We have to hope that our fairly shallow pool of investment funds is able to support New Zealand businesses in the tough times ahead

We have to hope that our fairly shallow pool of investment funds is able to support New Zealand businesses in the tough times ahead

Amid all the blur of activity around the Government and the Reserve Bank pumping in billions of dollars to prop up the economy, it's easy to overlook a rather salient point.

Debt is fine as far as it goes - but a lot of businesses are going to need more capital, by which I mean their 'own' money as opposed to borrowed money.

Are our rather small financial markets going to be able to provide the kind of capital that will be required?

If we go back to the Global Financial Crisis in 2008 the real nub of the problem was that, having taken massive losses, financial institutions needed - not more borrowed money - but injections of capital from shareholders. Ultimately governments came to the party. The banks were bailed out and we could start to move on.

In New Zealand a lot of our companies suffered damage in the aftermath of the GFC and they had to raise capital from shareholders. This was done remarkably well by many and the companies were able to pick themselves up. Many shareholders who took part in capital raisings post the GFC did very well out of it too.

But, and it's a big but, the GFC had fairly well defined origins and a very specific crunch point. After the bank bailouts had happened it's not right to say it was 'all over' as such, but for the most part the problems WERE in the open and it was about recovering from there. 

The obvious difference this time around - and this is why direct comparisons with the GFC are dangerous - is that the length and severity of this crisis will ultimately be decided by when the virus is no longer an issue. And nobody knows how long that will take.

This isn't the GFC

Therefore simply applying a GFC Playbook in how to handle the crisis - and how to recapitalise businesses that will need recapitalising - is fraught with risk. And that's simply because businesses might raise the money they THINK they will need now - but will have to go to the well again if things don't improve as quickly as hoped or expected. And how are shareholders going to react if told in six months time "ah, you know that money we grabbed off you and said would be enough for us, going forward, well...it ain't". 

Apologies if I sound alarmist because I don't want to be. But obviously we need to keep business failures to a minimum and the ability of companies to properly capitalise themselves will be crucial. 

I think the Government and the Reserve Bank are so far collectively doing a great job of keeping money flowing and keeping confidence up.

However, in the months ahead, businesses big and small are going to need to face the fact that damage has been done to their balance sheets and the only real way to 'repair' that is for injections - not of more debt, but of investment capital.

Blowing holes in the balance sheet

It is one of the unpleasant foibles of a company balance sheet that the way to get rid of debt is by paying it off physically. However, getting rid of equity/shareholders' funds (the money that would theoretically be paid out to shareholders in the event that the company sold itself up and wound up) is as easy as a stroke of the pen.

Yes, that's right, all you have to do is write down the value of the company's assets and whammo down go the shareholders' funds by the same amount. Company directors routinely get away with murder when communicating with shareholders and talking about 'non-cash writedowns' that have no effect on the operation of the company. 

In a way, it's correct. But the fact is if a company whacks $50 million off the value of its assets (and therefore $50 million off the value of shareholders' funds) that's 'real' enough. It means the company's worth $50 million less than it was yesterday and the shareholders would collectively pocket $50 million less if you sold up all the assets and return their funds tomorrow.

All of which is a slightly long-winded way of saying the kind of ructions we are currently experiencing have the ability to blow big holes in balance sheets and make a mess of shareholders' funds.

An embattled airline's lament

Poor old Air New Zealand would be a standout example at the moment. It's agonisingly transformed in a couple of months from being a nearly $6 billion a year turnover international long haul airline into a modest regional carrier with maybe at best turnover of $500 million (but obviously with the lockdown running a much less than that level at the moment). I fly on Air NZ domestically a lot and I think it's a crying shame.

What the asset valuations at Air NZ are going to look like when it next opens its books for the June year will be beyond interesting to see. But given that most of its fixed assets (planes) are currently parked up growing weeds there's going to have to be some savage writedowns. Assets that generate $6 billion of revenue are worth plenty. Assets generating $500 million, not so much.

And of course this all comes off the shareholders funds. But in the meantime the debt (and Air New Zealand had something like $3 billion of it last time I looked) is still there. So, let nobody be fooled that the $900 million the Government has loaned our airline is a 'rescue' as I've seen it described. It's breathing space, that's what that is. Air NZ will need capital and lots of it. Fortunately we own 51% of it so one way or another that will happen. 

The main point of debate with Air NZ I might imagine is around the 49% of the company that's owned by other shareholders and just how they are accommodated. Personally I wouldn't be surprised it the taxpayer ends up owning 100% of Air NZ. Right now that probably looks like the least bad option.

