F-1 1 d544187df1.htm FORM F-1 Form F-1
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As filed with the United States Securities and Exchange Commission on July 11, 2018.

Registration No. 333-            

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM F-1

REGISTRATION STATEMENT

UNDER

THE SECURITIES ACT OF 1933

 

 

CNFinance Holdings Limited

(Exact name of Registrant as specified in its charter)

 

 

Not Applicable

(Translation of Registrant’s name into English)

 

 

 

Cayman Islands   6199   Not Applicable
(State or other jurisdiction of
incorporation or organization)
  (Primary Standard Industrial
Classification Code Number)
  (I.R.S. Employer
Identification Number)

44/F, Tower G, No. 16 Zhujiang Dong Road

Tianhe District, Guangzhou City, Guangdong Province 510620

People’s Republic of China

+86-201-62316688

(Address, Including Zip Code, and Telephone Number, Including Area Code, of Registrant’s Principal Executive Offices)

 

 

Cogency Global Inc.

10 E. 40th Street, 10th Floor, New York NY

10016

(800) 221-0102

(Name, address, including zip code, and telephone number, including area code, of agent for service)

 

 

Copies to:

 

James C. Lin, Esq.

Li He, Esq.
Davis Polk & Wardwell LLP
c/o 18th Floor, The Hong Kong Club Building
3A Chater Road
Central, Hong Kong
+852 2533-3300

 

David T. Zhang, Esq.

Steve Lin, Esq.

Meng Ding, Esq.

Kirkland & Ellis International LLP

c/o 26th Floor, Gloucester Tower

The Landmark

15 Queen’s Road Central

Hong Kong

+852 3761-3300

 

 

Approximate date of commencement of proposed sale to the public: As soon as practicable after the effective date of this registration statement.

If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box.  ☐

If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ☐

If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ☐

If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ☐

Indicate by check mark whether the registrant is an emerging growth company as defined in Rule 405 of the Securities Act of 1933.

Emerging growth company  ☒

If an emerging growth company that prepares its financial statements in accordance with US GAAP, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards† provided pursuant to Section 7(a)(2)(B) of the Securities Act.  ☒

† The term “new or revised financial accounting standard” refers to any update issued by the Financial Accounting Standards Board to its Accounting Standards Codification after April 5, 2012.

 

 

CALCULATION OF REGISTRATION FEE

 

 

Title of each class of
securities to be registered
 

Proposed

maximum

aggregate

offering price(1)

 

Amount of

registration fee

Ordinary shares, par value US$             per share(2)(3)

  US$200,000,000   US$24,900

 

 

(1) Estimated solely for the purpose of determining the amount of registration fee in accordance with Rule 457(o) under the Securities Act of 1933.
(2) Includes ordinary shares initially offered and sold outside the United States that may be resold from time to time in the United States either as part of their distribution or within 40 days after the later of the effective date of this registration statement and the date the shares are first bona fide offered to the public, and also includes ordinary shares that may be purchased by the underwriters pursuant to an over-allotment option. These ordinary shares are not being registered for the purpose of sales outside the United States.
(3) American depositary shares issuable upon deposit of the ordinary shares registered hereby will be registered under a separate registration statement on Form F-6 (Registration No.333-            ). Each American depositary share represents              ordinary shares.

 

 

The Registrant hereby amends this registration statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment which specifically states that this registration statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933, as amended, or until the registration statement shall become effective on such date as the Commission, acting pursuant to such Section 8(a), may determine.

 

 

 


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The information in this prospectus is not complete and may be changed. We may not sell these securities until the registration statement filed with the Securities and Exchange Commission is effective. This prospectus is not an offer to sell these securities and it is not soliciting an offer to buy these securities in any state where the offer or sale is not permitted.

 

Subject to completion

Preliminary Prospectus dated             , 2018

             American Depositary Shares

 

LOGO

CNFinance Holdings Limited

Representing              Ordinary Shares

 

 

This is an initial public offering of American depositary shares, or ADSs, representing ordinary shares of CNFinance Holdings Limited.

We are offering              ADSs. Each ADS represents              of our ordinary shares, par value US$             per share.

Prior to this offering, there has been no public market for the ADSs. It is currently estimated that the initial public offering price per share will be between US$             and US$            .

We [have applied for] listing the ADSs on the New York Stock Exchange under the symbol “            .”

We are an “emerging growth company” under applicable U.S. federal securities laws and are eligible for reduced public company reporting requirements.

 

 

See “Risk Factors” beginning on page 18 for factors you should consider before buying the ADSs.

 

 

Neither the United States Securities and Exchange Commission nor any other regulatory body has approved or disapproved of these securities or passed upon the accuracy or adequacy of this prospectus. Any representation to the contrary is a criminal offense.

 

     Per ADS      Total  

Public offering price

   US$                   US$               

Underwriting discounts and commissions(1)

   US$      US$  

Proceeds, before expenses, to us

   US$      US$  

 

(1) See “Underwriting” for additional disclosure regarding compensation payable by us to the underwriters.

The underwriters have a 30-day option to purchase up to an additional              ADSs from us at the initial public offering price less the underwriting discount.

The underwriters expect to deliver the ADSs against payment in U.S. dollars in New York, New York on             , 2018.

 

 

 

J.P. Morgan    Credit Suisse

 

 

Haitong International

 

 

The date of this prospectus is             , 2018.


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TABLE OF CONTENTS

 

 

 

     Page  

Prospectus Summary

     1  

Implications of Being an Emerging Growth Company

     7  

Our Corporate Information

     7  

Conventions Which Apply to This Prospectus

     7  

The Offering

     10  

Summary Consolidated Financial Data and Operating Data

     12  

Risk Factors

     18  

Special Note Regarding Forward-Looking Statements

     59  

Use of Proceeds

     60  

Dividend Policy

     61  

Capitalization

     62  

Dilution

     63  

Exchange Rate Information

     64  

Enforceability of Civil Liabilities

     65  

Corporate History and Structure

     67  

Selected Consolidated Financial Data

     70  

Management’s Discussion and Analysis of Financial Condition and Results of Operations

     74  

Industry Overview

     104  

Business

     108  

Regulation

     140  

Management

     155  

Principal Shareholders

     162  

Related Party Transactions

     165  

Description of Share Capital

     166  

Description of American Depositary Shares

     175  

Shares Eligible for Future Sale

     187  

Taxation

     189  

Underwriting

     195  

Expenses Relating to This Offering

     205  

Legal Matters

     206  

Experts

     207  

Where You Can Find Additional Information

     208  

Index to Consolidated Financial Statements

     F-1  

We are responsible for the information contained in this prospectus. We have not authorized anyone to provide you with different information, and we take no responsibility for, and can provide no assurance as to the reliability of, any other information others may give you. We are not, and the underwriters are not, making an offer to sell these securities in any jurisdiction where the offer or sale is not permitted. You should not assume that the information contained in this prospectus is accurate as of any date other than its date.

We are offering to sell, and seeking offers to buy, the ADSs only in jurisdictions where offers and sales are permitted. The information contained in this prospectus is current only as of the date of this prospectus, regardless of the time of delivery of this prospectus or of any sale of the ADSs.

We have not taken any action to permit a public offering of the ADSs outside the United States or to permit the possession or distribution of this prospectus outside the United States. Persons outside the United States who

 

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come into possession of this prospectus must inform themselves about and observe any restrictions relating to the offering of the ADSs and the distribution of the prospectus outside the United States.

Until             , 2018 (the 25th day after the date of this prospectus), all dealers that buy, sell or trade ADSs, whether or not participating in this offering, may be required to deliver a prospectus. This is in addition to the obligation of dealers to deliver a prospectus when acting as underwriters and with respect to their unsold allotments or subscriptions.

 

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PROSPECTUS SUMMARY

The following summary is qualified in its entirety by, and should be read in conjunction with, the more detailed information and financial statements and the related notes appearing elsewhere in this prospectus. In addition to this summary, we urge you to read the entire prospectus carefully, especially the risks of investing in our ADSs discussed under “Risk Factors” and information contained in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” before deciding whether to buy our ADSs. This prospectus contains information derived from various public sources and certain information from an industry report commissioned by us and prepared by Oliver Wyman, a third-party industry research firm, to provide information regarding our industry and market position in China. We refer to this report as the Oliver Wyman report. Such information involves a number of assumptions and limitations, and you are cautioned not to give undue weight to these estimates. We have not independently verified the accuracy or completeness of the data contained in these industry publications and reports. The industry in which we operate is subject to a high degree of uncertainty and risk due to a variety of factors, including those described in the “Risk Factors” section. These and other factors could cause results to differ materially from those expressed in these publications and reports.

Our Mission

Our mission is to provide accessible, affordable and efficient financing solutions to micro- and small-enterprise owners in China, helping them achieve their business dreams.

Overview

We are a leading home equity loan service provider in China with established business infrastructure. According to the Oliver Wyman report, we are the second largest home equity loan service provider among non-traditional financial institutions in China in terms of outstanding loan principal as of December 31, 2017. We facilitate loans by connecting micro- and small-enterprise (“MSE”) owners with our funding partners. MSEs refer to both individual business owners and registered micro- and small-enterprises with annual revenue of less than RMB20 million. With more than ten years of experience in the loan service industry, we have established a national network of 73 branches and sub-branches in over 40 cities in China. The extensive local knowledge and resources we have acquired while building our business infrastructure distinguish us from other market players. In 2016 and 2017, we originated home equity loans with aggregate principal amount of RMB8.3 billion and RMB17.1 billion, respectively, representing an increase of 105.8%. For the three months ended March 31, 2018, we originated home equity loans with an aggregate principal amount of RMB2.2 billion.

Our primary target borrower segment is MSE owners who own real properties in Tier 1 and Tier 2 cities in China. We originated home equity loans for 12,983 and 23,705 borrowers in 2016 and 2017, respectively, representing an increase of 82.6%. For the three months ended March 31, 2018, we originated home equity loans for 3,949 borrowers. These MSE owners typically have quick cash flow turnover from their business operations with high demand for working capital. Their financing needs are often unpredictable, time-sensitive and frequent. Our target borrowers are underserved by traditional financial institutions. Traditional financial institutions often impose stringent and inflexible loan application requirements designed for large corporations, making it difficult for MSE owners to meet such requirements. In addition, time-consuming and cumbersome requirements often limit MSE owners’ ability to meet their imminent financing needs. Moreover, unlike in the United States where home equity loans commonly serve as a financing alternative, according to the Oliver Wyman report, traditional lenders in China, such as banks, typically do not grant loans secured by second lien interests and are generally less incentivized to introduce innovative home equity loan products.

We aim to serve our target borrowers by facilitating home equity loans and providing tailored services. Our standardized and integrated online and offline credit application and assessment process shortens the time of loan disbursement to as fast as 48 hours from submission of a qualified loan application with all necessary



 

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documentation, providing expeditious financing solutions to MSE owners. We typically facilitate home equity loans to MSE owners in the form of installment loans with a monthly contractual interest rate typically ranging from 0.9% to 1.3% and a tenor typically ranging from one to eight years, assisting borrowers’ short-term and long-term business plannings. In 2016 and 2017 and for the three months ended March 31, 2018, the average tenor of the home equity loans we originated was 50, 66 and 65 months with the weighted average effective interest rate (inclusive of interests and financing service fees, if applicable, payable by the borrowers) of 26.0%, 23.7% and 22.4% per annum, respectively. The increase in the average tenor is because starting from April 2017 we facilitated more loan products with a longer term of eight years, and the decrease in the weighted average effective interest rate is because we ceased charging financing service fees to the borrowers starting from August 2017, and loan products with a term of eight years typically have a lower effective interest rate. The loan products are secured by first or second lien interests on real properties. 61.1%, 58.0% and 57.8% of our total home equity loan origination volume in 2016, 2017 and for the three months ended March 31, 2018, respectively, was secured by second lien interests. Depending on the value of the collateral and the creditworthiness of the borrower, we offer flexible loan principal typically ranging from RMB100,000 to RMB3,000,000.

We have a rigorous and robust risk management system. Our risk mitigation mechanism is embedded in the design of our loan products, supported by an integrated online and offline process focusing on risks of both borrowers and collateral and further enhanced by effective post-loan management procedures. Our extensive business infrastructure supports our operations by providing various offline services, such as on-site visits, interaction with local real property bureaus and debt collection. Collateral for loans we facilitate is geographically dispersed in Tier 1 and Tier 2 cities in China to diversify our risk concentration in any local real estate market. Our home equity loan products are typically installment loans which require monthly payments comprising principal and interests repayments. We timely monitor borrowers’ credit status, which enables us to take actions quickly if we believe there is a risk of default. Our practical risk assessment focuses on both credit risks of borrowers and quality of the collateral. We have also established strict guidelines on the characteristics and quality of collateral, including, among others, a LTV ratio capped at 80%. The weighted average LTV ratio of the home equity loan origination volume was 65.9%, 66.7% and 62.6% in 2016, 2017 and for the three months ended March 31, 2018, respectively. As of December 31, 2016 and 2017 and March 31, 2018, the NPL ratio was 1.50%, 1.66% and 1.75%, respectively. Charge-off ratio in 2016, 2017 and for the three months ended March 31, 2018 was 0.005%, 0.093% and nil, respectively.

The loans we facilitate are primarily funded through a trust lending model with our trust company partners. Our trust company partners are well-established with sufficient funding sources and have licenses to engage in lending business nationwide. Our trust company partners are regulated by CBIRC and all the trust plans are registered with the CBIRC. This structure provides us with stable funding sources. Under the trust lending model, our trust company partners set up trust plans and acquire funding from their investors. Trust plans are typical investment vehicles in which investors participate by subscribing to trust units and receive a return as set out in subscription agreements. Each trust plan issues multiple trust products which are funded with senior and subordinated units at a pre-determined ratio with a term of one to three years. The loans funded by the trust products, however, have terms typically ranging from one to eight years. For details of matching our funding sources and loans we facilitate, please refer to “Business—Our Funding Model—Matching of Terms of Funding Sources and Loans.” The contractual structural leverage ratio of the senior units and subordinated units of trust plans or products is determined pursuant to our collaboration agreements with our trust company partners, which set the upper limit to such ratio at a range of 3:1 to 9:1. Due to recent regulatory changes, we will work with our trust company partners to lower the contractual structural leverage ratio of each trust product to no higher than 3:1 before the end of 2020, the grace period provided by the Guiding Opinion on Regulating the Asset Management Business of Financial Institutions (the “Guiding Opinion”). As of March 31, 2018, the actual structural leverage ratio of our trust plans was generally no higher than 3:1. For details, please refer to “Business—Our Funding Model—Terms of the Trust Plans” and “—Funding Partners.” As part of the collaboration we have with our trust company partners, we are required to subscribe to all of the subordinated



 

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units of trust plans. By subscribing to subordinated units, we are entitled to the residual value from trust plans after certain payments to senior unit holders, trust company partners and third-party service providers. Payments to senior unit holders consist of expected investment returns which are usually paid quarterly and principal amounts which are repaid upon maturity. We as subordinated unit holders are paid an investment return each quarter after the quarterly payment to senior unit holders and upon maturity after the payment of principal amounts to senior unit holders. Our financing costs for the senior units, excluding the trust administrative fees, ranged from 9.75% to 12.4% per annum of the issuance amount of senior units in 2016, 2017 and for the three months ended March 31, 2018, our financing costs for subordinated units under repurchase arrangements with private equity funds ranged from 16% to 18% per annum of the transfer prices for such subordinated units in 2016, 2017 and for the three months ended March 31, 2018, and our financing costs for subordinated units under repurchase arrangements with third parties through a private financial assets trading platform ranged from 9.7% to 14% per annum of the transfer prices for such subordinated units in 2016, 2017 and for the three months ended March 31, 2018. Our cost of the subordinated units as measured by the investment amount was RMB1,928.6 million, RMB4,626.1 million and RMB4,802.3 million as of December 31, 2016 and 2017 and March 31, 2018, respectively. Our investment return from the subordinated units was RMB391.2 million, RMB1,595.3 million and RMB497.6 million in 2016, 2017 and for the three months ended March 31, 2018, respectively.

To a lesser extent, we also have a direct lending model through which we lend directly under our small loan licenses to borrowers with our own funding or funding we acquire from transfer of rights to earnings in loans principal, interest and financing service fee receivables to third parties with a repurchase arrangement. Our financing costs under such arrangement ranged from 9.7% to 14% per annum of the transfer prices in 2016, 2017 and for the three months ended March 31, 2018.

For details of our repurchase agreements with third parties under both the trust lending and direct lending models, please refer to “Business—Our Funding Model—Funding Sources” and “—Small Loan Direct Lending.” We generally rely on and will continue to rely primarily on our trust lending model, which is supplemented with our direct lending model. In 2017, funding from trust lending and direct lending models accounted for 95.4% and 4.6% of our total loan origination volume, respectively. For the three months ended March 31, 2018, funding from trust lending and direct lending models accounted for 99.7% and 0.3% of our total home equity loan origination volume, respectively.

Through our established network of sales teams and branch offices, we reach prospective MSE borrowers and assess their creditworthiness and collateral. If these borrowers meet our requirements, we refer them to our trust company partners who make their own credit decisions before directly lending to qualified borrowers. We help trust company partners sign loan agreements with borrowers directly, and assist borrowers in pledging collateral for the benefit of trust company partners. We are designated as the service provider and provide post-loan services such as payment monitoring, debt collection and release of collateral as the need arises. We provide top-up arrangement to trust plans associated with our subscription of subordinated units. Under this arrangement, we are required to manage the NPLs by repurchasing or replacing NPLs, or providing additional funding sufficient to cover outstanding principal and interests of NPLs. We receive a performance-based service fee up to 8% per annum of the size of the trust plan charged to the trust plans for the services we provide.



 

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The following charts illustrate the number of active borrowers, number of transactions, loan origination volume and outstanding loan principal of home equity loans as of and for the nine quarters ended March 31, 2018.

 

LOGO

We have grown significantly and were profitable in 2016, 2017 and for the three months ended March 31, 2018. Our total operating income increased from RMB867.3 million in 2016 to RMB2,013.0 million (US$320.9 million) in 2017, representing an increase of 132.1%, and from RMB400.8 million for the three months ended March 31, 2017 to RMB599.6 million (US$95.6 million) for the three months ended March 31, 2018, representing an increase of 49.6%. Our net income increased from RMB235.4 million in 2016 to RMB532.7 million (US$84.9 million) in 2017, representing an increase of 126.2%, and from RMB112.0 million for the three months ended March 31, 2017 to RMB196.7 million (US$31.4 million) for the three months ended March 31, 2018, representing an increase of 75.6%.

Our Strengths

We believe the following strengths differentiate us from our competitors, contributing significantly to our growth and success:

 

    leading home equity loan service provider well positioned to capture the massive and underserved financing needs of MSE owners;

 

    proven business model tailored to the financing needs of China’s MSE owners;

 

    well-established business infrastructure built for scale;

 

    robust risk management delivering superior asset quality; and

 

    experienced management team supported by dedicated workforce.


 

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Our Strategies

We plan to pursue the following strategies to grow and expand our business:

 

    broaden customer reach;

 

    diversify funding sources;

 

    provide value-added services to our third-party partners; and

 

    enhance technology and data analytic capabilities.

Our Challenges

Our business and successful execution of our strategies are subject to certain challenges, risks and uncertainties, including:

 

    our ability to maintain and enhance our relationship and business collaboration with our trust company partners and to ensure funding from them to provide sufficient amount to fund the home equity loans we facilitate; and

 

    the effectiveness of our risk assessment process and risk management system; and

 

    our ability to maintain low delinquency ratios for loans originated by us.

In addition, we face risks and uncertainties related to the regulatory environment in China, including:

 

    uncertainties associated with the interpretation and application of laws and regulations in China governing our business; and

 

    changes in the political and economic policies in China.

We also face other challenges, risks and uncertainties that may materially and adversely affect our business, financial condition, results of operations and prospectus. You should consider the risks discussed in “Risk Factors” and elsewhere in this prospectus before investing in the ADSs.

Corporate History and Structure

We started our operations in 1999 through Fanhua Chuang Li Information Technology (Shenzhen) Co., Ltd., which became our onshore holding company of the main operating subsidiaries in the PRC. In 2000, we formed our wholly owned Hong Kong subsidiary, China Financial Services Group Limited (“CFSGL”), as the offshore holding company of our PRC subsidiaries. In 2006, we were spun off from Fanhua Inc., a company listed on NASDAQ (symbol: FANH), and formed Sincere Fame International Limited (“SFIL”) under the laws of British Virgin Islands as the holding company of CFSGL. In January 2014, CNFinance Holdings Limited was incorporated under the laws of Cayman Islands. CNFinance Holdings Limited became our holding company through share exchanges with the shareholders of SFIL in March 2018. We conduct our business in the PRC primarily through Shenzhen Fanhua United Investment Group Co., Ltd., Guangzhou Heze Information Technology Co., Ltd. and their subsidiaries.

The following diagram illustrates our corporate structure with material subsidiaries as of the date of this prospectus. For a complete list of our subsidiaries, please refer to Note 1 to our consolidated financial statements as of and for the years ended December 31, 2016 and 2017 included elsewhere in this prospectus. We subscribe to the subordinated units of the trust products issued under long-term trust plans through three of our wholly owned subsidiaries, Guangzhou Heze Information Technology Co., Ltd., Guangzhou Chengze Information Technology Co., Ltd. and Shenzhen Fanhua United Investment Group Co., Ltd. From an accounting perspective,



 

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we are exposed to the risk and variability of returns from activities of the trust plans and are therefore required to consolidate the financial results of the trust plans, including the results related to the senior units. Financial data of a trust plan is consolidated as if the trust plan is a subsidiary. Income and expenses of the trust plans are consolidated on our consolidated statements of comprehensive income while assets and liabilities of the trust plans are consolidated on our consolidated balance sheet. We do not, however, have ownership interest in the trust plans from a legal perspective other than in the subordinated units that account for only a portion of the total outstanding amount of the trust plans. For details of the contractual structural leverage ratio of each trust plan, please refer to “Business—Our Funding Model.”

 

LOGO

 

 

Notes:

(1) Guangzhou Heze Information Technology Co., Ltd. is one of the entities through which we subscribe to subordinated units of trust products.
(2) Guangzhou Chengze Information Technology Co., Ltd. is one of the entities through which we subscribe to subordinated units of trust products.
(3) Shenzhen Fanhua United Investment Group Co., Ltd. operates our loan services business through various subsidiaries in the PRC and operates our small loan business through Beijing Fanhua Micro-credit Company Limited and Shenzhen Fanhua Micro-credit Co., Ltd.
(4) Established in May 2018.


 

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IMPLICATIONS OF BEING AN EMERGING GROWTH COMPANY

As a company with less than US$1.07 billion in revenue for the last fiscal year, we qualify as an “emerging growth company” pursuant to the Jumpstart Our Business Startups Act of 2012 (as amended by the Fixing America’s Surface Transportation Act of 2015), or the JOBS Act. An emerging growth company may take advantage of specified reduced reporting and other requirements that are otherwise applicable generally to public companies. These provisions include exemption from the auditor attestation requirement under Section 404 of the Sarbanes-Oxley Act of 2002, or Section 404, in the assessment of the emerging growth company’s internal control over financial reporting. The JOBS Act also provides that an emerging growth company does not need to comply with any new or revised financial accounting standards until such date that a private company is otherwise required to comply with such new or revised accounting standards. However, we have elected to “opt out” of this provision and, as a result, we will comply with new or revised accounting standards as required when they are adopted for public companies. This decision to opt out of the extended transition period under the JOBS Act is irrevocable.

We will remain an emerging growth company until the earliest of (i) the last day of our fiscal year during which we have total annual gross revenues of at least US$1.07 billion; (ii) the last day of our fiscal year following the fifth anniversary of the completion of this offering; (iii) the date on which we have, during the previous three-year period, issued more than US$1.0 billion in non-convertible debt; or (iv) the date on which we are deemed to be a “large accelerated filer” under the Securities Exchange Act of 1934, as amended, or the Exchange Act, which would occur if the market value of our ADSs that are held by non-affiliates exceeds US$700 million as of the last business day of our most recently completed second fiscal quarter. Once we cease to be an emerging growth company, we will not be entitled to the exemptions provided in the JOBS Act discussed above.

OUR CORPORATE INFORMATION

The principal executive offices of our main operations are located 44/F, Tower G, No.16 Zhujiang Dong Road, Tianhe District, Guangzhou City, Guangdong Province 510620, People’s Republic of China. Our telephone number at this address is +86 (020) 6231-6688. Our registered office in the Cayman Islands is located at the offices of Cricket Square, Hutchins Drive, PO Box 2681. Grand Cayman, KY1-1111, Cayman Islands. Our agent for service of process in the United States is Cogency Global Inc. located at 10 E. 40th Street, 10th Floor, New York, NY 10016. Our corporate website is www.cashchina.cn. The information contained in our website is not a part of this prospectus.

CONVENTIONS WHICH APPLY TO THIS PROSPECTUS

Unless we indicate otherwise, all information in this prospectus reflects the following:

 

    no exercise by the underwriters of their over-allotment option to purchase up to                  additional ADSs representing                  ordinary shares from us; and

Except where the context otherwise requires and for purposes of this prospectus only:

 

    “active borrowers” refers to borrowers with outstanding loan principal of home equity loans as at the end of a specified period;

 

    “ADSs” refers to the American depositary shares, each representing                  of our ordinary shares;

 

    “CAGR” refers to compound annual growth rate;


 

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    “China” or “PRC” refers to the People’s Republic of China, excluding, for the purpose of this prospectus only, Taiwan, Hong Kong and Macau;

 

    “contractual interest rate” refers to the interest rate prescribed under loan agreements;

 

    “effective interest rate” refers to the annualized internal rate of return based on initial outlay of loan principal, initial inflow of financing service fees (if applicable) and expected monthly inflow of repayments;

 

    “leverage ratio” refers to the ratio of total assets to total shareholders’ equity;

 

    “charge-off ratio” refers to the ratio of charge-offs during a period over the average beginning and ending balances of outstanding loan principal of the same period;

 

    “LTV ratio” refers to the ratio of loan amount to the value of asset collateral; the loan amount is calculated as the amount of all outstanding loans to be secured by the collateral;

 

    “NPL” refers to a loan being delinquent for over 90 days;

 

    “ordinary shares” prior to the completion of this offering refers to our ordinary shares of par value US$             per share;

 

    “Pearl River Delta region” refers to Dongguan, Zhongshan, Foshan, Guangzhou, Huizhou, Jiangmen, Shenzhen, Zhuhai and Zhaoqing;

 

    “quick disposal plans” refers to the mechanisms that we utilize to quickly dispose of delinquent loans or collateral to recover potential losses, including selling the delinquent loans to third parties or disposal of collateral without going through judicial proceedings;

 

    “RMB” or “Renminbi” refers to the legal currency of the People’s Republic of China;

 

    “senior units” refers to the senior units and intermediate units, if applicable, in a trust plan;

 

    “structural leverage ratio” refers to the ratio of the total amount of senior units and subordinated units; intermediate units are included as senior units for the purpose of calculation;

 

    “Tier 1 cities” refers to Beijing, Shanghai, Shenzhen and Guangzhou;

 

    “Tier 2 cities” refers to Dongguan, Foshan, Nanjing, Nanchang, Nantong, Xiamen, Hefei, Dalian, Tianjin, Changzhou, Xuzhou, Huizhou, Chengdu, Yangzhou, Wuxi, Kunming, Hangzhou, Wuhan, Jinan, Zhuhai, Shijiazhuang, Fuzhou, Suzhou, Xi’an, Zhengzhou, Chongqing, Changsha, Qingdao, Shaoxing, Ningbo, Wuxi, Ha’erbin, Changchun, Nanning, Wenzhou, Quanzhou, Guiyang, Taiyuan, Jinhua, Yantai, Jiaxing, Urumqi, Taizhou, Haikou, Jiaxing and Zhongshan;

 

    “total operating income” refers to the sum of (i) net interest and fees income and (ii) total non-interest revenue;

 

    “US$,” “dollars” or “U.S. dollars” refers to the legal currency of the United States;

 

    “we,” “us,” “our company,” “our,” and “CNFinance” refer to CNFinance Holdings Limited, a Cayman Islands company and its subsidiaries; and

 

    “Yangtze River Delta region” refers to Shanghai, Nanjing, Nantong, Hefei, Yixing, Changzhou, Yangzhou, Wuxi, Hangzhou, Jiangyin, Taizhou, Shaoxing, Suzhou, Jiaxing and Zhenjiang.

This prospectus contains information and statistics relating to China’s economy and its home equity loan industry derived from various publications issued by market research companies and PRC government entities, which have not been independently verified by us, the underwriters or any of their respective affiliates or advisers. The information in such sources may not be consistent with other information compiled in or outside China.



 

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Unless otherwise noted, all translations from Renminbi to U.S. dollars and from U.S. dollars to Renminbi in this prospectus are made at RMB6.2726 to US$1.00, the exchange rate set forth in the H.10 statistical release of the Federal Reserve Board on March 30, 2018. We make no representation that any Renminbi or U.S. dollar amounts could have been, or could be, converted into U.S. dollars or Renminbi, as the case may be, at any particular rate, the rates stated below, or at all. On July 6, 2018, the exchange rate as set forth in the H.10 statistical release of the Federal Reserve Board for Renminbi was RMB6.6396 to US$1.00.

In this prospectus, where information has been presented in thousands, millions, billions or trillions of units or percentages, amounts may have been rounded up or down. Accordingly, totals of columns or rows of numbers in tables may not be equal to the apparent total of the individual items and actual numbers may differ from those contained herein due to rounding.



 

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Table of Contents

THE OFFERING

 

Offering price

US$             per ADS.

 

ADSs offered by us

             ADSs (or              ADSs if the underwriters exercise their over-allotment option in full).

 

The ADSs

Each ADS represents              ordinary shares, par value US$             per share. The depositary will hold the ordinary shares underlying your ADSs. You will have rights as provided in the deposit agreement.

 

  We do not expect to pay dividends in the foreseeable future. If, however, we declare dividends on our ordinary shares, the depositary will pay you the cash dividends and other distributions it receives on our ordinary shares, after deducting its fees and expenses in accordance with the terms set forth in the deposit agreement.

 

  You may turn in your ADSs to the depositary in exchange for ordinary shares. The depositary will charge you fees for any exchange.

 

  We may amend or terminate the deposit agreement without your consent. If you continue to hold your ADSs after an amendment to the deposit agreement, you agree to be bound by the deposit agreement as amended.

 

  To better understand the terms of the ADSs, you should carefully read the “Description of American Depositary Shares” section of this prospectus. You should also read the deposit agreement, which is filed as an exhibit to the registration statement that includes this prospectus.

 

Ordinary shares

We will issue              ordinary shares represented by ADSs in this offering.

 

  All options, regardless of grant dates, will entitle holders to the equivalent number of ordinary shares once the vesting and exercising conditions on such share-based compensation awards are met.

 

  See “Description of Share Capital.”

 

Ordinary shares outstanding immediately after this offering

Immediately upon the completion of this offering,              ordinary shares will be outstanding, comprising              ordinary shares, par value US$             per share (or              ordinary shares if the underwriters exercise their option to purchase additional ADSs in full), including              ordinary shares, which number of shares has been calculated based on the initial offering price of US$              per ADS.


 

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Over-allotment option

We have granted to the underwriters an option, which is exercisable within 30 days from the date of this prospectus, to purchase up to an aggregate of              additional ADSs.

 

Use of proceeds

We expect to receive net proceeds of approximately US$              million from this offering, after deducting underwriting discounts and commissions and estimated offering expenses payable by us.

 

  We plan to use the net proceeds of this offering for working capital and other general corporate purposes. See “Use of Proceeds.”

 

Lockup

We, [our directors and executive officers and our existing shareholders] have agreed with the underwriters, subject to certain exceptions, not to sell, transfer or dispose of, directly or indirectly, any of ADSs or ordinary shares or securities convertible into or exercisable or exchangeable for ADSs or ordinary shares for a period of [180] days after the date of this prospectus. See “Shares Eligible for Future Sale” and “Underwriting” for more information.

