Chris Lee & Partners Ltd

Taking Stock 27 April 2023

THOUSANDS of NZ investors will be rejoicing at the news that the fee-hungry KiwiSaver funds run by Fisher Funds have been coerced into abolishing the absurd bonuses previously claimed.

The Auckland-based fund manager, having recently bought the Kiwibank KiwiSaver ledger, has announced that it is voluntarily ending its double dipping, explaining that it now has sufficient scale, after the Kiwibank purchase, to cope without second helpings of fees.

Of course the decision had absolutely nothing to do with market regulator signals that the regulator would be focusing on such fees with growing disrespect.

The ''voluntary'' cancellation of an utterly unreasonable, indeed rapacious, fee structure is good news for investors.

For Fisher Funds the proactive move solves a potential problem. Fighting regulators is expensive and unwise.

Formed decades ago by a then ground-breaking young woman (Carmel Fisher) with some corporate and fund management experience, Fisher Funds set out with a business model that somewhat resembled that of Money Managers.

For two decades, beginning in the 1980s, Money Managers had filled the pockets of its founder Douglas (Somers) Edgar, dominating a blue-collar retail market. It advertised heavily and invested heavily in Edgar's personal brand. Its fees were breathtakingly extravagant.

The Fisher Fund model was similar in that it relied on heavy advertising, the personal ''brand'' of its founder, charged hefty fees, and made headway by exploiting the media, both Edgar and Fisher becoming almost daily commentators on financial markets in much the same way that the Simplicity KiwiSaver founder Sam Stubbs does today.

Money Managers ramped up property syndication, in-house funds management and third-tier money lending, enabling Edgar to carve out sufficient rewards that he could retire as what some, vulgarly, refer to as a Rich Lister.

When Edgar was repositioning himself from a small Invercargill second-tier property investor to market guru, Fisher was at Prudential Insurance in the pre-1987 sharemarket, a trailblazer in that she was young, feminine, innovative and bright, carving out a bold approach to funds management concentrating on outsized holdings of illiquid stock. Risk taking was in her DNA.

By the time she founded her own company she had genuine experience and would have seen the success of Edgar's advertising concentration and noted his energy in developing a personal brand.

In later years she converted her company into an empire by using debt to acquire databases from the likes of Tower and Kiwibank.

Unlike Money Managers, her empire has been sustainable and now is her legacy.

She locked in large, repeating fees by cleverly listing various funds – Kingfish, Marlin and Barramundi – using the philosophy she had developed at Prudential, buying large chunks of low-cap shares, Pumpkin Patch being an example of a Kingfish target.

When anyone quickly builds a holding in an illiquid stock, they will initially record valuation gains. If you keep your finger on the ''buy'' button, you drive up the share price and will value your earliest, cheaper purchases at the last, high price that you have paid. The risk, of course, is that your strategy creates a market at an utterly unsustainable level, as happened with Pumpkin Patch.

Only for a short while did Kingfish, Marlin and Barramundi thrive under this model. Today, under the new management, the three listed funds have a different model, again unusual, in that Kingfish, for example, buys quality growth shares, collects very small dividends from those stocks, but pays the Kingfish shareholders high dividends, basing the dividends on the unrealised gains of the growth shares, not on income it receives.

This formula works well in a bull market, attracting shareholders who chase high dividends. Usually these are investors who have retired and need income.

The concept is hazardous in bear markets, an obvious issue being how such a model can fund dividends without leverage or dilution.

Kingfish's share price has fallen by 45% in the past two years, the market generally having fallen by less than half of that. Dividends must fall, by definition.

Fisher Funds, having been built on debt and acquisitions, has transitioned under its new owners, the American investment company TA and a TSB bank-developed Community Trust being the owners, TA being smaller but very much in charge.

The Community Trust investment is likely to be passive, with little strategic input on issues like fees, acquisitions and economic analysis. It is reasonable to assume TA's smaller shareholding has a full voice on all financial matters. Community Trusts are represented by people with social ambitions. TA is a hard, profit-focused organisation, with an American culture.

Carmel Fisher retired at a fortuitous time before the messes facing markets today had become simply toxic.

The new Fisher CEO is Bruce McLachlan, a mid-ranked banker, a divisional manager in the banks before a stint as CEO of the tiny Co-operative Bank.

McLachlan is not an analyst, a financial strategist, a sharemarket trader or an economist. He is a practical, pleasant fellow, well equipped to be the public face of an organisation whose American shareholders are best left to perform their work behind boardroom doors.

He will be highly attentive to the views of the regulators on such matters as bonus fees and incentive payments to executives, so may become an industry leader in addressing these subjects if he does so soon.

One has to hope all fund managers and KiwiSaver managers are paying attention.

The industry's annual fees are already extreme, even without the double-dipping bonus fees, especially in those businesses that perform no or minimal research, instead aping an index or double-intermediating by use of Exchange Traded Funds, a model that adds virtually no value.

Value-add must surely be the new mantra of all KiwiSaver and managed funds.

Prime Ministerial salaries and bonuses ought to be the victim of investor demands for a fairer balance between returns and internal costs.

The late Brian Gaynor's Milford brand has a significant appetite for fees but has regularly delivered value-add, though the current environment might be challenging.

Harbour Asset management has set the standards for genuine intellectual analysis (AND no bonus fees).

