Synchrony Financial (NYSE:SYF) reported net income of $640 million in the first quarter, up 28.3% from the year-ago period, as the company benefited from a lower tax rate and lower provisions for loan losses. Here's everything you need to know about its most recent earnings report. 

Synchrony Financial's first quarter: By the numbers

Metric

Q1 2018

Q1 2017

Year-Over-Year Change

Purchase volume

$29.6 billion

$28.9 billion

2.6%

Loan receivables

$77.9 billion

$73.4 billion

6.1%

Diluted earnings per share

$0.83

$0.61

36.1%

Data source: Synchrony Financial.

What happened with Synchrony Financial this quarter?

Financial businesses aren't exactly exciting, as little changes from quarter to quarter. That said, it's important to stay on top of key metrics -- loan growth, loan losses, and general credit quality -- to get an idea of how the business is trending over time. Here are some key metrics and events from the first quarter. 

  • Total loans grew to $77.9 billion at the end of the first quarter, up by about 6.1% from the year-ago period, and down about 5% from the previous quarter as borrowers paid down seasonally high balances from holiday spending.
  • Net charge-offs continue to rise. Synchrony Financial reported net charge-offs of 6.14% of average loans, up from 5.33% during the first quarter of 2017. The net charge-off ratio stood at 5.78% of average loans in the fourth quarter. 
  • Synchrony is building reserves against future loan losses. The company reported that its allowance for loan losses stood at 7.37% of its period-end loans, up from 6.37% a year ago and 6.8% at the end of the fourth quarter. 
  • Speaking of credit quality, it's notable that Synchrony Financial is targeting customers with higher FICO scores. Purchase volume among customers with credit scores above 721 grew 8% year over year, while purchase volume by customers with a sub-660 FICO score declined 15%, according to conference call commentary.
  • Private-label card issuers derive most of their lending volume from retail partners, so it was good to see that the company renewed relationships with Nationwide Marketing Group, Briggs & Stratton, and American Signature Furniture in the first quarter. It also signed new partnerships with Crate & Barrel and Mahindra, among others.
  • One of its retail partners, Toys R Us, is currently in liquidation and will soon close its doors for good. Synchrony hopes to retain its Toys R Us cardholders with a new 2% cash-back card. This is a model to watch, as it represents something of a case study in whether or not Synchrony can retain customers when its partners fold. 
  • Synchrony Financial is preparing to take over PayPal's (NASDAQ:PYPL) credit portfolio, a $6.8 billion book of business. The deal is expected to close in the third quarter of 2018, when Synchrony will become the exclusive issuing bank for PayPal Credit for 10 years. 

What management had to say

One of the most important details from the conference call was management's commentary about digesting the PayPal credit portfolio. The deal will add billions of dollars of loans to its books overnight, but Synchrony will also have to build up reserves for loan losses when it closes, which could lead to lower reported earnings in the second half of 2018.

$100 bills in glass jar.

The card issuer will have to beef up reserves for losses after the PayPal deal closes. Image source: Getty Images.

On the conference call, Brian Doubles, executive vice president and chief financial officer of Synchrony Financial, explained how the PayPal acquisition may negatively affect earnings in the latter half of the year:

The thing that you've got to remember with PayPal is it comes on with no reserves. We're obviously going to book our standard 14 to 15 months of forward losses. Those reserves will get built over nine to 12 months and think about a fairly significant portion of that reserve build coming in the second half. So, you'll see more of that reserve build in the third quarter, in the fourth quarter, and then it starts to taper off as you get into the kind of the first half of 2019.

The read here is that Synchrony Financial will take most of the accounting charges for roughly 14 to 15 months of forward loan losses relating to PayPal in a six-month period, weighing on its earnings in calendar 2018. 

The company has already beefed up its balance sheet as part of its "prefunding" plan for the PayPal book, noting that it issued $500 million of unsecured debt in the first quarter, and increased marketing spend to bring in more deposits to support the loan portfolio. 

Looking ahead

PayPal remains the biggest story for Synchrony in 2018, as the company has few retail relationships up for renewal this year. Its most significant renewals won't come until 2019, when two partnerships that together comprise 20% of its interest and fee income on retail cards will be up for renewal, according to its annual report.

Credit quality remains an important part of the story. Synchrony Financial executives have consistently said that more recent vintages (cards or loans from new customer relationships) are performing better than older vintages, as the company is pursuing cardholders with higher FICO scores.

On the conference call, management stuck with its earlier guidance for net charge-offs between 5.5% and 5.8% for the full year, despite a net charge-off ratio of 6.1% in the first quarter, suggesting that credit performance should get better from here.