Synchrony Financial (SYF) Earnings Call Transcript & Summary

All right. So we're at the top of the hour. I think we'll get started. Welcome, everyone, to the 22nd Annual Barclays Global Financial Services Conference. My name is Terry Ma, I'm the consumer finance analyst at Barclays, and we're very pleased to have Synchrony Financial with us today. We have Brian Wenzel, the CFO. So thank you, Brian.

Great. First of all, Terry, thank you for the invitation to come today. Maybe just before we get started, this week is an incredibly somber week for this city or country and hopefully, the world with what happened on 9/11 and I just want to say, it's not lost on our company or myself the people that directly impacted and indirectly impacted and hopefully, will all take some time this week to think about that because it's the day that will never be forgotten in our history. So thank you again for inviting me.

Yes. Thanks for coming. So I think with that, maybe let's just jump right into it. Let's start with late fees. It's probably not top of mind for investors as it was last year, but maybe -- it's obviously still an important outstanding item that can impact the industry and the company. So maybe just give us the latest update on litigation and the range of potential outcomes you're preparing for?

Yes. First of all, if anyone probably believes me on late fees, I've been wrong every time I thought about litigation. So I wouldn't think we're 6 months plus a couple of days into this, and we're still arguing -- the industry -- and the chamber is arguing venue and standing. But there is a hearing on 27th. Obviously, you can get the transcript from that. We'll see what -- the court has not ruled yet on venue and standing. But I think the important part of that, that came out of that hearing in advance, the defendants most certainly had argued that we were the only bank of outstanding as part of the [indiscernible] chamber and that some larger banks than us by size -- not by credit card size, but by size, JPMorgan, Truist, [indiscernible], et cetera. They're also part of that chamber. So we'll see what happens there. Terry, we approach this as the rule is going to go in place. That's how we're proceeding, and we will not back away from that because we think we're not [indiscernible] litigation or otherwise, the administration and the regulators want to do something here and similar to how you see with student loans. So we're going to proceed as if the rule goes into place, and our partners are on the same page with us.

Got it. So on the topic of mitigants, you mentioned more than 60% of the litigation efforts have been rolled out last quarter. Can you maybe just talk about where you stand to date and what else is left on the pipeline to roll out?

Yes. What we talked about in July was the first wave that's been completed. I mean, to send over 50 million CITs in a period of 6 months is just, to be honest with you, very difficult operationally, but I [indiscernible] be proud of the team of what we've done here. That's the first way. We have several partners who -- or a few partners that, that we've agreed to mitigants that will roll when the late fees rule actually goes into place. So [indiscernible] some main ways there. And there's continuing ways that happen as new accounts activate. And we have -- or I say accounts that were issued in the last 12 months, we'll renew -- we'll get changes in terms. And then most certainly, if you are an active [indiscernible] roll those out. So we'll continue to roll them out. We'll continue to look at the performance of those and continue to evaluate other types of terms changes or product changes that may come into play, but that's not in the short term.

Okay. And in terms of the amount in mitigants, you guys had initially guided to $650 million to $700 million mitigants. Do you still feel good about that number? And how should investors think about how much actually comes through this quarter and next quarter?

Yes. So it's first important to think about that $650 million to $700 million, and there's a combination of things that are in there. Number one, we had some slower volumes as there could be a potential negative reaction by some consumers to the terms changes. Two, there is a big RSA benefit that happens, particularly when the rule, as we planned it, to go into effect from October 1, that plays through. As we figure it today, I think we're going to have to make a decision with whether or not October 1 becomes realistic or not. So I think there's a handful of moving pieces in there. The way I think about it, Terry, and this is the first quarter which will have the full effect of the CITs in place and we're roughly 35 days into the quarter. When you look at it as a whole, right, when I think about attrition and when I think about conversion to e-bill from paper; on a whole, it's met or exceeded our expectations. We'll be back, I think, in October to give you more detail exactly what came through financially and probably what our thoughts are if the rule had not gone into effect by October 1, what that new timing looks like and what the update could be to the financial profile of the firm for 2024.

