Earnings Call Transcript - LX Q2 2020

Operator, Operator

Ladies and gentlemen, thank you for being here, and welcome to the LexinFintech Second Quarter 2020 Earnings Conference Call. I must inform you that this conference is being recorded today. Now, I would like to turn it over to our first speaker, Mr. Tony Hung, Senior Director for Capital Markets. Thank you. Please proceed, Tony.

Tony Hung, Senior Director for Capital Markets

Thank you, Operator. Hello, everyone, and welcome to Lexin's Second Quarter 2020 Earnings Conference Call. The company's results were issued earlier today and are posted online. Joining me today on the call are Mr. Jay Xiao, our Founder, Chairman and Chief Executive Officer; Mr. Craig Zeng, our Chief Financial Officer; Mr. Ryan Liu, our Chief Risk Officer; Mr. Stanley Zhao, our Senior Financial Director; and other members of our team. For today's agenda, Mr. Xiao will provide an overview of our recent performance and highlights, Mr. Zeng will discuss our financial results, and Mr. Liu will discuss our credit performance. Before we continue, I refer you to our safe harbor statement in the earnings press release, which applies to this call as we will make forward-looking statements. Also, please note that this call includes discussions of certain non-GAAP financial measures. Please refer to our earnings release, which contains a reconciliation of non-GAAP measures to the most directly comparable GAAP measures. Finally, please note that unless otherwise stated, all figures mentioned during this conference call are in renminbi. I will now turn the call over to our CEO, Mr. Xiao, whom I will translate for.

Jay Xiao, CEO

Hello, everyone. I'm very pleased today to announce that in the second quarter, all our operating metrics grew in a stable manner. Our to be model is beginning to deliver and to provide us with a new avenue for growth. Thanks to new initiatives, we've again produced decent results. This quarter, our revenues reached CNY3.0 billion, an increase of 19%. Our gross profit reached CNY968 million, and our non-GAAP pretax profit reached CNY541 million. Our new consumption platform strategy and our financial services business continues to expedite the growth of our to be model, providing us with risk-free Internet platform revenues of nearly CNY1 billion, of which, platform services was CNY419 million, an increase of 109%. In addition, revenues from Le Card memberships exceeded CNY24 million. This is our first time in disclosing these revenue numbers from our platform model. In the second quarter, we facilitated CNY41.1 billion worth of loans, an increase of 57.8% and exceeding our guidance of CNY38 billion. Our current loan balance is CNY61.9 billion, an increase of 52.4%. At the same time, our credit quality remains stable and risks are decreasing. As of today, our day-7 delinquency has declined to 2.32%, which is even lower than our numbers from the third quarter of last year. Under these conditions of growth, in the third quarter, we are expecting our loan originations to exceed CNY48 billion, an increase of over 30%. And we're also confident in our ability to achieve our full-year loan origination guidance of CNY170 billion to CNY180 billion. At the end of the second quarter, our number of registered users reached 95.3 million, an increase of 90%. On August 10, our number of registered users reached over 100 million. Lexin successfully became one of the few consumption platforms to achieve that milestone, which will open up new opportunities for our new consumption platform strategy. In the second quarter, we focused on new consumption and increased coverage in both online and offline consumption scenarios. Our three major brands, Fenqile, Lehua Card, and Le Card, all demonstrated strong growth momentum with increasing transaction numbers. Total orders from the three platforms reached CNY74.6 million, an increase of 168% from CNY27.8 million in the third quarter of 2019. As we enter the third quarter, we averaged 1 million transactions a day. Of our major brands, Lehua Card, first established the ability to deliver online installment purchase options to all consumption scenarios, connecting financial institutions with online and offline consumption scenarios and satisfying the users' needs for convenient online and offline consumption. In the second quarter, the Lehua Card and offline vendors developed joint sales, increasing total transactions by 4%, providing cumulatively over 4 million vendors with consumption transactions. Our membership consumption services brand, Le Card, continues to grow strongly with a repeat purchase rate of 59%. To date, Le Card is speeding up the pursuit of our strategy to connect more key online and offline global retail players and other well-known brands to jointly promote their brands and provide privileges and benefits, both online and offline. Just over a week ago, our registered users reached over 100 million, and we see how new consumption will open up new avenues of growth for us. At the same time, we are upgrading our own goals. Using technology to continuously create new consumption methods to enable hundreds of millions to live a happier life will be our calling, and devoting ourselves to using technology to change consumption, becoming the new consumption ecosystems leader, will be our goal. Since July, signs indicating a recovery in consumption have become clearer and consumption's year-on-year growth may reach 2%, representing the first signs of growth this year. Recently, the central government has also indicated that a core part of their economic work will involve speeding up the release of potential of the Chinese consumer and accelerating the establishment of structures and systems for creating domestic demand. We believe that with the recovery in consumption and favorable macroeconomic policies, we will be able to speed up the pursuit of our new consumption platform strategy and create even greater value. Next, I'd like to invite our CFO, Craig, to discuss our recent financial performance.

