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

Thank you for standing by, and welcome to the Australian Finance Group Limited Investor Briefing for AFG 2021 Full Year Results Announcement. [Operator Instructions] I would now like to hand the conference over to Mr. David Bailey, CEO. Please go ahead.

Thanks very much, and good morning, everyone. It's very -- I'm pleased that you could join us today and talk through our FY '21 results, which would represent a record result for AFG. If you go to Page 2 -- I'll just walk through the presentation. I won't touch on every line item in this, so we can move into questions. But the reported NPAT is up 35% to $51.3 million, which drives the final dividend of up -- being up of 57% to $0.074 per share. The underlying NPAT is up 37% as well to 49.6% (sic) [ $49.6 million ]. So this result is really a reflection of a -- really strong residential settlements, which were up by 28% to $43.6 billion. AFG Home Loans is a subset of that, also experienced a 10% increase in settlements to arrive at $3.45 billion. And the trail book now is $11.2 billion within that part of the business. AFG Securities. We talked at the half year about AFG post the pandemic starting to build flow. It's very, very pleasing. The second half lodgments and settlements are up 80% and 35%, respectively, on FY -- the second half of FY '20. And the closing book is up 17% $3.39 billion as of 30 June 2022 -- '21. Operating cash flow was up 45%, which is a testament to the cash flow generation capabilities of the business model, and our broker numbers are up to -- are over 3,050 as at 30 June 2021. A little bit look -- a -- of a closer look at the full year results. Residential settlements were up 28% to $43.6 billion. This growth is obviously supported by government stimulus, low interest rates, improved economic outlook. The first home buyers and upgraders were the main drivers of that sector, and also an increase -- an observed increase of flow to the third party or broker channel. The AFG Securities book, we said that we'll be building on this -- on the -- within that business post the pandemic, and to have a $3.39 billion loan book, which is up 17% after the slow start for the first half was very pleasing. The strong second half of the financial year really reflects increased activity across the market. We've talked about AFG Securities settlements. The lodgments are up 80% on the second half, which will drive a strong settlement pipeline into FY '22. Similarly, Commercial settlements, the first half were soft due to the obvious reasons of the pandemic. But in the second half, they are 23% higher than the second half of FY '20. Revenue as a consequence of all that, is up 11% in FY '21 on the back of settlements and loan growth across the business. Net interest is 35% higher in FY '21, being driven by the 17% growth in AFG Securities loan book. Operating cash flow, and Ben will talk to shortly, is up 45% to $58.6 million. And the total dividend has been maintained at 80% of underlying profit. So the underlying profit excludes the share of profit and associates, and I'll talk about the increased contribution from our investment in Thinktank very, very shortly. So that overall represents an increase of 32% on FY '20. So we think we're well positioned to continue to grow our earnings diversification strategy, cash and other financial assets of $282 million provide core balance sheet strength. The net securitization interest plus net cash flow from aggregation and white label trail books is up 20% and sits at just under $83 million. Strong cash flow generation is supported by the established trail books, which provides the annuity-style cash flows. So the strategic and market outlook. The market outlook -- the market continues to grow at record levels. We've talked about our settlement volumes. And whilst there's been initial -- whilst there's been an initial increase in first homebuyer volumes, this is being replaced by investors we've seen coming back into the market and supported by ongoing refinance and upgrader activities. So the volumes remain elevated. Additionally, the RMBS market remains buoyant, and the cost of funds allows a competitive environment for our AFG Securities business. Opportunities for nimble and fast-moving, nonbank lenders continue to be present in this marketplace, and the commercial finance market has recovered in the second half. The strategic outlook really hinges on brokers remaining important to the sector. The market share of brokers has increased during the period. And the overriding thematic is ongoing restrictions and lockdowns, together with varying lender turnaround times, increases the value of brokers to borrowers. Competition among aggregators remains high, however, and lenders, including neo and digital banks, continue to look to brokers to distribute their products and grow volumes. Our NIM has benefited from a lower cost of funds, and we would expect this to continue in the short term. So we think we're well positioned to continue to deliver growth. We're continuing to diversify through investment into growth opportunities, including higher-margin AFG Securities products, strong cash flow generation from a new restyle and trail and loan books, together with a debt-free balance sheet will allow AFG to move quickly and take advantage of organic and inorganic opportunities. Our investment and strategic alliance with Volt will begin to -- Volt Bank will begin to reap benefits in FY '22. We'll introduce a white label product in the second half of this half, together with integration, we commenced integration of key parts of their technology into our AFG Securities program. If I move over to AFG Home Loans, these settlements increased by 10%, and there's a chart there that shows the mix of those settlements. The loan book grew 7% to $11.2 billion. As highlighted at the end of December half year, we stabilized -- the stabilization of the funding market, we've made the decision to begin to grow AFG securities, and those volumes have returned. And the investment, again, with -- and strategic alliance with Volt, we'll introduce a new white label mortgage to the AFG Home Loans stable of products in the second half of this half. The AFG Securities business achieved settlements of $1.35 billion, and those volumes are up 35% on the second half of FY '20. The loan book grew to $3.39 billion. Higher-margin, near prime products refreshed, we -- sorry, we refreshed the higher-margin, near-prime products in this half and then launching an SMSF product in the first half very, very shortly, to broaden the product range even further. I think the important part is AFG Securities provides a lending -- a valuable lending proposition to brokers and customers. We are consistently in the top 5 lenders in terms of turnaround times, whilst we're also growing our book. And I think that is one of the key attributes of our AFG Securities business is it's decision time and consistency of credit decisions, which lends credibility and confidence to brokers recommending a product, which is well-priced and competitive in the marketplace. The increasing loan book as well as high NIM delivers a significant contribution to AFG's record financial performance. The net interest margin includes the impact -- obviously, the impact of the inverted BBSW, which drives an improved cost of funds. We expect our current cost of funds outlook to be expect -- to be continued for the next -- for at least the next 6 months. And our warehouse capacity as well as ongoing demand for our future and further our invested transactions remain strong. If you go to Page 11 of the book, you can see we've been able to continue to grow our AFG Securities business without having to sacrifice credit quality. The average loan size still sits at around about $450,000 to $500,000. The LVR band still remain very, very conservative. And the geographic distribution is broader, basically, where a majority of the population sits in the country. The AFG Securities book performance remains excellent. You can see there, we've got 27 loans out of 11,237 (sic) [ 8,829 ], which are in -- greater than 30 days. So it demonstrates a strong quality book and a strong credit -- underlying credit proposition. No loss has been incurred on non-LMI insured loans. And we mentioned there, there's been -- due to the lockdowns in Sydney and Melbourne, in particular, the hardships have moved to -- at 10 August to 0.93% of the book, which is about 61 loans. The more recent update on that is that number as of yesterday was 72 loans, of which 50% of them were actually still having interest-only payments on those. So a very, very strong position in terms of outlook around hardships. Our white label. I think our investment in Thinktank has been one of our other success stories. The -- as highlighted, commercial activity in the first half was probably a little bit softer due to the overriding impact of the pandemic. So that is really also a tale of 2 halves. There's been strong demand and improving volumes in the second half of FY '21. Importantly, our equity investment of 33% of -- into Thinktank has driven a $5.3 million contribution to earnings. And we're very -- obviously, very, very delighted in the progress Thinktank have made over the last 2 years, in particular. Moving on, one of the things we are doing is continuing to invest in technology. And our CRM platform is a key pillar of that widening investment in technology. We are starting to look at migration of each broker into that platform. And so we manage very carefully, recognizing that some of our brokers have been with us for a long time, and there's a large amount of data. So we will do it safely and slowly to ensure that the transition drives an excellent outcome for our brokers and ultimately, their customers. We're continuing to invest in our analytics platform to drive insights for our brokers, and also our own lending decisions. Brokers will obviously benefit from our investment in AFG Securities via our new lending -- our loan processing platform to enable an even quicker time to yes. And obviously, the investment with Volt will also drive a stronger digital proposition for our brokers, but also as a White Label alternative across our AFG Home Loans stable. AFG Business platform, that's probably been the softer one for the period. Obviously, on the back of the slowdown in commercial and asset finance areas in that first half, it's been -- it's -- the result is down 42%. The other point to remember is that we created AFG Business as a tool for residential brokers to transition into becoming a commercial broker as well. Importantly, at a time when brokers have never been busier in terms of volume and customer demand, their ability to branch out or their desire to branch out has been impacted because they're catering with the demands that they've got already with their existing residential customers. So we'll look to -- as the market continues to evolve, we'll look to step that part of the business out again. But in the short term, we would expect our results in that to be relatively flat moving forward. I might just cross -- hand across to Ben who can talk on some of the financial information.

