Lufax Holding Ltd (LU) Q2 2022 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by, and welcome to Lufax Holding Limited Second Quarter 2022 Earnings Call. [Operator Instructions] Please note that this event is being recorded. Now I would like to hand the conference over to your speaker host today, Ms. [Nu Shin Yen], the company's Head of Board Office & Capital Markets. Please go ahead, madam.

Thank you very much. Hello, everyone, and welcome to our second quarter 2022 earnings conference call. Our quarterly financial and operating results were released by our newswire services earlier today and are currently available online. Today, you will hear from our newly appointed Chairman and CEO, Mr. YS Cho, who will start the call by discussing change to our management team and then provide an update of the latest regulatory developments, macroeconomic, and COVID impacts and our latest business strategies. Our co-CEO, Mr. Greg Gibb will then go through our second quarter results and provide more details on our operations. Afterwards, our CFO, Mr. David Choy, will offer a closer look into our financials before we open up the call for questions. Before we continue, I would like to refer you to our safe harbor statement in our earnings press release, which also applies to this call as we will be making forward-looking statements. Please also note that we will discuss non-IFRS measures today, which are more thoroughly explained and reconciled to the most comparable measures reported under the International Financial Reporting Standards in our earnings release and the filings with the SEC. With that, I'm now pleased to turn over the call to Mr. YS Cho, Chairman and CEO of Lufax. Please?

Thank you all for joining our second quarter 2022 earnings conference call. I will start with today's call with changes to our management team and then provide an update of the latest regulatory developments, macroeconomic and COVID impacts followed by updates on our latest business strategies. Earlier this month, our Board approved the resignation of Chairman Ji Guangheng and my appointment as Chairman and CEO of Lufax. We would like to thank Chairman Ji for his contributions to Lufax and wish him every success in his new position as Executive General Manager of Ping An Group. We have also appointed Chen Dongqi as our General Manager; and David Choy as our CFO; and YJ Lim as our CRO. Greg is continuing to serve as our co-CEO, who will take an expanded role in our overall business going forward. In addition to continuing to oversee our wealth management efforts, Greg will oversee our finance, treasury, IT, IR functions, having CFO and CTO reported to him, and play a lead role in developing new business initiatives which we'll share more about at a later stage. Dongqi joined Puhui in 2013 and has had various senior management positions, including serving as a general manager for Puhui since 2020. Prior to joining Puhui, Dongqi served in multiple Ping An subsidiaries from 1996. David has served as the CFO to our retail lending business since joining 4 years ago. Before joining us, David was the Head of Treasury Department of Ping An Group and has served in various leaders roles within Ping An finance planning functions for 11 years. YJ joined Puhui in 2008, and has been overseeing the risk management function of our retail lending business for almost 14 years. Prior to joining us, YJ served in key risk management positions with several global banks, accumulating 25 years' experience in consumer risk management. Greg, Dongqi and I, together with management team will continue to drive Lufax' business development strategy operations in the future. On the regulatory front, our observation is that the overall credit environment is improving. Recently released policy statements seek to balance incentivizing and regulating the platform economy to bolster its healthy development over the long term. We have also seen positive recognition for the role credit enhancement plays is supporting credit availability for small businesses. In terms of [PDO's] requirements of no direct data connection with finance institutions, we can continue our current partnership model with funding partners through our guarantee company. Under this [indiscernible] model, we are not required to work with third-party credit agencies. As to the April 29 versification process, we have completed most of April 29 versification-related initiatives and have detailed action plans for the new remaining items. On the customer front, the COVID-19 resurgence in China in the second quarter has had a negative impact on small business owners, creating