Bread Financial Holdings, Inc. (BFH) Earnings Call Transcript & Summary

Next up, we have a team of executives from Alliance Data Systems, including President and CEO, Ralph Andretta; EVP and CFO, Tim King; and EVP of Operations and Credit Risk, Tammy McConnaughey. So welcome, everyone. We're thrilled to have you all joining us this morning. Your company, of course, is in the midst of some big changes, including your recent acquisition of Bread. So why don't we go ahead and get started? I believe the team has a short presentation for us, and then we'll get into Q&A. So I'm going to hand it over to Ralph.

Sanjay, thank you, and thank you, everybody, for joining. Thank you for joining today. We're excited to be here with you. The slides in today's presentation are available on our Investor Relations website. Starting with the agenda on Page 3. I'll begin with my opening remarks, review the actions we have taken in the past year and provide an update on our business and areas of focus. Then I'll turn it over to Tammy McConnaughey, our Head of Card Services Operations and Credit Risk. She'll discuss the current credit environment and our lending philosophy. After our prepared remarks, Tim King, our CFO, will join Tammy and me for a fireside chat with Sanjay. So we're looking forward to it. Slide 4 provides an overview of the company. Alliance Data consists of 2 segments: Card Services and LoyaltyOne. Card Services, which represents 80% of the company's total revenue, provides payment solutions supported by data and analytics and our digital capabilities. As Sanjay mentioned, we recently expanded the business with the acquisition of Bread in December, which further expanded our digital payment capabilities with buy now, pay later and installment lending. I will take -- I will talk more on our significant opportunities for Bread on a later slide. LoyaltyOne includes 2 businesses: the AIR MILES rewards program, a coalition loyalty program representing one of the largest, most recognized loyalty programs in Canada; and BrandLoyalty, which focuses on loyalty programs for grocery stores throughout the world. Each one of our businesses continues to adapt to the current environment and are performing well given the challenges of the past year. We remain focused on driving long-term sustainable shareholder value. Slide 5 highlights the recover, rebuild and regrow strategy and some of the major investments we made in 2020. Since I joined Alliance Data about 12 months ago, we have laid the foundation to position Alliance Data for sustainable, profitable, long-term growth. I'll provide a more in-depth review of our strategy during our investor conference in May; however, our acquisition of Bread is opening up new opportunities to leverage our digital offerings to capture incremental point-of-sale opportunities and build strategic technology platform partnerships. Bread's offering and integration capabilities enhance the growth prospects of our Card Services verticals and increase the addressable market of small to midsized merchants. At the same time, Bread offers our existing partners a broader digital product suite and additional white label solutions. With the transition of Card Services core processing to Fiserv, which began late last year, we will improve our brand partner conversions and our speed to market, including the ability to quickly and seamlessly add new products and capabilities that benefit our partners and our card members. The platform enables efficient integration and use of mobile wallets, virtual accounts, while supporting data and analytic capabilities and improving operational efficiencies. We'll also benefit from the reduction of capital expenditures, freeing up capital to invest in further growth initiatives. In 2020, we announced the launch of our Enhanced Digital Suite. This digital application helps our brand partners capitalize on the accelerated growth of e-commerce by attracting and bringing through more qualified applicants, a higher average purchase value and a higher credit sales conversion rate. The suite creates seamless process for shoppers to apply for, adapt and use our payment options. We are seeing improved year-over-year growth from our digital channels and would expect this trend to continue. Finally, we're pleased with the response to the launch of our new proprietary credit card, the Comenity Card. We launched this card in 2020, and we continue to see strong activation rates, engagement and cross-category shopping, especially among millennials. The Comenity Card allows services to -- our card member services to retain card member relationships and drive increased credit sales. These investments, together with our streamlined cost structure, position us for growth in the future. If you turn to Slide 6, I want to talk a bit about our international businesses. Our LoyaltyOne business continues to adapt and invest to be better positioned for the new environment. First, turning to AIR MILES. The team is seeing a gradual improvement in reward mile redemption as a result of the pivot of its rewards portfolio to emphasize more travel -- more nontravel merchandise. As travel opens up -- back up potentially in the latter part of the year, we see the opportunity for very strong growth driven by pent-up demand. BrandLoyalty expects revenue to improve in 2021 by the growth in Europe and the Asia Pacific regions as those economies recover. I'm excited about the prospects for both these businesses and remain committed to their success. On Slide 7, I want to shift to our Card Services business. As the economy improves, we continue to see a gradual improvement in both active program sales and total sales as we move into 2021. We would expect this trend to continue through the year as shoppers return to stores and online sales remain robust. The consumer remains strong and is driving the economic recovery. Tammy is going to talk about the strength of the consumer shortly. Slide 8 provides an overview of Bread's business models and revenue streams. Given all the interest in Bread, we wanted to show you how we're operating Bread as a division within our Card Services segment. Starting on the left in the direct acquisition model, Bread will continue to acquire small and medium-sized online partners, like the 60-plus partners they added in the fourth quarter of 2020. Bread provides a platform for these partners and will also provide the platform for Alliance Data's existing and new partners as they add to our digital capabilities. The receivables for all of these sales will sit on the Alliance Data's books. In the middle is a distribution model. Our strategic partner will acquire and own merchant relationships. Bread will provide the platform, and those receivables will also sit on Alliance Data's books. Alliance Data will provide the merchant acquirer with a small acquisition fee. The third model to the far right is a tech model offering. It is best represented by our recently announced strategic partnership with the Royal Bank of Canada. RBC leverages Bread's leading platform, and they acquire the merchant, they retain the AR, and Bread receives an ongoing transaction-based platform, servicing and marketing fee. We are tremendous -- we see tremendous opportunity in these 3 models to grow scalable, repeatable revenue streams. We are confident in our ability to more than double Bread's 2020 year-end AR of approximately $120 million. Given their existing strong pipeline of small and medium-sized merchants, the opportunity to soon add sales from Alliance Data's existing partners as well as adding new strategic distribution partnerships, we see this potential for exponential growth from this business. A key reason we acquired Bread was the versatility of Bread's leading technology platform. This platform can be deployed, leveraged in various ways and opens connections to new points of distribution to drive scalable growth across the entire network. To drive this growth, we are making material investments in the Bread platform. As we discussed on the fourth quarter earnings call, we are investing over $100 million in digital technology and analytics -- and data and analytics, with the majority going towards Bread. Page 9 outlines strategic areas we are focused and opportunistically investing in. With the acquisition of Bread and the move to Fiserv, we are leveraging technology to build a more efficient business model and evolving our product capabilities with digital advancement at the forefront. These initiatives and our key foundation elements will drive our company forward. One of our key foundational elements is proactive risk management, which is a strategic advantage for Alliance Data. I'm now going to turn it over to Tammy, and she will provide more color on our credit risk management philosophy. Tammy?

