Yiren Digital (YRD)

The Chinese use two brush strokes to write the word 'crisis'. One brush stroke stands for danger; the other for opportunity.

Consumer Finance in China

History and P2P funding

In China, accessing traditional credit cards and loans has historically been a challenge (The changing face of consumer credit, china takes the lead fintech payment). Instead of relying on conventional banking products, younger and middle-aged generations are increasingly turning to innovative fintech solutions. These platforms are not only more accessible but can also be utilized with nothing more than a smartphone and an internet connection.

Before 2018, many of these fintech companies were primarily funded by individual investors through peer-to-peer (P2P) lending models. However, a regulatory crackdown changed the landscape entirely. Chinese authorities mandated that these firms could only secure funding from institutional investors, forcing most P2P players out of business. While the surviving companies initially faced revenue declines due to their inability to fund new products, they demonstrated remarkable resilience. In the years that followed, they achieved extraordinary growth rates. With reduced competition and higher barriers to entry, profit margins expanded significantly.

Despite these positive developments, valuations in the sector remain strikingly low. Some companies are trading at less than 0.5 times price-to-book (PB) value and under 3 times price-to-earnings (PE), signaling a potential disconnect between market perception and underlying fundamentals.

China’s Economic Resilience

China’s economy has proven resilient, learning from its real estate crisis about the dangers of excessive leverage. With no unique systemic risks today, the claim that China is "uninvestable" makes it an even more compelling opportunity. The consumer finance sector, in particular, holds significant potential for value creation.

Industry Context

As mentioned earlier, the consumer finance industry has rebounded since the ban on P2P lending. Companies now benefit from larger datasets, more refined models, new GEN AI technologies and reduced competition. Yet, despite these positive developments, it’s easy to understand why the sector remains undervalued. Here’s a snapshot of the situation last year:

The scars of the 2016 regulatory crackdown—which wiped out billions of dollars in market value—still linger, fueling fears of a repeat scenario. Recent scandals involving fraudulent activities and manipulated financial figures by some players have only deepened skepticism. Add to this the broader narrative of pessimism surrounding China, often labeled as "uninvestable," and the industry just seems to face significant headwinds.

The shadow of the 2008 subprime mortgage crisis looms large, with many dismissing consumer lending as inherently unsustainable. Concerns over opaque documentation, potential defaults, high leverage, and complex subsidiary structures further compound doubts. Together, these factors create what seems like the perfect recipe for deep discounts.

However, not all perceived risks are truly toxic—some may even be advantageous. Among the sector, we find Yiren particularly compelling.

Yiren Digital

History

Yiren Digital Ltd., established in 2012 under CreditEase, has transformed into a forward-thinking digital financial services platform with a focus on innovation and global expansion.

In 2020, Yiren bolstered its service offerings by acquiring Hexiang Insurance Brokers , a move that expanded its footprint in the insurance brokerage space. This acquisition, alongside the establishment of Kechuang Xinlian in 2019 to drive e-commerce and micro-lending initiatives, underscores Yiren’s commitment to diversifying revenue streams.

On the global stage, Yiren has made significant strides, establishing Yiren Vision Pte. Ltd. in Singapore (2022) and acquiring lending platforms like Capital para Mexicanos Emprendedores in Mexico (2023). These moves signal Yiren’s ambition to scale beyond China and tap into emerging markets with strong growth potential.

More recently, Yiren announced a bold step into AI-driven innovation, leveraging DeepSeek to power its next generation of products. This integration positions Yiren at the forefront of fintech innovation, enhancing operational efficiency and customer experiences through advanced AI capabilities.

By combining strategic acquisitions, international expansion, and cutting-edge AI technology, Yiren is charting a path toward long-term value creation

Ownership

Creditease is Yiren’s main shareholder owning around 82% of the company. Creditease is a private financial conglomerate based in China focused on payments, wealth management and lending. Yiren’s CEO and founder, Ning Tang, indirectly owns 35% of the company through his 43% ownership of Creditease in which he is the sole director.

In 2015 Creditease listed on the market its subsidiary Yiren and it has maintained the same level of ownership through this time. There are potential risk that must be considered as Yiren’s operations are partly dependent on Creditease:

• Information and data sharing: after the business realignment in 2019 both companies signed an Intellectual Property License Agreement information which states cooperation on data sharing for borrower and investor information.

