Earnings Call Transcript - QFIN Q3 2022

Mandy Dong, IR Director

Thank you. Hello, everyone, and welcome to our third 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. 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 figures. 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 am very happy to report another strong quarter. First of all, let me share some recent developments in the market environment. China’s consumer finance industry has moved from rapid expansion to quality growth in the past two years. The industry has achieved substantial advancements in preventing systemic risks, protecting consumer rights and benefits, driving compliant business operations, and promoting competition. This has created a healthy ecosystem for the development of the consumer finance market. Over the past two years, the industry regulatory framework has gradually come into shape and the rectification project of the platform economy continued to progress. Currently, the regulatory landscape has settled down as presented in an article titled 'Presenting and Improving Modern Financial Supervision' published in the guidebook of the 20th National Congress of the Communist Party of China. Mr. Guo Shuqing, the Chairman of CBIRC, stated that financial innovation must be conducted under the premise of prudent supervision. We shall impose normalized supervision on the financial business of internet platform companies to promote the healthy and sustainable development of the platform economy. This implies that the Fintech industry is entering a state of regular supervision. Since the beginning of 2022, the macro economy and overall income have put pressure on China’s consumer market in terms of market demand and asset quality. However, the market started to slowly improve in Q3 as we saw credit demand begin to gradually recover and asset quality became relatively more stable than in Q2. Meanwhile, financial institutions have a demand for high-quality assets, injecting liquidity into the industry and boosting funding supply efficiency. Now moving on to our operations. Given the macro environment's complexity and uncertainties, we maintained a prudent operating strategy and leveraged technology to drive quality growth. Thanks to our practical, prudent, and risk management-first operating philosophy, our business demonstrated resilience and strength in several key areas, despite the macro headwinds. First, we achieved solid progress in balancing growth with asset quality. In Q3, total origination and facilitation volume was RMB110.7 billion, up 13% year-on-year and quarter-on-quarter. The outstanding loan balance was RMB160 billion, up year-on-year and 6% quarter-on-quarter. As a leading brand for Credit-Tech service in China, our 360 Jietiao brand became more well-known. As of the end of Q3, the cumulative number of registered users exceeded 200 million for the first time. The cumulative number of users receiving credit lines and conducting drawdowns on credit was approximately 43 million and 26.3 million, respectively, up by 17.6% and 12.8% year-on-year. Since Q3 of 2021, we have proactively reduced pricing and optimized user structure in response to market and regulatory changes. The decent progress in these areas has helped mitigate the negative impact of the macro environment. As our existing loans gradually reach maturity, our average price decreased slightly from Q2. Our asset quality significantly improved. The day-one delinquency rate went down to 4.5% in Q3, from 4.9% in Q2, and continues to improve. The M1 collection rate increased to 86.4% in Q3 from 85.2% in Q2. While updating our customer base, we continue to optimize our operations for high-quality users to increase their lifetime value based on our experience. High-quality users are usually more stable in credit demand and repayment capability; hence they generate considerable long-term value for our business. In terms of key operating metrics, the average loan value per user and average ticket per drawdown in Q3 were more than RMB14,000 and RMB8,000 respectively, with a 39.8% year-on-year increase. The average loan tenure also increased to 12 months in Q3, roughly one month longer than the same period last year. We believe that an upgraded customer base will translate into enhanced operating efficiency and more stable business performance in the long run. On the customer front, as we upgraded our customer mix and accumulated better know-how about our high-quality users, we will optimize the structure of our customer acquisition channels. This greatly improved our capability and efficiency in acquiring target users in Q3. The number of new users granted credit lines increased to 1.71 million, up by 19% quarter-on-quarter, while our marketing expenses remained almost flat compared to Q2. The acquisition cost per user with a granted credit line declined by 15% from Q2. Meanwhile, we further expanded and diversified the customer acquisition channels by working with different traffic platforms, including short and long videos, social media, search engines, and food delivery, etc. In addition, we improved our ability to identify users, especially high-quality users, and enhanced the efficiency of user acquisition by upgrading our RTA models and jointly developing models with past ones. For instance, empowered by our upgraded RTA models, our ability to identify devices improved to 90% in Q3 and our ability to identify high-quality users improved by more than 20% quarter-on-quarter. This greatly magnified the effectiveness of our online advertising. We also applied such capabilities to other channels, such as app stores, which will further improve our efficiency in these channels as well. As