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Synchrony Financial
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Good morning and welcome to the Synchrony Financial Second Quarter 2019 Earnings Conference Call. My name is Brandon and I'll be your operator for today. 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 in presentation are available on our Web site synchronyfinancial.com. This information can be accessed by going to the Investor Relations section of the Web site.
Before we get started, I want 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 Web site.
During the call, we will refer to non-GAAP financial measures and 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 webcast are located on our Web site.
Now it's my pleasure to turn the call over to Margaret.
Thanks Greg. Good morning everyone and thanks for joining us today.
Before I get into the second quarter results, I'd like to outline some of the important changes we recently made at the executive level of the company. Brian Wenzel has been promoted to President. In this role, he is focused on accelerating key growth initiatives across the company deepening the integration of the key functions for which he is responsible. These include business strategy, venture investments and M&A, enterprise data analytics, marketing including digital platforms, customer experience and the expansion of the company's direct-to-consumer banking and product strategy.
Brian Wenzel succeeds Brian Doubles as CFO. Brian has successfully served as Deputy Chief Financial Officer for the past year and as Chief Financial Officer for our retail card platform for more than 12 years. His experience imparts a broad perspective of our operations and a deep understanding of our people and partners. He will continue to focus on execution of our long-term financial and growth objectives.
These changes underscore a dedication to our strategic priorities and drive to continue to grow and transform the business. I am proud of what these leaders have achieved thus far and I am confident that we have the right people in the right roles to lead us into the future. You will have an opportunity to hear from them today as Brian Doubles will cover our digital innovation and data analytics initiatives that are helping to drive growth. And Brian Wenzel will detail our financial results.
I'll begin by providing an overview of our second quarter accomplishments on Slide 3. Our progress continued in the second quarter as our focus on driving growth both organically and through new partner programs across each of our sales platforms helped deliver strong results. Earnings of 853 million or a $1.24 per share included a reduction in the reserve related to the expected sale of the Wal-Mart portfolio which positively impact the results by $0.27.
Loan receivables grew 4%, on a core basis excluding the Wal-Mart portfolio, loan receivables grew a strong 17%. Net interest income and purchase volume both grew double digits and average active accounts were up 9%.
Our efficiency ratio of 31.3% is in line with our expectations. This has been achieved as we on-boarded to Paypal program. And I'm pleased to report that our conversion was successfully completed during the quarter. We look forward to continuing to partner with Paypal to develop innovative solutions to grow the program successfully.
We have also continued to make investments in our Direct Deposit Program. During the quarter, we grew deposits 6.6 billion or 11% over last year and much of this growth has come through direct deposits. We also recently renewed and extended key relationships and launched a new program. In our payment solutions sales platform, we recently extended relationships with CCA Global Partners and Penske Automotive. We also added new programs with Samsung HDAC and Zero Motorcycles.
During the quarter, we also launched our new program with Fanatics, the global leader in license sports merchandise. Together we are leveraging our deep expertise in data analytics to deliver personalized shopping experiences and enhance loyalty for fans.
As you know a key strategic priority is to grow our network to great broader acceptance and utility of our cards. We have been particularly successful in doing that with our care credit network. This quarter we expanded our care credit network to include Lehigh Valley's physicians Group and the Baylor Scott White Medical Center in Sunnyvale Texas.
We also renewed our relationship with Bosley and launched our partnership with Lighthouse. We remained highly focused on the risk adjusted returns of our programs, operating with a strong balance sheet and returning capital to shareholders. During the quarter, we began executing our new capital plan which includes share repurchases of up to $4 billion in a planned increase in the quarterly dividend to $0.22 per share beginning in the third quarter. Overall, this is a strong quarter for us as we continue to make progress against our strategic initiatives growing both organically and via new programs.
Our investments in innovative digital technology, data analytics and seamless customer experiences are fundamental to our success. And Brian will outline some of those achievements shortly.
Before I turn it over to him, I'll spend a few minutes on our sales platform results on Slide 4. In retail card, strong results were driven by our PayPal credit program acquisition, which was largely offset by the reclassification of the Wal-Mart portfolio. Loans were up 2%, but excluding the Wal-Mart portfolio, they were up 23%. Interest and fees on loans increased 16% over last year and purchase volume grew 14%. Average active accounts were up 11%. We are happy to have completed the conversion of the PayPal portfolio.
This is a key relationship in the rapidly growing digital payment space and has expanded our capabilities within the merchant environment and through this partnership, we are providing an enhanced customer experience for thousands of merchants and consumers. We are very excited about the continued opportunities with this valued partner. We have worked hard to renew our relationships in the retail card space and have had great success in doing so. Currently 97% are retail card ongoing partner interest and fees on loans are under contract until 2022 and beyond.
Payment solutions also delivered another solid quarter. We generated broad based growth across the sales platform with particular strength in home furnishings and power that resulted in loan receivable growth of 8%. Interest and fees on loans increased 6% primarily driven by the loan receivables growth. Purchase volume was up 4% and average active accounts increased 3%. Our initiative to develop and extend the utility of our payment solutions network cards has yielded solid results.
