Heartland Bank assigned a BBB- rating with stable outlook from Fitch alongside S&P's BBB- 'developing' rating

Fitch Ratings has assigned a BBB- long-term credit rating, its lowest investment grade rating, to Heartland Bank.

The rating comes with a stable outlook, and on the heels of rival Standard & Poor's recently revising the outlook on its BBB- Heartland rating to developing from negative.

Fitch said its rating reflects Heartland's niche business model, strong net interest margin, solid core asset quality, adequate capitalisation given its risks, and improving funding position. Also taken into account were improving prospects for Heartland's cost efficiency and profitability, albeit from a weak position relative to peers, and its exposure to and execution of an exit strategy for its non-core legacy property holdings.

"The weak asset quality performance of Heartland's non-core property assets remains a drag on profitability and capital. A change in strategy to reduce these loans, which totaled NZ$107 million at financial year end 30 June 2013, is likely to support a faster run-off. Provisioning of the portfolio is high, covering a significant proportion of impaired assets. Should further provisioning be needed, Heartland benefits from sound pre-impairment operating profits, providing some absorption capacity. Fitch views the legacy property portfolio as one of the main constraints to a higher rating."

At Heartland's annual meeting on Friday, CEO Jeff Greenslade said net profit after tax for the September quarter was $8.5 million, consistent with June's forecast for annual profit of between $34 million and $37 million for the year to June 30, 2014.

Meanwhile, Fitch also said Heartland's focus on niche banking products and services, where it believes it can achieve a leading market share, allows it to compete effectively against bigger banks.

"It offers motor vehicle finance, invoice and shorter-term asset finance for businesses and livestock for farmers in New Zealand. These are niche products in which Heartland has been able to gain greater market share and price-setting powers. This in turn supports a strong net interest margin relative to peers, providing capacity to absorb potential adverse credit developments in its core loan book. Cost management is an area that could, if improved, support pre-impairment operating profitability further in 2014."

Capitalisation was adequate, Fitch said, and likely to be boosted by the run-off of the higher risk weighted non-core property exposures.

"Funding has improved due to strong deposit growth, providing Heartland with a growing proportion of deposit funding from households," said Fitch.

"However, current liquidity levels are also viewed as a constraint on ratings. Fitch notes Heartland's liquidity position is evolving, with levels of on-balance sheet liquidity (cash and cash equivalents, and high quality liquid assets) increasing during 2013. Fitch places greater weight on these forms of liquidity relative to off-balance sheet sources, such as warehouse facilities. Heartland's small and declining residential mortgage portfolio means contingent liquidity sources are more limited than for peers as the bank is unable to execute material internal securitisations."

'Gaining momentum'

S&P said Heartland was "gaining momentum" in the implementation of its business strategies in areas such as livestock finance, motor vehicle finance, and invoice financing. S&P noted such markets are subject to less direct competition and lower contestability than traditional banking market segments.

"The rating could be raised if Heartland were to successfully further develop its business position in the next six-to-twelve months and economic vulnerabilities were not to worsen," S&P credit analyst Nico DeLange said. "In this scenario, we expect to raise the rating and the outlook would likely be revised to negative to reflect current credit concerns relating to New Zealand’s economic vulnerabilities."

"The rating could be lowered if credit concerns relating to New Zealand’s economic vulnerabilities (including NZ's material dependence on external borrowings, persistent current account deficits, and recent strong growth in house prices) escalated before any upward revision of our business position assessment. In that scenario, we would probably lower the rating and revise the outlook to positive, reflecting the trend of Heartland’s strengthening business profile," DeLange added.

See credit ratings explained here.