Earnings Call Transcript - LX Q3 2021

Operator, Operator

Thank you for standing by, and welcome to the LexinFintech Third Quarter 2021 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'd now like to hand the conference over to your host today, Ms. Patricia Cheng, Head of Capital Markets. Thank you. Please go ahead.

Patricia Cheng, Head of Capital Markets

Hello, everyone. Welcome to Lexin's Q3 earnings update. I'm joined today by Jay Xiao, Chairman and CEO; Sunny Sun, CFO; Jayden Qiao, CRO; and Erwin Lu, CTO. During the call, we will discuss business outlook. Any forward-looking statements that we make are based on assumptions as of today. The actual results may differ materially, and we undertake no obligation to update any forward-looking statements. Finally, unless otherwise stated, all numbers mentioned are in RMB. I will now turn the call over to Sunny to go through the financial performance. Sunny, over to you.

Sunny Rui Sun, CFO

Thank you, Patricia. Good morning, everyone. It's my pleasure to speak to you and give you an update on our third-quarter results. This quarter marks the execution of structural change of our core businesses. And I'm delighted to say the progress has been encouraging. Loan origination rose 15.6% year-on-year to RMB 255.9 billion, of which 42.9% was priced within 24%, up from 37.6% in the second quarter. If we look at the last month of Q3, the improvement was even bigger. About half was priced within 24% in September. Average APR for the September intake was 26.8%, down 1.4 percentage points from June. In line with regulatory direction as we adjust down loan pricing and move away from high APR borrowers. There will be a measured slowdown in top-line metrics. Total operating revenue reached RMB 2.97 billion in the third quarter, down by 5.9% from last year and within management expectations. As our CEO Jay mentioned in the earnings call of last quarter, we placed quality over scale. Gross margins posted a 54% increase to RMB 1.5 billion, as a percentage of revenue, gross margin advanced by almost 20 percentage points year-over-year and held steady quarter-on-quarter at about 51%. Moving on to expenses, we have stepped up the overall spending to support new growth initiatives such as the further build-out of my team and technology upgrades that Erwin, our Chief Technology Officer, is spearheading. At the same time, we have also been streamlining operations and keeping a diligent eye on general expenditure. G&A stays on a downward trend, going down by 2% year-over-year and 17% quarter-on-quarter. Net profit rose over 68% year-on-year to RMB 551 million in the third quarter. In addition, take rate stayed stable at 3.5% quarter-on-quarter. Top-line optimization, cost management, and operational efficiency are critical to profitability and will remain our priority. There have been constant noises about the sector this year. We understand investors' concerns. The third quarter results are proof that we are actively responding to change. And we are determined to enhance the resilience of our businesses. Next, I would like to turn the call over to Jayden, our Chief Risk Officer, to discuss credit performance. Over to you.

Jayden Yang Qiao, CRO

Thank you, Sunny. We have been proactive in mitigating the pressure of asset quality coming from the change in policy and macro environment. The 90-day plus delinquency ratio finished the quarter at 1.85%, unchanged from the end of Q2. In response to the 24% policy, we have tightened the underwriting criteria and approval rate. The sequential drop in the number of active users and loan origination volume reflects our proactive management of high-risk borrowers. In the transition, we do expect some volatility in short-term risk with the industry moving to reduce funding price at about 24%. The dropping liquidity will weigh on the repayment ability of some borrowers. In anticipation of the interruptions, we have strengthened the risk management framework for new businesses, the risk strategies, and models to ensure there's strict control over loan origination, especially when early-stage performance is not yet stable. Risk management builds on identifying, assessing, and monitoring risk; we will keep refining the process and will not compromise quality over volume. Lastly, I would like to highlight another recent change: engagement with the technology team. Our activities generate a vast amount of data from internal interactions to external relations. This wealth of knowledge is being turned into powerful analytics and predictive modeling. We have been working more closely with the technology team to better manage risk at both the business level and the operational level. I will pass it to Erwin, who will talk more about this topic.

