ANZ.NZX - Anyone holding?

[Snoopy]

ANZ have re-jigged their breakdown of loan categories for FY2017. These do not exactly line up with the loan categories for ANZ's subsidiary UDC. So some rearrangement of categories is required to line them up. Below is my take on how to do it.

	ANZ.NZ	UDC
Category 1	Agriculture	Agriculture Forestry & Fishing
	Forestry Fishing & Agricultural Services
		Mining
Category 2	Manufacturing	Manufacturing
Category 3	Electricity, Gas, Water & Waste Services	Electricity, Gas & Water
Category 4	Construction	Construction
Category 5	Wholesale Trade	Retail & Wholesale
	Retail Trade & Accommodation	Accommodation, Cafes & Restaurants
		Entertainment, Leisure & Tourism
Category 6	Transport, Postal & Warehousing	Transport & Storage
Category 7	Finance & Insurance Services	Finance, Investment & Insurance
Category 8	Public Administration & Safety	Government Administration & Defence
	Professioinal NZ Services
Category 9	Rental Hiring & Real Estate Services	Property & Business Services
Category 10	Households	Personal & Other Services
	All Others
		Education
		Communications
		Health & Community Services

SNOOPY

PS Now I can use this categorization to finish my previous post!

[Snoopy]

	HNZ (FY2016)	UDC (FY2016)
Agriculture Forestry & Fishing:	$680.680m (19.7%)	$494.192m (18.6%)
Mining:	$14.912m (0.4%)	$11.428m (0.4%)
Manufacturing:	$88.412m (2.7%)	$66.429m (2.5%)
Finance & Insurance:	$339.646m (9.8%)	$88.535m (3.3%)
Retail & Wholesale Trade:	$296.550m (8.6%)	$342.734m (12.9%)
Households:	$1,498.261m (43.3%)	$640.521m (24.1%)
Property & Business Services	$405.469m (11.7%)	$133.353m (5.0%)
Transport & Storage:	$26.715m (0.8%)	$460.450m (17.3%)
Other Services:	$110.747m (3.2%)	$418.199m (15.7%)

Total for Heartland $3,461.4m (100%) , with the collectively impaired assets yet to be adjusted for. This equates to a loan book YOY growth of 6.5%.

Total for UDC $2,655.8m (100%), with credit impairment already adjusted for. This equates to a loan book YOY growth of 9.3%.

My question is, can any of the underperformance of UDC in 'underlying earnings terms' be explained by the markets both UDC and Heartland are lending into?

Looking at the year on year figures, comparing each company to itself one year earlier, I am struck by the following observations:

1/ Heartland's rural loan book grew by 19% YOY. UDC's rural loan book only grew by 8% YOY. One explanation is that Heartland was more generous in rolling over marginal rural loans. This was confirmed on p7 of Heartland AR2016

"Despite the difficult circumstances facing the dairy industry, Heartland continues to support existing clients – which was the primary reason for the growth."

Some might see that as a high risk strategy, as this rollover growth decreased cashflow. Recent dairy price recovery in particular suggests that if a high risk gamble was made, it has paid off.

2/ Heartland's 'finance & insurance' book shrunk by 10% YOY. UDC's 'finance & insurance' book grew by 2% YOY. In big picture terms, finance and insurance is far more important to Heartland (nearly 10% of all business vs only just over 3% for UDC). Curiously the shrinkage of 'finance and insurance' at Heartland came in the year that Heartland acquired the 50% of Marac Insurance (general insurance and income protection) they did not own for $2.3m (a small fish acquisition?). So it must be the 'finance' bit of 'finance & insurance' that did most of Heartland's sector shrinking. Reading through the Heartland annual report, I can't find a mention of any business unit shrinking. So I am mystified as to where the shrinkage in the 'finance & insurance' book at Heartland came from. Given the evidence is that this shrinkage probably did Heartland more good than harm I am interested in solving this riddle. Any ideas? Did Heartland wind up some less profitable loans to large businesses during the year? (refer to p26 of Annual Results 2016 presentation).

3/ UDC are very up front that financing construction is part of their business mix. Heartland do not report 'construction' as a separate business category. So I have combined UDC's 'Construction' figures into the broad 'other services' basket.

UDC construction loans totalled $355.757m at EOFY2016, up from $344.072m at EOFY2015, and a not insignificant 13% of the total loan book. This construction increase of 3% YOY, is well below the average 9.3% YOY growth for the whole of %.UDC. One explanation for this modest growth is that some construction projects have become problematic. Developer margins have shrunk and UDC margins on these developments have shrunk consummately. Many fortunes have been made on property over the years. But less well advertised is that many have been lost through risky property development. I have heard anecdotal evidence that property developments around Auckland have been shelved. Are UDC feeling the construction pain?

