Lufax Holding (LU) Q3 2022 earnings call transcript

Thank you very much. Hello everyone and welcome to our third quarter 2022 earnings conference call. Our quarterly financial and operating results were released by our Newswire services earlier today and are currently available online. Today you will hear from our chairman and CEO, Mr. Y. S. Cho, who will provide an update of the macroeconomic and the COVID impacts. Our latest business strategies and recent regulatory developments. Our co-CEO, Mr. Greg Gibb, will then go through our third quarter results and provide more details on our business priorities. Afterwards, our CFO, Mr. 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 call, as we will be making forward-looking statements.

Please also note that we will discuss non-IFRS measures today, which are more thoroughly explained and reconciled to the most comparable measures reported under the International Financial Reporting Standards in our earnings release and findings with the SEC.

With that, I am now pleased to turn over the call to Mr. Y. S. Chou, Chairman and CEO of Lufax.

Thank you for joining. The third quarter has been challenging. Our core small business owner segment, which makes up 87% of our new loans facilitated excluding consumer finance loans, has been significantly impacted by the deteriorating macro environment in the third quarter. In periods of macroeconomic change, small businesses are typically the earliest to be impacted ahead of consumer finance and other lendings. As a result, our profitability has been negatively impacted due to rising credit impairment losses and credit enhancement costs. Ongoing pandemic controls and strong economic growth impacted credit quality in the third quarter. Our lead indicator for credit quality, the C2M3 ratio, which estimates the percentage of loans that will become non-performing at the end of three months, increased by 0.1% quarter on quarter to 0.8% this quarter.

However, our C2M3 ratio stood at 0.4% in the third quarter of 2021, indicating that credit quality has worsened considerably versus a year ago. In the third quarter of 2022, data from market analysts suggest that GDP share of cities with high and medium risk pandemic controls Increase versus the second quarter, which we believe is having a broader impact on small businesses, given a backdrop of declining business and consumer confidence. While credit quarter duration advanced across the board in the third quarter, we witnessed growing differences in economic resilience in various regions, which led to significant divergence in credit performance by region. Taking Shanghai for example, the C2M3 ratio for general unsecured loans spiked to 2.3% in second quarter this year.

But after a short period of time, after reopening, quickly returned to pre-lockdown level of 0.5% in third quarter 2022, demonstrating strong resilience. In comparison, C2M3 ratio for some other regions, in particular lower-tier cities, were worse and probably will take much longer to recover. Let me provide a sense of this by comparing credit quality for unsecured loans. On average, the C2M3 ratio for top performing regions, which mainly consists of cities and regions with strong economic foundations, such as Beijing and Shanghai, improved by one basis point in the third quarter compared to second quarter. So, why is the fee-to-em-see ratio for average performing regions and less desirable performing regions deteriorated by 13 and 20 basis points? Respectively, during the same period, this geographic divergence is fundamentally reshaping the map for where sustainable lending can be enabled midterm.

Today, about two-thirds of our existing business is in cities and regions where we believe the economic foundations are stronger and likely to be more resilient in recovery. Small businesses contribute to 60% of GDP and 80% of job creation while receiving only 26% of financing as of 2021 year end. We believe long-term demand will remain substantial as the small business owner segment is expected to be agile and responsive when the macro environment improves. We are confident that we are well positioned to rescale when the time is appropriate, leveraging our existing strengths, including extensive channels and institutional partnerships and a strong capital position.

However, medium term, we must first adjust our business strategies by deepening our focus on well-rated small business owners in more resilient cities with increased resilience on our direct sales force channel. The increased focus will result in reduced gross revenue in mid-term, but will improve the profitability and sustainability of new cities. We must go through a period of digesting credit losses on the existing vintages as they run down. While building up the more sustainable and profitable new portfolio, this process will likely result in new shape recovery pattern for our business. In the near term, we expect this adjusted strategy will generate new loan facilitation volumes at approximately two-thirds of the volumes we have generated in recent years.

