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

Good morning. Thank you all for joining Barclays Global Financial Conference. I'm very happy to be joined on the stage today by -- from Bread Financial. Making -- I'm going to hand it off to Ralph and Bread...

Thank you, and welcome. Happy to throw out the first [ financial conference ] of the day. With me on stage is Perry Beberman, our CFO; Val Greer, our Chief Commercial Officer; Tammy McConnaughey. Tammy is our Credit Risk Officer and Operations Officer. So Perry, myself and Val will be -- have some prepared remarks. And then -- any questions about credit? So anyway, why don't we get started? If you look at Slide 2, we were excited to have rebranded our company, Bread Financial earlier this year. The rebrand reflects the company's transformation, tech forward financial company, providing simple, personalized payment, lending and savings solutions. After a multiyear corporate transformation, Bread Financial, we've emerged a more innovative, nimble and streamlined company backed by technology and a platform solution that empowers today's customers. We'll continue to build on our 30-year legacy of creating value for our brand partners. We'll continue to invest in data and analytics, innovative technology, digital capabilities, all of which will help our drive our company forward. Bread Financial brands associated with our core offerings, which includes our private label and co-brand offerings that we offer to our partners. The Bread Cashback brand is new for us and is used for our recently introduced direct-to-consumer 2% cashback American Express Card, and Val will talk about that a little later. Bread Pay represents the payment and lending offerings on our versatile fintech platform, which includes our buy now, pay later solutions. And finally, Bread Savings, brand reflects rebranding of our community direct to Bread Savings for offering high-yield savings accounts and certificates of deposit. Our new brand offering emphasizes our focus on delivering a full spectrum of innovative payment lending and savings solutions that consumers need at every stage of their financial journey. So if you really think about it, we've gone from a strictly private label to multi-products and multi-offerings for our customer base and direct-to-consumer. If you move to Slide 3, I'd like to highlight just a few milestones over the past 3 years. We started with the addition of industry veterans with extensive experience like Val and like Perry, and we're very happy to find Tammy, who's a 30-year veteran of Bread Financial, formerly [ ADS ] at the company. So a mixture of both -- of veterans in the industry, and people who have been at Bread for a very long time. And then we've spun off LoyaltyOne, which was important for us. We'll get to that in a second. And then we rebranded as Bread Financial. So new people, we've refreshed our Board, we spun off ancillary companies, and we rebranded ourselves, Bread Financial to really focus on financial services for consumers. We were able to learn and adopt through the pandemic. I joined Bread 3 weeks before the pandemic. So I had 3 good weeks before the pandemic hit. And during that pandemic, we made responsible strategic investments and improvements in our business while successfully navigating the challenges of that macroeconomic environment. And we'll continue to support -- we'll continue to do that for our future success. From a capabilities perspective, some of our key milestones include: establishing that Comenity Card to retain and grow balances; launching the enhanced digital suite, enabling digital capabilities for our Bread partners during the pandemic; we acquired the Bread Pay platform, adding additional products and technology talent to the organization; we formed a strategic relationship with RBC, Sezzle and Fiserv; we introduced the Bread 2% American Express Cashback Card, which we'll talk about pretty soon; and then most recently, we transitioned our core processing to Fiserv, and we upgraded our technology to the cloud. So we modernized our technology. All of these transitions come with a level of challenges, but we feel good about where we are. And the capabilities and enhancements were fundamental in positioning Bread Financial to be more effective and efficient. So we're pretty -- we're on our way. On Slide 4, I'm going to go a little deeper into our business transformation and the impact of our financials. We made great strides in simplifying our business model and most notably completing the spin-off of LoyaltyOne, which I talked about earlier, in the fourth quarter of last year. The spinoff did a number of things. It strengthened our balance sheet by improving our capital ratios and reducing our leverage ratio while enabling a sharper focus on our investments and our future plans. It also marked the culmination of a 3-year strategy designed by our Board to simplify and streamline our company. The outcome now is a much stronger, more focused business profile. We know what we want to do, and we're very focused on what we are doing. The development of our full suite of lending products allows us to further balance our portfolio mix and diversity of our brand partner base, and we'll talk a little bit about that later. This balance is a key component of our improved financial resilience that positions the company for repeatable, drivable sustainable growth period after period. Good quality earnings. We'll continue to strategically invest in our digital platform and our innovative products and marketing. In fact, in 2022, we'll invest $125 million in that -- in our digital marketing and technology platforms. And last, but not least, we've continued to refined our priorities for ESG. We have a Board -- it has Board level oversight. We have an outstanding Board of Directors that were aligned with in terms of our direction, our decision-making, and they're very supportive in -- with us making all these disciplined financial decisions in the best interest of our stakeholders. On the bottom of the slide, we outlined key guiding business principles, including strong corporate governance, proactive risk management, prudent balance sheet management, disciplined expense management and enhanced core capabilities. These five elements guide our strategic decision-making, and they make it -- and they're critical for us to maintain long-term value. From a microeconomic perspective, overall, the consumer remains strong. While inflation -- high inflation remains persistent and a probability of a recession has been increasing, the unemployment rate is low, and wage growth, particularly is trending upwards, especially in the lower income segments. We continuously monitor economic data and the financial health of our customers ongoing. And certainly happy to answer questions about that. And our seasoned leadership team, which you see here has extensive experience, successfully navigating full economic cycles, especially including the downturns, and we remain proactive in managing our risk as we move forward. Given the slight pressure we're seeing in our early delinquency stages, we continue to take action to reduce exposure in some areas. We'll be prudent proactive given the uncertainties in the economy, and we expect normalization in our credit and payment metrics to continue and are closely monitoring the impacts from higher inflation and the stress that it will have on our customers and consumers. We do remain confident in our outlook as we migrate back to expected credit and payment levels. To date, in the quarter, we continue to see good credit sales. Our growth is slightly slower earlier in the quarter with the spike in gas prices year-over-year, and that affected discretionary spend. As gas prices began falling, we've seen corresponding improvement in discretionary spend and consumer sentiment. We are closely watching how our consumers adapt to the new economic realities, including potentially borrowing more on their cards. We are seeing stronger growth in certain areas like our proprietary cards and our co-brand cards and key verticals, including beauty. Credit sales in other categories, including apparel, are a bit softer, and you can see that in the industry data. But overall, credit sales, we believe, likely won't continue to be robust as they were coming out of the pandemic, but we expect growth to continue as we gain wallet share, and we gain net new partners as we move forward. Given our current visibility, we expect year-over-year sales growth to be in the mid- to high single-digit ranges in the third quarter and double digits in the fourth quarter. If you move to Slide 6, and before I turn it over to Val, I just want to reiterate how pleased we are with the success of our business development team. And you can see some of the marquee names that we've been able to work with and sign over the last couple of years. Val has assembled an extraordinary business development team, industry experts and people highly respected in the industry. And her team has their finger on the pulse of the marketplace. And 2021 was a record year for signings and renewals for the team, and we're very excited about that. With that, I'm going to turn it over to Val to talk a little bit about business development and other issues. Thank you very much for coming. Looking forward to your questions. Val?

