FinVolution Group Q2 FY2020 Earnings Call

Hello, ladies and gentlemen. Thank you for participating in the Second Quarter 2020 Earnings Conference Call for FinVolution Group. At this time, all participants are in listen-only mode. After management's prepared remarks, there will be a question-and-answer session. Today's conference call is being recorded. I will now turn the call over to your host, Jimmy Tan, Head of Investor Relations for the company. Jimmy, please go ahead.

Hello, everyone, and welcome to our second quarter 2020 earnings conference call. The company results were issued via newswire services earlier today and are posted online. You can download the earnings release and sign up for the company email alerts by visiting the IR section of our website at ir.finvgroup.com. Mr. Feng Zhang, our Chief Executive Officer, and Mr. Simon Ho, our Chief Financial Officer, will start the call with their prepared remarks and conclude with a Q&A session. During this call, we will be referring to several non-GAAP financial measures to review and assess our operating performance. These non-GAAP financial measures are not intended to be considered in isolation, or as a substitute for the financial information prepared and presented in accordance with U.S. GAAP. For information about these non-GAAP measures and reconciliation to GAAP measures, please refer to our earnings press release. Before we continue, please note that today's discussion will contain forward-looking statements made under the safe harbor provisions of the U.S. Private Securities Litigation Reform Act of 1995. Forward-looking statements involve inherent risks and uncertainties. As such, the company results may be materially different from the views expressed today. Further information regarding these and other risks and uncertainties are included in the company filings with the U.S. Securities and Exchange Commission. The company does not assume any obligation to update any forward-looking statements except as required under applicable law. Finally, we posted a slide presentation on our IR website providing details of the results for the quarter. I will now turn the call over to our CEO, Mr. Feng Zhang. Please go ahead, sir.

