Banking on long-term strategy

George Kerr has a long history in finance and is now set on building up PGC/Marac to be a listed bank. Photo / Supplied

George Kerr, the great-great-grandson of F.H. Pyne, who founded Pyne & Co in 1887, has history with Pyne Gould Corporation.

But the decision to pour tens of millions of dollars into the company over the past couple of years has been driven more by his view of financial history rather than of his family, he says.

Kerr is generally perceived to be the architect, or at least the driving force, behind the former stock and station business' new strategy to become a listed bank and funds management business and its large successfully executed recent capital raising to support those plans.

A prominent figure in the local funds management industry in the 1990s, he sold out of Spicers to global financial services giant AXA in 2001 and spent the next few years skiing and on "gardening leave".

"It gets a bit boring doing that for too long and I was a little bit young."

Getting back in the game, he teamed up with property developer and Queenstown neighbour John Darby on a bunch of projects including the Jacks Point development in Queenstown and the controversial New Chums Beach project in the Coromandel.

He also established Equity Partners Asset Management, whose fund Epic has drawn attention for its purchase of UK water and motorway services assets which had been packaged up into somewhat opaque investment vehicles by Australia's "fee factory" Macquarie Bank.

In early 2007 he first appeared on PGC's share register.

By that time, he said, he had a well-developed plan.

"It was blindingly obvious, really, that after a long time as a non-bank financial institution, PGC/Marac had earned the right to move on to the next phase and that it had the sort of quality and access to capital to make that occur."

The way he tells it, the decision was informed by his knowledge of the company's existing qualities rather than any historical family connection.

"As an investor I looked at PGC as a perfect vehicle to deliver capital to, to work on a strategy of building up to be a listed bank in New Zealand."

The original proposition was sketched out in initial meetings between Kerr and former Fay Richwhite merchant banker Stephen Walker, but Kerr says the plan had "many more fathers than just me and Stephen".

Over a couple of years he became the largest shareholder in the company, building up a 10 per cent stake at what now looks like a high price, paying as much as $4.50 a share.

Asked about this, he observes - somewhat ruefully - "It would have been better if there wasn't as much exposure to the property development loans, without question, and then it wouldn't have had to raise as much capital to achieve what we want to achieve".

The need for additional capital, largely to cover huge impairments on subsidiary Marac's property loan book, has seen existing shareholders diluted considerably, and the price of existing shares fall to a 10th of what Kerr paid for this initial cornerstone stake.

"But I tend to look at these things over a 10 to 20-year time frame, not five minutes. It's not a major."

That longer-term focus is, he says, one of the crucial differences between a fund manager's approach and his own thinking around PGC.

"Typically fund managers tend to be driven on short-term value. Cornerstone investors tend to be very much focused on understanding and agreement on the core strategy of the company, on the resources both at the board and executive level and, thirdly, on long-term value."

And the core strategy is?

"Clearly we believe we want to deploy capital into the banking and finance space, we believe capital deployed in this space over the long run will generate returns of 20 to 25 per cent return on equity, which is good. We think that will lead to a long run premium to capital employed.

"It will generate price to book multiples as opposed to dollar in, dollar out. If we deploy $500 million or so in this space over the next decade we think that's going to be worth a lot more than $500 million over time."

It's at this point where Kerr starts drawing on his knowledge of economic history to support his investment case.

"In the context of the banking environment we tend to like this sort of time for investing because you're investing at a discount as opposed to a premium to book value.

"Typically investors often buy when things are nice outside, when the economy is fine, when there's no negative news about property. Then they'll often pay two or three times book for a banking stock in those particular environments.

"What tends to happen over a period of time is there will be a problem in a particular sector - often property - leading to a recapitalisation of the particular stock.

"PGC/Marac is no exception and therefore it's had to recap itself the same way many others have had to and effectively at a discount to book.

"Those companies that have recapped at a discount to book, whenever this has happened historically, investors have typically over a long period of time been very well rewarded.

"I don't see it outside the context of what's been happening in history. Generally when you recap a banking or finance stock at this time of the market you tend to do very well."

But in addition to the "top down value issues", Kerr says there are a particular set of circumstances in New Zealand's finance sector at present which support his business case.

"You've got a situation where a lot of the Australian banks are reducing or are not as committed to New Zealand as they've previously been. Banks are tending to be reallocating capital either to Australia or Asia or other markets. That means for investors wanting to invest in New Zealand it creates a higher return on investment because the outcome of major operators deploying less capital in New Zealand stops the crowding out of people that do want to participate in that market and therefore leads to higher returns on that capital, as it should do.

"All those things combined lead to what we think is a strategic opportunity for PGC/Marac to operate very successfully in the banking and finance space."

That, of course, assumes PGC or Marac is able to gain a banking licence, a quest which has not been helped by Marac's property loan problems and a subsequent credit rating downgrade.

However, Kerr hopes to obtain a licence within the next 12 months.

Meanwhile, mixed up with the widely circulated idea that there is an opportunity for the emergence of local listed banks to take up some of the slack left by increasingly disinterested major banks has been the notion that the likely candidate would require the kind of scale which PGC does not possess on its own.

Consequently, talk of a tie-up between PGC and Alan Hubbard's South Canterbury Finance has been around for months.

"In short, there's no plans," says Kerr.

"The key message - the history - is these companies have been rivals for a long time, but also friends."

Kerr points out this rivalry has been sustained for the best part of a century largely thanks to both firms' ability to survive several boom-and- bust cycles that have taken out 30 or 40 younger smaller rivals every episode.

He doesn't see any reason why this current bust, although "bigger and nastier than almost any other", should see a much more different outcome.

In fact, PGC has taken steps to ensure this dominance by the two firms continues to endure.

"When someone is clearly requiring some short-term assistance, we're happy to help and that's all we've done," he says, referring to the $75 million loan Torchlight has extended to South Canterbury."

Hubbard also holds a meaningful stake in PGC and helped to alleviate the messy situation that developed as a result of PGC's subsidiary PGG Wrightson's abortive merger with Silver Fern Farms.

The mutual support between the two companies suggests the historical dominance of the South Island's financial industry by the two firms and associated interests will continue for some time to come.

GEORGE KERR
Age: 43
* Director of Pyne Gould Corporation and, with a 13 per cent stake, its largest shareholder.
* A leading light in New Zealand's funds management industry including stints with New Zealand Funds Management, Sterling Grace Portfolio Management, Spicers and Brook Asset Management.
* Other business interests include high-profile property developments including Queenstown's Jacks Point and Coromandel's proposed New Chums Beach project.
* Lives in Sydney or Queenstown "depending on what time of the year it is".
* Married with four children aged from 4 to 16 years old.