Thanks, Ralph, and thanks, everyone, for coming today. To give you some highlights of the great work accomplished by the team, earlier this year, we announced the early renewal of a long-term agreement with Ulta Beauty, a top millennial brand and one of our largest and fastest-growing brand partners. They have over 25,000 products and more than 1,300 stores and also sell through the Ulta app and ulta.com. The program is designed to enhance the benefit of Ulta's loyalty programs and increase engagement and spend among their more than 36 million loyalty members. Importantly, this renewal reinforced our industry-leading position in the beauty vertical, and was made possible by our demonstrated track record of growth, which was an important consideration for Ulta. Our breadth of lending products provides customer choice, increasing conversion rates, while also allowing Ulta to optimize the product mix for lifetime customer value. Also this year, we renewed our agreement with Victoria's Secret, which is our largest and longest tenured brand partner with nearly 1,400 stores and a Victoria's Secret app. As part of the renewal, we launched a new co-brand credit card, which complements the existing Victoria's Secret private label card, offering compelling rewards for purchases at Victoria's Secret as well as everyday purchases. This is a good example of our expanded product set, creating compelling new growth opportunities. We've also had success in signing new partners. Our most recently announced, a new long-term partnership with AAA, one of North America's largest and most trusted membership organization, serving more than 56 million U.S. members. Additionally, we reached a definitive agreement to acquire AAA's existing card portfolio, which is expected to be completed in the fourth quarter. As one of the largest full-service leisure travel organizations in North America, AAA provides a wide range of travel services and discounts as well as a variety of insurance products which further diversifies our portfolio. Through two unique co-brand card offerings with enhanced cardholder value proposition, we're excited to help AAA drive top-of-wallet usage, loyalty and growth. Along with AAA, we're also excited to welcome any other partners, including the NFL and its tens of millions of fans, I'm sure many of which were watching the games here last night, and their 32 affiliated club shots located at their stadium as well as welcoming Michaels and B&H Photo. We also just recently launched a new program with TBC Corporation which is the parent company of the brand's Midas, NTB, Tire Kingdom and Big O Tires. We continue to make investments in our Bread Pay platform based on three core pillars of growth. These pillars are built to drive overall asset diversification for our portfolio through direct integration with large members and SMB merchants like Nikon and Wayfair, distribution partnerships like Fiserv and Sezzle and platform partners like RBC looking to expand their product base. Through our diversified strategy, we have been able to grow our total merchant base by over 30% this year while also layering in incremental capabilities and enhancements and ensuring that our products, our bank -- are bank compliant. We look forward to working with our new and existing partners to drive incremental sales growth and customer loyalty through a very comprehensive product suite. While we continue to embrace our retail and private label heritage, we've expanded our verticals and product offerings to include both co-brand and proprietary cards, installment lending and savings products, which are highlighted on this slide. The continuous evolution and expansion of our products allow us to meet the needs of a wide variety of consumers in a way that increases conversion while allowing brands to manage the product mix and optimize profitability. Our unified front-end experience enables us to offer one of the widest payment product suites of any competitor with products that serve the entire generational spectrum. If we only offered one product as many of our competitors do, we would miss 40% of our customers' preferred payment method. Younger demographics value buy now, pay later, with millennials 2x as likely as Gen X-ers and 3x as likely as baby boomers to have used the BNPL service in the past 2 years. While BNPL is a product often sought by millennials, offering just a BNPL solution does not provide consumers the flexibility that they desire. Consumers want the ability to spread their purchases across different payment options, often based on the size of their baskets. When surveyed, 35% of Gen X and millennials prefer a BNPL for $100 purchase, but 65% selected another payment option. By having access to a rich product mix, consumers can grow with the brand by graduating into more