Bread Financial Holdings, Inc. (NYSE:BFH) Q2 2024 Earnings Call Transcript

Bread Financial Holdings, Inc. (NYSE:BFH) Q2 2024 Earnings Call Transcript July 25, 2024

Operator: Good morning, and welcome to Bread Financial’s Second Quarter 2024 Earnings Conference Call. My name is Towanda, and I will be coordinating your call today. At this time, all parties have been placed on a listen-only mode. Following today’s presentation, the floor will be opened for your questions. [Operator Instructions] It is now my pleasure to introduce Mr. Brian Vereb, Head of Investor Relations at Bread Financial. Sir, the floor is yours.

Brian Vereb: Thank you. Copies of the slides we will be reviewing and the earnings release can be found on the Investor Relations section of our website at breadfinancial.com. On the call today, we have Ralph Andretta, President and Chief Executive Officer; and Perry Beberman, Executive Vice President and Chief Financial Officer. Before we begin, I would like to remind you that some of the comments made on today’s call and some of the responses to your questions may contain forward-looking statements. These statements are based on management’s current expectations and assumptions and are subject to the risks and uncertainties described in the Company’s earnings release and other filings with the SEC. Also on today’s call, our speakers will reference certain non-GAAP financial measures, which we believe provide useful information for investors.

Reconciliation of those measures to GAAP are included in our quarterly earnings materials posted on our Investor Relations website. With that, I would like to turn the call over to Ralph Andretta.

Ralph Andretta: Thank you, Brian, and good morning to everyone joining the call. Starting with the highlights from the second quarter on Slide 2. I am pleased to report another quarter of solid results as we continue to navigate a challenging consumer and regulatory environment. Our strong results include net income of $133 million and earnings per diluted share of $2.66 or adjusted diluted EPS of $2.67 after adjusting for the anti-dilutive impact of our capped call transactions, which are related to the 2023 issuance and of convertible notes, which Perry will discuss more fully. Notably, our balance sheet continued to improve as we increased our tangible book value by 25% year-over-year to nearly $49 per share, improved our common equity Tier 1 capital ratio by 170 basis points year-over-year to 13.8% reduced our double leverage ratio to 110%, achieving our target of less than 115%.

Additionally, direct-to-consumer deposits increased 20% and year-over-year to $7.2 billion, representing 14 consecutive quarters of growth. During our Investor Day in June, we highlighted the Company’s transformation and our energized culture. The strong returns and capital generation that our business model can deliver and how our responsible capital allocation will build sustainable long-term value for our shareholders. We also announced our newest partnership with Saks Fifth Avenue. In the third quarter of this year, we expect to complete the conversion of the existing Saks portfolio and launched the new and enhanced program. In the second quarter, we made further progress implementing more of our mitigation strategy in response to the CFPB’s rule on credit card late fees.

Our ongoing discussions with brand partners have been productive, and we now have various pricing changes in market, including increased APRs and statement fees. We are closely monitoring the ongoing litigation related to the rule, and we’ll continue to implement our mitigation strategies given the uncertainty surrounding the timing and outcome. Regardless of the litigation outcome, we are confident in our ability to generate strong results and achieve our long-term strategic objectives and financial targets. From a macroeconomic perspective, consumer spending continues to moderate, reflecting persistent inflation and higher interest rates. As a result, second quarter trends reflected lower transaction sizes accompanied by more frequent shopping trips as well as reduced discretionary and big-ticket spending.

Credit sales were also impacted by our proactive credit tightening as we remain disciplined given economic pressures affecting payment capacity. Our credit actions have proven effective as delinquencies have trended lower, and the net loss rate is expected to have peaked in the second quarter. Our second quarter results reflect our position of strength with increased capital flexibility and financial resilience. We are better equipped to address uncertainty than ever before, positioning us well to generate long-term value for our shareholders. Turning to Slide 3. Our disciplined capital allocation strategy focuses on funding responsible, profitable growth, improving our capital metrics, reducing parent debt, and driving long-term shareholder value.

Indicative of the success of this strategy is the 410 basis point improvement in our common equity Tier 1 capital ratio over the last three years, as shown in the chart on the left. As I mentioned previously, we have also made progress on our debt reduction, as shown in the second chart. Over the last three years, we have reduced parent-level debt by 53%. And this quarter, we achieved our long-term double leverage ratio target of less than 115%. This is an impressive achievement given where we were just four years ago when I joined the Company. Finally, our tangible book value of $49 per share has grown at a 22% compound annual rate since the second quarter of 2021. Supported by our strong cash flow, we expect to continue to grow our tangible book value over time.

Turning to Slide 4. Our key focus remains on growing responsibly, managing the macroeconomic and regulatory environment, accelerating digital and technology offerings and driving operational excellence. As we highlighted during our Investor Day in June, our decisions are focused on creating sustainable value over the long term by effectively managing our credit risk while scaling and diversifying our product offerings, we can grow responsibly. Managing the macroeconomic and regulatory environment effectively is fundamental to our success. Although litigation is ongoing and timing and outcome unknown, we will continue to take actions to mitigate the potential financial impact of the CFPB late fee rule. We are confident in our strategy and have an experienced leadership team that has successfully navigated through regulatory changes in the past, such as card.

