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Edited Transcript of HGH.NZ earnings conference call or presentation 16-Sep-20 10:30pm GMT

Full Year 2020 Heartland Group Holdings Ltd Earnings Call

Sep 17, 2020 (Thomson StreetEvents) -- Edited Transcript of Heartland Group Holdings Ltd earnings conference call or presentation Wednesday, September 16, 2020 at 10:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Andrew Dixson

Heartland Group Holdings Limited - CFO

* Chris Flood

Heartland Group Holdings Limited - CEO of Heartland Bank

* Jeffrey Kenneth Greenslade

Heartland Group Holdings Limited - CEO & Non-Independent Executive Director

* Michael Drumm

Heartland Group Holdings Limited - Chief Legal & Bank Risk Officer

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Conference Call Participants

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* Jeremy Kincaid

UBS Investment Bank, Research Division - Associate Analyst

* Stephen Hudson

Macquarie Research - Head of Research

* Wade Gardiner

Craigs Investment Partners Limited, Research Division - Senior Research Analyst

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Presentation

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Operator [1]

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Good morning, everyone, and welcome to the Heartland Group Annual Results Call 2020. (Operator Instructions) I would like to turn the conference over now to Jeff Greenslade. Please go ahead.

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Jeffrey Kenneth Greenslade, Heartland Group Holdings Limited - CEO & Non-Independent Executive Director [2]

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(foreign language) Good morning. (foreign language) Welcome to everyone joining us today. (foreign language) I wish to acknowledge Maori Week and the importance of strengthening the Maori language. This announcement comes to you in very challenging and unprecedented times with COVID, and I'd like also to start with an (foreign language), the people of Heartland who responded extremely well and effectively to the COVID challenges. (foreign language) I am Jeff Greenslade, the Chief Executive of Heartland, and I welcome you all here today.

I am joined by other people who will speak during the course of the presentation: Chris Flood, the Heartland Bank Chief Executive; Andrew Dixson, the Group Chief Financial Officer; and Michael Drumm, who is the Bank Chief Risk Officer and General Counsel. So I'll kick off an introduction starting on Page 4 of the presentation. And I'll just mention some of the financial performance highlights before moving on to some strategic highlights, and I'll also talk about COVID before we dive down more deeply into the financial results with Andrew.

So as you can see from the results there, we achieved -- net profit after tax was $72 million, which was after a taking of an economic overlay in response to the uncertainties facing us or the future around COVID. Michael Drumm will address that in more detail soon, explaining how we arrived at that estimate and what it means. If you strip that away and look at underlying results, we were almost at $79 million, which was a 7.2% increase on previous year at the top end of the range that was indicated. What we saw during the course of the year is good growth in balance sheet, 5% in a difficult market, particularly a market that slowed during the second half of the year for the obvious reasons of the COVID lockdowns, and drove a net operating income growth of 13% to $235 million.

Andrew will go into more detail around some of the numbers, but a few things I'd like to highlight. There was good momentum in earnings, particularly still in the second half despite the slowing down in terms of growth with COVID. We did still see top line growth of around about 5% coming through the top line. The cost-to-income ratio in an underlying sense is sitting around that mid-40%, which compares very favorably generally but also particularly against other New Zealand-owned banks. And it's probably more elevated levels than we would normally expect to see given the investment that we've made in growth that we talked about the last time and also some of the additional costs that have come through in responding to COVID.

The final thing I'd like to pull out is impairments. Obviously, we have this extraordinary overlay, which is in response to the situation that -- circumstances that COVID presents so that on the face of it have seen total impairments increase from just under 0.5% to 0.65%. But in an underlying sense, what is very pleasing to see is that impairments went down from 0.49% to 0.44%.

Moving on to the next page, some of the strategic highlights. Firstly, I'd like to talk about the great strides forward we have been making in terms of our digitalization of our business. It's something I cannot emphasize enough the importance that, that is giving us in terms of extending our reach particularly through the development of our app, which will continue on in the next years. It is giving us virtual branches everywhere we need to be, giving us more reach at lower costs, lower onboarding cost and lower cost to serve. So the platform we are building and we'll continue to invest in is giving us a great opportunity in the future.

The second thing I'd like to highlight is that during this process in Australia and New Zealand during the environment, the onset of COVID and the consequent downturns in economic conditions, the rating agencies reviewed all of the banks. And in doing so, there are only 2 Australasian banks that were not given some kind of adverse rating or outlook. Heartland was one. I don't know who the other one was, but they must be pretty good. But it was a remarkable achievement to be only 1 of 2 banks that were not re-rated or had their outlook changed during this process. And it reflects the resilience of our book, and we'll talk a bit about that in a moment. And more particularly, something that we're focused very strongly on is ensuring that we have a strong, profitable base, and it was pleasing to see that recognized.

We have, I guess, increasingly demonstrated a differentiated model. It's one of the highlights of the year. And again, that is showing through -- particularly areas like reverse mortgages and rural, which have no direct impact from the COVID environment and carried along business as usual. We've also, during the COVID response, been able to utilize our digital capability to use remote onboarding very effectively. So we're able to continue our motor business during the lockdowns and differentiated ourselves as being one of the few being able to do that. We've also been working very hard in terms of funding some of the more interesting aspects of our book, being the reverse mortgages. And we were very pleased recently to announce a world's first Australian dollar, Australian reverse mortgage securitization with a 30-year final term. The ability to match-fund our reverse mortgages is something that is extraordinarily useful to us in terms of providing guaranteed tenure of our funding and also opening up a much deeper pool -- a broader pool of funding out of the U.K. and, ultimately we hope, the United States.

From a shareholders' perspective, we continue to see growth in underlying ROE, went up to 11.4%. If you strip out the impact of the overlay, it's 10.5%, but that underlying growth in ROE is something we're very pleased about. And that and other factors has flown through to our ability to pay a dividend, $0.025 per share of final dividend, giving a total dividend of $0.07 per year and at current share price, a different yield of more than -- just over 8%.

