Brexit, HBOS, Globo and the FRC

Is it not heartening that the Brexit divorce bill, and other terms, have been settled? The exact cost is unclear but it could be up to £40 billion – a lot of money you may say! However, the fact that the key negotiators, Mrs May, Barnier et al, all looked somewhat glum about the deal when announced perhaps tells us that it was a compromise in which both sides had to concede ground. Or perhaps they were just tired. The terms of any future arrangements including trade deals still need to be worked out so it’s a long way from being concluded.

Now that £40 billion figure, sounds a lot, even if it is spread over some years. Hard line brexiteers will be unhappy. But it’s all relative. For example the annual UK Defence Budget is over £35 billion and rising. In addition, I have just read the Financial Reporting Council’s report on the HBOS audit and you can see there on page 7 that HBOS had to write off £63.3 billion in loan losses. That was only one smaller sized UK bank. According to the Bank of England, the financial crisis that affected HBOS caused £7.3 trillion of losses in total in the UK.

The report from the Financial Reporting Council (FRC) on the audit of HBOS is a quite tedious and turgid document. To remind you, HBOS was a bank that almost went bust after making imprudent commercial property loans financed by short term debt. When Lehman’s collapsed and debt became difficult to raise, HBOS had to be supported by the Government and then bailed out by a merger with Lloyds TSB. The latter’s shareholders are currently pursuing a claim against the company and its directors over that event.

The reason the audit of HBOS was examined by the FRC was because the company obtained an unqualified audit report suggesting that it was a “going concern” when it soon turned out to be otherwise. These events date back to 2008 – that’s 9 years ago which shows the speed with which the FRC typically operates.

One interesting comment made in the FRC report is that it suggests on page 11 that liquidity support from central banks may be considered “a normal funding source…..and therefore reliance on such support does not mean that the bank is not a going concern…..”. As banks with a positive balance sheet are usually assumed to be eligible for “lending of last resort” from the Bank of England that might mean that HBOS would be considered to be a going concern even if it ran out of cash (which is the reason most banks go bust, not because of defective balance sheets – Northern Rock is a good example).

The report also refers on page 29 to “market expectations” at the time. Market participants did not expect the financial crisis to get worse which affected the auditor’s views. So now we know why the FRC let the auditors of HBOS (KPMG) off the hook!

As I mentioned in a blog post a couple of weeks ago (see https://roliscon.blog/2017/11/22/standard-life-uk-smaller-companies-and-frc-meetings/ ), I attended a meeting with the FRC organised by ShareSoc/UKSA. One of the issues raised was the lack of feedback from the FRC on the progress of investigations. I followed up with one of the speakers after the meeting, specifically about the case of Globo. I asked what was the status on the investigation of the audit of their accounts by Grant Thornton. As readers may know, Globo was a company that went into administration in 2015 after it was revealed that the revenue of the company was probably fictitious (see https://www.sharesoc.org/campaigns/globo/ for details). The report of the administrators made it clear that the cash on the balance sheet of Globo plc seemed to have disappeared, bringing into doubt the preceding audit report on that ground alone let alone the revenue recognition issue.

The FRC announced an investigation in December 2015, i.e. two years ago. What have the FRC been doing, when will the investigation likely conclude, are there any preliminary conclusions, etc, etc? All of these questions are very relevant as the answers might provide the basis for legal action by shareholders against the auditors and others. After several email exchanges with FRC staff, the only answer I managed to elicit is that the investigation is on-going. It has not even been turned into a “Formal Complaint”.

The reason more information could not be supplied is that it might prejudice “the overarching requirement for fairness”. My response was “I really do suggest that the FRC needs to reconsider its policies in this area. You have too much emphasis on treating those who have been complained about (i.e. auditors) fairly, while those who have complained are treated unfairly. This rather suggests, as we already knew, that the FRC is dominated by auditors who are the people it is supposed to be regulating”.

You will be amused to read in the FRC’s Publication Policy document (para. 3) that “Transparency contributes to public confidence in independent disciplinary arrangements….” but then proceeds to spell out all the restrictions it imposes that thwart it.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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Preparing for Brexit

Apparently MPs on the Public Accounts Committee are very concerned that a new Customs Declaration Service will not be ready in time for Brexit – at least this was in a report in the Financial Times, assuming it is not another of their scare stories. The timescale is indeed somewhat tight to get the new system in place before the likely Brexit date, particularly if one bears in mind that many Government IT projects overrun.

Inability to process export declarations quickly could result in massive queues of traffic awaiting clearance. I recall a previous suggestion that lorries might be backed up along the M20 as far as the M25 which would certainly personally inconvenience me.

