Earnings Call Transcript - QFIN Q3 2020

Operator, Operator

Ladies and gentlemen, thank you for standing by, and welcome to the 360 DigiTech Third 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, Ray. Hello everyone, welcome to our Third Quarter 2020 Earnings Conference Call. Our results were issued earlier today on our website. Joining me today are Mr. Wu Haisheng, our CEO and Director; Mr. Alex Xu, 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 materials discussed here may contain forward-looking statements, which are based on our current plans, estimates, and projections. 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 between non-GAAP and GAAP ones. Last, unless otherwise stated, all figures mentioned are in RMB.

Wu Haisheng, CEO

Thank you, Mandy. Hello everyone. I am very happy to report another set of record-breaking results of key operational and financial metrics in the third quarter. Total loan origination reached RMB66 billion during the quarter, up 12% on a sequential basis. Outstanding loan balance increased by 7.3% to RMB84.2 billion from RMB78.5 billion last quarter. Total revenue was RMB3.7 billion, up 10.9% from last quarter. Non-GAAP net income was RMB1.29 billion, up 36.7% from last quarter. It has been a very busy quarter in terms of regulatory change, which would create significant challenges for the Fintech industry. Since the beginning of the year when COVID-19 hit, we have now successfully navigated through three quarters under tremendous market uncertainties and volatility, with consistent execution and steadily improving results. This is a strong testament to the soundness of our strategies and the sustainability of our business. In the wake of the pandemic and the regulatory challenges, we believe the Fintech industry has become further polarized as companies with core competitive edge continue to strive with consistent performance across business cycles. While we have tightened our policy in customer acquisition and risk management following the uncertainty created by the High Court rate-cap ruling in Q3, we still achieved strong business growth, mainly benefiting from the noticeable recovery in the macro economy. Let me elaborate on three aspects. First, overall, we continue to generate consistent growth in the number of registered users, users with approved credit lines, and active borrowers. During the quarter, we added approximately 1.57 million new users with approved credit lines, similar to that of last quarter. Second, we have made noticeable progress in our new business initiatives embedded in Fintech, where Fintech companies provide their service in Infrastructure-as-a-Service, ICE for short, modules. This is a new industry change that started in Silicon Valley and is gradually accepted in China. A growing number of 2C platforms have embedded Fintech ICE as a standard component into their offerings in order to better monetize their user base and serve their customers' needs. We are in a strong position to benefit from this change as our ICE solutions offer better user experience and higher commissions.

Alex Wu, CFO

Thank you, Haisheng. Good morning and good evening 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 the detail. During the third quarter, we see continued rebound of our business momentum as consumer confidence and economic activities gradually recovered post-COVID-19. Benefiting from such macro trend, we have experienced robust consumer demand for credit along with noticeable improvement in asset quality. Total net revenue for Q3 reached RMB3.7 billion versus RMB3.34 billion in Q2 and RMB2.58 billion a year ago. The year-over-year comparison is somewhat distorted by the accounting standard change early this year. Revenue from credit-driven service, which we call cap-heavy, was RMB2.96 billion compared to RMB3.08 billion in Q2. The sequential decline was mainly due to the decline in take rate as we lowered our average interest rate in Q3. The average interest rate for the entire Q3 is 25.9% compared to 27.2% in Q2, following the Supreme Court ruling in late August. Revenue from Platform Services, which we call cap-light, was RMB748 million compared to RMB259 million in Q2. If you recall, in Q2, we took accounting charges against revenue because the projected delinquency rate for certain assets exceeded the performance benchmark set by revenue-sharing agreements with our partners. As the asset quality continued to improve, the actual performance of those assets turned out better than previously expected and the delinquency rate fell below the benchmark. Therefore, from an accounting perspective, the charge should be reversed in Q3. Aside from these charges, the underlying take rate for the Platform Service also modestly improved in Q3. Total operating expenses, excluding provisions, were roughly flat Q-on-Q but decreased 33% year-on-year. The year-on-year decline mainly reflects significant improvement in operational efficiency, particularly the deduction of customer acquisition costs. Sequentially, we were able to keep operating expenses stable as we grew our business substantially. Average customer acquisition cost per user with approved credit line was RMB172 in Q3, modestly higher than RMB167 in Q2. As the macro economy recovered, demand for online traffic increased significantly. Q3 is also a seasonally high demand period for online traffic, particularly around the intense online shopping events such as Double 11.

