HGH - Heartland Group Holdings

[dobby41]

Not hospitality n tourism....what I said our economy. Yes...I will see businesses especially on tourism n hospitality go bust. .but HGH loans are heavy on farming.... agriculture.....so....yeahhh...

Good point - thread context is important.

[Snoopy]

3/ 'Harmoney' (not a spelling mistake) started in 2014 as a peer to peer lender. Sadly for the small guy, the entry level lender needs - as of 1st April 2020 - a cool $10m to participate. That hasn't stopped the company facilitating over $1.6 billion in loans to over 50,000 customers on both sides of the Tasman. Heartland took a 10% stake in Harmony on 8th September 2014. Heartland made a further investment in 'Harmoney' on 15th January 2015 for a total investment of $3.5m. The second investment was needed to retain Heartland's 10% stake after 'TradeMe' bought in as a cornerstone investor. Based on the investment made by 'Trade Me', the market value of Heartland's 10% stake in 'Harmoney' became worth $5m.

'Harmoney' reported their first profit an after tax gain of $7.22m over FY2019. Included in these calculations were tax losses of $4.85m and deferred R&D expenses of $4.74m. Before tax 'Harmoney' lost $233,000 in the year to March 2019. At EOFY2019, 'Harmoney' had $367m of financial receivables on the books. Heartland's share of this receivables book amounted to $36.7m.

My understanding is HGH do a LOT of the wholesale funding of Harmoney's loan book. I think all of this lending is unsecured.

You are saying that the consolidation of Harmoney into the Heartland accounts is because Heartland act as wholesale funders for Harmoney. And it is the not insignificant wholesale funding of Harmoney's books that has put Heartland's shareholders at risk, not the was 10% now 13.1% of Heartland's shareholding in Harmoney?

I don't know exactly how much Heartland has invested in Harmoney as an equity partner. It was $3.5m at the time of the TradeMe joining the share register which gave an implied $5m value for the Heartland stake as a result of a $3,5m total cash investment up to that point. If the stake is now 31% higher and the price paid to increase that stake was the same price TradeMe paid, then Heartland must have invested:

$5m x 0,31 = $1.55m more

to up their stake to 13,1%. So total cash put up by Heartland is now $3.5m + $1.55m = $5.05m.

That looks small bikkies compared to the $367m of loans current on the Harmoney loan book today.

(see https://www.harmoney.co.nz/investors...ace-statistics)

I must say I find the Harmoney reporting very opaque. I have never seen a full balance sheet published by Harmoney itself. If anyone can lead me to that information then I am all ears

Yet in the Heartland Annual Review 2019, 'Harmoney and Other Consumer Lending' only totalled $224m (a total which probably includes at least 'SpotCap' as well), and a total which has risen to $250m in the 'Company Factsheet 2020 as at 31-12-2019'. So it doesn't look like Heartland are doing all of the wholesale funding for Harmoney. You are of the view that Harmoney is done for in the post Covid-19 environment Beagle? I have had a look at the Harmoney thread on the peer to peer forum. Some investors have had some loans go bad, but these have been offset by good returns on other loans. It doesn't read like Harmoney is collapsing 'over there'.

SNOOPY

[Beagle]

Sorry mate I am not following this one especially closely so can't be much help.

[Snoopy]

I must say I find the Harmoney reporting very opaque. I have never seen a full balance sheet published by Harmoney itself. If anyone can lead me to that information then I am all ears

Yet in the Heartland Annual Review 2019, 'Harmoney and Other Consumer Lending' only totalled $224m (a total which probably includes at least 'SpotCap' as well), and a total which has risen to $250m in the 'Company Factsheet 2020 as at 31-12-2019'. So it doesn't look like Heartland are doing all of the wholesale funding for Harmoney.

Look what popped up when I put 'Harmoney Balance Sheet' into the search engine. The article is dated 5th March 2020.

https://australianfintech.com.au/har...ouse-facility/

"(Harmoney) has secured its first debt warehousing facility in Australia from one of the big four banks to cover the company’s unsecured personal lending book with a two-year availability period. The A$115 (approx $NZ124) million facility is designed to enhance the company’s capabilities to offer online personal lending on its own balance sheet in the Australian market."

"The company has recently also scaled up to NZ$140million the existing debt securitisation warehouse from the Bank of New Zealand, a subsidiary of the National Australia Bank (NAB) Group of companies."

