Earnings Call Transcript - LX Q4 2023

Operator, Operator

Good day, and thank you for standing by. Welcome to LexinFintech's Fourth Quarter 2023 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. I would now like to hand the conference over to your first speaker today, Mandy Dong, IR Director. Please go ahead.

Mandy Dong, IR Director

Hello, everyone. Welcome to Lexin's fourth quarter and full-year 2023 earnings conference call. Our results were issued earlier today and can be found on our IR website. Joining me today are our CEO, Jay Xiao; CRO, Arvin Qiao; and CFO, James Zheng. Before we get started, I'd like to remind you of our Safe Harbor statement in our earnings press release, which also applies to this call. During the call, we may refer to business outlook and forward-looking statements, which are based on our current plans, estimates and projections. The actual results may differ materially, and we undertake no obligation to update any forward-looking statements. Last, unless otherwise stated, all figures mentioned are in RMB. In today's call, Jay will first provide an update on our overall performance. Arvin will discuss risk management progress. Lastly, James will cover the financial results in more detail. I will now turn the call over to Jay. His remarks will be in Chinese and English translation will follow.

Jay Xiao, CEO

Good evening and good morning. I'm pleased to give an update regarding our performance for the fourth quarter of 2023. In the face of the current macroeconomic environment and industry challenges, we adopted a prudent business strategy in the fourth quarter. We adhered to our strategy of dual business growth engine driven by data and risk management, achieving steady development. Total loan origination in Q4 reached RMB61.2 billion, a 9% year-over-year increase. Total loan origination volume for the full year was RMB249.5 billion, a 21.9% year-over-year increase. Loan balance grew to RMB124 billion, a 24.5% year-over-year increase. Revenue was RMB3.5 billion in Q4, a 15.1% year-over-year increase. Total revenue for the full year was RMB13.1 billion, a 32% year-over-year increase. In the fourth quarter, the industry faced increased challenges due to the slow recovery of the macroeconomic with credit demand and intensified competition. As a result, the risk level across the industry went up and we faced some short-term pressure on profitability. In response, we took a series of measures in risk management and refined operations to mitigate the impact. To be specific, in terms of new customers, we developed the low-end growth risk management system based on new customer segmentation and jointly built the RTA model in collaboration with platforms such as ByteDance, significantly improving our risk identification capabilities for online traffic in Q4, while the number of newly registered users remained the same compared to Q3. The number of new active users increased by 51.8% year-over-year. The early stage risk performance metrics of the newly issued loans stabilized and entered an improving momentum with nearly a 15% decrease in December. This will effectively bolster the inflow of high-quality customers and improve the overall asset quality. In terms of existing customers, in Q4, we focused on upgrading credit lines, granting pricing and trading strategy systems, further enhancing the competitiveness of top-tier customer offers. The proportion of transactions by super-prime and prime customer groups increased by 12% compared to the third quarter, and the risk level of new loans issued to existing customers decreased by over 15% compared to the previous quarter. We targeted potential customers who previously used our products, but did not activate for long periods or never activated their accounts before, and made offers to them, resulting in a conversion rate increase of over 50%. Leveraging enterprise WeChat will further improve customer service efficiency and satisfaction, accumulating 1.9 million followers. Through this risk management and refined operation measures, despite fluctuations in asset quality in the second half of 2023 across the whole loan facilitation sector, our overall asset quality started to stabilize in December with the day-one delinquency rate dropping 6% compared to the previous month and collection rate remained stable. Since we entered 2024, the quality of newly issued loans has continued to improve and the risk performance indicators of the overall asset portfolio are gradually improving as well. Our CRO, Arvin, will elaborate on this later. We are confident in bringing down the risk level of our assets going forward. In Q4, we invested RMB136 million in research and development, further advancing the application of AI large language models in our operations to improve work efficiency and customer experience. Through advanced training, our large language model can automatically analyze multiple data sources and identify users' industry applications, repayment intentions, and other relevant information. This capability enables us to create differentiated and personalized customer profiles and laboring systems, allowing us to implement data-driven precise customer segmentation strategies. In 2024, we will focus on the following key areas: First, bring down the risk level of overall assets and enhance profitability. We recently upgraded