	HNZ (FY2017)	UDC (FY2017)
Agriculture Forestry & Fishing:	$836.977m (21.3%)	$547.780m (18.4%)
Mining:	$19.006m (0.5%)	$15.091m (0.5%)
Manufacturing:	$76.445m (1.9%)	$59.203m (2.0%)
Finance & Insurance:	$395.804m (10.1%)	$70.125m (2,4%)
Retail & Wholesale Trade:	$189.141m (4.8%)	$367.356m (12.3%)
Households:	$1,717.407m (43.7%)	$820.382m (27.6%)
Property & Business Services	$347.776m (8.8%)	$171.163m (5.8%)
Transport & Storage:	$179.006m (4.6%)	$442.523m (14.9%)
Other Services:	$110.747m (3.2%)	$482.158m (16.2%)

Total for Heartland $3,931.2m (100%) , with the collectively impaired assets yet to be adjusted for. This equates to a loan book YOY growth of 14.3%.

Total for UDC $2,975.8m (100%), with credit impairment already adjusted for. This equates to a loan book YOY growth of 12.1%.

Looking at the year on year figures, comparing each company to itself one year earlier, I am struck by the following observations:

1/ Heartland's rural loan book grew by 23% YOY. UDC's rural loan book only grew by 11% YOY. Are Heartland continuing to be more generous in rolling over marginal rural loans? Provisioning in rural was much reduced (from $3m to just $0.3m). .

2/ Heartland's 'finance & insurance' book grew by 17% YOY, more than wiping out last years reduction.. UDC's 'finance & insurance' book fell by 20% YOY. In big picture terms, finance and insurance is far more important to Heartland (10% of all business vs only just 2.4% for UDC).

3/ UDC are very up front that financing construction is part of their business mix. Heartland do not report 'construction' as a separate business category. So I have combined UDC's 'Construction' figures into the broad 'other services' basket.

UDC construction loans totalled $408.987m at EOFY2017, up from $355.757m at EOFY2016, and represent a not insignificant 14% of the total loan book. This construction increase of 15% YOY in dollar terms, is now ahead of the average 12.1% YOY growth for the whole of UDC, - partially making up for the PCP slide. If UDC is representative, this indicates a much for favourable year of construction in the year ended 30th September 2017. Will this continue post the election of the Labour lead government?

To conclude this comparison, 'the raw table data' would suggest to me that UDC would be less exposed to an economic downturn, because the proportion of loans to 'Households' is lower. However, add back the $178m difference 'Retail and Wholesale' and the $409m in 'Construction' (with no separate Construction disclosure for this at Heartland) ,totalling $584m, (Retail and Construction are both fast responders to a Consumer downturn), and there may not be much difference, The enduring difference between the two is the much greater difference between 'Transport and Storage' in favour of UDC (17.4% of all loans verses 4.6% for Heartland) . This, despite Heartland increasing their exposure fivefold to this sector over the FY2017 financial year.

SNOOPY

[macduffy]

A question, Snoooy. Are you using UDC's "Agriculture, Fishing and Forestry" numbers in arriving at an 11% YOY growth rate for UDC's rural loan book? If so, I would suggest that their lending to this sector is heavily weighted towards the Forestry part. UDC have "traditionally" had a major share of the business of financing forestry machinery/loggers and such. On the other side of the category, I suspect that their involvement in other parts of the rural sector are comparatively modest, being left largely to their bank parent.

[Snoopy]

A question, Snoooy. Are you using UDC's "Agriculture, Fishing and Forestry" numbers in arriving at an 11% YOY growth rate for UDC's rural loan book?

Yes. I am not aware of any publicly declared information that breaks down 'Agriculture Fishing and Forestry' for UDC further.

If so, I would suggest that their lending to this sector is heavily weighted towards the Forestry part. UDC have "traditionally" had a major share of the business of financing forestry machinery/loggers and such. On the other side of the category, I suspect that their involvement in other parts of the rural sector are comparatively modest, being left largely to their bank parent.

Thanks for that insight. Forestry is still cyclical, albeit with a longer time frame between 'planting' and 'harvest' compared with a farmed animal. Forestry machinery / loggers would be likely purchased by contractors rather than forest owners. I guess that forest owners could postpone their harvesting by a couple of years if the price of logs really tanked. But whether the forestry contractors could or would adjust their equipment purchasing behaviour because of that is a question that I don't know the answer to.

