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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Ladies and gentlemen, thank you for standing by, and welcome to the 360 DigiTech Third Quarter 2020 Earnings Conference Call. Please also note, today's event is being recorded.
At this time, I'd like to turn the conference call over to Ms. Mandy Dole, IR Director. Please go ahead, Mandy.
Thank you, Ray. Hello everyone, welcome to our Third Quarter 2020 Earnings Conference Call. Our results were issued earlier today on our website. Joining me today are Mr. Wu Haisheng, our CEO and Director; Mr. Alex Xu, our CFO; and Mr. Zheng Yan, our CRO.
Before we begin the prepared remarks, I would like to remind you of the company's Safe Harbor statements. Except for historical information, the materials discussed here may contain forward-looking statements, which are based on our current plans, estimates and projections. Therefore, you should not place undue reliance on them. Forward-looking statements involve inherent risks and uncertainties. We caution that a number of important factors could cause actual results to differ materially from those contained in forward-looking statements. For more information about potential risks and uncertainties, please refer to the company's filings with the SEC. Also, this call includes a discussion of certain non-GAAP measures. Please refer to our earnings release for a reconciliation between non-GAAP and GAAP ones. Last, unless otherwise stated, all figures mentioned are in RMB.
I will now turn the call over to our CEO, Mr. Wu Haisheng.
[Foreign Language]
Thank you, Mandy. Hello everyone. I am very happy to report another set of record-breaking results of key operational and financial metrics in the third quarter. Total loan origination reached RMB66 billion during the quarter, up 12% on a sequential basis. Outstanding loan balance increased by 7.3% to RMB84.2 billion from RMB78.5 billion last quarter. Total revenue was RMB3.7 billion, up 10.9% from last quarter. Non-GAAP net income was RMB1.29 billion, up 36.7% from last quarter.
[Foreign Language]
It has been a very busy quarter in terms of regulatory change, which would create significant challenges for the Fintech industry. Since the beginning of the year when COVID-19 hit, we have now successfully navigated through three quarters under tremendous market uncertainties and the volatility, with consistent execution and steadily improving results. This is a strong testament to the soundness of our strategies and the sustainability of our business. In the wake of the pandemic and the regulatory challenges, we believe the Fintech industry has become further polarized as companies with core competitive edge continue to strive with consistent performance across business cycles.
[Foreign Language]
While we have tightened our policy in customer acquisition and risk management following the uncertainty created by High Court rate-cap ruling in Q3. We still achieved a strong business growth, mainly benefiting from the noticeable recovery in macro economy. Let me elaborate in three aspects.
[Foreign Language]
First, overall, we continue to generate consistent growth in the number of registered users, users with approved credit lines and active borrowers. During the quarter, we added approximately 1.57 million with new users with approved credit lines, similar to that of last quarter.
[Foreign Language]
Second, we have made noticeable progress in our new business initiatives embedded in Fintech, where [ph] Fintech companies provide their service in Infrastructure-as-a-Service; ICE in short, modules. This is a new industry change that started in the Silicon Valley and is gradually accepted in China. A growing number of 2C [ph] platforms have embedded Fintech ICE as a standard component into their offerings in order to better monetize their user base and serve their customers' needs. We are in a strong position to benefit from this change as our ICE solutions offer better user experience and higher commissions.
During the quarter, more and more 2C platforms took our ICE solutions, including Xiaomi, Mi10, and ITE [ph] among 16 platforms in total, and we have another 10 in the pipeline, including JD, BD [ph] and Baidu. This demonstrates the increasing recognition of market position by our partners.
[Foreign Language]
Third, we continue to advance our capital-light model as our long-term strategy. Capital-light and other tech empowered models further increased to approximately 28% of total loan origination during the third quarter. While we have [indiscernible] pace to grow our capital-light model so far this year, given the uncertain market conditions, we are fully confident that we will at least achieve our year-end target of 35% to 40% as we expect to see acceleration in the rest of the year. During the quarter, we also made considerable progress in providing more tech-empowered SaaS solutions. Today, we have established a cooperation with 15 institutions with over 50 - 5-0 - in pipeline.
