LexinFintech Holdings Ltd. Q1 FY2022 Earnings Call

Ladies and gentlemen, thank you for standing by, and welcome to the LexinFintech First Quarter 2022 Earnings Conference Call. At this time all participants are in a listen-only mode. I must advise you that this conference is being recorded today. I would now like to hand the conference over to your first speaker today, Ms. Jamie Wang, IR Manager. Thank you. Please go ahead.

Thank you, operator. Hello, everyone. Welcome to Lexin's First Quarter 2022 Earnings Call. With us on the line today are our CEO, Jay Xiao; CFO, Sunny Sun; and CRO, Jayden Qiao. Before we get started, I'd like to remind you that the call and presentation containing business outlook and forward-looking statements, which are based on assumptions as of today. The actual results may differ materially, and we undertake no obligation to update any forward-looking statements. Jay will first provide an update on our performance. Jayden will then discuss risk management. And lastly, Sunny will then cover the financial results in more detail. I'll now turn the call over to Jay. His remarks will be in Chinese and English translation will follow. Jay, please?

Good morning, everyone. 1Q '22 was a quarter full of uncertainty and challenges. In China, a number of major cities like Shenzhen, Shanghai, and Beijing have had to deal with the resurgence of COVID. The unpredictability of the pandemic has dented consumer confidence and led to a slowdown in the economy. Beyond China, the external environment is also highly volatile with high inflation in the U.S., a Federal Reserve that is committed to further rate hikes, the squeeze in liquidity, volatility in Sino-U.S. relations and the conflict between Russia and Ukraine. These factors combined have clouded the performance of capital markets and caused more uncertainty for our company and the whole sector. It's difficult to predict how these factors will develop in the next few quarters and how they will affect our operations and the execution of our strategy. The impact of COVID alone has surpassed that of 2020. We have always been proactively analyzing the situation, how consumer behavior will change and how the change in capital markets will affect listed companies. Given the core economy, pursuing scale at all costs will expose the company to more risk. We will work on the following instead: First, proactively responding to external change and adjusting operations and strategy to ensure asset quality; Second, further solidifying our foundation and increasing operational efficiency; Third, staying committed to our strategy in order to improve the diversification and quality of revenue. The management is committed and confident that we can handle the challenge and continue to build up a solid foundation to achieve long-term sustainable development. We have successfully navigated multiple policy changes in the past few years. Since our inception, we have facilitated over RMB 702 billion of loans and mapped a user base of over 171 million. These are a testament to our capability. In the first quarter, the loan origination volume reached RMB 43.2 billion and the outstanding loan balance was RMB 83.8 billion. To be honest, we're not pleased with the quarterly results. We have the potential to do more. But on the other hand, it should not be a disappointment because we had already done our best in responding to change and adjusting our operations. First, we further managed risk and controlled the impact of COVID by focusing on serving existing low-risk users and reducing the high-risk sales. Comparing 1Q 2022 to 1Q 2020, all risk and profitability indicators were better this time around. Second, we have been broadening the funding channels. Nationwide partners already made up 76% of the total funding in the first quarter. The mismatch in asset and liability due to the original policy restrictions that we experienced from the end of 2021 is now being addressed. Third, we continue to invest in new growth opportunities, including the technology-driven and new consumption-driven businesses. It is our strategic goal to further promote revenue diversification and our risk management capability. In the first quarter, noncredit-driven services made up 47.7% of total revenue, up by 10 percentage points year-over-year. Fourth, in compliance, we have been making further progress in bringing down the APR. In the first quarter, the APR went down to 25%. The mix of assets within 24% already reached 77.8%. Lastly, as a leading Fintech platform, Lexin is fully aligned with regulatory priorities. We have been providing credit support to SMEs and sole proprietors, facilitating the resumption of their operations. In the first quarter, loans to small and micro businesses amounted to RMB 4.24 billion, up 9.5% quarter-over-quarter. As I explained earlier this year, we are committed to three strategic priorities. First, strengthening the management of existing customers to increase profitability while ensuring risk performance. Second, enhancing the revenue structure to promote more diversification and service nature as a platform provider. Third, optimizing the management system to further increase operational efficiency. Given the uncertainty of the macro and operational environment, it's challenging to achieve loan growth of 10% this year, though we do expect 2Q loan origination volume to be higher than this quarter. We will bring our best business structure and risk performance matters more than scale. We will also work towards the 24% policy goal and keeping the full-year take rate at a similar level to this quarter, the first quarter 2022, while trying our best to aim for 3%. In summary, the external environment and COVID situation remain highly fluid. There will be both difficulties and opportunities. We have been implementing mitigating measures and will continue to work towards our target. On the policy front, the authorities have been sending signals to support the economy, driving credit demand, and promoting market liquidity. Moreover, the PBOC has also made positive comments on the industry ratification for Internet finance. The policy regime and development of the sector are getting more mature. These are all steps in the right direction. In the second half of the year, we believe that the domestic economy will gradually turn around in the presence of stimulus policies. And we are confident that we can ride out this cycle and continue to create more value for our shareholders. Now we'll pass it to Jayden, and he will discuss our risk management. Jayden, please?

