Newsletter December 2008
November 28, 2008
I am sending this newsletter a few days early due to the number of fixed interest opportunities available at present. If any of the bonds mentioned in the newsletter are of interest to you please let me know as soon as possible so I can put our bid in for them.
As we predicted, fixed-interest yields have tumbled throughout November. High quality bank bonds are now trading between 6.00% and 7.00%, and there are very few opportunities to achieve the 9.00% yields that were available only a few months ago. The sharp decline in yields is due to the expectation of further rate cuts by the Reserve Bank on December 4th. Some commentators are predicting a 1.50% cut in line with other central banks around the world as Governments attempt to shield economies from recession.
More institutions have been granted the Government Guarantee through November, and investors in Marac, South Canterbury Finance, Allied Nationwide Finance, UDC, and the Wairarapa Building Society can sleep easy knowing their investments carry no risk through to October 12, 2010. My concern is how the Government manages the withdrawal of the guarantee in two years time, and what effect that will have on investor behaviour. My advice to clients who are investing in financial institutions they would otherwise not have invested in is to ensure their deposits mature before October 2010.
The following table gives an indication of how far interest rates have dropped:
Security Maturity Rating Yield Price/$100
UDC Finance 18 months AA 6.20%
South Canterbury Finance 18 months BBB- 7.00%
Marac Finance 18 months BBB- 6.50%
Kiwi Bonds All terms AAA 5.25%
BNZ Income Securities (PIE) Perpetual A+ $109.30
ANZ Perpetual Bonds Perpetual A+ $109.50
PGG Wrightson Finance
Our allocation of PGG Wrightson bonds is full – there is a public pool so we can still accept applications, but cannot guarantee they will be accepted.
Fletcher Building Finance
Fletcher Building Finance is making a public offer of $100 million of capital notes with the ability to accept $100 million oversubscriptions. The capital notes will be issued in two series – May 2014, and May 2016. The interest rate initially being offered is 9.00%. Fletcher Building Finance may, at any time prior to the closing date, without prior notice, change the interest rates it offers, other than for those capital notes for which applications have been accepted at the date of the interest rate change.
The capital notes are unsecured, subordinated debt obligations of Fletcher Building Finance. The capital notes are guaranteed on an unsecured, subordinated basis by Fletcher Building Limited. Fletcher Building Finance and Fletcher Building Limited have covenanted that they will not pay dividends in respect of their respective ordinary shares while interest on the capital notes remains outstanding. The offer may remain open until 31 March, 2009 or such earlier date that Fletcher Building may determine.
Capital notes differ to bonds in that the company can elect to pay investors back at maturity in shares rather than cash. This provides some comfort to banks that have lent the company money. Capital notes also usually rank below other company debt, so you would be further down the queue in the event of a company failure. When investing in a security such as this you are relying on the underlying company (Fletcher Building) to perform well throughout the term of your investment.
These capital notes will be of interest to those of you who have GPG Finance, Trustpower, or Burns Philp Finance maturing in December. They are a similar type of security, carrying similar risk.
Genesis Energy
Genesis Energy Limited has registered a prospectus for an issue of unsecured, unsubordinated fixed rate bonds. The offer is for $150million (plus up to $75million of oversubscriptions). Two maturities are available (15 March, 2014 and 15 March, 2016) and the indicative rates are between 7.00% and 7.75%.
The rates will be set on December 1st, and the offer will be closing on December 19th.
South Canterbury Finance
South Canterbury Finance is considering making an offer of up to $75 million of first ranking, fixed rate, secured bonds with up to a further $25 million available by way of oversubscriptions. South Canterbury Finance has a guarantee under the New Zealand retail deposit guarantee scheme.
The bonds mature on 8 October 2010 and will pay interest of 8.00%. South Canterbury Finance has the right, at its discretion, to extend the term of the Secured Bonds by up to 12 months to 8 October 2011 in the event the Deposit Guarantee Scheme is extended by the Crown for at least a corresponding period.
Previous South Canterbury Finance bonds have sold out in days, and with the backing of the Government Guarantee this is likely to be the case again.
PLEASE CALL OUR OFFICE AS SOON AS POSSIBLE IF YOU ARE
INTERESTED IN ANY OF THESE SECURITIES
Finance Companies
St Laurence
St Laurence’s recapitilisation plan is finally with investors, and voting papers need to be in by December 3rd. St Laurence are aiming to repay 70% of debenture-holders’ principal and interest by December 2013, with the remainder paid back as and when they are in a position to do so. It seems a very long repayment scheme to me, however I do believe St Laurence (with significant capital injections from its shareholders) is better placed to recover investors’ funds than a receiver.
