Synchrony Financial (SYF) 2017 Q4 法說會逐字稿

Welcome to the Synchrony Financial Fourth Quarter 2017 Earnings Conference Call. My name is Vanessa, and I will be your operator for today's call. (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.

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.

Margaret Keane, President and Chief Executive Officer; and Brian Doubles, Executive Vice President and Chief Financial Officer, will present our results this morning. After we complete the presentation, we will open the call up for questions.

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

Thanks, Greg. Good morning, everyone, and thanks for joining us. I'll begin on Slide 3. We ended 2017 with a solid fourth quarter, which sets the foundation for 2018. Tax reform had an impact on our reported fourth quarter results, which Brian will cover later in the call. We expect to realize significant benefit from tax reform, and we will look to utilize this benefit in a way that drives value for our shareholders, employees and communities.

I'm going to spend my time today covering our business highlights, including the expansion of the strategic credit relationship with PayPal as well as what we achieved in 2017, and I will end with our strategic priorities. Brian will detail our financial results and our outlook for 2018 later in the call.

A very significant and exciting development in the fourth quarter was the agreement we announced with PayPal to significantly expand and extend our strategic consumer credit relationship. In addition to extending our co-branded consumer credit card program with PayPal, we will now become the exclusive issuer of the PayPal Credit online consumer financing program in the U.S. This will consolidate PayPal's 2 U.S. credit offerings under one relationship, which we extended with PayPal for 10 years. As part of this transaction, we will be acquiring PayPal's U.S. consumer credit receivables portfolio as well as interests held by other investors. We expect the transaction to close in the third quarter of this year.

Moving forward with PayPal to become the exclusive issuer of PayPal Credit in the U.S. is a natural extension of our successful 13-year relationship. The expanded program offers tremendous benefits for both Synchrony and PayPal. Together, we can deliver best-in-class experiences for credit customers. Combining our program management, credit capabilities and balance sheet with PayPal's data and risk platform and trusted brand as a leader in digital and mobile payment experiences should help create superior products and offerings for consumers and merchants. The 2 programs require our unique organizational focus, given that they address different customer needs, rewards for co-brand and financing for PayPal Credit, 2 areas in which we have expertise. Also, having one partner to holistically manage both of these programs for PayPal will allow for synergies and could provide opportunities for migrating customers between products as their needs change. Our strategy will focus on optimizing 3 main components to drive sustained growth: the consumer value proposition, merchant differentiation and world-class digital customer experience to support ongoing engagement.

This expanded relationship supports our continued reach within the rapidly growing digital payments channel. We have built a strong reputation in this space, and this program will allow us to meet evolving consumer needs. We primarily compete on our capabilities, including our significant experience, scale, dedicated teams, data analytics, loyalty programs, digital capabilities and proven record of providing value-added services to our partners. These capabilities all played an important role in expanding our relationship with PayPal. We have a long history and have worked closely with them during our tenure to develop innovative and effective products and value propositions for PayPal's customers. We are obviously very pleased to be extending this important relationship as we jointly leverage the new opportunities to significantly grow this program.

During the fourth quarter, we renewed several relationships, including Men's Wearhouse in Retail Card; Home Furnishings Association, Husqvarna Viking and Sweetwater in Payment Solutions; and Bosley and Sono Bello in CareCredit. This was obviously a very productive quarter for us, and we are pleased to continue to generate growth, both organically and through the launch of new innovative programs with exciting new partnerships.

Before I pass the call over to Brian to give details on our financial results for the quarter and our outlook for 2018, I'd like to provide a recap of the substantial progress we made on our strategic priorities in 2017. Growing our business remains a top priority, and in 2017, we achieved this through organic growth, new deals and the renewal of several key partnerships. We are driving organic growth through digital innovation, data analytics and innovative marketing, promotions and value propositions on several of our cards. We had a very successful year in renewing more than 15 key relationships and winning more than 20 new deals in our 3 sales platforms.

We continue to pursue new opportunities to expand our business, particularly in areas where we see outsized opportunity. PayPal is an example of this and is especially important as it will expand our presence in the digital payment space. Another example is our efforts to further penetrate the travel and entertainment sector, where appropriate, and we continue to make progress in 2017 with the launch of the Cathay Pacific program.

Extending the utility of our cards is another key focus area, particularly expanding the network in which our cards are accepted so that our cards can move to the top of cardholders' wallets. This is especially important in our Payment Solutions and CareCredit sales platforms, where we've been working to migrate cardholders towards more repeat purchase behavior.

To that end, in Payment Solutions, we launched the Synchrony CarCare network, which offers motorists the convenience of one card to pay for comprehensive auto care at thousands of service and parts locations as well as fuel at gas stations nationwide. The utility of this card continues to be enhanced with the addition of new partners, such as Mavis Discount Tire being added to the network. Similarly, we also launched the Synchrony HOME credit card network accepted by retailers at more than 10,000 locations in verticals such as home furnishing, flooring and electronics.

