Aprila Bank ASA (APRILA) Earnings Call Transcript & Summary

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

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

Welcome to Aprila's Q3 presentation. We will present some forward-looking statements today. These are based on what we have seen so far and what we are aware of, as of today. And based on this, we're extremely bullish about our business, going forward. I'll start by giving the highlights of the quarter. Kjetil will give the financials in a bit more detail. Then I'll give the outlook for the rest of the year. And finally, we'll take your questions. Please send your questions to [email protected]. The e-mail address is on the screen, [email protected] and we'll address them at the end. There are about 600,000 businesses in Norway and the vast majority of these don't get loans in traditional banks. This constraints the opportunity to grow and thrive. Our mission is to solve this problem. And we do this through technology, by developing ever-improving machine learning algorithms to predict risk and calculate limits so that we can offer loans in realtime. And we use technology to automate everything that can and should be automated so that we continuously reduce cost to serve our customers. We have about 1% of these 600,000 businesses as customers so far. So we have plenty of room to grow. And we are growing. Our gross income run rate grew from NOK 112 million at the end of Q2, NOK 230 million now at the end of Q3. Our gross margin before loan losses was 82% in Q3, which was above our target of 80% for 2022. And according to our customers, we have so far contributed to creating or preserving almost 3,000 jobs recently. The survey of our credit line customers, and according to them, 1/3 of them would not have survived without the credit line for Aprila. And another 1/3 were able to either hire an additional person or avoid having to downsize due to the credit line. So our customers are very happy. And despite the challenging market conditions with high inflation and increasing interest rates, our customers are thriving. They had an average gross income in the third quarter of NOK 1.5 million, which was up from NOK 1.3 million in Q3 last year. And on average, the businesses have increased their profitability despite rising factory costs. They have been able to improve their EBIT margin from 10% to 12%. There are two industries that have experienced a big margin compression, retail and real estate, but both of these sectors are well capitalized and prepared for a challenging environment. We did get a negative financial result of minus NOK 3.6 million this quarter. But despite this, we are actually very happy about Q3. We onboarded a record number of new credit line customer despite very moderate marketing spending. We onboarded 489 credit line customers, which contributed to our lending balance, growing more than 100% over the last 12 months. We -- secondly, we have made our machine learning PD models even better. This did have the unfortunate side effect of increasing our loan loss provisions with NOK 3 million. But it has a very important long-term value in the sense that we'll be able to select and price customers even more accurately going forward, which will strengthen our growth and profitability in the long run. And Visma and Aprila are back in love again. That's my favorite analyst quote, Vegard. We are taking over the business of Visma Finance. We have secured a strong distribution position in Visma's ERP systems, and we are receiving a significant investment from Visma to help us develop even better working capital products for the distribution inside the ERP systems. This diagram puts the Q3 onboarding number into perspective and shows what a strong quarter Q3 was in terms of customer growth. This was despite the fact that we had very moderate marketing spend the last two quarters. Q4 is normally our strongest quarter. In October, we onboarded 195 customers, a new monthly record. And this weekend, we ramped up our marketing significantly. So I'm confident that Q4 is going to be very, very strong. Our total income grew by 87% over the last 12 months. Spot factoring has been a run of product since the original Visma announcement that they were going to do factoring themselves. We still consider spot factoring a run-off product, and we will use the renewed partnership with Visma to build better working capital products for distribution inside ERP systems. Our current main product, credit line, is still growing at over 100% on an annual basis. And the growth in credit line is primarily driven by customer growth. Going forward, we believe that income per customers will stabilize but we aim to keep customer growth around 60% to 80% per year for the -- at least for the next 3 years. Our total income grew 87% over the last 12 months, costs only grew by 8%. Due to the incredible scalability of our business model, we can keep growing our income much faster in the future as well. Going forward, we target to keep growing our income by 60% to 80% per year and our cost around 30% per year. The biggest driver of our cost growth is continuously increased investment in marketing until we're a household name for all small business owners in Norway. Even before this quarter, I was very proud of our machine learning PD models. Our prediction models and prediction power was significantly better than the best credit rating agencies. And this is what enabled us to be much more comfortable onboarding small businesses as lending customers than traditional banks are. However, we did see that our lowest risk customers did have slightly higher default rates than the models predicted and thus contributed more loan loss provisions than we expected. This was a conundrum for me, and I thought that we simply would need much more data over a longer time period before this bias disappeared. But then our Chief Decision Scientist, Oystein Dannevig, was able to find a tweak in our machine learning algorithm that almost completely removed this bias. This means that we now have unprecedented precision in determining the probability of default for both, new applications and existing customers. So we're now in an even better position to select new customers and price the risk with ever-increasing precision. With this bias removed, we can increase approval rates, and we can set more accurate prices, which will lead to increased growth and increased profitability, going forward. But the one-off effect and negative effect of this is that we have to increase the PD of our low-risk customers in our IFRS 9 loan provisions. Since the majority of our customer base has much less than 20% default probability, this led to an overall increase of about NOK 3 million of our loan loss provisions. Our realized losses came in at NOK 937,000 in Q3. As a result of our growth and expected defaults in our portfolio, we had expected an increase of around NOK 8 million in loan loss provisions. But due to the changes in the PD model, we had to increase our loan loss provisions by NOK 11 million. The result is that our total IFRS 9 reported loan losses in Q3 ended up at around NOK 12 million. It is worth mentioning that the NOK 11 million in increased loan loss provisions does not mean that we will actually lose an additional NOK 11 million of the money we have led out in the future. Loan loss provisions is the measure of the difference between what we would have gotten if all customers paid all interests and fees and down payments on time and in full, and what we actually expect. More than 50% of the loan loss provisions are expected future unpaid interests and delayed down payments of the principal. So not actual losses in the sense that this is used in common language. And since our lending rates on average are around 24%, we have to discount all expected future interest payments and actual payments by 24% annually. This artificially inflates our loan loss provisions compared to traditional business banks that have an average lending interest rate of 5%, meaning that they can report a much higher net present value of future customer payments. But despite these artificially inflated loan loss provisions, we still have outstanding capital economics, compared to traditional banks. Traditional banks have a net interest rate margin of 3% to 5% before loan losses. And even in Q3, despite this NOK 3 million one-off increase in loan loss provision, we still have over 10% net interest rate margin after reported loan losses. This means that our marginal return on equity is -- will be at least, or is at least 3x higher than traditional banks. And considering that good traditional banks have a return on equity around 12%, this means that as we scale up our business model, we will get at least 36% return on equity. And the beauty of this is that we can -- we will be able to, going forward, combine high growth with great profitability. And the deal with Visma will strengthen our ability to do just so. We're taking over the business of Visma Finance, and in addition, 2 great people who we are delighted to get on board. Aksel, he was previously Head of Legal in Svea, Norway, comes from the position as Head of Legal, Risk and Compliance in Visma Finance and will join as Head of Legal in Aprila and report to me. And Ida, previously lead consultant in Visma Consulting, comes from the position as Head of Business Development and IT in Visma Finance, will join Aprila as Product and Technology Manager and will report to our Chief Product and Technology Officer, Israr. In addition, Visma will invest NOK 22.5 million in cash in Aprila, Amesto invests NOK 1.5 million, and [indiscernible] Defenses ownership share of 20% through SES, totaling a capital raise of around NOK 30 million. After this transaction, Visma will get an ownership share of around 4.6% in Aprila Bank. So Kjetil, what does this mean for our capital position?

