360 DigiTech Inc

NASDAQ:QFIN

Earnings Call Transcript 2022-Q2

[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 statement 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 figure mentioned are in RMB.

I will now turn the call over to our CEO, Mr. Wu Haisheng.

[Wu Haisheng, CEO]

[Foreign Language]

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% y-o-y. Outstanding loan balance reached RMB160.5 billion up 28% y-o-y. Despite volatile macro-environment with the Shanghai lockdown and resurgence of COVID in multiple states, we delivered a solid performance, which once again demonstrated a reliance 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 put emphasize on driving healthy and sustainable industry development through normalized supervision. As the regulatory environment gradually stabilized, we see clearer guidance.

On July 28, the Central Political Bureau of the community's party of China set up economic priorities for the second half of the year. The policy makers pledge 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, place them on the 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 now in the stage of regular data reporting, regarding credit agency report by Julian [ph], 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, CDIRC published a notice on strengthening the management of internet loan business of commercial banks and improving the quality and the efficiency of financial service; namely, Circular Number 14. The document is consistent with earlier guidance, including Circular Number 24 in 2021 and the Circular Number 9 in 2020 with the great period extended for one year till June 30, 2023. In addition, the document, once again, acknowledges the collaborated business model between commercial banks and related party in 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 extreme volatile market, we successfully executed our operational strategies and make great progress in funding, product risk management and customer base, as well as tech upgrading.

On the funding front, we further optimize our founding 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 founding cost for credit-driven loans decreased by 21 basis points on 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 of 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 the 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 user with granted grant line increased by 51% from Q1.

Looking across all customer acquisition channels, the credit approval rate of high quality user increased by roughly 20% on a sequential basis, meanwhile, we continue to enhance effectiveness of targeted customer acquisition. On one hand, we continuously upgrade our model for user quality screening. On the other hand, we expanded our media partner network for joint modeling and onboarded new partner, such as Price Deck. For our existing partners, such as Baidu [indiscernible].

We continue to upgrade our models. In other areas, we optimize the cost efficiency of user acquisition by upgrading our intelligent marketing platform. We also connected to new user acquisition resource, such as Baidu open screen app and total RTA resource.

In Q2, we quickly adjusted our risk strategies in response to resurgence of the pandemic, including acquiring higher quality customers and gradually cutting off higher risk users. We also completed major upgrade of our risk models to further leverage on user data. As a result, risk performance of new loan origination was great.

First payment, day one delinquency rate of new customers dropped to 3.01% in Q2 from 3.56% into Q1 and the first payment delinquency 30 days would that then 0.25% in Q2. In the meantime, they won 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 day one delinquency rate further dropped to 4.64%. The M1 collection rate of 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 make 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 tech upgrading strategy, we maintain that 55.7% of the loans originated and facilitated was 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 industry joined including China Mobile and Group Baidu and [indiscernible]. 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 lockdown and other multiple macro fluctuations with strong operational and financial results. Looking ahead into Q3, we will stay vigilant on the macroeconomy 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 reification 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 of time from micro per economic perspective. Early in the quarter, COVID lockdowns in Shanghai and other regions of the nation noticeably weakened consumer's confidence and altered consumption pattern for many.

Since the lockdown removed in June, we have observed some recovery in consumer's demand for credit; although the pace of the recovery are expected to be gradual and modest. Despite the impact from COVID and the generally soft macroenvironment, we continue to push for steady improvement in the overall asset quality throughout the quarter and the year.

With optimization of a risk model and contribution from high quality new borrowers, overall day one delinquency has been declining sequentially each and every month since beginning of this year even during the peak of the COVID lockdown 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.

30-day collection rate remains stable at around 86% in Q2. COVID lockdowns significantly hampered our collection operation in April and early May. 30 day collection rate hit the lowest point of this cycle in April at less than 85%. Then start to recover by July, it 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, 30-day collection rate was above 90% in Q2. These risk metrics continue to support our current user acquisition strategy, which focus on high quality segment of the market.

Total net revenues for Q2 was RMB4.2 billion versus RMB4.3 billion in Q1 and RMB4 billion a year ago. Revenue from credit-driven service kept heavy 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 in average prices of the loans. 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 the capital-light loan facilitation. During the quarter capital light loan facilitation and other technology solution combined account 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 solution to further mitigate potential risks so far this year. Such services typically have different commercial terms compared to regular capitalized light loan facilitation. Overall in the long run, we will continue to pursue technology-driven business model and expect capital light and other technology solutions to eventually become a significant majority of our business.

