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

With -- next with Perry Beberman, the CFO of Bread Financial. Perry has over 30 years of experience. Most of that time has been spent at Bank of America and MBNA before Bread. Great to be sitting down with you, Perry.

Good to sit down with you.

Maybe you can start off by telling us a little bit about what you're seeing in the quarter and the aftermath of what's happened with SIVB. Do you have any financial outlook updates that you'd like to share with us?

Sure. So the first quarter for us at Bread Financial has a few moving parts in it. First, in the quarter, everyone is aware that we have sold the BJ's portfolio. And that's, call it, nearly $2.5 billion. So that comes out of the portfolio in the first quarter. So you'll start to see that impact spend and things of that nature in the future. But even with that, I think we're seeing the trends of decelerating consumer spend, which is expected in this period of high inflation. But associated with the conversion, you'll see a gain on sale that we've disclosed in our 10-K over $200 million, that will go straight to the bottom line to retained earnings to improve our capital ratios. You also have that -- there'll be a net provision release. And I say net because also, as I've signaled before, expect in the first quarter that we'll be increasing our reserve rate, which is really driven by 2 factors: One is seasonality; and two is the BJ's portfolio going out that had a lower reserve rate. And then throughout the year, we'll just continue to monitor the economic conditions to see if we need to increase a little further or not. And then as it relates to the lost dollars in the quarter, we are impacted in the month of February, and that came out this morning. We had told everyone that you should expect over 100 basis points of impact from the conversion-related issues from when we had taken customer-friendly accommodations back in July. And now -- so we had suppressed loss rates in July, and now it's elevated in the month of February. So that was about 100 basis points for that. And then so I'd expect in March, it comes back down to more of what we would expect to see. And then we'll see further impacts of transition accommodations hitting in the second quarter with a peak rate over 8% in the month of May. And then as we look at the -- the other thing I'd comment is expenses, just making sure if there's people looking at this, that we expect expenses to be roughly flat to the fourth quarter in the first quarter and then start to come down after that. Hold on. One second. Are we good?

Okay. Can you give [Indiscernible] on the main point maybe [Indiscernible].

I'll try to give the short version again. So key points for the quarter, expenses flat to the fourth quarter. Expected the loss rate to be a little elevated in this quarter due to the transition impacts from the conversion impacting the month of February, then coming back down in March, but then elevated again in the second quarter with the peak rate of 8% -- over 8% likely in the month of May, but the other 2 shoulder months also being a little elevated from customer-friendly accommodations.

Okay. All right. Helpful. If we kind of stick at an industry level. Can you talk about how you'd characterize the health of the private label credit card industry today? How has it changed since the pandemic and some of the most recent events?

Yes. So -- as it relates to private label, it's something that I was not as familiar with before coming to Bread Financial as obviously I've become much more so. And really, what I've come to appreciate about it is the stickiness of the relationships and the consumers. Well, sure, you had a period of time where you introduced a little bit of the retailer risk in terms of are they viable, will they remain in business. But largely mall-based retailers have moved to omnichannel where they're taking on digital sales and the like. And you're able to do a lot of these private label partners is morph them into co-brand partners. So you have the private label that really cares for the customer, I'll say, on the lower end of the credit spectrum, and they can graduate them up to the co-brand product where you then capture more of their general purpose spend. Overall, I've been really pleased with that. And the growth in that is -- will remain important to Bread Financial, but also diversification into more of the co-brand aspects of those relationships and other relationships like NFL and AAA and partners like that to continue to diversify.

Okay. If we can stick with one more macro question here before digging into some more company-specific questions. Can you talk a little bit about what your house view is on whether the Fed is going to ultimately need to drive unemployment higher to temper inflation? And how that's filtering through the management of credit and everything else -- underwriting, et cetera?

