Synchrony Financial
NYSE:SYF
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Synchrony Financial
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Welcome to the Synchrony Financial Second Quarter 2018 Earnings Conference Call. My name is Vanessa and I will be your operator for today's call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. Please note that this conference is being recorded.
I will now turn the call over to Greg Ketron, Director of Investor Relations. Sir, you may begin.
Thanks operator. Good morning everyone and welcome to our quarterly earnings conference call. Thanks for joining us.
In addition to today's press release, we have provided a presentation that covers the topics we plan to address during our call. The press release, detailed financial schedules, and presentation are available on our website, synchronyfinancial.com. This information can be accessed by going to the Investor Relations section of the website.
Before we get started, I wanted to remind you that our comments today will include forward-looking statements. These statements are subject to risks and uncertainty and actual results could differ materially. We list the factors that might cause actual results to differ materially in our SEC filings, which are available on our website.
During the call, we will refer to non-GAAP financial measures in discussing the company's performance. You can find a reconciliation of these measures to GAAP financial measures in our materials for today's call.
Finally, Synchrony Financial is not responsible for and does not edit nor guarantee the accuracy of our earnings teleconference transcripts provided by third-parties. The only authorized webcasts are located on our website.
Margaret Keane, President and Chief Executive Officer; and Brian Doubles, Executive Vice President and Chief Financial Officer will present our results this morning. After we complete the presentation, we will open the call up for questions.
Now, it's my pleasure to turn the call over to Margaret.
Thanks Greg. Good morning everyone and thanks for joining us today. I'll begin on slide three. Overall, we had a good quarter with earnings of $696 million or $0.92 per share. Loan receivables grew 5% within our expected range and we generated solid net interest income growth of 3%. Brian will provide full details on our quarterly results later in the call.
Today I'd like to spend my time addressing the topics that are obviously of greatest interest this morning; the closing of the PayPal transaction and that we will not be renewing the Walmart program agreement. First, I'll start with PayPal. We are very excited about expanding the PayPal partnership which occurred July 02. PayPal's two U.S. credit offerings are now consolidated into one relationship providing significant opportunity for us, PayPal, and PayPal customers.
In addition to recently extending our cobranded consumer card program with PayPal for 10 years we are now the exclusive issuer of the PayPal credit online consumer financing program in the U.S. As part of the transaction we have acquired PayPal's U.S. consumer credit receivables portfolio as well as interest held by other investors totaling $7.6 billion. Moving forward with PayPal to become the exclusive issuer PayPal credit in the U.S. is a natural extension of our successful 14-year relationship.
This collaboration built on a key relationship in the rapidly growing digital payment space expands our capabilities within the merchant environment and leverages both companies' strengths in providing seamless digital payments and innovations for merchants and consumers. Together we can provide an enhanced customer experience for thousands of merchants and consumers combining our program management, credit capabilities and balance sheet with PayPal's platform and trusted brand as a leader in digital and mobile payments should help create superior products and offerings for consumers and merchants.
The two programs require a unique organizational focus given that they address different customer needs; rewards for co-brand and financing for PayPal credit, two areas in which we have expertise, also having one partner to holistically manage both programs for PayPal allows for synergies and could provide opportunities for migrating customers between products as their needs change. This expanded relationship supports our continued reach in the rapidly growing digital payments channel.
We have built a strong reputation in this space and this program will allow us to meet evolving consumer needs. We primarily compete on our capabilities including our significant experience, scale, dedicated teams, data analytics, loyalty programs, digital capabilities and proven record of providing value-added services to our partners. These capabilities all played an important role in expanding our relationship with PayPal.
We are obviously extremely happy to have expanded the significant relationship as we leverage the new opportunities to meaningfully expand the program. Brian will detail the financial impact this transaction will have on our outlook for the year later in the call.
We also announced that we will not be renewing our program agreement with Walmart which is set to end in the third quarter of 2019. It is important to note at the outset that one of the two potential scenarios will likely play out as a result of not renewing the program; either we sell the existing portfolio to a new issuer or the portfolio will stay with us and we convert the qualifying portion of the portfolio to a general-purpose card. In either scenario we believe we can replace the EPS impact resulting from the nonrenewal and we expect both options will be accretive to EPS relative to renewing the program. Brian will cover the financial implications of not renewing the program later.
With regard to not renewing the program, let me begin by saying that we are proud of the value we created for Walmart and our cardholders over the 18 years we managed the credit program for Walmart which began as a startup program. The product development, marketing, and servicing skills, value propositions, and technology, and digital expertise that we brought to the program all played a critical role in the growth and success of the program.
Last year we began discussions with Walmart about renewing our relationship. Although we competed aggressively to renew the program, we were unable to reach terms that would have made economic sense for our company and our shareholders. Instead we will focus on opportunities in other areas of our business where we see significant potential for growth at more attractive risk adjusted returns over time. This is consistent with our disciplined approach to managing our business for the long-term.
Our capabilities are best in class and we believe that our continued investments in digital and data analytics coupled with our long-standing expertise in managing these programs and scale makes us one of the best credit program providers in the U.S. In this case other elements were in play that would have resulted in an economic profile that was sub optimal for the capital supporting the program.
Our strategy across all platforms is based on building long-term relationships with our partners and cardholders by offering superior capabilities, service, and value propositions while generating attractive risk adjusted returns. As I have noted many times, we think about our growth opportunities against the broader backdrop of a payment industry that has been going through a period of significant change.
