Taking Stock 28 September 2023

IRRESPECTIVE of which political party gains the right to rule, investors seem certain to be offered a guarantee from the Government for bank deposits.

Neither major party seems to understand that heavy-handed capital requirements and supervision should preclude the need for a guarantee with the major banks, especially when coupled with the Open Bank Resolution (OBR), the current plan to salvage any struggling bank.

So a guarantee is likely. Legislation has the concept underway.

My expectation is that each bank will pay a fee that is scaled according to credit rating, perhaps with a few other criteria based on size, quality of assets, and profitability. The fee will affect the interest rate. I am not clear if investors will be able to decline the guarantee.

On that basis a TSB deposit guarantee would cost more than an ANZ deposit guarantee, meaning there might be an offer of, say, 6% for two years unguaranteed, 5.75% guaranteed, but for AA- banks, 5.5% and 5.25% respectively, if the banks have the option of offering a choice to investors - guarantee or no guarantee.

No doubt the banks would haggle over the value of each credit rating pip and the other criteria that will affect the cost to the banks of the guarantee option.

All of this seems fairly logical if we are going to move towards bank guarantees, given the hazards faced by the international banking system.

The global financial markets have never faced the conflating issues of impossibly high indebtedness, the urgency of funding a defence of extreme weather events, increasing civil dysfunction, and threats to global trade (and thus supply chains), as well as high, sticky inflation.

As a result, responsible banks are more risk averse. Other lenders are becoming active.

Perhaps I should moderate my view about government guarantees for bank deposits and accept that there is growing apprehension that the world order (read that as asset prices and civil obedience) is now more at risk than at any time in my life, democracy imperilled.

Crown guarantees might ward off a future panic-led flight from banks that would help nobody.

I will not alter my view on guaranteeing the higher return/higher risk non-bank deposit-takers, such as finance companies, credit unions and, the latest craze, private equity lenders. They should never again be guaranteed, in my opinion, at any cost.

There are really no retail finance companies in New Zealand that pay anything like enough additional return to offset the risk of capital loss, so they should remain a high risk option that should be reliant on offering high returns to willing investors.

I believe investors who want higher returns are much better to buy subordinated debt from the big, strong banks, than to accept an extra one percent (or whatever) from a much less transparent finance company, credit union, or private equity lender.

If investors want even higher returns, they will find these in the dividends of NZX-listed companies which operate in volatile sectors like retail, the admirable Hallenstein Glasson being an example of a company with high dividend yields (after tax).

Finance companies have some capital, they are regulated, but at best, loosely monitored. In theory their directors are subject to the “fit and proper person” inspection, though this regime is flawed and is all but useless.

The explanation is that if the Reserve Bank ruled Mr Texan Hat was “unfit”, Mr Hat would have the right to appeal, and a court might rule that he had an unhappy childhood, never been given enough pocket money, and should be given another chance to atone for his various commercial misdeeds.

Just have a close look at some of the individuals allowed to manage other people’s money.

So in practice, finance company investors must currently rely on the substance of the balance sheet, the skill of the management and the transparency of the accounts.

In my view all this reliance would need to be offset by a huge marginal gain if finance companies were to be usable; at least three percent, probably five, possibly ten percent, for those indulging in property development lending.

If the effect of the guarantee is for the Crown to eliminate risk, it should charge a commensurate amount for its risk in providing the guarantee, and let the investors choose to take or forfeit the guarantee. It should not use the fees from banks to cover the failures of others.

The Reserve Bank has not yet shown its hand as to how it would price the guarantee but if it charged banks and finance companies a similar amount, it would be time to build more funny farms to house the clots who would make such a decision.

Finance company transparency is still far from pure, and thus should attract only those who can analyse risk and be satisfied that the higher return is worth chasing.

Common behaviours still include:

1. Rolling over troubled loans, effectively rewriting a failed loan, giving the borrower time to refinance or recover. Think Bridgecorp, Hanover, St Laurence.

2. Capitalising interest and fees, meaning the borrower pays no debt servicing cost until the end of the loan. In some cases the whole loan is capitalised, meaning no repayments occur till a final, distant date. Finance companies survive on cash flow. There is no cash flow in a capitalised loan. Think Bridgecorp, Hanover, Strategic, South Canterbury Finance, Capital & Merchant Finance.

3. Relying on inflated valuations of assets, to avoid the need for write-offs. A troubled loan secured by a 200-foot old ship might look recoverable if the ship is valued at some substantial price. Old ships can be worth a negative amount if there is no real commercial use for them. Asset valuations are prone to be calculated by people who like the valuation fee and have good enough lugs that they can hear the quietest mumbled suggestions from the directors paying the fee. Think virtually all of the contributory mortgage funds and finance companies in 2006-2010.

4. Mis-stating the value of loan guarantors, and mis-documenting of those guarantees. An incomplete loan guarantee might prove to be worth nothing when the guarantee is called up.

5. Mis-stating the cash flow documents by showing all loans as though they will repay on due date, when many borrowers are promised, perhaps informally, that they can roll over any overdue payment. Think Bridgecorp, South Canterbury Finance, St Laurence, Strategic, virtually all other property lenders in 2006-2009.

Finance companies are still a threat, irrespective of who audits them, which (of our hapless) trustees oversee the trust deed, and how much effort is made to monitor and supervise them by the FMA and the Reserve Bank.

For retail non-bank depositors there is no sturdy defence.

The best solution would be to make directors, trustees, auditors, and managers personally liable for any incompetent or dishonest works, with penalties including jail, and confiscation of personal and trust assets, for the purpose of investor compensation.