Yes. So there's a lot in there, obviously, macro and a ton of opinions. And I think as any of you who followed my comments for the past year, I thought the economists were getting it wrong in terms of their expectations of inflation, what the Fed increases were going to look like. And so this inflationary environment is challenging all of Middle America, right? So you think about the, call it the K economy, where the people at the high end are all tackling higher food costs, over 10%, energy cost, I mean, the utility bills are up, okay. But for the middle Americans, that's challenging. If it's another $100 a month or whatever it is, they're making trade-offs and choices. So you're starting to see that come through in their payment patterns and how it's impacting their ability to pay leverage is coming back up and you're starting to see a rise in delinquencies. And that is not -- that's not surprising to me. And I just talk about what does it mean for later in the year. Again, I'd like to be optimistic and think that inflation will taper down becoming I'd say a little less optimistic at the pace it may come down. I think it's going to -- it's -- there's a lot of macro considerations out there that are kind of working against it, meaning the consumer is so healthy. The jobs are still out there. Wages are going up. And then business are passing those higher prices, higher wages on to consumers than the price of goods and consumers are paying for it. So there's really not a pull down in prices yet. So I think we're still a little ways off before the Fed accomplishes their goal. And I don't see a path where at this point that it can be avoided where unemployment won't increase to some extent. My base case and that we're operating on at Bread is hitting probably mid- to high 4% unemployment rate probably by the end of the year. And while I don't think that's going to impact losses this year, I think it's going to more so be a leading indicator for losses next year. But for us, what that would mean is think about inflation is what's driving our losses above our through-the-cycle 6% target this year. That is going to get replaced as inflation comes under control, the portfolio is going to cure a bit on that front. But then that unemployment element will replace that to keep losses perhaps a little higher. We'll know more, obviously, as the year goes on, but that's just forward-looking. I expect probably the rate increases to continue throughout this year and then hold steady probably midway through next year before they start to come down. But Again, I don't have a crystal ball, I wish I did. Because again, if we were having this conversation a week ago, I don't think we'd probably be talking about the SVB stuff and what that's meant to the deposit markets and everything else. I mean the world changes pretty quick sometimes.

That's for sure. Maybe if we could dig a little bit more into the credit theme. Some issuers are still saying they expect their delinquencies to flatten out and get back to 2019 levels, while you have others, including Bread that have seen delinquencies now surpass 2019 levels. Could you parse out for us how much of the increase we've seen so far has been a function of just normalization versus that stress that is being caused by inflation?

Sorry. So going back to the K economy theory, right? You've got super prime customers, high prime customers that are still normalizing back to their pre-pandemic levels of borrowing. And so that means their ability to pay has remained very strong. There's still additional savings from the stimulus that is sitting in their bank accounts at the high end of the credit spectrum. Middle America to the modern income folks, like I talked about earlier, I already see they are at the bottom part of the K, are feeling that strain. So as it relates to credit, yes, some of the, I'll call it, the big 4 who try not to have their loss rates breach 3% are still normalizing back to this pre-pandemic levels, and maybe they'll level out presumably unemployment remains moderate because, again, inflation is not impacting that population that much. For the rest of America, inflation is the primary driver of what's causing that straining, which is why we're above our 6% through-the-cycle expectation in a period of low unemployment. It's because of inflation. And that is the #1 concern of the Fed is getting inflation under control because of regressive tax on all Americans, but it impacts the more moderate income Americans far more than it does the more affluent.

Are you seeing any notable differences between early and late-stage delinquencies? And once customers that do enter late stage or maybe a color on cure rates?

Yes. So -- I'd say unfortunate for us is we had this confluence of a couple of things happening at once. And we had our conversion actions that we took to consumer accommodations that were throughout the second half of last year, putting noise into our numbers this year. So that is affecting like when I talked about second quarter losses being higher because of the actions that were taken in the fourth quarter, it means the late stages are a little elevated because they're going to be coming -- the loss is becoming due in a few months. But right now, we're seeing good signs and early stage delinquency coming down.

