HGH - Heartland Group Holdings

[Snoopy]

Today I want to look at the ability of Heartland to match their cash ingoings and cash outgoings over specified time periods. This goes back to what happened during the financial crisis where some finance companies declared a moritorium on payments to debenture holders because although solvent on paper, they ran out of cash to make the payments. My previous attempts at doing this were not very successful due to lack of disclosire in the annual and half year reports. Since Heartland has become a bank more information has come into the public domain . This time I will look at the end of period positional statement supplied to the reserve bank:

http://www.heartland.co.nz/uploadGal...nt%20Dec13.pdf

to see if I can do a better job.

Heartland looks at this issue under note 20

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20 Interest rate risk

Interest rate risk is the risk that the value of assets or liabilities will change because of changes in interest rates or that market interest rates may change and thus after the margin between interest earning assets and interest earning liabilities. Interest rate risk for the banking group refers to the risk of loss due to holding assets and liabilities that may mature or re-price in different periods. Interest rate risk is mitigated by managment's frequent monitoring of interest rate repricing profiles of borrowings and finance receivables and where appropriate the use of derivative instruments"

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A change of tactic is required here as six months ago I was writing tosh. The revised HY2014 report is as follows:

Time to look at the Liquidity Buffer ratio, the balance between monies borrowed and monies lent and matching up those maturity dates using a one year time horizon. The equation we are looking to satisfy is:

(Total Current Money to Draw On)/(Net Current Loans Outstanding) > 10%

On one side of the equation, we have borrowings.

HNZ BORROWINGS

HNZ has total borrowings of $2,524.460m (see Statement of Financial Position). This is made up of:

1/ Term deposits ($1,805.954m) lodged with Heartland (see note 11 'Borrowings').
2/ Securitized Borrowings total $267.645m
3/ Subordinated Bonds (new for HY2014 but only worth $3.369m)

Note 11 'Borrowings' gives no clear breakdown given of current and longer-term borrowing maturity dates.

The group has securitized bank facilities totalling $400m, all in relation to the Heartland ABCP Trust 1 (ABCP Trust). ABCP Trust has a maturing facility of $400m maturing 7th August 2014 (barely 5 weeks away),

These facilities are drawn by $268m (c.f. FY2013: $259m).

All securitized asset activity relates to a time frame no more than one year out in the future, but in this case just 5 weeks. Nevertheless, maturity date rollover renegotiations have happened without trouble over the last two years.

The amount of securitized holdings drawn has increased by $8m (3.1%). The maximum amount that can be borrowed under securitized arrangements has dropped too, from $500m to $400m. This is because the extra CBS Trust securitisation arrangements, worth up to $100m, have been wound up. The net result of all this is that the borrowing headroom available using securitized bonds is now:

$400m - $268m = $132m

All three sources of funds (itemized above) have been on loaned to customers who want loans.


HNZ LENDINGS

Customers owe HNZ 'Finance Receivables' of $1.905.850m. There is no breakdown in note 10 as to what loans are current or longer term. However, if we look at note 18b 'Contractual liquidity profile of financial assets and liabilities', we can see the expected maturity profile of total finance receivables due over the next twelve months.

$180.669m + $463.129m + $349.681m = $993.479m

These are offset by short-term borrowings over twelve months of

$599.902m + $751.307m + $647.731m = $1998.980m

Thus, the net expected maturity of receivables is:

$993.479m - $1,998.980m = -$1,005.501m

The negative sign means that less money is coming in from loans to customers that have matured, than the amount of money due to be repaid to the debenture holders. Such a gap can be closed by simply taking on more debenture borrowings. Nevertheless, it is also prudent to have some back up bank borrowing headroom (HNZ has $132m) to partially close the gap.

