LexinFintech Holdings Ltd. (LX) Q3 2018 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by, and welcome to the LexinFintech Third Quarter 2018 Earnings Conference Call. [Operator Instructions]. I must advise you that this conference is being recorded today. I would like to hand the conference over to your first speaker today, Mr. Tony Hung, Senior Director of Capital Markets. Thank you, and please go ahead.

Thank you, Operator. Hello, everyone, and welcome to Lexin's Third Quarter 2018 Earnings Conference Call. The company's results were issued earlier today and are posted online. Joining me today on the call are: Mr. Jay Xiao, our Founder, Chairman and Chief Executive Officer; Mr. Craig Zeng, our Chief Financial Officer; Mr. Ryan Liu, our Chief Risk Officer; Mr. Stanley Zhou [ph], our Senior Financial Director; and other members of our team. For today's agenda, Mr. Xiao will provide an overview of our recent performance and highlights. Mr. Zeng will discuss our financial results, and Mr. Liu will discuss our credit performance. Before we continue, I refer you to our safe harbor statement in the earnings press release, which applies to this call as we will make forward-looking statements. Also, this call includes discussions of certain non-GAAP financial measures. Please refer to our earnings release, which contains a reconciliation of 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 renminbi. I will now turn the call over to our CEO, Mr. Xiao, whom I will translate for.

I am pleased to announce that we continued our strong performance in the past quarter. In spite of events in the P2P sector as well as general tightening, we continue to obtain the recognition and trust of more and more financial institutions and individual customers. As a result, we achieved our fourth consecutive quarter of strong growth since our IPO. In the third quarter, our loan balance reached CNY 25.8 billion, an increase of 62.1% year-on-year. Our registered users reached 32.6 million, an increase of 61% year-on-year. Our non-GAAP EBIT reached CNY 405 million, an increase of over 100%. I'm especially pleased to announce that our revenues from financial technology also reached CNY 405 million, an increase of 404% year-on-year. For the first 9 months of 2018, we generated close to CNY 1 billion in net income. Our ability to navigate challenging marketing conditions and to continue to deliver strong results is first and foremost because we have always positioned ourselves with strong growth. Recently, China's macroeconomic policy has shifted. Deleveraging has temporarily stopped. Taxes are being substantially reduced. Consumption is being encouraged, all factors that are creating a favorable environment for our growth. Our strong performance is also a reflection of the recognition by our customers and partners of our business model, a recognition of our commitment to build a business that is highly compliant with multiple funding sources, consumption scenarios and a strong commitment to financial technology, the 3 cores of our business, which continue to pay dividend. On having multiple funding sources, Lexin, as a financial technology platform, began the process of attracting institutional funding partners at an early stage. Recently, we have announced a signing of a strategic cooperation agreement with the Bank of Nanjing. Recently, the institutional funding on Lexin's platform has exceeded 70%. As a result, we're happy to say that we were able to control the impact of the recent events in the P2P market on our business. In the third quarter, our total loan originations reached CNY 13.7 billion, of which CNY 5.58 billion were originated in September, which was 40% of the total for the quarter. From our September number, it is clear that our business has clearly already recovered. On the establishment of consumption scenarios in third quarter, we saw both central and local governments issuing new policies to increase consumptions and repeatedly placing an emphasis on consumer finance. Benefiting from this, in the third quarter, Lexin's e-commerce platform's GMV increased by 33.8% year-on-year, faster than both China's overall retail growth or China's overall e-commerce growth. During Singles' Day, our Fenqile e-commerce platform generated overall over CNY 100 million in GMV in 29 minutes, setting a new record, representing an increase of 200% year-on-year. We continue to strengthen the advantages provided by our Fenqile e-commerce platform. On our continued investment in technology in the third quarter, our risk management and operational systems continue to grow and improve. Lexin's artificial intelligence risk management engine, Hawkeye, completed multiple iterations developing location-based concentration anti-fraud methods, new user risk profiles and smart diagrams, user repayment projection analysis and automated asset quality analysis and other new processes, greatly improving our risk management capability. At the end of the third quarter, Lexin's 90-day-plus delinquency rate was 1.39%, maintaining a stable level. Lexin also established a new smart finance platform using smart finance concepts and artificial intelligence techniques, extending from the front-end client facing side to middle and back-end management, enabling us to increase the effectiveness of our innovations and R&D. We have reason to believe, as regulatory clarity continues to improve, Lexin, a company built by consumption scenarios and an ever-strengthening financial technology platform, will have even greater potential for growth in the future. Next, I'd like to invite our CFO, Craig, to discuss our financial performance.

