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Edited Transcript of SYF earnings conference call or presentation 19-Jul-19 11:30am GMT

Q2 2019 Synchrony Financial Earnings Call

Stamford Jul 22, 2019 (Thomson StreetEvents) -- Edited Transcript of Synchrony Financial earnings conference call or presentation Friday, July 19, 2019 at 11:30:00am GMT

TEXT version of Transcript

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Corporate Participants

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* Brian D. Doubles

Synchrony Financial - President

* Brian J. Wenzel

Synchrony Financial - Executive VP & CFO

* Gregory W. Ketron

Synchrony Financial - Senior VP & MD of IR

* Margaret M. Keane

Synchrony Financial - CEO & Director

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Conference Call Participants

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* Betsy Lynn Graseck

Morgan Stanley, Research Division - MD

* Bill Carcache

Nomura Securities Co. Ltd., Research Division - Research Analyst

* Donald James Fandetti

Wells Fargo Securities, LLC, Research Division - Senior Analyst

* John Hecht

Jefferies LLC, Research Division - Equity Analyst

* Kevin J. St. Pierre

KSP Research - Founder

* Moshe Ari Orenbuch

Crédit Suisse AG, Research Division - MD and Equity Research Analyst

* Richard Barry Shane

JP Morgan Chase & Co, Research Division - Senior Equity Analyst

* Ryan Matthew Nash

Goldman Sachs Group Inc., Research Division - MD

* Sanjay Harkishin Sakhrani

Keefe, Bruyette, & Woods, Inc., Research Division - MD

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Presentation

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Operator [1]

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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. (Operator Instructions) 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.

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Gregory W. Ketron, Synchrony Financial - Senior VP & MD of IR [2]

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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 and presentation are available on our website, synchronyfinancial.com. This information can be accessed by going to the Investor Relations section of the website.

Before we get started, I wanted 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 website.

During the call, we will refer to non-GAAP financial measures in 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 webcasts are located on our website.

Now it's my pleasure to turn the call over to Margaret.

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Margaret M. Keane, Synchrony Financial - CEO & Director [3]

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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 Doubles 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 our 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 $1.24 per share included a reduction in the reserve related to the expected sale of the Walmart portfolio, which positively impacted results by $0.27.

Loan receivables grew 4%. On a core basis, excluding the Walmart 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 the 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 HVAC and Zero Motorcycles. During the quarter, we also launched our new program with Fanatics, the global leader in licensed 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 create broader acceptance and utility of our cards. We have been particularly successful in doing that with our CareCredit network. This quarter, we expanded our CareCredit network to include Lehigh Valley Physician's Group and the BaylorScott White Medical Center in Sunnyville, Texas. We also renewed our relationship with Bosley and launched our partnership with Lighthouse. We remain 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 and 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 Walmart portfolio. Loans were up 2%. But excluding the Walmart 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% of 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 receivables 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 card has yielded solid results. We now have nearly 7 million cardholders in our Synchrony Car 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.

CareCredit continued to generate solid growth. Receivables growth of 7% was led by our dental and veterinary specialties. Interest and fees on loans also increased 7%, primarily driven by the loan receivables growth. Purchase volume was up 7% and average active accounts increased 5%.

With new partners signed 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, increase 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.

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Brian D. Doubles, Synchrony Financial - President [4]

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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 have 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 there that programs work seamlessly across whatever channel the customer uses. That means that cardholders must have access to their cards, rewards and account information across all channels seamlessly. Innovation such as digital apply; digital servicing; and Synchrony Plug-in, or SyPI, have helped 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 prefill to minimize the number of fields an applicant needs to enter and can prequalify 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 in Amazon Alexa and Google Home where 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 app. 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 through 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 their 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 through the right channel at the right time.

The value of data analytics is 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 in this 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.

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Brian J. Wenzel, Synchrony Financial - Executive VP & CFO [5]

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Thanks, Brian. I'll start on 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 Walmart portfolio. The reduction totaled $247 million or $186 million after tax and provided an EPS benefit of $0.27 to the quarter.

We generated strong year-over-year growth in number of areas as noted on Slide 8. Excluding the Walmart 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 continued to deliver solid organic growth. Overall, we're pleased with the growth we generated across the business as well as the risk-adjusted returns on this growth.

