Taking Stock 28 November, 2019

Johnny Lee writes:

If 2019 was a year of winners and losers, among the losers have undoubtedly been the companies facing increased overseas competition and artificial restrictions on market restructuring.

NZME has announced that it intends to re-engage with the Commerce Commission in an attempt to consolidate the media landscape.

Readers will be well aware of the challenges facing media outlets both within New Zealand and abroad. Today's jobseeker is far more likely to search online, using the likes of Seek or TradeMe, than to turn to the Jobs Wanted section of a newspaper. The days of heading home to watch the 6 O'clock News is making way to a generation which consumes their media live, watching news unfold from their smartphones.

Advertisers are increasingly turning to the likes of Google and Facebook to promote their businesses and products. NZME's half year report to market in August showed a decrease in profit, revenue and print volumes, as it turned its online asset, the New Zealand Herald website, to a subscription model for its ''premium'' content.

Arguably, the sector is too fractured, cutting margins to unsustainable levels. When this happens in a free market, consolidation is healthy and expected. However, formal consolidation, in New Zealand, requires the consent of the Commerce Commission.

The Commerce Commission's role, in this respect, is to ensure that ''the level of competition in a market is not substantially lessened by mergers or agreements between businesses''. The difficulty it faces when making these determinations is whether refusing such a merger would lead to worse outcomes.

Such outcomes could include further closures of community newspapers, increased use of paywalls across the industry, or a simple withdrawal from offering certain products and services. Paywalls, effectively paid membership for news, disproportionately impacts lower-income earners.

NZME's renewed efforts to convince the Government to back the merger is unlikely to gain traction unless it is able to present a materially different argument than the one made (and rejected) in 2017. In the comments made following its rejection, the Commerce Commission expressed skepticism that the scenarios put forward by the parties were plausible.

NZME's reported intention to implement a Kiwishare-type arrangement to protect certain functions from being disestablished by the merger should alleviate some concerns, but it remains to be seen whether the Commerce Commission will be swayed.

Proponents of increased Government influence in the funding and control of media will no doubt be monitoring the developments in the United Kingdom, with the state broadcaster being accused of doctoring footage in favour of certain political parties.

The Commerce Commission is likely to become an increasingly relevant factor for investors, as both the economic environment and ultra-low interest rates continue to change the nature of business and competition.

Established businesses are increasingly willing to forego profitability when competing in new markets, using the minimal cost of funding to justify expansion. This puts pressure on existing established players, who face a competitor willing to squeeze competition out of markets.

For consumers, this is a great short-term outcome, giving them access to goods and services at a price that would otherwise not be possible.

For investors, they face the challenge of choosing the likely dominant player within a market. In New Zealand, we have seen some seasoned players, such as Sky TV and Fletcher Building, simply walk away from certain business activities, allowing the competition to gain market share at a price point they view as uneconomic.

We continue to favour investment in credible, profitable, established companies, especially those operating in areas where the barriers to entry, in order to compete, are high.

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Chris Lee writes:

IF the rumour mills are right, New Zealand's National Party might in the next decade have its first high-performing business chief executive as a candidate for Prime Minister and Labour might have as a candidate for its top position one of New Zealand's best salesmen.

When Air New Zealand this week won its umpteenth award as the world's best airline, beaming from the sideline would have been Christopher Luxon, the airline's competent and acclaimed chief executive until recent weeks, when he retired and signalled a career in politics.

Air New Zealand has won accolades for its records in safety, innovation and performance, reinforcing Luxon's moniker as the best (and only) public company chief executive ever to have moved at a young age into politics.

When the media rather absurdly compared him to previous prime minister John Key, they were comparing an airline captain with the equivalent of the chief cabin steward.

Luxon’s executive skills across a wide spectrum of disciplines have made him the most lauded business leader ever to expose himself to politics in New Zealand, by my calculation.

Concurrently, the whispering campaign, perhaps amplified by a coterie of media cheer leaders, implied that one of the wiliest salesmen in our financial sectors, Sam Stubbs, was also eyeing up a political future, perhaps on the benches, opposite to those Luxon aspires to occupy.

Stubbs has displayed great media skills and a talent for gaining public attention well beyond his corporate status, a strategy often seen as a precursor to political adventure.

Stubbs, of course, is the founder of the robot-driven Kiwisaver fund Simplicity, after a career that touched Tower, Hanover Finance and GoldmanSachs, a trio of corporates that would have taught him the importance of using the media and honing his presentation skills.

He has so far made no mention in public of political ambition, preferring to pursue a newspaper role as a commentator on issues of the day, like climate change and board diversity.  He has become one of the ''people's champions''.

If he were to have his sights on a career in politics he would not compare in business achievements with Luxon, though the media might not differentiate between a champion CEO and a very eloquent salesman.

In recent years, Australia has attracted into politics several businessmen, including its current Prime Minister, so there is growing precedence for career switches between public and private sectors.

One wonders whether a stint in Cabinet, or as Prime Minister, is now seen as a turbo-charged leap forward on a curriculum vitae, or is the trend driven by a search for communal applause after all the pockets have been over-stuffed?

Indeed, many countries have elected the equivalent of Luxon to political leadership, Hungary being one example, where business success has led to political popularity.

If New Zealand is to develop a business-like strategy, perhaps for the first time ever, Luxon or Stubbs might be the sort of men able to draw together the teams of skilled people willing to tackle the big issues.

Their motive would not be the money paid to politicians.

Are we to see a new trend, with grossly over-enriched business leaders seeking to apply their skills to solve the globe's major problems, aspiring to address what escaped the priority lists of teachers, lawyers, farmers, accountants and FX traders?

To repeat my often-published view, a champion chief executive will be clever, transparent, energetic AND will have the personal skills to attract outstanding people with specialist skills. A champion CEO can be assumed when one observes the people around him skipping rather than trudging to work.

