Latitude Group Holdings Limited (LFS) Earnings Call Transcript & Summary

Thank you for standing by, and welcome to the Latitude Group Holdings Limited HY '23 Results. [Operator Instructions] I would now like to hand the conference over to Mr. Mitchell Hawley, Head of IR. Please go ahead.

Thanks, Ashley. Good morning, and welcome to Latitude's results briefing for the half year ending 30 June, 2023. I'm Mitchell Hawley, Head of IR and I'm joined by our MD and CEO, Bob Belan; and CFO, Paul Varro. In the spirit of reconciliation, Latitude acknowledges the Traditional Custodians of country throughout Australia and their connections to land, sea and community. We pay our respect to their Elders past and present and extend that respect to all Aboriginal and Torres Strait Islander peoples today. Just a reminder, at the end of the presentation, there will be an opportunity to ask questions. I'll now hand over to Bob to begin the presentation.

Thanks, Mitch. Thank you, everyone for joining today's first half '23 results briefing. I'll start things off today with a high-level summary of our results. I'll provide some commentary on the challenges that we face as a company in our first half and the impact that those challenges have had on our first half performance. Importantly, today, I'll also be outlining a set of key strategic priorities that will guide our activities moving forward, areas of focus that I see as being vital to ensuring Latitude's financial performance improvement and that will allow us to reach our full potential in the months and years ahead. For the period January 1 through 30 June, our company generated operating income of $334 million, which was down $37 million or 10% versus the prior year. Risk-adjusted income, which of course, factors in the cost of credit losses was $228 million, down 23% year-on-year. The drivers of that metric will be discussed later in our presentation. Cost discipline has been a consistent highlight in Latitude's results for quite some time and the first half of '23 was no exception. Despite inflationary pressures, we maintained very tight cost control and saw our cash operating expense decrease by 1% to $173 million. Prudent actions taken by the team to increase our loss provisions along with D&A, income tax expense, took our cash impact from continuing operations to $7 million. After accounting for amortization of intangibles and other notable items, including the $76 million in pretax costs related to the cyber incident, we recorded a statutory loss in the first half of $98 million from continuing operations. 2023 started off strong with new origination volumes in January and February, up around 12.5% versus the prior year and receivables balances reaching $6.5 billion. For context, that's the highest receivables balance level that we've seen in 23 months. The management actions that we're taking to deliver volume growth and manage our margins were beginning to generate the right outcomes, even against the backdrop of what I'd consider to be continued monetary policy tightening. That said, the cyber attack on our company in mid-March clearly impacted business operations and severely affected our first half performance. For a period of 6 weeks, new origination [Technical Difficulty] stocks, receivables declined, pricing actions were paused and collections activities were significantly disrupted. The work done by our teams to quickly but safely restore our systems and rebuild our business momentum has been extraordinary. As a result of those efforts, I'm really pleased to share that by the end of June, volumes were back to pre-incident levels, planned pricing changes were implemented and incremental actions by our collections team led to a material decline in delinquency rates, which had spiked during the period that our systems were offline. The last 6 months have been the most difficult in our company's history and the intensity of this period is frankly quite challenging to describe. That said, our company, our people and our business model remain resilient. The macroeconomic headwinds that have challenged our performance over the last 3 years seems to be slowly shifting and the competitive landscape, we believe is evolving in our favor. We've stabilized the business. And while there are several matters still to be resolved in the aftermath of the cyber incident, we are now shifting our focus to a set of initiatives designed to accelerate our growth and elevate our profitability into the future. Our path to full potential strategy, which is summarized in the deck puts the immediate term emphasis on the fundamentals, the tactics and the disciplines that have proven over time to drive strong and sustainable outperformance results. To give you some context in terms of what we have planned ahead, we'll continue to invest in system security enhancements to protect our company's assets into the future. We will focus on further optimizing our operating model and our cost base, which includes a workforce reengineering program planned for the second half of this year. We will maintain very strong margin discipline as a top priority and leverage our existing distribution advantage and sign new retail partners to profitably accelerate origination volume. We'll rationalize our portfolio and products and businesses to release capital and create the capacity required to invest more in our core capabilities, our customer experience and high-yielding growth opportunities. And we'll continue to leverage our balance sheet strength and funding headroom as an ongoing strategic advantage. To close things out on a positive note, there are a number of very key and important highlights that I want to call out that materialized in the first half. The first was the successful sale of our hallmark insurance business, which returned $99 million in capital back to our balance sheet. The support we received from our existing retail partners during this period has been extraordinary. All of our retail partnerships have been retained and several new retail partnerships have been added during this period. Progress made on the integration of the Symple business and technology have been exceptional. All new personal loans and auto loans are now being originated on the new Symple platform, and we're in the process of decommissioning high-cost legacy systems work that we expect to be completed by the end of this year. And finally, we've taken steps to restructure and expand my executive leadership team. We have in place a highly talented and globally experienced group that's committed to our success and are leading our core business lines and functions into the future. With that said, I'll now pass it over to our Chief Financial Officer, Paul Varro to walk you through our first half financial metrics in a bit more detail. Paul, over to you.

