High Templar Tech Limited (1QU) Risk Analysis

Our independent registered public accounting firm that issues the audit report included in our annual report filed with the SEC, as auditors of companies that are traded publicly in the U.S. and a firm registered with the U.S. Public Company Accounting Oversight Board, or the PCAOB, is required by the laws of the U.S. to undergo regular inspections by the PCAOB to assess its compliance with the laws of the U.S. and professional standards. According to Article 177 of the PRC Securities Law which became effective in March 2020, no overseas securities regulator is allowed to directly conduct investigation or evidence collection activities within the territory of the PRC. Accordingly, without the consent of the competent PRC securities regulators and relevant authorities, no organization or individual may provide the documents and materials relating to securities business activities to overseas parties. Because our auditors are located in the People’s Republic of 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. On May 24, 2013, PCAOB announced that it had entered into a Memorandum of Understanding on Enforcement Cooperation with the CSRC and the Ministry of Finance, which establishes a cooperative framework between the parties for the production and exchange of audit documents relevant to investigations in the United States and China. PCAOB continues to be in discussions with the CSRC and the Ministry of Finance to permit joint inspections in the PRC of audit firms that are registered with PCAOB and audit Chinese companies that trade on U.S. exchanges. On December 7, 2018, the SEC and the PCAOB issued a joint statement highlighting continued challenges faced by the U.S. regulators in their oversight of financial statement audits of U.S.-listed companies with significant operations in China. The joint statement reflects the U.S. regulators’ heightened interest in this issue. In a statement issued on December 9, 2019, the SEC reiterated concerns over the inability of the PCAOB to conduct inspections of the audit firm work papers with respect to U.S.-listed companies that have operations in China, and emphasized the importance of audit quality in emerging markets, such as China. On April 21, 2020, the SEC and the PCAOB issued a new joint statement, reminding the investors that in investing in companies that are based in or have substantial operations in many emerging markets, including China, there is substantially greater risk that disclosures will be incomplete or misleading, and there is also a greater risk of fraud. In the event of investor harm, there is substantially less ability to bring and enforce SEC, DOJ and other U.S. regulatory actions, in comparison to U.S. domestic companies, and the joint statement reinforced past SEC and PCAOB statements on matters including the difficulty to inspect audit work papers in China and its potential harm to investors. Inspections of other firms that the PCAOB has conducted outside 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 inability of the PCAOB to conduct inspections of auditors in China makes it more difficult to evaluate the effectiveness of our auditor’s audit procedures or quality control procedures as compared to auditors outside of China that are subject to PCAOB inspections. As a result, we and investors in our ADSs are deprived of the benefits of such PCAOB inspections. Investors may lose confidence in our reported financial information and procedures and the quality of Group’s consolidated financial statements.

Some of the Group’s institutional funding partners report delinquencies of the Group’s users to the credit reference center of the PBOC, which adversely affect such users’ abilities to obtain loans in the future. Due to errors in the Group’s interfaces with certain institutional funding partners, the Group failed to inform such institutional funding partners about repayments made by certain of the Group’s users. As a result, such institutional funding partners believed that the users were delinquent on loan repayments and therefore made erroneous reports to the credit reference center of the PBOC. Neither the Group nor the institutional funding partners are subject to legal liabilities if the institutional funding partners timely inform the PBOC about the errors after receiving complaints from the borrowers. As isolated incidents, the erroneous reports have not resulted in any material adverse effect on the Group’s business. To avoid future errors, the Group has started to request its institutional funding partners to compare their records of delinquent borrowers with the Group’s. However, there can be no assurance that the Group’s institutional funding partners will agree with the measure we proposed or that such measure will be effective in preventing errors. If additional erroneous reports were made to the PBOC in the future, the Group may suffer reputational damage due to the negative publicity, which could have a material adverse effect on the Group’s business, results of operations and financial condition.

