At the height of the boom, the international ratings agencies were happy to give “AAA” credit ratings to IOU paper which turned out to be rubbish.

Now it seems they can’t be too conservative.

However, Standard & Poor’s move last week to lower Broadlands Finance’s credit rating looked very much like putting the boot in.

S&P first rated Broadlands “BB-” in February this year with a negative outlook, based on its accounts for the six months ended September 2009.

They showed Broadlands’ sole shareholder, Tony Radisich, had $17.82 million in equity in the company or 43.7% of total assets. Soon after, Broadlands reported its results for the year ended March showing Radisich’s equity falling to 39.9% because of a blowout in the allowance for impaired loans to $11.84 million at March 31 from $8.23 million six months earlier, Radisich’s equity fell to 39.9%.

However, S&P didn’t move to change its rating until December 9 when it lowered it to “B,” still with a negative outlook.

By that time, S&P had Broadlands’ draft accounts for the six months ended September this year.

These show a dramatic improvement in Broadlands’ financial position, largely as a result of Broadlands getting a new auditor, Grant Thornton, to replace BDO. That followed Broadlands seeking a second opinion from KPMG on how BDO had been valuing its impaired loans.

Grant Thornton cut this valuation to just $5.17 million at September 30, boosting Radisich’s equity to 47.8%.

This is extraordinarily high for a finance company and in more normal times I’d probably be complaining about Broadlands’ lazy balance sheet.

S&P complained about Broadlands’ cash

at September 30 falling to $40,000 compared with its $13.3 million debenture book. However, Radisich owns about half this with external “mums and dads” holding just $6.9 million.

S&P also acknowledged by November 25, the company’s liquidity had risen to $467,000, yet another demonstration of Radisich’s willingness to continue supporting Broadlands. S&P questions how long he will remain so willing.

Showing it is wearing the opposite of rose-tinted glasses, S&P highlighted Broadland’s reinvestment rate in September of just 6.8% “although this has increased more recently.”

In fact, its reinvestment rate for November was 68% – the company acknowledges the reinvestment rate is very volatile, reflecting how small its external investor base has become.

Radisich says he was “a little disappointed” by S&P’s downgrade. “We’re better off at the present moment.” His view is that BDO became ultra conservative after a number of the finance companies it audited, including Dominion Finance, Capital + Merchant Finance and Five Star Finance, collapsed.

Mind you, given the number of finance companies which have collapsed, few accounting firms would have escaped unscathed. KPMG, for example, was Lombard’s auditor.

Broadlands’ managing director Rudi Kats says S&P may have been spooked by the South Canterbury Finance and Equitable Finance receiverships – like Broadlands, both had been dependent on a single shareholder, Allan Hubbard and the Spencer family respectively.

Kats says his company will be writing to the Reserve Bank about the situation. Given finance companies are now required to obtain credit ratings, the central bank should be ensuring the ratings agencies “behave in a responsible manner,” he says.

Commerce Minister Simon Power is seeking feedback on proposed new regulations governing corporate trustees who are supposed to protect the interests of investors in unit trusts and various debt issues.

Power’s Securities Trustees and Statutory Supervisors Bill aims to tighten up the rules by requiring all trustees to be licensed by the Securities Commission (and later by its replacement Financial Markets Authority).

Under the licensing regime, trustees would need to demonstrate adequate monitoring systems and processes, experience and infrastructure and financial strength. Trustees would also have to report regularly to the Securities Commission on their compliance with the licensing regime.

Power’s discussion document notes: “As far back as 2004 the

Financial Sector Assessment Program concluded that New Zealand places heavy reliance on private supervisors like trustees without requiring sufficient accountability for such supervisors.

It goes on: “The Registrar of Companies also noted specific problems with trustees following the finance company failures of 2006 to 2008, including a lack of capability, poor compliance with reporting requirements and weak trust deeds.”

In my view, Power is asking the wrong question. Instead of asking how to make trustees more accountable, he should be asking whether we should have trustees at all.

More than $5 billion of investors’ funds in finance companies, not including the South Canterbury Finance collapse, went down the toilet under the watchful eyes of trustees. All they seem good for is ticking boxes and, when all hope is lost, acting as undertakers by calling in the receivers.
Can anybody name a single instance of a trustee preventing investors’ money from being lost? Perpetual Trust, New Zealand Guardian Trust, Trustees Executors, Covenant Trustee Co.? I don’t think so.

All they have succeeded in doing is providing investors with an utterly false sense of protection.

The National Property Trust debacle earlier this year demonstrated trustees are more likely to act as roadblocks to investors’ wishes. Guardian Trust was intent of ignoring investors’ demands that National’s manager should be sacked after its parent company St Laurence Group went into receivership.

