HGH - Heartland Group Holdings

[Snoopy]

But as you know, PGF has just been sold to HNZ.

In the latest PGW interim report, authorized of 7th February 2011, this is what PGW management said about PGF:

“PGG Wrightson Finance had continued to benefit from its good fundamentals with strong reinvestment rates and initiatives to extend the book beyond the non-bank deposit taker Crown guarantee scheme.”

Yet a matter of weeks later PGF was portrayed to PGW shareholders as an effective “basket case” that could only be sold at net asset value. We shafted PGW shareholders were lucky to get even that, according to the PGW board. Somehow that fact PGF wasn’t even sold for asset value, because the unsaleable loans were retained by PGW by way of a special purpose investment vehicle, was overlooked. This suddeness in the fall of grace of PGF shocked and rocked me. Using the PGW board’s metric for measuring ‘finance unit trouble’, where does that now leave HNZ?

Your comparisons with Kiwibank were interesting Lizard. However the big difference is that ultimately if Kiwibank needs more money the government is there to supply it. And my hunch is the quality of Kiwibank loans is superior to Heartland too.

SNOOPY

[Snoopy]

So presumably, amongst the ST experts, credit risk is the main concern? How would you go about judging that?

Of practical concern for old owner PGW was the ongoing depositor and lender cashflows in PGF from here on in. Net negative cashflows would ultimately stress the now HNZ balance sheet, should that be required to be called upon as a result of depositors not reinvesting enough money. This was certainly the case with PGF as it existed within PGW. And this reasoning was put forward by the board of PGW as the real reason for the PGF fire sale.

I would be interested if you expanded a bit more on your opinion here Lizard as it relates to HNZ:
“My prior concerns were regarding liquidity, particularly in regard to the expiry of the govt guarantee. However, the accounts suggest that they have managed that quite well and the expiry in itself is unlikely to pose a threat at this point.”

In the case of PGF, it seemed that getting some balance with the depositor reinvestment rate and deposit rollover time period verses the underlying farmer loans was going to become an issue. Under note 23 of the PGF FY2011 accounts, we see that $185.924m of secured debentures are redeemable within a year (mostly this October, the one coming up in a few days) when the government guarantee scheme runs out. Could PGF as a stand-alone entity attract the required new and/or reinvested depositor capital in time? This is the capital required to match the $333.911m (see PGF FY2011 Note 14) of customer loans also due to expire over the June 2011 to June 2012 twelve month period.

Far from saving PGF, it looks like the government guarantee has contributed to the firm’s stand alone downfall by concentrating all the term deposit maturities around one date. Thus a ‘wall of reinvestment’ is created that cannot be easily hurdled.

How will putting on a new brand of running shoes allow the renamed Heartland (rural division) to clear this jump? Keeping back $90.9m of loans:

$333.911m- $90.9m= $243.0m

does help, yes. But it doesn’t fix the now HNZ problem from where I sit.

SNOOPY

[percy]

[QUOTE=Xerof;357190]Interesting they put these cucumber sandwich meetings on for depositors - what about the poor suffering shareholders?

At present it is most important to have depositors on side.HNZ are carry a lot of cash at present to help them get through the end of Govt guarantee.
You can not stay in lending business ,unless you have money to lend.It surprised me to learn that there are a lot of people with over half a mil just sitting in a cheque a/c earning no interest.It is very important for big lenders to meet the people at HNZ. If they like them they will lend them big money.I love going to these meetings.First, I look at people's shoes, then their trousers.Lovely shoes,and clothes made out of good clothe.Then it is fun watching who the local brokers are talking to.Real money draws them. Only takes a few minutes to work out who is worth big bucks.Old saying everyone laughs at a rich man's jokes is very true. So if your depositors like cucumber sandwichs,then make sure they get enough,and laugh with them.!!!!
]

[Lizard]

Hi Snoopy, This could take me hours to answer and will probably send everyone to sleep, so I'll try and limit it to a few main points.

Liquidity risk is covered on pages 32 & 33 of the HNZ FY11 report and in pages 16 and 17 of the PWF FY11 report. Note that leaving behind the impaired loans with PGW doesn't change the deposits due, and actually removes some receivables from the contractual maturity, so could be perceived as a negative in regards to cashflow from HNZ perspective (reality is, not much would have been likely to be received though).

There are two parts to the liquidity risk tables - those based on contractual maturity and those based on expected maturity. Contractual maturity pretty much presumes a wind-down scenario - no new deposits, no reinvestments. Under that scenario, most financial institutions will have a funding gap - banks can look pretty extreme with all those on-demand deposits versus long-term mortgages. Expected maturity is more relevant - and obviously the assumptions that go to making that up. HNZ appear to have presumed a 72% re-investment rate (no new deposits), and expected maturities show redemptions could easily be handled from maturing loans, without even resorting to the $267m of cash on hand or $280m of undrawn bank facilities.