Thank you, Jay. Thank you, Jamie. Good morning, everyone. Let me elaborate on what we've been doing in response to the resurgence of COVID. We have tightened the entire user acquisition process from advertising, credit in areas most affected by COVID, marketing spending has been reduced, and selection criteria revisited in order to manage this quarter to high-risk users. We are dedicating more resources to existing relationships where the visibility on credit performance is much higher. Overall, day one delinquency has been going down every month this year. Since the second half of last year in response to the 24% loan pricing, we have already taken mitigating actions to reduce exposure to high-risk users. The customer structure is, therefore, much stronger than a year ago. This has strengthened our defense against the surge in COVID in this wave. With the improvement in customer mix, day one delinquency is better and is now 12% lower from the end of December last year. The 30-day collection rate, on the other hand, recorded a modest decline in March and April. But we are seeing signs of stabilization in May. Back two years ago, when the pandemic first started in Wuhan, most of the collection team was located in city and the operations suffered a major interruption. After the incident, we decentralized the presence, upgraded the system and revisited the credit policy to ensure that we can respond more swiftly. We are, therefore, in a significantly better position to cope with the situation this time. The increase in 90-plus delinquency was within expectations given the macro environment and the reduction in the outstanding loan balance. The extent of increase is a better indicator of our ability to manage asset quality. And relative to some of the bigger players, we have been able to show more resilience. What China is going through is unprecedented. The visibility on the path to recovery is not the best, but we are constantly refining our strategies to enhance the risk models and analytics. The risk management team is also working more closely with marketing and business development teams to budget customer acquisition as well. In short, we are much better prepared than two years ago. Thank you. I will now pass it over to Sunny.

