CNFinance Holdings Limited (NYSE:CNF) Q2 2021 Earnings Conference Call August 23, 2021 8:00 AM ET Company Participants Bin Zhai - Chairman and Chief Executive Officer Conference Call Participants William Gregozeski - Greenridge Global Neil Gagnon - Gagnon Securities Disclaimer*: This transcript is designed to be used alongside the freely available audio recording on this page. Timestamps within the transcript are designed to help you navigate the audio should the corresponding text be unclear. The machine-a ...

CNFinance Holdings Limited (NYSE:CNF) Q1 2021 Earnings Conference Call May 27, 2021 8:00 AM ET Company Participants Matthew Lou - Investor Relations Li Ning - Executive Director & Chief Financial Officer Bin Zhai - Chairman & Chief Executive Officer Conference Call Participants William Gregozeski - Greenridge Global Rongrong Zhang - Cathay Capital Operator Good morning and welcome to CNFinance First Quarter 2021 Financial Results Conference Call. All participants will be in a listen-only mode. [Operator Ins ...

Financial Performance - Interest and fees income for 2019 was RMB 2,953,480,997, a decrease of 30.8% from RMB 4,278,820,368 in 2018[24] - Net interest and fees income after provision for credit losses in 2019 was RMB 1,123,548,583, down 41.3% from RMB 1,915,851,543 in 2018[24] - Net income for 2019 was RMB 534,643,942, a decline of 37.9% from RMB 860,908,711 in 2018[27] - Basic earnings per share for 2019 was 0.39, down from 0.69 in 2018, representing a decrease of 43.5%[27] - Total assets as of December 31, 2019, were RMB 13,026,248,967, compared to RMB 19,354,717,165 in 2018, reflecting a decrease of 32.8%[28] - Total shareholders' equity increased to RMB 3,598,532,495 in 2019 from RMB 3,045,555,380 in 2018, marking an increase of 18.1%[28] Business Strategy and Operations - The company has been exploring new business models since December 2018 to broaden its prospective borrower base[33] - The company introduced a new collaboration model in December 2018 to enhance its loan service offerings[32] - The company aims to maintain a low aggregate delinquency rate and improve operational efficiency amidst evolving market conditions[34] - Approximately 95.4%, 99.5%, and 100.0% of the home equity loan origination volume was funded under the trust lending model in 2017, 2018, and 2019 respectively[49] - The company has implemented a new collaboration model with sales partners, categorizing them based on loan amounts[76] Regulatory Environment - The regulatory environment for China's home equity loan market remains uncertain, impacting the company's operational strategies[33] - The trust company partners are required to comply with regulations limiting loans to no more than 30% of the paid-in balance of all trust plans under management[47] - The company has not been subject to any fines or penalties under PRC laws regarding historical credit enhancement arrangements as of the date of the annual report[41] - If deemed to be providing financing guarantees without required licenses, the company may face penalties including fines of up to RMB1 million and suspension of business[38] - The current regulatory environment for debt collection in the PRC remains unclear, potentially harming the company's reputation and ability to collect payments[105] Risk Factors - The COVID-19 outbreak is expected to adversely impact the company's results of operations, with a projected decrease in total revenue for the first quarter of 2020 compared to the previous year[57] - The company faces risks related to natural disasters and health epidemics, which could disrupt operations and adversely affect financial performance[53] - The company may face material adverse effects if its funding sources are deemed to violate PRC laws and regulations[83] - The company may not be able to achieve low aggregate delinquency rates for loans, which could adversely affect its business and results of operations[95] - The company is subject to risks related to the COVID-19 outbreak, which may negatively impact its ability to maintain or increase loan facilitation[93] Financial Ratios and Metrics - The aggregate delinquency rate for 2019 was 5.43%, while the aggregate NPL rate was 3.55%[69] - The delinquency ratio for 2019 was 21.08%, and the NPL ratio was 13.75%[69] - The actual structural leverage ratio