. In Professor Bowman’s opinion this is not a reasonable practice and is not based upon an analysis of variable costs.’

We watch it from a perspective of agreeing with the need for much more consolidation within parts of the NZ finance and banking sectors, which may be increasingly necessary if some lenders are only surviving on the basis of a large revenue item titled ‘fees’!

Fees such as those being challenged here might also explain one reason that family members agree to lend to each other, from time to time.

 

 

Kiwisaver – There has been a bit of chatter recently about the concept of introducing ‘capital protection’ services into Kiwisaver offerings and I wanted to say that even though we do not provide advice on Kiwisaver the proposals don’t make sense to us.

To provide ‘capital protection’ is to offer to reduce the risk profile of an investment. If you shift ‘risk’ you must simultaneously shift ‘return’. On top of this change the new service would incur a service fee, thus having negative impact on ones overall return from risk relationship.

Kiwisaver providers offer us with the opportunity to move our risk profile if we wish, whilst investing in Kiwisaver, usually covering the risk spectrum quite broadly as follows:

Cash or short term fixed interest investing;

Longer term fixed interest investing;

Low volatility, high dividend ‘growth asset’ investing;

Higher volatility, lower dividend prospect ‘growth asset’ investing.

Typically one can also choose some balance of these risks for their fund.

The only enhancement I see would be for Kiwisaver providers to enable us to nominate precise portions for each unique risk category offered, totaling 100% of the person’s funds being managed.

If an investor’s personal circumstances dictated a logical preference to reduce the risk profile of their investing then this change could occur via a change to the proportions without the introduction of any new fees (such as those relating to the purchase of a new capital protection tool).

The Financial Adviser Act determines that the public have access to advice relating to one’s investment decisions, if they find themselves uncertain about an appropriate risk to take. We don’t need to overlay an insurance industry on this sector.

We cannot pretend that risk does not occur and we must recognise that any ‘insurance’ to remove risk will cost more than the marginal loss of return resulting from the change.

Kiwisaver returns will be at their best long term if the industry is successful in keeping the cost of running the ‘machine’ down. The more complex it becomes the worse the performance shall be.

Investment News

Official Cash Rate – The Reserve Bank again increased the OCR by 0.25% to now reach 3.50% but the wording used in the announcement implies this may be the last increase before Christmas, unless economic surprises emerge. Dr Wheeler however does state that OCR increases are likely to continue in future (before the end of 2015) until it reaches a point of ‘neutrality’ which the RBNZ defined as being around 4.50% based on current conditions.

I had contemplated the idea that the RBNZ might use its quarterly Monetary Policy Statements as the likely times for OCR increase, plus one more increase on a review date but this is not what has happened. The RBNZ has used every date in sequence (MPS review, OCR review, MPS review etc) to increase the OCR rate by 0.25% at each decision point.

This ‘front loading’ of the increases during the earliest stages of the two year move to ‘neutrality’ implies that the RBNZ had become concerned about inflation risks, compounded by NZ’s behaviour in residential property markets. They must now feel they have regained control of the ‘loose sheep’ and can now return to analyzing the evolving macro-economic data that will drive future inflation risks.

So, we are at 3.50% now and are highly likely to be at 4.50% by Christmas 2015 and anything different depends on the quarterly cycles of economic facts. This confirms our often repeated view that investors are making decisions in a low interest rate environment and we think it will stay this way for many years.

The RBNZ repeated, in firm terms, its view about the NZ dollar being over-valued, and according to various analysts and valuation models this seems to be true, but in my opinion trying to encourage the NZD lower will be a bit like encouraging my eldest son to wash his own dishes and pick his clothes up off the floor; fundamentally the right outcome but an ongoing challenge to see it actually happen.

One sentence in the OCR statement particularly caught my attention; it said ‘Global financial conditions remain very accommodative and are reflected in low interest rates, narrow risk spreads, and low financial market volatility’. (The underline is mine).

Narrow risk spreads either mean that globally investors agree that returns for risk should reduce, or that short term funding costs are very low, and likely to stay that way for an extended period of time.

I don’t accept that the risks have declined so it is illogical to accept lower marginal returns.

So, in my opinion, ‘narrower risk spreads’ is evidence that marginal rewards have declined on the basis of an expectation that short term interest rates (cost of debt) will remain low for a very long period of time leaving a highly probably profit on the table for those willing to accept such risks (borrow money for revolving short terms and invest in longer term assets with higher returns).

Investors clearly feel that central banks of the world are assuring them that this is the most likely scenario for interest rates over a multi-year period, into the future, and why not believe this because it is exactly what we are being told to believe. Even the ‘first to move up’ RBNZ is pausing for ‘a Lange cup of tea’ with the OCR at a hardly frightening 3.50% to assess the impact of recent changes on our robust economy!

As a broad thought, in my opinion lower marginal returns on higher risk investments should mean that investors reduce the overall risk of their investment portfolio, not the opposite. The reason is because most investors do not use leverage in their investing so they do not enjoy the short term marginal trading benefits of ‘borrowing short term to invest long term’. Most investors place long term investments into a portfolio and as such, from a long term perspective, they should choose lower risk long term items in the current environment.

At some point financial market volatility will rise to a higher level, share market values will receive a vigorous shake and a few businesses will surprise us and come to grief and marginal returns for risk will widen again. Consistent with Kevin’s comments in Taking Stock last week, we just don’t know when such a change will happen!

Chorus Funding– Chorus (CNU) has signed an agreement with Crown Fibre Holdings (CFH) to confirm access to additional funding, should it be required, as CNU continue with the roll out of Ultra-Fast Broadband (UFB). This is what I would describe as a back stop funding facility which CNU will hope not to be forced into using, a little like a business having committed bank funding lines that exceed all budgeted plans.

Part of the reason for CNU seeking this back up funding agreement would be to support the banking syndicate’s expanded commitment to CNU following the marked decline in future revenue following the price regulation enforced by the Commerce Commission. (suspending the dividend no doubt helped too – Ed).

The CFH funding, if used, will have an interest cost of 8.50% and oblige CNU to not pay dividends to ordinary shareholders prior to the 2019 year.

I can think of a few ways to avoid using the CFH facility and not paying 8.50% but my preferred deal would be an issue of Mandatory Convertible Notes (MCN) paying 7.50% offered initially to CNU shareholders, with the gross amount required by CNU to be underwritten by the broking community who should have no difficulty introducing some non-shareholder investors to such an offer.

An MCN behaves like a fixed interest loan now but converts into ordinary shares at a prescribed ratio on a terminal date.

The MCN offer (proposed only by me at this stage and not the company!), such as I describe, would provide the funding that CNU is likely to require, at an interest cost below that offered by CFH and could direct some current cash flow returns to CNU investors who are being told not to expect dividends until beyond 2019.

As a utility business that is closely watched by the Commerce Commission CNU investors can in due course expect this business to become reasonably reliable with respect to revenue and dividends but clearly not until the roll out of UFB is complete. The 8.50% that CNU agrees it would pay CFH gives a CNU shareholder some idea of the gross income that CNU believes it can generate in future to pay dividends to its shareholders.

