HGH - Heartland Group Holdings

[RTM]

You're welcome mate. I have a strong dislike for major reductions in call account interest rates with no notification by the bank but Heartland are by no means the only offender. I just shifted $100K over to them the other day which is the only reason I looked afterwards to make sure the money had arrived. Might shift it back and buy some more yield stocks now as its getting close to the point where their call account is practically worthless, other than as a relatively safe place to store money.

The reason the BNZ is no longer my first bank is that over and over again they simply rolled my money over at a poor interest rate. Without communication. I advised them multiple times. Then I transferred my banking elsewhere.

[Snoopy]

This is an assessment of Heartland's total liabilities/borrowings (including the accumulated funds looked after for Mum and Dad's known as term deposits) in relation to Heartland's own underlying assets.

In April 2017, Heartland had a subordinated capital note issue of $A20m. Approximately 72% of the face value of the Notes will be recognised as Tier 2 Capital by our banking regulators. So we must add the 'Tier 1 capital' (being shareholder equity) to 72% of the 'Tier 2 capital' to obtain the total recognised 'tier' capital for liquidity purposes

Total Heartland Equity at balance date was	$664.160m	, PLUS
Tier 2 capital as apportioned (NZD1 = AUD0.9138)	$15.758m	EQUALS
Total Tier Capital	$679.918m

Total Heartland liabilities at balance date were $3,831.766m

So: Equity / Total Liabilities
= $679.918m / $3,831.766m = 17.7% > 17%

Result: PASS TEST

I have been a little generous compared to what the reserve bank might do, in including 'intangible assets' as 'underlying equity'. The Reserve bank effectively punishes a financial institution for spending on having up to date computer software (software is an intangible asset). Yet I see up to date software as a really good idea in keeping track of troublesome loans. Nevertheless, whether you agree with my reasoning or not, no one can dispute that Heartland was in a better loan security position at EOFY2018, than at the end of the previous three financial years.

{Note that I have changed my equity target for Heartland to the 17% equity (down from my 20% target) that Heartland had when former Reserve Bank Governor Wheeler originally approved Heartland as a bank. I had previously used 20% as the figure appropriate for a more marginal finance company without a strong history.}

The historical picture of this ratio is tabulated below.

	FY2012	FY2013	FY2014	FY2015	FY2016	FY2017	FY2018	Target
Total Tier Capital/ Loan Book	19.3%	17.7%	17.6%	16.6%	16.4%	16.9%	17.7%	>17%

Time to update the banking covenants for Heartland.

In a change of methodology from last year, I am going to consider 'Heartland Group Holdings' and not just 'Heartland Bank'. This is because the entity that shareholders can buy into is no longer just 'Heartland Bank'. We shareholders can only buy into 'Heartland Group Holdings' so it makes sense to only analyse that company.

What follows is an assessment of Heartland's total liabilities/borrowings (including the accumulated funds looked after for Mum and Dad's known as term deposits) in relation to Heartland's own underlying assets.

In March 2019, Heartland Australia had an unsubordinated capital note issue of $A50m. If this was still part of Heartland Bank, approximately 72% of the face value of the Notes would be recognised as Tier 2 Capital by our banking regulators. So we must add the 'Tier 1 capital' (being shareholder equity) to 72% of the 'Tier 2 capital' to obtain the total recognised 'tier' capital for liquidity purposes

Total 'Heartland Bank' Equity at balance date was	$603.390m
plus Total 'Heartland Australia' Equity at balance date was	$72.278m
plus Tier 2 capital as apportioned (NZD1 = AUD0.9566)	$37.633m
equals Total Tier Capital	$713.301m

Total Heartland liabilities at balance date were $4,250.736m

So: Equity / Total Liabilities
= $713.301m / $4,250.736m = 16.8% = 17% (with rounding)

Result: PASS TEST

I have been a little generous compared to what the Reserve Bank might do, in including 'intangible assets' as 'underlying equity'. The Reserve Bank effectively punishes a financial institution for spending on having up to date computer software (software is an intangible asset). Yet I see up to date software as a really good idea in keeping track of troublesome loans. The multi year picture is fairly steady with small deviations either side of my 17% equity ratio target.

