Synchrony Financial — 2018 Form 10-K
Reporting period: Fiscal year ended December 31, 2018; selected fourth-quarter figures are included. Synchrony is a consumer finance company focused on partner-branded credit cards and promotional financing, with a direct deposit-taking bank. It reported one operating segment.
Key financial results
| Metric | 2018 | 2017 |
|---|---|---|
| Interest income | $17.99 billion | $16.41 billion |
| Net interest income | $16.12 billion | $15.02 billion |
| Net interest income after retailer shares | $13.02 billion | $12.08 billion |
| Provision for loan losses | $5.55 billion | $5.30 billion |
| Net earnings | $2.79 billion | $1.94 billion |
| Diluted EPS | $3.74 | $2.42 |
| Operating cash flow | $9.34 billion | $8.58 billion |
| Net interest margin | 15.97% | 16.35% |
Fourth-quarter 2018 net earnings were $783 million, versus $385 million in fourth-quarter 2017; diluted EPS was $1.09 versus $0.49. The annual increase in earnings reflected higher net interest income and lower tax expense, partly offset by higher loan-loss provisions and operating expenses. The 2017 comparison includes $160 million of additional tax expense related to the Tax Act; 2017 adjusted net earnings, excluding that charge, were $2.10 billion.
Balance sheet, funding and credit
- Year-end loan receivables were $93.14 billion, up 13.7%; the PayPal Credit acquisition contributed $7.6 billion of receivables. Purchase volume rose 6.7% to $140.7 billion.
- Deposits were $64.02 billion, up 13.3%, including $49.4 billion in direct deposits and $14.6 billion in brokered deposits. Deposits represented 73% of funding sources.
- Total borrowings were $24.00 billion: $14.44 billion of securitized borrowings and $9.56 billion of senior unsecured notes. Year-end cash and equivalents were $9.40 billion; liquid assets were $14.8 billion. The company also reported $4.4 billion of undrawn committed facilities and more than $25 billion of unencumbered Bank assets.
- Allowance for loan losses was $6.43 billion, or 6.90% of receivables, versus $5.57 billion and 6.80% a year earlier. Over-30-day delinquencies were 4.76%, up from 4.67%; the net charge-off rate rose to 5.63% from 5.37%.
- Company common equity Tier 1 capital ratio was 14.0%, down from 16.0%; Synchrony and the Bank remained above applicable well-capitalized thresholds.
- Cash flow for the year included $19.04 billion used in investing activities, largely reflecting loan growth and the acquisition, and $8.25 billion provided by financing activities. Year-end cash including restricted balances was $10.38 billion.
Material changes and notable items
- The PayPal Credit acquisition closed July 2, 2018. Synchrony became the exclusive U.S. issuing bank for PayPal Credit through 2028 and recorded related servicing costs and a reserve build.
- Synchrony announced it would not renew its Walmart program. In January 2019 it agreed to sell the related receivables, with closing expected in late Q3 or early Q4 2019, subject to customary conditions. Walmart represented more than 10% of 2018 interest and fees on loans.
- Funding costs increased: interest expense rose 34.4% to $1.87 billion, primarily reflecting higher benchmark rates. Cost of funds increased to 2.30% from 1.90%.
- Other expense rose 9.3% to $4.10 billion, including higher employee, professional and processing costs; professional fees included PayPal interim servicing costs.
- Synchrony repurchased $1.9 billion of stock and paid $534 million in dividends during 2018. The quarterly dividend rose to $0.21 beginning in Q3.
Outlook, risks and contingencies
- Management expected average loan growth and interest income to benefit from business growth, while noting that the Walmart portfolio sale would reduce reported receivables growth. It expected 2019 net charge-offs to increase slightly, primarily due to PayPal Credit, partly offset by the Walmart sale; credit trends in the remaining portfolio were expected to be relatively stable.
- Management expected retailer-share payments to increase in absolute terms with program growth and performance. It also expected loyalty-program costs to be largely offset by interchange revenue.
- Key risks include consumer downturns and rising credit losses; concentration in a few large retail partners; partner loss or weaker partner sales; higher funding costs and interest-rate mismatch; deposit or securitization market disruption; and cyber, operational, regulatory and litigation risks. Five large programs, excluding Walmart, generated 44% of interest and fees on loans and 44% of receivables.
- The CFPB had sought information about marketing and servicing of deferred-interest promotions. The filing also describes consumer litigation and a securities class action filed in November 2018 alleging misleading statements about underwriting and the private-label card business. Management estimated reasonably possible losses for matters it could estimate as immaterial, while noting outcomes remain uncertain.
- CECL was scheduled for adoption on January 1, 2020; management expected it to increase the loan-loss allowance and reduce regulatory capital, with the impact dependent on portfolio quality and economic forecasts.
- The filing identifies a potential indemnification obligation to GE under the Tax Sharing and Separation Agreement in specified circumstances. Unrecognized tax benefits were $251 million at year-end. The auditor issued unqualified opinions on the financial statements and internal control over financial reporting.
Investor verification priorities
- Track credit performance, especially delinquency, charge-off and allowance trends, and the emerging PayPal portfolio’s loss experience.
- Verify the Walmart portfolio sale’s completion, proceeds, accounting effects and post-sale impact on revenue, receivables and credit metrics.
- Assess partner concentration and renewal or termination risks, including the economics of key programs and retailer-share arrangements.
- Monitor deposit growth and pricing, borrowing maturities, securitization access, liquidity availability and sensitivity to interest rates.
- Review developments in the CFPB inquiry, securities and consumer litigation, regulatory requirements, and the expected CECL capital and reserve effects.