New technologies are driving the consumer behavior and the convergence of in-store and digital commerce is opening up new opportunities that play to the strength of our business. These trends present us with a number of growth opportunities with the expansion of the PayPal strategic credit relationship being a great example of these opportunities.
We continue to feel good about the capabilities, products, marketing, servicing, and digital expertise and value propositions we bring to our partners, their programs and cardholders and the economics of these relationships and the ability to grow these programs. We attempted to reach a similar outcome with Walmart, but unfortunately we were not able to agree on terms that made economic sense for us and our shareholders.
Instead we will invest in opportunities that we think can generate greater returns over time and help us drive innovation in this space. Walmart has clearly been a sizable relationship for us. Not renewing our agreement at the terms required is the right long term outcome and it does present some options as we move forward.
I'm now going to turn the call over to Brian, who will walk you through the highlights on the quarter, provide details on the PayPal transaction impact to our outlook and discuss our options related to the Walmart portfolio, and the potential financial impacts.
Thanks Margaret. I'll start on slide six of the presentation. I'm going to briefly touch on the highlights of the quarter so that I can spend more time on the PayPal and Walmart nonrenewal impacts. This morning we reported second quarter earnings of $696 million which translates to $0.92 per diluted share. We continue to deliver good growth with loan receivables up 5% in interest and fees on loan receivables up 4% over last year.
The slower growth in recent quarters reflects the underwriting refinements we have noted previously. As we move forward and the impact from these items are included in the prior year run rate we would expect their impact to moderate in future quarters. RSAs decreased 16 million or 2% from last year primarily due to the Toys "R" Us bankruptcy. RSAs as a percentage of average receivables was 3.4% for the quarter compared to 3.6% last year.
The provision for loan losses decreased $46 million or 3% from last year driven by the lower reserve build. The reserve build in the quarter was $121 million lower than the $175 million range we had expected and substantially lower than the $325 million reserve build in the second quarter of last year. Both reflect the moderating trends in credit normalizations and slightly lower loan receivables growth due to the impact from our underwriting refinements.
Other expenses increased $64 million or 7% versus last year driven primarily by growth in strategic investments as well as expenses related to on-boarding the PayPal credit program. The efficiency ratio was 31% for the quarter compared to 30.1% last year and in line with our expectations. The slight increase was driven by growth, the timing of strategic investments, as well as the upfront build costs related to on-boarding PayPal credit.
Lastly we did continue our pre-funding in the second quarter ahead of the closing of the PayPal credit portfolio on July 02. As expected this impacted metrics in the second quarter such as the net interest margin which I will cover next on slide seven.
Net interest income was up 3% driven primarily by loan receivables growth and net interest margin was 15.33% compared to last year's margin of 16.2%. The margin was largely in line with our expectations. As expected the largest impact on margin performance was the impact of pre-funding the PayPal portfolio acquisition.
Next I'll cover our key credit trends on slide eight. In terms of specific dynamics in the quarter, the key highlights are the improving trends and delinquencies and the lower-than-expected reserve build of $121 million. 30+ delinquencies were 4.17% compared to 4.25% last year. The year-over-year trends in the 30+ delinquency rates continue to improve for the third quarter in a row with the 30+ delinquency rate now slightly below the prior year, reflecting a more modest impact from normalization and the impact of our underwriting refinements.
The net charge-off rate was 5.97% compared to 5.42% last year and in line with our expectations. The allowance for loan losses as a percent of receivables was 7.43% and the reserve build from the first quarter was $121 million. As I noted earlier, the reserve build was lower than the $175 million range we expected due to the improving credit trends and somewhat slower receivables growth as well as the impact from our underwriting refinements.
The most recent vintages continue to trend in line with our expectations. We started to make refinements to our underwriting in the second half of 2016 and we continue to see the positive impact of those changes. The vintage curve data suggests that the 2017 vintage is performing better than 2016 and more in line with our 2015 vintage. Not surprisingly these underwriting refinements continued to impact our purchase volume mix by FICO score.
If you look at purchase volume by FICO's stratification we continue to grow at a fairly strong pace and accounts with a FICO score greater than 721 which increased 8% over the same quarter last year. Our purchase volume for the below 660 FICO score range actually declined 13% reflecting the actions we've been taking. These trends help inform our view of loss expectations in 2018 and beyond.
Moving to slide nine, I'll briefly cover our expenses for the quarter. Overall expenses came in at $975 million up 7% over last year. Expenses continue to be primarily driven by growth and strategic investments as well as preparing for the expansion of the PayPal credit program.
Moving to slide 10 we ended the quarter at 16.6% CET 1 under the fully phased in Basel III rules. This compares to 17.2% on a fully phased in basis last year a 60 basis point reduction reflecting the impact of capital deployment through our capital plan and growth. During the quarter we completed the capital plan we announced in May of last year. We paid a common stock dividend of $0.15 per share and repurchased 210 million of common stock fulfilling the 1.64 billion and share repurchase our board authorized through June 30.
On May 17, we were pleased to announce our new capital plans through June 30, 2019. Our board approved an increase in the quarterly common stock dividend to $0.21 per share commencing in the third quarter and a share repurchase program of up to 2.2 billion. We began to execute our new plan in May repurchasing 281 million during the quarter in addition to the 210 to complete the prior program for a total of 491 million of repurchases in the second quarter.
