Earnings Call Transcript - QFIN Q2 2022

Operator, Operator

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

Mandy Dong, IR Director

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

Wu Haisheng, CEO

Hello everyone. I am very happy to report another strong quarter. In Q2, total loan origination and the facilitation volume reached RMB98.3 billion, up 11% year-on-year. Outstanding loan balance reached RMB160.5 billion, up 28% year-on-year. Despite the volatile macroenvironment with the Shanghai lockdown and resurgence of COVID in multiple states, we delivered solid performance, which once again demonstrated the resilience of our operations and risk management capabilities facing adversity. On the regulatory front, there are further developments in rectification work of platform economy. The recent regulatory meetings have all sent a clear signal that the reform is reaching an ending phase. Going forward, regulators will emphasize driving healthy and sustainable industry development through normalized supervision. As the regulatory environment gradually stabilizes, we see clearer guidance. On July 28, the Central Political Bureau of the Communist Party of China set up economic priorities for the second half of the year. The policymakers pledged to promote healthy, orderly development of the platform economy, complete the rectification work and conduct regular supervision. At a follow-up meeting by the PBLC on August 01, the Central Bank remarked significant progress of major platform rectification, and it will urge this company to complete the whole rectification project, placing them under regular supervision that is more standardized, transparent, and predictable. As a result, this promotes the growth of the platform economy in job creation and boosting consumption. We have completed most of the rectification work according to the regulatory requirements and are now in the stage of regular data reporting, regarding the credit agency report by Julian. We have already submitted our execution plans to regulators and have since maintained close dialogue with them based on feedback and direction from the regulators. We started to work with other business partners to implement our plan. In July, the CDIRC published a notice on strengthening the management of internet loan business of commercial banks and improving the quality and efficiency of financial services; namely, Circular Number 14. The document is consistent with earlier guidance, including Circular Number 24 in 2021 and Circular Number 9 in 2020, with the grace period extended for one year till June 30, 2023. In addition, the document, once again, acknowledges the collaborative business model between commercial banks and related parties in the internet lending business. We have already implemented the specific requirements outlined in this circular in our daily operations. In Q2, despite multiple headwinds from the macroeconomy and unexpected pandemic resurgence, we remain committed to our strategic set at the beginning of the year. In this extremely volatile market, we successfully executed our operational strategies and made great progress in funding, product risk management, and customer base, as well as technology upgrading. On the funding front, we further optimized our funding structure. During the quarter, we added 10 more joint banks and major urban and rural commercial banks with over RMB1 trillion AUM, which makes our funding supply more abundant. Thanks to improved funding supply and the resumption of issuance of ABS, our funding cost for credit-driven loans decreased by 21 basis points on a shore basis. Since the beginning of Q2, we have issued a total of RMB3.3 billion ABS at an average funding cost of 5%. On the product front, we continued to optimize product portfolios and lowered our average price. This marks our full compliance with 24% regulatory requirements. On the customer acquisition front, we continued to upgrade our user base during the quarter by expanding the coverage of our intelligent market RTA, namely real-time API model. We further increased the number of high-quality users and improved overall user quality. The coverage ratio of our precise targeting increased from 50% in Q1 to almost 100% in Q2. In the online advertising channels, the number of high-quality users with granted credit lines increased by 51% from Q1. Looking across all customer acquisition channels, the credit approval rate of high-quality users increased by roughly 20% on a sequential basis. Meanwhile, we continue to enhance the effectiveness of targeted customer acquisition. On one hand, we continuously upgraded our model for user quality screening. On the other hand, we expanded our media partner network for joint modeling and onboarded new partners, such as Price Deck. For our existing partners, such as Baidu, we continue to upgrade our models. In other areas, we optimized the cost efficiency of user acquisition by upgrading our intelligent marketing platform. We also connected to new user acquisition resources, such as Baidu open screen app and total RTA resources. In Q2, we quickly adjusted our risk strategies in response to the resurgence of the pandemic, including acquiring higher quality customers and gradually cutting off higher risk users. We also completed a major upgrade of our risk models to further leverage user data. As a result, the risk performance of new loan origination was excellent. The first payment day one delinquency rate of new customers dropped to 3.01% in Q2 from 3.56% in Q1, and the first payment delinquency 30 days would then be 0.25% in Q2. In the meantime, the one-day delinquency rate of our current loan book gradually went down to 4.71% in June from 5.11% in March. Such positive trends continued into July with the day one delinquency rate further dropping to 4.64%. The M1 collection rate of the current loan book trended up to 86.9% in June compared to 85.2% in March. Despite the impact of the pandemic, our overall asset quality improved in Q2, especially for new loan origination. This reflected the effectiveness of the adjustments we made and our ability to counter pandemic-related challenges. If macro circumstances stabilize for the rest of the year, we expect our risk management strategy to bring further improvement in asset quality. In terms of our technology upgrading strategy, we maintain that 55.7% of the loans originated and facilitated were under the capital-light model and other tech solutions in Q2. In the long run, we plan to modularize our leading technology into more products and better serve diverse financial institutions. In addition, the China Academy of Information and Communication Technology, namely CAICT, granted us among the first batch of companies under the Business Security Initiative, namely BSI, together with industry leaders including China Mobile and Baidu. This was a strong statement of our capabilities in business security management and technology. In Q2, we navigated through the extreme pandemic situation of city-wide lockdowns and other multiple macro fluctuations with strong operational and financial results. Looking ahead into Q3, we will stay vigilant regarding the macroeconomic environment and the pandemic development. Meanwhile, we are seeing an increasingly stable policy environment and a healthier industry ecosystem. We will maintain a prudent operational strategy, continue to upgrade our technology and customer base, and finish our rectification tasks.

