Synchrony Financial

Welcome to the Synchrony Financial Second Quarter 2022 Earnings Conference Call. My name is Vanessa, and I will be your operator for today's call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. During the question-and-answer session, if you have a question, please press 0, then 1 on your touch-tone phone. I will now turn the call over to Catherine Miller, Senior Vice President of Investor Relations.

You may begin. Thank you and good morning, everyone. Welcome to our quarterly earnings conference call. 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 or guarantee the accuracy of our earnings teleconference transcripts provided by third parties. The only authorized webcasts are located on our website. On the call this morning are Brian Doubles, Synchrony's President and Chief Executive Officer, and Brian Wenzel, Executive Vice President and Chief Financial Officer. I will now turn the call over to Brian Doubles.

Thanks, Catherine, and good morning, everyone. Synchrony continued to execute on our key strategic priorities and deliver strong financial results for the second quarter 2022, including net earnings of $804 million, or $1.60 per diluted share, a return on average assets of 3.4%, and a return on tangible common equity of 30.3%. These results were driven by Synchrony's differentiated business model and our deep understanding of the needs and expectations of our customers and partners. Consumer health also remained strong during the second quarter, which supported continued demand for the wide variety of products and services that our partners, merchants, and providers offer. As a result, Synchrony added 6 million new accounts, grew average active accounts by 4%, and achieved our highest purchase volume ever in a quarter of $47 billion, a year-over-year increase of 12%, or a 16% increase on a core basis. Dual and co-branded cards accounted for 38% of core purchase volume and increased 31% from the prior year. Consumer spend was broad-based across our platforms, leading to double-digit growth in our diversified value, health and wellness, digital, and home and auto platforms, as well as single-digit growth in our lifestyle platform. We also continue to see higher engagement across our portfolio as purchase volume per account grew by 8% compared to last year. The continued strength in purchase volume contributed to loan receivables growth of 5% year-over-year or 11% on a core basis. Our dual and co-branded cards accounted for 22% of core receivables and increased 27% from the prior year. We also continued to extend our reach and engage more customers, thanks to our ability to deliver our seamless experiences attractive value propositions, and broad suite of flexible financing options across our ever-growing network of distribution channels. To that end, we recently announced the launch of Synchrony SetPay, Pay in Four, through Pfizer's Clover point-of-sale and business management platform. This Buy Now, Pay Later offering further expands the suite of payment and financing options and will be part of the Pay with Synchrony app on the Clover app market for merchants. Through our partnership, Synchrony is able to expand our customer reach and distribution through hundreds of thousands of small businesses across the country. Synchrony's long-term partnership with AdventHealth, one of the largest not-for-profit healthcare providers in the U.S., is another example of how we continue to expand and deepen our reach in health and wellness. AdventHealth will offer CareCredit as its primary patient financing option and will accept Care Credit nationwide in more than 130 facilities, including hospitals, urgent care centers, outpatient clinics, and physician practices. As out-of-pocket health expenses continue to rise for consumers, Synchrony's Care Credit is a way for people to pay for care not covered by insurance, including deductibles, coinsurance, and copays. Care Credit's flexible financing options will be available for all points of care, and within the patient's AdventHealth account, which includes Epic's MyChart portal, enabling patients to manage their care needs alongside the resulting financial obligations. In addition to extending options for consumers to pay for care, CareCredit will also help streamline the health system's payment processes. In short, synchrony is increasingly anywhere our customer is looking to make a payment or finance a purchase, big or small, in person or digitally, We can meet them whenever and however they want to be met with a broad range of products and services to meet their needs in any given moment. This ability to deliver the versatility of our financial ecosystem seamlessly across channels, industries and retailers, and providers alike is what positions Synchrony so well to sustainably grow, particularly as customer needs change and market conditions evolve. We have one of the largest active account bases in the U.S. with more than 65 million active accounts, and yet our typical customer has less than two of our products on average. As we continue to expand our distribution channels and more effectively leverage our various marketplaces and networks, Synchrony can connect our partners with more customers and drive still greater lifetime value expansion. Take, for example, our home and auto care networks. where combined annual visits surpassed 300 million last year. And carecredit.com, which received almost 19 million provider views in 2021. As well as 19 health systems across the country and our strategic partnerships with point of sale platforms like Clover. No matter how you look at it, Synchrony is increasingly delivering the power of our networks on behalf of both our customers and our partners. Whether it's through the expansion of our existing customer wallet share, or increasing our reach to new customers, we are driving efficient and sustainable growth because of our increasingly ubiquitous presence and the universal utility of our offerings. From revolving lines like our private label, dual and co-branded cards, to our broad range of installment offerings and secured and commercial products, Synchrony's financial ecosystem can deliver the right financing offer for the right product at the right time. all while optimizing the value they see. And, of course, this is all enabled by our dynamic technology stack. Synchrony has prioritized innovation for many years and have the digital capabilities to facilitate deep integrations with sophisticated partners, as well as simple functionality for smaller local businesses. We can be as plug-and-play or as customized as necessary without increasing our level of investments. As Synchrony leverages our proprietary data, analytics, and underwriting through these integrations, we deliver not only seamless experiences, but also consistently powerful outcomes for both our customers and partners. The breadth and depth of our consumer lending expertise informs every aspect of our customer and partner strategies and allows us to support them and provide a great experience. The level of continuity that Synchrony provides across channels spend categories and partners, as well as through business and market changes, drives both loyalty and resilience for Synchrony and our stakeholders. From partners with digital omnipresence across spend categories and point of sale, and merchants that offer great value across discretionary and non-discretionary needs, to providers like doctors and dentists and major health systems like AdventHealth and St. Luke's, and practice management software like Epic. Synchrony is increasingly at the center of a broad range of financing needs, empowering our customers with choice and best-in-class value propositions that truly make a difference. This drives greater diversity and resilience in our portfolio, both in terms of our sales platforms and the industries we serve, as well as consumer spend categories. Our customers finance everyday purchases like gas, groceries, and routine medical expenses, as well as more episodic needs, like buying a new mattress or replacing a refrigerator. They derive great value from our general purpose and dual and co-brand cards, coupled with the best-in-class rewards they can earn on their spend. About half of our out-of-partner spend is comprised of non-discretionary spend like bill pay, discount store, drug store, health care, grocery, and auto and gas. And, of course, Synchrony also derives resilience from our disciplined approach to growth at appropriate risk-adjusted returns. Our sophisticated data analytics and our proprietary underwriting have enabled Synchrony to reach more customers and offer them greater financial flexibility while also maintaining or improving upon the predicted level of risk. In fact, since 2009, Synchrony has more than doubled our purchase volume, receivables, and interest income, while also growing our mix of prime and super prime customers by 14 percentage points. Meanwhile, we've built a very strong balance sheet, including a stable deposit base that represents more than 80% of our funding at any given time, consistent and efficient access to the debt capital markets, and a robust capital and liquidity position, such that we currently operate with 15% CET1 ratio and a 25% Tier 1 and credit reserve ratio. So when you bring it all together, Synchrony is uniquely positioned to deliver sustainable growth and resilient risk-adjusted returns even as market conditions change and the needs of our customers and our partners evolve. We leverage our proprietary data and analytics, diversified product suite, and dynamic tech stack to maintain low customer acquisition costs, deliver consistent credit performance, and drive greater customer lifetime value. We align our partners' interests with our own through retail share arrangements, which are designed to deliver consistent risk-adjusted returns for synchrony through changing market conditions. while also sharing program profitability with our partners. And we utilize a stable and efficient funding model to provide continuity to our customers and partners when they need it most. And with that, I'll turn the call over to Brian to discuss the second quarter financial performance in greater detail.

