INTERNATIONAL PERSONAL FINANCE PLC (IPF) Q2 2020 Earnings Call Transcript

INTERNATIONAL PERSONAL FINANCE PLC (LON: IPF) Q2 2020 earnings call dated Sep. 08, 2020

Corporate Participants:

Gerard Ryan — Chief Executive Officer

Justin Lockwood — Chief Financial Officer

Rachel Moran — Investor Relations Manager

Presentation:

Gerard Ryan — Chief Executive Officer

Good morning, everybody, and welcome. This morning, Justin and I will be happy to talk you through our results for the first six months of 2020. Now, not withstanding the changes to environment that you see this morning, we are going to stick to our tried and tested format. So I’m going to start by walking us through the high level results for the group and in particular, I’m going to pay attention to how COVID has impacted the business and how we took very swift action to make sure that we protected our people and the business as a whole.

I’ll then move on and talk about regulatory, but truthfully there is not a huge amount to cover this morning. Justin will then pick up and talk about the financials in a lot more detail and in particular, focusing on IFRS 9 accounting and how that’s flowed through the P&L, but also focusing on how the balance sheet has strengthened over the period and how we’ve taken cost out of the business to make ourselves more productive. We will also touch on our thoughts on refinancing, something that’s very important to us at this point in time.

Now after that, I’m going to start talking about strategy, because clearly as we’ve come through COVID, we’ve learned a lot of lessons and we have re-thought our strategy. So I’ll talk us through that for probably about 10 minutes at the end. And then, as always, we’ll have plenty of time for Q&A. Now because of the changed environment, on the Q&A, I think on the bottom of your screens, there should be a dialog box into which you can type any question you want. And then, Rachel is going to pick those up for us and at the end, we will cover all of those off hopefully. And to the extent that you would like a one-to-one meeting, if that’s not already arranged, Justin and I will be happy to facilitate that for you.

So with that, let me start now with the overview of the group. The first thing to say is that the initial 10 weeks of trading in 2020 from our point of view was very positive and in particular, here now, we were also very, very pleased with the improvement in credit quality in Mexico, something that we’ve spent a lot of time working on. But after 10 weeks, obviously, we were interrupted by COVID and we took swift and decisive action to protect our business and to protect our people and customers. Now we were very focused on optimizing collections because of the interruptions that COVID caused, we reduced cost significantly and very rapidly and we also protected liquidity across the group.

Now, many of you will have seen that over the past four months, we’ve been issuing what I would call brief trading updates to the market. And if you’ve seen those, you’ll have seen that we have a steadily improving performance across our collections and our credit issuance over that period. And if you saw the most recent update, which was in August, then you will have seen that we also recovered in full the tax dispute payment that we had in Poland. So we received all of the tax monies back plus nearly GBP10 million in interest, which is obviously very helpful.

However, notwithstanding that, clearly, COVID has had a big impact in the P&L. And so for the period of six months, we have a loss of GBP46.8 million pre-exceptional items. Clearly, we’ve learned a lot of lessons, as I’ve said. And so, we started to sit down and rethink the strategy and what it means for, how we think about the business going forward and I’ll pick all of that up at the end.

As there were a number of key areas where the business was impacted and I’d like to cover those off now on this next slide. And in particularly here now, we’re focusing on home credit and also on Europe. And there are three broad areas that we should look at. First of all, where our people were restricted from moving about their individual countries, then where we had temporary rate caps put in place and finally, moratoria, something that we haven’t had to deal with before. So starting now with the people restriction movements. Now this was the biggest single impact that we saw early in the pandemic and it started from about mid-March in Poland and then rolled through the rest of the countries.

And there were points in time for some of our countries in Europe where we had zero agent activity on the street. So we very rapidly had to put in place alternative payment methodologies for our customers, because obviously those customers repay their installments through the agent. But we did that very quickly and very successfully. And you can see that played out in the collections effectiveness improvements month-on-month. Now, after those restrictions were lifted, what was really interesting for us was that the vast, vast majority of our customers immediately wanted to go back to paying through their agent. I think that’s a testament to the strength of the relationship between the agent and the customer.

Now in order to facilitate that relationship continuing, clearly we needed to take care of our agents. And so, we provided them with lots of training on health and safety, and full PPE and that gave them the confidence to go back out on the street, but also gave our customers the confidence to meet with them on a weekly basis. Now there’s one other area I wanted to cover off here and that is the impact on agents’ incomes. Clearly, our agents earn the vast majority of their commission from what they collect from customers. And when they couldn’t go out and collect and they couldn’t go out and sell, clearly their earnings were going to be adversely impacted.

Well, we took the strategic decision to continue to support our agents’ income during this period. Now that cost us money, but from our point of view, the agents are the heart of our business and we wanted to support them, because they were not calling on customers, because it was imposed on them, not because they didn’t want to. And I have to say that our loyalty to our customers by supporting their incomes, I think is now being handsomely repaid by the collections effectiveness that you see in our statistics. Then turning to the temporary rate caps. Well, clearly we’re here, we’re talking about Poland, Hungary and Finland.

Now I’ll come back to Finland later, because we decided to collect out that portfolio. In Poland and Hungary, the rate caps have what I would call sunset clauses. In Poland, it expires on the 8th of March next year, in Hungary, it expires at the end of this year. Now in response to those reduced rate caps, we severely restricted the amount of credit we were issuing in both of those countries. We really, really tightened it up to just our best quality customers. However, as we get a month on and month on, we get closer and closer to the expiration of those temporary rate caps and you will see a significantly step of the credit issued in each of those countries.

And then finally here to turn to moratoria, something we haven’t had to deal with in the past. Now in Poland, Romania and the Czech Republic, the governments there introduced moratoria that were — what are called opt in. So consumers were allowed to opt in to this deferral of payments if they met certain criteria. And it is very important to note that these are deferral payments, it’s not debt forgiveness.

