Capital Constraints and growth in REL
Quote:
Originally Posted by
BlackPeter
Heartland is currently growing their REL portfolio, and yes, this will require additional capital - though not ad infinitum. I think the average duration of a REL is something like 8 to 10 years - i.e. give it another 6 years or so and they should get enough capital back through REL which they can recycle.
I have heard this 'recycling capital' for reverse mortgages argument before. My answer I have recycled below
Quote:
Originally Posted by
Snoopy
I need to be quite precise with my language here. I believe that the Australian Reverse Mortgage Business is very profitable right now. But the profits are paper profits in the sense that they cannot be cashed up by Heartland until the loan is ultimately cashed in.
'Building scale' is all about growing the size of the reverse mortgage portfolio. Growing the REL portfolio means that HBL will always have poor cashflow, because as 100 loans are paid back in the future (say), Heartland will have to fund 200 new equivalent loans to keep the growth going. So I see no end to the cashflow issue, provided the REL portfolio keeps growing.
Of course if the REL portfolio stops growing, then, at some time in the future (say ten-fifteen years) the cash flow situation will resolve itself. If Heartland were to decide to wind down their reverse mortgage portfolio in the future it would then become a cash flow generating engine for the company, the exact opposite of the situation now. But if the REL growth is halted, the earnings multiple that investors are prepared to pay for Heartland will go down. At that means the share price will shrink. Therein lies the 'balancing act' and the dilemma.
Then Jantar tried to put me straight.
Quote:
Originally Posted by
Jantar
I think you may be treating this issue as too much of binary situation rather than as a variable scale. Inflation alone would mean that simply replacing 100 matured loans with 100 new ones that there would be growth in absolute terms, if not in real terms, However the cashflow would be the equivalent of the compounded interest over the period of those loans. Increasing the number or value of loans by an amount equal to say half of the cash generated would achieve both cashflow and growth.
i don't think I commented at the time because i am not sure I fully understood what Jantar was getting at. What Jantar is saying is that the compounding cashflow from the reverse mortgage interest is what is really driving the profits.
Quote:
Seniors interest rate is 7.82%. It is variable but since we don't know how it will vary in the future I will keep it fixed for the purpose of this exercise. To keep the figures easy, Mr & Mrs Crusty will look to take out a $100,000 reverse mortgage loan.
|
Year 1 |
Year 2 |
Year 3 |
Year 4 |
Year 5 |
Year 6 |
Year 7 |
Year 8 |
Year 9 |
Year 10 |
Total |
Interest Payable |
$7,820 |
$8,432 |
$9,091 |
$9,802 |
$10,568 |
$11,395 |
$12,286 |
$13,247 |
$14,282 |
$15,399 |
$112,332 |
Time Discount Factor |
Face Value |
7.4% |
7.4%^2 |
7,4%^3 |
7,4%^4 |
7.4%^5 |
7.4%^6 |
7.4%^7 |
7.4%^8 |
7.4%^9 |
Time Discounted Interest |
$7,820 |
$7,851 |
$7,881 |
$7,912 |
$7,935 |
$7,974 |
$8,005 |
$8,037 |
$8,068 |
$8,099 |
$79,582 |
Here is a graphic demonstration of compound interest. Mr & Mrs Crusty end up paying back $112k interest on top of the $100k that they borrowed! Or put another way each dollar they spend in their ten years of retirement costs them $2.12.
Using the above model, Heartland could double their Seniors investment capital in dollar terms on each $100,000 loaned over ten years. (I note the Seniors interest rate has reduced a bit since I went through my above example.) So the corollary is that if Heartland retain all their 'reverse mortgage capital' inside their 'reverse mortgage business unit' then the size of the reverse mortgage portfolio can double in ten years. Doubling in ten years is equivalent to an annual compounding growth rate of:
$100,000 x (1+g)^10 = $200,000 => (1+g) = 2^0.1 => g=7.2%
On average if Heartland want to grow their reverse mortgage portfolio faster than this 7.2%, then they need more capital. But if they want to take money out of the reverse mortgage portfolio (to go towards paying a dividend for example) they will have to be content with a growth rate of rather less than 7.2%.
Over FY2018, Australian reverse mortgages in gross receivable terms, grew by 31% and the NZ reverse mortgages receivables grew by 12%. This was followed up by more compounding REL receivables growth of 24% for Australia and 11.4% for New Zealand over FY2019. So the Seniors portfolio is growing way faster than its own self funding underlying organic rate of around 7%. But how long will this growth continue? As at EOFY2019 the Australian Reverse Mortgage market share that Heartland has is 24% of all REL loans. Given no other major player is active in recruiting new business for lump sums in Australia, I think we could see Heartland's REL market share double to near 50% in Australia. At the underlying organic growth rate, that means Heartland will have to continue to raise new capital if they want to take less than ten years to reach that 50% market share target. Consequently I don't see any free cashflow coming out of the reverse mortgage business for many years. In fact I see a cash issue (or an Australian bond issue?) on the horizon as being the more likely way to speed up growth.
SNOOPY
Double hit for RELs in a recession
Quote:
Originally Posted by
BlackPeter
Snoopy wrote:
"What I am saying is that there is an underlying cash flow risk for the business going forwards. That risk can be fixed by shareholders putting their hands in their pockets and answering a rights issue call. I am saying that shareholders holding now should be prepared for a rights issue if capital market conditions change"
Fair enough, though you could say that about a lot of "growth" companies.
I think the potential situation is rather worse than putting Heartland into the same growth bucket as other growth companies.
