Lufax Holding Ltd (LU) Earnings Call Transcript & Summary

Ladies and gentlemen, thank you for standing by, and welcome to Lufax Holding Ltd Fourth Quarter 2023 Earnings Call. [Operator Instructions] After management's prepared remarks, we will have a Q&A session. Please note, this event is being recorded. Now I'd like to hand the conference over to your speaker host today, Ms. Liu Xinyan, the company's Head of Board Office and Capital Markets. Please go ahead, madam.

Thank you very much. Hello, everyone, and welcome to our fourth quarter 2023 earnings conference call. Our quarterly financial and operating results were released by our newswire services and are currently available online. Today, you will hear from our Chairman and CEO, Mr. Y.S. Cho, who will provide an update of our latest business strategies, the macroeconomic trend, recent developments of our business and special dividends. Our co-CEO, Mr. Greg Gibb, will then go through our fourth quarter results to provide more details on our business priorities and outlook. Afterwards, our CFO, Mr. David Choy, will offer a closer look into our financials before we open up the call for questions. Before we continue, I would like to refer you to our Safe Harbor statement in our earnings press release, which also applies to this call as we will be making forward-looking statements. With that, I'm now pleased to turn over the call to Mr. Y.S. Cho, Chairman and CEO of Lufax. Please.

Thank you. Thanks for joining today's call. During the fourth quarter, the economic environment remained complex and SBOs continued to come under pressure. Nevertheless, as we prioritize quality over quantity, we have now completed our major derisking actions and will continue to carry out a prudent strategy. We are confident that the strategic initiatives we have implemented form a solid foundation for longer-term growth and profitability and believe that cumulative impact of our strategic upgrades will optimize and recalibrate our risk-return profile to align with the prevailing macro environment in China. Now let me provide some updates to our quarter -- for the quarter. First, the broader macro environment remained challenging for SBOs. This is reflected in the SME Development Index published by the China Association of Small and Medium Enterprises, which declined slightly to 89.1 in the fourth quarter of 2023. Furthermore, the SME Business Conditions Index published by Cheung Kong Graduate School of Business declined from 49.9 in September to 47.8 in December. This indicates that SBO segment is likely to recover at a somewhat slower pace. Next, let's turn to our business. Throughout 2023, we've made five major derisking and diversification actions, including four mix changes and one business model adjustment. First, we have changed our segment and product mix. Our heavier concentration in the SBO segment and offerings of SBO business loans generated healthy profit prior to 2022. However, with the change of macroeconomic environment, such concentration drove a deterioration in both our operational and financial results in the past 18 months. To address this, we have strategically adjusted both product offerings and segments. In terms of product offerings, we have shifted from a predominant focus on SBO business loans to a more balanced offering of business and consumption loans. For our product portfolio, we've expanded our offerings to be more comprehensive, encompassing both installment and revolving payment options. Within the SBO segment, we refined our focus by targeting customers with better risk profiles, specifically those in the R1 to R3 rating range. Second, we have adjusted our regional mix. Since the second half of 2022, we we've observed significant variations in credit performance and resilience across different areas. Accordingly, we have completed the reduction in our footprint and are focusing on higher-quality geographies with expected greater economic resilience. Third, we have optimized our channel mix, especially our direct sales channel, which is the most important for our business. We recognize that our rapid historical expansion had resulted in lower productivity and higher risk with direct sales team and responded by optimizing the scale of our direct sales team. As a result, the number of direct sales team reduced from 47,000 at the end of 2022 to around 21,000 at the end of 2023. Fourth, we have adjusted our industry mix, reflecting the relative sustainability of industries under the changing macro environment. In our internal risk assessment, we have assigned great importance to consideration of each industry's economic cycle stage within our models and increased KYB and industry factors for enhanced model predictiveness. Finally, we have completed migration of our business model. As discussed previously, the high CGI premium charged by our business partners had negatively impacted our revenue and profit. We recognize the high third-party reliance reduced our tactical freedom. Therefore, we started negotiations with our funding partners at the end of 2022 and successfully completed transitioning to a 100% guarantee business model by the end of third quarter of 2023. In the fourth quarter of 2023, all the new loans were either granted by our consumer finance subsidiary as on-balance sheet loans or enabled by our guarantee company under the 100% risk-bearing business model, thus eliminating the drag factor of CGI. On a single account basis, new loans enabled under 100% guarantee models are expected to realize lifetime profitability, however, may record net accounting loss for the first calendar year due to higher upfront provisioning as compared with the loans on the CGI model. While this strategic shift enables us to capture greater economic value, it has also increased our risk exposures. Therefore, we remain prudent and prioritize quality over quantity throughout 2024. In terms of asset quality, compared to the third quarter, C-M3 flow rate experienced an increase in the fourth quarter. This was mainly driven by the reduction in our outstanding loan balance and short-term impact from the restructuring of our direct sales team and branches. With the completion of all the restructuring measures, we have seen gradual improvement of the flow rate in the first quarter of 2024. To sum up, during the fourth quarter, with the completion of derisking initiative, the downside of our business is under control and we have stronger visibility of our businesses. However, the upside will still need more time due to our prudent strategy and transformation of our business model. Finally, over the past quarters, we have consistently heard our shareholders' request for us to improve investor returns and capital efficiency. Considering the progress in business derisking and business model transformation as well as our outlook for the growth and capital requirements for the next several years, we believe we have the capability and now is the right time to return value to our shareholders through a special dividend in an estimated dividend size of approximately RMB 10 billion. Thanks. I will now return the call over to Greg.