The Group’s quarterly results of operations, including the levels of the Group’s total revenues, cost of revenues and operating expenses, net income/(loss) and other key metrics, may vary significantly in the future due to a variety of factors, some of which are outside of our control, and period-to-period comparisons of the Group’s operating results may not be meaningful, especially given the Group’s limited operating history. Accordingly, the results for any one quarter are not necessarily an indication of future performance. Fluctuations in quarterly results may adversely affect the price of our ADSs. Factors that may cause fluctuations in the Group’s quarterly financial results include: • the Group’s ability to attract new borrowers and maintain relationships with existing borrowers; • the amount of transactions; • the mix of products the Group offers; • delinquency rates of transactions the Group facilitates; • the amount and timing of cost of revenues and operating expenses related to acquiring borrowers and the maintenance and expansion of the Group’s business, operations and infrastructure; • the Group’s ability to establish relationship with additional institutional funding partners and maintain relationships with existing institutional funding partners; • the Group’s ability to secure funding for credit the Group facilitates on reasonable terms; • performance of the Group’s non-credit businesses; • the timing of expenses related to the development or acquisition of technologies or businesses; • network outages or security breaches; • general economic, industry and market conditions; and • changes in applicable laws and regulations. In addition, the Group may experience seasonality in its credit business, reflecting a combination of seasonality patterns of the retail market and the Group’s promotional activities. In recent years, many online and offline retailers in China hold promotions on November 11 and December 12 of each year, which drives significant increase in retail sales. Higher retail sales during the shopping seasons may generate greater demand for the Group’s credit products. As a result, the Group may record higher total revenues during the fourth quarter of each year compared to other quarters. On the other hand, the Group’s total revenues for the first quarter tend to be lower due to the Chinese New Year holiday that generally reduces borrowing activities. On the other hand, lower financing service fee amount may decrease the Group’s margin for the relevant periods. Due to the Group’s limited operating history, the seasonal trends that it has experienced in the past may not apply to, or be indicative of, its future operating results. Furthermore, the Group has commenced construction of its innovation park in Xiamen, Fujian Province, and the construction is expected to be completed in the first quarter of 2023. If the costs and expenses incurred for the construction exceed our planned limits, the Group’s financial results may be negatively affected. The Group may experience seasonality in the QD Food business. However, as the Group only launched the business recently, it has not observed any seasonal trends relating to QD Food.

The Group has started to wind down its budget auto financing business in the second quarter of 2019 to focus on its core consumer finance business. As a result, revenues generated from the Dabai Auto business will further decrease. Sales income in relation to Dabai Auto business was RMB411.4 million, RMB122.8 million and RMB23.3 million (US$3.7 million) in 2019, 2020 and 2021, respectively. As of December 31, 2021, the Group carried finance lease receivable of RMB31.9 million (US$5.0 million). The decrease in revenues generated from Dabai Auto business and any further write-down that may be recorded during the process of winding down such business may adversely affect the Group’s business, financial condition and results of operations.

All credit facilitated by the Group have fixed financing service fees. If prevailing market interest rates rise, the Group’s cost of capital for funds will increase, which may force the Group to increase the financing service fees it charges for on-balance sheet transactions. If the Group’s borrowers decide not to utilize the Group’s credit products because of such an increase in financing service fees, the Group’s ability to retain existing borrowers, attract or engage prospective borrowers as well as the Group’s competitive position may be severely limited. We cannot assure you that the Group will be able to effectively manage such interest risk at all times or pass on any increase in interest rate to the Group’s borrowers. If the Group is unable to effectively manage such an increase, the Group’s business, profitability, results of operations and financial condition could be materially and adversely affected. If prevailing market interest rates decrease and the Group fails to adjust the amount of financing service fees it charges for on-balance sheet transactions accordingly, prospective borrowers may take advantage of the lower funding cost offered by other parties. As a result, any fluctuation in the interest rate environment may discourage borrowers from making credit applications from the Group or utilize their approved credit, which may adversely affect the Group’s business.

