PipeCandy Memo: The George Costanza of Credit

Most ideas are not new. In many cases, it boils down to articulation and how it captivates the market.

Equated Monthly Installments and Zero-interest loans have existed before. Buy-Now-Pay-Later has captured the imagination. There are other reasons that compounded the adoption of BNPL, apart from the crisp acronym.?

1. Lending as a platform feature has removed the friction of distribution for lenders.?

2. Consumers had nowhere to spend during the last two years but to go to eCommerce websites

3. Easy money from government programs flooded the market

4. Sub-Prime or near-Prime consumers needed credit and would embrace it to buy their favorite ensemble to suit the many vibes they carry each day of their life

While distribution access has remained the same, every other part of the equation that propelled BNPL has developed cracks.

We know easy money is out. But what about consumer spending?

This is a question that businesses are asking every week now. The answer is a little like 'Stranger Things.' A series of unbelievable things happen, repeatedly...to a point where we all lose interest.

?Until April it was the expectation of ominous signs that kept us at the edge of our seats. We expected household spending to decline and consumer credit card spending to cool off. It didn't happen.

Revolving credit outstanding (which includes credit card debt) increased by $17.8B, which forms a part of a 1% increase in household spending over March 2022. In other words, households are increasing spending and using credit cards to fund it. This number is not inflation-adjusted but there will be an increase in spending even if you account for it. Household spending has increased 3.3% over the last 28 days in June when compared to the same period last year.

The dominant narrative has been that consumer spending at an individual and household level is robust, in spite of inflation.

But the Bank of America Institute's data that came on Thursday (7 July) shows that there is a contraction in the growth of household spending.

Here is the excerpt: Looking at total card spending excluding gas and grocery, the year-over-year growth rate for lower-income households contracted 1.0% year over year; for higher-income households, growth excluding gas and grocery remained positive but is on a downward trend.

Consumer spending declined in May by 0.4% reversing the trend of previous months. This decline is on a sequential basis and not YoY.

What happens to BNPL in an erratic market??

Well, BNPL is a lot like George Costanza – who has occasional periods of irrational over-confidence that lead to his worst possible times. Just like Costanza, BNPLs overestimate the robustness of their business model that was propped up by prolonged market aberration.

1. Rising interest rates make the cost of capital soar for BNPL. So just like everyone else in the world, you now have a business whose supply costs are high

2. There are no operating margins to speak of. During the best years of the bull run (2019 and 2020), Klarna's realized loan losses as a percentage of their interest income were 67% and 104%, It's a moderate 47% in 2021 but their valuation has been cut down from $45B to $6B. Klarna is a monster and the poster boy of the BNPL world.

3. BNPL is (and may remain) a product for the subprime market. Prime and above prime consumers may stick to revolving credit and subprime risks always go with market conditions. As household spending has started contracting, loan losses are going to increase – even on the 30-day credits that BNPL vendors offer

A listed fintech unicorn, backed by a Chinese fintech behemoth recently said (and I am not exactly quoting), "Retail investors don't understand us. We don't have one business model but many innovative ways to revolutionize payments." The stock has plunged 65% from its high.

BNPL is much the same as a pure-play business. Making money off of debt securitization (as Affirm does), in simple terms, means that there are not enough direct ways to make money off of the core customer base's interest payments and so poorly rated debt securities have to save the day. In a rising interest rate environment, money goes to safe debt instruments and not the fake meat patty burger equivalents of debt instruments. They are so processed, transformed, and sexy and yet very unhealthy.

BNPL as a part of an ensemble of credit offerings is another avenue to make money.?BNPL can be an acquisition channel for credit cards and adjacent (but regulated) products. Will we see a consolidation of?BNPL products within revolving credit offerings via acquisitions??

?1. Firstly, not all credit card players will find BNPL, a neat fit. BNPL is really training wheels for credit card usage. Can Discover Cards acquire customers more profitably through its current channels than through an acquisition of a BNPL player?BNPL valuations were high and no traditional credit card player would have paid that much to acquire a channel. Things are different now.

2. BNPL is a bit like sampling a new, shitty flavor of popsicle from an unknown brand at Walmart because it is free. There will be takers. But will that freeloader become a profitable, non-delinquent credit card customer?

In the years after the last financial crisis of 2008 until 2013, $141B of spending shifted from credit cards to debit cards and pre-paid cards. The dominant narrative then was the "Death of debit cards" and the rise of "digital wallets". No, none of that was true. In recessionary markets, people change their habits. But now, in the best of bull runs and free money, BNPL still grew a lot – which means, there exists a market at the bottom with precarious savings that is not eligible for traditional credit.

Will traditional credit card players and banks want access to this channel, in a recessionary market? Well, can Costanza get a date and make it to the second date?