SNOOPY

[Snoopy]

Updating the actual bad debt write offs in relation to the size of the loan book at the end of FY2016. Section 7 in the UDC 2016 Financial Statements is named "Provision for Credit Impairment". Bad debts actually written off are compared against the 'provision for loan impairment' stated on page 3, the 'Statement of Comprehensive Income'.

UDC	Bad Debt Write Off	New Bad Debt Provision
FY2010		$17.343m
FY2011		$4.891m
FY2012	$10.164m	$6.031m
FY2013	$12.399m	$7.123m
FY2014	$18.633m	$11.733m
FY2015	$12.162m	$10.427m
FY2016	$11.055m	$7.418m

Actual write offs look to be in a range of $10m to $12m, excluding the spike from FY2014

Putting these 'actual write offs' as a percentage of the end of year loan book gives them better context.

FY2012: $10.164m/$2,014.473m = 0.505%
FY2013: $12.399m/$2,065.117m = 0.600%
FY2014: $18.633m/$2,272.081m = 0.820%
FY2015: $12.162m/$2,347.163m = 0.518%
FY2016: $11.055m/$2,573.030m = 0.430%

For FY2016, UDC has the lowest percentage of write offs for the last five years.

For comparative purposes, it is informative to look 'over the fence' to Heartland Bank. Note 6 (AR2016) to work out the latest details of 'impaired asset expense' as follows:

FY2012: $5.642m
FY2013: $22.527m
FY2014: $5.895m
FY2015: $12.105m
FY2016: $13.501m

Normalize these against the total finance receivables:

FY2012: $5.642m/ $2078.3m = 0.271%
FY2013: $22.527m/ $2010.4m = 1.12%
FY2014: $5.895m/ $2607.4m = 0.226%
FY2015: $12.105m/ $2862.1m = 0.423%
FY2016: $13.501m/ $3114.0m = 0.434%

The nomalised write offs for UDC and Heartland have very curiously converged to close agreement!

	UDC Debt Write Off	Heartland Debt Write Off
FY2012	0.505%	0.271%
FY2013	0.600%	1.12%
FY2014	0.820%	0.226%
FY2015	0.518%	0.423%
FY2016	0.430%	0.434%

Updating the actual bad debt write offs in relation to the size of the loan book at the end of FY2017. Section 7 in the UDC 2017 Financial Statements is named "Provision for Credit Impairment". Bad debts actually written off are compared against the 'provision for loan impairment' stated on page 3, the 'Statement of Comprehensive Income'.

UDC	Bad Debt Write Off (Note 7: Provision for Credit Impairment)	New Annual Bad Debt Provision (Income Statement)
FY2010		$17.343m
FY2011		$4.891m
FY2012	$10.164m	$6.031m
FY2013	$12.399m	$7.123m
FY2014	$3,300m +$18.633m = $21.933m	$11.733m
FY2015	-$0.659m + $12.162m= $11.503m	$10.427m
FY2016	$1.297m + $11.055m = $12.352m	$7.418m
FY2017	-$2.860m + $7.698m = $4.838m	$5.929m

Actual write offs look to be in a range of $10m to $12m, excluding the spike from FY2014 and the unusually low figure in FY2017.

Putting these 'actual write offs' as a percentage of the end of year loan book gives them better context Note that:

1/ the 'actual write offs' are found in the annual change of the holding provision for bad debts and do not directly correspond to the top up expenses for this provision that may be found in each annual income statement.
2/ the denominator is the 'carrying value' of the Net Loans and Advances, This has already been adjusted for the provision for credit impairment, unearned income and deferred fee revenue and expenses.

FY2012: $10.164m/$2,014.473m = 0.505%
FY2013: $12.399m/$2,065.117m = 0.600%
FY2014: $21.933m/$2,272.081m = 0.965%
FY2015: $11.503m/$2,347.163m = 0.518%
FY2016: $12.352m/$2,573.030m = 0.490%
FY2017: $4.838m/$2,911.514m = 0.166%

For FY2017, UDC has easily the lowest percentage of write offs for the last five years.

For comparative purposes, it is informative to look 'over the fence' to Heartland Bank. See Note 6 (AR2017) to work out the latest details of 'impaired asset expense' as follows:

FY2012: $5.642m
FY2013: $22.527m
FY2014: $5.895m
FY2015: $12.105m
FY2016: $13.501m
FY2017: $15.015m

Note that unlike UDC, Heartland writes off uncollectible debts or part debts directly from each annual profit result. I will now normalize these against the 'total finance receivables'. 'Total finance receivables' are already adjusted for any provision for impairment and the present value estimate of future losses (AR2017, Note 11).