Accelerating our digital and technology capabilities remains a top priority. We are committed to fueling innovation, leveraging data and AI, and scaling our platform to enhance satisfaction for our customers, partners and associates. Finally, our heightened focus on operational excellence to drive improved customer experience, enterprise-wide efficiency, reduce risk and value creation is embedded in our decision-making. Our goal is to consistently generate operational and expense efficiencies that enable reinvestment in our business support responsible growth and achieve our targeted returns. Our experienced leadership team remains focused on generating strong returns through prudent capital and risk management, reflecting our unwavering commitment to drive sustainable, profitable growth and build long-term value for our shareholders through challenging economic and regulatory environments.

Now, I will turn it over to Perry to review the quarter’s financials and to discuss our outlook.

Perry Beberman: Thanks, Ralph, and good morning, everyone. Before I dive into the second quarter financial highlights, I’d like to discuss the financial benefits of the cap call transactions we entered into when we issued our convertible notes in 2023. The cap call transactions are set up to reduce the potential dilutive impact of the convertible notes up to a stock price of $61.48. Our GAAP diluted share count does not incorporate the anti-dilutive impact of these cap call transactions, which you can see incorporated in our adjusted non-GAAP figures on Slide 5. More specifically, the share amounts used in calculating adjusted net income per diluted share and adjusted income from continuing operations per diluted share have been adjusted for the anti-dilutive impact of our cap call transactions.

Reflecting this, our adjusted net income per diluted share was $2.67 and our adjusted income from continuing operations per diluted share was $2.66 in the second quarter. Moving to Slide 6, which provides our second quarter financial highlights. During the second quarter, credit sales of $6.6 billion decreased 7% year-over-year, reflecting moderating consumer spend and our strategic credit tightening, partially offset by new partner growth. Average loans of $17.9 billion increased 1% year-over-year, driven by growth in co-brand programs, highlighting our continued focus on product diversification. Revenue was $0.9 billion in the quarter, down 1% year-over-year due to reduced merchant discount fees resulting from lower big ticket credit sales.

Income from continuing operations increased $69 million due to a higher reserve release and lower noninterest expense compared to the same period last year. Looking at the financials in more detail on Slide 7. Total net interest income for the quarter remained essentially flat year-over-year, while noninterest income is down $8 million, resulting from the previously mentioned lower merchant discount fees on big ticket purchases. Total noninterest expense decreased 12% year-over-year primarily driven by a decrease in card and processing costs, including fraud and a reduction in depreciation and amortization costs and marketing expenses. Additional details on expense drivers can be found in the appendix of the slide deck posted on our website.

Pretax pre-provision earnings or PPNR increased $48 million or 11%. Turning to Slide 8. Loan yield increased 30 basis points year-over-year, benefiting from the upward trend in the prime rate, which caused our variable price loans to move higher in tandem, along with some small amount of CFPB mitigation-related APR increase impacts. Both loan yield of 26.4% and net interest margin of 18.0% were lower sequentially following typical seasonal trends. We expect a seasonal improvement in the net interest margin in the third quarter of 2024. On the funding side, we are seeing total funding costs moderate as deposit costs are stabilizing. Additionally, as you can see on the bottom right chart, our funding mix continues to improve, fueled by growth in direct-to-consumer deposits, which increased to $7.2 billion at quarter end, while wholesale deposits declined.

Direct-to-consumer deposits accounted for 40% of our average total funding, up from 33% a year ago. While we anticipate that direct-to-consumer deposits will continue to grow steadily, we will maintain the flexibility of our diversified funding sources, including secured and wholesale funding to opportunistically and efficiently fund and manage our long-term growth objectives. Moving to credit on Slide 9. Our delinquency rate for the second quarter was 6.0%, modestly down 20 basis points from the first quarter as a result of our credit-tightening actions. From this point forward, we expect future quarters to largely follow historical seasonal trends until we see broader macroeconomic improvements. The net loss rate was 8.6% for the quarter compared to 8.0% in the second quarter of 2023 and 8.5% in the first quarter of 2024.

The second quarter net loss rate was elevated compared to last year due to more challenging macroeconomic conditions, pressure in consumer payment rates as well as ongoing credit tightening and our slower responsible loan growth impacting the denominator. As anticipated, the second quarter net loss rate is expected to represent the peak for 2024. We anticipate a reduction in the net loss rate in the third quarter to 8% or slightly below before increasing seasonally in the fourth quarter to the low 8% level. Our outlook assumes a slow gradual improvement in the macroeconomic environment as it will take time for the lingering effects of a prolonged period of elevated inflation to dissipate. As expected, the reserve rate of 12.2% remained within the range we have seen over the past six quarters.

In this challenging macroeconomic environment, our conservative economic scenario weightings remained unchanged in our credit reserve modeling, and we believe our loan loss reserve provides an appropriate margin of protection. Consistent with what I said last quarter and based on our economic outlook, we expect the reserve rate to be lower at year-end 2024 versus year-end 2023, reflecting an overall improvement in delinquencies as well as improved credit quality in the portfolio. Further, our total loss absorption capacity comprised of the total company tangible common equity plus credit reserve rate ended the quarter at 26% of total loans, an increase of 100 basis points from last quarter and 270 basis points from a year ago, demonstrating a strong margin of protection should more adverse economic conditions arise.

