Item 2. Management’s Discussion and Analysis
Item 2: Management’s Discussion and Analysis of Financial Condition and Results of Operations
This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, including statements that involve expectations, plans, or intentions (such as those relating to future business, future results of operations or financial condition, new or planned features or services, mergers or acquisitions, or management strategies). Additionally, our forward looking statements include expectations related to anticipated impacts of the outbreak of the novel coronavirus. These forward-looking statements can be identified by words such as “may,” “will,” “would,” “should,” “could,” “expect,” “anticipate,” “believe,” “estimate,” “intend,” “strategy,” “future,” “opportunity,” “plan,” “project,” “forecast,” and other similar expressions. These forward-looking statements involve risks and uncertainties that could cause our actual results and financial condition to differ materially from those expressed or implied in our forward-looking statements. Such risks and uncertainties include, among others, those discussed in Part I, Item 1A, Risk Factors in our Annual Report on Form 10-K for the year ended December 31, 2019 (the “2019 Form 10-K”), as supplemented in the risk factors set forth below in Part II, Item 1A, Risk Factors, of this Form 10-Q, as well as in our unaudited condensed consolidated financial statements, related notes, and the other information appearing elsewhere in this report and our other filings with the Securities and Exchange Commission (“SEC”). We do not intend, and undertake no obligation except as required by law, to update any of our forward-looking statements after the date of this report to reflect actual results or future events or circumstances. Given these risks and uncertainties, readers are cautioned not to place undue reliance on such forward-looking statements. You should read the following “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in conjunction with the unaudited condensed consolidated financial statements and the related notes that appear elsewhere in this report. Unless otherwise expressly stated or the context otherwise requires, references to “we,” “our,” “us,” “the Company,” and “PayPal” refer to PayPal Holdings, Inc. and its consolidated subsidiaries.
Business Environment
We are 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 (“P2P”) 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.
Information security risks for global payments and technology companies like us have significantly increased in recent years. Although we have developed systems and processes designed to protect data we manage, prevent data loss and other security incidents and effectively respond to known and potential risks, and expect to continue to expend significant resources to bolster these protections, we remain subject to these risks and there can be no assurance that our security measures will provide sufficient security or prevent breaches or attacks. For additional information regarding our information security risks, see Part I, Item 1A, Risk Factors in our 2019 Form 10-K, as supplemented and, to the extent inconsistent, superseded below (if applicable) in Part II, Item 1A, Risk Factors in this Form 10-Q.
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In March 2020, the World Health Organization declared the outbreak of the novel coronavirus (“COVID-19”) as a pandemic. The outbreak has resulted in government authorities and businesses throughout the world implementing numerous measures intended to contain and limit the spread of COVID-19, including travel bans and restrictions, quarantines, shelter-in-place and lock-down orders, and business limitations and shutdowns. These measures have negatively impacted consumer and business spending and payments activity generally, and have significantly contributed to deteriorating macroeconomic conditions and higher unemployment in some countries, including those in which we have significant operations. The spread of COVID-19 has caused us to make significant modifications to our business practices, including enabling most of our workforce to work from home, establishing strict health and safety protocols for our offices, restricting physical participation in meetings, events, and conferences and imposing restrictions on employee travel. We will continue to actively monitor the situation and may take further actions that may alter our business practices as may be required by federal, state, or local authorities or that we determine are in the best interests of our employees, customers, and business partners.
While the current macroeconomic environment as a result of the COVID-19 outbreak has adversely impacted general consumer and merchant spending with a more pronounced impact on travel and events verticals, the spread of COVID-19 has also accelerated the shift from in-store shopping and traditional in-store payment methods (e.g., credit cards, debit cards, cash) towards e-commerce and digital payments and resulted in increased customer demand for safer payment and delivery solutions (e.g. contactless payment methods, buy online and pick up in store) and a significant increase in online spending in certain verticals that have historically had a strong in-store presence. On balance, our business has benefited from these behavioral shifts, including a significant increase in net new active accounts and payments volume. To the extent that consumer preferences revert to pre-COVID-19 behaviors as mitigation measures to limit the spread of COVID-19 are lifted or relaxed, our business, financial condition, and results of operations could be adversely impacted.
The rapidly changing global market and economic conditions as a result of COVID-19 have impacted, and are expected to continue to impact, our operations and business. The broader implications of the COVID-19 outbreak on our business, financial condition, and results of operations remain uncertain. For additional information on how COVID-19 has impacted and could continue to negatively impact our business, see below for specific discussion in the respective areas, and also refer to Part II, Item 1A, Risk Factors in this Form 10-Q.
The United Kingdom (“U.K.”) formally exited the European Union (“EU”) and the European Economic Area (“EEA”) on January 31, 2020 (commonly referred to as “Brexit”) and a transition period is expected to be in place until December 31, 2020 during which time the U.K. will remain in both the EU customs union and single market and follow EU rules, including those extending to EEA states. There is a significant lack of clarity over the terms of the U.K.’s future relationship with the EU, and the international bodies that are linked to it, after this date. Depending on the nature of the U.K.'s future relationship with the EU, we may be unable to utilize certain licenses and authorizations to operate within these markets, be required to obtain additional regulatory permissions to operate within the U.K. market, and could face additional legal and regulatory requirements. We are currently unable to determine the impact that Brexit will have on our business, as any impact will depend, in part, on the outcome of tariff, trade, regulatory, and other negotiations. For additional information on how Brexit could affect our business, see Part II, Item 1A, Risk Factors in this Form 10-Q.
Brexit could therefore contribute to instability in financial, stock and foreign currency exchange markets, including volatility in the value of the British Pound and Euro. We have foreign currency exchange exposure management programs designed to help reduce the impact from foreign currency exchange rate movements. Net revenues generated from our U.K. operations constituted 11% of total net revenues for both the three and nine months ended September 30, 2020, and approximately 10% of total net revenues for both the three and nine months ended September 30, 2019. During each of these periods, net revenues generated from the EU (excluding the U.K.) constituted less than 20% of total net revenues. Approximately 46% and 37% of our gross loans and interest receivables as of September 30, 2020 and December 31, 2019, respectively, were due from customers in the U.K. Approximately 10% and 6% of our gross loans and interest receivables as of September 30, 2020 and December 31, 2019, respectively, were due from customers in the EU (excluding the U.K.). The increase in the percentage of gross loans and interest receivable outstanding in the U.K. and EU as of September 30, 2020 as compared to December 31, 2019 was driven by an increase in the balances in those regions as we continue to originate consumer loans in our international markets, combined with a decline in our gross total loans and interest receivable outstanding due to minimal originations in our merchant portfolio.
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Overview of Results of Operations
The following table provides a summary of our condensed consolidated financial results for the three and nine months ended September 30, 2020 and 2019:
Three Months Ended September 30, Percent Increase/(Decrease) Nine Months Ended September 30, Percent Increase/(Decrease)
2020 2019 2020 2019
(In millions, except percentages and per share data)
Net revenues $ 5,459 $ 4,378 25 % $ 15,338 $ 12,811 20 %
Operating expenses 4,482 3,681 22 % 13,012 10,891 19 %
Operating income $ 977 $ 697 40 % $ 2,326 $ 1,920 21 %
Operating margin 18 % 16 % ** 15 % 15 % **
Other income (expense), net $ 167 $ (213) 178 % $ 880 $ 224 293 %
Income tax expense $ 123 $ 22 459 % $ 571 $ 192 197 %
Effective tax rate 11 % 5 % ** 18 % 9 % **
Net income $ 1,021 $ 462 121 % $ 2,635 $ 1,952 35 %
Net income per diluted share $ 0.86 $ 0.39 121 % $ 2.22 $ 1.64 35 %
Net cash provided by operating activities $ 720 $ 1,096 (34) % $ 4,607 $ 3,297 40 %
All amounts in tables are rounded to the nearest million, except as otherwise noted. As a result, certain amounts may not recalculate using the rounded amounts provided.
** Not meaningful
Three Months Ended September 30, 2020 and 2019
Net revenues increased $1.1 billion, or 25%, in the three months ended September 30, 2020, compared to the same period of the prior year driven primarily by growth in total payment volume (“TPV”, as defined below under “Net Revenues”) of 38%. Our acquisition of Honey Science Corporation (“Honey”) contributed approximately one percentage point to the growth rate of net revenues for the three months ended September 30, 2020.
Total operating expenses increased $801 million, or 22%, in the three months ended September 30, 2020, compared to the same period of the prior year due primarily to an increase in transaction expense, and to a lesser extent, increases in sales and marketing expenses, technology and development expenses, and general and administrative expenses. Our acquisitions of Honey and a 70% equity interest in Guofubao Information Technology Co. (GoPay), Ltd. (“GoPay”) collectively contributed approximately five percentage points to the growth rate of total operating expenses for the three months ended September 30, 2020.
Operating income increased by $280 million, or 40%, in the three months ended September 30, 2020, compared to the same period of the prior year due to growth in net revenues, partially offset by an increase in operating expenses. Our operating margin was 18% and 16% in the three months ended September 30, 2020 and September 30, 2019, respectively. Operating margin for the three months ended September 30, 2020 was positively impacted by revenue growth of 25%, outpacing operating expenses growth of 22%. Our acquisitions of Honey and GoPay collectively had a negative impact of approximately three percentage points on our operating margin for the three months ended September 30, 2020.
Net income increased by $559 million, or 121%, in the three months ended September 30, 2020, compared to the same period of the prior year due to the previously discussed increase in operating income of $280 million and an increase of $380 million in other income (expense), net driven primarily by net gains on strategic investments, partially offset by an increase in income tax expense of $101 million, driven primarily by tax expense on gains on strategic investments.
Nine Months Ended September 30, 2020 and 2019
Net revenues increased $2.5 billion, or 20%, in the nine months ended September 30, 2020, compared to the same period of the prior year driven primarily by growth in TPV of 29%. Our acquisition of Honey contributed approximately one percentage point to the growth rate of net revenues for the nine months ended September 30, 2020.
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Total operating expenses increased $2.1 billion, or 19%, in the nine months ended September 30, 2020, compared to the same period of the prior year due primarily to an increase in transaction expense, and to a lesser extent, increases in technology and development expenses, transaction and credit losses, general and administrative expenses, and sales and marketing expenses. Our acquisitions of Honey and GoPay collectively contributed approximately five percentage points to the growth rate of total operating expenses for the nine months ended September 30, 2020.
Operating income increased by $406 million, or 21%, in the nine months ended September 30, 2020, compared to the same period of the prior year due to growth in net revenues, partially offset by an increase in operating expenses. Our operating margin was 15% in each of the nine months ended September 30, 2020 and September 30, 2019. Our acquisitions of Honey and GoPay collectively had a negative impact of approximately three percentage points on our operating margin for the nine months ended September 30, 2020.
Net income increased by $683 million, or 35%, in the nine months ended September 30, 2020, compared to the same period of the prior year due to the previously discussed increase in operating income of $406 million and an increase of $656 million in other income (expense), net driven primarily by net gains on strategic investments, partially offset by an increase in income tax expense of $379 million, driven primarily by tax expense related to the intra-group transfer of intellectual property and gains on strategic investments.
Impact of Foreign Currency Exchange Rates
We have significant international operations that are denominated in foreign currencies, primarily the British Pound, Euro, Australian dollar, and Canadian dollar, subjecting us to foreign currency exchange risk which may adversely impact our financial results. The strengthening or weakening of the U.S. dollar versus the British Pound, Euro, Australian dollar, and Canadian dollar, as well as other currencies in which we conduct our international operations, impact the translation of our net revenues and expenses generated in these foreign currencies into the U.S. dollar. In each of the three and nine months ended September 30, 2020, we generated approximately 48% of our net revenues from customers domiciled outside of the U.S. In each of the three and nine months ended September 30, 2019, we generated approximately 47% of our net revenues from customers domiciled outside of the U.S. Because we generate substantial net revenues internationally, we are subject to the risks of doing business outside of the U.S. See Part I, Item 1A, Risk Factors in our 2019 Form 10-K, as supplemented and, to the extent inconsistent, superseded (if applicable) below in Part II, Item 1A, Risk Factors in this Form 10-Q.
We calculate the year-over-year impact of foreign currency exchange movements on our business using prior period foreign currency exchange rates applied to current period transactional currency amounts. While changes in foreign currency exchange rates affect our reported results, we have a foreign currency exchange exposure management program in which we designate certain foreign currency exchange contracts as cash flow hedges intended to reduce the impact on earnings from foreign currency exchange rate movements. Gains and losses from these foreign currency exchange contracts are recognized as a component of transaction revenues in the same period the forecasted transactions impact earnings.
In the three and nine months ended September 30, 2020 and September 30, 2019, year-over-year foreign currency movements relative to the U.S. dollar had the following impact on our reported results:
Three Months Ended September 30, 2020 Nine Months Ended September 30, 2020
(In millions)
Favorable (Unfavorable) impact to net revenues (exclusive of hedging impact) $ 73 $ (51)
Hedging impact (17) 58
Favorable impact to net revenues 56 7
(Unfavorable) Favorable impact to operating expense (21) 54
Net favorable impact to operating income $ 35 $ 61
Three Months Ended September 30, 2019 Nine Months Ended September 30, 2019
(In millions)
Unfavorable impact to net revenues (exclusive of hedging impact) $ (72) $ (281)
Hedging impact 70 180
Unfavorable impact to net revenues (2) (101)
Favorable impact to operating expense 34 146
Net favorable impact to operating income $ 32 $ 45
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While we enter into foreign currency exchange contracts to help reduce the impact on earnings from foreign currency exchange rate movements, it is impossible to predict or eliminate the total effects of this exposure.
