Synchrony Financial quarterly report, Q2 FY2017

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Synchrony Financial — Q2 2017 Form 10-Q

Reporting period: Quarter and six months ended June 30, 2017. Amounts are in U.S. dollars; financial-statement amounts are in millions unless noted.

Business context

Synchrony is a U.S.-focused consumer finance company operating through Retail Card, Payment Solutions and CareCredit. It provides credit cards, promotional financing and installment loans, principally through partner programs, and takes FDIC-insured deposits through Synchrony Bank. At quarter-end, loan receivables were $75.5 billion and deposits were $52.9 billion.

Financial performance and key metrics

  • Q2 earnings: Net interest income was $3.637 billion, up 13.2% year over year. Net earnings were $496 million, up 1.4%; diluted EPS was $0.61 versus $0.58.
  • First half earnings: Net interest income was $7.224 billion, up 12.5%. Net earnings were $995 million, down 7.1%; diluted EPS was $1.23 versus $1.28.
  • Credit costs and margins: Q2 provision for loan losses increased 29.9% to $1.326 billion; first-half provision rose 36.8% to $2.632 billion. Net charge-off rates were 5.42% for Q2 and 5.37% for the first half, versus 4.51% and 4.63%, respectively, a year earlier. Allowance coverage was 6.63%, up from 5.70% a year earlier. Net interest margin was 16.20% in Q2 and 16.19% for the first half.
  • Credit growth and activity: Quarter-end receivables increased 10.5% year over year to $75.458 billion, though they declined 1.2% from December 31, 2016, reflecting seasonality. Q2 purchase volume was $33.476 billion, up 6.2%; average active accounts were 68.6 million, up 4.7%.
  • Other income and expenses: Q2 other income fell to $57 million from $83 million, mainly from higher loyalty-program costs, including higher reward redemptions. Other expense rose 8.6% to $911 million, primarily from business growth, staffing, marketing, technology and operational costs.
  • Returns and efficiency: Q2 return on assets was 2.2% versus 2.4%; return on equity was 13.8% versus 14.5%. The efficiency ratio improved to 30.1% from 31.9%.
  • Cash flow and balance sheet: First-half operating cash flow was $3.518 billion, investing cash outflow was $960 million, and financing cash inflow was $141 million. Cash and equivalents ended at $12.020 billion. Total assets were $91.140 billion, total deposits $52.885 billion, borrowings $20.709 billion, and equity $14.332 billion.

Material changes versus comparable periods

  • Higher average loan receivables drove growth in interest income and net interest income; the company also cited higher revolve rates and benchmark rates as contributors to loan yields.
  • Credit performance weakened year over year: over-30-day delinquencies rose to 4.25% from 3.79%, and net charge-off rates increased. Management increased the allowance to reflect higher forecasted losses.
  • Deposit funding continued to expand. Direct deposits grew 6.6% from year-end to $40.4 billion, while brokered deposits declined; deposits represented 72% of total funding sources.
  • First-half results were affected by the larger loan-loss provision and higher operating expenses. Higher loyalty costs also reduced other income.

Liquidity, debt and capital

  • At June 30, liquid assets were $15.3 billion. The company also reported $6.6 billion of undrawn committed credit facilities and more than $25 billion of unencumbered Bank assets available as potential liquidity sources.
  • Senior unsecured notes totaled $8.5 billion; the Bank issued $750 million of 3.00% notes due 2022 during the quarter. The company reported compliance with debt covenants and no defaults.
  • Synchrony Financial and Synchrony Bank met applicable well-capitalized requirements. Company total risk-based capital was 18.7%; Bank total risk-based capital was 16.8%.
  • The Board announced a quarterly dividend increase to $0.15 per share beginning in Q3 2017 and authorized repurchases of up to $1.64 billion through June 30, 2018. The company repurchased $676 million of stock and paid $210 million in dividends in the first half.

Outlook, management commentary, risks and unusual items

  • The filing provides no specific earnings or credit-loss guidance. Management described seasonality in balances, delinquencies and charge-offs, and said it expects seasonal patterns to affect interim credit metrics.
  • Management estimated that an immediate 100-basis-point increase in interest rates would increase net interest income by approximately $143 million over the following 12 months, based on stated assumptions about growth and balance-sheet composition.
  • Key stated risks include consumer-credit deterioration and allowance-estimation uncertainty; reliance on retail partners and partner concentration; funding costs, deposit retention and market access; interest-rate mismatch; securitization early-amortization triggers; competition; cyber and operational disruption; and regulatory, legal and reputational exposure.
  • The company said the new CECL credit-loss standard, effective for it after December 15, 2019, is expected to increase its allowance for loan losses; the amount was not yet determined. It did not expect the revenue-recognition standard to materially affect revenue timing or measurement.
  • The CFPB had sought information concerning credit-bureau reporting and, in May 2017, issued a separate information demand concerning marketing and servicing of deferred-interest promotions. The filing also describes TCPA class actions. Management estimated reasonably possible legal and regulatory losses for matters it could estimate as immaterial, while cautioning outcomes could differ.
  • The company announced a GPShopper acquisition and reported acquiring the Citi Health Card portfolio. Other notable items included an $18 million pretax gain from sale of certain card-processing contractual relationships and elevated loyalty costs associated with higher redemption rates.

Important facts for investors to verify

  • Whether delinquency, charge-off and allowance trends stabilize, and how credit losses compare with management’s forecasts.
  • Whether deposit growth and funding diversification continue, and how funding costs and liquidity respond to market stress.
  • The effect of partner concentration, loyalty costs, retailer-share arrangements and recently announced or extended partner programs on profitability.
  • Any developments in the CFPB matters, TCPA litigation or other regulatory proceedings, including potential financial or operational consequences.
  • The eventual CECL transition impact, and whether planned dividends and repurchases remain consistent with capital, liquidity and regulatory constraints.