Okay. You've talked about how your portfolio today is about 50% co-brand. Does this increase your risk exposure in a downturn versus traditionally pure private label credit cards, which have historically been viewed as being sort of beneficial in a downturn because there's more limited utility versus general-purpose cards?

Yes. That's a fair question. I mean I think about it as -- you're talking about diversifying risk. And so when you think about product diversification, spend diversification, merchant partner diversification, what you try to do is not be overconcentrated in any particular place. And I think for us, the diversification into more general purpose spend has actually been beneficial because as people start to pull back on soft goods like clothing, because they're buying -- they have to get gas that's higher or food that's higher, being able to capture some of that general purpose spend has been good for the business overall.

If we move to seasoning. Some issuers have said that they're not seeing significant seasoning effects because their origination growth has been pretty stable, but you have others that are seeing more pronounced growth and more pronounced seasoning effects because they've added a lot of new accounts. Can you talk about how seasoning is impacting Bread?

Yes. So -- and I get that -- those mixed commentary, and it will vary by business by product [Indiscernible] and who they serve. So as you think about the season and dynamic, you're really talking about month on book and when do they hit their peak losses. For the more affluent customer or prime customers, you're probably looking at month 24 or so when they hit their peak losses. So when you start wedging in these large vintages, yes, they're going to start to seize and stack it so you get the delayed effect of the seasoning. When you look at our client base, we typically hit that peak loss rate in month booked 12. So we have less of that seasoning effect because we're always a lot closer to the peak rate of a particular vintage than other issuers. So it really depends on who they're serving and who they're bringing into their portfolio.

Okay. Maybe if you could take us inside the business from a risk management perspective and give us a little bit more color on whether you look at the performance of customers who have multiple accounts across your different partners. For example, would a customer facing stress at retail partner A inform how you think about the credit that you're extending to them at retail partner B?

100%, yes. When you think about credit management and risk management, that is one of the key things you look at. You look at the on-us behavior and not just within the one card, but you're looking at the total customer. And what that means if you see stress on one of the accounts and you take a credit action to, you call it risk detection where you may restrict line increases or access, you do that across the entirety of the customer. Similarly, you're also looking at all-for-us behaviors. So constantly different bureau of attributes, change in leverage, ability to pay and you try to consume as much information as you can real time and that you're making decisions in customer cohorts to actively manage credit. And it's living, breathing. So even in good times, you're doing that, but certainly in times like this, all the monitoring controls are in place. And we pulled back on our growth targets for this year to be mid-single digits versus where we had been in tandem with consumers reducing their spend. We're not leaning in as much on growing lines and doing more risk detection and being a little tighter with the buy box as appropriate. As you expect through a period like this, risk scores are going to start to migrate down. And so you need to be able to look around the corner and anticipate that.

Okay. One more on credit. Of course, no discussion on credit would be complete without talking about CECL. Maybe from where we sit, there's this interesting bull-bear debate among investors around CECL. On one side, there's a group that thinks CECL has done its job because reserves already contemplate elevated levels of unemployment. And that suggests that there isn't going to be a need for as much reserve building from here. Then there's -- on the other side, you've got a group that argues -- it's crazy to think we're not going to see additional reserve building in a scenario where unemployment goes to 5%. Can you talk about how you'd respond to both of those views?

