Synchrony Financial — Q3 2017 Form 10-Q
Business context and reporting period
Synchrony Financial is a U.S.-focused consumer lender operating through Retail Card, Payment Solutions and CareCredit. It offers private-label and co-branded cards, promotional financing, installment loans and FDIC-insured deposits. This unaudited filing covers the quarter and nine months ended September 30, 2017; comparisons are with the corresponding 2016 periods unless stated otherwise. The company reported one business segment.
Financial and operating performance
- Q3 revenue and earnings: Interest income was $4.233 billion, up 11.5%; net interest income was $3.876 billion, up 11.3%. After $805 million of retailer share payments and $1.310 billion of loan-loss provision, net earnings were $555 million, down 8.1%. Diluted EPS was $0.70 versus $0.73.
- Nine-month results: Interest income was $12.116 billion, up 11.9%; net interest income was $11.100 billion, up 12.1%. Net earnings were $1.550 billion, down 7.5%, and diluted EPS was $1.93 versus $2.01.
- Margins and returns: Net interest margin was 16.74% for Q3 (16.34% in Q3 2016) and 16.38% for the nine months (16.05%). Return on assets was 2.4% and 2.3%, respectively, versus 2.8% and 2.7%; return on equity was 15.3% and 14.4%, versus 17.3% and 16.6%.
- Loan growth and activity: Period-end loan receivables were $76.928 billion, up 8.9% year over year and 0.8% from December 31, 2016. Q3 purchase volume was $32.893 billion, up 4.0%; nine-month volume was $95.249 billion, up 5.7%. Average active accounts increased 4.0% in Q3 to 69.3 million.
- Credit performance: Q3 net charge-offs were $950 million and the annualized net charge-off rate was 4.95%, up 56 basis points year over year. The nine-month rate was 5.23%, up 69 basis points. Loans over 30 days past due were 4.80% of receivables, versus 4.26% a year earlier. The allowance was $5.361 billion, or 6.97% of receivables, compared with 5.82% a year earlier.
- Expenses and tax: Q3 other expense rose 11.5% to $958 million; nine-month expense rose 11.2% to $2.777 billion. The effective tax rate was 36.9% for Q3 and 36.7% for the nine months, slightly below 2016, primarily due to research and development credits.
- Cash flow: For the nine months, operating cash flow was $6.446 billion, investing cash flow was negative $2.248 billion, and financing cash flow was positive $396 million. Cash and equivalents increased $4.594 billion to $13.915 billion. These cash flows reflect lending and funding activity as well as earnings.
Funding, debt and capital
At September 30, deposits totaled $54.454 billion, or approximately 73% of funding sources; direct deposits were $41.6 billion. Borrowings were $19.899 billion, including $11.891 billion of securitized borrowings and $8.008 billion of senior unsecured notes. The company reported $16.4 billion of liquid assets, $5.6 billion of undrawn committed credit capacity, and more than $25 billion of unencumbered Bank assets available as potential liquidity sources. It was in compliance with debt covenants and reported no defaults.
Synchrony Financial’s total risk-based capital ratio was 18.7% and its CET1 ratio was 17.3%; the Bank’s corresponding ratios were 16.7% and 15.4%. Both were reported as well-capitalized. The company repurchased $1.066 billion of shares and paid $328 million in dividends during the first nine months. The quarterly dividend increased to $0.15 per share beginning in Q3; a repurchase program of up to $1.64 billion was authorized through June 30, 2018.
Material changes versus the prior comparable period
- Loan growth and higher yields lifted net interest income, but faster growth in credit-loss provision and operating expenses more than offset the gain, reducing net earnings.
- Provision for loan losses increased 32.9% in Q3 to $1.310 billion and 35.5% for the nine months to $3.942 billion. Management attributed the increases to higher net charge-offs, receivables growth and higher reserves.
- Other income declined to $76 million in Q3 and $226 million for the nine months, mainly because of higher loyalty program costs. Nine-month results included an $18 million pretax gain on sale of merchant-processing contractual relationships.
- Deposits grew 4.6% from year-end to $54.5 billion, as direct deposits increased 9.8% to $41.6 billion, partly offset by lower brokered deposits. Cash and equivalents rose from $9.321 billion at year-end to $13.915 billion.
Outlook, commentary, risks and unusual items
- The filing provides no specific earnings or revenue guidance. Management cited seasonality: receivables typically rise from August toward a late-December peak, while delinquency and allowance metrics can vary across quarters. The company said interim-period allowance ratios are generally higher than at year-end.
- Management expects the future CECL credit-loss standard, effective for the company in fiscal years beginning after December 15, 2019, to increase the allowance for loan losses; the amount was not quantified. Management did not expect the revenue-recognition standard effective after December 15, 2017 to materially affect revenue timing or measurement.
- Key risks include credit deterioration and allowance-estimate uncertainty; partner retention and revenue concentration; funding costs, deposit growth and market access; interest-rate changes; securitization triggers; regulatory and capital restrictions; cybersecurity and third-party disruptions; litigation; and possible restrictions on dividends and repurchases. A 100-basis-point immediate increase in rates was estimated to increase next-12-month net interest income by approximately $155 million.
- Regulatory and legal matters include a CFPB investigation concerning credit reporting and a May 2017 CFPB information demand related to marketing and servicing deferred-interest promotions, as well as TCPA class actions. Management estimated reasonably possible losses it could quantify as immaterial, but stated actual outcomes could vary and could materially affect a particular period.
- The company announced a GPShopper acquisition during the nine months; the filing text provided here does not state a purchase price. CareCredit Dual Card was announced/launched in October 2017, after quarter-end. Synchrony became a financial holding company in June 2017.
Important facts for investors to verify
- Whether rising delinquencies, charge-offs and the 6.97% allowance coverage translate into further credit-loss increases.
- How much loan growth, pricing and funding costs contribute to future net interest margin and earnings, particularly as benchmark rates change.
- Progress in expanding direct deposits and maintaining liquidity, including access to securitization and unsecured funding.
- Developments and potential financial effects of CFPB matters, TCPA litigation, partner relationships and the GPShopper acquisition.
- Regulatory capital, Bank dividend capacity and remaining authorization under the share repurchase program.