Wednesday, May 15, 2019

AAPL: How Popular are Apple's iPhone Financing Plans in the US? Here's a Look

Apple offers iPhone financing through 24-month zero-interest installment loans funded by Citizen's Bank (US). How popular is Apple's financing product? From the data I have gathered, the take-rate is pretty low- less than 1 million per quarter. It's probably not as low as it appears considering that a very low percentage of iPhones are bought at Apple retail stores. 

The loan payments are charged to the user's credit card each month through autopay. It's almost like financing the financing. It could be buyers don't want to fool with an installment loan and have it affect their credit report when they can just use their credit card to finance the purchase. That's less than ideal if the balance isn't paid down or off in short time. Credit card interest rates are typically relatively high, and the full balance of the purchase accrues interest from the start. 

The Apple plans are more advantageous since it's just the monthly payment (opposed to full balance) that would accrue credit card interest fees.  Given that Apple's stores are typically located in very affluent zip codes, it's likely very few buyers need financing plans.

With these plans, iPhone users can give back their iPhones to Apple after a year if they buy a new iPhone. Apple will pay off their loan balance. And the process restarts itself. 

How does Apple offer 0% financing? Especially given that not Apple, but a bank is the lender? 

Apple sells the loans at a discount. If a customer buys a 720 iPhone and agrees to 24 monthly payments of $30, Apple will sell that loan for perhaps $680. The bank earns $40 in interest income on $680 loan. Apple sweetens the deal with the bank by opening a bank account where proceeds from the loan sales are deposited. Apple has to keep a compensating balance at Citizen's- likely equal to the outstanding loan principal. Apple disclosed this arrangement in its most recent 10-Q due to the new accounting rules requiring restricted cash to be separated out on the balance sheet. 

Most often, when a company has a restricted cash balance it is due to credit quality concerns. Lenders will require cash to be set aside for collateral purposes, especially when a firm lacks other suitable assets to pledge as security. 

That is not the case here. Banks have to hold a minimum amount of deposits, or required reserves. If a bank takes in $100 of deposits they might only be able to make $90 in loans and having to keep only $10 of depositor's money on-hand (or on deposit at the Fed). If Citizen's originates $1M of iPhone loans and Apple deposits $1M in an account at Citizen's, then it doesn't eat into the bank's lending capacity. Since banks only have a finite amount of allowable lending capacity. They don't want to waste loanable funds on low margin loans when the bank has the opportunity to lend at higher interest rates. With a compensating balance on deposit, there is no opportunity cost for the bank, thus it will accept a lower rate. 

Plus, Apple reduces their cost of credit risk through loss-sharing agreements. In short, by reducing Citizen's credit and opportunity cost, Apple doesn't have to take as large of a haircut on the loan sales as Citizen's will accept earning a lower interest rate. 

Citizen's has disclosed the balance of "merchant partnership" loans which are the Apple iPhone financing plans f(or most quarters). Apple has only reported restricted cash for the most recent quarter- 2Q19 ending in March. The restricted cash balance included in non-current assets lines up with Citizen's numbers. I don't know what the restricted cash in current assets is from. The caption says "primarily" which obviously means not 100% so my take is the amount classified as current is related to something else. 

Taking the disclosed balances, I calculated the amount of new iPhone loans for each quarter. Using an assumption for ASP, the number of iPhones sold under installment plans can be calculated. 

The change in loan balance from quarter to quarter does not represent the amount of new iPhone loans extended since the previous quarter's balance will be paid down to some degree. Thus, the amount of payments made on the outstanding balance must be calculated first. 

I didn't take the time to try to be super accurate by incorporating more realistic assumptions since these numbers are so low it's not really worth the time. However, this should be roughly accurate.

1) 24 month Average loan life (none paid off early).
2) No payments are made on loan balances in the quarter which they originated.

You can see in the table the big jump for the quarters that the iPhone X and iPhone Xs / Max were introduced. 

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