[Foreign Language]
As our business continue to grow, our asset quality also near the best levels ever. During the quarter, we continued to execute our prudent risk management strategy with a slightly tightening buyers. Key leading indicator continued to improve since the end of second quarter. Day one delinquency rate further dropped to a record low of 5.3%, and the day-seven delinquency rate to only 0.8%, while M1 collection rate rose to about 90% [ph]. The strong risk management metric not only reflects continued improvement in macro economy, but also further validated the efficiency and capability of our risk management strategy and model.
[Foreign Language]
As a leading Fintech player, we have always ensured that we maintain the highest standard of compliance in line with the latest regulations. This is critical for healthy and sustainable development of our business. Since the middle of this year, the regulators have rolled out a series of policies and guidance closely associated with the development of Fintech industry. Overall, we believe the regulators are promoting industry orders for healthy and sustainable development.
[Foreign Language]
In early November, CBIRC issued the Interim Measures for the administration of internal micro lending consolidated [ph] paper, imposing a set of restrictions on micro-lending and joint lending operations. We believe the regulators are aiming to further lower leverage and prevent systematic risk in financial market. Currently, the outstanding balance of the outstanding loans issued through our micro lending subsidiary, accounts for less than 1% of the total loan balance, and joint lending accounts for around 0.01%. Therefore, based on our personal evaluation, the new rules will have little impact on our loan origination business. In addition, the leverage restriction may force some leading players to scale back their business. That creates opportunity for us to grab additional market share.
[Foreign Language]
CBIRC recently also issued a notice on promoting the sustainable development capability of consumer finance and auto finance companies and improving quality and efficiency of financial service. In our view, the notice will benefit consumer finance companies to expand their operations and to boost their business with loan facilitation platforms. In particular, it clearly sets out specific practices for the cooperation between consumer finance companies and the loan facilitation platforms, which will benefit leading loan facilitation platforms like us.
[Foreign Language]
We believe the busy regulatory movement in the past six months are a clear indication that Chinese Fintech industry is entering our phase of comprehensive regulation. These policies also show that rather than a strong-handed pressure, the regulators are promoting industry orders by supporting good practices and that are not so good ones. This will drive the healthy development of the industry and we are glad to see that.
[Foreign Language]
Outside our core business of consumer finance, we will also proactively be exploring new business opportunities and seeking more room for growth. Compounded with roughly RMB20 trillion consumer finance market, China's SME loan market is estimated to be around RMB50 trillion with over 50% of credit demand unmet. We know that a few players already developed sustainable approach, some using banking license to access the SME tax payer to support risk management, and some use extensive offline channels to reach potential SME customers.
[Foreign Language]
The early success of both strategies indicates that there are great opportunities for us as we have access to banking license through our affiliates and we have also established a large offline sales network with over 1,000 representatives. In addition, we are very excited to find that a significant portion of our existing customers are SME owners, which could provide a large pool of potential customers for SME lending.
[Foreign Language]
Despite the various challenges and difficulties related to macro economy, Fintech industry and our operation in the three quarters of 2020, we have successfully passed the multiple stress tests with outstanding performance. For the rest of 2020, we will carry on implementing prudent business strategies and further exploring new business initiatives. We are highly confident to exceed key operational targets that were set at the beginning of this year.
Now, I will pass the floor to Alex to offer some details of our operational and financial performance.
Thank you, Haisheng. Good morning and good evening everyone. Welcome to our quarterly earnings call. For the interest of time, I will not go over all the financial line items on the call, please refer to our earnings release for the detail. During the third quarter, we see continued rebound of our business momentum as consumer confidence and economic activities gradually recovered post-COVID-19. Benefiting from such macro trend, we have experienced robust consumer demand for credit along with noticeable improvement in asset quality.
Total net revenue for Q3 reached RMB3.7 billion versus RMB3.34 billion in Q2 and RMB2.58 billion a year ago. The year-over-year comparison is somewhat distorted by the accounting standard change early this year. Revenue from credit-driven service, which we call cap-heavy [ph] was RMB2.96 billion compared to RMB3.08 billion in Q2. The sequential decline was mainly due to the decline in take rate as we lowered our average interest rate in later Q3 to [indiscernible] and the average take rate for the entire Q3 is 25.9% - sorry, the interest rate for the entire Q3 is 25.9% compared to 27.2% in Q2, following the Supreme Court ruling in late August.
