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

Good afternoon, everyone. My name is Jeff Adelson here with the Morgan Stanley research team. Just going to read a really quick disclosure, and then we'll get started. Four important disclosures, please see Morgan Stanley research disclosure website at www.morganstanley.com for its last research disclosures. If you have any questions, please reach out to your Morgan Stanley sales representative. With that, good afternoon. Very happy to welcome to our conference in person. Bread Financial CEO, Ralph Andretta, CFO; Perry Beberman; and Val Greer, Chief Commercial Officer. Really appreciate you all coming in person to our conference this time.

Thank you for having us.

Sure. So let's get right into it. You put out some slides this morning. Maybe we could just talk about the 2Q update you put out there. It looks like you're talking about some credit, the 90 basis points impact charge-off you're seeing. Can you maybe just kind of dive in what you're seeing there?

Sure. I think to summarize, we had double-digit sales growth. Our receivables, both end of period and average are 12% period-over-period. So very excited about that. The 12% -- I'm sorry, the 90 basis points in our net loss rate for May is a result of a settlement of litigation. We bought back some old receivables from a third party. So it's not going to impact our -- it's not going to impact our loss rate going forward to going to change our guidance going forward. So that was 90 basis points in the net loss rate in May. We are very close to our execution of the Fiserv transformation with technology. So we should have that done by the end of the month. And if you noticed in the pages we sent out, there was a couple of pages in there one particularly I really like on our resiliency through a recession. So we -- certainly, I'll throw it to Perry, if you will lead explanation to that. But it's a really good page about how resilient we would be through a moderate recession and a severe recession. But all -- very positive book.

So that portfolio, which is an old portfolio that...

It's not the portfolio. Basically, we sold written off receivables to a third party through litigation, we were buying those receivables back. It's not a portfolio. It's not a particular portfolio. It is a combination of old receivables.

And that's out of the numbers now once. Okay. Got you. So what about the spending? You talked about the double-digit growth you're seeing this quarter. I think you were growing at 40% last quarter. Is that kind of stable, a little bit slower? And then what are you seeing under the hood? Are there certain categories that are faster or slower are our consumers rotating in and out of categories as they see higher inflation?

I'm going to ask Val to answer that.

Yes, sure. Yes, no worries. So, yes. I was sliding back a little bit here. So I think we continue to see a pretty healthy consumer out there. We see good engagement in both discretionary and non-discretionary spend at categories like grocery, pharmacy has remained strong. Retail, where people have started to come back more like a hybrid work environment, we see people come out and shop in retail, same with beauty. We have seen a little bit of a pullback in the number of gas trips. So as the gas price has gone up at the pumps, the sales are there, but the trips have slowed down a little bit. And then same with T&E. We've seen that just over the last couple of weeks or so start to really kind of pull back just a little bit. But overall, the consumer remains pretty healthy.

Got it. And then just one other housekeeping one on the out of the way before we get into it. You had the Spinco out there for a while now. You put out that 10b5-1 plan talking about selling that down. We've all seen the share price there, what it's done. Can you talk about what kind of financial impact that might have for you? What your plans are for that monetization strategy you talked about?

Yes, certainly, a lot has changed in their valuation since the initial spin. And to your point, we had it on the books at $50 million. In one of our more recent releases, we had to take down as we have our 19% share when they took a goodwill impairment, we took about $12 million of that. So that wrote down the -- what was on the books at the time from $50 million to $38 million, which implies about a $8 call it, $0.10 share. So anything below that, whatever the price is we get to the end of the quarter, we'll mark it down to the appropriate level. I won't say it's not going to be a material impact, but it kind of is what it is in terms of where they're trending right now. And as it relates to our 10b5-1 as you probably know, there was a price in there that had a floor at the time we executed it. So my expectation is that that's going to need to be revisited in another open window period to taking a look at what we do. But strategically, we're not speculative on the stock. So our view is monetize it as we had intended to, as we don't expect to be a long-term holder. It's not -- that's not our strategy.

Got it. Now that we got those out of the way, maybe Ralph, we could ship back into [indiscernible] one for you. Just wanted to talk about your recent rebranding efforts. I think it fits nicely with the broader efforts you've made as a company to diversify reorient the strategy despite all these efforts, I still think there's a cohort of investors out there that still associate you with the old ADS mall-based retail lender. Can you talk a little bit about the evolution of the company, what you think people might be missing today in the story?