Looking at our credit risk distribution mix, the percentage of cardholders with a 660-plus credit score improved 200 basis points sequentially and remained above pre-pandemic levels despite continued inflationary pressures. This improvement is primarily a result of our prudent credit tightening actions as well as our more diversified product mix. We continue to proactively manage our credit risk to protect our balance sheet and ensure we are appropriately compensated for the risk we take. Moving to Slide 10, which provides our 2024 financial outlook. While there is uncertainty surrounding the timing and outcome of the ongoing CFPB late fee rule litigation, our outlook now assumes no impact from the CFPB late fee rule this year. Considering that a stay is an effect, the number of motions, hearings and other procedural matters, including appeals, expected to take place in the litigation over the coming months as well as a pursued implementation period following the final legal ruling, our base case is that the rule does not become effective in 2024.

Our full year contemplates a slower credit sales growth rate as a result of moderation in consumer spending and credit tightening, both of which pressure loan and revenue growth and the net loss rate in the near term. In addition, our 2024 outlook assumes two interest rate decreases by the Federal Reserve in the second half of the year, which are expected to slightly pressure total net interest income. Based on our current economic outlook, proactive credit tightening actions, higher gross credit losses, and visibility into our new business pipeline, we expect 2024 average loans to be down low single digits on a percentage basis relative to 2023. Total revenue growth for 2024, excluding gain on portfolio sales is anticipated to be down low to mid-single digits with a full year net interest margin lower than 2023, reflecting higher reversals of interest and fees due to expected higher gross credit losses declining interest rates and a continued shift in product mix to co-brand and proprietary products.

This guidance includes the impact of early CFPB mitigation pricing changes, which are not material to the full year 2024 guidance. As a result of efficiencies gained from ongoing investments in technology modernization and digital advancement, along with disciplined expense management and reduced fraud we expect expenses to be down mid-single digits relative to 2023. Expenses are projected to increase in the second half of 2024 versus the first half, driven primarily by the addition of Saks Fifth Avenue portfolio and increased sequential marketing expenses of around $10 million in the third quarter. We would expect fourth quarter expenses to be higher than the third quarter based on seasonally higher employee compensation and benefits costs, and further increased marketing expenses.

As I mentioned earlier, the second quarter net loss rate is expected to be the peak for the year, and we continue to expect a full year net loss rate in the low 8% range for 2024. With the first half loss rate at 8.6% and a projected improved second half loss rate of approximately 8%, that would currently imply a full year net loss rate of around 8.3%. Again, our outlook assumes a gradual modest improvement in the economic conditions throughout the year aligned with most economists. Finally, our full year normalized effective tax rate is expected to be in the range of 25% to 26%. Quarter-over-quarter variability will continue due to timing of certain discrete items. We are confident in our ability to successfully manage risk return trade-offs through this challenging macroeconomic and regulatory environment, while continuing to make strategic investments that drive long-term value for our stakeholders.

Before opening the call for your questions, I want to take a moment to reiterate the financial targets that we shared during our Investor Day in June. You can see these targets on Slide 11. Note, this slide assumed an October 1 CFPB late fee rule change effective date. From a debt perspective, as Ralph mentioned earlier, we’ve already successfully reduced our double leverage ratio to less than 115%. For capital, our goal is to build total risk-based capital to around 16% with an initial CET1 build to approximately 14%. Over the longer term, we plan to optimize our capital mix through additional Tier 1 and Tier 2 capital which will allow us to lower our corresponding CET1 ratio. Overall, we will continue to grow tangible book value with the goal of generating a low to mid 20% ROTCE in the medium-term, and mid-20% ROTCE in the long term.

While there are many scenarios currently in play regarding our timing to achieve our target, given the uncertainty around the economy and potential regulatory changes, we are well positioned to deliver responsible growth, strong returns and capital distribution opportunities over time. Operator, we are now ready to open up the lines for questions.

Q&A Session

Operator: [Operator Instructions] Our first question comes from the line of Mihir Bhatia with Bank of America. Your line is open.

Mihir Bhatia: I wanted to start maybe by talking about just the purchase volume trends. Look, you obviously have a pretty diverse customer base. And you’ve talked previously about low-income consumers being impacted by inflation. And so, I guess a couple of questions on that. One is, are you seeing those impacts starting to moderate as we’ve had some wage growth here? And then also relatedly, is the pressures on the consumer spreading up the income scale? Or are you still seeing the pressures concentrated in that segment? Maybe just talk about that a little bit just from a where you’re seeing the pressures on what kinds of products, what kinds of retailers or categories, maybe?

Ralph Andretta: Yes. Thanks for the question. We’re still seeing consumers no matter where they are in the Vantage change help moderate self-budget. We see the biggest impact in discretionary and big ticket is where we see the biggest impact in terms of spend moderation. But I think as we move forward, as we said, we think we’ve peaked in the second quarter. I don’t think it’s going to be an immediate rush to the point of sale. I think it’s going to be a gradual improvement over time. People are still suffering from high inflation and the high interest rates. So, while we are — we’re anticipating a little bit of improvement, and I think it’s going to be very moderate as we move forward. But big ticket and discretionary spend were the biggest impact.