Now clearly the customers credit standing is not impacted nor is there any penalty interest, but in most cases, there is interest. Now because that’s an opt in and there are certain criteria to be met and because of the really positive relationship between our agents and our customers, the take-up in these three countries is in fact very low and for all three, it’s less than 3% across the board. Now when we cross over the border into Hungary, the government there adopted a different strategy. They created what’s called an opt-out moratorium.

Now by definition that means that all consumers were presumed to have decided to defer their payments. And so, as a result of inertia and just simply the construct, then the take-up there is greater, more of the order of about 22% or 23%, but that expires at the end of this year. And I just want to confirm that we are actually in active dialog with our customers, so we’re not prevented from talking to them. So we are in regular dialog with them, so that when that expires, hopefully we get back to getting those customers back on a repayment plan and in due course lending to them again. So how did all of that play out then in terms of our KPIs. Well, if you turn to the next slide, you’ll see the KPI on the left hand side of the screen over there for collections effectiveness.

Now for obvious reasons, as I’ve just explained, April was our toughest month, and as a group, we were down at 76% effectiveness. But every month we have progressed, so that by the end of August, we were at 96%. And if I were to take out Hungary, because of the moratorium effect, in fact, the rest of the group is at 100%. So really tremendous improvement over those months. The one that may surprise you though is the graph on sales, which is in the middle of the page here and you might be surprised at how restricted we have been in terms of issuing credit. Partly that is due to the things that happened because of COVID, but in fact, a big part of those is us being cautious, because we needed to understand two key things.

First of all, what — how effective would we be in terms of collections as each month went by. And the second thing is, what was the impact of COVID on the financial standing of each of our consumers. But now that we have a much better understanding — understanding of that and we’ve demonstrated that we are improving collections, what you can see on the graph is that we are stepping up credit issued each month. And also, as the temporary rate caps in the moratoria expire, clearly you will see that tick up quite significantly.

Now because we are, what I would call a short cycle business and by that, I mean our average term is say a year. What happens here is that if you collect effectively but you issue less credit than you had anticipated, then we have the option of changing asset classes, in effect, we can move portfolio into cash. And it’s a really, really strong defensive mechanism of this business in times of crisis. And so, what you see in this graph here is the volume of additional cash that we generated through our operations, so more or less GBP40 million each month and then when we get to August, it’s closer to GBP30 million. But on top of that, we have GBP45 million coming in from the tax payment and the interest in Poland. And really, this has created a significant cash balance on our balance sheet and Justin is going to talk about that as we talk about refinancing.

So let me talk now very briefly about regulation. And if you look at the page, you will see there are two countries that were concerned with, first of all, Poland and then Romania. Now in Poland, we have the temporary rate cap. It expires on the 8th of March of next year and we have every reason to believe that that will happen, and then we will revert to the old rate cap. But as each month goes by and we get closer to that expiration days, the value of profitability in each loan contract actually increases because of the construct of that rate cap.

Then the second thing in Poland is early settlement rebates. Now we’ve talked about this before, and the fact that there is a sector wide review in Poland on how early settlement rebates should be handled for consumers. And very lately, we’ve been in, what I would call very positive dialog with UOKiK, who are their consumer protection authority, I would say, in Poland. And so very soon, I think, we will see new market standards emerging in Poland for early settlement rebates.

Now based on our understanding, our expected impact in the P&L is of the order of about GBP5 million to GBP10 million PBT per annum, but that’s before we take any mitigating actions. And you will know from our history that when it comes to regulatory challenges, we are reasonably good or adept at mitigating strategies to try and offset some of the negative impacts that we see.

And then finally turning to Romania. Now in Romania we’ve talked before about the debate that was ongoing upon introducing a TCC, total cost of credit cap. That came into play in May of this year. And so, broadly speaking the way it works is that for our consumer loans of approximately EUR3,000 or less, the TCC cap is 100%. So if I lend you a 100, I can charge a 100 on top. Now I can confirm that the vast, vast majority of our lending in Romania falls beneath that EUR3,000 limit. And so, we will happily deal with this as it stands. It’s worth noting, however, that there is a constitutional court challenge underway as regards this piece of legislation, and we expect to hear a result on that in the next month or so. So that’s it then from a high level group standpoint.

Clearly, we’ve had a lot to deal with. I think we have learned a lot of lessons, but hopefully you can see from the KPIs that we have steadily improved our operational performance, and that then has sped through to a positive impact in the balance sheet, and Justin is going to come on and talk about that now.

So let me hand you over to Justin to take us through the financials in a lot more detail.

Justin Lockwood — Chief Financial Officer

Thank you. Thank you, Gerard, and good morning everyone. So I’m going to talk through the Group’s financial performance for the half year and we’ll go into detail about the drivers of the key lines in the P&L account. I’ll then move on to an update on the strength of the Group’s balance sheet, on cash flow generation and on our plans to refinance the Eurobond ahead of its maturity in early Q2 of next year. So this first slide sets out the key drivers of our financial performance and the pre-exceptional loss that we reported for the first half of the year.

As Gerard explained earlier, we responded to the challenges presented by COVID by implementing a significant credit timing in order to manage credit risk and liquidity. These actions which successfully form the backbone of our COVID response, resulted in a 42% reduction in credit issued year-on-year, and that fed through to an 8% reduction in average net receivables. Revenue contracted by 15% due to a combination of lower average net receivables and some compression in revenue yields. The reduction in collections that resulted from the disruptions rate in service, the impact of government debt repayment moratorium, unconstrained household budgets resulted in a material adverse impact on impairments with the annualized charge increasing by 10 percentage points since the 2019 year end.

In response to the pandemic, we swiftly implemented a cost control program, which delivered GBP24 million reduction in costs in the first half of the year. So this contraction in revenue and the increase in impairment was partially offset by a reduction in the cost base. And as a result, the group reported a pre-exceptional loss before tax of GBP46.8 million. During the next few slides, I’ll talk you through the key drivers of the P&L performance during the first half, starting with credit issued and receivables.