Perhaps Fisher Funds will now aim at a high tier of respectability by being the first to accept that bonus fees should play no role in an era of difficult conditions.

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ONE company whose shares are in most of our clients' portfolios is Chorus, the broadband provider whose pricing is regulated, perhaps because it is a monopoly.

It used to be a division of Telecom before Theresa Gattung somewhat recklessly misunderstood the determination of the Clark Labour government to prevent the use of price gouging and super profits that had been normalised by Telecom. Her regime led to a compulsory carve up.

Telecom was split into Spark and Chorus, the latter effectively a regulated monopoly allowed to price its charges based on a formula that related to a theoretical value of its assets, reviewable regularly.

Chorus today thrives, its monthly invoices paid obediently by most businesses and households.

The certainty of its income and dividends has led to its favoured status for investors wanting dividends and some comfort about the company's survivability.

In recent weeks the Chorus share price has risen following the decision to use some of its surplus revenue not to reduce high-cost debt, but to buy back its own shares.

Armed with around $140 million, Chorus has fuelled the market, buying its own shares as quickly as they become available.

Various fund managers have wondered what is causing the high speed of the process, with no apparent concern for the rising cost of the shares.

One possible answer might be Chorus' knowledge that its assets will soon be revalued, based on some sort of consumer inflation index, ultimately enabling Chorus to increase its charges and dividends.

High inflation would suit Chorus, in that respect.

My own, perhaps dinosaur, thinking is that Chorus would be a more sustainable business if it further reduced high-cost debt and used high levels of debt only when the cost of money was low, as it was until a year ago.

I have never supported the concept of reducing capital for ''balance sheet efficiency'' unless the cost of debt is virtually free, or ''negative'', as Robertson and Orr were forecasting two years ago.

The several years of ''free'' money has built a mindset in the young people who are today's corporate leaders, their experience not having been scarred by eras when expensive debt ruined many good business models, especially in the rural sector.

Now that we face an era of high debt servicing costs, we will see a return to the outdated maxim that debt can be a most feared four-letter word, like the word ''dead''.

Chorus may well be able to increase their charges by more than the extra cost of their debt, and that may lead to higher dividends, and a higher share price. Time will tell.

However it might also lead to a slightly higher level of uncertainty associated with the ''risk'' of its governors and executives miscalculating the heights interest rates reach when governments bungle their book balancing.

As a Chorus shareholder I would be more comfortable if I could believe Chorus' best return for risk is the use of existing debt facilities to fund share buy-backs.

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THE directors of Heartland will surely have been delighted with the success last week of their subordinated Tier Two bond issue, the coupon rate settling at 7.51% for five years. Heartland sought $75m and raised with oversubscriptions $100 million.

Such instruments have a capital credit from central banks and credit rating agencies for five years, making them valuable to issuing companies which have high conviction of their future profits that effectively replace this form of ''capital'' after five years.

Heartland took a risk in issuing a hybrid security so soon after the collapse of Credit Suisse and the subsequent wipe-out of the hybrid security Credit Suisse had issued in multiples of millions to wholesale investors.

Heartland's Tier Two bond was different in that it clearly ranked ahead of shareholders, but only a few weeks ago there was much market discussion on how the Credit Suisse failure would impact on any new issues of subordinated bonds in NZ. Heartland decided to proceed. Kiwibank now follows Heartland, though its issue, at similar rates to Heartland, is not identical in design.

Heartland's stable business, incrementally growing in scale, profit and dividends, has virtually no similarity to big banks, which typically take on risk that would not appeal to a niche bank like Heartland and, typically, spook investors when such banks are threatened.

The Heartland directors were brave to test the market just months after Credit Suisse's collapse and will be delighted to have raised $100 million, to help fund Heartland's Australian growth, which will kick off once its banking licence in Australia is confirmed in coming weeks.

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Kiwibank Bank – Subordinated Notes

 

Kiwibank Limited (KWB) has announced that it is considering an offer of tier 2 subordinated notes.

The notes will have a 10-year maturity date but may be repaid after 5 years if certain conditions are met. The notes are intended to be listed under the code: KWB1T2.

At this stage the interest rate has not been set but based on comparable market information it may be 6.50%p.a., or higher, fixed for the first 5 years (with interest paid quarterly). After 5 years the interest rate will be reset to a new interest rate (unless the Notes are repaid on this date).

More details are available on our website.

Please contact us if you are interested in this new issue.

Seminars

Our seminar programme begins on 29 May in Kapiti and finishes in Whangarei on 3 July.

The hour-long seminars aim to help investors survive an era of investment uncertainty.

Free admission for clients, friends, family and the public will be by an online ticket booking system, as we need to know attendance numbers.

Seminars will be held in Kapiti (May 29), Wellington (May 30), Lower Hutt (May 31), Nelson (1 June), Christchurch (6 June), Timaru (8 June), Dunedin (12 June), Invercargill (13 June), Palmerston North (19 June), Napier (20 June), Tauranga (26 June), Hamilton (28 June), Ellerslie (3 July), North Shore (4 July) and Whangarei (5 July).

Our booking system details will be notified soon.

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Travel

Edward will be in Auckland on 4 May (Ellerslie) and 5 May (Wairau Park).

Johnny will be in Christchurch on Wednesday 17 May, meeting at the Russley Golf Club Boardroom.