Thus, if a shareholder, of which I am one, is to wait until 2019 for dividends, which seems increasingly likely, then perhaps CNU could offer me a return of 7.50% on a second investment (The MCN’s) which would satisfy my current preference for some income now and simultaneously satisfy CNU’s need for additional equity at a future date. This combination of support for the CNU business will also satisfy CNU bankers (not a major concern of mine) and perhaps also provide CNU with a little more negotiating strength when meeting with their banking syndicate.

I am not all that fussed about whether the term offered on the MCN’s is five years or ten, or something in between; whatever suits CNU is fine by me.

The Chief Financial Officer of CNU, Andrew Carroll, is yet another past work mate from First NZ Capital (Credit Suisse), still a top quality business in NZ capital markets, and he is both a smart man and experienced in all of the securities types available to capital markets having been involved in originating many of them over the years.

He may yawn a little at my lack of inventiveness with this idea but I suspect that a simple idea will suffice here; debt behaviour now, equity behaviour later which nicely meets with a preference of CNU Investors; some income now, more income later!

Dorchester – Investors in Dorchester shares (DPC), often held as a result of the 2008 restructure, should be pleased to see the ongoing progressive development of the company through today’s takeover bid for the shares not already owned in Turners Auctions (TUA). The only condition of the offer is achieving control at 50.10%.

The bid, which includes the option of part payment using DPC shares values those DPC shares at 25 cents (the offer has been accepted by another major TUA shareholder). The 9% cost of the convertible notes being offered further confirms the sort of returns that DPC appears to now be reliably making from its expanding business.

Acurity – as if it was a race this morning, Acurity has also announced that its shares are also under a takeover offer with the majority shareholders (through Connor Healthcare) trying to reach 100% ownership with an offer to pay $6.50 per share for the shares not already held (71% held).

The tone of the media release seems intent on trying to scare ACY investors into accepting the takeover offer (Alert, improving Wakefield Hospital will be expensive) but this just serves to make me suspicious. If ACY needs a little more money for this repair, just send me a rights issue and ask!

Note to the ACY Board: If you are a little short of money then cancel the proposed ‘standard’ increase to directors fees and use that cash flow for increased debt servicing on the Wakefield Hospital developments!

Disclosure: I own a few ACY shares.

 

Ever The Optimist – The Orion Electricity story I read dwelled on the CEO’s salary but it also disclosed the potential for a bond offer from this monopoly business, which I now optimistically hope results in a bond offer for the public to invest in!

The Commerce Commission has approved an ‘extra-ordinary’ price increase for Orion to manage its higher than usual expenses relating to rebuild obligations and its financial position looks comfortable to me with respect to debt servicing.

The article spoke of a desire to increase debt by $135 million over the next three years, which looks like a nice size for a bond offer, or perhaps two different maturity tranches in a single offer?

Investors would be very happy to hear from them if they are of a mind to issue a new bond.

In fact, if they wanted to issue a Mandatory Convertible Note and subsequently list Orion on the NZX (selling some of the council owned shares) we would be even more excited about the offer!

 

INVESTMENT OPPORTUNITIES

Kiwi Income Property Trust – the new offer of a seven-year senior, secured, bond at 6.15% is open for only four more days and most application forms should now be in. The offer closes on August 1.

We have a small allocation left available. Please contact us urgently if you wish to arrange an investment.

Those who have authorized us to provide them with financial advice can find a research article on the Private Client page of our website.

BNZ Issue – We expect a subordinated bond offer from the BNZ (Tier I, or perhaps Tier II) over coming months and we continue to add names to this mail list.

ANZ Issue – We also expect a subordinated bond offer from ANZ bank over coming months and have a mail list open for this potential offer too.

TRAVEL

Kevin Gloag will be in Christchurch July 31 then Wanaka and Queenstown on August 22.

Chris will visit Timaru on September 1 and Christchurch on September 2 and 3.

Anyone wishing to arrange an appointment is welcome to contact us.

Michael Warrington

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Market News 21 July 2014

German Gross Domestic Product will have spiked higher last week, after their World Cup Football victory, and full employment will also have been achieved, especially in the service industry and council clean up divisions!

European football supporters will be wondering what crisis we speak of; the last three winners of the World Cup have been from the continent – Germany, Spain and Italy.

INVESTMENT OPINION

DCF – Discounted Cash Flow valuation.

If I am certain, or confident, that a future cash flow will occur then I can tell you what that cash is worth today by discounting it with a current market interest rate for the nominated period of time.

By way of example, the direct opposite calculation displays that $1.00 deposited today at an interest rate of 5.00% shall have a nominal value of $1.05 in 12 months time (immediately before the tax man knocks on the door – Ed).

The mirror image is thus: $1.05 cash flow in July 2015 is valued at $1.00 today if the current interest rate for 12 months is 5.00% (and you live in a tax free vacuum! – Ed). And pretend there is no inflation!

If the Discount Rate falls to 0.00% then $1.00 ‘then’ is the same as $1.00 ‘now’.

Currently it is this lack of real or nominal cost to leverage (0% interest rates), and zero or near to zero opportunity cost, that sees people with savings willing to invest  money into more property and business assets and to pay ever higher prices for those assets. This set of circumstances is unsustainable because there is only so far that we can stretch the rubber band and understandably there is a great reluctance to stretch it beyond 0% interest rates. Europe is trying out negative interest rates but this becomes exponentially stretched in my view so cannot last long at all.

However, as stated last week in the conversation about the Volatility Index, changing ones investment behaviour is all about the timing of the change to valuations and this is rather hard to forecast.

Sustainable increases in the present value of an investment require reasonably sustainable increases in future value (greater profits), not just decreasing discount rates (interest rates).

DCF calculations change every minute of every day as perceptions about future cash flow change and as interest rates move about, especially the longer-term interest rates. In my opinion though there is a single edged sword hanging over us with interest rates currently sitting at such low nominal and real levels.

Further declines for interest rates can only be modest in scale and so declining interest rates are unlikely to be disruptive to most investors and certainly not those already invested in property or businesses for such interest rate declines will serve to add temporary present value to their investment (alongside reduced opportunity cost, reduced business cost).

However, increases in interest rates will present a negative impact with a multiplier effect; the sharp edge of the sword, because rising interest rates will damage the Present Value of all assets and as values begin to fall emotions (fear of loss) will begin to drive subsequent investment decisions (to sell more, and more). Such a move would be compounded by short term traders who will jump on the new trend; trying to push the market even further before exiting with a quick short-term profit.

Most investors have seen this behaviour before, a few times, an asset once valued by the market at $1.00 can quickly (weeks, months) change to assessed as only being worth $0.65.

The only exception to this market behaviour will be for those investors’ holding plenty of short-term cash who await the opportunity of distressed selling by others and do not mind the fluctuations in the valuation of their portfolio (or can turn a blind eye – Ed). However, holding so much cash now, earning the lowest possible return, near zero in most countries, is a very hard asset allocation and discipline to retain.

Globally central banks have been cementing in a structural reduction in interest rates so as to afford the excessively high debt levels that exist. We have spoken before about the use of 30-40 year debt at ludicrously low interest rates (to re-finance troubled nations) as a tax on savers that, if successful, will have transferred yesteryears financial failures onto those who saved money.

Governments clearly see this long term apportioning of a short term cost as the only logical choice in their efforts to simultaneously maintain social stability. I can understand why a politician, seeking votes, would think this ‘settled’ way is the best choice but in the long run it is not helping because it results in poor behaviour by those who failed (they are incentivised to try the wrong thing again with the use of very cheap debt).

