American Financial Group Q4 2023 Earnings Call Transcript

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Provided by Quartr
March 21, 2024

There are 8 speakers on the call.

Operator

Ladies and gentlemen, thank you for standing by and welcome to Lufax Holdings Limited 4th Quarter 2023 Earnings Call. At this time, all participants are in listen only mode. After management's prepared remarks, we will have a Q and A session. Please note this event is being recorded. Now I'd like to hand the conference over to your speaker host today, Ms.

Operator

Lu Xian, the company's Head of Board Office and Capital Markets. Please go ahead, madam.

Speaker 1

Thank you very much. Hello, everyone, and welcome to our 4th 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.

Speaker 1

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 Gib, will then go through our 4th quarter results, provide more details on our business priorities and outlook. Afterwards, our CFO, Mr.

Speaker 1

David Choi, 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 as we will be making forward looking statements. With that, I'm now pleased to turn over the call to Mr. Y. S.

Speaker 1

Cho, Chairman and CEO of Rubax. Please.

Speaker 2

S. Cho:]

Speaker 3

Thank you. Thanks for joining today's call. During the Q4, the economy environment remained complex, and SCVOs continue to come under pressure. Nevertheless, as we prioritize quality over quantity, we have now completed our major de risking actions, and we'll 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.

Speaker 3

Now let me provide some updates for our quarter for the quarter. First, the broader macro environment remained challenging for SVOs. 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 Q4 of 2023. Furthermore, the SME Business Conditions Index published by Chunghong Graduate School of Business declined from 49.9% in September to RMB 47.8 in December. This indicates that SEO segment is likely to recover at a somewhat slower pace.

Speaker 3

Next, let's turn to our business. Throughout 2023, we've made 5 major derisking and diversification actions, including 4 mix changes and 1 business model adjustment. First, we have changed our segments and product mix. Our heavier concentration in the SEO segment and offerings or SEO business launch generated healthy profit prior to 2022. However, with the change of macro environment macroeconomic environment, such concentration drove a deterioration in both our operational and financial results in the past 18 months.

Speaker 3

To address this, we have strategically adjusted both product offerings and segments. In terms of product offerings, we've shifted from a predominant focus on SEO 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 SCBO segment, we refined our focus by targeting customers with better risk profiles, specifically those in the R1 to R3 rating range. 2nd, we have adjusted our regional mix.

Speaker 3

Since the second half of twenty twenty two, 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. 3rd, 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 low 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.

Speaker 3

4th, 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 greater importance to conservation 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 charges by our business partners had negatively impacted our revenue and profit. We recognized that high third party reliance reduced our tactical freedom.

Speaker 3

Therefore, we started negotiations with our funding partners at the end of 2022 and successfully completed transition into a 100% guaranteed business model by the end of Q3 2023. In the Q4 of 2023, all the new loans were either granted by our customer finance subsidiary as on balance sheet loans or enabled by our guaranteed company under the 100% risk bearing business model, thus eliminating the drag factor of CIGI. On a single account basis, new loans enabled under 100% year to models are expected to realize lifetime profitability. However, May record net accounting loss for the Q1 calendar year due to higher upfront provisioning as compared with the loans on the CZY model. While this strategic shift enables us to capture greater economic value, it has also increased our risk exposures.

Speaker 3

Therefore, we remain prudent and prioritize quality over quantity throughout 2024. In terms of asset quality, compared to the 3rd quarter, C2M3 flow rate experienced an increase in the 4th 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 Q1 of 2024. To sum up, during the Q4, with the completion of de risking initiative, the downsize of our business is under control, and we have stronger visibility of our businesses.

Speaker 3

However, the upside, we 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 return and capital efficiency, Considering the progress in our 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 with an estimated dividend size of approximately RMB10 1,000,000,000. Thanks. I will now return the call over to Greg.

Speaker 4

Thanks, YS. I'll now provide more details on our Q4 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 Q4. During the Q4 of 2022, our performance remained under pressure from the complex macro environment and challenges faced by SVOs.

Speaker 4

Our overall new loan sales were 47,000,000,000 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. 4th quarter revenue was $6,900,000,000 dollars a decrease of 44.3 percent year over year. This was primarily due to the reduction of our outstanding loan balance, which stood at 315,000,000,000 dollars at the end of 2023, a decline of 45% on an annual basis.