Mihir Bhatia: Anything from the — on the income side? Like is it just mostly still in the low-income consumer only?

Perry Beberman: Yes. So, this is Perry. So, what I think I’d share with you is that view on the economy overall I think we’ve been saying this, and I think we’re all saying the consumer has been pretty resilient. But they are definitely feeling the effects of that cumulative prolonged period of inflation and now the higher interest rates that are impacting them with inflation is still about 2% while it’s coming down, that’s a positive. Higher interest rates on things like their mortgages, auto, credit cards, personal loans, that they rose their spending power, and through higher monthly interest cost. So, you’ve got that affordability gap that’s still out there or lower and middle-income Americans. So, I think that’s where you’re going, it’s right?

The top third that consumers are just fine. Their higher income, higher scoring. They’re not showing any signs of stress, and we’re seeing that in our portfolio. Those high scores are not being affected. But that doesn’t tell us or other 2/3, and you are starting to see some of that stress creep up a little bit in the risk scores because these folks are trying to make ends meet and these other things are putting pressure on them. Now that said, there are positive signs that we’re seeing. And I think we’re all seeing it with what we expect to materialize in the second half of the year, and that was led by what we just saw with this quarter, where, as you mentioned, wage growth outpaced inflation. So that is good. And that’s particularly going to help the 2/3 of the consumers who are trying to rebuild their discretionary income.

And I think that’s going to be a positive. Inflation is coming down. So hopefully, again, wage growth stays up, inflation comes down, that’s more positive. Now you will have a little bit of offset with some modest increase in employment that everybody is expecting to finish the year at 4%, but that’s all in our outlook and forecast. But — so we’re monitoring the consumers really carefully. We have a really strong credit team that is taking credit actions appropriately. And — but I think we’re all waiting to see how this economy unfolds in the back half of the year.

Mihir Bhatia: And then if I could switch gears on credit. Just obviously, 2Q came in better than your initial guide. You gave some pretty good commentary on 3Q and 4Q and what your expectations are. And what I was curious though was what is your view as you enter into 2025, should that — do you expect losses to continue to moderate? I mean, you mentioned about them being kind of a seasonal until you see the economy improve. So, like my question is really, do you need the economy to improve to get your losses down towards your target? Or have the credit actions you’ve taken drive that loss rate lower, closer to your long-term targets? Because I mean you’re still at 8%, right? So, if you just get seasonality from here, like are we just going to stay above the long-term targets till you get an economic improvement?

Perry Beberman: So, I think you have a couple of things, a number of things that go into that. I’m not going to give guidance on 2025 at this point, but I can give you my thoughts on how this trend is going to play out over time, right? Our credit actions will the peak benefit that will happen in the second half of this year. So, the full benefit of our credit actions haven’t yet materialized all the way through. So that will be a run rate benefit into, call it 2025. Then we’re expecting — what I’ll say, is a slow gradual improvement in customer behavior. It’s going to take a prolonged number of quarters for the consumer behavior to improve given that they’re trying to deal with three years of this persistent high inflation and higher interest rates.

And that is going to take time to unwind. I mean there is no fast fix. We’re not expecting a big stimulus to come in and all of sudden consumer payments just improved dramatically. So, I expect there to be a slow gradual improvement through next year. But to get back to that 6% number that fast seems that would be a tough ask of the consumer. But I do think there’s going to be continued gradual improvement.

Operator: Our next question comes from the line of Jeff Adelson with Morgan Stanley. Your line is open.

Jeff Adelson: Just one point of clarification on the revenue guide. I know you removed the late fee rule implementation from the fourth quarter versus your last quarter guide. But I think last quarter, you also had discussed a scenario where the late fee rule didn’t go into effect. You were looking for, I think, down mid-single now you’re looking for down low to mid-single digits. Can you just talk about where some of the improvement came from there? Is that just continued efforts on the late fee offsets and CITs you’ve put out there? Or what else may have changed in the outlook?

Perry Beberman: Yes. It’s a modest change in the outlook, to your point. I think part of it is we’re only expecting two rate reductions, fed rate reductions. As I remember, we’re a little asset-sensitive. So, we will see a little bit of NIM compression when you have that. We also probably feel a little bit more confident about the second half of the year loss rate and what that means in terms of reversal of interest and fees. And then, we also have the line of sight into the CFPB mitigation actions while not material. It’s just — we’re just trying to get everything down a little tighter to what we expect to see.

Jeff Adelson: And just a follow-up on credit. I know at the Investor Day, you were talking about some nice stability in not only your early stage but your mid- and late-stage delinquencies. Could you just give us an update on what you’re seeing there this quarter? And — if I could maybe just pick a little bit on the monthly data. It did look like your second derivative on total delinquencies did increase a little bit this past month. Is there anything to that? Or do you probably still expect that trend of slowing will kind of continue to come through?

