Challenger Limited · ASX:CGF
Challenger — Challenger Financial Services Group — H1 2004 Earnings Presentation
133 slides from Challenger's earnings presentation, Feb 23, 2004
Slide 1: Add image for first slide
Add image for first slide 1
Slide 2: Market briefing – 31 December 2003 half year results
Challenger Financial Services Group Limited Market briefing – 31 December 2003 half year results Chris Cuffe, Chief Executive Officer Tim Foster, Chief Financial Officer 23 February 2004
Slide 3: Contents
Contents Business overview 3 Financial results 7 Assets under management / advice 36 Progress of core business units Annuities 39 Mortgage finance 75 Funds management, admin & financial planning 115 Other business issues 126 Summary 133 3
Slide 4: Business overview
Business overview • Diversified financial services company focussed on 3 strongly growing core businesses where we have competitive advantages: — Annuities – Backed by growth assets — Mortgage finance – Howard Mortgage Trust – Interstar Securities – The Mortgage Alternative — Funds management, admin
Slide 5: Events snapshot
Events snapshot 1 July Merger of Challenger International and CPH Investment Corp 26 August Included in S&P/ASX100 9 September Alliance – Orion Asset Management 29 September Acquisition – Interstar Securities 3 December Peter Greentree appointed Head of Equities, further strengthening existing inves
Slide 6: Contents
Contents Business overview 3 Financial results 7 Assets under management / advice 36 Progress of core business units Annuities 39 Mortgage finance 75 Funds management, admin & financial planning 115 Other business issues 126 Summary 133 6
Slide 7: Financial results
Financial results Summary of earnings 7 Modified accounting methodology 11 Breakdown of earnings 15 Group balance sheet 24 Other financial information 31 7
Slide 8: Summary of earnings
Summary of earnings Six months to 31 December 2003 Consolidated using Consolidated using Margin on Services annuities modified statutory basis accounting basis $m $m Profit pre-tax & corporate charges 66.6 28.7 Corporate charges (16.6) (16.6) Profit before tax 50.0 12.1 Income tax expense (16.7) (3.
Slide 9: Summary of earnings cont.
Summary of earnings cont. Pleasing result reflecting: • Transparent and solid profit from the annuity business: — Emerging annuitant margins — No property revaluation uplift — No subsidiary revaluation profit — Benefit from interest rate and A$ rises (MoS only) • Strong profit from mortgage finance
Slide 10: Summary of earnings cont.
Summary of earnings cont. • Fast growing but immature funds management, administration & financial planning business • Losses from non core businesses which we are rapidly addressing • Corporate charges include: — Amortisation of goodwill; and — CPH management fee up to 21 December 2003 10
Slide 11: Financial results
Financial results Summary of earnings 7 Modified accounting methodology 11 Breakdown of earnings 15 Group balance sheet 24 Other financial information 31 11
Slide 12: Modified accounting methodology
Modified accounting methodology • Group results presented both on: — A statutory basis (annuities result determined using the statutory Margin-on-Services methodology); and — Applying a ‘modified accounting’ methodology for the annuities segment • Alternative method of accounting for the annuity bus
Slide 13: Modified accounting methodology cont.
Modified accounting methodology cont. • Presented to assist the market in understanding the underlying operating profits of the annuity business, better reflecting business fundamentals: – Term annuities are fundamentally a ‘spread’ business – Rent and interest income earned on assets is used to pay
Slide 14: Modified accounting methodology cont.
