Taking Stock 29 April 2021

SO the real winner from the planned Crown guarantee for depositors will be . . .  drumroll . . . you guessed it, the Crown!

It can expect hundreds of millions in fees from which it should pay out . . . nothing, unless it has learned nothing from the 2008-2010 disasters overseen then by a morally and intellectually challenged Government and a dysfunctional public service.

Politicians should not be expected to have improved their knowledge since then.

Finance Minister Grant Robertson is a long-term public servant, with a void in market knowledge.  He will be getting strong opinions from Treasury, perhaps tainted by their perpetual focus on government department supremacy.

The Labour Cabinet comprises lots of pleasant people skilled in creating policy but there is a void of any evidence of ability to execute policy, let alone analyse banking behaviour and price risk.

Treasury is now headed by a smart woman, but still has a reputation to restore after a decade or more of ineptitude.  Its relationship with the Reserve Bank has been at best strained, often dysfunctional, and is likely to reflect its envy of the Reserve Bank’s authority.

The Reserve Bank now has some people with grunt, with private sector contacts, and is led by a ‘’ginger’’ with none of Robertson’s or Key’s need to be cuddled by the public.  It will not welcome Treasury or Robertson’s inexpert interventions.

For example, Robertson’s wish to adjudicate on bank lending would be as absurd as any wish, as Minister of Sport, to select the All Blacks.

Also important, the Companies Office is virtually non-existent, effectively recovering from a dark period when private sector lawyers replaced long-time specialists, the CO unable to attract staff with the required skill, after a mass exodus following egregious errors during the finance company implosion.

And in this environment, New Zealand is offering to guarantee what might be around $100 billion of deposits, from banks and finance companies!  The fee income will be hundreds of millions.  The Crown pay-out under the new guarantee should be nil.

Much will now depend on the Reserve Bank and Treasury collaborating to ensure a greenhorn Government is cornered into funding the Reserve Bank and Treasury into a new role as the High Court Judges of how to price and manage a new, massive liability.

The Government should fund this, and then rely on skilled supervision and supportive new regulations to prevent any pay-out.

The Reserve Bank will need to lure specialists from the UK. To achieve this, it will need the Ministry of Business Innovation and Employment to enter the real world, acknowledging that such skills and experience are not awaiting discovery in New Zealand.

Treasury and the Reserve Bank would have to bury their past discord.

The first and obvious issue of the guarantee will be the price of the guarantee, but there are much harder matters to resolve first.

Pricing should be assessed on risk.

A bank with an AA credit rating and a long history of an open, honest relationship with the regulators, might pay a fee of perhaps one eighth of one percent, 0.0125%.  It should not fail because of poor behaviour.

For such a mythical bank, the cost on its ‘’guaranteed’’ deposits might be $50 million a year, fob pocket coins to a large bank.

For a bank like the ANZ or Westpac, with inappropriate governance, a history of ‘’errors’’ in their communications with the regulators, and wavering Australian ownership commitment, the matrix designed to calculate fees might double or even treble that cost, if only to reflect uncertainty about the information provided by smart-alec bankers, believing their role is to outsmart the regulators.

For second-tier banks with lesser credit ratings but better records of co-operation with regulators and much lower deposit ledgers, the cost might be in single millions.

For a finance company seeking public deposits, like General Finance, the cost would be minimal in dollar terms but high in percentage terms, certainly a fee set at rates higher than 5%, reflecting the sector’s historical failure rates, the type of lending, the structures to manage risk, and the unproven quality of the shareholders to raise more capital.

This might seem harsh, but moral hazard enters the equation, as was so coarsely demonstrated by Key and Clark, when they ignored the fiduciary responsibility to supervise the risk of the guarantee introduced in 2008.

To refresh memories, what we had in that era (2008-2010) was an open safe for any villain to pillage, restocked with millions every night by the taxpayers, who had no say in the process.

There was no useful supervision of the lending institutions which raided the safe.  Some who sought to raid the safe were later jailed.  They should never have had access to the keys.

They could raise massive sums, effectively at government stock-based rates, and lend it at 20%, often more, cornering the margin gain but leaving the real risk with the poorly-protected taxpayers.

Treasury, the Reserve Bank, and the Companies Office were barely on talking terms, each responsible for different aspects of the scheme.

Key and his ministers arrogantly ignored advice and misrepresented the behaviour they were observing, Key once seeking to spin the idea that the nett cost of the scheme was minimal and irrelevant.

In effect, banks paid the fees to calm the nerves of their depositors, at a cost of several hundred million, while the non-bank deposit takers (finance companies, etc) paid very little to ensure they were funded and could chase the high margins applying to increasingly desperate property developers.

The victims were ultimately taxpayers and those investors who were not protected. The Billion Dollar Bonfire was the result.

The behaviour of all parties was disgraceful and led to the legacy for Key and his government that only the most plastic of people would disregard.

Getting the price right, so that it reflects risk and disincentivises abuse, is only the first step, this time.

Having a structure in the Reserve Bank that is well funded and has the right people is obviously essential. I observe in the Reserve Bank many competent people, today. It needs more of such people.

The Reserve Bank already monitors banks, insurance companies and finance companies but the guarantee will add a new threat that must be countered by extra layers of supervision.

That supervision would be ineffective if there were no changes to the details in the financial reporting, demanded of moneylenders.

The 2008 finance company disgrace was based on appalling accounting standards overseen by, I am sad to say, gutless or clueless auditors, by trustees of barely fifth form standards of financial skills, and worse still, overseen by regulators who with very few exceptions were little more than box-tickers, turning deaf ears to the chatter of informed market participants.

Securities Commission leaders, like Jane Diplock and Annabel Cotton, were very poorly chosen.

Sitting on the highest chair were governments, Clark’s and Key’s, which with almost no exceptions were keener on staying in office than on using their authority to make the investment world a better place.  Both governments should have been prosecuted for their lack of fiduciary responsibility.

This time, there must be a team of Reserve Bank and private sector leaders to devise new accounting standards that are meaningful.

The accounts MUST disclose true cash flows from lending and they must disclose the true type of lending.  Property developments are not defined by the nature of their aspirations but by the nature of the risk.

For example, a developer seeking to build 100 motel units needs a development loan, with no cash to repay until the loan is completed and sold.  This is not a ‘’motel loan’’.  Development loans are universally interpreted as being of high risk, needing strong levels of capital from the lender.

A ‘’motel loan’’ is a loan to a motelier, who is running a business that has cash coming in every night.  The failure to observe this distinction was a major factor in the billion-dollar bonfire over which a smiling Key presided, while the bandits were assassinating trusting investors.

One of the main explanations of why the likes of South Canterbury Finance, Strategic Finance, Hanover Finance, St Laurence and Bridgecorp attracted deposits was because they avoided cautious discussion on the level of high-risk development loans they were dispensing.  These issues were not discussed, because the subject was never disclosed, in their various public documents.

The credit-raters failed to see the risk.

This time the accounting standards must demand accurate coding of loans.  They must also deny lenders the right to mis-display cash flows.  The need to match the terms of deposits with the repayment schedule of loans is obvious. No development loan can be funded by short-term deposits.

This was not obvious to directors, executives, trustees, auditors and regulators during the last iteration of a Crown Deposit Guarantee system, their attention diverted by charts that deliberately mis-described the ability to collect loan repayments on time.

Provisioning for potential bad debts will also need much better definition.

A five-year development loan, requiring no capital (or even interest) servicing until the end of the fifth year, is not a ‘’good’’ loan, unless it is progressing well, is within its time budget, and is highly likely to attract buyers at a price exceeding the development cost.

The need to provision might be obvious in the first year if the project faced headwinds.

The likes of SCF, Hanover, Strategic and St Laurence misled, by not discussing headwinds. They misled investors, cynically and deliberately, yet escaped the judiciary.

Liquidity, risk, and the effect on future profits of problematical loans need to be so readily disclosed that even an accounting student can see the problem.

If these matters are not remedied, even the smartest people in the Reserve Bank will find it hard to price risk intelligently.

The Reserve Bank also has the right to deny governance or executive appointments to people who fail the fit and proper person test. The Financial Markets Authority should also have a voice on this subject.

Those who have committed fraud or failed repeatedly would obviously be declined any leadership role as should be those whose behaviour is anti-social (the Russell McVeagh predators of young women being an obvious example).

I suspect Adrian Orr would also like to bar cynical bank directors who spin the truth and obstruct the regulators’ view of the realities behind the presented information.

Orr should be empowered to challenge such people, just as he should be allowed to decline as bank directors those who have no relevant skills or experience.

If the taxpayers are going to guarantee potentially hundreds of billions they should have protection in the form of competent regulators of the scheme, armed with meaningful access to information, and empowered to boot out any plastic people who use their gig in governance or management to thwart the regulators.

If the Reserve Bank demands and is given such resources, the pricing of risk should ensure the only winners from this new, proposed guarantee would be the taxpayers, who would collect fees and should never have to pay out to a failed moneylending organisation.

The depositors would win in that they would feel safer about their choice of bank or finance company, but the Government would win by collecting hundreds of millions in underwriting fees without having to shell out the loot, better standards, properly enforced, being the real guardian of depositors’ money.

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Johnny Lee writes:

THIS may well be the calm before the storm.

