Affirm Holdings, Inc. (AFRM) Earnings Call Transcript & Summary

Okay. last but certainly not least. We have Affirm joining us today. Brooke Major-Reid, Chief Capital Officer; Rob O'Hare, SVP of Finance. Thank you so much for joining us. Before we start, I was reprehended for not mentioning it. There is a cocktail setup that will magically appear outside after the panel. So for anybody who wants to stick around and chitchat or drink away your troubles, whatever it is, there's -- there will be a bar out front. So thank you so much again for joining us. Appreciate it.

So it's great to have you here, Brooke, because there's a lot of, I think, infrequent questions at you or you're obviously perfectly qualified to answer. One thing that I wanted to ask was sort of like how nimble Affirm can be with the funding mix when you see GMV kind of going up in the quarter, maybe unexpectedly, how quickly can you kind of rotate around it and the funding mix? Or is it sort of like you got to lean into maybe warehouse or something like that to get there?

Really good question. So I operate in 2 minds. One is, regardless of what the business is doing, I need to be adding capital constructively at all times. And so the ability for us to grow should never be contingent upon my ability to find capital at the moment. The capital that we have, however, we fund the business across warehouse lines, for flow agreements that are bilateral and ABS. And we have static deals that are off balance sheet and revolving deals. So when you think about the mix, there should never be a point in time where a particular channel cannot eat our cooking. So we have loans that are 6 weeks and we originate loans debt to 60 months. I've structured and we have structured the ecosystem in funding so that most, if not all, our facilities can accept whatever flavor of loans that we originate at the time. So that's not a constraint. So we can be very flexible. Our warehouses tend to take vertical slices of our collateral forward flow similarly, although they skew longer. Our revolving ABS shelf takes a shorter duration, kind of less than 12, 24-month collateral, very short. It also has a pocket that we could fund and pay in for, but we tend to fund that in a particular warehouse specifically for paying for and then our static deals, we stood up largely to fund 0% Peloton loan. So that was a lot more -- we had a lot more volume there and we stood up an [indiscernible] for interest-bearing. So we can be very flexible around the ecosystem, and we're very grateful that all of the capital outside of the ABS capital that if we go to market, it's committed, committed capital and multiyear capital so we can be very, very flexible.

And how should we think about the relative weighting of those funding sources changing over time? Does the mix shift significantly and you report some of this out, but the mix shifted significantly period-over-period. And I guess what is the -- what is the driver -- the underlying drivers of why you'd see that mix shift? Is it demand for the paper? Is it pricing you're going to accept? Or what are the drivers of why that mix shifts around?

Yes. No, again, a really, really important point in terms of the mix. So Santa is out there, like I like to be able to kind of give my wish list around kind of structurally managing our equity in loans relative to kind of what's going on in a particular channel. A part of my job is to make sure that we can contribute in a positive way to unit economics. So in terms of the broader perspective on the mix, it's really about -- outside of credit and making sure we have access and risk managing the facilities -- it's really optimizing unit economics and our cash drag. So the warehouse lines, they're very attractively priced, but they're capital-intensive. Forward flow shows up differently in terms of cost of funds, that show up in gain on sale when we sell the loans and we get the value of that early upfront when we sell it versus when we keep loans on sheet. So the mix really comes from the flexibility that we want to have to maintain discipline around those 2 things. So there are times when like in Q2 you saw the warehouse has run a little bit hot because we entered a pocket where the ABS market wasn't quite as open and constructive. And you saw that in Q3 that utilization went down. So we anticipate that we'll continue to add capital constructively to manage the economics of the business but we also love the fact that the model, given the diversity of partners, the diversity of the channels will complement each other so that we have the flexibility going back to your original question, to really lean into others when it allows because we're when the market isn't quite as robust or fluid in different areas like we've seen in the ABS market. So it's not necessarily a demand thing per se. It's really around how do we optimize to manage the economics of our units and the cash on the balance sheet, cash usage.

