Taking Stock 26 November 2015

THE growing urgency for retired investors to secure their investment income stems from the global strategy to make the savers of the world pay for the over-indebted.

In Europe, Asia and the United States, over-indebted households, companies and governments are all now the beneficiary of virtually zero interest costs for their debt.

The flip side is that the savers of the world are receiving virtually no interest on their savings and increasingly are forced into buying shares to pursue any sort of a cash return.  In most countries, interest income is pitifully low.

The obvious result is that retired people needing investment income are being forced to accept the uncertainty and the risk of sharemarket performance, or being forced to spend their capital.

At the same time, pension funds are increasingly eating capital or taking greater risks to pay out their promised pensions, a trend that inevitably leads to failure.

When we told clients five years ago that our interest rates were almost inevitably heading to the range of 2-3.5%, people regarded this ‘’mess’’ as horrific.

In amongst all this mess are the world’s banks, no longer implicitly guaranteed by governments and now required to hold much higher levels of capital to underwrite errors or future disasters.

The logical consequence should be a downsizing of big banks, as they rid themselves of such high-risk profit centres as, say, their derivative trading desks.

All of this explains the dramatic changes that we are seeing globally, but in Australia and New Zealand, changes are more incremental as ‘’big bank bulldust’’ was not prevalent in the years leading up to the 2007-08 global financial crisis and our banks did not lapse into losses.

This also explains the latest offer from BNZ, an issue of subordinated Tier Two bonds, aimed at enabling BNZ to lift its capital ratios while it grows its banking business here and in Australia.

BNZ last week sought to raise at least $300 million with a Tier Two bond issue and had the right to accept over-subscriptions.

The markets responded with bids for the new issue exceeding $600 million.  The BNZ accepted $550 million and rejected the remaining sum offered.  Investors clearly want the yield offered.

All brokers and advisers who bid for the stock will now offer these new bonds to their clients.

The new bonds pay 5.314% per annum, interest paid quarterly, and will count fully as part of the BNZ’s capital requirements for five years.  They have a credit rating of BBB plus, exactly the rating of Contact Energy’s recent senior bond issue.  (BNZ itself has a rating of AA minus.)

After five years the bonds begin to lose equity recognition, so at that point the interest rate is either reset for a further five years, or the bonds are repaid, subject to Reserve Bank agreement (that BNZ is not weakened by paying them out).

In recent years, two BNZ subordinated bonds (BISHA and BNSPA) have been repaid after five years, rather than being continued, with the BNZ possibly deciding that there was limited value in retaining the bonds as they began to lose equity recognition at 20% per annum over the next five years.

New Zealand and Australian banks are already well supervised by the Reserve Bank, with NZ branches of the Australian banks subject to more stringent rules than their parents.

The NZ banks have been holding higher capital levels, and to a stricter timetable, than their Australian parents, and are required to classify the risk of individual lending activities (like home mortgages) as being riskier and therefore in need of more capital than a home mortgage in almost any other country.  Australian banks are now increasing their risk standard to the higher standard already operating in NZ.

There is no doubt a logic in this assessment of risky home mortgages in Auckland but much less logic in places where residential property values have not soared as Auckland’s house prices have.  The Reserve Bank has reacted to the Auckland risk by demanding even higher equity from those regional borrowers.

The new BNZ offer is typical of how ANZ, ASB and Kiwibank reacted to the new stricter requirements.

Quite responsibly the banks have agreed to pay a higher rate to obtain funding more flexibly than would be the case with either a term deposit or a share issue.

The flexibility the BNZ requires is the cause of the higher reward for investors, which offsets BNZ’s ability to extend the term if it needs to do so, or is required to do so as might be the case if BNZ was not meeting the requirements of the Reserve Bank when the bond is reviewable.

Investors benefit from a relatively better rate in return for their acceptance of the possibility that they may not be repaid in five years.  (The relatively high credit margin of 2.25% reflects the potential for the longer term.)

The additional margin paid to investors seems likely to shrink in the future for those who buy the bonds on the secondary market, as can be seen by the secondary market pricing of ASB’s subordinated bonds, which are virtually identical to BNZ’s.

The ASB notes were issued with a five-year coupon of 6.65% but now sell at around $1.06, at which price the true yield is below 5%, whereas the BNZ rate will be 5.314%.

Furthermore, ASB subordinated bonds may be purchased now, only after paying brokerage, whereas the BNZ Tier Two issue has no brokerage charge, and for those who allow advisers to ‘’manage’’ their investments, should be exempt from the 1% or greater annual charge made by advisers and some bucket shops.  (Fixed interest and cash investments should never be subject to such a high charge.)

All of this information is aimed at explaining why the BNZ Tier Two issue has led to such an enthusiastic response, with investors requesting double the $300 million BNZ sought (before over-subscriptions).

The issue closes on December 14 and pays an ‘’early bird’’ interest rate of 3.75% until December 14, when the coupon rate of 5.314% begins.

Our clients, and those who want access to the issue via our business, should contact us promptly.  Those who planned to use the maturing Trustpower bonds, repaid on December 15, should contact us now to arrange a means of recycling the Trustpower bonds.

It is important to differentiate the Tier Two bonds from ASB’s issue last week of senior bonds, at a rate of 4.24%.  This ASB issue left the investors to pay the distribution cost, meaning the yield on these seven-year bonds will be somewhat lower, after allowing for that brokerage cost.

It seems extraordinary to me that New Zealand investors have had to adapt and acknowledge that rates like 4.2% are now acceptable but the response of Asians, Americans, Brits and Europeans would be that our investors are blessed.  For them, 5% from a bank issue would be rich pickings.

Zero-2% is the new norm in many countries and in some cases the rates are negative.

(One wonders if advisers there charge clients to ‘’monitor’’ their ‘’negative’’ bond returns!)

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FOR the benefit of those clients interested in the technical details of the various tiers of bank debt, Kevin Gloag, Michael Warrington, David Colman and I conducted a series of seminars in February this year at public meetings in Invercargill, Dunedin, Timaru, Christchurch, Wellington, Kapiti, Nelson, Palmerston North, Hastings, North Shore, Auckland, Hamilton and Tauranga.

This was a major task for us but the seminars were well attended (around 1500 people) and provided accurate and meaningful discussion on the details of a new bank security that needed to be understood.

Shortly afterwards, the ANZ issued Tier One bonds so our timing was fortuitous.

The ANZ raised $500 million with Tier One securities, which rank ahead of share capital, but in the event of a banking disaster would behave more like shares than bonds.

Later, Kiwibank offered Tier Two bonds and raised $150 million.

Tier Two bonds rank ahead of shares and Tier One bonds in the event of a banking disaster and rank behind savings accounts, term deposits and cheque or call accounts.

So when banks issue securities now they have a variety of options.  They can issue shares, where the returns may vary and where the future value of the security is unstated and unknown.

