HGH - Heartland Group Holdings

[Snoopy]

However a weak credit rating is always a red flag, and rightly so ... and BBB isn't too strong. Much easier for money to disappear into thin air than to appear from it (unless you are a reserve bank).

HGH better worries about their credit rating, and I am sure they do. Did I just hear the words "Capital raise"?

I would call 'BBB' a solid credit rating for a middle tier lender. It is still investment grade. I wouldn't call it 'weak', although others may disagree as 'weak' is a comparative term. A reduction to BBB- would not be catastrophic. Heartland has operated there before.

I remember Jeff being asked at the last AGM what the difference operationally was between 'his' bank and those higher credit rated larger banks, in relation to credit ratings. IIRC Jeff said something like: Very little except the bigger banks loaned on a larger scale. Before Covid-19, both GJe(o)ffs were confident of using retained earnings to fulfill -now delayed- new Reserve Bank capital reserve rules. The fact that Heartland Bank (although not Heartland Holdings) is now banned from paying dividends until this crisis resolves is a kind of enforced capital raising. Whether there will be yet another capital raising, more conventionally structured, is still open to question. Watch the share price rocket if it isn't needed!

Personally I am most worried about the very profitable motor industry loan book. It is true many need a car to get to work or look for a job. But do they need a new car to do this? In tough times it might make sense to get the new car repossessed and use what would have been your new car payments for a couple of months to buy something more modest. We may have to wait until the end of the twelve week wage subsidy to see what happens in this regard. But I think a path still exists for 'no cash issue' at Heartland even if it is IMO a less likely path.

SNOOPY

[Playa]

I read somewhere recently(correctly or incorrectly)that a BBB rating translates to a 1 in 30 chance the bank may run into problems with making a full repayment of interest and principal,and a AAA rating was from memory 1 in 600

[Snoopy]

I read somewhere recently(correctly or incorrectly)that a BBB rating translates to a 1 in 30 chance the bank may run into problems with making a full repayment of interest and principal,and a AAA rating was from memory 1 in 600

I think you might have read this on the RBNZ website. That is where I found it four years ago in 2016 when I had a discussion on this very thread on understanding this very issue with Axe.

http://www.rbnz.govt.nz/-/media/Rese...dowsonwood.pdf

"Ratings are by their nature probabilistic. For example, the
historical probability of default associated with a AAA-
rated entity, while small, is not zero. In a portfolio of 600
separate AAA entities, an investor could expect one to fail,
on average, every five years, based on the default histories
summarised in table 1. A failure of a highly rated entity
is therefore neither inconceivable, nor ruled out by a AAA
rating from a rating agency."

If I rewrote this paragraph for the Heartland situation it would go like this

Ratings are by their nature probabilistic. For example, the
historical probability of default associated with a BBB
rated entity, while small, is not zero. In a portfolio of 30
separate BBB entities, an investor could expect one to fail,
on average, every five years, based on the default histories
summarised in table 1. A failure of a medium rated entity
is therefore neither inconceivable, nor ruled out by a BBB
rating from a rating agency."

SNOOPY

[Snow Leopard]

...Ratings are by their nature probabilistic. For example, the
historical probability of default associated with a BBB
rated entity, while small, is not zero. In a portfolio of 30
separate BBB entities, an investor could expect one to fail,
on average, every five years, based on the default histories
summarised in table 1. A failure of a medium rated entity
is therefore neither inconceivable, nor ruled out by a BBB
rating from a rating agency."

SNOOPY

Probably pinged you at the time over that statement and just to be consistent I will do so again:
It is not fail, it is default and default means 'to not pay on time and in full'.

The difference between a bank failing and a bank defaulting is huge.


Hopefully the Heartland empire will do neither.

[Snoopy]

The 'one in whatever' ratio (1:30 for a BBB organization) interpretation that the reserve bank quotes in their explanatory notes is

"The approximate, median likelihood that an investor will not receive repayment on a five-year investment on time and in full, based upon historical default rates published by each agency."

Probably pinged you at the time over that statement and just to be consistent I will do so again:
It is not fail, it is default and default means 'to not pay on time and in full'.

The difference between a bank failing and a bank defaulting is huge.

Hopefully the Heartland empire will do neither.

The quote I have reproduced above, and the one you referred to, are both taken from the Reserve Bank website. So it seems even the Reserve Bank can be a little loose with using the terms 'failure' and 'default'.

I guess what you are saying, SN, is that a default can be a signpost on the road to failure. But just because a financial institution goes past the 'default' signpost on the road, that doesn't mean the journey will end in the town of 'failure'.

Nevertheless here is my question of the day.

South Canterbury Finance depositors got paid out in full with no default. So is it true to say that South Canterbury Finance did not fail?

SNOOPY

[BlackPeter]

I would call 'BBB' a solid credit rating for a middle tier lender. It is still investment grade. I wouldn't call it 'weak', although others may disagree as 'weak' is a comparative term. A reduction to BBB- would not be catastrophic. Heartland has operated there before.

...

SNOOPY

I would agree - in normal times. However, these are not normal times.