Great. Thank you, Ralph, and good morning, everyone. I will start on Slide 11 and speak to the current macroeconomic trends we are monitoring as it relates to the future of credit performance. As I look at where we stand now, credit performance across the industry has benefited from unprecedented government stimulus and aid. With that comes, certainly in the pandemic, lower discretionary spend, higher savings rates, and all of that really has led to a very strong payment environment. This was most recently evident in our January credit metrics, which included a favorable impact on the stimulus payments. Looking out for the remainder of the first quarter, we see additional tailwinds from the expansion or extension of the government aid around eviction protection as well as the potential for an additional stimulus plan. In the second quarter, we expect continued positive momentum from the vaccine rollout, which could stimulate continued spending growth. As we look at the last 30 days, certainly, there has been some momentum on the vaccine rollout. In addition, we started to see a reduction in daily COVID cases. We are also focused on the potential impact of the low tax withholding rates on unemployment benefits that were paid last year, certainly monitoring this to ensure there isn't any negative impact on the consumer payments as we head into tax season. While the second half of the year provides optimism for increased demand for goods and services which should stimulate economic growth, there are also plenty of unknowns that lead us to be more cautious with our outlook for the second half of this year. I'll spend a little bit more time on the outlook in a later slide. Moving to Slide 12, it highlights our lending philosophy around providing consumers with fair and responsible lending across a full spectrum while generating profitable returns for our shareholders. We have well-established risk appetite metrics. We leverage flexible technology, multiple scores and decades of consumer data to optimize our profitability. Alliance Data has a proven ability to identify the good consumers across the full spectrum of lending. This is a strategic advantage for us and our company. It maximizes sales opportunities responsibly, which is important to our brand partners while driving growth and profitability for Alliance Data. Our underwriting practices include a grow and expand approach to providing initial credit in which we reward card members with increased credit limits after we see strong positive payment trends. We have continued also to make improvements in our underwriting process. We have upgraded to the latest tri-bureau score, Vantage 4.0. This allows for better insights in stratifying the good versus the bad performers in near-prime credit segments. Our platform facilitates a cutting-edge machine learning methodologies and more sophisticated strategies across the full life cycle of our card [ order ]. We have also very complex data models that leverage internal, bureau and alternative data, both in our underwriting process and our account management process. All of these opportunities, they meet the needs of our brand partners and they maintain our -- helps us maintain our underwriting discipline while we're generating very strong returns for our shareholders. Moving to Slide 13. In addition to a strong lending philosophy, we also believe a well-balanced portfolio is key to both driving higher returns and long-term profitable growth. Our portfolio has shifted quite a bit into a larger portion of co-brand balances, which have stronger credit performance and sales figures, yet slightly lower returns than the soft goods private label cards. As co-brand grows, this gives us the opportunity to drive additional growth in our private label offering and leverage our deep underwriting expertise. This will result in strong returns and more stable credit performance for the company as a whole. While not included on this slide, we are very pleased with the Bread credit metrics. Their sophisticated underwriting approach has appropriately balanced the risk and returns for that business profile. As we share our insights and our data with the Bread team, we see an opportunity to expand their lending base and provide additional profitability. At the end of the year, approximately 86% of Bread's originations were above [ 6 60 ]. Now I'll close with loss guidance. Our near-term credit metrics continue to improve as a result of the proactive changes that we have implemented and the government stimulus. Given the more favorable losses in January and the continued improving delinquency rates, we expect the first quarter losses to come in below 6%, a slight improvement from the outlook we provided on the fourth quarter call. As I discussed earlier, we remain cautiously optimistic for the latter part of 2021 given the continued uncertainties in the economic recovery. Ultimately, for the full year, we believe that the loss rate will remain stable from 2020, and we will provide updates as we gain additional visibility into the second half of the year. We are looking for continued momentum in vaccinations to restore consumer confidence and bring back discretionary spend as well. Loss rate is impacted by both credit risk management, but also our accounts receivable balance growth, so both bottom line growth and prudent loss management are key drivers for us going forward. I appreciate the opportunity to share our differentiated lending philosophy with you today. We remain confident in the strength of our company and focused on driving long-term shareholder value. Sanjay, we're now ready for the fireside chat portion of this call.