Now as we mentioned on the last slide, we influenced a very significant credit tightening in all our businesses in order to manage liquidity and credit risk in a highly uncertain environment. During this time, we were focused on serving our most loyal long-term customers to ensure that they continue to have access to credit. Group credit issued was 42% lower year-on-year, with slightly larger reductions in both Mexico and IPF Digital compared to Europe and this reflect the combination of two factors. Firstly, credit settings in Mexico and IPF Digital’s new markets have been tightened in the second half of 2019 in order to drive an improvement in credit quality.

And secondly, the relatively early resumption of agent service in Europe allowed us to ease credit settings and issue more credit to our best quality customers in this region. Average net receivables contracted by 8% and this was driven by a reduction in the size of the portfolio resulted from lower levels of credit issued together with higher impairment provisions booked in response to the pandemic.

Around half of the year-on-year reduction arose in Mexico where average net receivables contracted by 23% due to credit signing in both the second half of 2019 and the pandemic period and that’s together with the relatively short average duration of the portfolio in this market. Moving on now to revenue where we reported a 15% contraction. And this resulted from lower average net receivables and a compression in revenue yields. This compression was driven by combination of three factors.

Firstly, a shift in the mix of group receivables away from Mexico towards Europe where the portfolio has lower revenue yield. Secondly, the impact of our ongoing successful strategy to issue slightly larger and longer-term loans in our European home credit businesses, and these longer-term products have lower revenue yields. And finally, some higher early settlement charges in Poland that Gerard referred to earlier on the regulation slide.

Turning now to impairments. And on this slide I’ll explain the impact that the pandemic had on our impairment accounting. The application of IFRS 9 to the issues arising from COVID had a significant impact on the financial results in the period. The reduction in collection cash flows are unprecedented and are not built into our impairment models. We therefore performed a full review of expected credit losses and the timing of collections before implementing overlays to our standard impairment modeling to account for these extraordinary factors.

In our home credit businesses, restrictions on the movement of people resulted in our agent service to customers being disrupted. In addition, the implementation of the opt-out and debt repayment moratoria in Hungary had a material impact on customer repayment patterns in that country. As a result, we applied an overlay to our impairment models to estimate portion of customers whose repayment patterns were impacted by these issues as distinct from those customers where there had been an increase in credit risk. We estimate the future repayment patterns taken into account a combination of operational disruption, debt repayment moratoria and an expected recessionary impact.

We then assess the extent to which the reduction in cash flows will likely to be permanent or temporary. The permanent elements was recorded as an increase in expected credit loss and that increased provisions by GBP23 million and that’s set out in the table on the right hand side of the slide. We expect the temporary missed payments to be collected at the end of customers credit agreement rather than when agent services resumed.

And given the charges for lending on home credit products are largely fixed, these delayed cash flows have been discounted at the effective interest rate to arrive at a net present value. And this resulted in an additional impairment charge of GBP36 million, also in the table on the right. We expect this charge to reverse back through the P&L account during the next 12 months as the temporary missed payments are collected from our customers.

In addition to these two provision overlays, the impairment charge in the home credit businesses was adversely impacted by GBP20 million due to the actual value of missed collections during the pandemic impacted period. In IPF Digital, the key impacts of the pandemic were a reduction on the level of customer overpayments compared to monthly minimum obligations, an increase in request for payments holidays and disruption to forward flow that sale agreements.

In response, we reviewed payment holiday request patterns and made an assessment of the expected impact of the pandemic on our customers ability to make repayments. This information was used to assess the increased probability of customers defaulting and we created an overlay provision for this. In addition, our forward flow debt sale agreements with debt sale partners have been suspended or repriced. And given that these agreements are using our loss given default calculations, it resulted in a one-off incremental impairment charge. The combined impact of this and the impairment overlay provision in IPF Digital was GBP12 million.

So the total impact of the pandemic on the impairment charge in the first half of the year was GBP91 million, of which we expect GBP36 million to be temporary and will reverse through the P&L account in the next 12 months. So I’ll now move on to the impact that this COVID impairment accounting had on our businesses. The bars on the chart on the right hand side of the slide sets out annualized impairment as a percentage of revenue at June 2020 and that’s by reporting segments. And the line shows the increase in percentage points since the 2019 year end.

Overall, the pandemic results in the group impairment charges as a percentage of revenue increased by 10 percentage points to 37.5%. In our European home credit businesses, impairment increased by 16 percentage points, driven by the impact of the pandemic on impairment accounting with no substantive non-COVID impact on either credit quality or collections in these markets.

In Mexico, the 3 percentage point increase in impairment was significantly smaller than in Europe and this reflected the material improvements in underlying credit quality delivered by our focus on operational execution from the second half of 2019 onwards. This improvement partially offset the year-on-year increase in impairment arising from the pandemic. Impairment increased by 4 percentage points in IPF Digital.

In common with Mexico, we are focused on improving credit quality in the new markets in order to reduce impairment levels. And these actions resulted in a pleasing underlying improvement in credit quality in these markets. That was offset by the pandemic-related incremental impairment charge. As a key part of our COVID response strategy, we implemented an immediate cost control program. In the first half of the year, this was focused on significant cuts to discretionary expenditure, including the decision by senior management across the group to forego bonuses in 2020.

Earlier in the year and separate to the pandemic related cost actions, we also implemented reductions in head count in Poland and Mexico in order to optimize those operations and that resulted in a restructuring cost in the first half and we will generate cost savings going forward. Taken together, these actions resulted in a year-on-year reduction in group cost of 13% or GBP24 million, with savings being generated in all our reporting segments. During the second quarter, it became clear that the impact of the pandemic would result in IPF being a smaller business in the short-term and that meant unfortunately, we need to undertake a group-wide restructuring exercise to align the organization to its reduced scale post-COVID.

This action, which began in July, together with restructuring in Poland and Mexico in the first half, is expected to result in a reduction in our workforce of around 1,200 people and structural annual cost savings totaling GBP35 million. The one-off cost of this exercise is expected to be approximately GBP6 million, which is an addition to the GBP4.1 million that was reported as an exceptional item in the first half of the year. As you know, the relationship that agents have with their customers is at the heart of the success of the home credit business model, because it drive sales, regular collections, and customer retention. As Gerard mentioned earlier, we chose to support the incomes of our agents in order to proactively manage agent turnover and to maintain the agent customer relationship. Agents’ commissions declined by 7% year-on-year, which is lower than the reduction in collections.

