The Share Price Catches Up To Company Performance
Last time I wrote about Synchrony Financial (NYSE:SYF) in October 2023, I rated it a rare Strong Buy as the market was going through one of its regular bearish sentiment periods toward the stock. The timing of that article was fortunate, as it coincided with a 5-month low, and the stock has since returned over 36%.
Synchrony stock produced this impressive return even as the company finally started to show signs of the long-awaited slowdown in growth. In the company’s 4Q results, we see that the slowdown was led by the Home & Auto segment, where purchase volume swung to a negative change from the prior year. This was driven by lower gas prices and smaller project spending on home improvements. Despite this drop, loan balances still managed to grow by 7%, and interest and fee income grew 11% within Home & Auto. The other segments were stronger, with purchase volume up mostly single digits, but loan balances and interest income were still up double digits. While consumers are starting to slow their spending growth, they are also starting to carry larger balances on their accounts. Payment rates have come down over the past year, but they still remain above pre-2020 levels. This is good for Synchrony as long as defaults don’t spike up.
Speaking of defaults, charge-offs are still increasing, as are 30- and 90-day delinquency rates. In fact, they are now slightly above the average levels that existed in the 2016-2019 period. This is worth watching closely, but the company expects charge-offs to peak in the first half of 2024 and then settle into the same seasonal trends that prevailed pre-2020. On the positive side, Synchrony has been careful with its loan underwriting and is not taking on additional credit quality risk just to grow loan balances. The allowance for credit losses as a percentage of total loans has remained steady in the 10.25%-10.45% range for the past year.
Even with this underwriting caution, Synchrony grew gross loan balances by 11.7% in 2023, slightly above what I predicted in my last article. At the end of the year, the bank made two portfolio moves that will impact future results. First, Synchrony agreed to sell its Pets Best pet insurance business to Independence Pet Holdings for cash and an equity stake in IPH. Synchrony bought this business in 2019 and was not actively looking to sell, but IPH made an attractive offer that will produce a gain on sale of $750 million after tax in 2024. The second move was the recently announced acquisition of Ally Financial’s (ALLY) point-of-sale lending business. This business contains $2.2 billion of loan receivables, mainly in the Health & Wellness and Home & Auto segments. With these deals, plus continued growth in the base business, Synchrony expects to grow loan balances, now over $100 billion, by 6%-8% in 2024. While this is a slowdown from last year, it is still a healthy growth rate for a low-P/E bank like Synchrony.
Assumptions And Risks
Synchrony’s projections for 2024 are based on what looks like a soft-landing economic scenario: 4% unemployment, 1.7% GDP growth, and an ending Fed Funds rate of 4.75%. The interest rate projection agrees with the Fed’s and my own forecast but assumes fewer rate cuts than the 5-6 predicted by the market as measured by the CME FedWatch Tool. The unemployment and GDP forecasts are slightly more optimistic than the Fed and slightly less optimistic than my estimates.
Synchrony is also predicting a deposit beta of 30%. This means that for every 1 percentage point drop in Fed Funds rates, the bank only expects its deposit rates to drop by 30 basis points. Based on prior cycles, Synchrony sees deposit rates dropping slower than Fed Funds rates as customers lock in rates for longer periods with CDs. This could negatively impact Synchrony’s net interest margin in 2024.
As discussed above regarding credit quality, Synchrony is predicting a higher charge-off rate, partially offset by lower Retailer Share Arrangement costs. Finally, the bank expects continued cost efficiency improvement due to operating leverage from higher interest income.
The biggest risk to the forecast is of course macroeconomic conditions. Synchrony would have to increase loan loss reserves if the economic outlook deteriorates, ultimately showing up in higher charge-offs. As we saw in 2020, the bank is conservative with loss reserves and could over-reserve in one year resulting in a release of reserves the following year if the economy turns out less bad than anticipated. Another risk is a reduction in late fees allowed under CFPB rules. This has been under discussion for almost a year but the regulator has not announced its final rules yet. While good for customers, this rule change would likely negatively impact revenues of credit card companies. On the bright side for Synchrony, the bank has merchant partners that may be expected to share some of the cost of the rule change, unlike banks that lend directly without partnership participation. Any reduction in late fees would cause Synchrony to reject some low-credit score applications it might otherwise approve, resulting in lost sales for the merchant partner. As a result, the merchant partner has some incentive to amend the agreement with Synchrony to share some of the cost of late fee reduction, thereby retaining these sales to low credit quality customers. The current forecast assumes no impact from the late fee rule change, but this could change in future quarters.