Erwin Yong Lu, CTO

Thank you, Jayden. I took up the CTO role in February this year. This was a newly created position, and my mandate is to sharpen our in-house technology capability. By leveraging my international experience, including over a decade in the U.S. where I developed my career in software engineering at Microsoft and Facebook, optimization and innovation is our goal. People are the most valuable assets. The vast majority of the R&D spending is talent-related investments. We're bringing in new talent to improve the existing infrastructure and address new opportunities. At the backend, we have built up a core engineering team dedicated to machine learning, data processing, and customer acquisition, as well as risk management models. We've also been applying more AI and machine learning algorithms. In the middle tier, we have embarked on a re-architecturing of the platform into a kernel plugin structure to provide more flexibility and robustness in serving our technical development. As a result, the average engineering delivery cycle has been reduced by more than 30%. The new architecture has also improved extensibility to enable new features for future business requirements. On the business front, we have updated our apps to ensure we meet the latest regulations and fit the requirements without losing any of the existing user-friendliness. To cope with the new privacy protection, we have strengthened web security, encrypted storage of personally identifiable information data, as well as restrictions on data usage. In short, we are pleased to see that technology is playing a bigger role in helping us manage the cost of compliance and revenue. The upgrade has just begun. I look forward to sharing more with you later.

Patricia Cheng, Head of Capital Markets

Thank you, Erwin. Last but not least, a few words from Jay.

Jay Wenjie Xiao, CEO

It's a pleasure to talk to you all again. My colleagues have shared the highlights of the quarter, and I would like to take this opportunity to outline our recent and future activities. For our core Fintech business, we have been addressing recent regulatory changes by restructuring the business, lowering risk, and enhancing efficiency. Our efforts are yielding positive results. As Sunny mentioned, we managed to increase the exposure of loan prices by 24% while maintaining a steady scale. By September, the mix accounted for about half of the total, and the upward trend continues. Our 90-day delinquency ratio remained stable at 1.85%. In addition to realigning our business mix, we've also improved operational efficiency, with G&A expenses decreasing by 17% quarter-over-quarter to RMB 100 million, achieving a new low as a percentage of revenue and loan balance. More importantly, our take rate has not been negatively affected during this process, showcasing the efficacy of our strategy. We are confident that once the transaction is finalized next year, the sustainability and profitability of our business will be even stronger. In Maiya, we've further enhanced our product and service model, which is gaining recognition from offline merchants. GMV reached RMB 473 million in the third quarter, with offline contributions nearly doubling from Q1 and Q2 to RMB 185 million. China is the world's largest consumer market, and although Maiya is still in its early stages, the effects on brand recognition and merchant relationships are significant, with tremendous growth potential. The buy-now-pay-later model in China is unique, and Maiya will develop a local identity and distinct value, providing concrete gains for merchants and benefits for consumers. Additionally, we are committed to supporting small and micro business owners, aligning with policy direction. We increased loan origination to this group by 32% in Q1 and Q2, reaching RMB 5.2 billion. Lastly, I want to emphasize that quality growth has always been a top priority at Lexin. We are dedicated to optimizing our asset structure, improving credit quality and operational efficiency, while maintaining our four-year target. We will also continue to innovate and develop new products like Maiya and banking technology services to enhance our competitiveness and profitability in the long run. Thank you for your attention and support. We will now open up the floor for questions. Could you please repeat the instructions again?

Operator, Operator

First question comes from the line of an analyst at Nomura. Please go ahead.

Unidentified Analyst, Analyst

Hi, management team. Thank you for giving me this opportunity to raise a question. And congratulations on the strong results. I have a specific question for our new CFO, Sunny. I was wondering if you would be able to give us more guidance on the loan origination amount and the outlook for the fourth quarter this year? Thank you.

Sunny Rui Sun, CFO

I didn't catch the name.

Unidentified Analyst, Analyst

Ivy.

Sunny Rui Sun, CFO

Ivy. Hi, good morning, Ivy. Thank you very much for your question. For the outlook, as you just said, and as we reported, we had a very strong performance in the third quarter. Based on the information at hand, currently, we will maintain our full-year guidance on the loan origination. We do expect some temporary volatility in the operational metrics, as all the players along the value chain will take a bit of time to adjust to the new 24% policy. For the fourth quarter, as we emphasize, we will continue to place healthy growth over pure scale. We are also expecting that new growth areas will make higher contributions perhaps in the long run. So overall, we will maintain our outlook for the full year. We will also focus on structural changes, as we just mentioned, and also on operational efficiency.

Unidentified Analyst, Analyst

Yes, thank you. Thanks for the guidance.

Operator, Operator

Thank you for the question. Do you have any follow-up?

Unidentified Analyst, Analyst

No, that's it from my side. Thank you.

Operator, Operator

Next question comes from the line of Alex Ye of UBS. Please go ahead.

Alex Ye, Analyst

Hi, good morning. Thanks for taking my question. I have two questions. Firstly, you have mentioned that your current pricing mix is about 50% under 24%, not by interest rate. I'm just wondering, when do you expect our pricing transition to finish and fully comply? Also, related to that, when do you expect you could probably be more comfortable resuming growth after that adjustment? Second question is on your asset quality. I have seen your early indicators to FPD ratio ticking up a little bit in Q3. So just wondering if you could give us some color on the recent and also provide us some forward-looking outlook? Thank you.

Patricia Cheng, Head of Capital Markets

Alex, we'll have Jay answer your first question, and then Jayden will address your second question.

Jay Wenjie Xiao, CEO

As I mentioned previously, the 24% policy is the guidance provided by local authorities to certain financial institutions, requiring them to comply by June of next year. However, not all institutions have received this guidance on their own. We aim to complete the transition by June next year and will work to expedite the process. Nonetheless, since not all institutions have been instructed to comply, some may continue to operate above the 24% threshold after the deadline. While we undertake this structural change, our goal is to reduce risk and minimize the impact on the take rate. As shown in our Q3 results, we have maintained a steady take rate for newly acquired borrowers within the 24% range, exceeding 3%. Therefore, we are confident in our ability to sustain a healthy take rate following the transition next year.

Jayden Yang Qiao, CRO

Okay, I'll take the next question. As I mentioned in the call earlier, during the transition period, we do expect some volatility in short-term risk because the industry is moving to reduce some pricing at about 24%. As you notice, the FPD30 release is ticking up, but it is still maintained under 1%. As we continue focusing on improving our asset quality mix. Going forward, we do expect our long-term risk to continue being maintained at a relatively stable level. We have also noticed that for new acquired customers, the new orders placed with pricing at or below 24%. The FPD7 is well below the general population of our entire portfolio. So that is a good sign because we are acquiring high-quality customers, and the percentage is going higher in the next couple of quarters. As Jay mentioned, once we reach the end of the second quarter next year, we believe our short-term risk will continue to be maintained at the previous level. Thank you.

Alex Ye, Analyst

Thanks. That's it for me.

Operator, Operator

Thank you. Next question comes from the line of Ethan Wang of CLSA. Please go ahead.

Ethan Wang, Analyst

Thank you, and thank you management. I have two questions. The first one is about the requirement by PBOC to disconnect our data feed with funding partners that they back through the licensed credit agencies. Just wondering, in our case, do we have a timeline to make the change? Right now, are we working with any of those licensed credit agencies already? Which one is that, and what is the profit-sharing amount in the future? That may affect our take rate a little bit. More importantly, the details of the base collaboration. Since we're adding an added layer on the Maiya, does that mean we will need to change the way we collect data and how we handle that data? So that's the first question. My second question is on some data disclosure. We do see a lot more disclosure from this quarter, which we really appreciate. However, it seems that there are two things I'm missing, which were reported in the past: one is the sense of profit-sharing model. The total loan origination has a chart there, but there are no numbers, making it kind of difficult to understand the exact percentage. The second one is the funding costs in the third quarter.

Jay Wenjie Xiao, CEO

Yes, thank you, Jayden. Jayden will handle your first question, and then Sunny will take the second one.

Jayden Yang Qiao, CRO

Yes, thank you. So I'll take the first question. Due to the new requirement from PBOC, we're actively working with the credit bureaus. After a couple of negotiations, we already have a draft plan to work with a financial institution. At this time, I cannot reveal the name of the financial institution. We expect that by the end of this year, we will implement the new schedule according to our plan. Once this work is completed, we plan to propose the plan to PBOC and see if it can be approved by the regulators. During this implementation process, we do not expect any change to our cost, as this is a test pilot program for them and for us, so we agreed that during this test pilot process, we will not incur any costs for the data transferred or additional implementation required.

Sunny Rui Sun, CFO

Thank you, Jayden. For the second question, the first one I understand is regarding the contribution percentage of the profit-sharing business, which contributed 43.7% of the overall GMV in the third quarter. The second question about funding cost is that, thanks to the efforts of our sourcing colleagues, the funding cost has remained stable at 7.4%. Thank you.

Jayden Yang Qiao, CRO

Sure, thank you.

Operator, Operator

Thank you for the questions. Next question comes from the line of Ryan Roberts of Navis Capital. Please go ahead.

Ryan Roberts, Analyst

Hi, good morning. My question is kind of on Maiya a little bit. I think some of the early numbers on volumes look pretty promising. I want to check on the evolution of the business model. I believe that it's more of an emergent side. Could you share some more color on how the development is going? Also, on the borrower/user side, are you seeing any synergy in those users that choose BNPL services and how that might interact with your lending business and your efforts to drive loan growth from higher-quality borrowers? I believe earlier you said those were typically high-quality central customers that use BNPL. I was just curious how that's all shaking up. Thank you.