Luxon's work has won global respect, an accolade I cannot recall being according to any previous NZ leader before beginning the route to country leadership. One hopes his corporate skills will be blended with social awareness.

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THE team of eleven capital market participants who were asked to identify areas for improvement in our financial markets were themselves an eclectic bunch.

Nine were men, two were women. Several were genuinely competent market leaders with unblemished reputations.

The group's report, visible on the website NZX.com, made a number of suggestions to the Minister of Commerce Kris Faafoi, a journalist now in a position of power that would tax even those whose careers had been in commerce.

Some of the suggestions were clearly pragmatic, including the request for a restoration of Kiwisaver incentives, and the fairly obvious demand that would lead to share investors all paying the same tax rate on dividends.

It is indeed idiotic that some equity investors pay 28 cents on dividends, while others pay 33 cents, and it is just as nonsensical that the tax laws should favour the clients of fund managers over those investors who buy shares directly, as the task force reports have emphasised.

Years ago, the insurance industry conned politicians into providing tax breaks for certain investors, such as those whose superannuation funds were routed through breathtakingly inefficient superannuation fund managers, and such as those who provided for their medical needs by buying health insurance, rather than self-insuring.

The ineptitude of the insurance mutuals in the decades leading up to the demutualisation was epic.

Companies like AMP, National Mutual, NZI, Tower and the various British-owned insurers (Royal, Prudential etc) were disgraceful squanderers of policy-holder money.

Just in the 1980s National Mutual burned more than $100 million through empty-headed strategies, like pursuing an improbable banking presence.

Yet they convinced politicians to provide them with tax advantages that shrouded their goofiness.

Getting rid of the tax imbalances would be wonderful, and is a sensible suggestion by the Capital Market task force team, as is their strong recommendation that a central platform, like RealMe, be used to streamline the anti-money-laundering processes.

Yet there were curiosities in some of its work.

We are told, perhaps disingenuously, that research proves that an organisation with an equal mix of gender and diverse race in its executive team demonstrably out-performs organisations without that formulaic approach.

The only research I have seen is far from conclusive though intuitively it seems reasonable to assume a diverse mix of knowledgeable, experienced people would find better solutions than a group with just one-dimensional vision.

If gender diversity was a consideration, the latest capital market team might have tripped itself up.

The task force team named 130 people with whom it consulted before producing its conclusions.

Those consulted were an eclectic bunch but they were certainly not gender diverse. Of the 130 people consulted, 110 were men, and very few had surnames that implied diversity of race.

If there really is research that proves the value of an equal number of each gender in a governance or executive role, then the capital market team's research seemed to pay little heed to that concept.

Interestingly the NZ Productivity Commission, chaired by an outstanding long-term public service economist in Murray Sherwin, has a diverse range of excellent minds to assist with its analysis, including scientists, engineers, economists and academics.

Yet no one has been selected by a quota system. It just sought out excellence and experience. Thank heavens for that.

Ultimately, excellence in governance and in management must be the ambition.

One wonders whether the Capital Markets team and the Productivity Commission are signalling that quotas, in pursuit of diversity, are of lesser importance than the pursuit of excellence, with no barriers to selection based on gender, race or age.

I guess we will all agree that the removal of such barriers has been a triumph for common sense.

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WESTPAC’S exorbitantly-rewarded chief executive in Australia has resigned, following revelations that the bank had been a tad casual about its anti-money-laundering obligations.

Like its bigger competitor, the Commonwealth Bank of Australia, Westpac had been a little loose and failed to prevent illegal transactions sneaking through the system.

Readers might recall that the Australian investigation into banks found that the CBA had been allowing launderers to move around ATMs, depositing into each ATM bags full of cash, always $1.00 less than the amount that triggered an obligation to report the transaction to the authorities. A banking of $20,000 in cash was acceptable. A person with $200,000 to launder would visit 10 ATMs without activating the trip wire.

CBA's tolerance of such nonsense led to $799 million in fines, paid not by the directors or the executives but by the innocent shareholders.

Well Westpac has also made the odd blue. The CEO will no longer be receiving his nonsensical salary and the chairman will step down.

The number of illegal transactions was just too large to be written off as being irrelevant.

The number of illegal transactions exceeded 23 million, being thousands of illegal transactions each business day.

Perhaps someone should have noticed at least one of these and done something about it, do you think?

Yet I have sympathy for the bankers, a sentiment that would be more fierce if ever the sector were to lose its arrogant attitude towards executive salaries and bonuses.

My sympathy is a reaction against the hysteria driven by the faux anger of the media, inevitably replicated by the politicians, all stemming from unrealistic expectations of bankers and resentment of their extreme rewards.

Currently the world's most loathed category of people, understandably, are paedophiles.  So any banking blunder that involves an error that was exploited by such public enemies is naturally magnified and taints the bankers, as though they approved of such anti-social people. Some of the illegal transactions facilitated payments to or from paedophiles.

Had Westpac's 23 million unvalidated transactions affected only rugby league club salary caps, I suspect the Westpac CEO would today be recalibrating the bank's systems rather than looking for a new career.

Bankers should be on red alert. The media, itself under pressure to survive, will fuel the public with highly combustible material in its bid to survive.

Westpac's CEO should have been accused of system failure, perhaps stemming from a resentment of the extreme cost imposed on banks by those authorities trying to strangle the drug lords and various other money cheats.

The presentation of the failure as the enabling of paedophiles is sick, a headline-chasing piece of cynicism which, in the public's eyes, converted the Westpac negligence into a crime requiring capital punishment.

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SYNLAIT'S announcement that it is considering a retail bond offer is likely to be one of the final investment opportunities for this calendar year. Such an offer is likely to be for a term of five years, and be subordinated behind existing debt. The proceeds will be used to repay some of that debt.

Synlait is one of New Zealand's largest companies, with growing revenues and growing profits, and represents a sector that is undergoing rapid expansion. Synlait does not pay dividends, instead reinvesting its profits into the company to fuel further growth.