The New Zealand sharemarket, after peaking at record highs in January this year, has begun hovering at a stable level, with the odd bout of volatility in individual stocks. Over the past month, the market index has gained a few percent.

There has been some volatility, as the likes of Meridian and Contact have been poked and prodded by overseas shareholders, but most major stocks in our index have been stolidly stable.

With the absence of any change in direction regarding interest rates, company reporting all finalised in February, and a lull of corporate activity, investors have been able to take a rare breather.  There are some clues, however, that suggest this may need to be a particularly deep breath to prepare for the next few months.

One change will be the avalanche of money being returned to bondholders in the next 60 days.  Between the likes of Chorus (CNU010), New Zealand Post (NZP010) and others, more than a billion dollars will be re-entering the system in a space of only a few weeks, searching for a return.  The lack of interest in the term deposit market can help predict the direction of the flow of funds.

Some of this money will make its way to new bonds.  ASB Bank has launched a new bond (now closed), and others will likely join the pursuit of this money, providing some element of tension in market pricing.  Some will make its way to the secondary market, looking for long-dated fixed-interest securities at yields almost certainly lower than previously enjoyed.  And some of the funds will find its home in the sharemarket, where both risk and return are higher.

Already, investors are seeking early-mover advantage, anticipating the crowd joining them in the coming weeks.  The bond market has seen a flurry of interest in recent weeks, as people look to secure long-term rates at current pricing.

New issuance should accelerate, seeking to capitalise on the low interest rates and strong demand from investors for reliable, diverse securities.  This seems likely, although some issuers may feel sufficiently funded already.  Covid saw a majority of companies slash expenditure, building reserves until certainty returned.

Longer-term, other specific events will add fuel to this fire.  Tilt Renewables shareholders, subject to various approvals, will be receiving approximately $3 billion in cash in August, assuming the takeover proceeds as expected.  The impact of this will be slightly more muted, as Tilt is almost entirely owned by entities controlled by Infratil and Mercury.  Infratil, itself the subject of a takeover offer last year, will then evaluate the best use of its lion’s share of the proceeds.

Perhaps Infratil’s announcement today, of an acquisition in the health sector, is a taste of what is to come.

We also have additional bond maturities throughout the year, some substantial.  Historically, these have been matched by new bonds coming to market.  Our experience over the past six months tells us that there is already a huge number of buyers lying in wait, eager to lend to these borrowers at rates most would have thought unthinkable only a decade ago.

All told, the ‘’balance of power’’ is now firmly with borrowers, merely a year after the pandemic had placed it in the hands of lenders.

Investors should take this brief pause in market activity to familiarise themselves with their maturity profiles.  Holders of Chorus bonds and New Zealand Post bonds, in particular, should be considering their options come maturity.

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Edward will be in Wellington on Wednesday 12 May, in Auckland on June 10 & June 11, Napier on June 24 & June 25 and in Nelson in July.

Johnny will be in Christchurch on May 20 and again in June. He will also visit Tauranga on 12 May.

David will be in Kerikeri May 6 and Whangarei May 7.

If you would like to make an appointment, please contact our office.

Chris Lee

Managing Director

Chris Lee & Partners Limited

Taking Stock 22, April, 2021

David Colman writes:

THE promise of a ''guaranteed'' income ''for life'' has been exposed as false this year.

Lifetime Retirement Income closed the Guaranteed Income Fund after less than 5 and a half years since it was launched on 15 December 2015.

The similar Simplicity Guaranteed Income Fund has followed suit.

The Guaranteed Lifetime Annuity products together mustered about $200 million dollars under management after being heavily promoted by questionable financial 'advisers', perhaps paid to attend seminars and sell what they may have misunderstood.

In January of this year, the Reserve Bank of New Zealand asked Lifetime Income Limited to raise more funds as regulatory capital but the firm could not find a way to raise the amount required (approximately $10millon) by the deadline of 30 June this year.

In the context of financial markets, the failure to find such a sum implies a weak level of shareholder wealth.

The RBNZ would have been aware of the fund's lowly credit rating of B, several grades below a satisfactory rating.

In 2018, while the guaranteed funds still existed, Retirement Income Group (RIG), the company behind the Lifetime Income Fund, released an information memorandum to shareholders, existing and potential, with answers to the question of, 'why invest in Retirement Income Group Limited?'

An apparently simple answer was that RIG could charge hefty fees to manage people's savings and charge to insure that regular income so it might be paid after the savings were depleted. High returns to shareholders seemed possible.

So although I am disappointed for investors that were enticed by a 'guaranteed' income 'for life' which was initially offered at 5.0% per annum at retirement age of 65 (the original offer to 60 year olds was 4.50% per annum and up to 7.50% for 90 year olds) I am glad the same investors have a chance to evaluate their next step.

The memorandum described the retirement income industry as arguably one of the greatest opportunities for the New Zealand financial services industry, indicating that 400,000 Kiwisaver members with more than $36billion in assets would be in a position to transition to annuities in the next decade.

The insurance component, now being dropped, does not change the opportunity described above for ambitious fund managers/promoters so it is little wonder a replacement annuity is now touted minus the insurance component.

RIG has simply foregone the insurance component yet can still charge a fee to pay people a portion of their own money back to them in the form of regular returns from their managed fund.

The intention of providing an insured income for the rest of someone's life may have seemed admirable but from an investment perspective a variable annuity product, using the Guaranteed Lifetime Fund as an example, exposed participants to substantial fund management fees of 1.00% per annum and insurance fees of 1.35%.

If someone with $100,000 entered the scheme at 65 and lived to 90 then they would have paid tens of thousands of dollars for management fees and insurance to the managers over 25 years, an absurd percentage of their money.

Without the insurance cost the new notably higher management fee of 1.35% (why is this fee higher?) on the replacement unguaranteed fund for a 65 year old living to 90 would still pay many tens of thousands in fees on $100,000 in the fund over the 25 years.

Note: A person could draw down $4,000 (4%) a year from their own $100,000 for 25 years and not lose any of the principal in fees, a fairly logical, and superior, alternative but certainly not the only option.

The costly insurance component in the end didn't protect scheme members from the very things that the fund was promoted to protect them from, such as not having to worry about market crashes or low interest rates affecting their income even if achieving extended longevity.

Lifetime fund director Ralph Stewart indicated that very low interest rates, the uncertainty of Covid-19 and extreme market volatility contributed to the RBNZ requiring additional regulatory capital to be held by Lifetime Income Limited.

Covid-19 once again is easy to blame but in my view events such as seen in 2020 were likely to happen, and happen again, during the remainder of the Lifetime product for most participants.

Potential clients may have been more astute than the company estimated.

It looks like the insurance to guarantee income for the rest of someone's life that relied on returns from bond and share markets became too costly in the face of stubbornly low interest rates, less income from dividends and more volatile markets.

Optimistic assumptions of achievable fixed annual rates of return, that were estimated to be able to be guaranteed by the founders of the Lifetime scheme when it started, have unfortunately proven unrealistic, just as experienced capital market people predicted.

As a member of the New Zealand financial services industry I see the large numbers of Kiwisavers reaching retirement in a different way to that described by RIG in its memorandum.

I view the trend, more as an investor myself, in that Kiwisavers at retirement age and beyond have the opportunity to free themselves from the fund management fee machine.

Simplicity joined forces with The Lifetime guaranteed fund in 2017 and its founder, Sam Stubbs, described retirees' investment options as limited to low-interest term deposits or too-risky investments that offered higher returns. He said this when promoting the Simplicity guaranteed fund which has also been scrapped.

His views were either blinkered, or seen through a self-serving prism.

I can confirm retirees have a vast array of investment options available. A self-serving fund manager is simply ''selling'' when he suggests otherwise.

As the guaranteed fund has proven, no investment is without risk but disciplined and well-advised investors can manage their own portfolio with low ongoing costs and have great control of their own finances.

Not much is guaranteed in life and certainly no investment can be guaranteed for life no matter how long that may be.

An annuity is a complicated investment product. The initial investment in an annuity will decrease every year, influenced by fees, the performance of the underlying balanced fund and the amount paid in the form of fortnightly payments. Inflation will also eat away at what the income can afford.

I am relieved that annuities remain a niche and avoidable product in New Zealand.

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Chris Lee writes:

FOR all investors, including a social government, a key question now is whether or not it is too late to invest in property.

For some the issue is whether we can avoid inflation and thus avoid much higher mortgage rates, reducing the value of the investment.  Those with no debt welcome inflation.  It is a factor in the growing value of assets like property.

For some the issues are related to the consequences of rules made by people with usually very little experience in property investment.  It is hard to have confidence in those rushing through new law in pursuit of approval from their electorate.

We all know New Zealand has three major problems in residential property, and we know a Labour government will not be constrained by a shortage of funding.  Money for social housing is freely available at low cost.

The key questions are:

1. How to make property available to those on an average income;

2.How to coax those who have no access to shelter into a more optimistic and hygienic lifestyle;

3.How to ensure that those who are renters can have access to an acceptable standard of shelter, at a fair cost.

The third problem is easy to solve.

Go to Malta and discover how its government incentivises landlords with tax concessions granted only to landlords who sign a ''good landlord'' contract.  Incentives generate better behaviour.  Punishment just creates antagonism and encourages avoidance.