our risk team and invited Mr. Qiao Zhanwen to join us as our CRO. Mr. Qiao has over 10 years of experience in risk management at Ant Group, managing more than trillions in assets, and has extensive experience in the risk management space. Under his leadership, we have gained deeper understanding and set clear goals for improving our risk management framework and developing a full lifecycle risk management system. Accordingly, we have planned out specific measures. In the year ahead, we will implement risk management work in three main aspects: new customers, existing customers, and loan collections. For the first aspect, for new customers, we will continue to increase customer acquisition efforts, strengthen the development of our own customer acquisition channels, especially targeting white-collar newcomers, blue-collar workers, and mini or micro SME owners. Through the effective dynamic growth strategy of low-end growth, we will improve credit profile identification of high-quality customer groups, increase the volume of high-quality new assets, and drive down the overall risk levels. For the second aspect, for existing customers, we will strengthen the construction of underlying identification capabilities and match differentiated risk strategies based on different customer segments. Particularly, we are applying flexible pricing strategies to widen the price range for different customer segments. For high-quality customers, we will strengthen competitive offers, capture a large share of their wallets, and simultaneously lower overall portfolio risk. With over 200 million registered users, Lexin still has ample room for growth. For the third aspect, in terms of loan collection, we will strengthen collaboration with financial institutions, expand the scope of legal action, and improve its efficiency. We will continue to advance the development of the localized collection and recovery integrated system to effectively ensure user experience and efficiency in delinquent loan recovery. We will strengthen AI technology to enhance delinquent loan management systems, such as intelligent routing systems, and leverage large language models to improve loan collection efficiency. Secondly, we will continue adhering to the customer-oriented principle and improve our operation based on refined customer segmentation metrics. On one hand, we will strengthen customer credit profiling to offer differentiated products for various customer segments. In 2024, we will sharpen our focus on the SME customer segments and high-quality consumer segments, developing products such as speedy lending for growing customer segments. On the other hand, through the dynamic growth strategy system of low-end growth, we will serve customer needs and manage their risks throughout their entire lifecycle. Under this dynamic approach, we are able to offer appropriate products to their credit needs at each phase of the whole lifecycle. In addition to various products, we will continue to reinforce our work on the customer rights protection front. We have formed a consumer rights protection committee and a consumer rights protection center. In 2024, we will better meet customer demand and effectively improve customer satisfaction by enhancing consumer protection governance systems and mechanisms, therefore reducing the impact of malicious compliance around illegal groups. Thirdly, our Lexin consumption ecosystem is showing driving force for steady growth in our business through our tech-empowerment service business line. We will invest more in customer acquisition and expand to more city commercial banks and rural commercial banks, which will further fuel growth in scale and revenue. As for our offline inclusive loan business, we will continue to focus on low-tier cities that are located in industrial belts, conducting grid-based operations and targeting micro SME customers, self-employed business owners, and high-quality salary workers while offering more competitive products. We will continue to scale up our team, upgrade the Salesforce management system, enhance team management, and underline the differentiation advantages of customer acquisition and firsthand information-based credit profile identification. With regard to the e-commerce business, while maintaining our advantages in 3C products, we will expand to more trendy goods SKUs that attract younger consumers, strengthen differentiated trading and risk management strategies, upgrade risk management systems, improve user credit profile identification accuracy, and uplift approval and transaction rates, aiming to expand both scale and profitability. Fourth, concerning funding costs, our funding costs have already hit low 6%. This year, we will issue ADS and we expect this will further reduce funding costs. Looking ahead into 2024, we will adhere to prudent operation principles, prioritize risk management, and maintain steady growth in transaction volume throughout the year. We are confident that as our skills expand and risk performance continues to improve, our profitability will further increase. We will continue our recurring cash dividend program and return to shareholders. The Board has approved the plan to distribute cash dividends of approximately US$0.066 per ADS for the second half of 2023. Next, I will hand over the floor to our CRO, Zhanwen, to discuss risk management.