Thank you, Jay, and hello, everyone. I'm pleased to announce that in spite of the difficult funding conditions in the market in July and August, we have once again delivered strong results. In the interest of time, I will not go over line item by line item of our financials. For a more detailed discussion of our third quarter 2018 results, please refer to our earnings press release. Total operating revenue for the third quarter reached RMB 1.7 billion, driven by a significant rise in our loan facilitation and service fee. It should be noted that the rise in our loan facilitation fee was primarily due to the significant increase in off-balance sheet loan origination on our platform as a result of continuing growth of our business as well as business model adjustments. Adjusted net income was RMB 354 million, an increase of 213% from the same period a year ago, reflecting our continued strong growth and performance. Net income per ADS for the third quarter of 2018 was RMB 1.72 on a fully diluted basis. Non-GAAP fully diluted net income per ADS was RMB 1.93. We continue to see the future potential of our business model. In the performance of the customer cohort, whom we acquired in the first quarter of 2015, good balance has now risen to over RMB 11,500 and whose 30-day delinquency rate is still approximately 1% with a stable level of quarterly active -- activity rate at 44.1%. Our operating leverage continued to improve. Operating expenses as a percentage of average loan balance decreased to 4.9% in the year-to-date versus the 6.3% for 2017. Non-advertising marketing, advertising, G&A and R&D decreased to 1.7%, 0.6%, 1.2% and 1.4% of average loan balance, respectively. We currently have 32.6 million registered users and close to 9.6 million customers with credit lines, up from 7.6 million at the end of 2017. Overall, our average credit limit is approximately RMB 8,700, while our tenor has increased to 13.6 months. Our effective APR was at 23.2% for on-balance sheet loans. In terms of our funding, at the end of the quarter, approximately 50.7% of our funding came from our Juzi Licai platform and 49.3% of our funding came from institutional funding partners. This is for loan balance. Our sales and marketing side, we continue to maintain low customer acquisition cost. Customer acquisition cost per active customer were RMB 97 for the third quarter of 2018, and we acquired nearly 700,000 new active customers in the third quarter. For our fourth quarter guidance, we continue to expect strong growth and believe we will achieve RMB 17 billion to RMB 19 billion in loan originations for the quarter. I'm also pleased to announce that we recently completed a 0.12 strategic investment in Chung Wei Insurance [ph], which will give us greater strategic flexibility in the future. Next, I will invite Ryan. Ryan will discuss our credit situation. Ryan, please?

Thank you, Craig. We continued our strong and stable credit performance in the third quarter of 2018, and we continue to see positive results from our continued strategy of focusing on the educated young adult customers. Over 90 days plus delinquency ratio remains low at 1.39%. And we continue to see strong performance, and our lifetime charge-off ratio remains at around 2% to 2.5%. In the third quarter of 2018, our NPL ratio for on-balance sheet loans was 3.01%, and our NPL coverage ratio was 171.4%. In spite of the market and microenvironment conditions, we do not see any significant change in our credit quality that is outside of our range of expectations. Again, our credit quality is stable, and we expect that the overall charge-off ratio and the other credit statistics to remain at approximately the same level. With that, I conclude our prepared remarks. Operator, please proceed.