{Note that I have changed my equity target for Heartland to the 17% equity (down from my 20% target) that Heartland had when former Reserve Bank Governor Wheeler originally approved Heartland as a bank. I had previously used 20% as the figure appropriate for a more marginal finance company without a strong history.}

The historical picture of this ratio is tabulated below.

	FY2012	FY2013	FY2014	FY2015	FY2016	FY2017	FY2018	FY2019	Target
Total Tier Capital/ Loan Book	19.3%	17.7%	17.6%	16.6%	16.4%	16.9%	17.7%	16.8%	>17%

SNOOPY

[Snoopy]

This is an assessment method of looking at the underlying earning power of Heartland, compared to the interest bill they face while making their earnings. Updating for the full year result FY2018:

The EBIT figure is not in the financial statements. So I will use 'interest income' as an indicator for EBIT, once I have taken out the selling and administration costs

EBIT (high estimate) = $309.284m - $80.433m= $228.851m

Interest expense is listed as $125.483m.

So (EBIT)/(Interest Expense)= ($228.851m)/($125.483m)= 1.82 > 1.20

Result: PASS TEST

The historical picture of this ratio is tabulated below. It looks to be getting better and better.

	FY2012	FY2013	FY2014	FY2015	FY2016	FY2017	FY2018	Target
EBIT/ Interest Expense	1.15	1.22	1.44	1.52	1.65	1.79	1.82	>1.2

This is an assessment method of looking at the underlying earning power of Heartland Group Holdings, compared to the interest bill they face while making their earnings. Updating for the full year result FY2019:

The EBIT figure is not in the financial statements. So I will use 'interest income' as an indicator for EBIT, once I have taken out the selling and administration costs

EBIT (high estimate) = $334.330m - $85.589m= $248.741m

Interest expense is listed as $136.747m.

So (EBIT)/(Interest Expense)= ($248.741m)/($136.747m)= 1.82 > 1.20

Result: PASS TEST

The historical picture of this ratio is tabulated below. It looks to be getting better and better.

	FY2012	FY2013	FY2014	FY2015	FY2016	FY2017	FY2018	FY2019	Target
EBIT/ Interest Expense	1.15	1.22	1.44	1.52	1.65	1.79	1.82	1.82	>1.2

SNOOPY

[Snoopy]

The underlying debt of the company (debentures and other loan supporting borrowings removed) is the first factor in an attempt to assess the underlying shareholder owned skeleton upon which all the receivables that are loaned ultimately sit.

According to the full year (FY2018) statement of financial position the debt excluding borrowings is:

$24.249m + $11.459m = $35.708m (1)

-----

To calculate the total underlying company assets we have to (at least) subtract the finance receivables from the total company assets. I would argue that you should also subtract the 'Investment Properties' (the rump of the problem property portfolio) and the unspecified 'Investments' (held on behalf of policy beneficiaries) from that total:

$4,495.926m - ($3,984.941m +$9.196m + $340.546m) = $160.943m

We are then asked to remove the intangible assets from the equation as well:

$160.943m - $74.401m = $90.542m (2)

----


Now we have the information needed to calculate the 'underlying company debt' (skeletal picture) net of all Heartland's lending activities [ (1)/(2) ]:

$35.708m/$90.542m= 39.4% < 90%

Result: PASS TEST

The historical picture of this ratio is tabulated below.

	FY2012	FY2013	FY2014	FY2015	FY2016	FY2017	FY2018	Target
Underlying Gearing Ratio	20.2%	14.7%	40.5%	58.4%	37.4%	37.6%	39.4%	< 90%

The underlying debt of the company (debentures and other loan supporting borrowings removed) is the first factor in an attempt to assess the underlying shareholder owned skeleton upon which all the receivables that are loaned ultimately sit.

According to the full year (FY2019) statement of financial position the debt excluding borrowings is:

$22.498m + $7.532m + $10.372m = $40.402m (1)

-----

To calculate the total underlying company assets we have to (at least) subtract the finance receivables from the total company assets. I would argue that you should also subtract the 'Investment Properties' (the rump of the problem property portfolio) and the unspecified 'Investments' (held on behalf of policy beneficiaries) from that total:

$4,926.404m - ($3,029.231m +$1,318.819m + $11.132m + $354.928m) = $212.294m

We are then asked to remove the intangible assets from the equation as well:

$212.294m - $72.679m = $139.615m (2)

----


Now we have the information needed to calculate the 'underlying company debt' (skeletal picture) net of all Heartland's lending activities [ (1)/(2) ]:

$40.402m/$139.615m= 28.9% < 90%

Result: PASS TEST

The historical picture of this ratio is tabulated below.

