Earnings Call Transcript - LX Q3 2020

Operator, Operator

Ladies and gentlemen, thank you for standing by, and welcome to the LexinFintech Third Quarter 2020 Earnings Conference Call. At this time, all participants are in a listen-only mode. I must advise you that this conference is being recorded today. I’d now like to hand the conference over to your first speaker today, Mr. Tony Hung, Senior Director for Capital Markets. Thank you, and please go ahead, sir.

Tony Hung, Senior Director for Capital Markets

Thank you, operator. Hello, everyone, and welcome to Lexin's third 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, Founder, Chairman and CEO

Thank you, everyone. I'm happy to announce that we’ve again reported strong growth, and I can say that our new growth is of higher quality, lighter, and more agile. In the third quarter, we continued to implement our new consumption strategy, resulting in a 69.6% increase in total registered users, reaching 106 million. Our active users grew to 7.4 million, an increase of 21.3%. This growth allowed us to achieve 48.3 billion in new loan originations, up 30.6%, with revenues of 3.2 billion, gross profit of 978 million, and EBIT of 499 million. A key objective for us is the ongoing enhancement of our revenue quality. Lexin is transitioning rapidly from a capital-heavy risk-bearing loan facilitation model to a technology-driven non-risk bearing model. This approach allows Lexin to use advanced technology to serve financial institutions, enhance their operational efficiency, and manage customer acquisition and operations. Our third quarter platform and technology revenues reached 1.13 billion, making up 36% of total revenues, of which our non-risk technology revenues were 614 million, increasing 159% year-on-year. In new transactions, the non-risk pure technology segment constituted 40%, and since October, it has already exceeded 50%. This model allows financial institutions to manage risk better, enabling us to generate higher quality profits while complying with regulatory standards. Long-term, this will help Lexin to create a more agile and nimble model, providing ample room for growth. Consumption has been the primary driver of China's economy for the past six years, solidifying its role as the stabilizer and anchor of the Chinese economy as per capita GDP surpasses US$10,000. Growing domestic demand and fostering consumption will remain vital components of the government's new dual circulation strategy. Going forward, we will explore opportunities aligned with our new consumption strategy and introduce various new products and businesses. Our Lehua Card membership program is yielding initial results, and we have launched the new Fenqile app, which encompasses all consumption scenarios and builds a more open new consumption platform. We aim to seize the opportunities presented by the world’s largest consumer market, focusing on products and services tailored to new consumption. We are confident in our ability to achieve our loan origination guidance of 170 billion to 180 billion, which we set before the COVID-19 pandemic. Additionally, as an Internet platform with over 100 million registered users, we prioritize our users' hopes and aspirations. In August, Fenqile launched a comprehensive brand upgrade campaign to adapt to the consumption preferences of our young customers, promoting our “Just Right is Just Perfect” brand. We strive to leverage insights into our young customers’ product preferences to grow alongside them. Our new branding emphasizes Lexin’s long-term vision, enhances our brand’s positive image, and has garnered recognition and trust from various societal segments. 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 third quarter results, please refer to our earnings press release. Total operating revenue reached RMB3.2 billion in the quarter and credit-oriented service income reached RMB2.0 billion. Platform-based service income reached RMB614 million, representing an increase of 159% from the third quarter of 2019. Adjusted net income was RMB443 million. Fully diluted adjusted net income for the quarter per ADS was RMB2.15. Our operating leverage, operating expense as a percentage of average loan balance was 3.5% for the quarter and our advertising marketing, advertising, G&A, and R&D were 0.8%, 1.4%, 0.6%, and 0.7% of average loan balance, respectively. We currently have 106 million registered users; our customers with credit lines reached 25.2 million, up by 51% for September 30, 2019. We acquired nearly 1.7 million new active customers in the third quarter. For the quarter, our average tenure was 11.4 months, our nominal APR was 15%. The ongoing COVID-19 outbreak has brought and continues to bring many challenges and uncertainty to our business. But we believe that with the continued determined efforts of our team, we will still be able to achieve our initial stated guidance of RMB170 to RMB180 billion in loan origination for the year. 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 challenging conditions in the market, our credit quality continues to be high and within expected levels, and we fully expect our credit status to continue to perform well and at expected levels. Our 90-day plus delinquency ratio declined from the second quarter to 2.6% in the third quarter. And we continue to see stable improving credit performance as our lifetime charge-off ratio has stabilized. This is consistent with our previous statements and falls within our range of expectations. And we fully expect our credit performance to remain stable, continuing to improve towards the end of 2020 and into 2021. With that, I conclude our prepared remarks. Operator, please proceed with the question-and-answer session. (Audit End)