But I have some experience of implementing major IT systems for HMRC (or Customs and Excise as it then was) as I was involved in the implementation of the VAT system back in 1973 (when we joined the EEC at the same time). This was a project commenced two years earlier. It had to go operational on time, and it did so without a hiccup. One of the more successful events in my IT career although I only played a minor part in it. The key point I wish to make is that fixing a date when it had to go live concentrated everyone’s minds on the project, and it ensured the best expertise was available to deliver it. The VAT implementation project, which affected not just tax collection work by the Government but also almost all UK businesses was one of the biggest and most important Government IT projects ever completed.

Now when Mrs May decided to fix a specific date for when we will be leaving the EU, to my mind this was a wise thing to do. It will focus those responsible for the supporting systems to enable this to happen smoothly (whatever the nature of the deal, if any, finally agreed with the EU for post-Brexit trade arrangements) if a date is fixed now.

But yesterday the Daily Telegraph ran a front-page story on the “Brexit Mutineers” who were planning to revolt against a fixed date, and as a way to undermine Brexit it was suggested. Lots of other news channels covered the story and one of the mutineers, Bob Neill my local MP and one of the “mutineers”, appeared on television to suggest it was simply the normal democratic scrutiny process. The revolters also signed a letter printed in today’s Telegraph saying a fixed date was too inflexible. There may need to be last minute extensions to conclude a transitional deal. I beg to differ. A fixed date will concentrate the minds of both British and EU Brexit negotiators, which could be of course the reason for Mrs May’s decision.

On both political grounds, and to help those implementing the required systems, fixing a date is the right thing to do in my opinion.

Meanwhile the FT has an editorial supporting the “no fixed date” revolt, and they also published several letters today opposing Brexit. All I can do is yawn at their persistence in ignoring the realities of the situation.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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A Quick Guide to New Issues, SMRs, Car Market and Brexit

In today’s Financial Times (11/11/2017) Neil Collins gave a quick guide to new issues which is worth repeating. This is what he said: “Do not buy into an initial public offering if most of the capital raised is going out of the business, or if it replaces existing debt (because the capital has already left). Do not buy if private equity is selling. Do not believe any forward-looking statements, because if the prospects really were that good, the vendors would wait and get a higher price. Do not buy any share that has been listed for less than a year. You will miss some bargains but you will avoid many more disappointments. Leave it to the professionals to lose other people’s money.”

Those are wise words indeed. He also made some ascerbic comments on small nuclear power stations which he says have been rebranded as “small modular reactors” (SMRs) to make them less scary. Rolls-Royce, who have produced such reactors for submarines, have touted them as a potential future business growth area for several years, but the FT’s in-depth review of the subject last week suggested that they are not likely to be put into production any time soon. Meanwhile the share price of Rolls-Royce is still below where it was in 2014.

Neil Collins also commented on the car market. You probably don’t need to be told that new car sales have slumped. The share prices of car dealers are cheap as chips and even my shares in Auto Trader are down substantially this year. Indeed one could apply Neil’s comments about IPOs to the company although it has taken a couple of years to reveal that the debt when listed is handicapping the company now. The car market is inherently cyclical which is one reason why car dealers are normally not valued highly, and they also show low barriers to entry with the car manufacturers controlling the market to a large extent and limiting the profits that dealers make. But Auto Trader is similar to Rightmove in the property market. High margins, dominant market position and a business with great network effects with the result that competitors find it difficult to muscle in on their market. I think I’ll stick with it for a while yet.

I am not convinced that we have reached “peak car” as some have suggested. There seem to be more cars on the road than ever although traffic volumes have slowed in London where most such commentators live. But that is as much about political policies that have limited road space and caused congestion, mostly irrational, than car buyers desires. Another good analysis in the FT recently was about how “green” various car types actually are. On total life emissions, some smaller petrol/diesel vehicles can beat “all-electric” cars. How is that? Because the manufacture and decommissioning of electric vehicles generate large emissions, and producing the electricity for them often does also.

