Lexinfintech Holdings Ltd (LX) 2018 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to the LexinFintech Second Quarter and First Half 2018 Earnings Conference Call. (Operator Instructions) I must advise you that this conference is being recorded today.

I would now 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 Second 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, 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.

(foreign language)

I'm very pleased to announce that in the second quarter of 2018, we have continued the strong growth from previous quarters and have achieved solid results. At the end of the second quarter, our total registered users reached over 29 million, an increase of 80% from the previous year. Total loan originations reached CNY 16.6 billion, an increase of 68.4%, and our total outstanding loan balance reached CNY 24.7 billion, doubling from a year ago. In the second quarter, our adjusted net income reached CNY 502 million, achieving an all-time high. Overall, we have reached a stage where we are reaping the benefits of our investment in our financial technology. In the second quarter of 2018, Lexin from various financial services had achieved financial technology revenues of CNY 232 million, an increase of 339% year-on-year.

(foreign language)

Lexin spent 1/3 of our operating expenses on financial technology. In the first half of the year, we invested CNY 146 million, an increase of 45% versus last year. These investments allow us to not only achieve increasing business scale, but also greater operating efficiency. In 2015, our operating expenses represented 17.3% of our average loan balance. In 2016 and 2017, these costs were reduced to 8.9% and 5.8%, respectively. To date, our operating costs again declined to 4.7% of our average loan balance. Today's Lexin in every part of our operations is already fully utilizing AI technology and dramatically increasing our service quality and efficiency. Lexin's Hawkeye smart risk management engine utilizes over 7,500 risk model data points and can automatically process 98% of all orders [and] produce instantaneous results. In addition, our workflow system enables us to handle vast quantities of small individual loans, connecting financial institutions with borrowers, while accounting for differences among individual users, order type and asset quality, automatically determining the right credit level, pricing in accordance to the needs of the financial institution and providing them with assets instantaneously for their final review and approval. This entire process is fully automated with little manpower required. This greatly improves the loan acquisition ability as well as the loan quality of our funding partners. In the second quarter, Lexin's delinquency ratio remained low at 1.39%.

(foreign language)

Recently, there have been some noncompliant wealth management platforms exiting the market, which in turn, has impacted investor confidence and our related business has been impacted to a degree in the short term as well. In August, we saw that confidence from both our financial institutional partners and our Juzi Licai investors has clearly returned. That path, the path that Lexin is committed to, is one the regulators have also encouraged a commitment and belief in the use and strength of financial technology to better serve and improve the efficiency for our funding partners and to better service individual customers when solving consumption needs.

Recently on August 18, the CBIRC issued document No. 76, which seeks to say, "Expedite the development of consumer finance, strengthen the impact of consumption on economic growth, to add diversified products with different levels of consumption needs and to provide an improved differentiated financial product and services to support developing consumer finance, satisfying consumer consumption needs to create new financial services paradigm and to satisfy the consumer financial needs for education, health, culture, travel and other products."

(foreign language)

Thank you. Next I like to invite our CFO, Craig, to discuss our recent financial performance.

Thank you, Jay, and hello, everyone. I'm pleased to announce that we have continued our robust growth trend and again, delivered strong results. Our continuous strong performance is a reflection of our highly resilient business model, which is built on acquiring high-quality educated young adult customers and asserting multiple funding sources to serve their needs. In the interest of time, I will not go over line items by line items of our financials. For more detailed discussion of our second quarter and first half 2018 results, please refer to our earnings press release.

Total operating revenue for the second quarter reached CNY 1.78 billion, driven by our customer growth. Adjusted net income was CNY 502 million, including a onetime tax benefit of CNY 193 million. Net income per ADS for the second quarter of 2018 was CNY 2.57 on a fully diluted basis. Excluding the tax benefits, under normal operating basis, net income per ADS would have been CNY 1.5. Non-GAAP fully diluted net income per ADS was CNY 2.77.

