Affirm struggles to convince investors of fintech bona fides
Buy now pay later’ group becomes more reliant on loans amid plummeting share price. Max Levchin founded Affirm Holdings in the belief that younger people were more open to borrowing from Silicon Valley start-ups than established lenders. “Consumers, particularly millennials and Gen Z, have lost trust in financial institutions,” Levchin told investors last year, and “increasingly prefer more flexible and innovative digital payment solutions in lieu of traditional credit payment options”. His vision has made San Francisco-based Affirm one of the biggest “buy now, pay later” companies, which allow shoppers to obtain unsecured instalment loans when they buy clothes, electronics and other goods online. Quarterly results due on Thursday are expected to show a net loss of $156mn on $345mn of revenue, according to a Bloomberg poll of analysts. Some say Affirm bears a closer resemblance to a traditional financial institution than its digital sheen would suggest.
“These kind of hybrid financial technology stocks, they kind of trade like tech stocks when they’re growing really fast and the financial side of their business doesn’t cause any problems,” said Chris Brendler, an analyst at D A Davidson. “But if you start having higher losses or funding problems, that’s when they start to perform like financials.” Affirm’s pitch to retailers has been simple: by allowing the customers to split up payments for merchandise, sometimes without interest, they will sell more products. Retailers pay Affirm “merchant discount fees”, effectively a commission of a few percentage points of a purchase price. In 2020 nearly 60 % of the company’s revenue was derived from such fees. Affirm’s largest merchant during the pandemic was Peloton, the stationary bike maker whose sales are now in decline. But Affirm’s business mix has begun to shift after it signed partnerships with large retailers such as Amazon and Walmart — companies with enough heft to avoid having to pay merchant discount fees. Instead, the majority of Affirm’s revenue is now coming from its function as a lender: by selling loans either through securitisations or to third-party buyers such as insurance companies, or by earning interest income for the assets that it keeps on its own balance sheet. In its most recent reported quarter, more than half of the revenue came from interest income and gains on the sale of loans.
Affirm said it was still committed to growing its fee-generating businesses as part of a strategy to build “a menu of different products to meet consumer and merchant needs across cart sizes, categories, and payment terms”. Affirm said. Unlike a traditional bank, Affirm does not hold consumer deposits and instead relies on “warehouse” lines of credit.
“These kind of hybrid financial technology stocks, they kind of trade like tech stocks when they’re growing really fast and the financial side of their business doesn’t cause any problems,” said Chris Brendler, an analyst at D A Davidson. “But if you start having higher losses or funding problems, that’s when they start to perform like financials.” Affirm’s pitch to retailers has been simple: by allowing the customers to split up payments for merchandise, sometimes without interest, they will sell more products. Retailers pay Affirm “merchant discount fees”, effectively a commission of a few percentage points of a purchase price. In 2020 nearly 60 % of the company’s revenue was derived from such fees. Affirm’s largest merchant during the pandemic was Peloton, the stationary bike maker whose sales are now in decline. But Affirm’s business mix has begun to shift after it signed partnerships with large retailers such as Amazon and Walmart — companies with enough heft to avoid having to pay merchant discount fees. Instead, the majority of Affirm’s revenue is now coming from its function as a lender: by selling loans either through securitisations or to third-party buyers such as insurance companies, or by earning interest income for the assets that it keeps on its own balance sheet. In its most recent reported quarter, more than half of the revenue came from interest income and gains on the sale of loans.
Affirm said it was still committed to growing its fee-generating businesses as part of a strategy to build “a menu of different products to meet consumer and merchant needs across cart sizes, categories, and payment terms”. Affirm said. Unlike a traditional bank, Affirm does not hold consumer deposits and instead relies on “warehouse” lines of credit.
Cross River Bank, a A New Jersey-based start-up backed by top venture capital firms, originates Affirm’s loans, while the buy-now-pay-later group then manages the relationship with the customer. Affirm has also grown through securitisations, or bundling loans to sell as bonds, some of which it retains on its own books. Selling on debt generates cash to make future loans, and investor appetite for this kind of paper remains high. Two years ago, none of Affirm’s loans were funded through securitisation, according to data compiled by the company. By the most recent quarter, a third of Affirm’s $6bn portfolio had been bundled into bonds.
The shift from fees to lending and interest income has put new focus on Affirm’s underwriting process. Potential credit losses not only reduce the carrying value of loans that the company retains, but also the gains it can earn in secondary markets. In the last quarter of 2020, just 1.44 per cent of Affirm loans were marked four to 29 days delinquent or late in payment, according to company data. Four quarters later, that figure had edged up to more than 3%. In its most recent quarter, the amount of allowances that the group sets aside for potential loan losses had reached 6.5% of its loan book, up from 5.2 per cent in mid-2021. Interest rates charged to consumers can be as high as 30 %. “While we agree that Affirm serves an important payments function, we contend that Affirm is actually more a lender than a payments company,” Vincent Caintic, an analyst at Stephens, recently wrote. Affirm recently reached its gross profit margin target of 4 percent, which includes credit costs, even as operating costs and overhead have chewed up net income. Sceptics, however, have noted the company’s explosive growth in the past two years came at a time of falling unemployment and when US consumers were flush with government stimulus cash. Jim Chanos, the short seller and founder of hedge fund Kynikos Associates, has been a critic of Affirm and other financial tech starts-ups that have taken on big banks. “Every time, a group of internet-based lenders tries to convince the market that they have a better model to assess creditworthiness. They’re simply extending credit to people they shouldn’t be. And we won’t see this until you go through a downturn in the credit cycle,” Chanos said.