Hello, everyone, and thank you for joining our second quarter 2020 earnings conference call today. We are pleased to report healthy and solid results for the second quarter, thanks to the timely measures we took in response to the pandemic outbreak, the subsequent gradual economic recovery in China since the beginning of the second quarter and our unwavering focus on comprehensive credit risk controls. Given the lingering uncertainties due to COVID-19, we remain agile in our operations with a prudent risk management approach in the second quarter. Encouragingly, numerous operating metrics showed improving trends in the second quarter; in particular, credit risk across our platform has further improved, thanks to our continued investment in risk management technology, our prudent approach to risk management and our strategy to serve better quality borrowers. In terms of our most recent delinquency trends, our day one delinquency rate in recent weeks has further improved to about 7.5%. If you recall, on our previous earnings call, our day one delinquency rate was 9.7% for the May period and 12.4% in the fourth quarter of last year before COVID-19 appeared. Our 30-day loan collection recovery rate has further improved to about 88%, which is roughly four percentage points higher than the levels in May on our last earnings call and also in the fourth quarter of 2019. These improving trends can be clearly seen in the delinquency data provided in our earnings release. Delinquency performance for our first quarter 2020 vintage is about 30% to 40% below levels one year ago, and at historically low levels. Lastly, our vertical delinquency rates disclosed showed improvement quarter-on-quarter in almost all time buckets. The improvement is particularly significant in the early stages of delinquency, that is for loans that are 15 to 90 days past due. Such early-stage delinquency ratios have fallen back to levels at the end of last June and September. This is achieved despite our total loan balance contracting by 30% to 40% compared to a year ago, which means that the underlying improvement in credit risk is actually larger than the figures suggest. These figures show that our credit risk profile today is significantly better than it was before COVID-19, and compared to our historical range, thanks to our strategy to serve better quality borrowers, our continuous investment in risk assessment technology like our Magic Mirror technology system and our strong risk management capabilities. Another improving trend in the quarter can be found in funding on our platform. Funding from our institutional partners continues to be stable and ample. With the shift to higher-quality borrowers, we have seen keen interest from institutions to lend through our platform. One of our key focuses this year has been on lowering funding costs. We are pleased to report that the current cost of funds from institutions has recently fallen to around 8.5% compared to over 9% at the beginning of this year and over 10% last year. Despite all the challenges in the first half of the year, our business operations remain resilient and profitable, thanks to our technological capability and our relentless focus on executing our plan and strategy. Now, let me address the implications of the Supreme Court's latest decision to lower the rate cap on private lending to four times that of the loan prime rate. It appears that the general understanding of the Supreme Court's decision is, first, that it only applies to private lending and not licensed financial institutions. Secondly, the cost rate caps seem to be defined on a nominal APR basis. Although these caps seem to apply only to private lending, and since the first quarter of 2019, all funding on our platform has been from institutions, we decided to move proactively and swiftly after the Supreme Court's decision and adjust our cap on total borrowing for new loan originations to 15.4% on a nominal APR basis. This proactive approach supports the regulatory deduction for lower lending rates. The cap is equivalent to around 27% for our loan tenant profile, and it is lower than the average borrowing costs previously on our platform, which, prior to the adjustments, was running at around 33%. To meet the cost rate cap, we will discontinue service to some borrowers; however, we believe the vast majority of our customers, roughly 90%, can continue to be serviced profitably. Our loan volume guidance for the third quarter of RMB15 billion to RMB16 billion, representing an increase of 15% to 22% over the second quarter, shows that we can and will continue to service the vast majority of our borrowers under the new cap. Profitability will inevitably be lower than before, but as a result of the significant progress we have made in improving risk performance and operating efficiency in the past year, we believe we will be able to continue to operate the business in a profitable and sustainable way. We have a number of levels to pull. Firstly, with a higher quality borrower base, credit risk will be lower. We expect the vintage delinquency rates for these borrower profiles to be below 4.5%. Secondly, we expect the funding costs to further decline to below 8%. These targets are expected to be reached by the end of this year. And thirdly, we will continue to drive operating efficiency. Additionally, we will also collaborate more closely with our institutional partners to explore capitalized lending models. The significantly improved credit profiles of our borrowers and our strong technological capabilities make these new models an attractive proposition to our institutional partners. Our timely and successful transition of funding on our platform from P2P to institutions demonstrates our agility and the strength of our technology and management capabilities. Let me now update you on where we are on P2P. Our back book of P2P funded loans has shrunk to RMB2 million in July, so effectively none P2P. So, effectively, P2P is not a hindrance for us anymore. Finally, let me update you on other strategic initiatives, particularly how we are leveraging our technology capabilities to enable businesses in financial services. Our international business is one example, with Indonesia as our oldest and most developed international market. Our operations there were severely affected by the pandemic, especially between February and May. But as the Indonesian economy reopened, we have seen some very encouraging signs of recovery, and we are pleased to report that delinquency rates and loan volumes in our Indonesian business are back to the levels at the start of the year. We continue to leverage our technology and operational experience to empower banks and financial institutions in their consumer finance operations. We expect an increasing number of institutional partners to deploy our technologies. Another example of how we are leveraging our technology is our new wealth management business. Some of you who are individual investors on our platform may have received text messages about our wealth management offering, called LY Fortune in English. Our new wealth management business focuses on servicing the huge mass affluent segment in China, using our technology and extensive experience in acquiring customers online and in serving retail investors. We're confident in our ability to succeed in this new business initiative. Although the worst of the pandemic seems to be behind us, especially in China, we will remain vigilant towards the lingering risk from COVID-19. Given that the situation internationally is still fairly severe, with a long and proven track record in technology, innovation, and managing risk prudently and responsibly through credit and economic cycles, we believe our innovative and vigorous culture will enable us to navigate challenges and unlock the vast potential in China's enormous consumer finance and FinTech markets. With that, I will now turn the call over to our CFO, Simon Ho, who will discuss our financial results for the quarter.