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 [2016,] whose balance has now risen to over 11,300 and whose 30 days delinquency rate is 1.01%, all while maintaining a stable level of quarterly activity rates at 46.5%. In the quarter, we saw the benefits of our operating leverage as well. As Jay mentioned, operating expense as a percentage of average loan balance decreased to 4.7% in year-to-date versus 4.8% for the whole year 2017.

Now advertising -- marketing, advertising, G&A and R&D decreased to 1.6%, 0.6%, 1.2% and 1.3% of average loan balance, respectively. We currently have over 8.9 million users with credit line, up from 7.6 million at the end of 2017. Overall, our average credit limit has increased to over 8,700, while our tenor has increased to nearly 13 months. Our effective APR for the second quarter was 25.7%.

In terms of our funding, at the end of the quarter, approximately 57.9% of our funding came from our Juzi Licai platform and 42.1% of our funding came from our institutional funding partners.

On the sales and marketing side, we continue to maintain low customer acquisition costs. Customer acquisition cost per active customer was CNY 138 for the second quarter 2018, and we acquired over 0.5 million new active customers in the second quarter.

Guidance. Due to the impact to the existing assets of more or less compliant players from the market, which is a long-term profit, short-term investor confidence in the industry has been affected. However, we have seen an improvement in the market condition as well as a recovery of our individual investor confidence in our products. This has improved the condition for funding. We remain positive in terms of outlook and are adjusting our estimate for the total loan origination for the fiscal year 2018 to a range of CNY 65 billion CNY 75 billion.

Next, Ryan will discuss our credit situation. Ryan, please?

Thank you, Craig. In the second quarter of 2018, we continued our strong performance. Our strategy of focusing on acquiring the right customers continues to pay off in our strong performance. As Jay mentioned earlier, our 90-day-plus delinquency ratio remains low at 1.39%, and we continue to see strong performance, and our lifetime charge-off ratios continue to remain at around 2%.

In the second quarter of 2018, our NPL ratio for off-balance sheet loans was 2.34%, and our NPL coverage ratio was 168.6%. In addition, we have seen the strength of our strategy in growing with our customers. As Craig mentioned earlier, our delinquency ratio for the cohort which we acquired in the first quarter of [2016,] continues to be low at around 1%.

With that, we conclude our prepared remarks. Operator, please proceed.

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

(foreign language) So translating my question. I have 2 questions regarding to the funding. So first one is on P2P. We saw news that, last week, the regulators started this regulatory compliance check with the 108 detailed rules. So in terms of our P2P operation, what kind of amendment need to be made to comply with this new 108 rules? In particular, for loan balance, do we see stricter control? And how is the loan balance loan -- sorry, P2P loan balance situation in August? And second one is regarding to the institutional funding. So we saw the institutional funding percentage increased in the second quarter. So what's the outlook for institutional funding? How many institution funding partners have we see in the pipeline and already connected? And what is the funding quota for each institution? And what will be the funding mix at the year-end this year?

(foreign language)

So Jacky with regards to your question, first, regarding the 108 rules that have come out, what we're seeing is that it's actually pretty consistent with what's going on, on the local before, whether it's the 106 or [118,] and to some degree, actually, the requirements are lower. And as far as we can tell, we're already fully compliant with it. In fact, we did a quick assessment and internally, we definitely believe that we are there. Now that said, we would like the government also to take a closer look and inspect what we have done, and if need be, we can make some minor adjustments. So overall, I think we have faith that we are in a very good position when it comes to meeting the requirements of the 108 rules. Now regards to scale, there's definitely been no request from our side to limit the scale. But we do focus, again, on being compliant, and we're in close communications with all the regulatory authorities, and we'll work directly with the government to make sure that we're fully compliant. Now regards to the events last month with some noncompliant platforms having problems, we can see that immediately the government has taken effective steps to curb some of the problems that come out of that. Now given our situation where we have clearly better assets and also the fact that we are a very reputable public company, this has given our investors a lot of confidence. And recovery this month has been definitely quick and to some degree, accelerating as well. And we strongly believe that after the current turmoil, if you will, and the problems that occurred in the sector, we're going to come out of this much stronger and better than before because we've got better assets, and we have a much better reputation than anyone else.