Operator, Operator

Thank you. Ladies and gentlemen, we will now begin the question-and-answer session. Your first question comes from the line of Jacky Zuo from China Renaissance. Please ask your question.

Jacky Zuo, Analyst

Thank you, management, for addressing my questions. I have three inquiries. First, I would like to know about our loan volume guidance and the trend for next year. I've noticed that our loan growth is outpacing most competitors. What is our outlook for next year? Second, regarding our asset quality, could management provide details on the short-term delinquency rates, collection rates, and the vintage loss for the new loans originated in the first nine months of this year? Are there any write-back provisions we can expect in the upcoming months or quarters? Lastly, I'd like to discuss regulation. We've seen reports indicating that the trend is for fintech giants to deleverage, raising concerns about upcoming tightening on the loan facilitation model. Can you provide any insights on the regulatory trends? Thank you.

Craig Zeng, CFO

Jay addressed the first question about our guidance, and we are optimistic about meeting our targets this year. It has been quite challenging since we originally provided the guidance before COVID-19 during a period of growth. As reflected in our first-quarter results, we faced significant obstacles like many others. In the second half, we made adjustments, and thanks to the team's hard work, we are now very confident in our ability to reach our guidance for this year. This year's Singles Day was particularly successful, and we believe there’s a chance we might achieve a new record for loan origination in the fourth quarter. Looking ahead to next year, we anticipate continued improvement. The COVID-19 situation is gradually stabilizing, especially in China, where consumer activity is showing strong recovery. Singles Day this year outperformed last year, indicating robust consumer strength. With the economy expected to perform better next year, we see no reason for things not to improve. Additionally, our asset quality is also on the rise. Given these factors, we believe next year will be favorable, and we will keep everyone updated when we have more precise information about our expectations for 2024.

Jay Xiao, Founder, Chairman and CEO

So regarding your question about the asset quality trend, this quarter has shown overall improvement. For instance, the FPD7 decreased from about 2.3% to over 3.2%. Generally, every statistic that Ryan examines shows improvement. The M1 is up 5%, collections are stronger, and the 30-day delinquency rates for vintages in the third quarter have improved by 30%. In summary, the asset quality of new loan origination in the third quarter looks favorable, and we anticipate this trend will persist into next year. While the full impact of this quality performance may not be evident until next year's results, we definitely see this positive trend continuing.

Ryan Liu, Chief Risk Officer

Just one correction, the FPD7 is improving from 2.3 to 1.8.

