Heartland Group Holdings Limited (HGH) Earnings Call Transcript & Summary

Thank you for standing by, and welcome to the Heartland Group Market Update. [Operator Instructions] I would now like to hand the conference over to Mr. Andrew Dixson, CEO of Heartland Group. Please go ahead.

Good morning, and thank you for attending this briefing. I'm Andrew Dixson, Heartland Group Chief Executive. And with me today are Leanne Lazarus, Heartland Bank Chief Executive; Andy Wood, Heartland Risk Officer; and Kerry Conway, Heartland Bank Chief Financial Officer. This morning, Heartland updated the market on a material increase in impairment expense for its New Zealand Bank for the first half of financial year 2025. I'm going to walk through a summary of this morning's announcement and the key information related to it. This was supported by the investor pack that was also published this morning, which provides some important insights. At the end, we will allow plenty of time for analyst questions. It is important to note that this matter is confined only to certain loan portfolios within the New Zealand Bank. Other loan portfolios or the New Zealand and loan portfolios across our Australian bank are performing well and will be reported on in detail at our half year results on the 27th of February. We have announced an impairment expense of $49.6 million in our New Zealand Bank for the 6-month period ended 31 December 2024. This relates predominantly to arrears within Heartland Bank's Motor Finance and business lending portfolios where collectibility of customer arrears has been impacted by deteriorating economic conditions. This will significantly derisk and reposition the affected lending portfolios, and we believe is in the long-term interest of the business, customers and shareholders. The components of the $49.6 million are: firstly, a $20.2 million impact from writing off arrears net of expected recoveries and there are 2 parts to this. A $12.1 million impact from writing off arrears greater than 365 days past due and the Motor Finance and Open for Business loan portfolios, together with an $8.1 million write-off of businesses as usual. Secondly, a $19.4 million specific provision expense, predominantly for Asset Finance and older Business Relationship loan portfolios. Finally, a $10 million collective provision expense for the Motor Finance, Open for Business and Asset Finance loan portfolios. Before diving into the detail, I wanted to outline some key points. This will impact Heartland's net profit after tax for the first half in 2025, which we expect to be in the range of $2 million to $5 million, subject to completion of the first half 2025 interim review by Heartland's external auditors, which has substantially progressed. Writing off these arrears is expected to result in Heartland Bank's nonperforming loan ratio decreasing from 3.65% as at 30 June 2024 to 3.4% as at 31 December 2024. This approach will also enable more resources to continue to focus on addressing earlier stage arrears, which have started to show good improvement. Heartland Bank remains well capitalized with a total capital ratio of 14.8% as at 31 December 2024. It holds strong liquidity and the credit quality of its reverse mortgage and livestock Finance Portfolios remain strong. Our Australian bank, Heartland Bank Australia Limited is unaffected and continues to perform well. Growth has returned to its livestock finance portfolio, while strong growth continues on its reverse mortgage portfolio. The transition to a deposit-led funding mix remains on track to be substantially complete by 30 June 2025. Finally, while the Board is need to declare an interim dividend, its current expectation is that the increased Heartland Bank impairment expense will not prevent are paying an intertie dividend. The quantum of any dividend to be declared in respect of the first half will be carefully determined by the Board based on capital needs really accretive growth opportunities, balance sheet flexibility and financial performance. Working through the backdrop of economic conditions. As expected, economic volatility in New Zealand has continued during the 2025 financial year. However, during the first half of financial 2025, New Zealand economic conditions have, in fact, significantly deteriorated. In the pack, you will see data related to this deterioration that have been impacting some of our customers and the collectability of the loans. The latest GDP data for the September 2024 quarter combined with a significant restatement of the June 2024 quarterly GDP shows the largest 6-month fallen GDP since mid-1991, excluding the COVID-19 period. Other macroeconomic indicators reinforce us. with unemployment in New Zealand rising to a 4-year high at 5.1%, financial hardships up 16% year-on-year and company liquidations in New Zealand up 36% year-on-year. Consumer