LexinFintech Holdings Ltd. Q2 FY2021 Earnings Call

Ladies and gentlemen, thank you for standing by and welcome to the LexinFintech Second Quarter 2021 Earnings Conference Call. I must advise you that this conference is being recorded today. I'd now like to hand the conference over to your first speaker today, Ms. Patricia Cheng, Head of Capital Markets. Thank you. Please go ahead.

Hi, everyone. Welcome to Lexin's Second Quarter 2021 Earnings Conference Call. Our results were issued earlier today and are available online. Joining me today on the call are Mr. Jay Xiao, our Founder, Chairman and CEO; Mr. Kris Qiao, our Interim CFO; Mr. Jayden Qiao, Chief Risk Officer; and Ms. Beryl Haiyan, Senior Financial Director. Jay will first provide an overview of our recent performance and highlights. Kris will then discuss the financial results, and Jayden will discuss our credit performance. Before we begin, please note that our Safe Harbor statement in the earnings press release applies to this call as well as because we will be making forward-looking statements. The call may include discussions of non-GAAP financial measures. You can find the reconciliation between non-GAAP and GAAP in the earnings press release. Finally, unless otherwise stated, all numbers mentioned during this conference call are in RMB. I will now pass it over to Jay. His remarks will be in Chinese and translation will follow.

Hello everyone, it's great to speak with you again. The second quarter was a significant achievement for Lexin. We set all-time highs in several important metrics: loan origination, outstanding loans, operating revenue, and net income all reached record levels. This success did not come easily; we faced many challenges along our journey and responded with determination. Those of you who have been following us have seen some of our toughest times up close and witnessed how our team tackled these challenges and turned the business around, particularly after the decline in credit performance following COVID-19 last year. This situation prompted us to reassess our strategy and enhance our risk control system, improving our ability to manage asset quality, and our efforts are yielding results. Our credit performance has remained strong in recent quarters, with the 90-day delinquency ratio decreasing by over 100 basis points to 1.85% year-over-year in the second quarter, remaining stable sequentially. Jayden will provide more insights on this later. I want to emphasize the series of changes we have made and the capabilities we have developed, which have built a solid foundation to prepare us for any industry challenges that may come our way. Now, let's discuss the regulatory change, particularly the 24% pricing cap, its potential effects on us, and how we will respond. This change will significantly impact the industry. In response, we are also undergoing a transition. First, we will slow down our growth and pay closer attention to asset quality and profitability in our business model. As a result, we have decided to lower our full-year loan facilitation volume to RMB 230 billion from a previously estimated range of RMB 240 billion to RMB 250 billion. At Lexin, maintaining a healthy and sustainable business model is more important than achieving scale. We will not compromise the long-term health of our company for short-term volume gains. With the pricing affected by the 24% cap, we will adopt a more cautious approach and adjust our customer strategy accordingly. We will move away from low-quality customers and set a risk preference to manage our overall asset risk. For customers currently receiving rates below 24%, we will intensify our services for that group. Furthermore, we will improve our operational efficiency to ensure continued business profitability. The industry is constantly evolving, and we believe that any impact will be temporary and manageable. Once we implement these measures, we expect profitability to return to current levels. Our top priority is to ensure quality and sustainable growth in our core business while continuing to develop our new consumption strategy. The momentum for Maiya, our buy now, pay later offering, remained robust in the second quarter. Partnering with over 1,000 merchants and serving over 600,000 consumers, it generated GMB of RMB 3.9 million, which is five times what we achieved in the first quarter. This initiative will enable us to explore new opportunities and diversify our revenue streams. At the heart of consumer finance, the integration of life consumption and finance delivers much stronger results when combined. This belief is central to Lexin and reflects our core strengths. Thank you for your interest and support. Next, I would like to invite Kris to discuss the financial details.

We are proud of the performance in the second quarter. Customer metrics, as well as top-line and bottom-line results, all reached record highs. Let me explain the drivers in more detail, starting with the top-line. The number of active users reached 8.4 million in the quarter, a 24% increase year-over-year. Loan origination rose by 47.6% to RMB 60.6 billion year-over-year, and loan outstanding increased by 46.2% to RMB 9.5 billion. Total revenue went up by 10.5% to RMB 3.3 billion, setting another record level, and also increased by 11% sequentially. Platform-based strategic income was the biggest revenue driver, growing by 47.9%. This revenue segment, which has no credit exposure and includes platform-based services and online services, now constitutes a third of our total revenue. Moving on to protocols and funding, both maintained good momentum in the second quarter, with provisions holding steady sequentially, indicating stable asset quality in our portfolio and our risk management capabilities, which Jayden will elaborate on later. Additionally, funding costs continued to decrease quarter-over-quarter due to positive trends in volume risk and funding, and take rates improved both year-over-year and quarter-over-quarter. Although spending on sales and marketing increased in the second quarter in line with industry trends, we kept other administrative and advertising expenses stable. From business mix to risk management, funding structure, and cost control, all these factors contributed to an 87.7% growth in net income. Legal and regulatory challenges will require us to remain cautious in risk management and cost control. As Jay noted at the beginning, we will not compromise on quality for the sake of scale. Next, I would like to turn the call over to Jayden to discuss our credit performance. Jayden, the floor is yours.

