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

Thank you for standing by, and welcome to the investor briefing for Australian Finance Group 2025 Half Year Results Announcement. [Operator Instructions] I would now like to hand the conference over to Mr. David Bailey, Chief Executive Officer. Please go ahead.

Good morning, everyone, and with me is our CFO, Luca Pietropiccolo. AFG is pleased to present our half year results. The half has seen significant progress around our strategic initiatives. Our distribution business has continued to strengthen, underpinned by our recent investment in broker technology and record recruitment numbers. Our manufacturing business experienced record settlements and lower runoff activity and with now a record loan book size and steadily improving funding costs, we expect the efforts undertaken in the first half to provide a platform for stronger financial performance in the second half as well as into FY '26. Combined with progress on our equity investment in broker businesses as well as an improved outlook on our investment in Thinktank, we have a level of confidence as we turn into the second half of the year and into FY '26. I'll just turn -- I do a bit of a page turn here, and I'll go to page -- the introductory page on the deck. So AFG operates predominantly in a market -- a finance market where there's been $863 billion worth of settlements, of which 75% of those are driven via the mortgage broking channel. AFG has 4,100 mortgage brokers, which represents in terms of their monthly production, 1 in 10 mortgages written in the country continue to be written by an AFG broker. Over 550,000 Australians are supported each year by AFG brokers. In terms of our distribution business, which contributed 82% of our gross margin, it's underpinned again by a residential mortgage book of $205 billion, which grew 4% for the period. Our diversified products grew and we saw growth in our AFG Home Loans book despite some patchiness within some of the appetites of some of our providers to see a $13 billion book. Broker services, the number of broker services per broker grew by 8% to 3.8 per broker and asset finance experienced settlements of 12% growth of $1.8 billion. As mentioned earlier, we're very, very pleased with how the AFG Securities book has continued to build. We've seen growth in the half of over 23%. And our Thinktank business, our investment in Thinktank or the commercial business, which is Thinktank has had experienced a 10% loan book growth to achieve $6 billion for the half. Moving to Page 5 of the deck, the highlights for us. AFG's dividend yield, which is a fully franked dividend yield of 5%, an underlying return on equity of 16% and our investment in cash and liquid assets sits at $185 million. We've experienced record number of brokers and volumes. So settlements and lodgements in both our residential business and our securities business reflect strong growth and the roll into 2025 has also been strong. Brokers and AFG are well placed to gain market share in a growing market. 8% of the growth has been experienced in our distribution business, which is our lightest capital segment with a return on equity of about 39%. We've also undertaken 2 equity investments in broker groups, which is a new proposition to support growth for the broker and also deliver new earnings to the business. We also increased ownership in Fintelligence to 100%, allowing for new growth options within that business. Our recent strategic investments just mentioned deliver around about $5 million to $7 million annualized EBITDA from start of FY -- the start of the second half of financial year '25. Manufacturing remains well positioned for growth with that record loan book size and improving NIM and no additional losses have been experienced over the period. We have a strong balance sheet to assist in the growth of the business. Turning to Page 6. We're delivering on our strategic pillars. We have experienced 7% growth in our broker network, 13% residential settlement growth. Our technology investments, which we undertook over the last 18 months is delivering value to our brokers, and we're seeing a 35% -- roughly 35% productivity improvement from the brokers on the back of that technology, which gains an NPS of greater than 50. 46% of our AFG brokers are now subscribing to BrokerEngine Plus, which is up from 34% in the first half of FY '24. We're also delivering higher margin through our distribution network. Our securities loan book grew by $1 billion to $5.1 billion, which is up 23%. AFG Securities settlement growth in the same period was up -- was $1.4 billion, which is up from $0.6 billion in the first half of FY '24. So what we're seeing within the securities business is we're not only seeing good settlement growth, we're seeing book growth as well on the back of a slower runoff rate, which we're seeing signs of as funding costs have improved, we've been able to retain additional customers with better rates. Turning on Page 7, our financial highlights. We've talked a little bit about that. Our annuity style earnings is 72% of our earnings, which is up 7%. Our NPAT of $15.3 million is up 6%. Unrestricted cash sits at $55 million. And as mentioned previously, investments and liquid assets of $185 million. Our profit before tax of $22.3 million is driven predominantly by our distribution business, which continues to grow and continues to strength, and we're now seeing a growing contribution, and we expect to see a growing contribution from our manufacturing business over the second half and into FY '26. Jump to Page 9 of the slide. We continue to see brokers as being the preferred channel sitting at 75%, which is up 3% from 72%. We see that number heading towards 80% across the market. We're also seeing some of the things that we predicted or assumed over the medium term, and that's the consolidation towards larger groups, 20% in FY -- in March 23% -- sorry, in March 2023 is now 27% in terms of larger groups across the industry. And we will remind you we do generally over-index on the larger groups across the network. Our broker numbers are now sitting at 4,100, which is a growth of 7% over the same time last year. We've also recruited several large organizations