On March 14, the buy now, pay later (BNPL) company Affirm (AFRM -1.34%) raised its outlook for the current quarter and the full fiscal year, which ends June 30. The stock slumped more than 15% that day. Despite a tough day for markets, Bloomberg had also reported just a day before that the company had to postpone the sale of one of its bonds after an investor had pulled out at the last minute due to market volatility and concerns about the risk. Should investors be concerned? Let's investigate.
Here's what we know
The delayed sale had to do with one of Affirm's asset-backed securities (ABS), which is a pool of Affirm loans the company had packaged together through a trust or special purpose vehicle to sell to investors, which it has done several times before. Investors buy the securities, removing them from Affirm's balance sheet. The investors then collect principal and interest from the borrowers' payments on their individual loans.
According to Bloomberg, which cited anonymous sources, one of the main investors who had planned to purchase securities from the highest-rated tranches in the ABS pulled out at the last second due to volatility in the broader markets "that may have led to wider risk premiums than the company wanted."
"In light of the heightened levels of rates volatility, and consistent with our disciplined approach to navigating a volatile backdrop, we made the decision to temporarily hold off on issuing this transaction at this time," Affirm told Bloomberg.
Is it time to be worried?
Relying on the debt markets for liquidity always carries some risk. Since the pandemic began and after the initial scare very early on, investors have been more than willing to invest in consumer debt. Consumers have benefited from high savings rates and government aid from measures such as stimulus checks and enhanced unemployment benefits.
But in recent months, the stimulus has begun to fade, high levels of inflation have started to dent savings, and Russia's invasion of Ukraine has created other issues for consumers, such as high fuel prices. In addition, the Federal Reserve has begun raising its benchmark overnight lending rate, which will increase the cost of debt. All of this has made the market think a recession is well within the realm of possibility.
Image source: Getty Images.
To be fair, Affirm isn't the only company that has seen a change in the debt markets. In another article, Bloomberg reported that sovereign and U.S. junk bond sales have been way down recently from the norm. The auto lender World Omni Financial Corp also recently delayed the sale of one of its ABSes, which is backed by auto leases. Management issued a statement that said the deal is expected to go through later this year.
However, I think it is fair to be concerned about some of these BNPL loans being issued by Affirm, which were already under scrutiny when the credit environment was much more benign. Last September, a study from Credit Karma revealed that one-third of U.S. consumers who purchased something using BNPL had fallen behind on at least one payment. The Consumer Financial Protection Bureau also previously solicited data from several BNPL lenders, including Affirm.
Image source: Affirm fiscal Q2 2022 investor presentation.
Delinquencies at Affirm started to move higher between last July and December, although they then started to level off. On the company's recent earnings call, management noted that delinquencies were below the levels of fiscal years 2019 and 2020, despite the company loosening its credit box. But Affirm's quarterly filing also shows that in recent quarters it has originated way more loans to consumers more likely to default (although not necessarily of poor credit quality) and to more borrowers in new markets without sufficient data.
The other interesting thing is that Affirm's model has shifted away from zero-interest products to more BNPL loans that charge much higher annual percentage rates, as its mix of partnerships and sales have changed. This model can be more profitable, but it could also lead to higher delinquencies and defaults.
Hard with the uncertainty
It is possible that investors are overreacting to concerns regarding consumer debt -- after all, the consumer is still coming off a strong last couple of years. And Affirm did just increase its guidance for revenue less transaction costs, which bakes in losses on loan purchase commitments and the provision for credit losses. Affirm CFO Michael Linford recently told Yahoo! Finance that while the current "state of unease is certainly [being] felt in the equity capital markets and the debt capital markets... you're not seeing it in the consumer right now."
Unfortunately, given the uncertainty regarding Russia and Ukraine, inflation, and a potential recession, it's reasonable to expect the market to feel uneasy about Affirm loans considering there was concern six months ago in a much friendlier credit environment. I don't expect that uncertainty to dissipate until some of these macro and geopolitical uncertainties wind down or until Affirm has more data on delinquencies in the rising-rate environment, so I could certainly see the stock struggling to gain momentum in the near term.
