Taking Stock

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TAKING STOCK 19 October 2017

SO WHAT do we do with $900 million?

That was the question addressed by investors and fund managers last week when the powerful Dutch bank Rabobank returned to New Zealand investors and institutions the $900 million it had borrowed in 2007.

The return of $900 million has had a dramatic effect on yields in the bond market.

Perhaps half of that money has been returned to individual bank accounts, some $35 million to our clients, $100 million to the clients of Craigs Investment Partners, and very likely more to FNZC, which organised the issue in 2007.

Never before 2007, or since, has any issue attracted such a level of support.

The issue was open for just a few days in 2007, offering a 0.76% margin over the annual swap rate, at that time 8.66%, meaning the rate was 9.42% for the first year.

The credit rating of Rabobank was then AAA.

World credit markets were disintegrating in late 2007 and here the worst of the finance companies and trust company mortgage funds were collapsing.

It was a great piece of timing by Rabobank.  Most people were seeking a sanctuary.

In one week our company fielded calls from all parts of New Zealand, some wanting allocations of millions.  Complete strangers contacted us, and I suppose every trained member of the advisory sector had the same experience.

Of course after 2008 the global recovery depended on decades of zero interest rate policies (ZIRP), so when Rabobank reset its rates each subsequent year, the payments fell, eventually to an unsatisfactory 2.88% last year.

As rates fell, investors sold off the securities till the price reached 70 cents.

Those who understood the instrument, had competent advisors, expected it to be repaid in October 2017, and did not need higher quarterly cashflows, made a killing by buying in at 70c, with just a few years to wait for the $1.00 repayment.

Now that it has been repaid, the security can be said to have been a great choice for investors in 2007, even better for those who bought at a discounted price in subsequent years.

At roughly the same time as Rabobank raised $900 million, Origin Energy, the majority owner then of Contact Energy, raised $250 million through an Origin Energy redeemable share, which enabled the Australian-based Origin to use Contact Energy imputation credits, useable only in New Zealand.

This issue was priced at a 1.5% margin over one-year swap and was also based on an annual reset.

ASB arranged this issue.  At the time it was made clear that there was an intention to redeem the shares, though not a guarantee of timing.

The issue was also successful, paying in its first year more than 10%.

As rates fell, the security became less valuable, falling in price to less than 60c for a while.

Those who understood the security, and believed the company would eventually repay, bought at 60c, received their interest each quarter, and made a handsome gain when the securities were repaid at the $1.00 par price.

I recall all these events well for they led to the events that shall not be forgotten, and highlighted the dark side of the moon, for those people who do their damnedest to offer real information and help investors.

This sad saga began when an Auckland man rang and asked for an allocation of $2 million of Rabobank perpetuals.

I commented that that was a huge sum to put into one security and asked what percentage of his wealth that amount represented.

I was told that his wealth was none of my business.  Today I would politely reply that I could not help and hang up, but in 2007 the role of a broker included offering all credible choices to the public, and so I persisted, asking why he might not split his sum and include other options, such as the Origin Energy security.

I sent him both prospectuses, with a letter correctly outlining their features. He invested most of his money in Rabobank and some in Origin Energy.

When rates fell, and their market prices fell, he rang and told me we had misrepresented the securities.  I told him if that were true, I would buy them back at par, but our letters describing the products were precise and unarguably accurate, so he had no right to abuse us.

So he went off to a dishonest journalist who wrote about the wicked broker who had ‘’talked him into buying’’ these ‘’rotten’’ securities.

I challenged the feeble journalist, seeking an apology, provided proof that the investor was lying, but as my name had not been used I did not persist, though I wrote to the editor.  He did not seem to care, perhaps in part explaining my disrespect for that newspaper.

The incident made me resolve not to accept as clients those who refused to disclose their financial matters and it illustrated the lamentable state of journalism, where a weak or dishonest practitioner would not want the facts to spoil an attention grabbing headline.

Now that Rabobank and Origin Energy have both repaid the securities they have performed precisely as they were expected to perform.

Of course, those who held Rabobank now have to find replacement securities.

The flood of money has largely chased other fixed interest securities.

Soon the compulsory repayment of an Infratil issue (IFT170 on 15 November, 2017) will add to the problem.

Because there have been few new issues, and because so many of the listed debt securities have few sellers, to winkle out bonds from the secondary market causes significant price increases, hence lower yields.

As an example the ASB reset security (ASBPA) has risen in price by nearly 10% in 10 days, to a high of 87c.

It pays interest, reset annually at a rate 1.3% higher than the 1-year swap rate, and resets shortly, probably at a rate of around 3.4%.  If one buys the security at 80c, then the effective cash yield of 3.4c per dollar of face value, is a real return of 4.25% (on the 80c cost).

A fortnight ago ASBPA were 80c; today, because of the flood of money from Rabobank, the ASBPA might be 87c, meaning the yield is not 4.25%, but 3.9%.