My word, that would bring people to attention, especially if the courts were ruthless about applying the law and did not give “discounts” for historical hardship.

The other major problem might follow the new trend for private equity firms to lend large sums to corporates at impressively high rates, effectively substituting for nervous banks, or banks wanting to minimise the need to raise more capital to offset riskier loans.

Worldwide, and here, pension fund managers, indeed all sorts of fund managers, so-called “wholesale” clients, and now even retail clients, are being asked to invest in these private equity loans.

Because the private equity investors supply capital, not debt, there is very little motivation to monitor or supervise these funds, externally. 

Kiwisaver funds, unable to obtain exciting returns from traditional asset allocations, are subject to little scrutiny when they shuffle off other people's money into private equity, venture capital, angel investment funds, or property development. 

Private equity managers employ people to assess value, and then report the “assessed” value as though an “assessed” value is the same as a visible market value (established by actual transactions, willing buyers, willing sellers).

Kiwisaver and other fund managers then blur their results by treating “assessed” gains as being the equal of “market” gains. I see this as simple cheating.

When these fund managers include the high returns they receive from involvement in private equity loans, the results are rarely tempered by a credible assessment of the risk of bad debts. Remember, private equity funds do not have a buffer of real capital belonging to the PE firm.

Short term results are inflated for this reason.

Surely no government would propose to guarantee the funds used in private equity, yet that sector is attracting retail funds, many investors wrongly categorised as eligible for wholesale offers, often their eligibility certificated by the salesmen’s agents.

The funds invested are in “equity” (capital), not “debt”, even if the underlying asset is “debt”.

So a guarantee would be like underwriting contributory mortgage funds, even where managers may demonstrably be convicted criminals and anti-social misfits, without being banned from managing other people's money. At least one example exists.

In summary, “Crown” guarantees might soon be a credible method of avoiding any loss of confidence in our trading banks, providing the cost of the guarantee is ultimately met by the investor (through accepting a lower rate), or by bank shareholders, in accepting lower dividends.

But beyond the banks, the concept of a Crown guarantee is frightening and should not be done, as happened in 2008, without long and deep consultation with people who know the risks.

We should never forget the ill-framed guarantee brought in by Clark and then overseen childishly and uncommercially by Key, at a cost of several billion dollars to taxpayers.

Let us hope the Reserve Bank rings around some market veterans while it is framing a new guarantee.

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IF asked to name New Zealand’s most impressive public servants in the past 40 years, those who might be regarded as “long tooths” would probably reach agreement on a few contenders.

Graham Scott, Murray Sherwin, perhaps Francis Small, Margaret Bazley, and maybe the great Ministry of Works fabulous engineer, Charles Turner, might make most lists. But almost certainly the long serving Head of our Statisticians, Len Cook, would appear on virtually every nomination list.

Cook, now retired, held his position for decades and was highly regarded by politicians and community leaders for his intellect, his integrity, his neutrality and his wisdom.

Because he is held in such respect the whole nation should be paying close attention to a recent, very rare foray he has made back into the public arena, penning an article for a newspaper expressing concern about the standards and the neutrality of today's public sector.

His article highlighted the politicisation of the public sector, with the chief executives now effectively appointed by Cabinet, making them almost agents of a political party.

Cook referred to the three-yearly process that occurs after an election, when the various CEOs prepare papers to present to the incoming government.

He queried whether those papers remain a neutral summary of the issues, or whether they have become a summary of progress on the last government’s prioritised projects, the CEO appointment reliant on complicity with projects that are often ideological, often absurd.

He questioned the loss of expertise as New Zealand moves to an American mindset of wanting chief executives who are “managers” rather than leaders in their field. (By contrast, our best business leaders are certain they must have a deep focus on details.)

Cook raised the issue of the criteria used for selecting chief executives with the new emphasis on social requirements (gender, race etc.) rather than on relevant knowledge, experience, and familiarity with detail.

Cook brought attention to these issues at the same time as a head of The NZ Initiative, Roger Partridge, was expressing a similar concern.

Within days another experienced public sector leader, Kathy Spencer, penned an item for the Auckland newspaper pondering the implementation of change that has often been poorly researched and unwisely instructed (by politicians).

One of NZ's best ever public servants recently highlighted to me the absence of highly skilled researchers in both the Reserve Bank and Treasury, lamenting the paucity of PhD-holding public servants.

It seems fairly clear that New Zealand’s debt levels (shrouded by accounting practices), its economic growth (greatly exaggerated by the inclusion of the full cost of the public service), its productivity (distorted by the method of calculating GDP), and its failure to apply zero-based budgeting analyses combine to lock in high interest rates and a weak currency, almost as a new, permanent condition.

High deficits, growing reliance on debt, and dreadful spending will lead to permanently higher inflation and interest rates.

Investors need to consider what this means.

As a simple illustration of the distortion, consider the Gross Domestic Product (GDP) figure on which is calculated at the country's “growth”.

Because GDP is calculated by adding up all real products and services produced (by their dollar value), and then adding on the figure of whatever the public sector costs, the GDP figure is at best an amalgam that tells you nothing about our real productivity. Idiotically, the more we spend on the public sector, the higher we increase our GDP.

In 2017 the public sector cost NZ about $80 billion each year or, say, 80% of our total tax take.

In 2023, the public sector is expected to cost NZ around $150 billion, or approx. 120% of our tax take.

The GDP would have grown by $70 billion because we employed more public servants, paid them more, and generally spent more, inventing yet more government departments.