US interest rates are low, Japan’s are very low, European rates are at their lowest level for 200 years, even for the financially distressed nations. It is clear that these interest rates will not be allowed to move for a long period of time, but this insistence by central banks doesn’t make them right.

I believe that extra-ordinary pressure from one source (negative real interest rates in this case) will result in extra-ordinary, and in all likelihood unintended and undesirable, reactions elsewhere (equal and opposite – Ed). I just can’t see where these reactions will come from yet and certainly not when.

Negative short term and negative real interest rates are an incentive to those with debt and a threat to those with savings which is the direct opposite of the incentives that the world needs at present.

Low opportunity cost makes all speculative and less certain investments easier to ‘hold’ (gold, undeveloped property, unprofitable businesses etc) – How many such investments do you own?

Holding a lot of cash, earning very little, does not help your returns today. If an investor already has sufficient funds allocated to property and company shares, what other choices do they have to hold their income up?

Longer term fixed interest investing is one answer. You will be paid for extra duration, so in our view you should use it to your advantage.

As I described last week, fixed interest assets in NZ are not all that long term with most investments being 10 years until maturity or likely repayment date. The US 10 year bond is one of the most actively traded benchmarks on the basis that it is considered a good proxy for the whole curve; a mid-point if you will. US bonds are traded actively out to 30-year terms.

Given the potential for rising interest rates a 30-year bond is not something I would like to own! The marginal reward of 0.80% between 10 and 30 years just isn’t enough for the range of risks over that time frame.

Mind you, recent changes in the US yield curve tell us that expectations for interest rate hikes have been further delayed.

How so?

The interest rates offered for periods between 10 - 30 years have declined over the past month, at the same time as interest rates have increased slightly for terms between 2 - 5 years. This market reaction implies very low interest rates for a very long time, in the full knowledge that the US Federal Reserve is debating when to begin increasing interest rates. Clearly financial markets do not expect those increases to be all that significant.

Reverse Mortgage – In principle I find it frustrating that a person should feel the use of debt in retirement was the only opportunity to supplement the cash flow required, but increasingly it may make good sense for those whose savings run out.

Two unexpected circumstances that influence my principled view are enormous property valuations and very low interest rates. Certainly the presence of negative real interest rates (lower than inflation) would near encourage the use of debt!

Re-applying the Present Value maths above, a very low interest rate makes reverse equity mortgages a less expensive prospect for a family to consider now than for the previous generation.

The opportunity for increased use of reverse mortgage finance is especially true in Auckland where many find themselves with massive equity but little or no change in cash flow.

Downsizing a home by sale and purchase elsewhere is the logical way to extract equity from a home, but this is not always possible and for many it is not desirable.

The Labour party’s proposal to introduce a capital gains tax may influence the reverse equity market too if they happen to introduce it with a tax rate considered unreasonable by those with capital to be taxed.

The Tax Working Group concluded that people will be willing to pay tax if its application is considered fair and if it is levied widely and thinly. They observed that the only gaps in NZ tax collection were on capital and on land, although the central government acknowledged that New Zealanders pay reasonably high territorial taxes levied against land.

So, Labour’s proposal to introduce a capital gains tax needs to be debated and according to the TWG it should probably be introduced.

The reason I have dragged capital gains tax into this item about reverse mortgages relates to an article about CGT in the UK where their government has increased its CGT rate from 18% to 28% but experienced a 50% drop in the taxes collected! The members of the NZ TWG would be unsurprised; the answer lies in fairness.

If NZ introduces a CGT we must be very careful to apply a tax rate that can remain unchanged for decades.

One reaction to an excessive CGT tax rate might be for families to migrate growth assets to the next generation in exchange for depreciating assets (cars etc) and use reverse mortgages to progressively reduce the net asset value of the older person. If the older person has no net assets at the end of life, there is nothing left to pay taxes that may be due.

A CGT rate needs to carefully reflect upon tax that is not already collected from earnings on capital and to make it a ratio that tax payers consider to be fair and thus not worth wasting energy trying to avoid; then the cash collected will be fair and reliable.

I shall begin watching the growth in Heartland Bank’s reverse mortgage business  more closely to get a gauge on its growing acceptance by New Zealanders. Success in building this business may result in HNZ asking the market for more equity, longer-term deposits, or both.

By the by; the HNZ share price rise (which I have an incentive to watch) tells us all that things may be going rather well at HNZ.

Investment News

Ukraine – The shooting down of a civilian aircraft is both an example of the colossal error being made by some governments in allowing too much power to reach splinter elements within their countries and of the risks that investors face every day, many of which are hard to prepare for.

People will always express differing opinions about the way other countries govern and the ways some people are forced to live, however, whatever the beliefs and methods it is clear to me that given the information and resources now freely available to everyone, central governance is surely preferred over the disaggregation of power.

The declining level of ethical standards and tolerance around the world, combined with easy access to weapons, is resulting in some appalling human behaviour.

Leadership from various Presidents and Prime Ministers is not delivering change that I would consider desirable. The Pope is a very impressive person, in my view, but even his good leadership cannot solve this wider deterioration of behaviour.

On a partially related issue, we are in the midst of our first reporting season (annual) under the new Anti-Money Laundering and Countering Financing of Terrorism Act (AML) and I must say, in light of the quite obvious global increase in terrorism, reported levels of corruption and, presumably, free flowing money laundering around the world, the volume of new AML obligations sitting upon our industry in NZ does look more than a little excessive and in all likelihood relatively ineffectual from a global risk perspective. (A bit like the application of NZ’s carbon tax – Ed)

The reason for this gripe is that our new AML law exists as a direct consequence of pressure from the G20 governments, who may be succeeding in making the best behaved (such as NZ) even more compliant but they clearly have had no impact on those who are the greatest threat. It is a lot like the council worker who successfully prosecutes the polite owner of the poodle off its leash at the park but who turns a blind eye to the gang member’s unregistered Pit Bull.

With respect to making investment decisions in light of unexpected risks, like the shooting down of a civilian aircraft, we would strongly encourage investors to stick to the rules established for their own investing (personal investment policy) which recognises the outcomes that must happen (majority of one’s money) followed by the desirable return outcomes (minority of one’s money) regardless of changes to market conditions tomorrow.

For most, this will mean ensuring a satisfactory level of cash flow, ahead of the pursuit of growth, which in turn means a relatively high proportion of fixed interest investments.

It is becoming repetitive of me to say but while we all want higher interest rates and some believe such moves are still probable, we must protect ourselves against the possibility that interest rates could surprise us and fall and this outcome would compromise our income. With this thought in mind I observe that the US 10 year government bond (Treasuries) fell from 2.55% to 2.45% on Thursday night following the news from the Ukraine; other reactions saw Gold jump in price by US$20 (2%) and the Volatility Index (VIX) that we discussed only two weeks ago jumped from 11% to 15% over four hours.

At ‘times like these’, which increasingly means ‘at all times’, we are enthusiastic about keeping our investment policies and decisions as simple as possible, and frankly often as local as possible.

University Risk – There was a brief period shortly after Canterbury’s earthquakes when holders of the bonds issued by Canterbury University wondered if the University would be unable to meet its financial obligations given the rapid decline in student numbers and the enormous liability of rebuilding accommodation.