The 72% re-investment rate has been beaten by rates of 74-75% in July/August (although I would expect that there remains a significant chunk of deposits that will be redeemed in November/December and would be surprised if this rate is maintained). Furthermore, HNZ has had a steady stream of new deposits - at June, the rate was running at around $30m per month and the rate has since been said to be stable. Almost all of the new deposits and 80% of the re-investments have been choosing the non-guaranteed option. In reality, retail deposits fell by only $80m between the 5 Jan accounts and 30 June - a 5% reduction in overall deposits. This seems to suggest that their depositor base isn't about to head off into the sunset with the expiry of the guarantee.

The PWF side provides less information - there is a narrower asset-liability margin in maturities and, unlike HNZ, they only give the contractual data for debt repayments, which probably over-estimates versus expected repayments. In addition, the PWF040 will come up for redemption in early October, taking nearly $100m of cash to redeem. I am not sure if any attempts are being made to see these funds re-invested in HNZ, but will likely represent a substantial cash drain. As it stands, PWF contractual maturities suggest that this can be more than covered from debt repayments/lending contraction. I'd be a bit sceptical in that regard - along with recognising the cost attached to a shrinking loan book. However, HNZ have also been flagging another bond issue that could have the potential to replace these deposits.

My view is that the cash reserves, new investments and bank facilities look more than adequate to replace likely redemptions in the face of the guarantee expiring, taking into account recent re-investment rates. Although it is possible to come up with scenarios in which this is not the case, in my assessment, those scenarios would have to be quite extreme, such as re-investments crashing to 30% in the last quarter, along with no new investments.

One major point to be made here - I take the view that the expiry of the govt guarantee should see the low point in depositor funds. After that, I presume that investors will see HNZ as having survived and confidence will gradually increase. Continued low interest rates elsewhere provides ongoing impetus for yield-starved investors to put aside any anxiety. Obviously if investor confidence and deposits were to shrivel further beyond year end, that would not be a good thing - but that is more an issue of ongoing profitability than liquidity.

That brings me back to Credit Risk. Asset Quality has to be the hardest thing to gauge. Overdues, impairments and write-offs combine to provide some insight. These appear to be stabiliising. Providing they do not increase again, it seems likely that HNZ will be profitable and equity will not be further eroded. If this is the case, then the level of HNZ equity looks to me to be able to support considerably higher levels of lending and subsequent profits.

[Lizard]

Using your figures for the combined HNZ Lizard, $324m of net equity for about $2,100m of loans equates to a loan to equity ratio of 6.5:1. What would the combined loan book have looked like at HNZ without the acquisition of PGF! Actually I can answer that:

($2,100m-$290.8m)/($324m-$99.5m)= 8:1. A crisis averted by HNZ in buying PGF?

Well according to you Liz (on the other side of the transaction fence) it was actually PGF that was the ‘bad boy’ in this cauldron of doubtful loans.

Actually Snoopy, HNZ acquired very little in equity from the purchase of PGW - the asset price was based on adjust NTA, so in effect, they simply swapped cash on their books for some assets. As it happened, very few net assets - since they probably gave back over $95m in impaired assets and associated tax losses (I'm not sure if we received final figures on the transaction) and swapped cash for the remaining $7.5m. They then raised $58m of which about $55m went to pay off the ASB for exiting a risk-sharing arrangement. I doubt this was on PWF's balance sheet as a liability as would have been contingent I think, so that was a straight out give-away. In the end, HNZ ended up with $324m in equity vs the $296m they had at year end, so I am guessing that there were other parts to this transaction - e.g. some of those impaired loans given back to PGW might have already been provisioned and therefore not included in the original book value on which the transaction was based.

From the HNZ accounts, year end loan to equity was $1700m to $296m.

I just need to add some corrections to this post. The pro-forma equity for HNZ+PWF is $351m, the $324m is net tangible assets. It looks like the main transaction with PGW was neutral for company nta, but the overall equity was increased by the amount that went to ASB ($55m from equity raising) to purchase back the share of the loans under the risk-sharing agreement. It looks like they could have been purchased at a premium to book value under that agreement, as it appears intangibles must have risen from the $22m on the combined HNZ/PWF books to $27m in pro-forma.

The total depositors funds are now the HNZ depositors plus PWF depositors ($2.1bn). The total loans are the HNZ loans plus PWF loans, less $90m returned to PGW and plus $50-$55m purchased back from ASB risk-sharing facility (also $2.1b) plus any new lending since 30 June.

The total cash on book at year end was $340m plus a $280m undrawn bank facility for HNZ and presumably also the undrawn $100m bank facility for PWF. In addition, HNZ announcement in early August said that they were undertaking a further $100m of securitisation. Although they may have since re-loaned some of that funding, it does look as though they should have access to perhaps $750m of cash and funding facilities - enough to pay out one-third of the depositor base at a pinch without reducing lending.

[Lizard]

Your comparisons with Kiwibank were interesting Lizard. However the big difference is that ultimately if Kiwibank needs more money the government is there to supply it. And my hunch is the quality of Kiwibank loans is superior to Heartland too.

