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The rise and risks of investing in Buy Now Pay Later loans – legal comment

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The BNPL sector has witnessed a meteoric rise in popularity in recent years. BNPL provides consumers with immediate access to short to medium term credit or financing for relatively small consumer purchases, usually repayable over a period of months. The sector capitalised on the pre-eminence of online shopping during the Covid-19 pandemic. According to the FCA’s Woolard Review, since the beginning of the pandemic, 11% of UK consumers (around 5 million individuals) said that they have used a BNPL product, and the value of BNPL transactions (among the BNPL providers that the FCA engaged with) in the UK between January and December 2020 was estimated to total £2.7 billion, a figure which is predicted to rise.

Good for the Money?

As the BNPL market has grown, so too has the opportunity for securitisation of BNPL products. In August 2021, Affirm Holdings, Inc., an American BNPL Fintech, announced the securitisation of $500 million worth of BNPL loans, reflecting a potentially lucrative opportunity for investors as well as the offering banks. It is, however, not an opportunity without risk. The receivables due under the securities are only as viable as the underlying BNPL loans, which are in turn only as viable as the creditworthiness of the consumer borrower.

At present, it appears that, if any credit checks are undertaken at all, most BNPL providers only conduct very basic checks using automated soft credit searches. In addition, the limited checks that are undertaken are generally focussed on previous repayment history as opposed to affordability. In fact, according to the Woolard Review, a UK bank reported that:

of 677,000 of their personal current account (PCA) customers who made a payment to two of the large BNPL providers in November 2020, 10% had exceeded their overdraft allowance in the same month (and therefore exceeded an existing PCA facility in the same period).”

With little to no detailed affordability checks, the potential for consumers to use multiple BNPL providers at any one time, and the fact that there is no requirement for BNPL providers to report repayment history to Credit Reference Agencies, BNPL debt could balloon under the radar. Growing consumer debt appears in fact to be at the heart of the BNPL business model: BNPL credit comes at no upfront cost to the consumer (in that the product costs the same over several months as it does on the date of purchase) but fees are passed on to retailers. In order for these fees to make commercial sense for retailers, they must in turn be banking on selling more consumer goods. Seen from this perspective, the absence of upfront affordability assessments may be a large blind spot.

Contrast this to the hard credit searches routinely undertaken by credit facilities when consumers apply for loans, mortgages and credit cards, and it is understandable why the likelihood for late or missed payments among consumers regularly utilising BNPL products may be considered relatively high. From an investor’s perspective, and compared with mortgage-backed securities, the low value, high volume and unsecured nature of BNPL credit makes the prospects of large scale enforcement and recovery in the context of (hypothetical) growing consumer defaults look far worse.

Buy Now, Repent Later?

Institutions involved in the sale of BNPL receivables should therefore ensure that they are aware of the risks in the event of consumer default and investor loss. From the perspective of the manager or arranger of the securitisation, the most important point will be to be comfortable with the representations and warranties given – particularly regarding the nature and/or quality of the underwriting of BNPL loans. These are an obvious starting point for investors looking to recoup their losses, so banks selling securities to investors should ensure that appropriate due diligence is targeted at the forms of underwriting used by any BNPL provider. In the event of consumer defaults, aggrieved investors might be able to claim damages or recover the purchase price for any breaches of warranty or false representations in the sale documentation. Although regulation is coming and that current FCA rules on creditworthiness will likely apply to the BNPL sector, those rules do not yet apply and the accuracy of warranties and representations will be no less important as and when they do.

As the ramifications for overextended consumer debt can be very serious, institutions should take care to know what it is they are selling.

Sam Roberts is a partner, and Emily Davies an associate, at law firm Cooke, Young & Keidan LLP.

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