Zhanwen Qiao, CRO

Thank you, Jay. I'm glad to give an update regarding the risk management performance in Q4. First, let me give a few words of introduction about myself. I joined Lexin in December 2023. Prior to that, I served at Ant Group for over 10 years, in charge of the holistic risk management work of consumer credit products such as Ant Huabei and Ant Jiebei. I also served as the deputy general manager of Ant Consumer Finance Company in Chongqing, overseeing comprehensive risk management for consumer finance. I have deep involvement in the construction and integration of Ant’s consumer credit risk management system, with extensive practical experience in building risk management teams, innovative risk management technologies, and consumer credit risk management. In Q4, our asset quality showed some pressure mainly due to the slow macroeconomic recovery with consumer demand and the turmoil in the loan collection industry, which resulted in fluctuations in the risk performance of our existing loan book. We have taken timely and effective countermeasures to mitigate the impact, including strengthening risk identification capabilities, reclassifying customer segmentation, in-housing risk management of existing customers, upgrading risk management processes and accelerating talent acquisition. Looking at the asset quality of the overall loan book, the FPD7 of newly issued loans reached its peak level at the beginning of Q4 2023 and has since been gradually trending better on a monthly basis. The day-one delinquency rate of the overall assets reached its peak level in the middle of Q4 2023 and has been improving month by month, recently reaching its lowest point with over a 10% improvement compared to the peak level. Although the collection rate of the overall assets started to come under pressure in the second half of 2023, it began to stabilize and recover from January 2024. Next, let me give an update regarding the major progress we have made in risk management work streams in Q4. Firstly, in Q4, we further strengthened our risk identification capabilities. On the data front, we conducted in-depth joint modeling with several leading platform-based internet companies. By fully leveraging their massive amounts of scenario data, we have greatly improved the accuracy and stability of our risk scoring models. Additionally, in the development of risk models, we have introduced and applied cutting edge algorithms such as time series models and relationship graph models, effectively expanding our risk identification capabilities in both temporal and spatial dimensions. Based on richer scenario data and model algorithms, we have comprehensively iterated and upgraded the risk management system for our three core business lines that are consumer finance, offline inclusive finance, and e-commerce. The performance of our risk identification capabilities has improved by nearly 30%. Secondly, in Q4, we reconstructed our customer segmentation by using customer basic information, credit profiles, and customer credit scores to classify customers into four categories: super prime, prime, neo-prime, and sub-prime. Compared to the previous customer segmentation, this new approach has significantly improved risk level differentiation and stability among various customer segments. In the consumer finance business line, we have reconstructed the risk strategy and operational system throughout the customer lifecycle based on the new customer segmentation. This has led to a 35% increase in credit approval rate and a 10% decrease in risk level for new customer loans. In the future, we will further enhance our targeting of high-quality customer groups and leverage a dedicated growth strategy system to boost the drawdown rate of high-quality customers, thus expanding the scale of high-quality assets. Thirdly, for existing customers, we have upgraded and improved the overall credit approving, pricing, and transaction strategy systems through refined risk management for different customer segments. We have in-housed the competitiveness of offers for our super prime and prime customer groups. The ratio of GMV loss volume for our super prime and prime customer segments has increased by 12% compared to Q3, effectively improving our asset structure and reducing the risk of new loans to existing customers by 15%. Furthermore, we have achieved significant results in customer retention, through measures to prevent churn and recall loss of customers, particularly for our high-quality customer segments. Fourthly, we have upgraded our risk management tools and established a standardized risk strategy management process and framework. This enables standardized data input and decision output as well as the ability to orchestrate highly visualized and complex decision strategies. This has significantly improved the operational efficiency of our risk management system, supporting rapid strategy iteration and the launch of new business products. The upgraded risk management framework can effectively support a standardized link between risk management and marketing systems, further enhancing the responsive iteration and refinement among different parts of our operation process. Lastly, as we accelerate the implementation of the four mentioned risk management upgrade measures, we have also brought in a group of outstanding senior-level risk management talents from leading platforms in the industry. In the next quarter, we plan to further strengthen risk management from the following three aspects to ensure a continued decline in the risk level of newly issued loans. Firstly, we will expand and utilize more core data sources to comprehensively improve our risk identification, customer profiling, preference identification, and stability identification capabilities. Secondly, we will continue to enhance the modular construction of our risk management system, improving the standardization of risk strategies. We will transform core inputs from different dimensions into standardized modules such as income module, multiple platform module, responsive module, etc. This will further enhance the standardization and consistency of risk management strategies. Thirdly, we will develop intelligent risk management product capabilities by creating multiple products like risk management tools such as strategy robots and strategy experimentation platforms. These tools will further enhance the efficiency and precision of risk management work. Looking ahead into 2024, we will continue to uphold the principles of risk management priority and prudent operations. We will comprehensively upgrade our risk management capabilities in various aspects, including infrastructure, risk management framework, risk management data sources, models, strategies, tools, and talent teams. Our goal is to significantly enhance our risk identification capabilities for different customer segments. We will expedite the implementation of multiple specialized initiatives to strengthen risk management and refine our ability to manage customer risk throughout their entire lifecycle, including loan origination, loan servicing, and delinquent loan management. We will continue to enhance our ability to identify high-risk customers and employ various measures such as account closure, credit line reduction, and transaction interception to reduce the generation of delinquent loans. With confidence, capability, and effective methods, we aim to achieve a gradual decline in risk levels on a quarterly basis, refine asset quality, support steady growth, and improve profitability margins. Next, I'll hand over the floor to our CFO, James, for financial updates.