The second problem is easy.  Build extremely modest, cheap, lock-up units and give them to the homeless.  Go to Germany and observe the gibbed out, wired, warm, shipping containers, built with a tiny kitchen and bathroom and a decent bed.  All but the most damaged people would prefer this to living under cardboard boxes, as so many immigrants do in Brussels, as just one example.

The first problem can be resolved by visiting Britain or the USA where they have displayed a model that works.  This solution requires careful thought but, in headline terms, here is how that solution has developed.

Their equivalent of our Housing Corp/Kainga Ora buys up land, often recreational land that was used for community sports in the days when most people enjoyed activities such as golf, tennis, football, or even sunbathing.  Sequester the land.  Provide alternatives for the users.

In New Zealand terms, buy out one or two of Timaru's barely used golf clubs, facilitate the transfer of the members to another club, and use the land to build 1000 dwellings.  (That is the number you would build, for example, on the land occupied by an 18-hole golf course.)

Raise money with a 2.5% issue of Housing Corp bonds.  Indeed raise billions.  KiwiSavers, especially the index funds chained to indices, would provide money by the wheelbarrow full, even if the interest rate was close to zero.

Build $450,000 modern, dry, appropriate townhouses and build on the perimeter a car parking building so home carparks become obsolete.  Buy the land near available employment and near transport hubs.

Sell the townhouse that costs $450,000 only to those needing social housing, or affordable housing, but sell it for $250,000.

Ask for no deposit.

Lend the money at 3% for 25 years.

The mortgage repayments will be fixed at a third of median household nett income, so repayments are affordable.

Here is the key.

Impose a covenant which restricts the new ''owner'' to first offering any re-sale to Kainga Ora, at a price that is serviceable by 100% debt-funding at the same percentage of median income as the first buyer paid, that is, a third of nett median income.

So if in 10 years the median income has doubled, and mortgage rates have remained the same, then the capital gain for the first buyer is restricted to what the maths will dictate.

Meanwhile, Kainga Ora records the asset (the house) at cost price, never writing off the ''loss'', offsetting that loss because of the value of the right to buy the house back at a set formula.

Build enough houses over say, six years, to swamp the demand.  Create the builders by swapping no-cost tertiary education in construction for a five-year promise to work for Kainga Ora.

The solution would require a new acceptance that much of our recreational land now is barely used, and will be even more redundant, as the numbers playing team sport diminish.

Build skateboard parks or basketball hoops, or hip-hop dancing platforms, but do not kid yourself that one day young people will return to team sports that require coaching, practice, discipline and, most of all, the time to play on given days at pre-determined times.

So in summary:

- Go to Malta to learn how to constrain rents without constraining supply.

- Go to Germany to discover humane policies to help those whose aspirations have been destroyed.

- Go to Britain to discover how to change laws enabling the Crown to sequester land, provide modern houses at affordable rents, fund them with bond issues, and gain your return from a mix of your buyback rights and the satisfaction that the improved ''well-being'' of your population provides a meaningful return.

Leave all other housing provision to the private sector which will match market demand with a profitably priced supply.

NZ has some outstanding people in Kainga Ora.

Use them and use good strategies before they lose their energy under the pile of political indolence and incompetence that buries so many solutions, perhaps because of the oxymoronic expectation that public sector/political people have any capacity to visualize AND EXECUTE good ideas.

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TO complement the above plans, and ensure the plans can be executed, one more initiative would be required.

Our high schools would need to revert to the mission of preparing its students not just to be kind and inquisitive, but also to align their programme with available and useful vocations, so they can advance into real life.

That programme would ensure those high school students in rural areas might learn about meteorology, animal welfare, environmental hygiene, machinery usage, and a host of subjects more useful than ancient religions or solving quadratic equations.

And those with an aptitude for manual work might complete their NCEA in subjects that include construction.

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INVESTORS in the cynically managed Canterbury Mortgage Trust (CMT) have had their final repayment, bringing total returns, after 12 years of recovery, to around 93 cents in the dollar.

Those who have managed the recovery have recovered more than most from other mis-managed funds.  CMT, it should be recalled, was established by lawyers in Christchurch to do the type of lending that used to be performed by solicitors' contributory mortgage funds, or from their trust accounts (in earlier decades).

CMT promised to lend on real property (houses, buildings) and not on developments, and definitely not to those who represented extreme risk, like the serial defaulter David Henderson.

Governance of the fund was to be performed by Fund Managers Canterbury, a group of solicitors aided by at least one salesman of retail investments, one-time cricketer, Paul McEwan.

The governors broke their own rules, lending on property developments and to the likes of Henderson, thus imperiling investor funds which, when the fund collapsed in 2008/9, held $240 million (approx) of largely Cantabrian money, nearly all channelled to CMT by Christchurch financial advisers.  One does not imagine that these advisers were not being incentivised to recommend the fund.

To be fair to those advisers, most were from an insurance or real estate background and would have simply trusted the solicitors in charge to adhere to the rules.  Such advisers, common before advisers became licensed, were not selling knowledge, and not conducting useful due diligence.  Nor were they monitoring the behaviour of the fund.

When the CMT recovery began, the liquidators sued the various governors (Funds Management Canterbury) and succeeded in obtaining a confidential settlement, which is believed to be around $6 million, a trifling sum given the magnitude of their errors.

I regret that a High Court did not hear the case and give its view on the liability of the directors.

In today's environment, I would expect such an award to be far higher, but we have to accept that today's expectations of competent governance are rather higher than they were in 2009.

The CMT investors were repaid around 93 cents in the dollar, not including a small tax refund which differed amongst investors, depending on their personal tax rates.

The recent final liquidation report ends the subject.

What remains is the lesson.

My summary would be not to use contributory mortgage funds, but certainly not those whose governance is dominated by lawyers and financial salesmen.

Very few lawyers are streetwise, astute moneylenders, just as very few are of much value in weighing the risk and return of business investment decisions.  Their skill and expertise is in paperwork, not in assessing creditworthiness.

Financial salesmen are rarely useful directors, as we saw with Nathans Finance and Money Managers, in previous decades.

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Johnny Lee writes:

NEW Zealand investors have a name to add to their Christmas card list: BlackRock.

The world's largest asset manager has completed its sell-down of its two New Zealand holdings, Contact Energy and Meridian Energy, at market close on Friday last week.  Hundreds of millions of dollars worth of stock changed hands.

The sell-down was prompted by a rebalancing of the component weightings of the index that it follows.  It is perhaps easiest to explain this concept by way of example:

Previously, the fund (the iShares Global Clean Energy Fund) may have allocated 5% of funds under management to each of Contact and Meridian – in line with the underlying index that it chooses to follow.  This may have equated to perhaps 60 million shares in Meridian and 40 million shares in Contact Energy – a figure that changes day to day as more money pours into the fund.

Anyone with any rudimentary knowledge of the New Zealand Stock Exchange would have been aware that such a transaction, if conducted carelessly, had potential to wildly shift markets.  The New Zealand stock exchange does not have a high level of liquidity when compared to major overseas markets.  Meridian Energy might typically trade a few million worth of stock each day, an amount that diminishes to a figure closer to nil over holiday periods.  Simply put, very few New Zealanders are actively monitoring share prices on the 5th of January.  The cricket, rightly, takes priority.

Contact and Meridian saw substantial price growth as the large new buyer purchased as many shares as it could find.  The other stocks it invests in, such as Plug Power in the US, saw a similar effect.  The fund performs well, gaining 20% in a week, prompting more interest and more money to pour in.

Eventually, it becomes apparent that a fund purporting to ''measure the performance of companies in global clean energy-related businesses from both developed and emerging markets'' should not have a tenth of its assets in two income stocks in a country of 5 million people.

Following a change to the underlying index, controlled by Standard and Poor's, and telegraphed publicly and well in advance, this 5% was reduced to less than 1%.  With a stroke of a pen, BlackRock had too many shares in Contact and Meridian and must reduce its holdings.  New Zealand investors are aware of this and react accordingly.  The price falls.

Baffled New Zealanders, having sold the shares to a desperate BlackRock at $10 a share in January, were buying them back from a desperate BlackRock at $7.50 a share in April.

It would be tempting for investors in the ETF to believe that, somehow, New Zealand electricity stocks have hugely underperformed.  It would be easy to decide that, through some mysterious catastrophic event, an operator of a decades-old hydroelectricity plant was worth 25% less after a 90-day period.  Indeed, in all likelihood, the operators of the fund will justify this collapse in value due to ''index rebalancing'' or ''New Zealand underperformance''.

It was not. The root cause was two-fold:

The initial index construction was, fundamentally, flawed from the start.  Meridian and Contact Energy are both well managed companies, profitable and operating within a sector that is defensive in nature.  Investors in these stocks, typically, elect to invest for the semi-annual dividend income.  Share price growth is possible, perhaps due to business efficiencies, population growth, underlying interest rate changes or changes in the price of electricity.  However, neither is seeking to aggressively expand or corner a market.  Those seeking to ride a wave of investment into green technology could find a more likely target for such investment elsewhere.

Secondly, as stated above, the way the trade was executed was almost doomed to fail.