Revenue from Platform Services, which we call cap-light was RMB748 million compared to RMB259 million in Q2. If you recall, in Q2, we took accounting charges against revenue because the projected delinquency rate for certain assets exceeding performance benchmark set by revenue-sharing agreement with our partners. As the asset quality continued to improve, the actual performance of those assets turned out better than previously expected and the delinquency rate fell below the benchmark. Therefore, from an accounting perspective, the charge should be reversed in Q3. Aside from these charges, the underlying take rate for the Platform Service also modestly improved in Q3.
Total operating expenses, excluding provisions were roughly flat Q-on-Q but decreased 33% year-on-year. The year-on-year decline mainly reflects significant improvement in operational efficiency, particularly the deduction of customer acquisition costs. Sequentially, we were able to keep operating expenses stable as we grew our business substantially. Average customer acquisition cost per user with approved credit line was RMB172 in Q3, modestly higher than RMB167 in Q2. As the macro economy recovered, demand for online traffic increased significantly. Q3 is also a seasonally high demand period for online traffic, particularly around the intense online shopping events such as Double 11.
Non-GAAP net income was RMB1.29 billion versus RMB942 million in Q2 and RMB756 million a year ago. Once again, the year-on-year comparison was negatively impacted by the accounting standard change. Nonetheless, this is the first time ever our quarterly net income exceeding RMB1 billion mark. We are very proud for the achievement, particularly given the challenging market condition early in the year.
The overall macroeconomic condition is improving and the COVID-19 is largely contained in China. However, we will continue to take a prudent approach to expand our business and to manage overall risk. With strong operating results and increased contribution from capital-light model in Q3, our leverage ratio, which is defined as risk-bearing loan balance divided by shareholders equity, further declined to 7.4 times from 8.3 times in Q2 and 9.5 in Q1. We expect to see continued deleveraging in our business, driven by accelerating movement towards capital-light model and solid operating results.
Meanwhile, our provision coverage ratio rebounded to 436% in Q3 compared to 321% in Q2 and 400% in Q1. The sequential improvement in provision coverage ratio was mainly because of significant decline in projected delinquency rate for risk-bearing loans and our conservative approach to estimate provisions. We note that recently CBIRC lowered provision coverage ratio requirement for consumer finance companies to 130% from 150%.
Non-restricted cash balance reached a record high of approximately RMB4.8 billion in Q3. This was largely driven by strong operating results and effective management of working capital. Total cash and cash equivalents were RMB7.9 billion at the end of Q3. A significant portion of our cash was allocated to the security deposit with our institutional partners and registered capitals of different entities to support our daily operations. We believe that sufficient cash position will not only enable us to compete in the ever-changing market, but also position us to potential growth opportunity - to capture potential growth opportunities in a market recovery.
Finally, let me give you some color about our outlook for the fourth quarter. After delivering strong operating results in the three quarters of the year, we - our previous full-year long - original guidance - origination guidance appears too conservative. We now expect loan origination volume in the first quarter to be between RMB64 billion to RMB66 million, which implies full year loan origination guidance to be RMB244 - RMB242 billion to RMB244 billion, compared to our previous guidance of RMB200 billion to RMB220 billion. The revising guidance reflects current business momentum as well as normal seasonality.
With that, I would like to conclude our prepared remarks. Operator, we can now take some questions.
Thank you, management. [Operator Instructions] Our first question is from Jacky Zuo from China Renaissance. Please go ahead.
[Foreign Language]
So I will translate my question. So congrats on the strong results. My question is related to regulation. So we observe that the new online macro lending rules requires - actually a high capital requirement for the applicant. So what is our view on the new lending license and any plan to apply this license jointly with other parties? And in addition, do we expect any further tightening on the loan facilitation regulation, and what will be the timeline? Thank you.
Thank you, Jacky for your question. I would let our CEO to answer your question. Haisheng?