Modified accounting methodology cont. • Provides a more comparable methodology with funds management and mortgage finance products • Consideration given to direction emerging under international accounting standards • In addition to operating margins emerging under modified accounting, property back
Slide 15: Financial results
Financial results Summary of earnings 7 Modified accounting methodology 11 Breakdown of earnings 15 Group balance sheet 24 Other financial information 31 15
Slide 16: Breakdown of earnings
Breakdown of earnings Six Months to 31 December 2003 Statutory NPAT $m CFSG Trust 1 July to 21 December 32.6 CFSGL (Company) 22 December to 31 December 0.7 – Appendix 4D Total 33.3 Earnings summary aggregates the trust and company results for the period. ‘Corporatisation’ occurred on 22 December and
Slide 17: Breakdown of earnings by segment
Breakdown of earnings By segment Statutory basis Modified basis $m $m Annuities 60.2 22.3 Mortgage finance 13.5 13.5 Funds management, administration & (9.9) (9.9) financial planning Non-core businesses / assets 2.8 2.8 Profit pre-tax and corporate charges 66.6 28.7 Corporate charges (16.6) (16.6) P
Slide 18: Annuities - statutory result
Annuities - statutory result Margins emerging $m Planned profit margins released (MoS) 3.6 Net experience items (MoS) 0.2 Return from rent less interest used to repay 14.1 annuitant principal/senior debt Earnings on excess assets 1.7 Total margins emerging 19.6 Market related movements - effect of c
Slide 19: Annuities – modified accounting
Annuities – modified accounting Effective $m yield pa Revenue Net rental received 108.2 8.3% Investment income 41.0 6.0% Operating expenses Debt interest (61.4) 6.7% Annuitant interest (42.3) 4.6% Commissions paid (8.5) Gross margin 37.0 Overheads (14.7) Contribution pre-tax 22.3 Handout reconciles
Slide 20: Mortgage finance
Mortgage finance Revenue Operating Gross Overheads Contribution Expenses margin $m pre-tax $m $m $m $m Howard Mortgage 22.9 (3.8) 19.1 (9.4) 9.7 ³ Cost to income ratio <50% Trust ³ 3 months contribution Interstar Securities 39.7 (27.3) 12.4 (8.3) 4.1 ³ December rate rises will boost ongoing earnings
Slide 21: Funds management, administration & financial planning
Funds management, administration & financial planning $m Revenue 54.3 Operating expenses (33.1) Gross margin 21.2 Overheads (31.1) Contribution pre-tax (9.9) 21
Slide 22: Non core businesses / assets
Non core businesses / assets Contribution pre-tax $m Equity accounted profits from private equity investments 2.5 Profit on disposal of non core investments 3.8 Loss on non core businesses (3.5) Contribution pre-tax 2.8 22
Slide 23: Corporate charges
Corporate charges $m External costs in seeking to refinance and ← Non recurring post (2.7) January 2004 securitise the property-related debt ← Non recurring with CPHIC management fee (3.4) corporatisation ← Recurring as will be Other costs reimbursed to CPHIC (0.7) incurred directly Interest payable
Slide 24: Financial results
Financial results Summary of earnings 7 Modified accounting methodology 11 Breakdown of earnings 15 Group balance sheet 24 Other financial information 31 24
Slide 25: Group balance sheet
Group balance sheet 31/12/03 30/06/03 $m $m ³ $235m merger capital injection invested in period Cash 351 660 ³ $77m net cash impact on the Interstar acquisition Receivables and non Life 395 421 investments Forestry assets 54 - ³Acquired with Interstar Other assets 194 52 ³ Interstar DAC $116m (DAC,
Slide 26: Group balance sheet
Group balance sheet 31/12/03 30/06/03 $m $m Payables and 258 179 provisions Other liabilities ³ Swaps/forwards now asset at - 78 (swaps/forwards) 31/12/03 ³ Interstar plus tax on Taxation 108 75 period result Debt 2,112 2,023 ³ Refer analysis ³ Growth in annuity book and Policyholder liabilities 1,9
Slide 27: Debt comprises
Debt comprises 31/12/03 30/6/03 $m $m ← Effect of ÇA$ on Sterling/US$ Within property trusts 1,684 1,725 debt (offset by movement in hedges) Share finance margin 149 159 lending loans Core group debt 85 85 ← Secured over shares in Interstar facility 125 - Interstar and over future Interstar net inte
Slide 28: Goodwill
Goodwill $m As at 30 June 278 Goodwill on Interstar acquisition 158 Goodwill amortised: - Merger (6 months) (7) ³ Being amortised over - Interstar (3 months) (2) 20 years ³ Arisen because net assets on 22 December Goodwill adjustment on corporatisation (25) exceeded deemed market value of $0.47 per
Slide 29: Balance sheet analysis
Balance sheet analysis Goodwill Tax effect NTA* Total EMVONA EMVONA Life companies 461 136 (36) 561 Interstar (20) 156 - 136 Other (funds management, admin and financial planning, other 61 239 (40) 260 businesses & corporate debt) Merger/corporatisation goodwill - 246 - 246 Total 502 777 (76) 1,203
Slide 30: Balance sheet
Balance sheet Reconciliation to ‘corporatisation’ pro-forma Net assets $m ‘Corporatisation’ pro-forma 1,452 Lower share issue price (47c v 52c) (122) Long-term incentive plan not enacted prior (127) to 31 December 2003 Actual 31 December 2003 1,203 30