Thanks, Brian, and good morning, everyone. Synchrony delivered another strong financial performance for the second quarter, highlighting the benefits of our highly diversified business across our sales platforms, our partners, merchants, providers, and customers, and underpinned by the continued health of the consumer. This quarter, we achieved the highest quarterly purchase volume as a company, exceeding $47 billion, which reflected a 12% increase compared to last year. On a core basis, which excludes the impact of our recently sold portfolios in the prior and current year quarters, purchase volume grew 16% year-over-year. From a platform perspective, our diversified in value, health and wellness, digital, and home and auto platforms each continue to generate double-digit year-over-year growth in purchase volume, reflecting strong demand for the variety of goods and services we finance, as well as the broad partner merchant and provider networks that connect our customers and partners. At the platform level, Home and auto purchase volume was 12% higher due to continued strength in home as well as higher auto-related spend, reflecting the waning effects from the pandemic period, the preference for consumers to invest in the maintenance of their existing vehicles given the supply chain issues on new and used vehicle sales, and the impact of inflationary pressures on gasoline purchases and automotive parts. In diversified value, purchase volume increased 24% driven by the strong retailer performance and higher customer engagement. The 14% year-over-year increase in digital purchase volume generally reflected the growth across the platform. We experienced greater customer engagement, including higher average active accounts and spend per active among our more established programs and continued momentum in our new program launches. The 15% increase in health and wellness purchase volume was driven by broad-based growth in active accounts and higher spend per active account driven by our dental, pet, and cosmetic categories. Our lifestyle platform generated purchase volume growth of 2%, reflecting strong retailer sales and growth in our music, specialty, and luxury verticals, partially offset by the ongoing impact of inventory shortages in our outdoor vertical, and particularly strong growth in the prior year period. Loan receivables grew 5% year-over-year to $82.7 billion, or 11% on the core basis. We also continue to see sequential growth driven by strong purchase volume and partially offset by higher payment levels. Net interest income increased 15% to $3.8 billion, primarily reflecting the 13% increase in interest and fees due to higher average loan receivables. Payment rate for the second quarter, when normalizing for the impact of the portfolio sold during Q2, was 18.1%, approximately 20 basis points higher than last year, and approximately 250 basis points higher than our historical average. The net interest margin was 15.60% in the second quarter, a year-over-year increase of 182 basis points. The primary driver of our NIM expansion was a 570 basis point increase in the mix of loan receivables relative to total interest-earning assets, primarily due to the growth in average receivables and lower liquidity. This accounted for 105 basis points of the year-over-year increase in our net interest margin. In addition, the second quarter's 80 basis point improvement in loan yield contributed to a 63 basis point improvement in net interest margin, while the slight increase in interest-bearing liability costs reduced net interest margin by one basis point. RSAs were $1.1 billion in the second quarter and 5.42% of average receivables. The $121 million year-over-year increase was primarily driven by the continued strong performance of our partner programs and also included an approximate $10 million impact associated with our reinvestment of the gain on sale from portfolios sold during the second quarter. The reinvestment was in support of the growth initiatives in association with the value proposition launch. As a reminder, the RSA is designed to create mutual alignment of interests. While each agreement is unique to the partner program, we generally structure the majority of our economic arrangements such that the investment and upside opportunities are shared. So as slide seven demonstrates, the RSA enables our partners to share in the profitability of our programs while also providing economic protection to our business. In a rising credit loss environment, the level of RSA payment to our partner declines because the higher credit costs become a larger offset to the program's profitability. In addition, the minimum profitability threshold within each RSA ensures that Synchrony achieves an appropriate risk-adjusted return before any incremental program economics are shared with the partner. These minimum return thresholds also provide a buffer to our business in the occasional event of a regulatory change, such that the profitability of the program performance is impacted by, for example, a change in fees collected. This dynamic also is demonstrated in size seven due to the strength of our risk-adjusted return when the CARD Act became effective in 2011. Given the questions regarding the potential changes to late fee regulation, I thought I'd highlight two things. First, over 60% of our late fee revenue flows through our RSA agreements and would be subject to sharing with our partners. Second, greater than 95% of the late fees are covered through either repricing rights or change in law provisions, effectively change in regulation provisions. which were included in our program agreements adopted after the CARD Act was implemented. This is another example of how the RSA functioned as alignment of interest with our partners as market conditions change. Next, let's focus on provision for credit losses, which was $724 million for the quarter, a year-over-year increase due to the impact of a reserve release last year and partially offset by lower net charge-offs. Other income increased $109 million, primarily reflecting the impact of the $120 million gain on sale from the portfolio sold during the quarter. Excluding the impacts of the gain and certain reinvestments of the portion of the proceeds, other income would have been 3% lower year over year, primarily due to the impact of higher loyalty costs that were partially offset by interchange revenue year over year. Other expenses increased 14% to $1.1 billion, due to the impact of higher employee costs, marketing spend, information processing, and other expenses. Our efficiency ratio for the second quarter was 37.7%, compared to 39.6% last year. Excluding the effects of the reinvestment expenses deployed from the gain-on-sell proceeds, the efficiency ratio would have been 36.8%, an approximate 280 basis point improvement. The increase in employee costs versus last year reflected higher headcount, driven by growth and insourcing, as well as higher hourly wages and other compensation adjustments. Total other expenses included $62 million of costs related to additional marketing and site strategy actions as we reinvest the $120 million gain on sale through these and other growth and efficiency initiatives. As detailed in the appendix of our presentation, We expect that the gain on sale and reinvestment in Q2 and the remainder of this year will net out as EPS neutral on a full year basis. In summary, Synchrony generated net earnings of $804 million, or $1.60 per diluted share for the second quarter. We also generated a return on average assets of 3.4% and a return on tangible common equity of 30.3%. These strong net earnings and returns demonstrate the power and efficiency of our digitally-enabled model, combined with the compelling value of the financial products and services we offer through our financial ecosystem. Not only were we able to support the strong customer demand with a diverse range of products, but we're able to do so while maintaining cost discipline and strong risk-adjusted returns. Next, I'll cover our key credit trends on slide 11. At a macro level, we continue to see signs of gradual normalization across the credit spectrum of the portfolio. That said, even with this normalization, our 2021 and 2020 vintages continue to perform better than our 2019 vintages, and payment rates remain elevated versus last year, as well as compared to our historical average. With regard to delinquency, our 30-plus delinquency rate was 2.74%, compared to 2.11% last year, and our 90-plus delinquency rate was 1.22% compared to 1% last year. The year-over-year delinquency comparisons were primarily impacted by the prior year period's historic lows, at which point the impacts of COVID-19 stimulus and forbearance action had the greatest impact on the portfolio. Our portfolio's strong delinquency trends have continued to drive year-over-year improvement in our net charge-off rates, which was 2.73% compared to 3.57% last year, an 84 basis point improvement year over year, primarily reflecting the very strong consumer. Our allowance for credit losses as a percent of loan receivables was 10.65%, down 31 basis points from the 10.96% in the first quarter. Let's focus on some key trends