Got it. This is probably a good time to pause for the first audience response question. Can you just queue that up? So the question is assuming no late fee cap in 2024, what do you think is the incremental pretax income from late fee and mitigants for Synchrony in 2025. Is it, one, $550 million to $700 million; two, $700 million to $850 million; three, $850 million to $1 billion; or four, over $1 billion. Just queue up using the controllers in front of you. So 50% think it's going to be $550 million to $700 million; 34%, $700 million to $850 million. The remainder above $850 million. Do you have any comments on that?

No.

Okay. Fair enough.

It's not how I would have voted, but that's...

Okay, great. Maybe just turning to recent trends. Last quarter, you mentioned, you expected flat to low single-digit year-over-year declines in purchase volume in the second half. How is spending shaping up so far in the third quarter across each of your sales platforms?

Yes, a couple of things. The consumer is -- particularly, the lower income consumer is struggling with affordability, right? When you think about everything; utilities, rent, gas, groceries, everything just costs more. So they most certainly have been more discerning. I think when you move up the income ladder, we continue to see people pulling back on discretionary purchases, not in a troubled way, but just pulling back. So I think that low single-digit type sales number probably is still the right [indiscernible]. Interesting enough, we did have a, let's say, a stronger -- relative to current trends, a stronger Labor Day weekend, which partially [indiscernible] a lot of promotions in the home space as well as back-to-school kind of coming through there. The important thing, Terry, when we look at the spend and we pulled this data, we don't see signs of stress in the consumer. Like I told that even though you had just really tremendous earnings out of Walmart and Target, when we look at spend on our cards for Walmart, Target, Costco, BJ's, we do not see any shifts in behavior. So people weren't trading down yet to those types of discount retailers. When I look at -- I got it over the weekend, thank you for having this conference on Monday, [indiscernible] and ATV, we're not seeing troubling signs, right, relative to where the consumer is going. So the consumer right now is more managing than it's doing anything else, which we feel good about. I know there's a ton of focus and you may get to unemployment rate, but the unemployment rate is more people trying to enter the job market than losing a job. So again, we don't feel the pressure yet that the consumer is under duress. It is just more discerning given affordability.

Got it. Any noticeable differences in spend behavior between lower income versus higher income?

Yes. I mean we continue to see the same trend. So if you think about being low single digits, your lower income, lower credit score, say, folks are down high singles. And then you have positive variances when it comes to the higher income, higher credit grades. And one of the things when you look across the board, and I talked about pulling back on discretionary; most certainly, home and auto, lifestyle for us feel a little bit more because they are more discretionary. They are more bigger ticket. But we're starting to feel it even a little bit in health and wellness, where you see some of the more discretionary oriented purchase, whether it's cosmetic, LASIK, pulling back. So that's meant -- and again, that demand will ultimately come back. It just gets deferred to a large degree in an environment like this. But it is generally across the board, and it's more discerning to discretionary versus nondiscretionary.

Got it. Helpful. Maybe just turning to credit. You indicated last quarter you expect delinquencies to be in line or better than normal seasonality in the second half. We're also expecting second half charge-offs to be lower than the first half. July managed data showed the continuation of maybe the delinquency trends, August as well, you guys file the 8-K. Maybe just talk about how the third quarter is shaping up and what gives you confidence in the charge-off guide?

Yes, as you enter the back half of the year, when you think about delinquency, your losses are contained in the delinquency formation at that point. So you have some line of sight into the back half of the year. Unfortunately, for us, being such a large credit card issuer, we have variation in cycles, which makes it a little bit difficult for people to discern or do extra math in order to kind of get a rate. We printed a loss -- a charge-off rate for August that was 5.7%, but we had less cycle. I think when you cycle adjust it and then you back to seasonality and just seasonality for the change in average balance, we generally continue to see improvement. We're seeing sequential improvements, as I go year-over-year, as what we expected. Some people are talking about, we're not seeing the same seasoning as others. Our new accounts didn't balloon during the post-pandemic period. So we're more of the effect of others who have issued a lot of credit into the consumer space, some of which probably shouldn't have been there that we have a shared consumer. But we feel good about the trends, how they're developing. Now we're [indiscernible] we're entering a period, we should start to see some of the credit actions that we took in the other part that should begin to take effect, and that's something we'll watch closely as we move through the back half of the year because the effects of that generally are about a year out. So we should really see the effects in the first quarter, but you should start to see some impact. Most certainly, the way in which we've adjusted new account origination, we have seen the benefit of that kind of coming through, and it's been reflected in our new accounts. So the credit for us, we haven't been as volatile as others, slightly higher than our historical trends, but we continue to manage it and generally feel good about the profile.

