Earnings Call Transcript - QFIN Q1 2022

Operator, Operator

Ladies and gentlemen, thank you for standing by, and welcome to the 360 DigiTech First Quarter 2022 Earning Conference Call. Please also note today's event is being recorded. At this time, I would like to turn the conference call over to Ms. Mandy Dong, IR Director. Please go ahead, Mandy.

Mandy Dong, IR Director

Thank you. Hello, everyone, and welcome to our first quarter 2022 earnings conference call. Our results were issued earlier today and can be found on our IR website. Joining me today are Mr. Wu Haisheng, our CEO and Director; Mr. Alex Xu, our CFO and Director; and Mr. Zheng Yan, our CRO. Before we begin the prepared remarks, I’d like to remind you of our Safe Harbor statement in our earnings press release, which also applies to this call. We may refer to forward-looking statements based on our current plans, estimates, and projections. Also, this call includes discussions 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. I will now turn the call over to our CEO, Mr. Wu Haisheng.

Wu Haisheng, CEO

Hello everyone, I'm very happy to report a strong start to 2022. In Q1, total loan origination and the facilitation volume reached RMB 98.8 billion, up 33% year-over-year, and 2% quarter-on-quarter. Outstanding loan balance reached RMB 146.7 billion, up 44% year-on-year and 3% quarter-on-quarter. Despite the impact around the Chinese New Year and the macroeconomic and COVID outbreaks, our solid performance continued to demonstrate the resilience and flexibility of our operations. I recognize the major concern to the market right now is the COVID outbreaks. To deal with the situation, we created precautionary plans and took rapid response measures to make the impact on our business manageable. Such an effective response derived from our successful experience handling the pandemic back in 2020. Back then, our response was seen as very timely and effective in the industry. As the COVID resurgence occurred in Q1 in a number of Chinese cities, our team set and implemented a range of pre-emptive countermeasures. For example, we launched a multiperiod pandemic alert system for cities that are key to our business. In addition, we strategically scaled back our business for high-risk customers in industries hit by outbreaks, such as recreation and hospitality. Meanwhile, we proactively communicated with major funding partners about potential extensions for loan repayments. For borrowers who are unable to make repayments on time or lost the capacity to repay in the near term due to COVID, our customer service team stepped in to help them apply for repayment expansion. In the cities severely affected by the lockdown, it was very difficult for our offline team to acquire new customers. In such cases, we quickly shifted our team focus from offline customer acquisition to serving existing customers, which allowed us to uphold morale and sustain business performance. Thanks to the backing measures to mitigate impacts from COVID and our strategy to optimize our customer base, we successfully kept the impact on our asset quality under control. In the first half of this year, we are working to upgrade our customer base. This includes acquiring more high-quality users, resources to better serve high-quality users, and reducing exposure to high-risk borrowers. With these measures in place, the percentage of our Category A users, those with the best credit profile, greatly increased from the budgeted level. Our first payment, which represents the percentage of our first payment before 30 days, has also dropped quarter-on-quarter. At the same time, we upgraded our cloud bank system, which connects consumer demand with institutional offerings through smart matching, meaningfully improved the asset quality of online loan facilitation segments. For example, expected advantage loss rates decreased recently to between 2.4% and 2.7%, from 2.83% in Q4 last year. The credit quality of our new customers in Q1 was better than any of our previous quarters. With the impact of COVID, this performance was significantly better than last year, and we believe it will continue to improve. Although there was some fluctuation in the asset quality of our existing loan book due to COVID, the overall impact is still within our control. The day one delinquency rate of our existing loan book is 4.97%, better than last year, and at a relatively low level on record. Our collection rate dropped in Q1 with a significant decrease in lockdown cities such as Shanghai and Jilin; however, we notice that by May, the collection rate has stabilized in this region and it started to improve nationwide. As our user base continues to optimize, our risk performance will keep improving gradually. In Q1, our offline operation was restricted in some cities under COVID lockdown, such as Jilin, which temporarily put some pressure on offline user acquisition. The overwhelming impact on our online user base was limited. Although we do notice that many of them were less willing to spend in the challenging environment. Even in Jilin, with its relatively long lockdown, our total transaction volume only showed a small decrease compared to the pre-lockdown level. Currently, most municipal districts in Shanghai have reached zero COVID at the community level, and businesses are expected to resume operations in the near future. As such, our operations in this region are likely to gradually return to normal. Although COVID-related uncertainties are likely to persist throughout this year, with the counter solutions we have deployed over time and our enhanced ability to effectively respond to new outbreaks, we are confident that we will continue to keep the impacts of the pandemic manageable. Next, let me provide an update on industry policies, which the market follows closely. We have seen some top-down policy developments for the industry. On April 29, a political bureau report emphasized the healthy