Those debt facilities are designed to support future growth. The current Harmoney active loan balance is at $367m. I guess it is encouraging that two (or is it one, the wording of the article doesn't make this clear) other bank(s) is/are willing to back Harmoney. If Heartland had made $140m of facilities available to Harmoney which was then matched by $140m from the BNZ and then $124m came in from a mystery third banking player, then we have facility funding totalling just over $NZ400m in loans,

Digging back further, BNZ first stumped up with a initial $50m in 'securitisation funding' back in 7th March 2019.

https://www.interest.co.nz/banking/9...an-any-changes

Securitisation is the conversion of an asset, such as a loan, into marketable securities (this is often done by aggregating similar loans into a loan package).
Overseen by a trustee, 'Harmoney Warehouse Ltd' has been set up as a special purpose vehicle to issue the securitisation programme's notes. The idea is the securitisation notes are sold to debt market investors at some point. BNZ have taken on senior notes. 'Senior' in this context is that BNZ are the first in line to get paid should any debt go bad. If any debt goes bad then the first 70c in the dollar of any recoveries are paid out to BNZ. If there is any money left after that, then that money goes to the next financier down the securitisation scale (if any) termed the mezzanine financier. Harmoney has a mezzanine financier, another Australasian entity that does not want to be named. Finally, if there is no more money to pay back the funders, the difference must be made up from Harmoney's own shareholder equity.

An alternative to securitisation is wholesale or institutional funding.

Information on the Harmoney balance sheet has been reported in another article.

https://www.interest.co.nz/banking/1...creased-assets

Following the successful implementation of a securitisation programme, Harmoney's balance sheet has been transformed over the past financial year (ended 31st March 2019) . Total assets stood at $65.51 million, up from $9.72 million the year before. The biggest component in the increase is the addition of $37 million of finance receivables, which have been funded by $37 million of borrowings. Another asset referred to in the article was $4.5m of tax losses. This information allows us to work out an 'upper bound' of shareholder equity at the 31-03-2019 balance date.

Harmoney Shareholder Equity is less than: $65.5m - $37m - $4.5m = $24m

After balance date (the article was written on 24th July 2019) the article reports that an additional minimum $20m in shareholder equity was in the process of being raised (possibly as much as $25m).

In this article

https://www.interest.co.nz/personal-...ember-2014-has

another funder of Harmoney loans, TSB Bank, was revealed.

SNOOPY

[Beagle]

Wow, that's a lot of unemployed people that could give Harmoney the bird and walk away from their unsecured loan.

[Snoopy]

Wow, that's a lot of unemployed people that could give Harmoney the bird and walk away from their unsecured loan.

I am a bit flighty about Heartland's interest in Harmoney as well. But extrapolating a few thoughts from my previous post.

Assumption Let's assume that Heartland has the same senior debt funding conditions for supporting loans that the BNZ has,

Scenario Let's imagine that in the Covid-19 downturn, 30% of all money lent by Heartland to Harmony to be on lent to Harmoney customers is not returned.

Under this scenario, Heartland's 'loan support money' will be returned in full (because under the senior debt arrangement I have assumed, if the combined securitised debt goes bad, then the first 70c in the dollar of any recoveries will be paid out to Heartland). The next in line mezzanine financier will take a bath and get nothing of their loan back. Then the rest of the creditors will have to fight over the remaining assets of Harmoney that will be put into receivership. Under this scenario, Heartland will lose their equity in Harmoney, which I have previously estimated to be worth around $5m. That won't be nice for Heartland shareholders, but it wouldn't be the end of the world either. Could it be you are getting a little too worried about the bear mauling Harmoney to death, and the associated downstream effect on Heartland shareholders?

SNOOPY

[Beagle]

Snoopy - BEN has just announced Covid 19 provisioning of $148.3m https://www.news.com.au/finance/busi...ay+29+May+2020 and other banks provisioning is included in this article.

BEN has a market cap of almost exactly 5 times the size of HGH. If HGH's provisioning is in line with theirs's they can expect to provide one fifth of what BEN has which suggests Covid 10 provisioning for HGH might be somewhere around ~ $30m.

What might be a fun exercise seeing as you like to get your snout deep into these things is to compare market cap's of the other Aussie banks and their Covid 19 provisioning and see what that suggests on a relative basis for HGH ?

[winner69]

Worry that huge provisioning by other banks

Percy saw this likely to happen at Heartland and bailed before the **** really hit the fan

Reads the market well that percy.

[Snoopy]

Snoopy - BEN has just announced Covid 19 provisioning of $148.3m https://www.news.com.au/finance/busi...ay+29+May+2020 and other banks provisioning is included in this article.

BEN has a market cap of almost exactly 5 times the size of HGH. If HGH's provisioning is in line with theirs's they can expect to provide one fifth of what BEN has which suggests Covid 10 provisioning for HGH might be somewhere around ~ $30m.

What might be a fun exercise seeing as you like to get your snout deep into these things is to compare market cap's of the other Aussie banks and their Covid 19 provisioning and see what that suggests on a relative basis for HGH ?