In CareCredit, we recently announced the rollout of our new CareCredit Dual Card. This new card combines the promotional credit capabilities of the standard CareCredit card for purchases within our extensive network with the added convenience of MasterCard acceptance. The upgrade offers cardholders the ability to earn points for all purchases wherever MasterCard is accepted and offers enhanced rewards for health, fitness, grocery and debt-related purchases. We also further expanded the CareCredit network with our acquisition of the Citi Health Card portfolio in early 2017 and have also expanded into several new verticals, such as durable medical equipment, orthopedics and physical therapy. The number of provider locations increased by more than 10,000 in 2017.

The progress we've made in improving the utility and, therefore, the usage of our card is evidenced by our reuse rate. For Payment Solutions, the reuse rate in the fourth quarter was 29% and, for CareCredit, it was 54% of total purchase volume.

During 2017, we continued our focus in investment on enhancing our leading-edge digital and data analytics capabilities. Early in the year, we acquired GPShopper, an innovative developer of mobile apps that offer a full suite of commerce, engagement and analytics tools and through which we launched our innovative app plug-in we call SyPi. We now have 10 partners using the app plug-in, and to date, we've seen a significant growth in usage. We are expanding our mobile engagement capabilities, improving the functionality and ease-of-use for mobile users and our partners, and this capability-enhancing acquisition will help us to do that.

We have invested in a next-generation data environment, which gives us a more holistic view of the customer and enables us to drive higher engagement and a better customer experience using disparate data sources and machine-learning techniques. We now have access to approximately 70% of SKU or category level data on the over 1 billion transactions that go over our network compared to less than half of transactions just 3 years ago. This is important as we increasingly partner with retailers to leverage this information to grow their programs. Additionally, we are using advanced analytic techniques, such as media mix optimization, to improve return on marketing investments.

Given our significant operational successes and strong growth, we have also had to focus on funding that growth, and our deposit base has become an increasingly important part of that equation, especially direct deposits. We have made investments to enhance the online direct deposit experience for consumers, and this has helped drive direct deposit growth of 13% over the past year. Overall, deposits now comprise 73% of our total funding sources.

Through all of this expansion and investment, we've been able to maintain a strong balance sheet and deliver value to our shareholders not only through growth but via improved capital payout distribution, with both an increase in dividends and a substantial increase in share buybacks in the plan we announced last May.

I'll now turn the call over to Brian to outline our financial results for the quarter and our expectations for the upcoming year.

Thanks, Margaret. I'll start on Slide 6 of the presentation. This morning, we reported fourth quarter earnings of $385 million or $0.49 per diluted share, but this included the impact related to the remeasurement of our net deferred tax asset driven by the lower corporate tax rates in the Tax Cuts and Jobs Act passed in December. Excluding this impact, we earned $545 million or $0.70 per diluted share in the fourth quarter. We continued to deliver strong growth with loan receivables up 7% and interest and fees on loan receivables up 8% over last year. Overall, we're pleased with the growth we generated across the business. The interest and fee income growth was driven primarily by the growth in receivables.

Purchase volume grew 3% over last year. The slower growth compared to recent quarters was due to the underwriting refinements we have noted previously and the hhgregg bankruptcy. I will cover the impact of the underwriting refinements we've made in more detail later in the presentation. As we move forward and the impact from these items are included in the prior year run rate, we would expect their impact to moderate in future quarters.

We had another solid quarter in average active accounts growth, which increased 4% year-over-year, driven by the strong value propositions and promotional offers on our cards that continue to resonate with consumers. The positive trends continued in average balances with growth in average balance per average active account up 4% compared to last year.

RSAs decreased $32 million or 4%. While we shared the strong top line growth and positive operating leverage generated in the quarter, this was offset by higher incremental provision expense. RSAs as a percentage of average receivables was 3.9% for the quarter, down from 4.5% last year. For the year, RSAs were 3.9% versus 4.2% in 2016, reflecting one of the natural offsets in our business model.

The provision for loan losses increased 26% over last year, primarily driven by credit normalization. The reserve build in the quarter was $213 million, lower than the $275 million range we had expected, driven by moderating credit normalization trends as we enter 2018 and slightly lower receivables growth. I will cover the asset quality metrics in more detail later in the presentation.

Other income was $23 million lower than the prior year. While interchange was up $12 million, driven by continued growth in out-of-store spending on our Dual Card, this was offset by loyalty expense and increased by $36 million, primarily driven by everyday value propositions. As a reminder, the interchange and loyalty expense run back through the RSAs so there is a partial offset on each of these items. As we noted last quarter, we expect loyalty program expense as a percent of interchange revenue to trend near 100% with some quarterly fluctuation.

Other expenses increased $52 million or 6% versus last year, driven primarily by growth in marketing. We continue to expect expenses going forward to be largely driven by growth, including strategic investments in our sales platforms and our direct deposit program, enhancements to our digital and mobile capabilities and investments to automate and streamline our back office.

Lastly, the efficiency ratio was 30.3% for the quarter compared to 31.6% last year over 130 basis point improvement. The business continues to generate a significant degree of positive operating leverage.