Speaker 4

We recorded a net loss of 832,000,000 dollars in the Q4. This was mainly driven by elevated credit losses stemming from front loaded provisions associated with loans enabled under the 100 percent guarantee model, heightened risk exposure under the model and certain one off non operating losses. Now let's delve into our derisking initiatives that we have made progress on in 2023. As YS just explained, we have executed on 5 major derisking strategies, which included 4 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.

Speaker 4

In 2023, 73% of unsecured load 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 de risking 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% 24% in 2022.

Speaker 4

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 'twenty two, 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 the 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.

Speaker 4

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 63% of new sales, up from 57% in previous year. Turning to our business model, starting in the Q4, we've completed the strategic pivot as we fully transitioned to the 100 percent 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.

Speaker 4

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 Q4, our overall C2M3 increased to 1.2% from 1.1% in the prior quarter. This was primarily due to a reduction in our Puhue 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 seat to entry ratio in the Q1, given our increased 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.

Speaker 4

We expect new loan sales of 20 to be in the range of $190,000,000,000 to $220,000,000,000 and the ending balance to be between $200,000,000,000 $230,000,000,000 dollars Meanwhile, although we expect loans under the 100 percent 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 1st 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 20 23, the leverage ratio of our guarantees 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 $84,000,000,000 with our cash and bank balance outstanding at $39,600,000,000 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.

Speaker 4

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 US2.42 dollars per ADS or $1.21 per ordinary share with a total estimated size of approximately RMB10 1,000,000,000. To offer our shareholders full flexibility, each shareholder may elect to receive the dividend either all in cash or all in script. 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.

Speaker 4

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.

Speaker 2

Thank you, Derek. I will now provide a close look into our 4th 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 Wyatt and Grant 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 to above the globe regions, we sacrificed some of our business scale for better loan quality in the future.

Speaker 2

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 1, boosting accounting loss in early product life cycle under the business model. In the Q4 2023, our total income was $6,900,000,000 increasing by 44.3%. During the quarter, our technology platform base income was $3,000,000,000 representing a decrease of 49%. Our net interest income was $2,300,000,000 a decrease of 47% And our guarantee income was $886,000,000 a decrease of 47%.

Speaker 2

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 courses and other losses decreased by 33.2 percent year over year to $4,400,000,000 this quarter as we continue to enhance operational efficiency. In the Q4, total expenses decreased by 38.5 percent to $7,900,000,000 from $12,900,000,000 a year ago.

Speaker 2

This decrease was primarily due to a decrease in credit impairment losses and sales and marketing expenses, highlighting just a few of the key expenses items here. Our total sales and marketing expenses, which mainly include expenses for borrower acquisition courses, as well as general sales and marketing expenses, decreased significantly by 45.9 percent to RMB2 1,000,000,000 in the 4th 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 to our referral expense from the platform service attributable to the decreased transaction volume. Our credit and credit losses decreased by 43% to $3,600,000,000 in the 4th quarter, primarily due to the decrease in provision of loans and receivables as a result of the decrease in the loan balance. Our finance costs decreased by 19.1 percent to $50,000,000 in the 4th quarter from $501,000,000 in the same period of 2022, mainly due to the decrease of interest expenses as a result of the repayment of Ping An and Seaman convertible promissory notes during the year.

Speaker 2

As a result, net loss for the Q4 was $832,000,000 basically flat as compared to 8 $806,000,000 net loss in the same quarter of 2022. Meanwhile, our basic and diluted loss per ADS during the 4th quarter were both RMB1.48 or US7.21 dollars Turning now to our balance sheet. With abundant cash, we had repaid outstanding bond of US2.1 billion dollars and optionally convertible promise of $8,100,000,000 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 $92,100,000,000 and a cash balance of $39,600,000,000 and financial assets at fair value through P and L of $28,900,000,000 In terms of capital, as of the end of December 2023, the 2 main operating entities are well capitalized. Our guaranteed subsidiaries' leverage ratio was only 1.8x as compared to a maximum record limit of 10x.

Speaker 2

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

Thank you. We will now begin the question and answer session. Your first question comes from Emma Ju with Bank of America Securities. Please go ahead.

Speaker 5

Thank you for giving me the opportunity to ask the first question. I think 1st and foremost, everybody care about this special dividend. So what's the consideration behind this RMB10 1,000,000,000 special dividend? What are the key numbers or information that you rely on to arrive these RMB10 1,000,000,000 special dividend? And I have another question about your asset quality.

Speaker 5

So your flow rate, a leading indicator for the delinquency, continue to rise in the Q4 to 1.2%. But I also noticed in your report, you also mentioned that you actually see improvement of the flow rate in Q1 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? Thank you.