of trust plans was generally lower than 3:1 as of December 31, 2019[73] - The company's leverage ratio was 9.9 times, 6.4 times, and 3.7 times as of December 31 for the years 2017, 2018, and 2019 respectively[99] Collection and Loan Management - The company’s collection process is divided into distinct stages based on delinquency, with automatic reminders sent to borrowers as soon as collections commence[104] - The company may experience delays in collection efforts due to the COVID-19 outbreak, which could adversely impact its results of operations[106] - Loans secured by second lien interests accounted for 58.1% and 56.4% of the company's loan origination volume of home equity loans in 2018 and 2019, respectively[124] Compliance and Legal Risks - The company collects and stores a large volume of personally identifiable information, which is increasingly regulated under domestic and international privacy laws, creating potential compliance risks[128] - The company is subject to liabilities under the PRC Contract Law if it intentionally conceals material facts or provides false information, which could result in damages to trust company partners[126] - Non-compliance with PRC regulations regarding employee stock incentive plans may result in fines and legal sanctions for the company and its plan participants[216] Shareholder and Corporate Governance - Cathay Auto Services Limited holds approximately 23.3% of the company's ordinary shares, while CISG Holdings Ltd. and Kylin Investment Holdings Limited hold approximately 18.5% and 17.8%, respectively, indicating significant shareholder influence[175] - The concentration of ownership among major shareholders may discourage future changes in control, potentially impacting stockholder value[175] - The company has authorized the issuance of a maximum of 307,608,510 shares under the 2018 Plan, with all options currently outstanding[173] Operational Challenges - The company operates primarily in over 80 leased properties across various cities in China, with some properties lacking proper title certificates, potentially leading to operational disruptions[157] - Competition for skilled employees is intense, and the company may struggle to attract and retain qualified personnel necessary for its operations[160] - The company has identified a material weakness in its internal control over financial reporting, which could affect its ability to accurately report future financial results[168]

PART I [ITEM 3. KEY INFORMATION](index=8&type=section&id=ITEM%203.%20KEY%20INFORMATION) This section presents selected financial data from 2016-2018 and details significant risks related to business operations, regulations, and securities [Selected Financial Data](index=8&type=section&id=3.A.%20Selected%20Financial%20Data) The company shows strong growth in revenue, net income, and total assets from 2016 to 2018 Selected Consolidated Statements of Comprehensive Income Data (2016-2018) | Indicator | 2016 (RMB) | 2017 (RMB) | 2018 (RMB) | | :--- | :--- | :--- | :--- | | **Net interest and fees income** | 800,884,505 | 2,000,542,084 | 2,349,605,444 | | **Income before income tax** | 288,045,262 | 808,667,625 | 1,157,737,186 | | **Net income** | 235,441,839 | 532,672,757 | 860,908,711 | | **Comprehensive income** | 39,983,249 | 529,872,608 | 860,811,637 | | **Basic EPS** | 0.19 | 0.43 | 0.69 | | **Diluted EPS** | 0.19 | 0.40 | 0.62 | Selected Consolidated Balance Sheet Data (as of year-end) | Indicator | 2016 (RMB) | 2017 (RMB) | 2018 (RMB) | | :--- | :--- | :--- | :--- | | **Total assets** | 7,806,357,480 | 18,215,865,490 | 19,354,717,165 | | **Total liabilities** | 6,687,671,062 | 16,384,616,698 | 16,309,161,785 | | **Total shareholders' equity** | 1,118,686,418 | 1,831,248,792 | 3,045,555,380 | [Risk Factors](index=10&type=section&id=3.D.