mature product offerings over time based on their behaviors and their needs. Partnering with Bread Financial unlocks a graduation strategy that deepens customer engagement with the brand and benefits the merchants over the long run. Our analytics team can pull new cohorts of shoppers, identify purchase patterns and enable targeted acquisitions tactics for co-brand and private label products. This strategy has led to Bread Financial, putting a credit card into the wallet of 1 in 7 American adults, including 1 in 5 U.S. female adults. Unlike our competitors, we offer complete payment stack coverage, meaning a single-message strategy will be presented to consumers. We solve for the complexity of managing competing consumer propositions by offering a personalized intelligent and optimized messaging solution targeted to convert and grow shoppers with our partner brands. By having the full product suite and the supporting capabilities, we offer the right product to the right customer at the most relevant time. Our comprehensive product suite provides graduation and optimization strategies that increase the lifetime value of a customer for us and for our brand partners while helping to balance portfolio risk. Five years ago, we were predominantly focused -- if you turn to Slide 8. Five years ago, we were predominantly focused on specialty retail and department stores, with a particular strength in soft goods as a result of our heritage. We provided private label programs that were highly integrated into a retailer's loyalty program, offering consumers purchasing power and rewards. While these capabilities remain an important aspect of our business, the pandemic accelerated the shift to digital, and customers now have a new view and expectation for omnichannel delivery, service and the overall experience. To ensure we are not overly reliant on any one specific variable, whether it be a partner vertical, demographic segments or product type, we have purposely invested in product diversification over the past few years. Customers are looking for choice, ease and convenience. And we can now provide that choice of payment for consumers and our brand partners through our private label, co-brand, proprietary and Bread Pay offering. Our private label product boasts the highest revenue yield due to our ability to underwrite deeper given the lower credit lines. The addition of more co-brand balances to our portfolio has helped enhance our credit profile as the majority of cardholders have a VantageScore above 660. Further diversifying our portfolio, we now offer two proprietary cards, through our Comenity Card and our Bread Cashback American Express card, both of which help us capture incremental spend with no partner risk or sharing of economics. Finally, the addition of Bread Pay BNPL has increased our customer base as we've seen strong adoption with Gen Z and millennials. Moving to Slide 9. It provides additional views of our improving diversification across products and verticals. On the left side of the slide, you can see the balance between our private label and co-brand spend in the second quarter, with co-brand proprietary card and Bread Pay offerings now comprising over 50% of our sales. The right side of the slide illustrates our growing vertical diversification. We continue to expand to newer verticals and strengthen our share in verticals like health and beauty and travel and entertainment. You'll notice the specialty retail vertical now represents only 25% of overall sales as a result of our diversified growth. Transitioning to Slide 10, we successfully launched the Bread Cashback American Express Card in the spring of this year. The Bread Cashback card offers industry-leading [ assets ] and complements our existing suite of financial products as we continue to ensure our customers have access to robust solutions to serve their payment and saving needs at all stages of their financial lives. Cardholders receive unlimited 2% cashback, no annual fee, no foreign transaction fees and access to dining, travel and entertainment offers as well as comprehensive purchase identity and travel protection. In particular, this proprietary card provide additional opportunity to drive acquisition and growth with an appealing value proposition, especially within the millennial and Gen Z consumer base, while providing further product mix diversification for our overall portfolio. Our plans include increased marketing investment for the remainder of this year and into 2023 to drive profitable growth and adoption. Early indication on the launch has been positive with strong digital engagement and top-of-wallet behavior for Gen Z and millennials, including top 3 spend categories of everyday spend, grocery discount and dining. Now I'd like to turn it over to our CFO, Perry Beberman.