Speaker 3

Okay. Thanks for your question. Let me answer. So let me start with why we believe now is the right time for this special dividend. With a successful completion of our 5 major de risking initiatives I mentioned, including form exchanges and 1 piece 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.

Speaker 3

And then our stock has been traded at less than 0.2x PV. And then we have been continuously requested by investors to enhance investor 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.

Speaker 3

And if I explain why we arrived, how we arrived at this amount, why RMB 10,000,000,000, right, at this number, of course, we first studied our future 3 years development potential and how much capital we need to support the development. And then we also assumed in this calculation, we also assumed reasonably large buffer to increase our stable operation in the future. This is how we arrive at the JPY 10,000,000,000. And then the size of the billings, it seems maybe it looks like a very big compared with our the market cap. But I want to emphasize, actually, it is only just roughly 10% of our net asset.

Speaker 3

So this is 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 Puhu side, we said C2MC net flow ratio for Huhi loan increased from 1.11% in Q3 last year to 1.25% in the 4th quarter last year, right?

Speaker 3

And then this increase is mainly due to reduction of our full year outstanding loan balance and then temporary negative impact from our adjustment in our geography and direct sales restructuring. But Q1, we see improvement in net flow. And then we believe with the combination of all those restructuring measures, we see gradual improvement of flow rates 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 up. So when you get to the end of 2024, that our legacy portfolio or in other words, accounts we booked before 2020 3, we take nearly 10% of total portfolio.

Speaker 3

So in that sense, I think our gradual continuous improvement is of no doubt.

Speaker 5

Thank you. This is very helpful.

Operator

Thank you. Your next question comes from Richard Ju with Morgan Stanley. Please go ahead.

Speaker 6

Thank you. Thanks for the opportunity for the question. A couple of questions for me. First of all, on capital again. After the special dividend, what do you think the capital need to support the growth for loans?

Speaker 6

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 a smaller loan balance? So to

Speaker 4

Hey. Go ahead, Richard. Yes. Lastly You were just cutting off there. Could you just repeat the last two sentences?

Speaker 6

Sure. I just want to say like one, are there enough capital to support the loan volume growth after the special dividend? And secondly, if there are there still potentially excessive excess capital if the loan volume will be smaller, right? I mean, whether there's opportunity for another spec of dividend down the road. And then lastly is the funding cost trends that we're seeing at the moment.

Speaker 6

So 2 on the capital, 1 is on the funding cost. Thanks.

Speaker 4

Great. Richard, thanks. It's Greg speaking here. Overall, we have gone through, as Wyeth was just laying out, quite a comprehensive process looking out over the next couple of years on expected industry trend, our relative growth trend, capital requirements, liquidity requirements, buffer, we operate multiple licenses. We obviously have the guaranteed license.

Speaker 4

We have the consumer finance license. And we always keep our mind open for other licenses in the future. So after going through all that, we arrived at, given our significant cash position, a view on what we could release today that gives us still very substantial buffer going forward over the next couple of years. Obviously, our outlook for the market right now is still quite prudent. We're still focusing on quality over quantity.

Speaker 4

But if in a year or 2, that macro situation were to change and there were more opportunities, we've certainly retained enough capital that we could deploy in our current licenses to meet higher growth. So I think that your question is whether or not there could be additional capital released down the road. We're not considering that for the moment. We want to keep our flexibility for maybe a more positive market outlook, let's say, 12 to 24 months down the road. So I think our strategy here has been to provide the reward to make it meaningful, to deliver it in a way that allows investors to make a choice on whether they want to take some cash or do they actually want to effectively double down with the company and taking shares to make that a meaningful number today.

Speaker 4

But while leaving the company flexibility to continue to do the right thing and capture opportunities going forward with sufficient buffer. So that's I think the grounding or the ranging on this. In terms of funding cost, we did see funding cost over the last 12 months continue to come down. There's been 2 drivers of that. One has been the overall lower rate environment.

Speaker 4

The second though has been the change in the mix of our new business between Guaranty and Consumer Finance. Consumer Finance able to tap the interbank market, multiple funding sources has a lower net funding cost than the facilitation model by working with banks and trust companies. So as we continue to see the mix change, so that there is a greater proportion of consumer finance, even though we don't think the rate environment will necessarily drop that much in the foreseeable future, we do think that our mix change will continue to optimize slightly the overall cost of funds in the model.

