HGH - Heartland Group Holdings

[Snoopy]

1/ EBIT to interest expense > 1.2

EBIT is not listed as that, so I have had to improvise. On p10 (Interim
Statements of Comprehensive Income) we find the 'Interest Income'
figure and I have subtracted from that the selling and administration
costs also on p10.

EBIT = $101.770m-$35.691m= $66.079m

Interest expense is listed as $62.64m.

So (EBIT)/(Interest Expense)= ($66.079)/($62.64)= 1.05 < 1.2

Result: FAIL TEST

Updating for the full year result

EBIT (high estimate) = $205.148m-$65.547m= $139.601m

Interest expense is listed as $121.502m.

So (EBIT)/(Interest Expense)= ($139.602)/($121.502)= 1.15 < 1.20

Result: FAIL TEST but an improvement from the HY2012 position.

SNOOPY

[Snoopy]

Criterion 5/ Minimum Equity Contribution:
Tier 1 Risk Share Lending (basic equity capital and disclosed reserves) > 20%,
Tier 2 Risk share lending (this applies to undisclosed debts, and provisions against bad debts) > 30%.

There is no mention of Tier 1 or Tier 2 in the Heartland HY2012 interim report. I am not sure how to apply this test. Perhaps someone will confirm or correct my opinion?

I think the loans have to be grouped into both 'Tier 1' and 'Tier 2' categories. Once this is done then enough equity capital has to be set aside to cover 20% of the gross lending value of 'Tier 1' loans and
likewise 30% of the 'Tier 2' loans. Add these two required amounts of capital together and the figure should not exceed the actual underlying capital on the company balance sheet.


The 'best case' scenario is that all loans are Tier 1. $1,985.55m of loans are outstanding. 20% of that figure is:

0.2 x $1,985.55m = $397.0m

From p3, Heartland has total equity of $360m, which is insufficient no matter what the tier classification of the loans. Even if $20m of profit is booked to boost shareholder capital, there would still be a shortfall of capital of $17m assuming no growth in the loan portfolio.

Result: FAIL TEST

Once again there is no mention of Tier 1 or Tier 2 in the Heartland FY2012 report.

The 'best case' scenario is that all loans are Tier 1. $1,939.29m of loans are outstanding. 20% of that figure is:

0.2 x $1,939.29m = $387.9m

Heartland has total equity of $374.8m which is insufficient no matter what the tier classification of the loans.

Result: FAIL TEST

However the numbers are moving in the right direction. Heartland are certainly doing the right thing by retaining their earnings and not paying out a dividend.
Ironically the small reduction in the size of their loan book is helping too.

However the fact that the overall business is downsizing does mean less customer activity. Those shareholders looking for a step change in earnings are likely to be disappointed IMO.

SNOOPY

[Snoopy]

I guess the gearing ratio would be one important numerical foundation of a company. So how does HNZ stack up?

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Criterion 3/ Gearing Ratio (Total non-risk share liabilities to total non risk tangible assets) < 90%

Once again we look at p12 ('Interim Statements of Financial Position') where we can find the underlying debt of the company: $34,808,000.

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 problem 'Investment Properties' and the unspecified 'Investments' from that total:

$2,380.54m - ($2,075.21m +$58.08m + $24.31) = $222.94m

By contrast the Vehicles on lease should be readily saleable so for this exercise I would count those as non-risk assets.

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

$222.94m - $21.98m = $200.96m

Now we have the information needed to calculate the information asked for:

$34.8m/$200.96m= 17.3% < 90%

Result: PASS TEST

The underlying debt of the company according to the full year statement of financial position is: $33,802,000m.

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 problem 'Investment Properties' and the unspecified 'Investments' from that total:

$2,348.69m - ($2,078.28m +$55.50m + $24.22) = $190.09m

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

$190.09m - $23.00m = $167.09m

Now we have the information needed to calculate the underlying company debt net of all their lending activities:

$33.8m/$167.09m= 20.2% < 90%

Result: PASS TEST

I note that the relative debt has increased since the half year reporting date. However it is still well within acceptable levels. I would the debt position to worsen during the year because of all the deferred branch transformation expenditure that was shunted into the FY2013 year. It will pay to keep an eye on this figure.

SNOOPY

[Snoopy]

According to 'investorwords' (www.investorwords.com) the equity ratio is defined as:

=(Total Equity)/(Total Assets)

Using numbers from the Heartland HY2012 report dated 31-12-2012, page 11

= $360.2m/$2380.5m = 15.1%

Updating this number for the full year

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

Using numbers from the Heartland FY2012

= $374.8m/$2348.1m = 16.0%

This is a slight improvement on the half year position, achieved by both shrinking the loan book and not paying out any dividend from profits.

