Earnings Transcript for LX - Q3 Fiscal Year 2024

Operator: Good day, and thank you for standing by. Welcome to LexinFintech Third Quarter 2024 Earnings Conference Call. [Operator Instructions] Please be advised that today's conference is being recorded. I would now like to hand the call over to your first speaker today, Ms. Mandy Dong. Thank you. Please go ahead.

Mandy Dong: Thank you, Desmond. Good morning, and good evening, everyone. Welcome to Lexin's Third Quarter 2024 Earnings Conference Call. Our results were issued earlier today and can be found on our IR website. Joining me today are our CEO, Jay Xiao; CRO, Arvin Qiao; and CFO, James Zheng. Before we get started, I'd like to remind you of our safe harbor statement in our earnings press release, which also applies to this call. During the call, we may refer to business outlook and forward-looking statements which are based on our current plans, estimates and projections. The actual results may differ materially and we undertake no obligation to update any forward-looking statements. Last, unless otherwise stated, all figures mentioned are in RMB. Jay will first provide an update on our overall performance. Arvin will discuss risk management updates. Lastly, James will cover the financial statements in more detail. I will now turn the call over to Jay. Please kindly note, in today's agenda, Jay will give his whole remarks in Chinese, then the English version will be delivered via Jay's AI-based voice. Jay, go ahead, please.

Jay Xiao: Good morning, and good evening, everyone. It is my pleasure to share with you our performance for the third quarter of 2024. In the third quarter, we remain committed to a prudent and steady operational strategy driven by risk management upgrade and deep data analytics. This approach has allowed us to reduce our overall portfolio's risk and improve our asset quality. As low-risk new loans continue to grow, our overall asset structure is gradually improving. In the third quarter, loan originations reached RMB 51 billion. Outstanding loan balance stood at RMB 111.3 billion. Revenue was RMB 3.7 billion, and net profit was RMB 310 billion, with both revenue and net profit returning to a steady growth trajectory. As the fundamental of our portfolio continue to strengthen, we expect to see further improvements in the company's revenue and net profit in the future. Our performance in the third quarter includes the following 2 highlights. First, our ongoing efforts in risk management have yielded tangible results with continued improvement in new asset quality and a turning point in overall portfolio risk. The leading risk indicator, FPD7 of new loans decreased by about 13% compared to the second quarter, and day 1 delinquency ratio of the overall portfolio declined by around 9% compared to the previous quarter. During the quarter, we focused on expanding high-quality new loans by fully implementing the loan growth strategy on various business lines, supported by the following measures. We strengthened our reach and acquisition of target customer markets by optimizing key online advertising channels, leveraging our cumulative user base of over 200 million registered users. We explored their potential borrowing demands and conducted targeted reoffer to reactivate dormant high-quality customers. We brought in multiple third-party data sources and developed a dedicated risk model for small and micro business loans. This increased the credit identification accuracy for small and micro business assets by over 10%. Additionally, we upgraded our intelligent anti-fraud model, enabling us to more effectively detect and properly intercept potential fraud, further strengthening our anti-fraud capabilities. As the quality of new loans continues to improve, we expect overall portfolio risk to decline, laying a solid foundation for performance growth next year. The second highlight is our improved profitability driven by a continued focus on refining operations and optimizing fund and asset matching. In the third quarter, our net profit margin reached 8.45%, representing a quarter-over-quarter increase of 223 basis points due to the declined risk levels of overall portfolios and enhanced asset quality. Our assets got increasing recognition from various financial institutions, leading to a more diverse and healthy funding mix. This drove down our funding costs by 98 basis points from the second quarter, setting a new historical low. In the third quarter, we focused on meeting the diverse demands of younger customers through a range of products. For high-quality Small and Micro Business Owner segment, we enhanced the operations of our [Foreign Language] product, which means working capital loan, and expand our acquisition channels. We operated and optimized the strategies related to credit line, granting and pricing adjustments, customer retention and dropout prevention, et cetera. We also connected to dedicated funding channels, specifically for small and micro business loans. As a result, [Foreign Language] achieved a 78% increase in transaction volume quarter-over-quarter. For the super prime Salary Workers segment, we restructured the pricing strategy for [indiscernible] Card and implemented various measures, including credit line and pricing adjustments to boost customer borrowing activities. With overall risk level remaining stable, the number of drawdown customers increased by 24% compared to the previous quarter. Based on our new risk-based customer segmentation, we adjusted our fund and asset matching model and launched a new product, the Intelligent Credit Platform. The Intelligent Credit Platform operates under a light asset profit-sharing model in which the company bears no risk of principal loss and generates technology service revenue to traffic distribution. Through this model, we can direct various customer segments to funding partners that have complementary risk appetite from us. This approach enables us to reduce customer acquisition costs, broaden our customer base and increase revenue. Stable business growth is underpinned by continuous investment in technology and research and development. In the third quarter, we invested RMB 149 million in research and development to reinforce our industry-leading capabilities. Business management is comprehensively connected to the anomaly attribution system which enables real-time detection of fluctuations in business and operational metrics and automatically generating quantitative insights. In the quarter, the system has covered above 400 key business metrics. Time required for anomaly attribution has been reduced to within a few hours or even minutes compared to previous time requirement of a few weeks under the traditional manual model, empowering smart business and management decision-making. The accuracy of our proprietary AI model in intense recognition has further improved in post-loan management scenarios. Its accuracy is 17% higher than that of external solutions, which helped to reduce costs and enhance operational efficiency. With regard to consumer rights protection, a long-standing priority for us, we have continued to enhance our customer communication and service management processes and strengthened digitalization and system development of customer services in the third quarter. Key initiatives included refining our issue grading system, introducing a frontline service authorization protocol and optimizing customer service workflows. These measures have significantly improved service handling efficiency, leveraging the extensive customer service data from our platform. We analyzed and identified the root causes of customer experience challenges and empowered our frontline teams with enhanced skills in issue identification and resolution, strengthening collaboration with business units to improve the consumer rights protection review mechanism in order to identify and address consumer rights protection issues at an earlier stage. Looking ahead, we remain committed to a prudent operational approach focused on bringing down risk level of overall loans and enhancing profitability. Also, we will properly intensify our customer acquisition efforts and push for steady growth in business scale. As the proportion of high-quality new loans increases and existing loans mature gradually, we expect to see continued accelerated improvement in the asset quality of overall loan book. We remain in full confidence in our ability to deliver stronger profitability in the coming year. To further reward our shareholders, we plan to raise our dividend payout ratio from the current 20% of net profit to 25% starting in 2025. Now I would like to hand the floor over to our CRO. Thank you.

