Australian Finance Group Limited (AFG) Earnings Call Transcript & Summary

Ladies and gentlemen, thank you for standing by, and welcome to the investor briefing for AFG 2020 Full Year Results. [Operator Instructions] I'd now like to hand the conference over to your first speaker today, CEO, David Bailey. Thank you. Please go ahead.

Thank you, and good morning, everyone. With me is Ben Jenkins, our CFO, and you'll hear from Ben very, very shortly. AFG is very pleased and proud to announce a profit result of $38.1 million, which is up 15% on the prior financial year. Probably most importantly for me is the underlying NPAT, which is reflecting the cash earnings of the business spinning out of the trail book, and that's up 27% to $36.3 million. The result was underpinned by residential settlements, which were up 9% to $34.1 billion. And the other part was AFG Home Loans, which now looks after over 25,000 retail customers. This AFG Securities book, which is another platform of our earnings growth, experienced a very strong year with settlements up by 28% to $1.35 billion. We now have a loan book of $2.9 billion, which is up 41% on the prior year. The total result combines to drive a total dividend of $0.101 per share for the full financial year. And for the half year, a dividend of $0.047 per share. The financial results, moving on to the next page, the key takeouts for me, we saw total revenue increase by 6% to $698 million. Again, we saw the Securities book, which helped drive additional revenue, being up by 41% on the prior year. Underlying profit increased by 27%. This is something we've been talking about for a little while in terms of the AFG Home Loans book and the trail which is going to be generated from that business. That's actually really now translating into strong cash flow. So that was up 27% the underlying earnings -- underlying profit, supported by, again, that AFG Home Loans white label settlements washing through in terms of trail income, actual trail income, a strong NIM and growth in the overall Securities book. If you look back at and compare it to FY '19, we finished the year with a stronger balance sheet and higher profit, which given what the business has been through and what the Australian economy and the world economy has been through over the last 12 months, I think, is a sound endorsement of the business and the platform that we've been able to develop. So we're very proud of our ability to continue to grow the business during quite stressful periods. The business and industry performed well during the initial months of COVID panic -- pandemic, sorry, and has quickly adapted to a new way of working, which we'll touch on shortly. The strong cash flow generation, including trail book annuity type income, drives a continued dividend payout policy of 60% to 80%, which is consistent with what we quoted at the time of listing back in 2015. But we do caution that this is and will remain under constant review, given the extraordinary times we are in. Moving to the next page, we've got the settlements and the loan book growth. We talk -- settlements has been up over the year. And probably the first time in quite some time, we've actually seen and experienced residential settlements being growing in all states. The AFG Securities book is maintaining a strong arrears record and track record and remains below industry averages. That's really following a more conservative lending approach initiated by AFG historically, but also during -- as we responded to the pandemic. Lodgment volumes were slowed, which you would have seen when we undertook our -- or disclosed when we undertook our capital raising back in May, but it's pleasing that these lodgment volumes have now begun to improve. The trail book from the AFG Home Loans book, which I referred earlier, is up 14% to $10.5 billion, which is now driving significant cash flows into the business on an annual basis. The AFG Business platform experienced growth as well, is up to $346 million, which is extremely pleasing. And the Thinktank business, where we own 33%, their settlements in their white label product was up 79% to $160 million. Just touch on the trading update for the period. You can see our numbers are generally quite easily disclosed, where we -- via the use of our mortgage index, but we have recorded year-on-year growth each month of the second half of FY '20 and strong growth in each state for quarter 4 compared to FY '19. During the lockdown periods from March, we've already talked about brokers maintained their levels of activity with a shift of focus to refinanced loans. The recent bout of government initiatives and stimulus activity has now moved and refocused activities into the upgraders and first homebuyers' market, and we're a beneficiary of that. The July 2020 interestingly was a record lodgment and settlement month for the business with $6.3 billion and $3.6 billion, respectively, from -- in terms of lodgments and settlements. In terms of our AFG Securities business, I think the important part is we did -- as disclosed in May, we did slow down our originations into that area as we took stock on what was going on in the marketplace, and we did see a change in mix away from our traditional -- or more towards our traditional AFG Home Loans white label product. Importantly, as the funding market has returned, and we've taken some considered credit steps to increase AFG Securities lending. This has been made with lodgments improving to $116 million in July 2020. The strategic market and market outlook. COVID has changed the way we work, and I call it a watershed moment in terms of the mortgage broking industry. We now see the more recent industry stats, we saw brokers now in the last quarter were responsible 57% of all mortgages written in the industry across both channels. We are seeing more bank branches closing. Brokers continue to be crucial to competition and the distribution of financial products. The reach that brokers provide lenders and customers is vital. What we also saw during the whole COVID period, in particular, was the restriction on movement and limited access to branches accelerated the move to digital transactions and the new digital way of working. Brokers and their customers were quick to adapt to this change, and we're seeing more and more online interaction. The business is well capitalized, has a strong balance sheet with no debt and has a strong brand. We're positioned to withstand new funding and economic shocks that may arise. Investment in technology has ensured our brokers and staff have been able to adapt rapidly, and we'll continue to evolve and develop this capability. The strong cash flow generation of the book -- of the annuity stream of the book as well as our AFG Securities book will help underpin the strength of the business moving forward. The market outlook. COVID-19 drives -- continues to drive significant uncertainty. We're not really clear yet on what the full scale of the likely disruption to lending markets is going to be. We expect to see an impact on employment levels, business confidence and property prices generally. We just don't know the extent at this point in time and how it plays out and whether it will drag -- and some of the stimulus packages will drag demand forward or has dragged demand forward. Pleasingly, our AFG Securities COVID-19-related hardship percentages, which we talked about in May as