COFACE SA (COFA) Earnings Call Transcript

Good day, and thank you for standing by. Welcome to the COFACE Publication of 9 Months 2022 Results Conference Call. [Operator Instructions] Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Xavier Durand. Please go ahead.

Thank you, and welcome, everyone, to this earnings call. We're happy today to report our first 9 months of 2022. As you will see from the publication, it's been another great -- actually a record quarter for Coface. A bit of a paradox as at the same time, I guess, we're all aware of the risks out there in the economy. Just going quickly through the key numbers. You see that for the first 9 months, we're reporting EUR 228 million of profit. So actually, more than all of the last year, 2021, EUR 84 million in the third quarter, which is actually, I think, our best quarter ever. Turnover, up 15.2% at constant FX and perimeter, almost 18% on a reported basis. TCI continues to grow nicely at 16.6%. We still see some of the same trends at play that we've already discussed in the prior quarter, so I'm not going to repeat these. A few notable points. Client retention is at a record high, a new record high, I would say. Pricing is continuously down at minus 3%, in line with the first half of the year. Business information continues to see nice revenue growth, almost 16% in constant FX. You see that loss ratio is up, but still very good at 36.9% net ratio. The net combined ratio is up close to 8% at 63.8%. The gross loss ratio at 30% is up 5%. We're seeing continuous normalization of the environment, and I'll speak more to this in the later pages. The cost ratio is still very, very strong at slightly below 27%, and we'll talk about what's involved in this. And so for Q3, the net combined ratio is just below 60%. I mentioned the results of the net profit. The return on average tangible equity stands at 16.4%. I'll just remind everybody just for the note that the tangible equity per share is at 11.5%. A couple of notable events, I think, in the quarter, we managed to successfully refinance our Tier 2, which was due in 2024. So we've actually de-risked that 2024 deadline and we replaced the old debt with Solvency II comparable debt, which is going to help our solvency ratio. And then second, Moody's has reaffirmed our rating, but this time with a positive outlook. And I think in the face of the upcoming slowdown in the economy, I think that's pretty notable and a great recognition, I would say, of one where we stand as a company; second, I guess, the consistency of our underwriting procedures. And third, maybe the contribution of the information business to a more stable business model. The next page really talks about Russia. We've looked at a page like this now for the last few quarters. You can see that our exposure in the trade credit insurance limits has gone down 75%, including the FX. And if you exclude the FX impact, we would be well over 81% at this stage. 80% of what's left is really domestic exposures, which we're actually winding down as the contracts come up for renewal. The claims activity is still quite moderate. We further increased our reserve levels, and I'll talk more about this when we get to the reserving pages. We're really adjusting the business as we go, retaining the key risk and debt collections capabilities while at the same time right sizing, I would say, the frontend of the business to reflect our stance on where this is going. So that's really the story on Russia. Then I go to Page 7, which is the usual pages on growth. I've already mentioned the overall growth numbers. As I said, TCI continues to hold up pretty nicely and driven by client activity and very strong retention. You're seeing some FX impact of the strong USD versus euro in particular. Other revenues are up almost 10%. And I've already mentioned the information business growing close to 16% in the third quarter. We're still seeing lower debt collection fees. I guess at some point, this will turn around. And then factoring has been pretty good at 13% growth. And then another interesting feature, I think, is the nice reversal of growth for fees, which, as you know, has been decreasing now for several quarters, actually probably a couple of years and is now up 6.7% in constant FX. On Page 8, you see the split by region, and there's really not that much news here. You see Western Europe, Mediterranean & Africa, Asia Pacific, North America, Central Europe, all growing in, I would say, 12% to 17% range. Notable that Central Europe is growing as we are also winding down the Russian business. Northern Europe, which is Germany, Northern Europe, growing at close to 10%, and then still the outlier of Latin America, driven by commodities and commodity prices close to 30%. So pretty much growth everywhere, driven by some of the same trends, which you can see on Page 9. What you see on Page 9 is a continuation of the story that I've been giving for the last couple of quarters. On one hand, our new business is the lowest that it's been in the last 4 years. I think we've been consistent with our philosophy, which is to create value through the cycle. So we've been prudent and thoughtful in terms of underwriting new business in the face of what I would call a somewhat exuberant marketplace. We've been very focused on retaining our clients, and you see our retention rate at 93.5% is yet another record for the business. That's coming at obviously a price where we see the price effect negative 3%, which pretty much means we've given up the gains that we've made during the COVID times in 2020 and '21. And then volume continues to be strong. That's both the rebound from COVID, the COVID times plus inflation, driving 11% volume activity, which obviously benefits our activity as well. When I go to the last page on Page 10, it's been another great quarter. You see a 29.5% in Q3. We continue to see normalization happening. The number of claims has been increasing since the middle of 2021, where we reached the trough. So we're nearing precrisis levels in terms of the number of claims. However, we're not seeing the large claims that we would normally see. So the large losses are still below the average. We've taken deliberate actions to increase the reserves related to Russia and whatever exposures we still have there. And that's in face of, as you know, the escalation that's happening over there and the mobilization. So I think we've -- there's an element of prudence here. You can see that in the bottom right-hand chart with the new vintage being written at close to 81% reserve level. At the same time, you can see that where the business continues to perform because we're seeing very strong recoveries on their prior vintages. So that's pretty much a story here. On Page 11, we go into the regional view, and you can see that the 4 largest and traditionally more stable markets at the bottom have pretty much kind of stable and, I'd say, relatively benign losses, Western Europe at 23%, Northern Europe at 30%, Mediterranean & Africa just below 30%. One exception is Central Europe, where we've booked some reserves on Russia. And then the 3 traditionally more volatile markets are also doing well. North America below 30%, Latin America and Asia Pacific at 10% or even lower. And if you go to Page 12, you see the same story spelled out by quarter. What you see at the bottom is again, quite stable and good levels of losses in Western Europe, Northern Europe, you see a peak in Central Europe, corresponding to what I've mentioned in terms of booking some reserves on Russia. You had seen a peak in Q1 already, and then we had booked these exposures in Central Eastern Europe, and then the next quarter, we moved them to the regions where actually the losses actually were showing up or the exposures were actually allocated. That's why in Med and Africa, you had a peak in Q2, but then that did not happen in Q3. And then on the top, you see we had talked about one file in North America, which we booked for in Q2 and that did not repeat itself in Q3. Latin America has been pretty benign. And in Asia Pacific, it's pretty much the reverse. We had a large old claim on which we found a recovery or a settlement, and that drove actually the loss for the quarter to a negative. On the next page, we talk about the cost. So you see that our overall cost is growing quarter-to-quarter close to where our premiums is growing at 16%. And there's 2 components to that. The first one is -- has to do with the external acquisition costs, and you can see they're up 25 points. The reason for this is they are in our contracts with clients, some profit-sharing clauses, which when the losses are low means we pay more commissions, and that's really playing out. So part of this line is driven by the low losses that we're experiencing in the book. And then the second thing -- the second dark blue element here is the internal costs, which are up 13.4%. And again, within that, you have a few things -- a few different things in play. One is the investments that we're making in the business information line. The second one is that given the performance of the business, we anticipate that we're going to have higher costs in terms of incentives and profit shares with employees. So when you take that stuff out, you're down to 9.8% internal cost growth, and that's how I think we are continuing to drive positive operating leverage because our internal core, internal lasting costs are growing less than our premiums. So that drives the net cost ratio for the first 9 months of the year at 32 -- sorry, the gross -- it is gross, is at 32.2% versus the 33.8% that we have seen in 2019 and the 33% we had in 2021. Just to note again that given that the claims environment continues to be relatively low, the debt collection revenues are still low. I guess that's the story for the cost, and I'm going to pass it on to Phalla to take us through the next pages as we usually do.