that continue to support our strong performance and confidence we have in our business. First, the consumer remains in a strong position. The combination of robust labor markets, wage growth, and elevated savings continues to support the desire to spend and repay their financial obligations, while also managing through the impacts of the inflationary pressures. According to external data, stimulus spending segments have generally remained consistent from March through June. About two-thirds of consumers have either spent a portion of their stimulus or have the entire amount of stimulus they received still saved. The remaining third of consumers have spent the entirety of the cash stimulus they received during the last two years. When taking a look across the balance tiers, the top two tiers of the stimulus recipients, those with balances above $2,500, have seen modest balance decreases, while the lower tier, balances less than $2,500, have remained flat. During the second quarter, consumers rotated their spend within discretionary and non-discretionary categories as they managed higher costs from inflationary pressures while still fulfilling their everyday purchases. In general, we saw a slight variability across our out-of-partner spend volume and frequency trends. These fluctuations likely indicate that the consumer is not actively reducing total spend or frequency, but rather rotating their overall spend. So, for example, in certain categories like grocery, it appears that our customer is managing to ticket size and substituting items that are a greater priority, whether that means choosing a generic brand or forgoing a less desired item or treat. In terms of gas station spend, however, average transaction values have accelerated with rising gas prices, but transaction frequency has generally held constant, if not increased slightly. All this is to say we continue to see trends of a strong consumer who's moving through their day-to-day and spending money without meaningfully changing their choices or priorities. Second, the differentiated strengths of our business, as well as the underlying trends within our portfolio that we have discussed today, continue to demonstrate Synchrony's ability to deliver consistent, risk-adjusted returns through changing market conditions. In addition to the inherent resilience that comes from the diversification of our portfolio across spend categories, financing options, distribution channels, and customer demographics, Synchrony derives financial strength through our sophisticated, cycle-tested underwriting. The predictive power of our credit decisioning and account management capabilities supports more stable loss performance around our target credit loss range of 5.5% to 6%, even as economic conditions change and consumer creditworthiness evolves. From 2009 peak loss rate of 10.7% during the great financial crisis, the last decade's average of approximately 4.5% loss level, our portfolio has grown and evolved meaningfully. And even as the mix of partners and credit quality of our portfolio has shifted over that same decade, synchrony has grown significantly. and delivered resilient risk-adjusted returns within a band of 8.5 to 11%. It's also important to note that we've delivered these returns even as interest and fees have been coming at somewhat lower levels due to the elevated pay rates during the last two years. Moving on to another Synchrony strength, our funding, capital, and liquidity. Synchrony's balance sheet has been built to be resilient. Over time, we've diversified our business in support of our ability to generate consistent risk-adjusted returns, and considerable capital. This, in turn, has allowed us to grow and evolve our balance sheet such that we can fund growth efficiently without having to make trade-offs with regard to what's in the best long-term interest of our business and our various stakeholders. Let's start with the strong and stable foundation of Synchronize Funding, our deposit base. Deposits at the end of the second quarter reached $64.7 billion, an increase of $4.9 billion compared to last year. Our securitized and unsecured funding sources declined by $1.3 billion. This resulted in deposits being 84% of our funding compared to 81% last year, with both securitized and unsecured funding each comprising 8% of our funding sources at quarter end. Total liquidity, including undrawn credit facilities, was $18.9 billion. which equated to 19.8% of our total assets, down from 23% last year. As a reminder, before I provide the details on our capital position, it should be noted that we elected to take the benefit of the CECL transition rules issued by the joint federal banking agencies. The impact of CECL has already been recognized in our income statement and balance sheet. The annual transitional adjustment pertains strictly to our regulatory capital metrics. we ended the quarter at 15.2% CT1 under the CECL transition rules, 260 basis points lower than last year's level of 17.8%. The Tier 1 capital ratio was 16.1% under the CECL transition rules compared to 18.7% last year. The total capital ratio decreased 270 basis points to 17.4%. And the Tier 1 capital plus reserve ratio on a fully phased-in basis decreased to 25% compared to 28% last year. We continue to deliver robust capital returns to our shareholders. In the second quarter, we returned $809 million to shareholders through $701 million of share purchases and $108 million of common stock dividends. When considering our existing capital position today, Combined with the meaningful earnings and capital generation of our business, Century is particularly well positioned to execute our capital plan as guided by our business performance, market conditions, and subject to our capital plan and any regulatory restrictions. As a quarter end, our total remaining share repurchase authorization for the period ending June 2023 was $2.4 billion. Finally, let's review our full year outlook. which is summarized on slide 14 of our presentation and incorporates the following macroeconomic assumptions. Ten interest rate increases during 2022, qualitative tightening measures, a slowing economy resulting from these actions, continued higher inflationary conditions, and no additional impacts from the pandemic. We continue to anticipate broad-based strength in purchase volume as consumer savings declines and payment rate moderates, While on a lag, we also expect purchase volume growth to moderate. Given the strong purchase volume and loan receivables growth we've achieved in the first half of this year, we expect ending loan receivables to grow in excess of 10% versus the prior year. To the extent that payment rate moderates further, we would anticipate purchase volume to moderate and loan receivable growth to accelerate. We expect our net interest margin to be approximately 15.5% for the full year. As we move through the back half, net interest margin will be modestly lower due to the impacts of seasonal funding to support growth. Our net interest margin outlook also reflects the anticipated impact of rising benchmark rates, as well as the increase in interest and fees driven by the prime rate movement and payment rate moderation. Higher interest and fees will be partially offset by the impact of reversals as credit normalizes and the impact of benchmark rates on funding. To that end, we now expect net charge-offs of approximately 3.15% for the full year, reflecting the strong credit performance we experienced in the first half. As we move through the second half of the year, we continue to expect delinquency to rise modestly. We continue to expect reserve builds in 2022 to be generally asset-driven, absent a meaningful change in the macroeconomic environment. RSA expense will continue to reflect the impact of strong program performance and robust purchase volume growth, but should continue to moderate as net charge-offs rise. We now expect RSA as a percent of average loan receivables to be approximately 5.25% for the full year. In terms of other expense, we continue to expect quarterly levels to be approximately $1.05 billion. This outlook excludes the impact of the $120 million gain on sale that we are reinvesting in our business this year. As a reminder, we deployed $80 million of the gain on sale proceeds in 2Q and expect to deploy the remaining $35 to $40 million in the second half, such that the gain in reinvestments will be EPS neutral for the full year. We remain committed to delivering positive operating leverage. To the extent that our receivables or revenue growth is not tracking ahead of expense growth for the full year, we will moderate our spending where appropriate while still prioritizing the best long-term investments. An example of such is the opportunity might be to lower the workforce additions or reducing other discretionary spending. So to conclude, Synchrony is operating from a position of strength as we progress through 2022. We're confident in our business's ability to continue to deliver sustainable, attractive, risk-adjusted growth and resilient, peer-leading range of risk-adjusted returns, even if market conditions change. I'll now turn the call back over to Brian for his closing thoughts.

