HGH - Heartland Group Holdings

[Beau]

I have fond memories of MARAC finance too - when i started my first shop 12 years ago (Nov 2008 GFC!) - the banks wouldn't touch me, not even an OD - Marac loaned me $33k to get going ..... Then 2 years later they offered me a distressed store that they had security over - we did a deal - the other parties got to walk away without ugly bankruptcy process. Banks still wouldnt touch me four years in.

13 years later we are thriving. Thanks MARAC/HGH

Basically I think HGH does banking differently. Which is awesome in this environment....

Yes found Ashburton Loan and Building very accommodating right from when we walked in the door, even though interest rates of 9% in 1997 they could see our vision for the complex. Five years later had loan paid off sold lease then 18 months on sold land and buildings more than doubling our investment with there support. Over that time they amalgamated with Ashburton Permanant we purchased our entitled allotment of shares a little while later they even gave us some shares. Thats how we got on our Heartland journey.

[percy]

Thanks jimdog31 and Beau,
Great hearing real life positive experiences.

[Snoopy]

I don't see a significant cannibalisation threat from Household Capital Pty Ltd to Heartland's Seniors Australian business. These two are the only two active players of any size in the Australian REL market today. I see room for both brands to grow.

The concept of a bank organising their loan portfolio to take into account Reserve Bank mandated risk weightings is nothing new. Depending on how risky a class of loans is seen to be, the Reserve Bank can tailor the required capital to be held by a loaning bank to suit. Home mortgage lending has for a long time been regarded as the least risky form of lending, with the caveat that as the loan value to asset value ratio rises the risk of a home loan does go up. The Reserve Bank accounts for this by demanding a loaning bank has a greater amount of equity capital set aside for a more highly geared mortgage. Why is this of interest to HGH shareholders?

HGH shareholders supply the equity capital for Heartland. Thus if the Reserve Bank changes its asset class loan rating for a category of loans that means the bank must hold more capital for a given loan portfolio size. That extra capital must come from shareholders, either by reducing dividends paid to them or asking shareholders directly for more cash in a capital raising. Both these courses of action have negative implications for the HGH share price.

p19 of the recently released Forsyth Barr report on Heartland highlights just such a risk that I wasn't aware of:

"A significant risk for Heartland's reverse mortgage business is a potential change to the reverse mortgage weight risk used to calculate credit risk of risk weighted assets. Currently Heartlands reverse mortgage weight risks are ~52%"

APRA (the Australian Prudential Regulatory Authority ) had proposed that The RWA value for Reverse Mortgages be increased to 100% (effectively doubling the amount of capital that Heartland would have to hold against them). But after industry consultation, they decided to retain the current RWA ratings in 2019, provided the LVR ratio of the mortgage remained below 60%. In the case of Reverse Mortgages operated by HGH this is almost always the case (contracted LVAR 15% to 40%, so 60% indicates a borrower living until 100 or more, or a property market collapse). ForBarr considers the NZ reverse mortgage market has a similar unresolved risk.

I do not understand why APRA (or RBNZ) would even consider increasing the risk weighting on reverse mortgages. The underlying asset is exactly the same as an ordinary residential mortgage, except if anything the gearing tends to be lower. So if anything it would make more sense to reduce the risk rating for reverse mortgages, not increase it. Ordinary residential mortgages can have an RWA factor as low as 35% (p11 Forbarr report). I do see this as an overblown risk from a Forbarr perspective and this is an important reason why I am more bullish on HGH's prospects than they are.

SNOOPY

[Cyclical]

Just in case any depositors are worried about negative returns from their Heartland term deposits, I should point out that my table above does not show the full picture and was a 'tongue in cheek' reply.

Typically 'high risk banks' are required to back any loans they write. But that requires holding typically only 15% of their loaned out capital. So if term deposit rates did drop to -2% (not impossible but probably unlikely), or maybe 0% (more realistic - a NIM of 2% on deposited funds), then this would shrink Heartland's NIM down from 3.99% to 1.99% (apparently, or would it?). So on that basis it would be impossible to make any money if you were loaning out the money at the same rate you were borrowing it at. But that deposit NIM would only apply to 15% of the loan. The remaining 85% of the loan would not have to be funded by depositors.

That means from a 'profit perspective' Heartland's overall net interest margin that was 4% would decrease to:

(0.15 x 1.99) + (0.85 x 3.99) = 3.5% (actual effective NIM from a reduction in Heartland deposit rates by 2%)

At least, I think that is right. I am trying to show a non-proportional effect that reducing interest rates has on bank loan profits (and how Heartland can still make a profit with loan mortgage rates at 1.99%). This is made possible by retaining the existing 3.99% margin on the non bank backed part of the loan that is facilitated by the Reserve Bank of NZ being supportive of such lending. But no doubt I will be corrected if I have this wrong!