Not a bad concept Beagle. I see some implementation difficulties though. Westpac, for example, made big Covid-19 write downs in the half year results announced earlier this month. But then they announced those write downs only represented an initial bite at the Covid-19 write down cherry. Very likely more significant write downs would be coming. The main unaccounted for fear there seems to be what might happen to the value of office buildings once a whole lot of companies realise they don't need an office fortress in downtown Sydney or Melbourne. So the first problem is assessing what the final Covid-19 write down might be. The second problem is thinking of Westpac, for example, as a scaled up Heartland for the purposes of making write down estimations for the latter. One might ask how many downtown office blocks do Heartland finance? I suspect the answer is none. To be honest I am finding it hard to find a suitable measuring stick for Heartland. So rather than do a top down comparison of how Heartland should behave, based on experience of other companies, I am currently doing a 'bottom up' analysis. I am starting from Heartland's FY2019 result and superimposing on that what I think 'market forces' will do to profits going forward, division by division.

I don't think there is too much point in dwelling on FY2020 which only has a month to run. I am much more interested in FY2021 and FY2022. Stay tuned!

SNOOPY

[Snoopy]

I am going to base my earnings estimates on the normalized profits of Heartland in FY2019, before this Covid-19 thing hit

Heartland FY2019 (Normalised Profit): $73.617m+ 0.72x($1.8m+$1.3m+$1.1m) -$1.936m -$0.173m =$74.532m

I am going to use FY2019 as my 'base case' becasue tjhat result contains no impact of Covid-19.

Notes on Normalising Profit

1/ I have adjusted for the $4.2m in costs associated with listing on the ASX. Specifically this included $1.8m of corporate restructure and ASX listing costs, a $1.1 million dollar break fee due to the early repayment of a Tier 2 Australian Subordinated bond and $1.3m in foreign currency costs also related to the corporate restructure (See 'Annual Review FY2019 p40).
2/ I have removed the $1.936m fair value movement of investment property gain, and the $173k gain on sale of investments.

The adjustments I make below are based on what I believe will be a fairly significant changes in 'borrowing attitudes' and 'business opportunities' going forwards.

Reverse Mortgages

Jeff has a fairly bullish view on the growth prospects for reverse mortgages going forwards, at least for FY2020 By contrast I believe the reverse mortgage market will be flat by FY2021. My reasoning for this is that in a rising property market, oldies can feel good about taking out a reverse mortgages because the value of their home is increasing consummately and their overall wealth is not going down. By contrast, when property prices fall, not only is any capital they spent on a reverse mortgage lost. The interest charges very obviously burrow into the oldies remaining savings as well. I am not saying that all reverse mortgages for capital expenditure will stop. If a pensioner needs capital for a hip replacement or to purchase unfunded cancer drugs or to visit a faraway relative they will still borrow. But they might not borrow to update their car, or for an annual holiday in the sun. Many of the oldies have frugality built into their character. It is a psychological mindset that I think will see reverse mortgage growth stall.


Motor Vehicle Finance Adjustment

So what does this picture suggest for profitability in FY2021?

As at December 2019 the motor vehicle finance book at Heartland was $1,124m. Let's guess new vehicle sales were $500m of that. So a 45% reduction would see a loss of:

0.45 x $500m = $225m worth of finance business in turnover.

Motor vehicle finance has traditionally had some of the best margins at Heartland. Heartland's AGM presentation had an ROE north of 15%. In recessionary times I am going to stick to the 15% figure. This means the earnings that Heartland will miss out on due to plunging new car finance deals will be around:

0.15 x $225m = $34m

Of course the annual hit won't be this much, as finance typically has a three year cycle. So the FY2021 hit will be about 1/3 of that, $11.4m.

I am guessing the FY2022 impact will be only half that in FY2021, $5.7m, but unfortunately the financing effect from FY2021 is cumulative into FY2022.

Underlying profit was around $74m in FY2019 (a bit less in FY2020?). So it looks like new car financing alone will knock Heartland's profit down to just shy of $63m, or a 15% drop.

Lot's of figures pulled out of the air here.

Anyone like to comment if I am on the right track?

Business Finance (Part 1): O4B

So what does this picture suggest for profitability in FY2021?

'O4B' was 3% of the Heartland bank loan book in December 2019, with $158m of loans on the books.

Heartland has been earning an ROE of more than 15% on this O4B portfolio.
If O4B sinks, then the annual tax profit loss for Heartland will be about:

0.15 x $158m = $24m

That is likely an overestimate as O4B also offers partially secured loans of up to $250,000 (well beyond the $100,000 limit of the NZ government scheme) and secured and unsecured loans into Australia. Those boundaries are beyond the IRD scheme. I would estimate the actual annualised profit hit to be 80% of my calculated figure, or around $19m. I estimate the IRD loan scheme may have brought forward about three months worth of loan applications that otherwise might have gone through O4B. If the IRD scheme is dropped on 12th June as planned, then the impact flowing into FY2021 may only be a couple of months. That equates to a reduction in FY2021 profit of $19m x 2/12 = $3.2m.

