Synchrony Financial — Q3 2018 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2018. Synchrony is a U.S.-focused consumer lender operating through Retail Card, Payment Solutions, and CareCredit, primarily via Synchrony Bank. Figures below are in U.S. dollars; income-statement and cash-flow comparisons are year over year unless noted.
Financial performance and position
- Earnings: Q3 net earnings were $671 million, up 20.9% from $555 million; diluted EPS was $0.91 versus $0.70. Nine-month net earnings were $2.007 billion, up 29.5% from $1.550 billion; diluted EPS was $2.66 versus $1.93.
- Revenue and margins: Q3 net interest income rose 8.5% to $4.206 billion; nine-month net interest income increased 6.2% to $11.785 billion. After retailer shares and loan-loss provision, net interest income was $1.884 billion for Q3 and $5.448 billion year to date. Net interest margin declined to 16.41% in Q3 from 16.74%, and to 15.94% year to date from 16.38%.
- Credit costs and asset quality: Q3 provision for loan losses rose 10.8% to $1.451 billion; nine-month provision increased 3.8% to $4.093 billion. The allowance was $6.223 billion, or 7.11% of period-end loans, versus 6.97% a year earlier. Q3 net charge-off rate was 4.97%, nearly flat year over year; the nine-month rate rose to 5.67% from 5.23%. Over-30-day delinquencies improved to 4.59% from 4.80%.
- Expenses and taxes: Q3 other expense increased 10.0% to $1.054 billion; nine-month expense rose 8.6% to $3.017 billion, with PayPal-related servicing costs, growth, and technology investment contributing. Effective tax rates fell to 24.9% for Q3 and 23.7% year to date, primarily reflecting the Tax Act’s lower corporate rate.
- Portfolio growth: Period-end loan receivables were $87.521 billion, up 13.8% from September 2017. Q3 purchase volume was $36.443 billion, up 10.8%; average active accounts were 75.5 million, up 8.9%.
- Funding, debt, and liquidity: Deposits totaled $62.317 billion at September 30, up from $56.488 billion at year-end; they represented 72% of funding sources. Borrowings totaled $23.741 billion, including $14.187 billion of securitization borrowings and $9.554 billion of senior unsecured notes. Liquid assets were $18.2 billion; additional stated capacity included $4.6 billion of undrawn securitization commitments, a $0.5 billion revolving facility, and more than $25 billion of unencumbered Bank assets. The company reported compliance with debt covenants and well-capitalized status.
- Capital and shareholder returns: Company common equity Tier 1 ratio was 14.2%, down from 16.0% at year-end; Bank CET1 was 14.4%, down from 14.9%. Nine-month repurchases totaled $1.867 billion and dividends paid were $383 million ($0.51 per share). The quarterly dividend was raised to $0.21; $953 million remained under the $2.2 billion repurchase authorization at quarter-end.
- Cash flow, nine months: Operating activities provided $6.766 billion versus $6.106 billion. Investing used $12.751 billion versus $2.422 billion, including $7.342 billion for acquired loan receivables and increased securities purchases. Financing provided $6.439 billion versus $736 million, supported by deposit growth and debt issuance, partially offset by repurchases and dividends. Cash and equivalents were $12.068 billion at September 30, excluding restricted cash.
Material changes and notable events
- Synchrony acquired the U.S. PayPal Credit financing program on July 2, including $7.6 billion of outstanding receivables, and became PayPal’s exclusive U.S. issuer for that program through 2028. The acquisition contributed to portfolio, revenue, provision, and expense growth.
- Synchrony said it will not renew its Walmart Retail Card agreement, which expires July 31, 2019. It extended agreements with Lowe’s and JCPenney and announced several other partner extensions and additions.
- The Toys “R” Us bankruptcy partly offset growth in retailer-share arrangements. Loop Commerce, a digital and in-store gifting company, was acquired in June; contingent consideration could range up to $126 million depending on future revenue targets.
Outlook, risks, and contingencies
- The filing provides no specific earnings or revenue guidance. Management cited seasonal increases in loan balances and delinquencies in the second half of the year, with charge-off patterns affected by payment behavior and subsequent seasonal paydowns.
- Higher benchmark rates and deposit growth raised funding costs; management noted potential margin compression. A modeled immediate 100-basis-point increase in rates was estimated to increase net interest income by about $67 million over the following 12 months.
- Synchrony expected adoption of the CECL credit-loss standard, planned for January 1, 2020, to increase its allowance; the amount would depend on portfolio quality and economic conditions.
- Key risks include consumer credit deterioration, partner concentration and retention, funding costs and access, securitization triggers, interest-rate mismatches, regulatory and privacy requirements, cyber and operational risks, and limits on Bank distributions to the parent. Senior unsecured ratings carried negative outlooks from Fitch and S&P.
- The CFPB had issued a Civil Investigative Demand concerning marketing and servicing of deferred-interest promotions. The filing also describes TCPA class actions and a bankruptcy-related credit-reporting dispute. Management estimated reasonably possible losses it could quantify as immaterial and said it knew of no pending matter expected to materially harm financial condition or liquidity; outcomes remain uncertain.
Important facts for investors to verify
- How much of reported loan growth and earnings contribution is attributable to PayPal Credit, and how its credit performance and servicing costs develop.
- Whether the Walmart program transition causes portfolio runoff, revenue loss, or replacement costs after July 2019.
- Whether the higher allowance and nine-month charge-off rate adequately reflect expected credit losses, including seasonality and the acquired portfolio.
- Whether deposit repricing and other funding costs continue to outpace asset yields, and how liquidity and capital ratios evolve as loans grow.
- Developments in the CFPB inquiry, litigation, CECL implementation, and remaining share-repurchase authorization and dividend capacity.