• CreditEase agrees to provide Yiren long-term services and support in terms of user acquisition, collection, technology support, business consulting services

However, the above agreements are part of the standard market practices for controlling entities so they do not raise any possible cause for concern at this stage.

Yiren is a case of a company run and managed by its founder whose incentives should be aligned with shareholders. Efforts have been made to improve communication with potential investors and shareholder remuneration (the introduction of a dividend to return excess cash), but the company has yet to build confidence among minority shareholders as Creditease/ Ning Tang have exclusive control the outcome of shareholder actions in the company.

Competition: Why Yiren

In China’s competitive consumer finance sector, Yiren Digital stands out as a prudent investment despite the appeal of other players. A closer look at competitors reveals significant risks, but some also present interesting opportunities. Here’s how Yiren compares:

• Lexin : Lexin raises concerns with insider sell-offs, rising delinquency rates, and significant exposure in its guarantee business—$17 billion compared to Yiren’s ~$2.5 billion. Its balance sheet is weaker, and it trades at a higher valuation than Yiren. Earnings and margins are deteriorating, likely due to its guarantee services. Alarmingly, more than its equity is tied up in receivables, with roughly one-third classified as non-performing loans.

• Lufax : Lufax appears riskier, with a higher price tag and worse margins. The company is currently operating at a loss on its loan book and is heavily leveraged. These factors make it less attractive compared to Yiren, which maintains a stronger financial position.

• 360 DigiTech (QFIN) : Grizzly Research has raised serious allegations against QFIN, accusing the company of overstating profits and engaging in fraudulent activities. Concerns include questionable related-party transactions, self-dealing by controlling shareholder Hongyi Zhou, and rising delinquency rates masked by reduced loan provisions. The company is also accused of overleveraging through off-balance-sheet loans and issuing loans at illegal rates. With an auditor linked to past frauds, regulatory intervention seems likely, making this a high-risk investment.

• FinVolution Group : FinVolution has nearly tripled its revenue from $660 million in 2018 to $1.765 billion in 2023, but net income has declined from $359 million to $311 million over the same period. This drop is attributed to skyrocketing provisions and credit loss expenses, which surged from $15 million in 2018 to $740 million in 2023, slashing operating margins from 40% to 19%. While the company has been returning cash to shareholders, recent regulations have impacted its business. At 19% margins, it might seem like a good buy, but we prefer Yiren at current valuations.

• X Financial : X Financial stands out as a potential winner, possibly even better than Yiren. The company is aggressively returning cash to shareholders through dividends and buybacks, making it an attractive opportunity. It offers clear guidance, and with the founder/CEO owning 36% of shares, stock repurchases are more feasible compared to Yiren, where CreditEase owns ~80%. If this trend continues, X Financial could become a multibagger. Delinquency rates remain stable, and credit risk appears low, though visibility into its operations is limited.

• Jiayin Group : Jiayin Group is worth considering, trading at a PE ratio of 2.6 and offering an 11.5% dividend yield. However, it carries more leverage than Yiren and X Financial, with rising delinquency rates. The company commits to paying no less than 15% of net income as dividends and engages in stock repurchases. Founder and CEO ownership of 51% aligns incentives, but transparency remains a concern. Notably, Jiayin disclosed in its 2023 annual report that its maximum potential future payments for guarantees rose from RMB6.5 billion in 2022 to RMB13.7 billion (US$1.9 billion) in 2023—a significant increase that warrants caution.

Why Yiren?

While competitors face challenges ranging from deteriorating financials and regulatory risks to allegations of fraud, Yiren Digital stands out for its relatively strong balance sheet, manageable guarantee exposure, and strategic focus on institutional funding. At current valuations, Yiren offers a compelling risk/reward proposition, making it our preferred choice in the consumer finance space.

Businesses

Yiren’s main lines of business are easily explained by going through the revenue sources in its income statement:

Loan Facilitation services: Yiren’s primary product is small revolving loans, which account for approximately half of its revenue. However, the company does not act as a direct lender. Instead, it operates as a platform that connects institutional lenders with individual borrowers. The process can be summarised as follows:

• Yiren owns Yixianghua, an online lending platform with 4.5 million monthly active users, where individuals and small businesses can apply for small revolving loans.

• The company earns a service fee of approximately 4% (historical average of revenue from loans facilitation services over total loans generated) from institutional investors in exchange for customer referrals, collection services, and risk management.

• Yiren assigns credit ratings to borrowers, allowing for differentiated pricing based on their credit quality.

This platform-based model enables Yiren to generate revenue without taking on direct credit risk while leveraging its data and risk assessment capabilities.

Guarantee services: In China, online credit must be guaranteed, meaning loans facilitated through loan platforms must be insured by a third party. Previously, Yiren bore no credit risk, as it relied on external guarantors for its loans. However, in late 2023, Yiren acquired a guarantee business and began insuring its own facilitated loans. This shift has significantly increased its credit risk exposure, but the company expects higher risk-adjusted returns.

Transitioning to a credit insurance model has had a major impact on Yiren’s reported earnings. As per standard accounting practices, the company must provision for expected losses on guaranteed loans. This change has weighed on earnings in 2024, as provisions are recognised upfront, while income from these loans will materialise in the following year.

In the last quarter, a third of new loans were originated under this model, though they do not appear on the balance sheet. Investors should note that Yiren bears the full risk of loss in the event of defaults on its guaranteed loans. Assessing the adequacy of provisions relative to guaranteed exposure is challenging, as it relies on management disclosures on originations in earnings calls.

Insurance brokerage: Yiren operates as an insurance broker through its Hexiang platform, generating revenue primarily from commission fees paid by insurance companies when clients purchase insurance products. As a pure intermediary, Yiren does not bear any underwriting risk and earns a percentage of the initial premium quoted.

• Economics: Yiren earns brokerage commissions on health and life insurance policies based on pre-agreed percentages of the premiums paid by policyholders. Revenue is derived from both first-year initial premiums and renewal premiums for subsequent years throughout the policy term.

In the three months ending 30 September 2024, Yiren’s insurance brokerage services generated 85 million in revenue, with gross written premiums amounting to 1,400 million.

• Changes in the regulation: Stricter regulations in China have negatively affected Yiren’s insurance business, particularly in the life insurance segment. The PRC has lowered the guaranteed return on life insurance products from 3.5% to 2.5% annually, reducing their attractiveness and impacting sales.

Ecommerce: Electronic commerce services account for a third of Yiren’s revenue, yet this segment remains vaguely explained in company reports. Yiren describes it as the sale of non-financial services, such as healthcare products, but provides little detail beyond this.

This segment raises significant questions, as it has experienced rapid growth in recent years, only to plateau abruptly in the past year. Management has offered little to no explanation for this slowdown, adding to the uncertainty surrounding its future performance.

Yiren is expanding its global operations beyond China, with a primary focus on the Philippines and Mexico. However, reporting on these international ventures is minimal, and investors must rely on management’s statements during earnings calls for insights.

• Philippines

• Profitability: Achieved positive net profit in Q2 2024, with management indicating further profitability improvements in Q4 2024.

• Growth: Facilitated RBM 20 million in loan value as of Q2 2024.

• Costs: Customer acquisition costs are currently around 1% (approximately $5–$10 per person). The company is shifting its strategy, with plans to increase investment in acquisition efforts.

• Mexico: Yiren’s operations in Mexico are still in an early stage. While the market appears well-suited for its products, further developments will need to be assessed as the business evolves.

Risks

Competition Yiren may face margin compression as it prioritises market share expansion, following a period of high growth. This trend is typical in emerging markets—initially, margins are wider due to limited competition, but as the market matures and more players enter, profitability tends to decline. Customer acquisition costs are rising, and while management attributes this to a strategic shift towards higher-quality clients rather than pure growth, we believe that increasing competition is also a contributing factor.

We believe the industry is reaching a stabilisation phase, where the entry of new competitors will become increasingly limited due to the presence of multiple well-established players. The market has matured, reducing opportunities for disruptive newcomers to gain a significant foothold. The likelihood of traditional banks entering this space directly appears remote. Many banks are already indirectly involved as institutional investors, providing funding to platforms rather than competing with them. Given the highly specialised nature of the business and the regulatory scrutiny banks face, there is little incentive for them to enter the market as direct lenders or facilitators. Instead, their role will likely remain one of capital providers, rather than active participants in loan origination and facilitation.