Exact volumes will be determined by the over timing of macroeconomic recovery, which remains uncertain at this moment. While we hope that recovery will come sooner, our immediate plans assume a status quo in the current operating environment. Our optimization of resources, including further cost restructuring, will be completed over the next several quarters. During this time, we assume that our credit impairment losses and CDI credit enhancement costs will remain at elevated levels, while the underperforming portion of existing vintages run down, clearly impacting profits. Taking our certainties into account, we believe that timing for a notable improvement in our bottom line performance is more likely in 2024 than in 2023. This is clearly a challenge for us, but we are confident in our ability to execute.

We use this business reprioritization to continue to upgrade our technology, operations, and the risk management with the objective of strengthening our long-term market leadership in the small business owner segment. Given our resources, given our customer access, strong balance sheets, and long-term partnerships with financial institutions, we have the necessary advantages to navigate through this difficult period. While the operating environment demands change, the regulatory environment is now stabilizing. The 429 certification process led by PBOC and CBIIC has now transitioned to normalized regulation oversight without substantial outstanding issues for the company. Our bank guarantee model under which we bear 22.5% credit risk on the outstanding balance of loans we facilitated as of the end of September is distinct from a lending facilitation platform and in line with prevailing requirements.

Looking forward, we expect our portion of risk sharing with financial partners to increase to at least 30% over the next several quarters. As stated before, the use of our guaranteed company also allows us to share required data directly with funding partners. On October 25th, the CBIC released a report regarding the P&C industry, where credit guarantee insurance, a core component of our business model, is recognized as playing a positive role in helping small businesses increase their funding availability.

Finally, I have an update on change to our board. In consideration of potential Hong Kong listing requirements and to improve our ESG standing, we have added two new female directors, namely Ms. Cai Fang Fang and Ms. Fuxin to the board. In addition, we are pleased to welcome Mr. Ji-Guan Hong to join our board as director again. All three new directors are Ping An executives, reaffirming the ongoing support from our largest shareholder. The new board structure continues to be made up of nine members with four current independent directors, two current company directors, myself and Greg, and the three new directors who are Ping An executives. Under the new structure, we are reducing one independent director and adding an additional director nominated by Ping An.

I will now turn the call over to Greg for more detail on our operations results and business priorities.

Greg Fowler Thank you, Wayas. I will now provide more detail on results and our operational focus. Please note all figures are in RMB and all comparisons for the third quarter on a year-over-year basis, unless otherwise stated. Third quarter results were negatively impacted by deterioration in credit quality. As a result third quarter profit was billion declining 67 versus a year ago As a result of progressively tightening credit standards new loan volumes were billion declining 27 versus a year ago Credit impairment losses totaled billion increasing 137 year over year Overall profitability has also been negatively impacted by higher insurance premiums Total expenses including credit impairment losses asset impairment losses finance costs and financial costs and other losses decreased by 12.7% as a result of tighter cost control.

Third quarter revenue declined by 17.2% versus a year earlier to $13.2 billion, and our outstanding balance of loans facilitated decline by 1.3% versus a year earlier to $636 billion as of September 30, 2022. We've entered what we expect to be a U-shaped profitability pattern driven by the credit quality issues that WIADS detailed. Our historical loan vintages are now experiencing higher credit losses given the macro environment. As a result of progressive credit tightening, new business initiated in the last couple quarters is demonstrating better performance. But we must now follow a path of continuing to strengthen our collection on existing vintages while building up more sustainable and profitable new portfolio, While at the same time, we continue to refine our channel management to optimizing our direct sales force that we can be more nimble and efficient, and selecting and targeting a higher quality customer base with the most productive workforce.

This will mean reduced new business volumes and gross revenues in the medium term, but new business should be able to generate better results as compared to the historical loan vintages as a whole. We believe bottom line profit recovery will be driven by three factors, evolving credit performance of the historical vintages, runoff speed of the historical vintages, and growth rate of the prioritized new business.

At this stage, we can't accurately predict how long the historical vintages will see elevated credit impairment, as the drivers are fundamentally macro in nature. But as YS stated, timing for a notable improvement in our bottom line performance is more likely in 2024 than 2023, as new business volumes replace vintage volumes, and policy changes potentially lead to improvement in the macro environment.