Purchase volume growth was 12%, and average active accounts increased 9% over last year. RSAs increased $206 million or 32% from last year. Growth including the PayPal Credit program acquisition and improved program performance drove the increase. RSAs as a percentage of average receivables was 3.9% for the quarter, in line with our expectations. We continue to expect RSAs as a percentage of average receivables to be in the 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 6% from last year, mainly driven by the reduction in the reserve related to the Walmart 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 the PayPal Credit program. So overall, the company continued to generate strong results in the second quarter.

I'll 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 prefunding for the PayPal Credit program acquisition that was in line with our expectations.

We benefited from a 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 the net interest margin was a decline in loan receivables yield and an increase in interest-bearing and 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 Walmart portfolio sale later this year.

Next, I'll cover our key credit trends on Slide 10. In terms of specific dynamics in the quarter, I'll start 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 Walmart loan receivables to held for sale. The Walmart 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 the delinquencies on the $400 million in period-end loan receivables and high percentage of this receivables are delinquent and represent the majority of delinquent accounts in the Walmart portfolio in total, the exclusion of the $8 billion in held for sale from period-end loan receivables skewed the reported rates higher.

Also, impacting the delinquency rates is the addition of the PayPal Credit program acquired in the third quarter of 2018. If we exclude the impact of the PayPal Credit program and the Walmart portfolio, the 30-plus delinquency rate improved by approximately 10 basis points and the 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 the 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 rate to run closer to 1% we had reported in prior quarters looking back to 2018. While credit trends continued 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 Walmart 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 7.10% and the core reserve build in the second quarter was $114 million, excluding the impact from the reduction in reserves related to the Walmart portfolio and in line with our expectations. Looking forward, we expect the core reserve build for the third quarter will be in the $175 million range. This is higher than the second quarter due to 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 size of the Walmart portfolio that remains and held for investment.

Regarding future reductions in the loan loss reserve associated with the Walmart portfolio, we now expect the sale of the Walmart portfolio will 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 the reduction of the reserve will be around $250 million in the third quarter with the remaining reduction occurring in the fourth quarter when the portfolio is sold.

Regarding net charge-offs. The third quarter 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 in the 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 to expect net charge-offs for 2019 will be in the 5.7% to 5.9% range with a slight increase entirely driven by the impact to the PayPal Credit portfolio partially offset by the sale of the Walmart portfolio later this year. Excluding the impacts of PayPal and Walmart, net charge-off rate is expected to be similar to 2018.

Before I wrap up discussion on credit trends, I wanted to give you some visibility on our initial thoughts around the implementation of CECL beginning in 2020. We are finalizing our assumptions with alternatives that remain under evaluation, and we're 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 for 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. Also, the impact will depend upon the composition and asset quality of the portfolio, the economic conditions and forecast 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 stability 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 were 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 for 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 Walmart portfolio later this year. The efficiency ratio was 31.3% for the quarter to last year's 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 3-year term with a fixed rate of 2.34% and had strong demand and was significantly oversubscribed.

Turning to capital and liquidity. We ended the quarter at 14.3% CET1 under the fully phased-in Basel III rules. This compares to 16.6% 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 were pleased to announce our new capital plans 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 Walmart 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 equated 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 the 15.75% to 16% range for the year with a normal seasonality as well as some potential fluctuation around the Walmart portfolio sale later this year. RSAs as a percentage of average receivables was 3.9% for the quarter, in line with our expectations. We continue to expect the RSA percent to be in the 4.0% to 4.2% range for 2019.

Regarding credit. We expect the core reserve build for the third quarter to be largely driven by growth and a normal seasonality we see in the third quarter and will be in the $175 million range. We now expect the sale of the Walmart 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 around $250 million in the third quarter with the remaining reduction incurring in the fourth quarter when the portfolio is sold.

We still expect net charge-offs for 2019 will be in the 5.7% to 5.9% range with a slight increase over 2018 entirely driven by the impacts from the PayPal Credit portfolio partially offset by the sale of the Walmart portfolio later this year. Excluding the effects of PayPal and Walmart, 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. Decline from last year's second quarter to 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.

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Gregory W. Ketron, Synchrony Financial - Senior VP & MD of IR [6]

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That concludes our comments on the quarter. We will now begin the Q&A session. (Operator Instructions) Operator, please start the Q&A session.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And from Crédit Suisse, we have Moshe Orenbuch.

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Moshe Ari Orenbuch, Crédit Suisse AG, Research Division - MD and Equity Research Analyst [2]

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Great. Can you hear me? Can you hear me?

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Margaret M. Keane, Synchrony Financial - CEO & Director [3]

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Yes.

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Brian J. Wenzel, Synchrony Financial - Executive VP & CFO [4]

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Yes.

