Earnings Call Transcript - QFIN Q2 2023

Unidentified Company Representative, Senior Director of Capital Markets

Thank you, operator. Hello, everyone, and welcome to Qifu Technology's second quarter 2023 earnings conference call. Our earnings release was distributed earlier today and is available on our IR website. Joining me today are Mr. Wu Haisheng, our CEO; Mr. Alex Xu, our CFO; and Mr. Zheng Yan, our CRO. Before we start, I would like to refer you to our Safe Harbor statement in the earnings press release, which applies to this call as we will make certain forward-looking statements. Also, this call includes discussions of certain non-GAAP financial measures. Please refer to our earnings release, which contains a reconciliation of the non-GAAP measures to GAAP measures. Also, please note that, unless otherwise stated, all figures mentioned in this call are in RMB terms. Now, I will turn the call over to our CEO, Mr. Wu Haisheng.

Wu Haisheng, CEO

Hello, everyone. Thanks for joining our second quarter earnings conference call. During the quarter, given the softening macroeconomic recovery and a more cautious sentiment among consumer credit users, we remain committed to our prudent operating strategy and pursue meaningful growth, while maintaining stable risk performance. In Q2, total loan facilitation and origination volume on our platform reached RMB 124.2 billion, up 26.4% year-over-year and 13.5% quarter-over-quarter, reflecting an accelerated growth trajectory compared to Q1. By the end of Q2, our platform had empowered a total of 153 financial institutions and cumulatively served more than 47 million users with approved credit lines. Throughout the year, we have made steady progress in advancing our strategic upgrades to further improve profitability, while seeking high-quality growth. This will allow us to increase the margin of safety and strengthen the resilience of our business model against the complex macro environment. In terms of business growth, we have continued to expand and diversify our customer acquisition channels by partnering with multiple leading credit platforms under the embedded finance model; we have effectively expanded our coverage to the targeted users. We have also developed products tailored to different consumer and SME profiles, addressing varied users' needs and providing additional growth engines for our business. In terms of profitability, we have taken further steps to boost operational efficiency, reduce funding costs and improve risk assessment capabilities to optimize asset allocation and improve the overall profitability of our loan portfolio. Now, let me share some of our highlights in the second quarter. First, we continue to expand and diversify our customer acquisition channels, while leveraging innovative approaches to improve marketing efficiency. In July, we entered into partnerships with top-tier credit platforms, including short-form video platforms and payment providers to tap into their massive active user base. Through joint modeling, process innovation and the tailored user identification strategies, we boosted user conversion and enhanced our ability to reach targeted users. With marketing spending largely flat for our Q1, the number of new users making drawdowns increased 16% sequentially. Furthermore, we offered some experimental compelling rates to boost engagements, in a more innovative and effective way, with high-quality users with stable credit needs, stronger intention to borrow and appetite for larger credit lines, which also serves as an effective supplement to our existing user base. Moving forward, we will continue to explore effective ways to acquire and manage users from various segments, and address their diverse needs through product innovations. Second, we improved our user engagement capabilities and achieved a significant boost in user activity. Starting from user needs, we optimized our product, risks and operational strategies throughout the user lifecycle. We also enhanced our ability to identify users by leveraging PBOC credit data as well as data related to the broadly defined SME segments. This enabled us to offer more competitive rates and credit lines, and more flexible repayment methods catering to various users' needs, while ensuring the stability of our risk performance. As a result, we saw a notable improvement in drawdown intention among new and existing users. In addition, through our diverse user outreach and engagement approaches, the first month drawdown ratio of new borrowers increased by approximately 30% from Q1 and the reborrowing rates of existing borrowers, meaning the average percentage of existing borrowers with an outstanding loan balance, that drew down again the following month increased by approximately 8% from Q1. On top of this, we also introduced user loyalty programs and offered a broader range of products and benefits to boost users' engagement. Third, we kept our pricing and risk performance at stable levels, leveraging funding strength to further optimize our economic model. During the quarter, our deepened cooperation with financial institutions contributed to a further reduction in our funding costs that far outpaced the market rate cuts. In addition, through innovative product designs, we secured ABS investments from multiple state-owned banks and major joint-stock banks. We issued roughly RMB 5.3 billion of ABS in the quarter, up 132% quarter-over-quarter, leading to a further reduction in our overall funding costs. As our credit assessment capabilities steadily improve, we are collaborating with a broader spectrum of financial institutions, which will enhance our ability to optimize asset allocation and boost profitability. Fourth, our technology solution business advanced steadily and has begun to take shape. We further optimized our product matrix and the solutions to address the diverse needs of our banking partners. In terms of organizational development, we assembled a sizable team capable of providing professional service to financial institutions. Small and medium-sized banks are particularly keen to push forward their digital transformation with the support of our end-to-end tech solutions. A number of projects are currently in the implementation phase. Looking back at the first half of 2023, despite the softening macroeconomic environment, we balanced the growth and risks through our prudent operational practice and delivered solid results. In the second half, we will further expand our channel presence and product offerings to enhance user stickiness, forge closer partnerships with financial institutions, and optimize our asset allocation to improve our topline and bottom-line performance. Our ongoing efforts to refine and upgrade our business model will enhance the resilience of our company in today's macro landscape. We are confident that our industry position, unique resources, and capabilities will enable us to sustain our leadership position in the credit tech market and deliver even more robust growth in the long term. On June 20th, we announced a share repurchase program, under which we may repurchase up to USD 115 million worth of shares over the next 12 months. Since the announcement, we have been actively executing the program. We have strong confidence in the company's long-term profitability and cash flow performance and remain committed to rewarding and creating value for our shareholders through those shareholder returns initiatives. With that, I will now turn the call over to our CFO, Alex Xu, who will walk you through our financial results for the quarter.