We now have nearly 7 million cardholders in our Synchrony card care network with over 730,000 auto related locations nationwide where the card can be used. And we currently have approximately 5 million of Synchrony home cardholders that can use their cards at over 1 million locations. These networks along with other initiatives such as driving higher card reuse that now stands at approximately 30% of purchase volume excluding oil and gas have helped to drive growth and create significant opportunity for the future.
Card credit continues to generate solid growth, receivables growth of 7% was led by dental and veterinary specialties. Interest and fees on loans also increased 7% primarily driven by the loan receivables growth. Purchase volume was up 7% an average active accounts increased 5%.
With new partners on this quarter, we now have over 230,000 locations in the acceptance network and over 6 million active cardholders. We have significantly increased the network and utility of this card helping to drive the reuse rate to 54% of purchase volume in the second quarter.
We delivered solid growth across our sales platforms as we continue to extend relationships, increased card utility, expand networks and provide value added solutions to our partners and cardholders.
With that, I'll turn the call over to Brian Doubles.
Thanks Margaret. Good morning everyone. I'll begin my comments today on Slide 5.
We have made significant investments to develop leading digital technologies, which have been essential to delivering a seamless customer experience and helped us to drive both organic growth and acquire new programs. The rise of e-commerce and digital shopping experiences has required innovation to ensure that programs work seamlessly across whatever channel a customer uses. That means that cardholders must have access to their cards, rewards and account information across all channels seamlessly. Innovations such as digital apply, digital servicing and Synchrony plug-in or SyPi and help to meet the ever evolving requirements of our partners and their customers.
Digital apply is a powerful tool for credit applications that we can configure to each partner. It is an adaptive and responsive user experience that integrates dynamic and intelligent presale to minimize the number of fields an applicant needs to enter and can pre-qualify known customers. It can also incorporate first purchase offers, coupons and incentives.
Our digital servicing platform provides quick and easy access to key account servicing functionality that is optimized for the mobile experience. We have also developed virtual assistant servicing capabilities and Amazon Alexa and Google Home. Cardholders can do things like check their balance or make a card payment. Synchrony plug-in or SyPi is another powerful innovation that can quickly and seamlessly be integrated into a partner's mobile approximately.
Through this platform, customers can apply for credit, service their account and check for and redeem earned rewards. These innovations are having meaningful impacts on our ability to grow our online mobile channels. The digital sales penetration for our retail card consumers has been growing. Digital sales penetration was 34% in the second quarter. Overall nearly 50% of our applications are happening online with the mobile channel alone growing 47% over the same quarter of last year.
Furthermore, we now have over 2 billion of payments being made to SyPi and 200% average annual growth in visits since we launched the platform in July of 2016. While these are significant achievements, we are continuing to make important investments to stay ahead of this evolving landscape. We're focused on meeting customers where they are with the features they need and conveniences they may not yet have contemplated.
Turning to Slide 6, as you know data and the ability to analyze and make it actionable has increasingly become an integral part of the success of our programs. We have developed an integrated data ecosystem that leverages a broad set of data assets from Synchrony, our retail partners and other external sources to transform customer experiences through personalized marketing, enhanced credit underwriting, optimized customer servicing and informed fraud strategies.
We are developing transformative, innovative data and analytic capabilities driven by customer behavior data, which will enable us and our partners to engage with customers more deeply than ever before. It empowers us to provide the right experience to the right channel at the right time. The value of data analytics has demonstrated on Slide 6 of today's presentation where examples are provided to illustrate how data analytics is having a direct impact on program results.
Through use of shared data and analytics we have been able to improve credit line assignments for certain partners best customers by 20% to 30%. This results in a better customer experience and drives more sales for our partners and at the same time provides improved economics for the program.
Also enhanced customer segmentation powered by data and advanced analytics techniques has proven to lead to a reduction of observed fraud rates, customer behavior scores are good predictors of fraud. Customers that have low engagement with our partners have the highest propensity for fraud as much as 70 to 90 higher.
Customer segmentation based on customer engagement with our partners also allows us to build more effective targeting and offer strategies for marketing campaigns. Increasing our campaign returns, while enhancing the customer experiences. These strategies help us drive increases in customer spending and higher account balances. Given the powerful results of data analytics, we will keep investing and it's an important component of our business focusing on new methods to leverage and activate integrated data assets to help drive program performance and enhance the user experience.
With that, I'll turn the call over to Brian Wenzel.
Thanks Brian. I'll start in Slide 7 of the presentation. This morning we reported second quarter earnings of $853 million or $1.24 per diluted share. This included a reduction in the reserve related to expected sale of the Wal-Mart portfolio. The reduction totaled $247 million or $186 million after tax and provide an EPS benefit of $0.27 for the quarter. We generated strong year-over-year growth in a number of areas as noted on Slide 8. Excluding the Wal-Mart portfolio, loan receivables were up 17% interest, and fees on loan receivables were up 14% over last year reflecting the addition of the PayPal credit program last year.
