Synchrony Financial — 2017 Form 10-K
Business context and reporting period
Annual report for the fiscal year ended December 31, 2017; figures are in U.S. dollars. Synchrony is a U.S.-focused consumer finance company operating one business segment through Retail Card, Payment Solutions and CareCredit. It provides credit products through partner programs and gathers FDIC-insured deposits through Synchrony Bank.
During 2017, purchase volume was $131.8 billion. At year-end, loan receivables were $81.9 billion, with 74.5 million active accounts. The five largest Retail Card programs represented 53% of interest and fees on loans and 49% of receivables.
Financial performance and condition
| Metric | 2017 | 2016 |
|---|---|---|
| Interest income | $16.407 billion | $14.778 billion |
| Net interest income | $15.016 billion | $13.530 billion |
| Net earnings | $1.935 billion | $2.251 billion |
| Diluted earnings per share | $2.42 | $2.71 |
| Net interest margin | 16.35% | 16.10% |
| Net charge-off rate | 5.37% | 4.57% |
| 30+ day delinquency rate at year-end | 4.67% | 4.32% |
- Net interest income after retailer share arrangements rose 13.6% to $12.079 billion. Provision for loan losses increased 32.9% to $5.296 billion; other expense rose 9.7% to $3.747 billion. These factors, along with tax reform, contributed to lower reported earnings.
- Allowance for loan losses increased to $5.574 billion, or 6.80% of receivables, from $4.344 billion, or 5.69%. Net charge-offs were $4.066 billion.
- Operating cash flow was $8.916 billion; investing cash outflow was $9.410 billion and financing cash inflow was $2.775 billion. Cash and equivalents ended the year at $11.602 billion.
- Year-end deposits were $56.488 billion, including $42.7 billion in direct deposits and $13.8 billion in brokered deposits. Total borrowings were $20.799 billion, including $12.497 billion of securitization borrowings and $8.302 billion of senior unsecured notes.
- Liquidity included $15.1 billion of liquid assets, $6.0 billion of undrawn committed facilities, and more than $25 billion of unencumbered Bank assets. The Company’s Basel III transitional CET1 ratio was 16.0%; the Bank’s was 14.9%. Both were reported as well-capitalized.
- Return on assets was 2.1% versus 2.7%; return on equity was 13.4% versus 16.5%. The efficiency ratio improved to 30.3% from 31.1%.
Material changes versus the prior year
- Receivables increased 7.3% to $81.947 billion, while purchase volume rose 5.1%. Net interest income grew 11.0%, primarily from higher average receivables.
- Credit quality weakened: delinquency increased 35 basis points and net charge-off rate increased 80 basis points. Management attributed the deterioration to portfolio mix, account maturation and broader consumer trends.
- Deposits increased 8.5%, driven by 12.7% growth in direct deposits, partly offset by lower brokered deposits.
- Other income declined to $288 million from $344 million, including higher loyalty program costs ($704 million versus $547 million), partly offset by higher interchange revenue ($653 million versus $602 million).
- The Company repurchased $1.496 billion of shares and paid $446 million in dividends, compared with $476 million of repurchases and $214 million of dividends in 2016.
Outlook, commentary, risks and unusual items
- Management expected delinquency, net charge-off and allowance coverage trends to continue increasing in 2018, but at a more modest pace than in 2017. It also anticipated additional loan-loss reserves for the PayPal portfolio acquisition.
- Management forecast a 2018 effective tax rate of 24%–25%, before discrete items, following the Tax Act’s reduction of the federal corporate rate to 21%. The 2017 tax provision included $160 million of additional expense, primarily from remeasuring deferred tax assets and liabilities. Adjusted net earnings excluding this item were $2.095 billion; this is a non-GAAP measure.
- Synchrony agreed to acquire approximately $6.8 billion of PayPal U.S. consumer credit receivables and become the exclusive issuing bank for PayPal Credit point-of-sale financing for 10 years. Closing was expected in the third quarter of 2018, subject to regulatory approval and other conditions. Management expected capital ratios to decline after closing.
- Management expected to increase dividends and share repurchases in 2018, subject to Board and regulatory approval. It also anticipated growth in retailer-share payments and loyalty costs, with interchange revenue expected to offset much of the latter.
- Key risks include rising consumer credit losses, dependence on major Retail Card partners, funding and deposit competition, securitization access and early-amortization triggers, interest-rate mismatches, cyber and third-party disruptions, and regulatory or litigation exposure. A May 2017 CFPB investigative demand concerned marketing and servicing of deferred-interest promotions. The filing states that estimated reasonably possible losses for legal and regulatory matters that could be estimated were immaterial; outcomes remain uncertain.
- Fraud-related operational losses rose to $313 million from $203 million. The Bank also faced a CFPB inquiry into deferred-interest promotions and ongoing credit-reporting matters; the filing does not quantify a material expected loss for these matters.
- The Company reported unqualified audit opinions on its financial statements and internal control over financial reporting. Management concluded disclosure controls were effective at year-end.
Important facts for investors to verify
- Whether 2018 credit deterioration, charge-offs and reserve levels tracked management’s expectations, and how the upcoming CECL standard could change allowance requirements.
- PayPal transaction closing, portfolio performance, required reserves and resulting capital and funding effects.
- Retention and economics of the largest partner programs, including renewal terms and retailer-share arrangements.
- Progress in direct-deposit growth and continued access to securitization and other funding markets.
- Developments in CFPB matters, consumer-protection litigation and any related remediation, penalties or changes to promotional financing practices.
- Whether post-Tax Act earnings, dividends and repurchases are consistent with management’s outlook and remain within regulatory capital constraints.