Thank you, Feng, and hello everyone. In the second quarter, despite the challenging COVID-19 environment, we delivered non-GAAP operating profit of RMB576 million, representing a sequential quarter-on-quarter increase of 24.2%, further demonstrating the sustained profitability of our core business model. Our balance sheet and liquidity remain strong with RMB3.4 billion in unrestricted cash and short-term liquidity. Leveraging our strong technology, we look to capture new opportunities and expand our relationships with business partners. Now, turning to the financial results for the second quarter. In the interest of time, I would not walk through each item line by line on this call. Please refer to our earnings release for more details. Net revenue for the second quarter of 2020 increased by 10.3% to approximately RMB1.8 billion from RMB1.6 billion in the same period of 2019, primarily due to the adoption of ASC 326. Loan facilitation service fees decreased by 57% to RMB405 million for the second quarter of 2020 from RMB940 million in the same period of 2019, primarily due to the decline in loan origination volume and a decrease in the average rate of transaction fees. Post-facilitation service fees decreased by 52% to RMB153 million for the second quarter of 2020 from RMB316 million in the same period of 2019, primarily due to a decline in outstanding loans serviced by the company and the rolling impact of deferred transaction fees. Net interest income was RMB333 million compared to RMB274 million in the same period of 2019, mainly due to the increased interest income from expansion in outstanding loan balances of consolidated trusts. Guarantee income was RMB821 million for the second quarter of 2020 due to the adoption of ASC 326. Non-GAAP adjusted operating profit, which excludes share-based compensation expenses before tax, was RMB576 million for the second quarter of 2020, representing a decrease of 26% from RMB779 million in the same period of 2019. Other income increased by 24% to RMB34 million for the second quarter of 2020 compared with RMB28 million in the same period of 2019, primarily due to government subsidies. Net profit was RMB454 million for the second quarter of 2020 compared to RMB661 million in the same period of 2019. Turning to the balance sheet, we have a solid and conservatively positioned balance sheet; in particular, our cash position remains strong with approximately RMB3.4 billion of unrestricted cash and short-term investments as of the end of June 2020. I also want to make two additional points about our balance sheet. First, our capital leverage is conservative. If you compare the total outstanding loans on our platform of RMB21 billion by our shareholders' equity, the leverage ratio across the business was only 2.8 times. Secondly, credit risks are well reserved. We have RMB2 billion of restricted cash set aside specifically to cover quality assurance protection and guarantees given to our institutional funding partners. This restricted cash alone just about fully covers the expected credit losses from such guarantees, which were RMB2.1 billion. On top of this restricted cash, we also have RMB1.3 billion of quality assurance receivables that will be available from borrowers as they repay to cover such credit risks. We have continued to buy back our shares. Between May 2020 and August 2020, we repurchased approximately 15.1 million ADSs. As of August 24, 2020, we have cumulatively deployed approximately USD 111 billion to repurchase the company's ADSs. Since the amount repurchased is close to the prior authorized amount of USD 120 million, our Board has approved a new share repurchase program of USD 16 million, bringing the cumulative value of ADSs that can be bought back through our share repurchase programs up to USD 180 million. In closing, with strong technology, management capabilities, and a conservative balance sheet, FinVolution is well-positioned to adjust to the new environment and develop a sustainable business for the long term. With that, I will conclude my prepared remarks. We will now open the call to questions. Operator, please continue.

Yes. Thank you. We will now begin the question-and-answer session. The first question comes from Alex Ye with UBS.

Hi. Good evening management. Thanks all for taking my question. So, my first question is on the new interest rate cap. Given the new 15.4% nominal will be equivalent to a 27% IRR, could you share with us what's the current portion of your new loan that is priced above and below that cap? And so, you mentioned that you are now moving towards the level one to level three better quality customers. Could you also share with us what's the pricing levels for those better quality customers you are currently serving? That’s the first question. And second question is related to debt. Do you see any volatility through your asset quality? Lately over the past few days after the new interest rate cap news, given some borrowers may decide that they do not need to repay their debt, that is about the cap currently. And my last question is on your loan growth outlook. So, given we are on a great track to improving assets, when would you be more comfortable to resume better growth going forward? Thanks.