(foreign language)

With regards to the second question you have on the institutional funding, the thing, Jacky, you know, from the very beginning, the core part of our strategy has been to acquire diversified funding and it's because we have acquired diversified funding that we were able to limit the influence of the events in July. And because we have institutional funding, long term, we'll continue the strategy because institutional funding, ultimately, does have many unique advantages, whether it's on the basis of cost, scale that P2P does not have. And we'll continue to open more pathways into the institutional funding.

(foreign language)

And another thing that, I think, everyone is probably aware of is to get into the institutional funding partners and to access them is inherently more difficult with higher barriers. And as we do more of this, we're going to establish a very key competitive advantage. Currently, we have several in the pipeline. Overall, we are working with tens, if you will, of funding partners right now in the institutional side. And in the pipeline, right now, we also have tens of funding partners.

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(foreign language) So I have a follow-up question on the funding cost, both on P2P and the institutional side. So due to current P2P situation, we may see an increase in competition on the institutional funding. Will that push up the funding cost?

(foreign language)

And so Jacky, as you noted, 42% or so of our funding recently has come from institutions. In regards to the competition for institutional funding, as mentioned earlier, the barriers is actually quite high. It's not easy for other financial technology companies to access institutional funding. Overall, institutional funding partners inherently have high requirements. So for example, if your APR is too high, then they can't work with you, or if your bad debt is too high and your bad debt isn't low enough, they wouldn't work with you. Also, they require that you have certain amounts of technology as well as stability in your overall performance. In addition, they also need to have confidence in your team, management, et cetera. So this is not something that other companies can easily access. Now in our case, of course, we've already accessed this. In the future, we're going to commit more resources and dedicate more resources towards acquiring access to more institutional partners, which will then fuel our continued strong growth. Hope that answers your question?

So may I get the funding cost...

The funding cost side, for the P2P, we're -- for the P2P side, we -- you basically can see the range from our Juzi Licai platform. It's basically pretty stable this year. And the only thing different is sometimes we have seasonal promotions, and so that's quite stable there. Regarding the institution, the cost compared to the late last year is a little higher just because of the whole condition of the availability of the markets. But it's about similar to what we see last quarter. So if you see -- from where you can see in this quarter's number, actually, it's a combination of the historical funding costs. So overall, it's kind of 8% to 9% kind of the -- from institution.

Your next question comes from the line of Bo Pang with China Renaissance.

(foreign language) So my question will be more focused on the asset side. The first question is regarding to the loan APR. So we've seen the APR up sequentially in this quarter, but still way below the industry level. So what's the borrower acceptance on the price increase, first of all? And secondly, any borrower structure change in terms of their credit risk level associated with this change? And how should we think about the price change in the predictable future alongside with your product category expansion? And my second question is on the sales and marketing efficiency. So the user acquisition cost seems a little bit higher and lagging expectation in this quarter despite a very strong e-commerce performance, which is typically an entry point to our [managing consistency.] So can management share a bit more color on your thought regarding the user [regular] acquisition trend going forward and potential strategy of improving it?

(foreign language)

And so overall, in terms of the APR, we just raised it slightly and this is certainly within the normal market range or behavior. In terms of credit quality, there's definitely been no impact. We're still very much focused on serving high-quality credit customers, and hence, we haven't seen any changes to their credit quality. What has occurred is that we've done much more careful and detailed analysis of our customer cohorts and based on that analysis to maximize the possible economics and to come up with the most appropriate APR at different levels. And as a result of that detailed analysis, we've come up with the slightly higher APR. Now that said, overall, I think longer term, in terms of where the APR would be, it'll be probably around 24% range plus or minus a little bit. So normal range would be always around 24% plus or minus.