If the remaining 'outside of government scheme boundary' loans profit of $5m were to sink by 10%, then that would knock $0.5m off annual profits going forwards.

Likewise if the residual O4B loan profit balance of $19m- $3.2m = $15.8m were to reduce by 10%, that would wipe $1.6m off annual profits.

Now putting these three effects together, the expected annual profit decreases from the base year of FY2019 are as follows:

FY2021: -$3.2m - $0.5m - $1.6m = -$5.3m
FY2022: - $0.5m - $1.6m = -$2.1m

Business Finance (Part 2): Business Intermediated & Business Relationship

So what does this picture suggest for profitability in FY2021?

'Business Relationship' lending fell by 16% in FY2019 to $559.4m (Annual Review FY2019 p9), and I expect this trend to continue into FY2020 and FY2021. This means I am projecting the 'Business Relationship' loan book to be down to:

$559.4 x 0.84 x 0.84 = $395m

That number corresponds to the receivables book shrinking by $165m. We are told ROE for these loans is between 0% and 11% (AGM2019 Presentation p15). If the closed out loans averaged an ROE of 6%, this would represent a drop in Heartland profit from FY2019 levels of:

$165m x 0.06 = $10m

I am predicting that when some of the lending through intermediaries starts to shrink, Heartland will renew their interest in writing business relationship loans directly. So I see no further shrinkage in profit from this category between FY2021 and FY2022.

'Business Intermediated' lending is projected to grow in FY2020.

But I think that by FY2021, it will shrink back down 10% below FY2019 levels (down to $425.4m x 0.9 = $383m, a decrease of $42m). My reason for believing this is that there will be lower tradie activity in FY2021, and sensible tradespeople will have transferred to IRD backed ultra low interest loans, at least in NZ. The silver lining of this is that by existing Heartland customers effectively refinancing with the government, many bad debts to Heartland will be avoided. Business Intermediary loans have an ROE of between 11% and 15% (AGM2019 Presentation p15). If we assume the average margin is 13%, this will represent a loss of profit for Heartland in FY2021 of:

$42m x 0.13 = $5.5m

The kind of business loans sought by Heartland tend to be short term. So I am not expecting the general reduction in business loans to have a compounding effect year on year.

Rural Finance Adjustment

Rural finance at Heartland is transitioning between 'all of business funding' to funding seasonal assets. The former is far less profitable than the latter. So while I am expecting the rural loan book as a total receivable value to shrink, I am picking the Rural finance profit to remain flat,

Harmoney and Other Consumer Lending

Harmoney' reported their first profit, after an accounting standard change, of $7.22m over FY2019. Included in these calculations were a recognition of tax loss assets of $4.85m and deferred R&D expenses of $4.74m. Before these adjustments, 'Harmoney' lost $233,000 in the year to March 2019. At EOFY2019, 'Harmoney' had $367m of financial receivables on the books. The main profit that Heartland makes from Harmoney is not from the fraction of the Harmoney NPAT that they are entitled to via their partial ownership of Harmoney. No the profit comes from the provision of funds to Harmoney to run their loan book. If Heartland fund the loan book to the extent of their shareholding, then Heartland's share of this receivables book amounted to:

0.131 x $367m = $48m

At a 15% return on this loan money, this level of lending would produce:

0.15 x $48m = $7.2m of annual profit.

I predict that Harmoney will not survive the post Covid-19 and will be wound down in an orderly way mid way through FY2021. Other consumer lending should be OK.

	FY2021	FY2022
Baseline Reference Profit	$74.5m	$74.5m
Reverse Mortgage Adjustment	$0m	$0m
Motor Vehicle Finance Adjustment	($11.4m)	($17.1m)
Business Finance (Part 1) Adjustment	($5.3m)	($2.1m)
Business Finance (Part 2) Adjustment	($15.5m)	($15.5m)
Rural Finance Adjustment	$0m	$0m
Harmoney and Other Consumer Lending Adjustment	($3.6m)	($7.6m)
Total Forecast NPAT	$38.7m	$32.2m
No. Shares on Issue	581.0m	581.0m
Earnings Per Share	6.7cps	5.5cps

I don't think many current shareholders will be happy reading this! However, for those that exited at the right time, perhaps they will be happier? I am hoping the real results won't be as gloomy as this. I am also assuming in these calculations that all of Jeff's initiatives over the next couple of years come to nothing. That is a state of affairs that if you look at Jeff's record is unlikely to pan out. Still, what do they say in tough times? Hope for the best, but plan for the worst? Maybe in 2022 when interest rates on deposit drop to 0%, getting a 5c annual dividend on your Heartland shares will look attractive?

SNOOPY