challenges to our operations. With April and May being the most adversely impacted months. Our C-M3 monthly flow rate, which is leading risk indicator peaked in April at 0.83% and decreased to 0.61% in June. We believe in terms of domestic credit environment, the worst is now behind us. Nonetheless, domestic and international macro uncertainties, including COVID-19 resurgence, inflation and recession fears continue to persist and will likely place near-term pressure on our business operations and growth prospects. In the face of this difficult macro operating environment, we remain prudent in our operations and are prioritizing quality over volume growth for the balance of this year. While we remain cautious, key initiatives launched last year are starting to bear fruit for the medium term. We believe the sourcing contribution from Ping An has bottomed out and is now stabilized, contributing about 22% of our new loan sales in the second quarter. Our reduced loan growth this year is largely the result of our proactive focus on quality. Our selective tightening of credit standards by customer segment and geography has resulted in a meaningful narrow scope of new business sourcing in the first half. However, as a result of careful targeting of new growth by our direct sales team in better-performing regions, we have been able to offset some of the sourcing confliction brought by these tight credit standards. As of June, the percentage of high-quality talent in our direct sales force increased as we continue to execute our channel transformation. Our direct sales made up 53.6% of new loan sales in the second quarter, up from 49% a year ago. As and when the COVID impact recedes in negatively impacted regions, we will be able to quickly adjust our credit policy and fully deploy our strengthened sales force for accelerated business growth. While the specific timing for acceleration requires more observation, we are confident that when it occurs we are very well-positioned to adjust quickly. In fact, in the second quarter we restated our 70% increase in number of loan applications for direct sales year-on-year. Market demand and policy support is clearly evident, and it is now a matter of picking the right timing to expand our customer sourcing goal. Finally, I would like to share some updates on our business strategies. In the long term, we will continue to focus on solving the financial needs of small business owners who represent an important and growing share of China's middle class [indiscernible] and enhance our capabilities in the small business owner for our SBO segment. In the second quarter, our loans to small business owners made up 86.1% of new loan sales versus 77.6% a year ago. Going forward, we expand our offerings to meet all rounded needs of SBOs such as providing industry insights, online tools and other value-added services to help SBOs with their mix and set of functions. On these solid foundations, we [indiscernible] comprehensive financial services, including lending, wealth management and insurance products through expanded partnerships. This strategic direction seeks to expand our customer life cycle, deepen data-driven insights, strengthening customer loyalty and optimize our customer acquisition and management costs. Through our wealth management business, we will continue to focus on serving customers in the online fund distribution space, helping them to achieve their financial planning objectives through improved content and tools both pre and post investment. The online technology developed historically in the wealth management business for dynamic customer management we will further leveraged and aligned with future services for small business owners. Lufax has a long and proven history of making adjustments to anticipate and respond to the changing operating environment. In response to today's environment, we are further intuiting our mid and back office and technology teams and realigning our structure to achieve greater nimbleness and optimize resource allocation. Recent adjustments create more shared resources to better position our company for future growth opportunities. The scope of this adjustment will not trigger material changes in our revenue or cost structure in near term. Overall, we are confident in the steps we have taken and will continue to support the growth and development of small and micro businesses and the real economy at large. We also plan to adjust our dividend distribution to twice a year from once a year, to deliver value to our shareholders. With that, I will turn the call over to Greg, who will share our business updates in detail.