Moving back just to COVID just to sort of give some color around how we address that, what we had to deal with and what it means. The lockdown -- the initial knockdown was an enormous challenge for everybody, including the financial industries where we were classified as essential services. It's that we were able to -- indeed, from a customer service point of view, required to continue to work through at the same time as ensuring that all of our staff, 480-odd, could be capable of working from home. I was absolutely amazed at the hard work and ingenuity that was brought into play by our team. Within the first week, we had everybody ready to work from home. At the same time, we were inundated with calls from our customers, quite understandably, the uncertainty flowing through to concerns around what was happening with their loans, what was going to be happening in terms of repayments and so forth. Our staff did a fantastic job, where we rallied around that challenge and manning phones right throughout the country irrespective of job descriptions just to get on the phones, either picking up the phone or outbound calling to give our customers the reassurance that they needed that we were open for business and we were able to support them.

During this process, we offered a number of our customers support and in the consumer space mainly made up of motor with $143 million of loans that took up that offers of support, which was predominantly a payment holiday. In the SME business space, we had about just over $500 million taking up those offers of support. What I'm pleased to report is that as of the 27th of August 2020, 96% of the consumer loans and 98% of the SME and business loans are back on some form of usual or pre-COVID type of payment. So that really does reflect the resilience of our customer base. And also, when it comes to, say, for example, the SME customers that we have, the effectiveness of the measures that the government put in place, particularly the IRD loan that was put in place for small businesses, was extraordinarily effective in giving a lifeline to small businesses and the confidence to continue on in their business, similarly the way subsidies has had a major beneficial impact on both SMEs but also consumers directly that they have had money to be able to service their debt. And in terms of the expiry of the wage subsidies, what we are seeing is that unemployment is impacting disproportionately on the 15 to 24 year olds, where we have very, very, very small levels of exposure both in our own portfolios and indirectly through Harmoney.

So what we're seeing is very strong resilience from our customer base. We're seeing -- interestingly, whilst motor in the -- Chris will talk about this soon, in the second half rose about $164 million of new loans, we had about $164 million of loans repaid. Anecdotally, what we are hearing is a lot of our customers are using the payment holidays on their mortgage to redirect their debt servicing ability into other loans. So those loans are being repaid. So as Chris will talk about in a moment, he's got his work cut out, and he's pretty confident we'll be able to continue to grow, but we are seeing repayments, which are the reasons that's making Michael Drumm very happy in terms of the quality of the book.

We are also participating in the New Zealand government's Business Finance Guarantee Scheme. Chris, we've written how many loans in there?

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Chris Flood, Heartland Group Holdings Limited - CEO of Heartland Bank [3]

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We've done $8 million with exposures written so far, but we've got about 22 in the pipeline.

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Jeffrey Kenneth Greenslade, Heartland Group Holdings Limited - CEO & Non-Independent Executive Director [4]

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22 in the pipeline. It doesn't sound like a lot, but that's actually a disproportionate share of the total being done within the banking industry. We are also offering that product to noncustomers as well. So other banks' customers, whom we'll be advertising, come to us. We've got an online platform where we can process your Business Finance Guarantee Scheme loans very, very quickly.

We've also developed a new product as a result of the COVID environment. We've seen that there's an opportunity to recast a product, which has the amortization profile which is tailored to the specific needs of a customer rather than being on a one-size-fits-all amortization program. We have a thing called Heartland Extend, which allows customers with lumpier cash flows to match their amortization to the needs of their business. So we see -- the first stage of this COVID response was making sure our existing customer base was supported. We're now moving on, seeing opportunities to grow and offer more innovative services through our digital platforms and through our products.

All right. So I'll hand over now to Andrew Dixson, the Chief Financial Officer, who will take us through the financial results.

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Andrew Dixson, Heartland Group Holdings Limited - CFO [5]

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Thanks, Jeff. So I'm on Slide 8, which bridges our reported profit year-on-year. Net interest income increased $22.4 million, and this was a result of maintaining a strong interest -- net interest margin, which was consistent with the prior year at 4.33%, as well as growth in receivables of $215 million, which is covered on the next slide. Other operating income increased $5 million, and this is primarily due to the impact of the change in accounting for reverse mortgage fee income following the adoption of IFRS9. The increase reflects the full recognition in the current year of unamortized income on existing reverse mortgages as well as on new origination.

Impairment expense, excluding the economic overlay that's been mentioned and will be covered later in relation to COVID, increased $0.9 million, which resulted in an impairment ratio of 0.44%, which was a reduction from the prior year, which was 0.49%. The reduction reflects the receivables growth profile for the current year, which again will be covered on the next slide, in particular the continued strong growth in our reverse mortgage portfolios, we. Had limited growth in our personal loan portfolios and saw a continued reduction in large exposures in our business relationship and rural relationship portfolios. Operating expenses increased $21 million and took the cost-to-income ratio to 45.4%. The increase reflects a year of investment for Heartland and its people and its technology and also building product awareness. There was a $7.3 million increase in personnel expenses, which followed an increase in head count of 53 people, with that resource assisting both our continued growth but also to support customer support related to our response to COVID-19. There was a $3.4 million increase in marketing expenses. We continue to build our brand and awareness of our product set, particularly reverse mortgages. There was also a corresponding $6.2 million increase in customer acquisition costs related to the previously mentioned accounting change for the treatment of reverse mortgage origination expenses.

We also, as Jeff mentioned, have taken a COVID overlay, which will be covered later by Michael, which had a $6.9 million impact on net profit after tax. Pleasingly, adjusted NPAT, which removes the impact, was $78.9 million, which was an increase of $5.3 million or 7.2%.