Recently, we have witnessed positive signals around commitment by the banking system to support some key industries, including real estate. We believe these developments could potentially bring positive impact to the macro environment and our business, although the exact timing impact is yet difficult to predict. As we navigate through the current downturn, we will continue to strengthen our operating capabilities and financial institution partnerships.

We have recently launched our new small business owner ecosystem. Its intent is to engage potential customers at an earlier stage, deepen our interaction with existing customers, and create both new call-selling opportunities and a new source of customer referrals. As the first step, we launched the testing version of our Lu Dientong app in October 2022. Lu Dientong has an open platform design and is being populated with digital operating tools and industry-focused content for SBOs to operate their businesses more effectively. Blue Candone builds a WeChat moment that's like a social network, connecting our direct sales force with existing and prospective SBOs and helping these SBOs to better serve their existing and prospective customers to deliver more impactful marketing, more frequent engagement, and more direct feedback with their customers.

Compared with other players, we believe that our extensive offline direct sales network would allow us to acquire users more efficiently and offer more differentiated value to users. We are also continuing to develop Lufax Holding, which helps banks with strong risk capabilities acquire borrowers directly through dispersed sourcing agents nationwide. Under this model, the company does not provide or participate in credit risk sharing. Year to date, Lufax Holding provided online services to more than 10,000 active agents in their efforts to facilitate loans to partner finance institutions. For funding partners under our risk sharing model, we have increased 16 new bank partners compared to the same period last year. We continue to explore development of new data and technology solutions to share with our partner institutions in the areas of efficient customer matching, risk analytics, portfolio management, and collection services.

Our risk sharing reached 22.5% of the total portfolio as of September 30, 2022. The guaranteed company's net capital stood at $47.8 billion at the end of the third quarter, operating with a leverage ratio of 2.1 times. More broadly, our net assets stood at $95 billion with $46 billion cash on hand. Figures would provide confidence to our financial partners in this otherwise challenging environment. Our current guidance for the full year 2022 is total income $57 to $58 billion, with net profits ranging $8.5 to $8.9 billion. New loan sales for the full year are expected to reach $490 to $495 billion. Wealth management client assets are expected to end the year between $390 and $430 billion. These projections are below our previous estimates and reflect both the macroeconomic environment and our strategy to be more selective in credit selection.

These forecasts reflect our current views of the market and operational conditions which are subject to change. Finally, we would like to thank our shareholders for their continued support to our business. In October, we distributed our first PAP 2022 dividends of $0.17 per ADF, and we will continue to deliver value to our shareholders. We also continue to stay close with regulators and remain ready to initiate a Hong Kong listing plan as soon as permissible, subject to regulatory approvals.

With that, I would like to hand over to David to elaborate on our financial performance in greater detail.

Thanks, Greg. I will now provide a close look to our financials. This note says all numbers are in Remed-Been terms and all comparisons are on a year-on-year basis and as otherwise stated. Our total income for the first quarter was $13.2 billion, while net profit was $1.4 billion. Our total expenses for the first quarter grew by 11.5%. The increase in the total expenses was primarily driven by the increase in credit impairment causes, while our operating related expenses actually decreased by 12.7% due to operating efficiencies and optimizations.

Let's take a close look at our revenue. First of all, our revenue was negatively impacted by the economic environment, resulting in a 17.2% decrease in our top line this quarter. As we are dedicated to build up a more sustainable business model, the total income mix of our retail credit facilitation business continues to evolve. During this quarter, while technology platform-based income decreased by 13.3% to $6.7 billion, our net interest income grew 21.5% to $4.6 billion, and our guaranteed income grew by 44.1% to $1.9 billion. As a result, our retail credit facilitation platform service fees as a percentage of the total income decreased to 47.8% from 57.1% a year ago. As the trust funding model provided lower funding costs for the use of asset-backed securities, we continue to utilize them more in our funding mix.