And the decision to support incomes underpin the progressive improvements in collections effectiveness that we have reported in recent months. So to summarize, the group reported a pre-exceptional loss of GBP46.8 million. And this chart sets out a walk from the 2019 half-year profit to this year’s loss. The walk shows the key drivers of the year-on-year reduction in profitability. Firstly, the reduction in revenue arising from a combination of smaller portfolio and a reduction in revenue yields. And secondly, the increase in reported impairments arising from the pandemic.

And these two factors were partially offset by the measures that we’ve taken to reduce the group’s cost base. The group report a net exceptional charge of GBP6.5 million in the first half of the year, and that comprises three components. Firstly, a GBP10.6 million charge arising from our decision to collect out our business in Finland following a tightening of price controls in that market. This included an incremental impairment provision and a non-cash write down of software assets.

Secondly, a GBP4.1 million charge for restructuring in Poland and Mexico that I mentioned earlier, and these charges were partially offset by exceptional interest income of GBP8.2 million, resulting from the successful conclusion of the long-running Polish tax dispute. The amount recorded as an exceptional item relates to interest accruing between 2017 and 2019.

So I’ll now turn to the balance sheet, cash flow and liquidity, all of which have been in the spotlight more than ever during the pandemic. We came into this period with a very strong capital position, and I’m pleased to report that it continues to be very robust, with the equity to receivables ratio strengthened to 51.4% at June 2020. This is an increase of almost 7 percentage points since December 2019, and significantly higher than our target ratio of 40%. I can also confirm that this ratio strengthened further in July. At the time when temporary restrictions on the movement of people and debt moratoria impact in our collections effectiveness, we move swiftly to implement our short-term liquidity management structure in order to protect our cash flows.

This focus on liquidity resulted in cash generation of GBP160 million in the first half, and this was used to repay GBP84 million of sterling and Polish zloty bonds as they matured in the second quarter. We also bought back EUR8.8 million of the 2021 Eurobonds at an average price of EUR87 [Phonetic]. We closed the half year with non-operational cash balances and undrawn debt facilities of GBP213 million. Liquidity was further enhanced in July and August through continued operational cash generation, totaling GBP74 million and the GBP45 million tax refund following the conclusion of the long-running Polish tax dispute.

As a result, non-operational cash and headroom on debt facilities strengthened further to GBP326 million by the end of August. And now finally turning to our refinancing plans. The group has historically been funded from a combination of equity retained earnings, bond issuances, and bank facilities. And this is expected to be the case going forward, although the mix may vary reflecting business requirements and market conditions.

The overall debt funding requirements of the group has reduced due to contraction in the scale of the business, and the strengthening of the balance sheet, which has resulted in reduced levels of net debt. This gives us more flexibility when it comes to determine the mix of funding going forward. The covenants in our funding agreements are tested on a last 12 month basis.

And whilst we passed all the test at 30th of June 2020, the full impact of COVID is likely to temporarily affects our interest cover covenants in the short-term. We have therefore commenced discussions with our banks about making appropriate covenant amendments, and will address the same matter for each of our bond issuances in due course. As previously highlighted, we are very focused on the refinancing of the 2021 Eurobond. We’ve appointed debt advisors and we are actively planning to refinance this bond in 2020.

And with that, I’ll hand back to Gerard.

Gerard Ryan — Chief Executive Officer

Thank you, Justin. Okay, so quite a lot to take on board there, but clearly COVID has had a significant negative impact on the P&L and the vast majority of that coming through the impairment line. But it’s worth remembering that the single biggest element in that impairment change is the discounting element which will unwind over the coming 12 months. As a result of all of that, our balance sheet has strengthened and Justin just talked through our thoughts on the refinancing.

Now we’ve done a lot of work around the group in terms of our strategy over the past couple of months, bearing in mind the lessons that we’ve learned from COVID and I’d like to talk through our thoughts on strategy now. So I thought it would be helpful to start with just a contextual slides that you can see in front of you that deals with our position. So where do we come from? So first of all, just a reminder that we’ve been around for more than 100 years.

So if you take into account our U.K. heritage, it’s 130 years. And our role in society is very clear and that’s to make a difference in the lives of our customers by providing straight forward financial products, particularly from customers who find it difficult to get that finance elsewhere and we serve them through both our digital and home credit channels. And what we do is, we provide finance for what I would call life’s essential purchases.

And I think this is particularly important to understand, because what it means is our customers are right there, passing a shop window, see something they like and decide they want to borrow. Our customers borrow for what I would call a budgetary need. Now in terms of the type of product we offer, on average, our loan is, give or take GBP700 or GBP800, but we give our customers more or less a year to repay that. So the average weekly or monthly installment is relatively speaking quite small, but the reason is, it fits in to their affordability criteria and that is what is essential for us to make sure it is affordable for our customers. Now as to where we play in the market. We are not trying to compete with banks for prime customers, the As and the Bs. Our USP is in the lower-to medium-income bracket for customers who are — well, they have a blemish on their credit record or they are trying to build a credit record, and that’s where we really play to our strengths to help them with us.

And as we take that as our context and we think about the lessons we’ve learned coming through COVID, we’ve now set out in four different phases our strategy for the business. And you can see that here on this page. So starting over here with H1 2020. So Phase I of this strategy is what we’ve just been talking about for the past 20 minutes or 30 minutes. So protecting the business, protecting our agents, and protecting our customers, managing liquidity.

And I would say, today, we will probably give us ourselves a tick in the box on that particular element of the strategy, not withstanding the fact, but core elements of it will continue such as making sure that all of our agents continue to have the required PPE so they can do their job safely. Then Phase II is about rightsizing the business.

