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

Thank you, and good morning, everyone. Thanks for joining us today. I might just walk through the presentation relatively quickly. I'm not going to -- it's quite lengthy, so I won't labor on a lot of the slides, but I will like to touch a few key points. So if I move to Page 2 of the presentation, the half results for 2022 really demonstrates a diversified business model coming to the floor and delivering growth and profitability and excellent shareholder returns. We've experienced excellent growth in our branded products, as you've seen in the numbers, which we'll talk about later, and a strong trend of an emerging increase proportion of that manufacturing going into higher-margin products. You would be aware of our acquisition of intelligence, which brings forward our opportunity to drive further margin enhancing capabilities in a new asset class. Pleasingly, mortgage brokers are now 67% of the market in terms of the new originations. And that represents it being the dominant channel. And we believe AFG as a leading aggregator is well placed to continue to capitalize on this trend. The business has always had a strong cash flow generating capability, and this sort of empowers the confidence we have to enhance our historical dividend policy to a record interim dividend of 7% per share, which is an increase of 19% on the same half last year. Another factor or feature of the half has been that both major political parties are now supportive of the existing broker remuneration model. which removes a level of cloud, which is on the horizon around how the model would survive, should there be a change in government at the federal level. We have a $630 million market cap circa and a strong balance sheet, $225 million in net cash and other financial assets. If we take the end of the page, an important statistic, which we're very, very proud of is 1 in 10 home loans in Australia now are arranged by an AFG broker. That has helped fuel residential settlements to be up by 47% to $30.8 billion. And we now have a trail book, which is an important trial book in terms of driving cash flow into the business of $173.8 million. Pleasingly, AFG Home Loan settlements were up 90% to $2.8 billion, and that trail book now sits at $12.8 billion. Broker numbers have increased to 3,050. And if you add the brokers, the nonresidential brokers coming through from the acquisition of Fintelligence, that number is now 3,525. Moving across to Page 5. We talked about residential settlements being up by 47% to $30.8 billion. AFG Home Loans white label products are up 46%. Importantly, commercial and AFG business volumes were also up. You will remember, during the period, we had a -- during the pandemic those volumes are a little softer based on outlook of the small business and commercial sector. These seem to be starting to pick up again once more as confidence in the sector returns. An important part of the overall commercial business is our Thinktank business, our investment in Thinktank but also our Thinktank white-label volumes. Those volumes increased 94% to $127 million. AFG Securities has had a stellar 6 months, notwithstanding high runoff rates industry-wide, growth in AFG Securities has been well above system. We recently executed a third warehouse with a 2-year tenure, and we recently completed the settlement of our second nonconforming term deal for $450 million, which reflects acceptance of, by the market, of our mortgage assets and a new asset class. Key -- AFG Security is clearly a key driver for earnings of AFG in the future. If you look at the AFG Securities book on Page 7, the characteristics of the loan book feeds into the overall loan book performance. So what we have is a conservative book which drives an important level of credit quality. And you tip over the page to Page 8, you'll see the arrears performance, which is -- continues to be excellent. 25 out of the roughly 10,000 home loans are currently in arrears and only 15 loans are in hardship. So on the back of that, we've seen it possible to release some of our provision we've previously raised of about just under $400,000 in terms of provisions for nonrecovery. Page 9, we talk about our technology. Technology is and will always be a cornerstone of AFG's strategy, and we anticipate continued investment in our technology platform. We've made a small investment in BrokerEngine, which provides an advanced automated workflow and pipeline management tool with the ability to design bespoke customer journeys for AFG brokers and the broader Australian market. The important part of BrokerEngine is being used industry-wide and generates revenue in its own right as a fee-for-service or a Software-as-a-Service product. We talked -- released to the market details on Fintelligence when we made that acquisition. It's a proprietary tech platform, which will help build scale in terms of our footprint in the asset finance business and has integrated seamlessly with other business applications and has in-built API capability. We continue to invest in our analytics platform which not only drives insights for brokers to assist building their business, but also helps inform our distribution, manufacturing and lending decisions. And if you follow that back to the comment I previously made purely around the performance of the AFG Securities book, you can see that, that is starting and continues to provide dividends in terms of that business. Our strategic alliance with Volt will provide access to a digital banking platform and an AFG personal -- branded personal finance manager app, which helps provide our brokers in the future with a refencing capability for their customers from other financial services providers looking to access those customers. Financials, I'll pass across to Ben Jen.

