Earnings Call Transcript - QFIN Q2 2020

Operator, Operator

Good day, ladies and gentlemen. Welcome to the 360 Finance Second Quarter 2020 Earnings Conference Call. Please also note, today's event is being recorded. At this time, I'd like to turn the conference call over to Ms. Mandy Dole, IR Director. Please go ahead, Mandy.

Mandy Dole, IR Director

Thank you, Shen. Hello, everyone, and welcome to our second quarter 2020 earnings conference call. Our results were issued earlier today on the IR website. Joining me today on the call are Mr. Wu Haisheng, our CEO and Director; Mr. Alex Wu, our CFO; and Mr. Zheng Yan, our CRO. Before we begin the prepared remarks, I would like to remind you of the company's Safe Harbor statements. Except for historical information, the material discussed here may contain forward-looking statements. These statements are based on our current plans, estimates and projections, and therefore, you should not place undue reliance on them. Forward-looking statements involve inherent risks and uncertainties. We caution that a number of important factors could cause actual results to differ materially from those contained in forward-looking statements. For more information about potential risks and uncertainties, please refer to the company's filings with the SEC. Also, this call includes a discussion of certain non-GAAP measures. Please refer to our earnings release for a reconciliation of the non-GAAP measures to the most directly comparable GAAP ones. Last, unless otherwise stated, all figures mentioned are in RMB. I will now turn the call over to our CEO, Mr. Wu Haisheng.