The sheer weight of money returning to shareholders both this month and next is likely to play a major role in determining the final price (coupon) of the bonds, an unfortunate dynamic that seems likely to persist.

We have a list for investors wanting to learn more once the offer is made, and readers are welcome to contact us if they wish to join the list.

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Edward will be in Wellington on 12 December. Please contact us if you would like to meet him.

Chris Lee

Managing Director

Chris Lee & Partners Ltd

Taking Stock 21 November, 2019

Chris Lee writes:

IF you were to ask just about any international fund manager what he considered to be New Zealand’s main competitive advantages, at or near the top of his list would be its abundance of water.

As one German fund manager puts it: ‘’You have so much water you tip most of it into the sea.’’

Yet our use of water is highly controversial, with many offering vigorous opposition to any proposal to re-route water, before it drains to the sea.

When the late Allan Hubbard preached irrigation of the Canterbury Plains, he was vilified by many. When his ideas prevailed, New Zealand’s wealth rose, as the redirected water restored the value of the land.

Hubbard’s project to build a lake in the Southern Alps, at Opihi, and then provide constant water supply to 12,000 hectares and an old river has brought undeniable wealth to South Canterbury.

The lake is now a safe playground for pleasure boating, the river has been restored, its water flow allowing trout fishermen to pursue their pleasure, but most of all 12,000 hectares are no longer useless parched land in summer, and useless mud land in winter.

Those 12,000 hectares produce enough peas and beans, and enough pasture-based milk, that the Port of Timaru has a flourishing new cannery alongside and a modernised Fonterra dairy factory up the road.

With the revenue from these activities the port has flourished. Literally hundreds of jobs were created by storing and controlling water flows.

The quality of the river water has been restored.

And the losers were?

So it was a valuable experience to spend a day last week in the pristine valleys west of Oamaru observing the success of the North Otago Irrigation Company (NOIC), whose project, partly driven by a skilled, insightful district council, has lit up the area.

More than a decade ago, the project was planned. It needed the owners of the dry farms in those valleys south of the Waitaki River to make a long-term commitment to bear the cost of bringing water to their rich soil, enabling the farmers to improve greatly their productivity.

The project could not have succeeded without the Waitaki District Council’s leadership and seed finance. Fortunately, this is a no-debt council, with an understanding of the relationship between the rural and the town economies.

In summary, the population in the area has beaten its forecasted growth numbers by nearly 20 per cent in the period after irrigation.

To convince the farmers to capitalise NOIC with more than $50 million of cash and to commit to meet the fixed costs each year of NOIC (perhaps $50,000 per farmer on average) was a major task.

To convince them to put up their farms as security for their commitment would have needed financial analysis that was virtually undeniable. No farmer parts with cash, pledges his land, and guarantees to write a cheque each year for $50,000 unless he can see long-term, real financial benefits.

More than 50 farmers, with some 23,000 hectares in a catchment area of 68,000 hectares, voted with their wallets and their land. Their rewards are now apparent.

NOIC obtained a long-term consent to take 8 cubic metres of water per second (8000 litres per second) from the lower end of Waitaki, a river actually designated as Cantabrian, the river being the border between South Canterbury and North Otago.

A canal delivers the allocated water to NOIC’s primary pump station which pumps the water several hundred metres uphill to sub-stations which deliver pressurised water, on demand, to farmer shareholders, NOIC being in effect a co-operative.

The farmers report that land that used to produce about seven tonnes of pasture per hectare now produce 12 to 15 tonnes, in an area previously cursed by its low annual rainfall of about 22 inches (500ml), and further cursed by the hot, dry north-westerlies.

The Waitaki is among New Zealand’s most consistently full rivers, catching the snow melt and the rain that falls in the Southern Alps. It has power generating stations run by Genesis and Meridian and its normal flow below the lower of the hydro stations is around 250 cubic metres per second, of which nearly 3.5% is diverted to the NOIC canal. The flow is never allowed to drop below 150 cubic metres per second.

To distribute its pumped water, NOIC had to build more than 200km of pipelines into the hills and valleys of its shareholders.

That was achieved years ago. The infrastructure now must be maintained but should last well into the next century.

The water allows year-round use of the land; stock is not sold off during droughts; milk production is now reliably forecast, enabling farmers to make sensible use of the futures market; far more people work on farms, live in the area, produce children for rural schools, and far more food is produced. And the Waitaki District Council collects more rates.

All of this brings a grin to a capital markets participant yet the most impressive outcome has not been the measurable financial gain of shifting water to a dry area.

It is the environmental focus that has made the NOIC scheme a model that is celebrated by the iwi, the Greens, the councils and the farmers.

Every participant who bought into the co-operative was required to sign up to a three-year environmental audit, well before these audits were introduced by law-makers this year.

Wetlands, planting and QE covenanting are features of the farms. In my 20-mile drive through the member farms, not a sprig of gorse was visible to me.

Small farm lakes were evident, surrounded by planting, in the effort to eliminate run-off into waterways and sediment pollution.  Some lakes had a jetty and dinghy for recreational activities.

The farmers to whom I spoke seemed to believe that the costs of planting, low tens of thousands without accounting for time and energy, had been offset by the enhanced value of the farm.

Fresh water koura were evidence that the wetland water was pure.

The area has produced a model for the concept of irrigation.

The farmers pay the fixed costs of the irrigation scheme each year and then pay for the water they need during dry periods.

The local power network appreciate their large customer because it uses power to pump water in the months when power consumption is lower, principally in the summer.

The environmentalists and iwi see the nurturing of the land and waterways, the council is collecting more in rates, the number of tourists, fascinated by the high quality of the farms, is increasing, and one imagines the farm equipment providers are busier.

Those who have made this happen have set a standard for New Zealand.

They have made an idea happen, taking the risk to achieve returns that amply reward all parties.

In modern parlance, they have walked the walk, rather than sat in rooms finding reasons not to tackle what initially must have been a ‘’tough sell’’.

