Buy now, pay later products such as Afterpay and Zip have become a popular payment method, but the sector is facing a perfect storm of rising interest rates, bad debts, a crowded marketplace and looming regulation.
For businesses such as Daniel McCarthy's butcher shop in regional Victoria, offering customers the option to use a buy now, pay later (BNPL) service has resulted in sales growth.
"It has been pivotal for our online business," Mr McCarthy said.
The payment method is used for about 60 per cent of online sales at his business, and customers are also using it at the shop.
His customers who use it also spend more — an average of $140, compared to $30 using other payment types in store.
"People can buy a bulk pack and not actually shell out their money for it," he said.
"They can put it on a payment plan, and it just works with their budgets."
Buy now, pay later companies effectively buy a customer's debt in exchange for a merchant fee.
The customer makes repayments to the BNPL company in instalments and the service is interest-free.
Fees apply if repayments are missed and some companies also charge other account fees.
However, while BNPL has been great for many retailers, particularly during the COVID-19 pandemic, some say the glory days are over for the sector.
Start-ups — including Afterpay and Zip — once dominated the scene, but traditional banks such as CBA, Suncorp and NAB, along with Apple, are muscling in.
"You've seen a land grab where these businesses are spending a lot of money on sales and marketing to acquire new customers," UBS analyst Tom Beadle said.
"Those customers aren't necessarily good customers.
"In fact, you could almost argue that they self-select poor-quality customers. So what these businesses need to do is sort of focus on keeping those good customers that repay and obviously weeding out those [who] don't."
Zip Co's bad debt and expected losses quadrupled to $148.3 million in the six months to December, 2021, compared to the corresponding period for the previous year, according to the company's latest half-year results.
Afterpay's expected credit loss was up 50 per cent, to $151.112 million, in the six months to December 31, according to the company's latest update to the United States Securities and Exchange Commission.
Mr Beadle said bad debts were rising because of pressure on household budgets.
"And with those bad debts rising, it then creates a circular effect because the buy, now pay later companies then tighten their lending standards," he said.
"So that then slows top-line growth further."
Bad debts as a percentage of Afterpay's outstanding consumer loans sit at 13.9 per cent, according to analysis by payments consultant Grant Halverson covering the 2021 calendar year.
Zip's percentage sits at 9.7 per cent, followed by non-ASX-listed major players Klarna's (8.5 per cent) and Affirm's (6.5 per cent).
In comparison, the Commonwealth Bank's arrears at 90 days for credit cards for the same period were 0.5 per cent and 1 per cent for personal loans, according to the data.
Mr Halverson expects CBA's write-off rate at 180 days to be about half that.
Inflation and rising interest rates are also hitting the sector hard in other ways, prompting mass job lay-offs in the industry.
Market analyst Roger Montgomery has been a long-time critic of the sector and maintains it is a bad investment.
"As interest rates rise, in response to rising inflation, then of course what happens is your costs go up," Mr Montgomery said.
"So, the margin that you make on your book of loans declines and, at the same time, consumers spend less, so your revenue line is actually coming down.
"I call them profitless prosperity stocks."
BNPL shares tank
Buy now, pay later stocks have tumbled in response to the many problems the sector is facing.
On the Australian Stock Exchange, Afterpay is down 50 per cent from $176 to $84.33 since it merged with US pay giant Square at the start of the year.
Latitude and Humm's merger was abandoned as the companies' stocks sunk, down 40 per cent and 45 per cent respectively from a year ago.
Zip Co's stocks plummeted 93 per cent, down from $8.21 to 53 cents in a year. It is planning to buy Sezzle, which has tumbled 96 per cent, from $8.24 to 30 cents.
Despite Zip Co's share price falling off a cliff, Zip Co's chief operating officer, Peter Gray, is optimistic.
"In March, we did take proactive steps to reduce our global-cost footprint. And we'll see the benefits of those in the [2023 financial year] as we accelerate our path to profitability."
Mr Montgomery said the end of cheap money meant some BNPL players would not survive.
"Some of these businesses will disappear and we'll never see them again," he said.
"That's a fact in this environment. There'll be no more funding for them."
Regulation looming
The BNPL sector has so far managed to avoid regulation because its providers do not technically charge interest and there is a loophole in the National Credit Code.
Some BNPL companies have signed up to a voluntary code of practice, which consumer advocates argue does not contain enough protections.
Financial Services Minister Stephen Jones said that was about to change.
"[I'm] not interested in having an argument about whether or not this is credit. It clearly is," he said.
"Irrespective of how it's structured, it's credit."
Details of how BNPL products would be regulated would be worked out after consulting with the industry and consumer advocates, he said.
Mr Jones said it could start with legislating the industry's code of practice and a strategic review to find out what the gaps were.
"That doesn't mean that every single term of the national consumer credit legislation applies in exactly the same way. It won't. But it will be brought within the rubric of the National Consumer Credit Act."
He has pledged to get the legislation before parliament within 12 months.
"I don't want us having this conversation next year," Mr Jones said.
The looming regulation of BNPL globally is another knock to the sector.
Mr Gray said Zip remained supportive of fit-for-purpose regulation.
"The minister has suggested that the first steps would be legislation of the industry code, and it would sit as a component of the national credit act, rather than be subject to all the components of the act," Mr Gray said.
"We do believe that our services are credit [but] they don't need the same sort of regulation as might govern a mortgage.
"And, of course, we've seen that regulation of the banking sector does not necessarily deliver better outcomes. It's more about the product construct and the intent of the providers."
Consumer advocates — such as chief executive of the Financial Rights Legal Centre Karen Cox — said there was no reason for BNPL products not to be subject to the same rules as other forms of credit.
"The proof is in the pudding," Ms Cox said.
"So, whatever checks they are doing, it is not the same as doing proper, responsible lending checks as required under the credit law."
Michael Fredericks is the managing director and founder of FuPay, which offers a budgeting service along with BNPL and cash-advance products.
He said the voluntary code did not provide enough consumer protections and he supported BNPL being regulated under the National Credit Code as it stands.
Mr Fredericks said regulation would also allow BNPL players to extend repayment time frames that were shorter and, therefore, exempt them from credit laws.
"Some people struggle to make repayments within that time frame," he said.
"It's only really appropriate for a small amount of money, that [is] under the $200 mark.
"We think the balance is to have greater flexibility beyond that, which means you've got to be regulated but not to have open-ended credit … staying away from that debt trap or, we think, the bad credit model of credit cards."
Mr Fredericks said FuPay does not publish the percentage of bad debt from its sales because it was not a listed company.
"It's in the single digits, and it is declining," he said.