Wu Haisheng, CEO

Thank you, Mandy. Hello, everyone. I'm very proud to report strong financial and operating results for the second quarter. While the macroenvironment remains challenging, we still set a number of records in key operational metrics. Total loan origination reached RMB 58.9 billion during the quarter, up 21.8% year-on-year. Outstanding loan balance increased to RMB 78.5 billion from RMB 74.1 billion a quarter ago. For the second quarter, total revenue reached RMB 3.34 billion and non-GAAP net income reached RMB 942 million. This is the most outstanding quarterly result since our IPO. Our solid performance under the still uncertain macro backdrop further demonstrates the effectiveness of our prudent operational strategy, as well as the resilience of our customer base and our risk management system. We believe we have built a structural advantage over our peers, which enables us to successfully navigate through previous market uncertainties, such as the P2P crackdown, the regulatory changes, and the pandemic. In each of those cases, we further strengthened our leadership position. When the macro environment and economy recover, we see continued improvement in our operational metrics and we feel confident in our future prospects. Our take rates for the quarter improved noticeably, driven by our continued efforts to boost operational efficiency and refine our risk management system, funding structure, and customer acquisition channels. Average pricing during the quarter was 27.2% on an IRR basis, which is equivalent to 15% to 16% on an APR basis. Day 1 delinquency decreased to 6.2% at the end of Q2. This was even better than the pre-pandemic level of 6.5%. Moreover, our funding costs further decreased to 7.2% from 7.7% in the prior quarter, well below the peer average. In the first half of 2020, we issued a total of RMB 1.1 billion in ABSs, ranking number four behind Ant Financial, JD, and Xiaomi in terms of total insurance size. We acquired 1.6 million new customers with approved credit lines in the second quarter, which is RMB 200,000 more than in Q1. The average acquisition cost for those new customers was about RMB 167, modestly higher than in Q1. As the market gradually consolidates toward leading platforms, we have increasingly become the preferred fintech partner for many consumer-focused internet companies. So far, we have connected our service with 11 partners, including Xiaomi, Meituan, ICE, and many others, including JD, Didi, 58.com, and Weibo are in the pipeline. Our new product initiatives also tracked very well in Q2. Daily transaction volume of our virtual credit card products, V-pocket, reached RMB 15 million at the end of the second quarter, connecting 2.5 million accumulated users with about 2 million merchants and processing 450,000 daily transactions. The Intelligent Credit Engine, which connects institutions with our vast inactive user base, added another RMB 20 million in daily transaction volume to our platform. We expect the momentum to continue and greatly enhance the stickiness and activity level of our user base. We made further progress in strategically upgrading to a technology-powered digital platform. During the quarter, capitalized models and other tech-powered solutions accounted for over 26.9% of total loan origination, and we remain committed to increasing this capitalized contribution to 35% to 40% by the end of this year. In addition, we are also working on standardizing our risk management capabilities into service modules and offering them to financial institutions. As of now, six institutions have already used this service and 20 more are in the pipeline. In the long run, we will continue to invest more in our fintech capabilities and further strengthen our competitive advantage. By our calculation, tech-enabled revenues and platform service revenues are already nearly 50% of our total revenue. Recently, we proposed to our Board of Directors and shareholders to change our name to 360 DigiTech, which will better reflect our current business dynamics and long-term strategies. Last week, the Supreme People's Court of PRC announced a new guideline to reduce court-protected interest rate cap for private lending. We anticipated and prepared for this prior to the release. Shortly after the official announcement of the guideline, we held a conference call to communicate our point of view with the capital market. While it is generally believed that the new guidelines are only applicable to private lending, we are prepared for the possibility that the financial regulators may refer to this guideline as well. In addition, it is widely believed that the 15.4% interest rate cap referred to in the guideline is on a nominal APR basis, which is equivalent to roughly 27.3% on an IRR basis. This is more or less in line with our current average pricing. As a result, we expect the impact on our operations to be manageable. Recently, we tested some experimental pricing structures with a certain group of users, essentially offering loans to them at a lower rate than they otherwise would get. The results indicate that carefully managing the pricing discount could potentially lead to a higher customer LTV for the company, as users may become more active and engaged. In the intermediate term, we believe that regulators will likely encourage a gradual downward trend in interest rates, which is consistent with our long-term strategy of serving a much broader user base at a relatively lower price. In early May, our affiliate company, 360 Group, committed significant resources to become the controlling shareholder of the national bank, KCB. This will provide strong and vital support for us to further reduce funding costs, diversify product offerings, and strategically upgrade to a technology-powered digital platform. Finally, let me introduce our newly appointed CFO, Mr. Alex Wu. He was the CFO of Qihoo 360 when it was listed in the US. Many of you may already know him. Our former CFO, Jiang Wu, has been appointed as our CSO. I would like to thank Jiang Wu for his great efforts in building up a prudent internal financial system and presenting our company well in the capital markets. Now, I will pass the floor to Alex Wu to dive into the details of our financial performance.

