Synchrony Financial — 2014 Form 10-K
Reporting period: Fiscal year ended December 31, 2014; the filing also reports fourth-quarter results. Synchrony provides private-label and dual credit cards, promotional financing and healthcare financing through Retail Card, Payment Solutions and CareCredit. It completed its IPO in August 2014; GE retained approximately 84.6% ownership at year-end.
Financial performance and position
| Metric | 2014 | 2013 |
|---|---|---|
| Interest income | $12.242 billion | $11.313 billion |
| Net interest income | $11.320 billion | $10.571 billion |
| Retailer share arrangements | $2.575 billion | $2.373 billion |
| Provision for loan losses | $2.917 billion | $3.072 billion |
| Other expense | $2.927 billion | $2.484 billion |
| Net earnings | $2.109 billion | $1.979 billion |
| Diluted earnings per share | $2.78 | $2.81 |
| Net interest margin | 17.20% | 18.78% |
| Efficiency ratio | 31.7% | 28.6% |
| Return on assets | 3.2% | 3.5% |
- Growth and revenue: Purchase volume rose 9.9% to $103.1 billion; period-end loan receivables rose 7.0% to $61.3 billion. Non-GAAP platform revenue increased 7.5% to $10.126 billion. Retail Card contributed $6.917 billion, Payment Solutions $1.573 billion and CareCredit $1.636 billion.
- Credit quality: Net charge-offs were $2.573 billion, or 4.51% of average receivables, versus 4.68% in 2013. Delinquencies over 30 days declined to 4.14% from 4.35%. The allowance was $3.236 billion, equal to 5.28% of period-end receivables, compared with 5.05%.
- Cash flow: Operating cash flow was $5.340 billion, investing cash outflow $10.068 billion, and financing cash inflow $14.237 billion. Cash and equivalents ended the year at $11.828 billion, up from $2.319 billion, reflecting IPO and financing proceeds as well as business cash flows.
- Funding, debt and liquidity: Deposits totaled $34.955 billion, including $19.7 billion in direct deposits and $15.3 billion in brokered deposits. Borrowings totaled $27.460 billion: $14.967 billion securitized, $8.245 billion under the Bank Term Loan, $3.593 billion senior notes and $655 million owed under the GECC Term Loan. The liquidity portfolio was $12.9 billion; Synchrony also reported $6.1 billion of undrawn securitization capacity and more than $25 billion of unencumbered Bank assets.
- Capital: Equity was $10.478 billion, up from $5.960 billion. Management estimated a fully phased-in Basel III Tier 1 common ratio of 14.5%; this is a preliminary, non-GAAP estimate. The Bank reported a 17.1% total risk-based capital ratio and met its applicable well-capitalized requirements.
Material changes versus prior periods
- Annual net earnings rose 6.6%, supported by higher net interest income and lower loan-loss provision; higher retailer share payments and operating expenses partly offset the improvement. Annual diluted EPS declined from $2.81 to $2.78.
- Interest expense increased 24.3% to $922 million as Synchrony replaced much of its GECC funding with deposits and third-party debt. Funding costs rose to 1.69% from 1.56%, while net interest margin fell, in part because of increased low-yield liquidity balances.
- Other expense increased 17.8% to $2.927 billion, including costs for standalone infrastructure, IPO and separation work, marketing and business growth. Retailer share arrangements rose 8.5% to $2.575 billion.
- Deposits increased 35.9%, with direct deposits up 79.1%. The IPO generated approximately $2.8 billion in net proceeds and the company issued $3.6 billion in senior notes; it repaid approximately $8.0 billion of then-outstanding related-party debt.
- For the fourth quarter, net earnings were $531 million versus $443 million a year earlier; net interest income was $2.978 billion versus $2.849 billion.
Outlook, commentary and risks
- Management expected loan receivables and interest income to grow in the near to medium term, supported by expected average receivables growth, partner engagement and consumer spending. It expected yields to remain relatively stable near term absent significant pricing changes.
- Management expected higher funding costs than under historical GECC funding, while seeking to expand direct deposits and reduce GECC-related debt. It expected the annualized expense increase needed to operate independently to be fully incurred in 2015, partly offset by reduced GE allocations and transitional-service costs after separation.
- Synchrony planned to retain earnings and make no dividends or stock repurchases until Federal Reserve approval of its application to continue as a savings and loan holding company after separation. GE targeted separation for late 2015, but timing and completion depended on regulatory approvals, standalone readiness and other conditions.
- Key exposures include concentration in a small number of Retail Card partners: the ten largest generated 59.8% of platform revenue, and the five largest 47.1%. Partner non-renewals, retailer financial distress or reduced promotion could affect revenue and credit performance.
- Other significant risks include consumer-credit deterioration, adequacy of loan-loss reserves, interest-rate and funding-market changes, dependence on securitization and deposits, regulatory requirements and CFPB oversight, and operational, cyber-security and third-party service risks. Separation also entails execution costs, loss of GE brand support and possible additional regulatory capital, liquidity or operating conditions.
- Regulatory matters include a CFPB CareCredit consent order requiring up to $34.1 million in customer payments, plus ongoing training and business-practice changes. Separate CFPB and DOJ orders involved debt-cancellation refunds and remediation of excluded customers; the filing reports approximately $207 million in total consumer remediation, with approximately $75 million remaining at year-end. Management did not believe the orders themselves would materially affect future results, but noted possible reputational and further enforcement consequences.
- Unusual items included a $46 million pre-tax gain from credit-card portfolio sales in the fourth quarter and the effects of the 2013 allowance-methodology enhancement, which added $642 million to provision in 2013 and did not recur in 2014. The filing states that reasonably possible losses on other estimable legal and regulatory matters were immaterial; outcomes remain uncertain.
Most important facts for investors to verify
- Whether portfolio credit quality and the 5.28% allowance coverage remain adequate if delinquencies and charge-offs rise.
- Whether direct deposits continue to grow, funding costs stabilize, and liquidity remains available under stress; verify conditions on undrawn securitization capacity.
- Progress and costs of standalone operations, Federal Reserve approval and GE’s planned separation, including any resulting capital, liquidity or dividend restrictions.
- Renewal and performance of major partner programs, particularly disclosed non-renewals and the concentration of platform revenue.
- Completion and final cost of required customer remediation, and any further CFPB, DOJ, state or other regulatory actions.
- Reconcile cash generation and reported earnings against ongoing receivables growth, funding changes and one-time portfolio-sale gains; note that platform revenue and the estimated Basel III ratio are non-GAAP measures.