 

NYSE trading symbol

 

Payment and settlement

The underwriters expect to deliver the ADSs against payment therefor through the facilities of The Depository Trust Company on              , 2018.

 

Depositary

JPMorgan Chase Bank, N.A.

 

Risk factors

See “Risk Factors” and other information included in this prospectus for discussions of the risks relating to investing in the ADSs. You should carefully consider these risks before deciding to invest in the ADSs.


 

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SUMMARY CONSOLIDATED FINANCIAL DATA AND OPERATING DATA

The following summary consolidated statements of comprehensive income data for the years ended December 31, 2016 and 2017, summary consolidated balance sheet data as of December 31, 2016 and 2017 and summary consolidated cash flow data for the years ended December 31, 2016 and 2017 have been derived from our audited consolidated financial statements included elsewhere in this prospectus. The following summary consolidated statements of comprehensive income data for the three months ended March 31, 2017 and 2018, summary consolidated balance sheet data as of March 31, 2018 and summary consolidated cash flow data for the three months ended March 31, 2017 and 2018 have been derived from our unaudited condensed consolidated financial statements included elsewhere in this prospectus, and have been prepared on the same basis as our audited consolidated financial statements and include all adjustments, consisting only of normal and recurring adjustments, that we consider necessary for a fair presentation of our financial position and operating results for the periods presented. Our historical results are not necessarily indicative of results expected for future periods. You should read this “Summary Consolidated Financial Data and Operating Data” section together with our consolidated financial statements and the related notes and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this prospectus.

Consolidated Statements of Comprehensive Income Data

The following table presents our selected consolidated statements of comprehensive income for the years ended December 31, 2016 and 2017 and for the three months ended March 31, 2017 and 2018, respectively.

 

    For the Year Ended December 31,     For the Three Months Ended March 31,  
    2016     2017     2017     2018  
    RMB     RMB     US$     RMB     RMB     US$  

Selected Consolidated Statements of Comprehensive Income:

           

Interest and fees income

           

Interest and financing service fee on loans

    1,242,128,524       3,406,110,592       543,014,156       624,052,654       1,063,195,480       169,498,371  

Interest on deposits with banks

    1,417,305       4,337,177       691,448       448,981       2,138,161       340,873  

Total interest and fees income

    1,243,545,829       3,410,447,769       543,705,604       624,501,635       1,065,333,641       169,839,244  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Interest expense

           

Interest expense on interest-bearing borrowings

    (442,661,324     (1,401,191,685     (223,382,917     (226,604,844     (467,238,302     (74,488,777

Interest expense on amounts due to related parties

    —         (8,714,000     (1,389,217     (296,000     —         —    

Total interest expense

    (442,661,324     (1,409,905,685     (224,772,134     (226,900,844 )      (467,238,302 )      (74,488,777
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net interest and fees income

    800,884,505       2,000,542,084       318,933,470       397,600,791       598,095,339       95,350,467  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Provision for credit losses

    (111,362,044     (306,752,951     (48,903,637     (41,891,522     (143,547,335     (22,884,822

Net interest and fees income after provision for credit losses

    689,522,461       1,693,789,133       270,029,833       355,709,269       454,548,004       72,465,645  

Realized gains/(losses) on sales of investments, net

    66,878,501       (11,527,798     (1,837,802     (1,474,014     709,808       113,160  

Other-than-temporary losses on available-for-sale investments

    (36,692,695     —         —         —         —         —    


 

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    For the Year Ended December 31,     For the Three Months Ended March 31,  
    2016     2017     2017     2018  
    RMB     RMB     US$     RMB     RMB     US$  

Other revenue, net

    36,261,933       23,979,610       3,822,914       4,704,502       843,097       134,409  

Total non-interest revenue

    66,447,739       12,451,812       1,985,112       3,230,488       1,552,905       247,570  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating expenses

           

Employee compensation and benefits

    (299,225,819     (545,956,248     (87,038,269     (109,503,389     (117,113,556     (18,670,656

Share-based compensation expense

    —         (182,689,766     (29,125,046     (45,672,441     (9,928,792     (1,582,883

Taxes and surcharges

    (48,207,495     (38,835,933     (6,191,361     (10,958,462     (14,512,100     (2,313,570

Rental and property management expenses

    (24,404,690     (47,896,817     (7,635,879     (9,108,676     (14,055,902     (2,240,841

Impairment of goodwill

    (20,279,026     —         —         —         —         —    

Offering expenses

    —         —         —         —         (4,659,577     (742,846

Other expenses

    (75,807,908     (82,194,556     (13,103,746     (16,132,637     (19,907,912     (3,173,789

Total operating expenses

    (467,924,938     (897,573,320     (143,094,302     (191,375,605     (180,177,839     (28,724,586
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income before income tax

    288,045,262       808,667,625       128,920,643       167,564,152       275,923,070       43,988,628  

Income tax expense

    (52,603,423     (275,994,868     (44,000,075     (55,522,454     (79,176,187     (12,622,547

Net income

    235,441,839       532,672,757       84,920,568       112,041,698       196,746,883       31,366,082  

Earnings per share

           

Basic

    0.19       0.43       0.07       0.09       0.16       0.03  

Diluted

    0.19       0.40       0.06       0.09       0.15       0.02  

Other comprehensive income/(loss)

           

Net unrealized (losses)/gains on available-for-sale investments

    (194,680,052     (2,601,355     (414,717     (5,263,991     36,148       5,763  

Foreign currency translation adjustment

    (778,538     (198,794     (31,692     4,903       26,784       4,270  

Comprehensive income

    39,983,249       529,872,608       84,474,159       106,782,610       196,809,815       31,376,114  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 


 

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Consolidated Balance Sheet Data

The following table presents our selected consolidated balance sheet data as of December 31, 2016 and 2017 and March 31, 2018, respectively.

 

    As of December 31,     As of March 31,  
    2016     2017     2018  
    RMB     RMB     US$     RMB     US$  

Selected Consolidated Balance Sheet:

         

Cash and cash equivalents

    233,138,588       1,190,360,385       189,771,448       1,467,458,484       233,947,404  

Loans principal, interest and financing service fee receivables (net of
allowance)

    7,261,467,762       16,261,167,957       2,592,412,709       16,195,952,927       2,582,015,899  

Other assets(1)

    311,751,130       764,337,148       121,853,322       504,121,252       80,368,787  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total assets

    7,806,357,480       18,215,865,490       2,904,037,479       18,167,532,663       2,896,332,089  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Interest-bearing borrowings(2)

    6,293,027,316       15,707,936,178       2,504,214,549       15,389,774,201       2,453,492,045  

Other liabilities(3)

    394,643,746       676,680,520       107,878,793       739,771,063       117,936,910  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total liabilities

    6,687,671,062       16,384,616,698       2,612,093,342       16,129,545,264       2,571,428,955  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total shareholders’ equity

    1,118,686,418       1,831,248,792       291,944,137       2,037,987,399       324,903,134  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

Notes:

(1) Represents the sum of (i) available-for-sale investments, (ii) property and equipment, (iii) intangible assets and goodwill, (iv) deferred tax assets, (v) deposits and (vi) other assets as presented in our consolidated balance sheet.
(2) Represents the sum of (i) borrowings under agreements to repurchase and (ii) other borrowings.
(3) Represents the sum of (i) accrued employee benefits, (ii) amount due to related parties, (iii) income tax payable, (iv) deferred tax liabilities and (v) other liabilities as presented in our consolidated balance sheet.

Consolidated Cash Flow Data

The following table presents our selected consolidated cash flow data for the years ended December 31, 2016 and 2017 and for the three months ended March 31, 2017 and 2018, respectively.

 

    For the Year Ended December 31,     For the Three Months Ended March 31,  
    2016     2017     2017     2018  
    RMB     RMB     US$     RMB     RMB     US$  

Selected Consolidated Cash Flow:

           

Net cash provided by operating activities

    379,883,655       1,286,649,584       205,122,212       232,861,180       282,558,417       45,046,459  

Net cash (used in)/provided by investing activities

    (4,700,415,345     (9,583,892,655     (1,527,897,946     (1,654,631,509     252,630,604       40,275,261  

Net cash provided by/(used in) financing activities

    4,291,087,461       9,256,740,263       1,475,742,158       1,909,076,302       (257,891,696     (41,114,003

Net (decrease)/increase in cash and cash equivalents

    (29,444,229     959,497,192       152,966,424       487,305,973       277,297,325       44,207,717  


 

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    For the Year Ended December 31,     For the Three Months Ended March 31,  
    2016     2017     2017     2018  
    RMB     RMB     US$     RMB     RMB      US$  

Cash and cash equivalents at beginning of the period

    260,081,796       233,138,588       37,167,775       233,138,588       1,190,360,385        189,771,448  

Effect of exchange rate change on cash and cash equivalents

    2,501,021       (2,275,395     (362,751)       (218,159)       (199,226)        (31,761)  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Cash and cash equivalents at end of the period

    233,138,588       1,190,360,385       189,771,448       720,226,402       1,467,458,484        233,947,404  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Non-GAAP Financial Measure

Adjusted Net Income

We use adjusted net income, a non-GAAP financial measure, in evaluating our operating results and for financial and operational decision-making purposes. We believe that adjusted net income helps identify underlying trends in our business by excluding the impact of share-based compensation expenses, which are non-cash charges. We believe that adjusted net income provides useful information about our operating results, enhances the overall understanding of our past performance and future prospects and allows for greater visibility with respect to key metrics used by our management in its financial and operational decision-making.

 

     For the Year Ended December 31,      For the Three Months Ended March 31,  
     2016    2017      2017    2018  
     RMB    RMB    US$      RMB    RMB      US$  

Adjusted net income

   235,441,839    715,362,523      114,045,615      157,714,139      206,675,675        32,948,965  
  

 

  

 

  

 

 

    

 

  

 

 

    

 

 

 

Adjusted net income is not defined under U.S. GAAP and is not presented in accordance with U.S. GAAP. This non-GAAP financial measure should not be considered in isolation from, or as a substitute for, its most directly comparable financial measure prepared in accordance with U.S. GAAP. A reconciliation of the historical non-GAAP financial measure to its most directly comparable GAAP measure has been provided in the tables included below. Investors are encouraged to review the reconciliation of the historical non-GAAP financial measure to its most directly comparable GAAP financial measure. As adjusted net income has material limitations as an analytical metric and may not be calculated in the same manner by all companies, it may not be comparable to other similarly titled measures used by other companies. In light of the foregoing limitations, you should not consider adjusted net income as a substitute for, or superior to, net revenues prepared in accordance with U.S. GAAP. We encourage investors and others to review our financial information in its entirety and not rely on a single financial measure.

The following table reconciles our adjusted net income for the periods presented to the most directly comparable financial measure calculated and presented in accordance with U.S. GAAP, which is net income.

 

     For the Year Ended December 31,      For the Three Months Ended March 31,  
     2016      2017      2017      2018  
     RMB      RMB      US$      RMB      RMB      US$  

Net income

     235,441,839        532,672,757        84,920,568        112,041,698        196,746,883        31,366,082  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Add: share-based compensation expenses

     —          182,689,766        29,125,046        45,672,441        9,928,792        1,582,883  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Adjusted net income

     235,441,839        715,362,523        114,045,615        157,714,139        206,675,675        32,948,965  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 


 

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Table of Contents

Key Operating Data

The following table presents our funding capital by sources, loan origination volume, outstanding loan principal, number of active borrowers and number of transactions by funding model for home equity loans as of the dates or for the periods indicated.

 

     As of December 31,      As of March 31,  
Funding capital by sources    2016      2017      2018  
   Amount
(RMB
in
millions)
     % of total      Amount
(RMB
in
millions)
     % of total      Amount
(RMB
in

millions)
     % of total  

Trust lending

                 

Senior tranche

     5,169        71.4      11,504        69.5      11,169        69.0

Subordinated tranche

                 

Own funds

     1,929        26.6      1,413        8.5      1,130        7.0

Transferred to third parties

     —          —          3,213        19.4      3,672        22.7

Direct lending

                 

Own funds

     —          —          50        0.3      50        0.3

Transferred to third parties

     141        1.9      366        2.2      168        1.0

Total

     7,239        100.0      16,547        100.0      16,189        100.0

 

     For the Year Ended December 31,     For the Three Months
Ended March 31,
 
     2016     2017     2018  
   Amount
(RMB in
millions)
     % of total     Amount
(RMB in
millions)
     % of total     Amount
(RMB in
millions)
     % of total  

Loan origination volume by funding model

               

Trust lending

     7,809        94.1     16,281        95.4     2,196        99.7

Direct lending

     486        5.9     789        4.6     6        0.3
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total loan origination volume

     8,295        100.0     17,071        100.0     2,201        100.0
     As of December 31,     As of March 31,  
     2016     2017     2018  
   Amount
(RMB in
millions)
     % of total     Amount
(RMB in
millions)
     % of total     Amount
(RMB in
millions)
     % of total  

Outstanding loan principal by funding model

               

Trust lending

     7,014        95.1     15,941        95.6     16,078        96.1

Direct lending

     361        4.9     733        4.4     650        3.9
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total outstanding loan principal

     7,375        100.0     16,674        100.0     16,728        100.0

 

     As of December 31,     As of March 31,  
     2016     2017     2018  
     Number of
active
borrowers
     % of total     Number of
active
borrowers
     % of total     Number of
active
borrowers
     % of total  

Number of active borrowers by funding model

               

Trust lending

     13,140        92.9     25,446        96.7     26,378        97.2

Direct lending

     1,007        7.1     880        3.3     769        2.8
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total number of active borrowers

     14,147        100.0     26,326        100.0     27,147        100.0


 

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Table of Contents
     For the Year Ended December 31,     For the Three Months
Ended March 31,
 
     2016     2017     2018  
     Number of
transactions
     % of total     Number of
transactions
     % of total     Number of
transactions
     % of total  

Number of transactions by funding model

               

Trust lending

     13,606        95.3     25,509        96.8     4,070        99.8

Direct lending

     676        4.7     842        3.2     10        0.2
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total number of transactions

     14,282        100.0     26,351        100.0     4,080        100.0


 

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RISK FACTORS

You should consider carefully all of the information in this prospectus, including the risks and uncertainties described below and our consolidated financial statements and related notes, before making an investment in our ADSs. Any of the following risks and uncertainties could have a material adverse effect on our business, financial condition, results of operations and prospects. The market price of our ADSs could decline significantly as a result of any of these risks and uncertainties, and you may lose all or part of your investment.

Risks Related to Our Business

We have a limited operating history and our business practice continues to evolve, which makes it difficult to evaluate our future prospects.

We commenced our loan service business in 2006 and adopted our current business model in 2014. We have a limited operating history in the home equity loan market, especially in some aspects of our business operations, such as loan facilitation service and collateral management service, credit analysis and the development of cooperative relationships with funding partners and other business partners. Our ability to continuously attract borrowers and funding sources is critical to our business. We may from time to time introduce new loan services and products, make adjustments to our existing loan facilitation services and products and our risk management system, or make adjustments to our business operations in general.

The regulatory framework for China’s home equity loan market is evolving and may remain uncertain for the foreseeable future. If our business practices or the business practices of our trust company partners are challenged under any PRC laws or regulations, our business, financial condition, results of operations and prospects would be materially and adversely affected. From time to time we may refine existing commercial arrangements in our business operations to comply with changing regulatory focuses. Starting in November 2017, China Foreign Economy and Trade Trust Co., Ltd. (“FOTIC”), one of our primary trust company partners, amended its loan agreements with borrowers to add an option for FOTIC to demand payment of outstanding loan principal and interests before the maturity of the underlying trust funding. Starting in March 2018, we have been working with FOTIC to implement certain changes to our top-up arrangements (the “2018 FOTIC Funding Arrangements”) and performance-based service fee structure (the “2018 FOTIC Service Fee Structure”). For details, please refer to “Business—Our Funding Model—Credit Strengthening Services.” Unfavorable reception of the new business arrangements by potential borrowers could have a material adverse impact on our business, results of operations, financial condition and cash flows. We may face the risk of increased borrower complaints, potential supervision, examinations or enforcement actions by regulatory agencies and/or penalties for violation of financial regulations and other applicable laws and regulations. We may not be able to successfully address the risks and difficulties associated with the new business arrangement, which could materially harm our business and operating results. The modifications to our business arrangements may also increase the complexity of our business and may present new and significant challenges, as well as strains on our management, personnel, operations, systems, technical performance and financial resources. As a result, past performance of our practice does not necessarily indicate our future prospects and performance. Such past performance may or may not be sustained in the future.

You should consider our business and prospects in light of the risks and challenges we encounter or may encounter given the rapidly evolving market in which we operate and our limited operating history in this particular market. These risks and challenges include, among other things, our ability to:

 

    offer customized and competitive loan services and products;

 

    increase the utilization of our loan services by existing borrowers as well as new borrowers;

 

    maintain low delinquency ratios of loans originated by us;

 

    achieve an effective and efficient collection and foreclosure process to recover delinquent loans on behalf of our trust company partners in the event of loan default;

 

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    develop sufficient, diversified, cost-efficient and reputable funding sources;

 

    broaden our prospective borrower base;

 

    navigate through a complex and evolving regulatory environment;

 

    improve our operational efficiency;

 

    promote standardized and disciplined operational procedures in local offices;

 

    attract, retain and motivate talented employees to support our business growth;

 

    maintain and enhance relationships with our business partners;

 

    enhance our technology infrastructure to support the growth of our business and maintain the security of our system and the confidentiality of the information provided and utilized across our system;

 

    navigate economic condition and fluctuation; and

 

    defend ourselves against legal and regulatory actions.

Our historical credit enhancement arrangements to our trust company partners might be subject to challenges by relevant regulatory authorities, and we may potentially be required to obtain licenses.

Under our historical credit enhancement arrangements with our trust company partners, we are required to make payments for loan principal and interests that are in default. Under the 2018 FOTIC Funding Arrangements, our historical credit enhancement arrangements with FOTIC trust plans will be limited to existing loans and loans to be issued under existing trust products. We plan to implement similar changes for arrangements we have with our other trust company partners.

China Banking Regulatory Commission (“CBRC”), National Development and Reform Commission, Ministry of Industry and Information Technology, Ministry of Finance, Ministry of Commerce, the People’s Bank of China (“PBOC”), and the State Administration for Industry and Commerce jointly released Tentative Measures for the Administration of Financing Guarantee Companies on March 8, 2010 (“Tentative Measures”) and the State Council released Regulation on the Supervision and Administration of Financing Guarantee Companies on August 2, 2017, effective on October 1, 2017 (“Regulation on Financing Guarantee Companies”), both of which stipulate that no entity or individual may conduct the financing guarantee business without the approval of the relevant regulatory authorities. We do not charge any fees directly with respect to credit enhancement service and we do not hold qualifications for providing financing guarantee as a loan service provider. It is unclear whether our historical credit enhancement arrangements would be deemed as providing financing guarantee under PRC laws and regulations. As of the date of this prospectus, we have not been subject to any fines or penalties under the aforementioned regulations with respect to our historical credit enhancement arrangements. If we are deemed to be providing a financing guarantee without required licenses, we may be subject to penalties such as correction order, fines of up to RMB1 million and suspension of business, which could materially and adversely affect our business.

Furthermore, according to the Notice on the Regulation and Rectification of the “Cash Loan” Business (“Circular 141”) issued by the Internet Finance Rectification Office and the Online Lending Rectification Office, a banking financial institution or the like (including trust companies) shall not accept any credit enhancement service, loss-bearing commitment or any other credit enhancement service provided by any third-party institution without qualifications for providing guarantees when cooperating with them in lending businesses. Our PRC legal advisor, Han Kun Law Offices, advises us that it is uncertain whether Circular 141 would apply to us. Nevertheless, if we are deemed to be subject to and our collaboration with funding partners is deemed to be in violation of Circular 141, our funding partners could be subject to penalties, including suspension or termination of such credit enhancement arrangements with us, which may disincentivize our funding partners from future collaboration with us and could have a material adverse effect on our source of funding and results of operations.

 

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As of the date of this prospectus, we have not been subject to any fines or penalties under any PRC laws or regulations with respect to our historical credit enhancement arrangements. We cannot assure you that the regulatory authorities will not impose, among other things, regulatory warning, correction order, condemnation, fines or suspension of business license on us in the future because of our historical credit enhancement arrangements. Any of these actions by the regulatory authorities may have a material adverse effect on our business and results of operations.

Our trust company partners operate in a strictly regulated industry. If the practice of our trust company partners, including the cooperation arrangements with us, is challenged under any PRC laws and regulations, our business, financial condition and results of operations would be materially and adversely affected.

We provide home equity loan service to borrowers primarily through collaboration with our trust company partners. Our trust company partners operate in a highly regulated industry and, as a result, are required to comply with a wide array of laws and regulations that are continually evolving. If our collaboration arrangement is deemed to violate any of these laws and regulations, we may be required to make significant changes to our business arrangements. These changes may have a material adverse impact on our business, results of operations and financial condition and may not be implemented successfully.

According to Opinions of the General Office of the CBRC on Further Strengthening the Work of Supervising the Risks of Trust Companies, all local CBRC offices shall strengthen the analysis of the sources, durations and structure of the use of trust products’ funds, especially where the funds are open trust products issued in installments and are mismatched with the maturity date of its uses. All local CBRC offices shall (i) strengthen the screening and disposal of non-standard capital pool trusts, (ii) urge trust companies to dispose of existing, non-standard capital pools, (iii) prohibit the establishment of new non-standard capital pools, and (iv) submit monthly reports on the implementation of screening plans of non-standard capital pools, until standards are met. Capital pool is not a legal term defined under the PRC laws and regulations. Both standard capital pool and non-standard capital pool are strictly regulated. The major differences between standard capital pool and non-standard capital pool are qualification of investors and investees. Non-standard capital pool generally refers to the capital pool which mainly invests in non-standardized assets. Non-standardized assets include non-standardized debt assets and non-standardized equity assets, and only non-standardized debt assets are relevant to our business. Non-standardized debt assets generally refer to the debt assets with information disclosed only among trading parities and without public pricing. Only qualified investors are allowed to invest in non-standardized debt assets. Our trust company partners acquire funding primarily through trust products set up under various trust plans with a term of one to three years, while the loans we facilitate have tenors ranging from one to eight years. For details of matching of our funding sources and loan products we facilitate, please refer to “Business—Our Funding Model—Matching of Terms of Funding Sources and Loans.” Our trust company partners allocate committed funds from the trust plan accounts among approved borrowers, which could be viewed as creating a mismatch between an investor’s expected timing of exit and the maturity date of the loan. For details, please refer to “—Risks Related to Our Business—Loan products we facilitate may potentially be deemed as having a duration mismatch with underlying funding sources. We and our trust company partners may need to take additional measures to reduce any risks associated with the mismatch, which could materially and adversely affect our business and results of operations.” We do not have specific knowledge on whether our trust company partners are compliant with the foregoing regulation and relevant applicant laws and regulations when they are handling the payment by the borrowers and the payment to unit holders in trust plans. If our trust lending model is deemed as creating a duration mismatch, we may be required to make adjustments to our business practice and our source of funding, results of operations and financial condition may be materially and adversely impacted.

As part of continuous effort to comply with evolving laws and regulations, FOTIC, one of our primary trust company partners, amended the terms of their loan agreements with borrowers starting from November 2017 (the “2017 FOTIC Loan Agreement”). We have been working with FOTIC to further redesign our funding models to improve duration match of funding. Going forward, we will implement measures together with our trust company partners to ensure duration match of funding and loan products.

 

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Our trust company partners are also subject to other laws and regulations. For example, according to the Measures for the Administration of Trust Companies’ Trust Plans of Assembled Funds issued by the CBRC, trust companies may not provide loans in excess of 30% of the paid-in balance of all the trust plans under its management. It is our trust company partners’ responsibility to comply with these regulations and we have no specific knowledge as to whether our trust company partners are in compliance. We cannot assure you that our trust company partners have been in compliance at all times. As of the date of this prospectus, we are not aware of any material concerns under this regulation. However, we cannot assure you that relevant regulatory authorities would hold the same view, or impose additional restrictions on our trust company partners’ businesses. This regulation may limit our access to funding from our trust company partners in the future, which may have a material adverse impact on our source of funding and results of operations.

As of the date of this prospectus, we are not aware of any of our trust company partners being or having been subject to any material fines or penalties under any PRC laws or regulations for noncompliance as a result of their collaboration arrangements with us. We and our trust company partners have been in frequent communication with the governmental authorities to clarify the relevant regulatory requirements and to ensure that our collaboration is in full compliance with the laws and regulations. While we believe we currently are in compliance with existing PRC regulations, including Circular 141, in all material aspects, we cannot assure you that the PRC government authorities would agree with our interpretation of the relevant regulations. It is also possible that new laws and regulations may be adopted which, along with any possible changes needed to fully comply with any existing or newly released regulations, could require us to further modify our business or operations. The cost to comply with such laws or regulations would increase our operating expenses, and modifications of our business may have a material and adverse impact on our business, financial condition and results of operations. If any of our trust company partners are deemed to violate any laws, regulations and rules, they may face, among other things, regulatory warning, correction order, condemnation, fines, suspension of business license and criminal liability, which may have a material adverse impact on our funding source and results of operations.

Our business may be adversely affected if we are unable to secure funding on terms acceptable to us or our borrowers, or at all.

We fund most of the loans we originate through our trust company partners. Loans funded by our trust company partners are disbursed to borrowers directly through trust plans. 94.1%, 95.4% and 99.7% of our home equity loan origination volume was funded under trust lending model in 2016, 2017 and the three months ended March 31, 2018, respectively.

The availability of funding from our trust company partners depends on many factors, such as the availability of investors on their platforms and general economic conditions, change of regulatory requirements, actual and expected delinquency ratios compared to alternative opportunities, some of which are out of our control. Our trust company partners may seek to acquire borrowers independently or through other third parties. They may also develop their own credit analysis systems or use credit analysis services provided by other third parties, and as a result discontinue cooperating with us. In addition, our trust company partners may not be able to adapt their compliance practices with the evolving financial institution licensing and other regulations in the PRC. As a result, our ability to cooperate with our existing trust company partners may be subject to regulatory or other limitations. See “—Risks Related to Our Business—Some of our funding sources are highly regulated and are subject to the changing regulatory environment. If any of the funding sources is deemed to violate the PRC laws and regulations, we may need to secure new funding, failure of which may result in material and adverse impact on our business, financial condition, results of operations and prospects.”

As our business grows, we may need to obtain new funding sources or require current funding partners to increase the amount of funding provided. If there is a sudden or unexpected shortage of funds from our trust company partners or if we fail to maintain or develop relationships with our existing trust company partners or new funding partners, we may not be able to maintain necessary levels of funding without agreeing to less

 

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favorable terms, or at all. We may not be able to arrange additional, new or alternative methods of funding on favorable terms, or at all, or ensure that our cooperation with new funding partners will meet our expectations and the expectations of borrowers.

Additionally, if there is an unexpected scale of decrease in subordinated units due to a higher NPL ratio, we may not be able to arrange additional capital to increase our subordinated units contribution to satisfy the contractual structural leverage ratio as required by the subordinated units subscription agreement. If we are unable to secure sufficient funding on terms acceptable to us and our borrowers, or at all, we may not be able to provide attractive products and services to our borrowers, and our business, financial condition and results of operations may be materially and adversely affected.

In May 2018, FOTIC established Jinghua Structure Fund 27. As of June 30, 2018, Fanhua Inc., who holds 20.58% of our shares through CISG Holdings Ltd., and its subsidiaries subscribed to all of the senior units of Jinghua Structure Fund 27, which amounted to approximately RMB138 million. We subscribed to all of the subordinated units of Jinghua Structure Fund 27, which amounted to approximately RMB15.4 million. For details, please refer to “Related Party Transactions—Other Related Party Transactions.” To the extent that Fanhua Inc. and its subsidiaries subscribe to a large number of senior units, our reliance on them for incremental liquidity will increase over time, which may change our risk profile. We cannot assure you that Fanhua Inc. and its subsidiaries will continue to subscribe to the senior units of the trust plans set up by our trust company partners in the future. If funding from their subscription decrease, we may not be able to secure additional funding on terms acceptable to us, or at all.

Loan products we facilitate may potentially be deemed as having a duration mismatch with underlying funding sources. We and our trust company partners may need to take additional measures to reduce any risks associated with the mismatch, which could materially and adversely affect our business and results of operations.

The Guiding Opinion on Regulating the Asset Management Business of Financial Institutions (the “Guiding Opinion”) was issued by PBOC, together with China Banking and Insurance Regulatory Commission (“CBIRC”), China Securities Regulatory Commission (“CSRC”) and State Administration of Foreign Exchange on April 27, 2018. According to the Guiding Opinion, in order to reduce the risk of duration mismatch, the expiration date of closed-end asset management products, or the last open day of open-end asset management products, shall not be earlier than the termination date of the non-standard creditor’s assets the asset management products invested in directly or indirectly. The Guiding Opinion further prohibits the rolling issuance of a series of assets management products that enables the transfer of the principal, expected investment return and risks among different investors, which will be deemed as rigid payment to guarantee the principal and expected investment return of the product.

Under our trust lending model, the trust products set up under long-term trust plans usually have a term of one to three years while the loans we facilitate have tenors typically ranging from one to eight years. Once a trust product matures, the trustee is required to repay the expected investment return and principal to the senior unit holders. Under our credit strengthening services, we are required to make up for any shortfalls if the proceeds from loans are less than the principal amount invested by the senior unit holders and the agreed financing costs for the senior units which primarily consist of expected rate of investment return to the senior unit holders. Under these circumstances, our trust company partners will employ various measures to meet payment obligations under the maturing trust products while the loans funded thereunder remain outstanding, and may require us to contribute additional funding under our credit strengthening arrangements. For details of matching our funding sources and loan products we facilitate, please refer to “Business—Our Funding Model—Matching of Terms of Funding Sources and Loans.”

Under the 2017 FOTIC Loan Agreement, FOTIC has an option to demand repayment of outstanding loan principal and unpaid accrued interests before the maturity of the underlying trust funding, to match outstanding

 

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terms of the trust products that FOTIC set up for lending to the borrowers. As of the date of this prospectus, we have not received any notice or been made aware of any issues or concerns raised by the regulatory authorities on our business arrangements. As detailed implementation rules or regulations to the Guiding Opinion have yet to be promulgated, we cannot assure you that the regulatory authorities hold the opinion that our business arrangements are in compliance with the aforesaid regulation. Our business arrangements may be subject to challenges by regulatory authorities. As such, FOTIC and our other trust company partners may need to further modify their loan agreements with the borrowers and our collaboration arrangement with them, which could materially and adversely affect our business and results of operations.

Furthermore, if the borrowers are unable to repay FOTIC loans in time because of the accelerated payment schedule caused by option exercise because of the significant size of the accelerated lump sum payment, we may experience increase in our delinquency ratio, which could in turn result in a material adverse effect on our business and results of operations. Our trust company partners may have to utilize alternative funding to alleviate this issue. We cannot guarantee you, however, that such funding will always be available on acceptable terms, if at all. We may be required to contribute additional funding under our credit strengthening services, which may have a material adverse effect on our business and results of operations.

We provide credit strengthening services to the trust plans as the subordinated units holder, which may be subject to challenges by regulatory authorities.

Under the 2018 FOTIC Funding Arrangements and the arrangements we have with other trust company partners, we, as the subordinated unit holder, are required to provide certain credit strengthening services. For details, please refer to “Business—Our Funding Model—Credit Strengthening Services.”

The Guiding Opinion unifies the requirements and standards for various types of asset management products previously regulated by different regulatory authorities. The Guiding Opinion provides, among others, unified qualifications for investors, prudent operation principles of financial institutions, business isolation and independent custody. The Guiding Opinion prohibits direct or indirect guarantee for the principal and expected investment return of the senior unit holders of structural asset management products, which may impose restrictions on the structural arrangements we have with our trust company partners. However, the Guiding Opinion is relatively new and its interpretation and application remains uncertain. Our credit strengthening arrangements may be deemed as indirectly guaranteeing senior unit holders’ principal and expected investment return on the investments. As such, we may be required to further modify such arrangements with the trust plans, which could materially and adversely affect our business. As of the date of this prospectus, we have not received any notice or been made aware of any issues or concerns raised by regulatory authorities on our credit strengthening arrangements. We cannot guarantee you, however, that the regulatory authorities will hold the opinion that our credit strengthening arrangements are in compliance with the relevant regulations.

