Heartland Group Holdings Limited
Annual Report 2016

Plain-text annual report

Annual Report 2016 Annual Report 2016 Contents www.heartland.co.nz 3 Heartland’s Performance Heartland at a Glance in FY2016 Chairman and Chief Executive Officer's Report Ko te Pūrongo a te Pou Whakahaere me te Tiamana Our Company Board of Directors The Heartland Trust Corporate Governance Disclosure Statement1 Financial Statements Auditor’s Report Disclosures Director Disclosures Executive Remuneration Shareholder Information Other Information Directory 4 6 10 16 18 20 26 38 81 84 91 92 93 94 This Annual Report is signed on behalf of the Board of Heartland Bank Limited (Heartland) by Geoffrey Ricketts, Chairman, and Jeffrey Greenslade, Chief Executive Officer. Geoffrey Ricketts Chairman 23 September 2016 Jeffrey Greenslade Chief Executive Officer 23 September 2016 1 As a registered bank, Heartland is required to prepare quarterly Disclosure Statements. Heartland's financial statements for the year ended 30 June 2016 (reporting period) are contained in its Disclosure Statement for the same reporting period. 4 Heartland Bank Limited - Annual Report 2016 Heartland at a Glance in FY2016 11% Increase on final dividend for FY2015 Dividends Final dividend to be paid on 7 October 2016 5c PER SHARE Total shareholder return for FY2016 22% Total dividend of 8.5c FOR FY2016 Heartland at a Glance in FY2016 Heartland at a Glance in FY2016 www.heartland.co.nz 5 Net profit after tax $54.2M 12.5% increase on FY2015 Strongest interest margin among bank peers¹ .58% as at 31 March 2016 Heartland Bank Credit Rating BBB (stable) Return on equity of 11.1% 10.4% for FY2015 Earnings per share 11c 10c for FY2015 Heartland is proud to be the first New Zealand registered bank to be listed on the NZX Main Board ¹ See KPMG’s Financial Institutions Performance Survey March 2016 Quarterly Results 6 Heartland Bank Limited - Annual Report 2016 Chairman & Chief Executive Officer’s Report Chairman & Chief Executive Officer’s Report It is our pleasure to report another successful year for Heartland - not only a year of continued receivables growth and increased profitability - but also an historical year, in which Heartland New Zealand Limited and Heartland Bank Limited successfully amalgamated to form the first New Zealand registered bank to be listed on the NZX Main Board. Geoffrey Ricketts Chairman Heartland’s net profit after tax (NPAT) for the financial year ended 30 June 2016 (the 2016 Financial Year) was $54.2m, up $6m on the previous financial year (the 2015 Financial Year). Earnings translated to an average return on equity (ROE) of 11.1%, compared to ROE of 10.4% for the 2015 Financial Year. ¹ Total shareholder return means share price appreciation plus dividends received. ² See KPMG’s Financial Institutions Performance Survey March 2016 Quarterly Results. Heartland’s net tangible assets (NTA) increased from $420.3m to $433.5m during the 2016 Financial Year. On a per share basis NTA was $0.91 at 30 June 2016, compared with $0.89 at 30 June 2015. Total shareholder return¹ for the 2016 Financial Year was 22%. We were also pleased to note KPMG’s report², which confirmed Heartland’s Net Interest Margin as the strongest among its bank peers. Dividend The Board resolved to pay a fully imputed final dividend of 5.0 cents per share, on 7 October 2016, to shareholders on Heartland’s register at 5.00pm on 23 September 2016. At 5.0 cents per share, the dividend is an 11% increase on last year’s final dividend of 4.5 cents per share, which was paid on 2 October 2015. On 5 April 2016, Heartland also paid an interim dividend of 3.5 cents per share, totalling $16,566,952. When added to that interim dividend, the final dividend brings total dividends relating to the 2016 Financial Year to 8.5 cents per share, an increase of 13% on total dividends relating to the 2015 Financial Year. The Dividend Reinvestment Plan (DRP) was available and a discount of 2.5% was applied. The last date of receipt for a participation election from a shareholder who wished to participate in the DRP was 23 September 2016. For the full information on the DRP, please see Heartland’s Dividend Reinvestment Plan Offer Document dated 1 January 2016, which is available on our website. Business Performance All of Heartland’s core divisions - Business, Rural and Household - performed well, and net finance receivables increased by 9%, to $3.1b, during the 2016 Financial Year. Business The Business division’s net receivables increased by $95.0m, or 11.8%, to $898.8m. Receivables growth drove an increase in Net Operating Income (NOI) for the division, up $2.2m on the 2015 Financial Year to $43.0m. The Business division continued to develop its intermediary distribution network, and focussed in particular on product offerings to meet the needs of small to medium sized business customers. The Open for Business online origination platform (for small business loans) continued to be developed and improved, and distribution was extended to intermediaries. The Open for Business book grew to $11.2m, with growth accelerating from April 2016 following a comprehensive upgrade of the platform. Chairman & Chief Executive Officer’s Report www.heartland.co.nz 7 Financial Performance at a Glance Net interest income Net other income Net operating income* Expenses Profit before impairments and tax Impaired asset expense Net profit before tax Tax Net profit after tax (reported) Cost to Income Return on Equity Earnings per Share 12 months to June 2016 (NZ $m) 12 months to June 2015 (NZ $m) 146.7 10.9 157.6 69.9 87.7 13.5 74.2 20.0 54.2 44% 11.1% 11c 134.4 10.5 144.9 68.4 76.5 12.1 64.4 16.2 48.2 47% 10.4% 10c *Net operating income for FY2015 includes share of MARAC Insurance profit. Net Finance Receivables As at 30 June 2016 $2,607m 410 685 1,512 m $ $2,862m 488 804 $3,114m 552 899 1,570 1,663 30 June 2014 30 June 2015 30 June 2016 Household Business Rural Rural Despite the challenging rural environment, the rural division grew strongly, increasing net receivables by $64.8m, or 13.3%, to $552.5m. NOI was $26.3m, up $2.2m on the 2015 Financial Year. Growth primarily came from the sheep and beef sector, where Heartland utilised its livestock lending expertise through both relationship and intermediated channels to originate new business in term, working capital and livestock finance. Although Heartland's exposure to the dairy sector grew, that exposure is still relatively small (at only 7% of the total lending book at 30 June 2016) and the average loan to value ratio (LVR) for Heartland’s dairy exposures is just 64%. Despite the difficult circumstances facing the dairy industry, Heartland continues to support existing clients – which was the primary reason for the growth – and still has an appetite for new business with sharemilkers and dairy farmers who meet our lending criteria. Heartland has provided a buffer against any continued rural downturn, particularly in the dairy sector, by applying an additional collective provision. Household The Household division - which is made up of consumer, reverse mortgages and non-core residential mortgages - had another strong year, in which net receivables increased by $92.1m, to $1.7b, and NOI increased by $9.5m, to $86.1m. The consumer business – which includes motor vehicle loans, personal loans and lending through the Harmoney platform – grew strongly, achieving NOI of $59.2m (up 14.9% on the 2015 Financial Year) and net receivables growth of $85.8m, to $822.1m (up 11.7% on the 2015 Financial Year). Growth in net receivables from motor vehicle loans continued strongly, up 9.5% on the 2015 Financial Year to $767.4m, and the personal loan book, although relatively small, grew exponentially – net receivables were up 616.0% on the 2015 Financial Year to $17.9m. The performance of the reverse mortgage business, both in New Zealand and Australia, was particularly pleasing, with the size of the book increasing by $27.4m (8.2%) in New Zealand and A$38.6m (10.3%) in Australia to a total of $362.6m and A$413.5m respectively. After foreign exchange translation, this amounted to total growth, in New Zealand dollars, of $39.1m, and a total book size of $794.8m. 8 Heartland Bank Limited - Annual Report 2016 Chairman & Chief Executive Officer’s Report Strategic Focus Heartland’s strategic focus continues to be to provide innovative ‘best or only’ banking products in niche markets. Going forward, the aim is to deliver those products through ‘best or only’ channels, tailored for each niche market, in particular: • by providing a high touch, personal service to seniors (65 years+), a growing demographic with specific financial needs; • by providing a frictionless digital experience to the emerging ‘millennial’ market, who value speed and ease; and • by providing a fast and responsive service to the neglected segment of the small business market, through online origination for working capital and plant and equipment finance. With that focus in mind, our priorities are to enhance our digital distribution, to expand our Australian operation, and (if the right opportunity arises) to grow by acquisition. Digital Although we will continue to tailor each distribution channel to each niche market, in the future ‘best or only’ channels will, increasingly, be digital. Digital channels have the power not only to extend our reach and increase our scale, but also to streamline our processes and, most importantly, to deliver a better, faster customer experience. In April, we launched a comprehensive upgrade of Heartland’s Open for Business online distribution platform, which allows SME customers to apply for working capital or plant & equipment loans in just a few minutes. Going forward, we aim to leverage that technology by rolling-out the ‘Open for’ concept in other markets and sectors. Recognising the importance of strong technology platforms to support our ambitions for growth, we are poised to transition to a first-class core banking system, provided by technology innovators Oracle, which will integrate and simplify our IT environment, reduce costs, and further rationalise our processes. Jeffrey Greenslade Chief Executive Officer fundamentals are compelling, and there is potential to secure a market-leading position (such as through a unique relationship or distribution capability). This could include an Australian Open for Business platform, for example. Acquisitions and Capital At last year’s Annual Meeting, Heartland advised shareholders of its intention to undertake a regulatory capital issue and to subsequently undertake a return of capital. However, the Board elected not to proceed with those transactions during the 2016 Financial Year, as we believe that continued volatility in the financial markets since then has created, and continues to create, acquisition opportunities. Australia This year, we have seen strong organic growth in our Australian business, primarily as a result of expanding our Australian intermediary distribution network. Looking forward, we aim to build on that momentum by introducing other ‘best or only’ Heartland banking products into the wider Australian market where the sector Both in New Zealand and Australia, the potential for acquisitions remains a key part of Heartland’s strategy. Heartland will pursue an acquisition where it is value accretive, and where it delivers access to innovation, compelling distribution capability or involves products which are the same or similar to an existing core competency. Chairman & Chief Executive Officer’s Report www.heartland.co.nz 9 Heartland has elected not to proceed with the regulatory capital issue and return of capital in the 2016 Financial Year at this time. It may still do so in the future should it be deemed appropriate. Heartland continues to assess acquisition opportunities as they arise, and to monitor its capital position. Looking forward Looking forward, Heartland expects underlying asset growth to continue for the 2017 financial year, and we are projecting increased volumes in each of the core divisions. We expect comparatively faster growth in Heartland products which are distributed online (personal loans and Open for Business loans), given their modest size currently and the size of the market opportunity available. Heartland expects its NPAT for the year ended 30 June 2017 to be in the range of $57m to $60m, and, for the reasons above, we believe we are well-placed to meet that target. This guidance range does not take into account the impact of any potential capital management initiatives or acquisitions. Geoffrey Ricketts Chairman of the Board Jeffrey Greenslade Chief Executive Officer Net profit after tax 12 months to 30 June 2016 $54.2m 12.5% from FY2015 Net operating income 12 months to 30 June 2016 $157.6m 9% from FY2015 Net finance receivables As at 30 June 2016 $3.1bn $251.9m from 30 June 2015 Return on Equity As at 30 June 2016 11.1% from 10.4% as at 30 June 2015 10 Heartland Bank Limited - Annual Report 2016 Ko te Pūrongo a te Pou Whakahaere me te Tiamana Ko te Pūrongo a te Pou Whakahaere me te Tiamana (Chairman & Chief Executive Officer’s Report) E hīkaka nei māua ki te pūrongorongo atu i te angitū o tētehi anō tau mō Heartland Bank Limited – ehara i te mea mō te kaha piki haere o ngā kaute nama me ngā hua – heoi he tau whakahirahira i hono tahi ai a Heartland New Zealand Limited me Heartland Bank Limited ki te whakatū i te pēke tuatahi o Aotearoa kua whakarārangihia i te Poari Matua o NZX. Ko te $54.2 miriona te whiwhinga pūtea kua tangoihia kētia te tāke i te tau pūtea i mutu ai i te 30 o Pipiri, 2016 (te Tau Pūtea o 2016). He $6 miriona te pikinga i tēnā o te tau pūtea o mua (i te Tau Pūtea o 2015). Nā ngā pūtea utunga te ROE i huri ai ki te 11.1%, he pikinga mai i te 10.4% i te Tau Pūtea o 2015. I eke ngā rawa tūturu o Heartland i te $420.3 miriona ki te $433.5 miriona i te Tau Pūtea o 2016. Kia tirohia ake ia hea, $0.91 te nui o ngā rawa tūturu i te 30 o Pipiri, 2016, tēnā i te $0.89 i te 30 o Pipiri, 2015. I muri i te tangohanga o te tāke i piki ai ngā hua tūturu a Heartland i te $420.3 miriona ki te $433.5 miriona i Te Tau Pūtea o 2016. Nā konā, ko ia wāhi i ōrite ai ki te $0.91 i te 30 o Pipiri, 2016, he mea whakataurite ki te $0.89 i te 30 o Pipiri, 2015. Ko te 22% te nui o te pūtea i whiwhi ai ngā kaiwhaipānga mō te Tau Pūtea o 2016. I harikoa hoki māua i ngā kōrero i te pūrongo a KPMG mō te utu huamoni i ahu mai i a Heartland me tērā i tukuna ai ki ngā kaitaupua pūtea e mea ana ko tērā te mea kaha o ngā kaiwhakataetae katoa. Hua Moni I te 5 karaka, i te ahiahi o te 23 o Mahuru, 2016, e 5.0 hēneti mō ia hea te nui o te hua moni whakamutunga i utua ai e te Poari ki ngā kaiwhaipānga i runga i te rēhita a Heartland. He 11% pikinga tēnei i te hua moni whakamutunga e 4.5 mō ia hea o te tau kua mahue ake nei. I te 5 o Paengawhāwhā, 2016, he mea utu hoki e Heartland tētehi pūtea whiwhi taurewa, 3.5 hēneti mō ia hea, $16, 566, 952 te nui. I te otinga atu, he pikinga 13% ki te 8.5 hēneti mō ia hea te katoa o ngā hua moni mō te Tau Pūtea 2015. I wātea te Rautaki Pūtea Haumi Hua Moni, ka mutu, he mea whakahekenga te utu o te 2.5%. Ko te 18 o Mahuru, 2015 te rangi whakamutunga i aro ai a Heartland ki te kōwhiringa whakauru mō te hunga kaiwhaipānga i pīrangi kia whai wāhi atu i roto i te Rautaki Pūtea Haumi Hua Moni. E kite ai koe i ngā mokamoka katoa mō te Rautaki Pūtea Haumi Hua Moni, tēnā, tirohia te tāpaetanga o roto i te rautaki rā i tā mātau paetukutuku, i tāpirihia atu ai i te 1 o Kohitātea, 2016. Ngā Whakatutukinga o te Pakihi I whai hua katoa ngā wāhanga matua o te pakihi – Pakihi mai, Taiwhenua mai, Whare mai, katoa ēnei i tino eke, ā, e 9% te pikinga o ngā kaute nama pūtea ki te $3.1 piriona, i te Tau Pūtea o 2016. Pakihi I piki ngā pūtea kaute nama o ngā wāhanga Pakihi i te $95 miriona, i te 11.8% rānei ki te $898.8 miriona. $2.2 miriona te pikinga o ngā kaute nama ki te $43.0 miriona i roto i te wāhanga Pūtea Whiwhi Whakahaere Whare i te Tau Pūtea o 2015. He rite tonu te whakawhanake a te wāhanga Pakihi i tana rangapū rotanga kaiwhakarite. I arotahi te wāhanga rā ki ngā whakaputanga e ngata ai te hiahia o ngā kaihoko pakihi iti me ngā kaihoko pakihi wawaenga. I whakawhanaketia tonutia te tūāpapa taketake ipurangi o Open for Business (mō ngā pūtea taurewa pakihi iti), ā, ko ngā kaiwhakarite hoki i whai wāhi ai ki ngā ratonga. I eke te pukapuka e kīia nei ko Open for Business ki te $11.2 miriona, he nui ake tēnā i te marama o Paengawhāwhā, 2016 whai muri i tonu iho i te whakahoutanga mai o te tūāpapa. Taiwhenua Hāunga ngā piki me ngā heke o te taiao taiwhenua, i kaha tonu te pikinga o tēnei wāhanga i ngā kaute nama pūtea i te $64.8 miriona, i te 13.3% rānei ki te $552.5 miriona. $2.2 miriona te pikinga o te Pūtea Whiwhi Whakahaere Whare i te $26.3 miriona i te Tau Pūtea o 2015. Ko te Pūrongo a te Pou Whakahaere me te Tiamana www.heartland.co.nz www.heartland.co.nz 11 11 Nā te wāhanga hipi me te wāhanga kau i tino eke ai tēnei wāhanga. I whakamahi a Heartland i ōna pūkenga nama kararehe mā roto atu i ōna pānga ki te whakatakune i ngā pakihi hou, i te haupū rawa me te pūtea kararehe. Ahakoa i hau te rongo o te whare kau a Heartland, he iti tonu tērā (e 7% noa iho o te puka nama i te 30 o Pipiri, 2016), ā, 64% noa iho te toharite o te nama taurewa ki te wāriu o te hau o te putanga o te whare kau a Heartland. Ahakoa ēnei āhuatanga uaua kei te aroaro o te ahumahi whare kau, ka tautokona tonutia e Heartland ana kiritaki. Koinā pū i piki ai tēnei wāhanga, ka mutu, kua hiahia tonu ki te āwhina i ngā pakihi iti e whai wāhi ai ngā kaipāmu e tutuki ai i a rātau ngā paearu hoatu taurewa. Kua tāpirihia tētehi whakaritenga e tauārai ai a Heartland ki ngā paheketanga ohaoha taiwhenua i roto i te wāhanga whare kau. Whare Ko te kiritaki, ko te mōkete hurikōaro me te mōkete tāone hauiti ngā tino o te wāhanga Whare. I eke anō ngā mahi hokohoko i te tau nei, $92.1 miriona te nui o te pikinga ki te $1.7 piriona, ā, $9.5 miriona te pikinga o te Pūtea Whiwhi Whakahaere Whare ki te $86.1 miriona. Ko te taurewa waka, ko te taurewa whaiaro, me te taurewa mā roto i a Harmony ngā wāhanga o te pakihi kiritaki i kaha eke i te tau nei ki te $59.2 miriona (he 14.9% pikinga mai i te Tau Pūtea o 2015), ā, $85.8 miriona te pikinga o te kaute nama ki te $822.1 miriona (he 11.7% pikinga mai i te Tau Pūtea o 2015). I kaha piki tonu ngā kaute nama o ngā taurewa waka, he 9.5% pikinga ki te 767.4 miriona i te Tau Pūtea o 2015. Ahakoa te iti o te puka taurewa whaiaro, i piki hoki tērā ki te $17.9 miriona, he 616.0% pikinga tēnā i te Tau Pūtea o 2015. I pai te wāhi ki te pakihi mōkete kōaro i Aotearoa me Ahitereiria. He pikinga $27.4 miriona (8.2%) i Aotearoa, ā, he pikinga A$38.6 miriona (10.3%) i Ahitereiria. Ko te $362.6 miriona te katoa o te tatau o roto o Aotearoa, ā, ko te A$413.5 miriona i Ahitereiria. Hei whaiwhai noa ake i ngā kurutete whakawhiti tauiwi, he $39.1 miriona pikinga tēnei ki te $794.8 miriona i te tāra o Aotearoa. Te Aronga Rautaki Ko te rato i te tino o ngā hua pēke i roto i te mākete tonu te rautaki e whāia nei e Heartland. Ā haere ake nei, e tutuki ai te whāinga, mā ngā tino huarahi, mā te huarahi kotahi anake rānei ēnei hua e tukua ai, e hāngai tonu ana ki ia mākete pēnei i ēnei e whai iho nei: • mā te whakarato i tētehi whakaritenga kounga ki ngā kaumātua (65 tau te pakeke nuku atu rānei), he tatauranga iwi e tupu haere ana, he maha hoki ōna hiahia pūtea motuhake; • mā te whakarato i tētehi wheako mati ngāwari noa nei ki te mākete o anamata e ngākau nui ana ki te wāriu me te tere; ā, • mā te whakarato i tētehi ratonga tere ki te wāhanga iwikoretanga o te mākete pakihi iti, mā roto atu i te pūtaketanga o te ipurangi mō te pūtea tōpū mahi me te rawa ahumahi, mō te pūtea taputapu hoki. Ko te whakapai i ngā whakaratonga mati tā mātau e aro nei e whakanui ake ai i ā Ahitereiria whakahaere, ā, kia eke hoki ki taumata kē atu mehemea e taea ana. Mati Ahakoa ka whakahāngai tonu mātau i ngā huarahi whakaratonga ki ia mākete, ā haere ake nei ka mati haere ngā huarahi ‘best or only’ Ehara i te mea ka taea e ngā huarahi mati te toro atu ki tēnā, ki tēnā anake, heoi mā tēnei hoki e whakahou ā mātau tukanga, e whakatere ai, e whakapai ake ai hoki i te wheako o te kiritaki. Nō te marama o Paengawhāwhā, i whakarewahia ai te whakahoutanga mai o te tūāpapa whakaratonga ipurangi a Heartland e kīia nei ko ‘Open for Business’ e āhei ai ngā kiritaki SME ki te tono mō te pūtea tōpū mahi, mō ngā taurewa rawa ahumahi, taputapu rānei i ngā miniti torutoru noa iho. Ā haere ake nei, e mea ana mātau ki te whakahaere i tērā hangarau mā te momo ariā e kīia nei ko ‘Open for’ i ētehi atu mākete me ētehi atu wāhanga. Mā te mōhio ki ngā tino tūāpapa hangarau ki te tautoko i ō mātau tūmanako kia tupu haere e rite ai mātau ki te whakawhiti atu ki tētehi pūnaha pēke kounga i raro i a Oracle e whakakotahi ai, e whakangāwari ai i te taiao hangarau me te utu, e whai take hoki ai ā mātau tukanga. 12 Heartland Bank Limited - Annual Report 2016 Ko te Pūrongo a te Pou Whakahaere me te Tiamana Te Anga Whakamua Ka anga whakamua tonu te pūtaketanga o te whakatupu rawa ā te Tau Pūtea o 2017, ā, e whakarite ana hoki mātau i te pikinga o ngā rahi i roto i ngā wāhanga matua. Ki tā mātau nei titiro, ka tere piki ngā hua o Heartland e tukuna ana mā te ipurangi (ko ngā taurewa whaiaro me ngā taurewa ‘Open for Business’), i runga hoki i te mōhio ki te rahi o mohoa noa nei me te rahi o te āheinga mākete e wātea ana. E mea ana a Heartland ka eke te whiwhinga pūtea kua tangoihia kētia te tāke mai i te $57 miriona ki te $60 miriona ā te tau e mutu ai ā te 30 o Pipiri, 2017, ka mutu, e mōhio nei mātau ka tutuki tērā. Kāore ēnei kōrero e whaiwhakaaro ake ana ki ngā mea pēnei i ngā whakaritenga whakahaere pūtea tōpū me ētehi atu whakaritenga. Geoffrey Ricketts Tiamana o te Poari Jeffrey Greenslade Pou Whakahaere Ahitereiria I tēnei tau, kua kite nei mātau i te pikinga haeretanga o ngā whaiwaro i roto i ngā pakihi o Ahitereiria, he hua tēnei kua puta i te whakarahinga haeretanga o ngā hononga whakaratonga waenga o Ahitereiria. Mō te anamata, e anga whakamua ai ka arotahi tonu ki te whakauru i ētehi atu hua pēke o Heartland e hāngai ana ki te ‘best or only’ ki te mākete huri noa i Ahitereiria i ngā wāhi e mōhio nei mātau e eke ana ngā takenga o te wāhanga nei, ka mutu, mā te whanaungatanga ahurei, mā te āheinga o te whakaratonga rānei pēnei i te pitomata kia mau tonu ki te tūranga tuatahi o te ao mākete. Ko te ‘Open plan for Business’ o Ahitereiria pea ka whakaurungia atu. Ngā tangohanga me te Haupū Rawa I te hui ā-tau i tērā tau, i whakamōhio atu a Heartland ki ana kaiwhaipānga mō tana hiahia kia tīmata i tētehi take haupū rawa mana whakahaere me tētehi utunga ki ngā kaiwhaipānga. Heoi, kāore te Poari i whakaae kia kōkirihia ērā whakaaro i te Tau Pūtea o 2016 i runga tonu i te matawhawhatitanga o ngā mākete pūtea i tērā wā kua whai atu, e whai wāhi tonu nei ngā tangohanga. He nui tonu te wāhi ki ngā tangohanga i roto i te rautaki a Heartland huri noa i Aotearoa me Ahitereiria. Ka whai a Heartland i tētehi tangohanga e whai wāhi atu ai tētehi ki te auahatanga, ki te āheinga whakaratonga, ki ngā hua e rite ana ki ngā pūkenga matua onāianei. Kua oti kē i a Heartland te whakatau kia kaua e koke whakamua me ngā take haupū rawa mana whakahaere me te utunga ki ngā kaiwhaipānga i te Tau Pūtea o 2016 i tēnei wā, heoi, ki te kitea he hua, hei ā taihoa ake nei pea tēnei kaupapa kōkirihia ai. Kia ara ake he āheinga tangohanga, ka tirohia tērā e Heartland me tana tūranga matua hoki. Heartland's Strategic focus www.heartland.co.nz 13 Heartland's focus To provide innovative 'best or only' banking products in niche markets that are under-serviced by the major banks. Our markets Emerging A frictionless digital experience to the emerging millennial market, who value speed and ease. Growing High touch personal service to seniors (65+) which is a growing demographic with specific financial needs. Neglected A fast and responsive online service to the neglected segment of the small business market. 14 Heartland Bank Limited - Annual Report 2016 Heartland's People Heartland's People Chris Cowell. Todd Somerville, Sarah Selwood and Richard Lorraway. Jeff Greenslade and Chris Flood. Heartland's People www.heartland.co.nz 15 Simon Owen. Sarah Smith, Michael Drumm and Shannon Beech. Lydia Zulkifli, Joshua Williams and Andrew Dixson. Joan Scott. Michael Drumm. Darryl Harnett. Ben Russell. 16 Heartland Bank Limited - Annual Report 2016 The Board of Directors Board ofDirectors As at the date of this Annual Report, the directors of Heartland are as follows: Jeffrey Greenslade LLB Chief Executive Officer – Appointed 30 September 2010 Jeff has over 20 years’ experience as a senior banking executive, including with the ANZ National Banking Group, where he last held the position of Managing Director of Corporate and Commercial Banking. From February 2006 until February 2008 he spent time on the board of UDC Finance Limited. Jeff has also held a number of senior positions in the Institutional and Capital Markets areas of The National Bank of New Zealand and its subsidiary, Southpac. Jeff is responsible for the strategic and operational management of Heartland. He joined Heartland as Chief Executive Officer of MARAC Finance Limited in 2009. John Harvey BCom, CA Director – Appointed 31 December 2015¹ John has considerable financial services experience and 36 years in the professional services industry, including 23 years as a partner of PricewaterhouseCoopers. Since his retirement from PricewaterhouseCoopers in 2009, John has pursued a career as an independent director of a number of companies, including Port Otago Limited, Balance Agri-Nutrients Limited, NZX listed Stride Property Limited and NZX/ASX listed Kathmandu Holdings Limited. He is also chairman of NZ Opera Limited. Bruce Irvine BCom, LLB, FCA, CFInstD, FNZIM Director – Appointed 31 December 2015¹ Bruce is a chartered accountant and was admitted into the Christchurch partnership of Deloitte in 1988. He was Managing Partner from 1995 to 2007 before his retirement from Deloitte in May 2008 to pursue his career as an independent director. Bruce is also Chairman of Christchurch City Holdings Limited, and a director of several public and private companies, including House of Travel Holdings Limited, Market Gardeners Limited, PGG Wrightson Limited, Rakon Limited, Scenic Circle Hotels Limited and Skope Industries Limited. Bruce is involved in a voluntary capacity as a trustee of Christchurch Symphony. ¹ Note that John Harvey and Bruce Irvine were directors of Heartland Bank Limited prior to the amalgamation with Heartland New Zealand Limited on 31 December 2015 and became directors of Heartland New Zealand Limited on amalgamation (renamed Heartland Bank Limited). For a full list of each director’s other directorships, please refer to the Disclosure Statement. The Board of Directors www.heartland.co.nz 17 Graham Kennedy J.P., BCom, FCA, ACIS, ACIM, CFInstD Director – Appointed 30 September 2010 Graham has over 40 years’ experience as a chartered accountant and business advisor. He is now an independent professional director and Chairman of a number of private companies, providing him with governance experience across a diverse range of business sectors including property, tourism, agribusiness, transport, construction and professional services. Graham is also actively involved, at a governance level, in a variety of community-based charitable organisations. Sir Christopher Mace KNZM CM Inst D Director – Appointed 30 September 2010 Sir Chris is an Auckland based company director with experience in the New Zealand and Australian business environment. He is Chairman of the Crown Research Institute, The National Institute of Water and Atmospheric Research (NIWA) and a Commissioner of the Tertiary Education Commission. He is also a board member of the New Zealand Initiative and continues as a director and/or investor in a number of companies. In June 2016 he was appointed as a Knight Companion of the New Zealand Order of Merit for services to science and education and in 2005 was made a CNZM for services to Antarctica and the community. He was inducted into the Business Hall of Fame in 2015 and was the 2011 Maori Business Leader of the Year. Geoffrey T Ricketts CNZM LLB (Hons), LLD (honoris causa), CFInstD Chairman – Appointed 30 September 2010 Geoff has extensive experience in New Zealand and Australia as a commercial lawyer, company director and investor. He is Chairman of The Todd Corporation Limited, Vero Insurance New Zealand Limited, and a director of Suncorp Group Limited, and a number of private companies. He was formerly Chairman of Lion Nathan Limited. Geoff is also Chairman of The University of Auckland Foundation. Gregory Tomlinson AME Director – Appointed 18 March 2013 Greg is a Christchurch based businessman and investor with 40 years’ experience owning, managing and building businesses. An early pioneer of the mussel industry of Marlborough, he has established Impact Capital with active investments in the aged care, animal pharmaceutical, finance and wine sectors. Greg and his wife Jill support a variety of charities in New Zealand and abroad. 18 Heartland Bank Limited - Annual Report 2016 The Heartland Trust TheHeartland Trust Every year The Heartland Trust supports organisations, clubs and schools across the country that are dedicated to helping young New Zealanders unlock their true potential. As these examples from the past year show, that potential could be on the sports field, on the stage, or through academic opportunities that might otherwise be out of reach. Tangaroa College Rugby The Heartland Trust is closely involved with First XV rugby in schools around the country, helping to fund playing kit and training equipment. One of those schools is Tangaroa College in Otara, where the roll is 75 per cent Pasifika and 20 per cent Maori, with Palagi and Asian students making up the rest. It’s a school that takes its rugby seriously, and we are delighted to have the Heartland name on the front of the jerseys. A recent Metro magazine article on the school said this: “Tangaroa College is a success story. They’re proud of what they do there, and you don’t have to spend long, with teachers or students, to see that.” Photo credit: Courtesy of Metro Magazine/Simon Young Photographer. The Heartland Trust www.heartland.co.nz 19 Schools Music Festival Around 500 young singers from 15 Mid Canterbury primary schools performed over three nights in the annual Heartland Bank Schools Music Festival in Ashburton. Heartland has sponsored the popular event for more than 20 years, and Ashburton branch manager Andrew Wilson says it fits perfectly with the bank’s local focus. “All around the country, Heartland is committed to giving back to the communities that support us. A festival like this, which brings together family, friends and the wider community, is a great way to do it”. King’s College Scholarships Heartland has for several years funded full scholarships for high-achieving boys to attend King’s College in Auckland. This year we are proud to have added two scholarships for outstanding female students as well. Heartland’s chief executive, Jeff Greenslade, says the purpose of the scholarships is: “to create opportunities for talented young students to benefit from a first class education that would otherwise be out of reach to them.” Scholarship recipients August Wairau and Cora Prime. 