Standard and Poor's lowers outlook on Heartland's credit rating to negative citing asset quality and earnings profile

Standard & Poor's has affirmed its BBB- credit rating on Heartland Building Society, but lowered its outlook to "negative" from "stable" saying the wannabe bank's asset quality and earnings profile aren't consistent with the current rating and are weaker compared with other similarly rated peers

Heartland Building Society, a subsidiary of Heartland New Zealand which was created through January's merger of Marac Finance, CBS Canterbury and Southern Cross Building Society, said the affirmation of S&P's lowest investment grade rating provides the group with certainty to proceed with its application to the Reserve Bank for bank registration, as well as its proposed acquisition of between NZ$400 million and NZ$430 million worth of rural lender PGG Wrightson Finance's good loans.

However, in lowering its outlook on Heartland, which has deposits covered by the extended Crown retail deposit guarantee scheme until December 31, S&P raised concerns about "headwinds" in the commercial property market and general operating environment.

"The outlook revision recognises our view that Heartland's asset quality and earnings profile are not consistent with the current rating, and are weaker compared to other similarly rated peers," S&P said.

"The outlook revision reflects the slower-than-anticipated stabilisation and improvement in Heartland's key asset quality indicators and earnings profile, which are assessed as being weaknesses to the current 'BBB-/A-3' issuer credit rating." See S&P's report here.

"Headwinds in the commercial property market and the general operating environment have contributed to our view that it will now take longer for Heartland to restore its asset quality and earnings profiles to levels supportive of the rating and comparable to other, similarly rated, peers."

The credit rating agency, which made global headlines last weekend when it downgraded the United States' sovereign rating to AA+ from AAA, said Heartland's ratings could be lowered if asset quality metrics were to deteriorate further, and if the deterioration caused an adjustment in S&P's overall view of the group's credit profile, or if it were unable to improve key asset-quality metrics and achieve core earnings consistent with its current rating over the next 12 months.

"(And) the rating outlook could return to stable if Heartland were successful in managing down its nonperforming asset level and improve core earnings to a sustainable level more supportive of current ratings," said S&P.

Heartland said an improvement in its earnings and the managing down of its exposure to its legacy property development book were areas of current management focus.

"In particular, earnings have been forecast to improve by FY2012 based on core business and the reduction of one-offs relating to merger activities. Additionally, strategies are in place to accelerate the exit of exposures to property development. Furthermore, the performance of loans in Heartland’s core activities remains strong," Heartland said.

Heartland is due to report its June year financial results on Friday, August 19, and has forecast net profit after tax of between NZ$6 million and NZ$8 million. That's well down on a pro-forma figure provided in merger documents from the previous year of NZ$11.37 million with Heartland attributing much of the drop to one-off costs. The building society is predicting net profit will surge to between NZ$20 million and NZ$24 million in the June 2012 year.

Meanwhile, earlier this week Heartland said nearly half its NZ$1.6 billion worth of retail deposits still carry the Crown guarantee that's due to expire on December 31.  It said its retail deposit reinvestment rate during July was 75% with about 90% of new deposits and roughly 80% of reinvestments during July either non-guaranteed, or for a term extending out beyond the expiry of the Crown guarantee. Heartland also said it had liquidity of about NZ$650 million.

Heartland said its annual results would include "adequate provisioning" of its property development book and "substantial" one-off costs associated with the merger, plus investment in both new infrastructure aimed at meeting bank standards and expansion in distribution channels designed to bolster growth.

"The confirmation by S&P of the investment grade rating underpins the strength of Heartland. The change in outlook does not imply any deterioration in underlying risk but, rather, reflects the rating agency’s desire to see faster improvement in earnings and exit of the legacy property development book," Heartland said.