Thank you, Kris and Patricia. As both Jay and Kris mentioned, asset quality remained stable in the second quarter. Our 90 days plus delinquency ratio finished the quarter at 1.85%, down over 100 basis points year-over-year and remaining steady compared to the first quarter's 1.84%. Moreover, the 30 days plus delinquency ratio improved to 3.37% from 3.6% in the first quarter. In terms of charge-off, the vintage rate remained steady at about 3.5% for loans originated during the 12-month period ended June 30. The new customers we acquired in the second quarter have proven to be as good as those from the first quarter, as shown by the first payment default rate for 30 days plus loans, which remained below 1%. Of course, we cannot be content with our existing efforts. Regulatory changes will lead to transformations in the industry and in credit quality. We need to ensure that our system can screen for quality assets, set the right pricing, and monitor performance. To this end, risk management remains a key focus. I took on the CIO role earlier this year with a clear mandate to solidify our risk control initiatives. We have been instituting changes before the latest policy changes. These include refining risk strategies across the customer lifecycle as well as strengthening the risk models for each product and channel. We have also stepped up our collection efforts, all aimed at boosting Lexin's capability to weather any market uncertainties. With that, I conclude our prepared remarks. Operator, please proceed with the question-and-answer session.

Thank you. We will now begin the question-and-answer session. Your first question comes from the line of Eddie Leung of Bank of America Merrill Lynch.

I have two quick questions. The first one is about the regulation, as Jay mentioned that you would be adjusting down to the full-year loan growth target. From a user perspective, how will that impact your user acquisition channel or marketing activities? Secondly, regarding Maiya, the buy now pay later initiative, can you share any demographic or user profile characteristics? How might these users differ from the mainstream users of our loans or our borrower user base? Thank you.

Let me quickly translate this. On the regulatory change, we have decided to revise our guidance because quality is very important to us. That's why in this process, we need to reduce high-risk users. The purpose is to maintain take rate and profitability of the business. You can see that the changes we have to make include funding and how to service our existing users. In terms of our customer acquisition strategy, there will be major adjustments that we have to implement and we have been doing so. We have been adjusting our business in response to our customers. When you look at the regulation with this 24% pricing cap, we must adjust how we screen and how we do the advertising. We will not go after small loan sizes and high pricing rates. We also have to strengthen our reach to this core group of customers, and of course, there will be some increase in costs. In regard to offline initiatives, we will also ramp up our offline team. Looking at our portfolio business, the offline business comprises loans all priced below 24% with asset quality that exceeds the overall average. The average loan size is also higher, making this a main channel for us, one that we will continue to invest in. At the beginning of the year, we had about 1000 people on the team; now we have about 2000. We have already begun to see the impact in the third quarter. The monthly contribution from the portfolio team has almost doubled since the start of the year. Online, the quality of Maiya users is significantly better than last year. There are two characteristics: first, the Maiya product itself is interest-free installments, which naturally attracts higher quality customers. When there are high interest rates, lower-quality customers tend to seek high-interest loans because they cannot obtain loans elsewhere. Second, regarding data, we do this offline in collaboration with other brands. Nowadays, only customers with a certain income level frequent malls where these shops are located. Thus, we can attract higher quality customers this way. Up to now, when we assess potential and risk, we see that Maiya has outperformed our expectations.

Thank you. Your next question comes from the line of Ethan Wang from CLSA.

I have two questions. The first is about the regulatory challenge of keeping the APR within 24%. Has management conducted any quantitative forecasting on how this might affect the take rate and loan origination over the next two to three years? The second question concerns our capital-light business model. While we've been transitioning to a capital-light model for several years, we've chosen to keep that percentage stable. With the new 24% APR cap, will that strategy change, or do we plan to maintain it at the current level? Thank you.

