Profile: Synchrony Financial

June 9, 2023 | Premium Service | We recently added Synchrony Financial (SYF) to our bank surveillance group, replacing the institutions f/k/a Signature Bank and Silicon Valley Bank. For those of our readers not familiar, SYF was established in 2003 as GE Capital Retail Finance Corp, a thrift holding company based in beautiful Draper, UT. In March of 2014, SYF changed its name to Synchrony, which is today the largest white-label credit card issuer in the US. What can SYF tell us about the bleeding edge of unsecured consumer credit?

The first thing to notice about SYF is that it is more profitable than most banks and also has a higher default rate. We would not insult SYF by comparing them to Citigroup (C), which has a gross spread on its loans of 6% and a default rate 3x the large banks in Peer Group 1. No, SYF has a gross yield of almost 15% or 50% higher than CapitalOne Financial (COF) at 9.5% at year-end 2022.

Source: FFIEC

Now COF’s gross spread near 10% suggests an internal default rate target of “B,” so at 15% gross spread SYF is looking for more like a “CCC” target customer. Net losses of 3% at year-end 2022 put SYF in the “BB” category, but the real question is where will the loss rate be a year from now? The average net loss rate for Peer Group 1, of note, is just 0.09% at year-end 2022.

SYF’s default rate is orders of magnitude above Peer Group 1. The high default rate makes SYF maintain very high loss reserves equal to more than 10% of total loans. The bank also maintains mid-teens equity capital, a level that is appropriate to the level of risk and the unsecured nature of much of SYF’s lending.

Non-core funding dependence of 25% of total assets of $110 billion is another notable component of this relatively high risk business model. SYF mitigates this concern by maintaining a large pile of liquid assets, but ultimately net loans and leases are 150% of core deposits. SYF describes the deposit base in its last Form 10-K:

“The Bank obtains deposits directly from retail, affinity relationships and commercial customers ("direct deposits") or through third-party brokerage firms that offer our FDIC-insured deposit products to their customers ("brokered deposits"). At December 31, 2022, we had $71.7 billion in deposits, $58.0 billion of which were direct deposits and $13.7 billion of which were brokered deposits. At December 31, 2022, deposits represented 84% of our total funding sources. Retail customers accounted for the substantial majority of our direct deposits at December 31, 2022. During 2022, retail deposits were received from approximately 506,000 customers that had a total of approximately 980,000 accounts. The Bank had a 87% retention rate on certificates of deposit balances up for renewal for the year ended December 31, 2022. FDIC insurance is provided for our deposit products up to applicable limits.”

The bank buys and securitizes consumer loans from its customers in a variety of channels including home & auto, health & wellness and other verticals that are less easy to describe, as shown below. Notice that SYF is taking 10% out of these subprime loan categories in terms of spread and fees. The bank also charges significant late fees on loan delinquencies, another point of vulnerability in a recession. Defaulting customers don't pay late fees.

The bank also raises deposits from this same base of customers, a novel and to date successful strategy. But the $30 billion plus in noncore deposits at SYF presents the same market funding risk that eventually took down three large regional banks in Q1 2023 and caused others to fail. Like all banks, SYF has seen its funding costs galloping higher, rising 219bp to 3.4% at the end of Q1 2023.

Given that net interest margin is still over 15% and the efficiency ratio is just 35%, SYF has a lot of extra profitability to absorb loss mitigation expenses. That said, net charge-offs were barely above 2% this time a year ago and at the end of Q1 2023 were at 4.49%. COF, by comparison, was just 1.35% net loss at year end 2022.

“Credit normalization remains in line with expectations,” SYF reported to shareholders in Q1 2023. “Delinquencies will approach pre pandemic levels by mid year. Net charge off dollars to generally rise sequentially through year; not

expected to reach pre pandemic levels on an annual basis until 2024.” We generally agree with SYF on the timing, since credit cards generally are still a long way from pre-COVID loss rates.

Source: FDIC

Ultimately, we must measure SYF against the other bank providers of consumer credit. The SYF model is well north of COF in terms of spread and defaults, but frankly this bleeding edge of the world of retail finance is the most important component of economic growth and job creation – and also among the most profitable. There are dozens of smaller bank issuers of credit cards with much higher gross spreads, default rates and profits than SYF.

At just over 1x book value and with a six month beta of 1.3x, SYF is hardly a speculative name in the bank group and is at the top of most rankings in Peer Group 1. But that is the problem. The mere fact that it is arguably the outlier among large banks above $100 billion in assets in so many metrics measured by the FFIEC begs the question, as shown in the table below.

The operating results of SYF speaks to a superior operating team that understands asset turns and credit equally. Note for example, that SYF manages to achieve more than 100% of total assets in terms of earning assets, a remarkable metric. But the hyper-efficient operating metrics of SYF make us take a step back in wonder and awe.

If there is a consumer recession lurking in the next year or two in the US, you’ll see the early signs of that event in the results of SYF. Just as Citi is the early indicator for the top five money centers, SYF is the bellwether for credit card issuers. We must confess to a certain bias in favor of the consumer finance world because it is literally the oil in the crankcase of economic activity.

We like SYF a lot more than Ally Financial (ALLY), for example, because the total returns are higher and have been in the age of QE. COF is a good comparable for SYF among the larger banks, but SYF is really more like the smaller specialty bank card issuers with gross yields in mid-double digits. Fact is, the operating metrics of SYF put them in the same league as American Express (AXP), but SYF gets no such respect.

Yet the lingering concern that we raise for our readers is the combination of a one-third market funded book and the highest default rate in Peer Group 1. We could see net defaults on the SYF book pop to 6% this year and, along the way, drag most of Peer Group 1 to above average net loss rates. The volatility we see everywhere in the world of funding and credit tells us to take caution.

Below is our bank surveillance group, sorted from lowest to highest in terms of total return. We note that SOFI leads the group followed by NYCB, our sole bank common stock holding at this time. SYF is in the middle of the pack, but note that investors like Warren Buffett have exited the stock recently because of the prospect for higher credit costs.

Source: Bloomberg (06/08/2023)

The Institutional Risk Analyst is published by Whalen Global Advisors LLC and is provided for general informational purposes only and is not intended for trading purposes or financial advice. By making use of The Institutional Risk Analyst web site and content, the recipient thereof acknowledges and agrees to our copyright and the matters set forth below in this disclaimer. Whalen Global Advisors LLC makes no representation or warranty (express or implied) regarding the adequacy, accuracy or completeness of any information in The Institutional Risk Analyst. Information contained herein is obtained from public and private sources deemed reliable. Any analysis or statements contained in The Institutional Risk Analyst are preliminary and are not intended to be complete, and such information is qualified in its entirety. Any opinions or estimates contained in The Institutional Risk Analyst represent the judgment of Whalen Global Advisors LLC at this time, and is subject to change without notice. The Institutional Risk Analyst is not an offer to sell, or a solicitation of an offer to buy, any securities or instruments named or described herein. The Institutional Risk Analyst is not intended to provide, and must not be relied on for, accounting, legal, regulatory, tax, business, financial or related advice or investment recommendations. Whalen Global Advisors LLC is not acting as fiduciary or advisor with respect to the information contained herein. You must consult with your own advisors as to the legal, regulatory, tax, business, financial, investment and other aspects of the subjects addressed in The Institutional Risk Analyst. Interested parties are advised to contact Whalen Global Advisors LLC for more information.