A glance at any portfolio from Warren Buffett's Berkshire Hathaway (NYSE:BRK.A)(NYSE:BRK.B) from any era proves that the man loves financial companies. As ever, these days some of Berkshire's largest holdings are in famous financials; big bank Wells Fargo is the company's No. 2 stock by market value, while credit card giant American Express (NYSE:AXP) isn't far behind at No. 5.
Recently, Berkshire Hathaway revealed in a regulatory filing that it amassed a nearly 17.5 million-share position now worth $533 million in Synchrony Financial (NYSE:SYF). Unlike Wells Fargo and AmEx, Synchrony is an under-the-radar company unfamiliar to many. What would attract Berkshire to such a seeming non-entity? Buffett has been mum on the subject so far, but we can tease out a few likely reasons.
For those not familiar with Synchrony and its operations, the company is an issuer of store credit cards. If you've got certain plastic from retailers such as Gap, Walmart, and even Amazon, among many others, you're a Synchrony customer.
The key difference between Synchrony and the more high-profile credit card companies, like Buffett's beloved AmEx, is the end-user base. A typical card issuer, be it AmEx or a bank such as Wells Fargo, is relatively more selective about who it accepts as a cardholder. For obvious reasons it tends to award cards to individuals with decent salaries, and good credit scores and histories.
Synchrony is more forgiving. After all, retailers want to have as large and loyal a customer base as possible, and they want to make it convenient for those folks to buy their wares. Getting cardholder numbers up is the mission in this segment.
As a result, Synchrony's customers as a group have relatively low credit scores. In the company's Q2, 28% of its cardholders had FICO scores at or below 660, the level considered to be a "fair" quality credit risk.
The knock-on effect is that Synchrony boasts steep loan losses and, consequently, high charge-offs. During the quarter, the former totaled $1.3 billion, while the company's charge-off rate was 5.4%. Careful AmEx's most recently reported charge-off rate, by comparison, was a mere 1.8%. Wells Fargo's consumer credit card portfolio stood at 3.7%.
The flip side of this is that Synchrony's net interest margin -- the difference between what the company pays out on its liabilities, and what it takes in from its assets -- is relatively rich. During Q2 it stood at just over 16%, miles above Wells Fargo's 2.9%, and AmEx's 8.9%.
The trend is Buffett's friend
That discrepancy surely hasn't escaped Berkshire Hathaway's notice. Nor has Synchrony's recent jump in total net interest income (by 13% on a year-over-year basis in Q2), on the back of encouraging growth in purchase volume from its cardholders. Zooming out, overall U.S. consumer spending has been on the rise lately, and many prognosticators expect it to continue heading north.
The credit card industry as a whole is benefiting from this. According to data from the Federal Reserve, outstanding credit card balances at the end of June were almost 6% higher on a year-over-year basis.
Buffett and his colleagues are likely also cheered by the fact that Synchrony consistently posts chunkier profit margins than their old favorite AmEx. The former also pays a relatively higher dividend; its upcoming quarterly payout yields nearly 2% on the current share price, higher than AmEx's 1.5%.
Finally, Warren is very fond of companies that have wide "moats," i.e. competitive advantages that are difficult to replicate. In Synchrony's case it's the standard bearer for store card issuers, with a portfolio that's second to none. It's tough to build a client list that can compete with one that features names like Amazon and Walmart only on the first page.
To sum, Berkshire Hathaway now owns a big stake in the king of the store card segment, at a time when business is set to keep rising on the back of very favorable consumer trends. We can imagine that Buffett will hold on to his shiny new financial industry investment for quite some time.