Synchrony Financial (SYF) Q3 2014 Earnings Report, Transcript and Summary

Welcome to the Synchrony Financial Third Quarter 2014 Earnings Conference Call. My name is Christine, and I will be the 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. Greg, you may begin.

Thanks, operator. Good morning, everyone, and welcome to our third quarter earnings conference call. Thanks for joining us today. In addition, to our press release, we've provided the 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 could be accessed by going to the Investor Relations section of the website. Before we get started, I want 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, our President and Chief Executive Officer; and Brian Doubles, our Executive Vice President and Chief Financial Officer will present the results on the call this morning. After we complete our presentation, we will open up the call for questions. Now, it's my pleasure to turn the call over to Margaret.

Thanks, Greg. Good morning, everyone, and thanks for joining us. We welcome you to our first Synchrony Financial earnings conference call. I would like to take this opportunity to thank our partners, our customers, our employees, GE and our new investors for making possible the launch of Synchrony Financial as a public company. For those of you listening in and who are not familiar with Synchrony Financial, I wanted to briefly touch on who we are and what makes our business model compelling. Let's start on Slide 3 of our presentation. First, we are the largest provider of private label credit cards in the U.S. and a leader in financing for major consumer purchases and Healthcare Services. In aggregate, we have over $58 billion in receivables and nearly 60 million active account holders. Our range of credit products are offered to consumers, through our long-standing and diverse partnerships. That include national and regional retailers, manufacturers, buying groups and healthcare service providers. It's important to note that while we are a new public company, our consumer finance heritage dates back over 80 years. That's an important from an experience standpoint, but also demonstrates our commitment to our partners. We will support them through all business cycles. We provide a compelling value proposition to both our partners and consumers. Our loyalty and retail credit product suite is integrated with our partners to allow consumers to apply for credit, manage their accounts and access most customer services, seamlessly over their channel of choice, in store, online or mobile. We help our partners grow their businesses, with targeted marketing and loyalty programs. We have advanced data analytics and a CRM platform that enables us to transform big assets into actionable, retail insight, delivering targeted marketing, based on consumer behavior, which help our partners drive traffic and gross sales. To support our partner program and maximize program effectiveness, we have dedicated on-site teams and marketing centers of excellent that work with our retailers to provide customized real-time solutions. Of course, our cardholders benefit from the promotions and loyalty rewards and the ability to finance and compartmentalize major purchases. We are also supporting our partners and cardholders through the evolving payment landscape. We have long viewed mobile logs as an important channel to our payment strategy. We have a platform today that allows customers to apply and buy, service their accounts and receive awards on their mobile device. Payments are the last leg of our development. Our strategy is to build, partner and invest in the development of payment services that benefit our partners and cardholders. Our focus is security, ease of payment and delivery of an optimal value proposition and customer experience. We are working closely with our partners to understand their preferences, as well as the preferences of our cardholders, as we evaluate which wallets make the most strategic sense. I think it's important to note that we are in discussion with key players, testing emerging technologies and piloting mobile payment applications, as part of our roadmap to developing long-term successful mobile payment solutions. And we're very pleased to announce today, that we have signed up to participate in the Apple Pay program for our Dual Cards. We will be in a position to place participating Dual Cards into the Apple Pay wallet. We have also invested in LoopPay, which is an innovative mobile payments platform company. LoopPay's payment technology is a mobile phone application and accessory case that enables mobile payments at the register, where you swipe your credit card. LoopPay works with most existing point-of-sale systems and allows consumers to upload any payment, loyalty or IV cards via a patented magnetic, secure transmission technology and does not require merchants to update point-of-sale hardware. In early September, the merchant customer exchange announced their payments, loyalty and offers platform called CurrentC, which is a mobile payment network. Many of our partners are engaged with MCX, so clearly, we are supportive of the CurrentC platform, as they work to continue to develop their capabilities. At the end of the day, it is our belief that consumers will choose the device they prefer to pay with. And it's our job to build the capability to play in the emerging technology landscape and to ensure that our cards have a very strong value proposition, so that the cardholders choose to put our partner's cards in their wallet of choice. Now I want to spend a few minutes on our growth opportunities. We have demonstrated a strong record of winning new partners and renewing partnerships, a testament to our partner-driven operating model. We also have a track record of growing organically through increasing penetration at our retailers, by increasing the number of cardholders and getting a greater share of our customers' spend. We believe, we have a significant opportunity to increase the penetration of our retail card partners' more than $550 billion in sales volume. Further, we have an opportunity to expand our focus on small business lending. We currently handle approximately $10 billion in annual small business purchase volume, and have some attractive capabilities that we believe, we can further leverage. And to support our loan receivables, we are driving significant growth in our direct deposit base. Since the first quarter of 2013, when we acquired approximately $6 billion of deposits from MetLife, we have grown direct deposits to over $18 billion, as of the end of