Yes. So let's go to the reinsurance page, a record low past losses and commissions drive reinsurance results. If you look at the premium cession rate, it is at 27.1%. This is basically similar to the cession rate that we have pre-COVID, pre-backstop period. So I would say a little bit much more back to normal. Then if we look at the cession rate at 11%, I think here 2 highlights. The first one, as you remember, in Q1, we have put behind us the impact of the backstop where we have released reserves that went back to the government that put in place the public schemes. And then if you look at Q2, Q3, I think the claims cessions was pretty low as well, and this is really linked to the low claim's environment. Consequently, of course, the insurance results end up at EUR 128 million and makes our reinsurers pretty happy. Net combined ratio, moving to the next page, we are moving up from 56.1% to 63.8%. Two components here. Net cost ratio down almost 4 points. This is 2 items, of course, cost discipline is in our DNA, I would say, but also higher commissions from the reinsurance, and this is thanks to the renewal terms and conditions that we got at the end of 2022. Net loss ratio up from 25.4% to 36.9%. This is driven by the fact that they have the losses normalizing a little bit, and of course, all the additional reserves that were put on Russia. If we move to the next page, which is a view of our financial portfolio. The mark-to-market value is up at EUR 2.8 billion. A couple of things to be noted here. First, you can see that we continue to de-risk our investment portfolio, and we have reduced our equity exposure now down to 3% and I think in favor of bonds, this is one thing. The second thing is that we're still maintaining a very high level of liquidity. We have 18% and this is way coming from -- we have a very strong cash generation resulting from the very strong business performance is helping us to reinvest in a much higher yield than we used to do in the past. And then our hedging strategy is still in place. And this also, I would say, account for in our P&L impact this quarter. You can see that the net investment income is moving up from EUR 31 million almost last year to EUR 39 million this year with an accounting yield without realized gains moving to from 0.9% to 1%, and I just want to be -- I think to highlight the fact that all the new money that we're investing now is above 2%. So we will see, over time, of course, the investment income going up by definition. If we move to the next page, I also want to highlight that in the EUR 2.8 million, it doesn't take into account the additional cash that we have received from the liability management. This cash is we're talking about almost EUR 150 million is sitting in the current account as we speak. And it will be redeployed, of course and reinvested in a much higher yield that we see today. Liability Management, I think as Xavier mentioned, we successfully did it in September. So basically, here is really to de-risk the refinancing deadline that we have in 2024 on our sub debt, the EUR 380 million Tier 2 loan that we have maturing in March 2024. So we have bought back 40% of it. And at the same time, we have issued a Tier 2, I think, fully fledged, Solvency II, Tier 2 sub debt 10-year bullet at EUR 300 million at 6%, and this one will mature in September 2032. As a consequence of this liability management transaction, we will have a temporary impact of additional Tier 2 debt with additional impact on the Solvency II, boosting it for 10 points, of course, until March 2024. If we move to the next page, again, a super profit for 9 months year-to-date September 2022 at EUR 228 million, out of which EUR 84 million is coming from Q3 only, with an operating income up 24% and the net income up 20%. If we move to the next page on the return on average tangible equity, stands at 16.4%. If we go to the change in equity, EUR 2.1 billion at the end of December 2021. Of course, we paid our dividend. We have recorded our very strong year-to-date net income. And you can see that we are still healthy mark-to-market unrealized loss coming from our investment portfolio, given the increased interest rate, impacting mostly, of course, the fixed income portion of exposure of our assets. And as I already mentioned earlier in the Q2 call and Q1 call, you know that we are in a buy-and-hold mode, which means that this is really temporary. We have no intention to realize these losses. In terms of return on average tangible equity moved up from 12.2% to 16.4% is only made up by the technical and financial results net of tax. With this, I hand over to Xavier.