[Operator Instructions]. Your first question comes from the line of Jacky Zuo with Deutsche Bank.

I will translate my questions. Basically, I have three questions. First one is on sales and marketing cost. The sales and marketing cost actually went down Q-on-Q, and also the customer acquisition cost went down as well. So just want to get some color on this cost and also try to ask the breakdown of customer acquisition channels and the future strategy on customer acquisition. Second question is related to institutional funding. So we saw a strong institutional funding in Q3. Just try to understand how many institutional funding partners do we have now. How much of the loan quota -- funding quota do we have? And recently, we saw the news on the tightening of the loan presentation corporation with institutions, especially with regional banks. Do you have any preparation for this tightening? And third question is regarding to the Q4 guidance. We actually expect a strong Q4 performance, so just want to try to get some color on the recent performance in October and November.

So regarding your first question, Jacky, on the overall sales and marketing situation, so third quarter, as mentioned, was a little bit tricky. So we decided to be much more conservative and careful with our marketing. But fortunately, our marketing team continues to be highly efficient, so we were able to acquire a lot of customers at a very reasonable cost. However, we have to stick with the previous numbers and guidance, which is probably more accurate for longer term at CNY 100 to CNY 200 for the customer acquisition. That's definitely still the case. And in terms of our customer acquisition methods, there really hasn't been any major change. It continues to be the methods that we previously discussed, but we will certainly continue to use them and improve upon them. Yes. Now in terms of what we mentioned earlier about the new draft policy that was put out, basically, we're quite optimistic about it and the implications from it because, previously, there were a lot of financial institutions that did not have a framework for operating. And now there is increasing regulatory clarity for the assisted lending and assisted loans model. So the other thing that the document indicated were limits and actual limits and percentages, et cetera, which we feel very positive about and can also sometimes be misinterpreted because, on one hand, while there is limits to banks, the scale of the Chinese banks are actually quite large. It sets aside a very, very clear percentage, but there's still a very large percentage available of the hundreds of billions that are out there among these banks. And if you look at our scale, our scale is maybe something like 20 billion right now. So we had access to be to the hundreds of billions. It actually increases our potential. So hence, we're very positive about this. But obviously, everybody's waiting for the final draft. And the other thing that I'd like to emphasize is, as mentioned, we're a platform built on multiple funding sources. Whether it's funding sources such as trust, ABSs or otherwise, we've always established multiple funding sources. And as you can see from our third quarter results, it's a clear reflection of our ability to adapt due to the fact that we do have these multiple sources. With regards to your third question on the loan originations for October, what was mentioned -- we've given guidance for the fourth quarter of CNY 17 billion to CNY 19 billion. And as we just emphasized earlier, in September, there's clear numbers that -- indicating that our business is very much back on track. And it's safe to say that, for October, our business once again is back on the historical track of growth.

Your next question comes from the line of Cindy Wang from DBS.

So my question is take rate in third quarter was 7.8% versus 6.9% in second quarter this year and 5.6% in third quarter last year. However, the APR was 23.2% in third quarter versus 25.7% last quarter. So what's the driver for the take rate to increase in third quarter? Is that coming from the decrease in cost of funding side? Or any other drivers? So are we going to see the trend continue in fourth quarter and next year?

Yes. So basically, with regards to the 23.2%, for example, that's obviously on-balance sheet calculation only, which is easier to provide. We talk about the off-balance sheet number, it would be a slightly different calc, and as a result, it may lead to some slight confusion. Now overall, because of what occurred in the third quarter, where there's an increasing amount of off-balance sheet items, as a result, the off-balance sheet is higher, so it's actually going to be hard to do what you just did, which is derive directly what the take rate really is. But what I can say is that the take rate is actually quite stable. Obviously, it depends on what's happening with the cost of funding and other things, but generally, it is quite stable. And basically, Cindy, more than happy to talk to you in more detail later on about the calculations.

Your next question comes from the line of Alex Ye from UBS.

