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's 2021 Half Year Results Announcement. [Operator Instructions] Please be advised that today conference is being recorded. I would now like to hand the conference over to your first speaker today, Mr. David Bailey, CEO of Australian Finance Group. Thank you. Please go ahead.

Thanks very much, and good morning, everyone, and appreciate the time you've taken to listen into this presentation. I thought we'd start off by announcing we're very, very pleased to announce that a reported NPAT, which is up 36% to $24.97 million for the half. And the underlying, corresponding underlying NPAT for the same period is up 41% to $24.88 million, which drives an interim dividend increase of 9% to $0.059 per share. The underlying impact or supporting areas of the results and the highlights were around a residential settlement volume being up by 24%. Home loans now, AFG Home loans now services over 27,000 customers. The securities book, AFG Securities book, which is a subset of the AFG Home loans book stands at $2.96 billion, which is up 18% on the prior comparative period. Residential trail book is up 5% to $160 billion and the AFG Home loans trail book is up 9% to $10.7 billion. The key takeouts for the year show a revenue increase of 300 -- of 11% to $371 million. Strong cash flow generation from the trail books continuing, which is always a feature of our business. AFG brokers and broader industry performed well during the various COVID lockdowns across the country, including -- and enjoyed the benefit of the support through the government stimulus. The strong financial result drives an increase of 9% on the half year dividend per share. Government stimulus initially supported increases in first home buyers as well as upgraders, and there's been a strong level of refinance activity. Importantly, for us is that customers are seeing brokers as the avenue of obtaining best advice around their home loan and then -- which is the largest expense in their household budget during a period of crisis. AFG Security settlements volumes did decrease with the reduced credit appetite, and that was forecast by us at our June 30 results presentation. And then we did say we would still look to build that once the market returned. And I'm pleased to say we are returning to those volumes, and I'll touch on that a little later. AFG Home Loan settlements are up 17%, and that was really driven by a mix change. As we said, we reduced our focus on AFG Securities during a period of uncertain market conditions and moved the focus towards White Label funders. Since July 2020, volumes have steadily increased in this part of the business. The commercial loan book is up 5% to $8.7 billion. The strategic and market outlook. The market outlook, we feel that the market and the business has adapted for uncertainty -- the market has adapted, but uncertainty remains in the marketplace. We've recorded residential -- record residential settlement volumes into -- during FY '21. And at the start of FY '21 -- the second half of FY '21 is very encouraging. Whilst the timing and impact of the withdrawal of these initiatives and the extent that demand has been dragged forward is unclear. We do remain positive about the outlook for the industry and the willingness of the government to respond further if necessary. AFG Securities COVID-19-related hardships continue to improve. I'm pleased to say as of yesterday, the payment deferral hardship arrangements now represents 0.2% of our loan book, which is 2 customers. And interest only arrangements are at 0.57% of the book, which is around about 37 customers. We've also seen a conducive RMBS funding market return in the half, and cost of funds remain competitive as a result of the reductions in the BBSW. In terms of the Connective merger, we're still waiting a court case, given the closing arguments are complete and the judge has retired to consider his decision. During the pandemic, brokers have grown their market share of the mortgage industry. Many of these customers, we believe, will not return to bank direct. Government initiatives have contributed to greater market share for the 4 majors during the COVID period. Brokers are important to smaller lenders, the competition and choice they bring as they expand their credit appetite. We remain well positioned in the industry and able to adapt to market changes. We're well capitalized, a strong balance sheet, no debt and a strong brand. Unrestricted cash, trail book assets, financial assets and subordinated capital totaled $267 million. Strong cash flow generation of the business model, including annuity-style revenue from the existing book is a feature of our business. We're undertaking our new technology refresh, which represents significant focus on improving technology to support brokers and customers as they embrace the new ways of working. We've invested in growth opportunities, including technology for brokers and customers, Thinktank manufacturing and our investment in Mortgage Advice Bureau, which is a different offering for brokers. Our existing warehouses are restructured and rolled over and the AOFM have already been refinanced out of one of those arrangements. If I turn to AFG Home Loans, the trail book increased 9% to $10.7 billion. Settlement volumes were down 6% to $1.47 billion, with a changing mix towards White Label funders as AFG Securities reduced its credit appetite during the initial stages of the COVID-19. Since the market -- the funding market has stabilized, there's been an increase -- there has been a measured increase in credit appetite and mix back towards AFG Securities during first half of FY '21. In particular, settlements of $446 million in AFG Securities, whilst it was a decrease of 35%, the book remained higher than in June 2020. Following measured slowdown of activity in June 2020 during the COVID pandemic, and we did broadcast this, a reestablishment of credit appetites have been implemented, and December and January volumes are in line with the prior year. So the business is back and building in that part of the business. AFG Securities proposition to brokers and their customers remain with fast turnaround times, consistent credit decisioning and important competitive products. In the first half of FY '21, the net interest margin included the benefit of an inverted BBSW rate, which lowered the cost of funds compared to the first half of 2020. We successfully completed $700 million term transaction in July 2020 as well as our first nonconforming transaction of $500 million in October 2020. Since the broader lockdown, AFG Securities lodgements has steadily increased to historic volumes. February volumes are on track to be in line with the prior year. Total subordination of $32 million at December 31, 2020, while requirements may increase in the short term with book growth, AFG remains well capitalized. A key ongoing feature of our program has been the arrears performance, and this continues to be excellent. 50% of our book has an LVR less than 70%, with prime loans greater than 80%, all covered by LMI. A reminder that, that is the underpinning part of our AFG Securities book. National house prices remained strong across most markets. The next slide really displays the key characteristics of our program. The LVR bands, as previously discussed, the reasonably -- an average loan size of circa $500,000, and the distribution shows that the loans are where population broadly resides. At December 31, 2020, in a book of 7,833 loans, there were only 26 loans in arrears greater than 30 days, which is consistent in terms of impressive numbers with prior periods. No losses have incurred on non-LMI insured loans. And loans, as I said, in COVID hardship has reduced to 0.02% and those were the further -- and there's a further 37 loans where customers are paying interest only. A reminder, at the onset of the pandemic, those numbers were closer -- the combined numbers were closer to 10%, which is a reflection of the work the team has done in terms of working with those customers, but also our overriding credit policy. Thinktank has had another successful period. While settlements have decreased to $65 million on the back of a softer commercial market due to COVID, there are signs of improvement and some continued -- but some continued short-term impact is expected. The profit contribution from the investment increased 102% for the half to $2.3 million. I want to talk briefly about our continued investment in technology. This is something we've been talking about for a while. We are getting close to launching our new broker portal, which we will call Suite360, and that will be on track to introduce the first brokers in the first -- in the fourth quarter of FY '21. This will bring a full broker experience with complement -- and be complemented with the rollout, including training and onboarding and data migration of the existing brokers of the FLEX system. In a world where brokers time is increasingly tied up with compliance, the system will allow the broker to become more efficient on their day-to-day work and allowing a greater level of service to their customers. As mentioned earlier that the commercial market has been subdued during the COVID-19 pandemic, and this has also been reflected in the AFG business numbers. The important part of -- remember about the AFG business program is that it targets brokers who've never written residential mortgages before. In a period where we've had unprecedented levels of mortgage volume applications, brokers have -- had less time to concentrate on other services such as AFG business. I would add that we do have 32 lenders on the panel from mortgages, short term and trade receivable and asset finance products, and allows an option for a broker to service their customers. I just thought I'd pass across now to Ben to talk a little bit about the financials.