over the period, which over time will contribute an additional $2 billion worth of settlements per annum across the network. On to Page 10. Residential mortgage activity continues to be at a record level. Settlements for AFG brokers was up 13% to $32 billion. We're seeing 20 years of consistent book growth within our broader trail book. That now sits at $205 billion. Growth in broker numbers and improving technology is supporting that broker -- let me start that again. Growth in broker numbers and improving broker efficiency supported by some of our investments in broker technology has improved that settlement volume across the network. Our closing trail book, a reminder, that provides stable and predictable annuity style earnings for future years. The broader across the industry trail book runoff rate has softened. It's still above longer-term averages. But we are seeing softness in that number, which all goes well for future value and annuity style earnings on that. Whilst our broker payout ratio has crept up a little bit, it does reflect our investment or our indexing towards the larger groups who drive more efficiency through our business because they are delivering more volume on a per broker perspective. The business model is delivering higher earnings. There's a slide -- the chart on Page 11, which talks about the underlying gross profit contribution per broker. You can see there's been growth between the first half of '24 to the second half of '25 with broker services CAGR of 13%. We would expect that number in terms of the contribution of gross profit as the securities book and the securities business takes hold to improve on an ongoing basis. On Slide 12, we're seeing growing demand for diversified products from our brokers. So AFG white label, despite some of the softness and appetite of some white label providers has been able to grow settlements to $950 million for the half, which is up 8% on the last half. It's supported by now 6 white label lenders. We've introduced 2 new lenders since 2022. The $8 billion white label loan book is delivering again, annuity-style earnings, which is higher than our normal trail book earnings that we generate through the traditional broker -- broader broker business. Broker utilization is important for us. And what we're seeing is brokers beginning to -- building on the number of products that are writing more than one product. So you see a chart there, which has seen since December '20 through to December '24 a slowly increasing number of brokers who are writing more than one product across the network. This really lends into a broker looking to diversify their income and AFG providing those services to them and those opportunities for them to drive additional products and obviously on the back of that additional income. So brokers, we're seeing an evolution of brokers expanding their traditional role to provide other levels of finance and other levels of financial support to their customers. And we see that particularly relevant in the larger broking groups across the network. Our value-add services, which are what AFG also provides to our brokers are growing. 46% of our AFG users are currently using BrokerEngine Plus, which is up from 34% same time last year. That generates higher revenue per user for brokers. You can see the number of BrokerEngine subscribers have grown to 3,300 brokers. We've introduced new compliance technology to assist our brokers, and we're going to introduce some new marketing services over the next 6 to 12 months to continue to build on the platform that we've already built in terms of additional services and subscription income for those brokers by adding value to our broader proposition. On Page 14, I want to spend a little bit of time talking about AFG Securities and the record settlement growth. Lodgements in Q2 and early calendar year '25 creates a strong second half settlement pipeline. Scale efficiencies have delivered around $2 million worth of savings through investment in process and our loan origination program. So we're being able to do more with the same number of -- broadly the same number of staff. So the leverage that we're able to obtain through those investments in technology and efficiencies are starting to wash through. The net interest margin is improving 113 bps, and we expect that -- whilst we expect that to continue to be below the long-term average of 133 bps, it's supported by cost of funds improvements, 3 warehouses were renewed during the period at a lower cost. And of course, we recently completed a 2025 first term transaction, which is a nonconforming deal last week, which will deliver additional cost savings across 20% of our -- sorry, of our existing warehouse funding. Our investment in Thinktank, which as a reminder, we own 32%. They're able to grow their loan book over the period. A reminder, at the time of investment, their loan book sat at $0.8 billion, so just under $1 billion. Our contribution from Thinktank was $400,000, which is below -- obviously well below the 2024 first half. It's been obviously impacted by the same things which have been impacted for -- from the AFG Securities business. But as funding costs have improved, they've been able to grow the book, and we'd expect the Thinktank business to contribute a significantly stronger amount in the second half of FY '25 and also into FY '26. Credit quality is important. We've continued to maintain a strong credit quality book. So a reminder that 76% of our mortgages are prime mortgages. Whilst that drives a lower NIM in terms of the mix, the added benefit of that is obviously in terms of the credit quality that we are able to generate. The loan balance, 38% are below $500,000 and 89% of those loans have an LVR of 80%. Importantly, those loans that are above 80% are all mortgage insured on an individual loan-by-loan basis. So the arrears performance is outstanding, 0.8% of the book. Cumulative loss, as a reminder, is just under $270,000. On the back of an increased size of the book, the math tells us we need to improve -- increase our loan provisioning, but we are not seeing anything within our loan book at this stage, which is causing concern. I might pause there and pass across to Luca to talk about the financials.

