Earnings Call Transcript - QFIN Q4 2021

Operator, Operator

Ladies and gentlemen, thank you for standing by, and welcome to the 360 DigiTech Fourth Quarter and Full Year 2021 Earnings 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 fourth quarter and full year 2021 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 measures. 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 another solid quarter that capped off a strong year. In 2021, total loan facilitation through our platform reached RMB357.1 billion, up 45% year-on-year. This exceeds the midpoint of our full-year guidance. In Q4, total loan facilitation reached RMB96.9 billion, up 40% year-on-year. The outstanding loan balance reached RMB142 billion, up 54% year-on-year. Our business overcame multiple challenges related to macroeconomic uncertainty, the erratic outbreak of COVID, and a fast-changing regulatory environment in a volatile year of 2021. We delivered growth while maintaining stable asset quality, further demonstrating the resilience and flexibility of our business. Now, let me walk you through some updates for Q4. Regulation remains an area of significant attention. The government policy for 2022 is very clear: to achieve economic growth by driving consumption, which suggests further support for the development of consumer finance. We expect policymakers to introduce additional measures to drive consumption and support SMEs as China's State Council has prioritized this policy theme. We also anticipate that local municipalities will work with financial industry reports to support the expansion of the consumer finance industry through a proper loosening of financing restrictions for consumer finance companies. At the central government level, the PBOC has acknowledged the value of fintech and its development plans for 2022 to 2025. There are tremendous opportunities for financial institutions and tech companies to collaborate and contribute to the digital transformation of the financial sector. In Q4, we started implementing rectification measures in accordance with the regulatory requirements. We have enhanced our corporate governance structure and focused on our core business. At our recent briefing, the Chairman of CDIRC stated that the self-check part of the rectification work has been largely completed. The overall progress of rectification has been smooth so far, and we are confident about completing the rectification work based on the regulatory guidelines and our own business needs. We increased the registered capital of our micro-lending subsidiary to RMB5 billion, enhancing our capabilities to serve users and manage risk moving forward. We will continue our strategy on both direct and indirect loan services. On one hand, we offer loans through our micro-lending company directly to target customers and industries. On the other hand, we will work with credit agencies and help financial institutions better serve consumers. We believe that financial regulators will continue to work on implementing the previously released general regulatory principles, such as financial services being undertaken only with the proper financial license. We will focus on executing the rectification plan and regularly monitoring our progress. We are entering the late stage of the manual rectification process and waiting for the review and certification by the regulators. In Q4, we also made progress in several other compliance-related areas. The average API loans facilitated through our platform declined by 2% from previous quarters, effectively lowering the cost for our borrowers. In terms of data-related compliance, we continue to increase our investment in data security and data protection. The China Cybersecurity Technology and Certification Center (CCRC) awarded security certification to our flagship product. The 360 account APP received another national certification for privacy protection. We also obtained the ISO 27701 certification for privacy protection management, issued by SGS, a well-known international certification organization. This is the second important international standard certification in privacy and information protection we received, following the ISO 27001 Information Security Management System a few months ago. In addition, the Cybersecurity Measurement Bureau under the Ministry of Industry and Information Technology (MIIT) issued a written commendation for our excellent performance and special recognition for app users' privacy protection. In Q4, we also achieved excellent results in several operational areas. On the product front, our consumer loan business experienced high-quality growth throughout the year. Our SME loan product, launched last year, grew rapidly and delivered satisfactory results in Q4. The total amount of new approved credit lines for SME loans accelerated and grew by 16% sequentially to RMB9.3 billion as of the end of 2021. The outstanding loan balance of SME loans represented 13% of our total loan book. Meanwhile, we continue to refine our SME products and expand to better quality customer segments by offering larger ticket-size products targeting specific SME groups offline. For example, we collaborated with banks to access corporate credit records, allowing us to offer larger ticket-size credit products and attract more high-quality SME borrowers. Another effective approach is that we offer customized products to retail borrowers in the tobacco and alcohol sectors during Chinese New Year, when their funding needs surge