Thanks, Bob, and good morning, everyone. What we thought we'd do is just take you through some of the key financial drivers of the results. So, if you go to Page 15, I won't go into these in too much detail, except to say 4 key points. So firstly, on the left-hand side, as Bob said, cash NPAT of $7 million and a statutory loss of $98 million, largely impacted by the cyber incident and obviously, cost of funds as well. Both of those are on our guidance that we issued in May. Despite the strong half -- to the half with volumes up 12%, volume finished down 3%. Obviously, that then flows into our receivables portfolio as well. Operating income is stable at 10.5%, thanks to the pricing we've done late in '22 and into '23. But obviously, rates impacted both by cost of funds and also the increases in losses. Despite the stat loss for the half, TER was still strong at 7%, and the Board made a prudent decision to pause the dividend for the half. If we turn to Page 16, we've just laid out some of the key drivers of the results starting with the top left-hand side, you can see there our volume trajectory. And as we said, pre to cyber incident, we were up 12.5% to 13%. Then you can see in that little gray part of the middle part of the half, the cyber incident really impacting our volumes relative to the '22 period, which left us 3% off for the half. But as you can see, by the time June came around, we're pretty much back to the 2022 period for June. Bottom left-hand side of the page, repayments eased, which was good news for us. So, down 400 basis points versus 2022, but still 500 basis points higher than the long-term average, which you can see in the little pink bar there, which is 2019. The right-hand side is what manifest in our receivables. And as you can see, despite the lowering repayments, the lower volume meant that receivables were down 4% half-on-half and pretty flat year-on-year. If we move to Page 17, I'll now take you through the P&L. And then top left-hand side, you can see there our operating income and despite the pricing that we did adding $31 million, operating income was still down $37 million year-on-year. Obviously, you can see there with costs still weighing down on the result. The bottom left-hand side shows you that in terms of yields and the pricing that we did added 97 basis points, offset by the 244 basis points of cost of funds due to the unprecedented size and speed of those cost of funds increases. As you can see on the bottom little line there below the walk, that's the movement half-on-half. And you can see some of the momentum coming through the op income line with yield now up 73 bps on the half and cost of funds up only 117 bps. So, we're starting to close that gap. Operating income only down $8 million half-on-half. If we turn to Page 18, we've showed you this chart before, but it shows you our evolution of our operating income. And you can see on the top left-hand side, the revenue yield, the interest expense and the sum of those 2, obviously producing the operating income. And you can see there the stabilization of our operating income. The new part of the chart is really the progression, if you like, of our operating income and we've deconstructed that between our interest income and our cost of funds. So, in the blue parts of the bar, you can see our interest income initially the repricing that we did in early '22 helped to mitigate some of the price reductions that we did in '21 and stabilized our yields. But then obviously, cost of funds, which you can see in the purple bars move really rapidly after the first half of '22 and into the second half of '22 and '23 and outpaced our pricing. But then you can see the blue bars again in the first half of '23 start to pick up. So, we're pretty happy with that momentum. We've obviously got more pricing planned in the second half of 2023, which will help lift that yield some more. If we turn to Page 19, it just gives you a bit of an overview of our credit and delinquency performance. Top left-hand side, you would have seen this chart before, but our new originations remained strong and obviously, a good quality as well. You can see the quality of the CR1 mix for the half. The bottom left-hand side shows the long-term trend in our delinquencies. And you can really see the tick up in 30+ and 90+ as we said in the second quarter of 2023 due to the cyber incident. What we've done is lay out those delinquent disease on the right-hand side. And you can see the impact of the cyber event really specifically in April and May, where we reached a peak of 30+ delinquencies. What we then did is obviously reapply our collections practices and you can see the really steep reduction in our delinquencies. But also that chart just gives you a sense of how that elevated debt profile moves through the delinquency buckets. And you can see, as of June, 90+ still elevated. That's due to come down through the back end of this quarter. But we expect really Q3 to manifest the higher charge-offs of that initial cyber event. You'll also notice on the 30+ chart on the right-hand side, whilst we are coming down, we do expect 30+ to be slightly elevated than start of the year due to the inflationary pressures on consumers generally. If we move to Page 20, those higher delinquencies and credit performance manifest in the higher charge-offs. And you can see there, we've split out the Jan-Feb period relative to the post-cyber period, you can see that pickup in charge-offs in particular. And obviously, we've had to increase our provisioning levels. We think that's a prudent provision given where charge-offs are at the moment and for the half at 3.31%. As Bob said, our cost discipline remains and will continue to remain a key focus area for the management team with first half costs flat, you can see some of the FTE reductions that we made back end of '22 and into '23, helping keep our costs flat and offset our cost inflation. As Bob noted as well, we continue to look at the operating model as part of the past to full potential. And so we'll expect to see some more changes in terms of our FTU profile going forward. If we move from our core OpEx to our notable items, and this is what separates really the cash NPAT result and statutory result, really, that's made up of 4 key drivers. Firstly, the $76 million cyber costs and provisions made in the half. The second biggest one is the continued expense from the Symple integration at $16 million. We also exited BNPL, so we wrote off those assets, which was a further $17 million. And then we have our usual item of our amortization of acquisition intangibles, which relates to the initial acquisition of the business from GE. So, those 4 key items are one-offs, if you like, make up about $130 million of the total. And obviously, our cost focus remains to make sure we keep those as low as possible. And finally, I'll finish just with our funding and balance sheet, another strong half for the treasury team with three transactions completed in the half. This really allows us to maintain our investor diversity, our balanced maturity that you can see there. And are also delivering $1.4 billion of headroom, giving us plenty of room to grow through '23 and into '24. We also made really strong capital strength, as I said before, with our TER ratio maintained at 7%. With that, I'm going to hand it back over to Bob. Over to you.

