Bread Financial Holdings, Inc. (NYSE:BFH) Q4 2023 Earnings Call Transcript

Bread Financial Holdings, Inc. (NYSE:BFH) Q4 2023 Earnings Call Transcript January 25, 2024

Bread Financial Holdings, Inc. beats earnings expectations. Reported EPS is $0.9, expectations were $-0.73. Bread Financial Holdings, Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good morning. And welcome to Bread Financial’s Fourth Quarter Earnings Conference Call. My name is Emily, 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. The floor is yours.

Brian Vereb: Thanks you. 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 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 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. I will highlight our major accomplishments for 2023. We continue to execute on our strategic initiatives by growing responsibly and strengthening our balance sheet. Additionally, we continue to optimize data and technology while investing to capture future growth opportunities, inclusive of the sale of the BJs portfolio in February of 2023 and our strategic credit tightening, loans grew at a low-to-mid single digit rate compared to 2022 as forecasted. PPNR or profitless tax and loan loss provisions grew for the full year, as well as for each quarter in 2023, demonstrating our ability to deliver sustainable profitable growth.

During 2023 we launched and renewed several key brand partner relationships. New partners included iconic brands such as Dell Technologies and the New York Yankees, and we were pleased to renew multiple partners including our longstanding business relationship with Signet. Importantly, our top five partners are currently secured through 2028 and more than 85% of our current loan portfolio has contracted through 2025. Our continued success reflects the dedication of our associates, our nimble customer first approach, our enhanced — and our enhanced technology capabilities. We achieved significant progress in reducing our parent level debt during the year while refinancing both our term loan and revolving line of credit. We also obtained our inaugural holding company issuer credit rating in November.

Following, we completed a $600 million senior unsecured note offering in December that was opportunistically upsize to $900 million earlier this month. With a portion of this new financing, we paid off our term loan early in December of 2023. Consistent with our parent level debt reduction plan, we paid down approximately $500 million of parent unsecured debt in 2023 and an additional $100 million in January of 2024. Additionally, we strengthened our balance sheet highlighted by 18% year-over-year growth to direct — our direct-to-consumer deposits of $6.5 billion at year end. These actions coupled with our strong cash flow generation and disciplined capital allocation improve the company’s financial flexibility and capital ratios further fortifying our balance sheet.

Investments in technology and driving innovation are paramount to our success. In 2023 we hired more than 100 new engineers, the cloud expertise and optimize our data and technology by adding new systems capabilities. These included API enhancements, enriched software development kits, unified salesforce integration, virtual card commercialization, as well as the launch of the Bread Financial mobile app. We also successfully converted a majority of our Comenity Mastercard portfolio to the new Bread Rewards American Express program for every day spend achieving strong activation and balanced build post conversion. Finally, we strengthened our relationship with our brand partners by delivering enhanced value propositions that helped drive sales, as well as meet the evolving needs of our customers.

We are pleased with the progress we achieved in 2023 and remain focused on driving continued success throughout 2024 and beyond. Moving to the highlights for the fourth quarter on slide four. The fourth quarter marked our 11th consecutive quarter of year-over-year PPNR growth, further demonstrating our ability to deliver sustainable profitable growth. Net income was $43 million despite credit losses above — or above our through the cycle average in the current challenging macroeconomic environment. Additionally, we continue to deliver on our commitment to build long-term shareholder value as our tangible book value per share approached $44, representing a 49 year-over — 49% year-over-year increase. We are proud of the progress we have made in executing on our debt plan, strengthening our balance sheet and enhancing our financial resilience.

The economy continued to be impacted by macroeconomic headwinds, including persistent inflation, high interest rates and the resumption of student loan repayments. These factors led to a moderation in consumer spending and pressured consumers’ ability to pay. As we enter 2024, we maintain disciplined credit risk management, given continued economic pressures that affect consumer spending and ability to pay. Our ongoing prudent credit tightening is driven by both the current environment and uncertainty around future economic conditions persistent inflation pressure and the impact of elevated interest rates. We have continued to responsibly manage our underwriting and credit line management, while proactively eliminating our exposure by tightening approval rates, pausing line increases and prudently implementing credit line decreases.

