As mentioned upboard, Square applied for a commercial loan license in Utah a couple of weeks ago and I think its another great move. It will basically be an extension of Square Capital, but now SQ will not be dependent on third parties actually making the loans:
Since the financial crisis, the market has not acted kindly toward companies that have taken on credit risks. Normally, I would not want a high-flying financial technology company that I had an investment in, with heady growth numbers and a nosebleed valuation, to take on this type of risk. Even if the loan default risks never materialize, the move runs the very real risk of the market assigning the company a much-lower valuation multiple. Yet, in this particular case, I find the action to be the next logical step in Square’s progression from a payment-processing company to a unique one-stop shop for meeting nearly all of a small business’s needs.
Here are three reasons, in particular, why I believe Square is not taking on excessive credit risk and that its expansions into business banking if approved, will be another wildly successful move for the company and its investors.
1. The past success of Square Capital
Square Capital has seen a huge amount of success since being introduced, proving it is fulfilling an unmet need in today’s marketplace. In its most recently reported quarter, Square loaned $318 million through Square Capital, a 68% increase year over year. That money was spread out over more than 49,000 business loans for an average loan size of about $6,500.
Read more at https://www.fool.com/investing/2017/10/10/3-reasons-opening-…
Matt
Long SQ
MasterCard (MA), PayPal (PYPL), Skechers (SKX) and Square (SQ) Ticker Guide
See all my holdings at http://my.fool.com/profile/CMFCochrane/info.aspx
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Thanks Matt. I’ve been confused by this, and I’m still a little bit so even after reading your article. What is the big difference from what Square Capital has always done? Bigger loans?
At first I thought they might be lending to business that are not Square customers, but based on your article that doesn’t seem to be the case.
Thanks,
Bear
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What is the big difference from what Square Capital has always done? Bigger loans?
That’s a good question, Bear. So, with Square Capital, Square wasn’t actually lending out the money. They would use third party lenders that would actually handle that part (or for the vast majority of the loans anyway) and Square basically facilitated the loan. I didn’t even catch this until Square’s second quarter shareholder letter, when the company announced the Canada Pension Plan Investment Board, an investment manager with over $300 billion in assets under management, was a new loan purchaser for the quarter. If the banking application is approved, Square will actually be allowed to loan the money to its sellers too, not just facilitate the process.
It might help to think of it as if you open up a credit card account with a retailer, like Home Depot or Amazon, and purchase $1000 of merchandise using the cards. In both those cases, it’s not actually Home Depot or Amazon that extended that credit to you, it was a third party (e.g. Synchrony Financial). That was basically Square Capital’s model, except in Square’s case it would use its own data to find suitable borrowers.
I hope that helps.
Matt
Long AMZN, HD, SQ
MasterCard (MA), PayPal (PYPL), Skechers (SKX) and Square (SQ) Ticker Guide
See all my holdings at http://my.fool.com/profile/CMFCochrane/info.aspx
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So, with Square Capital, Square wasn’t actually lending out the money. They would use third party lenders that would actually handle that part (or for the vast majority of the loans anyway) and Square basically facilitated the loan.
Fascinating, Matt! I can see why they would want to do it themselves! Square came up with this amazing way to figure out who to lend to and how to get paid back, and their loans therefore have this amazing loss rate of only about 4%. The banks, who were used to 8% loss rates, were probably loving this (even if Square’s fee came out of their end…which I don’t know). But then Square must have thought…wait a minute, why are we letting the banks profit from our innovation?
If approved, I bet this will be a windfall for Square. Instead of just the fee they get on Square Capital loans, which has already been huge for them, they’ll be able to capture the interest as well!
Thanks again,
Bear
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The downside to being a bank:
new regulations?
reduced margins?
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