HGH - Heartland Group Holdings

[Beagle]

I guess the way the SP has been creeping up, small shareholders are unlikely to get shares under the proposed placement as cheaply as were offered to the big investors under the placement. Does anybody have any idea as to when the SPP will take place? The new year is not so new now.

I believe the company said it will happen after the half year result on 21 February. I'd presume that details of the SPP will be announced contemporaneously with the half year result. I will subscribe and bought some more on market yesterday too.

[BlackPeter]

I guess the way the SP has been creeping up, small shareholders are unlikely to get shares under the proposed placement as cheaply as were offered to the big investors under the placement. Does anybody have any idea as to when the SPP will take place? The new year is not so new now.

I think they said small shareholders will either get the same price as the placement - or a 5 or 10 day average of the share price prior to SPP time, whatever is the cheaper. This means we still should get the new shares for the same price as the big investors. Just worried about the scaling - i.e. we probably don't get many of them ;

Not sure about the timing, but would assume we learn more over the next couple of weeks when their board comes back from summer holidays ...

[Bjauck]

Thanks I thought about buying on market to add to my holding at time of the placement...oh well....scaled back crumbs from the spp better than nowt, I suppose.

[Snoopy]

Retired:

Provide a personalised service to the 65+ via reverse mortgages. This requires an accessible and friendly branch structure, as the retired like to be able to eyeball their bank manager. Nevertheless the information is there on line too. ( https://www.seniorsfinance.co.nz/ )
e.g. Seniors Finance (Australia and New Zealand). Growing the reverse mortgage business will result in higher ROE (lower Reserve Bank risk weighting for housing, less capital applied) but a more compressed margin.

Banks are required to hold capital against each category of exposure according to the relative riskiness of that type of exposure. The minimum capital ratio is fixed at 8 percent of risk-weighted assets; so the amount of capital required to be held against each loan is determined by the risk weighting for that type of loan. For every additional dollar lent on an exposure with a 100 percent risk weighting, a bank will be required to hold an additional 8 cents of capital, whereas for a less risky loan with a risk weighting of 50 percent, only 4 cents of additional capital will be required.

On the subject of using Reverse Mortgages to improve the 'capital efficiency' of Heartland. The following information is from Resrve Bank paper RS2A on 'capital adequacy'.

BS2A-capital-adequacy-framework-standardised-approach-oct-2015.pdf, From page 45.

The following risk weightings apply to mortgages not past 90 days due.

Loan to Valuation Ratio	Non-property investment Residential Mortgage Loan	Property investment Residential Mortgage Loan	Reverse Residential Mortgage Loan
<60%	35%	40%	50%
>60% & <80%	35%	40%	80%
<80%	35%	40%	Various
>80% & <90%	35%	50%	100%
>90% & <100%	50%	75%	100%
>100%	100%	100%	100%

For comparison, a 0% risk weighting applies to:

1/ Notes and coins held on site
2/ Gold Bullion held in own Vaults

OTOH the risk weighting for equity holdings are 300% if they are publicly traded, and 400% if they are not.

Small and Medium business loans and Rural Loans are not mentioned specifically. The paper says that:

"A 100% risk weight applies for an asset not specifically provided for."

A conventional mortgage will generally have a lower risk weighting that a reverse mortagage. But Heartland IIRC have contracted out all of their conventional mortgage business to Kiwibank.
Given the four key markets that Heartland are targeting, it seems the only way to reduce risk weighting for Heartland is to do more reverse mortgages!

SNOOPY

[Snoopy]

Conclusion

'On the one hand' BUT 'on the other hand'. Anyone got a comment to make to help stop me wavering? I think that am going to have to sleep on this!

When you are looking at a complicated business across several 'growth' sectors, one approach is to look at the size of the sector loan book, make an estimate of future loan book growth, then add everything together.

Market Sector	Loan Book Size (A)	Growth Rating (B)	(A) x (B)
Millennials	$844m	10%	$84.4m
Retired	$377m	20%	$75.4m
Small & Medium Enterprises	$942m	-10%	-$94.2m
Rural	$619m	-10%	-$61.9m
Total			+$3.7m

While some sectors of the Heartland business show real growth potential, others face real threats. Naturally I need to add that the size of the loan book does not directly imply profitability. But I do believe there is a correlation between 'sector loan book size' and 'sector profitability'.

The above analysis shows that over the sectors that Heartland managment is concentrating on, growth will be marginal.

One counter-argument to the above is that my analysis of the 'Rural' and 'SME business' sector is too broad. Accounting standards require loans that Heartland make to farmers and small businesses to be categorised. But Heartland is taking a much smarter approach of 'cherry picking' within these broad loan categories. So it is not accurate to say that Heartland are going 'head on' against other 'Agricultural' and 'SME' lenders.

