Taking Stock 26 November 2020

THERE are two areas of bank lending that provide the Australian banks with leverage in their arguments with the Government and the Reserve Bank.

The issues are coming to a head and are of great importance to the nation.

There is no debate about mortgage lending to home buyers.  The banks will chase that lending at low margins.  Home mortgage lending requires very little bank capital and produces very little in bad debt.  It does not threaten our banking stability, providing house prices do not slump.

The areas of lending resistance are in property development and lending to our productive sector (dairy, meat and wool, horticulture, fishing, viticulture etc).

The Australian banks are crucial funders of these activities.  They know our country needs constancy in these areas and they know we know.

How do we increase our housing supply if our developers cannot reliably access funding?

The Government thinks it can help with property development lending, perhaps even establishing a source of funds for these activities.

Heaven help us if that idea becomes reality as commercial property and property development lending require street wisdom and experience not visible in the public sector.

Regrettably we have no Rural Bank.  It was destroyed years ago, and was finally absorbed by the National Bank, itself bought by ANZ. ANZ is now our largest bank and, judging by recent years, our poorest-governed bank and one that seems to have a protruding middle finger to brandish at New Zealand's public sector.

Rural lending has stalled in the past year, the specialist rural bank, Rabobank, unable or unwilling to pick up the accounts that banks like ASB have wanted to abandon.

Whether this signals the poor quality of ASB's rural portfolio or its general level of comfort is anyone's guess.

The Chinese seem keen to take up opportunities to lend to our rural sector.

In my view the rural sector is wise to inspect with suspicion the covenants in the loan documents of Chinese banks.

Those banks have historically made cynical use of amateurish politicians at governance level, from which I infer a degree of Chinese-based control that is less than ideal.

Who can forget the covenants in the loan to the Mataura Valley Dairy Co?  Those conditions enabled the Chinese bank to recall its $150 million loan within 24 hours if the Chinese 60% majority owner ever sold down its shareholding by just one share, a process that could potentially have delivered the dairy company into Chinese ownership.

Perhaps the Crown should re-establish a Rural Bank, run by private sector specialists, to offset this over-dependence on offshore-owned banks.

Property development lending is important but should not be done with the same goofiness as the small business loan product brought in as a Covid-relief package.

Property developers operate on very low capital, usually use other people's money to fund their developments, and destroy unsecured creditors and even secured lenders when they fail.

Happily we seem cemented into an era when every property produced in an urban area will find a buyer, even when the properties have been crammed into an area where only the smallest car could get in and out, and where neighbours would be very aware of the difficulties of others suffering from hiccups or other digestive interruptions.

Currently, the developers emerge with around 20% nett margins, often pre-paying themselves with creditors' money during the building process.

Wise bankers demand a high level of pre-sales, but the unsecured creditors always take the chance that the development finishes roughly within budget, on time, enabling titles to be granted and settlements to occur.

The tradies are paid along the way with bank funding but unsuccessful developments always leave tradesmen with an unhappy deficit.

Why developers can get away without secured personal guarantees to tradesmen is a mystery best explained, I suppose, by their superior lobbying skills, when laws were framed.

Even if banks play hardball with politicians and regulators, development funding is best left to banks and, perhaps, the rare investment bank that has access to the best banking skills.

The sure sign that we are nearing the end of the development cycle will be the emergence of the likes of St Laurence, Strategic, Bridgecorp or Hanover, whose appalling leaders and owners collectively stripped more than a billion from NZ investors after those companies lost any moral compass in the years between 2005 and 2007.

When the next iteration of cheats and liars arrives, any investor simply must demand a return that reflects risk.

Ideally the regulators would ensure the next wave of development financiers cannot access retail investors without a company structure heavy on capital and highly prescriptive on matters like transparency, executive bonuses, dividends, and related party lending.

But the regulators and legislators seem reluctant to be highly prescriptive.

I observe the first of a new round of development lenders will be led by the Wellington-based, Hong Kong born, Chow brothers, no longer described as brothel owners but now self-described as property moguls.

As an aside no one should ever be described as a commercial property owner if he/she has debt levels of any significance.  Ownership implies control.  Heavily indebted ''owners'' have control only at their lender's tolerance level.

Commercial properties fluctuate greatly in value at different parts of the cycle.

Their owners often think of the difference between a highly volatile and potentially short-lived valuation and the debt as being their ''capital'' or ''nett worth''.

As we all know, the banks determine when the debt ratios are too high and will force a sale at a price they determine when the cycle changes.

It is a somewhat sick joke that many owners acclaim the (temporary) nett differences between ''valuation'' and debt as their nett worth, or even more dishonestly, regard that difference as ''cash'' available to make further purchases.   Access to a conditional bank lending facility would be described as ''cash'' by only the most pretentious charlatans.

The Chows will now know that the banks want to see debt on commercial properties fall well below 60%, as the property cycle becomes less predictable.