And here now, we’re talking about taking cost over the business structural cost and I’ll come on and talk about that a little bit more. But also it’s about looking at the investments that we’ve made across the group and assessing whether or not those investments are going to make the required return in the near term and if not, taking decisions on that. And the backdrop against all of this is an absolute focus on operational effectiveness, because that neatly then leads us into this one here, which is how do we rebuild the business in 2021.

Now our expectation is that there will be positive demand from our customer segment and the reason goes back to why our customers borrow, it’s because of a budgetary need, it’s not discretionary. So that demand will continue, but we also believe that at the same time there will be less supply. And so, with those two together with a strong operational focus means we can then progress into the fourth phase, which is focused on longer term growth.

So, as you know, the core engine of this business for many, many years has been European home credit, where our teams do an absolutely outstanding job for us. And that then enables us to invest in Mexico and IPF Digital, the two big, big opportunities we have for growth in the long-term. So what I’d like to do now is talk through Phases II, III and IV in a little bit more detail. So first of all on rightsizing the business.

Now clearly here we are talking about cost to start with. At this point in the year, we expect it to be a significantly larger business, and therefore, we had capacity in the business to do a lot more activity. So what I asked our leadership team to do was to look at the capacity they had today and what they would need over the coming 18 months and to figure out how to take out the excess capacity out of the business. However, the instruction was also very clear that people wouldn’t be heroes for coming forward with cost cuts today, but then coming back in six months and requesting new hires. So what we are looking to do is take our capacity but not capability.

And as a result, you heard Justin mentioned that we will take out 1,200 roles out of the business out of a total of approximately 6,800, and most of that will be actually complete by the end of September into early October. Now in addition to that, clearly we have cut a lot on discretionary expenditure.

Now some of that will come back as we increased volumes, but the structural piece won’t come back. So to give you another example, clearly, as a — as a result of the reduction in headcount, but also as a change in response to COVID about how we work and we work more flexibly now and more remotely, we absolutely expect to have a much smaller footprint in terms of the number of head offices we have throughout the businesses.

Now it will take some time for that to feed through because of lease contracts, but some of those are coming up in the next 12 months to 24 months. So we’ll see cost reductions there as well. Now moving on from cost and looking at the investments we have made. We’ve already said we’re going to collect out our portfolio in Finland. Clearly that’s a disappointment, because it’s a very nice business and a great team doing a good job for us there. But unfortunately, the returns aren’t going to be strong enough in the near-term. But we have a successful track record of collecting our portfolios before, and I have every reason to believe will be successful in this instance as well.

Now in Poland, we have two digital businesses, we’ve got Provi Direct and we’ve got Hapi. They operate on different technology stacks, but broadly speaking, they serve the same customer segment. So what we’re doing now is we’re merging those two businesses and that will give us opportunities in terms of cost savings, but will also and very importantly help us to improve credit quality. And then finally turning to Mexico.

In Mexico, where we’ve made huge improvements in terms of credit quality. We have approximately 76 branches. We’ve done a line by line review of each of those branches in terms of their history, but also in terms of their opportunities. And we’ve decided that there are four of those branches that we are going to exit. Now all told, all of these changes will give rise to tens of millions of pounds of structural cost reduction and an improved focused on returns. And then underpinning all of that is what you see on the bottom here, which is this continued focus on collections and so progressive improvements.

And even though we are currently at 96% collections effectiveness, I fully expect that that will improve in the coming months and that really neatly then leads us into the next phase of our strategy. And that is about rebuilding the business in 2021. Now what you see on this side of the page is our views on demand and supply. Now our view is because of the reason our customers borrow demand will essentially stay constant and we already see that that is the case.

Now in addition, we also think that there are going to be a number of customers who are going to drop into our segment who previously were good customers for banks. But unfortunately as a result of the impacts of COVID, they will no longer being good credit risk for banks, but those customers in our view would be perfect customers for our digital business in particular. Now at the same time, we also think that there is going to be a reduction in supply. So on the non-bank financial institution space, we know that a number of our competitors are already struggling.

And in fact, over the last number of months, we’ve been offered two not-in substantial businesses. So we think reduced supply from direct competitors there. And then finally on to banks. Now over the last couple of years, you’ve heard Justin and I talk about the fact that banks are trying to top slice our best quality customers. Well, our experience in the past is that when things are tougher, banks reduce their risk appetite quite rapidly.

And so, we think they are going to pull back from that space. Now all of this is very important to us in terms of rebuilding the business, but it’s particularly important, because if you look at this piece here, we have put in place the groundwork in 2020. So as both Justin and I have already referenced, we have protected the USPs of the home credit business and we’ve also rightsized it in terms of taking a lot of structural cost out. But this one is an interesting one. We have give or take 20,000 agents on the street every week talking to customers.

So there was every opportunity during the pandemic that we could trip up reputationally as a result of those agents being out there talking to customers. But as a result of the focus that we put on that area, protecting our customers and protecting our agents, our reputation has come through this fully intact, and that’s no mean fees. And then finally down here, we talk further about the strong operational focus and how that is helping us now already to rebuild volumes as we head into the last quarter and then into 2021. So as we think about the longer or the medium to longer term then, let’s talk about the individual business units starting with European home credit.

Now in European home credit, clearly, we expect to gain market share because of exits as I’ve already discussed and because of constant demand with new customers coming in as well. But in addition and we’ve mentioned this in previous presentations, we also intend to provide a fully digital offering wherever we have home credit. And I guess, rather inauspiciously, we launched a digital business in the Czech Republic, a number of months ago. So it’s on reduced volume at the moment, but that really is just an indication that we are now on the path to introducing digital in every home credit country. We also expect and we’ve started to introduce what we call hybrid. Now hybrid is a concept where we have customers or consumers coming to us, who are not quite good enough to go end-to-end with digital. But maybe they could complete the first part of their journey with us digitally and then fulfillment needs to be through an agent for last or final detailed checking.

And it’s worth noting that we are the only business, the only business who can provide that combination. So I think that’s going to be very powerful for us in Europe. In addition, you’ve heard us talk about handheld technology, so MyProvi. That’s now fully rolled out across Europe and currently being rolled out in Mexico. And so, we’re trying to digitize all elements of the journey with the exception of that face to face contact with the customer. Probably the best strategy we have had in European home credit for a number of years is the concept of gradually increasing the loan size and extending the loan term.

