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Morningstar | Synchrony's PayPal Partnership Helping Fill Void Left by Walmart

Kicking off 2019, Synchrony Financial reported no significant surprises. The company earned $1.56 per diluted share in its first quarter. Though this represents 88% growth, much of that was attributable to a $0.56 per share reserve release related to the pending loss of Walmart. Even excluding those nonrecurring gains, Synchrony would have realized impressive earnings growth, advancing 20% from the previous year. Over the past year, Synchrony has increased total receivables by 3%. Excluding Walmart, Synchrony’s portfolio would have seen growth of 17%. It’s apparent that Synchrony’s partnership with PayPal has really helped fill Walmart’s void. While we anticipate the strength in the PayPal portfolio to continue, Synchrony will probably need to continue finding new partners like PayPal as some of its other retail partners face significant challenges. Though declining retailer health has been a tailwind for Synchrony, eventually it will become a headwind.

During the quarter, the company reduced its share count by 1.7%, modestly higher than we expected. Once the Walmart sale is complete, Synchrony will have even more capacity for repurchases and we could increase our fair value estimate. For now, we’re maintaining our fair value estimate of $32 per share.

It will be interesting to see what impact, if any, PayPal has had on Synchrony’s higher retailer share arrangements. For the quarter, RSAs as a percentage of average receivables were 4.2%, on the high end of management’s 2018 guidance. We suspect management’s RSA guidance was formulated based on an expectation for higher credit losses that so far have failed to materialize. For the quarter, provisions to average receivables was 3.8%, the lowest rate since Synchrony was spun off from General Electric. If we add back the implied $520 million in reserve releases, we get a provisioning rate of 6.1%. While much higher, it’s still a sequential improvement of nearly 40 basis points. Overall, it’s probably better for Synchrony to miss its guidance for RSAs but realize lower-than-expected credit losses. However, we’d encourage investors to spend time scrutinizing the RSA line. If Synchrony is signing new partners at lower margins, it’s likely here where its results will be first noticeably affected. For now, it appears to us that improving credit quality is largely driving higher payments to partners and is not the result of improving terms for retailers.

It appears a meaningful portion of Synchrony’s growth in retail cards is the result of consumers carrying higher balances. Average active accounts grew 9.7% while average loan receivables grew 16.7%. Some of this is probably attributable to PayPal’s portfolio mix, but we think it’s worth cautioning investors, since the easiest way for credit card companies to increase loans is to grant higher spending limits. However, this type of growth is of lower quality and can result in higher credit losses. We think it’s likely that Synchrony’s credit provisions will resume growing for the remainder of 2019.