Thank you, David, and good morning, everyone. We are pleased with the results for the half, with profit up 20% and is enabling a dividend of $0.07 per share. Reported NPAT is $4.1 million higher than underlying NPAT, a higher runoff activity is offset by higher settlement activity and growth in our travel. Strong growth in the AFG Securities to 36% to over $4 billion is particularly pleasing. The growth has offset the competitive pressure on NIM with net interest up 17% on the same period last year. Moving to Slide 12. Our diversification strategy has delivered earnings growth and reduced our book reliance on residential aggregation margin. Residential aggregation gross profit has reduced from overall in 2015 to 29% as we continue to build out our aggregation network in other asset classes and add lending products in those asset classes will continue to add further margin. Moving to Slide 13. Our business remains capital-light and generates strong cash flows. This is highlighted by our total travel on net assets increasing to $104 million. Net cash of $32 million and our investments in other businesses and subordinated notes of $90 million for a total of $225 million. Operating cash flow is down on underlying NPAT due to commission timing difference. This can be seen in the chart on the top right, with cash flow significantly higher than underlying NPAT in the second half of FY '21. That remains robust over the periods. As noted on the previous slide, operating cash flows are down due to the timing difference of the large commission receipt and payment [ either ] side of 30 June. When we normalize for this, our cash flows remain very strong with annuity-style cash flows from our trail book and growing purities loan book placing as well to continue to drive growth into the future. Moving to the summary balance sheet. Our balance sheet is healthy and in a net cash position. The investment involved is recognized during the half at fair value on the balance sheet as 1 of the major changes. And in addition to that, Fintelligence was also consolidated into our balance sheet at 31 December. Given the 31 December effective day, profits will be recognized from 1 January in our P&L. There are further details on our Fintelligence acquisition accounting in the appendix to the pack. Moving to Slide 16. And as noted earlier, the gap between underlying reported profit has increased due to the higher runoff high-growth in settlements. This is typically in periods of strong settlement growth. And over time, the gap between the 2 will close. On average, approximately 2 to 3 months of trail commission is collected in half for new settlements with 4.9 years of income is recognized. The average loan life for new loans has reduced from 5 to 4.9 years due to the filing. Moving to Slide 17, Other income. Pleasingly, service fees have continued to increase by 12% compared to the first half of FY '21. This is due to broker numbers rising and also the increased take-up of additional aggregation services such as compliance, professional indemnity insurance and services. Thank you, everyone. I will now hand back to David to continue the presentation.

