Earnings Call Transcript - QFIN Q4 2022

Operator, Operator

Ladies and gentlemen, thank you for standing by, and welcome to the 360 DigiTech Fourth Quarter and Full-Year 2022 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. Please also note today's event is being recorded. At this time, I'd like to turn the conference call over to Ms. Karen Ji, Senior Director of Capital Markets. Please go ahead, Karen.

Karen Ji, Senior Director of Capital Markets

Thank you, operator. Hello, everyone, and welcome to 360 DigiTech's fourth quarter and full-year 2022 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'd 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'll turn the call over to our CEO, Mr. Wu Haisheng. Please go ahead.

Wu Haisheng, CEO

Hello, everyone. Thanks for joining our Q4 2022 earnings conference call. On the macro environment front, we experienced a volatile quarter in Q4, swinging from widespread restrictions across China in October and November to the border reopening and the cancellation of almost all COVID-19 restrictions in December. This concluded nearly three years of strict COVID control policies in China. Regulatory authorities also announced that the rectification of financial business within the major Internet platform companies has been mostly completed. At a meeting held on February 27, 2023, the China Banking and Insurance Regulatory Commission called for proactive coordination between financial, fiscal, and social policies to provide greater support for the growth of private consumption and domestic demand in China. The financial market department of the People's Bank of China also pledged to facilitate the healthy development of the platform economy in three ways, including speeding up the rectification of the remaining minor issues with some Internet platform companies, improving standards for regular supervision, and developing financial measures to support the sustainable healthy development of the firm economy. Our industry is therefore headed in a more positive direction. As of the end of Q4, we have partnered with a total of 143 financial institutions for our loan facilitation business. Total loan origination and facilitation volume was RMB104.6 billion, up 8% year-over-year. As of the end of Q4, the cumulative number of users with approved credit lines reached approximately 44.5 million, and cumulative borrowers with successful drawdowns reached approximately 27 million, up by 16% and 11% year-over-year, respectively. In the last Q4, China implemented its most extensive COVID control measures since 2020. While in December, the government adjusted its COVID policies, and a massive wave of infections subsequently occurred across China. Given the uncertainties posed by both the COVID and the initial period of reopening, we tightened our customer acquisition and credit assessment policies in Q4. These, together with the optimization of our user base, have helped improve our day-one delinquency rate from 4.5% in Q3 to 4.3% in Q4, the lowest level since 2018. Despite the volatility in our 30-day collection rate due to COVID resurgence, our overall risk performance remained stable. With our user base upgraded, our pricing also stabilized. The average IRR of the loans originated and facilitated during this quarter was flat sequentially. We scaled back our marketing efforts, given our concerns about the credit risk associated with the COVID. Meanwhile, we continue to upgrade our ICE model and improved our capabilities and efficiencies to acquire targeted users. In Q4, the acquisition cost per new user with credit lines decreased by approximately 24% sequentially. We further expanded and diversified our customer acquisition channels by working with different types of traffic platforms, including short- and long-form video, social media, search engines, and food delivery platforms. In terms of cooperation with financial institutions, liquidity remained ample in the financial systems during Q4, leading to strong demands for high-quality assets by financial institutions and a further reduction in our funding cost. As of the end of Q4, we had established long-term partnerships with 143 financial institutions, including over 10 joint-stock banks and major urban and rural commercial banks with more than RMB1 trillion, allowing us diversified funding sources. Our funding cost decreased by roughly 20 basis points sequentially. For ABS issuance, we issued RMB1.8 billion in Q4 at an average funding cost of 5.4%. There was some unusual level of volatility in the bond market in the quarter. Whereas some industry peers canceled ABS issuance on a large scale, we continued to issue at a relatively stable price. We also made steady progress on the credit agency reform, namely Duanzhilian in Q4. As of December 31, 2022, we had substantially completed the system integration with our financial institution partners under Duanzhilian in accordance with our plan submitted to the regulator to ensure our practice complies with the new rules. Our loan facilitation process with these partners remained stable in terms of both credit approval rate and key risk metrics. Given the macro challenges and COVID countermeasures, China's consumer finance and SME credit markets