Bread Financial Holdings, Inc. (NYSE:BFH) Q3 2023 Earnings Call Transcript

Bread Financial Holdings, Inc. (NYSE:BFH) Q3 2023 Earnings Call Transcript October 26, 2023

Bread Financial Holdings, Inc. beats earnings expectations. Reported EPS is $3.46, expectations were $2.24.

Operator: Good morning, and welcome to Bread Financial’s Third Quarter Earnings Conference Call. My name is Bruno and I’ll 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 open for your questions. [Operator Instructions] It is now my pleasure to introduce Mr. Brian Vereb. Head of Investor Relations at Bread financial. The floor is yours.

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Brian Vereb: Thank you, Bruno. Copies of the slides we will be reviewing and the earnings release can be found on the Investor Relations section of our website. On the call today we have Ralph Andretta, President and Chief Executive Officer of Bread Financial, and Perry Beberman, Executive Vice President and Chief Financial Officer of Bread Financial. Before we begin, I would like to remind you that some of the comments made on today’s call, 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 will provide useful information for investors.

Reconciliation of those measures to GAAP are included in our quarterly earnings materials posted on our Investor Relations website at breadfinancial.com 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 Slide three. Bread Financials business model, which features and industry leading risk adjusted yield, conservative reserves, strong capital positioning is built to consistently performed well through the full cycle. Our third quarter results which include net income of $171 million and a 25% return on equity demonstrate our continued financial resilience despite losses above or through the cycle average in this current more challenging macroeconomic environment. Funded by strong cash flows for operations we completed our authorized $35 million share repurchase in the quarter, which represented 935,000 shares. Additionally, we continue to deliver on our commitment to build long-term shareholder value as tangible book value per share exceeded $42 nearly triple the level compared to the fourth quarter of 2020, when I joined the company.

During the quarter we launched Ross Dress for Less, the largest off price apparel and home furnishing chain in the U.S. Also at the beginning of October we successfully closed on Dell Technologies consumer credit portfolio, purchase of approximately $400 million and simultaneously launched the Dell program, which includes a broad suite of payment solutions and expands opposition in a consumer electronics market. Through our industry expertise, technology and data and analytic capabilities, we are well positioned to drive value for both our new and existing partners. The economic environment, remains challenging and consumers contend with numerous headwinds including the compounding effect of persistent inflation relative to wage growth, high interest rates, the resumption of student loan payments, and gas volatility.

Broadly speaking, these factors are weighing on consumers and in part led to the reduction in our credit sales in the third quarter, particularly within our retail and home industry verticals. For moderate to low income Americans, who have depleted much of their excess pandemic era savings, we noted a reduction in travel and entertainment spending, as these consumers focus more on non-discretionary purchases. By contrast, higher income consumers have continued to spend on health, beauty and experiences. Prime and Super Prime cardholders remain resilient and are spending approximately the same amount as they did last year. However, as evidenced by many retailers updated financial outlooks, economic pressures are expected to continue to manifest in terms of softer sales in the fourth quarter.

Given the ongoing macroeconomic stresses faced by many consumers, we have continued to responsibly tighten our underwriting and credit line management. We proactively manage our exposure by tightening approval rates, pausing, line increases, and implementing line decreases were prudent. While these adjustment limits sales and loan growth, we see these as the right actions to support improved credit performance over time, where we make focused on responsible growth and we’ll continue to manage underwriting to meet our risk return thresholds. From a regulatory perspective, we are developing mitigation strategies in anticipation of the CFPB’s final rule on credit card late fees, which would have significant impact on our business if unmitigated, we actively engaged with our brand partners regarding possible outcomes and strategies.

Having effectively managed through significant regulatory changes and vary credit cycles in the past, our seasoned leadership team is focused on addressing potential impacts to our business, and committed to generating strong returns through prudent capital risk management. Turning to Slide four, our key focus areas for 2023 remain unchanged. They are growing responsibly, strengthening our balance sheet, optimizing data and technology and strategically investing in our business. As I mentioned on the last slide, our management team is committed to driving responsible growth that will deliver long term shareholder value. We continue to expand and renew our partnerships with an emphasis on sustainable profitable growth. Strengthening our balance sheet remains a top priority and is integral to our long term strategy.