Yes. So we -- it's not just a name change. It's a mindset change for us. And I think with the missing what I hope they're not missing is a couple of things. One is we are way different company than we were 3 years ago. 3 years ago, we were a one-trick pony. We were a private label company. That's where we were. That's what we did. We didn't really lean in heavily into digital, and it was a legacy leadership team. If you look at it now, we are -- have diversified our portfolio, our product set. So we have private label, which will always be a good part of our business. We have direct-to-consumer credit cards, but we just launched the American Express 2% cash back card. We have the Comenity Card. That Comenity Card has 1 million customers in it. So really well -- it's been really picked up by the marketplace. We have buy now, pay later, pay-in-four, and we have installment loans, so we have direct-to-consumer deposits. So we are a different company than we were just less than 3 years ago, and we have a robust co-brand portfolio now as well. That has diversified our portfolio. We've leaned in heavily into digital. We've made significant investment in digital, and Val will probably talk about that a little bit. And we have revamped our leadership team. So the leadership team you see here has got 100 years of lending experience. I say I have the most. I won't display any ages. I'll take the most. But it's a team that our industry veterans. And not just at the senior level, but everyone that came has a followership. So they bought people. So the team is focused and knows how to lend, knows had to collect, knows how to underwrite. And so we're, again, a different organization than we were just a short 3 years ago. Our balance sheet is stronger with the -- you mentioned the spin and the sale of the company. So we've got a balance sheet now that is -- that's gaining strength, but more transparent with our investors. We're a little -- I think we're opaque in the past were more transparent now. And we are not overpromising and underdelivering. We're telling you what we're going to do, and we're hitting our marks. And I think that's the type of company we're building.

And as part of that diversification, you recently launched the Amex 2% cash back card, really interesting strategy. I know you've had some success with the co-brand maybe shifting a little bit more on the front foot there trying to get new customers in the door outside of when a retailer goes under. But what has that been like? What are the customers coming in the door like compared to the existing book? How is the uptake going on the product right now?

So I will -- so full disclosure, I'm an American Express veteran. So I really like the product. But -- and it's American Express's strategy is to be more inclusive. And we're an opportunity for them to be more inclusive in terms of underwriting. In terms of performance, I'm going to ask Val to talk about performance of the card.

Sure. So we've been very targeted on the product. I think for those of you that might not have seen the product launch, it is a 2% cash back across all categories. There's no annual fee, there's no foreign exchange fee that fully leverages all of the Amex benefits, both on the protection, the ID, the travel, you can buy lounge passes through Amex through their resi program. You can get dining reservations, you get 10% off or free appetizer. So it is a very high value product. And what we're really doing is targeting a little bit more around the millennials, the Gen-Zs, entry level where that type of product, typically you would see consumers much more on the affluent scale coming in. For us, it's been important to kind of democratize and bring it in much more in the middle market. And so we have been very targeted. We've got about 30%, 35% of new accounts are coming in the Gen-Z and millennial segment, which is where we wanted to see them. We have large swaths coming in, in the middle segment as well. The average credit line is running about 6,000. So a nice healthy balance between those more on the affluent side and those on the targeted side.

And that will be something that over time is a little bit lower loss, maybe a little bit lower yielding at the same time, but...

Exactly. And the other piece I would highlight there is when Ralph talked about the investments we've made in technology, in digital and in mobile, on that new cash back card, you can go from application to approval to downloading it in your digital wallet to actually transacting with it at a point of sale in about 30 seconds. And so those types of experiences are really important as we look to grow our share of market.

Early days, but I can tell you at least 4 cards in that portfolio are very active. My family.

I'll have to look into that one. It sounds like it's working well. 2% cash back is nothing to bet your eye at. Maybe just Val piggybacking off those comments on tech, how are retailers responding your existing new prospective ones responding to your tech changes, the enablement and convenience that you've driven in recent years? And maybe as part of that follow-up what percent of your retailers in the book today do you -- are you finding or now like engaging in an omnichannel fashion, maybe with the BNPL or multiple products as opposed to just one private label credit card?