%20Risk%20Factors) The company faces risks from its limited operating history, reliance on trust funding, high leverage, and potential PFIC classification - The company has a limited operating history in the home equity loan market, having adopted its current business model in 2014, making future prospects difficult to evaluate[26](index=26&type=chunk) - The company's historical credit enhancement arrangements may be challenged by PRC regulators as **providing financing guarantees without the required licenses**, potentially leading to penalties[29](index=29&type=chunk)[31](index=31&type=chunk) - A significant portion of loan funding comes from trust company partners, with **99.5% of home equity loan origination volume funded under the trust lending model in 2018**[40](index=40&type=chunk)[59](index=59&type=chunk) - The company's leverage ratio was high at 7.0x, 9.9x, and **6.4x** as of year-end 2016, 2017, and 2018, respectively, exposing it to liquidity risk[83](index=83&type=chunk) - The aggregate delinquency rate for originated loans **increased from 4.26% in 2017 to 7.58% in 2018**, while the aggregate NPL rate increased from 1.00% to 1.05% in the same period[80](index=80&type=chunk) - There is a high probability that the company was a **Passive Foreign Investment Company (PFIC)** for the 2018 tax year and will continue to be, which could result in adverse U.S. federal income tax consequences for U.S. taxpayers holding its shares or ADSs[258](index=258&type=chunk)[260](index=260&type=chunk) [ITEM 4. INFORMATION ON THE COMPANY](index=45&type=section&id=ITEM%204.%20INFORMATION%20ON%20THE%20COMPANY) This section details the company's history, business model targeting MSE owners, organizational structure, and applicable PRC regulations [History and Development of the Company](index=45&type=section&id=4.A.%20History%20and%20Development%20of%20the%20Company) The company was spun off from Fanhua Inc. in 2006 and completed its IPO on the NYSE in November 2018 - The company was spun off from Fanhua Inc. (NASDAQ: FANH) in 2006[262](index=262&type=chunk) - Completed its **initial public offering in November 2018**, listing its ADSs on the New York Stock Exchange under the symbol "CNF"[263](index=263&type=chunk) [Business Overview](index=45&type=section&id=4.B.%20Business%20Overview) The company facilitates home equity loans for MSE owners primarily through a trust lending model, bearing first-loss risk Home Equity Loan Origination Volume | Year | Aggregate Principal (RMB billion) | YoY Change | Number of Borrowers | | :--- | :--- | :--- | :--- | | 2016 | 8.3 | - | 12,983 | | 2017 | 17.1 | +106.0% | 23,705 | | 2018 | 9.5 | -44.4% | 16,167 | - The primary target borrowers are **Micro and Small-Enterprise (MSE) owners** who own real properties in Tier 1 and Tier 2 cities in China and are underserved by traditional financial institutions[266](index=266&type=chunk) - The company's primary funding source is a trust lending model, which accounted for 94.1%, 95.4%, and **99.5% of total home equity loan origination volume** in 2016, 2017, and 2018, respectively[296](index=296&type=chunk)[300](index=300&type=chunk) - Under the trust lending model, CNFinance subscribes to all subordinated units of the trust plans, entitling it to residual value but also exposing it to **first-loss risk**[270](index=270&type=chunk)[305](index=305&type=chunk)[308](index=308&type=chunk) - The company has established a national network of **64 branches and sub-branches** in over 40 cities in China, providing local knowledge and resources for loan origination, security perfection, and debt collection[330](index=330&type=chunk) [Organizational Structure](index=70&type=section&id=4.C.%20Organizational%20Structure) The company is a Cayman Islands holding entity operating in the PRC through subsidiaries and consolidating trust plans as VIEs - The company is a **Cayman Islands holding company** that operates its business in the PRC primarily through its subsidiaries, including Shenzhen Fanhua United Investment Group Co., Ltd. and Guangzhou Heze Information Technology Co., Ltd[262](index=262&type=chunk)[420](index=420&type=chunk) - For accounting purposes, the company consolidates the financial results of the trust plans it collaborates with, as they are considered **Variable Interest Entities (VIEs)** due to the company's exposure to their risk and returns[420](index=420&type=chunk)[746](index=746&type=chunk) [Property, Plant and Equipment](index=71&type=section&id=4.D.%20Property,%20Plant%20and%20Equipment) The company leases its headquarters in Guangzhou and maintains office spaces in over 40 cities across China - The company's headquarters are in Guangzhou, China, under a lease expiring in September 2022 and it also leases office space in over 40 other cities[423](index=423&type=chunk) [OPERATING AND FINANCIAL REVIEW AND PROSPECTS](index=71&type=section&id=ITEM%205.