Is Affirm the Tesla of Finance?

More and more consumers are choosing this payment method to make online purchases. As many as 39% of today’s online shoppers have tried BNPL for at lease one purchase.

Affirm (AFRM) is one of, if not the, biggest players in the BNPL financing game.

As you’ll see just one of the many attributes Affirm has going for it is an ability to raise cash from its loyal consumers, just like Tesla. That cash or “float” allows the company to innovate faster. So is Affirm the Tesla of Finance, with a technology lead, loyal consumer base, and data advantage?

What is Affirm?

Affirm offers a new way to buy things without taking on huge amounts of debt to do so. As you’re about to discover it offers a compelling value proposition to both merchants and consumers.

Affirm was founded in 2012 by Max Levchin, the company’s CEO. Levchin was also a co-founder of another payments company, PayPal. Affirm took its shares public in 2021 and has a current market cap of nearly $14 billion.

The San Francisco-based company offers loans with no long-term commitment at point of sale. Payment terms can range from just three months to as long as five years.

These payment plans are offered through companies with which Affirm as partnerships, such as Amazon (AMZN), Walmart (WMT), and Peloton (PTON).

Gross volume of merchandise measures retail transactions net refunds. For Affirm, gross merchandise volume was $2.5 billion at the end of Q2 2021 – almost double the GMV from 2020.

So how exactly does Affirm offer such a great way to pay? And what are the pros and cons of these short-term installment loans?

How Does Affirm Work?

While each BNPL provider is a little different, the premise of buy-now-pay-later is much the same from provider to provider:

• At checkout, in the payment options section, consumers see an option that allows them to spread out payments over a given number of installments.
• Consumers apply for this short-term loan right in checkout and most consumers are typically approved within seconds.
• When approved, you make your first payment in checkout while agreeing to pay the remainder in equal payments, either over the next few weeks or months (depending on terms and provider).

For instance, say you’re shopping on Walmart.com. Once you get to the checkout page, you’ll have the option to pay for your purchase using Affirm. It’s not Walmart that offers this extension of credit – Walmart allows Affirm to offer the credit. Affirm is a third-party lender.

Why Affirm “Works”

Around 21% of Americans were denied access to credit cards in 2020. Affirm’s BNPL premise appeals to this segment of the country that can’t get a credit card as well as individuals who simply prefer this type of fixed payment plan.

In 2020, consumers spent an average of $17 billion using BNPL plans for online purchases, more than doubling from a year prior. As Affirm becomes more popular, it’s relying on investor financing more than lenders to build its funding.

Recent deals in the BNPL arena showcase its popularity. For instance, PayPal (PYPL) is buying Paidy, a Japanese startup payments company for $2.7 billion, and Square (SQ) has agreed to purchase Afterpay (AFTPF & AFTPY) for $29 billion.

Affirm Finances Using Securitizations

Affirm has a few ways it funds business – one of these ways is with securitizations. This is similar to what SoFi and Upstart are doing.

Affirm entered securitizations in mid-2020 and has six transactions under its belt. In Q2 2021, Affirm was able to fund around 33% of its portfolio of $4.7-billion-worth of short-term loans with cash from these transactions.

Each transaction is a bundle of the company’s loans-turned-securities, which are then sold to investors.

In the past, Affirm had relied on borrowing against the balance of these short-term loans, also known as warehouse financing, and direct sales of these loans to other companies.

Securitization transactions don’t require as much equity capital as warehouse financing, for instance, which Affirm soon will cease doing, according to Michael Linford, Affirm’s CFO. Warehouse financing dropped from 42% in 2020 to just 19% in 2021.

Most of Affirm’s funding comes from the sale of these loans that the company hasn’t bundled up into securities. Directly selling loans to outside companies was 49% of Affirm’s funding mix for Q2, which brought in $2.3 billion – almost doubling from 2020.

In comparing Affirm to Tesla, there will always be analysts who believe Tesla is far overvalued and can’t keep up with current share prices. Looking at Affirm’s strong “buy” signals, you could say the same for Affirm.

But, just like Elon Musk is always looking to the future and the next new thing, Affirm aspires to substantially scale its business from where it is now. This takes multiple funding sources while it goes through its scaling pains so the company never becomes overly reliant upon just one source.

The Complexity of the Business Model

Affirm is a lot different than your typical lender. Its business model differs quite substantially from most traditional banks. Today’s mainstream bank uses the deposits of its members to fund their loans.

Affirm instead has two banks on call, Cross River and Celtic Bank. These two banks originate the majority of Affirm’s loans. Affirm then buys these loans from the originating bank and becomes the servicer for the loan’s lifetime.

Like many other lenders in the fintech space, Affirm puts some of its securitizations on the books and gets rid of others. In Q3 2021, the company sold its riskiest portion to third-party investors. This allowed Affirm to take this “hit” off the books, helping the company record over $16 million in gains.

Also in Q3 2021, Affirm recorded over $42 million from the sale of loans, which is a gain of over $31 million from the previous year. At the same time, however, the company reported net losses of over $128 million for Q3 2021 – Q3 2020 showed profits of $34.8 million.

While the expansion into securitizations helped diversify the company’s funding, these streams of capital could dry up if investors become nervous or the economy tanks any further. Some analysts believe, as they do for Tesla, that this type of growth simply isn’t sustainable in the long run.

But Affirm sees the warehouse credit lines as a stopgap in the event the company is unable to access securitization funding. In the interim, there are no plans to accumulate further corporate debt in the name of business.

So, while analysts may be wary, investors are enthusiastic. Demand for the company’s securitizations is strong. The company’s entire funding model offers options – or workarounds – in the event things should head south. If any one funding source were to suddenly disappear, there would be another in its place.

So, is Affirm the Tesla of finance? Is Tesla the right comparison? Only time will tell, but for now it appears Affirm is in a league of their own.

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