Without doubt, a real leader would be assessing whether there was value for money in all this new spending, and where there was no or little value, that leader would be closing down that spending.

Investors need to consider this when investing, as Crown spending involves greater debt at the new, higher, interest cost.

My thought is that we investors might want to carve out some money to put into stronger, more transparent economies, less reliant on ever-increasing debt, the money often spent on framing photographs of the emperor’s silk.

That might not be why Len Cook has raised the issues he did and might just be singularly my response.

I commend the articles he, Partridge and Spencer wrote as being worthy of thought for all investors.

The likelihood of any significant reduction in interest rates is somewhere between nil and infinitesimal and will not change until we collect more revenue and spend it intelligently.

As a bright American bank executive said in a Bloomberg podcast last week, the last decade of “free” money will not recur in her lifetime.

She looked a great deal younger than me!

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Travel Dates – October

Our advisors will be in the following locations, on the following dates:

11 October – Christchurch – Johnny

17 October – Wairarapa – Fraser

24 October – Takapuna (Spencer on Byron) – Chris

25 October – Ellerslie (Ellerslie International) – Chris

27 October – Christchurch - Fraser

Clients and non-clients are welcome to contact us to arrange an appointment.

Chris Lee and Partners Ltd

Taking Stock 21 September 2023 

Fraser Hunter writes:

WITH the election just around the corner, the political landscape is buzzing with activity. Campaigns are in full throttle, and it's evident that the election narrative is set to dominate our headlines over the next few weeks. 

While many assume that elections can significantly sway markets and economies, it's essential to remember that New Zealand often bucks this trend. The lead-up, confirmed result and aftermath of an election may not always translate to dramatic market shifts.

For the NZ economy, this can also be the case. One of the key takeaways from the Treasury’s PREFU update last week was that, regardless of the election's outcome, government spending will remain tight.

A lot can change in a month but, as it stands, offshore bookmakers, which can be a useful real-time indicator of sentiment, currently have National as a $1.15-$1.25 favourite to provide the next Prime Minister. Labour is at approximately $4.50. 

The minor parties are largely outsiders, but interestingly the odds for an ACT Prime Minister on some sites were as low $11.50. For comparison, those are comparable odds for England to win the Rugby World Cup. 

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ELECTIONS, by their very nature, bring in a wave of uncertainty. This can often lead to heightened caution when it comes to capital allocation decisions, affecting share markets and broader business investments. Until the political landscape becomes clearer, this caution can result in lower liquidity in the market and larger price fluctuations.

As we step into a time of year traditionally known for market volatility across global markets, it's essential to keep a broader perspective. New Zealand has consistently been seen as highly stable across the investment world. Even with shifts in our political landscape, the global investment community typically remains confident in our nation's resilience.

Yet it's crucial to remember that much of our share market is in the hands of international funds and investors. While New Zealand's market might be small on the global scale, it's precisely this size that makes it more sensitive. Any hint of political or economic instability here, even if it's just a perception, can lead to rapid and significant changes in our currency, bond yields, and share prices.

The rising prominence of parties like ACT, for instance, could be interpreted as a change in our usual political stability, reflecting broader global trends.

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DIVING deeper into the specifics of the political landscape, the Radio NZ election coverage offers a wealth of information on polls, Facebook ads, campaign financing, data from the debates and advance voting numbers. In particular, the coverage offers a revealing look into political advertising on platforms like Facebook and Instagram. 

ACT's approach to advertising on these platforms is particularly noteworthy. In 2021, its advertising spend significantly outpaced its competitors, with its expenditure estimated to be more than three times that of the nearest rival. 

Initially, the ads seemed to resonate mainly with males over 50. As time progressed, their reach expanded, capturing the attention of almost all age groups, save for the youngest demographic, but largely still targeting a predominantly male audience. 

Over the past three years, the tone of ACT's ads has undergone a transformation. From being predominantly negative in the year following the last election, they shifted more to a neutral stance, and now their messaging is mostly positive (though less positive than all other parties). 

If nothing else, ACT has demonstrated a well-planned and executed campaign that has positioned the party in a strong position heading into the election but also, if betting agencies are to be believed, a conceivable shot at the Prime Minister's seat. 

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AT a glance, examining NZX returns since 1990 might suggest that a National Government aligns with favourable share market outcomes. With 11 terms in consideration - six under National and five under Labour - one could observe slightly better returns in the 90 days post-election results and notably stronger returns throughout the government's term under National.

However, it's essential to delve deeper. Pinpointing the precise influence of a New Zealand government on the share market is a challenging endeavour. Market dynamics are influenced by a heap of factors including interest rates, profit trajectories, access to capital, and overarching global events. 

It's also worth noting that significant events like the dot com bubble, the Global Financial Crisis, and the recent upheavals due to Covid-19 and subsequent interest rate adjustments all transpired during Labour's tenure.

Markets are far more complex than historical returns might suggest. It is simplistic to attribute market movements to the governance of one party or another._ _ _ _ _ _ _ _ _ _ 

POLITICAL parties, with their particular agendas, can have more impact on the trajectory of specific industries or companies than the broader market. For instance, a coalition between National and ACT will reopen the door for offshore oil and gas exploration. Such a move could be a lift for energy and power companies, especially for firms like Genesis, which have significant ties to oil and gas revenues.

The agricultural sector, too, might see favourable winds with a softer stance on emission reductions compared to the proposals from Labour or the Greens.