I'll move to Slide 7 and cover our net interest income and margin trends. Net interest income was up 8%, driven by the continued strong loan receivables growth. The net interest margin was 16.24% compared to last year's margin of 16.26%. The margin was largely in line with our expectations. The margin benefited from a slightly higher mix of receivables versus liquidity, on average, compared to last year as we continue to optimize the amount of liquidity we're holding and have deployed excess liquidity to support our strong receivables growth. This was offset by a slight decline in the yield on receivables, down 8 basis points from last year, as well as higher funding costs that increased by 18 basis points, driven by higher rates in our interest-bearing liabilities, primarily due to higher benchmark rates and pre-funding related to PayPal. We will cover our expectations for the margin going forward in our 2018 outlook later.

Next I'll cover our key credit trends on Slide 8. In terms of specific dynamics in the quarter, I'll start with the delinquency trends. 30+ delinquencies were 4.67% compared to 4.32% last year, and 90+ delinquencies were 2.28% versus 2.03% last year.

Moving to net charge-offs. The net charge-off rate was 5.78% compared to 4.65% last year. The largest contributing factor to the increase in NCOs continues to be normalization. This resulted in a 5.37% NCO rate for the year, near our expectations.

The allowance for loan losses as a percent of receivables was 6.8%, and the reserve build from the third quarter was $213 million. As I noted earlier, the reserve build was lower than the $275 million range we expected due to moderating impact from credit normalization and somewhat slower receivables growth.

As we look forward to 2018, I'd like to describe the impact related to the underwriting refinements on our more recent vintages and our purchase volume growth. First, the most recent vintages continued to trend in line with our expectations. As you remember, we started making refinements to our underwriting in the second half of 2016, and we continue to see the positive impact to those changes. Additionally, we have continued to make incremental underwriting changes throughout the year, and the vintage curve data suggests that the 2017 vintage is performing better than 2016 and more in line with our 2015 vintage.

Not surprisingly, these underwriting refinements have also resulted in changes to our purchase volume mix by FICO score. If you look at purchase volume by FICO stratification, we continue to grow purchase volume at a fairly strong pace in accounts with a FICO score greater than 721, which increased 10% over the same quarter last year, while purchase volume for the below 660 FICO range actually declined 13%, reflecting the actions we have been taking. These trends help inform our view of loss expectations in 2018 and beyond. Later, I will provide our outlook on credit expectations for next year.

In summary, while credit continues to normalize from here, we expect the pace of the change and the impact on our results will moderate as we move into 2018, assuming stable economic conditions. We continue to see good opportunities for continued growth at attractive risk-adjusted returns.

Moving to Slide 9, I'll cover our expenses for the quarter. Overall, expenses came in at $970 million, up 6% over last year. Expenses continued to be primarily driven by growth in marketing. As I noted earlier, the efficiency ratio was 30.3% for the quarter, over 130 basis point improvement over last year as we continued to drive operating leverage in the core business while continuing to fund our strategic investments. For the full year, the efficiency ratio was 30.3%, down over 80 basis points from the prior year and well below our original outlook back in January of approximately 32%.

Moving to Slide 10, I'll cover our funding sources, capital and liquidity position as well as continued execution of the capital plan we announced in May. Looking at our funding profile first. One of the primary drivers of our funding strategy has been the continued strong growth of our deposit base. We continue to view this as a stable, attractive source of funding for the business. Over the last year, we've grown our deposits by over $4 billion, primarily through our direct deposit program. This puts deposits at 73% of our funding, slightly higher than the 72% level we were operating at last year. We expect to continue to drive growth in our direct deposit program by continuing to offer attractive rates and great customer service as well as building out our digital capabilities. Longer term, we continue to expect to grow deposits in line with our receivables growth. Overall, we're pleased with our ability to attract and retain our deposit customers.

As part of our pre-funding plan for the PayPal Credit portfolio, we did issue $1 billion of 10-year fixed rate debt in the fourth quarter, which was very well received by the market. We will continue to execute our pre-funding plan as we prepare to onboard the PayPal portfolio in the third quarter of 2018. The pre-funding will consist of both deposit and wholesale funding. So overall, we continue to execute our funding strategy and feel very good about our access to a diverse set of funding sources.

Turning to capital and liquidity. We ended the quarter at 15.8% CET1 under the fully phased-in Basel III rules. This compares to 17% on a fully phased-in basis last year, around 120 basis point reduction, reflecting the impact of capital deployment through our capital plan and growth. Total liquidity was $21.1 billion, which is equal to 22% of our total assets. This is down from 22.5% last year, reflecting the deployment of some of our liquidity. We expect to be subject to the modified LCR approach, and these liquidity levels put us well above the required LCR levels.

During the quarter, we continued to execute on the capital plan we announced in May. We paid a common stock dividend of $0.15 per share and repurchased 430 million of common stock during the fourth quarter. We have a little over $600 million remaining in share repurchases of the $1.64 billion our board authorized through the 4 quarters ending June 30, 2018. We will continue to execute the new share repurchase plan subject to market conditions and other factors, including any legal and regulatory restrictions and required approvals.

Overall, we continue to execute on the strategy that we outlined previously. We've built a very strong balance sheet with diversified funding sources and strong capital and liquidity levels, and we expect to continue deploying capital for growth and further execution of our capital plan in the form of dividends and share repurchases.