SNOOPY

[Snoopy]

I have been covering these hurdles out of my original order to better match the flow of this thread. But there is one more bankers test that HNZ must face.

4/ Single new customer group exposure (as a percentage of shareholder funds) <10%

I can't find any information in the Heartland HY2012 interim report on customer concentration. Since one of the objectives of merging all the entities that formed Heartland together was to reduce the concentration of risk, I don't think it likely that a single customer has 10% or more of the balance of the loans outstanding.

The HNZ interim report does say that post merger, 40% of loans are now in the Canterbury region (note 11). That might mean regional volatility need be considered in future.

Result: PROBABLE PASS (interim report has insufficient information)

Customer concentration is of course an indirect measure of potential risk. Of more interest perhaps is real risk.

Interesting reading from Note 32C in the Full Year 2012 accounts.

There is a large jump in Grade 6 categorized loans. Grade 6 is the 'monitor' category up from $93.269m to $183.814m. Grade 6 is the jargon used by Heartland when a loan is on the cusp of going bad. Obviously these loans have not gone bad at this point, and that should be emphasized. Nevertheless if even half of those loans did go bad it would wipe out a whole years profits. This is something that should make Heartland shareholders cautious. A call for new capital from shareholders is now officially an 'on the horizon possibility', even though Heartland have only said so indirectly in this obtuse way.

SNOOPY

[Snow Leopard]

...There is a large jump in Grade 6 categorized loans. Grade 6 is the 'monitor' category up from $16.3m to $62.9m. Grade 6 is the jargon used by Heartland when a loan is on the cusp of going bad. Obviously these loans have not gone bad at this point, and that should be emphasized. Nevertheless if even half of those loans did go bad it would wipe out a whole years profits. This is something that should make Heartland shareholders cautious. A call for new capital from shareholders is now officially an 'on the horizon possibility', even though Heartland have only said so indirectly in this obtuse way.

SNOOPY

I fail to see where you are getting these numbers or beliefs from.

There are $183.8M of Grade 6 loans and another $78.3M in grades 7-9 in the Judgement portfolio. Each grade has a % expectation of becoming a loss and the Grade 6 does not mean that "a loan is on the cusp of going bad", even with the name Monitor.

Further there are $28.3M in Active or lower categories of the Behavioural portfolio.

Read all of 32 and you will get a better feel for the state of the loans in terms of past due, impaired and provisions for impairment. Also you can find the total written-off.

best wishes
Paper Tiger

[Snoopy]

I fail to see where you are getting these numbers or beliefs from.

There are $183.8M of Grade 6 loans and another $78.3M in grades 7-9 in the Judgement portfolio. Each grade has a % expectation of becoming a loss and the Grade 6 does not mean that "a loan is on the cusp of going bad", even with the name Monitor.

Further there are $28.3M in Active or lower categories of the Behavioural portfolio.

Read all of 32 and you will get a better feel for the state of the loans in terms of past due, impaired and provisions for impairment. Also you can find the total written-off.

PT I have read section 32 again and I do believe that my concerns are justified. Perhaps when I mentioned the phrase 'loan going bad' that has a connotation of 100% loss. That was not what I meant and was poor phrasing on my part. The 'judgment portfolio' represents business loans where there is an ongoing relationship with the client. The financial statement clearly states that new loans are made with security judged to be between 'Strong' (Grade 2) and 'Acceptable' (Grade 5). No new loans are made under 'Monitor' Grade 6. So it can be inferred that these loans have some risk of impairment, but have not yet been provided for on the books.

The other lower category of loans, Grade 7-9, will already to provided for to an extent in the accounts. That increase in 'Grade 6 ' loans represents are significant yet unaccounted for risk for HNZ.

SNOOPY

[Snoopy]

Gaze at these tables for long enough and it becomes clear that the securitisation measures were mostly just to allow space in case an unexpectedly large proportion (i.e. nearly all of the investors with maturities prior to the end of the guarantee) turned out to be only hanging in until expiry (after all, at that stage they could be perceived as safer than the bank, but with better rates!). I think from memory that later announcements have indicated that the reinvestment rate actually held up solidly and new investments rose, so the extra liquidity buffer provided by the securitised facility was probably not necessary. Having said that, in financial services, safety begets investor confidence and investor confidence begets safety. So there was no point risking any false rumours tipping things over at the last minute.