Well, at the end of September, Aprila CET1 ratio was 39.7%, which is more than 2x the current capital requirements. All else being equal, this means that our loan book could have been twice the size today and we would still be sufficiently capitalized. When we held the presentation for the second quarter, we expected the Norwegian FSA to determine a revised Pillar 2 requirement for Aprila during the fall. This process called SREP has been delayed, and we don't know when FSA will determine a new Pillar 2 buffer for Aprila. However, we have been informed by the FSA through their final report from the on-site inspection held earlier this year that they will get back to us with a letter on retail classification. And just to provide some context, retail classification can be applied to exposures towards private individuals and SMEs and it reduces the risk weight with 25 percentage points. If the FSA decides to deny Aprila the opportunity to use retail classification, our capital ratio would decrease with around 8 percentage points. And if so, the bank would still be sufficiently capitalized with a CET1 ratio of 32% at the end of September. We do not share FSA's opinion on this matter, neither do our advisers. In any case, as you mentioned, however, we will raise NOK 30 million in December at the closing of the Visma Finance transaction. And following that transaction, Aprila will be capitalized for strong growth, also without the opportunity to use retail classification. Now let's move on to the key figures for the third quarter. At the end of the quarter, we had 5,790 unique customers. And today, almost halfway into the fourth quarter, I can inform you that we will reach 6,000 unique customers within the next few days. Moving on to gross lending. This number has more than doubled over the past year, reaching NOK 595 million at the end of the third quarter. The effect of this is that we have seen a growth in total income of 87% over the last year, reaching NOK 25 million in the third quarter, as we can see in the upper right chart. Cost income, lower right -- no, left chart, came in at 67%. And the reason why this figure is higher than it was in Q2 is simply that we, in the second quarter, only have 2 months of ordinary salary payments and 1 month of holiday pay. Next chart, loan losses were high in the quarter, as explained in detail by Halvor, measured in percent of gross loans and annualized. Loan losses were 8.6%, up from 7% in Q2. And finally, profit after tax came in at minus NOK 3.6 million. Over the past year, we have added close to 1,400 new credit line accounts, ending the third quarter with 3,241 accounts. 86% of the customer accounts had a drawdown at the end of the quarter. The average balance per account has continued its upward trend and reached 165,000 at the end of the quarter. And this 86% share of the customer that had a drawdown, had on average, drawn a balance of NOK 192,000. Spot factoring. We stopped spot factoring of news -- 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 turn, this leads to lower transaction volumes, and we purchased invoices for NOK 139 million in the third quarter compared to NOK 159 million in the second quarter. Spot factoring accounted for 18% of gross income in the quarter. Average margin was 3.7%. Three industries, retail, construction and services accounted for 80% of the purchase invoices. At the end of the quarter, we had 3,212 open spot factoring accounts of which 75% have used the product. Although volumes are declining on this product, the product profitability is very good with a gross profit margin of around 50%. So Halvor has talked a lot about loan loss provisions today. So I will use this slide to give you some details on what we have done to make it easier for our customers to pay on time. If you look at the upper right chart, you see that loans which are more than 30 days past due, declined from 7.9% at the end of the second quarter to 7.8% at the end of the third quarter, despite the significant increase in loans that are more than 90 days past due. And the reason for this is that we have improved our operational processes when it comes to collecting payments. As an example, we introduced payment reminders on SMS this summer, and this has had a very positive effect. And from this month, we have changed the process for collecting interest payments on credit line. So we collect interest payments through direct debit out to [indiscernible] in Norwegian. We used to do this once every month. From this month and onwards, we will triple this number. So since every failed debit consists of four attempts, this means that from now on, we will try to collect interest payments up to 12x each month. Okay. So although loan losses are as high as 39% of gross income in Q3, we emphasize that we maintain our long-term ambition to keep loan losses at around 25% of gross income. So that was the most important figures from the third quarter. So I'll give the stage back to you now, Halvor.