Slide 31: Financial results
Financial results Summary of earnings 7 Modified accounting methodology 11 Breakdown of earnings 15 Group balance sheet 24 Other financial information 31 31
Slide 32: Capital structure
Capital structure Balance 000’s sheet value $m Ordinary shares on issue 2,439,036 1,140.5 Non-transferable options held by CPH (pursuant to 300,000 60.0 corporatisation) - Strike price of $0.65 (exercise any time until 22/12/13) - Fair value via Grant Samuel valuation Former Challenger International
Slide 33: Key ratios
Key ratios Current Net asset backing $0.49 EPS 1.4c 33
Slide 34: Summary of cash flow
Summary of cash flow Life Non-life Total $m $m $m Cash at 30 June 2003 478 182 660 (inc. life company $235m cash injection) Operating cash flow 107 (34) 73 Investing activities cash flow (332) (68) (400) Financing activities cash flow 5 (7) (2) Prior period reclassification/FX changes 20 - 20 Cash a
Slide 35: Non-life operating net cash outflow
Non-life operating net cash outflow Key drivers Actions taken Cash drag from growth in Interstar • Rate rises in December will reduce cash drag going forward • Draw down on Interstar facility • Well progressed in securitising Interstar’s mortgage servicing right Howard Mortgage Trust generates Will
Slide 36: Contents
Contents Business overview 3 Financial results 7 Assets under management / advice 36 Progress of core business units Annuities 39 Mortgage finance 75 Funds management, admin & financial planning 115 Other business issues 126 Summary 133 36
Slide 37: Assets under management/advice
Assets under management/advice Managed investments 31/12/03 30/06/03 Annuities investments 31/12/03 30/06/03 (including market linked life policies) $m $m (including fixed rate superannuation $m $m and allocated pension) Australian equites funds/mandates 1,156 535 Direct property 2,559 2,614 Interna
Slide 38: Number of investors
Number of investors 31/12/03 31/06/03 Long term annuities 16,542 14,753 Short term annuities 8,118 8,955 Managed funds 77,348 70,658 Closed life policies 2,886 3,004 Total 101,894 97,370 38
Slide 39: Contents
Contents Business overview 3 Financial results 7 Assets under management / advice 36 Progress of core business units Annuities 39 Mortgage finance 75 Funds management, admin & financial planning 115 Other business issues 126 Summary 133 39
Slide 40: Annuities
Annuities Challenger’s annuity model 40 Sales and market share 46 Assets backing the model 55 Cash flow 60 A growing earnings stream 64 Risk management 66 Regulatory matters 73
Slide 41: The basic proposition
The basic proposition • Retirees attracted to social security and tax advantages provided by complying annuities • Annuitants want to forgo investment risk for the certainty of fixed/known returns • Challenger is a patient investor, hence growth assets are attractive as we can ‘ride out’ volatility
Slide 42: Annuities are an efficient source of funds for the assets we invest in
Annuities are an efficient source of funds for the assets we invest in and a beneficial investment for many retirees Retirement Finding assets Supplying which deliver Income both stable income certainty to income to Australian annuitants retirees and growth prospects to Investment shareholders Our a
Slide 43: Why we employ leverage
Why we employ leverage • Cash flow matching — Property cash flows are generally not sufficient to pay interest and principal on annuity obligations — Prudent use of leverage allows us to: – Increase property cash flows to meet all obligations as they fall due – Generate an attractive return for annu
Slide 44: Possibility of having less leverage
Possibility of having less leverage • Two developments are influencing our capital strategy in relation to property assets — The cost of annuity funds relative to other sources of funds has been falling – It is becoming sensible to explore retiring some senior debt and replacing it with new annuitan
Slide 45: Managing our capital
Managing our capital • Capital buffers are used to mitigate risks in our asset portfolio — Leasing and other property risk — Refinance risk — Credit risk — Market risk • Capital management serves to insulate annuitants from shocks to our asset portfolio • Capital provisions are prescribed by: — Life
Slide 46: Annuities
Annuities Challenger’s annuity model 40 Sales and market share 46 Assets backing the model 55 Cash flow 60 A growing earnings stream 64 Risk management 66 Regulatory matters 73
Slide 47: Sales – long term annuities
Sales – long term annuities Sales (qtrly) - long term annuities 140 120 100 80 $m 60 40 20 0 Sep Dec Mar Jun Sep Dec Mar Jun Sep Dec Mar Jun Sep Dec Mar Jun 2000 2000 2001 2001 2001 2001 2002 2002 2002 2002 2003 2003 2003 2003 2004 2004 Financial year totals 2001 $211.8 m 2002 $337.5 m 2003 $413.4 m
Slide 48: Sales – short term annuities
