Aprila Bank ASA (APRILA) Earnings Call Transcript & Summary

Hello, everyone. I'm Halvor Lande, CEO of Aprila Bank.

And I'm Kjetil Barli, CFO of Aprila Bank.

We are extremely excited to welcome you to Aprila Bank's Q2 presentation. We will present some forward-looking statements today. They are based on what we're aware of as of now and our expectations of how things like Norway's economy and interest rate will evolve going forward. But even though we have very strong predictive models in the form of our machine learning algorithms, we have not yet developed a crystal ball to tell us exactly what the future will look like. I'll start by giving the highlights of the quarter. Kjetil will present the financials in more detail and with a slightly updated format. I'll present our priorities and outlook going forward. And finally, we'll take your questions. The chat function on this webcast is disabled, so please send your questions on mail to the e-mail address on the screen, and we'll address them towards the end. As usual, a quick recap. Aprila Bank is a digital bank providing credit to small and medium-sized businesses so far only in Norway. What makes us distinctive is our continued technology development to, one, use every improving machine learning algorithms to predict the risk of individual businesses so that we can offer limit in price in real time and automate everything that can and should be automated to reduce cost to serve our customers. At the end of Q2, we had 5,521 lending customers. Of these 30 were landlords from a home rental factoring pilot we did together with Schibsted, but the remaining 5,491 are small and medium-sized businesses. And 98% of these are small businesses with 20 employees or less. But we are experiencing increased demand from medium-sized businesses, which now accounts for 2% of our customer base. In total, we added 428 customers in the quarter, another churn of 251. The majority of the churn was due to the introduction of monthly fees for all credit line customers NOK 249. However, the P&L contribution from this was positive as I'll get back to later. A big milestone during the second quarter was that our gross income run rate surpassed NOK 100 million with a good margin. From this, we have to subtract direct variable costs such as commissions to partners, interest rates to our savings customers. But even after this, we achieved a gross margin of 84%, which is a new record for Aprila. And last but not least, according to our customers, so far we have contributed to creating or saving 2,500 jobs since the start of our bill. But the biggest milestone in the second quarter was that we are finally profitable. And what a timing, in the market environment with significant uncertainty, skyrocketing inflation and interest rates and valuations of unprofitable growth companies being hammered, we've gone from burning equity to creating return on equity. The net result for the quarter was plus NOK 1.6 million and our gross profit margin improved from 80% to 84% and our operating expenses compared to the same quarter last year actually reduced by NOK 1.1 million. And the strong growth continues. Gross lending grew by 18% in the quarter, gross income by 22% in the quarter and most importantly, total income, which is what we live off, jumped by 28%. In total, we are still growing at an annual rate of around 100%. And we are sufficiently capitalized for continued strong growth. We raised NOK 60 million in the quarter and improved our equity positions even more with the NOK 1.6 million positive result in the quarter. It is such a relief to be done with fundraising, so that we now can focus 100% on profitable growth going forward. As I mentioned, total income is our most important revenue metric. It is gross revenues less interest we pay on deposits and direct variable costs such as commissions to partners. Total income jumped from NOK 18 million to NOK 23 million in the second quarter, which is the biggest quarterly increase ever and the biggest percentage growth in 5 quarters. And the growth is, of course, coming from our hit product credit line. Total income from credit line has tripled over the last 12 months from NOK 6 million in Q2 last year to NOK 18 million this quarter. Originally, we planned for Visma to take over our spot factoring customers during the second quarter. However, we will continue with spot factoring for the time being and we are in discussions with Visma as to if or when the spot factoring will be discontinued. Customer growth is still the most important growth driver of credit line, but contribution from average income per customer is increasing. There are 2 reasons for this. As I mentioned, in June, we introduced monthly fees of NOK 249 for all customers, all trade line customers. Before this, a substantial share of our customers were not paying fees at all, only interest rate. This resulted in significant churn among the small customers that have never drawn up the credit line, and that really resulted in an increase in average customer revenue for the remaining customers. The net P&L impact was very attractive because we had to make loan loss provisions even for the customers that were not using credit line. So the introduction of fees for all reduced our loan loss provisions and increased our revenues. The other reason is that we're seeing increasing application volumes from medium-sized companies requesting large credit lines from NOK 1 million and up. We have not deliberately been targeting this segment. But now that they're starting to show up, they are, of course, very welcome. These customers typically have lower risk and significantly higher lifetime value. As a result, we're increasing focus on adapting the product to attract these kind of customers going forward. There are about 30,000 medium-sized businesses in Norway and the majority of these are also underserved by traditional banks. The big drop in cost from Q1 to Q2 is primarily because we don't have salary expenses in June, but also because we relaxed our marketing investments a bit in Q2 to ensure that we would actually be profitable in Q2 as promised. In Q3 and Q4, our quarterly costs will be back around NOK 80 million. But the big picture that this graph illustrates is the scalability of our business model. Due to the constant expenditures on technology development to improve our products and reduce variable costs, our fixed costs are a very big share of our total cost base around NOK 60 million per year. But our variable costs are low and declining and our gross profit margin is very high compared to other banks and other companies in general. This means that as we continue to grow, we'll become very profitable over time and then be able to deliver a much higher return on equity than what is possible for a traditional bank. Our realized losses are stable around NOK 0.5 million per quarter. But in Q2, we had to increase our loan loss provisions with NOK 7.8 million due to 3 reasons. Reason number one was that share of late payments from customers increased from around 7% to 8% in the quarter, possibly due to more challenging market conditions for small businesses in Norway. The second reason is that we increased our lending balance with NOK 76 million, of which we have to take approximately 3% loan loss provisions to cover potential future losses corresponding to NOK 2.3 million in new loan loss provisions. And finally, third reason, one-off changes in our IFRS 9 model resulted in about NOK 1.7 million in loan loss provision increase. Nevertheless, we have to book this against our earnings together with realized losses. NOK 1.5 million corresponds to 32% of our gross income, which is higher than our target of losses being less than 25% of gross revenues, and it is much higher compared to traditional banks where losses are typically less than 10% of gross income from lending. But what drives return on equity is the absolute return on assets that your business model achieves. Net interest rate margin measures the return on lending capital after interest rate costs and commissions to partners. Traditional banks have net interest margins have 2% to 4% before losses, we have a net interest rate margin of 14% after losses. This is equivalent to being able to borrow money at 0% and invest risk-free at the rate of 14%. And we can invest, i.e. lend approximately 5x our equity, meaning we can achieve a 70% return on equity before internal costs. To compare 20% return on equity is in practice at fixed ceiling for most banks and very few banks or other companies for that matter are able to return 12% return on equity over time. I believe that we eventually will be able to deliver consistently over 30% return on equity due to this business model. And in the second quarter, we increased our equity with NOK 62 million, around NOK 60 million in new equity and a plus NOK 1.6 million from the positive net profit in Q2. So what does this mean in practice, Kjetil?