Yes. I think there's certainly -- a philosophical approach is to CECL. Look, none of these models are perfect. And there's always a degree of judgmental overlays and risk overlays that you take based on what you believe your outlook is for the economy. And you and I have been connecting now for a bit. And you know I lean in a little bit more on the conservative side because these loss models, these CECL models are all built and conditioned on historical change in unemployment and those cycles. None of these models are built on periods of elevated inflation. So for me, took the approach, look, I'm going to lean in a little bit on the S3, S4 scenarios that had unemployment nearly approaching 8% in pretty short order. So weighted those a little more heavily because the models didn't care for this inflationary period. There's no scenario I believe we get to 8% unemployment in a 12-month period. But -- so that aside, you still lean, where others may be taking the approach I don't view those as highly probable at all, but they're not caring for inflation because their consumers aren't as impacted by inflation. So again, it goes back to their portfolio, it goes back to their philosophy and some may be fine chasing that rate up as unemployment goes up. Again, it is different philosophies across the different firms. I think we all try to take a prudent approach. But whether you're more risk taker or more conservative, you end up somewhere on the different spectrum. But I do think we're in a better position with CECL, although I think I struggle with it because when you're trying to make investment decisions, you're better off doing on a cash flow basis or an NPV type thing, not really factoring in CECL, but I can tell you our Board members and others who are not as accustomed to it, that growth tax is tough. And we think more sophisticated investors see right through that because you're taking all the future losses that you expect could possibly happen on day 1, but you're not discounting in bringing forward all the future revenues. But in the past, what would happen is losses would go up 100 or 200 basis points, and you compound that with having to increase the reserve at the exact same time for that. So today with CECL, you can get ahead of it a little bit by leaning on the risk factor. So as losses rise now throughout if they were to go up further from here, the CECL rate doesn't necessarily have to move. So -- and then it'll obviously get released as -- hopefully, I'm wrong.

If we move on past credit, I wanted to ask a couple of questions on the CFPB late fee proposal. But before we do that, I wanted to also ask others, we'll leave a few minutes and if you all have any questions, you you'd like to jump in with [Indiscernible]

You've got a lot of 4-letter acronyms you want to talk about CECL, CFPB.

Yes. That's right. Maybe if we can sort of set aside the deterrence aspect of it. And maybe could you talk a little bit about how the $8 late fee cap that the CFPB is proposing compares to what you would view as the actual incremental cost of collecting on past due accounts. Is there room for that to potentially move higher? And then maybe I'll just rope in the other question here. Could you talk a little bit about any projections you have in terms of timing or potential delays around the proposal?

Yes. I think -- look, they obviously had data and analysis they got from the big issuers on what appears to be a variable cost to collect. And I think about when I started in this space back in the late '80s, people using dialers and Rolodexes and the cost to collect was pretty high. It was also unsophisticated today. I think cost to collect has become more efficient through the analytics and tools that are available to make sure you're optimizing your collection efforts. But the cost to collect is just one aspect of the cost to lend and the cost of credit. I think that's the part that they're perhaps missing is that's a key component because, look, at the end of the day, investors are expecting us to get a return on capital and for the risk you're taking. So ultimately, it has to come back to higher APRs or fees to the customer in order for us to continue to underwrite those customers. So where this ultimately lands? Not sure. I do expect that this to be a little bit of a protracted comment period in terms of how they absorb the information. From what I can tell, they don't seem to want to listen very well. So it will obviously get taken up in court. And your guess on how that turns out is probably as good as mine. But all I can say is from inside Bread Financial, getting a playbook together, making sure we understand by partner, by customer, by risk band, what actions have to be taken to fully recoup the impact of whatever the late fees end up being. And think about that as higher APRs, probably across the board. It may vary the degree to which it goes up by risk score, introducing perhaps maintenance fees or everyone to call them like the way it was in the early '90s for a lot of accounts at annual fees. You could end up having to restructure some partner share agreements, if they want us to continue to underwrite those certain accounts and ultimately, reducing the number of accounts that you're right, where you no longer hurdle and get the return that you're expecting. So it will limit access to credit for certain customers.

Maybe if we can kind of link in some of the dynamics there with economic sharing, and that's another topic that's very -- that comes up frequently in discussions with investors. Can you maybe remind us how common economic sharing arrangements are across your retail partners and potentially if that's something that started to factor into your discussions yet, given like what's happening with the CFPB or is it's still too early for that?

