Business Breakdowns
· Fraser
[00:00:00] S1: The key principle to think about on the funding side of the business is Affirm is trying to build out a diversified range of funding sources with lots of redundancy. So they have different investor types, banks, insurers, and other institutions funding these loans — securitized, non-securitized, on-balance sheet, off-balance sheet, static, revolving, fixed and floating rates. The list goes on. Affirm is in the process of getting a banking license. They will also have consumer deposits as a piece of the funding mix. And the idea is that if you have the broad group of funding sources, you're never reliant on any individual piece. If for whatever reason the private credit market has issues, or the banking ecosystem has issues, or insurance companies are having issues — unless the whole system dries up, Affirm has built a very sophisticated capital markets engine to ensure it's got this diversified funding base with plenty of redundancy. So the outcome of this diversified funding strategy is about 50% of loans are off balance sheet in forward flow facilities and static ABS facilities. And then the other 50% is on balance sheet in warehouses and revolving ABS facilities. And you can imagine the warehouse is typically where a lot of the redundancy is, because you fund the loans via the warehouse and then think about where you want to move them subsequently. But it's not a case of you all of a sudden building up lots of loans on balance sheet and then three quarters later selling a big chunk. The split between on balance sheet and off balance sheet, and the splits between the different funding sources, is very consistent and constantly managed. The key risk you have on the funding side of the business is more in the short term, and this goes to the 2022–2023 scenario. When Affirm writes the loan to the consumer and the consumer accepts the loan, the interest rate is fixed. So if the average loan term is 11 or 12 months, the interest rate is fixed over that period of time. A small portion of the funding base is floating. And so if the Fed lifts rates very quickly in serious magnitude, you have this short-term gap where you're not earning any more interest on that pool of loans that's amortizing, and you've got to wait for the new loans at the higher interest rate that you're charging to flow through the book.
· Fraser
Because the book turns so quickly — I think I mentioned — within a quarter, 50% of the loan book would be on the higher interest rate, and within two quarters, 75% would be on the higher interest rate. So it's a one- to two-quarter air pocket. That's really what we saw in 2022, 2023. Because that book turns quite quickly, rates have to move very quickly and very sharply to have a material impact. So for example, in the most recent reporting, I think the business said if rates rose by 100 basis points, it would have, call it, a $90 million impact to the P&L. And this is a business doing $2.5 billion of gross profit this financial year. I think the bigger issue is if rates go from 0 to 5% and you have a 500-basis-point increase — then that causes a big issue. 50 to 100 basis points over the course of many months or quarters doesn't have as much of an impact. What's also interesting is the mechanism is slightly different to a credit card. Let's say Affirm was offering 12-month loans on a $500 couch at a 15% interest rate, and then the Fed lifts rates and now all of a sudden Affirm has to charge a 25% interest rate for the new loans it's writing — that actually chops out a bunch of the loans they were otherwise writing at that lower interest rate. There are a certain pool of consumers that turn up, and Affirm says that's good credit and good underwriting to offer someone a $500 loan at a 15% interest rate, but it's not good credit, and we don't think it's worth the risk, to offer that same person a $500 loan at a 25% interest rate. The bigger issue in these air pockets is actually growth slows materially, because Affirm just stops writing loans to a portion of their user base that they were previously. And because the interest rate being charged to the consumer on the loans outstanding doesn't change, you don't necessarily see a huge blowout in credit losses. Credit losses did rise in 2022, but typically it's because there's a whole bunch of other debt that consumers have that's variable rate, and so they get squeezed elsewhere in the credit ecosystem. It's a combination of growth and margins, and it's one or two quarters of impact, and that's only in those moments where — 2022 was the largest and fastest rise in interest rates in 40 years or something. The average gyrations of interest rates shouldn't have a material impact on the business.
· Fraser
When we think about these credit businesses, it's not like a credit card portfolio, where you have a whole bunch of people sitting on a revolving balance, paying the minimums every month, with balances that are compounding on variable rates, so that when interest rates rise, they were paying 15% on their revolving balance and now it's 25%. And so all of a sudden you have this huge washout of credit losses. With Affirm, the mechanism by which it impacts the P&L and the business is different, and we think healthier and lower risk than what you would see in these credit card businesses. Which is why — and we can talk about valuation — the network effects alone make the business more like an American Express than a Capital One or a Synchrony, but also just how the credit hits the P&L and what happens in these downturns also makes Affirm a better business than the Capital Ones and the Synchronies. Now, the fair argument is that obviously Amex has a very affluent customer base. Affirm is called the average American. Arguably, there's some sort of trade-off there between different customer base, but operating in a faster-growth part of payments, in the sense that we've talked about BNPL taking share of e-commerce, which is taking share of retail. And so you've got this big tailwind behind you relative to Amex, which is that more traditional card network.
