Synchrony Financial (NYSE:SYF), the financial institution that specializes in store-branded credit cards, was one of the most beaten-down stocks as the COVID-19 pandemic caused the U.S. economy to grind to a halt. At the market's March lows, Synchrony had declined by 65% for the year on fears that spiking unemployment could lead to a rise in loan losses in its credit card portfolio.

Since the lows, however, Synchrony's stock has bounced back somewhat. The stock has gained back roughly half of its losses, and now is no longer trading for quite the fire-sale valuation we saw a few months ago.

So, the question is: With shares still significantly off the pre-pandemic highs, but much higher than they were at the depths of the market crash, is Synchrony Financial worth a look?

Woman sorting through a handful of credit cards.

Image source: Getty Images.

Store credit cards are a risky business

The main reason Synchrony's stock price took such a steep dive in the market crash -- even relative to other bank stocks -- is the nature of its business. Credit card lending is one of the riskiest types of lending banks do. In tough times, people typically make sure their mortgage and car payments are covered before worrying about their credit cards. Plus, unlike those types of debt, there is no house or car that the lender can repossess if a credit card customer stops paying.

Not only is credit card lending risky, but store credit cards are an especially risky subtype. Store credit cards typically have looser credit standards compared with traditional bank-issued credit cards. To illustrate this, consider that Synchrony's charge-off rate in 2019 was about 6% of outstanding loans, and this was in a strong economy. In contrast, the default rate for conventional mortgages is about 0.9% and the charge-off rate for 60-month new vehicle loans is less than 0.3%.

The point is that when the economic climate gets rough, store credit card default rates can easily spike into double digits. Synchrony and most other financial institutions are preparing for this by adding to their loss reserves, but it's still a serious threat to profitability. And it's simply too early to tell just how badly the current recession will hurt Synchrony's customers.

But they can also be very profitable

Speaking of profitability, that's the argument in favor of the store credit card business. Because of the higher risk involved, store credit cards generally have significantly higher interest rates than bank credit cards. The average interest rate on a bank credit card is about 16%, but with store cards, it's not uncommon to see rates approaching 30%.

Because of this, there's a ton of potential for profit. Synchrony's net interest margin is currently 15.15%. Most banks are happy with a net interest margin in the 2%-3% range, especially in today's low interest environment. Even other credit card issuers can't compare – Discover's net interest margin is 10.3% and even that is on the high end for the industry.

Is Synchrony a buy while it's down?

The short answer is that it depends on your risk tolerance and how long you're planning to invest. Synchrony's business model is solid from a long-term perspective, and the company is well capitalized. And with the financial support the U.S. government has provided to affected consumers should certainly help Synchrony avoid a worst-case scenario when it comes to loan defaults.

On the other hand, investors should expect nothing short of a volatile roller coaster ride in Synchrony's stock price as the pandemic (and its economic effects) continue to unfold. The bottom line is that Synchrony could be an excellent stock at the current share price for patient long-term investors, but only for those who are willing to ride out the near-term ups and downs.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.