Well, thank you, guys, for spending some time and giving us the update. A little positive on credit there. But maybe we start with Ralph. So Ralph, you've been at ADS for a little over a year now. Obviously, it's been a rollercoaster ride. And maybe you could just talk about what you've learned through the pandemic, how you think ADS is positioned today, what you're most excited about and the steps you're taking to make the company sort of what you want it to be in the future.

Sure. Well, Sanjay, I got to say, I like rollercoasters because it's a thrill. And this last year has been a thrill at ADS. I feel good about how we came out of 2020 for a number of reasons. One is you saw my slide recover, rebuild, regrow. We did recover. We put some bad news behind us. We strengthened our balance sheet. We focused on liquidity. We did all the things you needed to do. We cared for our employees, all the necessary things you needed to do to get through the pandemic. But we didn't stop there. We added talent to the organization, really good talent. Talent in digital, talent in general managership, talent in business development, so we added talent across the organization, and we merged that talent with existing good talent at ADS. So strengthened our talent pool, not just at the top but through the organization. And then we made strategic investments, the investment in Bread, the investment in Fiserv, the Enhanced Digital Suite, the investment in rolling out the Comenity Card were all really smart investments in my mind that the team made in 2020 to come out of the pandemic stronger than we went in. And I think that's important, so I feel good about that. As we -- and through all that, we trimmed our expense base. So if you think about our expense base in 2021, it's going to be flat to 2020, and that expense base includes $150 million of investment. So as we exited, we feel really good about where we are. We leaned in heavily on digital. We've seen some early success. We've invested in data and analytics, and that will pay dividends for us as we move forward. So as we ended 2021, I feel I've got the right team. We, for first time in the long term, we have a diversification of product, and we have a very different way to go-to-market than we had in the past. So all that tended to be -- that was a good -- as I look back at the pandemic, as bad as it was, I think we made some wise decisions in 2020 that will help us -- that will benefit us going forward.