We also continue to deliver solid organic growth. Overall, we're pleased with the growth we generate across the business as well as the risk adjusted returns on this growth. Purchase volume was 12% an average active accounts increased 9% over last year. RSA has increased $206 million or 32% from last year. Growth including the PayPal credit program acquisition and improve program performance drove the increase. RSA's has a percentage of receivables was 0.9% for the quarter inline with our expectations. We continue to expect RSA's as a percentage of average receivables to be in a 4.0 to 4.2 range for 2019, which I will cover in more detail later.
The provision for loan losses decreased $82 million or million, mainly driven by the reduction, the reserve related to the Wal-Mart portfolio partially offset by a core reserve build of $114 million in the quarter. I will cover the asset quality metrics in more detail later in the presentation
Other expenses increased $84 million or 9% versus last year driven primarily by expenses related to the addition of PayPal Credit program. So, overall the company continued to generate strong results in the second quarter.
I will move to Slide 9, and cover our net interest income and margin trends. Net interest income was up 11% driven primarily by the addition of the PayPal credit program and loan receivables growth. The net interest margin was 15.75% compared to last year's margin of 15.33% which include the impact of the pre-funding for the PayPal credit program acquisition and was in line with our expectations.
We benefited from higher mix receivables as a percent of total earning assets compared to last year driven primarily by the PayPal Credit program acquisition and loan receivables growth.
Also impacting net interest margin was a decline in loan receivables yield and an increase in interest bearing liabilities cost. The loan receivables yield was 20.94% a decline of 9 basis points versus last year mainly due to the impact of the PayPal Credit program acquisition. The increase in total interest bearing liabilities cost was 49 basis points to 2.73% predominantly from higher benchmark rates.
We believe the net interest margin will continue to run in the 15.75% to 16% range for the year with normal seasonality and some potential fluctuation around the Wal-Mart portfolio sale later this year.
Next I'll cover our key credit trends on Slide 10, in terms of specific dynamics in the quarter also with our delinquency trends. The 30 plus delinquency rate was 4.43% compared to 4.17% last year and the 90-plus delinquency rate was 2.16% versus 1.98% last year. The increase in delinquency rates was primarily due to the reclassification of approximately $8 billion in Wal-Mart loan receivables to held for sale.
The Wal-Mart consumer loan receivables that we expect to charge off prior to the expected portfolio sale remain in period end loan receivables which was approximately $400 million in loan receivables at quarter end. Given that we continue to report that delinquencies on the $400 million in end period loan receivables and a high percentage of these receivables are delinquent and represent the majority delinquent accounts in the Wal-Mart portfolio in total, the exclusion of the $8 billion and held for sale from period loan receivables skewed the reported rates higher.
Also impacting delinquency rate to the addition of the PayPal Credit program acquired in the third quarter of 2018. If you exclude the impact of the PayPal credit program and the Wal-Mart portfolio, the 30-plus delinquency rate improved by approximately 10 basis points and then 90 plus delinquency rate improved by approximately 5 basis points compared to last year reflecting stabilizing credit trends.
Moving on to net charge offs. The net charge off rate was 6.10% compared to 5.97% last year and 6.06% last quarter and was somewhat lower than expectations due mainly to higher recovery levels. We had expected net charge offs to trend 20 to 30 basis points higher in the second quarter compared to the first quarter. The recovery rate as a percentage of average receivables was 1.2% for the quarter and we had expected that rate closer to 1%. We had reported in prior quarters looking back to 2018.
While credit trends continue to improve, this was partially offset by the impact from the addition of the PayPal Credit program. Excluding the impact of the PayPal credit program and the Wal-Mart portfolio, net charge off rate was down approximately 5 basis points compared to last year. The allowance for loan losses as a percent of receivables was 7.0% and a core reserve bill in the second quarter was $114 million excluding the impact from the reduction in reserves related to the Wal-Mart portfolio and in line with our expectations.
Looking forward, we expect the core reserve build for the third quarter will be in $175 million range. This is higher than the second quarter due to an expected acceleration in loan receivable growth and the normal seasonality we see in the third quarter. Consistent with the outlook we provided in January, we expect to see some degree of acceleration in core loan receivables growth in the second half of this year. After taking into account that starting in the third quarter, we'll be comparing the period last year that include the PayPal Credit program. The acceleration in growth reflects the opportunities we have in the fast growing digital space as well as the diminishing impact on growth from declining sides of the Wal-Mart portfolio that remains and held for investment.
Regarding future reductions in the loan loss reserve associated with the Wal-Mart portfolio. We now expect the sale of the Wal-Mart portfolio will be completed in October. The remaining loan loss reserves held against the portfolio was approximately $350 million at the end of the second quarter. We expect the reduction in the reserve will be around $250 million in the third quarter with the remaining reduction occurring in the fourth quarter when the portfolio was sold.