Perry Beberman: Yes. I think what I would characterize things is stable and improving that, again, we’re in an improving economy, credit actions are taking place — you’ve got some seasonal things happening within delinquency. So again, our early stages is stable, and we’re starting to see some improvement in — very slow improvement in those mid to late stages. But the roll rates remain high in those later stages because nothing’s changed for, I’ll say, the consumer who does go delinquent, they have a hard time getting out of delinquency once they’re in. And that’s when you think thematically around why you need wage growth and things to improve for them, that’s what we hear from the customer, what strain them. It’s just that high inflation and wages aren’t keeping up.

Operator: Our next question comes from the line of Sanjay Sakhrani with KBW. Your line is open.

Sanjay Sakhrani: Perry, could you maybe just talk about what you might be looking at in your data to give you an indication of whether or not the consumer is sort of flat to doing worse. I mean, do you look at like monthly minimum payments, cash drawdowns. I’m just curious because I think there’s a lot of confusion as we’ve heard from some of the questions before. We’re hearing the consumer slowing down, they’re spending, but you guys are saying this is the industry that the consumer is generally fine. So maybe you can just give us a little bit more on sort of what informs you that the consumer is doing well. And then secondly, just — if rates start coming down, how quickly does that feed into the health of your consumer? Does it help them improve their health?

Perry Beberman: Sanjay, great questions in there. And that’s where the benefits of having as many consumers as we do that we can monitor through stratification segmentation. We do look at what’s happening with our consumer. And we talked about this before, when you hear, I’ll say the being banks talk, they have a much fuller view of those high-net-worth customers, they have the view of customers who are not credit eligible that we don’t underwrite. So — and you’ll hear things from the big networks and they’re giving perspectives on spend overall. What we monitor are things like their payment trends, how many people are making no payment, how many people are making min pay, multiples of min pay. So, we are starting to see fewer customers at zero pay and more making min pay.

But that’s something we want to very carefully. So you do look at on us, payment behaviors, off us payment behaviors. So I think it’s — so when we say the customer is, I’ll say, improving, it’s from the result of the credit actions and a little bit of this wage growth that’s in place. So, I don’t want to give an indication that, wow, things are improving dramatically. It’s stable with modest improvement, and that’s what we expect to see in the back part of the year. I mean for us to guide. We’re still going to have 8% losses in the back half of the year. That’s still a pretty strained environment for the consumer. While improving, it’s going to take a slow gradual improvement to return to our, I’ll say, through-the-cycle targets.

Sanjay Sakhrani: And then your base case or late change to implication next year. Can you just maybe give us a little bit more detail on sort of how those mechanisms work? And then, how does that affect like your ability — I mean I don’t know the change has been much of you guys always felt like you can offset it and you can still grow book value. But I’m just curious on the margins, what kind of impact does it have to the fundamentals on a go-forward basis — your ability to sort of overcome some of the impact?

Perry Beberman: Yes. So, look, the reason why we took it out of our guidance for this year, and when we see where things are going right now, the parties involved with the litigation, they’re still little getting over where this litigation should be hurt, right? And that now is set for, I think it’s August 27, and that could possibly result in another appeal of the judge’s ruling. And this is before the courts actually consider the merits of the lawsuit filed by the industry. So that’s why we don’t think the impact will happen in 2024. We’re not taking that assumption of what that could mean to 2025. but the teams continue to work very closely with all of our brand partners. We’ve been very thoughtful about the timing of when we roll out changes to the consumer for some of the changes that we have put in the market, we took a, I’ll say, a half step towards the back part of 2023.

It was some pricing that was already in our guidance. Some of the things that we just put in market around paper statement fee and some, again, further pricing APR increases. As you know, APR increases take time like 18 months up to three years to fully get the benefit of that to work through the P&L. And we’re also monitoring very closely any change in customer behavior, because you don’t want to have the unintended consequence where it more than offset the good of what you’re trying to get from it. So that’s being carefully watched. And so, the rollout will continue throughout this year. We’re assuming the change will go into effect at some point next year. We don’t really have our guide on that at this point, but we have the teams working as if it will happen in short order right after the litigation gets through.

Again, not knowing any outcome of the upcoming elections, and we don’t want to speculate on that.

Operator: Our next question comes from the line of Moshe Orenbuch with TD Cowen. Your line is open.

Moshe Orenbuch: Great. And most of my questions have been asked and answered. But maybe if — coming back to the kind of macro issue of the low-end consumer and the timing of kind of rebounding of growth, is there a way to kind of segregate out portions of your portfolio or if your partners to think about like what could be kind of earlier and the leader in that? How do you sort of think about that? And kind of — because we’ve noticed some of the kind of low-end furniture type are starting to see a little bit of a rebound. So, is there a way to talk about what portions of your portfolio, even where there’s been that pressure and when we could start seeing some of the rebound in on what pieces?

Perry Beberman: So, I’d answer that a couple is one, we’ll answer with regard to rebounding growth. We’re going to have a number of tailwinds behind us from a growth standpoint. One, think about general macro improvement, like you said, these consumers start to get wage growth going inflation comes down, it can free up more discretionary income, that will help the lower end consumer. And wage growth has been more prominent in the lower income brackets than the high-income bracket. So that will be an aid to these consumers. The second thing that will impact our, I’ll say, loan growth is when we march back down towards a 6% loss rate versus being over eight and you think about the interest and fees associated with that, too, that’s almost a 3% tailwind as we march back towards that.

