Lexin Slows Down Lending As Latest Regulatory Wave Rocks Fintechs

Key Takeaways:

• LexinFintech is voluntarily slowing down its lending activity while it awaits the next major move in China’s rapidly evolving regulatory environment
• Company’s shares tumbled after its latest quarterly results announcement, despite reporting 10% revenue growth and 88% profit growth

By Thomas Zhang

Solid growth is the gold standard for investors, even though such growth may not guarantee stock will rise. That lesson is on display once more in the latest earnings report from online loan facilitator LexinFintech Holdings Ltd. LX.

The headline numbers in the report released late last week don’t look bad. Lexin earned revenue of 3.27 billion yuan ($506 million) in the second quarter, up 10.5% year-on-year. Total loan originations for the period reached 60.6 billion yuan, representing an even bigger 47.6% increase, and net profit soared an even larger 87.7% to 787 million yuan.

But none of that seemed to impress investors, who dumped Lexin’s stock to the tune of a more than 13% decline after the report came out to a price of about $7. Analysts were equally bearish. CLSA downgraded the stock to “outperform” from “buy”, slashing its target to $9.70 from $17. DBS similarly downgraded it to “hold” from “buy”, setting an even lower target of $7.20; and Citi lowered its price target to $9.89 from $18.55.

So why are investors so pessimistic in spite of such seemingly solid numbers?

Part of the answer, some industry observers noted, lies in a recent regulatory change, or more specifically, a potential change. Word of that change has come in reports that were already widespread in late July saying Beijing would like to cap annual interest rates for personal loans at 24%, down from the current 36%.

Such a move would almost certainly reduce the profitability of fintech companies like Lexin, which has been transforming from a direct lender to a “capital light” business model of middleman loan facilitator between borrowers and banks.

CEO Jay Xiao admitted on Lexin’s earnings call that such a change could “reshape” the entire online lending industry. As a result, he added, Lexin would “slow down our pace” and “lower full-year loan facilitation volume” to 230 billion yuan from a previous pace of 240 billion yuan to 250 billion yuan. “We will step up the focus on asset quality,” he announced.

Across China’s online lending sector, the transformation of business models from direct lending to middleman loan facilitation has been going on for a while. LexinFintech is one of such lenders that have gone down that road. Many have taken the step in response to a flood of new regulation toward the young sector, as Beijing seeks to rein in the freewheeling group that was previously only lightly regulated and had little experience with risk control.

For Lexin and other companies that have taken the loan facilitator path, the upside is that they lose the risk of loan defaults and move such risk to banks. But in exchange for taking that risk, banks pay facilitators like Lexin lower fees than they would if both companies were sharing the risk burden.

Regulation involving data security is also weighing on the sector, with online lenders facing stricter requirements on collecting personal data when taking on new customers. Providing user data to financial institutions other than those making actual loans has also been banned, putting a severe damper on fees generated from providing risk management as a service.

Regulatory Storm

The “storm of regulation” is coming from all directions and shows no signs of slowing. The People’s Bank of China, the central bank, has recently warned that it may limit commissions that fintech companies like Lexin are allowed to take when they generate businesses for banks. And in late July, the Ministry of Industry and Information Technology signaled its intent to curb “harassing” pop-up windows that are widely used by fintech companies to acquire new customers.

Lexin certainly isn’t alone in seeing its stock stumble despite posting solid second-quarter results. Similarly decent results from most of its peers over the last two weeks have failed to lift many of their shares, as investors remain fixated on the impact of new, proposed, and rumored regulations.

Loan facilitator FinVolution Group reported handsome second-quarter results showing its revenue grew 31.7% to 2.38 billion yuan year-on-year, while net profit rose 36.7% to 620 million yuan. Yet the stock was nearly unchanged through the end of last week from its pre-announcement levels.

The picture was more mixed for Qudian Inc., whose second-quarter revenue plunged by nearly two-thirds year-on-year even as its net profit grew more than 50%. Like many of its peers, the former microlender has been shifting to becoming a middleman loan facilitator and is shrinking its loan books in that process. Investors responded positively to its report, sending the stock up 7%, from $1.57 to $1.68 after the announcement. It last closed at $1.70 on Tuesday.

360 DigiTech Inc., regarded by some as one of the sector’s best bets, seems to be one notable exception. Its latest report showed 19.8% revenue growth in the second quarter to 4 billion yuan, with net profit jumping 76.6% to 1.5 billion yuan. Its stock leaped 15% immediately after the announcement and has continued to climb. At its latest close of $22.80, the shares are now 34% above where they traded before the Aug. 19 announcement.

Broadly speaking the sector remains lowly valued due to all the regulator uncertainty. Lexin now trades at a low price-to-earnings (PE) ratio of 3.8, while FinVolution is a bit higher at 5. Even 360 DigiTech is still quite low at 4.3, while Qudian trades at the lowest 1.4.

For those who may see such low valuations as an investment opportunity, a quick history review may help to put the group in better context. China’s fintech sector first began to emerge about a decade ago, starting with electronic payment firms and then adding peer-to-peer (P2P) lenders and later consumer credit providers. The sector has seen companies forced to continually reinvent themselves following each new wave of regulation, with many smaller players simply shutting down. That’s made the sector a difficult place for investors, especially those looking to bet on who will thrive over the longer term.

The latest wave of regulation dates back to last November when the Alibaba-backed behemoth Ant Group abruptly called off its blockbuster IPO. Policies, rather than fundamentals, now play an increasingly greater role in investors’ decision-making, with some investors looking for the latest clues in policy direction from the words of China’s leaders.  

Against that backdrop, the decision by Lexin’s Xiao to slow down growth may look like a prudent way to better assess the broader situation and steer the company through the latest regulatory storm into calmer waters over the long term.