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Moshe Ari Orenbuch, Crédit Suisse AG, Research Division - MD and Equity Research Analyst [5]

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Sorry about that. So I guess maybe the -- given that you're now pretty close to the transitioning out of Walmart 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. It has the potential to expand significantly through. And so talk about how you're thinking about that as a vehicle for driving the overall loan growth.

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Margaret M. Keane, Synchrony Financial - CEO & Director [6]

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We're -- so first, I think the first thing that's really great, Moshe, is that we've completed the conversion, which was a fairly significant size 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 the merchant base of PayPal. So we see this as a big part of our growth story going forward.

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Moshe Ari Orenbuch, Crédit Suisse AG, Research Division - MD and Equity Research Analyst [7]

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Great. And maybe switching gears just a little bit. You -- despite getting a late start during the quarter, you were able to buy back 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?

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Brian J. Wenzel, Synchrony Financial - Executive VP & CFO [8]

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Great. Thanks, Moshe. The way I would think about it is you have the core capital return plan based upon our earnings. If you look at how the Walmart capital gets freed up, we have $522 million of reserves, which released in the first quarter, $247 million in the second quarter. We've guided to $250 million in the 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 in a cadence you can think about for 2019.

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Operator [9]

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From Jefferies, we have John Hecht.

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John Hecht, Jefferies LLC, Research Division - Equity Analyst [10]

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You guys spent a bit more time talking about digital innovation and kind of the 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?

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Brian D. Doubles, Synchrony Financial - President [11]

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Yes, John. This is Brian. 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 5 years. I think it's -- if you look at our investment in Payfone, our acquisition at 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 -- it's 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 cost, all the way through the back end making a payment and not having to call to 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 win new programs. So it's a real differentiator for us.

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John Hecht, Jefferies LLC, Research Division - Equity Analyst [12]

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Okay. That's helpful. And I guess you guys are the first card company to give -- this quarter to give some a little bit more detailed guidance around CECL. I'm wondering within the guidance you gave us, out of curiosity as much as anything, what's the duration that, I guess, in the different portfolios you have that they assigned or that you assigned?

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Brian J. Wenzel, Synchrony Financial - Executive VP & CFO [13]

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Yes. Thanks, John. We really can't get into too much detail around some of those assumptions, obviously. We're 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, whether there are accounts other than industry participants, and we generally believe we're in line with other card issuers.

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Operator [14]

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From JPMorgan, we have Rick Shane.

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Richard Barry Shane, JP Morgan Chase & Co, Research Division - Senior Equity Analyst [15]

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Congratulations, Brian and Brian, on your respective new role. When I look at the sort of preliminary work on CECL, that suggests, if you were to implement today, a CET1 in the high 11s, low 12s 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.

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Brian J. Wenzel, Synchrony Financial - Executive VP & CFO [16]

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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 2019 and going through the period 2020. As we think about capital, the posting of these additional reserves 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 the posting of these losses and really reduce our capital threshold, our CET1 threshold. That's discussions we've begun to have with our regulators and work out over time. But again, this loss absorption capacity that's being built through the posting of reserves should allow us to lower the CET1 ultimately over time is our belief.

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Richard Barry Shane, JP Morgan Chase & Co, Research Division - Senior Equity Analyst [17]

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Great. 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 saying?

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Brian J. Wenzel, Synchrony Financial - Executive VP & CFO [18]

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Yes. Our discussion with the rating agencies preliminarily has been that they don't believe CECL 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.

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Operator [19]

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From Goldman Sachs, we have Ryan Nash.

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Ryan Matthew Nash, Goldman Sachs Group Inc., Research Division - MD [20]

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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 talk about $150 million to $250 million of core reserve build, you are growing in the 8% to 9% range. So is that how we should maybe think about where loan growth could be headed over time?

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Brian J. Wenzel, Synchrony Financial - Executive VP & CFO [21]

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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. We had loan receivable growth of 3% in the first quarter, 4% in the second quarter. We've guided to a 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 CareCredit. And the broader acceptance is happening there as well as, as Brian has kind of highlighted, some of our fast-growing digital channel. So we do see an acceleration in the back half of the year in growth. And again, reserve should be primarily growth-driven as we move forward.

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Ryan Matthew Nash, Goldman Sachs Group Inc., Research Division - MD [22]

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Got it. And then maybe if I can ask a follow-up on Rick's question regarding CECL. 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 3-year phase-in.

