HMY - Harmoney Corp Limited

[Muse]

If things are progressing better than expected and it looks so wonderful. Why are HGH not buying more shares if this share is perceived undervalued?

Well HGH did buy more last year but us cynics will have a view on the underlying reason for that. But I'd say two areas

Modestly rising interest rates are net net a positive for financial institutions. Rapidly rising inflation and rapidly rising interest rates (that still aren't keeping up with inflation) aren't. If discretionary spending turns off people won't need as many loans or harmoney's service. More relevant are inflations impact on peoples ability to service their debts and later on if interest rates create higher levels of unemployment - both those influence incurred credit losses, which impacts the bottom line. The wholesale funding HMY and other instos rely on also have certain credit quality covenants, which if breached could see undrawn funding lines withdrawn. Stagflation is getting mentioned more and more, so not surprising to see sentiment wane.

The other item is Heartland is a capital constrained business. It has prudential capital adequacy rules it must follow. It pays out high levels of profit in the form of dividend. And they recently acquired an australian business and probably debt funded it which may reduce their last reported capital adequacy stats. The capital adequacy requirements are lifting and its possible in a few years heartland may have to either reduce their dividend payout ratio or raise capital (or some combination of both) in order to meet them. So probably not the best use of its scarce resources to further invest into an early stage, high risk fintech that won't be paying dividends for the new several years.

See post 506 for more on heartland - one that I have a personally meaningful position in and doing a lot of work on in a personal capacity.

EDIT - apols on re-reading I know that all read negatively, not my intention on a day where the q3 release had excellent credit stats and record growth etc and not saying stagflation is going to happen, just how the market may perceive it and how it could impact the business. and i think its good to have eyes wide open at the moment

[jimdog31]

If things are progressing better than expected and it looks so wonderful. Why are HGH not buying more shares if this share is perceived undervalued?

theyll have internal limits on weighting of investments. No different to the big banks weighting in particular sectors ie rural, commercial, residential

[jimdog31]

Well HGH did buy more last year but us cynics will have a view on the underlying reason for that. But I'd say two areas

Modestly rising interest rates are net net a positive for financial institutions. Rapidly rising inflation and rapidly rising interest rates (that still aren't keeping up with inflation) aren't. If discretionary spending turns off people won't need as many loans or harmoney's service. More relevant are inflations impact on peoples ability to service their debts and later on if interest rates create higher levels of unemployment - both those influence incurred credit losses, which impacts the bottom line. The wholesale funding HMY and other instos rely on also have certain credit quality covenants, which if breached could see undrawn funding lines withdrawn. Stagflation is getting mentioned more and more, so not surprising to see sentiment wane.

The other item is Heartland is a capital constrained business. It has prudential capital adequacy rules it must follow. It pays out high levels of profit in the form of dividend. And they recently acquired an australian business and probably debt funded it which may reduce their last reported capital adequacy stats. The capital adequacy requirements are lifting and its possible in a few years heartland may have to either reduce their dividend payout ratio or raise capital (or some combination of both) in order to meet them. So probably not the best use of its scarce resources to further invest into an early stage, high risk fintech that won't be paying dividends for the new several years.

See post 506 for more on heartland - one that I have a personally meaningful position in and doing a lot of work on in a personal capacity.

EDIT - apols on re-reading I know that all read negatively, not my intention on a day where the q3 release had excellent credit stats and record growth etc and not saying stagflation is going to happen, just how the market may perceive it and how it could impact the business. and i think its good to have eyes wide open at the moment

hey moose, in your workings, have you looked into what potential credit losses flow from the 90 day arrears?

how do they calculate the 0.46% of arrears ? is it based on total book value? I guess while the loan book value is increasing qoq its easy for this figure to come down as the base thats being calculated against is increasing?

Whats your best guess at incurred credit losses for 2022 and 2023? (all things being equal, not necessarily weighting 2023 higher based on the current state of the world)

[Rawz]

Heartland probably will be looking at an exit FY23+ once the peer to peer lending is well and truly gone and HMY is tuning out a solid 8 figure profit

Like FM says they will need the capital for their bank requirements and also they now have a good pathway of expansion into Aus with reverse mortgages + livestock. Next step asset finance. so best to put the money into that growth one would have thought. rather than a slice of another listed company

One thing for sure is HGH will be wanting over $2 for their holding.

