Q3 2023 Futu Holdings Ltd Earnings Call

Participants

Daniel Yuan; Chief of Staff & Head of IR; Futu Holdings Limited

Hua Li; Founder, Chairman & CEO; Futu Holdings Limited

Yu Chen; CFO; Futu Holdings Limited

Chiyao Huang; Research Associate; Morgan Stanley, Research Division

Leon Qi; Analyst; Daiwa Securities Co. Ltd., Research Division

Li Wan; Head of Financial Research; BOCOM International Securities Limited, Research Division

Peter Zhang; Analyst; JPMorgan Chase & Co, Research Division

Yun-Yin Wang; Research Analyst; China Renaissance Securities (US) Inc., Research Division

Presentation

Operator

Hello, ladies and gentlemen. Welcome to Futu Holdings Third Quarter 2023 Conference Call. (Operator Instructions) Today's conference call is being recorded. If you have any objections, you may disconnect at this time.
I would now like to turn the conference over to your host for today's conference call, Daniel Yuan, Chief of Staff to CEO and Head of IR at Futu. Please go ahead.

Daniel Yuan

Thanks, operator. And thank you for joining us today to discuss our third quarter 2023 earnings results. Joining me on the call today are Mr. Leaf Li, Chairman and Chief Executive Officer; Arthur Chen, Chief Financial Officer; and Robin Xu, Senior Vice President.
As a reminder, today's call may include forward-looking statements which represent the company's belief regarding future events, which by their nature are not certain and are outside of the company's control. Forward-looking statements involve inherent risks and uncertainties. We caution you that a number of important factors could cause actual results to differ materially from those containing any forward-looking statements. For more information about the potential risks and uncertainties, please refer to the company's filings with the SEC, including its Annual Report on Form 20-F.
So with that, I will now turn the call over to Leaf. Leaf will make his comments in Chinese, and I will translate.

Hua Li

[Interpreted] Thank you all for joining today. In the third quarter, we acquired around 65,000 paying clients, a 12% sequential increase. Our total paying clients reached 1.65 million, up 14% year-over-year. 3 quarters into 2023, we have exceeded our full year guidance by acquiring over 163,000 paying clients.
In the third quarter, Hong Kong market contributed over 40% of new paying clients. This acceleration in client acquisition was driven by the relief rally in the first half of the quarter and successful marketing around the government's Green Bond and Silver Bond issuances in the second half. These 2 bond offerings attracted allocation-driven clients to our platform. In late July, we opened the first offline store in Hong Kong to raise brand awareness, assist clients with account opening, demonstrate advanced product features, and address inquiries regarding our products and services. Through this offline store, we managed to attract middle-aged and senior clients at a lower customer acquisition cost. In fact, clients aged 55 and above contribute at over 50% of paying clients acquired through the offline store in the third quarter.
In Singapore, we launched successful marketing campaigns to promote our cash management product, Cash Plus (sic) [Money Plus], thereby growing our paying clients by 35% year-over-year. We continued to observe improvement in client quality in the U.S. as net asset inflow of new paying clients trended higher. In September, we officially launched our brokerage business in Japan and Canada, now offering clients access to U.S. stock trading in Japan and U.S. and Canadian stock trading in Canada. During the early innings of market launch, we will remain focused on refining our account opening golden process, expanding trading products, and honing our brand positioning and marketing messages. Despite bearish sentiments across global equity markets, we recorded another quarter of over 98% paying client retention rate.
We continue to enrich trading product offerings across markets. In Singapore, we launched fractional shares for U.S. stocks and ETFs to enhance accessibility for novice investors. We optimized our product for active options traders by introducing multi-leg options rollover strategy in Hong Kong and the U.S. This trading function gives options traders flexibility to roll contracts near expiration to a later date at different strike prices.
Total client assets increased by 27% year-over-year to HKD 468 billion. While the market pullback dragged the valuation of our client stock holdings, total client assets remained stable quarter over quarter due to robust net asset inflow. Notably, total client assets in Singapore achieved double-digit sequential growth for the fifth consecutive quarter, which was partially driven by higher new asset quality. The average asset balance of new paying clients in Singapore was 20% higher than the prior quarter.
Trading volume in the third quarter rebounded as clients traded more actively amidst heightened volatility. Total trading volume increased by 14% sequentially to HKD 1.1 trillion, of which U.S. stock trading constituted around 75%. Higher trading turnover of the Magnificent Seven stocks led U.S. stock trading volume to grow by 19% quarter over quarter. Hong Kong stock trading volume increased by 5% sequentially, mainly driven by rising trading interests in leveraged and inverse ETFs. Margin financing and securities lending balance slipped 4% quarter over quarter as some clients unwound their bets against popular U.S. technology names.
Total client assets in wealth management grew to HKD 52 billion as of quarter end, up 100% year-over-year and 19% quarter over quarter. In the third quarter, client assets in bonds increased by 87% sequentially as U.S. Treasury bills maintained high yield. In Hong Kong, structured notes were met with high demands from high-net-worth clients after risk appetite abated amid macro uncertainties. As a result, private fund balance grew by 52% quarter over quarter. In Singapore, total client assets in wealth management increased by fivefold year-over-year, driven by tripling of wealth management clients and higher average asset balance. In the third quarter, we further expanded our product portfolio in Singapore by introducing structured notes and [FGS] bonds.
We have 391 IPO distribution and IR clients as of quarter end, up 30% year-over-year. In the third quarter, we acted as joint bookrunners of several high-profile Hong Kong IPOs, including those of TUHU Car, 4Paradigm, and KEEP. We also participated in the Hong Kong IPOs of all companies with market capitalization over HKD 10 billion by the end of quarter. In the first 3 quarters, we underwrote 26 Hong Kong IPOs and ranked first among all Hong Kong brokers according to Wind.
Next, I'd like to invite our CFO Arthur to discuss our financial performance.