So just to wrap this up, it's been the best quarter in our history by many dimensions, double-digit revenue growth, both in TCI and in the business information space. 16.4% our return on equity, a low loss ratio despite the fact that we've actually increased our reserves on Russia. We're all aware of the risks out there. I mean, clearly, there are many, many signs the economy is slowing down. There's many clouds, I would say, on the horizon, and we've gone through the list many times, timing policies, political risk and geopolitical risk, obviously, the energy crisis in Europe, et cetera, et cetera, COVID and what so. In the face of that, I would say, risky environment, we've remained true to our strategy, which is to apply continued underwriting discipline, to be consistent in our reserving policy. And I think that's being recognized if I think of the positive outlook by Moody's, I think that's one of their arguments. I think we're very focused on our clients because in the end that's how we create value through the long term is this real partnership with clients. So we have very high retention, actually the best we've ever had. And then when we look at our NPS score, which is something we spend a lot of time on, it's also the best that we've had, and it's been up consistently. So I think the takeaway is we've got clear operating principles, creating value through the cycle, being disciplined. We're not going to change the stance that you guys have now been accustomed to for the last almost 7 years, 6.5 years. And we're going to remain true to the values that have supported us so far. And I think in this more uncertain environment, this is going to be key in order to continue to perform. So with that, I'm going to leave it to everyone for questions.

