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Edited Transcript of PPDF.N earnings conference call or presentation 20-Aug-19 12:00pm GMT

Q2 2019 PPDAI Group Inc Earnings Call

Aug 26, 2019 (Thomson StreetEvents) -- Edited Transcript of PPDAI Group Inc earnings conference call or presentation Tuesday, August 20, 2019 at 12:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Feng Zhang

PPDAI Group Inc. - Co-CEO

* Jimmy Tan

PPDAI Group Inc. - Head of IR

* Jun Zhang

PPDAI Group Inc. - Co-Founder, Chairman of the Board & Co-CEO

* Tak Leung Ho

PPDAI Group Inc. - CFO

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Conference Call Participants

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* Daphne Poon

Citigroup Inc, Research Division - Associate

* Huanan Zhou

UBS Investment Bank, Research Division - China Financials Research Analyst

* John Cai

Morgan Stanley, Research Division - Research Associate

* Sanjay Harkishin Sakhrani

Keefe, Bruyette, & Woods, Inc., Research Division - MD

* Tian Hou

* Tianxiao Hou

T.H. Capital, LLC - Founder, CEO & Senior Analyst

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Presentation

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Operator [1]

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Hello, ladies and gentlemen. Thank you for participating in the Second Quarter 2019 Earnings Conference Call for PPDAI Group, also known as Paipaidai. (Operator Instructions) Today's conference is being recorded.

I would now like to turn the conference over to your host, Mr. Jimmy Tan, Investor Relations Director for the company. Jimmy, please go ahead.

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Jimmy Tan, PPDAI Group Inc. - Head of IR [2]

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Hello, everyone, and welcome to Paipaidai Second Quarter 2019 Earnings Conference Call. The company results were issued via newswire services earlier today and are posted online. You can download the earnings release and sign up for the company distribution list by visiting the IR section of our website at ir.ppdai.com. Mr. Cliff Zhang, our Chairman and Co-Chief Executive Officer, Mr. Feng Zhang our co- Chief Executive Officer and Mr. Simon Ho, our Chief Financial Officer, will start the call with their prepared remarks and conclude with a Q&A session.

During this call, we will be referring to several non-GAAP financial measures to review and assess our operating performance. These non-GAAP financial measures are not intended to be considered in isolation or as a substitute for the financial information prepared and presented in accordance with U.S. GAAP. For information about these non-GAAP measures and reconciliation to GAAP measures, please refer to our earnings press release. Before we continue, please note that today's call will contain forward-looking statements under the safe harbor provisions of the U.S. Private Securities Litigation Reform Act of 1995. Forward-looking statements involve inherent risk and uncertainties. As such, the company's results may be materially different from the views expressed today. Further information regarding these and other risk and uncertainties is included in the company's filings with the U.S. Securities and Exchange Commission. The company does not assume any obligation to update any forward-looking statements, except as required under applicable law. Finally, we post a slide presentation on our IR website, providing details of our results for the quarter.

I will now turn the call over to our Chairman and co-CEO, please go ahead.

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Jun Zhang, PPDAI Group Inc. - Co-Founder, Chairman of the Board & Co-CEO [3]

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Okay. Thank you, Jimmy. Hello, everyone, and thank you for joining our Second Quarter 2019 Earnings Conference Call today. During the second quarter, we continued our focus on driving healthy results and maintaining robust and above-standard regulatory compliance. Our solid growth momentum amidst a dynamic and a volatile market environment reflects a constant demand for technology-driven consumer finance services in China. We are particularly pleased with the following metrics for the quarter. Firstly, our institutional funding base showed a continuous progression, translated into a 29% year-over-year and 13% quarter-over-quarter increase in our total loan origination volume, which reached RMB 21.6 billion. Secondly, our operating revenue achieved a 47% year-over-year and a 7% quarter-over-quarter increase. And thirdly, our dedicated efforts to grow both our user and borrower bases continued to show encouraging results as the number of registered users exceeded 99 million, and the number of cumulative borrowers exceeded 16.5 million at the end of June. Investment in technology and artificial intelligence is at the heart of PPDAI. By leveraging our technologies as a service offerings, we are enabling our institutional partners in consumer finance and creating deeper relationship with our partners. The rapid uptake and acceptance by external third-party financial service providers reaffirms PPDAI's presence as the leading consumer finance marketplace with strong technology -- technological capabilities. We're also extending our technologies and our capabilities to overseas market. We have started to operate in Indonesia and the Philippines this year with plans to explore other Southeast Asian markets.