The Guiding Opinion provides a grace period by the end of 2020. During the grace period, new products issued by the financial institutions shall be subject to the Guiding Opinion, and existing products not in compliance with the Guiding Opinion shall be gradually phased out. After the grace period, financial institutions shall not issue or renew any asset management products not in compliance with the Guiding Opinion.

Our trust company partners may need to lower the structural leverage ratio of the trust plans which could materially and adversely affect our business.

The Guiding Opinion sets a limit on the contractual structural leverage ratio which is calculated as the total amount of senior units divided by subordinate units, and intermediate units shall be included as senior units for the purpose of this calculation. For a fixed-income product, the structural leverage ratio shall not exceed 3:1. The contractual structural leverage ratio of the trust plans or products set up by our trust company partners is determined pursuant to our collaboration agreements with them, which set the upper limit to such ratio at a range of 3:1 to 9:1. As of March 31, 2018, the actual structural leverage ratio of our trust plans was generally lower

 

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than 3:1. For details, please refer to “Business—Our Funding Model—Terms of the Trust Plans” and “—Funding Partners.”

Our trust company partners may need to modify the collaboration agreements with us in order to comply with the foregoing structural leverage ratio limit requirement. As such, we may need to contribute additional funding to maintain a lower structural leverage ratio and our overall cost of funding may increase, which could materially and adversely affect our business.

Our concentration of funding provided by our trust company partners may have a material adverse effect on our financial condition, liquidity and results of operations, if we lose any of our trust company partners either as a result of its decision to acquire services from our competitors or otherwise.

94.1%, 95.4% and 99.7% of our total home equity loan origination volume was funded under trust lending model in 2016, 2017 and the three months ended March 31, 2018, respectively. Among the loans originated through our trust lending model, 98.4%, 87.3% and 83.0% were funded through FOTIC trust plans in 2016, 2017 and the three months ended March 31, 2018, respectively. Although we have longstanding relationship with our trust company partners, there is no certainty as to the continuation of the relationships between our trust company partners and us. We endeavor to diversify our funding source but there is no assurance that we will be successful. The loss of any of our trust company partners, whether as a result of its decision to acquire services from our competitors, or otherwise, would have a material adverse effect on our financial condition, liquidity and results of operations.

Any lack of requisite approvals, licenses or permits applicable to our business may have a material and adverse impact on our business, financial condition and results of operations.

Our business is subject to governmental supervision and regulation by the relevant PRC government authorities. Together, these government authorities promulgate and enforce regulations that cover many aspects of the operation of the home equity loan and finance industries. For details, please refer to “Regulation.” Our PRC legal advisor, Han Kun Law Offices, advises us that our businesses do not need special approvals or licenses, other than our small loan business and subject to “—Risks Related to Our Business—Our historical credit enhancement arrangements to our trust company partners might be subject to challenges by relevant regulatory authorities, and we may potentially be required to obtain licenses.” We are further advised that these opinions are subject to uncertainties and the regulatory authorities may hold a different view. As of the date of this prospectus, all of our small loan subsidiaries have obtained such approvals or licenses.

Some of our funding sources are highly regulated and are subject to the changing regulatory environment. If any of the funding sources is deemed to violate the PRC laws and regulations, we may need to secure new funding failure of which may result in material and adverse impact on our business, financial condition, results of operations and prospects.

We have multiple funding sources to support our business model, including funding sources that are highly regulated. Although we may or may not be subject to any direct material fines or penalties from the relevant regulatory authorities, if our funding sources are deemed to violate any relevant regulations in collaboration with us directly or indirectly, our business, financial condition, results of operations and prospects would be materially and adversely affected.

According to Circular 141, an Internet small loan company may not sell, transfer or substantively transfer its credit assets through Internet platforms or any local financial exchange, and any funds financed through transfer of credit assets or assets-backed securities shall be counted as on-balance-sheet financing when calculating the total financing/net capital ratio of the small loan company. Our small loan subsidiaries are not Internet small loan companies and according to the consultations with the local government financing bureaus, our small loan subsidiaries will not be subject to the restrictions solely applicable to Internet small loan companies. We fund our small loan direct lending business partially from listing rights to earnings to earnings in loans principal, interest

 

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and financing service fee receivables on Guangdong Financial Assets Exchange (the “Exchange”) before the promulgation of the Circular 141. Our PRC legal advisor, Han Kun Law Offices, advises us that we are not in violation of the restrictions under the aforesaid regulation. We are further advised that these opinions are subject to uncertainties and the regulatory authorities may hold a different view.

Historically, we listed certain rights to earnings to earnings in loans principal, interest and financing service fee receivables and rights to earnings in subordinated units on local financial exchanges. Such listed products were subsequently traded to Internet platforms and ultimately to third-party investors on such platforms. According to Notice on Strengthening the Rectification of Asset Management Business through the Internet and Carrying Out the Inspection and Acceptance Work issued by the Internet Finance Rectification Office (the “Internet Asset Management Notice”), an entity is not allowed to sell asset management products through an Internet platform without permits. An Internet platform shall not act as agency channel for any local financial exchange to distribute asset management products which are (i) prohibited to be sold by local financial exchanges or (ii) sold in restricted manners by local financial exchanges. As such, we plan to replace such funding model with funds from transfer of rights to earnings to earnings in loans principal, interest and financing service fee receivables to third parties either directly, such as to qualified private equity funds, or through other permitted means including trading on local financial exchanges without involving Internet platforms.

We subscribe to the subordinated units and therefore have rights to the residual earnings under such trust plans. We historically acquire certain funding for the subordinated units by transferring our right to earnings with a repurchase arrangement to private equity funds. According to the regulations on private equity funds, private equity funds shall no longer engage in loan business and starting from February 12, 2018, the Asset Management Association of China will no longer accept new product filings which are not within the permitted investment scope of private equity funds. Private equity funds filed before February 12, 2018 may continue to invest in loan business. Our private equity funding sources’ filing of products in collaboration with us were all accepted before February 12, 2018. Our PRC legal advisor, Han Kun Law Offices, advises us that such regulations have no material adverse effect on our funding model, as we may, under the realm of the regulatory framework, continue to work with our existing private equity funding channels and similar private equity funding channels whose products have been duly filed before February 12, 2018. We are further advised that these opinions are subject to uncertainties and the regulatory authorities may hold a different view. We cannot assure you that the registered channels can satisfy our financing needs, or that such regulations will not impose material restrictions on our future business operations as we continue to grow our business.

According to Notice of the China Banking Regulatory Commission on Relevant Issues concerning Regulating the Investment Operation of Wealth Management Business of Commercial Banks promulgated in March 2013 (the “Wealth Management Notice”), a commercial bank is subject to certain investment threshold of non-standardized debt assets. Neither our trust company partners nor we have specific knowledge on whether a commercial bank investing in the senior units is in compliance with the Wealth Management Notice. As of the date of this prospectus, we are not aware of noncompliance by commercial banks as senior unit holders. We cannot assure you, however, commercial banks as senior unit holders will be in compliance in the future. If commercial banks as senior unit holders violate the Wealth Management Notice, such violation will have a material adverse effect on our trust company partners’ funding sources and our business operations.

As of the date of this prospectus, we are not aware of any material fines or other penalties under any PRC laws or regulations with respect to the aforesaid funding resources. If our practice, or the practice of our funding partners in collaboration with us, is deemed to violate any laws, regulations and rules, we may face, among other things, regulatory warning, correction order, condemnation, fines, suspension of business license and criminal liability. If such situations occur, our business, financial condition, results of operations and prospects would be materially and adversely affected.

 

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We lack product and business diversification. Accordingly, our future operating income and earnings are more susceptible to fluctuations than a more diversified company.

Currently, our primary business activities include facilitating home equity loans and providing loan management services to borrowers and trust company partners and to a lesser extent, direct lending through our small loan subsidiaries. If we are unable to maintain and grow the operating income from our current business or develop additional revenue streams, our future operating income and earnings are not likely to grow and could decline. Our lack of product and business diversification could inhibit the opportunities for growth of our business and results of operations.

If we are unable to maintain or increase the amount of loans we originate or if we are unable to retain existing borrowers or attract new borrowers, our business and results of operations will be adversely affected.

To maintain and increase the amount of loans we originate, we must continue to engage our existing borrowers and attract new borrowers, both of which may be affected by several factors, including interest rates of loans we originate, our brand recognition and reputation, our loan services and products offered, our efficiency in operating offline branches and engaging prospective borrowers, the effectiveness of our credit analysis system, our ability to secure sufficient and cost-efficient funding, service fees we charge to trust plans, our borrower experience and the PRC regulatory environment. In addition, we acquire borrowers through our extensive national network, and we have also entered into agreements with our channel partners to utilize the Internet platforms or offline network they operate to engage some of our prospective borrowers. If these channels are less effective or less efficient than anticipated, if we are unable to continue to use these channels, or if we cannot expand our channel network, we may not be able to acquire or engage new and existing borrowers efficiently. In addition, we may also impose more stringent borrower qualifications to ensure the quality of the loans we facilitate, which may negatively affect the amount of loans we facilitate. If we are unable to attract borrowers or if borrowers do not continue to use our services, we may be unable to increase our loan origination volume and corresponding income, and our business and results of operations may be materially and adversely affected.

Our concentration in loans secured by real properties may increase our credit losses in times of deterioration in local or national property markets, which would negatively affect our financial results.

The home equity loans we facilitate are secured by residential or commercial properties in our market areas. As of March 31, 2018, 92.8% and 7.2%, of the outstanding loan principal for home equity loans we originated was secured by residential and commercial real properties.

A significant decrease of property values will cause an increase in LTV ratio, resulting in borrowers having little or negative equity in their property, which may reduce new loan originations and provide incentive to borrowers to strategically default on their loans. Risk of loan defaults and foreclosures are unavoidable in the home equity loan industry. We may be subject to such risks as we may be required to make payments under historical credit enhancement arrangements we provided to our trust company partners. Our historical credit enhancement arrangements with FOTIC will start phasing out in March 2018. However, our top-up arrangements to trust plans as a subordinated unit holder remain effective. We cannot fully eliminate credit risk, and as a result credit losses may occur in the future.

If we are unable to achieve low delinquency ratios for loans originated by us, our business and results of operations may be materially and adversely affected.

We may not be able to achieve low delinquency ratios for loans originated by us, or such delinquency ratios may be significantly affected by economic downturns or general economic conditions beyond our control and beyond the control of individual borrowers. The outstanding principal of home equity loans originated by us was RMB7,375 million, RMB16,674 million and RMB16,728 million as of December 31, 2016 and 2017 and March 31, 2018. The delinquency ratio for loans originated by us increased from 5.38% as of December 31, 2016 to 7.17% as of December 31, 2017 and further to 11.04% as of March 31, 2018. Our NPL ratio increased from

 

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1.50% to 1.66% and further to 1.75% as of the same respective dates. We experienced a significant increase in our delinquency ratio and NPL ratio in the first quarter of 2018, which was a result of changing market environment, slower growth of outstanding loan principal and longer collection process. For details, please refer to “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Loan Performance Data and Trend Analysis.” If we were to continue to experience increase in delinquency ratio or NPL ratio, we may not have sufficient capital resources to pay defaulted principals and interests to our trust company partners according to our historical credit enhancement arrangements or top-up arrangements. Our service fee charged to trust plans could also be significantly reduced under the 2018 FOTIC Service Fee Structure if this were to occur. Accordingly, our results of operations, financial position and liquidity could be materially and adversely affected. Furthermore, our borrower base continues to expand with the growth of our business operations, which may include loan applicants with lower creditworthiness. We may not be able to achieve low delinquency ratios for loans originated by us in the future, or return to the low delinquency ratio or NPL ratio we achieved in the past.

Our high leverage ratio may expose us to liquidity risk and we may not have sufficient capital reserve to manage losses.

As part of the collaboration we have with our trust company partners, we subscribe to subordinated units in trust plans through our subsidiaries and fund those units with (i) our own funds and (ii) funding from transferring our right to earnings in subordinated units to third parties. We transfer our right to earnings in subordinated units to third parties with a repurchase arrangement, which requires us to repurchase the right to earnings in subordinated units. For details of our repurchase agreements with third parties under the trust lending model, please refer to “Business—Our Funding Model—Funding Sources.” In 2016, 2017 and for the three months ended March 31, 2018, we transferred our right of earnings in subordinated units to a certain private equity fund and to a certain third party through a private financial assets trading platform. Our financing costs under such repurchase arrangement ranged from 16% to 18% per annum of the transfer prices in 2016, 2017 and for the three months ended March 31, 2018, and our financing costs under such repurchase agreements with a third party through a private financial assets trading platform ranged from 9.7% to 14% per annum of the transfer prices in 2016, 2017 and for the three months ended March 31, 2018. We are required to consolidate all of the results under trust plans on our consolidated financial statements, including those of the senior units. This consolidation is necessary as our trust lending model creates exposure to variability of returns from the activities of the trust plans.

We also operate direct lending business through our small loan subsidiaries. We finance our direct lending business with (i) our own funds and (ii) funds we receive from third parties by transferring our rights to earnings in loans principal, interest and financing service fee receivables to third parties together with a repurchase arrangement. Such repurchase arrangements require us to repurchase these rights to earnings at a fixed repurchase price within a specified period of time (generally within 360 days). The difference between the transfer price we receive and the fixed repurchase price is the effective financing costs for entering into repurchase arrangements. Our financing costs under such arrangements ranged from 9.7% to 14% per annum of the transfer prices in 2016, 2017 and for the three months ended March 31, 2018.

As a result of our funding model, we may be exposed to high leverage ratio. Our leverage ratio was 7.0 times, 9.9 times and 8.9 times as of December 31, 2016 and 2017 and as of March 31, 2018, respectively. Our high level of borrowings and leverage ratio may adversely affect our liquidity and business operations, including but not limited to increasing our vulnerability under adverse economic condition, potentially limiting our ability to raise more debt and increasing our exposure to interest rate fluctuation. Our business and results of operations also depend on our ability to secure cost-effective financing. The third parties to whom we transfer our right to earnings or small rights to earnings in loans principal, interest and financing service fee receivables may not continue to provide funding at rates acceptable to us, and we may not find alternative financing at similar rates, or at all.

If we continue to have a high leverage ratio, our exposure to liquidity risk may restrict our ability to make necessary capital expenditures or develop business opportunities in the future. For the credit strengthening services we provide, we may also be required to provide additional funding when there is an NPL in the loan

 

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portfolio. Due to this arrangement and our high leverage ratio, we may not have sufficient capital reserve to manage potential losses in the future, which may adversely affect our results of operations and financial positions. In addition, although we are not currently subject to any capital reserve requirement, we cannot assure you that the regulatory authority will not impose such requirements in the future, which may have a material adverse impact on our results of operations and financial positions due to our high leverage ratio.

If our risk management system fails to perform effectively, such failure may materially and adversely impact our operating results.

Credit assessment of our borrowers is conducted by our risk management system. Such system uses credit analysis and data from prospective borrowers and multiple external sources and might not be effective as we continue to increase the amount of transactions, expand the borrower base and broaden our borrower engagement efforts through different channels in the future. If our system is ineffective or if the credit analysis and data we obtained are incorrect or outdated, our risk management abilities could be negatively affected, resulting in incorrect recommendations or denials of loan applications or mispriced loan products. If we are unable to effectively and accurately assess the credit risks of borrowers or price loan products appropriately, we may be unable to offer quality services to our trust company partners or borrowers. Our risk and credit assessment may not be able to provide more predictive assessments of future borrower behavior or result in better evaluation of our borrower base when compared to our competitors. Pursuant to the terms of our collaboration agreements with trust company partners, trust company partners are ultimately responsible for approving the loans applications and we are not subject to any penalties for inaccurate risk assessment or mispriced loan products. However, we ultimately bear credit risk on loans we facilitate as we have payment obligations under our historical credit enhancement arrangements or credit strengthening arrangements. For details, please refer to “Business—Our Funding Model—Credit Strengthening Services.” In addition, our performance-based service fee and return under the subordinated units may be reduced as a result of increased NPLs. If our risk management system fails to perform effectively, our business and results of operations may be materially and adversely affected.

Our business depends on our ability to collect payment on and service the transactions we facilitate.

We offer post-loan management services to our trust company partners. We have implemented payment and collection policies and practices designed to optimize compliant repayment, while also providing superior borrower experience. Our collection process is divided into distinct stages based on the days of delinquency, which dictates the level of collection steps taken. For example, automatic reminders through text, voice and instant messages are sent to a delinquent borrower as soon as the collections process commences. Our collection team will also make phone calls to borrowers following the first missed payment and periodically thereafter. We may also resort to arbitration or litigation to recover delinquent loans or assign those loans to a third party and collect proceeds upfront. Despite our servicing and collection efforts, we cannot assure you that we will be able to collect payments on the transactions we facilitate as expected. As we are exposed to credit risks as the subordinated unit holder and also as a result of credit strengthening services we provide, our failure to collect payment on the transactions will have a material adverse effect on our business operations and financial positions. In addition, our collection team may not possess adequate resource and manpower to collect payment on and service the loans we facilitated. If we fail to adequately collect amounts delinquent or due, then our service fees charged to trust plans may be delayed or reduced and our results of operations will be adversely affected. As the amount of transactions facilitated by us increases in the future, we may devote additional resources into our collection efforts. However, there can be no assurance that we would be able to utilize such additional resources in a cost-efficient manner.

Moreover, the current regulatory regime for debt collection in the PRC remains unclear. Although we aim to ensure our collection efforts comply with the relevant laws and regulations in the PRC and we have established strict internal policies that our collections personnel shall not engage in aggressive practices, we cannot assure you that such personnel will not engage in any misconduct as part of their collection efforts. Any such misconduct by our collection personnel or the perception that our collection practices are considered to be aggressive and not compliant with the relevant laws and regulations in the PRC may result in harm to our reputation and business, which could further reduce our ability to collect payments from borrowers, lead to

 

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decrease in the willingness of prospective borrowers to apply for the home equity loans we facilitate, or fines and penalties imposed by the relevant regulatory authorities, any of which may have a material adverse effect on our results of operations.

If our allowance for loan losses is not sufficient to cover actual loan losses, our results of operations would be negatively affected.

Our business is subject to fluctuations based on local economic conditions. These fluctuations are neither predictable nor within our control and may have a material adverse impact on our operations and financial condition. In determining the amount of the allowance for loan losses, we analyze our loss and delinquency experience by loan categories and we consider the effect of existing economic conditions. In addition, we make various assumptions and judgments about the collectability of loan portfolios, including the creditworthiness of borrowers and the value of real properties serving as collateral for the repayment loans. If the actual results are different from our estimates, or our analysis is incorrect, our allowance for loan losses may not be sufficient to cover losses inherent in loan portfolio, which would require additions to allowance and would decrease our net income. Our emphasis on loan growth and on increasing portfolio, as well as any future loan deterioration, will require us to increase our allowance further in the future. Any increase in our allowance for loan losses or loan charge-offs as required by regulatory authorities may have a material adverse effect on our results of operations and financial condition.

Increases in market interest rates could negatively affect the amount of loans facilitated by us and cost of funds provided to borrowers.

Borrowers’ costs of borrowing mainly consist of interest rates. An increase in prevailing interest rates could result in an increase in the interest rates of loans we facilitate, and borrowers may be less likely to accept such adjusted terms. If borrowers decide not to use the products or services we offer because of such an increase in market interest rates, our ability to retain existing borrowers and engage prospective borrowers as well as our competitive position may be severely impaired. If we are unable to effectively manage such market interest rate risk, our business, profitability, results of operations and financial condition could be materially and adversely affected.

Our overall funding costs may fluctuate with market interest rates while the interest rates for existing loans are fixed during the terms of the loans. As a result, an increase in the market interest rates may negatively impact the availability and cost of our funding, which may have a material adverse impact on our profitability and results of operations.

We are involved in legal proceedings in the ordinary course of our business from time to time. If the outcomes of these proceedings are adverse to us, it could have a material adverse effect on our business, results of operations and financial condition.

We are involved in various legal proceedings in the ordinary course of business from time to time. In our opinion, based on the facts known at this time, the ultimate resolution of these ordinary course legal proceedings will not have a material adverse effect on our financial position or results of operations as a whole. However, no assurances can be given as to the outcome of any pending legal proceedings, which could have a material adverse effect on our business, results of operations and financial condition. For debt-collection purposes, we initiate legal proceedings against borrowers to recover payments that are delinquent for 30 days if we cannot reach agreement with the default borrowers by then. As of March 31, 2018, we had 289 collection legal proceedings pending before courts and arbitration tribunals with amounts in dispute of RMB278.6 million, where we or our trust company partners sued borrowers of such delinquent loans. We may not be able to obtain or enforce favorable judgments or arbitration awards, or recover the amounts in dispute in full or at all. Furthermore, claims arising out of actual or alleged violations of law could be asserted against us by individuals, governmental or other entities in civil, administrative or criminal investigations and proceedings. These claims could be asserted under a variety of laws

 

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and regulations, including but not limited to contract laws, online or private lending laws or regulations, consumer protection laws or regulations, intellectual property laws, information security and privacy laws, and labor and employment laws. For further details, see the section headed “Business—Legal Proceedings.” These actions could expose us to adverse publicity and to monetary damages, fines and penalties, as well as suspension or revocation of licenses or permits to conduct business. Even if we eventually prevail in these matters, we could incur significant legal fees or suffer reputational harm, which could have a material adverse effect on our business and results of operations as well as our future growth and prospects.

The foreclosure action and enforcement process may be time-consuming, difficult and uncertain for legal and practicable reasons, which could adversely affect our liquidity, business, financial condition and results of operations.

The home equity loans we facilitate are secured by collateral, normally residential or commercial real properties owned by borrowers. In the event that a borrower is in default and the payment is past due for over 30 days or upon the incurrence of unusual situations (such as forfeiture of the collateral), we may need to help our trust company partners initiate judicial or arbitration proceedings against the defaulting borrower and foreclose the real property collateral. Historically, we were able to help our trust company partners enforce their rights to the collaterals through a power of attorney that was signed by the borrower and notarized by a notary public before loan disbursement. This allowed the trust company partners to quickly dispose of the collaterals without having to involve the borrower. Due to recent regulatory development, we have ceased this practice. As a result, we may need to resort to judicial or arbitration proceedings more frequently to help our trust company partners foreclose on the collateral. The judicial or arbitration proceedings may be time-consuming and may not ultimately be possible. In addition, the enforcement process may be difficult in practice. Furthermore, the defaulting borrowers may have concealed, transferred or disposed of their assets beforehand, which make it difficult or impossible for us to apply for attachment. Moreover, if the attached assets are found to be subject to prior mortgage or other third parties’ rights during proceedings, our interests will be ranked behind these prior parties, thereby limiting or even preventing us from full coverage by the collateral. As a result, in case of defaults we may not be able to recover the full amount of loans and outstanding interests or at all, and in turn our liquidity, business, financial condition and results of operations could be adversely affected.

Credit and other information that we receive from prospective borrowers and third parties about a borrower and the collateral may not accurately reflect the borrower’s creditworthiness or the collateral’s fair/recoverable value, which may compromise the accuracy of our credit assessment.

For the purposes of credit risk assessment, we obtain from prospective borrowers and third parties certain information of the prospective borrowers or the prospective real property collateral, which may not be complete, accurate or reliable. A credit report on a borrower or prospective collateral generated by our third-party sources may not reflect that particular borrower’s actual creditworthiness or the prospective collateral’s actual market value because it may be based on outdated, incomplete or inaccurate information. Additionally, once we have obtained a borrower’s information, the borrower may subsequently (i) become delinquent in the payment of an outstanding obligation; (ii) default on a pre-existing debt obligation; (iii) take on additional debt; or (iv) sustain other adverse financial events, making the information we have previously obtained inaccurate. Such inaccurate or incomplete borrower information could compromise the accuracy of our credit assessment and adversely affect the effectiveness of our risk management, which could in turn harm our reputation, lower our service fees charged to trust plans, and as a result our business and results of operations could be materially and adversely affected.

We currently determine the preliminary market value of the prospective real property collateral using external databases at the time borrowers submit their loan applications. We also conduct site visits to cross-check conditions and verify information of the prospective real property collateral. In addition, we compare the preliminary third-party appraiser report with quotes on an anonymous basis from local real estate agencies in the same neighborhood. However, there is no assurance that we have complete and accurate information relating to

 

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the prospective real property collateral. If we overestimate market value of the real property collateral, the loans we facilitate may not be fully secured, which could affect the accuracy of our credit assessment and the effectiveness of our risk management. Therefore, our reputation, and as a result, our business and results of operations could be materially and adversely affected.

Our business operations may be negatively impacted if borrowers use loan proceeds to engage in activities prohibited or not encouraged by regulators.

Borrowers supply a variety of information that is included in the standardized loan applications prepared by us, including intended use of proceeds. We verify such information by conducting site visits and informal interviews. As our business continues to grow and our borrower base continues to expand, we might not have enough resources to continuously verify or monitor the information provided by the borrowers, such as intended use of loan proceeds. The loan agreements our borrowers enter into limit the use of proceeds to business operation purposes, not purchase of real property or consumption. The trust companies have the right to require early payment if proceeds were not used for business operation purposes. However, we cannot guarantee and may not effectively monitor that the loan is strictly used for business operating purposes. The borrower may use loan proceeds for other purposes with increased risk than as originally provided or use loan proceeds to engage in activities prohibited or discouraged by regulators. Such activities may harm our reputation and negatively impact our business operations.

Fraudulent activity could negatively impact our operating results, brand and reputation and cause the use of our loan facilitation services to decrease.

We are subject to the risk of fraudulent activity associated with borrowers, our trust company partners and third parties handling borrower information. Our resources, technologies and fraud detection tools may be insufficient to accurately detect and prevent fraud. Significant increases in fraudulent activity could negatively impact our brand and reputation, reduce the volume of loan transactions facilitated through us and lead us to take additional steps to reduce fraud risk, which could increase our costs. High-profile fraudulent activity could even lead to regulatory intervention, and may divert our management’s attention and cause us to incur additional expenses and costs. Although we have not experienced any material business or reputational harm as a result of fraudulent activities in the past, we cannot rule out the possibility that any of the foregoing may occur causing harm to our business or reputation in the future. If any of the foregoing were to occur, our results of operations and financial condition could be materially and adversely affected.

We are subject to credit cycle and the risk of deterioration of credit profiles of borrowers.

Our business is subject to the credit cycle associated with the volatility of the general economy. If economic conditions deteriorate, we may face increased risk of default or delinquency of borrowers, which will result in lower returns or losses. In the event that the creditworthiness of borrowers deteriorates or we cannot track the deterioration of their creditworthiness, the criteria we use for the analysis of borrower credit profiles may be rendered inaccurate, and our risk management system may be subsequently rendered ineffective. This in turn may lead to higher delinquency ratios and adverse impacts on our reputation, business, results of operations and financial positions.

Our current business model has a relatively large exposure to second lien mortgage.

In 2017 and for the three months ended March 31, 2018, loans secured by second lien interest accounted for 58.0% and 57.8% of our loan origination volume of home equity loans, respectively. For loans secured by second lien interests, our rights over the collateral will be subordinated to other secured creditors with higher priority. If the borrowers default, we may not be able to collect the full amount of our security interests in the collateral due to lien subordination. There is no assurance that we will be able to realize the value of the collateral as we anticipated in a timely manner, or at all. As a result, our business, financial condition, results of operations and prospects may be adversely affected.

 

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We primarily rely on our trust company partners to fund loans to borrowers, which may constitute provision of intermediary service, and our agreements with these trust company partners and borrowers may be deemed as intermediation contracts under the PRC Contract Law.

Under the PRC Contract Law, if an intermediary intentionally conceals any material fact or provides false information in connection with the conclusion of the proposed contract, which results in harm to the client’s interests, the intermediary may not claim for service fees and shall be liable for the damages caused. Therefore, if we intentionally conceal material information or provide false information to our trust company partners and are found at fault, or if we fail to identify false information received from borrowers or others and in turn provide such information to our trust company partners, we could be held liable for damages caused to our trust company partners as an intermediary pursuant to the PRC Contract Law. On the other hand, we do not assume any liability solely on the basis of failure to correctly assign a credit limit or pricing to a particular borrower in the process of facilitating a loan transaction, as long as we do not intentionally conceal any material fact intentionally or provide false information, and are not found to be at fault otherwise. However, due to the lack of detailed regulations and guidance in the area of home equity loans and the possibility that the PRC government authority may promulgate new laws and regulations regulating home equity loans in the future, there are substantial uncertainties regarding the interpretation and application of current or future PRC laws and regulations for the home equity loan industry, and there can be no assurance that the PRC government authority will ultimately take a view that is consistent with ours.

The personal data and other confidential information of borrowers and our partners which we collect or are provided access to may subject us to liabilities imposed by relevant governmental regulations or expose us to risks of cyber-attacks, computer viruses, physical or electronic break-ins or similar disruptions.

We receive, transmit and store a large volume of personally identifiable information and other confidential data from borrowers and our partners. There are numerous laws regarding privacy and the storing, sharing, use, disclosure and protection of personally identifiable information and user data. Specifically, personally identifiable and other confidential information is increasingly subject to legislation and regulations in numerous domestic and international jurisdictions, the intent of which is to protect the privacy of personal information that is collected, processed and transmitted in or from the governing jurisdiction. This regulatory framework for privacy issues in China and worldwide is currently evolving and is likely to remain uncertain for the foreseeable future. In addition, there may be limits on the cross-border transmission of user data even to the extent that such transmission is within our company. We could be adversely affected if legislation or regulations are expanded to require changes in business practices or privacy policies, or if governing jurisdictions interpret or implement their legislation or regulations in ways that negatively affect our business, financial condition and results of operations. In addition to laws, regulations and other applicable rules regarding privacy and privacy advocacy, industry groups or other private parties may propose new and different privacy standards. Because the interpretation and application of privacy and data protection laws and privacy standards are still uncertain, it is possible that these laws or privacy standards may be interpreted and applied in a manner that is inconsistent with our practices. Any inability to adequately address privacy concerns, even if unfounded, or to comply with applicable privacy or data protection laws, regulations and privacy standards, could result in additional cost and liability for us, damage our reputation, inhibit the use of our platform and harm our business.

In addition, the data we possess may make us an attractive target for and potentially vulnerable to, cyber-attacks, computer viruses, physical or electronic break-ins or similar disruptions. Furthermore, some of the data we possess is stored on our servers, which are hosted by third parties. While we and our third-party hosting facilities have taken steps to protect confidential information to which we have access, our security measures may be breached in the future. Any accidental or willful security breaches or other unauthorized access to our database could cause confidential borrower, partner information to be stolen and used for criminal purposes. Security breaches or unauthorized access to confidential information could also expose us to liability related to the loss of the information, time consuming and expensive litigation and negative publicity. If our security measures are breached because of third-party action, employee error, malfeasance or otherwise, or if design flaws

 

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in our software are exposed and exploited, our relationships with borrowers and partners could be severely damaged, and we could incur significant liability.

Because techniques used to sabotage or obtain unauthorized access to systems change frequently and generally are not recognized until they are launched against a target, we and our third-party hosting facilities may be unable to anticipate these techniques or implement adequate preventative measures. In addition, the Administrative Measures for the Security of the International Network of Computer Information Network, effective on December 30, 1997 and amended on January 8, 2011, requires us to report any data or security breaches to the local offices of the PRC Ministry of Public Security within 24 hours of any such breach. Any security breach, whether actual or perceived, would harm our reputation, and could cause us to lose borrowers and partners and adversely affect our business and results of operations.

Any failure by us or our third-party service providers to comply with applicable anti-money laundering laws and regulations could damage our reputation.

