360 DigiTech Inc

NASDAQ:QFIN

Earnings Call Transcript 2021-Q2

[Operator]

Ladies and gentlemen, thank you for standing by, and welcome to the 360 DigiTech Second Quarter 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 Dole, IR Director. Please go ahead, Mandy.

[Mandy Dole, Director, IR]

Thank you. Hello everyone and welcome to our second quarter 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 would like to remind you of our Safe Harbor statements in our earnings press release, which also apply to this call. We may refer to forward-looking statements based on our current plans, estimates and projections. Also, this call includes a discussion 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. Haisheng.

[Haisheng Wu, CEO]

[Foreign Language] Hello, everyone. I am very happy to report another quarter of record-breaking operational and financial results. During the quarter, financial institutions originated RMB88.5 billion loans through our platform, marking another record high, up 50% Y-o-Y and 19% Q-o-Q after reaching RMB100 billion milestone in Q1.

Outstanding loan balance continued to grow to RMB111.6 billion in Q2 up 50% Y-o-Y and the 15% Q-o-Q. Total revenue was RMB4 billion in Q2, up 20% Y-o-Y and 11% Q-o-Q. Non-GAAP net income was RMB1.62 billion, up 71% Y-o-Y and 15% Q-o-Q.

Despite a continuously changing macro and regulatory environment, we've delivered five consecutive quarters of record-breaking results. Over the past few years, we have build a comprehensive operational system that demonstrates remarkable resilience through cycles. To be more specific, our diversified users, acquisition channels and scenarios allow us to effectively hatch any volatility from a particular channel.

Our extensive network of diverse financial institutional partners gives us sufficient flexibility in terms of funding cost, geographic coverage and pricing. Our improved risk management capabilities allow us to target different user segments with effective pricing based on different market dynamic. Our access to some key financial license at ecosystem bridge capacity to comply with average change regulatory environment.

Over the last six weeks also, QFIN along with other Chinese ADRs has experienced extreme volatility in the market. While there are multiple risk factors triggered such as share price movement with the risk to market overreacting to the elements and ignoring the solid fundamental and strong growth prospects of QFIN.

As such, after evaluation with the approval of our board, management decide to launch a share buyback program. The company intends to repurchase up to US$200 million of it's ADR through open market or other forms of transaction over the course of next 12 months. We believe at current market conditions, share repurchase offers extremely attractive opportunity to restore our cash and to generate great returns to our shareholder.

We continue to make progress in multiple strategic initiatives and gradually unlock tremendous growth opportunities. We made significant progress on diversified user acquisition strategy. Customer base continued as well and customer quality improved. Our embedded finance mode drove significantly. The number of new borrower in Q2 peaked the highest level in the past six quarters at more than 10% sequentially. The number of SME borrower acquired offline also increased significantly.

Our embedded finance model contributes close to 40% of our new customers with approved credit line in Q2. So far we have established cooperation with 22 leading traffic platforms with another eight in the pipeline. Our SMEs finance business also achieved a breakthrough performance in Q2 by presenting our ties with leading industry partners and optimizing credit approval process and policies. Total amount of new approved credit lines increased 22% Q-on-Q to RMB7.1 billion and outstanding loan balance increased 45% sequentially with our ticket size exceeding RMB250,000.

Meanwhile we're rolling out to customer's loan products catering to the specific funding needs to different industries. In July, we launched tobacco business and have served more than 700 offline tobacco business owners. In the second half of this year, the plan to launch other industry specific loan products targeting cross-border ecommerce supply chain finance as well as agriculture and the forestry sectors,

Loan facilitation under the capital-light model accounted for roughly 56% of total volume in Q2 and for the month of July capital-light accounted nearly 60% almost reach our full year goal for tech upgrading strategy. For our smart marketing product, I see Intelligence Credit Engine, the number of active users increased 74% Q-on-Q. The transaction volume and outstanding balance both went up by 36%.

As for the recent regulatory change, we want to share our feedback here. As one of the 13 leading internet half [ph] on the April 29 regulatory meeting, we have maintained regular communications with regulators. Currently the sales assessment and related at ratification process are moving forward in an orderly manner. We fully understand the regulator's requirements and expectations for the industry.

Our business is relatively focused and has a clear path towards full compliance with regulatory requirements. We don't have online payments, online insurance or online brokerage operation, which has stepped up to more restrictive regulations. For our loan facilitation business, we don't do joint lending nor have overlapped -- over leveraged ABS insurance. That we are highly confident to satisfy all of the revised regulatory requirements when everything's said and done.

