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

[Audio Gap] with Alliance Data Systems. My name is Bill Carcache. I cover the consumer finance space for Wolfe Research. And we're very excited today to be sitting down with Perry Beberman, the CFO of ADS. Perry has been in the CFO role at ADS for less than a year but has about 30 years of experience in the industry, including his time at Bank of America and MBNA before that. The format of our discussion today will be fireside chat, and we'll leave some time at the end for audience questions.

Perry, the investment community has had the opportunity to hear from you on the quarterly earnings calls as well as other conferences, but I thought it would be really interesting for us to start today's discussion by having you take us back to when you first joined ADS roughly 8 months ago and walk through how your focus has changed? And how have your priorities evolved over that time frame?

Thanks, Bill, and thanks for having me. Yes, it's been quite a journey over the first 8 months. The good news is coming into the role, they will lean on the 30 -- nearly 35 years of credit card experience from those 2 experiences you've mentioned. And this was really a -- it's a great situation to be in, jump right in, and we had the spin transaction, right. So we're getting -- if I'm getting to know the team, trying to get up to speed on things, we have just announced during the period while I was waiting to leave during the Garden lease that we were spinning off the Loyalty Ventures. So as soon as I joined, was put on point to run that to make sure we're optimizing the value for ADS and setting up Loyalty Ventures to be successful. So that was -- and that was really largely the strength in our balance sheet. That remains a focus for me going forward to make sure that we get our capital ratios up to where we need them to be around peer levels and bringing the experience of disciplined, profitable, responsible growth into the team. It's been well embraced. This place has been transforming over the past 2 years since Ralph Andretta joined and brought in Val Greer to lead as our Chief Commercial Officer. And she's brought definitely that mindset of grows -- our business development team is really strong and then building terrific momentum. And so when we look at this in terms of investing for growth, enhancing our customer value, driving cost -- lower cost to serve and ultimately, long-term shareholder value, the partnership with finance is working really well here. So I've been very pleased with the discipline that we have in place and how it's been embraced.

That's helpful. I want to ask you to comment on how you see the spending environment for the business, the physical point of sale and digital commerce are both very important to ADS. Where are we in terms of the consumers' willingness to return to the physical point of sale relative to pre-pandemic levels? And where do you see us normalizing versus, say, 2019?

Yes. So when I think about it, there's no question that during the pandemic, stores were closed and there was less people -- people to go out. And we almost saw a little microcosm of that. I'll say in the month of January when Omicron had spiked, there was a little bit less activity in store for 2 reasons. One, people were sick, so staying home for 10 days to cure, but also some workers weren't able to get in to sell as much. We heard that from some brand partners in the physical [indiscernible]. But again, in March, I mean, in February, there was a volume bounce back, the credit sales bounced back. And so far, in March, things are looking fine. So when I think about it, the mixture of digital is going to remain relevant, right? So you've got to have a relevant presence. So our brand partners have very strong digital sites to drive bond for those customers that get what they want. But [indiscernible] think about beauty, they go in, and they want to have [indiscernible] they want to go in and try a color and make sure it looks right and then they go buy. So some things happen in store, they want to try close on. So I think there's always going to be a place for a strong physical footprint for our merchants, and we want to be there for them and we want to be there for the digital purchases, and I think we're well positioned for that. And then one other thing, you think about shopping. Shopping is also very much of a social thing for a lot of people. And I joke with my wife [indiscernible] saying this, but to her, I look as a sport. She likes to go out and just browse around and go through in T.J. Maxx, Marshalls -- it's just -- it is an activity [indiscernible] go out and they socially go out with friends to do this. So I think there's always going to be a place for physical. And I think our partners recognize that.

Makes sense. This may be a question that's easier to answer in time, but do you think the private label marketplace will have permanently changed in any way because of the pandemic as we look back with the benefit of hindsight over time? And that's either from the perspective of the consumer or ADS in terms of impact to the execution of underwriting or marketing or any other aspect of the business?

