It is hard to argue with the fact that people love BNPL lending. It is fast, approval rates are nearly 100%, and who wouldn’t want to treat themselves to a $150 purchase on four easy payments? But lenders, consumers, and investors need to wonder if the process is all a castle built on sand.
The popularization of Buy Now Pay Later lending comes at a unique time. Retailers stress the economy as sales plummet. Consumers contend with high unemployment, face masks, and an unsteady economy. Everyone is looking for a way to hunker down and try to keep life as normal as possible
With the holidays behind us and e-commerce gaining scale, we see BNPL as a new-fangled lending replacement and achieving scale as IPOs bring in billions. The industry calls it “new,” but companies like GE Finance (now Synchrony) and Household Finance (Now Capital One) built their empires on a similar merchant-centric model. However, both companies kept a laser-focus on credit quality.
What comes to mind is the short-lived existence of peer-to-peer (P2P) lending, once the darling of Wall Street, and now a lousy investor memory. Remember Lending Club?
- Stock surges 56% on opening day, newly values the company at $8.5B
- The S-1 states that Lending Club sees itself as the next fixture of this sharing economy.
- Big banks operate through thousands of branches nationwide, branches that remain open throughout the day even if nobody is visiting them.
- But peer to peer lending websites have no branches, vaults, or tellers.
If you were one of the unlucky ones that bought at the peak price of $128.70 (December 26, 2014), you might feel differently than the trader who buys the stock on February 16, 2021, at $12.65. And, if you follow the company, you’d know they are trying to upend the business model they created, according to Business Journals.
- LendingClub issued a death certificate on its peer-to-peer lending business, telling the SEC that it plans to shut down that operation at year-end.
- So-called peer-to-peer lending has been on life support for years. When family offices and later hedge funds and other institutional investors jumped into the business of supplying the money to finance loans on LendingClub’s platform, the company said it was a lending marketplace, not a peer-to-peer lender. After all, few people borrowing money on LendingClub consider billionaires to be their peers.
Or, you may have favored Prosper Marketplace, which did not prosper. It was a good idea at the time. However, SEC reports indicated a 22.45% charge-off rate, enough to send a risk manager into retirement.
Then, we have Social Finance, better known as SoFi. SP Global reported: “By April, Citigroup Inc. was having trouble marketing a new securitization of loans from personal-focused lender Prosper Marketplace Inc., leading the two firms to end their partnership. Without this important source of capital, Prosper saw originations fall 55.5% during the second quarter of 2016.”
Now, I am not a skeptic, in fact, it is my job to understand new lending forms, and I will often borrow to test a new product, to understand the business model better, and feel the user experience, as discussed in BNPL Borrowing: Confessions of a Credit Card Manager. But some sirens are calling that credit managers must consider before they start changing their well-established credit models or get into acquisition modes with ridiculously priced offers.
- In Australia, BNPL Lender Zip received a “please explain notice” (see here) from the Australian Stock Exchange to explain sudden surges in stock valuation, as Business Insider stated to “ account for the company’s market cap jumping $1 billion in the space of a few hours.”
As good as the sales numbers look, the inverse is true of credit quality, according to The Drum.
- A GlobalData survey in November found that 52% of BNPL shoppers had at some point been unable to make a payment through a credit plan they’d used.
- A UBS survey conducted in Australia last September found that the proportion of BNPL users on the federal government’s stimulus packages (JobKeeper and JobSeeker) was substantially above that of non-users and that 60% of the respondents on JobKeeper believed they would have defaulted on their BNPL payments without government subsidies.
- Credit quality is under review by regulators in the largest BNPL markets.
BNPL has interesting aspects, such as placing the merchant in the center of the financing relationship and the benefits of digital lending. At the same time, you have to wonder if growth is too fast to be sustainable or overly optimistic rather than being realistic. And that is something we saw with P2P lending. Short-lived, lots of losses, and limited long-term value to consumers, financial institutions, and investors.
The calculus of lending is simple. Lenders gain from lending money at prices greater than the funding cost. Subtract operating costs, credit risk, and marketing expenses. When this gets out of whack, you must consider safety and soundness, for all players involved.
Overview by Brian Riley, Director, Credit Advisory Service at Mercator Advisory Group