And then as the consumer is improving, we then unwind some of those credit tightening strides that were in place around line increases, higher approval rates, and all that will as well be a tailwind to growth. And that’s not the — you mentioned what Ralph talked about, the terrific business development team that we have out there that are continuing to win opportunistic deals for us.

Moshe Orenbuch: Maybe just kind of think on that note, as you kind of look out at the landscape, do you see opportunities for additional portfolios, either conversions or kind of start-up opportunities. And now that perhaps the late fee issue is at least on hold for a while? How are the potential partner? What’s that channel look like?

Ralph Andretta: Yes, it’s Ralph. We do. We announced Saks Fifth Avenue earlier this year, early this quarter, really excited about that to get that in next — in the third quarter. And this morning, we just announced HP. So, we’re excited about that opportunity. It’s a de novo opportunity for us. And if you look at HP, we have Dell, Sony and even to B&H Photo in there, we have a real-nice electronic vertical, which we really like. And the pipeline is always active. Our business development team, I’ll match up against any. I think it’s second to none. And we’re always engaged in deals that are coming due. And also, again, what I love about our team, it’s up and down the spectrum. So, it’s $100 million deals to the $1 billion deals, we’re able to play very comfortably in that with those guidelines. And they’re active and busy, and we certainly see, we win more than our share as we go forward.

Perry Beberman: Yes. And you’ve asked a question about with the CFPB happening or not happening, the one thing I think that’s common in the marketplace, all of our competitors are, I’ll say, pretty rational, right? Sometimes it’s something that’s strategic that somebody wants to win really badly and that won’t take lesser economics. But traditionally, you win based on your capabilities and the partnership. And the CFPB ruling is contemplated in the economics through the discussions, whether the partner somewhere else, they stay where they are or they come to us, it has to be contemplated, and we are very capital disciplined. And with the amount of opportunity in front of us, we’re also making sure we’re selective with who we’re signing and that it fits with our strategic verticals as well as delivering the right capital return for our shareholders.

Operator: Our next question comes from the line of Bill Carcache with Wolfe Research Securities. Your line is open.

Bill Carcache: Following up on your comments about the resiliency of the consumer. There is a view among some that we could see a delayed charge-off effect as customers that are delinquent today and potentially would have charged off by now in a normal cycle, have instead been able to avoid charging off because of all the financial support they received during COVID. Is that a risk that you worry about in your portfolio?

Perry Beberman: So great question. I think that dovetails into the question earlier. You’re starting to see some of the pressure start to creep up the risk bands. And I think that is something that everybody is watching are some of those middle-income American starting to feel the pressure that the lower and moderate-income Americans had felt last year, right? And this has been a theme that we’ve talked about, I think, for over 18 months that stimulus that had built up and the savings that were in place, for the lower- and moderate-income Americans had been depleted. And those are the people that when you see our portfolio. That’s why you’re seeing the peak losses come through because that has already happened. And now, we’ve taken credit actions to make sure we’ve taken care of the population that we see at risk.

But that’s why partly you think there’s going to be prolonged period of time for losses to get all the way back down to the 6% range because the stress is still there. I mean, that’s the issue with our economy right now is this prolonged period of high inflation, high interest rates, consumer debt is high, it’s impacting folks. So, it’s a concern, but I don’t see it as something where there’s going to be a — this next wave coming through because we’re really on top of this.

Bill Carcache: And then as a follow-up, with your CET1 now at 13.8% very close to that initial target that you laid out at your Investor Day, is it reasonable to start modeling buybacks as you cross that 14% threshold?

Perry Beberman: So, what I would say is our first binding constraint is total risk-based capital, and that needs to get above 16%. And then I would share — this, I think I mentioned this previously at Investor Day, but I did it, then we have a last slug of CECL phase-in that will happen in January 2025, so in the first quarter ’25 and that’s 65 basis points. So, we’ve got to care for that care for the expected growth in the portfolio. And that’s when — and then obviously continue to look at our debt stack and other things. But I think that’s when you start to think about where we need to be to start having considerations of other capital opportunities.

Operator: Our next question comes from the line of Vincent Caintic with BTIG. Your line is now open.

Vincent Caintic: First question, I wanted to focus on NIM and specifically the loan yield. So, understanding that the loan yield was down quarter-over-quarter due to seasonality. But I wanted to get a sense of how much you’ve been able to add price as a CFPB mitigants. So, I was wondering if there’s a way maybe separate out the seasonality versus the pricing you’ve been able to put in. And then separately, if there’s any other impact. So, for instance, the tightening credit underwriting, if that’s maybe pushing you up market and therefore, having a lower price?

Perry Beberman: Yes. NIM, the 18% this quarter being down 70 basis points linked quarter. That was really pressured from the sequentially higher reversal of interest and fees, as well as not delinquencies improving coupled with a mix in the book as we’re booking fewer private label cards that tend to have some more late fees. We’re seeing a little bit lower yield from those. So that’s a result of having a little bit better early-stage delinquency. And so, you should expect the net interest margin to come back up in the third quarter seasonally, also aided by a lower reversal of interest and fees in the third quarter as you’ll have a meaningful reduction in losses. As it relates to your question on how much of the mitigation action APRs are built through.