Operator, Operator

Thank you, management. Our first question is from Jacky Zuo from China Renaissance. Please go ahead.

Jacky Zuo, Analyst

So I will translate my question. So congrats on the strong results. My question is related to regulation. So we observe that the new online macro lending rules require a high capital requirement for the applicant. So what is our view on the new lending license and any plan to apply for this license jointly with other parties? And in addition, do we expect any further tightening on the loan facilitation regulation, and what will be the timeline? Thank you.

Alex Wu, CFO

Thank you, Jacky for your question. I would let our CEO answer your question. Haisheng?

Wu Haisheng, CEO

I will translate for our CEO. Jacky, regarding your question about the micro-lending license, there are a few aspects involved in this notice. One is about the joint lending. Actually, on this asset, we nearly have less than 1% of our total loan balance, which is a very, very small portion. Secondly, the notice mentioned some regional restrictions about micro lending and also the recurring facility. We barely have that part either. About the registered capital, it requires about RMB1 billion for local lending and RMB5 billion for national lending. Actually, looking at our whole business, we mainly use other funding sources rather than the micro-lending license. Therefore, we are focused on the loan facilitation platform, not relying on the micro-lending license. In the long term, we are targeting not to leverage the micro-lending license. Furthermore, please consider, we have a banking license, and if we want to increase the registered capital, it's easier for us to register under the banking license. Jacky, regarding your question about regulation on the loan facilitation business, please recall that in July, the regulator released online lending guidance for commercial banks, and recently they issued notice about the consumer finance company loan facilitation business. Those notices indicate the regulator's view; they legitimize the loan facilitation business. In the long term, we do not think that the regulator is tightening the loan facilitation business in China; he is actually promoting industry order for healthy and sustainable development. Also, if you look at the Chinese market, traditional banking cannot develop the micro lending consumer finance capability on their own. The relationship between traditional institutional banking and loan facilitation platforms are complementary and collaborative. We can forge synergy and become the inter-operable model.

Jacky Zuo, Analyst

So my follow-up question is regarding the ICE model. As we mentioned, we are cooperating with other traffic platforms. What is the percentage of this cooperation of our loan volume currently and what is the outlook?

Wu Haisheng, CEO

Well, in terms of the newly acquired users, the API model, or we call the embedded Fintech model, accounts for roughly 20% to 30%, and we still continually see the growth momentum in terms of this customer acquisition. The platforms with consumption scenarios, when they choose loan facilitation platforms, they require a better user experience and a high commission rate, which are our strong competitive advantages. That's why there are many other platforms lying in the pipeline.

Alex Wu, CFO

Jacky, I want to add one point, to your question, the 20% Haisheng just mentioned is actually for the new user acquisition percentage, but from a loan volume perspective, given that a significantly larger percentage is coming from old users, the new format is only contributing roughly 2% to 3% of the loan volume we're generating.

Jacky Zuo, Analyst

Got it. Very clear. Thank you so much.

Operator, Operator

Thank you. Next question is from Daphne at Citi. Please go ahead.

Daphne Poon, Analyst

So I will translate my questions. It is mainly regarding the loan origination and customer acquisition outlook. So first, when we look at the third quarter new borrowers' number is still flattish Q-o-Q. So just want to check whether, like, it seems that the loan volume growth in the third quarter is mainly driven by larger ticket sizes given to the existing borrowers. So, if possible, can management also share the average ticket size on the borrowers for the third quarter? And for your guidance for the fourth quarter only implies a flattish loan volume Q-o-Q. So just wondering why the growth will not be stronger if everything continues to improve and whether there is any seasonality here. Lastly, if you can share the outlook in terms of your loan origination for next year. Thank you.

Alex Wu, CFO

Thanks, Daphne. I would like Haisheng to answer more of the overview side of your question. Then I will give you some detailed numbers. Haisheng?

Wu Haisheng, CEO

Okay, I will translate for our CEO. First of all, yes, you are right, we will see more contribution from existing customers in terms of loan origination in Q3. About the ticket size, yes, we see it relatively stable compared to last quarter. About our Q4 outlook, there are a few reasons that we give this outlook. Number one is usually there is seasonality in the last quarter, especially considering some traffic pressure from e-commerce platforms is gradual. Secondly, we are a very prudent company; we stay vigilant about any alerts regarding the pandemic and the macro conditions down the road, and we don't think it's wise to adopt an aggressive approach in the fourth quarter. Overall, for next year's outlook, I don't have a very concrete number to share now, but I can give a rough idea that we expect to see continued improved momentum next year. I will elaborate on a few aspects. Number one, as we explore more new initiatives this year, we expect to see the growth materializing next year. Secondly, considering our affiliates' stake in KCB, we expect to see the synergy and co-developed products ramping up next year. Thirdly, regarding the SME loan business, I mentioned in my speech, we have started already, and for example, regarding the channels, we have already covered most of them.

