Heartland boss says constraints on reverse equity mortgages in NZ have been supply driven not demand driven

By Gareth Vaughan

Reverse equity mortgages offer a better investment alternative for asset rich but cash poor retirees than finance company debentures, according to Heartland Bank CEO Jeff Greenslade who hopes to "breathe new life" into the reverse equity mortgage market.

Heartland announced a deal on Friday to buy Sentinel in New Zealand and the Australian Seniors Finance business for NZ$87 million from the Quadrant Private Equity controlled Seniors Money International (SMI). The deal sees SMI shareholders taking about a 9% stake in Heartland. Greenslade told interest.co.nz he hoped Heartland’s push into reverse equity mortgages will see it do about $90 million worth of new lending a year.

Greenslade suggested reverse equity mortgages could be a better investment option for asset rich but cashflow poor retirees than finance company debentures.

"In the past some of these people have been enticed into investing in finance company debentures to try and supplement their income and we all know how that worked out for them. So we see that as better alternative for them, in terms of how they manage their financial planning," said Greenslade.

The other side of the equation is where they wish to live, their lifestyle choices. A lot of people would like to age in their (own) home, and this gives people the ability to stay in their family home longer than they may otherwise be able to."

Reverse equity mortgages enable asset rich but cash poor home owners to borrow money against part of the equity they have in their home. An Auckland District Law Society paper, issued in 2007, concluded unless the borrower is over 70 years old and intends to borrow only a small proportion of their equity, they should be very circumspect about entering into such a mortgage.

'A long-term property view'

Greenslade acknowledges reverse equity mortgages are complex.

"You are taking a risk on long-term property prices and how they interact with long-term interest rates, and how they work in combination with life expectancy, which dictates how long you’re going to be in the house or lifestyle choices. Because a lot of people, for example if you look at the States, people repay the loan because they move out into the next stage of their occupancy into a smaller unit or into some form of care."

"All those factors combined dictate the underlying risk behind a reverse mortgage," said Greenslade.

"What it means is the property risk is one component, and it’s a long-term property view, which is a much more even index to be concerned about rather than short-term property variation."

Greenslade said Heartland aims to breathe new life into SMI given it has been limited to top up loans for existing customers since suspending writing new business in October 2012. The suspension was due to a lack of funding after ASB's parent Commonwealth Bank of Australia (CBA) stopped providing funding for new business.

Reverse equity mortgages have struggled to take off in New Zealand, especially since the global financial crisis (GFC). Among other banks SBS Bank and ASB offer them.

'Constrained by supply not demand'

Greenslade told interest.co.nz the constraints on reverse equity mortgages have been supply driven not demand driven.

“The participants who have been there were all adversely affected by the GFC for various reasons. So the growth of new business just slumped following the GFC as liquidity dried up,” Greenslade said.

“But if you look at how much Sentinel was doing prior to the GFC, they were getting close to $100 million a year, $90 million a year on average.”

“Now from where I sit any business that can generate $90 million of new lending per year is a very attractive proposition. But I’m also confident that if this for the first time gets some sponsorship and reliable continuity of funding, we expect to be able to grow this business very well in the future,” Greenslade said.

New lending of $90 million a year was something Heartland “must be aspiring to,” he added.

“Because that’s what they (Sentinel) did prior to the GFC and the only thing that changed was the tap went off. As far as we can see there was nothing on the demand side to suggest that the product failed for that reason. It was simply lack of liquidity.”

Aussie business held through a subsidiary

In terms of the Australian business being bought, Greenslade said this would be held by a wholly owned subsidiary outside Heartland itself, funded by CBA. Heartland doesn't plan to offer any other financial services in Australia. Nonetheless Greenslade said Heartland has no intention of selling Australian Seniors Finance and wants to grow that business, working through existing SMI relationships, building societies and small banks.

Heartland, which obtained its banking registration from the Reserve Bank in December 2012, keeps its regulator fully informed on everything it's doing, Greenslade added, but "what we’re doing doesn’t trigger any approval process."

The bank targets specialist market niches where it believes it can achieve a leading position, rather than going head to head with big banks in the most competitive markets such as residential mortgages.

Credit rating agency Fitch said the Heartland acquisition would not impact its BBB- credit rating, which has a stable outlook.

"As most of New Zealand's population holds its wealth and future pension in property, Fitch believes there is reasonable potential for further growth. Potential risks are mostly, but not exclusively, of an operational nature," Fitch said. "Heartland has put in place tight guidelines to limit these risks and protect its reputation. Fairly strict loan-to-value ratio (LVR) limits should protect Heartland from any potential house price corrections. However, longer life expectancy could create repayment pressure."

"As the transfer will take place over time, the impact on Heartland's capital should be manageable, and Fitch expects Heartland will improve its retained earnings. The loan book is well seasoned and diversified, with Sentinel's average LVR standing at 32.7% in December 2013. The Australian Home Equity Release mortgage book will remain on Heartland's balance sheet, funded exclusively by Commonwealth Bank of Australia's funding arrangements," Fitch added.

Standard & Poor's affirmed its BBB- Heartland rating with a developing outlook.

Reinsurance remission

SMI recorded a $65.7 million profit after tax in the year to March 31, 2013, up from a loss of $73.5 million the previous year when it was hit by a $78.5 million impairment charge on goodwill stemming from its acquisition of Australian Seniors Finance in 2007. The 2013 profit was bolstered by a $63.2 million debt remission (or release) following the termination of reinsurance treaties and settlement of reinsurance debt with Hannover RE. This involved a payment of $8.1 million, funded through a CBA loan.

Heartland has also established a specialist team for strategic growth, new product assessment and development. It's headed up by Michael Jonas, the bank's recently appointed head of strategic and product development. This team of four will "evaluate and progress acquisition opportunities, and evaluate, design and embed new products." Potential acquisitions are measured primarily with reference to return on equity and earnings per share accretion, Heartland says.

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