FY2012: $5.642m/ $2078.3m = 0.271%
FY2013: $22.527m/ $2010.4m = 1.12%
FY2014: $5.895m/ $2607.4m = 0.226%
FY2015: $12.105m/ $2862.1m = 0.423%
FY2016: $13.501m/ $3114.0m = 0.434%
FY2017: $15.015m/ $3546.0m = 0.423%

Summarizing and comparing the above information:

	UDC Debt Write Off	Heartland Debt Write Off
FY2012	0.505%	0.271%
FY2013	0.600%	1.12%
FY2014	0.820%	0.226%
FY2015	0.518%	0.423%
FY2016	0.430%	0.434%
FY2017	0.166%	0.423%

The question that rears its ugly dead from the above data table is as follows:

Why is the impairment percentage so much lower for UDC in FY2017 compared with UDC's past year results? Perhaps we had a really low impairment year? But if that was true, we might expect a similar reduction in impaired loans over the same time period from the closely comparative Heartland. This didn't happen. I do note that UDC was put up for sale over the FY2017 financial year and it would have been helpful to show the accounts in their best possible light leading up to any sale. So were the impairments at UDC for FY2017 really that much lower? Or has some 'window dressing' gone on here?

That is a point to ponder for potential investors, if UDC is floated on the sharemarket soon!

SNOOPY

[Snoopy]

UDC construction loans totalled $408.987m at EOFY2017, up from $355.757m at EOFY2016, and represent a not insignificant 14% of the total loan book. This construction increase of 15% YOY in dollar terms, is now ahead of the average 12.1% YOY growth for the whole of UDC, - partially making up for the PCP slide. If UDC is representative, this indicates a much for favourable year of construction in the year ended 30th September 2017. Will this continue post the election of the Labour lead government?

Further to Macduffy's enlightening post on Agricultural Financing, I had assumed UDC 'Construction' referred to maximising the returns on loans on some undercapitalised Auckland property developers who had been turned down at bank shop front level, but shunted across to UDC as a 'safety net' to avoid them becoming the prey of mezzanine financiers. However on reflection (and because I have never heard of UDC financing a property development) I now think it is far more likely that UDC is financing concrete mixers, bulldozers, dump trucks and scrapers in their 'Construction' loan segment.

SNOOPY

[macduffy]

Yes, I would think that there would be a fair bit of machinery/equipment financing in the Construction number but, going back a long time now, it wasn't unknown for finance companies such as UDC to be financing property development. Given the paucity of such competitors these days, I would expect that UDC would be able to be very selective in choosing to finance good projects.

[Snoopy]

Note 11d (page 17 UDC Financial Statements for FY2016), lists the internal risk grading of the loan assets on a scale of 0 to 9. On this scale 0 is the lowest risk while 9 means a default.

	UDC Vulnerable Loans
	Judgement	Total
	Grade 6+
2012	$975.744m +$80.745m +$55.403m	$1,111.892m
2013	$1,157.111m +$83.790m +$24.814m	$1,265.715m
2014	$811.700m +$92.366m +$34.883m	$938.949m
2015	$904.338m +$81.156m +$32.640m	$1,018.134m
2016	$1,127.677m +$96.727m +$17.657m	$1,242.061m

The grade 6 and 'more risky' categories for EOY2016 added up represents a fraction of the total loans outstanding as follows:

$1,242.061m / $2,684.750m = 46.3% of total loan assets.

The Credit impairment provision on the books, not yet removed from the above total, is noted as $28.909m (note 11d)

========

For comparative purposes it is interesting to see what happens when we take the same statistics for Heartland bank. The situation is not strictly comparable because Heartland has a different credit risk system for so called 'Behavioral Loans'. Behavioral loans consist of consumer and retail receivables usually relating to the financing of a single asset.

OTOH 'Judgement Loans' are graded on the 1-9 system. Grade 1 represents a 'Very Strong' loan. Grade 9 represents a loan 'At Risk of Loss'. Grade 6 represents a loan that should be monitored. A 'Judgement loan' within Heartland consists mainly of business and rural lending, including non-core property, where an ongoing and detailed working relationship has been developed.

The grade 6 and 'more risky' categories of 'Judgement Loans' plus the equivalently vulnerable 'Behavioural Loans' sum up to a total amount of Heartland Vulnerable Loans' represent a fraction of the total loans outstanding as follows:

$204.029m / $3,135.203m = 6.51% of total loan assets.

Some impairment ($16.259m) (Note 18b) has already been taken onto the book over the years. Add to this a reverse mortgage fair value adjustment of ($4.987m) This total impairment of $21.246m represents

$21.246m / $175.428m = 12.1% of the Grade 6 (monitor) and below grade assets.

