China’s Online Lenders in Rut as Quality Borrowers Dwindle

It’s difficult for any lender to grow its business in a cooling economy, and Chinese fintechs that once wowed investors with their rapid growth by doling out funds to hungry consumers and small businesses are no exception.

The latest quarterly results from three of China’s leading loan facilitators – FinVolution Group (FINV.US), 360 DigiTech (QFIN.US) and LexinFintech Holdings Ltd. (LX.US) – show how the group is bearing the brunt of a slowing Chinese economy in the same way direct lenders are.

An economic downturn can hit lenders two ways. When all’s well, many people and businesses race to borrow on the assumption that their future income will be sufficient to repay their debt. But when things go south, many of those same entities hunker down and pause their borrowing. Ones that continue to borrow also become more likely to default on their debt. In such situations, lenders can take a double-hit from a slowdown in lending activity and an increase in bad loans.

Last Monday, FinVolution — a former direct lender that transformed to a middleman between banks and borrowers to survive a harsh regulatory crackdown on the fintech sector — reported a year-on-year decline of about 6% in its second-quarter net profit to 585 million yuan ($87.4 million). Its net revenue growth slowed to about 12%, down from 16% and 32% in the previous two quarters, respectively.

China’s economic slump has put the company, as well as other loan facilitators and direct lenders alike, in a bit of Catch-22 situation. While credit demand in general is weakening, loan companies could perhaps achieve more impressive top-line revenue growth by aggressively pursuing consumers or small businesses that are desperate for funds as their business sputters.

But in such times, such borrowers are exactly the type that any lenders should avoid due to the higher likelihood of defaulting on their loans. Even though companies like FinVolution act as loan brokers for banks, they do have arrangements to pay back some or all of the funds to the original lenders when there are defaults, exposing them to the same credit risks that direct lenders face.

This means that online loan providers at the moment should sacrifice revenue growth, which they appear to be doing. The higher quality borrowers they do manage to find ultimately bring in less revenue and lower fees because they pay lower interest rates due to their better creditworthiness.

The worst part for fintech loan companies is that they typically lend to consumers or smaller private sector customers that are inherently riskier than large, stable businesses that borrow from traditional state-owned banks. That shows up in FinVolution’s ratio of loans delinquent for more than 90 days, which shot up to 1.6% at the end of June from about 1% a year earlier despite its efforts to be more prudent in selecting customers.

Provisions that the company sets aside to repay its partner lenders in case of defaults more than doubled year-on-year in the second quarter, far outpacing a 44% increase in its total outstanding loans. That hit FinVolution’s bottom line hard.