NZF Group (NZF and NZF010)

[Jaa]

Yes, this is true - that is why they are Capital Notes instead of debentures. The value of conversion is by a typical 95% VWAP of the 20 days prior to maturity date. Maturity date is 15/03/2011.

Remember, current market capitalisation of NZF is about $15million. There are over $20million of NZF Capital Notes.

My current view is that:

1) if the companies situation were to remain the same as the current situation - they would find roll over or repayment a better option compared with replacing current dominant shareholders with capital noteholders. They are profitable at existing levels of debt - they need to increase capitalisation well before the maturity of the capital notes.

2) if the company were to get into trouble ... this is the classic death spiral situation - in which capital noteholders become the new owners and existing holders would be wiped out.

Hi Enumerate, thanks for your response. Thought I had better continue this discussion in the right place.

Unlike you, I assumed the worst case that the notes will be converted into shares in March next year. You are right that this would leave the current bondholders owning ~58% of the company with an effective entry price of 11 cents a share. The shares last traded at 20 cents, their all time low. Though the only bid at the moment is at 4 cents!

A few points/questions:

1) Are the NZF010 notes covered by the government guarantee until October?

2) Studying its business units, the company does show promise. However they seemed to specialise in low-doc mortgages (especially Finance Direct) which I would assume can't have gone well for them over the last couple of years?

3) If we extrapolate from their interim report and their Jul-Dec 09 profit of $2.6m to get a normal full year profit of $5m this would give their 20 cents shares a P/E of 7.3 on the combined capitalisation (Shares and Converted Notes) or a P/E of 4.1 for the notes at 0.55714. Half of these $5m in earnings comes from non interest income aka fees so should be fairly stable.

4) Any idea of the size of their KiwiSaver book? Trail commissions on this in the future will be substantial if they are indeed being paid trail commissions which is the industry norm. Hulijch may well decide to buy out the company to save this cost and to secure what must be one of their key distribution channels?

5) Where I expected weakness, I found strength in that their impaired loans actually improved by $1m in the last half year. Can this number be relied upon?

6) What do S&P see that we don't to have rated them a B (Outlook Negative) in Feb this year?

Anything else I am missing?

[Enumerate]

1) Are the NZF010 notes covered by the government guarantee until October?

No, they are Capital Notes - not retail "non-bank" deposits

2) Studying its business units, the company does show promise. However they seemed to specialise in low-doc mortgages (especially Finance Direct) which I would assume can't have gone well for them over the last couple of years?

Not true ... they are 1st mortgage specialist and they fund these mortgages with bank loans, not publicly issued debentures. Where do you find reference to "low doc" loans - I thought they were careful lenders.

3) If we extrapolate from their interim report and their Jul-Dec 09 profit of $2.6m to get a normal full year profit of $5m this would give their 20 cents shares a P/E of 7.3 on the combined capitalisation (Shares and Converted Notes) or a P/E of 4.1 for the notes at 0.55714. Half of these $5m in earnings comes from non interest income aka fees so should be fairly stable.

I agree ... with banks withdrawing from the mortgage market, I would have thought there would have been growth prospects. They also indicated that they would diversify into insurance.

4) Any idea of the size of their KiwiSaver book? Trail commissions on this in the future will be substantial if they are indeed being paid trail commissions which is the industry norm. Hulijch may well decide to buy out the company to save this cost and to secure what must be one of their key distribution channels?

I believe they act as an agent for Huljich Wealth Management - hence they do not directly have a Kiwisaver book.

5) Where I expected weakness, I found strength in that their impaired loans actually improved by $1m in the last half year. Can this number be relied upon?

It is the application of IFRS accounting standards to potential mortgage "break fees" - they were very conservative in accruing the potential loss, which never eventuated and hence the write back.

6) What do S&P see that we don't to have rated them a B (Outlook Negative) in Feb this year?

The mortgage business does not need an S&P rating - it relies solely on bank money. It is only the consumer finance arm (NZF Money) that raises public money through debentures that has applied for the S&P rating. They pointed out the thin capitalisation of the parent group as being an issue. They further made the point that margins were thin. What can you say ... yes, I would like thicker margins and higher equity capitalisation, as well.

Anything else I am missing?

Main risk is if the banks withdraw the funding lines to the parent - NZF Group. I would see selling part of NZF Money as a solution to the credit rating issue with the consumer finance arm. A JV with Rabobank would go down nicely ...

Bottom line is that these guys have been ignored by the market. They are in the Huljich sphere of influence. This is good news as far as I am concerned ... it means NZF Group has a seriously wealthy backer with the insight to survive the GFC. The beat up on Peter Huljich, which we have covered in another thread, is further evidence of the resentment and envy that drives the industry. If you are weakened by bad decisions - you score points by trying to tear down those that are strong.

I have my eyes open ... but I am comfortable about the risk/reward the NZF010's present. I have even bought a few NZF ords to gain access to the NZF AGM.