On your second question about customer acquisition costs, we have always emphasized like the -- we are not looking for even lower customer acquisition cost. We think the customer acquisition cost between CNY 100 to CNY 200 is a very comfortable zone for us. And regarding to the increase compared with first quarter of the customer acquisition cost, we still have been pretty effectively acquiring over 0.5 million of the new active customers, but from the cost side because we're not buying traffic, we're not doing lot of online advertisement to acquire customer, so majority of our customer acquisition costs were actually people-related cost. So it's like over 70%, it's people-related cost. And second quarter is kind of annual salary adjustment time. So we adjust people's salary and that becomes the major reason of the customer acquisition cost increase, so that will be locked for the year. So this is the kind of normal kind of trend you will see every second quarter of the year.

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

(foreign language) So I have 3 questions. The first one is on asset quality. We have seen your 90-days-plus delinquency ratio has declined quarter-on-quarter. Can we have more color on the -- on your early delinquency rates, say, 30 to 89 days so that we can have a good understanding of your recent credit performance, especially for July and August given the industry events? And the second question is on the funding side of your Juzi Licai platform. We see there is a minor decline in terms of the outstanding loan volume as far as the investors. Are we taking any measures to ensure we are getting back more investor confidence? And we are competing with other leading platforms, does it mean we will see more pressure on the funding front going forward? And lastly, do you have any rough figure on what's the percentage of the highly educated customers versus your total customers?

Okay. Let me your answer your first question. Since -- right now, we see the whole portfolio, [what we are seeing is] quite stabilized, as we mentioned earlier. And it will remain -- remains positive, so it remains around 1.4%. So from my perspective, if this number around 1.4%, 1.5% is within range, so it is stabilizing. So actually from Q1 to Q2, we see all our portfolios remain stable. So even with early delinquency or late bucket is both within reach. So because we did not release early delinquency numbers before, so I'm afraid I would not release those here. But I can tell you, the whole performance in the whole portfolio remains stable.

Regarding the percentage of high-educated people, we basically focus on high educated people solely. Like we -- in our annual report, we're seeing over 90% of the total customer was highly educated. But in the -- that's kind of the one of the line we are using. But actually, in our current customer portfolio, we are even higher than that. So majority of our -- we will see over 90% or even over 95% of the people in our customer portfolio with high education.

Yes. Alex, maybe, could you repeat the second question that you had a little bit? I understand it was about Juzi a little bit?

Yes, yes, okay. (foreign language) So my second question is on your -- the funding side of your Juzi Licai platform. So we are seeing your -- decline in your -- the loan balance and investment number in July. So it's again, a measure we are taking to ensure that we will see a [rebound] in investor confidence going forward, and we will see a rising funding -- rising pressure on your funding cost.

To the second question, first, Jay mentioned in his response to Jacky's question already said, like last month because of the whole industry environment so with the customer -- the confidence of buying new investments in the P2P, they have been impacted by those short-term market conditions. As we have a better reputation and we have the solid kind of the background and a solid asset quality, I think, we -- our investors actually have more confidence than average industry, so we already see the rebound of the customer evidence -- confidence. So basically, that Jay already mentioned. Regarding to the cost, we did see some of the players kind of increase their interest rates, increase their returns on their products, but we don't think we need to do that, actually. If you keep kind of follow, we're waiving down in our Juzi Licai platform, we did change our interest rates actually in our platform as well. From the long run, I think, in this area, it's not kind of the high interest rates, high return type customers, it's the quality of the assets, the trust of the company and the stabilize of the operation what attracts the investors' confidence.

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

(foreign language) So my first question is, firstly, how do we come up with the loan facilitation guidance of CNY 65 billion to CNY 75 billion versus previous CNY 80 billion? So based on our calculation, right now the first half, the loan facilitation has achieved 42% to [48%]. So supposedly, the second half would be the peak consumption season, so the borrowers would have more installment loan demand. Do you think the guidance is a bit conservative? And my second question is, right now, how much of the loans are covered by insurance in our platform? And what the trends look like?

