China fintech:Poised to dominate consumer finance

China’s fintech lending sector is booming. Whilst there will inevitably be setbacksfrom tighter regulations and many players will fail, we are convinced that onlineofferings are a formidable threat to banks, in the vastly underpenetratedconsumer finance segment. We initiate coverage of the fintech lending sectorwith a positive view and recommend investors buy Yirendai and Qudian. Ourtarget price implies a one-year TSR of 43% on YRD and 32% on QD.

    Consumer credit sector is under-served

    Household leverage in China is low because individual savers and borrowers areunder-served by banks. This is partly due to a lack of consumer credit records.With rising adoption of mobile internet, fintech lenders are filling that gap withinnovative solutions involving short-term cash advances and instalment loans.We project fintech loans will register a 37% CAGR over the next 5years.

    Borrower acquisition and retention are key success factors

    Fintech lending companies make money by charging facilitation fees toborrowers over their platforms. However, despite low-cost online models,customer acquisition costs are rising and remain a significant hurdle. Soundcustomer retention and repeat business is therefore vital to profitability.

    Funding structure is a critical determinant

    P2P remains the predominant funding source. Whilst we consider this moreexpensive and prone to more regulation, we think strong brands like Yirendaican benefit from a stickier customer relationships. By contrast, non-P2P lenders,especially with proper licences, are tapping into cheaper funding sources frombanks, trusts and even the securitization market.

    Credit risk management yet to be proven

    Given limited public credit records, fintech lending platforms have utilisedunconventional data sources such as social media and online shopping recordsduring the credit approval process. Credit insurance and shared reserve poolsare also common protections for lenders. Whilst pooling unfortunately introducescredit risk for shareholders, the reserving rates (defined as reserves as aproportion of total principals), appear reasonable on our analysis and willcontinue to rise for as long as defaults remain low.

    Initiate on Yirendai (YRD US) and Qudian (QD US) with OP

    Yirendai