James Zheng, CFO

Thank you, Zhanwen. I will now provide more details on our financial results. Please note that all numbers are in RMB unless otherwise stated. In a challenging economic landscape marked by modest economic recovery and consumer spending pressure, we closed 2023 on a positive note, achieving our business target. Despite industry-wide risk volatility, our commitment to strategic pillars, rigorous risk management, customer segmentation, upgrading operational refinement, and cost optimization has fortified our financial framework and yielded positive business results. I'd like to highlight a few points related to our operations and financial progress from last quarter. Loan origination and profitability growth: Despite the controlled loan growth in response to the industry risks in Q4, we have recorded commendable loan volume and profitability increases over the year. Our Q4 GMV reached RMB61.2 billion, a 3.3% sequential decline reflecting our tightened credit standards and focus on quality growth. The annual loan origination grew by 21.9% to RMB249.5 billion with outstanding loan balance up 24.5%. Annual revenue surged by 32% and the net income spiked by 56.2%, excluding investment-related impairment losses. Second, we have demonstrated strong and resilient revenue-generating and growth capability. Despite the GMV year-over-year growth of only 9.2% in Q4, the revenue growth outpaced at 15.1% year-over-year. In Q4, we have continued to lower borrowing costs for our users. We cut the weighted average APR by 0.4% to 23.7% from 24.1% in Q4 a year ago, thus resulting in a 40 basis point decline in pricing. Additionally, as a general practice to reduce risk exposure, we have shortened the new loan tenor from an average of 13.9 months to 12.3 months. The 40 basis point decline in pricing, the shortened tenor, along with industry-wide risk penetration, did not significantly impact the overall Q4 revenue take rate. We only saw a marginal revenue take rate dip of 25 basis points to 2.47% from 2.72% a year ago. This is due to the strong positive revenue uplifting effect from lowered funding costs and continued improvement in customer early payoff. We have recorded a historically low funding cost of 6.18% in Q4, down 63 basis points year-over-year. We achieved this through ample funding and partnerships with cost-efficient national financial institutions. The funding cost hit a new record low level below 6% in February, and we expect this downward trend to continue going forward. We have taken some proactive measures to reduce the borrower's early repayment. The repayment ratio lowered to only 87% of the peak level in 2023. Thirdly, we have substantially optimized our cost structure. We trimmed down the total expense, including processing services, sales and marketing, R&D, and G&A as a percentage of average loan amount from 4.51% in Q4 2022 to 3.88% in Q4 2023, thanks to the execution of our cost optimization project. One such example is the user acquisition cost, where we realized significant savings on acquisition costs per user in Q4, thanks to our upgraded RTA marketing model and more attractive loan offerings. Our sales and marketing expenses ascended slightly by 4.6% compared to last quarter, while our new users with approved credit lines and new active users grew much faster at a rate of 21.5% and 35.7%, indicating a 14% and 17% unit acquisition cost saving respectively. Fourth, the risk fluctuations and its impact: The industry-wide risk fluctuation during the second half of last year has impacted us as it did our peers. Asset quality metrics have shown signs of stress, including the D1 delinquency rate, M1 collection rate, and the 90-plus days delinquency rate. Our 90-plus days delinquency rate moved to 2.9% versus 2.67% in the last quarter. We have enacted risk mitigation strategies that are stabilizing the situation close to the end of the year and early part of this year. The immediate financial impact is a sequentially