Sales – short term annuities Sales (qtrly) - Short term annuities 180 160 140 120 $m 100 80 60 40 20 0 Sep Dec Mar Jun Sep Dec Mar Jun Sep Dec Mar Jun Sep Dec Mar Jun 2000 2000 2001 2001 2001 2001 2002 2002 2002 2002 2003 2003 2003 2003 2004 2004 Financial Year Totals 2001 $264.2 m 2002 $280.9 m 200
Slide 49: Market growth – long term annuities
Market growth – long term annuities Market sales - long term annuities 1,600.0 1,400.0 1,200.0 1,000.0 $m 800.0 600.0 400.0 200.0 0.0 2000 2001 2002 2003 Source: Plan for Life The market appetite for long term annuities is growing strongly 49
Slide 50: Market growth – short term annuities
Market growth – short term annuities Market sales - short term annuities 3,000.0 2,500.0 2,000.0 $m 1,500.0 1,000.0 500.0 0.0 2000 2001 2002 2003 Source: Plan for Life The short term annuities market has declined, due to more attractive alternatives 50
Slide 51: Long term annuities – strong growth predicted
Long term annuities – strong growth predicted • The ageing population and government policy favour retirement products • Complying annuities (which are long term) are suitable products for Department of Social Security (DSS) and Reasonable Benefits Limits (RBL) retirement planning • Market predicted
Slide 52: Challenger’s market share
Challenger’s market share Market share - annuity sales 40.0% Short Term 35.0% Long Term 30.0% 25.0% 20.0% 15.0% 10.0% 5.0% 0.0% 0 1 1 2 2 9 9 0 2 3 3 0 1 9 00 01 02 03 -0 -0 -0 -0 -0 -9 -9 -0 -0 -0 -0 -0 -0 9 n- n- n- n- n- p p p p ec ec p ar ar ec ec ar ar Se Se Se Se Se Ju Ju Ju Ju Ju M M M M D D
Slide 53: Rates - Challenger still a market leader
Rates - Challenger still a market leader A n n u ity M a rk e t R a te s (1 5 Y e a r N il R C V ) - M a rg in to A U D S w a p 1 .0 % A M P L ife A X A A u s tra lia B T F in a n c ia l G ro u p C h a lle n g e r L ife 0 .5 % C itic o rp L ife C o lo n ia l / C o m m In s u re IN G Tower W e s tp a
Slide 54: Future sales strategies
Future sales strategies • Increase adviser/investor education about the benefits of complying annuities • Synergistic benefits from funds management branding and distribution efforts • If suitable long term asset opportunities present themselves we have the flexibility to provide higher rates to ann
Slide 55: Annuities
Annuities Challenger’s annuity model 40 Sales and market share 46 Assets backing the model 55 Cash flow 60 A growing earnings stream 64 Risk management 66 Regulatory matters 73
Slide 56: Current asset mix
Current asset mix Looking through internal underlying property trusts Assets Liabilities Properties 2,559m Policy holder liabilities 1,818m Senior debt & 1684 Fixed income 1,169m Interest rate swaps 60 1,744m Cash & other 256m Other liabilities 60m Excess of assets over FX forwards 84m 446m liabilit
Slide 57: Current property portfolio
Current property portfolio Property allocation 31/12/03 by sector by location Retail / QLD US entertainment 2% 12% NSW 13% 22% Industrial 6% UK 25% Tas 2% SA Vic Commercial 2% ACT 24% WA 81% 9% 2% 57
Slide 58: Fixed income portfolio
Fixed income portfolio Other 14% Converting preference shares 26% Bank bills 8% Floating rate notes 11% Convertible & capital notes 10% Mortgage backed secuities 11% Bonds 20% 58
Slide 59: Type and supply of long term assets
Type and supply of long term assets • Commercial property will continue to play a major part — Due to unique combination of term, income stability and growth potential — We are comfortable sourcing properties offshore — We are in active discussion on several acquisition opportunities • Actively expl
Slide 60: Annuities
Annuities Challenger’s annuity model 40 Sales & market share 46 Assets backing the model 55 Cash flow 60 A growing earnings stream 64 Risk management 66 Regulatory matters 73
Slide 61: Cash flow projections
Cash flow projections 500 Operating cash flow Cash 400 Terminal value of properties 300 $m 200 Predominantly fixed income disposals in excess of annuitant obligations 100 0 2004 2008 2012 2016 2020 >=2024 (100) Based on existing asset portfolio Lease cash flow projections adjusted for expected defau
Slide 62: Cumulative cash balance projection
Cumulative cash balance projection 3,500 3,000 2,500 2,000 $m 1,500 1,000 500 0 2004 2007 2010 2013 2016 2019 2022 Based on existing asset portfolio Lease cash flow projections adjusted for expected Assumes no new business defaults Assumes no dividends paid Proceeds forecasted reflect capital expend
Slide 63: Cash available for dividends/growth
Cash available for dividends/growth • ‘Spread’ means model is strongly cash flow positive • Main use of cash is to pay down annuitant principal (i.e. to extinguish liabilities)… analogous to a compulsory ‘dividend reinvestment plan’ • For the existing book, after meeting annuitant obligations, free
Slide 64: Annuities
Annuities Challenger’s annuity model 40 Sales and market share 46 Assets backing the model 55 Cash flow 60 A growing earnings stream 64 Risk management 66 Regulatory matters 73
Slide 65: A growing earnings stream