Given the core value of a good education network there seemed no doubt to us that a combination of insurance, government support and good financial management would ensure the university continued to run well and that obligations would be met; which is precisely what has happened.

This perception is now further endorsed by the government’s offer of $107 million to Lincoln University (Agricultural specialist) for the necessary rebuild of a significant proportion of its accommodation; and thus the certainty of its existence too.

I remain disappointed that other universities have not approached capital markets to issue long term bonds as part of the long term funding for their infrastructure development.

Capital Markets – I have a growing confidence that the various missing pieces from NZ capital markets are showing signs of forming and coming together, for the wider benefit of NZ capital markets and thus the benefit of our economy.

I can now draw a line of information that flows through the following:

Crowd Funding;

Peer to Peer lending;

Angel (venture capital) Investment funding;

NZX ‘lite disclosure’ (exchange of equity securities in adolescent businesses);

NZX Main board (exchange of equity securities in mature businesses);

NZX Debt board (exchange of debt securities, typically mature, large businesses);

Generally less visible to the public, but always present right across the scale spectrum, one finds bank debt financing and private placements of large-scale debt financing to professional fund managers (investors).

I have attended a number of angel or venture capital investment discussions and they are energizing. Further, the NZX is now also engaging with this sector and in conjunction with the ‘NZX Lite’ offering there is good reason for small and new business ventures to be equally energized by the opportunity to connect investors with good business opportunities.

I am also enthused by news that some very competent executives and professionals are agreeing to join the boards and management teams of some emerging businesses. I think these people are displaying a mix of generosity and enthusiasm in offering their time to such new businesses and I doubt it has anything to do with the directors’ fees. Indeed some very new ventures may not even be paying such fees yet.

To be clear, I am not encouraging the majority of investors to seek new investment opportunities in the first items on the list above where the scale is usually very small and the risk of failure is highest. I am pointing out that in my view that NZ capital markets seem to be maturing, witnessed by a developing capital markets continuum for most business types from new/small/developmental businesses through to mature/larger/successful businesses with their securities trading regularly on a major stock exchange.

The ultimate success will take a while for us to see but if the ‘master plan’ proves to be successful then the size of the NZX trading board (population) should bare witness.

 

Ever The Optimist – For the first time in many years some of the Central Otago ski fields have been forced to close their mountain access roads due to car parks being full. They are full because of the huge number of Australian tourists visiting the area for winter fun in the snow.

It isn’t ideal that any of these tourists should miss out on a day in the snow but such punters are likely to have re-allocated their day to another nearby field so I doubt there will be any grumpiness.

And, once the daylight hour’s activities are done you can just imagine the volume of money flowing through the tills at the bars, spas and restaurants; the warmth and the ‘glow’ of this economic feeling may well have helped reduce the power bills in the area too!

 

INVESTMENT OPPORTUNITIES

Kiwi Income Property Trust – the new offer of a seven-year senior, secured, bond is now open and investors are welcome to request a firm allocation from us (first come, first served). The offer closes on August 1.

The interest rate has been set at 6.15%p.a. Interest will be paid semi annually in January and July; a good choice for those trying to expand their cash flow throughout the year. Most use the months of March, June, September, and December.

The recent decline in long term interest rates has resulted in demand for this issue increasing, so if you are contemplating investment we suggest that you take action soon to secure an allocation.

Investors are welcome to contact us if they would like a copy of the prospectus (also on our website) and a firm allocation.

Those who have authorized us to provide them with financial advice can find a research article on the Private Client page of our website.

Scales– This share offer closes tomorrow. Thank you to those who participated in this offer with Chris Lee & Partners.

Listed Managed Fund – QV Equities Ltd (QVE) new offer of shares in a listed fund is now open, with the fund managed by Investors Mutual Ltd which is owned and managed by staff with 25-35 years of industry related experience. The offer closes on 8 August.

QVE will focus on companies outside the ASX top 20. Detailed information about the offer is available on their website: http://qvequities.com/ but importantly in my view includes a free option to buy more units at $1.00 (until 2016) to help offset the usual dip in Net Asset Value for a new offer such as this one.

The fund offers a competitive fee structure, which excludes a performance fee (good on them). The fee will be 0.90% up to $150 million and 0.75% thereafter.

Payment for the investment will be in AUD (we may be able to assist with conversion of NZD).

Investors seeking investment in a listed, managed, exposure to Australian shares (beyond the ASX top 20) may wish to consider this offer. We are happy to supply the offer document to you, if asked to do so.

EROAD – has confirmed its intention to offer new shares and raise up to $40 million capital to expand its business, a business that offers products that allow transport companies to better manage and pay road user charges and keep track of their fleet.

Timing is intended to be mid-July followed by listing on the NZX in mid-August.

We have a mail list for investors to join if they wish to hear more about such an investment, if offered.

BNZ Issue – We still expect a subordinated bond offer from the BNZ (Tier I, or perhaps Tier II) and we continue to add names to this mail list.

ANZ Issue – One day, we believe ANZ will also line up to offer the public a subordinated bond. We have a mail list open for this potential offer too.

TRAVEL

Kevin Gloag will be in Christchurch July 31 then Wanaka and Queenstown on August 22.

Chris will visit Timaru on September 1 and Christchurch on September 2 and 3.

Anyone wishing to arrange an appointment is welcome to contact us.

Michael Warrington

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Market News 14 July 2014

The Pope has made his first significant error, or is about to.

The headline reads: The Vatican is turning to big-hitting Wall Street players for help as it tries to leave its scandal-tainted banking past behind.

Talk about frying pan and fire.

We are all human, and make mistakes, and the current Pope will be the least surprised that he too succumbs to this condition.

INVESTMENT OPINION

VIX – The ‘Volatility Index’ (VIX), which financial markets monitor to ascertain the current state of fear in financial markets, is very near to its all-time low (day end) of 10.42% in January 2007 and I think this is another reason for elevated concern about what is round the ever sharpening corner.

Interestingly the previous low of 10.63% was in January 1994.

For those with long memories, which my greying hair dictates must now include me, one might recall that in February 1994 the US Federal Reserve surprised many by deciding to increase its official cash rate at a time when a recession was not yet resolved and Europe was trying to introduce a continent wide European Rate Mechanism (ERM). The US actions resulted in sharp increases to long term interest rates (+5.00%!) and the shock of it all increased market volatility.

Yes, I hear you calling for the US to take the same action again and hope for a +5.00% increase in returns across fixed interest portfolios; a wish that is as likely as winning Lotto to stock the wallet.

The 2007 low preceded the slump in the Chinese stock market by one month and the failure of Bear Stearns by five months (the point of recognition that ultimately sparked the Global Financial Crisis).

The VIX index regularly increases to 25% during times of financial market duress, has touched 40% three times and reached 60% in October 2008 which was heart stopping stuff.

The VIX sits at 11.65% as I write. It will inevitably rise again. Sadly, I cannot tell you what the next cause of increased volatility will be, just that I know it will happen. As all parents know, extra-ordinary quietness is a reason to be concerned.

As an aside I think it would be a fair criticism that the VIX index appears US centric, partially blind to the rest of the globe, because the market’s indifference to Middle Eastern, Russian or emerging market concern. However, there is no avoiding the influence of US market opinion, even if they are quiet, because they are so influential on the price volatility for New Zealand’s financial market.