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Brian J. Wenzel, Synchrony Financial - Executive VP & CFO [23]

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Yes, you're right. The capital impact will be phased-in over 3 years. As part of our capital plan that we submitted through regulators, we incorporated our initial estimate of CECL into that, and we obtain a work with them with regard to how that's treated. Again, we think about it as building loss absorption capacity, and our CET1 rate should come down over time and be in line with peers, first of all, but taking into account the fact that we're posting these higher reserves.

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Operator [24]

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From Nomura, we have Bill Carcache.

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Bill Carcache, Nomura Securities Co. Ltd., Research Division - Research Analyst [25]

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Sorry if I missed this, but my first question is for Brian Wenzel. 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?

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Brian J. Wenzel, Synchrony Financial - Executive VP & CFO [26]

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Yes. So -- 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 3 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, our 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 are comfortable 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 5 times since April this year. We've lowered the high-yield savings really relating to the competition in 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 CECL and Capital. They obviously know there's a large transition that's going on in the market participants, and they understand that. I think they're going to be fairly flexible in the short term.

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Bill Carcache, Nomura Securities Co. Ltd., Research Division - Research Analyst [27]

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That's great. And 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 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.

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Brian D. Doubles, Synchrony Financial - President [28]

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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, like these are all things that drive real efficiency for a company. So I would absolutely think about it as driving both top line growth, revenue growth as well as operating efficiency.

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Operator [29]

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From Wells Fargo, we have Don Fandetti.

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Donald James Fandetti, Wells Fargo Securities, LLC, Research Division - Senior Analyst [30]

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So Brian, so on the NIM, I think 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 internal. Is 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.

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Brian J. Wenzel, Synchrony Financial - Executive VP & CFO [31]

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Yes. The net interest margin was right where we expected it to be in line with expectations. As it moves sequentially, there was a decline in interest and fees, which is primarily related to the acquisition of the PayPal Credit portfolio, a slight shift in the alarm mix with our loan receivables down 50 basis points versus the first quarter and the 9 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%.

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Donald James Fandetti, Wells Fargo Securities, LLC, Research Division - Senior Analyst [32]

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Okay. And then I think Synchrony is largely through their underwriting adjustments that started back in 2015 or '16, but it seems like there's mixed signals out in the card business right now. At least in general corporates, you have companies like J.P. Morgan accelerating growth, top line rates and potentially raising the 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?

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Brian J. Wenzel, Synchrony Financial - Executive VP & CFO [33]

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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 time frame. 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're 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 Walmart being down year-over-year, that we see stabilizing credit trends. 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, I mean, 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.

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Donald James Fandetti, Wells Fargo Securities, LLC, Research Division - Senior Analyst [34]

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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.

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Brian J. Wenzel, Synchrony Financial - Executive VP & CFO [35]

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Recoveries, again, this quarter was 1.2% of our average loan receivables, so better than we expected and what we guided to really in -- 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 participants in the marketplace. So obviously, we're 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.

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Operator [36]

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From Morgan Stanley, we have Betsy Graseck.

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Betsy Lynn Graseck, Morgan Stanley, Research Division - MD [37]

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A question on -- I just wanted to understand a little bit about PayPal. I know you very nicely carved out the NCO ex PayPal and Walmart. I'm just -- and 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 significant loan growth and spend growth. I just wanted to understand how you're toggling that with the credit side.

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Margaret M. Keane, Synchrony Financial - CEO & Director [38]

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Yes. We work closely with PayPal in terms of how we're building out the growth strategies with them, and they're pretty sophisticated on the credit side. And 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 in the environment we're in right now. But I can say that the integration of the 2 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.

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Brian J. Wenzel, Synchrony Financial - Executive VP & CFO [39]

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The only thing I'd 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 off that portfolio really compensate for that. And again, when you contemplate that relative to Walmart exit later this year, obviously, from a credit perspective, we're better off as a company.

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Betsy Lynn Graseck, Morgan Stanley, Research Division - MD [40]

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Yes. No, definitely. And I'm thinking also that, obviously, this is a mobile online customer side. And as a result, we'd think that, that generates a little bit higher rev growth over all. Is that accurate?

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Margaret M. Keane, Synchrony Financial - CEO & Director [41]

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Yes, it's a fast-growing payment platform, I would say.

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Betsy Lynn Graseck, Morgan Stanley, Research Division - MD [42]

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And then just a follow-up question is regarding the outlook for capital. I know you touched on it earlier. But we've got the Fed coming up with this tailoring rule, and you guys don't even have to do CECL. I know you opt-in in your own way. But when you read that tea leaves of what's going on with how the Fed is thinking about the SEB and how it's thinking about the tailoring rule, should we be anticipating that you can have a lower start point for what your stress levels of capital are? Or does the -- 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."