[Operator Instructions] And it comes from the line of Michael Huttner from Berenberg.

Well done for record results. I have 3 questions. First one, can you give a feel for what your main shareholders thinking at the moment, whether they want to invest more in trade credit or other activities? The second is, can you talk about a little bit more about the claims numbers and kind of the background both to Q3 and maybe the current just to give us a better feel for how the underlying trends are, because it's just that we don't have the claims numbers. And then third one is on business information. So Moody's said this is a positive, and it stabilized your business model. Can you say, once you stop investing, what would the margin be? Would it be a kind of 30% margin on, I think it's about EUR 70 million of revenues at the moment annualized?

Yes. Well, I'll take your questions in the order. As far as our main shareholder is concerned, I think you should go ask them because I can't speak for them. So I really cannot answer that question, quite frankly. In terms of claims, I think we've been clear. We started with a spike in claims in COVID in the Q2 '20. And then things reversed themselves as the governments threw a lot of money, whatever it takes at the economies in different markets. And then that reached -- that brought together a serious drop in claims, which I think we reached the trough in June 2021. So we're like now a year and 3 months later. And since then, it's been growing, probably slower than we would have anticipated, but still the claims numbers have been rising. And I guess we're in an environment where they continue to rise. And I think it's pretty consistent with the environment that you're reading about everywhere, timing of monetary policies, increasing interest rates, some inflation that's pinching the wallets of people. So there's some inertia in this whole thing, but I think the -- it is pretty much what you would expect in a cycle. It's anybody's guess as to where exactly that goes, and it will also be driven by the actions of the government. So I think you'll see different -- you're probably going to see different situations by market depending on how wealthy they are and how much money they're willing to and constrained spend by their constituencies.

Can you just maybe give us a feel for the numbers in terms of either the progression of claims or the trough and -- just to get to a bit of a feel. I don't know if that…

No. I mean the only thing I think I mentioned is we are nearing the levels of claims in terms of numbers that we had in 2019, but we're not seeing large claims and like we would normally, I would say, at mid-cycle, so. And then in terms of business information, what was your question, I'm trying to remember?

It's how much money you could make once you stop investing?

Well, the only time we've given an indication, I think it was at the end of last year and what was the number, Thomas, that we -- was it 30%? I think it was at 30%. It was a 30% margin that we highlighted at the time. What we're doing is we're investing right now. So obviously, we're less concerned with the amount of money we make than with building the infrastructure, the back office, the sales capabilities, the value proposition and all the stuff and the technology that has to go into a more mature and more scalable business. So then -- but I think that's really what we communicated.

And when do you think you would open the tap?

Look, when you're faced with this stuff, I mean, it's a pretty small business, right? I mean it makes what EUR 50-something million. For me, the potential out there is such that it wouldn't make a lot of sense to try and milk it now and it just doesn't make any sense. So it's more important to create the value and build it up unless we really were under the gun and we just needed the income, but I don't think that's a priority here.

We will now take the next question. And it comes from the line of Hadley Cohen from Deutsche Bank.

Two questions, please. Firstly, I'm just wondering, Xavier, I mean you're now running at record profits at the 9-month level versus any previous full year. So I'm just wondering how you're thinking about that in the context of 4Q? Now I think there's always an element of seasonality in the fourth quarter. But I mean, to what extent are you thinking about being even more conservative in the fourth quarter, assuming claims activity remains on trend as we've seen in the past few quarters and leaving an additional buffer to combat potential volatility going into next year and beyond? Or put another way, if we assume that you have another very strong quarter or claims activity remains in line with sort of what we're seeing at the moment and you report a normal quarter in that respect, to what extent do you think it still makes sense to be paying out such a high payout ratio on that in terms of cash? Or could you look to keep some -- again, keep some additional buffer behind for potential volatility? So that's my first question. And then my second question is a very, very simple one, and apologies if I'm missing something very obvious, for Phalla. The accounting yield ex realized gains, the 1%, that is not annualized, correct? So on an annualized basis, it's slightly higher than that compared to the just over 2% that you're reinvesting currently?