Arvin Qiao: This is translation of CRO's remarks. In the first quarter, we continued to adhere to the strategy of tightened risk standard and profitability enhancement, focused on generating more high-quality assets and improve the accuracy and efficiency of high-risk asset control. We also upgraded the real-time anti-fraud detection capability, further refined the third-party data management system and build a real-time interactive risk management capability. Leading risk indicators for new assets and the overall assets continued the downward trend from the previous quarter. FPD7 of new assets decreased by about 13% compared to the second quarter and the overall asset day 1 delinquency rate decreased by about 9% compared to the second quarter. We expect this downward trend of leading risk indicators will continue in the fourth quarter. Specifically, in terms of risk management for new assets from new customers, we have made significant progress in both new customer acquisition through online advertising channels and activating dormant customers on Lexin's existing user base. In terms of new customer acquisition through online advertising channels, we have focused on key high-quality channels and accelerating phasing out long-tail high-risk channels. Meanwhile, we have continuously strengthened our risk identification capabilities and upgraded risk strategies for new customers, resulting in a stable decline in the risk level of new customers acquired through online advertising channel. Compared to the second quarter, the risk level of new customers acquired through this channel has decreased by 10%. By the end of the third quarter, leading indicator FPD7 for new customers have significantly decreased by about 50% compared to its peak in Q4 last year. Currently, the risk level of new customers acquired through online advertising channel has generally declined to a reasonable range. In terms of reactivation and conversion of dormant customers, we have deeply explored the borrowing needs of over 200 million customers on Lexin's existing user base. To fully leverage Lexin's large customer base advantage, we have strengthened our risk identification capabilities and improved our risk strategy system to identify high-quality users. Through targeted reoffers and coordination with our operational team, we have precisely reached and reactivated high-quality dormant customers with potential borrowing demand. In the third quarter, the number of reactivating dormant customers nearly doubled compared to the second quarter with the credit drawdown rate of approved customers increasing by 47% comparatively in the [indiscernible]. Moreover, the customer acquisition cost of reactivated dormant customers is low and the risk level is about 20% lower than that of new customers acquired through online advertising channels. In the fourth quarter, we will continue to intensify efforts to reactivate and convert existing customers in order to sustain the growth of new customers at low cost and low risk. On the front of new loans from existing customers, in the third quarter, we focused on three major projects