Thanks, Brian. Very few consumer financing providers in the market today have Synchrony's unique combination of broad customer base and wide range of partners and providers, diverse product suite and deep distribution channels, innovative technology capabilities, and robust funding capital and liquidity. Synchrony's core strengths enable us to consistently and efficiently connect our customers and our partners and provide continuity through high-quality outcomes, including the right financing product at the right time with attractive value propositions and a best-in-class experience for our customers. Incremental customers with stronger lifetime value for our partners and sustainable growth and consistently strong risk-adjusted returns for our stakeholders. And with that, I'll turn the call back to Catherine to open the Q&A.

That concludes our prepared remarks. We will now begin the Q&A session. So that we can accommodate as many of you as possible, I'd like to ask the participants to please limit yourself to one primary and one follow-up question. If you have additional questions, the investor relations team will be available after the call. Operator, please start the Q&A session.

Thank you. We will now begin our question and answer session. If you have a question, please press zero, then one on your touchtone phone. If you wish to be removed from the queue, please press 0, then 2. If you're using a speakerphone, please pick up the handset first before pressing the numbers. Once again, if you have a question, please press 0, then 1. And our first question is from Ryan Nash with Goldman Sachs.

Hey, good morning, everyone.

Hey, Ryan. Good morning, Ryan.

So, Brian, maybe can you unpack the net interest margin guide in a bit? I think you said 10 hikes, which is a little below the market. And I guess... Is the change in guidance reflective of the outperformance or any other drivers? And maybe can you just talk about the deposit pricing strategy from here, given the pace of hike and what's included for betas in terms of the updated margin guidance?

Yeah, thanks, Ryan. I'll try to unpack that question in pieces. So the first is when we look at our reserve modeling and how we think about the back half, we use 10. We're probably at 13 now. you know, as we said in the past, we are generally interest rate insensitive. We're $1.4 billion liability sensitive now. So the fact that the rates kind of come through does not have a big impact on our business and really shouldn't affect or shouldn't really impact our net interest margin in the back half of the year, number one. You know, as you think about deposit betas, you know, this has been an interesting topic. And I think, people are looking back really to the last cycle quite a bit with regard to the betas. And I think the important part is to understand for us as, you know, our issuer-specific book, you know, we do have a bigger shift between savings and CDs. The duration is down a little bit from what used to be 11 months to five, but we're, you know, we're 57, 60 percent savings now. When you look at the rates start, you know, where the rates were at the start of the cycle, they were much higher than what they were at the start of this cycle. So beta is a little bit higher. It's competitive. We're going to continue to move with the market, but we have a lot of growth to fund in the back half of the year. So the deposit bids will be slightly higher than the past cycle, but clearly manageable. I think as we think of margin in the back half of this year, the real key is going to be how much liquidity we have in our average interest earning assets. So we expect that whatever the interest-bearing liability cost increase will be largely offset with higher interest and fee income. So that will be almost, I'll call it neutral, so to speak, in the back half. And then you're just going to feel the effects as we move into the third quarter to pre-fund growth for the fourth quarter. That will cause what I would call a normal seasonal decline in margin as we move forward.