That's super helpful and also speaks to the degree to which when you guys were years ago, sitting down and designing their firm model, that flexible funding mix, it certainly has turned out to be an important component of the story. What -- how do you decide whether you want to keep something on balance sheet or move it off the balance sheet? What are the advantages or disadvantages of the on balance sheet off balance sheet?

The primary advantage of on balance sheet is that we get the benefit of the economics over time. And because we are comfortable with our ability to underwrite and risk manage and comfortable with the credit outcomes we generate, we really objectively don't have a problem keeping loans on sheet. But going back to the point about just kind of attenuating and managing the equity and loans when we're growing a portfolio and growing the business, if we have warehouse advance rates in the mid-high 80s and probably close to mid-80s now, you have ABS advance rate in terms of revolver in the 90s, that even though it's higher leverage execution, it creates a cash drag, particularly as you're growing. So you really -- what we try to do is manage it such that -- we don't -- we're not creating a huge cash drag as we grow, but we're also saying, where is the most constructive part of the market with respect to pricing. Because right now, on the bilateral side, there's kind of a divergence of views in terms of what the consumer what credit -- people may be saying, okay, the -- what potentially at the top of the rate side or it's actually a little more clear now than it was maybe 6 or 12 months ago, but credit is the piece where people are debating with the severity of the deterioration that we would anticipate. So pricing does actually still matter, but the point about making sure that we are managing that cash, the capital efficiency and unit economics. That's how we think about whether we keep loans on or off sheet. And the short originations are typically on sheet because they're not really -- they turn over too quickly for forward flow buyers.

Does the funding source change at all based on the for example, where the loans are being rigid is international versus a U.S. loan or whatever particular product is a rate -- interest rate loan or buy that. But does it -- do you tumor that front end to the funding source? Or not as all just get pulled up in packaged up?

So in terms of the geography and the kind of how we manage it, it's a very similar model. So we have our Canadian business, and we use the same -- a similar construct, a similar model. So we have warehouse and loan purchase agreements in Canada. We don't have -- we have not tapped or issued ABS to the market just isn't as deep as it is in the U.S. So we've always been -- we've had conversations and are always looking to see if that becomes a channel for us. But right now, we fund the business really well across the 2 channels in Canada. Any jurisdiction that we go into, our typical model is we equity fund for a while, and then we aggregate and then we stand up these facilities that are very diverse and offer us flexibility to fund the business at scale.

So call it just kind of like a tipping point where it makes sense to do that.

Yes. Absolutely.

And -- what about the -- if you could comment on sort of the duration and/or commitment of terms with the forward flow and where house line partners. How often do those -- I guess, I guess the only question is when it comes to the pricing of the vehicles, how long is that commitment? Do those commitments come back and renegotiate pricing? How much visibility do you have to the terms that you have access to with those 2 vehicles?

Right. So with respect to warehouse lines across the board, they're typically multiyear -- so on average, 2 years. We have maybe one or so on the flow side, that's a slightly longer but generically speaking, 24 months. And revolving period, we've moved from 18-month revolving period to 24 months. So we like to have that multiyear commitment. With respect to kind of refinancing the warehouse lines, floating rate with the spread utilized -- unutilized fees, et cetera. So that's pretty standard. You have visibility there reflected in the curve at any point in time. Forward flow very bespoke. So you -- we have insurance companies, pension funds, head funds, got our partners, large banks, and they have different needs. So when we originally set up the agreement, those can either be structured such that there are 6 months repricing, some annual repricing based on credit. Some are structured such that there's an adjustment for rates, not credit. So the -- on the forward flow side, you find there's a variation in terms of the structures and how we manage those. But generally speaking, the intention of that book is to remain largely fixed in terms of the yield. And there are times like in pockets of volatility where there's a conversation maybe around how do we protect the yield of our partners. And that's the levers that we pulled through increasing to 36 or having some sort of construct that minimizes downside. So there are different things for different partners that we do. But the objective really is to have a lot more visibility into where that -- where those changes may occur and the forward flow book, and it's just been a little less consistent in the last kind of 12 months or so given the rate environment.