face headwinds on both the demand and risk grounds in 2022. Against this backdrop, we stick to our prudent operating strategy and leverage technology to drive quality growth. In 2022, total loan origination and facilitation volume was RMB412.4 billion, up 15.5% year-over-year and in line with our guidance at the beginning of the year. We made solid progress in optimizing our user base, allowing us to weather the macro headwinds and stabilize our asset quality. Our day-one delinquency rate decreased by more than 1 percentage point to 4.3% in Q4 from 5.4% in the same period last year, highlighting the resilience of our business. In light of the volatile macro environment, we kept the percentage of loans originated and facilitated under our capitalized model, ICE and other tech solutions relatively stable at roughly 56% in 2022. These business models have provided us with more flexibility to balance risks. We also maintained disciplined cost control and optimized our operational efficiency during the year. As such, we achieved our targeted net take rate for our baseline business despite the decline in loan pricing. We remain committed to fulfilling our social responsibilities as we operate our business. In 2022, we served a total of 910,000 self-employed individuals and 1.08 million business owners, supporting about 6 million jobs. Given the gradual resumption of economic activity since the start of 2023, we have seen a modest recovery in credit and a notable improvement in our asset quality. Our day-one delinquency rate in February decreased further to 4.1%, while the 30-day collection rate quickly recovered to last Q3 level, showing a faster-than-expected improvement in our risk performance. Now let me share with you our outlook for 2023. First of all, the continued reduction in our credit costs and funding costs has created favorable conditions for us to better serve our users. We have approximately 44.5 million cumulative users with approved credit lines. How to effectively convert them into borrowers and increase the credit utilization of our existing borrowers will be crucial to driving our overall growth. To enhance our engagement with inactive users, we will step up our marketing and outreach efforts while optimizing our product mix and risk control strategies. We will also seek to improve our user retention rate for existing borrowers by refining our operations to offer them products and user experiences that better serve their needs. We will continue to diversify our customer acquisition channels. We have already established a clear competitive edge in the customer segment with borrowing costs from 18% to 24%. Meanwhile, there are many traffic platforms that have large diverse user bases but lack the expertise to engage with users in our target segments. As we adjust our overall loan pricing to below 24%, our embedded finance business will be able to cover more leading traffic platforms. We expect more strategic partnerships to be launched later this year. We will explore market opportunities to serve a broadly defined SME segments including SMEs, SME owners, entrepreneurs, and self-employed individuals. Public data shows consumer demand in certain sectors has recovered quickly since the Chinese New Year. The recovery in private consumption will improve the credit demand and the repayment ability of the broadly defined SME segment. To capitalize on these opportunities, we will develop targeted products to better serve their credit needs. Approximately, 30% of our current user base are broadly defined SMEs whose outstanding loan balance only accounts for roughly a little bit higher than 30% of the total. This leaves substantial room for growth. In terms of the tax solution business, we operate this in our financial institution through our end-to-end technology solution. This will enable us to generate more risk-free revenue, serve a greater number of high-quality users with lower pricing through our bank partners, and expand our total addressable markets. This year, we will focus on extending the depth of our tech solution services to improve our take rate. With these services in place, we believe that our tax solution business will see growth in loan volume and revenue. Finally, I would like to conclude my prepared remarks with a small thought. Our company is very young, having only been around for over six years. The sector that we are in is also at the very early stage of its lifecycle. Our team is young and motivated, and our initial entrepreneurial dream has just begun to materialize. We strive to deliver far more brilliant results than what we have achieved today. We believe that 2023 will be a good year for us, thanks to the supportive government policies and the recovering macro economy combined with our strong strategies and unique positioning. Although the macroeconomic rebound has not been very robust so far in the first quarter, we have great confidence that 2023 will be a year of growth. As we continue to improve our risk performance, expand our customer acquisition channels, optimize our funding costs, and improve our services to broadly defined SMEs, we expect fruitful years ahead. 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 and the full year.