[Foreign Language]
I will translate for our CEO. Jacky, regarding your question about the micro-lending license, there are few aspects involved in this notice. One is about the joint lending. Actually on this asset, we nearly have less than 1% of our total loan balance, which is a very, very small portion. Secondly, the notice mentioned some regional restriction about micro lending and also the recurring facility. We barely have that part either. About the registered capital, it requires about RMB1 billion for local lending and RMB5 billion for the national lending. Actually, look at our whole business, we mainly use other funding source rather than the micro-lending license. Therefore, we are focused on the loan facilitation platform, not relying on the micro-lending license. And we - in the long term, we are targeting not to leverage the micro-lending license. Furthermore, it will - please consider, we have banking license, and if we want to increase the registered capital, it's more easier [ph] for us to register in the banking license.
[Foreign Language]
Jacky, regarding your question about regulation on loan facilitation business, please recall that in July, the regulator released online lending guidance of commercial banks and recently they issued notice about the consumer finance company loan facilitation business. Those notice indicate regulator's view, they legitimize loan facilitation business. In the long term, we do not think that regulator is tightening the loan facilitation business in China, he is actually promoting industry order for a healthy development and a sustainable development. Also, if you look at China market, the traditional banking cannot develop the micro lending consumer finance capability on their own. The relationship between traditional institutional banking and loan facilitation platforms are complementary and collaborative. We can forge synergy and become the inter-operable model.
[Foreign Language]
So my follow-up question is regarding to the ICE model. As we mentioned, so we are cooperating with other traffic platforms. So what is the percentage of this cooperation of our loan volume currently and what is the outlook?
[Foreign Language]
Well, in terms of the new acquired users, the API model, or we call the embedded Fintech model takes account roughly 20% to 30%, and we still continually see the growth momentum in terms of this customer acquisition. The platform with consumption scenarios, when they choose loan facilitation platform, they require you need to have better user experience and high commission rate, which are our strong competitive; that's why there are a lot other platforms lying in the pipeline.
Jacky, I want to add one point, that is - to your question, the 20% Haisheng just mentioned is actually for the new user acquisition percentage, but from a loan volume perspective, given the significant larger percentage is coming from old users, so the new format is only contributing roughly 2% to 3% of the loan volume we're generating.
Got it. Very clear. Thank you so much.
Thank you. Next question is from Daphne at Citi. Please go ahead.
[Foreign Language]
So I will translate my questions. So it is mainly regarding the loan origination and customer acquisition outlook. So first, when we look at the third quarter new borrowers' number is still flattish Q-o-Q. So just want to check whether like - it seems that the loan volume growth in the third quarter is mainly driven by larger ticket sizes are given to the existing borrowers. So, if possible, can management also share the average ticket size on the borrowers for the third quarter? And for your guidance for fourth quarter only implies a flattish loan volume Q-o-Q. So just wondering why the growth will not be stronger if everything continues to improve and whether there is any seasonality here. And lastly, like if you can share the outlook in terms of your loan origination for next year. Thank you.
Thanks, Daphne. I would like Haisheng to answer more kind of overview side of your question. Then I will give you some detailed numbers. Haisheng?
[Foreign Language]
Okay, I will translate for our CEO. First of all, yes, you are right, we will see more contribution from existing customers in terms of loan origination in Q3. About the ticket size, yes, we see relatively stable compared to last quarter. About our Q4 outlook, there are a few reasons that we give this outlook. Number one is usually there are seasonality in the last quarter, especially considering some traffic pressure from e-commerce platforms, is gradual. Secondly, we are a very prudent company, we stay vigilant about any alert about - of the pandemic and the macro conditions down the road, and we don't think it's wise to give so aggressive approach in the fourth quarter.
[Foreign Language]
Sure. Overall, for next year outlook, I don't have very concrete number to share now, but I can give a rough idea that we expect to see continued improved momentum next year. I will elaborate a few aspects. Number one, as we explore more new initiatives this year, we expect to see the growth showing up next year. Secondly, considering our affiliates' stake in KCB, we expect to see the synergy and co-developed products ramping up next year. Thirdly, about SME loan business, I mentioned in my speech, we started already and, for example, for the channels to be, we have already covered most of them.