Thank you, YS. I'll now go through our second quarter results and provide more details on our operations. Please note that all numbers are in renminbi terms, and all comparisons are on a year-over-year basis unless otherwise stated. The second quarter was both a difficult and [indiscernible] time for the economy and our business. Difficult for our business in terms of needing to be very selective in new growth while facing increased credit costs resulting mostly from COVID. Steadying is that our early-stage risk indicators peaked in April and are now showing size of recovery while we continue to pursue ongoing improvements in our operations. Through this period we've remained committed to providing inclusive funding solutions to small business owners with 86.1% of new loans sales distributed to small business owners, up from 77.6% in the same period last year. However, our committed stance on prioritizing quality over volume for the last several quarters resulted in second quarter total income growth of 3.1% year-on-year. We have taken a firm stance on cost control, with total second quarter expenses, excluding credit and impairment losses and other financial costs and losses declining 11% year-on-year. Nonetheless, the increase in credit losses, where we directly bear risk through our guarantee company, led to a profit decrease of 37.9% in the second quarter versus a year ago. Our net profit in the first half decreased by 15.2% versus a year ago. While these results are clearly below the expectations we set for ourselves at the beginning of the year, we believe our strategy provides protection on the downside that will allow us to adjust quickly as the macro environment gradually recovers. Now let's take a closer look at several of the core drivers for our business model and operating performance. As YS just mentioned, first, we believe that the recent policy and regulatory announcements are positive for our business model medium-term. Supporting small businesses is only becoming more important in China's current economic priorities. On the regulatory front, there was increased recognition of the role that credit enhancement can play in helping funding availability for small business owners. In the second quarter, excluding our consumer finance subsidiary, credit insurance provided by our 7 insurance partners to customers covered 76% of new loans. The role of our guarantee company and its role in data transmission to our funding partners has recently been clarified. We have received feedback that we will not need to share data with funding partners through a third-party credit agency under the current bank guarantee model. In the second quarter, the average APR to loans facilitated portfolio-wide reached 21.4%, down from 21.8% in the previous quarter. We will continue to leverage our unique business model and take guidance from central policy initiatives to continue to enhance our market positioning. Second, our channel transformation continues to push ahead. New business sourced from Ping An channels in the second quarter dropped to 22% from 31% a year ago. Importantly, new customers sourced in the first half of this year are a better quality than those sourced in the second half of last year. In regions where we've been successful in hiring higher-quality direct sales, the growth in productivity improvements have also been stronger. When combining our channel adjustments with selective regional growth, differentiated by superior credit performance, we are managing to optimize the overall quality of our new business in otherwise difficult market conditions. Third, we are seeing improved funding costs across our partner network. In the second quarter, overall bank and institutional funding costs have decreased by about 10 basis points. This improvement is driven both by the benign interest rate environment and strong demand by funding partners. Demand amongst our funding partners reflects both their desire for our quality assets and their need to increase exposure to the small business owner segment. Our number of funding partners in the second quarter reached 78%, about a 10% increase over the first quarter. Fourth, our balance sheet remains robust. As of the end of the second quarter, our net assets stood at RMB 97 billion, was RMB 43 billion in cash on hand, and the leverage ratio for our guarantee company stood at roughly 2x, demonstrating our resilience in the face of risk fluctuations. We believe that our strong capital position will enable faster resumption of growth when the macro environment stabilizes. At this point in the cycle, our unit economics are holding up reasonably well. Despite the decrease in effective interest rate APR, we have observed relative resilience in terms of the take rate, reflecting ongoing improvements made in funding costs, credit insurance costs and early repayment impact over the last 12 months. In terms of net margins, sales and operating expenses in the second quarter have improved somewhat versus a year ago to offset partially the increased credit cost we bear through our guarantee company. Let me dive further into the change in credit costs, as this has had the largest impact on our overall profitability. Total credit costs in the second quarter were RMB 3.5 billion, an increase of 152% versus a year ago. The increase was mainly due to increased risk sharing through the guarantee company and the deterioration of underlying volume driven largely by the COVID resurgence. As a reference, excluding the consumer finance subsidiary, the self-guaranteed portion of new loan sales increased from 16% in the second quarter of 2021 to 22% in the second quarter of 2022. If we further look into the early risk indicators, in December 2021, the C-M3 flow rate was 0.53%. In April, following the COVIF resurgence in Shanghai and other regions, the portfolio's C-M3 flow rate peaked at 0.83%. In June 2022, the C-M3 indicator stood at 0.61%. In the 2020 COVID wave, the C-M3 flow rate peaked at 0.98% and then return to pre-COVID levels within a 3-month period. Given the weaker macroeconomic environment today versus 2020, we anticipate that the return to normalized C-M3 flow-through rates will require a more extended period. This reality combined with the uncertainty of potential for further COVID outbreaks is the foundation for maintaining a prudent stance. In the second half of this year, we do expect our lending-facilitated unit economics take rate to be negatively impacted by increased credit insurance costs on new business as our credit insurance partners price up in response to COVID's resurgence in the first half. We are reviewing possible pricing adjustments to reflect the change in credit insurance costs. However, we do not expect absolute credit costs to increase substantially in the second half as we believe the worst is already behind us based on the early risk indicators. But a return to our historical unit economic levels, both top and bottom line will certainly have to wait until 2023 with a host improvement in the overall macroeconomic conditions. We believe we are planting the right seeds for the medium term, and are taking a prudent approach, but continue to build on strong underlying fundamentals to be able to reengage in net new business growth when the timing is right. It is with this in mind that we turn to our guidance for the second half. For the full year 2022, we expect our new loans facilitated to be in the range of RMB 563 billion to RMB 590 billion, and our client assets and wealth management to be in the range of RMB 390 billion to RMB 430 billion. We expect our total annual income to be in the range of RMB 60.3 billion to RMB 61.7 billion, and our net profit to be in the range of RMB 13 billion to RMB 13.4 billion for the full year 2022. This suggests flat to slightly negative revenue growth for the full year and a decline in annual profits up to 22%. If noncash foreign exchange losses are excluded from the calculation of net profit, the projected decline in annual profits will be approximately 17%. These forecasts reflect our current and preliminary views on the market and operational conditions, which are subject to change. Surprises to the upside derived from possibly more aggressive economic policy support are more likely to be visible in 2023. Finally, we are fully aware of potential delisting risks in the U.S. and are ready to initiate a Hong Kong listing plan as soon as permissible and subject to relevant regulatory requirements. As YS mentioned earlier, starting from this year, we will be distributing our dividends twice a year to deliver greater value to our shareholders. Our Board has approved a dividend distribution of USD 0.17 per ADS for the first half of 2022. I will now turn it over to David for more details on our financial performance.