Sure. Thanks, Alex, for your questions. As Feng mentioned on the call just now, prior to the Supreme Court decision, our average internal rate of return was running at 33%. This average includes approximately 20% of our loan originations priced at a 24% internal rate of return. We have been working to increase the proportion of 24% internal rate of return loans, and our original intention was to continue this trend. However, the Supreme Court decision expedited those plans. To answer your second question about volatility in delinquencies and credit risks, we have not detected any issues at this time. Regarding the loan volume outlook, due to the adjustments we are implementing after the Supreme Court's decision, our loan volume in September will decrease moderately compared to August. We plan to maintain this level for the fourth quarter, allowing the business to adjust fully. This may result in the fourth quarter loan volume being flat or slightly lower than the third quarter. Our goal is to utilize the remaining time this year to adjust to the new environment and start 2021 fresh and focus on growth. That's our plan, and I hope that addresses your questions, Alex.

Sure. Sure. That’s clear. Thank you.

Thank you. And the next question comes from Daphne Poon with Citi.

Hi. Good evening management. Thanks for taking my question. My question is also regarding your pricing adjustments. Can you share your take rates outlook other than yield pricing rate given that you're lowering the IRR to 27%? In terms of the pricing range going forward, is it accurate to say that going forward, it will be at a lower range, with most of the loans being concentrated around this ceiling of the cap? Also, you mentioned earlier that most of your borrowers, roughly 90%, continue to be served under this new APR cap. Does that mean that previously you were charging too much for these borrowers? And, I mean, it is mostly the same group of borrowers with a lower APR. Does that mean that credit costs will not come down as much and will be similar to before? Finally, your expected credit cost to stabilize in the longer term; do you see more room for decline?

Sure. Thanks, Daphne. All very great questions. Firstly, on the take rates: in the first half of 2020, our take rate was relatively stable throughout, running at about 4.4%. As we've mentioned, under the new limits, profitability will inevitably be lower, but we will have room to improve on credit risk, funding cost, and operating efficiency. With the forward guidance that Feng provided, by the end of the year, we aim for funding costs below 8% and vintage delinquency below 4.5%. You can get a pretty good sense of the potential economics that our business can and will continue to operate profitably. I do want to note that this is not a static exercise; it’s a dynamic process. There are several factors adjusting simultaneously, and the end results are very much dependent on our management team's efforts. In terms of whether we are overcharging our customers, it is a bit dynamic. What we have found is overall, the first half of the year has turned out to be better than we expected regarding credit risk. We're currently projecting vintage delinquency rates could be around 4.5%, which is lower than our previous estimate of 6%. In terms of long-term credit cost outlook, we’re aiming for 4.5% by the end of this year. We would like to do better if we can.

I'll just add that we are optimistic that in the long term, the risk profile of vintage delinquency rates will be even better than the 4.5% guidance number we provided. I think, Daphne, you followed us long enough and we have a pretty solid track record of being relatively conservative in our guidance on that front.

Great. Understood. Just one follow-up. On the cost side, do you see more room for cost optimization? I noticed your costs are still around 7% to 8% of your operational balance, which appears higher than some of your peers?

Daphne, thanks for that. We have been relatively conservative during the last six to nine months, and our loan origination volume has come off. Much of the cost concerns you're commenting on are related to our prudence during this period. Our loan balance has declined by about 30% to 40% compared to a year ago. Once we adjust to the new environment and resume growth, I believe you will see significant operating cost improvement. We will continue to leverage our technologies to improve efficiency, particularly optimizing labor-intensive functions in the company like loan collections, etc. So, there is definitely room for improvement.

Okay. Got it. Thanks.

Thank you. And the next question comes from Jacky Zuo with China Renaissance.

Good evening, management. Thanks for taking my question. Just a follow-up question on regulation. From my understanding, the Supreme Court issued a document in October last year stating that the IRR above 36% will be illegal. Will that document still be valid from your understanding? How do we view loan pricing above 15.4% APR and below 36% IRR in that range? Will you consider continuing to operate in that pricing range? If not, what do you think about that pricing range? If everyone exceeds that pricing range, do you see some contingent risks from these segments of borrowers if there's no credit supply to them?

