You may know Affirm Holdings (AFRM -2.08%) as a fintech company that facilitates "buy now, pay later" loans. It isn't just a middleman, though, connecting consumers with lenders. The company is also a lender itself, holding $2.5 billion worth of loans on its books as of the end of June. That was up by 25% from the $2 billion loan portfolio it was sitting on a year earlier. To this end, interest income of $528 million accounted for nearly 40% of the $1.35 billion in revenue that Affirm booked in its recently ended fiscal 2022. In other words, its lending activities are about as meaningful to its finances as transaction fees are.
That's a potentially growing problem. As the company's own loan portfolio expands, its quality is deteriorating. Indeed, 30-day delinquencies are nearly as high as they've ever been for Affirm, including in early 2020 after the COVID-19 pandemic struck.
The risk that this trend will continue is far too big for current and prospective shareholders to ignore, particularly with the growing threat of sustained macroeconomic turbulence.
Affirm is seeing some alarming trends
In retrospect, nobody should be too surprised. People (and people in the U.S. in particular) have a penchant for spending more money than they arguably should. They also seem to be more carefree about their debts at the worst possible times. The Federal Reserve Bank of New York has reported that non-housing debt in the U.S. reached a record-breaking $4.45 trillion as of the second quarter of this year, even though the economy has yet to fully recover from the effects of the pandemic, and even with the specter of a recession on the horizon.
The thing is, Affirm's delinquencies have been on the rise for well over a year now. That trend has not only carried on into the first two months of the company's fiscal 2023, which began July 1, but appears to have accelerated recently.
Source: Affirm Holdings' fiscal 2022 earnings call deck.
Given the other relevant data, however, rising loan delinquencies could have been expected. That is, in step with more and more underperforming or nonperforming loans, the average creditworthiness of Affirm's borrowers is slumping.
The company uses its own proprietary ITACS credit-rating system to determine whether to extend loans. It's not difficult to understand though: The higher a person's ITACS score, the more creditworthy they are. The lower the score, the riskier that individual's loan is. On Affirm's scale, scores between 96 and 100 represent the most creditworthy borrowers, and as the chart below makes clear, as of late 2020, roughly three-fourths of its loan portfolio fell in that category. But as of the end of last quarter, only a little over half of the company's loans held for investment were in that lowest risk group, while the share of higher-risk borrowers has grown markedly.
Data source: Affirm Holdings. Chart by author.
There's a clear price to pay for these lowered standards. Charge-offs -- or loan write-downs -- for the recently ended fiscal year reached $69.5 million. That may not seem like much, but it was nearly seven times more than the previous fiscal year's charge-offs of $10.3 million, and far beyond fiscal 2020's figure of $2.1 million.
More to the point, Affirm's write-downs have grown considerably faster than its loan portfolio itself has. The $2.5 billion in loans it's currently carrying on the books is only about 150% more than its portfolio of just over $1 billion two years back.
Tread lightly, if you dare tread at all
It's not necessarily the end of the world for Affirm. Weakening loan performance and rising delinquencies can be expected for a new type of lending start-up that's seeking rapid growth and hoping to win market share.
This trend of deteriorating creditworthiness among its borrowers and rising loan delinquencies still raises too many questions, however, if only because the cost of even just a few non-performing loans can be considerably greater than the cost of servicing loans that are being paid back as expected. In some cases, it can be on the order of 10 times as much. Given that this will be the first time we get to see the "buy now, pay later" loan business under duress though, it's nearly impossible to predict the eventual cost of these growing delinquencies and corresponding charge-offs.
This sort of uncertainty alone can seriously undermine a stock's value.