Thank you, Dave, and good morning, everyone. Cash flows from operating activities were up 53% on the same period last year. The increase in operating cash flows was due to a number of factors, including higher residential settlements in trail books and growth in the white label trail book. In addition, the growth in the AFG Securities loan book and elevated NIM contributed strongly to the growth in cash flow. It also includes investment of technology during the half of $2.6 million. And as Dave mentioned earlier, it's allowed us to increase the interim dividend to $0.059 per share. Moving on to the summary balance sheet. AFG maintained a strong debt-free balance sheet with the pillars listed there contributing to a foundation of $267 million and a debt-free position that allows us to grow into the future and provides a good platform. It means we're well positioned to undertake future strategic growth and investments for both organic or inorganic opportunities. The total net asset of the trail book is now up to $96 million. Moving on to the next slide and the impact of trail book accounting. We've talked about the growth in the white label trail book for a number of years now and how the profit would run ahead of cash flow. As that book begins to mature, the cash flow has started to catch up and the -- that's driven an increase in underlying profit of 41% above half one FY '20. You can also see there the average loan life has decreased slightly across the book, and that's off the back of higher refinance activity over the last period. Moving on to other income. Service fees has increased 8% in half, which includes broker services such as compliance, professional indemnity insurance and marketing services, which is really pleasing. The prior periods were particularly busy in terms of conferencing activity. And going back to FY '17, we've mentioned previously the volume bonuses are no longer part of the industry and has contributed to some of the decrease in other income. Thank you, everyone. I'll now hand back to Dave to continue.