Yes. Thanks, Dave. So I will just start on Slide 17, the financial results highlights slide. The momentum that we had as we left FY '24 has carried on and underpins this half's numbers, and we are continuing to see that momentum through January and February. That said, in our manufacturing business, that momentum will take some time to translate to higher earnings as the average book increases and NIM starts to lift. As mentioned by Dave earlier, we are seeing very positive trends across the business, and that is translating to growth in our gross margin in both distribution and manufacturing. NPAT for the half increased 6% to $15.3 million. You can see on this slide, our OpEx increased 7% or $3.3 million, driven by higher amortization, which represented 1/3 as we've previously highlighted, as our new BrokerEngine Plus program and other major technology programs were completed and started amortizing in October. Higher ECL provision, as Dave just mentioned, of $200,000 and then the residual relates to the introduction of new roles, which are primarily associated with top line growth initiatives, whether that be the broker investments program, new sales positions or contractor roles that we've converted to permanent employees, which obviously has a benefit -- a cash benefit to the business. The cost-to-income ratio continues higher than what we would like it to be, and we have been focused on ensuring the delivery of our new technology platform. And with that now in place, we have shifted our focus back into the business to focus on productivity. A few other things I'll highlight on this slide. As I mentioned at the full year, we are seeing that historically high levels of runoff continue to reset as we return to a more baseline level of policy intervention post the big banks term funding facility removal. Runoff has been showing a sustained reduction over the past 18 months and the past 6 months is the lowest we've had since 2019. Finally, on this slide, we have declared a fully franked dividend of $0.038 per share, which represents a 60% payout ratio. The ex dividend date is 6 March, and the dividend will be payable on 9 April. Turning to Slide 18. This slide summarizes the performance of our reporting segments. If I focus first on distribution, which is AFG's core business, it provides very strong returns at 39%, and that is despite capital being recently deployed, which is yet to start making a return, mainly in technology and our broker investments program. The result is underpinned by annuity style income generated from the $205 billion trail book. This segment delivers consistently strong returns with no credit exposure and this year represented 82% of our gross profit. Distribution earnings were $92 million -- $29 million, up 8% on last year. And as Dave mentioned, during FY '24, we invested to improve our technology proposition. On manufacturing, which is our securitization program and where we take the credit risk, the earnings of that segment have stabilized at $8 million and adjusting for the lower contribution of our Thinktank investment returned to growth up 8%. The NIM has trended up and for the half averaged 113 basis points with our exit NIM of 114 basis points, but still below the same time last year by 2 basis points. Clearly, the higher book balance will be a benefit to our earnings as NIMs improve. I know Dave just touched on it, but I do want to emphasize the quality of the book with another outstanding period and that has continued post the half year. As a point of reference, in AFG's history, we've recorded just over $260,000 in losses with over $12 billion of loans written, and we carry a provision of $3.5 million currently. Final thing I'll highlight in relation to the manufacturing segment is the cost-to-income ratio at 35%. OpEx has been broadly flat. And as Dave mentioned, the efficiency dividend that we're getting out of those increased volumes represents just over $2 million in savings. Turning to central services. It recorded a loss of $15 million, which was 18% higher than the prior half, driven largely by higher FTEs, as I mentioned before. On Slide 19, this slide shows the gross profit we generate from our business segments. I think this slide summarizes the business well in terms of numbers. It shows that our higher returning distribution business generates 82% of our gross profit. Within our distribution business, we have a diversity of higher returning growth options. And finally, that our manufacturing segment provides exposure to the returns that credit markets provide when the conditions are right. The table shows overall gross profit up 4% with growth in both distribution and manufacturing. Our distribution business represented $57 million of the gross profit for the half split across 3 key drivers. Firstly, our residential trail and upfront commissions, which combined stayed flat as the payout ratio continued to lift and that was offset by our settlement growth. The second is the higher margin income we generate from our broker network in white label and other asset classes. This was up 9%. Our white label had a solid half after last year's step-down when our partners focused on volumes from their proprietary channels. Although ADI partners are focused elsewhere, we added new partners in early 2024 with products that our brokers, customers are demanding. And as a result, we saw an 8% lift in our white label settlements. The third split is obviously our investments in technology, and we see the growth come through in the subscription income line, which is up 12%, and Dave spoke to our future expectations there. On payout ratio, I'll just spend a couple of minutes because I'm sure there will be some questions. The payout ratio is driven by the mix of our settlements with there being a wider range of payout ratios primarily driven by the size of the broker group. As you know, we over-index in larger groups, and that is because of the full service offering we provide. In turn, it does mean that our white label and securitization products are more competitive. We see a notable benefit to our integrated margin. These larger groups are also more likely to benefit from the efficiency that comes from utilizing our technology services and in turn increased subscription fee income. I guess in summary, the strategy is about leveraging the number of brokers we have and moving through the verticals. The manufacturing, you can see at the bottom of the slide that the gross profit returned to growth, up 9%, driven by the higher book size. We would expect to continue to see growth in both book and NIM in the second half where competition remains rational. I did want to remind people that we have 4 warehouses, and we saw a reduction in 3 of our warehouses during the half. This reduced our weighted average cost of funds and again, will contribute to second half earnings. We do balance retaining the savings that we make from cost of funds versus ensuring our product remains competitive in market to grow the book in anticipation of even further margin expansion in future periods. Turning to Slide 20. And as Dave outlined earlier, we have been very focused on delivering the strategy, which we presented in December '23 and outstanding progress has been made. AFG has a long history of taking a disciplined approach to deploying capital and frequently assessing the returns we make from the capital we have deployed. I've previously outlined the prudent methodology we take to ensure we deliver the returns that exceed not only our internal expectations, but deliver sustainable long-term shareholder returns. Given the heightened period of capital investment we've been through, this slide demonstrates the expected uplift in earnings we expect from that investment as we move into the second half. In summary, on an annualized basis, we expect our EBITDA to lift between $5 million to $7 million commencing in the second half of FY '25. I'm sure we'll get a few questions on the bottom row. The uplift there is simply the higher book at $5.1 billion, partly offset by lower NIM of 3 basis points. Finally, if we move to our balance sheet and cash flow, as you know, AFG has very strong cash-generating assets, and we have $187 million in cash and other liquid assets. Our balance sheet strengthened combined with our high returning distribution business puts us in an excellent position to find opportunities to invest both for our brokers to improve their businesses and also for our shareholders to grow returns. The chart in the middle shows that we traditionally have a very high conversion rate -- cash conversion ratio. But for the half, we finished at 80%. The lower-than-usual cash conversion was affected by 2 key things: one, the timing of commissions paid; and two, an additional payment run that occurred in the first -- in the second half of FY -- sorry, the first half of FY '25 compared to the half year -- second half of FY '24. I expect our full year cash conversion will be closer to our traditional range of 90% to 100%. During the half, we commenced our program to directly invest into broking businesses. It will take some time for that pipeline to build here, and we'd expect to see steadily investing between 4 to 8 groups per annum. I would expect peaks and troughs to the number of groups we invest in. This will flow through from maintaining a discipline in the application of our investment metrics and only partnering with those where we think there is a strong alignment on business thinking. At this stage, these investments will only be minority interest with our rights protected through reserve matters and positions on the respective forwards. With that, I'll leave it there. Thanks, everyone, and I'll hand back to Dave.