Finally, housing stands out as the most polarising area of policy change. With National and ACT poised to potentially reverse Labour's bright line and interest deduction policies, coupled with a recent surge in migration, there's an increasing expectation of a recovery in the property market. This could spur growth in property-related companies, the construction industry, and even the retirement sector.

However, it's worth noting a recent shift in the listed property sector. A consensus between National and Labour to eliminate structural depreciation for commercial building owners has already sent ripples through the market. Portfolios like GMT and PCT felt the brunt, while VHP remained relatively insulated due to its offshore holdings.

In the end, although the political climate has an impact on the market, over the longer term the true drivers of a company's worth can come down to its credibility, its governance, its ability to maintain and grow profits, and its ability to adapt and thrive in changing future environments. Great companies perform regardless of who is in power, have an eye to the future, and are willing to adapt. 

The electricity sector, both locally and internationally, is a prime example of this, which is why the return of further oil and gas exploration is unlikely to have the impact it would have had five years ago.

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LIKE the stock market, the economy is impacted by various factors, with government policies being just a part of the puzzle. New Zealand's Gross Domestic Product (GDP) growth, both before and after elections, shows little impact based on the election outcome. Instead, global economic conditions, the timing within business cycles, and interest rate shifts often play more substantial roles.

One of the visible impacts of the upcoming election is the sentiment within the business community. Small to medium-sized enterprises (SMEs), are particularly sensitive to uncertainties and hold strong beliefs that the outcome of the election is critical to the future success of the business. 

Often, businesses adopt a "wait and see" approach during election periods, reflecting the uncertainty elections bring.

_ _ _ _ _ _ _ _ _ _

OVER the past two weeks, we received a couple of data points about the economy for the next government. The first was Standard and Poor’s reaffirming the country's credit rating, and the second Treasury’s PREFU release. The Prefu is a standard pre-election budget update to ensure political parties have up-to-date information and an incoming government is not alarmed at the state of the country when they come in. 

Overall, both documents indicated the economy is in a healthier state than previously thought, with record immigration and bouncing house prices expected to keep the country afloat and a recession expected to be avoided. 

However, Standard and Poor's release did include warnings of potential credit risks from a growing current account deficit, high external and private-sector debt, and volatile property prices. 

Regardless of who wins the upcoming election, the next government will need to carefully manage the country's finances.

_ _ _ _ _ _ _ _ _ _ _

THE Treasury’s release was immediately met with questions from media and economists about the upgraded economic outlook. The forecasts suggest a growth rate of 2.6% for the next year, inflation to return below 3%, and unemployment seeing a small uptick to 5.4%. It anticipates a modest surplus coupled with an increase in debt in the subsequent years.

While rosy, the Treasury's outlook also includes its own list of warnings and concerns. Treasury acknowledged that these forecasts are challenging, there are plenty of uncertainties, and it doesn’t incorporate unbudgeted election promises. 

One of the most sombre takeaways from the updated budget was the lack of headroom to fund any new policies or initiatives. The bulk of the budget is already allocated to “spending to keep the lights on”, with limited ability to cut costs. 

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

THE overall sentiment in New Zealand, echoed in elections and the media, is one of uncertainty, austerity, and a growing desire for change. This sentiment is not unique to New Zealand, but a global thematic. 

While we expect New Zealand to be resilient, and external evaluations of our economy continue to highlight we are doing ok and better than most, the heightened risk on any single economy underscores the value of global diversification as a risk mitigation strategy. 

While investing abroad comes with its own set of challenges, such as more demanding administration, currency fluctuations and high global market valuations. For investors with time on their side, these are likely to normalise over time. 

For those looking for more diverse options, products like the Smartshares suite of NZX-listed ETFs, or the larger and more targeted ASX-listed providers such as Betashares, Vanguard, or iShares products might be worth exploring.

Don’t hesitate to get in touch with one of our advisers if you would like to discuss further.

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Travel Dates – September

Our advisors will be in the following locations, on the following dates:

27, 28 September – Tauranga – Johnny

29 September – Hamilton – Johnny

11 October – Christchurch - Johnny

Clients and non-clients are welcome to contact us to arrange an appointment.

Chris Lee and Partners Ltd

Taking Stock 14 September 2023

AS this newsletter is used by unadvised clients, by the public, and by interested parties from many sectors, it cannot offer personal financial advice.

If I were a newspaper reporter or columnist, I could say what I like, offering advice to all and sundry on any subject, irrespective of any inexpertise, as we see most weeks in organs like the NZ Herald and Stuff, from people with no relevant qualifications or experience.

Go figure that out. The media runs amok.

If I were allowed to offer specific advice the discussion in this item would finish with an imperative.

As I cannot, readers should draw their own conclusion, or ask a newspaper reporter or teacher who makes a living offering opinion or advice on a critically important area of life in which they must have a passing interest.

The issue, highly important, is what to do if one is stuck in an unlisted property syndicate where the grasping manager in charge of the fund has a much higher “duty” to earn handsome management fees than he has to the investors, over whom he presides.

Right now there are literally dozens of such syndicates holding their statutory annual meetings, some in Auckland, some in Wellington, some scattered around the South Island.

These meetings come at a time when a Nelson syndicator/manager is facing allegations of fraud, his investors having endured a puzzlingly low return for years and having been denied an effective voice in the fund that uses their money.

This, I regret, is pretty much normal in New Zealand.

Syndicating property for a very fat fee, collecting investor money by grossly over-promoting the concept and promising improbable “targeted” returns blighted the 1990s when Waltus and Money Managers devised structures that could succeed from investors only if tenancy rates remained close to 100%, if rentals only ever went up, and if debt servicing costs never rose.

