Last week we learned that Square, best known for their small business credit card processing service, is getting into the consumer loan business. Lending is not new to Square, they launched Square Capital in 2014 to help their small business customers get access to capital. But they have never offered a financing option direct to the consumer until now.
While the typical transaction on Square is small they had more than 36 million transactions larger than $250 in the past year. And these are the transactions they are going after with their new Square Installments product.
Loans will range from $250 to $10,000 and will have terms of three, six or twelve months. Interest rates will range from 0% – 24% APR. The application process is fairly simple with applications able to be completed in store on the customer’s own phone and most applications will be approved or rejected instantly. Square takes on the credit risk as the customer pays the loan back to Square directly and the merchant receives the full amount of the sale.
The way it works is that the customer, once approved, is given a virtual credit card number to provide to the merchant to process the transaction and trigger the loan. It is interesting that they quote APRs starting at 0%. Given that Square will be making significant income on the merchant processing fee I could see how offering a super prime customer a 0% loan could make sense for them in certain situations.
In this CNBC article they provide the example of a small business owner who participated in the pilot program and was able to increase sales by 20% to 30% by offering installment loans. The average loan size for this merchant was around $4,000.
Square is entering into an increasingly crowded market for point of sale financing. Affirm has done well over $1 billion in installment loans at the point of sale with over 1,000 merchants on board now. PayPal has their PayPal Credit product offering financing on amounts of $99 or more. Then there is fintech startup LendingUSA, CareCredit in the healthcare space, GreenSky in the home improvement space and AfterPay, the successful Australian company that is looking to expand to the US. Not to mention incumbent banks with their legacy point of sale business.
Having said that, Square does have a big advantage with their huge customer base. It is supposedly simple for a merchant to sign up for this program, they say it takes just 10 minutes. Having signed up the merchant is really in a no lose situation in offering credit because it is Square that is taking on the risk.
Square Capital has been growing their small business lending operation over the past few years. In the second quarter they facilitated $390 million worth of business loans, or cash advances, a 22% increase from the year prior. That makes them one of the largest small business lenders in the country. Their new installment loan business will also fall under the Square Capital umbrella.
What will be interesting to see is whether Square goes out to the capital markets to fund Square Installments. With their small business financing operation most of the capital comes from external investors with only $85 million in loans on Square’s balance sheet as of the end of Q2.
My Take
Success for Square Installments, given that they have customer acquisition nailed, is all going to come down to underwriting. They are new to consumer lending and so they are unproven in this area. While they have had success in small business financing, providing an unsecured loan to consumers is a very different operation.
The good news for Square is that there is a large pool of people with experience in this process and we have come a long way in the last few years in our ability to underwrite loans instantly. I read that they will be using machine learning to determine the creditworthiness of the borrowers which is a no brainer.
I have no doubt that Square will be able to attract a large number of customers for their service. And given the short term nature of these loans they will be able to see the results of their underwriting quickly and adjust as necessary. Funding off their own balance sheet they can afford to take their time to learn.
I will be very surprised if Square does not become a major player in point of sale financing in the near future.