Although these actions impacted our 2023 sales and loan growth, our credit distribution has stabilized above pre-pandemic levels. In anticipation of the CFPB’s final rule on credit card late fees, we are proactively implementing our plans intended to address the change in regulation, which if left unmitigated would have a significant impact on our business. We are engaged with our brand partners regarding necessary mitigating actions and expect to implement many of these actions prior to the final rule becoming effective. Additionally, we continue to strategically diverse business to be less relying on late fees with continued growth in our co-brand and proprietary products, and our improved credit profile. We expect the rule to be challenged in court and we will be monitoring the situation closely.

Having successfully managed through significant regulatory changes and varied credit cycles in the past, our seasoned leadership team is focused on addressing the impact to our business while continuing to generate strong returns through prudent capital and risk management. Turning to slide five, as we have highlighted previously, our disciplined capital allocation strategy, which focuses on profitable growth, improving metrics and reducing parent level debt has driven substantial growth in tangible book value over the past several years. Looking at the first chart, you can see that since the first quarter of 2020, we have more than tripled our TCE to TA ratio. We aim to further enhance our total company capital metrics from where we are today.

Additionally, we will balance achieving these targets with continued investment in our business and long-term growth, consistent with our capital priorities. Later this year we plan to host an Investor Day, where we will further discuss our capital targets and allocation strategies. Moving to the second chart, I will again highlight the progress we have made with respect to debt reduction. In just over three years, we have reduced parent level debt by 54% paying down more than $1.7 billion and we paid down an additional $100 million this week, which is not included in that figure. Finally, the improvement in our tangible book value per share has grown at a 38% 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 meaningfully improved financial resilience and strengthened balance sheet should yield a company valuation that is a multiple of our tangible book value. We remain confident in our strategy and are focused on managing our business responsibly to build long-term value for our stakeholders. Turning to slide six, let’s review our key focus areas for 2024. Our initiatives build on the momentum we generated in 2023, while enabling us to proactively adapt to evolving macroeconomic conditions. Our key focus areas for 2024 include, growing responsibly, managing the macroeconomic and regulatory environment, accelerating digital and technology offerings and driving operational excellence. We remain committed to generating responsible growth, while further scaling into first finding our product offerings to align with a challenging economic landscape.

In doing so, we will optimize brand partner growth and revenue opportunities. Although our sales and loan growth may moderate in 2024, our responsible decisions are focus on creating long-term value for shareholders. Managing the macroeconomic and regulatory environment effectively is fundamental to our success, with the proposed CFPB credit card late fee rule coupled with persistent macroeconomic headwinds pressuring consumers, we are executing several mitigation strategies intended to help offset the anticipated financial impact. Perry will provide more details in his remarks. Accelerating our digital and technology capabilities remains a top priority and I am pleased to welcome Allegra Driscoll to our organization as new — as our new Executive Vice President and Chief Technology Officer.

Allegra’s proven track record as an innovative envision leader when combined with our deep understanding of financial services will be essential as we advance our tech innovation and modernization. Throughout 2024, we will focus on further building our capabilities to enhance customer experience and satisfaction. Finally, we will intensify our focus on operational excellence to accelerate continuous improvement gains that drive improved customer experience, enterprise-wise efficiency, reduced risk and value creation. Our goal is to consistently generate expense efficiencies that enables reinvestment in our business, support responsible growth and achieve our targeted returns. Before I turn it over to Perry, I want to thank our associates for their continued dedication and hard work.

Our seasoned leadership team remains committed to generating strong returns through prudent capital and risk management as we move forward. I will now turn it over to Perry.

Perry Beberman: Thanks, Ralph. Slide seven provides our 2023 financial highlights. Bread Financial’s credit sales of $28.9 billion decreased 12% year-over-year reflecting the sale of the BJs portfolio in February 2023, moderating consumer spending and our ongoing strategic credit tightening, partially offset by new partner group. Average loans of $18.2 billion increased 3% year-over-year driven by the addition of new partners. As Ralph noted, we have proactively tightened our credit underwriting and credit line assignments for both new and existing customers given the economic uncertainties and pressures affecting a large portion of our customer base. Revenue increased $463 million or 12% year-over-year driven by higher finance charge yields and non-interest income including the gain on portfolio sale, partially offset by higher interest expense and reversals of interest and fees resulting from higher gross credit losses.