and business defaults have increased 39% and 22%, respectively, year-on-year. Construction and manufacturing are 2 of the sectors most affected by the recent deterioration. Both the sectors, Heartland Bank supports within its Asset Finance open for business and older business relationship lending. In response, we have increased provisions across the affected portfolios, and we are writing off Motor Finance and Open for Business loans greater than 365 days past due, net of anticipated recoveries. We are also fundamentally changing our collections processes, policies and strategies. In terms of write-offs, -- the $12.1 million net impact from writing off all arrears greater than 365 days past due and Heartland Bank's Motor Finance and Open for Business loan portfolios, constitutes a $27.2 million write-off of these loans less than $11.2 million release of collective provisions held against these loans and an assumed $3.9 million recovery from continued collections efforts. Of these arrears being written off 77% related to the Motor Finance portfolio and 23% are Open for Business loans. This is detailed by portfolio on Slides 5 and 6 of the investor presentation. In terms of specific provisions, the $19.4 million expense is predominantly for Asset Finance and older Business Relationship lending within the transport, construction forestry and agriculture sectors, where the probability of recovery has reduced substantially since June 2024. This increase reflects the impact of the current economic deterioration on trading conditions in these sectors, security valuations and overall recoverability prospects of these nonperforming clients. The majority 69% of these loans were originated prior to Heartland Bank updating its limiting standards in 2020 and our loans which Heartland Bank no longer rates. In terms of collective provisions, the $10 million collective provision expense is due to the impact of the prolonged recessionary environment on loans within Heartland Bank's Motor Finance, Open for Business and Asset Finance portfolios. In particular, the economic deterioration for business lending with reference to the increased rate of liquidations and receiverships in New Zealand has resulted in an increase in estimated probabilities of default and an increase in the resulting loss. These are key inputs applied to model collective provisions. In terms of collections improvements. Heartland Bank has historically taken a supportive and judgment-based approach to helping customers and arrears repay their loans, particularly through the COVID-19 period. This approach had worked well, particularly during more stable economic conditions and due to the markets Heartland Bank. As the economy has deteriorated and Heartland Bank has grown its arrears management practices, while remaining supportive require a more proactive and prescriptive approach. As such, we have made changes to our collections, recoveries and write-off strategies. These changes include: for Motor Finance and Open for Business, adopting a more prescriptive reposition policy, which sees recovery action taken much sooner in the collection cycle. We have implemented a prescriptive 180-day write-off policy. We have only engaged with debt collection agencies immediately post write-off to enhance recovery outcomes. For older Business and Rural Relationship loans, changes to risk rating, security valuations, Heartland Bank's restructuring policy and the strategy and timing of intervention measures are underway to strengthen nonperforming line management. Looking forward, while there may be some positive economic tailwinds emerging in New Zealand in the second half of financial 2025, conditions for consumers and businesses are expected to remain challenging. We expect this to be particularly prevalent in the -- within the forestry, transport, agriculture and construction sectors, and we will continue to proactively work with impacted customers. Our target state is to have no arrears greater than 180 days in Motor Finance or Open for Business by 30 June 2026, achieved through a combination of 3 things: Firstly, all future arrears in the Motor Finance and Open for Business portfolios will be managed under the new 180-day write-off policy. Secondly, we will proactively manage motor finance and open business loans currently between 100 and 365 days past due. And thirdly, through the write-off of loans greater than 365 days past due, as outlined today. These conditions deteriorate further than what is currently anticipated and provision within Heartland Bank's lending portfolios, an additional impairment could result in the second half of the financial year. This could be up to $8 million in write-offs in addition to what is considered business as usual and up to $5 million in specific provisioning. With that, I'll now open to the floor for questions.