Thanks, Val. Starting on Slide 11, you'll see that average loan growth has inflected higher since the second quarter of 2021, driven by the post-pandemic economic rebound in credit sales, coupled with growth and deepening with our existing brand partners and our new business development success that which Ralph and Val highlighted. We expect loan growth to continue to accelerate in the third quarter with year-over-year growth between 13% and 14%. As Val mentioned, we expect to add the AAA portfolio in the fourth quarter, which will further increase our growth at year-end, well beyond the normal seasonal spike we see around the holidays. It is also important to note that the BJ's portfolio will exit in the first quarter of 2023. Moving to Slide 11, we'll highlight our funding strategy to support this loan growth. We are building on the momentum from our new brand launch with strong growth in our retail deposit balances through our Bread Savings offerings. From the second quarter of 2020, we have a compound annual growth rate of 58%, a $3.9 billion of average retail direct-to-consumer deposits over 2 years. As you can see from the chart on the right, our retail deposits represent 36% of our total deposits, up from 14% 2 years ago and were 21% of our total funding in the second quarter of 2022. We expect that our retail deposit base will continue to increase, becoming an even more meaningful portion of our funding strategy over time, further strengthening our positioning and profitability. As a further proof point in our continued success with growth in retail deposits, I'm pleased to announce that we surpassed $5 billion of balances in August and expect average deposits to approach $4.9 billion in the quarter, a $1 billion increase or 25% increase from the second quarter. Turning to Slide 13. With this strong balance sheet growth, it is important that we are growing responsibly. One metric that we follow closely to ensure that we are on track is pretax pre-provision earnings or PPNR. Our PPNR increased 24% year-over-year in the second quarter of 2022, marking the fifth consecutive quarter that we have seen year-over-year double-digit growth in PPNR. Our PPNR growth, along with our proactive risk management, position us to drive sustainable profitable growth. As I noted on the last earnings call, we will grow prudently, making the appropriate decisions to ensure we are delivering long-term value and not taking undue risk. Moving to Slide 14. I will speak to our strength and financial resilience. Through our business transformation efforts, we have improved our balance sheet, loss absorption capacity and funding mix. We've enhanced our credit risk management and underlying credit distribution and we've refined our recession readiness playbook. These changes strengthen our financial resilience, better positioning Bread Financial to deliver sustainable, profitable growth with an expectation to outperform historic loss levels through an entire economic cycle. Through prudent management, we have strengthened our balance sheet and capital ratios, including an improvement in our TCE to TA ratio of nearly 400 basis points in 2 years to 7.5%. Our higher capital position and our increased credit reserves at 11.2% of loans, combined with our PPNR margin that is greater than 10%, positioned Bread Financial with substantial loss absorption capacity and ability to weather potentially difficult economic conditions. Enhancing our credit risk management and underlying credit distribution was a key element of our business transformation. This led to a credit mix shift towards higher-quality cardholders with around 60% of our portfolio above a 660 VantageScore in the second quarter. Across the industry, we do expect credit scores to migrate lower over the coming quarters as consumers' credit normalization continues from wind down of stimulus benefits coupled with the impact from higher inflation. As Ralph mentioned, we manage our portfolio proactively. We have a recession readiness playbook in place and implemented elements swiftly at the onset of COVID with a focus on managing open-to-buy and helping consumers manage their credit lines and balances in a healthy manner. We continue to see a strong overall consumer in terms of spending and payments. We do place extra emphasis on customers who are more sensitive to these high and persistent inflationary pressures to ensure they can manage their credit while maintaining purchasing power. We have also benefited from our implementation of enhanced risk stratification and technology enhancements to build additional resilience in our portfolio. When you combine our improved risk profile with a more diverse portfolio and brand partner base, we believe that we are better positioned than we have ever been for