Alex Wu, CFO

Thank you, Haisheng. Good evening and good morning, everyone. Welcome to our quarterly earnings call. For the interest of time, I will not go over all the financial line items on the call. Please refer to our earnings release for those details. Q2 marked a sharp rebound in our business momentum from Q1. As concerns over COVID-19 gradually faded, the country entered recovery mode and economic activities gradually picked up during the quarter. Benefiting from such micro-trend, we experienced a robust rebound in our operations, particularly in the second half of the quarter. Total net revenue for Q2 reached RMB 3.34 billion versus RMB 3.18 billion in Q1 and RMB 2.23 billion a year ago. The year-over-year comparison is somewhat distorted by the accounting standards change early this year. Total operating expenses, excluding provisions, increased by 12% Q-on-Q, but decreased 27% year-on-year. The sequential increase was partly driven by our deployment of resources to support business growth in the quarter. In particular, we further strengthened our collection operations and on-the-ground customer acquisition team. A year-over-year decline reflects a significant improvement in customer acquisition costs. Non-GAAP net income was RMB 942 million versus RMB 255 million in Q1 and RMB 692 million a year ago. Once again, the year-over-year comparison was impacted by the accounting standard change. On an apple-to-apple comparison basis, under the old accounting standard, non-GAAP net income would have been approximately RMB 1.3 billion, representing an approximately 87% year-over-year increase. With a growing contribution from the capital-light model and the sizeable increase in shareholders' equity, the leverage ratio declined meaningfully to 8.3 times in Q2 compared to 9.5 times in Q1. Again, the leverage ratio was also impacted by the accounting standard change. Under the old standard, the leverage ratio in Q2 would have been 6.3 times versus 9.8 times a year ago. While the leverage ratio may vary from quarter to quarter, we expect to see an overall downward trend going forward as the capital-light model continues to grow and we continue to create shareholders' equity. Meanwhile, our provision coverage ratio remained at a healthy 3.2 times in Q2 compared to 4.0 times in Q1. The sequential decrease in the provision coverage ratio was mainly because the loans originated in previous quarters performed better than expected, and the provision for those loans was lowered by approximately RMB 300 million in Q2. For risk-bearing loans originated in Q2, we took a similar conservative approach to Q1 to estimate potential losses and the provisions for contingent liability. Free cash reached a record high of RMB 1.8 billion in Q2. This was largely driven by strong operating results and effective management of working capital. Total cash and cash equivalents were RMB 7.4 billion at the end of Q2. The majority of our cash was allocated to security deposits with our financial institutional partners, and also for the registering capital of different entities to support our daily operation. We also leave a sizable buffer for any market uncertainties in our cash reserves. We believe that such a sufficient cash position will not only enable us to compete in an ever-changing market, but also position us to capture potential growth opportunities in the market recovery. Finally, let me give you some color about our outlook for the third quarter and the full year. The strong positive momentum we experienced in the second half of Q2 has continued into the current quarter, both in demand and asset quality. However, with the global pandemic still lingering and the impact of the recent regulatory change still somewhat unclear, we will continue to take a prudent and conservative approach in our business planning. Therefore, we would like to maintain our full-year loan origination guidance of RMB 200 billion to RMB 220 billion. With that, I would like to conclude our prepared remarks. Operator, we can now take some questions.

Operator, Operator

We have a question from Ms. Daphne Poon from Citi. The floor is yours, Ms. Daphne.

Daphne Poon, Analyst

So I will translate the questions. So, mainly two questions. The first question is regarding your loan pricing. Just wanted to get a sense from the management, given the latest regulation coming out from the Supreme Court, how fast and how much you expect your APR to come down, say, in the coming few quarters or next one to two years' time? And also, whether you have done any stress tests about what your breakeven interest rate would be? And the second question is about the Intelligence Credit Engine that you mentioned earlier. You mentioned it for activating some of your existing users. So, can you elaborate more in terms of the product features, such as loan terms, pricing, interest rates, etc., and how is that different from your current capital light model? Thank you.

Wu Haisheng, CEO

Okay. In terms of the trend of interest rates or pricing, quite a while ago, we already determined that the overall interest rate trend will gradually trend down, both from our understanding of the regulatory environment and also from internal assessments. We believe that with gradually lowered interest rates or pricing, we can reach a broader user base to basically increase the overall size of the business in the long run. And also, looking at our current structure in terms of take rates, I think we have a reasonably good take rate within our current operation, which means that there's plenty of room to maneuver in the new interest environment. Our overall operational efficiency is probably among the best within our peers. That again gives us room to profit and achieve growth in the new interest environment. With KCB joining us as a partner, we additionally have an advantage in terms of lower cost funding, which will also help us deal with the relatively lower pricing environment. For the breakeven point tied to your second question, obviously, it's a little early to make detailed calculations. Roughly speaking, based on a back-of-the-envelope calculation, we currently look at it being about 16% on an IRR basis. That's approximately our breakeven point under the current model. I should note that this estimation does not consider any incremental volume associated with the lower rate environment. In terms of the Intelligence Credit Engine, the main purpose is to activate our what you could call 'sleepy users.' As you know, we have nearly 30 million users with approved credit lines, but at any given time, less than 10 million are actually using the credit. This means close to 20 million users we consider inactive. For these users, we link them with financial institutions, and the product will be based on the bank's brand rather than the 360 brand. We also use a differentiated pricing strategy to attract those users. Many may have a better impression of the bank's brand; that is how we aim to activate these users from a dormant state. The difference between the Intelligence Credit Engine and the capital light model is that, in the Intelligence Credit Engine, as I said earlier, the brand is under the bank's name, not ours. Additionally, in this model, we do not handle after-loan management; the bank manages that aspect. In contrast, under the capital light model, we do the after-lending management work. However, we assist the bank with customer acquisition and some pre-screening in terms of risk management prior to lending activity. The pricing or take rate for the Intelligence Credit Engine is slightly lower than the capital light model, but not significantly different. That’s it, Daphne.