Got it. And if I can ask a follow-up maybe for both of you. So, you know, the reserve today is 10.65%, still above day one CECL, despite obviously very low losses. Now, I know this partially is hard to answer, but can you maybe just help us understand how you think about reserve building in a modest downturn, maybe relative to past cycles? And can you maybe just talk about how you think about the relationship between rising unemployment and losses, you know, in a recession, just given... the strong liquidity position that Brian Doubles had outlined that consumers are in in the prepared remarks?

Yeah, let me take that, Ryan. So I think if you were to think about where we are from a delinquency standpoint, our reserve just on a model basis, right, a pure model would probably be lower than day one today. So I know a lot of folks are sitting around saying, well, you're approaching day one. Given the credit performance, you would argue that it probably would have been lower than day one if we were back in that period of time. I think as we move forward, you know, we're going to see the relationship that you normally see between unemployment and charge-offs will hold for a little bit. But I think given where it is, how low it is, given the high amount of savings, similar to what we saw both back in 20 and back in the GFC, you'll probably break correlation between unemployment and that charge-off rate. So I think... You know, it's important to watch that, but it's also going to be important the actions we take. I think as people think about the path to normalization, I think some people are underestimating. We're at such a low rate now, we have the ability to take actions to control the charge-off to the extent the macroeconomic environment deteriorates quickly. That's very different than if we were at our mean, that charge-off rate. So we would anticipate reserves as we move forward to mainly be growth-driven. And we hopefully will be able to manage if the macroeconomic deteriorates inside of what we think that mean loss rate is.

Yeah, I think Ryan just expanded on that a little bit. You know, we've been pleasantly surprised all year by the strength of the consumer. You know, we're running at below half of our target loss rate in the business. So to Brian's point, we've got a lot of room to move and we'll have plenty of time to move if we need to, if we start to forecast. you know, a worsening macroeconomic scenario as we head into 23. But, you know, the consumer from all aspects, whether you look at spend, whether you look at credit, at this point in time, it's still really strong. I think they've got the excess savings. I think two-thirds of customers either saved a portion or all of the stimulus. So that's going to take a few quarters to burn through, and we'll You know, we're looking at this every day, and if we think, you know, as we move into 23, I think we feel really good about how we're positioned for the balance of this year. But as we move into 23, if we need to make some modifications to kind of keep us within our target loss rate, we'll absolutely do that.

Thank you. We have our next question from Moshe Orenbach with Credit Suisse.

Great, thanks. And Brian Doubles, you had talked a little bit about offering of additional products to existing customers. Maybe I was hoping you could kind of expand on that a little bit, maybe talk about, you know, how you can, you know, how you could do that, what areas of the portfolio you think are best, you know, kind of situated for that, and maybe what that could add to your growth rate over, you know, the intermediate term.

Yeah, sure, Moshe. I think this is one of the most exciting things that we're working on, frankly, is this multi-product suite and these offerings for our partners. And one of the things that's changed really over the last, I would say over the last six months, is partners in our discussions with them, they realize that there's an opportunity for them to rationalize and be a little more thoughtful about their point of sale and the products that they offer their their customers. And this is where we think we actually have a big advantage in that we've got a very robust product suite, whether it's a pay-in for a longer-term installment, private label, co-branded dual card. We think of it almost like a menu where we can go into a partner and say, look, this is what we have. These are the products that we think fit your customer based on their purchases and their spend patterns. And they're pretty excited about that. And I think that the benefit also for us is we can do that in a way where we're earning a very attractive return. And at the same point, we should be able to reduce costs for our partners. And so I would just tell you there's a lot of engagement, both big partners as well as small to mid-sized partners. And the other big part of this that we don't spend enough time talking about is just the integration model. And I think this is a big differentiator for us as well. So as you know, we have big partners. We have small partners and providers in health and wellness. And they have, I would say, different needs in terms of how we integrate with them. So we'll have a big partner that is very interested in, you know, a robust, full API technology stack integration so it's seamless within their app. You know, Venmo is a good example of that. all the way down to the small dentist, you know, who needs something very simple where the customer can just apply, you know, while they're sitting in the waiting room. And we can offer that spectrum of integration solutions. That's a really big deal because the one thing that we've seen, which is really important right now, is, you know, the technology resources that sit inside of our partners, whether big or small, they don't have the bandwidth, frankly, and we need to make it super easy for them to to integrate our products, our solutions, give them access to those financing options. Clover is another great example. We just announced we're opening up SEPPAY Pay in 4 inside of our app, which sits on the Clover platform. That's a really big deal because that allows us to build something once and distribute it to thousands of partners all at the same time. So if you think about our strategy to take a step back, you really have to think about it as having a very comprehensive product suite to meet the needs of, you know, very different and diverse partners. But then also, what are your integration strategies and how do you make that seamless and easy for the partner base? So, again, one of the most exciting things that we're working on across the business right now.

Perfect. Thanks. And just as a follow-up, from a credit standpoint, as you started the year, there was some caution, I guess. You had some caution about how some of your customers who had been, let's say, you might perform. And obviously, you know, that concern has kind of burned through. Could you just talk a little bit about, you know, and you mentioned a lot about the state of the liquidity of your customers. What are you looking at to kind of gauge, you know, their health at this stage? I mean, what are the, you know, what are the key things that you would look at and say, wow, that's, you know, now that's better or, you know, or we're seeing that normalization continue? Thanks.

Yeah, thanks Moshe. So I think when we think about the consumer today, you're right. The ones that received all plus forbearance was ones we tracked very early on in the year. We continue to watch very closely the population of people who are still on student loan forbearance. So we're tracking that population of people as they move through. You know, from a performance standpoint, we look at a couple different things. We obviously look at, you know, how a spending behavior pattern changes. We drill in from a credit standpoint. We drill into payment behavior pattern increases and watch who is paying statement pay, who's paying the minimum pay, who's paying between those two, and see if we see any dramatic shifts that are occurring inside those populations. And we look at that relative to credit grade. And, again, we have not seen any real signs of broad-based deterioration. Certain cohorts have migrated back to 2019-ish pandemic levels, but we have not seen broad-based deterioration. That goes into the low unemployment. That goes into hourly wages. It goes into increased savings. So there's a lot of things that are still in there. So we're watching a lot with regard to spending and behavioral patterns that are in there. And, again, population of people, really, I think the student loans are the ones that are the greatest interest to us right now.