They can issue Tier One bonds by paying a margin over bank ‘’swap’’ rates of around 3.5%, meaning a total rate promised of around 7.0% (at current swap rates).

They can issue Tier Two bonds by paying a margin over swap rates of around 2.25%, meaning a total rate of around 5.3%.

Or banks can issue senior bonds or offer term deposits at rates of around 3.00% to 4.2%, depending on the length of the term.

Investors will need to get used to these different instruments.  They are here to stay.

Our advised clients will find Kevin Gloag’s research page on our website, with technical explanations.

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THE 1150 contributors to a fund investigating the possibility of a claim on behalf of South Canterbury Finance Perpetual preference share investors should soon know the outcome of the investigation.

The details of the investigation remain under wraps with the legal team which has spent several months analysing literally thousands of pages of documents and conferring with various parties experienced in such matters.

The investigation’s outcome should be advanced and possibly concluded before Christmas.

Contributions to the cost of the investigation continue.

Many investors will wonder why the investigation did not take place in 2010-11.

At that time formal complaints to the Financial Markets Authority were investigated but the FMA decided not to make a decision on any litigation until the Serious Fraud Office had completed its proposed fraud case against various South Canterbury Finance directors and its 2005-2009 chief executive Lachie McLeod.

The logic of this delay was that a concurrent case might have adversely affected the SFO’s $1.7 billion case, trumpeted by the SFO as New Zealand’s ‘’biggest ever’’ fraud case.

Sadly, this decision cost SCF perpetual preference shareholders some three years of wasted time.

The SFO case, inevitably, was delayed and delayed.  The criminal case was heard in 2014.  After it ended, the FMA announced it would not proceed but would reconsider its potential involvement if a privately-funded investigation produced evidence that a claim was justified.

Time was then of the essence.

In January 2015 I met with a prominent QC and the head of a Hamilton law firm and in May held meetings in Invercargill, Dunedin, Timaru, Christchurch, Wellington, Kapiti and Auckland where I discussed the need for an investigation, with approximately 1200 investors attending these meetings.

Chris Lee & Partners Ltd and my family had contributed cash, office support and time to initiate the investigation and, after the meetings, about 1200 people contributed to a fund said to be the largest of its type ever achieved in New Zealand.

The investigation which began this year has taken much longer than intended, as it has uncovered issues that could not have been foreseen, when it used legal research teams to analyse documents.

The result has been that time and money has been consumed far beyond anticipated levels, but the work has been thorough.

If a claim proceeds, and that should be determined soon, much of the required work would have been completed.

It remains my hope that a claim proceeds but I do not make the decision.

If it does not, the years of research, meeting with investors, my prior knowledge of SCF and its slide into disrepute, and my sideline involvement with the investigation, would have produced no benefit for investors, other than the knowledge that substantial effort had been made to bring the issue to a conclusion.

If no case emerges, the book I have long wanted to write would address an even wider range of subjects and would necessarily finger those who might otherwise be regarded as having ‘’behaved legally’’ in their roles at SCF.  I would much prefer that the truth is told in the High Court.

Meanwhile, investors await patiently the expert conclusion, which will follow external reports currently being prepared.

Investors have been represented by an Action Group committee comprising Michael Connor, a chartered accountant with big firm auditing experience, and now a skilled financial adviser in Auckland, and Dan Tait-Jamieson, an experienced, significant Wellington investor, and myself.

Our time is donated, as is the time required of my office to collect and account for the funding of the investigation, the development of a database and the communication process.

I hope to visit Invercargill, Dunedin, Timaru, Christchurch, Wellington, Kapiti and Auckland to meet again with investors in January, to discuss the legal team’s report to the Action Group.

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LEST we forget.

It is now five years since New Zealand’s most disgraceful corporate behaviour resulted in 29 men losing their lives at Pike River’s coal mine.

Rebecca Macfie demonstrated in her chilling book, Tragedy at Pike River Mine, details of the litany of cover-ups and appalling governance and management errors, proved by the mountain of evidence that the Pike River mine was never designed or managed to put worker safety at the level it belonged – at the top of all other issues.

Financial pressures, ego and gravely-inept assessments of risk led to the explosions that killed 29 men.  The guilty parties are lucky they were not subject to Chinese justice.

I had invested a modest sum in that project, believing the utterly wrong information provided to investors by those responsible for communications.

The Pike River Coal directors were:

John Dow (Chairman)

Tony Radford

Arun Jagatramka

Dipak Agarwalla

Stuart Nattrass

Raymond Meyer

Peter Whittall, was the Chief Executive, replacing

Gordon Ward.

The public inquiry into the Pike River disaster found not enough evidence to justify criminal proceedings against any party and no conclusion could be reached as to the cause of the disaster, though it is clear that methane gas, so often recorded at well beyond acceptable levels, caused the explosion, and that the mine was inadequately vented and poorly designed.

Macfie’s book, which I reviewed some years ago, should be compulsory reading for all mine inspectors, for all aspiring company directors and for all of those, including auditors, sharebrokers and investment bankers, who implicitly testify to the integrity of all aspects of a mining operation.

It is also good value for helping investors to recognise that unknown investment risks always exist.

In my opinion, the book exposes Pike River as the most disgraceful business in New Zealand’s history, and for those who place lives ahead of money, provides nauseating evidence of dreadful corporate governance.

My conclusion is that none of the company’s directors or executive management should remain in governance or executive positions, in any company.  Never again.

The appalling behaviour of South Canterbury Finance and its various associated parties may have set an awfully low benchmark for cynical and greedy behaviour and probably did contribute to health issues that have resulted in illness and premature death for many investors.

Pike River Coal, however, was the pits.

Lest we forget.

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Travel and Office News

I will be in Auckland (Albany Motor Lodge) on Tuesday 8 December and at Mount Wellington (Waipuna Lodge) on Wednesday 9 December.

I will then be in Hastings (Pernel Orchard Café) on Friday 11 December.

The following week I will be in Christchurch (Chateau on the Park) on Tuesday 15 December (pm) and Wednesday 16 December (am).

Any investors wishing to meet pre-Christmas should contact our office to arrange a suitable time.

Our office closes for Christmas on Friday 18 December and reopens on Monday 11 January, though our Timaru office reopens a day later on Tuesday 12 January (delayed by a family wedding).

During the break, we will continue to be available by email (info@chrislee.co.nz) or by phone as follows:

Clients needing an urgent response or transactional help over this period are welcome to contact us as above.

Chris Lee

Managing Director

Chris Lee & Partners Ltd

 

Next week: What the Motor Finance dealers think of the company’s governance.


Taking Stock 19 November 2016

RECENT reference to the Heartland plan to take over Motor Trade Finance also recorded my view that Turners was perhaps being cheeky in attempting to lift its shareholding in MTF at a price nearly one-third lower than Heartland’s proposed takeover offer.

