LexinFintech Holdings Ltd. Q2 FY2022 Earnings Call

Thank you all for standing by, and welcome to the LexinFintech Second Quarter 2022 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. Please be advised that today's conference is being recorded. And I would now like to hand the conference over to your speaker, Ms. Echo Yan, IR Director of LexinFintech. Thank you. Please go ahead.

Thank you, operator. Hello, everyone. Welcome to Lexin's second 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 contain 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, Sunny will cover the financial results in more detail, and lastly, Jayden will discuss risk management. I'll now turn the call over to Jay. His remarks will be in Chinese, and English translation will follow. Jay, please?

Hello, everyone. It is my pleasure to talk to you again and share our second quarter 2022 earnings performance. In the second quarter, total loan originations reached RMB49.1 billion, up 13.9% quarter-over-quarter. Total operating revenue was RMB2,410 million, up 40.9% quarter-over-quarter. Net profit was RMB167 million, up 105.5% quarter-over-quarter. The number of both active users and new active users were higher than those in the first quarter. Funding costs continued to decrease and risk indicators remain stable. Our CFO and CRO will provide more details later. The growth in the second quarter was mainly due to the recovered performance of our business in June. In June, the company delivered RMB18.4 billion in loan originations. The contribution percentage of loan originations from low-risk trading customers increased by 15 percentage points in June compared with that number in March. While the risk of new loans continued to improve, by the end of the second quarter the percentage of 24 weeks was over 80% and we are capable of meeting our relevant compliance rules and regulations. The data in June has shown that we have returned to a steady growth trajectory, and growth trends will continue. The growth in June is mainly due to the timely adjustment of our business strategy. In the first five months of this year, with the resurgence of the pandemic and associated macroeconomic pressure, we did not only pay attention to the sale of, but adopted a more prudent business strategy. At the end of May, with adjustment of pandemic prevention policies and social and economic recoveries, we gradually adjusted our strategy and fully restored the credit potential of our existing high-quality customers. Based on our huge user base, we achieved notable results. The specific business strategy adjustments can be summarized as three major initiatives. The first is to increase the proportion of high-quality customers while decreasing high-risk customers. In the past few months, especially in April and May, when the pandemic was severe and the macro economy was under pressure, we were prudent in loan originations and took the initiative to control the scale. Although the impact of the pandemic was factually greater in the second quarter than in the first quarter, our risk performance was generally stable and the quality of new loan originations was better. The 90-day delinquency rate was 2.63%. The overall day-one delinquency rate has continued to decrease since last December. In July, it dropped 11% compared with the average number in the first quarter. The 30-day collection rate was consistently above 90%. Compared with May, early indicators of new loan originations in June have decreased by over 15%. In fact, we further improved the quality of customer acquisition. We have large targeted high-quality customer acquisition programs for young professionals, modern youth, and urban white collars. Additionally, the Lexin and Puhui team has leveraged the strength of its offline test to attract more high-quality customers for micro-loans. We upgraded the core modeling capabilities with partner institutions to further improve the quality of our applicants and introduced more high-quality data sources to strengthen our ability to identify first platform users. Furthermore, we adjusted the customer acquisition spend based on demographic differences in the impact of pandemic resurgence. These are the main measures that have made us better prepared to cope with challenges in the future. Third, we strengthened the segmentation operation of existing high-quality customers. Based on the user data accumulated by Lexin and external data sources, we divided customers into several segments and conducted several batches of AB technique to fully validate the effectiveness of the operation strategy of the sub-customer groups, which helped us significantly improve operating efficiency. For example, the per capita contribution of the premium customer groups was 60% higher and ARPU was 20% higher. Specific initiatives include, in terms of data, we have comprehensively strengthened the coverage and application of the PBOC credit modeling, through which we established a new model that contains more complex labeled dimensions and improved the accuracy of identifying high-quality customers by more than 25%. In terms of technology, we have improved our user identification capabilities and operational efficiencies through various models. We upgraded our profitability risk model and thanks to more precise customer segment management and the introduction of more data sources, the accuracy of model identification was improved by more than 20%. We expanded the applications of external data with financial institutions in various ways. The business strategy adjustment yielded good results, mainly due to the four core capabilities we have accumulated over the past nine years. First, user operation capability, reflected in our accurate identification of high-quality customers and segmentation operation, allows us to meet them at different stages through various products and services. Second, the ability of risk control allows us to continuously improve our user identification and operation. We have introduced high-quality external data that further analyzes internal user behaviors and iterates the risk control model at a pace that continuously improves the efficiency and accuracy of hypothetical testing. Third, the ability of funding is reflected in our funding cost control and partner expansion. Current funding costs continue to decrease since February of this year and over the past year, a number of our financial partners have continued to expand, with more than 130 financial institutions currently cooperating with us. Lastly, I would like to elaborate on our data and technology capabilities. Lexin's R&D investments have been industry-leading. In the second quarter, we invested RMB150 million in R&D, up 18.5% year-over-year. We have integrated the technical capabilities we have accumulated over the years and upgraded them into Lexin's smart business engines. The smart business engine, which not only provides a full set of intelligent analysis and decision-making tools, but also helps the business in rapid operations and iterations, greatly improves the efficiency of decision making and business operations. The smart business engine has already taken effect in our daily operations. Beyond the aforementioned customer segment operation strategy, it has also improved the operating efficiency of our offline Puhui team. Thanks to the digital operation tools of the engine, the contribution of each employee of our Puhui team has increased by 30% and the scale of SMEs has increased by 50%. Notably, these trends in consumption scenarios, customer segmentation, and full profitability are integrated into our business, forming a self-reinforcing loop that requires Lexin's ecosystem. Lexin's unique high-frequency and high-repeat-rate consumption scenarios, such as Sentinel and Maiya, our installment payment ecommerce platforms, position Lexin advantageously in acquiring more high-quality customers. Our high-quality customer base will continue to scale and enhance Lexin's core business process. The increase in scale and process of core business enhances our ability to launch data, thus improving our model and technical capabilities. Our advanced technology and risk control capabilities enable Lexin to provide services to our financial institutions and merchants. Sharing capabilities with financial institution partners and merchants allows us to connect with more funding pools and scenarios. This advantage of abundant scenarios enables us to attract more high-quality customers, perpetuating the cycle. This is also our unique and long-term competitive advantage. We are confident in our business strategy and long-term development. The company and management teams' share repurchase programs will remain in execution; therefore, we will provide more details later. Finally, I would like to talk about Lexin's corporate social responsibility initiatives. In response to the pandemic resurgence in the second quarter, we launched a specific program to help SMEs manage their cash liquidity challenges. In the second quarter, the amount of small and micro-loans was RMB5.4 billion. For SMEs more affected by the pandemic resurgence, we also took several measures to assist them in overcoming challenges. Looking at the recovery in June, it continued into Q3, and our loan origination guidance in Q3 will be RMB53 billion or above. This guidance reflects the company’s current expectations, which is subject to change. Let me now hand over the call to our CFO for a financial update. Thank you.

