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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