CNFinance Holdings Limited (CNF) Q1 2019 Earnings Call Transcript

CNFinance Holdings Limited (NYSE: CNF) Q1 2019 Earnings Call May 22, 2019, 7:00 a.m. ET

Prepared Remarks:

Operator

Good day and welcome to the CNFinance First Quarter 2019 Earnings Conference Call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing *0. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press *1 on your telephone keypad. To withdraw your question, please press *2. Please note today's event is being recording.

I would now like to turn the conference over to Rene Vengastan. Please go ahead.

Rene Vengastan

Thank you, Rocco. Hello, everyone, and thank you for joining us today. CNFinance first quarter 2019 earnings were distributed earlier today and are available on the IR website at ir.cashchina.cn, as well as on PR Newswire's services.

On the call today from CNFinance, we have Mr. Bin Zhai, Chairman and Chief Executive Officer, and Mr. Ning Li, Chief Financial Officer. Mr. Zhai will review business operations and company highlights, followed by Mr. Li who will discuss financials. Both will be available to answer your questions during the Q&A session that will follow.

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Before we begin, I would like to remind you that this conference call contains forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934 as amended and as defined in the U.S. Private Securities Litigation Reform Act of 1995. These forward-looking statements can be identified by terminology such as will, expect, anticipate, future, in turn, plans, believes, estimates, target, going forward, outlook, and similar statements. Such statements are based upon the management's current expectation and current market and operating conditions and relate to events that involve known and unknown risks, uncertainties, and other facts, all of which are difficult to predict and many of which are beyond the company's control, which may cause the company's actual results, performance, or achievements to differ materially from those in the forward-looking statements.

Further information regarding these and others risks, uncertainties, or factors are included in the company's filing with the U.S. Securities and Exchange Commission. The company does not undertake any obligation to update any forward-looking statement as a result of new information, future events, or otherwise, except as required under applicable law.

It is now my pleasure to introduce Mr. Zhai. Please go ahead.

Bin Zhai -- Chairman and Chief Executive Officer

Thank you, Rene, and thank you all for joining us today. On today's call, I'd like to cover some business and operational developments, the current industry and market environment, and review programs and future plans for our collaboration model. After all that, I will be taking your questions with our CFO.

During the first quarter of 2019, revenue came in at 890 million RMB with net income of 140 million RMB. Even though the provision for credit loss was 170 million RMB, our actual loss rate remained consistently low in fact.

As discussed in our fourth quarter of 2018 conference call, under our old trust lending model, the company has to contribute 25% of the total loan amount to support financing for its customers in order to support the long-term sustainable growth of the company and to create greater value for shareholders without the need for more capital investment. We started to upgrade our business model into the collaboration model by establishing a long origination partner services platform.

Under this model, we cooperate with [inaudible] local loan originators to act as our sales partners who source and recommend clients to us. Our standardized risk control system assesses and recommends these clients to specific trust company partners, who will then facilitate the loans. In order to guarantee the loans, sales partners are required to pay 20% of the recommended loan amount to our platform as a credit risk mitigation position. Consequently, the sales partners are motivated to bring high quality assets as they stand to gain from the position they have to put up.

Under this collaboration model, the benefits to the company are three-fold. First, it reduces employee cost as these partners are not full-time employees and the company only needs to compensate them when the loans that they originate are accepted. Second, it reduces the company's risk exposure as 20% of the 25% subordinate trench subscribed by the company is secured by the credit risk mitigation position. And third, increased ROE for shareholders.

Our mission is to provide accessible, affordable, and efficient financing solutions for those MSA owners who are often underserved by traditional financial institutions. There is enormous potential in China's home equity loans market. According to a report by Oliver Wyman, the size of the home equity loans market provided by nontraditional financial institutions will reach 2.5 trillion RMB by 2022 at an average annual compound growth rate of 20% in the next five years. The total number of MSA owners who owns properties in first and second-tier cities are approximately 53 million. We are serving less than 100,000 customers as of today, so there's still a huge market to grow our business.

Currently, there are many small-scale and standardized regional and independently operated home equity loan originators in China. However, each originator has his own strength. After devoting extensive resources toward developing our business over the past 10 years, we have become the second largest financial service provider in the industry, second to Ping An Puhui only. We have developed a [inaudible].