Now that we have on-boarded the PayPal credit portfolio, I wanted to recap our current view for the year which is on slide 11. As you will know, our current view for 2018 including the PayPal portfolio is fairly consistent with the outlook we provided back in January. Starting with receivables growth taking into account the addition of the nearly $8 billion PayPal portfolio, we still expect our year-over-year growth rate to be in the 13% to 15% range.
Regarding our margin outlook for the full year 2018 it is unchanged at 15.75% to 16% including the impact of the PayPal portfolio acquisition. For the next two quarters we expect the margin to be in the 16% range as the liquidity from the pre-funding is deployed to fund the portfolio restoring the margin back to around 16% for the remainder of the year.
We expect RSAs to run closer to 4% of average receivables for the year, down from the 4.2% to 4.4% range in the previous outlook. RSAs have been trending lower reflecting the slower growth in recent quarters a modest reduction in yield given improving delinquency trends and the impact of the Toys"R"Us bankruptcy.
We continue to expect NCOs to be in the 5.5% to 5.8% range for the full year of 2018 including the impact of the PayPal portfolio. We expect credit normalization to continue to moderate. It is also important to remember that seasonality typically results in a lower net charge-off rate in the third quarter.
Regarding loan loss reserve builds going forward we thought it would be helpful to break out core reserve build and PayPal reserve build dynamics we expect next quarter. Regarding the reserve build on our existing or core portfolio, we expect the builds to continue to transition to be more growth driven as we move through the rest of 2018 and will be similar to this quarter in the $125 million to $150 million range in the third quarter.
The on-boarding of the PayPal credit portfolio will result in much higher reserve build in the second half of this year due to the accounting requirements around portfolio acquisitions. We expect the reserve build related to the PayPal portfolio to be in the $300 to $325 million range in the third quarter for a total reserve build of $425 million to $475 million next quarter.
Turning to expenses, we continue to generate positive operating leverage and continue to expect the efficiency ratio to be around 31% for the full year. We also continue to expect our return on assets will be around 2.5% for 2018.
In summary, the business continues to generate good growth with attractive long-term returns. Assuming economic conditions and the health of the consumer are consistent going forward, our expectation is that core reserve builds will continue to moderate through this year which combined with continued growth of the business and the impact from the continuing capital actions will help us continue to generate EPS growth in 2018.
Moving to slide 12, I will walk you through the strategic options for the Walmart portfolio and the potential impacts. Not renewing the program will result in two options regarding the future of the portfolio which we have portrayed on slide 12. In both cases we believe that we can replace the EPS impact of not renewing the program and we expect that both options will be accretive to EPS relative to renewing the program.
The two options are we sell the portfolio to the new issuer or we retain the portfolio and convert it to a Synchrony branded MasterCard beginning in the first quarter of 2019. The direction and timing will likely unfold over the next several months. This is a process that is contractually defined and we expect to have clarity on the direction we'll be headed with the portfolio by the end of the first quarter next year.
I will start with the scenario were the portfolio was sold to the new issuer. There is a valuation process that will take place and once evaluation process is complete Walmart or the new issuer will have the option to purchase the portfolio at the price determined by the valuation process. If the portfolio was purchased it would transfer to the new issuer in the third quarter of 2019. For us this will free up capital. The way to think about that is using a CET 1 level near 15% as a proxy post the addition of the PayPal portfolio.
Given the size of the Walmart portfolio of approximately $10 billion this would be around $1.5 billion of capital freed up. There is also the potential gain on the portfolio as well as releasing the reserve held against the portfolio. While we don't know the specifics at this point, we estimate approximately $2.5 billion could potentially be available to buy back shares or utilize on higher returning alternatives.
We would expect to deploy this capital quickly starting as soon as the determination is made whether the portfolio is being sold or retained. We have also identified $300 million to $350 million of expected ongoing expense savings after the portfolio was sold. We believe there would be enough capital available to be deployed to our share buybacks and other alternatives and that combined with expense savings will be enough to offset the EPS impact of not renewing the program and be accretive to EPS had we renewed the program.
The sale of the portfolio will not impact the return profile of the company and would also improve certain operating metrics such as credit quality. As an example, the net charge-off ratio alone would improve by approximately 60 to 70 basis points.
Moving to the second scenario, once we have clarity on whether we retain the portfolio, we would begin converting the qualifying portion of the portfolio to a general-purpose card. This builds on the successful strategy we used for the formal Toys "R" Us portfolio after they filed bankruptcy. There are several benefits in doing this. First, we retain all the economics generated from the program as we no longer share the portfolio returned to an RSA.
Second we gain a significant level of diversification in our overall portfolio as we will have a higher mix of general-purpose cards without a contractually defined term tied to a program renewal and we gain flexibility through the potential of increasing our offerings to existing and prospective cardholders in conjunction with strategies such as building out a full-scale deposit platform.
And we also have the potential to significantly improve the credit quality of the portfolio at acceptable risk-adjusted returns over time that would enhance the overall return profile of the portfolio. Under this scenario we would begin the conversion of qualifying accounts as early as the first quarter of 2019. For accounts that are not initially converted to a general-purpose card, those cardholders can continue to use their cards at Walmart over the next three years and we will receive royalties from Walmart for card usage over this period.