%20OPERATING%20AND%20FINANCIAL%20REVIEW%20AND%20PROSPECTS) This section analyzes financial performance for 2016-2018, highlighting income growth alongside rising delinquency rates and decreased loan origination [Operating Results](index=72&type=section&id=5.A.%20Operating%20Results) In 2018, net income grew 61.6% despite lower loan originations, driven by a larger loan portfolio and reduced operating expenses Key Financial Performance (2016-2018) | Indicator (RMB millions) | 2016 | 2017 | 2018 | | :--- | :--- | :--- | :--- | | Total operating income | 867.3 | 2,013.0 | 2,338.2 | | Net income | 235.4 | 532.7 | 860.9 | - In 2018, interest and financing service fee on loans **increased by 25.6% to RMB 4,278.8 million**, primarily due to an increase in the daily average outstanding loan principal[511](index=511&type=chunk) - Total operating expenses **decreased by 16.8% in 2018**, mainly due to an 18.8% decrease in employee compensation and a 78.3% decrease in share-based compensation expenses[520](index=520&type=chunk) Loan Performance Metrics (as of year-end) | Metric | 2016 | 2017 | 2018 | | :--- | :--- | :--- | :--- | | Aggregate delinquency rate | 3.69% | 4.26% | 7.58% | | Aggregate NPL rate | 1.04% | 1.00% | 1.05% | | Allowance ratio | 1.95% | 2.64% | 5.44% | | NPL provision coverage ratio | 130.6% | 159.3% | 218.8% | [Liquidity and Capital Resources](index=87&type=section&id=5.B.%20Liquidity%20and%20Capital%20Resources) The company's liquidity improved significantly in 2018, with cash increasing to RMB 3.2 billion, supported by strong operating cash flow Summary of Cash Flows (RMB millions) | Cash Flow Activity | 2016 | 2017 | 2018 | | :--- | :--- | :--- | :--- | | Net cash from operating activities | 379.9 | 1,286.6 | 1,332.7 | | Net cash (used in)/from investing activities | (4,700.4) | (9,583.9) | 641.4 | | Net cash from/(used in) financing activities | 4,291.1 | 9,256.7 | (2.5) | - As of December 31, 2018, the company had **cash and cash equivalents of RMB 3.2 billion**, a significant increase from RMB 1.2 billion at the end of 2017[535](index=535&type=chunk) - The company received **net proceeds of approximately US$45.7 million** from its initial public offering in November 2018[684](index=684&type=chunk) [Research and Development](index=92&type=section&id=5.C.%20Research%20and%20Development) The company invests in its technology system to support platform scalability, with R&D expenses decreasing in 2018 Research and Development Expenses | Year | R&D Expenses (RMB millions) | | :--- | :--- | | 2016 | 8.5 | | 2017 | 4.8 | | 2018 | 1.4 | [Tabular Disclosure of Contractual Obligations](index=93&type=section&id=5.F.%20Tabular%20Disclosure%20of%20Contractual%20Obligations) As of year-end 2018, the company had total contractual obligations of RMB 125.5 million related to operating leases Contractual Obligations as of December 31, 2018 (RMB) | Obligation Type | Total | Less than 1 year | 1-3 years | 3-5 years | More than 5 years | | :--- | :--- | :--- | :--- | :--- | :--- | | Operating lease commitment | 125,481,028 | 55,912,805 | 49,017,842 | 15,302,669 | 5,247,712 | [DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES](index=93&type=section&id=ITEM%206.%20DIRECTORS,%20SENIOR%20MANAGEMENT%20AND%20EMPLOYEES) This section details the company's leadership, compensation, board structure, and employee base as of 2018 [Directors and Senior Management](index=93&type=section&id=6.A.%20Directors%20and%20Senior%20Management) The company's leadership team is headed by Chairman and CEO Bin Zhai and CFO Ning Li, supported by a seven-member board - **Bin Zhai** serves as the Chairman of the Board and Chief Executive Officer[575](index=575&type=chunk) - **Ning Li** serves as the Executive Director and Chief Financial Officer[577](index=577&type=chunk) [Compensation](index=95&type=section&id=6.B.%20Compensation) Executive officers received RMB 1.6 million in cash compensation in 2018, with key leaders holding substantial option grants - In fiscal year 2018, the company paid an aggregate of **RMB 1.6 million in cash compensation** to its executive officers[585](index=585&type=chunk) Outstanding Equity Awards to Key Executives (as of report date) | Name | Options Outstanding | Exercise Price (Per share) | Expiration Date | | :--- | :--- | :--- | :--- | | Bin Zhai | 40,000,000 | RMB 0.5 | Dec 31, 2022 | | Ning Li | 30,000,000 | RMB 0.5 | Dec 31, 2022 | | Jun Qian | 20,000,000 | RMB 0.5 | Dec 31, 2022 | | Zehui Zhang | 20,000,000 | RMB 0.5 | Dec 31, 2022 | [Board Practices](index=97&type=section&id=6.C.