So, just to close off the formal part of today's presentation, I'll turn your attention to Slide 13 of the document where we speak to 3 key points regarding the outlook. Stating the obvious cyber incident has had clearly a material impact on our business operations and has disrupted our financial performance. That said, and as I mentioned and as Paul highlighted as well, the recovery has been strong and I'm quite proud of the work that the team has done here to drive that recovery. As momentum builds, as our planned initiatives for that period during the cyber incident and post begin to take hold, we believe that, that will lead to a pretty significant but steady improvement in yields over time. Inflationary pressures persist and cash rates remain high, but we anticipate delinquency, charge-offs and repayment rates to really just normalize to levels that are much more sort of historical in nature. At the moment, unemployment remains strong and that gives us some confidence on that metric. The last point I'd like to raise is retail spending, consumer confidence has not been great. There's a bearish outlook on those 2 elements. However, historically, our products have been really well positioned to support periods in the economic cycle where those conditions manifest. And so our view is that there is some upside with regards to our sales finance business as it relates to the period in the economic cycle where retail spend and consumer confidence may be challenged. And I'll just close it off by saying we're of the view and reiterate our position and guidance that cash NPAT through this year will be in the range of $15 million to $25 million. With that, that ends the formal part of today's presentation. We'll now open up for some Q&A.

Thank you. [Operator Instructions] Your first question comes from Lara Tufegdzic with Bank of America.

Bob and Paul, my question was in regards to Latitude's increase in provisioning. How much of this was driven by new originations versus the back book? And additionally, now that the elevated charge-offs caused by cyber have passed, would you anticipate for provisioning to come off as well in future periods?

Lara, really, the increase in provision was due to the higher charge-offs that we exhibited in the first half. And as you'd be aware, that was really 2 parts. One is environmental where we saw in January and February, a slight tick up in our delinquency, but the biggest driver of it was the elevated charge-off and debt profile that we saw in March and April due to the cyber incident where we weren't able to collect on our delinquent accounts for the full 6-week period. In terms of where the setting is, we're actually pretty confident with it at 4.22%. If you look at the ratio, which we've got on the page there compared to the long-term averages, if we assume that our charge-offs will normalize somewhere in that sort of 3.5% range, the coverage we've got at the moment is about 1.3x. And obviously, we'll reassess that provision as we come to the December half end as well and just have a look at the environment as well as the charge-off performance post cyber. But at this stage, we certainly think the provision is prudent.

Your next question comes from Minh Pham with Barrenjoey.

Bob and Paul, I've just got 2 questions. On the margin outlook, I understand that the [ RAI ] pricing actions should continue to help margins over the next period, especially if there are no more RAI prices impacting funding costs. You've spoken in the past about moving into the higher-risk CR3 customers. And I've seen in the presentation today that's actually reduced. Obviously, there's been a few distractions this half, but are you expecting some margin uplift from higher-risk customers as well?

Yes. Certainly, I'd say some of the reduction in the CR3 was obviously not originating in particular, PLs for that 6-week period. There's certainly been no overt changing strategy in the half NIM. Obviously, as we remix some of those risk grades that will naturally help the top line interest income and obviously, NIM yield as well. At the moment, we're originating at rates on the personal loans book, in particular, at rates higher than the portfolio. And so we should expect to see that continued lift in the NIM rate on our personal loans portfolio going forward.

And I may just add that we will constantly and continuously look at our credit strategies, make sure that they're operating within the tolerances of the organization. And to the extent that there's opportunity to appropriately price CR3s, we certainly don't have an aversion to bringing CR3 customers more of them into the franchise. And so within our Money division, which has very granular risk-based pricing, that positions us pretty well to be able to cater for that segment into the future.