the third quarter, an increase of $12 billion in a little over 18 months. And we will continue to make investments in marketing the brand and building out the product suite and platform to grow our direct deposit business. All of this contributes to our solid financial performance and profile. Since 2011, we have grown receivables nearly 9% annually, and produced a strong earnings profile. We have very attractive returns, strong capital and liquidity, and are well-positioned for future capital return, after our separation from GE. I'll now move to a discussion about the third quarter. The highlights on Slide 4 will be consistent with what I've just discussed. First, let's take a look at our financial results. This morning, we reported third quarter earnings per share of $0.70, which was driven by several key factors. Looking at the business as a whole, purchase volume was up 11%, helping drive receivable growth of 7% over the same quarter last year. Platform revenue growth was strong at 9%. Asset quality remained stable to slightly improving, with net charge-offs down 2 basis points and 30 plus delinquencies down 6 basis points. Expenses were in line with expectations. The increase was driven by investments we made to help grow the business and to support the buildout of our stand-alone infrastructure, as we prepare for separation. Capital and liquidity were significantly strengthened with our stock and debt issuances during the quarter. Tier 1 common capital was 15.1%, and high-quality liquid assets were over $14 billion at quarter end. Looking at our business highlights. We renewed 2 of our largest partners during the quarter, Lowe's and QVC. With Lowe's, we have now renewed our 5 largest programs through 2019 and beyond. In addition, we added nearly 1,000 partners to our payment solutions platform and nearly 9,000 CareCredit provider locations, since the third quarter of last year. I'll speak more to the performance of each of our 3 business platforms later. Aside from our successful IPO and debt issuance, some other highlights during the third quarter included the launch of a cash back value proposition that makes the new Sam’s Club program the most competitive credit reward program in the club category, along with EMV chip-enabled technology to enhance security on the new Sam’s Club Dual Cards. We also launched EMV cards at Walmart. And our goal is to have all of our Dual Cards chip-enabled by the late 2015. As you may have seen on various media outlets, we also launched our brand campaign to help build our business and banking platform. We had a stand-alone readiness plan that we're executing to build the infrastructure to operate as a separate entity from GE. We have made significant progress on this plan. We are also working with regulators to meet the requirements to operate as a separate regulated entity, as we progress through 2015. Moving to Slide 5, for a perspective on our key growth metrics. Purchase volume for the quarter was $26 billion, an increase of 11% over the last year. This helped drive receivable growth of 7% to $56.8 million. Our average active accounts were up to 59.9 million, which is a 7% increase from last year. And platform revenue was up a strong 9% over the third quarter of last year. We continue to feel good about the growth we're seeing across the business. Many of our partners have positive growth in purchase volume, and we continue to drive incremental growth through our value proposition and promotional and financing offers. On the next slide, I'll spend a few minutes discussing the performance within each of our sales platforms, before turning it over to Brian, to give you more detail on our financial results. We continue to see solid growth across all 3 sales platforms, Retail Cards, Payment Solutions and CareCredit. Retail Card, which is a leading provider of private label credit cards and also offers Dual Cards and small-business products, partners with 19 national and regional retailers that collectively have over 33,000 locations across the United States. Retail Card accounts for approximately 2/3 of our receivables and platform revenue and we generated strong growth across our partner programs, growing receivables 6% over the last year. The growth helped drive platform revenue improvement of 10%. We also grew average active accounts 6% during the same time frame. We are actively looking at potential new programs and additional renewable opportunities in Retail Cards. Payment Solutions, which accounts for approximately 20% of our receivables and 16% of our platform revenue, is a leading provider of promotional financing for major consumer purchases, primarily, in the home furnishing, consumer electronics, jewelry, automotive and power product markets. We have over 260 programs with 62,000 partners that collectively have nearly a 118,000 locations. The majority of our industry had positive year-over-year growth in both purchase volume and receivables. Performance was particularly strong in the home furnishing and automotive product market. Purchase volume was up 9% versus last year and average active accounts were up 9%, driving receivable growth of 7% and platform revenue growth of 6%. Our marketing initiatives and improved penetration were among the key drivers of growth. We are also actively pursuing a pipeline of potential new partnership opportunities in this platform as well and recently announced multiyear agreements with Select Comfort, the International Diamond Center and REEDS Jewelers to provide consumer financing. CareCredit, which accounts for about 12% of our receivables and 70% of our platform revenue, is a leading provider of financing to consumers for elective healthcare procedures that include dental, veterinary, cosmetic, vision and audiology services. The majority of our partners are individual and small groups of independent healthcare providers. The reminder are national and regional healthcare providers. We service a broad network of over 155,000 providers, with over 185,000 locations. The majority of our specialties showed year-over-year growth in both purchase volume and receivables, with veterinary, vision and dental care turning the highest receivable growth. Purchase volume was up 5% and average active accounts were up 8%, driving receivables growth of 6% and platform revenue growth of 8% over last year. In sum, a strong quarter across each of our sales platforms. As focused on expanding and deepening our partnership and programs yielded solid performance. I'm now going to turn the call over to Brian, to provide a review of our financial performance for the quarter.