Looking ahead, we will remain committed to expanding our core strengths while placing a sharp focus on our business strategies. We expect PPDAI to continue to capture the enormous potential in the consumer finance market both domestically and abroad.

Now I'd like to pass the call over to our co-CEO Feng to discuss on an update of our business.

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Feng Zhang, PPDAI Group Inc. - Co-CEO [4]

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Thank you, Cliff, and hello, everyone. We are thrilled by our second quarter performance that not only illustrates the sustained market demand, but also our high resiliency as supported by a vibrant user base, diverse funding structure and a structure -- and a strong technological capability. As Cliff mentioned, we remain confident in our ability to deepen the diversification in funding sources and extend our institutional funding partners, driving healthy growth in the long term. As all of you are aware, the diversification of our funding has been a major strategic initiative for us over the past year. This funding transformation has been rapid. In the second quarter, 45% of our loan origination volume was funded by institutional partners, up significantly from 10% in the same period a year ago, and a further increase from 31% in the previous quarter.

The proportion of institutional funding further increased to 53% in July. We now have more than 20 institutional funding partners active on our platform. This has enabled us to deliver steady growth in loan volume quarter by quarter, and our loan volume in the second quarter is nearly 30% higher than a year ago. The profitability of our loans funded by institutional partners is healthy. In the second quarter, 40% of our operating revenue came from loans funded by institutional partners, a significant increase from 24% in the first quarter. Now turning to credit. Delinquency rates were generally stable in the second quarter and continued to perform within our expectations. If you look carefully at our vertical delinquency rates, at the end of June, you will see that there have, in fact, been small improvements versus the previous quarter and the delinquency rates are mostly back to the lowest levels since September, 2017.

Thanks to our strong and effective risk management. We expect delinquencies to remain stable in the near term. Turning to regulations. There continues to be uncertainty in regulation, specifically, on P2P registration process. It is uncertain whether, there will be a registration process and if so when it will happen. As most of you are aware, we have been adhering to the government's triple decline policy since the beginning of the year. This refers to the monthly reduction in the outstanding loan balance, the number of investors and the number of borrowers for the part of our business that is funded by individual P2P investors. In the coming months, we plan to set up -- we plan to step up our implementation of the government's triple decline policy, and we expect the loan origination volume funded by individual P2P investors to decline more significantly than in the first half of the year. We will continue to accelerate our strategy to expand our funding from institutional sources. The momentum and outlook are strong.

Credit commitments from our institutional partners totaling over RMB 45 billion. In the first half of 2019, RMB 15.6 billion of loan originations were funded by institutions. And in the second half of 2019, we expect loan originations funded by those partners to be in the range of RMB 32 billion to RMB 38 billion, implying at least double that in the second half of the year versus the first half. Despite the expected decline in P2P funded loan originations, we still expect our total loan volume in the third quarter to be in the range of RMB 22 billion to RMB 24 billion, representing moderate quarter-over-quarter growth. And we expect roughly 70% of such loan originations to be funded by institutional partners. We believe there continue to be a certain degree of fluidity and uncertainty in the regulatory environment so it is hard to say how much more decline there will be with any great certainty.

I want to emphasize that P2P funding from individuals is becoming less and less important as we continue to accelerate our strategy to diversify our funding sources. We are confident in our ability to achieve these targets, given our proven technologies and end-to-end capabilities to support financial institutions from customer acquisition, risk assessment, to loan servicing and the collections. Our scale and experience with 99 million registered users, over 16 million cumulative borrowers and the 12-years that we have been in this business, and our strong management team and ability to execute. Looking forward, consumer finance in China remains a large and under-penetrated market, the market demand is huge, and we are confident in capturing the potential of this vast market.

With that, I will now turn the call over to our CFO, Simon Ho, who will discuss our financial results for the quarter.

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Tak Leung Ho, PPDAI Group Inc. - CFO [5]

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Thank you, Feng, and hello, everyone. We are delighted to have achieved solid operational and financial results in the second quarter as lending volumes steadily increased, underscoring the strength of our markets and the growth trajectory of our business. In particular, our operating efficiency and profitability continues strong momentum, highlighted by a 60% year-over-year increase in non-GAAP adjusted operating income and a healthy non-GAAP operating margin of 50%, thanks to our effective cost control.

Our balance sheet remains solid with approximately RMB 2.4 billion of cash and short-term liquidity. Notably, our quality assurance fund remains sufficient with a total balance of RMB 5.8 billion, equivalent to 22.5% of the total outstanding loan principal and interest with quality assurance. Our results demonstrate the strength and resilience of our business model and our ability to navigate changing market dynamics.