we continue to advance our tech-upgrading strategy, our capital-light and other solution businesses accounted for a larger portion in Q3. We are a tech-driven company empowered by innovation with cybersecurity in our DNA and strong capability in big data intelligence. We help financial institutions establish their credit infrastructure and empower them in the full business operation flow with our big data analytics and tech solutions. In Q3, loans originated and facilitated under the capital-light model and other tech solutions accounted for 58.4% of the total loan volume, up by 2.6 percentage points. At the end of Q3, we had partnered with 58 financial institutions under the capital-light model. We also refined and upgraded our fintech SaaS product line. We transformed our end-to-end credit system based on functionality. Additionally, we innovatively support a hybrid cloud model where financial health services and local deployments work side-by-side, featuring set-up of retail credit infrastructure in 20 days, both online and offline, and system deployment in full compliance. Our new solutions offer more one-stop solutions to medium-sized enterprises, helping them transform and grow their retail credit business. Going forward, as we facilitate more transactions for our platform with stable asset quality and a good track record, we will expand our collaboration with financial institutions in depth and breadth. This will further boost the percentage of our capital-light and tech solution businesses in the total mix in the long run. Thirdly, our funding structure and funding costs both improved significantly with ample liquidity in China's financial system this year. Financial institutions have a strong demand for high-quality assets. As a leading credit-tech service provider, our assets are in high demand given our strengths in scale, data, and risk management. These allow us to optimize the mix of our funding partners, obtain more flexible funding options, and reduce funding costs. As of the end of Q3, we partnered with 141 financial institutions, including more than 10 joint stock banks and major rural and urban commercial banks with over RMB1 trillion AUM, giving us a highly diversified funding source. Our funding cost for value-driven loans decreased by roughly 30 basis points sequentially to 6.5%, and we expect it to sustain at a low level in Q4. We issued RMB2.7 billion of ABS in Q3 at an average funding cost of 5.0%. As we continue to optimize our customer mix, our funding advantages will become more pronounced. Fourthly, on the regulatory front, the rectification project of the platform economy has entered the ending phase. We maintained close communication with the regulators as we implemented our registration plan. At the end of Q3, we completed most of the required rectification items and received positive feedback from regulators. Regarding the credit agency report, or 'Xinyong' in Chinese, we are implementing the transformation plan together with the credit agency and our founding partners. In Q3, we facilitated the very first loan in the new credit rating system and received recognition from the regulator. We are now proactively implementing this plan. Let me also provide an update on our secondary listing in the Hong Kong Stock Market. This morning, we submitted the posted hearing information path, PHIT in short, to the Hong Kong Stock Exchange. We have taken the interests of our current shareholders into full consideration in pursuing this listing. We believe that we will be able to optimize our investor structure and boost liquidity through the Hong Kong secondary listing. While enhancing our operations, we always keep in mind our social responsibility. Our mission is to enable opportunities for people by providing safe, convenient, and inclusive Fintech services for consumers and households through technology innovation. By improving financial institutions, we have built tech solutions powered by our AI and cloud computing. We strive to improve the quality and efficiency of financial services. We stand by consumers whose needs are often unmet. While maintaining the high standards of risk management, we aim to make financial services accessible to all in a more efficient manner and to better serve the real economy. We are mindful of our social responsibility by giving back to society and providing support to the disadvantaged. As part of our efforts to drive rural revitalization and promote common prosperity in China, in September this year, we donated RMB1 million for building a model for rural revitalization. Looking back at the past three quarters, we navigated through a constantly changing market by careful planning and a prudent operating strategy, despite multiple headwinds in the macro environment. We achieved solid growth and improved our risk performance, demonstrating the strong resilience of our business. Key messages show that our business is on track, and we are confident we have met our guidance for 2022. Going forward, despite ongoing challenges, our mission remains unchanged. That is promoting financial inclusiveness through technology to better support the real economy and create more value for society. There is still tremendous unmet demand for credit from both consumers and financial institutions. We believe that based on our prudent approach to operations and risk management, our business can navigate the current business cycle and capitalize on the growing momentum as the market recovers. Only under a prudent strategy can we manage fluctuations and achieve steady and sustainable long-term growth. Moving ahead, we will continue to generate value for our shareholders through our solid performance.