Yes. So for as long as I've been doing this, every contract looks different. It is rare. I mean for real small deals, you might have more of a standard cookie-cutter type deal, but largely, you have deals that are -- have no revenue share, except to the extent they get paid for every new account that gets open, they get a bounty and then they get a royalty on basis points for every dollar spent on the card, and it could be each year, if the account is still open, they may get another bounty for that. So that would be -- there's no profit share. Others have. We get a certain ROA, they get a share then above our threshold ROA, where they'd be very exposed to this. Others have a hybrid of all. So it's hard to quantify. It's -- but 95% of our contracts allow for us under regulatory change to go in, redo pricing, reopen discussions. So -- but what I'd tell you is -- these are partnership agreements. And the objective is not for our partner to take it on the chin because of regulatory change. Our goal is to keep them whole and keep ourselves whole. The consumer is paying for this today, the consumer needs to be paying for this tomorrow. And so if the CFPB's objective was to spread out the late fees among a broader set of customers or through APRs and other fees, that's the -- what will happen.

There's a view that you don't share the cost of higher credit losses across your partnerships, but instead bear the full consequences of credit, whether that's good or bad, can you speak to that? At a high level, I understand every agreement is different...

It's -- that is -- again, it goes back to -- it varies by contracts. Some contracts are more exposed to changes in credit losses. Others are not so much so. I think when certain -- when partners have gone through periods of economic stress, they realized pretty quick that, hey, you know what, I want to be in the business of selling product. You be in the business of underwriting and taking on the credit risk, make sure you get paid for that, but that's our job. And then their job is to market and develop loyalty programs that resonate with their customers. So I think it will be interesting to see the other side of this and what retail partners want in terms of contracts when you go through a period of economic stress and they realize their revenues get suppressed, just economics alone. I mean, with the macro conditions of credit losses and then you take into something like the CFPB, you may be looking at a different style of contract going forward.

Understood. And maybe last one here on economic sharing. You guys have talked about having late fee exposure that's sort of in the same ballpark as Synchrony. But they emphasize this RSA benefit that is an offset and downturn, including the benefit that the RSA would provide if the profitability of the programs were reduced due to lower late fees. So some investors have concluded your exposure is likely greater than Synchrony's. Is that a fair characterization? Maybe could you speak to that?

Yes. I have my IR guy here right in front and I like to say that our -- when we think about late fees for us, if you take Synchrony Plus because we're more of a full spectrum lender. So on that front, but that comment, I'd say it's probably not wrong in that, again, I don't know they're booked that well. But with the fact that we don't have as much discrete sharing, yes, they have in a hedge in there. But what I can assure you is that in the name of partnership, they're not looking for their partner to have reduced revenues as a result of this action. Their partner is going to be looking for them and like our parts will look to us just to make sure they stay whole. So it sounds good in theory, but if that's the case, the partner is not going to be very happy and Bread Financial will be very happy to help work with them in the future.

If we could switch gears to some questions on capital and corporate structure. You've talked about managing Bread as if it were a bank holding company. And internally, maybe could you talk a little bit about how you -- whether you think about capital at the enterprise level, a lot of issuers will have CET1 targets in the neighborhood of 11%, give or take. Do you look at CET1 at the enterprise level? And maybe more broadly, do you view CET1 as your binding constraint?

So real good question. So we are maturing our capital management policy, practice and everything that goes in between at Bread. When I joined, there was no enterprise capital policy. There was no capital planning. The banks had more rigor around it, what they had to do because they were regulated by the FDIC. But as a commercial holding company that didn't exist. What we're putting in place, we've introduced and had approved by our Board our capital policy. And with that comes a capital plan, and like you asked about -- with all the ratios you would expect. And I expect our binding constraint to probably total capital in the near term and then getting our capital levels up to an appropriate amount. And we put out there a marker of getting to a minimum of 9% TCE to TA with the room-entry target we put out there. I think when I started, we were closer to 2%. And at the end of this quarter, with the gain on sale, some provision release, lower assets I expect that we'll be back above the over 8% we were at the end of third quarter. We dropped in the fourth quarter to seasonal growth and AAA and the big provision build we had to have, but we should be north of the target that we have set. But at that point, now we're into a mature -- I guess said we are maturing this, we're setting internal operating targets to get more in line with peer levels for the risk we have, the stress models we're putting in place. And again, when it comes to capital priorities, we haven't changed from what we've said. We want to make sure we have capital to support the responsible growth, and that means profitable growth, not growth for anything. You see that to where we pull back on split pay. The economics weren't there. We pulled back on it. We want to continue to grow responsibly over time. And with that, that's the first priority. Second priority is paying down debt. We are still working on that capital structure at the enterprise level. And so that's a piece of refinancing that paying it down and then ultimately return to shareholders once we feel like we're in a strong position.

