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TOWER’s Wahine storm

Friday, April 11th 2008, 11:05AM 6 Comments

by Philip Macalister

Have you been trying to get your mind around the closure of the TOWER Mortgage Fund? I have and this is my take on it. My immediate question, and the one readers posed to me, was whether this is another finance company or ING credit fund. While some portray it that way I think they are wrong and this is something different. Finance company issues tend to be around asset quality, management and liquidity, particularly getting cash in from retail investors. ING's credit funds are directly related to the international credit crunch, while TOWER’s fund is more remotely related. The biggest relationship between TOWER and the others is that the credit crunch is changing market conditions. TOWER Investments CEO Sam Stubbs described it to me as being like the perfect storm. The fund had weathered 18 years of changing market conditions, but could not get through this one. It's just too big – sort of like the Wahine storm. Perhaps the biggest factor to bear in mind is that banks are aggressively chasing capital. This is great for investors but I wonder whether the pendulum has swung too far. Not long ago risk was repriced and banks were giving away money without charging enough interest for the risk (read US sub-prime crisis and NZ lo-doc lending). Now they are, arguably, paying too much for capital. Just look at the offers from Rabobank, BNZ and ANZ National. Poor old TOWER can't compete with these rates in its mortgage fund, and I suggest not many others can too. Stubbs agrees with me that it is weird for an asset manager to be giving money back to clients, but suggests new funds to keep the money within TOWER are not far away. He also reckons that TOWER will earn big brownie points from customers for taking this stance and acting early. The comments on Monday which most surprised me were the ones relating to the level of arrears. The company said it was just over 9%, which sounded incredibly high for a fund that has a conservative lending profile. It seems, after talking to Stubbs that that is the arrears rate which is actively managed and that the actual non-collection or default rate is around 1% and 2%. He says the 9.1% rate dropped to 8% on Tuesday after just one loan was sorted. The other point which is worth making is that the fund isn’t being closed because of a run on redemptions, as others have reported. “That’s absolutely not correct,” he says.
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Comments from our readers

On 11 April 2008 at 3:17 pm Maurizio Piglia said:
That's a fair assessment, and in this case, I totally sympathize with Mr Stubbs.
The returns the Banks are offering are unrealistic....not because they are too high Phil. But because that's where the risk today is higher.

The issuances you quoted were not bonds...where Tier 1 capital emissions and with all the due clauses to call them if and when conditions will be better...but if the banks are paying the capital those (high) prices, is for the good reasons they are now the dangerous points of the system.

And somehow , they are setting themselves up to shoot a cannonball in their own keels by raising the costs of the mortgages to the non subprime ( the regularly paying punters) to offset the high price of capital they themselves triggered by financing mortgages that should have never been.

I come from a country that is not a model of financial savvy...but so far, in my place, my generation was raised with the idea that if you wanted a home, you start working in your 20s renting one and saving, then you bought a small home in your 30's with at least a 50% down payment, and a 10, max 15 years mortgage.

In your late forties, you sold the small home and traded up, always with a 10/15 years mortgage, from 55 to 65 you saved money since you would be, by then ,motgage free, and at retirement time, you sold the large dream home, bagged the capital and headed for a remote seaside location where life is less expensive.

And no one found this timeline outrageous. 1 year ago, I had just came to NZ, was watching TV , and the light was on a couple, he was 23, she was 21, just married and both working, and the interviwer then was facing the camera, and looking utterly outraged because the young couple could not afford a home,due to the high prices, and that was presented as a matter of national shame.
To use a Kiwi expression...I was totally buggered!

I didn't dream to buy a home when I was 21...even dream was too expensive, and at that time it seemed totally natural.

To make a long story short, I can understand why Tower is unwinding, How can you compete with the over 10% pay outs offered bythe Banks ?

But who invested in the "safe" offerings of the banks should beware of "safe" things paying well above the Bank bill rates.
Higher returns are equal higer risks, it is one of the most rigid and true relationships of the financial markets.
And you should beware also of the social consequences, since passing the costs on the viable mortgage payers will make a portion of them less and less comfy in paying that mortgage...therefore deepening the very same gap that started it all...the gap to make ends meet for Joe Public.

Beware..the Banks are shortsighted and driven by the quarter results...they will not look if after that hill there is a precipice, exactly as they did with subprimes and CDOs, when THEY started it all.
On 12 April 2008 at 12:47 am Peanut H said:
Maurizio so much sense. Most people genuinely believe banks are unsinkable and there is no such thing as a risky bank. Most people also naively believe the Government will step in as they did with the BNZ and Air NZ crisis if a bank gets into trouble.

Towers Sam Stubbs knows any storm, even a perfect one, will soon blow over and realistically we will see lower interests rates within the next 6 months. Therefore you can understand my reticence in swallowing the perfect storm scenario.