Thank you. We have our next question from Betsy Grosick with Morgan Stanley.

Hi, good morning.

Good morning, Betsy.

Brian Doubles wanted to just dig in a little bit on the credit quality of the book. You mentioned during your remarks about how the portfolio has been skewing to prime, super prime, and wanted to get your sense as to how you're thinking about that trajects over the next year or so, maybe even just a couple of quarters if you want. I'm wondering if you're anticipating that with the new programs that will continue and how that is at all ameliorated by the increase in the near prime, subprime portfolio, you know, increasing their borrowing as inflation continues to kick in here. Just wondering how you think that trajects. Thanks.

Yeah, look, I'll start and ask Brian to comment. Look, I think the portfolio has never been in better shape than it is right now, no matter how you look at it. You know, you look at the delinquencies, the loss rate at roughly half of what we would target in this kind of environment, coupled with the fact that we've seen this really strong migration, which has been intentional over time, to skew more prime and less subprime. And I think you know, we're not contemplating anything as we move into the back half of this year or into 23 that would change that profile. You know, we feel, again, really good about the operating environment right now. If you remember, you know, going back when losses started to reach these all-time lows, we didn't take the opportunity to open up on underwriting. You know, if anything, what we did was we kind of we kind of dialed back some of the cuts that we made or modifications that we made in the beginning of the pandemic, but we stayed very disciplined. And there were clearly opportunities where we could have went deeper, where we could have put our foot on the gas, but we knew that, you know, we were in this window where the consumer was really strong or benefiting from the stimulus, but we didn't take that opportunity to go a lot deeper. In fact, we maintained our discipline. And that's how we're going to continue to to run the business through the back half of the year and into 23. And so I wouldn't envision a big shift in that prime, near prime mix. I don't know, Brian, if you'd add anything.

Yeah, the two things I'd probably add is, one, origination of new accounts today under indexes into non-prime. So I think from that standpoint, to echo Brian's comments, we're not leaning in there. Lines continue to be lower in the non-prime segment than pre-pandemic levels. I do think over the course of time you will see the non-prime migrate up a little bit as you continue to see the unwind of score migration that happened during the pandemic and as balances return back to a more normalized level. But that's not really underwriting driven. That's really reversal of the trend that you saw during the pandemic.

Okay, and then on the follow-up, this is a really nitty-gritty. gritty little question, so sorry for the question, but on page 14 in the guide, on credit normalization, you're saying that DQs, you know, credit normalization will continue with DQs rising modestly in 2H22, and I think in the last deck, you used the word slow rise, so what am I supposed to take from that? Like, modestly and slow rise seem to me to be the same type of message, but maybe I'm wrong there.

Yeah, you know, Betsy, first of all, we do appreciate all questions, even if they are nitty-gritty. So what I tip back and say, you're going to see, you know, it's not changing perspective with regard, you know, credit has overperformed in the first half of the year, which means the starting point in the back half is a little bit differently, but we don't see a drastically different trajectory from where we are here through the end of the year. Credit will be better for the entire year than when we sat here, you know, 90 days ago and most certainly six months ago. But, you know, we feel really good about credit as we move through the back half of the year, and we feel good how that sets us up, to be honest with you, in 23, even given the uncertain macroeconomic background.

Thank you. We have our next question from John Pencari with Evercore ISI.

Morning. Morning, John. Back to the reserve, your comment that the reserves build from here should be more asset driven. Does that mean that you think a stable reserve ratio is likely for the near term? And then also from a CECL perspective, I know you indicated in your broader economic guidance the expected economy to slow. So even from a CECL perspective, wouldn't that warrant some credit related reserve build as the economic scenarios that you factor in worsen? Thanks.

Yeah, thanks for the question. So the way we look at the model, you know, obviously we have the base credit model that looks at the delinquency formation today and how that rolls out to loss over our reasonable supportable period. We have done a number of overlays on there which are more stressful with regard to how the consumer will will evolve and how the macroeconomic situation evolves. So I think with those overlays, you get to a point where we have, you know, what I would call an elevated reserve relative to day one CISO and where the portfolio sits today after that. So I think as you think about moving forward in the environment to the extent that an adverse situation, an adverse macroeconomic situation develops, those overlays in theory become embedded into the core reserve model And therefore, you have growth-driven reserve here over the near term.

And thank you. Our next question is from Sanjay Sakrani with KBW.

Thanks. Good morning. I guess the first question is on the RSA. Obviously, you guys expect it to now be at the low end of the prior guidance. I'm just curious what's driving that. I was a little surprised because the loss rate also is expected to be lower than that usually is. The two kind of work in inverse ways. So maybe you could just talk about that, Brian Wenzel.

Yeah, you have two different dynamics. You have obviously some of the operating favorability that you have coming through. There is mix that comes through here as well as gap coming out of the portfolio that brings you back down. That operated at a slightly higher RSA percent. All that brings you down to the lower end of the range.

Okay. And so going forward, we should expect it to be more – correlated to the various operating metrics, given gaps out?

Yeah, yes, it should correlate to it. We also, you know, back on page seven of the DAC, you know, we also, one of the things that I know people are trying to model RSAs in a way that they can be more predictable. I think we showed a metric here, which is RSA relative to purchase volume, because remember, there is a significant portion of the the RSA that is volume-oriented, that tends to be a more stable metric. I think you can look at a quarter-over-quarter seasonality, and I think will help people as they try to build their models as they go through it. Again, we do believe that we're going to migrate back to that 4% to 4.5% level as net charge-offs normalize and as the interest-to-be revenue and yield normalizes as well.

Okay, great. And my follow-up question is for Brian Doubles. Obviously you talked about the launch of Pay and For on Clover. I'm just curious, how much of that product is actually being utilized by merchants where you have a relationship versus not? Is it 100% your own customers today? And then also there's been a significant dislocation in valuations for players in this space. I'm just curious if there's anything you might do differently on a go-forward basis as a result of that. Thanks.