a potential recession. We will remain proactive in our approach as we continuously update our risk management models and underwriting criteria in this rapidly changing macroeconomic environment. In summary, we continue to strengthen our financial resilience and maintain the tools necessary to successfully manage through the entire economic cycle. On Slide 15, you can see the build in our loss absorption capacity as shown on the graph on the left of the slide. At 20.1%, our tangible equity plus credit reserves represent almost $4 billion of loss absorption capacity, if needed, and should provide an additional level of comfort given our improved credit profile. Our capital priorities have remained consistent. We have prioritized funding profitable, responsible growth and investing in new products and capabilities, at the same time, remain focused on improving our enterprise capital and debt metrics to be more in line with peers. The primary way we will achieve this is through building tangible common equity through retained earnings and paying down parent-level debt. We have reduced the parent level debt by nearly 40% since the second quarter of 2020, primarily with the proceeds from the spinoff of LoyaltyOne directed toward paying down debt from our long-term loan. Once we are satisfied with the level of our enterprise capital metrics, we will discuss with our Board additional levers for capital return to shareholders. Turning to Slide 16. As already mentioned, we expect average loan growth for the quarter to increase 13% to 14% year-over-year. We expect full year net interest margin to be around 19%, with third quarter seasonality being somewhat higher and then dropping in the fourth quarter as seasonal holiday balances build and we acquire the AAA portfolio. As I have previously noted, we will see the majority of our $125 million incremental investment in product development, digital and technology enhancements and marketing expenses hit in the third and fourth quarter of 2022. We expect third quarter expenses to increase approximately $40 million sequentially from the second quarter. The benefit of these investments better position the company for continued growth and improved efficiency going forward. We are expecting an effective tax rate of approximately 30% to 32% for the third quarter and the expected full year rate remains between 25% and 26%. Looking at credit metrics. For August, we expect the net loss rate to be similar to the June rate and the delinquency rate to continue to move higher from July as a result of typical seasonality of up 10 to 20 basis points plus an additional increase from continued normalization. We'd expect the delinquency rate to move higher around this time aligned with typical seasonal trends before moving lower towards the end of the year. For full year, we remain comfortable with our net loss rate guidance in the low to mid-5% range. Fourth quarter losses are expected to be above that range aligned with the normalization of our delinquencies earlier this year and the normal seasonal trend of a higher loss rate in the fourth quarter. This will likely result in the full year loss rate being in the top half of our forecast. With the addition of the AAA portfolio in the fourth quarter, we expect year-end loans to be between $21 billion and $22 billion before dropping in the first quarter of 2023 as we exit the BJ's portfolio and seasonal balances run off. Note, this will have a material impact in our loan loss reserve balance with a large build in the fourth quarter and a likely release in the first quarter of 2023. We will continue to maintain a conservative position when it comes to establishing our CECL reserve balance. You saw us increase our reserve rate last quarter to remain proactive given the increasing probability of a consumer recession per economist. Until we pass this period of significant economic uncertainty, we expect our reserve rate to remain elevated. Given the current economic environment, I would expect a slight increase in the rate for the third quarter, given the persistence of high inflation, but we'll have to see where we end at the end of the quarter. Overall, we are pleased with how our business transformation efforts have materialized. We have achieved many targeted milestones including expanding our product offerings, advancing our digital capabilities, enhancing our talent, strengthening our balance sheet and adding a renewing iconic and diversified brand partners to support our continued growth. We remain focused on providing financial resilience and sustainable profitable earnings growth for years to come. Thank you for your interest, and hope you have a great day. Please let me know if you have any questions or additional areas you'd like us to cover during Q&A.