Alex Xu, CFO

Thank you, Haisheng. Good morning and good evening, everyone. Welcome to our fourth quarter earnings call. As Haisheng discussed earlier, we delivered another strong quarter in the very challenging macro environment. COVID outbreaks and the restrictions created additional headwinds for our operations during the quarter, particularly in December. However, since the reopening in early January, we have experienced some modest pickup in demand for consumer credit, with asset quality noticeably improving. In Q4, we continued to target a higher quality and lower risk user base and drive further improvement in user quality despite significant macro uncertainties. Key leading indicators, day-one delinquency, have been on a steady declining trend throughout 2022. It was 4.3% in Q4 versus 4.5% and further declined to approximately 4.1% in February. To this day, the declining trend continued. The continued improvement in day-one delinquency reflects the user base upgrade and macro improvement in the new year. The 30-day collection rate was 84.7% in Q4 versus 86.4% in Q3. This deterioration of our collection operations was due to the decline in consumer confidence following the timing of COVID restrictions in November and the surge in COVID cases in December. As the COVID cases peaked in late December and the reopening progressed, by early February, the 30-day collection rate has quickly recovered to above the Q3 level. Total net revenue for Q4 was $3.9 billion versus $4.1 billion in Q3 and $4.4 billion a year ago. Revenue from credit-driven service capital heavy was RMB2.8 billion in Q4 compared to RMB2.9 billion in Q3 and RMB2.7 billion a year ago. The slight year-on-year growth was mainly due to growth in on-balance sheet loan volume as we achieved better utilization of our micro-lending license. This solid performance was more than enough to offset the decline in average pricing of the loan and the decrease in off-balance sheet facilitation volume. Off-balance sheet facilitation revenue take rate declined sequentially due to an adjustment in early repayment. On a year-on-year basis, the take rate declined slightly despite significant price cuts. Revenue from platform service capital light was RMB1.1 billion in Q4 compared to RMB1.2 billion in Q3 and RMB1.7 billion a year ago. The year-on-year decline was mainly due to a decrease in volume and average prices of capital light loan facilitation. Q4 and full-year 2022 capital light loan facilitation, ICE, and other technology solutions combined account for roughly 56% of total loan volume. As macro conditions gradually improved in 2023, we will try to strike an optimal balance between risks, growth, and profitability. As such, the contribution from capital light, ICE, and other technology solutions will likely remain range-bound in the near term. In the long run, we will continue to pursue a tech-driven business model while seeking a balance among various forms of non-risk-bearing solutions based on the macro environment and operational conditions. During the quarter, average IRR pricing of the loans we originated and/or facilitated remained stable quarter-over-quarter, well within the regulatory rate cap requirements. Looking forward, we expect pricing to be relatively stable for the coming quarters. Sales and marketing expenses decreased by approximately 34% sequentially in Q4. During the quarter, we lowered the pace of new user acquisition as we focus more on existing users' engagement given the extremely challenging macro conditions. We added approximately 1.5 million new credit line users in Q4 compared to approximately 1.7 million in Q3. The unit cost to acquire a new credit line user declined approximately 24% sequentially. The decline in customer acquisition costs mainly reflects our continued effort to drive efficiency in our operations as well as the soft demand in muted economic activities. As macro conditions gradually improve in 2023, we may also adjust the pace of new user acquisition along the way. Meanwhile, re-energizing the existing user base will continue to be a main driver for our growth. 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. Overall, the risk profile of our loan portfolio remains stable in Q4, as increased contributions from new loans from high-quality borrowers offsetting negative impacts on old loans by macro uncertainties. Although macro conditions appear to be gradually improving, it may still take some time to reflect in consumer behavior. As such, we continue to take a prudent approach in booking provisions against potential credit loss. Total new provisions for risk-bearing loans in Q4 were approximately RMB1.7 billion, and the write-backs of previous provisions in the quarter were marginal. The provision coverage ratio, which is defined as total outstanding provisions divided by total outstanding delinquent loan balance, was 456% in Q4 compared to 406% in Q3. With solid operating loss and stable contributions from capital light models, our leverage ratio, which is defined as risk-bearing loan balance divided by shareholders' equity, was at a historical low of 3.5x in Q4 compared to 4.3x a year ago. We expect to see a rather stable leverage ratio for the time being until capitalized contributions resume growth in the future. We generated approximately RMB1.8 billion cash from operations in Q4 compared to RMB1.6 billion in Q3. The sequential increase in operating cash flow was mainly driven by better working capital management. Total cash and cash equivalents were RMB10.9 billion in Q4, essentially flat quarter-over-quarter. Non-restricted cash was approximately RMB7.2 billion in Q4, also flat sequentially. In the last few quarters, we took a more conservative approach to deploy our cash in day-to-day business, mainly due to macro uncertainties. As economic conditions improve, we may look for opportunities to deploy resources to launch new initiatives, develop new technology, and expand service offerings. Non-GAAP net profit was RMB919 million; net income for 2022 was RMB4.21 billion. 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 accordance with the dividend policy approved by our Board, we declared another quarterly dividend of US$0.16 per ADS for Q4. Finally, regarding our outlook for 2023. 2022 was an extremely challenging year in terms of macro conditions where we start to see tentative signs of economic recovery in the new year, the lingering economic impact from the past on consumer confidence and behavior may still last for a little bit. At this junction, we see modest recovery in consumer credit demand with growth potentially accelerating throughout this year. As such, we expect total loan volume for 2023 to be between RMB455 billion and RMB495 billion, representing year-on-year growth of 10% to 20%. As always, risk forecasts reflect 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

First question comes from the line of Judy Zhang from Citi. Please go ahead.