It also required the manager to be competent and to have a client-first mindset.

Let us just say that not all of these conditions were evident.

Money Managers heavily promoted the concept through its talkback advertising show on Sunday mornings, where it bought an hour of time for around $6000 a day.

Absurdly, its radio show host, Doug (Somers) Edgar would claim that a building with a (short term) tenancy with a government department was the equivalent of government stock, a statement as reckless and baseless as his claim that the status of a deposit with a contributory mortgage fund, First Step, was comparable with that of a bank deposit.

Waltus paid intermediaries 6% for marketing its syndicates.

When a new syndicate failed, it once raided funds from another cash-rich syndicate, without investor consultation, to support the new offer that was not generating sufficient funds to justify bank funding.

Let us just say the 1990s led to an era of lousy promoters, syndicators and managers, with lousy results for many investors.

Not all syndicates failed, despite the mis-selling and the amateurish management.

Inflation and relatively stable debt servicing costs led to some syndicates temporarily succeeding.

Those few that were wisely managed had some successes, principally because the investors clamoured to sell when prices rose.

The motive of the investors to sell could have been for any or all of several reasons: -

- The reality that after several years, the investors were getting older and thus had a changed risk attitude.

- Buyers were offering a price that, if accepted, would lock in a handsome gain.

- Debt costs were vulnerable to increase as stupid corporate behaviour signalled an imminent global crisis.

- A global crisis might (and did) cause tenancy failures.

- A change in government could (and did) alter the government's demand for inner city office space (2008-2017).

- Investors were carefully analysing the prospects of a building and concluding that a changing world might mean tenants would be demanding more favourable leasing prices and conditions.

- Fund managers had displayed selfishness, greed and/or incompetence.

Those syndicates that were drafted with integrity allowed the investors to vote on a sale and allowed investors to sack the fund manager if it was refusing to respond to investors’ clamour.

In the era around 2008 many syndicates were collapsing, some choosing to amalgamate and rebrand.

Run by a family I did not admire, Waltus syndicates were folded into Urbus Properties, which folded into ING Properties, and ultimately into Argosy Properties.

Money Managers’ syndicates became Dominion Properties, then DNZ, and then split into Investore Properties and what is now called Stride Properties, the last named having failed to sell off its properties to a fabricated new company to have been named Fabric Properties.

Stride aspired to be a property manager, having worked out that such a role required little capital, had no exposure to debt costs, and would be immune to the loss of contracts that it would design, except under unusual circumstances.

Augusta Properties, the creation of the Francis/Reynolds youngsters whose fathers had created Chase Corp in the 1980s, folded into Centuria Properties, a listed ASX company, which conditionally bid for Augusta at $2.00, had its bid accepted then, when Covid arrived, reduced its bid to $1.00, which was also accepted.

Other syndicators, like Kevin Podmore's St. Laurence group, simply went broke, the victim of a quite moronic diversification into moneylending, where bad debts erased equity at a speed that implied childish moneylending skills.

I recall all of this to highlight that the current storms facing property syndicates are simply repeats of the past.

Improbably low interest rates encourage over-use of debt; low rates lead to high multiples of income being used to purchase buildings (for fear of missing out). Even the best listed property funds have found their interest bill has increased by a third.

Inflation bites. Debt servicing rates rise. The fast buck fund managers are found to have no Plan B. Fund management contracts make it difficult for investors to sell buildings when prices are high. Tenancies become vulnerable.

Valuations fall. Banks want debt reduction.  Investors are all a few years older and more risk-averse.

The targeted returns become improbable.

A ruddy great mess results.

What should have happened is this: when the signals were of valuations at extreme heights, the fund manager should have invited investors to instruct him to sell, while there was still liquidity in the market.

Of course the fund manager, enjoying his million-dollar fees (say 3% of the value of the fund) had no motive to cause a sale other than to protect his reputation.

The fund manager rarely had aligned interests; rare, but not never.

One fund our company used in the past decade was chosen because its manager provided a put option, ensuring investors could exit at par once a year, and a further option guaranteeing to buy out investors after 10 years, at the higher of par or 90% of market value.

The same syndicator at least once waived a good share of his annual fees to ensure dividends were paid.

That syndicator, Ian Cassels, deserved support and success.

The three buildings he has syndicated have delivered credible dividends, meaning he has not been required to buy many units via his put option.

Regrettably many syndicators have less substance and are less conscious of their responsibility to investors.

There was one meeting taking place this month which should have put real heat on the fund manager to change his behaviour.

This fund, which I will name in the future, is paying the tiniest imaginable dividend, having failed for years to meet its target.

The managers still claim their properties are “worth” a figure that nobody would pay and still claim that a share sale of a few hundred shares represents a true picture of the “last sale” market price for the share.

Investors are all several years older, the fund established many years ago.

The investors may not want to wait for the expected recovery in 5-10 years and will certainly not like receiving dividends at a level nothing like the promised level.

The fund manager should take the initiative and poll the clients with a questionnaire and preface that looks like this: -

“The fund is unable to deliver returns as forecast when we designed the fund. Any recovery will be slow. We will halve our fees and agree to an annual vote (51%) to give investors the option of either replacing us as fund managers or instructing us to discover a true market value. We would report back to you immediately, and then accept an immediate vote (simple majority) on selling each property as a buyer emerges.

