China’s Economic Slump Leaves Internet Lenders Battling Bad Loans

360 DigiTech, FinVolution and Lexin all reported first-quarter net profit declines and growing delinquent loans, amid a grim outlook for China’s economy

Key takeaways:

•      360 DigiTech and FinVolution posted 12% and 9% profit declines in the first quarter, respectively, while Lexin’s profit plunged by 89%

•      Delinquent loans rose for all three lending platforms, forcing them to increase loan-loss provisions

By Warren Yang

The fortunes of consumer lenders are a good proxy for the state of an economy. When times get rough, individuals with shaky income are often among the first to feel the pinch. And their stress can quickly trickle down to their lenders as they fail to repay their loans on time.

Such vulnerability is on prominent display in the latest financial results from a trio of Chinese internet lending platforms. Late last month, 360 DigiTech (QFIN.US) reported a 12% year-on-year fall in its first-quarter net profit, while FinVolution Group (FINV.US) last week posted a 9% decline. While those were bad, the situation was far worse at LexinFintech Holdings Ltd. (LX.US), which also last week reported its profit plunged 89%.

A common theme in all three companies’ latest results was rising loan delinquencies during the three months, which hurt each in one way or another depending on their business models.

All three companies were once direct lenders that later transformed into loan facilitators connecting borrowers and banks, though to varying degrees. FinVolution is largely focused on loan facilitation, while both Lexin and 360 DigiTech continue to do some direct lending as well as using their balance sheets on a substantial scale.

360 DigiTech’s proportion of loans delinquent for three to six months nearly doubled to 2.4% at the end of March from about 1.3% a year earlier. Similarly, Lexin’s ratio rose to 2.4% from 1.8%, while FinVolution saw the figure climb to 1.6% from 1.1%

The trend suggests borrowers are having growing difficulty repaying their debt as China’s economy slows after years of breakneck growth. The situation has been compounded recently due to massive Covid-related restrictions that have put millions out of work, both temporarily and permanently, and also led to growing unemployment among recent graduates who are often some of the most enthusiastic borrowers. All that hurts the fintech lenders by forcing them to set aside more money as provisions to cover possible loan losses, adding to costs.

360 DigiTech more than tripled provisions for loans on its own balance sheet in the first quarter from a year earlier. That dwarfs a near doubling of interest income from such loans, which would have been nice, if it wasn’t more than offset by the hefty price to cover potential losses.

In addition, the company, which is controlled by software security giant Qihoo 360, boosted allowances it can tap into to pay its bank partners when there are defaults for loans that 360 DigiTech effectively guarantees for those partners. The increases in such charges contributed to a decline in the company’s operating profit even as its revenue grew during the latest quarter.

The story is similar for FinVolution. Like 360 DigiTech, the company makes provisions to cover loan losses for its bank partners under repayment guarantee schemes. And FinVolution boosted such allowances, which are the biggest part of its operating expenses, by nearly 47% in the first quarter. 

Growing business

Both 360 DigiTech and FinVolution still managed to grow their business substantially in the first quarter. The former expanded its loans facilitated and originated by 33% year-over-year during the period, while the latter posted a 48% increase in transaction volume. So it seems that people are still more than happy to borrow money, even if they can’t necessarily pay it back.

But the case was different for Lexin, whose loan origination dropped nearly 20% year-on-year, while the number of active users of its products decreased 31%. As a result, the company’s total operating revenue dropped. And yet provisions to cover defaults on third-party loans provided by its lending partners still increased.

Lexin’s business shrank, unlike the other two, possibly because it turned more cautious, opting to minimize risks, even at the expense of revenue growth.

Regardless of their individual differences, the three companies’ first-quarter results show they are united by powerful headwinds as dark clouds hang over China’s economy. That’s being amplified by restrictions tied to China’s zero-Covid policy, which have led economists to widely expect the country’s GDP growth to slow notably this year, possibly even slipping into contraction territory in the second quarter.

China’s hardline stance on Covid-19 means lockdowns and other tough measures can disrupt commercial activities anytime, as they have in many parts of China. That includes a two-month citywide lockdown in Shanghai in April and May, which brought economic activity in China’s largest city and financial hub to a virtual standstill.

This leaves private lenders like the fintech trio more vulnerable than large state-owned banks because the former target individuals and small businesses that are financially weaker than big government-backed companies served by the latter. Tellingly, the nonperforming loan (NPL) ratio of Industrial and Commercial Bank of China (1398.HK; 601398.SH), the country’s top bank, actually declined at the end of March from a year earlier.

Investors certainly seem downbeat on the three fintechs. 360 DigiTech shares are down about a quarter this year, while Lexin stock has lost nearly half of its value. FinVolution shares are faring better but still have fallen more than 16%. Both 360 DigiTech and FinVolution shares trade at price-to-earnings (P/E) ratios of less than 4, a modest multiple for an internet company. The P/E ratio for Lexin is even more humble, at about 1.6.

After surviving a harsh regulatory crackdown to rein in rampant growth among internet lending platforms, the three fintechs have come a long way, increasingly shifting their focus to screening for relatively high-quality borrowers. That still didn’t prevent them from taking a hit in the first quarter as the Chinese economy at large went south.

The second quarter may prove even tougher for 360 DigiTech, Lexin and FinVolution, given that Shanghai’s prolonged lockdown began right at the start of the three-month period amid outbreaks of the highly infectious Omicron variant. Seeking to avoid a similar fate, the city of Beijing also rolled out restrictions that heavily limited local retailers’ operations.

Analysts polled by Yahoo Finance project that all three companies’ earnings will fall this year before rebounding in 2023. This is in line with how the Chinese economy is generally forecast to perform this year and next. That’s little surprise, but means both business and shares of all three fintechs could face some challenging times in the second half of this year.

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