$132m / $1,005.501m = 13.1% > 10%

=> Pass Short term liquidity test

SNOOPY

[Snoopy]

A change of tactic is required here as six months ago I was writing tosh. The revised HY2014 report is as follows:

Time to look at the Liquidity Buffer ratio, the balance between monies borrowed and monies lent and matching up those maturity dates using a one year time horizon. The equation we are looking to satisfy is:

(Total Current Money to Draw On)/(Net Current Loans Outstanding) > 10%

On one side of the equation, we have borrowings.

HNZ BORROWINGS

HNZ has total borrowings of $2,524.460m (see Statement of Financial Position). This is made up of:

1/ Term deposits ($1,805.954m) lodged with Heartland (see note 11).
2/ Securitized Borrowings total $267.645m
3/ Subordinated Bonds (new for HY2014 but only worth $3.369m)

Note 11 gives no clear breakdown given of current and longer-term borrowing maturity dates.

The group has securitized bank facilities totalling $400m, all in relation to the Heartland ABCP Trust 1 (ABCP Trust). ABCP Trust has a maturing facility of $400m maturing 7th August 2014 (barely 5 weeks away),

These facilities are drawn by $268m (c.f. FY2013: $259m).

All securitized asset activity relates to a time frame no more than one year out in the future, but in this case just 5 weeks. Nevertheless, maturity date rollover renegotiations have happened without trouble over the last two years.

The amount of securitized holdings drawn has increased by $8m (3.1%). The maximum amount that can be borrowed under securitized arrangements has dropped too, from $500m to $400m. This is because the extra CBS Trust securitisation arrangements, worth up to $100m, have been wound up. The net result of all this is that the borrowing headroom available using securitized bonds is now:

$400m - $268m = $132m

All three sources of funds (itemized above) have been on loaned to customers who want loans.


HNZ LENDINGS

Customers owe HNZ 'Finance Receivables' of $1.905.850m. There is no breakdown in note 10 as to what loans are current or longer term. However, if we look at note 18b, we can see the expected maturity profile of total finance receivables due over the next twelve months.

$180.669m + $463.129m + $349.681m = $993.479m

These are offset by short-term borrowings over twelve months of

$599.902m + $751.307m + $647.731m = $1998.980m

Thus, the net expected maturity of receivables is:

$993.479m - $1,998.980m = -$1,005.501m

The negative sign means that less money is coming in from loans to customers that have matured, than the amount of money due to be repaid to the debenture holders. Such a gap can be closed by simply taking on more debenture borrowings. Nevertheless, it is also prudent to have some back up bank borrowing headroom (HNZ has $132m) to partially close the gap.

$132m / $1,005.501m = 13.1% > 10%

=> Pass Short term liquidity test

Time to update the Liquidity Buffer ratio, the balance between monies borrowed and monies lent and matching up those maturity dates using a one year time horizon. The equation we are looking to satisfy is:

(Total Current Money to Draw On)/(Net Current Loans Outstanding) > 10%

On one side of the equation, we have borrowings.

HNZ BORROWINGS

HNZ has total borrowings of $2,524.460m (see note 28). This is made up of:

1/ Term deposits ($1,736.751m) lodged with Heartland. However, in a big change from FY2013…
2/ $555.708m of Bank Borrowings now appears on the balance sheet.
3/ Securitized Borrowings total $228.623m
4/ Subordinated Bonds (new for FY2014 but only worth $3.378m)

Note 28 does not contain a clear breakdown of current and longer-term borrowing amounts and their maturity dates.

Banking facilities are provided by CBA Australia but for both Australia and New Zealand. These facilities are, I believe, in relation to the recently acquired reverse mortgage portfolio. These banking facilities are secured over the homes on which the reverse mortgages have been taken out. These loans have a maturity date of 30th September 2019. That means they are classed as ‘long term’ for accounting purposes. Additional borrowing capacity is available up until 30th June 2016, but only if certain scheduled repayments are met by the Heartland group. It follows that Heartland can’t rely on CBA Australia as a source of short-term funds.