Our ongoing disciplined balance sheet management actions enhance our financial resilience and provide additional flexibility for capital utilization, including supporting business growth, and further reducing debt. On the data and technology front, we are leveraging innovative capabilities gained from our platform conversion, system enhancements and expanded product portfolio. In addition, machine learning remains one of the many tools we have utilized for many years to bring stronger credit risk models to continually enhance our underwriting line management and collections. We continue to invest in a range of technology innovations from data and customer analytics, to self-service and digital capabilities. We strive to deliver exceptional value and experiences for our cardholders.

Our goal is to continuously generate expense efficiencies that enable reinvestment in our business, support responsible growth and achieve our targeted returns. Moving to Slide five, we have significantly enhanced our financial resilience, strengthening our balance sheet and funding mix while effectively managing credit risk. Over the past few years we have diversified our product mix through partner co-brand growth, the introduction of two proprietary cards and the launch and expansion of Bread Pay. Co-brand spend now comprises approximately 50% of our credit sales enabling us to capture incremental sales as consumer spending patterns shift and responsible evolving economic conditions. Additionally, our broader product suite increased our total addressable market opportunity and diversifies our spend.

We have generated significant growth in our direct-to-consumer deposits, which reached $6.1 billion in the third quarter. This additional source of funding has strengthened our balance sheet and enhanced our financial flexibility. We have also strengthened our balance sheet by reducing debt and building capital while maintaining conservative loan loss reserve of 12.3%, for the last three quarters. Our loan loss reserve rate is 300 basis points higher than our CECL day one rate in 2020. Our quarter end total absorption capacity, which we defined as our allowance for credit losses plus tier 1 capital divided by the total end of period loans was 24%, providing a strong margin of protection should more adverse economic conditions arise. We remain confident in our discipline credit risk management and our ability to drive sustainable value through the full economic cycle.

We are committed to delivering responsible profitable growth, which may entail responsibly slowing growth during more uncertain economic periods. Turning to Slide six. Our disciplined capital allocation strategy, which focuses on profitable growth and proving capital metrics and reducing debt has driven substantial growth and tangible book value over the past several years. Looking at the first chart, you can see that since the quarter first quarter of 2020, we have more than tripled our TCE to TA ratio. Moving to the second chart, we are proud of the progress we have made with respect to debt reduction. And just over three years, we have reduced parent level debt by 55%, paying down more than $1.7 billion. We aim to further enhance our total company, our total company capital metrics.

From where we are today, we will balance achieving these targets with continued investment in our business and growth aligned with our capital priorities. Before I turn it over to Perry, I will again highlight the improvement in our tangible book value per share, shown on the last graph, which has grown at 37% compounded annual rate since the first quarter of 2020. Supported by our strong cash flow generation, we expect to continue to grow our tangible book value. We believe this growth combined with our meaningful improved financial resilience and a strengthened balance sheet should yield a company valuation that is multiple of tangible book value. Our significant accomplishments over the past three years demonstrate our focus and the success of managing our business responsibly to build long term value for our stakeholders.

We remain confident in our strategic direction, and our commitment to drive long term value creation. Now I’ll turn it over to Perry to discuss the financials for the quarter.

Perry Beberman: Thanks, Ralph. Slide seven provides our third quarter financial results. Bread Financials credit sales were down 13% year-over-year to $6.7 billion, reflecting the sale of the BJs Wholesale Club portfolio in late February 2023, strategic credit tightening and moderating consumer spending, partially offset by new partner growth. As Ralph highlighted, we have been proactive in tightening our credit, underwriting and credit line assignments for both new and existing customers, given the economic uncertainties and pressures affecting a portion of our customer base. Average loans were flat year over year driven by the addition new partners and a lower consumer payment rate offset by the sale of the BJs portfolio in February and softening credit sales.