Great. Thanks, Margaret. I'll start on Page 7 of the presentation. The business earned $548 million of net income, which translates to $0.70 per diluted share in the quarter. Overall, the business delivered strong top line growth, with purchase volume up 11% and receivables up 7%. If you adjust for the loans that were moved to held-for-sale, receivables were up 9%. Net interest income after retailers' share arrangements was up 8% compared to last year. It's also up 8% year-to-date. So this continues the strong trend that we've seen all year. RSAs were up $13 million or 2%, driven by growth in the programs, partially offset by increases on the provision and other expense lines. The provision increased to $134 million compared to last year, largely driven by growth in the receivables and the year-over-year impact of the methodology changes we completed in 2013. Asset quality continued to be stable. 30 plus delinquencies were 4.26%, down 6 basis points versus last year and the net charge-off rate was 4.05%, down 2 basis points versus last year. Other income was down $18 million or 16% versus last year. Interchange was up $19 million, driven by continued growth in auto store spend on our Dual Card. This was offset by loyalty expense, which was up $26 million, primarily, driven by the launch of our new value proposition at Sam’s Club, that Margaret mentioned earlier. Other expenses increased in line with our expectations and were driven by 3 key components: First, we're making investments to support ongoing growth, particularly in our retail card programs. As many of you are aware, we recently completed long-term extensions with many of our large partners and as part of those renewals, we set aside more dollars in the marketing and growth funds to support those programs. Second, we also launched our new branding campaign in September, and continued our marketing efforts with a focus on our deposit products. And lastly, we continue to invest in the infrastructure build, as we executed our plan to separate from GE. So overall, the business had a strong quarter. We executed on a number of key transactions, including the IPO and closing over $13 billion of new financing. We also made good progress on our plan to separate from GE. I'll flip to Page 8 and walk you through net interest income and our margins. Net interest income was up 7%, driven by strong receivables growth, which was partially offset by higher funding costs. The net interest margin declined to just over 17%, which was in line with our expectations. As you look at the net interest margin compared to last year, there are a few dynamics worth highlighting. First, it's important to point out that the yield on our receivables continues to be relatively stable. A small reduction of 21 basis points year-over-year was the result of a slightly higher payment rate in the quarter. The majority of the decline of approximately 230 basis points was driven by the build in our liquidity portfolio. We increased the high-quality liquid assets on the balance sheet to $14.1 billion, which is up $12 billion versus last year. We have the cash conservatively invested in short-term treasuries and deposits at the Fed, which results in a lower yields in the rest of our earning assets. Lastly, on interest expense, the overall rate was up 14 basis points to 1.7%. We have had quite a bit of change to our funding profile, so let me give you a breakdown by funding source. First, the cost of our deposits were down 18 basis points to 1.6%. This was largely driven by an increase in our direct deposits, which were up $10.5 billion versus last year. This is a very attractive source of funds for us, and we expect to continue to grow our direct deposit base going forward. Securitization and funding costs increased 24 basis points to 1.5%, driven by extending some maturities in our master note trust and the addition of $5.6 billion of undrawn securitization capacity. Our other debt costs increased 77 basis points to 2.4%, driven by the higher rate on the GE Capital and bank loans, as well as the unsecured bonds. It's worth noting here that the new bonds we issued are longer tenure, so we swapped out some shorter-term, variable-rate funding for longer dated, fixed-rate funding. So this should benefit us in a rising interest rate environment. Let me close out on margins and make a few comments on our outlook for the next few quarters. First, we expect the margins on our core receivables will continue to be stable. In terms of our overall net interest margin, it's important to highlight that this quarter reflects a partial impact from the additional liquidity and funding cost. Once these are fully reflected in our results, we expect to see the net interest margin come down in the 15% range and remain relatively stable. During the IPO, we provided guidance of 14% to 15% on net interest margin, so we do expect to be at the higher end of that range. On Page 9, I'll walk through some of our key credit metrics. Before I get to that, however, I thought it'd be helpful to provide some perspective on the seasonal trends in our portfolio. As you can see in the charts, we typically see lower delinquency levels in the first and second quarters, which we believe is driven by the tax return season and consumers paying down holiday balances in the first half of the year. Charge-off rate naturally follows delinquencies, and so you see it hit a low point in the third quarter. And we typically see receivable balances grow, as well as delinquencies increase, in the third and fourth quarters, driven by vacation and holiday seasons. These trends have been fairly consistent over time, so that should give you a good framework on how to think about it going forward. So let me turn more specifically to the results for the third quarter. Overall, we continue to see stable trends on asset quality. 30 plus delinquencies were 4.26%, down 6 basis points versus last year, 90 plus delinquencies were 1.85%, up 2 basis points. The net charge-off rate was also stable at 4.05%, down 2 basis points from last year. Lastly, the allowance for loan losses as a percentage of receivables was very consistent, with the last 2 quarters at 5.5%. We also measure reserve coverage by comparing the reserves to the last 12 months charge offs and we're currently at 1.2x coverage, which equates to roughly 14 months' loss coverage in our reserve. This has also been very consistent all year. In terms of our go forward expectations, overall, we feel good about our portfolio and our underwriting strategies. We also think that unemployment will continue to be fairly benign. So given those dynamics, we expect our credit trends to continue to be relatively stable. Let me turn to Page 10 and cover expenses. Overall, the expenses were in-line with our expectations and were driven by overall business growth, plus incremental investments in the programs and our brand, as well as the infrastructure we're building as part of our separation from GE. Let me give you a breakdown of $153 million increase for the quarter. Employee costs were up $66 million, as we added additional