Jay Wenjie Xiao, CEO

Maiya is currently focused on Shenzhen and Guangdong Province. We have been exploring some studies related to shopping mall apartments, and the initial feedback has been positive. During major festivals like National Day and the Mid-Autumn Festival, we observed a significant increase in transactions and contributions from merchants that worked with Maiya compared to those that did not. Our merchant partners undergo a trial period, and we have noticed a strong conversion to paying customers afterward, with fees ranging from 3% to 4%. Regarding asset quality, the FPD7 for offline merchants is very low, just a few basis points, and our customer profile typically includes individuals with strong spending power. Currently, our goal is to provide value to merchants, helping them enhance their transaction volumes and repeat sales before expanding further. At this stage, we are not considering bringing Maiya users into the loan facilitation business, as our focus is on enhancing emerging value and ensuring that we remain a key retail consumption gateway for our users before exploring the next area.

Ryan Roberts, Analyst

Sure, thanks.

Operator, Operator

Thank you for the questions. Next question comes from the line of Richard Xu of Morgan Stanley. Please go ahead.

Richard Xu, Analyst

Just two questions from me. One is, is there any plan to reduce long-term interest rates to 20%, given some rumored guidance in certain regions? Secondly, is there currently a detailed cooperation plan in place? Thanks.

Jay Wenjie Xiao, CEO

On your question about the 20% guidance, we have not received any information from the regulators regarding that new level. First, the CBRC has consistently stated a 24% level for commercial banks, despite some local guidance for various financial institutions. It's important to consider the nature of our business; we focus on consumer finance, and the 24% level aligns with policy and is also recognized globally. Therefore, we do not anticipate any further tightening on this level from the regulators. Last year, you could observe the Supreme Court's decision regarding the 15.4% on LPR, and the CBRC continues to adhere to our 24% level. When we examine our risk management and customer base, we are confident that we can maintain profitability even if loan pricing decreases to 15%. To illustrate this, our current funding costs are approximately 7%. A reduction in loan pricing would lead to a lower risk preference, causing our risk costs to decrease to between 3% and 4%. Our operational expenses will be around 2% to 3%. This is why we believe that although we do not foresee any changes to the 24% level, if it were to decrease, we would still remain profitable.

Jayden Yang Qiao, CRO

I’ll briefly address the second question. The project has three phases, and we are currently in Phase 1. This phase includes collaboration with financial institutions to finalize the plan details. We have reached an agreement on the specifics and key milestones, and we aim to sign a project contract for implementation by the end of this year. Phase 2 will be dedicated to implementation, and we anticipate that the entire project will be completed by the end of this year or the first quarter of next year. Once we successfully implement the plan, Phase 3 will focus on obtaining approval from the PBOC. We will prepare a document to propose to the PBOC to seek approval for the plan.

Richard Xu, Analyst

Okay, just one quick follow-up. When do you expect the plan to be approved? When do you plan to submit the plan for approval to PBOC?

Jayden Yang Qiao, CRO

Right, we do not have a specific date to submit the plan. However, if everything goes smoothly, we expect to have the first round of submission toward the end of this year or early next year.

Richard Xu, Analyst

Got it. Thank you.

Jayden Yang Qiao, CRO

Thank you for the questions.

Operator, Operator

We have new questions from Ethan Wang from CLSA. Please go ahead.

Ethan Wang, Analyst

So my question is a follow-up on the separation of data feeds from FinTech to banks. When you work with credit partners, can you explain what kind of data you'll share with them? Do you also provide them with the algorithm? What types of products can be generated that would be relevant for banks? Please provide some details. Thank you.

Jayden Yang Qiao, CRO

So basically, it's not just acting like traditional institutions. What I mean is they take an active role in this process; we transfer the data required by PBOC to them. They actually take some processing of the data, and they transfer the processed data to the financial institutions. That's how this plan would work eventually. As you mentioned, in the future, according to PBOC, we still need to wait for further instructions; the algorithms might be placed on the bank's side as well.

Ethan Wang, Analyst

Thank you.

Operator, Operator

Thank you for the questions. At this time, there are no more questions from the line. I'd like to hand the call back to the management for closing remarks.

Patricia Cheng, Head of Capital Markets

Thank you, everyone, for your time and interest. We will wrap up the call here, and we look forward to speaking with you. Thank you.