Pursuant to the Circular of the General Office of the PRC State Council on Issuing the Implementing Proposals for the Special Rectification of Internet Financial Risks adopted in April 2016, online finance institutions are required to segregate assets of the institutional funding partners and borrowers in a custodian bank from their own assets. However, there is uncertainty as to the implementation of such regulations, and the scope of online finance institutions which are subject to such assets segregation liabilities remains unclear. In addition, commercial banks in the PRC currently only provide custodian services to online lending information intermediary institutions as defined under the Interim Online Lending Information Intermediary Measures. We do not consider the Group as an online lending information intermediary institution as defined under the Interim Online Lending Information Intermediary Measures, and the Group currently does not engage commercial banks in the PRC to provide such custodian services to the Group. The Group uses its best efforts to separate its own assets from those assets of the institutional funding partners to whom the Group transfers credit drawdowns by setting up separate bank accounts to monitor the assets of such institutional funding partners. However, since such bank accounts are still under the Group’s names and all the assets are therefore considered to be owned by the Group from a PRC legal perspective, if any person enforces a judgment against the Group’s assets, the assets of the institutional funding partners and borrowers will be enforced against as well. In addition, if the Group is deemed as an online lending information intermediary institution by the applicable regulatory authorities under the Interim Online Lending Information Intermediary Measures in the future, the Group may be subject to regulatory measures, such as warnings, fines and other measures permitted under the law, for the Group’s current practices.

The Group generates a material portion of its total revenues from financing service fees. In 2021, financing income, which the Group recognizes for its on-balance sheet transactions, comprised 75.9% of the Group’s total revenues. In addition, the Group recognizes revenues from loan facilitation services when it matches borrowers with funding partners and the funds are transferred to the borrowers. Additionally, revenues from post-origination services are recognized evenly over the term of the loans as the services are performed. As such, the amount of financing service fees charged under such arrangements may affect the amount of loan facilitation fees that the Group collects. Any material decrease in the Group’s financing service fees would have a substantial impact on the Group’s margin. In the event that the amount of financing service fees the Group charges for credit drawdowns it facilitated decrease significantly in the future and the Group is not able to reduce its cost of capital for funds from institutional funding partners or to adopt any cost control initiatives, the Group’s business, financial condition and results of operations will be harmed. To compete effectively, the financing service fees the Group charges could be affected by a variety of factors, including the creditworthiness and ability to repay of the borrowers, the competitive landscape of our industry, the Group’s access to capital and regulatory requirements. The Group’s financing service fees may also be affected by a change over time in the mix of the types of products the Group offers and a change to the Group’s borrower engagement initiatives. The Group’s competitors may also offer more attractive fees, which may require the Group to reduce its financing service fees to compete effectively. Certain consumer financing solutions offered by traditional financial institutions may provide lower fees than the Group’s financing service fees. Although we do not believe such consumer financing solutions currently compete with the Group’s products or target the same unserved or underserved consumers in China, such traditional financial institutions may decide to do so in the future, which may have a material adverse effect as to the financing service fees that the Group will be able to charge. Furthermore, as the Group’s borrowers establish their credit profile over time, they may qualify for and seek out other consumer financing solutions with lower fees, including those offered by traditional financial institutions offline, and the Group may need to adjust its financing service fees to retain such borrowers. In addition, the Group’s financing service fees may be affected by many macroeconomic factors beyond the Group’s control, such as inflation, recession, the state of the credit markets, changes in market interest rates, global economic disruptions, unemployment and fiscal and monetary policies. The Group’s financing service fees, to the extent they are fully or partially deemed as interest, may also be subject to the restrictions on interest rate as specified in applicable rules on private lending. Circular 141 provides that overall capital cost charged on a borrower, comprised of interests and fees, should be in compliance with the judicial interpretations by the Supreme People’s Court of the PRC regarding interest rates in private lending. According to the Private Lending Judicial Interpretations, if the annual interest rate of a private loan is higher than 36%, the excess will be void and will not be enforced by the courts. In an effort to comply with potentially applicable laws and regulations, the Group adjusted the pricing of its credit products in April 2017 to ensure that the annualized fee rates charged on all credit drawdowns do not exceed 36%. See “—The laws and regulations governing the online consumer finance industry in the PRC are still at a nascent stage and subject to further change and interpretation. If the Group’s business practices or the business practices of the Group’s institutional funding partners are deemed to violate any PRC laws or regulations, the Group’s business, financial condition, results of operations and prospects would be materially and adversely affected.” In addition, as some of the Group’s institutional funding partners are prohibited from charging fees at annualized rates in excess of 24%, the Group cooperates with various insurance and asset management companies to charge additional fees from the relevant borrowers so that the overall fee rates applicable to such borrowers would still be within the limit of 36% on an annualized basis. If such arrangements were found by the regulatory authorities to be in violation of the applicable laws and regulations, the Group’s business, results of operations and financial condition could be materially and adversely affected. Under the Second Revised Private Lending Judicial Interpretation issued by the Supreme People’s Court in December 2020, total annual percentage rates (inclusive of any default rate, default penalty and any other fee) for private lending exceeding four times that of China’s benchmark one-year loan prime rate, or LPR, as published on the 20th of each month will not be legally protected. Based on the LPR of 3.7% as published on April 20, 2022, such cap would be 14.8%. According to the Second Revised Private Lending Judicial Interpretation and Reply by Supreme People’s Court to Issues Concerning the Scope of Application of the New Judicial Interpretation on Private Lending, the interest rate cap is not applicable to the lending business of financial institutions and their branches that have been established with the approval of financial regulatory authorities. Rather, this new policy is generally interpreted as only being applicable to private lending, while the Group’s business almost entirely involves financial institutions. However, it is important to note that the Second Revised Private Lending Judicial Interpretation is newly promulgated, and the policy is subject to further clarifications by courts and regulatory authorities. If the same interest rate cap were applied to the Group’s business as required by relevant courts or regulatory authorities, the Group’s profitability may suffer a material adverse impact, and the Group could incur net losses. In addition, the Circular 141 requires financial institutions to ensure that the loan facilitation operators they cooperate with do not collect interests or fees from borrowers. Although the Group no longer charges borrowers directly of any financing service fees, the Group does receive service fees from the Group’s institutional funding partners and third-party guarantee companies, which in turn charge fees from borrowers. We do not believe such practice is in violation of Circular 141. However, as the Circular 141 and other relevant regulations lack detailed guidance, the relevant authorities have broad discretion in the interpretation and implementation of such rules. We cannot rule out the possibility that the government authorities would still consider the Group’s business practices described above to be in violation of Circular 141. These regulations may be interpreted or enforced in ways that are different from our understanding and expectations. Moreover, the PRC government may seek to enhance the regulatory scrutiny of our industry and promulgate new laws and regulations in response to the growth of consumer finance. To the extent that any new laws and regulations or any interpretations of existing laws and regulations restrict the Group’s ability to continue its current operations, cause any aspects of the Group’s current operations to become non-compliant, or impose material compliance costs on it, the Group’s business and results of operations may be materially and adversely affected.