Yes. So I think coming through the pandemic omnichannel had a whole new meaning, right, before omnichannel with kind of e-commerce digital and it was a physical store. Coming through the pandemic, the adoption around all things mobile really accelerated. So omnichannel is very much around, you can start your shopping journey on your laptop at home. You can go into a physical store. You can touch and feel the fabrics and really under some of their life, you can use your mobile phone to then scan a QR code, get an application, get approved and check out at POS. So today, omnichannel is very important to our merchants and being able to start and stop and intervene anywhere in that shopping journey across any channel. And so our investments in technology were a really important piece of that as well as in data and analytics. So we introduced what we call a unified Software Development Kit. So our merchants today, when they integrate into that SDK, it's one integration, and they can access all of our product suite. So they can pull down on co-brand, private label, installment lending, let pay all through one integration. And then the data and analytics that we've been investing in sits behind the engine that uses information from multi-tender loyalty programs from checkout information, to then determine what the most relevant offering might be. That's resonated very well with our merchants, and it's using that data and technology to streamline the customer experience.

And are you finding the BMPL piece is an important part of that conversation? Or do you think that maybe that's fading to the waste side a little bit?

So the buy now, pay later is an important part of the conversation. So the more choice that you provide, the better top of funnel conversion rate that you're going to have, not all products appeal to all consumers. And what we find is, particularly on the buy now, pay later space, many of the Gen-Zs and millennials do look for more of a cash and a budget management payment tool as their entry into the credit landscape. They then look to transition and are looking for rewards and move into and graduate into some of the stickier products long-term. So while not all merchants choose to pull down on all of them, they have access to all of them and those that do have access to see that higher top of funnel conversion.

Got you. And then just maybe sticking with buy now, pay later a little bit while we're on the topic. What are you guys seeing in your conversations with retailers are. We've heard some commentary from others that you're seeing discount rates come down. You've seen Apple Pay announced that they're coming out there with the product. What's your kind of view of the space? What have you seen?

Yes. I think over the last couple of years, we saw we saw a pretty rapid rise in the buy now, pay later parties. We saw valuations go sky high. And those valuations many times were based on growing sales volume. And so there was a lot of irrational economics being placed out there to get that top line growth, and they weren't necessarily looking at unit economics or profitability. What we've seen now is that has come around where, in fact, profitability is important. You know the economics are important. So you have started to see some moderation in that merchant discount fee. So meaning those fee that starts to rise to reflect more of that profitability. I think Apple, of course, is Apple. It will be interesting to see what they do. At this point, we don't know everything about that product, in particular, what we don't know is the merchant discount rate that they will charge. What we do know, of course, Apple always charges a premium. And so I think they will certainly charge their fair share for that type of product offering.

Got you. That's helpful. Maybe just Perry give you a little bit more airtime here. Everyone...

He appreciates that.

That was good. I was really enjoying this.

So everyone is focused on credit today. There's a lot of recession fears out there. Maybe you could help us understand what you're seeing in your book. You put out the number today. It still seems like you're seeing pretty stable delinquencies. Your outlook is pretty stable. Is there anything under the hood, maybe by cohort, by spend category that gives you pause? Or is it...

Well, I think not to give us pause to say, hey, tap the breaks and stop underwriting. But to your point, we're monitoring at a very granular segment level by product, by risk score, by behavior type, by vertical. So we've got an in-depth set of analytics, and we're looking at all those parts. You see some softness in a couple of spots. And when you see that, you do some line increase strategies or you slow down, what line increases might look like, you may underwrite a little less, but nothing that's material. So you're still playing surgically on the fringes. And -- but that's -- we call it dynamic underwriting rate. You do that just as a normal course of business. For 25 years, we've been doing this. But the tools are getting better, we're watchful, but we're not seeing weakness across the board and the consumer. Payment rates remain elevated above what we had expected them to be at this point in the normalization cycle. Delinquencies are actually better than what we had expected at this point normalization. So -- and when I say normalization, that was the effects of stimulus wearing down and consumers returning to normal payment behavior. So there's nothing that we're seeing as overly concerning other than being incredibly watchful of the environment of rising interest rates. And as we've talked previously, a rise in interest rates for the credit card product does not affect, say, the private label customer has about a $400 average balance if it goes up 400 basis points, you can do the math on what that means over the course of the year. That's not going to trigger them into financial crisis. So we always think about the biggest concern is when they don't have the ability to pay. And grants there's a topside part of it, which is things cost more, but they can make trade-offs around what they want to spend on. It's really employment. And today, we have a really robust employment environment, where there's more jobs out there that still people are having a hard time filling in the service industry, which is one of the big places that you think we would underwrite. So it's something we feel really good about. I mean again, watchful, concerned as others are in terms of what this might mean, but we're not seeing stress fractures within the portfolio right now.