First, we have established a standardized data-driven risk control system and an efficient post-loan management system. We combined these two systems to effectively minimize human errors. Second, we have established more than 40 branches in Tier 1 and Tier 2 cities across China, giving our customers the convenience of localized services right in the heart of their neighborhood. Third, from more than a decade of operation experience, we are able to adjust product structures swiftly to better serve the financial needs of MSA owners.

Simultaneously, we have established strong partnerships with many financial institutions to obtain low-cost, stable, and sufficient sources of funding for future growth. This [inaudible] have created a stable foundation and support for us to upgrade our business to a collaboration model. We believe this collaboration model will benefit all partners significantly.

First of all, this models empowers geographically diverse sales partners who have client basis and limited funding by offering them competitive products with a robust risk control system for assessment and post-loan services. This collaboration will lower our sales partners' risks, broaden the company's client base, and readily expand the company's market share. Furthermore, we and the sales partners have established a mechanism to balance benefits and risks. Sales partners can indirectly obtain low-cost, institutional fund by investing 20% as the credit risk mitigation position. The mechanism not only incentivizes our sales partner to generate high quality loans but also rewards them handsomely on their credit risk mitigation position. For our company, the mechanism enables us to reduce the amount of capital we need and lower our risk profile as well.

Last but not least, our collaboration model is equipped with a robust risk control and post-loan management system, which provides us with monitoring and management services for all the loans facilitated. This system strengthens our partnership with our trust company partners and also lays the foundation to further lower our funding cost and develop high-quality clients.

Our collaboration model has performed exceptionally well in its first quarter of operation. We have signed cooperation agreements with approximately 600 sales partners, 300 of whom have already begun introducing borrowers to our company. Total loan origination volume approached 1 billion RMB during the first quarter with over 1,900 transactions, and this model has already become profitable. I know current takes, we are confident that we will reach a loan origination volume of 10 billion RMB in 2019. As this model matures and stabilizes, we strongly believe that our profitability will gradually increase going forward.

And with that, we will pass to our CFO.

Ning Li -- Executive Director and Chief Financial Officer

I'm Li, CFO of the company. Thanks again to everyone joining us today. I will walk you through our first quarter 2019 financials. We believe year-over-year comparison is the best way to review our performance. Unless otherwise stated, whole percentage changes I'm going to give [inaudible]. As of March 31st, 2019, total outstanding loan principal decreased to 14 billion RMB compared to 15 billion RMB as of December 31st, 2018. Total loan origination volume was 998 million RMB.

Interest and financing service fee on loans was 888 million RMB, a decrease of 70%, primarily due to the decrease of the loan origination volume, which is a result of the company's strategic focus on ensuring loan quality over loan growth and devoting its resources on the new collaboration model, which is currently at its early stage. This slow down of loan facilitation has led to a decrease in the interest and financing service fee on loans. Interest and fee expenses was 419 million RMB, compared to 467 million RMB in the same period of 2018, primarily due to a general decrease of the loan origination volume. Net interest and fees income were 473 million RMB, a decrease of 21% from 598 million RMB in the same period of 2018.

Provisions for credit losses was 173 million RMB, an increase of 20% from 144 million RMB in the same period of 2018. Total operating expenses were 137 million RMB, a decrease of 24%, compared with 180 million RMB in the same period of 2018. Income tax expenses was 46 million RMB, a decrease from 79 million RMB in the same period of 2018. Net income was 136 million RMB, a decrease of 31% from 197 million RMB in the same period of 2018. As of March 31st, 2019, the company had cash and cash equivalents of 2 billion RMB, compared with 3 billion RMB as of December 31st, 2018.

The aggregate delinquency rate for loans originated by the company, which represents total balance of outstanding loan principal for which any installment payment is past due for one or more days as a percentage of the aggregate total amount of loan we originated since 2014 increased from 7.6% as of December 31st, 2018 to 8.2% as of March 31st, 2019. The increase in aggregate delinquency rate was a result of the changing market environment, slower growth of outstanding loan principal, and the longer collection process.

...

That's all for the quick review of our first quarter results. Right now, I'd like to open up the call for Q&A. Operator, please begin.

Questions and Answers:

Operator

Thank you. We will now begin the question and answer session. To ask a question, you may press *1 on your touch-tone phone. If you're using the speakerphone, we ask that you please pick up your handset before pressing the keys. To withdraw your question, please press *2. Today's first question comes from Zhao Bin Yang of Shenwan Hongyuan. Please go ahead.

