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  1. #11
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    I was surprised to read Chris Lee speculating that IFT should consider re-structuring the terms of the interest re-set on these securities to show leadership amongst the issuers of indexed securities (banks, Origin). Issuers of these securities have incidentally benefited from an unforeseen change in dynamic between interest rates on wholesale and retail funding rates due to Basel requirements. As I read it, he suggested that retaining adherence to the current formula was inappropriate, unethical and exploitative, given that it now results in subordinated debt being rolled over at interest rates below those of current higher-ranking issues.

    It will be interesting to find out if that comment was based solely on wishful thinking.

  2. #12
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    Probably a combination of wishful thinking and talking his own - or rather, his clients' - book!

    A bit much to expect an issuer to change the terms of an issue because conditions/circumstances move in its favour. We wouldn't expect investors to agree to changes if the situation was reversed.

    Does Chris Lee have much credibility these days?

  3. #13
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    by the way tim - you should be ashamed of the article you wrote for the herald.

    If anyone missed it - tim argues against mandatory ratings for debt issues to retail punters arguing:

    1. The rating agencies messed up with the GFC so why trust them
    2. Ratings just give advisors a cop-out
    3. Ratings are expensive to get

    My view on things is this:

    Does having mandatory ratings increase the protection of retail investors?
    Does it do so at a reasonable cost?

    THE ANSWER IS YES!

    A cynic might wonder what IFT's currently listed bonds would be rated as. It seems to me not too highly. Perhaps IFT prefers to pull the wool over mum and dads eyes. SHAME!!
    Last edited by modandm; 11-01-2012 at 06:54 AM.

  4. #14
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    I just came across this on the IFT web-site which gives their response on the issue of IFTHA interest rates:
    http://www.infratil.com/content/view/2868/155/

    Their main argument seems to be that fixing the terms in any straight-up way involves a transfer of value from shareholders to bond holders, given that the current market price for IFTHA is around 55cps. This seems a somewhat one-side argument, given shareholders have benefited from an unforeseen transfer of value to them via both lower interest paid and via the company buying back on market at a substantial discount. And I am guessing only a small proportion of bonds will have changed hands from the original holders.

    A return to "expected" interest rates (i.e. investors could have expected these subordinated bonds to give them at least a 1.5% premium to a bank term deposit) would cost IFT less than $4m per year - a value which they've already saved for the past few years.

    In 2009, the IFT notes to the accounts assigned a value of $420m to the contractual cashflows on the bonds (before that, I doubt that the accounts gave a figure, but, if IFRS had been in use, the amount would likely have been considerably higher). Just two years later, in 2011, the value of contractual cashflows has fallen to $334m - and given they are perpetual, this can't be attributed to cashflows paid.

    I am not arguing that they should necessarily change the structure of the IFTHA's to suit conditions, I am simply suggesting that their "transfer of value" argument for not undertaking a restructuring in favour of bondholders is fallacious given that it would simply be reversing an unforeseen transfer of value that has already occurred.

    While it can be argued that these things can go either way - and bondholders just got unlucky this time - it should be borne in mind that IFT retained the option to redeem for cash on notice (at the higher of face value or market value) and would no doubt have chosen to hurriedly do so if unforeseen circumstances had sent luck the other way.

  5. #15
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    Quote Originally Posted by modandm View Post
    by the way tim - you should be ashamed of the article you wrote for the herald.

    If anyone missed it - tim argues against mandatory ratings for debt issues to retail punters arguing:

    1. The rating agencies messed up with the GFC so why trust them
    2. Ratings just give advisors a cop-out
    3. Ratings are expensive to get

    My view on things is this:

    Does having mandatory ratings increase the protection of retail investors?
    Does it do so at a reasonable cost?

    THE ANSWER IS YES!

    A cynic might wonder what IFT's currently listed bonds would be rated as. It seems to me not too highly. Perhaps IFT prefers to pull the wool over mum and dads eyes. SHAME!!
    I have found Infratil one of the better communicators of information about their Company and cannot see any real reason to criticize the article.
    Rating agencies have definitely failed in their assessments at various times and one can wonder just how independent they really are.
    As the saying goes do your own research. As for the IFT perps I think there is no real reason why they should change the conditions. Chris Lee is being a wee bit optimistic.

    Westerly

  6. #16
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    Must say I agree with those sentiments Westerly, with the exception of Lee being a wee bit optimistic - his suggestion is ludicrous...

    The 'problem' with the Perps pricing is partly to do with absolute levels of interest rates, but IMO, far more to do with credit risk pricing movements since these were issued. The 'credit risk' margin that the market was offered and accepted at Issue was 150 pips above the benchmark one year swap rate. That is no longer appropriate in todays market - it's more like 500 basis pips (as is being paid on their fixed term bonds issued at ~8.0% (~3.0% market base rate plus ~5.0% implied IFT credit margin) So, to achieve that yield, the price must be ~54 cents for the $1

    For those who buy now, they hold some comfort that the Perps are pricing the Infratil credit risk a whole lot better, and unless credit markets get worse (possible) then the downside is limited. Holders will pick up the narrowing of credit spreads going forward, plus any benefit from the 'normalisation' of base rates, where the returns will be magnified by the deep discount currently available.

