Synchrony Financial (SYF) — Q2 2022 Earnings Call Transcript

Thank you, and good morning, everyone. Welcome to our quarterly earnings conference call. In addition to today's press release, we have provided a presentation that covers the topics we plan to address during our call. The press release, detailed financial schedules, and presentation are available on our website. This information can be accessed by going to the Investor Relations section of the website. Before we get started, I wanted to remind you that our comments today will include forward-looking statements. These statements are subject to risks and uncertainty, and actual results could differ materially. We list the factors that might cause actual results to differ materially in our SEC filings, which are available on our website. During the call, we will refer to non-GAAP financial measures in discussing the Company's performance. You can find a reconciliation of these measures to GAAP financial measures in our materials for today's call. Finally, Synchrony Financial is not responsible for and does not edit or guarantee the accuracy of our earnings teleconference transcripts provided by third parties. The only authorized webcasts are located on our website. On the call this morning are Brian Doubles, Synchrony's President and Chief Executive Officer; and Brian Wenzel, Executive Vice President and Chief Financial Officer. I will now turn the call over to Brian Doubles.

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

Thanks, Brian, and good morning, everyone. Synchrony delivered another strong financial performance for the second quarter, highlighting the benefits of our highly diversified business across our sales platforms, our partners, merchants, providers, and customers, and underpinned by the continued health of the consumer. This quarter, we achieved the highest quarterly purchase volume as a company, exceeding $47 billion, which reflected a 12% increase compared to last year. On a core basis, which excludes the impact of our recently sold portfolios in the prior and current year quarters, purchase volume grew 60% year-over-year. From a platform perspective, our diversified value, health and wellness, digital, and home and auto platforms each continue to generate double-digit year-over-year growth in purchase volume, reflecting strong demand for the variety of goods and services we finance, as well as the broad partner, merchant, and provider networks that connect our customers and partners. At the platform level, home and auto purchase volume was 12% higher due to continued strength in home as well as higher auto-related spend, reflecting the waning effects from the pandemic period, the preference for consumers to invest in the maintenance of their existing vehicles given the supply chain issues on new and used vehicle sales, and the impact of inflationary pressures on gasoline purchases and automotive parts. In diversified value, purchase volume increased 24%, driven by the strong retailer performance and higher customer engagement. The 14% year-over-year increase in digital purchase volume generally reflected the growth across the platform. We experienced greater customer engagement, including higher average active accounts and spend per active among our more established programs and continued momentum in our new program launches. The 15% increase in health and wellness purchase volume was driven by broad-based growth in active accounts and higher spend per active account driven by our dental, pet and cosmetic categories. Our lifestyle platform generated purchase volume growth of 2%, reflecting strong retailer sales and growth in our music, specialty and luxury verticals, partially offset by the ongoing impact of inventory shortages in our outdoor vertical and particularly strong growth in the prior year period. Loan receivables grew 5% year-over-year to $82.7 billion or 11% on a core basis. We also continue to see sequential growth driven by strong purchase volume and partially offset by higher payment levels. Net interest income increased 15% to $3.8 billion, primarily reflecting the 13% increase in interest and fees due to higher average loan receivables. The payment rate for the second quarter, when normalizing for the impact of the portfolio sold during Q2, was 18.1%, approximately 20 basis points higher than last year, and approximately 250 basis points higher than our historical average. The net interest margin was 15.60% in the second quarter, a year-over-year increase of 182 basis points. The primary driver of our NIM expansion was a 570-basis-point increase in the mix of loan receivables relative to total interest-earning assets, primarily due to the growth in average receivables and lower liquidity. This accounted for 105 basis points of the year-over-year increase in our net interest margin. In addition, the second quarter's 80-basis-point improvement in loan yield contributed to a 63-basis-point improvement in net interest margin, while the slight increase in interest-bearing liability costs reduced net interest margin by 1 basis point. RSAs were $1.1 billion in the second quarter and 5.42% of average receivables. The $121 million year-over-year increase was primarily driven by the continued strong performance of our partner programs and also included an approximate $10 million impact associated with our reinvestment of the gain on sale from portfolios sold during the second quarter. The reinvestment was in support of the growth initiatives in association with the value proposition launch. As a reminder, the RSA is designed to create mutual alignment of interest. While each agreement is unique to the partner program, we generally structure the majority of our economic arrangements such that the investment and upside opportunities are shared. So as Slide 7 demonstrates, the RSA enables our partners to share in the profitability of our programs while also providing economic protection to our business. In a rising credit loss environment, the level of RSA payment to our partner declines because the higher credit costs become a larger offset to the program's profitability. In addition, the minimum profitability threshold within each RSA ensures that Synchrony achieves an appropriate risk-adjusted return before any economics are shared with the partner. These minimum return thresholds also provide a buffer to our business in the occasional event of a regulatory