Got it. And you touched on the unemployment trends or the employment rate a little bit. Is that something you're concerned about? And have you seen any early signs of higher unemployment take effect on your portfolio?

No. Again, I think you have to get to why did unemployment go up? There were more people looking for jobs, but no, it has not. There's been no discernible change when we look at collections and what's flowing into collections. How people are settling in collections related to unemployment at this level. Movement of 10 or 20 basis points isn't that really meaningful to be [indiscernible] from a reserve standpoint or from an actual flow-through effect to our book, so now...

Got it. And longer term, you guys have kind of indicated that 5.5% to 6% net charge-offs is kind of the right way to think about where losses drift back -- maybe just talk about the time line to get there and what gives you confidence that you will get there?

Yes. Look, I'll start with the last one. What gives us confidence is that's where we underwrite to. We look at probability of defaults, exposure to default and we're trying to manage inside that range because when we look at that range, when I look at the revenue that comes from this all risk adjusted, that gives us the most optimal return for value, right? If we underwrite before that, we're going to have to enhance that revenue profile in order to make it meaningful to do that. So we're targeting that across the board. And we do that at a partner and channel level. So that's all we have. Now you do have external influences. I talked about historically, this industry put out 2 of the largest vintages ever the last couple of years. People expanded their credit boxes in order to kind of gain share during the post-pandemic period. There was too much credit put into the system across the board at that point. And that flows through for all issuers. That's why you see people have loss rates that were 3% or 2%, being above that now. There's just too much credit in the system. So that will work its way through. We look at the way in which our trends on delinquency have moved. And we hopefully feel we will migrate back to that level. We haven't given guidance beyond 2024. In 2024, we focused more on EPS given the moving pieces with late fees. We'll be back in January and give you a view probably on a loss perspective where you expect that rate to be for full year '25.

Got it. And maybe just to follow up on that point on the 2 larger vintages, which I think you're talking about 2021 and 2022. Any color on how 2023 is performing, 2023 vintage, relative to '21 and '22 and then also relative to what you saw pre-pandemic?

Yes, we tend to break vintage into 6-month snapshot. So when you look at first half of '23, that's performing better than '21 or '22, but probably not in line with '18. Second half of '23 and first half of '24, which is early, are performing better than 2018. So that tells us the underwriting actions, we took and put in place during that period, have had the desired effect as it goes through. But again, we didn't upsize our vintage level like many others during that '21 and '22. So it's not as pronounced, the impact on our portfolio versus others.

Got it. That's helpful color. Maybe turning to the reserve ratio. You indicated you expect to end the year with a flat reserve ratio relative to year-end '23. I guess, did the recent unemployment number change that qualitative portion on the reserve? And maybe asked another way, what level of unemployment does your reserve actually contemplate?

Yes, we got it to a flattish in the period. I don't think -- between here and the end of the year, unless there's a significant movement in unemployment, I don't expect it to have a material effect on the reserve per se. I think when you look at 3Q versus 4Q, the question for us will be, do we have better line of sight on the macro economy and what's happening here? And most certainly, I think the market expects the Fed to cut rates, I think on the 18th when they meet or in third week of September. We'll see what they do there and see how much they do there. But we're in the reserve setting process now. So I don't think that unemployment in and itself will change our view that at the end of the day, it will be flattish, whether that's more in 3Q or 4Q. Again, you're going to have [indiscernible] just may be you have growth [indiscernible] offset by rate in 3Q or 4Q.

Got it. And then the reserve ratio, if you exit the year flat relative to 2023, it's going to be about 40 basis points above CECL day 1. Is CECL day 1 still the right reference point for investors to kind of anchor to? And what do you need to see to actually have you release reserve ratio back down there?