part of our capital raise, have continued to improve. And I'll touch on those in a minute. This is really a reflection of the focused and disciplined approach to hardship and arrears, which has been maintained throughout this period. The impact of the withdrawal of the government stimulus will leave on this area remains to be seen. Lodgment activity in FY '20 and July 2020 has maintained its strong year-on-year growth, and the appetite for the RMBS market has returned. Whilst cost of funds are wilder -- wider, they have been supplemented by historic low bank bill swap rates. The update on Connective merger is, obviously, during the period, in the last few months, the ACCC indicated that they will not oppose the transaction. And the other noncustomary condition being the court approval is still being deliberated on by the judge. Just want to quickly touch on AFG Home Loans because it's an important part of our business, and we did talk about briefly how the trail book now is at $10.5 billion. That -- we said a number of years ago that this would be a book build process and sort of the profit would run ahead of the cash. What we're seeing now as that business has established and continues to grow, the cash flow from that trail book is starting to wash through on a consistent level. Settlement volumes were consistent with FY '19, but I think most of you will remember that we did say that we were going to try and change the mix of that funding. So what we did do and did see in the first 9 months of the financial year was remove -- was a greater focus on the AFG Securities product and less focus on the AFG Home Loan's white label product. Obviously, when the pandemic hit, we slowed down our originations on purpose in the Securities product and wrote more of the Home Loans product over that period. We're now starting to see more Securities product being written now that we are comfortable in what the funding cycle looks like, and we'll touch on the balance sheet and our warehouse capacities very, very shortly. AFG Securities, as explained as part of the capital raise, is an important part of our business, and we did react reasonably quickly by slowing down originations in that part. Pleasingly, as I said, we are -- the full year result, even when you consider the slowdown during March -- sorry, April through to June, is that settlements of $1.35 billion was still achieved, which is an increase of 28%. The industry -- sorry, our arrears remain well below industry averages, whilst our COVID numbers have improved. And that's really a reflection of the unique position AFG has in the marketplace -- in terms of the mortgage marketplace. In FY '20, the net interest margin also increased with the benefit of the significantly lower BBSW. Our Securities business, which I mentioned just then, we undertook just after the end of the financial year a $700 million term transaction, which allowed us to increase warehouse capacity moving forward. In addition, that was on top of the $500 million transaction we completed. I think it was in about October in FY '20. We've renegotiated the limits on our warehouses. So we do have a level of dynamic warehousing available to us. And at -- the small warehouse, which we had available to us with Deutsche Bank, has been refinanced prior to the end of the financial year through to one of our existing warehouses. That did require us to put more additional capital to support, which is one of the reasons why we raised the capital in the first place back in May. Our total subordination sits at $37.1 million. Whilst we expect subordination requirements in this environment will continue to -- are likely to increase, these may not be to the same degree as we originally anticipated. We do remain optimistic. We are also prepared structuring of this business for the possibility of more debt market shocks, and the balance sheet and the business is in a stronger position than it's ever been. In terms of the AFG Securities and the operational side of things. If you exclude the hardships, and I'll touch on hardships in a moment, we have 19 loans in 30 days of arrears plus, and that's out of a balance of over 7,500 loans, which then does reinforce the strong underwriting and arrears performance of the business, which has been maintained over a number of years and is a reflection of the unique position AFG has in the marketplace. 50% of the book has an LVR less than 70%. More than half the loans in COVID hardship have now returned to either part or full payments. Total hardship has reduced to 5.3% as at the 21st of August. I think most will remember the hardship number during -- disclosed during May was around about 10%. So that 5.3% is almost a 50% reduction. And the clear piece of that is that in terms of deferrals, principal and interest, that number is now down to about 2.03%. So we -- whilst we are alert to further economic and community stress as government stimulus is withdrawn, we think we are well placed, and it's a good position to be compared to some of our peers in the marketplace. AFG Business, we've grown that business from $130 million in settlements in FY '19 to $346 million in FY '20. That's been fueled by both an increase in the number of lenders in the panel, but also the number of brokers who've used the platform has increased from 241 -- sorry, increased to 241 from 138 in the second half of FY '19. I would note that in terms of where we are in the economic climate at the moment, the lending environment for commercial we're seeing as being considerably constrained in the short term as restrictions on businesses continue in many states. Thinktank is another thing we're very, very happy with in terms of performance for the year. Our white label settlements have increased to $160 million, which is almost double the $89 million in FY '19. And the number of brokers using that product has also increased to 261 from 186. The equity investment, which is around about 33%, drove a profit contribution increase of 52% to $2.3 million in FY '20. I do caution, the lending environment will remain constrained in the short term, in particular, as a reflection of the COVID restrictions. I touched earlier on our ongoing investment in technology. And COVID has actually -- I talked about it being a watershed moment for the industry. And really, it's been probably one of the only positives that you've seen coming out of COVID, and that's been the embracing of technology and the rush to use new technology to fulfill customers' demands rather than rely on traditional methodology. So our technology build, which was underway, has been -- is continuing to evolve, but we have taken the opportunity to incorporate some of that functionality within our new technology so that we can hit the ground running when that new technology is released. That new technology reflects a new customer portal, which will be released in the first half of FY '21; and a broker portal, which will be released in the second half of FY '21 as well. All of this is built on the fact that we believe brokers will become busier. Brokers who were looking to take time will take -- create economies of scale within their business, and technology should be an enabler in that space. And as a leading aggregator, we see technology as a key differentiator in terms of our overall proposition. I'll just pass across now to Ben, and he can walk through the financial information.