employees over the past year to support growth in the business and the infrastructure build, as we prepare for separation. Professional fees were up $39 million. This is largely driven by consulting and legal expense related to our separation, as well as the continued investments we're making in our direct deposit platform to enhance our capabilities. Marketing costs were up $61 million, as we've increased investment in our programs, continued our marketing efforts around our direct deposit platform, as well as launching the new brand for the company. Other expenses were down $13 million, primarily driven by lower assessments from GE, as we begin the process to separate. So overall, our efficiency ratio was 31.9% for the quarter, which still indicates a very efficient operation compared against other financial institutions. In terms of how we're thinking about the expense run rate going forward, we thought it would be helpful to reiterate the guidance we provided in the S-1 and give you an update on those estimates. First, we disclosed and we thought the incremental marketing expense from the renewals would be in the range of $100 million to $150 million a year. Our current estimate is $120 million, so very close to our original estimate. Second, we estimated a $90 million to $100 million of costs related to launching our new brand and continuing our marketing efforts on deposits. Here, we expect to be closer to a $100 million, driven primarily by the plans to continue to grow our deposit platform. Lastly, we disclosed approximately $200 million to $300 million of incremental costs related to infrastructure build. These costs are really spread across a few key areas, building out our stand-alone infrastructure, replacing certain services we received from GE, strengthening our regulatory and compliance processes and migrating to our own dedicated IT data centers. In these areas, we expect to spend approximately $250 million, which is a mid point of our earlier guidance. So in total, we believe we're on track here and expect to be at the midpoint of the range we provided in the S-1. On Page 11, I'll cover our capital and liquidity position. As you know, we had a very active quarter and made a number of changes to our balance sheet, as part of the IPO and the other transactions that we completed. So we wanted to start with an overview of the sources and uses from those transactions. First, the IPO generated just under $3 billion of proceeds, which were retained by the company. Next, we completed our debt offering shortly after the IPO. Given the strong demand, we are able to increase the size of the deal from $3 billion to $3.6 billion. Lastly, we received $9.5 billion of funding from a syndicate of banks and GE Capital. So with the total proceeds of approximately $16 billion, we repaid just over $8 billion of intercompany financing from GE Capital. We've also used the additional $600 million of proceeds from the bond offering to prepay the GE Capital and bank loans. Our strategy here is to continue to prepay both of these loans ahead of their contractual maturity in 2019. And then the remaining funds, approximately $7.3 billion, we used to strengthen our liquidity. So turning to capital, we ended the quarter at 15.1% Tier 1 common under Basel I. This level places us among the highest in our peer group. This translates to 14.6% common equity Tier 1 under the fully phased-in Basel III guidance. The only other point I'd make regarding our capital level is that consistent with our communications during the IPO, we do not plan to return capital through dividends or buybacks until we complete the separation from GE. So we do expect our capital levels will continue to increase during that time. So moving to liquidity. Total liquidity increased to $19.7 billion and is comprised of $14.1 billion in cash and short-term treasuries and an additional $5.6 billion in undrawn securitization capacity. This gives us total available liquidity equal to 27% of our total assets. Overall, we're executing on the strategy that we outlined as part of the IPO. We've built a very strong balance sheet, with diversified funding sources and strong capital and liquidity levels. On Page 12, I'll cover our funding profile. One of the primary keys to our funding strategy is to continue to grow our deposit base. We view this as a stable, low-cost source of funding for the business. Over the last year, we've grown our deposits by over $10 billion, and primarily, through our direct deposit program. This puts deposits at 54% of our funding. So we're well-positioned to meet our long-term target of being 60% to 70% deposit funded. Funding through our securitization facilities was pretty flat year-over-year at just over $15 billion. However, we did extend some maturities and added the undrawn capacity to further strengthen liquidity. And as I mentioned earlier, we completed our first unsecured bond deal, which was well-received and allowed us to increase the size of the deal to $3.6 billion. The pricing was better than expected, which allowed us to go out a little longer in duration. Lastly, I want to talk through some recent developments related to the GE Capital loan. First, our strategy is to continue to reduce our reliance on GE Capital for funding. So on October 6, we brought in an additional $750 million of bank financing and used the proceeds to pay down the GE Capital loan. Given this happened outside of the quarter, you don't see it reflected in the numbers, but the net effect is that the third-party debt increased to $11.8 billion and the GE Capital loan reduced to $655 million. This is a positive result for the business. Given the GE Capital loan carries a higher spread, this early pay down will save us approximately $15 million a year in interest expense. So overall, we feel very good about our access to diverse set of funding sources. We'll continue to focus on growing our direct deposit platform and using the proceeds from future unsecured bonds to prepay the bank and GE Capital loans. I'll turn to Page 13 and just provide a quick summary on the quarter. The business delivered strong purchase volume and receivables growth. We completed long-term extensions with 2 of our largest customers, and we continue to add new partner and provider relationships every day in Payment Solutions and CareCredit. We announced the agreement with Apple and continue to strengthen our mobile offerings for our partners and consumers. Our deposit growth is ahead of schedule, and we're on track to deliver our long-term target of having 60% to 70% of our funding from deposits. We will continue to manage a strong balance sheet, with capital and liquidity levels that are above our peer group. We also remain focused on building out our infrastructure and executing on our plan to separate from GE. And lastly, I did want to mention today that I provided some insight on how we're thinking about 2015. We are planning to provide some more specifics around our 2015 outlook, as part of our fourth quarter earnings call in January. And with that, I'll turn it back over to Margaret.