Yes. I think about it, private label, and it's not a place where I had deep, deep experience from where I came from, but I'm incredibly impressed with the degree of engagement that the private label card has for our consumers. And again, if you think about full spectrum lending, a lot of the private label starts out with low lines, focused in store, then you can graduate them to more of a co-brand card and you can graduate come up and increase line as you do, too. But the big thing about private label is the deep sense of loyalty and the rewards the customer gets and the personalization. And that private label for the brand partner is vital because it keeps the customer in their brand ecosystem. And with that, it drives deeper loyalty. And for us, like I mentioned, we're able to give lower lines, we can underwrite deeper. And again, that enables more sales for the merchant partner. So in that regard, I think so long as the brand partners find value, which we know they do, private label will be around for a long haul. So that's the thing where I look at for us in terms of what the customers want and what the brand partners want. They want to make this experience more frictionless for the customer point of sale, whether it's in-store or online, and we're doing that through a digital enhancement.

Shifting gears, a little bit to credit. There's a lot of concern around headwinds from lower child tax credits, to end of student loan forbearance, rising gasoline prices and the geopolitical uncertainty. How would you characterize the health of the ADS consumer that you described? Are you seeing any evidence of negative credit migration at this point? And if not, if it's too early, how long do you think it will be before the consumer begins to feel sort of credit stress from, for example, these higher gasoline prices?

We break that in 2 parts because one thing is the wind down of the economic stimulus that I've been talking about for the past 6 months is we expected normalization to occur, right? And so if you go and now you look at our delinquency rates, you've seen some of that normalization. And that could be a good thing. While nobody likes higher losses with a little bit of normalization, you give a higher revolve rate, a little more sloppy pay. So some of that is healthy to a point, and that's important. And so what we're seeing around normalization is, I say, right on pace for where we thought it would be and that we are actually seeing internally a little bit better delinquency than what we had originally thought, losses coming a little better than what we had thought. So not a lot, but I mean things are tracking almost as we had expected because we weren't expecting big spike event and things are trending. So when I think about it from the aspects of the wind down of the stimulus that is happening as we thought now. You get into the geopolitical uncertainties and inflation, that's the new news from where we were. And how long does inflation last, right? Was it shorter term, longer term because that will put more pressure on the consumer overall? But that also means for a period of time, you'll have more credit seekers, people will have to revolve a little more balanced. And again, the thing to remember here is that this -- the stress that's here with the geopolitical is not resulting in driving up unemployment in the U.S. There's still over 10 million jobs open in the U.S. where we have a labor shortage. So anybody wants to work and get to work. And [indiscernible] people can work and they have income, largely speaking, they will pay their bills. And with wage growth that's occurring either from companies paying more or people jobs changing to go get more pay, it seems like this is manageable to a point. And that's where I think we're still optimistic that this thing will moderate evenly over time and not have a big spike event. But we're watching fuel prices. It clearly -- it forces customers to make trade-offs between going out to dinners and now having to buy groceries. So they have $100 less a month because they have to pay more fuel costs. I mean, that's real. And that's what responsible consumers will do is make choices of that nature. Now when it relates to our loss rate expectation, I mentioned that we're normalizing as expected. So one thing as people are looking at near term, we give a full year outlook that we'd be in the low to mid-5% range. And I would expect first quarter will be in the low end of the full year outlook and 2Q should be a little bit closer to the higher end of the outlook full year as delinquency that you saw in late 2021 pull through in the second quarter.

That's helpful. Following up on your comments around normalization. There seems to be a lot of focus on the credit normalization piece and the eventual headwinds that the industry is going to face when that inevitably occurs. But there seems to be a little bit less confidence it seems in payment rate normalization. Could you frame for us how you're thinking about the interplay between both credit and payment rate normalization? Do you worry that one will occur before the other? Or would you expect them to occur together?

Again, I think we said we don't -- I wish we had a crystal ball because it is the holy grail of questions for all credit card lenders. But I do think we -- there's an interplay as delinquency starts to come back up, payment rates naturally are coming back down. And there's an intersection as you get later out in the year where we -- we think we hit more of that normal steady-state launches into 2023. It is possible that inflation could get that -- accelerate that a little bit, but I don't see it being dramatically different.