Now we are able to do this, because every year, over the past number of years, we’ve improved the credit quality in this business. So you only need to look back through the statistics and you will see that we’ve been producing record levels of quality in European home credit. And so, we’ve gradually stepped up as you can see on the chart here, the average value of the loan, relatively speaking, it’s still small and we’ve extended the term by a couple of weeks at a time. But that is helping us to offset some of the margin compression that’s come from regulatory changes.

And then finally, as we look forward in the business, clearly, the temporary rate caps are going to come off, the moratoria are going to expire and we will step up the volume of lending in these European markets in addition to the final point here, which is to extend the array of value-add products that we provide to our customers. At the moment, it’s mostly insurance, it is not on our balance sheet, but it’s something that our customers really value, because we can provide them with straightforward insurance products that are at a price point that they can’t personally get, but we because of group purchasing power can do.

Now turning to Mexico. Well, as I said, we spend a lot of time in 2019 improving the credit quality in Mexico, but also strengthening the leadership team. And it’s fair to say that in quarter four of 2019 and the first 10 weeks of 2020, we were really very, very happy with the performance of the leadership team and the results coming from the business. Clearly we were then interrupted by the COVID. So how do we now think about Mexico? Well, I think the answer really is in this chart, because if you look at segment D in this chart, you will see that there are over 40 million consumers that are available to refinance.

Now these consumers, for them, the home credit model is perfect. And the reason is, these consumers are hugely under-banked, a fraction of what it is in Europe. Secondly, they are very much in the cash end of the economy for that reason. But finally, culturally, they really value face-to-face interactions. All of those things playing to the strength of home credit. At the same time, it creates barriers for entry and that’s good from our point of view. Now we’ve made structural reductions to the cost base, which will play out particularly in 2021 and beyond. And so, having looked also at the returns on individual branches, we expect this business to come back on [Indecipherable] in 2021 and further.

And then finally, turning to IPF Digital. Now you’ve heard us talk about IPF Digital in the past is having two core pillars. So pillar one would be what we call our established markets. So Finland, Latvia and Lithuania, and Estonia — thank you, mental block, Estonia. And then we have our new markets which are Poland, Spain, Australia and Mexico. Now obviously we are going to collect at Finland and I think we will do that very successfully. But that still leaves the Baltic markets and these are going to remain the core of this business for a number of reasons. First of all, they are the businesses that do all of the product development. They use the most advanced credit tools that we have and they design new ones which are subsequently rolled out across the business.

And also, they build the technology, the platform that we use across the whole digital operation. In terms of development of product, you can see on the screen here, we’ve got a picture of our mobile wallet. Now we’ve talked before about the fact that we’ve gone from installment lending, mostly to revolving credit in this business and the next stage of that evolution is the mobile wallet. And effectively it provides banking like services to these customers. Now you could quite rightly say, well, that’s not new and it’s not. But for this particular customer segment, we think this is going to be really important and very helpful to us.

Now even without Finland, the Baltic markets are actually very profitable. Clearly, they are under a bit more pressure because of regulatory change, but they have fantastic market positions in each of those businesses and the brand — Credit24 is the brand that we use in these markets is the most recognized brand in consumer finance outside of high street banks. So then, how does that help us when we think about the new markets? Well, first of all, the technology is proven and it works. We know there is going to be a high customer demand and we genuinely believe that the mobile wallet will be extremely helpful in these new markets.

The other thing is that we are very focused on returns and clearly we’ve talked about, merging the two Polish businesses and that is underway. Over the last three to four years, we’ve invested a lot of money on this side of the page, new markets and as we approach the end of 2019, we felt really positive about bringing those markets to breakeven and then into profitability. COVID is an interruption, but it’s temporary. So our view is, as COVID moves on hopefully in the very near future, we will get back on track to bring these businesses to profitability. And the great thing is that these businesses have significantly larger populations for us to serve than we could ever dream about in the Baltics or Fenno-Baltic.

So that then is how we are thinking about the strategy and quite a lot of that will be familiar to you, but truthfully, that’s okay. The reason being that the strategy was absolutely working pre-COVID. So we are taking the lessons from COVID, when nuancing the strategy, we’ve restructured the cost base, we’ve taken the vast majority of the pain from COVID in the first six months of the year and now we’re gearing back up for a rapid return to profitability and growth.

So let me turn to this final page. And what we’ve titled this is a strong investment case and a positive outlook. And this page is important to us because in effect it summarizes what we believe about the business and it’s important because clearly we are thinking about refinancing. So the first thing to say is that, we are a highly responsible business. We do not rely on penalty income to drive our P&L. What the customer signs up to on day one is largely speaking what they need to pay us over the lifetime of the agreement. Even if in the home credit business, for many of them, it take slightly longer than the contractual period. So we do a lot of work in this space to make sure that we are socially inclusive and I think that helps us in the long term. It helps us with customer stickiness and the number of customers who continually come back to us to be served through this home credit model.

In terms of risk management, now over the last number of years, we’ve had significant changes on the regulatory framework in this business. But I think we’ve demonstrated that we’ve been able to maintain the profitability notwithstanding those changes and we have a very diverse portfolio across countries and we have a good product set. And so we’ve shown that we can manage credit regulation and liquidity across all of these. You probably picked up already that in terms of the fundamentals of the business coming through COVID, actually they are quite robust at this point in time.

We’ve maintained the USPs, demand we think will be constant and the business model is clearly very, very resilient. And you can see that when we come to the next point, which is about strong cash generation and the balance sheet. Because as I said at the outset, when times are tougher or if there is a credit crisis, we have the option, a very defensive option of changing asset classes from portfolio into cash and that’s effectively what you’ve seen. And now what we’d like to do, as we come out the other side of COVID is switchback, but switchback in a paced manner. So upping the level of credit as we think is appropriate.