20 Heartland Bank Limited - Annual Report 2016 Corporate Governance The Board and management of Heartland are committed to ensuring that Heartland maintains corporate governance practices in line with current best practice. Codes of Conduct Heartland’s Code of Conduct and Directors’ Code of Conduct set out the ethical and behavioural standards expected of Heartland’s directors and employees. The Codes of Conduct are available on Heartland’s website. The Board has established policies and protocols which comply with the corporate governance requirements of the NZX Main Board Listing Rules and which are consistent with the principles contained in the NZX Corporate Governance Best Practice Code. This governance statement outlines the main corporate governance practices applied by Heartland as at 30 June 2016. During the year the Board reviewed and assessed Heartland’s governance structure to confirm that its governance practices are consistent with best practice. The Board considers it has complied with the NZX Corporate Governance Best Practice Code for the year ended 30 June 2016. This section of the Annual Report reflects Heartland’s compliance with the guidelines set out in the Financial Markets Authority’s handbook Corporate Governance in New Zealand Principles and Guidelines. Heartland’s Constitution, Board and Board Committee charters and key governance codes and policies are available on Heartland’s website, www.heartland.co.nz. Principle 1 – Ethical Standards Directors set high standards of ethical behaviour, model this behaviour, and hold management accountable for delivering these standards throughout the organisation. Heartland expects its directors and staff to act honestly and in good faith, and in the best interests of Heartland at all times. They must act with the care, diligence and skill expected of a director or staff member of a registered bank which issues securities and accepts funds from the general public, and has its shares publicly traded on the NZX Main Board. Directors and staff are required to act honestly and fairly in all dealings with Heartland’s shareholders, customers, investors and service providers. Each director and staff member has an obligation, at all times, to comply with the spirit as well as the letter of the law, to comply with the principles of Heartland’s Code of Conduct, the Directors’ Code of Conduct and Heartland’s Constitution, and to exhibit a high standard of ethical behaviour. Insider Trading Policy The Board continually assesses whether any matters under consideration are likely to materially influence Heartland’s share price and therefore whether additional trading restrictions should be imposed on directors and senior employees of Heartland. All directors and senior employees of Heartland are required to obtain consent before buying or selling shares in Heartland and to certify that their decision to buy or sell shares has not been made on the basis of inside information. Gender Diversity Heartland considers diversity in all its forms a strength, and is committed to supporting initiatives which foster diversity at all levels of the organisation. The following table shows the gender diversity of Directors and Officers of Heartland at 30 June 2016.1 Positions Directors Officers As at 30 June 2016 Female Male Total 1 (12.5%) 7 (87.5%) 2 (28.5%) 5 (71.4%) 8 7 21 Senior Executives 6 (29%) 15 (71%) All Staff 171 (47.5%) 189 (52.5%) 360 “Officers” include J K Greenslade and all persons who report directly to him in an executive capacity. Principle 2 – Board Composition and Performance There is a balance of independence, skills, knowledge, experience and perspectives among directors to ensure an effective Board. Role of the Board The Board of Directors is responsible for corporate governance and setting Heartland’s overall strategic direction. The Board charter regulates Board procedure and describes the Board’s role ¹ As at 30 June 2015, there were 2 (20%) female directors and 8 (80%) male directors across the boards of both Heartland New Zealand Limited and Heartland Bank Limited. Of a total of 9 officers, 3 (33.3%) were female and 6 (66.7%) were male. Corporate Governance www.heartland.co.nz 21 and responsibilities in detail. The Board establishes objectives, strategies and an overall policy framework within which the business is conducted. Day-to-day management is delegated to the Chief Executive Officer (and, in the case of risk management, to the Chief Risk Officer). The Board regularly monitors and reviews management’s performance in carrying out its delegated duties. The Board schedules regular meetings at which it receives briefings on key strategic and operational issues from management. Board Processes Heartland was formed by the amalgamation of Heartland New Zealand Limited (HNZ) and its subsidiary Heartland Bank Limited (HBL) on 31 December 2015. Prior to the amalgamation, each of HNZ and HBL had separate boards, which met separately. On the amalgamation, one continuing Board was formed for Heartland, made up of J K Greenslade, G R Kennedy, C R Mace, G T Ricketts and G R Tomlinson (who were reappointed with approval of shareholders at the annual shareholder meeting on 11 December 2015) and N J Greer, E J Harvey and B R Irvine (who were appointed to Heartland’s board with effect from the amalgamation). The Boards of HNZ and HBL each held 5 meetings during the first half of the financial year ended 30 June 2016, and, following the amalgamation, the Board of Heartland held 5 meetings. The table below shows attendance by each director at the meetings of the Boards and Board Committees of which he or she was a member. All of the then-serving directors of HBL and HNZ attended the Annual Meeting of both companies held on December 2015. Prior to Amalgamation HBL and HNZ Boards HBL Audit Committee HBL Risk Committee HNZ Audit & Risk Committee HNZ Governance & Remuneration Eligible to Attend Eligible Eligible Eligible Eligible Attended to Attend Attended to Attend Attended to Attend Attended to Attend Attended J K Greenslade 5 HBL & 5 HNZ 5 HBL & 5 HNZ N J Greer E J Harvey B R Irvine 5 HBL 5 HBL 5 HBL 5 5 5 G R Kennedy 5 HBL & 5 HNZ 4 HBL & 4 HNZ C R Mace 5 HNZ 5 G T Ricketts 5 HBL & 5 HNZ 5 HBL & 5 HNZ D J Taylor 5 HNZ 5 - - 3 3 3 3 3 - - - 3 3 2 3 3 - - 2 2 - 2 2 - - - 2 2 - 2 2 - - - - - - 3 - 3 3 - - - - 2 - 3 2 - - - 2 - - 2 - - - - 2 - - 2 - Post Amalgamation Board Audit Committee Risk Committee Governance, Remuneration & Capital Committee Eligible to Attend Eligible Eligible Eligible Attended to Attend Attended to Attend Attended to Attend Attended 5 5 5 5 5 5 5 5 5 5 4 5 5 4 5 5 - - 2 2 2 - 2 - - - 2 2 2 - 2 - - 3 3 - 3 3 - - - 3 3 - 3 3 - - - - - 1 - - 1 1 - - - 1 - - 1 1 J K Greenslade N J Greer E J Harvey B R Irvine G R Kennedy C R Mace G T Ricketts G R Tomlinson 22 Heartland Bank Limited - Annual Report 2016 Corporate Governance Board Membership, Size and Composition The NZX Main Board Listing Rules provide that the number of directors must not be fewer than three. Subject to this limitation, the size of the Board is determined from time to time by the Board. As at 30 June 2016, the Board comprised eight directors, being an independent Chairman, the Chief Executive Officer and six non- executive directors. The Board encourages rigorous discussion and analysis when making decisions. The Board recognises the need to have a range of complementary skills, knowledge and experience in order to support the implementation of its strategic priorities, and for the Board to have a balance of skills and attributes in order to support diversity at board level. With this in mind, the Board regularly reviews its composition and formally assesses its collective skills, knowledge and experience using a skills matrix developed specifically for Heartland. This exercise provides an opportunity to reflect on and discuss current Board composition, as well as succession planning. The current Board comprises directors with a mix of qualifications and skills who hold diverse business, governance and industry experience and is presently focussed on extending its collective experience in retail, as well as in the Australian banking market. Nomination and appointment of directors Procedures for the appointment and removal of directors are governed by Heartland’s constitution. A director is appointed by ordinary resolution of the shareholders, although the Board may fill a casual vacancy, in which case the appointed director retires at the next Annual Meeting but is eligible for re-election. Nominations for election as a director may be made by shareholders up until a closing date, which must not be more than two months before the date of the Annual Meeting. On appointment, each director signs a letter which sets out Heartland’s written expectations, including, among other things, its expectations regarding the time commitment required to perform the role effectively. The letter is accompanied by a Director’s Corporate Governance Manual, which includes key information for Heartland’s directors, including relevant charters and policies. Independence of Directors A director is considered to be independent if that director is not an executive of Heartland and if the director has no direct or indirect interest or relationship that could reasonably influence, in a material way, the director’s decisions in relation to Heartland. As at 30 June 2016, the Board determined that N Greer, E J Harvey, B R Irvine, G R Kennedy, C R Mace and G T Ricketts were the independent directors. Board Performance Assessment and Training The Board undertakes a formal review of its own, its committees’ and individual directors’ performance at least annually, and - as noted above - will regularly review its composition using a skills matrix. This is to ensure it has a range of complementary skills, knowledge and experience in order to effectively govern Heartland, to monitor its performance, and to support the implementation of its strategic priorities – in the interests of its shareholders. The Board regularly receives training in matters which are relevant to Heartland’s operations under a formal Board training programme. Principle 3 – Board Committees The Board uses committees where this enhances effectiveness in key areas while still retaining Board responsibility. Board Committees The Board has three permanently constituted committees to assist the Board by working with management in specific areas of responsibility and then reporting their findings and recommendations back to the Board. Each of these committees has a charter which sets out the committee’s objectives, membership, procedures and responsibilities. A committee does not take action or make decisions on behalf of the Board unless specifically mandated. The committee charters are available on Heartland’s website, www.heartland.co.nz. Other ad hoc Board committees are established for specific purposes from time to time. Audit Committee Membership is restricted to non-executive directors, with at least three members, the majority of whom must be independent. The Chair of the Audit Committee must be an independent director who is not the Chair of the Board. As at 30 June 2016, the members of the Audit Committee were B R Irvine (Chair), E J Harvey, G R Kennedy and G T Ricketts. The role of the Audit Committee is to advise and provide assurance to the Board in order to enable the Board to discharge its responsibilities in relation to the oversight of: • The integrity of financial control, financial management and external financial reporting. • The internal audit function. • The independent audit process. As at 30 June 2016, the Board determined that all committee members had a recognised form of financial expertise in accordance with the Audit Committee’s charter. Risk Committee Membership is restricted to non-executive directors, with at least three members, the majority of whom must be independent. The Chair of the Risk Committee must be an independent director who is not the Chair of the Board. Corporate Governance www.heartland.co.nz 23 As at 30 June 2016, the members of the Risk Committee were N J Greer, E J Harvey (Chair), G R Kennedy and C R Mace. The role of the Risk Committee is to advise and provide assurance to the Board in order to enable the Board to discharge its responsibilities in relation to the oversight of: • The formulation of its risk appetite, as defined in the Risk Appetite Statement. • The monitoring of the effectiveness of the Enterprise Risk Management Framework (ERMF). • Assurance that all risks within the key risk categories which are relevant to Heartland and its subsidiaries have been appropriately identified, managed and reported to the Board in accordance with the ERMF. Governance, Remuneration and Capital Committee The Committee is required to have at least three directors, the majority of whom must be independent. As at 30 June 2016, the members of the Governance and Remuneration Committee were G T Ricketts (Chair), B R Irvine and G R Tomlinson. The role of the Governance, Remuneration and Capital Committee is to advise and provide assurance to the Board in order to enable the Board to discharge its responsibilities in relation to: • Corporate governance matters. • Remuneration of the directors, Chief Executive Officer and senior executives and remuneration policies generally. • Director and senior executive appointments, Board composition and succession planning. • Capital management. Principle 4 – Reporting and Disclosures The Board demands integrity in both financial reporting and in the timeliness and balance of corporate disclosures. The Board is committed to ensuring the highest standards are maintained in financial reporting and disclosure of all relevant information. The Audit Committee oversees the quality and timeliness of all financial reports, including all disclosure documents issued by Heartland or any of its subsidiaries. The Chief Executive Officer and Chief Financial Officer are required to certify to the Audit Committee that the financial statements of Heartland and its subsidiaries present a true and fair view of Heartland and comply with all relevant accounting standards. Principle 5 – Remuneration The remuneration of directors and executives is transparent, fair and reasonable. Non-Executive Directors’ Remuneration Total remuneration available to non-executive directors of Heartland and its subsidiaries is determined by shareholders. The current aggregate approved amount by shareholders is $1,000,000 per annum. Heartland’s policy is to pay directors’ fees in cash. There is no requirement for directors to take a portion of their remuneration in shares and there is no requirement for directors to hold shares in Heartland. However, as at 30 June 2016 all directors held shares, or a beneficial interest in shares, in Heartland (see the “Directors’ Disclosures” section of this Report for further details). Senior Executive Remuneration The objective is to provide competitive remuneration that aligns executives’ remuneration with shareholder value and rewards the executives’ achievement of Heartland’s strategies and business plans. All senior executives receive a base salary and are also eligible to participate in short-term and, in some cases, long-term incentive plans under which they are rewarded for achieving key performance and operating results. Principle 6 – Risk Management The Board has a sound understanding of the key risks faced by the business. The Board regularly verifies that Heartland has appropriate processes that identify and manage potential and relevant risks. The Board ensures that Heartland has a Risk Management Programme in place which identifies, manages and communicates the key risks that may impact Heartland’s business. Specific risk management strategies have been developed for each of the key risks identified. The Risk Committee of the Board oversees the risk management programme and strategy. Heartland also has in place insurance cover for insurable liability and general business risk. Principle 7 – Auditors The Board ensures the quality and independence of the external audit process. The Audit Committee is responsible for overseeing the external, independent audit of Heartland’s financial statements. The Audit Committee ensures that the level of non-audit work undertaken by the auditors does not jeopardise their independence. 24 Heartland Bank Limited - Annual Report 2016 Corporate Governance Heartland’s External Auditor Independence Policy provides guidelines to ensure that non-audit related services do not conflict with the independent role of the external auditor, and the Audit Committee ensures that non-audit work undertaken by the auditors is in accordance with that Policy. That Policy also sets out guidelines in relation to the tenure and re-appointment of the external auditor, which the Audit Committee ensures are complied with. Refer to Heartland’s website for a copy of the External Auditor Independence Policy. The external auditor monitors its independence and reports to the Audit Committee bi-annually to confirm that it has remained independent in the previous six months, in accordance with Heartland’s External Auditor Independence Policy and the external auditor’s policies and professional requirements. There have been no threats to auditor independence identified during the year ended 30 June 2016. Heartland also has an internal audit function which is independent of the external auditors. The Audit Committee approves the annual internal audit programme, which is developed in consultation with management of Heartland. Principle 8 – Shareholder Relations The Board fosters constructive relationships with shareholders that encourage them to engage with Heartland. The Board is committed to maintaining a full and open dialogue with all shareholders, as outlined in the Shareholder Communications Policy and the Disclosure Policy, both of which are available on Heartland’s website. Heartland keeps shareholders informed through: • Periodic and continuous disclosure to NZX. • Information provided to analysts and media during briefings. • Heartland’s shareholder website (shareholders.heartland.co.nz). • The Annual Meeting, at which shareholders have the opportunity to ask questions. • Annual and half year reports. The Board encourages full participation of shareholders at the Annual Meeting to ensure a high level of accountability. Heartland’s external auditor also attends the Annual Meeting and is available to answer questions relating to the external audit. Principle 9 – Stakeholder Interests The Board respects the interests of stakeholders within the context of Heartland’s ownership type and its fundamental purpose. Heartland has a wide range of stakeholders and aims to manage its business in a way which builds sustainable value and produces positive outcomes for stakeholders. As a listed entity which is a registered bank, Heartland recognises its responsibility to respect and balance the interests of its stakeholders (including customers, staff, regulators and shareholders). www.heartland.co.nz 25 26 Heartland Bank Limited - Annual Report 2016 Disclosure Statement For The Year Ended 30 June 2016 For the year ended 30 June 2016 Disclosure Statement For The Year Ended 30 June 2016 www.heartland.co.nz 27 Contents General information Priority of creditors' claims Guarantee arrangements Directors Auditor Conditions of Registration Pending proceedings or arbitration Credit ratings Other material matters Directors’ statements Statement of Comprehensive Income Statement of Changes in Equity Statement of Financial Position Statement of Cash Flows Notes to the Financial Statements Basis of reporting Performance 1 Segmental analysis 2 Net interest income 3 Net operating lease income 4 Other income 5 6 7 8 Selling and administration expenses Impaired asset expense Taxation Earnings per share Financial Position Investments 9 Investment properties 10 11 Finance receivables 12 Operating lease vehicles 13 Borrowings 14 Share capital and dividends 15 Other balance sheet items 16 Fair value Risk Management 17 Risk management policies 18 Credit risk exposure 19 Asset quality 20 Liquidity risk 21 22 Concentrations of funding Interest rate risk Other Disclosures 23 Significant subsidiaries and interests in joint arrangements 24 Structured entities 25 Staff share ownership arrangements 26 Capital adequacy 27 Insurance business, securitisation, funds management, other fiduciary activities 28 Contingent liabilities and commitments 29 Application of new and revised accounting standards 30 Events after the reporting date Historical summary of financial statements Independent auditor’s report 28 28 28 29 30 31 36 36 36 37 38 39 40 41 43 43 44 45 46 46 46 47 47 48 49 49 50 51 51 51 52 54 57 59 62 67 68 70 70 70 71 73 78 79 79 79 80 81 28 Heartland Bank Limited - Annual Report 2016 Disclosure Statement For The Year Ended 30 June 2016 GENERAL INFORMATION This Disclosure Statement has been issued by Heartland Bank Limited (the bank) and its subsidiaries (the banking group) for the year ended 30 June 2016 in accordance with the Registered Bank Disclosure Statements (New Zealand Incorporated Registered Banks) Order 2014 (as amended) (the Order). The Financial Statements of the bank for the year ended 30 June 2016 form part of, and should be read in conjunction with, this Disclosure Statement. Words and phrases defined by the Order have the same meanings when used in this Disclosure Statement. On 31 December 2015, there was a change to the composition of the banking group as a result of an amalgamation of companies. Prior to 31 December 2015, the banking group comprised the company that was then known as “Heartland Bank Limited” (Former Heartland Bank) together with its subsidiaries. At that stage, Former Heartland Bank was wholly owned by a company then known as “Heartland New Zealand Limited” (Heartland New Zealand). On 31 December 2015, Former Heartland Bank amalgamated, by way of short form amalgamation, with Heartland New Zealand (the Amalgamation). Heartland New Zealand continued as the amalgamated company (with Former Heartland Bank being struck off the register of companies), but changed its name to “Heartland Bank Limited”. As a result of the Amalgamation, Heartland Bank Limited became a registered bank under the Reserve Bank of New Zealand Act 1989 and the banking group expanded to include the company that is now known as Heartland Bank Limited. Refer to the Reporting entity note within the notes to the financial statements for further detail. The bank's address for service is Level 3, Heartland House, 35 Teed Street, Newmarket, Auckland. Name and address for service The name of the Registered Bank is Heartland Bank Limited. The bank's address for service is Heartland House, 35 Teed Street, Newmarket, Auckland. Details of incorporation The bank was incorporated under the Companies Act 1993 on 30 September 2010. Interests in 5% or more of voting securities of the bank Name Harrogate Trustee Limited FNZ Custodians Limited Percentage held 10.12% 5.04% No person has the ability to directly or indirectly appoint 25% or more of the Board (or other persons exercising powers of management) of the bank. PRIORITY OF CREDITORS' CLAIMS In the event of the bank becoming insolvent or ceasing business, certain claims set out in legislation are paid in priority to others. These claims include secured creditors, taxes, certain payments to employees and any liquidator’s costs. After payment of those creditors, the claims of all other creditors are unsecured and would rank equally with each other. The loans sold to the Heartland ABCP Trust 1 (ABCP Trust) are set aside for the benefit of investors in the ABCP Trust (See Note 24 - Structured entities for further details). GUARANTEE ARRANGEMENTS As at the date this Disclosure Statement was signed, no material obligations of the bank were guaranteed. 2 Disclosure Statement For The Year Ended 30 June 2016 www.heartland.co.nz 29 DIRECTORS All Directors of the bank reside in New Zealand. Communications to the Directors can be sent to Heartland Bank Limited, 35 Teed Street Newmarket, Auckland. The Directors of the bank and their details at the time this Disclosure Statement was signed were: Name: Geoffrey Thomas Ricketts CNZM Chairman - Board of Directors Type of director: Independent Non-Executive Director Qualifications: LLB (Hons), LLD (honoris causa), CF Inst D Occupation: Company Director External Directorships: AAI Limited, Asteron Life Limited, Highground Trust Limited, Janmac Capital Limited, Macmine Investments Limited, Maisemore Enterprises Limited, MCF 1 Limited, MCF 2 Nexus Limited, MCF 3 Limited, MCF 4 Limited, MCF 5 Limited, MCF 6 Limited, MCF 7 Limited, MCF 8 Limited, MCF 9 Limited, MCF 10 Limited, MCF2 (Fund 1) Limited, MCF2A General Partner Limited, MCF2 GP Limited, Mercury Capital No.1 Fund Limited, Mercury Capital No. 1 Trustee Limited, New Zealand Catholic Education Office Limited, NZCEO Finance Limited, O & E Group Services Limited, Oceania and Eastern Australia Pty Limited, Oceania and Eastern Finance Limited, Oceania and Eastern Group Funds Limited, Oceania and Eastern Holdings Limited, Oceania and Eastern Limited, Oceania and Eastern Securities Limited, Oceania Capital Limited, Oceania Securities Limited, Quartet Equities Limited, SBGH Limited, Suncorp Group Limited, Suncorp Group Holdings (NZ) Limited, Suncorp Group New Zealand Limited, Suncorp Group Services NZ Limited, Suncorp Insurance Holdings Limited, Suncorp Life and Superannuation Limited, Suncorp Life Holdings Limited, Suncorp Metway Limited, The Centre for Independent Studies Limited, The Todd Corporation Limited, Todd Management Services Limited, Todd Offshore Limited, Vero Insurance New Zealand Limited, Vero Liability Insurance Limited. Name: Edward John Harvey Qualifications: BCom, CA Type of director: Independent Non-Executive Director Occupation: Company Director External Directorships: Ballance Agri-Nutrients Limited, Chalmers Properties Limited, Fiordland Pilot Services Limited, Investore Property Limited, Kathmandu Holdings Limited, New Zealand Opera Limited, Pomare Investments Limited, Port Otago Limited, South Freight Limited, Stride Holdings Limited, Stride Investment Management Limited, Stride Property Limited, Te Rapa Gateway Limited. Name: Bruce Robertson Irvine Qualifications: BCom, LLB, FCA, CF Inst D, FNZIM Type of director: Independent Non-Executive Director Occupation: Company Director External Directorships: Air Rarotonga Limited, Avon Pacific Holdings Limited, B R Irvine Limited, Blackbyre Horticulture Limited, Bowdens Mart Limited, Bray Frampton Limited, Britten Motorcycle Company Limited, Canterbury Spinners Limited, CCHL (2) Limited, CCHL (4) Limited, CCHL (5) Limited, Chambers @151 Limited, Christchurch City Holdings Limited, Christchurch City Networks Limited, Cockerill and Campbell (2007) Limited, Godfrey Hirst NZ Limited, Godfrey Hirst Australia Pty Limited, GZ Capital Limited, GZ NZ Limited, GZ RES Limited, Hansons Lane International Holdings Limited, House of Travel ESP Trustee Limited, House of Travel Holdings Limited, Lake Angelus Holdings Limited, Lamanna Bananas (NZ) Limited, Lamanna Bananas Pty Limited, Lamanna Limited, Limeloader Irrigation Limited, Market Fresh Wholesale Limited, Market Gardeners Limited, Market Gardeners Orders (Christchurch) Limited, Market Gardeners Orders Wellington Limited, MG Group Holdings Limited, MG Marketing Limited, MG New Zealand Limited, Noblesse Oblige Limited, PGG Wrightson Limited, Phimai Holdings Limited, Quitachi Limited, Rakon ESOP Trustee Limited, Rakon Limited, Rakon PPS Trustee Limited, Scenic Circle Hotels Limited, Skope Industries Limited, Southland Produce Markets Limited, Wavell Resources Limited. Name: Graham Russell Kennedy Qualifications: J. P., BCom, FCA, ACIS, ACIM, CF Inst D Type of director: Non-Independent Non-Executive Director Occupation: Company Director External Directorships: Ashburton Aquatic Park Limited, Ashburton Central Limited, Avon Properties (2008) Limited, BK&P Trustees Limited, BK Riversdale Trustees Limited, Black Gnat Properties Limited, Black Quill Investments Limited, Bradford Group Holdings Limited, Cates Grain & Seed Limited, Concurrent Properties Limited, Crescent Custodians Limited, Earth & Sky Limited, Eastfield Investments Limited, Hornby Consortium Limited, Lake Extension Trust Limited, Norman Spencer Nominees Limited, NZ Express Transport (2006) Limited, Rural Transport Limited, Timaru Central Limited, Trevor Wilson Charities Limited, Trevor Wilson Charities (No. 2) Limited. Name: Sir Christopher Robert Mace KNZM Qualifications: CM Inst D Type of director: Independent Non-Executive Director Occupation: Company Director External Directorships: Akitu Equities Limited, Akitu Capital Limited, Akitu Health Services Limited, Akitu Investments Limited, Goldburn Resources Limited, Helicopter Enterprises Limited, Janik Equities Limited, Janmac Capital Limited, J N S Capital Limited, Mace Capital Limited, Mace Construction Limited, Mace Developments Limited, Mace Enterprises Limited, Mace Investments Limited, Maisemore Enterprises Limited, National Institute of Water and Atmospheric Research Limited, Niwa Vessel Management Limited, Nuffield Forestry Limited, Oceania and Eastern Finance Limited, Oceania and Eastern Group Funds Limited, Oceania and Eastern Holdings Limited, Oceania and Eastern Limited, Oceania and Eastern Securities Limited, Oceania Capital Limited, O & E Group Services Limited, Paroa Bay Station Limited, PPT Trustee (NZ) Limited, Pukeha Farms Limited, Quartet Equities Limited, Ryburn Lagoon Trust Limited, St. Just Enterprises Limited, The New Zealand Initiative Limited. 3 30 Heartland Bank Limited - Annual Report 2016 Disclosure Statement For The Year Ended 30 June 2016 DIRECTORS (CONTINUED) Name: Gregory Raymond Tomlinson Qualifications: AME Type of director: Non-Independent Non-Executive Director Occupation: Company Director External Directorships: Argenta Limited, Chippies Vineyard Limited, Forte Health Group Limited, Forte Health Limited, Impact Capital Management Limited, Impact Capital Limited, Indevin Group Limited, Little Ngakuta Trust Company Limited, Lokoya Limited, Mountbatten Trustee Limited, Nearco Stud Limited, Ngakuta Trust Company Limited, Oceania Healthcare Holdings Limited, Oceania Healthcare Limited, Pelorus Finance Limited, St Leonards Limited, The Icehouse Limited. Name: Jeffrey Kenneth Greenslade Qualifications: LLB Type of director: Non-Independent Executive Director Occupation: Chief Executive Officer of the bank External Directorships: Brew Greenslade & Company Limited. Conflicts of interest policy All Directors are required to disclose to the Board any actual or potential conflict of interest which may exist or is thought to exist upon appointment and are required to keep these disclosures up to date. The details of each disclosure made by a Director to the Board must be entered in the Interests Register. Directors are required to take any necessary and reasonable measures to try to resolve the conflict and comply with the Companies Act 1993 on disclosing interests and restrictions on voting. Any Director with a material personal, professional or business interest in a matter being considered by the Board must declare their interest and, unless the Board resolves otherwise, may not be present during the boardroom discussions or vote on the relevant matter. Interested transactions There have been no transactions between the bank or any member of the banking group and any Director or immediate relative or close business associate of any Director which either has been entered into on terms other than those which would in the ordinary course of business of the bank or any member of the banking group be given to any other person of like circumstances or means, or could be reasonably likely to influence materially the exercise of the Directors' duties. Audit committee composition Members of the bank's Audit Committee as at the date of this Disclosure Statement are as follows: Bruce Robertson Irvine (Chairperson) Independent Non-Executive Director Edward John Harvey Graham Russell Kennedy Geoffrey Thomas Ricketts Independent Non-Executive Director Independent Non-Executive Director Independent Non-Executive Director AUDITOR KPMG KPMG Centre 18 Viaduct Harbour Avenue Auckland 4 Disclosure Statement For The Year Ended 30 June 2016 www.heartland.co.nz 31 CONDITIONS OF REGISTRATION These conditions apply on and after 1 November 2015. The registration of Heartland Bank Limited ("the bank") as a registered bank is subject to the following conditions: 1. That— (a) (b) (c) (d) the Total capital ratio of the banking group is not less than 8%; the Tier 1 capital ratio of the banking group is not less than 6%; the Common Equity Tier 1 capital ratio of the banking group is not less than 4.5%; the Total capital of the banking group is not less than $30 million; and (e) the bank must not include the amount of an Additional Tier 1 capital instrument or Tier 2 capital instrument issued after 1 January 2013 in the calculation of its capital ratios unless it has received a notice of non-objection to the instrument from the Reserve Bank; and (f) the bank meets the requirements of Part 3 of the Reserve Bank of New Zealand document "Application requirements for capital recognition or repayment and notification requirements in respect of capital" (BS16) dated November 2015 in respect of regulatory capital instruments. For the purposes of this condition of registration, - the Total capital ratio, the Tier 1 capital ratio, the Common Equity Tier 1 capital ratio and Total capital must be calculated in accordance with the Reserve Bank of New Zealand document: “Capital Adequacy Framework (Standardised Approach)” (BS2A) dated November 2015. an Additional Tier 1 capital instrument is an instrument that meets the requirements of subsection 8(2)(a) or (c) of the Reserve Bank of New Zealand document "Capital Adequacy Framework (Standardised Approach)" (BS2A) dated November 2015. a Tier 2 capital instrument is an instrument that meets the requirements of subsection 9(2)(a) or (c) of the Reserve Bank of New Zealand document "Capital Adequacy Framework (Standardised Approach)" (BS2A) dated November 2015. 