Okay. If we were to focus in on the specific vintages, what kind of trends are you seeing across more recent vintages? And how does the performance compare with pre-pandemic performance?

Yes. So I think the way to think about the more recent vintages compared to pre-pandemic, the biggest shift for us has been on product mix. Our newer vintages have focused on more co-brand and proprietary. And I think as you look forward throughout this year into 2023, that's a stated goal of ours, right, to think about where we were pre-pandemic was almost 100% private label card and now trying to morph into a little bit, I'll say, broader mix in the portfolio between private label, co-brand, proprietary card, installment lending, a little bit of a split pay in there. So we'll get a little more diverse portfolio.

Taking a step back, sort of a bigger picture question. Can you help us understand how you assess the profitability of your customer acquisitions and how does that profitability that you're seeing today compared with history? Also curious, based on your comments at the beginning, whether you brought a sort of fresh perspective to assessing and measuring customer profitability? Or is it really just similar to how ADS has looked at it previously?

Yes. So one thing to think about is what is different at ADS than, I think, some other places is they truly underwrite for profit, meaning I've known this for as long as I've been in the industry, some of your best margins, best profit occur in that near prime space, but some companies have a risk framework where they're targeting a loss rate and not profit. So they'll steer away from that population. At ADS, the underwriting is very sophisticated and disciplined in their underwriting for profit. So in the near prime space, making sure that those they count cohort will be profitable and caring for a higher level of capital assigned to them. So the return on equity that you're assigning to that cohort pass the hurdle. And not only hurdle, they have to hurdle with 50% stress losses in that. So that's a good discipline. So I was very pleased with that. So the biggest change that's happening is to make sure the team has an appreciation for the diversification and product mix. Some products, some proprietary products we're going to go a little bit better credit quality may produce a little bit lower return. But you mix that in with the, I'll say, a little bit riskier course of portfolio that has higher returns, you can blend into something that we really like the balance in the portfolio. As it relates to financial -- disciplined financial decisions, on the side of investments and renewal is probably where I bring a lot to the table in terms of experience and working with the team to make sure they have a support as we're trying to get these things done through negotiations, where [indiscernible] try to be creative on some items. And the team has been, again, very receptive, and we're ending up some really positive results. And one of the things that finance professional, not every deal is a good deal. You try to tell folks that, hey, when you get to a situation where the answer is no, do not want to go any further that could be a really good decision for the company as much as it is for deals that you win. And that discipline is really important to drive long-term success. And we'll hear Ralph and I talk about with Val; we're not going to chase growth at any cost. You got no one to walk away.

Yes. That's really helpful. Your comments around the underwriting to a more stressful scenario. Does that give you comfort that the business would be able to sustain profitability even in a severe recession scenario?

That is clearly the goal, to make sure you're positioned for that. And that's also why you think about -- maybe probably talk about CECL reserves somewhere later in the conversation, we can jump around it. That's why you hold a little bit more of a cautious outlook in times like this to make sure that in a period of stress that you don't have to add a lot to your provisions because you already cared for that appropriately with proper underwriting that you can sustain the stress condition.

Would you consider the investments that you're making in technology modernization and digital advancement to be table stakes? Or would you expect a positive return on those? And would you be willing to adjust investment spending to the extent necessary to achieve positive operating leverage in 2022 sort of getting to that commitment to positive operating leverage question?

Yes. Let me start with the first part of last, which is absolutely -- we're committed to achieving positive operating leverage. But when I say that, if something happened to the point where we really weren't able to deliver and [indiscernible] was critical that we invested, there could be a period or a quarter where maybe we don't achieve positive operating leverage because the investment is too important for us not to make. But we are committed, and at this point, don't see a reason why we would not be able to deliver on positive operating leverage. And that should always be our goal. So we'll start with that. Now as it relates to the investments around tech modernization and digital advancement, those are a combination of, I'll say, table stakes to remain relevant to your partners, relevant to your customers. But without question, I expect a positive return. Those investments will unlock value in a number of ways. One, by -- I'll say, by moving from an internal card processing, moving that from old technology, moving it to Fiserv is giving us the ability to use different price points and things that will also enhance our revenue in addition to driving down our costs internally. So that will deliver a positive return over time for us. And then on the digital enhancements, you think about what that does for customer engagement, loyalty, enabling things for our brand partners that they're looking for, the data analytics that go behind that, coupled with then you are also driving down a -- you have lower cost to serve. So that has real tangible benefits. So these investments are a combination, I'll say, table stakes, but also expect to be able to see a positive ROI out of that.

