Lufax Holding Ltd

NYSE:LU

Earnings Call Transcript 2023-Q1

[Operator]

Ladies and gentlemen, thank you for standing by, and welcome to Lufax Holding Limited First Quarter 2023 earnings call. [Operator Instructions].

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.

[Liu Xinyan, Head, Board Office and Capital Markets]

Thank you very much. Hello, everyone, and welcome to our first quarter 2023 earnings conference call. Our quarterly financials and our briefly 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 our latest business strategy, the macroeconomic trends and the recent development of our business.

Our co-CEO, Mr. Greg Gibb will then go through our first quarter results and will provide more details on our business priorities and the key drivers. Afterward, 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 now pleased to turn over the call to Mr. Y.S. Cho, Chairman and CEO of Lufax. Please.

[Y.S. Cho, Co-CEO & Chairman]

Thank you for joining. As reflected on the first quarter, it is clear that macro and operating environments continue to pose challenges for many small business owners. However, we are encouraged by some indications of an economic bond, giving us cautious optimism in our U-shape recovery. We remain committed to navigating the challenges that lie ahead and maintain our unwavering focus on building a more resilient business. We continue to exercise patients, prudence and preparedness for the anticipated macro upstream in our SBO segment.

Let me provide some updates for the first quarter. First, there are some signs of a great recovery in the macro environment though they remained unevenly distributed at a nascent stage. China's first quarter GDP growth expanding by 4.5% year-on-year indicated that the country is on track for its 2023 growth target of 5%.

In addition, China's National Bureau of Statistics stated that first quarter was of promising start to the macro recovery. However, Chinese industry profits declined 21% year-over-year, and we continue to see a divergence in the pace of recovery across industries.

While small business owners are becoming more confident and may takes some time for macroeconomic tailwinds to flow through to our core SME segments. To give an example of this improving sentiment and Peking University survey, a survey which was published in February, showed that approximately 80% of SBOs are optimistic about their business outlook in 2023. Over half of survey participants are expecting business volume increases of more than 50% this year. However, it is important to note that SBOs have had less than 2 months of normal operations in the first quarter after the spike in COVID cases and the Chinese New Year holiday. But it will take time for SBOs to fully resume new business investments, which underpins lending demand.

Now let me talk about the impact on our business. I would like to start by showing our outlook on the U-shaped recovery. During the first quarter, we will resort on improvement in credit rating mix and credit quality for new loans initiated in the last 2 quarters. 82% of new unsecured loans in the first quarter fell within our top 3 credit rating categories versus 41% a year ago.

Year on growth is increasingly concentrated in our preferred top-third and middle-third regions, which we believe will prove to be more resilient as the macro environment improves. Notably, the deterioration in asset quality has slowed down substantially in the first quarter. We have also witnessed early signs of increments in asset quality and certain economically vigilant regions and industries. We expect that flow rate will continue to improve gradually through the end of this year, when operations of SMEs gradually recover. We also expect that credit charge-offs for the risk-bearing loans will likely peak in the second quarter and then gradually decline in the second half of this year.

In the second half, we do expect total credit costs to remain elevated, but underlying driver will shift from the past charge-offs to [indiscernible] arising from increasing the portion of loans, we provide full guarantees for. This will be supported for net margins in 2024 and beyond. As new growth and portion guaranteed by us increased progressively over the next several quarters. We anticipate that the revenues will decline at a slower pace than they did this quarter. By year-end, we expect the portion of loans that we bear risk as a percentage of entire portfolio to exceed 40%. This ratio stood at 24.5% at the end of the first quarter.

Our ability to focus more on new business is made by -- made possible by 3 factors. One, the improving macro environment, two, ongoing progress in funding partners for our deployment of the model where we provide the entire guarantee. And three, the recent completion of our front line restructuring, which was difficult but necessary. As a result, the main drivers of our U-shaped recovery are taking shape. But as we have stated previously, we expect a notable recovery in profits underpinned by stabilized to the 2024 event.