Thank you, Kjetil. So our priorities for Q4 have evolved slightly from the Q2 presentation. Our top priority going forward at the end of Q2 was to maintain a high growth trajectory. But what we have seen now is that our growth has been surprisingly high in Q3 despite the fact that we did very moderate marketing spending. And we have concluded that that's because of the big marketing push that we did in Q1. So the effect of that marketing was much bigger and lasted much longer than what we had expected. And this means that we now see that marketing is an even bigger opportunity to drive even more growth and drive it even longer than what we had previously thought. So we really want to take opportunity of really accelerating our growth because we believe that this will create a lot of shareholder value. Our two other priorities remain the same: Strengthen the competitive advantage against potential future competition in this blue ocean market of small business lending and continue to improve our underlying profitability. Our gross income, as I mentioned, run rate at the end of Q3 was NOK 130 million, which was exactly what our target guiding was. Our gross margin was also in line, slightly above our guiding. And we overdelivered on our customer growth target, which was 3,100. For the full year, at the end of 2022, we still expect our gross income run rate to be over NOK 150 million. We expect our gross margin before loan losses to be around 80%, and we expect well over 3,500 credit line customers by the end of the year. This concludes our presentation, and we are now ready to take your questions. Again, if you didn't write it down last time, the e-mail address is [email protected]. So Kjetil, let's move over to Per Christian in the lounge and answer some questions.

