Qfin Holdings - Q1 2019

Transcript

Operator (participant)

Welcome to the 360 Finance First Quarter 2019 Earnings Conference Call. All participants will be in a listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star, then one on your touchtone phone. To withdraw your question, please press star, then two. Please note this event is being recorded. I would like to now turn the conference over to George Shao, Head of Investor Relations. Please go ahead.

George Shao (Head of Investor Relations)

Hello, everyone, and welcome to our First Quarter of 2019 Earnings Conference Call. Our results were issued earlier today and can be found on the IR section of our website. Joining me today on the call are Mr. Jun Xu, our CEO; Mr. Haisheng Wu, our President; Mr. Alex Wu, our CFO; Mr. Yan Zheng, our Vice President; and Fan Zhang, our General Counsel. Before we begin our prepared remarks, I would like to remind you of the company's safe harbor statement in connection with today's conference call. Except for any historical information, the material discussed on this conference call may contain forward-looking statements. These statements are based on our current plans, estimates, and projections, and therefore, you should not place undue reliance on them. Forward-looking statements involve inherent risks and uncertainties.

We caution you that a number of important factors could cause actual results to differ materially from those contained in any forward-looking statement. For more information about the potential risks and uncertainties, please refer to the company's filings with the SEC, including its registration statement. In addition, this call will also include discussions of certain non-GAAP financial measures. Please refer to our earnings release, which contains a reconciliation of the non-GAAP measures to the most directly comparable GAAP measures. Finally, please note that unless otherwise stated, all figures mentioned during this conference call are in RMB. So with that, I will now turn the call over to our CEO, Mr. Xu.

Jun Xu (CEO)

All right. Thank you, George, and thank you all for joining us today. We're pleased to report another strong quarter. I will cover four aspects of the business. First, we keep setting new records in terms of growth. We originated RMB 41 billion of loan, and the outstanding balance reached RMB 53 billion, widening our leadership in the sector. We continued to invest heavily in the future. We added 3.5 million new users with credit line and 2.2 million of borrowers. Both are new records for the company. We will continue the growth strategy for the next couple of years. We have less than 1% of the consumer lending market in China, and the headroom for growth is immense. The return on investment for new customer acquisition remains very attractive. We don't want to be a niche player.

Our aspiration is to be a leading platform and serve most of the Chinese households with borrowing needs over time. We believe in our sector, growth is a privilege for leading platforms rather than a choice. It requires a platform to possess the ability to source new customers at scale, to secure sufficient funding, and to manage credit risk well simultaneously. Therefore, we have been seeing the market become increasingly concentrated in the last 18 months, and we anticipate the leading platforms will continue to grow faster than the industry average. Secondly, I will talk about our credit quality. In spite of the faster growth, we continued to lead the industry in credit quality. 90-day plus delinquent ratio was 0.94% as of March 31st, 2019.

Then the annualized vintage loss rate, which is the ultimate, ultimate metric we look at, continued to be within our expected rates and lead the industry. In line with our aspiration to serve most of Chinese households with borrowing needs over time and leveraging our improved credit risk management skills, we proactively extended services to users with different risk-adjusted returns. Although these near-prime segments carry higher charge-off rates, they generate higher risk-adjusted returns, netting the effects of higher APRs and risk costs. In addition to serving more near-prime segment customers, we are also working on improving activities and the stickiness of the super prime segments. We created a dedicated team for it to make sure we provide more tailored lines and pricing for our best customers. We hope this will become another important source of growth for us going forward. Thirdly, I'll comment on the funding situation.

In Q1, we substantially increased the number of funding partners. Most of the additions are national financial institutions that can do business across the country. I think it's from what we can see, our needs for the year are multiple times covered by the national financial institutions by now. Through our internal stress testing, even the rumored restriction on regional banks' ability to disburse loans nationally came into effect immediately, our funding availability and the funding costs shouldn't be adversely affected. We're very pleased to report that on February the 1st, we issued our first ABS at the Shanghai Stock Exchange at a funding cost of approximately 5%. In Q1, we gained approval for RMB 10 billion such securities in 2019 at both Shanghai and Shenzhen Stock Exchange.