Regarding net charge offs. The third quarter net charge-off rate tends to be seasonally lower than the second quarter. The credit related purchase accounting impact from the PayPal Credit program acquisition in July of last year was also a significant driver and 100 basis point decline in net charge offs in the third quarter from the second quarter of last year. We expect the decline to be more modest this year and more in line with historical declines of 40 to 50 basis points from the second quarter. This is in line with our expectations and included in our 2019 net charge-off outlook. We continue expect net charge offs for 2019 will be in the 5.7% to 5.9% range with the slight increase entirely driven by the impact of the PayPal Credit portfolio partially offset by the sale of the Wal-Mart portfolio later this year. Excluding the effects of PayPal and Wal-Mart, net charge-off rate was expected to be similar to 2018.
Before I wrap up discussion on credit trends, I want to give you some visibility on our initial thoughts around the implementation of CSO beginning in 2020. We are finalizing our assumptions with alternatives that remain under evaluation and we are still analyzing a number of factors for potential inclusion or exclusion based on the predictive capabilities over time. We have commenced parallel testing on our core model and our models are undergoing validation testing. We also continue to work with and obtain feedback from regulators.
While these key factors remain open based on our current view our preliminary estimate from the initial impact would have been 50% to 60% increase in the total allowance for loan losses compared to what we have reported at the end of the second quarter. [Indiscernible] impact will depend upon the composition and asset quality of the portfolio, the economic conditions and forecasts upon adoption in addition to the factors I noted previously.
In summary credit trends have leveled off and are showing improvement in line with our expectations and we expect the trends to continue to show [stay low] [ph] as we move forward assuming stable economic conditions. We continue to see good opportunities for continued growth and attractive risk adjusted returns.
Moving to Slide 11, I'll cover expenses for the quarter. Overall expenses came in at $1.1 billion up 9% over last year and we're primarily driven by the acquisition of the PayPal Credit program. Year-to-date expenses are up 7%. We do expect the expense growth rate to slow in the second half of this year due to the following factors.
First, beginning with the third quarter, we'll begin comparing against quarters post the acquisition of the PayPal Credit portfolio. In addition to this, will be the favorable impact on expenses after the sale of the Wal-Mart portfolio later this year. The efficiency ratio was 31.3% for the quarter here last year level and in line with expectations.
Moving to Slide 12, over the last year we've grown our deposits $6.6 billion or 11% primarily through our direct deposit program. This puts deposits at 75% of our funding compared to 73% last year. In June, we issued $850 million in secured debt out of our Synchrony Card Issuance Trust. The issuance has a three year-term with a fixed rate of 2.34% that strong demand and were significantly oversubscribed.
Turning to capital and liquidity. We ended the quarter at 14.3% CET1 under the fully phased in Basel 3 rules. This compares to 16.3% on a fully phased in basis last year reflecting the impact of the capital deployment through the acquisition of the PayPal Credit program, organic growth and continued execution of our capital plans.
On May 9, we are pleased to announce our new capital plan through June 30, 2020. Our Board approved an increase in the quarterly common stock dividend to $0.22 per share commencing in the third quarter and share repurchase program of up to $4 billion, which includes the capital freed up from the expected sale of the Wal-Mart portfolio. We began to execute our new plan in May repurchasing shares totaling $725 million during the second quarter. This represented 21.1 million shares repurchased during the quarter.
Total liquidity including undrawn credit facilities was $23.7 billion which equate to 22.3% of our total assets. This is down from over 28% last year reflecting the deployment of some of our liquidity for the PayPal Credit program acquisition.
Overall, we continue to execute the strategy that we outlined previously. We're committed to maintaining a very strong balance sheet with diversified funding sources and strong capital and liquidity levels and we expect to continue to deploy capital through the growth and further execution of our capital plan in the form of dividends and share repurchases.
Before I conclude, I wanted to recap our current view for the third quarter and the year. Overall, the net interest margin performed in line with our expectations for the second quarter. We believe the net interest margin will continue to run at 15.75% to 16% range for the year with the normal seasonality as well as some potential fluctuation around the Wal-Mart portfolio sale later this year.
RSA as a percentage of average receivables were 3.9% for the quarter in line with our expectations. We continued to expect the RSA percent to be in the 4.0% to 4.2% range for 2019. Regarding credit we expect the core reserve bill for the third quarter to be largely driven by growth in a normal seasonality we see in the third quarter and we'll be in $175 million range.