Queenstown – 2014, six years on from the ‘Global Financial Crisis’, which was probably named by some experienced parent who was familiar with regular crises and felt the financial one needed its own title, and Queenstown is beginning to look rather robust in an economic sense.

Long term readers of this website may recall Chris describing in 2007 that possible problems in Queenstown, if they materialize, could provide a lead indicator to a bursting bubble; relating to property development at that point. That bubble did indeed burst, shredding the rubber into unrecognizable pieces.

Today Queenstown is to begin night flights, is receiving 40-55 flights per day including many direct from Australia and is experiencing increasingly robust property sales activity. One property related headline caught my attention: ‘Strong investor demand pushes commercial property yields below 5% in Queenstown’.

This headline discloses an expectation of capital gains by property investors; otherwise there is little point in accepting such low yields, along with the risk of weaker occupancy than forecast.

My subsequent thought was for Dorchester investors waiting for the remaining properties in the Dorchester Property Trust (DPT) to be sold, including Goldfields in Queenstown. If DPT cannot sell the property in this environment something is very wrong with either their expectations or the property itself.

Queenstown will be very grateful for the latest polar blast which helps top up the snow cover and the bank accounts of local businesses.

We will know that optimism has settled in for a longer period when we again read about the shortage of affordable accommodation for employees.

Investment News

Credit Rating Upgrade – Fitch Ratings agency has upgraded New Zealand’s credit rating to ‘AA (positive outlook)’ up from stable outlook.

This is very good news and is a compliment to the financial management of the NZ government (Ministers of Finance, past and present) and to the current strength of the NZ economy.

Fitch notes that the upgrade to, perhaps ‘AA+’, is more likely if New Zealanders take the opportunity to save money during the current boom. So, keep exporting, reduce spending and keep saving.

Fitch said ‘vulnerabilities remained, primarily related to net external debt of the country (mostly private debts, not government debt) and a dependence on strong commodity prices’. We can begin to solve the debt vulnerability if we do actually save more money!

Fitch also said ‘New Zealand remains heavily exposed to developments elsewhere, notably in China and Australia’.

As I have said before, you will always be exposed to a risk of change in volume or price when doing business; these are risks that cannot be avoided. The particularly focused risks of Australia and China are a function of proximity and best price for our exports being concentrated with the biggest buyer at present, which, again are desirable positions to maintain (closest to deliver and best price paid for the most volume).

As long as we have developed deeper market distribution than the volume of produce to sell our economy should be fine. Alongside such broad distribution options we must manage our financial risks to acknowledge that we will not always sell at top dollar, but when top dollar is available we must take it from whichever buyer(s) appears at the front of the queue.

A credit rating upgrade in ‘this world’ is both unusual and a compliment worth broadcasting widely.

Kiwibank – following on from the story above, Fitch has also placed Kiwibank on credit watch positive (AA currently) in recognition of its position as a 100% subsidiary of NZ Post, which is in turn a State Owned Enterprise.

Fitch is quoted as saying: ‘The agency believes support would likely flow from the sovereign through NZ Post to Kiwibank, should NZ Post find it difficult to provide support itself’.

It clearly doesn’t say ‘government guaranteed’…. Does it?

We wrote about this weak attempt at selling a perception (or is it the reality that is the perception? – Ed) in Market News on 12 May and now believe that the government would be wise to sell 49% of Kiwibank’s shares (list on the NZX) to release the ever-increasing contingent liability from the taxpayer.

The government is about to tender some of its banking services. I understand that Kiwibank has said it will not be bidding for the transactional business and whilst this may be an honest statement about the bank’s resources, or capabilities, surely a five or ten year contract from the Crown would provide sufficient confidence to get on and develop those resources. (Kiwibank may bid for payments, cards, and foreign exchange services)

A long term banking contract with a relatively reliable profit margin would be another way for the government to deliver necessary capital to Kiwibank.

Why wouldn’t the government seek out such a contract with one of its own businesses? After all, it wasn’t so long ago that a mutual ownership situation delivered a brand change for a petrol station near a high traffic airport.

This Kiwibank story keeps bringing me back to the need for the government to invite new shareholders onto the register. I know, it’s all about timing and in 2014 the answer to selling shares in Kiwibank is a political ‘NO’ but that doesn’t make the idea wrong.

The bigger Kiwibank becomes, the bigger taxpayer contingent liability becomes and the more our government defies the intentions of the Basel III international banking reforms, which set out to reduce (remove?) taxpayer liability from banking sector failures.

I can see an irony brewing, if I use the ACC policy where the government insisted on matching assets with liabilities dollar for dollar (wise governance); a bigger Kiwibank and thus a bigger contingent liability would require the government to set aside even more taxpayer dollars for the benefit of Kiwibank!

The outcome of selling some shares in Kiwibank will, in my opinion, become clearer and clearer as the bank grows. For now, a credit upgrade is good news for all involved (including recent bond investors).

MRP – Investor conversations no longer include disappointment about the MRP share price being below the IPO price and perhaps this is because they have received their dividends, recognise the reasonable expectation that the dividends will continue and believe that the political threat is currently diminished.

Certainly those investors can see the ongoing good performance of the company, updated through current road shows, with slides available on the NZX website:

https://www.nzx.com/files/attachments/196656.pdf

The two Chief Executives, Doug Heffernan – old (with all due respect) and Fraser Whineray – new, kindly presented this information to the NZ Shareholders Association last week and both were quite optimistic about both their business and New Zealand’s opportunities to improve our whole energy sector.

Doug Heffernan had the experience, right back to NZ Electricity Department, to explain the enormous improvements that have occurred over the past 40 years to the benefit of NZ as a whole with respect to energy.

One development that they would like to see next is a move of the political focus from electricity pricing, which they can display as competitive, to what they consider to be the elephant in the room; changing New Zealand’s fuel of choice in the transport sector, encouraging a trend from fossil toward renewable fuels.

They point out that we are one of the world’s best producers of renewable energy (5th by percentage of local generation) but we import large volumes of fossil fuels, so a trend toward renewable energy in the transport sector should be very good for the countries balance of payments and Current Account outcomes and the local environment. As a supplier of renewable energy they would say this, and should, but that doesn’t dilute the facts.

We have raised the importance of the US becoming self-sufficient with its energy needs; the same would be true for NZ if we could achieve such a position.

I also picked up on a bit of excitement relating to the metering side of the business and the increased potential to deliver half hourly usage monitoring to enable consumers to reduce their overall energy costs via reductions to the volume of energy consumed.

This extra detail has allowed MRP to deliver an accurate use profile for prepay customers who historically found energy consumption difficult to manage. This service has seen bad debts and disconnections fall from 0.50% of customers to only 0.10% now which is an enormous improvement just by helping those customers understand and manage the situation better.

A marketing person would want me to use the term ‘optimise’ at this point but I have become rather cynical of such terms…. Optimise, maximise, … hypnotise. I see ‘Webinar’ appears to be dropping out of the lexicon, which is a relief to me.

Heffernan and Whineray pointed out that local shareholder support had grown since the IPO with ‘offshore selling’ of shares by the impatient traders being purchased by retail scale investors in NZ (holdings up by 2.5% of the register).