Contact Energy had never – ever – reached $10.  After trading for years between $4.50 on a bad day and $9 on a great day, the price was suddenly pushed close to $11.  Meridian Energy saw exactly the  same pattern, rocketing above $9 a share, well above any previous high.  Existing buyers, sitting in the queue at $7 and $8 a share, shrugged their collective shoulders and waited.  They did not have to wait long, with the price retreating towards normal levels within a week.

An actively managed fund would have certainly approached this differently.  With more discretion available to them, such a fund manager would have been able to co-ordinate the investment through brokers, finding large sellers to minimise the on-market impact to the share price.

This is not to suggest Contact will never again reach these lofty heights.  But realistically, the market price has settled again around $7, and in all likelihood, a return to $10 a share would prompt a significant amount of profit taking, limiting any potential gain.  Time will tell.

BlackRock remains a large shareholder of the company, although its holdings in both energy companies have fallen below the 5% threshold that marks a holding as Substantial and requires heightened levels of disclosure.  The share price should see reduced volatility, as the impact of this single buyer and seller will be less pronounced.

Ultimately, BlackRock (more precisely, the investors in this fund) has transferred hundreds of millions into the hands of New Zealand investors over the past three months, in what has turned out to be an expensive lesson for trading in comparatively illiquid markets.

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Kevin will be in Timaru on April 27.

Edward will be in Auckland on April 29 (Albany) & April 30 (Remuera). He also plans to be in Auckland on June 10 & June 11, Napier on June 24 & June 25 and in Nelson in July.

Johnny will be in Christchurch on April 28 and again each month in May and June. He will be in Tauranga on May 12.

David will be in Kerikeri on May 6 and Whangarei on May 7.

If you would like to make an appointment, please contact our office.

Chris Lee

Managing Director

Chris Lee & Partners Limited

Taking Stock 15 April, 2021

BILL HWANG, an Asian/American, who from scratch built an amazing US$10 billion fortune by speculating in sharemarkets, last month vaporised his absurd wealth.

Hwang's leveraged American equity fund, Archegos Capital, specialised in Chinese and American technology and media shares, borrowing extreme multiples of Archegos' money to hydraulic the prices of a few chosen shares.

When one of those companies thought it would exploit the high share price that Hwang had pumped up, it arranged an enormous rights issue, not realising that Hwang would have to fund hundreds of millions to take up his share of the issue.  It did not know Hwang's extreme position because that position was hidden.

When Hwang could not find any more willing lenders, he had to decline his rights.  The share price of the rights-issuer tanked, and suddenly the lenders to Hwang acquired the same sort of look on their faces that signals a one-year-old needs a nappy change.

The subsequent events drove prices down almost in one day, leaving Hwang's capital in tatters, the highly leveraged investor the latest in a long queue of share and property punters to discover that extreme debt, in a downturn, is another form of arsenic, imbibed only by those who fancy a painful death.

On its own, the collapse of Archegos was not particularly significant, but the underlying behaviours in this disaster have sent out distress signals to all market participants and investors.

The first signal is the return of devices used to avoid disclosure and thus escape the attention of regulators.

The second signal is the deep appetite of greedy, poorly-led global banks for high-margin lending.

The third signal is the return of selfish, foolish behaviour by banks, proving their indifference to their clients or the market generally.

I guess you could posit that a fourth lesson from all of this stems from the moronic pursuit of useless, meaningless wealth, at the risk of ignominy.

And there may be a fifth lesson about the insatiable greed of bankers, with their focus on self-reward.

Surely every investor will shudder at the exposure of yet another loophole designed to avoid regulators by not disclosing leverage.

Hwang borrowed vast sums, even from banks that originally judged him to be using dangerous investment strategies, Hwang then went further into leverage, using derivatives to exaggerate his position.

In some cases he succeeded in gaining control of shares backed by just two per cent of his own capital.  In other words if a share price fell 2%, his capital was drowning.

Shares fell 50%, not 2%.

Warren Buffett once described derivatives as weapons of mass destruction. (There are now quadrillions of $USD of extant derivatives.)

We all understand that a derivative purchased to offset a risk – say a dairy farmer buying an option to sell a kilo of milk fat at NZ$7.50 – is an extremely logical transaction.  But a share investor buying options to sell 10 million kilos of milk fat is simply a naked punter.

Surely such a (fabricated) punter would not find a counterparty and a lender to facilitate such a transaction?  You would think that, would you not?

In Hwang's case you would be wrong.

That such transactions occurred points to the second frightening evidence that yet again, despite the lessons of 2007-08, major banks will chase the fat margins available from dopey, hidden, dangerous lending.

JP Morgan Chase and Goldman Sachs were hip deep in this mire.  Credit Suisse was up to its armpits, Nomura somewhere between hips and armpits.

Where is the mentality of their governors and senior executives?  Do they prefer to play the game of whose profit can be most obscene, rather than whose profits are most sustainable?

The response of JP Morgan Chase and Goldman Sachs to the first whiff of a problem was a signal that you might argue was protection of their most unwise exposure.

You could also argue it was brain dead, selfish behaviour that made the problems much worse than they needed to be.

Imagine that JP Morgan Chase and Goldman Sachs had lent 10 billion early enough that the shares they held as security had grown in value to 20 billion.

Faced with that first whiff, they offered their security for sale at the price that restored their ten billion, making no attempt to discover whether there was a real market at some higher figure.  The share price naturally tanked, given the cheap price of the offered shares.

Was this clever – get in first and escape – or was this psychopathic behaviour – to hell with the other creditors, the shareholders and the market itself? Would you place your business in the hands of such selfish operators?

As an interjection, I wonder if they had learned their strategy from the clowns who incinerated a billion by flogging off the assets of the late Allan Hubbard and his company South Canterbury Finance.  Their behaviour was proof that we have a lot of D-graders in our markets. I cannot explain why intelligent people or the public sector would ever engage with D-grade people or organisations.

The fourth issue raised – the nonsensical willingness to burn your own excessive fortune in pursuit of nothing meaningful - reminded me of a conversation I had with the late Frank Renouf in the 1980s.

One of his properties was a beachside house in Paraparaumu Beach, so he was a local. I once criticised his willingness to put money at risk by dealing with flea-ridden third parties.

He rang me and sought an understanding from me that he deserved sympathy, not criticism.  He said he had once been worth $170 million but was now almost penniless, without the income to support his lifestyle.

''Frank,'' I said, ''If you really did have $170 million, did it never occur to you to put $10 million in 10-year government stock at 10%, so you would always have an income to pay for your lifestyle?'' His response was that one does not reach $170 million of wealth by using strategies such as I proposed.

Extreme wealth requires a double or nothing mentality. Is that intelligent?

Perhaps what Hwang might have sensibly done is to confer with those with pragmatic strategies before putting all his money, and that of others, on the nose of number 18 in race one.

Credit Suisse has lost nearly US$3 billion, Nomura US$2 billion, and many other banks lost hundreds of millions because they supplied Hwang with dopey loans.

The fifth signal I observed came from the disclosure that the large global banks are practising yet another strategy to make gluttonous revenues by using an undisclosed arrangement when organising new share listings.

The latest tactic is what some call a ''greenshoe'' arrangement.

The organising broker of a $1 billion issue agrees to charge fees that might be, say 2% ($20 million), but to augment that figure by negotiating an undisclosed right (but not obligation) to buy AFTER the listing a tranche of $30 million worth of shares at the issue price. Note this is a right, not an obligation.

Those with long recall might let their thoughts drift back to the days when Fay and Richwhite negotiated a similar one-sided right when they sold Telecom.

The broker, knowing the value of that right, then shorts the shares on day one.  If the price falls, the broker buys back and makes maybe many millions.  If the shares rise, the cost of the short is offset by the gain the broker makes by exercising his right to buy at the listing price. How is this behaviour consistent with putting one's clients first?

Obviously in a fair world this uneven arrangement would be disclosed in the issue documents. Disclosure, sadly, is often avoided.

We live in a world dominated by greedy people, who arm themselves with doubtful opinions from rent-an-opinion lawyers, hypothesising that disclosure is unnecessary. The brokers feel reassured that they have a ''legal opinion'' supporting them, should they be challenged by regulators.

Still under scrutiny is the recent disastrous UK float of Deliveroo, badged as the worst ever UK float, investors having lost hundreds of millions in the days after the float.

This issue has not been labelled as a ''greenshoe'' victim, but it may have been.

Authorities are investigating short-selling.

As Hwang and Archegos has shown us conclusively, the cleaning up of markets with careful regulations, fastidious regulators, and reformed culture in the banks, remains a dream. We still need heavier rules. And jails.

_ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _

THE current noise regarding capital gains retained by retirement villages largely emanates from groups speaking on behalf of the retired occupants, rather than from the occupants themselves.

To me the source of the news could only be outsiders, as the residents have never been compelled to sign contracts to move into villages. Independent and often family oversight of the signing process is commonplace and negates any suggestion that retirement village residents have been coerced or conned into signing unfair contracts.

The truth is that the monthly cost of the housing and facilities provided for the use of residents would be much greater if there were no or little capital gain for the owners of the village to offset that cost.

The village owners believe they are under-pricing the costs of buying and living in a village, but gaining full recompense by swapping that lower cost now, for a handsome gain when a unit is resold.