1A. That— (a) the bank has an internal capital adequacy assessment process (“ICAAP”) that accords with the requirements set out in the document “Guidelines on a bank’s internal capital adequacy assessment process ('ICAAP')” (BS12) dated December 2007; (b) under its ICAAP the bank identifies and measures its “other material risks” defined as all material risks of the banking group that are not explicitly captured in the calculation of the Common Equity Tier 1 capital ratio, the Tier 1 capital ratio and the Total capital ratio under the requirements set out in the document “Capital Adequacy Framework (Standardised Approach)” (BS2A) dated November 2015; and (c) the bank determines an internal capital allocation for each identified and measured “other material risk”. 1B. That, if the buffer ratio of the banking group is 2.5% or less, the bank must: (a) according to the following table, limit the aggregate distributions of the bank’s earnings to the percentage limit to distributions that corresponds to the banking groups buffer ratio: Banking group's buffer ratio Percentage limit to distributions of the banks' earnings 0% - 0.625% >0.625% -1.25% >1.25% - 1.875% >1.875% - 2.5% 0% 20% 40% 60% (b) prepare a capital plan to restore the banking group's buffer ratio to above 2.5% within any timeframe determined by the Reserve Bank for restoring the buffer ratio; and (c) have the capital plan approved by the Reserve Bank. For the purposes of this condition of registration, - “buffer ratio”, “distributions”, and “earnings” have the same meaning as in Part 3 of the Reserve Bank of New Zealand document: “Capital Adequacy Framework (Standardised Approach)” (BS2A) dated November 2015. 2. That the banking group does not conduct any non-financial activities that in aggregate are material relative to its total activities. In this condition of registration, the meaning of “material” is based on generally accepted accounting practice. 5 32 Heartland Bank Limited - Annual Report 2016 Disclosure Statement For The Year Ended 30 June 2016 CONDITIONS OF REGISTRATION (CONTINUED) That the banking group’s insurance business is not greater than 1% of its total consolidated assets. 3. CONDITIONS OF REGISTRATION (CONTINUED) For the purposes of this condition of registration, the banking group’s insurance business is the sum of the following amounts for entities in the 3. banking group: That the banking group’s insurance business is not greater than 1% of its total consolidated assets. if the business of an entity predominantly consists of insurance business and the entity is not a subsidiary of another entity in the banking (a) For the purposes of this condition of registration, the banking group’s insurance business is the sum of the following amounts for entities in the the insurance business to sum is the total group whose business predominantly consists of insurance business, the amount of banking group: (a) (b) (b) consolidated assets of the group headed by the entity; and if the business of an entity predominantly consists of insurance business and the entity is not a subsidiary of another entity in the banking if the entity conducts insurance business and its business does not predominantly consist of insurance business and the entity is not a group whose business predominantly consists of the insurance business to sum is the total subsidiary of another entity in the banking group whose business predominantly consists of insurance business, the amount of the consolidated assets of the group headed by the entity; and insurance business to sum is the total liabilities relating to the entity's insurance business plus the equity retained by the entity to meet the if the entity conducts insurance business and its business does not predominantly consist of insurance business and the entity is not a solvency or financial soundness needs of its insurance business. subsidiary of another entity in the banking group whose business predominantly consists of insurance business, the amount of the insurance business, the amount of In determining the total amount of the banking group’s insurance business— insurance business to sum is the total liabilities relating to the entity's insurance business plus the equity retained by the entity to meet the (a) solvency or financial soundness needs of its insurance business. all amounts must relate to on balance sheet items only, and must comply with generally accepted accounting practice; and In determining the total amount of the banking group’s insurance business— (b) if products or assets of which an insurance business is comprised also contain a non-insurance component, the whole of such products (a) or assets must be considered part of the insurance business. all amounts must relate to on balance sheet items only, and must comply with generally accepted accounting practice; and For the purposes of this condition of registration,— (b) if products or assets of which an insurance business is comprised also contain a non-insurance component, the whole of such products or assets must be considered part of the insurance business. "insurance business" means the undertaking or assumption of liability as an insurer under a contract of insurance: For the purposes of this condition of registration,— “insurer” and “contract of insurance” have the same meaning as provided in sections 6 and 7 of the Insurance (Prudential Supervision) Act 2010. "insurance business" means the undertaking or assumption of liability as an insurer under a contract of insurance: “insurer” and “contract of insurance” have the same meaning as provided in sections 6 and 7 of the Insurance (Prudential Supervision) Act That aggregate credit exposures (of a non-capital nature and net of any allowances for impairment) of the banking group to all connected 2010. persons do not exceed the rating-contingent limit outlined in the following matrix: Credit rating of the bank 1 That aggregate credit exposures (of a non-capital nature and net of any allowances for impairment) of the banking group to all connected persons do not exceed the rating-contingent limit outlined in the following matrix: Connected exposure limit (% of the banking group’s Tier 1 capital) 75 AA/Aa2 and above Credit rating of the bank 1 AA-/Aa3 A+/A1 AA/Aa2 and above A/A2 AA-/Aa3 A-/A3 A+/A1 BBB+/Baa1 and below A/A2 Within the rating-contingent limit, credit exposures (of a non-capital nature and net of any allowances for impairment) to non-bank connected A-/A3 persons shall not exceed 15% of the banking group’s Tier 1 capital. BBB+/Baa1 and below Connected exposure limit (% of the banking group’s 70 Tier 1 capital) 60 75 40 70 30 60 15 40 30 15 For the purposes of this condition of registration, compliance with the rating-contingent connected exposure limit is determined in accordance Within the rating-contingent limit, credit exposures (of a non-capital nature and net of any allowances for impairment) to non-bank connected with the Reserve Bank of New Zealand document entitled “Connected exposures policy” (BS8) dated November 2015. persons shall not exceed 15% of the banking group’s Tier 1 capital. For the purposes of this condition of registration, compliance with the rating-contingent connected exposure limit is determined in accordance That exposures to connected persons are not on more favourable terms (e.g. as relates to such matters as credit assessment, tenor, interest with the Reserve Bank of New Zealand document entitled “Connected exposures policy” (BS8) dated November 2015. rates, amortisation schedules and requirement for collateral) than corresponding exposures to non-connected persons. That exposures to connected persons are not on more favourable terms (e.g. as relates to such matters as credit assessment, tenor, interest rates, amortisation schedules and requirement for collateral) than corresponding exposures to non-connected persons. 4. 4. 5. 5. 1 This table uses the rating scales of Standard & Poor's, Fitch Ratings and Moody's Investor Service (Fitch Ratings' scale is identical to Standard & Poor's). 1 This table uses the rating scales of Standard & Poor's, Fitch Ratings and Moody's Investor Service (Fitch Ratings' scale is identical to Standard & Poor's). 6 6 Disclosure Statement For The Year Ended 30 June 2016 www.heartland.co.nz 33 CONDITIONS OF REGISTRATION (CONTINUED) 6. That the bank complies with the following corporate governance requirements: (a) (b) (c) (d) (e) (f) the board of the bank must have at least five directors; the majority of the board members must be non-executive directors; at least half of the board members must be independent directors; an alternate director,— (i) (ii) for a non-executive director must be non-executive; and for an independent director must be independent; at least half of the independent directors of the bank must be ordinarily resident in New Zealand; the chairperson of the board of the bank must be independent; and (g) the bank’s constitution must not include any provision permitting a director, when exercising powers or performing duties as a director, to act other than in what he or she believes is the best interests of the company (i.e. the bank). For the purposes of this condition of registration,— “independent,”— (a) in relation to a person other than a person to whom paragraph (b) applies, has the same meaning as in the Reserve Bank of New Zealand document entitled “Corporate Governance” (BS14) dated July 2014; and (b) in relation to a person who is the chairperson of the board of the bank, means a person who— (i) meets the criteria for independence set out in section 10 except for those in paragraph 10(1)(a) in BS14; and (ii) does not raise any grounds of concern in relation to the person’s independence that are communicated in writing to the bank by the Reserve Bank of New Zealand: “non-executive” has the same meaning as in the Reserve Bank of New Zealand document entitled “Corporate Governance” (BS14) dated July 2014. 7. That no appointment of any director, chief executive officer, or executive who reports or is accountable directly to the chief executive officer, is made in respect of the bank unless: (a) (b) the Reserve Bank has been supplied with a copy of the curriculum vitae of the proposed appointee; and the Reserve Bank has advised that it has no objection to that appointment. 8. That a person must not be appointed as chairperson of the board of the bank unless: (a) (b) the Reserve Bank has been supplied with a copy of the curriculum vitae of the proposed appointee; and the Reserve Bank has advised that it has no objection to that appointment. 9. That the bank has a board audit committee, or other separate board committee covering audit matters, that meets the following requirements: (a) the mandate of the committee must include: ensuring the integrity of the bank’s financial controls, reporting systems and internal audit standards; the committee must have at least three members; every member of the committee must be a non-executive director of the bank; the majority of the members of the committee must be independent; and the chairperson of the committee must be independent and must not be the chairperson of the bank. (b) (c) (d) (e) For the purposes of this condition of registration, “independent” and “non-executive” have the same meanings as in condition of registration 6. 10. 11. That a substantial proportion of the bank’s business is conducted in and from New Zealand. That the banking group complies with the following quantitative requirements for liquidity-risk management: (a) (b) (c) the one-week mismatch ratio of the banking group is not less than zero percent at the end of each business day; the one-month mismatch ratio of the banking group is not less than zero percent at the end of each business day; and the one-year core funding ratio of the banking group is not less than 75 percent at the end of each business day. For the purposes of this condition of registration, the ratios identified must be calculated in accordance with the Reserve Bank of New Zealand documents entitled “Liquidity Policy” (BS13) dated July 2014 and “Liquidity Policy Annex: Liquid Assets” (BS13A) dated December 2011. 7 34 Heartland Bank Limited - Annual Report 2016 Disclosure Statement For The Year Ended 30 June 2016 CONDITIONS OF REGISTRATION (CONTINUED) 12. That the bank has an internal framework for liquidity risk management that is adequate in the bank’s view for managing the bank’s liquidity risk at a prudent level, and that, in particular: (a) (b) (c) is clearly documented and communicated to all those in the organisation with responsibility for managing liquidity and liquidity risk; identifies responsibility for approval, oversight and implementation of the framework and policies for liquidity risk management; identifies the principal methods that the bank will use for measuring, monitoring and controlling liquidity risk; and (d) considers the material sources of stress that the bank might face, and prepares the bank to manage stress through a contingency funding plan. 13. That no more than 10% of total assets may be beneficially owned by a SPV. For the purposes of this condition,— “total assets” means all assets of the banking group plus any assets held by any SPV that are not included in the banking group’s assets: “SPV” means a person— (a) (b) to whom any member of the banking group has sold, assigned, or otherwise transferred any asset; who has granted, or may grant, a security interest in its assets for the benefit of any holder of any covered bond; and (c) who carries on no other business except for that necessary or incidental to guarantee the obligations of any member of the banking group under a covered bond: “covered bond” means a debt security issued by any member of the banking group, for which repayment to holders is guaranteed by a SPV, and investors retain an unsecured claim on the issuer. 14. That— (a) no member of the banking group may give effect to a qualifying acquisition or business combination that meets the notification threshold, and does not meet the non-objection threshold, unless: (i) the bank has notified the Reserve Bank in writing of the intended acquisition or business combination and at least 10 working days have passed; and (ii) at the time of notifying the Reserve Bank of the intended acquisition or business combination, the bank provided the Reserve Bank with the information required under the Reserve Bank of New Zealand Banking Supervision Handbook document “Significant Acquisitions Policy” (BS15) dated December 2011; and (b) no member of the banking group may give effect to a qualifying acquisition or business combination that meets the non-objection threshold unless: (i) the bank has notified the Reserve Bank in writing of the intended acquisition or business combination; (ii) at the time of notifying the Reserve Bank of the intended acquisition or business combination, the bank provided the Reserve Bank with the information required under the Reserve Bank of New Zealand Banking Supervision Handbook document “Significant Acquisitions Policy” (BS15) dated December 2011; and (iii) the Reserve Bank has given the bank a notice of non-objection to the significant acquisition or business combination. For the purposes of this condition of registration, “qualifying acquisition or business combination”, “notification threshold” and “non-objection threshold” have the same meaning as in the Reserve Bank of New Zealand Banking Supervision Handbook document “Significant Acquisitions Policy” (BS15) dated December 2011. 15. That the bank is pre-positioned for Open Bank Resolution and in accordance with a direction from the Reserve Bank, the bank can— (a) close promptly at any time of the day and on any day of the week and that effective upon the appointment of the statutory manager— (i) (ii) all liabilities are frozen in full; and no further access by customers and counterparties to their accounts (deposits, liabilities or other obligations) is possible; (b) (c) apply a de minimis to relevant customer liability accounts; apply a partial freeze to the customer liability account balances; (d) reopen by no later than 9am the next business day following the appointment of a statutory manager and provide customers access to their unfrozen funds; (e) (f) maintain a full freeze on liabilities not pre-positioned for open bank resolution; and reinstate customers' access to some or all of their residual frozen funds. For the purposes of this condition of registration, “de minimis ”, “partial freeze”, “customer liability account”, and “frozen and unfrozen funds” have the same meaning as in the Reserve Bank of New Zealand document “Open Bank Resolution (OBR) Pre-positioning Requirements Policy” (BS17) dated September 2013. 8 Disclosure Statement For The Year Ended 30 June 2016 www.heartland.co.nz 35 CONDITIONS OF REGISTRATION (CONTINUED) 16. That the bank has an Implementation Plan that— (a) is up-to-date; and (b) demonstrates that the bank's prepositioning for Open Bank Resolution meets the requirements set out in the Reserve Bank document: "Open Bank Resolution Pre-positioning Requirements Policy" (BS 17). For the purposes of this condition of registration, “Implementation Plan” has the same meaning as in the Reserve Bank of New Zealand document “Open Bank Resolution (OBR) Pre-positioning Requirements Policy” (BS17) dated September 2013. 17. That the bank has a compendium of liabilities that— (a) at the product-class level lists all liabilities, indicating which are— (i) (ii) pre-positioned for Open Bank Resolution; and not pre-positioned for Open Bank Resolution; is agreed to by the Reserve Bank; and if the Reserve Bank's agreement is conditional, meets the Reserve Bank's conditions. (b) (c) For the purposes of this condition of registration, “compendium of liabilities”, and “pre-positioned and non pre-positioned liabilities” have the same meaning as in the Reserve Bank of New Zealand document “Open Bank Resolution (OBR) Pre-positioning Requirements Policy” (BS17) dated September 2013. 18. That on an annual basis the bank tests all the component parts of its Open Bank Resolution solution that demonstrates the bank's prepositioning for Open Bank Resolution as specified in the bank's Implementation Plan. For the purposes of this condition of registration, “Implementation Plan” has the same meaning as in the Reserve Bank of New Zealand document “Open Bank Resolution (OBR) Pre-positioning Requirements Policy” (BS17) dated September 2013. 19. 20. 21. 22. That, for a loan-to-valuation measurement period, the total of the bank’s qualifying new mortgage lending amount in respect of APIL with a loan- to-valuation ratio of more than 70%, must not exceed 5% of the total of the qualifying new mortgage lending amount in respect of APIL arising in the loan-to-valuation measurement period. That, for a loan-to-valuation measurement period, the total of the bank's qualifying new mortgage lending amount in respect of ANPIL with a loan-to-valuation ratio of more than 80%, must not exceed 10% of the total of the qualifying new mortgage lending amount in respect of ANPIL arising in the loan-to-valuation measurement period. That, for a loan-to-valuation measurement period, the total of the bank's qualifying new mortgage lending amount in respect of non-Auckland loans with a loan-to-valuation ratio of more than 80%, must not exceed 15% of the total of the qualifying new mortgage lending amount in respect of non-Auckland loans arising in the loan-to-valuation measurement period. That the bank must not make a residential mortgage loan unless the terms and conditions of the loan contract or the terms and conditions for an associated mortgage require that a borrower obtain the bank's agreement before the borrower can grant to another person a charge over the residential property used as security for the loan. In these conditions of registration,— “banking group”— means Heartland Bank Limited (as reporting entity) and all other entities included in the group as defined in section 6(1) of the Financial Markets Conduct Act 2013 for the purposes of Part 7 of that Act. "generally accepted accounting practice" has the same meaning as in section 8 of the Financial Reporting Act 2013. In conditions of registration 19 to 22,— "ANPIL", APIL", "loan-to-valuation ratio", "non-Auckland loan", "qualifying new mortgage lending amount in respect of [ ... ]" and "residential mortgage loan" have the same meaning as in the Reserve Bank of New Zealand document entitled "Framework for Restrictions on High-LVR Residential Mortgage Lending" (BS19) dated November 2015. "loan-to-valuation measurement period" means a period of six calendar months ending on the last day of the sixth calendar month, the first of which ends on the last day of April 2016. 9 36 Heartland Bank Limited - Annual Report 2016 Disclosure Statement For The Year Ended 30 June 2016 PENDING PROCEEDINGS OR ARBITRATION There are no pending legal proceedings or arbitrations concerning any member of the banking group at the date of this Disclosure Statement that may have a material adverse effect on the bank or the banking group. CREDIT RATINGS As at the date of signing this Disclosure Statement, the bank's credit rating issued by Fitch Australia Pty Ltd (Fitch Ratings) was BBB stable. This BBB credit rating was issued on 14 October 2015, following an upgrade from BBB- stable and is applicable to long term unsecured obligations payable in New Zealand, in New Zealand dollars. The following is a summary of the descriptions of the ratings categories for rating agencies for the rating of long-term senior unsecured obligations: Fitch Ratings Standard & Poor's Moody's Investors Service Description of Grade AAA AA A BBB BB B CCC AAA AA A BBB BB B CCC Aaa Aa A Baa Ba B Caa Ability to repay principal and interest is extremely strong. This is the highest investment category. Very strong ability to repay principal and interest in a timely manner. Strong ability to repay principal and interest although somewhat susceptible to adverse changes in economic, business or financial conditions. Adequate ability to repay principal and interest. More vulnerable to adverse changes. Significant uncertainties exist which could affect the payment of principal and interest on a timely basis. Greater vulnerability and therefore greater likelihood of default. Likelihood of default considered high. Timely repayment of principal and interest is dependent on CC - C RD to D CC - C Ca - C favourable financial conditions. Highest risk of default. D - Obligations currently in default. Credit ratings from Fitch Ratings and Standard & Poor’s may be modified by the addition of a plus or minus sign to show relative status within the major rating categories. Moody’s Investors Service apply numerical modifiers 1, 2, and 3 to show relative standing within the major rating categories, with 1 indicating the higher end and 3 the lower end of the rating category. OTHER MATERIAL MATTERS There are no material matters relating to the business or affairs of the bank or the banking group that are not contained elsewhere in this Disclosure Statement which would, if disclosed in this Disclosure Statement, materially affect the decision of a person to subscribe for debt securities of which the bank or any member of the banking group is the issuer. 10 Disclosure Statement For The Year Ended 30 June 2016 www.heartland.co.nz 37 DIRECTORS' STATEMENTS Each Director of the bank states that he or she believes, after due enquiry, that: 1. As at the date on which the Disclosure Statement is signed: (a) (b) the Disclosure Statement contains all the information that is required by the Order; and the Disclosure Statement is not false or misleading. 2. During the year ended 30 June 2016: (a) (b) (c) the bank complied with all conditions of the registration; credit exposures to connected persons were not contrary to the interests of the banking group; and the bank had systems in place to monitor and control adequately the banking group’s material risks, including credit risk, concentration of credit risk, interest rate risk, currency risk, equity risk, liquidity risk, operational risk and other business risks, and that those systems were being properly applied. This Disclosure Statement is dated 16 August 2016 and has been signed by all the Directors. G. T. Ricketts (Chair - Board of Directors) G. T. Ricketts (Chair - Board of Directors) B. R. Irvine B. R. Irvine J. K. Greenslade G. R. Kennedy E. J. Harvey G. R. Tomlinson C. R. Mace 11 38 Heartland Bank Limited - Annual Report 2016 Disclosure Statement For The Year Ended 30 June 2016 STATEMENT OF COMPREHENSIVE INCOME For the year ended 30 June 2016 Interest income Interest expense Net interest income Operating lease income Operating lease expenses Net operating lease income Lending and credit fee income Other income Net operating income Selling and administration expenses Profit before impaired asset expense and income tax Impaired asset expense Operating profit Share of joint arrangement profit Profit before income tax Income tax expense Profit for the year Other comprehensive income Items that are or may be reclassified subsequently to profit or loss: Effective portion of changes in fair value of cash flow hedges, net of income tax Movement in available for sale reserve, net of income tax Movement in foreign currency translation reserve, net of income tax Items that will not be reclassified to profit or loss: Movement in defined benefit reserve, net of income tax Other comprehensive (loss) / income for the year, net of income tax Total comprehensive income for the year Earnings per share from continuing operations Basic earnings per share Diluted earnings per share Total comprehensive income for the year is attributable to owners of the Bank. The notes on pages 43 to 79 are an integral part of these financial statements. The notes on pages 17 to 53 are an integral part of these financial statements. Jun 2016 Jun 2015 NOTE $000 $000 2 2 3 3 4 5 6 7 265,475 118,815 146,660 260,468 126,041 134,427 8,869 6,230 2,639 3,339 4,923 10,350 7,087 3,263 3,077 3,940 157,561 144,707 69,872 87,689 13,501 74,188 68,403 76,304 12,105 64,199 - 137 74,188 64,336 20,024 54,164 16,173 48,163 (708) (208) (4,047) (2,709) 898 2,136 (93) 50 (5,056) 375 49,108 48,538 8 8 11c 11c 10c 10c 12 Disclosure Statement For The Year Ended 30 June 2016 www.heartland.co.nz 39 STATEMENT OF CHANGES IN EQUITY For the year ended 30 June 2016 Treasury Employee Currency Available Defined Foreign Share Shares Benefits Translation for sale benefit Hedging Retained Capital Reserve Reserve Reserve Reserve Reserve Reserve Earnings NOTE $000 $000 $000 $000 $000 $000 $000 $000 Total Equity $000 Balance at 1 July 2015 413,917 (272) 2,200 2,231 1,170 94 (1,552) 62,337 480,125 Total comprehensive income / (loss) for the year Profit for the year Other comprehensive loss, net of income tax Total comprehensive income / (loss) for the year Contributions by and distributions to owners Dividends paid Dividend reinvestment plan Share based payments Shares vested Treasury shares acquired Total transactions with owners 14 14 25 - - - - 7,300 - 160 - 7,460 - - - - - - 50 (2,390) (2,340) - - - - - 1,888 (210) - 1,678 - (4,047) (4,047) - (208) (208) - (93) (93) - 54,164 (708) (708) - 54,164 54,164 (5,056) 49,108 - - - - - - - - - - - - - - - - - - - - - - - - (37,690) (37,690) - - - - 7,300 1,888 - (2,390) (37,690) (30,892) Balance at 30 June 2016 421,377 (2,612) 3,878 (1,816) 962 1 (2,260) 78,811 498,341 Balance at 1 July 2014 406,142 (926) 1,476 95 272 44 1,157 44,362 452,622 Total comprehensive income / (loss) for the year Profit for the year Other comprehensive income / (loss), net of income tax Total comprehensive income / (loss) for the year Contributions by and distributions to owners Dividends paid Dividend reinvestment plan Share based payments Shares vested Treasury shares sold Total transactions with owners 14 14 25 - - - - 7,621 - 138 16 7,775 - - - - - - 629 25 654 - - - - - 1,491 (767) - 724 - 2,136 2,136 - - - - - - - 898 898 - - - - - - - 50 50 - - - - - - - 48,163 48,163 (2,709) - 375 (2,709) 48,163 48,538 - - - - - - (30,188) (30,188) - - - - 7,621 1,491 - 41 (30,188) (21,035) Balance at 30 June 2015 413,917 (272) 2,200 2,231 1,170 94 (1,552) 62,337 480,125 The notes on pages 17 to 53 are an integral part of these financial statements. The notes on pages 43 to 79 are an integral part of these financial statements. 