		Heartland Vulnerable Loans
	Behavioural			Judgement	Total
	Arrangement	Non Performing Repossession	Recovery	Grade 6+
2012	$13.750m	$4.386m	$2.740m	$185.315m +$53.360m +$14.036m +$13.741m	$287.118m
2013	$8.416m	$2.226m	$1.936m	$198.370m +$18.034m +$21.518m +$27.761m	$278.051m
2014	$7.571m	$2.113m	$2.113m	$165.776m +$14.833m +$13.520m +$3.412m	$159.338m
2015	$15.855m	$3.087m	$3.687m	$99.849m +$14.937m +$4.514m +$7.082m	$149.011m
2016	$14.923m	$6.507m	$7.171m	$125.902m +$20.434m +$16.904m +$12.188m	$204.029m

A summarized comparative table between UDC (Year ending 30th September) and Heartland (Year ending 30th June) is below:

	UDC					Heartland
	Impaired Loans (A)	Grade 6+ Loans [total Vulnerable](B)	(A)/(B)	Total Loans (C)	(A)/(C)	Impaired Loans (A)	Total Vulnerable Loans (B)	(A)/(B)	Total Loans (C)	(A)/(C)
2012	$38.481m	$1,111.892m	3.46%	$2,141,780m	1.79%	$8.032m	$287.118m	2.80%	$2,086.303m	0.785%
2013	$37.460m	$1,265.765m	2.95%	$2,198,653m	1.70%	$15.961m	$278.051m	5.74%	$2,026.337m	0.788%
2014	$31.805m	$938,899m	3.38%	$2,375.936m	1.34%	$14.999m	$159.338m	9.41%	$2,622.392m	0.571%
2015	$31.529m	$1,018,134m	3.10%	$2,461.224m	1.28%	$16.433m	$149.011m	11.0%	$2,878.513m	0.571%
2016	$28.909m	$1,242.061m	2.33%	$2,684.750m	1.08%	$21.246m	$204.029m	10.4%	$3,135.203m	0.678%

Note 10d (page 18 UDC Financial Statements for FY2017), lists the internal risk grading of the loan assets on a scale of 0 to 9. On this scale 0 is the lowest risk while 9 means a default.

	UDC Vulnerable Loans
	Judgement	Total
	Grade 6+
2012	$975.744m +$80.745m +$55.403m	$1,111.892m
2013	$1,157.111m +$83.790m +$24.814m	$1,265.715m
2014	$811.700m +$92.366m +$34.883m	$938.949m
2015	$904.338m +$81.156m +$32.640m	$1,018.134m
2016	$1,127.677m +$96.727m +$17.657m	$1,242.061m
2017	$1,201.747m +$133.791m +$11.618m	$1,347.156m

The grade 6 and 'more risky' categories for EOY2017 added up represents a fraction of the total loans outstanding as follows:

$1,347.156m / $3,005.059m = 44.8% of total loan assets.

The Credit impairment provision on the books, not yet removed from the above total, is noted as $29.278m (note 10d)

========

For comparative purposes it is interesting to see what happens when we take the same statistics for Heartland bank. The situation is not strictly comparable because Heartland has a different credit risk system for so called 'Behavioral Loans'. Behavioral loans consist of consumer and retail receivables usually relating to the financing of a single asset.

OTOH 'Judgement Loans' are graded on the 1-9 system. Grade 1 represents a 'Very Strong' loan. Grade 9 represents a loan 'At Risk of Loss'. Grade 6 represents a loan that should be monitored. A 'Judgement loan' within Heartland consists mainly of business and rural lending, including non-core property, where an ongoing and detailed working relationship has been developed.

The grade 6 and 'more risky' categories of 'Judgement Loans' plus the equivalently vulnerable 'Behavioural Loans' sum up to a total amount of Heartland Vulnerable Loans' represent a fraction of the total loans outstanding as follows:

$241.486m / $3,575.613m = 6.75% of total loan assets.

Some impairment ($25.865m) (Note 19e) has already been taken onto the book over the years. Add to this a reverse mortgage fair value adjustment of ($3.851m) This total impairment of $29.716m represents

$29.716m / $241.486m = 12.3% of the Grade 6 (monitor) and below grade assets.