Thanks to the stimulating financial and the liquidity environment in China, we observed downward trend in funding costs with our financial institution partners, and I believe the trend will materialize into noticeable funding cost reduction in Q2 and the rest of the year. Lastly, I want to comment on the strategy of shift to financial technology platform. The percent of loans we don't take credit risks has risen significantly in Q1, and we expect this will further increase significantly over the rest of the year. We referred over three million customers to banks, consumer finance companies, and other lending platforms in Q1, where we do not take any credit risks. We launched four financial technology products, and it covers credit scoring, propensity to borrowing scores, credit hungry scores, and blacklist checking. This is a part of our efforts to open our capabilities to third-party lenders.

15 institutions are testing the products at the moment, including banks like ICBC. With that, I will pass the call over to Alex Wu, our CFO, to give an update on the financial situation.

Alex Wu (CFO)

Thank you, Jun. Hopefully, you all have the, have had the chance to take a look at our earnings release already, so I will try to keep my comments short, so we have more time for the Q&As. As Jun just mentioned, we saw 235% growth on our top line on a year-over-year basis, 303% growth in operating income, and 335% growth in our non-GAAP operation income. Three hundred and forty percent growth in our net income, and 382% growth in our non-GAAP net income. So not only are we growing extremely quickly, we are also gaining more operating leverage as we continue to scale our business.

Breaking, breaking this down a little bit more, our total net revenue was mainly driven by loan facilitation services, which increased 248% compared with the first quarter of 2018. The rise was mainly due to an increase in loan origination facilitated by our platform, which increased 179% for the same period last year and increased 25% from last quarter. In terms of the cost structure, it mainly includes three items: origination, servicing, sales, marketing, and G&A expenses. Given all the numbers disclosed in the report, let me just give you a little bit more flavor on the details. The percentage of the operating and servicing expense, obviously, excluding share-based compensation of the revenue, was 10.6%, compared to 14.1% last quarter.

The percentage of G&A expense, excluding SBC of the revenue, was 2.4%, compared to 2.7% last quarter. This speak to our increasing operating efficiency. While the percentage of sales and marketing expense, excluding share-based compensation, expense over revenue, was 34.3%, compared to 30.1% last quarter. The increase of this percentage was because we view our sales and marketing expense more of a long-term investment, since each new customer to our platform will continue to contribute to our business on an ongoing basis. In terms of margins, our non-GAAP operating margin in the first quarter was 46.2%, which is a solid improvement from 35.6% in the first quarter of last year.

Our net margin in the first quarter was 35.8%, which was higher than the 27.3% level we hit in the same quarter last year. On a non-GAAP basis, when we take out the share-based compensation that I mentioned earlier, our net margin goes up to 39.3% for first quarter. Again, these numbers speak to not only the greater economies of scale as we grow our business, but also the hard work we have put in to streamline our operations and improve efficiency. Finally, moving over to the balance sheet, our total cash stands at RMB 3.4 billion, including cash, restricted cash, and the security deposits prepaid to the third parties.

Our total cash increased 20% compared with the number by the end of 2018, which provides a solid foundation for to our growing business and daily operation. One other item, line item, that I would like to point out is our loan receivables. This jumped from RMB 888 million at the end of the year, to RMB 1.9 billion by the first quarter of this year. This was mainly because we increased our cooperation with trust and issued ABS to diversify our funding source, as Jun just mentioned. We do plan to issue more ABS in the future. All in all, we believe we have a very solid financial performance that gives us both a substantial cushion and significant firepower as we expand our business.

With that, I will conclude our prepared remarks, and we will be happy to take your questions now.