Thanks, Luca. Just a couple of moments to talk about the outlook. On Slide 23, a lot of those slides will be -- a lot of that data is probably well known to most analysts on the call. But I think one of the important points is that the broker share sits at 75%. And that's been underpinned really by the number of branch reductions, which have occurred. So whilst there's been a temporary halting in the number of branch -- reduction of branch numbers, the trend which you've seen over the number of years has helped fuel the growth in market share for broker, and we expect that number from 75% to continue to grow up towards the 80% and beyond. Mortgage volumes are increasing with the benefit of the recent cash rate cycle change. We're seeing improvement in credit growth, both in the housing and commercial sectors. And the funding costs for nonbanks, which we've highlighted as part of our presentation, are moving below the longer-term average for the nonbank cohort. Slide 24, we've attempted to highlight what our ambition is around our business. And we're seeing -- obviously, we're seeing 13% current residential settlement growth over a period through to FY '29. We feel as if that number aspirationally, and these are aspirations, but it indicates the investment parameters that we're working within. Number of broker investments, as Luca highlighted, we expect that to grow over the period to grow to about 35. The level of broker service income mix as a percentage of the distribution gross profit to continue to improve and our underlying cost to income as we bring more and more efficiencies through the business to be sub-50%. Our ambition around our securities business is a $9 billion book with an average NIM of 120 basis points. At this point, I will remind everyone, our mix of product is predominantly prime, and we do that for a reason. That comes at a lower NIM, but also comes with a safe and reliable return on those loans with respect to arrears and loss performance. So on Page 25 as a wrap-up, our strategy is based on 3 pillars: grow our broker network, provide that network with market-leading technology and deliver higher margin through the distribution. More broadly, we feel credit market conditions continuing to improve, growth in broker share from 75% to 80%. We have a record AFG Securities loan book, which -- the higher loan book contributing between $3 million to $4 million EBITDA per annum. And continued investment in the portfolio to diversify our earnings, our recent investments adding between $2 million to $3 million EBITDA per annum. So in summary, we believe for the half, it's a solid and pleasing result. As we turn into the half, we're starting to see some reward for the investment in our strategic initiatives, providing an excellent platform that provides us with confidence for the balance of FY '25 and importantly, into FY '26 and beyond. I might pause there now and take questions.