Alex Xu, CFO

Okay. Thank you, Haisheng. Good morning and good evening, everyone. Welcome to our second quarter earnings call. Despite the slower-than-expected market recovery, we continue to see modest improvement in many aspects of our operations throughout the first half of the year. Users' activity levels measured by drawdown ratios continue to improve in recent months, which led to the accelerated loan volume growth in Q2. Although the pace of market recovery is still uncertain, we are proactively taking some actions to optimize our product and service offerings, strengthen relationships with key partners, and ultimately drive long-term sustainable quality growth. In Q2, the quality of our user base remains solid. Key leading risk indicators were relatively stable, near the best level of recent quarters. Day 1 delinquency was 4.2% in Q2 versus record setting 4.1% in Q1. The slight uptick in day 1 delinquency somewhat reflects borrowers' sentiment towards the ongoing macro uncertainties. 30-day collection rate was 87.2% in Q2 versus 86.2% in Q1. This sharp rebound mainly reflects the seasonal factors, as well as some improved collection efficiency. As economic recovery remains uncertain, we may continue to see some fluctuation in these metrics in the near future. Although overall risk level should be relatively stable in our continued effort to proactively mitigate risks. Total net revenue for Q2 was RMB 3.9 billion versus RMB 3.6 billion in Q1 and RMB 4.2 billion a year ago. Revenue from credit-driven service capital-heavy was RMB 2.8 billion in Q2 compared to RMB 2.6 billion in Q1 and RMB 2.9 billion a year ago. The year-on-year decline was mainly due to the overall decline in expected average tenor of new loans, as well as lower average interest rates. The sequential increase reflects growth in loan volume under capital-heavy and relatively stable effective tenors. Early repayment levels were relatively stable in Q2 versus Q1. On-balance sheet loans continued to grow nicely and account for nearly 19% of the total loan volume. We issued a record RMB 5.3 billion ABS, up 143% and 132% year-on-year and sequentially, respectively, which helped us further lower our overall funding cost and drive for better utilization of our microlending licenses. Revenue from platform service capital-light was RMB 1.13 billion in Q2 compared to RMB 969 million in Q1 and RMB 1.24 billion a year ago. The year-on-year decline was mainly due to overall decline in expected average tenor of the loans and also the modest decline in average pricing. For Q2, capital-light loan facilitation, ICE and other technology solutions combined account for roughly 58% of the total loan volume, compared to roughly 56% in the prior quarter. We expect this ratio to be gradually trending down for the remainder of the year to a normalized level. Also, we are evaluating different components of our operations and seeking a better mix between risk-bearing and non-risk-bearing solutions based on macro environment and operational conditions. During the quarter, average IRR of the loans we originated and/or facilitated remained stable quarter-on-quarter, well within the regulatory rate cap requirement. Looking forward, we expect pricing to remain relatively stable for the coming quarters. Sales and marketing expense increased slightly quarter-on-quarter as we remained prudent and continued to diversify user acquisition channels. We added approximately 1.5 million new credit line users in Q2, roughly flat versus the first quarter. Unit costs to acquire a new credit user also increased marginally quarter-on-quarter at approximately RMB 296. While we will continue to drive for efficiency in our operations, we may adjust the pace of our new user acquisition based on macro conditions throughout 2023. Meanwhile, we'll continue to focus on re-energizing our existing user base, as repeat borrowers historically contribute a vast majority of our growth. Although we will continue to take a prudent approach in booking provisions against potential credit losses, we should expect further write-back of the provisions from previous periods, as overall risk profile of our loan portfolios has been stabilizing to improving. Total new provisions for risk-bearing loans in Q2 were approximately RMB 1.9 billion and the write-backs of previous provisions were approximately RMB 525 million. Provision coverage ratio, which is defined as total outstanding provision divided by total outstanding delinquent loan balance between 90 and 180 days, was 511% in Q2 compared to 432% in Q1. With solid operating results and stable contributions from the capital-light model, our leverage ratio, which is defined as risk-bearing loan balance divided by shareholders' equity, was again at historical low of 3.3x in Q2 compared to 4x a year ago. We expect to see leverage ratio fluctuating around this best level in the near future. We generated approximately RMB 1.8 billion cash from operations in Q2, roughly flat quarter-on-quarter. Total cash and cash equivalent was RMB 8.5 billion in Q2 compared to RMB 9 billion in Q1. Non-restricted cash was approximately RMB 5.3 billion in Q2 compared to RMB 5.1 billion in Q1. The sequential decline in cash position was mainly due to the increased cash usage in our balance sheet lending. As we discussed earlier, we're continuing to look for opportunities to deploy resources to large new initiatives, develop new technology, and expand service offerings. Non-GAAP net profit was RMB 1.147 billion in Q2 compared to RMB 976 million in Q1. As we continue to generate healthy cash flow from operations, we believe our current cash position is sufficient to support our business development and to return to our shareholders. In Q1's earnings call, we announced to increase our dividend payout ratio to 20% to 30% and switch to a semi-annual dividend distribution schedule. Today, we're glad to declare a semi-annual dividend of $0.25 per ordinary share or $0.50 per ADS, in U.S. dollars both, which represent approximately 30% of the payout ratio. Also, in June 20, 2023, we announced a share buyback plan to repurchase up to $150 million over a 12-month period. As of August 18, 2023, we have already bought approximately USD 28 million worth of our ADS in the open market at an average price of $18.03. We will continue to execute the buyback program in accordance with the relative rules and regulations. With the full execution of the repurchase program and the dividend plan, we may return more than half of our net profit to our shareholders. Going forward, we will continue to optimize our capital allocation plan and make timely adjustments to generate higher returns to our shareholders. Finally, regarding our outlook, we see accelerated year-on-year growth in loan volume in Q2, driven in part by easy comparison. We do notice continued uncertainty in the macro economy. At this juncture, we still see a slow recovery in consumer credit, with the growth rate somewhat depending on macro conditions for the rest of the year. As such, we would like to adjust our full year total loan volume target for 2023 to between RMB 470 billion and RMB 485 billion, representing a year-on-year growth of 14% to 18%. As always, this forecast reflects the company's current and preliminary view, which is subject to material changes. With that, I would like to conclude our prepared remarks. Operator, we're now open to take some questions.