Wall Street is also focusing on the details of its business model. In March, at a time of turmoil in the bond market, Affirm pulled a $500mn financing transaction that it planned to use to fund future loans to customers. At a recent investor event, Affirm’s chief financial officer, Michael Linford, played down the move, saying the withdrawn transaction was “a sign of strength, not a sign of weakness”. He added: “We felt really good about the business and thought like we didn’t need to try to jam a deal.” The company was ultimately able to close the deal last week in a transaction that was oversubscribed, at slightly lower yields than originally planned, according to a person familiar with the matter. In a securities filing in March, Affirm said it still had nearly $10bn in committed capital that was more than adequate to support near-term loans. If the economy began to deteriorate, the company said it could quickly adjust its lending policies, particularly because its loans are not extended for long periods such as those for cars or homes. “But on the front end of a recession, that is to say as things start to get worse and deteriorate, assuming there’s a meaningful unemployment surge associated with that, then we would experience higher losses,” Linford said at a March investor conference. “However, given the short duration of our asset, we think we’d be able to reposition the funnel quite a bit.”
The shift from fees to lending and interest income has put new focus on Affirm’s underwriting process. Potential credit losses not only reduce the carrying value of loans that the company retains, but also the gains it can earn in secondary markets. In the last quarter of 2020, just 1.44 per cent of Affirm loans were marked four to 29 days delinquent or late in payment, according to company data. Four quarters later, that figure had edged up to more than 3%. In its most recent quarter, the amount of allowances that the group sets aside for potential loan losses had reached 6.5% of its loan book, up from 5.2 per cent in mid-2021. Interest rates charged to consumers can be as high as 30 %. “While we agree that Affirm serves an important payments function, we contend that Affirm is actually more a lender than a payments company,” Vincent Caintic, an analyst at Stephens, recently wrote. Affirm recently reached its gross profit margin target of 4 percent, which includes credit costs, even as operating costs and overhead have chewed up net income. Sceptics, however, have noted the company’s explosive growth in the past two years came at a time of falling unemployment and when US consumers were flush with government stimulus cash. Jim Chanos, the short seller and founder of hedge fund Kynikos Associates, has been a critic of Affirm and other financial tech starts-ups that have taken on big banks. “Every time, a group of internet-based lenders tries to convince the market that they have a better model to assess creditworthiness. They’re simply extending credit to people they shouldn’t be. And we won’t see this until you go through a downturn in the credit cycle,” Chanos said.
Wall Street is also focusing on the details of its business model. In March, at a time of turmoil in the bond market, Affirm pulled a $500mn financing transaction that it planned to use to fund future loans to customers. At a recent investor event, Affirm’s chief financial officer, Michael Linford, played down the move, saying the withdrawn transaction was “a sign of strength, not a sign of weakness”. He added: “We felt really good about the business and thought like we didn’t need to try to jam a deal.” The company was ultimately able to close the deal last week in a transaction that was oversubscribed, at slightly lower yields than originally planned, according to a person familiar with the matter. In a securities filing in March, Affirm said it still had nearly $10bn in committed capital that was more than adequate to support near-term loans. If the economy began to deteriorate, the company said it could quickly adjust its lending policies, particularly because its loans are not extended for long periods such as those for cars or homes. “But on the front end of a recession, that is to say as things start to get worse and deteriorate, assuming there’s a meaningful unemployment surge associated with that, then we would experience higher losses,” Linford said at a March investor conference. “However, given the short duration of our asset, we think we’d be able to reposition the funnel quite a bit.”
Comment :
BNPL = no credit checks + merchant fees greater than credit card interchange fees.
Who benefits? The BNPL customer who otherwise wouldn’t get credit. Who pays? The non-BNPL customer who is subsidizing the provision of subprime credit through higher prices.
The impact on the merchant and the BNPL provider is ambiguous. Merchants offering BNPL are betting the increased sales volume will compensate for lower margins.* Investors in BNPL providers are betting the fees (+ interest) will more than cover NPLs.
The BNPL model rests on two pillars. First, it exploits peoples biases: (a) the bias of subprime customers to take on debt they can’t afford and to ignore hidden fees and conditions; (b) the bias of non-BNPL customers to ignore the hidden subsidies they extend to subprime buyers; (c) the bias of BNPL investors to buy into the hype and fail to think through the credit cycle. Second, it engages in regulatory arbitrage by extending credit with fewer safeguard than offered by regulated credit providers.
Net-net this is the latest iteration of the old model to ram more credit into the throats of people who can’t afford it. Brought to you by a bunch of tech bros who are telling you with a straight face that they’re doing this to make the world a better place.
How does the warehouse funding work? If customer borrows, is affirm the counterparty or cross river is? How does cross river vs affirm make money from lending to customers and securitizing the loan?
This sounds like subprime mortgages and low-quality securitizations circa 2007-2008 all over again. Very short memory of when the commercial paper market dried up… but I’m guessing management was still in high school way back then.
Similar, but a $50, 3 month loan for a t-shirt is a bit different to $300k, 25 year mortgage
When people from San Francisco and New York only speak to the same kinds of people and become convinced they're smarter than everyone else and their company is worth a gazillion dollars... I mean, I'm sure the Excel model is top-notch but I am curious 1) take a class on social science... history may be a good start 2) talk to the people who are convinced you're full of banana pudding.
I admit to schadenfreude watching the Tiger cubs trip over monetary policy and demographics
I admit to schadenfreude watching the Tiger cubs trip over monetary policy and demographics
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