The residents, having made an informed decision to enter the village, have a lifestyle that meets all of their expectations. They can afford the generally good facilities and services because of the swapping of the capital gain.

The model works as an alternative to a reverse mortgage in the sense that retired life is enjoyed, while some of the cost is extracted from the eventual estate.

Resident satisfaction is extraordinarily high.

I know this, having seen surveys of residents from two of the listed companies, and analysed annually the survey results of the leading retirement village (Parkwood, in Waikanae) with which I had a governance role for 28 years.

Resident satisfaction levels were remarkably close to 100 per cent.

To argue that the model used by Ryman, Oceania, and Summerset is unfair is not a sustainable position to take.

There are many alternatives to retirement village living, including the housing of any infirm retired people within their family.

Given that so many families today have no capacity to help their parents during working hours, many families welcome the trade-off of a reduction in the size of the estate, in return for dignified lifestyles for their relatives.

Sharing life with the elderly is rarely an issue for Maori, Pasifika or Asian families.  In my 28 years not once that I recall did any from these cultures seek to buy into the villas or units in the village I helped to govern.

South African, British, American, Australian, Canadian, Dutch, German, and European New Zealanders made up 99% of the families I would have met in our village.

The truth is that the likes of Ryman, Summerset and Oceania have been spectacularly successful in matching the promises they made, with their performance.

To generalise, a couple in say, Howick in Auckland, or Churton Park in Wellington, can sell their family home for perhaps $1.5 million, move into a modern, secure, well-appointed village for perhaps $1 million, and then live out their lives, enhanced by the $500,000 of change from the move.

The average stay in a villa is around eight years, in a care unit much less, so the $500,000 can be consumed in amounts that genuinely make a difference to quality of life.

Meanwhile the shareholders of Ryman, Summerset and Oceania receive modest dividends, perhaps around 2%, but over time expect capital gains, by way of enhanced share value.

The call for government intervention in the model is absurd.

If there were no returns for private sector endeavour, many of those who enjoy care facilities would be forced to line up at Crown-owned hospitals.  As there is currently no capacity there, new geriatric hospitals would have to be built.

Would such hospitals match what the retirement villages deliver?

Does anyone recall the likes of Silverstream's hospital for geriatrics?

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Johnny Lee writes:

AIR New Zealand's decision to delay its inevitable capital raising until later this year is sensible, and one that should be welcomed by most shareholders.

The delay is, in my opinion, good news for long-term shareholders.  Assuming the situation regarding the opening of a travel bubble proceeds as expected, the delay will give investors additional time to observe its impact before re-affirming their commitment to the company.

An earlier capital raising, pricing in a greater degree of uncertainty, would have demanded a steeper discount.  While this appeals to opportunists seeking to buy at a dollar to sell at a ten-cent profit, it perhaps attracts the wrong type of shareholder for a company in this position.

The capital raising, likely to be in excess of a billion dollars, will dramatically increase the number of shares on issue and will almost certainly demand a steep discount to entice shareholder interest from its minority shareholders.  The Government has publicly and repeatedly offered to support the issue as the largest shareholder.  The 48% not owned by the Crown will represent the large unknown in the issue.

The Government's decision to support this issue should not be a justification for others to do the same.  The Government has several incentives in play – including outstanding loans, political motivations and strategic interests – that do not align with an ordinary shareholder.  Shareholders should judge the upcoming capital raising on its merits and against each individual's needs and goals.

The share register has undoubtedly been through some change over the past year.  Income investors, who are typically long-term investors who buy more than they sell, mostly abandoned the stock last year to de-risk and seek to maintain their income in other stocks in more favourable sectors.  They were replaced by other investors, including value investors.  Value investors seek to buy an asset they regard as undervalued, believing it would recover in the fullness of time.  While it is still unknown whether air travel and tourism will in fact recover to their previous heights, such investors would have weighed the risk against the reward and acted accordingly.  Broadly speaking, they have been rewarded for this risk-taking.

Another type of investor who began accumulating shares in Air New Zealand was the micro-investor, buying perhaps dozens of shares at a time through online platforms.  Thousands of New Zealanders do this and, through sheer force of numbers, have begun displaying an influence on market pricing, predominantly in smaller stocks.  While some investors shun volatility, these investors often welcome it, focusing their attention on stocks that swing wildly.  With volatility comes the opportunity to trade at a short-term profit.

The relevance of this shift in the share register is the reaction when a large-scale capital raising is finally announced.  Will retail share investors be prepared, and able, to contribute to their share of the billion-dollar price tag?  If not, will underwriters (assuming underwriters can be found) pick up the bill, diluting those investors at what will surely be a heavily discounted price? Will the Government be the underwriter? Does it even want to be?

Perhaps one solution would be to issue the shares by way of a renounceable rights issue, giving those unwilling or unable to contribute more, the opportunity to sell their entitlement on market.  People wanting to buy more at the discounted price can buy this entitlement, perhaps at a modest discount.

By way of contrast, Contact Energy's recent capital raising was conducted as a share purchase plan, allowing shareholders to purchase up to $50,000 worth of stock at a discounted price.  This was hugely oversubscribed, as shareholders bid for disproportionately large amounts, forcing scaling. The same outcome has been achieved by Oceania Healthcare, with its placement this week.

So Air New Zealand shareholders have been put on notice.  A capital raising is coming, with details later this year, barring a miraculous improvement in global conditions. It will be one of the largest in recent memory, at a price almost certain to represent a substantial discount. The market knows this.  It should not be surprised if it comes to pass.

Air New Zealand, logically, chose to reduce its scale during last year.  By reducing its workforce and fleet size, it endured a sustained period of low demand, as restrictions on movement were imposed.  This was not unique to Air New Zealand – almost every airline globally faced the same intense pressure to eliminate costs.

Now the company is preparing to re-engage with the world.  There remains significant risk.  The growing outbreak in India proves that.  However, with the imminent opening of our borders to Australia, an important next step is about to take place.

_ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _

TAKE note, however: capital raisings do not always go to plan.

The recent discussion around GameStop makes for an interesting case study.

GameStop shares have been topical this year after retail investors bought millions of dollars worth of GameStop shares, using money which was largely supplied directly by the US Government in the form of stimulus packages.  These investors believed that certain institutional investors who had heavily shorted the stock would be required to buy them back in due course.  As the supply of stock was bought up, desperate buyers would pay ever higher prices to cover their positions, driving the price to illogical levels.  Largely, this is exactly what occurred.

Last month, when GameStop was required to post its quarterly sales update, the company mentioned that it was evaluating whether to raise more capital at such elevated levels by issuing more shares to its new shareholders for cash, effectively asking them to ''put their money where their mouth is''.

Predictably, the share price fell heavily following the announcement.  Many existing shareholders would have neither the resources nor the inclination to pump further cash into the company, and issuing more shares to existing holders for cash would be dilutionary to non-participants.

Do not assume that a share price trading at a certain level implies the company is worth that price.  The price represents the markets view on a share price value at a given moment with the information available at the time.

_ _ _ _ _ _ _ _ _


Edward will be in Auckland on April 29 (Albany) & April 30 (Remuera). He also plans to be in Auckland on June 10 & June 11, Napier on June 24 & June 25 and in Nelson in July.

Johnny will be in Christchurch on April 28 and again each month in May and June. He will also be in Tauranga on May 12.

David will be in Palmerston North on April 21, Kerikeri May 6 and Whangarei May 7.

Kevin will be in Timaru on April 27.

Michael will be in Auckland on Tuesday 4 May (Milford).

If you would like to make an appointment, please contact our office.

Chris Lee

Managing Director

Chris Lee & Partners Ltd

Taking Stock 8 April

What should an investor expect of public-listed company directors?

Knowledge, experience, good judgement, and integrity, in no particular order, might be a traditional response to that question.

I would add morality, dignity and maturity, to my response.

In the past week we have learned what the courts think and how they judge failure.

In a later Taking Stock item today I will consider what changes to behaviour must follow exposure of Ron Brierley's pathetic and abusive behaviour. He is in disgrace, faces possible jail terms, extradition, removal of his (silly) Knighthood, perhaps an inevitable outcome for a grossly over-hyped era of business accolades.

But even more topical is the detailed, and I would guess irreversible, views of the Court of Appeal.

Its decisions involving Mainzeal's inept directors ought to be welcomed with trumpets and drums by all genuine, competent directors, and by investors.

In my opinion, investors and directors should take the time to digest the court's ruling, and in doing so should tip their hat to the parties who created the opportunity for the Court of Appeal to bring clarity to the relevant laws.

The background is as follows:

Mainzeal Group, an NZX-listed construction company with a Chinese controlling shareholder, selected a board of directors who appointed a retired politician, Jenny Shipley, with virtually no visible commercial experience and certainly miniscule construction knowledge, as Chairperson.

In some ways, this was no surprise.

In communist China, politicians have great privilege, wide power and often can literally arrange execution by bullet for those who oppose them. The excellent books Mr China, and In the Jaws of The Dragon, discuss these issues.

So in China, retired politicians anywhere are wrongly assumed to be almost omnipotent, though far from omniscient.

Chinese shareholders hold much more respect for such people than we do. We look for knowledge, experience, good judgment, etc. So we should.