So I have two questions. First of all, we learn from your remark that Lexin has invested in an insurance company recently, so I wonder what will be the implication on our third-party guarantee or insurance policies going forward. And what's the latest progress on our compliance for -- and registration process? And second question is about the accounting impact. So given that we are going to adopt the ASC 606 accounting policy next year, which will allow us to recognize our revenue upfront, so I wonder what would be the impact on our take rate. Can you give us some guidance on this?

Alex, with regards to your first question, with regards to, first, the investment in the insurance company, as -- although, currently, if you look at the macro policy of the government, it's presenting a very unique opportunity for us. The central government is certainly encouraging insurance companies to enter the consumer finance market. And then fitting with the strategy, we had a unique opportunity to invest in an insurance company and, hence, we took the opportunity. Now in terms of the potential positives to our business, currently, we're certainly in discussions with our new strategic partner. We're discussing various options and various ways that we can work together. However, at this time, there's no real concrete details, so it would be a little bit premature to talk about some of the strategic directions. However, we certainly believe that this is a long-term, strategic positive, and this is something that should bring additional opportunities to us. With regards to the P2P registration, we submitted timely submissions to all the relevant authorities under the government time line, and we've definitely done that and was one of the first companies to do that. And we'll continue to be one of the first companies to basically adhere to whatever time lines the government issues and be first to be aware of what -- to be compliant with the relevant authorities. So Alex, with regards to the question around the adoption of ASC 606, obviously, a lot of the companies have not -- most or all of them, in our space, have already adopted that policy for revenue recognition. And obviously the main impact is just the timing of the revenue recognition. Now the thing that makes it a little bit more complicated in our case is that in the event that we do adopt it, we will also no longer be an EGC. So hence, there will be other impact that also that we would need to be prepared for it, EGC being emerging growth company. And also in terms of the actual final impact, I mean obviously, the primary thing is just that there will be earlier recognition of revenues. And in terms of modeling and how the projections and numbers will work, it would tie more to originations as opposed to outstanding balances. Historically, we've always been more conservative with our revenue recognition. And in the foreseeable future, we may have to adopt the ASC 606, but we're still analyzing the exact potential impact. So hence, there's still some analysis to be done on our end on this.

Yes, but just adding 1 point, like you see the impact for some other companies been using the -- apply for 606, the impact, if any, should be the positive impact for the whole result.

Your next question comes from the line of Miranda Zhuang from Bank of America Merrill Lynch.

. I have two questions. The first one is can management comment about the trends of funding cost in September and October? And what's the expectation for the fourth quarter? And then my second question is, in the prepared remarks, management mentioned about the upgrade of the risk management engine. So can you elaborate more on what's new in this engine and any initial improvements in risk management that you have seen?

So first on the cost of capital, on the institutional funding side. Basically, there can be times when there are faster changes because it is institutional funding. And over the fourth quarter, the cost of funding from institutionals is definitely getting better. That said, this doesn't necessarily have -- has a direct impact on everyone's businesses because, for example, if your cost of capital, cost of funding rises then, in turn, that might translate actually into higher APRs for your customers and occurs vice versa as well. So it might not be actually that direct an impact overall. And when times are a little bit tougher, we would take steps to protect our customers and to ensure that they have a quality experience. But when times are much better and there are much more better avenues, if you will, and cheaper sources of funding and we have more choices, then at that time we would probably be able to pick and choose a bit more. So with regards to the second question, with regards to new functions of the risk management or the Hawkeye system, during the third quarter, we've performed on our multi-systems, multiple iterations of models. Few examples of which is with regards to our antifraud system and the iterations there, we were able to contain the new frauds detected to under 50 cases using the new system. Given that there are instances where we're dealing with thousands and thousands of cases, to keep it under 50 is actually quite an achievement. Also regards to the second example on asset quality, the asset performance and the credit performance monitoring system will also conduct doing various iterations. And every week, we can isolate a couple of high-risk segments and provide additional details and precisions within the system. So again, this is something that now we're doing on the asset level as well as we're getting into more and more details and more and more precise analysis of our assets. So in terms of the automated monitoring, I like to also emphasize that now, on a monthly basis, the monitoring of the different segments can be done into the different segments, whereby each segment of the current month is compared to the previous month's segment and we can detect immediately what segment of our customers is having a particular trouble. And there can be automatic alerts that come to our system. And this is allowing us to have greater precision in our analysis of credit and also greatly reducing the need for manpower for assessing the various cases. So this is all driven also by our artificial intelligence engine.