SNOOPY

discl: Not a banker

Hey Snoopy, what am I missing here? Are you implying that a "high risk bank" can fund 85% of a mortgage loan with cheap money from the RBNZ, presumably at the OCR? Does that then mean you are basing your 3.5% NIM off a forward looking OCR of -2%. If so, their current NIM on the 1.99% special isn't flash but is that Heartland taking an educated punt on the likelihood that the OCA is going to be circa -2% in the not too distant future? Mind you, the special is only for 12 months fixed isn't it, so just attractive enough to lure/buy some customers and then look to build that NIM further down the track?

[Snoopy]

Hey Snoopy, what am I missing here? Are you implying that a "high risk bank" can fund 85% of a mortgage loan with cheap money from the RBNZ, presumably at the OCR? Does that then mean you are basing your 3.5% NIM off a forward looking OCR of -2%. If so, their current NIM on the 1.99% special isn't flash but is that Heartland taking an educated punt on the likelihood that the OCA is going to be circa -2% in the not too distant future? Mind you, the special is only for 12 months fixed isn't it, so just attractive enough to lure/buy some customers and then look to build that NIM further down the track?

My logic is based on looking at the 'before' and 'after' picture, comparing a NIM of 4% from the previous year against whatever it might shrink to over FY2021.

I am saying that:

1/ IF you compare 4% from 'last year' (somewhat hypothetical because this is the average NIM for all loans across the HGH group and Heartland weren't pushing regular mortgages at all last year), but take into account that the reduced margin on the 'borrowed from the term deposit holder' (margin now down from 4% to 2% based on 1.99% mortgage rate and zero interest being paid to the deposit holder - Note I have given up on the idea of the deposit holder being 'paid' (sic) -2%) loan component

2/ THEN the margin for the 'whole of the loan' reduces by much less than the 2% reduction in loan margin for the 'term deposit funded' part of the loan might imply. Why?

What I haven't commented on is the cost of the loan money not covered by 'term deposit money'. I am saying that the cost of issuing this money (85% of the loan capital effectively created out of thin air) is regulated by the Reserve Bank. And I am saying that because the Reserve Bank is keen to keep the wheels of business turning, they will not make it harder for Heartland to access the 85% balance of RBNZ regulated loan money that they want Heartland to lend out.

(0.15 x 1.99) + (0.85 x 3.99) = 3.5% (actual effective NIM from a reduction in Heartland deposit rates by 2%)

From p18 of the initial ForBarr report on Heartland :

"Since the outbreak of Covid-19, the RBNZ has also taken a number of reactive measures. In addition to announcing a 75% percentage point rate cut to 0.25%, the RBNZ introduced a number of support mechanisms in addition to relaxing the requirements around lending restrictions."

SNOOPY

[Cyclical]

My logic is based on looking at the 'before' and 'after' picture, comparing a NIM of 4% from the previous year against whatever it might shrink to over FY2021.

I am saying that:

1/ IF you compare 4% from 'last year' (somewhat hypothetical because this is the average NIM for all loans across the HGH group and Heartland weren't pushing regular mortgages at all last year), but take into account that the reduced margin on the 'borrowed from the term deposit holder' (margin now down from 4% to 2% based on 1.99% mortgage rate and zero interest being paid to the deposit holder - Note I have given up on the idea of the deposit holder being 'paid' (sic) -2%) loan component

2/ THEN the margin for the 'whole of the loan' reduces by much less than the 2% reduction in loan margin for the 'term deposit funded' part of the loan might imply. Why?

What I haven't commented on is the cost of the loan money not covered by 'term deposit money'. I am saying that the cost of issuing this money (85% of the loan capital effectively created out of thin air) is regulated by the Reserve Bank. And I am saying that because the Reserve Bank is keen to keep the wheels of business turning, they will not make it harder for Heartland to access the 85% balance of RBNZ regulated loan money that they want Heartland to lend out.

(0.15 x 1.99) + (0.85 x 3.99) = 3.5% (actual effective NIM from a reduction in Heartland deposit rates by 2%)

From p18 of the initial ForBarr report on Heartland :

"Since the outbreak of Covid-19, the RBNZ has also taken a number of reactive measures. In addition to announcing a 75% percentage point rate cut to 0.25%, the RBNZ introduced a number of support mechanisms in addition to relaxing the requirements around lending restrictions."