The iwi, the environmentalists, the council and the farmers are showcasing North Otago.

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David Colman writes:


LAST week Minister of Commerce and Consumer Affairs Kris Faafoi appointed Jane Wrightson as New Zealand’s next Retirement Commissioner, replacing Pete Cordtz who has held the position in the interim following the previous commissioner Diane Maxwell.

Wrightson, as Retirement Commissioner, will lead the CFFC (Commission for Financial Capability), tasked with helping New Zealanders better manage debt, accumulate savings, own homes and handle financial emergencies.

The CFFC encourages better financial behaviour, reviews retirement income policy, and plays a part in monitoring the retirement sector.

Retirement income policy is currently under review, performed every three years. The review is concerned with the affordability of NZ Superannuation which costs more than $14billion per annum (about 4% of GDP) and will continue to rise under current settings.

A proposal that has popped up is that funds built up using Kiwisaver could then be used for a new service titled Kiwispend, the name (using a now rather platitudinous, ornithological prefix) for an annuity.

The proposed annuity is designed to pay someone who has saved and built up investments through Kiwisaver to then have a proportion of the funds paid in regular amounts from the investments at a fixed rate in retirement.

Fees associated with Kiwisaver charged by fund managers that affect overall returns are likely to still be present with Kiwispend, which would likely involve management fees and the additional cost of an insurance premium, which is significant.

Lifetime Income is an existing annuity scheme that may be touted as a model, or a future provider, of Kiwispend services. It offers income for life either at a fixed rate (or inflation adjusted) at a rate determined by the age you are when you provide the scheme with your funds.

For example, individual rates for 60, 65 and 70 year olds are fixed rates of 4.5%, 5.0% and 5.5% respectively (the inflation adjusted rate starting much lower) as at the time of this newsletter.

Note: These payout rates are scheduled to be changed on 2 December and I would be very surprised if the rate is not cut substantially to reflect the ongoing decline of investment returns.

Using an annuity is akin to paying a fund manager and insurer to provide you with an allowance from your own investments and is a reasonably sophisticated scheme.

Careful consideration of Kiwisaver has been required since inception and if Kiwispend moves from concept to a final product I would expect and encourage equal measures of, or more, scrutiny of such a scheme and its providers. Fees and insurance premiums will be a large ongoing cost. Capital structures would need to pass that scrutiny. Credit ratings of at least A should be a requirement of any such scheme.

Our advised clients are welcome to view an article on our client private page to learn more about the Lifetime Income annuity scheme.

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Johnny Lee writes:

WHEN a company produces a profit, it faces a decision on how to best utilise the excess funds.

A company may choose to focus on growth, reinvesting the money back into the company or acquiring another business. It could also look at returning money to shareholders, by way of dividends. Most companies in New Zealand pay dividends, usually imputing them based on taxes paid by the company, to return funds to shareholders.

The other way to return value to shareholders is to buy back existing shares.

Share buybacks occur when a company decides to buy shares either on market or off market, giving each individual shareholder the opportunity to accept or decline the offer. Occasionally, a buyback will be compulsory. The shares are then usually cancelled, reducing the number of shares on issue, effectively driving the share price up as demand and supply shifts to accommodate the new buyer and the reduced number of shares on issue.

Share buybacks are sometimes used in place of a dividend, either for tax reasons or if the company believes the share price significantly undervalues the company itself.

In New Zealand, buybacks are reasonably common, with the likes of Fletcher Building, Auckland Airport and Infratil all purchasing their own shares in recent times.

Buybacks have recently become topical abroad, with some US-based political figures calling for an outright ban on the use of buybacks, criticising them as lazy and inefficient governance, and tainted by management possessing stock options or having performance bonuses based on share price performance.

In the United States, share buybacks were illegal until the early 1980s, as they were considered a form of stock price manipulation. A new rule was introduced at this time, detailing guidelines where a buyback would not be considered manipulative. Since then, literally trillions of dollars have been used to buy back shares, boosting share prices and enriching executives who stand to gain from the increase in share price.

New Zealand, fortunately, is small enough that such cynical greed would be exposed.

Tying executive remuneration to performance is a logical and useful tool, forcing senior management to focus on shareholder wealth in order to improve their own. However, the excessive use of stock buybacks and the increasingly short tenures of executive contracts highlights the need for vigilance among voting shareholders, and effective conflict management policies.

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Metlifecare shareholders should maintain a keen eye on their investment in the coming weeks, after the company announced it had received an expression of interest in acquiring the company, albeit at levels the board consider unsatisfactory. Metlifecare have often noted the significant discount of its share price relative to its Net Assets, recently recorded at $6.96.

Metlifecare’s share price lifted sharply, along with the other major listed retirement stocks.

There are no details around the specific price the buyer is considering, nor any certainty that such an expression of interest will proceed to a formal offer to take over the company.

Consolidations in this sector are already occurring. Earlier this year, Australian retirement operator Aveo Group was subject to a takeover offer from Canadian-based Brookfield Asset Management, best known in New Zealand as the part-owner of Vodafone.

We will endeavour to keep readers updated as the situation develops.

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Edward will be in Napier on 2 December and Blenheim 4 December.

Chris will be in Christchurch on December 10 (pm) and December 11 (am), his final visit until February 2020.

Chris Lee

Managing Director

Chris Lee & Partners Ltd

Taking Stock 14 November, 2019

ONE does not often hear good news from moneylending organisations these days. In general, those organisations are under political, regulatory and social pressure because of their indiscretions and, oddly, because of their profitability.

Their indiscretions are the result of unintelligent governance and leadership over many years; decades.

The BNZ displayed this insensitivity recently with Angela Mentis, its leader, stupidly extolling half truths, bragging about how the bank had increased annual leave, but failing to acknowledge that the bank had also decreased its previous equivalent amount of “family leave”.

Do bank executives feel cocooned from scrutiny?