Thank you, Jayden. Thank you, Jay. Hello, everyone. It's my pleasure to speak to you again. The management team is dialing in from different locations today. With wide lockdown measures to contain the pandemic, economic activities have faced different degrees of interruptions or even complete shutdown. In the first quarter, we made a decision to step up the provision, so we can have a stronger buffer to weather the turbulences. Most of the increase was reflected in day one provision for new loan originations. This is the main reason behind the drop in revenue. Just to recap, both of the provisions for our contracts are recognized as deductions to revenue. Further decline in loan pricing is another factor. Loans priced within 24% APR reached 78% of loan originations in the first quarter, up by 40.5% year-over-year and 18.5% quarter-over-quarter. Volume did hold up well given the current environment. Loan originations reached RMB 43.2 billion, down less than 1% quarter-over-quarter. The outstanding loan balance stood at RMB 83.8 billion, just a slight drop of 2.5% quarter-over-quarter. Consumer sentiment has become much more subdued. And most of all, we have also tightened credit assessment. On the funding side, about 76% of the funding in the first quarter came from nationwide funding partners, up by more than 10% from the fourth quarter. Funding costs began to climb at the end of last year, where regional financial institutions pulled back from cross-border lending. This shock led to a mismatch between assets and liabilities, which has gradually been resolved. The offline Puhui team has been effective in meeting the needs of our regional partners. At the headquarters level, we have also got more nationwide relationships. The uptrend in funding cost has since reversed. With a dedicated sales team, we expect to bring on board more national partners. The top line performance is always subject to external volatility from regulatory, to macro, to COVID. This is the nature of the credit business. We are proud to see how quickly Lexin is able to adapt to new changes and how teams from across the company can quickly adjust our operations and support each other. Now let me go through the expenses. Sales and marketing expenses rose 4% year-over-year to RMB 360 million, a seasonal trend as we laid out the full-year foundation in the first quarter. For the loan facilitation business, we did adjust the acquisition strategy and scale back advertising in areas affected mostly by COVID. This was done in March. There was also spending related to the expansion of technology-driven services and the new consumption-driven services. Research and development rose 23% to RMB 153 million, reflecting our continuous investment in technology to support business initiatives. G&A expenses went down by 11% year-over-year to RMB 170 million. It was a drop both year-to-year and quarter-over-quarter, demonstrating the continued improvement of our operational efficiency. Net profit did decline and went down to RMB 81 million in the first quarter, but the business remained profitable. Our cash reserve also remains solid. Cash position stood at RMB 5.6 billion at the end of March, 9% above last year. The increase in shareholders' equity was 30% in the same period to RMB 8.2 billion. In these challenging times, we remain focused on building our long-term capabilities in order to stay compliant and resilient. On the regulatory front, we maintain constant dialogue with regulators. We have been reinforcing internal control and processes and carrying out self-examinations based on the same requirement as the 13 platforms. The priority is to ensure the stability of the credit-driven business while broadening the reach into technology-driven and new consumption-driven services. The contribution from noncredit-driven services increased by 10% year-over-year to 47.7% of total operating revenue in the first quarter, demonstrating the progress in diversification. We have already built up a large base of individual users and insights into Chinese consumers which we can leverage to generate more 2B and 2F opportunities. And our relationships with 2B and 2F can also serve to further enhance our interactions with 2C. The current environment is not easy. The past quarter saw a sharp rise in COVID numbers in a few regions and the government instituting lockdown and other restricted measures, some of which are much more stringent than the previous outbreaks. But this is not the first time that Lexin has to come from uncertainty. The business fundamentals are more solid than two years ago when COVID first started. We are in a stronger position to respond to change. The recovery path will not be a straight line, but we believe both China and Lexin will come out of it stronger. Thank you.

Operator, we're now open to taking some questions.

Our first question will come from Alex Ye at UBS. Please go ahead.

So my first question is on the outlook for take rate. So just now you mentioned, the company will try to maintain your take rate for the full year at around the Q1 level of around 3%. So I'm wondering if you could give us more color on how both the asset quality and your pricing cut will have different impacts for your outlook in the coming quarters. In particular, if we assume your asset quality is sequentially improving from May, shouldn't we expect your take rate to also improve sequentially? Second question is on your capital-light percentage contribution in terms of loan volume. Could you give us some color on the current percentage in Q1 and the plan ahead?

So the first question regarding the take rate. I understand the question is about how we can maintain the take rates at the Q1 level, which is currently at 2.7%. And while we are trying our best and strive to maintain the 3% take rate for the full year. To start with, as Jay and Jayden and myself outlined earlier, obviously, there are a lot of uncertainties associated with the micro environment. And if the COVID situation does not worsen in China, we believe that we'll be able to, first of all, maintain a stable funding cost. In Q4 and Q3 this year, our funding cost went up a little bit to above 8%. But we have seen a very clear trend that it has stabilized in Q4, and we believe that the funding cost will be maintained between 7.5% to 8% this year. Secondly, I think in terms of the risk cost and the level of risk, Jay and Jayden have also outlined the situation. We will be focusing on managing the existing customers and we have a lot of data about them. We understand their behavior, and we also have clearer digitalized segmentation analysis regarding these existing customers. Therefore, we feel that we will manage risk in a more controllable manner going forward. And thirdly, I think in terms of overall business performance, Jay has outlined earlier that in the second quarter, our loan scale is expected to be slightly higher than Q1. And our revenue will continue to be stabilized. So therefore, we feel that with all the efforts and measures that were taken to contain the risk and also to contain the funding cost, the take rate should be able to be maintained at the Q1 level. And of course, we will do our very best to strive for the 3%. The second question is regarding the profit-sharing model. We have not deliberately maintained a percentage or fixed percentage of the profit-sharing model. Because for us, as we have repeatedly emphasized, focusing on controlling risk, focusing on profitability is our priority. Therefore, the profit-sharing model is a natural result of us taking such measures. But traditionally, I mean, historically, our profit-sharing model has been maintained at about between 25% to 30% or so within our overall loan origination.