    By that I mean:

    If today you buy IFTHA's at 54 cents for FV of $1.00, your coupon is 4.22%, but your yield is 7.81% (ignore the dirty pricing issue)

    If rates rise to 10%, the coupon rises to 11.5%, but your yield balloons out to a very tidy 21.3%


    I do have one issue with Tim's comments regarding 'fairness' to shareholders with regard to the buy-backs - these securities are hybrid, and I would like to be considered as more of a shareholder, not a bondholder. To say therefore that shareholders are benefiting from the buy-backs when ONLY ordinary shareholders take the benefit, sticks in my craw


    Discl: hold at 55 and 58, and will accumulate more in due course
    Last edited by Xerof; 11-01-2012 at 02:11 PM.

  7. #17
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    As a shareholder (of Ords - for Xerof purposes), I would be annoyed if they did change the terms. The terms were well published at the time they were issued.

    Many holders of debt did much worse out of the GFC than IFTHA holders who have just been screwed as the spread has widened. At least the debt is still worth something!
    Free delivery worldwide with Book Depository http://www.bookdepository.co.uk

  8. #18
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    You could argue that there is a "moral hazard" in allowing Infratil to buy back the perpetuals at the discounted price.

    Market "convention" is that perpetuals are rarely "perpetual". They are usually redeemed, in full, at some point. Infratil controls this "intervention" - given they are profiting from collapse in bank bill swap rate given to the real market risk price - there is moral hazard in their at market purchases.
    Do not consider my postings as investment advice. I am here to share research and to speculate on what might be. The boundary between fact and conjecture might not always be clear - best to treat all comments as speculation.

  9. #19
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    Been thinking about this one further, to determine my view on whether IFT should show some greater degree of concern for bondholders.

    Firstly, as I see it, the main problem for investors is not in itself the low interest rate, but the unexpectedly high fall in the face value that results from the comparison between the interest now available on IFTHA and other available issues of similar ranking. With a fixed rate bond, holders expect the face-value to change, maybe by 5-10% over the life of the bond as interest rates change. It may change more dramatically if the financial status of the issuer changes. However, with a perpetual with annual reset, holders are looking to have more stability in their capital but accepting the variation in their income, although aware that a change in the financial status of the issuer would have some impact.

    However, the fall in face value has not been caused by IFT becoming less financially sound. Nor has it been caused by the fall in the interest rate per se - which has tracked the OCR cuts as it would be expected to. What is unexpected it that retail deposits and other more secure forms of debt did not absorb all the cuts in OCR. This resulted in the historical difference of the benchmark rate at around 50bp above deposits crossing over to become a 150bp spread in the other direction. Chart below from the RBNZ:

    Attachment 3751

    The result is that the IFTHA's now attract about 200bp less interest than they would have had the historical relationship stayed the same. If this had been applied today, IFTHA's would be attracting about 6.22% interest - which is probably closer to what holders would be expecting at this point in the cycle.

    Now I don't understand completely why this happened. The question is, whether it is cyclical, a structural change or a transitory change?

    If it is a cyclical change, then how long is the typical cycle and could issuers have guessed they were at a peak? It doesn't look particularly cyclical from that chart though, as the gap was fairly consistent over more than one business cycle. If a longer term series could show that it is cyclical, then issuers may have outsmarted investors - which is not the way a company like IFT which regularly goes back to the market might like to be perceived and may want to give some consideration to restoring their tarnished image. (It would be interesting to know how well their current bond issue is being taken up.)

    If it is a structural change, then either it was foreseen by issuers (in which case they really do deserve to be distrusted from now on) or it was unforeseen, in which case you would think that there would not be any resistance from IFT at all in coming forward, stating that it was unintended consequence of structural change and proceeding to offer a solution that restores interest to around the expected 6.22% mark.

    If it is a transitory change, then IFT are correct to assert that eventually the balance is likely to be restored, deposit rates will fall below wholesale rates, the premium in the IFTHA's will return and their face value will be (somewhat) restored. In that case, I can agree with IFT that the wisest course of action is to do nothing, as any attempt to alter the formula risks making things worse.

    I would be interested if anyone can shed more light on whether the change in relative rates is likely to be cyclical, structural or transitory.

  10. #20
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    Great post, Liz!

    No, I've got no idea what the answer is to your question - something akin to the meaning of life! My hunch is that we won't know until future events play out and that IFT have just got lucky with abnormally low rates - as indeed it could be said for any borrower paying market rates these days while inflation continues merrily along. I don't think we can credit IFT's Treasury with any particular foresight in this regard, however much we may admire their management. (I do)

    It also makes a lot of sense, of course, for the company to buy back and retire these securities at current prices, assuming that they can replace the funds at a comparable rate. Can't blame them for doing this but it doesn't necessarily mean that it's also a good buy for private investors unless one is convinced that these low rates are a cyclical or transitory phenomenon.
    Last edited by macduffy; 14-01-2012 at 02:17 PM.

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