Thanks, Y.S. I'll now provide more details on our fourth quarter and full year 2023 results and our operational focus for this year. Please note, all figures are in renminbi unless otherwise stated. I'd like to start with an overview of our performance during the fourth quarter. During the fourth quarter of 2022, our performance remained under pressure from the complex macro environment and challenges faced by SBOs. Our overall new loan sales were RMB 47 billion, representing a year-on-year decline of 39.6%. This was mainly due to subdued demand for high-quality loans from SBOs, coupled with our prudent strategy as we transit to the 100% guarantee model. Among total new sales, approximately 40% was contributed by consumer finance as we transition our portfolio mix. Fourth quarter revenue was RMB 6.9 billion, a decrease of 44.3% year-over-year. This was primarily due to the reduction of our outstanding loan balance, which stood at RMB 315 billion at the end of 2023, a decline of 45% on an annual basis. We recorded a net loss of RMB 832 million in the fourth quarter. This was mainly driven by elevated credit losses stemming from front-loaded provisions associated with loans enabled under the 100% guarantee model, heightened risk exposure under the model and certain one-off nonoperating losses. Now let's delve into our derisking initiatives that we have made progress on in 2023. As Y.S. just explained, we have executed on five major derisking strategies, which included four significant changes to our business mix and transition to the new business model. First, our segment adjustments have fundamentally shifted the new business mix in favor of R1 to R3 rated customers. In 2023, 73% of unsecured loan new customers were rated R1 to R3 compared to 49% in 2022. In addition, strategic adjustments to our product offerings have resulted in a new business mix that reflects our significant derisking measures. This has prompted a gradual transformation of our existing portfolio mix. In 2023, consumer finance sales accounted for 34% of new loan sales, up from 12% in 2022. Concurrently, the proportion of unsecured loans and secured loans decreased to 44% and 22%, respectively, from 64% and 24% in 2022. As a result, our balance mix has shifted with consumer finance balance as a percentage of total balance rising to 12% at the end of 2023 compared to 5% at the end of 2022. The proportion of unsecured loans decreased from 66% from 73% as of the end of '22, while the proportion of secured loans remained flat. During 2024, we anticipated continued consumer finance diversification and majority of the unsecured balances will fall under the 100% guarantee model by the end of 2024. Next, our regional adjustments have involved a targeted reduction of our footprint in less economically resilient regions characterized by relatively higher risk. This strategic shift is reflected in our geographic coverage, which has decreased from over 300 cities at the end of 2022 to 146 cities at the end of 2023. In terms of channel adjustments, we have concluded the restructuring of our direct sales. The number of direct sales team members was reduced from 47,000 at the beginning of the year to 21,000 by the end of the year. In 2023, the direct sales channel contributed to 63% of new sales, up from 57% in the previous year. Turning to our business model. Starting in the fourth quarter, we've completed a strategic pivot as we fully transition to the 100% guarantee model. This move has transformed our portfolio mix and increased our risk-bearing as vintages run-off and the loans under the new model take shape. As a result, our risk-bearing by balance increased to 39.8% at the end of 2023, up from 23.5% at the end of the previous year. During the fourth quarter, our overall C-M3 increased to 1.2% from 1.1% in the prior quarter. This was primarily due to a reduction in our Puhui business' outstanding balance and temporary negative impact from our geographic and direct sales restructuring in the past quarter. Although, we have seen improvement in the C-M3 ratio in the first quarter, given our increased risk exposure under the new model, we continue our prudent strategy to prioritize quality over quantity in 2024. Now let's turn to our outlook for 2024. We expect new loan sales of 2024 to be in the range of RMB 190 million to RMB 220 billion and the ending balance to be between RMB 200 billion and RMB 230 billion. Meanwhile, although we expect loans under the 100% guarantee model will be lifetime profitable on a single account basis, it is important to highlight that loans under this model may record accounting loss in the first calendar year due to higher upfront provisions. Under our projected business scale, we believe we have a strong balance sheet to support the business operations, capital and liquidity requirements. At the end of 2023, the leverage ratio of our guarantee subsidiary was 1.8x, far below the regulatory limit of 10x. Our consumer finance capital adequacy ratio stood at approximately 15.3%, well above the required 10.5%. As for the balance sheet, we hold liquid assets of RMB 84 billion with our cash and bank balance outstanding at RMB 39.6 billion. With the strong capital position and visibility into our business growth in the medium term, we are well positioned to further respond to our shareholders' consistent feedback to increase shareholder returns. And on top of the regular dividend and share buybacks that we have performed over the past 3 years, our Board of Directors has approved, subject to shareholders' approval, a special dividend of USD 2.42 per ADS or $1.21 per ordinary share with a total estimated size of approximately RMB 10 billion. To offer our shareholders full flexibility, each shareholder may elect to receive the dividend either all in cash or all in scrip. As we are dual listed in the U.S. and Hong Kong stock markets, the shareholders in each market will have to follow the respective procedures for receiving the special dividend. More details will be disclosed in our announcements and the statutory circulars in due course. The special dividend is subject to the approval of shareholders at the Annual General Meeting, which will be held on May 30 with a record date of April 9. I will now turn the call over to David, our CFO, for more details on our financial performance.

