News } Tabak

Under Pressure

TBK View Newsletter: October 2010

It's the terror of knowing
What this world is about
Watching some good friends
Screaming "Let Me Out"

To see the Queen "Under Pressure" live at Montreal video click here

Bank turns the screws

It’s been a constant theme in my newsletters that diversification of lenders attached to specific securities is best way to avoid sleepless nights as a borrower.

Well it’s no different now, but as the credit crunch continues and with the demise of the finance companies and other non-bank lenders, banks continue to be the dominating force in obtaining debt finance.

By far the greatest number of request we receive now are to replace existing finance as the banks demand debt reduction, or as existing financiers have gone out of business or retrench. This includes financiers reducing or ceasing lending as they amalgamate seeking banking licences. The Canterbury Building Society, Southern Cross Building Society and Pyne Gould Corporation proposal to merge their banking related activities, is a good example of the latter. To see the proposal click here.

Well as I’ve reported in previous newsletters it’s not all bad news. Other private lenders are appearing and equity participation and is now becoming a viable alternative to refinancing existing loans at a time debt finance is extremely hard to obtain. It’s not easy and requires a lot of work structuring an offer that will attract investors, but it can be done. Right now I’ve got examples of clients either “under pressure” from the bank to reduce their exposure, or of their own free will seeking a more “comfortable” position, where I’ve been able to offer this alternative.

These offer excellent returns to private investors and do not require personal guarantees. They offer a win-win situation where the owner deleverages and the investor can obtain a far better return than that offered at a time of low deposit rates - which are likely to continue in a world where Governments are forced to keep interest rates low

Such opportunities usually require larger sums of money and are open only to “Eligible Persons” as defined in the Securities Act, but if it’s of interest to you either as person looking to relieve the pressure - or looking for an investment - give me a call or email me on john.paine@tbkcapital.co.nz.

Interest rates will rise – but not right now

In last month’s newsletter I talked about a series of articles on interest rates published by Westpac economists Brendan O’Donovan and Dominick Stephens. I said they should be compulsory reading for everyone who is in business (or owns a house). To see that issue click here

A more recent article entitle “Raising interest” shows why the New Zealand banking system has only limited scope to raise funds from local deposits by paying higher interest rates to investors placing money on term deposit.

The banking system here sources about 45% of its funding from retail deposits such as credits in personal and business bank accounts and term deposits. The balance is sourced from wholesale markets, most of which comes from offshore. Since the Global Financial Crisis it has become more difficult and expensive for banks to raise money in this way.

Adding to the fund raising difficulties banks have, the Reserve Bank regulations that have sprung from the Global Financial Crisis make retail funds significantly more attractive to banks than wholesale funds. This is because banks now have to 65% of their funding from “core” sources and wholesale funds lose their core status when there is 6 months remaining to maturity, whereas most retail deposits are counted at 90% core right up to the day of maturity.

Consequently banks are competing more for retail deposits and this has driven up the interest rates the banks are paying for them. The higher cost of funds will be passed on to borrowers so the ultimate result of the Global Financial Crisis will be higher interest rates and little change in the retail/wholesale mix of bank funding.

For a copy of this latest and the previous articles look under NZ Economic Bulletins here on Westpac’s web site.

But don’t expect a rapid rise. The consensus amongst virtually all commentators is the Official Cash Rate will remain as it is for the rest of this year and probably until March 2011.

And there’s no indication offshore rates will rise rapidly as the Western economies continue to experience problems. The latest news from the U.S. is a statement from the Fed saying more action was needed to bring down America’s unemployment rate, which raised the prospect of more quantitative easing – a synonym for printing money – and led to a further drop in value for the U.S. currency.

The perceived lag in any increase in offshore or domestic rates indicates floating rates here will remain on hold for some months. Fixed term rates – which are more a function of offshore interest rates – also look to be on hold and will only rise if there is a substantial turnaround in sentiment on the global economy.

But the currency has risen - now

A side effect of the woes offshore - and continued quantitative easing – has resulted in a low U.S dollar and a subsequent rise in the Australian and New Zealand currencies in relation to it.

It was interesting to read an article in Sharechat entitled “Stimulus sparks optimism” about the how the Bank of Japan cutting its benchmark interest rate to “virtually zero” and creating a 5 trillion yen (US$60 billion) fund to buy government bonds and other assets to support the economy, had created optimism in the equity markets. Policy makers in the U.S. and the U.K. were also considering quantitative easing measures.

"You've got central banks globally continuing to use the tools at their disposal beyond simple interest rate policy to stimulate more capital velocity in the system," Craig Peckham, equity trading strategist at Jefferies & Company in New York, told Reuters.

