Synchrony Is Enjoying Strong Loan Growth, but Credit Card Charge-Offs Will Continue To Rise

Equity Analyst

Michael Miller

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Synchrony Financial partners with retailers and medical providers to offer promotional financing as well as private-label and co-branded general-purpose credit cards. While the company’s CareCredit cards and installment loans have consistently performed well, its private-label and co-branded credit cards, co-marketed through partnerships with retailers, can often face material headwinds when retail sales suffer. These headwinds can be particularly intense if the retailers that Synchrony partners with fail during a recessionary period, which adds to the already meaningful macroeconomic exposure of credit card issuers in general.

The company has also had to contend with the loss of Walmart in 2018 and Gap in 2021. These were significant blows, as the Walmart credit card program was about 13% of Synchrony’s receivables at the time and the Gap credit card program was about 5%. Synchrony will likely continue to have to choose between revenue growth and margins as it is pressured at the negotiating table by its merchant partners to offer more-attractive revenue-sharing agreements. 

The future for Synchrony is not completely bleak. Repayment rates industrywide have normalized, and retail spending growth has been strong. The bank saw significant loan growth as well as net interest margin expansion in the second half of 2022 as operating conditions improved. New credit card programs with Venmo and Walgreens give avenues for Synchrony to add incremental growth, and the company has its own buy now/pay later option through Clover.

On the other hand, credit costs have been rising in 2023, a trend we expect to continue into 2024. Synchrony had been enjoying net charge-offs well below normal levels for several years, but in 2023, net charge-offs industrywide have begun to increase rapidly, and Synchrony is no exception. That said, Synchrony’s rate of normalization has been slower than most of its peers. Additionally, its balance sheet is strong, and while we do see higher net charge-offs on the horizon, we do not expect the bank to come under financial strain.

Business Strategy & Outlook

In our view, Synchrony Financial does not have an economic moat, as we do not believe that it has a durable competitive advantage that will allow it to continue to earn excess returns on capital, particularly in light of the shift toward online purchases and the increasing size of digital retailers. Synchrony is the leading issuer of private-label credit cards by purchasing volume and by outstanding receivables, but its scale in the overall credit card market is more modest. Any weakness in private-label credit card growth will likely remain a headwind for Synchrony, as its co-branded general-purpose cards are only 23% of its interest income. Moreover, outside of its existing relationship agreements, Synchrony has no identifiable competitive advantage over any other major issuers of credit cards.

Historically, Synchrony’s retail card segment has been able to establish long-term relationships with major retailers using partnership agreements in which the retailer markets Synchrony’s credit cards through both physical and online channels. These partnership agreements are typically long, anywhere from five to seven years, and have historically been sticky, with most of Synchrony’s partners electing to renew repeatedly. The longevity of these partnership agreements has benefited Synchrony, but the switching costs faced by its partners have eroded over time, and the value proposition of Synchrony’s credit card partnerships has become more dependent on the payments it makes to its partners and their customers.

Synchrony provides value to its retail card partners in three ways. First, Synchrony makes direct payments to the retailer through retailer share arrangements. The specifics of these arrangements are negotiated when a partnership agreement is signed or renewed, and they transfer revenue from Synchrony to the retailer based on the economic performance of the credit card program. These retailer share arrangements are a significant expense. In 2019, Synchrony paid out more than $3.8 billion to its partners. Second, Synchrony’s credit cards use reward structures as an incentive for consumers to direct more of their spending to the retail partner. As credit card competition has increased and reward structures industrywide become more generous, Synchrony has been forced to follow suit, and over the last five years, the cost of these programs has grown at more than 21% per year. Finally, Synchrony provides retailers an easy way to collect valuable data on their customers. When customers sign up for one of Synchrony’s credit cards, they are providing the retailer with personal information that can then be tied to purchasing patterns. This data can be used to identify a retailer’s most active customers and then market to them directly using targeted offers. From the perspective of the retailer, Synchrony’s credit cards provide valuable data and reward its most valuable customers while also generating incremental revenue.

However, Synchrony’s credit cards are no longer the only way for retailers to collect this data. Online shopping by its very nature requires customers to create online accounts that provide retailers with the same personal information and purchase data. By the end of 2019, 39% of transactions with Synchrony’s cards occurred online, highlighting the overlap in data collection. Additionally, digital retailers have become an increasingly important part of Synchrony’s partnership base. In 2015, digital retailers were responsible for 7.7% of Synchrony’s interest income, but by 2019, this figure had risen to 20.4%. These new retailers benefit less from the data collection opportunity of Synchrony’s credit cards, and firms such as PayPal, Amazon, and Alphabet are unlikely to rely on Synchrony’s own data analytics. The diminished value of its data collection efforts makes it easier for retailers to switch credit card providers if they believe they can receive better terms elsewhere. 