Alex Xu, CFO

Thank you, Haisheng. Good morning and good evening everyone. Welcome to our third quarter earnings call. Before I start my regular update, let me first introduce a new member of our capital market team, Ms. Unspecified Name, who recently joined us as a Senior Director of Capital Market. She will provide valuable insights, experience, and leadership to our capital market and IR team. With our upcoming listing in the Hong Kong Stock Exchange, we look forward to having her and other team members offer better services to our shareholders and broader investment community. As Haisheng discussed earlier, we delivered another solid quarter in a changing macro environment. From July to September, demand for consumer credits through our platform grew sequentially each month, although the velocity and magnitude of such improvement were modest. During the quarter, we continued to push for steady improvement in overall asset quality by further engaging with a high-quality new borrower base. Overall, the day-one delinquency rate has been on a steady declining trend month after month so far in 2022, coming in at 4.5% for Q3 versus 4.9% in Q2 and further declining to 4.3% in October. The continued improvement in day-one delinquency further validates our strategic focus on the high-quality user segment. The 30-day collection rate also improved in Q3 and reached the best level in 2022. During the quarter, we resumed most standard collection activities to pre-COVID lockdown levels, which drove the improvement of the metrics. Once again, we see clear outperformance by new borrowers versus existing borrowers. Total net revenue for Q3 was 4.1 billion, compared to 4.2 billion in Q2 and 4.6 billion a year ago. Revenue from credit-driven services was 2.9 billion, compared to 2.9 billion in Q2 and 2.6 billion a year ago. The year-on-year growth was primarily due to growth in on-balance sheet loan volume, more than offsetting the negative impact from the decline in average pricing of the loans. Revenue from platform services was 1.2 billion, compared to 1.2 billion in Q2 and 2 billion a year ago. The year-on-year decline was mainly due to product mix change in platform services and decline in average pricing of capital-light loan facilitation. During the quarter, capital-light loan facilitation, ICE, and other technology solutions combined accounted for roughly 58% of total loan volume. Given the still changing microenvironment, we continued to increase the portion of loans processed through ICE and other technology solutions to further mitigate potential risks. These solutions generally have different commercial terms compared to regular capital-light loan facilitation. In the long run, we will continue to pursue a tech-driven business model while striking a balance between various forms of non-risk bearing solutions based on the macro environment and operational conditions. During the quarter, average IRR prices of the loans we originated and/or facilitated declined modestly to just below 22%, well within the 24% rate cap requirement. We expect pricing to remain relatively stable in the coming quarters. Sales and marketing expenses increased by approximately 2% sequentially in Q3. The slower pace of increase reflects our continued effort to improve the efficiency of our user acquisition system and drive cost efficiency. Please note, during the quarter, we added approximately 1.7 million new credit line users, compared to approximately 1.4 million in Q2. The unit cost to acquire a new credit line user declined approximately 15% sequentially. As such, the average cost per dollar amount of new credit lines also declined by a similar magnitude quarter-on-quarter. 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 continues to improve in Q3 due to the contributions from new loans from higher quality users, although impacts from macro uncertainty and the latest outbreak of COVID cases across the nation were still somewhat visible. Although we continue to take a prudent approach in booking provisions against potential credit loss, re-evaluations of previous quarter's provision yielded sizable write-backs as macro conditions improved quarter-on-quarter. Total new provisions across four different categories for loans originated and facilitated during the quarter was approximately 1.8 billion, while approximately 300 million in previous provisions were written back. With strong operating results and increased contributions from the capital-light model, our leverage ratio, defined as risk-bearing loan balance divided by shareholders' equity, was at a historical low of 3.8x in Q3, compared to 4.3x a year ago. We expect to see a rather stable leverage ratio for the time being until capital-light contributions grow beyond certain bounds in the future. We generated approximately 1.6 billion in cash from operations in Q3, compared to 1.1 billion in Q2. The significant sequential increase in operating cash flow was mainly driven by better working capital management. If you recall, last quarter due to some COVID-related administrative procedure delays, we were unable to collect certain receivables on time. Those receivables were eventually settled in Q3, boosting our cash flow. Total cash and cash equivalents was 10.8 billion in Q3, compared to 11.4 billion in Q2. Non-restricted cash was approximately 7.2 billion in Q3 versus 7 billion in Q2. In the last couple of quarters, we took a more conservative approach in deploying our cash in day-to-day business, mainly due to macro uncertainty. Ideally, a significant portion of our cash would normally be allocated to support the security deposit with our institutional partners or to fund balance sheet lending in a normal business growth scenario. Non-GAAP net profit was 1.04 billion, compared to 1.02 billion in Q2. 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 quarterly dividend of US$0.16 per ADS for Q3. Finally, regarding our outlook for the fourth quarter. Although we managed to deliver solid operating and financial results so far this year in a very challenging macro environment, we still want to maintain a prudent approach to plan our business for the near-term, particularly given the recent resurgence of COVID cases nationwide and the subsequent restrictive measures taken by local authorities. At this point, we expect total loan volume for Q4 to be between RMB102.5 billion and RMB112.5 billion, representing year-on-year growth of 6% to 16%. 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 my prepared remarks.

