Stock Down 93%, Affirm’s BNPL Model Suffers As Funding Costs Rise

Letting too many people borrow money to buy stuff that they can’t otherwise afford creates an economic sugar high followed by a crash.

That’s what happened in the years leading up to the 2008 financial crisis. Lenders made it easy for people who lacked sufficient income to buy houses. Investment banks packaged those mortgages into securities and sold them to heavily leveraged financial institutions.

Confidence in subprime mortgage backed securities eroded as did Wall Street’s willingness to keep funding the financial institutions that levered up to buy the securities.

That led to the collapse of Bear Stearns and Lehman Brothers and a financial crisis that cost $23.7 trillion in government bailouts and guarantees to patch up.

Could the market for Buy-Now-Pay-Later (BNPL) loans follow a similar trajectory?

After all, Affirm Holdings — whose stock trades 93% below its November 2021 high — does something similar. It makes unsecured installment loans at low interest rates to help millennials and Gen Z shoppers buy clothes and electronics — and “neatly repackages them for investors,” according to Bloomberg.

I don’t see BNPL securitization collapsing the global financial system, but I would not buy Affirm stock. With credit problems rising, valuations dropping, and competition from Apple, the best hope for Affirm shareholders could be getting acquired by an incumbent like Capital One COF .

BNPL Securitizations Are Smaller Than Were Subprime MBS

While there are plenty of problems facing BNPL incumbents, the industry is much smaller — accounting for about 2.7% of 2021 e-commerce or $97 billion, according to CNBC. Meanwhile — much of that BNPL debt is not securitized. For example, according to Bloomberg, Affirm securitizes only 30% of its loans.

That is far less than the $685 billion subprime mortgage-backed securities market, according to the IMF, was in 2008 so I am guessing that the withdrawal of capital from BNPL will not cause another financial crisis.

Nevertheless, Affirm’s BNPL-backed securities are falling in value and becoming more costly to issue as rising interest rates and near-record inflation “cast a shadow over the sector,” according to Bloomberg.

This spring, Affirm’s borrowing costs through securitizations more than quadrupled. For example, in February 2021, Affirm paid a coupon of 0.88% for notes maturing in four years. In May, Affirm’s coupon was 4.3% for securities that mature in May 2027, noted Bloomberg.

While securitizations are not a big source of financing for BNPL lenders, Fitch Ratings is concerned about higher credit risks. Harry Kohl, a Fitch Ratings who covers the asset-backed securities sector, told Bloomberg, “When you are originating to borrowers with low or thin credit — the younger demographic, essentially — that’s always a warning for us and something that could be an indicator of potential negative credit performance.”

BNPL Valuations Falling

Affirm is not alone in suffering BNPL woes — rivals Afterpay and Klarna are also being put to the test due to missed payments and rising interest rates. According to the Wall Street Journal, here’s how much BNPL delinquencies have risen:

• Affirm. Loans outstanding that were at least 30 days late rose from 1.4% in March 2021 to 3.7% in March 2022
• Afterpay. Losses equaled 1.17% of total payment dollars processed during its latest quarter, compared with 0.9% for its latest full year ended June 2021.
• Zip. “Bad debts and expected credit losses” surged 403% in the last six months of 2021 compared with the same period a year prior

The broad deterioration of the BNPL industry’s credit quality is taking its toll on private market valuations. As the Journal reported, Klarna is in discussions to raise more funding at a significant discount to its previous valuation.

Specifically, the Journal noted that Softbank-backed Klarna is in talks to raise $500 million at a valuation of $15 billion — that is a 67% cut from its peak valuation of $46 billion in 2021.

To be sure, Klarna’s losses have soared. It reported a quintupling of its net loss to about $250 million in the first quarter of 2022 and said in May that it would lay off 10% of its workforce “owing to what it called a volatile economic environment and the need to cut costs,” noted the Journal.

Affirm’s First Quarter Results And Forecast

Affirm released its latest results on May 12 and its stock popped 30%, after the company reported strong results for the third fiscal quarter and raised guidance.

According to Invezz, Affirm lost 19 cents per share in the third quarter — which was 27 cents a share less bad than the FactSet consensus while revenue increased 54% to $354.8 million — about $10 million more than expected.

For fiscal 2022, Affirm forecasted its revenue in a range between $1.33 billion and $1.34 billion — the bottom end of which matched experts’ forecast, according to Invezz.

Affirm stock rose from a closing price of $18.04 on May 12 to $25.71 on May 19.

BNPL Competition From Apple

Since then Affirm stock has fallen 24%. One possible reason is that in early June, Apple announced its intention to enter the BNPL industry by allowing Apple Pay users to split purchases into interest-free installments.

This is not great news for rivals like Affirm. MoffettNathanson partner, Lisa Ellis, told Yahoo!Finance that the announcement was not a surprise but it indicates “commoditization in this space” which would naturally pressure standalone players like Affirm and Klarna. She argued that Apple or another incumbent might add BNPL — which she dubbed a “financing feature” — by acquiring such companies.

Affirm’s Bullish And Bearish Cases

One analyst is unabashedly bullish on Affirm due to its “remarkable growth trajectory,” according D.A. Davidson’s Chris Brendler. As MarketWatch reported, Brendler thinks that macroeconomic pressure can “reduce [BNPL] competition” and that investors are not giving Affirm enough credit for its “advantages in underwriting and funding.”

What’s more Brendler sees Apple as competing in a different segment than Affirm and expects that greater regulatory scrutiny of BNPL will keep new rivals from entering the space.

Not all analysts are so bullish. Wedbush analyst David Chiaverini initiated coverage with an Underperform rating due to rising competition, a long and winding path to profitability, and slowing e-commerce sales.

Count me among the Affirm bears. In January 2021, I saw some big risks to owning Affirm stock after a boffo IPO — including a high valuation, intensifying competition, and the possibility of slowing growth post-pandemic.

With 14.14% of its float sold short as of May 31, I think the bears are on the right side of Affirm.