We now expect to sale of the Wal-Mart portfolio to be completed in October. The remaining loan loss reserve held against the portfolio was approximately $350 million at the end of the second quarter. We expect a reduction in the reserve to be round $250 million in the third quarter with the remaining reduction occurring in the fourth quarter when the portfolio was sold. We still expect net charge offs for 2019 will be in the 5.7% to 5.9% range with the slight increase over 2018 entirely driven by the impact from the PayPal Credit portfolio partially offset by the sale of the Wal-Mart portfolio later this year. Excluding effects of PayPal and Wal-Mart the net charge-off rate is expected to be similar to 2018. The third quarter net charge-off rate tends to be seasonally lower than the second quarter.
The decline from last year's second quarter to the third quarter of 100 basis points was also driven by the credit related purchase accounting impact from the PayPal Credit program acquisition. We expect the decline to be more modest this year and more in line with historical trends of 40 to 50 basis points.
Turning to expenses, we continue to generate positive operating leverage and still expect the efficiency ratio to be around 31% for the full year.
In summary, the business continues to generate strong growth with attractive risk adjusted returns.
I'll now turn the call back to Greg to open the Q&A.
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, sir. We will now begin the question-and-answer session. [Operator Instructions] And from Credit Suisse we have Moshe Orenbuch. Please go ahead.
Great. Can you hear me? Can you hear me?
Yes. All right.
Thanks. Sorry about that. So I guess maybe the -- given that you're now pretty close to transitioning out of Wal-Mart and talking about the potential for acceleration in organic loan growth. Could you talk about how PayPal figures into that? I mean that relationship was growing probably 25% or 30% before and has the potential to expand significantly through and so talk about how you're thinking about that as a vehicle for driving overall loan growth?
Yes. So far, the first thing that's really great that we've completed the conversion which was a fairly significant sized conversion for us and that went really seamlessly which we're really excited about. And I think now we can refocus our attention on a list of initiatives we have that really are targeted to drive growth for the program. I think we have our teams working closely together, I would say it's a really strong partnership and we're really working on both technology enhancements as well as program enhancements to really be even more integrated as we go into the marketplace and really work with the merchant base of PayPal, so we see this as a big part of our growth story going forward.
Great thanks. And maybe switching gears just a little bit despite getting a late start during the quarter you were able to buyback over $700 million worth of the stock. I mean are you looking to kind of continue at a similar pace. Like how should we think about the deployment of that 4 billion?
Great. Thanks Moshe. The way I would think about it is, you have a core capital return plan based upon our earnings. If you look at how the Wal-Mart capital gets freed up we had $522 million of reserves which released in the first quarter, $247 million in the second quarter. We've guided to $250 million in third and $100 million in the fourth. When you tax effect that and then look at the capital it gets released upon the portfolio conveyance in the fourth quarter that's kind of how you should think about how capital gets freed up and the gains you can think about for 2019.
Great. Thanks so much.
From Jefferies we have John Hecht. Please go ahead.
Thanks very much guys. You guys spent a bit more time talking about digital innovation and that kind of greater activity from online activity and Internet-based activity. I'm wondering just at a high level over time should we expect that to reduce customer acquisition costs or servicing costs.
Yes, John. Hey, this is Brian. Yes, absolutely. I think this is an area that continues to be a real strength for us. It's an area that we've been investing pretty heavily in over -- really the last five years. I think it's -- if you look at our investment in pay phone, our acquisition of GPShopper. We're now getting 50% of our apps through the digital channel.
If you look at mobile we've seen 47% growth year-over-year really good online sales penetration at retail card, it's about 3x the national average. And so, as we think about it it's really -- its acquisition all the way through servicing and paying your bill.
And so, part of this is clearly an efficiency play. We love the fact that customers can apply for credit. It reduces our acquisition costs all the way to the back-end making a payment and not having to call somebody in customer service. But I think if you look even beyond that. This is really helping us drive organic growth, but also helping us when new programs, so it's a real differentiator for us.
Okay. That's helpful. Thanks. I guess you guys are the first card company to give this quarter -- to give some a little bit more detailed guidance around CESO. I'm wondering within the guidance you gave us out of curiosity as much as anything is that you what's the duration that I guess in the different portfolios you have that they assigned or that you assigned?
Yes. Thanks John. We really can't get into too much detail around some of those assumptions. Obviously, we are primarily a card based company. We have some commercial products, but again, we're working through those assumptions now going through the various constituencies we have where there are accounts or participants in and when we generally believe we're in line with other card issuers.
Understood. Thank you guys very much.
Thanks John.
From JPMorgan, we have Rick Shane. Please go ahead.
Hey guys. Thank you for taking my questions this morning. And congratulations Brian and Brian on your respective new role. When I look at the sort of preliminary work on CESO that suggests, if you were to implement today a CET11 in the high 11, low 12 type range please correct me if you think I'm wrong there. But, I am curious given that this is a lot of geography how you will look at your CET1 targets going forward and will you consider lowering those targets?