As you may already know, the proposed the new regulation will not allow loan facilitation platform to provide credit assessment related data directly to financial institution and such data transfer must go into a licensed accredited agency. We have preemptively communicated with the regulators to understand the policy direction and to make necessary preparations. We will take multiple actions to satisfy this new regulation.

On one hand, we can cooperate with existing third party credit agency. On the other hand, we can also seek partners to jointly launch a new credit agency.

Recently, some media reports indicate that regulator will require consumer finance companies to implement an owing interest rate cap of 24% for consumer lending. This is consistent with the regulator's long-term agenda to support real economy by lowering financing costs for consumers and SMEs meaning also consistent with our long-term business planning. Our own balance sheet loan and SME loan business already priced below 24% while our consumer facilitation business, even under a more restrictive stress test in which we assume to cut our price to below 24% rather rapidly, we do not expect a price cut to have a minimal impact to our operational and financial results in 2021.

As for 2022, it will be a transitional year when the entire industry will comply with 24 rate cap by June. In our stress test, we continue to see how the volume growth in 2022 and net take rate should be around 3%. There were also some positive factors that may mitigate negative impact from the 24% rate cap. With lower price, we should be able to develop a partnership with larger national banks that typically offer more stable funding at lower funding cost.

In addition, with all of our asset at 24% or lower, we should be able to significantly increase the issuers of ADS which carries a much lower funding cost around 5% to 5.5% versus around 7% from banks. Furthermore, at lower prices, we can attract more high quality borrowers, which will naturally drive down overall credit costs by 1% to 2% point. Finally, based on our experience, lower pricing normally boost the borrower activities, retention rate and lifetime value LTV.

To conclude we believe more prime customer and better quality financial institution would come along with lower price products. This will ultimately enhance our operational efficiency and make our business more resilient and sustainable. Such change may set up a solid base for us to accelerate it well after 2022. We feel quite optimistic.

I would now like to address the temporary removal of our 360 DigiTech app from app store. The removal was due to our product engineer miss out one of the function that was required by the regulators. We have already fixed the issue and our app has been restored to all major app store to today. We have conducted a thorough internal review and improved our operating protocol to ensure such incidents never happen again. Thanks to our diversified customer acquisition channel and the balance the product makes the impact at remove to our operation has been minimal.

During the quarter, we continue to diversify our funding source. We accelerated the pace of ABS insurance with total RMB2.1 billion ABS in Q2 at an average Cooper rate of 5.3%, which has brought our total ABS insurance to RMB3.1 billion so far this year, ranking us number four in the market. As our risk management system to support more business, we continue to see further enhance of our asset quality. The 90-day trust delinquency ratio across our platform was 1.19%. The M1 platform rate remained stable at 90.8% and day one delinquency rate at 5%.

We continue to expand the scale of our collaboration with KCB. Total accumulate loan facilitation volume as of Q2 was RMB33.5 billion. Outstanding balance was RMB20.4 billion at the end of Q2 up 66% from Q1. We sped the scale of the KCB partnership to remain relatively stable for the timebeing. We have deep rooted trust and a great flexibility in our collaboration with KCB. Going forward, we will proactively explore new sproduct and business opportunities through our collaboration with KCB.

We made some good progress on the ESG [ph] front which draws more and more attention. When [indiscernible] province this July, we took swift action to support by donating RMB20 million through the 360 Foundation. Meanwhile, we organized the local team to join the rescue efforts.

We're quite satisfied with our performance in the first half of 2021. This fruitful result comes along from dedicated efforts of our excellent team. I would like to express my gratitude to their hard work. [indiscernible] and great companies are always in great change. We have successfully demonstrated our capabilities and ambition over the past five years. Fin cap [ph] is a vast market with huge potential and fin cap product has profoundly changed financial service landscape and user experience. We will continuously launch innovative products and are dedicated to become the premium player in this market.

Now let me turn to our CFO, Alex to run through more detailed info. Thank you.

[Alex Xu, CFO]

Thank you, Haisheng. Good morning and good evening, everyone. Welcome to our quarterly earnings call. For the interest of time, I will not go over all the financial line items on the call. Please refer to our earnings release for the details.

As Haisheng mentioned, we delivered robust operating and financial results for the first half of 2021, powered by strong consumer demand for credit and further improvement in asset quality. The strong business momentum appears continuing into current quarter. In fact, we have seen record-breaking volumes in recent months, despite some reported softness of micro economic activities lately.

Total net revenue for Q2 was RMB4 billion versus RMB3.6 billion in Q1 and RMB3.34 billion a year ago. Revenue from credit-driven service capital heavy was RMB2.4 billion compared to RMB2.45 billion in Q1 and RMB3.08 billion a year ago. The year-over-year decline was mainly due to facilitation volume mix change as capital-heavy contribution decreased significantly.

