Challenger Limited · ASX:CGF
Challenger — Challenger Financial Services Group — H1 2004 Earnings Presentation
136 slides from Challenger's earnings presentation, Feb 23, 2004
Slide 1: Cover letter to ASX
2 challenger er Financial Services Group Sydney 23 February 2004 The Manager Company Announcement Platform Australian Stock Exchange Limited 30 Bridge St SYDNEY NSW 2000 Dear Sir/Madam, Re: Challenger Financial Services Group Limited Attached is the Market Release and CEO’s Presentation of Challenge
Slide 2: Market Release: Half Year Results to 31 December 2003
2 Challenger Financial Services Group MARKET RELEASE 23 February 2004 CHALLENGER FINANCIAL SERVICES GROUP LIMITED HALF YEAR RESULTS TO 31 DECEMBER 2003 23 February 2004, Sydney - The Board of Directors of Challenger Financial Services Group Limited (Challenger - ASX code:CGF), today announced a net
Slide 3: Market Release (continued)
“Term annuities are fundamentally a spread business with the rent and interest earned on the assets used to pay annuitant interest, senior debt interest, commissions and expenses.” Chailenger’s mortgage finance division, including Howard Mortgage Trust and Interstar Securities (acquired on 29 Septem
Slide 4: Slide 4
Slide 5: Market briefing - 31 December 2003 half year results
eS challenge Financial Services NS) 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 6: Contents
€2 challenge Financial Services Greasy. Contents — Business overview 3 Financial results 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
Slide 7: Business overview
&2 challenge EWP Financial Services Group Business overvi Div, ed 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
Slide 8: Key events in the period
€2 challenge Financial Services Gremsy: 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 strengthen
Slide 9: Contents
€2 challenge Financial Services Greasy. Contents Business overview 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
Slide 10: Financial results
Financial result Summary of earnings Modified accounting methodology Breakdown of earnings Group balance sheet Other financial information challenge Pinamctal Services Grea:
Slide 11: Summary of earnings
€2 challenge Financial Services Greasy. Profit pre-tax & corporate charges 66.6 28.7 Corporate charges (16.6) (16.6) Income tax expense (16.7) (3.5)
Slide 12: Summary of earnings continued
€2 challenge Financial Services Gremsy: gs cont. — Summary of earnif Pleasing result reflecting: e 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 (Mo
Slide 13: Summary of earnings continued
6 e Summary of eat Se challenge 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
Slide 14: Financial results
€2 challenge Pinamctal Services Grea: Financial results Summary of earnings 7 Modified accounting methodology 11 Breakdown of earnings 15 Group balance sheet 24 Other financial information 31
Slide 15: Modified accounting methodology
&2 challenge CERT Financial Services Group ting 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 e Alternative method of a
Slide 16: Modified accounting methodology continued
€2 challenge Inaatclat Sanviegs Crema ng methodology cont. Modified accounti ° 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
Slide 17: Modified accounting methodology continued
€2 challenge inaatclat Sanviegs Crem g methodology cont. , Provides a more comparable methodology with funds management and mortgage finance products e Consideration given to direction emerging under international accounting standards e In addition to operating margins emerging under modified accoun
Slide 18: Financial results
€2 challenge Financial Services Greasy. Financial results Summary of earnings 7 Modified accounting methodology 11 Breakdown of earnings 15 Group balance sheet 24 Other financial information 31
Slide 19: Breakdown of earnings
€2 challenge . as Financial Services Grsy: Breakdown of € Six Month: December 2003 CFSG Trust 1 July to 21 December CFSGL (Company) 22 December to 31 December . 0.7 ~ Appendix 4D Earnings summary aggregates the trust and company results for the period. ‘Corporatisation’ occurred on 22 December and h
Slide 20: Breakdown of earnings by division
€2 challenge Financial Services Greasy. Breakdown of e 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 Corporate charges (16.6) (16.6)
Slide 21: Annuities - statutory result
Annuities - stat Margins emerging ‘Planned profit margins released (MoS) Net experience items (MoS) Return from rent less interest used to repay annuitant principal/senior debt Earnings on excess assets Total margins emerging Market related movements - effect of changes in interest rates, forex rate