We know how poorly their governors understand scrutiny.

The ANZ chairman John Key could barely have displayed more folly when he sought to use his diminishing media capital to gloss over the bank’s errors with supervising the expense claims of its chief executive David Hisco.

It seems to me that the ANZ was highly cynical in selecting Key as its NZ branch chairman, presumably imagining that his media capital would lead to better public relationships.

I accept that the NZ branch role has little need for vision, strategy or tactics, but it seemed to be highly cynical to pay such little heed to what the public expects from a chairman.

Whatever Key is, he is not a visionary or a strategist, though in the narrow fields of foreign exchange and politics he may be a wily tactician, a grouping not lacking in numbers.

His social maturity would be something each of us might assess differently, some impressed with his personal interactions with the likes of Obama, Cameron, and other short-term political leaders, others more focused on evidence of larrikinism, displayed in restaurants, on talkback radio dross and in Parliament.

My personal focus is on values-based, intelligent decision making.

Banks need a break from the environment in which they have basked in the past three decades. A period of respectful behaviour, even austerity, with a focus on their retail customers, the regulators and their investors would be an agenda I would applaud.

The good news I spotted last week was the confession of one modern-age quasi ‘’bank’’, Harmoney, that the basic premise of its banking model was flawed and would be changed.

Harmoney set out to be a ‘’peer-to-peer’’ lender, arranging faceless loans with online borrowers and on-selling bits of each loan to online retail investors, who would choose which low-rate or high-rate loan they wanted to fund. In theory, the computer assessed which loans were to high-risk borrowers, charged a higher rate, and filtered out low-risk borrowers, charging them lower rates. Investors chose which loans suited them.

In old banking terminology, this was ‘’matrix’’ loan approving, creating questions posed by a computer to the aspiring borrower, checking his credit ratings, and then assessing his answers.

As a theory of how to make good loans, it is about as cretinous as would be an All Blacks selector who chose as his wings the people who could run fastest, no other criteria required.

Real and value-add lenders often decline a loan because the proposed borrower is trying to fund something he should not borrow to buy. A successful car salesman may well be able to show that his past earnings could repay a loan for a $20,000 jet ski.

An experienced lender would want to assess the state of the car sales market now, not listen to what it was like last year, and might even want to ask whether the jet ski would be used so rarely that hiring a jet ski became a better option.

A good lender would be nosy enough to seek out reliable people who can testify to the character of the proposed borrower. This was my job 42 years ago. Nothing should have changed.

An investor in loans ought to be interviewed to ensure he understands any risks that are not obvious. How, for example, will one check that the insurance on the jet ski is renewed each year or that the jet skier is going to meet the behavioural conditions of the insurance policy?

Matrix lending is a cheap, robotic shortcut, which reduces the intermediation cost at the significant cost of being a glib assessment of risk.

Harmoney now sees that. It accepts that its model has not worked out well.

It will no longer ask retail investors to choose the loan they fund by accepting the logic of an easily-gamed matrix.

Harmoney instead will raise wholesale money to lend by approaching the banks and institutions, effectively securitising its lending portfolio and underwriting the loans, promising to repay the banks, which should apply their knowledge.

Harmoney’s cost of funds will therefore be priced expertly, its ‘’no hands’’ approach will change and because it should be able to raise money at a better price, it should lend at lower rates, attracting a better class of borrower.

It must have noticed that its matrix is regularly ‘’gamed’’ and is an inadequate predicter of risk and loan worthiness.

In effect, it will begin to behave like a banker rather than like a broker. I commend its decision.

It should be noted that banks can sometimes succeed with loan applicants interrogated online by a matrix, because the banks genuinely can afford the bad debts and will have solid data on the likely level of future bad outcomes.

Retail investors in a loan might say they can afford losses but most experienced advisers will know that a realised loss hurts investors much more than the concept of a possible loss.

Banks usually charge ridiculous rates for credit card loans – still around 18% per annum – because they have the data to show that bad debts on average will eat up 8% of the 18%, leaving a healthy nett margin for the bank. The honest borrowers underwrite the defaulters.

I loathe this logic, not understanding why a meticulous, ethical borrower should subsidise a feckless, irresponsible borrower.

One day credit card, unsecured lending will have variable rates, charging the meticulous borrower 6% and simply not allowing the irresponsible borrower to obtain credit.

Harmoney now seems to understand this.

That is good news.

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THE BNZ is to abolish staff bonuses, restricting these ‘’entitlements’’ to senior executives.

The staff will not be asked to cross-sell.

With a bit of luck, the BNZ will revert to having appropriately small branches for those customers who prefer face-to-face banking, the staff devoted to being skilled administrators, working in a culture of ‘’customer first’’. The instruction to mix administration with less-than-subtle selling will have been withdrawn.

In small areas like Geraldine, Otaki, Featherston, Waipawa, Waverley or Opunake, there might yet be an unbranded banking centre, allowing congregations of all faiths to enjoy a local facility at minimal cost to each banking brand. Who knows? We might even have a mobile caravan bank visiting the even smaller settlements for an hour or two each day.

If these developments occur, they will come as no surprise to any long-term readers of our newsletters. We urged the banks to think like this (putting customers first) 27 years ago.

My guess is that banking will not be the only activity that will need to think creatively about servicing very small towns.

Our wonderful doctors, who have served NZ so well, are now reaching an average age that invites retirement planning. There are very few young doctors willing to take on a general practitioner’s role, even in towns of a few thousand people.

So the prospects for tiny towns and villages seems bleak. Will we have many caravans visiting towns, some offering banking, some offering medical advice, dental services or even legal services?

Or will we do all of this online?

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IF our under-skilled, poor-performing, under-resourced Ministry of Business, Innovation and Employment ever wants to write its laws on the basis of real data, one law it would re-write is the awful, self-serving Insolvency Practitioners Act that Parliament passed a few weeks ago.

Most of us never come across insolvency practitioners, receivers, liquidators or statutory managers.