Well, following the equity issues completed in the second quarter, the bank had a CET1 ratio of 41.3% at the end of June, which is more than 2x the capital requirement. All else being equal, this means that our loan book could have been more than twice the size today and the bank would still be sufficiently capitalized. The capital requirement will increase by 2.5 percentage points over the next 3 quarters, reaching 21.5% by the end of March 2023. And these are currently known changes, which apply to the majority of Norwegian banks. During the fall, we expect [ FSA ] to determine a revised Pillar 2 requirement for Aprila. The current requirement of 4% was originally issued as a so-called start-up buffer when Aprila's banking license was granted almost 5 years ago. Now let's look at our key figures for the second quarter. It finally makes sense to start using traditional performance measures for banks, such as cost income and return on equity. So from this quarter and onwards, we will report these 6 figures on the first slide of this section of our quarterly presentations. Starting with unique customers, upper left, we had 5,521 unique customers at the end of the second quarter, up from 5,344 at the end of the first quarter. As mentioned by Halvor, this is a weaker customer growth than we have experienced historically. And there are 2 reasons for this. One, we spend less on marketing. And 2, we introduced a monthly fee for all credit line customers. And this resulted in a high, but intended and profitable churn. Moving on to gross lending. This number increased by 18% in the quarter from NOK 438 million to NOK 517 million. The growth in gross lending combined with increased interest and fee income, resulted in a total income of NOK 22.9 million up from NOK 17.9 million in Q1, an increase of 28%, as Halvor mentioned earlier. Cost income, lower left chart, came in at 56%. Operating expenses in the second quarter are, as Halvor mentioned, lower than normal, with only 2 months of ordinary salary expenses. With full salary payment in the quarter, the cost-to-income ratio would have been 70%. Still a strong improvement from Q1. Next chart, loan losses measured in percent to gross loans and annualized came in at 7%, up from 5.2% in Q1. And finally, profit after tax came in at NOK 1.6 million, equivalent to an annualized return on equity of 5%. Taking a closer look at the credit line product. We added net 210 accounts in the quarter and now close to 2,900 open credit line accounts at the end of the quarter. 84% of the customer accounts had utilized the credit line at the end of the quarter. The average balance per account has continued its positive trend and reached NOK 157,000 at the end of the quarter and the 84% share of our customers that had a drawdown at the end of the quarter had an average balance of NOK 187,000. Moving on to spot factoring. We purchased invoices with a total nominal value of NOK 159 million in Q2. Spot factoring accounted for 24% of gross income in the quarter. Our average margin was 3.8%. Services, retail and construction industries accounted for close to 80% of the purchase invoices. And at the end of the quarter, we had 3,301 open spot factoring accounts, of which 71% had used the product by the end of the quarter. We stopped onboarding of new spot factoring accounts from Visma early February. So the growth in new accounts has now turned negative due to churn. In terms of the future of this product, as Halvor mentioned, we will continue with spot factoring for the time being, and we are in discussions with Visma as to if or when the offering will be discontinued. Loan losses in Q2 came in at NOK 8.4 million, NOK 7.8 million in loan loss provisions and NOK 0.6 million in realized losses. NOK 1.7 million of the loan loss provisions were related to a one-off. Without this one-off, the ratio of loan losses to gross income would have been in line with our long-term ambition of 25%. Looking at days past due in the upper right chart, DPD 31 plus increased by 1.2 percentage points. The main driver behind this was exposures to our 91 days or more past due. This is an expected development and the trend will continue until we start offloading our NPL portfolio. We are in discussions with potential buyers and we'll consider to complete our first NPL sale this fall. Finally, loan loss allowances in percent of gross loans were 7.3% at the end of the quarter compared to 6.7% at the end of the last quarter. So that was the most important figures from the second quarter. So I'll give the stage back to you now, Halvor.

