PayPal Holdings, Inc. 10-Q

Item 1: Financial Statements PayPal Holdings, Inc. CONDENSED CONSOLIDATED BALANCE SHEETS September 30, 2020 December 31, 2019 (In millions, except par value) (Unaudited) ASSETS Current assets: Cash and cash equivalents $ 6,112 $ 7,349 Short-term investments 8,046 3,412 Accounts receivable, net 482 435 Loans and interest receivable, net of allowances of $ 819 and $ 258 as of September 30, 2020 and December 31, 2019, respectively 2,597 3,972 Funds receivable and customer accounts 30,530 22,527 Prepaid expenses and other current assets 937 800 Total current assets 48,704 38,495 Long-term investments 3,439 2,863 Property and equipment, net 1,757 1,693 Goodwill 9,119 6,212 Intangible assets, net 1,146 778 Other assets 1,417 1,292 Total assets $ 65,582 $ 51,333 LIABILITIES AND EQUITY Current liabilities: Accounts payable $ 159 $ 232 Funds payable and amounts due to customers 32,530 24,527 Accrued expenses and other current liabilities 2,457 2,087 Income taxes payable 100 73 Total current liabilities 35,246 26,919 Deferred tax liability and other long-term liabilities 2,872 2,520 Long-term debt 8,937 4,965 Total liabilities 47,055 34,404 Commitments and Contingencies (Note 13) Equity: Common stock, $ 0.0001 par value; 4,000 shares authorized; 1,172 and 1,173 shares outstanding as of September 30, 2020 and December 31, 2019, respectively — — Preferred stock, $ 0.0001 par value; 100 shares authorized, unissued — — Treasury stock at cost, 116 and 105 shares as of September 30, 2020 and December 31, 2019, respectively ( 8,242 ) ( 6,872 ) Additional paid-in-capital 16,248 15,588 Retained earnings 10,809 8,342 Accumulated other comprehensive income (loss) ( 332 ) ( 173 ) Total PayPal Stockholders’ equity 18,483 16,885 Noncontrolling interest 44 44 Total equity 18,527 16,929 Total liabilities and equity $ 65,582 $ 51,333 The accompanying notes are an integral part of these condensed consolidated financial statements. 4 Table of Contents PayPal Holdings, Inc. CONDENSED CONSOLIDATED STATEMENTS OF INCOME Three Months Ended September 30, Nine Months Ended September 30, 2020 2019 2020 2019 (In millions, except per share data) (Unaudited) Net revenues $ 5,459 $ 4,378 $ 15,338 $ 12,811 Operating expenses: Transaction expense 2,022 1,701 5,604 4,877 Transaction and credit losses 344 340 1,375 999 Customer support and operations 449 390 1,271 1,177 Sales and marketing 471 316 1,256 1,001 Technology and development 674 533 1,910 1,527 General and administrative 503 401 1,501 1,239 Restructuring and other charges 19 — 95 71 Total operating expenses 4,482 3,681 13,012 10,891 Operating income 977 697 2,326 1,920 Other income (expense), net 167 ( 213 ) 880 224 Income before income taxes 1,144 484 3,206 2,144 Income tax expense 123 22 571 192 Net income $ 1,021 $ 462 $ 2,635 $ 1,952 Net income per share: Basic $ 0.87 $ 0.39 $ 2.25 $ 1.66 Diluted $ 0.86 $ 0.39 $ 2.22 $ 1.64 Weighted average shares: Basic 1,172 1,175 1,173 1,174 Diluted 1,190 1,188 1,186 1,188 The accompanying notes are an integral part of these condensed consolidated financial statements. 5 Table of Contents PayPal Holdings, Inc. CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME Three Months Ended September 30, Nine Months Ended September 30, 2020 2019 2020 2019 (In millions) (Unaudited) Net income $ 1,021 $ 462 $ 2,635 $ 1,952 Other comprehensive income (loss), net of reclassification adjustments: Foreign currency translation adjustments (“CTA”) 8 ( 90 ) ( 111 ) ( 148 ) Net investment hedge CTA gain — — 55 — Unrealized (losses) gains on cash flow hedges, net ( 163 ) 71 ( 111 ) 7 Tax benefit (expense) on unrealized (losses) gains on cash flow hedges, net 2 ( 1 ) 1 — Unrealized (losses) gains on investments, net ( 12 ) ( 5 ) 10 16 Tax benefit (expense) on unrealized (losses) gains on investments, net 3 1 ( 3 ) ( 5 ) Other comprehensive income (loss), net of tax ( 162 ) ( 24 ) ( 159 ) ( 130 ) Comprehensive income $ 859 $ 438 $ 2,476 $ 1,822 The accompanying notes are an integral part of these condensed consolidated financial statements. 6 Table of Contents PayPal Holdings, Inc. CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY Common Stock Shares Treasury Stock Additional Paid-In Capital Accumulated Other Comprehensive Income (Loss) Retained Earnings Noncontrolling Interest Total Equity (In millions) (Unaudited) Balances at December 31, 2019 1,173 $ ( 6,872 ) $ 15,588 $ ( 173 ) $ 8,342 $ 44 $ 16,929 Adoption of current expected credit loss standard — — — — ( 168 ) — ( 168 ) Net income — — — — 84 — 84 Foreign CTA — — — ( 171 ) — — ( 171 ) Net investment hedge CTA gain — — — 71 — — 71 Unrealized gains on cash flow hedges, net — — — 144 — — 144 Tax expense on unrealized gains on cash flow hedges, net — — — ( 2 ) — — ( 2 ) Unrealized gains on investments, net — — — 15 — — 15 Tax expense on unrealized gains on investments, net — — — ( 4 ) — — ( 4 ) Common stock and stock-based awards issued and assumed, net of shares withheld for employee taxes 8 — ( 382 ) — — — ( 382 ) Common stock repurchased ( 8 ) ( 800 ) — — — — ( 800 ) Stock-based compensation — — 295 — — — 295 Balances at March 31, 2020 1,173 $ ( 7,672 ) $ 15,501 $ ( 120 ) $ 8,258 $ 44 $ 16,011 Net income — — — — 1,530 — 1,530 Foreign CTA — — — 52 — — 52 Net investment hedge CTA loss — — — ( 16 ) — — ( 16 ) Unrealized losses on cash flow hedges, net — — — ( 92 ) — — ( 92 ) Tax benefit on unrealized losses on cash flow hedges, net — — — 1 — — 1 Unrealized gains on investments, net — — — 7 — — 7 Tax expense on unrealized gains on investments, net — — — ( 2 ) — — ( 2 ) Common stock and stock-based awards issued and assumed, net of shares withheld for employee taxes 1 — 52 — — — 52 Common stock repurchased ( 1 ) ( 220 ) — — — — ( 220 ) Stock-based compensation — — 361 — — — 361 Balances at June 30, 2020 1,173 $ ( 7,892 ) $ 15,914 $ ( 170 ) $ 9,788 $ 44 $ 17,684 Net income — — — — 1,021 — 1,021 Foreign CTA — — — 8 — — 8 Unrealized losses on cash flow hedges, net — — — ( 163 ) — — ( 163 ) Tax benefit on unrealized losses on cash flow hedges, net — — — 2 — — 2 Unrealized losses on investments, net — — — ( 12 ) — — ( 12 ) Tax benefit on unrealized gains on investments, net — — — 3 — — 3 Common stock and stock-based awards issued and assumed, net of shares withheld for employee taxes 1 — ( 41 ) — — — ( 41 ) Common stock repurchased ( 2 ) ( 350 ) — — — — ( 350 ) Stock-based compensation — — 375 — — — 375 Balances at September 30, 2020 1,172 $ ( 8,242 ) $ 16,248 $ ( 332 ) $ 10,809 $ 44 $ 18,527 7 Table of Contents PayPal Holdings, Inc. CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (continued) Common Stock Shares Treasury Stock Additional Paid-In Capital Accumulated Other Comprehensive Income (Loss) Retained Earnings Noncontrolling Interest Total Equity (In millions) (Unaudited) Balances at December 31, 2018 1,174 $ ( 5,511 ) $ 14,939 $ 78 $ 5,880 $ — $ 15,386 Adoption of lease accounting standard — — — — 3 — 3 Net income — — — — 667 — 667 Foreign CTA — — — ( 67 ) — — ( 67 ) Unrealized losses on cash flow hedges, net — — — ( 46 ) — — ( 46 ) Tax benefit on unrealized losses on cash flow hedges, net — — — 1 — — 1 Unrealized gains on investments, net — — — 11 — — 11 Tax expense on unrealized gains on investments, net — — — ( 2 ) — — ( 2 ) Common stock and stock-based awards issued and assumed, net of shares withheld for employee taxes 6 — ( 302 ) — — — ( 302 ) Common stock repurchased ( 8 ) ( 705 ) ( 45 ) — — — ( 750 ) Stock-based compensation — — 256 — — — 256 Balances at March 31, 2019 1,172 $ ( 6,216 ) $ 14,848 $ ( 25 ) $ 6,550 $ — $ 15,157 Net income — — — — 823 — 823 Foreign CTA — — — 9 — — 9 Unrealized losses on cash flow hedges, net — — — ( 18 ) — — ( 18 ) Tax benefit on unrealized losses on cash flow hedges, net — — — — — — — Unrealized gains on investments, net — — — 10 — — 10 Tax expense on unrealized gains on investments, net — — — ( 4 ) — — ( 4 ) Common stock and stock-based awards issued and assumed, net of shares withheld for employee taxes 5 — ( 73 ) — — — ( 73 ) Stock-based compensation — — 235 — — — 235 Balances at June 30, 2019 1,177 $ ( 6,216 ) $ 15,010 $ ( 28 ) $ 7,373 $ — $ 16,139 Net income — — — — 462 462 Foreign CTA — — — ( 90 ) — — ( 90 ) Unrealized gains on cash flow hedges, net — — — 71 — — 71 Tax expense on unrealized gains on cash flow hedges, net — — — ( 1 ) — — ( 1 ) Unrealized losses on investments, net — — — ( 5 ) — — ( 5 ) Tax benefit on unrealized losses on investments, net — — — 1 — — 1 Common stock and stock-based awards issued and assumed, net of shares withheld for employee taxes — — ( 19 ) — — — ( 19 ) Common stock repurchased ( 3 ) ( 350 ) — — — — ( 350 ) Stock-based compensation — — 275 — — — 275 Balances at September 30, 2019 1,174 $ ( 6,566 ) $ 15,266 $ ( 52 ) $ 7,835 $ — $ 16,483 The accompanying notes are an integral part of these condensed consolidated financial statements. 8 Table of Contents PayPal Holdings, Inc. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS Nine Months Ended September 30, 2020 2019 (In millions) (Unaudited) Cash flows from operating activities: Net income $ 2,635 $ 1,952 Adjustments: Transaction and credit losses 1,375 999 Depreciation and amortization 888 685 Stock-based compensation 999 736 Deferred income taxes ( 6 ) ( 122 ) Gains on strategic investments ( 973 ) ( 170 ) Other 10 ( 130 ) Changes in assets and liabilities: Accounts receivable 7 ( 103 ) Changes in loans and interest receivable held for sale, net — 4 Accounts payable ( 93 ) ( 51 ) Income taxes payable ( 115 ) ( 33 ) Other assets and liabilities ( 120 ) ( 470 ) Net cash provided by operating activities 4,607 3,297 Cash flows from investing activities: Purchases of property and equipment ( 640 ) ( 530 ) Proceeds from sales of property and equipment 120 17 Changes in principal loans receivable, net 523 ( 1,111 ) Purchases of investments ( 28,333 ) ( 19,808 ) Maturities and sales of investments 19,733 17,390 Acquisitions, net of cash and restricted cash acquired ( 3,609 ) — Funds receivable ( 1,060 ) ( 1,292 ) Net cash used in investing activities ( 13,266 ) ( 5,334 ) Cash flows from financing activities: Proceeds from issuance of common stock 72 78 Purchases of treasury stock ( 1,370 ) ( 1,106 ) Tax withholdings related to net share settlements of equity awards ( 463 ) ( 473 ) Borrowings under financing arrangements 6,966 5,471 Repayments under financing arrangements ( 3,000 ) ( 2,509 ) Funds payable and amounts due to customers 7,822 2,376 Other financing activities ( 15 ) — Net cash provided by financing activities 10,012 3,837 Effect of exchange rate changes on cash, cash equivalents, and restricted cash 26 ( 49 ) Net change in cash, cash equivalents, and restricted cash 1,379 1,751 Cash, cash equivalents, and restricted cash at beginning of period 15,743 13,233 Cash, cash equivalents, and restricted cash at end of period $ 17,122 $ 14,984 Supplemental cash flow disclosures: Cash paid for interest $ 91 $ 76 Cash paid for income taxes, net $ 444 $ 220 The below table reconciles cash, cash equivalents, and restricted cash as reported in the condensed consolidated balance sheets to the total of the same amounts shown in the condensed consolidated statements of cash flows: Cash and cash equivalents $ 6,112 $ 6,877 Short term investments 23 10 Funds receivable and customer accounts 10,987 8,097 Total cash, cash equivalents, and restricted cash shown in the condensed consolidated statements of cash flows $ 17,122 $ 14,984 The accompanying notes are an integral part of these condensed consolidated financial statements. 9 Table of Contents PayPal Holdings, Inc. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) Note 1— Overview and Summary of Significant Accounting Policies Overview and Organization PayPal Holdings, Inc. (“PayPal,” the “Company,” “we,” “us,” or “our”) was incorporated in Delaware in January 2015 and is a leading technology platform and digital payments company that enables digital and mobile payments on behalf of merchants and consumers worldwide. PayPal is committed to democratizing financial services and empowering people and businesses to join and thrive in the global economy. Our goal is to enable our merchants and consumers to manage and move their money anywhere in the world, anytime, on any platform, and using any device. We also facilitate person-to-person payments through our PayPal, Venmo, and Xoom products and services and simplify and personalize shopping experiences for our consumers through our Honey Platform. Our combined payment solutions, including our core PayPal, PayPal Credit, Braintree, Venmo, Xoom, iZettle, and Hyperwallet products and services, comprise our proprietary Payments Platform. We operate globally and in a rapidly evolving regulatory environment characterized by a heightened regulatory focus on all aspects of the payments industry. That focus continues to become even more heightened as regulators on a global basis focus on important issues such as countering terrorist financing, anti-money laundering, privacy, cybersecurity, and consumer protection. Some of the laws and regulations to which we are subject were enacted recently, and the laws and regulations applicable to us, including those enacted prior to the advent of digital and mobile payments, are continuing to evolve through legislative and regulatory action and judicial interpretation. New or changing laws and regulations, including the way laws and regulations are interpreted and implemented, as well as increased penalties and enforcement actions related to non-compliance, could have a material adverse impact on our business, results of operations, and financial condition. Therefore, we monitor these areas closely to design compliant solutions for our customers who depend on us. Significant Accounting Policies Basis of Presentation and Principles of Consolidation The condensed consolidated financial statements include the financial statements of PayPal and our wholly- and majority-owned subsidiaries. All intercompany balances and transactions have been eliminated in consolidation. Noncontrolling interest reported as a component of equity on our condensed consolidated balance sheets represents the equity interests not owned by PayPal and is recorded for consolidated entities we control and of which we own less than 100%. Noncontrolling interest is not presented separately on our condensed consolidated statements of income as the amount is de minimis. Investments in entities where we have the ability to exercise significant influence, but not control, over the investee are accounted for using the equity method of accounting. For such investments, our share of the investee’s results of operations is included in other income (expense), net on our condensed consolidated statements of income and our investment balance is included in long-term investments on our condensed consolidated balance sheets. Investments in entities where we do not have the ability to exercise significant influence over the investee are accounted for at fair value or cost minus impairment, if any, adjusted for changes resulting from observable price changes, which are included in other income (expense), net on our condensed consolidated statements of income. Our investment balance is included in long-term investments on our condensed consolidated balance sheets. We determine at the inception of each arrangement whether an entity in which we have made an investment is considered a variable interest entity (“VIE”). If we determine it is, we then assess if we are the primary beneficiary, which would require consolidation. As of September 30, 2020, we held an investment in a VIE which did not qualify for consolidation as we are not the primary beneficiary. The investment balance is de minimis and included as a non-marketable equity security in long-term investments on our condensed consolidated balance sheets. These condensed consolidated financial statements and accompanying notes should be read in conjunction with the audited consolidated financial statements and accompanying notes included in our Annual Report on Form 10-K for the year ended December 31, 2019 (the “2019 Form 10-K”) filed with the Securities and Exchange Commission on February 6, 2020. 10 Table of Contents PayPal Holdings, Inc. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) In the opinion of management, these condensed consolidated financial statements reflect all adjustments, consisting only of normal recurring adjustments, which are necessary for a fair statement of the condensed consolidated financial statements for interim periods. Certain amounts for prior years have been reclassified to conform to the financial statement presentation as of and for the three and nine months ended September 30, 2020. Use of Estimates The preparation of condensed consolidated financial statements in conformity with U.S. generally accepted accounting principles (“GAAP”) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the condensed consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. On an ongoing basis, we evaluate our estimates, including those related to provisions for transaction and credit losses, loss contingencies, income taxes, revenue recognition, and the valuation of goodwill and intangible assets. We base our estimates on historical experience and various other assumptions which we believe to be reasonable under the circumstances. These estimates may change as new events occur, and as additional information surrounding the impact of the novel coronavirus (“COVID-19”) pandemic is obtained. Actual results could differ from these estimates and any such differences may be material to our financial statements. Investments Short-term investments include time deposits, money market funds, government and agency securities, and corporate debt securities with original maturities of greater than three months but less than one year when purchased or maturities of less than one year on the reporting date. Long-term investments include time deposits, government and agency securities and corporate debt securities with maturities exceeding one year, and our strategic investments. Government and agency securities and corporate debt securities are classified as available-for-sale and are reported at fair value using the specific identification method. Unrealized gains and losses are reported as a component of other comprehensive income (loss), net of related estimated tax provisions or benefits. Accrued interest receivable on available-for-sale debt securities totaled $ 31 million and $ 54 million at September 30, 2020 and December 31, 2019, respectively, and is included in other current assets on our condensed consolidated balance sheets. We elect to account for foreign currency denominated available-for-sale investments underlying funds receivable and customer accounts, short-term investments, and long-term investments under the fair value option as further discussed in “Note 9—Fair Value Measurement of Assets and Liabilities.” The changes in fair value related to initial measurement and subsequent changes in fair value are included in earnings as a component of other income (expense), net. Our strategic investments consist of marketable equity securities, which are publicly traded, and non-marketable equity securities, which are investments in privately held companies. Marketable equity securities have readily determinable fair values with changes in fair value recorded in other income (expense), net. Non-marketable equity securities include investments that do not have a readily determinable fair value and equity method investments. The investments that do not have readily determinable fair value are measured at cost minus impairment, if any, adjusted for changes resulting from observable price changes in orderly transactions for an identical or similar investment in the same issuer (the “Measurement Alternative”). All gains and losses on these investments, realized and unrealized, are recorded in other income (expense), net on our condensed consolidated statements of income. Our investments where we have the ability to exercise significant influence, but not control, over the investee are accounted for as equity method investments and our share of the investee’s results of operations is included in other income (expense), net. We assess whether an impairment loss on our non-marketable equity securities and an other-than-temporary impairment loss on our equity method investments has occurred due to declines in fair value or other market conditions. If any impairment is identified for non-marketable equity securities or impairment is considered other-than-temporary for our equity method investments, we write down the investment to its fair value and record the corresponding charge through other income (expense), net in our condensed consolidated statements of income. 11 Table of Contents PayPal Holdings, Inc. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) Our available-for-sale debt securities in an unrealized loss position will be written down to fair value through a charge to other income (expense), net in our condensed consolidated statements of income if we intend to sell the security or it is more likely than not we will be required to sell the security before recovery of its amortized cost basis. For the remaining available-for-sale debt securities in an unrealized loss position, if we identify that the decline in fair value has resulted from credit losses, taking into consideration changes to the rating of the security by rating agencies, implied yields versus benchmark yields, and the extent to which fair value is less than amortized cost, among other factors, we will estimate the present value of cash flows expected to be collected. If the present value of cash flows expected to be collected is less than the amortized cost basis, a credit loss exists and an allowance for credit losses is recorded, limited by the amount that the fair value is less than the amortized cost basis. Any impairment that has not been recorded through an allowance for credit losses is recognized in other comprehensive income. Loans and Interest Receivable, Net Loans and interest receivable, net represents merchant receivables originated under our PayPal Working Capital (“PPWC”) product and PayPal Business Loan (“PPBL”) product and international consumer loans originated under our PayPal Credit products. In the U.S., we partner with an independent chartered financial institution that extends credit to merchants using our PPWC product or PPBL product and purchase the related receivables extended by the independent chartered financial institution. For our international consumer credit products, we extend credit through our Luxembourg banking subsidiary. For our merchant credit products outside the U.S., we extend working capital advances in the U.K. and loans in Germany through our Luxembourg banking subsidiary, and we extend working capital loans in Australia through an Australian subsidiary. As part of our arrangement with the independent chartered financial institution in the U.S., we sell back a participation interest in the pool of merchant receivables. For this arrangement, gains or losses on the sale of the participation interests are not material as the carrying amount of the participation interest sold approximates the fair value at time of transfer. The independent chartered financial institution has no recourse against us related to their participation interests for failure of debtors to pay when due. The participation interests held by the chartered financial institution have the same priority to the interests held by us and are subject to the same credit, prepayment, and interest rate risk associated with this pool of merchant receivables. All risks of loss are shared pro rata based on participation interests held among all participating stakeholders. We apply a control-oriented, financial-components approach, and account for the asset transfer as a sale and derecognize the portion of the participation interests for which control has been surrendered. Loans, advances, and interest and fees receivable are reported at their outstanding balances, net of any participation interests sold and pro rata allowances, including unamortized deferred origination costs and estimated collectible interest and fees. We maintain the servicing rights for the entire pool of consumer and merchant receivables outstanding and receive a fee approximating the fair value for servicing the assets underlying the participation interest sold. We offer both revolving and installment credit products to our international consumers. The terms of our consumer relationships require us to submit monthly bills to the consumer detailing loan repayment requirements. The terms also allow us to charge the consumer interest and fees in certain circumstances. Due to the relatively small dollar amount of individual loans and interest receivable, we do not require collateral on these balances. U.S. Consumer Credit Portfolio In November 2017, we reached an agreement to sell our U.S. consumer credit receivables portfolio to Synchrony Bank (“Synchrony”). Following the closing of this transaction in July 2018, Synchrony became the exclusive issuer of the PayPal Credit online consumer financing program in the U.S. We no longer hold an ownership interest in the receivables generated through the program and thus, no longer record these receivables on our condensed consolidated financial statements. PayPal earns a revenue share on the portfolio of consumer receivables owned by Synchrony, which includes both the sold and newly generated receivables, and it is recorded in revenue from other value added services on our condensed consolidated statements of income. 12 Table of Contents PayPal Holdings, Inc. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) Through the closing of the transaction with Synchrony, we continued to work with an independent chartered financial institution to extend credit to U.S. consumers using our PayPal Credit product. We purchased the related receivables extended by the independent chartered financial institution until July 2018. As part of the arrangements we had with the independent chartered financial institutions in the U.S., we sold back a participation interest in the pool of U.S. consumer receivables outstanding under PayPal Credit consumer accounts. For these arrangements, gains or losses on the sale of the participation interest were not material as the carrying amount of the participation interest sold approximated the fair value at time of transfer. Allowance for Loans and Interest Receivable The allowance for loans and interest receivable represents our estimate of lifetime expected credit losses inherent in our portfolio of loans and interest receivables. Increases to the allowance for loans receivable are reflected as a component of transaction and credit losses on our condensed consolidated statements of income. Increases to the allowance for interest and fees receivable are reflected as a reduction of net revenues on our condensed consolidated statements of income, or as a reduction of deferred revenue when interest and fees are billed at the inception of a loan or advance. The evaluation process to assess the adequacy of allowances is subject to numerous estimates and judgments. The allowance for loans and interest receivable is primarily based on expectations of credit losses based on historical lifetime loss data as well as macroeconomic forecasts applied to the portfolio, which is segmented by geographic region, delinquency, and vintage, among other factors. Loss curves are generated using historical loss data for each loan portfolio and are applied to segments of each portfolio, categorized by geographic region, first borrowing versus reuse, delinquency, credit rating, and vintage, among other factors, which vary by portfolio. We then apply macroeconomic factors such as forecasted trends in unemployment and benchmark credit card charge-off rates, which are sourced externally, using a single scenario that is most appropriate to the economic conditions applicable to a particular period. Projected loss rates, inclusive of historical loss data and macroeconomic factors, are applied to the principal amount of our consumer and merchant receivables. We may also include qualitative adjustments that incorporate incremental information not captured in the quantitative estimates of our expected lifetime losses. Our consumer receivables are primarily revolving in nature and do not have a contractual term; however, the reasonable and supportable forecast period we have included in our projected loss rates based on externally sourced data is approximately seven years . Our merchant receivables vary in contractual term; however, the reasonable and supportable forecast period considered for projected loss rates is approximately 2.5 to 3.5 years, depending upon the product. The allowance for losses against the interest and fees receivable is determined primarily by applying loss curves to each portfolio by geography, delinquency, and period of origination, among other factors. In connection with our agreement to sell our U.S. consumer credit receivables to Synchrony and the designation of that portfolio as held for sale in November 2017, we reversed the corresponding allowances against those loans and interest receivable balances. Such allowances on any newly originated U.S. consumer loans and interest receivables, held for sale were not established. Adjustments to the cost basis of this portfolio until the sale was completed, which were primarily driven by charge-offs, were recorded in restructuring and other charges on our condensed consolidated statements of income. Leases We determine whether an arrangement is a lease for accounting purposes at contract inception. Operating leases are recorded as right-of-use (“ROU”) assets, which are included in other assets, and lease liabilities, which are included in accrued expenses and other current liabilities and deferred tax liability and other long-term liabilities on our condensed consolidated balance sheets. For sale-leaseback transactions, we evaluate the sale and the lease arrangement based on our conclusion as to whether control of the underlying asset has been transferred and recognize the sale-leaseback as either a sale transaction or under the financing method. The financing method requires the asset to remain on the condensed consolidated balance sheets throughout the term of the lease and the proceeds to be recognized as a financing obligation. As of September 30, 2020, we had no finance leases. 13 Table of Contents PayPal Holdings, Inc. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) ROU assets represent our right to use an underlying asset for the lease term and lease liabilities represent our obligation to make lease payments arising from the lease. ROU assets and lease liabilities are recognized at the lease commencement date based on the present value of lease payments over the lease term. Our leases do not provide an implicit rate; we use an incremental borrowing rate for specific terms on a collateralized basis based on the information available on the commencement date in determining the present value of lease payments. The ROU asset calculation includes lease payments to be made and excludes lease incentives. The ROU asset and lease liability may include amounts attributed to options to extend or terminate the lease when it is reasonably certain we will exercise that option. Lease expense for operating leases is recognized on a straight-line basis over the lease term. We evaluate ROU assets related to leases for indicators of impairment whenever events or changes in circumstances indicate that the carrying amount of an ROU asset may not be recoverable. When a decision has been made to exit a lease prior to the contractual term or to sublease that space, we evaluate the asset for impairment and recognize the associated impact to the ROU asset and related expense, if applicable. The evaluation is performed at the asset group level initially and when appropriate, at the lowest level of identifiable cash flows, which is at the individual lease level. Undiscounted cash flows expected to be generated by the related ROU assets are estimated over the ROU assets’ useful lives. If the evaluation indicates that the carrying amount of the ROU assets may not be recoverable, any potential impairment is measured based upon the fair value of the related ROU asset or asset group as determined by appropriate valuation techniques. We have lease agreements with lease and non-lease components. We have elected to apply the practical expedient and account for the lease and non-lease components as a single lease component for all leases, where applicable. In addition, we have elected the practical expedients related to lease classification, hindsight, and land easement. We apply a single portfolio approach to account for the ROU assets and lease liabilities. Allowance for Transaction Losses We are exposed to transaction losses due to credit card and other payment misuse as well as nonperformance from sellers who accept payments through PayPal. We establish an allowance for estimated losses arising from completing customer transactions, such as chargebacks for unauthorized credit card use and merchant-related chargebacks due to non-delivery of goods or services, buyer protection program claims, and account takeovers. This allowance represents an accumulation