Obviously, it seems like the stock is responding to some of the strategic moves you've made. But I guess as we think about the pandemic and the impact it's had on your consumers as well as your merchants, how have those behavioral changes affected how ADS will go-to-market in the future?

Well, I think the pandemic has done a number of things, right? So it really identified the weak. So those that were prior to the pandemic that were teetering on bankruptcy did indeed go into bankruptcy, so we saw that happen. Those that were -- and restructured themselves, so they may come out stronger. Some didn't survive, but some restructured themselves. So we saw that happen. And those that survived are restructuring, so we're working with them to make them even stronger as they come out of bankruptcy. Those that didn't make it through, because we have the Comenity Card, we're able to save those card members and still have them as part of the ADS family. So that was, to me, a positive thing. It also changed the way consumers transact. So we were heavily focused on bricks-and-mortar in the mall. Not a bad place to be, it's where traffic is, where people are. But during the pandemic, obviously, we saw people buy online, and online really go off the charts. So the investments we made and the changes we made in terms of increasing our online presence, our online capabilities were the right things to do as we went through the pandemic. I also want to emphasize that it's customer-facing and not just driving sales, but also servicing. So we did a lot of things to help drive -- better our servicing, more online servicing, which not only satisfies the customer, but also reduces our cost to serve. So we looked at it not only driving top line growth, but also driving bottom line growth in the things that we did as we came out of the pandemic. We have really good opportunity to do that. Lastly, we had the opportunity during the pandemic to really put some -- restructure some deals that we had that really were not advantageous as we went into the pandemic, whether they were vendor relationships, whether they were deals that we had struck and had high hope for that didn't materialize, in 2020, we were able to really put those behind us and kind of put some -- get the focus on the future instead of being focused on the future with having baggage. So those were all real -- as I think about how the consumer came out of it, how we came out of it and how our partners came out of it, out of 2020 into 2021.

And just staying on that thought and that -- in terms of the competitive backdrop, I mean, there's been some large relationships that have moved between issuers recently. I'm just curious when we think about your renewals over the next couple of years, how do you feel about the chances of renewing?

Listen, I think you've seen a number of portfolios move, so the competition is as fierce as I've ever seen it out there. It is pretty fierce, and the competition for receivable is pretty fierce. So if you look at our renewals, our renewals are spread out evenly over the next 5 to 7 years. So as we think about our renewals, they're out there for 5 to 7 years. And we purposely spread those renewals, so we're not -- in any year, we're not really hampered by any 1 large renewal as we move forward. In fact, if you look about our renewals, 40% of our renewals are between now and 2024 and 60% are after 2024. We do have a competitive situation coming up in the -- this year with one of our renewals for about $0.5 billion worth of ANR. We are -- we know the competition is fierce, so -- and we know we're going to do the right thing for our shareholders. It's not getting -- renewing at all costs because when you renew at all costs, you get all costs. And we're not going to renew just for the sake of renewing and have it be a negative impact on our shareholders, so we are contemplating a competitive situation with one of our partners. And we're contemplating potentially that loss of that partner. That said, if I was talking to you a year ago, it would have worried me a whole lot more than it worries me today. Don't get me wrong, I don't like losing a partner. I hate to lose. But if you think about the products and weapons now we have in our arsenal that we didn't have a year ago, the focus is to build AR, so not just losing it but rebuilding and building ANR. So if you think about Bread, if you think about our Comenity Card, if you think about our Enhanced Digital Suite which helps our customers purchase online and drive volume and drive acquisitions, you think about data and analytics for better targeting and better sales, all those things are designed to drive profitable growth, profitable ANR growth and profitable EBIT growth. So I don't like to lose a partner, but we're going to be competitive, but we're not going to overpay at our shareholders' expense. But it is a competitive marketplace.

