Consumer finance companies have been ravished by the rapidly rising interest rate environment, and the trend showed no signs of letting up for the buy now, pay later (BNPL) company Affirm (AFRM 3.08%).
Affirm was a big winner in 2021 when tech stocks were all the rage and ascending to higher valuations every day. But over the last year, Affirm's stock is down 67% as the BNPL space has come under scrutiny and soaring interest rates have really made Affirm's business model difficult to operate. Let me explain.
Higher rates hurt in multiple ways
Affirm extends credit to consumers who put zero money down and then pay off the purchase in multiple installment payments. Some of Affirm's loans carry no interest, while others carry as much as a 36% annual percentage rate.
Image source: Getty Images.
To fund these loans, Affirm sells loans to investors and has agreements in place with a variety of partners that extend the company debt to fund its loans. As interest rates have gone up aggressively over the last year, the cost of this debt has as well, with funding costs at Affirm rising by more than $24 million in the last six months of 2022. Affirm can also reprice the yields on its loans higher, but that takes time and is hard to do with the Federal Reserve raising interest rates so quickly.
Additionally, with excess savings from the pandemic dwindling and high consumer prices due to inflation, consumers are no longer as flush as they once were. This has resulted in higher loan losses as the credit environment normalizes. Affirm saw its provision for credit losses rise by $42.5 million in its most recent quarter.
Affirm is also concerned about the macro environment and has tightened underwriting, which has slowed gross merchandising volume (GMV), the main driver of revenue at the company.
Underwhelming results
In its second fiscal quarter of 2023 ending Dec. 31, Affirm saw record GMV (gross merchandise value) of nearly $5.7 billion, but that came in below the company's earlier outlook.
Affirm also provided guidance for its full fiscal year of 2023, which also came in below analyst estimates. Affirm is expecting revenue for the full fiscal year of $1.55 billion and GMV of as much as $20 billion, which is below the consensus high-end estimate of $21.5 billion.
Affirm hopes to achieve positive adjusted operating income as it exits fiscal year 2023, but I think there is a lot of uncertainty around this goal, given the environment. The company has also announced plans to tighten its belt by laying off 19% of its workforce and eliminating products with uncertain revenue outlooks, such as Affirm Crypto.
What will investor appetite look like?
Affirm's life should get a bit easier once the Fed stops raising rates, which is expected to happen this year. This would enable funding costs to stabilize, and the company then should be able to raise rates on its interest-bearing loans enough so it can meet the desired return thresholds of its investors.
But the consumer might still struggle this year if the economy takes a sudden turn and falls into a recession. That could crimp consumer demand and lead to further credit concerns for investors that purchase Affirm's loans.
I am also interested to see how equity investors approach fintech companies like Affirm, having seen the damage of rising rates on the business. Yes, the Fed has never raised rates this quickly before, but I still think it shows that consumer finance companies need to prepare their business models better for rising-rate environments. Otherwise, whenever investors sniff signs of inflation and rising interest rates, they may quickly abandon stocks like this.