Yes. So I guess, I'm trying to understand your first question because we never make forward-looking statements. I'm not going to tell you what's going to happen in Q4. And by the way, I don't know it. But I guess your question is more about the payout ratio or something like this or conserving capital in the face of…

Well, yes. I mean it's -- if you have a similarly strong quarter, as we've seen this quarter or in previous quarters, do you need to report that all through to the bottom line? Or can you keep some of that back in terms of extra provisioning or reserving? Or if not, then does it make sense to reduce the payout ratio relative to what we've seen in previous years?

Look, we're going to stay true to everything we do, which is we have some well-defined processes to define reserve levels and all that good stuff. And we also have a payout ratio based on a comfort scale in terms of solvency. So we're going to stay true with this stuff. I mean there's really no change in policy here as we go into the fourth quarter. And I'll remind everyone that our comfort scale says 80% payout ratio, when is that when we get above the about the [ EUR 175 million ], right?

Yes. I'm taking the last question. Yes, you're right. This is the accounting for 9 months, okay? And when I say that we're investing above 2 is really above 2. You can see that the 10 years bond, the 10 years [ is at EUR 170 million ], just to remind everybody where -- the level of interest rate that we have today.

We will now take the next question. And it comes from the line of Benoit Valleaux from ODDO BHF.

So 3 questions on my side. One of 2 going to be on pricing. You still have a very low loss ratio, but in the same time, economic outlook continue to deteriorate. So in this condition, what do you expect for next year? I mean do you believe that price might continue to decrease? Or on the opposite, do you expect some rebound in pricing? And similarly, regarding reinsurance, what is your expectation at this stage regarding reinsurance? And might you change? Or do you want keep it at this stage, I would say, to change your insurance coverage or not for next year? The second question is maybe on capital. I know that you don't disclose Solvency II at September. But nevertheless, can you provide us any view on the trend that you can see excluding what you have made on that, of course? And second question also related to that, you will replace EUR 380 million debt by the new Tier 2 debt of EUR 300 million. So in the end of the March '24, there will be a decrease in your leverage ratio. So I'd just like to understand, I mean, why have you decided to reduce your leverage and why EUR 300 million? I mean, can you just explain us to better understand how you have determined, I would say, these figures? And the third topic, sorry, is maybe on IFRS 17, we are now at end October. So I assume that you might have a good visibility on the implication of IFRS 17. So can you share please with us any a few comment on your expectation on impact on net income, shareholders equity? And if in top of this, do you believe that under IFRS 17, you will be able to maintain the level of buffer you have on your reserving policy or not, or if you have a stronger constraint which might lead to some changes on that?

Okay. Let me take number one, first of all, in terms of pricing, I mean, the way this business works is I know there's risks out there and there's mounting evidence that the economy is slowing everywhere. The clients don't want to hear this until they really see it. So it's a game, right? We see more -- on one hand, we see more appetite for clients to stay insured or become insured. On the other hand, those that are insured are showing us the low losses and saying they think it's worthy of continuing to discuss the price, plus I think the market is very, very aggressive. And so I do think that the price compression that you've seen this year is it will take a little bit of time for -- to change in terms of cycle. In terms of reinsurance, I mean, we -- this is the time of the year when we're in the discussion phase. Usually, this gets concluded sometime in January. So I won't make any comment, but I don't think -- again, I'd just remind everyone, reinsurance is not something you play with every year and just trying to outsmart your partners. They're 20-year partners, and they're here for the long term. So we're going to be fairly consistent. I'm going to leave the next 2 questions to Phalla here.

