Lufax: The World’s Largest P2P Lending is Pivoting from Core Business
Earlier this year, Lufax announced plans for a $60 billion IPO in the Hong Kong Stock Exchange[i]. Lufax currently has a 22% market share in the P2P space (8 times the nearest competitor Iqianjin), and over Rmb 270 billion ($43billion) in loans outstanding with expected yields of c. 8.4%[ii]. Lufax’s gargantuan valuation would place it in the top three most valuable fintech companies in the world, and more than 20x the value of LendingClub[iii], but it masks severe challenges that Lufax has had in its core business, P2P lending.
The P2P Lending space has been plagued with very fundamental marketplace failures that have made it nearly impossible for any marketplace provider to (ever) return sustainable profits. Chief amongst these are:
- Fraud: for instance, Lufax’s competitor Ezubao ran a Madoff-style Ponzi scheme that defrauded 1 million investors about $7.4billion[iv]
- Lack of enforcement: the unsecured nature of the credit makes it near impossible to penalize defaulters, leading to abnormally higher NPLs (non-performing loans). For instance, it is interesting to note that nearly 80% of the 40+ million P2P users in China are signed onto Lufax’s platform even though it has only 22% of all loans by value
- Low switching costs: borrowers can easily switch platforms, and with over 2,000 online P2P lenders in China alone, borrowers are spoilt for choice
The challenges above are not unique to the Chinese marketplace. LendingClub has experienced widening losses ever-since its IPO due to: governance scandals, heightened regulatory scrutiny and escalating rates of delinquencies amongst its riskiest customers[v].
At a fundamental level, the value proposition of peer-to-peer lending is suspect at best. Lenders typically clamor on the sites to provide access an investment alternative that promises above-market rates of return, typically in the 12% range. To be successful, lenders would need to be able to distinguish different risk-profiles so that they only lend to creditworthy borrowers. Additionally, they need to have deep enough capital to diversify their portfolio because investing in a single loan leads to a binary outcome (default or no default) which, given the high rates of NPLs (over 20%) would quickly scare most peer investors. As such, the successful lenders in the ‘peer to peer’ space tend to be sophisticated hedge funds rather than individual investors, which thus questions the need of a peer-to-peer platform in the first place.
Lufax, like other P2P lenders is also subject to runs on funds. Last year, for instance, it suffered from a massive run on its funds after a screenshot was circulated on Chinese social media claiming that Lufax would be singled out for the impending regulation by the Chinese government that “is expected to wipe .out many of the country’s 2,400 lending platforms”[vi].
Lufax’s options in the P2P Lending space are limited. First, it is difficult to double-down on the P2P marketplace given ever-widening losses that seem too strenuous even for deep-pocketed players, and there’s no sign of the losses ever turning around. Secondly, despite the multiplicity of network effects (both direct network effects and two-sided network effects), it is not clear that this will ever be a winner-take-all marketplace in the near future, if ever. Despite the regulatory crackdowns, there are still over 2,000 lenders and the rate of consolidation and exits is still relatively low.
Source: DBS Group[vii]
Other options for growth would have included offering higher value loans such as car-loans or even mortgages, but these have been haltered by regulators who restrict P2P players from participating in this space that is dominated by banks. Even if they could participate in this space, it is still unclear how P2P lenders would be able to properly assess risk better than banks or even enforce collateral contracts in their loan agreements with other lenders in the platform.
These challenges have forced Lufax to pivot away from its core business, into the growing retail-investing market and to offer products more similar to E-trade or Robinhood that allow clients to invest in / trade securities such as equities, fixed-income products, mutual funds[viii]. Wealth management is a completely different line of business but one that helped Lufax post a first-time profit ahead of its planned IPO. The profit was ‘attributable to a 3.5% increase in net investment income …. Half of which came from equity, especially in high dividend blue-chips listed in Hong Kong’[ix].
Lufax’s pivot away from its core business raises significant questions about the future of the peer to peer lending space. In my view, the industry was/has been an interesting experiment into potential ways to deploy private capital to potentially achieve above-market returns, but the long-term sustainability of the sector is very weak. The sector has benefited from lax regulation, but that is changing as the market increases. Individual, unsophisticated lenders on these platforms (i.e. ‘peers’) are at a huge disadvantage relative to sophisticated hedge-funds that can more efficiently assess risk. While attempts have been made to build in algorithms that automatically distribute invested capital to partially solve the problem, the value proposition of ‘above-market’ returns is quickly eroded and these lenders are better off investing in other more traditional investment options.