Welcome to the Aprila lounge. I have some very interesting questions for you here today. The mass market view from the FSA was somewhat surprising. On your estimates, what will your CET1 be in the first quarter '23 with 75% risk weights?

Well, it will be -- the effect as of the 30th of September, would have been 8% decline. So our CET1 ratio as of the 30th of September would have been 32% instead of around 40%. And then, we will raise NOK 30 million of new capital. So I would guess that it will be close to 40% again.

Good. Will you recognize deferred tax assets in the fourth quarter?

We have an ongoing discussion with the auditor on that topic. So I don't know the answer on that now.

Halvor, can you give some more details on which tweaks were made to the PD model? No?

It's quite complex. Basically, about removing biases in the machine learning model so that it even more accurately predicts PD for all risk levels. I don't know. I'm not able to go into details -- more details.

Okay. Is there anything in the Visma financing agreement, closing conditions that can lead to the agreement not getting to closing?

I don't see any risk factors that could end up making the deal not close. The only uncertainty factor that I do see is that the closing is dependent on a final approval from FSA. And until Visma has gotten that final approval, we can't close the deal. We do expect the final approval to come before Christmas.

[indiscernible] Kjetil, you have previously mentioned the potential sale of the NPL portfolio, but you didn't mention that now. Was that intentional? Is it sold? Or if not, why not?

Well, that's right. I have mentioned previously, and we're working on it. We have received quite good interest for it. And we have also received some indicative bids. Our ambition is to close the transaction before Christmas. And -- but we will only sell if we get a price that we are satisfied with.

Good. Can you comment on, Kjetil, on the net interest margin? It appears to have been more or less steadily falling for some quarters. Will it continue to fall?

No, we don't think so. Well, there are three reasons why the net interest margin after losses has declined over the past year. First, we are transitioning away from spot factoring, which has a very high net interest margin after losses. Funding costs have increased first as for all banks. A year ago, our funding cost was 1%. Now it's 2.75%. And number three, loan losses in the third quarter last year were very low and third quarter this year was -- they were quite high. So that are the three main differences for the big difference. Going forward, we expect net interest margin after losses to be around 13% to 14%, which is a very high level, as Halvor mentioned. A typical bank is between 3% and 5% before loan losses. DNB, the past 5 quarters, have been around 3% after losses actually. Bank Norwegian, between 8% and 9%. And our average has been around 13%. The same as, for example, Advanzia Bank, which is the most -- or one of the most profitable banks in Europe. And they are at the same level that we are, and their ROE is around 40%. They are very profitable, and that's the level that we are at and will most probably, be for the near future.

Good. Halvor, do you still plan to stop offering spot factoring?