Next on Slide 11, I'll recap our 2017 performance versus the outlook we provided last January, starting with loan receivables. Our growth of 7% was in line with our outlook range of 7% to 9%. The growth in 2017 continued to be driven by the strong value props on our cards and our marketing strategies with our partners, delivering strong organic growth. Our continued investments in mobile, innovation and data analytics capabilities are enhancing our ability to drive organic growth as well as win new programs. Moderately tempering some of the growth was the impact from the underwriting refinements we began to implement in the second half of 2016 and continued in 2017.

Net interest margin was 16.35% for the year, which is better than the original range of 15.75% to 16% we provided back in January. Higher receivables yield from higher revolve and benchmark rates, a more optimal asset and funding mix, along with some benefit from a lower-than-expected deposit rate data, were the major drivers for the outperformance.

RSAs as a percent of average receivables came in substantially lower than our outlook last January. RSAs came in at 3.9% versus the outlook of 4.4% to 4.5%, mainly driven by the sharing of higher provision expense partly offset by program performance. This demonstrates the countercyclical nature of RSAs.

Our net charge-off rate of 5.37% was largely in line with our revised outlook in the low 5% range. Net charge-offs continued to normalize off the very favorable levels in 2015 and 2016, and we expect this to continue into next year, which I will discuss in our outlook.

The efficiency ratio for the year was 30.3%, significantly lower than the outlook of around 32%. We continued to drive strong operating leverage through higher margins, revenue growth and increased productivity, which all led to the outperformance.

And lastly, we generated a return on assets of 2.3%, excluding the impact of the tax act. The higher margin and operating leverage were offset by higher provision expense. The higher provision expense was partially offset through the RSAs.

Moving to our 2018 outlook on Slide 12. Our macro assumptions for 2018 assume the Fed continues to tighten this year and the unemployment rate is mainly stable. We are providing a view without the impact of onboarding the PayPal Credit portfolio as well as an outlook including the portfolio. We expect to close in the third quarter of 2018 and assume a closing date of July 1, 2018, for purposes of the outlook.

Our outlook for receivables growth without PayPal is in the 5% to 7% range. The slightly lower growth rate takes into account underwriting refinements and assumes economic trends continue. We expect to grow sales volume at 2 to 3x broader retail sales and for e-commerce to continue with strong growth. We expect the addition of the PayPal Credit portfolio to drive the growth rate in the 13% to 15% range in the second half of 2018.

We believe our margin before the PayPal portfolio impact would continue to run in the 16.25% range next year, but pre-funding the portfolio will have a dilutive effect on the margin as the funding is held in short-term liquid assets until the portfolio is onboarded. We believe this may push the margin down closer to 16% and, depending on the timing and magnitude of the pre-funding, may push the margin into the 15.75% to 16% range for the full year of 2018.

We expect that RSAs as a percent of average receivables will trend back into the 4.2% to 4.4% range for 2018. This is higher than the 3.9% for 2017 and reflects continued strong performance of our programs, somewhat higher loyalty program expenses and moderating reserve build expectations. The expansion of the PayPal program in the second half of 2018 will not impact the expected range.

In terms of credit, we expect net charge-offs for 2018 will be in the 5.5% to 5.8% range, driven by continued normalization and slightly lower receivables growth. While the timing of the PayPal portfolio addition, given its size, will impact the NCO rates in the second half, we expect to end in the similar range for the full year.

Looking at seasonality and net charge-offs. We typically see the NCO rate trend higher in the first quarter compared to the fourth quarter due to the seasonal decline in receivables. While the increase has been in the 50 to 70 basis point range over the past 2 years, we are expecting a more modest increase as normalization moderates and closer to what we have seen historically.

Regarding loan loss reserve builds going forward, we expect the reserve builds will transition to be more growth-driven, given our expectation that credit normalization trends will continue to moderate. The addition of the PayPal portfolio will add to the reserve builds in the second half of this year. We will need to establish a reserve for the portfolio under our reserving methodology, and we anticipate a substantial portion of the reserve will be established by year-end 2018. Given the size of the portfolio, this will substantially add to our overall reserve builds in the back half of 2018. This is the main driver of the EPS dilution we expect in the second half of the year after we acquire the portfolio. For the first quarter, we expect the reserve build to be in the $200 million to $225 million range, similar to the fourth quarter and down from the prior run rate driven by moderating credit normalization trends.

Moving to the efficiency ratio. For 2018, we expect to continue to operate the business with an efficiency ratio of approximately 31% similar to 2017. This would not change with the impact of adding the PayPal portfolio. We expect to continue to drive operating leverage in the core business. However, this will be partly offset by continued spend on strategic investments we feel are important to the business. Our efficiency ratio continues to compare favorably to the industry, and we feel well positioned to manage this going forward as we expect the business to continue to generate positive operating leverage over the long term.

Finally, we expect to generate a return on assets of around 2.5% in 2018, including the impact of lower corporate taxes and the estimated dilution from the PayPal transaction. Given the lower corporate tax rates passed in the tax act, we expect our effective tax rate will be in the 24% to 25% range going forward. This includes both federal and state taxes.