Thanks, Ben. I thought it is important to talk a little bit about business strategy and update you and highlight some of the key things that are moving within the business. And on Slide 19, you'll see a chart which talks about AFG today and where we want to take the business. So if you like, we are aggregating the peach-colored cylinder. We are aggregating across a number of asset classes now. We participate in additional margin opportunities with white label, so with white label and manufacturing in both home loan and commercial. And from an AFG Home Loans perspective, we had $12.7 billion under our own label. Of that, $4 billion of it comes through AFG Securities, which is manufactured through our RMBS program. The ambition over time is to plug in more manufacturing type assets and more manufacturing capability through other asset classes. It's not manufacturing, it's white label opportunities. So as you have seen, with commercial, we take a white label opportunity with Thinktank, but we're also taking equity slice of Thinktank's business, which enables us to participate also in the equity side of the upside of that business. as it continues to grow successfully. A reminder, the Thinktank this year has contributed $2.6 million to our earnings profile for the half, which is up from about $1.9 million the same time last half. So that's been very, very successful. Moving forward, we've got asset and finance -- asset finance, which represents, if you combine intelligence around about $1.7 billion per annum. The ambition from here is to look to manufacture and distribute white label or manufacture into that asset class to generate additional margin generating capability within the business. So as you can see, the model is quite simple in terms of it's identifying areas of distribution establishing a strong footprint within that distribution and then harnessing that distribution to identify opportunities to either white label or manufacture. And so far, that has been very successful. And if you turn the page sorry, I'll talk about that on Page 21, as that's been very, very successful. If you just jump to Page 21, I might be just as easy while I'm here. You can see in FY '15 in terms of the time line, in FY '15 is at the time of listing, we had an NPAT of around about $15 million and an AFG Securities loan book of $1 billion, residential settlements of $31 billion. Jump forward to FY to the second -- for this half of FY '22, we have a profit number, which is double that over the full year for the business. Our AFG Securities book has reached $4 billion our residential settlements, interestingly, are almost aligned spot on with the full year number for FY '15. And we've been able to then generate an opportunity for the business to harness that distribution to drive further margin-generating capability through other asset classes and through the margin-generating activities of white label and, of course, manufacturing directly. So the key strategy is to diversify earnings by building distribution and margin-enhancing activities and it's working and it's delivering results. Our investment in our own technology and recent fintech acquisitions positions us to maximize growth opportunities and continue to improve the broker and customer experience across multiple asset classes. And as I've mentioned, asset finance and commercial distribution are underserved markets and is the next cab off the rank for us to continue to grow our business and improve our diversification capability across the Australian finance market. I will jump to Page 22 now and talk about our investments. We've talked briefly about Thinktank. We're very, very pleased with how Thinktank has taken a significant part of the Australian commercial market. We have obviously own around about 32% to 33% of that business. We obviously participate in white label activities there. Mortgage Advice Bureau is a small subaggregation business for 1 of a better term, which enables us to gain exposure to a different type of aggregation model across the Australian market, a model which is based on a very, very successful U.K. market model. We've talked about Volt in terms of what is providing us is not only a white label capability as we begin to roll those out. They are in pilot mode at the moment. We're looking to step that out over the next month or so to a broader population of brokers. We also developed in conjunction with that and access to a personal finance manager. So there is a strategic alliance there, which we expect to pay dividends for us in the years to come. We've talked about Fintelligence being -- our 70%, 75% interest in Fintelligence. And BrokerEngine, which is a small but important part of our business moving forward, in that it provides advanced workflow management software, so that all brokers across the industry are capable of using that technology, if not an AFG centric technology, moving forward. I might just pass across to -- sorry, I might jump straight across to our outlook, which is on Page 24. What we're seeing at the moment is the residential market remains strong. The performance of AFG, which I think is important as you look through that time line, through the mortgage -- residential mortgage cycle has been proven. There's been peace, there's been troughs, but the business has continued to maintain momentum and grow its business. Competition does remain high, but we believe AFG's offering remains compelling, through our balance sheet, industry-leading compliance, advocacy and analytics capability and broader technology considerations position us, I believe, ahead of our competitors. Broking and aggregation in other asset classes will provide additional opportunities for growth. The trail, which is something Ben mentioned before, does provide a natural hedge during lower levels of activity. Loan lines do extend and more cash is collected from that business. We are positive about the outlook in the mortgage market. And if you combine that with the increasing number of customers electing to choose mortgage brokers at the source of financial means of accessing the mortgage market, we remain positive about how that will flow through to AFG. Our ongoing investment capability to continue to invest in technology associated with the mortgage industry does place us in a strong position to take advantage of opportunities in a fast -- increasingly fast-moving sector. If I look at the next page on manufacturing and lending, the funding markets remain open, and attractive. We expect they will continue to function normally. Recent term transactions translates into greater warehouse capacity and our products continue to gain traction. Lenders have historically responded in rising interest rate environment and adjusted rates to customers to restore some level of NIM or maintain levels of NIM at the very least. And 1 thing that I think, which a lot of people don't necessarily fully appreciate, but you can start seeing that coming through in terms of our performance of our book, but also in the quality of the book, but also in the means of us being able to punch about our weight in terms of that footprint. Our home ground advantage and I call it the home ground advantage, it's data-driven and it targets product development and marketing and key differentiator, sorry, in terms of distribution and book performance. If I jump ahead to Page 26 for slide update, a quick update on terms of trading in FY January 2022. January is traditionally a very, very slow market for the industry. Historically, it's when brokers take their holiday, spend time with family during the school holidays. But we did see those numbers slightly above and it's understandable that, that slowed down over such a hectic year. But the numbers were slightly above those experienced in FY '21 for January. Our home loan numbers were up 33% compared to the same period and AFG Securities logs was 72% higher than January. And importantly, settlements are 122% higher. And we're starting to see some levels of growth in the WA and Queensland markets being maintained. And to line up with our residential activity in January, New South Wales and Victoria were slightly off at the same time last year. Turning to Page 27, I'm just highlighting the investment highlights. And that just does go back to the time line that we've talked about in terms of how the business has grown. I just wanted to highlight the TSR over a 3- and 5-year period in terms of returning and creating value for our shareholders. The number of 135% to 185% over a 5-year period is very, very positive. The key driver is, obviously, if you look at that, has really been the AFG Securities book and also the capital light and robust balance sheet that we possess. All this adds up to a dividend yield of around about 6% at the half year and it's been at least 5% over the last 4 years. So in conclusion, I'd just like to highlight the settlement growth across the business as well as the success of AFG's earnings diversity and strategy that amounts for underpin the strong cash flow generation of the business. The residential market -- mortgage market has started FY '22 strongly and the daily run rates are still remaining strong. The broker market share is obviously at record levels. Fintelligence will bring forward our ambitions to fund an additional asset class in asset finance. Our business model generates strong cash flows. And as I said again, it's a capital-light balance sheet and enhances our capability to maintain an excellent dividend policy. Our AFG securities volumes continue to increase. We've got a loan book of over $4 billion, which is a decent footprint in a growing, in a competitive marketplace. The successful shift in volume towards higher-margin products will provide some NIM protection for us moving forward. And we remain well funded to continue to grow and support our strategy. So in summary, we do remain positive about the outlook of the mortgage market and the opportunity to grow in other asset classes. Our investments are aligned to accelerate this growth. With that note, I will pause and open up for questions.

