General Electric's $20-billion initial public offering of its cards unit puts a lot on credit. The conglomerate plans to spin off Synchrony this week at some 11 times last year's income. That's a small discount to Discover, but store-branded credit cards are a riskier business. An uptick in charge-offs, currently near their lows, could hit the unit quick and hard.
Providing store credit might not be as dicey as its reputation once implied, but almost a third of Synchrony's loans fall into the category of subprime, compared with only about 18 per cent of Discover's personal credit card business.
The GE unit, which offers credit for customers at the likes of Amazon, PayPal, Toys "R" Us and Wal-Mart Stores, also has higher net charge-offs of borrowings more than 30 days past due: 4.1 per cent at the end of March compared with 1.65 per cent at Discover.
Those will increase for all lenders when the economy slows, though that may be a way off. After all, unemployment is falling and interest rates are still low. But the Federal Reserve is expected to raise rates next year, and at seven years, the current recovery has already lasted longer than in previous credit cycles.
Synchrony has proved that it can withstand big losses during its 80-year history. Its rate for loans more than 30 days delinquent at the end of 2009, for example, was 8.2 per cent. So there's little reason to doubt that the company can survive another downturn, assuming executives stick to current lending policies, as they say they plan to do, while running an independent company.
The real question is what a slowing economy would do to returns. Average charge-offs over the long term should be around six per cent. That two percentage point rise would cost Synchrony almost $1.1 billion, or $715 million after taxes, based on the company's $54 billion in currently outstanding loans. The hit would strip almost two-fifths off last year's earnings and reduce return on equity to 14 per cent from 22 per cent. If delinquencies rise by only one percentage point, the resulting 18 per cent ROE would still be far better than virtually any bank, big or small, can manage. For potential investors in Synchrony, though, it's a warning sign that GE may be asking for too much credit.
Providing store credit might not be as dicey as its reputation once implied, but almost a third of Synchrony's loans fall into the category of subprime, compared with only about 18 per cent of Discover's personal credit card business.
The GE unit, which offers credit for customers at the likes of Amazon, PayPal, Toys "R" Us and Wal-Mart Stores, also has higher net charge-offs of borrowings more than 30 days past due: 4.1 per cent at the end of March compared with 1.65 per cent at Discover.
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Synchrony has proved that it can withstand big losses during its 80-year history. Its rate for loans more than 30 days delinquent at the end of 2009, for example, was 8.2 per cent. So there's little reason to doubt that the company can survive another downturn, assuming executives stick to current lending policies, as they say they plan to do, while running an independent company.
The real question is what a slowing economy would do to returns. Average charge-offs over the long term should be around six per cent. That two percentage point rise would cost Synchrony almost $1.1 billion, or $715 million after taxes, based on the company's $54 billion in currently outstanding loans. The hit would strip almost two-fifths off last year's earnings and reduce return on equity to 14 per cent from 22 per cent. If delinquencies rise by only one percentage point, the resulting 18 per cent ROE would still be far better than virtually any bank, big or small, can manage. For potential investors in Synchrony, though, it's a warning sign that GE may be asking for too much credit.