and turnover increases. To capitalize on such opportunities, we simplified approval procedures and increased direct sales for the e-commerce group. In December, credit lines granted to tobacco retail borrowers acquired by our direct sales team accounted for more than 20% of total SME transactions, with the transaction volume increasing by 106% on a monthly basis. Meanwhile, starting this year, to offer differentiated services to SMEs and consumers and improve efficiency, we will serve SME users through an upgraded app separate from 360 DigiTech. In addition, on top of the credit services we currently provide, we will actively explore other services and products to better support SMEs' business operations. In collaboration with financial institutions, we leverage our technological advantages and expand partnerships with stronger financial institutions. This enables us to further optimize our mix of financial institution partners and establish a more balanced and resilient network. Newly added financial institution partners have brought renewed coverage, strong risk management capabilities, and diverse business lines; moreover, our ICE products offer passive add-ons to better meet compliance requirements for some banks. This will enable us to develop standard solutions for collaborating with more banks in the future. Meanwhile, we continue with ABS insurance totaling RMB1.1 billion, achieving a collection rate of 5.7%. This brought our total ABS insurance for the full year to RMB6.5 billion, up by 282% year-on-year. Our overall ABS funding cost for 2021 was 5.47%. As for our customer base, the overall quality of newly acquired customers gradually improved, coupled with lower pricing. The value of these high-quality customers will be released over the lifecycle as prices decline; we noted that some key indicators of user quality improved significantly, such as the ratios of users with multi-platform credit lines, users with mortgage and car loans, users with stable income, and users with tangible assets, based on the A/B testing we conducted. The drawdown ratio and returns from rates are both higher or lower pricing; we expect these customers will generate higher LTV as well. In Q4, we made noticeable progress in enhancing our tech capabilities across multiple platforms, remaining committed to becoming a tech-empowered facilitator serving our financial institution partners and borrowers. We leveraged our AI and big data technology to effectively identify customer risk profiles and match funding needs and resources based on massive data inputs. Firstly, we implemented major upgrades to our AI risk management systems framework, significantly improving our ability to identify users and enlarge our processing capacity. Our average user quality increased by over 20%. Our efficiency in user acquisition also improved by over 20%. The scale of our identifiable user base increased threefold. Secondly, we continue to innovate by deepening the integration of AI applications with our other risk management systems in areas such as community detection, hierarchical federated learning, and risk management strategy automation. This has strengthened our ability to identify potential borrowers and major risks. Thirdly, regarding AI-powered operational technology, our proprietary production diagnostic platform provides one-stop smart diagnostic service, incorporating automated tools to ensure the stability and accessibility of our services. The platform can identify problems within 30 seconds and boost our diagnostic efficiency by 99.0%. Looking ahead to 2022, considering the macro uncertainties, we will continue to adopt a prudent operational strategy, as we have learned from past experiences. We believe that maintaining a prudent and steady approach in daily operations is the golden standard, especially when macro uncertainties arise. After all rectifications undertaken in 2021, we expect to see a much clearer regulatory framework for the entire industry in 2022, allowing industry participants to focus more on long-term business development. We will prioritize our technology-driven strategy and continue to invest in R&D, further pursuing innovative solutions and business models for our B2B business and exploring more diverse products and services for different financial institutions. Meanwhile, we will collaborate with stronger financial institutions to optimize the mix and quality of our partnership network, ultimately boosting the sustainability of our services. For our B2C business, we will continue to upgrade our technology and models to better identify high-quality borrowers and optimize our user base matrix. We will roll out more products catering to these high-quality customers, which will drive higher customer LTV and retention rates. We anticipate very positive changes in our business following the groundwork we laid last year, and we are looking forward to the year ahead. For our balance sheet loan business, we have increased the registered capital of our licensed micro-lending subsidiary to RMB5 billion. This is a crucial strategic resource that we will capitalize on. With these structural upgrades and improvements, I believe we will serve our customers, partners, and society more efficiently in 2022, emerging as a healthier, more resilient, and sustainable company. This will enable us to better serve the real economy and contribute to steady economic growth. Now, I will turn the call over to our CFO, Alex xu, for more financial details.