[Operator Instructions] Your first question comes from Wade Gardiner with Craigs Investment Partners.

Just a couple of questions from me. I'm just trying to get back to your -- was it $2 million to $5 million guidance for the first half impact? What's the tax impact of these provisions?

Multiply by the New Zealand corporate tax rate.

Sorry, it's -- sorry, I missed the first part of that, I think. So the entire 50-odd mill is deductible, even though low its provisions.

That's right. $14 million uptick.

Okay. In which case, can you also give there for a bit of color around what you're seeing with net interest income and in particular, some of the recovery and the NIM that you've alluded to in the past?

I can at this stage, Wade, sorry, because we're still in the midst of the interim review, which is, as I said, substantially progressed, however, until it's finalized we can't give those details at this point of time.

Okay. And I take it from your comments that any impairments coming out of the Aussie Bank is essentially very, very small -- and nothing for reverse mortgages and maybe a very small amount for livestock?

I can confirm that.

Okay. And therefore, worst case is what you're saying is the second half, you could have another sort of impairment expense of $21 million, which is basically write-off 8 business as usual and 5 specific provisions taking the total for the year to sort of up to around the about $70-odd million.

As a worst case, yes.

Our next question comes from Andrew Harvey-Green with Forsyth Barr.

A couple of questions from me. So just following on from Wade in terms of the just making sure the total impairment expense we're talking about is just purely motor and business related. So there's nothing in rural or any other business units.

There are 3 rural loans including us, but 3 rural relationship lines, as we call them. But very much immaterial in terms of the rest of the makeup.

Okay. Okay. But that's the total for the whole group that we're looking at for the first half?

That's correct. .

Yes. Okay. Next question is just thinking about OpEx going forward and whether changes -- these changes in policies or, I guess, in terms of additional processes that you might be putting in place, whether we can expect any change on OpEx going forward?

As I said, we're still working through our interim results at this stage, so I can't comment too much on that. We are investing heavily in people in the collections area, which will obviously have a cost impact, however, is expected to drive benefits in the future through enhanced recovery outcomes.

Yes. Okay. Next question I just had is you gave an update to the market, I guess, at the back end of November, which had some impairments in there. What's really changed over the last 2 months to sort of have this really big impairment come through at this point in time.

Yes. I'm happy to answer that. My name is Andy Wood. I'm the Chief Risk Officer in the bank. I think what's really changed is the realization of the magnitude of the economic contraction. You'll recall that we had a restatement of the June GDP quarter. I think that went down to negative 1.1, and then we followed that with a September negative quarter of 1%. So if you exclude the extraordinary COVID period, which obviously benefited from a lot of fiscal support, a lot of monetary policy support and indeed regulatory support. That's -- what we've just gone through is that sort of boiling 30-year recession. So the magnitude of the economic downturn is the fundamental thing that has changed over the last 6 months. And that in turn has sort of impacted on our confidence in the collectability of these buyers.

Yes. Okay. And last question for me is, I guess, in previous releases, you still talked about having those long-term goals around the $200 million. Is that still intact? Or is that something that's under review? I guess there's a degree of recovery that's going to required after this?

At this stage, they remain intact, we will provide further comment during our half year announcement. .

Next question comes from Grant Lowe with Jarden.

Just a couple for me. Just around the assumptions for the FY '25, '26 outlook and I guess I'm referencing the last slide in your pack ultimately. So I mean looking at the FY '24 annual report, the underlying assumption for the economy was unemployment heading about 5.5% on a weighted basis in your scenarios in FY '25. We're still sort of sitting at around 5.1%. Has there been any change in your base assumptions around the unemployment and other sort of macroeconomic variables get to -- I guess the expectation was that if things play out towards that 5.5% in the lines were already provided for?

No, we haven't changed our assumptions. Our assumptions actually have matched what's played out. However, the increase really in unemployment has been skewed towards construction and machinery based work, which has had a greater impact than we anticipated, particularly on business borrowers. Our assumption was largely based around the most ratable support services.

Got it. Okay. And so in terms of the -- so you said second last bullet point there, expected to be no further arrears for the Motor Finance and Open for Business loans at the end of the year, but the net bottom point talks around potential uplift of $8 million and $5 million. What would be the drivers for that change in terms of macroeconomic variables or otherwise that you're sort of alluding to there?

So firstly, we're talking about eliminating all arrears 180 days and over by 30 June 2026, so not this current financial year.