	FY2012	FY2013	FY2014	FY2015	FY2016	FY2017	FY2018	FY2019	Target
Underlying Gearing Ratio	20.2%	14.7%	40.5%	58.4%	37.4%	37.6%	39.4%	28.9%	< 90%

SNOOPY

[Snoopy]

According to the full year (FY2019) statement of financial position the debt excluding borrowings is:

$22.498m + $7.532m + $10.372m = $40.402m (1)

The $10.372m figure I refer to above is a 'Derivative Financial Position'.

Something I look for in any set of annual accounts is when a change is presentation happens with no explanation. This year there is an entry for 'Derivative Financial Instruments' in both the asset and liability breakdown of the balance sheet. If you go back to the FY2018 account presentation these entries are not there, although they have been retrospectively written into the FY2018 accounts when the FY2018 balance sheet was restated for comparison purposes in the current year (FY2019).

'Derivative Financial Positions' have really jumped up in size too, and are now over ten times larger on the asset side and around five times larger on the liabilities side (FY2019 Balance Sheet vs FY2018 Balance Sheet). In the FY2019 accounts there is a comprehensive explanation of what these are under note 12. However there appears to be no information as to whether the corresponding numerical entries are 'Fair Value Hedges' or 'Cashflow Hedges'.

Why does this matter? Because when I calculated 'Banking Covenant 3', I feel that:

1/'cashflow hedges' are part of the 'interest rate cashflows' WHEREAS
2/ 'fair value hedges' are interim changes in capital valuations that should nevertheless all come out in the wash at the end of the life of the derivative.

This means that when I consider the capital position of the company I should probably consider type 2/ hedges but not type 1/ hedges. Or maybe my thinking is wrong on this? Can anyone offer some insight as to why these 'Derivative Financial Positions' have suddenly appeared on the balance sheet and what part of the Heartland business they relate to?

SNOOPY

[Snoopy]

With all the recent market upheavals, shareholders might like to know just how conservatively geared HBL is in an historical context.

Updating this number for the full year FY2018. The equity ratio is an assessment of the balance sheet risk of the total company, with all finance receivables and the supporting borrowings (whether they be from debenture holders or parent supporting banks) included.

Equity Ratio = (Total Equity)/(Total Assets)

Using numbers from the Heartland AR2018

= $664.160m/ $4,495.926m = 14.8%

The customer loan base (finance receivables) growth year on year (+12.4%) has in relative terms reversed and is now growing more slowly that the company equity (+16.6%). This means the balance sheet has been made 'less stressed' over the year.

The significant increase in share capital over the year was therefore from (reference "Statement of Changes in Equity")

1/ Retained Earnings:	$71.221m - $47.895m = $23.326m
2/ Dividend Reinvestment Plan:	$12.745m
3/ Share Based Payments to staff:	$0.666m
4/ Issue of Share Capital:	$59.225m - $0.910m = $58.315m
Total	$95.052m

This is a significant increase on the 'new capital generated' within the existing Heartland over FY2017 ($71.254m), with most of that increase accounted for in an even bigger capital raising undertaken over FY2018.

The historical picture of this ratio is tabulated below.

	FY2012	FY2013	FY2014	FY2015	FY2016	FY2017	FY2018	Target
Equity Ratio	16.0%	14.6%	15.0%	14.3%	14.1%	14.1%	14.8%	-

So Heartland is more conservatively geared than at any time in the last four years.

Updating this number for the full year FY2019 for 'Heartland Group Holdings'. The equity ratio is an assessment of the balance sheet risk of the total company, with all finance receivables and the supporting borrowings (whether they be from debenture holders or parent supporting banks) included.