If we look to compare the loan book size over a longer period:

Year	Category	Gross Loan Book	Increment	Category	Gross Loan Book	Increment
2016	Agriculture	$628.202m	(+25.7%)	Property & Business Services	$405.469m	(+26.6%)
2013	Agriculture	$499.942m		Property & Business Services	$320.198m

We can see that Heartland are growing the loan book areas they are targeting. I believe that watching what a company does is a better guide to valuation than listening to what a company says they will do. Heartland have made progress in their most risky targeted areas. So who am I to say that increasing profits do not follow?

I do believe there are serious risks to growing the Heartland business from here. But given management's performance to date, we cannot assume that management will not be able to tackle those risks.

Accordingly to the question I posed on "Heartland having a top three market position in their chosen areas of operation', I have to answer 'yes'.

SNOOPY

[Snoopy]

This is the summary for those millennials who are 'attention span challenged'. Warren Buffett's scanning of the 'growth potential' of a company can be summarized in four quick questions.

Q1/ Does Heartland Bank have a top three market position in the markets in which it chooses to operate? (Ref: my post 8523)
A1/ Yes

Q2/ Does Heartland Bank have a 'normalised profit' increasing 'earnings per share trend'? (Ref: my post 8493)
A2/ Yes

Q3/ Does Heartland Bank have a record of earning a superior ( >15% ) return on shareholder equity? (Ref: my post 8495)
A3/ No

Q4/ Does Heartland Bank have the capability of operating at increasing Net Profit margins? (Ref: my post 8510)
A4/ Yes

Overall Conclusion

Heartland is not able to satisfy all the requirements to apply Warren Buffett's compounding growth model. This does not mean that Heartland is necessarily a poor investment going forwards. It just means that Heartland must be analyzed in a different way.

SNOOPY

[Snoopy]

Q3/ Does Heartland Bank have a record of earning a superior ( >15% ) return on shareholder equity? (Ref: my post 8495)
A3/ No

To put this into perspective I want to quote from the Mary Buffett authoered 'Buffetology Workbook' p53

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"Warren has figured out that high returns on shareholder's equity can produce great wealth for shareholders. Thu, Warren seeks to invest in companies that consistently earn high returns on shareholders equity.

To fully understand why Warren is so interested in high returns on shareholders equity let us work through a hypothetical scenario.

Shareholders equity is defined as a company's total assets less the company's total liabilities. Kind of like equity in your house. Let's say you bought a house as a rental property and paid $200,000 for it. To close the deal you invested $50,000 of your own money and borrowed $150,000 from a bank. The $50,000 you invested in the house is your equity in the property.

When you rent out your house, the amount of money that you earn from the rent, after paying your expenses mortgage and taxes would be your 'return on equity'. If you rented your house out for $15,000 per year and had $10,000 in total expenditures then you would be earning $5,000 on your $50,000 equity. The return on your $50,000 would be the $5,000 you earned. This equates to a 10% return on equity. ( $5,000/ $50,000 = 10%).

<snip>

The average return on equity for an American Corporation over the 1960 to 2000 period (book was published in 2001) was 12%. This means that , as a whole, year after year, American business only earns 12% on its shareholder equity base. Anything above 12% is above average. Anything below 12% is below average. And below average is not what we are looking for.

What Warren is looking for in a business is consistently higher than average returns on shareholder equity. We are not talking about 12% or 13% but a rate of 15% and above - the higher the better.


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We have to consider here is that these are American figures. NZ, for so long a 'commodity based' market, may have had historical return on 'overall market equity' figures that are slightly lower than the USA. Nevertheless the Heartland return on equity figures are damning.

Financial Year	Net Sustainable Profit (A)	Shareholder Equity EOFY (B)	ROE (A)/(B)
2012	$26.606m + 0.72($5.642m + $3.900m) =$30.476m	$374.798m	8.1%
2013	$6.912m + 0.72($22.527m+ $5.101m)= $26.804m	$370.542m	7.2%
2014	$36.039m	$452.622m	8.0%
2015	$48.163m - 0.72(0.588m) = $47.743m	$480.125m	9.9%
2016	$54.164m - 0.72(1.136m) = $53.346m	$498.341m	10.7%

Using ROE as a measure, Heartland is very definitely a below average business. I almost said 'well below average', but I knew that kind of talk would just upset 'the faithful' ;-P.