Now let me briefly go over the financial results for the second quarter. In the interest of time, I would not walk through each item line by line on this call. Please refer to our earnings release for more details. Operating revenues for the second quarter of 2019 increased by 47% to approximately RMB 1.6 billion from RMB 1.1 billion in the same period of 2018 primarily due to the increase in loan facilitation service fees, post-facilitation service fees and interest income from loans invested mainly through trusts. Loan facilitation service fees increased by 25% to RMB 940 million for the second quarter of 2019 from RMB 753 million in the same period of 2018 primarily due to the increase in loan origination volume.

Loan facilitation service fees from loans funded by institutional funding partners were RMB 378 million in the second quarter of 2019. Post-facilitation service fees increased by 53% to RMB 316 million for the second quarter of 2019 from RMB 206 million in the same period of 2018 primarily due to the increase in loan origination volume and the rolling impact of deferred transaction fees. Post-facilitation service fees from loans funded by institutional funding partners were RMB 55 million in the second quarter of 2019.

Net interest income and loan provision losses were an income of RMB 195 million compared to an income of RMB 18 million in the same period of 2018 mainly due to the increased interest income from the expansion in the outstanding loan balances of consolidated trusts.

Non-GAAP adjusted operating income, which excludes share-based compensation expenses before tax, was RMB 779 million for the second quarter of 2019, representing an increase of 60% from RMB 487 million in the same period of 2018. Other income was RMB 46 million for the second quarter of 2019 compared with RMB 297 million in the same period of 2018 primarily due to the decrease in the gain in quality assurance and returns from short-term investments.

Income tax expenses were RMB 153 million for the second quarter of 2019 compared with RMB 158 million in the same period of 2018. Net profit increased by 8.7% to RMB 661 million for the second quarter of 2019 from RMB 608 million in the same period of 2018. Before I hand the call over to Q&A, I'd like to conclude by emphasizing a few points regarding our funding transition. We expect institutional loan volumes to at least double in the second half of the year versus the first half. And the revenue margin of loans funded by institutional partners is only slightly lower as shown by the fact that revenue contribution from institutional funding is 40% of total revenues at slightly lower proportion versus the loan volume contribution from institutional funding of 45% in the second quarter. Finally, over the past year, despite the changes and challenges to the industry, we have continued to deliver consistent performance. So in conclusion, we are confident in our ability to navigate this transition and changes in the industry. And the long-term opportunity in China's consumer finance market is huge, our core capabilities position us well to enjoy the benefits of this vast opportunity.

With that, I will conclude my prepared remarks. We will now open the call to questions. Operator, please continue.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And our first question today comes from John Cai with Morgan Stanley.

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John Cai, Morgan Stanley, Research Division - Research Associate [2]

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I have 3 questions. So the first one is about the mix of institution and retail funding. So can you disclose it by balance? How many balance -- outstanding balance funded by institution versus retail? And in terms of balance, what kind of the expected loan balance funded by P2P towards the end of the year? And related to that, it's on the economics of institution and retail funding, it seems the take rate is similar because the -- of the portion from institutional funding in terms of loan volume and the revenue contribution seems similar. So my understanding is that the product is quite different. So maybe this -- can you put more colors on the economics.

And the second question is about customer acquisition. I noticed that originations and servicing expense and sales and marketing pick up on a sequential basis. Can the management share more about the customer acquisition efforts and the cost? And the final questions is about some trends. So I noticed that customer acquisition pickup and then -- but the repeat ratio or the repeat borrowing ratio also pick up and the average ticket size decline sequentially and also the tenure also decline. So just wondered -- my understanding is that if we lend more to the new borrowers potentially the ticket size and tenure might decline, but it seems that repeat ratio is telling the other story. Just wonder if there is any underlying reasons behind that?

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Tak Leung Ho, PPDAI Group Inc. - CFO [3]

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Sure. John, let me try to attack some of those -- address some of those questions. In terms of the loan balance, our peer to peer -- sorry, our institutional loan balance at the end of the June quarter was roughly around RMB 12 billion, this is up about maybe 70% on a quarter-on-quarter basis. And our peer to peer balance at the end of the year was close to -- sorry, in June, was close to about 20 -- just under RMB 20 billion. Okay, that just gives you an idea. We haven't quite extrapolated all that till the end of the year, but I think you're pretty good at your math so you might be able to do some very well educated guesses, given the volume guidance we've just provided.

