Synchrony Financial — Q1 2018 Form 10-Q
Business context and reporting period
Synchrony Financial is a U.S.-focused consumer finance company operating through Retail Card, Payment Solutions and CareCredit. It offers private-label and co-branded cards, promotional financing, installment loans and FDIC-insured deposits. The filing covers the three months ended March 31, 2018; income and cash-flow comparisons are against Q1 2017, while balance-sheet comparisons are generally against December 31, 2017.
During Q1, Synchrony financed $29.6 billion of purchase volume and had 71.3 million average active accounts. Period-end loan receivables were $77.9 billion.
Financial and operating metrics
| Metric | Q1 2018 | Q1 2017 / comparison |
|---|---|---|
| Interest income | $4.244 billion | $3.913 billion; up 8.5% |
| Net interest income | $3.842 billion | $3.587 billion; up 7.1% |
| Net interest income after retailer share arrangements | $3.122 billion | $2.903 billion |
| Provision for loan losses | $1.362 billion | $1.306 billion |
| Other income / other expense | $75 million / $988 million | $93 million / $908 million |
| Earnings before taxes / net earnings | $847 million / $640 million | $782 million / $499 million |
| Diluted earnings per share | $0.83 | $0.61 |
| Net interest margin / efficiency ratio | 16.05% / 30.9% | 16.18% / 30.3% |
| Net charge-off rate | 6.14% | 5.33% |
Net earnings rose 28.3%, supported by higher net interest income and a lower tax provision, partly offset by higher loan-loss provision and operating expense. The effective tax rate fell to 24.4% from 36.2%, primarily reflecting the Tax Act reduction in the federal corporate tax rate.
Q1 operating cash flow was $1.915 billion, versus $1.480 billion in Q1 2017. Investing cash flow was $755 million provided, and financing cash flow was $313 million used. Cash and equivalents were $13.044 billion at quarter-end; cash including restricted amounts was $14.174 billion.
At March 31, total assets were $95.6 billion, deposits $56.6 billion, borrowings $21.0 billion and equity $14.4 billion. Deposits represented 73% of total funding sources. The company reported $18.6 billion of liquid assets, $5.5 billion of undrawn securitization capacity, $0.5 billion of undrawn revolving-credit capacity and more than $25 billion of unencumbered Bank assets.
Synchrony and the Bank were reported well-capitalized. Synchrony Financial’s total risk-based capital ratio was 18.1%; the Bank’s was 17.4%. The company repurchased $410 million of stock and paid $114 million in dividends during the quarter.
Material changes versus comparable periods
- Period-end loan receivables grew 6.1% year over year to $77.9 billion, driven mainly by purchase-volume and active-account growth. They declined 5.0% from year-end, consistent with seasonal post-holiday balance paydown.
- Credit performance weakened year over year: over-30-day delinquencies rose to 4.52% from 4.25%, and the net charge-off rate increased to 6.14% from 5.33%. The allowance was $5.738 billion, or 7.37% of receivables, versus 6.37% a year earlier and 6.80% at year-end.
- Interest expense increased 23.3% to $402 million; average cost of funds rose to 2.10% from 1.84%, reflecting higher benchmark rates, deposit competition and pre-funding related to the PayPal credit portfolio acquisition.
- Other expense increased 8.8%, mainly from employee costs, marketing and business development, professional fees and information-processing costs. Other income declined 19.4%, primarily because of higher loyalty-program costs.
- Direct deposits increased 5.4% from year-end to $45.0 billion, offset by lower brokered deposits; total deposits were relatively flat.
- Q1 cash flows included $2.546 billion of debt-security purchases, and the liquidity portfolio increased, primarily due to retaining excess operating cash as part of the PayPal acquisition pre-funding strategy.
Outlook, commentary, risks and unusual items
The filing provides no specific earnings or financial guidance. Management describes seasonal declines in receivables in the first half of the year and says interim-period allowance coverage can rise seasonally even as past-due balances decline. Past-due balances fell to $3.5 billion from $3.8 billion at year-end, while the allowance ratio increased.
Management estimates that an immediate 100-basis-point increase in interest rates across interest-sensitive assets and liabilities would increase net interest income by approximately $70 million over the following 12 months. This is an estimate, not guidance, and depends on assumptions about future growth and balance-sheet composition.
Key risks include consumer credit deterioration and allowance-estimation uncertainty; higher funding costs, deposit competition and interest-rate mismatches; reliance on retail partners and partner concentration; access to securitization and capital markets; regulatory and capital requirements; and litigation, CFPB matters, cybersecurity and operational risks. The filing states that reasonably possible losses for legal and regulatory matters that management could estimate were immaterial, but actual outcomes could differ. It describes a CFPB investigation involving credit reporting and a separate information demand concerning deferred-interest promotions, as well as TCPA class actions; aggregate damages sought in some cases are unspecified.
The company expects the new CECL credit-loss standard, effective for it in 2020, to increase the allowance for loan losses; the amount was not yet determined. The company reported no securitization early-amortization events, no defaults under credit facilities or senior notes, and compliance with debt covenants. It also reported no material changes to the risk factors in its 2017 Form 10-K.
Important facts for investors to verify
- Whether rising delinquency and charge-off rates persist, and how they affect provision expense, allowance coverage and earnings.
- Whether deposit costs continue to rise faster than asset yields, pressuring net interest margin and funding economics.
- The timing, completion and financial effects of the referenced PayPal credit portfolio acquisition and associated pre-funding.
- Partner concentration, renewals and program economics, including retailer-share arrangements and the performance of newly announced or extended partnerships.
- Developments in the CFPB matters and TCPA litigation, and any change in the company’s assessment of potential losses.
- The eventual CECL transition impact and any changes to capital, liquidity, or limits on dividends and repurchases.