James Zheng: This is James. Now it's my turn. Thank you, Arvin. I will now give a more detailed update on our financial results, noting that all figures are presented in RMB, unless stated otherwise. During the past quarter, we adhered to our principles of prudent operation and continued the upgrading of our risk management capabilities and the transformation of overall business. Our efforts yielded satisfying results, evidenced by stable loan origination volume and a strong [indiscernible] growth. Total revenue amounted to approximately RMB 3.7 billion, remaining steady compared to Q2. Net profit showed a significant growth, increasing by 36.7% quarter-over-quarter to reach RMB 310 million. Here are 3 key highlights explaining our robust financial performance. First, substantial profit increase driven by higher revenue take rate. The sharp increase in net profit was primarily driven by higher take rate, which reached a record high of 3.25%, up by 35 basis points from 2.91% of Q2 and 81 basis points from 2.44% of the same quarter last year. The take rate calculation is derived by adding credit-oriented income and the tech empowerment income, subtracting funding costs and the various provisions, then dividing by new loan origination volumes for the quarter. A few core drivers supported this increase, including the following. One, the continued improvement in the risk level of new loans in Q3, evidenced by FPD7, which decreased by about 13% from Q2. Two, a new record low in funding cost of 4.28%, which fell by nearly 100 basis points from Q2 of 5.26% and 6.36% of the same quarter a year ago. We achieved this through ample funding and partnerships with cost-efficient national financial institutions. It also underscores the increasing confidence of our funding partners in our assets. Three, continued optimization of user loan early payoff ratio and the revenue from some value-added peripheral services. Second key highlight is the improved asset quality. The asset quality of our total loan book improved in Q3. Total provision cost, the 4 lines in our income statement, including provisions for financing receivables, contract assets and receivables, provision for contingent guarantee liability and fair value change in our financial guarantee derivatives and fair value loans decreased by RMB 21 million to RMB 1.61 billion from Q2. The day 1 delinquency rate of total portfolios increased by 9% compared to Q2, thanks to our ongoing business transformation initiatives, especially in the risk management upgrading project. As we are gradually phasing out higher-risk existing loans and we generate a better quality new loans, we believe the peak risk level of our total portfolio is behind us. The third key highlight is the enhanced efficiency in customer acquisition. In Q3, we improved customer acquisition efficiency through 2 major channels

Operator: [Operator Instructions] First questions will come from the line of Yada Li from CICC.

Yada Li: [Foreign Language] Then now I do the translation. Congrats to the exciting results. My first one is, what's management view on the growth strategy for the fourth quarter following the rollout of government policy stimulus at the end of September? And can we see signs of consumer loans demand recovery based on the current operational data? And secondly, what's the core drivers for the significant net profit growth this quarter? And will this growing momentum of net profit continue in the following quarters?

Jay Xiao: [Foreign Language]

Mandy Dong: This is Mandy. Let me translate for Jay.

Mandy Dong: Well, since the government rolled out the economic stimulus measures at end of September, we did observe some positive change in the short-term demand. However, whether it will turn into a long-term sustainable recovery still depends on the ongoing improvement in the macroeconomic environment in the future. So based on the quarter-to-date Q4 operational data, we see that total volume loan origination is generally flattish compared to the same period in Q3. We think this is due to our continued prudent operational strategy. We focus on maintain asset quality, especially control the higher risk part. Therefore, there hasn't been a significant growth in the overall loan origination volume. Well, although the total volume remained roughly at the same level, there has been a continuous optimization in our asset structure. We have seen a slight increase of the high-quality customer with consistent recovery and enhancement in the high-quality demand. At the same time, we are proactively promoting the growth of high-quality assets, continuing to increase the portion of high-quality assets and improve overall asset quality. Additionally, our recent upgrade in the customer acquisition strategy has proved to be effective. So we are actively deploying for the growth of new customers, we think which would lay a solid foundation for our growth next year.