Thanks, Brian. I'll close with a few brief points on Slide 14, and then let Greg get us into the Q&A portion of the call. To summarize, we are a leader in the private-label credit card business and are in a unique position to capitalize on our deep partner integration and further leverage the compelling value proposition we provide partners and consumers. Our fundamentals are solid, with strong capital liquidity and our business generates strong returns. And looking ahead, we have attractive growth opportunities, particularly to further leverage data analytics and mobile and e-capabilities, as we continue to seek ways to provide even more value to our partners and consumers and stay at the forefront of emerging payment trends. Finally, we are generating strong deposit growth through our online bank and this should help support our growth objectives moving forward. In sum, we are well positioned to leverage our past success, solid foundation and unique market position to help drive growth with existing partners, as well as develop new partnerships and consumer relationships. We look forward to reporting our progress on future calls and interaction with the investment community. We are very excited about the prospects for the future of Synchrony Financial and those critical to our success, our employees, partners and cardholders. That concludes our comments on the quarter. So now, I'll turn the call back over to Greg to open up for Q&A.

Thanks, Margaret. Operator, we're now ready to begin the Q&A session. As we do so, I'd like to ask the participants to please limit yourselves to 1 primary and 1 or 2 follow-up questions, so that we can accommodate as many of you as possible.

[Operator Instructions] Our first question comes from Ryan Nash from Goldman Sachs.

I wanted to start with loan growth. You noted 9%, including held-for-sale. Can you just maybe help us better understand some of the components across the platforms, how much is coming from new account additions versus willingness for customers to take on additional debt. And Margaret, you did note across both Retail Card and Payment Solutions that you are looking at new partners. Just how active is the pipeline? And how should we think about the timing of these announcements? And was there any impact from the IPO process, potentially slowing the announcements of these potential new partners?

Okay. So I'll have Brian start, and then I'll answer the second half.

Sure. So Ryan, we've continued to see strong growth across all 3 platforms. As you highlighted, excluding Dillard's and Meijer, which we moved to held-for-sale in the second quarter, kind of the core is up 9%. That's spread pretty evenly across the 3 platforms. So we still continue to feel pretty good about the growth that we're getting. It's both new account growth, as well as active account growth. So one of the things we've been very focused on particularly, in Payment Solutions and CareCredit, is getting that repeat purchase volume. And so now, if you look at CareCredit, 47% of our purchases are repeat transactions. If you go back 5 years ago, we're -- it was probably one and done. You weren't getting that repeat volume. So that's been a big focus of ours. And then, also in the Payment Solutions platform, repeat transactions are 24%. Again, 5 years ago, that was probably close to 0. So I would say it's a combination of all of those drivers that have given us strong growth.

So Ryan, on your question about growth strategy, I'd say first of all, we still have -- our biggest opportunity is still driving organic growth, which we're very focused on. But what I would tell you is we reorganized our business development team. We've added additional resources to really jump on the opportunity for what's out there in our pipeline. We have a very active pipeline. We're really focused on all 3 platforms. We felt good about what's in our pipeline. And I think, you saw in our announcement today particularly for our Payment Solutions, we announced REEDS Jewelers, as well as the International Diamond. And I think, you can expect to hear more of that in the coming months for all 3 platforms.

Got it. And then, my second question would just be related to separation, a 2-part question. First, Margaret, from an higher-level, would you be able to give us a timeline on the milestones that we need to see for you to reach separation? I mean, clearly, you're investing a lot of these different initiatives, but it would be helpful just to understand what some of the key initiatives and things we need to see, before you go to the Fed. And then, for Brian, on separation expenses that you outlined in Slide 10, the $470 million or so that you would expect to incur, how much of that is actually currently embedded in the run rate, that you show on the right side? And how should we expect to ramp-up to occur over the next few quarters?

Great. So Ryan, as we said, we're still targeting late 2015. And they're really, a couple of key things that have to be accomplished. The first is, and you saw this in our expense build out, we need to demonstrate that we have standalone capabilities and we're operating as a stand-alone company. The second is, we will have to apply through an application process with the Fed. We're anticipating doing that first half of 2015. Once that happens and the Fed will come in and actually evaluate our standalone capability. So they're going to want to see that we have the infrastructure in place. So with that said, we're really targeting first half of 2015 to get the application done, have the Fed come in and then, the timeline after that will be contingent upon the approval from the Fed.

And then, Brian, on the expenses?

Yes, the expenses. I think, probably, the easiest way to think about it is if you just break down the spend this quarter and look at it year-over-year, so expenses are up $153 million year-over-year. $43 million of that is just related to growth in the business. The other $110 million is really tied to those 3 categories, that I outlined in the $470 million run rate for the year. So if you just take the $110 million and you annualize it, that would get you fairly close to the $470 million. So a lot of this is in our run rate already. There's going to be little bit of seasonality in some of the spend, so I would think about it coming in over the next 2 or 3 quarters. And then from there, we would expect our expenses to grow more in line with revenues.

Got it. But we shouldn't see another big ramp up, is what you're saying?

No, you shouldn't. Costs are going to grow in line with revenues. I think, you got 2 or 3 more quarters here of the build. But if you look at the third quarter, a lot of this is in our run rate already.

Our next question comes from Betsy Graseck from Morgan Stanley.

A couple of questions. One just on the reserving and one on the digital platform. So on the reserving, Brian, I heard you highlight that the ALR ratio has been holding steady about 14 months, recently. I just wanted to understand if that's what you're anticipating, we should be keeping that to? Or is there anything incremental for credit deterioration that you're looking for, just seasonally speaking?

Yes. No, Betsy, we're not seeing anything on credit deterioration at this point. If you look at the metrics, 30 plus is stable, 90 plus is stable and the charge-off rate is pretty flat year-over-year. So we continue to feel like credit's going to be, it's not going to get a lot better from here, but it's not going to get worse either. So that's how we're thinking about it. And if you look at the reserve profile has been fairly consistent. I did mention 14 months. The only problem with that metric is it's backward looking. Obviously, we reserve more on an incurred loss basis. So a more forward-looking view. But that is not a bad way to think about it, a combination of looking at the reserve coverage on receivables and reserves against the last 12 months' charge-offs. The one thing that you don't want to do though is to just take reserves over the current period charge-offs, because there'll be a lot of seasonality in that metric. So really use the last 12 months, is a much better indicator.