Yes. First of all, let's make sure we level set on what the kind of day 1 CECL was, which was day 1 and only day 1 because of the pandemic things that happened. It was a 9.9% rate. When you adjust it for the change in accounting for TDR, it's probably 9.6%. If you think about a flattish reserve rate being around, I guess, 10.3% end of last year, that 10.3% number is probably 60 or 70 basis points. There's nothing structurally in the portfolio that says we can't get back to that day 1 rate, to be honest with you. So we expect it to migrate there over time. It's just -- most certainly, when you think about the reserving methodology today and your qualitative overlays, it's just -- when does the macroeconomic environment clear enough where you don't have a lot of that concern. Most certainly, if I go back to the end of '19 and into '20, I don't think we had macroeconomic concerns. There was concerns about a pandemic, which we all probably got wrong differently, because I don't think we expected the world to shut down the way it did. But there wasn't a big macro concern back in '19 to '20, maybe there should have been more, but there wasn't. So I think when that clears, we'll migrate back towards that level. There's nothing structurally that's different.

Got it. Helpful. Switching gears a little bit, just talk about partnerships. Can you maybe just touch on the market for co-brand and private label? What are you seeing with respect to competition, especially from the newer start-ups entering the space? I think a company called Imprint recently picked up Brooks Brothers. Any comments on that?

Yes. The marketplace remains competitive, for the most part, rational. I sit back and say, you see in different spots, different players historically. So whether it was a Cap One at certain point, a Citibank at certain points, Barclays that has become more active. You see other issuers kind of [indiscernible] U.S. Bank, et cetera, for certain types of relationships. I think we continue to see that. It's going to be interesting, the dynamic that develops here in probably the next 2 years where you've got Cap One, which is very, very focused on closing those scrubber transactions. So we'll see what their participation rate is within the space. Citi most certainly has realigned some of its business and whether or not they continue to have some focus on the retail part of their business, and they just want to hold what they have. Barclays continues to be an aggressive [indiscernible] in the space. But again, they've had some RWA management issues here in the U.S. So we'll see how that plays through that. Those are things that we'll have to watch. But again, for our existing clients, we try to win them every day. But the wins that we're going after -- you will be very disciplined on pricing. We always price recession through the contract life because if you do a 7- to 10-year deal, you probably will see a recession. We're probably not the lowest priced company, but we think we have the assets that demand the premium price and the value proposition that demands that. So there's competition. I wouldn't say it [indiscernible] a lot. But I think the dynamics in the industry, we don't want to see how people react here in the next couple of years.

Got it. In terms of renewals, are there any material partnerships coming up from renewal on the horizon, either in your portfolio or maybe out there? Obviously, Walmart is out there. Can you maybe just talk about broadly your approach that's selecting retail partners separately?

Yes. Let me start where you ended, like how do we select partners. And this is an important piece for us. We want someone who views a credit program as something that's integral into their value proposition. It's one that's going to focus on their loyal customers. It's part of their business model. It's supported fully at the C-suite level. That gives you great engagement rate relative to the program and importance -- or someone who just wants to use it as a vehicle to try to extract or monetize their customer base is probably not a partner for us. I think you look at loyal customers. So when you look back to Venmo, Verizon, and Walgreens; the last 3 big de novo programs we launched, they were programs that had customers who are very loyal to their brands, very strong brands. You don't see people flipping around between Walgreens and CVS and Rite Aid. Most certainly, once you engage with the phone, you're not probably switching between Verizon another carrier. Venmo, once you get used to a cash transfer app or payment-to-payment vehicle, you're not flopping around. So that's important to us. It's important to them and how they drive value with their customers. We extended Verizon, but the important part of Verizon was, we also added equipment financing now. So we're able to expand, given our product suite, into a multiproduct setting. So when I think about relationships, it's really where the customer wants to go. When you talk about our existing customers, again, I think we have well over 90% of our contracts extending '26 and beyond. There are a few that are kind of coming up here that -- but again, we work to try to extend these ones every day and there's natural points in which we can extend before it gets closer to a mature day, we'll do so. But we like the brands we're with and we like the opportunities that are on our pipeline today.

Got it. What about sales platforms? Any particular sales platform you have, you're looking to build out or increase exposure to?