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Jeffrey Kenneth Greenslade, Heartland Group Holdings Limited - CEO & Non-Independent Executive Director [6]

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I'm sorry. The next page is the growth of receivables. So as you can see, there's a waterfall chart, taking us from where we ended up last year until we ended. And just probably the key things to draw out is a similar picture of the previous years, where we're seeing growth in those core areas, particularly in Australia, and it's something we find very compelling about Australia. It's that for the same effort, you get roughly twice or 3x the growth. So we'll talk a bit about that in a moment. Good growth across all those core activities, to some extent reflecting a slower second half, all the obvious reasons. And the other thing to draw out there is that the same picture, as last time, those noncore areas, business relationship and rural relationship, declining. So underlying growth, good, slightly impacted by the second half. The underlying growth in terms of its mix is in line with strategy.

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Andrew Dixson, Heartland Group Holdings Limited - CFO [7]

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So covering the key performance measures, which I've talked through previously. Net interest margin, again, was strong, consistent with the prior year at 4.33%. The cost-to-income ratio has increased due to the previously mentioned investment in people, technology and awareness as well as the impact of the reverse mortgage accounting change. Nonperforming loans are elevated comparably to the prior year, which is a result, to some degree, of COVID but not materially. And it's important to note that NPLs have reduced subsequently to year-end. The reported impairment expense ratio of 0.65% does include the impact of that COVID overlay. And stripping that out, the ratio is 0.44%, which is down from 0.49% in the prior year.

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Jeffrey Kenneth Greenslade, Heartland Group Holdings Limited - CEO & Non-Independent Executive Director [8]

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Okay. Thank you, Andrew. Just turning now to shareholder return. We've touched on most of these metrics in terms of ROE and earnings per share coming through both in an underlying sense and in the -- of the application of an economic overlay. So just referring again to the dividend, something that we're very pleased to be able to pay in the current environment, noting that currently, the Reserve Bank of New Zealand has restricted dividends by banks. So that's applying to all banks, including ourselves. But reflecting the diversity of our structure and our group, we are able to continue to pay a dividend, reflecting [Heartland sales] thanks to the success of our business in Australia.

All right. So we have talked about this economic overlay a number of times. It's something that the banks in New Zealand have been announcing and will continue to announce. It's an unusual mechanism that's required from -- applied in accounting circumstances where the environment is not adequately contemplated by conventional models or by other ways of assessing the potential for losses. Michael Drumm, our Chief Risk Officer, will take us through this. The overlay itself was applied only to the banks. So it's only been applied within the bank, and Michael can explain the process we went through in terms of assessing its necessity.

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Michael Drumm, Heartland Group Holdings Limited - Chief Legal & Bank Risk Officer [9]

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Thanks, Jeff. So excluding the overlay, which I'll talk to separately shortly, impairment expenses, which had -- as a percentage of gross receivables, has reduced year-on-year from 49 basis points to 44. This is a result of an increase in credit quality and improvements in the collection process, which we've dedicated a significant resource to. So those things together mean that fewer loans have rolled through to stages 2 and 3, and more of those that have rolled through to stages 2 and 3 have subsequently been remedied. Of course, the main focus from a provisioning perspective has been on the overlay.

So coming in terms of into COVID, I think we were very comfortable with the quality of our book and very comfortable with our provision position, and that strength or Heartland strength more broadly was recognized by Fitch when our rating was affirmed in May in the midst of COVID. So after COVID hit, we attempted contact with nearly all of our business borrowers with an exposure of more than $20,000 and all of our consumer borrowers to offer whatever assistance we could. That resulted in around about $510 million worth of our business customers going into an initial variation and around $140 million of consumer customers going into an initial variation. And these were payment holidays, interest-only periods and other payment arrangements.

Subsequent to the initial period, we developed a product, Heartland Extend, which enables a flexibility of payments. We developed that to help customers that we [thought on and helped] in the future, in addition to offering the product more broadly. What we've seen, when our customers have come off those original variations, is that the bulk of them are going back into normal payment activity, fewer than we expected going into and feel the need for Heartland Extend or other types of support. That's inevitably a result of a number of things, including the extensive government support packages that have been offered during COVID.

We remain in contact with our business customers. We have been in contact with them a number of times and currently going through a process to determine or to help them ensure that they're on the best medium to long-term plan or product that they can be on at the moment. But we did see an elevation of arrears and also NPLs during COVID. We are seeing that reduced now, which is obviously pleasing. And we're comfortable with the position of credit quality of bulk and provision levels. However, we are very conscious that there are many moving parts. The economic conditions remain difficult to forecast, and there's a lot of uncertainty around what we're going to see in the future. So what we did is a modeling exercise to look at what our expected credit loss could be in the future, and we adopted 3 methodologies.

Our first methodology looked at the customers that we had provided initial support to and applied increased notional provisions to those customers to provide us with a range. The second methodology looked at our GFC loss experience on the motor book and extrapolated the increase in losses across the effective parts of our books. And the third methodology looked at establishing a correlation based on industry data between macroeconomic factors and loss rates and using that correlation and applying it to what we expect to see in terms of macroeconomic conditions going forward and providing us with some expected loss ranges. So based on those 3 methodologies, we had a range of between 4 -- approximately $4 million and $12 million, and we decided to take an overlay of $9.6 million. I think it's important also to note that we took the time to think about this. We took the time to ensure that we had as much information around economic conditions and around credit performance of our book and all of our books and made that decision taking into account that information. We expect to need to review the overlay in time, and that may change depending on economic conditions and performance of the book but we're comfortable where we are right now.

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Jeffrey Kenneth Greenslade, Heartland Group Holdings Limited - CEO & Non-Independent Executive Director [10]

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Thank you, Michael. We're now going to move to the divisional summaries. I will start with Australia before I hand over to Chris about -- the Bank Chief Executive to talk about the New Zealand operations.