You are going to hear about covenants

Anyway. Moving on. I've talked about asset values. The other thing you are going to hear about a lot in coming days, weeks and months is banking covenants. Companies don't talk about them. You often don't know what banking covenants a company actually has. And you only tend to hear about them when they are breached or in danger of being breached.

What are covenants? Well, they are undertakings given by the borrower to the lender, generally expressed in financial ratios, such as a promise to cover interest costs X times by revenues or operating earnings. Or there may be an agreement not to have debt exceed shareholders' funds by more than X% and so on.

The point is that a sudden sharp economic shock that produces a very rapid loss of earnings and drop in shareholders' funds can blow up covenants pretty quickly. And once a company's breached its covenants it's breached the terms of the loan and so therefore the loan is in theory repayable on demand. 

Now, no sensible lender is going to do that as a first resort in such an environment. But the way to fix the problem is through more capital.

Already we've seen Auckland Airport getting its lenders to agree to waive the covenants till the end of next year - on the condition that money is raised, hence the whopping $1.2 billion capital raising - $1 billion in an institutional offer and $200 million in share purchase plan. (At time of writing on Tuesday the airport had just announced successful completion of the $1 billion institutional offer - which is a great effort)

Raising up a storm

I give Auckland Airport great credit for being so fast off the mark (only Kathmandu with its $200 million-plus was faster among big companies) - providing even the seemingly massive $1.2 billion is going to be enough for what might be a long time.

And others will want to go where Auckland Airport's gone. A very casual glance among some of the big players on the NZX suggest that the likes of Air NZ (as we've mentioned), Fletcher Building, Infratil, Sky City, Sky Network TV and Tourism Holdings may all have varying wants or needs to bolster their coffers.

There will be plenty of businesses big and small that do want to raise capital. 

Collectively it is going to involve billions of dollars - as we've already seen with Auckland Airport. 

As I said earlier the recapitalisation process for corporate NZ after the GFC was done quite well. 

It might not go as well this time

This time I fear could be a lot harder. The more money that is sucked out of the market the more difficult it is for those who haven't raised capital to then do so. And the other point to note is that if a company is having a big capital raising that often forces investors to sell other shares in order to find the money to take part in that capital raising. So, that puts downward heat on other share prices.

Because of the unique situation put upon us by the lockdown this capital-needing situation is likely to arise far more swiftly than we've seen before. 

I think the Government, for all its great help so far, will need to keep a close eye. Whether it could or should help out any businesses that might struggle to raise capital is a debate for another time or place. But this is going to be a very fluid situation that will require quick solutions.

We welcome your help to improve our coverage of this issue. Any examples or experiences to relate? Any links to other news, data or research to shed more light on this? Any insight or views on what might happen next or what should happen next? Any errors to correct?

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26 Comments

Indeed. The 'Revaluation Reserve' item on the Equity side of the Financial Position Statement is gonna be zeroed toute suite, being as how it arose from continual asset revaluations that reflected local price inflation, as much as anything real in the business. Poster child: Auckland property prices.

I wouldn't be too quick to urge the Gubmint to 'keep an eye' on this: they might be more inclined to get the NZSF's arm up behind its back and suggest, gently, that NZSF skew their asset allocation towards NZ capital-hungry businesses. That's cutting right across two core principles: that investment allocation be based on a hard-nosed appraisal of candidates; and that allocation be diversified as much as possible to avoid correlated failures in a single sector, or location, or nation.

And then there's KiwiSaver funds....

Amid all the blur of activity around the Government and the Reserve Bank pumping in billions of dollars to prop up the economy,...

Where's the inflation? - the nominal five year note yield recorded by the RBNZ is ~0.64% - the 2025 linker yields around 0.463%. Thus the ~5 year breakeven inflation rate is about 0.1770%. Not much forward opportunity being priced there.

I dont see inflation on the horizon unless its imported. Deflation yes as wage growth turns negative. All the talk about printing money is only relevant if it genuinely adds to the velocity of money but given demand will be falling off a cliff and banks will still apply fairly rigid lending criteria I just can't see any reason for inflation to take hold.

More likely to be deflation, which the banksters have been trying to postpone.

It happens when only the few capture the spoils. Demand is only there if one can afford the product or service. Essential goods and services prices are now beyond alot of people without government subsidy. A large component of revenue which should be taxed is sitting in these tax havens; which need a bloody shake up.

And in a finite system, one can not have infinite growth. Interest on interest only works for so long, before debt consumes us all.

When the fed, and other central banks print money, they change it from finite, to infinite. The situation now is serious deflation, printing money is inflationary, which is the central banks aim, inflation. The danger is that deflation is hard to control once it takes hold, so the knee jerk reaction is to print way too much money, and in no time at all, the result is runaway inflation. Bad news is, despite promises, the only cure for high inflation, is high interest rates. The economy is not stuck between a rock and a hard place, it's simply facing it's choice in which manner it would like to collapse. NZD becomes worthless, or about 50% to 80% less than it is today.