		Heartland Vulnerable Loans
	Behavioural			Judgement	Total
	Arrangement	Non Performing Repossession	Recovery	Grade 6+
2012	$13.750m	$4.386m	$2.740m	$185.315m +$53.360m +$14.036m +$13.741m	$287.118m
2013	$8.416m	$2.226m	$1.936m	$198.370m +$18.034m +$21.518m +$27.761m	$278.051m
2014	$7.571m	$2.113m	$2.113m	$165.776m +$14.833m +$13.520m +$3.412m	$159.338m
2015	$15.855m	$3.087m	$3.687m	$99.849m +$14.937m +$4.514m +$7.082m	$149.011m
2016	$14.923m	$6.507m	$7.171m	$125.902m +$20.434m +$16.904m +$12.188m	$204.029m
2017	$18.512m	$4.956m	$4.889m	$166.155m +$27.669m +$16.749m +$2.556m	$241.486m

A summarized comparative table between UDC (Year ending 30th September) and Heartland (Year ending 30th June) is below:

	UDC					Heartland
	Impaired Loans (A)	Grade 6+ Loans [total Vulnerable](B)	(A)/(B)	Total Loans (C)	(A)/(C)	Impaired Loans (A)	Total Vulnerable Loans (B)	(A)/(B)	Total Loans (C)	(A)/(C)
2012	$38.481m	$1,111.892m	3.46%	$2,141,780m	1.79%	$27.426m	$287.118m	9.55%	$2,105.702m	1.30%
2013	$37.460m	$1,265.765m	2.95%	$2,198,653m	1.70%	$50.491m	$278.051m	18.24%	$2,060.867m	2.45%
2014	$31.805m	$938,899m	3.38%	$2,375.936m	1.34%	$24.381m	$159.338m	15.3%	$2,651.754m	0.919%
2015	$31.529m	$1,018,134m	3.10%	$2,461.224m	1.28%	$31.654m	$149.011m	21.2%	$2,893.724m	1.09%
2016	$28.909m	$1,242.061m	2.33%	$2,684.750m	1.08%	$26.148m	$204.029m	12.8%	$3,140.106m	0.833%
2017	$29.278m	$1,347.156m	2.17%	$3,005.059m	0.974%	$29.716m	$241.486m	12.3%	$3,575.613m	0.831%

SNOOPY

[percy]

Yes, I would think that there would be a fair bit of machinery/equipment financing in the Construction number but, going back a long time now, it wasn't unknown for finance companies such as UDC to be financing property development. Given the paucity of such competitors these days, I would expect that UDC would be able to be very selective in choosing to finance good projects.

I would be very surprised to hear UDC were financing property developments.
Machinery/equipment yes.
Forestry.Again a huge amount of machinery/equipment/trucks financed.

[Snoopy]

During FY2016 'Heartland New Zealand Limited' and 'Heartland Bank Limited' combined into a single listed entity.

Heartland in their breakdown of the 'Asset Quality of Financial Receivables' (AR2016 Note 19a) list the following three mutually exclusive problem loan categories.

a/ Loans at least 90 days past due.
b/ Loans individually impaired.
c/ Restructured assets.

these loans are partially written off, and accounted for in the 'Provision for Impairment' (a separate listing category, d/).

My definition of a Heartland 'stressed loan' total can be calculated as follows:

'Stressed Loan Total' = (a)+(b)+(c)-(d)

The column (W) lists the actual dollar amount in bad debts written off over that period, as detailed in AR2016 note 19e.

Heartland
Date	'Stressed' Loans on the books (X)	Net Financial Receivables (Impairments deducted) (Y)	(X)/(Y)	Write Offs (W)	Gross Financial Receivables (Z)	(W)/(Z)
EOHY2012	$87.728m	$2,075.211m	4.23%	$12.138m+$1.685m	$2,104.591m	0.66%
EOFY2012	$90.489m	$2,078.276m	4.35%	$14.636m+$3.180m	$2,105.702m	0.85%
EOFY2013	$48.975m	$2,010.393m	2.43%	$6.679m+$1.961m	$2,060.867m	0.42%
EOFY2014	$41.354m	$2,607.393m	1.59%	$35.258m+$3.260m	$2,631.754m	1.46%
EOFY2015	$39.066m	$2,862.070m	1.36%	$1.555m+$1.910m	$2,893.704m	0.12%
EOFY2016	$37.851m	$3,113.957m	1.21%	$12.010m+$6.653m	$3,135.203m	0.60%

The objective here is to take the Heartland figures and compare those to the equivalent figures for UDC. There are little differences in reporting standards that make this difficult.

For example, Heartland have a class of loans called 'Judgement Loans'. They pass annual judgement on these loans by rating them on a scale of 1 to 9 plus 'default'.

There is a second broad category called 'Behavioural Loans' which are separately rated, not using a 1-9 scale.

UDC appear to rate all of their loans on a scale of 1 to 8 plus default (UDC Financial Statements 2016, note 11d). I have previously defined UDC 'Vulnerable Loans' as classes 6,7 and 8. But category 6 is very large. So I am now going to change my comparative and talk about 'Stressed Loans' which are calculated by:

Take loan total from categories 7 and 8
add 'Default' loans
less Provision for Credit Impairment.