I explained that as Heartland does not supply MTF with hire purchase loan agreements (it is not a motor vehicle dealer) it is not able to buy MTF shares unless MTF approved.

Generally the dealers do not want external shareholders but I sense many MTF dealers want Heartland to succeed with a full takeover.

Turners CEO Todd Hunter has communicated with me, noting that as its share of MTF business has risen, it wants to make commensurate increases in its shareholding in MTF, which now has a semi-corporate structure, albeit from a cooperative base, and cooperative-like rules.

Hunter says Turners’ desire to build a position has no relation to Heartland’s ambitions, despite speculation.

This declaration will be a source of concern for Heartland, as it implies that Turners’ shareholding in MTF could block a bid to take over the financier.

The elephant that frightens MTF dealers has always been the recourse demanded by MTF from all car dealer members.  MTF’s recourse requirements means that every hire purchase deal funded by MTF must be guaranteed by the dealer who wrote the hire purchase agreement.

Hire purchase agreements that are carefully supervised produce next to zero bad debts so the recourse condition is a rarely used backstop, but as the guarantee is enforceable, the dealer must record it as a contingent liability.

One can imagine that the major car dealers – the big brand names – are not pleased to carry contingent liabilities, as by definition they weaken the dealers’ borrowing ability with banks.

But two other parties like the guarantee.

Those investors who bought into Forsyth Barr’s issue of MTF perpetual notes were told that the recourse facility effectively underwrote the risk of MTF’s failure.

Those investors are protected by a trust deed overseen by a trustee.  That deed relies on the recourse arrangement implicitly.

The second grouping to fund MTF is those banks that provide a facility secured by the hire purchase agreements, though banks may regard the recourse as simply a precaution, as bad debts are very low.   

If Heartland Bank were to succeed one day in owning MTF it would have the option of forfeiting the recourse requirement, possibly in return for paying a lesser share of the revenue to the car dealers.

Heartland might also swap the MTF perpetual notes for a much better Heartland security as the MTF perpetual notes pay a low credit margin over swap rates and trade at a significant discount to par.

If Heartland swapped these for a security that had a maturity date on it, or offered a fair credit margin, the new security would trade at a value nearer par, allowing those who bought into the original issue to escape, one day!

The focus of MTF’s board should therefore be on the perpetual notes, where the public are being hurt, rather than on the shares, where car dealers can escape at a profitable price of $1.50, if Heartland proceeds with a bid.

Turners, in seeking a blocking vote by buying more shares at $1.10, will be seen as a threat to this whole plan, and is therefore a potential threat to any plan to rescue the public, stuck in these discounted notes.

Heartland’s bid will be dependent on the decision of the Supreme Court which is heading an appeal from MTF against a finding that MTF dealers charged booking fees that were manifestly excessive.

If the Supreme Court disallows the appeal, MTF may need to repay many millions to those who paid the fees for many years.

The Court of Appeal over-ruled MTF’s appeal so the Supreme Court finding will be MTF’s final protest.

My final comment to every user of hire purchase is never to pay fees or buy insurance of any sort from a car dealer without first being convinced that the insurance is necessary and then comparing the premiums with those offered by other insurers.  Fees should reflect fair value for a legitimate expense.

In the past it has often been said that car dealers may make more revenue from insurance, booking fees, and finance revenue-sharing, than they make from the margin between the cost of a car and its sale price.

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

A well-seasoned media friend of many years wants me to explain why so little business news or analysis reaches the public these days.

I perhaps have caused minor offence previously by noting how so-called business papers (e.g. NBR) and ‘’business’’ sections of newspapers are filled up with government news, legal or regulatory news, and promotion backed by advertisements (e.g. motoring ‘’news’, or wine ‘’news’’ or political opinion/ commentary, e.g. Oram, Hooton).

My conclusion is that this aversion to investigative journalism, this lack of focus on what is relevant to investors and this fear of critical analysis has allowed the growth of greedy, often corrupt behaviour, often to the distinct disadvantage of decent people, entitled to the protection implied by an inquisitive, energetic and informed media.

For example I am very sure New Zealand tax-payers would not have lost a billion dollars in the South Canterbury Finance farce had the media been focussing on the need for transparency of the decisions made during that period.

The experienced media friend tells me that the game changer for journalism was not the falling advertising revenue, nor any predisposition to enjoy the largesse of corporate knaves dispensing red wine and cigars, though young journalists are impressed by such ‘’wealth’’.

The game changer was a series of often frivolous but expensive defamation claims that began to eat up budgets and eventually cost the media millions of dollars that falling revenues could not fund.

Rather than allow the High Court to decide what was defamatory, the media eventually succumbed to the power of ‘’bigger wallets’’ and made two key commercial decisions.

* They would negotiate rapid ‘’settlements’’ often involving promises to be ‘’nice’’ to the corporate people who threatened them.

They could do this by regular flattering reference to them or by offering them space to express their opinions, thus endorsing the images the bullies want to present.

* They would cease to go beyond token efforts to analyse critically or to investigate clearly poor corporate behaviour and would instead just publish ‘’blurb’’, allowing PR people access to news columns, to promote each and every ‘’tech’’ start-up, for example.

If the sole result of these strategies were to convert our media, especially the NBR and the business sections of Sunday papers, into insipid, boring guff, then there would be no doubt about the outcome.  Defamation writs might cease.

Clearly the ultimate outcome would be disrespect for the media, falling circulation, falling advertising revenue, and eventually the outcome would be newspapers whose front pages were filled with such trash as ‘’horror’’ stories about someone driving at 135kph down a motorway, an activity that in many countries is performed by virtually everyone, including the media, every day, without the sky descending.

But the result that I dislike is the effect of there being no penetrating insight into business decisions and behaviour.

Unpatrolled by journalists like the late Warren Berryman, corporate New Zealand has less risk of being exposed for the sort of behaviour that inevitably leads to the public losing its money.

The major losses we will all recall stemmed from the sharemarket dishonesty in the 1980s, the simultaneous property market dishonesty, the less expensive but ridiculous ‘’tech wreck’’ of 2001, and the finance company/ mortgage trust cheating that cost investors nearly three billion dollars after the 2008 collapse.

I do not know which will be the next activity that wipes out billions of investor money.

It could be a combination of disasters stemming from crowd funding, or direct (P2P) lending or property syndication or Kiwisaver mishaps or more of the insurance scams or more real estate scams.

The regulators will do their best to frame regulations that describe fair practice and good standards, to try to stem the damage.

Scumbags using structures that protect themselves from financial accountability will defeat the regulators for a period and during that period the only real hope will be that whistle blowers might alert the media, in the hope that rotten practices get exposed.