Alex Xu, CFO

Thank you, Haisheng. Good morning and good evening, everyone. Welcome to our quarterly earnings call. As Haisheng mentioned, despite facing multiple macro challenges, we delivered solid Q4 results in both operations and financial terms, finishing 2021 with a series of record-setting annual numbers on the books. During the quarter, we saw continued healthy consumer demand for credit, while asset quality fluctuated in Q4 mainly as a result of challenges in the environment. We are glad to see improvement in the new year as funding becomes more ample. Net revenue for Q4 was $4.4 billion versus $4.6 billion in Q3 and $3.3 billion a year ago. Revenue from credit-driven service (capital heavy) was $2.71 billion compared to $2.62 billion in Q3 and $2.56 billion a year ago. The year-on-year and sequential increase was primarily due to growth in on-balance sheet loans and the releasing of guaranty liability on previous loan balances, more than offsetting the decline in capital-heavy facilitation volume and revenue take rate. The take rate decline was as expected as the average prices of our loans were lowered by 200 basis points during the quarter. However, the offsetting factors have yet to kick in. Revenue from platform service (capitalized) was $1.71 billion, compared to $1.99 billion in Q3 and $780 million a year ago. The strong year-over-year growth was mainly driven by a significant increase in capitalized loan volume. The sequential decline was due to a decrease in capitalized loan volume along with a modest decline in revenue take rates in Q4. During the quarter, capital-light and other technology solutions contributed roughly 54% of total loan volume. Capital-light loan volume was negatively impacted by seasonal shortages of overall funding supply, as well as 24% rate cap-related tightening from traditional funding sources. At least for the first half of 2022, we expect the capital-light percentage contribution to our total volume to remain fluctuating around current levels as the industry gradually adjusts to the new rate cap. At the core of our long-term growth strategy, we will continue to pursue a tech-driven business model. After this transitional period in 2022, we expect capital-light contributions to become a larger portion of our business in the long run. During the quarter, the average pricing of our loan portfolio dropped by 200 basis points, and by the end of 2021, the average interest rate of loans on our platform were already below 24%. The 200 basis point cut in Q4 was faster than the previous trajectory, and we did it proactively. We believe this will provide us with great flexibility in Q1 and Q2 of 2022 to remain compliant with the regulatory requirements and ultimately hit our retail target by the mid-year deadline. During the quarter, the average customer acquisition cost per user proved credit line was RMB390 compared to RMB305 in Q3. As we elaborated in last quarter's earnings call, we continued to focus on attracting high-quality borrowers, specifically those with larger credit lines and relatively lower risks. The average ticket size of these customers typically ranges between RMB150,000 to RMB200,000 compared to an average of RMB10,000 for our regular borrowers. The unit costs to acquire those high-quality customers are understandably much higher than for regular borrowers. So to compare things apples-to-apples, excluding large ticket-size customers in both consumer and SME markets, the average costs per approved credit line of regular borrowers was approximately RMB246 in Q4 compared to RMB249 in Q3. As we have discussed in the past, average costs per approved credit line is a calculated number with limited value in our internal decision-making process. We will continue to use lifecycle ROI and LTV as key metrics to determine the pace and scope of our customer acquisition strategies. Throughout 2021, we have maintained healthy ROI and LTV trends, which in turn drove stable net take rates. As overall risk metrics fluctuated in Q4, we continued to adopt a prudent approach in booking provisions against potential credit losses. New provisions for contingent liability on loans originated in the quarter were approximately RMB1.6 billion. Meanwhile, approximately RMB400 million of provisions from contingent liability of previous loans were written back as actual performance of those loans was better than expected. The effective tax rate for Q4 was approximately 14.8%, bringing the full year's effective tax rate to approximately 17.3%. Going forward, we expect the effective tax rate to normalize to around 15%, which will be sustainable in the foreseeable future based on the current tax planning schedule. With strong overall operating results and stable contributions from our capitalized model, our leverage ratio, defined as the risk-bearing loan balance divided by shareholders' equity, remains at a historical low of 4.3 times in Q4 compared to 6.6 times a year ago. We expect to see a stable leverage ratio for the time being until capitalized contributions zoom into growth. We generated RMB2 billion in cash from operations in Q4 compared to RMB1.8 billion in Q3 and RMB1.2 billion a year ago. Total cash and cash equivalents were RMB9.6 billion in Q4 compared to RMB7.6 billion in Q3. Non-restricted cash was approximately RMB6.1 billion in Q4 versus RMB4.2 billion in Q3. The meaningful increase in cash was partly due to the timing of the registered capital increase for our micro-lending subsidiary, leading to a large cash balance being held in bank accounts at year-end, as opposed to being deployed in the normal course of business. As always, a significant portion of our cash would normally be allocated to support on-balance-sheet loans and security deposits with our institutional partners. As we continue generating healthy cash flow from operations, we believe our current tax position is sufficient to support business growth, invest in key technologies, satisfy regulatory requirements, and return value to our shareholders. If you'll recall, our Board of Directors approved a quarterly dividend policy in Q3, allowing us to distribute approximately 15% to 20% of quarterly net income after tax in the form of cash dividends on a recurring basis. In accordance with this dividend policy, we declared another quarterly dividend of US$0.26 per ADS for Q4, representing approximately 20% of our Q4 earnings. Finally, let me give you an update on our outlook for 2022. As previously communicated to the market, we believe 2022 will be a transitional year for the industry as participants adjust to new regulatory settings and some macro uncertainties. Therefore, we expect total loan volume for the year to be between RMB410 billion and RMB450 billion, representing year-on-year growth of 15% to 26%. This transitional year presents an opportunity to optimize our operations, strengthen our technology platform, and upgrade our customer base—building an even stronger foundation for future growth. As always, this forecast reflects the company's current and preliminary views, which are 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. For those who can speak Chinese, please kindly ask your question in Chinese first, followed by an English translation. Additionally, in order to have enough time to address everyone on the call, please keep to one question and one follow-up and then return to the queue if you have more questions. Thank you. Our first question is from Yao Lee from CICC. Please go ahead.