Yes. Thank you. The first thing I'd say is that, obviously the range we announced this morning doesn't really impact our capital plan. First of all for [Technical Difficulty] going through the period 2020. As we think about capital, the posting of these additional reserves really, really creates additional loss absorption capacity which reduces our unexpected buffer really in the capital range. So when we think about it, we obviously believe that we should get credit for posting these losses and really reduce our capital threshold or CET1 threshold. That's discussions we've begun to have with our regulators and work out over time. But again, this loss absorption capacity is being built through the posting of reserves should allow us to lower this CET1 ultimately over time is our belief.
And we certainly agree. I'm curious you've mentioned that you're in conversations with the regulators the other constituent there would be the rating agencies what are they say?
Our discussion with the rating agencies preliminarily has been that they don't believe CESO is really a credit event. They understand the loss absorption capacity. We're familiar with their models and we're in discussions with them as well about how we think about the additional buffer that's put in by posting these reserves upfront. So, we are engaged with both of our agencies.
Sure. Thank you so much.
Thank you.
From Goldman Sachs we have Ryan Nash. Please go ahead.
Hey, good morning guys.
Good morning.
Maybe I can ask a question on the 175 million of reserve build that you're expecting in the third quarter. Should we think about that as a new run rate as growth improves? And I guess related to that historically when you talked about a 150 million to 200 million of core reserve built, you were growing in the 8% to 9% range. Is that how we should maybe think about where loan growth could be headed over time? Thanks.
Great. Thank you. The way I think about it is, our reserves going forward should primarily be growth driven. What we see as we look into the back half of this year, we see an acceleration of growth as we move forward [Technical Difficulty] stable growth of 3% the first quarter, 4% in the second quarter. We guided to 5% to 7% range and we expect that growth to accelerate in the back half of the year really through all of our programs and platforms. We're seeing terrific growth out of our payment solutions platform through the expansion of the auto and home network there. Through care credit and the broader acceptance is happening there as well as Brian has kind of highlighted some of our fast growing digital channels. So we do see an acceleration in the back half of the year in growth. And again, the reserve should be primarily growth driven as we move forward.
Got it. And then, maybe if I can ask a follow up on Rick's question regarding CESO. So, you obviously have several years for the implementation just wanted to get a sense for when you think about capital return going forward, how you think about the ability to use the three year phase in? Thanks.
Yes. You are right. The capital impact would be phased in over three years as part of our capital is going to originate through regulators we incorporated our initial estimate of CESO into that and we will continue to work with them. With regard to how that's treated again, we think about it as building losses absorption capacity and our CET1 rate should come down over time and be in line with peers first of all. But, taking account the fact that we're posting these higher reserves.
Thanks for taking my question. Thank you.
From Nomura we have Bill Carcache. Please go ahead.
Hi. Good morning. Sorry if I missed this but my first question is for Brian Wenzel. Hey, Brian, can you discuss how we should be thinking about the impact of a more accommodative Fed and maybe any color that you can give us on the impact of each 25 basis point cut?
Yes. Thank you. Let me start with the second one as far as the interest rate environment. Obviously, we know what's modeled out there today which is a forecast of three movements. We have done several models and scenarios where we've looked at the impact of rates on our business. And generally when you think about our business or assets and liabilities are fairly well-matched against each other. And we really try not to take exposure to rates. So we're fairly balanced whether it's a rising rate environment or declining rate environment. So, when we look at those models that we've done, we're fairly comfortable or comfortable with that. The net interest margin for the year will be in the 15.75% to 16% range. And then we've had the ability really to manage our retail deposits and CD business. And we've lowered rates on CDs 5x since April this year with lower high yield savings really relating to the competition of the market and where the interest rate forecast is going. So we felt comfortable that we can deliver on our net interest margin again given our balance sheet we're not really exposed to interest rate movements.
With regard to the accommodative Fed, we obviously work with them on CESO and capital, they obviously know there's a large transition that's going on in the market for participants and they understand that I think are going to be fairly flexible in the short term.
That's great. Thank you. Separately I had another question for Brian Doubles. Thanks Brian for the new slides and the commentary on the impact of digital innovation on your growth. There's been a lot of focus on the digital investments that some of your less efficient competitors are making for example in public cloud technology. Can you give us a sense of how to think about the impact of your digital investments on your operating efficiency over time, is there room for your digital investments to benefit both the numerator and the denominator of your efficiency ratio such that we can expect further improvements from your already industry leading levels. Any color on that would be great. Thank you.
Yes. Sure, Bill. I mean absolutely I think we view digital as a big initiative for us both in terms of driving growth, driving revenue for our partners. Again, existing partners but also winning new relationships. And every time we win a new relationship obviously given our scale, we get real efficiencies and real operating leverage there. But, then if you look at everything that one of our customers does through a digital channel saves us money. It saves us money the more we're able to move towards e-statements and people checking their statements on either in the app or online whether they're making payments through the app and we have now over 2 billion of payments that are coming through our SyPi apps. I think these are all things that drive real efficiency for the company. So I would absolutely think about it as driving both top-line growth, revenue growth as well as operating efficiency.
It's very helpful. Thank you.
Thanks Bill.