That hope seems to have been erased because of the media’s fear of writs from corporate slobs often using other people’s money to fund their legal attacks, often trying to deflect attention from their own greedy or poor behaviour, or seeking media silence while they seek to cover up their own mistakes.

What might break this cycle?

One weapon for those who receive gagging writs is to head to court and let a judge weigh up the arguments and to award full costs rather than scale costs, when there is evidence of a trumped-up claim by some slob.

That might require a law change aimed at deterring these slobs.

Another solution might be to have compulsory pre-hearings, without legal representation (or cost) that allows a learned, free judicial hearing of the claim, and has the power to stop the claim immediately, or to allow it to proceed under the warning that full costs will go to the winner.

Currently, defamation cases usually provide for costs based on an approved scale, a formula that ensures neither party will be fully reimbursed.

This might mean that if the plaintiff wins $50,000 and scaled costs, he actually might lose, as a court case inevitably costs hundreds of thousands and scale cost awards are usually around two thirds of actual costs.

A third option might be to get an early resolution with a simple correction, perhaps with an apology, and a standard modest award, if justified.  Surely this outcome would not terrify media owners and directors.

Obviously none of these would be the right answer if someone was falsely accused of paedophilia, or some heinous action that really did affect their reputation (assuming they had a justifiably good reputation).

A further improvement will come when the Courts order solicitors to behave honestly and properly when they write to someone about some alleged defamation.

Currently dozens of the lance corporals in the legal world send out letters stating ‘’you have defamed Mr X’’ when they should be saying ‘’Mr X believes you have defamed him’’.

Only the Courts can determine what is defamatory, not lawyers.  Dime-a-dozen solicitors have no right to usurp the authority of the courts by pretending that they, the solicitors, can determine what is defamatory.  They cannot.  They are bluffing.

I imagine seasoned business people chuckle when they see this sort of feeble fist-waving from legal practitioners.

Indeed few solicitors have any personal knowledge of defamation cases, which very rarely reach court because of the reasons described earlier.

How does the media react to defamation claims?

Major media organisations retain law firms with expertise in defamation.  The media seek to insure themselves against the costs of any lost case, so they must refer every writ or threat to their insurer, regardless of its merit.

Of course the insurer then takes control of the case and decides strategy.

If the insurer decides to retract, apologise and pay some sort of sum, and costs, the decision may well be a monetary decision, rather than a moral decision.

The insurer has had a few million in premium payments, and is simply being pragmatic in not risking the loss of a case.

I recall one such case in recent years where a corporate slob won, despite some mouth-watering evidence that might have produced a very different result.

So long as the ease of filing a claim remains and the pre-trial process is unstructured and expensive, the result is likely to remain unsatisfactory.

The outcome is a pitifully docile media, failing in its often self-claimed role to be one of the protections for the general public.

If that lofty role is to vanish, what is left?

Information is available for nothing.  Learned analysis has a value but is not available.

Does the media degenerate into an infotainment organ aimed at the lowest common denominator, with the sole goal of turning a pound into a guinea, for the benefit of its shareholders, with no moral objectives?

_ _ _ _ _ _ _ _

THE key defences to defamation claims are: –

1) That the information is true (and not malicious);

2) That the published item was an honest opinion based on a reasonable interpretation of the facts;

3) That the plaintiff is such a slob that he cannot be defamed as his reputation is deservedly dreadful anyway;

4) That the words printed are not defamatory.

It is with sadness that I note that very rarely is defence number three used.

In my opinion, it should be a standard defence when corporate slobs seek to bully the media from examining corporate poor behaviour.

One successful defence might clear the system of a whole lot of trumped-up charges.

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LONG marooned have been the investors in Babcock & Brown subordinated notes, an issue organised by UBS during the period prior to the 2008 Global Financial Crisis.

In this era, the likes of Macquarie, Babcock & Brown, and at the bottom end, Allco and MFS, set up dozens of projects based on high leverage and promises of high returns.

Indeed the tiny Australian company Allco once pretended it was the right party to be involved in a takeover of Qantas, an action akin to a grasshopper threatening to eat an elephant.

Allco was best known in New Zealand for its dreadful behaviour when it bought out Strategic Finance, unconditionally guaranteed the issue of Strategic preference shares, and then helped to strip Strategic of its limited liquidity by taking a huge dividend just before Strategic collapsed.  Lovely people.  The guarantee was worth nothing.  Never Again!

Babcock & Brown was slightly more reputable but also failed, leaving New Zealanders out of pocket when its note issue in Australia and New Zealand failed, despite its guarantor within the group claiming an S & P investment grade rating.  (Small wonder S & P lost credibility).

Several years ago the Babcock & Brown (BNB) liquidator collected from investors some contributions for a legal fund to attack various BNB directors and succeeded in extracting some tens of millions from the errant directors.

The liquidators, Deloitte, then won court approval to reward those who contributed to the legal fund on a ratio of $10 back for every $1.00 contributed, but with the proviso that no BNB note investor could be returned more than his original investment.

Having paid out that money to the legal fund contributors from the settlement, Deloitte then was bombarded by claims from other creditors, meaning the sum that remained from the directors’ settlement was being targeted by hundreds of creditors, as well as the note-holders.

So the courts will have to resolve who is entitled to the remnants of the kitty.

My memory is that there was around $600 million in the note issue, so if there were $60 million left from the directors’ settlement, note-holders might have recovered 10 cents in the dollar.

I do not know the figure available to be distributed.  It might be only $25 million, in which case four cents in the dollar sounds more like it.

Furthermore Deloitte has charged several million for its work.

Last week Deloitte advised BNB note-holders that additional claims from unsecured creditors now total $145m.

It does sound as though BNB investors may now be lining up little more than a cent in the dollar.

New Zealand investors may again feel as though they too are being despatched to some sort of financial equivalent of Christmas Island.

Those New Zealand investors who recall how the Australian company Girvan robbed New Zealand holders of St Martins Property Fund in the late 1980s may well regard the likes of Babcock & Brown, Allco and MFS as proof that we Kiwis should be very wary of Australians who say that they wish to share their largesse in New Zealand.

There seems to be evidence of a path well used by failed international wide boys casting their eyes on Australia, from where, after failing, they head to an even smaller market to try their luck in a tinier pond, like New Zealand.  One hopes regulators are watching them closely.

Those who watched the HBOS International bankers destroy value in New Zealand may well be nodding as they recall Babcock & Brown, Allco and MFS.

Keep an eye on our Never Again list.

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LAST week’s discussion on what employers look for when considering the hiring of university graduates brought a response from a now retired South Island accountant.

He tells me his firm refined its employment processes by looking for SWANS.

New employees had to be:-

S for Smart

W for Works Hard

A for Ambitious and

N for Nice

It worked a treat for his firm, he writes.

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TRAVEL:

I will be in Auckland, Christchurch and Hastings in December, dates to be confirmed.