We also used a foreign currency exchange contract, designated as a net investment hedge, to reduce the foreign currency exchange risk related to our investment in a foreign subsidiary. Gains and losses associated with this instrument will remain in accumulated other comprehensive income until the foreign subsidiary is sold or substantially liquidated.
Additionally, in connection with our services that are paid for in multiple currencies, we generally set our foreign currency exchange rates daily and may face financial exposure if we incorrectly set our foreign currency exchange rates or as a result of fluctuations in foreign currency exchange rates between the times that we set our foreign currency exchange rates. Given that we also have foreign currency exchange risk on our assets and liabilities denominated in currencies other than the functional currency of our subsidiaries, we have an additional foreign currency exchange exposure management program in which we use foreign currency exchange contracts to offset the impact of foreign currency exchange rate movements on our assets and liabilities. The foreign currency exchange gains and losses on our assets and liabilities are recorded in other income (expense), net, and are offset by the gains and losses on the foreign currency exchange contracts. These foreign currency exchange contracts reduce, but do not entirely eliminate, the impact of foreign currency exchange rate movements on our assets and liabilities.
Financial Results
Net Revenues
Our revenues are classified into the following two categories:
• Transaction revenues : Net transaction fees charged to merchants and consumers on a transaction basis primarily based on the volume of activity, or TPV, completed on our Payments Platform. Growth in TPV is directly impacted by the number of payment transactions that we enable on our Payments Platform. We earn additional fees on transactions where we perform currency conversion, when we enable cross-border transactions (i.e., transactions where the merchant and consumer are in different countries), to facilitate the instant transfer of funds for our customers from their PayPal or Venmo account to their debit card or bank account, and other miscellaneous fees.
• Revenues from other value added services : Net revenues derived primarily from revenue earned through partnerships, referral fees, subscription fees, gateway fees, and other services we provide to our merchants and consumers. We also earn revenues from interest and fees earned primarily on our portfolio of loans receivable, and interest earned on certain assets underlying customer balances.
Active accounts, number of payment transactions, number of payment transactions per active account, and TPV are key non-financial performance metrics (“key metrics”) that management uses to measure the performance of our business, and are defined as follows:
• An active account is an account registered directly with PayPal or a platform access partner that has completed a transaction on our Payments Platform or through our Honey Platform, not including gateway-exclusive transactions, within the past 12 months. A platform access partner is a third party whose customers are provided access to PayPal’s Payments Platform through such third party’s login credentials. The number of active accounts provides management with additional perspective on the growth of accounts across our Payments and Honey Platforms as well as the overall scale of our platforms.
• Number of payment transactions are the total number of payments, net of payment reversals, successfully completed on our Payments Platform or enabled by PayPal via a partner payment solution, not including gateway-exclusive transactions.
• Number of payment transactions per active account reflects the total number of payment transactions within the previous 12-month period, divided by active accounts at the end of the period. The number of payment transactions per active account provides management with insight into the number of times a customer is engaged in payments activity on our Payments Platform in a given period.
• TPV is the value of payments, net of payment reversals, successfully completed on our Payments Platform, or enabled by PayPal via a partner payment solution, not including gateway-exclusive transactions.
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As our transaction revenue is typically correlated with TPV growth and the number of payment transactions completed on our Payments Platform, management uses these metrics to gain insights into the scale and strength of the Payments Platform, the engagement level of our customers, and underlying activity and trends which are indicators of current and future performance. We present these key metrics to enhance investors’ evaluation of the performance of our business and operating results.
Net Revenues Analysis
The components of our net revenues for the three and nine months ended September 30, 2020 and 2019 were as follows:
Three Months Ended September 30, Percent Increase/(Decrease) Nine Months Ended September 30, Percent Increase/(Decrease)
2020 2019 2020 2019
(In millions, except percentages)
Transaction revenues $ 5,076 $ 3,955 28 % $ 14,236 $ 11,564 23 %
Revenues from other value added services 383 423 (9) % 1,102 1,247 (12) %
Net revenues $ 5,459 $ 4,378 25 % $ 15,338 $ 12,811 20 %
Transaction revenues
Transaction revenues grew by $1.1 billion, or 28%, and $2.7 billion, or 23%, for the three and nine months ended September 30, 2020, respectively, compared to the same periods of the prior year. The increase was mainly attributable to our core PayPal products and services, due primarily to strong growth in TPV and the number of payment transactions, both of which resulted primarily from an increase in our active accounts, and to a lesser extent, an increase in revenue from currency conversion fees due to growth in cross-border transactions.
The current macroeconomic environment as a result of the COVID-19 outbreak has adversely impacted general consumer and merchant spending with a more pronounced impact on travel and events verticals. However, we have experienced strong growth in online retail, gaming, and food volume, offsetting this decline. The duration and severity of the impacts of COVID-19 remain unknown, and we currently expect that we will continue to experience adverse impacts to our transaction revenue growth rate in affected verticals for the remainder of the year.
The following table provides a summary of our active accounts, number of payment transactions, TPV, and related metrics:
Three Months Ended September 30, Percent Increase/(Decrease) Nine Months Ended
September 30, Percent Increase/(Decrease)
2020 2019 2020 2019
(In millions, except percentages)
Active accounts (1)
361 295 22 % 361 295 22 %
Number of payment transactions 4,013 3,090 30 % 11,015 8,901 24 %
Number of payment transactions per active account 40.1 39.8 1 % 40.1 39.8 1 %
TPV $ 246,691 $ 178,670 38 % $ 658,990 $ 512,521 29 %
Percent of cross-border TPV 16 % 17 % ** 16 % 18 % **
All amounts in the table are rounded to the nearest million, except as otherwise noted. As a result, certain amounts may not recalculate using the rounded amounts provided.
(1) Includes 10.2 million active accounts contributed by Honey on the date of acquisition in January 2020.
** Not meaningful
Transaction revenues grew more slowly than TPV and number of payment transactions for the three and nine months ended September 30, 2020, compared to the same periods in the prior year due to a higher proportion of P2P transactions (primarily from our Venmo products) from which we earn lower fees and a higher portion of TPV generated by large merchants and platform partners who generally pay lower rates with higher transaction volumes. Additionally, foreign currency exchange hedging contributed to a decline in transaction revenues with hedging losses recorded in the three months ended September 30, 2020 compared to gains recorded in the prior period, and a net decline in hedging gains in the nine months ended September 30, 2020 as compared to the prior period. Changes in prices charged to our customers did not significantly impact transaction revenue growth for both the three and nine months ended September 30, 2020.