Understood. That makes a lot of sense. If we could move to funding, ADS has done a good job of attracting retail deposits which are now up to about 18% of your total interest-bearing liabilities from just 6% in early 2020. How should we think about ADS' mix of retail deposits and other funding sources over time, including wholesale deposits, unsecured and secured borrowings. I guess -- will you eventually be primarily deposit-funded like your peers? And maybe you could frame a little bit for us how you think about getting there?

Yes. So we've already moved from about, as you mentioned, 6% of our direct-to-consumer deposit to 18%. At this point, we have a stated goal of trying to get to 50%. And if you think about our -- the growth that we're going to have in the portfolio, which we've said will be high single, low double digits, a lot of that growth -- most of that growth will be funded through direct-to-consumer retail deposits. That alone will start to shift our mix as we march towards that stated goal of 50% funding over time from direct-to-consumer deposits. And so we're looking to have a more diversified funding base, a little less reliance on wholesale deposits or brokered CDs where the regulators don't like that as much. There's more stickiness in the retail deposit space.

Next, I wanted to turn to capital. You obviously focus on CET1 at the regulated bank subsidiary level. But -- maybe if you could frame for us the extent to which you're also looking at it at the enterprise level. That seems like it may be a little bit different versus how ADS has looked at things in the past? And could we eventually see you migrate towards a bank holding company structure?

Yes. So to your question, we are definitely looking at the right structures for us. I mean, you can see already from the way we have put out our financials, it's -- we're trying to be more representative of the way a bank holding company would present so that the analysts and investors can have better comparability. We're working through our capital structure. At this time, we still got little ways to go to get up to the level, which we think is a minimum of 9% TCE/TA ratio. We'll obviously convert that into a total corporate CET1 ratio, so we have some more comparability. But that's something which we're working towards. And it will be not just a fixed number we're striving for with what the peers are doing, what's the regulatory environment and making sure that we're doing what's best in the interest of our company for the legal entity structure and that bank holding company view with a lot of considerations in there. But we're definitely working through that.

Understood. And to what extent, like if we're thinking about the buying constraint sort of being stressed impacts on capital under stress versus like rating agencies, do rating agencies come into the picture as well in terms of impacting how you think about capital?

Yes, it could, right? I mean, so that's the thing. It's when -- right now, I get that question a bit, hey, should you become a national bank, should you become a bank holding company? And the easy answer is, well, if we want to get smacked by the OCC right out of the gate for being undercapitalized, sure. But I think it's prudent first, let's get to the right amount of capital. And then we can go and look at getting rated. We can look at what banking structure works for us, but we've got some work to do, I'll say, to continue to transform this company and shore up the balance sheet, getting where we made a significant step forward at the time of spin. And every quarter, we're going to continue to make positive momentum on that. So it's just a matter of time and being patient to get there. So then we feel we could do -- we'll have a lot more optionality. But we have a plan in place. We've got work groups working through this to make sure that we're well positioned at the time we do -- make a decision on which way we want to go.

Yes, makes sense. Switching gears to -- there's been a lot of focus on the risk of late fees getting significantly reduced now that the CFPB has indicated that it's taken a closer look at what it is calling junk fees in its words. How much do late fees contribute to ADS' profitability? And if you could frame that for us? And how are you thinking about the risk that those will be reduced?