David Colman will be in Palmerston North, Wanganui and the Taranaki District next week.

Kevin Gloag will be in Christchurch next Friday November 27.

Any clients wishing to meet in any of these cities is welcome to contact us to arrange a suitable time.

Chris Lee

Managing Director

Chris Lee & Partners Ltd


Taking Stock 12 November 2015

THE huge profits earned by the Australian banks in New Zealand will be seen as corporate bullying by some, and by others will be seen as a core strength of the NZ economy.

The fact that our over-indebted rural sector has not been put to the sword by its bankers has been a big part of New Zealand’s relatively robust survival during and after the global financial crisis.

I confess that I regard a strong, profitable banking sector as a key assumption when I make business and personal financial plans.

Those who hanker for the days when the likes of the BNZ was Crown-owned, and engaged with head office people who enjoyed grouse and port for lunch after their meetings, probably forget what that sort of marshmallow behaviour produced in the 1980s.  Who will forget the greed and selfish behaviour of the likes of Fay and Richwhite, sanctioned by politicians?

The BNZ, on the brink of failure, was sold off, ultimately to the strong National Australia Bank, because the then finance minister, Ruth Richardson, had no confidence in the bank’s recovery.  At that time NAB’s shares were worth 10 times BNZ’s shares.  At that ratio, those who swapped would now be doing rather well.

I would far rather NAB owned BNZ than leave it at the mercy of commercial dopes like Richardson, or for that matter any politician, of any hue.

Many New Zealanders will regret that about 90% of our banking is now subject to Australian ownership but this dominance is not impenetrable and one day will reduce, perhaps our banks merging to make a real competitor.

We have in our arsenal the modest SBS Bank, based in Southland, the community-owned TSB, the Co-operative Bank, the Crown-owned Kiwibank and the publicly-owned Heartland Bank.

Ultimately these could form ‘’Aotearoa Bank’’, at which point New Zealanders who disliked the Australian style could vote with their wallet and join a NZ bank that would have scale and would produce decent returns.

These thoughts were ignited last week when I read the views of media commentators warning that trouble was ahead, as bank returns on equity had fallen from 15.5% per annum to 15.0%.  Time to panic.  Not.

One might muse that if banks have to raise their capital levels that a natural consequence would be a slight fall on the returns on equity, but such an obvious conclusion causes us to revisit a long-argued debate about the bleak standards of business commentary in New Zealand, probably related to the absence of business experience or business participation amongst the columnists and reporters who present our business news, with very few exceptions.

To revert to the subject, I record my view that a 15% return on equity is a most satisfactory outcome, especially if it can be achieved without a reliance on such risks as derivative trading.  Returns on equity are not required to rise every year, let alone every quarter.

That our banks are in good shape was confirmed when the fledgling but impressive bank Heartland (HNZ) announced it is to raise a modest $50m in Tier Two bonds in April next year.

If the swap rates remain constant this should mean HNZ offers a 10-year instrument with some early repayment rights at a rate exceeding 6.0%.

Heartland says it would use this hybrid capital either to finance the purchase of Motor Trade Finance or to cancel some shares and replace real capital with hybrid capital.

I far prefer the purchase of MTF, which would be a natural fit for Heartland, and would improve the governance and management of the large, car dealer-owned, vehicle financier.

I have never believed in banks returning capital.  My view is they can never have too much capital and should accept lower returns on equity as the offset of greater balance sheet strength.

Particularly I recall how ANZ bought back its own shares in 2007 at AUD$36 and then, after the 2008 crisis, had a rights issue at a figure of nearer $14, effectively incinerating hundreds of millions of dollars.  Surely increased strength is worth a reduced return on equity.

Heartland should buy Motor Trade Finance as its experience and success in vehicle lending is proven, its ability to finance growth in this market is obvious, and it would be replacing a financier whose capital structure is weak.  It has often been poorly managed and governed.

However, the potential takeover has some problems to overcome.

For one thing, HNZ is not allowed to be an owner of MTF unless all the licenced motor vehicle dealers who own MTF agree to change its constitution.

Currently MTF can be owned only by car dealers.  The reason Turners rather cheekily was able recently to buy MTF shares is that Turners has a motor vehicle dealing licence.  (It auctions cars and needs a licence).

HNZ would improve MTF and would gain from obvious synergies if it took over MTF so it would happily pay $1.50 per share, whereas Turners are somewhat cheekily trying to build a shareholding at nearer $1.10 a share, presumably to make a quick quid if HNZ does proceed with its bid.

It is very difficult to imagine MTF dealers wanting Turners to have much say in running MTF, given that Turners is arguably the rural cousin, nouveau and predominantly operating well away from the top of the market.

If MTF changes its constitution and HNZ takes over MTF, it would position HNZ strongly for the inevitable talks one day, aimed at getting some or all of TSB, SBS, Kiwibank, Heartland and maybe the Co-operative Bank to form a strong, viable NZ-owned bank, perhaps under the Kiwibank banner, perhaps structured so that the Crown is the major holder (i.e. it does not sell any Kiwibank shares) but the new entity is listed on the NZX.

Perhaps Rob Morrison and Infratil could be a catalyst for a move to unite New Zealand’s fledgling banks.

Who would be offended by that?

_ _ _ _ _ _ _ _ _ _

THE BNZ’s long-anticipated Tier Two bond issue has now been formalised and will open in two weeks.

We expect the coupon to be set somewhere between 5.25% and 5.50%, and expect the issue to be well supported, given the continuing signs of falling bank deposit rates. 

Following the success of Infratil in raising more than $100 million with its eight-year bond, I expect BNZ to be well supported and to reach the $300 million targeted.  BNZ may take unlimited over-subscriptions, though I suspect ‘’unlimited’’ really means ‘’unspecified’’.

Although this is an offer of 10 years (two terms of five years) BNZ’s historical behaviour in repaying on the first call date (five years) has been exemplary and further reinforced by its timely repayment of ‘’old’’ Tier One securities BISHA and BNSPA.

Now that banks have greater capital requirements, the world is moving away from implicit Crown guarantees.

These hybrid issues have become more frequent but ultimately may be replaced by simple equity issues such as ANZ recently held, though ANZ has also had a wholesale hybrid issue in Australia at a credit margin that was generous.

Many regard hybrid bank securities as having rates that are more attractive than bank deposits, but underlying security that is more like that of a share, without the upside but with less volatility than a share price.

The BNZ issue will tell us a fair bit about how the New Zealand public view Tier Two issues, which rank ahead of Tier One and ahead of ordinary capital, but behind bank deposits.

While so many investors are being squeezed by falling interest rates, Tier Two issues may become the fall-back position for yield-seeking investors.

A year or more ago, I noted here that subordinated bank offers looked to me to be a much better source of extra yield than mortgage trusts or finance companies.