I have redefined the 'Total Financial Assets' as listed in note 11d to be 'Net Financial Receivables'. I feel it is misleading because the previously defined total if 'Provision for Credit Impairment' has already been taken off the total.

UDC
Date	'Stressed' Loans on the books (X)	Net Financial Receivables (Impairments deducted) (Y)	(X)/(Y)	Impaired Asset Expense (W)	Gross Financial Receivables (Z)	(W)/(Z)
EOFY2011	$126.218m	$2,007.012m	6.29%	$15.103m	$2,049.504m	0.74%
EOFY2012	$96.670m	$2,102.299m	4.60%	$10.164m	$2,141.780m	0.47%
EOFY2013	$86.877m	$2,161.193m	4.02%	$12.399m	$2,198.653m	0.56%
EOFY2014	$95.364m	$2,344.131m	4.07%	$18.633m	$2,375.936m	0.78%
EOFY2015	$82.267m	$2,429.695m	3.39%	$12.162m	$2,461.224m	0.49%
EOFY2016	$85.475m	$2,655.841m	3.22%	$11.055m	$2,684.750m	0.41%

The key point to note here is that the 'impaired loan expense' / 'write offs' (represented by letter 'W' in each case) only occur:

1/ when that portion of the loan has gone through the whole loan review system and is 'done and dusted'. AND
2/ when a loan repayment has been missed, or a non payment is imminent

OTOH 'Stressed Loans' are very much a judgement call by management.

They may
1/ recover,
2/ stay stressed or
3/ have to be impaired, or worse, written off.

As a shareholder in either ANZ or Heartland, I would hope that management would have a robust process that identifies problem loans before they have to be written off. So as a shareholder I would hope such loans were seen as 'stressed' before an actual write off was declared. So how to check that this is what happens in reality? One way is to look at the 'stressed loans' for both companies on an annual trending basis and see how this compares with the equivalent trend in write offs.

In the case of both UDC and Heartland, the normalised stressed loan percentage is consistently going down. However, the actual write offs per year are not going down in proportion. One interpretation of this is that both companies are assuming a lower number of loan write offs will be necessary in the future (because stressed loans are reducing). However, because this is not happening, this could suggest that both companies are pumping their declared results by making insufficient stressed asset provisioning for the future.

Alternatively it could mean that both companies are getting much better at identifying what are really stressed loans, and that allows them to have relatively lower stressed asset monitoring.

What is a 'Stressed Loan'? For the purpose of this discussion, I have a special definition.

Stressed Loan Definition	UDC	Heartland
	1/ Take loan total from categories 7 and 8	a/ Take loans at least 90 days past due.
	2/ add 'Default' loans	b/ add Loans individually impaired.
		c/ add Restructured assets. (*)
	3/ less Provision for Credit Impairment	d/ less Provision for Credit Impairment.'
	4/ equals 'Total Stressed Loans'	e/ equals 'Total Stressed Loans''

(*). (Note that from FY2017 ' Restructured Assets' are now not reported on by Heartland.)


A 'Stressed Loan' can be thought of as a kind of 'Vulnerable Loan', as previously described, but with the Impairment provision taken out. There is no overlap between a 'stressed loan', as defined here, and the amount of money written off each year in bad debts. But yes, 'Stressed Loans' are very much a judgement call by management.

They may
1/ recover,
2/ stay stressed or
3/ have to be written off.

As a shareholder in either ANZ (owner of UDC) or Heartland:

1/ I would hope that management would have a robust process that identifies problem loans before they have to be written off.
2/ So as a shareholder, I would hope such loans were seen as 'stressed' before being classified as 'impaired' and certainly before an actual write off was declared.

How does one check that this is what happens in reality? One way could be to look at the 'stressed loans' for both companies on an annual trending basis and see how this compares with the equivalent annual trend in write offs.


Heartland

The column (W) lists the actual dollar amount in bad debts written off over that period, as detailed in AR2017 note 19e.