Chris will advise dates next week for his next visits to Christchurch, Auckland and Timaru.

Clients are welcome to contact us to arrange an appointment.

Chris Lee

Chris Lee & Partners Limited

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Taking Stock 20 April 2023

IF the primary issue facing investors today is the negative effect on asset prices that results from higher interest rates, the biggest headache for the Government might be the difficulty it faces in raising money to fund its swelling deficit, which feeds those interest rates.

Higher rates lead to much lower asset prices, pretty much as night follows day. Amongst many other things, they damage the property market and in particular they create grief for illogical, unlisted property syndicates.

By definition, as I discussed last week, these syndicates usually own properties that the major property investors would not buy, believing that despite ‘’free’’ money, the properties were over-priced and required a tail wind to achieve even modest returns.

The strength of the NZX-listed property trusts is that listed trusts can, did, and possibly will, raise new capital (at a discount from current share prices) to remove the fear factor that would become a component of the interest rate banks set when banks see under-capitalised borrowers.

For those reasons I wrote last week about the generally fragile state of most unlisted property syndications.

The listed property trusts are also likely to endure rising rates and falling property valuations but are less vulnerable to bank overreaction - forced sales etc. Their access to capital, and the quality of their assets, are points of difference.

For investors, this wave of problems is arriving as we speak.

However, the Government is unlikely to be fussed; some punters make money, others lose. That is the mindset in the Beehive.

Perhaps the financial market regulators will check for signs of improper behaviour, and perhaps the Commerce Commission will receive complaints under the Fair Trading Act, but for Hipkins, Robertson et al the problem is not likely to appear on their agenda.

If they have the competence and experience to understand the real problem, they will instead be plotting how to retain access to Asian wealth managers when NZ comes to appeal for new government bond fundraising, to offset the bulging deficits that will soon confront us.

These deficits, sooner or later, will tell us how much real cash losses have accrued from Robertson’s goofy subsidising of the Australian banks during Covid.

Readers will recall that Robertson funded banks by buying back their long-dated government bonds, when yields were 1%, meaning the banks, which sold to him, creamed off (taxable) profits of billions from taxpayer money. Robertson then agreed that the taxpayers would bear the cost of reselling these bonds back to the banks at the currently cheaper ‘’market price’’. Treasury intermediated this. It must release the long bonds at prices that eventually will lead to an $8-10 billion loss. Taxpayers, as always, bear the cost of political bungling.

One day this loss will appear in a deficit, contributing to the weakness of the NZ dollar, adding impetus to our likely credit rating fall, and ultimately leading to greater need for NZ to borrow from the global bond markets at an even greater cost.

Herein lies the conundrum that would keep alert any informed member of Cabinet with a desire to return to the job after the election.

You see, our country’s poor trading account, with record deficits, our growing fiscal debts, and our weakening currency has turned off many funds and some countries that have previously lent huge sums to NZ, by participating in bond offers. Bad governance is not an attractive selling feature.

When we could borrow at 1%, or even 2%, we should have been overfilling our pockets, borrowing as much as we could for as long as we could. We indeed did borrow then, but we should have been chasing every dollar we could at that 1% rate.

When we borrow $50 billion at 1% for 10 years, our interest cost on that money will be $500 million per year, or $5 billion over 10 years.

When we borrow $50 billion at today’s rate of 4% for 10 years, our interest cost is $2 billion, or $20 billion over 10 years.

We have a Debt Management Office (DMO) to manage this function.

As so much of Wellington’s public service has been politicised, subject to all sorts of soft demands, the likes of the DMO and Treasury have had high staff turnover, Treasury last year hitting 40%. (The Reserve Bank turnover also was high.)

The best people are often those who do not stay.

So one cannot assume we have an optimal number of skilled, experienced, long-serving people in the DMO, or in Treasury or, for that matter, in Cabinet.

If we have an under-resourced group appointed to seek ever more foreign money to fuel our desire to live beyond our means, then we have a real, scary problem.

The prospects are even bleaker when we as a country lose respect, as we are doing now.

Only in recent days have we been told that our current account deficit is now worse than Greece and Cyprus, sitting in the very bottom group of the world’s most blessed countries.

A small part of the solution might be to widen our funding net.

Currently we rely heavily on a small number of Asian countries whose wealth funds respect NZ as having enforceable law with which to protect global investor rights.

An impediment to fundraising is the low level of liquidity for those who want to trade our government bonds, after they have bought them in the original issue.

Perhaps a part of the solution lies within our stock exchange, the NZX already being slanted towards debt instruments.

If the NZX was paid to run a daily market in benchmark government bonds, might that encourage a wider market, including retail investors, to supply funds for new issues of government bonds?

Might our KiwiSaver industry, now controlling $90 billion, allocate more to NZ Government bonds?

I have no doubt it is the difficulty in liquidating fixed interest holdings that deters many from participating in an asset class that should have significant appeal, given the tremors in other asset classes, and the ongoing losses that KiwiSaver managers are overseeing.

Clearly we need a reset of Treasury, a strengthening of the DMO, and a Cabinet in Parliament that includes people with a background that can draw on capital market knowledge.

Do we also need the NZX to provide transparency and access to new capital for NZ Government funding, as well as providing a liquid, daily market?