The Fed is expected to detail more asset purchases when its policy committee next meets in early November. In an interview with the Wall Street Journal, Chicago Fed President Charles Evans said he favours “much more accommodation” given the labour market’s woeful state.

Despite investors’ glee with the prospect of more easing, some cautionary flags are being raised. Ultra-loose monetary policies by the Fed and the European Central Bank were throwing the world into "chaos" rather than helping the global economic recovery, Nobel Prize winning economist Joseph Stiglitz said on Tuesday.

A "flood of liquidity" from the Fed and the ECB was bringing instability to global foreign exchange markets, Stiglitz told reporters after a conference at Columbia University. "The irony is that the Fed is creating all this liquidity with the hope that it will revive the American economy," he said. "It's doing nothing for the American economy, but it's causing chaos over the rest of the world. It's a very strange policy that they are pursuing."

Last week the Australian dollar reached 99.2 U.S. cents - some expect it to go beyond parity by the end of the year – and the Kiwi topped 75 U.S. cents for the first time since this time last year. There’s a feeling the world economies are in the midst of a currency war. See Herald article here and that the Aussie dollar is in danger of a correction which the Kiwi would inevitably follow – see article here

There’s been a lot of talk in the past of how a strong New Zealand dollar is bad for our exporters but it’s interesting to see how that view has subsided in recent times. This is probably a result of the shift in the importance of the countries to which we export. According to Moody's economist Matthew Circosta, the continued strength in Australia and China should offset the impact of the U.S. strength on New Zealand's economy.

"The Kiwi is actually falling against the Australian dollar, improving New Zealand's export competitiveness against its biggest customer," he said, adding China, New Zealand's second-largest export market, had also allowed its own currency to rise in recent weeks.

While Mr Circosta warned that falling US and Europe currencies could dampen New Zealand's trade growth in the short term, demand for soft commodities in Asia, where more than 50% of exports are sold, would "benefit over the longer term" through higher income and population growth. To see the Stuff article click here

Residential property

Even though it’s Spring and the time we’d expect to see an upsurge in house listings there’s no flood of properties coming on the market. Vendors clearly do not feel “under pressure” to sell and with no rise in interest rates on the foreseeable future are happy to sit.

Average national house prices are where they were three years ago and seem to be hanging in there. But and those that are offered for sale sell at good prices.

A recent Landlords blog entitled “Uncanny prediction for house prices” shows interesting charts from an ANZ presentation showing house prices and turnover through their peaks from 1970 through to now. It shows the most recent housing boom lasted for 24 quarters and prices rose something like 80%.

The first chart shows housing prices screaming up from 2002 to 2007 when the current downturn started and the recent climb back. They say “The idea is that the bust time would be quite long and house prices would fall 20 - 25% from their peak. At the time this graph was put together the falls had run for 12 quarters yet prices were down only 11%. What’s fascinating is after they came off their peak they bounced again. The message is that it seems that the housing market just won’t crash.

The second chart compares two housing cycles, being the mid to late 1990’s and 2007 through to now, which show an amazing correlation. Extrapolating the graph of current turnover with the previous experience would indicate the bottom of the current cycle has been reached.

The author of the presentation, ANZ economist Khoon Goh, writing in the latest issue of NZ Property Magazine about housing affordability, says although homes are becoming more affordable they are still on the expensive side. If we follow this view it is likely the gap will close through a rise in incomes rather than house prices. To see the article and graphs click here

In my view it’s back to that location location thing. There’s a lack of quality houses in established areas being offered for sale and those that are continue to be well sought after.

The latest QV report supports this view. In an article last week entitled “Lack of quality listings on the market”, they say “Although listings remain far out-weighted to sales, there is a lack of well-presented properties on the market, especially in Auckland and Wellington. Those that do come up are selling quickly and for good prices.” But properties that are not well presented and lacking maintenance or have perceived flaws are either failing to sell or buyers are discounting their offers accordingly.

Footnote

Just when you thought governments had it all under control ........ The Economist Magazine publishes an interactive view of government debt across the planet.

They say “The clock is ticking. Every second, it seems, someone in the world takes on more debt. The idea of a debt clock for an individual nation is familiar to anyone who has been to Times Square in New York, where the American public shortfall is revealed. Our clock shows the global figure for all (or almost all) government debts in dollar terms.” To see where New Zealand stands in comparison with the rest of the world click here

Cheers

JP

John Paine
TBK Capital Limited

Email: john.paine@tbkcapital.co.nz

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