change such that the profitability of the program performance is impacted by, for example, a change in fees collected. This dynamic was demonstrated on Slide 7 due to the strength of our risk-adjusted return when the CARD Act became effective in 2011. Given the questions regarding the potential changes to late fee regulation, I thought I'd highlight two things. First, over 60% of our late revenue flows through our RSA agreements and will be subject to sharing with our partners. Second, greater than 95% of the late fees are covered through either repricing rights or changes in law provisions, effectively change in regulation provisions, which were included in our program agreements adopted after the CARD Act was implemented. This is another example of how the RSA functions to align interests with our partners as market conditions change. Next, let's focus on the provision for credit losses, which was $724 million for the quarter, a year-over-year increase due to the impact of a reserve release last year and partially offset by lower net charge-offs. Other income increased $109 million, primarily reflecting the impact of the $120 million gain on sale from the portfolio sold during the quarter. Excluding the impacts of the gain and certain reinvestments of the portion of the proceeds, other income would have been 3% lower year-over-year, primarily due to the impact of higher loyalty costs that were partially offset by interchange revenue year-over-year. Other expenses increased 14% to $1.1 billion due to the impact of higher employee costs, marketing spend, information processing, and other expenses. Our efficiency ratio for the second quarter was 37.7% compared to 39.6% last year. Excluding the effects of the reinvestment expenses deployed from the gain and sale proceeds, the efficiency ratio would have been 36.8%, an approximate 280-basis-point improvement. The increase in employee costs versus last year reflected higher headcount driven by growth and insourcing, as well as higher hourly wages and other compensation adjustments. Total other expenses included $62 million of costs related to additional marketing and site strategy actions as we reinvest the $120 million gain on sale through these and other growth and efficiency initiatives. As detailed in the appendix of our presentation, we expect that the gain on sale and reinvestment in Q2 and the remainder of this year will net out as EPS neutral on a full year basis. In summary, Synchrony generated net earnings of $804 million or $1.60 per diluted share for the second quarter. We also generated a return on average assets of 3.4% and a return on tangible common equity of 30.3%. These strong net earnings and returns demonstrate the power and efficiency of our digitally-enabled model, combined with the compelling value of the financial products and services we offer through our financial ecosystem. Not only were we able to support the strong customer demand with a diverse range of products, but we're able to do so while maintaining cost discipline and strong risk-adjusted returns. Next, I'll cover our key credit trends. At a macro level, we continue to see signs of gradual normalization across the credit spectrum of the portfolio. That said, even with this normalization, our 2021 and 2020 vintages continue to perform better than our 2019 vintages, and payment rates remain elevated versus last year as well as compared to our historical average. With regard to delinquency, our 30-plus delinquency rate was 2.74% compared to 2.11% last year, and our 90-plus delinquency rate was 1.22% compared to 1% last year. The year-over-year delinquency comparisons were primarily impacted by the prior year period's historic lows, at which point, the impacts of COVID-19 stimulus and forbearance actions had the greatest impact on the portfolio. Our portfolio of strong delinquency trends has continued to drive year-over-year improvement in our net charge-off rate, which was 2.73% compared to 3.57% last year, an 84-basis-point improvement year-over-year, primarily reflecting the very strong consumer. Our allowance for credit losses as a percent of loan receivables was 10.65%, down 31 basis points from the 10.96% in the first quarter. Let's focus on some key trends that continue to support our strong performance and confidence we have in our business. First, the consumer remains in a strong position. The combination of robust labor markets, wage growth, and elevated savings continues to support the desire to spend and repay their financial obligations while also managing through the impacts of the inflationary pressures. According to external data, stimulus spending segments have generally remained consistent from March through June. About two-thirds of consumers have either spent a portion of their stimulus or have the entire amount of stimulus they received still saved. The remaining one-third of consumers have spent the entirety of the cash they received during the last two years. When taking a look across the balance tiers, the top two tiers of the stimulus recipients, those with balances above $2,500, have seen modest balance decreases, while the lower tier balances less than $2,500 have remained flat. During the second quarter, consumers rotated their spend within discretionary and non-discretionary categories as they managed higher costs from inflationary pressures while still fulfilling their everyday purchases. In general, we saw a slight variability across our out-of-partner spend volume and frequency trends. These fluctuations likely indicate that the consumer is not actively reducing total spend or frequency, but rather rotating their overall spend. So for example, in certain categories like grocery, it appears that our customer is managing to ticket size and substituting items that are of greater priority, whether that means choosing a generic brand or forgoing a less desired item or treat. In terms of gas station spend, however, average transaction values have accelerated with rising gas prices, but transaction frequency has generally held constant, if not increased slightly. All this is to say, we continue to see trends of a strong consumer who is moving through their day-to-day and spending money without meaningfully changing their choices or priorities. Second, the differentiated strength of our business, as well as the underlying trends within our portfolio that we have discussed today, continue to