Regarding the brand marketing of the general-purpose card as well as loyalty costs associated with our offering a very attractive value prop on the card, these costs will be more than funded by the economics we now retain that previously were being shared with Walmart as well as the interchange fees we earn on card usage.
We will also have an opportunity to optimize the cost structure supporting the portfolio. Overall we believe either scenario, whether we sell the portfolio or retain it will replace the earnings per share being generated by the program and will be accretive relative to what we could have earned from the program if we had renewed it.
And with that, I'll turn it back over to Margaret.
Thanks Brian. I'll provide a quick wrap up and then we'll open the call for Q&A. We continue to generate solid results as well as driving growth organically, expanding important programs such as PayPal by launching and renewing key programs and making strategic investments to improve our position in this ever evolving marketplace.
We are also seeing other important elements of our business, such as credit quality continue to perform as we had expected. All of this contributes to our ability to return capital to shareholders and we were pleased to announce the significant increases in our dividend and share repurchase program in May. We also focused on deploying capital through organic growth and program acquisitions such as the PayPal program as well as the capability enhancing investments such as e-commerce.
And while we are disappointed that we are not renewing our program with Walmart, we are focused on either optimizing the capital freed up if the portfolio was sold or leveraging the benefits from retaining the portfolio. Both provide us the ability to replace and potentially improve EPS and other operating metrics that would have otherwise resulted from renewing the program. We remain focused on risk adjusted returns pursuing strategies that help us to profitably grow the business and deliver value for our partners, cardholders, and shareholders.
I'll now turn the call back to Greg to open up the Q&A.
Thanks Margaret. That concludes our comments on the quarter. We will now begin the Q&A session. So that we can accommodate as many of you as possible, I'd like to ask participants to please limit yourself to one primary and one follow up question. If you have additional questions the Investor Relations team will be available after the call. Operator, please start the Q&A session.
Thank you. [Operator Instructions] And we have our first question from John Hecht with Jefferies.
Good morning guys and thanks very much for all the details around Walmart and PayPal and thanks for taking my questions. The first on Walmart, you guys specifically carved out the change in the loss patterns and expense savings, just wondering is there any - would there be any change to the RSA metric in the absence of Walmart?
So, why don't I walk you through just a little more detail in terms of what to expect on the key metrics, so obviously in terms of the profitability of the business it doesn't really change the return profile of the company as we noted. The biggest impact you see if the portfolio is sold is that improvement in net charge-offs, so you'd see that 60 to 70 basis point improvement there.
And then you'd see partial offsets on yield. It would come down just slightly. And then RSAs would move a little higher excluding the Walmart portfolio. And then all in you get back to a similar return for the overall business. So again, I think the biggest change you are going to see is the improvement in the credit metrics and it will be neutral to the return.
Okay, thanks Brian. And then I know you guys haven't given any guidance pertaining to 2019, but you will be I think lapping a lot of the tightening next year, but we're also going to have the PayPal portfolio in there. Brian, what's your perception of kind of normalized growth in the portfolio once tightening has been fully imbedded in the system? And then have you guys - can you guys give an update on the way you see the PayPal portfolio growth rate separately?
Yes, sure John. Obviously we don't give 2019 growth guidance but in terms of the impact the credit actions are taking we've been pretty clear that we'll start to lap those starting probably first or second quarter of 2019 and we would expect to move back more historical norm in terms of the core growth rate for the business, so no change to that view.
PayPal is obviously growing at a much faster rate. We see a lot of incremental growth opportunity of PayPal even above and beyond, what we've been - what the program has been growing historically, so ton of opportunity there. So we feel pretty good. As you think about a combination of a strong core growth rate once we start to lap these credit actions combined with bringing on a really high growth program like PayPal, we feel pretty good about 2019, but other than that we're not going to be real specific at this point. We'll give you some more color in January when we do our outlook.
Great, thanks very much for the color.
Sure
And thank you. Our next question is from Moshe Orenbuch with Credit Suisse.
Great, I was sort of hoping you could expand a little bit on the comment that you made about the kind of results had you retained the program being kind of forgetting the exact words that you used, but maybe just expand on what that would have meant in terms of the ability to earn to generate the returns on your capital and maybe relate that to the discussions that have been out there about some of Walmart’s desire for expansion of Walmart Pay and does that result in some shift in the way your business you know kind of continues as we go forward?
Yes, sure Moshe. Why don’t I start on the more financial question and then Margaret can talk on the latter one. Look, this program was somewhat unique in terms of the profile. That became a challenge for us from an economic standpoint. And in this case we just weren't able to earn a return that was in line with the credit risk of the portfolio. Under the old agreement we were earning an acceptable return for that risk. In the renewal discussions it became clear that we weren't going to be able to maintain that acceptable return level for the risk that we were taking.
So look as we went through the process it became clear that either option that we've portrayed on that slide was accretive to what a renewal would have earned for us. And that combined with the risk sharing in the program, the credit risk profile of the portfolio, this became very challenging for us. And I'll just, Margaret.
Yes, so I wouldn't say you know Moshe we’re already in Walmart Pay and I think it’s important to note and this is critical as we have another whole year with the program, so we're going to have to continue to support Walmart in every way we can and will continue to leverage Walmart Pay since our cards are in it. So we did, no go ahead.
It's just a follow up, I mean PayPal also is available as a payment method on – at Walmart.com right?