Zhao Bin Yang -- Shenwan Hongyuan -- Analyst

So, the question is last year, under the old model, the net income of the company was high. A huge portion of the income came from the subscribed subordinate units. However, under the new model, you're giving up 20% of those profits to the sales partners, so why would the company want to change its business model? Can you explain why is the new model good for the company?

Bin Zhai -- Chairman and Chief Executive Officer

So, the answer is firstly, under the original model, in order to develop the business, we have to keep on hiring more sales, so the labor cost of the company will keep on going up. And the second thing is, under the old model, the company has to subscribe to all of the subordinate units. It makes it harder to expand the business side since we have to keep on investing capital to the subordinate units. And the third thing is under the original model, the company also has to bear all the credit risk, and whenever the company wants to expand its business or the aggregate delinquency rate goes up, the company will need to prepare a huge amount of own funds for buyback, so it will bring huge pressure on the company's cash flow.

And the collaboration model will offer solutions for those three limitations. First off, we're encouraging the salespeople to become our sales partners, so that way, they won't be on our payroll anymore, therefore we could reduce our labor cost. Secondly, since the sales partners now have to put up a credit risk mitigation position, they will actually bear risks with us together, so therefore, they are motivated to recommend assets with caution. Therefore, the quality of assets is guaranteed.

Thirdly, this new collaboration model will release our own funds for intermediate business, and we can expand our business size. And also, our risks will be reduced. And also, more funds gave us the possibility to enter a new market when it's necessary. And fourthly, since we are operating under a platform model now, it gives us bargain power against the trust companies because the new model will help us to gain market share and also reduce our aggregate delinquency rate and makes it possible for us to lower our financing cost and create greater value for the shareholders in the future.

And as for why we are not keeping the original model and the new model together, it's because under the collaborative model, we are trying to attract those small loan originators in the market to cooperate with us by becoming our sales partners. If we still keep the old model, we're still competing with them, and we are worried they might be doubtful of our new platform.

Zhao Bin Yang -- Shenwan Hongyuan -- Analyst

And the second question is after we upgrade to the collaboration model, are we moving any assets out of the consolidated balance sheet? Is this gonna be any influence on the company's financial reports?

Translator

So, the CEO handed this question to our CFO, Mr. Li Ning, and he's gonna answer that for you.

Ning Li -- Executive Director and Chief Financial Officer

So, our financial perspective is it's still us that's signing the agreements with the trust companies. Those small loan originators couldn't really cooperate with the trust companies directly. So, it is still us that values subscribing to the subordinate units. We are only funding a way to transfer the risk to our sales partners. And we have also discussed with our auditors, and we feel like the trust company assets will still be considered as VIE in our consolidated balance sheet. But at the same time, since we are getting 20% of the credit risk mitigation position, we are going to consider that as an asset in our balance sheet. So, currently, the balance sheet will still reflect this side of our assets. The risk factors will be put in the footnote just so the investors will have a better understanding. As for the P&L, since we are getting the 20% of the credit risk mitigation position, the provision will be much lower in the future. I hope this answers your question.

Translator

So, there's no further questions from Shenwan Hongyuan.

Operator

Thank you. As a reminder, ladies and gentlemen, if you would like to ask a question, please press *1 at this time. We will pause momentarily to assemble our roster. Since we have no further questions, I'd like to turn the conference back over to the management team for any final remarks.

Rene Vengastan

Thank you, operator. We now have a question that was submitted earlier by email by Macquarie. Please go ahead.

Translator

So, the question from Macquarie was what caused the aggregate delinquency rate and aggregate NPL rate to go up? Is this situation going to be better in the foreseeable future?

Bin Zhai -- Chairman and Chief Executive Officer

So, this question is also answered by our CFO, Mr. Li Ning.

Ning Li -- Executive Director and Chief Financial Officer

This number was actually higher than the fourth quarter of 2018 in the first quarter of 2019. There are actually two indicators. The first one is the aggregate delinquency rate, which represents the loan volume that is delinquent for over one day, and the second indicator is the aggregate NPL rate, which represents the rate of the loan principal amount that is delinquent for over 90 days. First of all, since we are transferring from the original model to the new collaboration model, so the outstanding loan amount under the old model was actually smaller. So, instead of using a rate, we prefer to use the value. As for the delinquency rate, we don't see much increase from the fourth quarter of last year to the first quarter of this year.