Slide 22: Annuities - modified accounting
Annuities — accounting €2 challenge Financial Services Gremsy: 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) Overheads (14.7) Handout reconciles to statutory result 1a
Slide 23: Mortgage finance
€2 challenge Financial Services Gremsy: Mortgage financ Howard Mortgage 22.9 (3.8) 19.1 (9.4) 9.7 < Cost to income ratio <50% Trust Interstar < 3 months contribution Securities 39.7 (27.3) 12.4 (8.3) 4.1 < December rate rises will boost ongoing earnings The ; Mortgage - . . (0.3) (0.3) < New busines
Slide 24: Funds management, administration & financial planning
Funds. managem & financial’ plann nt, administration ing Revenue 54.3 Operating expenses (33.1) Gross margin 21.2 Overheads (31.1) <2 challenge Fiovametat Services Geonsy:
Slide 25: Non-core businesses
€2 challenge Pinamctal Services Grea: 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)
Slide 26: Corporate charges
securitise the property-related debt (2.7) CPHIC management fee (3.4) Other costs reimbursed to CPHIC (0.7) Interest payable on core debt (3.2) Interest received on surplus funds 2.3 Goodwill amortisation Total corpora e charges 2 challenge Financial Services Gremsy: Non recurring post January 2004
Slide 27: Financial results
€2 challenge Financial Services Greasy. Financial results Summary of earnings 7 Modified accounting methodology 11 Breakdown of earnings 15 Group balance sheet 24 Other financial information 31
Slide 28: Group balance sheet - assets
Group balance st Cash 351 660 Receivables and non Life 305 421 investments Forestry assets 54 - Other assets (DAC, tax, prepayments) a 52 Property investments 2,559 2,614 Other life investments (inc. $24m swaps/forwards) 1,276 965 EMVONA 376 376 Goodwill 402 278 Total assets 5,607 5,366 28 €2 challe
Slide 29: Group balance sheet - liabilities
a €2 challenge Financial Services Gremsy: Group balance s Payables and provisions 208 179 Other liabilities 7 78 < Swaps/forwards now asset at (swaps/forwards) 31/12/03 . € Interstar plus tax on Taxation 108 75 period result Debt 2,112 2,023 € Refer analysis € Growth in annuity book and Policyholder
Slide 30: Debt
Within property trusts 1,684 1,725 Share finance margin 149 159 lending loans Core group debt 85 85 Interstar facility 125 - Vendor finance from 65 . Zurich Capital Markets Other finance leases 4 4 Howard Finance 7 50 debentures 2 challenge Financial Services Gremsy: « Effect of ®A¥¢ on Sterling/US$
Slide 31: Goodwill
2 challenge Financial Services Gremsy: Goodwill As at 30 June 278 Goodwill on Interstar acquisition 158 Goodwill amortised: - Merger (6 months) (7) € Being amortised over - Interstar (3 months) (2) 20 years <€ Arisen because net assets on 22 December Goodwill adjustment on corporatisation (25) excee
Slide 32: Net tangible assets / intangibles
€2 challenge Pinamctal Services Grea: 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 * Challenger classifies management rights and other EMV
Slide 33: Corporatisation pro-forma
€2 challenge Financial Services Greasy. ‘Corporatisation’ pro-forma 1,452 Lower share issue price (47c v 52c) (122) Long-term incentive plan not enacted prior to 31 December 2003 (127)
Slide 34: Financial results
Financial result Summary of earnings Modified accounting methodology Breakdown of earnings Group balance sheet Other financial information challenge Pinamctal Services Grea:
Slide 35: Capital structure
Capital structure 2 challenge Financial Services Gremsy: 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 Int
Slide 36: Key ratios
Key ratios | €2 challenge Financial Services Greasy. Net asset backing $0.49 EPS 1.4¢
Slide 37: Cash flow
€2 challenge Pinamctal Services Grea: Cash. at 30 June 2003 (inc. life company $235m cash injection) 478 182 660 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
Slide 38: Non-life operating cash outflow
Non-life opera outflow — . &2 challenge Pinamctak Services NS) netcash © | 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 servicin
Slide 39: Contents
€2 challenge Financial Services Greasy. .Co ntents 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
Slide 40: Assets under management/advice
oo challenge gement/advice Australian equites funds/mandates 1,156 - Direct property International equities funds/mandates 14 14 Property securities funds/mandates ri Fixed interest, including hybrids 1,146 846 Direct property (via syndicates) 174 109 Cash 265 499 Mortgage funds 2,992 2,627 Private
Slide 41: Number of investors
€2 challenge Financial Services Gremsy: Number of inves 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 a Ag
Slide 42: Contents
€2 challenge .Contents Preto 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
Slide 43: Annuities
eS challenge Pinamectak Services Greig 1s 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 44: The basic proposition
€2 challenge Financial Services Gremsy: The basic propo . 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 attractiv
Slide 45: Annuities as a source of funds
€2 challenge Financial Services Gremsy: ~ Annuities are an efficient source of funds for the assets we Javest in and a beneficial investment for many retirees Retirement Finding assets Supplying which deliver income Income both stable certainty to income to Australian annuitants retirees and growth
Slide 46: Why we employ leverage
€2 challenge Financial Services Gremsy: Why we employ A 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 ~ Gener
Slide 47: Possibility of having less leverage
& challenge EMS stouncial Services Group Possibility of havi g 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
Slide 48: Managing our capital
€2 challenge Financial Services Gremsy: Managing our ca + 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 ¢ Capit
Slide 49: Annuities
€2 challenge Financial Services Greasy. _ 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 50: Sales - long term annuities
€2 challenge Financial Services Gremsy: annuities Sales - long ter : Sales (qtrly) - long term annuities 140 120 400 - & 80 s se we 60 es ss = = = = Ss he een on hUrehlhUdrehlUmUrlhmUmUmrelh hUmclh Uc hUmnlhUmdlhUmnlhUmnlhUm 2H WH HOA OA Oa HH HOA 0 Sep Dec Mar Jun Sep Bec Mar Jun Sep Dec Mar Jun Se
Slide 51: Sales - short term annuities
aAnititiac aan challenge annuities charen Sales - short ter Sales (qtriy) - Short term annuities Sep Dec Mar Jun Sep Dec Mar Jun Sep Dec Mar Jun Sep Dec. Mar Jun 2000 «©2000 «62001 «62001 «2001 2001 «2002, 2002 2002) 2002 )= 2003, 2003) 2003 = 2003 2004 = 2004 Financial Year Totals 2004 $264.2 1m |
Slide 52: Market sales - long term annuities
€2 challenge inanchat Services Geena: ING term annuities Market sales - long term annuities 0.0 2000 2004 2002 2003 Source: Plan for Life The market appetite for long term annuities is growing strongly
Slide 53: Market sales - short term annuities
&2 challenge Pinamekat Services: ns hort term annuities Market sales - short term annuities 3,000.0 2,500.0 2,000.0 $m 4,500.0 4,006.0 500.0 0.0 2000 2001 2002 2003 Source: Plan for Life The short term annuities market has declined, due to more attractive alternatives
Slide 54: Long term annuity market predicted to grow strongly
el ‘ & challeng se — strong Long, term ann ite Ny th predicted 6 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 *
Slide 55: Challenger's market share
€2 challenge Financial Services Gremsy: _Challenger’s ma Source: Plan for Life Reduced pricing has impacted our market share
Slide 56: Annuity market rates
<2 challenge still a market @ Uae" ae - Chala . Annuity Market Rates (15 Year Nil RCV) - Margin to AUD Swap —*- AMP Life AXA Austr all ia 6.5 % F 0.0% $ 0.5 % 15% pt SEEEPEEEEESLEE CEP PLOS Source: Plan for Life Each annuity we write is now more profitable
Slide 57: Future sales strategies
-. } a & challenge 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
Slide 58: Assets backing the model
eS challenge Finamectal Services: Greg I$ 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 59: Current asset mix
€2 challenge Pinameckak Services Geentaye Current asset’m uc internal underlying property trusts 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 8
Slide 60: Current property portfolio
€2 challenge Pinamctal Services Grea: rtfolio Current property Property allocation 31/12/03 by sector by location Retail / us QLD entertainment 12% 2% Nsw 13% 22% Industriai 6% UK / 25% Tas 2% Commercial 81% 9% 2% Rg
Slide 61: Fixed income portfolio
€2 challenge Financial Services Gremsy: Fixed income pc Other Converting preference shares 26% Bank bills 8% Floating rate notes 11% Convertible & capital notes 10% Mortgage backed secuities 11% 20% ge
Slide 62: Type and supply of long term assets
€2 challenge Financial Services Greasy. Type and supply of long term * 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 acquis
Slide 63: Cash flow
€2 challenge Financial Services Greasy. . 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 64: Projected cash flows
$m €2 challenge Financial Services Greasy. [2 Operating cash flow HBB Cash [2 Terminai value of properties 300 4 200 ~ = 7 Predominantly fixed income disposals in excess of annuitant obligations 100 0 of 2004 2008 2012 2016 2020 >=2024 (400) Based on existing asset portfolio Assumes no new business