In cooperation with our trust company partners, we have adopted various policies and procedures, including internal controls, “know-your-customer” procedures, customer due diligence and customer screening procedures, for anti-money laundering purposes. In addition, we rely on and may in the future, rely on other third-party service providers, in particular the custody banks and payment agents that handle the transfer of funds between borrowers and lenders, to have their own appropriate anti-money laundering policies and procedures. Custody banks and payment agents are subject to anti-money laundering obligations under applicable anti-money laundering laws and regulations and are regulated in that respect by the PBOC. If any of our third-party service providers fail to comply with applicable anti-money laundering laws and regulations, our reputation could suffer and we could become subject to regulatory intervention, which could have a material adverse effect on our business, financial condition and results of operations. Any negative perception of the industry, such as that arising from any failure of other home equity loan service providers to detect or prevent money laundering activities, even if factually incorrect or based on isolated incidents, could compromise our image or undermine the trust and credibility we have established.

The PRC Anti-money Laundering Law, effective in January 2007, sets forth the principal anti-money laundering requirements applicable to financial institutions and non-financial institutions with anti-money laundering obligations, including the adoption of precautionary and supervisory measures, establishment of various systems for client identification, retention of clients’ identification information and transactions records, and reports on large transactions and suspicious transactions. However, as the detailed anti-money laundering regulations of home equity loan facilitators have not been published, there is uncertainty as to how the anti-money laundering requirements will be interpreted and implemented, and whether home equity loan service providers like us must abide by the rules and procedures set forth in the PRC Anti-money Laundering Law that are applicable to non-financial institutions with anti-money laundering obligations. We cannot assure you that the anti-money laundering policies and procedures we have adopted will be effective in protecting our business from being exploited for money laundering purposes or will be deemed to be in compliance with applicable anti-money laundering implementing rules if and when adopted.

If we are unable to maintain relationships with our third-party service providers, our business will suffer.

We rely on third-party service providers to operate various aspects of our business. For instance, third parties supply us with external data including real property valuation, borrowers’ credit histories, government data and blacklists. Furthermore, we engage third-party service providers to maintain our security systems, ensuring confidentiality of data and preventing malicious attacks.

Our relationships with various third parties are integral to the smooth operation of our business. Most of our agreements with third-party service providers are non-exclusive and do not prohibit third-party service providers from working with our competitors. If our relationships with third-party service providers deteriorate or third-

 

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party service providers decide to terminate our respective business relationships for any reason, such as to work with our competitors on more exclusive or more favorable terms, our operations may be disrupted. In addition, our third-party service providers may not uphold the standard we expect under our agreements. If any of these were to happen, our business operations could be materially impaired and our results of operations would suffer.

Misconduct, fraud, errors and failure to function by our employees or third-party service providers could harm our business and reputation.

We are exposed to the risk of misconduct, fraud and errors by our employees and third-party service providers with whom we collaborate. We rely on our sales staff for borrower acquisition and we do not have full control over sales staff’s conduct or conduct of their respective acquisition channels while sourcing borrowers. In addition, we rely on our employees for debt collection. We aim to ensure that our collection efforts comply with the relevant laws and regulations in the PRC and we have established strict policies that our employees should not engage in aggressive practices while performing debt collection. Nevertheless, we do not have full control over our employees. Misconduct and errors by our employees could result in violations of law by us, regulatory sanctions and/or serious reputational or financial harm. We cannot always deter misconduct and errors by our employees, and the precautions we take to prevent and detect these activities may not be effective in all cases. There cannot be any assurance that misconduct and errors by our employees will not lead to a material adverse effect on our business. Any of these occurrences could result in our diminished ability to operate our business, potential liability to third parties, inability to attract borrowers and funding sources, reputational damage, regulatory intervention and financial harm, which could negatively impact our business, financial condition and results of operations.

Misconduct and errors by our trust company partners, channel partners and other parties with whom we collaborate with could harm our business and reputation.

We are exposed to the risk of misconduct and errors by our trust company partners, channel partners and other business partners with whom we collaborate. We could be materially and adversely affected if personal information was disclosed to unintended recipients or if an operational breakdown or failure in the processing of transactions occurred, whether as a result of human error, purposeful sabotage or fraudulent manipulation of our operations or systems. Financial products and financial institutions are heavily regulated in China. We are not regulated as a financial institution, but we may be indirectly subject to PRC financial regulations as a result of cooperation with financial institutions as our funding source partners. If any financial product designed by us and our funding partners is deemed to violate any PRC laws or regulations, we may be jointly liable due to the service we provide, or we may have to terminate the relationship with our funding partners. It is not always possible to identify and deter misconduct or errors by our trust company partners, channel partners and other business partners, and the precautions we take to detect and prevent such activities may not be effective in controlling unknown or unmanageable risks or losses. If any of our funding partners, channel partners and other business partners misuse or misappropriate funds, commit fraud or other misconduct or fail to follow our rules and procedures when interacting with our borrowers, we could be liable for damages and subject to regulatory actions and penalties. We could also be perceived to have facilitated or participated in the illegal misappropriation of funds, documents or data, and therefore be subject to civil or criminal liability. Any of these occurrences could result in our diminished ability to operate our business, potential liability to third parties, inability to attract third parties, reputational damage, regulatory intervention or financial harm, which could negatively impact our business, financial condition and results of operations.

If we do not compete effectively in our target markets, our operating results could be harmed.

The PRC’s home equity loan market is rapidly evolving. We compete with financial products and companies that attract potential borrowers or funding sources, or both. Particularly, we compete with other financial service companies that facilitate home equity loans.

 

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Some of our current or potential competitors have significantly more financial, technical, marketing and other resources than we do and may be able to devote greater resources to the development, promotion, sale and support of their platforms and distribution channels. Their business models may also ultimately prove more successful or more adaptable to new regulatory, technological and other developments. Our current or potential competitors may also have longer operating histories, more extensive borrower base, more data and distribution channels, greater brand recognition and brand loyalty and broader partnership relationships than we have. For example, established Internet companies, including social media companies that possess large, existing borrower bases, substantial financial resources and established distribution channels may enter the market. Traditional financial institutions may also focus on the MSE market, which may have a material adverse impact on our business and results of operations as we may not necessarily have competitive advantage. Our competitors may be better at developing new products, responding quickly to new technologies and undertaking more extensive marketing campaigns. If we are unable to compete with such companies or meet the need for innovation in our industry, the demand for our services could stagnate or substantially decline and we could experience reduced operating income, any of which could harm our business.

When new competitors seek to enter our target market, or when existing market participants seek to increase their market share, they sometimes undercut the pricing and/or terms common in that market, which could adversely affect our market share or ability to exploit new market opportunities. In addition, since the home equity loan lending industry is a relatively recent development in China, potential partners and borrowers may not fully understand how our business works and may not be able to fully appreciate the features that we have invested in and adopted on our business as compared to other home equity loan service providers. Our pricing and terms could deteriorate if we fail to act to meet these competitive challenges. Further, to the extent that our competitors are able to offer more attractive terms to our trust company partners, such trust companies may choose to terminate their relationships with us. All of the foregoing could adversely affect our business, results of operations, financial condition and future growth.

If negative publicity arises with respect to us or the home equity loan lending industry in general, our employees, our third-party service providers or our trust company partners, our business and operating results could be adversely affected.

If negative publicity arises about the home equity loan lending industry or the secured lending industry in general in China or our company, including the quality, effectiveness and reliability of our business, our ability to effectively manage and resolve borrower complaints, privacy and security practices, litigation, regulatory challenges and the experience of borrowers with our services, even if inaccurate, could adversely affect our reputation and the confidence in, and the use of, our services, which could harm our business and operating results. The PRC government has recently instituted general regulations and specific rules, including the Guiding Opinion, to develop a more transparent regulatory environment for assets management products. See “—Our business may be adversely affected if we are unable to secure funding on terms acceptable to us or our borrowers, or at all.” Many companies in China’s home equity loan lending industry have not been fully compliant with these regulations, which prevents these companies from providing home equity loans. To the extent that borrowers associate our company with these failed companies, they may be less willing to use our services. Harm to our reputation can also arise from many other sources, including employee misconduct, misconduct by our partners, or third-party service providers, failure by us, our partners or third-party service providers to meet minimum standards of service and quality, inadequate protection of borrower and partner information and compliance failures and claims. Additionally, negative publicity with respect to our partners or service providers could also affect our business and operating results to the extent that we rely on these partners or if borrowers associate our company with these partners.

If we fail to promote and maintain our brand in an effective and cost-efficient way, our business and results of operations may be harmed.

Our brand and reputation are integral to our acquisition of borrowers and funding sources, and we intend to invest in marketing and brand promoting efforts. The success of our marketing efforts and borrowing experience

 

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with our services are integral to our ability to attract new and retain repeat borrowers. Our marketing channels include traditional media such as telephone marketing, direct sales and marketing campaigns, as well as online media, search engine optimization and search engine marketing. If our current marketing efforts and channels are less effective or inaccessible to us, or if the cost of such channels significantly increases or we cannot penetrate the market with new channels, we may not be able to promote and maintain our brand and reputation to maintain or grow the existing borrower base. If we are unable to promote and maintain our brand and reputation in a cost-efficient manner, our market share could diminish or we could experience a lower growth rate than we anticipated, which would harm our business, financial condition and results of operations.

Any failure to protect our own intellectual property rights could impair our brand, negatively impact our business or both.

Our success and ability to compete also depend in part on protecting our own intellectual property. We rely on a combination of copyright, trade secret, trademark and other rights, as well as confidentiality procedures and contractual provisions to protect our proprietary technology, processes and other intellectual property. However, the steps we take to protect our intellectual property rights may be inadequate. Third parties may seek to challenge, invalidate or circumvent our copyright, trade secret, trademark and other rights or applications for any of the foregoing. In order to protect our intellectual property rights, we may be required to spend significant resources. Litigation brought to protect and enforce our intellectual property rights could be costly, time-consuming and distracting to management. Our failure to secure, protect and enforce our intellectual property rights could seriously adversely affect our brand and adversely impact our business.

We may be sued by third parties for alleged infringement of their proprietary rights, which could harm our business.

Our competitors, as well as a number of other entities and individuals, may own or claim to own intellectual property relating to our industry. From time to time, third parties may claim that we are infringing on their intellectual property rights. We may, however, be unaware of the intellectual property rights that others may claim cover some or all of our applications, technology or services. Any claims or litigation could cause us to incur significant expenses and, if successfully asserted against us, could require that we pay substantial damages or ongoing royalty payments, restrict us from conducting our business or require that we comply with other unfavorable terms. We may also be obligated to indemnify parties or pay substantial settlement costs, including royalty payments, in connection with any such claim or litigation and to obtain licenses, modify applications or refund fees, which could be costly. Even if we were to prevail in such a dispute, any litigation regarding our intellectual property could be costly and time-consuming and divert the attention of our management from our business operations.

We have existing debts and may incur more in the future, which may adversely affect our financial condition and negatively impact our operations.

We have substantial existing debts and we may incur more in the future. The incurrence of debt could have a variety of negative effects, including:

 

    default and foreclosure on our assets if our operating income is insufficient to repay debt obligations;

 

    acceleration of obligations to repay the indebtedness (or other outstanding indebtedness), even if we make all principal and interest payments when due, if we breach any covenants that require the maintenance of certain financial ratios or reserves without a waiver or renegotiation of that covenant;

 

    our inability to obtain necessary additional financing if the debt security contains covenants restricting our ability to obtain such financing while the debt security is outstanding;

 

    diverting a substantial portion of cash flow to pay principal and interest on such debt, which would reduce the funds available for expenses, capital expenditures, acquisitions and other general corporate purposes; and

 

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    creating potential limitations on our flexibility in planning for and reacting to changes in our business and in the industry in which we operate.

The occurrence of any of these risks could adversely affect our operations or financial condition.

Certain data and information in this prospectus were obtained from third-party sources and were not independently verified by us.

This prospectus contains certain data and information that we obtained from various government and private entity publications including industry information from Oliver Wyman. Statistical data in these publications also include projections based on a number of assumptions. The Chinese credit industry, and home equity loan industry in particular, may not grow at the rate projected by market data, or at all. Failure of this industry to grow at the projected rate may have a material adverse effect on our business and the market price of our ADSs. In addition, the new and rapidly changing nature of the home equity loan lending industry results in significant uncertainties for any projections or estimates relating to the growth prospects or future condition of our industry. Furthermore, if any one or more of the assumptions underlying the market data is later found to be incorrect, actual results may differ from the projections based on these assumptions.

We have not independently verified the data and information contained in such third-party publications and reports. Data and information contained in such third-party publications and reports may be collected using third-party methodologies. In addition, these industry publications and reports generally indicate that the information contained therein was believed to be reliable, but do not guarantee the accuracy and completeness of such information.

Our business depends on the continued efforts of our senior management. If one or more of our key executives were unable or unwilling to continue in their present positions, our business may be severely disrupted.

Our business operations depend on the continued services of our senior management, particularly the executive officers named in this prospectus. While we have provided different incentives to our management, we cannot assure you that we can continue to retain their services. If one or more of our key executives were unable or unwilling to continue in their present positions, we may not be able to replace them easily or at all, our future growth may be constrained, our business may be severely disrupted and our financial condition and results of operations may be materially and adversely affected, and we may incur additional expenses to recruit, train and retain qualified personnel. In addition, although we have entered into confidentiality and noncompetition agreements with our management, there is no assurance that any member of our management team will not join our competitors or form a competing business. If any dispute arises between our current or former officers and us, we may have to incur substantial costs and expenses in order to enforce such agreements in China or we may be unable to enforce them at all.

We may have exposure to greater than anticipated tax liabilities.

We are subject to enterprise income tax, value-added tax, and other taxes in each province and city in China where we have operations. Our tax structure is subject to review by various local tax authorities. The determination of our provision for income tax and other tax liabilities requires significant judgment. In the ordinary course of our business, there are many transactions and calculations where the ultimate tax determination is uncertain. Although we believe our estimates are reasonable, the ultimate decisions by the relevant tax authorities may differ from the amounts recorded in our financial statements and may materially affect our financial results in the period or periods for which such determination is made.

 

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Certain of our leased properties may have defective titles and we may be forced to relocate operations affected by such defects, which could cause disruption to our business and have a negative impact on our business operations and financial condition.

As of June 30, 2018, we operated our businesses primarily in over 100 leased properties in Shenzhen, Guangzhou, Chongqing, Beijing and other cities in China. We have not signed lease contracts or not renewed expired lease contracts with respect to a small portion of such leased properties, and we may be forced to relocate if the lessors request us to leave the premises. With respect to a small portion of such leased properties, the lessors failed to provide title certificates evidencing property ownership of these lessors. According to PRC laws and regulations, where a landlord lacks title evidence or rights to lease, the relevant lease contracts may be void or unenforceable under PRC laws and regulations, and may also be subject to challenge by third parties. Moreover, a small portion of the leased properties are mortgaged by the lessors. In case the mortgagees enforce the mortgage, we may not be able to continue using our leased properties. In addition, a small portion of our lease contracts have not been registered with the relevant regulatory authorities. According to PRC laws and regulations, failure to register lease contracts will not affect the effectiveness. However, landlords and tenants may be subject to administrative fines for such failure.

As of the date of this prospectus, we are not aware of any action, claim or investigation being conducted or threatened by the relevant regulatory authorities with respect to defects in our leased contracts or leased properties. However, we cannot assure you that such defects will be cured in a timely manner, or at all. Our business may be interrupted and additional relocation costs may be incurred if we are required to relocate operations affected by such defects. Moreover, if our lease contracts are challenged by third parties, it could result in diversion of management attention and cause us to incur costs associated with defending such actions, even if such challenges are ultimately determined in our favor.

Competition for employees is intense, and we may not be able to attract and retain the qualified and skilled employees needed to support our business.

We believe our success depends on the efforts and talent of our employees, including risk management, software engineering, financial and marketing personnel. Our future success depends on our continued ability to attract, develop, motivate and retain qualified and skilled employees. Competition for highly skilled technical, risk management and financial personnel is extremely intense. We may not be able to hire and retain these personnel at compensation levels consistent with our existing compensation and salary structure. Some of the companies with which we compete for experienced employees have greater resources than we have and may be able to offer more attractive terms of employment. In addition, we invest significant time and expenses in training our employees, which increases their value to competitors who may seek to recruit them. If we fail to retain our employees, we could incur significant expenses in hiring and training new employees, and the quality of our services and our ability to serve borrowers and our partner funding sources could diminish, resulting in a material adverse effect to our business.

Increases in labor costs in the PRC may adversely affect our business and results of operations.

The economy in China has experienced increases in inflation and labor costs in recent years. As a result, average wages in the PRC are expected to continue to increase. In addition, we are required by PRC laws and regulations to pay various statutory employee benefits, including pension, housing fund, medical insurance, work-related injury insurance, unemployment insurance and maternity insurance to designated government agencies for the benefit of our employees. We expect that our labor costs, including wages and employee benefits, will continue to increase. Unless we are able to control our labor costs or pass on these increased labor costs to borrowers by increasing the fees of our services, our financial condition and results of operations may be adversely affected.

 

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If we cannot maintain our corporate culture as we grow, we could lose the innovation, collaboration and focus that contribute to our business.

We believe that a critical component of our success is our corporate culture, which we believe fosters innovation, encourages teamwork and cultivates creativity. As we develop the infrastructure of a public company and continue to grow, we may find it difficult to maintain these valuable aspects of our corporate culture. Any failure to preserve our culture could negatively impact our future success, including our ability to attract and retain employees, encourage innovation and teamwork and effectively focus on and pursue our corporate objectives.

We do not have any business insurance coverage.

Insurance companies in China currently do not offer as extensive an array of insurance products as insurance companies in more developed economies. Currently, we do not have any business liability or disruption insurance to cover our operations. We have determined that the costs of insuring for these risks and the difficulties associated with acquiring such insurance on commercially reasonable terms make it impractical for us to have such insurance. Any uninsured business disruptions may result in our incurring substantial costs and the diversion of resources, which could have an adverse effect on our results of operations and financial condition.

We face risks related to natural disasters, health epidemics and other outbreaks, which could significantly disrupt our operations.

We are vulnerable to natural disasters and other calamities. Fire, floods, typhoons, earthquakes, power loss, telecommunications failures, break-ins, war, riots, terrorist attacks or similar events may give rise to server interruptions, breakdowns, system failures, technology platform failures or Internet failures, which could cause the loss or corruption of data or malfunctions of software or hardware as well as adversely affect our ability to provide products and services on our platform.

Our business could also be adversely affected by the effects of Ebola virus disease, Zika virus disease, H1N1 flu, H7N9 flu, avian flu, Severe Acute Respiratory Syndrome, or SARS, or other epidemics. Our business operations could be disrupted if any of our employees is suspected of having Ebola virus disease, Zika virus disease, H1N1 flu, H7N9 flu, avian flu, SARS or other epidemic, since it could require our employees to be quarantined and/or our offices to be disinfected. In addition, our results of operations could be adversely affected to the extent that any of these epidemics harms the Chinese economy in general.

Our headquarters are located in Guangzhou, where most of our directors and management and a large majority of our employees currently reside. Consequently, we are highly susceptible to factors adversely affecting Guangzhou. If any of the abovementioned natural disasters, health epidemics or other outbreaks were to occur in Guangzhou, our operation may experience material disruptions, such as temporary closure of our offices and suspension of services, which may materially and adversely affect our business, financial condition and results of operations.

If we fail to implement and maintain an effective system of internal controls, we may be unable to accurately or timely report our results of operations or prevent fraud, and investor confidence and the market price of our ADSs may be materially and adversely affected.

Prior to this offering, we were a private company with limited accounting personnel and other resources with which to address our internal controls and procedures. Our management has not completed an assessment of the effectiveness of our internal control over financial reporting, and our independent registered public accounting firm has not conducted an audit of our internal control over financial reporting. In the course of auditing our consolidated financial statements as of December 31, 2016 and for the year ended December 31,

 

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2017, we and our independent registered public accounting firm identified one material weakness in our internal control over financial reporting and other control deficiencies as of December 31, 2017. A “material weakness” is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the company’s annual or interim financial statements will not be prevented or detected on a timely basis. The material weakness identified relate to

 

    our lack of sufficient financial reporting and accounting personnel with appropriate knowledge of U.S. GAAP and SEC reporting requirements, and

 

    our lack of comprehensive accounting policies and procedures manual in accordance with U.S. GAAP.

We have taken measures and plan to continue to take measures to remedy the material weakness. For details, please refer to “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Internal Control over Financial Reporting.” The implementation of these measures may not fully address the material weakness in our internal control over financial reporting, and we cannot conclude that they have been fully remedied. Our failure to correct theses material weakness or our failure to discover and address any other material weaknesses could result in inaccuracies in our financial statements and could also impair our ability to comply with applicable financial reporting requirements and related regulatory filings on a timely basis.

Upon the completion of this offering, we will become a public company in the United States subject to the Sarbanes-Oxley Act of 2002. Section 404 of the Sarbanes-Oxley Act of 2002, or Section 404, will require that we include a report from management on our internal control over financial reporting in our annual report on Form 20-F beginning with our annual report for the fiscal year ending December 31, 2018. In addition, once we cease to be an “emerging growth company” as such term is defined in the JOBS Act, our independent registered public accounting firm must attest to and report on the effectiveness of our internal control over financial reporting. Our management may conclude that our internal control over financial reporting is not effective. Moreover, even if our management concludes that our internal control over financial reporting is effective, our independent registered public accounting firm, after conducting its own independent testing, may issue a report that is qualified if it is not satisfied with our internal controls or the level at which our controls are documented, designed, operated or reviewed, or if it interprets the relevant requirements differently from us. In addition, after we become a public company, our reporting obligations may place a significant strain on our management, operational and financial resources and systems for the foreseeable future. We may be unable to timely complete our evaluation testing and any required remediation.

During the course of documenting and testing our internal control procedures, in order to satisfy the requirements of Section 404, we may identify weaknesses and deficiencies in our internal control over financial reporting. In addition, if we fail to maintain the adequacy of our internal control over financial reporting, as these standards are modified, supplemented or amended from time to time, we may not be able to conclude on an ongoing basis that we have effective internal control over financial reporting in accordance with Section 404. Generally speaking, if we fail to achieve and maintain an effective internal control environment, we could suffer material misstatements in our financial statements and fail to meet our reporting obligations, which would likely cause investors to lose confidence in our reported financial information. This could, in turn, limit our access to capital markets, harm our results of operations and lead to a decline in the trading price of our ADSs. Additionally, ineffective internal control over financial reporting could expose us to increased risk of fraud or misuse of corporate assets and subject us to potential delisting from the stock exchange on which we list, regulatory investigations and civil or criminal sanctions.

We will incur increased costs as a result of being a public company, particularly after we cease to qualify as an “emerging growth company.”

Upon completion of this offering, we will become a public company and expect to incur significant legal, accounting and other expenses that we did not incur as a private company. The Sarbanes-Oxley Act of 2002, as well as rules subsequently implemented by the SEC and the New York Stock Exchange, impose various

 

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requirements on the corporate governance practices of public companies. As a company with less than US$1.07 billion in revenues for our last fiscal year, we qualify as an “emerging growth company” pursuant to the JOBS Act. An emerging growth company may take advantage of specified reduced reporting and other requirements that are otherwise applicable generally to public companies. These provisions include exemption from the auditor attestation requirement under Section 404 of the Sarbanes-Oxley Act of 2002, or Section 404, in the assessment of the emerging growth company’s internal control over financial reporting. The JOBS Act also permits an emerging growth company to delay adopting new or revised accounting standards until such time as those standards apply to private companies. However, we have elected to “opt out” of this provision and, as a result, we will comply with new or revised accounting standards as required when they are adopted for public companies. This decision to opt out of the extended transition period under the JOBS Act is irrevocable.

We expect these rules and regulations to increase our legal and financial compliance costs and to make some corporate activities more time-consuming and costly. After we are no longer an “emerging growth company,” we expect to incur significant expenses and devote substantial management effort toward ensuring compliance with the requirements of Section 404 and the other rules and regulations of the SEC. For example, as a result of becoming a public company, we will need to increase the number of independent directors and adopt policies regarding internal controls and disclosure controls and procedures. We also expect that operating as a public company will make it more difficult and more expensive for us to obtain director and officer liability insurance, and we may be required to accept reduced policy limits and coverage or incur substantially higher costs to obtain the same or similar coverage. In addition, we will incur additional costs associated with our public company reporting requirements. It may also be more difficult for us to find qualified persons to serve on our Board of Directors or as executive officers. We are currently evaluating and monitoring developments with respect to these rules and regulations, and we cannot predict or estimate with any degree of certainty the amount of additional costs we may incur or the timing of such costs.

We have granted, and may continue to grant, share incentives, which may result in increased share-based compensation expenses.

[We adopted an equity incentive plan in 2018, or the 2018 Plan, for the purpose of granting share-based compensation awards to employees, officers, directors and consultants to incentivize their performance and promote the success of our business.]

We account for compensation costs for all share-based awards using a fair-value-based method and recognize expenses in our consolidated statements of comprehensive income in accordance with U.S. GAAP. Under the 2018 Plan, we are authorized to grant options, restricted stock units and other types of awards the administrator of the 2018 Plan decides. Under the 2018 Plan, the maximum aggregate number of shares which may be issued pursuant to all awards is              shares. As of the date of this prospectus, options to purchase a total of              ordinary shares were outstanding under the 2018 Plan. We believe the granting of share-based awards is of significant importance to our ability to attract and retain key personnel and employees, and we will continue to grant share-based awards in the future. As a result, our expenses associated with share-based compensation may increase, which may have an adverse effect on our results of operations.

Certain of our existing shareholders have substantial influence over our company, and their interests may not be aligned with the interests of our other stockholders.

CAA Holdings Company Limited, a company incorporated in the British Virgin Islands holds 100% of the total outstanding shares of Able Boom Investments Limited, Complete Joy Investments Limited, Goldsource Holding Limited, each of which is a company incorporated in the British Virgin Islands and holds approximately 2.83%, 27.94%, 6.65% and 3.61% of our ordinary shares, respectively. Cathay Auto Services Limited, a company incorporated in the British Virgin Islands holds approximately 25.96% of our ordinary shares. As a result, each shareholder has significant influence over our business, including decisions regarding mergers, consolidations, liquidations and the sale of all or substantially all of our assets, election of directors and other

 

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significant corporate actions. This concentration of ownership may also have the effect of discouraging, delaying or preventing a future change of control, which could deprive our stockholders of an opportunity to receive a premium for their shares as part of a sale of our company, and might reduce the price of our ADSs.

Failure to make adequate contributions to various employee benefits plans as required by PRC regulations may subject us to penalties.

Companies operating in China are required to participate in various government-sponsored employee benefit plans, including social insurance plans, unemployment insurance, medical insurance, work-related injury insurance, maternity insurance, housing provident fund and other welfare-oriented payment obligations, and contribute to the plans in amounts equal to certain percentages of salaries, including bonuses and allowances, of employees up to a maximum amount specified by the local government from time to time at locations where our employees are based. The requirement of employee benefit plans has not been implemented consistently by the local governments in China given the different levels of economic development in different locations. Our failure in making adequate contributions to various employee benefit plans and in complying with applicable PRC labor-related laws may subject us to late payment penalties, and we could be required to make up the contributions for these plans as well as to pay late fees and fines. If we are subject to late fees or fines in relation to the underpaid employee benefits, our financial condition and results of operations may be adversely affected.

Our branches have not made full contributions to the social insurance plans and the housing provident fund for employees as required by the relevant PRC laws and regulations. As of the date of this prospectus, we are not aware of any notice from regulatory authorities or any claim or request from these employees in this regard. We have obtained written confirmations from local human resources and social security bureau of 37 of our branches. These confirmations state, in respect of the relevant periods stated therein, that no administrative penalties had been imposed and/or non-compliance had not be identified regarding social insurance. Our PRC legal advisor, Han Kun Law Offices, advises us that based on the confirmations, the possibility that the local human resources and social security bureau of those branches request for payment or impose administrative fines or penalties regarding social insurance is remote. However, we cannot assure you that the relevant regulatory authorities will not require us to pay outstanding amounts and impose late payment penalties or fines on us, which may materially and adversely affect our business, financial condition and results of operations.

The inconsistency of domicile and place of business of our PRC subsidiaries may have a material adverse effect on our business and operations.

Substantially all of our assets and operations are located in China. We have developed a network of 73 branches and sub-branches in over 40 cities in China. According to the PRC laws and regulations, the domicile and the place of business of our PRC subsidiaries should be the same. As our business grows rapidly, we may change the place of business according to market development strategy. We cannot assure you that the domicile of all the PRC subsidiaries, branches and sub-branches are consistent with the place of their business. In the event that our PRC subsidiaries, branches and sub-branches cannot be reached by relevant regulatory authorities at the domicile or place of business they provided, such subsidiaries, branches or sub-branches may be included in the unusual operation enterprise list, and may be required to rectify or may be imposed with penalties, which may adversely affect our business and results of operations.

From time to time we may evaluate and enter into strategic alliances, which could divert significant management attention and resources, disrupt our business and adversely affect our financial results.

We may from time to time evaluate and enter into strategic alliances with various third parties. Strategic alliances with third parties could subject us to a number of risks, including the potential failure to achieve the expected benefits of the alliance, risks associated with potential leakage of proprietary information, non-performance by the counterparty and an increase in expenses incurred in establishing new strategic alliances, any of which may materially and adversely affect our business. Strategic alliances will also divert the management’s time and resources from our normal operations and we may have to incur unexpected liabilities or expenses.

 

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Risks Related to Doing Business in China

Changes in China’s economic, political or social conditions or government policies could have a material adverse effect on our business and operations.

Substantially all of our assets and operations are located in China. Accordingly, our business, financial condition, results of operations and prospects may be influenced to a significant degree by political, economic and social conditions in China generally. The Chinese economy differs from the economies of most developed countries in many respects, including the level of government involvement, level of development, growth rate, control of foreign exchange and allocation of resources. Although the Chinese government has implemented measures emphasizing the utilization of market forces for economic reform, the reduction of state ownership of productive assets, and the establishment of improved corporate governance in business enterprises, a substantial portion of productive assets in China is still owned by the government. In addition, the Chinese government continues to play a significant role in regulating industry development by imposing industrial policies. The Chinese government also exercises significant control over China’s economic growth through allocating resources, controlling payment of foreign currency-denominated obligations, setting monetary policy and providing preferential treatment to particular industries or companies.

While the Chinese economy has experienced significant growth over past decades, growth has been uneven, both geographically and among various sectors of the economy. Any adverse changes in economic conditions in China, in the policies of the Chinese government or in the laws and regulations in China could have a material adverse effect on the overall economic growth of China. Such developments could adversely affect our business and operating results, lead to a reduction in demand for our services and adversely affect our competitive position. The Chinese government has implemented various measures to encourage economic growth and guide the allocation of resources. Some of these measures may benefit the overall Chinese economy, but may have a negative effect on us. For example, our financial condition and results of operations may be adversely affected by government control over capital investments or changes in tax regulations. In addition, in the past the Chinese government has implemented certain measures, including interest rate adjustment, to control the pace of economic growth. These measures may cause decreased economic activity in China, which may adversely affect our business and operating results.

A severe or prolonged downturn in the Chinese or global economy could materially and adversely affect our business and financial condition.