So Australia, really a story mostly about the reverse mortgages there, and we start -- and we're continuing to see high levels of growth at 18%, moved up to $958 million, probably slightly less than what we expected. There has been some slowdown. We're talking of a high base of growth. That 18% may have been more like a 20-odd percent if not for COVID, and really that's a reflection not of demand for the product, just the logistics given the types of lockdowns in various states, particularly in Victoria, where it's just physically very hard to execute a reverse mortgage and meet the sort of compliance standards, the transparency and education that needs to go along with offering a reverse mortgage. But we have still performed very well. And indeed, we have transported some of our digital technology to Melbourne, in particular, in order for our customers to be able to do a lot of their processing remotely. So that's very pleasing, and we see that will continue to grow. We are the largest active player in Australia. You may recall from the last time we spoke, the major players had pulled out. So we are the largest. There are some smaller players in the market, but we are growing market share continuously now at 26%.

Prior to the COVID outbreak, we were looking to expand our Open for Business digital platform into Australia. That went into hibernation during the lockdown periods, but we are looking to reboot that. And we continue to support our partners in Australia, being Spotcap in the SME space and Harmoney in the consumer space. As I mentioned earlier, Andrew Dixson and his team have done fantastic work in terms of both expanding the existing pool of funding within Australia. There has been a large, quite considerably, but also now having opened up this rich theme of long-dated debt coming out of offshore markets. So we are very well placed to grow for the future in Australia. Chris?

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Chris Flood, Heartland Group Holdings Limited - CEO of Heartland Bank [11]

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Thanks, Jeff. New Zealand reverse mortgage growth of 10% are a little more modest than Australia. That doesn't benefit from the large broker portal but large number of brokers that are active in that market in New Zealand. So 10%, it's all generated directly and was a pleasing result, noting the modest levels of activities in April and May during the lockdown both in terms of application and inquiry levels. Pleasingly, borrower behavior has returned post-lockdown and pipelines have rebuilt. Inquiry levels are increasing week-on-week. And you'll see how the advertising on TV, marketing the product throughout the year and improving awareness remains a significant opportunity for us here in New Zealand. We do expect an improved performance in the year ahead, noting that the safety of being able to retire in your own home remains a significant -- well, remains an attractive proposition for many people for safety reasons in a COVID environment. And this is a high-quality book with an average loan-to-value, LVR, of just 24%. And noting the business has originated in the June '20 year at an average LVR of just 10%.

So turning now to Open for Business. And really, this was an outstanding result given growth was achieved pre-COVID. And in fact, we operated also in the April through June period. And there are a number of reasons for that runoff. Firstly, repayments, as Michael noted, remained very close to schedule. The IRD loans provided an opportunity for businesses to retire higher-yielding debts and replace it with interest-free debt. And also, lower mortgage interest rates also pulled a few loans out early as they secured them against their property. The Heartland Extend product Jeff has spoken to and the Business Finance Guarantee Scheme will afford support for our existing customers in this portfolio and presents an opportunity for new-to-bank relationships. We expect solid growth as a consequence in the year ahead, noting the advantages afforded borrowers by an end-to-end digital platform. They're able to access a solution via the mobile phone they carry around in their pockets. And that solution extends to include our Heartland Extend product and BFGS.

Turning now to Business Intermediated. And that was another strong performance for the division. Assets grew 17%, mostly weighted to the first half of the year, although we did grow throughout the year and now stand at about $0.5 billion. The strategy is underpinned by strong relationships with partners mainly -- in mainly truck, trailers and plant and equipment. And it's a highly scalable model. It places our staff at or near point of sale, so discussing with a potential borrower right at the point he knows exactly what it is he's buying and what he needs. And the scalability is sort of most noted by, if you can, [here saying] where the book is now to -- back in 2016 when it was something like $180 million, we have about 20% less sales staff as our partners have become more adept at selling the product directly. Pleasingly, pipelines are solid and building. We're growing. We expect that rate of growth to accelerate. The division will benefit from the digital investment Jeff and Andrew spoke to earlier, and we expect a very, very solid performance in the year ahead.

Turning now to motor. And this part of the presentation, I'm typically calling out another great year of double-digit growth for motor, but the March-April lockdown and, in fact, a tougher first half in terms of number of motor vehicle sales really put -- [paid that]. I think a climate of uncertainty sort of also dampened some consumer appetite for debt, and we saw a high degree of early repayment as borrowers replaced high-yielding motor debt with mortgage debt. So when you compare year-on-year, so the year ending June '20 to year ending June '19, vehicle sales were about something like 14%. So in that context, 3% growth was a solid result in what was a tough market and represented market share gains that we're very pleased about and I actually spoke to you at this time last year. We started the year strongly with a record volume recorded in July and growth in August, notwithstanding a Level 3 lockdown, and we expect strong double-digit growth in the year ahead, a return to normal.

Talking now about Harmoney and other personal lending. Receivables growth in those portfolios was more modest and all pre-COVID. A dampened consumer demand discussed earlier and tighter risk settings and repayment flows remaining very close to scheduling receivables, in fact, contracted in the second half. Pleasingly, like Heartland's experiences, borrowers coming off payment holidays are mostly returning to scheduled repayments. Impairments were higher but, I'd stress, within budget. And notwithstanding the tighter risk settings noted earlier, we do expect second half growth in these ledgers.

Turning now to livestock finance and agreement. COVID largely did not impact livestock. It had a slight impact in terms of some processing capacity and transportation issues. But what COVID didn't do, the drought did. So we had a relatively tough year this year. As always, receivables is not a great way to measure the performance of this business because we have assets on the box anywhere between 90 days for lands through to 18 months or 2 years for cattle. So we focus on the increase in net operating income at 12%. That was very pleasing. The team have been busy in what is the off-season, establishing new agent relationships to broaden our footprint and contacting farmers so as to understand what their needs are in the year ahead. And at this early point of the season, we have approved limits of around $190 million for the year ahead.