Now in terms of the -- your questions about obviously -- I'm going jump around to customer acquisition costs. The customer acquisition cost in the second quarter, you're right, did increase somewhat. On average, it was about RMB 190 per new borrower in the second quarter. This increase versus the first quarter was due mainly to the shift in the borrow mix towards the higher credit quality segment which we've flagged before, and this is in line with the strategy and our focus. And this segment has somewhat higher acquisition costs. But overall, at about RMB 190, this is a relatively low level compared to our peers. Going forward, we do expect customer acquisition cost to somewhat increase as our borrower base continues to shift towards this higher credit quality segment.

You did mention about our ticket size and our loan tenure. Our ticket size decline a little bit in the quarter, on average mainly because the proportion of repeats loans went up in the quarter as you highlighted. And the ticket sizes for repeat loans tend to be a bit smaller than first time loans. Some of these as you know may be just top up loans, utilizing unused credit limits so there is a bit of an influence there. The loan tenure shortened very slightly during the quarter and from what I can see, where I can see it, it's mainly because certain -- some institutional partners that we were servicing preferred shorter -- a bit shorter tenure. So -- but there is really no change in our strategy in either of these areas. Now with regards to your second question John, you mentioned about take rates, economics, institutional, retail being not too different. What specifically, did you wanted to know more about?

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John Cai, Morgan Stanley, Research Division - Research Associate [4]

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Yes. So probably just can you give us some -- like waterfall, the gross customers' pay-in deduct by funding cost and probably some estimated credit cost. Yes, so sort of the product difference. Yes.

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Tak Leung Ho, PPDAI Group Inc. - CFO [5]

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Let me put it this way, John, I mean we could obviously go through a lot more details afterwards. I think if you compare the profitability of our institutional funding business versus sort of the P2P side, there are a few differences to take in mind first. One is there is a bit of a borrower profile difference, the borrowers that are funded by institutional funds tend to be at the better credit quality end of our range of borrowers that we service. So the expansion in our institutional funds means we are extending into borrowers of better credit quality. And generally speaking, we do offer lower borrowing rates to the segment, but they also have lower delinquency rates.

In terms of profitability as we've mentioned before, there is obviously some small difference, but not hugely different from our overall profitability. And you can see this obviously by comparing those ratios I've given, contribution of loan volume versus revenues. And I think overall, if you look at our institutional funded business, I would say that we would think that the overall profitability of the segment will be quite similar to other online lending platforms that are currently funded by -- mainly by institutions. And I think the ROAs that we eventually -- that we generate from this part will be pretty similar I think with other players in this space as well. So probably in the sort of 5%, 7% mid- to higher single-digit level ROAs, which I think is very respectable and attractive level for any consumer finance business.

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John Cai, Morgan Stanley, Research Division - Research Associate [6]

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That's very helpful. So if I may follow-up on the institutional funded. Just want to know what would be any balance sheet impact? I understand the transplant as you really need to consolidate there, but for -- we have RMB 12 billion institutional fund and the trust is roughly at around RMB 5 billion. So I just wondered, the rest RMB 7 billion whether we have any guaranteed liabilities that would need to take on the balance sheet for the institutional funded.

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Tak Leung Ho, PPDAI Group Inc. - CFO [7]

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So you're referring to the treatment of the credit risk, right? For the institutional business. So no, the remainder of the non-trust part of our institutional funded loans do not sit on our balance sheet. They -- where we do give sort of credit some sort of, we call it, risk assurance -- a credit assurance protection. It is accounted for in the same way as what we do for the quality assurance fund. It is under guarantee accounting. It's considered a guarantee liability on our balance sheet, and you'll see that together at the moment with the quality assurance fund payable and quality assurance fund receivable on our balance sheet.

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Operator [8]

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Your next question come from Daphne Poon with Citi.

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Daphne Poon, Citigroup Inc, Research Division - Associate [9]

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So I have a couple of questions on the institutional funding side. So first is the quality of mix of funding partners that you have. I would like to have an update like in terms of how many are from trust versus how many are from may be banks and the other consumer finance companies? And also we noticed that the take rate for your institutional funded loans was up slightly quarter-over-quarter so I wonder what would be the drivers behind?

And maybe more specifically, the institutional funding cost, what's the trend over the past quarter? And lastly is that, you mentioned earlier that you have about RMB 45 billion in terms of credit commitments from the financial institutions. So does that mean that you can actually like fully replace your P2P funding with these institutional fundings like even in the worst case that there is no P2P registration at all? And I'm not sure like whether there would be any hurdle in preventing that. So that's my questions.