Let's say you have a property worth $1m and take out what ends up being a a ten year reverse mortgage for $100,000. The bill at the end of ten years is $200,000, with all the compounding interest rolled up. But as a long term property owner, you might be expecting your property might have appreciated to be worth $1.2m over ten years. So in headline dollar terms you still have your $1m nest egg intact to pass on to your children. You feel good, and your children can't feel hard done by, as your very generous nest egg to them is intact.
Now let's look at an alternative property market scenario where property prices flat line for ten years. In that case your nest egg drops to $800,000. The wider economy is much cooler under this scenario, so your children are not getting ahead as much. Such a scenario might make you think twice about taking out that reverse mortgage in the first place. Do you really need that world cruise? Why not hang onto your old car rather than upgrade to a new one? So demand for reverse mortgages could drop. But the value of the underlying asset on which the reverse mortgage is based also drops in relative terms. So the existing reverse mortgages become more risky.
What I am saying here is that in a recession the reverse mortgage gets a double whammy. The first hit being a drop in demand for new reverse mortgages. The second hit being a new capital risk to the existing REL portfolio. I don't think most growth companies would face a 'double hit' like that in a recession.
SNOOPY
Buffett Point 2/ Increasing 'eps' trend: One Setback Allowed (FY2019 perspective)
Quote:
Originally Posted by
Snoopy
Eagle eyed readers will note that I have revised some of my assumptions on what one off items are taxable or not.
Financial Year |
Net Sustainable Profit (A) |
Shares on Issue EOFY (B) |
eps (A)/(B) |
2014 |
$36.039m + $0.056m = $36.095m |
463.266m |
7.8c |
2015 |
$48.163m - $0.588m - $0.098m = $47.477m |
469.980m |
10.1c |
2016 |
$54.164m - $1.136m - $0.322m = $52.706m |
476.469m |
11.1c |
2017 |
$60.808m - 0.72x$1.2m - $0.628m - $0m = $59.316m |
516.684m |
11.5c |
2018 |
$67.513m + 0.72x$1.3m - ($4.8m + $0.6m) -$0.156m - $0m = $62.893m |
560.587m |
11.2c |
Notes
1/ Property plant and equipment sale loss of $56k added back into FY2014 result.
2/ Profit of $588k from investment sale and $98k from Property Plant and Equipment sales removed from FY2015 result
3/ Profit of $1.136m from investment sale and $322k from Property Plant and Equipment sales removed from FY2016 result
4/ Profit of $0.628m from investment sale removed from FY2017 result. A $1.2m insurance write back that made the impaired asset expense for FY2017 unusually low and hence artificially inflated profits has been removed from the FY2017 result (refer FY2018 annual report).
5/ Profit of $0.156m from investment sale removed from FY2018 result. The after tax effect of $1.3m in 'one off costs' (system integration $0.5m, legacy system write off $0.3m and corporate restructure $0.5m) have been added to the FY2018 profit. Profits from the sale of the 'bank invoice finance business' of $0.6m and $4.8m recovered from a legacy MARAC property loan have been removed from the FY2018 profit.
6/ I have been unable to locate property plant and equipment sales profits/losses for FY2017 and FY2018.
Result:
Pass Test
I am not going to go through a full Buffett review this year, because I know that Heartland will not pass the return on equity requirement. Notwithstanding this, that doesn't mean that Heartland is not a worthwhile investment according to other criteria. And it is always interesting to look at the trend of what I deem to be 'normalised profit'. See if you agree with the various adjustments I have made.
Financial Year |
Net Sustainable Profit (A) |
Shares on Issue EOFY (B) |
eps (A)/(B) |
2015 |
$48.163m - $0.588m - $0.098m = $47.477m |
469.980m |
10.1c |
2016 |
$54.164m - $1.136m - $0.322m = $52.706m |
476.469m |
11.1c |
2017 |
$60.808m - 0.72x$1.2m - $0.628m - $0m = $59.316m |
516.684m |
11.5c |
2018 |
$67.513m + 0.72x$1.3m - ($4.8m + $0.6m) -$0.156m - $0m = $62.893m |
560.587m |
11.2c |
2019 |
$73.617m + 0.72x($1.8m + $1.3m + $1.1m) -$1.936m -$0.173m - $0m = $74.532m |
569.338m |
13.1c |
Notes
1/ Profit of $588k from investment sale and $98k from Property Plant and Equipment sales removed from FY2015 result
2/ Profit of $1.136m from investment sale and $322k from Property Plant and Equipment sales removed from FY2016 result
3/ Profit of $0.628m from investment sale removed from FY2017 result. A $1.2m insurance write back that made the impaired asset expense for FY2017 unusually low and hence artificially inflated profits has been removed from the FY2017 result (refer FY2018 annual report).
4/ Profit of $0.156m from investment sale removed from FY2018 result. The after tax effect of $1.3m in 'one off costs' (system integration $0.5m, legacy system write off $0.3m and corporate restructure $0.5m) have been added to the FY2018 profit. Profits from the sale of the 'bank invoice finance business' of $0.6m and $4.8m recovered from a legacy MARAC property loan have been removed from the FY2018 profit.
5/ Profit of $0.173m from investment sale removed from FY2019 result. The after tax effect of $4.2m in 'one off costs' (corporate and ASX listing $1.8m, one off currency costs of $1.3m and the Australian bond break fee of $1.1m) have been added back to the FY2019 profit. Lastly i have removed the $1.936m book gain on the fair valuation of an investment property.
6/ I have been unable to locate property plant and equipment sales profits/losses for FY2017 and FY2018 and FY2019.
Result: Pass Test
SNOOPY