Banks like the ANZ will have made this clear.

So the Chows have engaged people like John Key and the former BNZ economist Tony Alexander to appear at an opening function of a new property development fund, available to wholesale (but not retail) investors, launched in Auckland in recent days.

As a further aside, I wonder if Alexander, who depends on his reputation, was wise to compere this function.

I understand Key's ''social influencing'' talents but Alexander has a fine reputation to uphold and, being self-employed, should surely restrict his appearances to the least controversial undertakings.

The Chows want the new fund to finance their own property developments and believe the fund will be successful without the inflexible constraints that come with bank loans.

These inflexibilities might include a high level of pre-sales before any lending takes place.

In this demand a bank is actually helping the unsecured creditors, even if that outcome is accidental.

In my view the Chow fund, with all of its obvious risks, the largest being a cyclical downturn, should be paying investors a rate similar to what the Chows plan to make – 20%.

The investors might rank slightly ahead of whatever Chow capital is in the fund, but the distinction is meaningless.

If the development ever fell into the hands of the banker, and thus ended up in the hands of a receiver or liquidator, the only people who would ever see a return would be the banks and the Cheshire Cat receiver, who under existing idiotic law, is effectively accountable to none of the unsecured creditors.

History suggests the greater the recoveries the higher the receiver's fees, meaning more snowballs thrive in an inferno, than unsecured creditors benefit from receiverships.

The Government wants property developers to build tens of thousands of houses.

The banks will baulk if property development lending requires more bank capital.

The Government might think it could become a property development lender.

The Government's regulators might allow the Chows to fund their developments with wholesale investor money.

But none of these solve the problem, other than temporarily.

As the funding is inherently very high risk, the only meaningful solution is a very high lending rate drawing attention to the height of the risk.

Twenty percent has a nice ring to its bell.

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WHEN did New Zealand last produce a listed public company chairman who took a stand against the nonsensical salaries and bonuses awarded to company executives?

Perhaps the gravelled tones of Ron Trotter might have protested, perhaps Jim Wattie, or Woolf Fisher had a view, but in recent times there have been very few who have observed that invisible fine silk does not exist.

So the chairman of both the ugly Sky City Entertainment Group, (a casino-based company ex-Brierley) and the rather more salubrious Summerset Group, Rob Campbell, deserved full attention when he spoke out last week.

Campbell has had a most unusual path to public company chairmanship.

After an era of Tom Skinner, Jim Knox and Fintan Patrick Walsh leadership in trade unions, Campbell arrived as a representative of workers, clutching not a pint of Red Band but a glass of merlot, talking not about saveloys and chips, but discussing scallops and crayfish.

He was effective in union representation, despite his culinary tastes.

Yet it was a surprise to see him transition to corporate governance, where his skills converted him to extreme wealth, a condition he might once have mocked.

Last week he observed that executive pay and bonuses were excessive, and needed addressing.

In New Zealand this is obvious, average listed company CEO wages now averaging 20 times the average pay, whereas in the 1970s, that ratio was often three or four times.

Yet we are but babes in the woods compared to the USA or Britain, where the ratio exceeds a riot-threatening 200 times, the USA S&P500 CEOs averaging $20 million a year.

The ratios are revolting.

They began to multiply in the early 1980s and in New Zealand, probably linked to that awful era when the likes of Chase, Equiticorp, Brierley, Jones, Renouf, Judge, Euro-National, National Pacific, Pacer Kerridge and Fay Richwhite were breeding their acolytes.

What began with no laws to prevent insider trading converted to an era when the media abetted anyone who handed out bottles of red wine, enticing the media to depict corporate chiefs as people who could feed millions with a snapper and a loaf of Vogels, rather than as plebians with the ambition to become patricians.

Corporate rewards became revolting, creating a new tier of people who captured wealth from the middle classes yet enjoyed the media's adulation.

Campbell may now generate new thinking on the subject.

His Sky Casino group grossly overpaid its previous CEOs and should now revert to acknowledging that its product range hardly requires unique talent to maintain its market position. Casinos do not find solutions for viruses or solve quadratic equations.

The same could be said of most of our listed public companies.  It would be possible to make a case that today's extreme packages for executives are simply theft from shareholders.

The same argument would hold up if directed at those fund managers who claim some of the rewards that can be accomplished with high risk, when the only money at risk belongs to people other than the fund manager.

The argument might also hold water in the debate over whether any fund managers should ever ''own'' the contract to manage money but should instead be able to be replaced without cost, if a majority of investors are unhappy with the fund manager.

Corporate executives of listed companies who do their job brilliantly can be rewarded by backing their ability, buying shares in the company and benefitting from the share price recognition of their excellent performance.

Privately-owned companies can do what they like.  As long as they are not using ''other people's'' money, they cannot be said to be stealing from their shareholders, or others.