Any prolonged slowdown in the Chinese or global economy may have a negative impact on our business, results of operations and financial condition. In particular, general economic factors and conditions in China or worldwide, including the general interest rate environment and unemployment rates, may affect micro and small-enterprise owners’ willingness to seek credit and our partners’ ability and desire to invest in loans. Economic conditions in China are sensitive to global economic conditions. The global financial markets have experienced significant disruptions in the past, including the escalation of the European sovereign debt crisis from 2011, which may continue. While the Chinese economy has experienced significant growth over past decades, growth has been uneven, both geographically and among various sectors of the economy. There is considerable uncertainty over the long-term effects of the expansionary monetary and fiscal policies adopted by the central banks and financial authorities of some of the world’s leading economies, including the United States and China. There have also been concerns over unrest in the Middle East and Africa, which have resulted in volatility in financial and other markets. Significant uncertainty exists regarding the timing of UK’s anticipated withdrawal from the EU and the effects such withdrawal may have on world economy, as well as uncertainty regarding the likelihood and timing of policy changes by the Trump Administration in the United States and the subsequent impact on world economy. There have also been concerns about the economic effect of the tensions in the relationship between China and surrounding Asian countries. If present Chinese and global economic uncertainties persist, we may have difficulty in obtaining funding sources to fund the credit utilized by borrowers. Adverse economic conditions could also reduce the number of quality micro and small-enterprise owners seeking credit from us, as well as their ability to make payments. Should any of these situations occur,

 

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the amount of loans facilitated to borrowers and, therefore, our operating income will decline, and our business and financial condition will be negatively impacted. Additionally, continued turbulence in the international markets may adversely affect our ability to access the capital markets to meet liquidity needs.

Uncertainties with respect to the PRC legal system could adversely affect us.

The PRC legal system is a civil law system based on written statutes. Unlike the common law system, prior court decisions under the civil law system may be cited for reference but have limited precedential value.

In 1979, the PRC government began to promulgate a comprehensive system of laws and regulations governing economic matters in general. The overall effect of legislation over the past three decades has significantly enhanced the protections afforded to various forms of foreign investments in China. However, China has not developed a fully integrated legal system, and recently enacted laws and regulations may not sufficiently cover all aspects of economic activities in China. In particular, the interpretation and enforcement of these laws and regulations involve uncertainties. Since PRC administrative and court authorities have significant discretion in interpreting and implementing statutory provisions and contractual terms, it may be difficult to evaluate the outcome of administrative and court proceedings and the level of legal protection we enjoy. These uncertainties may affect our judgment on the relevance of legal requirements and our ability to enforce our contractual rights or tort claims. In addition, the regulatory uncertainties may be exploited through unmerited or frivolous legal actions or threats in attempts to extract payments or benefits from us.

Furthermore, the PRC legal system is based in part on government policies and internal rules, some of which are not published on a timely basis or at all and may have a retroactive effect. As a result, we may not be aware of our violation of any of these policies and rules until sometime after the violation. In addition, any administrative and court proceedings in China may be protracted, resulting in substantial costs and diversion of resources and management attention.

You may experience difficulties in effecting service of legal process, enforcing foreign judgments or bringing actions in China against us or our management named in the prospectus based on foreign laws.

We are a company incorporated under the laws of the Cayman Islands, while we conduct substantially all of our operations in China, and substantially all of our assets are located in China. In addition, all our senior executive officers reside within China for a significant portion of the time and most are PRC nationals. As a result, it may be difficult for our shareholders to effect service of process upon us or those persons inside China. In addition, China does not have treaties providing for the reciprocal recognition and enforcement of judgments of courts with the Cayman Islands and many other countries and regions. Therefore, recognition and enforcement in China of judgments of a court in any of these non-PRC jurisdictions in relation to any matter not subject to a binding arbitration provision may be difficult or impossible.

We may rely on dividends and other distributions on equity paid by our PRC subsidiaries to fund any cash and financing requirements we may have, and any limitation on the ability of our PRC subsidiaries to make payments to us could have a material and adverse effect on our ability to conduct our business.

We are a Cayman Islands holding company and we rely principally on dividends and other distributions on equity from our PRC subsidiaries for our cash requirements, including for services of any debt we may incur. Our PRC subsidiary’s ability to distribute dividends is based upon its distributable earnings. Current PRC regulations permit our PRC subsidiaries to pay dividends to its respective shareholders only out of their accumulated profits, if any, determined in accordance with PRC accounting standards and regulations. In addition, each of our PRC subsidiaries is required to set aside at least 10% of its after-tax profits each year, if any, to fund a statutory reserve until such reserve reaches 50% of its registered capital. Each of our PRC subsidiaries as a Foreign Invested Enterprise, or FIE, is also required to further set aside a portion of its after-tax profits to fund the employee welfare fund, although the amount to be set aside, if any, is determined at its

 

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discretion. These reserves are not distributable as cash dividends. If our PRC subsidiaries incur debt on their own behalf in the future, the instruments governing the debt may restrict their ability to pay dividends or make other payments to us. Any limitation on the ability of our PRC subsidiaries to distribute dividends or other payments to their respective shareholders could materially and adversely limit our ability to grow, make investments or acquisitions that could be beneficial to our businesses, pay dividends or otherwise fund and conduct our business.

In addition, the Enterprise Income Tax Law and its implementation rules provide that a withholding tax rate of up to 10% will be applicable to dividends payable by Chinese companies to non-PRC-resident enterprises unless otherwise exempted or reduced according to treaties or arrangements between the PRC central government and governments of other countries or regions where the non-PRC resident enterprises are incorporated.

PRC regulation of loans to and direct investment in PRC entities by offshore holding companies and governmental control of currency conversion may delay us from using the proceeds of this offering to make loans or additional capital contributions to our PRC subsidiary, which could materially and adversely affect our liquidity and our ability to fund and expand our business.

Any funds we transfer to our PRC subsidiary, either as a shareholder loan or as an increase in registered capital, are subject to approval by or registration with relevant governmental authorities in China. According to the relevant PRC regulations on foreign-invested enterprises, or FIEs, in China, capital contributions to our PRC subsidiaries are subject to the approval of or filing with the MOFCOM or its local branches and registration with a local bank authorized by the State Administration of Foreign Exchange, or SAFE. In addition, (i) any foreign loan procured by our PRC subsidiaries is required to be registered with SAFE or its local branches and (ii) our PRC subsidiaries may not procure loans which exceed the difference between its total investment amount and registered capital. For the restriction and limitation on the amount of loans, please refer to “Regulation—Regulations on loans to and direct investment in the PRC entities by offshore holding companies” for details. We may not be able to complete such registrations on a timely basis, with respect to future capital contributions or foreign loans by us to our PRC subsidiary. If we fail to complete such registrations, our ability to use the proceeds of this offering and to capitalize our PRC operations may be negatively affected, which could adversely affect our liquidity and our ability to fund and expand our business.

On March 30, 2015, the SAFE promulgated the Circular on Reforming the Management Approach Regarding the Foreign Exchange Capital Settlement of Foreign-Invested Enterprises, or SAFE Circular 19, which took effect as of June 1, 2015. SAFE Circular 19 launched a nationwide reform of the administration of the settlement of the foreign exchange capitals of FIEs and allows FIEs to settle their foreign exchange capital at their discretion, but continues to prohibit FIEs from using the Renminbi fund converted from their foreign exchange capital for expenditure beyond their business scopes, providing entrusted loans or repaying loans between nonfinancial enterprises. The SAFE issued the Circular on Reforming and Regulating Policies on the Control over Foreign Exchange Settlement of Capital Accounts, or SAFE Circular 16, effective in June 2016. Pursuant to SAFE Circular 16, enterprises registered in China may also convert their foreign debts from foreign currency to Renminbi on a self-discretionary basis. SAFE Circular 16 provides an integrated standard for conversion of foreign exchange under capital account items (including but not limited to foreign currency capital and foreign debts) on a self-discretionary basis which applies to all enterprises registered in China. SAFE Circular 16 reiterates the principle that Renminbi converted from foreign currency-denominated capital of a company may not be directly or indirectly used for purposes beyond its business scope or prohibited by PRC laws or regulations, while such converted Renminbi shall not be provided as loans to its nonaffiliated entities. As this circular is relatively new, there remains uncertainty as to its interpretation and application and any other future foreign exchange related rules. Violations of these Circulars could result in severe monetary or other penalties. SAFE Circular 19 and SAFE Circular 16 may significantly limit our ability to use Renminbi converted from the net proceeds of this offering to fund the establishment of new entities in China or its subsidiaries, to invest in or acquire any other PRC companies through our PRC subsidiaries, or to establish VIEs in China, which may adversely affect our business, financial condition and results of operations.

 

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Fluctuations in the value of the Renminbi could have a material and adverse effect on your investment.

The change in value of the Renminbi against the U.S. dollar and other currencies is affected by various factors such as changes in political and economic conditions in the PRC. On July 21, 2005, the PRC government changed its decade-old policy of pegging the value of the Renminbi to the U.S. dollar, and the Renminbi appreciated more than 20% against the U.S. dollar over the following three years. Between July 2008 and June 2010, this appreciation halted and the exchange rate between the Renminbi and the U.S. dollar remained within a narrow band. Since June 2010, the Renminbi has fluctuated against the U.S. dollar, at times significantly and unpredictably. It is difficult to predict how market forces or PRC or U.S. government policy may impact the exchange rate between the Renminbi and the U.S. dollar in the future.

Any significant appreciation or revaluation of the Renminbi may have a material adverse effect on the value of, and any dividends payable on, our ADSs in foreign currency terms. More specifically, if we decide to convert our Renminbi into U.S. dollars, appreciation of the U.S. dollar against the Renminbi would have a negative effect on the U.S. dollar amount available to us. To the extent that we need to convert U.S. dollars we receive from our initial public offering into Renminbi for our operations, appreciation of the Renminbi against the U.S. dollar would have an adverse effect on the Renminbi amount we would receive from the conversion. In addition, appreciation or depreciation in the exchange rate of the Renminbi to the U.S. dollar could materially and adversely affect the price of our ADSs in U.S. dollars without giving effect to any underlying change in our business or results of operations.

Governmental control of currency conversion may limit our ability to utilize our operating income effectively and affect the value of your investment.

The PRC government imposes controls on the convertibility of the Renminbi into foreign currencies and, in certain cases, the remittance of currency out of China. We receive substantially all of our operating income in Renminbi. Under our current corporate structure, our Cayman Islands holding company primarily relies on dividend payments from our PRC subsidiaries to fund any cash and financing requirements we may have. Under existing PRC foreign exchange regulations, payments of current account items, including profit distributions, interest payments and trade and service-related foreign exchange transactions, can be made in foreign currencies without prior approval of SAFE by complying with certain procedural requirements. Specifically, under the existing exchange restrictions, without prior approval of SAFE, cash generated from the operations of our PRC subsidiaries in China may be used to pay dividends to our company. However, approval from or registration with appropriate government authorities is required where Renminbi is to be converted into foreign currency and remitted out of China to pay capital expenses such as the repayment of loans denominated in foreign currencies. As a result, we need to obtain SAFE approval to use cash generated from the operations of our PRC subsidiaries to pay off their respective debt in a currency other than Renminbi owed to entities outside China, or to make other capital expenditure payments outside China in a currency other than Renminbi. The PRC government may at its discretion restrict access to foreign currencies for current account transactions in the future. If the foreign exchange control system prevents us from obtaining sufficient foreign currencies to satisfy our foreign currency demands, we may not be able to pay dividends in foreign currencies to our shareholders, including holders of our ADSs.

Certain PRC regulations may make it more difficult for us to pursue growth through acquisitions.

Among other things, the Regulations on Mergers and Acquisitions of Domestic Enterprises by Foreign Investors, or the M&A Rules, adopted by six PRC regulatory agencies in 2006 and amended in 2009, established additional procedures and requirements that could make merger and acquisition activities by foreign investors more time-consuming and complex. Such regulation requires, among other things, that the MOFCOM be notified in advance of any change-of-control transaction in which a foreign investor acquires control of a PRC domestic enterprise or a foreign company with substantial PRC operations, if certain thresholds under the Provisions on Thresholds for Prior Notification of Concentrations of Undertakings, issued by the State Council in 2008, are

 

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triggered. Moreover, the Anti-Monopoly Law promulgated by the Standing Committee of the NPC which became effective in 2008 requires that transactions which are deemed concentrations and involve parties with specified turnover thresholds must be cleared by the MOFCOM before they can be completed. In addition, PRC national security review rules which became effective in September 2011 require acquisitions by foreign investors of PRC companies engaged in military related or certain other industries that are crucial to national security be subject to security review before consummation of any such acquisition. We may pursue potential strategic acquisitions that are complementary to our business and operations. Complying with the requirements of these regulations to complete such transactions could be time-consuming, and any required approval processes, including obtaining approval or clearance from the MOFCOM, may delay or inhibit our ability to complete such transactions, which could affect our ability to expand our business or maintain our market share.

PRC regulations relating to the establishment of offshore special purpose companies by PRC residents may subject our PRC resident beneficial owners or our PRC subsidiary to liability or penalties, limit our ability to inject capital into our PRC subsidiary, limit our PRC subsidiary’s ability to increase their registered capital or distribute profits to us, or may otherwise adversely affect us.

In July 2014, SAFE promulgated the Circular on Relevant Issues Concerning Foreign Exchange Control on Domestic Residents’ Offshore Investment and Financing and Roundtrip Investment Through Special Purpose Vehicles, or SAFE Circular 37, to replace the Notice on Relevant Issues Concerning Foreign Exchange Administration for Domestic Residents’ Financing and Roundtrip Investment Through Offshore Special Purpose Vehicles, or SAFE Circular 75, which ceased to be effective upon the promulgation of SAFE Circular 37. SAFE Circular 37 requires PRC residents (including PRC individuals and PRC corporate entities) to register with SAFE or its local branches in connection with their direct or indirect offshore investment activities. SAFE Circular 37 is applicable to our shareholders who are PRC residents and may be applicable to any offshore acquisitions that we make in the future.

Under SAFE Circular 37, PRC residents who make, or have prior to the implementation of SAFE Circular 37 made, direct or indirect investments in offshore special purpose vehicles, or SPVs, will be required to register such investments with SAFE or its local branches. In addition, any PRC resident who is a direct or indirect shareholder of an SPV is required to update its filed registration with the local branch of SAFE with respect to that SPV, to reflect any material change. Moreover, any subsidiary of such SPV in China is required to urge the PRC resident shareholders to update their registration with the local branch of SAFE. If any PRC shareholder of such SPV fails to make the required registration or to update the previously filed registration, the subsidiary of such SPV in China may be prohibited from distributing its profits or the proceeds from any capital reduction, share transfer or liquidation to the SPV, and the SPV may also be prohibited from making additional capital contributions into its subsidiary in China. On February 13, 2015, the SAFE promulgated a Notice on Further Simplifying and Improving Foreign Exchange Administration Policy on Direct Investment, or SAFE Notice 13, which became effective on June 1, 2015. Under SAFE Notice 13, applications for foreign exchange registration of inbound foreign direct investments and outbound overseas direct investments, including those required under SAFE Circular 37, will be filed with qualified banks instead of SAFE. The qualified banks will directly examine the applications and accept registrations under the supervision of SAFE.

Several of our shareholders that we are aware of are subject to SAFE regulations, and we expect all of these shareholders will have completed all necessary registrations with the local SAFE branch or qualified banks as required by SAFE Circular 37 immediately before the completion of this offering. We cannot assure you, however, that all of these individuals may continue to make required filings or updates on a timely manner, or at all. We can provide no assurance that we are or will in the future continue to be informed of identities of all PRC residents holding direct or indirect interest in our company. Any failure or inability by such individuals to comply with SAFE regulations may subject us to fines or legal sanctions, such as restrictions on our cross-border investment activities or our PRC subsidiary’s ability to distribute dividends to, or obtain foreign exchange-denominated loans from, our company or prevent us from making distributions or paying dividends. As a result, our business operations and our ability to make distributions to you could be materially and adversely affected.

 

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Furthermore, as these foreign exchange regulations are still relatively new and their interpretation and implementation has been constantly evolving, it is unclear how these regulations, and any future regulation concerning offshore or cross-border transactions, will be interpreted, amended and implemented by the relevant government authorities. For example, we may be subject to a more stringent review and approval process with respect to our foreign exchange activities, such as remittance of dividends and foreign-currency-denominated borrowings, which may adversely affect our financial condition and results of operations. In addition, if we decide to acquire a PRC domestic company, we cannot assure you that we or the owners of such company, as the case may be, will be able to obtain the necessary approvals or complete the necessary filings and registrations required by the foreign exchange regulations. This may restrict our ability to implement our acquisition strategy and could adversely affect our business and prospects.

Any failure to comply with PRC regulations regarding the registration requirements for employee stock incentive plans may subject the PRC plan participants or us to fines and other legal or administrative sanctions.

In February 2012, SAFE promulgated the Notices on Issues Concerning the Foreign Exchange Administration for Domestic Individuals Participating in Stock Incentive Plan of Overseas Publicly Listed Company, replacing earlier rules promulgated in 2007. Pursuant to these rules, PRC citizens and non-PRC citizens who reside in China for a continuous period of not less than one year who participate in any stock incentive plan of an overseas publicly listed company, subject to a few exceptions, are required to register with SAFE through a domestic qualified agent, which could be the PRC subsidiaries of such overseas-listed company, and complete certain other procedures. In addition, an overseas-entrusted institution must be retained to handle matters in connection with the exercise or sale of stock options and the purchase or sale of shares and interests. We and our executive officers and other employees who are PRC citizens or who reside in the PRC for a continuous period of not less than one year and who have been granted options will be subject to these regulations when our company becomes an overseas-listed company upon the completion of this offering. Failure to complete the SAFE registrations may subject them to fines and legal sanctions, there may be additional restrictions on the ability of them to exercise their stock options or remit proceeds gained from sale of their stock into the PRC. We also face regulatory uncertainties that could restrict our ability to adopt additional incentive plans for our directors, executive officers and employees under PRC law. See “Regulation—Regulations on Foreign Exchange—Regulations on Stock Incentive Plans.”

If we are classified as a PRC resident enterprise for PRC enterprise income tax purposes, such classification could result in unfavorable tax consequences to us and our non-PRC shareholders and ADS holders.

Under the PRC Enterprise Income Tax Law and its implementation rules, an enterprise established outside of the PRC with its “de facto management body” within the PRC is considered a “resident enterprise” and will be subject to the enterprise income tax on its global income at the rate of 25%. The implementation rules define the term “de facto management body” as the body that exercises full and substantial control and overall management over the business, productions, personnel, accounts and properties of an enterprise. In 2009, the State Administration of Taxation, or SAT, issued a circular, known as SAT Circular 82, which provides certain specific criteria for determining whether the “de facto management body” of a PRC-controlled enterprise that is incorporated offshore is located in China. Although this circular only applies to offshore enterprises controlled by PRC enterprises or PRC enterprise groups, not those controlled by PRC individuals or foreigners, the criteria set forth in the circular may reflect the SAT’s general position on how the “de facto management body” text should be applied in determining the tax resident status of all offshore enterprises. According to SAT Circular 82, an offshore incorporated enterprise controlled by a PRC enterprise or a PRC enterprise group will be regarded as a PRC tax resident by virtue of having its “de facto management body” in China, and will be subject to PRC enterprise income tax on its global income only if all of the following conditions are met: (i) the primary location of the day-to-day operational management is in the PRC; (ii) decisions relating to the enterprise’s financial and human resource matters are made or are subject to approval by organizations or personnel in the PRC; (iii) the

 

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enterprise’s primary assets, accounting books and records, company seals, and board and shareholder resolutions are located or maintained in the PRC; and (iv) at least 50% of voting board members or senior executives habitually reside in the PRC.

We believe our company is not a PRC resident enterprise for PRC tax purposes. However, the tax resident status of an enterprise is subject to determination by the PRC tax authorities and uncertainties remain with respect to the interpretation of the term “de facto management body.” If the PRC tax authorities determine that our company is a PRC resident enterprise for enterprise income tax purposes, we will be subject to PRC enterprise income on our worldwide income at the rate of 25%. Furthermore, we will be required to withhold a 10% withholding tax from dividends we pay to our shareholders that are nonresident enterprises, including the holders of our ADSs. In addition, nonresident enterprise shareholders (including our ADS holders) may be subject to PRC tax at a rate of 10% on gains realized on the sale or other disposition of ADSs or ordinary shares, if such income is treated as sourced from within the PRC. Furthermore, if we are deemed a PRC resident enterprise, dividends paid to our non-PRC individual shareholders (including our ADS holders) and any gain realized on the transfer of ADSs or ordinary shares by such shareholders may be subject to PRC tax at a rate of 20% (which, in the case of dividends, may be withheld at source). These rates may be reduced by an applicable tax treaty, but it is unclear whether non-PRC shareholders of our company would be able to claim the benefits of any tax treaties between their country of tax residence and the PRC in the event that we are treated as a PRC resident enterprise. Any such tax may reduce the returns on your investment in the ADSs or ordinary shares.

We face uncertainty with respect to indirect transfers of equity interests in PRC resident enterprises by their non-PRC holding companies.

On February 3, 2015, the SAT issued the Public Notice Regarding Certain Corporate Income Tax Matters on Indirect Transfer of Properties by Non-Tax Resident Enterprises, or SAT Bulletin 7. SAT Bulletin 7 extends its tax jurisdiction to transactions involving the transfer of taxable assets through offshore transfer of a foreign intermediate holding company. In addition, SAT Bulletin 7 has introduced safe harbors for internal group restructurings and the purchase and sale of equity through a public securities market. SAT Bulletin 7 also brings challenges to both foreign transferor and transferee (or other person who is obligated to pay for the transfer) of taxable assets.

On October 17, 2017, the SAT issued the Announcement of the State Administration of Taxation on Issues Concerning the Withholding of Nonresident Enterprise Income Tax at Source, or SAT Bulletin 37, which came into effect on December 1, 2017. The SAT Bulletin 37 further clarifies the practice and procedure of the withholding of nonresident enterprise income tax.

Where a nonresident enterprise transfers taxable assets indirectly by disposing of the equity interests of an overseas holding company, which is an Indirect Transfer, the nonresident enterprise as either transferor or transferee, or the PRC entity that directly owns the taxable assets, may report such Indirect Transfer to the relevant tax authority. Using a “substance over form” principle, the PRC tax authority may disregard the existence of the overseas holding company if it lacks a reasonable commercial purpose and was established for the purpose of reducing, avoiding or deferring PRC tax. As a result, gains derived from such Indirect Transfer may be subject to PRC enterprise income tax, and the transferee or other person who is obligated to pay for the transfer is obligated to withhold the applicable taxes, currently at a rate of 10% for the transfer of equity interests in a PRC resident enterprise. Both the transferor and the transferee may be subject to penalties under PRC tax laws if the transferee fails to withhold the taxes and the transferor fails to pay the taxes.

We face uncertainties as to the reporting and other implications of certain past and future transactions where PRC taxable assets are involved, such as offshore restructuring, sale of the shares in our offshore subsidiaries and investments. Our company may be subject to filing obligations or taxed if our company is transferor in such transactions, and may be subject to withholding obligations if our company is transferee in such transactions, under SAT Bulletin 7 and/or SAT Bulletin 37. For transfer of shares in our company by investors who are

 

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non-PRC resident enterprises, our PRC subsidiaries may be requested to assist in the filing under SAT Bulletin 7 and/or SAT Bulletin 37. As a result, we may be required to expend valuable resources to comply with SAT Bulletin 7 and/or SAT Bulletin 37 or to request the relevant transferors from whom we purchase taxable assets to comply with these circulars, or to establish that our company should not be taxed under these circulars, which may have a material adverse effect on our financial condition and results of operations.

The audit report included in this prospectus is prepared by an auditor who is not inspected by the Public Company Accounting Oversight Board and, as such, you are deprived of the benefits of such inspection.

Our independent registered public accounting firm that issues the audit report included in this prospectus, as an auditor of companies that are traded publicly in the United States and a firm registered with the Public Company Accounting Oversight Board, or the PCAOB, is required by the laws of the United States to undergo regular inspections by the PCAOB to assess its compliance with the laws of the United States and professional standards. Since our auditors are located in China, a jurisdiction where the PCAOB is currently unable to conduct inspections without the approval of the Chinese authorities, our auditors are not currently inspected by the PCAOB.

Inspections of other firms that the PCAOB has conducted outside of China have identified deficiencies in those firms’ audit procedures and quality control procedures, which may be addressed as part of the inspection process to improve future audit quality. The lack of PCAOB inspections in China prevents the PCAOB from regularly evaluating our auditors’ audits and its quality control procedures. As a result, investors may be deprived of the benefits of PCAOB inspections.

The inability of the PCAOB to conduct inspections of auditors in China makes it more difficult to evaluate the effectiveness of our auditors’ audit procedures or quality control procedures as compared to auditors outside of China that are subject to PCAOB inspections. Investors may lose confidence in our reported financial information and procedures and the quality of our financial statements.

Proceedings instituted by the SEC against Chinese affiliates of the “big four” accounting firms, including our independent registered public accounting firm, could result in financial statements being determined to not be in compliance with the requirements of the Exchange Act.

Starting in 2011 the Chinese affiliates of the “big four” accounting firms, including our independent registered public accounting firm, were affected by a conflict between U.S. and Chinese law. Specifically, for certain US-listed companies operating and audited in mainland China, the SEC and the PCAOB sought to obtain from the Chinese firms access to their audit work papers and related documents. The firms were, however, advised and directed that under Chinese law, they could not respond directly to the U.S. regulators on those requests, and that requests by foreign regulators for access to such papers in China had to be channeled through the CSRC.

In late 2012, this impasse led the SEC to commence administrative proceedings under Rule 102E of its Rules of Practice and also under the Sarbanes-Oxley Act of 2002 against the Chinese accounting firms, including our independent registered public accounting firm. A first instance trial of the proceedings in July 2013 in the SEC’s internal administrative court resulted in an adverse judgment against the firms. The administrative law judge proposed penalties on the firms including a temporary suspension of their right to practice before the SEC, although that proposed penalty did not take effect pending review by the Commissioners of the SEC. On February 6, 2015, before a review by the Commissioner had taken place, the firms reached a settlement with the SEC. Under the settlement, the SEC accepts that future requests by the SEC for the production of documents will normally be made to the CSRC. The firms will receive matching Section 106 requests, and are required to abide by a detailed set of procedures with respect to such requests, which in substance require them to facilitate production via the CSRC. If they fail to meet specified criteria, the SEC retains authority to impose a variety of additional remedial measures on the firms depending on the nature of the failure. Remedies for any future

 

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noncompliance could include, as appropriate, an automatic six-month bar on a single firm’s performance of certain audit work, commencement of a new proceeding against a firm, or, in extreme cases, the resumption of the current proceeding against all four firms. If additional remedial measures are imposed on the Chinese affiliates of the “big four” accounting firms, including our independent registered public accounting firm, in administrative proceedings brought by the SEC alleging the firms’ failure to meet specific criteria set by the SEC with respect to requests for the production of documents, we could be unable to timely file future financial statements in compliance with the requirements of the Exchange Act.

In the event that the SEC restarts the administrative proceedings, depending upon the final outcome, listed companies in the United States with major PRC operations may find it difficult or impossible to retain auditors in respect of their operations in the PRC, which could result in financial statements being determined to not be in compliance with the requirements of the Exchange Act, including possible delisting. Moreover, any negative news about any such future proceedings against these audit firms may cause investor uncertainty regarding China-based, US-listed companies, and the market price of our common stock may be adversely affected.

If our independent registered public accounting firm was denied, even temporarily, the ability to practice before the SEC and we were unable to timely find another registered public accounting firm to audit and issue an opinion on our financial statements, our financial statements could be determined not to be in compliance with the requirements of the Exchange Act. Such a determination could ultimately lead to the delisting of our ADSs from the New York Stock Exchange or deregistration from the SEC, or both, which would substantially reduce or effectively terminate the trading of our ADSs in the United States.

Regulation and censorship of information disseminated over the Internet in China may adversely affect our business and reputation and subject us to liability for information displayed on our website.

The PRC government has adopted regulations governing Internet access and the distribution of news and other information over the Internet. Under these regulations, Internet content providers and Internet publishers are prohibited from posting or displaying over the Internet content that, among other things, violates PRC laws and regulations, impairs the national dignity of China, or is reactionary, obscene, superstitious, fraudulent or defamatory. Failure to comply with these requirements may result in the revocation of licenses to provide Internet content and other licenses, and the closure of the concerned websites. The website operator may also be held liable for such censored information displayed on or linked to the websites. If our website is found to be in violation of any such requirements, we may be penalized by relevant authorities, and our operations or reputation could be adversely affected.

Risks Related to Our ADSs and This Offering

An active trading market for our ordinary shares or the ADSs may not develop and the trading price for our ADSs may fluctuate significantly.

We [have applied] to list the ADSs on the New York Stock Exchange. We have no current intention to seek a listing for our ordinary shares on any stock exchange. Prior to the completion of this offering, there has been no public market for the ADSs or our ordinary shares, and we cannot assure you that a liquid public market for the ADSs will develop. If an active public market for the ADSs does not develop following the completion of this offering, the market price and liquidity of the ADSs may be materially and adversely affected. The initial public offering price for our ADSs will be determined by negotiation between us and the underwriters based upon several factors, and we can provide no assurance that the trading price of the ADSs after this offering will not decline below the initial public offering price. As a result, investors in our securities may experience a significant decrease in the value of their ADSs.

The trading price of the ADSs is likely to be volatile, which could result in substantial losses to investors.

The trading price of the ADSs is likely to be volatile and could fluctuate widely due to factors beyond our control. This may happen because of broad market and industry factors, including the performance and

 

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fluctuation of the market prices of other companies with business operations located mainly in China that have listed their securities in the United States. In addition to market and industry factors, the price and trading volume for our ADSs may be highly volatile for factors specific to our own operations, including the following:

 

    variations in our earnings and cash flows;

 

    announcements of new investments, acquisitions, strategic partnerships or joint ventures by us or our competitors;

 

    announcements of new offerings, solutions and expansions by us or our competitors;

 

    changes in financial estimates by securities analysts;

 

    detrimental adverse publicity about us, our services or our industry;

 

    announcements of new regulations, rules or policies relevant for our business;

 

    additions or departures of key personnel;

 

    release of lockup or other transfer restrictions on our outstanding equity securities or sales of additional equity securities; and

 

    potential litigation or regulatory investigations.

Any of these factors may result in large and sudden changes in the volume and price at which our ADSs will trade.

In the past, shareholders of public companies have often brought securities class action suits against those companies following periods of instability in the market price of their securities. If we were involved in a class action suit, it could divert a significant amount of our management’s attention and other resources from our business and operations and require us to incur significant expenses to defend the suit, which could harm our results of operations. Any such class action suit, whether or not successful, could harm our reputation and restrict our ability to raise capital in the future. In addition, if a claim is successfully made against us, we may be required to pay significant damages, which could have a material adverse effect on our financial condition and results of operations.

Because our initial public offering price is substantially higher than our net tangible book value per share, you will experience immediate and substantial dilution.

If you purchase ADSs in this offering, you will pay more for your ADSs than the amount paid by our existing shareholders for their ordinary shares on a per ADS basis. As a result, you will experience immediate and substantial dilution of approximately US$                 per ADS. Please refer to “Dilution” for a more complete description of how the value of your investment in our ADSs will be diluted upon the completion of this offering.

If securities or industry analysts do not publish research or reports about our business, or if they adversely change their recommendations regarding the ADSs, the market price for the ADSs and trading volume could decline.

The trading market for the ADSs will be influenced by research or reports that industry or securities analysts publish about our business. If one or more analysts who cover us downgrade the ADSs, the market price for the ADSs would likely decline. If one or more of these analysts cease to cover us or fail to regularly publish reports on us, we could lose visibility in the financial markets, which in turn could cause the market price or trading volume for the ADSs to decline.

The sale or availability for sale of substantial amounts of ADSs could adversely affect their market price.

Sales of substantial amounts of the ADSs in the public market after the completion of this offering, or the perception that these sales could occur, could adversely affect the market price of the ADSs and could materially

 

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impair our ability to raise capital through equity offerings in the future. The ADSs sold in this offering will be freely tradable without restriction or further registration under the Securities Act, and shares held by our existing shareholders may also be sold in the public market in the future subject to the restrictions in Rule 144 and Rule 701 under the Securities Act and the applicable lockup agreements. There will be                  ADSs (representing                  ordinary shares) outstanding immediately after this offering, or                  ADSs (representing ordinary shares) if the underwriters exercise their over-allotment option in full. In connection with this offering, [we, our directors executive officers and certain existing shareholders] have agreed, subject to certain exceptions, not to sell any ordinary shares or ADSs for [180] days after the date of this prospectus without the prior written consent of the representatives of the underwriters. However, the underwriters may release these securities from these restrictions at any time, subject to applicable regulations of the Financial Industry Regulatory Authority, Inc. We cannot predict what effect, if any, market sales of securities held by our significant shareholders or any other shareholder or the availability of these securities for future sale will have on the market price of the ADSs. Please refer to “Underwriting” and “Shares Eligible for Future Sale” for a more detailed description of the restrictions on selling our securities after this offering.