Thank you, Kjetil. For the second half of 2022, we have the same priorities as for the first half, but we have reversed the order. The top priority now is to maintain a high-growth trajectory so that we can really start capitalizing on the outstanding capital economics of our business model. The second priority is to strengthen competitive advantage. This is important because we believe there will be more competitors in this space once others start realizing how attractive this segment is when you do it in the way we do it. And last but not least, we want to keep improving the unit and capital economics of our business model even further. On the first priority, we are evolving our credit line product to be more relevant for medium-sized businesses. We continue to optimize offers to increase growth while keeping marginal interest margin after losses high. And we still see a big potential to unlock demand by using marketing and communication to spread knowledge of our offering to the 0.5 million underserved small- and medium-sized businesses in Norway. On the second priority, we continue to create an even more seamless and gratifying customer experience to increase attractiveness and retention. Our offerings should not only be useful, but delightful to use. Our PD model, that is Probability of Default model, is continuously learning and improving every month as our volume of observed business outcomes grow exponentially. And we now have sufficient volumes of collection cases to start applying the same machine learning technology to our LGD model, Loss Given Default. And we have finally collected enough PSD2 data that we can actively start incorporating this into our PD model. On the third priority, we continue to optimize our pricing models to improve the rate and return of successful customer applications, and we continue to reduce cost to serve by automating servicing and monitoring of customers as well as reporting and compliance activities. When it comes to our guiding going forward, we still believe that our gross income run rate will surpass NOK 150 million during the year, driven by credit line. We expect gross margin to remain very high and hopefully increase even further from today's level, but we no longer expect more than 4,500 credit line customers at the end of the year. There are 2 reasons for this. Reason number one is we now see that high customer growth impacts short-term profitability even more than we had previously thought, both in terms of marketing costs and in terms of loan loss provisions, which both have to be taken upfront, whereas customer revenue accrue over time. The second reason is that, as I mentioned earlier, we see a surprising amount of interest for larger loans for medium-sized businesses. As a result of this, we are diverting some of our growth focus to target this segment more accurately, both in terms of product development and in terms of marketing. This reduces the gross number of customers, but increases balance, income and profitability per customer so that overall gross income and profitability remains stable. In terms of growth and profitability for the rest of the year, we're trying to balance these obviously conflicting priorities so that we're targeting around 0 in net result, both for Q3 and for Q4. This concludes our presentation, and we're now ready to take your questions. And here's the e-mail address for the questions.

Do we have any questions, Kjetil?

No questions yet.

So everything was crystal clear.

Yes, it looks like it.

One question that I've gotten already is that is how it's looking after the second quarter? And the answer to that is, obviously, July was a bit soft, like usual. However, we received almost twice as many applications and customers in July this year compared to July last year. And already this far in August, we're seeing application volumes back to the normal level from earlier in -- earlier this year. So it looks like the growth is continuing on the same track.

We have started to get some questions now. So let's start with the first one from [ Herman Sal ] in Pareto. Could you talk a bit more about what type of SME customers you're looking to attract?

So our focus has always been and will continue to be small businesses with less than 21 employees and less than NOK 20 million in revenues. And as I said, these are 98% of our customers. They're extremely underserved by traditional banks, but we are now also starting to focus on the medium-sized customers with between NOK 20 million and NOK 100 million in revenues. In terms of industries, we are -- and geographies, we are completely agnostic as long as it's Norway. We have customers from every industry and every municipality in Norway. And actually, surprisingly, identical distribution of our customers compared to the overall customer or small and medium-sized business distribution in Norway. So that's our focus, small and medium-sized businesses in Norway across all industries.

Very good. So we have more questions. This one is from [ Jack Fransen ]. The question is, why only 2 salaries in Q2? And the reason for that is that June is holiday pay. So -- and that expense is booked in the 11 other months. So then there's only 2 months of salary in Q2. Next question is from [ Adil Osmani ]. He says, medium-sized customers, any elaboration on size of interest, et cetera? I think he's thinking about the -- talking about larger segments.

Yes. So our interest rates are, in general, from 10% to 30% per year depending on the risk level. However, for the larger loans and medium-sized businesses, they are typically much closer to the 10%. And the least risky of these businesses with very solid equity and profitability positions and good track record get 10% in interest approximately.

It might also be he's asking about the typical size of…