Investors would be hoping that when ASB no longer can claim equity credit for the subordinated security, it would repay the $1.00 par cost, so if one bought at 87c now, and was repaid $1.00 in , say, four years, there would have been a 13c gain, as well as the interest received.

Many other fixed interest securities have been scooped up by those repaid by Rabobank.

The recently issued Heartland Bank bond sells at a significant premium because of this buying spree, as an example.

The problem will grow further, in all likelihood on December 15, when it is expected that the French bank Credit Agricole will repay its subordinated bonds.

Credit Agricole issued $250 million of five-year reset securities in December 2007, to raise NZD to lend to the Canadian pension fund that most unwisely borrowed nearly two billion to buy the Yellow Pages from Telecom.

Telecom, whose clever strategist was at the time Marko Bogoievski (currently Managing Director of Infratil) was working then for Theresa Gattung.

He had the foresight to observe the risk of the Yellow Pages losing its dominant position in business advertising so he looked for a buyer and found a Canadian teachers pension fund that had a contrary view of the future.

The Canadian fund borrowed a huge sum from the likes of Deutsche Bank, Goldman Sachs, and many banks, including Credit Agricole.

The syndication of lenders have now no hope of collecting the repayments, in fact much of the debt is now converted to fairly useless shares in the company that owns the Yellow Pages.

Credit Agricole will have written off its loan but it will need to repay investors one day, and the most likely day is December 15, 2017.

It has the right to rollover the loan but the expectation is that Credit Agricole will repay.

The bank is barely known in New Zealand, though those with good memories will recall Calyon Investments, which laid the rotten egg that hatched into Credit Sails notes, an infamous issue to New Zealand investors in 2006, organised by Forsyth Barr.

This was the issue that was so mis-described  that the Commerce Commission sought a prosecution against the issue organiser after discovering some fairly unsavoury processes and some foolish behaviour which culminated in a Forsyth Barr senior person describing, in an email, the investors as ‘’flies’’.

The Commerce Commission files did not show any of the parties in a favourable light but agreed ultimately to a huge settlement ($61 million), paid for by insurers and Forsyth Barr, the latter’s share being $5 million, as I now have been told.

Calyon, owned by Credit Agricole, is unlikely to have much success in New Zealand and even Credit Agricole itself might be tainted by the dreadful Credit Sails behaviour.  Investors should never forget such behaviour.  A permanent boycott would be an understandable response.

If Credit Agricole repays on December 15, there will be even more downward pressure on secondary market rates.

Those brokers, economists and analysts who continue to forecast interest rate rises will be aware that the global strategy continues to be ‘’low rates forever’’ and will be aware of the bundles of money returning to investors.

I am unsure how that matches with their expectation of great increases in yields.

Globally these events are the cause of much higher allocations of investments to assets like property and shares, forcing these prices up, in pursuit of yields higher than the very low bank deposit rates, and the low bond rates.

It is extraordinary, but still true, that rates in New Zealand are higher than in any country with as strong a balance sheet as our country currently enjoys.

So what does one do with $900 million?

I guess the answer is to get knowledge of what is available from sharebrokers and financial advisers or those who actually understand the various securities available, and describe them accurately.  No useful information is likely to be sourced from the newspaper!

The likelihood is low rates for even longer, and a sharemarket still being fed by KiwiSavers, yield chasers and (probably) foreign money.

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THE Chinese institutions, sovereign wealth funds, and their high nett worth individuals are keen to invest in New Zealand.

Investments here provide diversification, high yields, and lead to relationships, particularly in the food sector, that are seen as desirable.

By and large they have proved to be honourable investors, with long term strategies.

The wealth of the top 1% in China has helped lift our asset prices, has helped maintain low interest rates, and has enhanced our ability to trade with an enormous market in a country with over four times the size of America’s population.

As you will have seen through their involvement with Synlait Milk, of which a Chinese company owns about 35%, relationships have been most helpful in opening doors and satisfying regulators.

The Chinese investors, however, have one significant feature that New Zealanders will never share.

They greatly respect politicians, even more so cabinet ministers, and they seem to revere prime ministers, no matter how inept, immoral or uncommercial they may be.

There is an explanation.

In China, politicians have great power, can make or ruin by intervening in commerce, and are greatly feared because of that power.

Perhaps they assume at least a little of this power rests with our own politicians.

Perhaps they assume that networks of government officials ensure squeaky doors get oiled.

It is probably from this mistaken respect that, as an example, Jenny Shipley was unwisely asked to chair the Asian controlled Mainzeal Construction.

Mainzeal, shockingly governed by Shipley and her team, was a serial poor performer, trading at a level way beyond its meagre capital resources, and eventually collapsed, costing sub-contractors, creditors and shareholders almost as much, say, as Bridgecorp cost its investors.