Yao Lee, Analyst

Okay. That was a good translation. The first one is, I'd like to know the progress of the pricing adjustments. What's the proportion of loans in 2021 that are priced under 24%? And how much can this proportion reach in the first quarter this year? I am wondering whether pricing going downward has shocked our target customers, and how we are shifting our customer acquisition strategy. Thanks.

Alex Xu, CFO

Sure, thanks, Yao. I will take the first part of the question and then Haisheng will address the second part. So in the first quarter, over 70% of our customers are priced below 24%. And as mentioned in the prepared remarks, by the end of the year, the average price was already below 24%. In this quarter, we expect an even larger portion of customers to be priced below 24%. We are pretty confident that we will reach the targeted rate cut goal by the mid-year deadline. Haisheng?

Wu Haisheng, CEO

Yes. Let me address the question regarding our customer acquisition strategy to access higher-quality customer groups. We will navigate through three approaches. Number one, further invest in R&D to improve our technology, enhancing AI models to better identify customer risk profiles. Secondly, we will adapt our API customer acquisition methods with our capital enhancement studies. We have learned from offline trends, which historically show a much better approach, especially for high-quality customers.

Operator, Operator

Our next question is from Richard Xu from Morgan Stanley.

Richard Xu, Analyst

Basically, my question is on the funding front. There's been an increase in ADS, as well as completion of capital injections into small loan companies. I want to see whether there are credit lines with banks, and whether cooperation with the banks is still expanding. What will be the long-term mix in terms of funding between capital light and capital heavy, and their different funding sources?

