Consumer financial services giant Synchrony Financial (NYSE:SYF) issues its first-quarter 2018 earnings release next week, on April 20. In advance of the report, the following are three key themes investors should watch, addressing both recent trends, and opportunities Synchrony seeks to capitalize on this year:
1. Continued growth in net interest income
Investors have a habit of looking first at a company's top-line revenue number when earnings are released. For a banking enterprise like Synchrony, which finances consumer goods and purchases, that number is net interest income, before adjustments. Net interest income is essentially the interest Synchrony earns from its customer loans receivable, minus certain costs associated with earning the revenue.
Through a consistent push to partner with major retailers, Synchrony has increased its net interest income at a healthy clip in recent quarters. In the fourth quarter of 2017, Synchrony improved net interest income by 8% to $3.9 billion. For the full year, the company's net interest income expanded by 11%, to $15 billion.
Shareholders should also track retailer share arrangements (RSAs), and the company's provision for loan losses, in the first quarter. These two adjustments are shown on Synchrony's income statement directly following its top-line net interest income number.
RSAs are payments Synchrony makes to its retail partners once defined economic thresholds of a card program are met. Synchrony's provision for loan losses represents an income statement adjustment made each quarter to increase or decrease its "allowance for loan losses" -- a sort of reserve account on the balance sheet to handle projected card defaults.
While the total amount of RSA payments doesn't fluctuate greatly from quarter to quarter, the provision for loan losses can significantly affect net interest income. Earlier this month, I discussed how Synchrony's provision for loan losses has trended upward in a rather sharp manner in recent quarters, which has both negative and positive implications.
In 2017, modestly higher RSAs, coupled with the steeper loss provision, cut net interest income after retailer share arrangements and provision for loan losses (Synchrony's true net interest income) to just 2% growth for the year. Investors will hope to see a bit higher growth in the current year from net interest income after RSAs and loan loss provisions.
2. Healthier credit quality metrics
As I explained in my previous article linked to above, part of the higher provision for loan losses over the last few quarters resulted from a slight deterioration in credit quality metrics. Net charge-offs as a percentage of loan receivables increased by 80 basis points in 2017 versus the prior year. And loans 30-plus days past due at year-end rose a modest 0.35% against 2016.
One credit quality metric I intend to focus on in the upcoming report is net charge-offs. The dollar volume of written-off accounts on Synchrony's books jumped 29.5% in 2017, totaling a nearly $1 billion increase to $4.1 billion. Management explains this surge as part of ongoing credit "normalization." Simply put, credit normalization describes a reversion to greater credit risk for consumer lenders, as the current economic cycle and lengthy rebound from the Great Recession begin to show some wear and tear.
Generally, I believe Synchrony's ramp-up in charged-off accounts is healthy, as it coincides with a recent initiative by management to underwrite higher credit-quality customers. Almost two-thirds of Synchrony's consumer lending is now underwritten for customers with FICO credit scores of 660 or higher. Nonetheless, shareholders should watch the charge-off trend, and look for moderation in 2018.
3. Updates on the PayPal receivables transaction
Last November, Synchrony and PayPal (NASDAQ:PYPL) announced an extension of their existing consumer credit partnership, as Synchrony agreed to purchase the payments specialist's consumer receivables portfolio for $6.8 billion. Through the deal, Synchrony will become the exclusive issuer of PayPal's U.S. consumer financing program, "PayPal Credit," for the next 10 years.
It's an advantageous transaction for both companies. PayPal will off-load its credit receivables portfolio to a company that is in the business of consumer financing, and can use the freed-up capital to expand its more lucrative transactions business. Synchrony will obtain a quality receivables portfolio that will grow largely through PayPal's efforts over the next 10 years, thus providing predictable and expanding net interest income.
In Synchrony's upcoming earnings report, investors can anticipate an update from management on the complex transaction, which is slated to close in the third quarter of this year. Synchrony has already issued approximately $1 billion of fixed-rate debt to pre-fund the deal. Pertinent details will include cost estimates to completely fund the transaction. Pre-funding will modestly impact earnings this year, as Synchrony will incur financing costs in advance of earning its first revenue from PayPal credit customers. I'll be on the lookout for commentary on this topic, and will be sure to provide details in a post-earnings follow-up.