PayPal’s Lending Business Grows

Still image from a recent video promoting PayPal’s consumer credit product. Source: PayPal.com.

PayPal Generates A Lot of Cash

Getting the most out of an assetIt’s advantageous for PayPal to utilize the enormous cash it generates to further increase revenue. The company does this by lending to consumers via “PayPal Credit,” and to merchants via “PayPal Working Capital.”

$1.9 billion of free cash flow in 2015, from $9.2

billion in sales.

PayPal Itself Is Not A BankPayPal is primarily a transaction processor. It isn’t a licensed lender in the United States.

The company’s chartered financial institution partners, like Synchrony Bank (formerly GE Capital Retail) actually own the credit accounts its customers open. The banking partners lend money when customers use PayPal Credit to make a purchase.

PayPal Working Capital (PWC) works similarly, only the borrowers are merchants who use credit to grow their businesses.

But PayPal Does Own the Loans Made to Customers and MerchantsAfter a customer or merchant borrows from one of PayPal’s banking partners, PayPal buys the loan receivable from the bank. The bank still owns the account, but PayPal owns the loan. The total amount of loans receivable on PayPal’s books grew 17% last year.

Net loans and interest receivable on PayPal’s balance sheet:

December 31st, 2014: $3.6 billion

December 31st, 2015: $4.2 billion

Fees and Interest from Built-In CustomersSelling new services to existing customers is an extremely cost-efficient way to open up new revenue streams. PayPal Credit is an option that can be marketed to the company’s customers at the point of sale. Similarly, PWC can be marketed when merchants log in to their PayPal payment processing accounts.

The loans in many cases are lucrative for PayPal. The company charges an interest rate of 19.99% on consumer credit, which customers can avoid completely by paying within agreed upon terms of 6, 12, or 18 months.

A missed payment in a PayPal Credit account can result in a fee of up to $35.

Mosaic at Mobile World Congress, Barcelona 2016. Image: PayPal.com

The PWC program doesn’t charge interest, rather, a borrowing fee is assessed on the loan amount. Merchants choose a percentage of future sales that will be sent to PayPal for repayment at each completed transaction. There is no time limit for repayment, but selecting a higher repayment percentage results in a lower borrowing fee for the merchant. Image: PayPal.com

A Profitable and Growing Side Business

Interest and fee income from PayPal Credit and PWC are the main drivers of the company’s “Other Value Added Services” revenue line item.

• Other value added services equaled $1.1 billion in 2015.

• This amount was approximately 12% of total company income.

• It also represented 22% growth over 2014.

• PWC in particular is scaling up almost exponentially: Total PWC receivables held by PayPal grew 309% last year, to $421 million.

Risks: Loan losses & fast expansionEach quarter, PayPal writes off loans which are considered unrecoverable against its loan income. Last year, PayPal recorded $298 million in loan losses, equal to roughly 7% of its total ending loan receivables balance of $4.2 billion. PayPal provisions against expected loan losses by periodically adjusting an allowance against loans receivable.

Another risk involves the company’s liquidity. As these credit products expand, they may outpace PayPal’s ability to fund them. To help prevent this, PayPall now sells portions of its loans receivable portfolio to private investors at a small premium.

This isn’t quite as lucrative as holding and collecting the receivables, but it allows PayPal to keep building its lending business, while actually decreasing risk. In 2015, the company sold receivables with a gross value of $708 million to third parties.

““We are [also] seeing strong growth in our PayPal credit products. PayPal Credit is available at millions of online stores as a funding option through the PayPal wallet, giving consumers enhanced flexibility for how they pay, while often boosting basket sizes for merchants. In addition we have tripled the originations of our PayPal Working Capital product...”

--PayPal CEO Dan Schulman, PayPal Earnings Conference Call, 1/27/2016. Source: Thomson Reuters Edited Transcript

Observations

● As PayPal expands its customer and merchant bases, its loan activities will likely swell beyond the current level of 12% of total revenue.

● The $4.2 billion of total loans receivable is a fraction of what the company could loan. It’s actually made $24.8 billion in credit available to its customers through current approvals!

● Loan activity is one of several examples (cross country remittances and foreign currency exchange are two others) of PayPal’s determination to move beyond legacy transaction revenue. It’s a competitive advantage that lessens some of the investment risk in PayPal as competitors try to wrest away its payments processing market share.

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