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

Can you just comment a little bit on the aggregation margin and how you're seeing that sort of trending with the sort of level of runoff and the level of activity on new front book and the various mix differences you've got?

Yes. So I think the residential business has probably been as busy as what has been busy it's ever been. And I think we see the period of continuation of that, at least for the short term. activity on the ground is still strong. In terms of margin in relation to payout ratio, there is still competitive pressure there. We don't expect that to, I guess, flatten out just yet. There will continue to be a little bit of pressure there as the competitive environment for brokers continued. Yes.

And just on the NIM -- benefits on the funding side, partially offsetting were mostly offsetting the pricing, and obviously, you had some mix differences in this world. But can you just talk about the sort of outlook for your sort of funding trends and also what you're seeing on the sort of pricing side and where your sorting NIMs can get to in the next half?

Yes. So I think it remains competitive for lending as everyone would probably be pointing out in the results announcement. I think the change in mix is a greater portion of higher-margin products will help offset that to a degree. I don't think it will offset it completely. And we have had some benefit over the last few months in terms of cost of funds. I'd probably expect that now to, I guess, begin to head in the other direction. We're probably at the low point in terms of cost of funds in the market right now, and expect that to step out a little bit over time. I think there will be some pressure on NIM in the short term until there is a point where lenders look to move their rate customer to adjust for higher cost of funds to put NIM back into the business in the medium term. So I guess I can't get your forecast on NIM specifically. But it's fair to say that where we are at the moment is as high as we've ever been really or pretty close to it. Will NIM go all the way back to, I guess, the sort of 130, 140 basis points than it was a few years ago? We'd like to hope not, but I think we can maintain it at a level higher than that.

I think that's the important time of the diversification in terms of the product. Historically, the securities business has been driven purely on a prime and it's a hunting -- it's a very competitive marketplace. So the diversification of product and leveraging the data and the information we have to identify opportunities, which generate a higher margin is an important part of our strategy moving forward. in terms of debt markets, obviously, with what's going on in the Ukraine. You've seen some spreads widen in terms of more recent NIM deal. Investors less than always looking for an opportunity to take a few extra points and these circumstances, it's probably a little understandable. So we're very happy to be 1 of the first in the marketplace for our $450 million deal, which enabled us to lock in some pricing because since that time, we've seen spreads widen.