James Zheng: Okay. Yes, Let me -- this is James. Let me answer your second question. Basically, the second question is give little more details in terms of our net profit for this quarter and also the forecast for next. In Q3, the net profit reached approximately about RMB 310 million. It is a very significant quarter-over-quarter growth of 36.7%. Really, the growth is attributed to the company's continued focus on strengthening our core competencies, especially in risk management, the continuous optimization of overall operations over the past 2 years. Specifically, really two drivers. The first one is the improvement in asset quality, as both Jay and as Arvin mentioned a few times. Basically, we’re benefiting from the strategic focus on the risk management – overall upgrade, new asset quality continued to optimize in Q3. The overall quality in Q3, actually in terms of asset quality, it really reached a turning point, beginning to stabilize and recover as the batch of loans with higher risks that we issued in second half of last year gradually mature. So based on our preliminary estimate, we would expect a considerable growth in net profit next year on a year-over-year basis. Obviously, as you know, we’re going to provide guidance for next year after we report our Q4 numbers. In this quarter, the FPD7 for the new assets decreased by approximately 13% quarter-over-quarter and the day 1 delinquency rate for the total assets decreased by about 9% in comparison with the second quarter. We would expect this downward trend of risk level continue in fourth quarter and into next year as well. So basically, that’s the first driver in the profit improvement. The second driver really is the record low funding cost. It's really driven by the ample market liquidity and a strong demand for the high-quality consumer credit assets. The funding cost continued to drive in Q3 is about 100 basis points lower than Q4, marking our largest quarterly optimization in the past couple of years. I can dive little bit more into the details, basically looking at the financial statement perspective. If you look at the pre-tax profit, it increased by RMB 95 million quarter-over-quarter. Obviously, if you look at the specifics, there are pluses and minuses here. If we look at the plus side, excluding the e-commerce revenue, there is an increased revenue related to the loan business in the amount of about RMB 150 million. And also, there’s a reduction in the total risk provisions and contributing to about RMB 20 million to the net profit quarter-over-quarter. Obviously, the minus side include the decreased e-commerce gross profit by about RMB 30 million in Q3. And also there’s increased processing and servicing costs for collections and OpEx of about RMB 50 million. So if we net both the plus and minus side together, it contributed to an increased pre-tax profit of about RMB 108 million. And this leads to the net income increase of about RMB 83 million quarter-over-quarter, a record quarter-over-quarter growth of about 37%. Again, we are happy with the result in Q3, and we expect a better profit increase for next year, which will provide a more detailed guidance after we report Q4. Hopefully, this answers your question.

Operator: Our next questions comes from Yuying Zou from CLSA.

Yuying Zou : [Foreign Language] Let me do the translation. The first question, management mentioned that it was -- the risk level of new loan has been continuously optimized quarter-over-quarter and overall asset quality has also improved compared to Q2. Could you elaborate on the main measures taken in Q3 to optimize the risk level of new loans and provide an outlook on the expected progress of the overall asset quality recovery in the future? And the second question is about the newly launched Intelligent Credit Platform model. Could you elaborate more on the future plan on this new business line and its impact on the company's business scale and profitability?

Arvin Qiao: [Foreign Language]

Mandy Dong: Let me translate for Arvin.

Mandy Dong: So in Q3, regarding the key areas in risk management space, we primarily focused on improving several assets

Jay Xiao: [Foreign Language]

Mandy Dong: Let me translate for Jay's comments.