If we are moving towards a one in hundred years recession (or depression) as some analysts predict, then (based on the probabilities you cited above), a BBB rating (with an annual default rate of 1:150) would bring us close to a flip the coin chance of the entity getting in trouble this year.

And don't get me wrong - I don't expect HGH to go belly up if they play this right, but I think the board might be well advised to consider their capital requirements in these extraordinary times.

And yes, car finance is clearly one of their Achilles heels in troubled times. Existing loans will have significantly higher rates of stressed loans (two digit unemployment rates are bad for consumer loans) ... and new business is likely to shrink for some time. In both China as well as in Europe car sales numbers dropped drastically (i.e. more than 50%), meaning as well less need for car finance.

[Snoopy]

Heartland Receivables (Dec 2019)	$M	%
Reverse Mortgages	$ 1,424	31%
Motor Vehicle Finance	$ 1,124	25%
Harmoney & other consumer lending	$ 250	5%
Business Finance	$ 1,009	22%
Open for Business	$ 158	3%
Rural Finance	$ 621	14%
total	$ 4,586

Attachment 11175

These are not normal times.

If we are moving towards a one in hundred years recession (or depression) as some analysts predict, then (based on the probabilities you cited above), a BBB rating (with an annual default rate of 1:150) would bring us close to a flip the coin chance of the entity getting in trouble this year.

And don't get me wrong - I don't expect HGH to go belly up if they play this right, but I think the board might be well advised to consider their capital requirements in these extraordinary times.

And yes, car finance is clearly one of their Achilles heels in troubled times. Existing loans will have significantly higher rates of stressed loans (two digit unemployment rates are bad for consumer loans) ... and new business is likely to shrink for some time. In both China as well as in Europe car sales numbers dropped drastically (i.e. more than 50%), meaning as well less need for car finance.

I get your 'top down' interpretation of looking at the situation BP. But if we carry on with that logic, what you are effectively saying is that approximately half of all BBB rated financial institutions will fail as a result of this Covid-19 crisis. The glass half full view of the situation is that half of all BBB rated financial institutions will not fail. So rather than not invest in any BBB rated financial institution (which I admit is a legitimate response to the situation we investors fine ourselves in), I prefer to ask a separate question:

"What are the characteristics of a BBB rated finance company that will lean it towards becoming one of the survivors?"

I think Reverse Mortgages as a loan category look sound. The big issue here is getting the cashflow to finance growth. But HGH seem to have no problem raising money from wholesale bonds and with interest rates even lower going forwards, I think there will be a scramble for any fixed interest return above junk bond level. The fact is that reverse mortgages tend to be leveraged less than conventional mortgages. On average this ups the safety factor for shareholders in this portion of the business.

Rural lending is still a 'bogey boy'. But, with the disruption in tourism, 'rural' is suddenly the primary export driver again. I don't believe that all of our rural commodities will have a great year going forwards and the climatic risks of rural lending remain. However the portfolio being steered towards 'short term funding' (like funding livestock fattening) is regarded by Basel 3 architects as being far less risky than funding capital projects. And the comparative risk against lending to the tourism sector means that bankers should look on 'Rural' more kindly going forwards. I don't see an excessive risk from lending to the rural community going forwards.

Business Finance is a big question mark for me. But we do have the government backstop of underwriting 80% of the value of new loans, and government wage subsidies. That adds up to quite a cushion of government support. The businesses that Heartland finance are unlikely to be 'too big to fail'. But the government certainly doesn't want too many of these businesses to fail. So the next few weeks will be very important for this part of the loan book.

Funding new vehicle sales I see as the troublesome part of the loan book going forwards. Nevertheless historically this has been the most profitable part of the business. Profits going forward may not be great. But if we can get away without making a big loss, then I don't think this branch of the business will bring Heartland down.

I am trying to be dispassionate about this, not always easy when you are a shareholder. But it does look to me as though Heartland will be a BBB survivor.

SNOOPY

[Balance]

NAB beating the field by reporting earlier (ahead of the three other Australian banks) to raise capital.

Almost a given that Heartland is going to have to raise additional capital as well to protect its BBB rating.

Question is when - in August when they announce the full year results or asap?

[traineeinvestor]

NAB beating the field by reporting earlier (ahead of the three other Australian banks) to raise capital.

Almost a given that Heartland is going to have to raise additional capital as well to protect its BBB rating.

Question is when - in August when they announce the full year results or asap?

If I was running HGH (or anyone else needing capital), I'd be doing it as early as possible – the market has rallied off it's lows, there's a sense of optimism with Covid-19 cases declining and lockdown rules being eased (only fractionally) but we've yet to see much of the economic damage and there's a question about whether the government will support business by reducing taxes or kick them when they're down with increases and new taxes. Then there's the "beat the rush" and "beat the rumour" aspects.

Disclosure: not held

[nztx]

I'd really laugh if HGH pulled a different deal out of the bag - like No Cap Raise needed & retained the Div,
when the Big Aussie Blanks are flying around trying to fill large imaginary holes in the deck ..

Will TSB, SBS, NZCU & Co-operative Bank all likely be scratching their heads wondering how & if - to raise some capital ?