Payment plans that allow shoppers to split the cost of things like clothes, makeup and home appliances were all the rage last year. The companies behind the plans saw their valuations increase. Scores of retailers rushed to add them to the checkout. In August Block Inc. (formerly Square Inc.) announced a nearly $29 billion all-stock deal for Afterpay, one of the largest companies in the business.
But late payments or related losses are piling up for the biggest players in the industry—Affirm Holdings Inc., Afterpay and Zip Co. Their borrowing costs, meanwhile, are rising. Buy-now-pay-later companies sometimes rely on credit lines whose rates rise and fall in line with the Federal Reserve’s benchmark rate, which has risen 0.75 percent so far this year and is poised to go up even more. Is.
Investors who were once obsessed with business are retreating. Affirm went public in January 2021 at $49 a share and has grown to more than $170 by November. The stock closed Tuesday at $28.50. SoftBank-backed Klarna Bank AB is looking to raise up to $1 billion in a deal that could value it in the at least $30 billion range, far below the roughly $46 billion valuation it achieved last year.
The youth industry finds itself in a difficult position at a time when the economy is slowing down and, some fear, is headed for a recession. Buy-now-pay-later companies boomed when consumers ran out of cash and were buying goods at a rapid pace. How they perform in a recession, when savings evaporate, spending slows down and bad debt rises is not tested.
To weather the storm, Afterpay and Zip are slowing down their new origins.
“We’re keeping a real focus on accelerating our path to sustainable growth, strong unit economics and critically-accelerated profitability,” said Peter Gray, Zip’s co-founder and Global Chief Operating Officer.
Klarna said last week that it plans to lay off about 10% of its workforce. It has also tightened lending standards “to reflect this evolving market context,” a spokesperson said.
Affirm CEO Max Levchin has a more upbeat note. On an earnings call in May, he said buy-now-pay-later plans such as Confirm not charging late fees would be in higher demand during a recession. “It is our mission to improve people’s lives, and we will be prepared to meet this demand – but again – our approach is simply to extend the debt that we believe can be repaid and repaid,” he said. Will go.”
The buy-now-pay-later business originated in the post-financial crisis world of cheap funding and fewer crimes.
They rely less on traditional credit scores and reports – and in some cases bypass them altogether. This makes them attractive to people with limited savings and low credit scores. Subprime consumers accounted for about 43% of shoppers who applied for payment plans or loans at retailers’ checkout between the fourth quarter of 2019 and 2021, according to credit-reporting firm TransUnion, though they only accounted for nearly 43% of the U.S. adult population. make up 15%. ,
While consumer-loan defaults and delinquencies remain low across the board, there are signs of rising inflation and the end of pandemic-era stimulus programs leading to more subprime borrowers falling behind on their loans.
At Affirm, about 3.7% of outstanding debt dollars held on the company’s balance sheet were at least 30 days late at the end of March, up from 1.4% a year earlier. Affirm said the increase reflects an easing of underwriting standards that had tightened earlier in the pandemic. The company’s finance chief said earlier last year that crimes were at historic lows “and that’s not how we intend to run the business.”
Afterpay’s loss amounts to 1.17% of total payment dollars processed during its latest quarter, compared to 0.9% for its latest full year ended June 2021. Zipp said that compared to its “bad debt and expected credit losses” the last six months of 2021 increased by 403%. With the same period a year ago, Zipp said the growth was due to the companies it acquired in 2021.
“The industry as a whole, which has seen bad loans, really missed that moment,” Zip President Diane Smith-Gander said at a shareholder conference in Australia last week. “And now we have to dig our way out of that.”
Increasing defaults have prompted investors to demand higher returns on pack-up loans that they purchase from buy-now-pay-later companies. According to FinSight, the firm’s most recent securitization price in April yielded a weighted average yield of 4.61%, which is approximately 3.3 percent higher than the February 2021 securitization.
A former industry executive said the rise in bad debt could increase the risk that banks and other lenders cut buy-now-pay-later companies, or demand very high interest rates.
Rising interest rates mean that some buy-now-pay-later companies are already paying more for funding. Most loans have floating interest rates, which means it becomes more expensive when the Federal Reserve raises its benchmark rate.
Affirm has the potential to pass some of the higher funding costs to merchants in the form of higher fees or to its borrowers because it charges interest. The company said that most of its funding is from fixed-rate debt, and the impact of rising rates will be minimal until next year.
The rate hike could prove more painful for companies like Afterpay, which derive most of their revenue from deals and late fees with merchants. Afterpay said it plans to rely more on its cash to fund receivables, reducing the need to tap its warehouse line.
Block Chief Financial Officer Amrita Ahuja said of Afterpay on the company’s recent earnings call, “We believe that what we are building will be resilient and a sustainable over the long term for both sides of the ecosystem, merchants and consumers. The strategy will be there.”