Dorchester
The Dorchester deferred payment plan is due out this week. They hope to repay investors’ principle over a three-year period, and will possibly pay 20% of that principle prior to Christmas.
Strategic
Strategic are (again) working with their trustee on a plan to restructure the company, and hope to have something to put to investors before Christmas. Like St Laurence, I believe the Strategic management are better placed than a receiver to recover money for their investors.
Credit Ratings
The ratings you see assigned to the debt securities in this newsletter have nothing to do with my personal view of the company – they are ratings assigned by a credit ratings agency. The ratings represent the probability of a company defaulting on its obligations. Below is the Standard & Poors’ rating scale.
Rating Estimated Probability of Default Over an Average One-Year Period
AAA 0.00% – 0.01%
AA 0.01% – 0.02%
A 0.05% – 0.10%
BBB 0.20% – 0.40%
BB 0.60% – 1.60%
B 3.00% – 11.00%
CCC
CC 25.00% – 30.00%
C
Ratings provide a good comparison between companies, but like any research, are based on historic information.
Equities
The sharemarket continues to take its lead from the United States and Europe, and we are seeing unprecedented volatility. Sometimes this volatility is on very low volumes, which distorts prices. My advice to buyers of shares hasn’t changed over the last six months – that is to buy in stages rather than try and time the bottom of the market. The NZSX50 has dropped 38% since October 2007. I am confident that buyers of quality shares at current prices (provided they have a long-term view) will not regret their decision.
Newsletter November 2008
November 3, 2008
The Global Bailout
Volatility, fear, panic, (and Government intervention) – all the things financial markets don’t like, and we have seen them all in the space of two months. Governments around the world clearly had to do something to restore confidence in the markets. Banks were too scared to lend to each other and there was the potential for a real meltdown amongst financial institutions. The problem with Government intervention is; often it sends all the wrong signals. We are seeing it now in New Zealand, as the Government guarantee of financial institutions unfolds. It was always going to be fraught with anomalies – who is included and who is excluded? Investment funds are flooding out of mortgage and managed funds in favour of banks and finance companies. AXA has just frozen a $225 million mortgage fund, pre-empting mass withdrawals. This is exactly what the Government was trying to avoid by including finance companies and building societies in the scheme. It seems the more the Government intervenes, the more they have to intervene. What would have been simpler in my view (I’m a recognised expert on economic policy!) was to guarantee people’s deposits at a specific date, and any investments made after that date carry the risk associated with individual institutions.
What effect will the massive global Government intervention have on us? My knowledge of economics is limited to a couple of introductory papers at university, and some practical experience following the crash in 1987. The theory tells me that central banks pumping billions of dollars into an economy causes inflation, and most financial shocks have been followed by periods of high inflation. The practical experience tells me high inflation is very beneficial for those who borrow money to invest in assets that grow in value, but very damaging for those with most of their wealth in cash. We may be entering a period of low interest rates coupled with a (relatively) high rate of inflation, and investors need to be aware of what effect this will have on their wealth. If all your assets are in fixed interest, and you spend all the income it generates, your wealth can be severely eroded by inflation.
Fixed Interest
Yields are falling in line with expectations, after the Reserve Bank dropped the Official Cash Rate to 6.50% on October 23. Unfortunately there have been no really startling fixed interest opportunities in the last couple of months. The Auckland Airport bond issue paying 8% for eight years was filled before we even received the hard copy of the investment statement. What that tells me is there is a large amount of cash in the banks looking for a slightly better return. The banks themselves have started issuing more debt, with the BNZ and the ANZ National Bank seeking to raise $50 million and $100 million respectively. However, instead of issuing new bonds they reopen an existing bond issue and investors buy them as if they were buying on the secondary market. For example, the BNZ reopened their 27 May 2015 8.675% bond. Anyone buying it now will receive the 8.675% coupon payment semi-annually until maturity in 2015, but they have to pay approximately $105 per 100 to get it. This gives you a yield of 8.00%. The banks are not paying brokerage to us so we must charge clients secondary market brokerage rates of 1% if they want to buy these bonds.