Thank you, Dave, and good morning, everyone. Before I get into the summary cash flow on Page 16, I'd just like to point something out in the P&L this year that we've reclassified. So the commission expense relating to AFG Securities loans has been reclassified from commission expense to interest income, and we've reclassified the comparative figure of this as well. So this is disclosed on Page 59 of the annual report. And it's -- the movement in the current year was $9.9 million, and the comparative figure was $7.2 million. Moving into the summary cash flow. It has been a strong year for the cash flow generation of the business, which has been driven higher by higher activity in the business and the positive working capital movements in the year compared to last year. That's across the residential business. It's had a strong volume growth and also the AFG Securities business with the book up 36%, driven by book growth and lower cost of funds in the market. The AFG Home Loans trail book has also increased over the period, which has contributed. FY '21 cash flow has also included the funding of our investment in technology, Mortgage Advice Bureau and Volt Bank out of existing cash and cash reserves. The investment in intangibles is primarily our CRM technology project that David has touched on. Moving on to Slide 17 and the summary balance sheet. Our balance sheet remains simple and strong with the key elements, the AFG residential, Commercial and Home Loans trail books, which are now at $98 million on a net basis, the AFG Securities loan book and unrestricted cash of just under $107 million. And our balance sheet leaves us well placed to fund future growth, either organic or inorganic. On Slide 18, we touch on the trail book accounting, which has driven underlying profit up 37%. As you would expect in this environment, we have significantly higher refinance activity. The loan life of loans within our trail book has reduced slightly. You can see on the slide there, down from 5.1 years to 5 and 3.2 to 3.1 at the bottom end of that range. On Slide 19, we touch on other income, which remains a continuing positive story with service fees, in particular, 13% higher in FY '21. This is a result of good growth in broker numbers as well as the take-up of additional services. Service fees in this regard cover compliance, PI and marketing and technology services. On Slide 20, we touched on our July 2021 trading update. Again, there's strong growth across the majority of the country, the AFG Home Loans business and the AFG Securities business. And settlements as well in July were a record for the business as the strong lodgment pipeline for the half has continued to feed through. That one call out there that looks a little bit different to the rest is the growth in lodgments in WA, up 1% year-on-year. And that's really a function of the fact that WA this time last year was already out of lockdowns and benefiting from the stimulus activity and was up 14% on July 2019 and 2020. This leaves us in a strong position to continue the volumes into the start of FY '22, and we're encouraged by this. I'll hand back over to Dave now to conclude.