Daphne Poon, Analyst

So, just a follow-up question regarding the longer-term take rate and the outlook. At what level do you think it will decline or at what level do you feel more comfortable in the long term? Thanks.

Wu Haisheng, CEO

We really don't set a target for the take rate in our daily operation. What we focus on is the dynamic that, in this new interest environment, we want to serve a broader user base. As the environment encourages an overall reduction in the take rate across the industry, we will follow that trend. Therefore, we do not foresee or expect a dramatic decline in the take rate in the short term. It will likely be a gradual adjustment reflecting the overall industry scenario.

Operator, Operator

Next, we'll have Mr. Jacky Zuo from China Renaissance.

Jacky Zuo, Analyst

Congrats on the results. So, my main question is about asset quality. I just want to ask, what is the trend in July and August regarding day 1 delinquency rate, 30 days collection rate, and what is our estimate for the vintage loss ratio of new loans issued in the first half? Lastly, can we disclose the day 7 delinquency rate? Thank you.

Zheng Yan, CRO

The overall improvement of asset quality continued into the current quarter. As Mr. Zheng basically mentioned, exiting the second quarter, our day 1 delinquency rate was about 6.2%. Currently, for a few weeks, it's consistently been below 6% for the day 1 delinquency rate. For the 30-day collection rate, exiting the second quarter, we were at about 88%. This number is now between 89% and 90%, continuing on a very positive trend line there. In terms of expected vintage loss for the current portfolio, our range was given as between 2.5% to 3.5%. Currently, this number, or as of the end of the second quarter, sits at about 3%. Given the delinquency leading indicator trend that we've been observing, it’s possible that the actual vintage loss will be lower than expected. For FPD7, the delinquency rate, pre-pandemic, we were running at about 0.9% to 1%. At the peak of the pandemic, we peaked at 1.84%. Now, we've bounced back to a significantly lower rate; we’re currently at about 0.8% for that metric.

Jacky Zuo, Analyst

So, a simple follow-up on this, I have observed that, given the improved asset quality, we should have a provision write-back in the second quarter. So, what is the number that we expect for the write-back in the third quarter? Thank you.

Alex Wu, CFO

Sure, Jacky. I will take this part of the question. If you look at the financial statements, for the first quarter, we booked a RMB 1.7 billion provision for contingent liability. Of that RMB 1.7 billion, RMB 1.4 billion was for the loans issued in Q1 and RMB 300 million was for loans issued prior to Q1. In the second quarter, the total provision for contingent liability was about RMB 1 billion. Within that RMB 1 billion, the provision for loans issued in Q2 was RMB 1.32 billion. However, because the loans we issued in previous quarters performed better than we initially expected, we had a write-back of about RMB 300 million in Q2 for those provision numbers. That gives you the net provision for contingent liability for Q2 at about RMB 1 billion.

Jacky Zuo, Analyst

Do we expect further write-back in the third quarter?