Thank you, Greg. I will now provide a close look into our fourth quarter results. Please note that all numbers are in renminbi terms and all comparisons are on a year-over-year basis unless otherwise stated. As Y.S. and Greg mentioned before, our performance was impacted by macroeconomic environment in which the small business owner sector has been under pressure throughout the period. Through strategic adjustments to 100% guarantee model and prioritizing higher-quality customer segments and better geographical regions, we sacrificed some of our business scale for backlog quality in the future. This strategic transition inevitably caused our average loan balance and total income to continue to decrease, whilst the expected credit loss provision is required to be booked upfront in day one, boosting the accounting loss in early quarter life cycle under the new business model. In the fourth quarter 2023, out total income was RMB 6.9 billion, decreasing by 44.3%. During the quarter, our technology platform-based income was RMB 3 billion, representing a decrease of 49%. Our net interest income was RMB 2.3 billion, a decrease of 47%; and our guarantee income was RMB 886 million, a decrease of 47%. All are basically in line with the decrease of outstanding loan balance, in which guarantee income decreased by a lesser magnitude due to the offsetting effect of an increase in risk-bearing by the company. Turning to our expenses. We remain committed to cost optimization. Our total expenses excluding credit and asset impairment losses, finance costs and other losses decreased by 33.2% year-over-year to RMB 4.4 billion this quarter as we continue to enhance operational efficiency. In the fourth quarter, total expenses decreased by 38.5% to RMB 7.9 billion from RMB 12.9 billion a year ago. This decrease was primarily due to a decrease in credit impairment losses and sales and marketing expenses. Highlighting just a few of the key expense items here. Our total sales and marketing expenses, which mainly include expenses for borrower acquisition costs as well as general sales and marketing expenses, decreased significantly by 45.9% to RMB 2 billion in the fourth quarter. The decrease was mainly due to decreased loan-related expenses as a result of the decrease in the new loan sales and decreased retention expenses as well as referral expenses from the platform service attributable to the decreased transaction volume. Our credit impairment losses decreased by 43% to RMB 3.6 billion in the fourth quarter primarily due to the decrease in provision of loans and receivables as a result of the decrease in loan balance. Our finance costs decreased by 90.1% to RMB 50 million in the fourth quarter from RMB 501 million in the same period of 2022, mainly due to the decrease of interest expenses as a result of the repayment of Ping An and C-Round convertible promissory notes during the year. As a result, net loss for the fourth quarter was RMB 832 million, basically flat as compared to RMB 806 million net loss in the same quarter of 2022. Meanwhile, our basic and diluted loss per ADS in the fourth quarter were both RMB 1.48 or USD 0.21. Turning now to our balance sheet. With abundant cash, we had repaid the outstanding bond of RMB 2.1 billion and optionally convertible promissory note of RMB 8.1 billion for the year 2023. After all these debt repayments, as of December 31, 2023, we have total equity attributable to owners of the company of RMB 92.1 billion and a cash balance of RMB 39.6 billion and financial assets at fair value through P&L of RMB 28.9 billion. In terms of capital, as of the end of December 2023, the two main operating entities are well capitalized. Our guarantee subsidiary's leverage ratio was only 1.8x as compared to a maximum regulatory limit of 10x; and our consumer finance company capital adequacy ratio well stood at approximately 15.3%, well above the required 10.5% regulatory requirement. Overall speaking, we are in a net cash position after taking into account all the external bank debt. All of these factors offer substantial backing for the company to navigate through the challenging macroeconomic environment and the transition period while providing foundations for us to continually rewarding back to our investors. That concludes our prepared remarks for today. Operator, we are now ready to take questions.