Exactly. So then, any build in reserve really is a function of the loan growth?

That's definitely what we're seeing right now. So we expect to continue to build reserves in line with receivables growth.

Okay. And then, Margaret, I just wanted to dig in a little bit on the digital that you talked about, and in particular, this recent article on you highlighting the Innovation Station that you drove over the past several years to increase card purchases significantly. What was it? 62%, or something like that, between 2010 and 2013. So I wanted to understand, if the digital activities that you're working on now are going to be able to drive significant growth from here? Or is it more table stakes?

So, thanks for that question. So I would tell you that we continue to see great growth on online and mobile. And it's something that we're very focused in. About a little more than a year ago, I was out at Stanford University's Engineering School and actually spend time with the leader there, who works with really a group of millennials. And it really gave me the concept of how I really unleash the talent in the millennials on my team, and really create a different work environment for them. So we created this Innovation Station, which is really a cross-functional team. So it's really not only computer geeks, but also our risk teams, our operational teams to really figure out a unique way to really focus on ideation and accelerating our capabilities in the market. So what we're seeing and the fact that we've done this has really helped us to accelerate what are partners are looking for and what consumers are looking for. For instance, we do something called the Bolt session, where we actually bring partners and end consumers. And we take a business issue or problem we're trying to solve from a digital perspective and we actually by the end of the day have a prototype. And we can test it with consumers right there. So it's really a way for us to think more broadly about where the world is going from a digital perspective and something we're extraordinarily focused on.

And if I tie that into what you're working on with Apple Pay, can you help us understand how you're thinking about how Apple Pay is going to impact not only your card members, but your merchant partners as well? And then, do you see an opportunity for Apple Pay, beyond the dual cards, into the PLCC only cards?

Sure. So why don't I just talk about our strategy around mobile payments in general. And the way we think about this is, we really want our cards in as many mobile wallets as possible. And I think, when you think about the consumer themselves, we're going to have to drive this from both our partners' perspective, as well as the consumer perspective. But at the end of the day, it's really going to be up to the consumer on how they choose to make their payments and what device they're using. So our strategy, right now, is really to work with all the wallets. We're not going to holdback just on Apple. And we are working with partners who do MCX, so we'll be partnering with them. The good news for us, and we're -- I should also say we're doing some of our own virtual payments, too. We have 2 applications out there now, where our partners have asked to create an application for them for payments. So we're really looking at this very broad base. For us, our applications today allow customers to apply and buy, service almost all of their account online and get the rewards. So we really see payments as the last leg of the stool. And then, our job is really to make sure we have a very strong consumer value proposition, so that the customers want to load the cards inside wallets. And then the last one I would tell you, we are interested in getting our private-label credit cards, as well as our Dual Cards into all the wallets. So we really view this as a big opportunity. It's really going to be a seamless experience from a customer perspective for us. And we're very excited about partnering with Apple on the Dual Cards for the partners that want to be on that application.

Our next question comes from Don Fandetti from Citigroup.

Margaret, I was wondering if you could just provide an update on how you see the CFPB playing out, maybe over the next year or so, on deferred interest. And then secondarily, PayPal looks like it's going to be an independent entity. I don't know, if that has any impact on your 2016 renewal. Just thought I'd check in on that.

Sure. So why don't I start with the CFPB first. So we will be supervised by the CFPB. They're one of our ongoing supervisors. We know that they are working on looking at deferred interest right now. The silver lining for us is that, we had gone through a review with them on our CareCredit business. And we believe that the learnings we got out of that review from CareCredit, we're applying them across the business. So I can't say, ultimately what they're going to ultimately decide, but we feel like, we had a little more insight to what they were looking for. And at the end of the day, their goal is really to be fair and transparent, or they want us to be fair and transparent to consumers, which is something we believe into. So that's about what I could say on the deferred interest portion. On PayPal, we've had -- we've been a long partner with the PayPal. We've been with them since 2014. Obviously, they're making a very big strategic decision to split off from e-Bay. We disclosed, in our S-1, that we would not be renewing their deal after 2016. So they will be moving on and exploring their own business in a different way. So that's where we are on PayPal.

Our next question comes from the Rick Shane from JPMorgan.

I have one sort of conceptual question and then just one sort of housekeeping. Brian, you're going through and you talked a little bit about why the loyalty program expenses were higher, related to Sam's Club. The question I have for you is this, should we think about as coincident with volume or as a precursor to volume?

I would think about it as coincident, Rick. So we loaded -- we launched the Sam’s Club value proposition. That's part of what you're seeing in there. That's been very well-received. So as we rollout new value propositions, you're going to see that grow in line with our purchase volume. We kind of had a reset, I think, in the third quarter, because we rolled out some new very attractive value propositions. But it should definitely lineup with purchase volume going forward.

Okay, great. So it's not -- we shouldn't see it as an investment. We should see it tied directly to the activity you get each quarter.

That's right. Similar...

Okay, great. And then on the housekeeping side, Can you just go through the end of the period asset balances for credit cards, installment loans, commercial loans and other loans?

Sure. Let me give you -- let me start with commercial and small business. We ended at $1.4 billion, which is up 3.5% versus last year. Installment was $1.1 billion, which is down 21%, but if you remember, we completed the HI sale in the fourth quarter of '13. So if you adjust that out of the numbers year-over-year, the installment book would be up 8%. So that's certainly an area that we continue to grow.