The key point to note here is that the 'impaired loan expense' / 'write offs' (represented by letter 'W' in each case) only occur:

1/ when the impaired portion of the loan has gone through the whole loan review system'. AND
2/ when a loan repayment has been missed, or a non payment is imminent

Heartland
Date	'Stressed' Loans on the books (X)	Net Financial Receivables (Impairments deducted) (Y)	(X)/(Y)	Write Offs (W)	Gross Financial Receivables (Z)	(W)/(Z)
EOHY2012	$87.728m	$2,075.211m	4.23%	$12.138m+$1.685m	$2,104.591m	0.66%
EOFY2012	$90.489m	$2,078.276m	4.35%	$14.636m+$3.180m	$2,105.702m	0.85%
EOFY2013	$48.975m	$2,010.393m	2.43%	$6.679m+$1.961m	$2,060.867m	0.42%
EOFY2014	$41.354m	$2,607.393m	1.59%	$35.258m+$3.260m	$2,631.754m	1.46%
EOFY2015	$39.066m	$2,862.070m	1.36%	$1.555m+$1.910m	$2,893.704m	0.12%
EOFY2016	$37.851m	$3,113.957m	1.21%	$12.010m+$6.653m	$3,135.203m	0.60%
EOFY2017	$38.341m	$3,545.896m	1.08%	$2.140m+$9.531m	$3,567.191m	0.33%

Note: During FY2016 'Heartland New Zealand Limited' and 'Heartland Bank Limited' combined into a single listed entity.


UDC

I have redefined the 'Total Financial Assets' as listed in note 10d to be 'Net Financial Receivables', because they have already had their 'Provision for Credit Impairment' deducted (netted off).

UDC
Date	'Stressed' Loans on the books (X)	Net Financial Receivables (Impairments deducted) (Y)	(X)/(Y)	Impaired Asset Expense (W)	Gross Financial Receivables (Z)	(W)/(Z)
EOFY2011	$126.218m	$2,007.012m	6.29%	$15.103m	$2,049.504m	0.74%
EOFY2012	$96.670m	$2,102.299m	4.60%	$10.164m.	$2,141.780m	0.47%
EOFY2013	$86.877m	$2,161.193m	4.02%	$12.399m	$2,198.653m	0.56%
EOFY2014	$95.364m	$2,344.131m	4.07%	$21.933m	$2,375.936m	0.92%
EOFY2015	$82.267m	$2,429.695m	3.39%	$11.503m	$2,461.224m	0.47%
EOFY2016	$85.475m	$2,655.841m	3.22%	$12.352m	$2,684.750m	0.46%
EOFY2017	$116.131m	$2,975.781m	3.90%	$4.838m	$3,005.059m	0.16%

Discussion

In the case of Heartland, the 'stressed loan' percentage is consistently going down. However, the actual write offs per year do not show an obvious correlation to the same year's 'stressed loan' figure. In FY2014, for example, the quantum of write offs are almost equal to the quantum of stressed loans. Yet one year later (FY2015) the write offs are only less than one tenth of the stressed loans. Will the case of FY2016 and FY2017, where stressed loans are two to three times the amount actually written off become the new norm?
.
In the case of UDC, the stressed loans look to float around at 4% of the total, much higher than the Heartland equivalents of recent years. For FY2017 only, the 'Impaired Asset Expense' to 'Gross Financial Receivables' is startlingly low, even as the stressed loans jumped up. A one year aberration? Despite making my own interpretation of how to define a 'stressed loan' at UDC - to bring the number more into line with what happens at Heartland - the stressed loan percentage at UDC remains stubbornly high in comparison. UDC loans are perhaps more heavily weighted towards 'working equipment' which may not have much 'fire sale' value during a business downturn. So could it just be in the nature of the UDC business that management need to keep a really close eye on a large portion of their loans? How they do this, while using a skeleton staff compared to Heartland, remains a mystery to me!

What would I like to see in these figures? If you accept that:

1/ When a loan is written off it is largely too late to fix it, AND
2/ The overall number of write offs can be contained (it is inevitable that in any lending organisation, some loans will have to be written off)

THEN I am interested in how management deals with 'stressed loans' before they get to that stage.

My concern is that the write offs at UDC over FY2017 are exceptionally low, and there is an unusual incentive for management to project the result like this (UDC is up for sale). Write offs are also down at Heartland over the comparable period (which could indicate a favourable market to lenders), but not by as much. The percentage of 'stressed loans' at UDC remains significantly comparatively higher than Heartland. There are a couple of ways to interpret that:

Either:

1/ UDC staff remain 'exceptionally diligent' in reviewing stressed loans (as assessed by UDC) and this policy is leading to lower and lower actual write offs.
2/ UDC are being exceptionally lenient in classifying some loans as stressed when really they should be wholly or partially impaired or maybe even written off.

I would have expected more 'exceptional diligence' from Heartland, simply because they have more staff. The Heartland pattern of reducing 'write offs' coupled with reducing 'stressed loans' does make a plausible narrative. But I am concerned that some of those UDC stressed loans may be a little more stressed than UDC management are letting on. It is hard to be definitive about one year's results. In the meantime I would be cautious in assessing the UDC write off picture.

SNOOPY