Revenue from capital-light was RMB1.6 billion compared to RMB1.15 billion in Q1 and RMB259 million a year ago. The robust growth was mainly driven by exceptional progress we have made in capital-light and other technology solutions. During the quarter, capital-light and other technology solution contributed roughly 56% of total loan volume while the underlying take rates were relatively stable. We expect capital-light contribution percentage to continue to increase in the second half and to reach roughly two third of our total volume by the year end.

During the quarter average pricing was 27.2% compared to 26.6% in Q1 and 27.2% a year ago. Assuming the reported 24% rate cap guideline will be implemented across industry, we are expecting over a pricing to gradually trending downs in mid 2022 to satisfy the rate cap requirement. In our stress test, even under the more restrictive and steep rate cut scenario, where we assume we cut the rates to below 24%, starting from September the 1st. In such scenario, we should still be able to maintain housing growth and profitability in the transitional year of 2022 and resume to a more robust and gross afterwards.

As macroeconomic activities picked up in China in the first half, demand for internet traffic also increased significantly along the way. In addition, we also proactively accelerated the pace of customer acquisition in the last couple of quarters to take advantage of the overall positive business trend. As such, we have experienced some uptake in sales and marketing expenses. Average customer acquisition cost on the consumer lending side for the quarter was about RMB237 compared to RMB206 in Q1.

As we discussed in the past, average cost per approved credit line is a calculated number was limited value in our decision-making. We will continue to use life cycle ROI and LTV as key metrics to determine the pace and scope of our customer acquisition strategy.

So far in 2021, ROI trend have encouraged us to take a more proactive approach to accelerate the growth of our customer base. Non-GAAP net income was RMB1.61 billion in Q2 versus RMB1.41 billion in Q1 and RMB942 million a year ago. We once again set a new record in quarterly profitability, driven by higher facilitation volume and noticeable improvement in asset quality. Effective tax rate was approximately 18% for the quarter -- sorry, for the first half of 2021. We see a similar level of ETR for the rest of the year. Longer term, we are expecting our normalized ETR to return to approximately 15%.

As we move towards a more technology-driven business model, we continue to see marked improvement in operating margins as increasing contribution from capital-light and other technology solution will generally lead to higher margin structure. Overall, we expect the profitability growth to be more or less, keep pace with the facilitation volume growth throughout this year.

With strong operating results and increased contribution from capital-light model in Q2, our leverage ratio, which is defined as risk bearing loan balance divided by shareholder's equity, further declined to 4.8% from sorry, 4.8 times from 5.4 times in Q1 and 8.3 times a year ago. We expect to see continued de-leveraging in our business driven by further movement to our capital-light and solid operating results.

Total cash and cash equivalent was RMB8.8 billion in Q2 compared to RMB9.2 billion in Q1. Non-restricted cash was approximately RMB5.2 billion in Q2 versus RMB6 billion in Q1. The modest decline in cash was mainly due to more proactive deployment of cash in our operations to support ABS and the pre ABS assets, which generates higher returns.

Meanwhile, a significant portion of our cash also allocated -- was also allocated to security deposit with our institutional partners and registered capitals of different entities to support our daily operation. As we continue to generate strong cash flows through operations, we believe our current cash position is more than sufficient to support the expansion of our business, to invest in key technologies and to satisfy potential regulatory requirements.

Therefore, we believe it is a prudent decision to use some of our quote unquote, free cash to invest in our own stock, which is priced at just around the company's liquidation value. For a company that is still generating healthy growth for the next few years, we believe it is a great bargain.

Finally, let me give you some update about our outlook for 2021. The operating results for the first half of 2021 were very encouraging and the momentum doesn't slow so far in current quarter. Although we intend to keep our tradition of a conservative approach in providing forward guidance, the numbers start to speak for themselves. As such, we would like to raise our 2021 total loan volume guidance to be between RMB340 billion and RMB350 billion compared to previous guidance of RMB310 billion and RMB330 billion. The revised guidance represent year-over-year growth of 38% to 42%. As always, this forecast reflects the company's current and preliminary view, which is subject to material changes.

With that, I'd like to conclude our prepared remarks. Operator, we can now take some questions.

[Operator]

Thank you, management. [Operator instructions] Our first question is from Richard at Morgan Stanley. Please go ahead.

[Richard Xu, Morgan Stanley]

Basically, two questions from me. One is on the basically sending borrowing information through the credit scoring agencies, any detailed discussion on the actual process because it's been a little while. And you mentioned basically there has been a further discussion and there's different versions out there. Just want to see what is the latest development on that front? Secondly, is obviously very good loan volume, any discussion with regulators in terms of any views or guidance on the pace at the proper pace. Thank you.