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Tak Leung Ho, PPDAI Group Inc. - CFO [10]

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Okay. In terms of the breakdown and the mix of our institutional funding, currently, the majority of our institutional funding comes from commercial banks and consumer finance companies. And we will continue to focus on working with banks and consumer finance companies. As we said, in total, we have over 20 institutional funding partners active with us. I would say, roughly around half of those are commercial banks and consumer finance companies, okay? The institutional funding cost trend, currently, it's between around 10% to 11%. The demand that we see from institutions remains strong, and we do see room going forward for the lower funding cost from institutions, okay?

And the take rate for the institutional -- for the quarter-on-quarter, I don't know how you calculate, but I mean from where we're sitting, it's -- obviously it's largely similar, it hasn't changed much on a quarter-on-quarter basis. So that might just be the way things are accounted for or you might be looking at the trusts as well, which there is a lag effect coming in. With respect to the RMB 45 billion credit commitment, I think we're pretty confident in achieving what we set out to achieve. And so far, the performance of institutional -- the funding has been beating our expectations every quarter.

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Feng Zhang, PPDAI Group Inc. - Co-CEO [11]

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Yes. This is Feng. I would just add to the third question. The way we are looking at, we would expect in the third quarter that the volumes from institutional funding will be accounting for about 70% of our total loan origination volume, and this percentage will continue to increase fairly quickly to -- towards the end of this year. So yes, to your question, we're very confident even in the possible scenario that the registration of P2P doesn't happen, we think the impact to us is going to be fairly limited and manageable.

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Tak Leung Ho, PPDAI Group Inc. - CFO [12]

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Daphne, does that answer your questions?

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Daphne Poon, Citigroup Inc, Research Division - Associate [13]

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Yes, that's very helpful.

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Operator [14]

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And our next question comes from Alex Ye with UBS.

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Huanan Zhou, UBS Investment Bank, Research Division - China Financials Research Analyst [15]

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So my first question is about the P2P funding. So in opening remarks, you just mentioned that in the second half, the company is going to execute the triple decline more rapidly and -- so I wonder, what's the reason for that? Is that due to the regulatory requirements? Or is it because we are proactively shrinking our P2P balance? And I wonder what's our future strategy on this. And my second question is about the institutional funding part. So obviously, we're looking at very strong growth in the second half with a double -- with a doubling of the loan volume funded by institution.

So I wonder what's the underlying drivers for that. How we are going to achieve that? So are we expecting more funding to connect with that -- funding partners connect with us? Or we just need to ramp up our current credit lines and that's enough to take us there? And finally, I wonder if you could give us some update on your latest pricing trend and take rate trend? And any shift in your product strategy?

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Tak Leung Ho, PPDAI Group Inc. - CFO [16]

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Sure, Alex. Thanks for your question. With regards to the triple decline, clearly, there's been -- as you read and been aware, this has been the government's policy since the beginning of this year. We -- obviously, we do have an active regular communication with the regulators. And obviously, we believe that at the moment, there is still a certain amount of uncertainty and fluidity as we have been guiding -- we have been emphasizing. The right way to go is to continue and to more strictly implement this triple decline. But again, if there is any more significant -- anything significant to update, we will come back with that, right? This is what we know at the moment. But as Feng mentioned, P2P funding is becoming a less and less important part of our overall business, and they will become pretty much a minor part by the end of this year. Maybe I'll hand over to Feng to talk about the institutional growth and the credit commitments and what drives our confidence and outlook.

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Feng Zhang, PPDAI Group Inc. - Co-CEO [17]

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Yes. Sure. As we disclosed that right now, at this point, we have about 20 active partners and the total line approved by these partners, totaling RMB 45 billion. So that essentially means that is actually more than what we expect to issue loan -- the volume that we need from institutional partners for the second half of the year. But I don't think we stop there. We have a very healthy pipeline for institutions, and we think we're going to continue to expand the base of our institutional partners, and we'll continue to expand total credit lines extended to us by our institutions.

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Tak Leung Ho, PPDAI Group Inc. - CFO [18]

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Yes. And Alex, finally, on your question about pricing and the take rate. As we guided on our previous call in -- for the first quarter, we did say, our take rate, which is -- that we used to disclose that's mainly for -- mainly applying to the P2P funded -- retail funded part of the business, that take rate will return to more historical normal levels in the 6% to 7% range as we focus more on borrowers with better credit quality and strengthen our cooperation with institutional funding partners. What we did in the second quarter -- early in the second quarter was we did lower borrowing costs where we thought they have deserved in order to meet the requirements for our institutional partners, and also to obviously achieve our mission of wider, broader financial inclusion. And as a result, this take rate in the second quarter did decline, it fell to 6.4% in the second quarter compared to 7.7% in the first quarter because of these pricing changes and adjustments we implemented in the second quarter. But from here, going forward, we expect this take rate to be relatively stable in the near term. So I hope this answers your question, does it? Alex? Is this okay?