almost flat revenue in Q4 and increased provisioning of credit impairment costs. Total provision-related cost items, including provision for financing receivables, provision for contract assets and receivables, provision for contingent guarantee liabilities, and the changing fair value of financial guarantees and loans at fair value increased by 7.1% on a quarter-over-quarter basis due to the increased pressure on our asset quality in Q4. We are maintaining ample bad debt provisions with a robust coverage ratio of approximately 317%, which is defined as the total provision amount divided by the principal amount of 90-plus days delinquent loans. Apart from the above four operational highlights, I would like to elaborate a little bit more on specific items from the financial statements. First, investment-related impairment losses. The major impact on earnings came from the investment impairment related to a domestic investment of a private bank, excluding the after-tax impact of RMB224 million of investment-related impairment losses. The net profit for the fourth quarter was RMB236 million with a net margin of 6.7%. Second, some notes on revenue line items: Guarantee income grew steadily by 11% on a quarter-over-quarter basis and 42% on a year-over-year basis due to continuing release from existing loan books. Tech-empowerment services fell 6% from last quarter and increased 3.4% from last year, primarily due to the reduced volume in tech-empowerment business. Third, some notes on cost line items: Funding costs on our income statement, which related to our on-balance-sheet loan generation, dropped significantly by 42.1% quarter-over-quarter and by 47.9% year-over-year due to the maturity of a portion of trust funding in Q4. Additionally, processing and servicing costs increased by 15.3% in Q4 compared to the previous quarter due to the increased risk management initiatives and projects. General and administrative expenses rose by 26.6% in Q4 from last quarter due to the addition of more risk management talents. Fourth, on-balance-sheet items: Our cash position is strong, ending the quarter with around RMB4.4 billion in hand and a solid equity position of RMB9.7 billion. We continued our recurring cash dividend plan and declared a cash dividend for the second half of 2023 amounting to around US$10.8 million, equivalent to roughly 20% of total net profit for the second half of 2023. The total 2023 combined dividend payout is about US$0.182 per ADS with a dividend yield at roughly 10% based on the year-end closing price of 2022. Looking ahead, we will continue to either maintain or increase the dividend payout ratio to our shareholders when the market condition improves. Looking forward to 2024, due to the uncertainty of economic growth and our prudent approach, we expect the annual GMV amount for the full year 2024 to be no less than that of last year as we remain focused on enhancing risk management as a top priority and net profit will grow from last year as well. In summary, 2023 was a year of rebound with strong growth in both top and bottom line, surpassing many peers driven by our core strategies. We remain focused on improving risk management capabilities, upgrading user groups, operational excellence, and cost optimization to capitalize on our emerging opportunities. That concludes our prepared remarks. Operator, we are now ready for the Q&A session. Please open the floor for questions. Thank you.

Operator, Operator

Thank you very much. We will now conduct a question-and-answer session. Our first question comes from Alex Ye of UBS. Please go ahead.

Alex Ye, Analyst

I have the question for Mr. Qiao, who was previously in charge of risk management for Ant Group's trillion-dollar balance of consumer loans. Since you have been with Lexin for several months now, we would like to learn about the key reasons that have led you to choose to join the platform and the many challenges and opportunities you have seen since joining?