From the bottom of p12 of the 2012 financial statements:

"The Group enters into transactions whereby it transfers assets recognised on its Statements of Financial Position, but retains either all risks and rewards of the transferred assets or a portion of them. If all or substantially all risks and rewards are retained, then the transferred assets are not derecognised from the Statements of Financial Position. Transfers of assets with the retention of all or substantially all risks and rewards include, for example, securitised assets and repurchase transactions." (my bold emphasis)

So HNZ retains the downside risk for their sold off securitized assets after all?

SNOOPY

[Snoopy]

I have had a conceptual problem with this question for a while, so this might be the time to lay the cards I have on the table, using Heartland as an example.

Criterion 3 shows that Heartland's core assets: offices staff and the tools they need to do their job, are quite conservatively financed with plenty of capital.

Criterion 5 shows that in relation to the business and home loans outstanding on the books, Heartland is if anything quite short of capital.

So, does Heartland have adequate capital or not?

Time to answer my own question. Heartland has more than enough capital ring-fenced in the accounts to operate their core office network. However their lending capital, from a finance company perspective, is still inadequate for the loan book as viewed from a shareholder risk perspective.

SNOOPY

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[Snoopy]

2/ Liquidity buffer ratio (including bank lines) >10%

The hurdle setters don't specify, but I believe that this test is to provide an insight into how current liabilities are matched to current assets. It could be thought of as a 'stress test' on liquidity with a twelve-month time horizon.

From p12 (Interim Statements of Financial Position) we see HNZ has total borrowings of $1,985,551,000, made up principally of term deposits lodged with Heartland. Note 11 is meant to give a breakdown of these borrowings. Strangely there is no breakdown given of current and longer-term borrowings. Nevertheless Note 11 contains this tantalizing hint.

"On 2 August 2011, the Group entered an agreement with its securitisation facility provider to increase the MARAC ABCP Trust 1 securitisation facility by $100m to $300m, and to extend its maturity date to 8 August 2012."

This gives the impression of Heartland almost operating 'hand to mouth' with even this new banking syndicate agreement expiring within just a
year of being signed. To proceed further I can only assume that all funds deposited with Heartland, directly or indirectly (via securitisation) are 'current liabilities'.

This money has been on loaned to customers who want loans. These customers owe HNZ 'Finance Receivables' of $2,075,211,000. Again there is no breakdown as to what loans are current and longer term. Given:

1/ I understand 'liquidity' to be a balance between the maturity profile of current debenture holders VERSES
2/the loan periods associated with those on lent funds are unknown,

then my analysis comes to a full stop. Any ideas as to how to proceed from here, or even opinions on if I am on the right track, would be greatly appreciated.

Result: UNCERTAIN (due to lack of published loan data). But if almost all depositors have put their money with Heartland on a one year or less basis, then I am not encouraged.

Time to reevaluate liquidity.

HNZ has total borrowings of $1,939,489,000, made up principally of term deposits lodged with Heartland.

Note 24 is meant to give a breakdown of these borrowings. Once again there is no breakdown given of current and longer-term borrowings

The information given on the secularized facilities is as follows

"The Group has securitisation facilities in relation to the Trusts totalling $450.0 million. On 27 February 2012, the Group entered into an agreement with its securitisation facility provider to extend the maturity date of Heartland ABCP Trust 1 $300 million securitisation facility to 6 February 2013. On 19 December 2011, the Group entered into an agreement to increase CBS Warehouse A Trust securitisation facility by $100 million to $175 million. $25 million of this increase matured on 1 April 2012. The maturity date of the remaining $150 million CBS Warehouse A Trust securitisation facility is 22 July 2013."

IOW all activity relates to a time-frame no more than one year out in the future.

The amount of securitized holdings has increased when I would have expected it to decrease now that HNZ has fully rolled out of the government deposit guarantee scheme.

"The Group has bank facilities totalling $650.0 million (2011: $475.0 million)."

That increase is good for future flexibility.

This money has been on loaned to customers who want loans. These customers owe HNZ 'Finance Receivables' of $2,078,276,000. Again there is no breakdown as to what loans are current and longer term (note 16).

Given:

1/ I understand 'liquidity' to be a balance between the maturity profile of current debenture holders VERSES
2/the loan periods associated with those on lent funds are unknown,

then my analysis comes to a full stop (again).

The only thing I do note is that the amount borrowed as debentures and deposits from customers has gone down (by $6.022m) and the amount lent to customers has gone up (by $3.065m). Given that bank facilities have gone up by $175m over the same period this isn't an issue.

SNOOPY