Square’s equity decline focuses on credit risk
On Wall Street, there is a phrase that is talked about a lot. Depending on who is saying the phrase, it can be understood as “risk appetite” or “risk appetite”. Most often, these sentiments apply to investors and their portfolios, spanning stocks, bonds or other assets. Risk is what someone assumes, apparently for some gain, perhaps disproportionate gains.
However, the risk appetite extends to other areas of finance as well, and risk is what lenders assume when they part with equity or credit. There is always a risk that these lenders will not be reimbursed.
Now we could know that Square stocks, or earnings, fell more than 8% on Monday (October 8), opening a week in which the company was scrutinized over the risks that might lurk in its business model as that model evolved . The risks, however, said Wall Street analyst Mark Palmer BTIG, are neglected.
Palmer has a “sell” rating on the title. The stock is up 148% year-to-date. It can be easy to dismiss the analyst as a “permanent” on the name, even if it has enriched many holders.
However, returning to his concerns, the analyst said – through reports such as CNBC – that the recently launched “Square Payments” (which, as the name suggests, offer payment plans) can expose the business in a way that makes it vulnerable to credit markets. Palmer cited the risks to the company’s business model, and “credit risk in particular,” stressing that extending credit to growth is a risky proposition.
The mechanisms of structured financing are such as loans to Square merchant customers – which can range from $ 250 to up to $ 10,000 – are divided into periods of three, six, or 12 months, with payments separated into fixed monthly amounts. Those applying for these loans must be pre-approved and the merchants receive the payments in advance. Square will hold loans on its balance sheet and eventually sell those loans to third parties, a practice it already employs with its loans to merchants.
Thus, Square has an appetite for risk inherent in granting loans to new audiences. Buyers who open their wallets to Square merchants, especially for big ticket items, are private individuals, likely already being exploited. The risk here is therefore double – dependent on the end consumer and then again on the model that keeps some loans on the balance sheet, which also includes the sale of loans to investors. In the latter’s case, Palmer noted, selling loans after origination can still be a volatile proposition. Just watch Loan Club.
The movement has been telegraphed and has a deployment, with a start in 22 states. Square envisions a national presence and enters a space where flags are already planted in the ground – nototably, players like To affirm and Pay Pal. Installment loans are nothing new, but the rise of FinTech is driving data, risk assessment and machine learning that influence underwriting decisions.
Interestingly, Affirm charges a range of 10% to 30% for annual percentage rates on its installment loans, while the range for Square will be 0% to 24%. Palmer noted that the forks raise questions about being paid for the risk taken.
The risk becomes riskier
The question seems legitimate at a time when risk can become riskier. This is reflected in the general brush that painted stock market activity on Monday – and in the names that give credit to individuals and / or traders. Consider the fact that PayPal shares fell 3% and consider Amazon (which extends credit to small businesses). Even the credit card companies were down about 2% (and a little more) that day.
Of course, the drop came on a day when the ideas of lending, liquidity, and interest rates were fresh on the minds of investors. Chinese stocks were single digits in the middle. Trade wars are looming and the consumer seems to be caught in the middle. Incidentally, the International Monetary Fund (IMF) in the afternoon cut its growth forecast for the global economy on those same concerns, amid those same trade disputes. The forecast now, the IMF said in its World Economic Outlook, has been reduced by 20 basis points to a new estimate of 3.7 percent.
These are key figures.
A little deeper below the surface, and in the US economy in particular, other numbers show the risk, well, the risk. The number of accounts that are credit accounts, as reported by TransUnion, grew up at a healthy pace. Between the start of 2017 and the beginning of 2018, the number of auto loans increased by more than 4%, credit cards increased by about 2.6% and personal loans by 13.2%. Obviously, consumers are comfortable opening new credit-related accounts.
This level of comfort comes amid decades-long lows in unemployment and where wage growth exists. Again, rates are on the rise too – making it more expensive to hold the aforementioned debt at a time when, say, credit card debt on the ground, so to speak, stands at around $ 1 trillion, a level not seen since the Great Recession.
In the midst of the great credit embrace, the Bank for International Settlements (BRI) said the FinTech lending model has yet to be tested. They haven’t gone through a period of worsening yet – a when, not a if. Savings, after all, are cyclical, just like loans. The decline in Square shares, whether it is a failure or a trend, can draw attention to the true cost of credit for consumers, investors and, of course, FinTech companies themselves. .