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MANY, including me, define clickbait as the practice of building an unnecessary fire to attract attention, often to juice up the readership numbers that entice the advertising agencies.

Talkback jocks specialise in this.

The formal news media now apes this practice, inviting often unaccomplished people to contribute regular opinion pieces aimed at generating readership responses.

Hence we have the distasteful spectacle of liquored-up public bar buffoons displaying their ‘’phobes’’ in the sort of forums that invite readership responses to clickbait.

The practice is growing but childish, chasing quick-fix solutions to fading media relevance.

It is not new. It is now 17 years since a forum was allowed to develop, speculating on my being Chinese, a woman, a criminal, a member of a Triad, and an owner of a gold Rolls Royce. Happily, none of my grandchildren were around to be confused about their granddad.

When a retired press officer wrote recently that the Government should intervene in the sale and purchase process that precedes a life in a retirement village, a mini storm developed, keyboard warriors responding as, in fairness, did a small number of people who had unresolved problems.

My article last week noted that retirement villages were an option for people with some wealth, often generated by a sale of the family home, and that the requirement of the law prevents anyone from buying a licence to occupy without having a clear conversation on the formula used for ultimate sale, the central thesis of the ill-informed newspaper column.

I should have discussed two other matters, the first being the confusion in the media, and possibly the general public, between a retirement village and a rest home.

The second matter should have been the potential value of the Fair Trading Act.

Rest homes are usually small, family-run businesses, rarely with any property ownership rights for their residents. The are not retirement villages.

Many of the residents are referred to the rest homes by health authorities. Most of the residents are women. The government subsidises or pays the whole fee for most rest home residents.

Few rest homes ever make much surplus; indeed, they survive largely because of the wonderful, generous community spirit of their owners, who often work ridiculous hours for very little reward.

The government sets the charges (because it is usually the source of payment). The government rate is miserably low, making it very hard for rest home owners to make any meaningful surplus.

The residents are generally treated with kindness and provided with facilities and food that will be subsidised by the owners. Inflation will be hurting owners.

There is absolutely no point in creating law that squeezes the rest home providers. With only rare exceptions, they are people for whom we should be grateful.

Retirement villages, generally speaking, are to rest homes what a 4-star hotel is to a backpackers’ hostel. They are essentially a user-pays option for people with money. Previous Governors-General have been retirement village users. Retirement villages are for lifestyle seekers.

Generally, they sell the right to occupy a dwelling for life in exchange for a sum of money made up of some or all of three components.

1. Key money (a lump sum paid for the right to use communal facilities – a user-pays approach).

2. A purchase price (usually discounted to around 75% of the average property price applying in the area).

3. A deferred maintenance payment (deferred rather than paid up front, to allow the resident to retain more capital with which to live a full life while health and age allows).

Many villages charge no key money but charge greater deferred maintenance fees.

The three fees, or any two of them, are designed to ensure the village owners eventually receive a fair return for the risks involved in building and managing the village. They deserve that return.

There are often other fees.

1. A fee for ongoing costs (roading, infrastructure maintenance, communal power costs, general staffing, grounds maintenance). This is usually a weekly or monthly charge, with no or little margin for the retirement village owners.

2. A fee for special needs (personal help in times of need). This is a user-pays service.

3. A fee for premium rooms (paid as a choice by those wanting a particular location or view). This is never subsidised by the government.

From all these fees, retirement villages survive, provide for their residents, meet the myriad regulatory impositions, manage their debt, meet all financial obligations, maintain (and develop) their villages, and pay extremely modest dividends to their shareholders.

Shareholders provide the capital because they believe the demand to live in villages will grow, that surpluses will one day expand, and they believe there will be appreciation of capital assets, particularly based on location (land). The returns for risk for shareholders are highly visible and are right now negative for anyone who bought into listed companies in the past three years.

Every resident must consult a solicitor to discuss the details of the original purchase of the licence to occupy, before they buy a licence to occupy. The law stipulates this. Nobody is duped into buying.

A very powerful law underwrites the behaviour of retirement village owners and management, and a very powerful force ensures villages behave well.

The law is the Fair Trading Act. If a village owner reneges on any service promised in the sale and purchase process, the law would be invoked if the matter was not resolved; and so it should be invoked.

The other powerful force is the market.

Why is it more expensive to move into Ryman, or Summerset, Arvida or Oceania? The answer is the quality and location of their villages, and the high standards they maintain.

All this recent clickbait was written by people apparently with neither knowledge of the sector, nor respect for the decision-making process practised by 50,000 adults, nearly all of whom are people who have had successful lives and are rather more clued-up than clickbait journalists.

Of course there will be scores, maybe hundreds, of people who now regret their decision, just as there are people who no doubt wish they had not bought shares in Ryman at $16, its share price now being $5.40.

But there are nearly 50,000 people living in retirement villages who will attest loudly that their decision was right and would prefer that click baiters do not disparage them.

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Heartland Bank subordinated notes

 

Heartland Bank Limited is issuing a subordinated note tomorrow morning with a minimum interest rate of 7.30% p.a. for the first 5 years with an indicative margin range that suggests the initial interest rate could be higher.

The Notes will constitute Tier 2 Capital for Heartland Bank's regulatory capital requirements, will have an interest rate reset after 5 years, and a fixed maturity date of 10 years. The notes may be repaid after 5 years or on any quarterly Interest Payment Date after that date.