Alex Wu, CFO

If you look at the way we've taken provisions in both the first and second quarters, for the new loans, we were quite conservative. We booked RMB 1.4 billion in the first quarter and RMB 1.3 billion in the second quarter. So, both reflect a very conservative approach. If the current trend continues, meaning asset quality continues to improve, you should expect to see this write-back on the provisions in the coming quarters.

Operator, Operator

Now I'd like to call upon Mr. Steven Chan from Haitong International.

Steven Chan, Analyst

After the change of the name from 360 Finance to 360 DigiTech, I just want to understand whether there will be any change in the business strategy? Especially, are we going to change from a fintech company to a tech fin company? Especially, are we going to introduce—we have introduced this Intelligence Credit Engine, which is very similar to the capital light model. If we're really going to change from a fintech company to a tech fin company, which bigger player should we compare ourselves with? Should we compare with OneConnect or Qingdong? Thanks.

Wu Haisheng, CEO

Yes, we proposed to change our name from 360 Finance to 360 DigiTech because if you look at the history of the company, the founding team is from 360 Group, which is more of a tech-based team. Our resources, at least in the initial founding, came from the technology side. We apply those resources and capabilities to the financial service industry. In the short term, we still have plenty to do for the financial service segment of the market. For example, the customers we're serving today are focused on the mid to high end in terms of the interest range. Down the road, we want to cover a broader user base, including lower and mid to lower interest rates. Particularly with the help of KCB, we can reach that goal. So, we will eventually find ourselves building a, whether you call it a tech fin or fintech platform, a unique one compared to most others because we will likely be one of the only ones able to serve a broad customer base with a full range of interest rates in the future. Additionally, on the institutional side, we already engage with over 100 financial institutions. Many of those institutions have different service scenarios we can work on, developing more standardized products to enable our tech capabilities in the future. Ultimately, from your question, we probably resemble OneConnect a bit. However, we also have a loan facilitation business and lending business that makes us somewhat of a combination of Ant Financial's GFA plus OneConnect. Furthermore, we recently acquired an affiliate insurance broker license, which can eventually become part of our listed company's portfolio. This will allow us to expand our business beyond current lending and tech services by adding additional elements.

Operator, Operator

In the interest of time, we would like to have the last question from Mr. Ethan Wang from CLSA.

Ethan Wang, Analyst

My question is on customer acquisition channels. Just wondering what is the split of the customer acquisition channel now compared to pre-pandemic? I hope management can share more data on the V-credit product, so we can understand more about its growth. Thank you.

Wu Haisheng, CEO

In terms of customer acquisition, given the ongoing market uncertainty, our customer acquisition strategies are currently more focused on existing or returning users, which allows us better control over customer acquisition costs. In addition to focusing on existing users, we are also utilizing technology and the way we acquire our users to control costs. For example, we have partnerships with platforms like Xiaomi and Meituan, which allows us to utilize a revenue-sharing model for customer acquisition. This helps enhance our overall user acquisition cost management. Given our current focus on existing users, we have significant room for acquiring new users in the future. Once the overall market conditions improve, we will adjust our strategies accordingly. I want to emphasize our new customer acquisition strategy through partnerships with major internet platforms. In the past, these platforms had many partners to choose from among other fintech providers. However, over time, they realized, especially concerning asset quality and customer service metrics that we significantly outshine our peers. This means that we have essentially become their preferred or default partner among internet platforms. Recently, we have begun to accelerate the connection of our services with these internet partners, with 11 partners already linked, and we still have numerous more in the pipeline. Customer acquisition via these partnerships currently accounts for about 20% of our total new customer acquisition. Additionally, I want to refer to our relationship or potential partnership with KCB; notably, banks have better brand recognition and lower-cost capital. Thus, through our partnership with KCB, we can design various low-priced products for our customers. Furthermore, with the bank’s involvement, we can connect our platform with more practical applications, ultimately allowing us to cover a much broader user base with diverse interest rates.

Operator, Operator

Thank you very much. Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may now disconnect. Thank you very much.