Revenue for the quarter was $1.0 billion up 5%, while total non-interest expenses increased 3% year-over-year, income from continuing operations was $173 million up 29% and diluted EPS from continuing operations was $3.46. Looking at financials in more detail, on Slide eight. Total net interest income was flat year-over-year. Total non-interest income benefited from three factors. Higher cardholder and brand partner engagement initiatives in the prior year post our conversion, higher merchant discount fees and interchange revenue earned in the current year and lower payments under our retailer share agreements due to lower credit sales and higher losses. Total non-interest expenses increased 3% from the third quarter of 2022, yet declined $28 million or 5% sequentially.

The year-over-year increase was primarily an increase in card and processing costs, including fraud, and higher employee compensation and benefit costs. This was partially offset by reduction in marketing expenses and depreciation amortization costs. The sequential decline in expense has largely reflected lower fraud expenses, lower depreciation, amortization costs and our continued focus on driving efficiency through our prior and ongoing investment in technology. Additional details on expense drivers can be found in the appendix of the slide deck. Income from continuing operations was up $39 million for the quarter versus the third quarter of 2022, while pretax pre-provision earnings or PPNR grew for the 10th consecutive quarter, increasing by 7% year-over-year.

Turning to Slide nine. Loan yields continue to increase, up 140 basis points year-over-year. Loan yields benefited from an upward trend in the prime rate, causing our variable price loans to move higher in tandem. Net interest margin was seasonally elevated in the third quarter at 20.6%. Looking at the sequential change from the second quarter, both loan yield and net interest margin benefited from a decrease in the reversal and interest in fees related to reduced sequential credit losses. Also, funding costs continue to rise and remain in line with our expectations. We would expect net interest margin to move lower sequentially in the fourth quarter following typical seasonality and due to an increase in the reversal of interest in fees related to expected in a sequential increase in gross losses.

As you can see on the bottom right graph, we continue to improve our funding mix through our actions to grow our direct to consumer deposits, which increased to $6.1 billion in the third quarter. 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 efficiently fund our long-term growth objectives. Moving to credit on Slide 10. Our delinquency rate for the third quarter was 6.3%, up from second quarter as expected, driven by continued macroeconomic pressures. The net loss rate was 6.9% for the quarter compared to 5.0% in the third quarter of 2022 and 8.0% in the second quarter of 2023. The third quarter net loss rate was elevated compared to last year’s level due to more challenging macroeconomic conditions, pressuring the consumer’s payment rate as well as actions taken to the transition of our credit card processing services in June of 2022.

That benefited the loss rate in that quarter. The net loss rate declined sequentially from the second quarter as the final impact from the transition of our credit card processing services was reflected in our July credit metrics. The reserve rate remained flat sequentially at 12.3%. We intend to maintain a conservative weighting of economic scenarios in our credit reserve model in anticipation of ongoing macroeconomic challenges and the consequential impact on our future credit losses. As macroeconomic headwinds persisted during the quarter, our credit risk score distribution deteriorated slightly compared to the second quarter, driven by downward score migration from existing customers, despite new account risk scores by distribution being well above the portfolio blend.

Even so, our percentage of card holders with a 660 plus credit score remained above pre pandemic levels, given our prudent credit, tightening actions and our more diversified product mix. As Ralph touched on, we continue to proactively manage our credit risk to protect our balance sheet and ensure we are appropriately compensated for the risk we take. We closely monitor our projected returns with the goal of generating risk adjusted margins above our peers. Finally, Slide 11 provides our financial outlook for the full year of 2023. Our financial outlook is updated to reflect slowing sales growth as a result of both our strategic and targeted credit tightening as well as an expected continued moderation in consumer spending. For the full year average loans are expected to grow in the low to mid-single digit range relative to 2022, based on the latest economic outlook.

We anticipate year end period loans to be around $19.3 billion inclusive of the recently acquired Dell portfolio of approximately $400. We expect revenue growth to be slightly above our average loan growth in 2023, excluding the gain on sale from BJs with a full year net interest margin similar to the 2022 full year rate. Full year total non-interest expenses are expected to be up 8% to 9% compared to 2022 with fourth quarter total expenses slightly higher than the third quarter driven by increased seasonal marketing and employee benefits costs. We updated our net loss rate outlook as we now anticipate the full year 2023 rate will be in the mid-7% range, including impact from the transition of our credit card processing services in June 2022.