The Group collaborates with institutional funding partners to fund certain credit drawdowns it facilitates. The Group’s current institutional funding partners include banks, trust companies, consumer finance companies, asset management companies and other institutions. For credit drawdowns currently funded by institutional funding partners, such credit drawdowns are typically either facilitated to borrowers directly from institutional funding partners or indirectly from institutional funding partners through trusts the Group established in collaboration with trust companies. Currently, the Group primarily fund its loan book business with its own capital. The total amount of transactions facilitated by the Group under the loan book business and the transaction services business in 2021 was RMB15,117.3 million (US$2,372.2 million), and RMB480.8 million (US$75.4 million) of such transactions was funded by the Group’s institutional funding partners. The Group’s funding arrangements has changed significantly since inception. The Group’s funding arrangements may continue to evolve. There can be no assurance that the Group’s cooperation with new institutional funding partners will meet its expectations or the expectations of borrowers. The availability of funding from institutional funding partners depends on many factors, some of which are out of our control. Some of the Group’s institutional funding partners have limited operating history, and there can be no assurance that the Group will be able to rely on their funding in the future. The Group’s ability to cooperate with new institutional funding partners may be subject to regulatory or other limitations. In addition, regardless of the Group’s risk management efforts, credit facilitated by the Group may nevertheless be considered riskier and have a higher delinquency rate than loans provided by traditional financial institutions. In the event there is a sudden or unexpected shortage of funds from the Group’s institutional funding partners or if the Group’s institutional funding partners have determined not to continue to collaborate with the Group, the Group may not be able to maintain necessary levels of funding without incurring high costs of capital, or at all. Furthermore, the Group had historically relied on one institutional funding partner to fund a substantial portion of credit facilitated by the Group. While the Group has since managed to diversify its funding sources, there can be no assurance that the Group’s funding sources will remain or become increasingly diversified in the future. If the Group becomes dependent on a small number of institutional funding partners and any such institutional funding partner determines not to collaborate with the Group or limits the funding that is available, the Group’s business, financial condition, results of operations and cash flow may be materially and adversely affected. Since inception, the Group has from time to time experienced, and may continue to experience, constraints as to the availability of funds from the Group’s institutional funding partners. Such constraints have affected and may continue to affect user experience, including by limiting the Group’s ability to approve new credit applications or resulting in the Group having to curtail the amount that can be drawn down by borrowers under their existing credit limits. Any prolonged constraint as to the availability of funds from the Group’s institutional funding partners may also harm our reputation or result in negative perception of the credit products the Group offers, thereby decreasing the willingness of prospective or existing borrowers to seek credit products from the Group or to draw down on their existing credit. In addition, the Group may not be able to obtain timely payment of the relevant fees from the institutional funding partners and the Group’s relationship with them may suffer as a result.