Yes. I do find it interesting that the CFPB is calling out late fees in their category of junk fees because they're the ones who regulate late fees, right, through the CARD Act, CFPB sets what that fee amount can be and should be and they evaluate it every year through the safe harbor fee process. And usually, it's going up about $1 a year and we comply with that. So I think that is curious that that's happened. So I don't know what would be required for the changed position on that. Obviously, we're monitoring it, and we'll evaluate the impact if it happens. When you do underwrite your prime, that is the late fee probability, I'll say, is contemplated in pricing. So where you think about -- and that's why it's included in interest income for us and a number of other peers, and we don't break that out. But if something were to happen, the one thing you think everybody has seen through CARD Act, banks will pivot, issuers will pivot. Issuers are not interested in producing lower returns on capital. So there will be actions taken and lots of things contemplated, whether it's revenue share agreements get impacted, whether different fees are introduced for annual fees. And I'm thinking back to the early days in card used to be annual fees and annual fees went away. Pricing used to be low, and you can reprice higher when [indiscernible] do that. So I think it's a matter of things will adjust if something were to happen on the late fee front. And that's just the way -- I would imagine you hear that from all the large issuers as well.

Yes. Yes, it's interesting because like there was a lot of focus on penalty-based pricing in the subprime space when the Card Act was introduced. And so you saw sort of a rejiggering of the model and a shift away from penalty-based pricing towards more of NII. And so it sounds like from your comments, you're suggesting to the extent that anything were to happen that the industry would sort of adjust to the point where probably the returns ultimately would not be significantly impacted.

That would be my expectation.

Yes. But it's a very interesting point that you make -- the CFPB is essentially granted a safe harbor. And they've sort of given that safe harbor has made issuers feel comfortable with establishing the late fees that are all in compliance with those levels. And so if they're going to change that now, they have the jurisdiction to change it. But they're basically going to have to establish a rationale or a thought process for why it was -- it's been allowed all along. And so why is that and how is that changing now? Is that...

It's been allowed for over a decade, right? And now on what basis is it no longer valid. So I'm not part of a -- I'm sure there's going to be a lot of folks having lots of discussions and [indiscernible] with the regulators as well. I can assure you is that we are incredibly compliant and that's how we approach everything, and we'll address this and have plans in place if it needs -- for some course corrections.

Yes. That makes a lot of sense. I wanted to go back to some of your earlier comments around the disclosures, Perry. I think we often get questions about differences in disclosures across the card issuers. We've already seen a lot of improvements in disclosures during your time at ADS, including the addition of metrics like risk-adjusted yields, which we hadn't historically seen from ADS, and you've also got rid of the concept of adjusted EBITDA. How focused are you on, I guess, ultimately, getting ADS to look more like its credit card issuing peers? And are there any other areas of enhanced disclosures that thinking about that you can share with us today?

Well, I appreciate the fact that you appreciate the improvement that we've made. The first time I picked up a set of financials from ADS [indiscernible] is like, well, what is adjusted core EBITDA and all these other things. So it was -- it's definitely different when there was more of a kind of commercial conglomerate type of reporting. So it was a big focus of mine and our company to improve the transparency into our financials for more comparability. And we are tech forward financial services company, but we're, I'll say, predominantly a bank first and want to make sure that the comparability is there for you guys to use the information, and I think it's been very well received to date. At this point, I feel very comfortable with where we're at, and we do not plan on major changes to those disclosures for some period of time.

Yes. The first time I heard EBITDA after funding costs or adjusted EBITDA after funding costs that took a little bit to sort of try to register that. Maybe shifting gears to sharing, economic sharing. ADS has not historically disclosed the impact of its economic sharing arrangements with its retail partners. First, can you remind us whether most of ADS' agreements involve sharing of revenues or profits? And is this something that you'd consider providing in the future?

So in the retail share agreements, they're all different. And that was true of where I've been before and certainly here is every partnership has a different construct. Some are -- it's a basis points on spend, credit sales. Some is on a percentage of revenue; some is on earnings before tax. Some is -- there's all different methods by which that is calculated, including some bonus points on new accounts open. So it's -- they're all different. So that's the one thing I would start with is they're all different and unique. And then within our [ RSA ] line is also interchanged. So you think about that as net of those -- the partner fees we pay loyalty fees. It's also for co-brand cards, the gross interchange left customer awards and less partner sharing with those partners. So there's a lot of moving parts there. But at this point, we do not plan to change our reporting and disclosure.