While our tighter underwriting and credit line management should benefit future loss performance, these actions raise the loss rate in the near term by lowering our projected loan balance, which forms the denominator in the net loss rate equation. We now expect the fourth quarter net loss rate to be approximately 8%, driven by normal seasonal trends, continued consumer payment pressure and the denominator effect from lower loan growth. In addition, we expect fourth quarter delinquency rate to be relatively consistent with the third quarter. Sticking with credit, with the addition of the Dell portfolio in early October and the fourth quarter anticipated seasonal increase in transactor balances, it is likely the reserve dollars will increase, but the reserve rate could decline slightly at year-end.

The increase in transactor balances will also temporarily reduce our capital metrics in the fourth quarter as is typical each year-end. Our full year normalized effective tax rate is expected to remain in the range of 25% to 26% with quarter-over-quarter variability due to timing of certain discrete items. One final item before wrapping up, as you can see in the financial tables provided in the Appendix, we are now reporting total company regulatory capital ratios and our double leverage ratio. As Ralph highlighted, you can see the disciplined management decisions and successful execution of our plans over the past three years. Briefly looking ahead to 2024, we will stay true to pursuing responsible, profitable growth. We expect consumer macroeconomic pressures to continue to drive softer consumer spending, which, coupled with our continued tighter credit underwriting and line management actions, will likely lead to loan growth remaining below our longer-term targets next year.

Also, we currently project that our net loss rate will peak in 2024, subject to economic conditions. We will provide specific guidance for 2024 during our fourth quarter earnings call in January and more details around our intended mitigation strategies after a final CFPB rule is released. In closing, we are effectively managing risk return trade-offs through an ongoing challenging macroeconomic environment while continuing to strategically invest and drive long-term value for our stakeholders. Operator, we are now ready to open up the lines for questions.

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Q&A Session

Operator: [Operator Instructions] We do have our first question. It comes from Sanjay Sakhrani from KBW. Sanjay your line is now open. Please go ahead.

Sanjay Sakhrani: Thank you, good morning. Ralph, I appreciate that this CFPB rules are fluid from a timing perspective, but it seems like we’re going to get something by the end of the year, and it’s probably going to be close to that $8. I’m just curious if you’ve started to think about like and implemented any mitigation efforts or tested to see what you might be able to do? And how comfortable are you with mitigation?

Ralph Andretta: Yes, Sanjay, thanks for the question. We’re waiting like everybody else for the final ruling from the CFPB. We’d like it to come sooner than later so we can just get focused on it even more. But we’re testing different APRs in the marketplace and a variety of other type of fees to close gaps. We’re working with our partners diligently. They understand what the issue is and the impact it could have on their business as it could have in our business. And we continue to collaborate with them on mitigations. In terms of how long it will take, what the mitigations will be closing the gaps, we’ll know more when the final ruling comes out. But rest assured, we’re focused on it. We’re testing different strategies and working very collaboratively and diligently with our partners.

Perry Beberman: And I would just add to what Ralph said there, right? Some of this, it’s hard to implement some of the changes that you have teed up before the final rule comes about. And so that’s what we are waiting on. And I would say that I think we all believe and know that this is going to get litigated in court. And the question is how long before we actually have to implement. And one other thing I’d share is — and we’ll share more when and if the rule becomes final. But we expect the initial impact as a percent of total revenue will be more impactful to Bread Financial and will be higher than peers, given our higher proportion of private label credit card accounts and our deeper underwriting.

Sanjay Sakhrani: Yes. Absolutely. Perry, maybe just a question for you on like credit. You talked a little bit towards the end about the reserve rate, and I know it’s going to go down sort of in the third quarter because you had the — I’m sorry, in the fourth quarter because you had the transactor build. But I’m just curious, as we look out to next year, maybe you could just speak to how you’re seeing delinquency migration, obviously choppy backdrop who knows where things go, but seems stable-ish at this point. But just how the reserve rate would migrate if there’s stability? Thanks.