We can hardly complain in one sentence that our banks are too profitable and in the next sentence claim that our banks are at great risk of failure.

Banks fail when they make massive losses, not when they are reporting billion dollar profits.

_ _ _ _ _ _ _ _ _ _

WHILE driving home from a meeting with a legal team, I heard a journalist on National Radio dishing out financial advice to prospective users of Kiwisaver.

Specifically, she advised parents of very young children to encourage them to do their saving through Kiwisaver even if the amounts involved were less than $10.

No one will ever hear this advice from me.  I regard it as banal advice.

There is no $1000 kick-start, so without a $521 tax break and an employer subsidy, earnings are generally pitifully small, fees very likely in most years to gobble up most, or all, of the earnings.  And Kiwisaver is locked up for many years.  Thanks, Mum and Dad.  Great.

I cannot imagine a bleaker way to educate children than to see their savings stand still, barely move ahead, or occasionally go backwards.

Journalists are exempted from the Financial Advisers Act and therefore can prattle on with inane advice if they wish, though I strongly disagree with this exemption.  They are neither accountable nor even responsible for advice given, nor do they have experience in handling other people’s money.

Indeed I often read or hear very poorly-based advice, and often see evidence of a complete absence of product or market knowledge, though I have to say that this particular journalist usually offers correct information on Kiwisaver.  Information is different from advice.

My advice continues to be that young children should have full access to any ‘’savings’’ and thus the savings should be in bank accounts where there are no fees, and where returns for risk are better (thanks to Kiwisaver fees).

_ _ _ _ _ _ _ _ _ _

I DISCOVERED just last week that the Financial Markets Authority has expanded its access to market expertise by appointing as an associate director, Rebecca Thomas, who heads Mint Asset Management, a successful niche fund manager.

Thomas has genuine knowledge and experience and plays a useful role by actively policing public company governance behaviour.

Indeed she may have had a hand in encouraging Contact Energy to sharpen up its board and might also have been one of those who ensured that Mighty River Power cleaned up its board before it was listed.

It is most encouraging to discover that the FMA is continuing to seek out people with market expertise and market experience.

The FMA’s inaugural CEO Sean Hughes used an unofficial group of what he called market influencers as a source of daily knowledge of market disturbances.

That Thomas is now perhaps just one such source of information for the FMA is a good sign that the regulator is open to outside knowledge.

No regulator would want to find that it was unaware of relevant trends or events on the daily markets.

_ _ _ _ _ _ _ _ _ _

THE impressive growth of the NZ founded company, Nuplex, will resonate nicely with its long-term shareholders, especially given the childish games that threatened its recovery six years ago.

Genuine Nuplex investors six years ago were unsettled by rumours that Nuplex was about to breach its banking covenants, at a time when banks were often in panic mode.

The country’s leading investment bankers were consulted and came up with a sledgehammer response, persuading Nuplex to enter a fully-underwritten deeply discounted rights issue at just 23c per share.

By accepting this advice, the company immediately restored its banking goodwill and soon after consolidated its shares with a one-for-four share restructure, meaning the rights issue was effectively at 92 cents.  Those who chose not to take up their rights were punished for not supporting their company.

Thereafter these shares have continued to pay handsome dividends, the banks are settled, profits and growth have been impressive, the share price is now around $4.10 and Nuplex has announced the discovery of a unique formula with its resins that might dramatically improve the performance of its paints, and perhaps improve market share, profits and dividends.

This must be a most satisfying outcome for its board and the investment bankers who reacted so decisively to ward off negative sentiment in 2009.

Contrast that outcome with the puerile response of a NZ investment banking competitor in 2009.

It persuaded a journalist to run a newspaper campaign criticising the Nuplex plan as unnecessary and unfair.

The journalist, arguably one of our best, will no doubt wince when he recalls how unwise he was to be conned by the commercial games of an investment bank, smarting because its plan to restore order for Nuplex was spurned in preference to the plan implemented.

Nuplex shareholders should be celebrating, unanimously, a strong company that survived the global financial crisis by raising capital in a particularly nervous market.

Any chagrin should be shared by the unprofessional investment bankers and maybe by the fragile bankers, though in defence of the bankers it is fair to note that no one knew for sure that Nuplex would recover so well, and so quickly, from the changed world that followed the global crisis.

_ _ _ _ _ _ _ _ _ _ _

VICTORIA University, like all such institutions, is moving further towards monetising its research, and in so doing is conducting research that is more likely to be relevant to the wider public.

Recently it surveyed employers to discover what they expect from university graduates, and what best equips graduates to find employment.

Were the employers wanting to see A grades, ability to solve algebraic equations, fluency in Swahili, or ability to debate social and political puzzles?

Does a law firm, or a bank, or a government department, or a public or private company, carefully peruse grades and sift out the As from the Bs?

As we heard in My Fair Lady, not bleeding likely!  The survey results were highly predictable.

Employers want evidence of work ethic, client-first attitudes, ability to work within existing culture and work forces, reliability, honesty and some evidence, probably at infancy level, to solve problems and to think.

They also want to see evidence of self-esteem, ability in English, maths and comprehension, and they might hope to see signs of a genuine interest in, and aptitude for, the type of work on offer.

It is probably useful that this subject has been raised by the research, as one would expect any university course to end with a ‘’finishing school’’ session, at which a handful of employers would spell out the best and worst ways to transition into adulthood and employment.

By way of disclosure I have to confess that the last five people employed by our business were asked lots about their knowledge, their experience, and the evidence of their work ethic, their commitment to others and their ability to work with others.

Not one was asked about their marks in exams, or participation in student community activities.

Schools and universities do not exist solely to transition children and teenagers into an adult work force, but if the educators did not prepare for transition, they could regard them as hopelessly failed educators.

Meanwhile I welcome the move of universities to produce research that might help the employment process and make one final plea:  The ability to write competent and comprehensible letters, and to get the arithmetic right 100% of the time, would be an expectation of many, perhaps most, employers, certainly those employers who want their business to survive indefinitely.

_ _ _ _ _ _ _ _ _ _

TRAVEL:

I will advise my Auckland date for December as soon as I have a date for my next meeting in December with the SCF legal investigation team.  I also hope to visit Hastings and Christchurch in December, dates set around the Hamilton meeting.

Any clients wanting to meet in December in Auckland, Christchurch or Hastings are welcome to email me now.

 

Kevin will be in Christchurch on 27 November.

David will be visiting Palmerston North, Whanganui and New Plymouth on 24th, 25th and 26th November.

GOOD NEWS

Edward has now resumed his NZ career, based in our Paraparaumu Office, after two years of experience in Canada, including the completion of his Canadian financial exams there.  He has returned with his new wife Kalyn.  Welcome back from Dad!

Anyone wishing to see any of our advisers is welcome to contact us to make an appointment.