Towers 1%-2% actual non-collection rate should not be a worry so long as the 1%-2% is not what is going to be written off, is there more to this figure than is being disclosed?

A quick analysis of the Tower fund tells me it has delivered around 5.33% net per annum after 33% tax for the last 7 years compared to say bank term deposits over the last 7 years of 4% net per annum after 33% tax. So no real problems with returns as banks will soon be back offering their 5-6% gross term deposit rates.

Most other mortgage funds are going ahead PIE'D PIR'D and seeking new funds and new lending business. So why not Tower?
On 13 April 2008 at 10:01 pm Sharon T said:

Interesting to also see Brian Gaynor come out with a similar story to you Phil, rather than the dramatics portrayed by the NBR with the 'interview' or 'commentary' by a lending competitor. As an investor in a range of managed fund products from cash through to equity, I am interested in this latest development as it's a move away from the debenture market debates. So, based on what has been said to date, and some basic research, these are my thoughts, for what its worth.


History shows the TOWER fund has won several awards, yet the mortgage fund NBR quoted has not (it's a newbie though). So the TOWER fund must have been doing something right to earn that?


The comments in the NBR particularly intrigued me in so far as it screamed out, "look at me, we're better than everyone else", so I did some digging on Midland Trust. I see from the Midland Trust prospectus and investment statement that the manager of the fund Peter Harrison is a CA from South Africa, (not a seasoned lender it seems) and is a recent arrival on our shores. And its mortgages were mainly originated from lawyers' nominee funds (as also stated in the NBR) - so we have mortgages sourced by lawyers managed by an accountant!!! What exactly do they know about lending? It's like me asking the dairy owner to fix my plumbing.


I also want to ask why didn't Peter Harrison put up his arrears statistics instead of just bagging TOWER's? Perhaps, just perhaps, and I don't know if this is the right terminology, his fund has only capitalised interest loans which are not yet showing as arrears - but they probably will when they mature and there is no cash flow for the borrower because of this market. Time will tell I think. I do hope his comments don't come back to haunt him and his investors. I recall this lending style was raised in the paper about Lombard and its Brooklyn loan.


Another thing to ask then - is the lending of all these trusts the same? I think not, as if they were lending in the same circles, then rates of return and arrears would be similar wouldn't they? According to the published FundSource data TOWER's return does seem to be quite a bit lower, so probably indicating either a more conservative lending book than its competitors, who appear to pay a higher return, or otherwise TOWER lends out at a lower rate than its competitors - but then wouldn't competitors then drop their rates to compete? I'm confused.


Like Peanut H says, there probably is too much drama being made over the arrears as well I think. We are in tight times and I think the TOWER announcement just came at the wrong time on the back of Lombard. If they shut it down 18 months ago before Bridgecorp, Provincial and the rest, nothing would have been said in the papers. What other mortgage lenders have closed in recent years that we never heard about?


And I also don't understand Stubbs' comments about PIE difficulty. Why doesn't he tell us what these difficulties are as we are told other mortgage trusts have done it - but interestingly the Midlands Trust who was quoted in the NBR also hasn't yet converted.


Overall TOWER seems to be doing the right thing in my opinion, if they have a fund which cannot compete or beat a bank deposit, then it makes sense to wind it down and pay out as they announced. Unfortunately for TOWER, timing is the issue here.


On 13 April 2008 at 10:49 pm Maurizio Piglia said:
Peanut, you are right.
Adding the numbers.....it doesn't make all much sense winding up.

This, of course, if the conditions are as reported, so, if all the money can be refunded in a timely manner and in full..well, even if the written off is 1-2%...stil OK.

But I guess we haven't heard the end of this...Hope I'm wrong, but Phil, If I were a reporter, I'll keep digging.
On 14 April 2008 at 10:48 pm Sharon T said:

I must clarify my earlier comments before anyone gets uptight and too PC.


My remarks were only meant to infer that a fund of some four years with unknown people behind it is not really in a position to comment on;

a)what I have read has been a well managed fund for some 18 years, and

b) thier thoughts on the industry as a whole.

They were not personal upon Peter Harrison's character - merely facts I found.


It is very clear that after 18 years that market forces have impinged - some may say unfairly - on TOWER.


I don't know what digging will do - the numbers are there -apparently only some 8% ($17m?) of the loans are now 30+ , so they must be managing them OK. What will digging find exactly? Who the borrowers were? Not Bluestone, I read today.


Can anyone advise how we find out about any lending firms' recent arrears before investors give away thier money? Not ones in one year old accounts. Do they hand this out? Or is it sensitive data?


As i said, my view is that a down-turned market has hit some borrowers hard. Give them time and they will repay.


It's not like the fund lent 100% loans (its investment statement says first residential mortgages only to maximum 75% LVR) or did second mortgages, so there is some equity buffer if I read it right.