Thank you, Jay. Good morning, and good evening, everyone. It's my pleasure to speak to you again. Our business was under pressure due to unforeseen regional COVID surges in April and May, but thanks to the determination and effective measures taken by the government and society as a whole, the pandemic has been gradually contained. In addition, we are also encouraged and inspired by multiple macro stimulus measures adapted by various government bodies that will boost consumption and credit business. We remain committed to our strategic priorities of enhancing and diversifying the revenue structure while strengthening operational efficiency and optimizing our risk assessment capabilities. Our sustained efforts in technology innovation and digital transformation have produced more visible results this quarter. Let me now go through some key financial performance of the second quarter. I'm delighted to report that total loan origination in the second quarter was RMB49.1 billion, representing a 13.9% increase quarter-over-quarter. The outstanding loan balance stood at RMB86.6 billion, representing a 3.3% increase compared with last quarter. While the management team is not completely satisfied with this top-line result, we are encouraged by the positive momentum. Total operating revenue was RMB2.4 billion, representing a 40.9% increase quarter-over-quarter. Revenue from new consumption-driven location-based services was RMB538 million, an increase of 69% from the first quarter of 2022 and an increase of 32.2% from the same period in 2021. Revenue from technology-driven platform services was RMB436 million, a 12.3% decrease quarter-over-quarter. Revenue from credit-driven platform services was RMB1.4 billion, representing a 60.4% increase quarter-over-quarter. As you might have noticed, we reorganized our revenue segmentation since Q1 this year. This is a better reflection of the quality of our revenue and the diversified nature of our businesses. The contribution from non-credit-driven services was more than 40% of total revenue this quarter at RMB974 million, which has grown at 19.4% quarter-over-quarter. This is in line with our long-term strategic goal of building a more risk-tolerant and high-quality revenue structure. In compliance with government guidance, loan pricing in Q2 continued to fall and approached 24%. By the end of June, the mix within the 24% APR reached 81.1%, a 3.3% increase quarter-over-quarter. Now let's move on to the expense side of the second quarter. Sales and marketing expenses increased by 32.5% quarter-over-quarter, but decreased by 3% year-over-year to RMB477 million. As you know, in Q1, guided by our quality-over-quantity operational priority, we scaled back our advertising costs, especially in areas that were likely affected most by COVID. This quarter, together with the gradual improvement of the macro environment and the containment of the COVID situation, we increased our marketing promotion expenses to drive future growth but still remained generally cautious in overall spending. Research and development expenses also increased by 1.3% quarter-over-quarter and 18.5% year-over-year to RMB155 million, reflecting our continuous investments in upgrading our technology capabilities. G&A expenses decreased by 3.3% quarter-over-quarter and by 6.4% year-over-year to RMB130 million. Similar to the first quarter, it demonstrated a continuous improvement in our operational efficiency. Net profit was RMB167 million in the second quarter, representing a 105% increase quarter-over-quarter. Since we have taken a more prudent approach to reflect risk in the first quarter by stepping up the day-one provision based on the external situation, we expect that our profit will continue to show an upward trend in the second half of this year. Next, quick updates on our share repurchase program. On March 16, 2022, the company’s Board of Directors authorized a US$50 million share repurchase program. As of June 30, 2022, the company had repurchased approximately 13 million ADSs for approximately US$31 million under this program. The share repurchase program demonstrates our confidence in our long-term potential, and management remains open-minded about expanding the share buyback program in the future, should we deem it appropriate as a way of giving back to shareholders. I'd like to emphasize our unwavering determination to execute both the current initiatives and the long-term strategy of adequate investments in technology and operational optimization as priorities to drive long-term sustainable business development. Finally, as we mentioned earlier, and was also brought up by Jay, even though we have experienced some headwinds in the first few months this year due to the resurgence of COVID, we never stopped our efforts to advance our capabilities to better serve our customers and develop our business models. Looking ahead, based on the current information at hand, we are cautiously optimistic about the performance of the second half. We expect loan originations for the third quarter to reach RMB53 billion. We will continue to pursue a sustainable and resilient business approach and will remain alert to any material signs of external changes that might impact our business, responding quickly and responsibly. With that, I will turn the call over to our CRO, Jayden. Jayden, please.