Regarding your first question, yes, in the normal kind of trend, the second half, it's a kind of the more demand from the customer compared with the first half. This year, it's a little special because we see this whole kind of check out of the China financial industry, both on the institution side and the P2P side. Institution side, actually, it's not -- nothing -- basically, nothing to do with what we've been doing, it is a whole kind of the market on the deleverage kind of the efforts. So this year, it's a little uncertain on how quick the market can come back in the second half. So that's why we've been giving our range to see how quick the market can come to the normal kind of stage. Used to be, the market will pick up pretty quickly on August, September, then go to the peak on November and early December. Now we see lot of positive signs, but to -- coming back to the -- all the fundings, everything, it still takes time for us to be more clear. Regarding to the asset price, the demand side, actually, the demand is quite strong this year. We really handled the pressure of to have enough fundings to satisfy all the demands. I think that's not only a Lexin thing. The market feel the similar thing. So the reason we're being very optimistic is, first, we see demands there. Second is we see the sign from the government really want to help this industry. What we've been doing is more diversified customer finance is right on the direction the customer want to be encouraging. So we see mixed signs, like past months with some of the negative news impacts. In the -- for the future, we see lots of positive things. So let's see. While we get more kind of information, we'll let you know what our newly target is. And then regarding your question on the insurance, we have different models. We're using -- we have a financial guarantee company. We have our P2P to work with the insurance -- third-party insurance company. And also, we will have a close discussion with our regulators saying, how they want to do with our P2P, which model they like. Now it looks like the insurance is one way they may accept it. So we didn't give any exact percentage yet. I don't have that number on my head right now. But -- so we -- because of the asset quality we have, actually, it's not a difficult thing for us to find a partner to provide that kind of assurance to our customers, the investors.

Your next question comes from the line of Lucy Li with Goldman Sachs.

(foreign language) The first one is on loss on the guarantee liabilities line. So I wonder if the same idea is provisioned for credit losses. May I simply add up the 2 to arrive at the provision? If so, then is it true that the credit cost this quarter is higher than Q1 this year, even though the delinquency rates and overdue rates seems to be stable quarter-on-quarter? And the second question is on the e-commerce platform. There has been very strong growth in terms of GMV this quarter and we have seen even higher margins on the e-commerce side. I wonder, what's the one, what's the percentage of e-commerce loan -- like loans originated or loan balance from -- contributed by the e-commerce platform? And secondly, in a normalized situation, what's was right margin we're looking at?

Thanks for the follow-up. Firstly -- your first question is really being very detailed accounting question. The simple answer is -- quick answer is, we cannot be adding these 2 together. This one is on-balance sheet and one is off-balance sheet. Off-balance sheet is more like, the guarantee liability is more for the Juzi Licai platform. We even put a [side] operation, but it's -- we cannot adding that. For more details, I think you can -- we can even have a follow-up call. We can go through you with all the detailed calculation and how you should do that in your model. But put simply, you cannot adding these 2 together. So your second question about the -- our loan through the e-commerce platform and other, so actually, this is not we -- how we depreciate that. We're actually looking at a person. So if a same person, we actually don't depreciate, his -- this loan coming from he's buying something from an e-commerce or is he borrowing cash. Actually, for us, it's the same kind of risk and same kind of person, so same kind of category. So for us, actually, we do more from the people perspective. So e-commerce is one place we satisfy our customers’ needs on the high ASP stuff, and also, we're collecting data from there and their behavior data. But from risk and from other perspective, actually, we didn't separate that. Secondly, our margin of our e-commerce, used to be, we -- last year, we were talking about more like a breakeven because our e-commerce is more focused on pre-pay products, like -- especially like Apple products, their gross margin is pretty low. So while we -- our goal is to have our customer while they're purchasing our e-commerce with installment payment, we were giving a big part of our gross margin back to them to let them only pay 1 margin, not 2 margins. So we basically gain from their financial service income, not from the product margin. But with more and more increasing customers and old customers we had, we actually enhanced our SKUs on our e-commerce platform. Now we have about 1 million SKUs, so which means we have lots of high margin products we may offer in our e-commerce platform, so -- which allow us actually to be -- e-commerce to be a profit center instead of a cost center for the -- for our whole portfolio. We don't have a set margin percentage for our e-commerce at this moment. We're actually being -- we are in the transition of that. We -- I think the first breakeven was last fourth -- last year fourth quarter and this is only third quarter -- second quarter we [are winning] on our profit center. So we will -- we still think this is not being very significant compared with the whole financial we have. So you can simply make it pretty even or just a little profit kind of center for us.