Jay Xiao, Founder, Chairman and CEO

I believe everyone has heard various perspectives regarding what the regulators are communicating in response to your question, Jacky. Overall, the regulators and the government aim to support the healthy regulatory growth of the industry. They clearly acknowledge the technological contributions and advancements made by companies like ours. Additionally, the regulators seek to ensure a fair market where all similar businesses are treated equally; no entity should receive preferential treatment over another for engaging in similar activities. It is evident, and many can agree, that the new policies have a very limited effect on us. Our use of the microloan license is minimal, and the regulations surrounding ABS also affect us little. Therefore, we do not anticipate significant impacts from the regulatory front. Regarding the loan facilitation model, as you may be aware from your previous writings, the CBRC established clear roles and guidelines earlier this year. We have been fully compliant with these established rules and regulations, which is why we are actively pursuing a profit-sharing model that leverages our technology and aligns with regulatory objectives. In this framework, financial institutions will assume the risk as previously indicated by regulators, while we will earn a service fee for connecting the right clients with these institutions. This approach aligns well with longstanding regulatory goals. Furthermore, it supports the government’s aim of promoting consumption within the dual circulation strategy. We have recently observed announcements suggesting a possible easing of various constraints. In this evolving environment, we are becoming increasingly compliant with regulatory expectations. We believe that, given the current landscape and a fairer market, Lexin will encounter numerous opportunities, including possibilities to undertake initiatives that were previously unfeasible. Therefore, we remain optimistic about the direction of the regulatory environment and the opportunities it may present.

Operator, Operator

Your next question comes from the line of Ethan Wang from CLSA. Please ask your question.

Ethan Wang, Analyst

I have two questions. First, I want to follow up on asset quality. Although we are seeing an improving trend, there seems to be an increase in provision relative to loan origination compared to last quarter. Can you explain the reason for this? Additionally, there were some investment-related losses in other income. Are these connected to asset quality? I would like more details on that. My second question is about the take rate. The ratio of service revenue to loan origination has risen slightly since last quarter. What factors are driving this, especially in a context of decreasing interest rates and a shift to a capitalized model? Thank you.

Jay Xiao, Founder, Chairman and CEO

I think regarding asset quality and the current situation, we need to adopt a conservative stance due to the ongoing impacts of COVID-19 and other economic factors. As such, we may have to be more cautious with some of these figures. When it comes to provisions, it's important to differentiate between new and old clients. The situation is improving with new clients, as we can see positive trends, but we must exercise more caution with older clients. There are various factors at play that aren't solely indicative of new or positive trends. Now, addressing your question about other income, as Craig mentioned, there are several factors involved, including an FX loss related to the US dollar and improvements in the value of the renminbi. Regarding your question about the take rate, it's not straightforward. We can't make a simple calculation as it encompasses future items, past items, and runoff. It's a mix of different elements, partly under the new accounting standard, but we need to account for the runoff first. There are multiple components involved, and it could be beneficial for us to have a more detailed conversation about these calculations in the future.

Ethan Wang, Analyst

Just a quick follow-up on the take rate. I’m wondering if management can provide more information or guidance on the future trend of the take rate. Thank you.

Jay Xiao, Founder, Chairman and CEO

We didn't provide any guidance on the take rate trend. Overall, it remains relatively stable across different models, such as our profit-sharing model and direct lending model, so it has been quite stable. However, there is a mix, and it is changing.

Operator, Operator

Your next question comes from the line of Sanjay Jain from Aletheia Capital. Please ask your question.

Sanjay Jain, Analyst

Thank you, management, for your presentation. A few questions. Let me start with a follow-up on the profit-sharing model. As per my calculation, your take rate in profit-sharing of the fee rate seems to have fallen from 7.8% in the fourth quarter of last year to 6.8% in the second quarter and further to 6.5% in the third quarter. I mean, I know your numbers internally could be different from what I'm trying to estimate. But can you confirm that the fee in profit-sharing is down by 100-plus basis points compared to the fourth quarter? And is this because this is the preps of the profit-sharing model that the losses for banks have gone up, so they are passing on those losses to you and that's why your fee has fallen?

Tony Hung, Senior Director for Capital Markets

Okay. Sanjay, I’ll translate that for you…

Sanjay Jain, Analyst

Yeah, sorry. Yeah, please.

Tony Hung, Senior Director for Capital Markets

No problem. So, regarding our profit-sharing model, there's no risk to us. We aren't required to pay anything to banks or financial institutions, as it doesn't reach those levels. Recently, there hasn't been that mechanism affecting the profit-sharing model. As for the profit-sharing figures, it might be helpful for us to connect privately to gather all the numbers. Stanley doesn't have last year's fourth quarter calculation available, but from what I can see earlier this year, it was around 3.2% to 3.4%. It's not significantly high like over six or seven percent, which might just be a minor detail in the calculation. It certainly hasn't decreased drastically, and in our model, we don't really need to allocate any amounts to the banks.

