Chinese online lender Yirendai (NYSE:YRD) might initially seem like a good investment. Analysts expect its revenue and EPS to respectively rise 69% and 7% this year, followed by 40% sales growth and 44% earnings growth next year.
Yirendai's stock also looks cheap at 10 times earnings and 8 times next year's earnings, and the company recently paid a special dividend of $1.50 per share (a 3.5% yield when it was paid in late September) and introduced a semi-annual dividend equivalent to roughly 15% of its net income.
That combination of high growth, low valuations, and a decent dividend seem to make Yirendai, the Chinese equivalent of LendingClub, a great buy. That's why the stock is up more than 60% for the year.
However, I still wouldn't touch Yirendai for three simple reasons.
1. It's a subprime lending platform
Yirendai is China's first peer-to-peer lending platform. The Chinese P2P lending market, which is worth about $60 billion today, blossomed in the late 2000s to serve customers who were under-served by traditional banks.
However, many banks intentionally avoided those customers because they were subprime borrowers. Yirendai classifies its loans in "grades" between A and D. Grade A loans are considered "mostly prime," while B, C, and D loans are deepening subprime levels.
Only 1.7% of Yirendai's loans were Grade A last quarter. 8.7% were Grade B, 14.1% were Grade C, and 75.5% were in the "deep subprime" Grade D category. The four grades offer transaction fee rates between 5.6% and 27.6%.
Having a high percentage of Grade D borrowers generates big profits for Yirendai, but it could also lead to a devastating crash during an economic downturn. Yirendai claims that its delinquency rates for loans past due by 15-89 days was just 1.8%, compared to 1.6% in the prior quarter -- but it doesn't disclose any data on loans which were delinquent for more than 90 days. There are also troubling reports that CreditEase, which owns a majority stake in Yirendai, is actually using the company as a "dumping ground" for its worst loans.
2. Chinese regulators are cracking down
The Chinese P2P lending market grew from fewer than ten platforms to over 2,000 in just over seven years. But it's also been plagued with scams, predatory lenders, and Ponzi schemes, and some loans were simply used to fund real estate purchases -- which exacerbated the country's housing bubble.
In response, the government started capping the amount that could be borrowed, with individuals restricted to borrowing 200,000 yuan ($30,000) from a single P2P platform and a maximum of 1 million yuan ($151,000) spread across multiple lenders. Businesses were capped at 1 million yuan per lender and 5 million yuan ($756,000) in total loans. The message was clear: P2P lenders shouldn't supplant traditional banks.
Chinese regulators also recently capped interest rates for loans at 36%, but will only help enforce uncollected loans with rates under 24%. This means that Yirendai might need to lower its Grade D transaction fees to remain compliant. Yirendai's rival, Alibaba's (NYSE:BABA) affiliate Ant Financial, recently axed all of its loan products with interest rates exceeding 24%.
3. Tough competition from larger rivals
Ant Financial, which also backs another micro-lender called Qudian (NYSE:QD), isn't Yirendai's only big competitor. Online search giant Baidu's (NASDAQ:BIDU) Financial Services Group and e-commerce marketplace JD.com's (NASDAQ:JD) JD Financial both offer online micro-loans, which are tethered to their larger ecosystems.
If these lenders follow Ant Financial's lead and cap their interest rates to stay in the government's good graces, Yirendai's rates and fees might look much less attractive to potential borrowers.
The market is catching on...
Yirendai's stock has fallen nearly 20% over the past three months on concerns about tighter regulations on the P2P lending market. Qudian, which went public in mid-October, also had a terrible market debut. It priced its IPO at $24, but the stock now trades at just over $12.
Those declines indicate that US investors are getting skeptical about Chinese online lenders like Yirendai, which have opaque relationships with their parent companies and rely on a market of subprime borrowers. Investors who want exposure to this market with a wider safety net should consider buying Alibaba, Baidu, or JD instead.