Disclosure: I own a few MRP shares and view them as likely to feature in my portfolio for a long time. I also own a few MRP bonds.

New NZX Market – Minister of Commerce has granted the NZX an exemption that will allow NZX to establish a new market with an alternative disclosure regime, which differs from the traditional continuous disclosure requirements of the NZX Main Board (not that all such issuers cope with such disclosure obligations very well).

We would expect the NZX to have a ‘no returns’ policy, stopping listings on the Main Board from jumping back to the new NZX Lite board (my title), in an attempt to declare that continuous disclosure is ‘too hard’.

FMA's approval of the market rules is now required before NZX will be able to approve listings on the new market.

Key features of the ‘new, broader’ market include:

- Small to mid-sized businesses with an expected market capitalisation of $10-100 million

- Reduced costs and complexity, both during the listing process and ongoing

- More support for companies listed on the market

- A streamlined regulatory environment, with a set of simpler rules and procedures

- The presence of market making and research to aid efficiency and liquidity

- Better information on companies for investors through quarterly updates, research coverage and key operating milestones

This is a good development for NZ capital markets and has stemmed from the work of the Capital Markets Development Task Force.

 

Ever The Optimist – Extra consuming is not really what I look for but a 25 year high for vehicle sales does confirm a relatively high level of confidence locally.

Fortunately a portion of this data relates to biggest ‘commercial’ sales records since records began in 1981.

ETO II - Milk collection across New Zealand for the month of June reached 9 million kg of milk solids, 10.1 per cent higher than the same month last year.

Milk collection for the 12 months to June 30 reached 120m kg, the same level as the previous season, despite being down significantly in the spring, confirming a continued increase in production performance across NZ.

 

INVESTMENT OPPORTUNITIES

Kiwi Income Property Trust – the new offer of a seven-year senior, secured, bond is now open and investors are welcome to request a firm allocation from us (first come first served).

The interest rate has been set at 6.15%p.a. Interest will be paid semi-annually in January and July; a good choice for anyone trying to expand their cash flow throughout the year. Most use the months of March, June, September, and December.

Before one refers to my story about the VIX and any potential for interest rate increases, note that global problems can also deliver interest rate declines, which is precisely what is happening at present. The US 10 year bond yield has recently declined from 2.65% to 2.49%.

The offer closes on August 1 so, if you plan to invest, now is a good time to act. Interest begins at the issue rate (6.15%) the day your investment is processed, which beats leaving it in the call account any longer!

Investors are welcome to contact us if they would like a copy of the prospectus (also on our website) and a firm allocation.

Those who have authorized us to provide them with financial advice can find a research article on the Private Client page of our website.

MRP Bond – Thank you to all who participated in this offer with Chris Lee & Partners. Most investors received 100% of the amount sought, including those processed in the public pool.

The interest rate was set at 6.90% and bonds will now appear in your names at the registry (can be checked via Computershare’s website). I extend my compliments to Computershare for the thorough email sent out to confirm the new allotment of MRP bonds to each investor (for those who agree to use email by the registry).

Scales– This issue was popular enough to result in some scaling. Investors with a firm allocation are encouraged to send their completed applications to us promptly please. Post dated payment (prior to the close of July 25) is fine; we will hold until the nominated date.

Those who have authorized us to provide them with financial advice can find a research article on the Private Client page of our website.

Listed Managed Fund – There is a long stream of new investment opportunities at present, with this one being the first listed managed fund for a while. The name of the fund is QV Equities Ltd (QVE), managed by Investors Mutual Ltd.

QVE will focus on companies outside the ASX top 20. Detailed information about the offer is available on their website: http://qvequities.com/ but importantly in my view includes a free option to buy more units at $1.00 (until 2016) to help offset the usual dip in Net Asset Value for a new offer such as this one.

Another aspect that the managers dwelled upon was the competitive fee structure, which excludes a performance fee (good on them). The fee will be 0.90% up to $150 million and 0.75% thereafter.

IML is an experienced fund manager (16 years) focused on what I call old-fashioned value assessment and not speculation and market trading. They supplied the usual stream of historical performance statistics but the thing that appealed to me the most was that one of the people talking to us was the founder of the IML business.

The offer appealed to me (so I attended the presentation) on the basis that it is to be listed on the ASX at a time when the NZD / AUD is reaching back up to near all time highs.

The offer opens this week and closes on 8 August. Payment for the investment will be in AUD (we may be able to assist with conversion of NZD).

Investors seeking investment in a listed, managed, exposure to Australian shares (beyond the ASX top 20) may wish to consider this offer. We are happy to supply the offer document to you, if asked to do so.

MetroGlass Tech – has set its share price at $1.70 and assigned allocations to brokers. We have a small allocation available if investors wish to participate.

The offer opens on July 15th and closes on July 28th.

E-ROAD – has confirmed its intention to offer new shares and raise up to $40 million in capital to expand its business, a business that offers products that allow transport companies to better manage and pay road user charges and keep track of their fleet.

Timing is intended to be mid-July followed by listing on the NZX in mid-August.

We have a mail list for investors to join if they wish to hear more about such an investment, if offered.

Vista Entertainment Solutions – Vista Entertainment Solutions, a cinema ticketing software developer and film distribution company, plans to raise up to $100.3 million via a proposed share float next month.

The share float is to involve a mix of new capital ($40 million) plus shares sold by current owners (up to 37% of the business). The indicative share price range is (too wide) $2.10 - $2.70

BNZ Issue – We still expect a subordinated bond offer from the BNZ (Tier I, or perhaps Tier II) and we continue to add names to this mail list.

ANZ Issue – One day, we believe ANZ will also line up to offer the public a subordinated bond. We have a mail list open for this potential offer too.

TRAVEL

Kevin Gloag will be in Christchurch July 31 then Wanaka and Queenstown on August 22.

Chris will visit Timaru on September 1 and Christchurch on September 2 and 3.

Anyone wishing to arrange an appointment is welcome to contact us.

Michael Warrington

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Market News 7 July 2014

Chris, David and I have all just finished reading a financial markets book that describes an unsurprising but incredibly disappointing behaviour that will be shocking to the majority.

Flash Boys by Michael Lewis explains the largest, and I mean massive, insider trading rort in financial market history, centred in North American stock exchanges but unseen by most.

The fraud is simple, involving the front running of client orders (cheating), albeit that this is now done using computers and ever decreasing time scales. Timing (micro, milli and nano seconds) does not alter the behaviour of these crooks; the trading behaviour was simple front running.

It seems that every bank and broker in the US is selling its access to insider information about client investment behaviour to others (described as High Frequency Traders) who pay a fee for the information so that they may leap in front of that original investor client and extract a risk free profit from the trading behaviour.

A simple, slow moving example, might look like this:

A customer instructs his broker to buy 1,000 Fonterra shares at market price (no limit);

At the time the order is placed one could buy Fonterra shares at $5.73;

The corrupt broker (or the person he sells the information to) buys 1,000 Fonterra shares at $5.73 for his own account;

The same corrupt broker subsequently sells 1,000 Fonterra shares to the customer at $5.78.

The good news is that the small group of outraged people on Wall Street were smart enough and brave enough to challenge this appalling behaviour and take on the predators, a most unusual behaviour on Wall Street. These people set up a new exchange (IEX) with the purpose of benefiting the client (how novel – Ed).