Yes. So in terms of -- well, we don't disclose our solvency at Q3. However, you've seen that in Q2, we have disclosed some of the stress test. So if you look at the financial stress tests that we have disclosed at the end of Q2, we're pretty resilient, right? And then in terms of business, we're still underwriting very good business. So there's no reason -- in a nutshell, there's no reason why we are deviating much from in terms of solvency ratio. In terms of debt refinancing, the liability management is something which is, first, you do a tender to buy back the existing debt. And you know that the bondholders of existing debt, part of that is really sticking to what they have and namely the life insurers. So we're not in any way being able to buy back all. So it doesn't mean that we have -- the intention is to deleverage totally. So we'll see what will happen and we will assess contingency, if we need to come back to our EUR 380 million level at the end of March 2024. It's probably too early to say. For the time being, I think it was a good de-risking transaction, especially in light of the increased interest rates and increased spread. So I think we'll go back to you on terms of the division. It's not an objective here is really to de-risk the refinancing deadline.

And regarding IFRS 17?

So in terms of IFRS 17, as we disclosed, we are in a premium allocation approach, which is no CSM, as I mentioned. We have finalized our first-time application, which is the opening balance sheet of 1st of January 2022. And again, well, we'll not disclose it because it's still under audit. So you will have the formal information when it will be audited, and so stay tuned. We'll get back to you on this one.

I mean just one comment maybe on IFRS 17. We are a relatively short cycle business, right? I mean when we book a contract, I would say after 3 years, we pretty much know where this is going. So the only -- the economic performance of the business is not going to get impacted by the change in accounting methodology, right? And so the only thing we're talking about here is really the timing of it and how that gets played out in time. But you shouldn't see a change in economic performance of the business, nor would we change, I would say, our strategy or the way we run the business or deposit fee overall and our attitude towards the market or the opportunity.

The next question comes from the line of Thomas Fossard from HSBC.

That's a very clear question. Thomas? I don't think we're hearing anything.

One moment, please. Thomas has disconnected. I will go with the next question. It comes from the line of Michael Huttner from Berenberg.

My second chance. I have 2 questions. One is new clients versus old clients and the other one is potential deals or deal pipeline. So I understood from -- you're focusing on the existing clients, high retention, some price flexibility and you're more cautious on new business. Can you give a feel for the profitability of an old client, like old client versus a new client? And just to understand the mechanics, but also the numbers because you definitely have been growing more slowly than your peers in total, but that seems to have been very beneficial. And the second is on the deal pipeline, any indications, any ambitions, Xavier?

Deal pipeline, you mean in the core TCI business. Is that what you're…?

Anything. If you want to buy anything bigger, I'd be interested as well, but of course, TCI is the main one.

Yes. Well, I mean, in terms of -- we don't look at old versus new. We look at client quality, portfolio quality. I mean the way we underwrite a deal is we take a client. We try to understand first why they would want to get insured and are we going to be able to have a long-term partnership or not? And I think that's a key criteria. If we're going to be in that situation where we build a true partnership, then yes, we're interested. And then we -- it's a client-by-client decision based on the quality of their portfolio, the volatility of their business, blah, blah, blah and blah, blah, blah. So that's really how we look at it. I can't really give you a profitability outlook for new versus an old client. Because in the end, we're going to live together for 20 years. And if we live together for 20 years, I keep saying this. But the price point at which we are one day doesn't mean much. It's really what we get out of a 20-year relationship with all the ups and downs and the cycles and all the stuff that we're going to go through together. So that's really how we look at it. In terms of the deal pipeline, all I can say is what I've just said is in a time when there's no claims, there's less apatite in the market to get insured. In the times when things look a little bit more dicey or claims start going up, usually, you see more demand, right?

And I mean deals acquisitions.

Acquisitions. Well, I mean, the line on this one is always the same. This is not an infinite market. There's a limited number of opportunities. I think we look at them. And if and when we see, 1, is available, 2, is a good one, 3, is at a price that we like, then we go for it. There's a few conditions here.

And then if -- I'll push my luck just a little bit, third question I think was one that Hadley or you were discussing before is basically on the payout ratio. So 80% of the minimum in the past, you sometimes paid 100% even more using other tools like buybacks. Given the coming -- how you see the market at the moment, where would you be in that scale?