Mainzeal appointed Jenny Shipley to head its governance. Her knowledge base seemed irrelevant to this task. I said so at the time. Arguably, she was ill-equipped to know of Mainzeal's major failings, which included a history of using creditors' money as working capital, and no formal access to the alleged wealth of its prime shareholder, Richard Yan, a Chinese business opportunist never likely to underwrite business risk with his private wealth.

Shipley, a school teacher/politician, was exposed to problems with which she and the other pre-2011 directors were unaware, as she has since declared.

The other directors then included Peter Gomm and Clive Tilby, who clearly did not compensate for Shipley's shortcomings.

Formally, Mainzeal went broke in 2011, having tried foolishly and illegally to take on risky projects to recover from a financial situation which many, including me, regarded as irrecoverable.

Creditors, all up, lost more than $100 million and shareholders lost everything.

Crucially, around $70 million of the creditor money related to the period after the company had become insolvent.

The liquidators, BDO Spicers, supported by the litigation funder LPF, sought compensation for the creditors, claiming the directors were responsible for the losses, by allowing the company to trade at a time that they should have been aware of the insolvent state of the company.

In the High Court, a judge ruled against the directors involved, and awarded the liquidator $36 million, specifying $6 million to Shipley and two other directors, and $18 million to fall on Yan.

Curiously, these amounts coincided exactly with the indemnity insurance arranged by Mainzeal to protect directors for claims of incompetence or negligence. Yan was not a director.

Keep reading. This subject should be compulsory reading for investors and directors.

The indemnity insurer appealed the decision.

In doing so, it had no risk. Its total liability was around $20 million. Its only downside would have been the cost of the appeal, perhaps a million or two.

For the directors, an appeal was fraught with risk, as the appeal opened up the possibility that the damages might be increased, creating personal liability for Shipley and the two other directors.

At the Court of Appeal, the judge ruled that the business failure of Mainzeal was a fact of life and that the decision to fine the directors $36 million should be reversed. Phew. It said that insolvency itself did not provide a case for compensation.

But it then ruled that the directors, by taking on new projects after they should have known the company was insolvent, opened up another avenue for compensation, under Section 136 of the Companies Act.

Effectively, the Court ruled the directors are responsible for some or all of the losses of those creditors, who funded projects AFTER the directors should have known the company was insolvent, BUT not for losses before the insolvency was visible. Their liability is ''joint and several'', meaning those who are bankrupted by the claim would have their share of a claim transferred to the other directors, effectively, until the money is paid or all are compensated.

The losses that occurred after Mainzeal's insolvency totalled around $70 million.

Shipley, for reasons not yet discussed, became an owner of shares in a Chinese property company in the early 2000s. These shares are tucked away in a family trust, and are now said to be worth more than $10 million.

Shipley and the directors possibly will face huge personal compensation bills to those creditors. They are unlikely to thank the insurer for appealing the High Court decision, resulting in a potentially much more painful outcome for the directors.

In summary, I interpret the courts very logical finding as saying:

1. That if a company goes broke, that is bad luck for creditors and shareholders and in itself not an outcome requiring director compensation. All directors will be pleased to know that they are not expected to be infallible, omniscient or clairvoyant.

2. That if a company become insolvent, the directors should be aware of this and should not allow business to proceed and new creditors to be established, thereby switching the risk of past problems on to an unaware new bunch.

The Court of Appeal judges include David Goddard, a rare legal expert with deep commercial law and experience.

All sensible directors would understand that their tasks begin with understanding solvency. Solvency is the oxygen for a company. Insolvency requires a ''death'' certificate.

Shipley's legal representative in the Court of Appeal claimed that the Court of Appeal's ruling would deter anyone from ever agreeing to take on directors' responsibilities. Lawyers are rarely business leaders, are over-represented on boards and rarely have the rounded commercial skills to understand the relationship between risk, reward and responsibility, in my opinion. They sell their ability to interpret law, not their ability to measure risk and reward.

There are exceptions. I personally know a handful of excellent, rounded, socially-aware lawyers who have made valued contributions to governance.

But many are simply project-focussed, interpreters of regulations, many with demonstrably pitifully low understanding of commerce, as I once observed during a civil court case, where a QC could not see that secondary market transactions did not produce new capital for a company.

Far from frightening directors, the Court of Appeal has given clear, sane direction on Section 136 of the Companies Act.

In so doing it has provided clarity, and guidance that will reassure knowledgeable, competent people blessed with integrity and good judgment.

If we are to see an appeal to the Supreme Court, to review the Court of Appeal's judgement, one hopes that there would first be an assurance given that the cost of the appeal would not affect the ability of the directors to front up with the compensation to the relevant creditors, an amount quite possibly of $70 million, of which just $20 million would be subject to indemnity insurance.

If there is no appeal, a High Court will decide how much compensation must be paid.

May this be the new Court of Appeal ruling that deters any thoughts of people without relevant knowledge or experience from ever seeking the arguably attractive remuneration that directors earn.

Before such people seek the status and stipend of a director, perhaps they should become conversant with the Dunning Kruger Syndrome, ascribed to people who do not recognise their own shortcomings.

_ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _

The previous item began with a further list of qualities that I would expect of all directors in charge of other people's money – morality, dignity and maturity.

The Mainzeal directors made catastrophic errors but that does not imply they were immoral, undignified or immature. It simply implies they should not be public company directors because they did not display knowledge, experience or good judgement.

In contrast, the original founder of the large investment company Brierley Investments, Ron Brierley, did have enough knowledge and experience to govern a large public-listed company.

What most veterans in capital markets have known and never declared was that Brierley, like many wealthy people in the 1970s and 80s, did not have morality, maturity or (any) dignity.

It must be said that in that era, when there were few women directors or executives, there was a noticeable group of so-called business leaders whose behaviour was akin to schoolboys behind a bike shed.

That alone is an uncomfortable memory.

Bankers, sharebrokers, lawyers, accountants, politicians, the media, real estate agents, even car dealers knew about the vulgar and childish behaviour of this group of people, their tours of Thailand, South America, Eastern Europe etc, in pursuit of their infantile fantasies.

Shamefully, those who knew continued to treat these creeps with a ''respect'' that was co-related to their ability to pay often inflated bills. Money talked. Many decent people averted their eyes. That was the wrong response. It should not be the response today.

No-one applied the ''fit and proper'' person criteria. So there were no sanctions applied to exclude these creeps from positions of power. In fairness, only governance and executive positions that are overseen by the Reserve Bank legally required a fit and proper inspection. In my view all governance positions overseeing other people's money should face such inspection.

I could write a book about the stories of these foul, puerile people, of the 1970s and 80s.

Most of all, the politicians knew. More than a few politicians enjoyed the use of company-owned corporate jets, in return for endorsements, such as attending juvenile parties based around a swimming pool filled with unclad young females, paid to ''entertain''.

Brierley's conviction for indulging in vile imagery of children should be the catalyst for a new era of ''fit and proper'' person assessment.

The Russell McVeagh cases of a few years ago ended shamefully, with inadequate sanctions, in my opinion.

I proposed in my book The Billion Dollar Bonfire that improper people should be excluded from capital markets, where rewards are high. So too, in my opinion, should standards be high. The privileges should be offset by value-add and, most particularly, high standards.

We have a chance now to condemn the distasteful mindset that accepted ''locker room'' behaviour and other clear examples of abuse of power.

One hope will rest on the new weighting of women in governance and executive roles.

I argue that real men, Dads and grandfathers ought to be vociferous in demanding a safe environment for women, girls and boys but even more strident should be the voices of women, mothers and grandmothers.

Brierley, and perhaps a small but significant number of contemporaries, were not just granted ''get out of jail free cards'' in that era.

They were worshipped by the public, indulged by capital markets, occasionally even honoured by politicians.

Yet this cadre of so-called men were by any reasonable standard unfit for governance or executive roles – immature, immoral and lacking self-dignity.

I am pleased to note that the business leaders I have come to admire today exhibit none of these trashy behaviours.

_ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _

Johnny Lee writes:

LAST week's article discussing the potential sale of Westpac's New Zealand business generated a flurry of responses.

It is clear that any change to the status quo will have a dramatic impact on our banking landscape. Westpac has about 20% market share of our banking sector, employs thousands and manages billions of Kiwisaver dollars.

It is also clear that there is significant investor appetite for such a listing – at the right price.

If a sale proves to be the next step for Westpac New Zealand, it would form a useful starting point for a national discussion around banking within this country.

A number of our banks leverage their New Zealand connections to solicit business and offer a point of difference. The likes of Kiwibank, TSB and Co-Operative bank market themselves as ''locally owned'', hoping to inspire the public's loyalty. Others use sponsorship, from rescue helicopters to cricket, for these ends.

Some tout their wealthy shareholders, large profits and strong credit ratings as reason to trust them with public money, while others argue they are ''Kiwi owned'', keeping profits within New Zealand, as a selling point.

The niche banks might target specific ethnic groups, or particularly wealthy borrowers. Some target rural lending, others focus on business lending.

The end result is that four banks (ANZ, Westpac, BNZ and ASB) have almost total market share. Kiwibank's exposure is not insignificant but reflects the relative recency of its creation.

If Westpac were to break away from its Australian roots, with a partial sale via IPO to the general public, what could it become? What would potential investors want it to become?