Thank you, Dave, and good morning, everyone. So our cash flow from operating activities was strong in FY '20 at $40.3 million. This is due to -- well, the cash generation provided by the group's trail book remains a strong contributor and an asset for the business. The higher AFG Securities loan book and NIM have been key contributors to the increase in operating cash flows over the year. And the Securities book also provides a platform to generate cash flows in future years. FY '20 includes investment in technology, as mentioned on the previous slide to -- [ about our ] core broker platform, and the investment in intangible assets for the year was $2.6 million, which is up from the prior year. Moving on to the summary balance sheet on Slide 15. The group's balance sheet remains debt-free and in a healthy position to deliver future growth, whether that be organic or inorganic opportunities that may arise. It is worth touching on the restricted cash on the balance sheet at 30 June 2020. That amounts to $53.4 million of the cash balance, which is restricted cash. This is not AFG's -- as a reminder, this is not AFG's cash and forms part of the funding flows for the AFG Securities business. The trail book net asset continues to grow, which will provide annuity like cash flows over the coming years and is now up to $96 million, which is on the balance sheet and a strong asset for the business as well. The expected credit loss position that we touched on in the equity raising presentation in April -- or May, sorry, is included within loans and advances on the balance sheet. At 30 June, the expected credit loss provision has increased to $3.3 million, up from $800,000 at 30 June 2019, and reflective of the model and the shape of the book at this point in time. Moving on to the impact of trail book accounting on Slide 16. The trail book assumptions have remained largely consistent with 2019, with loan lives, the key driver of the trail book net asset value, remaining relatively steady. The discount rate for the last tranche of loans has decreased slightly to 4%. But as noted on that slide there, the discount rates once set aren't adjusted for the life of the loan. So this is just for the last year's worth of settlements that have been brought into the trail book. As the white label book, in particular, has begun to mature, the gap between reported and underlying earnings has narrowed, as you can see there, with a $1.8 million after-tax difference between underlying results and the results from continuing operations. Moving on to other income on Slide 17. Other income has decreased overall compared to FY '19 as sponsorship income, in particular, has reduced with limited [ broker ] conferences held in the second half of the year. This is really down to the impact of the COVID-19 pandemic and the inability to hold many of those conferences. Obviously, there has been a corresponding decrease in expenses in line with that reduction in sponsorship income. Pleasingly, however, again, there's been an increase in the repeat-type income of fee for broker services, which have increased 2% over the year. Our July trading update on Slide 18 is a pleasing result. July lodgments are up year-on-year in all states, with an increase of 28% overall. The July 2019 quarter it's worth pointing out was quiet a period, however, with credit subdued following the Royal Commission in the 2019 federal election. AFG Securities lodgments were down on FY '19, as you can see there, by about 39%. However, this is largely a result of us slowing down originations, as Dave has earlier mentioned, in April. And pleasingly, the increase in settlement -- sorry, the increase in lodgment activity since April has been good. So the lodgments in July 2020 were up to $116 million, which is a 128% increase compared to the April 2020 number, and reflects the considered credit steps that we're taking to increase lending in that business. So thank you, everyone, and I'll now pass back to Dave to conclude the presentation.

