The "Phantom Debt" of BNPL

Latest BNPL News

There is another “Buy now, pay later (BNPL)” provider that is seeking a US IPO—Klarna, as per the screenshot above. What does this mean for consumers and the economy?

As a prudent person, I have minimized my exposure to debts or credit facilities. The ones that I had included a home mortgage, automotive (car) loan, and study loan (for my tertiary education).

Executive Summary

Summary of the BNPL Situation in the USA

The BNPL industry in the US has seen rapid growth, particularly among younger demographics. While it offers convenience, it also poses risks:

Key Points:

• Rising Delinquencies: BNPL delinquency rates have increased, outpacing those of traditional credit cards in some cases.

• Hidden Debt: BNPL debt is often not reported to credit bureaus, creating a "phantom debt" problem.

• Overspending Risk: The ease of access to BNPL can lead to overspending and potential financial difficulties.

• Economic Impact: BNPL can contribute to consumer debt, potentially exacerbating economic challenges.

Overall Debt Outlook for the USA:

The US faces a significant debt burden, including:

• Consumer Debt: Rising credit card, student loan, and auto loan debt.

• Federal Debt: High and growing federal debt.

• Corporate Debt: Increased corporate borrowing.

This combined debt burden could lead to:

• Higher Interest Payments: Increasing the cost of servicing debt.

• Slower Economic Growth: Reduced spending and investment due to debt burdens.

• Credit Rating Downgrades: Potentially increasing borrowing costs.

To address these challenges, policymakers may need to consider fiscal and monetary policies to manage debt levels and promote sustainable economic growth.

The details of the research can be found in the next section.

My investing muse

Without transparency of the BNPL borrowings, the users' credit scores are “understated.” Credit scores (while cumbersome) are meant to limit excessive leverage that can lead to financial ruin. Is this developing into a crisis of “phantom debt?”

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One of the ways for us to understand delinquency and financial debt can be to see the debt and bad debts of their customers. There are reasonable concerns about trying to go around the credit rating as this can be seen as an alert. Thus, I do stay away from this sector.

This implies that we are not seeing the full picture of debt and delinquency in the USA. This is a chance that things are (likely) to be less healthy for our citizens.

The growth of this sector implies that there are more people requiring credit lines (with limited visibility and protection). Some of the people use the BNPL as short-term bridging loans but there is concern for people who use BNPL to buy necessities like groceries. There will be a point of no return where financial ruin kicks in, bringing distress and challenges.

I recommend caution. I hope that debts can see a reversing trend and yet hope is not a strategy. If possible, let us avoid leverage, spend within our means and research before investing. If the BNPL market continues to grow together with increasing bad debts, this is not a good sign.

Detailed research into BNPL and debts in USA

(the research is done with Google Gemini)

What is the situation involving buy now pay later in the USA?

The "Buy Now, Pay Later" (BNPL) sector in the United States has seen significant growth and evolution, reflecting broader trends in consumer finance, digital payments, and retail. Here's an overview of the current situation:

Growth and Popularity:

• Market Expansion: BNPL services have become increasingly popular, especially among younger demographics like Millennials and Gen Z. The convenience of splitting purchases into interest-free installments has made BNPL services attractive for both consumers and retailers.

• Major Players: Companies like Klarna, Affirm, Afterpay, PayPal's Pay in 4, and newer entrants like Sezzle and Zip have become household names. Klarna recently moved to file for an IPO in the US, indicating the sector's maturity and investor interest.

• Usage: Recent data suggests that a significant portion of American consumers has used BNPL for purchases, with usage rates climbing due to economic conditions where consumers seek to manage cash flow better or avoid high credit card interest rates.

Economic Impact:

• Consumer Behavior: BNPL has influenced shopping habits by allowing consumers to make purchases they might otherwise defer, thereby potentially increasing consumer spending. However, this convenience also comes with risks of overspending or accumulating debt.

• Retail Impact: Retailers have integrated BNPL options at checkout to increase conversion rates, average order values, and attract a customer base that might not have credit cards or prefer not to use them. This has been especially beneficial for online shopping platforms.

Challenges and Risks:

• Debt and Financial Health: There's a growing concern about the sustainability of BNPL usage. While these services often do not report to credit bureaus, missed payments can lead to fees, reduced spending...

What is the rate of default and delinquency experienced by the BNPL companies

Default and Delinquency Rates for BNPL Companies:

• General Observations:

  Rising Delinquencies: There has been an uptick in delinquency rates among Buy Now, Pay Later (BNPL) users, especially highlighted in recent reports. For instance, delinquencies on BNPL services have been noted to rise sharply, while credit card delinquencies remained relatively steady or showed only slight increases during similar periods.

  Default Rates: While specific default rates can vary by company due to their different business models, risk assessment strategies, and customer base, here are some insights:

  Affirm has reported that their delinquency rates for loans are improving and are in line with or better than pre-pandemic years, with a focus on managing credit risk effectively.

  Klarna experienced a decrease in delinquency rates in recent periods, attributing this to robust underwriting and responsible consumer behavior, with their credit loss rate at about 0.41% in Q2 2023.

  Industry-wide Perspective: The Consumer Financial Protection Bureau (CFPB) has suggested that BNPL borrowers are more likely to be delinquent on other credit products, indicating a broader issue of financial stress among BNPL users. This doesn't directly equate to BNPL default rates but points to a correlation with overall financial health.

