Fitch Affirms Synchrony Financial's Ratings at 'BBB-' and 'F3'; Outlook Stable
Today's rating actions have been taken as part of Fitch's periodic review of U. S. consumer-focused internet banks, which comprises four publicly rated firms.
KEY RATING DRIVERS
VRs, IDRs, AND SENIOR DEBT
The rating affirmations and Stable Outlook reflects SYF's market leading position in the U. S. private-label credit card industry, successful separation from General Electric Company (GE), seasoned management team, consistent operating performance, strong capitalization and liquidity levels, risk sharing arrangements with retail partners, and increased funding diversity as a result of strong deposit growth at Synchrony Bank.
Ratings remain constrained by SYF's monoline business model, high retail partner concentration, an above average mix of non-prime borrowers relative to general purpose card issuer peers, heightened regulatory, legislative and litigation risk, potential sensitivity of its deposit base to rising interest rates, and relatively short track record operating as a standalone entity.
After having received a non-objection to its capital plan from the Federal Reserve (Fed), on July 7, 2016, SYF announced that it had received board approval to initiate a $0.13 quarterly common dividend and a share repurchase program of up to $952 million over the four quarters ending June 30, 2017. While the shareholder distributions will have a slight negative effect on SYF's capital ratios, Fitch recognizes that SYF's expected earnings payout ratio is well below that of its peers despite its higher capitalization levels.
On June 14, 2016, SYF announced that net charge-offs for its portfolio were expected to deteriorate 20 - 30 basis points (bps) more than anticipated over the ensuing 12 months. As a result, starting in 2Q16 SYF expects to build higher reserves to reflect the higher loss expectations. The company's guidance is consistent with Fitch's view that credit losses would experience upward pressure in 2016 as new accounts season and consumer debt levels expanded, but would remain roughly in line with historical norms. Net charge-offs increased three bps to 4.59% in 1H16, while 30+ day delinquencies increased 26 bps to 3.79%. Reserve coverage strengthened to 5.70% of loans versus 5.38% a year ago, and held steady at 151% of loans past due at June 30, 2016.
Net income decreased to $1.1 billion for 1H16, down 2.0% from the prior year period. The decline was driven primarily by a sharply higher provision for loan losses based off of the June announcement, which was partially offset by higher net interest income. Period-end loans increased 11.2% year-over-year to $68.3 billion at June 30, 2016, driven by strong purchase volume growth of 12.6% and average active account growth of 7.3% versus the prior year period. Return on assets (ROA) and return on equity were 2.6% and 16.3%, respectively in 1H16. ROA was within management's public guidance of between 2.5% and 3.0% in 2016.
Fitch expects operating performance for the remainder of 2016 to remain strong, supported in part by a relatively stable macroeconomic backdrop in the U. S., market share gains at existing retail partners, and the addition of newly acquired partner relationships. Longer-term, SYF's margins may be pressured by more intense competition for retail partnerships, normalizing credit performance and continued investments in growth initiatives. Competitive intensity in both the co-brand card and private label card segments has increased markedly over the past couple of years, with several sizeable portfolios being either bid away from the incumbent card issuers or the incumbents having to take reduced economics. To the extent the high level of competitive intensity does not abate, it could lead to margin pressure and/or the loss of key retail partners for SYF as existing retailer contracts expire.
SYF is one of the more highly capitalized companies among its peer group and Fitch believes it has adequate liquidity to meet its upcoming debt maturities. At June 30, 2016, SYF's common equity Tier 1 capital ratio was 18.5% on a Basel III transitional basis, or an estimated 18.0% on a fully phased-in Basel III basis. SYF is not formally subject to the Comprehensive Capital Analysis and Review (CCAR) administered by the Fed. However, as noted above, the company submitted a capital plan to the Fed earlier in 2016 and received a non-objection to its planned shareholder distributions in July 2016. Although the company eventually plans to maintain an earnings payout ratio similar to that of its credit card issuer peers, SYF's shareholder distributions will lag those levels initially. As SYF's payout ratio increases over time, Fitch would expect the company's capital ratios to moderate toward levels that are closer to, but still well above its general purpose card issuing peers given the riskier assets in its portfolio.
Liquidity consisted of $14.0 billion of cash and short-term liquid assets representing 16.9% of total assets at June 30, 2016. SYF also had $7.0 billion of undrawn committed capacity under its securitization programs and more than $25 billion of unencumbered assets at Synchrony Bank, which Fitch views as potential sources of secondary liquidity. This compares favourably to the company's $1.0 billion in unsecured debt maturities over the next 18 months.
