On Wall Street, there is a phrase that gets bandied about a fair amount. Depending on who is mouthing the phrase, one might hear it as “appetite for risk” or “risk appetite.” Most often, those sentiments apply to investors and their portfolios, stretched across stocks, bonds or other assets. Risk is what someone takes on, ostensibly for some measure of gain, perhaps outsized gains at that.
However, an appetite for risk also extends to other corners of finance, and risk is what lenders take on when they part ways with capital or credit. There is always the risk that these lenders will not get paid back.
By now one might know that Square shares, or earnings, fell by more than 8 percent on Monday (Oct. 8), opening a week that saw the company receive scrutiny about risks that may be lurking in its business model as that model evolves. The risks, though, said sell-side Wall Street Analyst Mark Palmer of BTIG, are being overlooked.
Palmer has a “sell” rating on the stock. The stock is up 148 percent year to date. It may be easy to dismiss the analyst as a “permabear” on the name, even as it has enriched many a holder.
However, to get down to his concerns, the analyst said — per news reports such as CNBC — that the recently debuted “Square Installments” (which, as the name implies, offers payment plans) may expose the company in a way that makes it vulnerable to credit markets. Palmer cited risks to the company’s business model, and “credit risk in particular,” noting that extending credit to grow is a risky proposition.
The mechanics of the installment financing are such that the loans to Square merchants’ customers — which can range from $250 to as much as $10,000 — are broken up into three-, six- or 12-month spans, with the payments separated into fixed monthly amounts. Those who apply for those loans must be pre-approved and merchants receive the payments upfront. Square will hold loans on its balance sheet and, eventually, might sell those loans to outside parties, a practice it employs already with its loans extended to merchants.
Thus, Square has an appetite for risk, inherent in bringing loans to a new audience. The shoppers opening their wallets to Square merchants, especially for big-ticket items, are individuals, likely leveraged already. The risk here, then, is twofold — dependent upon the end consumer, then again on the model that keeps some loans on the balance sheet, which also includes selling loans to investors. In the case of the latter, Palmer noted, selling loans after origination can still be a volatile proposition. Just look at LendingClub.
The move has been telegraphed and has a rollout, with a debut in 22 states. Square is eyeing a nationwide presence, and is coming into a space that already has some flags planted in the ground — notably, players like Affirm and PayPal. Installment loans are nothing new, but the rise of FinTech brings with it data, risk scoring and machine learning to bear on underwriting decisions.
Interestingly, Affirm charges a range of 10 percent to 30 percent for annual percentage rates on its installment loans, while the range for Square will be from 0 percent to as high as 24 percent. Palmer noted that the ranges raise questions of getting paid for the risk that is being taken on.
Risk Gets Riskier
The question seems a legitimate one in an age where risk may be getting riskier. This is reflected in the broad brush that painted stock market activity on Monday — and across names that extend credit to individuals and/or merchants. Consider the fact that shares of PayPal were down 3 percent, and consider Amazon (which extends credit to smaller enterprises). Even credit card companies were down about 2 percent (and a bit more) on the day.
Of course, the drop happened on a day when thoughts of lending, liquidity and interest rates were fresh on investors’ minds. Chinese stocks were off mid-single digits. Trade wars loom, and the consumer seems to be caught in the middle. Incidentally, the International Monetary Fund (IMF) in the after hours cut its growth forecast for the global economy on those same concerns, amid those same trade disputes. The forecast now, said the IMF in its World Economic Outlook, has been trimmed by 20 basis points to a new estimate of 3.7 percent.
Those are headline numbers.
A bit more below the surface, and in the U.S. economy in particular, some other numbers show the risks of, well, risk. The sheer number of accounts that are credit accounts, as reported by TransUnion, have grown at a healthy clip. From the start of 2017 to the beginning of 2018, the number of auto loans grew by more than 4 percent, credit cards grew by about 2.6 percent and personal loans by 13.2 percent. Clearly, consumers are comfortable with taking on new credit-related accounts.
That comfort level comes amid multi-decade lows in unemployment, and where wage growth exists. Then again, rates are on the rise, too — which makes holding the aforementioned debt more expensive at a time when, for example, credit card debt out in the field, so to speak, stands at about $1 trillion, a level not seen since the Great Recession.
Amid the great embrace of credit, the Bank for International Settlements (BIS) said the FinTech model of lending is still a bit untested. They have yet to go through a period when conditions worsen — a when, not an if. Economies, after all, are cyclical, and so is lending. The Square stock drop, be it a blip or trend, may focus some attention on what the real cost of credit may be for consumers, investors and, of course, the FinTech firms themselves.