A growing earnings stream • Our earnings grow through time as: — Contracted rent rises — Annuity interest falls reflecting a declining balance of principal outstanding 65
Slide 66: Annuities
Annuities Challenger’s annuity model 40 Sales and market share 46 Assets backing the model 55 Cash flow 60 A growing earnings stream 64 Risk management 66 Regulatory matters 73
Slide 67: Property risk
Property risk • Mitigants — We have some diversification across geography and sector — Our portfolio is characterised by long leases to highly credit- worthy tenants – The value of the leases make up the majority of the value of our properties – Portfolio property values are less volatile – We are a
Slide 68: Historical property returns - Australia
Historical property returns - Australia 700 600 Index (Base:Dec 1984 = 100) 500 400 300 200 100 0 84 85 85 86 86 87 87 88 88 89 89 90 90 91 91 92 92 93 93 94 94 95 95 96 96 97 97 98 98 99 99 00 00 01 01 02 02 03 03 e c- un- ec- un- ec- un- ec- un- ec- un- ec- un- ec- un- ec- un- ec- un- ec- un- ec-
Slide 69: Commercial vs residential property values
Commercial vs residential property values 180 170 Commercial Index 160 Residential Index 150 140 Index 130 120 110 100 90 O 9 O 0 O 1 O 2 03 O 5 O 6 O 7 O 8 Fe 01 Fe 02 Fe 98 Fe 99 Fe 00 Fe 95 Fe 96 Fe 97 Ju 2 Ju 3 Ju 9 Ju 0 Ju 1 Ju 6 Ju 7 Ju 8 9 0 0 0 9 9 9 9 0 0 9 0 0 9 9 9 n- n- n- n- n- n- n- n-
Slide 70: Foreign exchange (FX) risk
Foreign exchange (FX) risk • Our policy is to minimize the exposure of the Life Company to movements in FX rates • Strategy — Hedge net operating cashflow after debt servicing through forward FX contracts — Hedge residual NPV using short term FX • See separate – more detailed paper 70
Slide 71: Refinance risk
Refinance risk • We have been exploring a range of ways of reducing the refinance risk in our portfolio (i.e. senior debt requiring renewal or LVR top-ups at ‘stress’ points) • The possibility of a large securitisation/credit wrap of our property portfolio was investigated but so far has proven unec
Slide 72: Systems and controls
Systems and controls • Portfolio management systems are being significantly upgraded — Based on investment bank risk management technology — Robust database environment rather than spreadsheet reliance — Enables continuous monitoring of a wide range of financial market risk and return characteristic
Slide 73: Annuities
Annuities Challenger’s annuity model 40 Sales and market share 46 Assets backing the model 55 Cash flow 60 A growing earnings stream 64 Risk management 66 Regulatory matters 73
Slide 74: Regulatory matters
Regulatory matters • All statutory funds meet solvency and capital adequacy requirements • Excess assets over statutory capital requirements have improved substantially since 30 June 2003 due primarily to interest rate increases with property values remaining firm • Statutory capital position has im
Slide 75: Contents
Contents Business overview 3 Financial results 7 Assets under management / advice 36 Progress of core business units Annuities 39 Mortgage finance 75 Funds management, admin & financial planning 115 Other business issues 126 Summary 133 75
Slide 76: Mortgage finance
Mortgage finance Overview 76 Australian mortgage market 78 Howard Mortgage Trust 82 Interstar Securities 91 The Mortgage Alternative 109
Slide 77: Overview
Overview Mortgage finance business Third party distribution via mortgage originators, brokers and financial planners Commercial Prime residential Non-conforming residential Howard Mortgage Trust Interstar The Mortgage Alternative (TMA) •• 100% 100% financed financed through through •• 100% 100% fina
Slide 78: Mortgage finance
Mortgage finance Overview 76 Australian mortgage market 78 Howard Mortgage Trust 82 Interstar Securities 91 The Mortgage Alternative 109
Slide 79: Australian mortgage market
Australian mortgage market • Australian housing credit — Averaged double digit growth each year for past 25 years — Since WWII never slowed below 8% pa — January signals a slowing from record levels • Strong expansion of non-bank origination — Brokers now originate approx 30% of all new home loans —
Slide 80: Australian mortgage market
Australian mortgage market Long term mortgage growth - cyclical (%) "Baby Boom" 40 Long and stable growth in mortgage credit 30 20 Great depression 10 WWII 0 -10 1925 1930 1935 1940 1945 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 Australia USA Source: UBS estimates, RBA, ABS, US Federal
Slide 81: Australian mortgage market
Australian mortgage market Long term mortgage funding growth Growth of housing lending and mortgage securitisation 500,000 450,000 400,000 Securitised mortgages Total Housing lending ADI's 350,000 300,000 $ million 250,000 200,000 150,000 100,000 50,000 - 88 9 0 1 2 3 4 5 6 7 8 9 0 1 2 89 90 91 92 9
Slide 82: Mortgage finance
Mortgage finance Overview 76 Australian mortgage market 78 Howard Mortgage Trust 82 Interstar Securities 91 The Mortgage Alternative 109
Slide 83: Howard Mortgage Trust - business model
