A warning sign for the Buy-Now-Pay-Later Affirm app

Some of the riskiest loans given to millennials and Gen Z buyers for clothes and electronics — and carefully repackaged for investors — are losing value.

Buy-now-pay-later loan securitization packages from one provider, Affirm Holdings Inc., are falling in price for investors to buy while becoming more expensive to issue, after rising rates and a cost of living crisis have cast a shadow over the sector.

Affirm has more than 12.7 million customers and issued around $3.9 billion in loans in the first three months of 2022. It was valued at $47 billion in September after a successful listing on the Nasdaq composite in January 2021, but its shares have fallen more than 80% this year.

The stock fell another 5.5% this week after Apple Inc. announced on Monday that it would enter the buy-it-now market, or BNPL, allowing iPhone users in the United States to make installment payments for their purchases.

Investor nerves

Affirm finances about a third of its business through securitizations — an asset class that has grown in importance during the subprime mortgage crisis — by pooling loans and selling tranches to investors. The model is relatively rare among BNPL companies, which tend to finance themselves through debt and, in the case of Klarna, customer deposits. Australian Zip pioneered securitization in this space, albeit through smaller deals than Affirm.

Harry Kohl, a Fitch Ratings analyst who covers the asset-backed securities industry, said the rating agency is “closely watching” Affirm’s securitizations after seeing weakening credit quality in its releases. public. “When you’re from low or thin credit borrowers – the younger demographic, basically – that’s always a warning sign for us and something that could be an indicator of potential negative credit performance,” Kohl said.

The deterioration in Affirm’s securitization values ​​also tells a larger story. Investors are starting to worry that the booming BNPL sector, which has earned sky-high valuations and was hailed as one of the fastest growing fintech genres just a year ago, could be hit by a double whammy from rising rates and a squeeze on household incomes.

The growth of Affirm

Affirm believes its business is robust, with a diversified funding model that will become profitable as it grows. “We are well positioned to drive growth while maintaining an attractive unitary economy, despite volatile market conditions and a rising interest rate environment,” a spokesperson said. Tech startups use “unit economics” to describe the profitability of an individual transaction and to indicate the long-term viability of the business.

The spokesperson said Affirm effectively offers a profit margin of 4.7% per trade, or revenue less transaction costs as a percentage of gross market value. That’s above its long-term target of 3% to 4%. In the nine months ending March 31, the San Francisco company reported a loss of $520.1 million, topping the loss of $312.6 million in the same period last year.

Like rivals Afterpay, owned by Klarna and Jack Dorsey, Affirm lets online shoppers get unsecured installment loans. It is well known for allowing consumers to purchase Peloton exercise bikes and spread the cost over months or even years. It charges interest on certain monthly offers, which helps protect against rising rates.

credit revolution

Affirm Founder Max Levchin said last year that young people were no longer willing to “tolerate going into permanent debt” using traditional credit cards and preferred to use the BNPL to pay for their purchases.

Most of the BNPL companies that have grown rapidly in recent years were created in a low interest rate environment. They now see the headwinds of rising interest rates and volatile credit markets, said Kevin Barker, an analyst at Piper Sandler & Co. “The ability to protect against higher funding costs is important. for long-term viability,” he said.

Affirm pushed back its last securitization sale in March, before selling bonds maturing in May 2027 at a coupon of 4.3% on the principal tranche. It paid 0.88% on the same tranche of a similar transaction issued in February 2021 which matures in August 2025. Although the yield at the time of pricing was 0.89%, the February bonds are now yielding 4.01%, according to a Bloomberg model that assumes borrowers will not prepay their debt, meaning they will pay the debt when the installment loan payment is due.

The February 2021 note’s tranche A hit its lowest dollar price in mid-May at 98.1 cents, down from a high in July 2021 when it was above par at 100.1 .

The cost of borrowing on Affirm’s warehouse credit facilities, a type of bank loan typically given to mortgage lenders, is also rising as it is pegged to benchmark rates, some of which have climbed more than 100 basis points. base so far this year. Less than 20% of the company’s funding is tied to floating-rate debt, and the company doesn’t expect rising rates to have a “significant impact” on earnings per trade in the fiscal year , according to a spokesperson for the company.

Transactions in the asset-backed securities market have weakened since the start of the year as volatility and concerns about rising interest rates caused spreads to widen and dollar prices to fall. The average stock had a price of $96.43 on Tuesday, according to the US Aggregate ABS Index.

Buy it now and pay later is here to stay and Affirm’s funding model is sustainable, said Piper Sandler’s Barker. The short nature of BNPL allows the company to eliminate delinquencies much faster than in the traditional bank or mortgage loan market.

“Subprime is still subprime. If you treat it that way and understand what you’re signing up for, it can be very profitable,” Barker said.

— Bloomberg writer Michael Tobin contributed to this report.

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