It was investor agitation amid complete inaction from Guardian Trust which resulted in the deal which internalised National’s management, cutting it loose from St Laurence.

Power’s proposed new regime will add further costs, which inevitably investors will pay, on top of existing trustee fees, generally a percentage of total assets and typically about 0.15%. The discussion document proposes a flat $1,242 annual fee per debt issue or unit trust, payable by the trustee.

But while investors’ money will pay the bills, effectively the new rules will still leave the debt issuer or unit trust manager in charge. In the case of unscrupulous issuers, the foxes will still be in charge of the hen house.

Would investors be any less protected without a trustee?

It’s been something of a rollercoaster for Nuplex over the last couple of years. At times, the board and senior management seem to have been out of touch with reality.

In May 2009 the NZSA wrote to 20 companies with an analysis showing they were carrying excessive debt based on their published 2008 annual reports. The market was outraged that we could be so “reckless” with our claims.

Provenco Cadmus (now in liquidation) came out bottom of the heap; Allied Farmers was not much better and almost all of the companies on the list subsequently went to the market to strengthen their balance sheets. So who was fooling who?

Nuplex was also on this list. Chairman Rob Aitken claimed our study was flawed. It is hard to see how he justified that position as just weeks earlier the company had been forced to ask shareholders for a bailout of biblical proportions. The reason – a huge debt to equity blowout!

Our study showed that even in June 2008 Nuplex may have been in breach of one bank covenant. Again, there was denial based on the company’s capital notes being equity rather than debt.  This subtlety was probably lost on the capital note investors.

When debt covenants were officially breached due to the GFC a few months later, the company saw no reason to inform its owner shareholders, despite the situation being critical. In the latest annual report Aitken claims that “shareholder interests were preserved”. Try telling that to anyone unable to afford to take up the seven for one rights offer!

In April 2010 the Securities Commission announced action against Aitken and the company for breaching continuous disclosure rules. Aitken continues to protest that covenants are only a guide. Until the bank actually enforces its rights, he seems to hold the view that the shareholders don’t need to know, despite the fact that at that stage their investment is probably heading down the toilet.

Now the Nuplex board seems to have agreed that moving the company domicile to Australia is the next smart move. There are three reasons given.

Firstly, New Zealand dividends could be partially imputed. The company tells us that at present all corporate overheads are carried in New Zealand meaning there are no New Zealand profits to impute against. The usual situation is to recover overheads from subsidiaries and remit these, thus alleviating this burden.  Quite why Nuplex cannot do this is something we are querying with them. In any event, it does not matter whether dividends are imputed or not. Either the company pays the tax and declares a lower dividend or the investor does so from a proportionately higher payout. The outcome is

the same. Only the process differs.

Secondly, Aitken claims greater liquidity in the larger Australian market. Nuplex might end up around 172 on the ASX200 if they can meet the appropriate liquidity hurdle which would not be the case at the moment. This hardly positions them in the headlights. In New Zealand, they would drop to 46 on the NZX50. So, coverage would diminish and arguably reweighting by passive funds could depress the share price. On Friday 17 September, 54,750 NPX shares traded on the ASX and 321,848 on the NZX. NPX’s argument is not supported by the facts. The reality is a lose/lose situation.

The final reason is a re-rating of NPX shares over time. In our view, this will be influenced by the company’s performance rather than where it is domiciled. Off the radar and with modest liquidity at best, the shares may indeed be re-rated, but not necessarily in the direction Aitken expects.

It has been said that capital is easier to find in Australia. This is undoubtedly true, but NPX have plenty of headroom to grow. Debt to NTA is a modest 15%. Until such time as it is demonstrated that additional equity is unavailable, this is a non-reason.

There are compelling arguments for staying put. New Zealand has a free trade agreement with China, a large and growing market for NPX. Australia does not. This is a global company. It could be based anywhere from an operational perspective. Moving to Australia is no panacea. Look at Nufarm.

So what are the reasons? Could it be related to the majority of the board and many executives being Australian based? A fear of flying? Or perhaps the New Zealand directors fancy all that international travel? All the personnel took the job knowing the present situation. It is a bit rich to now find fault with it.

Certainly, the company has become staggeringly generous towards its top people since the gradual shift to Australia gained momentum and business picked up. Retired CEO John Hirst collected $4.2 million for his last 9.5 months including $1.4 million bonus and $1.9 million termination, not forgetting the $370,000 that he escaped paying when the executive share scheme was cancelled in 2009. New CEO Emery Severin has pocketed $415,000 in his first 2.5 months. The NZSA is not averse to rewarding good performance, but this is getting out of hand.