Howard Mortgage Trust - business model • Australia’s largest commercial mortgage trust, established in 1985 • Consistent performance-in the top quartile of Australian mortgage trusts over the last 5 years to 31 December 2003 • Reputable and secure mortgage manager with solid independent research hou
Slide 84: Key statistics
Key statistics Approx as at 31 Dec 2003 Number of unitholders 40,000 Cash and liquid securities $0.8b Mortgage loans $2.2b Total investments (net asset value) $3.0b Number of mortgages 3,100 Average loan size $690k Range of current loan sizes $150k to $30m Average loan to value ratio 59% Average ter
Slide 85: Howard Mortgage Trust assets
Howard Mortgage Trust assets Mortgage security assets Mortgage assets by type Mortgage assets by state December 2003 December 2003 WA ACT, NT & TAS Industrial 5% 1% SA VIC 15% 3% 16% QLD 6% Residential 50% Commercial 30% Retail NSW 5% 69% 85
Slide 86: Loan types
Loan types • Commercial loans include: — Refinancing — Bridging finance — Property acquisition — Debt reconstruction — Asset backed lending • Loans are for commercial purposes, however security offered can include non commercial property — eg 50% of loans secured by residential properties 86
Slide 87: Origination process
Origination process • Loans sourced through referral database of over 1,000 contacts – brokers, accountants, solicitors, financial planners and real estate agents • Howard has an established underwriting team of 27 staff Australia-wide which ensure loan applications meet acceptable lending criteria
Slide 88: Howard Mortgage Trust growth
Howard Mortgage Trust growth FUM, applications and redemptions 200 3,500 180 3,000 $m apps/redemptions 160 140 2,500 120 $m FUM 2,000 100 80 1,500 60 1,000 40 500 20 - - Jun-02 Sep-02 Dec-02 Mar-03 Jun-03 Sep-03 Dec-03 APPS REDS FUM FUM increased 15% from $2.6b to $3.0b in 6 months to 31 December 20
Slide 89: Earnings drivers
Earnings drivers • FUM revenue — Driven by level of retail and wholesale investors — FUM drives management fee (fixed % FUM) – Wholesale fee 0.725% pa gross – Retail fee 1.125% pa gross • Lending revenue — Loans settled drives establishment fee income of 0.35% — Loan portfolio servicing fee 0.22% pa
Slide 90: Earnings drivers cont.
Earnings drivers cont. • FUM expenses — Upfront commissions paid to planners for new applications – Expensed immediately (hence in times of high FUM growth, earnings are lagged) — Trailing commission — Number of investor applications and redemptions drives administrative costs • Lending expenses — N
Slide 91: Mortgage finance
Mortgage finance Overview 76 Australian mortgage market 88 Howard Mortgage Trust 82 Interstar Securities 91 The Mortgage Alternative 109
Slide 92: Interstar - business model
Interstar -business model Training Interstar Funding Support _________________ ____________________ _ 3rd Party aligned originator Approval Approval Warehousing Servicing Loan Servicing Provided by $ series of banks Application Underwriting Application Securitisation Securities Mortgage backed secur
Slide 93: Product range
Product range • Products available (all white labelled) — Standard owner occupied and investment loans — Low doc loans — Fixed and variable rate loans – Fixed rate loans have interest swapped to floating — Construction loans — Interest only loans • Interstar reserves the right to change the variable
Slide 94: Low doc loans
Low doc loans • Available only for self employed borrowers provided they have a clean credit history • Are subject to a detailed underwriting process • Low doc loans have extra protection - maximum LVR of 80% as opposed to 90% for a traditional mortgage • Lending is capped at $600k per loan • Since
Slide 95: Origination process
Origination process • Wholesaler of prime residential mortgages via around 500 independent aligned originators • Interstar originators — Have to be approved — Receive training from Interstar with appropriate controls and follow-up • Originator sources client and prepares loan application documentati
Slide 96: Servicing process
Servicing process • Loan servicing is centralised in Interstar’s head office in Melbourne • All scheduled payments received by direct debit • Experienced credit team with a strong background in recoveries • Borrower arrears are managed through a structured credit recovery process 96
Slide 97: Funding process
Funding process • Approved loans are initially funded from warehouse trusts provided by Interstar’s banking partners • Committed warehousing capacity of over $4.5b with further scheduled • Funding is direct from warehouse trust to borrower — Providing underwriting and administration procedures are c
Slide 98: Funding process cont.
Funding process cont. • Trust issues Mortgage Backed Securities (‘MBS’) — Senior tranche approx 95% (rated AAA) — Subordinated tranches approx 5% (rated AA- being lowest rating of LMI providers) • MBS have floating interest rate which reset either monthly or quarterly • MBS issuances in domestic and
Slide 99: Funding process cont.