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Huanan Zhou, UBS Investment Bank, Research Division - China Financials Research Analyst [19]

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Yes, I have no further question.

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Operator [20]

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And our next question comes from Sanjay Sakhrani with KBW.

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Sanjay Harkishin Sakhrani, Keefe, Bruyette, & Woods, Inc., Research Division - MD [21]

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Just some follow-up questions. I guess on the institutional funding, that commitment that you have for RMB 45 billion, what's the duration of that commitment? And I guess are you guys thinking about sort of a longer-term funding sources outside sort of the shorter-term stuff that you have done thus far?

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Tak Leung Ho, PPDAI Group Inc. - CFO [22]

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Yes. Sanjay, I think typically if we look at the structure for institutional funding, they tend to be minimum of 12 months -- they tend to be longer than 12 months plus in tenure in duration. And given the ramp-up of our institutional funding, which we really start to ramping up big way over the last 12 months, I think a lot of this is -- a lot of these commitments are pretty new commitments that have come onto the books in recent months. And obviously, you've been tracking us for a while, this progression that we're seeing in institutional funding, I think has been accelerating on a quarter-on-quarter -- quarterly basis. In terms of a longer-term funding, it's clearly, something that we love to have, and we continue to explore. Clearly, there are certain limitations within the Chinese markets, happy to sit down and walk through those with you in more detail. But suffice to say that if the options become available, we would definitely not -- we would definitely consider using it.

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Sanjay Harkishin Sakhrani, Keefe, Bruyette, & Woods, Inc., Research Division - MD [23]

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And as far as the QAF, sort of like how relevant is it going forward? I mean is that still being used for even the institutions? Or should we expect that to decline over time?

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Tak Leung Ho, PPDAI Group Inc. - CFO [24]

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The QAF -- a large part of the QAF mainly services at the moment or relates to the retail P2P funded part of the business. So in fact, retail P2P part of the business declines then in relative terms that it will also decline in the QAF. Amongst the institutional funding that we do, there is some QAF in there. So the buffer is not as large as what we have for P2P -- retail P2P investors. So there is going to be a mix effect that will play through, but largely, it will continue to be relevant going forward.

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Sanjay Harkishin Sakhrani, Keefe, Bruyette, & Woods, Inc., Research Division - MD [25]

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Okay. I guess the final question. We've heard obviously the economy is mixed around the world and in China, I mean it's interesting that we're not really seeing that in your credit metrics. Is that partly because you're growing up market? Or is that you're seeing relative strength within your portfolios, generally speaking?

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Tak Leung Ho, PPDAI Group Inc. - CFO [26]

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No. I personally think it's partly the nature of the segment we service, our internal risk management ability. And if you look at our members, we haven't seen a huge impact coming through from the softening of the economy and all that. And I just want to highlight, if you look at our credit numbers, delinquency numbers, the context of this over the last 12 months, we've been through a lot of volatility in this industry from the pretty severe credit cycle we saw at the end of 2017. Early 2018, we had the closure of a significant number of P2P platforms over the past 12 months, over 1,000 P2P platforms closed down. And we also had quite a bit of a liquidity squeeze in the last summer and periodically. So we've been through a lot. And I think it's also a testament of obviously our own ability at the same time.

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Sanjay Harkishin Sakhrani, Keefe, Bruyette, & Woods, Inc., Research Division - MD [27]

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Absolutely. And I guess, I'm Sorry, one final question. On the regulatory process, when do we know in finality your guess to which direction this will go? And has anyone else in the market gotten close or even is operating any -- under any license or any purview on the peer-to-peer side?

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Tak Leung Ho, PPDAI Group Inc. - CFO [28]

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No. I don't think -- we're not -- I don't think any platform has gotten any license or registration as you suggested. And in terms of the timing, I think it's, again, it's not certain from where we sit and it's fluid. And we just have to keep in touch, and we'll keep you updated.

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Feng Zhang, PPDAI Group Inc. - Co-CEO [29]

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I agree with Simon. This is Feng, Sanjay. I agree with Simon, we don't know for sure whether this will happen and if so, when. But I think I want to reemphasize as I mentioned that we would expect that by the end of this year the proportion of the P2P funded loan originations is going to be accounting for a very small percentage of our total loan origination. So by that point, I think whether this happen, it's not going to be that important to us.

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Operator [30]

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(Operator Instructions) And you next question comes from Tian Hou with T.H. Capital.