Thank you, Greg. I will now provide a close look into our second quarter results. Please note that all numbers are in renminbi terms and all comparisons are on a year-over-year basis unless otherwise stated. Our total income for the first half grew by 8.4%, in which the total income for the second quarter grew by RMB 416 million or 3.1% year-over-year. Our total expenses for the first half grew by 24.1%. The increase in the total expense is primarily driven by the significant increase in impairment costs and also foreign exchange revaluation losses due to U.S. dollar appreciation. While our operating-related expenses actually decreased by 11% due to operating efficiency and optimizations. Net profit for the first half decreased by 15.2% and the same quarter net profit decreased by 37.9%. Next, let me highlight some of the key changes in the financials. First of all, we still achieved positive top line growth amidst a very difficult second quarter for China. Total income increased by 3.1% in the second quarter year-over-year or 8.4% in the first half. As we have advocated for building up a more sustainable business model, the total income mix of our retail credit facilitation business continued to evolve. During the second -- during the quarter, while platform service fees decreased by 23.1% to RMB 7.4 billion, our net interest income grew 55.3% to RMB 5 billion, and our guarantee income grew by 117.3% to RMB 1.9 billion. As a result, our retail credit facilitation platform service fees as a percentage of total income decreased to 45.2% from 62%. And as the trust funding model provides significantly longer funding cost, in particular in the [indiscernible] model. We continue to utilize them more in our funding mix, whereas the respective accounting treatment of revenue under this model is recognized under net interest income. We find that our net interest income as a percentage of total income actually increased to 32.8% from 31.8% a year ago. Moreover, as we continue to better utilize our guarantee company's abundant capital to bear more credit risk by ourselves instead of our P&C insurance partners, we generated more guaranteed income, reaching 12.7% as a total of income compared with 6% a year ago. In terms of wealth management, our platform transactional service fees increased by 14.7% to RMB 467 million in the second quarter from RMB 407 million in the same period of 2021. This increase was mainly driven by the increase in fees generated from our current products and services, partially offset by the runoff of legacy products. Turning to our expenses. We are cost conscious, and our operating expenses, excluding credit asset impairment losses and other losses actually decreased by 11%. In the second quarter, our total expenses grew by RMB 2.5 billion or 29% to RMB 10.9 billion from RMB 8.5 billion in the same period of 2021, primarily driven by the increase of credit impairment costs. Credit impairment losses actually increased by 152% to RMB 3.5 billion in the second quarter of 2022 from RMB 1.4 billion in the same fall of 2021. Total expenses, excluding credit and asset impairment losses, finance costs and other losses decreased by 11% to RMB 6.3 billion in the second quarter of 2022 from RMB 7.1 billion in period of 2021 to further improve our operating efficiency. Our total sales and marketing expenses, which mainly include expenses for borrowers and investor acquisition costs as well as general sales and marketing expenses decreased by 19% to RMB 3.5 billion in the second quarter. This decrease was in line with the decrease in new loan sales, the commission-based compensation structure. Of course, the continued optimization of productivity of our direct sales force also provide us with flexibility in our cost structure. Our general and administrative expenses also decreased by 4.5% to RMB 762 million in the second quarter from RMB 798 million in the same period of 2021, thanks to our stringent cost control measures as usual. Our operation and service expenses mildly increased by 7.1% to RMB 1.6 billion in the second quarter from RMB 1.5 billion a year ago, primarily due to the increase of trust plan management expenses, which is in line with the increase in consolidated trust plans. Our credit impairment losses increased by 152% to RMB 3.5 billion in the second quarter from RMB 1.4 million a year ago. This was mainly driven by 2 factors. First, the provision and indemnity losses driven by the increased risk exposure as we move towards a more balanced restricting model. As a reference, the company bore risk on 21.2% of its outstanding balance, up from 11.3% as of June of last year 2021. Secondly, the change in credit performance due to the impact of COVID-19 outbreak also contributed to the increase in credit and impairment losses. Our asset impairment losses increased to RMB 352 million in the second quarter from the RMB 2 million a year ago, mainly due to impairment losses of one legacy equity investment in [indiscernible], which is unrelated to our [indiscernible] which we have already planned to discontinue. Other losses were RMB 527 million in the second quarter compared with other gains of RMB 301 million a year ago, mainly due to the foreign exchange losses on our U.S. dollar debt exposure in the second quarter of 2022 as we witnessed a huge market volatility of U.S. dollars and renminbi in April. As a consequence of [indiscernible] our net income decreased by 37.9% to RMB 2.9 billion during the second quarter from RMB 4.7 billion in the same quarter of 2021. Meanwhile, our basic and diluted earnings per ADS during the second quarter were RMB 1.27 or USD 0.19, and RMB 1.23 or USD 0.18 respectively. On the balance sheet side. Our balance sheet remains strong and solid with cash and bank balance increased to RMB 42.9 billion. As of June, end of June 2022, we had a cash balance of 42.9 billion in cash at bank as compared with RMB 34.7 billion as of December 2021. In addition, liquid assets maturing in 9 days or less amounted to RMB 42.3 billion as of end of June 2022. As of end of June 2022, our guaranteed company's leverage ratio, leverage times is only at 2.03x, whilst regulatory requirement allow us to leverage up to 10x. All this provides strong support for the company to remain resilient in the face of economic downturn and continued ability in our dividend payout. That concludes our prepared remarks for today. Operator, we are now ready to take questions.

[Operator Instructions] Our first question is coming from Meizhi Yan from UBS.

My question is on asset quality. Greg mentioned that the flow rate seems to have bottomed out. And what's the recent trend in July and August? And given the Chinese economy, it doesn't look like it's going to improve much in the next few months or in the near term. What's your expectation then in the second half of this year for our asset quality?

Okay. So your question about asset quality, Meizhi. So we said, if you look at our C-M3 monthly net flow rate, it picked in April at 0.83% and decreased down to 0.61% in June. So we strongly believe the worst time is already over. However, we understand the current macroeconomic situation environment is not as good as back in 2020. So we take very prudent stance. And we anticipate that the return to normalized C-M3 flow rate's previous levels will require a more extended time. And it might stay at a relatively high level throughout this year. So we estimate the overall asset quality will remain at current levels in the second half as it relates to our credit impairment cost.

Can I follow up a bit?

Sure, sure. Please go ahead.

Yes. And I understand that I think the overall market concern has been on the property sector. I don't know if your -- maybe that has anything to do with the secured portfolio. I understand the secure portfolio is probably 20% or less of the total. But has the property sector situation impacted your asset quality at this point?

Actually, we have -- we don't see much impact from the secured portfolio. It takes about -- as of today, it takes about 20% of total loan balance. We have house secured loans. And then for that loan, our [APP] is not more than 70%. And then -- so from the house, the property market, that impact, actually we don't have any [indiscernible] from the secured loans.

Our next question comes from Chiyao Huang from Morgan Stanley.

So I got two questions. The first is, how do management see the current COVID control measures are impacting the underground operation of our direct sales? And second question is also about asset quality. Just wondering what the -- what are the active proactive measures we are taking to defend the asset quality currently.

Yes. Regarding, answering your first question about that, our ground force, the operation, you are well aware we have so-called offline/online [indiscernible] operational process. So during the COVID control period, our customers they have no problem to apply for loans through online app. So we don't see any barriers in loan application and underwriting procedures during -- even during the COVID control time. And then we are taking quite many corrective measures to cope with the arising concerns on the credit environment. So we tightened our underwriting policy very much, quite much starting from last year end and then continuously through the first half this year. And then as a result, our sales volume actually didn't increase. But if you look at it, it's mostly operated by our live agent Ping An channel, they decreased much. But if you look at our direct sales, I want to emphasize they still make positive growth. And then, more importantly, despite we tightened our automation policy much. Actually, their acquisition volume increased by almost 20%, right, so which -- where indicates market demand is still there. So as soon as we are ready, as soon as we see that the overall economy is turning better then we believe we have enough capacity to start our growth again.

Our next question comes from Yi Wu from Bank of America Security.

So just want to follow up on that. Since the second quarter lockdown, how do the company see the demand from the SME segment? And let's say, if China stays with this 0 COVID policy in the next 1 to 2 years, will that change your midterm loan growth target, right? Previously, I think the company is looking for generally the double-digit teens sort of the sustainable growth. If the 0 COVID doesn't change, will that impact your target? And also, is there any like sensitivity analysis you've done? Every 1 percentage point change in loan origination, how will that impact the net profit growth for the following 1, 2, 3 years?

Okay. Thanks. Our market demand, I want to say one more time, the overall market demand is now concerned because, yes, we all know that the overall market demand on loan from SBO segment are not as strong as before. That's true because they don't want to invest in the business expansion in this time. However, we also know that our market share is nearly about 1%. And then, as I just mentioned, if you look at our acquisition volume of direct sales channel, it increased [indiscernible] increased despite really reduced target market much. It increased by almost 20% in the first half. So the demand is there. We don't have any concern. Anytime we have more comfort on the credit environment, we can grow and then can deliver higher sales volume. And then your question about that, the sensitivity. This is quite -- yes, simply put, if you look at -- if you compare our annual ending loan balance, so loan balance at the end of December 31 every year and then compare that number with our new loan sales in that year, it's very close, it's very close. And then you know that loan balance -- average loan balance is a key driver of our net margin, net profit. So 1% sales volume drop, it means roughly 1% balance swap. So assuming there is no unit economics change, it means it's a 1% profit drop. And other questions.

Yes. No, I think just to follow up, the thing that I would emphasize is -- if you look at, as YS said, we really started to tighten credit kind of end of the third quarter last year and then more significantly fourth quarter. And then we had the transformation on channels with the change in thing on life. If you fast forward to today, over the last two quarters we've really been self-imposing restriction on our growth because if we're not comfortable with the credit quality, what we're really doing region by region is cutting out what we view to be the highest potential risk customers. And so if you look at what's going on today on the ground, two things are happening. One is the new customers that we do in regions that we do choose are of higher quality today than they were six months ago. So the key factor for us is the judgment on timing, right. We have more than enough funding, we have more than enough capital. We have full confidence in our credit models, but we need to be comfortable that the macro environment justifies putting our foot back on the gas. And we have our foot on the gas in probably about 2/3 of the regions today where we actually think there hasn't been as severe COVID impact and where we think the dynamics are right to do so. But there is a 1/3 of the regions that we're being very cautious on today. And so that's how we're planning it out. So to your question around if COVID policy continues for the long term, they will continue to have to be selective on credit quality, will have to continue to be selective on region. But if we do look at the third quarter now compared to where we were 3 months ago, it is better, right? It is clearly better from the time of the Shanghai lockdown and surrounding regions. But we'll continue to have to look at it region-by-region, quarter-by-quarter.

So on the year one, year two profit impact, I think my question was more about because of the delay, because the revenue was booked throughout the life cycle of the loan, so the slowdown this year will probably have a delayed impact. So how is that spread impacting next year or year three as well?

Yes. So there's clearly a roll-on effect of this, right? I mean, if you add less to your portfolio this year, then your base for next year gets somewhat impacted, that's for sure. But generally, the way we look at this business is on each new loan, new economics over a two to three-year period. And so if we're comfortable with that, it's really a question of then how much do you add year-by-year or quarter-by-quarter, and then you can really project down the road. So there is no question that -- you can see that our revenue growth through the second quarter this year was 3%, and that's because of actions we started to take 3 quarters ago, right? And so we will have to be a bit more prudent in our guidance around the medium term. But I think that when we look about kind of more medium to long term, it's really finding the right time to reengage and then you kind of know what the path is from there.