They will be listed on the exchange using the code HBL1T2.

The full details of the offer can be found on our website under current investments.

Please contact us by 9am tomorrow - Friday 21 April - with your CSN and amount if you would like a FIRM allocation.

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Travel

 

Edward will be in Auckland on 4 May (Ellerslie) and 5 May (Wairau Park).

Fraser will be in Timaru, Oamaru and Dunedin on Thursday 27 April and Friday 28 April.

Johnny will be in Christchurch on Wednesday 17 May, meeting at the Russley Golf Club Boardroom.

Clients are welcome to contact us to arrange an appointment.

Chris will be holding seminars around the country beginning in the last days of May, finishing in early July. We will contact all clients with dates and times next week, and details of how to apply for a free ticket.

Chris Lee

Chris Lee & Partners Limited

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Taking Stock 13 April 2023

IT will come as no surprise to investors when they discover that many property syndications are not going to meet their planned returns this year, or maybe for a long time.

Interest rates are impacting on many of the over-geared syndicates.

Property valuations fall when interest rates rise.

These two truisms mean that the surplus pool for investor returns diminishes, and the willingness of banks to maintain their debt levels quickly goes into reverse.

Banks are concerned about falling cash flow caused by higher costs and higher debt servicing costs, so what they demand with interest rate ''cover'' might be a problem. Syndicates rarely can raise new capital.

Banks want to see that buildings, even in a distressed, illiquid market, can still be sold off without the banks suffering losses.

Rising interest rates and rising inflation are two major problems for property syndicates. Rising bank nervousness exacerbates the problem.

And let us not talk about tenant vacancy rates, changes in society (working from home etc), and rising company liquidations.

The early signals of distress are coming from property owners and developers who hold excessive debt, have drained the surplus pool with dividends rather than repay debt, and are based on properties bought at the very top of the market, when experienced property investors were declining to bid at prices that seemed silly, or for building projects that needed a tailwind and ''free'' money to prosper.

Many such syndicates had their origins in ambitious people in a hurry to chase extreme wealth or in real estate companies and property valuation companies chasing fee-laden deals.

Our clients have asked me to research three of these syndicators, commonly used, particularly by Auckland investors.

Provincia is Auckland based, focuses on industrial property, aims to pay around 6% gross and relies on the Australian-owned trading platform Syndex to provide (sparse) liquidity for investors wanting to cash up. In today's environment, 6% is a poor return, given the liquidity issue. I am unaware of any significant buying interest, nor do I expect that to change until deep discounts are available.

Centuria is an Australian-listed manager of property syndicates. It bought out the untidy Augusta portfolio which had been rapidly built during a period when money was virtually ''free'' and when the commercial and industrial property market prices assumed that every plan would be successfully executed. Rising debt cost must impact on many of these ambitious plans.

Investors might recall Centuria bid for Augusta at $2 a share just before Covid cancelled the bid. Centuria then rebid at nearer $1. That the Augusta shareholders were still pleased to sell at the new price suggested a degree of fear about the future, a prescience that seems to have been justified.

The Australian company Centuria now has told its investors that it has in place interest rate hedging strategies that may delay a part of the effect of interest rate rises. That would be a relief.

As an aside, NZ investors will be relieved that Centuria bears no obvious similarity to earlier Australian property fund raiders, the ugliest of which was Girvan. This company invaded NZ in the late 1980s, buying a debt-free NZX-listed company, St Martins Property. Girvan geared up St Martins, borrowing money so it could buy a motley bunch of low-quality properties owned by Girvan.

The awful Aussies returned home, pockets full, rid of their property headaches, undeterred by the knowledge that NZ investors were buying Roundup with which to spray these pesky Australian invaders.

By contrast, Centuria bought Augusta at what it thought was a healthy discount and clearly hopes to outstay market setbacks.

A third major player is Mackersy, a syndicate manager now based in the Five Mile industrial village that was first imagined by the Zenith Applied Principles leader, David Henderson, recently released again from bankruptcy.

Five Mile was eventually built by developers with financial credibility and is now a stylish, modern centre for retailers and service sector providers, surrounded by modern houses, very close to Queenstown Airport.

Mackersy manages multiple syndicated properties. It is not to be confused with another property investment company of the same name based in Hawke's Bay, which is linked to a long-time Hawke's Bay farming family with the Mackersy moniker.

The Five Mile Mackersy manages properties all over the country but principally in the South Island. It recently amalgamated various syndicates, one or two of which were succeeding, some whose prospects look bleak.

One wonders why those in good syndicates allowed such an amalgamation. Such strategies resemble those used by Money Managers and Waltus nearly 20 years ago when the occasional successful syndicates were forced to take on some that were less attractive.

In particular, I recall Waltus using the cash of one highly-successful syndicate (bought when properties were too cheap) to prop up another poor syndication plan (committing to buy when properties were too dear).

One hopes that today the regulators would act to stop such abuse.

Waltus transitioned to Urbus Properties, then ING Properties, eventually ending up as part of Argosy.

Money Managers' various properties worked through DNZ Properties, Investore Properties, Stride Properties and still aspires to spin off Fabric Properties. One imagines the Money Managers culture is slowly decomposing.