You can read about IEX on Wikipedia too: http://en.wikipedia.org/wiki/IEX

The IEX volumes have increased rapidly since its launch in October 2013, now exceeding 50 million trades per day (its necessary minimum to succeed financially) and the growth confirms that investors are succeeding in their fight back against the insider trading, front running, predators.

Brad Katsuyama; a name to remember.

Perhaps the most frustrating part of this story is that the regulators and other stock exchanges didn’t enforce moral change because they were all being paid too much money by the predators, with the money stolen from investors!

Just as an aside, I am beginning to believe that this manipulated pricing behaviour happens on many different online booking systems.

I have seen prices change over a period of minutes, such as on air travel, when I ask about a price and back away to think about it, then use the same computer (which as a unique address) to re-approach the service provider but I am quoted a different price!

INVESTMENT OPINION

Technology – As a member of humankind I am excited about the technology developments occurring around us. As an investor I am scared.

Drafty? – Metroglass Tech (MGT) seems to be in a real hurry to float their shares on the NZX!

It’s almost like someone called in to report a broken window, its cold and the draft is cooling the home rapidly and MGT is on its way and hopes to have the situation resolved by sunset.

The media has reported that the share price will be set at $1.70 (a semantically important 5 cents above the $1.65 minimum) after discussions behind closed doors with institutional investors.

Behind closed doors… recall my comments from last week about the desirable alternative of transparent, all inclusive, public book builds using the easily developed, but steadfastly blocked, online service portals.

The vendor of MGT is…. one moment.. ahh yes, it is another private equity fund: Crescent Capital.

Private Equity ~ capital market development supporters?, leave value on the table?, transparency?

I have a view that MGT owners would be much better at selling opaque windows for a bathroom than clear windows for a sunroom.

Could it be that the marketing pitch for the current share price will include the high volume of building consents in Canterbury and Auckland plus the push to see councils accelerate further development?

What’s the rush?

Payment Methods – New securities offers began offering Direct Debit as a payment method in recent years and from our perspective it has worked very well; even better now that investors have clarified with their banks which accounts they can use for DD payments.

It is now time for those offerors, and the appointed registry, to offer investors the opportunity to nominate the date for processing their DD.

DD replaces the ‘old’ Cheque, which is very quickly disappearing from the payment landscape. However, the cheque offered the ability to set a date for processing the payment offered.

Registries make it clear that they will not recognize post dated cheques and we have some sympathy for this stance given the extremely high volume of paper work received by them during an Initial Public Offer.

If clients send us post dated cheques, with a note drawing our attention to it, we do manage the delivery of that investment to suit the investors wishes, as best we can.

It makes a lot of sense to me that investors should be asked a processing date for a DD because it comes with the following benefits:

The registry could ‘check’ with the bank (electronically) that the nominated account could be used for DD payment, and revert to the broker involved if the answer was negative;

The vendor of the securities, or their underwriter, would witness relief of their obligations to sell the securities or borrow the money sooner than they do currently because application forms would arrive sooner now that the investor has more control over the payment process;

The registry staff could smooth the loading process prior to allotment date (after the issue closes) rather than receiving 75% of the application forms in the last three days of an offer;

The investor would not lose out on an unknown number of days interest on their money. It is clearly imprecise when trying to match up movements of cash from interest bearing call accounts into an account awaiting payment outward for a new investment; and lastly

An investor would not need to miss out on interest if a courier should ‘misplace’ an important parcel!

Once the registry settles into DD with a nominated date, the next logical move would be to re-visit the ‘application for securities online’ as introduced by the government with its recent share floats. The combination of ‘apply for securities online’ and ‘pay by DD on a nominated date’ would be ideal for all involved as this would finally remove from the process the mountain of paper received by a registry.

Imagine if we then linked this service to an online book-build process for the investment offer (set pricing, determine access) and an online test for Anti Money Laundering obligations from a central source (Department of Internal Affairs are part way there with their REAL ME service).

Then we would be in great shape.

As we trip over dozens of IPO’s that lead us to believe that we are becoming masters of modern technology, where last week is no longer modern, surely we can come up with the technology that I describe above.

Rising interest rates – is the only choice left once you reach zero (or negative as in Europe on overnight cash!) but the aspect of rising interest rates that is hardest to see is the timing of the move, and to some extent the scale of that move.

For now it is only the overnight interest rates in many countries that have fallen to zero percent, or slightly negative, with other very short terms (days) heavily influenced by this situation and thus also sitting very near to zero. Longer-term interest rates remain nominally positive, albeit with the threat of delivering negative real returns.

If long-term interest rates fell to zero investors would stop lending for long periods; accordingly I doubt that zero interest rates for long terms will happen, although such certainty is usually unwise for prediction in financial markets.

We are witnessing a significant increase in the balance street strength of banks globally, especially in Australasia (recently reported as having four of the most profitable globally) so if an investor is offered a zero per cent return that investor will logically nominate the shortest term possible and hold the ‘free’ option of being able to move that money elsewhere as soon as possible.

Long-term interest rates, globally, are very low and investors must be asking themselves, why bother to invest and lend money long term?

Spanish 10 year bond yields are now trading at 2.67%, reported as being their lowest level in over 200 years (while a French Revolution occurred next door!). The same situation exists in Italy (2.84%) and France (1.72%). If you want to earn more than 3% on your European government bonds you have only two choices; Portugal (3.56%) and Greece (5.86%).

How did we reach this point whilst the word ‘crisis’ still echoes off the walls of historic buildings around Europe?

It simply isn’t credible to think that there are almost no risks (inflation or default) in these countries. However, for now financial markets hold a view, widely held, that these risks will not present themselves for a long period of time. That widely held view can be witnessed in the yield curves of the world which have a positive slope, expecting interest rates to increase next, but they are all visibly uncertain about when meaningful increases might occur.

Investors often cite to us a concern about rising interest rates as the reason for reluctance to invest in longer-term bonds. The reality seems to be that long-term interest rates will not rise soon, or far, and it is also true that most bonds in NZ are not long term at all. 1-5 years is considered short-term internationally, 5-10 years as medium-term.

Investors are offered extra reward for lending over longer terms and we think these returns will turn out to deliver higher real returns than repeated use of short term fixed interest investments.

Investment News

US Oil– The rapid move toward energy self-sufficiency for the US will have a significant and broad impact on the global economy. The point of self-sufficiency for the US must be very near because last month President Obama lifted a four-decade-old (since the 1970’s oil crisis) export restriction that once blocked the exporting of US oil.

Approval was granted last month, initially to two US businesses, to export a type of ultra-light oil known as condensate to foreign buyers. The buyers could turn the oil into gasoline, jet fuel and diesel. It is likely that approvals will be granted widely to export this ultra-light-oil, with rapidly increasing supply from shale oil mining.

The release of this light oil might explain the new widening of price between diesel (down) and petrol (stable or up) on NZ forecourts.

This surplus of domestically sourced energy in the US, which may well be boosted by Mexico’s moves to introduce competition into its oil exploration market, will surely see a significant change to foreign policy and presence, or lack of it from a US perspective, in the Middle East.

The self-sufficient energy position may well be a significant part of the support for the US economy and thus its share market, which continues to set new highs each month even though profit data is not yet rising across the economy. Markets are always looking ahead, as far as they can reliably see.