Again, it takes a long time for APR changes to burn into that full rate yield. And we’ve been really consistent on saying that I put that chart together, I think, over a year ago, illustrate how long that can take. And so, it’s not a meaningful impact in this quarter. It will just continue to slowly steadily impact the improving loan yield, but then you also have, like I mentioned earlier, risk mix changes, product mix changes and you could have a lower interest rate environment at some point.

Vincent Caintic: And then second question, just on the credit reserve. So, it was just nice seeing the credit reserves drop this quarter alongside the execution on losses for the quarter. Just wondering for your expectations for the third quarter and fourth quarter, is your expectations for the full year built into the credit reserves, so we should just expect credit reserves to sort of say stable at this rate going forward? Or as time goes on and you’re actually able to you execute on the guidance for the third and fourth quarter loss rate, we should be expecting that credit reserve to continue to come down?

Perry Beberman: So, what I would expect to have happen is, look, pleased that the reserve rate came down this quarter. It was funny because we had prior questions, do you ever see a point where you could have peak losses and have a reduction in your reserve rate, and it just happens that yes, we can and we did, right? This quarter, we hit the peak losses and we have our reserve rate coming down. And that’s a reflection of the better credit quality and delinquency that’s in the current portfolio. So as the year goes on, if everything holds steady, I expect that we’ll have a seasonal drop in the fourth quarter. And that’s, again, why we have confidence that the end of this year, we’ll have a lower reserve rate than where we exited 2023.

But I do expect a pretty stable reserve rate, not expecting sharp declines in the reserve rate consistent with what we’ve said. We expect a slow, steady improvement in the portfolio quality over time. I would expect something similar with the reserve rate over time. And the other part of this is, I mentioned it in the prepared remarks, our weightings of adverse scenarios remained unchanged at this point. So, the change from last quarter to this quarter is solely due to the improving credit quality. In time as we have more confidence in a more benign economic outlook, those can get unwound, but that will be much further down the road.

Operator: Our next question comes from the line of John Pancari with Evercore IS. Your line is open.

John Pancari: Good morning. On the late fee side, again, I know you removed it from your outlook. I guess just as it is and from what you’re seeing in terms of the expected impacts. Has the expected impact to revenue from the late fee? Any of those expectations? Have they changed at all and as well as the magnitude of the offsets that you expect, anything behind the scenes has it changed at all in terms of the expected impact aside from, I know your efforts to dial in the pricing changes, et cetera?

Perry Beberman: No, I wouldn’t say that anything’s changed in terms of our approach or the strategies, right? I mean these — it’s unfortunate. I mean, this is what happens when you get regulator making changes, probably not fully understanding the impact of what this would mean to all consumers. We are moving forward with higher APRs for everyone. We’ve introduced other fees there other policy changes that are in place. We put this — I’ll say, the paper statement fee and there is not something that we necessarily thought I’d say, the normal course of action, we would have done were not for the CFPB making this rule change. But we are rolling that out, I’ll say, thoughtfully and watching the changing consumer behavior as it relates to APRs or private label and things like that.

We’re not seeing any change in behavior. What we are seeing with the paper statement fee, as you would expect, many are opting to go digitally, which will benefit our expenses over time, which was great because we have real nice opportunities that drive people to 100% digital engagement. So, I’d say everything that is happening right now is happening as expected.

John Pancari: And then separately, on the funding side, I know you indicated deposit costs stabilizing. Could you give us a little bit more color there what you’re seeing and you’re able to see the — I guess, your expectation of the trajectory here on deposit costs? And maybe if you could just comment a little bit on how you expect deposit growth to progress in coming quarters.

Perry Beberman: Yes. So, we’ve got our direct-to-consumer deposits sitting at about 40% of our total funding. We’ve communicated our goal is to get to 50% of our funding from direct-to-consumer deposits and expect that each quarter here out, we’ll continue to grow thoughtfully with that. Our pricing, because of the way we are structured, we don’t have brick-and-mortar and all this and to have checking accounts, we are comfortable being towards the top of the league table as you see deposit pricing come down some. We actually were just in market recently with a small reduction in some of the deposit pricing. So, we’re monitoring it. We’re very actively monitor to make sure that we’re getting the growth in deposits that we expect. And on I expect it’s pretty stable right now. But if there’s sharp declines in Fed funds and the market moves, we’ll be prepared to move appropriately but making sure that we are where we want to be positioned to keep attracting deposits.

Operator: Our next question comes from the line of Terry Ma with Barclays. Your line is open.

Terry Ma: I think you indicated you don’t expect much incremental revenue from the mitigation actions this year. Can you maybe just talk about how the pricing actions and the incremental fees are progressing and when you would expect more meaningful contribution from those measures?

Perry Beberman: Yes. I think when — wedge is in, it’s the best way to say it, right? So, every month that goes by, more and more of the portfolio spend volume or balance will be subject to the higher APRs. And that just takes time. And I’ll just point you to the chart that I put out there as an illustration previously, gives you an idea of where are you 12 months after that. And so, you’re only partway through the benefit a whole 12 months after the fact that you increased the paper statement fees. It’s not a large amount in the this, I’ll say, certainly not this upcoming quarter. As we get into next year, it will become a more meaningful amount. But even then, the expectations, we’re going to have a lot more customers going paperless and digital.