Craig Zeng, CFO

Thank you, Jay, and hello, everyone. I'm pleased to announce that we have once again delivered strong results. In the interest of time, I will not go over line item by line item of our financials. For a more detailed discussion of our second quarter results, please refer to our earnings press release. Please also note that starting from the second quarter of 2020, we will be reporting revenue streams in three categories: online direct and service income, credit-oriented service income, and platform service income in order to provide relevant information. Total operating revenue reached RMB 3 billion in the quarter, and the credit-oriented service income reached RMB 2 billion, representing an increase of 48.8% from the second quarter of 2019. Platform-based service income reached RMB 419 million, representing an increase of 109% from the second quarter of 2019. Adjusted net income was RMB 453 million, reflecting our continued strong growth and performance. Fully diluted adjusted net income for the quarter for ADS was CNY2.21. On our operating leverage, operating expense as a percentage of average loan balance was 3.9% for the quarter, and advertisement, marketing, advertising, G&A, and R&D were 0.8%, 1.4%, 0.8%, and 0.9% of average loan balance, respectively. We currently have 100 million registered users, and our customer base with credit lines reached 22.7 million, up by 68.4% as of June 30, 2019. We acquired nearly 1.4 million new active customers in the second quarter. Overall, our average credit limit was RMB 10,039, while our average tenure was now 11.4 months, and our weighted average APR was 26.5% for this quarter. In terms of our funding, for the quarter, no funding for new loan originations came from our Juzi Licai platform, and all of our funding for new loan originations came from our institution funding partners. The ongoing COVID-19 outbreak has brought and continues to bring many challenges to our business, but we continue to see a recovery. We believe that with the continued recovery and the determined efforts of our team, we may still be able to achieve our previously stated guidance. Next, Ryan will discuss our credit situation. Ryan, please?

Ryan Liu, Chief Risk Officer

Thank you, Craig. We continued our stable credit performance in this quarter. In spite of a challenging condition in the market, our credit quality continues to be high and there with expected levels, and we fully expect our credit status to continue to perform well and at expected levels. Our 90 days delinquency ratio remains low at 2.99%, and we continue to see stable credit performance, and our lifetime charge-off ratio is approximately 4.5%. This is consistent with our previous statements and falls within our range of expectations. And we fully expect our stable performance to continue in 2020. With that, I conclude our prepared remarks. Operator, please proceed with the questions-and-answer session.

Operator, Operator

Our first question comes from Jacky Zuo from China Renaissance.

Jacky Zuo, Analyst

I have three questions. The first is about our new retail strategy and business model. Can you explain how we stand out from our competitors? Also, what percentage of new customers from Le Card is contributing to this new retail strategy, and how many of them can we convert into consumer finance customers? Additionally, could you clarify the definition of the order number we mentioned in the third quarter, which exceeded 1 million daily orders? My second question concerns our take rates. What is our outlook for the revenue take rate, especially in light of the increasing platform revenue-sharing model? We observed an improvement in take rates from the first to the second quarter—what is the trend we expect moving forward? Finally, regarding our costs, I've noted that processing and servicing costs remained relatively high in the first and second quarters. What is the expected trend for these costs going forward? Will they normalize in the future?