13 40 Heartland Bank Limited - Annual Report 2016 Disclosure Statement For The Year Ended 30 June 2016 STATEMENT OF FINANCIAL POSITION As at 30 June 2016 Assets Cash and cash equivalents Investments Investment properties Finance receivables Operating lease vehicles Other assets Investment in joint arrangement Intangible assets Deferred tax asset Total assets Liabilities Borrowings Current tax liabilities Trade and other payables Total liabilities Equity Share capital Retained earnings and reserves Total equity Total equity and liabilities Total interest earning and discount bearing assets Total interest and discount bearing liabilities The notes on pages 17 to 53 are an integral part of these financial statements. The notes on pages 43 to 79 are an integral part of these financial statements. Jun 2016 Jun 2015 NOTE $000 $000 9 10 11 12 15(a) 15(b) 7(c) 84,154 37,012 236,435 329,338 8,384 24,513 3,113,957 2,862,070 24,557 14,871 - 57,755 7,068 29,998 12,119 4,383 51,119 8,707 3,547,181 3,359,259 13 2,999,987 2,825,245 15(c) 6,754 42,099 7,869 46,020 3,048,840 2,879,134 14 418,765 413,645 79,576 66,480 498,341 480,125 3,547,181 3,359,259 3,427,117 3,221,246 3,005,853 2,834,100 14 Disclosure Statement For The Year Ended 30 June 2016 www.heartland.co.nz 41 STATEMENT OF CASH FLOWS For the year ended 30 June 2016 Cash flows from operating activities Interest received Operating lease income received Lending, credit fees and other income received Operating inflows Payments to suppliers and employees Interest paid Taxation paid Operating outflows Net cash flows from operating activities before changes in operating assets and liabilities Proceeds from sale of operating lease vehicles Purchase of operating lease vehicles Net movement in finance receivables Net movement in deposits Total cash provided (applied to) / from operating activities Cash flows from investing activities Net proceeds from sale of investment properties Proceeds from sale of office fit-out, equipment and intangible assets Net decrease in investments Total cash provided from investing activities Purchase of office fit-out, equipment and intangible assets Capital expenditure on investment properties Net increase in investments Purchase of MARAC Insurance Limited Total cash applied to investing activities Net cash flows from / (applied to) investing activities Cash flows applied to financing activities Net increase in wholesale funding Total cash provided from financing activities Dividends paid Net decrease in wholesale funding Total cash applied to financing activities Net cash flows applied to financing activities Net increase / (decrease) in cash held Opening cash and cash equivalents Cash impact of business acquisition (MARAC Insurance Limited) 23 Closing cash and cash equivalents The notes on pages 17 to 53 are an integral part of these financial statements. The notes on pages 43 to 79 are an integral part of these financial statements. Jun 2016 Jun 2015 $000 $000 251,814 243,729 9,468 7,940 8,951 7,017 269,222 259,697 79,661 60,346 131,378 126,179 20,297 9,956 231,336 196,481 37,886 63,216 7,933 7,386 (8,187) (11,544) (251,734) (259,871) 186,120 362,590 (27,982) 161,777 16,492 784 98,480 115,756 9,375 4,885 - 14,260 12,700 6,344 24 - 2,300 15,024 - 89,581 - 95,925 100,732 (81,665) 23 1,637 1,637 14 30,390 - 30,390 - - 22,567 57,877 80,444 (28,753) (80,444) 43,997 (332) 37,012 3,145 84,154 37,344 - 37,012 15 42 Heartland Bank Limited - Annual Report 2016 Disclosure Statement For The Year Ended 30 June 2016 STATEMENT OF CASH FLOWS For the year ended 30 June 2016 Reconciliation of profit after tax to net cash flows from operating activities Profit for the year Add / (less) non-cash items: Depreciation and amortisation expense Depreciation on lease vehicles Impaired asset expense Total non-cash items Add / (less) movements in operating assets and liabilities: Finance receivables Operating lease vehicles Other assets Gain on disposal of property, plant and equipment and intangibles Current tax Derivative financial instruments revaluation Deferred tax expense / (benefit) Deposits Other liabilities Total movements in operating assets and liabilities Net cash flows from operating activities The notes on pages 17 to 53 are an integral part of these financial statements. The notes on pages 43 to 79 are an integral part of these financial statements. Jun 2016 Jun 2015 $000 $000 54,164 48,163 2,153 5,695 13,501 21,349 2,010 6,375 12,105 20,490 (264,969) (275,274) (254) (2,446) (322) (1,125) (1,338) (5,078) 2,997 (98) 8,996 1,326 686 (3,420) 173,807 360,545 (7,534) (103,495) 3,130 93,124 (27,982) 161,777 16 Disclosure Statement For The Year Ended 30 June 2016 www.heartland.co.nz 43 NOTES TO THE FINANCIAL STATEMENTS For the year ended 30 June 2016 Basis of reporting Reporting entity On 31 December 2015, Former Heartland Bank was amalgamated, by way of short form amalgamation, with its ultimate parent, Heartland New Zealand. Heartland New Zealand has continued as the amalgamated company but has changed its name from Heartland New Zealand Limited to Heartland Bank Limited. Refer to General Information contained within the Disclosure Statement for further details. As a result of the Amalgamation, all of Heartland New Zealand's subsidiaries which were previously sitting outside of Former Heartland Bank, were brought into the banking group. The most significant of these businesses was the Australian reverse mortgage business. Other strategic investments, such as shareholdings in Harmoney Corp Limited, Ora HQ Limited and MARAC Insurance Limited, were also brought into the banking group. The financial statements presented are the consolidated financial statements comprising Heartland Bank Limited (the bank) and its subsidiaries (the banking group). Refer to Note 23 - Significant subsidiaries for further details. Unless otherwise stated, comparatives presented are for the consolidated group of the company previously known as Heartland New Zealand Limited. As at 30 June 2016 Heartland Bank Limited is a listed public company incorporated in New Zealand under the Companies Act 1993, a registered bank under the Reserve Bank of New Zealand Act 1989 and a FMC reporting entity for the purposes of the Financial Reporting Act 2013 and Financial Markets Conduct Act 2013. Basis of preparation The financial statements have been prepared in accordance with Generally Accepted Accounting Practice in New Zealand (NZ GAAP) and with the requirements of the Financial Reporting Act 2013. The financial statements comply with New Zealand equivalents to International Financial Reporting Standards (NZ IFRS) and other applicable Financial Reporting Standards as appropriate for profit-oriented entities, and the Registered Bank Disclosure Statement (New Zealand Incorporated Registered Banks) Order 2014 (as amended). The financial statements also comply with International Financial Reporting Standards (IFRS) as issued by the International Accounting Standards Board. The financial statements are presented in New Zealand dollars which is the bank's functional and the banking group's presentation currency. Unless otherwise indicated, amounts are rounded to the nearest thousand. The accounting policies adopted have been applied consistently throughout the periods presented in these financial statements. Certain comparative information has been restated to comply with the current year presentation. The financial statements have been prepared on the basis of historical cost, except for financial instruments, land and buildings and investment property, which are measured at their fair values as identified in the accounting policies set out in the accompanying notes. The financial statements have been prepared on a going concern basis after considering the banking group's funding and liquidity position. Financial assets and liabilities The banking group initially recognises finance receivables and borrowings on the date that they are originated. All other financial assets and liabilities (including assets and liabilities designated at fair value through profit or loss) are initially recognised on the trade date at which the banking group becomes a party to the contractual provisions of the instrument. The banking group derecognises a financial asset when the contractual rights to the cash flows from the asset expire, or it transfers the rights to receive the contractual cash flows on the financial asset in a transaction in which substantially all the risks and rewards of ownership of the financial asset are transferred. Any interest in transferred financial assets that is created or retained by the banking group is recognised as a separate asset or liability. The banking group derecognises a financial liability when its contractual obligations are discharged or cancelled or expire. The banking group enters into transactions whereby it transfers assets recognised on its Statement of Financial Position, but retains either all risks and rewards of the transferred assets or a portion of them. If all or substantially all risks and rewards are retained, then the transferred assets are not derecognised from the Statement of Financial Position. Transfers of assets with the retention of all or substantially all risks and rewards include, for example, securitised assets and repurchase transactions. Principles of consolidation The consolidated financial statements of Heartland Bank Limited incorporate the assets, liabilities and results of all controlled entities. Controlled entities are all entities in which the bank is exposed, or has rights, to variable returns from its involvement with the investee and has the ability to affect those returns through its power over the investee. Intercompany transactions, balances and any unrealised income and expense (except for foreign currency transaction gains or losses) between controlled entities are eliminated. The assets and liabilities of entities whose functional currency is not the New Zealand dollar, are translated at the exchange rates ruling at balance date. Revenue and expense items are translated at the spot rate at the transaction date or a rate approximating that rate. Exchange differences are taken to the foreign currency translation reserve. 17 44 Heartland Bank Limited - Annual Report 2016 Disclosure Statement For The Year Ended 30 June 2016 NOTES TO THE FINANCIAL STATEMENTS For the year ended 30 June 2016 Estimates and judgements The preparation of the banking group's financial statements requires the use of estimates and judgement. This note provides an overview of the areas that involved a higher degree of judgement or complexity. Detailed information about each of these estimates and judgements is included in the relevant notes together with the basis of calculation for each affected item in the financial statements.  Provisions for impairment - The effect of credit risk is quantified based on management's best estimate of future cash repayments and proceeds from any security held or by reference to risk profile groupings and historical loss data. Refer to Note 19(e) for further details.  Goodwill - Determining the fair value of assets and liabilities of acquired businesses requires the exercise of management judgement. The carrying value of goodwill is tested annually for impairment, refer to Note 15(b)(ii). The estimates and judgements used in the preparation of the banking groups financial statements are continually evaluated. They are based on historical experience and other factors, including expectations of future events that may have a financial impact on the entity. Performance 1 Segmental analysis Segment information is presented in respect of the banking group's operating segments which are those used for the banking group's management and internal reporting structure. All income received is from external sources, except those transactions with related parties, refer to Note 15(d) - Related party transactions. Certain selling and administration expenses, such as premises, IT and support centre costs are not allocated to operating segments and are included in Administration and Support (Admin & Support). Operating segments The banking group operates predominantly within New Zealand and comprises the following main operating segments: Households Providing a comprehensive range of financial services to New Zealand families (including term, transactional and savings based deposit accounts together with mortgage lending (residential and home equity release), motor vehicle finance and consumer finance) and some specific financial services to Australian seniors (home equity release mortgage lending). Business Rural Providing term debt, plant and equipment finance, commercial mortgage lending and working capital solutions for small-to-medium sized New Zealand businesses. Providing specialist financial services to the farming sector primarily offering livestock finance, rural mortgage lending, seasonal and working capital financing, as well as leasing solutions to farmers. The banking group's operating segments are different than the industry categories detailed in Note 19 - Asset quality. The operating segments are primarily categorised by sales channel, whereas Note 19 - Asset quality categorises exposures based on credit risk concentrations. During the period ended 30 June 2016, the following changes were made to the banking group's operating segments: - a business unit previously reported in the Household division was moved to the Business division. - lending through Harmoney, which was previously reported in the Business division, was moved to the Household division. - the non-core property segment was moved into the Business division. Comparative information has been restated to be consistent with the current reporting period. Jun 2016 Net interest income Net other income Net operating income Other selling and administration expenses Selling and administration expenses Profit / (loss) before impaired asset expense and income tax Impaired asset expense Profit / (loss) before income tax Income tax expense Profit / (loss) for the year Total assets Total liabilities Households Business Rural Admin & Total $000 $000 $000 79,320 6,752 86,072 17,995 17,995 41,061 1,921 42,982 9,015 9,015 26,111 152 26,263 4,351 4,351 Support $000 168 2,076 2,244 38,511 38,511 $000 146,660 10,901 157,561 69,872 69,872 68,077 33,967 21,912 (36,267) 87,689 7,161 60,916 3,381 30,586 2,959 18,953 - (36,267) - - - 20,024 60,916 30,586 18,953 (56,291) 13,501 74,188 20,024 54,164 1,687,232 907,205 552,461 400,283 3,547,181 - - - 3,048,840 3,048,840 18 Disclosure Statement For The Year Ended 30 June 2016 www.heartland.co.nz 45 NOTES TO THE FINANCIAL STATEMENTS For the year ended 30 June 2016 1 Segmental analysis (continued) Jun 2015 Net interest income Net other income Net operating income Other selling and administration expenses Selling and administration expenses Profit / (loss) before impaired asset expense and income tax Impaired asset expense Operating profit / (loss) Share of joint arrangement profit Profit / (loss) before income tax Income tax expense Profit / (loss) for the year Total assets Total liabilities 2 Net interest income Households Business Rural Admin & Total $000 $000 $000 70,765 5,823 76,588 20,071 20,071 38,666 2,112 40,778 7,480 7,480 23,884 135 24,019 4,878 4,878 Support $000 1,112 2,210 3,322 35,974 35,974 $000 134,427 10,280 144,707 68,403 68,403 56,517 33,298 19,141 (32,652) 76,304 5,879 50,638 5,716 27,582 510 - 18,631 (32,652) 12,105 64,199 - - - 137 137 50,638 27,582 18,631 (32,515) 64,336 - - - 16,173 50,638 27,582 18,631 (48,688) 16,173 48,163 1,600,547 828,362 487,673 442,677 3,359,259 - - - 2,879,134 2,879,134 Interest income and expense is recognised in profit or loss using the effective interest method. The effective interest rate is established on initial recognition of the financial assets and liabilities and is not revised subsequently. The calculation of the effective interest rate includes all yield related fees and commissions paid or received that are an integral part of the effective interest rate. Interest on the effective portion of a derivative designated as a cash flow hedge is initially recognised in the hedging reserve. It is released to profit or loss at the same time as the hedged item or if the hedge relationship is subsequently deemed to be ineffective. Interest income Cash and cash equivalents Investments Finance receivables Total interest income Interest expense Retail deposits Bank and securitised borrowings Net interest expense on derivative financial instruments Total interest expense Net interest income Jun 2016 Jun 2015 $000 $000 771 10,203 254,501 265,475 2,458 9,919 248,091 260,468 85,955 31,232 1,628 82,526 43,294 221 118,815 126,041 146,660 134,427 Included within the banking group's interest income on finance receivables is $1,664,000 (2015: $1,157,000) on individually impaired assets. 19 46 Heartland Bank Limited - Annual Report 2016 Disclosure Statement For The Year Ended 30 June 2016 NOTES TO THE FINANCIAL STATEMENTS For the year ended 30 June 2016 3 Net operating lease income Rental income from operating leases is recognised on a straight-line basis over the term of the relevant lease. Initial direct costs incurred in negotiating and arranging an operating lease are added to the carrying amount of the leased asset and recognised on a straight-line basis over the lease term. Profits on the sale of operating lease vehicles are included as part of operating lease income. Current year depreciation and losses on the sale of operating lease vehicles are included as part of operating lease expenses. Operating lease income Lease income Gain on disposal of lease vehicles Total operating lease income Operating lease expense Depreciation on lease vehicles Direct lease costs Total operating lease expenses Net operating lease income 4 Other income Jun 2016 Jun 2015 $000 $000 8,033 836 8,869 5,695 535 6,230 9,430 920 10,350 6,375 712 7,087 2,639 3,263 Rental income from investment properties is recognised on a straight-line basis over the term of the relevant lease. Other items of income are recognised at the fair value of the consideration received or receivable, net of the amount of goods and services tax (GST) levied. Rental income from investment properties Insurance income Gain on sale of investments Management fees Other income Total other income 5 Selling and administration expenses Personnel expenses Directors' fees Superannuation Audit and review of financial statements1 Other assurance services paid to auditor 2 Other fees paid to auditor 3 Depreciation - property, plant and equipment Amortisation - intangible assets Operating lease expense as a lessee Legal and professional fees Other operating expenses Total selling and administration expenses NOTE 15(d) Jun 2016 Jun 2015 $000 1,244 1,508 1,136 - 1,035 4,923 $000 1,478 - 583 500 1,379 3,940 Jun 2016 Jun 2015 $000 $000 39,051 39,619 743 748 436 43 107 1,081 1,072 2,281 2,352 21,958 69,872 917 782 431 23 125 777 1,233 2,001 2,318 20,177 68,403 1 Audit and review of financial statements includes fees paid for both the audit of annual financial statements and review of interim financial statements. 2 Other assurance services paid to the auditor comprise review of regulatory returns, trust deed reporting, and other agreed upon procedure engagements. 3 Other fees paid to the auditor include professional fees in connection with regulatory advisory services, project quality assurance, accounting advice and an internal audit quality assurance review. 20 Disclosure Statement For The Year Ended 30 June 2016 www.heartland.co.nz 47 NOTES TO THE FINANCIAL STATEMENTS For the year ended 30 June 2016 6 Impaired asset expense Non-securitised Individually impaired expense Collectively impaired expense Total non-securitised impaired asset expense Securitised Individually impaired (benefit) / expense Collectively impaired expense Total securitised impaired asset expense Total Individually impaired expense Collectively impaired expense Total impaired asset expense 7 Taxation (a) Income tax expense Jun 2016 Jun 2015 NOTE $000 $000 1,072 11,186 12,258 7,153 4,051 11,204 (9) 1,252 1,243 53 848 901 19(e) 19(e) 1,063 12,438 13,501 7,206 4,899 12,105 Income tax expense for the year comprises current tax and movements in deferred tax balances. Income tax expense is recognised in profit or loss except to the extent that it relates to items recognised directly in other comprehensive income, in which case it is recognised in equity or other comprehensive income. Income tax recognised in profit or loss Current tax Current year Adjustments for prior year Deferred tax Current year Adjustments for prior year Income tax expense recognised in profit or loss Income tax recognised in other comprehensive income Current tax Fair value movements of available for sale investments Deferred tax Defined benefit plan Fair value movements of cash flow hedges Income tax (benefit) / expense recognised in other comprehensive income Reconciliation of effective tax rate Profit before income tax Prima facie tax at 28% Higher tax rate for overseas jurisdiction Plus / (minus) tax effect of items not taxable / deductible Adjustments for prior year Utilisation of unrecognised tax losses Total income tax expense Jun 2016 Jun 2015 $000 $000 18,850 18,755 208 (195) 1,722 (756) (2,209) (178) 20,024 16,173 172 349 (36) (243) (107) 19 (1,052) (684) 74,188 64,336 20,773 18,014 135 114 (548) (450) 92 (141) (283) (1,509) 20,024 16,173 21 48 Heartland Bank Limited - Annual Report 2016 Disclosure Statement For The Year Ended 30 June 2016 NOTES TO THE FINANCIAL STATEMENTS For the year ended 30 June 2016 7 Taxation (continued) (b) Current tax Current tax is the expected tax receivable or payable on the taxable income for the year, using tax rates enacted or substantively enacted at the reporting date, and any adjustment to the tax receivable or payable in respect of previous years. Current tax for current and prior years is recognised as a liability (or asset) to the extent that it is unpaid (or refundable). (c) Deferred tax The banking group has recognised deferred tax assets, including those relating to the tax effects of income tax losses and credits available to be carried forward, to the extent that there are sufficient taxable temporary differences (deferred tax liabilities) relating to the same taxation authority and the same subsidiary against which the unused tax losses can be utilised. Deferred tax assets comprise the following temporary differences: Employee entitlements Provision for impairment Investment properties Intangibles and property, plant and equipment Deferred acquisition costs Operating lease vehicles Other temporary differences Total deferred tax assets Opening balance of deferred tax assets Acquisition of subsidiaries Movement recognised in profit or loss Movement recognised in other comprehensive income Closing balance of deferred tax assets (d) Goods and services tax (GST) Jun 2016 Jun 2015 $000 $000 1,038 1,229 5,797 6,633 1,358 1,473 (177) (399) (1,196) - (1,276) (1,543) 1,524 1,314 7,068 8,707 8,707 5,287 (952) (966) 279 7,068 - 2,387 1,033 8,707 Revenues, expenses and assets are recognised net of the amount of GST. As the banking group is predominantly involved in providing financial services, only a proportion of GST paid on inputs is recoverable. The non-recoverable proportion of GST is treated as part of the cost of acquisition of the asset or is expensed. (e) Imputation credit account Imputation credit account 8 Earnings per share Jun 2016 Jun 2015 $000 2,388 $000 3,484 The calculation of basic and diluted earnings of 11c per share at 30 June 2016 (2015: 10c per share) is based on the profit for the year of $54,164,000 (2015: $48,163,000), and a weighted average number of shares on issue of 473,359,905 (2015: 466,643,607). 22 Disclosure Statement For The Year Ended 30 June 2016 www.heartland.co.nz 49 NOTES TO THE FINANCIAL STATEMENTS For the year ended 30 June 2016 Financial Position 9 Investments The banking group holds investments in bank bonds and floating rate notes, local authority stock, public securities, corporate bonds and equity investments. Equity investments are classified as being fair valued through profit or loss and the fair value is based on unobservable inputs. All other investments held are classified as being available for sale and are stated at fair value less impairment, if any. The fair values are derived by reference to published price quotations in an active market or modelled using observable market inputs. Bank bonds and floating rate notes Public sector securities and corporate bonds Local authority stock Equity investments Total investments 10 Investment properties Jun 2016 Jun 2015 $000 $000 181,786 244,505 8,530 38,828 7,291 31,275 46,839 6,719 236,435 329,338 Investment properties have been acquired through the enforcement of security over finance receivables and are held to earn rental income or for capital appreciation (or both). Investment properties are initially recorded at their fair value, with subsequent changes in fair value recognised in profit or loss. Fair values are determined by qualified independent valuers or other similar external evidence, adjusted for changes in market conditions and the time since the last valuation. Opening balance Acquisitions Additional capital expenditure Sales Closing balance Jun 2016 Jun 2015 $000 24,513 - 24 $000 24,888 9,000 - (16,153) (9,375) 8,384 24,513 23 50 Heartland Bank Limited - Annual Report 2016 Disclosure Statement For The Year Ended 30 June 2016 NOTES TO THE FINANCIAL STATEMENTS For the year ended 30 June 2016 11 Finance receivables Finance receivables are initially recognised at fair value plus incremental direct transaction costs and are subsequently measured at amortised cost using the effective interest method, less any impairment loss. Past due but not impaired assets are any assets which have not been operated by the counterparty within their key terms but are not considered to be impaired by the banking group. Individually impaired assets are those loans for which the banking group has evidence that it will incur a loss, and will be unable to collect all principal and interest due according to the contractual terms of the loan. Restructured assets are impaired assets where the banking group expects to recover all amounts owing although the original terms have been changed due to the counterparty's difficulty in complying with the original terms of the contract and the amended terms are not comparable with similar new lending. Credit impairment provisions are made where events have occurred leading to an expectation of reduced future cash flows from certain receivables. These provisions are made in some cases against an individual loan and in other cases on a collective basis. When all appropriate collection and legal action has been performed and the loan is known to be uncollectible, it is written off against the related provision for impairment. Non-securitised Neither at least 90 days past due nor impaired At least 90 days past due Individually impaired Restructured assets Gross finance receivables Less provision for impairment Less fair value adjustment for present value of future losses1 Total non-securitised finance receivables Securitised Neither at least 90 days past due nor impaired At least 90 days past due Individually impaired Gross finance receivables Less provision for impairment Total securitised finance receivables Total Neither at least 90 days past due nor impaired At least 90 days past due Individually impaired Restructured assets Gross finance receivables Less provision for impairment Less fair value adjustment for present value of future losses1 Total finance receivables Jun 2016 Jun 2015 NOTE $000 $000 2,785,927 2,552,302 20,070 33,751 3,281 33,459 25,567 3,881 2,843,029 2,615,209 19,936 4,987 24,511 6,242 2,818,106 2,584,456 295,166 276,944 1,897 13 1,516 55 297,076 278,515 1,225 901 295,851 277,614 3,081,093 2,829,246 21,967 33,764 3,281 34,975 25,622 3,881 3,140,105 2,893,724 21,161 4,987 25,412 6,242 3,113,957 2,862,070 19(b) 19(c) 19(a) 19(e) 19(a) Refer to Note 19 - Asset quality for further analysis of finance receivables by credit risk concentration. Finance lease receivables Leases are classified as finance leases whenever the terms of the lease transfer substantially all the risks and rewards of ownership to the lessee. Amounts due from finance leases are recognised as finance receivables at the amount of the banking group's net investment in the leases. The table below provides an analysis of finance lease receivables for leases of certain property and equipment in which the banking group is the lessor. Gross finance lease receivables Less than 1 year Between 1 and 5 years More than 5 years Total gross finance lease receivables Less unearned finance income Less provision for impairment Net finance lease receivables Jun 2016 Jun 2015 $000 $000 29,710 50,030 - 32,484 66,835 68 79,740 99,387 10,614 14,315 132 170 68,994 84,902 1 A fair value adjustment of $8m for the present value of future losses was recognised on acquisition of New Sentinel Limited and Australian Seniors Finance Pty Limited. This fair value adjustment is amortised over the estimated lifetime of the finance receivables acquired. 24 Disclosure Statement For The Year Ended 30 June 2016 www.heartland.co.nz 51 NOTES TO THE FINANCIAL STATEMENTS For the year ended 30 June 2016 12 Operating lease vehicles Operating lease vehicles are stated at cost less accumulated depreciation. Operating lease vehicles are depreciated on a straight line basis over their expected life after allowing for any residual values. The estimated lives of operating lease vehicles vary up to five years. Vehicles held for sale are not depreciated but are tested for impairment. Cost Opening balance Additions Disposals Closing balance Accumulated depreciation Opening balance Depreciation charge for the year Disposals Closing balance Opening net book value Closing net book value Jun 2016 Jun 2015 $000 $000 42,186 8,187 43,595 11,544 (14,645) (12,953) 35,728 42,186 12,188 5,695 (6,712) 11,171 29,998 24,557 12,300 6,375 (6,487) 12,188 31,295 29,998 The future minimum lease payments receivable under non-cancellable operating leases not later than one year is $6,362,000 (2015: $7,961,000), within one to five years is $5,071,000 (2015: $6,225,000) and over five years is nil (2015: nil). 13 Borrowings Bank borrowings and deposits are initially recognised at fair value including incremental direct transaction costs. They are subsequently measured at amortised cost using the effective interest method. Deposits Subordinated bond Bank borrowings Securitised borrowings Total borrowings Jun 2016 Jun 2015 $000 $000 2,282,876 2,097,458 3,378 429,304 284,429 3,378 465,779 258,630 2,999,987 2,825,245 Deposits rank equally and are unsecured. The Subordinated bonds rank below all other general liabilities of the banking group. Securitised borrowings held by investors in Heartland ABCP Trust 1 (ABCP Trust) rank equally with each other and are secured over the securitised assets of that trust. Securitised borrowings comprise notes issued by ABCP Trust and drawings under the ABCP Trust’s bank facilities. The ABCP Trust has bank facilities of $350 million (2015: $350 million) in relation to the ABCP Trust, which mature on 1 February 2017. The banking group has an Australian bank facility provided by Commonwealth Bank of Australia (CBA bank facility) totalling $379 million (2015: $466 million). The CBA bank facility is secured over the shares in Australian Seniors Finance Pty Limited (ASF) and the assets of the ASF group (comprising ASF, the ASF Settlement Trust and the Seniors Warehouse Trust). The CBA bank facility has a maturity date of 30 September 2019. The banking agreements include covenants for the provision of information, attainment of minimum financial ratios and equity, compliance with specified procedures and certification of due performance by ASF Group. 14 Share capital and dividends Ordinary shares are classified as equity. Incremental costs directly attributable to the issue of ordinary shares and share options are recognised as a deduction from equity, net of any tax effects. Issued shares Opening balance Shares issued during the year Dividend reinvestment plan Closing balance The shares have equal voting rights, rights to dividends and distributions and do not have a par value. Jun 2016 Number of shares 000 Jun 2015 Number of shares 000 469,890 463,266 213 6,366 - 6,624 476,469 469,890 25 52 Heartland Bank Limited - Annual Report 2016 Disclosure Statement For The Year Ended 30 June 2016 NOTES TO THE FINANCIAL STATEMENTS For the year ended 30 June 2016 14 Share capital and dividends (continued) Under dividend reinvestment plans, the bank issued 3,711,076 new shares at $1.110 per share on 2 October 2015 and 2,655,142 new shares at $1.198 per share on 5 April 2016 (3,680,052 new shares at $1.015 on 3 October 2014 and 2,943,636 new shares at $1.320 on 7 April 2015). Dividends paid Final dividend Interim dividend Total dividends paid 15 Other balance sheet items (a) Other assets Jun 2016 Jun 2015 date declared cents per share $000 date declared cents per share 18/08/2015 23/02/2016 4.5 3.5 8.0 21,145 25/08/2014 16,545 23/02/2015 37,690 3.5 3.0 6.5 $000 16,394 13,794 30,188 Derivative financial assets consist of interest rate swaps and foreign exchange options. Interest rate swaps are held to manage the banking group's exposure to interest rate repricing risk arising from deposits, commercial paper issuance, current and future floating rate bank debt and investments. Foreign exchange options are used to manage the banking group's exposure to foreign exchange rate risk. Property, plant and equipment are stated at cost less accumulated depreciation and impairment. Depreciation is calculated on a straight line basis to write off the net cost or other revalued amount of each asset over its expected useful life to its estimated residual value. Derivative financial assets Trade receivables Prepayments Property, plant and equipment Total other assets (b) Intangible assets (i) Intangible assets with definite useful lives Jun 2016 Jun 2015 $000 $000 148 5,452 622 8,649 59 5,546 1,092 5,422 14,871 12,119 Software acquired or internally developed by the banking group is stated at cost less accumulated amortisation and any accumulated impairment losses. Subsequent expenditure on software assets is capitalised only when it increases the future economic value of that asset. Amortisation of software is on a straight line basis, at rates which will write off the cost over their estimated economic lives. All other expenditure is expensed immediately as incurred. Computer Software Cost (ii) Goodwill Jun 2016 Jun 2015 $000 12,612 $000 5,976 Goodwill arising on acquisition represents the excess of the cost of the acquisition over the banking group’s interest in the fair value of the identifiable net assets. Goodwill that has an indefinite useful life is not subject to amortisation and is tested for impairment annually. Goodwill is carried at cost less accumulated impairment losses. Goodwill Jun 2016 Jun 2015 $000 $000 45,143 45,143 Goodwill was tested for impairment as at 30 June 2016. In assessing impairment, an internal valuation model was developed to indicate the value of the business. This value was compared to the net assets of the banking group. There was no indication of impairment and no impairment losses have been recognised against the carrying amount of goodwill for the year ended 30 June 2016 (30 June 2015: nil). The banking group’s management and Board of Directors have assessed that goodwill should be allocated to the banking group as a cash- generating unit, as this is the cash generating unit at which goodwill is assessed for impairment and to which any future economic benefit will arise. 