Kevin Dowd 13 August 2018
Yesterday’s (12 August) Sunday Express on my Equity Release report, Asleep at the Wheel: The Prudential Regulation Authority and the Equity Release Sector, had some interesting comments from Steve Lowe, a director at specialist retirement group Just.
He said that I had not shown how I had arrived at the numbers cited in my report, so it is impossible to say if they are correct.
Actually, I did explain my numbers: the model calibrations and my justifications for them are explained on pp. 29-33 of my report.
Still, I grant that I can’t prove that my numbers are correct. It is possible that other people could come up with alternative calibrations that are better than mine or come up with an alternative model that is better than my model.
I explained my numbers and my model to give others an opportunity to say how they would improve on what I have done, and no-one has yet tried to do so.
But one thing I can prove is that the approach used by the industry is incorrect.
How do I know that the industry are getting it wrong? Because (1) the NNEG is a form of option, and (2) because the industry repeatedly confirms that it uses a variable – either the trend rate of growth of house prices or the expected or the actual rate of growth of future house prices – that option pricing theory says is irrelevant to correct option pricing. So if the industry is basing its NNEG valuations on a variable that does not affect correct option pricing, then it must follow that the industry is not valuing its options correctly.
And by its own admission, though not quite in those words
Mr Lowe goes on to say: “However, we agree firms should be prudent and set aside sufficient resources to allow for shocks in the economy.”’
Of course firms should be prudent but I have two questions for Just:
My results suggest that the companies are (greatly) under-valuing their NNEGs. Now I would like to believe that Just is valuing its NNEGs properly, so perhaps they can do what I have done and show how they arrive at their numbers so people like me can verify them. After all, if their numbers are correct, it can only help to have them externally verified.
By “setting aside sufficient resources to allow for shocks” I understand Mr. Lowe to be suggesting that companies should be well-capitalised, and if that is what he meant then I agree. But in that case, can (or how can) Just assure us that the company is well-capitalised now, before any shocks hit the economy.
I would like to trust Just but as the saying goes, trust but verify.
Oliver Ralph of the FT has a piece ‘just’ out, on fears about the impact of proposed new PRA rules on Just Group’s capital base.
All investors accept, or should accept, the importance of corporate transparency. The purpose of governance structures, including statutory reporting supported by independent external audit, is to ensure that minority shareholders receive reliable information about the value of firms and that company managers do not cheat them. Management should also be motivated to maximize firm value rather than pursue personal objectives (Bushman and Smith, citing Black 2000).