[Rawz]

hey moose, in your workings, have you looked into what potential credit losses flow from the 90 day arrears?

how do they calculate the 0.46% of arrears ? is it based on total book value? I guess while the loan book value is increasing qoq its easy for this figure to come down as the base thats being calculated against is increasing?

Whats your best guess at incurred credit losses for 2022 and 2023? (all things being equal, not necessarily weighting 2023 higher based on the current state of the world)

When they say 0.46% that will be of the total book. So customer payments are behind $2.8m ish and have been behind for 90+ days.

Then there will be payments behind for less than 90 days and this % will be higher than 0.46% But most of them will be caught up before they get to 90 days.. Under 90 days include some arrears that would never actually result in a credit loss. For example an A+ borrower changing banks and forgetting to update their direct debits.. this is why 90 day arrears is what is reported. It captures those that are most likely to lead to a credit loss.

HMY will of course attempt to work out an arrangement with the customers in arrears.. often this will work. Could just be a customer in-between jobs for example. If it looks bad a provision will be placed on the account. I.e. HMY guesses how much they will lose on it. If no resolution HMY will write off the debt (impairment expense) and send it off to TRAs debt collection agency (or similar).

FY21 impairment expense was 4% of avg book or $18.6m
FY22 impairment should be close to 3.8% of avg book so ~$22m
FY23.. best to watch unemployment numbers. Hmy says that will be the best guide to how the book will perform. Or lets see the provision rate in FY22 annual report. Maybe they increase it

Im going off the proforma numbers.. FM will have a much better idea on the real numbers, he's a very smart Moose..

[Ggcc]

Well HGH did buy more last year but us cynics will have a view on the underlying reason for that. But I'd say two areas

Modestly rising interest rates are net net a positive for financial institutions. Rapidly rising inflation and rapidly rising interest rates (that still aren't keeping up with inflation) aren't. If discretionary spending turns off people won't need as many loans or harmoney's service. More relevant are inflations impact on peoples ability to service their debts and later on if interest rates create higher levels of unemployment - both those influence incurred credit losses, which impacts the bottom line. The wholesale funding HMY and other instos rely on also have certain credit quality covenants, which if breached could see undrawn funding lines withdrawn. Stagflation is getting mentioned more and more, so not surprising to see sentiment wane.

The other item is Heartland is a capital constrained business. It has prudential capital adequacy rules it must follow. It pays out high levels of profit in the form of dividend. And they recently acquired an australian business and probably debt funded it which may reduce their last reported capital adequacy stats. The capital adequacy requirements are lifting and its possible in a few years heartland may have to either reduce their dividend payout ratio or raise capital (or some combination of both) in order to meet them. So probably not the best use of its scarce resources to further invest into an early stage, high risk fintech that won't be paying dividends for the new several years.

See post 506 for more on heartland - one that I have a personally meaningful position in and doing a lot of work on in a personal capacity.

EDIT - apols on re-reading I know that all read negatively, not my intention on a day where the q3 release had excellent credit stats and record growth etc and not saying stagflation is going to happen, just how the market may perceive it and how it could impact the business. and i think its good to have eyes wide open at the moment

Thanks for your well explained opinion.

I do agree that HGH recent purchase might hold back any opportunity to invest elsewhere, unless they capital raised beforehand.

If Harmony are doing well it will benefit shareholders and HGH shareholders. I just believe if Harmony are doing better HGH should jump on board with more shares and maybe capital raise.

Of course that is a story for another day.

[Muse]

hey moose, in your workings, have you looked into what potential credit losses flow from the 90 day arrears?

how do they calculate the 0.46% of arrears ? is it based on total book value? I guess while the loan book value is increasing qoq its easy for this figure to come down as the base thats being calculated against is increasing?

Whats your best guess at incurred credit losses for 2022 and 2023? (all things being equal, not necessarily weighting 2023 higher based on the current state of the world)

hey jimbo - see my current FY22 credit loss forecast for harmoney below

Attachment 13746

I'm pretty sure the arrears numbers they provide are for the total proforma book.