[Operator Instructions] Your first question comes from Emma Xu with Bank of America Securities.

I think, first and foremost, everybody care about the special dividend. So, what's the consideration behind this RMB 10 billion special dividend? What are the key numbers or information that you relied on to arrive this RMB 10 billion special dividend? And I have another question about your asset quality. So your flow rate, a leading indicator for the delinquency, continued to rise in the fourth quarter to 1.2%. But I also noticed in your report, you also mentioned that you actually see improvement of the flow rate in first quarter or quarter-to-date. So could you tell us how much improvement you already seen in first quarter? And what's your expectation for the overall asset quality trend in the coming quarters?

Okay. Thanks for your question. Let me answer. Let me start with why we believe now is the right time for this special dividend. With the successful completion of our five major derisking initiatives I mentioned, including four mix changes and one business model adjustment, we believe now the risk is under control and we have a clear visibility of our capital requirement for the coming next 2 to 3 years. And then our stock has been traded at less than 0.2x PV and then we have been continuously requested by investors to enhance investment return. Now you see that our ADS price is, if you compare with our -- the cash per ADS is far lower, far lower. So, market has not even reflected the available cash on our book in our valuation. So we hope to unlock hidden value behind our cash on hand by increasing our shareholder value through this dividend. And if I explain why we arrived -- how we arrived at this amount, why RMB 10 billion, right, this number. Of course, we first started our future 3 years development potential and how much capital we need to support the development. And then we also assumed -- in this characterization, we also assumed a reasonably large buffer to ensure our stable operation in the future. So this is how we arrived at RMB 10 billion. And then the size of dividend, it seems maybe -- it looks like very big compared with our the market cap. But I want to emphasize, actually it is only just roughly 10% of our net asset. So this is a reasonably good amount, I believe. And then to answer your last question about asset quality. Let me explain first about what's going on with our consumer finance business. Their NPL ratio has been consistent at around 1.5%, 1.4%. And then if I may explain about Puhui side, we said C-M3 net flow ratio for Puhui loans increased from 1.11% in third quarter last year to 1.25% in the fourth quarter last year, right? And then this increase is mainly due to reduction of our Puhui's outstanding loan balance and the temporary negative impact from our adjustment in our geography and direct sales restructuring, right? But fourth quarter, we see improvements in net flow. And we believe with completion of all those restructuring measures, we see gradual improvements of flow rate in the coming quarters. And also, you understand the old portfolio that we booked before 2023 is of worse quality, and that portfolio is now running off. So when you get to the end of 2024, that our legacy portfolio or in other words, accounts we booked before 2023, will take nearly 10% of total portfolio. So in that sense, I think our gradual continuous improvement is of no doubt.

Your next question comes from Richard Xu with Morgan Stanley.

After the special dividend, what do you think the capital needs to support the growth for loans? Will there still be enough buffer given obviously most of the loans will be guaranteed by your own capital at the moment? So on the flip side, given the projection on the reduced loan volume, are there still room to further reduce some of maybe the capital base and then do more special dividends with the smaller loan balance... [Technical Difficulty]

Yes. Go ahead, Richard.