Synchrony Financial — Q2 2015 Form 10-Q
Reporting period: Three and six months ended June 30, 2015. Synchrony provides consumer credit through Retail Card, Payment Solutions and CareCredit. It reported one business segment. GE owned approximately 84.6% of the company after its 2014 IPO. Comparisons with 2014 should be read with care: the 2014 statements were combined before June 30 and consolidated thereafter.
Financial performance and position
| Metric | Q2 2015 | Q2 2014 | Six months 2015 | Six months 2014 |
|---|---|---|---|---|
| Net earnings | $541 million | $472 million | $1,093 million | $1,030 million |
| Net interest income | $2,907 million | $2,720 million | $5,782 million | $5,463 million |
| Provision for loan losses | $740 million | $681 million | $1,427 million | $1,445 million |
| Other expense | $805 million | $797 million | $1,551 million | $1,407 million |
| Diluted EPS | $0.65 | $0.67 | $1.31 | $1.46 |
| Net interest margin | 15.77% | 17.84% | 15.75% | 18.29% |
- Net earnings rose 14.6% in Q2 and 6.1% for the first half. EPS declined as weighted-average shares increased from 705 million to 835 million following the IPO.
- Interest income increased 8.6% in Q2 and 8.0% year to date, mainly on higher average loan balances. Higher funding costs and a larger, lower-yield liquidity portfolio contributed to the lower net interest margin.
- Purchase volume was $28.8 billion in Q2 and $51.9 billion in the first half. Average active accounts were 60.9 million and 61.5 million, respectively.
- Period-end loan receivables were $61.4 billion, up 12.0% from June 2014, reflecting portfolio and account growth, including the BP portfolio acquisition. Receivables were up 0.2% from December 2014.
- Credit metrics improved year over year: 30+ day delinquencies were 3.53% versus 3.82%; net charge-off rates were 4.63% for Q2 and 4.56% for the first half, down 25 and 29 basis points, respectively. The allowance was $3.3 billion, or 5.38% of receivables.
- At June 30, deposits were $37.8 billion, total borrowings $23.7 billion, total assets $75.8 billion and equity $11.6 billion. Direct deposits reached $24.4 billion, up 23.9% from year-end; brokered deposits declined.
- Six-month cash from operating activities was $3.0 billion; investing activities used $3.0 billion and financing activities used $1.2 billion. Cash and equivalents declined by $1.2 billion to $10.6 billion.
- Reported Q2 return on assets was 2.9% versus 3.1%; return on equity was 19.2% versus 29.9%. The efficiency ratio improved to 33.5% from 35.5%.
Material changes and unusual items
- Funding shifted away from GECC related-party financing toward deposits and third-party debt. Synchrony repaid the remaining $655 million GECC term loan in Q1; GECC no longer provides funding. Interest expense rose 31.1% in Q2 and 37.6% in the first half, reflecting higher average liabilities and the funding mix.
- Other expense increased 10.2% year to date, driven partly by employee, professional and technology costs to build standalone operations. Q2 expense growth was partly offset by the absence of a $42 million consumer-remediation reserve increase recorded in Q2 2014.
- The company sold two credit-card portfolios in Q2 for $392 million and recorded a $20 million pretax gain. Higher loyalty-program costs partly offset increased interchange income.
- On July 23, 2015, after quarter-end, Synchrony issued $1.0 billion of 4.5% senior unsecured notes due 2025.
Liquidity, capital, outlook and risks
- Liquidity at June 30 included $13.7 billion of liquid assets, $6.1 billion of undrawn committed securitization capacity and more than $25 billion of unencumbered Bank assets available as potential liquidity. Management said it stress-tests liquidity and seeks diversified funding.
- The Bank met applicable well-capitalized requirements. The company reported a 17.2% Basel III transition common equity Tier 1 ratio and estimated a 16.4% fully phased-in ratio. Synchrony was in compliance with its loan covenants, including minimum liquidity requirements.
- Management said it planned to expand direct deposits and continue building standalone infrastructure. It expected to retain earnings and not pay dividends or repurchase shares until the Federal Reserve acted on its separation-related application; no specific earnings guidance was provided.
- Separation from GE remained subject to regulatory review and approval. GE’s continued ownership and control, the transition to independent operations, and potential additional capital or liquidity requirements were identified uncertainties.
- Other key risks include funding-cost increases, interest-rate and margin pressure, partner concentration and contract economics, consumer credit losses and allowance estimates, securitization early-amortization triggers, regulatory and consumer-protection actions, cyber and operational risks, and restrictions on Bank dividends.
- Consumer remediation under prior CFPB and DOJ orders was substantially complete at June 30; Synchrony estimated about $4 million of additional remediation remained for Q3. The CareCredit order required payments of up to $34.1 million, completed in Q2. The filing said estimable reasonably possible losses from other legal and regulatory matters were immaterial, while noting outcomes could vary and affect a period’s results.
- Management identified no material change to the risk factors in its 2014 Form 10-K. It reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Progress and conditions attached to Federal Reserve review of the GE separation, and the implications of GE’s continuing 84.6% ownership.
- Whether improving delinquencies and charge-offs persist, and whether the $3.3 billion allowance remains adequate through seasonal balance and delinquency patterns.
- How deposit growth, debt refinancing and market rates affect funding costs, net interest margin and liquidity.
- The sustainability of earnings growth after considering the $20 million portfolio-sale gain, rising standalone costs and prior-period remediation items.
- Completion of remaining consumer remediation and developments in the disclosed TCPA, credit-reporting and other legal matters.