Business context and reporting period
Synchrony Financial’s Form 10-Q covers the quarter and nine months ended September 30, 2015. The company provides consumer credit through Retail Card, Payment Solutions and CareCredit, primarily via Synchrony Bank. It operates as one business segment, substantially in the United States. Comparisons below are with the corresponding 2014 periods unless noted.
Synchrony was still majority-owned by GE, which held approximately 84.6%. After quarter-end, the Federal Reserve approved Synchrony’s transition to a standalone savings and loan holding company, and GE commenced an exchange offer on October 19, 2015.
Financial and operating highlights
| Metric | Q3 2015 | Nine months 2015 |
|---|---|---|
| Interest income | $3.392 billion | $9.719 billion |
| Net interest income | $3.103 billion, up 7.8% | $8.885 billion, up 6.5% |
| Net earnings | $574 million, up 4.7% | $1.667 billion, up 5.6% |
| Diluted earnings per share | $0.69, versus $0.70 | $2.00, versus $2.16 |
| Net interest margin | 15.97%, versus 17.11% | 15.81%, versus 17.80% |
| Return on assets | 2.9%, versus 3.2% | 3.0%, versus 3.4% |
| Efficiency ratio | 34.2%, versus 31.9% | 33.3%, versus 31.5% |
Q3 earnings growth reflected higher net interest income, partly offset by increased retailer share arrangements, loan-loss provision and other expenses. The lower EPS despite higher net earnings reflects a larger weighted-average share count. Platform revenue, a company-defined non-GAAP measure, was $2.740 billion for Q3, up from $2.519 billion; nine-month platform revenue was $7.986 billion, versus $7.410 billion.
Loans and credit quality
- Period-end loan receivables were $63.520 billion, up 11.9% year over year and 3.6% from December 31, 2014. Growth reflected purchase volume and account growth, including the BP portfolio acquisition.
- Q3 purchase volume was $29.206 billion, up 12.3%; average active accounts rose 3.9% to 62.2 million.
- Over-30-day delinquencies were 4.02%, down from 4.26% a year earlier. Q3 net charge-offs were 4.02% of average receivables, versus 4.05%; the nine-month rate was 4.37%, versus 4.57%.
- The allowance for loan losses was $3.371 billion, or 5.31% of period-end receivables, compared with 5.46% a year earlier. Provision was $702 million in Q3 and $2.129 billion for nine months.
Cash flow, funding and capital
- Nine-month operating cash flow was $4.295 billion; investing cash outflow was $5.610 billion and financing cash inflow was $1.758 billion. Cash and equivalents ended the period at $12.271 billion, up $443 million from year-end 2014.
- At September 30, deposits totaled $40.548 billion, borrowings $23.881 billion, total assets $79.442 billion and equity $12.158 billion. Deposits rose 16.0% from year-end, with direct deposits up 40.1% to $27.6 billion.
- Liquidity included $15.3 billion in liquid assets, $6.6 billion in undrawn committed securitization capacity and more than $25 billion in unencumbered Bank assets. The company reported compliance with its loan covenants.
- Synchrony issued $2.0 billion of senior unsecured notes and prepaid $3.6 billion of its Bank Term Loan during the first nine months; GECC funding was fully repaid in Q1. Higher-cost third-party funding contributed to a rise in the cost of funds.
- At September 30, the company’s Basel III transition common equity Tier 1 ratio was 17.5%; the Bank’s was 15.9%. The Bank met applicable well-capitalized requirements.
Material changes and management commentary
- Net interest income increased with receivables growth, but net interest margin declined as the liquidity portfolio expanded at lower yields, receivable yields softened, and funding costs rose. Management cited higher payment rates and growth in promotional balances as factors in lower receivable yield.
- Other expense rose 15.8% in Q3 and 12.1% for nine months, primarily reflecting standalone infrastructure and growth investments, employee and professional costs, information technology spending, and the EMV card rollout.
- Retailer share arrangements increased 4.3% in Q3 and 6.8% for nine months, reflecting growth and improved performance in programs with such arrangements. Loyalty program costs also weighed on other income.
- The company extended or added multiple partner agreements, including Amazon, Chevron, PayPal and BP in Retail Card, and new Payment Solutions partners. It also expanded CareCredit’s provider network.
- Synchrony stated it does not currently pay dividends. After the exchange offer, the board planned to consider a dividend policy and possible repurchases, subject to capital, liquidity, legal and regulatory constraints. No quantified earnings or revenue guidance was provided.
Risks, contingencies and unusual items
- Key stated risks include consumer credit deterioration, funding costs and access, interest-rate changes, partner concentration and retention, securitization early-amortization triggers, regulation, cyber and operational disruptions, litigation, and execution of the separation from GE. A 100-basis-point parallel rate increase was estimated to raise 12-month net interest income by approximately $102 million.
- No securitization early-amortization event had occurred. The filing notes that such an event could redirect collections to repay investors and constrain future funding.
- CFPB and DOJ consumer remediation programs described in the filing were completed during 2015. The company also settled a patent case. However, a CFPB information demand concerning credit reporting followed the ongoing Belton bankruptcy-related litigation; TCPA putative class actions also remained pending.
- Management estimated reasonably possible losses for legal and regulatory matters it could estimate were immaterial, while cautioning that actual outcomes could differ and some exposures could not be estimated. The filing says no known pending matter was expected to materially harm consolidated financial condition or liquidity.
- Management identified allowance for loan losses, impairment, income taxes and fair value as critical accounting estimates. It was evaluating the effects of new revenue-recognition and debt-issuance-cost accounting standards.
Important facts for investors to verify
- Whether the GE exchange offer and separation were completed as planned, and the resulting ownership, regulatory and standalone cost impacts.
- Whether receivables growth can offset continued margin compression and higher funding costs.
- Whether credit performance and allowance coverage remain adequate as seasonal delinquencies and portfolio growth affect losses.
- Whether direct-deposit growth and other funding sources sustain liquidity while reducing dependence on brokered deposits and securitization markets.
- Developments in the CFPB credit-reporting inquiry, pending class actions and any additional legal or regulatory remediation.