Thank you, Sunny. Good morning and good evening, everyone. Let me elaborate more on the risk management front. In this quarter, we maintained a cautious approach toward our credit risk, especially with several major cities and their surroundings hit by COVID for the first half of the quarter. On our customer acquisition side, we prioritized quality over quantity by adopting a more comprehensive and robust monitoring system, which allowed us to adjust our strategy dynamically in response to COVID throughout the entire process from acquisition to portfolio management. We have been seeing positive results from these actions, as our risk level has been controlled to a relatively small ratio compared to our peers. The overall day-one delinquency rate has declined for seven consecutive months and went down by 11% compared to the first quarter of this year. Our customer portfolio has strengthened as part of the 24% adjustment progress. Moreover, as Jay mentioned earlier, the enhancements in customer segmentation and risk assessment models have enabled us to focus on high-quality customer segments and increased loan volume contributions from lower-risk borrowers. The 30-day collection rate has witnessed recovery since May after a modest decline in March and April, as the impact from COVID subsided. We have been making advancements in our customer behavior analysis model to enhance collection efficiency while simultaneously expanding our collection team to reduce the impact brought by potential regional COVID surges in the future. We are in a solid position to respond more rapidly and accurately with fewer potential obstructions. The increase in 30-plus-day delinquencies was within the expected range, at 4.85% compared with 4.4% at the end of March. This was mainly due to the impact of COVID-related circumstances in April and May, along with a more prudent credit policy leading to modest growth in the outstanding loan balance compared to the fourth quarter. But as Jay mentioned earlier, we are focusing more of our efforts and resources on existing customers whose credit performance records are clearer. To strengthen our resilience, early indicators have already shown that our risk level on new loans has been lowered by over 15%, with the trend expected to continue in August. We anticipate that the 30-plus-day delinquency rate peaked in the second quarter. Finally, I would like to stress that we have evolved a more sophisticated risk management system from our experiences dealing with COVID outbreaks and economic fluctuations. We are now better prepared for any external uncertainty and complexity that may arise in the future. Thank you.

This concludes our prepared remarks. Operator, we are now ready to take questions, please.