Operator (participant)

Thank you. We will now begin the question and answer session. To ask a question, you may press star then one on your touchtone phone. If you are using a speakerphone, please pick up your handset before pressing the keys. If at any time your question has been addressed or you would like to withdraw your question, please press star then two. At this time, we will pause momentarily to assemble our roster. Our first question today comes from Richard Xu with Morgan Stanley. Please go ahead.

Richard Xu (Managing Director and Senior Equity Research Analyst at Morgan Stanley)

Hello, management. Thanks for taking my questions. I basically have three questions. The first one is, regarding to the cash management. Noted that a decrease of RMB 106 million cash balance in the first quarter, does the management see some further decline maybe in the next few quarters, or, does the company have a internal mandated cash ratio as percentage of total loan balance or, you know, something like that? And the second one is, regarding to the take rate. Our quarterly take rate shows some improvement in the first quarter. As the management mentioned, it's because of the, higher facility and service fee and post origination service fee and et cetera. I just wanna ask if there is any change on the product pricing, funding costs or credit costs front?

The third one is on the acquisition front, customer acquisition front. We noticed a RMB 770 million sales and marketing expenses in the first quarter, and just wanna check if the management's outlook on the customer acquisition going forward, both on the cost and acquisition channel fronts. Thank you.

Jun Xu (CEO)

Okay. So on the cash position, Alex, would you like to take that?

Alex Wu (CFO)

Sure. Thanks, Joey. This is a very good question. Actually, we want to address that. As I mentioned in our remarks, when you read our cash position, you should look at the three items. The first item is the cash and cash equivalents, the other one is the restricted cash, and the third one is the security deposit prepaid to third party guarantee company. Basically, all these three items are our cash. The reason they put in the different category, just because of business nature, in the rough sense, for $100 loan origination, we need to put in $5, as some kind of a deposit to the, an institution working with us. So, it's not a cash position decrease, in the past quarter, it's...

In total, actually increased by 20%. It's just, most of the cash went into the restricted cash and the security deposit prepaid to third-party guarantee companies. Hopefully, I, this will answer your question.

Jun Xu (CEO)

Yeah. On the take rate and the pricing, funding cost, credit cost. Overall, the pricing and the funding cost has remained very quite stable compared to the previous quarter. The credit cost actually has improved over the previous quarter, and it's below our expectation for Q1. So net-to-net, we see the APR as being stable. Funding cost, as I mentioned earlier, is trending down, and we will see some noticeable numbers in Q2 and the rest of the year, hopefully. And the credit costs were positive, will stay stable and remain well below our internal budget. I'll pass to our president, Haisheng, to address your question on customer acquisition.

Richard Xu (Managing Director and Senior Equity Research Analyst at Morgan Stanley)

Um,

Haisheng Wu (President)

...We now only have over 10 million users. We now only have over 10 million users. We are within the enormous consumer credit market. We have, you know, potentially billions of users. And right now, we are only in a position of acquired over 10 million users. Honestly, we still think we are in a early stage of development. And as our CEO mentioned, our headroom for growth is immense. You know, our return on investment and the customer retention is looking very good. What we believe is our current expenses spending on marketing is a long-term investment for the future.

And as to our, you know, outlook for cost of new customer acquisition, I think we're gonna, our future spending is gonna be in line with what we just mentioned, our, you know, our belief in the future. As to new channels, well, we are exploring different new channels on the basis of, you know, utilizing our current channels. We are keeping a very open-minded. Right now we are exploring several new channels, some of which looking very promising. For example, you know, our experiments with Kuaishou and Tencent channels has become very effective. Also, we are exploring in the e-commerce platform.

Richard Xu (Managing Director and Senior Equity Research Analyst at Morgan Stanley)

Okay.

Operator (participant)

Our next question comes from Jiang Zhang with China Renaissance. Please go ahead.

Jiang Zhang (Equity Research Analyst)

Hi, guys. Good evening, and congrats on the good quarter. So I got two questions. One is regards to the mix of the institutional funding partners. So within that, like, how much of that is national, and how much of that is regional financial institutions? And the second question I have is, can you just, you know, provide more color on the ABS products, and give us a sense of, like, what kind of scale are you guys are looking to achieve in the next two to three years? Thanks.