From Wells Fargo we have Don Fandetti. Please go ahead.
Hey, good morning. So, Brian..
Good morning, Don.
Thank you. So on the NIM, I think in the last quarter you said that NIM would be down slightly in Q2. It feels like it's down a little more than that but you've mentioned it's in line with your internals, it kind of maybe a tiny bit towards the lower end of your internal or is it just bouncing around? And then I have a credit question.
Yes. The net margin was right where we expected to be in line with expectations. As they move sequentially, there was a decline in [indiscernible] which is primarily related to the acquisition of the PayPal Credit portfolio, a slight shift in the [indiscernible] with our loan receivables down 50 basis points versus the first quarter and then nine basis points of pressure from our interest expense. So again, it was in line with where we thought it would be and for the year, again we still expect 15.75% to 16%.
Okay. And then, I think Synchrony is largely through their underwriting adjustments that started back in 2015 or '16. But if take those mixed signals out in the card business right now at least in general purpose you have companies like JPMorgan accelerating growth CapitalOne raising, potentially raising lines. Within private label, what are you seeing competitors do in terms of underwriting tightening and do you think that the industry is actually shifting to a little bit more of an aggressive card lending sort of positioning overall.
Yes. I can't really speak for what others are doing in the industry what I would say is, we made some refinements back in the '16 and '17 timeframe. We make refinements every day based upon what we see in the portfolios and channels that we operate in. We are not I'd say making significant changes either opening the credit throttle or closing the credit throttle and we are operating the portfolio. And I think you can see through our results when you look at 30 plus and 90 plus delinquencies ex PayPal and Wal-Mart being deep down year-over-year that we see stabilizing [Technical Difficulty]. So, we're not in a position where we're going to take actions either way as we move forward here. So we're comfortable with credit how it is performing, the vintages as we look at them, the 17, I'm sorry, the 18 vintage is performing in line and back to almost the '16 or '15 vintage and the early results on our '19 vintage are in line with '18. So, we're comfortable with where credit is at and we're not taking any significant changes.
Okay. And then on the recoveries, are you seeing better pricing or was this just kind of like a bulk sale, a little bit of color on the higher recoveries. I know they can bounce around quarter-to-quarter.
Recoveries again this quarter was 1.2% of our average loan receivables, so better than we expected and what we guided to really from the first quarter. And we're seeing that one we are seeing better pricing across most of our channels. We're seeing greater demand from the participants in the marketplace. So obviously, we were a little bit more opportunistic as I think about the first half of the year. But, I'd say overall recovery outside of those onetime transactions and flow arrangements recoveries, the results and performance is better than our expectations.
Thanks Brian.
Thank you.
From Morgan Stanley we have Betsy Graseck. Please go ahead.
Hi. Good morning.
Good morning.
Hi. Question on -- I just wanted to understand a bit about PayPal. I know you've very nicely carved out the NCO x PayPal and Wal-Mart and just then also the loan growth outlook. I'm just looking to understand as we think about your go-to-market strategy with PayPal because I would think that this is a portfolio that has opportunity for a significant loan growth and spend growth. And just wanted to understand how you're toggling that with the credit side.
Yes. We work closely with PayPal in terms of how we're building out this global strategies with them. And they're pretty sophisticated on the credit side. So, I think we're going to approach this in a thoughtful way. And as Brian said, there's no plans to just open up the throttle in any way or treat PayPal any differently than our other portfolios and the environment we're in right now. But, I can say that the integration of two of us how we think about marketing and really the -- a lot of the growth that really is important on the digital front is really around placement and offers. And I think PayPal is really good at this and we're working very closely with them to make sure we're offering the credit in the right places. And that really makes a big difference in terms of the quality of the customer that you get in and your ability to approve accounts.
The only thing I would probably add to that is, while PayPal operates at a slightly higher net charge off rate than the portfolio itself, the risk adjusted margin and the returns that we get of that portfolio really compensate for that. And again, when you contemplate that relative issue Wal-Mart [indiscernible] this year obviously from a credit perspective, we're better off as a company.
Yes. No, definitely, I'm just thinking also that obviously this is a mobile online customers that and as a result think that that generates a little bit higher rev growth overall. Is that accurate?
Yes. It's a fast growing payment platform I would say.
And then just a follow question is regarding the outlook for capital I know you touched on it earlier, but if we've got the Fed coming out with this tailoring rule and you guys don't even have to do CESO, I know you opt-in in your own way. But when you read the tea leaves of what's going on with how the Fed is thinking about the SCB and how it's thinking about the tailoring rule, should we be anticipating that you can have a lower starting point for what your stress levels of capital are or does that some of these new portfolios change that and say well that's an offset so we should still be running at the capital levels that we've been talking about.
