HGH - Heartland Group Holdings

[Snoopy]

I am a little overdue with this 'annual update, but better late than never.

Heartland has announced its intention for Heartland Bank to complete an issue of Tier 2 capital issue in FY2016, provided that market conditions remain favourable. An issue of Tier 2 capital would (in the absence of any other use) allow Heartland to return capital by way of a share buy back which would have a positive impact on ROE and EPS. This statement implies that at EOFY2015 30th June 2015) , all capital within Heartland was Tier 1 capital. It is nice to get confirmation of this, because this has been my assumption for several years. The awkward thing about this new Tier 2 capital is that it will make next years equivalent calculation more difficult!

$2,879.134m of loans are outstanding. 20% of that figure is:

0.2 x $2,879.134m = $575.8m

Heartland has total equity of $480.1m which is still below the 20% of loan target.

Result: FAIL TEST

Putting a number on it, the actual capital to loan ratio is:

$480.125m / $2,879.134m = 16.6%

This is down from the 17.6% of last year and now nearer the 17% equity that Heartland had when Governor Wheeler originally approved Heartland as a bank. Wheeler has of course slackened Heartland's requirement for capital since then. But the raw figure is not very encoraging, if progress is what you were seeking.

The promised capital note issue never happened. So once again this calculation is straightforward with all 'Tier 1 and Tier 2 capital' being shareholder equity.

Total Heartland Equity at balance date was $498.341m,

Total Heartland liabilities at balance date were $3,048.840m

So: Equity / Total Liabilities
= $498.341m / $3,048.840m = 16.3% < 17% (*)

Result: FAIL TEST

Note that I have changed my equity target for Heartland to the 17% equity (down from my 20% target) that Heartland had when Governor Wheeler originally approved Heartland as a bank. I had previously used 20% as the figure appropiriate for a more marginal finance company without a strong history. Even so, Heartland has did not have the amount of equity on the books to support a loan book of the current size in my judgement. However the December 2016 equity raising has no doubt addressed this issue for now.

The historical picture of this ratio is tabulated below.

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

SNOOPY

[Snow Leopard]

Once a pretty dodgy finance company always a pretty dodgy bank then Snoopy !

You were right to never invest in it.

Best Wishes
Paper Tiger

[Snoopy]

The underlying debt of the company (borrowings removed) according to the full year (FY2015) statement of financial position is:

$46.020m + $7.869m = $53.889m

-----

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:

$3,359.259m - ($2,862.070m +$24.513m + $329.338m) = $143.348m

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

$143.348m - $51.119m = $92.229m

------


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

$53.889m/$92.229m= 58.4% < 90%

Result: PASS TEST

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 recivables that are loaned ultimately sit.

According to the full year (FY2016) statement of financial position the debt excluding borrowings is:

$42.099m + $6.754m = $48.853m (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:

$3,571.181m - ($3,113.957m +$8.384mm + $236.435m) = $188.405m (2)

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

$188.405m - $57.755m = $130.650m

----


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

$48.853m/$130.650m= 37.4% < 90%

Result: PASS TEST

The historical picture of this ratio is tabulated below.

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

SNOOPY

[percy]

Once a pretty dodgy finance company always a pretty dodgy bank then Snoopy !

You were right to never invest in it.

Best Wishes
Paper Tiger

Classic post.Made my day.
Trouble was he believed his own posts.!
I used to say he was 100% wrong on this thread.
Works out [with dividends] over 5 years he has been 317.13% wrong.!!.

[Snoopy]

Updating this number for the full year FY2015.

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

Using numbers from the Heartland FY2015

= $480.125m/ $3359.259m = 14.3%

The customer loan base has increased a little faster than the company equity. This means the balance sheet is being worked a little harder. This isn't a problem if the risk of loans becoming distressed is going down.

Unlike FY2014, there was no major external acquisition. The most significant increase in share capital over the year was therefore from (reference "Statement of Changes in Equity")

1/ Retained Earnings: $48.538m - $30.188m = $18.350m
2/ Dividend Reinvestment Plan: $7.621m
3/ Share Based Payments: $1.491m
4/ Treasury Shares Sold: $0.041m

Total $27.503m

This is slightly more than the the new capital generated within the existing Heartland in FY2014 ($24.290m)

Updating this number for the full year FY2016. 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 AR2016

= $498.341m/ $3547.181m = 14.1%

The customer loan base has once again increased a little faster than the company equity. This means the balance sheet is being worked a little harder. This isn't a problem if the risk of loans becoming distressed is going down.

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

1/ Retained Earnings:	$49.108m - $37.690m = $11.418m
2/ Dividend Reinvestment Plan:	$7.300m
3/ Share Based Payments to staff:	$1.888m
4/ Treasury Shares Bought:	$2.390m
Total	$22.996m

This is a reduction in the new capital generated within the existing Heartland in FY2015 ($27.503m)


The historical picture of this ratio is tabulated below.

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

SNOOPY

[iceman]

We have a new CFO. Great experience as an auditor from Ernst & Young before going to AIR where he has been for 25 years, most recently as Deputy CFO.

[JeremyALD]

We have a new CFO. Great experience as an auditor from Ernst & Young before going to AIR where he has been for 25 years, most recently as Deputy CFO.

HBL hires a lot of good staff with experience. They recently took some top credit managers from Kiwibank and reshaped their Risk division. They are a bank with a future and a vision.

Really looking forward to watching their growth over the next few years, especially with a strong NZ economy.

[Snoopy]

Once a pretty dodgy finance company always a pretty dodgy bank then Snoopy !

You were right to never invest in it.