Sanjay Jain, Analyst

Okay. Okay. Yes. And so we can discuss offline. My second question is on the process of matching a loan to a bank partner. And I know you have explained this in the past. But let me ask again, when you receive a loan, and he's acceptable in your scoring criteria, and suppose the borrower is also satisfying the criteria, when you buy more than one funding partner, how do you select which funding partner the loan goes to? And then what options or choice does the funding partner have? Can they say more than yes or no? Can they say that, look, you know, you're sending me a 5,000 yuan loan, I can take 3,000 or you're sending a 5,000 yuan loan my way, but at 24%, I would like to get 26% from this customer. So how does it work? And if that bank says no, then does the loan go to the next one, or is it indicated, or kind of shared? And the final question on that is whether you co-lend a little bit, say 1% of each loan?

Tony Hung, Senior Director for Capital Markets

Okay, let me explain that for the team.

Jay Xiao, Founder, Chairman and CEO

You mentioned that if you're offered a 5,000 yuan loan, you might accept 3,000, or if you receive a 5,000 yuan loan at 24%, you're looking to get 26% from this customer. How does that process work? If that bank declines, does the loan move to the next lender, or is it indicated or shared in some way? Lastly, do you co-lend a small percentage, like 1% of each loan? Let me communicate that for the team.

Tony Hung, Senior Director for Capital Markets

So Sanjay, what Jay wants to emphasize is that when we connect the user to the funding partner, the one-co system is a very comprehensive and complex system. It's based on all the different funding partners' requests and everything they have inputted into the system. The focus is definitely on providing high-quality customer service, which means speed. Therefore, it is always a one-to-one situation, so there's no syndication or co-lending involved. That's the overarching logic. Additionally, there are other factors to consider, such as potential profitability, interest, and risk. We also need to determine the most appropriate funding model to use, whether it's loan guarantee, profit sharing, or something else. So there are a few different elements at play here.

Jay Xiao, Founder, Chairman and CEO

There’s no syndication or co-lending involved, making it a direct one-to-one model. Additionally, we need to take into account factors such as potential profitability, interest, and risk when determining the most suitable funding model, whether that be a loan guarantee, profit sharing, or another approach.

Tony Hung, Senior Director for Capital Markets

So with regards to the funding partners' choices, they obviously also have the choice to reject the credit that we provide, and many do. But of course, different funding partners have different rejection rates. So I'm very familiar with our customers, where we are familiar with the risk. As a result, they would have lower rejection rates. So for whatever reasons, more risk-averse and will have a high rejection rate. And as you know, if a partner rejects the credit, and in most media it goes to b, and then after that, for whatever reason, somehow nobody accepts the credit, then obviously, we will actually have to close the transaction. I think it's also worth emphasizing that maybe, and this is not necessarily an exact comparison, but maybe it's somewhat like the ride-sharing platforms here in China. There are a lot of different calculations that someone actually goes through when they fail a CAT; it could be something on the platform, somewhere outside of the direct platform, etc. It depends on the distance, it depends on the profit, really, etc. So there's definitely quite a few different things going on. That's quite complicated in the background.

Sanjay Jain, Analyst

Okay, okay. So just to be clear that the bank can only accept or reject a proposal when it comes from you?

Tony Hung, Senior Director for Capital Markets

There are a lot of different calculations that someone goes through when they fail a CAT; it could be something on the platform or somewhere outside of the direct platform. It depends on the distance and the profit, among other factors. There are definitely quite a few different elements at play, making things quite complicated in the background.

Jay Xiao, Founder, Chairman and CEO

Thank you.