Wu Haisheng, CEO

Yes. To answer your question, Richard, you are correct. We will continuously expand our number of financial institution partners by introducing stronger banks. As this proceeds, we can offer larger ticket sizes to better-quality customers. Secondly, regarding capital light volumes, we will explore more diverse products catering to the different needs of financial institutions, including marketing surveys, risk management surveys, and loan collection surveys.

Alex Xu, CFO

I just want to add one point. From a longer-term perspective, the capitalized contribution, as mentioned in the prepared remarks, will be moving higher from the current level. If you recall, in the past, we targeted around two-thirds or 70%. I think from a longer-term perspective, that remains a target. This year, we’ll fluctuate around this current level simply because the industry is adjusting to the new environment. Once we are done with this transition, the trendline will begin to move upward for capital light.

Operator, Operator

Our next question is from Ethan Wang, CLSA.

Ethan Wang, Analyst

Okay. I have two questions. Firstly, just a quick follow-up regarding the funding cost for the fourth quarter and the management's view on funding costs for this year. Secondly, there's market concern on tightening regulations for local financial institutions. For the regional banks we are collaborating with, are they expressing concerns on this front, and does this affect our business? Additionally, for guaranty companies, do we have various institutions across the country set up to cooperate with them for nationwide lending? Thank you.

Alex Xu, CFO

Okay. Thank you, Ethan. I will take the first part again, and then Haisheng will address the second one. For Q4, the funding cost was approximately 7%. Q4 normally presents a tightening period from a money supply perspective in the financial system, reflecting the funding costs. As we transition into this year, we anticipate that overall funding supply will become more sufficient. However, during this transitional period, we expect stable funding costs around 7%, and after we complete this transition phase, we may start to see a gradual but modest decline in funding costs in the long run.

Wu Haisheng, CEO

Yes, to answer your first question, your concern relates to the early requirement regarding online loan businesses for urban commercial banks. This regulation was introduced with a relatively long grace period for market participants. The cutoff date issue was January 1 of this year. Currently, all our financial institution partners are in compliance. Regarding the concerns about regional restrictions for guaranty companies, they can set up local branches nationwide to satisfy these requirements, which is comparatively easier than for banks to cover nationwide.

Ethan Wang, Analyst

Thank you.

Operator, Operator

Our next question is from Thomas Chong from Jefferies.

Thomas Chong, Analyst

Thanks, management, for taking my questions. I have two. My first question is about our SME strategy. Can management comment on how we should view contributions from this sector over the future, as well as the borrowing costs and loan sizes going forward, together with the industry categories we are working with? My second question is more about the macro headwinds we are facing these days, particularly the impact of COVID. Are we seeing any changes in terms of consumer behavior, particularly regarding the use of loans and policies?

Wu Haisheng, CEO

Well, first, regarding your question about the SME business, the average ticket size for SME products overall is about RMB50,000, with some tax laws requiring larger ticket sizes, typically over RMB250,000. For these larger loan amounts, we estimate market expansion at around 2%. Regarding the usage of loans, most of our consumers operate in industries that are less impacted by COVID and the macro economy; their usage of loans remains consistent with previous trends. I want to add more context to our operational strategy for the SME business line; despite the strong demand for borrowers and government support, we are adopting a prudent strategy in this sector. We are focusing on industries less impacted by the macroeconomy, such as manufacturing and retail. This year, we do not expect exponential growth within this business; rather, we will maintain a conservative approach. We also aim to explore more capital light and tech-driven solutions for financial institutions within this SME business.

Thomas Chong, Analyst

Appreciate it.

Operator, Operator

Thank you. This concludes our question-and-answer section. Now I give it back to the management for closing remarks. Thank you.

Mandy Dong, IR Director

Okay. Thank you for participating in the call. If you have any additional questions, please contact us offline and we'll discuss that. Thank you.

Operator, Operator

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