John Rainey
Chief Financial Officer and Executive Vice President, Global Customer Operations at PayPal
Thanks, Dan. I'd like to start by thanking the entire PayPal team for their continued commitment to serve our customers and execute on our priorities. We're reporting another very strong quarter. Our results are indicative of the strength, diversification and breadth of our two-sided Global Payments. Platform PayPal sits at the intersection of digital transformation and e-commerce penetration. As the largest open platform for digital payments globally, we're uniquely positioned to address the opportunity that these secular tailwinds present.
Over the past six quarters, our team's focus, collaboration and resilience have allowed us to innovate at scale and deliver our best performance in company history. Globally the pace and shape of the recovery varies. As the environment continues to evolve we are evolving with it to serve the changing needs of our consumers and merchants. During the second quarter, restrictions started to relax across our core markets and we saw the beginning of a return to normalcy in consumer behavior. Consumers are spending again in verticals that had been severely affected and have become more comfortable shopping in person and dining out.
Merchants are repositioning for the post-pandemic world. Relative to our expectations, which were for reopening spend to closely track vaccination rates, we've seen travel and events volumes return more rapidly. At the same time, in markets that have reopened elevated e-commerce spending above pre-pandemic levels is ongoing and indicative of permanent shifts in consumer behavior. On a two-year basis our business performance is remarkably consistent and very strong. Our second quarter results last year were exceptional. We grew revenue 20%, delivered a 28.2% operating margin, and grew non-GAAP EPS 49%. Both the operating margin and earnings growth were the best performance we've ever delivered.
It's remarkable that in the second quarter of this year when we're lapping this explosive growth, our business is continuing to perform at a very high level. Our results are even more impressive given the transitory headwinds we're facing from eBay. This year, as part of eBay's Managed Payments transition we're absorbing a rapid migration of marketplaces volumes off of our platform. Further compounding this effect is the eBay benefited meaningfully from COVID last year, which makes the comparison this year even more difficult. For context from 2016 to 2019, the three-year compound annual growth rate for eBay Marketplaces revenue on our platform was approximately 2%. And in 2020 this revenue grew 11%, approximately five times faster.
Also worth highlighting is that through this period as eBay's contribution to our revenue declined from 22% to 13% we've expanded our operating margin 500 basis points. Given the accelerated pace of migration in 2021 there is a more pronounced effect on our operating margin and earnings growth profile this year. At the same time, this is truly a transitory effect on our results, which we now expect to be very largely contained to 2021 with much less of a tail into next year. And as we've discussed over the past several quarters, near-term forecasting continues to be complex given the global macroeconomic backdrop, various stages of pandemic recovery and differing paths of reopening.
It's with this orientation and mindset that we head into the back half of 2021. Before discussing our outlook for the remainder of the year, I'd like to highlight our second quarter performance. Total payment volume grew 40% at spot and 36% on a currency neutral basis to $311 billion. Our Q2 TPV grew at a two-year compound annual growth rate of 34% accelerating from 33% in Q1 and indicative of the strong momentum in our business. Versus the second quarter last year, Merchant Services volume grew 43% currency-neutral. A resurgence in travel and advance as well as core payment volumes contributed to this performance.
This quarter eBay had a much greater effect on our TPV than in the first quarter. In Q2 eBay Marketplaces volumes declined 41% currency-neutral from last year. This is in comparison to a 3% decline last quarter. eBay represented 4% of our volume in Q2, down 512 basis points from last year. In addition to lapping elevated growth during the pandemic, we saw a faster ramp of the payments transition than what we had expected earlier this year, which resulted in a larger decline in Q2 volume. Given the speed at which we're seeing intermediation progress our plans now contemplate nearly 100% completion of the merchant migration by the end of the third quarter.
This accelerated timeframe means that while we expect a similar drag to our volume, revenue and earnings growth in the third quarter this impact lessens in Q4 and begins to tell off from there. As a result, we will have a much cleaner exit to 2021. Revenue increased 19% on a spot basis and 17% currency-neutral to $6.24 billion. Transaction revenue grew 17% to $5.8 billion and on a two-year basis transaction revenue grew 22.3% in Q2 versus 22.7% in Q1 of this year. In addition to the consistency of our results this performance is even more remarkable excluding eBay. In the second quarter, eBay Marketplaces revenue declined 51% in comparison to Q2 '20 and 27% sequentially. Our revenue excluding eBay grew 32%, an 11 point acceleration from last year's already strong second quarter.
Other value-added services revenue grew 40% on a spot basis and 36% currency-neutral to $441 million. These results were driven by strengthening credit performance and portfolio growth partially offset by lower interest income on customer balances. In the second quarter transaction take rate was 1.86% and total take rate was 2.01%. The mix effect of eBay contributed to more than a third of the 37 basis point reduction in take rate. The blended take rate on eBay volumes this quarter was 3.22% in comparison to 4.1% in Q2 last year. The remainder of the decline was primarily driven by reduced currency volatility in the quarter, which resulted in lower growth -- a lower growth rate in foreign exchange fees, a decline of $122 million from foreign currency hedges recorded as international transaction revenue and growth in bill payment volumes.
Bill payment is a vertical characterized by both a lower take rate and an overall lower cost of funding than our e-commerce volumes. Q2 was another great quarter of volume-based expense performance. Transaction expense came in at 81 basis points as a rate of TPV this year relative to 83 basis points last year. Transaction loss as a rate of TPV was a record low 9 basis points versus 12 basis points in Q2 last year. The net effect of credit provisioning on credit losses in the quarter inclusive of originations and reserve reversals resulted in a benefit of $104 million.