The Group faces the risk that borrowers fail to repay their principals and financing service fees in full. Estimated credit loss relating to on-balance sheet transactions is recorded as allowance for loan principal and financing service fee receivables. If the Group experiences higher delinquency rates, such allowance would also increase. See “Item 5. Operating and Financial Review and Prospects—B. Liquidity and Capital Resources.” The Group has established an evaluation process designed to determine the adequacy of its allowance for loan principal and financing service fee receivables. While this evaluation process uses historical and other objective information, it is also dependent on the Group’s subjective assessment based upon its experience and judgment. In addition, since January 1, 2020 and our adoption of ASC 326, the Group’s evaluation process also take into account certain forward-looking factors that reflect current conditions and reasonable and supportable forecasts of future economic conditions. Actual losses are difficult to forecast, especially if such losses stem from factors beyond the Group’s historical experience. The Group has limited experience managing its allowance for loan principal and financing service fee receivables. Furthermore, the Group shifted its focus of target borrower base from college students to young consumers in general starting from November 2015, and it may not be able to accurately forecast delinquencies of its current target borrower base. Given these challenges, it is possible that the Group will underestimate or overestimate the allowance for loan principal and financing service fee receivables. In addition, the Group is not subject to periodic review by bank regulatory agencies of its allowance for loan principal and financing service fee receivables. As a result, if the Group underestimates the allowance for loan principal and financing service fee receivables, there can be no assurance that the Group’s allowance for loan principal and financing service fee receivables will be sufficient to absorb losses or prevent a material adverse effect on the Group’s business, financial condition and results of operations. Conversely, if the Group overestimates the allowance for loan principal and financing service fee receivables, the Group will record higher provision for loan principal and financing service fee receivables, which will adversely affect the Group’s results of operations.

Credit limits for the Group’s borrowers are determined and approved based on risk assessment conducted by the Group’s proprietary credit assessment model and risk management system. Such model and system use big data-enabled technologies, such as artificial intelligence and machine learning, that take into account transactions that the Group has processed. While the Group relies on big data analytics to refine its model and system, there can be no assurance that its application of such technology will continue to deliver the expected benefits. As the Group has a limited operating history, it may not have accumulated sufficient credit analysis and data to optimize its model and system. Furthermore, the Group’s existing data and credit assessment model and risk management system might not be effective. If the Group’s system contains programming or other errors, if the Group’s model and system are ineffective or if the credit analysis and data the Group obtained are incorrect or outdated, the Group’s credit assessment abilities could be negatively affected, resulting in incorrect approvals or denials of credit applications or mispriced credit products. If the Group is unable to effectively and accurately assess the credit profiles of borrowers or price credit products appropriately, it may either be unable to offer attractive financing service fee and credit limits to borrowers, or be unable to maintain low delinquency rates of transactions facilitated by the Group. The Group’s risk and credit assessment may not be able to provide more predictive assessments of future borrower behavior and result in better evaluation of its borrower base when compared to its competitors. If the Group’s proprietary credit assessment model and risk management system fail to perform effectively, its business and results of operations may be materially and adversely affected.