Got it. And then the other 2 categories?

Other...

I'm just trying to tie it up to the average balances you provide on the charts.

Yes. Credit card is $18 million versus -- I'm sorry, other is $18 million versus $12 million versus last year. Credit cards was 55 -- $54.9 billion.

Our next question comes from Sanjay Sakhrani from KBW.

I just have a couple of questions. First is just on capital and M&A opportunities. When we think about your capacity to do M&A deals, how much are you constrained within the context of the amount of capital you want to have going into your submission to the Fed? And then secondly, on Apple Pay, one of your competitors seemed less excited to kind of put their private-label cards onto Apple Pay. And I was just wondering, what you guys see in that interaction with Apple Pay that might lead you to believe differently?

All right. Why don't I take the Apple Pay question and then, I'll turn the M&A question over to Brian. I did hear that, Sanjay, that one of our competitors was less -- our view is that this emerging technology is just the next step in the process for how customers are using their digital devices. So if you think about our cards today, we're seeing really good growth. And we also know that if a customer shops online, shops their mobile phone and shops bricks and mortar, we actually get more of their spend. So really, the payment is the last leg here. And we see this as a real opportunity for us to get incremental sales. And secondly, I think, given that hopefully these devices are going to be a lot more secure, we'll actually be able to reduce some of our fraud costs. So we see this as a real benefit to our consumers. Obviously, we have to work with our partners in selecting which wallets are good for them, but our goal is to try to be in as many places as possible.

And on your first question, Sanjay, I would start by saying we've had an active dialogue with our regulators over the last 18 months. We tried to incorporate some of that feedback into how we built the balance sheet. We're at 15% Tier 1 Common, which compares very well against really any financial institution. We're going to build capital from here until separation. I think in terms -- longer-term, after we complete the separation, the way we prioritize our use of the capital is, first, organic growth. So this is still a strong -- very strong organic growth story. It will continue to be. Second, I'd say we're going to continue to look at platform, our portfolio acquisitions. Margaret talked about, we've got a great pipeline across all 3 of our platforms. That will continue. So we really view those 2 things as our core, and that would be our first use of capital. Then we're going to look to establish a regular dividend and buyback. And then, I would put M&A kind of fourth. And it's something that we spend a lot of time on. We look at all the time. But I'd say, we're going to be very disciplined around M&A opportunities. We're going to be very thoughtful about anything we do there. And they're probably going to be more capability building, as opposed to deviating from the core of what we do.

Okay. Couple of more follow-ups. Just on Apple Pay, one more follow-up on Apple Pay. Just to clarify, Margaret, there's no change in the way you could secure -- the amount of data that you could secure from the merchant, as a result of Apple Pay, right? And then, just secondly, on -- there were lots of articles on Conn's, the furniture retail store in Texas, during the quarter. And I was just wondering if you could just talk about the scope of your relationship with them, because it seemed like they were having some problems?

Sure. So on Apple Pay, the way I would think about is similar to EMV, so there is that extra secure element. And I think the other is the fact that people tend to hold on to their wallet, I mean, to their phone versus sometimes their wallet or their cards. I think, there is a little bit more security there. But you're right. It's got the same kind of technology that SMB does from an NFC perspective and security. So to that point, I think, you're right. But I think, we just see these as another way to just add a bit more security out there in the marketplace around data and cards. On Conn's, what I would say to you is, I'll start and have Brian add a little more. First, we normally we don't comment on a particular partner like this, but given there is a unique situation and there's media out there, what I would say first is, they're a great partner. We've had them since 2009. Our job with Conn's is we actually underwrite the higher FICO portion of their book. We underwrite it ourselves. We hold those receivables, and we're not seeing any deterioration in the performance of the book that we have. I don't know Brian, if you would add anything.

Yes. The only thing I'd add is, the Conn's portfolio that we have is $160 million of receivable. So it's 0.2% of our total. It's fairly small for us. And I'll just echo Margaret's comments, that it's performing very much in line with our expectations.

Our next question comes from David Ho from Deutsche Bank.

I just wanted to talk about the retail sales outlook. Obviously, a little softening. As we get to the end of the year, you saw Walmart kind of reducing their same-store sales forecast. Obviously, a big part of your loan growth outlook. How do you see this playing out? And are you seeing any differences or changes in just the overall outlook for retail sales?

So we're not really seeing any difference. We've had a fairly solid 2014, and we're expecting that to hold through the holiday season. I think, the holiday season will be in line with how we've been seeing sales all year. What I would tell you, that consumer is out shopping, but I do think the consumer is definitely more cautious, particularly about big ticket spending. So I think, this is where they're spending more time thinking about what to purchase, how to purchase, and that's where I think promotional financing really helps that consumer make that purchase. But we're not really seeing any softening. On the Walmart comment, what I would say is, this is really where we bring value to our partners, when sales -- overall sales are softening, it's where we bring our capabilities to bear, and it's where we tend to have even greater connection with our partners on how to leverage the card program, our data analytics and CRM to really drive more sales and more customers into the store. So overall, we're feeling positive about the remainder of the year.

Okay. Just a quick follow-up. On the Walmart sales, do you typically, for mass retailers in general, do you still see 2 to 3x purchase volume growth usually with -- when you look at retail sales growth? Or is it smaller for the mass retailers?