In the quarter, we had an increase in loan origination activity and ended Q2 with $3.9 billion in gross receivables reflecting sequential growth of 11%. Strong performance of our loan portfolio, improving macroeconomic trends and the mix of shorter duration originations from our installment pay products resulted in our reserve coverage ratio declining to 14.9% from 21.4% at the end of the first quarter. As a result, transaction margin dollars grew 19% in the second quarter and transaction margin reached 56.8%. I'd now like to cover our non-transaction related operating expenses. Overall, these expenses increased 27% and represented 30% of revenue.
These are higher growth rates than what we've incurred historically, but as I suggested before, we believe that there has never been a more important time to invest in our business as the secular tailwinds in our business have perhaps never been stronger. In Q2, we again invested aggressively in product innovation and our go-to-market initiatives. Sales and marketing increased 68% in the quarter and technology and development spend grew 23%. On a non-GAAP basis, operating income grew 11% to $1.65 billion and our operating margin was 26.5%. This includes an approximately 12% or $360 million decline in transaction margin dollars from eBay Marketplaces.
Normalizing for the reserve build last year and subsequent release this year, non-GAAP operating income declined 7% and operating margin was 23.9%. And on a two-year basis, the compound annual growth rate for operating income is 29%. For the second quarter non-GAAP EPS grew 8% to $1.15. This includes an approximate $0.27 per share headwind from the decline in eBay Marketplaces transaction margin dollars. Adjusting for our increased credit provisions last year and this year's release of reserves, EPS declined 9%. And on a two-year basis, this represents 27% earnings growth annually. We ended the quarter with cash, cash equivalents and investments of $19.4 billion. And in addition, we generated $1.1 billion in free cash flow.
I'd now like to discuss our outlook for the rest of 2021. Our business is performing exceedingly well and overall, consistent with the outlook we provided on our last call. Given our strong year-to-date performance and our expectations for the back half, we're raising our TPV outlook and reiterating full year revenue and earnings. We now expect TPV growth to be in the range of 33% to 35% given the strong volume trends in our business. We continue to expect revenue for the year to be approximately $25.75 billion representing 20% growth on a spot basis. In addition, we continue to expect non-GAAP earnings per share to be approximately $4.70 or growth of approximately 21%.
We raised our 2021 revenue outlook by $250 million or approximately 1 point of growth when we reported our first quarter results in May. We're now absorbing more pressure from eBay than we had previously expected. Our current outlook contemplates an approximately 7 point negative impact to revenue growth for the year. This corresponds to an approximately $0.85 negative impact to non-GAAP EPS from reduced transaction margin dollars. We're pleased that the strength of our platform and the diversification of our business is allowing us to maintain this elevated outlook.
In addition, we expect to generate more than $5 billion in free cash flow or approximately $0.20 of free cash flow for every dollar of revenue. Now turning to guidance for the third quarter; this quarter we're up against our toughest revenue comparisons versus last year. In Q3 '20, we reported 25% revenue growth, our strongest performance for the year. As a result of this dynamic as well as eBay's Managed Payments transition, our plans had always assumed that in Q3 we would report our lowest level of quarterly revenue growth for the year.
However, we're now planning for eBay's drag on our revenue growth to be greater than previously expected resulting from both the accelerated pace of merchant migration in international markets as well as some additional core pressure, which magnifies this result. For the third quarter, we expect revenue to be in the range of $6.15 billion to $6.25 billion. At the midpoint, this represents growth of approximately 14% at spot and includes about 8.5 points drag from eBay or approximately $465 million negative impact. On a two-year basis, inclusive of the drag, our guidance represents 19% growth.
We also expect non-GAAP diluted EPS to be flat to last year or approximately $1.07, reflecting increased investments to support our growth initiatives and the pressure we're facing from eBay. Our financial performance over the first half of 2021 has been very strong and consistent with the guidance we've outlined at the outset of each quarter. At the same time, the environment in which we're operating while more stable than a year ago continues to be very dynamic and more challenging to predict than normal. Adding to the complexity is this exercise of predicting eBay's transition for which we have less-than-perfect visibility. Each quarter we've tried to provide our best estimate of the level of performance that we believe we can deliver.
Overall, our growth remains strong and importantly we continue to see the categories that benefited from quarantine measures and shelter in place activities last year, maintain higher levels of e-commerce volumes in comparison to pre-COVID levels. Our conviction and our ability to drive sustainably strong performance and in the strength of our franchise has never been greater. This year we expect to process approximately $1.25 trillion of payments volume. We expect to grow revenue by 20% more than offsetting pressure to revenue growth of approximately 7 points from eBay and lapping our strongest year with 22% revenue growth.
And given the momentum we have in development and innovation and the pace of scale of the new experiences we're bringing to our customers we are investing in our business at record levels. Further, last year we grew earnings 31%. On top of that performance, this year we plan to grow our earnings by 21%. Importantly, our team has never been more focused or aligned around the shared goal of being the leading digital payments company in the world. Last year was a pivotal moment in our history. And this year we're building on that foundation and continuing to realize our ambition for greater relevance, ubiquity and impact as a global payments leader. We look forward to sharing more of our progress with you.
With that, I'll turn it over to the operator for questions.