The Group reserves any estimated loss for on-balance sheet transactions due to the borrowers’ default as allowance for loan principal and financing service fee receivables. When evaluating the loan principal receivables on a pooled basis, the Group applies a roll rate model based on historical loss rates, while also taking into consideration macroeconomic conditions in order to calculate the pooled allowance. Subsequent to January 1, 2020, the Group adjusts the allowance that is determined by the roll rate-based model for various qualitative factors that reflect current conditions and reasonable and supportable forecasts of future economic conditions, in accordance with Accounting Standards Update (“ASU”) No. 2016-13, Financial instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments (“ASC 326”). Accordingly, any increase in the delinquency rates of on-balance sheet transactions would increase the Group’s allowance for loan principal and financing service fee receivables, and the Group recognizes any increase in allowance for loan principal and financing service fee receivables as provision for loan principal and financing service fee receivables for the relevant period. Such increase could have a material adverse effect on the Group’s business, results of operations and financial positions. Furthermore, if the actual delinquency rates for on-balance sheet transactions were higher than predicted, the Group’s cash flow would be reduced and the Group’s allowance for loan principal and financing service fee receivables may not be able to cover the actual losses as expected, which could have a material adverse effect on the Group’s working capital, financial condition, results of operations and business operations. In 2019, 2020 and 2021, on-balance sheet transactions represented 37.4%, 99.5% and 99.1% of the total amount of transactions under the Group’s loan book business. In 2019, 2020 and 2021, provision for loan principal and financing service fee receivables and other assets was RMB2,283.1 million, RMB1,641.4 million and a reversal of RMB151.8 million (US$23.8 million), respectively; and the Group’s provision ratio during the same periods was 9.5%, 7.8% and a reversal of 1.3%, as a result of the decrease was primarily due to the decrease in past-due on-balance sheet outstanding principal receivables. The Group’s charge-off ratio, which is defined as the amount of loan principal receivables the Group charged off during a period, divided by the total amount of on-balance sheet transactions during such period, in 2019,2020 and 2021 was 5.3%,11.6% and 2.6%, respectively. As of December 31, 2019, 2020 and 2021, the Group’s M1+ delinquency coverage ratio, defined as the balance of allowance for loan principal and financing service fee receivables at the end of a period, divided by the total balance of outstanding principal for on-balance sheet transactions for which any installment payment was more than 30 calendar days past due as of the end of such period, was 1.5x, 2.4x and 1.8x, respectively. With respect to on-balance sheet transactions, principal for which any installment payment was more than 30 calendar days past due accounted for 11.1%, 7.5% and 5.9% of total on-balance sheet outstanding principal as of December 31, 2019, 2020 and 2021, respectively. As of December 31, 2019, 2020 and 2021, the Group’s loan principal and financing service fee receivables for on-balance sheet transactions for which any installment payment was more than 90 calendar days past due were approximately RMB630.0 million, RMB254.9 million and RMB91.0 million (US$14.3 million), respectively. As of December 31, 2019, 2020 and 2021, the Group’s allowance for loan principal and financing service fee receivables were approximately RMB1,528.9 million, RMB849.2 million and RMB267.0 million (US$41.9 million), respectively. The Group does not accrue financing income on principal that is considered impaired or on credit drawdowns for which any installment payment is more than 90 calendar days past due. Financing income previously accrued but subsequently placed on nonaccrual status will be netted from the Group’s financing income for the current period. Therefore, an increase in delinquency rates of on-balance sheet transactions will lead to an increase in such adjustments of financing income.

In July 2019, we issued US$345 million aggregate principal amount of convertible senior notes due 2026. The convertible notes bear interest at a rate of 1.00% per year, payable on July 1 and January 1 of each year, beginning on January 1, 2020. The convertible notes will mature on July 1, 2026, unless earlier redeemed, repurchased or converted in accordance with their terms. As of March 31, 2022, we have repurchased US$297.5 million aggregate principal amount of convertible notes, and the outstanding principal amount was US$47.5 million. Our ability to make scheduled payments of the principal of, to pay interest on or to refinance our indebtedness, including the notes, depends on the Group’s future performance, which is subject to economic, financial, competitive and other factors beyond our control. The Group’s business may not continue to generate cash flow from operations in the future sufficient to service our debt and make necessary capital expenditures. If the Group is unable to generate such cash flow, we may be required to adopt one or more alternatives, such as selling assets, restructuring debt or obtaining additional equity capital on terms that may be onerous or highly dilutive. Our ability to refinance our indebtedness will depend on the capital markets and our financial condition at such time. We may not be able to engage in any of these activities or engage in these activities on desirable terms, which could result in a default on our debt obligations.

