Lexin, 360 DigiTech and FinVolution are turning their focus to high-quality borrowers at the expense of revenue growth to shield themselves from growing default risks

Key Takeaways:

  • Lexin and 360 DigiTech reported third-quarter revenue and profit declines as they refrained from lending to riskier borrowers and boosted default provisions
  • The results show that fintech loan facilitators are turning cautious to avoid default-related loan losses as China’s economy slows

By Warren Yang

“Risk management trumps all” appears to be the mantra for Chinese online loan companies these days as China’s economy slows sharply after years of breakneck growth, fueled in no small part by easy credit. And investors seem to appreciate the newfound focus.

That’s the message coming through in the latest results from a trio of online credit facilitators, with LexinFintech Holdings Ltd. (LX.US), 360 DigiTech (QFIN.US) and FinVolution Group (FINV.US) all reporting year-on-year declines in their third-quarter net profit last week. Details of their results vary, but the common theme is growing caution as they try to curb risks from China’s economic slowdown, which can hit borrowers’ finances and increase their chances of defaulting on debt.

That means that the trio sacrificed revenue growth to focus on higher-quality, or lower-risk, customers. Lexin’s third-quarter revenue declined 9.4% year-on-year, according to its latest earnings report released last Wednesday. Days earlier, 360 DigiTech posted a similar 10% fall. FinVolution’s results show it managed to increase its third-quarter revenue by about 18%. But even that growth was slower than in headier prior years.  

“At the current point of time, the management believes quality over quantity is the right approach to sustain a healthy status of our business,” Lexin CFO Sunny Sun said on the company’s earnings conference call, summarizing the broader sentiment right now.

The pressure to find financially sound borrowers and minimize defaults is the greatest for Lexin among the three because it has the highest delinquency rate. Loans delinquent for 90 days or longer, which are typically considered nonperforming, amounted to 2.66% of the company’s total at the end of September, up from 1.85% a year earlier and 2.63% at the end of June. The latest figure is more than double the average for traditional banks in China rated by Fitch Ratings.

Although Lexin is increasing its focus on high-quality borrowers with lower credit risks, which should reduce the need to book provisions against potential defaults, it still substantially boosted such allowances in the third quarter from a year earlier. Although Lexin is largely a loan broker between borrowers and banks, the company, like 360 DigiTech and FinVolution, faces credit risks because it helps to cover losses for its lending partners when borrowers default on loans it facilitates.

The third-quarter spike in provisions eroded Lexin’s net profit, but it also shows the company wants to be prepared in case defaults surge. Such proactive provisioning seems prudent at economically uncertain times like now. If actual loan losses are smaller than Lexin’s projection, it can always release some of its provisions and add them back to its revenue in future quarters.

Quality growth

360 DigiTech’s delinquency rate also surged in the past year and was at a similar level to Lexin’s at the end of June. But unlike its rival, the company’s figure fell a bit during the third quarter. This suggests a degree of success in screening out risky borrowers as 360 DigiTech, like Lexin, steps up efforts to drive “quality growth,” as CEO Wu Haisheng reiterated during the company’s earnings call.

Such efforts require constant investment to develop and refine risk assessment software, which isn’t easy when your profit is declining. For 360 DigiTech, funds from a new second listing in Hong Kong can come in handy for such investment. The company is offering 5.54 million shares to raise up to HK$492 million ($63 million), with pricing scheduled for Wednesday. It said it will use the proceeds to develop technology and credit assessment capabilities, among other purposes.

FinVolution exemplifies how a focus on high-quality borrowers can pay off in the long term. The company began targeting less risky consumers well ahead of Lexin and 360 DigiTech. As a result, its 90-day delinquency rate is well below those of the other two, at 1.44% at the end of September, even though that’s up by about 0.4 percentage points from a year earlier.

Because FinVolution already has a better system to assess credit risks and has accumulated experience, it can probably target qualified borrowers and boost its loan facilitation volume more easily than Lexin and 360 DigiTech. That’s likely why, unlike the other two, it was able to grow revenue in the third quarter despite the economic headwinds.

But the fact that FinVolution’s revenue growth was also weaker than in earlier years means it likely became more careful in pursuing new borrowers, probably both out of caution and because the pool of customers that met its risk criteria shrank. And like Lexin and 360 DigiTech, FinVolution also ramped up provisions against future potential defaults.  

Although the three companies’ latest reports were hardly stellar, all of their shares rallied after they were released. FinVolution stock now trades at a price-to-earnings (P/E) ratio of about 4, while the multiple for Lexin and 360 DigiTech exceeds 3. Granted, those valuations are hardly sky-high. But they do seem to indicate investors recognize the companies’ efforts to stay in the game in the long term, despite constantly changing regulations toward their sector.

All three have earned the title of “survivor,” weathering a harsh regulatory crackdown on online lenders by switching their business models to loan facilitation from direct lending. That achievement looks laudable, given that many of their former peers have disappeared or are fighting for survival. The latter group includes Qudian Inc. (QD.US), which is barely surviving after failed attempts to reinvent itself as a tutoring center operator and seller of ready-to-cook meals. Its third-quarter net loss swelled nearly sevenfold, with no clear path forward as it searches for a business model.

By contrast, Lexin, 360 DigiTech and FinVolution all deserve credit for not only sticking around, but also taking what seem like the right steps to stay in business over the longer term.

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