Alex Xu, CFO

Okay. Thank you, everyone. Thank you, Haisheng. Good morning. Welcome to our second quarter earnings call. As Haisheng discussed, we delivered another solid quarter in a rather challenging period from a micro per economic perspective. Early in the quarter, COVID lockdowns in Shanghai and other regions of the nation noticeably weakened consumer confidence and altered consumption patterns for many. Since the lockdowns were lifted in June, we have observed some recovery in consumer demand for credit, although the pace of the recovery is expected to be gradual and modest. Despite the impact from COVID and the generally soft macroenvironment, we continue to push for steady improvement in overall asset quality throughout the quarter and the year. With optimization of our risk model and contribution from high-quality new borrowers, overall day one delinquency has been declining sequentially every month since the beginning of this year, even during the peak of the COVID lockdowns in April and May. It was 4.9% for Q2 versus 5.2% in Q1 and further declined to 4.6% in July. Particularly, day one delinquency for new borrowers in Q2 was well below 4%, indicating clear better quality versus existing borrowers. The 30-day collection rate remains stable at around 86% in Q2. COVID lockdowns significantly hampered our collection operations in April and early May. The 30-day collection rate hit the lowest point of this cycle in April at less than 85%. Then, it started to recover by July and was already above 87%, the highest point so far this year. Again, we see clear outperformance by new borrowers versus existing borrowers. For new borrowers, the 30-day collection rate was above 90% in Q2. These risk metrics continue to support our current user acquisition strategy, which focuses on the high-quality segment of the market. Total net revenues for Q2 were RMB4.2 billion versus RMB4.3 billion in Q1 and RMB4 billion a year ago. Revenue from credit-driven services was RMB2.9 billion compared to RMB2.9 billion in Q1 and RMB2.4 billion a year ago. The year-on-year growth was mainly due to growth in loan volume and the longer average tenor of the loans, more than offsetting the negative impact from declining average prices of the loans. The capital-heavy facilitation revenue take rate actually improved modestly versus Q1, also due to longer loan tenure. Revenue from platform service capital light was RMB1.2 billion compared to RMB1.4 billion in Q1 and RMB1.6 billion a year ago. The year-on-year and sequential decline was mainly due to the decline in loan volume and the average price of capital-light loan facilitation. During the quarter, capital-light loan facilitation and other technology solutions combined accounted for roughly 56% of the total loan volume. Given the challenging microenvironment, we purposely increased the portion of the loans processed through and other technology solutions to further mitigate potential risks this year. Such services typically have different commercial terms compared to regular capital-light loan facilitation. Overall in the long run, we will continue to pursue a technology-driven business model and expect capital-light and other technology solutions to eventually become a significant majority of our business. During the quarter, the average IRR prices of the loans we originated and/or facilitated further dropped to between 22% and 23%, well within the 24% rate cap requirement. We expect pricing to be relatively stable for the coming quarters. Sales and marketing expenses increased approximately 11% sequentially in Q2, mainly because of the increase in high-quality user acquisition. Specifically, if we exclude backend expenses, the increase in average cost to acquire a new credit line user through third-party traffic sources was roughly in line with the increase in the average size of the new credit lines. As such, the average cost per dollar amount for a new credit line remained relatively stable quarter-on-quarter. As always, we will continue to use lifecycle ROI and LTV as key metrics to determine the pace and the scope of our user acquisition strategy to ensure the sustainability and the profitability of our operations. Although the overall risk profile of our loan portfolio continues to improve in Q2 due to the contribution from new loans from high-quality new users, impacts from micro uncertainties and COVID were still apparent on old loans from existing users. Therefore, we continue to take a prudent approach in booking provisions against potential credit loss. New provisions for contingent liability for loans facilitated in the quarter were approximately RMB1.3 billion. With strong operation results and stable contribution from the capital-light model, our leverage ratio, defined as the risk-bearing loan balance divided by shareholder's equity, was at a historical low of 4.0 times in Q2 compared to 4.8 times a year ago. We expect to see a rather stable leverage ratio for the time being until capital-light and other technology solution contributions become a bigger portion of the business in the future. We generated RMB1.1 billion cash from operations in Q2 compared to RMB1.4 billion in Q1. The sequential decline in operating cash flow was partly due to some COVID-related timing issues, as Shanghai being gradually reopened in late Q2, some business and administrative procedures within the financial system were still not running as efficiently as they normally should be, therefore causing some delays in collecting receivables from some of our financial institution partners. Total cash and cash equivalents were RMB11.4 billion in Q2 compared to RMB9.8 billion in Q1. Non-restricted cash was approximately RMB7 billion in Q2 versus RMB6.2 billion in Q1. As always, a significant portion of our cash will normally be allocated to support the security deposit with our institution partners in the normal course of business. As we continue to generate healthy cash flow from operations, we believe our current cash position is sufficient to support the growth of our business, invest in key technologies, satisfy potential regulatory requirements, and return value to our shareholders. In accordance with the dividends policy approved by our board last year, we declared another quarterly dividend of USD0.18 per ADS for Q2. The cash dividends represent approximately 20% of our Q2 earnings. Finally, regarding our outlook for 2022, as we discussed previously, we believe 2022 will be a fairly challenging year for the industry. As participants are settling into a new regulatory environment, meanwhile, the on-and-off outbreak of COVID, as well as associated measures to control the outbreak, adds additional uncertainties to an already soft macroeconomy. Therefore, we want to maintain a prudent approach to plan our business and mitigate potential risk. At this point in time, we would like to keep our full-year loan volume guidance of between RMB410 billion and RMB450 billion unchanged, representing year-on-year growth of 15% to 26%. We view this transitional year as an opportunity for us to further optimize our operation, strengthen our technology platform, and upgrade our customer base to build an even stronger foundation for future growth. As always, the 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 can now take some questions.