GPG Capital Notes
The 2003 GPG Capital Notes are due to mature in December, and GPG have offered investors the opportunity to either have the notes repaid in cash, or roll them over at a new rate of 9.00% for five years. GPG doesn’t need the money, hence the low rate. Their 2012 capital notes are trading on the secondary market at 10.50%, and there are a number of similar securities trading at those levels, so my advice would be to redeem the notes and look for somewhere else to put the money. A small selection of other opportunities includes:
Security Maturity Rating Yield Price/$100
Kiwi Bonds All terms AAA 5.25%
UDC Telephone Call A/C At Call AA 7.65%
Sky City Entertainment 15 May 2010 10.40%
BNZ Income Securities (PIE) Perpetual A+ $106.80
ANZ Perpetual Bonds Perpetual A+ $104.75
Trustpower
Just as this newsletter was being finalised we were informed that Trustpower intends to make a bond offer. Indications are the issue will be $100 million of unsecured, subordinated bonds paying quarterly interest of 8.40% per annum. Please let our office now as soon as possible if you are interested in this issue.
Equities
At some stage the equity markets will stabilise and there will be a return to normality. With interest rates dropping and predictions of further falls, the sharemarket becomes a very real alternative for investing a proportion of your funds. I may be sounding like a broken record but I can’t emphasise enough how much you need to be aware of the effects of inflation. In twenty years time $1 million may only buy an average three-bedroom home. We are retiring earlier and living longer so we need our retirement funds to last much longer than in the past. Having some money in equities over the long-term “should” help your investments keep pace with inflation. I read an interesting article recently by Warren Buffett, probably histories most successful value investor. Here is a small part of that article.
“A simple rule dictates my buying: Be fearful when others are greedy, and be greedy when others are fearful. And most certainly, fear is now widespread, gripping even seasoned investors. To be sure, investors are right to be wary of highly leveraged entities or businesses in weak competitive positions. But fears regarding the long-term prosperity of the nation’s many sound companies make no sense. These businesses will indeed suffer earnings hiccups, as they always have. But most major companies will be setting new profit records 5, 10 and 20 years from now. Let me be clear on one point: I can’t predict the short-term movements of the stock market. I haven’t the faintest idea as to whether stocks will be higher or lower a month — or a year — from now. What is likely, however, is that the market will move higher, perhaps substantially so, well before either sentiment or the economy turns up. So if you wait for the robins, spring will be over.”
We receive daily research on New Zealand and Australian companies and will provide this to you on an individual basis. Current “BUY” recommendations include Fletcher Building, Contact Energy, Trustpower, Sky TV, Fisher & Paykel Healthcare, Sky City Entertainment, Rakon, Monadelphous, Nufarm, Woolworths, BHP. CSL and AGL Energy.
Please note that any recommendations made in this newsletter are fairly generic, and I recommend you ring and discuss your own situation if you are thinking of investing in any securities mentioned in the newsletter.
Capital Guaranteed Investments
Man Investments (OM-IP) and Liontamer are two companies offering equities-based investment products with capital guarantees. Liontamer tends to base their offerings on themes such as energy or emerging markets, whereas Man Investments follow the same investment strategy they started using in 1997. Their first fund launched in August 1997 has generated a compound return of 17.50% per annum, with claims that most of their funds have returned between 10% and 20% per annum since inception.
How do they offer a capital guarantee, especially if they are investing in equities? They invest a proportion of your funds in a secure bond (usually with a large bank) for the term of the investment. Let’s say the investment runs for eight years, you put in $10,000, and the company can buy an eight-year bank bond paying 8.00%. They would invest $5,402 in the bank bond which would grow to $10,000 with compounding interest by the end of the eight-year period. So from day one they know they can pay you back your initial investment. The remaining $4,598 is invested in shares and higher risk securities such as futures and options. The hope is that the amount invested in the high-risk part of the fund generates returns in the order of 20% to 30% per annum to bring the overall return up to an acceptable level. These funds can perform well regardless of market direction depending on the types of securities they buy. For example, share options allow you to make money if you predict there will be a drop in the price.
Liontamer uses the Belgian KBC Bank for its guarantee and Man Investments uses the Commonwealth Bank of Australia. In some cases a rising guarantee is employed, whereby once unit prices reach a certain level, a certain percentage over and above your initial investment is also guaranteed. Although getting your capital back at the end of an investment period is reassuring, if that’s all you get it’s actually a very poor return. This is something that seems to be glossed over by those pushing this type of product. If your $10,000 was invested in the bank bond at 8% you would have $18,509 at the end of eight years. The other point to note is any guarantee is only ever as good as the company offering it. However, Man Investments and Liontamer have both performed well since these funds were launched, and do provide opportunities when markets are volatile as they are at present. They would suit investors seeking growth over income, and those with a long-term view.
Both these companies pay high levels of brokerage to advisers. We rebate any brokerage over 2.00% on these products back to the client.