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 & 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.
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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 & Partners Ltd
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