Thanks, Ben. So in conclusion, this has been a record financial performance for AFG, representing a 35% growth in NPAT and 45% growth in operating cash flow. So the success of AFG's ongoing earnings diversity strategy, which we set upon basically at and around just after listing and cash flow generation ability of the business is pretty clear. The residential market has continued to grow. Early signs is that this will continue in FY '22 despite some of the lockdowns across the country. Brokers are growing their share of the mortgage industry, and we expect brokers to continue to gain share. And as a participant in that, we expect to be successful in also growing our own share of broker. AFG is rolling out the new technology to efficiently service the customers' needs. We remain committed to further technology investment to support brokers and customers. AFG Securities is continuing its loan book growth. We have got a significant current pipeline of business, and there's been improvements in higher-margin products also providing an effective entry into the marketplace. The funding markets importantly remain conducive to growth. So we are positive about the outlook of the mortgage market. We are well capitalized. We have a strong balance sheet and continue to be a capital-light business model. And as you can see through the results, there's been a continuation of the strong cash flow generation capability of the business. So I'd like to thank you for your time, and we would open to questions now.

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

Just around the comment you make on sort of margins. Can you just sort of unpack that a little bit, what you're seeing on pricing competition and the sort of timing of when you next think you read back in the market from warehouse to RMBS?

Sure. So the RMBS market remains -- well, as of today, it remains very conducive to issuers in the marketplace. And we're probably continuing to be at strong low levels for the AAA piece. And so in terms of what we're seeing in the marketplace, the fixed rate product seems to have stepped out a little bit in terms of pricing. And the new battleground is really, in some ways, around the variable piece. So yes, that drives competition. But at the same time, we would be expecting -- based on our growth of the business, we would be expecting -- we always said we'd be back to the market in September, October, November, and that period with the term transaction, and that's -- we're still on target for that.

Your next question comes from Brendan Sproules from Citi.

I just have a couple of questions. Firstly, on the commission payaway, it looks like it's increased around 100 basis points over the year. Obviously, you had the accounting change there. That's probably not as steep as you saw in the first half. Could you maybe talk about the drivers of that looking forward? And then I have a question on the interest margins.