Tony Hung, Senior Director for Capital Markets

So with regards to your first question on the new consumption platform, I think, first, as you know, when we talk about the underlying consumption finance business, a very important part is that we need to control or have some ideas around the consumption scenario. And these involve both online and offline scenarios. And what we have done in terms of our overall strategy is to have greater control around these scenarios than develop, if you will, a system around this. Now also from these development of scenarios, we're able to get more customers. And this is why you're seeing that our customer acquisition continues to increase, and our total customer numbers now are over 100 million in terms of registered customers. Now in terms of development, originally, as you know, we had our original online consumption platform or e-commerce app. And as others also develop similar products and round out their offerings, we also certainly needed to develop more products. The second thing was to make, if you will, the availability of cash so that people can spend on different things. But more importantly, as you know, is recently the development of Lehua Card, which effectively opens up all the online as well as offline consumption scenarios. And when we open up these scenarios, you can see that the contribution from the customers is better, especially from compared to those customers that purely transacted on a monetary or cash basis. So another way at this provision or the development of the system covering all the consumption scenarios is that it enables us to literally see how our customers eat, sleep, live, et cetera, and therefore, improve the stickiness of the customers. Also, it's worth noting that while we have 100 million registered users, the amounts that we can provide financial services to is probably limited at this point to just over 20%. So we're going to aim to deliver more to more of our registered customers and users by providing more products and services. But most importantly, to do this, we have to have some control, some systemic way of recognizing and holding the consumption scenarios. And then this way, we can provide various products, not just financial products but also memberships, privileges, and other benefits. And also, through this, we can then utilize our technology. Whether it's our Hawkeye system or Wormhole system and ultimately, to help the banks provide the loans and financial products. So quite often, what I talk about to be, what I actually mean is to the banks. We're providing a way for the banks and the financial institutions to continuously operate and provide loans to customers. So when we talk about the whole consumption platform and the strategy with consumer loans, we have to recognize that they are mutually beneficial to each other. They provide benefits to each other directly whether it's providing additional consumption scenarios, providing traffic customers and providing ultimately, a stable source of high-quality customers. And we can see this example where we work with supermarkets, and we can see that there's healthy growth there and not only in the sense of just pure growth, but also healthy in terms of very stable credit quality customers. Yes. On the 1 million number, it's coming from both online as well as offline. And then we can see actually, the offline number is now over half of the total number. Yes. So I think everybody can direct your attention to the new investor presentation, which is posted on our website, which has more details around some of the changes. So you can say that, ultimately, we have different models. And as a result, because of the different models, there's different underlying take rates. Now in particular, the profit-sharing model, which will be a major thing this year and going forward. While we've done that for a long time, every single time that you start out working with a financial institution or a bank, they will, of course, start off with getting a higher take rate on their side, which means a lower take rate on our side. Now that said, things are definitely changing. And we do see a movement where the banks are getting relatively lower take rates compared to before. Now that said, we're probably looking at something like, for example, a 1% difference more or less between, if you will, the profit-sharing model and more traditional models. But again, we define that more funding partners are coming aboard. And as a result of that, the take rate will likely improve over time on the profit-sharing model. Yes. So there is history of this in, for example, direct lending or other related models, where in the beginning, it was something like 10%, whereas the P2P was something like 7%. But then over time, these are things that change. So it's probably just a process that takes a little bit of time. So with regards to the processing costs, well, a lot of it is related to what has happened as a result of the COVID-19 pandemic and its impact on our collections as well as our credit assessment, if you will. The collections' resources overall has been very tight. So as a result, we have to use certain third-party providers. And then we have to make sure that these providers meet our rigorous standards as well. And given the nature of the situation, our focus has certainly been more on stability than anything else as maintaining the quality of the credit is perhaps more important than anything else. And similarly, we see a situation for the overall assessment. But that said, we do feel that, in particular, for the credit assessment, the trends will be for the cost to be reduced over time.

Operator, Operator

Your next question comes from the line of Eddie Leung from Bank of America Merrill Lynch.

Eddie Leung, Analyst

So my question is about potential change in policy, wondering what's your thought on the potential impact from the proposed of lowering the APR that can get legal protection at court? And then a follow-up question about that is, what's the percentage of loans with APR under 24%?

