Finance

Nisha Gopalan is a Bloomberg Gadfly columnist covering deals and banking. She previously worked for the Wall Street Journal and Dow Jones as an editor and a reporter.

China's peer-to-peer lenders are getting ready to come to market, propelled to prominence by a wave of financial innovation that has seen the market explode in the past five years. Should investors be interested? That may depend on their time horizon.

Lufax, the biggest online platform matching borrowers with savers seeking better returns, is seeking to raise $1 billion in a funding round that would value the company at between $15 billion and $20 billion, Bloomberg News reports. Yirendai.com has already filed for a U.S. IPO that will probably raise more than $100 million. Dianrong.com, meanwhile, is set for a $500 million funding round next year, according to the Wall Street Journal.

For those looking for short-term gains, China's P2P lenders are probably a buy. Looking further into the future, the outlook is far less certain, and a bumpy ride is almost assured.

The hunt for yield in a world of ultra-low interest rates has driven a global surge in peer-to-peer lending. In China, the rush to exploit the trend has been turbo-charged by state control over the traditional banking system, which has held down deposit rates, and capital controls that restrict the investment options available to those with funds.

LendingClub may have been the first peer-to-peer lender to go public, but growth in China has left the U.S. in the shade. The number of platforms has ballooned to more than 2,500 this year, from a handful in 2010. Dianrong was set up by LendingClub founder Soul Htite.

Online Explosion
Number of P2P platforms in China
CICC Research
*Data for 2015 is to October

Unlike in the U.S., where individual borrowers dominate, credit-starved small businesses have flooded P2P platforms in China, some of which, including Yirendai, accept investments of as little as $15.

Backed by CreditEase, an online financial firm set up by a former investment banker almost a decade ago, Yirendai should be the first Chinese P2P lender to go public in the U.S. Having made $1.1 billion of loans and with just under 7 million users, it is smaller than Lufax, which Chinese investment bank CICC says had 70 billion yuan of loans and more than 16 million registered users.

Yirendai has already acquired the status of a ``unicorn,''  as unlisted startups valued at more than $1 billion are known. As for Lufax, its eye-popping valuation makes the Shanghai-based company a``decacorn'' and the world's most valuable financial technology startup, well ahead of LendingClub's $4.7 billion market value. The company, which is easily the biggest P2P lender in China, is likely go public in the next couple of years or so in Hong Kong, 

The appeal for investors tempted by China's P2P lenders is obvious: growth. Unsecured lending in China will expand an average of 26.6 percent a year by 2019 to 11.4 trillion yuan, from 3.5 trillion yuan last year, consultancy iResearch forecasts. Yirendai also comes cheaper than LendingClub, with the IPO valuing it at about 9.9 times forecast 2017 earnings, according to CICC. The U.S. lender trades at almost 29 times. 

Meanwhile, returns are higher. Sites such as Yirendai charge annual interest of as much as 36 percent to borrowers, while LendingClub's average is about 15 percent.

So what could go wrong? Extraordinary growth and profits bring extraordinary competition. Several hundred P2P lenders have closed down in the past couple of years, according to some analysts. Competition is driving down average interest rates. At the same time, the costs of maintaining the platforms and performing due-diligence checks isn't negligible. And the government has started putting regulations in place.

The biggest risk for investors in these companies is their inability to screen accurately for risky borrowers. There is no nationwide credit bureau such as Equifax or Experian, so defaults can't always be tracked. What data is collected nationally, by the People's Bank of China's credit database, isn't easily accessible.

That's not great news at a time when China's slowing economy is driving an increase in bad loans, albeit many of them extended to state-backed commodity firms rather than the small and medium-sized companies that are the main customers of P2P lenders. Unlike U.S. sites such as LendingClub, which can extend credit for as long as five years, the average P2P loan in China is only four to five months, and the amounts tend to be much higher. 

Rising Wave
China's total non-performing loans
Bloomberg/People's Bank of China

That puts a premium on the ability to assess credit quality. In China, only one group outside the conventional banks can lay claim to that expertise: the Internet giants. Alibaba affiliate MYbank and Tencent-backed WeBank have access to something the P2P lenders will never have directly -- big data. Alibaba's dominant e-commerce platforms give the company nationwide coverage and the ability to cut off borrowers that default, while Tencent's Wechat is the nation's most-used social networking app. MYBank parent AntFinancial is likely to sell shares in China in the next couple of years. WeBank, which started operations in January, is currently raising funds.

LendingClub's experience illustrates the shaky ground P2P stands on: The shares surged 56 percent on their debut in December 2014, but are down 50 percent this year. With China's prospects for a continued rise in bad loans, only the stout of heart need apply. Either that, or wait for the Alibaba and Tencent online banks to arrive.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Nisha Gopalan in Hong Kong at ngopalan3@bloomberg.net

To contact the editor responsible for this story:
Matthew Brooker at mbrooker1@bloomberg.net