26 Disclosure Statement For The Year Ended 30 June 2016 www.heartland.co.nz 53 NOTES TO THE FINANCIAL STATEMENTS For the year ended 30 June 2016 15 Other balance sheet items (continued) (c) Trade and other payables Derivative financial liabilities consist of interest rate swaps held to manage the banking group's exposure to interest rate repricing risk arising from fixed rate mortgage loans. Annual leave entitlements are accrued at amounts expected to be paid. Long service leave is accrued by calculating the probable future value of entitlements and discounting back to present value. Obligations to defined contribution superannuation schemes are recognised as an expense when the contribution is paid. Derivative financial liabilities Trade payables GST payable Insurance liability Due to related parties Employee benefits Total trade and other payables (d) Related party transactions Jun 2016 Jun 2015 NOTE $000 $000 5,866 12,988 14,238 5,235 - 3,772 6,407 14,808 16,571 - 2,448 5,786 42,099 46,020 15(d) On 17 July 2015, MARAC Insurance Limited (MARAC Insurance) became a wholly owned subsidiary of the bank. Previously, MARAC Insurance was a wholly owned subsidiary of MARAC JV Holdings Limited which the bank held as a joint arrangement. As a result, from 17 July 2015, related party transactions and balances with MARAC Insurance are eliminated on consolidation of the banking group. Refer to Note 23 for more details. MARAC Insurance, Heartland Cash and Term PIE Fund and some key management personnel invested in the bank's deposits. The investments of Heartland Cash and Term PIE Fund are detailed in Note 24 - Structured entities. Transactions with related parties MARAC Insurance Limited Interest expense Lending and credit fee income Other income Total transactions with related parties Due to related parties MARAC Insurance Limited Total due to related parties Transactions with key management personnel Jun 2016 Jun 2015 $000 $000 - - - - - - (31) 625 500 1,094 2,448 2,448 Key management personnel, being directors of the bank and those Executives reporting directly to the Chief Executive Officer and their immediate relatives, have transacted with the banking group during the year as follows: Transactions with key management personnel Interest income Interest expense Key management personnel compensation: Short-term employee benefits Share-based payment expense Total transactions with key management personnel Due (to) / from key management personnel Finance receivables Borrowings - deposits Total due (to) / from key management personnel Jun 2016 Jun 2015 $000 $000 104 (460) 68 (573) (5,064) (848) (6,268) (6,690) (2,693) (9,888) 1,428 1,391 (26,526) (14,386) (25,098) (12,995) 27 54 Heartland Bank Limited - Annual Report 2016 Disclosure Statement For The Year Ended 30 June 2016 NOTES TO THE FINANCIAL STATEMENTS For the year ended 30 June 2016 16 Fair value The fair values of financial assets and financial liabilities that are traded in active markets are based on quoted market prices or dealer price quotations. For all other financial instruments, the banking group determines fair value using other valuation techniques. The banking group measures fair values using the following fair value hierarchy, which reflects the significance of the inputs used in making the measurements. - - - Level 1: Quoted prices (unadjusted) in active markets for identical assets or liabilities. Level 2: Inputs other than quoted prices included within level 1 that are observable for the asset or liability, either directly (that is, as prices) or indirectly (derived from prices). Level 3: Inputs for the asset or liability that are not based on observable market data (unobservable inputs). The banking group recognises transfers between levels of the fair value hierarchy as of the end of the reporting period during which the change has occurred. (a) Financial instruments measured at fair value The following methods and assumptions were used to estimate the fair value of each class of financial asset and liability measured at fair value on a recurring basis in the Statement of Financial Position. Investments Investments in public sector securities and corporate bonds are classified as being available for sale and are stated at fair value, with the fair value being based on quoted market prices (Level 1 under the fair value hierarchy) or modelled using observable market inputs (Level 2 under the fair value hierarchy). Refer to Note 9 - Investments for more details. Investments valued under level 2 of the fair value hierarchy are valued either based on quoted market prices or dealer quotes for similar instruments, or discounted cash flows analysis. Investments in unlisted equity securities are classified as being fair valued through profit or loss and are valued under Level 3 of the fair value hierarchy, with the fair value being based on unobservable inputs. Finance receivables Fixed rate Home Equity Release loans classified as finance receivables are stated at fair value with the fair value being based on present value of future cash flows discounted using observable market interest rates (Level 2 under the fair value hierarchy). Derivative items Interest rate swaps are classified as held for trading and are recognised in the financial statements at fair value. Derivatives are initially recognised at fair value on the date on which a derivative contract is entered into and are subsequently remeasured at their fair value. Fair values are determined on the basis of discounted cash flow analysis using observable market prices and adjustments for counterparty credit spreads. (Level 2 under the fair value hierarchy). The following table analyses financial instruments measured at fair value at the reporting date by the level in the fair value hierarchy into which each fair value measurement is categorised. The amounts are based on the values recognised in the Statement of Financial Position. Jun 2016 Assets Investments Finance receivables Derivative assets held for risk management Total Liabilities Derivative liabilities held for risk management Total Jun 2015 Assets Investments Finance receivables Derivative assets held for risk management Total Liabilities Derivative liabilities held for risk management Total Level 1 $000 Level 2 $000 Level 3 $000 Total $000 229,144 - 7,291 236,435 - - 21,884 148 - - 21,884 148 229,144 22,032 7,291 258,467 - - 5,866 5,866 - - 5,866 5,866 311,815 - - 10,804 25,021 59 6,719 329,338 - - 25,021 59 311,815 35,884 6,719 354,418 - - 6,407 6,407 - - 6,407 6,407 28 Disclosure Statement For The Year Ended 30 June 2016 www.heartland.co.nz 55 NOTES TO THE FINANCIAL STATEMENTS For the year ended 30 June 2016 16 Fair value (continued) (b) Financial instruments not measured at fair value The following methods and assumptions were used to estimate the fair value of each class of financial assets and liabilities not recognised at fair value but for which fair value is calculated for disclosure purposes under level 2 or 3 of the fair value hierarchy. Cash and cash equivalents and other financial assets and liabilities The fair value of all cash and cash equivalents and other financial assets and liabilities is considered equivalent to their carrying value due to their short term nature. Finance receivables The fair value of the banking group's finance receivables is calculated using a valuation technique which assumes the banking group's current weighted average lending rates for loans of a similar nature and term. The current weighted average lending rate used to fair value finance receivables with a fixed interest rate was 8.65% (2015: 8.95%). Finance receivables with a floating interest rate are deemed to be at current market rates. The current amount of credit provisioning has been deducted from the fair value calculation of finance receivables as a proxy for future losses. Prepayment rates have not been factored into the fair value calculation as they are not deemed to be material. Borrowings The fair value of deposits, bank borrowings and other borrowings is the present value of future cash flows and is based on the current market interest rates payable by the banking group for debt of similar maturities. The current market rate used to fair value borrowings is 3.29% (2015: 4.32%). Other financial assets and financial liabilities The banking group has not disclosed the fair values for financial instruments such as short-term trade receivables and payables, because their carrying amounts are a reasonable approximation of fair values. The following table sets out the fair values of financial instruments not measured at fair value and analyses them by the level in the fair value hierarchy into which each fair value measurement is categorised. Jun 2016 Assets Cash and cash equivalents Finance receivables Finance receivables - securitised Other financial assets Total financial assets Liabilities Borrowings Borrowings - securitised Other financial liabilities Total financial liabilities Jun 2015 Assets Cash and cash equivalents Finance receivables Finance receivables - securitised Other financial assets Total financial assets Liabilities Borrowings Borrowings - securitised Other financial liabilities Total financial liabilities Level 1 Level 2 Level 3 Total Fair Value Total Carrying Value $000 $000 $000 $000 $000 84,154 - - - 84,154 - - - - - - 84,154 84,154 2,792,936 2,792,936 2,796,222 297,371 297,371 295,851 5,452 5,452 5,452 3,095,759 3,179,913 3,181,679 - - - - 2,727,417 284,429 - - 2,727,417 2,715,558 284,429 284,429 - 21,995 21,995 21,995 3,011,846 21,995 3,033,841 3,021,982 37,012 - - - 37,012 - - - - - - 37,012 37,012 2,582,776 2,582,776 2,584,456 279,491 279,491 277,614 5,546 5,546 5,546 2,867,813 2,904,825 2,904,628 - - - - 2,576,425 258,630 - - 2,576,425 2,566,615 258,630 258,630 2,448 20,594 23,042 23,042 2,837,503 20,594 2,858,097 2,848,287 29 56 Heartland Bank Limited - Annual Report 2016 Disclosure Statement For The Year Ended 30 June 2016 NOTES TO THE FINANCIAL STATEMENTS For the year ended 30 June 2016 16 Fair value (continued) (c) Classification of financial instruments The following tables summarise the categories of financial instruments and the carrying value and fair value of all financial instruments of the banking group: Jun 2016 Cash and cash equivalents Investments Finance receivables Finance receivables - securitised Derivative financial assets Other financial assets Total financial assets Borrowings Borrowings - securitised Derivative financial liabilities Other financial liabilities Total financial liabilities Jun 2015 Cash and cash equivalents Investments Finance receivables Finance receivables - securitised Derivative financial assets Other financial assets Total financial assets Borrowings Borrowings - securitised Derivative financial liabilities Other financial liabilities Total financial liabilities Held for trading Loans and receivables Available for sale Financial liabilities at amortised cost Total Carrying Value Total Fair Value $000 $000 $000 $000 $000 $000 - 84,154 - 7,291 - 229,144 - - 2,818,106 295,851 148 - - 5,452 - - - - 7,439 3,203,563 229,144 - - - - - - - 84,154 84,154 236,435 236,435 2,818,106 2,814,820 295,851 297,371 148 5,452 148 5,452 3,440,146 3,438,380 - - 5,866 - 5,866 - - - - - - 37,012 - - - - - - 6,719 - 322,619 - - 59 - 2,584,456 277,614 - 5,546 - - - - 6,778 2,904,628 322,619 2,715,558 2,715,558 2,727,417 284,429 284,429 284,429 - 21,995 5,866 21,995 5,866 21,995 3,021,982 3,027,848 3,039,707 - - - - - - - 37,012 37,012 329,338 329,338 2,584,456 2,582,776 277,614 279,491 59 5,546 59 5,546 3,234,025 3,234,222 - - 6,407 - 6,407 - - - - - - - - - - 2,566,615 2,566,615 2,576,425 258,630 258,630 258,630 - 23,042 6,407 23,042 6,407 23,042 2,848,287 2,854,694 2,864,504 30 Disclosure Statement For The Year Ended 30 June 2016 www.heartland.co.nz 57 NOTES TO THE FINANCIAL STATEMENTS For the year ended 30 June 2016 Risk Management 17 Risk management policies The banking group is committed to the management of risk and operates an Enterprise Risk Management Program (RMP) across four primary risk domains; credit, liquidity, market (including interest rate), and operational & compliance. The banking group's risk management strategy is set by the board of directors (Board). The banking group has put in place management structures and information systems to manage risks incorporated in the RMP. The banking group has separate monitoring tasks where feasible and subjects all risk processes to hindsight and internal audit, and accounting systems to regular internal and external audits. Role of the Board and the Board Risk Committee The Board, through its Board Risk Committee (BRC) is responsible for the overall risk management process and the development of the RMP. The role of the BRC is to assist the Board to formulate its risk appetite, understand the risks the banking group faces and to ensure that all policy and decisions are made in accordance with the banking group's corporate values and guiding principles. The BRC has the following responsibilities: - - - - - To advise the Board on the formulation of the Board’s Statement of Risk Appetite at least annually. To review reports from management concerning the RMP in the context of the Risk Appetite Statement in order to assure the Board of the programme’s effectiveness. To review reports from management concerning transactions involving risks in excess of the CRO’s authority limits in order to recommend to the Board any appropriate approvals or provide such approval where the BRC has delegated authority. To review reports from management concerning changes anticipated in the economic, business and regulatory environment (including consideration of emerging trends) and other factors considered relevant to the Risk Appetite Statement, in order to monitor them and advise the Board of any new risks or opportunities that could have a significant financial, regulatory or reputational impact. To review reports from management concerning the Bank’s internal compliance policies in order to advise the Board of their effectiveness and recommend their approval or variation (or, where the BRC has been delegated authority, as set out in the Policy Register, to itself approve or vary them). The BRC consists of four non-executive, independent directors. In addition the CRO and CFO attend the BRC meetings, and the CEO and directors who are not members of the BRC are entitled to attend BRC meetings. The BRC meets at least bi-monthly to review identified risk issues, and reports directly to the Board. A member of the BRC sits on the Audit Committee and vice versa. Audit Committee and Internal Audit The banking group has an internal audit function, the objective of which is to provide independent, objective assurance over the internal control environment. In certain circumstances, Internal Audit will provide risk and control advice to Management provided the work does not impede the independence of the Internal Audit function. The function assists the bank in accomplishing its objectives by bringing a systematic and disciplined approach to evaluate and improve the effectiveness of risk management, control, and governance processes. Internal audit is allowed full, free and unfettered access to any and all of the organisation’s records, personnel and physical properties deemed necessary to accomplish its internal audit activities. A regular cycle of review has been implemented to cover all areas of the business, focused on assessment, management and control of risks. The audit plan takes into account cyclical review of various business units and operational areas, as well as identified areas of higher identified risk. The audit methodology is designed to meet or exceed the International Standards for the Professional Practice of Internal Auditing of The Institute of Internal Auditors. Each audit has specific audit procedures tailored to the area of business that is being reviewed. The audit procedures are updated during each audit to reflect any process changes. Audit work papers are completed to evidence the testing performed in accordance with the audit procedures. Audit reports are addressed to the manager of the relevant area that is being audited in addition to other relevant stakeholders within the bank. Management comments are obtained from the process owner(s) and are included in the report. The internal audit function has direct reporting lines, and accountability to the Audit Committee of the bank and administratively to the CRO. A schedule of all outstanding internal control issues is maintained and presented to the Audit Committee to assist the Audit Committee to track the resolution of previously identified issues. Any issues raised that are categorised as high risk are specifically reviewed by internal audit during a follow-up review once the issue is considered closed by management. The follow-up review is performed with a view to formally close out the issue. The Audit Committee focuses on financial reporting and application of accounting policies as part of the internal control and risk assessment framework. The Audit Committee monitors the identification, evaluation and management of all significant risks through the banking group. This work is supported by internal audit, which provides an independent assessment of the design, adequacy and effectiveness of internal controls. The Audit Committee receives regular reports from internal audit. 31 58 Heartland Bank Limited - Annual Report 2016 Disclosure Statement For The Year Ended 30 June 2016 NOTES TO THE FINANCIAL STATEMENTS For the year ended 30 June 2016 17 Risk management policies (continued) Audit Committee and Internal Audit (continued) Charters for both the BRC and the Audit Committee ensure suitable cross representation to allow effective communication pertaining to identified issues with oversight by the Board. The CRO has a direct reporting line to the Chairman of the Board. The Head of Internal Audit has a direct reporting line to the Chairman of the Audit Committee. Asset and Liability Committee (ALCO) The ALCO comprises the CEO (Chair), Head of Banking, CFO, CRO and Treasurer. The ALCO has responsibility for overseeing aspects of the banking group's financial position risk management. The ALCO usually meet monthly, and reports to the BRC. The purpose of the ALCO is to support the BRC with specific responsibilities for decision making and oversight of risk matters in relation to: - Market risk (including non-traded interest rate risk and the investment of capital) - Liquidity risk (including funding) - Foreign exchange rate risk - Balance sheet structure - Capital management Executive Risk Committee (ERC) The ERC comprises the CEO (Chair), Head of Banking, CFO, CRO, Chief Strategy Advisor, Head of Internal Audit, Head of Retail and Consumer, Head of Rural, Head of Business, Head of Human Resources and Group General Counsel. The ERC has responsibility for overseeing all risk aspects not considered by ALCO, including that the internal control environment is managed so that residual risk is consistent with the banking groups risk appetite. The purpose of ERC is to support the BRC with specific responsibilities for decision making and oversight of the following risk categories: - Operational and compliance risk - Credit risk - Strategic risk - Legal and governance risk - Business risk Operational & compliance risk Operational & compliance risk is the risk arising from day to day operational activities in the execution of the banking group's strategy which may result in direct or indirect loss. Operational & compliance risk losses can occur as a result of fraud, human error, missing or inadequately designed processes, failed systems, damage to physical assets, improper behaviour or from external events. The losses range from direct financial losses, to reputational damage, unfavourable media attention, loss of staff or clients as a breach of laws or banking regulations. Examples include failure to comply with policy and legislation, human error, natural disasters, fraud and other malicious acts. Where appropriate, risks are mitigated by insurance. To ensure appropriate responsibility is allocated for the management, reporting and escalation of operational & compliance risk, the banking group operates a “three lines of defence” model which outlines principles for the roles, responsibilities and accountabilities for operational & compliance risk management: - - - The first line of defence is the business line management of the identification, management and mitigation of the risks associated with the products and processes of the business. This accountability includes regular testing and certification of the adequacy and effectiveness of controls and compliance with the banking group’s policies. The second line of defence is the Risk & Compliance function, responsible for the design and ownership of the Operational & Compliance Risk framework. It incorporates key processes including Risk and Control Self-Assessment (RCSA), incident management, independent evaluation of the adequacy and effectiveness of the internal control framework, and the self-certification process. The third line of defence is audit. Internal Audit is responsible for independently assessing how effectively Heartland is managing its risk according to stated risk appetite. The banking group’s exposure to operational & compliance risk is governed by a policy approved by the Board and managed by the ERC. This policy sets out the nature of risk which may be taken and aggregate risk limits, and the ERC must conform to this. Foreign exchange rate risk Foreign exchange risk is the risk that the banking group’s earnings and shareholder equity position are adversely impacted from changes in foreign exchange rates. The banking group has exposure to foreign exchange translation risks through its Australian subsidiaries (which have a functional currency of AUD), in the forms of profit translation risk and balance sheet translation risk. Profit translation risk is the risk that deviations in exchange rates have a significant impact on the reported profit. Balance sheet translation risk is the risk that whilst the foreign currency value of the net investment in a subsidiary may not have changed, when translated back to the New Zealand dollars (NZD), the NZD value has changed materially due to movements in the exchange rates. Foreign exchange revaluation gains and losses are booked to the Foreign currency translation reserve. Substantial foreign exchange rate movements in any given year may have an impact on other comprehensive income. The banking group manages this risk by setting and approving the foreign exchange rate for the upcoming financial year and entering into hedging contracts to manage the foreign exchange translation risks. 32 Disclosure Statement For The Year Ended 30 June 2016 www.heartland.co.nz 59 NOTES TO THE FINANCIAL STATEMENTS For the year ended 30 June 2016 18 Credit risk exposure Credit risk is the risk that a borrower will default on any type of debt by failing to make payments which it is obligated to do so. The risk is primarily that of the lender and includes loss of principal and interest, disruption to cash flows and increased collection costs. Credit risk is managed to achieve sustainable risk-reward performance whilst maintaining exposures within acceptable risk “appetite” parameters. This is achieved through the combination of governance, policies, systems and controls, underpinned by commercial judgement as described below. To manage this risk the BRC oversees the formal credit risk management strategy. The BRC reviews the Banking Group's credit risk exposures on a quarterly basis to ensure consistency with the Banking Group's credit policies to manage all aspects of credit risk. The credit risk management strategies ensure that: - Credit origination meets agreed levels of credit quality at point of approval. - Sector and geographical risks are actively managed. - Industry concentrations are actively monitored. - Maximum total exposure to any one debtor is actively managed. - Changes to credit risk are actively monitored with regular credit reviews. The banking group has adopted a detailed Credit Risk Framework which contains further detail and appetite regarding the above credit risk management strategies. The Framework is the overarching Credit Risk document and is supported further by Lending Standards that provide criteria for finance products within each business sector. The combination of the Credit Risk Framework and Lending Standards guides credit assessment, credit risk grading, documentation standards, legal procedures and compliance with regulatory and statutory requirements. The BRC has authority from the Board for approval of all credit exposures. Lending authority has been provided to the Banking Group's Credit Committee, for delegation through the business units under a detailed Delegated Lending Authority framework. Application of credit discretions in the business operation are monitored through a defined review and hindsight structure as outlined in the Credit Risk Oversight Policy. Delegated Lending Authorities are provided to individual officers with due cognisance of their experience and ability. Larger and higher risk exposures require approval of senior management, the Credit Risk Committee and ultimately through to the BRC. The banking group employs a comprehensive process of hind sighting loans to ensure that credit policies and the quality of credit processes are maintained. Home equity loans and negative equity risk Home equity release loans are a form of mortgage lending targeted toward the seniors market. These loans differ to conventional mortgages in that they typically are not repaid until the borrower ceases to reside in the property. Further, interest is not required to be paid, it is capitalised with the loan balance and is repayable on termination of the loan. As such, there are no incoming cash flows and therefore no default risk to manage during the term of the loan. Credit risk becomes 'negative equity' risk through the promise to customers that they can reside in their property for 'as long as they wish' and repayment of their loan is limited to the net sale proceeds of their property. The banking group's exposure to negative equity risk is managed by Credit Risk Policy in conjunction with associated lending standards specific for this product. Both New Zealand and Australia home equity operations are similarly aligned. The policy is managed and reviewed by Credit to ensure appropriate consistency across locations. (a) Maximum exposure to credit risk at the relevant reporting dates The following table represents the maximum credit risk exposure, without taking account of any collateral held. The exposures set out above are based on net carrying amounts as reported in the Statement of Financial Position. Cash and cash equivalents Investments Finance receivables Derivative financial assets Other financial assets Total on balance sheet credit exposures Jun 2016 Jun 2015 $000 $000 84,154 37,012 236,435 329,338 3,113,957 2,862,070 148 5,452 59 5,546 3,440,146 3,234,025 33 60 Heartland Bank Limited - Annual Report 2016 Disclosure Statement For The Year Ended 30 June 2016 NOTES TO THE FINANCIAL STATEMENTS For the year ended 30 June 2016 18 Credit risk exposure (continued) (b) Concentration of credit risk by geographic region Auckland Wellington Rest of North Island Canterbury Rest of South Island Australia: Queensland New South Wales Victoria Western Australia South Australia Rest of Australia Rest of the world 1 Collective provision Less acquisition fair value adjustment for present value of future losses Total on balance sheet credit exposures Jun 2016 Jun 2015 $000 $000 847,182 188,962 888,085 505,455 488,301 113,912 189,868 90,326 18,120 16,860 10,387 103,934 830,027 206,818 788,904 494,848 424,828 117,867 182,032 83,213 17,396 18,169 11,048 75,318 3,461,392 3,250,468 (16,259) (10,201) (4,987) (6,242) 3,440,146 3,234,025 1 These overseas assets are not Finance Receivables, they are Investments. These assets represent NZD-denominated investments in AA+ and higher rated securities issued by offshore supranational agencies ("Kauri Bonds"). (c) Concentration of credit risk by industry sector Agriculture Forestry and Fishing Mining Manufacturing Finance & Insurance Wholesale trade Retail trade Households Property and Business services Transport and storage Other Services Collective provision Less acquisition fair value adjustment for present value of future losses Total on balance sheet credit exposures Jun 2016 Jun 2015 $000 $000 628,202 537,286 52,478 14,912 88,412 35,126 14,105 93,779 339,646 377,318 36,040 82,665 260,510 193,862 1,498,261 1,397,003 405,469 396,939 26,715 20,068 110,747 102,317 3,461,392 3,250,468 (16,259) (10,201) (4,987) (6,242) 3,440,146 3,234,025 34 Disclosure Statement For The Year Ended 30 June 2016 www.heartland.co.nz 61 NOTES TO THE FINANCIAL STATEMENTS For the year ended 30 June 2016 18 Credit risk exposure (continued) (d) Commitments to extend credit Undrawn facilities available to customers Conditional commitments to fund at future dates Jun 2016 Jun 2015 $000 $000 147,903 114,855 116,217 108,037 As at 30 June 2016 there are no undrawn lending commitments to counterparties for whom drawn balances are classified as individually impaired (2015: nil). (e) Credit exposures to connected persons Credit exposures to non-bank connected persons at year end ($000's) Credit exposures to non-bank connected persons at year end (% of total Tier 1 Capital) Peak credit exposures to non-bank connected persons during the year ($000's) Peak credit exposures to non-bank connected persons during the year (% of total Tier 1 Capital) Jun 2016 - 0.00% - 0.00% Credit exposure concentrations are derived in accordance with the bank's conditions of registration, BS2A and BS8 and disclosed on the basis of actual credit exposures and calculated on a gross basis (net of individual credit impairment allowances and excluding advances of a capital nature). The banking group does not have credit exposures to connected persons other than non-bank connected persons. Peak end-of-day credit exposures to non-bank connected persons have been calculated using the banking group’s Tier 1 capital at 30 June 2016. The rating-contingent limit, which is applicable to the banking group, based on the Conditions of Registration imposed by the RBNZ is 15%. There have been no rating-contingent limit changes during the accounting period. Within the rating-contingent limit there is a sub-limit of 15% of Tier 1 capital, which applies to the aggregate credit exposure to non-bank connected persons. There are no individual credit impairment allowances against credit exposures to non-bank connected persons as at 30 June 2016. Exposures to connected persons are not on more favourable terms (e.g. as relates to such matters as credit assessments, tenor, interest rates, amortisation schedules and requirement for collateral) than corresponding exposures to non-connected persons. The banking group does not have any contingent exposures to connected persons arising from risk lay-off arrangements as at balance date. (f) Credit exposure to individual counterparties At 30 June 2016 the banking group did not have any period end or peak end-of-day credit exposures over 10% of equity to individual counterparties (not being members of groups of closely related counterparties) or groups of closely related counterparties (excluding central government of any country with a long-term credit rating of A- or A3 or above, or its equivalent, or any bank with a long-term credit rating of A- or A3 or above, or its equivalent, and connected persons) (2015: nil). The peak aggregate end-of-day credit exposure is determined by taking the maximum end-of-day aggregate amount of credit exposure over the period. The amount is then divided by the banking group's equity as at the end of the quarter. Credit exposures disclosed are based on actual exposures. The credit rating is applicable to an entity’s long term senior unsecured obligations payable in New Zealand, in New Zealand dollars. 