And I guess was this loss sort of contemplated as we were -- as you guys were thinking about this year? Or is this a little bit of a surprise?

No, we always -- in our forecasting, responsible forecasting, we always contemplate a loss of a partner or a bankruptcy. In the business that we're in, you really have to do that, so we've contemplated -- it's scenario planning, for lack of a better term, so we've contemplated it.

And I guess when we think about the potential for this loss, is it a capabilities issue or is it an economic issue? And when we think about the economic issue, is it just that another party is willing to take a lower return? Or do they have a funding advantage, so to speak? I'm just trying to think through those ideas.

Yes. I mean, again, if you talked to me a year ago, I would have had to put capabilities as part of the potential loss. But today, we can compete with anybody. I've got products, I've got services, I've got digital, I'm not worried about the capabilities. At the end of the day, it comes down to relationship and price, right? So it comes down to price. And somebody else is willing to take a lesser return on a partner than I'm willing to take from a shareholder perspective.

Got it. And I guess maybe to bring Tim in the discussion because we've talked about sort of growing retail deposits, and Ralph, as you know, from your experience at Citi, I mean it's definitely a powerful advantage that a big bank has when they have the ability to bring in low-cost deposits. I mean is there a way to sort of strengthen that more? I know you guys were going to invest some of the tax rebate proceeds to building out a consumer bank. But like where are we with that?

So clearly, the consumer -- direct-to-consumer bank is up and running. About $2 billion of total liabilities there, we'll continue to grow that. We'll continue to maintain our other sources of funding as well because we want to have a diverse source of funds, but we are active, and that should get to at least 1/3, if not more of our -- a part of our liability base over time. So clearly, it's up and running, and we'll optimize that. But of course, we want to maintain all of our sorts of funds for any type of contingency.

Sanjay, I think a couple of things on the deposits. So I think when we market deposits, we certainly market them to be competitive in the marketplace and, again, at the right price. So if you think about that consumer base we now have at the bank, that's ripe for cross-selling. That's a good base to cross-sell. They've got deposits with us, they trust us, and there's an opportunity to cross-sell and provide even more products to them as we move forward.

I mean you guys don't want to accelerate or make it bigger, like, I mean, is there a way to make it more than what it is today?

Sure, we can -- go ahead. I'm sorry, Ralph.

Yes. I'll start, and I'll hand it over to you. So there is, but you've got to look at your receivables growth, right? And what type of receivables you're growing and then what type of funding you need to satisfy that receivables growth and keep your margins. So there's always an opportunity to make it bigger. You want to make it bigger as you grow your receivables, so you could fund them appropriately. Tim, sorry.

Yes. So including -- yes, I'll go to the second one, Ralph. Clearly, there's an opportunity to grow that bigger. There is also the opportunity -- because it is a generally less expensive source of funds depending on where you are on that curve, everybody, of course, wants a short term, everything on the balance sheet on a decreasing declining interest rate environment, interest rates come back up again, they're going to applaud us for having some of the longer-term assets, whether they are term notes or they seek longer-dated CDs. So we're very prudent, obviously, in balancing that, but we will lean more heavily into that consumer deposit because it will be the least expensive form of funding, whether it's term or whether it's the money market accounts on behalf of the bank.

Got it. And if this loss occurs, it will be the portfolio as well unlike some of the previous losses before where it may not have been portfolio?

Yes, it may very well be. It very may well be the loss of the portfolio. But again, the ability to grow ANR in many different -- pull on different levers to grow ANR, we are expecting to mitigate that loss if it does happen.

Understood.

Yes. Sanjay, just to repeat what Ralph said before, so as we contemplated our guidance for getting out of the year, we considered losing a portfolio, we had identified a portfolio. So we started thinking about where we are at the end of the year, this is not going to move us off of where we were.

Got it. Perfect. I want to bring Tammy in the discussion because she had some good...