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Revenues from other value added services
For the three months ended September 30, 2020, revenues from other value added services decreased $40 million, or 9%, compared to the same period in the prior year. The decrease was primarily attributable to a decline in interest earned on certain assets underlying customer balances resulting from lower interest rates, a decrease in interest and fee income on our merchant loans and advances receivable resulting from a decline in originations, and a decline in our revenue share with Synchrony Bank (“Synchrony”). This decline was partially offset by incremental revenues from our acquisition of Honey, which contributed approximately 15 percentage points to the revenue growth rate for the three months ended September 30, 2020, and an increase in interest and fee income on our consumer loans receivable.
For the nine months ended September 30, 2020, revenues from other value added services decreased $145 million, or 12%, compared to the same period in the prior year due to a decline in interest earned on certain assets underlying customer balances resulting from lower interest rates and a decline in revenue earned from transition servicing activities provided to Synchrony, which ended in the second quarter of 2019. Additionally, a decrease in interest and fee income on our loans and advances receivable due to an increase in the allowances provided for interest and fees receivable, a decline in originations, and payment holidays that we provided to our customers as a part of our COVID-19 payment relief initiatives also contributed to the decline in revenues from other value added services for the nine months ended September 30, 2020. This decline was partially offset by incremental revenues from our acquisition of Honey, which contributed approximately 14 percentage points to the revenue growth rate for the nine months ended September 30, 2020.
The total gross loans and interest receivable balance was $3.4 billion as of September 30, 2020 and $3.7 billion as of September 30, 2019, reflecting a year-over-year decrease of 8% driven primarily by a decline in our merchant receivable portfolio due to reduced originations, partially offset by growth in our consumer receivable portfolio.
In response to the COVID-19 outbreak, we have taken both proactive and reactive measures to support our merchants and consumers that have loans and interest receivables due to us under our credit product offerings. These measures are intended to reduce financial difficulties experienced by our customers and include providing payment holidays, under which we granted payment deferrals to borrowers for varying periods of time, and amended payment terms through loan modifications in certain cases. These measures have adversely impacted and are expected to continue to adversely impact the recognition of interest and fee income in future periods. Given the uncertainty surrounding the COVID-19 outbreak, including its duration and severity and the ultimate impact it may have on the financial condition of our merchants and consumers, the extent of these types of actions and the impact they may have on our interest and fee income is not determinable. In addition, consumers that have outstanding loans and interest receivable due to Synchrony may be offered similar support, and ultimately may experience similar hardships that result in increased losses recognized by Synchrony, which may result in a decrease in our revenue share earned from Synchrony in future periods. In the event the overall return on the PayPal branded credit programs funded by Synchrony does not meet a minimum rate of return (“minimum return threshold”) in a particular quarter, our revenue share for that period would be zero. Further, in the event the overall return on the PayPal branded credit programs managed by Synchrony does not meet the minimum return threshold as measured over four consecutive quarters and in the following quarter, we would be required to make a payment to Synchrony, subject to certain limitations. Through September 30, 2020, the overall return on the PayPal branded credit programs funded by Synchrony exceeded the minimum return threshold.
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Operating Expenses
The following table summarizes our operating expenses and related metrics we use to assess the trends in each:
Three Months Ended September 30, Percent Increase/(Decrease) Nine Months Ended September 30, Percent Increase/(Decrease)
2020 2019 2020 2019
(In millions, except percentages)
Transaction expense $ 2,022 $ 1,701 19 % $ 5,604 $ 4,877 15 %
Transaction and credit losses 344 340 1 % 1,375 999 38 %
Customer support and operations 449 390 15 % 1,271 1,177 8 %
Sales and marketing 471 316 49 % 1,256 1,001 25 %
Technology and development 674 533 26 % 1,910 1,527 25 %
General and administrative 503 401 25 % 1,501 1,239 21 %
Restructuring and other charges 19 — ** 95 71 34 %
Total operating expenses $ 4,482 $ 3,681 22 % $ 13,012 $ 10,891 19 %
Transaction expense rate (1)
0.82 % 0.95 % ** 0.85 % 0.95 % **
Transaction and credit loss rate (2)
0.14 % 0.19 % ** 0.21 % 0.19 % **
(1) Transaction expense rate is calculated by dividing transaction expense by TPV.
(2) Transaction and credit loss rate is calculated by dividing transaction and credit losses by TPV.
** Not meaningful
Transaction Expense
Transaction expense increased by $321 million, or 19%, and $727 million, or 15%, in the three and nine months ended September 30, 2020, respectively, compared to the same periods of the prior year due primarily to the increase in TPV of 38% and 29% for the three and nine months ended September 30, 2020, respectively. The decrease in transaction expense rate for the three and nine months ended September 30, 2020, compared to the same periods of the prior year was due primarily to favorable changes in product mix and funding mix.
Our transaction expense rate is impacted by changes in product mix, regional mix, funding mix, and assessments charged by payment processors and other financial institutions when we draw funds from a customer’s credit or debit card, bank account, or other funding sources. The cost of funding a transaction with a credit or debit card is generally higher than the cost of funding a transaction from a bank or through internal sources such as a PayPal or Venmo account balance, or PayPal Credit. For the three and nine months ended September 30, 2020, approximately 1% and 2% of TPV, respectively, was funded with PayPal Credit. For each of the three and nine months ended September 30, 2019, approximately 2% of TPV was funded with PayPal Credit. For each of the three and nine months ended September 30, 2020, approximately 39% of TPV was generated outside of the U.S. For the three and nine months ended September 30, 2019, approximately 40% and 41% of TPV, respectively, was generated outside of the U.S. As we expand the availability and presentation of alternative funding sources to our customers, our funding mix may change, which could increase or decrease our transaction expense rate.
Transaction and Credit Losses
The components of our transaction and credit losses for the three and nine months ended September 30, 2020 and 2019 were as follows:
Three Months Ended September 30, Percent Increase/(Decrease) Nine Months Ended September 30, Percent Increase/(Decrease)
2020 2019 2020 2019
(In millions, except percentages)
Transaction losses $ 329 $ 256 29 % $ 847 $ 789 7 %
Credit losses 15 84 (82) % 528 210 151 %
Transaction and credit losses $ 344 $ 340 1 % $ 1,375 $ 999 38 %
Transaction loss rate (1)
0.13 % 0.14 % 0.13 % 0.15 %
(1) Transaction loss rate is calculated by dividing transaction losses by TPV.
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Transaction losses increased by $73 million, or 29%, and $58 million, or 7%, in the three and nine months ended September 30, 2020, respectively, compared to the same periods of the prior year. The increase in the three and nine months ended September 30, 2020 was primarily due to growth in TPV, partially offset by benefits realized through improvements in risk management capabilities, which also contributed to a decrease in our transaction loss rate in the three and nine months ended September 30, 2020, compared to the same periods of the prior year. The duration and severity of the impacts of the COVID-19 outbreak remain unknown. The negative impact on macroeconomic conditions could increase the risk of merchant bankruptcy, insolvency, business failure, or other business interruption, which may adversely impact our transaction losses, particularly for merchants that sell goods or services in advance of the date of their delivery or use.