Before I conclude, I wanted to reiterate our thinking around capital for 2018. We're planning to follow a very similar process as before. We will use the Fed scenarios and assumptions due out in February and develop a capital plan that we'll review with our board and our regulators in April and hope to be in a position to announce our capital plans on a similar time line as we did last year. While I cannot be specific as to our capital plans at this point, we would expect to continue deploying capital through both dividends and share buybacks, in addition to supporting our growth and program acquisitions.

And with that, I'll turn it back over to Margaret.

Thanks, Brian. I'll close with a recap of our strategic priorities that we continue to focus on to drive value to our partners, cardholders and shareholders. A top priority is to continue to execute across our 3 sales platforms, building upon our capabilities in marketing, analytics, loyalty and digital and mobile technology. We expect to continue to drive organic growth, and we'll evaluate potential new programs with appropriate risk-adjusted returns. We will make investments necessary to expand the utility of our card and work with our partners to deliver innovative ideas and attractive value propositions to drive card usage. We will continue to invest in next-generation data, analytics and technology offerings and leverage SKU and category level data to help drive an even higher level of engagement with our customers. Digital and mobile technologies will also remain a top investment priority as the market moves more to these channels as well as investing in the talent to help develop and drive these capabilities.

Our banking platform remains an important funding source, and as such, we will continue to broaden our products and capabilities. We will also continue to explore new opportunities to leverage our expertise and product offerings in areas where we may not have traditionally had meaningful penetration, such as the travel and entertainment space.

It remains paramount that we operate our business with a strong balance sheet and financial profile. We have proven our ability to do this, and it will remain a top priority for us in the future. We expect to support our business model with diverse and stable funding. We also expect to maintain strong capital and liquidity to support our operation, business growth, credit ratings and regulatory targets.

Finally, we will continue to leverage our strong capital position. Our capital priorities are: first and foremost, organic growth and program acquisitions; second, capital return through dividends and share repurchases; and lastly, M&A that helps us enhance our capabilities to support growth. Synchrony continues to be well positioned for long-term growth, and we look forward to driving further value for our partners, cardholders and shareholders in 2018.

Thanks, Margaret. That concludes our comments on the quarter. We will now begin the Q&A session. (Operator Instructions) If you have additional questions, the Investor Relations team will be available after the call.

Operator, please start the Q&A session.

(Operator Instructions) And we have our first question from Sanjay Sakhrani with KBW.

Brian, maybe first question on the credit quality and the performance in recent vintages. When I look at the charge-off rates for 2018, those seem to be trending a little bit softer than what you guys had initially talked about in terms of a range. Could you just reconcile that with the fact that you're seeing the later-stage vintages, recent vintages trend better?

Yes. Sure, Sanjay. So look, we generally say that credit is trending exactly in line with our expectations. We gave you an outlook of 5.5% to 5.8% for 2018. Based on all the trends that we're seeing, the pace of normalization will flow and will moderate as we move through the year, very consistent with our prior view. The only small tweak that we made was to factor in slightly lower receivables growth. So just due to some of the underwriting refinements that we made, we took down growth just slightly and that does have an impact on the rate. But when we look at the vintages, as we noted earlier, '17 vintage performing better than '16. It's more in line with 2015. We have seen a change in the mix on sales. We highlighted just in the fourth quarter that sales are down in that below 660 FICO range, but we're still seeing really good growth in the 720-plus range. Sales there were up 10%. So again, very much in line with our expectations. The only small tweak was to moderate the growth rate a bit on the core business heading into '18.

Okay, great. And then as far as the tax savings are concerned, I'm sorry if I missed this, but are you guys expecting to invest any of the tax savings? And do you expect any kind of competitive response or activity associated with some of the savings from the industry?

Yes. So Sanjay, it's Margaret. How are you? I think the 2 areas where we're looking to make an investment is really on our employees and our communities. In terms of investing in the business, we actually have a lot of growth initiatives already built into our plans so those are already accounted for. And I don't know, Brian, if you'd add anything else.

Yes. I'd say generally -- Sanjay, look, we're very focused on using this benefit in a way that drives real value for our shareholders. I think that's our primary objective. We're able to do some things for employees, a little bit more on charitable contributions. The impact there is pretty modest. It's included in our outlook. And then as Margaret said, we're always looking at where we can make additional investments in the business. But when we look at that, look, we're fully funding most of the growth initiatives today that meet our return hurdles. So anything additional there, from our perspective right now, will be pretty marginal.

Our next question comes from John Hecht with Jefferies.

High-level first question is maybe can you give us just any update on incremental trends in the competitive market and then any updates on the -- any progress for upcoming notable renewals.

Sure. So I think the competitive environment has been pretty much the same. We expect 2018 to be the same as 2017. I think probably, for us, what we're very focused on is our renewals. I can't comment at any particular one, but what I would tell you is that our teams are well entrenched in our partners and working every single day to work on those renewals and working hard to really focus on what our partners need. So we feel pretty good about the pipeline. We feel pretty good about the competitive environment. And we're investing to make sure we're meeting our partners' needs, and that's really what we're focused on.