Funding process cont. • Interstar receives fees for acting as mortgage servicer and manager of the warehouse and securitisation trusts • Interstar carries the highest service rating from S&P • Interstar is also a beneficiary of a residual net income spread after funding, servicing and trustee costs
Slide 100: Working capital
Working capital • Working capital required for: — Originators upfront commissions — LMI premiums (influenced by type of loan, size, LVR) — Deferred acquisition costs (DAC) amortised over lesser of 5 years or loan discharge — Issuance costs for MBS (dealer fees, professional fees) • S&P have develope
Slide 101: Integration
Integration • Formal asset and liability committee established • Compliance committee established • Capital markets skill-set now significantly expanded • Previously outsourced operating technology platform has been acquired by Challenger • Software vendor restricted from offering product to competi
Slide 102: Interstar’s performance
Australian mortgage market Interstar’s performance Market share as a % of approved deposit institutions and securitised mortgage lending 2.40% 2.20% 2.00% 1.80% 1.60% 1.40% 1.20% 1.00% Jun-01 Sep-01 Dec-01 Mar-02 Jun-02 Sep-02 Dec-02 Mar-03 Jun-03 Sep-03 102
Slide 103: Loan settlements v originators
Loan portfolio Loan settlements v originators 800,000,000 500 700,000,000 600,000,000 400 Number of originators 500,000,000 $Loans settled 300 400,000,000 300,000,000 200 200,000,000 100 100,000,000 0 0 Jun-01 Sep-01 Dec-01 Mar-02 Jun-02 Sep-02 Dec-02 Mar-03 Jun-03 Sep-03 Dec-03 Settlements Originat
Slide 104: Loan portfolio cont.
Loan portfolio cont. • Portfolio growth has been strong for many years driven by: – Cyclical credit growth – Increased market share due to increased distribution capacity – Growth in originators • In line with expectations, January originations down on previous quarter average, but up on January 200
Slide 105: Loan portfolio cont.
Loan portfolio cont. Portfolio 31 December 2003 Weighted average LVR Mortgage portfolio size $12.5b 70.1% Average loan size Approx $170k Number of loans Approx 75k Investment loans - units 15.5% 75.3% Investment loans - housing 100 % 27.5% 72.1% Owner occupied 57.0% 67.8% Standard 71.5% 71.3% 100 %
Slide 106: Loan portfolio cont.
Loan portfolio cont. • Arrears levels below industry averages • From over 80,000 loans in 8 years, only 57 loans have gone to LMI claim • From over $17b of loans in 8 years, LMI claims since 1995 have been less than $2.1m • All claims have been paid in full by the LMI provider • Funding from warehou
Slide 107: Earnings drivers
Earnings drivers • Level of mortgage funds under management — Driven by level of new loans settled less loan repayments • Diverse product mix (low doc, standard,etc) • Level of arrears (penalty interest) • Delivery rate to originators • Margin above swap of warehouse and MBS • Cash rate verses bond
Slide 108: Earnings drivers cont.
Earnings drivers cont. • Operating costs are driven by: — Level of new loan originations — Level of arrears management (headcount driven) — Mortgage funds under management 108
Slide 109: Mortgage finance
Mortgage finance Overview 76 Australian mortgage market 78 Howard Mortgage Trust 82 Interstar Securities 91 The Mortgage Alternative 109
Slide 110: Business model
Business model • Launch of TMA in February 2004, a non conforming mortgage wholesale financing business • Australian non conforming mortgage market is estimated by S&P to be in excess of 2.5% ($10b) of residential lending market • TMA complements the existing Interstar prime residential and Howard c
Slide 111: Product range
Product range • Non conforming mortgage products suit borrowers not serviced by traditional lenders due to their historical or current situation — New migrants — Retirees/ older borrowers — Lack of acceptable employment history — Self employed — Some form of credit impaired history • Full documentat
Slide 112: Origination process
Origination process • TMA will leverage the existing Interstar operating platform and originator relationships • Initial rollout has commenced to approximately 35 of Interstar’s current originators • First loans scheduled to be written in early March 2004 • Interstar recaptures benefits once TMA bor
Slide 113: Servicing
Servicing • Economies of scale will be achieved by using the established Interstar core lending systems • TMA utilise their own specialised underwriting and credit collection processes • Underwriting and credit management conducted out of Sydney 113
Slide 114: Funding process
Funding process • Loans are initially funded by a bank provided warehouse • TMA will sell loans (whole loan sales) to pay down the warehouse on a frequent basis • TMA has limited credit risk exposure while loans are in the warehouse which would generally amount to the future earnings to be earned on
Slide 115: Contents
Contents Business overview 3 Financial results 7 Assets under management / advice 36 Progress of core business units Annuities 39 Mortgage finance 75 Funds management, admin & financial planning 115 Other business issues 126 Summary 133 115
Slide 116: Funds management, administration & financial planning