Income from continuing operations increased $513 million to $737 million driven by a lower provision for credit losses and gain on portfolio sale, partially offset by higher income taxes. Moving to our fourth quarter financial highlights on slide eight. Similar to our full year drivers, fourth quarter credit sales and average loans were down year-over-year due to the sale of BJs portfolio, moderating consumer spending and credit tightening. Revenue reached $1.0 billion in the quarter, down 2% year-over-year due to lower late fee revenue, higher interest expense and higher reversal of interest and fees resulting from higher gross credit losses, partially offset by higher finance charge yield in non-interest income. Total non-interest expenses decreased 6% year-over-year, as we continue to gain operational efficiencies and better align our expenses with a more moderate growth outlook.

Income from continuing operations increased by $179 million driven primarily by a lower reserve build. Looking at the financials in more detail on slide nine. Total interest income for the quarter decreased 5% year-over-year, but increased 2% for the full year compared to 2023. Fourth quarter and full year 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 expense decreased 6% from the fourth quarter of 2022, yet was up on an annual basis as anticipated.

The year-over-year decrease in the fourth quarter was primarily driven by a decrease in card and processing costs, including fraud and a reduction in marketing expenses and depreciation amortization costs, partially offset by higher employee compensation and benefits costs. For the full year, investments in talent, technology and marketing primarily drove the increase. Additional details on expense drivers can be found in the appendix of the slide deck. As Ralph mentioned, pre-tax pre-provision earnings or PPNR grew for the 11th consecutive quarter, increasing 3% year-over-year in the fourth quarter. Turning to slide 10, loan yields increased 170 basis points year-over-year, benefiting from the upward trend in the prime rate causing our variable price loans to move higher in tandem.

Both loan yield of 27.7% and net interest margin of 19.6% were pressured sequentially from a seasonal increase in the reversal of interest and fees related to higher sequential gross credit losses. We expect this pressure to continue and lead to a sequential reduction in the net interest margin in the first quarter of 2024. Also funding costs continue to rise but remained in line with our expectations. 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 $6.5 billion in the fourth quarter, as well as meaningful reductions in our unsecured debt over time. While we anticipate that direct-to-consumer deposits will continue to grow steadily, we will maintain flexibility of our diversified funding sources including secured and wholesale funding to efficiently fund our long-term growth objectives.

Moving to slide 11, our delinquency rate for the fourth quarter was 6.5% up from the third quarter as expected, driven by continued macroeconomic pressures. We expect to continue delinquency rate to move slightly higher this month, before stabilizing and moving lower in 2024. The net loss rate was 8.0% for the quarter, compared to 6.3% in the fourth quarter of 2022 and 6.9% in the third quarter of 2023. The fourth quarter net loss rate was elevated compared to last year’s level due to more challenging macroeconomic conditions, pressuring the consumer payment rate that I mentioned, as well as ongoing credit tightening and slower responsible growth impacting the denominator. The reserve rate decreased sequentially to 12.0% as transactor balances increased seasonally in the fourth quarter.

We expect the first quarter 2024 reserve rate to return to approximately third quarter 2023 levels as transactor balances are paid down. We intend to maintain a conservative weighting of economic scenarios in our credit reserve model in anticipation of continuing macroeconomic challenges and uncertainty and the consequential impact on our future credit losses. Despite these headwinds, our credit risk score distribution mix remained flat to the third quarter as our percentage of cardholders with a 660 PLUS credit score remained above pre-pandemic levels due to our prudent credit tightening actions and a more diversified product mix. These dynamics reinforce our confidence that our credit metrics will show improvement in the second half of 2024.

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. Moving to slide 12, 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 for instalment lending. Our co-brand and proprietary products now comprise approximately 50% of our credit sales, enabling us to capture incremental general purpose sales as consumer spending pattern shift to more non-discretionary spend in response to evolving economic conditions.

Additionally, our broader product suite has increased our total addressable market and diversified our spend. Direct-to-consumer deposits, which have continued to grow steadily provide an additional source of funding that has strengthened our balance sheet and enhanced our financial flexibility. We have strengthened our balance sheet further by reducing debt and building capital, while maintaining a conservative loan loss reserve. Our loan loss reserve rate is nearly 300 basis points higher than our CECL day one rate in 2020. Our quarter end total loss absorption capacity, which we define as our allowance for credit losses plus Tier 1 capital divided by total end of period loans was 23%, providing a strong margin of protection should more adverse economic conditions arise.