Techniques employed by short sellers may drive down the market price of the ADSs.

Short selling is the practice of selling securities that the seller does not own but rather has borrowed from a third party with the intention of buying identical securities back at a later date to return to the lender. The short seller hopes to profit from a decline in the value of the securities between the sale of the borrowed securities and the purchase of the replacement shares, as the short seller expects to pay less in that purchase than it received in the sale. As it is in the short seller’s interest for the price of the security to decline, many short sellers publish, or arrange for the publication of, negative opinions regarding the relevant issuer and its business prospects in order to create negative market momentum and generate profits for themselves after selling a security short. These short attacks have, in the past, led to selling of shares in the market.

Public companies that have substantially all of their operations in China have been the subject of short selling. Much of the scrutiny and negative publicity has centered on allegations of a lack of effective internal control over financial reporting resulting in financial and accounting irregularities and mistakes, inadequate corporate governance policies or a lack of adherence thereto and, in many cases, allegations of fraud. As a result, many of these companies are now conducting internal and external investigations into the allegations and, in the interim, are subject to shareholder lawsuits and/or SEC enforcement actions.

It is not clear what effect such negative publicity could have on us. If we were to become the subject of any unfavorable allegations, whether such allegations are proven to be true or untrue, we could have to expend a significant amount of resources to investigate such allegations and/or defend ourselves. While we would strongly defend against any such short seller attacks, we may be constrained in the manner in which we can proceed against the relevant short seller by principles of freedom of speech, applicable state law or issues of commercial confidentiality. Such a situation could be costly and time-consuming, and could distract our management from growing our business. Even if such allegations are ultimately proven to be groundless, allegations against us could severely impact our business operations, and any investment in the ADSs could be greatly reduced or even rendered worthless.

Because we do not expect to pay dividends in the foreseeable future after this offering, you must rely on a price appreciation of the ADSs for a return on your investment.

We currently intend to retain most, if not all, of our available funds and any future earnings after this offering to fund the development and growth of our business. As a result, we do not expect to pay any cash dividends in the foreseeable future. Therefore, you should not rely on an investment in the ADSs as a source for any future dividend income.

Our Board of Directors has complete discretion as to whether to distribute dividends, subject to certain requirements of Cayman Islands law. In addition, our shareholders may, subject to the provisions of our articles

 

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of association, by ordinary resolution declare a dividend, but no dividend may exceed the amount recommended by our directors. Under Cayman Islands law, a Cayman Islands company may pay a dividend out of either profit or share premium account, provided that in no circumstances may a dividend be paid if this would result in the company being unable to pay its debts as they fall due in the ordinary course of business. Even if our Board of Directors decides to declare and pay dividends, the timing, amount and form of future dividends, if any, will depend on our future results of operations and cash flow, our capital requirements and surplus, the amount of distributions, if any, received by us from our subsidiaries, our financial condition, contractual restrictions and other factors deemed relevant by our Board of Directors. Accordingly, the return on your investment in the ADSs will likely depend entirely upon any future price appreciation of the ADSs. There is no guarantee that the ADSs will appreciate in value after this offering or even maintain the price at which you purchased the ADSs. You may not realize a return on your investment in our ADSs and you may even lose your entire investment in the ADSs.

We have not determined a specific use for a portion of the net proceeds from this offering, and we may use these proceeds in ways with which you may not agree.

We have not determined a specific use for a portion of the net proceeds of this offering, and our management will have considerable discretion in deciding how to apply these proceeds. You will not have the opportunity to assess whether the proceeds are being used appropriately before you make your investment decision. You must rely on the judgment of our management regarding the application of the net proceeds of this offering. We cannot assure you that the net proceeds will be used in a manner that would improve our results of operations or increase the ADS price, nor that these net proceeds will be placed only in investments that generate income or appreciate in value.

The approval of the China Securities Regulatory Commission may be required in connection with this offering under PRC law.

The M&A Rules purport to require offshore special purpose vehicles that are controlled by PRC companies or individuals and that have been formed for the purpose of seeking a public listing on an overseas stock exchange through acquisitions of PRC domestic companies or assets to obtain CSRC approval prior to publicly listing their securities on an overseas stock exchange. In September 2006, the CSRC published a notice on its official website specifying documents and materials required to be submitted to it by a special purpose vehicle seeking CSRC approval of its overseas listings. The interpretation and application of the regulations remain unclear. If CSRC approval is required, it is uncertain whether it would be possible for us to obtain the approval, and any failure to obtain or delay in obtaining CSRC approval for this offering would subject us to sanctions imposed by the CSRC and other PRC regulatory agencies.

Our PRC legal advisor, Han Kun Law Offices, advises us that, based on its understanding of the current PRC laws and regulations, we will not be required to submit an application to the CSRC for the approval of the listing and trading of our ADSs on the New York Stock Exchange because there are four WFOEs in the Group, and we established three of them by means of direct investment and not through a merger or acquisition of the equity or assets of a “PRC domestic company” as defined under the M&A Rules. The acquisition of Fanhua Chuang Li Information Technology (Shenzhen) Co., Ltd. (formerly known as Yi Li Chuangli Precision Instrument Technology (Shenzhen) Co., Ltd.) by Rich Wealth Technology Limited (Hong Kong) from Rich Wealth Holdings Limited (Hong Kong) in December 13, 2000, which was approved by Shenzhen Foreign Investment Bureau, is subject to Several Provisions on Changes in Equity Interest of Investors in Foreign-invested Enterprises, effective from May 28,1997, and not subject to the M&A Rules.

However, our PRC legal advisor further advises us that there remains some uncertainty as to how the M&A Rules will be interpreted or implemented in the context of an overseas offering, and its opinions summarized above are subject to any new laws, rules and regulations or detailed implementations and interpretations in any form relating to the M&A Rules. We cannot assure you that relevant PRC government agencies, including the CSRC, would reach the same conclusion as our PRC legal counsel, and hence we may face regulatory actions or other

 

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sanctions from the CSRC or other PRC regulatory agencies. These regulatory agencies may impose fines and penalties on our operations in China, limit our ability to pay dividends outside of China, limit our operating privileges in China, delay or restrict the repatriation of the proceeds from this offering into China or take other actions that could have a material adverse effect on our business, financial condition, results of operations and prospects, as well as the trading price of the ADSs. The CSRC or other PRC regulatory agencies also may take actions requiring us, or making it advisable for us, to halt this offering before settlement and delivery of the ADSs offered hereby. Consequently, if you engage in market trading or other activities in anticipation of and prior to settlement and delivery, you do so at the risk that settlement and delivery may not occur. In addition, if the CSRC or other regulatory agencies later promulgate new rules or explanations requiring that we obtain their approvals for this offering, we may be unable to obtain a waiver of such approval requirements, if and when procedures are established to obtain such a waiver. Any uncertainties and/or negative publicity regarding such approval requirement could have a material adverse effect on the trading price of the ADSs.

You may face difficulties in protecting your interests, and your ability to protect your rights through U.S. courts may be limited, because we are incorporated under Cayman Islands law.

We are an exempted company incorporated under the laws of the Cayman Islands. Our corporate affairs are governed by our memorandum and articles of association, the Companies Law (2016 Revision) of the Cayman Islands and the common law of the Cayman Islands (“Cayman Companies Law”). The rights of shareholders to take action against our directors, actions by our minority shareholders and the fiduciary duties of our directors to us under Cayman Islands law are to a large extent governed by the common law of the Cayman Islands. The common law of the Cayman Islands is derived in part from comparatively limited judicial precedent in the Cayman Islands as well as from the common law of England, the decisions of whose courts are of persuasive authority, but are not binding, on a court in the Cayman Islands. The rights of our shareholders and the fiduciary duties of our directors under Cayman Islands law are not as clearly established as they would be under statutes or judicial precedent in some jurisdictions in the United States. In particular, the Cayman Islands have a less developed body of securities laws than the United States. Some U.S. states, such as Delaware, have more fully developed and judicially interpreted bodies of corporate law than the Cayman Islands. In addition, Cayman Islands companies may not have standing to initiate a shareholder derivative action in a federal court of the United States.

Shareholders of Cayman Islands exempted companies like us have no general rights under Cayman Islands law to inspect corporate records or to obtain copies of lists of shareholders of these companies. Our directors have discretion under our articles of association that will become effective immediately prior to completion of this offering to determine whether or not, and under what conditions, our corporate records may be inspected by our shareholders, but are not obliged to make them available to our shareholders. This may make it more difficult for you to obtain the information needed to establish any facts necessary for a shareholder motion or to solicit proxies from other shareholders in connection with a proxy contest.

As a result of all of the above, our public shareholders may have more difficulty in protecting their interests in the face of actions taken by our management, members of the board of directors or controlling shareholders than they would as public shareholders of a company incorporated in the United States. For a discussion of significant differences between the provisions of the Companies Law of the Cayman Islands and the laws applicable to companies incorporated in the United States and their shareholders, please refer to “Description of Share Capital—Differences in Corporate Law.”

Certain judgments obtained against us by our shareholders may not be enforceable.

We are a Cayman Islands company and substantially all of our assets are located outside of the United States. Substantially all of our current operations are conducted in China. In addition, most of our current directors and officers are nationals and residents of countries other than the United States. Substantially all of the assets of these persons are located outside the United States. As a result, it may be difficult or impossible for you

 

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to bring an action against us or against these individuals in the United States in the event that you believe that your rights have been infringed under the U.S. federal securities laws or otherwise. Even if you are successful in bringing an action of this kind, the laws of the Cayman Islands and of China may render you unable to enforce a judgment against our assets or the assets of our directors and officers. For more information regarding the relevant laws of the Cayman Islands and China, please refer to “Enforceability of Civil Liabilities.”

The voting rights of holders of ADSs are limited by the terms of the deposit agreement, and you may not be able to exercise your right to direct the voting of your ordinary shares underlying your ADSs.

Holders of ADSs do not have the same rights as our registered shareholders. As a holder of our ADSs, you will not have any direct right to attend general meetings of our shareholders or to cast any votes at such meetings. You will only be able to exercise the voting rights which attach to the ordinary shares underlying your ADSs indirectly by giving voting instructions to the depositary in accordance with the provisions of the deposit agreement. Under the deposit agreement, you may vote only by giving voting instructions to the depositary, as holder of the ordinary shares underlying your ADSs. Upon receipt of your voting instructions, the depositary may try to vote the ordinary shares underlying your ADSs in accordance with your instructions. If we ask for your instructions, then upon receipt of your voting instructions, the depositary will try to vote the underlying ordinary shares in accordance with those instructions. If we do not instruct the depositary to ask for your instructions, the depositary may still vote in accordance with instructions you give, but it is not required to do so. You will not be able to directly exercise any right to vote with respect to the underlying ordinary shares unless you withdraw the shares and become the registered holder of such shares prior to the record date for the general meeting. When a general meeting is convened, you may not receive sufficient advance notice of the meeting to enable you to withdraw the shares underlying your ADSs and become the registered holder of such shares prior to the record date for the general meeting to allow you to attend the general meeting and to vote directly with respect to any specific matter or resolution to be considered and voted upon at the general meeting. In addition, under our post-offering articles of association that will become effective immediately prior to completion of this offering, for the purposes of determining those shareholders who are entitled to attend and vote at any general meeting, our directors may close our register of members and/or fix in advance a record date for such meeting, and such closure of our register of members or the setting of such a record date may prevent you from withdrawing the ordinary shares underlying your ADSs and becoming the registered holder of such shares prior to the record date, so that you would not be able to attend the general meeting or to vote directly. Where any matter is to be put to a vote at a general meeting, the depositary will notify you of the upcoming vote and to deliver our voting materials to you. We cannot assure you that you will receive the voting material in time to ensure you can direct the depositary to vote your shares. In addition, the depositary and its agents are not responsible for failing to carry out voting instructions or for their manner of carrying out your voting instructions. This means that you may not be able to exercise your right to direct how the shares underlying your ADSs are voted and you may have no legal remedy if the shares underlying your ADSs are not voted as you requested.

You may experience dilution of your holdings due to the inability to participate in rights offerings.

We may, from time to time, distribute rights to our shareholders, including rights to acquire securities. Under the deposit agreement, the depositary will not distribute rights to holders of ADSs unless the distribution and sale of rights and the securities to which these rights relate are either exempt from registration under the Securities Act with respect to all holders of ADSs, or are registered under the provisions of the Securities Act. The depositary may, but is not required to, attempt to sell these undistributed rights to third parties, and may allow the rights to lapse. We may be unable to establish an exemption from registration under the Securities Act, and we are under no obligation to file a registration statement with respect to these rights or underlying securities or to endeavor to have a registration statement declared effective. Accordingly, holders of ADSs may be unable to participate in our rights offerings and may experience dilution of their holdings as a result.

 

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You may be subject to limitations on the transfer of your ADSs.

Your ADSs are transferable on the books of the depositary. However, the depositary may close its books at any time or from time to time when it deems it expedient in connection with the performance of its duties. The depositary may close its books in emergencies, and on weekends and public holidays. The depositary may refuse to deliver, transfer or register transfers of our ADSs generally when our share register or the books of the depositary are closed, or at any time if we or the depositary thinks it is advisable to do so because of any requirement of law or of any government or governmental body, or under any provision of the deposit agreement, or for any other reason.

We are an emerging growth company within the meaning of the Securities Act and may take advantage of certain reduced reporting requirements.

We are an “emerging growth company,” as defined in the JOBS Act, and we may take advantage of certain exemptions from requirements applicable to other public companies that are not emerging growth companies, including, most significantly, not being required to comply with the auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act of 2002 for so long as we remain an emerging growth company. As a result, if we elect not to comply with such auditor attestation requirements, our investors may not have access to certain information they may deem important.

We are a foreign private issuer within the meaning of the rules under the Exchange Act, and as such we are exempt from certain provisions applicable to U.S. domestic public companies.

Because we qualify as a foreign private issuer under the Exchange Act, we are exempt from certain provisions of the securities rules and regulations in the United States that are applicable to U.S. domestic issuers, including:

 

    the rules under the Exchange Act requiring the filing with the SEC of quarterly reports on Form 10-Q or current reports on Form 8-K;

 

    the sections of the Exchange Act regulating the solicitation of proxies, consents or authorizations in respect of a security registered under the Exchange Act;

 

    the sections of the Exchange Act requiring insiders to file public reports of their stock ownership and trading activities and liability for insiders who profit from trades made in a short period of time; and

 

    the selective disclosure rules by issuers of material nonpublic information under Regulation FD.

We will be required to file an annual report on Form 20-F within four months of the end of each fiscal year. In addition, we intend to publish our results on a quarterly basis as press releases, distributed pursuant to the rules and regulations of the NYSE. Press releases relating to financial results and material events will also be furnished to the SEC on Form 6-K. However, the information we are required to file with or furnish to the SEC will be less extensive and less timely compared to that required to be filed with the SEC by U.S. domestic issuers. As a result, you may not be afforded the same protections or information that would be made available to you were you investing in a U.S. domestic issuer.

As a company incorporated in the Cayman Islands, we are permitted to adopt certain home country practices in relation to corporate governance matters that differ significantly from the New York Stock Exchange corporate governance listing standards. These practices may afford less protection to shareholders than they would enjoy if we complied fully with the New York Stock Exchange corporate governance listing standards.

As a Cayman Islands company listed on the New York Stock Exchange, we are subject to New York Stock Exchange corporate governance listing standards. However, New York Stock Exchange rules permit a foreign

 

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private issuer like us to follow the corporate governance practices of its home country. Certain corporate governance practices in the Cayman Islands, which is our home country, may differ significantly from the New York Stock Exchange corporate governance listing standards. To the extent we choose to follow home country practice in the future, our shareholders may be afforded less protection than they otherwise would enjoy under New York Stock Exchange corporate governance listing standards applicable to U.S. domestic issuers.

There is a high probability that we will be a passive foreign investment company for U.S. federal income tax purposes, which will generally result in adverse U.S. federal income tax consequences to U.S. taxpayers.

In general, a non-U.S. corporation will be a passive foreign investment company (a “PFIC”) for U.S. federal income tax purposes for any taxable year in which (i) 75% or more of its gross income consists of passive income or (ii) 50% or more of the average quarterly value of its assets consists of assets that produce, or are held for the production of, passive income. Passive income generally includes interest, income equivalent to interest, rents, dividends, royalties and certain capital gains.

The proper application of the PFIC rules to a company with a business such as ours is subject to uncertainty in some respects. For example, because we provide loan facilitation and other services in connection with the loans extended by our consolidated trust plans, it is not entirely clear whether and to what extent a portion of our interest income (as reflected on our consolidated income statement) could be treated as payable for such services. In addition, for purposes of the PFIC rules “passive income” is defined by way of a cross-reference to a specific provision under the “controlled foreign corporation” (“CFC”) rules of the Internal Revenue Code of 1986, as amended. A different provision under the CFC rules sets forth an exception for interest income derived by “eligible CFCs” that are “predominantly engaged” in the active conduct of a financing or similar business (the “Active Financing Exception”). It is unclear whether the Active Financing Exception is applicable to a company that is not a CFC, such as our company, and, even if it were so applicable, it is unclear whether we would be considered to be predominantly engaged in the active conduct of a financing or similar business and satisfy all of the exception’s requirements for any taxable year. U.S. taxpayers should consult their tax advisers regarding our PFIC status for any taxable year, including the availability of the Active Financing Exception. Due to the uncertainties described above, and based on the current and expected composition of our income and assets and the manner in which we operate our business (including our ownership of subordinated units in our consolidated trust plans), there is a high probability that we will be a PFIC for our current and future taxable years. Accordingly, when making their investment decision prospective U.S. investors should take into account the potential adverse consequences of owning shares of a PFIC. A U.S. taxpayer that owns our ADSs or ordinary shares during any year in which we are a PFIC will generally be subject to adverse U.S. federal income tax consequences. See “Taxation—Material U.S. Federal Income Tax Considerations—Passive Foreign Investment Company” in this prospectus. Prospective U.S. investors should consult their tax advisers concerning our PFIC status for any taxable year and the tax considerations relevant to an investment in a PFIC.

 

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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

This prospectus contains forward-looking statements that involve risks and uncertainties. All statements other than statements of historical facts are forward-looking statements. These statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different from those expressed or implied by the forward-looking statements.

You can identify these forward-looking statements by words or phrases such as “may,” “will,” “expect,” “anticipate,” “aim,” “estimate,” “intend,” “plan,” “believe,” “likely to” or other similar expressions. We have based these forward-looking statements largely on our current expectations and projections about future events and financial trends that we believe may affect our financial condition, results of operations, business strategy and financial needs. These forward-looking statements include, but are not limited to, statements about:

 

    our goals and growth strategies;

 

    our future business development, results of operations and financial condition;

 

    relevant government policies and regulations relating to our business and industry;

 

    our expectation regarding the use of proceeds from this offering;

 

    general economic and business condition in China; and

 

    assumptions underlying or related to any of the foregoing.

You should read thoroughly this prospectus and the documents that we refer to in this prospectus with the understanding that our actual future results may be materially different from and worse than what we expect. Other sections of this prospectus include additional factors which could adversely impact our business and financial performance. Moreover, we operate in an evolving environment. New risk factors and uncertainties emerge from time to time and it is not possible for our management to predict all risk factors and uncertainties, nor can we assess the impact of all factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements. We qualify all of our forward-looking statements by these cautionary statements.

You should not rely upon forward-looking statements as predictions of future events. We undertake no obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

 

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USE OF PROCEEDS

We estimate that we will receive net proceeds from this offering of approximately US$                 million, or approximately US$                 million if the underwriters exercise their option to purchase additional ADSs in full, after deducting underwriting discounts and commissions and the estimated offering expenses payable by us.

We plan to use the net proceeds of this offering for working capital and other general corporate purposes. In utilizing the proceeds from this offering, we are permitted under PRC laws and regulations to provide funding to our PRC subsidiaries only through loans or capital contributions and only if we satisfy the applicable government registration and approval requirements. We cannot assure you that we will be able to meet these requirements on a timely basis, if at all. See “Risk Factors—Risks Related to Doing Business in China—PRC regulation of loans to and direct investment in PRC entities by offshore holding companies and governmental control of currency conversion may delay us from using the proceeds of this offering to make loans or additional capital contributions to our PRC subsidiary, which could materially and adversely affect our liquidity and our ability to fund and expand our business.”

Pending use of the net proceeds, we intend to hold our net proceeds in short-term, interest-bearing, financial instruments or demand deposits.

 

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DIVIDEND POLICY

We have not previously declared or paid cash dividends and we have no plan to declare or pay any dividends in the near future on our shares or the ADSs representing our ordinary shares. We currently intend to retain most, if not all, of our available funds and any future earnings to operate and expand our business.

We are a holding company incorporated in the Cayman Islands. We rely principally on dividends from our PRC subsidiaries for our cash requirements, including any payment of dividends to our shareholders. PRC regulations may restrict the ability of our PRC subsidiaries to pay dividends to us. See “Regulation—Regulations on Dividend Distribution.”

Our Board of Directors has discretion as to whether to distribute dividends, subject to certain requirements of Cayman Islands law. In addition, subject to the provisions in our articles of association, our shareholders may by ordinary resolution declare a dividend, but no dividend may exceed the amount recommended by our Board of Directors. Under Cayman Islands law, a Cayman Islands company may pay a dividend out of either profit or share premium account, provided that in no circumstances may a dividend be paid if this would result in the company being unable to pay its debts as they fall due in the ordinary course of business. Even if our Board of Directors decides to pay dividends, the form, frequency and amount will depend upon our future operations and earnings, capital requirements and surplus, general financial condition, contractual restrictions and other factors that the board of directors may deem relevant. If we pay any dividends on our ordinary shares, we will pay those dividends which are payable in respect of the ordinary shares underlying the ADSs to the depositary, as the registered holder of such ordinary shares, and the depositary then will pay such amounts to the ADS holders in proportion to the ordinary shares underlying the ADSs held by such ADS holders, subject to the terms of the deposit agreement, including the fees and expenses payable thereunder. See “Description of American Depositary Shares.”

 

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CAPITALIZATION

The following table sets forth our capitalization as of March 31, 2018:

 

    on an actual basis; and

 

    on an as adjusted basis to reflect the issuance and sale of                  ordinary shares in the form of ADSs by us in this offering at an initial public offering price of US$                 per ADS, after deducting the underwriting discounts and commissions and estimated offering expenses payable by us (assuming the underwriters do not exercise their option to purchase additional ADSs).

You should read this table together with our consolidated financial statements and the related notes included elsewhere in this prospectus and the information under “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

 

     As of March 31, 2018  
     Actual      As Adjusted(1)  
     RMB     US$      RMB      US$  

Long-term borrowings from

          

Investors of trust plans(2)

     4,275,580,000       681,628,033        

Senior tranche of a trust plan which invests in the Company’s loans portfolio(3)

     117,819,051       18,783,128        

Investors of a wealth management product which invests in the Company’s loans portfolio(4)

     46,448,651       7,405,008        

Equity

          

Ordinary shares

     98,493       12,909,102        

Additional paid-in capital(5)

     578,955,539       79,405,733        

Retained earnings

     1,463,339,879       233,290,801        

Accumulated other comprehensive income/(loss)

     (4,406,512     (702,502)        

Total equity

     2,037,987,399       324,903,134        
  

 

 

   

 

 

    

 

 

    

 

 

 

Total capitalization(6)

     8,515,822,500       1,357,622,437        
  

 

 

   

 

 

    

 

 

    

 

 

 

 

Notes:

(1) The as adjusted information discussed above is illustrative only. Our additional paid-in capital, total equity and total capitalization following the completion of this offering are subject to adjustment based on the actual initial public offering price and other terms of this offering determined at pricing.
(2) Such borrowings represent funding from senior unit holders over one year in the trust plans under our trust lending model. Trust plans are treated as variable interest entities from an accounting perspective and are consolidated into our financial statements.
(3) Such borrowings represent funding from transfer of rights to earnings in loans principal, interest and financing service fee receivables over one year to a trust plan under our direct lending model which is used to fund the loans originated by our small loan subsidiaries.
(4) Such borrowings represent funding from transfer of rights to earnings in loans principal, interest and financing service fee receivables over one year acquired from trust products set up by our trust company partners to a wealth management product.
(5) Assuming the number of ADSs offered by us as set forth on the cover page of this prospectus remains the same, and after deduction of underwriting discounts and commissions and the estimated offering expenses payable by us, a US$1.00 change in the assumed initial public offering price of US$                 per ADS would, in the case of an increase, increase and, in the case of a decrease, decrease each of additional paid-in capital, total equity and total capitalization by US$                 million.
(6) Total capitalization equals the sum of long-term borrowings and total equity.

 

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DILUTION

If you invest in our ADSs, your interest will be diluted to the extent of the difference between the initial public offering price per ADS and our net tangible book value per ADS after this offering. Dilution results from the fact that the initial public offering price per ordinary share is substantially in excess of the book value per ordinary share attributable to the existing shareholders for our presently outstanding ordinary shares.

Our net tangible book value as of             , 2018 was US$             million, or US$             per ordinary share and US$                 per ADS. Net tangible book value per ordinary share represents the amount of total tangible assets, minus the amount of total liabilities, divided by the total number of ordinary shares outstanding. Dilution is determined by subtracting net tangible book value per ordinary share from the public offering price per ordinary share.

Without taking into account any other changes in such net tangible book value after March 31, 2018, other than to give effect to our issuance and sale of ADSs offered in this offering at an initial public offering price of US$                 per ADS, after deduction of the underwriting discounts and commissions and estimated offering expenses payable by us, our pro forma as adjusted net tangible book value as of March 31, 2018 would have been US$                 million, or US$                 per ordinary share and US$                 per ADS, to existing shareholders and an immediate dilution in net tangible book value of US$                 per ordinary share, or US$                     per ADS, to purchasers of ADSs in this offering.

The following table illustrates the dilution on a per ordinary share basis at the initial public offering price per ordinary share is US$                 and all ADSs are exchanged for ordinary shares.

 

Initial public offering price per ordinary share

   US$               

Net tangible book value per ordinary share

   US$  

Pro forma net tangible book value per ordinary share as adjusted to give effect this offering as of March 31, 2018

   US$  

Amount of dilution in net tangible book value per ordinary share to new investors in the offering

   US$  
  

 

 

 

Amount of dilution in net tangible book value per ADS to new investors in the offering

   US$  
  

 

 

 

The pro forma information discussed above is illustrative only.

The following table summarizes, on a pro forma basis as of March 31, 2018, the differences between the existing shareholders and the new investors with respect to the number of ordinary shares purchased from us in this offering, the total consideration paid and the average price per ordinary share paid at the initial public offering price of US$             per ADS before deducting estimated underwriting discounts and commissions and estimated offering expenses. The total number of ordinary shares does not include ordinary shares underlying the ADSs issuable upon the exercise of the over-allotment option granted to the underwriters.

 

                   Total Consideration                
     Ordinary shares Purchased      Amount (in
thousands of

US$)
            Average Price
Per Ordinary
Share
     Average Price
Per ADS
 
     Numbers      Percent      US$      Percent      US$      US$  

Existing shareholders

                 

New investors

                 

Total

                 

The discussion and tables above also assume no exercise of any stock options outstanding as of the date of this prospectus. As of the date of this prospectus, there are              ordinary shares issuable upon exercise of outstanding stock options with an exercise price of US$             per ordinary share, and there are a total of              ordinary shares available for future issuance upon the exercise of grants under the 2018 Plan. To the extent that any of these options are exercised, there will be further dilution to new investors.

 

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EXCHANGE RATE INFORMATION

Our reporting currency is the Renminbi because our business is mainly conducted in China and all of our revenues are denominated in Renminbi. This prospectus contains translations of Renminbi amounts into U.S. dollars at specific rates solely for the convenience of the reader. The conversion of Renminbi into U.S. dollars in this prospectus is based on the rate certified for customs purposes by the Federal Reserve Bank of New York. Unless otherwise noted, all translations from Renminbi to U.S. dollars and from U.S. dollars to Renminbi in this prospectus are made at RMB6.2726 to US$1.00, the exchange rate set forth in the H.10 statistical release of the Federal Reserve Board on March 30, 2018. We make no representation that any Renminbi or U.S. dollar amounts could have been, or could be, converted into U.S. dollars or Renminbi, as the case may be, at any particular rate, the rates stated below, or at all. The PRC government imposes control over its foreign currency reserves in part through direct regulation of the conversion of Renminbi into foreign exchange and through restrictions on foreign trade. On July 6, 2018, the rate was RMB6.6396 to US$1.00.

The following table sets forth information concerning exchange rates between the Renminbi and the U.S. dollar for the periods indicated. These rates are provided solely for your convenience and are not necessarily the exchange rates that we used in this prospectus or will use in the preparation of our periodic reports or any other information to be provided to you.

 

     Noon Buying Rate  

Period

   Period End      Average(1)      Low      High  
     (RMB per US$1.00)  

2013

     6.0537        6.1412        6.2438        6.0537  

2014

     6.2046        6.1704        6.2591        6.0402  

2015

     6.4778        6.2869        6.4896        6.1870  

2016

     6.9430        6.6549        6.9580        6.4480  

2017

     6.5063        6.7350        6.9575        6.4773  

2018

           

January

     6.2841        6.4233        6.5263        6.2841  

February

     6.3280        6.3183        6.3471        6.2649  

March

     6.2726        6.3174        6.3565        6.2685  

April

     6.3325        6.2967        6.3340        6.2655  

May

     6.4096        6.3701        6.4175        6.3325  

June

     6.6171        6.4651        6.6235        6.3850  

July (through July 6)

     6.6396        6.6434        6.6632        6.6341  

 

Source: Federal Reserve Statistical Release

 

Notes:
(1) Annual averages were calculated by using the average of the exchange rates on the last day of each month during the relevant year. Monthly averages are calculated by using the average of the daily rates during the relevant month.

 

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ENFORCEABILITY OF CIVIL LIABILITIES

We were incorporated in the Cayman Islands in order to enjoy the following benefits:

 

    political and economic stability;

 

    an effective judicial system;

 

    a favorable tax system;

 

    the absence of exchange control or currency restrictions; and

 

    the availability of professional and support services.

However, certain disadvantages accompany incorporation in the Cayman Islands. These disadvantages include, but are not limited to, the following:

 

    the Cayman Islands has a less developed body of securities laws as compared to the United States and these securities laws provide significantly less protection to investors; and

 

    Cayman Islands companies may not have standing to sue before the federal courts of the United States.

Our constitutional documents do not contain provisions requiring that disputes, including those arising under the securities laws of the United States, between us, our officers, directors and shareholders, be arbitrated.

All of our operations are conducted outside the United States, and all of our assets are located outside the United States. A majority of our directors and officers are nationals or residents of jurisdictions other than the United States and a substantial portion of their assets are located outside the United States. As a result, it may be difficult for a shareholder to effect service of process within the United States upon these persons, or to enforce against us or them judgments obtained in United States courts, including judgments predicated upon the civil liability provisions of the securities laws of the United States or any state in the United States.

We have appointed Cogency Global Inc. as our agent upon whom process may be served in any action brought against us under the securities laws of the United States.

Walkers, our counsel as to Cayman Islands law, and Han Kun Law Offices, our counsel as to PRC law, advise us, respectively, that there is uncertainty as to whether the courts of the Cayman Islands and China, respectively, would:

 

    recognize or enforce judgments of United States courts obtained against us or our directors or officers predicated upon the civil liability provisions of the securities laws of the United States or any state in the United States; or

 

    entertain original actions brought in each respective jurisdiction against us or our directors or officers predicated upon the securities laws of the United States or any state in the United States.