So we actually haven't made the final decision on that. Our hypothesis, together with Visma, is that Visma in our experience so far, we can develop much better and more suitable working capital products for distribution inside ERP systems than spot factoring. But until we have validated that hypothesis and developed the new working capital product, we will continue to offer spot factoring and -- but once the new product is in place, we will, of course, migrate all the existing spot factoring customers to the new product and close down spot factoring.

Growth seems to be slowing down, Halvor. Why?

So two reasons why growth slowed down compared to the previous quarter. Number one, as I said, we have had very moderate marketing spend in Q2 and Q3. And the second reason is that Q3 is -- basically contains the full summer vacation. So it has naturally lower business activity, especially on the spot factoring side. So that meant that our quarterly growth in Q3 was -- from Q2 to Q3 was moderate. But as I said, now we're actually planning to significantly accelerate growth and really hitting the gas pedal in terms of marketing. So just wait until after Q4 figures [indiscernible].

I look forward to that. So I suppose you don't expect to be profitable in the fourth quarter and with the marketing spend?

No, that's correct. We see the opportunity, this size of the approximately 500,000 underserved small businesses in Norway, it's just so big. The opportunity to take a very large share of that market in a relatively short amount of time is so attractive that we -- that's our top priority now. And it probably means that we will not be profitable in Q4 either.

And how is the growth going so far in the fourth quarter?

Very well. So as I mentioned, October was a record month so far, in terms of onboarding credit line customers. And typically, November is an even better month and now we're going full blast in marketing. So looking very good so far.

Another question here. Have you identified the customers that will be most challenged by the high level of inflation? And do you have control on this risk?

Yes. So currently, it looks like, there are 3 sectors that are negatively impacted by inflation. I mentioned real estate and retail. Retail, by the way, is much more important for us than real estate. Real estate is just a very small part of our portfolio. So retail is seeing margin compression. And real estate is experiencing probably issues with lower demand and falling prices and increasing interest rates. The third sector is IT. IT consultants are seeing slightly lower demand, and they're not able to protect their margins. So they have a slight margin erosion. But do we have control? Yes. As I mentioned in the presentation, retail and real estate are very well capitalized. And IT is very flexible and have so far only experienced a very small margin compression. So I'm not concerned about inflation.

Good. It's another question from the -- analysts. It appears that stage 1 loan loss provisions were in some release in the third quarter. Could you give us some details to why? Did you understand the question? I'm not sure I did.

Yes, so that's correct. We haven't booked -- the loan loss allowance on stage 1. It's around the same at the end of Q3 as it was at the end of Q2.

Any details to why?

Well, we have done several changes to the IFRS 9 model. And some of these changes have had the effect that stage 1 loan losses are -- loan loss allowances are at the same level.

And also because of the change in PD model, a lot of customers migrated simply for that reason from stage 1 to stage 2. So that's why you see an increase in stage 2 instead.

Okay. I haven't received any more questions. If anybody really wants to ask something, please send that now -- right now. Other than that, I guess, we're -- we can say that we're running out of time. So all in all, it looks good. Excellent. So one last -- one more question. You mentioned, you had the visit from the FSA. How did the report or visit go? Can you sum up the report in 2, 3 sentences?

I can try to give a 3-sentence summary. So number one, I think it's the shortest FSA report I've ever seen.

And that's the only right about problems? That's a good thing.

Yes. And they were actually quite complementary verbally, quite impressed by what we have built and everything that we are doing well. So I guess, their 2 main points was that they think, this mass market discount is questionable for us. We strongly disagree. So I'm very curious to see how they will explain that position or if they're willing to push that. And secondly, which was a bit more surprising was that they said that our operational risk was a bit high due to key people dependencies. And I think that was a good feedback. So that's one of the things we're working very hard on now, is making sure that we are not overly dependent on any single individual in the government.

And without hiring new people, but just [indiscernible].

And load balancing and so on. Yes.

Very good. No more questions coming in right now. Should we say, that's a wrap?

That's a wrap.