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Potential Train Wreck

With the rapid rise of the Buy Now Pay Later (BNPL) sector and some pretty astronomical valuations, I thought it was worth detailing our thoughts on the sector. While there is some great technology, some very smart business people and its exciting to see a shift to online and technology that is revolutionising micro lending, it’s worth remembering that micro loans and small retail finance isn’t without its risks.

We have serious concerns about the spread of easy credit being lent by listed companies fighting each other for market share of what has traditionally been categorised as “sub-prime”. The risk you have is that if a proper credit assessment process was in place many of these people would not be eligible for credit. Technology doesn’t improve the ability of a borrower to repay. With some listed companies trading at a multiple of revenue and little or no profits, there is only incentive for these companies to drive growth in the number of new accounts being established. There is an inherent conflict for a growing listed company which is trading off the quality of their customers versus the quantity of customers and just hoping that growth will high growing bad debts.

These loans are not asset backed. There is no checking if you have loans from other BNPL providers, if you have full-time employment or even a stable work history. One area where the technology is great is in cutting your credit when you are in arrears, something credit card companies don’t do unless you have breached your limit, but the loan is still impaired.

The lack of adequate credit checking in some cases is akin to the problems we had pre-GFC when money was cheap and being lent out with very little credit checking. Its where the NINJA loan originated. That’s the No Income, No Job, No Assets. I suspect that there are quite a few NINJA’s in the books of the BNPL sector.

The risk in the rapid rise of cheap credit becomes even more of an issue when you consider that interest rates are at all time record lows. There is the risk that record economic stimulus has been announced and that there is a very real prospect that the impact of global stimulus post Covid-19 will result in rate increases at some time in the future.

Don’t get me wrong, I think that there is a shift away from using plastic credit cards, partly because of the exorbitant rates that banks charge people on credit card balances. The banks sell large amounts of impaired credit card loans every year. The interest rate charge partly reflects the fact that users of that product need to cover the cost of bad debts in that product, they sell the debt to companies like Credit Corp who pay 20-30 cents in the dollar for those in arrears or impaired loans. The scary thing about this fact is that there is some credit assessment when you apply for a credit card.

I also think that mobile payment apps are the future and there is a need for quick online credit approvals. Zip has a good process and we have owned their shares but there is the continual desire for the companies to lend more and lend more to their existing client base. Afterpay has the ability if it executes well to build a brand globally like American Express, we have articulated our thoughts on that before when we bought the stock, but they are going to be many risks along the way and for a relatively new company it remains to be seen how they will manage the risk interest rate increases, the cost of collections in large countries like the US and competitive threats if Amazon, Google and Apple throw their balance sheets at competing with them.

Have a great weekend


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