Credit losses decreased by $69 million, or 82%, in the three months ended September 30, 2020, compared to the same period of the prior year due to a significant decline in loan originations related to our merchant loans and advances portfolio.
Credit losses increased $318 million, or 151%, in the nine months ended September 30, 2020, compared to the same period of the prior year due primarily to an increase in provisions for our loans and interest receivable associated with changes in current and projected macroeconomic conditions, including qualitative adjustments to 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. Our estimate of the macroeconomic impact on lifetime expected credit losses is most significantly impacted by projected unemployment trends and benchmark credit card charge-off rates, which directly correlate to the forecast of loans and interest receivables that we will charge off in the future. Credit losses for the nine months ended September 30, 2020 include the impact of the increase in actual unemployment rates during the current period and expectations of a prolonged economic recovery period over which the value of loans and interest receivable that charge-off are projected to exceed historical trends. If the actual unemployment and charge-offs vary from these projections as of September 30, 2020, the credit losses recognized in future periods will be impacted. Credit losses for the nine months ended September 30, 2020 consisted primarily of approximately $322 million of provision associated with the deteriorating macroeconomic projections, and to a lesser extent, provisions associated with originations and changes in credit quality during the period.
The consumer loans and interest receivables balance as of September 30, 2020 and September 30, 2019 was $1.6 billion and $1.0 billion, respectively, representing a year-over-year increase of 57% driven by growth in international markets. Approximately 87% and 93% of our consumer loans receivable outstanding as of September 30, 2020 and September 30, 2019, respectively, were due from consumers in the U.K.
The following table provides information regarding the credit quality of our consumer loans and interest receivable balance:
September 30,
2020 2019
Percent of consumer loans and interest receivables current (1), (2)
98.2 % 96.7 %
Percent of consumer loans and interest receivables > 90 days outstanding (1), (2), (3)
0.7 % 1.4 %
Net charge off rate (4)
5.0 % 4.3 %
(1) Prior period revised to conform to the current period presentation.
(2) Includes the impact of payment holidays provided by the Company as a part of our COVID-19 payment relief initiatives.
(3) Represents percentage of balances which are 90 days past the billing date to the consumer.
(4) Net charge off rate is the annual ratio of net credit losses, excluding fraud losses, on consumer loans receivables as a percentage of the average daily amount of consumer loans and interest receivables balance during the period.
The increase in the net charge off rate for consumer receivables at September 30, 2020 as compared to September 30, 2019 was primarily attributable to the continued expansion and maturity of our international consumer loan receivable portfolio.
We offer business financing solutions to certain small and medium-sized merchants. Total merchant loans, advances, and interest and fees receivable outstanding, net of participation interest sold, as of September 30, 2020 were $1.7 billion, compared to $2.6 billion as of September 30, 2019, representing a year-over-year decrease of 33%. The decrease in merchant loans, advances, and interest and fees receivable outstanding was due primarily to a reduction in originations due to modifications in our acceptable risk parameters as well as a shift to originations through the U.S. Government’s Paycheck Protection Program (“PPP”) administered by the U.S. Small Business Administration (“SBA”) and enacted in March 2020 under the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) in response to the COVID-19 pandemic. We do not own the receivables associated with the originations through the PPP. Approximately 84% and 8% of our merchant receivables outstanding as of September 30, 2020 were due from merchants in the U.S. and U.K., respectively, as compared to 84% and 9% as of September 30, 2019.
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The following table provides information regarding the credit quality of our merchant loans, advances, and interest and fees receivable balance:
September 30,
2020 2019
Percent of merchant receivables within original expected or contractual repayment period 77.6 % 90.5 %
Percent of merchant receivables > 90 days outstanding after the end of original expected or contractual repayment period (1)
9.8 % 3.8 %
Net charge off rate (2)
12.2 % 8.5 %
(1) Includes the impact of payment holidays provided by the Company as a part of our COVID-19 payment relief initiatives.
(2) Net charge off rate is the annual ratio of net credit losses, excluding fraud losses, on merchant loans and advances as a percentage of the average daily amount of merchant loans, advances, and interest and fees balance during the period.
The decline in the percent of merchant receivables within the original expected or contractual repayment period, increase in percent of merchant receivables greater than 90 days outstanding, and increase in the net charge off rate for merchant receivables at September 30, 2020 as compared to September 30, 2019, was primarily due to an increase in payment delinquency driven by financial difficulties experienced by our merchants associated with the economic impact of COVID-19 and also as a result of a significant decline in our outstanding merchant receivables balance due to repayments and reduced originations, which increases net charge offs and delinquency rates presented as a percentage of outstanding loan balance. Beginning in the third quarter of 2020, we have granted certain merchants loan modifications intended to provide them with financial relief and to help enable us to mitigate losses. The associated loans and interest receivables have been treated as troubled debt restructurings due to the significant changes in structure, including repayment terms and fee/rate structure. For additional information, see “Note 11—Loans and Interest Receivable” in the notes to the condensed consolidated financial statements in Part I, Item 1 of this Form 10-Q.
During the three and nine months ended September 30, 2020, modifications to the acceptable risk parameters of our credit products in response to the impacts of the COVID-19 outbreak resulted in the implementation of a number of risk mitigation strategies, including reduction of maximum loan size, tightening eligibility terms, and a shift from automated to manual underwriting of loans and advances. These changes in acceptable risk parameters have resulted in a deceleration in the growth of our borrowing base and a decrease in merchant receivables as of September 30, 2020. While the impact of COVID-19 on the economic environment remains uncertain, the longer and more severe the outbreak, the more likely it is to have a material adverse impact on our borrowing base, which is primarily comprised of small and medium-sized merchants, and a continued lower volume of lending activity during the remainder of the year. For additional information, see “Note 11—Loans and Interest Receivable” in the notes to the condensed consolidated financial statements in Part I, Item 1 of this Form 10-Q.
Customer Support and Operations
Customer support and operations expenses increased by $59 million, or 15%, and $94 million, or 8%, in the three and nine months ended September 30, 2020, respectively, compared to the same periods of the prior year due primarily to an increase in employee-related expenses and contractors and consulting costs in our operations function that support the growth of our active accounts and payment transactions, as well as customer onboarding and compliance costs.
Sales and Marketing
Sales and marketing expenses increased by $155 million, or 49%, and $255 million, or 25%, in the three and nine months ended September 30, 2020, respectively, compared to the same periods of the prior year due primarily to higher spend on marketing programs and employee-related expenses. Our acquisitions of Honey and GoPay collectively contributed approximately 21 and 20 percentage points to the growth rate of sales and marketing expenses for the three and nine months ended September 30, 2020, respectively.