Yes?

I'll go for it. So I would say the loss rate for the private label business does run higher, as we mentioned, right? That's really where we have more of a full spectrum lending. Also keeping in mind, though, that those credit limits that are established for that part of the business is relatively small. And then as Ralph and I think Perry mentioned on the co-brand cards, our actual risk score is much higher. So that loss rate generally runs much lower.

Anything else for us? Yes?

I had a question -- I was hoping you could drill down a little bit more on the different impacts you're seeing from inflation. I think you alluded to how in the third quarter, you saw softer spend, but then when gas prices backed off, you saw some -- talking about a more granular level, what you're seeing on spend and also how inflation...

Yes, sure. I think coming into Q3, we definitely saw the higher gas prices start to play in through some of our more mid-tier customer base where they had less discretionary spend. As those gas prices started to reduce, we did see a little bit of opening back up in some of our travel and entertainment categories that had been a little bit suppressed when gas prices were very high. I think the other thing that we've seen, a lot of the retail spend, the back-to-school shopping, back-to-college shopping, prior to this season, consumers were willing to really spend because their supply was so limited, and so they weren't really looking for promotions and sales. What we have seen is that higher awareness of some of the inflation in the categories where you now are -- particularly the back-to-school, back-to-college are, in fact, looking for those sales to be able to get their dollars to go just a little bit further, given inflation in some of the other categories. So gas certainly is suppressed, it went down, but I think the awareness of the consumer around inflation has been heightened. And so there is a little bit more of that cautiousness that we see, particularly around consumers now looking for some of those promotional discount activities where they were not doing that before.

And then just on the credit side. I mean you also alluded to seeing a little bit of pressure on early DQs. Can you talk more about where you're seeing that? Is it the most -- is it from your lower-income customers or nonprime? And is it inflation driving that? Or any other...

Yes. So certainly, where we are seeing the most impact, I would say, from inflation is in those lower-income customers, lower score customers, which, as Perry mentioned, reactivated our recession readiness earlier in this year and had already started to take actions knowing that not only potential inflation but also the fact that stimulus has started to wear off in addition some of the deferment on other loans was coming, going to come back around. So we certainly had already taken action on that population. And we are starting to see a shift, right, our normalization of payment rates, normalization and our delinquency levels as well as a result of the current environment.

Okay. If there's no other questions, I want to thank you all for your time and your interest. Appreciate it very much and looking forward to talking to some of you throughout the day. Everybody, have a good day.

Okay. If there's no other questions, I want to thank you all for your time and your interest. Appreciate it very much, and looking forward to talking to some of you throughout the day. Everybody, have a good day.

Thank you.