Under the PRC Civil Code, if an intermediary conceals any material fact intentionally 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 is liable for the damages caused. See “Item 4. Information on the Company—B. Business Overview—Regulations—Regulations related to Loans and Intermediation.” Therefore, if the Group fails to provide material information to institutional funding partners, or if it fails to identify false information received from borrowers or others and in turn provide such information to institutional funding partners, and in either case if the Group is also found to be at fault, due to failure or deemed failure to exercise proper care, such as to conduct adequate information verification or supervision of the Group’s employees, or to accurately detect and prevent fraud due to ineffectiveness of the Group’s fraud detection tools, the Group could be held liable for damages caused to institutional funding partners as an intermediary pursuant to the PRC Civil Code. In addition, if the Group fails to complete its obligations under the agreements with institutional funding partners and borrowers, it could also be held liable for damages caused to borrowers or institutional funding partners pursuant to the PRC Civil Code. On the other hand, the Group does not assume any liability solely on the basis of failure to correctly assign a credit limit to a particular borrower in the process of facilitating transactions, as long as it does not 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 online consumer finance platforms and the possibility that the PRC government authority may promulgate new laws and regulations regulating online consumer finance platforms in the future, there are substantial uncertainties regarding the interpretation and application of current or future PRC laws and regulations for the online consumer finance industry, and there can be no assurance that the PRC government authority will ultimately take a view that is consistent with ours.

For the purpose of credit assessment and pricing, the Group obtains prospective borrower’s credit analysis and other information from them as well as, with their authorization, from external parties, and assess applicants’ creditworthiness based on such information. Such external party’s credit assessment system may still be at a development stage and therefore have limitations in measuring borrowers’ creditworthiness. The Group has experienced instances where credit analysis information provided by an external party was not fully predictive of actual delinquency rates. Therefore, the Group does not rely on inputs from one or only a few external parties. Instead, the Group uses inputs from many external parties for its credit assessment model to enhance its risk management capabilities. As the credit assessment methodologies of external parties are not disclosed to the Group, the Group may not have adequate knowledge of the assumptions behind their credit analysis, which could cause the Group’s model to produce inaccurate results. In addition, if there is an adverse change in the economic condition, credit analysis information provided by external parties may not be a reliable reference to assess an applicant’s creditworthiness, which may compromise the Group’s risk management capabilities. As a result, the Group’s assessment of a borrower’s credit profile may not reflect that particular borrower’s actual creditworthiness because assessment may be based on outdated, incomplete or inaccurate information. In addition, the completeness and reliability of information on borrower’s credit risk available in the PRC is relatively limited. The PBOC has developed and put into use a credit reference center which remains relatively underdeveloped. The information available to the Group and external parties from whom the Group obtains information for its credit assessment model is limited. The Group also currently does not have a comprehensive way to determine whether prospective borrowers have obtained loans through other consumer finance platforms, creating the risk whereby a borrower may utilize the Group’s credit products in order to pay off loans from other sources. There is also a risk that, following the Group’s obtaining a borrower’s information, the borrower may have: • become delinquent in the payment of an outstanding obligation; • defaulted on a pre-existing debt obligation; • taken on additional debt; or • sustained other adverse financial events. Such inaccurate or incomplete borrower credit analysis and other information could compromise the accuracy of the Group’s credit assessment and adversely affect the effectiveness of the Group’s control over its delinquency rates. The Group may not be able to recoup funds underlying transactions made in connection with inaccurate or incomplete borrower credit information, in which case the Group’s results of operations will be harmed.