Thanks, Ben. So in conclusion, I think the FY result represents a very successful year by our business. It's been driven by growth across the business -- right across the business and a reflection of our earnings diversification strategy we set in place back in 2015. It's particularly pleasing against the backdrop of COVID and the impact of the Royal Commission at the start of the year. The challenges and effect of COVID-19 on our economy and capital markets do remain uncertain, and it is difficult to predict. But we maintain a cautious outlook and a conservative approach to capital and lending and supported by a strong balance sheet. The foundations we laid for AFG Securities in the prior years have provided strong growth in FY '20. The book has performed well during COVID, and is testament to our considered credit decisions that we make. Importantly, we're living in a world where the ability of brokers and willingness of customers to embrace technology has been reinforced during the period. We are committed to building upon our long-term strategy. And the merger with Connective, whilst has not been opposed by the ACCC, the transaction remains subject to court process, but is an important platform for our future growth. The business model, strong brand and balance sheet strength places us in a solid position to respond to any evolving situation out there. We do maintain a cautious outlook and remain alert to further economic and capital shocks, particularly as government stimulus is withdrawn. But at the time being, we think we are well placed to ride out any storm which may be presenting itself. On that note, I'll pass back to the facilitator and take any questions should there be any.

[Operator Instructions] Our first question comes from the line of Tim Lawson from Macquarie.

Just had a couple. Just can you comment on what the exit NIM is? Obviously, it's improved in the second half but probably stronger again in the fourth quarter.

Yes. It's not something that we disclose, Tim. So I think that you can, I guess, infer it from the level of BBSW at the beginning of the year to the second of the year -- second half of the year would probably be the best way to work it out. But it's not a number that we publicly disclose, sorry.

Yes. Okay. You've called out in July lodgments in AFG Securities business of $116 million. Is the conversion rate sort of similar to the group at about that sort of at 65%? And I guess, the question just trying to get to my estimate of about $50 million a month runoff, just trying to work out whether that $116 million lodgment is sufficient to effectively grow the book if it was to convert at that sort of 65% rate and hold at that volume level?