Operator

Thank you. Your next question comes from Yara Lee with CICC. Please go ahead.

Speaker 7

Hello, management. Thank you for taking my question. This is Yada with CICC. And my first question is by 4Q 'twenty three, the company has completed the transition into 100 percent guaranteed model, but the bottom line was still under pressure. And I was wondering what are the main causes and how long do they take before profits could be released?

Speaker 7

And what are the main drivers for the profitability recovery? And secondly, for the consumer finance company, how was the profitability? And in future development, how we could balance the growth of the SVO and consumer finance segments? And which one could be the strategic focus? And lastly, I was wondering, are we considering additional buybacks?

Speaker 7

And what is the main cause that we choose the special dividend instead of buying back? That's all. Thank you.

Speaker 3

Thanks, Yada. So let me pick up your first question. This is Yada speaking. Because of our decline in new loan volume, the revenue we generate from new book cannot offset the decrease caused by old book shrinkies. So and on the 100% guarantee model, new model, you know that we have to accrue a lot higher upfront provision that delay the profit ratio of our new business.

Speaker 3

But on a single account basis, new loans that we enable on the 1 to person loyalty model is delivering lifetime profitability, but just record net accounting loss for the Q1 of the year because of the higher front provision. So that's the reason of delaying public recognition. And then if I explain about what are the main drivers for profitability recovering, How can we understand this ahead? Then I would say 3 things, right? The first is absolute portfolio credit performance, which we can measure by net flow rates.

Speaker 3

And then second is optimization, further optimization of what Greg mentioned, operating cost and also importantly funding cost. And then lastly, our pace, pace of new sales loan growth. We decide 3 factors will make mostly decide our profitability recovery in coming years. And then if I will answer your the last question, it was about why special dividend over buyback? Have you considered buyback?

Speaker 3

If you compare dividend versus buyback, we believe, considering the situation we are in, dividend has several more advantages. First, our ability to deliver return to shareholders through buyback is quite limited because of low liquidity. The second is, as a dual primary listed companies in U. S. And also in Hong Kong, we need to maintain at least 25% public float by Hong Kong listing rule.

Speaker 3

And our current public float is only less than 32% now. So we have very, very limited space for buyback at this moment. And this time, our dividend, that it comes with an option to choose cash or scrip. So we believe this provides more flexibility than buyback to our shareholders. So that's the reason why we decided to provide special dividends over buyback.

Speaker 3

And then one more question there.

Speaker 4

Yes. Greg here. On consumer finance, basically 2023 was the 3rd kind of full year of operation for the company. And it has been scaling up from scratch when the license was acquired. So 2023 is a profitable year for consumer finance.

Speaker 4

As the scale of that business continues to increase, it's relative efficiency, there's still some room there as it continues to scale up and we change the overall mix of the portfolio. The question of how do we balance this and what is our main strategic focus going forward. So I think the way for us to describe this is our main strategic focus, our differentiation in the market remains around serving the small business owner. This is still our core element. Where we see consumer finance playing an important role is really in 2 ways.

Speaker 4

1 is that we do believe that there are good consumer finance opportunities to work through multiple channels to diversify our product offering into providing more smaller ticket, shorter term loans that makes us to be more nimble in a dynamic environment, but also providing these capabilities to small business owners as well, because small business owners sometime act in the capacity of their company needs, which we cover under the Pou Wei business model, and sometimes they have their individual needs. Of course, we're looking at these customers from a full credit view, right? But we sometimes find that small business owners, once they have taken a long term loan, they may still have smaller interim needs. And so we want to be in a position to serve these customers kind of on a longer lifecycle with more opportunities to interact with them. And through the interaction, creating more data points to understand them and their needs.

Speaker 4

So it is a way consumer finance is a way to diversify our product offering, to provide some nimbleness in terms of ticket size, to provide some additional data in terms of behavior, as well as additional touch points to our existing customers, as well as a deeper reach into the market. So we will continue to have SVO as a core capability. But if you look at the mix between the Puhui model and the consumer finance model, you've seen that mix change quite a bit over the last 12 months. And that transition to a more balanced development you'll probably see continue in the near to medium term.

Operator

Thank you. That concludes our question and answer session for today. I'll now turn the call back over to management for closing remarks.

Speaker 1

Thank you. This concludes today's call. Thank you for joining the conference call. If you have more questions, please do not hesitate to contact the company's IR team. Thanks again.

Operator

Thank you. This conference is now concluded. You may now disconnect.

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