Yes. The 2 platforms that I'd say stand out, number one is health and wellness. It has a tremendous market presence. It's one where we have tremendous connectivity with providers. We've over-indexed our investment into that platform. So I think as you look both -- you could see the effects over the last 18 months or so. But look forward, you're going to see that platform over-perform and over-index relative to the company average. And we're looking at that space as far as the number of specialties we're in. And especially if we're not in that, that we think that, that have a good opportunity for us to continue to expand and go into. The other space I'd say you see us kind of go into a little bit more is the digital platform that we're over-indexed relative to growth versus the others. And there, we just have some exciting partners that continue to grow in this environment. We have expanded relationships. You probably saw we -- a deal was announced with Apple Pay, where our product -- as of now, 1 of 3 banks. And there, if you look closely at the press releases of our product that shows in there that you have installment financing now on cards that can be loaded into the Apple Wallet. So you'll see that on our Synchrony Mastercard that's in the wallet -- will be out of in the early part of next year with installment financing. And listen, Apple is just a tremendous company. Their customer experience is terrific. And I think you partner that with someone like us who has tremendous scale and the ability for us to get more cards into the Apple Pay ecosystem, we'll be able to drive that forward. So we're excited about that opportunity, but it comes from scale, comes from having multi-products, et cetera. So I think you'll see us over -- index in those 2 platforms, particularly over the course of the next couple of years.

That's helpful. Maybe just turning to receivables growth. You've generated double-digit loan growth in 2022 and 2023. Any color you can provide on the drivers there, i.e., how much has come from the rebuilding of balances from existing customers versus the acquisition of new accounts?

Yes. So, I mean, if you go back and look at our new accounts -- our new accounts that did not materially change pre-pandemic or post-pandemic. Also during the pandemic period when you had maybe less than sort of traffic, our new accounts were down, but we never flexed new accounts. So it's not really coming from there. Most certainly, I think as you exited the pandemic period, the flow of money to consumers drove velocity higher, so a lot of the growth in the last couple of years has been more purchase line growth. Now I think as you see purchase line coming back to more normalized levels, you also see payment rates coming back, albeit not back to pre-pandemic period, -- so you're getting a little bit of asset build from the payment rate. But again, historically, it has been a little bit more purchase volume. Most certainly, I think this year, you see a little bit slower purchase volume, a little bit more coming from, again, payment rate, but a payment rate that's still meaningfully above historical levels. So it's not a troubling fact that we're seeing growth coming from there.

Got it. You indicated you were expecting receivables growth to continue to moderate year-over-year and to end the year with 6% to 8% receivables growth. Is that still the case? And then maybe just talk about longer term, what's the right level of growth in this business?

Yes. We guide our long-term financial framework between 7% and 10%, which is 2x or so GDP. And that really goes back to the fact that we are engaged with consumers [indiscernible] customers of our partners. So we expect above-average growth relative to GDP. When I think about this year, most certainly, this year is a little bit more transitory with regard to the macroeconomic background kind of playing through. But again, I think if you think about a business that should generate 7% to 10% receivable gross on annum, again, that's an average rate. Some years, it could be a little less than that. Some years, as you saw during the pandemic, a little bit more than that, but again, we're not necessarily growth at all costs. So I mean, that's why we didn't necessarily change our credit box or other things as we moved into the pandemic. It's more about being consistent with our partners -- our model, because we're tied into partners. You can't come on and off fret at other things. You need to be there consistently through them both in good times and in bad times.

Got it. Can we just queue up the last audience response question. We have about 10 minutes left. So over the next year, would you expect your position in Synchrony to: One, increase; two, decrease or three, stay the same? So the majority, 53%, stay the same; 29%, increase. So relatively bullish. Do you want to comment on this one?

Listen, I think for #3, for people who say stay the same, I presume that many investors right now are just trying to focus on, "Hey, listen, what's happening with late fees. And how do we get through the macroeconomic." I think as those 2 things clear, I think more people will ship relative to this chart. But I go back to -- Terry, fundamentally, the investment thesis in our company, you would want our company if you want to have probably above average growth on accounts receivable; a higher returning portfolio over the long term, right, ROA, most certainly, it has been a little bit pressured with higher interest rates; and then a capital structure that has access and a better return. That's, to me, a strong investment thesis. And I think you just got to work through a little bit of this cloudiness relative to late fees in the macro. And I hope we get more than 1 than 2.

Good. We have about 7 minutes left. So I'll just open it up to the audience for questions. We have one upfront over here.