Equity Ratio = (Total Equity)/(Total Assets)

Using numbers from the Heartland AR2019

= $675.668m/ $4,926.404m = 13.7%

The customer loan base (finance receivables) growth year on year (+9.1%) has in relative terms has reversed again and is now growing more rapidly that the company equity (+1.7%). This means the balance sheet has been made 'more stressed' over the year.

The historical picture of this ratio is tabulated below.

	FY2012	FY2013	FY2014	FY2015	FY2016	FY2017	FY2018	FY2019	Target
Equity Ratio	16.0%	14.6%	15.0%	14.3%	14.1%	14.1%	14.8%	13.7%	-

So Heartland is now more stressed, from an equity ratio perspective, than at any time in its history.

SNOOPY

[RTM]

Updating this number for the full year FY2019 for 'Heartland Group Holdings'. The equity ratio is an assessment of the balance sheet risk of the total company, with all finance receivables and the supporting borrowings (whether they be from debenture holders or parent supporting banks) included.

Equity Ratio = (Total Equity)/(Total Assets)

Using numbers from the Heartland AR2019

= $675.668m/ $4,926.404m = 13.7%

The customer loan base (finance receivables) growth year on year (+9.1%) has in relative terms has reversed again and is now growing more rapidly that the company equity (+1.7%). This means the balance sheet has been made 'more stressed' over the year.

The historical picture of this ratio is tabulated below.

	FY2012	FY2013	FY2014	FY2015	FY2016	FY2017	FY2018	FY2019	Target
Equity Ratio	16.0%	14.6%	15.0%	14.3%	14.1%	14.1%	14.8%	13.7%	-

So Heartland is now more stressed, from an equity ratio perspective, than at any time in its history.

SNOOPY

Is that a good or bad thing Snoopy ? Does it make Heartland more profitable for its shareholders ?
At what point should shareholders become concerned ?

[Snoopy]

Does it make Heartland more profitable for its shareholders ?

Since Heartland is using relatively less underlying equity to generate their profits, or alternatively the same amount of equity to generate more business, I would expect Heartland to be more profitable as a result

Is that a good or bad thing Snoopy ?

If nothing goes wrong in the loan portfolio, it is a good thing. But the more leveraged the total business, it will take a lesser downturn in the quality of the underlying loan assets to cause Heartland to need to raise more capital to shore up their capital base. That is a bad thing. Whether the net effect is 'good' or 'bad' will depend on how likely it is that you see the loan portfolio will deteriorate to an extent that more shareholder capital will need to be raised at a discount. That factor is not entirely under the control of Heartland. It also depends on 'market forces'.

An alternative way of looking at this figure could be to say that because the underlying quality of the ever expanding portfolio of 'reverse mortgage' loans are very high, less equity capital is needed to support them.

At what point shareholders become concerned ?

I wouldn't be concerned about a single 'Banking Covenant' statistic on its own. Best to look at them all together to get a feel for the overall picture. You will notice that unlike the other covenants, BC1 to BC3, there is no 'target' figure for BC4. The statistic thrown up for FY2019 may be the worst ever, but it is not so different to FY2016 and FY2017. I am not selling any of my own HGH shares because of this. You may need to keep an eye out for other signals. For example, if you heard that Jeff had taken a one way dive off the harbour bridge, that could be a sell signal? If it was the Sydney Harbour Bridge, that would be a definite worry!

SNOOPY

[RTM]

Thanks Snoopy.
I’ll sleep well then.

[BlackPeter]

Thanks Snoopy.
I’ll sleep well then.

Assuming HGH's equity ratio is the biggest of your concerns, I think you can.

Snoopy's numbers just demonstrate that they are doing a good job in increasing their REL business in Australia, which is a good thing, looking at the earnings.

As discussed earlier - these loans should be pretty safe ... unless HGH manages to overvalue the securities they held (like TRA did with their car loans ), underestimate the mortality rates (people living much longer than they statistically ought to) or unless the value of these securities takes a material plunge - like parts of Australia which are inhabited now becoming due to climate change (or other reasons) uninhabitable or at least undesirable to live in.

Not sure we or anybody can at this stage fully appreciate the last of these points ... so, yes, there will be risks related to climate change, which may or may not eventuate, but if they do they might be BIG and destroy property values big time. Might be sensible to put not all eggs into the HGH basket.