As a result, income from consolidated trust is recognized as net interest income. Our net interest income as a percentage of total income actually increased to 35% from 23.9% a year ago. Moreover, we continue to better utilize our guaranteed company's abundant capital to bear more credit rates by ourselves instead of through our P&C insurance partners. As a result, we generated more guaranteed income, reaching 14.1% of total income compared with 8.1% a year ago. In terms of wealth management, a platform transaction and service fees decreased by 22.1% to $164 million in the first quarter from $467 million in the same period of $20. This decrease was primarily caused by the decline in fees generated from our current products, partially offset by the increase in fees generated from platform service.

Our other income, which mainly includes account management fees, collections, and other value-added service fees charged to our credit and enhancement partners As part of the retail credit facilitation process, it was negative $129 million in the third quarter of 2022, compared to $997 million in the same period of 2021. The majority of the decreases were due to a refund of account management fees to our primary credit enhancement partner. As a result of worse than expected collection performance and narrowing down our service group, the change of fee structure that we provided, charge for our primary credit housing policies this quarter.

Turning to our expenses, we continue to prudently manage our operational expenses. Our total expenses excluding credit and asset impairment losses, finance causes, and other losses decreased by 12.7% year-over-year to $6.7 billion before. In the third quarter, our total expenses grew to $11.1 billion from $9.9 billion a year ago. This was prioritized by an increase in credit impairment losses of $2.3 billion year-over-year. Our total sales and marketing expenses, which mainly include expenses for borrowers and investor acquisition costs, as well as general sales and marketing expenses, decreased by 11.7% to $4.1 billion in the third quarter. This decrease was driven by a decrease in the new loan sales and optimization of our commission-based compensation structure. In addition to that, the continual optimization of productivity of our direct sales force also provides us with flexibility in our cost structure.

Our general and administrative expenses decreased by 36.8% to $592 million in the first quarter from $937 million in the same period of 2021, thanks to our stringent cost control measures. Our operation and services expenses decreased by 3 to 1 billion in the first quarter from 1 billion a year ago mainly due to the decrease of trust plan management expenses and our effective expense control measures Our credit impairment losses increased by 137.7% to $4 billion in the third quarter from $1.7 billion a year ago. This was mainly driven by two factors. One, to proclaim damaging losses driven by the increased risk exposure as we move towards a more balanced risk-taking model. And second, as a reference, the company bore risks on 22.5% of its outstanding balance, up from 14.8% as of September of 2021.

Second, the change in credit performance due to the impact of COVID-19 outbreaks also contributed to the increase in credit impairment losses. Our asset impairment losses decreased to 68 million in the first quarter from 410 million a year ago. The number for the third quarter of 2021 was unusually high mainly due to impairment losses of intangible assets and goodwill. Our finance courses increased by 82.1% to 6 million in the first quarter of 2022, from 168 million in the same period of 2021, mainly due to the increase in interest expense. Other losses were 7 million in the first quarter compared to the other gains of 36 million a year ago, mainly due to the foreign exchange losses.

As a result, our net even decreased to $1.4 billion during the first quarter from $4.1 billion in the same quarter of 2021. Meanwhile, our basic and diluted earnings per ADS during the first quarter were both. They may be 2.55 yuan or US$0.08.

On the balance sheet side, our balance sheet remains strong and solid as our cash at bank balance increases. As of September 30, 2022, we had a cash balance of $45.8 billion in cash at bank, as compared with $34.7 billion as of December 31, 2021. In addition, liquid assets matured in 90 days or less amounted to 46.5 billion as of the end of September 2022. As of the end of September 2022, our guaranteed company's leverage is only at 2.1 times, whilst regulatory requirements allow us to leverage up to 10 times. All these provide strong support for the company to remain resilient in the face of economic downturn. That concludes our remarks for today. Operator, we are now ready to take questions.

Okay, let me answer your question. If I missed any, please let me know later. So, the first question about asset quality and our C20 net flow trend. Our flow rate increased by 0.1% to 0.8% in third quarter this year from 0.7% in the second quarter. And considering the resurgence of COVID-19 and the regional lockdown recently, the flow rate in the near term, we believe it will stay at a relatively high level. And then looking at October-November number, it seems like it's stable, it's just there, does not change much. We believe the realization of COVID policy and then reopening, it will surely boost up consumption and investment, both are critical for the economy that is given by confidence level.

