It’s official: The S&P500 index is in a bear market, with the index falling more than 20% since peaking in early January. Investors are focusing on inflation and rising interest rates, which have rippled across the economy.
One area facing increasing pressures is the once-hot buy now, pay later (BNPL) industry. After explosive growth in recent years, BNPL companies could be facing a reckoning. Here are five industry trends that you should be watching.
1. Inflation will weigh on consumers
The consumer price index (CPI), a measure of inflation, increased 8.6% year over year in May, higher than economists expected and the fastest since December 1981. One concern is that inflation weighs on consumers, who could cut spending on goods and services — reducing opportunities for BNPL companies.
Another concern is that consumers use BNPL loans more to pay for things without knowing how much debt they are taking on. This could result in BNPL companies taking larger losses.
One metric to pay attention to is the provision for credit losses, which measures money set aside in a given period to cover expected losses on loans that could default. For example, the stand-alone BNPL company Affirm (AFRM 0.31%) posted a $182.6 million provision for credit losses through the nine months ended March 31, up from $40.4 million from the previous year.
This comes as BNPL companies already rack up losses. Affirm’s net loss was $520 million through the nine months ended March 31. Privately held Swedish fintech Klarna saw operating losses of $688 million last year, while Australia-based Afterpay (now owned by block) put up $113 million in losses during its 2021 fiscal year ended last June.
2. Higher interest rates will put pressure on BNPL companies
The Federal Reserve is committed to raising interest rates to tackle inflationary pressures not seen since the 1980s. This year, the Fed has increased the federal funds rate from near zero to a 1.75% upper range. Fed policy makers expect interest rates to reach 3.4% by the end of this year.
BNPL companies performed well when interest rates were low, which led to cheaper funding costs and plenty of cash to make loans to consumers.
However, rising interest rates and economic uncertainty have caused borrowing costs to increase significantly. For example, Klarna saw borrowing costs rise to their highest on record.
These higher rates will put more pressure on stand-alone BNPL companies like Affirm, while companies with large cash balances or banking charters like Block could fare better.
3. Consumers are using debt to pay BNPL loans
In one survey by LendingTree, 42% of BNP borrowers paid late on one of their loans. In another survey by UK-based Citizens Advice, 42% of BNPL users borrowed money from friends and family, credit cards, or personal loans to pay down their BNPL debt, including 51% of those aged 18 to 34.
Industry watchdogs argue that BNPL is too easy to use, causing consumers to take on more debt than they can handle. That leads us to the next headwind.
4. Regulators are increasing scrutiny of the industry
In January, the US federal Consumer Financial Protection Bureau (CFPB) opened an inquiry into BNPL lenders, citing concerns about growing consumer debt and data harvesting. The CFPB wants BNPL loans reported to credit-rating agencies so lenders can see how much debt a consumer has, while consumers would see their payment record on these loans reflected in their credit history.
European countries are concerned too, and in May, the Swedish Authority for Privacy Protection said it was opening an investigation into Klarna’s checkout service.
5. Apple’s entry into the space adds more competition
As if BNPL companies didn’t face enough headwinds, now they also face fresh competition from one of the largest companies in the world. This month, Apple (AAPL -0.38%) said it would launch its own BNPL installment loan option, Apple Pay Later. Apple sits on $80 billion in cash, which it can use to finance the business.
I’ll be interested to see how Apple performs once it rolls out its product, which could threaten stand-alone Affirm, along with PayPal and Block, which acquired BNPL businesses last year.
Given the many pressures BNPL companies face over the next year or two, as an investor I’ll be sitting on the sidelines until the dust settles.