Investors in property funds ought to demand best practices such as:

1) A simple, low-cost pathway to enable members to sack a fund manager or a trust company that ill performs.

2) A precise process to ensure existing syndicates can veto any deviation from the original, promised plans.

3) Total transparency about fees.

4) A clear and well-promoted platform to ensure secondary market transactions (liquidity for sellers).

5) Specific penalties for negligence displayed by trust companies which must be accountable for approving a trust deed and must be accountable for policing it.

6) Unalterable commitment by the promoters, fund managers, directors and executives to be personally liable for negligence or breaches of the deed.

It would help if the laws of the country were re-written, making it clear that malfeasance would result in directors/executives /fund managers/ trustees losing personal assets, facing bankruptcy and/or jail when there were instances of dishonesty, breach of promises or egregious incompetence.

Right now, market conditions are unfavourable, perhaps highly unfavourable. Rising interest rates, changes in business and consumer confidence, unwise political interference, rising vacancy rates, rising loan delinquency rates, skewed tax rules and probable recession are not helpful.

We must hope that Girvan's behaviour is not forgotten and that we find a solution to existing problems that, at worst, means investors have to wait years to recover their capital.

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NOT all banks react wisely to signals of distress. Some cling to the hope that leopards will change their spots.

Some bankers still confuse their loyalty to their borrowing clients with their obligation to their depositors and shareholders.

In every bank, when money and market conditions are favourably aligned, the banks reward and almost hero worship those bankers who increase lending and thus revenue.

When the conditions are deteriorating, wise banks reward those who reduce risk, eliminate expense (like bad debts), and downsize banking balance sheets. So they visit their major clients, demand a genuinely independent valuation of their assets, and insist on debt reduction, creating new, tougher covenants.

Currently, the better banks do this, aiming to get well-heeled borrowers to reduce debt to a maximum of 60% of very realistic asset values, and requiring borrowers to have contracted income that exceeds 1.4% times the bill for interest.

The unwise banks allow debt level to hover at 70%, even when the asset valuations are well out of date, perhaps last calculated two years ago.

Of course, some will claim the quality of their tenants, and inflation-indexed rent, preclude the need for the opinion of any valuer.

History suggests that such optimism is childish.

Consider a property landlord who has a $1 billion portfolio, financed with $650m of debt, $100m of genuine capital, and $250m of ''revaluation reserves''.

In today's environment, that $250m revaluation might easily be recalculated to be just $150m.   If that were the case, the company would have $0.9b of assets funded by 0.65b on debt. Debt ratio 72%.

Will the bank's internal rules allow this?

Will the bank tolerate a refusal to have the buildings revalued? Central banks are obliged to monitor and control the risk of trading bank sustainability.

Is our central bank currently demanding best banking practices? Are our bank director and auditors awake to poor business practices?

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THE current arm wrestle between wholesale markets (banks, fund managers and traders) and central banks manifests itself in what some would describe as inexplicable reductions in swap rates.

Interest rate swaps, for medium and long terms, are falling and fell further after our central bank hiked the overnight cash rate to 5.25% recently.

The central bank wants banks to lift deposit rates, rewarding those who save rather than spend, and to maintain high lending rates, to deter silly consumer spending (credit card usage etc).

The central bank wants to see less ill-advised consumer spending, a term it might also apply to government spending on vote-buying wastage.

But wholesale markets do best when money is cheap.

It may seem counter-intuitive but banks do best when money is cheap, margins are low, and inflation is low, as it is during these times that bad debts are low and the likes of credit card usage is high.

The current arm wrestle is destined to be won by the central bank.

Of course traders and banks will seek to read every signal as an excuse to encourage investors to beat ''the central bank''.

But the truism that never changes is that he who has the power and the money, wins. Central banks have power and money.

It would be a major surprise if swap rates force central banks to fall in behind.

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A FREELANCE journalist, previously a political party's press officer, last week posed what she thought was a rhetorical question in a weekend newspaper opinion piece.

She asked why anyone would spend ''hundreds of thousands or millions'' buying into a retirement village without any hope of capital gain, indeed a certainty of receiving a return (upon exit or death) that was less than they paid.

She implied that such people must be dim-witted.

May I help her out on behalf of the roughly 50,000 people who have chosen to buy into retirement villages, after complying with the law that requires them to receive legal advice before purchasing, and requires all the financial implications to be transparent?

Perhaps the freelance journalist needs the people who made those decision to explain that they are not dim-witted, not foolish, not unwise but instead are sufficiently well off and sufficiently skilled in planning that they want the lifestyle, security and affordable costs that retirement villages offer.

They have the money to buy what they want. They make the decisions. Most do not want to be dependent on their family to attend to any geriatric conditions that might eventually slow them down.

They want to be self-sufficient. They want access to care if they need it.

They know no government in the past 50 years has had an interest in supplying necessary health care and the high standard of living that independent retired people can have in these villages.

The journalist seems unaware that resident satisfaction surveys indicate that all but a tiny number of residents, far less than 10%, later lose their enthusiasm for the business model which makes its profit margin only when the resident dies or leaves. By contrast, far more than 10% of newspaper readers might find opinion pieces to be of little more value than fish and chip wrapping.

As someone who served as a community volunteer for more than two decades in New Zealand's oldest and arguably best retirement village, I can report I am unaware of any journalists or press officers who have chosen to seek their home in the village I served. That makes sense.