Slide 65: Projected cash balance
3,500 3,000 RD &2 challenge Finamctath tervices Gres: Z Lele 2004 2007 2010 2013 2016 2019 2022 Based on existing asset portfolio Assumes no new business Assumes no dividends paid Assumes building sales at end of major lease Lease cash flow projections adjusted for expected defaults Proceeds forecas
Slide 66: Dividends/growth
RR ak: 2 challenge Firamctal Services NS) vidends/g rowth “. ‘Spread’ means model is strongly cash flow positive Main use of cash is to pay down annuitant principal (i.e. to extinguish liabilities)... analogous to a compulsory ‘dividend reinvestment plan’ For the existing book, after meeting annuita
Slide 67: A growing earnings stream
Challenger’s annuity model Sales and market share Assets backing the model Cash flow A growing earnings stream Risk management Regulatory matters eS challenge Finamectal Services: Greg I$ 40 46 55 60 64 66 73
Slide 68: A growing earnings stream
€2 challenge Financial Services Greasy. A growing earnin: ¢« Our earnings grow through time as: — Contracted rent rises ~~ Annuity interest falls reflecting a declining balance of principal outstanding
Slide 69: Risk management
eS challenge Pinamectak Services Greig 1s 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 70: Property risk - mitigants
€2 challenge Financial Services Gremsy: 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
Slide 71: Historical property returns - Australia
<2 challenge Financial Sevvionsi ns} . Historical: proper y Preturns - Australia on Zo Index (Base:Dec 1984 = 100) LOLI LS SL LP POLI SI IL OS AD HDS PSAP PP POSS S ILS & FSH SI SES ISH SH SH SHS SESH IES ISH IH SH IH SHIH —PCA Total Return Index @=@ Challenger Total Return Index PCA Index construct
Slide 72: Commercial and residential property indices
€2 challenge Pinameckak Services Geentaye : Commercial] Nel re Commercial Index 160 . . — Residential index WA 150 Index = eS 3 EL P EES PEE PEE FEE EEE EEE PEO EF Commercial = JLL REIS Q3/2003 Residential = Real Estate Institute Annual Property Market Indicators The commercial market is not as over
Slide 73: Foreign exchange risk
€2 challenge Financial Services Gremsy: * 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
Slide 74: Refinance risk
€2 challenge Financial Services Gremsy: » 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 b
Slide 75: Systems and controls
€2 challenge Financial Services Gremsy: Systems and Cor * 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 m
Slide 76: Regulatory matters
eS challenge Finamectal Services: Greg I$ 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 77: Statutory fund solvency and capital adequacy
€2 challenge Financial Services Gremsy: 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 capi
Slide 78: Contents
€2 challenge .Contents Preto 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
Slide 79: Mortgage finance overview
eS challenge Finamectal Services: Greg I$ _ Overview 76 Australian mortgage market 78 Howard Mortgage Trust 82 Interstar Securities 91 The Mortgage Alternative 109
Slide 80: Overview
<2 challen ge Financtat Services ng Overview Each business utilises third party distribution Mortgage finance businesses are similar but cater to different sectors of the lending market; funding methodology or the order in which funding is organised varies between the businesses 77
Slide 81: Slide 81
Slide 82: Slide 82
Slide 83: Slide 83
Slide 84: Slide 84
Slide 85: Slide 85
Slide 86: Slide 86
Slide 87: Slide 87
Slide 88: Slide 88
Slide 89: Slide 89
Slide 90: Slide 90
Slide 91: Slide 91
Slide 92: Slide 92
Slide 93: Slide 93
Slide 94: Slide 94
Slide 95: Slide 95
Slide 96: Slide 96
Slide 97: Slide 97
Slide 98: Slide 98
Slide 99: Slide 99
Slide 100: Slide 100
Slide 101: Slide 101
Slide 102: Slide 102
Slide 103: Slide 103
Slide 104: Slide 104
Slide 105: Slide 105
Slide 106: Slide 106
Slide 107: Slide 107
Slide 108: Slide 108
Slide 109: Slide 109
Slide 110: Slide 110
Slide 111: Slide 111
Slide 112: Slide 112
Slide 113: Slide 113
Slide 114: Slide 114
Slide 115: Slide 115
Slide 116: Slide 116
Slide 117: Slide 117
Slide 118: Slide 118
Slide 119: Slide 119
Slide 120: Slide 120
Slide 121: Slide 121
Slide 122: Slide 122
Slide 123: Slide 123
Slide 124: Slide 124
Slide 125: Slide 125
Slide 126: Slide 126
Slide 127: Slide 127
Slide 128: Slide 128
Slide 129: Slide 129
Slide 130: Slide 130
Slide 131: Slide 131
Slide 132: Slide 132
Slide 133: Slide 133
Slide 134: Slide 134
Slide 135: Slide 135
Slide 136: Slide 136
Challenger Financial Services Group — H1 2004 Earnings Presentation on 6ix