As China's economy slows, internet-lending companies in the country are facing higher credit costs and a tougher environment for new loans.
The share prices of Lufax Holding Ltd., 360 DigiTech Inc. and LexinFintech Holdings Ltd. have all fallen sharply this year. Although all three companies are profitable, they have reported an increase in bad loans, which some analysts believe will only get worse.
The performance of these companies demonstrates how China's wider economic problems - which have impacted large banks and resulted in defaults among giant property developers - are affecting even businesses that cater to small borrowers. Although they have slightly different business models, all three help funnel loans from banks to consumers or the owners of small and midsize enterprises.
Lufax's second-quarter net profit was down 38% from a year earlier, while credit-impairment losses more than doubled to $496 million. About 1.7% of its total loans were over 90 days past due, compared with 1.1% a year earlier.
LexinFintech and 360 DigiTech reported that their profits fell by 79% and 37% respectively in the second quarter, due to an increase in bad debts. Lufax and LexinFintech also said that their new loan applications had decreased.
FinVolution Group, a U.S.-listed Chinese internet lender, had a better quarter, with a 5.7% drop in net profit. However, loans 90 days past due rose to 1.6% from 1%. The company targets higher-quality borrowers, which may explain the overall drop in net profit despite the increase in delinquent loans.
Johannes Au, a financial-services analyst at ABCI Securities, said that the rise in delinquency rates has only just begun and will continue in the coming quarters. He added that the situation is worse for internet lenders than banks, as their borrowers tend to be less creditworthy.
Lufax declined to comment when asked about the matter. LexinFintech, 360 DigiTech and FinVolution did not respond to requests for comment.
Banks typically use credit scores and income to decide whether to approve a loan. However, internet lenders may use a variety of information, including demographics, location, spending habits, and data from third-party sources, to make their decisions.
A typical consumer loan is usually for around $1,400, with a repayment period of around one year. For small-business owners, a loan can be up to $43,000 and two or three years. Most are unsecured, and online lenders tend to charge an interest rate of 20% or more to compensate for the risk.
Internet lenders typically don't make loans themselves, but instead act as intermediaries between lenders and borrowers. They often use third-party loan guarantors to reassure lenders, but as the economic slowdown worsens, they are facing more pressure to guarantee larger portions of these loans themselves. For instance, Lufax bore risk on 21.7% of its outstanding balance in the second quarter, up from 16% a year earlier.
Risk-sharing was initially a selling point for internet lenders, who positioned themselves as capital-light businesses. However, some of these companies are now under regulatory pressure to increase guarantees, according to Alex Ye, a China financials analyst at UBS. “Regulators want the biggest internet lenders to have more skin in the game so that they will be more careful in underwriting the loans,” he said.
Banks and other financial institutions may ask for more guarantees during difficult times, said Mr. Au of ABCI Securities. However, this presents an opportunity as well as a risk—by providing guarantees, internet lenders can generate higher fee income.
To prepare for the economic downturn, internet lenders are focusing on risk management instead of loan growth. Yong-Suk Cho, co-chief executive officer and chairman of Lufax, said in a recent earnings conference call that the company will prioritize asset quality over volume growth this year. New loans on its platform decreased by more than 15% in the last quarter.
Goldman Sachs analyst Thomas Wang believes that Lufax's credit impairment will remain high in the second half of this year and 2023. In a research report, Wang wrote that this is the right approach given the likely deterioration in the risk profile of the borrowers.
In addition to the economic slowdown, Chinese internet lenders are facing regulatory challenges that are further depressing their share prices. In an effort to support small businesses, Chinese authorities have been outlawing high-interest loans. In 2020, China’s Supreme Court lowered the ceiling for private lenders from 24% to four times the one-year loan prime rate—a calculation that now gives a maximum interest rate of 14.6%.
Many internet lenders have partnerships with banks, which means they are exempt from the new rule. However, this may not be a long-term solution.
"Even though small-business loan lenders are already operating below the cap, they may come under regulatory pressure to lower prices even further to support the real economy," said Mr. Ye of UBS. He believes that online lenders will eventually have to become licensed lenders to maintain profits.
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