Mandy Dong, IR Director

Okay. Alex, this is Mandy. Let me do the translation for Mr. Arvin. Well, I made my decision to join LexinFintech for several key considerations. Firstly, LexinFintech is one of the earliest established consumer finance platforms in China. It has accumulated over 200 million registered users with immense growth potential, and Lexin has built its unique Lexin consumption ecosystem that consists of various business lines, including consumer finance, offline inclusive finance, e-commerce, and SaaS tech products. We see tremendous synergy potential among these business lines. In my perspective, Lexin has a very solid foundation and a strong customer base. For the second point, you can see the risk level of Lexin's assets nowadays stands at a relatively higher level compared to other industry peers. However, I'm very confident that by implementing a proven quantitative risk management system and enhancing further refined risk management, we can bring down the risk level of Lexin assets to match industry average levels, and in the future, we can gradually improve to the leading level in the industry. In addition, the company's current PE ratio is quite low, indicating ample room for returns as we can gradually bring down the risk level and profitability will increase. Well, after the past few months of my work in the risk management space, I see further room for improvement in the following points. First, Lexin has utilized a lot of third-party data sources, but we may lack in quality in the future. In the future, we will improve the models, introduce more data sources, and improve model stability and risk identification accuracy. Secondly, the risk model nowadays mainly focuses on credit rating, credit scoring types, which shows a lack of variety. In the future, we will include more different types of models, including the credit profile type and responsiveness type. There's still room for improvement in building a more robust risk management system and a sufficient array of risk management tools. Over the past few months, we have already made notable progress in upgrading the risk identification system, establishing a full lifecycle risk management system, and building intelligent risk management tools to achieve the above-mentioned measures. We see the asset quality of newly issued loans already showed a turning point since the last year-end with risk levels declining on a monthly basis. Alex, hope that can address your question.

Alex Ye, Analyst

Thank you.

Operator, Operator

Thank you. Our next question comes from Yada Li of CICC. Please go ahead.

Yada Li, Analyst

I will do the translation. From the fourth quarter results, we observed the new users with credit lines went up by roughly 17% Q-on-Q. The sales and marketing expenses grew by only 5%. I think it indicates a significant improvement in customer acquisition efficiency. Can management share some more recent moves and efforts on customer acquisition?

Mandy Dong, IR Director

Yes, I'll do the translation for Jay. Firstly, in Q4, we further upgraded our model and strategy based on enhanced risk identification capabilities. We adopted a low-and-grow growth strategy on credit line approval and drawdown. This resulted in a notable improvement where users with credit lines increased by 40%, and credit drawdowns by high-quality users increased by 45%, while the risk level of those newly issued loans consistently decreased on a monthly basis. Secondly, we have put more effort into diversifying our channels in terms of customer acquisition, rather than solely relying on online advertising channels as previously done. We tailored products and services to cater to the needs of different customer segments. By that, we achieved a differentiated and diverse customer acquisition matrix. Specifically, for fresh graduates, micro-SME owners, and super-prime and prime users, we developed tailored customer acquisition approaches and products.

Operator, Operator

Thank you. Our next question comes from Yuying Zou of CLSA. Please go ahead.

Yuying Zou, Analyst

Let me do the translation. As Jay mentioned in his remark, Lexin has launched multiple growth strategies in 2024. Given the slow recovery of the domestic economy and the intensified competition in the domestic market, as more peers begin expanding their businesses internationally, does Lexin have similar business plans for the future?

Mandy Dong, IR Director

Yes, you are right. Expanding internationally is definitely one of our key growth strategies. Currently, we already have some business running in overseas markets. In 2024, we will expand business in selected overseas markets, either by acquisitions or by building the business from the ground up ourselves. We are confident that we can replicate our success in the China market overseas, although the business volume of our overseas operations is relatively small. We will update the market once we achieve more progress in the future.

Operator, Operator

Thank you. I see no further questions at this time. Thank you all for coming to this conference call. This is the end of our conference call. You may now disconnect. Have a great day everyone.

Jay Xiao, CEO

Thank you. Okay, bye-bye.

Mandy Dong, IR Director

Thank you. Bye.