Turning now to relationship. The reductions this year principally came about as a product of either commercial property sales or rural farm sales. The rank competition noted in early years has largely abated, and we do anticipate some modest growth in this year -- in the year ahead. But as with Open for Business, the Heartland Extend product and the BFGS scheme will help existing and new-to-bank borrowers not only weather the impacts and the uncertainty created by COVID but be in a position to optimize business opportunities as they emerge. And of course, they can do all -- realize all that by applying for a loan on their mobile phones. As with other portfolios, repayments were very much in line with the expectations.

I'll pass over to you, Andrew.

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Andrew Dixson, Heartland Group Holdings Limited - CFO [12]

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Thanks, Chris. So Slide 22, funding. So the group has continued to successfully grow and diversify its funding base. And we're very well positioned for the future growth opportunity before us.

In New Zealand, Heartland grew deposits $110.5 million (sic) [$100.5 million] and it continues to offer its customers market-leading products and deposit rates comparative to its peers despite the low interest rate environment. This was recognized again with Heartland being named as Canstar Savings Bank of the Year 2020, which is the third year in a row that, that has occurred. Deposit growth was also assisted by Heartland being the only bank to offer digital end-to-end deposit offering, either online and via its mobile app, which enables existing and new customers to take out a deposit very simply and efficiently, which has increased more increasingly important in these times through contactless means. Heartland has also shifted its wholesale funding away from short-term, uncommitted sources in favor of long-term, committed sources. And that -- and doing that has increased its motor vehicle loan securitization warehouse from $150 million to $300 million.

In Australia, it's been a very busy year, executing on our strategic funding plan to support the continued growth that, that business is experiencing. We completed a new $250 million reverse mortgage-backed securitization warehouse with a major financial institution. We also issued $100 million of medium-term notes to a financial institution. And most pleasingly, as Jeff has mentioned prior and as announced on Tuesday, we have just completed an innovative, $142 million, long-term reverse mortgage-backed financing transaction. It's a very exciting transaction for us, and it positions us for accelerated growth while materially reducing our refinancing risk in the business. It is innovative. It is long-dated. It's got a 30-year legal maturity. It was developed in partnership with our arrangers at Macquarie and has attracted significant offshore institutional investors, principally life insurers and pension funds. The significant benefits that this brings, it obviously reduces the asset liability mismatch of the reverse mortgage product given the uncertain cash flows that are inherently in that portfolio. It reduces the refinance risk, as I've mentioned, in terms of our existing warehouse funding, and it positions us well for future growth.

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Jeffrey Kenneth Greenslade, Heartland Group Holdings Limited - CEO & Non-Independent Executive Director [13]

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Thank you, Andrew. So just to move now to a bit of a strategic update. We find ourselves in a relatively fortunate position in the current environment. We have a large part of our book, the rural reverse mortgages, which are un-impacted by COVID, reverse mortgages in particular. The key risk issues are around exit factors for mortality and morbidity, which obviously, that is not an issue for us in terms of COVID. And most particularly, the key drivers of stress, if you like, in the book is the interrelationship between house price inflation and interest rates. And so far, we've seen in both Australia and New Zealand that housing prices have held up and interest rates have come down, which is a positive delta in terms of that book. So a large part of our book at the moment is -- it is sitting well. The areas which one would expect to be some degree of variability, which is the small business and consumer for the reasons we've discussed, have shown a great deal of resilience. And against that, we have around $60 million of unutilized collective provisions available for us. As Andrew mentioned, funding is very strong. So increasingly, we see ourselves turning towards the future in terms of the opportunities that are in front of us rather than the challenges. And so we talked about some of the opportunities that we wish to look at, and these -- unnecessarily new that they've been highlighted by the COVID environment, the same opportunities that we saw pre-COVID coming out of regulatory activity and disruption.

So in terms of New Zealand, we have developed a very low-cost model, which is differentiated from others. Throughout digitalization, we can distribute, process, onboard. All of those things which are very expensive to do around marketing and servicing are things where we see there are pathways to bring those costs down through greater digitalization. And in the first instance, that's giving us more reach. The virtual branch is what we call it. We see sense in looking to spread this low-cost model more broadly, obviously through growth but also amongst other industry participants at a time when the industry itself is facing the need for increased investment to face the demands of technology and compliance. Obviously, being a listed company, our model also provides greater or easier access to capital. So we think our model is reaching a point where it is something that we should consider in terms of how we extend it through consolidation within the use in the market. So it's something that we are going to explore.

In Australia, we wish to extend the reverse mortgage both through funding, organic funding. We're also very interested in looking at acquisitions of books there to the extent they are available, as I said earlier, to extend the categories that we have into that SME consumer space. And we think our timing is quite good to be coming in fresh with a clean book as the post-COVID environment becomes clearer.

As I discussed, underpinning everything we do is this unrelenting focus on digitalization. We really see the future is around the mobile phone or whatever the mobile phone evolves into. It is the most preferred mechanism for all demographics other than baby boomers, hence the fastest-growing mechanism or medium for that segment as well.

At the same time, the Board has asked management to consider. We -- Heartland is positioned at the moment in a market sense, noting that the market value for Heartland does raise questions versus the potential value of its component parts. And we will be looking at solutions to that, whether it's around some structural solutions or some -- better or increased messaging, so something that is -- will be considered, all possibilities but nothing yet has been predetermined.