That's correct, so if the customer has one of our cards or the program with us it will be used wherever PayPal is accepting. So I don't believe and I think you're kind of leading to this thought of capabilities and our capabilities maybe versus Capital One. But we strongly believe that our capabilities are best in class and our continued investments in digital and data are really paying off for us and we're seeing this more and more with our partners as they're placing a much higher value on our capabilities particularly us this transformation is having to you know going to digital.
So from our perspective, we felt like we could have delivered what Walmart wanted in terms of the digital transformation. As a matter of fact we put together a pretty incredible program that we thought we could continue to drive with them, but obviously as Brian said we couldn't get there on the economics.
Got it. Okay, thanks I'll get back in the queue.
Thank you, Moshe.
Thank you. Our next question comes from Sanjay Sakhrani with KBW.
Thanks, good morning. Just to follow up on those questions, obviously you have a large secondary relationship with another entity owned by Walmart. I guess could you just talk about your appetite therefore to bid for that deal given your experience with this RFP and is there a reason to believe that that process will be handled any differently than this one was?
Well, I'll start off by saying there are two separate contracts with two separate program agreements. The programs are different in terms of how they go to market just in terms of the Sam customer and being a little more business related then consumer related. Look we've had a long relationship with Sam's Club as well. That was also a startup. We've actually been with Sam's for 24 years. Look, I think our job right now is to continue to do the utmost servicing, delivering capabilities for Sam's and Walmart. I think at this point of us having that relationship for another year is really critical.
One of the things we have to do as a company is really make sure we're delivering to the best of our ability for both Walmart and Sam's and then you know we're committed to doing that. And I think it's really important that we treat these customers really well. We're going to continue to be in Walmart stores. We're going to continue to be in Sam's Clubs and it's important for my team, our teams to deliver the best possible service we can do and continue to innovate with Sam's.
So we're not going step back from that. So we would hope to renew Sam's and we're going to be in that process, we'll be aggressive and you know again I think the important point here is we don't have a bad relationship with Walmart. Our team has worked really well together with Walmart and Sam’s. So we're going to leverage that and continue to leverage that and we're going to really take the high road here and make sure we do the best we possibly can for the programs.
And I also just want to follow up on your answer to the last question for Moshe, just in terms of, I guess are you saying that the other issuers were just able to do the deal at lower economics than you were willing to go to and wasn't anything else? And then just maybe separately just in terms of offsetting the costs on this specific deal, how long can that continue to happen if other deals were to go the way Walmart did?
So I would say look, we can't really comment on like the final negotiations between Walmart and Cap One. What we can tell you is that in our heart of hearts, we believe we have the same if not better capabilities. We could have delivered on all fronts that Walmart wanted us to deliver on. We just could not get there in terms of what our economic expectation was for the program.
And I'd say that when you look at our other partners and our other renewals coming out we're very confident that this was a unique situation. We believe that our partners are valuing what we're delivering for them every single day. We continue to have partners come here in our innovation stations and in our offices in Chicago looking at all the capabilities we're delivering and we have confidence that we will be able to renew those relationships that are in the pipeline.
Thanks.
And thank you. Our next question is from Ryan Nash with Goldman Sachs.
Hey, good morning guys.
Good morning.
Good morning, Ryan.
Maybe as a follow up on Sanjay’s question, Margaret, I was just wondering can you talk about any efforts to accelerate with the renewal schedule of your next three or four biggest partners who are set to mature the next few years? I know in the past you've said you're always working towards renewal, but I was wondering if there's a specific effort to accelerate the renewal similar to what we saw another company do in the cobranded space after big partner lost that?
I would say Ryan, we're always looking to renew and I wouldn't necessarily say we're accelerating, but I would tell you we're having very good conversations with our partners in terms of what they're looking for from a value proposition perspective, how they're looking to transform their digital footprint and what we can do for them. So I feel very positive that we'll continue to have a good track record and show as we've done historically that we can renew our deals.
Got it and then just two small follow ups, first does Walmart loss it all change the strategic direction of the company and in particular make you think about a more diversified strategy such as being less reliant on individual partners and maybe it causes your return thresholds to differ as a more diversified company?
And then second, just for the capital you're deploying the $2.5 billion in share repurchase or other higher returning options, if you maybe expand on what some of those other options would be and would that include M&A? Thanks for taking my questions.
Sure, I will answer the first part and give the second part to Brian. So we are looking to diversify the business and we've actually been doing that. I think in particular, if you look at our PayPal and CareCredit business which are really both fast growing entities, we have lots of opportunity to diversify and continue to build out those platforms. And as a matter of fact as we do our 2019 planning we're really looking at ways to accelerate our opportunities in both of those platforms. We see tremendous opportunity with CareCredit and we're going to really leverage that platform to help us diversify the company.
And then I would just add to that, obviously we're going to do that in a way where we're very disciplined around our return profile. So as we think about diversification, payment solutions, CareCredit, are great ways to diversify out of large program concentrations that we have today at very attractive returns. General purpose card is another way to diversify.
Obviously we started to build out that strategy a little bit with what we did on Toys"R"Us. Depending on how Walmart goes, we would continue potentially down that path, and I think that's a nice way to diversify the portfolio at the same time doing it at very attractive returns. And then sorry Ryan, do you have one more?
Yes I have just a follow up on you talked about $2.5 billion in share repurchase or other high returning options, I was just hoping maybe could you expand on what those options were and would it include M&A?