Technology and Development
Technology and development expenses increased by $141 million, or 26%, and $383 million, or 25%, in the three and nine months ended September 30, 2020, respectively, compared to the same periods of the prior year due primarily to increases in employee-related expenses, amortization of acquired intangibles, and data center and cloud computing services utilized in delivering our products. Our acquisitions of Honey and GoPay collectively contributed approximately 15 percentage points to the growth rate of technology and development expenses for both the three and nine months ended September 30, 2020.
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General and Administrative
General and administrative expenses increased by $102 million, or 25%, and $262 million, or 21%, in the three and nine months ended September 30, 2020, respectively, compared to the same periods of the prior year due primarily to increases in employee-related expenses, professional services expenses, including those attributable to acquisition-related transaction expenses, and depreciation expense. Our acquisitions of Honey and GoPay collectively contributed approximately 13 percentage points to the growth rate of general and administrative expenses for both the three and nine months ended September 30, 2020.
Restructuring and Other Charges
Restructuring and other charges increased by $19 million and $24 million in the three and nine months ended September 30, 2020, respectively, compared to the same periods of the prior year.
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. 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.
Additionally, in the second quarter of 2020, we incurred asset impairment charges of $21 million due to the write-off of a certain right-of-use lease asset and related leasehold improvements in conjunction with exiting certain leased properties.
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 of 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.
For information on the associated restructuring liability, see “Note 17—Restructuring and Other Charges” in the notes to the condensed consolidated financial statements in Part I, Item 1 of this Form 10-Q.
Other Income (Expense), Net
Other income (expense), net increased $380 million and $656 million in the three and nine months ended September 30, 2020, respectively, compared to the same periods of the prior year. The increase was driven by net gains of $437 million and $803 million on strategic investments during the three and nine months ended September 30, 2020, respectively, compared to the same periods of the prior year primarily due to favorable changes in fair value related to our marketable equity securities. The increase in the three and nine months ended September 30, 2020 from net gains on strategic investments was partially offset by a decline in interest income driven by lower interest rates as well as an increase in interest expense associated with our fixed rate notes issued in the third quarter of 2019 and second quarter of 2020.
Income Tax Expense
Our effective income tax rate was approximately 11% and 5% for the three months ended September 30, 2020 and 2019, respectively. The increase in our effective income tax rate for the three months ended September 30, 2020, compared to the same period of the prior year was due primarily to an increase in tax expense associated with gains on strategic investments. Our effective income tax rate was approximately 18% and 9% for the nine months ended September 30, 2020 and 2019, respectively. The increase in our effective income tax rate for the nine months ended September 30, 2020, compared to the same period of the prior year was due primarily to tax expense related to the intra-group transfer of intellectual property and gains on strategic investments.
Our calculation of income tax expense for the three and nine months ended September 30, 2020 is dependent in part on forecasts of full year results. The impact of the COVID-19 outbreak to the economic environment is uncertain and difficult to predict and may change these forecasts, which could materially impact tax expense as reported for the three and nine months ended September 30, 2020.
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Liquidity and Capital Resources
We require liquidity and access to capital to fund our global operations, including customer protection programs, our credit products, capital expenditures, investments in our business, potential acquisitions and strategic investments, working capital, and other cash needs. The following table summarizes our cash, cash equivalents, and investments as of September 30, 2020 and December 31, 2019:
September 30, 2020 December 31, 2019
(In millions)
Cash, cash equivalents, and investments (1)(2)
$ 15,296 $ 11,722
(1) Excludes assets related to funds receivable and customer accounts of $30.5 billion and $22.5 billion at September 30, 2020 and December 31, 2019, respectively.
(2) Excludes total restricted cash of $83 million and $64 million at September 30, 2020 and December 31, 2019, respectively, and strategic investments of $2.2 billion and $1.8 billion as of September 30, 2020 and December 31, 2019, respectively.
Foreign Cash, Cash Equivalents, and Investments
Cash, cash equivalents, and investments held by our foreign subsidiaries were $7.7 billion as of September 30, 2020 and $7.2 billion at December 31, 2019, or 50% and 61% of our total cash, cash equivalents, and investments as of those respective dates. At December 31, 2019, all of our cash, cash equivalents, and investments held by foreign subsidiaries were subject to U.S. taxation under Subpart F, Global Intangible Low Taxed Income (“GILTI”), or the one-time transition tax under the Tax Cuts and Jobs Act of 2017. Subsequent repatriations to the U.S. will not be taxable from a U.S. federal tax perspective but may be subject to state or foreign withholding tax. A significant aspect of our global cash management activities involves meeting our customers’ requirements to access their cash while simultaneously meeting our regulatory financial ratio commitments in various jurisdictions. Our global cash balances are required not only to provide operational liquidity to our businesses, but also to support our global regulatory requirements across our regulated subsidiaries. As such, not all of our cash is available for general corporate purposes.
Available Credit and Debt
In May 2020, we issued fixed rate notes with varying maturity dates for an aggregate principal amount of $4.0 billion. 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. As of September 30, 2020, we had $9.0 billion in fixed rate debt outstanding with varying maturity dates.
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. 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.
We 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.
Other than as described above, there are no significant changes to the available credit and debt disclosed in our 2019 Form 10-K. For additional information, see “Note 12—Debt” in the notes to the condensed consolidated financial statements in Part I, Item 1 of this Form 10-Q.
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We have cash pooling arrangements with a financial institution for cash management purposes. Each arrangement allows for cash withdrawals from the financial institution based upon our aggregate operating cash balances held within the financial institution (“Aggregate Cash Deposits”). Each arrangement also allows us to withdraw amounts exceeding the Aggregate Cash Deposits up to an agreed-upon limit. The net balance of the withdrawals and the Aggregate Cash Deposits are used by the financial institution as a basis for calculating our net interest expense or income under each arrangement. As of September 30, 2020, we had a total of $4.1 billion in cash withdrawals offsetting our $4.1 billion in Aggregate Cash Deposits held within the financial institution under the cash pooling arrangements.
Liquidity for Loans Receivable Portfolio Growth
Growth in our portfolio of loan receivables increases our liquidity needs and any inability to meet those liquidity needs could adversely affect our business. We continue to evaluate partnerships and third party sources of funding for our loans receivable portfolio. In June 2018, the Luxembourg Commission de Surveillance du Secteur Financier (the “CSSF”) agreed that PayPal’s management may designate up to 35% of European customer balances held in our Luxembourg banking subsidiary to be used for European and U.S. credit activities. As of September 30, 2020, the cumulative amount approved by management to be designated for credit activities aggregated to $2.0 billion and represented approximately 24% of European customer balances potentially available for our corporate use at that date as determined by applying financial regulations maintained by the CSSF. We may periodically seek to designate additional amounts of customer balances, if necessary, based on utilization of the approved funds and anticipated credit funding requirements. Our objective is to expand the availability of our credit products with capital from external sources, although there can be no assurance that we will be successful in achieving that goal. Under certain exceptional circumstances, corporate liquidity could be called upon to meet our obligations related to our European customer balances.