35 62 Heartland Bank Limited - Annual Report 2016 Disclosure Statement For The Year Ended 30 June 2016 NOTES TO THE FINANCIAL STATEMENTS For the year ended 30 June 2016 19 Asset quality The disclosures in this note are categorised by the following credit risk concentrations: Corporate Rural Property Other Residential Lending to the farming sector primarily livestock, rural mortgage lending, seasonal and working capital financing, as well as leasing solutions to farmers. Includes lending to individuals and small to medium enterprises. Property asset lending including non-core property. All other lending that does not fall into another category. Lending secured by a first ranking mortgage over a residential property used primarily for residential purposes either by the mortgagor or a tenant of the mortgagor. All Other Consumer lending to individuals. (a) Finance receivables by credit risk concentration Jun 2016 Neither at least 90 days past due nor impaired At least 90 days past due Individually impaired Restructured assets Fair value adjustment for present value of future losses Provision for impairment NOTE 19(b) 19(c) 11 19(e) Corporate Residential All Other Total Rural $000 Property $000 Other $000 $000 $000 $000 654,353 4,293 22,667 56 - 3,561 - - 266 935,859 854,183 636,432 3,081,093 - 12,632 588 4,454 7,536 766 - - - 2,459 21,967 33,764 3,281 - (4,987) - (4,987) (4,464) (1,649) (8,416) (3,046) (3,586) (21,161) Total net finance receivables 676,905 2,178 948,377 846,738 639,759 3,113,957 Jun 2015 Neither at least 90 days past due nor impaired At least 90 days past due Individually impaired Restructured assets Fair value adjustment for present value of future losses Provision for impairment 19(b) 19(c) 11 19(e) 553,739 17,904 1,562 43 - - 884,942 837,063 553,502 2,829,246 286 6,854 - - 13,384 16,982 1,024 655 224 - 2,746 - 2,814 34,975 25,622 3,881 - (6,242) - (6,242) (2,173) (4,614) (14,368) (1,763) (2,494) (25,412) Total net finance receivables 571,075 2,526 901,964 829,937 556,568 2,862,070 (b) Past due but not impaired Jun 2016 Less than 30 days past due At least 30 and less than 60 days past due At least 60 but less than 90 days past due At least 90 days past due Total past due but not impaired Jun 2015 Less than 30 days past due At least 30 and less than 60 days past due At least 60 but less than 90 days past due At least 90 days past due Total past due but not impaired 10,822 4,837 3,051 4,293 23,003 7,338 3,752 416 17,904 29,410 - - - - - - - - 286 286 20,512 5,855 3,124 12,632 42,123 9,185 3,434 4,099 13,384 30,102 1,522 719 - 588 20,194 5,287 2,394 4,454 53,050 16,698 8,569 21,967 2,829 32,329 100,284 2,877 14,700 491 532 655 3,984 1,789 2,746 4,555 23,219 34,100 11,661 6,836 34,975 87,572 36 Disclosure Statement For The Year Ended 30 June 2016 www.heartland.co.nz 63 NOTES TO THE FINANCIAL STATEMENTS For the year ended 30 June 2016 19 Asset quality (continued) (c) Individually impaired assets Jun 2016 Opening Additions Deletions Write offs Closing gross individually impaired assets Less: provision for individually impaired assets Total net impaired assets Jun 2015 Opening Additions Deletions Write offs Closing gross individually impaired assets Less: provision for individually impaired assets Total net impaired assets (d) Credit risk grading Corporate Residential All Other Total Rural $000 Property $000 Other $000 $000 $000 $000 1,562 23,135 (1,420) (610) 22,667 869 21,798 6,854 350 (1,115) (2,528) 3,561 524 3,037 16,982 11,431 (12,005) (8,872) 7,536 3,509 4,027 2,818 1,072 17,090 700 7,709 32,707 (1,651) (10,375) (23,117) (677) 1,562 817 745 (561) 6,854 3,258 3,596 (317) 16,982 11,136 5,846 224 - (224) - - - - - 227 (3) - 224 - 224 - - - - - - - - - - - - - 25,622 34,916 (14,764) (12,010) 33,764 4,902 28,862 27,617 34,706 (35,146) (1,555) 25,622 15,211 10,411 The banking group's receivables are monitored either by account behaviour or a regular assessment of their credit risk grade based on an objective review of defined risk characteristics. The portfolio risk is regularly refreshed based on current information. The banking group classifies finance receivables as Behavioural or Judgement. The Behavioural portfolio consists of consumer, retail and home equity release receivables and usually relates to financing of or the acquisition of a single asset. Consumer loans are typically introduced by vendors of the asset financed and are smaller in value than Judgement loans. Consumer and retail loans are risk graded based on arrears status. Consumer and retail loans are classified as either not in arrears, active, arrangement, non-performing / repossession or recovery, as described below: • • • • Active – loans for which the arrears category has reached 5 days overdue. Arrangement – 5 to 34 days overdue accounts for which arrangements have or are in the process of being made for arrears to be repaid. Non-performing / Repossession – residential mortgage loans that are greater than 90 days past due / other loans for which security has or is in the process of being repossessed. Recovery loans – loans for which security has been sold and shortfalls are being sought from the customer or where other recovery action is being taken. The banking group also lends funds on its home equity release product which is considered behavioural but has no arrears characteristics. These loans are assessed on origination against a pre-determined criteria supported by an actuarial assessment of future losses. The assumptions embedded in that assessment are reviewed annually against actual experience. The Judgement portfolio consists mainly of Business and Rural lending. Judgement loans relate to loans where an on-going and detailed working relationship with the customer has been developed. Judgement loans are individually risk graded based on loan status, financial information, security and debt servicing ability. Exposures in the Judgement portfolio are credit risk graded by an internal risk grading mechanism. In the Judgement portfolio, grade 1 is the strongest risk grade for undoubted risk and grade 9 represents the weakest risk grade where a loss is probable. Grade 10 reflects loss accounts written off. Grades 2 to 8 represent ascending steps in management's assessment of risk of exposures. The banking group typically finances new loans in risk grades 2 to 5 of the Judgement portfolio. 37 64 Heartland Bank Limited - Annual Report 2016 Disclosure Statement For The Year Ended 30 June 2016 NOTES TO THE FINANCIAL STATEMENTS For the year ended 30 June 2016 19 Asset quality (continued) (d) Credit risk grading (continued) Corporate Residential All Other Total Rural $000 Property $000 Other $000 $000 $000 $000 Jun 2016 Judgement portfolio Grade 1 - Very Strong Grade 2 - Strong Grade 3 - Sound Grade 4 - Adequate Grade 5 - Acceptable Grade 6 - Monitor Grade 7 - Substandard Grade 8 - Doubtful Grade 9 - At risk of loss 936 5,553 16,523 90,431 405,299 79,468 414 11,495 10,223 - - - - - 266 - 3,037 - - - 20,593 75,078 178,616 295,342 46,168 20,020 2,372 1,965 13,897 1,132 2,098 1,712 - - - - Total Judgement portfolio 620,342 3,303 640,154 18,839 - - - - - - - - - - 936 40,043 92,733 271,145 702,353 125,902 20,434 16,904 12,188 1,282,638 Behavioural portfolio Not in arrears Active Arrangement Non-performing / Repossession Recovery Total Behavioural portfolio Provision for collectively impaired assets Fair value adjustment for present value of future losses 58,419 817 607 230 85 60,158 (3,595) - - - - - - - 301,797 833,201 604,652 1,798,069 5,875 3,092 1,194 1,172 1,522 1,209 - - 17,681 10,015 5,083 5,914 25,895 14,923 6,507 7,171 313,130 835,932 643,345 1,852,565 (1,125) (4,907) - - (3,046) (4,987) (3,586) (16,259) - (4,987) Total finance receivables 676,905 2,178 948,377 846,738 639,759 3,113,957 Jun 2015 Judgement portfolio Grade 1 - Very Strong Grade 2 - Strong Grade 3 - Sound Grade 4 - Adequate Grade 5 - Acceptable Grade 6 - Monitor Grade 7 - Substandard Grade 8 - Doubtful Grade 9 - At risk of loss 533 8,019 17,363 101,029 343,645 49,276 3,484 761 - - - - - - 286 - 3,596 - - - 30,113 52,022 160,527 259,241 50,162 11,453 157 7,082 2,480 463 3,791 5,315 125 - - - Total Judgement portfolio 524,110 3,882 570,757 12,174 - - - - - - - - - - 533 40,612 69,848 265,347 608,201 99,849 14,937 4,514 7,082 1,110,923 Behavioural portfolio Not in arrears Active Arrangement Non-performing / Repossession Recovery Total Behavioural portfolio Provision for collectively impaired assets Fair value adjustment for present value of future losses 47,208 415 443 201 54 48,321 (1,356) - - - - - - - 324,995 821,357 530,204 1,723,764 4,526 2,776 1,266 876 2,721 1,690 - - 13,535 10,946 1,620 2,757 21,197 15,855 3,087 3,687 334,439 825,768 559,062 1,767,590 (1,356) (3,232) - - (1,763) (6,242) (2,494) (10,201) - (6,242) Total finance receivables 571,075 2,526 901,964 829,937 556,568 2,862,070 38 Disclosure Statement For The Year Ended 30 June 2016 www.heartland.co.nz 65 NOTES TO THE FINANCIAL STATEMENTS For the year ended 30 June 2016 19 Asset quality (continued) (e) Provision for impairment Credit impairment provisions are made where events have occurred leading to an expectation of reduced future cash flows from certain receivables. These provisions are made in some cases against an individual loan and in other cases on a collective basis. Bad debts provided for are written off against individual or collective provisions. Amounts required to bring the provisions to their assessed levels are recognised in profit or loss. Any future recoveries of amounts provided for are recognised in profit or loss. Collective provisioning The term collectively impaired asset refers to an asset where an event has occurred of which past history indicates that there is an increased possibility that the banking group will not collect all its principal and interest as it falls due. No losses have yet been identified on these individual loans within the collectively impaired asset grouping, and history would indicate that only a small portion of these loans will eventually not be recovered. The banking group provides fully for its expected losses on collectively impaired assets. Collective provisions are assessed with reference to risk profile groupings and historical loss data. Other judgemental factors including economic and credit cycle considerations are also taken into account in determining appropriate loss propensities to be applied. The future credit quality of these portfolios is subject to uncertainties that could cause actual credit losses to differ materially from reported loan impairment provisions. These uncertainties include the wider economic environment, interest rates and their effect on customer spending, unemployment levels, payment behaviour and bankruptcy rates. No provisions are applied to loans that are newly written and loans that remain within their contractual terms, except where the banking group becomes aware of an event that might alter its view of the risk of a particular deal or group of deals. Individual provisioning Specific impairment provisions are made where events have occurred leading to an expectation of reduced future cash flows from certain receivables. For individually significant loans for which the assessed risk grade is considered a “potential loss”, an individual assessment is made of an appropriate provision for credit impairment. Credit impairments are recognised as the difference between the carrying value of the loan and the discounted value of management’s best estimate of future cash repayments and proceeds from any security held (discounted at the loan’s original effective interest rate). All relevant considerations that have a bearing on the expected future cash flows are taken into account, including the business prospects for the customer, the likely realisable value of collateral, the banking group’s position relative to other claimants, the reliability of customer information and the likely cost and duration of the work-out process. Subjective judgements are made in this process. Furthermore, judgement can change with time as new information becomes available or as work-out strategies evolve, resulting in revisions to the impairment provision as individual decisions are taken. Changes in judgement could have a material impact on the financial statements. Adequacy of the collective provision levels for each risk grouping is measured against historical loss experience at least annually. Adequacy of individual provisions is assessed in respect of each loan on a material development or at least quarterly. For Behavioural loans, excluding home equity release loans, arrears drive provision outcomes. Each arrears classification carries a provision for potential loss based on historical experience for that classification in the same portfolio. 39 66 Heartland Bank Limited - Annual Report 2016 Disclosure Statement For The Year Ended 30 June 2016 NOTES TO THE FINANCIAL STATEMENTS For the year ended 30 June 2016 19 Asset quality (continued) (e) Provision for impairment (continued) Corporate Residential All Other Total Rural $000 Property $000 Other $000 $000 $000 $000 Jun 2016 Provision for individually impaired assets Opening provision for individually impaired assets 817 3,258 11,136 Impairment loss for the year - charge / (credit) for the year - recoveries - write offs Closing provision for individually impaired assets Provision for collectively impaired assets 662 - (610) 869 (206) - (2,528) 524 607 638 (8,872) 3,509 - - - - - - - - - - 15,211 1,063 638 (12,010) 4,902 Opening provision for collectively impaired assets 1,356 1,356 3,232 1,763 2,494 10,201 Impairment loss for the year - charge / (credit) for the year - recoveries - write offs 2,258 (233) - (19) 2 - Closing provision for collectively impaired assets 3,595 1,125 3,630 193 (2,148) 4,907 1,301 5,482 12,438 70 (88) 3,046 8 (4,398) 3,586 273 (6,653) 16,259 Total provision for impairment 4,464 1,649 8,416 3,046 3,586 21,161 Jun 2015 Provision for individually impaired assets Opening provision for individually impaired assets 1,531 3,739 4,092 Impairment loss for the year - (credit) / charge for the year - recoveries - write offs - effect of discounting Closing provision for individually impaired assets Provision for collectively impaired assets (35) - (677) (2) 817 349 - (561) (269) 6,892 669 (317) (200) 3,258 11,136 - - - - - - - - - - - - 9,362 7,206 669 (1,555) (471) 15,211 Opening provision for collectively impaired assets 583 2,005 3,183 57 1,171 6,999 Impairment loss for the year - charge / (credit) for the year - recoveries - write offs 775 - (2) (691) 42 - Closing provision for collectively impaired assets 1,356 1,356 537 168 (656) 3,232 1,706 - - 1,763 2,572 3 (1,252) 2,494 4,899 213 (1,910) 10,201 Total provision for impairment 2,173 4,614 14,368 1,763 2,494 25,412 (f) Other assets under administration Other assets under administration are any loans, not being individually impaired or 90 days or more past due, where the customer is in any form of voluntary or involuntary administration, including receivership, liquidation, bankruptcy or statutory management. As at 30 June 2016, the banking group had assets under administration of $3,017,000 (2015: $2,476,000). 40 Disclosure Statement For The Year Ended 30 June 2016 www.heartland.co.nz 67 NOTES TO THE FINANCIAL STATEMENTS For the year ended 30 June 2016 20 Liquidity risk Liquidity risk is the risk that the banking group is unable to meet its payment obligations as they fall due. The timing mismatch of cash flows and the related liquidity risk is inherent in all banking operations and is closely monitored by the banking group. Management of liquidity risk is designed to ensure that the banking group has the ability to generate or obtain sufficient cash in a timely manner and at a reasonable price to meet its financial commitments on a daily basis. The banking group’s exposure to liquidity risk is governed by a policy approved by the Board and managed by the ALCO. This policy sets out the nature of risk which may be taken and aggregate risk limits, and the ALCO must conform to this. The objective of the ALCO is to derive the most appropriate strategy for the banking group in terms of the mix of assets and liabilities given its expectations of future cash flows, liquidity constraints and capital adequacy. The banking group employs asset and liability cash flow modelling to determine appropriate liquidity and funding strategies. The banking group holds the following financial assets for the purpose of managing liquidity risk: Cash and cash equivalents Investments Undrawn committed bank facilities Total liquidity Jun 2016 Jun 2015 $000 $000 84,154 37,012 229,144 322,619 66,000 90,000 379,298 449,631 Contractual liquidity profile of financial assets and liabilities The following tables present the banking group's financial assets and liabilities by relevant maturity groupings based upon contractual maturity date. The amounts disclosed in the tables represent undiscounted future principal and interest cash flows. As a result, the amounts in the tables below may differ to the amounts reported on the balance sheet. The contractual cash flows presented below may differ significantly from actual cash flows. This occurs as a result of future actions by the banking group and its counterparties, such as early repayments or refinancing of term loans and borrowings. Deposits and other public borrowings include customer savings deposits and transactional accounts, which are at call. History demonstrates that such accounts provide a stable source of long term funding for the banking group. The banking group does not manage its liquidity risk on a contractual liquidity basis. Jun 2016 Financial assets Cash and cash equivalents Investments Finance receivables Finance receivables - securitised Derivative financial assets Other financial assets Total financial assets Financial liabilities Borrowings Borrowings - securitised Derivative financial liabilities Other financial liabilities Total financial liabilities On 0-6 6-12 Demand Months Months $000 $000 $000 1-2 Years $000 2-5 Years $000 5+ Years $000 Total $000 84,154 - - - - - 84,154 - - - - - 11,309 18,198 87,931 135,611 7,291 260,340 634,053 393,951 512,900 850,623 2,894,979 5,286,506 92,427 72,671 97,377 70,280 148 5,452 - - - - - - - - - 332,755 148 5,452 84,154 743,389 484,820 698,208 1,056,514 2,902,270 5,969,355 718,587 860,437 - - - 4,646 5,866 21,995 552,208 285,236 - - 208,556 465,204 - - - - - - 718,587 892,944 837,444 208,556 465,204 - - - - - 2,804,992 289,882 5,866 21,995 3,122,735 Net financial (liabilities) / assets (634,433) (149,555) (352,624) 489,652 591,310 2,902,270 2,846,620 Unrecognised loan commitments Undrawn committed bank facilities 147,903 66,000 - - - - - - - - - - 147,903 66,000 41 68 Heartland Bank Limited - Annual Report 2016 Disclosure Statement For The Year Ended 30 June 2016 NOTES TO THE FINANCIAL STATEMENTS For the year ended 30 June 2016 20 Liquidity risk (continued) Contractual liquidity profile of financial assets and liabilities (continued) Jun 2015 Financial assets Cash and cash equivalents Investments Finance receivables Finance receivables - securitised Derivative financial assets Other financial assets Total financial assets Financial liabilities Borrowings Borrowings - securitised Derivative financial liabilities Other financial liabilities Total financial liabilities On 0-6 6-12 Demand Months Months $000 $000 $000 1-2 Years $000 2-5 Years $000 5+ Years $000 Total $000 37,012 - - - - - 37,012 - - - - - 27,039 47,376 35,801 237,409 19,852 367,477 544,745 334,438 501,222 841,869 3,291,828 5,514,102 87,168 68,824 92,675 66,949 59 5,546 - - - - - - - - - 315,616 59 5,546 37,012 664,557 450,638 629,698 1,146,227 3,311,680 6,239,812 746,637 731,784 - - 5,215 6,407 1,695 20,594 435,145 260,964 - 267 150,732 649,509 - - 522 - - - 748,332 764,000 696,376 151,254 649,509 - - - - - 2,713,807 266,179 6,407 23,078 3,009,471 Net financial (liabilities) / assets (711,320) (99,443) (245,738) 478,444 496,718 3,311,680 3,230,341 Unrecognised loan commitments Undrawn committed bank facilities 116,217 90,000 - - - - - - - - - - 116,217 90,000 Undrawn committed bank facilities of $66.0 million (2015: $90.0 million) were available to be drawn down on demand. To the extent drawn, $66.0 million is contractually repayable in 6-12 months' time upon facility expiry. 21 Interest rate risk The banking group's market risk is derived primarily of exposure to interest rate risk, predominantly from raising funds through the retail and wholesale deposit market, the debt capital markets and committed and uncommitted bank funding, securitisation of receivables, and offering loan finance products to the commercial and consumer market in New Zealand and Australia. Interest rate risk is the risk that the value of assets or liabilities will change because of changes in interest rates or that market interest rates may change and thus alter the margin between interest earning assets and interest bearing liabilities. Interest rate risk for the banking group refers to the risk of loss due to holding assets and liabilities that may mature or re-price in different periods. ‐ ‐ The banking group’s exposure to market risk is governed by a policy approved by the Board and managed by the ALCO. This policy sets out the nature of risk which may be taken and aggregate risk limits, and the ALCO must conform to this. The objective of the ALCO is to derive the most appropriate strategy for the banking group in terms of the mix of assets and liabilities given its expectations of the future and the potential consequences of interest rate movements, liquidity constraints and capital adequacy. To manage this market risk, the banking group measures sensitivity to interest rate changes by frequently testing its position against various interest rate change scenarios to assess potential risk exposure. The banking group also manages interest rate risk by: - Monitoring maturity profiles and seeking to match the re-pricing of assets and liabilities (physical hedging); - Monitoring interest rates daily and regularly (at least monthly) reviewing interest rate exposure; and - Entering into forward rate agreements and interest rate swaps and options to hedge against movements in interest rates. 42 Disclosure Statement For The Year Ended 30 June 2016 www.heartland.co.nz 69 NOTES TO THE FINANCIAL STATEMENTS For the year ended 30 June 2016 21 Interest rate risk (continued) Contractual repricing analysis The interest rate risk profile of financial assets and liabilities that follows has been prepared on the basis of maturity or next repricing date, whichever is earlier. Jun 2016 Financial assets Cash and cash equivalents Investments Finance receivables Finance receivables - securitised Other financial assets Total financial assets Financial liabilities Borrowings Borrowings - securitised Other financial liabilities Total financial liabilities 0-3 3-6 6-12 Months Months Months $000 $000 $000 1-2 Years $000 2+ Non-interest Years $000 bearing $000 Total $000 84,062 54,307 2,102,720 42,858 148 - - - - 92 84,154 1,458 92,566 37,003 11,894 49,897 156,153 230,743 63,728 87,089 111,588 235,730 65,173 7,291 236,435 194 2,818,106 - 295,851 - - - - 5,452 5,600 2,284,095 131,027 231,775 367,729 412,491 13,029 3,440,146 1,562,772 380,170 529,796 183,094 59,726 284,429 5,866 - - - - - - - - - - 21,995 2,715,558 284,429 27,861 1,853,067 380,170 529,796 183,094 59,726 21,995 3,027,848 Effect of derivatives held for risk management 235,387 (28,241) (54,756) (81,230) (71,160) - - Net financial assets / (liabilities) 666,415 (277,384) (352,777) 103,405 281,605 (8,966) 412,298 Jun 2015 Financial assets Cash and cash equivalents Investments Finance receivables Finance receivables - securitised Other financial assets Total financial assets Financial liabilities Borrowings Borrowings - securitised Other financial liabilities Total financial liabilities 36,928 137,742 1,962,329 40,193 59 - - - - 84 37,012 1,938 87,889 35,548 25,797 14,410 149,239 204,142 60,778 83,434 142,732 180,427 57,661 6,719 329,338 430 2,584,456 - 277,614 - - - - 5,546 5,605 2,177,251 125,375 235,814 301,986 380,820 12,779 3,234,025 1,529,593 375,635 411,061 119,351 130,975 258,630 8,102 - - - 250 - 503 - - - - 20,594 2,566,615 258,630 29,449 1,796,325 375,635 411,311 119,854 130,975 20,594 2,854,694 Effect of derivatives held for risk management 250,699 (25,355) (46,365) (88,039) (90,940) - - Net financial assets / (liabilities) 631,625 (275,615) (221,862) 94,093 158,905 (7,815) 379,331 The tables above illustrate the periods in which the cash flows from interest rate swaps are expected to occur and affect profit or loss. The management of interest rate risk against interest rate gap limits is supplemented by monitoring the sensitivity of the banking group's financial assets and liabilities to various standard and non standard interest rate scenarios. Standard scenarios which are considered on a monthly basis include a 100 basis point parallel fall or rise in the yield curve. There is no material impact on profit or loss in terms of a fair value change from movements in market interest rates. Furthermore there is no material cash flow impact on the Statement of Cash Flows from a 100 basis point change in interest rates. 43 70 Heartland Bank Limited - Annual Report 2016 Disclosure Statement For The Year Ended 30 June 2016 NOTES TO THE FINANCIAL STATEMENTS For the year ended 30 June 2016 22 Concentrations of funding (a) Concentration of funding by industry Finance Other Total borrowings (b) Concentration of funding by geographical area Auckland Wellington Rest of North Island Canterbury Rest of South Island Overseas 1 Total borrowings Jun 2016 Jun 2015 $000 $000 852,433 790,137 2,147,554 2,035,108 2,999,987 2,825,245 849,276 155,248 520,764 800,893 206,748 467,058 441,921 384,344 472,167 772,689 206,563 547,561 2,999,987 2,825,245 1 Included in Overseas funding is the CBA bank facility totalling $379 million (2015: $466 million), refer to Note 13 - Borrowings for more information. Other Disclosures 23 Significant subsidiaries and interests in joint arrangements Significant subsidiaries / Joint arrangements VPS Properties Limited New Sentinel Limited (NSL) 2 Australian Seniors Finance Pty Limited (ASF) MARAC Insurance Limited 3 Country of Nature of incorporation business and place of business New Zealand New Zealand Australia New Zealand Investment property holding company Financial services Financial services Insurance services Proportion of ownership interest and voting power held Jun 2016 Jun 2015 100% n/a 100% 100% 100% 100% 100% 50% 2 On 30 April 2016, NSL was amalgamated with the bank. 3 On 17 July 2015, the bank acquired the remaining 50% of MARAC Insurance Limited for $2.3 million. A loss on acquisition of $339k was recognised during the year ended 30 June 2015. MARAC Insurance Limited was previously a joint arrangement accounted for using the equity method. 24 Structured entities A structured entity is one which has been designed such that voting or similar rights are not the dominant factor in deciding who controls the entity. Structured entities are created to accomplish a narrow and well-defined objective such as the securitisation or holding of particular assets, or the execution of a specific borrowing or lending transaction. Structured entities are consolidated where the substance of the relationship is that the banking group controls the structured entity. (a) Heartland Cash and Term PIE Fund The banking group controls the operations of Heartland Cash and Term PIE Fund (Heartland PIE Fund). Heartland PIE Fund is a portfolio investment entity that invests in the bank's deposits. Investments of Heartland PIE Fund are represented as follows: Deposits Jun 2016 Jun 2015 $000 $000 80,527 45,110 44 Disclosure Statement For The Year Ended 30 June 2016 www.heartland.co.nz 71 NOTES TO THE FINANCIAL STATEMENTS For the year ended 30 June 2016 24 Structured entities (continued) (b) Heartland ABCP Trust 1 (ABCP Trust) The banking group has securitised a pool of receivables comprising commercial and motor vehicle loans to ABCP Trust. The banking group continues to recognise the securitised assets and associated borrowings in the Statement of Financial Position as it is the residual beneficiary and subordinated debt holder of the Trust. Despite the bank being the residual beneficiary, the loans sold to ABCP Trust are set aside for the benefit of investors in ABCP Trust and bank depositors will have no recourse to these assets. ABCP Trust's material assets and liabilities are represented as follows: Cash and cash equivalents - securitised Finance receivables - securitised Borrowings - securitised Derivative financial asset - securitised Derivative financial liabilities - securitised NOTE 11 13 15(a) Jun 2016 Jun 2015 $000 15,208 $000 5,553 295,851 277,614 (284,429) (258,630) - 59 (2,833) (1,995) (c) Seniors Warehouse Trust (SW Trust) and ASF Settlement Trust (ASF Trust) SW Trust and ASF Trust form part of ASF's home equity release business. They were both set up by ASF, as asset holding entities. The Trustee for both Trusts is ASF Custodians Pty Limited and the Trust Manager is ASF. The balances of SW Trust and ASF Trust are represented as follows: Cash and cash equivalents Finance receivables - Home equity release loans Borrowings - CBA Derivative financial liabilities 25 Staff share ownership arrangements Jun 2016 Jun 2015 $000 2,503 $000 1,207 434,688 424,445 (379,299) (372,333) (2,083) (3,608) The banking group operates a number of share-based compensation plans that are equity settled. The fair value determined at the grant date is expensed on a straight line basis over the vesting period, based on the banking group's estimate of equity instruments that will eventually vest, with a corresponding increase in equity. At the end of each reporting period, the banking group revises its estimate of the number of equity instruments expected to vest. The impact of the revision of the original estimates, if any, is recognised in profit or loss such that the cumulative expense reflects the revised estimate, with a corresponding adjustment to the employee benefits reserve. (a) Share-based compensation plan details Heartland LTI Net Share Settled Plan (LTI Plan) The LTI Plan has been allotted under three tranches (referred to as the 2013, 2014 and 2015 tranches). Under the LTI Plan participants are granted an option to acquire shares in the bank. The number of shares granted upon exercise of the options is based on the difference between the market price of the shares on the exercise date and the reference price. The market price is the volume weighted average price (VWAP) of the bank's ordinary shares on the NZX Main Board (Heartland Shares) for the 20 business days immediately before (but excluding) the exercise date for those options. The reference price will be 5% over the VWAP of Heartland shares for the 20 business days immediately following, but not excluding, the reference date. The reference dates of the 2013, 2014 and 2015 tranches are 26 August 2013, 25 August 2014 and 18 August 2015 respectively. The options are subject to the participants continued employment with the banking group for the service period of 3 years which begins on 1 July 2012, 1 July 2013 and 1 July 2014 for the 2013, 2014 and 2015 plans respectively. Participants in the 2013, 2014 and 2015 tranches will be able to exercise their options between September 2015 to 1 July 2017, September 2016 to 1 July 2018 and September 2017 to 1 July 2019 respectively. 