Lufax's "Lying Flat": A Strategic Retreat for Progress

On August 22, Lufax Holding (LU.N; 06623.HK), a leading financial service provider for small and micro enterprises in China, released its financial report for the second quarter of 2024.

According to the financial report, the total revenue for the first half of the year was 12.94 billion yuan; the net loss was 1.56 billion yuan, with the total revenue for the second quarter being 5.976 billion yuan, and the net profit turned from 1.004 billion yuan in the same period of 2023 to a loss of 730 million yuan.

Many investors, upon seeing the financial report, have been criticizing the company for "lying flat" and "going downhill."

Although the profit data does show that Lufax Holding is indeed facing short-term growth pressure, the continuous year-on-year growth in the number of customers and the balance of consumer finance loans, along with the continuous improvement in several key indicators such as the overdue rate and the non-performing loan ratio, all reflect the company's positive trend of improving operational quality in adversity.

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In-depth analysis reveals that the company has adopted a strategy of advancing by retreating.

Proactively slowing down to improve quality, several key indicators continued to improve in the second quarter.

As of June 30, Lufax Holding's loan balance was 235.2 billion yuan, a year-on-year decrease of 44.8%. In the second quarter, the total amount of new loans enabled by the company was 45.2 billion yuan, also a decrease of 15.5%.

Prudent development is a business strategy adopted by many leading financial service listed companies at present, reflecting a trend of slowing scale, such as Qifutech's loan issuance scale in the second quarter falling to 95.4 billion yuan, a sequential decrease of 28.8 billion yuan, and the balance falling to 157.78 billion yuan. However, while the scale is decreasing, the risk indicators are improving, and Lufax Holding has already shown signals of stabilizing risks.

As of June 30, the company's enabled loan balance (excluding consumer finance subsidiaries) overdue for more than 30 days decreased by 1.2% compared to the end of the first quarter. Among them, the overdue rate for general unsecured loans for more than 30 days decreased by 1.6% compared to the previous quarter, and the overdue rate for secured loans for more than 30 days decreased by 0.4% compared to the previous quarter.

At the same time, as of June 30, the company's enabled loan balance (excluding consumer finance subsidiaries) overdue for more than 90 days decreased by 1% quarter-on-quarter; the overdue rate for general unsecured loans for more than 90 days decreased by 1.3% quarter-on-quarter; the overdue rate for secured loans for more than 90 days decreased by 0.1% quarter-on-quarter.As of June 30th, the non-performing loan (NPL) ratio for the company's consumer finance loans stood at 1.4%, marking a 0.2% decrease quarter-over-quarter from the first quarter.

More importantly, in the second quarter, due to Lufax Holdings' optimization of risk management and the upgrade of its digital risk control system, with a focus on serving key customer groups and regions with more resilient small and micro economies, the quality of credit assets has seen a comprehensive improvement. The credit impairment loss decreased by 14.6% year-on-year to 2.856 billion yuan, and all overdue rate indicators have shown a comprehensive improvement.

Combining the descriptions from the financial reports of the past two quarters, it appears that the risk reduction measures taken by Lufax Holdings over a period have achieved certain results.

Against the backdrop of the need to unleash the vitality of small and micro enterprises this year, and the company's prudent business strategy leading to a slowdown in business scale, the significant improvement in so many important indicators is commendable and fully reflects the beginning of the company's transformation effects.

Key data continues to improve, validating the effectiveness of the new model.

Digging deeper into the financial report data for this period, we can also find some overlooked but very key highlights.

Firstly, the 100% guarantee model has brought an increase in business monetization capabilities.

Since last year, the company's small and micro loan business has fully transformed into a 100% guarantee model, introducing its own financing guarantee subsidiary to enhance the creditworthiness of small and micro enterprise owners, increasing their sense of financing acquisition, and also increasing its own business monetization capabilities through guarantee fees.

Under the new model, as of the end of the second quarter, the proportion of loan balances undertaken by the company (including consumer finance subsidiaries) increased from 27.5% as of June 30, 2023, to 56.7% (excluding consumer finance subsidiaries, the proportion of loan balances undertaken by the company increased from 22.4% as of June 30, 2023, to 49.9%). Consequently, the company's retail credit empowerment business income rate (take rate) calculated based on loan balances in the second quarter reached 9.3%, which is a significant increase of 2.3% compared to the same period last year.