Unidentified Analyst, Analyst

Okay, then. I will do the translation part. So, the first one is about the loan structure of the origination volume, so I noticed that you’ve disclosed origination volume for the risk management task, and I was wondering if you could elaborate more about the growth trend and its contribution out of the total in the future and how we balance the contribution between the capital light and the risk management side when we cooperate with a new financial institution? This is the first one. And the second one is about customer acquisition. I noticed that our cost control of sales and marketing expenses this quarter has been effective and average customer acquisition cost on the new users with credit lines has dropped significantly. Can you provide more color on what has been done differently on the customer acquisition strategy this quarter compared to before and what is the future trend?

Wu Haisheng, CEO

Okay. Let me translate. Tax upgrading has always remained our long-term strategy for our company. In recent years, we gradually advanced to more tax solutions starting from capital light to ICE to models. Recently, we are exploring a hybrid new business model that provides both our leading credit tax system and operational agent service. All of these tax services cater to the customized needs of different financial institutions. This year, we are exploring different models in collaboration with various financial institutions. Going forward, as we serve more financial institution customers and transact more loan volumes under this new model, we can further optimize our products, pursuing higher take rate models and serving more customers. The reason for our customer acquisition effectiveness is that starting from the end of last year, we made significant efforts to upgrade our IT infrastructure for online customer acquisition, which is now starting to bear fruit. Moreover, we also expanded and diversified our customer acquisition channels. For example, we not only upgraded our online advertising channels, but also applied our team model on various channels. We also cooperate with multiple traffic platforms, including app stores, etc. In addition, we pay close attention to market trends. For example, this year, there is a very popular mobile game in China. We closely watched the market to seize the opportunity to acquire our high-quality customers.

Hans Fan, Analyst

So, I have two questions. This is Hans Fan from CLSA. The first one is regarding the Hong Kong Listing plan; congratulations on that because it is the first online ADR of China to go back to Hong Kong for listing. I’m curious about the details regarding the lines and also whether there is a plan for primary listings as well?