As business owners, we moderate our behaviour and suppress our ambition by taking on business levels that we can afford, should the world dump on us.

But more than one business in every five ends up in trouble, unable to pay its bills. Often those businesses were under-capitalised (nothing to offset a bad day), over trading (using creditors’ money as cash flow, as Mainzeal did), failing to find enough customers or, most unfairly, being destroyed by the failures of those to whom they provided credit.

Again, an example of the latter of those problems was in the construction industry, where Mainzeal’s illegal and rapacious behaviour destroyed sub-contractors whose money was being eaten by Mainzeal, surreptitiously.

The sub-contractors were unwise ever to work with Mainzeal, that public company demonstrably over-trading, under-capitalised, error-ridden and leaderless.

But it is unrealistic to assume sub-contractors had the knowledge to sidestep such a large, NZX-regulated company.

Instead, the sub-contractors each week paid wages to their staff and probably borrowed to buy the materials to meet their commitments to Mainzeal. They were left unpaid when Mainzeal collapsed. The demise of such companies was mostly Mainzeal’s fault.

My point is that the sub-contractors, not being the cause of their demise, should not be further victimised by what happens when the sub-contractor goes into receivership or liquidation.

Since my book was published (The Billion Dollar Bonfire), I have been regularly contacted by those who could demonstrate that they had been cheated by the laziness or ineptitude of insolvency practitioners.

The most alarming were claims of simple dishonesty, one legal clerk citing a case of stock being purloined in the receivership process.

Many believed that being ‘’ripped off’’ by the lazy practices was seen as ‘’part of the punishment’’ of business failure.

Others believe that the receivers, buyers and bankers are indifferent to any party other than the secured lenders.

When a company fails, the most likely outcome is that the shareholders appoint a receiver or a liquidator, or that a bank imposes a receiver that it chooses to recover the money owed to the bank.

If the shareholder owes nothing to the bank, he himself might appoint a receiver, instructing him to repay all creditors and then return any surplus to the shareholders. Sadly this is rare.

Sometimes a company owner might have lent money to the company after first preparing an agreement that gives the shareholder priority over any recovered money. He would then have control of the receivership behaviour.

But the normal situation is that a bank appoints one of the small number of registered insolvency practitioners. Usually the bank will specify it wants its money back as soon as possible, and prefers to write off amounts rather than wait for better prices from the asset sales.

Once granted these lucrative assignments, the liquidator/ receiver will validate the asset and liability ledgers, collect up all the claims of unsecured creditors, and then either sell the business as a going concern, or more likely, sell off individual assets, applying the funds exclusively to the secured lender (the bank) until the bank has collected its loans and its penalty or unpaid interest. If there is any surplus, the unsecured creditors will get a dividend. Rarely does the shareholder receive anything.

But the receiver will pay himself each month. In theory, the bank authorises this payment. In practice, receivers tend to pad their bills without being questioned (eg photocopying costs 20c a page, car usage $2 a kilometre etc, time sheets unaudited, hourly rates absurd).

Third-party payments to valuers, lawyers and other advisers are rarely contested and are often indefensible, as we saw with South Canterbury Finance.

The asset sales are not supervised in any real sense. The receiver might advertise the sale of a truck, perhaps in a local paper. Those who tender to buy the truck might be opportunists, Steptoe & Son, or business competitors.

They will sniff a chance for the bargain of their lives. Rarely are these processes optimal.

There is no independent supervision of these asset sales. A lazy, soft or inept process might lead to assets selling for a fraction of their real value. For example, in a sale of office equipment, who compares the sale price of office chairs with the cost of an equivalent chair? Second-hand gear is often dumped onto Steptoe for a return of coins.

In bigger company failures, who contests the value of a brand, or a franchise, or a controlling interest in an external company?

Why is there no input from shareholders and the usually hapless unsecured creditors?

The answer to these questions will not be found in the submissions made before the latest Insolvency Practitioners Act was documented, debated in Parliament and then approved.

There were NO submissions, other than from lawyers, bankers, insolvency practitioners and trust companies, according to one insolvency operator, Damien Grant, who made this observation in his Sunday newspaper column.


Out came the one-sided new Act, defining pitifully small penalties for any poor work by receivers or liquidators.

The new Act required no supervision of receivers and liquidators.

It established no affordable, immediate process for contesting poor work.

For heavens’ sake, it led to the current situation that receivers and liquidators may ‘’self regulate’’ after registering with a Companies Office that itself has had so many recent defections that it is regularly described now as dysfunctional.

Of course there are competent, caring, sharp operators in the insolvency sector. I know two of them to whom I would lend my bach, happily.

Most lawyers, accountants, receivers, banks and trust companies are not without skills, or without conscience, but very few have ever been immersed in the wiles required to run businesses, understanding the intrinsic values of markets and assets, and the need for entrepreneurialism.

I once was travelling with a skilled contracting business owner when he stopped beside a paddock in the country, climbed a fence and inspected abandoned reels containing wire cable.

He recognised the value the cable would have on a particular project and after some effort discovered the city owner, who virtually gave it to him for taking it away.

The ’’owner’’ was, of course, a receiver.

The skilled businessman sold it that day for about $18,000, money that should have gone to the creditors for whom the receiver was acting.

The atrocious outcome achieved for taxpayers by the South Canterbury Finance receivers, McGrathNicol, should on its own have been the catalyst for a new relevant Insolvency Practitioners Act (IPA).

The opportunity, for the moment, has passed. The dog in the Toyota ads would have the right response to this missed opportunity.

Rip-offs, weak practices and old boy networks will continue to be a sick component of some receiverships and liquidations until the IPA is reviewed by a more caring party than MBIE.

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Edward will be in Auckland City on Thursday 21 November and Albany on Friday 22 November.

He will then be in Napier on 2 December and Blenheim 4 December.

Chris will be in Christchurch on December 10 (pm) and December 11 (am), his final visit until February 2020.