%20Board%20Practices) The seven-member board includes three independent directors and has established audit, compensation, and governance committees - The Board of Directors consists of **seven directors, three of whom are independent**[601](index=601&type=chunk) - The company has established an **Audit Committee, a Compensation Committee, and a Nominating and Corporate Governance Committee**[603](index=603&type=chunk) [Employees](index=100&type=section&id=6.D.%20Employees) As of year-end 2018, the company had 2,761 employees, with the majority focused on sales, marketing, and risk management Employee Breakdown by Function (as of Dec 31, 2018) | Function | Number of Employees | % of Total | | :--- | :--- | :--- | | Risk Management | 806 | 29.2% | | Sales and Marketing | 1,406 | 50.9% | | General and Administration | 217 | 7.9% | | Finance | 191 | 6.9% | | Others | 141 | 5.1% | | **Total** | **2,761** | **100.0%** | [Share Ownership](index=100&type=section&id=6.E.%20Share%20Ownership) As of March 2019, insiders and principal shareholders hold significant stakes, with the Chairman and CEO owning 38.2% Beneficial Ownership of Major Shareholders (as of March 31, 2019) | Shareholder | Beneficial Ownership (%) | | :--- | :--- | | Bin Zhai (Chairman & CEO) | 38.2% | | CAA Holdings Company Limited | 36.8% | | Cathay Auto Services Limited | 23.3% | | CISG Holdings Ltd. | 18.5% | | Cathay Capital Holdings II, L.P. | 10.8% | [MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS](index=102&type=section&id=ITEM%207.%20MAJOR%20SHAREHOLDERS%20AND%20RELATED%20PARTY%20TRANSACTIONS) This section outlines major shareholders and details transactions with related parties, including Fanhua Inc [Related Party Transactions](index=103&type=section&id=7.B.%20Related%20Party%20Transactions) The company engaged in transactions with Fanhua Inc., including a revolving loan agreement and a trust fund subscription - The company had a revolving loan agreement with Fanhua Inc. with a credit limit of up to **US$79.7 million**, which bore a 7.3% interest rate and expired in March 2018[627](index=627&type=chunk) - In May 2018, Fanhua Inc. subscribed to approximately **RMB 138 million in senior units** of the Jinghua Structure Fund 27, which were subsequently transferred to a third party in July 2018[628](index=628&type=chunk) [FINANCIAL INFORMATION](index=103&type=section&id=ITEM%208.%20FINANCIAL%20INFORMATION) This section includes the company's consolidated financial statements and discusses its dividend policy and legal proceedings [Consolidated Statements and Other Financial Information](index=103&type=section&id=8.A.%20Consolidated%20Statements%20and%20Other%20Financial%20Information) The company is not involved in material legal proceedings and does not plan to pay dividends, retaining earnings for growth - The company is **not currently a party to any material legal or administrative proceedings**[630](index=630&type=chunk) - The company has **no plan to declare or pay any dividends** in the near future, intending to retain earnings to operate and expand the business[631](index=631&type=chunk) [ADDITIONAL INFORMATION](index=105&type=section&id=ITEM%2010.%20ADDITIONAL%20INFORMATION) This section covers share capital, material contracts, and taxation, highlighting the company's likely PFIC status for U.S. investors [Taxation](index=105&type=section&id=10.E.%20Taxation) The company is tax-exempt in the Cayman Islands, subject to a 25% tax rate in the PRC, and is likely a PFIC for U.S. tax purposes - The company is **not subject to income or capital gains tax** in its jurisdiction of incorporation, the Cayman Islands[637](index=637&type=chunk) - The company's PRC subsidiaries are subject to a statutory **enterprise income tax rate of 25%**[639](index=639&type=chunk)[471](index=471&type=chunk) - There is a high probability that the company was a **PFIC for its 2018 taxable year** and will continue to be one, which carries adverse U.S. federal income tax consequences for U.S. Holders[649](index=649&type=chunk) [QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK](index=110&type=section&id=ITEM%2011.