This might be a question for either of you, but you decide who is the best when they started off. What about funding sources. What about the evolution of that part of your business? Should we just think of the same 4 categories that you're going to lean to for the long haul? Or how should we think about new findings versus maybe coming online. There is a process something that might generate some I know you have a savings product. How do you -- how should we think about other sources of capital that you might have access to over time? And whether that's a priority or whether you're pretty happy with the 4 chess pieces that you're moving around the board today?

I'm never happy with the four sets. So the strategy at the moment, and I think I can say that we won't become a depository institution anytime soon. Where we are from a GMV and growth perspective, we are ways away from needing to have a bank charter or access other types of depository capital in different ways. What I will say is that the scaling of the ecosystem is what's going to be very important. So ABS. We are kind of a nascent small issuer. We've issued just under $5 billion total since we stood up the program in 2020. We are very grateful for the reception and the access that we've received even with just the DBRS rating, the different shelves. So we feel like given that -- despite the fact that the ABS market can be challenging at times and windows open and close, the fact that we aren't overly reliant on that creates opportunities for us to be thoughtful about being programmatic. So I would say we have a lot of room to run in terms of continuing to refine the program and access ABS thoughtfully. The last 12 months has taught us that we have to be very disciplined about issuing. When you're in the market, you time it according to your risk parameters, but you have to execute at the market, and that's something we're committed to doing. On the forward flow side, we believe that there are other opportunities to scale how those deals are structured. So at the level we are now, we think there's still a lot of opportunity if we're structured the right way to scale that. And on the warehouse side, we continue to find it to be very constructive. And the warehouse part of our ecosystem is really for -- it's kind of a release valve. It helps us to aggregate for deals. The intention is never to have that channel fully utilized. You saw it run a little bit hot in Q2 because, again, we wanted to bring a deal that wasn't possible. And so it ran a little higher than we normally do. And the idea is that when the window was a little bit more constructive and open for us, we ended up having the collateral release from those. So there's a lot of opportunity, I think, for us to scale what we have today.

One thing that you guys have executed very well on is just managing delinquency rates and underwriting, et cetera. Talk about the advantages intrinsic to the model. I first look at this model a ways back, I felt like things like short duration, shortest duration or not like an auto loan or something like that. And just also kind of the idea that you're underwriting every transaction is -- would bring you sort of a better model independent of AI and your own skills in data science and whatever. How is that playing out in terms of the cycle, I guess, just what is the -- what are you doing right that comes to managing delinquency?

Yes. I mean I think it's definitely top of mind for everyone on the executive team is sort of getting credit right, and that means getting delinquency outcomes right for the loans that we own and for the loans that we sell to our partners, we don't ever differentiate between the two and we're looking at data sets, right? We only think about sort of credit decisions in a singular way and I think the structural advantages that you touched on are two of the most important ones, for sure, the fact that we are able to work with consumers. We already know we have a really high repeat rate, and we get to reunderwrite a transaction that, on average, is about $300 every time. So we're not extending even though we may extend $1,200 of credit to a consumer in a given year, we're able to get 3 or 4 bites at the apple with that, and we're able to sort of course correct if we see something change in the consumers file. If we see something change with repayments, we can react really, really quickly. And I think we also have -- we felt a big enough and diversified enough business that we've got a really awesome data set to look at. And we have teams of people that are staring at this every single day, looking for small deviations in the expected repayment outcomes versus what we had modeled, right? And so when we do see signs of stress or pockets of stress, we're able to change the underwriting in a pretty dynamic way and also a pretty localized way such that we're not -- we're doing everything we can to maintain volume and incrementality for our merchants too. We're not just lopping off big chunks of the business with underwriting changes. We're able to do it pretty tactically.