Say the $17m was 75% residential. That means the property values at lending was $22.5m. It's even more if it is commercial because the investment statement said 66%. So there is a buffer that isn't there, plus any increase in CV since the loan was done (less what we are told by BNZ about a 30% downturn).


Shat about second mortgages borrowers took out - if there was any. That means some finance companies lose out first. Am i missing something here? Why has this not been raised - which finance companies?


If they wrote off 1-2% that comes off income? So capital is still there?

Doesn't a fund of $220m earn $19m a year in income? So investors forgo income for a year. Better than losing capital like in so many debenture failures.


Maurizio, what do you think they should do - keep going? Why? If its not competitive, why keep it going? If Geoff Murphy's car only has three cylinders going, he's not going to keep racing it around the race track at Hamilton is he?


On 17 April 2008 at 2:36 pm Maurizio Piglia said:
No, I wouldn't justify keeping it alive if it is uncompetitive...but a fund is a slow animal, geared on long term.

In the end, what really matters, is if you think you can keep delivering the same returns you actually marketed the fund for...then the competitiveness to attract more capital is not paramount. Let's say you may just switch the spotlight from this fund, keep it just humming, gradually increase liquidity, and reimburse redemptions of customers wanting out, maybe trying to steer them towards more competitive funds of your company.

What is unnecessary is an announced wind down....unless you are facing an unusual number of redemption requests, maybe purely panic induced, that may have jeopardized your ability to raise liquidity in an ordinate and market savvy way.

In this environment, announcing a wind down officially does give you the option to delay redemptions and allow you to sell assets at reasonable market prices and not at firesale prices....which is, in the end , teh interest of the investors.

The thing that may have not been told to investors is that, substantially, a mortgage fund is an ILLIQUID form of investment...subject to have difficulties when everyone stampede to the exit at the same moment.

Also banks have troubles when people head for the exits all together.

The whole situation should neither be a drama, not a shame for a rock solid company like Tower...it has been made so by a certain propension of some media (not good returns specifically..) to increase drama.
Bridgecorp was, and is , drama, this is a glitch...but a proof that brick and mortar is safe, (maybe) , it keeps value (not always..) and is, substantially, ILLIQUID.

Maybe this is all that there is behind this...non drama.
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Lender Flt 1yr 2yr 3yr
AIA 4.55 2.55 2.69 2.79
ANZ 4.44 3.15 3.25 3.39
ANZ Special - 2.55 2.69 2.79
ASB Bank 4.45 2.55 2.69 2.79
Bluestone 3.49 3.49 3.49 3.49
BNZ - Classic - 2.55 2.69 2.79
BNZ - Mortgage One 5.15 - - -
BNZ - Rapid Repay 4.60 - - -
BNZ - Std, FlyBuys 4.55 3.15 3.29 3.39
BNZ - TotalMoney 4.55 - - -
CFML Loans 4.95 - - -
Lender Flt 1yr 2yr 3yr
China Construction Bank 4.49 4.70 4.80 4.95
China Construction Bank Special - 2.65 2.65 2.80
Credit Union Auckland 5.45 - - -
Credit Union Baywide 5.65 3.95 3.85 -
Credit Union South 5.65 3.95 3.85 -
First Credit Union Special 5.85 2.95 3.45 -
Heartland 3.95 2.89 2.97 3.39
Heartland Bank - Online 2.95 1.99 2.35 2.45
Heretaunga Building Society 4.99 3.50 3.40 -
HSBC Premier 4.49 2.45 2.60 2.65
HSBC Premier LVR > 80% - - - -
Lender Flt 1yr 2yr 3yr
HSBC Special - - - -
ICBC 3.69 2.45 2.65 2.79
Kainga Ora 4.43 2.93 3.07 3.24
Kainga Ora - First Home Buyer Special - 2.25 - -
Kiwibank 3.40 3.30 3.54 3.54
Kiwibank - Offset 3.40 - - -
Kiwibank Special 3.40 2.55 2.79 2.79
Liberty 5.69 - - -
Nelson Building Society 4.95 3.45 3.49 -
Pepper Essential 4.79 - - -
Resimac 3.39 3.35 2.99 3.35
Lender Flt 1yr 2yr 3yr
SBS Bank 4.54 3.05 2.99 2.99
SBS Bank Special - 2.55 2.49 2.49
The Co-operative Bank - First Home Special - - - -
The Co-operative Bank - Owner Occ 4.40 2.55 2.69 2.79
The Co-operative Bank - Standard 4.40 3.05 3.19 3.29
TSB Bank 5.34 3.29 3.45 3.59
TSB Special 4.54 2.49 2.65 2.79
Wairarapa Building Society 4.99 3.55 3.49 -
Westpac 4.59 ▼3.09 3.29 3.39
Westpac - Offset 4.59 - - -
Westpac Special - ▼2.49 2.69 2.79
Median 4.55 2.94 2.99 2.80

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