5 Buy Now, Pay Later Trends Smart Investors Are Watching

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It’s official: The S&P500 The index is in a bear market, with the index having fallen more than 20% since its peak in early January. Investors are focused on inflation and rising interest rates, which have rippled throughout the economy.

The buy it now, pay later (BNPL) industry is an area facing growing pressures. After explosive growth in recent years, BNPL’s businesses could face a settling of scores. Here are five industry trends you should watch.

Image source: Getty Images.

1. Inflation will weigh on consumers

The consumer price index (CPI), a measure of inflation, rose 8.6% year-on-year in May, beating economists’ expectations and the fastest since December 1981. One concern is that inflation is weighing on consumers, who may reduce their spending on goods and services. — reduce opportunities for BNPL companies.

Another concern is that consumers are using BNPL loans more to pay for things without knowing how much debt they have. This could lead to greater losses for BNPL companies.

One metric to pay attention to is the allowance for credit losses, which measures the money set aside over a period of time to cover expected losses on loans that could default. For example, the independent company BNPL To affirm (AFRM 0.31%) recorded a provision for credit losses of $182.6 million in the nine months ended March 31, compared to $40.4 million a year earlier.

This comes as BNPL companies are already racking up losses. Affirm’s net loss was $520 million for the nine months ended March 31. Privately owned Swedish fintech Klarna posted operating losses of $688m last year, while Australia-based Afterpay (now owned by To block) posted losses of $113 million in its 2021 fiscal year that ended last June.

AFRM Net Income Chart (TTM)

AFRM Net Income (TTM) given by Y-Charts

2. Rising interest rates will put pressure on BNPL companies

The Federal Reserve has pledged to raise interest rates to combat inflationary pressures not seen since the 1980s. This year, the Fed raised the federal funds rate from near zero to an upper range of 1, 75%. Fed policymakers expect interest rates to hit 3.4% by the end of the year.

Federal Funds Target Rate Upper Bound Table

Upper limit of the target federal funds rate given by Y-Charts

BNPL companies performed well when interest rates were low, resulting in lower funding costs and plenty of cash to lend to consumers.

However, rising interest rates and economic uncertainty have led to a significant increase in borrowing costs. For example, Klarna saw its borrowing costs reach their highest level ever.

These higher rates will put more pressure on standalone BNPL companies like Affirm, while companies with large cash balances or bank charters like Block may fare better.

3. Consumers use debt to pay BNPL loans

In a survey of LendingTree, 42% of BNP borrowers paid one of their loans late. In another survey by UK-based Citizens Advice, 42% of BNPL users have borrowed money from friends and family, credit cards or personal loans to pay off their BNPL debt, including 51% of 18 to 34 year olds.

Industry watchdogs say BNPL is too easy to use, forcing consumers to take on more debt than they can handle. That brings us to the next headwind.

4. Regulators are increasingly scrutinizing the industry

In January, the US Federal Consumer Financial Protection Bureau (CFPB) opened an investigation into BNPL lenders, citing concerns about rising consumer debt and data collection. The CFPB wants BNPL loans to be reported to credit rating agencies so that lenders can see how much a consumer is in debt, while consumers would see their payment history on those loans reflected in their credit history.

European countries are also affected, and in May the Swedish Privacy Authority announced that it was opening an investigation into Klarna’s payment service.

5. Apple’s entry into the space adds more competition

As if BNPL’s businesses hadn’t faced enough headwinds, they now also face new competition from one of the biggest companies in the world. This month, Apple (AAPL -0.38%) said it would launch its own BNPL installment loan option, Apple Pay Later. Apple is sitting on $80 billion in cash, which it can use to fund the company.

I’ll be interested to see how Apple performs once it rolls out its product, which could threaten standalone Affirm, as well as PayPal and Block, which acquired BNPL’s business last year.

Given the many pressures BNPL companies will face over the next couple of years, as an investor, I will stay away until the dust settles.