Tony Hung, Senior Director for Capital Markets

As a whole, I mean, all these discussions have to occur before the funding partner is put into the system. We have to basically discuss the parameters well in advance. That way, when the actual transaction comes in, the efficiency and customer experience is fast. So in essence, it can only be yes or no.

Jay Xiao, Founder, Chairman and CEO

All these discussions need to happen before we bring the funding partner into the system. We must agree on the parameters ahead of time so that when the actual transaction occurs, it is efficient and provides a good customer experience. Essentially, it can only be a yes or no decision.

Tony Hung, Senior Director for Capital Markets

I think Jay also wants to add that, typically when we work with your average financial institution, they begin on a platform with a high rejection rate because they are quite conservative, not surprisingly. And also they would recognize, and always we would recognize that the efficiency there is not the highest. But then we take steps to help them increase their efficiency and also develop their own risk control systems. So this year, we have a specific FinTech team that is working very directly with the banks to improve their risk control systems and also increase their efficiency to help them preserve the quality of the assets and also help them build the model and data. And we can see that we're making actually good inroads, and it may become a bigger part of our revenues in the future.

Sanjay Jain, Analyst

Okay, fair enough. Thank you. My last question is, you know, your loan origination volume this year has been very impressive. And you know, it's growing quite nicely over last year, and last year itself was very, very strong growth on the previous year. So I just want to reconfirm my impression about your customer profile. So my impression, based on our chats over the years, is that you have young, college-educated customer cohort, now 25, 26 years old. So has there been any change in that, any deviation? Are you moving up in terms of the age profile or going more into Tier 3, Tier 4, Tier 5 cities or less educated, maybe going into polytechnic rather than college, various parameters on the customer profile side, have they changed? And as your customers age, then what is your value proposition to them, vis-à-vis say borrowing unsecured loans from a bank?

Tony Hung, Senior Director for Capital Markets

Has there been any change in your young, college-educated customer base, now around 25 or 26 years old? Are you seeing a shift in the age profile or a movement into Tier 3, Tier 4, or Tier 5 cities, with possibly less educated customers, such as those from polytechnic institutions instead of colleges? Additionally, as your customers get older, what is your value proposition to them compared to borrowing unsecured loans from a bank?

Jay Xiao, Founder, Chairman and CEO

Has there been any change in the age profile of your customers? Are you moving towards Tier 3, Tier 4, or Tier 5 cities, or are you seeing more customers with lower education levels, perhaps opting for polytechnic rather than college? How has the customer profile changed? As your customers get older, what value do you offer them compared to unsecured loans from a bank?

Tony Hung, Senior Director for Capital Markets

You're absolutely right about the core profile of our younger customers. Overall, our customer base has evolved a bit. Many of our long-term customers, those who have been with us for five to six years, are increasingly white-collar professionals, and some even operate their own businesses. They may utilize the credit we allocate for various activities. Given this, we recognize the need for greater scale and additional services. Our experience and operational model enable us to expand into lower-tier cities, attracting a wider range of customers with diverse profiles. This shift is contributing to our growth and enhancing our capacity to sustain that growth.

Sanjay Jain, Analyst

Okay. Can you share some data about what percentage is now outside of say Tier 1, Tier 2 cities? What percentage is outside of the 25, 26-year college-educated kind of group?

Tony Hung, Senior Director for Capital Markets

Okay, Sanjay. But this will have to be the last question from you, sorry, let me translate for the team.

Jay Xiao, Founder, Chairman and CEO

Okay, Sanjay. But this will have to be the last question from your side, sorry, let me translate for the team.

Tony Hung, Senior Director for Capital Markets

So I think that might be a little bit too detailed at this time. And just very quickly, our average age is actually still at 25. But I think we can get into some of the more details later.

Sanjay Jain, Analyst

Okay. Thank you very much. Appreciate it.

Tony Hung, Senior Director for Capital Markets

The active customers is 25, yeah, sorry.

Operator, Operator

Your next question comes from the line of Steven Chan from Haitong International. Please ask your question.

