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.

Consumer lending is booming in China, thanks to a less thrifty younger generation who have cast off the save-at-all-costs mentality of their parents.

That means a spate of U.S. and Hong Kong flotations by consumer finance companies should be IPO gold for investors. But in a fizzy climate for new economy stars, they should be wary of a change to Beijing's light regulatory touch.

LexinFintech Holdings Ltd., backed by JD.com Inc. and with a CEO who previously worked at Tencent Holdings Ltd., is aiming for a Nasdaq listing. Yixin Group Ltd., an online car-loan provider, soared as much as 32 percent on its first day of trading in Hong Kong on Thursday after raising HK$6.8 billion ($867 million). Backed by Tencent, Yixin is the latest addition to a hot IPO market for firms linked to China's tech heavyweights.

It's not hard to see why this corner of the finance industry should be thriving. China's unsecured consumer loans amounted to just 9 percent of gross domestic product in the first nine months of this year, compared with 15 percent in the U.S., according to consultants Oliver Wyman. The educated 18- to 36-year-old borrowers LexinFintech targets tend to be ignored by banks, even though their job prospects mean that they're unlikely to default.

Young and Hungry
China's consumer finance market is expanding rapidly
Source: LexinFintech/Oliver Wyman

Auto financing, meanwhile, has exploded to account for more than a third of car purchases last year from 8 percent in 2011, according to CLSA Ltd. data. The retail portion of Yixin's IPO was more than 500 times oversubscribed.

Driving to Debt
Last year, 35 percent of cars were purchased via auto financing, up massively from previous years
Source:: CLSA

These consumer lending platforms have extraordinarily low levels of default despite high interest rates and the absence of a national credit rating agency for individual borrowers. That reflects the use of artificial intelligence and other technological tools to predict which loans will sour. Advances that are more than six months overdue make up less than 2 percent of the total at LexinFintech, for instance, though provisions for credit losses increased 195 percent in the nine months through September.

Still, the experience of Qudian Inc. provides a cautionary tale. The micro-lender's shares have retreated since surging on their New York debut last month after its founder gave an interview, according to Caixin, in which he implied that the company's interest rates were so high that it could afford to ignore defaults rather than trying to collect.

Allegations that some cash micro-lenders are charging excessive interest rates have prompted Chinese regulators to consider a crackdown on the sector, Bloomberg News reported this month. Qudian, which makes loans through a mobile app, said in its listing document that 59.5 percent of its 2016 transactions had “annualized fee rates” exceeding the 36 percent ceiling specified in Chinese law. The company, which is backed by Alibaba Group Holding Ltd. affiliate Ant Financial, said it cut its rates below the cap in April.

Peer-to-peer lender PPDAI Group Inc., which listed in New York last week, also said that its rates exceeded 36 percent once fees are included. The company's shares are trading below their offer price.

Regulatory risk may be lower for consumer lenders that draw their funding from institutional sources rather than individuals. LexinFintech and Yixin both get funding from banks and asset-backed securities. That enables these platforms to charge less: LexinFintech's loans, which are mostly used for small-scale purchases such as iPhones, carry an annual rate of 25.3 percent.

Still, a change in government attitudes remains a threat to consumer lenders, even those that enjoy the support of tech giants such as Tencent or JD.com.

As LexinFintech notes, consumer lending is such a new industry in China that "laws and regulations may change in ways that do not favor our development." Words to keep in mind when it comes to the latest vogue in Chinese finance.

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