Your next question comes from the line of Tian Lu and Lucy Li from Goldman Sachs.

So the first question is on funding. So just want to double check on the proportion of bank funding within the institutional funding and maybe in particular how many banks you're working with out of the 30-plus financial institutions. And also on the P2P side, the P2P funding balance should have declined quarter-on-quarter. What's our forecast or expectations going forward? And the second question is on the on and off- balance sheet loan transfer, is it largely finished? Or should we expect another 1 or two quarters for the process to finish? And what's the venture split of the on and off-balance sheet loan?

So Lucy, with regards to your question on the funding sources, with regards to what percentage is from banks, we haven't disclosed that in the past, but the majority of the funding is definitely from banks. And on your second question with regards to, due to our P2P and its future's percentage. We haven't taken any of the royalty way policy of growing our P2P balance per se or growing it strongly. Where the focus has been has been much more on cultivating our institutional funding sources because of the flexibility and the strategic value that, that brings. And we're certainly confident that, in the future, because of the fact that we have spent so much on cultivating this relationship that it will be one of the keys to our continuous strong growth. Yes, so Lucy, with regards to your second question on the transition from on to off balance sheet, as you know, due to the -- our P2P is now largely moving to off balance sheet, if not completely. Now that's not to say that there will be nothing on the balance sheet. There will still be some ABS, some trust, et cetera. But it's safe to say that in the near future, the main -- or the majority portions of our loans will be off-balance sheet.

Your next question comes from the line of Anderson Cha from BNP Paribas.

This is Anderson Cha calling from BNP Paribas. Let me ask 3 questions. First, with regards to the average loan ticket size and average loan tenor, can you share your expectation at which level those indicators would settle eventually? And the second question is can you give us more color on lower provisioning expenses compared to the second quarter and also gain on guarantee liabilities as opposed to the losses last quarter and how these line items would change in the coming quarters in relation to your current expectation about credit performance in the coming quarters? And relating to that, given our view that -- I mean, our credit performance pressures in the coming quarters, are you comfortable with increasing overall loan duration at this time? And my last question is based on my calculation of our margin on your e-commerce division appears to have improved in the past couple of quarters. And can you share any expectation in the coming quarters?

Sure, no problem, Anderson. Let me translate your questions for the team for a second, so hold on just a little bit.

Okay. Regarding your first question about loan size. Because our customer actually has been growing, so the ticket size -- we're not talking about like a 1-transaction ticket size per customer, loan balance actually may grow as we -- our customer -- each distribution will be more like flat. So you probably were expecting the loan size for each of our customer to be growing. As long as when our loan size has been growing, the duration will be growing probably a little bit, but we're not expecting things being changed there too much. The second is, if you're looking at our loan quality, actually, we're more likely to describe it as more stable. So the changing number of the guarantee liability on the line actually is more like an accounting calculation on how to book different things in different lines. So we probably can have more discussion there off-line with -- you can have that discussion with Tony or Stanley, our Senior Director of Finance. So but overall, we've been looking at our -- our loan quality being quite stable. We're not as concerned about the increasing of tenor as I explained earlier. The increase of the tenor and the loan size was more driven by our investing customer, which we have been -- have followed their risk profile for a while and their financial conditions, their incomes have been growing over that time. So for those customers, we have experienced how to give them credit lines and tenor to minimize the impact on risk. Your last question about our e-commerce. Our e-commerce business turned profits since fourth quarter of last year because it's a more diversified e-commerce site, used to be will be more focused on the prepaid products, as you know, our e-commerce was installment-only e-commerce. So we tend to share some of our product margin to our customer and to encouraging them to using our platform because we still can gain from the financial margins. But for -- now our products in the e-commerce are now back from including the prepaid products. We have more product lines and some of the lines have a better margin. So we actually don't need to share that much with the customer and we still can have a margin. And so we're not expecting the e-commerce have like a huge margin in the future. But they're being more breakeven to slightly profitable basically what we've been targeting right now.