Chris Lee

Managing Director

Chris Lee & Partners Ltd

Taking Stock 7 November, 2019

Johnny Lee writes:

ONE of the more common refrains we hear from clients in regards to ultra-low or negative interest rates is how the low rates seem counter-intuitive, self-defeating and unfair.

It can seem counter-intuitive for the many who have enjoyed a lifetime with positive interest rates, as negative interest rates makes fundamentally zero sense. Why would an investor choose to pay a bank to hold their money? In New Zealand, we are still in positive territory, with all the major banks still offering a return on an investor's money, albeit at record low levels.

It can also seem self-defeating. For many investors, returns on investments represent the bulk of their available money for spending. When interest rates fall, they are less likely to spend, as opposed to freeing them up to spend more.

The fairness argument is also understandable. For many investors, they have spent their entire lives saving for retirement, only to be told that the 'value' of a bank holding those savings is now virtually nil. The days of banks offering special rates to convince savers to deposit with them seem to be fading, as banks seem more inclined to chase those willing to borrow. Furthermore, very low returns should equate with no risk. In New Zealand, bank deposits are not 'no-risk' by definition.

All of these arguments have merit. It is absolutely counter-intuitive for savers to deposit money with a bank for a negative return. Over the past few months, politicians in Germany have proposed new laws to prevent exactly that – to prohibit banks from charging retail savers a return to hold their money. The banks argue that if they are being charged by the central bank, that they be allowed to pass on these charges to their customers. Wealthier customers are already being charged by the banks.

Would an investor choose instead to simply hold physical cash, in a safe or deposit box? The banks would argue that the value of their services is not nil, and having access to a credit card, online banking and even the mere storage of deposits would be worthy of a fee.

Investors suffering from falling returns will absolutely be experiencing a belt-tightening as returns fall. This is, largely, by design. The Governor of the Reserve Bank has made no secret that he views term deposit investments as unproductive and would rather see New Zealanders utilising their savings in assets that more directly contribute to national growth. We have already witnessed these dynamics among our clients, as term deposits in the range of 2.5-2.8%, before tax, struggle to generate significant interest from savers.

However, the benefits to borrowers are substantial. Most borrowers do so for fixed terms, meaning the benefits associated with rate cuts do not have an immediate impact. Once these flow through to borrowers, the savings are normally either applied to consumption, or reducing debt levels. Both of these outcomes have benefits to the economy at large.

The fairness of the situation is more difficult to analyse impartially and is unlikely to form part of the Reserve Bank's thinking. The key considerations made by the RBNZ, in respect to monetary policy, surround inflation and unemployment. When inflation diminishes, interest rates typically follow, in an effort to encourage demand, thus pushing prices higher. In theory, the failure to adjust to lower inflation could lead to deflation, which can have devastating impacts on an economy.

Deflation incentivises consumers to defer purchases, waiting for further price falls. This impacts employment and tax receipts, outcomes no Government wants, especially in an election year.

Unfortunately, falling interest rates also lead some people to borrow too much, anticipating rates remaining at low levels. Largely, these people have been rewarded with even lower rates and elevated asset prices. There is a moral hazard in this outcome, which also necessitates a transfer of wealth from older depositors to younger, risk-taking borrowers.

Today, many retirees are being left with three options: decrease spending to accommodate for falling returns, increase risk to maintain returns, or spend the capital accumulated over a lifetime of saving. The Reserve Bank does not wish to see a reduction in expenditure. Nor does it necessarily want investors to be exposed to undue risk, although these risks can be mitigated by regulatory change and careful discernment from investors.

Spending capital in such a low interest rate environment is a growing reality for savers globally. An increasing life expectancy and falling birth rates are resulting in an aging population, with dwindling numbers to inherit wealth. In the 1960s, New Zealand had a birth rate around four, meaning New Zealand women were having an average of about four children. Today, it's well below two. An increasing number of young people choose not (or are unable) to have children, which will lead to Governments using immigration to overcome gaps in the labour market.

Low interest rates seem likely to pervade our investment environment for many years. Any attempts by the Reserve Bank to return them to normality will be carefully considered, and in response to a sustained return to price inflation.

Currently, there are no obvious signals of demand exceeding supply, other than in housing.

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FUTURE generations of students seeking to understand the dynamics of this decade will be faced with volumes of research and analysis that seek to explain why the economic model is not functioning as it should.

In theory, falling interest rates should spur consumer spending, as people face fewer disincentives to borrow, and those borrowing incur a reduced cost of doing so. Consumer spending would fuel inflation, economic growth, employment and tax receipts.

Instead, we are witnessing stubbornly low inflation outside a few small pockets. These include goods that are deliberately and forcefully being inflated by decree (tobacco), services facing new extreme risks (insurance), monopolies increasingly exposed to the construction sector (including council rates) and products facing soaring demand from new markets (including meat and proteins).

Unfortunately, at least two of those are not considered to be a voluntary expense.

Within a capitalist model, competition is one of the largest drivers of price tension between buyers and sellers. If a buyer of widgets has multiple sellers to choose from, the competition encourages the sellers to be efficient, and ensures margins do not become unfair.

However, we are increasingly seeing the extremes of this behaviour across multiple industries, including construction and media. More and more firms are willing to absorb enormous losses for increasingly long periods of time in order to effectively 'force out' competition.

This is most evident within the media sector. The likes of Apple, Disney and Amazon are spending billions of dollars – and losing billions of dollars – trying to compete with Netflix, which is in turn losing billions of dollars a year. While debt remains at such extremely cheap levels, shareholders appear content to simply wait for competition to kill off smaller participants and create a stable market.

For consumers, these dynamics are artificially lowering the price of goods or services to their benefit.

Investors, however, should be wary when investing in loss-making ventures, and ensure the pathway to profitability is credible and achievable.