Operator, Operator

Our first question is Yao Lee, CICC. Please go ahead.

Yao Lee, Analyst

Okay then, I'll do the translation part. So under the current macroeconomic and pandemic uncertainties, most of the retail credit service providers and financial institutions have generally encountered pressure, such as the increase of customers' early prepayments, customer acquisition challenges after pricing adjustments. So I was wondering, in the context of these uncertainties, are there any changes in the willingness of our bank partners to operate with us? Are there any changes in the funding cost to customer acquisition cost and also the actual demand of our potential customers? If there were some certain challenges, what are our plans, and how are we going to overcome them? Thanks, management.

Zheng Yan, CRO

Yes. I will answer your question, Yao. First, your observation is correct. Due to the impact of the macroeconomy, financial institutions are under some pressures. However, thanks to our number one, accumulated credibility in the market, and from our consumer loan business. Number two, due to the financial institutions pressure from other asset costs, we observed that in Q2, our high-quality consumer loan assets are in high demand from financial institutions, which is reflected in the drop in funding costs that we have discussed. In July and August, we are seeing the trending down of our funding costs further. For your second question, as for the customer acquisition activities, due to the pandemic lockdown of offline activities, our customer drawdown activities have been massively impacted. Thanks to our series of countermeasures that apply more precise task customer targeting that the drawdown activity of our users is boosting. We did a lot of work in Q2. We are expecting to see that work bearing fruit in Q3.

Operator, Operator

Next question is Thomas Chong from Jefferies.

Thomas Chong, Analyst

Thanks, management, for taking my questions. My first question is about our SME strategies. Given the current macro backdrops, will we scale back the pace of our SME business as well as the offline sales team? My second question is about the average ticket size. Given the uncertainties of the macro environment, are we seeing the borrowers getting a lower ticket size and becoming a bit more prudent? Thank you.

Zheng Yan, CRO

Yes. Regarding the SME business, naturally, this is more sensitive compared to our consumer loan business; therefore, we take a more prudent approach to this business. We have tightened our credit standards for this business. As you can see, the total loan origination or facilitation in SME business in Q2 dropped significantly. This is number one. For the second point, regarding customer acquisition channels, for external channels where we have less control, we scale back the volume and focus more on our direct sales team for customer acquisition. Yes, Thomas, the vision that the customer consumption wellness jobs due to the impact of the pandemic is correct. However, we implemented a few countermeasures. Number one is we tightened the credit standards. That means we made the approval rate lower. Number two, we focused more on high-quality customers, which bring more value to the business. These two measures together make our ticket size relatively stable.