Case in point: Walmart. In 2018, Walmart decided to not renew its agreement with Synchrony in favor of signing a new agreement with Capital One. This was a significant loss for Synchrony, as the Walmart partnership accounted for approximately 13% of Synchrony’s credit card receivables at the time. While there have been no other major defections since 2018, we believe that the loss of Walmart is a sign that bargaining power has swung toward Synchrony’s partners, particularly retailers sophisticated enough to have their own data analytics teams. Synchrony’s partners are likely to demand more from it, and the company will be forced to accept lower margins or risk losing more partners to competitors.

While the Walmart credit card portfolio itself was not sold until late 2019, Synchrony responded to the loss of Walmart by seeking partnership renewals with Lowe’s and JCPenney in 2018. Synchrony’s bargaining power was likely diminished in these negotiations, and the impact of Walmart’s defection can be seen in Synchrony’s margins. In 2019, retailer share arrangement spending in the retail card segment was 27.75% of interest and fee income compared with an average of 25.4% over the prior five years. This increased even further in 2020, establishing a trend of higher revenue sharing with Synchrony’s partners. Synchrony is likely to continue to endure difficult negotiations with its retail partners during contract renewals. The loss of the Gap portfolio to Barclays in 2021 reflects the firm’s continued challenges in maintaining its partner base.

Without meaningful switching costs to Synchrony’s partnership agreements, we do not see a way for Synchrony to retain high-margin business in its retail card segment without its partners attracting competitive bids from Synchrony’s rivals. Many of its competitors are much larger, have lower costs of funding, and have more identifiable brand names. While Synchrony’s ability to retain technologically sophisticated partners like Amazon and PayPal does speak to the company’s capabilities, without significant technology development spending, we find it unlikely that Synchrony can develop a defensible advantage in product capabilities. Given the lack of competitive advantage, Synchrony’s retail card’s return on equity is likely to trend lower.

Unlike the retail card segment, payment solutions and CareCredit are heavily diversified, reducing partner bargaining power, and do not have significant retailer share arrangement spending. Both segments work by providing promotional financing for large-ticket items to the partner’s customers, increasing sales conversion rates. The promotional financing comes in the form of either deferred interest (no interest for the first 12 months, for example) or a discounted initial interest rate. Typically, most customers pay their loans off before the end of the promotional period, leading to a higher degree of asset intensity, particularly in payment solutions. A key distinction for CareCredit is that it is a single credit card program that various medical practices agree to accept and market. Payment solutions mostly follows the same model as retail card, in which each retailer has its own program. 

Synchrony’s partners in these segments are typically not motivated by the ability to market to its customers since purchases are either driven by need or inherently irregular, like the purchase of a mattress. Most purchases that occur using Synchrony’s cards in these segments are one-time purchases. Historically, roughly 30% of purchases at payment solutions and 50% of payments though CareCredit have been repeat purchases. As a result, Synchrony’s payment solutions and CareCredit partners are largely only concerned with approval rates for applications. The partnership agreements that Synchrony signs in these segments are often not exclusive, which means that a retailer could be offering multiple financing options alongside Synchrony’s credit cards. As a result, Synchrony competes with all forms of consumer financing in these segments, and its partners are mostly interested in Synchrony’s ability to issue additional loans with large promotional discounts to facilitate their sales. 

The same is not true of CareCredit, where gross interest is comparable to the rest of the firm even though these partnership agreements do not include retailer share arrangement spending. It could be argued that the existence of a single CareCredit program means that there is a network effect to the card program. The more consumers with the card, the more valuable it is for providers to accept it, and vice versa. There is a potential opportunity to build a strong defensible franchise in this segment of Synchrony’s business. However, given the small size of CareCredit, any potential network effects in the segment are insufficient to justify a moat for the entire company.

None

Economic Moat

Synchrony Financial

Synchrony Financial engages in the provision of consumer financial services. It operates through three sales platforms: Retail Card, Payment Solutions, and CareCredit. The Retail Card platform is a provider of private label credit cards, and also provides Dual Cards and small-and medium-sized business credit products. The Payment Solutions platform is a provider of promotional financing for major consumer purchases, offering private label credit cards and installment loans. The CareCredit platform is a provider of promotional financing to consumers for elective healthcare procedures or services, such as dental, veterinary, cosmetic, vision and audiology. The company was founded on September 12, 2003, and is headquartered in Stamford, CT.

Earnings data Q4 2023

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Synchrony Financial engages in the provision of consumer financial services. The firm is also involved in managing credit products through the following sales platforms: Home and Auto, Digital, Diversified and Value, Health and Wellness, and Lifestyle. The company was founded on September 12, 2003 and is headquartered in Stamford, CT.

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