“Please advise:

1. We continue to manage the fund for half the original fee with a 10-year horizon to pursue a market recovery. 

2. We immediately commission appropriate agents to obtain a bid for each building, to be submitted to investors, who by simple majority can accept or reject each building’s offer.”

What an honourable response that would be.

At a time when many syndicates are not delivering a fair return, investors should be granted the power to be polled and be put in charge of strategy.

The money at risk belongs to investors. Investors will instinctively know that property is an asset class that would not like an era of high interest rates and adversely changing business conditions.

As explained I am not allowed in Taking Stock to offer personal financial advice (buy, sell or hold) but I am permitted to suggest a process that diverts the responsibility of strategy and outcome away from fund managers and into the hands of those to whom the money belongs.

Demand a poll. Head to court if the fund manager refuses.

Let the majority response determine strategy.

Ninety cents in the dollar today is worth a huge amount more than $1.10 in 10 years’ time.

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THE decision of Fonterra to consider a reduction in board directors is logical.

Large boards are less efficient and decisive than smaller boards, especially when the board directors are appointed to represent vested interests, as happens when organisations like the Rugby Union board provide governance access to provincial unions.

Arrogance, incompetence, and parochialism reign, as occurred in rugby for many decades, with loss making unions having the numbers to drive bad decisions.

Fonterra had an era of awful governance, grossly overpaying an egotistical chief executive, and regularly “investing” funds in projects that were lightly researched and reflected the axiom that spending other people's money requires far greater wisdom than is usually visible in a room with locked doors, occupied by mediocre people.

Once on the board some directors clung to the “status” and never wanted to resign.

Fonterra is wise to tighten its numbers. It is a much smarter operation today.

Sadly, there may be an unintended consequence of reducing its numbers.

Most farmers to whom I have spoken believe that a key person in redirecting Fonterra from its disastrous decade of errors was the South Canterbury farmer Leonie Guiney, who with her husband Kieran, and helped by her four teenage/adult children, has become a significant leader in clean, modern dairy farming. They are outstanding community contributors and as farmers are gold standard.

In academic terms Leonie is bright, smart, all over the science and maths of dairy farming. She follows best practice processes, is a consumer of modern technology and, if not fearless, is easily able to present powerful arguments to any group, unafraid of critics, probably very careful not to be misrepresented by our amateurish media, therefore rarely seen on television or in the daily press.

If her energy were endless, she would make a wonderful prime minister, needing no fairy dust, no aspiration to be the tooth fairy, and quite capable of ensuring her views were accurately displayed without respect for the “gotcha”, mediocre, media.

Because she has served Fonterra for close to nine years, in theory she could be a prime candidate to be farewelled if Fonterra reduces its board size, though Fonterra’s rules would (and should) accommodate a longer stint if she signalled such additional energy.

Farmers would be unimpressed if she retired.

When a previous poorly-led Fonterra board first forced her to resign nine years ago, without fear she reverted to the farmers who very swiftly voted her back on the board. Leonie is no television creation with a need to be adored. She is real. I doubt that cow pats are referred to delicately on the farms she and Kieran own.

Her reappearance at Fonterra has coincided with the last few years of improvements in Fonterra’s governance and management. Kieran and Leonie’s farm practices have been based essentially on accepting the available rainfall and pasture growth as the basis of decision making, drying off dairy cows when nature provided insufficient pasture.

Anyone would drink from the streams that pass through their properties. Their costs are lower so they survive on lower volumes of milk sales.

The current gloom and doom around dairy farming is propagated by the media, which focuses on publicity-seekers, naturally enough. The truth is that smart farmers still operate profitably when the combination of milk prices and other income reach $7.50 (per kilo of milk fat). Smart farmers have reduced debt in the past three years when milk prices have been extremely high.  Fonterra’s dividends help.

The model followed by Kieran and Leonie is, at the very least, a clean alternative to what has become the unsustainable model on which the media loves to focus - endless fertiliser, overwatering, indifference to the environment. (I do not recall the last newspaper reporter to have owned and operated a farm.) If, after nine years of a highly-effective governance contribution, she wants to retire, Fonterra would be wise to search for her equivalent.

Or maybe it should look for less competent people to “dry off” and urge her to stay.

As the retired government statistician Len Cooke commented recently, there are no substitutes for people with knowledge, experience and ability. We should treasure such people, rather than discard them, when a charter or rule book dictates their usefulness has ended, or an election result provides opportunities to sack leaders.

Footnote: there is never a need for “quotas” to provide the most senior opportunities for people like Guiney.  The word “quota” might be insulting to them.

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Travel Dates - September

I will be in Christchurch, Ashburton and Timaru next week, diary fully loaded bar a spare hour in Ashburton on Tuesday afternoon (19 September).

Our advisors will be in the locations below, on the following dates:

19, 20 September – Napier - Edward

27, 28 September – Tauranga – Johnny

29 September – Hamilton - Johnny

Clients and non-clients are welcome to contact us to arrange an appointment.

Chris Lee

Chris Lee and Partners Ltd

Taking Stock 7 September 2023

ONE assumes that all CEOs and CFOs in New Zealand are on red alert, formulating plans to cope with many more years of expensive debt and expensive capital.

They will have noted that diverse countries like Indonesia, India, Korea, Canada, Britain, and Belgium have all recognised that, irrespective of possible recession, interest rates will not be significantly lower, and could be marginally higher.

Belgium is the most recent of the European Union countries to chase high-cost retail depositors, raising NZ$40 billion in recent days. Previous Belgian issues have been in hundreds of millions, not billions. Belgium induced 660,000 of its 10 million population to invest 21 billion euros in one-year, 3.3%, government bonds, an astonishing sum, possibly reflecting a flight to risk-free securities.