Yeah. So, Sanjay, I would say that the majority right now is with existing partners. That's where we've been having discussions over the past nine months, give or take, and integrating and launching. What I would tell you, though, is Clover is really an opportunity for us to reach a broader distribution of partners that don't do business with us today and make it really easy and seamless for them just to download our app and then pick from our various financing options. So, That's really the exciting part as we think about going forward is that one-to-many integration opportunity, which is, frankly, different than how we've managed the business in the past. So I think that's an exciting part of our strategy going forward. And then I would say just on valuations generally, I think that does potentially create some opportunities for us. We run a very active M&A pipeline program. You know, one of the things we were a little disappointed as we went through the pandemic, we thought valuations would check up a little bit. They did not. But we're starting to see some of that now. And that could create some opportunities for us, whether it's, you know, capabilities that would be easier to buy than build, some things like that. But, you know, I would tell you, we are very disciplined around M&A. We only look to do things that are you know, not only strategic, but also EPS accretive. And so we've got a pretty disciplined process around that. So I think there may be some more opportunities here just on the margin, but we'll maintain that discipline.

Thank you. Our next question is from Mihir Bhatia with Bank of America.

Good morning, and thank you for taking my question. Maybe I wanted to start with asking about loyalty program costs. Those have been increasing, you know, whether we look at it as a percentage of interchange revenue or purchase volume. And I was curious as to what is driving that. Is that just competition or are there particular programs, renewals, promotions ongoing that is making that line inflect higher? Just trying to understand how you expect that line to shake out longer term. I think historically it used to be around 100% of interchange revenue, maybe a little bit more. But it's pretty materially higher now, so just trying to understand more context there.

Yeah, first of all, good morning, Mahir. Yes, so I'd say this is less a function of competition, more a function of, you know, we've done some value props over the past, you know, 12 to 18 months, and we are seeing increased purchase volume through that. as our value propositions have resonated with consumers. So there isn't necessarily a reflection of changing to the competitive environment, it's refreshing value props that we normally do. And we've done it across a number of different programs, which is driving some of the higher loyalty. Again, some of the loyalty sits on our books. The vast majority sits with our partners, which is why the RSA is what it is, because they're paying the value prop cost from their proceeds out of the RSA. I think as you look forward, one of the interesting things you're going to see, and you'll see it really begin in the third quarter, is there's roughly $35 million of interchange that we will lose as our portfolios we sold this quarter have gone away. And the loyalty costs were 100% borne by those partners. So what you'll see is a theory of widening of that gap beginning in the third quarter as we move out. The offset to that, that $35 million, you know, call it 80-plus percent, comes out of the RSA. So they move in different directions, but from a P&L standpoint, it's neutral. Again, I think in most programs where we collect interchange and we pay the value prop, it's the same. Some of the programs you've got to remember are ones where we don't collect interchange that are private label products where we may be paying a loyalty cost. And again... This goes back into we had record purchase volume ever for this company during this quarter. We had record purchase volume last year for this company, record purchase volume for the first quarter of this year. So that volume is going to generate higher loyalty costs. So it's less about renewals and other things. It's really about our products resonating with consumers.

Thank you. That is very helpful. Thank you. And then just wanted to follow up a little bit on Betsy's question about just the credit profile evolution. How much of that is being driven by just your underwriting standards? Maybe just talk about what those look like today versus say 2020 or 2018, even just trying to understand how things are changing in the context of this.

Yes. So if you, if you walk through the pandemic, right, the early stages called the beginning part of the second quarter, um, We tightened our standards, right? Now, again, we are very different than most credit card issuers. We don't pull back entirely. It's our distribution model, so we don't necessarily do that. We tend to do things that we would call smarter with regard to credit. So instead of giving someone a dual card, we'll give them a private label card. We're a little bit more restrictive on some of the growth-related credit line increases, so we wouldn't do proactive credit line increases. At the margin, we would tighten up origination. I think as we moved into the second quarter of 2021, when we saw the environment not being as potentially pessimistic as we did a year earlier, we began to unwind some of those actions and some of those refinements. So again, I think if you look at the standards that exist today, they're probably a little bit tighter than I think 2019 levels, but approaching that. But our line sizes, again, are lower. But the good news is I think we continue to introduce different data points into our decisions that allows us to make smarter decisions both at the time of origination and at the time of which we're doing account management, i.e., authorizations, et cetera, that allows us to have a better profile. I think when we look at the vintages in 20 and 21, they still are outperforming that of 2018 and 2019. The 2021 vintage is... A little bit worse than 2020 because, again, we had probably a looser refinement strategy in 21 versus 20, but both are significantly better than pre-pandemic levels and I think sets us up, and that's one of the keys. It sets us up for what we're going to see in 23. So we're very, you know, as we sit here today, optimistic about the credit profile of the company.

And thank you. We have our next question from Brian Foran with Autonomous Research.

Good morning. I was actually going to ask about the vintages, which you just touched on. But is there any sense you can give on the magnitude of outperformance versus 2019, you know, delinquencies controlled for month seasoning or, you know, however you want to measure it, just trying to get a sense of is it a little or a lot or somewhere in between on how much the 20 and 21 vintages are outperforming?

What I'd say is 21 is probably in the middle between 20 and 19. And 20 is significantly lower is probably how I frame it. Brian, we don't break out actual performance of the vintage themselves with regard to coincident delinquency or loss rate. But as a frame of reference, 21 is in the middle, but significantly below 19.

And then maybe on competitive intensity, I mean, you touched a lot of different competitors' You know, I guess broadly, maybe it's fair to say your traditional card competitors are maybe still getting a little bit more intense competitively or maybe reaching a plateau. But again, Seth, there's been a pretty big retrenchment, it seems, in some of the newer fintech competitors. So, you know, maybe two questions. When you balance it all out, you know, is it kind of a net neutral or is competition actually competitive? maybe pulling back because of the FinTech side and, you know, any opportunities that that FinTech retrenchment does present? I know you touched on maybe some of the M&A, but maybe organic opportunities that it presents.