Alex Wu, CFO

Daphne, you just wanted to...

Wu Haisheng, CEO

Okay. So to elaborate more on the contribution of the existing customers, we have analyzed that 45% is due to the cross-selling of products, like increased customer activity and customer retention, and 25% is due to the operational efficiency improvement. For example, we have increased the different touchpoints through model integrations. The last portion is from the ticket size increase and the credit line increase. For example, for the SME owners and for people with cars or property, we will increase the credit line. So the ticket size is relatively stable this month. It's around somewhere 5,300 to 5,400.

Alex Wu, CFO

Yes. And Daphne, go ahead.

Daphne Poon, Analyst

So, I just wanted to follow-up regarding your partnership with Kincheng Bank and also the SME lending initiative you mentioned earlier. So first wondering whether this SME loan is just mainly granted for your partnership with Kincheng Bank, and also is there anything more that you can share regarding your current progress at partnering with Kincheng Bank and your expected contribution into next year? Thank you.

Wu Haisheng, CEO

Sure. Currently, we are implementing still very effective customer channels in terms of SME loans. Number one, for our extensive existing users, after we analyze, we are happy to see roughly 20% to 25% of them are SME owners and we have done some initial attempts to lend money to them. The asset quality tends to be better than our total loan book. Secondly, we leverage the Enterprise SaaS service companies to cover SME owners. Those enterprises include tax and invoice-related services. Thirdly, the offline channels have turned out to be very effective, as proven by Ping An, which is backed by Lufax. Nowadays, we have over 1,000 offline sales teams. Sure. I'll just give you a few updates on our cooperation with KCB. Firstly, regarding the funding side, we have advanced the progress with them. Secondly, collaborating with KCB, we are able to tap into some better quality prime customers. Thirdly, KCB has a banking license, which provides us with legitimate access to tax data, which is pivotal risk management data for SME loans. Thirdly, we are co-developing tax debt products with KCB. This will be the generalized model for our two-way business.

Alex Wu, CFO

Thank you, Daphne. Next one.

Daphne Poon, Analyst

Okay, thank you.

Operator, Operator

Thank you. Next question is from Ethan Wang at CLSA. Please go ahead.

Ethan Wang, Analyst

Thank you. My question is on take rate, especially on platform service tech leverage, which is quite strong in the third quarter. So just if management can share some color on the reasons behind this and the trend going forward. And a related question is on the APR level and the funding cost in the third quarter, and if there is some guidance for future quarters, that would be great. Thank you.

Alex Wu, CFO

Sure, thank you. I think I'll go in the reverse order in terms of questions. The first one, regarding the funding cost, in the third quarter, we continued to see a modest decline versus the second quarter. If you remember, in the second quarter, we were at 7.2% on average. In the third quarter, we are somewhere between 7% and 7.1%, so slightly lower. That's the funding cost. And secondly, regarding the interest rate, for the quarter the average is at 25.9%. The second quarter average, as you recall, was 27.2%. So you see that drop, mainly because starting from September we adjusted our pricing for all the products following the High Court ruling regarding the interest rate cap. So that's for the interest rate question. In terms of take rate for the cap-light model, it is, if you do the math, significantly higher than the second quarter and also probably higher than normal. The main reason is because, in my prepared remarks, I mentioned a little bit. If you recall, the second quarter, actually, the cap-light take model was quite low because, as I said, there was a batch of the assets where the projected performance in terms of delinquency exceeded the benchmark we set with our partners. According to the agreement, mostly stemming from the early agreement we had with the partners, if the delinquency exceeds a certain benchmark, our take rate will be reduced accordingly. So, that's the main reason for the Q2's take rate for cap-light dropping quite significantly. But that doesn't mean the actual loss for that batch of assets happened in Q2, it's just the projected kind of a delinquency. Now as the macro economy improved, the asset quality continued to improve. We saw for the third quarter that particular batch of assets, the actual loss turned out to be much better than previously expected and the delinquency was lower than the benchmark we set in the agreement. From an accounting perspective, whatever the charge you took in the second quarter has to be reversed back in the third quarter. So if you just look at the printed number, you see the third quarter's take rates are significantly higher than the second, but if you can read through all these kinds of noises, meaning adding back those charges to the second quarter and getting rid of this write-back in the third quarter, you'll see a modest improvement in the real core take rate for the cap-light model. For that number, we see very modest improvement in the third quarter versus the second quarter.