Yu Chen

Thank you, Leaf and Daniel. Now please allow me to walk you through our financial performance in the third quarter. All the numbers are in Hong Kong dollars, unless otherwise noted. Total revenue was HKD 2.7 billion, up 36% from HKD 1.9 billion in the third quarter of 2022. Brokerage commission and handling charge income was HKD 1 billion, an increase of 5% year-over-year and 6% Q-over-Q. Higher contributions from derivatives trading lifted blended commission rate from 8.8 basis points in the third quarter last year to 9.3 basis points this quarter. Interest income was HKD 1.5 billion, an increase of 71% year-over-year and 7% Q-over-Q. The sequential increase was mainly driven by higher interest rate on client cash deposits, partially offset by lower cash balance. Other income was HKD 137 million, up 28% year-over-year and 8% Q-over-Q. The increase was largely due to higher fund distribution income.
Our total costs were HKD 437 million, an increase of 101% from HKD 218 million in the third quarter of 2022. Brokerage commission and handling charge expenses were HKD 63 million, down 24% year-over-year and 14% Q-over-Q. The expenses didn't move in tandem with brokerage commission and handling charge income, mainly due to cost savings from our U.S. self-clearing business. Interest expenses were HKD 289 million, up 546% year-over-year and 31% Q-over-Q. The year-over-year and the Q-over-Q increase were both driven by higher interest expenses associated with our securities and lending business. Processing and servicing costs were HKD 86 million, down 6% year-over-year and 13% Q-over-Q. The year-over-year decrease was mainly due to savings from cloud service fee as a result of system optimization and the Q-over-Q decrease was mainly due to lower system usage fee.
As a result, total gross profit was HKD 2.2 billion, an increase of 28% from HKD 1.7 billion in the third quarter of 2022. Gross margin was 84% as compared with 89% in the third quarter of 2022. Operating expenses was up 17% year-over-year and up 5% Q-over-Q to HKD 893 million. R&D expenses were HKD 360 million, up 15% year-over-year and down marginally by 1% Q-over-Q. The year-over-year increase was mainly due to higher R&D headcount as we continue to upgrade our infrastructure, roll out new products and features, and customize products for international markets.
Selling and marketing expenses was HKD 212 million, down 10% year-over-year and up 21% Q-over-Q. The expenses declined year-over-year due to lower customer acquisition costs. And the Q-over-Q increase was primarily driven by accelerated paying client growth. General and administrative expenses were HKD 322 million, up 52% year-over-year and 3% Q-over-Q. The rise was primarily due to an increase in headcount for general and administrative personnel to support our international market. As a result, our net income increased by 45% year-over-year and declined by 3% Q-over-Q to HKD 1.1 billion. Net income margin expanded to 41% from 39% in the same quarter last year, mainly due to strong revenue growth and the lower selling and marketing expenses.
That concludes our prepared remarks. We'd now like to open the call to questions. Operator, please go ahead.