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Brian J. Wenzel, Synchrony Financial - Executive VP & CFO [43]

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Yes. So let me just clarify. I wish we could say we can opt in as CECL. Unfortunately, that is a requirement for us. As I think about capital as we move forward, obviously, we're very comfortable with the resiliency and the earnings of our business the way in which it performs the returns of our business as well as the RSA offset. So when we look at that and begin to look at the impact of CECL, we believe that we're going to be able to drive down our CET1 ratio because right now, we're in excess of peers. We're migrating down from where 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 only expect an impact from those rules on us.

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Betsy Lynn Graseck, Morgan Stanley, Research Division - MD [44]

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Yes. So like 11-ish or something like that is really where peers are kind of triangulating to. So that's what makes sense for you?

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Brian J. Wenzel, Synchrony Financial - Executive VP & CFO [45]

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Yes. I can't comment an 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.

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Betsy Lynn Graseck, Morgan Stanley, Research Division - MD [46]

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Yes. No, 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?

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Brian J. Wenzel, Synchrony Financial - Executive VP & CFO [47]

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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.

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Operator [48]

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From KSP Research, we have Kevin St. Pierre.

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Kevin J. St. Pierre, KSP Research - Founder [49]

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Brian, I'd just like to better understand the 17 basis point decline in average credit card yields in the quarter. You touched on it a moment ago, but I just wanted to dig into that. Is it mix? Is it lower revolve rates? What drove that?

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Brian J. Wenzel, Synchrony Financial - Executive VP & CFO [50]

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Yes. So when you look at it, we are seeing slightly higher revolve rate in the core business and some of the impact again of the interest rates movements blowing in, moving into the portfolio. The yield decline is solely related to where -- the majority of it 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've begun to take effect into the book, but it took a long time under the new card act rule, 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.

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Kevin J. St. Pierre, KSP Research - Founder [51]

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Got it. And then as a follow-up, in terms of expenses and particularly marketing 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?

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Brian J. Wenzel, Synchrony Financial - Executive VP & CFO [52]

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Yes. It -- again, our marketing and business development line, that will fluctuate a little bit with regard to campaigns when we do reissuances, when we relaunch value proposition. So there is some variability with that. They were not a big spender in commercial 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 and spend tens of millions, hundreds of millions of dollars into that. It's more thoughtful branding. Again, we expect that to grow generally in line with their volume and loan receivable growth.

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Operator [53]

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And our last question comes from Sanjay Sakhrani with KBW.

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Sanjay Harkishin Sakhrani, Keefe, Bruyette, & Woods, Inc., Research Division - MD [54]

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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 Walmart as we think through the exit run rate into next year for the efficiency ratio. Should that be also a good guide for the efficiency ratio as we move into next year as you don't have those costs in the run rate?

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Brian J. Wenzel, Synchrony Financial - Executive VP & CFO [55]

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Yes. So let me deal with your margin question first, Sanjay. As we kind of go in there, we obviously get the run rate of PayPal from the CIT coming in. We're not providing today 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 Walmart portfolio coming at 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 most certainly have greater visibility to what the interest rate environment is doing.

With regard to expenses, again, we're projecting 31% or guiding 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'll 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 Walmart cost out and be any part of the year for some of the fixed costs. The back half of the year, particularly in the fourth quarter, you'll see the variable cost come out. Now we'll get into the run rate as we move into 2020.

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Sanjay Harkishin Sakhrani, Keefe, Bruyette, & Woods, Inc., Research Division - MD [56]

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Okay. And my follow-up question for Margaret is just simply on the sort of micro competitive environment because one of your peers talked about the online players being a little bit more competitive in the market. I think I've heard you guys talk about it as well. Maybe you can just flush that discussion out and just talk about the pipeline going forward because 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?

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Margaret M. Keane, Synchrony Financial - CEO & Director [57]

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Yes. I would say we're excited about where the business is positioned 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 can 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 2 to 3 years will come up, but our pipeline in all 3 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 start-ups.

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Gregory W. Ketron, Synchrony Financial - Senior VP & MD of IR [58]

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Thanks for joining us on the call this morning. The Investor Relations team will be available to answer any further questions you may have. We hope you have a great day.

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Operator [59]

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Thank you. Ladies and gentlemen, this concludes today's conference. Thank you for joining. You may now disconnect.