So I'm just going to jump ahead to the January '21 -- 2021 trading. And on the back of a very strong half, what we've seen in January, which is traditionally a very quiet period is that brokers return to the offices very, very early in January and that was in response to the demand from clients. So residential lodgements are up 28% on the prior period to $4.8 billion and settlements of $3.7 billion. So we've built a very strong pipeline as we move into the second half of the year. AFG Home Loans lodgements were up 4% on January 2020, which again was a strong month for AFG Home Loans. AFG Securities were 3% higher than January 2020. So while settlements were 34% below on a comparatively softer pipeline and we've talked about the pipeline building from the time of the pandemic slowdown. And every month, we've increased volumes into the AFG Securities pipeline. So that pipeline is built nicely at this point in time. And despite various lockdown periods, brokers around the country remain -- have maintained high levels of activity and are the preferred channel to access home loans across the country. So in conclusion, we -- the first half of FY '21 is a positive result with a 41% growth in underlying NPAT, which does demonstrate the ongoing success of the earnings diversification strategy and the broker channel increasingly being the preferred means for Australian customers to access home loan products. The residential mortgage sector has performed strongly during the COVID pandemic, and government initiatives assisted the market including first homebuyers to drive record lodgment volumes. While the timing and impact of the withdrawal of these government initiatives and the extent that demand has been dragged forward is unclear, we do remain positive about the outlook for the industry and for the company and then for AFG's position within the industry. Following initial uncertainty in the funding market, AFG is now well positioned to continue to expand. AFG Securities continues to grow the loan book, representing a stable earnings platform for future years. AFG is -- we're also delivering a technology refresh to enable brokers to more efficiently deliver choice and competition to customers. Our industry advocacy is something we're very proud of during the post royal Commission period, remains very strong and important to us. And we're continuing to advocate for valuable regulation and compliance to support borrowers and maintain competition in the market. In summary, we believe we have a well-capitalized and strong balance sheet, a considered approach to lending and balance sheet will -- and a considered approach to lending and balance sheet protection will continue. AFG is well positioned in the industry with the ability to adapt to uncertain and changing market conditions. Thank you very much. I'll just pause and allow the facilitator to open up for questions.

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

Just in terms of the securitization book, can you just talk about the recent sort of levels of refi and runoff and how that flows through into the book growth in the next sort of half. We've seen the level of refi sort of moderate in that home loan data you did produce, and just in -- based on that sort of level of settlement or lodgment, how do you want to talk about it that needs to get done to see that will grow? So is that $100 million number you've called out in December is sufficient to grow the book?

Yes, it is Tim. Your typical run off rates that you'll see in the securitization program in the market use an average runoff of around about that 22% to 23%. It's fair to say it was probably slightly higher than that with all the refinance activity earlier in the half, which is moderating slightly. But even at those levels, it's certainly high 20s. You've still got enough volume coming in the front door to grow the book.

Just the level of competition. So how are you getting that sort of level of lodgement settlement in that AFG securitized book, given the level of competition from the major banks?