Jun Xu (CEO)

Okay, thanks. In terms of institutional funding, what we look at is not the actual composition. What we focus on is, among all the funding partners working with us now, how many of them are national, and how many of them are regional? As I said earlier, from what we can see now, our demand for funding this year are multiple times covered by national FIs, who have relatively lower cost of funding. So, unless something dramatic happens to the overall financial and liquidity situation in China, we're pretty proactive about our funding availability and funding cost for the rest of the year.

As I said earlier, the funding costs are trending down, and we're we will be able to report some actual numbers going forward. In terms of ABS, for this year, we've gained approval for RMB 10 billion ABS issuance with Shanghai and Shenzhen Stock Exchange. We're also, in the meantime, discussing ABNs. Now, ABN is another form of ABS that's issued on the interbank market. So for this year, we're looking at at least RMB 10 billion. And going forward, we would like to make ABS a much more important and source of funding as our assets have become more well-known to institutional investors. So we do anticipate ABS as a source of funding will become much more important for the next two or three years.

Jiang Zhang (Equity Research Analyst)

Okay, great. Thank you very much, guys, and congrats again.

Jun Xu (CEO)

Thank you.

Operator (participant)

Again, if you have a question, please press star, then one. Our next question today comes from Daphne Poon with Citi. Please go ahead.

Daphne Poon (Equity Research Analyst)

Hi, thanks for taking my questions. So, first, I would like to actually have a follow-up on the sales marketing expense. So if we look at it on a per new user basis, we see that actually has gone up, now, close to 200 RMB per new user, based on our calculation. So I'm wondering if that is, you see that as more of an industry trend because of increasing competition, or is, is more because you're doing a more aggressive customer acquisition efforts in the quarter? And, second is on the vintage delinquency rate.

So, if we look at the vintage loss rate for the 2Q 2018 cohort, we actually see the curve has gone up a little bit steeper, while we see the long duration is actually pretty stable. So I'm wondering, like, how should we interpret that or any particular reasons behind? And third, like, lastly, is on the I remember last quarter, we talked about a new initiative on the SME lending, like partnering with some banks. So wondering if there's any update on the progress on that front. Thank you.

Jun Xu (CEO)

Okay. I'll start with the first two, and I'll ask Alex, our CFO, to answer your third question. On customer acquisition cost, yes, it has gone up a little bit, it's within our budget. It's also in line with our observation of the rising acquisition cost across the market. And in particular, this year, as funding situation has improved for the sector, we see more competition on the traffic front. But again, if you look at return on investment, we're still very, very positive about this kind of spending, and this is actually below our internal budget in terms of customer acquisition cost, unit cost. On the delinquency rate, it's not that our risk has deteriorated.

It's driven by the shifting mix of our portfolio, as I mentioned. As we gained more confidence and experiences with our credit model, we increased the share of near-prime customers, where we price them close to 36 APRs and as a percentage of the portfolio. And as I mentioned, although their charge-off rate is a little bit higher, but APRs more than enough to offset that effect. So if you look at the same pricing cohort, as I mentioned earlier, the credit cost actually has improved in Q1, compared to the previous quarter. Alex, can you take-

Alex Wu (CFO)

Yeah.

Jun Xu (CEO)

the SME question?

Alex Wu (CFO)

Yeah. So in the past quarter, we are still testing this, the product. You know, we basically. Right now, we have the focus on the existing borrowers. We will check their behaviors and see whether they are more like SME or more like individual. That is our key pilot product at this moment. At the meantime, we are trying to find more scenarios and to get more familiar with different scenarios and help the small SMEs in that specific scenario to increase their business scales. Overall, given that there is no numbers disclosed in our quarterly report, we can't disclose any details. But, and what we can say is, this small business SME business is on the right track.

We will give you more updates when it is mature enough to show its individual data.

Operator (participant)

Again, it is star, then one, to ask a question.