And I thought you put out a really interesting slide today, which highlighted your buffer in the reserve against some of these periods of losses you've had in the past. You talked about this 5.5% to 6% loss rate you're looking for the long-term, when you've had these recessionary-type levels of 7.5% to 8%, 9% to 9.5%. Can you talk about how you built the reserve today and maybe how the reserve would respond in the future should losses start to rise? In prior periods, we saw pretty sharp increases in the reserve, but now you've got CECL in place. So just help us understand the dynamic there.

No, I appreciate you mentioned that slide. That was exactly the point so hey, there's more resilience built into our company and business than ever before. And some of it is just educating folks around it. These are the types of spreads that PPNR spread that we have to cover losses. And we're not modeling sharing what the models might say different outcomes could be we're taking real actuals and say, hey, we're still resilient in terms of profit even with those incredibly elevated periods of loss. And our expectation is because the book we have today is a better credit risk profile, improved product mix that we expect the portfolio to perform better even if they were like conditions to what either of those 2 scenarios were. And then we have the additional buffer where I'll say the CECL reserve is almost double what they would have been in past pre-recession. So again, more of a buffer to absorb losses. And at the same time, our TCE to TA ratio is near 8%. And so that's a capital buffer that in past periods, they had negative. This company had negative TCE to TA. So we feel good about that. And then specific to your question around CECL we've got another model out there that new generation. And that point, there's because we've been cautious and we're 10.8%, I can foresee it going up a little bit, but I don't see points where you're going to see a 500 basis point jump like you might have seen some big increases in the past when the reserve levels were very low because we're already caring for the life of loan losses in the portfolio. So we'll refresh it every quarter, get different economic outlooks that come in. But we are, from our own conservative modeling because again, when we talked about this at the earnings call last time, we saw what was happening. We did not believe that the Moody's forecast, we're picking up enough of what those -- the outlook was and concern. So we tilted a little heavier into some of the more severe recession just to be conservative in rate. So I think there's going to be an opportunity for us to pull back some of that as it starts to pull through in baseline views.

Got you. I just want to take a minute and see if anyone has any questions in the audience before we continue. Not, I can continue. So just on the pipeline, Val, so we've heard a lot from you and the team and your success at building the pipeline. We've already seen a number of wins come through B&H, TBC, you've got the NFO now. Is there anything else in the pipeline you're even more excited about? What kind of retailers are you going after? What types of conversations are you having?

Yes. So we do have a very robust pipeline. And I think for us, there is some criteria that makes a partner, a really good partner at the table. And I would say, not just retailer, but if you think about the NFL and others, it's about the brand, and it's also about are they coming to partner with you? So it takes work from both sides to really grow and make a program successful. So some of our partners, we have tender share with them 30%, 40%, 50% of their tender share. So very, very sizable and meaningful. So we look for that type of joint and mutual alignment as we move forward with our partners. I think this year, we'll bring on about $2 billion in incremental AR through our partnerships. Some of them we announced, as you mentioned, Harley, TBC, B&A, rue21 and Michaels. We have another partner that will come on in the back part of this year. It is a portfolio conversion. And so that will also be part and parcel of that $2 billion that we'll bring on this year. A lot of these opportunities are between 5- and 10-year agreement. So as you can imagine, the sales cycle on those opportunities is pretty long. When we're able to talk about the one that comes on in the back part of this year, that will be about 2.5 years that we've been engaged with that particular partner before it becomes publicly known. And so very long sales cycle. So when we say we feel good about our pipeline, we have visibility for a period of time into what that pipeline is looking.

Is that 5% to 10% inclusive of that kind of 2.5-year lead up for...