So over the last years, and this is very interesting, over the last 10 years, we’ve issued over 25 million loans, and generated over GBP1 billion of profitability. And at the same time, we paid out nearly GBP250 million in dividends. And Justin’s talked at length about the balance sheet and the fact that now our equity to receivables sounds at just over 51%, but also our net assets are approaching nearly GBP400 million, in addition to which we have lots of cash on the balance sheet and a lot of undrawn facilities. And so finally then, and this is the important piece, we are on a track to reestablish growth and profitability in a rapid way. I am prevented legally from talking about profitability next year. You just going to have to draw your own inference from what you’ve heard here today. But our view is that the steps we need to take for that rapid return to profitability and growth, those steps are already in place and we are going to build on that over the coming months.

And I think you will continue to see improvements in our collections and then a significant step up in credit issuing over the months. So that’s it in summary, in terms of our first six months and how we are thinking about the business going forward. So Justin, if you want to come up and join me now and we’re going to do Q&A. But just as we get ready for that, I just want to take the opportunity to say a huge thank you to all of my colleagues throughout the business.

This has been an amazing six months. You know, we went in the space of three weeks from having 6,000 plus colleagues in head offices to having over 6,000 people working remotely and we did that very effectively and swiftly. We’ve taken a lot of cost out of the business and we are now structurally set up to start to re-grow the business and that’s all as a result of the work that you guys are doing. So a huge thank you from me and the board for that.

So with that, now we’re going to turn it over to questions. And Rachel, I think you’ve been monitoring the questions coming through.

Questions and Answers:

Rachel Moran — Investor Relations Manager

Yes. Thank you. We’ve got — the first question is from Frederick van Hale from [Indecipherable]. What is still in the pipeline for ECL and additional provisions going forward based on your knowledge to date? And secondly, can you give some more context on the refinance of the 2021 bonds in light of the going concern principle? And we’ve had a similar question from RBC along those lines.

Gerard Ryan — Chief Executive Officer

Okay. Well, let me pick up on the impairment question and the expected credit losses point. As I’ve touched on in the presentation, we made what we believe to be a proved assessment by assuming a deterioration in the quality of the pre-COVID portfolio, assuming a recessionary impact in the second half of 2020, assuming an extension in the effective terms of the agreement and the softening of our post write-off recoveries. We think we’ve taken a very prudent approach to the impairment accounting and we’ll need to see a lot go wrong in order for the provisions to be understated based on what we know at the moment. Now you can never be 100% certain, but that’s the approach that we take on ECL. And just to reiterate the point on the discount in charge, that GBP36 million that I touched on, that will reverse back through P&L accounts in the next 12 months.

Justin Lockwood — Chief Financial Officer

And then the refinancing? So let me start on the refinancing. I think part of the question was to do with this material uncertainty.

Rachel Moran — Investor Relations Manager

Correct.

Justin Lockwood — Chief Financial Officer

The material uncertainty phrases in there, because we are obliged to put it in, and we are obliged to put it simply because nobody is forced to give us finance as we go forward. But obviously we have appointed debt advisors and we’ve been working with them now for a couple of months. And their feedback to us is that, based on how the market stand today and the results that we presented you with today in terms of the strength of the balance sheet and the momentum in the business, they are very confident about the refinancing, but notwithstanding that we are obliged to put that phrase in. But clearly the Board of Directors have reviewed all of this. And taking that on board, and their conclusion is that the going concern is appropriate, and we absolutely believe that to be the case.

Rachel Moran — Investor Relations Manager

Okay. We’ve got a question here from John Hamilton. When will dividends be reinstated?

Justin Lockwood — Chief Financial Officer

Well, I think, what we’re going to do is we will assess whether dividends are appropriate at the point in time when that arrives. So we’ll be looking at the performance of the business, how much credit we’re issuing, how the P&L is performing, the state of the balance sheet, all of those things that you would expect us to do. And at that point, we would have a debate around the board table about whether or not it was appropriate to pay out a dividend. Anything else?

Gerard Ryan — Chief Executive Officer

No.

Justin Lockwood — Chief Financial Officer

So really we will assess all the inputs to that, but it’s not something that you do six months in advance or 12 months in advance. You look at it as you get closer to the days, you look at the performance, and all of those points, and then you make your decision.

Gerard Ryan — Chief Executive Officer

The only thing to add to that is, clearly, we have a long history of paying dividends and we absolutely intend to get back to that position in due course.

Justin Lockwood — Chief Financial Officer

Yeah. I’m speaking as a shareholder. I want to get back to paying dividends.

Rachel Moran — Investor Relations Manager

Okay. We’ve got two questions here from Ludmila, Generali. Do you expect impairments of deferred tax assets or goodwill in the second half of the year? And the second question is, what was the pre-COVID collections effectiveness?

Justin Lockwood — Chief Financial Officer

So as part of our review of the balance sheet at the half year, we performed impairment assessments against both deferred tax assets and goodwill. And there were no issues arising from that. Clearly, we will look at that again at year-end based on the circumstances that we see, but we have done a formal review at the half year. In terms of the collections effectiveness. Collections effectiveness pre-COVID is a 100%. So what we’ve been trying to do here is to show how well we are collecting compared to a normalized level. So you should take a normalized level has been not 100% effectiveness and how we are doing against that gives you that comparison.

And as Gerard touched on earlier, if we exclude Hungary, which has got it’s own particular issues from that — those numbers, then the group was at 100% collections effectiveness in August, and 96% even including the position in Hungary.

Rachel Moran — Investor Relations Manager

Okay. Portia Patel at Canaccord. Given that the rate cap discussion in Poland has been ongoing for many years, how can you be sure that the current cap is temporary?

