Synchrony Financial — Q3 2014 Form 10-Q
Reporting period: Quarter ended September 30, 2014; comparative results are for Q3 and the first nine months of 2013. The interim financial statements are unaudited. Because the business moved from combined to consolidated presentation during 2014, historical comparisons may not represent results as a standalone company.
Business context
Synchrony provides consumer credit through Retail Card, Payment Solutions and CareCredit. It financed $26.0 billion of purchase volume in Q3 and $73.1 billion year to date, and had 60.5 million active accounts and $56.8 billion of loan receivables at quarter-end. The August IPO and related transactions began GE’s planned staged exit; GE retained approximately 84.6% ownership.
Financial performance and position
- Q3 earnings: Interest income was $3.123 billion, up 8.2% year over year; net interest income was $2.879 billion, up 6.5%. Net earnings fell 14.5% to $548 million, from $641 million. Earnings per diluted share were $0.70, versus $0.91.
- Nine-month earnings: Interest income was $8.982 billion, up 8.5%; net interest income was $8.342 billion, up 8.0%. Net earnings rose 2.7% to $1.578 billion, from $1.536 billion.
- Revenue by platform: Platform revenue, a company-defined non-GAAP measure, was $2.519 billion for Q3 and $7.410 billion for nine months. Retail Card contributed $1.694 billion and $5.057 billion, respectively; Payment Solutions $403 million and $1.149 billion; CareCredit $422 million and $1.204 billion.
- Margins and expenses: Net interest margin decreased to 17.11% in Q3 from 19.69%; the nine-month margin was 17.80% versus 18.74%. Q3 other expense rose to $728 million from $575 million, and the efficiency ratio increased to 31.9% from 26.9%. Higher standalone-company, marketing and IPO/separation costs contributed.
- Credit quality: Q3 net charge-offs were 4.05% of average receivables, slightly below 4.07% a year earlier; the nine-month rate increased to 4.57% from 4.52%. Delinquencies over 30 days improved to 4.26% from 4.32% year over year. The allowance was $3.102 billion, or 5.46% of period-end loans, versus 5.24% a year earlier.
- Cash flow and liquidity: Nine-month operating cash flow was $4.294 billion; investing cash outflow was $3.911 billion and financing cash inflow was $12.106 billion. Cash and equivalents ended at $14.808 billion, up from $2.319 billion at year-end 2013. Liquid assets were $14.1 billion; the liquidity portfolio including undrawn facilities was $19.7 billion.
- Funding and capital: Deposits were $32.689 billion, up from $25.719 billion at December 2013; direct deposits reached $18.3 billion. Total borrowings were $27.584 billion, including $15.091 billion of securitization borrowings, $11.088 billion of third-party debt and $1.405 billion of related-party debt. Total equity was $9.941 billion. The Company’s Basel I Tier 1 common ratio was 15.1%; the Bank’s Tier 1 risk-based capital ratio was 15.7%.
Material changes, outlook and risks
- The IPO and August debt transactions generated approximately $2.8 billion of net equity proceeds and materially changed the funding mix. Synchrony repaid $8.0 billion of existing GECC debt, entered into new term loans, and issued $3.6 billion of senior notes. On October 6, after quarter-end, it borrowed a further $750 million and reduced the GECC term loan balance to $655 million.
- Management identified expected loan growth, rising or higher-cost funding, potential interest-rate changes, partner agreement renewals, retailer-share payments, regulatory developments and increased standalone operating costs as important business trends. No specific earnings or revenue guidance is provided in the filing.
- Five Retail Card partner agreements, representing $1.9 billion of loans including loans held for sale, were not expected to renew; two related portfolios totaling $1.493 billion were classified as held for sale, with sales expected in Q4. PayPal’s agreement was extended to October 2016, with no further extension expected. Separately, five other Retail Card agreements were extended during the first nine months.
- CFPB and DOJ orders require refunds, other customer remediation and compliance measures concerning debt-cancellation products and certain collection practices. The filing cites approximately $37 million of remediation still to be completed; it says the orders did not materially affect Q3 financial statements because amounts had been reserved. A $42 million increase in consumer-remediation reserves was recorded in Q2.
- Standalone readiness and regulatory approval, funding costs and access, partner concentration and retention, credit losses, capital and liquidity requirements, and extensive consumer-finance regulation remain key risks. Management reported compliance with debt covenants at September 30 and no securitization early-amortization events. It also stated that dividends or repurchases would not be considered until the Federal Reserve application related to separation was approved.
Important facts for investors to verify
- Whether the held-for-sale portfolios were sold as expected and what the final proceeds and earnings effects were.
- Progress on partner renewals, particularly the five agreements not expected to renew and the PayPal relationship.
- Subsequent funding costs, deposit growth and liquidity after the IPO-related cash build and October debt refinancing.
- Whether loan-loss allowances and charge-off trends remain adequate as receivables grow and seasonal delinquency patterns develop.
- Completion and ultimate cost of required customer remediation, and progress toward regulatory approval and operating independently of GE.