SNOOPY

I agree with that point re government funding. However, I haven't seen anyone on this forum proclaiming that Kiwibank is about to need more capital or in any trouble. As for asset quality, that was my point about overdues and impairments - yes they are higher in HNZ relative to loan book (as would be expected in a finance company), but relative to equity, they perhaps don't compare as unfavourably with Kiwibank as might have been expected.

Should also point out that PWF didn't look like a complete basket case given that their funding maturities had actually lengthened on prior year. I also seem to remember from looking in the past that they had quite a high proportion of deposits on call - that may be classed as less than 12 months maturity, but these aren't likely to be withdrawn en masse.

The bigger concern was probably more around asset quality and also funding the bond redemption. I suspect some of those maturing loans weren't likely to be repaid on time and the short term funding gap might have caused some hiccups. Also, ASB may have had dibs on some of the better loans under their risk-sharing agreement - I really haven't looked into that. Must have been very few options available to them, as it seems to me that they pretty much gave PWF away.

[winner69]

WTF ... shareorice close to having a 4 in front of it .. whats up as whatsup kept asking

Soemthign not right eh

Is that really a 4 in front of the HNZ shareprice .... where's whatsup when we really need him

[Lizard]

I am not terribly expert in analysing financial stocks and have made more than my share of investing mistakes. I also have a heap of respect for Xerof, Winner and Snoopy, who are all ringing the alarm bell on HNZ. So, since I recently acquired a few HNZ, am hoping someone can further outline the concerns in relation to the accounts.

My prior concerns were regarding liquidity, particularly in regard to the expiry of the govt guarantee. However, the accounts suggest that they have managed that quite well and the expiry in itself is unlikely to pose a threat at this point. Nor is there any sign of Marac raising rates to attract funds (although to some extent, they will have benefited from widening spread over bank deposits through a fall in bank rates).

So presumably, amongst the ST experts, credit risk is the main concern?

Hey, Winner - neither you nor Xerof answered my recent query and Snoopy said he's not expert in financials either. Is it Credit Risk you are thinking is the issue? If so, how do you go about assessing it and forming a view?

[winner69]

Hey, Winner - neither you nor Xerof answered my recent query and Snoopy said he's not expert in financials either. Is it Credit Risk you are thinking is the issue? If so, how do you go about assessing it and forming a view?

Suppose at the end of the day it is 'credit risk' being the issue - but more from a perspective of the future direction of the company.

Agree done a good job in bringing together the 3 entities into 1 and as such getting some critical mass. Also have some pretty big aspirations like 20% ROE (or was that Belg saying that was possible?)

The foundation of the business is 2 building societies and a more traditional finance company (Marac accounts looked pretty sick before the bailout and Southern Cross accounts show big losses the last 2 years and I didn't look at CBS)

HNZ wants to become a banK - to me a red flag when the businesses now the foundation of HNZ have been like SCBS says 'For 87 years, the Society has been helping New Zealanders to invest their savings and to purchase property.'. Yep simple model in taking peoples savings and invested wisely (with 1st mortgages) in mainly residential property. Suppose CBS was much rhe same and as percy reminds me marac has been a successful finance company for years. (Mind you SBS is an old fashioned building society with a banking license so maybe a model does work)

Call me old fashioned now but the way HNZ seems to be heading is far removed from what the platform businesses have based their success on. With growth and earnings aspirations like they seem to have the red flag is doing business a different way ... probably taking more risks (non traditional lending areas/ less security etc)

And I still think the finance head saying 'Heartland aims to encourage depositors by becoming a bank, reasoning that people are more relaxed about putting money in a bank than with a finance company' isn't a good look. Is this the only thing they have to engender investor confidence? Almost as bad as Hangover using Dougal to say how safe they were.

So at the end of day suppose credit risk is the issue ... probably not now (you never know as there is a lot of noise around the book) but what it might look like in a few years time, esp as they seem to be moving away from traditional old fashioned models that ahve been successful. They'll probably even up with a treasury dept trading in derivatives and the like with investors money before they lend it out.

[Lizard]

Thanks Winner.

I'm still at a bit of a loss - you seem to suggest that they would be taking more risk by being a "bank" when I would have thought that could have meant they could take less risk. Surely that would mean they could go to mainstream lending rather than having to pick from those borrowers rejected by mainstream banks with lower cost of funds? The main reason I can see for becoming a bank is that banks (or at least the brokers who sell a large proportion of those loans) have weakened their lending criteria over the years and are now so undiscerning that they don't leave much in pickings for the traditional 2nd tier. After all, from what I can gather, the big 4 will lend me enough money to have me working until 75 while living off unsalted rice with no heating or phone in order to pay the mortgage - and that's presuming interest rates never go up.

Coincidentally, I was rung by Heartland today regarding a deposit due to mature for which I'd only recently posted off the form. This is not the place to go into details, but the calibre of that conversation was way, way beyond anything I've experienced since the good old days of telephone banking... not the "enter your pin" variety, but the days when one could ring the bank and they recognised your voice. If there isn't a place for this in the modern world, there is still a place for it in my sentiments.