[Haisheng Wu, CEO]

So for the trust version of revelation on the administration of credit assessment business was announced and we have been communicating with regulators for a long time that actually in the market, that there is no standard solution available so far for now, and also as Mr. Zheng has mentioned that actually there are two or three solutions, we care about.

The first one is that we applied for credit agency [ph] to launch a new credit agency. And the second one is we cooperate with existing credit agency quite an agency to continue our business. Also with our in-depth cooperation with KCP, which offers us another alternative before the solution, whatever solution we adopt in the end, the process of product might be different. However, it will not affect our results of the risk management and our risk models.

So for your second question, regarding to our growth rate, actually, we have seen that the growth is not the problem, and the regulators focus more on the standardization of the product and our business. Also, we have seen that in the requirement by the regulators, they have issue that they want the platforms, internet platforms to sustain the growth and support real economy continuously.

[Operator]

Our next question is from Alex Ye at UBS. Please go ahead.

[Alex Ye, UBS]

I'll translate my question. Firstly, on the regulatory developments, so it looks like the current direction from the regulators is continue to tighten the various perks that as part of the data collection by the internet coming in. So I'm wondering assuming the regulators issue more stringent regulations on consumer data collection then use in the future. How would that affect our current practice of data collection and use and how would that affect our credit model?

Second question is on your plan to work combined with the 20% interest rate cap. So you mentioned that in your stress test, you are going to comply fully comply with the 10% cap type September if you're, but so if I stress that then with your -- your base case or your target trajectory or combined with that new cap and then third question is also related to the interest rate trend. So market concern about the 20% cap is only just the beginning of the future regulatory requirement of a further question down the overall lending rates.

So I'm wondering if you have any comment on that and specifically given you also ramping up your MS -- your SME loan. So it looks at defect might be subject to further pressure from lower rate, no guidance. Also we appreciate your comments. Thanks.

[Haisheng Wu, CEO]

Okay. Thank you, Alex, for your question. So regarding to your first one, that we actually wastage happening as well about the data capture and usage in this industry. So for regulators side, we think there are two basic principles. The first one is the minimum of standard for data capture. So apart from capturing data from the customer side, like forecasting before and all application, we are working for actively with third party credit agency for industry and asked to know data sources as well as replacement.

And the second principle is that the customer authorization is mandatory before data capture. As you may know, that our removal of our 360 account applications from app stores was caused by these problems. So we will emphasize more on this principle in the future. We believe that with our relatively standard process and the impact of this tattling principles will have minimum the impact on our business.

Regarding to your second question, the timeline of the all in interest rate cap at 24%, actually we say that there are different timelines for different institutions. Some institutions will you follow the guideline that outstanding balance of the of the loan over 24% will be reduced to zero by end of June next year. And some institutions follow the guidance that there will be no new originations by June next year. So we will follow these accordingly,

Regarding to your third question that if the 24% interest rate cap will be lowered more, actually as all market participants know 24% interest rate cap has been the window guidance from regulators to banks for a long time. Recently media reports back to labor base interest cap, weight requirement expands to consumers nd those competence since the 24% cap has existed in the industry for quite some time, we don't think the rate cap will split to go down. Thank you for your question.

The more regarding to the increased the rate of eat launch, of course, regulator is one to say the interest rate to be as low as possible, but there is no standards as it is similar to the consumer finance industry. They are different and virus needs and supplies of the SME loans. As a platform, as intermediary, we will continue to offer the various services to meet a different candid needs of the SME loans. Thank you.

[Operator]

Our next question is from Jacky Zuo of China Renaissance, please go ahead.

[Jacky Zuo, China Renaissance]

So let me translate, so congrats for these strong results. My first question is related to regulation as well. So for the 24% interest rate cap mentioned in the stress test for next year regarding the margin probably will go down to 3%. So just want to understand what these are, assumptions behind this chest test regarding to APR funding calls and credit cards and other expenses and any chance we can give offload for APR in the third quarter?

And second question is regarding to the estimate loan. We we've seen other competitors also moved to this new business. So how are we going to differentiate our SME loan products and what is the APR margin and our growth target this year? And is this SME loan included in our new guidance? Thank you,

[Haisheng Wu, CEO]

Thank you, Jackie. Regarding to your first question about the stress test, actually what we have delivered now is a relatively static test with all other factors, status quo, especially there's no improvement in our efficiency. So we asked him that there is no cost to changes in this version of the stress test.