It would join Heartland as a listed New Zealand bank, but many, many times larger. With a market capitalisation in the billions, it would form an integral part of share portfolios, Kiwisaver portfolios, ETFs and managed funds around the country. Public listing would also invite overseas buyers to acquire a holding.

Investors in Kiwisaver – most New Zealanders – would suddenly find themselves as part-owners of this bank, and their own financial fortunes tied to its performance. The reporting of huge profits being distributed to shareholders may elicit a smile, rather than groans.

We have other locally owned banks, of course. But Westpac would argue that its size and breadth of product offering sets it apart from the smaller players. Could Westpac position itself as The People’s Bank? It is already the bank for our Government - although this role is not permanent – and has connections throughout our economy. With banks closing branches and cancelling cheques, could a new set of owners of Westpac seize an opportunity to rebrand the bank?

Westpac has instructed Macquarie to assess the options available to Westpac.

This review has the potential to guide a major change to our financial landscape. It is too early to know what direction this review might take. The sheer size and market dominance of the company will be the biggest hurdle to any divestment. However, a sale would represent a huge opportunity to move the company into a new direction, in a sector facing significant change.

A review might also offer us a glimpse of the changing opportunities for banks, perhaps signalling lower risk, lower profits and perhaps even less ridiculous salaries and bonuses.

_ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _

AMP Group's ongoing struggles, and appalling management of its twilight years, reared its ugly head again over the last week, as media leaks within its leadership team forced an awkward stock exchange announcement.

AMP shares are widely held in New Zealand, following its merger with AXA a decade ago, themselves the by-product of a demutualisation and name change. AMP is also among our largest Kiwisaver providers, with billions of Kiwisaver dollars under management.

The company has not had a good week.

It began with the publication of a report by a prominent Australian media outlet stating that CEO Francesco De Ferrari was to stand down by day's end. The company quickly responded, somewhat bizarrely, that it was aware of reports and confirmed that De Ferrari was the CEO of the company, a revelation to absolutely no one who would read such a stock exchange announcement.

A subsequent update, hours later, stated that he had not resigned. Staff were told to disregard the news. Somewhat perversely, the share price fell. De Ferrari's reign had not been universally popular.

Six days later, AMP announced to the stock exchange that De Ferrari had ''retired'', and Alexis George was to take over later this year. The share price began climbing. De Ferrari was out, and Alexis had found herself in pole position.

The handling of these announcements is bound to raise questions regarding continuous disclosure obligations, but more importantly highlight the level of dysfunction within the senior levels of the company. Announcements of such significance should never be foreshadowed by media chatter in this way.

A revolving door of leadership, whether in sport, politics or business, never leads to excellence, and rarely leads to outperformance. Bringing on a new CEO to manage a divestment of assets is a challenging role, and one that does not tend to endear you to your staff or to the public. Requesting additional compensation mere months into the role will only add to the discord.

One hopes Ms George has learned from the missteps of her predecessor.


Edward will be in Blenheim on April 15, in Auckland on April 29 (Albany) & April 30 (Remuera). He also plans to be in Auckland on June 10 & June 11, Napier on June 24 & June 25 and in Nelson in July.

Johnny will be in Christchurch on April 28 and again each month in May and June. He plans to visit Tauranga in May (dates to be advised).

David will be in Palmerston North on April 21, Kerikeri May 6 and Whangarei May 7.

Kevin will be in Timaru on April 27.

Michael will be in Auckland on Tuesday 4 May (Milford).

If you would like to make an appointment, please contact our office.

Chris Lee

Managing Director

Chris Lee & Partners Limited


Taking Stock 1 April 2021


YOU would not expect the All Black selectors to seek out the selection opinions of the Chatham Island Rugby Club.

Using the same logic, why would a five million citizen country like New Zealand seek advice from a 500,000 citizen Mediterranean island like Malta?

The answer might be that the bigger fish approached the little one because the little one had found a clever solution that might greatly help the bigger fish.

It was six years ago that I met in Malta with a group of retired senior civil servants, to chat about the excellence of their health, education, housing and tourism policies.

Subsequently, I passed on what I had learned to Key's government, suggesting it look at Malta's solutions.

In housing, particularly rental housing, some of their strategies seem very pertinent.  They solved these problems:-

- Tenants wanting certainty of tenure;

- Landlords wanting returns on capital;

- Government wanting light-handed but effective control (of pricing and landlord behaviour).

Here was their solution:

Landlords were to be given a choice.  If they agreed to long-term leases and good standards, and agreed to limit rental increases to an indexed figure managed by the government, then those landlords were eligible for tax concessions relating to interest deductibility and depreciation.

Landlords who preferred to have short-term leases (less than 10 years) could do what they liked, and raise rents as they liked, but would not be eligible for tax concessions.

This policy ensured families could gain security of shelter without fear of massive rent increases.

Those who were effectively wanting to make no long-term commitments could live in the world of opportunists.

The result, as you can imagine, is that the government was not constantly fending off requests for subsidies from families with no ability to counter rapacious, opportunistic landlords.

If you revert to the distant past you can find Malta's government had owned most of the housing stock, having built the social housing to a level where it was dominant.

The government had unwisely built a culture that could be mistaken for tenancy entitlement, at the taxpayer's expense.

The old Maltese system was inefficient and produced bizarre anomalies.

For example, in the 1970s under Malta's Roman Catholic culture, in which it was quite outlandish for a couple to live together ''in sin'', engaged couples would enrol with a political party, expecting to be offered a house when one became available.  Then they could get married and live together.

Join the wrong party (National or Labour) and you would be frozen out until the electorate voted in your party.

You could change your enrolment to the other party, but you were not offered a house until the next election.  My wife had a cousin whose engagement lasted EIGHT years, because she kept enrolling with a party that lost the upcoming election.

There were not enough houses.

The housing market changed when private investors entered.  Prices rose, but the cost of rentals rose, requiring the government to offer subsidies to troubled tenants.

The better solution was to incentivise stable solutions.  The tax system did its job.

Malta is different today, its housing prices reflecting the demand created by immigrants, but most landlords sign up to the tax concessions, so tenants have stability of tenure.

Little Malta's solutions in other areas might also have an application in New Zealand.

In education, it encourages school leavers to pursue knowledge in useful areas like science, medicine, technology, health and construction by PAYING students a living wage, providing they pass their university exams.  No fees are charged for diligent students.

Failure brings an end to the student wage.  Bonding is part of the contract.

Its education system produces so many doctors and dentists that Malta boasts that if you break your tooth you will find an available dentist within the hour.

We experienced at first hand the health system when a family member fell heavily and suffered a compressed fracture of the spine on a Sunday.  Within an hour, the ambulance, with four medical people, had him in hospital, a spine specialist in his room, a moulded cast being built, pain relief effective.

Visitors to him in hospital were offered coffee and finger food.  He was treated superbly. Two days later, the ambulance returned him to us, in his new cast.  The bill was 600 euros, about NZ$1,000. 

We have listened to Malta's tourism leaders.

Malta has 500,000 people, but outside Covid, welcomes three million tourists a year. With that ratio (6:1 tourists:citizens), New Zealand would be catering for 30 million tourists, not our pre-Covid figure of four million.

Imagine the infrastructural logistics – water, sewerage, power (air conditioning), rental cars, buses, airports (Malta has one, fabulous airport), restaurants etc.

Remember, Malta's main island is roughly twice the size of Wellington harbour, while its second island, Gozo, is about the size of Wellington harbour.

As I learn and observe, I record and communicate, as anyone would (and should).

The thoughts fell on the deaf ears of our often-inadequate politicians and a public service whose collective inclinations may not be conducive to learnings from a Mediterranean island.

So let me repeat the formula for housing: long leases, good standards that are policed, and adherence to a government rental index (roughly the same as a Consumer Price Index), would lead to generous tax incentives.

Less desirable landlord strategies are not incentivised.

Anyone listening this time?

_ _ _ _ _ _ _ _ _ __

AUSTRALIA'S most obnoxious bank, judged by its behaviour in New Zealand over many decades, has been Westpac.

It has had several poorly-chosen leaders, it has behaved abrasively in capital markets, and its Australian leaders have had boorish attitudes towards our governments, regulators and people.

Yet the Government selected it, some years ago, to handle the NZ government's banking.

Pricing must have been the only criterion.

Its current response to demands from our banking regulator (the Reserve Bank) has been aggressive, leading to the threat (promise?) to quit its NZ operation.

This so reminds me of a self-annointed business ''leader'' who used to organise occasional sports events with organisations with whom he dealt.

On one such occasion – a cricket match for which he supplied the gear – he was rapidly dismissed, and packed up the gear and drove home when he was denied a ''second chance''.  I call this the Spoilt Brat Syndrome.

Westpac says it might sell its NZ operation.  It is NZ's third largest bank, though the speed with which it is closing branches might change this.

A trade sale might be possible to an American or European bank but would not likely be endorsed by the regulators if it were to a current large participant in NZ.

NZ as a destination, both financially and socially, is seen as desirable by the German, Canadian and American population.

It is hard to see a Chinese bank being approved.

A part sale via a New Zealand listing might be an intermediate decision, leaving Westpac with control but NZ institutions and investors with more ownership.

That would be welcomed and might be a model that ANZ, National Australia Bank and Commonwealth Bank of Australia might observe with interest.