Moving now to something which is again very core, that's what we do, which is around our customers and our culture, which underpins everything we're doing, is our values, our matapono. And I'm really delighted to be able to report some of the progress we've made in terms of demonstrating those values in our communities, the importance of mahi tika, of doing the right thing; mahi toa, of being bold; mahi tipu, of always evolving and working together. So what we've seen is we were a finalist in the diversity awards, the cultural celebration last night. I was there. Unfortunately, I think we came second. We didn't win it, the category, but it was [recommended] by everybody to get us in, in the first place. We have -- are now a Living Wage Employer. We're really pleased to be able to report that we have 50 Maori and Pasifika students participating in our Manawa Ako internship, which has been a fantastic source of very bright, talented, young men and women and who are also teaching us a lot about our organization that bring a lot of [mana] to Heartland. During this period of COVID, I just want to make it very clear, we have been employing people. We've been growing our head count both in response to the needs of our customers but also the fact that we are seeing ourselves growing in the future. And as Andrew mentioned, we have picked up a number of awards in terms of how we are servicing our deposit customers and our reverse mortgage customers in particular.

No presentation on banking group will be complete without a regulatory sort of update. So Michael, I'll pass over to you to give us just the -- what's happening in that area.

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Michael Drumm, Heartland Group Holdings Limited - Chief Legal & Bank Risk Officer [14]

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Thanks, Jeff. So look, there have been some delays in the COVID environment in terms of regulatory change agenda. I think it's fair to say that that's picking back up now. And the 2 most significant ones on our radar are what's called the conduct legislation. So what that's going to require of banks is that we have -- as a core part of our business, have the conduct principle that we treat with our customers fairly. We've done obviously a lot of work coming out of the culture and conduct review, which positions us really well for that legislation if and when it comes in, noting that there's some political uncertainty. So we're pretty comfortable with that and obviously support it as well. The other piece of legislation that's under review is the Reserve Bank of New Zealand Act. Submissions are open on that at the moment. And our interest is primarily in relation to the proposed deposit guarantee scheme design and what exactly would be guaranteed and how much it would cost banks to participate in that scheme. So as I say, that's open to consultation at the moment, and we'll be looking into that in a lot of detail and consulting on it shortly. So those are the 2 most significant regulatory items on the agenda.

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Jeffrey Kenneth Greenslade, Heartland Group Holdings Limited - CEO & Non-Independent Executive Director [15]

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Thank you. So turning now to the last page, Page 27. Much of this has been covered already and I -- obviously, the final thing is just our guidance for FY 2021, where we currently have that in the range between $83 million and $85 million.

So thank you very much for your patience in listening, and now we'll pause and be available for questions. Thank you very much.

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Questions and Answers

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Operator [1]

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(Operator Instructions) We do have phone questions. We'll take our first phone question from Wade Gardiner. Please go ahead.

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Wade Gardiner, Craigs Investment Partners Limited, Research Division - Senior Research Analyst [2]

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Hello? Wade here from Craigs. Can you hear me?

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Jeffrey Kenneth Greenslade, Heartland Group Holdings Limited - CEO & Non-Independent Executive Director [3]

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Yes, we can hear you, Wade. Welcome.

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Wade Gardiner, Craigs Investment Partners Limited, Research Division - Senior Research Analyst [4]

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Look, a few questions from me. First of all, while we're on your guidance for FY '21, can you tell us what the impairment assumptions that you've included in there?

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Andrew Dixson, Heartland Group Holdings Limited - CFO [5]

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It's really a continuation of impairment rates as they're currently playing out. So that's simple as that, the underlying.

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Jeffrey Kenneth Greenslade, Heartland Group Holdings Limited - CEO & Non-Independent Executive Director [6]

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Yes, yes, sort of reasonably flat.

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Wade Gardiner, Craigs Investment Partners Limited, Research Division - Senior Research Analyst [7]

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Okay. So call it, 45 basis point type level?

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Andrew Dixson, Heartland Group Holdings Limited - CFO [8]

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Correct.

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Wade Gardiner, Craigs Investment Partners Limited, Research Division - Senior Research Analyst [9]

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Roughly. Okay. With Heartland Extend, can you tell us what the take-up of that has been in dollar terms?

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Andrew Dixson, Heartland Group Holdings Limited - CFO [10]

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Around about $120 million, Wade. I can get more up-to-date details of that, if you like. Around about $120 million predominantly across the business.

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Jeffrey Kenneth Greenslade, Heartland Group Holdings Limited - CEO & Non-Independent Executive Director [11]

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Yes.

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Andrew Dixson, Heartland Group Holdings Limited - CFO [12]

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So the consumer take-up has been quite a lot lower than expected, last time I looked around about $20 million, $25 million, and the balance in the business was around about $100 million when I last looked.

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Wade Gardiner, Craigs Investment Partners Limited, Research Division - Senior Research Analyst [13]

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Would...

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Jeffrey Kenneth Greenslade, Heartland Group Holdings Limited - CEO & Non-Independent Executive Director [14]

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About 1,600 clients were taken up.

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Wade Gardiner, Craigs Investment Partners Limited, Research Division - Senior Research Analyst [15]

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Right. Given the nature of it, it's something that, I guess -- and I might be wrong here, but from the description that you gave, it's something that -- essentially to help people out through tough times. The nature of it is therefore potentially risky. Would these be loans that -- in the normal course of business if someone came to you and said, "I want a loan. This is my situation," that you would give?

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Jeffrey Kenneth Greenslade, Heartland Group Holdings Limited - CEO & Non-Independent Executive Director [16]

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Yes, very much so...

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Wade Gardiner, Craigs Investment Partners Limited, Research Division - Senior Research Analyst [17]

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It's just -- I just -- I guess the issue I've got here is are you -- by having this product, are you just kicking the can down the road?

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Jeffrey Kenneth Greenslade, Heartland Group Holdings Limited - CEO & Non-Independent Executive Director [18]

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No. The intention is to offer more flexibility to customers because what we have done is taking customers who are required to pay their loans at a very fast pace. So if you compare with the mortgages, a lot of people can just pay interest or they can pay over 20-odd years. In our space, we have had customers -- or in business, they don't pay any principal all. So they have more revolving loans. So yes, the question, we always put ourselves prior to COVID, why are we putting this sort of customer on a rapid repayment regime? And then when COVID came along, we decided to offer that sort of flexibility. So customers are still repaying principal, thus paying it in a more extended form or they can have more flexibility how they would pay it. And where we see this longer term is that -- one of the biggest problems we've got is the short duration of our book. It's that it repays so very, very quickly. So what we're hoping to do is to get more customer loyalty at the same time by giving them more flexibility. So yes, it was borne out of the COVID environment. A lot of customers, the vast majority of customers decided not to take it up. [They were] off of it, but we've got -- what is it, just over 1,600 customers across consumer and small businesses that have taken it up and now then -- were in arrears before they took it up in terms of pre-COVID arrears.