Financial Model Update
Synchrony did not issue a net interest margin forecast for 2024. I am assuming a reduction of 50 basis points because of the lag in deposit rates dropping compared to the Fed Funds rate as discussed above. My resulting net interest income forecast of $18.4 billion is at the high end of the bank’s guidance of $17.5 – $18.5 billion.
Because my macro forecast is slightly more optimistic than Synchrony’s, I am assuming RSA costs at the high end and charge-off rate at the low end of company guidance. Loan balance growth is 7% from year-end 2023 to year end 2024. I am also assuming the loss reserve stays at around 10.3% of loan balances. The Other Income line includes a $974 million pre-tax ($750 million after-tax) gain on sale for Pets Best. The efficiency ratio is at the company guidance midpoint of 33% if you exclude the Pets Best gain from the denominator, or 31% if included. Tax rate is assumed similar to 2023.
The resulting EPS forecast is $7.39 per share, so the P/E is an attractive 5.1. (Without the Pets Best gain on sale, the EPS would be $5.51 for a P/E of 6.8). My adjusted EPS estimate is slightly below the analyst consensus of $5.60.
Looking at the balance sheet, I assume Synchrony will maintain deposits at a similar percentage of funding as they did in 2023. I show borrowings and other liabilities unchanged from year end 2023. On the earnings call, the bank discussed the intent to issue up to $750 million of new preferred stock but is in no hurry to do so at high-interest rates. There is currently $734 million outstanding of Synchrony’s one preferred issue (SYF.PR.A) which has a current yield of 7.94%. Synchrony has been an active buyer of its own common stock, reducing its share count by 7.1% in 2023. For 2024, I am assuming buybacks of $170 million per quarter. With the higher stock price, I see the share count dropping 4.4% in 2024.
Synchrony ended 2023 at a P/B of 1.18, about where it ended 2022. With the expected book value growth in 2024, the current share price of $37.50 represents a forward P/B of 0.95 at the end of the year, and a price/tangible book of 1.06. While less attractive than it was last quarter at a lower share price, a P/B under 1 is still historically low for Synchrony.
Updating the peer comparison from last quarter, Synchrony has maintained the trailing P/B premium that it had over Ally and Capital One (COF) and remains cheaper than Discover (DFS). The trailing P/B is now back above 1, but still below the average of the past 5 years.
Synchrony continues to have the cheapest valuation on a trailing P/E basis, and the discount has widened over the past year.
Preferred, Bonds, And Deposit Rate Update
As discussed above, the Series A preferred now has a current yield of 7.94%, which is 3.8% above the 10-year Treasury yield. This spread is now 65 basis points lower than last quarter. The yield is also now in line with other BB-rated preferreds. The preferreds are not as attractive as they were in 2023 during the banking crisis but are well-covered and worth holding. If the bank does issue another series of preferred shares, it could put pressure on the existing Series A, so I would be cautious of buying more here.
Bond spreads have narrowed even more than the preferreds. For example, the 3.95% senior note due 12/1/2027 (CUSIP: 87165BAM5) now has a yield to maturity of 5.81%, a spread of 167 basis points over the 10-year. This is down from a spread of 283 basis points last quarter.
Synchrony continues to offer attractive FDIC insured deposit products. The high-yield savings account pays 4.75%, same as last quarter. CD rates have also held up better than Treasury or corporate bond rates since last quarter. Current specials include a 9-month CD with an APY of 5.3% and a 15-month at 5.2%.
Synchrony shares have risen considerably in the last quarter, better reflecting the performance of the company. Some slowdown in consumer spending and a reduction in credit quality is expected in 2024, along with lower net interest margins. Offsetting these negatives are loan balance growth, both inorganic and from the Ally deal, greater cost efficiency, and a gain on sale from the Pets Best insurance business. Overall these changes are a net positive, and I expect the book value at the end of the year to be slightly under the current market price. This is still an attractive valuation making the shares a Buy, though a downgrade from Strong Buy last quarter.
For savers and investors seeking less risk, Synchrony’s CDs and savings accounts are now my top choice due to the minimal change in rates from last quarter and their FDIC insurance. The senior notes and preferreds no longer have the deep discounts that resulted from the banking crisis in 2023. While these are well-covered and safe to hold, further price appreciation is limited unless more rate cuts are on the way than I currently expect.
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