As payments start-up Square starts to act more like a traditional bank, one analyst is worried about its ability to handle the same credit risks.
Shares of the San Francisco-based company closed 8.5 percent lower Monday after BTIG analyst Mark Palmer raised concerns about its exposure to credit markets, which he says could be accelerated by its most recent small business lending product.
"The market appears to be overlooking any risks to the company's business model, and credit risk in particular," Palmer said in a note to clients Monday. "Our bearish thesis on Square (SQ) is predicated in part on our view that the company's increasing dependence on the extension of credit to its customers to spur its growth has made its business model increasingly vulnerable to volatility in the credit markets."
Last week, Square Capital launched "Square Installments," to let users charge for big purchases by splitting them up into smaller, fixed monthly payments. Square takes on the loan, and the customer buying the product pays it back in three, six or 12-month periods. That new offering "is likely to increase this vulnerability," in Palmer's view.
BTIG has a "sell" rating on the stock, which is up 200 percent year over year. Palmer's price target is $30, roughly $64 below where Square was trading at Friday's close. Shares were trading near $85 Monday afternoon.
Palmer also flagged the 0 to 24 percent annual percentage rates, or APRs, of Square's new loans. In comparison, APRs of loans offered by private alternative lender Affirm tend to range between 10 percent and 30 percent, he said.
"We believe this should raise questions about whether SQ will be sufficiently paid for the risk it will take on the program," Palmer said.
Palmer did point out that Square retains only a small portion of those loans to merchants on its balance sheets and sells most of them to investors. But he also reminded clients of the "painful lessons" learned in early 2016 by investors in the stocks of online marketplace lenders such as LendingClub.
"Firms that sell the loans they originate are nevertheless vulnerable to volatility in the credit markets as concerns about funding could negatively impact perceptions of their growth trajectories," he said.
Shares of PayPal, which has a program called Working Capital to provide loans to merchants based on sales history, closed 3 percent lower Monday. Amazon, which began extending credit to small business owners in 2011, ended the day down 1.3 percent. Credit card companies Visa and Mastercard both closed roughly 2.4 percent lower, following concerns about deteriorating credit conditions.
The move into lending is hardly new for Square. The company launched Square Capital in 2014, and has steadily increased offerings for the "under-banked," who historically have trouble accessing credit, with options like small loans and cash advances.