No. No, that 5% and 10% is from the time that you've launched. So these are very long-term tenure type partnership.

And have you found that expand? I think we've heard anywhere from like 3 to 7 years, some go to 10, but it seems like that's maybe a little bit longer than we typically hear about.

No. I would say 3 is more typical of when we talked about some of the new products under the BNPL space. Many of those started off as 1- and 2-year type agreement. Those you might see more on the shorter end. But as you talk about some of the stickier products and those tend to be between the 5 and the 10.

Jeff, under the Val's leadership, we rebuilt our business development team. And it's paying tremendous dividends. 2020 -- 2021 was the best year ADS now Bread Financial has ever had in terms of renewals and new signings. We went [ 20 in 1 ]. So not even the patriots did that. And it's not just -- it's the renewals really are -- really helped drive our business. In fact, 90% if our receivables are renewed between 2023 and correct me if I'm wrong, 75% of our receivables are renewed between to 2025.

Into 2025.

In 2025. So that's good quality repeatable earnings for the next few quarters.

It's a sort of subject you're bringing up. You don't have to...

I'm [indiscernible] my heart all over again.

You must be happy about that.

Yes. Thrilled.

Well, maybe we could switch over to just expenses. So you've talked about this incremental $125 million you're putting out there for tech modernization, marketing. You're still targeting positive operating leverage. Where are you finding you're having to invest the most? What are you prioritizing? And where are you perhaps seeing a little bit more bleed or impact from inflation coming through right now?

I start, Perry, and I'll turn it over to you. So I think we've leaned in heavily on digital investment, and we'll continue to do that. If you don't invest in digital, that's table stakes today, and people will leave you. I think that's critically important. We have a -- leaning in on our proprietary products. So the American Express product, the new branding, we're leaning in there as well pretty heavily. And wages as -- like everybody else, where we've seen an influx in wages, and we see that, and we're focused on that. But all said, we have -- we've committed to positive operating margin, and we don't see that as being an issue.

Yes. I think when you think about going forward, what I'm excited about is the opportunity that we've built a baseline of marketing investment into this year through the rebrand and leaning in on proprietary card and leaning in on going deeper with some of our brand partners. And then say that about 1/3 and then 2/3 as Ralph talked about, was the digital transformation and...

[indiscernible] intense over here.

The platform modernization with Fiserv. So again, my expectation is going forward, revenues will continue to grow. We'll continue to get cost to serve efficiencies. So a big part of our data analytics investment that's in that will drive lower cost to serve that allow for further reinvestment. And in more capabilities and hopefully increasing marketing again in every subsequent period.

I don't know, Perry will like this, too. It's like -- and if we don't see the growth in revenue, we've got levers to pull back, right? So we're very focused on we're timing our investments, the pace of our investments. When we lean in, when we lean out if we don't see those investments returned and so forth.

And where would you pull back if you needed to, you think?

The easiest place to pull back, and it's not always my favorite is marketing because that's very quickly, right? But you would look -- we would look at our technology investments and saying, what is critical for us to be competitive in the marketplace and what isn't? But we will look across the board. I'm a big believer in investing in marketing. It's important. And that's an easy knee-jerk reaction to pull back on marketing. And that we would look across the board. One of the things we've done in the organization is we have outsourced our non-core processes. So if you think about when we walked into this company, we had a remittance center. We were running a printing plan. We were doing all those things. that for a financial services company doesn't make sense. So we've kind of shed that overhead in the past and kind of rethought our footprint around. And so we're leaner than we used to be. And with the -- with the Fiserv conversion does 3 things for us. One, it's going to lower our costs, not by a dramatic amount, but it's going to lower our costs. Second, it gives us great new capabilities. We had a legacy system that we've got new capabilities around co-brand, around pricing that will utilize help drive -- to drive revenue. And third, if there's a rewrite of [indiscernible] off a bid, we're not doing it, we're a participant in that. And that's -- so we're leading with Fiserv, They'll be responsible for that. So we thought about where our areas that businesses that we need, that we shouldn't be in that we should just dramatically reduce our cost base around that.

And one of the things which I am very pleased with is over time, the company has migrated to a bit more of a called a hybrid model, where in technology and in operations. they partner with, I'll say, contractors or outsourcing some activity such that you can flex that up and down as the business grows rapidly, you can -- you have that they can scale quickly. And if it contracts in a spot, you can pull back. So that's another part of our flexible staffing model.