development of the platform economy and the completion of the special rectification measures for the platform economy. The PBOC and the CDIRC made similar comments at subsequent special meetings. Both regulators are about to complete the rectification of financial operations of platform companies and implement normalized supervision while supporting the healthy development of the platform economy. These signals indicate that the current rectification of the industry is close to an end. Related internet platform companies will complete the rectification process under the guidance of financial regulators and will be under regular supervision afterward. After over a year of rectification, these companies will be the first in the industry to be fully compliant and well positioned to develop a healthier and more sustainable framework. At the industry level, in early April this year, the PBOC and CDIRC jointly issued a notice to enhance financial services to support pandemic control, economy, and social development. The documents mentioned leveraging the benefits of financial services provided by internet platform companies while promoting the disciplined and healthy development of such services. This is a recommendation by the financial regulator of the positive role internet platform companies play in financial services. On the business front, our strategy and focus this year is the structural optimization of our user base and funding sources to enhance user lifetime value and increase the sustainable contribution of high-quality funding, therefore, further improve our operational resilience. In Q1, we achieved noticeable progress in some key areas. On the funding side, we continued to optimize our funding structure. First, we ensured a sufficient funding supply to support business growth. Second, we continuously optimized the funding costs and contractual terms with our funding partners, as our high-quality assets are in high demand from financial institutions. Third, we expanded funding partnerships with joint-stock banks and major urban and rural commercial banks, which have broader regional coverage and strong funding supply. Such expansion will prepare us to better serve business growth and deal with economic uncertainty. So far, we have connected with approximately 70% of national financial institutions. Additionally, we expect to add three more national joint banks or private banks into our partnership and have another seven in the pipeline. On the product side, we have followed regulatory guidance closely. Specifically, starting in April, the IRR of all loans originated through our platform is within 24% ahead of the regulatory timeline. Regarding credit agency reform, we are proactive and have designed our workload structure with credit agencies, intending to gradually implement these procedures. Furthermore, we have also adapted our product offerings to align with our optimized funding structure, reflecting the asset preferences of new national funding sources. This has allowed us to improve our loan approval rate. In Q1, we connected with more national joint-stock banks. Meanwhile, given the preference of big banks for higher quality assets and the increased risk of new prime borrowers in the current macro environment, we restructured our asset infusion engine to optimize the matching between loans and funding institutions. We also introduced a dynamic adjustment in our returns for financial institutions. This adjustment allows banks to get a fine loan that aligns with their preference while ensuring their expected return. The loan approval rate of our partner banks grew above 75% in Q1, up from roughly 70% in December. As for our users, our key strategy this year is to improve the quality of our user base. So far, we have achieved very noticeable progress. Specifically, we leveraged a combination of newly developed predictive models, real-time API technology, and capacity expansion to effectively optimize the quality of user acquisition. Among the customers that applied in Q1, 31% received the highest rating from financial institutions for their low risk profile. Multiple key indicators of user quality continue to improve, such as the ratio of users with fewer multi-platform credit lines, users with mortgages and car loans, users with stable income, and users with tangible assets. The improvements in these indicators show that we have greatly enhanced the resilience of our business and increased user lifetime value. The external environment brought many challenges to our business in Q1. However, our team once again rose to the challenge and delivered solid results. Given the ongoing uncertainty related to COVID, we will continue to stay vigilant to potential risks and maintain prudent operations to accomplish our strategic objectives in this transitional year. 2022 will be quite challenging for both our company and the industry. There is pressure on China-U.S. relations, regulatory developments for the industry, and impacts from the pandemic. Nonetheless, we believe these factors are gradually turning around, especially with recent policy signals. In addition, our consumer loan assets demonstrate very strong resilience during the pandemic. Looking at our current data compared to the time during the pandemic back in 2020, we are quite confident about our business prospects as the most recent wave of COVID outbreaks gradually subsides in China. We expect to see business activities return to normal. The structural upgrades we have made this year to our user base and funding network will position us more competitively. We have seen greater demand for our services, both from end users and from financial institutions, and that precisely has led to our growing value. Going forward, we will invest more in technology to boost our operational efficiency, which will enable us to continually build our competitive advantage in our markets at quick scale and magnitude. Next, I will turn to our CFO, Alex.