• Charge-off Rates:

  The charge-off rate for BNPL services in 2021 was around 2.39% according to some analyses, likely higher in subsequent years due to economic pressures. Charge-offs refer to when loans are deemed uncollectible.

• Specific Instances:

  Data from X posts have indicated that historically, BNPL loss rates have been around 1%, with some companies like Square mentioning even lower rates for their BNPL services compared to other loan products.

• Comparative Analysis:

  BNPL delinquency rates have been described as outpacing those of traditional credit cards in some reports, suggesting that the sector might face higher risk due to its customer base, which often includes those with less established credit or financial strain.

• Market Dynamics:

  The industry has seen a mixed response to rising interest rates and economic conditions. Some BNPL companies have strict lending standards and safeguards against losses, maintaining relatively low default rates, while others might experience higher delinquencies due to less rigorous underwriting or economic factors affecting their customer base.

• Outlook:

  The BNPL sector is at a crossroads where growth in user base and transaction volumes must be balanced with credit risk management. Companies are adapting by potentially tightening credit assessments or offering longer terms with interest to cater to different consumer needs while managing risk.

This overview indicates that while BNPL services have provided a convenient payment solution, they also introduce new dynamics in consumer credit with varying degrees of default and delinquency rates across providers. The sector continues to evolve, with companies focusing on sustainable growth through better risk management and consumer education on financial responsibility.

With BNPL not required to update credit bureau, we would not know the extent of debt incurred by the various. Collectively, what is the trend of the BNPL market in USA and how does this add to the debt crisis that we see in consumers? In the grand scheme of things, what is the debt outlook for USA when we add federal and corporate debt together?

Trends in the BNPL Market in the USA:

• Market Growth: The BNPL market in the USA has seen exponential growth, with transaction volumes increasing significantly year over year. This growth is fueled by consumer demand for flexible payment options, especially in an era where cash flow management is crucial due to economic uncertainty.

• Consumer Adoption: BNPL services have become popular across various demographics but particularly with younger consumers who are either credit-averse or looking for alternatives to traditional credit cards. This trend is supported by the integration of BNPL options at checkout by a wide range of retailers, both online and in physical stores.

• Lack of Credit Reporting: BNPL loans are generally not reported to credit bureaus, which means they do not contribute to traditional credit scores but also hide the full scope of consumer debt. This opacity leads to:

  Phantom Debt: Analysts refer to the unreported BNPL debt as "phantom debt," suggesting that the actual debt levels of American consumers might be underestimated by traditional metrics.

• Debt Accumulation: While BNPL can be beneficial for cash flow, there's a risk it contributes to a hidden debt crisis:

  Consumer Behavior: The ease of access to BNPL can lead to over-leveraging, where consumers use multiple BNPL services for purchases, potentially leading to a cycle of debt if not managed properly.

  Missed Payments: Although BNPL often doesn't accrue interest if paid on time, late payments can incur fees, which can exacerbate financial stress for those already in precarious financial situations.

Impact on the Broader Debt Crisis:

• Consumer Debt: The actual impact of BNPL on consumer debt might be larger than reported, given the lack of transparency. This adds to the rising consumer debt, which includes:

  Credit Card Debt: Already at record levels.

  Student Loans: Although some relief measures have been in place, they remain a significant portion of consumer debt.

  Auto Loans: With increasing delinquency rates.

• Federal Debt: The U.S. federal debt is at an all-time high, projected to continue growing due to:

  Fiscal Policies: Including tax cuts, spending on social programs, and stimulus packages.

  Interest Rates: Rising rates increase the cost of servicing this debt.

• Corporate Debt: U.S. corporations have also ramped up borrowing, particularly through bonds:

  Low Interest Rate Environment: Companies took advantage of historically low rates to finance growth, buybacks, or acquisitions.

  Refinancing: Many firms have refinanced debt at lower rates, but with rates rising, this will become more expensive, potentially leading to corporate deleveraging or defaults.

Debt Outlook for the USA:

• Combined Debt Levels: When considering consumer, federal, and corporate debt together, the U.S. faces:

  A Debt-to-GDP Ratio: This ratio has been climbing, potentially reaching unsustainable levels if not addressed through economic growth or policy adjustments.

• Economic Implications:

  Interest Payments: The cost of servicing this debt, especially with rising rates, could become a significant portion of federal expenditure, potentially limiting fiscal flexibility for other investments or emergency responses.

  Economic Growth: High debt levels might dampen economic growth if consumers and businesses reduce spending due to debt servicing needs.

  Credit Rating: Persistent high debt could pressure the U.S. credit rating, affecting borrowing costs.

• Policy Responses:

  Fiscal Policy: There might be calls for fiscal responsibility, possibly through tax reforms, spending cuts, or finding new revenue sources.

  Monetary Policy: The Federal Reserve might need to balance inflation control with economic support, which could influence debt dynamics.

• Long-term Concerns:

  Without significant policy changes or economic growth, the debt situation could lead to a crisis where managing debt becomes a primary economic challenge, potentially at the expense of other priorities like infrastructure, education, or healthcare.

The BNPL sector's growth adds a layer of complexity to this scenario by potentially underestimating consumer leverage, which, in a broader economic context, contributes to an already complex debt environment in the USA.

@TigerStars

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