(Bloomberg) -- PayPal Holdings Inc. shares slumped after the payments giant said a key measure of profits shrank in the second quarter as the company had to set aside more money to cover souring loans it has made to merchants. 

The stock plummeted 10% to $65.63 at 9:58 a.m. in New York, making it the third-worst performer in the S&P 500 index. 

PayPal’s adjusted operating margin narrowed to 21.4% in the second quarter from 22.7% in the first three months of the year, the San Jose, California-based company said in a statement after the close of regular trading Wednesday. That missed the 22% guidance the company had previously provided and came as the company tightened underwriting standards for loans it has made to merchants in recent months.

“We saw some increased losses in our PayPal business-loan portfolio,” Chief Executive Officer Dan Schulman said in a telephone interview. “We tightened on originations and we’re seeing the effects of that in the quarter. We put a provision in for our losses and I expect that to be a temporary blip across results.” 

In recent years, PayPal has expanded its loan offerings for the millions of merchants that process payments across the firm’s many platforms, and these days the company offers business and working-capital loans. The business loans can be as small as $5,000 and as big as $150,000 for repeat borrowers. 

The results echo those of American Express Co., which last month said it’s begun to see softness in its portfolio of cards dedicated to US small business. The Federal Reserve said this week that a “significant” share of banks reported having tightened standards on loans to small businesses in the second quarter.

Spending growth on PayPal’s platforms accelerated in the second quarter, meanwhile, as consumer confidence continues to soar amid moderating inflation. 

Total payments volume rose 11% to $376.5 billion, higher than the $372 billion average of analyst estimates compiled by Bloomberg and faster than the 10% growth the company posted in the first three months of the year. 

PayPal has benefited from the ongoing strength of US consumers and their increased willingness to travel and spend more on experiences in the aftermath of the pandemic. Consumer confidence advanced to a two-year high in July, aided by a strong job market and easing inflation.

“E-commerce seems to be bouncing back as inflation cools,” Schulman said. “You’re seeing a return in discretionary spend.”

Next CEO

PayPal has been searching for a replacement for Schulman as the longtime CEO prepares to leave the company in coming months. Ahead of his departure, Schulman has sought to refocus the company on the core checkout experience it’s long been known for, while also working to improve operating leverage, or the ability to grow revenue faster than expenses. 

To do that, he’s sought to rein in costs. PayPal in January said it would cut 2,000 staffers, or 7% of the company’s total workforce at the time. 

PayPal is now in the final stages of the CEO search process and has narrowed the pool of candidates down to “several outstanding” executives, Schulman said Wednesday on a conference call with analysts. 

“I’m eager to welcome PayPal’s next CEO, to work with them on a seamless onboarding and to support them and the amazing PayPal team as I transition to my role on the board,” he said.

PayPal’s increased provisions come as investors have grown increasingly concerned about pressure on margins. That’s because the company continues to invest in its unbranded-payments technology and shareholders fear that business is less lucrative than the branded PayPal checkout experience.

That pressure seemed to continue in the second quarter: volume through PayPal’s branded checkout options climbed by a percentage in the “mid-single digits,” compared with 11% growth for the company overall. In the quarter, PayPal saw its transaction margin — a measure of how profitable the firm’s core business of processing transactions is — shrink to 45.9%, marking the third consecutive quarter that metric narrowed. 

“We understand that over the medium to long term, we need to deliver growth in our transaction-margin dollars to ensure we sustainably grow our earnings,” Schulman said on the conference call.

(Updates with share price in second paragraph, additional CEO commentary in last paragraph.)

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