Mandy Dong: Well, thanks to our continued effort to strengthen the internal capability, especially the risk management capability, we have been able to upgrade the risk identification capability that enabled us to conduct a more precise customer segmentation and launch the new model, ICP, short for Intelligent Credit Platform model. ICP is a capital-light profit-sharing model where Lexin does not bear the risk of principal loss. The new model expands our addressable market while smooth the potential risk fluctuation across credit cycle. Through the ICP model, we can identify customers with different risk levels more precisely, provide more accurate segmentation and differentiated pricing, then distribute these assets to financial institutions with corresponding and complementary risk appetite. This approach allow us to offer customer longer life cycle service, thereby generating more sustainable revenue from technology service. Well, although the ICP model just got launched in Q3 and only accounts for a very small portion of our total loan volume currently, we believe this business line is crucial to adjusting our overall asset structure and turn our business model into a more sustainable one. We believe ICP model still has a significant growth potential. We will continue to make product mix adjustment through expanding this model. Zou, hope this address your question.

Operator: The next questions comes from the line of [Yufeng Chan] from Huatai Securities.

Unidentified Analyst: Okay. Let me do the translation. I have 3 questions. The first one is, we noticed management also mentioned that the funding cost hit a new record low this quarter. Could you elaborate on the driving factors behind this and provide an outlook on funding cost for Q4? And the second one is, in Q3, unit customer acquisition cost significantly decreased and the number of new approved credit line customers increased substantially quarter-on-quarter. Could you introduce the main measures taken and whether the customer acquisition cost will continue to drop in the future?

James Zheng: Okay. I will take the first question [indiscernible] Funding cost decreased by approximately 100 basis points to 4.28% in comparison with Q2. This really marks the 11th consecutive quarter of reducing funding cost since Q1 of 2022, reaching a new historic low and achieving the largest quarterly reduction. For the fourth quarter, given that we're already at a historic low funding cost and also considering there is a kind of a seasonality of tightened funding typically before the end of the year, right, for financial institutions, so we anticipate a relatively milder optimizations in funding cost for Q4. Looking ahead to 2025, with the continued implementation of easing money policies supporting the macroeconomic recovery and more recognition from the funding partners as our asset quality continues to improve, so we have confidence that we will continue to optimize the funding cost and enhance our overall profitability next year.

Jay Xiao: [Foreign Language]

Mandy Dong: Let me translate for Jay's comments.

Mandy Dong: So regarding your question about the cost of customer acquisition, the reduction of this is mainly attributable to several measures. Number one, we have significantly improved our capability and efficiency in customer acquisition through the online advertising channel on a quarter-over-quarter basis. Unit cost of users with approved credit line dropped by 24% Q-on-Q and the number of users with approved credit line increased by 22%. As for the portion of good quality and high potential users, total number with approved credit line rose by 34% and the total amount of the credit drawdown increased by 30%. Meanwhile, we are able to draw down the unit cost acquisition of good quality users by 40%. As a result, the risk level of new customers dropped by 10% compared to Q2. Moreover, the proportion of good quality users continue to hike and the payback period got shortened. We believe with the strengthened customer acquisition capability, we will probably increase investment in customer acquisition front in the future in order to lay a foundation for the business growth next year. The second measure, we have intensified efforts to activate and convert dormant customers. Over the past 11 years, Lexin has accumulated a large user base, roughly more than 200 million users. In the future, we will continue to refine the operations in order to provide more accurate credit line granting and the loan pricing for customers to activate dormant customers. In Q3, the total number of reactive dormant customers nearly doubled compared to Q2 with the credit line drawdown rate of the approved customer increased by 47% comparatively in the [indiscernible]. Moreover, the customer acquisition cost for the reactive state customer is low and the risk level is about 20% lower than that of the new customer from online advertising channel. Therefore, in Q4, we will continue to intensify efforts to reactivate and convert existing customers in order to sustain the growth of new customers at low cost and low risk. For the third front, we have further strengthened our cooperation with the KA – leading KA channels in Q3. By far, the volume growth and the profitability looks good. We will continue to increase the investment in this channel in the future. I hope this addressed your question, [Yufeng]. Operator, can you check if there is more questions on the line?

Operator: There are no more questions on the line. Please continue.

Mandy Dong: Okay. Then, thank you, everyone, again, for joining us today. If you have further questions, please contact via the contact information on our IR website. Thank you, all. Have a good day, and good night. Bye Bye.

Operator: This concludes today's conference call. Thank you for your participation. You may now disconnect your lines.