The information given in note 28 on the securitized borrowing facilities is as follows:

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The group has securitized bank facilities totalling $400m, all in relation to the Heartland ABCP Trust 1. (ABCP Trust) has a maturing facility of $400m maturing 4th February 2015,

These facilities are drawn by $229m (c.f. FY2013: $259m).

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Bank borrowings no longer explicitly rank equally with the securitized bonds. Therefore, I think it is safe to assume that if HNZ got into cashflow difficulty, the different classes of borrowings would be repaid in the following order:

1/ Bank Borrowings,
2/ Securitized Borrowings,
3/ Subordinated Bond (new for FY2014 but only worth $3.378m) and finally
4/ deposits from debenture holding customers.

IMO that represents a large new incremental risk for Heartland depositors that has received no media attention.

All securitized asset activity relates to a time-frame no more than one year out in the future, in this case just 6 months. Nevertheless, maturity date rollover renegotiations have happened without trouble over the last two years.

The amount of securitized holdings drawn has decreased by $30m (12%). This is a significant drop. The maximum amount that can be borrowed under securitized arrangements has dropped too since FY2013, from $500m to $400m. This is because the extra CBS Trust securitization arrangements, worth up to $100m, have been wound up. The net result of all this is that the borrowing headroom available using securitized bonds is now:

$400m - $226.6m = $173.4m

All four sources of drawn funds itemized have been on loaned to customers who want loans.


HNZ LENDINGS

Customers owe HNZ 'Finance Receivables' of $2,607,393,000. There is no breakdown in note 20 as to what loans are current or longer terms. However, if we look at note 39, we can see the expected maturity profile of total finance receivables due over the next twelve months.

$50.234m + $629.645m + $483.727m = $1,163.426m

These are offset by short-term borrowings for repayment over twelve months of

$18.922m + $242.431m + $195.682m = $457.035m

Thus the net expected maturity of receivables is:

$1,163.426m - $457.035m = $706.391m

If more money is coming in from customer loans being repaid, than is having to be repaid to the debenture holders, then this is a good thing for liquidity. There is no need to increase corporate borrowings to supplement debenture repayments.

=> Pass Short term liquidity test

I do note is that the amount borrowed as ‘debentures and deposits’ (borrowings) from customers has gone up by $426.9m (+21%) and the amount lent to customers (receivables) has gone up by $597.0m (+30%). This is a huge turnaround. In its formative years (FY2012 and FY2013) Heartland did nothing but shrink and now for the very first time it is growing. However finance receivables at fair value acquired as a result of the newly acquired “Heartland Home Equity Release” business were valued at $715.222m. That means the underlying legacy business at Heartland is continuing to shrink, down:

$715.2m - $597.0m = $118.2m

This is a drop of 6% in finance receivables terms.

Borrowing facilities have gone down by at least $100m over the same annual comparative period. So Heartland have upped their current period risk profile by having a smaller buffer to cover a growing mismatch between borrowings and receivables. It is still well within limits though!

SNOOPY

[Snoopy]

The half year report for HY2014 (to 31st December 2013) is as much of interest for what it doesn't say than what it does say.

In contrast to last year, Note 13 on 'Borrowings', makes no mention of the relatively high proportion of deposits from the Canterbury region. Perhaps many of those Cantabs with deposits followed Percy's advice and used their deposit money to buy Heartland shares when those deposits matured? In any instance the overall deposit book has shrunk very slightly from the full year balance date. So the rebalancing of regional risk doesn't reflect a lot more money coming in from other regions and growing the deposit book overall. I would have expected the overall deposit book to strengthen as Heartland's credit rating improves. But I can't see any real evidence for that in the HY2014 report.

The previous half year report had a section headed 'credit risk and asset quality'. That heading is no longer there in the latest HY report. Instead the 'Asset quality of Finance Receivables' information has migrated to the 'Finance Receivables' section. Of particular note is the fall in 'At least 90 days past due' receivables down to $19.5m, from $49.2m a year previously.