Yes. Look, I think it's fair say it's similar, probably slightly better, but not materially different. And if loan lives stay around where they are, then you would see some growth in the book. But the -- yes, I guess, the unknown over the future is the level of runoff and refinancing activity. But as things stand right now, it would be sufficient enough to drive growth in the book at the moment.

Yes. Okay. How much -- I mean was there a big acceleration in that refi within that AFG book -- Securities book?

Look, I think we're seeing a high level of refinance activity across the board. As you've seen in our mortgage indexes as there's been people with either incentive to save a little bit of money or time on their hands to look at their finances, there's been a little bit more activity on the refinance front.

Okay. And just a final question for me. Just on the asset quality, you've taken that $2.5 million increase in provision. When we look in the annual report, it looks like the expected credit loss rate has reduced. Is that just because the number of loans that have been classified as underperforming and nonperforming is higher, bringing that [ effectively ] average down? Just trying to understand those moving parts.

I think the difficulty in looking at that at the moment is probably the fact that loans are in hardship rather than arrears. And so that typical banding is a little bit different to what it would normally be. I think as the number of basis points of the overall book, the expected credit loss provision certainly increased.

Yes, okay. Yes. So it's the $2.5 million that we should be thinking about rather than the rate?

Yes.

Our next question comes from Richard Wiles from Morgan Stanley.

Just got a couple of questions relating to Slide 5, which is the update on lodgments. The level of lodgments has gone up and you mentioned how strong it was in July. I'm just wondering, firstly, if there's anything we should read into the downward trend in the average loan size. What's actually driving that?

That's a good question. Look, I think generally, you are seeing a level of credit tightening across the board from lenders. So they're still available and willing to lend, but they are taking a closer look at expenditures and so forth. The other piece is that there would be a -- probably look at the mix. You need to look a little bit of their mix in terms of the average loan size, what's making up that mix. So I'd need to do a little bit more digging on that one.

Okay. And just my second question is, and I'm not sure if you disclosed it elsewhere. But what's the mix in variable versus fixed rate loans? And how is that trending at the moment? How is it changing?

Yes. So there's an Appendix at the back of the presentation. I'll just dig it up for you to give you the right number. So what we did see is a spike, particularly in May, around that fixed rate product. Are they in here?

I don't think so.

We took it out. So we did see a spike for around about 25% of all businesses being written in fixed rate product. And that was really on the back of -- yes, I think, ANZ had a 2.19% rate with a $3,000 cash back, that number got increased once they got a bit -- bit busy, it got increased to 2.29% plus -- and then started creeping up again. So historically, that average is around about 10% to 12%, and we're starting to see it trend back down towards that number, but we're not there yet.

Our next question comes from Azib Khan from Morgans Financial.

Ben, a question for you on provisioning. Can you confirm that the hardship and arrangement cases are being treated as stage 1 exposures?

It depends on the case. In some cases, they are. We've taken a constructive view around how to treat these, and I guess, taken a proportionate view around them as well. So I think where we've landed is a relatively conservative position and increased the probability of default on some of those cases where we view appropriate.

All right. So -- I mean there was -- your provisions -- if I recall correctly, your provision was about $1.2 million as at April. So that was up roughly $450,000 from June last year to April, and then it looks like you've topped up by $2 million just in the last 2 months of the half. That $2 million top-up in the last 2 months, was that more driven by a revision to your macro assumptions? Or was it driven by SICR?

What was the last thing you said, sorry, Azib?

Was it driven more by macro assumptions? Or was it driven more by a significant increase in credit risk as per AASB 9?

No, it wasn't driven by an increase in credit risk. It was driven by the review of the model and the macro assumptions around that.

Can you tell us what your macro assumptions now are in relation to that, Ben? Particularly with regards to what you're assuming for GDP and unemployment?

No, it's not something we publicly disclose. Sorry, Azib.