2015 Special Grant (LTI SG) Participants of the LTI SG will be able to exercise the options in the period beginning on the date the market price of Heartland shares is equal to $1.50 and ending on 1 July 2017. Market price is calculated based on the VWAP of a Heartland share for the 10 business days immediately before (but excluding) the exercise date for those options. The options are subject to the participants continued employment with the banking group for the service period of 3 years which begins on 1 July 2014. Following exercise a lock up period until 1 July 2020 will apply during which participants are restricted from disposing of shares. The reference price is the amount (if any) by which the market price of Heartland shares at the time of exercise exceeds $1.00 (based on a volume weighted average price of Heartland shares for the prior 20 business days), plus the aggregate amount of cash dividends (cents per Heartland share) paid by the bank in the period from 1 April 2015 until and including the date the options are exercised. However, for the purpose of calculating the settlement amount, the market price of Heartland shares is capped at $1.50 and any increase above this amount shall be disregarded. 45 72 Heartland Bank Limited - Annual Report 2016 Disclosure Statement For The Year Ended 30 June 2016 NOTES TO THE FINANCIAL STATEMENTS For the year ended 30 June 2016 25 Staff share ownership arrangements (continued) Senior Executive Scheme (SES) The SES was established in June 2016 as a replacement of the LTI Plan and LTI SG for certain affected participants only (Senior Executives). Under the SES, Senior Executives forfeited their options under the 2014 and 2015 tranches of the LTI Plan and the LTI SG as consideration for the grant of shares under the SES. Under the SES, selected Senior Executives purchased Heartland shares with proceeds from a settlement amount paid to them by the bank. The shares are unable to be sold or otherwise disposed of by the Senior Executive until 30 June 2019. Until then, if the Senior Executive ceases their employment with the bank, the bank has a call option requiring the Senior Executive to give the shares back to the bank for no consideration. The SES has been treated as a modification of the Senior Executive entitlements under the 2014 and 2015 tranches of the LTI Plan and the LTI SG. The incremental fair value granted is $0.49 million based on the value of shares acquired under the SES less the fair value of the benefits forfeited under the 2014 and 2015 tranches of the LTI Plan and the LTI SG. 1 July 2014 Granted Exercised Forfeited 30 June 2015 Granted 1 Committed but not granted 1 Exercised 2 Modified to SES 3 Forfeited 30 June 2016 SES LTI SG LTI Plan Number of Number of Number of Shares options options - - - - - - - - - 5,004,975 5,208,403 8,954,082 - - - (507,342) 5,208,403 13,451,715 - - - 9,246,957 2,026,121 (540,414) 1,858,676 (3,906,302) (6,415,127) - - (314,173) 1,858,676 1,302,101 17,455,079 1 The fair value of options granted during the period under the LTI Plan is $1.90 million. This fair value was derived using the Black-Scholes model. The key inputs used in the model are: - Volatility 20.5% (calculated based on the historical movement in Heartland's shares) - Risk free rate 2.669% p.a. - Estimated option life 3.9 years - Expiry date 30 June 2019 - Share price at issue $1.15 2 3 Weighted average share price on exercise was $1.24. The fair value of shares issued during the period under the SES is $2.39 million, which was based on the a quoted price on the NZX Main Board including transaction costs. (b) Effect of share-based payment transactions Award of shares SES LTI SG LTI Plan Total expense recognised Jun 2016 Jun 2015 $000 $000 132 1,406 163 187 1,888 48 - 36 1,407 1,491 As at 30 June 2016, $1.51 million of share scheme awards remain unvested and not expensed (30 June 2015: $0.93 million). This expense will be recognised over the vesting period of the awards. In the prior year the banking group had a cash settled share scheme. The banking group recognised an expense of $1.56m in respect of this. (c) Number of options outstanding at 30 June 2016 LTI SG LTI Plan - 2013 tranche LTI Plan - 2014 tranche LTI Plan - 2015 tranche Options Remaining Outstanding life (years) 1,302,101 4,376,584 5,535,712 7,542,783 18,757,180 1 1 2 3 46 Disclosure Statement For The Year Ended 30 June 2016 www.heartland.co.nz 73 NOTES TO THE FINANCIAL STATEMENTS For the year ended 30 June 2016 26 Capital adequacy The banking group is subject to regulation by the RBNZ. The RBNZ has set minimum regulatory capital requirements for banks that are consistent with the internationally agreed framework developed by the Basel Committee on Banking Supervision. The resulting Basel II and III requirements define what is acceptable as capital and provide for methods of measuring the risks incurred by the banking group. The banking group’s Conditions of Registration prescribes minimum capital adequacy ratios calculated in accordance with the Capital Adequacy Framework (Standardised Approach) BS2A. The banking group has adopted the Basel II standardised approach per RBNZ BS2A to calculate its regulatory requirements. Basel II is made up of the following three Pillars: - - - Pillar 1 sets out the minimum capital requirements for credit, market and operational and compliance risks. Pillar 2 is designed to ensure that banks have adequate capital to support all risks (not just those set out under Pillar 1 above) and is enforced through the requirement for supervisory review. Pillar 3 outlines the requirements for adequate and transparent disclosure. Basel III was developed in order to strengthen the regulation, supervision and risk management of the banking sector. The measures aim to improve the banking sector's ability to absorb shocks arising from financial and economic stress; improve risk management and governance; and strengthen banks' transparency and disclosures. The requirements that impact capital are as follows: - - - - The level of capital required to be held by banks increased through the introduction of new minimum capital requirements for Common Equity Tier 1 (CET1) capital, Additional Tier 1 (AT1) capital and Total capital as a percentage of risk-weighted-assets (RWA's). A capital conservation buffer held over and above the minimum capital ratio requirements used to absorb losses during periods of financial and economic stress. A counter-cyclical capital buffer be held and to be used at the RBNZ’s discretion, to assist in attaining the macro-prudential goal of protecting the banking sector from periods of extraordinary excess aggregate credit growth. Strengthen the calculation of RWAs, particularly in respect of counterparty credit risk. The Basel III requirements have not effected the banking group's minimum capital requirements as the banking group’s Conditions of Registration prescribe minimum capital requirements higher than the Basel III requirements. The capital adequacy tables set out on the following pages summarise the composition of regulatory capital and the capital adequacy ratios for the banking group as at 30 June 2016. Internal Capital Adequacy Assessment Process (ICAAP) The bank has an ICAAP which complies with the requirements in 'Guidelines on a Bank's Internal Capital Adequacy Assessment Process ("ICAAP")' BS12 and is in accordance with its Conditions of Registration. The Board has overall responsibility for ensuring the banking group has adequate capital in relation to its risk profile and establishes minimum internal capital levels and limits above the regulatory minimum. The banking group has established a Capital Management Policy (CMP) to determine minimum capital levels for tier one and total capital under Basel III and in accordance with its Conditions of Registration. The documented process ensures that the banking group has sufficient available capital to meet minimum capital requirements, even in stressed events. It describes the risk profile of the banking group and the risk appetite and tolerances under which it operates, and assesses the level of capital held against the material risks of the bank (both Pillar One and Pillar Two). The ICAAP identifies the additional capital required to be held against other material risks, being concentration risk, strategic / business risk, reputational risk, regulatory risk and model risk. See Note 26(l) for further details. Compliance with minimum capital levels is monitored by ALCO and reported to the Board monthly. The ICAAP and CMP is reviewed annually by the Board. 47 74 Heartland Bank Limited - Annual Report 2016 Disclosure Statement For The Year Ended 30 June 2016 NOTES TO THE FINANCIAL STATEMENTS For the year ended 30 June 2016 26 Capital adequacy (continued) (a) Capital Tier 1 Capital CET1 capital Paid-up ordinary shares issued by the banking group plus related share premium Retained earnings (net of appropriations) Accumulated other comprehensive income and other disclosed reserves Less deductions from CET1 capital Intangible assets Deferred tax assets Hedging reserve Defined benefit superannuation fund assets Total CET1 capital Additional Tier 1 Capital Nil Total Tier 1 Capital Tier 2 Capital Subordinated bond Foreign currency translation reserve Total Tier 2 Capital Total Capital (b) Capital structure Ordinary shares Jun 2016 $000 421,377 78,811 (31) (57,755) (7,068) 2,260 (469) 437,125 - 437,125 1,455 (1,816) (361) 436,764 In accordance with BS2A, ordinary share capital is classified as Common Equity Tier 1 Capital and is not subject to phase-out from eligibility as capital under the Reserve Bank of New Zealand's Basel III transitional arrangements. The ordinary shares have no par value. Each ordinary share of the bank carries the right to vote on a poll at meetings of shareholders, the right to an equal share in dividends authorised by the Board and the right to an equal share in the distribution of the surplus assets of the bank in the event of liquidation. Reserves Available for sale reserve The available-for-sale reserve comprises the changes in the fair value of available-for-sale securities, net of tax. These changes are recognised in profit or loss as other income when the asset is either derecognised or impaired. Hedging reserve The hedging reserve comprises the fair value gains and losses associated with the effective portion of designated cash flow hedging instruments. Defined benefit reserve The defined benefit plan reserve represents the excess of the fair value of the assets of the defined benefit superannuation plan over the net present value of the defined benefit obligations. Retained earnings Retained earnings is the accumulated profit or loss that has been retained in the banking group. Subordinated bond Heartland's 2018 Subordinated Bonds (the Bonds) constitute Tier 2 Capital of the banking group. The Bonds had an issue period from 12 July 2013 to 15 December 2013 and have a maturity date of 15 December 2018. The Bonds pay quarterly interest in arrears at a rate of 6.5% per annum, provided the bank will be solvent immediately after the payment is made. The bank may elect to repay the Bonds prior to 15 December 2018 if a regulatory event or tax event occurs and provided it will be solvent immediately after the repayment and the Reserve Bank has consented to the repayment. The Bonds are subordinated to all other general liabilities of the banking group and are denominated in New Zealand dollars. If the Reserve Bank or a Statutory Manager requires the bank to write down the Principal Amount and/or the interest on the Subordinated Bonds, the Bonds will be written down and could be reduced to zero to comply with the Reserve Bank’s loss absorbency requirements. The bank has not had any defaults of principal, interest or other breaches with respect to these Bonds. 48 Disclosure Statement For The Year Ended 30 June 2016 www.heartland.co.nz 75 NOTES TO THE FINANCIAL STATEMENTS For the year ended 30 June 2016 26 Capital adequacy (continued) (c) Credit risk (i) On balance sheet exposures Jun 2016 Cash and gold bullion Multilateral development banks Multilateral development banks Public sector entities Banks Banks Corporates Corporates Corporates Welcome Home Loans - loan to value ratio (LVR) <= 90%1 Welcome Home Loans - LVR > 90%1 Welcome Home Loans - LVR > 100%1 Residential mortgages < 80% LVR Residential mortgages 80 < 90% LVR Residential mortgages 90 < 100% LVR Residential mortgages 100%+ LVR Past due residential mortgages Other past due assets - provision > 20% Other past due assets - provision < 20% Non property investment mortgage loan < 80% LVR Non property investment mortgage loan 80 < 90% LVR Non property investment mortgage loan 90 < 100% LVR Non property investment mortgage loan > 100% LVR Property Investment Mortgage Loan < 80% LVR Property Investment Mortgage Loan 80 < 90% LVR Property Investment Mortgage Loan 90 < 100% LVR Property Investment Mortgage Loan < 100% LVR All other equity holdings Other assets Not risk weighted assets Total on balance sheet exposures (ii) Off balance sheet exposures Total exposure Risk weighting Risk weighted exposure $000 % $000 Minimum Pillar One capital require- ment $000 92 38,766 53,110 38,828 138,827 35,145 1,024 7,000 506 5,492 1,916 205 822,695 8,460 2,635 4,604 731 5,771 45,037 17,101 2,716 469 8,771 6,446 345 896 1,789 7,291 2,227,481 63,032 3,547,181 - 0% - 0% 10,622 20% 7,766 20% 27,765 20% 17,573 50% 205 20% 3,500 50% 506 100% 1,922 35% 958 50% 205 100% 287,943 35% 4,230 50% 1,976 75% 4,604 100% 731 100% 5,771 100% 67,556 150% 5,985 35% 1,358 50% 352 75% 8,771 100% 2,578 40% 242 70% 806 90% 1,789 100% 400% 29,164 100% 2,227,481 - 0% - - 850 621 2,221 1,406 16 280 40 154 77 16 23,035 338 158 368 58 462 5,404 479 109 28 702 206 19 64 143 2,333 178,198 - 2,722,359 217,785 Total exposure Credit conversion Factor Credit equivalent amount Average risk weight Risk weighted exposure $000 $000 $000 % $000 Minimum Pillar One capital require- ment 1 $000 Jun 2016 Direct credit substitute Performance-related contingency Other commitments where original maturity is more than one year Other commitments where original maturity is less than or equal to one year Market related contracts 2 Interest rate contracts Interest rate contracts Total off balance sheet exposures 5,058 7,815 134,805 127,953 16,750 249,101 541,482 100% 50% 50% 20% n/a 0.5% 5,058 3,908 67,403 25,591 100% 100% 5,058 3,908 100% 67,403 100% 25,591 405 313 5,392 2,047 - 1,246 103,206 20% 20% - 249 - 20 102,209 8,177 1 The LVR classification above is calculated in line with the bank’s Pillar 1 Capital requirement which includes capital relief for Welcome Home loans that are guaranteed by the Crown. 2 The credit equivalent amount for market related contracts was calculated using the current exposure method. 49 76 Heartland Bank Limited - Annual Report 2016 Disclosure Statement For The Year Ended 30 June 2016 NOTES TO THE FINANCIAL STATEMENTS For the year ended 30 June 2016 26 Capital adequacy (continued) (d) Additional mortgage information - LVR range Jun 2016 Does not exceed 80% Exceeds 80% and not 90% Exceeds 90% Total exposures On balance sheet exposures Off balance sheet exposures 1 Total exposures $000 $000 $000 825,729 11,084 10,091 846,904 1,781 827,510 - 17 11,084 10,108 1,798 848,702 At 30 June 2016, $2.1 million relating to Welcome Home loans, whose credit risk is mitigated by the Crown is included in "Exceeds 90% residential mortgages". (e) Reconciliation of mortgage related amounts Loans and advances - loans with residential mortgages On balance sheet residential mortgage exposures subject to the standardised approach Off balance sheet mortgage exposures subject to the standardised approach Total residential exposures subject to the standardised approach Jun 2016 $000 846,904 846,904 1,798 848,702 (f) Credit risk mitigation As at 30 June 2016 the banking group had $7.6 million of Welcome Home Loans, whose credit risk was mitigated by the Crown. Other than this the banking group does not have any exposures covered by eligible collateral, guarantees and credit derivatives. (g) Operational Risk Operational risk Operational risk is calculated based on the previous 12 quarters of the banking group. (h) Market risk Market risk end-of-period capital charge Interest rate risk only Market risk peak end-of-day capital charge Interest rate risk only Market risk end-of-period capital charge Foreign currency risk only Market risk peak end-of-day capital charge Foreign currency risk only Implied risk weighted exposure Aggregate capital charge $000 185,039 $000 14,803 Implied risk weighted exposure Aggregate capital charge $000 100,880 105,360 59,016 59,016 $000 8,070 8,429 4,721 4,721 Peak end of day aggregate capital charge at the end of the period is derived by following the risk methodology for measuring capital requirements within Part 10 of the Standardised Approach. Peak end of day aggregate capital charge is derived by determining the maximum end of month capital charge over the reporting period. Based on the portfolio of the banking group’s risk exposures, it is considered by management that the difference between end of month aggregate capital charge and end of day aggregate capital charge is insignificant. 1 Off balance sheet exposures means unutilised limits. 50 Disclosure Statement For The Year Ended 30 June 2016 www.heartland.co.nz 77 NOTES TO THE FINANCIAL STATEMENTS For the year ended 30 June 2016 26 Capital adequacy (continued) (i) Total capital requirements Total credit risk and equity On balance sheet Off balance sheet Operational risk Market risk Total (j) Capital ratios Total exposure after credit risk mitigation Risk weighted exposure or implied risk weighted exposure Total capital requirement per BS2A $000 $000 $000 3,547,181 541,482 n/a n/a n/a 2,722,359 102,209 185,039 159,896 3,169,503 217,785 8,177 14,803 12,791 253,556 Capital ratios compared to minimum ratio requirements Common Equity Tier 1 Capital expressed as a percentage of total risk weighted exposures Minimum Common Equity Tier 1 Capital as per Conditions of Registration Tier 1 Capital expressed as a percentage of total risk weighted exposures Minimum Tier 1 Capital as per Conditions of Registration Total Capital expressed as a percentage of total risk weighted exposures Minimum Total Capital as per Conditions of Registration Buffer ratio Buffer ratio Buffer ratio requirement (k) Solo capital adequacy Common Equity Tier 1 Capital expressed as a percentage of total risk weighted exposures Tier 1 Capital expressed as a percentage of total risk weighted exposures Total Capital expressed as a percentage of total risk weighted exposures Jun 2016 % Jun 20151 % 13.79% 4.50% 13.79% 6.00% 13.78% 8.00% 12.79% 4.50% 12.79% 6.00% 12.86% 8.00% 5.78% 2.50% 4.86% 2.50% Jun 2016 % 15.78% 15.78% 15.77% Jun 20151 % 14.45% 14.45% 14.53% For the purposes of calculating capital adequacy on a solo basis, subsidiaries which are both wholly owned and wholly funded by the bank are to be consolidated with the bank. Therefore, capital adequacy on a solo basis is calculated based on the bank and its subsidiaries excluding ABCP Trust, SW Trust and ASF Trust. (l) Capital for other material risks In addition to the material risks included in the calculation of the capital ratios, the banking group has identified other material risks to be included in the capital allocation (being concentration risk, strategic / business risk, reputational risk, regulatory and model risk). As at 30 June 2016, the banking group has made an internal capital allocation of $85.83 million to cover these risks (2015: 68.7m)1. 1 The capital ratios as at 30 June 2015 are the ratios previously disclosed for the registered bank at that date, Former Heartland Bank. 51 78 Heartland Bank Limited - Annual Report 2016 Disclosure Statement For The Year Ended 30 June 2016 NOTES TO THE FINANCIAL STATEMENTS For the year ended 30 June 2016 27 Insurance business, securitisation, funds management, other fiduciary activities Insurance business The banking group conducts insurance business through its subsidiary MARAC Insurance. The banking group's aggregate amount of insurance business comprises the total consolidated assets of MARAC Insurance of $8.80 million, which is 0.25% of the total consolidated assets of the banking group. The banking group's objective is to minimize the insurance risk to within acceptable levels through policies and procedures implemented by management. Should adverse conditions arise, these policies and procedures are expected to mitigate the impact of the conditions on the banking group. Marketing and distribution of insurance products The banking group markets and distributes term life insurance and general insurance covering risks such as redundancy, bankruptcy or suspension of employment. The insurance products are underwritten by MARAC Insurance Limited, a subsidiary of the banking group. During the year ended 30 June 2016, there have been no material changes in the banking group's marketing and distribution of insurance products. Securitisation As at 30 June 2016, the banking group had securitised assets amounting to $296 million (2015: $278 million). These assets have been sold to ABCP Trust (a special purpose vehicle investing in motor vehicle, truck and trailer and commercial loans originated by the banking group and funded through the issuance of commercial paper and also through liquidity facilities). Note 24 - Structured entities provides further information on the securitised assets. The bank received fees for various services provided to the securitisation vehicles on an arm's length basis, including servicing fees. These fees were recognised as earned. All securitisation vehicles form part of the banking group. Funds management and other fiduciary activities The banking group, through Heartland PIE Fund Limited, controls, manages and administers the Heartland Cash and Term PIE Fund and its products (Heartland Call PIE and Heartland Term Deposit PIE). Note 24 - Structured entities has further details. The Heartland Cash and Term PIE Fund deals with the bank in the normal course of business, in the bank's capacity as Registrar of the Fund and also invests in the bank's deposits. The banking group provides investment advice to a number of clients, which includes the provision of other fiduciary activities. The banking group is considered to control the Heartland Cash and Term PIE Fund, and as such the Heartland Cash and Term PIE Fund is consolidated within the financial statements of the banking group. Risk management The banking group has in place policies and procedures to ensure that the fiduciary activities identified above are conducted in an appropriate manner. It is considered that these policies and procedures will ensure that any difficulties arising from these activities will not impact adversely on the banking group. The policies and procedures include comprehensive and prominent disclosure of information regarding products, and formal and regular review of operations and policies by management and internal and external auditors. Further information on the banking group's risk management policies and practices is included in Note 17 - Risk management policies. Provision of financial services and asset purchases Over the accounting period, financial services provided by the banking group to entities which were involved in the activities above (including trust, custodial, funds management and other fiduciary activities) were provided on arm's length terms and conditions and at fair value. Any assets purchased from such entities have been purchased on arm's length terms and conditions and at fair value. 52 Disclosure Statement For The Year Ended 30 June 2016 www.heartland.co.nz 79 NOTES TO THE FINANCIAL STATEMENTS For the year ended 30 June 2016 27 Insurance business, securitisation, funds management, other fiduciary activities (continued) Peak aggregate funding to entities The banking group did not provide any funding to entities conducting funds management and other fiduciary activities, or insurance product or marketing and distribution activities described in this note, during the year (2015: $nil). The bank provided funding to ABCP Trust, which is a member of the banking group involved in securitisation activities. This funding is provided to facilitate the purchase of asset backed securities from the banking group in order to support the securitisation facility. Peak end-of-day aggregate amount of funding provided ($000's) Peak end-of-day aggregate amount of funding provided as a percentage of the banking group's Tier 1 Capital as at the end of the year TOTAL TRUSTS Jun 2016 Jun 2015 85,525 30,613 19.6% 9.0% Seniors Warehouse Trust ASF Settlement Trust ABCP TRUST Jun 2016 Jun 2015 Jun 2016 Jun 2015 Jun 2016 Jun 2015 Peak end-of-day aggregate amount of funding provided ($000's) Peak end-of-day aggregate amount of funding provided as a 52,507 percentage of the total assets of the individual entity as at the 12.2% n/a n/a 4,157 n/a 28,861 30,613 66.5% n/a 10.7% 10.5% end of the year For this purpose, peak ratio information was derived by determining the maximum end-of-day aggregate amount of funding and then dividing that amount by the amount of the entity's assets or the banking group's Tier 1 Capital (as the case required) as at the end of the year. 28 Contingent liabilities and commitments Letters of credit, guarantee commitments and performance bonds Total contingent liabilities Undrawn facilities available to customers Conditional commitments to fund at future dates Total commitments 29 Application of new and revised accounting standards (a) New standards and interpretations adopted Jun 2016 Jun 2015 $000 $000 12,873 12,873 14,844 14,844 147,903 114,855 116,217 108,037 262,758 224,254 No new standards and amendments to standards have been adopted from 1 July 2015 in the preparation of these financial statements. (b) New standards and interpretations not yet adopted A number of new standards, amendments to standards and interpretations are not yet effective for the year ended 30 June 2016, and have not been applied in preparing these financial statements. The new standards identified which may have an effect on the financial statements of the banking group are: Standard and description Effective for annual years beginning on or after: Expected to be initially applied in year ending: NZ IFRS 9 Financial Instruments , which specifies how an entity should classify and measure financial assets and 1 January 30 June liabilities. 2018 2019 NZ IFRS 9 Financial Instruments (2013) , which provides a principles-based approach to hedge accounting and aligns 1 January 30 June hedge accounting more closely with risk management. 2018 2019 NZ IFRS 16 Leases , contains guidance on identification, recognition, measurement, presentation, and disclosure of 1 January 30 June leases by lessees and lessors. 2019 2020 The full impacts of NZ IFRS 9 and NZ IFRS 16 are yet to be assessed. 30 Events after the reporting date There have been no material events after the reporting date that would affect the interpretation of the financial statements or the performance of the banking group. 53 80 Heartland Bank Limited - Annual Report 2016 Disclosure Statement For The Year Ended 30 June 2016 HISTORICAL SUMMARY OF FINANCIAL STATEMENTS Statements of Comprehensive Income For the year ended 30 Jun 16 30 Jun 15 30 Jun 14 30 Jun 13 30 Jun 12 Audited Audited Audited Audited Audited $000 $000 $000 $000 $000 Interest income Interest expense Net interest income Other net income Total operating income before other gains Employee benefits Other operating expenses Profit before impairment and tax Impaired asset expense Decrease in fair value of investment properties Net profit before tax Share of joint arrangement profit Profit before income tax Income tax expense / (benefit) Net profit after tax attributable to owners of the entity Other comprehensive income for the year net of tax Effective portion of changes in fair value of cash flow hedges, net of tax Net change in available-for-sale reserve, net of tax Movement in foreign currency translation reserve, net of income tax Net change in defined benefit reserve, net of income tax 265,475 118,815 146,660 260,468 126,041 134,427 210,297 101,221 109,076 206,349 110,895 95,454 205,148 121,502 83,646 10,901 10,280 13,079 11,433 157,561 144,707 122,155 106,887 39,799 30,073 87,689 40,401 28,002 76,304 13,501 12,105 - - 35,765 28,974 57,416 5,895 1,203 74,188 64,199 50,318 - 137 486 74,188 64,336 50,804 20,024 54,164 16,173 48,163 14,765 36,039 33,861 36,486 36,540 22,527 5,101 8,912 504 9,416 2,504 6,912 11,238 94,884 34,661 30,886 29,337 5,642 3,900 19,795 534 20,329 (3,277) 23,606 (708) (208) (4,047) (93) (2,709) 1,111 898 2,136 50 (12) 95 3 1,056 276 - 462 378 (103) - (435) Total comprehensive income for the year, net of tax 49,108 48,538 37,236 8,706 23,446 Dividends paid to equity holders 37,690 30,188 19,930 13,591 - Statements of Financial Position Total assets Individually impaired assets Total liabilities Total equity Audited Audited Audited Audited Audited As at 30 Jun 16 30 Jun 15 30 Jun 14 30 Jun 13 30 Jun 12 $000 $000 $000 $000 $000 3,547,181 3,359,259 3,016,888 2,504,627 2,348,089 33,764 25,622 27,617 69,301 56,825 3,048,840 2,879,134 2,564,266 2,134,085 1,973,291 498,341 480,125 452,622 370,542 374,798 Historical financial information has been taken from the audited financial statements of the banking group. 