Okay. Thank you very much.

Our next question will come from Xiao Liang at Morgan Stanley. Please go ahead.

So my first question is about the full year loan growth. Any change of the plan given the current situation, and any target new targets? And second question is about from the risk perspective. I wonder if there is any color on the early indicators such as day 1, et cetera, can management share with us any quantitative metrics on that front by the end of last year, by the end of the first quarter and the latest trends?

So I'll answer the first question. As for loan volume, we have not yet changed our guidance for the full year 2021 despite challenges. But we actively believe that the economy will get better and we're still targeting and aiming for the 2022 guidance that we provided.

For new issue loans, thanks to the strategies introduced in the fourth quarter last year for the 24% pricing policy, early day risk indicators such as FPD30 trended better quarter-over-quarter. FPD30 stood at 0.63%, down by 15% compared with the fourth quarter last year. While for recent wealth, since we still face some impact from COVID, we see a little bit uptick from the trend, but the new customers' quality is better than existing ones. The overall asset quality of 90-day plus delinquency and 30-day plus delinquency increased from Q4 last year. However, overall day 1 delinquency has been going down every month this year and is now 12% lower from the end of December last year. The 30-day collection rate, on the other hand, recorded a modest decline in March and April. But we are seeing signs of stabilization and better trends in May. Some of the pressures include a further drop in pricing. Financial institutions continue to step away from high-risk users, and also a slowdown in macroeconomics has impacted employment and consumption. Together with the COVID lockdown and restrictions, we also see some different degrees of impact to our portfolio. But going forward, we believe risk performance will stabilize in the second quarter this year and continue to improve through the rest of the year.

Thank you, Management.

We have no further questions. Our next question will come from Ethan Wang at CLSA. Please go ahead.

I have two questions. The first is a follow-up on asset quality. For Lexin, the rate of repeat customers has always been high in the current environment. Jayden mentioned that we have tightened some lending standards, so new borrowers may perform better regarding asset quality. Therefore, looking ahead, is there any strategic change in our lending standards? Are we focusing on identifying better existing borrowers, or are we adjusting our customer profile to target older borrowers with different occupations? My second question is about the Maiya business or the buy now pay later segment. We understand that a significant portion of Lexin's business comes from offline transactions, but with the ongoing COVID situation in China, will there be any shifts in strategy going forward? For instance, will we increase our online business efforts? Thank you.

I'll address the first question regarding the asset quality for our current customers. This does not imply that our existing customers or assets are poor compared to new ones. Statistically, new customers can present higher risks, while our long-term customers are generally more stable. The new customers tend to have lower APRs and exhibit greater stability as we gather more performance data on them. Our current focus is on managing our existing assets and exploring their potential. Overall, our asset quality is slightly improving compared to our past performance, and it remains stable within the industry. As previously mentioned, we are beginning to see signs of stabilization in the second quarter and expect asset quality to improve if the economy recovers from COVID and macroeconomic conditions improve. Regarding the Maiya business, our offline team is currently conducting trials in Shenzhen, our main city and headquarters. This initiative previously involved collaborations with offline brands and real estate. Our app launched in the first quarter and has been effective in helping offline brands establish an online presence and manage customer traffic, leading to an increase in sales. We are currently processing over 1,000 tickets daily in the first quarter and are exploring connections with more online platforms through our app. The COVID situation did impact our sales volume and ticket sizes in the first quarter, particularly due to a brief lockdown in Shenzhen. However, Maiya provides more than just buy now, pay later functionalities; it also adds value by increasing customer traffic and retention, leading to larger transaction sizes. I believe this is the way forward and aligns with broader economic trends. I hope that answers your question.

Thank you.

Thank you. We have no further questions, so I will pass back to management for closing remarks. Thank you.

Thanks again, everyone, for joining us today. If you have any more questions, please contact us offline. Our contact information is available on our website. Thank you.

Thank you. This concludes today's conference call. Thank you all for joining. You may now disconnect.