And how does maybe an investment in the cloud or data analytics? Is that something you've been engaging in more lately? Or just help maybe investors understand how that's been going?

Val, do you want to take that?

Yes. I mean data and analytics underpins so much of what we do, whether it's on the front end with marketing, whether it's on underwriting servicing. So data and analytics has been a big investment for us. We have more than 300 models today that are on machine learning. So we've implemented that over the last 2.5 years. Artificial intelligence is very big in the models as well. All of our data and analytics actually are in the cloud. So that is a big part of where we house the machinery to run the data and analytics so that we don't have any capacity constraints in terms of how much analytics we run when we run. So yes, it will continue to be a big part of our -- when we think about our technical infrastructure, that is part of it that supports on the data and analytics side.

And artificial intelligence machine learning, have made our reps smarter and better at what they do. So just to give you kind of an example. We use artificial intelligence for skip tracing, looking for phone numbers to -- for collections. Now that's all done by machine learning now. So our reps are focused on what they need to be focused on, which is collections and ensuring that we're doing the right things by our customers. So we've done a lot of things. So even right across the patch not just an acquisition or spend, but end-to-end, we've used data and analytics for the organization.

Yes. And it might not sound very sexy, but things like bots, we'll use to scan all of our partner marketing materials that are out on the web or in the app or through mobile, so that we're always compliant. So we use them pretty much across the board.

Got you. And then just maybe on NIM. You guys have not really been presenting as a bank holding company for a long time now. So I think we're all still adjusting our models to the new disclosures. But you're in an interesting place now, deposit beta is a hot topic right now, but you're trying to grow your deposit base more than others are at this point. So typically, card lenders have been a little bit more liability-sensitive in rising rate cycles. Why should you perhaps not be so much liability-sensitive at this point?

Yes. So when you think about it -- if I was guiding NIM, I'd say it should be around 19% is for the rest of the year to get out for a full year basis. We're 70% variable price loans. And with a big part of our, I'll say, funding is almost equally variable. So as we're cycling through growth, you think our growth is going to be if it's double digits. We're going to grow deposits to fund that growth direct-to-consumer. And then as we're winding down other funding mechanisms like brokered CDs, that gets replaced with direct-to-consumer. So the consumer side on the assets for the credit cards are priced to prime. So they'll go up as the Fed raises and the big banks raise prime, those customers start paying the higher rate the next day after last day of the month. So that goes up. And then so we're fine with a pretty high beta because it reprices the deposit side that goes up with it. So we're trying to be basically neutral. And we are actually slightly accretive right now for the next, I'll say, 350 basis points of increases.

And is there any sort of timing we should be aware of on perhaps when the Fed funds actually rises after other market rates out there? Or...

It's -- when I tell you, we're marginally accretive, it's not material. So I don't think that's a concern.

That flies after me now. So maybe just to kind of wrap it up, Ralph, what are you guys most excited about over the next 1 to 2 years as a company with your strategic vision?

There's a page in there I'm most excited about. It's Page 6. It's our expanded product set. So our expanded product set that looks over Gen-X, Gen-Z, millennials, baby boomers, we have products for all and it's a graduation strategy. That's what makes me -- not the fly must be from Discover. That's what makes me very excited about the organization. I was showing you there's 2 charts in there. The chart that Perry talked about in terms of our resiliency through a recession, that lets me sleep at night. The chart about our product set and the 160 partners and 90% renewal rate, that's what gets us out of the bed in the morning because there's growth there and responsible growth. And I think I'm excited to demonstrate to our investors that it's consistent, responsible repeatable growth. And that's what we're going to deliver to the marketplace. And also, I'll be -- I'll brag a little bit. I've got one of the best teams in the business. Industry veterans, we we've all worked in large banks, are working here, being able to make decisions quickly, put those decisions into action has been a revelation and a liberation for all of us. That's what I'm excited about. I definitely got a pinch moment going on, right?

It's a big fly. Well, I think we are actually just about out of time. So thank you, Ralph, Val, Perry, it's a pleasure to have you here in person and goodbye to this little fly.

Thank you, all.