Operator, Operator

The first question comes from Alex Ye from UBS.

Alex Ye, Analyst

So my question is, there appears to be some dislocation between the strong volume growth and the less strong revenue growth in the past two quarters. So, is it mainly due to the higher repayments issue or is there some product mix change that led to such changes? So, how should we expect the revenue take rate trend going forward?

Alex Xu, CFO

Sure, I’ll address this, Alex. You’re essentially correct. The growth in the loan balance and the slower revenue growth compared to the loan volume growth is primarily due to the shorter duration of loans this year. This is partly a result of the early repayment issue we faced in the first quarter, which significantly affected our revenue at that time. In the second quarter, while early repayments peaked around April and have been gradually improving since then, we are still seeing shorter loan durations compared to historical averages. This shorter duration impacts the accumulation of the loan balance and also slows the revenue growth relative to loan volume. From a product mix perspective, we have not significantly shifted to shorter-duration products; the main factor remains the issues I previously mentioned. Looking ahead, since the second quarter, we have implemented measures to extend the duration of our loans. We have noted gradual improvements from May to July, and we will continue to take steps to manage loan durations in the second half. Consequently, we expect some improvement in the revenue take rate compared to the first half.

Operator, Operator

Next question comes from the line of Frank Zheng from Credit Suisse.

Frank Zheng, Analyst

This is Frank from Credit Suisse. The first question is about the current macro environment and the credit risk performance of the portfolio. Are there any additional provisions we anticipate needing, or is there potential for further write-backs, particularly since the provision coverage ratio has increased to over 500% this quarter? The second question is a follow-up. Can management provide more details on the measures being taken to extend the duration of loans? I'm also curious whether we are favoring longer or shorter durations in the current macro environment.