And regarding to the loan performance, I would like to add up something. So you see the purpose of risk management in this company is to maximize the profitability by balancing the risk and the rewards. So we are not only looking at the charge-off ratio. It's the only parameter we manage that is not that big. So for some business, currently, as you see in the chart, that is around 2%, the bottom is around like 2.5%. So for the customer -- those adding up about -- we feel that 2.5% in that range is quite comfortable for us. So in some cases, we will do some tests and we'll see if there's a possibility to like open our door a little bit to welcome a customer coming for some like high segment as I mentioned earlier so with some technology we can identify through our AI systems and we'll be able to take positives to minimize the risk. So you see the overall performance, we try to keep it as stable. And for -- in the future and we think this trend would be continued.

Your next question comes from the line of John Sy [ph] from Morgan Stanley.

So I have two questions and the first one is on the customer acquisition. Actually in the third quarter, there's funding availability issues of the sector. Despite we reduced our budget for customer acquisition, we actually see the new customers increase to around 700,000, which is not pretty higher than the previous two quarters. I would like to understand the drivers behind that. And the second question is about R&D, and we see the R&D expense for the third quarter as a pretty decent increase on a Q-on-Q basis or on a year-on-year basis. So I was wondering if the management can share the allocations of the R&D. And what's the expected levels of the coming years and how would the R&D expenditures improve our efficiencies and on what metrics?

Yes. So John, with regards to your first question on customer acquisition. I think it's probably worth noting that, in general, the third quarter tends to be a high point for us versus especially, for example, the first quarter, where there's the Spring Festival or even the second quarter, in fact. And also, we were very careful and selective with the allocation of our marketing dollar. And hence, we were quite successful in the third quarter as well. Regarding your second question on the R&D, we'll continue to invest and spend in the R&D and as mentioned, we will continue to put the marketing -- sorry, put the R&D dollars into many areas, not the least of which will be risk management. And in fact, we have a separate R&D team for risk management which is actually relatively unique in the industry and, as Ryan mentioned earlier, the many, many new things that we're trying and we're doing that were ongoing and testing on with regards to the risk management R&D. Also, we're doing things with new technologies, with various parts of the financial ecosystem and platform, so that's also areas where the R&D dollar is going. There's some things that we don't expect to see any real returns in the immediate future. But long term, we know that the payoff could be quite substantial. So whether it's things like watching or whether it's things with our financial platform or ecosystem or, of course, as just mentioned, with our risk management, there is a whole variety of areas that we're putting our R&D dollar into.

Can I have a quick follow-up? Just wonder on the new customer, and I think probably they will have a higher APR and because they're new, so we probably use the new money to fund them. And the new money is typically off-balance sheet based on my understanding. So can I -- I'm not sure if that's true. So the off-balance sheet APR would be higher than the on-balance sheet.

Not necessarily. Our balance sheet -- actually, well, we're -- overall, we had -- we're -- it depends, really depends on the customer. So it's not depends on -- on our balance sheets, we have a different sort of pricing, it's more like with the customer itself and which categories they fall in that may have a different price strategy.

There are no further questions at this time. I would like to hand the conference back to today's presenters. Please continue.

Thank you, operator, I think you can now conclude the call.