Campbell's social concerns and range of experiences make me wonder if his name is in the frame for a future governor of the Reserve Bank.

If it were in that frame then banks should start lobbying to hold on to Adrian Orr forever.

Campbell's varied perspectives might well be the catalyst for new thinking about many issues, with corporate excesses being just the first.

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David Colman writes:

It was great to see another company added to our local exchange with HMY - Harmoney being the latest addition to both the NZX and ASX on 19 November.

A$92.5 million was raised at A$3.50 per share, giving the company at listing a market capitalisation of just over A$350 million.

Funds raised are intended to fund growth in the Australian and New Zealand personal finance sector.

Peer to peer lending was discontinued on 1 April 2020 but personal finance needs continue to be met by the company via personal loans arranged quickly online.

The current loan book totals approximately NZ$470 million to new and repeat customers across Australasia.

Harmoney charges hefty establishment fees to borrowers and receives a net interest margin being the difference between the interest rate charged to the consumer and the interest rate paid to the wholesale lender.

An operational update comparing the four months to October 2020 versus forecasts showed total income marginally ahead (2% higher), and net profit well ahead (52% higher) with the loan book and loan originations very close to forecast.

Following the IPO, HMY shares have initially traded at slightly below the listing price with a low volume of shares trading.

Trading volume is constrained by 72.3% of the company's shares being held by larger shareholders including various companies, trusts and senior management that cannot sell under voluntary escrow arrangements.

Escrow arrangements permit selling after the publishing of half year results (for the period ending 31 December 2020) for unaffiliated shareholders, or full year results (for the period ending June 2020) for affiliated shareholders.

Harmoney's first interim results as a listed company for the period up to 31 December 2020 are scheduled to be released in February 2021 at which time unaffiliated shareholders will have the opportunity to sell shares if they choose.

NZX-listed Heartland Group (HGH) holds 8.4% and formerly listed Trade Me holds 7.6% of the shares on issue.

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ANOTHER IPO is also in the works with the New Zealand Rural Land Company (NZL) offer open since Monday evening.

NZL is looking to raise between $75million and $150million to fund rural land acquisitions, buying land from farmers and then leasing it back to those farmers.

Acquisitions will have the combined goals of providing growing recurring revenue from long term leases from quality tenants and capital growth from land value gains.

The company is at a very early stage, has no financial history and has not yet entered into any contracts to acquire land, dairy farms being its initial target.

Investors should read the offer document carefully and seek advice before committing to the issue.

The NZX will be ecstatic to see increased IPO activity that may help stem the trend of companies opting to list across the Tasman and help replace firms that have delisted following successful takeover offers.

A rural based property company will provide an additional option for property investors in a sector that is not represented on the exchange at present.

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TWO weeks ago I wrote about the then imminent IPO of Ant Group, which is China's largest financial technology group.

The IPO was to be the largest in history but with less than a week before the shares could trade specific regulations were drafted concerning micro lending which affected a large and growing part of Ant Group's operations.

At the last minute the high profile US$34.4billion IPO was suspended and the way the company had marketed the firm as a technology firm (allowing sky-high valuations) was put in doubt as regulators made it known that the firm was seen increasingly as a financial institution for which the new regulations would apply.

Due to the growing number of small online loans by Ant Group (using big bank financing) to individuals and small businesses (which large banks steer clear of directly) the new rules will require the giant Ant Group and other smaller rivals (there are over 7,000 microfinance companies in China) to hold more capital, curbing projected profitability.

Many saw the new regulations as a very public, politically motivated, rebuke of Jack Ma, billionaire founder of Alibaba and Ant Group, who has, too often it seems, been a vocal critic of the financial system that helps fund his businesses.

The regulations themselves likely reduce risk for most parties involved (including retail investors) but are certain to curtail projected profits, and sharply reduce the indicative value, that attracted investors to the now suspended, and perhaps cancelled, Ant Group listing.

Alibaba, which holds a third of Ant Group, saw its market capitalisation fall by more than twice the value of the IPO in the days following the release of the draft regulations.

The scuppered IPO is a good reminder that, especially in communist countries, even a giant company is at the mercy of government intervention.

The complicated mix of communist doctrine and capitalist driven expansion creates a confusing and sometimes uncomfortable business landscape in China.

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Ryman Healthcare has announced a new issue of 6 year senior secured bonds with our estimate of the interest rate being between 2.20% and 2.50%. The interest rate will be set on the 7 December.

The issue will be fast-moving, booked by contract note with brokerage paid by Ryman.

More details are available on our website on the Current Investments webpage.

Please contact us if you would like to go on the list to invest in the bonds.

TRAVEL

Chris will be in Albany next Tuesday 1 December (pm) and in Ellerslie on Wednesday 2 December (am).

Michael will be in Hamilton on 7 December and Tauranga on 9 December.

Please let us know now if you would like an appointment in your town.