In April 2020, PayPal was approved to participate in the PPP administered by the SBA. The program was designed to provide a direct incentive for small businesses to keep their workers on payroll during the COVID-19 outbreak and includes initial loan repayment deferrals and debt forgiveness provisions for eligible borrowers. The PPP expired on August 8, 2020, but may be subject to further extension by the U.S. government. Loans made under this program are funded by an independent chartered financial institution that we partner with, and the related receivables are not purchased by PayPal. We receive a fee for providing origination services and loan servicing for the loans and retain operational risk related to those activities. Through the August 8, 2020 expiration date, originations facilitated through PayPal under this program were approximately $2.1 billion.
Credit Ratings
As of September 30, 2020, we continue to be rated investment grade by Standard and Poor’s Financial Services, LLC, Fitch Ratings, Inc., and Moody’s Investors Services, Inc. We expect that these credit rating agencies will continue to monitor our performance, including our capital structure and results of operations. Our goal is to be rated investment grade, but as circumstances change, there are factors that could result in our credit ratings being downgraded or put on a watch list for possible downgrading. If that were to occur, it could increase our borrowing rates, including the interest rate on borrowings under our credit agreements.
Risk of Loss
The risk of losses from our buyer and seller protection programs are specific to individual customers, merchants, and transactions, and may also be impacted by regional variations in, and changes or modifications to, the programs, including as a result of changes in regulatory requirements. For the periods presented in these condensed consolidated financial statements included in this report, our transaction loss rates ranged between 0.13% and 0.15% of TPV. Historical loss rates may not be indicative of future results. The duration and severity of the impacts of the COVID-19 outbreak remain unknown. Its negative impact on macroeconomic conditions could increase the risk of merchant bankruptcy, insolvency, business failure, or other business interruption, which may result in an adverse impact on our transaction losses, particularly for merchants that sell goods or services in advance of the date of their delivery or use.
Stock Repurchases and Acquisitions
During the nine months ended September 30, 2020, we repurchased approximately $1.4 billion of our common stock 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.
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In January 2020, we completed our acquisition of Honey for 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. For additional information, see “Note 4—Business Combinations” in the notes to the condensed consolidated financial statements in Part I, Item 1 of this Form 10-Q.
Other Considerations
In the second quarter of 2020, we announced our commitment to invest $530 million to support racial equality. The investments will include: charitable contributions, grants to small businesses, internal investments to support and strengthen diversity and inclusion initiatives, and an economic opportunity fund, which will include bolstering our relationships with community banks and credit unions serving underrepresented minority communities, as well as investing directly into black- and minority-led startups and minority-focused investment funds.
Our liquidity, access to capital, and borrowing costs could be adversely impacted by declines in our credit rating, our financial performance, and global credit market conditions, as well as a broad range of other factors including those related to the COVID-19 outbreak discussed elsewhere in this Form 10-Q. In addition, our liquidity, access to capital, and borrowing costs could be negatively impacted by the outcome of any legal or regulatory proceedings to which we are a party. See Part I, Item 1A, Risk Factors in our 2019 Form 10-K, as supplemented and, to the extent inconsistent, superseded below in Part II, Item 1A, Risk Factors in this Form 10-Q, as well as “Note 13—Commitments and Contingencies” to the condensed consolidated financial statements in Part I, Item 1 of this Form 10-Q for additional discussion of these and other risks that our business faces.
We believe that our existing cash, cash equivalents, and investments, cash expected to be generated from operations, and our expected access to capital markets, together with potential external funding through third party sources, will be sufficient to fund our operating activities, anticipated capital expenditures, and our credit products for the foreseeable future. Depending on market conditions, we may from time to time issue debt, including in private or public offerings, to fund our operating activities, finance acquisitions, make strategic investments, repurchase shares under our stock repurchase program, or reduce our cost of capital.
Cash Flows
The following table summarizes our condensed consolidated statements of cash flows:
Nine Months Ended September 30,
2020 2019
(In millions)
Net cash provided by (used in):
Operating activities $ 4,607 $ 3,297
Investing activities (13,266) (5,334)
Financing activities 10,012 3,837
Effect of exchange rates on cash, cash equivalents, and restricted cash 26 (49)
Net increase in cash, cash equivalents, and restricted cash $ 1,379 $ 1,751
Operating Activities
We generated cash from operating activities of $4.6 billion in the nine months ended September 30, 2020 due primarily to operating income of $2.3 billion, as well as adjustments for non-cash expenses including: provision for transaction and credit losses of $1.4 billion, stock-based compensation of $999 million, and depreciation and amortization of $888 million. Net income was also adjusted for net gains on our strategic investments of $973 million, changes in income taxes payable of $115 million, and changes in other assets and liabilities of $120 million, primarily related to actual cash transaction losses of $816 million incurred during the period and an increase in other assets of $218 million, partially offset by an increase in accrued expenses and other liabilities of $814 million and an increase in funds payable and amounts due to customers of $118 million.
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We generated cash from operating activities of $3.3 billion in the nine months ended September 30, 2019 due primarily to operating income of $1.9 billion, adjusted for non-cash expenses related to provision for transaction and credit losses of $999 million, stock-based compensation of $736 million, and depreciation and amortization of $685 million. Net income was also adjusted for net gains on our strategic investments of $170 million, changes in other assets and liabilities of $470 million, primarily related to actual cash transaction losses incurred during the period, deferred income taxes of $122 million, and accounts receivable of $103 million.
In the nine months ended September 30, 2020 and 2019, cash paid for income taxes, net was $444 million and $220 million, respectively.
Investing Activities
The net cash used in investing activities of $13.3 billion in the nine months ended September 30, 2020 was due primarily to purchases of investments of $28.3 billion, acquisitions (net of cash acquired) of $3.6 billion, changes in funds receivable from customers of $1.1 billion, and purchases of property and equipment of $640 million. These cash outflows were partially offset by maturities and sales of investments of $19.7 billion, changes in principal loans receivable, net of $523 million, and proceeds from the sale of property and equipment of $120 million.
The net cash used in investing activities of $5.3 billion in the nine months ended September 30, 2019 was due primarily to purchases of investments of $19.8 billion, changes in funds receivable from customers of $1.3 billion, changes in principal loans receivable, net of $1.1 billion, and purchases of property and equipment of $530 million. These cash outflows were partially offset by maturities and sales of investments of $17.4 billion.