Question and Answer Session

Operator

(Operator Instructions) The first question comes from the line of Leon Qi with Daiwa.

Leon Qi

[Interpreted] This is Leon from Daiwa. My first question is regarding our new market, especially in Japan. We understand we just launched Japan in late September. I'm interested in the user behavior in terms of our Japan new clients. Does management see any early indicators in terms of the trading velocities, margin, landing penetration and the specific trading products that our Japanese clients are being engaged in? Is there any significant differences in terms of these matrix for customers in Japan versus other markets? And also, I'm interested to know the customer acquisition cost for us in Japan so appreciate any color on the unit economics in Japan.
And my second question is on wealth management. We do appreciate the very rapid growth of our AUM in wealth management and per management introduction just now, money market fund is a major reason behind that. So I'm sure this is partly because of the high U.S. interest rates. But if we look at it from a cross-interest rate cycle perspective, how much proportion does management expect the nonmoney market fund products to contribute in our overall wealth management AUM? And also, what is our take rate on money market fund now?

Yu Chen

Leon, let my colleague, Daniel, answer the first question first and I will answer the second question.

Daniel Yuan

Sure. So unfortunately, we now only offer U.S. cash equities trading to our Japanese clients, so we don't have margin, we don't have Japanese stock trading, so we only have data for client behavior on U.S. stock trading. And so far, the turnover of U.S. stock trading is not so different from what we've seen in other markets. That being said, we have a very aggressive and ambitious product roadmap for next year and some of the products that I mentioned that we don't support now will be rolled out in the next couple of quarters.
And in terms of client acquisition cost, because we are coming from a small base of clients, whereas we have a lot of fixed costs for setting up offices in Japan and hiring marketing personnel. So obviously, our CAC for this quarter and next quarter in Japan will be higher than our group average. But over time, as we increase the number of clients in Japan, the CAC will gradually come down. And so far, we have no reason to believe that the CAC in Japan will be higher than what we've seen in other markets. And just to give you some other colors and updates on our Japan business, we now have slightly over 400,000 users on our platform and overall users have been very active. And we've observed that on average during the trading days our DAU to user ratio was close to 20%, which is the highest among all of the markets we are currently in. And user growth, along with paying client growth, will be our key priorities for next year.

Yu Chen

Okay. For second question regarding the wealth management, I think the key for us to do this kind of business is to engage a client and focus on the long-term values of the clients. Therefore, we do not put too emphasis on the near-term monetizations. But having said that, the take rate for these money market funds is essentially just similar to our other products, such as equity products or fixed income products. I think we have already established a very comprehensive matrix in terms of the product offerings in our (inaudible). For instance, besides the money market fund, we also have the equity products, fixed income products. In particular, as Leaf mentioned in the opening remarks, we have launched free floating rate note, FCN products, in the past 2 quarters and record very strong growth. We think these products will further diversify our clients' asset allocations and help them to navigate different interest rate cycles down the line.