· S0
[00:00:00] S0: So we've covered now the economics, the moats, underwriting models, the team, the funding, the mechanisms behind it, and I want to talk about where it goes from here. Management has been pretty aggressive and has laid out a plan to roughly double the business to $100 billion in GMV. Maybe lay out where the different levers are to get there — where you feel the most conviction and maybe the most skeptical.
· Fraser
[00:00:00] S1: If I start at the highest level of the TAM, and then we can drill into the next few years, the stats are somewhat overwhelming. In the US alone, there's about $1.3 trillion of credit card balances outstanding, versus Affirm's total loan book, on balance sheet and off balance sheet, of about $20 billion. Affirm is a speck relative to the US credit card ecosystem. Even if you look at GMV, where Affirm processed $50 billion — if you added up Visa, Mastercard, and Amex's credit card volumes, it's about $13 trillion each year. So Affirm is still tiny relative to the overall opportunity. Not suggesting it's ever going to be as big as Visa, Mastercard, or Amex, but there's still a lot of room to grow. Even if we were to just pick Capital One, Capital One processes over 15 times Affirm's GMV each year. So Affirm is large in the sense it processes $50 billion of GMV and is integrated with some of the biggest merchants in America, but there's still a very long way to go. And I think when you speak to Max and when you hear Max on podcasts and earnings calls, you get that sense that they are still very early and he's very ambitious about where he wants to take this business. These medium-term milestones they set themselves at these investor forums every few years are the stepping stones along the way. It's not a final endpoint where investors should assume the business hits the wall at $100 billion of GMV and never grows from there, or grows at industry card volume from there. So if we're then to drill into that medium-term framework — as I mentioned, they have a June year-end, but they delivered about $50 billion of GMV to June of this year. They're targeting $100 billion, greater than 25% annual growth on that path. So it works out they'll get there within a few years, in theory. And when they communicate to the market, they are very explicit about what is in that guidance and what is not in that guidance. And so what is in that growth target is the core US business plus the card plus international. Edge, which is their white-label offering for US banks, and agentic commerce sit on top of that. So if those two products were to be successful, we would expect that $100 billion of GMV to actually end up being higher. So if we focus on very quickly running through those three pillars — core, card, international — we've talked about the core.
· Fraser
E-commerce is still taking share of US retail at a touch over 20% share. BNPL can still triple its share of US e-commerce if you look at benchmarks elsewhere in the world. And Affirm is about 50% market share of BNPL and expanding. So you've got the triple tailwind in that core business. The added context is only 75 of the top 250 US merchants actually use Affirm or have Affirm integrated today. So that core business should continue growing very nicely through the future. The second big lever is the card product. Again, this isn't a product that's being advertised widely with very high CACs, like a lot of other card products that are out there. It's purely for the consumers that are already coming through that core customer acquisition funnel, and it allows consumers to pay now, pay later, pay now and decide later, and spend in-store and with online merchants without a direct Affirm integration. It's already, call it, 20% of users and GMV, growing very, very quickly, and has been hugely successful and delivers great unit economics to Affirm at roughly the same rates as the overall broader business, potentially actually a little bit higher. There is the obvious downside from card — you're not getting the product-level data from the merchant integrations. What's interesting is that hasn't seemed to have hurt underwriting outcomes. What Affirm would say is it just makes personalizing offers a lot harder. So when you're integrated with a merchant, you're getting all this really rich data — from what you've clicked on, what you added to the basket, what you took out of the basket, all the way through. You can imagine all the data points. And so ultimately what offers you're showing can be personalized not only to the user and their history of repayment and the offers they've selected, but also the types of things in the basket. So that's the card. The third piece — and this is more nascent, and the company would suggest is a smaller driver of growth — is the international piece. There's a range of perspectives on international. You can imagine — we've just mentioned that BNPL is already reasonably saturated in a lot of overseas markets, when you think about Europe or places like Australia and New Zealand.