demonstrate Synchrony's ability to deliver under market conditions. In addition to the inherent resilience that comes from the diversification of our portfolio across spend categories, financing options, distribution channels, and customer demographics, Synchrony derives financial strength through our sophisticated cycle-tested underwriting. The predictive power of our credit decisioning and account management capabilities supports more stable loss performance around our target peer loss range of 5.5% to 6%, even as economic conditions change and consumer creditworthiness evolves. From the 2009 peak loss rate of 10.7% during the great financial crisis, the last decade's average of approximately 4.5% loss level, our portfolio has grown and evolved meaningfully. And even as the mix of partners and credit quality of our portfolio has shifted over that same decade, Synchrony has grown significantly and delivered resilient risk-adjusted returns within a band of 8.5% to 11%. It's also important to note that we've delivered these returns even as interest and fees have been coming at somewhat lower levels due to the elevated pay rates during the last two years. Moving on to another synchronous strength: our funding, capital, and liquidity. Synchrony's balance sheet has been built to be resilient. Over time, we have diversified our business in support of our ability to generate consistent risk-adjusted returns and considerable capital. This, in turn, has allowed us to grow and evolve our balance sheet such that we can fund growth efficiently without having to make trade-offs with regard to what's in the best long-term interest of our business and our various stakeholders. Let's start with the strong and stable foundation of Synchrony's funding: our deposit base. Deposits at the end of the second quarter reached $64.7 billion, an increase of $4.9 billion compared to last year. Our securitized and unsecured funding sources declined by $1.3 billion. This resulted in deposits being 84% of our funding compared to 81% last year, with both securitized and unsecured funding each comprising 8% of our funding sources at quarter end. Total liquidity, including undrawn credit facilities, was $18.9 billion, which equated to 19.8% of our total assets, down from 23% last year. As a reminder, before I provide the details on our capital position, it should be noted that we elected to take the benefit of the CECL transition rules issued by the joint federal banking agencies. The impact of CECL has already been recognized in our income statement and balance sheet. The annual transitional adjustment pertains strictly to our regulatory capital metrics. We ended the quarter at 15.2% CET1 under the CECL transition rules, 260 basis points lower than last year's level of 17.8%. The Tier 1 capital ratio was 16.1% under CECL transition rules compared to 18.7% last year. The total capital ratio decreased 270 basis points to 17.4%. And the Tier 1 capital plus reserve ratio on a fully phased-in basis decreased to 25% compared to 28% last year. We continue to deliver robust capital returns to our shareholders. In the second quarter, we returned $809 million to shareholders through $701 million of share repurchases and $108 million of common stock dividends. When considering our existing capital position today, combined with the meaningful earnings and capital generation of our business, Synchrony is particularly well positioned to execute our capital plan as guided by our business performance, market conditions, and subject to our capital plan and any regulatory restrictions. As of quarter end, our total remaining share repurchase authorization for the period ending June 2023 was $2.4 billion. Finally, let's review our full year outlook, which is summarized on Slide 14 of our presentation and incorporates the following macroeconomic assumptions: 10 interest rate increases during 2022, qualitative tightening measures, a slowing economy resulting from these actions, continued higher inflationary conditions, and no additional impacts from the pandemic. We continue to anticipate broad-based strength and purchase volume. As consumer savings declines and the payment rate moderates, we also expect purchase volume growth to moderate. Given the strong purchase volume and loan receivables growth we've achieved in the first half of this year, we expect ending loan receivables to grow in excess of 10% versus the prior year. To the extent that the payment rate moderates further, we would anticipate purchase volume to moderate and loan receivable growth to accelerate. We expect our net charge-offs for the full year to be approximately 3.15%, reflecting the strong credit performance we experienced in the first half. As we move through the second half of the year, we continue to expect delinquency to rise modestly. We continue to expect reserve builds in 2022 to be generally asset-driven absent a meaningful change in the macroeconomic environment. RSA expense will continue to reflect the impact of strong program performance and robust purchase volume growth but should continue to moderate as net charge-offs rise. We now expect RSA as a percent of average loan receivables to be approximately 5.25% for the full year. In terms of other expenses, we continue to expect quarterly levels to be approximately $1.05 billion. This outlook excludes the impact of the $120 million gain on sale that we are reinvesting in our business this year. As a reminder, we deployed $80 million of the gain on sale proceeds in Q2 and expect to deploy the remaining $35 million to $40 million in the second half, such that the gain and reinvestments will be EPS neutral for the full year. We remain committed to delivering positive operating leverage. To the extent that our receivables or revenue growth is not tracking ahead of expense growth for the full year, we will moderate our spending where appropriate, while still prioritizing the best long-term investments. Examples of such opportunities might be to lower workforce additions or reduce other discretionary spending. So to conclude, Synchrony is operating from a position of strength as we progress through 2022. We are confident in our business' ability to continue to deliver sustainable, attractive risk-adjusted growth and a resilient peer-leading range of risk-adjusted returns, even if market conditions change. I'll now turn the call back over to Brian for his closing thoughts.