During the quarter, 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 360 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 new credit line remained relatively stable Q-on-Q. As always, we will continue to use lifecycle ROI and LTV as a 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 continue to improve in Q2 due to the contribution from new loans from high quality new users, impacts from micro uncertainty and COVID were still apparent on old loans from existing users.

Therefore, we continue to take prudent approach in booking provisions against potential credit loss. New provisions for contingent liability for loans facilitated in the quarter was approximately RMB1.3 billion. With strong operation results and stable contribution from capital-light model, our leverage ratio, which is defined as risk-bearing loan balance divided by shareholder's equity was at historical low of 4.0 times in Q2 compared to 4.8 times a year ago. We expect to see rather stable leverage ratio for the time being until Capital Light and other technology solution contribution become a bigger portion of the business in the future.

We generate RMB1.1 billion cash from operation in Q2 compared to RMB1.4 billion in Q1. The sequential decline in operating cash flow was in part due to some COVID-related timing issue as Shanghai being gradually reopened in late Q2, some of the business and administrative procedures within the financial system were still not running as efficient as what normally should be, therefore causing some delays in collecting receivables from some our financial institution partners.

Total cash and cash equivalent was 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 normal business course.

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 and to satisfy potential regulatory requirement and to return to our shareholders. In according to 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 the participants are settling in a new regulatory environment, meanwhile, the on and off outbreak of COVID as well as associated measures to control the outbreak added 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 upgrading our customer base to build an even stronger foundation for future growth. As always the forecast reflects the company's current and the 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 instructions] Our first question is Yao Lee, CICC. Please go ahead.

[Yao Lee, CICC]

[Foreign Language]

Okay then, I'll do the translation part. So under the current microeconomic and the pandemic certainties, so we saw most of the retail credit service providers, the financial institutions generally has encountered certain pressure, such as the increase of customer's early prepayment, the customer acquisition challenges after the pricing adjustments.

So I was wondering in the context of these uncertainties, are there any changes, willingness of our bank partners to operate with us and are there any changes in the funding cost to the customer acquisition cost and also the actual demand of our potential customers? And if there were some certain challenges, what our plans and how are we going to overcome it? Thanks management.

[Zheng Yan, Chief Risk Officer]

Yes. I will answer your question, Yao. That first your observation is correct. Due to the impact of macroeconomy, financial institutions are under some pressures however, thanks to our number one, accumulated credibility in the market, then from our consumer loan business. Number two, financial institutions pressure from other asset costs actually in Q2, our high quality consumer loan assets is in high demand from financial institutions that is reflected by the job in funding costs that we already discussed. In July and August, we are seeing the trending down our funding cost further.

For your second question, as for the customer acquisition activities, due to the lockdown of pandemic of offline activities, our customer drawdown activities is to some extent massively impacted. Thanks to our series of counter measures that we apply more precise task customer targeting that the draw down activity of our users are boosting. We have done a lot work in Q2. We are expecting to see the work bearing fruit in Q3.

[Operator]

Next question is Thomas Chong from Jefferies.

[Thomas Chong, Jefferies]

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 and, my second question is about the average ticket size. Given the uncertainties of the macroenvironments, are we seeing the borders are getting a lower ticket size and they are getting a bit more prudent. Thank you.

[Zheng Yan, Chief Risk Officer]

Yes. Regarding SME business; naturally, this is more signaling called than our consumer loan business that we take a more prudent approach on this business. We have tightened our credit standard for this business. As you can see the total loan origination offer facilitation in SME business in Q2 dropped big. This is number one. For the second point, as for the customer acquisition channel, for external channels that we have less control we scale back the volume, and more focus on our direct sales team of customer acquisition.

[Thomas Chong, Jefferies]

[Foreign Language]

[Zheng Yan, Chief Risk Officer]

Yes Thomas, the vision that the customer consumption wellness jobs due to the impact of pandemic is correct. However, we released a few counter measures. Number one is we tighten the credit standards. That means we make -- the approve rate is lower. Number two, we focus more on the high quality customers, which bring more value to the business, two measures together that makes our ticket size rather relatively stable.