Sure. Okay. So there has been a chunky increase in that provision. But if I take a look at your provision coverage ratio as a percentage of your book, it's at about 11 basis points, which is around 1/3 at the level where the major banks are right now. How do you reconcile that difference? And I suppose there's a related question as well. Your hardship and arrangement percentages are now down to 5.33%, which is lower than what a lot of the banks are reporting. In what ways do you think your book may be better quality than that of the other prime lenders?

It's a range of factors really. And it comes down to the fact that we're not a bank, and we don't have bank balance sheet so we're not able to land into areas that the banks are able to. So we have to maintain much more higher credit pools to allow term transactions out into the RMBS market. So all loans over 80% have LVR, have LMI attached to it where we're focused on category 1 post codes. Outside of that, if there's an LVR over 70% in some of the high-risk areas, you also have LMI attached to that, and the LMI's are a loan-by-loan policy. So if you look at our arrears history and our loss history, it's significantly clean, and there's not a lot of loss history at all or arrears. I think we typically have, yes, 15 to 20 loans in arrears across the entire book.

Okay. Just coming back to the hardships and arrangements. So you've made a comment that more than half of the loans in COVID-19 hardship have now returned to either part or full payments. Those that have returned to part payments, are they being reflected in the 5.33%?

Yes, they are.

Okay. And the AOFM's forbearance SPV, is that now live?

Yes, it is, Azib.

And is that something you've started to tap?

No.

It's something you plan on tapping?

Probably not at this point in time.

And that's because you can see a continual trending down in those hardship and arrangement percentages?

There's that, and it's an expensive facility, Azib. It's being priced at a general -- at an ASB facility. So it takes into account motor vehicles personal loans, et cetera, et cetera. And once you look at it from a mortgage perspective, the cost of funds in terms of tapping that on are quite expensive.

Right. Okay. And just one last question for me about your $700 million term transaction. So I noted that there were no hardship or arrangement cases that were put into that transaction. Moving forward or I suppose, in the near term, do you expect that to continue to remain the case? I mean is that the indication you're getting from RMBS investors that they don't have any appetite for any hardships or arrangement cases to be tipped into the new term transactions?

It's a really interesting question, isn't it? It's not going to help you much because it depends. Particularly, some are relatively comfortable once they understood the forbearance facility. And that -- and AFG are a signatory to that. So we did -- we have access to it if we need it. But at this point in time, I can't see us needing to do it based on the spread that's available in the pool anyway. So some are a bit more relaxed about it, particularly those from overseas. But at this point in time, I think the common market view is that we won't include it because it's less confusing.

And just one last one for me. So I think you said earlier, David, that during the lockdown, you started skewing the AFG Home Loans new business towards white label. Are you now saying that you're now skewing back towards the AFGS business?

Yes. We're starting to see -- we did slow originations down significantly. And so what we are saying is that we are starting to write business again, but we are conscious that we still do have credit people doing hardship calls and management of cases. So again, we're not back to -- we're nowhere near back to where we were prior to COVID landing.

[Operator Instructions] Our next question comes from Oliver Stevens from Hartleys.

Maybe this is being preemptive, but with Connective, can you give us some sort of background as to how that's all still going? Not making assumptions that the deal goes through, but how is the relationship there? And is it still your intention to go ahead if you get the opportunity?

Yes. It's -- look, I think it's being -- I mean the case is being heard in Victoria. So there, we had some challenges at the moment in terms of natural work flow. So I would have hoped that we'd have had a decision before now, but it clearly hasn't happened yet. Yes, we're constantly in contact with Connective in terms of engaging with them and understanding their business. And we're still looking forward to completing that transaction.

And Dave, broadly, do you think the pricing structure would be the same?

Yes. Yes. Yes, I would.

There are no further questions in queue. [Operator Instructions] There appears to be no further questions, so I will pass back for any final comments.

Thank you very much, and thank you, everyone, for attending. I recognize it's a busy day for results and so forth. So I do appreciate you being online. We'll certainly see some of you over the next few weeks, virtually, unfortunately, but stay safe and hope to see you soon. Thanks for your attendance.

Thank you so much. Ladies and gentlemen, thank you for your interest. You may now disconnect.