As for the NPL rate, it's increased a little bit bigger than the delinquency rate, and here are the main reasons for that. First of all, some of our old collecting methods cannot be used anymore since last year. For example, the power of attorney was signed between the borrowers and the company was considered as invalid. And right now, the most used collecting method is just to go for judicial procedures. For example, when we can still use the power of attorney, we don't have to go through a lawsuit to dispose the collateral, and the usual time that it takes is only 90 days. And since the power of attorney is not in use anymore, and the deregulation of the industry is being more and more strictly, it's taking a longer time for us to trying to dispose the assets.

However, it doesn't mean that negotiating with the borrowers is not useful anymore. What we are using now is that we are using both the judicial procedure and trying to negotiate with the delinquent borrowers. Even though it's taking more time for us to dispose the asset, which is shown on the NPL rate is causing it to go up, it doesn't mean that it's influencing the recovery of our loans. For example, the full year of 2019, the loan amount which is delinquent for over 30 days was 900 million RMB, but the refund we get from the collecting was 935 million RMB.

And as for those that were delinquent for over 90 days, the delinquent amount was 459 million RMB, and the refund we got was actually 462 million RMB. As for the first quarter of 2019, the total delinquent amount which was delinquent for over 30 days was 214 million RMB, but the refund we get was 230 million RMB. And as for those that are delinquent for over 90 days, the delinquent amount was 141 million RMB, and the refund we got was actually 143 million RMB. So, based on that, we are positive that the refund we get could cover the delinquent amount. We have to admit that the current condition of the market is causing the delinquent rate and NPL rate to go up. However, it doesn't really affect our ability to recover our loan amount.

Translator

And that's the answer from our CFO. Hope that answers your question.

Operator

Thank you. We also have another audio question from Ran Zhang of Cathay Capital. Please go ahead.

Ran Zhang -- Cathay Capital -- Analyst

There are actually two questions. The first one is does the company have any plans for dividends. The second question is does the company do second mortgage or will the second mortgage affect the collateral quality.

Bin Zhai -- Chairman and Chief Executive Officer

The company has always been considering to pay dividends. However, since we didn't really raise enough funds during IPO and we have to pay off many expenses [inaudible] China, so we're not really going to pay dividends in this quarter, but there is a possibility in the future.

As for the second question, we first want to introduce how we really do the second mortgage. First of all, the banks don't really do second mortgage, so it's one of our products that we have an advantage in. Actually, second mortgage doesn't have a lot of differences between first mortgage because we still only facilitate 70% of how much the collateral is worth as a loan. For example, if a collateral is worth 1 million RMB, and the first mortgage was probably 0.5 million RMB, the whole amount of the loan of first mortgage and second mortgage will be 70% of that 1 million RMB, which is 0.7 million RMB. So, what we will put out as the second mortgage was to subtract that 0.5 million RMB from the 0.7 million RMB, which is 0.2 million RMB. So, we still have approximately 30% of the house value being guaranteed.

And the difference between first mortgage and second mortgage is that the borrowers have had to serve their first mortgage first and then the second mortgage. However, since we have the 30% of guarantee I talked about, we are still in a good position. However, the collecting method we use and the collecting procedure that we have to follow is no different between first mortgage and second mortgage, but since the banks are often too slow to start the collecting procedure, it's usually us who starts it. So, all in all, the second mortgage is considered a follow-up for the existing products of the bank and also one of our products that we have competitive advantages in.

Translator

And that's the answer from the CFO. I hope that answers your question.

Operator

Thank you. And as a reminder, ladies and gentlemen, if you would like to ask a question, please press *1 at this time. This concludes our question and answer session. I'd like to turn the conference back over to Rene Vengastan for any closing remarks.

Rene Vengastan

Thank you, Rocco. This concludes our call tonight. Thank you all for your participation and continued interest in our company. Good night.

Ning Li -- Executive Director and Chief Financial Officer

Good night. Thank you.

...

Operator

Thank you. This concludes today's conference call. Thank you all for attending today's presentation. You may now disconnect your lines and have a wonderful day.

Duration: 53 minutes

Call participants:

Rene Vengastan

Bin Zhai -- Chairman and Chief Executive Officer

Ning Li -- Executive Director and Chief Financial Officer

Zhao Bin Yang -- Shenwan Hongyuan -- Analyst

Ran Zhang -- Cathay Capital -- Analyst

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Prepared Remarks:

Questions and Answers:

Call participants: