Late last month, LendUp, an online lender that aims to provide quality credit to the financially underprivileged, announced it had secured a strategic investment from PayPal (NASDAQ:PYPL). The press release did not disclose the amount of the investment or the terms of the deal, but the partnership appears to be even deeper than the invested funds.
The investment appears to simultaneously scratch two itches for PayPal. First, PayPal’s management has been very open with its belief that the company is well-positioned to assist the world’s underbanked population. Second, PayPal has long insisted it needs to offer a full suite of payment options to customers if it is going to be a leader in the payments industry. In order to do so, the company has maintained it needs to offer credit to customers and has tirelessly defended PayPal Credit to analysts who don’t like that the platform exposes the company to some amount of credit default risks.
In one fell swoop, PayPal’s investment in LendUp might help the company accomplish both objectives.
Serving the world’s underbanked
On LendUp’s website, the company states that more than half of the U.S. population has a credit score under 680, meaning they cannot be approved for credit at most financial institutions. The site explains that consumers in this segment will pay more than $250,000 over the course of their lifetimes for basic financial services. LendUp believes it can make a profit by offering affordable financial products to these consumers, which will simultaneously help them build their credit.
This meshes incredibly well with PayPal CEO Dan Schulman’s belief that his company is uniquely situated to help those who don’t have access to even the most basic banking capabilities. At the recent Bernstein Annual Strategic Decisions Conference, Schulman stated:
… There are 2 billion people throughout … the world that are not well-served. There’s 70 million or so here in the United States. And I think that our platform, because it’s all software, you’ve got all the power of a bank branch for these underserved customers in the palm of their hands right now, you can do things electronically that make it faster and simpler and more secure and less expensive to do everyday transactions like cash and check deposit, pay a bill, and there’s no reason why that shouldn’t be done over an electronic platform, and start to bring in those underserved markets into the electronic and digital world. I think that will be incredibly beneficial for society.
Giving credit where credit is due
Regular users of PayPal probably know that PayPal offers credit to its customers through its PayPal Credit platform. PayPal normally offers credit to customers at checkout, offering account holders no-interest payments on purchases greater than $99 if the loan is paid off within six months. PayPal also offers credit to small- and medium-sized businesses through its PayPal Working Capital program, which is then paid back through small amounts from each transaction going back to PayPal. Schulman believes both services are important to PayPal’s future. In the company’s 2016 fourth quarter conference call, he explained:
… Credit is and will continue to be an important flywheel for us. Credit gives flexible payment option to both our merchants and our consumers. It reduces [cart] abandonment, it increases basket size for our merchants and our consumers. When somebody uses credit, they do two times the spend on our PayPal network than somebody who doesn’t. When we do PayPal working capital on average, those that we lend to, they see their sales go up 20%-plus. And so it’s a tremendous flywheel for us … We can be very responsible in who we lend to and how much we lend to them. And we have great amounts of data, and really, I think world-class modeling around this.
In its most recently reported quarter, PayPal CFO John Rainey stated that loan losses for its consumer and retailer credit programs totaled $129 million, or approximately 4.3% of revenue. The net charge-off rate was 6.9%. The numbers were similar to PayPal’s 2016 fourth quarter when loan losses equaled $123 million and the net charge-off rate was 7%. In both quarters, revenue from value-added services grew greater than 20%, which Rainey said was “predominantly” driven by credit.
Killing two birds with one stone
For most of the past year, PayPal’s executive management has hinted at a desire to consider a more “asset-light” credit strategy, whereby the company could outsource different aspects of the loan process. For instance, in 2016’s fourth quarter conference call, Schulman talked about “further partnering on the origination side” to free up cash and give PayPal additional flexibility. In March, at the Morgan Stanley 2017 Technology, Media, and Telecom Conference, COO Bill Ready talked about increasing partnerships with banks so PayPal does not have as much credit risk on its balance sheets.
This investment with LendUp might very well be the first step in that direction. It also is another way PayPal can serve the world’s underbanked population, something that its earlier acquisition of TIO Networks also accomplished. For investors, it’s important to note this means the partnership could lead to more customers and less credit risk on the company’s balance sheet, something that could very well lead to a higher valuation for the stock.
Of course, dealing more with customers with lower credit scores also brings along its share of risks, which is why Schulman better be right about the “world-class modeling” Paypal uses to find potential customers to offer credit. Still, offloading the credit risks from its balance sheet and finding more account holders are two goals that investors should continue to cheer.
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