The people who will know what the Australian banks are pondering are few in number and do not include the usual crowd of attention-seekers who will be commenting in our media, irrespective of their irrelevance.

Those who have useful, inside knowledge are far too high up the ladder to consider discussing this subject in our media.

In my view the great news is that our Reserve Bank Governor, Adrian Orr, who is genuinely experienced and knowledgeable, is rattling the Australians by uncovering the cynical deceptions they practise.

But there should be one note of warning.

Because banks became too big to fail, and were rescued, at some risk, in the past, the regulators now seek to drive out risk, at the expense of banks' short-term profits.

Foreign exchange trading, sharebroking, real estate, derivative trading and wealth management are all examples of activities which greatly bolstered banking profits and brought into banking people who sit far from the culture of stability that regulators would prefer.

The point here is that standard banking, low-risk behaviour carries little risk and has low returns.

Driving out all the high-return activities might lead to a new, much lower, value for the banking sector.

I am one of those who would happily buy into banking shares but the price I would pay would be at a much lower multiple of sustainable dividends than might have been the case a decade ago.

Prospective Westpac investors will need to consider the effect of a coming era of banking austerity.

_ _ _ _ _ _ _ _ _ _

RECENTLY I recorded with pleasure that the new iteration of Fisher Funds, now governed and owned by TSB interests, is no longer the organisation that Carmel Fisher designed.

Fisher was a sort of Jacinda Ardern character in the 1980s, a new brand of fund manager, nice smile, well-mannered and loved by the media, bright and energetic.

At Prudential Insurance she became a legend, developing funds that researched tiny public-listed companies and then kept buying their shares until her fund had significant (10-20%) shareholdings.

Of course, if you aggressively buy a small, illiquid stock, you will drive the share price up, so in a bull or even a neutral market your short-term results will look great.

Of course, if you concentrate on a few stocks that are, by definition, aspirational and illiquid, you accept high risk, in pursuit of high returns.

In the 1980s, Fisher managed funds that one year recorded 80% returns, then lost a similar figure the next year.

I preferred not to support her funds.  Yet she succeeded in building a funds management empire that enabled her to sell out with a $100 million plus, take-home reward for her adventurousness.

As Fisher Funds' most visible entity, Kingfish today does not buy large holdings in illiquid shares, to manufacture short-term gains at spectacular levels.

But a friend and distinguished retired fund manager points out to me that Kingfish still pursues unusually large holdings in few stocks.  Its largest holding might be 20% of a fund while its top five stocks might be 60% of the total fund.

So there is still the issue of concentration of risk.

The good change is that the stocks chosen are now NOT low or medium-sized NZX companies, so the liquidity of the shares held is very much less in danger during periods of static or bear markets.

There will remain market interest in the governance of the funds, and the skill of the researchers will always be in focus, but the good news for the users of Kingfish, Marlin, Barramundi and the Fisher managed funds, and Kiwisaver funds, is that the TSB appears to have recognised the risk of concentrations of illiquid holdings.

The bad news is that attracting the right governors and executives is harder for an institution (like TSB) than it is for the best operators with private ownership.

Footnote: Fisher achieved scale by buying out the suite of Tower Investment funds that had been amateurishly managed by the struggling insurance company, once named Government Life, in the years since it demutualised.

_ _ _ _ _ _ _ _ _

Johnny Lee writes:

THE moves by Westpac Bank to review its New Zealand business, and the ramifications of a potential sale of the business, are likely to feature in financial headlines for some time.

It is important to note that, so far, the only announcement Westpac has made is that it has appointed Macquarie Capital to review its New Zealand business.  There is every possibility that the review concludes with Westpac retaining its New Zealand arm, and the status quo being maintained.

However, there are certain factors that make this less likely.

Firstly, Westpac will be acutely aware of the effect that such a cloud of uncertainty has on its local staff.  Westpac employs thousands of New Zealanders, who now face doubt regarding their future with the company.  Performance will suffer.  Morale will suffer.

 The bank will not have opened this ''can of worms'' without at least some intention of divesting itself of the business.

Secondly, what needs to be considered are the ramifications of Westpac retreating.  The bank will know that Adrian Orr is unlikely to cower before the concern of Westpac New Zealand losing its large Australian owner.  If this is intended as some form of brinksmanship to express displeasure towards the Reserve Bank, which I think is unlikely, Westpac may have chosen the wrong governor to entangle itself with.

The public reaction to Rio Tinto's withdrawal at Tiwai Point shows that New Zealanders are fairly unblinking in their response to such games.  Westpac, and indeed the banking sector in general, has struggled to garner public goodwill for many years now.  The revelations over the past few years, in regards to the Australian Royal Enquiry, have cemented Westpac's position towards the bottom of the pack.

Westpac will be keenly aware that if the company determines that the best course of action is for it to retain complete ownership of its New Zealand arm, it will be recommitting to its current relationship with the Reserve Bank.

If instead this review is genuine, and a demerger was to take place, the consequences of this are enormous.

A simple demerger – a pro rata distribution of shares in Westpac Bank New Zealand (WBN) to existing shareholders – would force tens of thousands of Australians to familiarise themselves with the intricacies of our sharemarket, seek out a New Zealand broker and sell on market.  Experience tells us that such a sale would be swift.  The tax ''penalty'' of owning overseas shares would likely incentivise action.

A total sale to a competitor would require a player of small enough size to avoid competition concerns, and one interested in acquiring a million new customers, with products ranging from home loans to insurance to credit cards.  Such a competitor would need to have an interest in expanding within a country of five million people, with a regulator actively trying to remove risk from the financial system and a Government seemingly trying to diminish the equity base of its assets.

Furthermore, a competitor would seek a significant discount, knowing that brand loyalty is crucial to customer retention in New Zealand.  Many – arguably, too many – banking customers remain with their individual bank for their entire lives, often staying simply because their parents chose that bank for them.  A large-scale shake-up and distance from the Westpac brand could prompt some to review its connection with the bank, especially if the new owner were one that struggled to connect with its customers.

Credit concerns would arise.  The likes of Standard and Poor's place value on Westpac's ownership structure and the implicit backing of a major Australian bank.  Changes to these ratings could have impacts on the costs of borrowing.

A public sale and subsequent listing on the New Zealand Stock Exchange is an option.  Westpac Australia could choose to sell the business to New Zealand investors and distribute the capital raised to its existing, mostly Australian, shareholders.

The sheer size of such a listing would prove challenging for our equity markets.  Investors who took part in the government IPOs (Mighty River Power, Genesis and Meridian) will recall the extensive groundwork that was required – years in the making - for listings many times smaller than the proposed valuation that would be applicable to a total listing of Westpac New Zealand.

If Westpac chose to retain a proportion of the company, it would need to ensure that that proportion was small enough to justify the process.

I have no doubt that Kiwisaver funds, exchange-traded funds, institutional investors and retail investors alike would share an interest in such an IPO – an IPO that would create one of the largest companies on our exchange.  Structured (and pitched) correctly, investors would be buying into New Zealand's largest locally listed bank, ''keeping profits on our shores'' and compelling such investors to engage with the bank on a customer level.  Priced and managed appropriately, WBN could form an integral part of income portfolios across the country and reinvent its image among the population.

A decision to list the company on our exchange will, of course, impact existing companies.  Our current total market capitalisation, $180 billion at the time of writing, will not simply grow by the amount listed.  Money does not appear from thin air, and asking New Zealanders to write cheques for say, ten billion dollars, will not simply be sourced from cash accounts.  Share prices will naturally see some minor downward pressure to accommodate the new listing.

While I agree that such a whale of a listing would be a boon to our exchange, it does come with another cost.  An IPO of such enormous size would dwarf other listings, consuming time, expertise and of course extensive capital during the listing process.  Other listings, such as the 2 Degrees IPO mentioned over the past fortnight, would effectively be in competition with WBN.  While low interest rates have deepened the pool of investible wealth in our country, this would be uncharted territory for our investment banking community.

The other alternative is that the status quo is maintained.  While this is in some ways the most logical outcome, one would certainly question the wisdom of engaging in such a public process if this outcome had not already been mostly discounted.

So investors must wait.  Macquarie Capital's review of Westpac's New Zealand business will take time and involve a large number of stakeholders.  If a sale does proceed, investors will be keen to hear the rationale as to why Westpac Bank is retreating from New Zealand, while simultaneously inviting the public to buy the company.  This is always a delicate balance, seeking to appease existing (Australian) shareholders, and new (New Zealand) investors.

We will continue to keep readers informed as the situation develops.

_ _ _ _ _ _ _ _ _ _


Edward will be in Blenheim on April 15, in Auckland on April 29 (Albany) & April 30 (Remuera).  He also plans to be in Auckland on June 10 & June 11, Napier on June 24 & June 25 and in Nelson in July.

Johnny will be in Christchurch on April 28 and again each month in May and June.  He plans to visit Tauranga in May (dates to be advised).

David will be in Palmerston North on April 21, Kerikeri May 6 and Whangarei May 7.

Kevin will be in Timaru on April 27.

Mike will be in Auckland early May (dates to be advised).

If you would like to make an appointment for any of the above dates please contact our office.

Chris Lee

Managing Director

Chris Lee & Partners Ltd

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