Okay. And then Margaret, do you have any of the digital stats that -- you've given these historically, the e-commerce composition and the growth in that segment?

Sure, sure. So I would say that online sales were up 15% year-over-year, and that growth is in line with where the industry is now, which is about 15%. I would say one of the real positive is we continue to see some really good sales penetration in our Retail Card business, which was up 26%, 1.5% over the prior quarter. So we continue to stay very focused on this in driving volume through the mobile and digital channels.

Our next question comes from Moshe Orenbuch with Crédit Suisse.

Brian, I was intrigued by the disparity between the growth at the higher end of the FICO band and the lower end. Just maybe, could you talk a little bit of how long that persists? I mean, is that several quarters? Or is it longer than that? And when can that -- that effect of the lower FICO band kind of -- will that go away?

Yes. Moshe, look, it's a good question. I think we would clearly expect that to moderate as we head into 2018. What you're seeing really, and you saw a little bit of it in the third quarter and the fourth quarter, is really the cumulative impact of those underwriting refinements that we made starting in the second half of '16. So you're starting to see that come through the books. So when you look at -- and I should just comment that we're still booking plenty of sales between 600 and 660 FICO. That's still a great segment for us. We're still booking profitable volume at attractive returns there. It's just when you compare it to what we were doing a year ago, it's down slightly. So I would think about it continuing for a couple more quarters, hard to predict exactly. We're constantly going in and making these refinements based on where we're seeing the returns and where we're seeing the profitability.

Got it. And just as a follow-up question. The PayPal is dilutive to your returns in 2018. Could you talk a little bit about what that would mean as it goes forward past that both from the standpoint of what you might see in terms of its impact on the company's growth and returns?

It's obviously a great growth opportunity for us. We could not be more excited about the program and the expanded partnership with PayPal. I think in terms of how to think about it going forward, we've been very clear on '18 what the impact is at PayPal. As you move into 2019, it's definitely accretive from an EPS standpoint. Longer term, the return is in line with the overall return of the business. So we really like the program. We really like the returns. It's got a very resilient earnings profile through multiple scenarios, which is something, obviously, that you know we look for when launching a new program or expanding a partnership. So we're -- like I said, we couldn't be more excited about it.

Our next question comes from Bill Carcache with Nomura.

Brian, we saw the year-over-year change in your delinquency rate slow last November for the first time in 2017 and then held there again in December we saw this morning. Is it reasonable to expect that, that downward trajectory that we're now seeing is going to continue as we look ahead? And ultimately, does that translate into less reserve building in 2018 versus 2017 and also less reserve building in '19 versus '18 x PayPal and assuming that the current environment -- macro environment that we're in persists?

Yes. Sure, Bill. Look, great question. I think as you pointed out, the delinquency trends did begin to moderate this quarter. So last quarter -- or I guess third quarter year-over-year, they were up 54 basis points. We saw that come down to 35 basis points and increase in the fourth quarter year-over-year. So that was in line with our expectations. It's obviously driven by some of the tightening that we've done. We would expect that trend to continue. That's part of what you saw in the reserve build coming in better than our expectations here in the fourth quarter. We've given you a view of what we think reserves look like in the first quarter. Clearly, for the year, we expect the reserve builds to moderate and return to being more growth-driven than they were, certainly, in 2017. So again, the outlook, very consistent, both on credit and reserve builds, to where we thought it would be earlier in the year.

So perhaps just to extend that thought process a little bit. I guess by definition, moving to more growth-driven from previously having not only being growth-driven but also normalization and seasoning-driven, that effectively would mean a lower reserve build in '18 versus '17. Is that thought process reasonable?

Yes. That's reasonable, Bill. I mean -- so just go back to 2017, our reserve builds for the first 3 quarters were in that $300 million to $350 million range per quarter. That's come down now to the $213 million in the fourth quarter. We're giving an outlook for the first quarter of $200 million to $225 million, so similar to the fourth quarter. And if you just kind of run that out, again, excluding PayPal, right, the core reserve build, the expectation would be they would moderate and be lower in '18 compared to '17. Then obviously, the addition of PayPal will significantly add to the reserve build in the second half. So the best way to think about PayPal is we're bringing on the portfolio most likely in the third quarter and we're starting with a reserve of 0. So effectively, over, call it, roughly 9 months, maybe 12 months, we're going to build a full reserve under our existing methodology. So think about 14 to 15 months forward loss coverage on that, and we're going to build it over 9 to 12 months. So a lot of that is going to come in, in the second half of the year, and that's really the driver of the $0.20 of dilution that we indicated back in November on PayPal, really driven by that allowance build.

That's great. If I may, quickly, on my follow-up on NIM. I wanted to ask perhaps just -- if you could clarify the NIM compression. Isn't that more optical than anything else in the sense that it's driven by the liquidity build associated with kind of pre-funding and so there really is no kind of negative or adverse NII impact from the liquidity that you're bringing?