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Chris Flood, Heartland Group Holdings Limited - CEO of Heartland Bank [19]

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I think the other point to make to that, Jeff, is that even though, Wade, there are -- 1,600 customers have taken it up, many have maintained their current payment flow. So they haven't reduced their payment. What we're recognizing is that in an environment that may be -- sort of stutter along that pressure points will come and the sort of product gives that -- it's an easy way for them to have flexibility. Had they come to us directly without it, we would have made the same decision and extended the loan, but it would have been a re-documentation process and more cumbersome.

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Jeffrey Kenneth Greenslade, Heartland Group Holdings Limited - CEO & Non-Independent Executive Director [20]

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And Wade, to the extent that there are some people in here that subsequently go through some stress, whether it's COVID-related or not, we will still see it because they start to pay some principal. And people, when they default, they defaulted a lot. They don't just sort of part pay the principal. So we'll still see those early warning signs coming through. And happy to sort of keep you posted on how that portion of the book performs.

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Wade Gardiner, Craigs Investment Partners Limited, Research Division - Senior Research Analyst [21]

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Okay. Just in terms of the deposits, you said it here on Page 22, deposits grew $100 million in quarter 4. On my estimates, the second half, the deposit book only grew $30 million. So does it mean you saw a decline of $70 million in quarter 3? Am I reading that right?

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Chris Flood, Heartland Group Holdings Limited - CEO of Heartland Bank [22]

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Yes. Wade, it's Chris here. There was a -- when we entered into lockdown, there was sort of larger depositors removed their funds, and we were down in the March month. And that was by -- I think by the middle of May, we had caught that up and actually moved ahead.

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Wade Gardiner, Craigs Investment Partners Limited, Research Division - Senior Research Analyst [23]

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Okay. And what's sort of the first couple of months of FY '21 look like in terms of deposit growth?

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Chris Flood, Heartland Group Holdings Limited - CEO of Heartland Bank [24]

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Well, the deposit growth in first few months have been relatively flat, and that's a product of the amount of liquidity we're carrying. So we're not pushing hard for deposits. We are continuing to get more new depositors. But what we're seeing is a move to smaller deposit holdings from a larger number of customers.

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Jeffrey Kenneth Greenslade, Heartland Group Holdings Limited - CEO & Non-Independent Executive Director [25]

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But Andrew, we have been -- please explain that we have been sitting on quite a lot of liquidity because of a lot of depositors.

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Andrew Dixson, Heartland Group Holdings Limited - CFO [26]

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Yes. Absolutely. So as I mentioned, we have increased the auto warehouse facility, which provides nearly $300 million of effectively undrawn liquidity. And we carried an excess liquid asset position into COVID, and that has continued on. So we don't have a requirement to be growing deposits at this point in time.

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Operator [27]

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(Operator Instructions) We'll take our next question from...

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Stephen Hudson, Macquarie Research - Head of Research [28]

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It's Steve Hudson from Macquarie. Just a couple from me. Just on the reverse mortgage book, I just wondered if you could give us a feel for what your share of origination is in both countries. You've obviously given us some useful data around current market share, but just interested in the marginal change there.

Just -- I suppose coming back to the question on deferrals. It sounds like the Harmoney Extend (sic) [Heartland Extend] product might be a couple of percent of your book. It sounds like mortgages across New Zealand banking are sort of more like about 14% in deferral. And you may have benefited from that money being channeled into debt repayment. So I just wondered if we should look to sort of overall mortgage deferrals coming down as a sort of a -- if you like, a condition for your current overlay to be adequate, if that makes sense.

And then just thirdly, I just wondered if you could give us a bit of a feel for the $0.025 dividend that you paid out of the non-bank group. That -- if you annualize that, that's close to half of the dividend that you paid last year, yet your reverse mortgage book over in Australia is probably closer to 1/4 of your book. I just wondered if we would be ill-advised to annualize that $0.025 dividend if the Reserve Bank's conditions of registration are extended.

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Jeffrey Kenneth Greenslade, Heartland Group Holdings Limited - CEO & Non-Independent Executive Director [29]

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Andrew, can we start with the last one first, dividends?

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Andrew Dixson, Heartland Group Holdings Limited - CFO [30]

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Yes. So Stephen, I think your question was annualizing this year's dividend particularly given that it's come from the Australian business. I would -- it will be considered as we go. That business continues to be profitable, and there is excess capital that is available for distribution. We don't have a policy around that. So it's a hard one to advise whether annualizing that is the right thing to do. I would probably caution against it.

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Jeffrey Kenneth Greenslade, Heartland Group Holdings Limited - CEO & Non-Independent Executive Director [31]

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I'll cover the question around the deferrals.

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Andrew Dixson, Heartland Group Holdings Limited - CFO [32]

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Yes.

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Jeffrey Kenneth Greenslade, Heartland Group Holdings Limited - CEO & Non-Independent Executive Director [33]

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So look, in my experience there, that won't be what's happening. What we're seeing is some customers repaying their high-yielding debt, either principal loan or car loan, and replacing it with mortgage debt because its rates are cheaper. Those customers that are in deferral with their mortgages when they come back on, my expectation is that they will continue to repay. And in fact, if you look at the -- our experience in our motor book, which is where most of those customers will sit through the GFC, mortgage customers were -- who also had car loans were our best-performing sort of group of people. So they do have options. And particularly noting in this environment compared to GFC, the actual mortgage rates are a lot lower. So I think people's ability to repay in this environment compared to then will be greater.