Look the western world has had a 30 year deflationary period because of outsourcing most of it's manufacturing to China. The easiest way to bring inflation back to the west is to apply trade tariffs and drive up imported costs. Bingo prices go up inflation goes up and then interest rates can go up.

If capital is too shallow, just print some more?

" I wouldn't be surprised it the taxpayer ends up owning 100% of Air NZ. Right now that probably looks like the least bad option."
Spot on.
And that raises the question of Fletchers as well. The least bad option for them might be to invest in some new stationary with the heading "Ministry of Works".

Back to our egalitarian socialist roots?

it may eventually lead to cheaper avacados...

Could we be seeing NZ crayfish in stores again?

Cant say the course over the past 30 years has been a good one. Free market my ass Rogered by Douglas

Now that one made me laugh out loud. A precious resource not to be undervalued in times like these, thanks.

FBU? Not with a barge pole.

Bad enough that AirNZ has been classed as "too Kiwi to fail".

a bit of a shallow article, low on real analysis ~ how many sectors require capital, size of fund raising, appetite from investors etc.

Also interesting at the SME end of the scale. If SME owners have used equity in houses as capital, things could get quite awkward in a correction.

Or as collateral for debt - that's quite common too...

Airlines are not generally profitable. It is a cyclical business as well as subject to a range of limiting factors like fuel, weather, international relations and climate change etc. How many times must we go through this before people learn?

AirNZ was very lucky that it was able to operate in a window of profitability for so long and even luckier the financial engineering didn't ruin the company thanks to taxpayers bailing it out.

Fitch,join in and downgrade the big four. Puts them on negative watch for good measure.

If the crisis drags and there is significant changes in demand and supply - e.g. international tourism declines significantly for the medium term - then injecting capital into some firms may simply not be enough to keep them going. Significant economic restructuring may be required in sectors like tourism. I note that Gareth Morgan on RNZ was arguing against supporting businesses and for focusing more on supporting people directly last week, on the basis that some firms would not recover so wage subsidies were not cost effective. Who knows what is the best approach with so much uncertainty over how long the virus will last - its a nightmare situation with no easy or best solutions, only less bad ones.

Some firms are just too important to fail: Fletchers (employs 10,000) and their expertise will be needed to do some much-needed infrastructure work for the future and keep all those employees working.......i.e. Fletchers playing the role of the old Ministry of Works so needlessly put to the sword by both National and Labour in the 1980s and 1990s.

Coming into this crisis NZ had debt/GDP of only 20%, didn't it? Very low by world standards.
At end of WW1 Britain had debt/GDP of 250% so how did they deal with it? They got stuck in to the obscenely rich landed gentry and taxed the hell out of them; many estates with acres of manicured grounds and sprawling mansions had to break up their estates to pay the taxman.
Why shouldn't we have a close look at our "fortune 500" and see what we can squeeze out of them. Are they untouchable?

Talked about land (where so much money is in NZ) then jumped to the fortune 500. Why not stay on land, in that point? It has been making obscene untaxed income and sucking money out of productive export enterprises.

If a reset it the way out, then the only way to do it is let those companies that can't see out the next so many months go bust. Just like the banks were supposed to have increased capital holdings, so too should all companies of national importance. The assets will still be there, it's simply the irresponsible executives that get sacked. If any govt intervention is required, it should be to ensure those same execs are not re-employed. That way ,if the government purchases the assets, it gets them at a great price, and re-employ previous workers, with an increased remuneration, as the former executive salaries, bonuses, share options etc, can be more representavely spread across the entire organisation. After all, the corporate sector would act in a similar manner with regard to letting a competitor go bust before taking over it's assets. Why bail out the executive class above market rates?

Lock-down reading suggestion:
https://www.scoop.co.nz/stories/HL1507/S00101/the-fire-economy-new-zeala...

Watch the current NZ govt/opposition party, RBNZ/Orr+team, Boutique/banks/'independent' economist, collective local sub-conscious decision making process at play.. 'whats going to happen with my housing portfolio?' - Bangs! oh noo knee jerk.. oh noo borrowing more, QE more, subsidy more.
To Ed. can you bring back that cartoon? the one Adrian try to flog the dead horse? put back in, but added a phantom feed in front of it, Jacin/govt/opp line up with phantom bucket of grass, water and those crumbling phantom plan of regulatory measures: CAR, deposit guarantee, LVR, FHB deposit, DTI and the wild cowboy from US try to shoot Chinese traditional trader, which silently bring the martial art sword about to chop the head of that dead horse. Fun time ahead, for our FIRE economy!

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