The 'Provision for impaired assets' has its own stand alone note (17).

The RECL (Real Estate Credit Limited) agreement for difficult property assets, much discussed in the HY2013 report, has been brought back in house. Overall though this report does not go into enough detail to get a great feel for customer concentration risk.

Time for our once a year peak into customer ‘asset distribution’ and ‘asset quality’. Our concentration test is that:

Highest single new customer group exposure (as a percentage of shareholder funds) <10%

The greatest regional area of credit risk in dollar terms is Auckland, with $725.318m worth of assets. This represents:

$725.218m/ $2,891.597m = 25% of all loans

However this represents a proportion well short of the 40%+ regional loan share that used to apply to the Canterbury region at HY2013. So I don’t rate that concentration of loans in Auckland as being an issue. Particularly so when ‘Auckland’ is such a varied catch all group.

Now a word on asset loan quality.

Looking at Note 38d, the Grade 6 monitor assets have come down a lot from $198.37m to $115.76m. Great news!

Next, the sum of the grade 7, 8 and 9 assets is now $31.765m, down from $67.313m. This is a very significant improvement.

When these loans appear on the balance sheet, they are netted off against provisions for impaired assets already made. The provision for collectively impaired assets is now $6.999m, down from $15.961m. However, there is a new provision that wasn’t there in FY2013 of $8m, a ‘fair value adjustment for present value of future losses’. What does that new provision mean? The losses are going to be realized sooner than expected perhaps?

Overall, ‘problem assets’ (grade 6, 7, 8 and 9 combined) total $147.591m. This is down 45% on the $265.683m recorded in FY2013.

SNOOPY

[Snoopy]

The 'Finance Receivables' on the balance sheet have alrady had a $34.214m provision for impairment taken off them. From note 11 'Gross Finance Receivables' were $1,940.064m



Rexamining note 11, I may have double counted some of those problem property assets. The note says:

At least 90 days past due $19.518m
Individually impaired $53.1m
Restructured assets $3.994m

That sums to $76.712m. Take off a provision for impairment of $34.214m and I get $42.498m.

However that $76.712m does not correspond to the:

"non-core property assets comprised net receivables of $25.6m and investment properties of $61.5m." (page 5 in same report)

which sum to $87.1m. Anyone know why the difference?



$42.498m / $1,905.85 = 2.2%

A much less worrying result. Apologies to all those Heratland shareholders that suffered a heart attack yesterday as a result of my calculations. I wonder why HNZ chose to stop measuring bad debts this way?

Bad debts are outlined as follows:

At least 90 days past due $34.034m
Individually impaired $27.617m
Restructured assets $4.064m

Allowance for impairment ($16.361)m
PV of Future Losses Adjustment ($8.000)m

Total Stressed Loans (impairments deducted) $41.354m

Gross Financial Receivables $2,631.754m
Total Finance Receivables $2,607.393m

Stressed Loan Percentage (impairment removed)= $41.354 m/ $2,607.393m = 1.59%

SNOOPY

[vorno]

SNOOPY

Oh yip, I see now.

[Snow Leopard]

...However, there is a new provision that wasn’t there in FY2013 of $8m, a ‘fair value adjustment for present value of future losses’. What does that new provision mean? The losses are going to be realized sooner than expected perhaps?...

...and when you get to HNZ Financial Statements for the Full Year to 30th June 2014: Note 20 all will become clear.

Best Wishes
Paper Tiger

[Snoopy]

...and when you get to HNZ Financial Statements for the Full Year to 30th June 2014: Note 20 all will become clear.

Ah I see. The $8m provision is in connection with the home equity release portfolio acquisition.

"Of the $8m fair value adjustment, $0.5m was raised as a result of the acquisition of $30.5m of home equity release loans in December 2015 and $7.5m was raised persuant to the HER acquisition."

Then follow the number trail to note 43.