Yes. That's -- I think I've made the comment around half year as well, the difficulty in looking at just the pure commission expense line over the commission income into the mix between residential and AFG Home Loans with a different payaway. So that can impact it. I think the thing I would point to is the Slide 18, where we talked to the impact of trail book accounting. The percentage paid away to residential brokers on average is around 94.3%, which is disclosed on that page there, which is up slightly on last year. So we typically see that grow somewhere between 15 and 30 basis points on an annual basis. And with the competition in the market, we'd expect that to continue for a little while, at least.

Okay. And just a question on the net interest margins in your securities book. Just sort of the outlook going forward, given that the funding costs, particularly, as you mentioned, the securitization market looked quite favorable at the moment. How are you -- it's a big benefit by our funding costs in this year. How do we think about this next year in terms of the benefit of securitization funding and then what you'll pass on ultimately in your pricing? And then my second part of the question is the sort of big shift towards soft managed super and also the near prime, should that expand the NIM over time?

Yes. Look, it's a good question. I think the cost of funds in the warehouse and our RMBS markets at the moment remains quite conducive as we said earlier in the presentation. And as long as BBSW remains inverted, where it is, that will continue to provide some benefit. The counter to that is there's a higher level of competition in the -- particularly in the prime low LVR segment of the market, which is an important segment for RMBS transactions. So what you -- I guess we're benefiting from on the cost of funds side, we're probably losing a little bit on the needed rate customer to continue to grow the book. And that's where the SMSF and other higher-margin products becomes important to increase the mix of those into the book to continue to maintain the NIM at around its current levels. There's certainly some pressure on it from a new rate customer perspective and competition in the market as there always is in the industry. So I think you -- they -- we expect those to probably largely counterbalance each other over the next 3 to 6 months.

I think that -- Brendan, I think that the important call out there is there's been a considered step-out into some of the near-prime piece. We've always had a leased product, but we haven't really concentrated on it as much. And we certainly recognize a higher level of competition in the marketplace for pure prime. And so to step out into some of the near prime and this -- and the launch of the self-managed super fund has been designed to control any NIM contraction. And therefore, basically, offset any impact that we may have in terms of competition for the prime piece.

[Operator Instructions] Your next question comes from Richard Wiles from Morgan Stanley.

I have a couple of questions. Firstly, your positive commentary on the outlook for the mortgage market. Does that make any assumption as to whether [ APRA ] and the RBA would introduce some macroprudential measures? And if they do, can you make any comment on the potential impact on volumes? And any comment on what types of measures might have for most detrimental effect on your outlook for settlements? And then secondly, David, you mentioned in the presentation, I think it's in the slide as well that AFG Securities sits in the top 5 lenders on turnaround. What is the turnaround time? How are you defining it? Why do you think you're so good? And why do you think some of the larger organizations haven't improved their performance given how important this issue is and how it's been an issue for a couple of years now? So 2 questions, macroprudential measures and turnaround times.

Sure. Look, our view of our macroprudential is -- still remains that whilst there's uncertainty in the marketplace in terms of lockdown, that's probably been pushed down the road a little bit. The easiest -- if there was a macroprudential likely to impact the majors and after regulated organizations, it's probably debt-to-income ratio, that seems to be the simple one. And that would probably slow down certain areas and certain lending in places. The impact that, that would have on us, I made the comment in the pack that the nonbank financial institutions are probably a lot more nimble than others. And in terms of something -- a trickle-down effect, nonbanks can generally move credit decisions and actioning for the marketplace into new areas faster than other organizations. In particular, AFG, in terms of the data we have around our brokers and our activity and the types of loans being written, we've always felt that we are more nimble than even the nonbank financial institutions. So what -- in terms of -- I think it's debt to income, if it comes. Does is -- is it -- obviously, they've introduced those things to slow down. So it would slow down. I'm not convinced at this point in time that, that slowdown would slow down AFG Securities significantly in the marketplace. However, we are a microcosm of the broader mortgage market, but I still think there's opportunities for us to grow, if that's to wash through. Now what we're seeing at the moment is we're starting to see the first home buyers come out of the market. I think the latest data was they're sitting around the midteens. We're seeing investors come back. So that -- those numbers invested as of last couple of weeks looking at -- over the last couple of weeks are probably around 27% of that flow. If the regulator wants to make some changes, they might look at investor again and that might slow things down. And the other part of the question, it just escaped me.

Turnaround time.