I didn't lose any debenture money in NZ's "great finance company collapse" around the global financial crisis, because I didn't invest any money in finance company debentures PT. I am surprised how short people's memory is in relation to finance companies, even ones that choose to mitigate risk for marketing purposes by rebranding themselves as banks. Of course I would have invested in Heartland with perfect hindsight. But you cannot invest to capture past profits that are already on the balance sheet. You can only invest looking forwards taking into account risk. The trick is to balance 'likely return' against 'likely risk'.

You crow about your profits from Heartland. But there are several times over the last few years that these profits were far from certain.

1/ If you look at the EBIT to Interest Expense Ratio when Heartland was formed my post (8477) you can see that their position was very marginal back in FY2012/FY2013. The threat of a recapitalisation that would provide breathing room at a big discount to the current share price back then and since has been omnipresent.

2/ Despite bluster about capital returns over the last couple of years, the real situation required Heartland to make a cash issue of shares late in CY2016. A check of the constantly declining equity ratio (my post 8478) has hinted that eventually a recapitalisation was going to be required. Heartland got the recapitalisation plan away at a very good price. But that good price was never assured before the event.

3/ Legacy Prperty Assets: Go back through FY2013 and FY2014 and it was a surge in the property market that put Heartland on track. This was not forseeable before the event and initially even Heartland offloaded those problem properties to George Kerr as they saw little point of wasting managment time on dead duck legacy assets. As we know those properties were subsequently bought back and the vast majority have been successfully disposed of. But none of this looked certain or even likely back in FY2013.

4/ High Agricultural Exposure (my post 8469): Agriculture by its nature is a volatile industry. ANZ IIRC are by far the largest rural lender in dollar terms. Yet if you look at ANZ.NZ, Agriculture makes up just over 10% of all loans (FY2016) and the Agricultural loan balance was flat in compared to FY2015. Contrast this to Heartland which, although a much smaller lender in gross terms, has 18% of its loan portfolio in Agriculture, and greatly increased this (by 17% of FY2015 gross loans) from FY2015.

So far the signs are that all of the above outlined risks will not have a significant ongoing effect on Heartland results going forward. But you cetainly could not say that at many times in the past. Just because a comnpany overcomes its risks, that doesn't make the company less risky before events unfold.

The problem with retrospective analysis is that too often those doing the analysis leave out risk and assumed the profit path trodden was pre-ordained. This is never the case with any company. So please forgive me if I insist on running the risk ruler over any finance company that I propose to invest in. At the time I was very pleased to not invest in Heartland, given all the risks that abounded. If you as an investor were nevertheless aware of the risks and chose to make your investment in spite of those risks then good on you. Your 'high risk' investment has been rewarded with a 'high return'. If OTOH you invested in Heartland simply because you saw a blip on a chart with no other analysis, then you are a fool who has had a lucky payday. Personally I keep as much luck out of my investment decisions as I can. And if that means being extra careful about risk, and losing some opportunities along the way, then so be it.

SNOOPY

[percy]

Must admit the more research I do the better my luck is.!!
Did a lot of research on HBL,and as it turns out I have been exceedingly lucky.
Must be the quality of my research, rather than the quantity of those unlucky enough to miss the bus.?

[Beagle]

The problem with retrospective analysis is that too often those doing the analysis leave out risk and assumed the profit path trodden was pre-ordained. This is never the case with any company. So please forgive me if I insist on running the risk ruler over any finance company that I invest in. At the time I was very pleased to not invest in Heartland, given all the risks that abounded. If you as an investor were nevertheless aware of the risks and chos eto make your investment in spite of those risks then good on you. Your high risk investment has been rewarded with a high return. If OTOH you invested in Heartland simply because you saw a blip on a chart with no other analysis, then you were a fool that had a lucky payday. Personally I keep as much luck out of my investment decisions as I can.

Snoopy

I'm with you on this one. The outcome was never cast in stone, and never is. Return even with hindsight needs to be measured commensurate with the risk carried and the duration thereof.
My history with HBL has been brief and most times I haven't been prepared to wear the risk. I invested at ~ 85 cents in early 2014 immediately after the credit rating upgrade, (no way they'd downgrade in a hurry and dairy was still doing okay for some of 2014) so at the time of my entry I deemed Heartland to be a low - moderate risk investment. As conditions markedly deteriorated in the dairy industry into early 2015 I exited at ~ $1.30 for an investment of less than a year during mostly favorable times. I got circa 55% capital gain plus dividends and took what I consider to be pretty moderate risk for a short duration.

At times over the last two years it has been apparent that the risks to dairy have been extreme and it is very fortunate that milk prices have recovered, (if they hadn't the effects could have been extremely ugly for the industry and all banks including HBL). I take a similar approach to Snoopy as I won't wear periods of high risk and am prepared to forego potential returns if my risk assessment suggests there's a better risk adjusted return to be had elsewhere. While being out of HBL for about 2 years and missing only ~ 20 cents of capital gain by and large I've achieved better returns with less risk elsewhere.

I'm pleased the industry has recovered, its good for the banks, good for the economy and most of all good for the beleaguered dairy farmers who are doing their best to recover from two truly horrendous years but are now struggling with much higher level's of debt and are also facing the distinct possibility of increasing interest rates.

I think on a risk adjusted basis HBL is now a pretty reasonable hold but I think its pretty clear in the last two years shareholders have carried considerable risk, (whether they acknowledge it or not) and returns in that timeframe have been pretty modest. Maybe they get to $1.60 by Christmas 2017 ?, maybe not ? Dividend yield is pretty good though. Maybe the SP goes up in line with EPS from here, (I think the current PE is at full stretch) so on a 1 year view maybe a 10% capital gain and 8% gross divvy, possible 18% total shareholder return which isn't too shabby.