With all these plugs I just gave for the FT, it is unfortunate that it coninues to publish such tosh about Brexit. Most of their writers predict the financial outcome will be calamitous. Whether that will be the outcome or not, I don’t have the space to provide a full analysis here, but most people who voted for Brexit did not consider the financial issue as conclusive. Consider an American colonialist in the year 1775, before their declaration of independance. No doubt with an economy very reliant on trade with Great Britain many people would have counselled against leaving the protection of their parent country. Did that deter them? No because they valued freedom more highly. They wanted control over their own affairs including that over taxes, and not to be ruled by a remote and undemocratic regime where they had minimal representation. That is the analogy that all the remainers should think about.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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National Grid, Johnston Press, Crown Place VCT, Lloyds Bank, LoopUp and Brexit

I had a busy day yesterday, but let me first comment on the news today. National Grid (NG.) published their half year results this morning. They reported “Adjusted operating profit, excluding timing up 4%….” but statutory earnings per share were down by 12%. What exactly does “adjusted for timing” mean? I have no idea because the announcement does not explain it in any sensible way. For example, it says under “UK Timing”: “Revenues will be impacted by timing of recoveries including impacts from prior years”. Why are these revenues not being booked in the relevant period? Why are they not being recognised as revenues in the period concerned? Looks like a simple “fudge” to me as “adjustments” to reported figures in accounts often are. Many analysts seem to have a negative view of the stock, and I am coming to the same conclusion. I sold some of my holding in the company this morning.

I have previously mentioned the requisition of an EGM at Johnston Press (JPR), but the company has rejected this on the basis that it is “not valid”. It seems this is because the shareholder who requested it holds their shares in a nominee account (i.e. are not on the register). Yet another example of the obstruction caused by the use of nominee accounts. Changes to the law in this area are required to fully enfranchise all shareholders. See the ShareSoc Shareholder Rights campaign for more information: https://www.sharesoc.org/campaigns/shareholder-rights-campaign/

Yesterday morning I attended the AGM of Crown Place VCT, managed by Albion Capital. No excitement there. Just a competently managed VCT and a well run AGM with a presentation from one of their investee companies (PayAsUGym) who have developed an innovative business selling gym sessions. Crown Place made a total return of !4% last year and currently provide a tax free dividend yield of 6.9% which is covered twice by earnings. The expense ratio is 2.4% which is certainly better than many of the VCTs I hold. Previously this company had a strong focus on “asset-based” investments but they are now restricted by the new rules for VCTs so they are moving into more “exciting” fields. There are also concerns about further rule changes or removal of tax reliefs in the budget next Wednesday. Investors in tax incentivised vehicles seem to be getting nervous.

After lunch with representatives of AGMInfo, I filled an hour or so before the ShareSoc AGM by dropping into the Lloyds Bank legal action nearby which I have mentioned in previous blog posts. On the witness stand was former CEO of Lloyds TSB Eric Daniels being cross examined by the littigants QC. He gave a confident performance and was clearly well prepared. He said he was “bitterly disappointed” over the need to raise £7 billion in capital and was also disappointed that they would end up more highly capitalised than other banks. It was clear from his other comments that there was a certain momentum to go through with the deal (the acquisition of HBOS) and that they did not revisit the benefits of the transaction at every turn (e.g. as more information came out of the due diligence work for example).

He disclosed that in a conversation with the FSA there were real concerns that they could lose the vote of shareholders. This could be because there were views that HBOS could remain independent, although the Government had already indicated that it was promptly going to be nationalised if no rescue deal could be done; and because Lloyds TSB shareholders might vote against it.

The case continues. Lloyds Bank and the former directors continue to say that the claims have no merit of course.

It was then onto the ShareSoc AGM. Again no great excitement there. Mention was made of a possible merger with UKSA and as a former director of both I spoke in favour of that. Spreading the fixed costs over two organisations of a similar size makes a lot of sense. It should never have been necessary to set up a rival organisation to UKSA, but interesting to note that ShareSoc has more members now so my efforts in recent years were not in vain.

The ShareSoc AGM was followed by one of their company presentation seminars. Of interest to me (being current holders) were the two by LoopUp (LOOP) and Ideagen. I reported on Ideagen recently on coverage of their AGM so will only cover LoopUp herein. The presentation by their joint CEO Steve Flavell was slick but it was more a sales pitch for the product/service to customers than one to investors. The issue of them having two joint CEOs was raised in a question later.

The emphasis was on the simplicity of the service, so anyone could take it up easily and quickly. This is the major USP as there are lots of other conferencing products around. Most interesting was his explanation that they leapfrogged the “chasm” by ignoring the early adopters (who often like techy products) by aiming straight for the “mainstream majority”. His reference to “Crossing the Chasm” is from a book of that name by Geoffrey Moore which is essential reading for all sales/marketing executives in the software field, or investors in early stage technology companies likewise. Just had a chat with an Uber driver about this book – he has a degree in marketing – that’s the modern world for you. It will be a great shame if Sadiq Khan manages to put Uber out of business – might miss out on intelligent conversations with cab drivers. I read the book when it first came out back in the 1990s and Mr Flavell had read it also. I highly recommend the book. LoopUp is clearly a sales/marketing driven organisation but the technology is sophisticated enough to make it all look simple.