Tony Hung, Senior Director for Capital Markets

So Eddie, we've also seen the reports, obviously, and I think it's fair to say that, ultimately, there is no conclusion, if you will, from any of the government authorities. And then after the article was out, there was certainly a lot of media responses and other things that came out discussing the particular news. And I think a lot of it basically indicated that, well, ultimately, this doesn't really match the situation or the needs in China right now. Now the goal ultimately is to lower the APR to strengthen the economy that we can certainly understand, and it does make sense by itself. But what it will do and how they will do it in a way that makes sense, obviously, we don't know and no one knows yet. Now we did do our own analysis on our underlying business as well, which we can share. We can say that businesses where we're making loans over 24% APR, we don't really have that. We're basically focused on an IRR definition of things. And we're much focused on the 24% IRR. Where we can be in the most recent quarter, we were at around 26%. Well, when we calculated, if we adhere to some of the calculations stringently, then we might have a 10% reduction in our service fees or revenues. And anybody who is over that, we would cut off, unfortunately, as a customer. But in turn, this is going to reduce our overall risk. So in turn, there may be some benefits to it as well. And if we ultimately go to those types of customers, then under at least the current situation, we can certainly direct these customers to others who would do business within the new constraints of the rules. And hence, we may be able to earn a referral fee, which would help offset any potential losses.

Operator, Operator

Our next question comes from the line Alex Ye from UBS.

Alex Ye, Analyst

I have three questions. First, I'm interested in the asset quality outlook. The vintage charge-off rate has remained around 4.5%, which aligns with management's earlier expectations of 3.5% to 4.5%. What is the current expected lifetime loss for the Q1 and Q2 loans we just facilitated? Also, what is the recent trend in borrowing costs? Specifically, regarding the risk-sharing model, how many institutional funding partners are we collaborating with on this model? Lastly, I want to discuss sales and marketing expenses. We've noticed that per customer acquisition costs have increased slightly in Q2, but overall they've been stable. What is the outlook for the second half of this year, and what does this mean for our overall marketing budget?

Tony Hung, Senior Director for Capital Markets

Alex, regarding the overall projections for our book, we are likely looking at a range of 3.5% to 4.5%, with the number currently at 4.5%, but expected to decrease over time. For the first and second quarters, based on current trends, we anticipate around 4%. We hope to see improvements in the third and fourth quarters. As for funding costs, they are currently at 7.7%, which is a record low for us. We expect these costs to continue to decline, although the rate of decrease might slow down, given that we already have favorable funding conditions from banks. It's important to note that the focus should remain on our profit-sharing model, which accounted for about 30% of our funding in the second quarter and has now risen to approximately 40%. By year-end, we aim to approach or exceed 50% through this model. This approach aligns well with regulatory expectations and allows banks to earn more by taking on greater risks. We are rapidly expanding our network of partners, currently exceeding 10, and expect continued growth. The profit-sharing model offers multiple advantages, including no need for risk reserves and no leverage requirements, which significantly enhances our liquidity and ability to scale. However, it does come with some downsides, such as lower profitability due to profit sharing. Despite this, we are committed to expanding this model in the future, as it facilitates an asset-light approach and enables faster growth. On the sales and marketing front, last year was exceptional, with significant spending on online marketing that successfully acquired many customers. However, the influx of new customers brought some risks, particularly related to COVID-19, which potentially exposes underlying credit issues among these customers. Consequently, we are reducing our reliance on online channels while still focusing on acquiring new customers. As a result, our customer acquisition costs have fallen to under CNY150 per customer, and we aim to maintain stability in the second half of the year. We will emphasize offline customer acquisition as part of our new consumption platform strategy, which is designed to incorporate more offline scenarios. Customers obtained through offline channels tend to be less expensive to acquire and of higher quality. We will continue online efforts but will implement stricter standards to attract fewer, but healthier customers from those channels.

Operator, Operator

Our next question comes from the line of Yushen Wang from CLSA.

Yushen Wang, Analyst

So I have two questions. First, on APR. We understand that in the second quarter, the APR was down quite a lot. And so even if the interest rate cap potential change does not happen in the future. So we also expect a lower APR down the road due to the lower interest rate environment in China? And my second question is on asset quality. I just wonder if management can share with us some details on the D7 delinquency ratio?