Just with the comment that you sort of hope to hold rises above that sort of medium-term average, sort of $130 million, $140 million. With that new mix, you've obviously got sort of things that might be 40 basis points above prime in terms of margin, but then asset finance can be as high as 300 or 400. So I'm just trying to get a feel for how much of that benefit versus history, I think, comes from mix and particularly sort of appetite for how much of that asset finance you're willing to write and what sort of extra NIM you can get?

Yes. Look, I think to be clear, we wouldn't be getting -- we can't start a asset finance securitization business in the period of 6 months. So we wouldn't expect in the short term that, that asset finance NIM would wash through in this half. It's probably a 6- to 12-month exercise. But in terms of that 40 basis points on the non-prime or, 1 of the better term, non-prime business that you've seen through the chart that, that percentage is continuing to grow, and it's -- ultimately, we'd like to get that to around about 40% of flows I think.

Yes. Okay. And last question for me. Just on -- there's obviously quite a bit of moving parts between the sort of new business runoff, but you've also shortened the assumed loan life. So just trying to unpack that sort of gap between reported and underlying and maybe you could call out particularly the short loan life impact on that gap? And any other commentary on that new business and runoff would be helpful.

Yes. I think it's fairly typical in a period of growth, Tim. And it's just a reflection really of the size of the business now with $31 billion worth of settlements in half compared to going back in time, say, FY '17, '18, '19, where we're doing sort of 34%, 35% in the whole year. And if you look at those periods there, underlying as a percentage of reported profit is around about 85%, 86%, which what it is now. So it really is just a function of the fact that you're putting a lot of new business onto the balance sheet that you've only collected a couple of months of cash from, yet you're recognizing 5 years' worth of in 1 quarter. Loan loss shortened slightly in this period as we see a peak in runoff as the market normalizes, you'd expect that to extend a little bit over time. But yes, what you're seeing in the difference between underlying and reported runoff is fairly typical for a period of growth like this.

Are you able to quantify the impact of the short line life assumption?

That's not something that we've disclosed, Tim, sorry.

Your next question comes from Brendan Sproules from Citi.

Firstly, I first question I have is just on the outlook for settlements. Obviously, $30.8 billion for the half is quite a high number. Just looking at the last 12 months, you've seen quite a change from where we were 12 months ago with obviously the last 2 months, I imagine being very strong. Do you think this is a high watermark for your residential settlements as we look forward?

Look, I think it's certainly been a purple patch. Brendan. The flip side of that is we're comfortable in terms of our level of recruitment in our pipeline, and we factored in also the level of broker share. There are some counterbalancing elements of that. But the market, as everyone known, has been red hot for a long period of time. If I look at the lodgement pipeline, obviously, there's a dip in January, simply because of people taking Christmas leave and so forth. But the daily run rate, which feeds the lease the number of settlements or the volume of settlements into the full year, we think we're almost cooked in terms of the full year settlement number. We've probably only got 1 month left to go before we could probably draw a line as to where those numbers are. And to be honest, what we're seeing at the moment is still strong.

And my second question just relates to -- in the next couple of years, if we do get a slowdown in the housing market, particularly if interest rates rise, which is what the market is expecting. How is your business different now in terms -- and I look at this on Slide 21, the '17 to '19 period, when the housing market did slow, you did have relatively flat profit there. Is that the type of profile that we would expect in an event of a slowing market? Or is there other things that you think will help you grow your profit in that period?

That's a good question. I think the other observation in that period is that we've had a very immature securitization business. And so, it was more reliant on the aggregation and residential broker settlement volumes, which are washing through the business. I think that's a differentiator for us where we are now. I also think the additional acquisitions or investments we've made in someone like Fintelligence enables us to access a different part of the market, which is outside of the home loan cycle. So I think the other thing which people seem to not necessarily appreciate is that if you go to broker, if you trickle down to the 3,000-odd brokers that we have in the marketplace, if the new builds aren't there or the new homeowners aren't there, the investors come in. If there's opportunity to refinance there's opportunities to refinance. The brokers will find work and keep the wheels turning along. And then as you point to increasing number, we've had a watershed moment with the banks shutting branches during the pandemic and people moving towards broker. I think we're now at 67% of the market, which is kind of an exponential jump from where it's been historically. And I think those customers would have been treated well and enjoyed the experience. And I think they're customers for life now, Brendan. So if you factor all of those things in, we do think -- if you look at the residential settlement volumes, unless there's a drastic reduction in home loan prices. There is some level of natural, I'll call it, a CPI accretion in terms of settlement anyway, in terms credit growth and size of loan. So to say we're going to go back to '17 and '18 type flatlining. I'm not too sure because there's a number of moving parts. But you counter that by saying we have been very much in a market, which has been fueled by low interest rates.