Yes, I think, it differs by retailer. And I wouldn't categorize it by mass versus -- part of this is the level of support for the program and the amount of advertising that we do. I think that's a driver. I think, when you look at it in its entirety and this has been very consistent over the last 4 or 5 years, you look at retail sales broadly, we tend to be 2 to 3x the broader retail sales market. Same is true, if you just look at revolving credit. It's been up 3%, and we're up more than 2x that. So that ratio holds in total, but it gets difficult to segment it below that, to be honest.

Okay. And then, just a quick one on penetration rates. You guys have noted that about 28% from midsize retailers, a little lower for mass retailers. How are those trends trending in the most recent quarter? And how do you view that as an opportunity, outside of macro sales growth and some of the other online initiatives as the driver of loan growth?

Yes. I'd say they've been very consistent. Our goal in each one of our programs is to continue to increase that penetration. And that's been consistent with -- you can't grow at 2x the retail sales broadly, if you're not gaining penetration every day, both from other tender types, as well as just gaining greater penetration within that retail partner. So that's continued to kind of hold true.

Our next question comes from Mark DeVries from Barclays.

My first question is just a follow-up on your last point. Do you have any thoughts theoretically on kind of how far penetration rates at your merchant partners can go?

I'd tell you that, we have some that are below 5% and we have some that are in the high 40% range. And so it really is retailer by retailer. But that's the kind of penetration that's possible. And on days where we run a certain promotion, it can be in the 80% range. I don't know if, Margaret, could you add?

No, no. We had -- we always have a contest each year on how high we can go, and I think our max is 86%.

Okay. So I assume you feel you're a long ways from the point where you kind of maxing out penetration with your individual partners?

Absolutely. That gets back to the point of, if you think about just retail cards $550 billion in annual sales volume, our ability to drive just 1% penetration, that would be a big win for all of us. So that's kind of how we think. That's why we have to pay a lot of attention to organic growth, as well as new opportunities.

Okay, great. And then on a related point, what's driving your retail card purchase volume growth to be meaning stronger than the actual account growth and receivable growth here? And do you have any sense for whether Dual Card is growing purchase volumes faster than private-label here?

Why don't I start and then I'll -- the one thing you have to take under account when you look at the growth rates, if you're looking at purchase volume compared to receivables, receivables, if you adjust for held-for-sale, are actually up 10%. And so then you'd see those 2 aligned more closely. So in retail cards, those -- that's where we moved Meijer and in Dillard's, into held-for-sale.

Okay. And then the difference, if any, between the purchase growth you're seeing in Dual Card versus private label?

We continue to see strong growth in both. We would typically see stronger growth in Dual Card, because we're flipping private-label consumer cards to Dual Cards over time. Our strategy is one where we start consumers out with a smaller balance and over time, we look to grow that line and ultimately, flip it into a Dual Card. So just that dynamic of the flip results in dual card growth outpacing private label. But we really look at it program by program, in total, and not so much by individual product.

Operator, we have time for one more question.

Our final question comes from Ken Bruce from Bank of America.

You addressed a lot of my questions. I guess, maybe if you could address the RSAs in the quarter within the retail segment were up. I know you had called that out, pre-IPO. But could you tease out, essentially, how much of that was maybe one-time or where you expect that to be over the near-term and what some of the key drivers are within the RSAs, please?

Yes. If you look at the RSAs, there's quite a bit that goes on there, Ken, as you know. So they were up 2% year-over-year. I think you had to start with the fact that revenue receivables growth was well in excess of that. So the RSAs take into account the other line items on the P&L. So you've got provisions and other expense that run through there as well. And so, if you look at RSAs as a percentage of receivables, which is not a bad way to look at it, I think it was down from 5.2% last year to 4.8%. We think 4.8%, that's a fairly normal quarter for us. And so, we would expect it to stay fairly consistent from here. There's definitely some seasonality there, though, that you have to take into account.

And then, maybe just on that particular point, when does it seasonally higher? Is it -- got a larger fourth quarter effect? If you could just give us a little background on that?

It tends to be a little bit higher in the third quarter, actually.

Okay. And maybe, kind of following-up on a question Sanjay asked. There's been a number of deals that have been highlighted as possibly coming to market and on the M&A front. And I guess, the question is, do you think that you would be able to -- from a capital perspective, do you feel that you've got the capacity to be able to look at a sizable M&A transaction at this juncture? Or do you think that it would require some additional steps, if in fact, if you put yourself in a position to acquire one of those larger portfolios? Just in the context of, obviously, the separation, what you're building up for that, independent of maybe an M&A transaction, but obviously, a large one would probably stretch the capital base and what you might be able to do to accommodate that.

Well, I think, I need to -- let me separate it into the 2 buckets. So I think, if it were a portfolio acquisition that was in our core, that would certainly be something that we would look to do and we would be conscious of our capital levels, particularly as we're in this application phase and working to get approval to separate. I think -- so those are things that we've -- like I said, we've got an active pipeline and we're going after those opportunities. I think any true M&A that's outside of what we would consider a core portfolio acquisition is probably unlikely here in the short term, as we work through the application process and get approval to separate.

So we're going to wrap up the call, but just a couple of points. We're pleased with our progress since the IPO and we really are continuing to work hard towards -- driving towards separation. We have a very strong underlying team, and we're working on all the things we talked about today on the call. And while we're in a very fast-moving space, we really believe that we're well positioned to take advantage of the environment right now, both from a standpoint of our partners and the consumer. So thank you very much. And Greg?

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

This concludes today's conference. Thank you for participating. You may now disconnect.