No one in the sector was surprised, except, apparently Shipley and her equally inept directors, who seemingly had no idea that the company had no real access to capital, terribly thin cashflow, millions of unpaid bills, and such a dreadful reputation that some experienced contractors simply would not work with Mainzeal.

These matters will no doubt be aired in court, if no earlier settlement is achieved.

To be fair, it is not just Shipley that the Chinese applauded.

There are many politicians with no or meaningless corporate skills who have been allowed to make a living through figurehead attraction, rather than relevant skills.

The likes of Roger Douglas and Fran Wilde were effective politicians but in my view were as relevant as directors of Brierley Investments Ltd as the All Blacks props Jazz Muller and Keith Murdoch might have been.

Going back into previous decades, I recall Brian Talboys, once dragged into the appalling Pacer Pacific Group, a spectacular example of a company driven by hope rather than reality.

Lombard Finance Ltd had THREE absolutely inappropriate figurehead politicians, Hugh Templeton, Bill Jeffries and the pompous Doug Graham, presiding over an activity and some drongos with whom no experienced commercial person would have shared a cup of tea.

I do understand how the likes of Jim Bolger and Michael Cullen came to chair a government owned monopoly, where commerce, competition and sales/marketing are not as relevant as government sanctioned process.

John Key will be a good ambassador for Air New Zealand, perhaps opening doors and attracting deal makers.  Air New Zealand will have others who focus on strategy and compliance.  The Chinese will like him.

His new role in the ANZ has been grossly misunderstood.  The ANZ NZ board has a token role in decision making, approximately equal to my role as chief culinary advisor to my wife.

Perhaps it was the Chinese respect for retired politicians that led to Ruth Richardson being paid to sit on the board of Synlait Milk.  I cannot imagine any other reason.

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I guess this subject of choosing appropriate directors who add value to governance and performance will come up if the Litigation Funder LPF is allowed to present its cases against Mainzeal and Property Ventures Group.

In both these cases, the vast majority of experienced people knew that failure was imminent YEARS before the liquidators were appointed, just as was the case with some of the worst finance companies.

The performance of directors needs to be assessed in a High Court.

We need more case law outlining the legal standards expected just as we need more case law around the performance of our trust companies and auditors.

The sad fact is that out of court settlements often mean the Court never gets to hear the truth, assess it, and adjudicate on what is acceptable.

We do have a fit and proper person assessment made of people.

It would be useful to know the matrix used when making these assessments.

One wonders whether the matrix examines such considerations as relevant experience and subject knowledge, and whether previous corporate failures are considered.  Would Donald Trump be ‘’fit and proper’’?  Pardon?

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IF, as rumoured, the Wellington property developer, syndicator and property owner Willis Bond plans to achieve an NZX listing, it will need a particular focus on governance.

Property developers and entrepreneurs are involved in an activity that seeks rich returns for real risk.

This sort of model needs ample capital, access to more emergency capital at quick notice, ample banking confidence, high levels of skill and experience, and a totally transparent approach to all stakeholders.

Willis Bond has done remarkably well over the past 20 years, with virtually no public disasters, gradually building a reputation that has attracted deep-pocketed admirers.

My warning is this.

Strategic Finance, when the late Jock Hobbs was at the helm, also built up a band of wealthy admirers, and it too won bank admiration, working transparently and co-operatively, for example, with the Maori money in Wellington.  The retirement village at Athletic Park was an example of this teamwork.

However it allowed irrelevant people into its governance, its key shareholders wanted money out without regard to the quality of the buyer, its management and some directors began to behave without transparency – for example allowing staff to underwrite projects to reach minimal sales requirements – and when Hobbs was ill, no longer a shareholder, and no longer in charge, Strategic decomposed, exposing some dreadful people who now feature on our ‘’never again list’’, Allco Hit providing some of those people.

Ultimately its founders, its directors and its key people were seen to be weak, greedy or self-focussed, or all of the above.

Willis Bond is not in an identical field but it is in a similar activity, attracting similarly entrepreneurial spirits, and people willing to accept higher risks to achieve higher returns.

Currently it enjoys a status that few of its competitors have achieved.

If it does list on the NZX it should engage with the very best of our corporate directors, and should lock up the existing shareholders for a long period, ensuring their shareholdings are not liquid for some years.

If it does list, perhaps next year, it will be one of the largest listings of the year.

It will want to seek blue ribbon status, so will be hoping to attract the best of our investment bankers to guide it.

Sure as anything, it will not want retired politicians on its board!

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I will be in Christchurch on October 24 and 25.

Edward will be Hawke’s Bay on Tuesday November 7 and Taupo on Wednesday November 8.  He will then be in the Wairarapa on Monday November 20 and in Auckland on Thursday 30 November.

Kevin will be in Ashburton on November 23.

Anyone wanting to make an appointment should contact us.

If you wish to be alerted about the next time we visit your region please drop us an email and we will retain it and get back to you once dates are booked.


Chris Lee

Managing Director

Chris Lee & Partners Limited

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