Alex Xu, CFO

Okay. Thank you, Haisheng. Good morning and good evening, everyone. Welcome to our first quarter earnings call. As Haisheng discussed earlier, we had a solid quarter in this rather rough period from a microeconomic perspective. Consumer demand for credit came in more or less consistent with normal seasonality in Q1. While we did experience some impacts from the resurgence of COVID in some regions in China, overall asset quality actually modestly improved during the quarter as optimization of our risk model and the contribution from high-quality new borrowers more than offset COVID-related fluctuations among existing borrowers. Of the two leading indicators of asset quality, overall day one delinquency improved to 5.2% from 5.4% quarter-on-quarter. More importantly, day one delinquency for new borrowers in Q1 came in well below 4%, indicating clearly better quality compared to existing borrowers. Overall, the 30-day collection rate declined modestly to 86% from 87% quarter-on-quarter, mainly because we had to make necessary adjustments to our collection operations in regions significantly impacted by COVID. Again, we see clear differentiation between new borrowers and existing borrowers. For new borrowers, the 30-day collection rate remained above 90% in Q1. These risk metrics further validate the effectiveness of our user acquisition strategy, which focuses on the high-quality segment of the market. Total net revenue for Q1 was 4.3 billion versus 4.4 billion in Q4 and 3.6 billion a year ago. Revenue from credit-driven services, capital heavy, was 2.9 billion, compared to 2.7 billion in Q4 and 2.5 billion a year ago. The year-on-year and sequential increase was mainly due to longer average tenor of the loans, growth in our balance sheet loans, as well as the release of guarantee liability on previous loan balances, more than offsetting the negative impact from the decline in average prices of the loans. Capital heavy facilitation revenue take rate actually improved modestly versus Q4 also due to longer tenor. Revenue from platform service, capital light, was 1.4 billion, compared to 1.7 billion in Q4 and 1.1 billion a year ago. The year-on-year growth was mainly driven by a significant increase in the capital light loan balance. The sequential decline was due to a decrease in capitalized loan volume alongside the decline in cap-light revenue take rate in Q1. During the quarter, cap-light and other technology solutions contributed roughly 64% of the total loan volume. As we discussed in previous calls, we expect cap-light and other tech solutions' percentage contribution to our total volume to remain fluctuating around the current level throughout this year. Longer term, though, we will continue to pursue a tech-driven business model and expect cap-light to become a larger portion of our business in the long run. During the quarter, the average prices of our loan portfolio dropped by 50 basis points and were below 24%. In fact, all new capital-heavy and capital-light loans are already priced below 24% at this point. We're very confident in achieving the rate cap requirement ahead of the regulatory deadline. During the quarter, sales and marketing expenses declined approximately 12% quarter-on-quarter, mainly because of the Chinese New Year holiday and our prudent control of the pace of our user acquisition. On a blended basis, the average cost per approved credit line was 417 compared to 319 in Q4. Again, this blended calculation evenly distributes sales and marketing expenses among users with high credit lines of between RMB 100,000 to RMB 200,000, as well as those who are regular users with credit lines between RMB 10,000 to RMB 20,000. Logically, the unit cost to acquire those high-ticket size users should be justifiably much higher than for regular users. Therefore, making a comparison of planned user acquisition cost becomes neither relevant nor reliable. So on an apple-to-apple basis, excluding large-ticket size users, the average cost per approved credit line for regular users was approximately 322 in Q1, compared to 246 in Q4. More importantly, the average cost per dollar monthly credit line remained relatively stable quarter-on-quarter for regular users. As always, we will continue to use lifecycle ROI and LTV as key metrics to determine the pace and scope of our user acquisition strategy to ensure the sustainability and profitability of our operations. Although the overall risk profile of our loan portfolio modestly improved in Q1 due to the contribution from high-quality new users, the impacts from macro uncertainty and COVID resurgence were still noticeable among existing users. Therefore, we continued to take a prudent approach in booking provisions against potential credit loss. New provisions for contingent liabilities for loans originated in the quarter were approximately 1.4 billion. Meanwhile, approximately 440 million of provisions for contingent liability of previous period loans were written back as actual performance of those loans was better than expected. With operating results and stable contributions from the cap-light model, our leverage ratio, defined as the risk-bearing loan balance divided by shareholders' equity, was at a historically low 4.2x in Q1, compared to 5.4x a year ago. We expect to see a rather stable leverage ratio for the time being until capital-light contributions resume growth in the future. We generated approximately 1.4 billion in cash from operations in Q1, compared to 2 billion in Q4. The decline in operating cash flow was mainly due to some COVID-related timing issues. As Shanghai was in lockdown late in Q1, we were unable to complete some administrative procedures that are normally required near the end of a quarter to collect receivables from some financial institutional partners. As such, possibly 400 million in Q1 receivables have been pushed into Q2 to collect, assuming the lockdown in Shanghai is gradually easing. Total cash and cash equivalents was 9.8 billion in Q1 compared to 9.6 billion in Q4. Non-restricted cash was approximately 6.2 billion in Q1 versus 6.1 billion in Q4. As always, a significant portion of our cash would normally be allocated to support the security deposit and other usage in the normal course of our business. As we continue to generate healthy cash flow from operations, we believe our current cash position is sufficient to support the growth of our business, to invest in key technologies to satisfy potential regulatory requirements and to return to our shareholders. In accordance with the dividend policy approved by our board last year, we declared another dividend of U.S.$0.22 per ADS for Q1. The cash dividends represent approximately 20% of our Q1 earnings. Finally, regarding our outlook for 2022, as we communicated to the market previously, we believe 2022 will be a transitional year for the industry as participants adjust to the new regulatory settings. Meanwhile, the unexpected outbreak of COVID, as well as associated measures to control the outbreak, creates additional macro uncertainties. Therefore, we want to maintain a prudent approach to plan our business and mitigate potential risks. At this point, we would like to keep our full-year loan volume guidance of between RMB 410 billion and RMB 450 billion unchanged, representing year-on-year growth of 15% to 26%. We view this transitional year as an opportunity to optimize our operations, strengthen our technology platform, and upgrade our customer base to build an even stronger foundation for our future growth. As always, this forecast reflects the company's current and preliminary view, which is subject to material change. With that, I would like to conclude our prepared remarks. Operator, we can now take some questions.