Thank you. We will now begin the question-and-answer session. Our first question comes from Yada Li at CICC. Please go ahead.

Okay. Then I will do the translation part. So the first question is about our new consumption services, and I was wondering how to view the development so far in 2Q 2022 and going forward. Could you please give us more color about the business model of Maiya? And I'd like to know how much it will contribute to our total revenue in the future? The second question is about the change of our operational data disclosure, for example, the total GMV. I was wondering if you could elaborate more about it and what are the main drivers of sales management?

The first question is about our new consumption services, and I was wondering how to view the development so far in the second quarter of 2022 and moving forward. Could you please provide more details about the business model of Maiya? Also, I would like to understand how much it will contribute to our total revenue in the future. The second question concerns the change in our operational data disclosure, such as the total GMV. I was hoping you could elaborate on this and share the main drivers of sales management.

In the first half of this year, we faced challenges due to COVID, which impacted our new consumption business. However, through our investments and strategic adjustments, we managed to drive our new consumption business relatively well. Despite the pressure, both our indiscernible and Maiya businesses have shown quarter-over-quarter and year-over-year growth. Notably, during the mid-year promotion on June 18, our performance increased by 30% to 40% compared to the same period last year. With ongoing investment and timely strategy adjustments, we are gradually seeing improved performance. Regarding our Maiya offline business, we not only supported stores but also launched initiatives to enhance branding. In the second quarter, we successfully launched our Maiya app, which received positive feedback. With our capabilities in both offline and online services, we are able to offer more diverse and improved services to our merchant accounts. After launching the Maiya app, over 50% of our transactions were processed online, and we are seeing very promising trends in payments. We are able to charge a 30% take rate, and given our current progress, we are very optimistic about the future of our new consumption business.

Let me translate this myself. I think the question earlier was about the new disclosure approach towards e-commerce GMV. This reflects our reorganization of our revenue, and this new disclosure approach only reflects our new consumption-driven LBS services. GMV and our revenue exposure adjustments are aligned.

Thank you, operator. Next question, please.

Our next question comes from Alex Ye from UBS. Please go ahead, Alex.

First one is on the sales and marketing expense. So the new borrower sales and marketing expense has increased quite significantly compared to the previous two years, almost doubling. So I'm wondering what are the key drivers behind this? Is it more due to fierce competition, tightened credit approvals, or is there any other one-off reasons? Looking ahead, what should be the kind of normalized level we should expect? The second question is on asset quality. The company has been focusing on quality for a while, and management has mentioned some improvement in day-one delinquency, but so far, we haven't seen much improvement from the vintage curve or your disclosed FPD 30-day plus delinquency chart. So I'm wondering when could we start to see this kind of asset quality improvement reflected in your financials, including your take rate and topline? Thank you.

Could you provide an estimate for the normalized level we should anticipate? Additionally, regarding asset quality, the company has prioritized quality for some time, and management has indicated improvements in day-one delinquency. However, we have yet to observe significant enhancements from the vintage curve or the 30-day plus delinquency chart. When can we expect to see this asset quality improvement reflected in your financials, such as your take rate and topline? Thank you.

Let me take the first question regarding the sales and marketing acquisition costs. There are mainly two reasons for the increase in customer acquisition costs. The first is the macroeconomic pressures associated with the COVID resurgence. During this period, we took a prudent approach to control the scale and be more cautious regarding the approval rate, thus further improving the management of the quality of our newly originated loans. The second reason is that as you all know, we are adjusting our pricing from 36% to 24%. During this optimization process, customer acquisition costs also increased at certain periods.

We experienced an increase in customer acquisition costs. The first reason is the macroeconomic pressures related to the COVID resurgence. During this time, we adopted a cautious strategy to manage scale and approval rates, which helped improve the quality management of our newly issued loans. The second reason is our ongoing adjustment of pricing from 36% to 24%. Throughout this optimization process, we also saw customer acquisition costs rise during certain periods.

I would like to take the opportunity to share the trend and several approaches we will take in the future. First, we will increase our capabilities in filtering and pre-recognizing our customers, continuously improving our risk-adjusted model. Firstly, we can identify our customers' quality and behaviors more accurately. Secondly, through our segmentation management of our customers, we can provide better service to our high-quality customers. We've divided our current customers more precisely into several categories, such as urban white collars and comparable segments, where customer quality is higher while the competitive environment is relatively stable. This will also aid in controlling costs.