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Tianxiao Hou, T.H. Capital, LLC - Founder, CEO & Senior Analyst [31]

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The question is related to a recent news and -- so the regulatory agencies asking P2P lenders to what that term is? Access to certain government system and -- not access, it's hard to say -- I mean your system and government system has to be -- your system has to be accessible by the government something like that. So I wonder if PPDAI has -- Paipaidai has already finish that. And the reason I asked for that is because in this government policy that the court number, like 22 something, they say, if you're not bring your date -- system to their system, so you may not be able to practice P2P business. So it looks like a really serious policy measurements. So that my question come from. Just wondered what's the progress on that front?

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Tak Leung Ho, PPDAI Group Inc. - CFO [32]

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Okay. Tian, there's various system that are required for P2P platforms to connect into government systems to be complaint. And thankfully, we comply with all of them. We are live and feeding data with all of the systems that are required by us, I can tell you that. And that is not a reason in our case for rejecting any of our applications in our view. So we are connected to all those systems that you mentioned. Yes.

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Tian Hou, [33]

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That's very helpful. Makes me feel better. And also the thing is you guys got a lot of institution money and institution funding. So I wonder what are those institutions. And so we saw some local bank like (inaudible) they have some problems. So I just wondered what kind of an institution you are teaming up with today. And I just hope you guys not exposed to other people risk.

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Tak Leung Ho, PPDAI Group Inc. - CFO [34]

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Sure. I think -- Tian, I think that's a great question. For -- let me address just a few things, of course, for the consumer finance companies clearly, they are -- they all belong to the nationwide consumer finance companies in the trust base. We work with basically all the leading trust companies that are active in consumer finance assets for the banks. We do work with a number of city commercial banks, and I think our concern is around there. We -- in terms of city commercial banks, we don't partner, work with any of the names that have been in the press lately with their issues. And we do have criteria for selecting our bank partners. We look for those that have solid operating history, healthy financials, liquidity, capital adequacy.

And at the end of the day, we do see still a lot of demand from the space because there are still over -- even in -- the city commercial banks, smaller regional banks, there's 4,000 -- over 4,000 of these city and rural commercial banks in China, and our balance sheet isn't that large relative to these names. So I think there is still -- quite a lot of us -- room for us to expand and service these players. These banks are also fairly well suited to working with us because at the moment, they don't have the sufficient capability to obviously -- to do consumer lending, and therefore, they most need our services and support.

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Operator [35]

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The next question is a follow-up from John Cai with Morgan Stanley.

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John Cai, Morgan Stanley, Research Division - Research Associate [36]

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So just one ratio that I would like to follow-up. In particular is related to the QAF projected loan balance. I think, now we have a QAF fund that's equivalent to 22.5% of the loans. Just wonder how do we see these ratios going forward because now it's -- I think it's a blended or weighted average of institutional and retail. My understanding is that potentially there's room for this to decline because our institution and overall, we're looking for better quality customers. And another question about customer acquisition or growth actually. Because -- first of all, Feng can you talk about the total customer acquisition cost we spend this quarter? I think there is some sales and marketing and origination and servicing. And the second question is, what is the total cost we should expect going forward because it seems the acquisition cost is reasonable, and then the risk is controllable and we have sufficient funding obviously. And it seems that we can spend more on customer acquisition to fuel growth going forward. And I think the final question is about maybe plan b because I think now we're moving to institutions and the other players, I heard they are trying to get some online micro-loan license. Just wonder other than loan facilitation or through the institution, this -- are there any other plan we are working in preparation of the potential no registration scenario for P2P.

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Tak Leung Ho, PPDAI Group Inc. - CFO [37]

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Yes. Okay. John, thanks for your questions. I think that in terms of the quality assurance fund, the coverage ratio of 22.5%. Yes, I do think the future trend will be lower, and exactly for the reasons that you mentioned because of the mix effects, the fact that we're shifting towards a somewhat different segment of borrowers. But also to bear in mind, the buffer -- the quality assurance fund buffer that we've had -- that we do have between individual P2P funding versus institutional funding is a bit different. The P2P funding historically has been very, very strongly over reserved that you understand, right? And that's how we ended up winning over 20% coverage ratio, which is pretty, pretty, pretty big. Now -- so it will come down, but I think we continue to maintain fairly prudent and conservative view on quality -- on our quality assurance buffer and funds.