As part of our U-shaped recovery plan, we have implemented several strategic initiatives. We have completed the restructuring of our direct sales force and further optimized our headquarter and frontline operating costs. Total expenses, including -- excluding credit impairment losses, finance and other costs in the first quarter decreased by 21.5% versus a year ago. The total number of that exchange costs decreased from as of the end of 2022 to around as of the end of the first quarter. We managed to retain the most positive members of our direct sales team, whose average productivity is more than double that of those who departed. In line with our plan, 80% of new business in the first quarter came from top-third and middle-third regions versus 70% a year ago.

Now that we have completed our organizational restructuring. We are focused on several priorities. Firstly, we continue to increase the proportion of risk-bearing or new loans we , under which our guaranteed subsidiary provides 100% credit enhancement. We are encouraged to see our funding partner support for the model where we provide the entire guarantee. Furthermore, as we deepen our position as an SBO adviser. We're focus on product diversification and cross selling between our retail credit in every month model and our customer finance business to meet customer needs.

This will diversify our lending duration mix, gradually adding shorter duration products to our longer-term duration base. Finally, we continue to enhance in our post loan recovery efforts to claw back a portion of past credit losses. These key initiatives are supported by our continued investments in technology, during the first quarter, we deployed new technology to help us gain deeper insights into our small business owners daily operations.

For customer onboarding, we strengthened our capabilities of -- by further embedding facial, voice and location verification features. As a result, we further enhance our ability to access -- to assess owners' business status. For the underwriting process, we introduced real-time assessment of customers' online marketing activities allowing us to further evaluate their business momentum and repayment capabilities. These changes in credit process are augmenting our historical individual credit assessment so-called KYC with a deeper insight with owners business and industries, KYB.

Next, let's move on to the capital markets. We successfully completed our Hong Kong listing by production on April 14. Marking on important milestone in our corporate development the listing will increase our exposure through out of Hong Kong market and broaden our investor base to continue to create value for our shareholders.

Additionally, we are pleased to announce that we paid out the second half of 2022 dividend an aggregate amount of USD 114.6 million, in April 2023, demonstrating our commitment to maintain a stable dividend policy. Finally, as we heard in our last only call we have substantially completed our regulatory rectification efforts, and the industry is now entering a phase of normalized provision -- supervision. We believe this normalized supervisory framework will provide greater stability and predictability for our industry, and we will work closely with regulatory authorities to ensure our compliance with all relevant regulations.

I will now turn the call over to Greg for more details on our operating results.

[Gregory Gibb, Co-CEO & Director]

Thank you, Y. S. I will now provide more details on our first quarter results and our operational focus for this year. Please note all figures are in renminbi unless otherwise stated. In the first quarter of 2023, our top line and bottom line performance were adversely impacted by the challenging macro environment. Our total income was CNY 10.1 billion, representing a decrease of 18.2% compared with the last quarter of 2022. This was mainly driven by the decrease in new loans and the pricing pressure from our credit insurance partners. Despite the challenges on our top line performance, we did turn the corner and achieved profitability this quarter. with a net profit of CNY 732 million, primarily due to a decrease in credit impairment losses.

Now let's dive into the details of our key drivers of the top line performance. One of the key drivers is our loan volume. In the first quarter of 2023, our new loans enabled were CNY 57 billion, representing a year-over-year decrease of 65%. This was mainly driven by our tightened credit standards on new loans enabled. Executing on our strategic initiative in response to the elevated credit impairment losses in the first quarter, we continue to prioritize higher-quality SBO customer segments concentrated in economically more resilient geographies. The proportion of new unsecured loans enabled in the R1 to R3 customers, which are our top 3 rankings in our R1 to R6 scale, increased to 82% in the first quarter from 41% in the same period of last year. Meanwhile, the contribution from customers in the top third and middle-third regions continued to increase and reached 80% in the first quarter of 2023 compared to 70% a year ago.

New loans were adversely impacted in the short run by the optimization of our direct sales team, which was difficult but necessary for the long-term development of the company. The optimization was completed in the first quarter, and we managed to retain the more experienced and productive members of our direct sales force. The average productivity are by retained direct sales employees is more than double that . We believe that we are on the right path, and we expect to see the results reflected in upcoming quarters. Additionally, we have observed that new loan vintages enabled after we tightened our credit standards demonstrate improved asset quality compared with older loan vintages.