I also disclose that my wife and I may move into a retirement village at a later time in our lives. We will not feel uninformed or foolish.

I offer these thoughts out of courtesy.

A less courteous response would be to advise the journalist to display knowledge when writing columns to make her living. Without research and knowledge such offerings can easily be seen as vulgar click-bait, of value to no one.

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Heartland Bank subordinated notes

Heartland Bank Limited is issuing a subordinated note next week which, based on market conditions, could offer an interest rate of around 7.00%.

The Notes will constitute Tier 2 Capital for Heartland Bank's regulatory capital requirements, will have an interest rate reset after 5 years, and a fixed maturity date of 10 years. The notes may be repaid after 5 years or on any quarterly Interest Payment Date after that date.

The full details of the offer can be found on our website under current investments.

Please contact us with your CSN and an amount if you would like to be pencilled in on our list and we will contact you on Monday once further information has been released.

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Travel

Chris will be in Christchurch on April 18 and 19 (FULL).

David will be in Palmerston North on Wednesday 19 April and in Lower Hutt on Thursday 20 April.

Edward will be in Nelson 21 April, and in Auckland on 4 May (Ellerslie) and 5 May (Wairau Park).

Fraser will be in Timaru, Oamaru and Dunedin on Thursday 27 April and Friday 28 April.

Clients are welcome to contact us to arrange an appointment.

Chris will be holding seminars around the country beginning in the last days of May, finishing in early July. We will contact all clients with dates and times shortly, and details of how to apply for a free ticket. We are not taking names or confirmations at this stage.

Chris Lee & Partners Ltd

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Taking Stock 6 April 2023

MOST investors our company meets probably hold the opinion that short selling is a scourge of modern sharemarkets.

Those who short sell believe a share price will fall and then try to make their forecast self-fulfilling by borrowing shares, selling them immediately, perhaps distorting the natural rhythm of sellers and buyers, and then celebrating on those occasions when they succeed in crashing the share price.

Many retail investors believe these distortions should be illegal.

Others believe that short selling is just another legal way of punting.

A few believe that short sellers are doing the market a favour by generating activity and liquidity.

Some ask where the short sellers find the stock to begin the process.

The answer is these short sellers hire the stock from those fund managers whose various funds are committed to holding a minimum number of a stock, and cannot trade it.

Various index funds, exchange traded funds, and pension funds, promise to hold a minimum number of particular stocks so they cannot, and do not, make conscious decisions to sell.

If they can lend out a stock for a reasonable fee, they are generating another stream of income from shares, to add to dividend income.

Occasionally those fund managers share some of that fee with their investors (in my view ALL of this income should go to investors).

So Smart Alec A borrows 100,000 shares in Troubled Company A from Fund Manager B and immediately sells them at market prices, say $2.00.

By the time Smart Alec has to return the shares to Fund Manager A, Smart Alec will hope the share price has tanked to $1.50, providing Smart Alec with a profit of $50,000, from which the hire cost, say $5,000, must be calculated and paid. Smart Alec wins.

Is this a desirable practice or a casino-like feature of fund management and share markets?

Opinions vary.

I referred to this practice in Taking Stock last week when I discussed the inevitable marker behaviour when it senses that a listed company might hold a discounted rights issue.

Institutions which are convinced a rights issue will occur will sell the share immediately and hope to buy back at a cheaper price, if or when the rights issue is announced.

In recent days, some in the market have been guessing that Heartland Bank might have a rights issue.

Heartland is awaiting news that it has been granted an Australian banking licence. When this is granted, Heartland may confirm acquisitions which will enable it to expand into various niches of Australian banking.

It may need more capital to do this. It has previously declared its plan to raise Tier Two capital.

Some in the NZ market have reached the view that Heartland will have to resort to a rights issue when it gets its licence, instead of a Tier Two note issue.

The market has gained conviction about this guess because it expected global banking frailties to put an end to any plan held by a bank like Heartland to offer Tier One, loss-absorbing bonds, such as Credit Suisse had offered, prior to its collapse.

One wonders if the market’s assumptions are wrong.

Heartland currently has ample capital and might wish to offer what I call ‘’temporary capital’’ by offering Tier Two notes, a hybrid product, not the same as Tier One, loss-absorbing bonds.

The concept of issuing Tier Two is founded on the company belief that it will make future profits that enable the company to generate revenue reserves, in effect replacing ‘’temporary’’ Tier Two capital with future accumulated profits.

If global banking tremors ease, it is absolutely feasible that Heartland might issue Tier Two notes, move forward with its Australian expansion, and thus create more ‘’capital’’ to fund the growth without any need to raise share capital.

Those institutions trying to second guess Heartland’s plans by short-selling Heartland’s shares may well find, like Posie Parker, that they have tomato sauce on their toupees.

Heartland has been extremely well managed for more than a decade, has skilfully delivered each year more profit and dividends than it ever promises, has built a growing credit rating, and to be blunt, has been smarter than the big banks, ahead of the curve in several areas, finding lending niches and delivery systems that have been clever.

It has built a digital business requiring very little expenditure on branch representation. It is probably fair to say that other banks somewhat resent the nimbleness of Heartland.

It dominates the profitable reverse mortgage market and has managed its liquidity cleverly.