Operator, Operator

Thank you, management. We will now begin the Q&A section. Our first question, Yao Lee, CICC.

Yao Lee, Analyst

Then now to the translation part. So the first one is about we have made a capital injection last year for our micro loan license. Could you please elaborate more about how we plan to use it? Is it just a preparation for applying for the national license? Or are we actually starting to use it as an alternative funding source maybe in the very near future? And the second one is considering the resurgence of the COVID-19 and uncertainties in the economy. There will be some challenges, especially in loan collection and offline business development. So to be more specific, how are we going to deal with the situation? Thanks.

Wu Haisheng, CEO

Hi, for the two of your questions, for the first one. Yes, you are right regarding the 5 billion capital that we used to inject into the micro lending license. On the other hand, we also leveraged the capital as a funding resource through the channel of ADS or joint lending products, both of which can improve our leverage ratio. For your second question, first of all, we do not do the post-collection through offline; the pandemic impacted us only through offline technology mark revision. Half of our loan processes are conducted online, which is a valid limitation during the pandemic. Hope this clarifies all your questions.

Operator, Operator

The next question is Thomas Chong, Jeffries.

Thomas Chong, Analyst

Thanks management for taking my questions. I have a question regarding our business trend on a month-by-month basis, starting in April? How should we think about the low end and high end of the guidance and our assumption about a couple of weak trends in the coming quarters? How should we think about the recovery in terms of consumer sentiment in the coming quarters? My second question is about how we are seeing the business trend in top and lower tier cities, given the pandemic impact more on the tier one cities? Thank you.