As we focus on higher-quality SBOs, the average ticket size has naturally increased as a result. Average ticket size of unsecured loans for the first quarter of 2023 increased to revenue CNY 270,000 from CNY 240,000 average for the year of 2022. Our Consumer Finance business saw healthy growth in the first quarter despite the challenges in our retail enablement model. The total outstanding balance for consumer finance loans in the first quarter of 2023 was CNY 29.6 billion, up 39% year-over-year, and credit performance was in line with the industry credit performance. Contribution from our consumer finance business grew as a percentage of new loans enabled and increased from 11% in the first quarter of 2022 to 24% this quarter.

Further diversifying our product offerings. Another key driver of our top line performance is take rate. As mentioned earlier, our take rate remains compressed, which is mainly due to the elevated premiums charged by credit insurance partners. Although our tightened credit standards have improved asset quality of new loans, credit insurance premiums have remained at an elevated level to date. We are proactively addressing the take rate pressure by continuing to modify our credit enhancement arrangements. Under these arrangements, our guaranteed company provides full credit enhancement without the involvement of external credit insurance partners. We are encouraged by the fact that our funding partners are supportive of the shift as of mid-May, 5 out of 6 Trust partners and 37 out of 78 bank partners have agreed to extend credit under the model where we provide the entire guarantee.

In addition, 31 of our funding partners are already extending new loans under the model where we provide the entire guarantee. As a result, our credit risk-bearing by balance in the first quarter, further increased to 24.5% and is expected to exceed 40% by the end of this year. We believe we have adequate capital to support the increase in risk-bearing loans as the leverage ratio of our guaranteed subsidiary was less than 2x. And as of the end of the first quarter, well below the regulatory limit of 10x. As such, we expect our take rate will gradually improve over the next several quarters as we increase the guarantee portion for new loan business.

Next, let's go to the details of our bottom line drivers. The main driver of recovery in our bottom line was a decrease in credit impairment losses. In the first quarter, credit impairment losses declined by more than and to CNY 3.1 billion from billion in the fourth quarter of 2022. This was mainly driven by a notable decrease in provisions compared with the previous quarter as we've taken a more conservative view on the outlook for credit quality prior to post-pandemic reopening. As the macro environment gradually normalizes and activity is picking up in the first quarter, we partially released a portion of the previously [indiscernible] provisions, which had a positive impact on our P&L.

The improvement in our credit impairment losses is also visible in our C-M3 ratios. The forward indicator on asset quality that we monitor closely, it stood at 1% in the first quarter, remaining unchanged compared with the fourth quarter of 2022. This was primarily attributable to the increase of C-M3 for general unsecured loans from 1.1% in the fourth quarter of 2022 to 1.2% in the first quarter, but this was partially offset by a decrease in the flow rate for secured loans from 0.6% to 0.5%. while the asset quality of secured loans is clearly improving, it is worth noting the deterioration in asset quality of unsecured loans has slowed down substantially in the first quarter, and the delta of C-M3 flow rate was 10 basis point increase versus a 20 basis point increase in the fourth quarter of 2022. We will continue to monitor closely such indicators in the coming quarters as they are critical to determining the speed of our U-shape recovery.

Looking ahead for the remainder of 2023, we expect credit impairment losses at each quarter to be on par with those during the first quarter. This is mainly due to our planned expansion of the model where we provide the entire guarantee during the coming quarters. The extension of such model will increase upfront provision levels, but should result in improved net margins over the medium term.

During the first quarter, we continued to make progress on our new SBO ecosystem, as a recap, our new value-added services platform, branded LuDianTong, is an open platform populated with digital operating tools and industry content to support business development for our small business owners. We intend to use this platform to engage potential customers at an earlier stage, deepen our interaction with existing customers and create both new cross-sell opportunities and a new source of customer referral.

As of March 31, 2023, we had approximately 1.9 million registered customers on LuDianTong who has submitted their complete business or personal information, an expansion of roughly sevenfold from the end of 2022 and through this first quarter. As Y.S. mentioned in the face of an uneven post-pandemic economic recovery, we are cautiously optimistic in realizing our U-shape recovery. However, we will remain prudent on absolute levels of new growth until we see definitive improvement in overall lending demand and credit quality. While we expect to see gradual recovery in our core business metrics in the second half of this year, notable bottom line performance improvement is expected to be a 2024 event.

I will now turn it over to David, our CFO, for more details on our financial performance.

[David Choy, CFO]

Thank you. Greg. I'll now provides a closer look at our first quarter results. Please note, all numbers are in renminbi terms, and all comparisons are on a year-on-year basis unless otherwise stated. As Y.S. has [indiscernible] before our performance was impacted by the macro environment and our customer selection resulting of 41.8% our top line total income to CNY 10.1 billion for the first quarter. Loss of total expenses decreased by 8.8% to CNY 9 billion as a result on was RMB 732 million in the first quarter of 2023.

During this quarter, our technology-based income -- techcom-based income was CNY 5 billion, representing an increase of 46.1% of our revenue. Our net interest income was CNY 3.3 billion, a decrease of 32.8% and our guaranteed income was CNY 1.4 billion, representing a decrease of 25.5%. As a result, our technology platform-based income service fees as a percentage of total income declined to 49.7% from 53.7% a year ago. In addition, due to the increase of income from consumer finance loans, our net interest expense of total income actually increased to 33.2% from 28.8% a year ago. Furthermore, as we continue to better utilize our guaranteed company's abundant capital to bear more credit risk by ourselves instead of through our P&C insurance partners, we generated more guarantee income, reaching 14.1% of the total income as compared with 11% a year ago.

Our other income, which mainly includes account management fees, collections and other value-added service fees charged to our credit enhancement partners as part of the retail credit enablement process was CNY 227 million in the first quarter of '23 compared to CNY 704 million in the same period of '22. The change was mainly due to change in the fee structure that we charge to our primary credit enhancement partner.

Turning to our expenses. We continue to prudently manage our operational expenses. Our total expenses excluding credit and asset impairment losses by this quarter and other losses decreased by 21.5% year-over-year to CNY 5.7 billion quarter. Returning to the operating efficiency, in the first quarter, our total expense decreased by 11.8% to CNY 9 billion from CNY 10.2 billion a year. This decrease was primarily driven by sales and marketing expenses.

Our total sales and marketing expenses, which mainly includes expenses for borrowers and investor acquisition costs as well as general sales and marketing expenses decreased by 32.4% to CNY 3 billion in the first quarter.

The decrease was driven by 3 factors, first, a decrease in new loan sales and reduction in commissions. Second, the decrease in investor acquisition and retention expenses and referral expenses for platform services driven by decrease [indiscernible]. And finally, the decreased general, sales and marketing expenses, which was driven by the decrease in new sales.

Our general and administrative expenses increased by 4.2% to CNY 756 million in the first quarter, mainly due to the fixed cost, which decreased low volume. Our operating and servicing expenses decreased by 2% to CNY 1.6 billion in the first quarter, mainly due to the expense controlling measures and decreased loan balance and new loan sales. Our credit impairment losses was CNY 3.1 billion in the first quarter compared with CNY 2.8 billion a year ago, an increase of 10.9%, it was primarily driven by the increase in indemnity losses as a result of worsening credit performance due to -- largely due to the part of [indiscernible] of economic environment partially offset by the increase in [indiscernible] driven by the pace of .

Our finance costs decreased by 10.5% to CNY 189 million in the first quarter from CNY 211 million for -- the in the same period of 2022, mainly due to the increase of interest from bank deposits, partly offset on the increase of the interest spend driven by increased business rates. As a result, net profit for the first quarter was CNY 732 million compared with net profit of CNY 1.3 billion in the same quarter of '22. Meanwhile, our basic and diluted earnings per ADS during the first quarter, both RMB 0.30 or USD 0.04 [indiscernible]. On the balance sheet side, our balance sheet remains strong and solid cash at bank products increased as of March 31, 2023 with a cash balance of CNY 51.3 billion as compared with CNY 43.9 billion as of the end of last year.

In addition, liquid assets maturing in 90 days or less amounted to CNY 40.2 billion as of the end of March 2023, our guaranteed subsidiary income [indiscernible] 1.7x [indiscernible] regulatory limit of 10x. All this provides strong support the company to mainline base of other sensors actually continue our stable different payout policy.

That concludes our prepared for today. Operator, we are now ready for the questions.

[Operator]

[Operator Instructions]. We now have our first question from Alex Ye from UBS.

[Alex Ye, UBS]

So my question is mainly on the pricing outlook. So could you give us some color in terms of what's the average loan pricing for our portfolio and about the pricing for the new unsecured loans. So -- and I guess there are 2 parts to this question. First, on the regulatory front. So we have been lowering the loan price in the past 2 to 3 years due to some regulatory pressure. So I'm wondering if there any follow-up or comments from the regulators in terms of where we are? Do you think we have reached a level where the regulator is now more comfortable with?

And second, if we just put aside the regulatory pressure for now and just focus on the supply and demand dynamics for the SBO segment, should we expect some further downward pressure on loan pricing ahead given now that we are further upgrading our customer profile to better quality borrowers, and given the current pace of economic recovery appear to be quite modest, Thanks to hear your view.

[Y.S. Cho, Co-CEO & Chairman]

Thanks, Alex, for the question. So far, we haven't got any further instructions from regulators about further rolling APR. If you look at the first quarter APR -- blended APR for all new loans in the first quarter is already less than 20%. And then that, if you compare with other peers, we are absolutely and obviously lower than other peers, average APR. We are quite low.

So I believe we are in a good shape in terms of our APR level. And I believe that really we'll met regulatory requirements and now we also have more flexibility in others for just APR upwards or downwards, whenever necessary. Our overall price is more determined by market demand and supply. And also, we consider our operating costs, which includes funding cost and the credit cost and then our -- the operating costs, which include sales expense, right? So we don't think that the it high-risk [indiscernible] segment, which will necessarily further reviews of our APR, we already less than again, less than 20% for all loans. So I expect -- I don't expect a notable change in terms of APR in near future.

[Operator]

We now have our next question from Emma Xu of Bank of America.

[Emma Xu, Bank of America Merrill Lynch]

I have two. The first one is about asset quality. So we see -- on one hand, we see some encouraging signs of your portfolio. As the management mentioned earlier that there is already some green shoots in the business and you expect flow rate to gradually improve in the coming quarters. However, on the other hand, we see the flow rate of your unsecured loan continued to increase in first quarter while total flow rate just remained flat quarter-over-quarter. So could you give us more discussion about your -- the asset quality of your legacy loan portfolio.

And a related question is how is the collection of your charge of loans as the management also mentioned in the report that you are trying to increase the effort to recover past credit losses, which may contribute to the net profit in the future. So could you give us more details on this brand?

The second question is about the loan demand. So how is the loan demand so far? And is the high CGI cost, the major reason limit your loan growth in first quarter. What's your progress of moving to the 100% guaranteed model? And will we expect to see the loan growth more -- to see more strong loan growth in the second half when you move to this entire guaranteed model?

[Y.S. Cho, Co-CEO & Chairman]

Thanks, Emma. The situation in asset quality has slowed down substantially in the first quarter. If you look at C-M3 growth rate for the total loans was 1.0% in the first quarter this year, which remained unchanged from first quarter last year. But if we consider that our balance -- loan balance has been declining in this month, month after month. So if we're analyzing this, for example, if you only compare the accounts, whose milestone book is less than 6 months or 12 months. So if we remove the impact from declining balance on our net flow rate. Then now we already see sort an increment trend. I believe we can show -- we can demonstrate more obvious implements from the next quarter onwards. So that you have confidence. And as the company continuously carry on new sales for credit plan, now we observe an improvement in credit rating mix and credit quality for new loans initiated in the last 2 quarters.

Yes, you know that we had a large amount of charge-off last year, so that is one of our focus this year. We are now strengthening our cost recovery actions to claw back more from the past credit losses. And to answer your question about loan demand. Our loan demand is decided by how our SBO customers see your future economy, right? And industry regard you haven't seen any obvious change in a world but no matter what, if you understand our monthly new sales volume and then our market share, actually, loan demand is not about a concern because we are compared to the market size, our market share is very small.