[Operator Instructions]. Your next question comes from Azib Khan from Morgans Financial.

Thanks, David and Ben. My first question is, it looks like the runoff rate of the AFG's back book has increased quite notably in the half. Have you experienced a greater than usual amount of customer attrition in the back book in the half?

Yes. I think everyone has a bit. I think the level of competition in the market has driven run off up for every single lender in the market. And that's why you see the loan life of the trail will come down a little bit as well. So for us to be immune to that, I think we certainly couldn't say that. I think it's -- it was probably stronger earlier in the half than later. It's starting to normalize a little bit now.

And has much of that attrition being the result of refis from variable to fixed?

Yes. Some of it has been, but there's also a lot of competitive, I guess, variable rates in the market. Now there's probably more competition around variable to fixed run, and the fixed rates have moved out a bit. But we're a year into that fixed-rate period where there was a lot of 2 and 3-year rates locked in, and I think that's going to present an opportunity for AFG Securities over the next year those rates roll off and customers get the road shock of moving from a, say, 1.99 to a standard variable rate that could be well into the 3.

And so then, you said you noticed a slowdown in the attrition rate towards the latter end of the half. Does that mean that the downward pressure on NIM from retention pricing is abating a bit now?

No, I wouldn't say it's completely gone. I think there's some aggressive pricing out there that feels like lenders are, I guess, hedging their bets that there will be a rate move or something like that in the future to they'll be able to adjust back book pricing. So there is still a lot of competition out there that will present some downward pressure on NIM. But look, we've touched on during the presentation, the change in mix for us is quite important. and it's been quite successful over the last 6 months, and we can't see any reason why that can't continue into the future.

Sure. On the funding side of your NIM, has there been any recent reduction in the cost of your warehouse facilities?

So we brought a new warehouse on towards the end of the half, and we rolled our largest warehouse in December, and those were both rolled at rates that were typically in at point in time, which while cost of funds are probably getting at a little bit now. At that point in time, they were a robust position, I guess.

With where RMBS spreads are sitting at the moment, do you expect a continued reduction in your average cost of funding?

No. I think we'll find RMBS might trickle out a little bit in terms of cost of funds. So I think they're probably more in line with warehouse costs now, is where I'd expect them to be. So the market is still good and still strong, but will you get a cost of fund benefit of terming out in the short term? I'm not sure.

Sure. And just 1 final question on the aggregation side. Average upfront and trail broker payout ratio still trending up? Or are they starting to plateau now?

Yes, they're still trending up slightly. I think there's a little way to play out to. They're probably not trending up as significant as they were 3 or 4 years ago, but it would be remint say that they're not still moving north slightly.

Can you tell us what those levels are now, Ben, the average upfront in the average trail payout?

Yes, there's a slide. Where are we? Slide 12. Well, we've actually disclosed the residential upfront payout ratio, on that page there. So you can see that we're just under 94.5% at the moment. Now that's all new business. Obviously, Trail is set and forget, to the payout ratio. So that's a little bit under that, but a new trail business, which is what drives the recognition in the P&L anyway, give that rate.

It's also just under 94.5%.

That's right.

There are no further questions at this time. I'd now like to hand back to Mr. Bailey for closing remarks.

Thanks very much, and thanks, everyone, for being part of conference. I do look forward to actually meeting a lot of you in person hopefully in the next couple of weeks when we're out of our gilded cage here. So but feel free to touch base with Ben and myself in the intermission should there be any questions. But thanks very much, and look forward to seeing you soon.