%20QUANTITATIVE%20AND%20QUALITATIVE%20DISCLOSURES%20ABOUT%20MARKET%20RISK) The company's primary market risks include interest rate, foreign exchange, and inflation risk - The company is exposed to **interest rate risk**, as rising rates could reduce demand for its loan products and increase its own funding costs[669](index=669&type=chunk) - Substantially all revenues are denominated in Renminbi (RMB), which is not freely convertible and is subject to fluctuation against the U.S. dollar, creating **foreign exchange risk**[670](index=670&type=chunk)[671](index=671&type=chunk) - Inflation in China has not materially impacted results of operations, with the consumer price index increasing by 1.9% in 2018[674](index=674&type=chunk) [DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES](index=111&type=section&id=ITEM%2012.%20DESCRIPTION%20OF%20SECURITIES%20OTHER%20THAN%20EQUITY%20SECURITIES) This section describes the fees associated with the company's American Depositary Shares (ADSs) managed by the depositary bank [American Depositary Shares](index=111&type=section&id=12.D.%20American%20Depositary%20Shares) ADS holders are subject to various fees by the depositary, from which the company received a US$0.4 million payment in 2019 - ADS holders are subject to fees from the depositary, including up to **$5.00 per 100 ADSs for issuance/cancellation** and up to $0.05 per ADS for cash distributions[675](index=675&type=chunk)[676](index=676&type=chunk) - In March 2019, the company received a **US$0.4 million cash payment** from the ADR program's depositary bank, JPMorgan Chase Bank, N.A[682](index=682&type=chunk) [CONTROLS AND PROCEDURES](index=113&type=section&id=ITEM%2015.%20CONTROLS%20AND%20PROCEDURES) Management concluded that disclosure controls were ineffective as of year-end 2018 due to a material weakness in financial reporting - Management concluded that as of December 31, 2018, the company's **disclosure controls and procedures were ineffective**[689](index=689&type=chunk) - A **material weakness was identified** in internal control over financial reporting due to a lack of sufficient financial reporting and accounting personnel with appropriate experience in U.S. GAAP and SEC reporting requirements[691](index=691&type=chunk) - The company is implementing remediation measures, including **hiring more qualified accounting personnel** and providing regular U.S. GAAP training[692](index=692&type=chunk) [CORPORATE GOVERNANCE AND ACCOUNTING](index=114&type=section&id=ITEM%2016.%20[Reserved]) This section covers corporate governance, including the audit committee financial expert and principal accountant fees [Audit Committee Financial Expert](index=114&type=section&id=16.A.%20Audit%20Committee%20Financial%20Expert) The Board has identified Mr. Fengyong Gao, an independent director, as the audit committee financial expert - **Mr. Fengyong Gao**, an independent director, has been identified by the Board as the "audit committee financial expert"[696](index=696&type=chunk) [Principal Accountant Fees and Services](index=114&type=section&id=16.C.%20Principal%20Accountant%20Fees%20and%20Services) Total fees paid to the independent auditor, KPMG Huazhen LLP, were RMB 13.1 million in 2018 Auditor Fees (RMB in thousands) | Fee Type | 2017 | 2018 | | :--- | :--- | :--- | | Audit Fees | 730 | 12,738 | | Audit-Related Fees | - | 330 | | Tax Fees | - | - | | Other Fees | - | - | | **Total** | **730** | **13,068** | [FINANCIAL STATEMENTS](index=116&type=section&id=ITEM%2018.%20FINANCIAL%20STATEMENTS) This section contains the company's U.S. GAAP consolidated financial statements for 2016-2018 with an unqualified audit opinion [Report of Independent Registered Public Accounting Firm](index=119&type=section&id=Report%20of%20Independent%20Registered%20Public%20Accounting%20Firm) KPMG Huazhen LLP issued an unqualified audit opinion on the 2016-2018 consolidated financial statements - The independent auditor, KPMG Huazhen LLP, provided an **unqualified opinion** on the consolidated financial statements for the three-year period ended December 31, 2018[708](index=708&type=chunk) - The audit was conducted in accordance with the standards of the **Public Company Accounting Oversight Board (PCAOB)**[710](index=710&type=chunk)