And given we are focused, we understand that small businesses are typically the earliest to be impacted ahead of consumer finance and other lending in the downturn. They are more sensitive to COVID control measures as shown in our C2M3 network location recently. But likewise, we believe their performance will respond to the relaxation of COVID control policy quickly. So once policy gets loosened, and then we believe their performance will improve relatively quickly. And then the third question about our take rate in relation with the CGI premium. We hope a recovery will come soon. For example, in Shanghai, where we experienced almost three months consecutively, Our current performance is one of the best among 35 launches we have.

So the regional economy, the regional that the STBO environment is now hugely different. But in overall, we hope, like Shanghai, the other region can recover quickly with the relaxed pandemic control measures. But we assume it's uncertain, so we assume a status quo in the current operating environment. So in fourth quarter and early 2023, we assume that our CDI credit enhancement costs will remain at high levels, and then it affects our take rate for sure. So to mitigate this impact on take rate, we continuously optimize our funding costs, which Which is now less than 6%. And then we also keep reducing our operating costs to offset the impact from rising sea life costs. And we believe the timing for a notable U-shaped, U-shaped implements in our take rate.

In particular, the released COVID control policies, and then if we see real actions, then we believe we will see more likely in 2024 That is our fair estimation. And the last question was about loan pricing. Our portfolio API by loan balance is well in line with policy guidelines. And then it's now 21% in the third quarter, which is reduced from 21.4% from the second quarter. But if you look at new loans, it's already less than 20%. So by now, we believe, we strongly believe we are in full compliance with the regulations and window guidance given from CDIT regarding APR. And that we haven't received any further notification on reducing our APR further. And in addition to comply with regulatory requirements and guidance, the decrease of APR is also driven by our own strategy to target higher quality segments.

And in your term, we maintain our overall API level for neurons while we focus more on high-quality SBO segments in more economically resilient regions. And then, okay. Alex, any follow-up question on that?

The operating environment has been fundamentally reshaped for our STBO segments, and then this is also expected to continue in the near and then near to mid-term, we think. COVID resurgence in various key cities, it affected our operation in sales and collection. It affected lots of branches, our concentrators, and the consumer confidence level remains low, indicating overall weak market demand. So basically we got quite immediate direct hit from the macro environment change. And then having those in mind, we adjusted our risk policy and growth plan, focusing more on quality segments. So that as a result decreased our new sales volume recently. Then, so what coping measures we have to deal with the situation, we will continue to prioritize quality over volume in the meantime, and focus on sustainable profitability.

Meaning, less scale, but we go after profitable and sustainable segments. We tighten our credit standards policy and focus on customers with higher risk rating, and then particularly customers in more developed regions, and then also customers in better performing segments. And then lastly, channel-wise, we develop more direct sales channels, and then reduce dependence on other channels because we see higher customer quality from our own US channels.

Okay, then some questions about the outlook. So on the outlook, as we put forward this morning, we do think it is a U-shaped pattern. So let me explain a little bit more how this plays out. So the existing portfolio, which was acquired as early as 2020, which is still in force. So we have 2020, 2021, 2022, which makes up our existing portfolio. Over the last three quarters, we have progressively tightened our credit standards, but there is part of the portfolio which was brought into pre-tightening. That part of the portfolio is experiencing elevated levels of impairment and credit costs, and that will continue to play through over the next couple quarters. The business that we have acquired in the last couple of quarters, as Wyatt's outlined, has been done at a much higher credit standard.

That part of the business is performing better. What you have to visualize is that we have, if you will, the legacy book gradually running off over the next 12 to 18 months. Then the new book that we've been building up over Over the last couple quarters as well, will grow with a higher level of profitability. But as we have tightened our credit standards, the absolute volume in the near term will be less. You can envision the legacy running off, that's one line, and the building of the new book with new credit standards increasing, that's another line. When those two lines cross, that will determine, if you will, the turning point in our U-shaped Bottom line, a proper recovery.