Jacky, thanks for your question. The answer is straightforward. As we laid out on the call, we swiftly moved after the Supreme Court's decision to cap all our new originations on the platform to the 15.4% nominal APR. We are not planning to operate up to the 36% IRR limit unless we receive firm legal opinions that allow us to do so. As of today, we have capped all our new originations at the 15.4% APR nominal level. Regarding what happens if others lend between below 36% IRR but above 15.4% APR, I think that’s a question that's better suited for a lawyer. We are not entering that space. We are very focused on compliance within the company.

Maybe a follow-up. For these new loans originated, you mentioned you plan to do 15.4% APR, so for existing borrowers priced higher than that, how soon will you offer these cheaper price loans to them? Will it be instantly or later this year?

We are applying this new rate cap on all new loan originations. If a borrower has an outstanding loan priced higher than that, that was made before the Supreme Court's decision, then that will continue to stay. All new originations will be capped at the new level.

I would just add that this will include new drawdowns from existing borrowers if they have additional credit lines. Essentially, from yesterday, after the decision, all loans issued, either for completely new customers or existing customers' new drawdowns, will be capped at a 15.4% nominal APR. I want to be very clear on that.

Okay. Thanks. Good. Thank you so much.

Thank you. And the next question comes from Yiran Zhong with Credit Suisse.

Hi. Good morning – sorry – good evening management. Just a follow-up on your customer acquisition as you continue to upgrade your customer base. It seems you are sticking with existing customers for now, with very high repeat borrowing rates and slow new customer acquisitions. What’s your customer acquisition strategy going forward? When do you plan to be more aggressive and ramp up your volume? Do you expect a more intense competitive landscape in the new targeted borrower segment compared to your previous borrower base? Thank you.

Thanks, Yiran. You're right that we have been servicing many existing customers, which is partly due to our conservatism. However, we have a large pool of existing customers. We have not entirely ceased new customer acquisition at any point this year. It has decreased, but lately it has actually been picking up. Among the new customers we have acquired, a significant percentage has been in the higher-quality segments, the 24% IRR segment. A likely scenario is that we will run approximately 15% of volume with new customers, and 85% existing. This proportion has been roughly where we are at for the last 12 months and should remain the norm as we fully adjust our business. We will continue to acquire and have been acquiring new customers in the higher-quality segment. The acquisition costs for these new borrowers have been drifting up, reflecting our ongoing efforts. I believe we can continue to acquire at the necessary volumes in this segment without facing undue competitive pressures.

Okay. Thank you.

Thank you. And the next question comes from Steven Chan with Haitong International.

Good evening, management. Two quick questions. First one: Based on your new scenario, what will be your breakeven point, meaning the breakeven lending rate under your new business scenario? Will the 24% IRR customers be profitable? This is my first question. The second question is about the wealth management business. Could you elaborate more on this new business? What sort of license are you getting? Is it legal to sell wealth management products on the internet platform?

Steven, thank you for your questions. Firstly, at the IRR of 24%, those customers are profitable; otherwise, we wouldn't be operating in that space at all. Regarding your question about the breakeven rate, I want to clarify that profitability is a dynamic process. If the yield goes down, quality and risk can improve, and funding costs may potentially lower as well, so it’s interrelated. We’d be happy to sit down and walk you through this topic in more detail. Regarding the wealth management business, we think the market for mass affluent individuals in China is huge. We leverage our existing technologies and our good experience in servicing retail investors, which we gained during our P2P days. We've facilitated about RMB1.4 billion of investment through LY Fortune so far. The model does not require us to be asset manufacturers; we introduce customers to partners who provide these products. We’re actively engaging in areas like bank deposits where no license is needed to distribute. For fund sales, we are partnering with a third-party company that has a fund distribution license to ensure compliance. Thus, our business model is fully compliant.

Thank you. Very clear. Thanks.

Thank you. As there are no further questions, I would like to turn the call back over to the company for closing remarks.

Thank you once again for joining us today. If you have further questions, please feel free to contact FinVolution Investor Relations team. Good night everyone.

Thank you. This concludes this conference call. You may now disconnect your lines. Thank you.