We have conducted internal analysis and modeling on the impact of the 24% cap. Currently, most of our customers in terms of risk profile are below 24%. For this group of customers, we definitely have room to adjust pricing to meet the criteria while retaining these customers and their volume. The group with a risk profile above 24% is the one we need to reduce. Our goal with lower pricing is to decrease the overall risk and thus maintain our asset quality. Regarding the profit-sharing model, which is the capital-light model mentioned, we aim to at least maintain our current level. We will examine the balance between profit sharing and risk-bearing to ensure compliance with requirements while preserving asset quality. Once all measures are fully implemented, we expect our take rate to be around 3% to 3.5%, which we will be able to maintain.

Your next question comes from indiscernible of MS.

My first question is about the new personal data protection regulations. Based on your judgment, which parts of the process do you think could be affected and need modification? Is there any preliminary plan? Additionally, concerning the extra compliance costs, what impact might this have on expenses? My second question pertains to the 24% pricing cap. Are there any new strategies or dilution elements that could potentially reduce funding costs? Thank you.

Regarding personal data protection, our approach is rooted in minimal requirements, which we have always followed in our data collection. We have made some adjustments to our app to ensure compliance, including a few minor changes. For example, in the authorization process, new users used to agree to a master policy with a single authorization. Now, they must provide separate permission for usage. This will slightly increase compliance costs, but it should not impact our risk analysis results. As many definitions and specifics remain unclear from regulators, we will closely monitor the situation. In response to your second question about funding costs, we anticipate that they will remain stable and could decrease somewhat over time. With the 24% pricing cap, we expect improvements in risk and asset quality, which will enable us to form partnerships with additional funding providers. We will also increase the issuance of ADS, which will enhance our funding structure and help reduce costs.

Your next question comes from Alex Ye of UBS. Please ask your question.

My first question is about your latest developments in SME loans. I'm curious whether the average interest rate or the cap for this type of SME loan is below 24%. If it is, I would assume it would be less impacted by the 24% interest rate cap. Do you expect this business to keep being a stable growth driver for Lexin over the next year? Are there target volume contributions you anticipate for the SME lending business in the next two to three years? My second question is about the Maiya business. Can you provide an update on its latest developments, including growth over the last few months and your plans for continued expansion? Thank you.

We started the SME business this year because some users on our platform are small business owners. We began offering lending based on tax records and invoices. We are taking a careful approach to this business since the loan amounts are larger than retail and the assessment period is longer for evaluating risk and monitoring performance. Therefore, we are starting with a test sample to understand the risk characteristics and refine our risk model. If our risk model proves to be effective, we plan to increase the volume next year. Regarding Maiya, we launched this new business early in the year. As mentioned earlier, the quality has surpassed the average of our users, and we see significant potential in this market. The first quarter focused on the initial rollout, and in the second quarter, we pilot-tested the business across more industries. We've partnered with more brands, and the feedback has been encouraging. Recognition of this business is growing in China, which will help drive GMV. Brands we've worked with offline have reported an increase in average spending and additional purchases. We’ve been establishing regional teams since Q3, expanding beyond Shenzhen to further test this business model. Although it's still early days, the buy-now, pay-later model has global support, highlighting strong potential in China, where Lexin is positioned as a leading player in this area.

Your next question comes from Jacky Zuo of China Renaissance. Please ask your question.

I have two follow-up questions. First, regarding the Maiya product, as we are beginning to build our regional teams, do we have any GMV guidance for Maiya for the third quarter? Second, concerning the loan volume and APR for the third quarter, what is the expected volume compared to the second quarter? From what I understand, we are starting to adjust our APR. What is the APR level in the third quarter and how might that affect our net take rate? What percentage of high-risk customers are we estimating? Thank you.

We expect a significant increase from the second quarter to the third quarter. As I mentioned earlier, we are building teams in new cities and expanding beyond Shenzhen. However, we anticipate more substantial growth once the teams are fully established. Currently, we foresee a considerable quarter-on-quarter increase and are working to bring new cooperation agreements online. Regarding your second question about APR and take rate, we started adjusting our business immediately after the policy announcement. In July and August, APR has decreased, leading to a lower take rate. Despite this adjustment, risk has improved, resulting in lower risk costs. It's still early to provide exact figures as we recently started this process, but we expect to achieve better risk management and sustain profitability once these adjustments are finalized. Concerning high-risk borrowers in the third quarter, currently, borrowers with pricing risks above 24% make up less than 10%. We have already begun to reduce this segment further. For our existing customers, we may see higher defaults and repayment challenges if liquidity tightens, and we will manage this through ongoing monitoring. For new customers, we have refined our strategy in customer acquisition and segmentation, leading to better quality in the new risks we are taking on, helping to mitigate the risks from existing customers. Therefore, we expect stable performance.

Operator, I think we can wrap up the call here. If there are any further questions, we can always continue offline.

Thank you. Ladies and gentlemen, that does conclude the conference call for today. Thank you for participating. You may all disconnect.