Alex Xu, CFO

I will address the first part of your question and then let our Chief Risk Officer, Mr. Zheng, handle the second part. Regarding provisions, we have maintained a consistent policy of booking them conservatively to ensure they adequately cover potential risks. Historically, aside from a few exceptional quarters, we've generally seen write-backs from previous provisions. Currently, while our risk profile remains relatively stable with some fluctuations, we expect to see write-backs in the upcoming quarters. The extent of these write-backs will depend on various evaluations and circumstances with all manufacturers. Furthermore, when it comes to booking additional provisions, we will adopt a prudent approach based on our assessment of the macro environment. If we determine it is necessary, we will increase our provisions to mitigate potential risks. Regarding the provision coverage ratio of 511% compared to last quarter's 430%, it's important to note that this is not a target we aim for; rather, it's a calculated figure resulting from the provisions we book relative to that quarter's loan volume and evaluations. Now, I'll pass the second part of your question to Mr. Zheng.

Yan Zheng, CRO

We believe loan duration is a combined result of contractual tenor and early repayment. So first, I will talk about early repayment. Early repayment was steadily declining, mainly due to the macro environment changes, and the second reason is our operational efforts. From a macro perspective, the early repayment sentiment was cooling off. We have observed that the early repayment ratio for our historical loan portfolio has been decreasing for four consecutive months from April to July. From an operational perspective, we have refined our strategy to reduce early repayment in three ways. The first is we applied a new telemarketing rule to incorporate the early repayment ratio into the KPIs of the salespersons, so the salesperson tends to control this ratio. Second, we offer some benefits to retain the users when they have the intention for early repayments. Three, we reduced the seven-day interest-free coupon to avoid those short-term borrowers. Based on those optimizations, we have seen improvement in our early repayment situation. As for contractual tenor, we won't say shorter the better or vice versa. We offer tenor based on the user profile. For example, for those who have stable income and higher creditworthiness, we tend to offer a longer tenor to lower their repayment pressure. But for those who have less long-term visibility, we tend to reduce risk exposure and shorten the tenor to control the risk. So, different user profiles and the ticket sizes will have different impacts on short-term and long-term credit risks. We will further upgrade our self-developed GBST model, the Gradient Survival Tree model, to improve the fitness of long tenor and balance profitability and risks. In conclusion, in the current macro conditions and our proactive management, we expect the early repayment ratio will further decline and our effective loan duration will increase in Q3. Hope this answered your question?

Operator, Operator

We'll move on to the next questions from the line of Emma Xu from Bank of America Securities.

Emma Xu, Analyst

I have two questions. The first is about loan demand in the third quarter. We observed a decline of RMB 42 billion in short-term household consumption loans in July, indicating that the recovery in consumption remains weak. What is your perspective on loan demand? The second question pertains to loan pricing. Will the weak loan demand affect your loan pricing? Additionally, with the LPR being cut twice since June, will you need to reduce your loan pricing as well?

Wu Haisheng, CEO

I will answer your question. We also noticed that the citizens' short-term loan has decreased in July. From our perspective, our loan balance continued to increase in July and August, unlike the declining trend of the citizens' short-term loan balance. From a demand perspective, since the beginning of this year, we have seen some structural changes in terms of users' demand. From user quality perspective, the highest quality users tend to repay the loan earlier, while the lower quality users have relatively stable demand. And from the usage perspective, the broadly defined SME users are more active than the consumer credit users, especially for those in the construction, transportation, tourism, hotel, and catering industries. Plus, our operational efforts, we have gained efficiency improvements in managing the broadly defined SME segment. Given the softer consumer credit demand, we expect to increase our spending on the broadly defined SME users. We will further increase our penetration in the broadly defined customer segments in new user acquisition. And for existing users, we will improve our service quality to enhance user stickiness. In terms of the pricing, we expect the pricing will remain stable in the future. From our past experience, the LPR rises or cuts had very little impact on our pricing. Our pricing is mainly determined by the supply and demand in this market.

Operator, Operator

One moment for the next question. Next question is from the line of Yada Li from CICC.

Yada Li, Analyst

I'll do my translation. This is Yada with CICC and today I just have one quick question. I was wondering could you please elaborate more about the consideration behind the $150 million share repurchase program this time? And should we consider it as a regular way to return value to the shareholders?

Wu Haisheng, CEO

Thank you for the question. Each quarter, we assess our cash position and capital allocation strategy. When we see free cash that is not generating significant returns, we look to put that cash to use, either through dividends or buybacks. This is an ongoing process for future quarters. We aim to find an optimal balance between buybacks and dividends as the best method of returning value to shareholders. Our immediate focus is on completing the $150 million buyback program, and during this process, we will review our strategy to decide on next steps. In the long run, I see a combination of buybacks and dividends as our approach.

Alex Xu, CFO

Okay. Thanks for everyone joining the conference. Since we have our peers right behind us in their earnings call, so to their courtesy, we just conclude our call here. If you have additional questions, please contact us offline. Thank you.

Operator, Operator

Thank you for the questions. In the interest of time, I will now conclude the Q&A session. I would like to hand the call back to management for closing remarks. Thank you. This concludes today's conference call. Thank you for participating. You may now disconnect.