SNOOPY

Thanks Snoopy, I think I know where you are coming from, but personally I'm struggling to arrive at ~3.5%, unless you think OCR is going to -2% while Mortgage rates remain unchanged at 1.99%.

Here's my stab at it, all things being equal...please tell me where I'm going wrong:

At today’s rates:
Laon Amount	$100,000.00	1.99%	$1,990.00
Funding Sources:
Term Deposit	$15,000.00	1.05%	$157.50
RBNZ	$85,000.00	0.25%	$212.50
Total Loan Cost			$370.00
		NIM ($)	$1,620.00
		NIM (%)	1.62%
Hypothetical in 6 months:
Laon Amount	$100,000.00	1.49%	$1,490.00
Funding Sources:
Term Deposit	$15,000.00	0.25%	$37.50
RBNZ	$85,000.00	-1.00%	-$850.00
Total Loan Cost			-$812.50
		NIM ($)	$2,302.50
		NIM (%)	2.30%

[Snoopy]

Thanks Snoopy, I think I know where you are coming from, but personally I'm struggling to arrive at ~3.5%, unless you think OCR is going to -2% while Mortgage rates remain unchanged at 1.99%.

Here's my stab at it, all things being equal...please tell me where I'm going wrong:

At today’s rates:
Loan Amount	$100,000.00	1.99%	$1,990.00
Funding Sources:
Term Deposit	$15,000.00	1.05%	$157.50
RBNZ	$85,000.00	0.25%	$212.50
Total Loan Cost			$370.00
		NIM ($)	$1,620.00
		NIM (%)	1.62%
Hypothetical in 6 months:
Loan Amount	$100,000.00	1.49%	$1,490.00
Funding Sources:
Term Deposit	$15,000.00	0.25%	$37.50
RBNZ	$85,000.00	-1.00%	-$850.00
Total Loan Cost			-$812.50
		NIM ($)	$2,302.50
		NIM (%)	2.30%

I think I can get that net interest margin up a bit Cyclical. A home loan has an RWA (Risk Weightings Adjustment) as low as 35%. That means the loan capital to back up a 35% RWA $100,000 mortgage is not $15,000, but only 0.35 x $15,000 = $5,250. So the bank's cost of 'income in' verses 'funding' on that loan now look like this:

At today’s rates:
Loan Amount	$100,000.00	1.99%	$1,990.00
Funding Sources:
Term Deposit	$5,250.00	1.05%	$55.13
RBNZ	$94,750.00	0.25%	$236.88
Total Loan Cost			$292.01
		NIM ($)	$1,697.99
		NIM (%)	1.70%

That is of course is just the interest charge bit of the NIM. Normally on top of that there are application fees, approval fees, variation fees etc. Looking on the Heartland website for 'mortgage fees', this particular 1.99% offer looks clean (although that 20% deposit requirement might knock out some applicants). However, I think the key point here is that historical Heartland's 4% net interest margin is across the whole loan book. In some loan categories, the NIM would be less than 4%. Furthermore the 'net interest margin' is only one input factor into the 'net profit margin'. It might be worthwhile settling for a lower NIM if it meant less follow up was required to manage payments due, which implies a positive effect on the 'net profit margin'.

SNOOPY

[Scrunch]

IMO there isn't 3-4% margin home loan lending for the sub-set of borrowers with 20%+ equity.

What there is however, is potentially strong returns on the equity HGH needs to put in to back these loans. As Snoopy notes, they are a 5% not 15% equity product. If HGH lends $100m, and get a 1 to 1.5% net margin, its earning $1-1.5m/yr in margins from the $100m lent. With only $5m of equity allocated to the loans, the $1 to $1.5m made is now generating a 20% to 30% return on equity.

Across 2015 to 2020 HGH had a net surplus/equity ratio between 10% and 11%. Operational expenses and tax will lower the returns noted above and any fees charged will increase it. After factoring these in, the lending would look to have the potential to increase, rather than lower surplus/equity ratio - assuming you have an operationally efficient process behind the scenes. This is inherently possible from a web-based application process to borrowers with a low risk profile.

If done properly, lending at 2-2.5% still has the potential to be value creating relative to other lending alternatives. If done on any scale, it would however lower the NIM and lower impairment levels.

[Snow Leopard]

What is this?

Heartland Bank staff go on strike

[Cyclical]

What is this?

Heartland Bank staff go on strike

Broken link there Snow Leopard. Here's another http://business.scoop.co.nz/2020/10/...low-pay-rates/

The market doesn't seem too phased by it ATM.