Daphne, you just wanted...
[Foreign Language]
[Foreign Language]
Okay. So to elaborate more on the contribution of the existing customers, so we have analyzed that 45% is due to the cross-selling product like - increased the customer activity and also the retention of the customers, and 25% is due to the operational efficiency improvement. For example, we have like increased the different touch points through the model integrations. And the last one is from the ticket size increase and the credit line increase. For example, for the SME owners and for people with cars or property, we will increase the credit line. So the ticket size is relatively stable in this month. It's around somewhere 5,300 to 5,400.
[Foreign Language]
Yes. And Daphne, go ahead.
[Foreign Language]
So, I just wanted to follow-up regarding your partnership with Kincheng Bank [ph] and also the SME lending initiative you mentioned earlier. So first wondering whether this SME loan is just mainly granting for your partnership with Kincheng Bank, and also is there anything more that you can share regarding your current progress at partnering with Kincheng Bank and your expected contribution into next year? Thank you.
[Foreign Language]
Sure. Currently, we are implementing still very effective customer channels in terms of SME loans. Number one, for our extensive existing users, after we analyze, we are happy to see roughly 20% to 25% of them are SME owners and we have done some initial attempts to lend money to them. The asset quality tends be better than our total loan book. Secondly, we leverage the Enterprise SaaS service companies to cover SME owners. Those enterprise set include tax and the invoice-related service. And thirdly, the offline channels turn out to be very effective, as is proven by Ping An which is backed by Lufax. Nowadays, we have over 1,000 offline sales teams.
[Foreign Language]
Sure. I'll just give you a few updates on the - on our cooperation with KCB. Firstly, regarding the funding side, we have advanced the progress with them. Secondly, collaborating with KCB, we are able to tap into some better quality prime customers. Thirdly, KCB has banking license, which provide us to legitimately access tax data, which is the pivotal risk management data for SME loan. Thirdly [ph], we are co-developing tax debt products with KCB. This will be the generalized model for our two-way [ph] business.
Thank you, Daphne. Next one.
Okay, thank you.
Thank you. Next question is from Ethan Wang at CLSA. Please go ahead.
[Foreign Language]
Thank you. My question is on take rate, especially on platform service tech leverage is quite strong in the third quarter, so just if management can share some color on the reasons behind this and the trend going forward. And a related question is on the APR level and the funding cost in the third quarter, and if there is some guidance for future quarters, so that would be great. Thank you.
Sure, thank you. I think I'll go the reverse order in terms of questions. The first one, in terms of the funding cost, third quarter, we continued to see modest decline versus the second quarter. If you remember, the second quarter we're at 7.2% on average. Third quarter we are somewhere between 7% and 7.1%, so slightly lower. That's the funding cost. And secondly, regarding interest rate, for the quarter the average is at 25.9%. The second quarter average, as you recall, is 27.2%. So you see that drop, mainly because starting from September we adjust our pricing for all the products following the High Court ruling in terms of interest rate cap there. So that's for the interest rate question.
And then in terms of take rate for cap-light model, it is if you do the math, significantly higher than the second quarter and also probably higher than normal. The main reason is because, in my prepared remarks I mentioned a little bit. If you recall, the second quarter, actually, the cap-light take model is quite low - was quite low, because as I said, there is a batch of the assets, the projected performance in terms of delinquency exceeded the benchmark we set with our partners. According to the agreement, mostly the early time sort of agreement we had with the partners, if the delinquency exceeding certain benchmark, our take rate will - being reduced accordingly. So that's the main reason for Q2's take rate for cap-light drop quite significantly. But that doesn't mean the actual loss for that batch of assets happened in Q2, it's just the projected kind of a delinquency.
Now as the macro economy improved, the asset quality continued to improve. So we'll get over the third quarter that particular batch of assets, the actual loss is actually much better than previously expected and making the delinquency lower than the benchmark we set in the agreement. So from accounting perspective whatever the charge you took in the second quarter has to be reversed back in the third quarter. So if you just look at the printed number, you see the third quarter's take rates are significantly higher than the second, but if you can read all these kind of noises, meaning adding back those charges to the second quarter and get rid of this write-back in the third quarter, you compare to the real core take rate for the cap-light model. For that number, we see very modest improvement in the third quarter versus the second quarter.