No, sorry, right. Yes. So what would be -- what would lift -- I mean you've got a portfolio of loans at the moment you provided for on a forward-looking basis, what would be the driver for the [ 13 ] over and above where we update them the way of looking at it?

Well clearly, further deterioration in the key drivers of that being unemployment, GDP and the -- and further payment suffering in the business sector, more liquidations, more receiverships.

Yes. Okay. You have to sort of quantify any of that and coming up with $13 million or not at stage?

Not on this call, not at the stage, but we can come back to you.

Okay. And then just around -- so with the motors portfolio, in particular, like previously referenced -- previous impairments referenced the legacy lending. How much of the additional increment today is due to legacy loans versus more recent lending by which I sort of understand that the legacy is sort of pre FY '19 ending?

At least 3 quarters relate to legacy what we're terming legacy I think [indiscernible].

Okay. I guess -- so what sort of comfort can you give around the change in lending standards since the FY '19 period and whether there might be some increase in that? I know you sort of touched on it previously, but I guess, I sort of look at your growth in the motor book 50% since FY '19. Is there anything you can say to sort of give some sort of comfort around how that was achieved without compromising lending standards?

So Andy Wood here, the CRO of the bank just to elaborate on that. So just I think it's probably worth making the point. In terms of the specific provisions that we've taken, as Andrew said, 70% of those SPs of around $20 million originated before 2020. That's before the bank revised its business riding strategy. So in respect of -- these are the Business Relationship loans in the main, those loans, we would no longer write. We changed our business providing strategy in 2020. So these are definitely legacy issues. The motor portfolio, as you say, has grown business writing strategies, there are -- after the calibration of our credit standards changes often as we sort of reflect the economic situation. So I think that this is really a story in terms of legacy in respect to the SPs, more than the motor although obviously some of these motor loans that we are writing off here with more 65 days past due, clearly, clearly some years ago. But what we're looking to do here is to sort of put a line in sand for some of the older stuff.

Your next question comes from Stephen Hudson with Macquarie Securities.

Just a couple from me. The Reserve Bank dashboard gave some indication of where your OpEx was traveling for the first quarter, if you in regards to the New Zealand bank. And we saw sort of quite a step-up of about 17%. Can you just talk to that? That is obviously public information. So I just wondered if that was the new sort of run rate for OpEx in the New Zealand bank?

It will reflect the new run rate for the New Zealand bank. One of the key drivers will be the amortization of the core banking system upgrade, which we signaled during the full year announcement, which I believe was about a $6 million per annum increase. We will elaborate more on the action.

Okay. And in terms of -- can you just remind us sort of some of the quirky accounting de-designation of hedging impacts that you talked to as guidance for FY '25?

Again, I'll cover that during the half year, slightly with a -- terms of showing a difference between report and underlying, there will be a small difference because of the de-designation, but that's all we've gone. We're talking maybe $1 million, but we'll cover that during the half year presentation in more detail.

Okay. And then in terms of the 2028 Reserve Bank sort of ultimate total capital ratio requirement for you of 16%. You've talked in the past about a 200 basis point buffer above any TCR requirement. Is that still a sort of a valid buffer to use to calculate your equity track from here?

I think that buffer will reduce as the requirements, be done. So I wouldn't expect we get to 16% in older a 200 basis point buffer at that point, but it's valid for now.

There are no further questions at this time. I'll now hand back to Mr. Dixson for closing remarks.

Thank you again for taking time to join this call. As I hope you'll appreciate, we have sought to provide a comprehensive and detailed explanation of some human expense, why it was needed, how Heartland Bankers responded and how this repositions the bank for the future. Lastly, reminder that Heartland will report on its first half 2025 financial results and provide an NPAT guidance range for FY 2025 on 27 February 2025. We will be able to answer questions about the wider group performance at that time as well as respond to any additional questions related to today's announcement. With that, we'll draw this brief to a close. Thank you all once again.

That does conclude our conference for today. Thank you for participating. You may now disconnect.