Funds management, administration & financial planning Overview 116 Market trends 118 Funds management (ex Howard Mortgage Trust) 119 Platform administration 123 Margin lending 124 Financial planning 125
Slide 117: Overview
Overview Funds management, administration & financial planning Platform Funds management Margin lending Financial planning administration In-house •• In-house Provision of •• Provision of Provision of •• Provision of •• A A licensed licensed financial financial manufacturing manufacturing administra
Slide 118: Market trends
Market trends • Market continues to grow strongly — Retail managed fund market increased in value from $236b to $267b (13.1%) for 2003 — Privatised superannuation system — Significant intergenerational transfer of wealth • Acceptance that different equity styles suit different market cycles • Boutiq
Slide 119: Funds management
Funds management • Expanded in-house manufacturing team capabilities eg appointment of Peter Greentree — Highly rated by research houses eg van Eyk recently released ratings of Challenger’s Australian equity funds: – Australian Share Fund – ‘A’ rated – Smaller Companies Fund - ‘AA’ rated — Received
Slide 120: Funds management
Funds management • Strategic alliances — Launched Challenger Orion Australian Share Fund in November 2003 – Already highly rated by research houses – van Eyk recently ‘A’ rated 120
Slide 121: Funds management
Funds management • Significantly improved dealer group/adviser/platform take-up of Challenger products since mid 2003 • Ranked 8th in net retail inflows for December 2003 quarter, up from 17th in previous quarter • Institutional support continues to grow – New institutional mandates since 1 July 200
Slide 122: Funds management
Funds management • Continued focus on improving administration efficiencies — Implementing single IT platform — Already decommissioned one registry system and reduced exposure to another two. Expect by end of calendar year to have decommissioned six of the remaining registry systems — Significant re
Slide 123: Platform administration
Platform administration • Simplification of Synergy platform — Reduced number of products — Gaining infrastructure benefit from Group — Funds under administration has grown by 8.5% to $1.55b • Exploring how we can leverage our developing systems capabilities 123
Slide 124: Margin lending
Margin lending • Implemented contemporary registry system • Re-negotiating new funding sources • Redefining offering with distinct features in preparation for re-launch next quarter 124
Slide 125: Financial planning
Financial planning • Funds under advice grew from approximately $2.5b to $3.0b over 6 months to 31 December • 165 advisers as at 31 December 2003 — 4th fastest growing dealer group (by organic means)* — Top 20 dealer group by size* • Successful transition to new FSR licence regime • Seeking to furth
Slide 126: Contents
Contents Business overview 3 Financial results 7 Assets under management / advice 36 Progress of core business units Annuities 39 Mortgage finance 75 Funds management, admin & financial planning 115 Other business issues 126 Summary 133 126
Slide 127: Other business issues
Other business issues Exit of non core businesses 127 Niche assets to be retained 130 Dividend policy 131 Corporate structure 132 127
Slide 128: Exit of non core businesses
Exit of non core businesses • Howard Finance – sale completed • New Zealand operations – fully exited • UK operations – fully exited • Garrisons Accounting – administration expected to be completed in March 2004 • Endowment warrant business - in discussions with preferred bidder • Corporate superann
Slide 129: Exit of non core businesses
Exit of non core businesses • Pursuing the orderly sale of the following private equity assets: — Endeavour Health Care — Tritel — Acrux — Future Fibre Technologies • Sale of forestry assets purchased with Interstar is well progressed – final bidders commenced due diligence with completion expected
Slide 130: Niche assets to be retained
Niche assets to be retained • Private equity investment in Australian Fast Foods – suitable for the life company investment portfolio • Beston Wine Industry Trust (ASX: BWI) — Attractive ‘alternative’ asset class — High value for investors (10% pa cash returns just reported for half year ended 31 De
Slide 131: Dividend policy
Dividend policy • At this stage of development, the Board believes capital is better deployed internally while we are building Challenger’s structure and developing and acquiring new business streams and expect no dividends will be paid in the near to medium term • The Board will continue to monitor
Slide 132: Corporate structure
Corporate structure Challenger Financial Services Group Limited (ASX listed:CGF) Challenger Life Interstar / TMA (marked-to-market environment) Howard Mortgage Challenger Managed Synergy Financial Planning Trust Investments Masterfund/Wrap Corporate simplification project is well under way The curre
Slide 133: Summary
Summary • Challenger is a diversified financial services company, focused on 3 strongly growing core businesses where we believe we have comparative advantages • Modified accounting methodology provides transparency to the annuities business, and shows a robust ‘spread’ not reliant on property reval
Challenger Financial Services Group — H1 2004 Earnings Presentation on 6ix