Yes. So only just clarifying, I wish we say we can opt-in as [indiscernible] unfortunately that is a requirement for us. As I think about capital as we move forward here, obviously we're very comfortable with the resiliency of the earnings of our business the way in which performs the returns of our business as well as offsets and we look at that. And then begin to look at the impact of CESO, we believe that we're going able to drive down our CET1 ratio because right now we're in excess of peers. We're migrating down when we started a number of years ago at 18% down. We believe we'll be able to be in line with our peers over the long-term. So, we don't really expect an impact from those rules on us.
Eleven-ish or something like that is really where peers are kind of triangulating too. So that's what makes sense for you.
Yes. I can't comment exact long-term target, but again we are working to get in line with our peers, given the profile of our business that's where we think we should operate. And that's the discussions that we're having with them.
Yes. Now, I get that okay. And so if the Fed is kind of like migrating a little bit even lighter with the tailoring rule et cetera, you'll just follow the path on that?
Obviously as the rules come out we'll assess them and engage in dialogue and be compliant with them. So again, we'll be nimble.
All right. Thanks Brian.
Thank you.
Thanks Margaret.
From KSP Research, we have Kevin St. Pierre. Please go ahead.
Hi. Good morning.
Good morning, Kevin.
Brian, I'd just like to better understand the 17 basis point decline into average credit card yields in the quarter. You touched on it a moment ago, but I just wanted to dig into that. Is it mixed a bit low or moderate, what drove that?
Yes. So, when you look at it we are seeing a slightly higher revolve rate in the core business and some of the impact again of the interest rates movement is moving into the portfolio. The yield decline is solely related to where the majority of is related to the impact of the PayPal Credit portfolio that comes in at a lower yield. But again, we took pricing actions last year on the portfolio. They begun to take effect into the book but they take a long time under new [Kodak] [ph] rules and we expect that to be fully in a run rate basis in 2020. So it's really the acquisition of PayPal Credit that's driving the decline.
Got it. Thanks. And then as a follow up. In terms of expenses and particularly marketing and business development maybe it's just me watching too much golf and tennis, but I've certainly noticed a big increase in the commercials and the advertising. Where should we think that line item goes over time?
Yes. Again, our marketing and business development line that will fluctuate a little bit with regard to campaigns when we do reissuances, we relaunch value proposition. So there is some variability with that. We are not a big spender in commercials things like that. We've done some things in order to position our brand externally -- but that's -- we're not going to migrate into other peers, it's been tens of millions, hundreds of millions of dollars into that it's just more thoughtful branding. Again, we expect that to grow generally in line with their volume and loan receivable growth.
Great. Thank you.
Thank you.
And our last question comes from Sanjay Sakhrani with KBW. Please go ahead.
Thanks. Good morning. I guess Brian, I wanted to follow up on the NIM and the yield trajectory. You mentioned the PayPal repricing. As we look to next year, is it safe to assume that all else equal. I know rates might move around a little bit and that might affect your assets, but the trend is higher on the yield because of the repricing tailwind that you have related to PayPal? And then, secondly, similar question on expenses, I think I heard you say that expenses have been elevated related to PayPal and Wal-Mart as we think through some of the exit run rate into next year for the efficiency ratio. Should that be also a good guy for the efficiency ratio as we move into next year as you don't have those costs in the run rate.
Yes. So let me deal with your margin question first, Sanjay. As we kind of go in there, we will obviously get the run rate of PayPal from the CIT come in. We're not providing today's specific guidance as it relates to 2020 as we'll do that in January as part of a more comprehensive look. The biggest change obviously is Wal-Mart portfolio coming out which operates at a higher net interest margin relative to its losses. So there will be some effect there, we'll provide more guidance to you in January with regard to the trends and we'll certainly have greater visibility to work through interest rate environments doing.
With regard to expenses again, we're projecting 31% or going to 31% for the year. We're very comfortable with that. As you think about going into 2020 again we'll provide guidance on that. Obviously, we've converted from an interim servicing basis this quarter from PayPal to us so there's be some line item shifts that happen in there. So that will be fully in the run rate.
And again, we started to implement some of the Wal-Mart cost out and be any part of the year for some of the fixed costs. In the back half of the year particularly in the fourth quarter, you'll see the variable costs come out, now we'll get into the run rate as we move into 2020.
Okay. My follow up question for Margaret is just simply on the micro competitive environment. One of your peers talked about the online players being a bit more competitive in the market. I think I've heard you guys talk about it as well maybe you could just flush that discussion out and just talk about the pipeline going forward. I know you're absorbing quite a big deal right now, but as we look to the pipeline of future deals how does that look.
Yes. I would say we're excited about where the businesses position right now and we do feel like we're winning because of our digital capability, our data analytics capability and some of the things we continue to build out. I would say there's not a lot of big deals out there Sanjay. A couple of big deals maybe in the next two, three years will come up, but our pipeline and all three platforms is pretty robust. And what we're trying to make sure we do is ensure we're winning the deals that meet the returns that we're comfortable with. But I think there's enough out there that we feel confident that we can win both existing portfolios and startups.
All right, great. Thank you.
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