I think the way -- that's a good way to think about it, Bill. So the core net interest margin is very stable around that 16.25% range, very consistent with the 2017 rate, so core NIM stable. And then as you start to include the impact of pre-funding PayPal, that does bring the margin down a bit. That funding that we're going to bring on here in the first half, we hold that in short-term assets until the portfolio is brought on the books. So you've got a combination of some negative carry on that funding. You've also got the impact from the larger denominator on the NIM rate. So you'll probably see the largest impact in the second quarter before we bring the portfolio on. So I would think about NIM adjusted for PayPal closer to 16%. It could dip a little below that depending on the timing and the magnitude of the pre-funding. That's why we gave you a little bit of a conservative range, 15.75% to 16%. It was really driven by the timing and the magnitude of that funding. It's a little bit unknown at this point. But again I think, importantly, core net interest margin, very stable.

Our next question comes from Ryan Nash with Goldman Sachs.

Brian, maybe if I can ask about the RSAs. So it came in at 3.88%, well below the original guidance. And now we're talking about getting it back to kind of 4.3% in the middle -- midpoint of the range. I guess given that it seems like a lot is also shifting to the loyalty line at this point, can you just maybe talk about the interplay of the 2 and how we get back from this 3.88% to something in the 4.2% to 4.4% range? And can you just maybe talk about are the RSAs impacted at all by tax reform? Or are all the programs based on pretax profitability?

Yes. Sure, Ryan. There's a lot in there, so bring me back if I missed something. I think in terms of the RSA, the best way to think about it is go back to our original outlook for 2017, which was 4.4% to 4.5%, okay, 4.4% to 4.5% for the year. That's what I would consider more of a historical norm on the RSAs. Now as you pointed out, we ended the year at 3.9%, right? And that was due primarily to the retailers sharing in that incremental provision expense that we had as well as additional loyalty program expense, okay? So those 2 items more than offset the increase in sharing from higher margins, and we also had better operating leverage year-over-year. So look, I think that's obviously a good thing. That highlights one of the natural offsets to credit normalization for our business. So now as you start to think about 2018, we expect the RSAs to be in that 4.2% to 4.4% range. That reflects both the combination of strong program performance but we also expect the reserve build, as I mentioned earlier, to moderate as we move through the year, so just a construct of lower reserve builds. Obviously, our partners will benefit from that. That increases the RSA payments, and it puts us closer to that historical range. It doesn't put us all the way back, but we think somewhere in the 4.2% to 4.4% range.

Got it. Now if I could just ask a follow-up, just in terms of the credit guidance, the 5.5% to 5.8%. Given that consumers are obviously going to get a benefit from tax reform, can you talk about is there anything baked into your guidance in terms of improving credit from customers having more money in their pocket? And I guess just related to that, given the lower core growth that you're going to be experiencing in the 5% to 7% relative to last year, I think last quarter you had said something around $170 million or so for reserving for growth. Is that still the right number? Is it lower now, given the fact that growth is a little bit slower?

Yes. Sure, Ryan. So there's nothing in the outlook for better economy or consumers benefiting from personal tax reform. Obviously, lower personal tax rate should provide more discretionary income to the consumer. We would expect to benefit somewhat either through increased sales or on the credit side. But look, it's really too early to speculate on either of those. We haven't baked anything into the forecast. So I think -- look, there is some reason potentially to be optimistic there. We didn't include anything. So I think it's still a little bit early to tell. And then your other question was on...

The absolute level of growth reserve build, given slower growth.

Yes. Look, I think that drove a little bit of the build in the fourth quarter being a little bit better than our expectations going forward. That's included in our outlook, that reserve build will moderate and come down slightly. But the best way to think about the reserve builds in '18 compared to '17 is credit normalization leveling off. We will continue to book reserves, book reserves for growth. We're not going to give you a split. It's a little bit difficult to estimate out beyond, really, the first quarter. But I think the important thing is that we've included an outlook that, as credit normalization is going to level off, you'll see that in the reserve build. The reserve build will become more growth-driven, and that's all in line with our earlier outlook.

Our next question comes from Mark DeVries with Barclays.

My question mainly has to do with how conservative you feel this new charge-off guidance is. I mean,, you guys, I think, have been -- I know that every other guidance item have been overly conservative. But on this one, you've had to make -- in charge-offs, you've had to make revisions in the past. Just interested to get your perspective on when you set this new guidance for '18, were you kind of mindful of setting at a level where you're pretty confident you're going to be within that, if not below that range?

Look, Mark, I -- we tend to give you -- we try to give you our best view of what we think 2018's going to look like. Some things typically perform a little bit better. Some things come in a little bit worse than we think. If you go back to 2017, we showed you how we performed against all the key metrics, and you also have natural offsets in the business I think you need to take into account. So if you just kind of walk through the '17 performance, we saw more credit normalization than we thought we would back in January of last year. And the offset to that is lower RSAs and better margins, and you get back to a very strong return. And so I think I -- with the exception of maybe margins where, given the timing of the pre-funding, that can drive a difference in the rate. I wouldn't call the guidance conservative. I think the outlook is our best view. And look, we're obviously all focused on trying to beat those metrics where we can.

Okay, fair enough. And then just on the pre-funding, is there anything you can do or considering to push that out a bit so that you're not carrying too much cash on balance sheet well in advance of getting those receivables?