On the current valuation, the company has obviously a long way to go to grow into that valuation. Questions were raised about whether growth could be accelerated (revenue only up 39% in 2016m and 44% in the interims this year). But I expressed scepiticsm on attempts at a faster growth rate to Flavell after the meeting.

The Financial Times continue to publish anti-Brexit stories and editorial every day. My letter to the editor on the dubious bias, which they published, has obviously had no impact whatsoever. Tim Martin, CEO of JD Wetherspoon, had a lot to say about the subject of the impact of Brexit on food costs in his latest trading statement. He accused the media, and the Chairman of Sainsburys and that of Whitbread, and the head of the CBI, for completely distorting the facts. Rather than food prices rising after Brexit, he suggests they will fall. For his arguments see:

https://www.investegate.co.uk/wetherspoon–jd–plc–jdw-/rns/fy18-q1-trading-update/201711080700068513V/

My conclusion is quite simply that some foods might become more expensive, others might become cheaper, and home-produced products might also be cheaper; plus the Government might be able to save a lot of money on contributions to subsidising inefficient farmers. But that of course means that food buying habits might change as consumers react to price changes. Is that a bad thing? Readers can ponder that question.

Whether the Chairmen or CEOs of public companies should be making comments on essentially political issues, one way or the other, is also a question to consider. I suggest that might best be left to bloggers like me. Sainsburys and Whitbread (Costa, Premier Inns) might find they disaffect half their customers while having minimal impact on public opinion.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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Brexit, and the Finances of the Young

The national media continue to try to turn news into controversy. Their words are often incendiary and designed to provoke debate and therefore attention – as a means no doubt of promoting their publications. So their headlines become “verbal click-bait”.

As most people now read news on the internet, the publishers could be considered as acting as “trolls”. Here is the definition in Wikipedia of an internet troll: “In Internet slang, a troll is a person who sows discord on the Internet by starting quarrels or upsetting people, by posting inflammatory, extraneous, or off-topic messages in an online community with the intent of provoking readers into an emotional response or of otherwise disrupting normal, on-topic discussion…….”

Written words are not the only example. Laura Kuenssberg of the BBC has adopted a similar verbal approach in her reporting. It’s not just Labour party members who should be complaining about her hysterical style.

There were a couple of news items this week that caught my attention in this area. There were several comments on the report issued by the FCA on family finances. The report indicated that half of UK adults were “financially vulnerable” and that those in their 20s and 30s were reliant on borrowing (personal loans and credit card debt). It reported that one fifth of 25-34 year olds have no savings at all with many struggling to pay bills. But this was interpreted by some of the media as the new “generational divide”.

But was it not always so? I certainly don’t recall having much in the way of savings at the age of 30 and lived from month to month, sometimes using credit card debt. In other words, I doubt that the situation has been changing over time; although the elderly have become better off lately due to rising state pensions I am not convinced the young have been getting poorer. But the media like to put a “spin” on any news item to grab attention.

As the report shows, the elderly do have more savings as one might expect but they are not evenly distributed. One amusing statement in the report is “A high proportion of retirees do not know how much savings they have”.

It’s a report well worth reading although rather long at almost 200 pages. Here is one useful titbit of information from it: “Around one in five (22%) 45‑54 year olds hold a stocks and shares ISA and the same proportion hold shares or equities directly”. It would have been good to obtain more detail information on that but it just shows there are a lot of shareholders out there.

Another example of media hysteria is the reporting on the Brexit negotiations. Will it be a hard or soft Brexit? Will the bill be £20 billion or £100 billion? Are Tories threatening to quit if there is any compromise, or revolt against the rule of Theresa May? Will Jeremy Corbyn scupper the whole affair by underming the Bill going through Parliament to support it? Who really knows, but it all makes for good headlines.

The Financial Times has become one of the leaders in scare mongering over Brexit with regular articles of a polemic nature by Martin Wolf and Simon Kuper on the topic. The latest example was by Martin Wolf in yesterdays FT. Now I have never thought much of Mr Wolf’s opinions on financial matters since he supported the nationalisation of Northern Rock, but his latest article (headlined “Zombie ideas about Brexit that refuse to die”) is pure hysteria. I don’t mind the occasional editorial opinion piece on Brexit, or some reporting on the potential technical difficulties if not slanted, but this piece was just propoganda in essence. It pointed out all the difficulties associated with a “hard” Brexit where no trade deal is agreed beforehand, but that is well known and most folks do not think that is likely. It certainly did not give a balanced view of the arguments for or against Brexit and what our negotiating stance should be. In reality there is likely to be a compromise of some kind – that is what politics usually ends up being about – compromise after compromise. Indeed it is one of the frustratations of anyone in the political world that achieving revolutions, rather than compromise, is not just difficult but exceedingly time consuming.