So we don't really worry about loan demand at this moment. And the decrease of new loan growth, recent decrease was mainly driven by our tightened underwriting credit policy and also partially to our GST reform. That was the reason. And spin of 100% guaranteed model, we are making a great progress. We are very happy. We are encouraged to see that our funding partners did provide good support for the model where we provide the entire guarantee by now 5 out of 6 trust partners they agreed and 37 out of 78 bank partners they also agreed to expand credit on the model where we provide a full guarantee. In addition, 31 of our funding partners are already providing loans under this model. So we are making a good progress. And then I think the formation can be relatively quick.

[Operator]

We now have our next question from Richard Xu of Morgan Stanley.

[Richard Xu, Morgan Stanley]

I have questions on funding costs. Just wondering what's the funding cost at the moment, basically, as we change from the insurance model to the guaranteed model? And what's the overall impact on take rate and what would be the level expected to stabilize when shift to guaranteed model is largely complete.

[Gregory Gibb, Co-CEO & Director]

Thank you, Richard. It's Greg here. If we look at the funding costs, which are about 6% overall. They have come down about 30 basis points if you look at the first quarter on a year-on-year basis. As we shift to the 100% guaranteed model, we're not seeing much change in that funding cost. In fact, probably you're seeing the market more broadly coming down. So any shift to the guaranteed model is really not having a net impact in terms of funding cost increase. We think it will be quite stable as we look forward through the remainder of the year.

On the take rate, if you kind of go and look at historically, our take rates has been in the sort of 8% to 10% range, more recently due to the higher credit guarantee insurance costs, that take rate is now closer to about 7%, 8% range.

As we then move to the 100% guaranteed model, right? So if you look out over a year or 1.5 years from now when more of the portfolio will be 100% guaranteed, that credit premium or credit insurance premium that was previously paid to our CGI partners will be earned by us. And that number was historically about 5% to 6%. So if you take a base today of 7% to 8%, which is obviously compressed because of the higher CGIPs and we move to the guaranteed model, where that take rate moves over to us. Then you should be looking at on a stabilized basis over the longer term, a take rate of about 14%. So we think that's, Rich, where things will end up probably in about 1.5 years from now when we've made more of the complete shift.

[Operator]

We now have our next question from Yada Li of CICC.

[Yada Li, CICC]

This is Yada from CICC. My question today is regarding the risk-bearing percentage. And I was wondering what is the trend of this percentage going forward? And how to view this change and potential impact on our top line credit impairment losses and the bottom line. And that's all.

[Gregory Gibb, Co-CEO & Director]

In terms of the risk-bearing percentage, as of the end of this first quarter, it was at about 24%. We expect by the end of the year, on a portfolio basis to be over 40%. And that means, as you move through the second half of the year for new loans, a much higher percentage will be under this 100% self-guarantee model. Now as we go through that process, similar to the question that Richard just asked, that will increase our top line revenue because you're basically moving what was paid previously to credit guarantee insurance partners onto the balance sheet, and therefore, the revenue will come with it. So that will provide a basis for a revenue increase.

As we take on more credit risk, we initially have to provision for the new loans. So that is front-loaded in the model. So what you'll see in our overall credit impairment costs right? We had credit impairment costs in Q1 of CNY 3.1 billion. We expect this number over the next couple of quarters to remain stable, but what's driving it, the mix is changing.

So CNY 3.1 billion in the first quarter is mostly from the credit impairment cost from the legacy portfolio, if you will, the existing past book. As we move into the second half of this year, you'll still be at about CNY 3 billion or so credit impairment cost, but more and more of it will be coming from the fact that the new business has done -- a higher percentage of new business is done through self-guarantee.

So while that carries a higher upfront cost, if we look forward into 2024, it should also improve our net margin, right? Because you're shifting from a very high credit insurance cost today of over 10%, right, to a model where we think that the new business that we're doing should perform more in line with historical levels. And that should be, therefore, constructive for our 2024 profitability.

[Operator]

There are no more questions on the line. That concludes our question-and-answer session for today. I will now turn the call back over to our management for closing remarks.

[Liu Xinyan, Head, Board Office and Capital Markets]

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]

This concludes today's call. Thank you for joining. You may now disconnect your lines. Thank you.