Ethan Wang, Analyst

Got it. Thank you, Alex. Just a quick follow-up. So the high take rate for the capital-light model in the third quarter may have partially contributed to a reversal of the charge in the second quarter. So in the fourth quarter and onwards, should we assume that this reversal is one-off, so this will be gone and the take rates will lower to normalize? Is that the correct understanding?

Alex Wu, CFO

I think, in general, that's probably the right assumption. Given the macro economy continues to improve, we don't expect any sort of piece of assets to exceed any of those benchmarks anymore. So that's—the noise will be gone either way. Overall, and remember that since September, our overall pricing has come down a little bit that for cap-light model, the take rate is also related to a certain degree of the pricing. So, for the fourth quarter, we will see flattish to slightly downward on the take rate for the cap-light model.

Ethan Wang, Analyst

Thank you.

Operator, Operator

Thank you. Your next question is from Steven Chan at Haitong International. Please go ahead.

Steven Chan, Analyst

My question is divided into two parts; one follow-up on the lending rate APR. I just want to know if the decline in APR is actually related to pressure from the funding partners or from the market. Do we see a stabilized trend in Q4? And then for the micro finance loan facilitation business, if you compare it with the business model of peers, actually, the business model is completely different from the consumer finance loan facilitation model, especially one for acquisition cost, the per customer acquisition cost was actually very high. Are we going to see a similar pattern too? In terms of risk management system, do we have to cater for bigger ticket sizes and longer tenors? Can our current risk management system accommodate this change like ticket size? Finally, even in terms of the guarantee model, you do not provide back-to-back guarantees to the customer. Currently, for our guarantee business model, we provide back-to-back guarantees. So, are we going to follow a similar pattern or do we have some unique business model in terms of guarantee or capital-light business for the inclusive micro finance loan facilitation business trends?

Alex Wu, CFO

Thanks, Steven. I would like our CEO and CRO to take your question.

Wu Haisheng, CEO

Okay, I will translate for our CEO. For the reason of lower APR in Q3, the main reason is that we proactively lower APR to fully comply with the regulation. We have pretty much completed this project in Q3 and will have a stable situation in Q4. Yes, sure. About the customer acquisition cost for our SME loans, in the market, there are two successful strategies from two of our peers. Number one is Ping An from Lufax. It has an offline coverage team. Secondly, WeBank currently has around RMB100 billion loan balance applied online service providers to channel the SME owners. Both of their customer acquisition strategies are successful, and we apply a different strategy. If we learn from that, the customer acquisition cost will vary a bit. Yes. Regarding your question about the SME loan guarantee model, since we have established deep-rooted cooperation with all our funding partners in the past few years, we track each other very closely. Currently, we have a few billion RMB in terms of SME loans, and we are advancing the SME loans to a capital-light model without guarantee. No, just I will turn to the CRO regarding your risk question about SME loans.

Yan Zheng, CRO

Okay, I will translate. As Haisheng and Mr. Zheng have mentioned before, historically, we have SME customers and based on different data sources, we can achieve or we have different credit lines. For example, for SME owners with a license, we have around 80,000 to 90,000. For invoice data, we have around 140,000. And for the tax data, we have around 300,000. We can say that the risk performance is about 20% lower than the average of our total assets. For the duration, it is about 17 to 18 months. So there is no fundamental difference from the three to six months period. Therefore, we can see that our risk management mechanism can work on this customer base. Historically, we have also proved that each time we conduct refinement operations and improvements of the model, we can actually upgrade the customers.

Steven Chan, Analyst

Very clear. Thank you.

Yan Zheng, CRO

Operator, Operator

Thank you. That's all for today's Q&A session. I now would like to hand it back to management for closing remarks.

Alex Wu, CFO

Thank you, operator. Thanks, everyone for participating in our call. If you have additional questions, please feel free to contact us. Thank you.

Operator, Operator

That's the conclusion of today's conference call. You may disconnect. Good-bye.