[Operator Instructions] Your first question comes from Tom Strong with Citi.

The first question I have is just around the equity broker investments you're making with your first 2 completed. I mean what kind of time frame or, I guess, pipeline are you looking for towards your 35 aspiration? Should we sort of just expect a pretty ongoing program here? And what sort of metrics are you looking to acquire these groups at?

Tom, it's Luca. Thank you for the question. So just in terms of pipeline, a flag there that we'd expect between 4 to 8 per annum. It's fair to say that the first couple of -- the first year or so, we need to build the pipeline. It's a new initiative in the industry. So we spent a bit of time doing that. We're quite pleased with the level of interest that we're seeing at the moment. So 4 to 8 this year will probably be closer to 4 and then we'll build. And then in terms of the metrics, we want to take minority equity interest between 20% to 40% in these businesses of sizable nature and primarily with residential. So there's a few other metrics around the type of business that we're looking at as well. And clearly, it needs to make our hurdle rates from a financial perspective.

Okay. That's clear. And just another question, if I could, just around the distribution business. I mean, if you look at the drivers of the distribution gross profit, I mean, it's coming through these other income lines like your subscription income, diversified products. I mean you put some numbers around the penetration of how many of your broker groups have taken up some of these products you've invested in. But where do you think that penetration can get to and over how long?

Yes. Thanks, Tom. It's Dave. I think the broader proposition we're talking about is that we do feel as if consolidation continue to build in the industry. And as that consolidation builds across the industry, the larger groups are going to become more multifaceted around the number of services they are offering, and we're starting to see that even across our cohort. That number is really difficult to predict. I think we're talking about 58% doing one product. But as we add more services, so as an example, with our Partner Connect program, we are offering at this point in time, asset finance. We're offering -- we started -- commenced offering life insurance and health insurance through AIA. We've obviously got a commercial loan piece. So that's not going to suit a lot. My broader proposition is that most brokers should be offering at least 2. And the easier ones for them to do would be the life insurance, and also the asset finance when they come across one of those. So 58% are doing 1. I would say -- more than one, sorry, I would say that number is 2 to 3 for the bigger groups and probably that number hit 50% -- sort of 40% to 50% should be doing 2 to 3 and maybe that 51% or 58% doing 1, I think that probably holds still for a short period of time for the next couple of years. So our strategy there, Tom, is really just to add additional services where a broker can choose and select those which are more appropriate for them. So I'm not sure how I can answer that question more precisely, to be honest.

Maybe just the one thing, Tom, to add to that would be in that outlook slide, we sort of guided to that 30% of our gross profit coming from new income streams, and that primarily relates to broker services, whether that be BrokerEngine where we'd expect to get to close to 100% and just broadening out that platform. So that's probably not a bad guide. And clearly, as that gross profit number grows, that percentage represents a significantly larger earnings absolute dollar number.

[Operator Instructions] We are showing no further questions at this time. And that does conclude our conference for today. Thank you for participating. You may now disconnect.