Max Levchin founded Affirm Holdings in the belief that young people were more open to borrowing from Silicon Valley start-ups than established lenders.
“Consumers, especially millennials and Gen Z, have lost faith in financial institutions,” Levchin told investors last year, and “increasingly prefer more flexible and innovative digital payment solutions over instead of traditional credit payment options”.
His vision has made San Francisco-based Affirm one of the largest “buy now, pay later” companies, enabling shoppers to secure unsecured installment loans when buying apparel, electronic devices and other goods online. Investors gave the loss-making company a maximum market capitalization of $47 billion after its IPO last year, valuing it more as a flashy tech disruptor than a needy lender.
Now, with tech stocks falling and interest rates rising, investors are having second thoughts.
The company’s market capitalization fell to $5 billion after its stock fell 89% from a high last November. Quarterly results due Thursday are expected to show a net loss of $156 million on $345 million in revenue, according to a Bloomberg poll of analysts. Some say Affirm looks more like a traditional financial institution than its digital brilliance suggests.
“These kind of hybrid fintech stocks, they sort of trade like tech stocks when they’re growing really fast and the financial side of their business is not a problem,” said Chris Brendler, an analyst at DA Davidson. “But if you start having higher losses or finance issues, that’s when they start behaving like finance.”
Affirm’s pitch to retailers is simple: by allowing customers to split payments for goods, sometimes without interest, they will sell more products.
Retailers pay Affirm a “merchant rebate fee,” effectively a commission of a few percentage points of the purchase price. In 2020, nearly 60% of the company’s revenue came from these fees.
Affirm’s biggest merchant during the pandemic was Peloton, the stationary bike maker whose sales are now declining.
But the makeup of Affirm’s business began to shift after signing partnerships with big retailers such as Amazon and Walmart — companies hefty enough to avoid having to pay merchant rebate fees.
Instead, the majority of Affirm’s revenue now comes from its function as a lender: selling loans either through securitizations or to third-party buyers such as insurance companies, or collecting revenue from interest for the assets it keeps on its own balance sheet. . In the last reported quarter, more than half of revenue came from interest income and gains on the sale of loans.
Affirm said it remains committed to growing its fee-generating business as part of a strategy to create “a menu of different products to meet consumer and merchant needs across basket sizes, categories and terms of payment”.
“This is a key point of differentiation that strongly positions Affirm to build on our momentum as a leader in a massive and rapidly growing industry as consumers continue to seek flexible options to pay on their own. rhythm,” Affirm said.
Unlike a traditional bank, Affirm does not hold consumer deposits and instead relies on “warehouse” lines of credit. Cross River Bank, a New Jersey-based start-up backed by top venture capital firms, originated Affirm’s loans, while the buy now, pay later group then manages the relationship with the customer.
Affirm has also grown through securitizations or pooled loans to be sold as bonds, some of which are kept on its own books. The sale of debt generates cash to make future loans, and investor appetite for this type of paper remains high.
Two years ago, none of Affirm’s loans were funded by securitization, according to data compiled by the company. As of the last quarter, a third of Affirm’s $6 billion portfolio had been consolidated into bonds.
The move from commissions to loans and interest income has put a premium on Affirm’s underwriting process. Potential credit losses not only reduce the book value of the loans the company keeps, but also the gains it can make in the secondary markets.
In the last quarter of 2020, just 1.44% of Affirm loans were marked four to 29 days past due or overdue, according to company data. Four quarters later, that figure had risen to more than 3%. In its last quarter, the amount of provisions the group sets aside for potential loan losses had reached 6.5% of its loan portfolio, up from 5.2% in mid-2021. Interest rates charged to consumers can be as high as 30%.
“While we agree that Affirm performs an important payments function, we argue that Affirm is actually more of a lender than a payments company,” Stephens analyst Vincent Caintic wrote recently.
Affirm recently hit its gross profit margin of 4%, which includes credit costs, even as operating costs and general expenses ate away at net profit.
Skeptics, however, noted that the company’s explosive growth over the past two years came at a time of falling unemployment and when American consumers were on the verge of government stimulus money.
Jim Chanos, the short seller and founder of hedge fund Kynikos Associates, criticized Affirm and other fintech start-ups that went up against big banks.
“Each time, a group of lenders on the Internet try to convince
the market that they have a better model to assess creditworthiness.
They just give credit to people they shouldn’t be. And U.S
you won’t see it until you get through a downturn in the credit cycle,” Chanos said.
Wall Street is also focusing on the details of its business model. In March, at a time of bond market turmoil, Affirm completed a $500 million financing deal that it planned to use to fund future customer loans.
At a recent investor event, Affirm’s chief financial officer Michael Linford played down the move, saying the withdrawn deal was “a sign of strength, not a sign of weakness.”
He added: “We felt really good about the company and felt we didn’t need to try to block a deal.”
In a securities filing in March, Affirm said it still had nearly $10 billion in committed capital, which was more than enough to support short-term lending. If the economy starts to deteriorate, the company said it could quickly adjust its lending policies, especially because its loans aren’t extended for long periods like those for cars or homes.
“But at the start of a recession, which is when things start to get worse and worse, assuming there’s a significant increase in unemployment associated with that, then we would incur higher losses. “, Linford said at an investor conference in March. “However, given the short duration of our asset, we think we would be able to reposition the funnel a bit.”
Additional reporting by Harriet Agnew in London