Yeah, I think the competitive set has been fairly stable, actually. I don't think that whether you're a mature competitor, one of our larger competitors, or the smaller FinTechs, I don't think that they've they've changed their strategies or their competitive intensity, plus or minus, given the uncertainty as we head into 23 and 24. I think you might see some of that as we get more through the back half of the year and some of these signs become a little bit more real if that does materialize. But I would say the competitive set has been pretty consistent. Pricing and economics has continued to be pretty rational. You know, one of the things that we were looking for as we went through the pandemic is, you know, do we start to see competition really take advantage of a best-ever credit environment? I think we saw some of that on the fintech side, but the more traditional competitors stayed pretty disciplined, we stayed disciplined. I think, you know, that'll be helpful going forward. And I think the real question is, what does this look like as we head into 23 and beyond? Yeah.

Thank you. We have our next question from Kevin Barker with Piper Sandler.

Thank you. You mentioned some additional macro overlays on your reserving ratios or just looking at your overall CECL reserving. Could you give us a little bit more detail on, you know, some of those major macro overlays that you have embedded within the reserving? And then at what point would you start to say that the reserving level needs to rise or, like, what unemployment rate would you say – we start to need to see significant moves in the reserve law.

Yeah, thanks, Kevin. So when you look at our baseline model, we start with the Moody's baseline, which is generally going to be a flat, what I would call an unemployment environment and a GDP that's generally flat to decelerating over the next couple of years. I think when we start to look at the allowance and look at the overlays that get put in there, We're looking at forecasts that have the CPI accelerating. So we think about it in two different ways. The first is probably the easiest way to think about it is late-stage performance. So we think about it as you have a deteriorating unemployment environment that stresses your late-stage performance. delinquencies, which will flow through the model rather quickly. That's really where we look at it. We look at it in that context of being the roll rates that exist in that overlay as being more dramatic than what we saw pre-pandemic levels. So it's a faster roll to loss. The other overlay that we put on it is really related to what we say is related coming out of the Russia-Ukraine war that we see out there. And what that does is we have early stage deteriorating more quickly, an upswing in bankruptcies, which are probably at historic lows, and that flows through the model with not as much deterioration in the back end or a severe deterioration in the back end. So you have a much bigger piece flowing through the model. So those are the ways in which we've kind of done the overlays. Let's try to correlate it because, again, I think, Kevin, the one thing that's demonstrated a couple periods of time here is that you have seen a dislocation between what had been very correlated metrics, unemployment to loss. Traditionally, you see a correlation between gas prices and entry rate and what I would call early-stage performance. We're not seeing that today, so you're broken correlation, and that's really – because of the effects of the stimulus and the forbearance that come through. So we have taken it really in two different ways and two different scenarios to create different overlays, which is, one, severe back-end deteriorations, and, two, a more front-end deterioration that flows through with what I would call a sharper increase in non-age losses.

So given the uncertainty that we have out there and the different macro scenarios scenarios that could play out, and obviously the cycle could be different. Have you considered being a little bit more conservative in deploying capital in this environment, just given the uncertainty we have in the outlook?

A couple of things, Kevin. One, we're operating at over 400 basis points above our CET1, so to start there, we're in a very different position than probably all of our peers are. and those in the banking industry. So start with that premise, number one. Two, under most scenarios, we have a strong business that generates a lot of capital. And even under stress scenarios, you know, we didn't lose money during the pandemic in any quarter. So we continued to generate capital during that period. Three, you know, we just got done with our preliminary run of our second quarter stress test, our normal stress test, and then we run you know, the Moody's S6 and S7 stress tests, and we remain in a very solid position. So as we look at the environment, you know, as we look at the environment, as we sit here today, look at those stress, look at our position, we don't believe there's a reason today to curtail our current share of our purchase plans. That being said, we continually look at the macroeconomic environment, and we continue to look at our ability to generate capital through earnings. And if we need to make an adjustment similar to March of 20, we will. But again, as we sit here today, given the stress that we run, the severe stress that we run, we feel comfortable with our current capital plan that's in place.

Thank you. We have time for one more question. Our final question is from Mark DeVries with Barclays.

Yeah, thank you. Really appreciate all the color you gave on kind of what you're observing from spend behavior, you know, given the inflationary pressures. Are you seeing any kind of divergence and trend across the credit spectrum, or are those trends pretty consistent from kind of, you know, super prime all the way down to non-prime?

Yeah, so what I'd say, Mark, is we're seeing positive what I would call transaction values and frequency and consistency of frequency across all credit grades. I think the strongest credit grade we see is actually in the prime, so not super prime and not non-prime, but we are seeing continuous strength in the non-prime. So there's nothing discernible as I look across the credit grades, either on a transaction value basis or a frequency basis, nor do we see it across any of the sales platforms. It's remarkably consistent the performance and the growth across all the platforms by credit grade. So again, I think when we look at the data and I look at the data by category, what we're seeing is that the consumer is not changing spending dollar-wise and their behaviors. They're just making different decisions inside their everyday spend. And it's not even just moving from discretionary and non-discretionary. They're just being more discriminant with regard to how they're spending their money. And it really goes to the power of the diversification that we have inside our sales platforms and in our sales platforms and inside of our sales platforms.

Got it. And then just to follow up, the payment rate also doesn't really seem to be getting affected given inflation, which seems pretty bullish. But kind of what are your expectations for that as we kind of look out for the back half of the year?

Yeah, again, we've anticipated that you're going to see a moderation in the payment rate as we move back. We have seen a little bit of a shift in the payment behavior patterns between statement pays and min pays in between. So we've seen some of that moderation. We've seen some cohorts go back to 2019 levels. We expect it to begin to migrate back. The migration, I'll be honest with you, from our expectations back in January has been a little bit slower than we anticipated, which just goes back to the overall strength of the consumer, but we do expect it to slow just probably a little bit slower pace than anticipated at the beginning part of the year, which, again, is positive from a credit standpoint and, again, the strength in our purchase volume is helping us to get to that 10-plus percent loan receivable growth by the end of the year.

Thank you. Thank you, ladies and gentlemen. This concludes our conference for today. We thank you for participating. You may now disconnect.