Steven Chan, Analyst

My question is a follow-up regarding the provision charges. You indicated that the increase in provision charges in Q2 was partly due to some old customers. I would like to clarify if this is linked to a decline in asset quality or delinquency among these customers, or is it more about being prudent? If it's a prudent approach, should we expect potential write-backs in upcoming quarters? Additionally, concerning credit costs, which are defined as provision charges as a percentage of average loans outstanding, do you anticipate that Q4 credit costs will revert to the levels seen in Q2, or will they remain at Q3 levels? For my second question, based on my estimates, customer acquisition costs per head appear to have decreased in Q3 compared to Q2. What is the reasoning behind this trend? Do you have any guidance for Q4 regarding customer acquisition costs? Thank you.

Tony Hung, Senior Director for Capital Markets

Do you think that the Q4 credit cost will likely return to the Q2 level or will you just stay at the Q3 level? And the second question is regarding my own estimation; it seems that customer acquisition costs per head declined in Q3 compared to Q2. What is the rationale behind this? Do you have any guidance for Q4 on the trend of these customer acquisition costs? Thanks.

Craig Zeng, CFO

So on the provisions, I think we have to monitor the customer behavior very carefully. And based on the data that we're seeing from the old customers, which are primarily the customers that we acquired in the second half of last year 2019, Q3, Q4 met the online advertising method. The customer behavior requires us to be a little bit more conservative. And I think in the fourth quarter, we’ll certainly, again, take a very similar approach. And just see how the customers behave.

Tony Hung, Senior Director for Capital Markets

So on the provisions, I think we need to closely monitor customer behavior. Based on the data we're observing from our older customers, mainly those acquired in the latter half of 2019, Q3 and Q4 matched the online advertising approach. The behavior of these customers necessitates a more conservative strategy. I believe in the fourth quarter, we will adopt a similar approach and observe how customer behavior evolves.

Craig Zeng, CFO

I believe our customer acquisition strategy has remained quite stable overall regarding our approach and the costs we aim to incur to acquire customers. You won't see any major increases or decreases on a per-customer basis; instead, the current quarter appears stable or slightly lower. There are specific reasons for that, but no significant trends in either direction. For instance, in the third quarter, we reduced our reliance on online ads and increased partnerships, which typically have lower costs. This is one of the main reasons. Additionally, the third quarter has historically been favorable for acquiring customers, and that remains unchanged. Overall, there are no long-term increases or decreases in trends; it's really quite stable. As always, we've emphasized diversifying our customer acquisition strategy and leveraging multiple channels. This year, for example, we plan to focus more on Lehua Card and collaborate with various platforms, trying to move away from the standard traffic methods we've used before. We're currently doing more partnerships in music instruction and online video platforms, such as Tencent video, where we offer memberships when someone opens an account with the Lehua Card. This should help bring more stability to our costs as we explore these channels moving forward.

Steven Chan, Analyst

My last question is about the guidance management provided last time regarding achieving a vintage of around 4% or even lower in the second half of this year. However, looking at the first three quarters of Q3, the vintage remains approximately 4.5%. Do you still have confidence in this target, and can you provide us with an updated outlook on the vintage trend for Q4? Are you still confident that you can reach a vintage of 4% by year-end?

Tony Hung, Senior Director for Capital Markets

My last question is about management's guidance from last time, which indicated an aim for a vintage of 4% or even lower in the second half of this year. However, if we consider the first three quarters of Q3, the vintage is still approximately 4.5%. Do you still have confidence in this target, or can you provide updated guidance on the vintage trend for Q4? Are you still confident that you can achieve a vintage of 4% by the end of this year?

Craig Zeng, CFO

Yeah. So basically, for the fourth quarter for the new loans, were 4%; yeah, we’re full confidence we should be able to accomplish that for the new loans.

Steven Chan, Analyst

Thank you.

Operator, Operator

As there are no further questions, we will conclude our conference for today. Thank you for participating. You may all disconnect.