Now, the exact timing for that really depends a little bit on whether there is real progress on policy change, including COVID, because we believe as soon as you have any policy change, the small business owners will respond quite quickly. And then two things will happen. The first is that the quality of the legacy business, if you will, the business initiated over the last couple of years, should actually show, you know, So, demonstrated improvement. That's number one. Number two is our willingness to accelerate new business growth at the higher standard will also increase. So, it's very hard to call right now which quarter is going to be the bottom, but if we think about this over the next year to 18 months, we know it's somewhere in that period.

And for us, what is most important is to make sure that even if we assume the worst case, which is nothing changes for the next 12 months, that we are in a very good position in terms of our capital base, in terms of our funding partners, in terms of the network and how we're prioritizing our channels. So that as soon as it does change, we can step on the gas pedal again and be very strong financially and fundamentally in our footprint and in our chosen segment. So we are doing a lot of preparation for that day that it comes, where we have confidence that we have hit that bottom in the U, and it's really time to accelerate.

We do believe that if we look around the industry that at that time our competition will most likely be less, and our relative leadership in the market will be intact, and our ability to extend it should come at that time. So it's very hard to call, as you know, a mark at the bottom, but we are relatively clear that it should be within the course of 2023, and therefore 2024 is really where you should see the notable improvement. But I really want to emphasize when we face an environment like this, the first thing to do is to really make sure that you assume the worst and are going to not only survive but prosper when it recovers.

And so that is the way we prioritize who we're selecting to serve now, how we're managing costs, where we're putting resources. So in light of that, to your follow-up question on buyback. We have bought back over time now about 110 million shares, represents more than 800 million U. S. that we bought back progressively since being listed. In the current environment, we believe we want to place, obviously, liquidity as number one. Obviously, we have a lot of it, which is important, I think, just in giving confidence to our financial partners. Two, Two, we would then prioritize dividends, and then three, we would look at other ways to create value for shareholders. In terms of dividends, obviously our policy is a cap of 40%.

That's something we will look at if needed over time, but we will prioritize dividends over maybe other aspects in the near term. Emma, does that answer your questions?

We haven't disclosed those specifics, but I think YS gave a pretty good indication of the following concept, which is even in our legacy portfolio, we have seen greater regional differentiation in credit performance. As we look across the existing book, even within the existing legacy book, we think about two-thirds of it is placed in geographies which are reasonably economic resilience, which means that of the existing book that was initiated back in 2020-2021, it's going to be in regions which are poor performing.

That doesn't give you an exact number because we haven't disclosed it, but it gives you a sense of magnitude. We are not saying the entire legacy book is bad, a lot of it is actually quite well positioned, and as we build the new book, it is actually prioritized in those stronger geographies as well. So if we've done our strategy right with the way we've tuned our credit policy, the way we're doing new business, that should help us on the upside of the EU as soon as the environment improves.

First, Yada for the questions. I guess you mentioned about the cost control and also about the CGI chat. So, first, simply put, for the cost control in particular for the DMP, I think key words is to keep focused and be nimble and efficient. We have to be placing focus on optimizing and improving the quality of our direct sales team. We also observe more significant improvements in our productivity in regions where we are successful in hiring high quality EF teams. We will keep neighbor and efficient as we are now getting more selective in targeting a higher quality customer base. In terms of the CGI percentage and cost, I think I mentioned before, what we do hope, a recovery will come sooner, but as of today, we are now assuming a critical status quo scenario, which in medium term, we assume a credit enhancement cost will still remain at elevated levels, and our CGI percentage will be at pretty much the same level we have right now.

On the question of potential Hong Kong listing, we still see it as a very important thing to be ready for, and getting ourselves ready is something that we have been focusing on. In terms of earliest timing, we would have to do it off of the back of our 2022 financial results, We're staying very close to regulators understanding whether or not any other communication is required for actually initiating the process. I think that the, as Gwaius talked about, the rectification completion, the 429 rectification completion, I think has created greater certainty. You've seen some other movement in the industry on this front. And so as soon as this is, you know, viable from both our financials being ready in terms of your financials, that's something we would obviously prioritize.

Okay, 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 team offline. Thanks again. Thank you.

Thank you. This concludes today's call. Thank you, everyone, for joining, and you may disconnect your line now.