Operator

Next question comes from the line of Chiyao Huang with MS.

Chiyao Huang

[Interpreted] The first question is on idle cash. We saw some sequential decline in idle cash. So just wondering what's the reason for that and if we are seeing some of the existing clients are shifting their cash to mutual funds or other products. And also a related question is for the new inflow of client AUM, what's roughly the proportion between stocks and other investment products such as mutual funds?
And second question is can management talk about the strategy in Japan, as we are seeing some local brokers are offering zero commission already. So what's our competitive strategy there and what's the thinking about the future monetization? Would we be considering building more comprehensive financial offerings and capabilities in Japan in order to improve the monetization over time?

Yu Chen

[Interpreted] In terms of your first question, the idle cash decrease was primarily due to our clients shift their cash positions to more equity stocks, especially on the U.S. stock assets, at quarter end. And also the partial reason is because some clients allocated more on the wealth management products during the quarter end as well. In terms of the new clients inflows, the allocations among cash, stock, and also the wealth management, roughly stock positions accounts for 70% and the wealth management products account for 10%, and the remaining belongs to the idle cash.

Daniel Yuan

And Chiyao, I will take your second question on our monetization strategy in Japan. And yes, as you mentioned, we have seen a couple leading brokers in Japan gone to zero commission for Japanese stock trading. And we have reasons to believe that other brokers in Japan will probably follow suit. So well, no one's going to make money from Japanese equities trading, but U.S. stock trading is still quite profitable. SBI and Rakuten, for example, charge 45 bps for U.S. stock trading. We tend to price more aggressively than these incumbents, but we still expect to make very decent margins on U.S. stock trading. And as of the end of last year, we have seen that there are 2.3 million U.S. stock investors in Japan. That's relatively low compared to Japanese stock investors, but that has been growing pretty fast. As of the end of 2019, there were about 1 million U.S. stock investors. So over the past 4 years, it has more than doubled.
And besides U.S. stock trading commission, we also intend to monetize over margin financing and foreign exchange fees. We observed that Japanese investors really like to trade on margin. We have seen that for the industry average number, around 50% of their trades are placed with margin. So that's going to be a key revenue driver. And then for FX charges, we understand that in order to compensate for zero commission for Japanese stock trading, all of the brokers in Japan charge pretty hefty fees for FX. So as the trading volume of U.S. stock trading on our platform grows, we also expect FX revenue to make a meaningful contribution.

Operator

Next question comes from the line of Cindy Wang with China Renaissance.

Yun-Yin Wang

[Interpreted] So I have 2 questions. First one is related to Japan market. Can you share the color of Japan's (inaudible) plans progress. What's the conversion rate from registered users to paying clients? And have you seen new paying clients increasing month over month?
Second question is, is the Futu subsidiaries applying for digital assets trading platform in Hong Kong? What is the progress looks like and what is your preparation work for digital assets trading platform? Would you be able to launch trading functions immediately once your license is approved?

Yu Chen

Cindy, I will answer your second question first, and my colleague Daniel will answer your question regarding to Japan. [Interpreted] We echo the Web3 policies advocated by the Hong Kong government who want to build up Hong Kong as a Web3 global centers. In the past several quarters, we carefully studied the policies and the regulations issued by Hong Kong SFC. PantherTrade, a wholly subsidiary within Futu Group, submitted VSAP (sic) [VASP] license application to Hong Kong SFC last month, and we expect the whole application process may take at least 6 to 9 months, if we have the luck to get approval in principles. And we have not formed a very concrete business plans afterwards, and we will continue to modify this content in the next couple of quarters and hopefully we can give some new updates in next Q2 or Q3.

