Synchrony Financial — Q2 2018 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2018; comparisons are with the corresponding 2017 periods unless noted. Synchrony is a U.S.-focused consumer finance company offering credit cards, promotional financing, installment loans and FDIC-insured deposits through retail, Payment Solutions and CareCredit platforms.
Financial performance and position
| Metric | Q2 2018 | Six months 2018 | Comparison / context |
|---|---|---|---|
| Net earnings | $696 million | $1.336 billion | Up 40.3% and 34.3%, respectively |
| Net interest income | $3.737 billion | $7.579 billion | Up 2.7% and 4.9%, respectively |
| Provision for loan losses | $1.280 billion | $2.642 billion | Down 3.5% in Q2; relatively flat for six months |
| Diluted EPS | $0.92 | $1.75 | Compared with $0.61 and $1.23 |
| Net interest margin | 15.33% | 15.69% | Down from 16.20% and 16.19% |
| Net charge-off rate | 5.97% | 6.06% | Up from 5.42% and 5.37% |
Higher average loan receivables supported interest income and earnings. The lower effective tax rate—22.0% for Q2 and 23.2% for six months, versus 37.1% and 36.6%—primarily reflected the Tax Act’s reduction in the federal corporate tax rate. Higher funding costs and operating expenses partly offset revenue growth.
- Loans and credit quality: Period-end loan receivables were $78.879 billion, up 4.5% year over year but down 3.7% from December 31, 2017, primarily reflecting seasonality. The allowance was $5.859 billion, or 7.43% of receivables, versus 6.63% a year earlier. Over-30-day delinquencies improved to 4.17% from 4.25%; 90-plus-day delinquencies rose to 1.98% from 1.90%.
- Funding, debt and liquidity: Deposits totaled $59.0 billion at June 30, up 4.5% from year-end and equal to 73% of total funding; direct deposits grew 8.2% to $46.2 billion. Borrowings totaled $21.7 billion, including $12.2 billion of securitization borrowings and $9.6 billion of senior unsecured notes. Liquid assets were $21.5 billion; additional sources included $6.0 billion of undrawn securitization capacity, $0.5 billion under a revolving facility and more than $25.0 billion of unencumbered Bank assets.
- Capital and returns: Company and Bank capital ratios met well-capitalized requirements. Synchrony Financial’s total risk-based capital ratio was 18.0%; the Bank’s was 17.6%. The company repurchased $901 million of stock and paid $227 million in dividends during the first half. It announced a quarterly dividend increase to $0.21 beginning in Q3 and a new repurchase authorization of up to $2.2 billion through June 30, 2019.
- Cash flows: For the six months, operating activities provided $4.081 billion, investing activities used $2.274 billion, and financing activities provided $2.266 billion. Cash and equivalents were $15.675 billion at June 30, compared with $11.602 billion at year-end.
Changes, outlook and notable items
- Interest expense rose 31.2% in Q2 and 27.3% for the first half, reflecting higher rates and deposit growth. Cost of funds increased to 2.24% and 2.17%, respectively, from 1.86% and 1.85%. Management also attributed lower asset yields and higher funding costs in part to pre-funding the PayPal portfolio purchase.
- Other expense increased 7.0% in Q2 and 7.9% for six months, mainly from employee costs, professional fees and information processing associated with business growth and strategic investment.
- On July 2, 2018, after quarter-end, Synchrony completed its acquisition of $7.6 billion of PayPal U.S. consumer credit receivables and became the exclusive U.S. issuing bank for PayPal Credit through 2028. The filing provides no specific full-year earnings or financial guidance.
- On July 26, 2018, Synchrony announced it would not renew its Walmart Retail Card agreement, which expires July 31, 2019. Toys “R” Us’ bankruptcy also reduced Q2 retailer share arrangements.
- Synchrony acquired Loop Commerce in June. The acquisition includes contingent consideration with a reported fair value of $29 million and potential payments ranging from zero to $126 million, dependent on future revenue targets.
- Management cited consumer credit, economic and interest-rate conditions, funding access and costs, partner concentration and retention, operational and cybersecurity risks, and regulatory and legal matters among the risks to results. It expects the CECL accounting standard, effective in 2020 unless early adopted, to increase the loan-loss allowance; the amount is not yet clear.
- The filing reported ongoing legal and regulatory matters, including a CFPB inquiry into deferred-interest promotions and TCPA class actions. The CFPB informed the Bank on July 3 that its Enforcement Office did not intend to recommend enforcement action regarding a separate credit-reporting matter. Management estimated reasonably possible losses for matters it could estimate as immaterial, while noting outcomes remain uncertain.
Important facts for investors to verify
- Track charge-offs, delinquencies and allowance adequacy: charge-off rates rose year over year even as over-30-day delinquencies declined.
- Assess whether loan growth and PayPal integration can offset higher funding costs and the decline in net interest margin.
- Evaluate the earnings, portfolio and partner-concentration effects of the Walmart agreement ending in 2019, alongside PayPal’s contribution.
- Review the effect of planned dividends and repurchases on capital and liquidity, including applicable regulatory restrictions.
- Monitor CECL implementation, legal and regulatory developments, and Loop Commerce contingent payments.