[Alex Xu, CFO]

Okay. Thomas, just add a couple more point there. One is on the SME as Haisheng mentioned, if you look at our earnings release, this quarter the credit line, the new credit line granted to SME is about RMB4.9 billion and the actual long facilitator or originated two SME 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 just want to make sure when we talk about SME, we are talking about rather narrowly defined SME. So meaning like that's real SME as opposed to some of the players talking about more broadly defined SME. So that's the -- that makes a difference. Secondly, regarding the ticket size, if you look at, for example average draw down we look at for Q2, is increased by roughly 5% sequentially. So, that's just added point to Haisheng's comments. Once we pass through the lockdown period, we actually see pretty -- still see pretty noticeable growth in terms of ticket size in consumption. Thank you.

[Operator]

[Operator instructions] Our next question is Alex Ye from UBS.

[Alex Ye, UBS]

[Foreign Language]

So my question is for mainly on your tech rate outlook. So during -- you have mentioned that your average IRR during the quarter was 22% to 23% and expect that to remain stable going forward. And you also mentioned that your funding cost is improving and your credit performance is also stabilizing. So I'm wondering if we could expect some stabilization or improvement to your takeaway going forward. Thank you.

[Alex Xu, CFO]

Sure. Alex. Let me take your question here. You are generally, you're right. Given that we are already reached a point in terms of pricing goal, based on the regulatory guidelines. So we don't see really too much pricing downward trend going forward for the remainder of the year. And with that, the overall take rate I would say you probably will see a more stable take rate.

If anything, there could be some improvement there, but of course, other factors you need to consider is the number one, the microenvironment and that will have I would say more impact than usual. If we have a rather stable microenvironment than other assumptions we can assume it will be a stable to maybe modestly improve take rate. But if some something, unexpected happening on the micro front, then there will be another question there.

From funding cost, as Haisheng mentioned, sure, second quarter we're 6.8%. And right now we are sitting at about 6.5%. So, there's maybe still a little bit room to go in terms of lowering funding cost, given the current money supply is pretty available out there. There may be some -- still some room to go, but overall I would say from our modelling perspective, we are conservatively, you can model a rather stable take rate, if you want to add some to it modestly, then that's also fine.

[Operator]

Next question. Is Richard [ph] from Morgan Stanley.

[Unidentified Analyst]

[Foreign Language]

Basically my question is on the competitive environment in China at the moment given 360 DigiTech is also aiming for low risk bars, basically it's also from overlap with the targeted customer by like, and banks etcetera. So what's the competitive landscape at the moment?

[Wu Haisheng, CEO]

[Foreign Language]

Yes, you are right. After we lower our average product price, the overlap of target markets with other drawings, like you mentioned, and banks that increased a little bit. However, we do not see the direct head-to-head competition with them. There are a few reasons. Number one, the consumer loan market is the grant market with multilayers. For example, banks, they have 10% price product and has 15%.

Our price range as we discussed previously, if we bring 22% to 23%. Number two, we believe different companies can arrive and prosper based on their unique competence, for example, and has tripled their unique ecosystem. For us, we do not have any eCommerce platform or eCommerce ecosystem. Therefore, we can collaborate with all the platform in the market and cover the full spectrum of customer groups.

[Operator]

And our next question is [indiscernible] CLSA.

[Unidentified Analyst]

[Foreign Language]

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

[Wu Haisheng, CEO]

[Foreign Language]

Okay. So our risk management team has been working with other teams closely to make several adjustments in the second quarter. Firstly, improving the quality of nearly acquired customers with the comprehensive coverage of RTA and in duration of the model. The number of our best quality customers has been doubled compared with the first quarter.

And secondly, improving the data mining of the People's Bank of China Quality Report, we have set up a joint project team and derived 18,000 effective variables from the quality report, covering the optimization of several models, including competitive offer exploration, high quality customers identification, bad customers identification, career model, income and liability model, etcetera. And in the meanwhile we evaluate customers with poor credit performance more cautiously.

Thirdly, we improved the resource allocation to high quality customers on the operation side, including pricing credit lines and promotions. With these actions, the credit performance of new transactions has been improved. We have seen that FTD 30 days, Q2 dropped by about 20% compares with first quarter and it's maintained a downward trend in July and August. With the academic outbreak, we can see lower rates, which truly demonstrates the resilience of our team and our asset.

Now over the results of some actions mentioned above have not been fully reflected as some actions are in pilot, we need to absorb long term performance. Therefore, with fully adoptions of these actions, we are very confident to retain stable risk performance in the future. As for 90-day delinquency rates, it will be lower in 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 can clarify your question.

[Operator]

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

[Alex Xu, CFO]

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