I'm confident FY22 total incurred credit losses (banks sometimes call them 'charge offs') will be inline to slightly below FY21 levels (I actually see them decreasing from 3.88% of average book to ~3.73%). For my shorter term forecasts I tend to look at the movement in half year ICL losses and segment them by warehouse/statutory and p2p as the differences are large, thinking about how the environment has changed, and keeping in my mind the arrears ratio for each period and how that compares to the ICL % trend.

I see FY22 2nd half ICL expenses as % of average book rising a little bit from the first half of the year - like 15bps or so - for the proforma group. But I actually see both warehouse and p2p increasing - the decreasing proforma is simply a function changing weighed average between the two.

Warehouse/statutory ICL's % have been pretty stable. I assume a slight increase in the second half of FY22 relative to the first half but think the full year number will be similar to FY21

P2P a different bag. This book is run off and I expect will be at or close to zero by 31 December 2022. The book is old, relatively higher risk, in run off, and ICL's are clearly on the rise. I infer what the actual incurred credit losses will be based on the closing 'total expected credit loss' provision provided at 31 december 2021, and phase that based on how I see that book running down as it is repaid.

I sense check my 2H group/proforma ICL expense as a % of average receivables by noting 31 march 2022 +90day arrears were the same as the 31 December/1H FY22 figures.

For my longer term forecasts, I am still to update my model for FY23 and beyond. But in summary incurred credit losses are a function of 3 things: macro factors, the age of the book, and changes to the mix or riskiness of the lending (ie p2p which used to dominate the book vs warehouse which is much more credit worthy)

When I forecast any financial institution I always at the top of my assumptions have a little baseline of economic indicators (interest rate forecasts, unemployment, wage inflation, CPI, etc) I keep in mind when setting my operating assumptions (change in receivables, interest income & expense assumptions, credit losses, overhead inflation etc). I use the average of the 4 big bank forecasts (but sometimes over ride their longer term forecasts with long term averages). Unemployment and real wage growth the two most important when thinking about credit losses.

The age of the book is the other big thing. When originations are really strong the average ICL expense tends to be lower. People don't tend to take out a loan and then default on it a few weeks later. So a fast growing book should have relatively low expenses and as it matures those %'s should rise even if the macro environment remains identical.

When I get a chance to update my model I'll post / PM you some of the outputs

[Muse]

hey moose, in your workings, have you looked into what potential credit losses flow from the 90 day arrears?

how do they calculate the 0.46% of arrears ? is it based on total book value? I guess while the loan book value is increasing qoq its easy for this figure to come down as the base thats being calculated against is increasing?

Whats your best guess at incurred credit losses for 2022 and 2023? (all things being equal, not necessarily weighting 2023 higher based on the current state of the world)

I also think harmoney has a pretty good shot at reaching/surpassing a $700m gross receivables book by the end of june. even when updating for further QoQ declines in NZ originations

[jimdog31]

hey jimbo - see my current FY22 credit loss forecast for harmoney below



I'm pretty sure the arrears numbers they provide are for the total proforma book.

I'm confident FY22 total incurred credit losses (banks sometimes call them 'charge offs') will be inline to slightly below FY21 levels (I actually see them decreasing from 3.88% of average book to ~3.73%). For my shorter term forecasts I tend to look at the movement in half year ICL losses and segment them by warehouse/statutory and p2p as the differences are large, thinking about how the environment has changed, and keeping in my mind the arrears ratio for each period and how that compares to the ICL % trend.

I see FY22 2nd half ICL expenses as % of average book rising a little bit from the first half of the year - like 15bps or so - for the proforma group. But I actually see both warehouse and p2p increasing - the decreasing proforma is simply a function changing weighed average between the two.

Warehouse/statutory ICL's % have been pretty stable. I assume a slight increase in the second half of FY22 relative to the first half but think the full year number will be similar to FY21

P2P a different bag. This book is run off and I expect will be at or close to zero by 31 December 2022. The book is old, relatively higher risk, in run off, and ICL's are clearly on the rise. I infer what the actual incurred credit losses will be based on the closing 'total expected credit loss' provision provided at 31 december 2021, and phase that based on how I see that book running down as it is repaid.