In New Zealand, we have seen this approach adopted by many participants in the construction sector, with firms seemingly willing to build projects at levels that allowed for insufficient cost escalation.

The same approach was made during the ongoing battle between Sky TV and Spark. Prior to bidding for the domestic cricket broadcasting rights, Sky TV claimed 'If anybody out-bids us, they'll go broke'. Spark proceeded to out-bid Sky TV

It seems inevitable that the global economy will one day, perhaps in the far future, return to inflationary pressures and rising interest rates. The economic model we use produces this outcome by design. However, these cycles have historically occurred at far shorter intervals than currently being witnessed. The extraordinarily low cost of debt, coupled with the enormous cash reserves built up by market leading companies, is leading to a willingness from firms to engage in protracted battles of loss leading, fuelling these pockets of deflation, to dominate markets.

One does not have to buy in to this model!

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OF all the economic indicators observed by market participants, unemployment data is arguably the most important.

The unemployment rate is a measure of those who are both able to work and actively searching for work, yet unable to secure employment.

It does not include those considered outside the labour force – such as retirees, students, those unable to work for health reasons, and those not actively seeking work. Including this data would create a less useful statistic, for comparative purposes.

During the third quarter (September) of this year, the unemployment rate rose to 4.2%, after falling to 3.9% in the June quarter. The rise was largely expected, and is unlikely to cause consternation among the Reserve Bank's Monetary Policy Committee.

Unemployment this low will include those who are long-term unemployed, perhaps located outside of areas of booming employment. Some unemployment is also necessary, as it allows firms some 'slack' to grow without putting increasing pressure on inflation.

A rate of 4.2% should not cause alarm. Nor is a small increase, against a backdrop of historically low levels, necessarily indicative of a change in the trend. However, investors should monitor this particular data point more closely than most. Unemployment impacts on demand, and more importantly debt servicing, which can cause headaches for banks in times of stress.

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WESTPAC Bank has joined the line of listed companies approaching shareholders for capital, announcing a $500 million dollar capital raising from its retail shareholders, as part of a broader $2.5 billion dollar raising.

Documentation will be sent to shareholders on 12 November.

The offer gives shareholders the opportunity to buy up to $30,000 worth of stock at a price of $25.32 AUD. It will not include the December dividend, so comparisons to the current price should factor in this disadvantage.

Westpac Bank has included a provision for a share price fall. If the share price drops below the price above at the time of the offer closing, the shares will be allotted at a reduced price.

Kiwi Property Group, by comparison, did not include such a provision. Its share price has since traded below the purchase price of its own equity raising.

We continue to anticipate more listed companies choosing to reach out to shareholders, shoring up their balance sheets while share prices remain around record levels.

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Chris Lee writes:


DISCUSSION last week on the corrupt behaviour in Malaysia, the focus of a book called Billion Dollar Whale, led to fresh information being sent to me from London and Malaysia.

I recorded that this multi-billion international scandal involved an idiot, Jho Low, who connived with the Malaysian Prime Minister, Najib Razak, to steal billions from money ostensibly raised to build infrastructure in Malaysia.

Goldman Sachs raised the money helped by a sovereign guarantee of the bond allegedly connected to a Middle Eastern fund. I now believe the billions stolen have been at the ultimate cost of the Malaysian government, which repaid the duped investors and guarantors, displaying somewhat more honour than our Governments have done, with investors they allowed to be duped.

I learn that Malaysia is pursuing restoration of the money by hunting for Jho Low, seeking reparations from its previous Prime Minister and suing Goldman Sachs for the somewhat eye-watering sum of US$7.5 billion, or thereabouts.

Low is said to be hiding, aided by those who benefited from his munificence, in the days when Low was raiding the Malaysian fund.

Razak is awaiting trial.

Low is said to have offered to repay some hundreds of millions on the basis that he is not charged and would do so from kindness.

The Malaysian government says that Goldman Sachs has offered to settle for US$2 billion but the Malaysians regard this as inadequate. If no better offer is made a writ will be filed seeking US$7 billion.

Worldwide coverage of such a lawsuit would not be an irrelevant factor, one imagines.

One must continue to ponder what sort of people not only behave in this egregious manner but somehow also convince themselves that such behaviour would not have inevitable consequences.

Goldman Sachs, for heavens' sake, is virtually the core of the executive who run the United States, its senior people having held the major roles in finance and economics for George Bush, Barack Obama and the current fellow, Donald Trump.

 _ _ _ _ _ _ _ _ _ _ _ _

GOLDMAN Sachs raised about seven billion from Wall Street and other investors with these bond issues, the money allegedly being raised to build new infrastructure in Malaysia.

The unadmired American merchant bank Goldman Sachs charged Malaysia about 10% of all money raised – roughly $700 million USD.

By way of contrast Infratil has recently raised around $270 million, its various broking supporters, like my company, charging Infratil 1% for their support – roughly $2.7 million.

I have never heard of any serious issue paying anything like 10%, though if you go back 30 years you might recall a rural share fund marketed by Douglas Lloyd Somers-Edgar that paid brokerage of around 7%, a figure that still causes those who accepted it to blush.

There was also a university which raised $10 million and paid $800,000 of that to the greedy people who arranged the deal. I am not aware of any blushing, in this case.

But a sovereign fund paying 10% to an American merchant bank in the last few years?

Good heavens. Those charges would also compare with those paid for by the NZ taxpayers for the receivership costs of South Canterbury Finance, where the total receivership cost of $55 million was around 7% of the piffling sum that the receiver raised by discounting SCF's assets to random passers-by.

That receiver, McGrathNicol, returned $800 million to the government, which had paid out investors around $1.9 billion.

The same assets that were sold for $800 million are today worth a figure nearer $3 billion than $2 billion

The eyes water!


Chris will be in Christchurch on December 10 (p.m.) and December 11 (a.m.), his final visit until February 2020. 

David will be in New Plymouth on November 14.

Chris Lee

Managing Director

Chris Lee & Partners Ltd

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