Got it. Thank you, Alex. Just a quick follow-up. So the high take rate for capital-light model in the third quarter, maybe partially contributed to a reversal of the charge in the second quarter. So in the fourth quarter and forwards, should we assume that this reversal is one-off, so this will be gone and the take rates will go fairly lower to be normalized? Is that the correct understanding?
I think, in general, that's probably the right assumption. Given the macro economy continue to improve, we don't expect any sort of piece of assets to exceed any of those benchmark anymore. So that's - the noise will be gone either way. And overall, the - and remember that since the September, our overall pricing coming down little bit that for cap-light model the take rate also related to certain degree of the pricing. So for the fourth quarter, we will see flattish to slightly downward on the take rate for the cap-light model.
[Foreign Language]
Thank you.
Thank you. Your next question is from Steven Chan at Haitong International. Please go ahead.
[Foreign Language]
My question, divided into two part; one follow-up on the lending rate APR. Just want to know the decline in APR. Actually related to the pressure from the funding partners or from the market, do we see a stabilized trend in Q4? And then for micro finance loan facilitation business, if you compare with the business model of Lufax, actually the business model of Lufax is completely different from the consumer finance loan facilitation model, especially one for acquisition cost, the per customer acquisition cost actually was very high. So are we going to see a similar pattern too? In terms of risk management system, they have to cater for bigger ticket size and then longer tenor. Is our current risk management system - can our current risk management system cater for this change in like ticket size?
And finally, even in terms of like guarantee model, you do not provide back-to-back guarantee to the customer. Currently, like, for our guarantee business model we provide back-to-back guarantee. So are we going to follow this similar pattern or do we have some unique like business model in terms of like guarantee or capital-light business for the inclusive micro finance loan facilitation business trends?
Thanks, Steven. I would like our CEO and CRO to take your question.
[Foreign Language]
Okay, I will translate for our CEO. For the reason of lower APR in Q3, the main reason is that we proactively lower APR to fully comply with the regulation. We pretty much have done this project in Q3 and will be stable situation in Q4.
[Foreign Language]
Yes sure. About the customer acquisition cost to our SME loans, in the market, there are two successful strategies from two of our peers. Number one is the Ping An from Lufax. It is offline coverage team. Secondly, that adopted by WeBank, currently they have around RMB100 billion loan balance [indiscernible] applied online service providers to channel the SME owners. Both of them - the customer acquisition strategy are successful and we apply the different strategy. If we learn from that - the customer acquisition cost will vary a bit.
[Foreign Language]
Yes. Regarding your question about SME loan guarantee model, since we have deep - cooperated with all our funding partners in the past few years, we have established deep-rooted cooperation and we track each other very much. Currently, we have a few billion RMB banners in terms of SME loans, and we well advance the SME loans to a capital-light model without guarantee.
[Foreign Language]
No, just I will turn to CRO regarding your risk question about SME loans.
[Foreign Language]
Okay, I will translate. As Haisheng and Mr. Zheng has mentioned before that historically, actually we have SME customers and based on the different data sources, we can achieve - or we have different credit lines. For example, for SME owners with a license we have around 80,000 to 90,000. And for data of invoice, we have around 140,000. And for the tax data, we have around 300,000. And we can say that the risk performance is about 20% lower than average of our total assets. For the duration, it is about 17 to 18 months. So there is no fundamental difference from the three to six months period. So we can see that actually our risk management mechanism can work on this customer base. And historically, we have also proved that every time if we do the refinement operation and improvement of model, we can actually do an upgrade to the customers. Yes.
Very clear. Thank you.
[Foreign Language]
[Foreign Language]
Thank you. That's all for today's Q&A session. I now would like to hand it back to the management for closing remarks.
Thank you, operator. Thanks, everyone to participate in our call. If you have additional questions, please feel free to contact us. Thank you.
That's the conclusion of today's conference call. You may disconnect. Good-bye.