Synchrony Financial — 2019 Q3 Form 10-Q
Reporting period: Three and nine months ended September 30, 2019. All amounts are U.S. dollars; financial statement figures are in millions unless noted. Synchrony provides consumer credit and deposit products through Retail Card, Payment Solutions and CareCredit. The company reported one operating segment.
Financial performance
| Metric | Q3 2019 | Q3 2018 | First nine months 2019 | First nine months 2018 |
|---|---|---|---|---|
| Interest income | $4,981 | $4,694 | $14,505 | $13,112 |
| Net interest income | $4,389 | $4,206 | $12,770 | $11,785 |
| Provision for loan losses | $1,019 | $1,451 | $3,076 | $4,093 |
| Net earnings | $1,056 | $671 | $3,016 | $2,007 |
| Diluted earnings per share | $1.60 | $0.91 | $4.40 | $2.66 |
| Net interest margin | 16.29% | 16.41% | 16.04% | 15.94% |
| Net charge-off rate | 5.35% | 4.97% | 5.80% | 5.67% |
- Net earnings rose 57.4% in Q3 and 50.3% for the nine-month period. The increases included Walmart portfolio-related reserve reductions of $248 million and $829 million, respectively, and also reflected higher net interest income. These reserve effects make reported earnings growth an important item to assess.
- Net interest income increased 4.4% in Q3 and 8.4% year to date, mainly as average loan receivables grew. Interest expense increased 21.3% and 30.7%, respectively, as funding costs and deposit balances rose. Cost of funds was 2.71% for Q3 and 2.69% year to date.
- Retailer share arrangements increased 16.6% in Q3 to $1,016 million and 26.1% year to date to $2,829 million, reflecting program performance and growth.
- Purchase volume was $38.4 billion in Q3 and $109.2 billion year to date, up 5.4% and 8.8%. Average active accounts were 76.7 million in both periods.
- Other expense was $1,064 million in Q3 and $3,166 million year to date, up 0.9% and 4.9%. Year-to-date increases included PayPal Credit acquisition-related servicing and business growth.
Balance sheet, cash flow and capital
- At September 30, loan receivables were $83.2 billion, down 4.9% from a year earlier; total assets were $105.9 billion, deposits $66.0 billion and total borrowings $20.4 billion. Total equity was $15.1 billion.
- Cash and equivalents were $11.5 billion, compared with $9.4 billion at December 31, 2018. The company reported $15.2 billion of liquid assets, $6.0 billion of undrawn securitization capacity, $0.5 billion under its unsecured revolver, and more than $25 billion in unencumbered Bank assets available as potential liquidity.
- For the first nine months, operating cash flow was $6.7 billion, investing cash outflow was $0.9 billion, and financing cash outflow was $4.4 billion. Cash flow from operations was slightly below the $6.8 billion reported in the comparable 2018 period.
- Deposits funded 76% of total funding sources. Total deposits rose 3.1% from year-end, with direct deposits up 8.7% to $53.7 billion, partly offset by lower brokered deposits.
- Company and Bank capital ratios remained above applicable well-capitalized thresholds. At September 30, the Company’s common equity Tier 1 ratio was 14.5%; the Bank’s was 14.6%.
- Synchrony repurchased $2.2 billion of stock and paid $440 million in dividends during the first nine months. The Board authorized repurchases of up to $4.0 billion through June 30, 2020; the quarterly dividend increased to $0.22 per share beginning in Q3.
Credit quality and material changes
- The allowance for loan losses was $5.6 billion, or 6.74% of period-end loan receivables, versus 7.11% a year earlier. Provision expense fell 29.8% in Q3 and 24.8% year to date; the Walmart-related reserve reductions were a primary driver.
- Loans more than 30 days past due were 4.47% of period-end receivables, down from 4.59% a year earlier. Management attributed the decrease in part to the Walmart portfolio’s pending sale and lower included delinquencies.
- The net charge-off rate increased to 5.35% in Q3 and 5.80% year to date. The filing notes that delinquency and loss measures are affected by seasonal consumer payment patterns.
- In Q1, Synchrony reclassified $8.2 billion of Walmart-related receivables as held for sale and recorded a $522 million reserve release. It completed the sale and conversion of the $8.2 billion portfolio on October 11, 2019, after quarter-end.
- Reported period-end loan receivables include the effect of the Walmart reclassification; average loan and purchase-volume measures include held-for-sale activity. Comparisons should account for this presentation change and the PayPal Credit acquisition.
Outlook, risks and unusual items
- The filing provides no specific earnings or revenue guidance. Management describes growth in purchase volume, active accounts and direct deposits, while noting funding-cost pressures, retailer share costs, credit losses and seasonality.
- Synchrony planned to adopt the CECL expected-credit-loss standard on January 1, 2020. Its preliminary estimate indicated that adoption at September 30, 2019 would have increased the allowance for loan losses by approximately 50% to 60% and reduced regulatory capital; the estimate remained subject to model refinement, economic conditions and regulatory discussions.
- Federal Reserve rules issued October 10, 2019 categorize Synchrony as a Category IV organization. Certain liquidity and risk-management requirements become applicable in 2021, with supervisory stress testing commencing in 2022. The company said it was not then required to conduct company-run stress tests.
- Key risks include consumer-credit deterioration and allowance-estimation uncertainty; higher funding costs, deposit competition and interest-rate mismatches; dependence on major retail partners; securitization triggers and market access; regulatory and capital constraints; cyber and operational risks; and litigation. No material changes to the risk factors in the 2018 Form 10-K were reported.
- Legal matters include consumer-protection and credit-reporting proceedings, TCPA class actions, and securities and derivative litigation concerning underwriting and private-label card business disclosures. Management estimated reasonably possible losses for matters it could quantify as immaterial, but cautioned that outcomes could affect results in a particular period. A CFPB investigative demand concerning deferred-interest promotion marketing and servicing was also disclosed.
- The company reported no early-amortization events in its securitization trusts, no defaults under credit facilities or senior notes, and compliance with senior-note covenants at September 30, 2019.
Important facts for investors to verify
- How much of the 2019 earnings increase reflects recurring operating performance versus Walmart-related reserve releases, and what were the final effects of the October sale?
- Whether higher net charge-offs and funding costs are sustained, and how they affect net interest margin, provision expense and profitability.
- The final CECL allowance and regulatory-capital impact at adoption, compared with the preliminary 50%–60% allowance estimate.
- Post-Walmart trends in loan receivables, purchase volume, partner concentration and growth across the three platforms.
- Progress and remaining capacity under the share repurchase program, alongside capital and liquidity needs and regulatory restrictions.
- Developments in disclosed legal and regulatory matters, including the CFPB inquiry and securities litigation.