of the estimated amounts of probable transaction losses as of the reporting date, including those which we have not yet identified. The allowance is monitored regularly and is updated based on actual data received, including actual claims data reported by our claims processors. The allowance is based on known facts and circumstances, internal factors including experience with similar cases, historical trends involving loss payment patterns, the mix of transaction and loss types, as applicable. Additions to the allowance are reflected as a component of transaction and credit losses on our condensed consolidated statements of income. At September 30, 2020 and December 31, 2019, the allowance for transaction losses totaled $ 178 million and $ 136 million, respectively, and was included in accrued expenses and other current liabilities on our condensed consolidated balance sheets. Allowance for Negative Customer Balances Negative customer balances occur primarily when there are insufficient funds in a customer’s PayPal account to cover charges applied for Automated Clearing House returns, debit card transactions, and merchant-related chargebacks due to non-delivery or unsatisfactory delivery of goods or services, which are generally within the scope of our protection programs. Negative customer balances can be cured by the customer by adding funds to their account, receiving payments, or through back-up funding sources. We also utilize third-party collection agents. For negative customer balances that are not expected to be cured or otherwise collected, we provide an allowance for lifetime expected losses. The allowance represents expected losses based on historical trends involving collection and write-off patterns, internal factors including our experience with similar cases, other known facts and circumstances, and reasonable and supportable macroeconomic forecasts, as applicable. Loss rates are derived using historical loss data for each delinquency bucket using a roll rate model that captures the losses and the likelihood that a negative customer balance will be written-off as the delinquency age of such balance increases. The loss rates are then applied to the outstanding negative customer balances. Once the quantitative calculation is performed, we review the adequacy of the allowance and determine if qualitative adjustments need to be considered. We write-off negative customer balances in the month in which the balance becomes outstanding for 120 days. Write-offs that are recovered are recorded as a reduction to our allowance for negative customer balances. 14 Table of Contents PayPal Holdings, Inc. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) Negative customer balances are included in other current assets, net of the allowance on our condensed consolidated balance sheets. Adjustments to the allowance for negative customer balances are recorded as a component of transaction and credit losses on our condensed consolidated statements of income. The allowance for negative customer balances was $ 266 million and $ 263 million at September 30, 2020 and December 31, 2019, respectively. Recent Accounting Guidance In 2020, the Financial Accounting Standards Board (“FASB”) issued amended guidance that provides transition relief for the accounting impact of reference rate reform. For a limited period, this guidance provides optional expedients and exceptions for applying GAAP to certain contract modifications, hedging relationships, and other transactions affected by a reference rate expected to be discontinued due to reference rate reform. The amended guidance is effective through December 31, 2022. Our exposure to LIBOR is primarily limited to an insignificant portion of our available-for-sale debt securities and, accordingly, we do not expect reference rate reform to have a material impact on our condensed consolidated financial statements. Recently Adopted Accounting Guidance In 2019, the FASB issued amended guidance for simplifying certain aspects for the accounting for income taxes. This amended guidance is intended to remove certain exceptions to the general principles in current GAAP, reduce the cost and complexity in accounting for income taxes, and improve financial statement preparers’ application of income tax-related guidance. This guidance does not create new accounting requirements. It is effective for fiscal years, and interim periods within those years, beginning after December 15, 2020, with early adoption permitted. We early adopted this guidance in the first quarter of 2020. Adoption of this guidance did not have a material impact on our condensed consolidated financial statements. In 2016, the FASB issued new guidance on the measurement of credit losses on financial instruments. Under the new guidance, credit losses on loans, trade and other receivables, held-to-maturity debt securities, and other instruments reflect our current estimate of the expected lifetime credit losses and generally result in the earlier recognition of allowances for losses. Credit losses on available-for-sale debt securities with unrealized losses are recognized as allowances for credit losses limited to the amount by which fair value is below amortized cost. Additional disclosures are required, including information used to track credit quality by year of origination for most financing receivables. We are required to apply the provisions of this guidance as a cumulative effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is adopted with impairment of available-for-sale debt securities applied prospectively after adoption. We adopted the new guidance effective January 1, 2020. For additional information, see “Note 11—Loans and Interest Receivable.” There are other new accounting pronouncements issued by the FASB that we have adopted or will adopt, as applicable. We do not believe any of these accounting pronouncements have had, or will have, a material impact on our condensed consolidated financial statements or disclosures. Note 2— Revenue PayPal enables its customers to send and receive payments. We earn revenue primarily by completing payment transactions for our customers on our Payments Platform and from other value added services. Our revenues are classified into two categories: transaction revenues and revenues from other value added services. Disaggregation of Revenue We determine operating segments based on how our chief operating decision maker (“CODM”) manages the business, makes operating decisions around the allocation of resources, and evaluates operating performance. Our CODM is our Chief Executive Officer, who reviews our operating results on a consolidated basis. We operate as one segment and have one reportable segment. Based on the information provided to and reviewed by our CODM, we believe that the nature, amount, timing, and uncertainty of our revenue and cash flows and how they are affected by economic factors are most appropriately depicted through our primary geographical markets and type of revenue categories (transaction revenues and revenues from other value added services). Revenues recorded within these categories are earned from similar services for which the nature of associated fees and the related revenue recognition models are substantially the same. 15 Table of Contents PayPal Holdings, Inc. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) The following table presents our revenue disaggregated by primary geographical market and category: Three Months Ended September 30, Nine Months Ended September 30, 2020 2019 2020 2019 (In millions) Primary geographical markets United States (“U.S.”) $ 2,820 $ 2,327 $ 7,940 $ 6,811 United Kingdom (“U.K.”) 606 455 1,670 1,342 Other countries (1) 2,033 1,596 5,728 4,658 Total net revenues (2) $ 5,459 $ 4,378 $ 15,338 $ 12,811 Revenue category Transaction revenues $ 5,076 $ 3,955 $ 14,236 $ 11,564 Revenues from other value added services 383 423 1,102 1,247 Total net revenues (2) $ 5,459 $ 4,378 $ 15,338 $ 12,811 (1) No single country included in the other countries category generated more than 10% of total revenue. (2) Total revenues include $ 128 million and $ 295 million for the three months ended September 30, 2020 and 2019, respectively, and $ 529 million and $ 828 million for the nine months ended September 30, 2020 and 2019, respectively, which do not represent revenues recognized in the scope of Accounting Standards Codification Topic 606, Revenue from contracts with customers . Such revenues relate to interest, fees, and gains earned on loans and interest receivable, as well as hedging gains or losses, and interest earned on certain assets underlying customer balances. Net revenues are attributed to the country in which the merchant is located, or in the case of a cross-border transaction, may be earned from the country in which the consumer and the merchant respectively reside. Revenues earned from other value added services are typically attributed to the country in which either the customer or partner reside. Note 3— Net Income Per Share Basic net income per share is computed by dividing net income for the period by the weighted average number of common shares outstanding during the period. Diluted net income per share is computed by dividing net income for the period by the weighted average number of shares of common stock and potentially dilutive common stock outstanding for the period. The dilutive effect of outstanding equity incentive awards is reflected in diluted net income per share by application of the treasury stock method. The calculation of diluted net income per share excludes all anti-dilutive common shares. The following table sets forth the computation of basic and diluted net income per share for the periods indicated: Three Months Ended September 30, Nine Months Ended September 30, 2020 2019 2020 2019 (In millions, except per share amounts) Numerator: Net income $ 1,021 $ 462 $ 2,635 $ 1,952 Denominator: Weighted average shares of common stock - basic 1,172 1,175 1,173 1,174 Dilutive effect of equity incentive awards 18 13 13 14 Weighted average shares of common stock - diluted 1,190 1,188 1,186 1,188 Net income per share: Basic $ 0.87 $ 0.39 $ 2.25 $ 1.66 Diluted $ 0.86 $ 0.39 $ 2.22 $ 1.64 Common stock equivalents excluded from income per diluted share because their effect would have been anti-dilutive — 1 1 2 16 Table of Contents PayPal Holdings, Inc. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) Note 4— Business Combinations Honey Science Corporation We completed our acquisition of Honey Science Corporation (“Honey”) in January 2020 by acquiring all outstanding shares for total consideration of approximately $ 4.0 billion, consisting of approximately $ 3.6 billion in cash and approximately $ 400 million in assumed restricted stock, restricted stock units, and options, subject to vesting conditions. We believe our acquisition of Honey will enhance our value proposition by allowing us to further simplify and personalize shopping experiences for consumers while driving conversion and increasing consumer engagement and sales for merchants. The following table summarizes the preliminary allocation of the purchase consideration to the fair value of the assets acquired and liabilities assumed: (In millions) Goodwill $ 2,962 Customer lists and user base 115 Marketing related 30 Developed technology 572 Total intangibles $ 717 Accounts receivable, net 55 Deferred tax liabilities, net ( 76 ) Other net liabilities ( 23 ) Total purchase consideration $ 3,635 The intangible assets acquired consist primarily of customer contracts, trade name/trademarks, and developed technology with estimated useful lives of three years . The excess of the purchase consideration over the fair value of net tangible and identifiable intangible assets acquired was recorded as goodwill, and is attributable to the workforce of Honey and the synergies expected to arise from the acquisition through continued customer acquisition, cross selling initiatives, and product enhancements. We do not expect goodwill to be deductible for income tax purposes. The allocation of the purchase price for this acquisition has been prepared on a preliminary basis and changes to the allocation to certain assets, liabilities, and tax estimates may occur as additional information becomes available. In association with the acquisition, we assumed restricted stock, restricted stock units, and options with an approximate grant date fair value of $ 400 million, which represents post business combination expense. The equity granted is a combination of shares issued to certain former Honey employees subject to a holdback arrangement and assumed Honey employee grants, which vest over a period of up to four years and are subject to continued employment. We have included the financial results of the acquired business in our condensed consolidated financial statements from the date of acquisition. Revenues and expenses related to the acquisition and pro forma results of operations have not been presented for the three and nine months ended September 30, 2020 because the effects of this acquisition were not material to our overall operations. There were no acquisitions or divestitures completed during the nine months ended September 30, 2019. 17 Table of Contents PayPal Holdings, Inc. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) Note 5— Goodwill and Intangible Assets Goodwill The following table presents goodwill balances and adjustments to those balances during the nine months ended September 30, 2020: December 31, 2019 Goodwill Acquired Adjustments September 30, 2020 (In millions) Total goodwill $ 6,212 $ 2,962 $ ( 55 ) $ 9,119 The goodwill acquired during the nine months ended September 30, 2020 was associated with the acquisition of Honey. The adjustments to goodwill during the nine months ended September 30, 2020 pertain to foreign currency translation adjustments. Intangible Assets The components of identifiable intangible assets are as follows: September 30, 2020 December 31, 2019 Gross Carrying Amount Accumulated Amortization Net Carrying Amount Weighted Average Useful Life (Years) Gross Carrying Amount Accumulated Amortization Net Carrying Amount Weighted Average Useful Life (Years) (In millions, except years) Intangible assets: Customer lists and user base $ 1,202 $ ( 768 ) $ 434 6 $ 1,114 $ ( 700 ) $ 414 7 Marketing related 321 ( 268 ) 53 3 294 ( 239 ) 55 3 Developed technology 999 ( 516 ) 483 3 445 ( 343 ) 102 3 All other 441 ( 265 ) 176 7 436 ( 229 ) 207 7 Intangible assets, net $ 2,963 $ ( 1,817 ) $ 1,146 $ 2,289 $ ( 1,511 ) $ 778 Amortization expense for intangible assets was $ 114 million and $ 52 million for the three months ended September 30, 2020 and 2019, respectively. Amortization expense for intangible assets was $ 343 million and $ 160 million for the nine months ended September 30, 2020 and 2019, respectively. Expected future intangible asset amortization as of September 30, 2020 was as follows (in millions): Fiscal years: Remaining 2020 $ 108 2021 398 2022 336 2023 99 2024 97 Thereafter 108 Total $ 1,146 Note 6— Leases PayPal enters into various leases, which are primarily real estate operating leases. We use these properties for executive and administrative offices, data centers, product development offices, and customer service and operations centers. Many leases include one or more renewal or termination options. These options are not included in our determination of the lease term at commencement unless it is reasonably certain the Company will exercise the option. When we reach a decision to exercise a lease renewal or termination option, we recognize the associated impact to the ROU asset and lease liability. 18 Table of Contents PayPal Holdings, Inc. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) While a majority of lease payments are based on the stated rate in the lease, some lease payments are subject to annual changes based on the Consumer Price Index or another referenced index. In the event of changes to the relevant index, lease liabilities are not remeasured and instead are treated as variable lease payments and recognized in the period in which the obligation for those payments is incurred. All of PayPal’s variable lease payments are based on an index or rate. The short-term lease exemption has been adopted for all leases with a duration of less than 12 months. PayPal’s lease portfolio contains a small number of subleases. A sublease situation can arise when currently leased real estate space is available and is surplus to operational requirements. The components of lease expense were as follows: Three Months Ended September 30, Nine Months Ended September 30, 2020 2019 2020 2019 (In millions) Lease expense Operating lease expense $ 42 $ 33 $ 122 $ 99 Sublease income ( 2 ) ( 1 ) ( 4 ) ( 5 ) Total lease expense cost $ 40 $ 32 $ 118 $ 94 Supplemental cash and noncash information related to leases were as follows: Three Months Ended September 30, Nine Months Ended September 30, 2020 2019 2020 2019 (In millions) Cash paid for amounts included in the measurement of lease liabilities Operating cash flows from operating leases $ 40 $ 31 $ 113 $ 93 Right-of-use assets obtained in exchange for operating lease liabilities $ 15 $ 32 $ 261 $ 100 Supplemental balance sheet information related to leases was as follows: September 30, 2020 December 31, 2019 (In millions, except weighted-average figures) Operating lease right-of-use assets $ 655 $ 479 Other current lease liabilities 133 104 Operating lease liabilities 594 403 Total operating lease liabilities $ 727 $ 507 Weighted-average remaining lease term — operating leases 7.0 years 5.8 years Weighted-average discount rate — operating leases 4 % 5 % 19 Table of Contents PayPal Holdings, Inc. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) Future minimum lease payments for our operating leases as of September 30, 2020 were as follows: Operating Leases Fiscal years: (In millions) Remaining 2020 $ 41 2021 154 2022 118 2023 103 2024 93 Thereafter 319 Total $ 828 Less: present value discount ( 101 ) Lease liability $ 727 Operating lease amounts include minimum lease payments under our non-cancelable operating leases primarily for office and data center facilities. The amounts presented are consistent with contractual terms and are not expected to differ significantly from actual results under our existing leases. In the first quarter of 2020, we entered into a sale-leaseback arrangement as the seller-lessee for a data center as the buyer-lessor obtained control of the facility. We sold the data center and simultaneously entered into an operating lease agreement with the purchaser for the right to use the facility for 8 years. The Company received proceeds of approximately $ 119 million, net of selling costs, which resulted in a de minimis net gain on the sale transaction. In the second quarter of 2020, we incurred asset impairment charges of $ 21 million within restructuring and other charges on our condensed consolidated statements of income. The impairments included a reduction to our ROU asset in the amount of $ 17 million, which were attributed to certain leased space we are no longer utilizing for our core business operations, a portion of which is being sub-leased. As of September 30, 2020, we also have additional operating leases that have not yet commenced, primarily for real estate and data centers, with minimum lease payments aggregating to $ 96 million. These operating leases will commence prior to the end of fiscal year 2021 with lease terms of 3 years to 10 years. Note 7— Other Financial Statement Details Accumulated Other Comprehensive Income (Loss) The following table summarizes the changes in accumulated balances of other comprehensive income (loss) for the three months ended September 30, 2020: Unrealized Gains (Losses) on Cash Flow Hedges Unrealized Gains (Losses) on Investments Foreign Currency Translation Adjustment (“CTA”) Net Investment Hedge CTA Gain (Loss) Estimated Tax Benefit (Expense) Total (In millions) Beginning balance $ 58 $ 24 $ ( 269 ) $ 24 $ ( 7 ) $ ( 170 ) Other comprehensive income (loss) before reclassifications ( 180 ) ( 12 ) 8 — 5 ( 179 ) Less: Amount of loss reclassified from accumulated other comprehensive income (“AOCI”) ( 17 ) — — — — ( 17 ) Net current period other comprehensive income (loss) ( 163 ) ( 12 ) 8 — 5 ( 162 ) Ending balance $ ( 105 ) $ 12 $ ( 261 ) $ 24 $ ( 2 ) $ ( 332 ) 20 Table of Contents PayPal Holdings, Inc. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) The following table summarizes the changes in accumulated balances of other comprehensive income (loss) for the three months ended September 30, 2019: Unrealized Gains (Losses) on Cash Flow Hedges Unrealized Gains (Losses) on Investments Foreign CTA Estimated Tax Benefit (Expense) Total (In millions) Beginning balance $ 118 $ 8 $ ( 151 ) $ ( 3 ) $ ( 28 ) Other comprehensive income (loss) before reclassifications 141 ( 6 ) ( 90 ) — 45 Less: Amount of gain (loss) reclassified from AOCI 70 ( 1 ) — — 69 Net current period other comprehensive income (loss) 71 ( 5 ) ( 90 ) — ( 24 ) Ending balance $ 189 $ 3 $ ( 241 ) $ ( 3 ) $ ( 52 ) The following table summarizes the changes in accumulated balances of other comprehensive income (loss) for the nine months ended September 30, 2020: Unrealized Gains (Losses) on Cash Flow Hedges Unrealized Gains (Losses) on Investments Foreign CTA Net Investment Hedge CTA Gain (Loss) Estimated Tax Benefit (Expense) Total (In millions) Beginning balance $ 6 $ 2 $ ( 150 ) $ ( 31 ) $ — $ ( 173 ) Other comprehensive income (loss) before reclassifications ( 53 ) 10 ( 111 ) 55 ( 2 ) ( 101 ) Less: Amount of gain reclassified from AOCI 58 — — — — 58 Net current period other comprehensive income (loss) ( 111 ) 10 ( 111 ) 55 ( 2 ) ( 159 ) Ending balance $ ( 105 ) $ 12 $ ( 261 ) $ 24 $ ( 2 ) $ ( 332 ) The following table summarizes the changes in accumulated balances of other comprehensive income (loss) for the nine months ended September 30, 2019: Unrealized Gains (Losses) on Cash Flow Hedges Unrealized Gains (Losses) on Investments Foreign CTA Estimated Tax Benefit (Expense) Total (In millions) Beginning balance $ 182 $ ( 13 ) $ ( 93 ) $ 2 $ 78 Other comprehensive income (loss) before reclassifications 187 15 ( 148 ) ( 5 ) 49 Less: Amount of gain (loss) reclassified from AOCI 180 ( 1 ) — — 179 Net current period other comprehensive income (loss) 7 16 ( 148 ) ( 5 ) ( 130 ) Ending balance $ 189 $ 3 $ ( 241 ) $ ( 3 ) $ ( 52 ) 21 Table of Contents PayPal Holdings, Inc. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) The following tables provide details about reclassifications out of AOCI for the periods presented below: Details about AOCI Components Amount of Gains (Losses) Reclassified from AOCI Affected Line Item in the Statement of Income Three Months Ended September 30, 2020 2019 (In millions) (Losses) gains on cash flow hedges — foreign exchange contracts $ ( 17 ) $ 70 Net revenues Unrealized losses on investments — ( 1 ) Other income (expense), net $ ( 17 ) $ 69 Income before income taxes — — Income tax expense Total reclassifications for the period $ ( 17 ) $ 69 Net income Details about AOCI Components Amount of Gains (Losses) Reclassified from AOCI Affected Line Item in the Statement of Income Nine Months Ended September 30, 2020 2019 (In millions) Gains on cash flow hedges — foreign exchange contracts $ 58 $ 180 Net revenues Unrealized losses on investments — ( 1 ) Other income (expense), net $ 58 $ 179 Income before income taxes — — Income tax expense Total reclassifications for the period $ 58 $ 179 Net income Other Income (Expense), Net The following table reconciles the components of other income (expense), net for the periods presented below: Three Months Ended September 30, Nine Months Ended September 30, 2020 2019 2020 2019 (In millions) Interest income $ 17 $ 47 $ 72 $ 144 Interest expense ( 58 ) ( 29 ) ( 150 ) ( 78 ) Gains (losses) on strategic investments 209 ( 228 ) 973 170 Other ( 1 ) ( 3 ) ( 15 ) ( 12 ) Other income (expense), net $ 167 $ ( 213 ) $ 880 $ 224 22 Table of Contents PayPal Holdings, Inc. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) Note 8— Funds Receivable and Customer Accounts and Investments The following table summarizes the assets underlying our funds receivable and customer accounts, short-term investments, and long-term investments as of September 30, 2020 and December 31, 2019: September 30, 2020 December 31, 2019 (In millions) Funds receivable and customer accounts: Cash and cash equivalents $ 10,987 $ 8,387 Time deposits 289 514 Available-for-sale debt securities 14,786 10,190 Funds receivable 4,468 3,436 Total funds receivable and customer accounts $ 30,530 $ 22,527 Short-term investments: Time deposits $ 1,690 $ 614 Available-for-sale debt securities 6,279 2,734 Restricted cash 77 64 Total short-term investments $ 8,046 $ 3,412 Long-term investments: Time deposits $ 32 $ — Available-for-sale debt securities 1,183 1,025 Restricted cash 6 — Strategic investments 2,218 1,838 Total long-term investments $ 3,439 $ 2,863 As of September 30, 2020 and December 31, 2019, the estimated fair value of our available-for-sale debt securities included within funds receivable and customer accounts, short-term investments, and long-term investments was as follows: September 30, 2020 (1) Gross Amortized Cost Gross Unrealized Gains Gross Unrealized Losses Estimated Fair Value (In millions) Funds receivable and customer accounts: U.S. government and agency securities $ 8,854 $ 6 $ — $ 8,860 Foreign government and agency securities 1,347 2 — 1,349 Corporate debt securities 1,973 1 — 1,974 Short-term investments: U.S. government and agency securities 1,786 — — 1,786 Foreign government and agency securities 1,574 — — 1,574 Corporate debt securities 2,917 2 — 2,919 Long-term investments: Foreign government and agency securities 486 — ( 1 ) 485 Corporate debt securities 696 2 — 698 Total available-for-sale debt securities (2) $ 19,633 $ 13 $ ( 1 ) $ 19,645 (1) “—” Denotes gross unrealized gain or unrealized loss of less than $1 million in a given position. (2) Excludes foreign currency denominated available-for-sale debt securities accounted for under the fair value option. Refer to “Note 9 — Fair Value Measurement of Assets and Liabilities.” 23 Table of Contents PayPal Holdings, Inc. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) December 31, 2019 (1) Gross Amortized Cost Gross Unrealized Gains Gross Unrealized Losses Estimated Fair Value (In millions) Funds receivable and customer accounts: U.S. government and agency securities $ 4,996 $ — $ — $ 4,996 Foreign government and agency securities 1,392 — — 1,392 Corporate debt securities 2,112 — — 2,112 Short-term investments: Foreign government and agency securities 533 — — 533 Corporate debt securities 1,955 — — 1,955 Long-term investments: U.S. government and agency securities 140 — — 140 Foreign government and agency securities 207 — — 207 Corporate debt securities 676 2 — 678 Total available-for-sale debt securities (2) $ 12,011 $ 2 $ — $ 12,013 (1) “—” Denotes gross unrealized gain or unrealized loss of less than $1 million in a given position. (2) Excludes foreign currency denominated available-for-sale debt securities accounted for under the fair value option. Refer to “Note 9 — Fair Value Measurement of Assets and Liabilities.” As of September 30, 2020 and December 31, 2019, the gross unrealized losses and estimated fair value of our available-for-sale debt securities included within funds receivable and customer accounts, short-term investments, and long-term investments for which an allowance for credit losses has not been deemed necessary in the current period, aggregated by length of time those individual securities have been in a continuous loss position, was as follows: September 30, 2020 (1) Less than 12 months 12 months or longer Total Fair Value Gross Unrealized Losses Fair Value Gross Unrealized Losses Fair Value Gross Unrealized Losses (In millions) Funds receivable and customer accounts: U.S. government and agency securities $ 730 $ — $ — $ — $ 730 $ — Foreign government and agency securities 310 — — — 310 — Corporate debt securities 355 — — — 355 — Short-term investments: U.S. government and agency securities 475 — — — 475 — Foreign government and agency securities 131 — — — 131 — Corporate debt securities 142 — — — 142 — Long-term investments: Foreign government and agency securities 463 ( 1 ) — — 463 ( 1 ) Corporate debt securities 291 — — — 291 — Total available-for-sale debt securities $ 2,897 $ ( 1 ) $ — $ — $ 2,897 $ ( 1 ) (1) “—” Denotes gross unrealized loss or fair value of less than $1 million in a given position. 24 Table of Contents PayPal Holdings, Inc. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) December 31, 2019 (1) Less than 12 months 12 months or longer Total Fair Value Gross Unrealized Losses Fair Value Gross Unrealized Losses Fair Value Gross Unrealized Losses (In millions) Funds receivable and customer accounts: U.S. government and agency securities $ 2,452 $ — $ — $ — $ 2,452 $ — Foreign government and agency securities 563 — 30 — 593 — Corporate debt securities 825 — — — 825 — Short-term investments: Foreign government and agency securities 115 — — — 115 — Corporate debt securities 424 — — — 424 — Long-term investments: U.S. government and agency securities 100 — — — 100 — Foreign government and agency securities 75 — — — 75 — Corporate debt securities 27 — 44 — 71 — Total available-for-sale debt securities $ 4,581 $ — $ 74 $ — $ 4,655 $ — (1) “—” Denotes gross unrealized loss or fair value of less than $1 million in a given position. Unrealized losses have not been recognized into income as we neither intend to sell, nor anticipate that it is more likely than not that we will be required to sell, the securities before recovery. The decline in fair value is due primarily to changes in market conditions, rather than credit losses. We will continue to monitor the performance of the investment portfolio and assess whether impairment due to expected credit losses has occurred. Amounts reclassified to earnings from unrealized gains and losses were not material for the three and nine months ended September 30, 2020 and 2019. Our available-for-sale debt securities included within funds receivable and customer accounts, short-term investments, and long-term investments classified by date of contractual maturity were as follows: September 30, 2020 Amortized Cost Fair Value (In millions) One year or less $ 18,106 $ 18,116 After one year through five years 1,526 1,528 After five years through ten years 1 1 Total $ 19,633 $ 19,645 Strategic Investments Our strategic investments include marketable equity securities, which are publicly traded, and non-marketable equity securities, which are investments in privately held companies. Our marketable equity securities have readily determinable fair values and are recorded as long-term investments on our condensed consolidated balance sheets at fair value with changes in fair value recorded in other income (expense), net on our condensed consolidated statements of income. Marketable equity securities totaled $ 1.6 billion and $ 1.3 billion as of September 30, 2020 and December 31, 2019, respectively, including the impact of the sale of securities during the three months ended September 30, 2020. 25 Table of Contents PayPal Holdings, Inc. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) Our non-marketable equity securities are recorded in long-term investments on our condensed consolidated balance sheets. As of September 30, 2020 and December 31, 2019, we had non-marketable equity securities of $ 7 million and $ 27 million, respectively, where we have the ability to exercise significant influence, but not control, over the investee and account for these equity securities using the equity method of accounting. The remaining non-marketable equity securities do not have a readily determinable fair value and we measure these equity investments at cost minus impairment, if any, and adjust for changes resulting from observable price changes in orderly transactions for an identical or similar investment in the same issuer. All gains and losses on these investments, realized and unrealized, and our share of earnings or losses from investments accounted for using the equity method are recognized in other income (expense), net on our condensed consolidated statements of income. The carrying value of our non-marketable equity securities totaled $ 601 million and $ 524 million as of September 30, 2020 and December 31, 2019, respectively. Measurement Alternative Adjustments The adjustments to the carrying value of our non-marketable equity securities accounted for under the Measurement Alternative in the nine months ended September 30, 2020 and 2019 were as follows: Nine Months Ended September 30, 2020 2019 (In millions) Carrying amount, beginning of period $ 497 $ 293 Adjustments related to non-marketable equity securities: Net additions (1) 74 75 Gross unrealized gains 45 133 Gross unrealized losses and impairments ( 22 ) — Carrying amount, end of period $ 594 $ 501 (1) Net additions include additions from purchases, reductions due to sales of securities, and reclassifications when Measurement Alternative is subsequently elected or no longer applies. The following table summarizes the cumulative gross unrealized gains and cumulative gross unrealized losses and impairment related to non-marketable equity securities accounted for under the Measurement Alternative for investments held at September 30, 2020 and December 31, 2019, respectively: September 30, 2020 December 31, 2019 (In millions) Cumulative gross unrealized gains $ 262 $ 230 Cumulative gross unrealized losses and impairment $ ( 27 ) $ ( 5 ) Unrealized gains (losses) on strategic investments, excluding those accounted for using the equity method The following table summarizes the net unrealized gains (losses) on marketable and non-marketable equity securities, excluding those accounted for using the equity method, held at September 30, 2020 and September 30, 2019, respectively: Three Months Ended September 30, Nine Months Ended September 30, 2020 2019 2020 2019 (In millions) Net unrealized gains (losses) $ 162 $ ( 228 ) $ 670 $ 170 26 Table of Contents PayPal Holdings, Inc. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) Note 9— Fair Value Measurement of Assets and Liabilities Financial Assets and Liabilities Measured and Recorded at Fair Value on a Recurring Basis The following tables summarize our financial assets and liabilities measured at fair value on a recurring basis as of September 30, 2020 and December 31, 2019: September 30, 2020 Quoted Prices in Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) (In millions) Assets: Cash and cash equivalents (1) $ 1,200 $ — $ 1,200 Short-term investments (2) : U.S. government and agency securities 1,786 — 1,786 Foreign government and agency securities 1,574 — 1,574 Corporate debt securities 2,919 — 2,919 Total short-term investments $ 6,279 $ — $ 6,279 Funds receivable and customer accounts (3) : Cash and cash equivalents 732 — 732 U.S. government and agency securities 8,860 — 8,860 Foreign government and agency securities 3,810 — 3,810 Corporate debt securities 2,116 — 2,116 Total funds receivable and customer accounts $ 15,518 $ — $ 15,518 Derivatives 121 — 121 Long-term investments (2),(4) : Foreign government and agency securities 485 — 485 Corporate debt securities 698 — 698 Marketable equity securities 1,617 1,617 — Total long-term investments $ 2,800 $ 1,617 $ 1,183 Total financial assets $ 25,918 $ 1,617 $ 24,301 Liabilities: Derivatives $ 221 $ — $ 221 (1) Excludes cash of $ 4.9 billion not measured and recorded at fair value. (2) Excludes restricted cash of $ 83 million and time deposits of $ 1.7 billion not measured and recorded at fair value. (3) Excludes cash, time deposits, and funds receivable of $ 15.0 billion underlying funds receivable and customer accounts not measured and recorded at fair value. (4) Excludes non-marketable equity securities of $ 601 million measured using the Measurement Alternative or equity method accounting. 27 Table of Contents PayPal Holdings, Inc. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) December 31, 2019 Quoted Prices in Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) (In millions) Assets: Cash and cash equivalents (1) $ 2,835 $ — $ 2,835 Short-term investments (2) : Foreign government and agency securities 757 — 757 Corporate debt securities 1,977 — 1,977 Total short-term investments 2,734 — 2,734 Funds receivable and customer accounts (3) : Cash and cash equivalents 683 — 683 U.S. government and agency securities 4,996 — 4,996 Foreign government and agency securities 2,653 — 2,653 Corporate debt securities 2,541 — 2,541 Total funds receivable and customer accounts 10,873 — 10,873 Derivatives 135 — 135 Long-term investments (4) : U.S. government and agency securities 140 — 140 Foreign government and agency securities 207 — 207 Corporate debt securities 678 — 678 Marketable equity securities 1,314 1,314 — Total long-term investments 2,339 1,314 1,025 Total financial assets $ 18,916 $ 1,314 $ 17,602 Liabilities: Derivatives $ 122 $ — $ 122 (1) Excludes cash of $ 4.5 billion not measured and recorded at fair value. (2) Excludes restricted cash of $ 64 million and time deposits of $ 614 million not measured and recorded at fair value. (3) Excludes cash, time deposits, and funds receivable of $ 11.7 billion underlying funds receivable and customer accounts not measured and recorded at fair value. (4) Excludes non-marketable equity securities of $ 524 million measured using the Measurement Alternative or equity method accounting. Our marketable equity securities are valued using quoted prices for identical assets in active markets (Level 1). All other financial assets and liabilities are valued using quoted prices for identical instruments in less active markets, readily available pricing sources for comparable instruments, or models using market observable inputs (Level 2). A majority of our derivative instruments are valued using pricing models that take into account the contract terms as well as multiple inputs where applicable, such as currency rates, interest rate yield curves, option volatility, and equity prices. Our derivative instruments are primarily short-term in nature, generally one month to one year in duration. Certain foreign currency contracts designated as cash flow hedges may have a duration of up to 18 months. As of September 30, 2020 and December 31, 2019, we did not have any assets or liabilities requiring measurement at fair value without observable market values that would require a high level of judgment to determine fair value (Level 3). 28 Table of Contents PayPal Holdings, Inc. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) We elect to account for foreign currency denominated available-for-sale debt securities under the fair value option. Election of the fair value option allows us to recognize any gains and losses from fair value changes on such investments in other income (expense), net on the condensed consolidated statements of income to significantly reduce the accounting asymmetry that would otherwise arise when recognizing the corresponding foreign exchange gains and losses relating to customer liabilities. The following table summarizes the estimated fair value of our available-for-sale debt securities under the fair value option as of September 30, 2020 and December 31, 2019: September 30, 2020 December 31, 2019 (In millions) Funds receivable and customer accounts $ 2,603 $ 1,690 Short-term investments $ — $ 246 The following table summarizes the gains (losses) from fair value changes recognized in other income (expense), net related to the available-for-sale debt securities under the fair value option for the three and nine months ended September 30, 2020 and 2019: Three Months Ended September 30, Nine Months Ended September 30, 2020 2019 2020 2019 (In millions) Funds receivable and customer accounts $ 83 $ ( 86 ) $ 80 $ ( 88 ) Short-term investments $ — $ ( 4 ) $ ( 24 ) $ ( 8 ) Financial Assets and Liabilities Measured and Recorded at Fair Value on a Non-Recurring Basis The following tables summarize our financial assets and liabilities held as of September 30, 2020 and December 31, 2019 for which a non-recurring fair value measurement was recorded during the nine months ended September 30, 2020 and the year ended December 31, 2019, respectively: September 30, 2020 Significant Other Observable Inputs (Level 2) (In millions) Non-marketable equity investments measured using the Measurement Alternative (1) $ 191 $ 191 Other assets (2) 35 35 Total $ 226 $ 226 (1) Excludes non-marketable equity investments of $ 403 million accounted for under the Measurement Alternative for which no observable price changes occurred during the nine months ended September 30, 2020. (2) Consists of ROU lease asset recorded at fair value pursuant to an impairment charge recorded in the second quarter of 2020. See “Note 6—Leases” for additional information. December 31, 2019 Significant Other Observable Inputs (Level 2) (In millions) Non-marketable equity investments measured using the Measurement Alternative (1) $ 303 $ 303 (1) Excludes non-marketable equity investments of $ 194 million accounted for under the Measurement Alternative for which no observable price changes occurred during the year ended December 31, 2019. We measure the non-marketable equity investments accounted for under the Measurement Alternative at cost minus impairment, if any, adjusted for observable price changes in orderly transactions for an identical or similar investment in the same issuer. Impairment losses on ROU lease assets related to office operating leases are calculated using rent per square foot derived from observable market data. 29 Table of Contents PayPal Holdings, Inc. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) Financial Assets and Liabilities Not Measured and Recorded at Fair Value Our financial instruments, including cash, restricted cash, time deposits, loans and interest receivable, net, certain customer accounts, and notes receivable are carried at amortized cost, which approximates their fair value. Our fixed rate debt had a carrying value of approximately $ 8.9 billion and fair value of approximately $ 9.6 billion as of September 30, 2020. Our fixed rate debt had a carrying value and fair value of approximately $ 5.0 billion as of December 31, 2019. If these financial instruments were measured at fair value in the financial statements, cash would be classified as Level 1; restricted cash, time deposits, certain customer accounts, and long-term debt would be classified as Level 2; and the remaining financial instruments would be classified as Level 3 in the fair value hierarchy. Note 10— Derivative Instruments Summary of Derivative Instruments Our primary objective in holding derivatives is to reduce the volatility of earnings and cash flows associated with changes in foreign currency exchange rates. Our derivatives expose us to credit risk to the extent that our counterparties may be unable to meet the terms of the arrangement. We seek to mitigate such risk by limiting our counterparties to, and by spreading the risk across, major financial institutions and by entering into collateral security arrangements. In addition, the potential risk of loss with any one counterparty resulting from this type of credit risk is monitored on an ongoing basis. We do not use any derivative instruments for trading or speculative purposes. Cash Flow Hedges We transact business in various foreign currencies and have significant international revenues and costs denominated in foreign currencies, which subjects us to foreign currency risk. We have a foreign currency exposure management program in which we designate certain foreign currency exchange contracts, generally with maturities of 18 months or less, to reduce the volatility of cash flows primarily related to forecasted revenues denominated in foreign currencies. The objective of the foreign currency exchange contracts is to help mitigate the risk that the U.S. dollar-equivalent cash flows are adversely affected by changes in the applicable U.S. dollar/foreign currency exchange rate. These derivative instruments are designated as cash flow hedges and accordingly, the derivative’s gain or loss is initially reported as a component of AOCI and subsequently reclassified into revenue in the same period the forecasted transaction affects earnings. We evaluate the effectiveness of our foreign currency exchange contracts on a quarterly basis by comparing the critical terms of the derivative instruments with the critical terms of the forecasted cash flows of the hedged item; if the critical terms are the same, we conclude the hedge will be perfectly effective. We did not exclude any component of the changes in fair value of the derivative instruments from the assessment of hedge effectiveness. We report cash flows arising from derivative instruments consistent with the classification of cash flows from the underlying hedged items that these derivatives are hedging. Accordingly, the cash flows associated with derivatives designated as cash flow hedges are classified in cash flows from operating activities on our condensed consolidated statements of cash flows. As of September 30, 2020, we estimate that $ 84 million of net derivative losses related to our cash flow hedges included in AOCI are expected to be reclassified into earnings within the next 12 months. During the three and nine months ended September 30, 2020 and 2019, we did not discontinue any cash flow hedges because it was probable that the original forecasted transaction would not occur and as such, did not reclassify any gains or losses to earnings prior to the occurrence of the hedged transaction. If we elect to discontinue our cash flow hedges and it is probable that the original forecasted transaction will occur, we continue to report the derivative’s gain or loss in AOCI until the forecasted transaction affects earnings, at which point we also reclassify it into earnings. Gains and losses on derivatives held after we discontinue our cash flow hedges and gains and losses on derivative instruments that are not designated as cash flow hedges are recorded in the same financial statement line item to which the derivative relates. 30 Table of Contents PayPal Holdings, Inc. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) Net Investment Hedge We used a forward foreign currency exchange contract to reduce the foreign currency exchange risk related to our investment in a foreign subsidiary. This derivative was designated as a net investment hedge and accordingly, the derivative’s gain and loss was recorded in AOCI as part of foreign currency translation. During the second quarter of 2020, this derivative matured. The accumulated gains and losses associated with this instrument will remain in AOCI until the foreign subsidiary is sold or substantially liquidated, at which point they will be reclassified into earnings. The cash flow associated with the derivative designated as a net investment hedge is classified in cash flows from investing activities on our condensed consolidated statements of cash flows. During the nine months ended September 30, 2020, we recognized $ 55 million in unrealized gain on the foreign currency exchange contract designated as a net investment hedge within the foreign currency translation section of other comprehensive income. As of September 30, 2019, we did no t have a net investment hedge. We have no t reclassified any gains or losses from AOCI into earnings during any of the periods presented. Foreign Currency Exchange Contracts Not Designated As Hedging Instruments We have a foreign currency exposure management program in which we use foreign currency exchange contracts to offset the foreign currency exchange risk on our assets and liabilities denominated in currencies other than the functional currency of our subsidiaries. These contracts are not designated as hedging instruments and reduce, but do not entirely eliminate, the impact of foreign currency exchange rate movements on our assets and liabilities. The gains and losses due to remeasurement of certain foreign currency denominated monetary assets and liabilities are recorded in other income (expense), net, which are offset by the gains and losses on these foreign currency exchange contracts. The cash flows associated with our non-designated derivatives that hedge foreign currency denominated monetary assets and liabilities are classified in cash flows from operating activities on our condensed consolidated statements of cash flows. Fair Value of Derivative Contracts The fair value of our outstanding derivative instruments as of September 30, 2020 and December 31, 2019 was as follows: Balance Sheet Location September 30, 2020 December 31, 2019 (In millions) Derivative Assets: Foreign currency exchange contracts designated as hedging instruments Other current assets $ 13 $ 45 Foreign currency exchange contracts designated as hedging instruments Other assets (non-current) — 1 Foreign currency exchange contracts not designated as hedging instruments Other current assets 108 89 Total derivative assets $ 121 $ 135 Derivative Liabilities: Foreign currency exchange contracts designated as hedging instruments Other current liabilities $ 97 $ 58 Foreign currency exchange contracts designated as hedging instruments Other long-term liabilities 21 13 Foreign currency exchange contracts not designated as hedging instruments Other current liabilities 103 51 Total derivative liabilities $ 221 $ 122 31 Table of Contents PayPal Holdings, Inc. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) Master Netting Agreements - Rights of Setoff Under master netting agreements with respective counterparties to our foreign currency exchange contracts, subject to applicable requirements, we are allowed to net settle transactions of the same type with a single net amount payable by one party to the other. However, we have elected to present the derivative assets and derivative liabilities on a gross basis on our condensed consolidated balance sheets. Rights of setoff associated with our foreign currency exchange contracts represented a potential offset to both assets and liabilities by $ 85 million as of September 30, 2020 and $ 92 million as of December 31, 2019. We have entered into collateral security arrangements that provide for collateral to be received or posted when the net fair value of certain financial instruments fluctuates from contractually established thresholds. The following table provides the collateral exchanged: September 30, 2020 December 31, 2019 (In millions) Cash collateral posted (1) $ 111 $ 12 Cash collateral received (2) $ — $ 39 (1) Right to reclaim cash collateral related to our derivative liabilities recognized in other current assets on our condensed consolidated balance sheets. (2) Obligation to return counterparty cash collateral related to our derivative assets recognized in other current liabilities on our condensed consolidated balance sheets. Effect of Derivative Contracts on Condensed Consolidated Statements of Income The following table provides the location in the condensed consolidated statements of income and amount of recognized gains or losses related to our derivative instruments designated as hedging instruments: Three Months Ended September 30, Nine Months Ended September 30, 2020 2019 2020 2019 (In millions) Net revenues Total amounts presented in the condensed consolidated statements of income in which the effects of cash flow hedges are recorded $ 5,459 $ 4,378 $ 15,338 $ 12,811 Gains (losses) on foreign exchange contracts designated as cash flow hedges reclassified from AOCI $ ( 17 ) $ 70 $ 58 $ 180 The following table provides the location in the condensed consolidated statements of income and amount of recognized gains or losses related to our derivative instruments not designated as hedging instruments: Three Months Ended September 30, Nine Months Ended September 30, 2020 2019 2020 2019 (In millions) Gains (losses) on foreign exchange contracts recognized in other income (expense), net $ ( 40 ) $ 31 $ ( 8 ) $ 30 Losses on equity derivative contracts recognized in other income (expense), net (1) ( 64 ) — ( 64 ) — Total gains (losses) recognized from contracts not designated as hedging instruments $ ( 104 ) $ 31 $ ( 72 ) $ 30 (1) During the three months ended September 30, 2020, equity derivative contracts were entered into and matured which related to the sale of a portion of a strategic investment. The cash flows associated with the equity derivative contracts are classified in cash flows from investing activities on our condensed consolidated statements of cash flows. 32 Table of Contents PayPal Holdings, Inc. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) Notional Amounts of Derivative Contracts Derivative transactions are measured in terms of the notional amount; however, this amount is not recorded on the balance sheet and is not, when viewed in isolation, a meaningful measure of the risk profile of the derivative instruments. The notional amount is generally not exchanged, but is used only as the underlying basis on which the value of foreign currency exchange payments under these contracts is determined. The following table provides the notional amounts of our outstanding derivatives: September 30, 2020 December 31, 2019 (In millions) Foreign exchange contracts designated as hedging instruments $ 4,017 $ 4,550 Foreign exchange contracts not designated as hedging instruments 12,930 17,131 Total $ 16,947 $ 21,681 Note 11— Loans and Interest Receivable We offer credit products to consumers and certain small and medium-sized merchants. We work with an independent chartered financial institution that extends credit to merchants using our credit products in the U.S. We purchase receivables related to credit extended to U.S. merchants by the independent chartered financial institution and are responsible for servicing functions related to that portfolio. During the nine months ended September 30, 2020 and 2019, we purchased approximately $ 1.5 billion and $ 3.4 billion in merchant receivables, respectively. Consumer Receivables We offer revolving and installment credit products to consumers who choose PayPal Credit at checkout. The majority of installment loans allow consumers to pay for a product over periods of 12 months or less. As of September 30, 2020 and December 31, 2019, the outstanding balance of consumer receivables, which primarily consisted of revolving loans and interest receivable due from international consumer accounts, was $ 1.6 billion and $ 1.3 billion, respectively. We closely monitor the credit quality of our consumer receivables to evaluate and manage our related exposure to credit risk. Credit risk management begins with initial underwriting and continues through to full repayment of a loan. To assess a consumer who requests a loan, we use, among other indicators, internally developed risk models using detailed information from external sources, such as credit bureaus where available, and internal historical experience, including the consumer’s prior repayment history with PayPal Credit products where available. We use delinquency status and trends to assist in making new and ongoing credit decisions, to adjust our models, to plan our collection practices and strategies, and in determining our allowance for consumer loans and interest receivable. 33 Table of Contents PayPal Holdings, Inc. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) Consumer Receivables Delinquency and Allowance The following table presents the delinquency status of consumer loans and interest receivable at September 30, 2020 and December 31, 2019. Since our consumer loans are primarily revolving in nature, they are disclosed in the aggregate and not by year of origination. The amounts are based on the number of days past the billing date. The “current” category represents balances that are within 29 days of the billing date. September 30, 2020 December 31, 2019 Amortized Cost Basis Revolving Percent Amortized Cost Basis Revolving Percent (In millions, except percentages) Current $ 1,593 98.2 % $ 1,279 96.7 % 30-59 days 11 0.7 % 15 1.1 % 60-89 days 6 0.4 % 9 0.7 % 90-179 days 12 0.7 % 19 1.5 % Total consumer loans and interest receivable (1), (2), (3) $ 1,622 100.0 % $ 1,322 100.0 % (1) Excludes receivables from other consumer credit products of $ 57 million and $ 92 million at September 30, 2020 and December 31, 2019, respectively. (2) Includes installment loans of $ 216 million and $ 80 million at September 30, 2020 and December 31, 2019, respectively, substantially all of which were current and originated within the past 12 months. (3) Balances at September 30, 2020 include the impact of payment holidays provided primarily in the second quarter of 2020 by the Company to some consumers as a part of our COVID-19 payment relief initiatives. The following table summarizes the activity in the allowance for consumer loans and interest receivable for the nine months ended September 30, 2020 and 2019: September 30, 2020 September 30, 2019 Consumer Loans Receivable Interest Receivable Total Allowance (1) Consumer Loans Receivable Interest Receivable Total Allowance (1) (In millions) Beginning balance $ 49 $ 8 $ 57 $ 27 $ 3 $ 30 Adjustment for adoption of credit losses accounting standard 24 4 28 — — — Provisions 227 47 274 18 6 24 Charge-offs ( 57 ) ( 10 ) ( 67 ) ( 30 ) ( 4 ) ( 34 ) Recoveries (2) 21 — 21 25 — 25 Other (3) 7 1 8 ( 1 ) — ( 1 ) Ending balance $ 271 $ 50 $ 321 $ 39 $ 5 $ 44 (1) Excludes allowances from other consumer credit products of $ 4 million and $ 11 million at September 30, 2020 and September 30, 2019, respectively. (2) The recoveries were primarily related to fully charged-off U.S. consumer credit receivables not subject to the sale to Synchrony. (3) Includes amounts related to foreign currency remeasurement. Provisions for the nine months ended September 30, 2020 were primarily attributable to changes in current and projected macroeconomic conditions which resulted in approximately $ 200 million of provisions, and included the impact of qualitative adjustments primarily to account for the impact of payment holidays provided as part of our COVID-19 payment relief initiatives. Additionally, originations and changes in credit quality resulted in approximately $ 70 million of provisions for the nine months ended September 30, 2020. Changes to the charge-offs for the nine months ended September 30, 2020 were primarily attributable to the overall growth in our portfolio. The provision for credit losses relating to our consumer loans receivable portfolio is recognized in transaction and credit losses on our condensed consolidated statements of income. The provision for interest receivable due to interest earned on our consumer loans receivable portfolio is recognized in revenues from other value added services as a reduction to revenue. Loans receivable past the payment due date continue to accrue interest until they are charged off. 34 Table of Contents PayPal Holdings, Inc. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) We charge off consumer receivable balances in the month in which a customer’s balance becomes 180 days past the billing date. Bankrupt accounts are charged off within 60 days after receipt of notification of bankruptcy. Charge-offs that are recovered are recorded as a reduction to our allowance for loans and interest receivable. Merchant Receivables We offer business financing solutions to certain small and medium-sized merchants through our PayPal Working Capital (“PPWC”) and PayPal Business Loan (“PPBL”) products. As of September 30, 2020 and December 31, 2019, the total outstanding balance in our pool of merchant loans, advances, and interest and fees receivable was $ 1.7 billion and $ 2.8 billion, respectively, net of the participation interest sold to an independent chartered financial institution of $ 77 million and $ 124 million, respectively. Through our PPWC product, merchants can borrow a certain percentage of their annual payment volume processed by PayPal and are charged a fixed fee for the loan or advance based on the overall credit assessment of the merchant. Loans and advances are repaid through a fixed percentage of the merchant’s future payment volume that PayPal processes. Through our PPBL product, we provide merchants with access to short-term business financing for a fixed fee based on an evaluation of the applying business as well as the business owner. PPBL repayments are collected through periodic payments until the balance has been satisfied. The interest or fee is fixed at the time the loan or advance is extended and is recognized as deferred revenues included in accrued expenses and other current liabilities on our condensed consolidated balance sheets. The fixed interest or fee is amortized to revenues from other value added services based on the amount repaid over the repayment period. We estimate the repayment period for PPWC based on the merchant’s payment processing history with PayPal, where available. For PPWC, there is a general requirement that at least 10 % of the original amount of the loan or advance plus the fixed fee must be repaid every 90 days. We calculate the repayment rate of the merchant’s future payment volume so that repayment of the loan or advance and fixed fee is expected to generally occur within 9 to 12 months from the date of the loan or advance. On a monthly basis, we recalculate the repayment period based on the repayment activity on the receivable. As such, actual repayment periods are dependent on actual merchant payment processing volumes. For PPBL, we receive fixed periodic payments over the contractual term of the loan which generally ranges from 3 to 12 months. We actively monitor receivables with repayment periods greater than the original expected or contractual repayment period. We closely monitor credit quality for our merchant loans and advances that we extend or purchase so that we can evaluate, quantify, and manage our credit risk exposure. To assess a merchant seeking a business financing loan or advance, we use, among other indicators, risk models developed internally which utilize information obtained from multiple internal and external data sources to predict the likelihood of timely and satisfactory repayment by the merchant of the loan or advance amount and the related interest or fee. Primary drivers of the models include the merchant’s annual payment volume, payment processing history with PayPal, and prior repayment history with PayPal’s credit products where available, information sourced from consumer credit bureau and business credit bureau reports, and other information obtained during the application process. We use delinquency status and trends to assist in making (or, in the U.S., to assist the independent chartered financial institution in making) ongoing credit decisions, to adjust our internal models, to plan our collection strategies, and in determining our allowance for these loans and advances. 35 Table of Contents PayPal Holdings, Inc. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) Merchant Receivables Delinquency and Allowance The following table presents the delinquency status of the principal amount of merchant loans, advances, and interest and fees receivable by year of origination. The amounts are based on the number of days past the expected or contractual repayment date for amounts outstanding. The “current” category represents balances that are within 29 days of the contractual repayment dates, or within 29 days of the expected repayment date. September 30, 2020 (In millions, except percentages) 2020 2019 2018 2017 2016 Total Percent Current $ 931 $ 409 $ 8 $ — $ — $ 1,348 77.6 % 30 - 59 Days 67 75 6 — — 148 8.5 % 60 - 89 Days 27 40 4 — — 71 4.1 % 90 - 179 Days 40 99 11 — — 150 8.6 % 180+ Days 1 14 4 1 — 20 1.2 % Total (1) $ 1,066 $ 637 $ 33 $ 1 $ — $ 1,737 100 % (1) Balances include the impact of payment holidays provided primarily during the second quarter of 2020 by the Company as a part of our COVID-19 payment relief initiatives. The following table presents our estimate of the principal amount of merchant loans, advances, and interest and fees receivable past their original expected or contractual repayment period as of December 31, 2019, prior to the adoption of the new credit losses accounting guidance as described in “Note 1—Overview and Summary of Significant Accounting Policies.” December 31, 2019 (In millions, except percentages) Within Original Expected Repayment Period 30 - 59 Days Greater 60 - 89 Days Greater 90 - 180 Days Greater 180+ Days Total Past Original Expected Repayment Period Total $ 2,523 $ 115 $ 61 $ 100 $ 17 $ 293 $ 2,816 89.6 % 4.1 % 2.1 % 3.6 % 0.6 % 10.4 % 100 % The following table summarizes the activity in the allowance for merchant loans, advances, and interest and fees receivable, for the nine months ended September 30, 2020 and 2019: September 30, 2020 September 30, 2019 Merchant Loans and Advances Interest and Fees Receivable Total Allowance Merchant Loans and Advances Interest and Fees Receivable Total Allowance (In millions) Beginning balance $ 171 $ 20 $ 191 $ 115 $ 15 $ 130 Adjustment for adoption of credit losses accounting standard 165 17 182 — — — Provisions 298 27 325 181 22 203 Charge-offs ( 197 ) ( 20 ) ( 217 ) ( 140 ) ( 16 ) ( 156 ) Recoveries 13 — 13 11 — 11 Ending balance $ 450 $ 44 $ 494 $ 167 $ 21 $ 188 36 Table of Contents PayPal Holdings, Inc. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) Provisions for the nine months ended September 30, 2020 were primarily attributable to changes in current and projected macroeconomic conditions which resulted in approximately $ 150 million of provisions, and included the impact of qualitative adjustments to mainly account for the impact of limitations in our expected credit loss models that have arisen due to the extreme fluctuations in both the actual and projected macroeconomic conditions during the period as well as to incorporate varying degrees of merchant performance in the current environment and expected performance in future periods. Additionally, originations occurring primarily in the first quarter of 2020 resulted in approximately $ 115 million of provisions and changes in credit quality resulted in approximately $ 55 million of provisions for the nine months ended September 30, 2020. Changes to the charge-offs for the nine months ended September 30, 2020 were primarily attributable to a significant expansion of the portfolio in 2019 and a decline in transaction processing volume on our Payments Platform for certain merchants which adversely impacted the delinquency of our merchant loans, advances, and interest and fees receivable portfolio. For merchant loans and advances, the determination of delinquency is based on the current expected or contractual repayment period of the loan or advance and fixed interest or fee payment as compared to the original expected or contractual repayment period. We charge off the receivables outstanding under our PPBL product when the repayments are 180 days past the contractual repayment date. We charge off the receivables outstanding under our PPWC product when the repayments are 180 days past our expectation of repayments and the merchant has not made a payment in the last 60 days, or when the repayments are 360 days past due regardless of whether the merchant has made a payment within the last 60 days. Bankrupt accounts are charged off within 60 days of receiving notification of bankruptcy. The provision for credit losses on merchant loans and advances is recognized in transaction and credit losses, and the provision for interest and fees receivable is recognized as a reduction of deferred revenues included in accrued expenses and other current liabilities on our condensed consolidated balance sheets. Charge-offs that are recovered are recorded as a reduction to our allowance for loans and interest receivable. Troubled Debt Restructurings (“TDRs”) In instances where a merchant is able to demonstrate that they are experiencing financial difficulty, we may modify loans or advances (or, in the U.S., the independent chartered financial institution may modify loans) and the related interest receivable for which it is probable that without modification we will be unable to collect all amounts due. These modifications are intended to provide merchants with financial relief, and to help enable us to mitigate losses. These modifications include an increase in term by 1 to 5.5 years while moving the delinquency status to current. Further, certain loans and advances have been modified to replace the initial fixed fee structure at the time the loan or advance was extended to a fixed annual percentage rate applied over the amended remaining term, which will continue to accrue interest at the fixed rate until the earlier of maturity or charge-off. These modifications had a de minimis impact on our condensed consolidated statements of income in the three and nine months ended September 30, 2020. Allowances for TDRs are assessed separately from other loans within our portfolio and are determined by estimating expected lifetime credit losses utilizing the modified term and interest rate assumptions. Historical loss estimates are utilized in addition to macroeconomic assumptions to determine expected loss rates. Further, we include qualitative adjustments that incorporate incremental information not captured in the quantitative estimates of our expected lifetime credit losses. The following table shows the merchant loans and interest receivables which have been modified as TDRs in the three and nine months ended September 30, 2020: Number of Accounts (in thousands) Outstanding Balances (1) (in millions) Weighted Average Payment Term Extensions (in months) Loans and interest receivable 6 $ 238 38 (1) Balances are as of modification date. A merchant is considered in payment default after a modification when the merchant's payment becomes 60 days past their expected or contractual repayment date. For loans that have defaulted after being modified, the increased estimate of expected lifetime credit loss is factored into overall expected credit losses. As of September 30, 2020, there were no merchant loans and interest receivables classified as TDRs that have subsequently defaulted on payments. 37 Table of Contents PayPal Holdings, Inc. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) Note 12— Debt Long-term Debt Fixed Rate Notes On May 18, 2020, we issued fixed rate notes with varying maturity dates for an aggregate principal amount of $ 4.0 billion. Interest on these notes is payable on June 1 and December 1 of each year, beginning on December 1, 2020. We may redeem the notes in whole, at any time, or in part, from time to time, prior to maturity, at the redemption price. Upon the occurrence of both a change of control of the Company and a downgrade of the notes below an investment grade rating, we will be required to offer to repurchase each series of notes at a price equal to 101 % of the then outstanding principal amount, plus accrued and unpaid interest. The notes are subject to covenants including limitations on our ability to create liens on our assets, enter into sale and leaseback transactions, and merge or consolidate with another entity, in each case subject to certain exceptions, limitations, and qualifications. Proceeds from the issuance of these notes may be used for general corporate purposes, which may include funding the repayment or redemption of outstanding debt, share repurchases, ongoing operations, capital expenditures, and possible acquisitions of businesses, assets, or strategic investments. On September 26, 2019, we issued fixed rate notes with varying maturity dates for an aggregate principal amount of $ 5.0 billion. The notes issued from the May 2020 and September 2019 debt issuances are senior unsecured obligations and are collectively referred to as the “Notes.” As of September 30, 2020, we had an outstanding aggregate principal amount of $ 9.0 billion related to the Notes. The following table summarizes the Notes: Balance at September 30, 2020 Maturities Amount Effective Interest Rate (in millions) September 2019 debt issuance of $ 5.0 billion: Fixed-rate 2.200 % notes 9/26/2022 $ 1,000 2.39 % Fixed-rate 2.400 % notes 10/1/2024 1,250 2.52 % Fixed-rate 2.650 % notes 10/1/2026 1,250 2.78 % Fixed-rate 2.850 % notes 10/1/2029 1,500 2.96 % May 2020 debt issuance of $ 4.0 billion: Fixed-rate 1.350 % notes 6/1/2023 $ 1,000 1.55 % Fixed-rate 1.650 % notes 6/1/2025 1,000 1.78 % Fixed-rate 2.300 % notes 6/1/2030 1,000 2.39 % Fixed-rate 3.250 % notes 6/1/2050 1,000 3.33 % Total term debt $ 9,000 Unamortized premium (discount) and issuance costs, net ( 63 ) Total carrying amount of term debt $ 8,937 The effective interest rates for the Notes include interest on the Notes, amortization of debt issuance costs, and amortization of the debt discount. The interest expense recorded for the Notes, including amortization of the debt discount and debt issuance costs, was $ 56 million and $ 134 million for the three and nine months ended September 30, 2020, respectively. The interest expense recorded for the Notes, including amortization of the debt discount and debt issuance costs, was $ 2 million for the three and nine months ended September 30, 2019. 38 Table of Contents PayPal Holdings, Inc. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) Five-Year Revolving Credit Facility In September 2019, we entered into a credit agreement (the “Credit Agreement”) that provides for an unsecured $ 5.0 billion, five-year revolving credit facility that includes a $ 150 million letter of credit sub-facility and a $ 500 million swingline sub-facility, with available borrowings under the revolving credit facility reduced by the amount of any letters of credit and swingline borrowings outstanding from time to time. We have designated certain subsidiaries as additional borrowers under the Credit Agreement for which a portion of the borrowing capacity of the facility is available to them. In March 2020, we drew down $ 3.0 billion under the Credit Agreement. In May 2020, we repaid the $ 3.0 billion using proceeds from the May 2020 debt issuance. As of September 30, 2020, no amounts were outstanding under the Credit Agreement, and accordingly, $ 5.0 billion of borrowing capacity was available for the purposes permitted by the Credit Agreement, subject to customary conditions to borrowing. The total interest expense and fees we recorded related to the Credit Agreement was approximately $ 1 million and $ 14 million for the three and nine months ended September 30, 2020, respectively. Other Available Facilities We also maintain uncommitted credit facilities in various regions throughout the world, with borrowing capacity of approximately $ 130 million in the aggregate. This available credit includes facilities where we can withdraw and utilize the funds at our discretion for general corporate purposes. Interest rate terms for these facilities vary by region and reflect prevailing market rates for companies with strong credit ratings. As of September 30, 2020, substantially all of the borrowing capacity under these credit facilities was available, subject to customary conditions to borrowing. Future Principal Payments As of September 30, 2020, the future principal payments associated with our long term debt were as follows (in millions): Remaining 2020 $ — 2021 — 2022 1,000 2023 1,000 2024 1,250 Thereafter 5,750 Total $ 9,000 Other than as provided above, there are no significant changes to the information disclosed in our 2019 Form 10-K. Note 13— Commitments and Contingencies Commitments As of September 30, 2020 and December 31, 2019, approximately $ 2.7 billion and $ 3.1 billion, respectively, of unused credit was available to PayPal Credit account holders. Substantially all of the PayPal Credit account holders with unused credit are in the U.K. While this amount represents the total unused credit available, we have not experienced, and do not anticipate, that all our PayPal Credit account holders will access their entire available credit at any given point in time. In addition, the individual lines of credit that make up this unused credit are subject to periodic review and termination based on, among other things, account usage and customer creditworthiness. 39 Table of Contents PayPal Holdings, Inc. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) Litigation and Regulatory Matters Overview We are involved in legal and regulatory proceedings on an ongoing basis. Many of these proceedings are in early stages and may seek an indeterminate amount of damages. If we believe that a loss arising from such matters is probable and can be reasonably estimated, we accrue the estimated liability in our financial statements. If only a range of estimated losses can be determined, we accrue an amount within the range that, in our judgment, reflects the most likely outcome; if none of the estimates within that range is a better estimate than any other amount, we accrue the low end of the range. For those proceedings in which an unfavorable outcome is reasonably possible but not probable, we have disclosed an estimate of the reasonably possible loss or range of losses or we have concluded that an estimate of the reasonably possible loss or range of losses arising directly from the proceeding (i.e., monetary damages or amounts paid in judgment or settlement) are not material. If we cannot estimate the probable or reasonably possible loss or range of losses arising from a legal proceeding, we have disclosed that fact. In assessing the materiality of a legal proceeding, we evaluate, among other factors, the amount of monetary damages claimed, as well as the potential impact of non-monetary remedies sought by plaintiffs (e.g., injunctive relief) that may require us to change our business practices in a manner that could have a material adverse impact on our business. With respect to the matters disclosed in this Note 13, we are unable to estimate the possible loss or range of losses that could potentially result from the application of such non-monetary remedies. Amounts accrued for legal and regulatory proceedings for which we believe a loss is probable were not material for the nine months ended September 30, 2020. Except as otherwise noted for the proceedings described in this Note 13, we have concluded, based on currently available information, that reasonably possible losses arising directly from the proceedings (i.e., monetary damages or amounts paid in judgment or settlement) in excess of our recorded accruals are also not material. However, legal and regulatory proceedings are inherently unpredictable and subject to significant uncertainties. If one or more matters were resolved against us in a reporting period for amounts in excess of management’s expectations, the impact on our operating results or financial condition for that reporting period could be material. Regulatory Proceedings We are required to comply with U.S. economic and trade sanctions administered by the U.S. Department of the Treasury’s Office of Foreign Assets Control (“OFAC”). We have self-reported to OFAC certain transactions that were inadvertently processed but subsequently identified as possible violations of U.S. economic and trade sanctions. In March 2015, we reached a settlement with OFAC regarding possible violations arising from our sanctions compliance practices between 2009 and 2013, prior to the implementation of our real-time transaction scanning program. Subsequently, we have self-reported additional transactions as possible violations, and we have received new subpoenas from OFAC seeking additional information about certain of these transactions. Such self-reported transactions could result in claims or actions against us, including litigation, injunctions, damage awards, fines or penalties, or require us to change our business practices in a manner that could result in a material loss, require significant management time, result in the diversion of significant operational resources, or otherwise harm our business. On March 28, 2016, we received a Civil Investigative Demand (“CID”) from the Federal Trade Commission (“FTC”) as part of its investigation to determine whether we, through our Venmo service, have been or are engaged in deceptive or unfair practices in violation of the Federal Trade Commission Act. The CID requested the production of documents and answers to written questions related to our Venmo service. We have cooperated with the FTC in connection with the CID. On February 27, 2018, we entered into a Consent Order with the FTC in which we settled potential allegations arising from our Venmo services between 2013 and 2017. The Consent Order does not contain a monetary penalty, but requires PayPal to make various changes to Venmo’s disclosures and business practices. The FTC approved the final Consent Order on May 24, 2018. Any failure to comply with the Consent Order may increase the possibility of additional adverse consequences, including litigation, additional regulatory actions, injunctions, or monetary penalties, or require further changes to our business practices, significant management time, or the diversion of significant operational resources, all of which could result in a material loss or otherwise harm our business. 40 Table of Contents PayPal Holdings, Inc. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) PayPal Australia Pty Limited (“PPAU”) self-reported a potential violation to the Australian Transaction Reports and Analysis Centre (“AUSTRAC”) on May 22, 2019. This self-reported matter relates to PPAU incorrectly filing required international funds transfer instructions over a period of time under the Anti-Money Laundering and Counter-Terrorism Financing Act 2006 (“AML/CTF Act”). On September 23, 2019, PPAU received a notice from AUSTRAC requiring that PPAU appoint an external auditor (a partner of a firm which is not our independent auditor) to review certain aspects of PPAU’s compliance with its obligations under the AML/CTF Act. The external auditor was appointed on November 1, 2019. As required under the terms of AUSTRAC’s notice, as amended, PPAU issued interim reports to AUSTRAC on December 31, 2019, March 13, 2020, May 6, 2020 and July 7, 2020 and a final report on August 31, 2020. PPAU is continuing to cooperate with AUSTRAC in this matter, including remediation activities and future reporting to AUSTRAC of international funds transfer instructions based on the operation of the AML/CTF Act. We cannot estimate the potential impact, if any, on our business or financial statements at this time. An adverse outcome arising from any associated proceeding or further matter initiated by AUSTRAC could result in measures beyond AUSTRAC's supervisory process, including enforceable undertakings, injunctions, damage awards, fines or penalties, or require us to change our business practices in a manner that could result in a material loss, require significant management time, result in the diversion of significant operational resources, or otherwise harm our business. Legal Proceedings In November 2017, we announced that we had suspended the operations of TIO Networks (“TIO”) as part of an ongoing investigation of security vulnerabilities of the TIO platform. On December 1, 2017, we announced that we had identified evidence of unauthorized access to TIO’s network, including locations that stored personal information of some of TIO’s customers and customers of TIO billers and the potential compromise of personally identifiable information for approximately 1.6 million customers. We have received a number of governmental inquiries, including from state attorneys general, and we may be subject to additional governmental inquiries and investigations in the future. In addition, on December 6, 2017, a putative class action lawsuit captioned Sgarlata v. PayPal Holdings, Inc., et al. , Case No. 3:17-cv-06956-EMC was filed in the U.S. District Court for the Northern District of California (the “Court”) against the Company, its Chief Executive Officer, its Chief Financial Officer and Hamed Shahbazi, the former chief executive officer of TIO (the “Defendants”) alleging violations of federal securities laws. The initial complaint alleged that Defendants made false or misleading statements or failed to disclose that TIO’s data security program was inadequate to safeguard the personally identifiable information of its users, those vulnerabilities threatened continued operation of TIO’s platform, the Company’s revenues derived from TIO services were thus unsustainable, and consequently, the Company overstated the benefits of the TIO acquisition, and, as a result, the Company’s public statements were materially false and misleading at all relevant times. The plaintiff who initiated the lawsuit sought to represent a class of shareholders who acquired shares of the Company’s common stock between February 14, 2017 through December 1, 2017 and sought damages and attorneys’ fees, among other relief. On March 16, 2018, the Court appointed two new plaintiffs, not the original plaintiff who filed the case, as interim co-lead plaintiffs in the case and appointed two law firms as interim co-lead counsel. On June 13, 2018, the interim co-lead plaintiffs filed a first amended complaint, which named TIO Networks ULC, TIO Networks USA, Inc., and John Kunze (at that time, the Company’s Vice President, Global Consumer Products and Xoom) as additional defendants. The first amended complaint was purportedly brought on behalf of all persons other than the Defendants who acquired the Company’s securities between November 10, 2017 and December 1, 2017. The amended complaint alleged that the Company’s and TIO’s November 10, 2017 announcement of the suspension of TIO’s operations was false and misleading because the announcement only disclosed security vulnerabilities on TIO’s platform, rather than an actual security breach that Defendants were allegedly aware of at the time of the announcement. Defendants’ filed their motion to dismiss the first amended complaint on July 13, 2018 and the Court granted the motion, without prejudice, on December 13, 2018. Plaintiffs filed a second amended complaint on January 14, 2019. The second amended complaint alleges substantially the same theory of liability as the first amended complaint, but no longer names Hamed Shabazi as a defendant. The remaining Defendants filed their motion to dismiss the second amended complaint on March 15, 2019, and a hearing was held on July 16, 2019. The court granted Defendant’s motion to dismiss with prejudice on September 18, 2019; plaintiffs have appealed the dismissal and the appeal is pending. We may be subject to additional litigation relating to TIO’s data security platform or the suspension of TIO’s operations in the future. 41 Table of Contents PayPal Holdings, Inc. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) General Matters Other third parties have from time to time claimed, and others may claim in the future, that we have infringed their intellectual property rights. We are subject to patent disputes and expect that we will increasingly be subject to additional patent infringement claims involving various aspects of our business as our products and services continue to expand in scope and complexity. Such claims may be brought directly or indirectly against our companies and/or against our customers (who may be entitled to contractual indemnification under their contracts with us), and we are subject to increased exposure to such claims as a result of our acquisitions, particularly in cases where we are introducing new products or services in connection with such acquisitions. We have in the past been forced to litigate such claims, and we believe that additional lawsuits alleging such claims will be filed against us. Intellectual property claims, whether meritorious or not, are time-consuming and costly to defend and resolve, could require expensive changes in our methods of doing business, or could require us to enter into costly royalty or licensing agreements on unfavorable terms or make substantial payments to settle claims or to satisfy damages awarded by courts. From time to time, we are involved in other disputes or regulatory inquiries that arise in the ordinary course of business, including suits by our customers (individually or as class actions) alleging, among other things, improper disclosure of our prices, rules, or policies, that our practices, prices, rules, policies, or customer/user agreements violate applicable law, or that we have acted unfairly and/or not acted in conformity with such prices, rules, policies, or agreements. In addition to these types of disputes and regulatory inquiries, our operations are also subject to regulatory and/or legal review and/or challenges that may reflect the increasing global regulatory focus to which the payments industry is subject and, when taken as a whole with other regulatory and legislative action, such actions could result in the imposition of costly new compliance burdens on our business and customers and may lead to increased costs and decreased transaction volume and revenue. Further, the number and significance of these disputes and inquiries are increasing as our business has grown and expanded in scale and scope, including the number of active accounts and payments transactions on our platforms, the range and increasing complexity of the products and services that we offer, and our geographical operations. Any claims or regulatory actions against us, whether meritorious or not, could be time consuming, result in costly litigation, settlement payments, damage awards (including statutory damages for certain causes of action in certain jurisdictions), fines, penalties, injunctive relief, or increased costs of doing business through adverse judgment or settlement, require us to change our business practices in expensive ways, require significant amounts of management time, result in the diversion of significant operational resources, or otherwise harm our business. Indemnification Provisions In 2015, PayPal became an independent publicly traded company through the pro rata distribution by eBay Inc. (“eBay”) of 100 % of the outstanding common stock of PayPal to eBay stockholders (which we refer to as the “separation” or the “distribution”). We entered into a separation and distribution agreement, a tax matters agreement, an operating agreement, and various other agreements with eBay to govern the separation of the two companies and the relationship of the two companies going forward. These agreements provide for specific indemnity and liability obligations for both eBay and us. Disputes between eBay and us have arisen and others may arise in the future, and an adverse outcome in such matters could materially and adversely impact our business, results of operations, and financial condition. In addition, the indemnity rights we have against eBay under the agreements may not be sufficient to protect us, and our indemnity obligations to eBay may be significant. 42 Table of Contents PayPal Holdings, Inc. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) In the ordinary course of business, we include limited indemnification provisions in certain of our agreements with parties with whom we have commercial relationships. Under these contracts, we generally indemnify, hold harmless, and agree to reimburse the indemnified party for losses suffered or incurred by the indemnified party in connection with claims by any third party with respect to our domain names, trademarks, logos, and other branding elements to the extent that such marks are related to the subject agreement. We have provided an indemnity for other types of third-party claims, which are indemnities mainly related to intellectual property rights, confidentiality, willful misconduct, data privacy obligations, and certain breach of contract claims. We have also provided an indemnity to our payments processors in the event of card association fines against the processor arising out of conduct by us or our customers. It is not possible to determine the maximum potential loss under these indemnification provisions due to our limited history of prior indemnification claims and the unique facts and circumstances involved in each particular situation. To date, no significant costs have been incurred, either individually or collectively, in connection with our indemnification provisions. Off-Balance Sheet Arrangements As of September 30, 2020 and December 31, 2019, we had no off-balance sheet arrangements that have, or are reasonably likely to have, a current or future material effect on our consolidated financial condition, results of operations, liquidity, capital expenditures, or capital resources. Protection Programs We provide merchants and consumers with protection programs for certain transactions completed on our Payments Platform. These programs are intended to protect both merchants and consumers from loss primarily due to fraud and counterparty performance. Our buyer protection program provides protection to consumers for qualifying purchases by reimbursing the consumer for the full amount of the purchase if a purchased item does not arrive or does not match the seller’s description. Our seller protection programs provide protection to merchants against claims that a transaction was not authorized by the buyer or claims that an item was not received by covering the seller for the full amount of the payment on eligible sales. These protection programs are considered assurance-type warranties for which we estimate and record associated costs in transaction and credit losses during the period the payment transaction is completed. The maximum potential exposure under our protection programs is estimated to be the portion of total eligible transaction volume (total payment volume) for which buyer or seller protection claims may be raised under our existing customer agreements. Since eligible transactions are typically completed in a period significantly shorter than the period under which disputes may be opened, and based on our historical losses to date, we do not believe that the maximum potential exposure is representative of our actual potential exposure. The actual amount of potential exposure cannot be quantified as we are unable to determine total eligible transactions where performance by a merchant or consumer is incomplete or completed transactions that may result in a claim under our protection programs. The following table shows changes in the allowance for transaction losses and negative customer balances related to our protection programs for the three and nine months ended September 30, 2020 and 2019: Three Months Ended September 30, Nine Months Ended September 30, 2020 2019 2020 2019 (in millions) Beginning balance $ 373 $ 395 $ 399 $ 344 Provision 329 256 847 789 Realized losses ( 280 ) ( 309 ) ( 863 ) ( 822 ) Recoveries 22 14 61 45 Ending balance $ 444 $ 356 $ 444 $ 356 43 Table of Contents PayPal Holdings, Inc. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) Note 14 — Stock Repurchase Programs During the nine months ended September 30, 2020, we repurchased approximately 11 million shares of our common stock for approximately $ 1.4 billion at an average cost of $ 128.31 . These shares were purchased in the open market under our stock repurchase programs authorized in April 2017 and July 2018. The July 2018 stock repurchase program became effective during the first quarter of 2020 upon completion of the April 2017 stock repurchase program. As of September 30, 2020, a total of approximately $ 8.7 billion remained available for future repurchases of our common stock under our July 2018 stock repurchase program. Note 15 — Stock-Based Plans Stock-Based Compensation Expense We record stock-based compensation expense for our equity incentive plans in accordance with GAAP, which requires the measurement and recognition of compensation expense based on estimated fair values. The impact on our results of operations of recording stock-based compensation expense under our equity incentive plans for the three and nine months ended September 30, 2020 and 2019 was as follows: Three Months Ended September 30, Nine Months Ended September 30, 2020 2019 2020 2019 (In millions) Customer support and operations $ 63 $ 51 $ 179 $ 144 Sales and marketing 45 31 131 95 Technology and development 138 119 384 292 General and administrative 127 72 330 226 Total stock-based compensation expense $ 373 $ 273 $ 1,024 $ 757 Capitalized as part of internal use software and website development costs $ 13 $ 10 $ 34 $ 29 Note 16 — Income Taxes Our effective tax rate for the three and nine months ended September 30, 2020 was 11 % and 18 %, respectively. Our effective tax rate for the three and nine months ended September 30, 2019 was 5 % and 9 %, respectively. The difference between our effective tax rate and the U.S. federal statutory rate of 21% in the above periods was primarily the result of foreign income taxed at different rates and discrete tax adjustments, and for the nine months ended September 30, 2020, tax expense related to the intra-group transfer of intellectual property. During the three months ended September 30, 2020, we settled income tax audits in France and Germany. Neither of these settlements had a significant impact on our condensed consolidated statements of income. In June 2019, the U.S. Court of Appeals for the Ninth Circuit reversed a lower court decision in Altera Corp. v. Commissioner and held that a Treasury Regulation requiring stock-based compensation to be included in a qualified intercompany cost sharing arrangement was valid. In June 2020, the U.S. Supreme Court denied Altera's petition for certiorari. We have reviewed this decision and determined that no adjustment to PayPal’s condensed consolidated financial statements is required as a result of this development. Note 17 — Restructuring and Other Charges During the first quarter of 2020, management approved a strategic reduction of the existing global workforce, which resulted in restructuring charges of $ 19 million and $ 74 million during the three and nine months ended September 30, 2020, respectively. 44 Table of Contents PayPal Holdings, Inc. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) The approved strategic reduction in 2020 is part of a multiphase process to reorganize our workforce concurrently with the redesign of our operating structure, which we expect will span multiple quarters. We primarily incurred employee severance and benefits costs, as well as other associated consulting costs under the 2020 strategic reduction. We experienced delays, primarily as a result of COVID-19, in the execution of these restructuring actions, which are now expected to be completed by the end of the first quarter of 2021. The following table summarizes the restructuring reserve activity during the nine months ended September 30, 2020: Employee Severance and Benefits and Other Associated Costs (In millions) Accrued liability as of January 1, 2020 $ 9 Charges 74 Payments ( 46 ) Accrued liability as of September 30, 2020 $ 37 Additionally, in the second quarter of 2020, we incurred asset impairment charges of $ 21 million due to the write-off of a certain ROU lease asset and related leasehold improvements in conjunction with exiting certain leased properties. See “Note 6—Leases” for additional information. During the first quarter of 2019, management approved strategic reductions of the existing global workforce, which resulted in restructuring charges of $ 78 million. The approved strategic reductions for 2019 were intended to better align our teams to support key business priorities and included the transfer of certain operational functions between geographies, as well as the impact of the transition servicing activities provided to Synchrony, which ended in the second quarter of 2019. We primarily incurred employee severance and benefits expenses under the 2019 strategic reductions, which were substantially completed by the end of the first quarter of 2020. 45 Table of Contents