China’s internet lenders are feeling the pain of the economic slowdown

Online lending companies in China are facing rising credit costs and a tighter environment for obtaining new loans due to the country’s slowing economy.

Their performance shows how China’s broader economic woes – which have hurt the largest banks and included defaults on giant property developers – are affecting even companies that cater to small borrowers. Although the three business models are slightly different, they all help shift loans from banks to consumers or owners of small and medium businesses.

Lufax’s second-quarter net profit — the largest of the three, with a market value of about $7.5 billion — fell 38% from a year earlier, while credit impairment losses more than doubled to $496 million. About 1.7% of its total loans were more than 90 days past due, compared to 1.1% a year earlier.

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LexinFintech and 360 DigiTech said their profits fell 79% and 37%, respectively, in the second quarter due to higher bad debts. Lufax and LexinFintech said their new loans are down.

FinVolution GroupAnd the

FINV -4.46%

A US-listed Chinese internet bank targeting high-quality borrowers had a better quarter, with net profit down 5.7%. But loans past due after 90 days rose to 1.6% from 1%.

The rise in delinquency rates is just beginning and will continue in the coming quarters, said Johannes O, financial services analyst at ABCI Securities. He added that the situation for Internet lenders is worse than for banks, as borrowers tend to be less creditworthy.

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Covid-19 lockdowns, crackdown on corruption, and more have put the Chinese economy on a potentially rampant path. Dion Rabouin of the Wall Street Journal explains how the economic downturn in China could hurt the United States and the rest of the world. Illustration: David Fang

Lofax declined to comment. LexinFintech, 360 DigiTech and FinVolution did not respond to requests for comment.

While banks generally rely on credit scores and income in deciding whether to approve a loan, online lenders use a range of information that can include demographics, location, spending habits and even data on browsing history, which are obtained from third parties.

A typical consumer loan usually equates to about $1,400, with a repayment period of about one year. For small business owners, the loan can be up to $43,000 for two or three years. Most are unsecured, and online lenders tend to charge an interest rate north of 20% to compensate for the risk.

Internet lenders generally do not provide these loans themselves, but rather act as intermediaries between lenders and borrowers. They usually use third-party loan guarantors to reassure lenders, but as the economic slowdown worsens, they face more pressure to secure larger portions of these loans themselves. For example, Lufax assumed a risk of 21.7% of its outstanding balance in the second quarter, up from 16% a year earlier.

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Risk sharing was initially a selling point for internet lenders, who positioned themselves as venture capital firms. Some of these companies are under regulatory pressure to increase safeguards, said Alex Yi, China financial analyst at UBS.

“Regulators want some of the biggest internet lenders to have leverage in the game so they can be more careful about underwriting the loans,” he said.

Mr. Au of ABCI Securities said that banks and other financial institutions may also require more collateral in difficult times. But this presents an opportunity as well as a risk – by providing guarantees that online lenders can generate income above fees.

To prepare for an economic downturn, Internet lenders are putting themselves on the defensive, focusing on risk management rather than loan growth. Yong Suk Cho, Co-CEO and Chairman of Lufax, said on an earnings conference call recently that the company will prioritize asset quality over volume growth this year. New loans on its platform fell more than 15% last quarter.

“We believe this is the right approach given that the risk profile of borrowers has likely deteriorated,” Goldman Sachs analyst Thomas Wang wrote in a research report. Mr. Wang expects Lufax’s credit weakness to remain high in the second half of this year and 2023.

On top of the economic slowdown, Chinese internet lenders are facing regulatory challenges that hurt their stock prices even more. In an effort to support small businesses, the Chinese authorities are banning high-interest loans. In 2020, China’s Supreme Court lowered the cap on private lenders from 24% to four times the one-year base loan rate – a calculation that now gives a maximum interest rate of 14.6%.

Many internet lenders have been exempted from the new rule thanks to partnerships with banks, whose cap is still 24%. But this may not be a long-term solution.

“Although their rates are already below the cap, small business loan lenders may come under some regulatory pressure to further reduce loan pricing 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.

write to Michelle Chan at [email protected]

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