Forsyth Barr analysts see integration of technology systems and TSB’s low lending and earnings growth as potential risks to a successful merger with Heartland

The proposed takeover of TSB by Heartland Group Holdings will give the latter's Heartland Bank subsidiary a chance to compete in home loans, not just niche lending market segments, according to Forsyth Barr analysts.

Heartland Group Holdings announced earlier this week it has signed a deal with TSB's parent, the Toi Foundation, to buy TSB in a deal valued at $620 million, comprising debt, equity and cash. The combined bank will be named TSB Heartland Bank. 

In a research report published on Wednesday, Ben Crozier and Andrew Harvey-Green said Heartland is currently a “meaningful player” in multiple niche lending segments.

“This merger gives Heartland Group Holdings a solid starting point in the significant NZ home loans market that it lacked when it attempted to enter the market organically,” they said.

“Home loans provide a balance between Heartland Group Holdings’ attractive reverse mortgage portfolio and its less attractive motor/business lending. Importantly, this should reduce earnings volatility and risk within its NZ bank and has the potential to improve its credit rating longer term.”

Home lending scale

Heartland Group Holdings CEO Andrew Dixson told analysts in an investor briefing on Tuesday that the merger provided an opportunity for Heartland to scale its home lending portfolio. 

“This is an area where Heartland Bank has not been able to achieve meaningful scale organically and the acquisition of TSB addresses that directly,” he said.

TSB’s lending portfolio currently includes $6.5 billion in home loans, representing 84% of the bank’s total lending.

To get the merger across the line, the banks will need the satisfaction of several conditions. These include community consultation by Toi Foundation with Taranaki residents and the backing of Toi's trustees, Heartland shareholder approval and Reserve Bank of New Zealand approval.

Heartland has a long-term credit rating of BBB with a stable outlook from Fitch Ratings. To get the merger confirmed, Fitch will need to reaffirm that the combined bank will have a credit rating of at least BBB with a stable outlook. Fitch released a statement saying it had placed Heartland's credit ratings on rating watch positive following the TSB announcement.

The deal is scheduled to be completed in December 2026.

'Meaningful execution risks'

Crozier and Harvey-Green said they believe the deal is a positive one for Heartland, but it comes with “meaningful execution risks”.

“The key to unlocking value from the merger is synergies. Heartland Group Holdings believes it can reduce about 12% of the combined operating expenditure through eliminating duplicated overheads. We believe this is achievable but see the integration of technology systems and TSB’s recent low lending and earnings growth as potential risks to a successful merger,” they said.

“While the deal is not yet finalised, we view it as likely to proceed, so incorporate it into our forecasts.”

TSB's total lending stood at almost $7.774 billion at March 31, up just $90.3 million year-on-year, based on Reserve Bank data. Its March quarter return on equity was 4.4% down from 7.7% in the March quarter last year, but its net interest margin was 2.3% up from 2%.

"Local asset sales are an emotive topic for many in New Zealand, but this merger has the clear potential to improve returns for the Toi Foundation, from  less than 2% distributions yield to about 6%. Given the material increase in distributions to the Foundation, we believe the deal has a high likelihood of progressing," Crozier and Harvey-Green said.

They note TSB’s current return on equity of 6% is comfortably below its cost of capital and Heartland Group Holdings’ 12% target, which is why the deal values TSB at 0.75x its book value.

Forsyth Barr has retained a neutral rating for Heartland Group Holdings' shares.