54 Disclosure Statement For The Year Ended 30 June 2016 www.heartland.co.nz 81 38 to 79 82 Heartland Bank Limited - Annual Report 2016 Independent Auditor’s Report Independent auditor’s report To the shareholders of Heartland Bank Limited Report on the bank and banking group disclosure statement 38 to 79 We have audited the accompanying financial statements and supplementary information (excluding supplementary information relating to Capital Adequacy) of Heartland Bank Limited (“the bank”) and its related entities (“the banking group”) on pages 12 to 53 of the disclosure statement. The financial statements comprise the statement of financial position as at 30 June 2016, the statements of comprehensive income, changes in equity and cash flows for the year then ended, and a summary of significant accounting policies and other explanatory information of the banking group. The supplementary information comprises the information that is required to be disclosed in accordance with Schedules 2, 4, 7, 9, 13, 14, 15 and 17 of the Registered Bank Disclosure Statements (New Zealand Incorporated Registered Banks) Order 2014 (as amended) (the “Order”). This report is made solely to the shareholders. Our audit work has been undertaken so that we might state to the shareholders of the bank those matters we are required to state to them in the auditor’s report and for no other purpose. To the fullest extent permitted by law, we do not accept or assume responsibility to anyone other than the shareholders, for our audit work, this report or any of the opinions we have formed. Directors' responsibility for the disclosure statement The directors are responsible for the preparation of the disclosure statement, including financial statements prepared in accordance with Clause 24 of the Order and generally accepted accounting practice in New Zealand, that is a fair presentation of the matters to which they relate. The directors are also responsible for such internal controls as they determine are necessary to enable the preparation of the banking group financial statements that are free from material misstatement whether due to fraud or error. The directors are responsible for the preparation and fair presentation of supplementary information, in accordance with Schedules 2, 4, 7, 13, 14, 15 and 17 of the Order. Auditor’s responsibility Our responsibility is to express an opinion on the disclosure statement, including the financial statements prepared in accordance with Clause 24 of the Order and the supplementary information disclosed in accordance with Schedules 4, 7, 13, 14, 15 and 17 of the Order. We conducted our audit in accordance with International Standards on Auditing (New Zealand) (“ISAs (NZ)”). Those standards require that we comply with ethical requirements and plan and perform the audit to obtain reasonable assurance about whether the banking group financial statements are free from material misstatement. An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the banking group’s financial statements (excluding the supplementary information relating to Capital Adequacy). The procedures selected depend on the auditor’s judgement, including the assessment of the risks of material misstatement of the banking group’s financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal controls relevant to the banking group’s preparation of the banking group’s financial statements that present fairly the matters to which they relate in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the banking group’s internal controls. 55 Independent Auditor’s Report www.heartland.co.nz 83 Independent auditor’s report To the shareholders of Heartland Bank Limited Report on the bank and banking group disclosure statement We have audited the accompanying financial statements and supplementary information (excluding supplementary information relating to Capital Adequacy) of Heartland Bank Limited (“the bank”) and its related entities (“the banking group”) on pages 12 to 53 of the disclosure statement. The financial statements comprise the statement of financial position as at 30 June 2016, the statements of comprehensive income, changes in equity and cash flows for the year then ended, and a summary of significant accounting policies and other explanatory information of the banking group. The supplementary information comprises the information that is required to be disclosed in accordance with Schedules 2, 4, 7, 9, 13, 14, 15 and 17 of the Registered Bank Disclosure Statements (New Zealand Incorporated Registered Banks) Order 2014 (as amended) (the “Order”). This report is made solely to the shareholders. Our audit work has been undertaken so that we might state to the shareholders of the bank those matters we are required to state to them in the auditor’s report and for no other purpose. To the fullest extent permitted by law, we do not accept or assume responsibility to anyone other than the shareholders, for our audit work, this report or any of the opinions we have formed. Directors' responsibility for the disclosure statement The directors are responsible for the preparation of the disclosure statement, including financial statements prepared in accordance with Clause 24 of the Order and generally accepted accounting practice in New Zealand, that is a fair presentation of the matters to which they relate. The directors are also responsible for such internal controls as they determine are necessary to enable the preparation of the banking group financial statements that are free from material misstatement whether due to fraud or error. The directors are responsible for the preparation and fair presentation of supplementary information, in accordance with Schedules 2, 4, 7, 13, 14, 15 and 17 of the Order. Auditor’s responsibility Our responsibility is to express an opinion on the disclosure statement, including the financial statements prepared in accordance with Clause 24 of the Order and the supplementary information disclosed in accordance with Schedules 4, 7, 13, 14, 15 and 17 of the Order. We conducted our audit in accordance with International Standards on Auditing (New Zealand) (“ISAs (NZ)”). Those standards require that we comply with ethical requirements and plan and perform the audit to obtain reasonable assurance about whether the banking group financial statements are free from material misstatement. An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the banking group’s financial statements (excluding the supplementary information relating to Capital Adequacy). The procedures selected depend on the auditor’s judgement, including the assessment of the risks of material misstatement of the banking group’s financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal controls relevant to the banking group’s preparation of the banking group’s financial statements that present fairly the matters to which they relate in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the banking group’s internal controls. 55 84 Heartland Bank Limited - Annual Report 2016 Director Disclosures Directors The following persons were directors of Heartland and its subsidiaries during the year ended 30 June 2016. Company Directors Heartland Bank Limited (formerly Heartland New Zealand Limited) ¹, ² Jeffrey Kenneth Greenslade Non-Independent Director (reappointed 31 December 2015) Nicola Jean Greer Independent Director (resigned 25 July 2016) Edward John Harvey Independent Director (appointed 31 December 2015) Bruce Robertson Irvine Independent Director (appointed 31 December 2015) Graham Russell Kennedy Independent Director (reappointed 31 December 2015) Christopher Robert Mace Independent Director (reappointed 31 December 2015) Geoffrey Thomas Ricketts Independent Director (reappointed 31 December 2015) Deborah Jane Taylor Independent Director (resigned 31 December 2015) Gregory Raymond Tomlinson Non-Independent Director (reappointed 31 December 2015) ASF Custodians Pty Limited Julie Marie Campbell-Bode (resigned 5 February 2016) Andrew John Ford (appointed 5 February 2016) Richard Glenn Udovenya Australian Seniors Finance Pty Limited Julie Marie Campbell-Bode (resigned 5 February 2016) Andrew John Ford (appointed 5 February 2016) Richard Glenn Udovenya HBL Australian Finance Pty Limited (formerly Heartland Seniors Finance Pty Limited) Julie Marie Campbell-Bode (resigned 5 February 2016) Andrew John Ford (appointed 5 February 2016) HBL Australian Investments Pty Limited Julie Marie Campbell-Bode (resigned 5 February 2016) Andrew John Ford (appointed 5 February 2016) Christopher Patrick Francis Flood Heartland NZ Trustee Limited Jeffrey Kenneth Greenslade Heartland PIE Fund Limited Jeffrey Kenneth Greenslade Bruce Robertson Irvine ¹ Canterbury Building Society Limited, Heartland Bank Limited, Heartland Financial Services Limited, Heartland NZ Holdings Limited, MARAC JV Holdings Limited amalgamated into Heartland Bank Limited (formerly Heartland New Zealand Limited) on 31 December 2015. ² Heartland HER Holdings Limited and New Sentinel Limited amalgamated into Heartland Bank Limited (formerly Heartland New Zealand Limited) on 30 April 2016. Director Disclosures www.heartland.co.nz 85 Company Directors MARAC Insurance Limited Andrew James Aitken (Appointed 14 December 2015) Christopher Patrick Francis Flood (Appointed 3 May 2016) Brian Thomas Gibbons (Resigned 17 July 2015) Jeffrey Kenneth Greenslade (Resigned 3 March 2016) Christopher Robert Mace Sarah Elizabeth Ann Smith (Appointed 14 December 2015) Mark Roland Winger (Resigned 17 July 2015) Seniors Finance Custodians Pty Limited Julie Marie Campbell-Bode (Resigned 5 February 2016) Andrew John Ford (Appointed 5 February 2016) Richard Glenn Udovenya Seniors Finance Pty Limited Julie Marie Campbell-Bode (Resigned 5 February 2016) Andrew John Ford (Appointed 5 February 2016) Richard Glenn Udovenya Sentinel Custodians Limited Garry Dean Bishop (resigned 28 August 2015) Christopher Patrick Francis Flood VPS Properties Limited Christopher Patrick Francis Flood (Appointed 5 August 2015) Michael Danton Jonas (resigned 5 August 2015) 86 Heartland Bank Limited - Annual Report 2016 Director Disclosures Interests Register The following are the entries in the Interests Register of Heartland (and its subsidiaries) made during the year ended 30 June 2016. Indemnification and Insurance of Directors Heartland has given indemnities to, and has effected insurance for, directors of Heartland and its subsidiaries to indemnify and insure them in respect of any liability for, or costs incurred in relation to, any act or omission in their capacity as directors, to the extent permitted by the Companies Act 1993. The cost of the insurance premiums to Heartland and its subsidiaries for the year ended 30 June 2016 was $56,761.79. Share Dealings by Directors Details of individual directors’ share dealings as entered in the Interests Register of Heartland under Section 148(2) of the Companies Act 1993 during the year ended 30 June 2016 are as follows (all dealings are in ordinary shares unless otherwise specified): J K Greenslade No. of Shares Nature of Relevant Interest Acquisition/ Disposal Consideration Date of Acquisition/ Disposal 50,000 On-market purchase Acquisition $57,500 19 August 2015 36,521 31,413 27,311 156,549 517,453 154,784 254,890 33,854 85,470 38,354 Allotment of shares under Dividend Reinvestment Plan Acquisition $40,538.31 2 October 2015 Retirement as trustee of the PGC Director Share Scheme Disposal Nil 6 October 2015 Allotment of shares under Dividend Reinvestment Plan Acquisition $32,718 5 April 2016 On-market purchase under LTI scheme Acquisition $203,944.82 13 June 2016 On-market purchase under LTI scheme Acquisition $672,012.76 14 June 2016 On-market purchase under LTI scheme Acquisition $199,361.15 15 June 2016 On-market purchase under LTI scheme Acquisition $329,570.33 16 June 2016 On-market purchase under LTI scheme Acquisition $43,516.45 17 June 2016 On-market purchase under LTI scheme Acquisition $110,707.33 20 June 2016 On-market purchase under LTI scheme Acquisition $49,299.49 22 June 2016 E J Harvey No. of Shares Nature of Relevant Interest 94,370 Disclosure of shares held following appointment as director on 31 December 2015 Acquisition/ Disposal Consideration N/A N/A Date of Acquisition/ Disposal N/A – disclosure of shares held following appointment as director 2,566 Allotment of shares under Dividend Reinvestment Plan Acquisition $3,074.06 5 April 2016 Director Disclosures www.heartland.co.nz 87 B R Irvine No. of Shares Nature of Relevant Interest Acquisition/ Disposal Consideration 92,236 361,162 N/A – disclosure of shares held following appointment as director on 31 December 2015 N/A N/A – disclosure of shares held following appointment as director on 31 December 2015 N/A N/A N/A Date of Acquisition/ Disposal N/A – disclosure of shares held following appointment as director N/A – disclosure of shares held following appointment as director G R Kennedy No. of Shares Nature of Relevant Interest 36,249 34,476 14,766 922 36,249 34,476 922 Appointment as executor of the estate of Hazel Kathleen Hammond Appointment as executor of the estate of Arthur Geoffrey Hammond Acquisition Acquisition/ Disposal Disposal Consideration Nil Nil Date of Acquisition/ Disposal 19 August 2015 17 September 2015 Allotment of shares under Dividend Reinvestment Plan Acquisition $16,230.26 2 October 2015 Appointment as executor of the estate of Patricia Edna Christie Registered holder as executor of the estate of Hazel Kathleen Hammond Registered holder as executor of the estate of Arthur Geoffrey Hammond Registered holder as executor of the estate of Patricia Edna Christie Acquisition Nil 6 October 2015 Disposal $45,844.58 2 November 2015 Disposal Nil 18 December 2015 Disposal $1,087.96 4 February 2016 C R Mace No. of Shares Nature of Relevant Interest 713,705 286,295 Beneficial interest in on-market purchase by JNS Capital Limited Beneficial interest in on-market purchase by JNS Capital Limited Acquisition/ Disposal Consideration Date of Acquisition/ Disposal Acquisition $816,486.65 3 and 8 September 2015 Acquisition $329,239.25 10 and 11 September 2015 88 Heartland Bank Limited - Annual Report 2016 Director Disclosures General Notice of Disclosure of Interest in the Interests Register Details of directors’ general disclosures entered in the relevant interests register under Section 140 of the Companies Act 1993 during the year ended 30 June 2016 are as follows: G R Kennedy Resigned as a director of Germinal Seeds N.Z. Limited effective 15 June 2016 D J Taylor (resigned 31 December 2015) Appointed Chair of Landcare Research effective 1 July 2015 (formerly Deputy Chair) Appointed a Director of OTPP New Zealand Forest Investments Limited (effective 13 July 2015) Term on the NZ Accounting Standards Board completed but remains on the External Reporting Board G R Tomlinson Appointed a Director of The Icehouse Limited on 27 March 2016 Details of directors’ general disclosures entered in the relevant interest register under Section 140 of the Companies Act 1993 prior to 1 July 2015 can be found in earlier Annual Reports. Specific Disclosures of Interest in the Interests Register There were no specific disclosures of interests in transactions entered into by Heartland or its subsidiaries during the period 1 July 2015 to 30 June 2016. Information Used by Directors No director of Heartland or its subsidiaries disclosed use of information received in his or her capacity as a director that would not otherwise be available to that director. Directors’ Relevant Interests Set out in the table below are the shares, and options which are convertible into shares, in which each director of Heartland had a relevant interest as at 30 June 2016. Director J K Greenslade N J Greer (resigned 25 July 2016) E J Harvey (appointed 31 December 2015) B R Irvine (appointed 31 December 2015) G R Kennedy C R Mace G T Ricketts D J Taylor (resigned 31 December 2015) G R Tomlinson Number of Ordinary Shares Beneficial Number of Ordinary Shares Non-Beneficial Number of Options 2,273,260 - 96,936 454,398 495,828 13,289,728 12,289,728 50,000 48,224,352 440,677 - 6,047,026 6,487,703 6,057,026 6,047,026 6,047,026 - - 1,496,268 Nil Nil Nil Nil Nil Nil Nil Nil Director Disclosures www.heartland.co.nz 89 Directors’ Remuneration The current total directors’ fee pool for the non-executive directors of Heartland and its subsidiaries approved by shareholders at the Annual Shareholder Meeting held on 31 October 2014 is $1,000,000 per annum. The total remuneration received by each non-executive director who held office in Heartland and its subsidiaries during the year ended 30 June 2016 was as follows: ³ Board/Committee Board Audit Committee Governance, Remuneration and Capital Committee Risk Committee Chair $125,000 $15,000 $10,000 $20,000 Member $75,000 $7,500 $5,000 $10,000 The total remuneration and value of other benefits⁴ received by each non-executive director who held office in Heartland and its subsidiaries during the year ended 30 June 2016 was as follows: Director Company Remuneration A J Aitken (appointed 14 December 2015) MARAC Insurance Limited N J Greer (resigned 25 July 2016) E J Harvey B R Irvine G R Kennedy C R Mace G T Ricketts Heartland Bank Limited Heartland Bank Limited Heartland Bank Limited Heartland Bank Limited Heartland Bank Limited Heartland Bank Limited D J Taylor (resigned 31 December 2015) Heartland New Zealand Limited G R Tomlinson R G Udovenya Heartland Bank Limited Australian Seniors Finance Pty Limited R A Wilks (resigned 31 December 2015) Heartland Bank Limited Total Directors’ fees exclude GST where appropriate. In addition, directors are entitled to be reimbursed for costs associated with carrying out their duties. $17,565 $82,500 $98,750 $121,250 $92,500 $85,000 $142,500 $41,250 $80,000 A$30,000 $45,000 $836,315.28 ³ Note that following the amalgamation on 31 December 2015 changes were made to directors fees, therefore fees to 31 December 2015 differ from those from 31 December 2015 ⁴ In addition to these amounts, Heartland meets costs incurred by directors, which are incidental to the performance of their duties. This includes providing directors with telephone concessions and paying the cost of directors’ travel. As these costs are incurred by Heartland to enable directors to perform their duties, no value is attributable to them as benefits to directors for the purposes of the above table. 90 Heartland Bank Limited - Annual Report 2016 Director Disclosures Remuneration and/or Other Benefits from the Company and its subsidiaries to Executive Directors The remuneration for Executive Directors includes a fixed remuneration component and a variable remuneration component comprising short- term incentives and/or long-term incentives. Long-term incentives are offered to selected employees (including the Executive Directors in their capacity as employees) in order to: • • Incentivise and motivate participants to continue in employment with the Heartland group for the applicable service period; Incentivise and motivate participants to exercise long-term thinking to contribute to the long-term success of the Heartland group; and • Align the interests of participants with those of Heartland and its shareholders. J K Greenslade (Chief Executive Officer) The tables below detail the nature and amount of the remuneration and the value of other benefits received by J K Greenslade (being Heartland’s only Executive Director) during the financial year ended 30 June 2016. Fixed Remuneration and Short-Term Incentive (STI) Fixed ($) 900,000¹ Variable STI ($) 800,000² Total ($) $1,700,000 ¹ Fixed remuneration received during the year ended 30 June 2016. ² This comprises two cash payments of $600,000 and $200,000 respectively which relate to the year ended 30 June 2016 but are to be paid in the financial year ending 30 June 2017. Long-Term Incentive (LTI) Number of benefits issued/ acquired during FY16 Value of benefits issued/ acquired and amortising during FY16 Value of benefits issued/ acquired in past years and amortising during FY16 Senior Executive Scheme 1,241,354 shares² $418,612 - ² The Senior Executive Scheme settles the options previously issued to J K Greenslade (and certain other senior executives) relating to the 2014 and 2015 financial years. The value of the benefits received under the scheme is spread (for accounting purposes) until 30 June 2019. Further detail on the scheme is set out below. Long-term incentive schemes Set out below is a brief description of Heartland’s long-term incentive schemes for its employees as at 30 June 2016. Further information is set out in Note 25 of the financial statements. Senior Executive Scheme The Senior Executive Scheme (SES) effects an agreed settlement of the options previously issued to certain senior executives (Senior Executives) under the Share Settled Options Plan described below. The settlement occurred in June 2016. The options were settled following an agreement between Heartland and the Senior Executives that the options had achieved their objectives and therefore should be capped. To effect the settlement, the Senior Executives agreed to forfeit the options issued to them in respect of the 2014 and 2015 financial years in consideration for the issue of Heartland shares. The Senior Executives have agreed to hold those shares in escrow (i.e., to not sell or otherwise transfer ownership) until 30 June 2019 or the occurrence of a change of control event (Release Date). A call option enables Heartland to require the Senior Executive to transfer their shares back to Heartland for no consideration in the event the Senior Executive ceases their employment at any time before the Release Date. Share Settled Options Plan Under the Share Settled Options Plan (Options Plan), selected employees were granted share settled options (Options), being a right (the exercise of which is contingent and dependent on certain factors, including continued employment by the Heartland group and the market value of Heartland’s shares) to receive in the future Heartland shares as incentive based remuneration. Executive Remuneration www.heartland.co.nz 91 The key terms of the Options Plan are: • When Options are exercised, a settlement amount is • The Options are linked to a three year service period beginning on the first day of the financial year in respect of which the options are granted. • The employee can exercise their Options at any time during a specified exercise period which generally commences 20 business days after Heartland’s annual results announcement for the last financial year of the service period and ends approximately two years later. • The reference price of each Option is an amount equal to 5% over the volume weighted average price (VWAP) of Heartland shares on the NZX over 20 business days immediately following the issue date of the Options (Reference Price). calculated. The settlement amount is the amount by which (as multiplied by the number of Options): – The VWAP of Heartland shares on NZX over 20 business days immediately preceding the exercise date (Market Price), exceeds – the Reference Price, less the aggregate amount of cash dividends (cents per share) paid by Heartland in the period from the date those Options were granted until and including the exercise date for those Options. • The employee receives Heartland shares having an aggregate Market Price equal to the settlement amount. The number of employees of Heartland and its subsidiaries (including former employees), other than directors, who received remuneration, including non-cash benefits, in excess of $100,000 during the year ended 30 June 2016 is set out in the remuneration bands detailed below. Remuneration $100,000 to $109,999 $110,000 to $119,999 $120,000 to $129,999 $130,000 to $139,999 $140,000 to $149,999 $150,000 to $159,999 $160,000 to $169,999 $170,000 to $179,999 $180,000 to $189,999 $190,000 to $199,999 $210,000 to $219,999 $220,000 to $229,999 $230,000 to $239,999 $240,000 to $249,999 Number of Staff Remuneration Number of Staff 21 14 11 16 8 6 8 1 2 2 3 1 2 1 $250,000 to $259,999 $270,000 to $279,999 $290,000 to $299,999 $300,000 to $309,999 $310,000 to $319,999 $360,000 to $369,999 $410,000 to $419,999 $440,000 to $449,999 $450,000 to $459,999 $520,000 to $529,999 $550,000 to $559,999 $560,000 to $569,999 $1,110,000 to $1,119,999 3 1 1 1 2 2 1 1 1 1 1 1 1 Total 113 92 Heartland Bank Limited - Annual Report 2016 Shareholder Information Spread of Shares Set out below are details of the spread of shareholders of Heartland as at 19 August 2016. Size of Holding 1–1,000 shares 1,001–5,000 shares 5,001–10,000 shares 10,001–50,000 shares 50,001–100,000 shares 100,001 shares and over TOTAL Number of Shareholders Total Shares % of Issued Shares 1,038 2,778 2,023 3,800 652 452 10,743 636,567 8,014,554 15,745,306 86,761,251 46,509,760 318,801,428 476,468,866 0.13% 1.68% 3.30% 18.21% 9.76% 66.91% 100% Twenty Largest Shareholders1 Set out below are details of the 20 largest shareholders of Heartland as at 19 August 2016. Rank Shareholder Total Shares % of Issued Shares 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 Harrogate Trustee Limited FNZ Custodians Limited Forsyth Barr Custodians Ltd Oceania & Eastern Limited Philip Maurice Carter Citibank Nominees (NZ) Ltd Accident Compensation Corporation Investment Custodial Services Limited Leveraged Equities Finance Limited Heartland Trust National Nominees New Zealand Limited HSBC Nominees (New Zealand) Limited HSBC Nominees (New Zealand) Limited Investment Custodial Services Limited Jarden Custodians Limited Custodial Services Limited JPMorgan Chase Bank TEA Custodians Limited New Zealand Depository Nominee Limited Jeffrey Kenneth Greenslade & Sarah Ormond Greenslade TOTAL FOR TOP 20 HOLDERS 48,224,352 24,272,949 18,543,113 12,289,728 10,126,405 8,955,692 8,561,415 8,259,824 6,966,269 6,047,026 6,025,921 5,564,127 5,460,975 5,019,618 4,500,000 3,461,711 3,368,863 2,721,007 2,521,479 2,273,260 193,163,734 10.12% 5.09% 3.89% 2.58% 2.13% 1.88% 1.80% 1.73% 1.46% 1.27% 1.26% 1.17% 1.15% 1.05% 0.94% 0.73% 0.71% 0.57% 0.53% 0.48% 40.54% Substantial Product Holders At 30 June 2016, the following product holders had given notice in accordance with Sections 276 and 277 of the Financial Markets Conduct Act 2013 that they were substantial product holders in Heartland. The number of shares shown below are as advised in the most recent substantial product holder notices to Heartland and may not be their holding as at 30 June 2016. Name Number of Shares Class of Shares Total Number of Shares in Class Harrogate Trustee Limited and Gregory Raymond Tomlinson 40,285,070 Ordinary 476,468,866 The total number of ordinary shares on issue as at 30 June 2016 was 476,468,866. 1 Any person wishing to acquire an interest in 10% or more of Heartland’s shares must obtain the consent of the Reserve Bank of New Zealand before they do so. Other Information www.heartland.co.nz 93 Auditors’ Fees KPMG has continued to act as auditors of Heartland and its subsidiaries. The amount payable by Heartland and its subsidiaries to KPMG as audit fees during the year ended 30 June 2016 was $479,000. The amount of fees payable to KPMG for non-audit work during the year ended 30 June 2016 was $107,000. These non-audit fees were primarily for regulatory compliance services and they complied with the Heartland’s External Auditor Independence Policy. Credit Rating As at 1 September 2016, Heartland had a Fitch Australia Pty Limited long-term credit rating of BBB (outlook stable). Exercise of NZX Disciplinary Powers NZX Limited did not exercise any of its powers under Listing Rule 5.4.2 in relation to Heartland during the year ended 30 June 2016. NZX Waivers Set out below is a summary of all waivers granted to Heartland by NZX Limited within, or relied on by Heartland, within the 12 month period preceding 30 June 2016. Heartland has also relied on a waiver from NZX Limited relating to director nominations for its 2016 Annual Meeting. For the purposes of the amalgamation of Heartland New Zealand Limited and Heartland Bank Limited that took effect on 31 December 2015, Heartland was granted waivers from the following Listing Rules in relation to the nomination, appointment, election and retirement of directors at its 2015 Annual Meeting: Listing Rule 3.3.5 NZX waived the requirement that the proposed directors of Heartland who were existing directors of Heartland Bank Limited, but not existing directors of Heartland New Zealand Limited, be nominated by a shareholder on the basis that shareholders were already familiar with these proposed directors and therefore this requirement was an unnecessary procedural step. Heartland did not believe this waiver prejudiced shareholders’ rights under this Listing Rule, especially as shareholders still had the opportunity to nominate additional directors during Heartland’s director nomination period. Listing Rule 3.3.6 NZX waived the requirement that the directors appointed by the Board during the course of 2015 were required to retire with effect at the 2015 Annual Meeting on the basis that all existing directors either retired or retired and sought re-election with effect on 31 December 2015. The directors who would ordinarily have been required to retire and seek re-election at the 2015 Annual Meeting under Listing Rule 3.3.6 were Deborah (Jane) Taylor and Jeffrey Greenslade (who was reappointed by the board as an executive director before his term of appointment reached 5 years as required by Listing Rule 3.3.9). NZX also waived the requirement that the directors appointed to Heartland on the amalgamation (by being named in the resolutions passed by the board) seek re-election at Heartland’s 2016 Annual Meeting on the basis that they were approved by shareholders at the 2015 Annual Meeting and the ordinary rotation requirements in Listing Rule 3.3.11 apply from 31 December 2015. The waiver was granted on the conditions that: • all of Heartland’s existing directors retired at the 2015 Annual Meeting with effect from 31 December 2015 (however, they were eligible for election as directors of Heartland at the 2015 Annual Meeting); • • • • the amalgamation resolutions, which specified the names of the persons who were to be the directors of Heartland upon amalgamation, only named persons who were elected by Heartland’s shareholders at the 2015 Annual Meeting as directors of Heartland; the waiver, its conditions and their implications are clearly and prominently disclosed in Heartland’s annual report for each year the waiver is relied on; this waiver and its implications were explained in Heartland’s notice of meeting for the 2015 Annual Meeting; and this waiver and its implications are explained in Heartland’s notice of meeting for the 2016 Annual Meeting. Listing Rule 3.3.11 NZX waived the requirement that a number of Heartland’s directors retire by rotation at the 2015 Annual Meeting on the basis that all existing directors either retired or retired and sought re-election with effect from 31 December 2015. The directors who would ordinarily have been required to retire by rotation (but would be eligible for re-election) at the 2015 Annual Meeting under Listing Rule 3.3.11 were one of Christopher Mace and Gregory Tomlinson (as determined by the Board). Heartland also obtained a waiver from Listing Rule 3.3.5 to the extent it prohibited Heartland from imposing a precondition on the nomination of a director to its board. A waiver was required because Heartland is a registered bank and, before any person can be appointed as a director, that person must satisfy certain requirements of the Reserve Bank of New Zealand (RBNZ). Satisfaction of these requirements is therefore a precondition to Heartland accepting any director nomination. The effect of this precondition is that the RBNZ must provide its non-objection to the proposed appointment of any nominee before the closing date for director nominations. Heartland has relied on this waiver in respect of any director nominations for its 2016 Annual Meeting. The waiver was granted on the conditions that: • • satisfaction of the RBNZ’s requirements is the only precondition to Heartland accepting a director nomination; the waiver, its conditions and their implications are clearly and prominently disclosed in Heartland’s annual report for each year the waiver is relied on; • Heartland gives not less than 30 business days’ notice of the closing date for director nominations; • Heartland gives an overview of the RBNZ’s requirements in the same notice; and • Heartland assists any prospective nominee with the administrative steps required to meet the RBNZ’s requirements by providing the necessary documentation to be completed by the nominee, procuring a New Zealand criminal history check and submitting all information to the RBNZ for assessment. 94 Heartland Bank Limited - Annual Report 2016 Directory Directory1 Chairman Chief Executive Officer Director Director Director Director Director Auditor KPMG KPMG Centre, 18 Viaduct Harbour, Auckland 1010 T 09 367 5800 Share Registry Link Market Services Limited Level 11, Deloitte House 80 Queen Street, Auckland 1010 T 09 375 5998 F 09 375 5990 E enquiries@linkmarketservices.com W www.linkmarketservices.com Directors Geoff Ricketts Jeffrey Greenslade John Harvey Bruce Irvine Graham Kennedy Chris Mace Greg Tomlinson Registered Office 35 Teed Street Newmarket Auckland 1023 PO Box 9919 Newmarket Auckland, 1149 T 0508 432 785 E info@heartland.co.nz W www.heartland.co.nz Heartland Executives Jeffrey Greenslade Chief Executive Officer Laura Byrne Chief Strategy Advisor Michael Drumm General Counsel Chris Flood Head of Banking Richard Lorraway Chief Risk Officer Rochelle Moloney Head of Corporate Communications Simon Owen Chief Financial Officer 1Correct as at 1 September 2016 

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