When it comes to the question around origination and reverse mortgages in both countries, very difficult to give you a definitive answer. As far as we're aware, there's only one other provider in New Zealand, which is SBS. We are unsure how much they do, but from what we can tell, not a lot. We would say that we virtually hold the market here in New Zealand. In Australia, there is -- depends how you define it. It's very hard to define it because there are federal government equivalents. There are a state government, quasi equivalents. There are a number of credit unions and small funds that do offer reverse mortgages. When -- and there is no, like, organized industry body that collects the information. So -- but every now and again, someone drops around and does produce some data. The last one is somewhat dated, but the last one, we were growing around about 60%, 70% of the market, but that was, I think, probably a year or so ago. Andrew, how do you think?

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Andrew Dixson, Heartland Group Holdings Limited - CFO [34]

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Yes. That's exactly right. And we wouldn't expect that to have changed. So -- if there hasn't been new competition into the market in either country that would materially have shifted those 2 systems.

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Jeffrey Kenneth Greenslade, Heartland Group Holdings Limited - CEO & Non-Independent Executive Director [35]

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Just one other question, sorry. We just wanted to -- on Wade, with deposits just in terms of -- we didn't cover where retail depositors are currently.

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Andrew Dixson, Heartland Group Holdings Limited - CFO [36]

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Yes. Sorry, Wade. So there were some outflows at the back end of March when the original lockdown occurred. Since that time, we've continued to grow deposits, and flows have increased. And that's during a time where we've continued to drop rates as has the rest of the market. So the positive inflows remain strong.

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Operator [37]

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We'll take our next question from...

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Jeremy Kincaid, UBS Investment Bank, Research Division - Associate Analyst [38]

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It's Jeremy from UBS. Can you hear me?

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Jeffrey Kenneth Greenslade, Heartland Group Holdings Limited - CEO & Non-Independent Executive Director [39]

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Yes. Hi, Jeremy.

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Jeremy Kincaid, UBS Investment Bank, Research Division - Associate Analyst [40]

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A couple of questions for me. Firstly, I just would like to understand how you think about your capital ratio now. Obviously, there's the 2 businesses, the registered bank business and the Australian business. It's probably a little bit unfair to look at the core Tier 1 capital ratio that's on the RBNZ dashboard. I'm also not sure if it's up to date given the overlays. So I was just -- 2 questions there, a, how should we think about? And how do you think about it? And what is that ratio now? And what's the direction of travel?

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Jeffrey Kenneth Greenslade, Heartland Group Holdings Limited - CEO & Non-Independent Executive Director [41]

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In a general sense, I'll kick off, and Andrew can comment in terms of the bank in particular. The group ratio of capital is driven by 3 things. There's the consolidation of the bank and Australia. So the bank is really driven by the obvious regulatory requirements, which you'll be familiar with. And they are what they are. That flows through -- up to the group. Australia, the leverage is defined by essentially what we are able to -- how we are able to leverage our reverse mortgage businesses because that's the vast majority of what we do. As you may have seen from our recent announcement around the long-dated mortgage facility that we've put in place, we achieved 98% leverage. So that gives us sort of encouraging sort of prospects for the future in terms of that flowing up to the group as well. But that said, the final part or the third part of the piece that we look to is what we suspect the rating agency would like to see for maintaining our rating. So Andrew, is there anything you want to...

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Andrew Dixson, Heartland Group Holdings Limited - CFO [42]

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Yes. Look, I -- well covered. I guess the bank with the ban on distributions is accumulating capital at the moment. So I think your question is what is the ratio at the moment. It's a tick over 13% and continues to grow. And that puts us well on the pathway to complying with the new rules for capital, which have been deferred, but we're well ahead of the game on that one. And then Australia, as Jeff mentioned, is driven by what we can't fund [via this]. And as we noted in our announcement, the recent long-term financing transaction had a leverage of 98%. So we have excess capital in that business, and this will only -- these types of transactions will only improve that position.

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Jeremy Kincaid, UBS Investment Bank, Research Division - Associate Analyst [43]

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Okay. I thought if it's -- I thought it was 13.5% last year. So if it's 13.1%, is that not going down year-on-year? And what's going on from this? What's the current thinking around lifting it to the proposed change -- the proposed 16%? Do you think you can get there just with repurposing into different risk-weighted portfolios? Or do you think you might need Tier 2 capital or tier 1 capital?

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Andrew Dixson, Heartland Group Holdings Limited - CFO [44]

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Addressing your first point -- so that was 13.49% last year. The lower ratio this year is reflective of us remediating some of the noncompliance matters that have played out during our independent review. In terms of your other question around the -- getting to 16%, I guess that's a long way off. I think it's a 7-year transition period, and the components of that do depend on where the RBNZ lands on things like hybrid capital. So I think there's a number of things to play out over a reasonably long period of time to answer that question definitively.

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Jeremy Kincaid, UBS Investment Bank, Research Division - Associate Analyst [45]

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Okay. Sure. And then just finally for me. In your statement of cash flows, which is something we don't typically look at for banks, but there was an increase in investments of $55 million. Do you know what that was?

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Andrew Dixson, Heartland Group Holdings Limited - CFO [46]

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That -- I imagine that is just an increase in our liquid asset stock.

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Operator [47]

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We have no further phone questions at this time.

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Jeffrey Kenneth Greenslade, Heartland Group Holdings Limited - CEO & Non-Independent Executive Director [48]

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Okay. So thank you very much for your attending and for your questions and also very much appreciated for your ongoing support. And please feel free to contact any of us should you wish to have any further conversations. Thank you very much.

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Operator [49]

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Ladies and gentlemen, this concludes the Heartland results announcement presentation. Thank you for your participation.