It is certainly regrettable that the Financial Times, since its takeover by Nikkei in 2015 has become much more politicised, and there is less factual reporting and more opinion. Perhaps it is just pandering to the views of most of its readers (the London-centric financial players and international businessmen) but if they expect to influence politicians or the wider community they will be disappointed.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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Brexit, and Ryanair

The media continue to try and blow up stories out of all proportion. Lately it has been on the likely terms of a Brexit deal with the EU, and Boris Johnson’s claims about the £350 million per week paid to the EU at present.

The reality on the latter is that the Daily Telegraph article by Boris claimed we would “regain control” over £350 million paid to the EU (which was based on a Treasury paper on the full EU membership fee (£19.5 billion per annum, which I think everyone will agree is a lot of money). However, that’s not the net cost to the UK because we get a rebate on membership as negotiated by Mrs Thatcher which reduces it to £14.6 billion, plus we get a lot back in the form of subsidies and grants – for example from the Common Agricultural Policy (CAP). A rough estimate is that we get back between £5 and £6 billion from those. So the net figure is more like £9 billion per annum, but that’s still a lot of money. For example, the NHS budget for this year is £124 billion, so you can see the impact that an extra £9 billion might have.

But Boris was accurate in the sense that we have little control over the £5 to £6 billion of grants and subsidies. The UK has long wanted to reform the CAP which is more designed to subsidise inefficient continental European farmers than keep food prices low in the UK. Subsidies of some kinds to some farmers might continue in the UK post Brexit, but in a different form and possibly lower. But only with Brexit will the UK regain control so we can manage these matters more rationally. What most “remainers” seem to ignore is that a lot of the Brexit voters voted to leave because of wanting to get out of the undemocratic EU where UK voters had no significant influence, we were a small fish in a big pond, and likely to be outvoted on any major issues. Mr Juncker’s recent speech made it clear that the EU was headed for a closer political and economic union which many UK voters have found abhorrent. Historically most UK voters supported joining the “common market”, but they never wanted to join a “United States of Europe” with EU laws and bureaucrats dominant and were misled by UK politicians who did. That certainly applied to the existing EU structure and calls for democratic reform have gone nowhere.

There was a very good article in the FT yesterday by former Chancellor Nigel Lawson (no relation) on Brexit where he points out that the Office of Budget Responsibility forecasts the cost of EU membership to fall from £12.6 billion in 2018/19 to zero in 2019/20. Nigel also said “Those who say that a good trade deal is in the best interests of the EU and the UK alike fail to understand what the EU is about. It is not about economics at all. It is a political enterprise, dedicated to the achievement of full political union”. He discounts the problem of “no trade deal” based on the ability to trade under WTO terms. James Dyson recently indicated he saw little problem with that also.

Should we pay to access the Common Market, in a “transition” phase or permanently? It obviously depends on what deal is put on the table, but the attitude of the EU Commission so far suggests it won’t be a good one. In my view the UK can prosper without close involvement with the EU and without paying anything other than contractually committed minimums as part of the exit process. The UK can prosper based on its own resources and the trade with other international partners than the EU, so if they don’t want tariff free access to the UK, then we can give up tariff free access to theirs. It might just stimulate UK manufacturing so we don’t have to rely on buying German cars, washing machines, refrigerators, et al.

Ryanair

One of the folks complaining about the possible impact of Brexit is Michael O’Leary, CEO of Ryanair. He suggests flights from the UK to Europe may be halted unless a deal is done to cover flight access.

But Ryanair has been hit lately by problems with crew scheduling that have resulted in cancellation of many flights. The service to the affected passengers has also generated numerous complaints. It just looks like an operational cock-up, compounded by abysmal management responses thereafter to mollify customers.

Now I have a motto of never flying Ryanair after an event over 15 years ago. I was booked to fly on Ryanair out of Stansted but a hijacked plane was diverted to land there. The radio news said the airport was closed so I diverted to another airline via City airport to get to Dublin on time for a business meeting. Ryanair claimed Stansted was never closed (not true I believe) and refused to pay compensation.

Anyone who follows the news will know of repeated complaints from passengers about the behaviour of Ryanair. Being low cost surely does not justify the low quality of service. It’s the kind of company I would not just avoid flying with, but also investing in.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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