Daniel Yuan

[Interpreted] And I'm going to translate for myself. So right now, in Japan, the user-to-client conversion rate as well as the client to paying client conversion rate are both lower than what we have observed in other international markets. And we think there are 2 main reasons behind it: #1 is that our account opening golden process still has a number of friction points. So far, the mid-to [back-office] in the Japan brokerage industry are still characterized by a lot of outsourced systems that have really unsatisfactory user experience. And in order to start account opening soon, we leveraged some of these outsourced systems which really have a negative impact on our users' experience and thus impacted the conversion rate from account opening to asset deposit. And in the next couple of quarters, we plan to invest into our account opening process and gradually replace these outsourced systems with our proprietary system.
And the second reason behind this low conversion rate so far is the lack of key trading products. And as mentioned earlier, we now only offer U.S. cash equities trading to Japan users. And in the first quarter of next year, we plan to launch Japanese stock trading as well as NISA account. Although we are really confident that Futu's U.S. stock trading capabilities lead our Japanese peers by a very wide margin. In Japan, the Japanese stock investing is still very popular. And we understand based on our user survey that lack of Japanese equity trading is a key reason that prevents them from opening accounts with us.

Operator

(Operator Instructions) Next question comes from the line of Peter Zhang with JPMorgan.

Peter Zhang

[Interpreted] Okay, let me do the translation. My first question is a follow up question regarding the Japan product line. I wish to understand, going forward, will the clients in Futu's clients in Hong Kong or Singapore market being allowed to trade Japan stock. Is this in your product pipeline? My second question is regarding the blended commission fee rate. We notice that the blended commission fee rate declined sequentially in third quarter. We wish to understand what's the reason behind and what will be the trend going forward?

Yu Chen

[Interpreted] 2 questions, #1 is for the Japan stock trading offering to the markets outside of Japan, our answer is definitely it will be a yes and has already been in our product pipeline. Hopefully, we can launch the Japan stock trading to our clients in Hong Kong and Singapore in the near future. And we do think this kind of product offering will be further helpful to our client engagement in these markets and also increase the client's participations in our platform and also our top line will also be benefit arising from that.
Regarding the blended commission rate fluctuation as we elaborate to the market several quarters, it is mainly due to the client's trading behaviors because our U.S. stock trading commissions do have different price manuals and 1 manual is actually not based on the percentage of the trading volume but on the number of the shares. So when people trade these big blue chips or these OTT stocks, the combination will have the implications on the blended commission rate as well. In the third quarter, the fluctuation is mainly because of that. And going forward, we think the blended commission rate, if we take out this trading pattern's reasons, can maintain stable in the near future.

Operator

Next question comes from the line of Li Wan with BOCOM International.

Li Wan

[Interpreted] Can you give us a breakdown of interest income and what will be the impact from Fed's rate cut next year?

Yu Chen

[Interpreted] In terms of the interest income, year to date, the interest revenues contributed from client's idle cash is much bigger than the interest income derived from the margin lending and the security lending business. And going forward, we do not think the Fed's rate cut will be very fast. And in circumstances when the rates cut, normally, it will be helpful to the trading volumes for the whole capital markets for our clients as well. Therefore, we do think the trading revenues arising from this rate cut will largely offset the potential idle cash revenue decrease.

Operator

Next question comes from the line of Emma Xu with BofA Securities. Ms. Xu, if you have muted from your end, please unmute yourself and you can go ahead with your question. Ms. Xu, can you go ahead with your question? Ms. Emma Xu, can you go ahead with your question?

Daniel Yuan

Well, it seems that Emma is not here tonight. So operator, do have any further questions on the line?

Operator

There are no more questions, so I will now hand the call back over to Mr. Yuan for closing comments. Thank you.

Daniel Yuan

Sure. Yes. So that concludes our call today. On behalf of the Futu management team, I would like to thank you for joining us today. If you have any further questions, please do not hesitate to contact me or any of our Investor Relations representatives. Thank you and goodbye.

Operator

Thank you. This concludes our today. Thank you for participating. You may now disconnect.
[Portions of this transcript that are marked [Interpreted] were spoken by an interpreter present on the live call.]