From my perspective as a potential 'growth' investor, this problem is serious. Part of the problem is regulatory. The reserve bank is requiring banks to back up their lending with more capital than has historically been required. Other banks address this hurdle by issuing such things as 'bank bonds', an alternative source of 'Tier 1' capital. Heartland has talked about doing this in the past, but so far has not issued "Heartland Bonds'. If they did, then return on shareholder equity could potentially be boosted. Yet with only a BBB credit rating, would there be enough corporate interest in Heartland Bank Bond to get an issue away?

If there is a case for investment in Heartland today, I feel as though it will be as a dividend play. So how does one fairly value Heartland from a dividend perspective?

SNOOPY

[Beagle]

If there is a case for investment in Heartland today, I feel as though it will be as a dividend play. So how does one fairly value Heartland from a dividend perspective?

.... http://www.investopedia.com/terms/d/ddm.asp

[Snoopy]

If there is a case for investment in Heartland today, I feel as though it will be as a dividend play.

I think it is worthwhile to look at the dividend history in dollar terms, verses the consummate funding requirements of management. I intend to leave out FY2012 as that was the year that Heartland established their capital base to move forward from. But what in dollar terms has happened since FY2012?

Year	Dividends Paid	New Capital Subscribed	Dividends Paid 'per share'
FY2013	$13.951m	$0m	1.5cps(sp) + 2.0cps
FY2014	$19.930m	$65.161m	2.5cps + 2.5cps
FY2015	$30.188m	$7.662m	3.5cps + 3.0cps
FY2016	$37.690m	$4.190m	4.5cps + 3.5cps
FY2017(f)	$39.485m(f)	$30.000m(f)	5.0cps + 3.5cps(f)
Total	$141.244m	$107.013m

(f) indicates forecast result. Dividends paid based on a constant eps from FY2016, but increased in proportion to the estimated number of new shares on issue at EOFY2017. New Capital subscribed based on the $20m + $10m capital raising programs already announced, but does not assume any contribution from the dividend reinvestment plan.

The interesting point about this table is that if you regard HBL as a 'dividend paying share', then the company has required the equivalent of just over 75% of that dividend to be reinvested so that management can carry on with their growth plans. There is nothing wrong with this of course, if you consider Heartland as a 'growth' investment. But as my post 8534 has shown, the utilisation of capital has been questionable.

So if growth, if measured by utilisation of capital is questionable, and net cash returns are questionable, what is the compelling reason to invest in Heartland from here?

SNOOPY

[noodles]

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We have to consider here is that these are American figures. NZ, for so long a 'commodity based' market, may have had historical return on 'overall market equity' figures that are slightly lower than the USA. Nevertheless the Heartland return on equity figures are damning.

Financial Year	Net Sustainable Profit (A)	Shareholder Equity EOFY (B)	ROE (A)/(B)
2012	$26.606m + 0.72($5.642m + $3.900m) =$30.476m	$374.798m	8.1%
2013	$6.912m + 0.72($22.527m+ $5.101m)= $26.804m	$370.542m	7.2%
2014	$36.039m	$452.622m	8.0%
2015	$48.163m - 0.72(0.588m) = $47.743m	$480.125m	11.9%
2016	$54.164m - 0.72(1.136m) = $53.346m	$498.341m	10.7%

Using ROE as a measure, Heartland is very definitely a below average business. I almost said 'well below average', but I knew that kind of talk would just upset 'the faithful' ;-P.

From my perspective as a potential 'growth' investor, this problem is serious. Part of the problem is regulatory. The reserve bank is requiring banks to back up their lending with more capital than has historically been required. Other banks address this hurdle by issuing such things as 'bank bonds', an alternative source of 'Tier 1' capital. Heartland has talked about doing this in the past, but so far has not issued "Heartland Bonds'. If they did, then return on shareholder equity could potentially be boosted. Yet with only a BBB credit rating, would there be enough corporate interest in Heartland Bank Bond to get an issue away?

If there is a case for investment in Heartland today, I feel as though it will be as a dividend play. So how does one fairly value Heartland from a dividend perspective?

SNOOPY

Snoopy,
HBL started with a low return on equity and has been growing the return on equity ever since.

In 2011, the profit was $7m. Now it is $54m. A 670% increase in NPAT.
In 2011, the equity was $296. Now it is $498. A 68% increase in equity

So you can see that the profit growth far exceeds the equity growth. That does not seem like a "below average" business to me. In fact it appears that the management of HBL are best of breed.

Your 15% baseline is for companies with a long track record. HBL is young and started with low profits and high equity. If you start on a low base, of course it is going to take time to get to 15%.

EDIT: Average return on equity for US banks is 9%. Looks like HBL is above average.

https://ycharts.com/indicators/us_re..._for_all_banks

noodles