Yes, so primarily that's bigger investments in some of our really fast growing programs, Amazon, T.J.Maxx, obviously PayPal, as well as investments in CareCredit payment solutions. But lastly I think we will take a harder look at M&A opportunities. We have a very active process around that. We've always had a very active process around that. We're very disciplined in that sense though around price and valuation. So I think you will see us take a harder look at that, but we're going to maintain our discipline and look for attractive entry points and good returns for shareholders.
Thanks for the color.
Thanks.
And our next question comes from Don Fandetti with Wells Fargo.
Brian, a couple of questions around credit, on PayPal, can you talk a little bit about what percentage of that reserve bill is done in Q3 and sort of how the remainder will play out? I know you've talked about it in the past, but could you clarify that?
And then also how much of a mark was on the PayPal portfolio? And then sort of a follow up to credit, it looks like the 30+ delinquencies in the core portfolio as why clearly trending while they're down year-over-year, but I think the later stage delinquencies didn't see that kind of improvement just want to get your thoughts on that?
Yes, sure Don. Let me start with your last question because I think that kind of leads into some of what we're expecting to see on the reserves in the second half. So look, second quarter in terms of overall credit came in inline or slightly better than our expectations, so we didn't change our outlook for the full year. But I can tell you we're very encouraged by the delinquency trends that we're seeing across the portfolio.
If you just look at the year-over year trends over the last four quarters, we are running anywhere between 27 basis points up to 54 basis points up and we saw our 30+ delinquencies come down year-over-year and now down 8 basis points. So we feel really good about what we're seeing on the portfolio. You obviously saw that flow through and a reserve build that was $121 million compared to our expectation of around $175 million.
So things are trending in the right direction, vintages look good, we're seeing a good mix in terms of the sales. We're still seeing really good growth on sales on accounts above 720 FICO. So things trending in line and we feel if anything second quarter came in a little bit better than our expectation.
In terms of the 90+ question they you had, we've always for the last year have been pretty clear that you're obviously going to see a first in 30+ then you're going to see at 90+ and then you'll see it in net charge offs. So this quarter you clearly saw it come through in 30+. We would expect 90+ next quarter, the quarter after and then obviously net charge offs are going to start to level off as well in the second half which is very much in line with what we said a year ago when we started just some of those modest tightening, so that's credit generally.
So let me switch to the reserves and in terms of PayPal, so you have to remember on PayPal that you know the portfolio comes on without any reserves. It comes on at fair value, so we have to build that reserve basically from zero, the bulk of which occurs over the first nine to 12 months.
And we will take more of that in the third quarter, it will come down a bit, in the fourth, will give you a sense for what we think that looks like next quarter. And then continue to build that reserve into the first half of 2019, but at smaller amounts. Obviously then you're going to see in the third quarter. So it's a little bit of a sliding scale, you take more of it upfront. The majority of that reserve is built within the first year.
And was there I guess, was there was a pretty modest mark on the portfolio for sort of [indiscernible].
Oh yes, sorry that was the last question, yes it was a pretty modest mark. If you go back to the guidance that we put out in January, you can see with and without PayPal our net charge off rate was unchanged at 55 to 58. So while there is a slight mark on PayPal it doesn't move us off of our full year NCO guidance.
Thanks.
Thank you.
Thank you. Our next question is from Mark DeVries with Barclays.
Yes, thanks. So we've been hearing some skepticism from investors about the $300 million to $350 million of expense sales you've identified in your strategic options, could you just kind of walk us through where you see those expenses sales coming from?
Yes, sure. The easiest way to think about this is those are the expenses that are really associated with the program. So you've got a combination of directly attributable costs related to the program and the portfolio and then you've got a portion of fixed costs that will come out as we right size the business for the portfolio leaving.
So it's actually, it's fairly straightforward. I mean when we look at the business and we actually have, but we haven't had a lot of time to work on this. We have a fairly detailed plan. By function and we know where the costs come out when we look at right sizing the business for the portfolio moving.
Okay, got it. And then I was hoping you could clarify what's meant by both options being accretive to EPS relative to renewal terms. I'm assuming that means relative to the dilution you would have suffered under the economics that you would have had to accept to renew, but can you comment on whether this is also accretive to what you know consensus numbers might be for 2019 or 2020?
Well, obviously I can't comment on the consensus, but what I can tell you is we know kind of where we stopped in the negotiating process and when we look at these two alternatives relative to that, these two options are EPS accretive. Does that make sense?
Yes, okay but am I correct in my reading that it's - you're just saying it's accretive to what EPS would have been pro forma under the terms that you would have had to accept to renew?
We believe it would have taken to renew, I think importantly though if you put that point aside, either of these options replace the EPS of the program. So EPS neutral to what the program was earning and accretive to what we believe a renewal would have cost us.
Understood. Okay, thank you.
Yep.
Thank you. Our next question comes from David Scharf with JMP Securities.
Good morning. Thanks for taking mine as well. A question focusing on maybe helping us better understand the stickiness of these programs in light of the renewal process and specifically. My understanding is that one of your public competitors has noted in the past that for non-cobrand for pure store card programs, they own all the data, the skew level transaction data, not the retailer. And I guess it's a three-part question. One is for your pure store card programs, do you own all of that data? Secondly, is there any data you retain that's yours not to retailers in dual card programs? And then thirdly maybe just remind us about the mix between the two for balances?