So, you are able to tell us what the front book NIM is at the moment. You mentioned personal loans is higher than the portfolio.

No, we're not going to disclose that at this stage.

And maybe just a second question, if I could, on costs. You have shown good cost discipline. But as we've mentioned in the past, a number of the operating expenses sit below the line. I understand some of those cyber-related costs will be recoverable, but we've seen from your larger bank peers come out with higher cost outlooks given increased investment spend on cyber and scams. That's just become the cost of doing business. So, interested in your thoughts on how you think those investments will play out in costs over the next year or 2?

Yes, sure. So, we're currently undertaking some work to have a look at the changes to our environment that we would need to do post the cyber incident. And we would certainly expect to just treat those as a business as usual cost as we continue to develop our infrastructure in that space. We are undergoing further reviews of our operating structure, as you would expect us to do. That may allow us to build in some capacity in order to mitigate both inflationary pressures and changes that we would need to make in that space going forward.

Your next question comes from Andrei Stadnik with MS.

Can I ask my first question around the Symple re-platforming. What are the additional benefits to come in the second half from the full re-platforming? And why is there like a difference between shifting some of the books versus the full re-platforming to come in the second half?

Andrei, there's a number of benefits from migrating from what were 2 very old platforms, ICBS and Genesis on to the new Q2 platform. The first one is actually a better customer and broker experience. So, we're able to improve our pull-through rates and therefore, overall conversion rates and volume off the back of a better customer experience. It also integrates better with our brokers as well. So, all of that allows you to actually for the same number of applications, deliver more written volume. It also crucially in this interest rate environment, it allows us to write variable rate products. And so previously, for the last 20-odd years before the Symple acquisition, Latitude only had the ability to write fixed rate personal loans and auto loans. Symple allows us to write both fixed and variable. And we've seen a large shift in mix from fixed to variable in this interest rate cycle. So, it was really good timing that we were able to flip over to the Q2 acquisition. The one that we referred to, which is the integration of the whole portfolio, so the roughly $2.5 billion across Australia and New Zealand, that allows us to actually deliver some of the cost synergies. So, we were running 2 older platforms. We're now migrating off those platforms and running on 1 platform going forward and that will allow us to deliver some of the cost synergies for that acquisition as well.

And maybe one last point, which is the digitization of the end-to-end application experience drives pretty significant operational efficiencies in that process. And so as those operational benefits are realized, it obviously creates cost synergies. We can exit operational costs because many of those activities that were previously done manually are now digital.

My second question, can I ask around the capital. It was quite a sharp movement from 8.5% capital ratio down to 7%. And that seems to include almost $100 million benefit from the Hallmark insurance sale. So, what were some of the headwinds on capital?

Yes, good question. Remember, the starting -- your starting number of the 8.5-odds still included in insurance. So, in the balance sheet, whilst we held insurance, it still had all of its cash and investments in that TER calculation. So, the main driver of the reduction in TER for the half was the $98 million statutory loss. All that happened with the insurance business was that it was disposed of and we got to keep some of that cash because it wasn't tied up due to the APPA regulations.

And maybe as a final question. You obviously took over as CEO recently, what's your view in terms of like the product set and what kind of evolution would you like to see and maybe to like Latitude's product set going forward?

Yes. Look, we have -- I am of the view that we have a very resilient business model, one that served the need of Australian consumers, lenders and retailers for quite some time. Our sales finance product is very unique in the market. And what we're seeing is as consumer confidence in retail sales begin to struggle, the reliance on products like ours amongst our retailers historically has increased. And so that's a really important product for us. It represents a very large component of our P&L. And that will be a product and a set of capabilities that we continue to invest in, both from a customer experience perspective, new capabilities, but also expanding our distribution. What I mean by that is adding more retail partners that we think opportunities will present themselves on in the coming months. What I'd say is that we are in a privileged position on the money side of our business, having now transitioned off of the legacy technology and on to the Symple technology that affords us a number of new opportunities to expand the product set and better service the needs of customers here as well as in New Zealand, as evidenced by a significant take-up in the variable rate loan that we've seen since that was launched around the middle of next year. The last point I'd make is we have to continue to pay attention to what consumers are interested in, how the market is shifting and make sure we adapt our product set to meet those needs. But as it stands right now, I think we're quite well-positioned on that front.

There are no further questions at this time. I'll now hand back to Mr. Bob Belan for closing remarks.

Thank you all for joining today's call. Nothing further from Mitch, Paul and I. I know that we have a number of individual conversations that are planned in the coming days, which we're looking forward to. Thanks for making the time for us. Enjoy the rest of the day.

That does conclude our conference for today. Thank you for participating. You may now disconnect.