Our next question comes from [Yada Li] from [CICC].

I'm Yadav from CICC, and we have two questions for today. The first one is about the insurance cost. I'd like to know that what is the trend of our insurance cost in 2Q '22 and how to view the trend in the next two quarters? And if the pandemic repeats and when we see the macroeconomic uncertainty intensifies, how can we ensure that we have enough, the insurance partners to provide the credit enhancement. And the second one is about, we adopted a prudent business development strategy this year, and however when the business growth is not our primary goal, other changes to our direct selling teams through team work and how to control the operating cost brought by a large direct selling team at this stage.

Okay. Thank you, Yadav. I guess your first question is about the insurance cost. Yes, as we all know, insurance itself is a risk business. I do and we all trust our insurance partner, the ability and the know-how to price risk in the long-term and sustainable perspective. Of course, short-term volatility in credit risk do exist and it do add volatility in our insurance costs. But I think in the long term you get normalized bidding to our business model. What I want to emphasize is that at Lufax we have established quite an extensive credit enhancement sharing mechanism with our partners. Looking at quarter 2 as an example, we take 22% of risk from our new sales and only less than 70% of the risk is taken by our insurance partners. Our reliance on property insurance has been reduced to less than 7%. And second, we do have sufficient capital to increase our self-guarantee ratio and further reduce the pressure on credit enhancement or the pressure on the uses cost. And just to mention and emphasize again, our guarantee company's leverage ratio is only 2x, but the regulatory requirement can allow us to go up to 10x. And we are currently considering to further increase the self-financing ratio to probably first, say, in the medium term and when we feel timing is appropriate. So this is my comments on your first question. And I don't see any issue to have our insurance company partners to continue to [work above] because we are building up this business relationship and partnership for a very, very long-term perspective. The second question I think is about with the changing of our business development strategy, what kind of changed our [VF] team in terms of the routine work and what is the impact to operating costs. I think our core duty of our VF team hasn’t primarily changed at all. It still remains the core for business customer acquisition, but we are actually adding more context to them in building stickiness with our small business owner customers and to know more about them on the risk to help us better price our customers. So we do expect them to cooperate with the collection team to communicate and build more connections between the customers. And I think -- I don't think it will take too much time to help them, and it won't incur additional cost as well. In terms of the cost, as you will know and as all know, our cost structure is very flexible. Our commission-based structure allow us to be resilient in tough times and have energy to source, to fuel business in good times. So I don't think we have extra burden for us for our cost, and you already see a kind of rate optimization in cost in the first half of this year.

Yes, Yadav, I would just add, on the specifics of the numbers, if you look, new loan sales year-on-year are reduced by about 15%. And then if you look at our direct sales headcount, we are down about 10% from the end of last year. So we -- but the reduction in the total sales force is coming mostly from removal of a middle layer of management. So our actual number of frontline people have not decreased by that much, which goes back to the point that YS has made, which is the total amount of new loan growth from VF has actually increased year-on-year for the first half. So while we've optimized the structure of the sales force, what they do hasn't changed, but their productivity has actually been improving while, we've maintained an overall headcount control through the way we deploy those resources. If you actually look through the second quarter, sales and marketing expenses are optimized versus a year ago by about 19%. So as the volumes change, we are adjusting our expenses accordingly. And so I think we're in quite good positioning for our overall cost optimization. And the only issue that we have to deal with, I think, in the next two quarters is our insurance partners where there's more than enough capacity will price up because of the changes in the first half. But this is something that's rolling on a quarterly basis. So as the risk flows through, as we move in towards next year, then there will be repricing again. So overall, we've been showing quite a bit of flexibility on that front.

Thank you. I will now hand over the time to management team for closing remarks.

Okay. So this concludes our second earnings conference call. And thank you all for attending this call. Thank you.

Thank you. Ladies and gentlemen, this concludes today's call. Thank you for joining. You may now disconnect your lines.