"This ($7.5m) amount is conservative relative to the actual loss history in the acquired businesses. Since inception of the acquired business in 2003, actual losses of $0.2m have occured. However the group has determined to take this amount as a fair value adjustment having considered actuarial modelling (based on conservative assumptions) as to the portfolio performance in the future. While there is no material current loss history in the home equity release portfolio acquired, every home equity release portfolio (including the acquired businesses) will ultimately experience some loss across the life of the portfolio."

From note 43 the HER portfolio has a fair value of $713.971m. So a $7.451m provision represents:

$7.451m / $713.971m = 1.0% of the portfolio, and that figure is regarded as 'conservative' (?). That doesn't sound very conservative to me. But since Heartland haven't released their assumptions in coming to this conclusion, there isn't much more I can say about it except to say it is certainly not 'clear'.

SNOOPY

[winner69]

Ah I see. The $8m provision is in connection with the home equity release portfolio acquisition.

"Of the $8m fair value adjustment, $0.5m was raised as a result of the acquisition of $30.5m of home equity release loans in December 2015 and $7.5m was raised persuant to the HER acquisition."

Then follow the number trail to note 43.

"This ($7.5m) amount is conservative relative to the actual loss history in the acquired businesses. Since inception of the acquired business in 2003, actual losses of $0.2m have occured. However the group has determined to take this amount as a fair value adjustment having considered actuarial modelling (based on conservative assumptions) as to the portfolio performance in the future. While there is no material current loss history in the home equity release portfolio acquired, every home equity release portfolio (including the acquired businesses) will ultimately experience some loss across the life of the portfolio."

From note 43 the HER portfolio has a fair value of $713.971m. So a $7.451m provision represents:

$7.451m / $713.971m = 1.0% of the portfolio, and that figure is regarded as 'conservative' (?). That doesn't sound very conservative to me. But since Heartland haven't released their assumptions in coming to this conclusion, there isn't much more I can say about it except to say it is certainly not 'clear'.

SNOOPY

Snoopy, time to retread John Kay. I bet you did not do your homework and read it last time I posted it

Why mean outcomes are often meaningless

http://www.johnkay.com/2014/07/30/wh...en-meaningless

Last couple of paragraphs

There is no “right” answer to the problem of accounting for these kinds of uncertainty; only a need to acknowledge that there is never such a thing as a single true and fair view, only a range of possible outcomes. When a business has many long-term contracts, or teeters on the verge of bankruptcy, that range may be very wide.

I can see the difficulty a bank chief financial officer will encounter if they tell depositors, shareholders and regulators that annual earnings are something between a loss of $5bn and a profit of $10bn; but such a statement may be the only view of the company’s affairs that is genuinely true and fair.

So Snoopy you just have to have faith in their 'judgement' in assessing these things.

[winner69]

Snoopy - maybe the question should be 'was $25m a good price for a market leading HER business?'

(Would have been $17m if it wasn't for that adjustment)

[Snoopy]

Snoopy - maybe the question should be 'was $25m a good price for a market leading HER business?'

(Would have been $17m if it wasn't for that adjustment)

Have you turned up the rose tint on your glasses Winner? Note 43 on the FY2014 annual results clearly shows consideration paid for the HER business by Heartland was $86.140m, not $24.984m. The circa $25m that you refer to was the goodwill element of the purchase only, as you well know.

I kind of see where you are coming from though. Of that $86m paid, $61m of that price was for net tangible assets. So what you are saying is, paying $61m and getting $61m dollars worth of assets is a 'value neutral' transaction, and the only bit that Heartland are really paying for is the $25m in goodwill, over and above the net asset price. I don't buy that though.

IMO your position is tantamount to saying you can decouple the net assets that make up the business from the 'intellectual property' that you bought into that was running the assets. The two have to work together for the business to have value. But I am sure that in your heart of hearts you know that anyway.

SNOOPY