To some extent, where US shares and interest rates go, so too does NZ and Australia leaving us with some room for near term confidence about markets.

Rabobank Update – Rabobank came through NZ for its regular annual update, which includes presentations by the bank’s Chief Financial Officer (Bert Bruggink), normally based in the Netherlands. I suppose it is possible that he will have presentations in Brazil shortly, timed nicely to enjoy the current success of their national football team!

It is nice to see continued evidence of their very stable staffing as it is the same CFO who offered the bonds to us in 2007 and if my memory is correct he has been employed by the bank for something like 28 years so far. On this basis I expect to seem him still present as CFO, or perhaps CEO, in 2017 to deliver on the intention to repay callable bonds that the market anticipates.

One must admire the consistency of Rabobank’s message, supported by the tenure of its staff: (my interpretation of the quote) ‘We have a strategy of explaining the bank’s intentions clearly and meeting market expectations of the bank. With respect to callable securities (such as RBOHA and RCSHA) we understand the markets expectation around being repaid at the first available call date (first possible repayment date)’.

The first available call date for RBOHA (annual reset perpetual security) is 8 October 2017.

The first available call date for RCSHA (five year reset perpetual security) is 18 June 2019.

Consistent with such expectations and intentions Rabobank confirms that they repaid $155 million of a similar perpetual security on its first available call date in 2013. They have three more tranches up for call this year (November and December) at which point it should become even clearer to holders of the RBOHA securities in NZ that repayment in 2017 is highly probable.

At this point we again commend the behaviour of BNZ with the repayment of its perpetual securities and lament the relative silence on the matter from ASB Bank.

Rabobank continues to increase its capital to most impressive levels, with a target for total capital of near 22% (currently 19.8%). They are certainly well clear of regulatory minimums.

Interestingly the CFO later discussed why the massive flood of 0% cash in Europe did not seem to be increasing lending to business. Simply put he contemplated that perhaps the new, much higher, capital demands were the reason lending was not increasing. Some banks are having difficulty raising new equity; some are aggressively trying to reduce their loan books to assist with the ratios. Lower interest rates are not having a meaningful impact on lending intentions.

Bruggink has a point, but given the damage caused when a business has insufficient equity, with respect to weathering a storm, I am not going to support an argument for lower equity levels. To be fair, Bruggink wasn’t encouraging less equity either; more likely, he was pointing out just how long it might be before lending activity increases in Europe and thus how slow economic growth might be there.

The push by Europe, Japan, the US, and it seems most nations other than NZ, to encourage more consumption and perhaps a little inflation through the application of zero interest rates runs counter to a view that I agree with, expressed nicely and simply by its author Jean-Baptiste Say; “the encouragement of mere consumption is no benefit to commerce”, “it is the aim of good government to stimulate production; of bad government to encourage consumption”.

As we, and many others, have said previously; you cannot buy your way out of debt. Many economies and persons within them have far too much debt and its repayment will be as slow as watching paint dry. The only alternative is to write it off and accept the loss.

Back to Rabobank.

I admire Rabobank’s stand not to issue covered bonds that place those lenders ahead of the majority of lenders to a bank.

Key risks that I heard were (all seem easily managed):

Commercial lending, and retail outlets in particular, are resulting in much higher provisions and write offs than normal;

The European Central Bank’s Asset Quality Review may result in a regulated approach to Loan to Value ratios and it sounds as if Dutch settings may not be as tight as others in Europe.  However, a recent change to tax deduction law is likely to see a declining trend for Dutch LVR’s.

All in all the presentation reminded us of Rabobank’s relatively conservative and consistent approach to banking and capital markets, which continues to give us confidence in the bank.

Ever The Optimist – The government has delivered on a promise to support increased international telecommunication network development with a $65 million commitment to the proposed Hawaiki Cable connecting NZ to the US and Australia.

The $65 million the government will pay includes an initial $15 million contribution and annual tenancy fees over the 25-year period paid to Hawaiki, conditional on other telecommunications companies entering pre-sale contracts.

I sense a growing need to research just how and where this cable will pass through Hawaii on its way to the US mainland.

 

INVESTMENT OPPORTUNITIES

There is an ongoing stream of Initial Public Offers of securities, with no end in sight. I look forward to the day when Christchurch City Council offers shares in some of its businesses too.

MRP – Thank you to all who have invested in the rather popular MRP bond offer and returned their applications so promptly.

Investors have done a fabulous job with fast turn-around of applications forms. This is increasingly important given the ever-shortening time frames when new bond offers emerge.

Kiwi Income Property Trust – has registered a new offer of seven year senior, secured, bonds which will set an interest rate somewhere between 6.10% - 6.30%p.a. (paid semi annually in January and July).

The offer opens this week on July 11 and closes on August 1.

We have a mail list for this bond offer and all investors are welcome to contact us and ask to be added, should they wish to do so.

Those who have authorized us to provide them with financial advice can find a research article on the Private Client page of our website.

Scales– The pricing for this share offer has been set at $1.60 which we think is sensible.

Having the price set at the bottom of the indicative range seems to confirm a confidence that professional and retail demand will be sufficient but that no investor was willing to pay a price within the estimated range. In fact I ponder the likelihood that professional investors targeted a price of $1.50 but relented on 10 extra cents when the vendor threatened to cancel the offer.

It will have been frustrating for the seller to accept a share price at the bottom end of the range recommended by their financial advisers; it may look weak to some observers. Vendors and advisers always hope for mid point or higher.

The vendors may well be disappointed but they still agreed to do the deal and sell the shares. I suspect they are still smiling as they take some profit on a good investment. In my opinion most of the value lost on a Scales investment was lost by the tax payer when the South Canterbury Finance receiver sold the business so aggressively.

The vendors of Scales have gained some value as a result of the development in the apple market over the past three years, and they deserve some reward for this risk, and the structural changes they have made to the business. 

It seems that the new buyers of Scales are being offered a fair price for the shares.

The offer opened on July 5, closing by July 22 and listing on the NZX on July 25.

Those who have authorized us to provide them with financial advice can find a research article on the Private Client page of our website.

E-ROAD – has confirmed its intention to offer new shares and raise up to $40 million capital to expand its business, a business that offers products that allow transport companies to better manage and pay road user charges and keep track of their fleet.

Timing is intended to be mid-July followed by listing on the NZX in mid-August.

We have a mail list for investors to join if they wish to hear more about such an investment, if offered.

Vista Entertainment Solutions – Vista Entertainment Solutions, a cinema ticketing software developer and film distribution company, plans to raise up to $100.3 million via a proposed share float next month.

The share float is to involve a mix of new capital ($40 million) plus shares sold by current owners (up to 37% of the business). The indicative share price range is (too wide) $2.10 - $2.70

BNZ Issue – We still expect a subordinated bond offer from the BNZ (Tier I, or perhaps Tier II) and we continue to add names to this mail list.

ANZ Issue – One day, we believe ANZ will also line up to offer the public a subordinated bond. We have a mail list open for this potential offer too.

TRAVEL

Kevin Gloag will be in Christchurch July 31 then Wanaka and Queenstown on August 22.

Anyone wishing to arrange an appointment is welcome to contact us.

Michael Warrington

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