Tony Hung, Senior Director for Capital Markets

Yes. So first, on the APR. I can't say that we would agree with you on saying that the APR had a rapid decrease. We know what you're saying. But we would say that overall, our APR has actually been fairly steady around this range. We've had some fluctuations. But generally speaking, it's been stable and hasn't moved that much. Ultimately, it probably depends much more on customer acquisition and other things going on and the risk of the underlying customers. If we're acquiring higher risk customers, then we'll probably end up with higher APRs. Now that said, long term, yes, we absolutely believe that the APR will decrease because our goal has always been to grow with our customers and to serve better our customers over time. So as we do, our underlying customers' credit quality will improve. So as a result, the APR will probably decrease anyway. So on the more, shall we say, shorter delinquency and asset quality numbers. The 7-day number currently is at 2.32%. This is actually a 12-month low. The 1-month collection number, right now, it's actually better than this time last year. In fact, it's better than the Q3, Q4 number last year by something like 20%. So we're actually doing very well right now on the leading numbers. And when we look at the underlying overall asset quality, I think we're increasingly going to levels where we would be very comfortable historically. Now that said, if you look at numbers like the 30-day, the 90-day because these numbers do have a lag, they are higher, and they will be higher. But we think that overall, they peaked at the end of the second quarter or towards the end, and you'll start to see all these numbers improve in the third quarter and fourth quarter.

Operator, Operator

Our next question comes from the line of Daphne Poon from Citi.

Daphne Poon, Analyst

So my question is on the customer acquisition side. So you mentioned earlier that you will spend more efforts on your offline customer acquisition, including the partnership with the consumption scenarios. So just want to understand, first, what is the average customer acquisition cost here? And also, what is the kind of fee model when you're partnering with the merchants? And also, if possible, can you share the contribution from Lehua Card in terms of your new borrowers' number in the second quarter?

Tony Hung, Senior Director for Capital Markets

We haven't conducted a detailed recent analysis on the offline customer acquisition costs, partly due to the additional investment models being utilized and the relatively lower cost of new employees. However, based on the available data, we're acquiring new active borrowing customers at an average cost of CNY150, and we believe the offline cost is lower than this figure. In terms of our partnerships, we do not engage in revenue sharing. Instead, we focus on leveraging consumption scenarios to offer various benefits. For instance, if there's a supermarket promoting a deal where a customer can buy 30 items to receive a discount, we implement these strategies to attract customers, which also benefits the supermarket by bringing in potential new clientele. These membership privileges significantly reduce our costs, and our data indicates they help us attract high-quality customers. It's difficult for us to quantify the contribution of new customers from the Lehua Card at this moment, as we can't definitively determine if a new customer was primarily drawn by this product or for other reasons while using the Lehua Card. Nonetheless, we can share that this segment is experiencing rapid growth, with month-on-month increases reaching up to 10%. This aspect of our business is crucial for our overall growth, accounting for 30% of our new originations.

Operator, Operator

And last question comes from the line of Cindy Wang from DBS.

Cindy Wang, Analyst

Ryan mentioned that the vintage will be 4% in the second half of this year. Could you provide insight into whether this improvement in vintage is due to the overall market credit rates getting better, our strategy to attract more quality borrowers, or enhanced collections leading to the overall vintage improvement? My second question concerns the provision for credit losses related to contingent liabilities, which was CNY769 million in the second quarter. Can you break down how much of the provisions are due to changes in economic assumptions and how much is because of credit deterioration?

Tony Hung, Senior Director for Capital Markets

So with regards to the improving credit quality. I think it can only be said that there are many reasons for that, and there's many things working together to bring that about. One, of course, is an improving macro environment. And with an improving macro environment, you will have an improving credit environment, and hence, you have an overall improving environment. Literally the same credit policies in February, if you implemented in February versus you implement, again, the exact same credit policy now, you're actually going to get vastly different numbers, different results, and different first payment defaults, et cetera. So that's one aspect of this. Another aspect is that, well, it's always an entire process. It's always a whole process. So something comes in. A particular number defaults or a particular number will make their first payment. The collections occur, the collections then are tightened, optimized, et cetera. And then from there, then things overall start to improve. So you have all these different factors going up. This is why we feel that by year-end, we should probably be looking at something like a 4% number. Yes. So on the breakdown, I think, maybe it's best not to think of it that way or to look at it that way directly simply because you do have different things going on; there are different models, whether it's guarantees or derivatives. And then there are different assumptions within the different models. So it's definitely not a simple thing. Now that said, it's just like what Ryan said. The overall situation is clearly getting better. So certainly, the underlying assumptions would need to reflect that as well. So you can say that on that basis, certain things are improving.

Operator, Operator

There are no further questions at this time. Presenters, you may continue.

Tony Hung, Senior Director for Capital Markets

Okay. Operator, I think you can close the call then.

Operator, Operator

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