Financing Activities
We generated cash from financing activities of $10.0 billion in the nine months ended September 30, 2020 due primarily to changes in funds payable and amounts due to customers of $7.8 billion and $7.0 billion of cash proceeds from the issuance of long-term debt in the form of fixed rate notes as well as proceeds from borrowings under our Credit Agreement. These cash inflows were partially offset by the repayment of outstanding borrowings under our Credit Agreement of $3.0 billion, the repurchase of $1.4 billion of our common stock under our stock repurchase programs, and tax withholdings related to net share settlement of equity awards of $463 million.
We generated cash from financing activities of $3.8 billion in the nine months ended September 30, 2019 due primarily to $5.5 billion of cash proceeds from the issuance of long-term debt in the form of fixed rate notes as well as borrowings under a prior credit agreement, and changes in funds payable and amounts due to customers of $2.4 billion. These cash inflows were partially offset by repayment of $2.5 billion of borrowings under a prior credit agreement, the repurchase of $1.1 billion of our common stock under our stock repurchase programs, and tax withholdings related to net share settlement of equity awards of $473 million.
Effect of Exchange Rates on Cash, Cash Equivalents, and Restricted Cash
Foreign currency exchange rates had a positive impact of $26 million and negative impact of $49 million on cash, cash equivalents, and restricted cash for the nine months ended September 30, 2020 and 2019, respectively, due primarily to fluctuations in the exchange rate of the U.S. dollar to the Australian dollar.
Off-Balance Sheet Arrangements
As of September 30, 2020, 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.
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Critical Accounting Policies and Estimates
The application of U.S. GAAP requires us to make estimates and assumptions about certain items and future events that directly affect our reported financial condition. We have established detailed policies and control procedures to provide reasonable assurance that the methods used to make estimates and assumptions are well controlled and are applied consistently from period to period. The accounting estimates and assumptions as described in our 2019 Form 10-K and as supplemented and, to the extent inconsistent, superseded within this section are those that we consider to be the most critical to our financial statements. An accounting estimate is considered critical if both (a) the nature of the estimate or assumption is material due to the levels of subjectivity and judgment involved, and (b) the impact within a reasonable range of outcomes of the estimate and assumption is material to our financial condition. Senior management has discussed the development, selection, and disclosure of these estimates with the Audit, Risk and Compliance Committee of our Board of Directors. Our significant accounting policies, including recent accounting pronouncements, are described in our 2019 Form 10-K and as supplemented and, to the extent inconsistent, superseded within “Note 1 — Overview and Summary of Significant Accounting Policies” to the condensed consolidated financial statements in this report.
A quantitative sensitivity analysis is provided where that information is reasonably available, can be reliably estimated, and provides material information to investors. The amounts used to assess sensitivity are included to allow users of this report to understand a general directional cause and effect of changes in the estimates and do not represent management’s predictions of variability. For all of these estimates, it should be noted that future events rarely develop exactly as forecasted, and estimates require regular review and adjustment.
Transaction and credit losses
Transaction and credit losses include the expense associated with our customer protection programs, fraud, chargebacks, and credit losses associated with our loans receivable balances. Our transaction and credit losses fluctuate depending on many factors, including: total TPV, current and projected macroeconomic conditions, including unemployment rates and merchant insolvency events, changes to and usage of our customer protection programs, the impact of regulatory changes, and the credit quality of loans receivable arising from transactions funded with our credit products, which include our PayPal Credit consumer products and merchant loans and advances arising from our PPWC and PPBL products.
We establish allowances for negative customer balances and estimated transaction losses arising from processing 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. Additions to the allowance, in the form of provisions, are reflected in transaction and credit losses on our condensed consolidated statements of income. The allowances are monitored regularly and are updated based on actual claims data. The allowances are based on known facts and circumstances, internal factors including experience with similar cases, historical trends involving loss payment and write-off patterns, the mix of transaction and loss types, as well as current and projected macroeconomic factors, as appropriate.
We also establish an allowance for loans and interest receivable, which represents our estimate of lifetime expected credit losses inherent in our portfolio of loans and interest receivable. This evaluation process is subject to numerous estimates and judgments. The allowance is primarily based on expectations of credit losses based on historical lifetime loss data as well as macroeconomic factors. Loss curves are generated using historical loss data for our loan portfolios and are applied to segments of each portfolio, categorized by geographic region, first borrowing vs. reuse, delinquency, and vintage, among other factors. 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. We utilize externally sourced macroeconomic scenario data to supplement our historical information due to the limited period in which our credit product offerings have been in existence. Projected loss rates, inclusive of historical loss data and macroeconomic factors, are applied to the principal amount of our consumer and merchant receivables. Further, we include qualitative adjustments that incorporate incremental information not captured in the quantitative estimates of our expected lifetime losses. While our consumer receivables are primarily revolving in nature and do not have a contractual term, 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 also vary in contractual term, and the reasonable and supportable forecast period we have considered for projected loss rates is approximately 2.5 to 3.5 years, dependent upon the product. The allowance for loss against the interest and fees receivable is determined primarily by applying loss curves by geography, delinquency, and period of origination, among other factors.
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Determining appropriate expected credit loss allowances for loans and interest receivable is an inherently uncertain process and ultimate losses may vary from the current estimates. We regularly update our allowance estimates as new facts become known and events occur that may impact the settlement or recovery of losses. The allowances are maintained at a level we deem appropriate to adequately provide for lifetime expected credit losses at the balance sheet date after incorporating the impact of externally sourced macroeconomic forecasts. These forecasts project scenarios for future unemployment and benchmark credit card charge-off rates. As of September 30, 2020, we utilized externally published projections indicating a gradual decline in forecasted U.S. unemployment rates as well as forecasted credit card charge-off rates over the reasonable and supportable period, following peak unemployment rates of approximately 14% and 10% in the second and third quarters of 2020, respectively, resulting in an overall principal and interest coverage ratio of approximately 24%. The projected gradual decline in unemployment and credit card charge-off rates is reflective of a prolonged recovery period where we may experience elevated charge-off rates. A significant change in the forecasted macroeconomic factors could result in a material change in our allowances. Our allowance as of September 30, 2020 has been adjusted to account for the proactive and reactive measures that we have taken that are intended to reduce financial difficulties experienced by our customers, and other 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. These qualitative adjustments were made to incorporate varying degrees of merchant performance both in the current environment as well as expected future performance, and to account for payment holidays granted. Our allowance as of September 30, 2020 has not been adjusted to account for the potential impacts of the CARES Act, which are also intended to help mitigate the negative impact the current pandemic may have on the financial condition of our customers. We are unable to predict the ultimate impact of these actions which may result in adjustments to our allowance for loans and interest receivable in future periods. An increase of 1% in the principal and interest coverage ratio would increase our allowances by approximately $34 million based on the loans and interest receivable balance outstanding as of September 30, 2020.
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Text extracted from the filing as submitted to EDGAR. Formatting, tables and exhibits are simplified for reading; the original document is authoritative for anything you rely on.