For comparative purposes, NZ would need to raise $20 billion from 330,000 people. The biggest issue I recall in recent times is $1 billion collected by the BNZ last month.

Britain has seen retail bond rates exceed 6.0%.

Indonesia is to sell its passport to raise billions, a form of equity.

Here in New Zealand a medium-sized property trust has shown the market a tidy way of raising money quickly.

Precinct Properties, for the second time in ten years, is offering to retail investors a convertible note that will pay a handsome fixed rate for three or four years and then convert into shares on maturity at what would either be a tiny discount, or a discount that might be significant if property markets grow in value in a few years’ time

Precinct, once named AMP Office Trust, has led the way more than once in offering attractive well-crafted deals to strengthen its balance sheet. More than 15 years ago it raised capital at an extreme discount with a rights issue designed and underwritten by Jarden. At the time its shares were trading close to $1.00. The rights issue was at 62 cents. During a difficult time it raised a large amount of capital that calmed its bankers and soothed its investors.

A few years ago, Jarden designed a convertible note for Precinct Properties that also succeeded.

That note paid around 4.8% interest. After about four years the notes converted into shares at $1.40, although at the time of conversion the share price well exceeded $1.40, providing a win for investors if they chose to sell. (They received more shares because the conversion formula was capped at $1.40.)

The new imminent Precinct issue will offer both a three-year term, with an ultimate maximum strike price for conversion of $1.36, or a four-year term with a maximum strike price of $1.40.

Both will pay at least 7% per annum.

If the share price in four years’ time is above the strike price, then shareholders will receive a capital gain. If the share price is below the strike price, then investors will receive extra shares to ensure they get their original investment back. This protects investors from a falling share price, and rewards investors if the share price of PCT increases - a rare win-win situation.

The offer is open now and closes tomorrow at 10am (8 September). Payment would be due no later than 19 September.

Please note that Precinct will be paying the transaction costs for this issue. Accordingly, clients will not be charged brokerage.

Further information, including a presentation and investment statement can be found here:https://www.chrislee.co.nz/uploads//currentinvestments/PCTHC.pdf

If you would like a firm allocation of these notes, please contact us urgently.

My opinion is that far more listed companies should be using this type of instrument, which effectively avoids obstructing other avenues of debt and will placate bankers.

Senior debt issues, that rank pari passu with banks, help to calm the banks but not as much as what is, effectively, a future underwritten equity issue.

Conversely, many in the age group of 40-70 have time to wait for some sort of recovery of property prices, probably dependent on lease renewals and a hoped-for slight fall in the high debt costs that apply now, most property owners now paying between 7% and 9% for their debt component.

This, of course, eats into income, threatens the dividend pool, and ultimately leads to devaluation of property, investors wanting returns that relate to the risk-free rate.

All but the most desired of properties ought now to be selling at multiples of returns around 8 to 10, rather than the absurd multiples of 15-25 that applied when money was virtually free.

The CEOs and CFOs of our major companies will also know that the banks are subjected to ever more micro-managing by the regulators, capital ratios and risk weightings under scrutiny.

Naturally banks want to avoid expensive capital issuance so if debt covenants and regulations put pressure on bank lending one obvious option for banks is to reduce the lending to the commercial property sector.

An important measure for bankers is the interest rate cover.

If a property has nett income-to-debt servicing ratios of one, then the property owner is using all available nett income to service debt.

A ratio of two used to be commonplace. Today 1.5 would placate some banks. The truth is that many property syndicates have a ratio of less than one, forcing them to borrow more to pay their interest, an ugly option.

Inevitably, some syndicate collapses will occur, property prices becoming vulnerable as forced sales occur. Clever syndicates will sell before their troubles are in the public domain.

The same fear grips many retailers, who will also be concerned about debt costs.

That sector has had a 95% increase in liquidations and receiverships in the past year.

Its fate is relevant to property prices, rentals, sales, bank panic, and ultimately the cost of debt. Higher credit margins are a logical response to bank fear. Retailers carry much debt, typically some of it funding stock that may well be slow-moving, currently.

My hope is that the NZ CEOs and CFOs whose balance sheets give them options will recognise the future-proofing that convertible notes provide.

Investors would use such notes only when they were issued by strong companies. We still have ample examples of this.

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WHAT some may describe as the naivety of the public sector and the current government was displayed in the structure used by Treasury to rescue Air New Zealand from the collapsed travel sector during Covid.

The Crown provided debt at a far cheaper rate than the banks would ever have risked.

Arguably the Crown, a 51% owner, was the right, possibly the only, potential rescuer. The rights issue was poorly designed by the Crown and its advisers.

As the skies began buzzing with aircraft again, the Crown shifted upwards its debt cost, eventually to a level that might have been commercial, Air New Zealand shareholders the indirect winners of the ridiculously low rate originally attached to the Crown bail-out. 

What the Crown should have done was to have priced its support so it could claim a fair return for the extreme risk it took during a health epidemic whose outcome was unknown.

Had a bank agreed to take that risk, it would and should have structured its support so that it received a very full return in the event Air New Zealand was restored and again achieved high levels of profit, as is happening now, thanks to high fares and enthusiastic travellers. The wily banker would have used its negotiating power when Air NZ had no other options.

Effectively the Crown should have said that before dividends are ever again paid, we will claim the surplus as reward for the risk we took.