Under the Group’s loan book business, it has entered into off-balance sheet funding arrangements with certain institutional funding partners, which directly fund credit drawdowns by borrowers for credit products and receive guarantees from the Group. The Group also funded budget auto financing products under off-balance sheet arrangements historically. Borrowers directly repay principal and financing service fees to the relevant institutional funding partners, who will in turn deduct the principal and fees due to them from the repayments and remit the remainder to the Group as its loan facilitation fees. Revenues from loan facilitation services are recognized when the Group matches borrowers with funding partners and the funds are transferred to the borrowers. At the inception of each off-balance sheet transaction, the Group records the fair value of (i) guarantee liabilities, which represent the present value of the Group’s expected payout based on the estimated delinquency rate and the applicable discount rate for time value; or (ii) risk assurance liabilities, which considers the premium required by a third-party market participant to issue the same risk assurance in a standalone transaction, as applicable. The contingent loss rising from risk assurance liabilities is recognized when borrower default is probable, and the amount of loss is estimable. Subsequent to January 1, 2020, the contingent liability relating to the expected credit losses arising from the contingent aspect of the risk assurance liability is initially measured under current expected credit loss model, or CECL model, in accordance with ASC 326. Accordingly, an increase in the expected delinquency rates of off-balance sheet transactions would result in an increase in the amount of guarantee liabilities and risk assurance liabilities, which are recognized as changes in guarantee liabilities and risk assurance liabilities. In 2019, 2020 and 2021, off-balance sheet transactions represented 62.6%, 0.5% and 0.9% of the total amount of transactions under the Group’s loan book business, respectively, and the Group recognized RMB1,143.4 million, a reverse of RMB87.9 million and a reverse of RMB201.6 million (US$31.6 million) of changes in guarantee liabilities and risk assurance liabilities during such periods, respectively. Furthermore, if the actual delinquency rates for off-balance sheet transactions were higher than expected, the Group’s guarantee liabilities and risk assurance liabilities may not be able to cover the actual losses as expected, which could have a material adverse impact on the Group’s working capital, financial condition, results of operations and business operations. The Group’s guarantee liabilities and risk assurance liabilities were RMB1,517.8 million and RMB31.4 million as of December 31, 2019 and 2020, respectively, and the Group paid the relevant institutional funding partners RMB2,084.1 million and RMB1,684.4 million in 2019 and 2020, respectively, as a result of borrowers’ default for off-balance sheet transactions. The Group’s guarantee liabilities and risk assurance liabilities were RMB0.9 million (US$0.1 million) as of December 31, 2021. Although the relevant amount under the Group’s off-balance sheet transactions decreased significantly as it primarily funded its credit products with its own capital in 2021, we cannot assure you that off-balance sheet transactions will not increase in the future.

The Group launched the Wanlimu e-commerce platform, which offers online luxury fashion products, in March 2020. The Group is in the process of winding down this business to focus on the Group’s other service offerings. The Group operated the Wanlimu e-commerce platform primarily on the basis of just-in-time ordering, whereby the Group purchased the relevant products from suppliers upon receiving customer orders. As of December 31, 2021, inventory relating to the platform amounted to RMB1.4 million (US$0.2 million). As the Group is winding down the Wanlimu e-commerce platform, it may be subject to a heightened risk of inventory obsolescence, a decline in inventory values, and inventory write-downs or write-offs. In addition, the Group may be required to lower sale prices in order to reduce inventory level, which may lead to lower gross margins. Any of the above may materially and adversely affect the Group’s results of operations and financial condition. The Group launched Wanlimu Kids Clubs, an early childhood education business, in January 2021, and the Group is in the process of significantly downsizing such business. As a result, the Group may incur significant write-downs or write-offs of leasehold improvements and equipment relating to its Wanlimu Kids Clubs business, which may in turn have a material and adverse effect on the Group’s results of operations and financial condition.

We believe that a critical component of the Group’s success is its corporate culture, which we believe cultivates efficiency, fosters innovation, encourages teamwork and embraces changes and development. As the Group develops the infrastructure of a public company and continues to grow, we may find it difficult to maintain these valuable aspects of the Group’s corporate culture. Any failure to preserve the Group’s culture could negatively impact the Group’s future success, including the Group’s ability to attract and retain employees, encourage innovation and teamwork and effectively focus on and pursue the Group’s corporate objectives.