SYF has broad access to multiple sources of funding, including lower cost deposits through Synchrony Bank and unsecured senior notes. Since its July 2014 IPO, SYF has issued $7.1 billion of senior unsecured notes with various maturities ranging from 2017 through 2025. Fitch expects SYF to continue to seek to utilize a diverse mix of funding sources and maintain its investor relationships across various classes of debt (e. g. unsecured debt markets and securitizations) while growing its online deposit franchise. Fitch views SYF's deposit funding strategy positively as it reduces concentration risk and provides more funding flexibility in the event that wholesale funding sources become inaccessible and/or cost prohibitive.
SYF's loan portfolio is well-positioned for a rising rate environment. At June 30, 2016, assuming an immediate 100 bps increase in interest rates, SYF estimated that net interest income over the following 12-month period would increase by approximately $158 million. However, the interest rate sensitivity of the online deposit channel remains untested during periods of rising interest rates.
LONG - AND SHORT-TERM DEPOSIT RATINGS
Synchrony Bank's uninsured deposit ratings of 'BBB/F2' are rated one notch higher than their respective IDRs because U. S. uninsured deposits benefit from depositor preference in the U. S. Fitch believes that this preference in the U. S. gives deposit liabilities superior recovery prospects in the event of default.
HOLDING COMPANY
SYF's IDR and VR are equalized with its bank subsidiary, reflecting its role as the bank holding company, which is mandated in the U. S. to act as a source of strength for its bank subsidiaries. Ratings are also equalized reflecting the very close correlation between holding company and subsidiary failure and default probabilities.
SUPPORT RATING AND SUPPORT RATING FLOOR
SYF has a Support Rating of '5' and Support Rating Floor of 'NF'. In Fitch's view, SYF is not systemically important, and therefore, the probability of sovereign support is unlikely. SYF's IDRs and VRs do not incorporate any support.
RATING SENSITIVITIES
VRs, IDRs, AND SENIOR DEBT
Positive ratings momentum could be driven by further diversification of SYF's retail partners, a meaningful decline in the percentage of the loan portfolio comprised of nonprime borrowers, limited deterioration in credit performance, demonstrated ability to sustain above average profitability through credit and interest rate cycles, and continued shift in funding mix toward retail deposits.
Furthermore, Fitch believes the durability of Synchrony Bank's internet-based deposit platform in a rising rate environment will be a key consideration in evaluating the strength of the company's funding profile. Positive rating momentum could also develop from the company's ability to successfully execute on its product expansion and diversification strategy (general purpose cards and checking accounts) over time while maintaining strong underwriting standards and profit margins.
Negative rating momentum could develop from the loss or default of a key retail relationship, substantial credit quality deterioration, a meaningful reduction in capitalization or liquidity, an inability to access the capital markets on reasonable terms for funding, above average shareholder distributions, and/or potential new and more onerous rules and regulations. Negative rating momentum could also be driven by an inability of SYF to maintain its competitive position and earnings prospects in an increasingly digitized payments and consumer lending landscape.
The senior unsecured debt ratings are primarily sensitive to changes in the Long-Term IDRs of SYF.
LONG - AND SHORT-TERM DEPOSIT RATINGS
Synchrony Bank's uninsured deposit ratings are rated one notch higher than the IDR. The deposit ratings are primarily sensitive to any change in SYF's Long-and Short-Term IDRs.
HOLDING COMPANY
Should SYF's holding company begin to exhibit signs of weakness, demonstrate trouble accessing the capital markets, or have inadequate cash flow coverage to meet near-term obligations, there is the potential Fitch could notch the holding company IDR and VR from the ratings of the bank subsidiary.
SUPPORT RATING AND SUPPORT RATING FLOOR
Since SYF's Support and Support Rating Floors are '5' and 'NF', respectively, there is limited likelihood that these ratings will change over the foreseeable future.
Fitch has affirmed the following ratings:
Synchrony Financial
--Long-Term IDR at 'BBB-';
--Viability Rating at 'bbb-';
--Senior unsecured debt at 'BBB-';
--Short-Term IDR at 'F3';
--Support Rating at '5';
--Support Rating Floor at 'NF'.
Synchrony Bank
--Long-Term IDR at 'BBB-';
--Viability Rating at 'bbb-';
--Short-Term IDR at 'F3';
--Support Rating at '5';
--Support Rating Floor at 'NF';
--Long-Term Deposits at 'BBB';
--Short-Term Deposits at 'F2'.
The Rating Outlook is Stable.
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