Perry Beberman: Thanks, Sanjay. Yes. So as we think about the reserve rate, I think it is dependent on what you say. It’s what happens with the economy next year. And as we signaled, and I think it’s playing out pretty much as we expected. I think we were foreseeing things that perhaps a lot of the economic forecasts were in seeing in terms of what was happening with the consumers we serve, the pressure that this elevated environment of inflation puts into the consumer base and what that means for future delinquency and losses. We were caring for that when we increased our reserve rate to 12.3%. Like I said previously, we did not expect unemployment to be the driver of this. It was more about the pressure from this compounding effect of inflation.

So the degree to which the Fed is able to get, I’ll say, inflation under control, whether it’s the back half of next year, you start to see inflation coming down, a lot of this is you could tell with what the Fed’s view on rates are. Now you start to see economists thinking the Fed’s going to maybe increase the rate one more time or so or keep rates higher longer, that aligns to our view that rates were going to remain higher longer, which implies inflation is going to remain a little higher longer before hitting that 2% target rate. So we said we expect our losses to peak next year, whether it’s mid-year or remains a little elevated throughout the year. Is hard to know. That’s really going to be macro dependent. But I would expect that as we think about the reserve rate, the reserve rate should remain pretty steady throughout next year, and it’s going to be macro dependent upon when that rate can come down.

So we start to have a brighter outlook, and that might be — if we see a brighter outlook in 2025. That means towards the end of next year, the reserve rate comes down. If the outlook does not improve, you expect the reserve rate to hold kind of where it is.

Sanjay Sakhrani: Okay, that’s great. Thank you so much.

Operator: Our next question comes from Robert Napoli from William Blair. Robert, your line is now open, please go ahead.

Robert Napoli: Thank you. Good morning. Maybe just following up, I guess that’s the biggest question. As you looked at — I’m sure you have all types of models for mitigation and what affects. What do you have a confidence level in being able to generate attractive returns post the adjustments, if assuming we go to the lowest level in late fees? What is your confidence level being able to drive reasonably attractive returns, I guess, at Bread under any scenario?

Perry Beberman: Thanks for the question. I mean, that’s — first of all, we don’t know what the final rule is. And so to your point, if we go to the current $8 fee, you should expect that we said in the past and it’s continued to be true that APRs will have to go up across the board for all customers. You’ll start to see some fees for credit where it means upfront origination fees, promotional — fees on promotional bonds like for big ticket or annual or monthly fees. That would be true. Then you’re going to have some restructuring of partner contracts. I mean, so as Ralph talked about earlier, we’re very engaged with our partners. Look, we’re in this together and trying to protect their economics as well as ours, but we’ve got to underwrite, as you said, to protect returns for shareholders.

And we’re running through a bank, so we have a responsibility to make sure from a safety and soundness standpoint that we’re doing that as well. So you’re going to see some tightening of credit standards, which means we’ll see — which will result in fewer customers being extended credit. So you might — we might grow a little less than what we otherwise might have in, I’ll say, private label, but then that will free up capital to deploy into other product adjacencies. So there’s a lot to sort through. But yes, there’s a full expectation that we will be able to run a business delivering strong returns in the future. It might be a little bit of a burn-in period with the APR changes. But when you look to get to the other side of it, we have full expectation to be able to deliver strong returns.

Robert Napoli: And then I guess, given that your confidence there and given that your stock is so far below book value, tangible book value right now. What are your thoughts on capital, on capital return and balancing that with the new potential regulatory changes coming up as well? But it seems like a good opportunity for confidence level, is that high to increase tangible book value by reducing the share count even?

Perry Beberman: Yes. I think when we think about our capital structure, I’ll first start by saying our priorities remain unchanged, right, supporting responsible, profitable growth, make sure we’re investing in our technology and digital capabilities to serve our brand partners and customers. We’re still not where we want to be on that front. Ralph talked about earlier, we’re paying down our debt. We need to pay down our debt to get below 115% double leverage ratio. We want to continue to build our capital ratios to fortify this balance sheet and then we could think about things like you mentioned around further returns to shareholders. But in this environment, with the uncertainty around the macro side of things, and as you noted on the regulatory front, it would not be responsible to take, say, a strong action like that.