Judy Zhang, Analyst

I will translate my question. So thank you management for giving me the first opportunity. I'd like to ask a question, first place. And my questions are regarding the credit demand. How significant is the credit demand recovering? Do you see things reopening? And what's the main reason for not seeing a strong recovery? And also we saw the management give a relatively conservative loan origination growth guidance for this year, which is like 10% to 20% year-on-year growth, which is just below the loan volume growth guidance of last year, which was 15% to 25% year-on-year growth. What's the key reason behind? Thank you.

Wu Haisheng, CEO

Karen Ji, Senior Director of Capital Markets

Thanks, Judy. In terms of the credit recovery, actually, we have seen some surge of consumer behavior recovery right after the reopening. And we also see a modest recovery in credit. But if we look at different sectors, we have seen some sectors leading the recovery, for example, the restaurant and tourism sectors. But some of the industries are lagging behind. So we believe it takes some time for the outlook for employment and personal income to eventually benefit from the recovery of consumption and boost the credit demand recovery. So it's not currently the time for the credit demand to recover immediately. Although the recovery in credit needs is not so robust in Q1, we believe that Q2 and Q3 will be better.

Wu Haisheng, CEO

Karen Ji, Senior Director of Capital Markets

In terms of our guidance, actually we are a company sticking to our promise. We won't allow the situation where we cannot deliver our promise. Even in the extreme situation last year, we still stuck to our initial guidance at the beginning of the year, and actually we delivered that. So in terms of the guidance for this year, we think it's within market expectation, and we tend to take a prudent view for the pace of our loan volume growth this year. We believe if the market situation improves further later this year, we will also adjust our growth pace. We believe this year will be good for us. Hope this answers your questions, Judy.

Operator, Operator

Thank you for the questions. Next question, we have the line from Yada Li from CICC. Please proceed.

Yada Li, Analyst

Then I will do the translation. Hello, management. This is Yada from CICC and thanks for taking my questions. During the COVID pandemic, we noticed that you paid more attention to the operation of the existing users in terms of the customer acquisition side, and therefore the new loan sales were partly from the premium existing users. I was wondering if the marketing budget will increase in 2023 and 2024? What kind of customer acquisition strategy will you adopt in the future? And what are the main factors that determine whether to increase the marketing budget? That’s all. Thank you.

Wu Haisheng, CEO

Karen Ji, Senior Director of Capital Markets

Thanks, Yada, for your question. I want to highlight the major growth driver for our business. Actually, we have over 40 million users with approved credit lines and over 20 million borrowers. So you can see that we have over 20 million users who have never borrowed money from us. In terms of new customers, we actually acquire 3 million to 4 million new customers each year. So it's very crucial for us to spend more time and make more efforts in engaging our existing users. We believe this will be a major driver for the growth of our business in the future.

Wu Haisheng, CEO

Karen Ji, Senior Director of Capital Markets

From a marketing budget perspective, we actually allocate budget to existing users and new users. For existing users, we will spend money to reach out to them and use some offers to incentivize them, using some better offers to call them back and improve user experience for those broadly defined SME borrowers to keep them active on our platform. So we will keep our budget for the engagement of all existing users.

Wu Haisheng, CEO

Karen Ji, Senior Director of Capital Markets

For the new users, we will expand our network to cooperate with more platforms in terms of the embedded finance business model, because our pricing is already below 24%. This brings us opportunities to connect with more quality platforms to serve a larger customer base. In terms of marketing spending, considering the recovery of credit needs and user activity, we will first prioritize our work to increase credit utilization for those new users and then we will consider expanding our marketing to acquire new users. Hope this clarifies your question.

Operator, Operator

Thank you for the questions. Next question comes from the line of Thomas Chong from Jefferies. Please go ahead.

Thomas Chong, Analyst

Thanks management for taking my questions. My question is about competition. Going into the future, in terms of the pricing side, how should we think about the competition with friends or social media? Thank you.

Wu Haisheng, CEO

Karen Ji, Senior Director of Capital Markets

First of all, we think we are quite differentiated from the traditional banks and large Internet platforms in terms of pricing. We actually enjoy a competitive edge in serving the pricing segment between 18% to 24%. So we don't believe that we will have head-to-head competition with those large platforms or traditional banks. On the contrary, we think we can provide additional value to them by cooperating with those platforms.