So the retailer owns the data on the card programs. We do not own that data. I would say on dual card it’s little different because there is in-store and out of store, so we do get the out of store data. And your third question was?
Oh I’m sorry, just I guess an update maybe pro forma Walmart terminating maybe with a mix of balances between a pure store card program versus dual card?
I'll let Brian, answer that.
So one other important point just on the data, so while the data is owned by the retailer or the program, we own all of the data analytics. We owned all the data models. We own all of the, what we consider data capabilities on the program. So the data moves but all of the analytics horse power and the capabilities obviously remain with us.
And then just in terms…
Does that make sense?
Yes, no, no, no, that's very helpful. Yes.
Yes, the mix specifically, I don’t know if you’re asking specifically on Walmart, but Walmart is split roughly 50-50 dual card private label and then if you look at the split of spend on dual card it's about 60% of the spend is actually outside Walmart.
Yes and actually if possible I was more curious on the mix pro forma Walmart leaving kind of the rest of the portfolio.
It wouldn’t change the mix of the company dramatically. it wouldn’t significantly change that mix at all.
Okay, thanks very much.
Yep
And thank you. Our next question comes from Rick Shane with J.P. Morgan.
Hey guys thanks for taking my question this morning. Hey Brian, when you walked through the Walmart numbers what you show was that proportionately NCOs are high, proportionally yields are high, proportionally RSAs are low. I'm curious proportionately about purchase volume and portfolio growth, so we can think about how to take that out going forward?
Yes, I would think about absent Walmart that we're still back to our more historical growth rate. I don't think it changes our view on what we can do from a core growth standpoint. So I don't think it changes that mix either in terms of purchase volume, active accounts or receivables growth rate for the company.
And there's nothing unique related to Walmart in the relationship between purchase volume and loan growth?
A - Brian Doubles
There's not. I mean you can infer some things from what we've indicated on what it does to our loss or a little bit more of a revolving nature in that portfolio, but other than that it wouldn't be dramatic. And you have to remember I think importantly if the Walmart portfolio comes out in that scenario we just brought on PayPal which is a very high growth portfolio. So you have to think about those too kind of in conjunction. They are similarly sized programs. One is certainly you know what the growth rate is on PayPal because it's been disclosed over the last couple of years, very high growth, lots of opportunity going forward, so you've got to factor that in as well.
Okay, got it. Thank you very much.
And our next question comes from Ken Bruce with Bank of America.
Thank you, good morning. Of the two options that you pointed out for the Walmart portfolio, do you have a preference for one outcome or the other? I understand you're not necessarily in control of it, but do you have a preference for which one you may be handed and/or are you agnostic to that and why?
Yes, look and we feel pretty good about our ability to execute both options and in either situation we believe we can replace the EPS impact. The options are accretive to a renewal scenario and at this point either option looks attractive to us. We'll obviously know more as we work through the process to determine whether the portfolio is going to move or whether we will retain it. We will also get the more visibility around the potential gain if it's sold. So all of those things will kind of factor in here, but what I can say is that we feel pretty good about our ability to execute either option.
Okay, well I guess the reason I ask is one obviously you export those customers and the other you retain some part of it to such a degree that you're trying to diversify your business away from that partnership concentration you've got a nice leg into a general purpose card in that case and so I hear that you're interested in building that, the second option may seem like a better alternative, just so I’m just kind of asking if you have a preference one way or the other?
That's exactly right. I think that the first option is more straightforward frankly. And the second option has a nice diversification angle to it that we like. And in both cases again we think we can execute either option, we can do it in a way to generates positive EPS result.
Okay and then that in terms of the discussion around capabilities, I think I understand a lot of that kind of tends to be focused on the technology side of it at least that's how the some of the commentary pre the deal announced last night was being kind of talked about. One of the other aspects of it is credit capabilities in terms of Synchrony is willing this to go deep into a credit file in order to essentially kind of remain in some of these partnerships programs. Do you have any kind of comments there or thoughts around how, what your willingness is in order to expand that credit box to be able to remain competitive in these situations?
You know, I think Brian said this before, I've said it before, for us it's really around the overall return of the program and we look at each of these contracts and programs and partnerships on that whole risk reward base. And I think in this case it was unique and we could not get to the overall return of the portfolio for Walmart that would mean what we thought was a return that we were willing to take. So I don't think it's really about the credit box, it's really about the overall return on a program and our ability to deliver for the partner.
Yes, I mean as we said in the past like we have general underwriting guidelines that we apply across the entire business, but we also customize our underwriting by program by platform. So it's never been a one size fits all approach. We manage our programs to different loss rates based on the overall return as Margret said, that we're trying to achieve and we can do that in our programs using the customized underwriting. But at some point if you're not getting the return for the credit risk, you're taking then you know that becomes unattractive.
Right, so you didn't tighten the box around the Walmart program and that might have kind of lead to that decision?
No, I would not assume that. I mean the credit actions that we took over the past year and a half were fairly modest frankly and while they're having the desired result they were applied across pretty much the entire business.
Okay, thank you.
And thank you. Our next question is from Eric Wasserstrom with UBS.
Thanks very much. Brian, my question is has to do with your debt spreads, it looks like they've moved out about 40 or 50 basis points since July when I guess the Walmart things start to be discussed in a public market, can you just talk about the funding environment for you right now and if that spread widening creates any concerns or changes your outlook for funding cost over the near to medium term?