Walkers has informed us that it is uncertain whether the courts of the Cayman Islands will allow shareholders of our company to originate actions in the Cayman Islands based upon securities laws of the United States. In addition, there is uncertainty with regard to Cayman Islands law related to whether a judgment obtained from the U.S. courts under civil liability provisions of U.S. securities laws will be determined by the courts of the Cayman Islands as penal or punitive in nature. If such a determination is made, the courts of the Cayman Islands will not recognize or enforce the judgment against a Cayman Islands company, such as our company. As the courts of the Cayman Islands have yet to rule on making such a determination in relation to judgments obtained from U.S. courts under civil liability provisions of U.S. securities laws, it is uncertain whether such judgments would be enforceable in the Cayman Islands. Walkers has further informed us that although there is no statutory enforcement in the Cayman Islands of judgments obtained in the federal or state

 

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courts of the United States (and the Cayman Islands are not a party to any treaties for the reciprocal enforcement or recognition of such judgments), a judgment obtained in such jurisdiction will be recognized and enforced in the courts of the Cayman Islands at common law, without any reexamination of the merits of the underlying dispute, by an action commenced on the foreign judgment debt in the Grand Court of the Cayman Islands, provided such judgment (a) is given by a foreign court of competent jurisdiction, (b) imposes on the judgment debtor a liability to pay a liquidated sum for which the judgment has been given, (c) is final, (d) is not in respect of taxes, a fine or a penalty, and (e) was not obtained in a manner and is not of a kind the enforcement of which is contrary to natural justice or the public policy of the Cayman Islands.

Our PRC legal advisor, Han Kun Law Offices, advises us that there is uncertainty as to whether the courts of the PRC would enforce judgments of United States courts or Cayman courts obtained against us or these persons predicated upon the civil liability provisions of the United States federal and state securities laws. Our PRC legal advisor further advises us that the recognition and enforcement of foreign judgments are provided for under PRC Civil Procedures Law. PRC courts may recognize and enforce foreign judgments in accordance with the requirements of PRC Civil Procedures Law based either on treaties between China and the country where the judgment is made or on reciprocity between jurisdictions. China does not have any treaties or other form of reciprocity with the United States or the Cayman Islands that provide for the reciprocal recognition and enforcement of foreign judgments. In addition, according to the PRC Civil Procedures Law, courts in the PRC will not enforce a foreign judgment against us or our directors and officers if they decide that the judgment violates the basic principles of PRC law or national sovereignty, security or public interest. As a result, it is uncertain whether and on what basis a PRC court would enforce a judgment rendered by a court in the United States or in the Cayman Islands.

 

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CORPORATE HISTORY AND STRUCTURE

Corporate History

We started our operations in 1999 through Fanhua Chuang Li Information Technology (Shenzhen) Co., Ltd., which became our onshore holding company of the main operating subsidiaries in the PRC. In 2000, we formed our wholly owned Hong Kong subsidiary, China Financial Services Group Limited (“CFSGL”), as the offshore holding company of our PRC subsidiaries. In 2006, we were spun off from Fanhua Inc., a company listed on NASDAQ (symbol: FANH), and formed Sincere Fame International Limited (“SFIL”) under the laws of British Virgin Islands as the holding company of CFSGL. In January 2014, CNFinance Holdings Limited was incorporated under the laws of Cayman Islands. CNFinance Holdings Limited became our holding company through share exchanges with the shareholders of SFIL in March 2018. We conduct our business in the PRC primarily through Shenzhen Fanhua United Investment Group Co., Ltd., Guangzhou Heze Information Technology Co., Ltd. and their subsidiaries.

 

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Corporate Structure

The following diagram illustrates our corporate structure with material subsidiaries as of the date of this prospectus. For a complete list of our subsidiaries, please refer to Note 1 to our consolidated financial statements as of and for the years ended December 31, 2016 and 2017 included elsewhere in this prospectus. We subscribe to the subordinated units of the trust products issued under long-term trust plans through three of our wholly owned subsidiaries, Guangzhou Heze Information Technology Co., Ltd., Guangzhou Chengze Information Technology Co., Ltd. and Shenzhen Fanhua United Investment Group Co., Ltd. From an accounting perspective, we are exposed to the risk and variability of returns from activities of the trust plans and are therefore required to consolidate the financial results of the trust plans, including the results related to the senior units. Financial data of a trust plan is consolidated as if the trust plan is a subsidiary. Income and expenses of the trust plans are consolidated on our consolidated statements of comprehensive income while assets and liabilities of the trust plans are consolidated on our consolidated balance sheet. We do not, however, have ownership interest in the trust plans from a legal perspective other than in the subordinated units that account for only a portion of the total outstanding amount of the trust plans. For details of the contractual structural leverage ratio of each trust plan, please refer to “Business—Our Funding Model.”

 

LOGO

 

 

Notes:

(1) Guangzhou Heze Information Technology Co., Ltd. is one of the entities through which we subscribe to subordinated units of trust products.
(2) Guangzhou Chengze Information Technology Co., Ltd. is one of the entities through which we subscribe to subordinated units of trust products.

 

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(3) Shenzhen Fanhua United Investment Group Co., Ltd. operates our loan services business through various subsidiaries in the PRC and operates our small loan business through Beijing Fanhua Micro-credit Company Limited and Shenzhen Fanhua Micro-credit Co., Ltd.
(4) Established in May 2018.

 

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SELECTED CONSOLIDATED FINANCIAL DATA

The following selected consolidated statements of comprehensive income data and selected consolidated cash flow data for the years ended December 31, 2016 and 2017, and selected consolidated balance sheet data as of December 31, 2016 and 2017 have been derived from our audited consolidated financial statements included elsewhere in this prospectus. The following selected consolidated statements of comprehensive income data and selected consolidated cash flow data for the three months ended March 31, 2017 and 2018, and selected consolidated balance sheet data as of March 31, 2018 have been derived from our unaudited interim condensed consolidated financial statements included elsewhere in this prospectus. Our consolidated financial statements are prepared and presented in accordance with U.S. GAAP. Our historical results do not necessarily indicate results expected for any future periods. You should read this Selected Consolidated Financial Data section together with our consolidated financial statements and the related notes and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this prospectus.

Consolidated Statements of Comprehensive Income Data

The following table presents our selected consolidated statements of comprehensive income for the years ended December 31, 2016 and 2017 and for the three months ended March 31, 2017 and 2018.

 

    For the Year Ended December 31,     For the Three Months Ended March 31,  
    2016     2017     2017     2018  
    RMB     RMB     US$     RMB     RMB     US$  

Selected Consolidated Statements of Comprehensive Income:

           

Interest and fees income

           

Interest and financing service fee on loans

    1,242,128,524       3,406,110,592       543,014,156       624,052,654       1,063,195,480       169,498,371  

Interest on deposits with banks

    1,417,305       4,337,177       691,448       448,981       2,138,161       340,873  

Total interest and fees income

    1,243,545,829       3,410,447,769       543,705,604       624,501,635       1,065,333,641       169,839,244  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Interest expense

           

Interest expense on interest-bearing borrowings

    (442,661,324     (1,401,191,685     (223,382,917     (226,604,844     (467,238,302     (74,488,777

Interest expense on amounts due to related parties

    —         (8,714,000     (1,389,217     (296,000     —         —    

Total interest expense

    (442,661,324     (1,409,905,685     (224,772,134     (226,900,844 )      (467,238,302 )      (74,488,777
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net interest and fees income

    800,884,505       2,000,542,084       318,933,470       397,600,791       598,095,339       95,350,467  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Provision for credit losses

    (111,362,044     (306,752,951     (48,903,637     (41,891,522     (143,547,335     (22,884,822

Net interest and fees income after provision for credit losses

    689,522,461       1,693,789,133       270,029,833       355,709,269       454,548,004       72,465,645  

Realized gains/(losses) on sales of investments, net

    66,878,501       (11,527,798     (1,837,802     (1,474,014     709,808       113,160  

Other-than-temporary losses on available-for-sale investments

    (36,692,695     —         —         —         —         —    

Other revenue, net

    36,261,933       23,979,610       3,822,914       4,704,502       843,097       134,409  

Total non-interest revenue

    66,447,739       12,451,812       1,985,112       3,230,488       1,552,905       247,570  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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    For the Year Ended December 31,     For the Three Months Ended March 31,  
    2016     2017     2017     2018  
    RMB     RMB     US$     RMB     RMB     US$  

Operating expenses

           

Employee compensation and benefits

    (299,225,819     (545,956,248     (87,038,269     (109,503,389     (117,113,556     (18,670,656

Share-based compensation expense

    —         (182,689,766     (29,125,046     (45,672,441     (9,928,792     (1,582,883

Taxes and surcharges

    (48,207,495     (38,835,933     (6,191,361     (10,958,462     (14,512,100     (2,313,570

Rental and property management expenses

    (24,404,690     (47,896,817     (7,635,879     (9,108,676     (14,055,902     (2,240,841

Impairment of goodwill

    (20,279,026     —         —         —         —         —    

Offering expenses

    —         —         —         —         (4,659,577     (742,846

Other expenses

    (75,807,908     (82,194,556     (13,103,746     (16,132,637     (19,907,912     (3,173,789

Total operating expenses

    (467,924,938     (897,573,320     (143,094,302     (191,375,605     (180,177,839     (28,724,586
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income before income tax

    288,045,262       808,667,625       128,920,643       167,564,152       275,923,070       43,988,628  

Income tax expense

    (52,603,423     (275,994,868     (44,000,075     (55,522,454     (79,176,187     (12,622,547

Net income

    235,441,839       532,672,757       84,920,568       112,041,698       196,746,883       31,366,082  

Earnings per share

           

Basic

    0.19       0.43       0.07       0.09       0.16       0.03  

Diluted

    0.19       0.40       0.06       0.09       0.15       0.02  

Other comprehensive income/(loss)

           

Net unrealized (losses)/gains on available-for-sale investments

    (194,680,052     (2,601,355     (414,717     (5,263,991     36,148       5,763  

Foreign currency translation adjustment

    (778,538     (198,794     (31,692     4,903       26,784       4,270  

Comprehensive income

    39,983,249       529,872,608       84,474,159       106,782,610       196,809,815       31,376,114  

Consolidated Balance Sheet Data

The following table presents our selected consolidated balance sheet data as of December 31, 2016 and 2017 and March 31, 2018.

 

    As of December 31,     As of March 31,  
    2016     2017     2018  
    RMB     RMB     US$     RMB     US$  

Selected Consolidated Balance Sheet:

         

Cash and cash equivalents

    233,138,588       1,190,360,385       189,771,448       1,467,458,484       233,947,404  

Loans principal, interest and financing service fee receivables (net of allowances)

    7,261,467,762       16,261,167,957       2,592,412,709       16,195,952,927       2,582,015,899  

Other assets(1)

    311,751,130       764,337,148       121,853,322       504,121,252       80,368,787  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total assets

    7,806,357,480       18,215,865,490       2,904,037,479       18,167,532,663       2,896,332,089  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Interest-bearing borrowings(2)

    6,293,027,316       15,707,936,178       2,504,214,549       15,389,774,201       2,453,492,045  

Other liabilities(3)

    394,643,746       676,680,520       107,878,793       739,771,063       117,936,910  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total liabilities

    6,687,671,062       16,384,616,698       2,612,093,342       16,129,545,264       2,571,428,955  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total shareholders’ equity

    1,118,686,418       1,831,248,792       291,944,137       2,037,987,399       324,903,134  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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Notes:

(1) Represents the sum of (i) available-for-sale investments, (ii) property and equipment, (iii) intangible assets and goodwill, (iv) deferred tax assets, (v) deposits and (vi) other assets as presented in our consolidated balance sheet.
(2) Represents the sum of (i) borrowings under agreements to repurchase and (ii) other borrowings.
(3) Represents the sum of (i) accrued employee benefits, (ii) amounts due to related parties, (iii) income tax payable, (iv) deferred tax liabilities and (v) other liabilities as presented in our consolidated balance sheet.

Consolidated Cash Flow Data

The following table presents our selected consolidated cash flow data for the years ended December 31, 2016 and 2017 and for the three months ended March 31, 2017 and 2018.

 

    For the Year Ended December 31,     For the Three Months Ended March 31,  
    2016     2017     2017     2018  
    RMB     RMB     US$     RMB     RMB     US$  

Selected Consolidated Cash Flow:

           

Net cash provided by operating activities

    379,883,655       1,286,649,584       205,122,212       232,861,180       282,558,417       45,046,459  

Net cash (used in)/provided by investing activities

    (4,700,415,345     (9,583,892,655     (1,527,897,946     (1,654,631,509     252,630,604       40,275,261  

Net cash provided by/(used in) financing activities

    4,291,087,461       9,256,740,263       1,475,742,158       1,909,076,302       (257,891,696     (41,114,003

Net (decrease)/increase in cash and cash equivalents

    (29,444,229     959,497,192       152,966,424       487,305,973       277,297,325       44,207,717  

Cash and cash equivalents at beginning of the period

    260,081,796       233,138,588       37,167,775       233,138,588       1,190,360,385       189,771,448  

Effect of exchange rate change on cash and cash equivalents

    2,501,021       (2,275,395     (362,751     (218,159     (199,226     (31,761
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cash and cash equivalents at end of the period

    233,138,588       1,190,360,385       189,771,448       720,226,402       1,467,458,484       233,947,404  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Non-GAAP Financial Measure

Adjusted Net Income

We use adjusted net income, a non-GAAP financial measure, in evaluating our operating results and for financial and operational decision-making purposes. We believe that adjusted net income help identify underlying trends in our business by excluding the impact of share-based compensation expenses, which are non-cash charges. We believe that adjusted net income provide useful information about our operating results, enhance the overall understanding of our past performance and future prospects and allow for greater visibility with respect to key metrics used by our management in its financial and operational decision-making.

 

    For the Year Ended December 31,     For the Three Months Ended March 31,  
    2016   2017     2017   2018  
    RMB   RMB   US$     RMB   RMB   US$  

Adjusted net income

  235,441,839   715,362,523     114,045,615     157,714,139   206,675,675     32,948,965  
 

 

 

 

 

 

 

   

 

 

 

 

 

 

 

Adjusted net income is not defined under U.S. GAAP and is not presented in accordance with U.S. GAAP. This non-GAAP financial measure should not be considered in isolation from, or as a substitute for, its most

 

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directly comparable financial measure prepared in accordance with U.S. GAAP. A reconciliation of the historical non-GAAP financial measure to its most directly comparable GAAP measure has been provided in the tables included below. Investors are encouraged to review the reconciliation of the historical non-GAAP financial measure to its most directly comparable GAAP financial measure. As adjusted net income has material limitations as an analytical metric and may not be calculated in the same manner by all companies, it may not be comparable to other similarly titled measures used by other companies. In light of the foregoing limitations, you should not consider adjusted net income as a substitute for, or superior to, net revenues prepared in accordance with U.S. GAAP. We encourage investors and others to review our financial information in its entirety and not rely on a single financial measure.

The following table reconciles our adjusted net income for the periods presented to the most directly comparable financial measure calculated and presented in accordance with U.S. GAAP, which is net income.

 

    For the Year Ended December 31,     For the Three Months Ended March 31,  
    2016     2017     2017     2018  
    RMB     RMB     US$     RMB     RMB     US$  

Net income

    235,441,839       532,672,757       84,920,568       112,041,698       196,746,883       31,366,082  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Add: share-based compensation expenses

    —         182,689,766       29,125,046       45,672,441       9,928,792       1,582,883  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Adjusted net income

    235,441,839       715,362,523       114,045,615       157,714,139       206,675,675       32,948,965  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION

AND RESULTS OF OPERATIONS

You should read the following discussion and analysis of our financial condition and results of operations in conjunction with the section entitled “Selected Consolidated Financial Data” and our consolidated financial statements and the related Notes included elsewhere in this prospectus. This discussion contains forward-looking statements that involve risks and uncertainties. Our actual results and the timing of events could differ materially from those anticipated in these forward-looking statements as a result of various factors, including those set forth under “Risk Factors” and elsewhere in this prospectus.

Overview

We are a leading home equity loan service provider in China with established business infrastructure. According to the Oliver Wyman report, we are the second largest home equity loan service provider among non-traditional financial institutions in China in terms of outstanding loan principal as of December 31, 2017. We facilitate loans by connecting MSE owners with our funding partners. Our primary target borrower segment is MSE owners who own real properties in Tier 1 and Tier 2 cities in China.

With more than ten years of experience in the loan service industry, we have established a national network of 73 branches and sub-branches in over 40 cities in China. The extensive local knowledge and resources we have acquired building our business infrastructure distinguish us from other players in the market. In 2016 and 2017, we originated home equity loans with aggregate principal amount of RMB8.3 billion and RMB17.1 billion, respectively, representing an increase of 105.8%. For the three months ended March 31, 2018, we originated home equity loans with an aggregate principal amount of RMB2.2 billion. We originated home equity loans for 12,983 and 23,705 borrowers in 2016 and 2017, respectively, representing an increase of 82.6%. For the three months ended March 31, 2018, we originated home equity loans for 3,949 borrowers. In 2016 and 2017 and for the three months ended March 31, 2018, the average tenor of the home equity loans we originated was 50, 66 and 65 months with the weighted average effective interest rate (inclusive of interests and financing service fees, if applicable, payable by the borrowers) of 26.0%, 23.7% and 22.4% per annum, respectively. The increase in the average tenor is because starting from April 2017 we facilitated more loan products with a longer term of eight years, and the decrease in the weighted average effective interest rate is because we ceased charging financing service fee to the borrowers starting from August 2017, and loan products with a term of eight years typically have a lower effective interest rate.

Our practical risk assessment focuses on both credit risks of borrowers and quality of the collateral. We have also established strict guidelines on characteristics and quality of collateral, including, among others, a LTV ratio capped at 80%. The weighted average LTV ratio of the home equity loan origination volume was 65.9%, 66.7% and 62.6% in 2016, 2017 and for the three months ended March 31, 2018, respectively. As of December 31, 2016 and 2017 and March 31, 2018, the NPL ratio was 1.50%, 1.66% and 1.75%, respectively. Charge-off ratio in 2016, 2017 and for the three months ended March 31, 2018 was 0.005%, 0.093% and nil, respectively.

We have grown significantly and were profitable in 2016 and 2017. Our total operating income increased from RMB867.3 million in 2016 to RMB2,013.0 million (US$320.9 million) in 2017, representing an increase of 132.1%, and from RMB400.8 million for the three months ended March 31, 2017 to RMB599.6 million (US$95.6 million) for the three months ended March 31, 2018, representing a growth of 49.6%. Our net income increased from RMB235.4 million in 2016 to RMB532.7 million (US$84.9 million) in 2017, representing a growth of 126.2%, and from RMB112.0 million for the three months ended March 31, 2017 to RMB196.7 million (US$31.4 million) for the three months ended March 31, 2018, representing an increase of 75.6%.

Under the contractual arrangements with our trust company partners, we subscribe to subordinated units of trust plans and also provide services to trust plans. As a result, we are entitled to (i) the investment return payable to us as subordinated unit holder and (ii) a performance-based service fee up to 8% per annum of the size of trust

 

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plans payable to us for our services provided to trust plans. Our cost of the subordinated units as measured by the investment amount was RMB1,928.6 million, RMB4,626.1 million and RMB4,802.3 million as of December 31, 2016 and 2017 and March 31, 2018, respectively. Our investment return from the subordinated units was RMB391.2 million, RMB1,595.3 million and RMB497.6 million in 2016, 2017 and for the three months ended March 31, 2018, respectively.

As a subordinated unit holder, we are exposed to variability of returns from activities of trust plans and are therefore required to consolidate the financial results of trust plans on our consolidated financial statements, including those of the senior units. Therefore, the service fee charged to trust plans is considered inter-company transaction and is eliminated together with management service expenses of trust plans for accounting purposes. In 2016 and 2017, we generated a service fee charged to trust plans of RMB331.8 million and RMB555.9 million, respectively. For the three months ended March 31, 2017 and 2018, we generated a service fee charged to trust plans of RMB169.5 million and RMB234.3 million, respectively.

Major Factors Affecting Our Results of Operations

Our business and results of operations have been, and are expected to continue to be, affected by a number of factors, many of which are outside of our control, including the following:

Ability to maintain and expand borrower base

Due to the nature of our business, our ability to increase our loan origination volume largely depends on our ability to acquire new borrowers for the loans we facilitate. We acquire borrowers primarily through our own network and sales personnel. Most of our borrowers have been engaged through our local offices and word-of-mouth marketing. We have also started collaborating with various channel partners to acquire new borrowers and use a variety of traditional and Internet marketing channels, including commercial banks and leading Internet companies who have access to underserved MSE owners. We originated home equity loans for 12,983, 23,705 and 3,949 borrowers in 2016, 2017 and for the three months ended March 31, 2018, respectively. Our results of operations and ability to sustain and increase loan volumes will depend on our ability to maintain and expand borrower base. We intend to continuously dedicate resources to borrower acquisition and services.

Effective risk management

Our operating income and profitability are largely affected by our risk management capabilities. We are exposed to credit risks under the trust lending model as a result of subscription of subordinated units and credit strengthening services and being a lender under the direct lending model. As such, our ability to accurately assess default risks through our credit analysis system directly affects our loan delinquency ratios and profitability.

We believe that our comprehensive risk management system has delivered superior asset quality throughout our operations in various macro-economic environments and through different economic cycles. Our dual-factor risk assessment with integrated online and offline process focuses on both the creditworthiness of borrowers and the quality of collaterals. We have also established systematic post-loan management procedures to enhance our risk management. Any significant weakness in our risk management system will directly or indirectly result in an increase in delinquency of loans originated by us or a failure of our loan servicing to recover losses. For a detailed discussion of our risk management, please refer to “Business—Our Competitive Strengths—Robust risk management delivering superior asset quality.”

Relationship with our funding partners

Our collaborative relationships with our funding partners are critical to our operations. We mainly collaborate with our trust company partners through trust lending model. In 2016 and 2017 and for the three months ended March 31, 2018, 94.1%, 95.4% and 99.7% of our total home equity loan origination volume was

 

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funded under trust lending model, respectively. The availability of funds from our funding partners affects our liquidity and the amount of loan transactions that we can facilitate, which directly affects our profitability. Terms of our collaboration agreements with our funding partners generally set the financing costs of our home equity loan business. Our financing costs for senior units excluding the trust administrative fees, ranged from 9.75% to 12.4% per annum of the issuance amount of senior units in 2016, 2017 and for the three months ended March 31, 2018. The interest charged by trust company partners to our borrowers affects our profitability. If we fail to maintain or deepen our existing relationships with our trust company partners, our liquidity and profitability may be adversely affected. A general deterioration of our relationships with our funding partners will result in a significant decrease in liquidity or in our service fees charged to trust plans, and we may not be able to secure alternative financing on terms acceptable to us or our borrowers, or at all. This may result in a decrease in the volume of loans we facilitate, which has a material adverse impact on our business and results of operations. For detailed discussion relating to our relationship with our funding partners, please refer to subsections headed “Business—Our Funding Model.”

China’s macro-economic environment

Our business depends on the growth of MSE owners’ demand for home equity loan financing, which in turn depends on China’s macro-economic environment. General economic factors, including the real estate prices, credit environment for MSEs, interest rate environment and unemployment rates, may affect borrowers’ willingness to seek home equity loans and/or repayment capability. For example, significant increase in interest rates could cause prospective borrowers to defer obtaining loans as they wait for interest rates to decrease. Additionally, a slowdown in the economy, resulting in a rise in the unemployment rate and/or a decrease in real income, may affect MSEs’ revenue. All these factors may affect borrowers’ repayment capability and their willingness to seek loans, which may potentially affect delinquency ratios.

Government regulations and policies

The regulatory environment for China’s financial market is developing and evolving, creating both challenges and opportunities that could affect our financial performance. We must adapt to developments in regulations and policies and may have to adjust our business practices, funding structures and product offerings from time to time. We will continue to ensure that we are compliant with existing laws, regulations and government policies relating to our business and to comply with new laws and regulations that may arise in the future. For an overview of applicable laws and regulations and risks relating to our business, see the sections headed “Regulations” and “Risk Factors.”

Loan Performance Data and Trend Analysis

Our operating results and financial condition are directly affected by the performance of the loans we originate. We closely monitor key loan performance data, including the data set out below, to track the performance of the loans we originate and adjust our risk management strategies intelligently and dynamically.

 

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The following chart sets forth the performance of the loans we originated as of December 31, 2016 and 2017 and March 31, 2018 as measured by delinquency ratio, NPL ratio, allowance ratio and NPL provision coverage ratio.

The performance of loans originated by us is subject to general economic environment, housing market condition and asset quality of China in general, hence may be subject to fluctuations from time to time. We focus mainly on the NPL ratio as home equity loans over 90 days past-due are more difficult and time-consuming to recover. Our NPL ratio remained stable as of December 31, 2016 and 2017 and March 31, 2018, and was 1.50%, 1.66% and 1.75%, respectively.

 

     As of December 31,     As of March 31,  

Loan performance metrics

   2016     2017     2018  

Delinquency ratio(1)

     5.38     7.17     11.04

NPL ratio(2)

     1.50     1.66     1.75

Allowance ratio(3)

     1.95     2.64     3.48

NPL provision coverage ratio(4)

     130.6     159.3     199.9

 

Notes:

(1) Delinquency ratio represents total balance of outstanding loan principal for which any installment payment is past-due (for one or more days) as a percentage of the outstanding loan principal as of the date.
(2) NPL ratio represents total balance of outstanding loan principal for which any installment payment is over 90 calendar days past-due as a percentage of the outstanding loan principal as of the date.
(3) Allowance ratio represents amount of allowance for loan principal, interest and financing service fee receivables as a percentage of the outstanding loan principal and interest and fee receivables as of the date.
(4) NPL provision coverage ratio represents amount of allowance for loan principal, interest and financing service fee receivables as a percentage of the balance of NPL principal as of the date.

Our delinquency ratio has increased from 5.38% as of December 31, 2016 to 7.17% as of December 31, 2017 and further to 11.04% as of March 31, 2018. As the personal lending and home equity loan market in China is becoming more sophisticated and rigorously regulated, since 2017 we have proactively established various policies and internal control procedures to ensure more prudent and disciplined collection efforts. For example, our staff may need to take a more reserved approach without disturbing the peace, which can be less effective in encouraging the borrowers to repay quickly. This has caused delays in recovery of delinquent loans under certain circumstances, which caused the increase in our delinquency ratio.

Our NPL ratio has remained stable and experienced a slight increase from 1.50% as of December 31, 2016 to 1.66% as of December 31, 2017 and further to 1.75% as of March 31, 2018 due to changes in one of our collection methods. Historically, we were able to help our trust company partners enforce their rights to the collateral through a power of attorney that was signed by the borrower and notarized by a notary public before loan disbursement. This allowed the trust company partners to quickly dispose of the collateral without having to involve the borrower. Due to recent regulatory changes, we ceased this practice. As a result, the overall disposal time for collateral is now longer, resulting in an increase in the NPLs and thus a corresponding increase in the NPL ratio.

Our allowance ratio has increased from 1.95% as of December 31, 2016 to 2.64% as of December 31, 2017 and further to 3.48% as of March 31, 2018 while our NPL provision coverage ratio has increased from 130.6% to 159.3% and further to 199.9% as of the same dates. Increases in allowance ratio and NPL provision coverage ratio are primarily attributable to the increases in the amount of allowance for loan principal, interest and financing service fee receivables. Such amount of allowances is composed of both collectively assessed allowances for non-delinquent loans and loans delinquent within 90 days and individually assessed allowances for NPLs or loans considered impaired. In general, collectively assessed allowances are derived by applying a provision rate of loans that are collectively assessed, which is determined using a roll rate-based model. The roll

 

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rate-based model stratifies the loans principal, interest and financing service fee receivables by delinquency stages which are divided by days overdue and projected forward in next stage using probability of default. Individually assessed allowance, for the loans whose payments are contractually past due more than 90 days or which are considered impaired, is established when the discounted cash flows, collateral value (less disposal costs) or observable market price of the impaired loan are lower than its carrying value. We believe that we have been applying appropriate provision rates when collectively assessing allowances for loans and have not materially adjusted such provision rates since 2016. As both of our non-delinquent loans and delinquent loans within 90 days have increased since 2016 in parallel with our business expansion, there is a general increase in our allowance ratio and NPL provision coverage ratio.

We also monitor delinquency ratio by differentiating delinquent loans over different delinquent days. The following table sets forth the delinquency ratios for all outstanding loans originated by us as of the respective dates indicated.

 

     Delinquent for  

Delinquency ratio by delinquent days(1)

   1-30 days     31-90 days     91-180 days     Over 180 days  

March 31, 2016

     4.62     1.61     0.88     2.74

June 30, 2016

     2.84     0.66     0.37     2.34

September 30, 2016

     3.18     0.34     0.27     1.68

December 31, 2016

     3.49     0.39     0.21     1.29

March 31, 2017

     2.16     0.47     0.51     1.04

June 30, 2017

     1.88     0.42     0.28     1.03

September 30, 2017

     2.14     0.85     0.38     0.96

December 31, 2017

     4.32     1.19     0.77     0.89

March 31, 2018

     4.90     4.39     0.29     1.46

 

Note:

(1) Delinquency ratio by delinquent days represents the outstanding loan principal for which any installment payment is 1 to 30, 31 to 90, 91 to 180 and over 180 calendar days past due as a percentage of the total outstanding loan principal as of a specified date.

We incur losses and charge-off loans when we determine that the loan is uncollectable after exhausting all collection efforts. The following tables sets forth below our charge-off ratio for the periods indicated.

 

     For the Year Ended
December 31,
    For the Three Months Ended
March 31,
 
     2016     2017     2018  

Charge-off ratio

     0.005     0.093     —    

Our charge-off ratio remained low at 0.005%, 0.093% and nil in 2016, 2017 and for the three months ended March 31, 2018 as we continue to dispose of collateral through judicial or arbitration proceedings and utilize other quick disposal plans available to manage NPLs (including sale of loans to third parties in exchange for proceeds upfront, or disposal of collateral voluntarily by the defaulting borrowers and repay the defaulted loans with the proceeds).

Selected Income Statement Items

Total operating income

Our total operating income represents the sum of (i) net interest and fees income and (ii) total non-interest revenue. Net interest and fees income represents total interest and fee income netting of total interest expense. In 2016, 2017 and for the three months ended March 31, 2018, we generated net interest and fees income of RMB800.9 million, RMB2.0 billion (US$318.9 million) and RMB598.1 million (US$95.4 million), respectively. Total non-interest revenue comprises net realized gains/(losses) on sales of investments, other-than-temporary

 

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losses on available-for-sale investment and other revenue. In 2016, 2017 and for the three months ended March 31, 2018, we generated total non-interest revenue of RMB66.4 million, RMB12.5 million (US$2.0 million) and RMB1.6 million (US$0.2 million), respectively.

Under the contractual arrangements with our trust company partners, we subscribe to subordinated units of the trust plans and also provide services to trust plans. As a result, we are entitled to (i) the investment return payable to us as subordinated unit holder and (ii) a performance-based service fee of up to 8% per annum of the size of trust plans payable to us for our services provided to trust plans. As subordinated unit holder, we are exposed to variability of returns from activities of trust plans and are therefore required to consolidate the financial results of trust plans. Therefore, the service fee charged to trust plans is considered inter-company transaction and is eliminated together with service expenses of trust plans for accounting purposes. As a result, the total payments to us under our trust lending model, together with the interest spread under our small loan direct lending model and certain non-interest revenue, is reflected on our consolidated financial statements as total operating income.

The following table sets forth a breakdown of our total operating income for the periods indicated.