Other policy change that we have and waiver policies and other things, all those are going to go in effect. And some of this I probably was remiss in saying this earlier if I didn’t, is we’re not trying to put these actions in place to accrete a ton of revenue in the near term while we wait for resolution on the litigation. We are trying to do very thoughtfully with our brand partners time the rollout of these things. So that we’re not doing anything detrimental to the consumer before something like the late fee drop goes in. And if we do have to put some things in place earlier as we are, there may be a point where there is some consideration of investing more back into the program in consideration with that brand partner.

Terry Ma: And then on the reserve rate being lower as you exit this year compared to last year. I think another peer had initially messaged that earlier this year, but is now indicating kind of like a flat reserve ratio year-over-year. So maybe just speak to your confidence in the macro and the performance of your portfolio to take that reserve rate lower this at the end of this year?

Perry Beberman: Yes. What I’d say is that, look, I can’t speak to everyone else’s models, right? But industry-wide, we call it — we’re hearing something normalization, seasoning of recent vintages, consumer pressure, we’re creeping up into different risk score seems to be a theme for them. Now what I’d remind you of is that we moved our reserve rate up earlier than others based on anticipated impacts to our customers of high inflation, and it proved to be the right action as we’ve had a stable reserve rate for over six quarters. So based on the expected stable and slightly improving macro conditions, our improved credit quality and resulting delinquencies should allow for modest reductions of our reserve rate over time again, with fourth quarter having a normal seasonal reduction before the first quarter increases back up a little bit.

But that’s what we’re expecting to see. And we feel very confident in our process. We were and we use the term conservative, I’d call it just prudent, right? We have a very experienced team of people at this company who’ve been through different macro environments. And we knew to get ahead of this thing early and anticipating what inflation can mean to our customers. Now others didn’t increase their reserve rates to the degree we did. And now they’re continuing to see pressure and maybe they need to get to where a different spot than where we are. But we feel very confident with where we are and confident in the guidance that we’re giving.

Operator: Our next question comes from the line of Reggie Smith with JPM. Your line is open.

Reggie Smith: I guess real quick, can you remind us what proportion of your portfolio has been — or you’ve been able to kind of implement or had the partner agreed to some of these mitigation efforts? And then, I have a few follow-ups.

Perry Beberman: We have not given a proportion of the portfolio. But I would tell you that conversations have happened with 100% of the brand partners. And as we had talked about previously, each brand partner is unique. Some are opting for somewhere promo fees, some of the companies or this or other they introduce other fees for credit. Some are changing service level agreements, serving strategy. So, I mean, there’s a lot that goes into these things and others have to — are discussing partner compensation changes, different revenue share things. So again, our commercial team is very active with all of the partners. And as I mentioned earlier, that’s why I use the word thoughtful rollout of these strategies.

Reggie Smith: And I guess with that said, I would imagine that right now, given the uncertainty that I guess any agreement that hasn’t been struts probably on hold so we get more clarity?

Perry Beberman: I don’t know if I would use the word on hold. I’d say they’re all progressing and in a state of readiness to take appropriate action. I mean look, time is our friend. Let’s just call that what it is, right? Every month that goes by and delays our company is getting stronger and stronger from a capital standpoint. The macro environment is improving. We’re in a better state of readiness for whatever we have to do systemically from a technology side to implement product changes. So, we’re feeling very good about our ability to get strong returns should a regulatory change to be put in place.

Reggie Smith: And then if I could ask — when I look at the model, I guess the processing costs were down sequentially, definitely lower than we had expected. You called out, I guess, some efficiencies there. What’s driving that? Is that the Fiserv deal? And how sustainable is that kind of run rate that we have there?

Perry Beberman: Yes. So, as with the expenses, we’re at a, I’ll say, probably a low point for the year, right? We’ve had benefits year-over-year as our fraud team has done an amazing job getting fraud strategies in place to tighten things down. The whole industry experienced some fraud attacks last year. Now I think most of the industry has got under control and our team certainly does. We’re going to see an increase in expenses in the third quarter because you’ve got Saks coming online. So that’s a portfolio purchase for servicing and the cost involved with getting that up and going as well, you’re going to see an increase in marketing, sequential marketing is going to be up about $10 million in the third quarter. And then in the fourth quarter, expenses will rise again from there because fourth quarter is always sequentially higher for us as a result of, again, further increases in marketing for the holiday seasons as well as our employee benefits costs are seasonally higher in that quarter.

Operator: Ladies and gentlemen, I’m showing no further questions in the queue. I would now like to turn the call back over to Ralph Andretta for closing remarks.

Ralph Andretta: Sure. Well, a couple of thank you for — thank you to Perry for fielding all the questions today. I appreciate that very much. And thank you to all of you for your continued interest in Bread. We look forward to you look forward to talking to you again in next quarter. And everybody, have a terrific day. Take care.

Operator: Ladies and gentlemen, this concludes today’s conference call. Thank you for your participation. You may now disconnect.