Yes, it really doesn't create much of a concern for us. I think they are wider by maybe 35 basis points. We're very focused though as you know on deposit growth. That's our most attractive funding source. We're still seeing really good growth on deposits. We got very a strong franchise there that we continue to build out. So I think like any pressure that we see in the fixed income spreads in the unsecured or secured markets, we think we can offset and with higher deposit growth. So overall we don't think that's a big impact to how to think about net interest margins going forward.
Okay, thanks very much.
And thank you. Our next question comes from Matthew O'Neill with Autonomous Research.
Yes, hi thanks for taking my question. Brian, I think in the last two calls you’ve given some additional commentary around spend growth sort of parsed by kind of high cycle bucket and low cycle bucket, I don't know if you'd be willing to give us an update on that?
Yes, sure. So very consistent this quarter with prior quarters, if you look at purchase volume by FICO stratification we continue to see really good growth in that 721 plus FICO range. So sales on those accounts was up 8% this quarter versus the prior year and then purchase volume on accounts below 650 FICO declined 13%, so very similar to prior periods. And again that's a - we still expect that to be a relatively short term phenomenon. I think we'll start to lap that in the first half of 2019 and you'll see that influence our overall growth rate for the company in a positive way.
Got it and thanks. As a follow up I was hoping you could maybe just talk a little bit more about the strategic direction around potentially getting further into general purpose card issuance, it makes sense around the Toys"R"Us portfolio and obviously if you were to retain the Synchrony portfolio and sorry the Walmart portfolio and start turning that into general purpose card you'd be more weighted in that direction versus some probably earlier comments about it being a bit of a competitive advantage with certain retailers that you guys aren’t also kind of focused on your own general purpose card and the retailers partner card, just wondering what you think about that sort of dynamic going forward?
Yes, sure. So look I think we're always interested in pursuing diversification opportunities if we can do it at attractive returns. And as we look at adjacencies to what we do today, this is a pretty close adjacency. So we think there's you know minimal execution risk. As you said, it's pretty competitive out there, particularly in the higher end, so I don't think that's where we would play, but we think we can carve out a very profitable niche for ourselves here.
We're pretty confident given what the early returns on Toys"R"Us and some of the trends that we're seeing there that we can develop an attractive value proposition that works for a segment of the population. So we're seeing better activation on that portfolio than we thought we would. We're seeing good usage and so we think that this is a strategy for us longer term.
We're going to be cautious and careful around it. We're going to continue to test on the accounts that we have today. And then as you think about you know that second option for Walmart, we do think that in that scenario we can convert a fairly significant number of those customers to a general purpose card.
As I said earlier, about 50% of the Walmart portfolio today is a dual card, so they're kind of acting like a general purpose card already. And if you look at the spend on those cards it's about 60% outside of Walmart. So that gives us some comfort that there is a population there that we can convert and would be very receptive to a Synchrony branded card with a very attractive value proposition.
And average of bad debt we have plenty of experience of people from the industry in our team and on our teams, so we're confident that we have the capability to really execute on that.
Understood, thanks for the time.
Hey Vanessa, we have time for one more question.
Thank you, Sir. Our last question is from Bill Carcache with Nomura.
Thank you, good morning. Does the focus on returning the $2.5 billion freed up by Walmart under the sale option in any way delay your ability to return the other call it roughly $2 billion of excess capital that you have or would you make every effort to get that out by 2019 as well? And in response to the earlier question about whether some of that, a portion of the $2.5 billion could be used for other alternatives, could you just confirm that spending on any other alternatives would not delay the replacement of the lost EPS?
That's right. So were viewing the $2.5 billion as incremental to what we would have otherwise gone and asked for as part of a capital plan. So while we may include a portion of it in a capital plan in order to get formal approval from the board and our regulators, we are viewing that as incremental. We do expect to execute it in 2019. We think it will be done in the second half of 2019. We've had preliminary discussions with our board and our regulators on it. Obviously there will be a formal approval process that we have to go back around, but at this point we do feel pretty good about our ability to execute it.
Okay and then as a follow up, is there anything unique to the Walmart portfolio that allows you guys to fully offset its loss via buyback and to what extent would you be able to summarily offset the loss of other portfolios if they were to happen?
Without getting too specific, I think in all of these cases whether it's Toys"R"Us, whether it's Walmart we have options at our disposal to offset the EPS impact or at least mitigate a substantial portion of it through the strategies or similar strategies that we've outlined here for Walmart. So look, I think what's important is we have options available. We can execute those options. We feel comfortable with them and they give us a nice EPS offset.
So contractually like it is just reasonable to conclude that your agreements broadly speaking put you in a position to be able to mitigate the loss of any portfolio should they happen is the general rule?
Most of our contracts would play out similar to this one in that either the portfolio moves to a new issuer or we retain it and we would run a similar strategy to what we're proposing here and convert the cards to a Synchrony branded product or I should say you know potentially another program in the company. So it does depend a little bit on the contract, but the financial outcome would be very similar.
Got it, thank you very much for taking my questions.
Thanks Bill.
Okay, thanks everyone for joining us on the call this morning and your interest in Synchrony Financial. The investor relations team will be available to answer any further questions you may have.
And thank you. Ladies and gentlemen, this concludes today's conference. We thank you for participating. You may now disconnect.