Chris Lee

Managing Director

Chris Lee & Partners Ltd


Taking Stock 4 November 2015

THE departure from New Zealand of Goldman Sachs and now Deutsche Bank might have rattled the cages of fund managers and the NZX, but the importance of these exits is relatively low, in some respects.

There will be concern that these exits may lead to even lower liquidity for our bond market, and less variety of research available.

Liquidity is a huge issue potentially, as in tougher times New Zealand cannot sustain its bond market without international capital.  The Reserve Bank will worry about this.

Research is a lesser concern, but still a legitimate debate for fund managers, who trade on the information and expert analysis that they assemble.

But for retail investors, there are changes occurring that will be of much greater relevance than the decision by Goldman and Deutsche that New Zealand offers too few opportunities at this time.

Retail investors rarely rely on their own research.

They either rely on the research done by the sharebroking firms, and buy shares or bonds recommended by competent brokers, or they rely on the research performed by fund managers, accessed indirectly through competent financial advisers, and invest via fund managers.

Though many, indeed most, financial advisers sell managed funds based on the opinions and analysis of the likes of the underpowered (my opinion) Morningstar group, there are advisers who add value with their own knowledge of the different securities available and have the experience to work out which fund managers more often might add value, and know how to access securities directly.

I see little change ahead for investors who choose one of these paths to assist with investment.  Goldman Sachs and Deutsche Bank were rarely helpful to retail investors.

Where the big change is inevitable is where the investor has effectively handed over investment choices to a DIM adviser – someone who has been given by the investor the right to apply the adviser’s discretion to invest without reference to the investor, in anything he thinks would be suitable for the investor.

Literally tens of thousands of New Zealanders have trusted their money to individual advisers under this discretionary investment management service (DIM).

The broking firms Craigs and Forsyth Barr make the bulk of their revenue by charging somewhere between 1% and 2% to manage funds for individual clients and there are still hundreds of one-man band financial advisers who each manage the money of 30-100 people under this sort of arrangement.

Until twelve months ago, any authorised adviser could be registered to offer this service, though the vast majority of such advisers worked under an umbrella that offered some protection.

For example, Craigs has about 100 (or more) advisers but the company has an investment committee to guide the advisers and Craigs would have a strong compliance officer to ensure no adviser could put the company at great risk by offering indefensible advice.

Today DIM advisers must be individually licensed and are under increasing FMA scrutiny.  So they should be.  Many are stretched to meet fair standards.

Furthermore the directors of companies whose staff offer this service will be getting legal advice that the directors are personally liable for errors made by the advisers.

For example, David Kirk, the former rugby player, is currently a director of Forsyth Barr, which offers the DIM service.  Kirk is not an executive director and will need to be certain that all the investment decision-making processes are foolproof, if he is to be relaxed about his potential liability.

A wider issue is the question of how easy it would be to insure such a liability if any director was with a company with a track record of failed advice.  I suspect insurers will one day want to audit the processes very carefully, and will charge poor performers much more, or might even decline to insure those tied to poor performers.

While this threat looms, sharebroking firms, certainly in other jurisdictions like the USA, are also finding that brokerage has been so automated that the service, at face value, is now done for virtually no cost.  Indeed ‘’free‘’ brokerage is available, by some definitions, in the USA.

Why would any company accept falling, indeed no, revenue for a service that itself has significant compliance cost, and is increasingly facing the risks of litigation?

Compliance, liability and litigation are ugly sisters, especially if margins are vanishing.

Credit Suisse, a giant company, sees no logic in this service in the USA under these conditions.  It is to quit its huge sharebroking operation there.

Why does any business accept such a dangerous model?

Cynically, I would guess that many US broking firms have sneakily altered their model, using the miracles of information interception to enable the brokers to replace brokerage with insider trading.

Indeed they may be creaming off much more than brokerage.

Simply put, a client who buys 1000 Apple shares at $500 could pay no brokerage, but would be worse off than the client who at the same time bought 1000 Apple shares at $495 and paid one percent brokerage.

Given the trend in the USA to use the miracles of electronic intervention to intercept market information and exploit that knowledge, it is likely that brokers are replacing brokerage with what they will call arbitrage.

They buy the Apple shares at $495, half a second before they sell to the client at $500.

This sort of behaviour is ugly and lacks the transparency of brokerage.

I hope that the regulators in New Zealand will never condone this sort of behaviour.

Falling margins, zero brokerage, rising compliance costs, increasing regulator fines, increasing litigation . . . all of these trends cannot continue without big changes to the services available to retail investors.

To cope with these changes, market participants need to have substantial capital, long-term goals, gold standards of governance, highly competent staff, and an unalterable commitment to ‘’client first’’ behaviour.  And they need to make a profit.

How many broking firms in New Zealand today can make a profit from their broking operation?  Very few, I guess.

I would argue that the pendulum at the moment is swinging too violently towards an unsustainable arc.

By all means chase out the cheating market participants by fining them, prosecuting them, exposing their poor standards and demanding they compensate their clients.

By all means probe the behaviour of DIM advisers and be sceptical about the conflicts of interest should broking firms allow their investment banking deals to be rammed into the accounts managed by their DIM advisors.

BUT, retail investors are not advantaged by the higher fees or hidden fees, which are set to produce the necessary margin to ensure advice and services are maintained.

My guess is that unless change occurs, New Zealand will finish up with fewer choices, fewer services, and more cost, perhaps hidden.

The bucket shops which charge one or more per cent to ‘’manage’’ fixed interest and cash assets may just be the first signal that the pendulum is out of control, in terms of income.

I suspect Kiwibank might argue that in terms of cost the extremes of the Anti-Money Laundering requirements might also be a sign of a wildly-swinging pendulum.

We want investors to win.  Clients first.

Is that a universally-accepted objective?

_ _ _ _ _ _

ONE practice that no retail investor should accept is the bucket shop practice of charging clients one per cent per annum, or more, to manage bond or cash securities.

There is often no value-add in the management role, indeed there might be negative value-add if the bucket shop allows its advisors to cram into portfolios any bonds that the firm has underwritten.

In that instance there is a risk that the bucket shop could selfishly eliminate its underwriting risk by using DIM clients to effectively underwrite the bucket shop’s commitment.

Yet such a bucket shop would be paid an underwriting fee, brokerage AND one per cent per annum client fees.

Triple dipping is hardly a ‘’client first’’ signal.

The best brokers charge a minimal amount to manage fixed interest and cash portfolios, and never rely on DIM clients to offset underwriting commitments.

Of course the best financial advisers seek to mimic the best broking standards, and some do.

This subject is one that is sure to interest the Financial Markets Authority as the pendulum continues to swing violently.

_ _ _ _ _ _

AS we have often discussed, retail investors can find useful help and meaningful information from the best sharebroking/investment banking companies, where the leadership and governance is of a high standard.