Wu Haisheng, CEO

Okay. Hi, Thomas. Thanks for your question. So, from the overall business trend, our current assumption is that, as you know, Shanghai will be gradually reopened starting from maybe June. We are assuming a certain level of activity will return to Shanghai, perhaps also starting next month. We don't expect a sort of a V-shaped turnaround right away. I don't think that’s included in our model. We expect a rather slower, gradual kind of recovery after COVID. For tier one cities, the Shanghai situation is well published, and like I said, we expect to get some kind of a return to normal operation starting from June. Other cities such as Beijing have a slightly different situation, as the significant portion of normal life in those areas is still remaining. Yes, there are certain kinds of community lockdowns, but the situation in Beijing is much better than it was in Shanghai at the peak of the pandemic last month. Therefore, we will continue to closely monitor developments in Beijing; however, I don't believe it will impact our business as significantly as the situation in Shanghai.

Operator, Operator

Next question is Alex Ye from UBS.

Alex Ye, Analyst

Okay. I will translate all my questions. The first one is on asset quality. Can you give us some color on your latest trend on day one and M1 collection rate? We were expecting them to remain stable or see some deterioration in Q2. I also want to clarify, as mentioned, whether the expected loss will improve from 2.8% refers to the total loan book. The second question is on take rate and APR. What's your average APR now? What's the current trend from now into Q2? Do you expect it to further decline? Do you expect your take rate to bottom in Q1 or may it continue to head downward? For all your new users that have a bit lower risk, I'm assuming they will have a lower APR. From a risk-adjusted perspective, how does their return compare to existing users? Thank you.

Wu Haisheng, CEO

Yes. Starting in April, the IRR for loan production facilitated and originated through our platform is about 22%. In the near term, we expect this rate to remain relatively stable; we do not expect to see a significant drop in APR.

Zheng Yan, CRO

Thank you. To clarify your question regarding vintage loss, it indicates the new transactions drawn down in the first quarter. For the new customers who inquired in the first quarter, the performance will be better than previous transactions in the first quarter because we have seen the quality of our new customers improve. As for your first question, the delinquency rate also refers to existing loans on book, and we have seen that it has decreased in April and May. If you check the new transactions, it decreased to 3%. Regarding the recovery or collection rate, apart from regions like Shanghai, Beijing, and Wuhan, for other regions, the recovery rate is better than in April. We foresee that overall performance or recovery rates will improve in the second quarter. Hopefully, this clarifies your question.

Wu Haisheng, CEO

For the new customers we acquired in the first quarter, if we only consider the short-term return, yes, compared to the previous user base, they are relatively lower. However, we place more value on the whole lifetime value that this new group of users contributes, which is much better than the previous user group.

Operator, Operator

Alex Xu: Operator, we will probably have time to take one more, if any. Next question is Ethan Wang from CLSA.

Ethan Wang, Analyst

Just a quick follow-up question on take rate, between narrow take rates also affected by funding cost. Just wandering in the cloud environment whether it depends, we have dropped in with some pressure. Just want to see if management can offer more color there. Thank you.

Wu Haisheng, CEO

Yes. Ethan, to answer your question, first, we do notice we have sufficient funding supply this year. We noticed a declining trend in funding costs. However, we do not see a noticeable decline that actually occurred, as in the previous year, we had already reduced a lot of our funding costs. Our focus is more on our tech business; for example, the capital light model, which is less impacted by funding costs.

Alex Xu, CFO

I just wanted to add a quick point here. Basically, what Haisheng means is that as we expand into large national banks—that's actually our focus this year—there will be a modest drop in funding costs but not as significant as we had in the last year or previous couple of years. At present, we are likely among the best funding cost providers among our peers.

Operator, Operator

And this is the end of the Q&A session. Now I hand back to management for closing remarks. Thank you.

Alex Xu, CFO

Okay. Thank you again to everyone who joined our conference call. If you have additional questions, please contact us offline. Thank you.

Operator, Operator

This concludes our conference call. You may disconnect now. Goodbye.