We are continually enhancing our risk-adjusted model. First, we can more accurately identify the quality and behaviors of our customers. Second, by managing our customer segmentation, we can offer improved service to our high-quality customers. We have categorized our current customers into several precise segments, such as urban white-collar professionals and similar groups, where customer quality is higher and the competitive landscape is relatively stable. This approach also helps us manage costs more effectively.

The second initiative we are working on leverages our offline Puhui team. Currently, each offline Puhui team employee can usually bring in one or two customers; if we calculate the cost per person, it is actually lower compared to online costs. Thirdly, besides the continued optimization of our online investments, we are also exploring opportunities to develop some non-standardized channels for traffic acquisition. These non-traditional channels are less impacted by the evolving policies. In the short term, the increase in our customer acquisition cost is still mainly due to our model adjustments aimed at understanding customers better and pursuing high-quality customers. From a long-term perspective, we believe our customer acquisition costs will decline as we optimize relevant models and approaches.

I'm going to translate what I just said. As Jay mentioned in his presentation, all our early indicators towards the end of the second quarter, especially in July and August, indicate a downward trend. Essentially, all the early indicators of risk performance show improving credit quality. However, it will take time for these early indicators to transform into a longer-term, more stable indicator. For instance, what we released in our 30-day plus delinquency indicator only reflects the performance of May. When comparing May's performance to that at the end of March, the improvement is around 10%. However, for June's performance, even though the 30-day plus delinquency rate has not yet fully emerged, the improvement is close to 18%. What I'm saying is that it takes time for your 30-day FPD and vintage loss numbers to accurately reflect the recent quality improvements. Expect to see this improvement in the next one or two quarters. Thank you.

Next question, please.

That's good for me. Thank you.

Thank you. Our next question comes from Hans Fan of CLSA. Please go ahead, Hans.

So I got two questions regarding regulations. The first one is on the APR cap. Management just mentioned that the APR of less than 24% already counts for more than 80%, which is good. But I'm wondering when we are targeting to achieve full compliance regarding all existing loans priced below 24%. The second question is about the decoupling of direct links, that is, the data feeds from launching to the banks. Progress from our peers also looks like it's pretty slow. So I'm curious about our plan and when we expect to complete, or at least have some practices regarding the decoupling of direct links, and how is the regulator viewing our plan?

I'm interested in when we aim to reach full compliance for all existing loans priced below 24%. Additionally, concerning the decoupling of direct links, which refers to the data feeds from our launches to the banks, it seems progress among our peers is also quite slow. I'm curious about our strategy and timeline for completing this decoupling, as well as the regulator's perspective on our plan.

Regarding the 24% pricing policy, we consider it more of a government guideline rather than a strict requirement for loans. Local authorities have shown different leniency in terms of this policy. In the second quarter, we have already had more than 80% of our pricing within 24%, demonstrating our capability to make further pricing adjustments. We maintain a small amount of business pricing above 24%, which is still contingent on some local demands. We are capable of adjusting pricing to 24% or below; however, we do not currently have a targeted timeline for this. As for the impact on our take rate, I must say there is not much difference in performance between pricing above or below 24%. The impact on profit is relatively similar. In Q2, our pricing was already very close to 24%, and we have the capacity to make further adjustments in the future, but we currently do not have a timeline for that.

Our ability to adjust pricing is contingent on local demands, with the possibility of setting it to 24% or lower. However, we do not have a specific timeline for this change. Additionally, the difference in performance between pricing above or below 24% is minimal, and the effect on profit remains relatively consistent. In Q2, our pricing was already near 24%, and we have the capability to make further adjustments, but there is no timeline established at this moment.

Regarding the regulation about disconnection, I want to emphasize that our progress is actually quite fast and the pace is not slower than our peers in the industry. To be honest, as is known, there are two partners or bureaus that can provide relevant cooperation with us. We already have cooperation with them and have various plans prepared to connect if the official requirement is issued. Observing the recent issues, the 14 documents show that the authorities have extended the discussion on these connection policies for more than a year, and we interpret this policy extension as a positive sign. To be honest, there are currently no official requirements or instructions from the authorities. We believe that the authorities and relevant government agencies are seriously considering these types of requirements and their impacts on industry players, especially medium and small banks, as well as the effects on China's economy during this special period. However, as I stated earlier, we view this policy with a positive perspective and are fully prepared to cooperate with the partners in the future. Our current pricing policies are ready to go once the specific requirements are issued.

Thank you. That's all the time we have for questions today. I will hand back to management for closing comments. Thank you.

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