Oh, turnaround time. Yes. I'm sorry. Our turnaround time is measured by -- we say top 5, that's 6 days. So it's lodged to unconditional. So obviously, lodged to unconditional means that the customer can go turn around on their finance offer -- or sorry, on the sale offer or actually move straight into an auction and have confidence in being able to place a bid. Why has it -- I think -- why has it been such a long-term problem? I think there's a couple of factors. I think, first of all, it's resourcing within financial institutions around credit departments and which ones -- where the credit people are in terms of the business flow so there has probably been some -- and it's been well documented, some preferential treatment of in-house originated loans versus third-party channel. We're seeing that change over the last 6 months in particular. So we are at 6 days and we're starting to see some of the lenders come in towards that number. But it's just us -- around turnaround time, it's consistency of credit decision. Now brokers work on making sure that they don't look stupid in front of a client because they've recommended someone into a client and they can't get a credit decision. If you build confidence with a broker around the customer proposition, you'll get return business on the provider that's in the best interest of the client. And in this market, particularly right now, the client wants to know where they've got finance more than ever. So can -- is there a magic answer as to why? I think different lenders have different turnaround times for different reasons, constant change in your credit policies, resourcing, moving resourcing offshore to onshore. There's been a multitude of factors. And some are still getting -- some are getting it right, right? Some -- and you'll see that in the mortgage index organizations, which are starting to get it right because they're getting more flow.

David, if I could just follow up on that last piece. One of the large banks has just announced that they're bringing in their mortgage processing centers back onshore, adding jobs in Australia. Do you think that will make a difference in the current environment?

I think it will, but there will be a transition, right? I think it's a positive step, not only for the economy, but more so for -- ensure consistency of treatment and consistency of oversight. So I think that will take -- without doubt, it's a massive project, but I think it's a positive.

Your next question comes from Azib Khan from Morgans Financial.

A few questions for me. To keep it easy, I might just ask them one by one. Firstly, can you explain the reasoning for excluding share of profit of associates in setting your dividend payout ratio? I'm particularly intrigued by that given your very strong unrestricted cash position. So I would just like to understand the rationale there.

Yes. It's simply linked to the fact that there's no dividend cash flow coming out of those associates at this point in time. It's a position that -- we'll continue to assess and reassess that.

So when will you receive that cash?

Oh, that's paid in the dividend from the underlying businesses.

Right. So why isn't that coming through already, Ben? Why isn't that coming through in the form of cash already?

They're continuing to invest within their own businesses at this point in time. They've got strong growth. You can see in the intake numbers, in particular, the level of growth that's been within that business. And as a securitization business, there is capital requirements within it. But as you see, from our own investments, you hit a point in time where the cash flow that comes from those loan books is quite strong, and that will come.

So if I take a look at fintech, obviously, the commercial sentiment looks like that they've been going backwards, obviously, given the conditions. You talked about improving commercial lending market in the second half. But where would Thinktank be reinvesting their profits? What areas are they reinvesting in? Are they looking to broaden their product suite? I do know they've been growing their home loan product pretty fast as well. But are they looking to diversify their business? Or what are the areas where they're looking to reinvest their profit?

Yes. So the settlements you're looking at that we exposed in our investor presentation is just the settlements that come through our network. So that's not the overall settlements for the Thinktank business. They're seeing strong growth over the last period in the residential products they sell and SMSF and those types of products. So it's a combination of the existing commercial business, which is continuing to grow and the other products as any securitization business as there's capital requirements at the bottom of warehouse and securitization structures. And they're also investing in technology across the business to lift the standard there. So it's a combination of those 2 things.

Okay. Coming back to your own cash position. You've obviously talked about having an unrestricted cash position now of about $107 million. If I try to exclude working capital requirements from that, I would estimate that you've still got surplus cash, excluding working capital of above $60 million. Now that Connective isn't going ahead, what do you plan on doing with the surplus cash? Will you look at other opportunities to acquire distribution?

I think that's a fair assessment, Azib. Just because Connective isn't on the table, at the moment, it doesn't necessarily mean that we're -- we've stopped considering other opportunities. So we -- other growth opportunities, you've -- just sauntered up there to -- other opportunities looking for distribution.

And probably the other thing worth calling out of there is a portion of that, we don't keep in reserve the AFG Securities business and the potential need to invest more capital in that business at a point in the cycle.

Sure. In terms of your partnership with Volt, is it fair to say that the Volt white label economics come with a better commission arrangement than your existing white label suite?

No, I couldn't comment on something which is commercial in confidence.

So I'm not asking for numbers, but as an indication, I mean, should -- when we're modeling Volt, should we be using your -- the average extra upfront in trail that you get on white label products? Or will it be a little bit better than that?

You should just use what we're using -- what you're currently using, Azib.

Okay. So it's no better than the existing?