Wu Haisheng, CEO

Karen Ji, Senior Director of Capital Markets

Because of these differentiation points, we realized that a lot of Internet giants' platforms want to expand their outreach to different types of customers. Our core competencies can help them expand their customer base and increase their credit product offerings, thus enhancing their loan volume to their users. We believe this is the additional value we can provide to those platforms. Yes. I hope this answers your question, Thomas.

Operator, Operator

Thank you for the questions. Next question comes from the line of Hans Fan from CLSA. Please go ahead.

Hans Fan, Analyst

So this is Hans Fan from CLSA. I got a question related to the loan outlook because the management was mentioning that this year is going to be a better part in the second half. I was wondering about the lending pace across different quarters. And also in terms of the split between capital heavy and platform services, how do we think about the split this year? Do we have a target for the split in the longer run? Thank you very much.

Wu Haisheng, CEO

Karen Ji, Senior Director of Capital Markets

In terms of the quarterly pace, we expect it will ramp up throughout the year, which means the loan volume will grow quarter-by-quarter because we believe the credit needs will benefit from the recovery of consumer behavior. So the loan volume in the second half of this year will be increasing compared to the first half.

Wu Haisheng, CEO

Karen Ji, Senior Director of Capital Markets

Okay. In terms of the contributions from our asset-light or platform service business model. First, we believe this is our long-term strategy to develop our platform service business model, because we always position ourselves as a fintech company. In the long run, we believe the loan volume contribution from the capital light will further increase. However, if we look at the short-term, we will adjust the loan volume contribution from the asset light business model based on our assessments of the macro environment and credit risk associated with it. We want to achieve a healthy profitability for our business. We expect the overall contribution from the capital light business to remain stable this year. But in the next step, we will better develop our tech solution business because it’s a pure tech business model. As our customer base grows, our loan volume will also increase, and we expect the contribution from the capital light or platform service to further increase in the future.

Alex Xu, CFO

Hans, I just want to add a couple of points regarding the growth rate for this year. We noticed that in the recent few days, some of the companies related to the consumer market reported their earnings. They gave a somewhat disappointing outlook for the first quarter in terms of year-over-year growth. Although last year Q1 was a relatively normal quarter, meaning there wasn't really much disruption in operations in last year's Q1, the comparison is not that easy. However, even with that kind of not so easy comparison, we are expecting year-over-year growth in terms of volume this year. As we move forward for the remainder of the year, as Haisheng mentioned, we may see gradual acceleration of growth quarter-by-quarter on a year-over-year basis. That's a point I'd like to add. Thank you.

Hans Fan, Analyst

Got it. Thank you.

Operator, Operator

Thank you for the questions. In the interest of time, we'll now take the last question. Lastly, we have the line from Alex Ye from UBS. Please go ahead.

Alex Ye, Analyst

I'll translate my question. I have two follow-ups on your loan guidance for this year. If we look at the midpoint of your guidance of 15%, can we ask what are the underlying assumptions here? For example, would you still frame the consumer credit recovery as modest? And do you need to increase your risk appetite in order to achieve this loan target? Secondly, for the higher end of your target at 20%, I'm just wondering what things or data points you need to see to be more comfortable going forward with that higher end and what are the drivers? Thank you.

Wu Haisheng, CEO

Karen Ji, Senior Director of Capital Markets

Okay. I will pass this question to our CRO, Zheng Yan.

Zheng Yan, CRO

From a risk appetite perspective, we will take a prudent credit assessment approach this year, so we can see further improvement in our risk performance in 2023. For example, our day-one delinquency rate in February has come down to 4.1%. The 30-day collection rate also recovered to the highest level of last year in February, and we believe that in March, those two indicators will further improve. So this year, overall risk performance will be better than last year. Our guidance is based on the assumption that the recovery of the macro environment will improve the outlook for employment and personal income and eventually benefit the recovery of credit needs. At the same time, we believe there is an assumption that our risk performance will continue to improve down the road. If things get better, then all the recovery of credit needs and the risk performance accelerates this year, we will also consider adjusting our growth pace. This is our answer.

Operator, Operator

Thank you very much. With that, I'd like to hand the call back to management for closing.

Alex Xu, CFO

Okay. Thank you, again, everyone for joining us for the meeting. If you have additional questions, please feel free to contact us offline. Thank you. Bye-bye.

Operator, Operator

That does conclude today's conference call. Thank you for your participation. You may now disconnect your lines.