My own view is that it should more regularly offer 3, 4 or 5-year bonds, to strengthen the match between deposits and loans, but Heartland has proved itself adept at maintaining a very liquid business, its capital and liquidity ratios better than most of its competitors.

Recently, it lost a stalwart when its long-serving chairman Geoff Ricketts died suddenly. As new chair Greg Tomlinson will be an outstanding replacement, Tomlinson being from the very top drawer of New Zealand’s business leaders.

If Heartland issues Tier Two bonds, probably at rates of around 7.00%, I will be a buyer.

If the short sellers retreat, having burnt a few bob at the Totalisator window, I will not be present at the Wailing Wall.

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WHILE Heartland and our other listed banks seem to have impressive control over their treasury functions (managing liquidity) the same cannot be said for the American banks.

This raises the question of the moral hazard of taxpayers’ underwriting of bad bank behaviour and foolish depositor behaviour.

New Zealand’s public sector-trained finance minister Grant Robertson is determined to introduce a taxpayer guarantee for all bank deposits and quite absurdly, all deposits on finance companies and other non-bank deposit taking organisations.

He should look not at whether other countries have such a hazardous arrangement but whether such mis-use of taxpayer funds produces equitable results.

Last month Silicon Valley Bank provided interesting insight into this practice.

It was a bigger bank than the likes of CBA and ANZ.

It borrowed enormous sums of ‘’hot’’ short-term money. Most of its deposits far exceeded the US $250,000 limit placed on the guarantee.

When its concealed problems emerged – its assets were falsely displayed in its balance sheet – the ‘’hot’’ money could be withdrawn in tens of billions, per day. The run on the bank destroyed it. Its treasury management and risk management was hopeless. A fifth of its deposits were withdrawn in one day!

Silicon Valley Bank was not alone.

More than $10 trillion of US bank deposits are not guaranteed because the deposits grossly exceeded the $250,000 eligibility limit.

The US government, through the Federal Reserve Bank, levy banks to build a fund to meet any call on the guarantee it has unwisely promised.

Over the last 15 years the fund had gradually built up to $175 billion, to cover the trillions of bank deposits.

The Silicon Valley Bank collapsed after receiving requests for $42 billion to be paid out in 24 hours. Ouch!

All the major US banks similarly conceal losses in their bond portfolios. The combined losses, if realised, would far exceed the available insurance fund. Loss of confidence can lead to panic withdrawals.

One must hope and play one’s role, in not shouting ‘’Fire’’ if any smoke is irrelevant.

Generally, any hidden potential losses in banks are offset by capital raising, a relatively straightforward procedure for all stock exchange listed banks.

The likes of Warren Buffett rescued Goldman Sachs after the 2008 crash by stumping up more than $100 million, admittedly at a discounted buy-in price. When Goldman Sachs recovered, Buffett won, big time.

Any guarantee from the Crown, committing to socialise bank or depositor losses in the interests of stability, is a hazard because it has the potential to:

1.Encourage banks to take on more risk, knowing the bank will be underwritten by the Crown.

2.Encourage depositors to chase the highest rate, without any thought given to the risk of banking failure.

A better option would be for the Crown to buy at a hefty discount shares in the bank, though even that represents a moral hazard.

As it is now, poor old Joe Blow, waiting for his new hip operation, may find the funds to enable this procedure have had to be diverted to protect greedy bankers or unwise depositors, under Robertson’ plan.

Nor can it be said that central bankers, politicians, or public servants have much clue about the risks shrouded by banks or other deposit-takers, as we saw in NZ when the finance companies collapsed in 2007-2010.

The response from politicians and the public sector was to cover up appalling errors and to make crass recovery decisions which quite unnecessarily bonfired enough money to build several hospitals.

‘’Chump change’’, one shallow political buffoon described the loss of $100 million.

My observation is that our listed banks – CBA (ASB), NAB (BNZ), Westpac, ANZ, Heartland – and others including Kiwibank and Rabobank, are all much more risk averse than the American banks, or even the British and European banks.

Banks in countries like Italy and Greece simply could not survive without the implied guarantee of the taxpayers.

Perhaps part of the explanation for our risk aversion is the absence here of a morally hazardous fallback position on taxpayer funds (or highly under-powered ‘’insurance’’ funds).

My solution would be that instead of underwriting banking hazards we should make it clear, indeed irreversible, that stupid risks with other people’s money lead to personal accountability, meaning asset confiscation, personal bankruptcy and incarceration, in circumstances that were clearly egregious.

While we allow lobbyists and vainglorious lawyers to argue against this, my solution seems unlikely to be supported by politicians.

Robertson says a taxpayers’ guarantee is a better answer.

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Travel

Chris will be in Christchurch on April 18 and 19 (FULL).

David will be in Palmerston North on Wednesday 19 April and in Lower Hutt on Thursday 20 April.

Edward will be in Nelson 21 April, and in Auckland on 4 May (Ellerslie) and 5 May (Wairau Park).

Fraser will be in Dunedin on Thursday 27 April.

Chris will be holding seminars around the country beginning in the last days of May, finishing in early July. We will contact all clients with details of dates and times shortly. We are not taking names or confirmations at this stage.

Clients are welcome to contact us to arrange an appointment.

Chris Lee & Partners Ltd

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