NPX is an iconic New Zealand company. A real “garage to global” success story.  81.6% of shares are held in NZ. NPX has been incredibly well supported by NZ investors. The NZ capital markets can ill afford to lose another primary listing.

There is no advantage to the majority of shareholders in moving the domicile.

Aitken could do well to reflect that ultimately shareholders will decide whether such a move is wise, and indeed whether he retains the confidence of the NZ majority owners.

To find out more and support the NZSA, join up online at www.nzshareholders.co.nz The best 30c per day you will ever invest!

Contributed by John Hawkins, NZSA Chairman.

Why, all my friends and family ask me, are insurance advisers getting all worked up over a form?

Alright, you got me – my friends and family have never requested any information from me about insurance advisers; ever.

Except for today. This afternoon, or maybe it was the morning, a family member – whom I cannot name for legal reasons – explained how her insurance adviser switched her life policy to another company.

This, I immediately thought thanks to my conditioning in the trade, sounds like a clear case of ‘churn’.

Churn, in the insurance business, occurs when advisers switch their clients to different providers merely to generate a new lump of commission.

Typically, life insurance advisers receive a large upfront commission at the time of initial sale – over 200% of the first year’s premium in some cases, which is high by world standards – and a much lower ongoing payment, also known as a trail, as long as the policy remains in force.

Insurers pay a high upfront commission to advisers to get the business but need to keep the client on their books for a number of years to make a profit.

Life companies, then, are worried about the ‘churn’ effect. The irony, of course, is that it is the insurers themselves who, for competitive reasons, create the temptation to churn by offering higher commissions.

A number of high-profile cases have revealed examples where ‘churn’ has left clients with a lesser degree of life cover after the change of insurers.

And this is the problem the Investment Savings and Insurance Association (ISI) has tried to counter with its new Business Replacement Rules – the form that has so enraged the advisory industry.

Advisers are angry because the proposed ISI policy would allow insurance companies to contact clients who have been switched to new firms – in effect allowing insurers to question the quality of their advice.

But there are many good reasons why advisers will switch clients to new companies – and good advisers will clearly explain the change and how that affects their clients’ cover.

It’s also up to clients to ask those questions of their advisers.

So I asked my family member, XXX XXXXXX, why her adviser had recommended the change.

“Oh God no,” she said. “I asked him to find something cheaper – with the same cover. I was paying way too much.”

Before you enter a trade, the most important decision you will make is determining how much money to risk on the position. The 2% Rule represents the actual percentage of a trader’s capital that he or she is willing to risk on a single trade should it go against them. So a trader with $100,000 capital will risk $2,000 per trade.

The 2% Rule is a concept many traders use, however the exact percentage you choose will be determined by your own trading capital. Traders with $100,000 or greater may use a 1% or 2% Rule, while those with smaller accounts may use a 3% or 4% Rule. Either way, the only way to be successful in the market is to reduce losses when they do occur.

Managing your risk is a key element to being a successful trader. Novice traders are quick to look at how much money they could make, however many have no plan for when to cut a losing trade. Successful traders will have a trading plan that will include a predetermined figure on how much they are willing to risk on each trade such as 2%. Having a set figure will also take the emotion out. Disciplined traders that stick to the 2% Rule will have the benefit of being able to make clear decisive trading decisions. If the trade moves against them by 2% of their trading capital, the position is exited. This is one area novice traders struggle with and end up losing more money than they should.

The level of risk per trade, 1 or 2% of your trading capital, is kept at a small amount to avoid a string of losses that could wipe out your entire trading pot. Losses are always going to occur, but limiting the losses and preserving your trading capital are vital for staying in the game.

Using the 2% Rule, with $100,000 trading capital, it would take 50 straight losses to wipe out your entire trading capital. You might get a few trades wrong in a row, but you would have to be very unlucky to have 50 bad trades in a row straight-up. On the other hand, if you risked 25% of your capital per trade, it would only take 4 wrong trades to wipe you out. Even successful traders will have 4 losing trades on occasions.

An example of the 2% Rule: A trader with $100,000 trading capital decides to buy stock XYZ. The trader decides that he wishes to risk 2% – or $2000 – on the trade.

Now that he has determined how much he is risking, he will now need to work out the position size. He could buy $20,000 worth of stock and have it fall 10% before getting out, or he could buy $10,000 worth of stock and have it fall 20%. In each case, he is still only willing to risk $2,000 on the trade.

Should XYZ fall and the position is closed out with a $2,000 loss, the trader will still have $98,000 of trading capital.

To practise the 2% Rule, why not open up a demo account with IG Markets, the world’s No. 1 CFD provider.* www.igmarkets.co.nz

* Largest retail CFD provider by revenue (excluding FX). Source: Published financial statements. As at November 2009.