Instead, the Air New Zealand minority shareholders, many by number being novice Sharesies investors, will be a full part of the dividend payment, effectively subsidised by the Crown’s inability to find an adviser that would have structured a survival package, commercially.

Perhaps the Air New Zealand problem should have been handled by a very low-price takeover by the Crown, ensuring any return would belong to the Crown for its role in rescuing the airline (again).

It could have done this with the intention to release for an NZX-listing 49% back to the public once the airline’s survival had been ensured (or if the airline survived, perhaps I should write).

Even then, I confess I would be leaving it to Sharesies to rustle up the money for that re-listing.  Airlines have demonstrated that they are a highly volatile service to own. New Zealand needs an airline. Investors do not need to own it.

A former director of the Reserve Bank once said to me that the demise of South Canterbury Finance, and the disgraceful amount of money bonfired by inane, incompetent people, provided proof that the public sector was, in his words, absolutely hopeless at managing private sector assets.

I suspect his view was not changed by the Air New Zealand Covid rescue plan.

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LAST week's item about the Mainzeal Construction court case discussed the potential difficulty the liquidator, and the litigation funder, might have in obtaining full payment from the directors and the insurer, on whom penalties of around $50 million were imposed by the Court.

I expect within reason the insurer will pay, as instructed, though insurers are an obstructive lot, expert in delaying their payments.

I have no knowledge of the financial well-being of any of the penalised directors, but I do know that those chasing full payment are well aware of an asset that would be a useful source of funds if it were saleable.

I refer to the shares in Richina Pacific, majority owned by director Richard Yan, domiciled in China. To the apparent NZD value of at least $15 million, the director, Jenny Shipley, or her family trust, owns RP shares.

Richina Pacific (RPL on the NZX) had been formed in the 1990s and attracted Yan’s interest. He had attended Auckland Grammar in the 1980s under a scholarship. He raised tens of millions in 1994 for RP to invest in China, most of the money raised offshore. RP went on to buy an iconic Wellington property company, Mobil-on-the-Park, later selling it at a poorly chosen time.

It also bought a majority interest in Mainzeal in 1995 and later bought the listed company Mair Astley, a failed tannery company, and a saltwater aquarium in Beijing. In building such an eclectic, unconnected, portfolio it resembled Brierley Investments.

Yan became CEO of RP in 1999, lived mostly in China, moved RP’s head office to Bermuda in 2003 and transferred head office to Kuala Lumpur in 2005.

Throughout the turbulent, error-ridden history of Richina Pacific, Shipley loudly supported Yan and to this day has a shareholding that is theoretically by far her greatest asset.

It was unsurprising that Yan chose Shipley, a nouveau in commerce, to be his chairwoman of Mainzeal Construction. She was unwise to accept. There was no logic in her appointment.

Yet Shipley is only one of a large number of New Zealanders who own RP shares.

Others, like Active Equities, created by former Brierley executives (Collins etc) own millions of shares in Richina, sitting in their books, unsaleable with, in effect, no voting power to untangle the company.

Yan has control. If he chose to pillage the company, who would stop him? Chinese law would not make it easy to control him.

Some time ago he delisted RP so today there is no market for the shares. Yan controls the company, pays himself handsomely, calls the shots, and appears completely indifferent to the fate of Mainzeal Construction, which RP owned. He has been instructed to pay around $20 million to Mainzeal’s creditors. The tune I hear may be the dawn chorus but it also may be him, whistling.

Indeed, when Mainzeal’s gauche directors were defending the company's solvency problems by relying on Yan to make a shareholder advance, Yan was writing in emails that his “wife” was uncomfortable about Mainzeal. (Smart lady.)

RP owns really valuable land in what is known as the “second ring” of a major Chinese city, the inner ring being effectively the most expensive real estate, the “second ring” being not far behind.

If you believe valuations, RP’s assets in the last 20 years have soared in worth, making Shipley’s very modest initial holding (US$50,000) now worth at least NZ$15 million by the calculation of other RP shareholders. This would dwarf any other visible wealth.

The problem is that RP sheds no dividends and there are no external buyers, presumably because Yan’s 51% shareholding enables him to decide what his salary should be, and what happens with the surplus.

Investors are not so much locked in, as under armed guard.

I am uncertain how a court order from NZ would be received by Yan, in China, though I think I have a pretty good idea of the outcome.

I suspect he has structured his ownership in a way that protects him.

Without being able to get the proceeds of the sale of RP shares, how would the Mainzeal’s liquidator and the litigation funder access the sums needed to meet the penalties imposed by the Court, in particular on Shipley?

Shipley does not own a farm anymore.

She is not likely to be a high earner.

Presumably she would not want to be bankrupted - an awful fate for a one-time Prime Minister - but if she cannot sell her RP shares, where is there room for her to meet the court ordered obligation?

The rogue in the story is Yan, an elusive and self-focused man, who has no reason other than morality to prioritise any New Zealand court order.

This puzzle is ugly.

One must hope that somehow Yan is cornered and forced to return capital to the RP shareholders.

I can think of dozens of New Zealanders who might volunteer for permanent jury service if the RP shares produced cash.

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Travel Dates - September

Our advisors will be in the following locations, on the following dates:

8 September - Auckland (CBD) - Edward

13 September - New Plymouth - David

14 September - Wellington – Edward

19, 20 September – Napier - Edward

18, 19, 20 September - Christchurch, Ashburton, Timaru – Chris

27, 28 September – Tauranga – Johnny

29 September – Hamilton - Johnny

Clients and non-clients are welcome to contact us to arrange an appointment.

Chris Lee and Partners Ltd

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