Even in the poorer companies, with weak or greedy leadership, there will be pockets of competent people, often themselves scornful of their leader.  One Auckland branch actually turns their backs on their leader when he calls in, I am told by some dissenting staff.

Of course the best fund managers also produce good research and providing their funds are accurately sold and fully understood by their sales force (financial advisers) these people can be seen as investors’ friends.  Indeed the best fund managers are playing a proactive role in cleaning up poor governance, by leveraging their voting power.

Sadly a third source of theoretical help, the credit rating agencies, have failed to create much confidence in their proclamations.

I enjoyed regular dinners years ago with Infratil’s founder Lloyd Morrison, who died from leukaemia at a cruelly young age.  Lloyd was a thinker, and was bold in making his decisions.

Our discussions often focussed on the slavish and lazy reverence attributed to lazily-conceived credit ratings.

For many intermediaries and advisers, the credit rating was the sole rationale for recommendations, yet virtually no one bothered to assess the skills and track records of the credit rating agencies.

Furthermore the matrix used by agencies was often mathematical, rather than investigative, so ratings agencies were easily gamed as we all saw with the likes of Enron, Merrill Lynch, Lehman Brothers etc (and South Canterbury Finance).

Products built on sub-prime loans were AAA-rated, as were banks and insurance companies who built their revenues with very little attention to risk.

The 2008 financial crisis brought change.

It remains a miracle that the likes of Standard & Poor’s survives in business rather than being a victim of multi-billion law suits seeking compensation for cynical and astonishingly incompetent behaviour.  In some ways, S&P’s behaviour was similar to Volkswagen’s behaviour.

New Zealand investors will recall the rating (AA) ascribed to Credit Sails, which comprised so much risk that it could and did become worthless, based on the failure of a tiny percentage of its doctored portfolio.

The response of the ratings agencies to the 2008 exposure of their business model has been to downgrade just about everything to levels that do not differentiate good from bad in any meaningful way.

The agencies will argue that all they do is apply maths to individual company ratios, apply historical failure data, and then match historical failure with various ratios.

For example if a company’s mathematical risk profile was similar to profiles of companies that previously have failed, the model credit rating gets set on that basis.

Inadequate qualitative research is done, yet qualitative research often produces the most useful conclusions.

To me the logic is similar to that which might argue that if the winner of the last ten Melbourne Cups drew barriers between one and six, then any other horse would virtually have no show.

As a result of Lloyd Morrison’s disrespect for credit ratings, his company, Infratil, has never sought a credit rating.

If it chose to engage with an agency, the metrics might produce an investment grade rating for Infratil.

I guess some people care.

The institutions and fund managers whose trust deeds define their investment policies by credit ratings would not hold Infratil bonds.  Full stop.  Obviously they care about credit ratings.

I cannot help but compare the ratings that we are asked to regard seriously today.

A subordinated bond issued by a Crown-owned entity (Kiwibank) is today rated a greater risk than was assessed by Fitch when it rated Hanover Finance in 2008.  Really?

Those who avoid responsibility for their decisions by blindly following credit ratings will buy bonds from companies assessed at BBB but will not, one presumes, buy bonds from say Ryman, if it ever chooses to diversify its funding base.  (Ryman has no credit rating).

I guess our recommendations to advised clients must respect the artificiality of the influence of credit ratings, and the potential emphasis placed on ratings by courts and regulators.  But I do so with a heavy sigh.  Was Enron not rated AA?

I harbour doubts, having met analysts from credit rating agencies, and read the sort of unhelpful stuff that the likes of Morningstar produces (Morningstar is a ‘’bible’’ for managed fund salespeople who do no personal research).  For those who can be bothered, go back and see what Morningstar said about Z Energy when it listed.

In my lexicon Auckland Airport represents less credit failure risk than almost any other non-government organisation in New Zealand, much less risk than say Fonterra, yet the agencies think otherwise.

I think I know which of Auckland Airport or Fonterra the late Lloyd Morrison would rather own!

_ _ _ _ _ _

CREDIT ratings probably play a role in helping financial markets determine the credit margins applied to debt instruments.

The ultimate rates offered to investors comprise a base rate (say, the interbank swap rate) plus a credit margin.

Credit margins can vary on the basis of emotion.

For example, Rabobank’s instrument RBOHA was priced at the one-year swap rate plus 0.76% when it was offered in 2007 but when its instrument (RCSHA) was offered in 2009 the credit margin was 3.75%, not because Rabobank was more at risk but because the emotion of the market was different (and the term was longer).

Another anomaly is the difference between Australia and New Zealand fixed-interest markets.

Regularly the undeveloped Australian fixed interest market is offered margins much higher than would be offered in New Zealand, where retail investors have a greater appetite for fixed interest products.

Just recently AMP offered Australians what were effectively Tier One securities at a credit margin of 5.5%.  Add the swap rate and the return is attractive, more than 8.0%.

Sadly these Australian instruments are less attractive in New Zealand, as Tier One bonds issued in Australia pay dividends that include franking credits, which are of use to very few New Zealand investors.

If a bank in New Zealand offers Tier One bonds now I would expect the credit margin to be nearer four per cent, not anywhere near 5.5%.

And Tier Two bonds might pay a credit margin of 2.25% meaning a five-year rate might exceed five per cent after adding on the five-year swap rate.

Why are we cheaper in New Zealand?

I suspect the answer is that demand exceeds supply in New Zealand.

It thus falls on competent advisers to guide their clients.

The credit rating agencies will not be of much help in this process.

_ _ _ _ _ _

I SEE that Deloitte is soon to announce at a fun awards event its assessment of New Zealand’s top company and chief executives etc.

The judges will be the principal people from South Canterbury Finance in 2010, Samford Maier Junior and Neil Paviour-Smith.  The SCF CEO Lachie McLeod might not have been available to be a judge.

I wonder if Leopard Breweries on the same night will announce the best All Black fullback of all time.  The judges might be Colin Farrell and Kit Fawcett.

_ _ _ _ _ _

THE chairman Bryan Mogridge has resigned from George Kerr’s company, PGC.

His resignation is for personal reasons but is several years too late.

Mogridge holds a prominent position on our Never Again list, having presided over a company that would be a leading contender for New Zealand’s worst-governed company.

Note to all company directors:  if a company is struggling and is not meeting its obligations to investors and regulators, resign immediately, unless you can bring about immediate change.  Do not wait several years before resigning.  You will not be forgiven.

_ _ _ _ _ _

TRAVEL:

I will be in Christchurch on November 11 available for appointments.

Michael will be in Hamilton on 12 November.

Kevin will be in Christchurch on 27 November.

David will be visiting Palmerston North, Whanganui and New Plymouth on 24th, 25th and 26th November.

Chris Lee

Managing Director

Chris Lee & Partners Ltd


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