And then, with regards to our customer acquisition cost. Yes, you're right, there is -- that the majority of our sales and marketing expenses, I think like maybe 80% of 90% of that is customer acquisition-related. And there's also some that is sitting in origination and servicing. And I recall from memory that may be about 20% or so of the origination and servicing relates to, again, customer acquisition. So I think that will help you just get a sense of the total amount that we're spending. I think the total amount we're spending would be similar in aggregate number to may be the sales and marketing expenses we reported. And that -- as we build this business out, we will -- obviously, we will need to spend more.

But still, I think the long-term and lifetime value of the customers that we are gaining and acquiring is still very profitable as we mentioned earlier on the call about the profitability expectations for the institutional funded business. And finally, in terms of the micro lending licenses and other licenses. I think, we already have an internet micro lending company ourselves, but obviously if we're offered the opportunity for another one, and we would definitely certainly consider. So this is definitely one option down the road that we think will present itself. Yes. But generally, we will keep an open mind and we will consider.

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John Cai, Morgan Stanley, Research Division - Research Associate [38]

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So the total customer acquisition cost, how do we see that in the second half of this year? Any chance that it might go up significantly because we want to go faster?

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Tak Leung Ho, PPDAI Group Inc. - CFO [39]

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I think if you -- it depends on, obviously, the overall growth. I think we are slowing down in the P2P side. We've guided towards pretty -- we've guided toward positive loan origination growth in the third quarter, but it's still obviously within moderate bounds. And the likely similar situation possibly in the fourth quarter as well. So we're not at the moment growing by 100% at that rate. So I don't think you need to worry -- overly worry about that. And we'd try to keep good control around our overall cost.

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John Cai, Morgan Stanley, Research Division - Research Associate [40]

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Yes. I'm actually thinking that if the environment and that the acquisition efficiency is okay, it's probably okay to spend more? But yes, it's still up to the company.

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Operator [41]

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And our next question is a follow-up from Alex Ye with UBS.

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Huanan Zhou, UBS Investment Bank, Research Division - China Financials Research Analyst [42]

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Simon, I just have 2 quick questions. So first is, we have 20 funding partners active for now and couple of them banks or consumer finance companies, and we have RMB 45 billion of credit line. So I just wondered if we can have a comparative number in the last quarter. So for us to just have a sense of how much progress we have made in just the past quarter? And my second question is on the loan volume of about RMB 21 billion in the Q2. So could you give us a breakdown of that in terms of the accounting treatment by on and off balance sheet?

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Tak Leung Ho, PPDAI Group Inc. - CFO [43]

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So I think from the last quarter, we were probably looking at about, I think it was like 10 to 15-ish institutional funding partners, I might have to confirm that. Last quarter 10 to 15?

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Unidentified Company Representative, [44]

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About there.

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Tak Leung Ho, PPDAI Group Inc. - CFO [45]

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I think it was around there. We're now over 20, we're not at 20, we are over 20 by the way. I don't recall what the credit line is for last quarter, again, you're stressing me out. But I think the growth is pretty fast, has been pretty fast during the quarter, right? If you look at the loan balance that the outstanding balance of institutional funding basically on a quarterly basis, we're growing at like close to 100% a quarter. So if you think about that type of rate then it will be quite different 3 months ago, 3 months after. And Alex, what is your sort of your last final part of the question, I slipped my mind. Sorry. Could you repeat that? Alex?

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Huanan Zhou, UBS Investment Bank, Research Division - China Financials Research Analyst [46]

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Yes. Of the RMB 21.6 billion of loan volume in the second quarter, right? So we have 45% of that from institutions. So I just wondered if you could give us a breakdown of that further into how much of that go to the on balance sheet and how much go to the off balance sheet?

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Tak Leung Ho, PPDAI Group Inc. - CFO [47]

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The only part of the institutional funding that goes on balance sheet is the trust -- is the trust component. And in the third -- in the second quarter, that component was roughly speaking about may be 30-odd-percent -- 30%-ish around there. The rest is off balance sheet, not on balance sheet. Yes.

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Huanan Zhou, UBS Investment Bank, Research Division - China Financials Research Analyst [48]

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So just to confirm, is it 30% on balance sheet, right?

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Tak Leung Ho, PPDAI Group Inc. - CFO [49]

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Yes. Yes. Yes.

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Operator [50]

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And this will conclude our question-and-answer session. I'd like to turn the conference back over to the company for closing remarks.

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Jimmy Tan, PPDAI Group Inc. - Head of IR [51]

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Thank you, once again for joining us today. If you have further questions, please free to contact Paipaidai Investor Relations through the contact information provided on our website or in our press release.

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Operator [52]

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This concludes today's conference. You may now disconnect your lines at this time, and have a great day.