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

That concludes our prepared remarks. We'll now begin the Q&A session.

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

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

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

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

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

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

Yes, Moshe. I believe one of the most exciting initiatives we're currently engaged in is our multiproduct suite and the offerings we have for our partners. Over the past six months, we have noticed that partners are realizing the opportunity to streamline and be more strategic about their point of sale and the products they provide to their customers. This is where we feel we have a significant advantage. Our product suite is quite extensive, including options like longer-term installments, private labels, and co-branded dual cards. We approach it like a menu, presenting partners with a range of products tailored to their customers' purchasing behaviors and spending patterns, and they seem to be really enthusiastic about it. Importantly, we can implement this in a way that ensures attractive returns for us while potentially lowering costs for our partners. We are actively engaging with both large and small to mid-sized partners. A crucial aspect that we don't emphasize enough is our integration model, which we see as a key differentiator. We cater to a variety of partners, from large corporations to small health and wellness providers, each with unique integration needs. For example, larger partners may require a comprehensive API technology stack for seamless integration, while smaller partners, like dentists, might need a simple application process for customers in their waiting rooms. We can provide that range of integration solutions, which is vital because many partners lack the technical resources to manage complex implementations, and we aim to make it as straightforward as possible for them to integrate our products and solutions. Additionally, we’re excited about launching SetPay pay in 4 within our app on the Clover platform, which enables us to create a solution once and distribute it to numerous partners simultaneously. In summary, our strategy involves offering a comprehensive product suite to meet the diverse needs of our partners and ensuring that our integration strategies are seamless and easy to implement. This is one of the most thrilling projects we are currently pursuing across the business.

Perfect. As a follow-up, at the beginning of the year, there was some caution regarding how certain customers, who had received deferments elsewhere, might perform. It seems that concern has lessened. Could you discuss the indicators you are monitoring to assess the financial health of your customers at this point? What are the key factors that signal improvement or ongoing normalization?

Thank you, Moshe. When we consider the current consumer landscape, it's true that we monitored individuals who received forbearance early in the year. We are still closely observing those who remain in student loan forbearance as they transition through their financial situations. From a performance perspective, we analyze various factors, including changes in spending behavior. We examine payment behaviors, noting who pays the full statement, the minimum, or amounts in between, to identify any significant shifts within those groups. We assess these trends according to credit tiers and, so far, we haven’t detected widespread deterioration. Some segments have reverted to levels comparable to pre-pandemic times, while overall conditions remain stable. This is supported by low unemployment rates, rising hourly wages, and higher savings rates. Therefore, we are closely monitoring spending and behavioral trends, with particular attention on the student loan demographic.

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

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

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

Okay. On the follow-up, I have a detailed question regarding Page 14 in the guide, specifically about credit normalization. You mention that delinquency rates will rise modestly in the second half of 2022. In the previous presentation, you referred to this as a slow rise. What should I understand from this? Modestly and slower seem to convey a similar message, but I might be mistaken.