 

    For the Year Ended December 31,     For the Three Months Ended March 31,  
    2016     2017     2017     2018  
    RMB     RMB     US$     RMB     RMB     US$  

Interest and fees income

           

Interest and financing service fee on loans

    1,242,128,524       3,406,110,592       543,014,156       624,052,654       1,063,195,480       169,498,371  

Interest on deposits with banks

    1,417,305       4,337,177       691,448       448,981       2,138,161       340,873  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total interest and fees income

    1,243,545,829       3,410,447,769       543,705,604       624,501,635       1,065,333,641       169,839,244  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Interest expense

           

Interest expense on interest-bearing borrowings

    (442,661,324     (1,401,191,685     (223,382,917     (226,604,844     (467,238,302     (74,488,777

Interest expense on amounts due to related parties

    —         (8,714,000     (1,389,217     (296,000     —         —    

Total interest expenses

    (442,661,324     (1,409,905,685     (224,772,134     (226,900,844     (467,238,302     (74,488,777
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net interest and fees income

    800,884,505       2,000,542,084      
318,933,470
 
    397,600,791       598,095,339       95,350,467  

Non-interest revenue

           

Realized gains/(losses) on sales of investments, net

    66,878,501       (11,527,798     (1,837,802     (1,474,014     709,808       113,160  

Other-than-temporary losses on available-for-sale investments

    (36,692,695     —         —         —         —         —    

Other revenue, net

    36,261,933       23,979,610       3,822,914       4,704,502       843,097       134,409  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total non-interest revenue

    66,447,739       12,451,812       1,985,112       3,230,488       1,552,905       247,570  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total operating income

    867,332,244       2,012,993,896       320,918,582       400,831,279       599,648,244       95,598,037  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Interest and fees income

Interest and financing service fee on loans

Our interest and financing service fee on loans represents interest payment from borrowers under our trust lending model and direct lending model, and financing service fee charged on borrowers for the loan services we provide. Financing service fee is deferred and amortized over the average life of the related loans using the effective interest method. Due to recent regulatory changes, we ceased charging such financing service fee starting from August 2017.

Interest on deposits with banks

Our interest on deposits with banks represents interest generated from our cash deposits with banks.

 

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Interest expense

We recorded interest expense of RMB442.7 million, RMB1.4 billion (US$224.8 million) and RMB467.2 million (US$74.5 million) in 2016, 2017 and for the three months ended March 31, 2018, respectively. Our interest expense consists of interest expense on interest-bearing borrowings and interest expense on amounts due to related parties. In 2016 and 2017, the interest expense on interest-bearing borrowings was RMB442.7 million and RMB1.4 billion (US$223.4 million), accounting for 100.0% and 99.4%, respectively, of our total interest expense for the same periods. For the three months ended March 31, 2018, the interest expense on interest-bearing borrowings was RMB467.2 million (US$74.5 million), accounting for all of our total interest expense for the same period.

Interest expense on interest-bearing borrowings

Interest expense on interest-bearing borrowings consists primarily of financing costs payable to (i) senior unit holders, (ii) third parties to whom we transferred right to earnings in certain of our subordinated units in trust plans with a repurchase arrangement, and (iii) third parties to whom we transferred certain rights to earnings in loans principal, interest and financing service fee receivables with a repurchase arrangement.

Interest expense on amounts due to related parties

Fanhua Inc. holds 20.6% of our equity interest and granted us loans in 2017. Such transaction was priced on arm’s length. These borrowings bear an interest rate of 7.3% per annum and are repayable on demand.

Non-interest revenue

Realized gains/(losses) on sales of investments

Realized gains/(losses) on sales of investments consist of realized gains and losses from the disposal of available-for-sale investments, presented on a net basis.

Other-than-temporary losses on available-for-sale investments

We invested RMB10.0 million and RMB40.0 million, respectively, in the mezzanine tranche and junior tranche of an asset management scheme in 2014. The scheme principally invested in entrusted loans to a real estate company in Jiangxi province. We recorded losses of RMB36.7 million with respect to this investment in 2016.

Other revenue

Other revenue consists of mortgage agency service revenue, asset management revenue, net loss on disposal of subsidiaries, labor outsourcing services income, foreign exchange gain/(loss), register services income, net loss on disposal of property, plant and equipment and others.

Operating expenses

Our operating expenses consist of employee compensation and benefits, share-based compensation, taxes and surcharges, rental and property management expenses, impairment of goodwill, offering expenses and other expenses.

 

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The following table sets forth our operating expenses, in absolute amounts and as percentages of total operating income, for the periods indicated.

 

    For the Year Ended December 31,     For the Three Months Ended March 31,  
    2016     2017     2017     2018  
    RMB     %     RMB     US$     %     RMB     %     RMB     US$     %  

Operating expenses

                   

Employee compensation and benefits

    299,225,819       34.5%       545,956,248       87,038,269       27.1%       109,503,389       27.3%       117,113,556       18,670,656       19.5%  

Share-based compensation expense

    —         —         182,689,766       29,125,046       9.1%       45,672,441       11.4%       9,928,792       1,582,883       1.7%  

Taxes and surcharges

    48,207,495       5.6%       38,835,933       6,191,361       1.9%       10,958,462       2.7%       14,512,100       2,313,570       2.4%  

Rental and property management expenses

    24,404,690       2.8%       47,896,817       7,635,879       2.4%       9,108,676       2.3%       14,055,902       2,240,841       2.3%  

Impairment of goodwill

    20,279,026       2.3%       —         —         —         —         —         —         —         —    

Offering expenses

    —         —         —         —         —         —         —         4,659,577       742,846       0.8%  

Other expenses

    75,807,908       8.7%       82,194,556       13,103,746       4.1%       16,132,637       4.0%       19,907,912       3,173,789       3.3%  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

    467,924,938       53.9%       897,573,320       143,094,302       44.6%       191,375,605       47.7%       180,177,839       28,724,586       30.0%  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Other expenses primarily consist of (i) office expenses, which mainly include expenses relating to office renovation and expansion of office facilities; (ii) entertainment and traveling expenses; and (iii) advertising and promotion expenses.

The following table sets forth breakdown of other expenses in absolute amounts and as percentages of total operating income, for the periods indicated.

 

    For the Year Ended December 31,     For the Three Months Ended March 31,  
    2016     2017     2017     2018  
    RMB     %     RMB     USD     %     RMB     %     RMB     USD     %  

Other expenses

                   

Office expenses

    14,453,830       1.7%       18,769,477       2,992,296       0.9%       4,248,766       1.1%       3,861,989       615,692       0.6%  

Entertainment and traveling expenses

    11,767,688       1.4%       14,506,006       2,312,599       0.7%       2,789,224       0.7%       2,467,640       393,400       0.4%  

Advertising and promotion

    16,383,290       1.9%       15,028,164       2,395,843       0.7%       2,412,217       0.6%       5,040,036       803,500       0.8%  

Research and development expenses

    8,507,265       1.0%       4,794,998       764,435       0.2%       775,734       0.2%       —         —         —    

Consulting fees

    5,736,437       0.7%       9,282,890       1,479,911       0.5%       1,678,687       0.4%       3,726,696       594,123       0.6%  

Depreciation and amortization

    6,595,476       0.8%       10,804,855       1,722,548       0.5%       2,231,483       0.6%       2,987,655       476,302       0.5%  

Communication expenses

    2,530,162       0.3%       2,598,250       414,222       0.1%       562,789       0.1%       577,181       92,016       0.1%  

Asset management expense

    3,887,977       0.4%       —         —         —         —         —         —         —         —    

Provision for cost method investment

    1,270,001       0.1%       —         —         —         —         —         —         —         —    

Others

    4,675,782       0.5%       6,409,916       1,021,891       0.3%       1,433,737       0.4%       1,246,715       198,756       0.2%  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total other expenses

    75,807,908       8.7%       82,194,556       13,103,746       4.1%       16,132,637       4.0%       19,907,912       3,173,789       3.3%  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Taxation

Cayman Islands

We are incorporated in the Cayman Islands. Under the current law of the Cayman Islands, we are not subject to income or capital gains tax. In addition, dividend payments are not subject to withholding tax in the Cayman Islands.

Hong Kong

Our wholly owned subsidiary, China Financial Services Group Limited, is subject to Hong Kong profits tax on their activities conducted in Hong Kong at a uniform tax rate of 16.5%. Payments of dividends by our subsidiaries to us are not subject to withholding tax in Hong Kong.

 

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PRC

Our subsidiaries and their subsidiaries in China are companies incorporated under PRC law and, as such, are subject to PRC enterprise income tax on their taxable income in accordance with the relevant PRC income tax laws. Pursuant to the PRC Enterprise Income Tax Law (the “EIT Law”), which became effective on January 1, 2008, a uniform 25% enterprise income tax rate is generally applicable to both foreign-invested enterprises and domestic enterprises, except where a special preferential rate applies. For example, enterprises qualified as “High and New Technology Enterprises” are entitled to a 15% enterprise income tax rate rather than the 25% uniform statutory tax rate. The enterprise income tax is calculated based on the entity’s global income as determined under PRC tax laws and accounting standards.

According to the Notice of the Ministry of Finance and the SAT on Implementing the Pilot Program of Replacing Business Tax with Value-Added Tax in an All-round Manner, which became effective on May 1, 2016, entities and individuals engaged in the sale of services, intangible assets or fixed assets within the PRC territory are required to pay value-added tax instead of business tax. Following the implementation of the Pilot Plan for Imposition of Value-Added Tax to Replace Business Tax, or the VAT Pilot Plan, most of our PRC subsidiaries and affiliates have been subject to VAT, at a rate of 6% or 17%, instead of business tax.

As a Cayman Islands holding company, we may receive dividends from our PRC subsidiaries through China Financial Services Group Limited. The PRC EIT Law and its implementing rules provide that dividends paid by a PRC entity to a nonresident enterprise for income tax purposes is subject to PRC withholding tax at a rate of 10%, subject to reduction by an applicable tax treaty with China. Pursuant to the Arrangement between Mainland China and the Hong Kong Special Administrative Region for the Avoidance of Double Taxation and Tax Evasion on Income, or the Hong Kong Tax Treaty, the withholding tax rate in respect to the payment of dividends by a PRC enterprise to a Hong Kong enterprise may be reduced to 5% from a standard rate of 10% if the Hong Kong enterprise directly holds at least 25% of the PRC enterprise. Pursuant to the Notice of the State Administration of Taxation on the Issues concerning the Application of the Dividend Clauses of Tax Agreements, or SAT Circular 81, a Hong Kong resident enterprise must meet the following conditions, among others, in order to apply the reduced withholding tax rate: (i) it must be a company; (ii) it must directly own the required percentage of equity interests and voting rights in the PRC resident enterprise; and (iii) it must have directly owned such required percentage in the PRC resident enterprise throughout the 12 months prior to receiving the dividends. In August 2015, the State Administration of Taxation promulgated the Administrative Measures for Nonresident Taxpayers to Enjoy Treatment under Tax Treaties, or SAT Circular 60, which became effective on November 1, 2015. SAT Circular 60 provides that nonresident enterprises are not required to obtain preapproval from the relevant tax authority in order to enjoy the reduced withholding tax. Instead, nonresident enterprises and their withholding agents may, by self-assessment and on confirmation that the prescribed criteria to enjoy the tax treaty benefits are met, directly apply the reduced withholding tax rate, and file necessary forms and supporting documents when performing tax filings, which will be subject to post-tax filing examinations by the relevant tax authorities. The SAT promulgated the Announcement on Certain Issues Concerning the Beneficial Owner in a Tax Agreement, or Circular 9, on February 3, 2018, effective as April 1, 2018, which provides guidance for determining whether a resident of a tax treaty country is the “beneficial owner” of income under China’s tax treaties and similar arrangements.

China Financial Services Group Limited may be able to benefit from the 5% withholding tax rate for the dividends it receives from our PRC subsidiaries if it satisfies the conditions prescribed under SAT Circular 81 and other relevant tax rules and regulations. However, according to SAT Circular 81 and SAT Circular 60, if the relevant tax authorities consider the transactions or arrangements we have are for the primary purpose of enjoying a favorable tax treatment, the relevant tax authorities may adjust the favorable withholding tax in the future. In addition, according to Circular 9, a beneficial owner shall generally engage in substantial business activities, and an agent shall not be considered a beneficial owner and, therefore, shall not qualify for those benefits. It is possible, however, under Circular 9, China Financial Services Group Limited would not be considered the “beneficial owner” of any such dividends, and that such dividends would as a result be subject to withholding tax at the rate of 10% rather than the favorable 5% rate applicable under the Hong Kong Tax Treaty.

 

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If our holding company in the Cayman Islands or any of our subsidiaries outside of China were deemed to be a “resident enterprise” under the PRC EIT Law, it would be subject to enterprise income tax on its worldwide income at a rate of 25%. See “Risk Factors—Risks Related to Doing Business in China—If we are classified as a PRC resident enterprise for PRC enterprise income tax purposes, such classification could result in unfavorable tax consequences to us and our non-PRC shareholders and ADS holders.”

British Virgin Islands

Under the current laws of the British Virgin Islands, our company is not subject to tax on income or capital gains. In addition, upon payments of dividends by our British Virgin Islands subsidiaries to their shareholders, no British Virgin Islands withholding tax will be imposed.

Internal Control Over Financial Reporting

Prior to this offering, we have been a private company with limited accounting personnel and other resources with which to address our internal control over financial reporting. In connection with the audit of our consolidated financial statements as of and for the two fiscal years ended December 31, 2016 and 2017, our independent registered public accounting firm identified one material weakness in our internal control over financial reporting. As defined in standards established by the PCAOB, a “material weakness” is a deficiency, or combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the annual or interim financial statements will not be prevented or detected on a timely basis.

The material weakness that has been identified related to:

 

    our lack of sufficient financial reporting and accounting personnel with appropriate knowledge of U.S. GAAP and SEC reporting requirements, and

 

    our lack of comprehensive accounting policies and procedures manual in accordance with U.S. GAAP.

Such material weakness, if not timely remedied, may lead to significant misstatements in our consolidated financial statements in the future.

To remediate our identified material weakness, we intend to adopt several measures to improve our internal control over financial reporting, including (i) hiring more qualified accounting personnel, including a financial controller, with relevant U.S. GAAP and SEC reporting experience and qualifications to strengthen the financial reporting function and setting up a financial and system control framework; (ii) implementing regular and continuous U.S. GAAP accounting and financial reporting training programs for our accounting and financial reporting personnel; (iii) setting up an internal audit function as well as engaging an external consulting firm to assist us with assessment of Sarbanes-Oxley compliance requirements and improvement of overall internal controls; and (iv) preparing comprehensive accounting policies, manuals and closing procedures to improve the quality and accuracy of our period-end financial closing process.

We expect that we will incur significant costs in the implementation of such measures. However, we cannot assure you that all these measures will be sufficient to remediate our material weakness in time, or at all. See “Risk factors—Risks Related to Our Business—If we fail to implement and maintain an effective system of internal controls, we may be unable to accurately or timely report our results of operations or prevent fraud, and investor confidence and the market price of our ADSs may be materially and adversely affected.”

As a company with less than US$1.07 billion in revenue for our last fiscal year, we qualify as an “emerging growth company” pursuant to the JOBS Act. An emerging growth company may take advantage of specified reduced reporting and other requirements that are otherwise applicable generally to public companies. These provisions include exemption from the auditor attestation requirement under Section 404 of the Sarbanes-Oxley

 

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Act of 2002, in the assessment of the emerging growth company’s internal control over financial reporting. The JOBS Act also provides that an emerging growth company does not need to comply with any new or revised financial accounting standards until such date that a private company is otherwise required to comply with such new or revised accounting standards. However, we have elected to “opt out” of this provision and, as a result, we will comply with new or revised accounting standards as required when they are adopted for public companies. This decision to opt out of the extended transition period under the JOBS Act is irrevocable.

Critical Accounting Policies, Judgments and Estimates

We prepare our financial statements in accordance with U.S. GAAP, which requires our management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosures of contingent assets and liabilities at the balance sheet dates and the reported amounts of revenues and expenses during the reporting periods. We continually evaluate these judgments and estimates based on our own historical experience, knowledge and assessment of current business and other conditions, our expectations regarding the future based on available information and assumptions that we believe to be reasonable, which together form our basis for making judgments about matters that are not readily apparent from other sources. Since the use of estimates is an integral component of the financial reporting process, our actual results could differ from those estimates. Some of our accounting policies require a higher degree of judgment than others in their application.

The selection of critical accounting policies, the judgments and other uncertainties affecting application of those policies and the sensitivity of reported results to changes in conditions and assumptions are factors that should be considered when reviewing our financial statements. We believe the following accounting policies involve the most significant judgments and estimates used in the preparation of our financial statements. You should read the following description of critical accounting policies, judgments and estimates in conjunction with our consolidated financial statements and other disclosures included in this prospectus.

Our consolidated financial statements include the results of the trust plans as the trust lending model creates exposure to variability of returns from the activities of the trust plans. All intercompany transactions and balances, including payment of service fees from trust plans to us, are eliminated in consolidation.

Revenue recognition

Revenue is recognized when all of the following conditions are met: persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the price is fixed or determinable and collectability is reasonably assured. These criteria as they relate to each of the following major revenue generating activities are described below:

Interest and financing service fee on loans

Interest and financing service fee on loans, which include financing service fee on loans, are collected from borrowers for loans and related services. Interest and financing service fee on loans which are amortized over the contractual life of the related loans are recognized in consolidated statements of comprehensive income on effective interest method.

Interest and financing service fee on loans includes the amortization of any discount or premium or differences between the initial carrying amount of an interest-bearing asset and its amount at maturity calculated using the effective interest basis.

The effective interest method is a method of calculating the amortized cost of a financial asset and of allocating the interest and financing service fee on loans over the years. The effective interest rate is the rate that exactly discounts estimated future cash payments or receipts through the expected life of the financial instrument. When calculating the effective interest rate, we estimate cash flows considering all contractual terms of the financial instrument but does not consider future credit losses. Interest on the impaired assets is recognized using the rate of interest used to discount future cash flows.

 

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Mortgage agency service revenue and asset management revenue

We earn mortgage agency service revenue from providing mortgage agency services to borrowers applying for a bank loan. This kind of revenue is recognized at the time when loan is granted as that is the point of time the Company fulfils the customer’s request, and is then recognized on an accrual basis in accordance with the terms of the relevant agreements.

We receive asset management revenue from providing asset management services for investors. The asset management revenue is calculated and accrued on a daily basis based on the daily net asset values of the asset management products under management.

Realized gains/(losses) on sales of investments

Realized gains/(losses) consist of realized gains and losses from the sale of available-for-sale investments, presented on a net basis.

Rendering of services

When the outcome of a transaction involving the rendering of services can be estimated reliably, revenue from the rendering of services is recognized by reference to the stage of completion of the transaction based on the services performed to date as a percentage of the total services to be performed.

When the outcome of a transaction involving the rendering of services cannot be estimated reliably, revenue is recognized only to the extent of the costs incurred that it is probably recoverable.

Loans

Loans are reported at their outstanding principal balances net of any unearned income and unamortized deferred fees and costs. Loan origination fees and certain direct origination costs are generally deferred and recognized as adjustments to income over the lives of the related loans.

We facilitate loans to borrowers through structure funds which are considered as consolidated variable interest entities (“VIEs”) and we evaluated VIEs for consolidation in accordance with ASC 810 in the “Consolidated VIEs” section of Note 1 to our consolidated financial statements. Providing credit strengthening services for the loans to trust company partners under the structure funds is one of the key factors to determine that we should consolidate the structure funds as we are the primary beneficiary of the funds. As a result, the loan principal remains on our consolidated balance sheets, whilst the funds received from senior unit holders are recorded as other borrowings in our consolidated balance sheets as disclosed in Note 12(b)(i) to our consolidated financial statements.

Non-accrual policies

Loans principal, interest and financing service fee receivables are placed on non-accrual status when payments are 90 days contractually past. When a loans principal, interest and financing service fee receivable is placed on non-accrual status, financing service fees accrual ceases. If the loan is non-accrual, the cost recovery method is used and cash collected is applied to first reduce the carrying value of the loan. Otherwise, interest income may be recognized to the extent cash is received. Loans principal, interest and financing service fee receivables may be returned to accrual status when all of the borrower’s delinquent balances of loans principal, interest and financing service fee have been settled and the borrower continues to perform in accordance with the loan terms for a period of at least six months.

Charge-off policies

We incur losses and charge off loans when we determine the remaining balance is uncollectable after exhausting all collection efforts. In order to comply with Accounting Standard Codification (“ASC”) 310, we

 

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consider loans principal, interest and financing service fee receivables meeting any of the following conditions as uncollectable and charged-off: (i) death of the borrower; (ii) identification of fraud, and the fraud is officially reported to and filed with relevant law enforcement departments; or (iii) the amount that we conclude that it has exhausted its collection efforts.

Allowance for credit losses

Allowance for credit losses represents management’s best estimate of probable losses inherent in the portfolio.

The allowance for credit losses includes an asset-specific component and a statistically based component. The asset-specific component is calculated under ASC 310-10-35, on an individual basis for the loans whose payments are contractually past due more than 90 days or which are considered impaired. An asset-specific allowance is established when the discounted cash flows, collateral value (less disposal costs) or observable market price of the impaired loan are lower than its carrying value. This allowance considers the borrower’s overall financial condition, resources, and payment record, the prospects for support from any financially responsible guarantors and, if appropriate, the realizable value of any collateral.

The allowance for the remainder of the loan portfolio is determined under ASC 450 using a roll rate-based model. The roll rate-based model stratifies the loans principal, interest and financing service fee receivables by delinquency stages which are divided by days overdue and projected forward in next stage using probability of default. In each stage of the simulation, losses on the loans principal, interest and financing service fee receivables types are captured, and the ending delinquency stratification serves as the beginning point of the next iteration. This process is repeated on a monthly rolling basis. The loss rate calculated for each delinquency stage using loss given default, then applied to the respective loans principal, interest and financing service fees balance. We adjust the allowance that is determined by the roll rate-based model for various Chinese macroeconomic factors, i.e., gross-domestic product rates, interest rates and consumer price indexes. Each of these macroeconomic factors are equally weighted, and a score is applied to each factor based on year-on-year increases and decreases in that respective factor.

Income tax

Income tax is accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statements carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carry forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. We recognize the effect of income tax positions only if those positions are more likely than not of being sustained. Recognized income tax positions are measured at the largest amount that is greater than 50 percent likely of being realized. Changes in recognition or measurement are reflected in the period in which the change in judgment occurs. We classify interest and penalties recognized on the liability for unrecognized tax benefits as income tax expense.

Share-based compensation

We measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award and recognize the cost over the period the employee is required to provide service in exchange for the award, which generally is the vesting period. We recognize compensation cost for an award with only service conditions that has a graded vesting schedule on a straight-line basis over the requisite service period for the entire award, net of estimated forfeitures, provided that the cumulative amount of compensation cost recognized at any date at least equals the portion of the grant-date value of such award that is

 

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vested at that date. Forfeiture rates are estimated based on historical and future expectations of employee turnover rates.

In November 2009, SFIL adopted the 2009 SFIL Share Incentive Plan, or the 2009 Plan. Under the 2009 Plan, SFIL granted options to its directors and employees to purchase up to 25,678 ordinary shares. Pursuant to the option agreements entered into between SFIL and the option grantees, the options vested over a five-year period from 2010 to 2014. The number of options that the grantees are entitled to in each year was calculated based on the key performance indicator scores of the grantees in the respective prior year and continued employment was not regarded as vesting condition. Accordingly, 60%, 10%, 10%, 10% and 10% of the award options vested on January 1 of each of the years 2010 to 2014, respectively. In January 2011, SFIL divided the existing issued shares of US$0.10 each share into US$0.01 each share. SFIL also allotted and issued new shares to its existing shareholders using a ratio of 1:637. Upon completion of such share split and share allotment, the number of shares under the 2009 Plan was adjusted from 25,678 to 163,825,640. Accordingly, the exercise price was adjusted from RMB3,190 to RMB0.5. Such options expired on December 31, 2016, and as of December 31, 2016, no option was excised.

In January 2017, SFIL adopted the 2017 SFIL Share Incentive Plan, or the 2017 Plan. Under the 2017 Plan, SFIL granted 187,933,730 options to its certain management and employees to purchase up to 187,933,730 ordinary shares. The term of the options will not exceed ten years from the date of the grant. Accordingly, 60%, 20% and 20% of the award options shall vest on December 31 of each of the years 2017 to 2019, respectively. Unless terminated earlier, the 2017 Plan will terminate automatically in 2022.

On             , 2018, we [adopted] our 2018 CNFinance Holdings Limit Share Incentive Plan, or the 2018 Plan, to replace the 2017 Plan and [granted]              options to purchase up to              of our ordinary shares under this plan to replace the granted and outstanding options under the 2017 Plan.

Share-based payment transactions with employees, such as share options are measured based on the grant date fair value of the equity instrument. We recognize the compensation costs net of estimated forfeitures over the applicable vesting period. The estimate of forfeitures will be adjusted over the requisite service period to the extent that actual forfeitures differ, or are expected to differ, from such estimates. Changes in estimated forfeitures will be recognized through a cumulative catch-up adjustment in the period of change and will also impact the amount of stock compensation expense to be recognized in future periods. There was no market conditions associated with the share option grants.

The fair value of options granted to employees is determined based on a number of factors including valuations. In determining the fair value of our equity instruments, we referred to valuation reports prepared by an independent third-party appraisal firm, based on data we provided. The valuation reports provided us with guidelines in determining the fair value of the equity instruments, but we are ultimately responsible for the determination of all amounts related to share-based compensation recorded in the financial statements.

Excluding the options containing service vesting conditions, we calculated the estimated fair value of the options on the respective grant dates using a binomial option pricing model with assistance from independent valuation firms, with the following assumptions:

 

     Share awards
granted on
November 1,
2009
    Share awards
granted on
January 3,
2017
 

Expected volatility

     71     40

Expected dividends

            

Risk-free interest rate

     3.50     3.10

Expected term (in years)

     5       5  

Expected life (in years)

     7.17       6  

 

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The contractual life of the share option is used as an input into the binomial option pricing model. Exercise multiple and post-vesting forfeit are incorporated into the model. Since our shares had not been publicly traded at the time the options were issued and our shares were rarely traded privately, expected volatility is estimated based on the average historical volatility of comparable entities with publicly traded shares for the period before the date of grant with length commensurate to contractual life of the options. The risk-free rate for the expected term of the option is based on the yield to maturity of China’s six-year government bond at the date of grant. We have has not declared or paid any cash dividends on our capital stock, and do not anticipate any dividend payments on our ordinary shares in the foreseeable future.

If any of the assumptions used in the binomial option pricing model changes significantly, share-based compensation expense for future awards may differ materially compared with the awards granted previously.

The following table sets forth the fair value of options and ordinary shares estimated at the dates of option grants indicated below with the assistance from an independent valuation firm.

 

Date of options grant

   Options granted      Exercise price      Fair value
of option
     Fair value
of ordinary
shares
 

November 1, 2009

     25,678       
RMB3,190
 
     RMB640.10        RMB1,506  

January 3, 2017

     75,173,492        RMB0.50        RMB1.26        RMB1.72  

January 3, 2017

     112,760,238        RMB0.50        RMB1.27        RMB1.72  

For the options granted on November 1, 2009, we recognized compensation expenses up to RMB16, 435,974 and for the options granted on January 3, 2017, we recognized compensation expenses of RMB182, 689,766 in 2017. There was no income tax benefit recognized associated with the share-based compensation expense.

As of December 31, 2017, the total unrecognized compensation cost related to unvested stock options granted under the 2017 Plan[, which was replaced by the 2018 plan,] amounted to RMB55,601,233. Such cost is expected to be recognized over a weighted average period of 1.29 years.

Property and equipment

Property and equipment are stated at cost and are depreciated using the straight-line method over the estimated useful lives of the assets, as follows:

 

Category

  

Estimated useful life

Leasehold improvement

   1 year-6 years

Office and other equipment

   1 year-5 years

Motor vehicles

   3 years-8 years

Repair and maintenance costs are charged to expense as incurred. Retirements, sales and disposals of assets are recorded by removing the cost and accumulated depreciation from the asset and accumulated depreciation accounts with any resulting gain or loss reflected in the consolidated statements of operations.

Non-GAAP Financial Measure

Adjusted Net Income

We use adjusted net income, a non-GAAP financial measure, in evaluating our operating results and for financial and operational decision-making purposes. We believe that adjusted net income helps identify underlying trends in our business by excluding the impact of share-based compensation expenses, which are non-cash charges. We believe that adjusted net income provides useful information about our operating results,

 

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enhances the overall understanding of our past performance and future prospects and allows for greater visibility with respect to key metrics used by our management in its financial and operational decision-making.

 

    For the Year Ended December 31,     For the Three Months Ended March 31,  
    2016     2017     2017     2018  
    RMB     RMB     US$     RMB     RMB     US$  

Adjusted net income

    235,441,839       715,362,523       114,045,615       157,714,139       206,675,675       32,948,965  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Adjusted net income is not defined under U.S. GAAP and is not presented in accordance with U.S. GAAP. This non-GAAP financial measure should not be considered in isolation from, or as a substitute for, its most directly comparable financial measure prepared in accordance with U.S. GAAP. A reconciliation of the historical non-GAAP financial measure to its most directly comparable GAAP measure has been provided in the tables included below. Investors are encouraged to review the reconciliation of the historical non-GAAP financial measure to its most directly comparable GAAP financial measure. As adjusted net income has material limitations as an analytical metric and may not be calculated in the same manner by all companies, it may not be comparable to other similarly titled measures used by other companies. In light of the foregoing limitations, you should not consider adjusted net income as a substitute for, or superior to, net revenues prepared in accordance with U.S. GAAP. We encourage investors and others to review our financial information in its entirety and not rely on a single financial measure.

The following table reconciles our adjusted net income for the periods presented to the most directly comparable financial measure calculated and presented in accordance with U.S. GAAP, which is net income.

 

    For the Year Ended December 31,     For the Three Months Ended March 31,  
    2016     2017     2017     2018  
    RMB     RMB     US$     RMB     RMB     US$  

Net income

    235,441,839       532,672,757       84,920,568       112,041,698       196,746,883       31,366,082  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Add: share-based compensation expenses

    —         182,689,766       29,125,046       45,672,441       9,928,792       1,582,883  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Adjusted net income

    235,441,839       715,362,523       114,045,615       157,714,139,       206,675,675       32,948,965  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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Results of Operations

The following table sets forth a summary of our consolidated statements of comprehensive income for the periods presented. This information should be read together with our consolidated financial statements and related Notes included elsewhere in this prospectus. The results in any period are not necessary indicative of our future trends.

 

    For the Year Ended December 31,     For the Three Months Ended March 31,  
    2016     2017     2017     2018  
    RMB     RMB     US$     RMB     RMB     US$  

Interest and fees income

           

Interest and financing service fee on loans

    1,242,128,524       3,406,110,592       543,014,156       624,052,654       1,063,195,480       169,498,371  

Interest on deposits with banks

    1,417,305       4,337,177       691,448       448,981       2,138,161       340,873  

Total interest and fees income

    1,243,545,829       3,410,447,769       543,705,604       624,501,635       1,065,333,641       169,839,244  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Interest expense

           

Interest expense on interest-bearing borrowings

    (442,661,324     (1,401,191,685     (223,382,917     (226,604,844     (467,238,302     (74,488,777

Interest expense on amounts due to related parties

    —         (8,714,000     (1,389,217     (296,000     —         —    

Total interest expense

    (442,661,324     (1,409,905,685     (224,772,134     (226,900,844     (467,238,302     (74,488,777
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net interest and fees income

    800,884,505       2,000,542,084       318,933,470       397,600,791       598,095,339       95,350,467  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Provision for credit losses

    (111,362,044     (306,752,951     (48,903,637     (41,891,522     (143,547,335     (22,884,822

Net interest and fees income after provision for credit losses

    689,522,461       1,693,789,133       270,029,833       355,709,269       454,548,004       72,465,645  

Realized gains/(losses) on sales of investments, net

    66,878,501       (11,527,798     (1,837,802     (1,474,014     709,808       113,160  

Other-than-temporary losses on available-for-sale investments

    (36,692,695     —         —         —         —         —    

Other revenue, net

    36,261,933       23,979,610       3,822,914       4,704,502       843,097       134,409  

Total non-interest revenue

    66,447,739       12,451,812       1,985,112       3,230,488