Talk about the potential kind of regulatory outlook under both Republican and Democratic administration. On the one hand, Democrats, especially the CFPB, have been pretty activist in terms of consumer protection. We can argue whether they're actually protecting the consumer. But actually, already it has been a conservative quarter of overturn the number of regulatory decisions. So how do you see the sort of the variables looking forward?

Yes. One of the fortunate things of being in business over 90 years, you learn to live with both sides of the parties, Republican or Democratic, and we'll just work with whoever. I mean, I think if you ask which is better for your business, one would argue one administration, one argue the other administration. Most certainly, we expected a probably more active regulatory market. Most certainly, the regulatory framework has been a little bit more aggressive given some of the bank failures that you've seen. So we continue to work for it. I mean, it's just an environment we prepare for. Most certainly, if we think that there are things that happen that are not in line with [indiscernible] fairly, we'll work with others to try to push back on that. Late fee is being a great example. It's most transparent fee ever known. And if you just pay it on time, you never get to pay. And so to put adjectives on it like it's a junk fee or things like that, that -- and then you put [indiscernible], but we feel if not compliant with the card act, the industry will take action and we'll continue to do that. And whether that's Republican or Democratic, we'll work through it. And that's the one thing about having a long history, as you understand, you need to work through different types of regimes and philosophies relative to regulation.

We have one question up front here.

Why do you think Synchrony has had such long-standing relationships with partners such as Lowe's? And is there ever a concern about concentration risk having such large partners in your portfolio?

To answer the first one, we work hard every day. Our culture is around being partner centric, right? So if I sat back today, I wouldn't be surprised if this is 9:00 on a Monday that we have people in those offices, they're going through what [indiscernible] happened over the weekend. We understand how to operate with that. That's our core. And I think people struggle trying to come into this space is how do I replicate that model? You think it looks like issuing a credit card, it's really not. So I think it's built up over a lot of time, our ability to execute both in-store and digitally, know what works, gives us a competitive advantage. That's why I talk about hopefully getting a higher return for our value proposition. We don't have to execute in the space. Most certainly, I think for a lot of different reasons, we watch concentration. We have some very large partners which are great, and we know how to operate within that. We know how to plan our capital around that. But it's one that doesn't drive us away from the marketplace. We're uniquely situated here. We're not going to pivot and go right and do other products. This is what we do. And I think it's a barrier entry. Even some names that come in and won large relationships from us, they have not done very well and they left us. It's a really tough marketplace to work in and execute it. And that's why we've been focused on it since 1930s [indiscernible]. So we love the partners, we love long-standing partners, some of which have been with us 4-plus decades.

Any other questions from the audience.

Can you just talk about the capital structure a little bit. There's been a remix from CET1, the preferred equity over time. So just maybe let us know if that's kind of steady state, if there is more preferred that you could see in the capital structure and maybe even other types of instruments like Tier 2 in the total capital stack.

Yes. So I think over the last 5 or 6 years, you've seen us develop the capital stack. We had CET1 -- and to be honest with you, above our target CET1. As you are close to your target, in order to maximize Tier 1, your risk-based capital, we want to make sure that -- I'll start with Tier 2, that we had enough subordinated debt in there to maximize the risk-based capital stack [indiscernible] become a binding constraint. When you think about Tier 1, getting enough preferred out there where you can maximize that. We're not quite there yet. We probably have another $200 million to $300 million of preferred to go in order to fully maximize our Tier 1 ratio when you continue to look to take our CET1 down to get down to the target. There's been a lot of discussion of our company about our ability to get to target and whether or not we would or could. This company back in, I want to say, 2016 had a 17-plus-percent CET1 and we've migrated that down into the 12s, and we're going to continue to go, and there's a pace and a cadence as you bring your stakeholders along with you whether that's the regulators, the rating agencies, most certainly investors. So we're focused on being efficient there. So the only thing I'd say left is we have a little bit more preferred in order to be optimal relative to making sure we all have a binding constraint on Tier 1 and risk-based capital.

I think we probably have time for one more, if there are any. I think that's a wrap.

Terry, I appreciate the opportunity today and great attendance at the conference. So thank you for inviting us.

Thank you for coming.