However, as we have known that there is a few improvement of our cost, for example, for our funding positive, before we have a large portion of our funding from a consumer finance component with a relatively higher funding positive, and our ABS volume is also limited. However, with a lowering cap interest rate, we can have more something from national banks or larger national banks, and we can increase our ABS volume.

So we accept, expect our funding cost to be lowered by 1%. And we have the quality loss expectation to be lowered by around 1% as well. So another major cost, the customer acquisition costs will be lowered as well. So we expect that actually the take rate of 3% will be improved in the future

For the third quarter of this year, we have started with a lower APR task. So the APR will be lowered, but there will be no meaningful impact on our financial results of the next quarter.

So for your second question, regarding to our compatibilities of asset loans, so there are two aspects. The first one is about risk management. Our SME business is different from the traditional ones because we focus more on the SME side. Considering not traditional SME loans are over RMB10 million TK size is not fully data driven.

However, we have adopted the do it engine regarding to our risk management about SME loans. That is we evaluate from the individual side and from the corporate side with TK size of 250,000. On average, we have used and food to equalize our accumulated experience on risk management in the past years on consumer finance.

And the second advantage of us is the corporation with KCP. The only three platforms in China market that are able to have in-depth cooperation with banks. We believe we have the advantage of data and funding cost regarding to the SME business.

So for our target date of SME loans this year, it, we account for around 10% to 15% of our total loan origination. And it has been covered in our guidance

[Alex Xu, CFO]

Okay. Jackie just I have a few sort of a clarification and add up to Mr. Wu's comments there. Number one, the most important clarification, next 3% is not a margin. It's the take rate, right? Our net margin this quarter was 40%. And if anything, for the next couple of quarters, we'll probably see a little bit expansion of net margin then this Q2. So the 3% though is the take rate on loan balance. That's we have been saying this in the past.

And then secondly also regarding the second half pricing trend even though we, our stress test was taken, the more drastic cuts starting from September 1st, basically on that day everything goes below 24, but in reality that's not going to be the case. Just like Haisheng mentioned, it's really dependent on the pace of our financial institution partners, their kind of progress there.

So most likely it will be a gradual trending down toward that kind of a goal by the end of June of next year. So if you do a Adenia kind of distribution on any given quarter from now to the mid of next year, you'll probably looking at maybe one percentage or a little bit over one percentage point change in pricing if you're just average out.

So that's the regarding the pricing change and then this kind of a change for 2021 for the remainder of 2021, we don't see any kind of a meaningful impact in loan volume and or the the take rate. That's why in my prepared remarks, I mentioned that the second half of probability will most likely keeping pace with the loan volume growth. You have our guidance for the full year, you can do the calculation, re-uptake at the the computation the, sorry, the probability the number for the second half, Okay, so that's the another clarification.

Then the third point is really about how do we get that 4%, sorry, 3% take rate when this posting be said and done, I have a kind of a back of the envelope calculation let's assume our current mix in terms of capitalized versus cap heavy at six to eight versus 46 day being the cap light. And normally the reality is our cap light side of business carry a higher pricing versus the cap heavy.

So if we let's say cut all the pricing to 22.5% then on the cap heavy side that we need to cut roughly about 2% on the life side, we need to cut roughly about 6.5% to 7%, but keeping in mind that 6.5% to 7% cut is actually the overall cut. Remember we are only taking 30% of that sharing. So 6% to 7% cut to us is only 2% in real impact, right.

So essentially the, the cap line and cap heavy, basically you have a similar 2% impact just by the pricing alone. That's a pretext impact. If you add the tax rate on it the net impact on the pricing alone will probably be somewhere around the 1.7%, 1.8% maybe. Okay, so that's a pricing alone. And then forget about the funding cost savings, operational efficiency, and all these other things. The one clear change will be the risk factor just simply because when the pricing coming down, you're naturally targeting a high quality group of users. Okay.

For that by our estimate the, the savings from after tax savings from that sort of a credit cost side will be coming somewhere around 0.6% to 0.8% range. So if you deduct a pricing impact 1.7 deduct 8.8, or sorry, 0.6, 0.8, from the 1.7, 1.8, you got roughly 1%. That's not even considering anything on the funding costs, on operational efficiency and, and all the other things we actually mentioned earlier. So that's the very rough calculation just for your reference.

[Jacky Zuo, China Renaissance]

That's very clear. Thanks guys.

[Operator]

Thanks so much. That's the end of the Q&A session. I would like to hand it back to management for briefing closing remarks.

[Alex Xu, CFO]

Okay. Thank you everyone again, to join our conference call. And if you have any additional questions, feel free to contact us. Thank you.