Sure. I think the areas where we've been concentrating with our brokers is we've still got a good rate to customer for customers who don't want a variable rate. And the feedback we're getting from the market is that a fixed rate, interest rate, whilst attractive, does come with monthly -- sorry, annual fees. And so the comparative rate does push it above that 1.99% rate that most people are advertising. We're also seeing customers who are coming into cash and bank -- most banks with a fixed rate product are not providing an offset account. So the conversation with -- from brokers with customers is if you're looking for some flexibility, the variable rate does stack up quite well and it allows you to put extra funds in against your mortgage at the time. The other most and probably the most important part of this Tim is turnaround time and consistency of credit. We've got -- you would have seen in our mortgage index, which we released in October -- sorry, in early January, the average days to turnaround time to unconditional are sitting in the mid-20s. That number is still being maintained. AFG, you can get -- our current turnaround times are at 1 day for an unconditional and 7 days to -- sorry, 1 day for conditional and 7 days for unconditional, which is industry leading. So the experience the brokers are getting in an environment where the market is clogged up is a very good one.

Okay. And then just on the other expenses line, it looks like they're sort of back to a level that's more consistent with sort of pre COVID levels for the half. Just trying to understand whether there's any one-offs in there with your release provisions or have held them from what you had at June?

Yes. So the 2 biggest driver that -- the biggest drive there really is activity around conferencing. And so without a big conference in the half, a lot of the cost of that from that line comes out. The provision for expected credit losses has been maintained at basically the same level as 30 June at December 31.

Okay. And then last question for me. Just the equity account of profit kicked up a bit as well versus history. Can you just talk about what's going through that line and what the outlook might be?

Yes. So that's primarily Thinktank for the half. The MAB investment only came in late in the half for about a month or so. And the Thinktank contribution there is really off the back of their growth. Obviously, we take our percentage share of their profit into the P&L. So being a securitization business there continue to grow the book and benefited from inverted BBSW over the past 6 months as well.

Our next question today comes from the line of Brendan Sproules with Citi.

Look, I'd just like to ask around the commissions that you pay to your brokers, it looks like the percentage has increased reasonably substantially this period. Could you maybe talk about some of the drivers of that, particularly around the mix between upfront and trail commissions? And also, what impact did the higher repayments that we're seeing in the system across most lenders have on your trail book and also what you pay away to your actual brokers?

Yes. So the average pay away is just over 94%, and it has increased slightly during the half. That's probably the similar levels to what it has over previous periods. And that's just driven by the competitive pressures that are in the market from other aggregators and the pressure that puts on the margins we retain to keep our brokers essentially. The mix in product from lender doesn't have any impact on the payout ratio at all. So regardless of what product it is or which lender it comes from, the payout to a broker is the same.

And so just a follow-up on that, what about the difference in mix? You'd have a higher mix of upfront conditions relative to trail in this period given the sharp levels of settlements. Is there a higher rate on the upfront?

Yes, there is. Yes. The trail payout ratio is based on historical agreement at that point in time. So if it was a loan from 5 years ago, the payout ratio on the trail there is based on the loan from 5 years ago. So there is a difference from a cash perspective, from an accounting perspective, the -- you're effectively recognizing 5 years' worth of trail income in the month that you settle that loan, and that will be recognized at the current payout ratio.

Right. Just the second question I have, just following up on the operating expenses. You obviously mentioned the impact of having no conference. Obviously, you're now sort of tracking it at sort of less than $50 million for the year. Is the sort of $55 million operating expenses that you had in FY '20 a more reasonable guide to your cost base going forward, assuming that your conference does resume now that COVID impacts are lessening?

Yes. Look, I mean, the conferencing activity and those sorts of bits and pieces will be there. I think they will occur and it's just a matter of time. And I think the other thing that's worth remembering is that as AFG Securities business continues to grow, we'll need to invest in additional people there. And so there will be some pressure on the line from that perspective. And the technology build that is occurring is obviously, the majority of it is capital at this point in time, but there's also some need to invest in people and other items there to continue to develop that.