I guess, broadly speaking, there's a view for one of your competitors that discloses the [ RSA ] that there's an inverse relationship between [ NCOs ] and sharing and [indiscernible] less sharing and vice versa and that sort of tends to serve as a little bit of a natural hedge. Does that dynamic -- I know you mentioned that there's different drivers, but does that dynamic broadly hold inside of ADS' portfolios?

Yes. I think what they're talking about is when you have a full P&L share or risk-adjusted revenue share, there's a partial hedge in there, right? But it's a partial hedge, right? If we went down 5% of earnings because of that, okay, the partner share would go down that amount. So let's be cautious. I mean they're all -- like I already mentioned, all of our deals are different, some have a risk-adjusted revenue share or earnings, others don't. So there's a partial hedge in there, sure. But it's certainly not a one for one in any way.

Understood. Now we're approaching our last few minutes, if anyone wants to work in a question, please submit it through the system. If not, that's okay. I'll keep going here. I guess going back to credit a little bit. It sounds like its -- credit is fundamentally benign at this point based on what you're seeing. And maybe going back to your reserve rate comments earlier, how should we be thinking about the trajectory of your reserve rate given that there's still some pandemic-related uncertainty in like other moving parts. And in Q4, you guys have a seasonally higher mix of transactors. How does that impact the reserve rate? If you could frame that for us?

Sure. So one thing we -- before what's going on in Ukraine and the impacts then back here domestically. I was signaling a steady reserve rate throughout the year until more certainty emerges. And that -- when I said that, that was not including seasonal aspects of it. So I think your point is spot on, is that in the fourth quarter at the end of period balances, you had a lot more transactors in there. And so when you move in the first quarter when those transactors roll off, you would expect a higher reserve rate for seasonality. And then throughout the year, that would come down, all else being equal as those transactors come back in later in the year in the fourth quarter. Our outlook was trying to under -- what we had a little bit of, I'll say, a conservative outlook was in that we were unsure what the economic stimulus wind-down would look like to our population. So we're still monitoring that. And everything there looks like, okay, it's going okay. It's going as expected. Still not to the other side of it yet. Now with Ukraine that does introduce that inflation risk that we've talked about and something that we are really watchful for. And does it create any additional strain at some point, again, to a point, more borrowing, more credit seekers, more line utilization, more evolved. It can be good. Again, it's a matter of -- but now it's something else that you have to, I'll say, be cautious of as you look at the different, I'll say, [ Moody ] outlooks, right, probably all seeing different ranges of possible outcomes. So it's something we need to contemplate as we set our reserve rate for the quarter.

Right. So it sounds like seasonally there, you would expect a little bit of an uptick given that transactor dynamic. But then would there -- beyond that, would there be further upward pressure? Or does it hold -- we'll have to see?

I think we have to see, but I would say that if there's an outlook of sustained high inflation, one might think that things are going to have to hold at an elevated -- more elevated level for a little bit a time to be prudent and cautious. And that's not a bad thing. It's just -- it is what it is because you want to be [ cautious through ] this. And again, with us growing at the pace that we are in will be one of the fastest growing credit card companies out [indiscernible] tax with it. And so when you strip out the CECL reserve, if you really look at our core earnings, we're going to produce those -- the core ROEs in the mid- to high 20s. And the easiest way to see it is just pull out that CECL growth tax as we call it, and that give everybody a really good understanding of the type of returns we're delivering. And if you normalize the capital ratio in that to 9% for a sense of what those ROEs look like, that's a measure which I'd like to look at that. But in terms of the CECL reserve, it's going to move around in there. Again, we're continuing to evolve our modeling, both in terms of methodology, the segmentation, the economic input. So all this combined, I can't give you the final answer yet because we've got to do the work still as we march through this quarter and then taken the latest economic outlooks.

That's super helpful. Unfortunately, with that, it looks like we're out of time. But Perry, this has been super helpful. We sincerely appreciate the opportunity to sit down with you. It's been very informative and look forward to continuing the discussion with you guys.

Well, Bill, thanks for the time. Thanks, everyone...

Thanks, everyone.