We remain confident in our disciplined credit risk management and ability to drive sustainable value through the full economic cycle, delivering responsible profitable growth remains a top priority, even if doing so requires a disciplined slower rate of growth during extended economic uncertainty. Finally, slide 13 provides our 2024 financial outlook. Our 2024 outlook factors in an expected slower rate of credit sales growth as a result of continued moderation in consumer spending and ongoing strategic credit tightening. Both of which will pressure loan growth and the net loss rate. In addition, our 2024 outlook assumes multiple interest rate decreases by the federal reserve in the second half of the year, which will pressure total net interest income.

At this time our outlook does not factor in the potential impacts of the proposed CFPB late fee rule. Based on our current economic outlook, executed and expected proactive credit tightening actions, higher gross credit losses and the visibility into new business pipeline, we expect 2024 average credit card and other loans to be down low-single digits relative to 2023. Excluding the BJs portfolio, which was sold in 2023, we expect 2024 average loans would be up low-single digits. Total revenue growth for 2024 excluding gains on portfolio sales is anticipated to be down low-to-mid single digits, driven by both lower average loans and net interest margin. Note, that the BJ portfolio exit in 2023 reduced our 2024 year-over-year revenue growth guidance by 1% to 2%.

We expect our full year net interest margin to be below the full year of 2023 rate due to higher reversal of interest and fees given higher gross credit losses, declining interest rates and a continued shift in product mix to co-brand and proprietary products. Consistent with our prior commentary, the potential initial impact of the CFPB credit card late fee rule is significant to our business given our mix of private label accounts and deeper underwriting. For context, while not included in our 2024 outlook, assuming a hypothetical October 1, 2024 effective date, if the rule were to be implemented as proposed, our current estimate is that the rule would reduce fourth quarter 2024 total revenue by approximately 25% relative to the fourth quarter of 2023.

This estimate is net of certain mitigation actions that we will proactively implement this year. It should be noted that the estimated revenue impact does not yet include any contractual changes to the retailer share arrangements with partners. Once the final rule is published, we will take further mitigating actions in coordination with our brand partners to preserve program profitability over the long-term. We expect the financial impact to be increasingly mitigated over time as our actions take effect with substantial progress expected within the first four quarters post-implementation. As I discussed in December at an Industry Conference, certain mitigation actions will require a longer timeframe to reach full mitigation value, such as APR changes.

Therefore, we will proactively implement certain actions in advance of the final rule implementation, inclusive of fee and policy changes. Additionally, we expect there will be impacts of future loan growth due to the necessary underwriting changes to ensure we maintain profitability thresholds, which unfortunately will restrict access to credit for some consumers. All that said, given that a final rule has not yet been published and industry litigation is expected, the timing of the rule implementation and resulting financial impact will vary. In fact, it is possible there is no financial impact in 2024. Shifting to operating leverage, as a result of efficiencies, gained from ongoing investments in technology modernization and digital advancement, along with disciplined expense management, we aim to deliver nominal positive operating leverage for 2024, despite net interest margin headwinds.

With our focus on expense discipline and operational excellence, we expect total expenses will be lower in 2024 than 2023 assuming our current economic outlook remains intact. We expect a net loss rate in the low 8% range for 2024, peaking in the first half of the year with each of the first two quarters of the year in the mid-to-high 8% range as inflation continues to pressure consumers’ ability to pay and moderate their spend. Our outlook is inclusive of our ongoing credit tightening actions and expected slower loan growth impacting the net loss rate. Finally, our full year normalized effective tax rate is expected to be in the range of 25% to 26% with quarter-over-quarter variability due to the timing of certain discrete items. In closing, the executive leadership team and I are confident in our ability to successfully manage risk return tradeoffs to this challenging economic environment, while continuing to make strategic investments that 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: Thank you. [Operator Instructions] Our first question today comes from the line of Vincent Caintic with Stephens. Please go ahead. Your line is open.