It can be anticipated that in the future, as the proportion of 100% guarantee model loans in Lufax Holdings' loan balances continues to increase, the take rate, which reflects the monetization capabilities of new business, is expected to continue to rise.Secondly, Lufax Holdings has a strong balance sheet performance. Moreover, as of the end of the second quarter, the leverage ratio of the guaranteed subsidiary was only 2.4 times.

With such ample asset reserves, Lufax Holdings is well-positioned to continue implementing the "100% guarantee" new model strategy in a complex economic environment, building brand strength for long-term development, and consolidating its market position.

It is important to note that under the 100% guarantee model, the company needs to set aside a certain proportion of risk reserves, which is significantly higher than when using external partners for credit enhancement. This situation will affect the company's short-term profitability, and since the introduction of the new model last year, the company's net profit has been in deficit.

However, one of the significant benefits of this model is that the company will be able to realize profits by gradually collecting fees throughout the entire life cycle of the loan. At the same time, when the loan is fully repaid, the excess amounts previously set aside can be "written back."

In other words, the impact of loan business under the new model on the company's profit is "short-term paper loss, later profit realization," but overall, it is profitable. To put it simply, it is like enduring hardship first and then enjoying sweetness.

Looking at the latest data, in the second quarter, the company's total loan amount (excluding consumer finance subsidiaries), the forward-looking indicator C-M3 that reflects asset quality trends has continued to improve, with a migration rate of 0.9% for the period, compared to 1.0% in the first quarter; the migration rates for the general unsecured and secured loans enabled by the company in the second quarter were 0.9% and 0.7%, respectively, compared to 1.0% and 0.7% in the first quarter.

With the denominator of the company's loan balance significantly decreasing in the short term, the continuous improvement of the aforementioned indicators, along with all overdue indicators, is a very rare performance.

At the same time, this means that the cost losses caused by the risk provisions under the company's 100% guarantee model will be much less than previously expected, significantly increasing the company's later profit repair space.

In the first half of the year, Lufax Holdings has made significant progress in the quality of its loan assets, proving that its strategic choices are highly effective. As Mr. Zhao Rongxu, Chairman and CEO of Lufax Holdings, said: "In the second quarter, we focused on the 'quality' rather than the 'quantity' of our business. As the proportion of loans enabled under the 100% guarantee model in inclusive loan balances continues to increase, we expect continuous transformation to further enhance our future income rate.

ConclusionIn recent years, fluctuations in the macroeconomic environment have increased the challenges faced by small and micro enterprises (SMEs) in their operating environment. Financial institutions must enhance their risk control capabilities in order to remain invincible. At present, Lufax Holdings' choice of a "100% guarantee" model, while effectively managing risks, is a crucial core competency. Moreover, by assuming risks, it leverages financial resources to encourage "willingness, courage, ability, and proficiency" in lending to SMEs.

Lufax Holdings demonstrates strategic foresight, making it an excellent choice for securing a better future. This model is akin to "sending charcoal in snowy weather," providing enhanced credit services to those in need, thereby improving the accessibility of financing. This approach can significantly gain customer recognition and favor, leading to an increase in clients and business over time. In essence, this represents a higher strategic vision.

According to publicly reported data, Lufax Holdings has made considerable progress by leveraging its guarantee model to mobilize financial resources for SMEs and benefiting the public. For instance, the overall rate for SME financing services has continued to decline. In the first half of the year, the company served 125,000 SME owners, increased targeted support in regions with developed micro-economies such as Jiangsu and Guangdong, and focused on assisting small businesses in manufacturing and industries vital to the national economy and people's livelihoods. In the first half of the year, Lufax Holdings helped 11,042 technology-based SMEs secure 5.11 billion yuan in financing.

Compared to peers who opt to reduce guarantee business in pursuit of a "lighter" approach, Lufax Holdings may seem to be at a disadvantage and carrying a heavy load. However, in reality, the company is strategically retreating to advance, making its path increasingly easier. Therefore, it is worth giving more time to observe the future performance of Lufax Holdings.