Gerard Ryan — Chief Executive Officer

Portia, as you know as well as I do, there are no guarantees when it comes to politics. But the rate cap — the rate — the temporary rate cap that’s in there today has a sunset clause and that’s due to expire on the 8th of March. As you would expect, we stay very close to these things and everything that we hear and see confirms for us that that exploration will actually happen. But the other thing you say is, it’s been talked about for years, but actually the pre-COVID rate cap has been in existence since March ’16, so unchanged from March ’16 through to, let’s call, as March 2020. What’s been happening is that there were debates about it being reduced, but they resulted in no action, zero action. So the rate cap has been constant for, give or take, four years. But just to confirm, our view and based on what we talk with our team and here on the stage is that it will actually expire on the 8th of March. And to be fair, I think, there is a logic to that, because when you think about it from a politician’s perspective, they want these economies to be rebooted and they want businesses like ours, in particular, for our sector to continue to provide finance that’s affordable but also in volume into their markets and having a constant rate cap like we had for the last four years helps us to do that.

Rachel Moran — Investor Relations Manager

Okay. The next question is from Lucas, Santander. There’s an ongoing discussions with unions in Poland and how is that going to affect your IPF cost reduction plans?

Justin Lockwood — Chief Financial Officer

I’ll pick up on that one. So we touched on the cost reduction plans. So the plans take out 1,200 roles in the organization to deliver GBP35 million of structural cost savings. Gerard said that actually we expect that process to be concluded towards the end of this month or the next month. The only market where we still have discussions going on is Poland, and I can confirm that we are working through the statutory collective consultation process, that’s now been completed as planned, and we’ve moved on to the individual consultation exercises. So that processes is running in line with our internal expectations.

Rachel Moran — Investor Relations Manager

Okay. We got a question here from Lucy. What developments of the split between home credit versus digital businesses is expected in the medium-term for individual countries?

Gerard Ryan — Chief Executive Officer

What development of the split…

Rachel Moran — Investor Relations Manager

Yeah, between home credit and digital business.

Gerard Ryan — Chief Executive Officer

Does it mean relative volume or scale?

Rachel Moran — Investor Relations Manager

It doesn’t say, but I think — we can come back to Lucy as well.

Gerard Ryan — Chief Executive Officer

I assume you probably mean relative scale. So our expectation is that relatively speaking, home credit will continue to be by far the largest share of the volume of the business for the next few years and that’s because it is so well established and so well liked by the consumer segment. Then the digital business clearly has had a knock because of COVID and clearly we are going to collect out Finland but we will get back on track in terms of issuing value. But for the next couple of years or more, you will see home credit continue to be the lion’s share of the business. And also, obviously, the lion’s share of the profitability and returns, because those are the returns that we then used to invest to bring the new markets in digital to breakeven and into profitability.

Rachel Moran — Investor Relations Manager

Okay. And this is the last question that we have today. Will the trading updates continue?

Gerard Ryan — Chief Executive Officer

We haven’t discussed that actually.

Justin Lockwood — Chief Financial Officer

We haven’t — the next trading update we will do will be for the month of September. So we will certainly be doing a third quarter.

Gerard Ryan — Chief Executive Officer

Quarter, yeah.

Justin Lockwood — Chief Financial Officer

And we’ll probably consult with shareholders to see whether they continue to be of value and of use going forward. We are trying to be entirely transparent with the operational performance through this COVID period, and clearly today we’ve now explained how all that will also flow through to the P&L account. So we tend to continue to keep investors up to date with the…

Gerard Ryan — Chief Executive Officer

And I think people really appreciate. We know we’ve had a lot of feedback that people after a month one started to get used to this update and really liked us. I don’t think we would want to get into a habit of having to report every month for the next year. But clearly, there are a lot of moving parts. So yeah, we will have a chat about that.

Rachel Moran — Investor Relations Manager

That’s it. Thank you.

Gerard Ryan — Chief Executive Officer

Okay. Well, thank you for all the questions…

Rachel Moran — Investor Relations Manager

Sorry. There is one that’s just coming in. I’m sorry. Will Brexit impact on the long-term IPF profitability?

Gerard Ryan — Chief Executive Officer

No, I don’t think so. And I know that’s a very brief and quick answer. But if we think about, well, actually it might do depending on the strength of sterling, because what we have in the U.K. is the head office here and some cost, but we don’t have, let’s say, a trading operation. All of those operations are outside of the U.K. So from our point of view, Brexit in the U.K. shouldn’t really have a big impact. We’ve looked at all the moving parts such as we have contractors here who developed technology for us and all of that. So we’re on top of all of that, and we’re looking very closely as any potential tax impact, but what we can’t predict I suppose is the relative strength of other currencies where we make our profits versus sterling. But other than that, I don’t think there’s going to be — we don’t think there is a real impact from Brexit. Not that we can see.

Justin Lockwood — Chief Financial Officer

All of our businesses operate under domestic licenses where licenses are required and all of our businesses currently operate through statutory entities that are based in those countries.

Gerard Ryan — Chief Executive Officer

Yeah. Anymore —

Rachel Moran — Investor Relations Manager

Well, that’s all that’s come through. If anybody else has got any other questions, also they can get in touch with us.

Gerard Ryan — Chief Executive Officer

Yeah.

Rachel Moran — Investor Relations Manager

And we will answer them in due course.

Gerard Ryan — Chief Executive Officer

And just to re-extend the offer that, if you want to talk to us on a bilateral basis afterwards or set up a meeting, we’re more than happy to do that, because there is a lot of information in today’s presentation and the announcement that we made this morning, a lot of moving parts. For me, particularly, what I take from it is, we have soaked up the vast majority of the pain financially relating to COVID and that for a first six month period. And as Justin said, the biggest part of the movement in impairment was that discounting element, which effectively should unwind over the next 12 months.

I guess, you could accuse us of taking a very cautionary stance in terms of credit issued, but we think that was the right thing to do before — so that we could assess the credit worthiness — the new credit worthiness, just put it that way, of customers post-COVID. But you will see a step-up that credit volume over the coming months.

And as I said, I’m prevented from really talking about profitability next year. So I’m just going to say the foundation blocks for a rapid return to profitability and growth are all in place. So thank you very much everybody for joining. I hope the new format worked okay for you and we look forward to catching up with many of you later in one-to-one meetings. Thank you.

Justin Lockwood — Chief Financial Officer

Thank you. Bye.

Rachel Moran — Investor Relations Manager

Thank you.