Yes. Look, I would say we are acutely aware of how expensive that pre-funding is, and we're going to try and manage it as best we can. This is a very large asset that we're going to bring on here in the third quarter. We're going to be in regular dialogue with PayPal on timing and when we expect to close, and we're not going to bring $1 of funding on that we don't have to.

Our next question comes from Rick Shane with JPMorgan.

There's an interesting relationship that's developing between spend growth and loan growth, and the gap has widened. Brian, you or Margaret, you've actually given some very good metrics on the differentiation between the 660 spend above and below. I'm a little bit surprised to see the gap loan growth widen to spend as you have less concentration from the 660 borrowers

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line limits for the higher FICO borrowers?

Yes. So I think the best way to think about this is that when you're making underwriting refinements and tightening a bit, like we have been, you're going to see that materialize first in your sales, right? So that's where you're starting to see that. You saw in the third quarter. You see in the fourth quarter. And then the other underlying dynamic of credit normalization is you tend to pick up more revolve in the overall portfolio, right? Where back in 2014, '15 and '16, we saw kind of an acceleration in deleveraging, that's come back a bit and -- so you see more revolve on the overall portfolio, which is offsetting that decline in purchase volume. Now obviously over time, after, again, the cumulative impacts of some of these -- some of the tightening that we've done, you're going to see that result in somewhat lower receivables growth, which is really what you're seeing in our outlook in that 5% to 7% range. So at some point, that purchase volume will materialize, and those 2 line up more closely. Does that make sense?

Yes, it does. And obviously, the retail partners really value the liquidity that you provide to their customers. Are you getting any pushback as you tweak the underwriting and make less credit available to those sub-660 borrowers?

I think our partners are very cognizant of the fact that they don't want to put credit in the hands of people that can't handle it, and we work very closely with them. In many cases, almost all cases, their names are on the cards. So we work very closely with them, and we are not getting any pushback on credit. They work closely with us, and again, we all want to be responsible here, including our partners.

And again, these are modest refinements. These aren't wholesale changes to our underwriting strategy. You're seeing a bit of the cumulative effect on sales, but we're not changing the overall risk profile of the portfolio.

Our next question comes from Betsy Graseck with Morgan Stanley.

Just a question on the net charge-off rate with the 5.50% to 5.80% guidance for next year with and without PayPal. I'm just wondering if there's -- without PayPal, are you thinking that it's more in the lower end of the range and with is towards the higher end of the range? I just wondered because PayPal's credit quality, at least, as they've been underwriting it, is a bit riskier than what you've been underwriting. So I'm kind of struck by the fact that you've got the same numbers for both scenarios.

Yes, Betsy. So look, I think PayPal might move us around within the range. We don't think it changes the range for the full year. I think it's a good question. Just given the PayPal portfolio, it does run at a higher loss rate than our portfolio in the aggregate. As you start to think about 2019 and beyond, we do expect there would be some upward bias on the rate as we move through 2019 and beyond that, but it's a little hard to be specific that far out.

And do you anticipate running the portfolio from a credit perspective the same way they've run it? Or do you expect to run that piece of the portfolio in line with how you've been running the rest of your book?

Yes, sure. Well, first, I would just say we're very comfortable with the risk profile of the PayPal portfolio. At this point, we don't anticipate any significant changes in the way that it's being underwritten today. We're obviously going to leverage our underwriting analytics and our process, but we're also going to utilize PayPal's scores and some of their techniques. They've got a lot of really great transactional data that we can leverage. So when you combine what they're doing today with some of our proprietary underwriting techniques and some of our models, I think we can get even more sophisticated around how we manage the portfolio together, so

Is that something that's walled...

No, go ahead.

Is that walled off to PayPal? Like can you utilize what you learn from that with others or that's walled off to that relationship?

Yes -- no. It's a very customized by program, so we don't air across programs. It's very proprietary and customized for the individual programs. So what I would say on PayPal, look, we ultimately control underwriting, but we're going to leverage the data, the tools, the expertise of both companies to make the best underwriting decisions we can.

Our last question will come from Ashish Sabadra with Deutsche Bank.

Just maybe a quick clarification. So the efficiency ratio of 31% that you've guided to, that does include any kind of reinvestments from the tax benefit that you would've get? Is that, right?

That's correct.

Okay. Was there any kind of noise from the hurricanes in the quarter? And if there was, can you help quantify that? And just maybe the second part to that would be any comments on the recovery trends, have those been trending? And how do you think about recovery going forward?

Yes, sure. So on the hurricanes back in October, I think we disclosed that hurricane impact would put us towards the higher end of the net charge-off rate. I wouldn't highlight really anything other than that. And then on recoveries, nothing really in the quarter. Recovery pricing was pretty stable.

Okay. And maybe on the hurricanes, if I can just ask a follow-up. Like as you go forward, what are your expectations? Because that hurricane effect should really come off. So should we see better like underlying trends continue but that hurricane negative impact come off?

Yes. I wouldn't think about it as being material going forward.

Okay. Thanks, everyone, for joining us on the conference call this morning and your interest in Synchrony Financial. The Investor Relations team will be available to answer any further questions you may have, and we hope you have a great day.

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