Wu Haisheng, CEO

Okay. Sure. So, for the Hong Kong listing timetable, as you know we just released the PHIP this morning, and basically our intention is to follow the normal procedures of the Hong Kong Exchange to push for the final official perspectives release, followed by the marketing roadshow and then the listing. That’s our intention. In terms of exactly how many days or how long it will take, you can refer to some other cases; I believe the normal course in a regular basis is somewhere within a two-week timeframe, so that is roughly the planning. Secondly, it is more about the future primary listings. That certainly is an area or direction we’re looking at seriously. There are certain benefits to becoming a primary listed company in Hong Kong, but firstly, we need to finish this secondary listing, and then when we meet certain criteria, we can apply for dual primary listing. So, it’s kind of a step-by-step process; we are currently focused on completing the first step, and when the conditions are ready, we will pursue the next one. In Q3, we see that overall pricing declined slightly compared to Q2. This is mainly due to our existing loans gradually reaching maturity. Going forward, as we see the loan mix shift from our new customers and stabilize with old customers, we expect pricing to remain stable.

Unidentified Analyst, Analyst

Hi. Thanks to management for taking my questions. I have two questions regarding the results. The first question is about loan pricing; I wanted to know the exact new loan pricing for the loans granted throughout the third quarter this year. And the second question is about loan demand. As Mr. Xu just mentioned, we’re seeing better loan demand in the third quarter compared to the second quarter. In your view, what is the typical profile that is demanding more new loans? Where is this better loan demand coming from, for example, which sectors or segments?

Wu Haisheng, CEO

Yes. The pricing in Q3 is slightly lower than 22%. In terms of the business nature, actual consumer loans are quite adaptive. We see this demand gradually recovering from customers in areas that were previously restricted.

Alex Xu, CFO

Okay. I just want to probably add a little color on that. To your question about the profile, we’re not particularly tracking specific professional categories; that’s not our focus, and also that’s not the kind of data we can provide regarding which segments are showing improvement. However, as Haisheng mentioned, you can imagine that areas that had been locked down, for instance, in Shanghai during March, April, and May, when the lockdowns were lifted, there was a noticeable rebound in demand. That is part of what has driven this recovery in the third quarter.

Unidentified Analyst, Analyst

Okay. Thanks a lot. Understood.

Thomas Chong, Analyst

Thanks management for taking my questions. My first question is about the competitive environment, given that the APR is trending down for a lot of the Fintech companies. I just want to get a sense of how we should think about the landscape in the future. My second question is about the trends in recent quarters. My third question is about Q4 guidance. Given the pandemic situation, I just want to get a sense about the high end and low end of the guidance and under what scenario should we expect to hit the low end, should we expect the pandemic to worsen from the current situation?

Wu Haisheng, CEO

First of all, from the point operator, since the market has seen more competitive compliance deals as of last year. We expect more competition going forward. Secondly, the credit market is a large market with multiple layers; different players tend to overlap across various segments. There are two factors to consider when we assess ticket size. One factor is the macro environment; as we adopt a prudent approach, our risk management strategy won't drive up our ticket sizes. The second point, as we continuously upgrade our customer base this year, we find that good customers can generate more value, create longer lifetime value, and result in larger ticket sizes.

Alex Xu, CFO

Sure. Thomas, I want to add a bit to your last question regarding the Q4 guidance. Essentially, the guidance reflects our view on the current macro conditions. The Chinese market is very dynamic due to changing COVID-related policies and the local authorities' responses to those policies. We have heard mixed messages; some areas are more aggressively reopening, while others still maintain restrictive measures. It’s a shifting dynamic, but based on what we see today, our Q4 guidance appears to be within a comfortable range. If the latter half of this quarter continues to improve, we will likely see better performance, and vice versa.

Thomas Chong, Analyst

Thank you.

Alex Xu, CFO

Thank you.

Mandy Dong, IR Director

Thank you again, everyone, for joining us for this conference call. If you have any additional questions, please feel free to contact us offline. Thank you. Have a good day. Bye-bye.

Operator, Operator

Ladies and gentlemen, this concludes today’s call. You may now disconnect.