Synchrony Financial — Q2 2016 Form 10-Q
Business context and reporting period
Quarter and six months ended June 30, 2016; comparisons are to the corresponding 2015 periods unless stated otherwise. Synchrony is a U.S.-focused consumer lender operating through Retail Card, Payment Solutions and CareCredit, and funds lending primarily with deposits and securitizations. It reported one business segment. The company had 68.3 billion dollars of period-end loan receivables and 66.5 million average active accounts in Q2.
Key financial metrics
| Metric | Q2 2016 | Six months 2016 | Comparison / context |
|---|---|---|---|
| Interest income | $3.515 billion | $7.035 billion | Up 10.6% and 11.2%, respectively |
| Net interest income | $3.212 billion | $6.421 billion | Up 10.5% and 11.1% |
| Net earnings | $489 million | $1.071 billion | Down 9.6% and 2.0% |
| Diluted EPS | $0.58 | $1.28 | Q2 2015: $0.65; six-month 2015: $1.31 |
| Net interest margin | 15.86% | 15.80% | Prior-year periods: 15.77% and 15.75% |
| Provision for loan losses | $1.021 billion | $1.924 billion | Up 38.0% and 34.8% |
| Net charge-off rate | 4.49% | 4.59% | Prior-year periods: 4.63% and 4.56% |
| Period-end loan receivables | $68.282 billion | Up 11.2% year over year; nearly unchanged from Dec. 31, 2015 | |
| Deposits | $46.427 billion at June 30 | Up 7.1% from year-end; direct deposits were $34.1 billion | |
| Total borrowings | $19.295 billion at June 30 | Down from $24.279 billion at year-end, including repayment of the $4.1 billion Bank Term Loan |
Q2 earnings before taxes were $771 million (versus $861 million); other income was $83 million (versus $120 million), and other expense was $839 million (versus $805 million). Return on assets was 2.4% for Q2 and 2.6% for the six-month period; return on equity was 14.6% and 16.3%, respectively.
For the six months, operating cash flow was $2.972 billion, investing cash flow was negative $1.235 billion, and financing cash flow was negative $2.275 billion. Cash and equivalents declined $538 million to $11.787 billion. The separate liquidity portfolio was $14.0 billion at June 30, down from $14.8 billion at year-end. Additional liquidity included $7.0 billion of undrawn securitization capacity and more than $25 billion of unencumbered Bank assets.
At June 30, the allowance for loan losses was $3.894 billion, or 5.70% of receivables, versus 5.38% a year earlier and 5.12% at year-end. Company capital ratios included 18.5% Common Equity Tier 1 and 15.6% Tier 1 leverage; the Bank reported 16.1% and 13.6%, respectively. Both were classified as well-capitalized.
Material changes versus the prior comparable period
- Loan growth and account growth drove higher interest income: average loan receivables rose 11.4% in both the quarter and six-month comparison; purchase volume increased 9.4% in Q2 and 12.6% year to date.
- Higher loan-loss provisioning more than offset revenue growth, contributing to lower earnings. Management linked the reserve build to receivables growth and increased delinquent accounts.
- Over-30-day delinquencies rose to 3.79% from 3.53% a year earlier; over-90-day delinquencies rose to 1.67% from 1.52%. The Q2 net charge-off rate nevertheless declined year over year.
- Interest expense increased 12.2% in Q2 and 12.7% year to date, mainly reflecting deposit growth and higher short-term benchmark rates. Cost of funds was 1.88% in both 2016 periods.
- Other income fell, primarily because the prior year included a $20 million pre-tax loan-portfolio sale gain and 2016 had higher loyalty costs; increased interchange revenue partly offset those factors.
- Direct deposits expanded while brokered deposits declined. The company repaid the remaining Bank Term Loan during the first half and repaid the remaining third-party debt of the Synchrony Receivables Trust in Q2.
Outlook, management commentary, risks and unusual items
- Management estimated that the net charge-off rate could increase by 20–30 basis points over the next 12 months, reflecting Q2 delinquency trends and its assessment of portfolio and consumer conditions.
- No full-year earnings or revenue guidance is provided in the supplied filing text. Management said it expected to maintain capital and liquidity above regulatory minimums and continued investing in direct banking and stand-alone infrastructure.
- After quarter-end, the Board approved a quarterly dividend of $0.13 per share and a share repurchase program of up to $952 million for the four quarters ending June 30, 2017. The first dividend was payable August 25, 2016; repurchases were subject to market conditions, approvals and restrictions.
- Interest-rate sensitivity: an immediate 100-basis-point increase across rate-sensitive assets and liabilities was estimated to increase net interest income by approximately $158 million over the following 12 months. Actual effects depend on repricing and benchmark relationships.
- Key risks include consumer credit deterioration, dependence on major retail partners, deposit and market funding access and cost, securitization early-amortization triggers, interest-rate mismatch, regulation and litigation, and operational, cybersecurity and third-party risks. The filing reported no securitization early-amortization events and compliance with debt covenants.
- The CFPB sent the Bank a Notice of Opportunity to Respond and Advise in May 2016 concerning credit-bureau reporting; potential enforcement action was under consideration. The company said estimable reasonably possible legal and regulatory losses were immaterial, while noting that outcomes could differ and some matters could not be estimated.
- Prior CFPB remediation and refunds related to CareCredit, debt-cancellation marketing and fair-lending matters were completed in 2015. These matters may still pose reputational or further regulatory risk.
Important facts for investors to verify
- Whether delinquency trends and the 20–30 basis-point charge-off outlook translate into higher realized losses, provisions and allowance coverage.
- Whether growth in loan balances and deposits sustains net interest income after funding costs, retailer-share payments and loyalty expenses.
- The performance and concentration of major retail partner programs, and the timing and economics of renewals or extensions.
- Execution of the direct-deposit strategy, continued access to securitization funding and maintenance of liquidity and capital buffers.
- Developments in the CFPB credit-reporting matter, TCPA class actions and other regulatory or litigation exposures.
- Regulatory approvals and constraints on the announced dividend and share repurchase program, including the Bank’s capacity to distribute funds to the parent.