Alex Xu, CFO

Okay, Thomas, I'll add a couple more points there. One is on the SME business. As Haisheng mentioned, if you look at our earnings release, the new credit line granted to SMEs is about RMB4.9 billion, and the actual loans facilitated or originated to SMEs is about RMB7.8 billion. Roughly compared to last quarter, that loan volume was a little bit over RMB10 billion. So that's the numbers there. But I want to make sure when we talk about SME, we're referring to rather narrowly defined SMEs, meaning like that’s real SMEs as opposed to some players talking about more broadly defined SMEs. So that's the differentiator. Secondly, regarding the ticket size, if you look at, for example, the average drawdown we look at for Q2, it increased by roughly 5% sequentially. So that’s just an added point to Haisheng's comments. Once we pass through the lockdown period, we still see pretty notable growth in ticket size in consumption. Thank you.

Operator, Operator

Our next question is Alex Ye from UBS.

Alex Ye, Analyst

So my question mainly centers on your take rate outlook. During the call, you mentioned that your average IRR during the quarter was 22% to 23% and expect that to remain stable going forward. You also mentioned that your funding costs are improving and your credit performance is also stabilizing. I’m wondering if we could expect some stabilization or improvement in your take rate going forward. Thank you.

Alex Xu, CFO

Sure, Alex. Let me take your question here. You are correct. Given that we have already reached a point in terms of pricing goals, based on the regulatory guidelines, we do not foresee too much pricing downward trend going forward for the remainder of the year. With that, the overall take rate will be more stable. If anything, there could be some improvement there; however, other factors to consider are the macroenvironment, which will likely have more impact than usual. If we have a stable macroenvironment, then others' assumptions suggest it will be a stable to potentially modestly improved take rate. If something unexpected happens on the macro front, then that would be another question. As for funding costs, as Haisheng mentioned, in the second quarter we were at 6.8%, and right now we are sitting at about 6.5%. So there may still be a little room to go in terms of lowering funding costs, given the current money supply being pretty available. Overall, I would say from our modeling perspective, we conservatively anticipate a rather stable take rate. If you want to add to it modestly, that's also acceptable.

Operator, Operator

Next question is from Richard from Morgan Stanley.

Unidentified Analyst, Analyst

Basically, my question is on the competitive environment in China at the moment. Given that 360 DigiTech is also aiming for low-risk borrowers, we also see overlap with the targeted customer base of banks, etc. So what's the competitive landscape at the moment?

Wu Haisheng, CEO

Yes, you are right. After we lowered our average product price, the overlap of target markets with other players, like you mentioned, including banks, has increased a little bit. However, we do not see direct head-to-head competition with them. There are a few reasons. Number one, the consumer loan market is a vast market with multiple layers. For example, banks might offer products priced at 10% and others at 15%. Our price range, as we discussed previously, is around 22% to 23%. Number two, we believe different companies can thrive and prosper based on their unique competencies. For example, some may triple their unique ecosystems. For us, we do not have any e-commerce platform or e-commerce ecosystem. Therefore, we can collaborate with all the platforms in the market and cover the full spectrum of customer groups.

Operator, Operator

And our next question is from CLSA.

Unidentified Analyst, Analyst

My question is more about quality. Management just mentioned that looking to the second half, we are going to see improvement in overall risk indicators. My question is more about how we see the pace of this improvement. Is it a gradual bumpy one, or a notable improvement, especially regarding the COVID flare-ups recently in across many cities? And also, when do we expect the 90-day delinquency ratio to pick up? Yeah, that's my question. Thank you.

Wu Haisheng, CEO

Okay. Our risk management team has been collaborating closely with other teams to make several adjustments in the second quarter. Firstly, we improved the quality of newly acquired customers with comprehensive coverage of RTA and introduced into our model. The number of our best-quality customers has doubled compared with the first quarter. Secondly, we improved the data mining of the People's Bank of China Quality Report. We set up a joint project team and derived 18,000 effective variables from the quality report, covering the optimization of models including competitive offer exploration, high-quality customer identification, bad customer identification, career model, income and liability model, etc. Meanwhile, we evaluate customers with poor credit performance more cautiously. Thirdly, we improved resource allocation to high-quality customers on the operations side, including pricing, credit lines, and promotions. With these actions, the credit performance of new transactions has improved. We have seen that day one delinquency dropped by about 20% compared with the first quarter and has maintained a downward trend in July and August. With the pandemic outbreak, we can see lower rates, which truly demonstrates the resilience of our team and our assets. The results of some actions mentioned above have not been fully reflected yet as some actions are in pilot; we need to observe long-term performance. Therefore, with the full adoption of these actions, we are very confident to sustain stable risk performance in the future. As for the 90-day delinquency rates, it will be lower in the third quarter. As we focus more on 30-day delinquency rates, it has been the lowest in July, and our future target will be within 2.5% to 3%. Hope this clarifies your question.

Operator, Operator

And this is the end of our question-and-answer section. I now hand it back to your management for conclusion.

Alex Xu, CFO

Okay. Thanks again for joining us for the conference call. If you have any additional questions, please feel free to contact us offline. Thank you.