Even if overall growth slows, Yiren may still expand its net income through its loan facilitation and guarantee services, provided that its risk-taking business model develops as expected. A successful transition towards guaranteeing its own facilitated loans could enhance risk-adjusted returns, offsetting potential declines in top line growth.

What is the real credit risk? Yiren effectively operates as a credit insurer without fully reflecting its credit exposure on its balance sheet. This risk primarily stems from its guarantee business, which is expected to account for 50% of total loan facilitation in 2025. If origination levels remain consistent with 2024, this would translate to approximately RMB 13 billion in outstanding guaranteed exposure.

A key concern is that Yiren provides loans to borrowers who could be classified as subprime or junk-rated, typically individuals in poor financial condition. However, the default term structure for such loans generally improves over time, with most defaults occurring in the early stages. Since Yiren primarily facilitates short-term loans, the long-term impact of defaults is somewhat mitigated.

Interestingly, default rates in this borrower segment tend to have a weaker correlation with macroeconomic conditions. These borrowers are already in financially distressed situations at the outset, meaning an economic downturn does not necessarily worsen their repayment ability as much as it would for more creditworthy borrowers. This characteristic helps limit Yiren’s unexpected losses, the primary risk, therefore, lies in the accurate estimation of expected losses, which should be covered through provisioning.

Yiren’s ability to absorb credit risk depends on the adequacy of its provisions for expected losses. However, given the limited disclosure on its outstanding guaranteed exposure, it is impossible to assess whether provisions are sufficient. The company does not report this exposure on a continuous basis, creating uncertainty for investors regarding its true credit risk and capital adequacy.

Regulation risk Immature industries are particularly vulnerable to regulatory risk, which is further amplified in highly leveraged sectors. In the past, they have been impacted by changes in P2P regulations and, more recently, by adjustments to insurance rate regulations.

Ownership Yiren’s ownership structure is heavily concentrated, with CreditEase as its dominant shareholder. Unlike publicly traded firms that prioritise maximising returns for individual investors, Yiren’s strategic direction is largely shaped by CreditEase’s interests and long-term objectives. This ownership dynamic may partly explain Yiren’s aggressive investment in AI, as the parent company seeks to enhance its technological capabilities rather than solely focusing on short-term profitability.

Recently, Yiren announced the fusion of DeepSeek internally and the launch of B2B AI products, indicating a shift towards AI-driven financial services. While this investment may drive future growth, it raises questions about whether these initiatives align with shareholder value creation or serve broader strategic interests of CreditEase. This could translate into increasing research and development costs as we have seen in recent periods which for the moment have not materialized in significant operating expenses reduction or increased revenue sources.

A key concern in companies with dominant majority ownership is the potential for misaligned incentives. There is always a risk that the CEO or controlling shareholders could use the company’s resources to advance their own priorities, rather than focusing on maximising shareholder value. While there is no direct evidence of such behaviour at Yiren, similar patterns have been observed in other industry competitors. Investors should closely monitor capital allocation decisions and corporate governance to ensure that minority shareholder interests remain protected.

Investment thesis and misleading earnings.

In our stock analysis, we delve deep into a company’s story and core business fundamentals, focusing exclusively on situations that allow for a concise and practical valuation approach.

Regulatory changes in insurance brokerage have slowed growth, but next year’s performance is expected to remain unaffected. While a recovery in this segment is possible, it is not currently anticipated.

Valuing such a volatile and high-risk company is challenging, but let’s consider a conservative scenario:

• No further growth in any business line and no additional revenue from AI investments.

• A normalization of guarantee services accounting, assuming a modest 1% margin in this segment, would shift the company from a quarterly loss of USD 20 million to a gain of USD 10 million.

This results in an additional USD 30 million per quarter, bringing total quarterly profit to USD 80 million when added to the base profit of USD 50 million. On an annual basis, this equates to approximately USD 320 million in net income against a market capitalization of USD 600 million—implying a price-to-earnings ratio of under 2x and a price-to-book ratio of around 0.5x.

Even with all the risks considered, the valuation appears too attractive to ignore.