TheStreet
Synchrony, a U.S. little-known bank with four branches nationwide, has garnered attention for inking major credit-card dealers with the likes of Amazon.

On the lips of Wall Street analysts, a new expression is taking hold as speculation mounts that the U.S. economy might be slowing down: the "late-cycle" trade.

It's a jargony way of describing a simple concept: Investors can make fast money by betting on companies with high-risk strategies if the current economic cycle extends its 10-year-old expansion, already tied for the longest in U.S. history. But if a recession starts to take hold that is remotely akin to the last one in 2008-2009, they'd better get out -- quick.

One stock that fits the type is Synchrony Financial (SYF - Get Report) , a little-known U.S. bank with just four branches nationwide. The Stamford, Connecticut-based bank garnered headlines this month when it inked a deal with Amazon.com (AMZN - Get Report) to provide credit cards to shoppers with poor credit histories. Synchrony was part of the engine and light-bulb maker General Electric (GE - Get Report)  before the 2008 financial crisis but was sold off through a 2014 initial public offering and subsequent share exchange for more than $20 billion. 

Synchrony specializes in "private label" credit-card partnerships with retailers including Amazon, Gap (GPS - Get Report) , J.C. Penney (JCP - Get Report) , Lowe's (LOW - Get Report) , PayPal (PYPL - Get Report) and Sam's Club, a division of Walmart (WMT - Get Report) . These credit cards tend to attract customers with worse payment histories, since the retailers typically dangle the offers at the checkout counter to increase sales and build brand loyalty; most applicants end up qualifying. The retailers also get a kickback from the bank's eventual lending profits.  

And because the borrowers are considered higher risk, the bank charges higher interest rates, currently about 22% annually on credit-card balances.

It's been a winning strategy since President Donald Trump juiced the U.S. economy with his $1.5 trillion of tax cuts in late 2017. Synchrony increased its book of loans and other assets by 11% last year, three times faster than JPMorgan Chase (JPM - Get Report) , the largest U.S. bank. And Synchrony's lending margins -- the interest rate charged on loans minus what it pays out on deposits -- averaged 16%, dwarfing New York-based JPMorgan's 2.5%. 

That sort of profile would normally be a reason to buy the stock -- especially since it looks cheap based on historical valuation measures. Synchrony shares are trading at about 1.6 times the bank's net worth, down from about 2.4 times at the end of 2017, according to the data provider FactSet. 

But here's where the late-cycle risks come into play: Since Synchrony's customer base skews toward those with low credit scores, it has a far higher rate of defaults. Synchrony's loan losses last year represented 5.6% of total loans, more than 10 times the rate at JPMorgan.

And in a recession, the bank's loan losses likely would double, said Donald Fandetti, a credit-card company analyst for Wells Fargo Securities in New York. 

"It's a difficult situation, because it's a good business, and the stock's cheap," Fandetti said in a phone interview. "But the investors we talk to are worried about the late cycle."  

U.S. economic growth is projected to slow to about 2.4% this year from 2.9% in 2018. But fears are growing that the economy could slip into recession as early as next year. A recent survey by the National Association for Business Economics put the odds of a recession at 15% for 2019, rising to 60% in 2020.

At the same time, Federal Reserve Chairman Jerome Powell pledged last week to "act as appropriate to sustain the expansion." That could signal lower official interest rates ahead, which likely would reduce consumers' monthly credit-card payments and encourage them to borrow more. 

"The Fed cutting rates early and aggressively may turn late-cycle risks into mid-cycle, which may boost risk appetite for now," analysts at the Wall Street bank Morgan Stanley wrote Friday in a report. 

Such a turn would bode well for Synchrony's growth as well as the performance of its $51.6 billion portfolio of retail credit-card loans. 

The U.S. unemployment rate, currently at 3.6%, is at its lowest in nearly half a century. But in a recession, joblessness would likely surge, leaving many borrowers unable to afford credit-card payments. Even households with healthy finances would probably cut back on spending -- curbing their credit-card balances.    

"A lot of lenders think we're due for a turn in the credit cycle," said Leslie Parrish, a former official of the Consumer Financial Protection Bureau who now works as a senior analyst at the consulting firm Aite Group.

According to Parrish, cash-strapped borrowers in a recession would likely prioritize payments on mobile phones or auto loans over credit cards that can typically only be used at specific retailers. 

Synchrony's new card with Amazon is billed as a "credit builder." Essentially, customers with low credit scores can deposit up to $1,000 in a Synchrony bank account -- usually by snail-mailing a check or money order -- and get an equivalent credit line that can be used to make purchases on the e-commerce giant's website.

Over time, if customers pay their bills regularly, they can get a regular Amazon credit card. If they fall behind, the bank can grab the deposit as collateral.

"Issuers require this deposit because it makes the deal less risky for them," said Jake Lunduski, lead credit industry analyst at Credit Card Insider.

But it's the rest of Synchrony's loans that are giving investors pause, since those are mostly unsecured with no collateral, meaning that the bank would have less recourse to get its money back if borrowers stopped paying.

As of March 31, some 26% of Synchrony's customers had credit scores from Fair Isaac Corp., or FICO, of 660 or below, presenting at least "moderate" credit risk, according to the bank's corporate filings. JPMorgan, by contrast, had just 16% of its U.S. credit-card customers with FICO scores below 660. FICO scores range from 300 to 850; a score of 760 or more is considered excellent.   

At an investor conference in late May, Synchrony CEO Margaret Keane said she sees few near-term risks. 

"We don't see anything right now that concerns us," Keane said. "The core economy is actually running pretty well. People are working. And I think that makes a big difference for our business. And we're feeling confident where we sit today."

Keane, 59, served as head of GE's retail credit-card platform from 2004 to 2011, became CEO of GE's North American retail-finance business in 2011 and was named CEO of Synchrony following the 2014 separation from its former parent. She took home $11.4 million last year in total compensation.  

She knows firsthand what can go wrong when a recession comes, as occurred following the 2008 financial crisis. According to GE's corporate filings, the industrial company's annual costs for bad U.S. consumer loans shot from about $1.2 billion in 2006 to more than $3 billion in each of 2008, 2009 and 2010.   

That's what usually happens when late cycle turns to down cycle.  

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