Yes, Betsy, we value all questions, even the detailed ones. To clarify, you will observe credit normalization. While credit has performed well in the first half of the year, setting a different starting point for the second half, we do not anticipate a significantly different direction from our current position through the end of the year. Credit will perform better throughout the entire year compared to what we projected 90 days ago and certainly six months ago. We are optimistic about credit as we proceed into the latter half of the year, and we believe it positions us well, especially considering the uncertain macroeconomic environment in 2023.

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

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

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

Yes. You have two different dynamics. You have, obviously, some of the operating favorability that's coming through, and there is mix that comes through here as well as gap coming out of the portfolio that brings you back down that operates at a slightly higher RSA percent, all that brings you down to the lower end of the range.

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

Yes, it should correlate to it. On Page 7 of the presentation, one of the things that people are trying to model is RSAs to make them more predictable. We presented a metric here, which is RSA relative to purchase volume. It's important to remember that a significant portion of RSAs is volume-oriented, which tends to be a more stable metric. You can observe quarter-over-quarter seasonality, and I believe this will assist people in building their models. We anticipate migrating back to the 4% to 4.5% level as net charge-offs normalize and as revenue, interest income, and yield stabilize as well.

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

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

Yes, I would say this is not primarily due to competition but rather because we have implemented several value propositions in the past 12 to 18 months. This has led to an increase in purchase volume as our value offerings have resonated with consumers. While some loyalty is recorded on our books, the majority belongs to our partners, which explains the current RSA since they cover the costs of the value propositions from their revenue. Looking ahead, an interesting point is that we will experience about $35 million in lost interchange due to the sale of portfolios this quarter. The loyalty costs associated with those sales were fully covered by our partners. So, you can expect to see a widening gap starting in the third quarter as we move forward. The majority of the impact from this $35 million will be directed at the RSA, leading to changes in different areas, though overall it will be neutral from an earnings perspective. Most of the programs where we do collect interchange and pay out the value proposition will remain similar. It is important to note that some programs do not collect interchange, such as private label products, where we might incur loyalty costs. This is also relevant because we achieved record purchase volumes this quarter, following previous records last year and in the first quarter of this year. As a result, these volumes will lead to higher loyalty costs. Ultimately, it’s less about renewals and more about how our products are appealing to consumers. During the early stages of the pandemic, particularly at the start of the second quarter, we tightened our credit standards. However, our approach differs from that of most credit card issuers. We do not completely retract; rather, we adapt our distribution model. We choose smarter credit strategies. For example, instead of issuing a dual card, we opt for a private label card. We are also more selective with growth-related credit line increases and avoid automated increases in credit limits. As we entered the second quarter of 2021 and the environment appeared less negative than the previous year, we started to relax some of those restrictions. Currently, while our standards are somewhat tighter compared to 2019, they are getting closer to those levels. Although our credit line sizes are smaller, the positive aspect is that we are incorporating various data points into our decision-making, which allows us to make more informed choices both during the origination phase and in account management.

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

What I'd say is '21 is probably in the middle between '20 and '19 and '20 is significantly lower. It's probably how I frame it, Brian. We don't break out actual performance of Device themselves with regard to coincident delinquency or loss rate. But as a frame, we referenced '21 in the middle, but significantly below '19. What I'd say is we expect that whatever the interest-bearing liability cost increase will be largely offset with higher interest and fee income.

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

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

Thank you for your insights regarding the inflationary pressures. Are you noticing any differences in trends across the credit spectrum, or are the trends fairly consistent from super prime all the way down to non-prime?

Yes. So what I'd say is we're seeing positive what I would call transaction values and frequency, and consistency of frequency across all credit grades. I think the strongest credit we see is actually in the prime, so not super prime and not non-prime, but we are seeing continued strength in the non-prime. So there's nothing discernible, as I look across the credit grade either on a transaction value basis or a frequency basis, nor do we see it across any of the sales platforms. It's remarkably consistent the performance and the growth across all the platforms by credit grade. So again, I think when we look at the data, and I look at the data by category, what we're seeing is that the consumer is not changing spending dollar-wise and their behaviors. They're just making different decisions inside their everyday spend. And it really goes to the power of the diversification that we have inside our sales platforms. We expect it to begin to migrate back. The migration, I'll be honest with you, from our expectations back in January has been a little bit slower than we anticipated, which just goes back to the overall strength of the consumer. But we do expect it to slow just probably a little bit slower based than I anticipated at the beginning part of the year, which, again, is positive from a credit standpoint. And again, the strength in our purchase volume is helping us to get to that 10-plus percent loan receivable growth by the end of the year.