Your last question comes from the line of [John Chai] with Morgan Stanley.

(foreign language) So I'll translate the first question, first. So my question is about the change of the accounting in the Juzi Licai. So we have seen that from April that all the loans facilitated on the Juzi Licai will be accounted as off-balance sheet. Just wonder what's the detail change in the product designs? And what will we expect the progress to be? So by the end of this year, approximately, how many percentage will be off-balance sheet as a group? And then, what would be the revenue recognition for this off-balance sheet loan versus the previously off-balance sheet loan? Would we need to adopt to the ASC 606 accounting policy?

Thanks, [John]. To answer your question, actually, we -- Lexin is a tech-based company. So to providing technology service to the -- to our partners, including individual investors and institutional investors is, obviously, our goal. So we've been keep changing our model to be more like into a tech-based company, being a tech provider. So I think this is also in line with what the regulator wants us to do. So we've been keeping good efforts on that direction. So this is one of the milestones we have is moving our Juzi Licai platform all alone so that platform to be off-balance sheet. But regarding the revenue recognition, actually, we didn't change that. We'll still being using over the period methodology to recognize the revenue. We do have a little change like the guarantee -- loss guarantee liability kind of thing but that's -- overall, with the whole trend of that recognized over the period haven't been changed. Second question -- second, your question about 606, we're still using 605 actually. We -- today, compared to our peers, I think most of our peers be using 606 already. We are using 605. Actually, our revenue recognition is kind of more deferred rather than others being with the 60 -- and the 606 have more revenue has been early recognized. For our time, come -- based on what the size we have, the revenue we have, we think the right time for us to make that change is end of this year. So we will -- starting from next year, we will be using all the new 606.

(foreign language) So I will translate my last 2 questions. And the first one is about tax rate. So we have seen this deferred tax recognized in the second quarter. So I just wonder if going forward, we will assume that provision will be deductible, so the effective tax rate will come to a more normalized level of 25% or below? And the final question is about regulations. So we have seen that there's some tightening on the off-line promotion activities by online lenders to promote their products to borrowers. So just wonder if there would be any -- just wonder how should we interpret that? And do we see an impact on our current operation?

Thanks, [John]. For your first question, yes, in the future, actually, you can putting the model like all the provisions can be tax deducted. That's basically what we have been able to do this way. And regarding for the long-term effective tax rate, you probably can assume around 15%. That's the effective tax rate you will see in the near term. Second question regarding for the off-line promotion of the P2P products, we never did off-line promotion for P2P products. We didn't do any kind of off-line promotions while we [met] those. So that actually will not impact us at all.

So just a quick follow-up because I've seen this -- so previously, it might be only regulations on the funding size or we don't -- we can't promote to the investor offline. But it seems that the latest recognitions have also some wordings about asset size. So I'm not sure if that's relevant.

So asset size, like we probably do some. We do -- we probably promote our e-commerce sites, not really being -- I would see what exactly you're being talking about. For that one, it may be -- it's on the asset side or it's on the funding side. But here for the asset side, we've been very clearly -- we've been carefully being compliant with all the regulations, even when we do promote our e-commerce sites.

Thank you. There are no further questions.

Okay, operator, if there are no further questions, I think you can conclude the call.

Ladies and gentlemen, that does conclude the conference for today. Thank you for participating. You may all disconnect.