Vincent Caintic: Hi. Good morning. Thanks for taking my questions and I appreciate the CFPB late fee estimate and putting an impact number out there and so I wanted to unpack that a bit. On the 25%, I guess, I want to understand the confidence level on that, as well as how much further lower it can go. So thinking about the 25%, if you have — I guess, how much of that — how much mitigating impacts are influenced in 25%. So maybe, like, what would it be without the mitigating impacts and then how low do you think it could go and what impacts or what mitigations would need to happen to get to that lower rate? Thank you.

Perry Beberman: Thanks, Vincent, for the question. I am glad you appreciate us giving some guidance and increasing transparency there. What we have provided is, what I’d say is, a downside scenario, meaning it’s — assuming the late fee rule comes out as proposed at $8, 25% cap with an effective October 1 with no partner adjustment considerations there, there were program considerations. And as we talked about in what I provided at one of the past conferences, some of the mitigating actions are just going to take time, right? APR changes take time to burn through. So there’s a lot more value that will come from mitigating action. So within, you can imagine, if you think about the six months of impact that might be in place if we start to do some pricing changes, if the rule comes out pretty soon, there’s not a, I’d say, a ton of mitigation within that number. The value is going to come over time.

Ralph Andretta: Vincent it’s Ralph. I think the thing to remember is, we have a really seasoned team here that has been through Card Act and has managed through that and managed to return to profitability. So that’s what we are going to do. We are going to focus on what it takes to return to profitability. It’s going to take a little bit of time. We thought it was important today to kind of put it down, the worst case scenario out there, but we are really focused on closing the gap over time and we have been working on it since February of 2023.

Vincent Caintic: Okay. I appreciate it. So it sounds like the 25%, you only really have six months of higher APRs in there. And then could you maybe discuss what actions you expect to take once the rule becomes finalized and what the impact of those mitigation strategies could be? And then also what the merchants are — your discussions with the merchants on all of these? Thank you.

Ralph Andretta: Yeah. And when you think about the actions, it will — yeah, when you think about pricing actions, some of those require partner agreement. So Val Greer and her team have been very active in working with each partner, meeting with them all, trying to figure out what the right solution is for them, should this rule go into effect. And so part of it is you need to have the rule actually come out with the final parameters, and then each partner will work with our team to figure out what’s the right level for them to work through this. I mean, it could be promotional fees for some partners. They are not having to change pricing. Others are going to want to lean in harder on APRs and some may want to give up some royalties to make sure we still underwrite deeper.

There’s going to be credit actions that are taken. So all the things that we have talked about, all the different levers are going to be in play and it’s really going to be partner dependent, product dependent in terms of what that will look like. So it’s hard to nail that down with a lot of specificity until the rule comes out, until the team gets to work with each partner in order to figure out what’s the right path for them.

Vincent Caintic: Okay. I appreciate it. Very helpful. I will get back in the queue. Thank you.

Operator: Our next question comes from Mihir Bhatia with Bank of America Merrill Lynch. Please go ahead.

Mihir Bhatia: Hi. Thank you for taking my questions and good morning. Just off maybe just staying on the late fee topic, I think, you said the net of the mitigation actions, it will be 25% and we appreciate the specificity of the disclosure. But I was wondering if you could maybe taking step further, what will be the gross impact if you don’t implement the net, the mitigation actions. What I am trying to understand is how much are you mitigating proactively versus what it would be if you didn’t, because it also sounds like, hey, this will might not come in. There will be litigation. So just trying to understand what is the, I guess, I don’t know if the insurance is the right word, like proactively mitigating you are taking a bit of a revenue hit too, so or maybe getting revenue boost, I guess? Yeah.

Perry Beberman: Yeah. Mihir, I appreciate that question, right. I think some of it is, we are giving you the hypothetical downside risk for the fourth quarter of this year. Look, I don’t bet, and so, but some that do would say, there is a highly unlikely, it’s highly likely that rule would actually impact this year. But for us, we wanted to give you a sense of what it would look like or could look like if it came out as proposed impacted the particular quarter that we mentioned, because we just released the fourth quarter of 2023, so we are giving you a comparable quarter whereas if we roll that forward to first quarter of 2025 or second quarter of 2025, it becomes much harder to provide a degree of estimation. So the degree of mitigation is not significant relative to the impact of the fee change itself.