I sense check my 2H group/proforma ICL expense as a % of average receivables by noting 31 march 2022 +90day arrears were the same as the 31 December/1H FY22 figures.

For my longer term forecasts, I am still to update my model for FY23 and beyond. But in summary incurred credit losses are a function of 3 things: macro factors, the age of the book, and changes to the mix or riskiness of the lending (ie p2p which used to dominate the book vs warehouse which is much more credit worthy)

When I forecast any financial institution I always at the top of my assumptions have a little baseline of economic indicators (interest rate forecasts, unemployment, wage inflation, CPI, etc) I keep in mind when setting my operating assumptions (change in receivables, interest income & expense assumptions, credit losses, overhead inflation etc). I use the average of the 4 big bank forecasts (but sometimes over ride their longer term forecasts with long term averages). Unemployment and real wage growth the two most important when thinking about credit losses.

The age of the book is the other big thing. When originations are really strong the average ICL expense tends to be lower. People don't tend to take out a loan and then default on it a few weeks later. So a fast growing book should have relatively low expenses and as it matures those %'s should rise even if the macro environment remains identical.

When I get a chance to update my model I'll post / PM you some of the outputs

As always Moose, you illuminate the numbers, I love it.

Interested to know both yours and Rawz underlying thesis for why youve bought in.

I’ll go first!

My thesis is that Harmoney isnt really selling loans . They are proving their underlying system, stellare, for customer acquisition.

once they hit $1 billion of loans and if they can keep their ICL lower or relative to the big banks, for the same customer profile, while maintaining a low overhead acquisition structure, then they have a product that all 4 banks want to own.

The banks that wholesale to them, are also watching to see how good it works.

If im right, and they execute over the next 2 years, they could have multiple bidders that have very deep pockets.

Very exciting to hold this stock.

[Rawz]

Hey Jimdog i largely agree with your thesis. Especially potential takeover target, lets hope it doesn't get to that though.. this should be a very good long term compounder.

I have invested in HMY because i believe they have the best model out of all the new fintechs on the block. All of HMYs competitors like plenti, moneyme, wisr etc use brokers (as well as going direct to market). HMY have chosen a direct to consumer model. This model is scalable globally. They have built (and continue to refine) Stellare which is the technology that profiles potential customers using many many data points.. originally via google but now also via the meta social media platforms (FB and instagram). When their target profile searches 'car finance, house renovation finance, consumer finance' etc HMY will bid more than its competitors to be the top search result. And when the dodgy profiles search for finance HMY dont bid.. amazing stuff. All their competitors have a shotgun marketing approach hitting all profiles that search finance..

Better Margins: If i was to have a guess a broker is going to typically want 1.00% - 2.00% cut of the rate (i.e. funder provides 10% rate to broker who sells it to the customer at 11-12%) for placing a deal with a funder for consumer finance, not mortgage finance.. So straight away HMY has this great advantage where they do not need to pay this. They can either enjoy higher margins (which they do as they reported being cashflow positive on a much smaller book than their competitors), or they can secure more A+ customers by offering a 1-2% lower rate to win the deal.

Better Customer Retention If a broker places a customer with a funder who controls the customer? I say the broker. I say the next time that customer needs additional consumer finance they go to their broker and the broker places the finance where ever the next best deal is (or next best margin for them). This is where HMYs 3 Rs business comes in. They control the customer and can remarket to the customer at no cost. Easy for the customer to stay with HMY rather than go through the process of setting up a new account elsewhere.

In a nutshell I believe HMY is better at finding and retaining A+ customers. As each quarter goes by the model is proven even more than the last. Aussie is remarkable. Next quarter we could see book growth of $70m based on current run rate. That will mean it has grown from $135m at the start of the financial year to $309m at the end. The total book will be around $700m. Their original guidance earlier in the financial year was to grow the book by $100m and end at $600m. Wow they are going to smash that. Obviously even management didnt expect Aussie to be such the success story it is.

The fintechs are the future and the big banks are slow to react and change their models. Everything is going online and being automated. HMY are in the right space and executing. Shareholders will be rewarded in time.