So the buybacks would start done at that point once you've gotten the capital to the target levels?

Target levels and haven't cared for paying our debt.

Debt. Understood. Maybe switching gears. Do you expect loan growth to continue to outpace spending growth as payment rates and revolve rates continue to normalize? And maybe if you could talk a little bit about how a recession would change that dynamic of that sort of normalization that we're seeing?

Yes. It's interesting. I haven't really thought about characterizing it that way. But on a macro basis, yes, as spend per account, let's go with that, would come down. And then their payment rate comes down because they're increasing their levers to balanced increases, so [Indiscernible] are growing even though spend -- the rate of spend is coming down. Again, growth is still spend -- growth in the account, but that's a part of it. But for us as well, it's also where you're putting on new brand partners, are you putting on more direct-to-consumer brand products. So that will vary by business. But on a consumer basis, the answer is yes. I think what you're seeing is they're increasing their leverage in total even while they're slowing their pace of spend growth, but they still spend growth per customer.

Okay. That's helpful. We have about 5 minutes left. Are there any questions from the audience? Okay. We'll keep going. On funding, you talked about direct-to-consumer deposit funding having a target of 50% versus 26% today. Within that, can you parse out for us how you're thinking about the relative attractiveness of things like CDs versus other online savings and when you market accounts that -- that repriced lower more quickly in a down rate scenario to the extent that we go down that path. There's been a lot of focus also on exposure to uninsured deposits, if you could also speak to that and sort of in light of the SIVB situation? What's Bread's mix of uninsured deposits?

Yes. We -- our mix of insured deposits is well north of 80%. So we don't have a lot of uninsured deposits in our direct-to-consumer deposit business. And it's something which we do view as a valuable way of funding the business, both in terms of remixing our current funding but also funding growth that we're seeing. So we're not afraid of being towards the top of the rate table. It is still a very attractive cost of funds for us. And as rates increase, our assets increase. So as we've said, and I think for folks who wonder like how is Bread Financial impacted? Could it be anything like one of these other firms. You could see it in our NIM expansion, we're slightly asset sensitive in that. We've been seeing a slight bit of NIM accretion during periods of rising rates. So it goes to show that as rates rise, we're going to -- the top line APRs on our assets are going up.

Okay. Maybe if we could go back to -- this is a bit of a conceptual question. So in the world before CECL, most issuers would base their allowance on expected next 12 months of charge-offs. But today in the post-CECL world, a lot of credit card issuers are out talking about probability weighting different charge-off scenarios to arrive at their allowance for lifetime losses as you are. Maybe could you talk a little bit from a forecasting perspective, what you would think some of the implications are of those 2 different approaches? This is sort of our first cycle going through CECL and maybe anything stand out to you from that?

Yes. So it kind of dovetails on to the comment I made earlier. The old approach was, let's just say, if you had 3% losses in period, you would then take the next 12 months and assign the fact that what are your loans going to look like, what's your growth and make sure you have that same amount of coverage for the loans that you're going to have in the future and today, but it's one incurred rate basis. The way you look at it now is not -- you're not just covering for the next 12 to 13, 14 months of coverage, you're covering for the entire life of the loan that's on the books today of losses that you might foresee and you're then applying a risk overlay for different economic scenarios and to some weighting in that. So before you would be catching up to the cycle because really, if losses went from 3% to 4%, okay. Now I -- I'm up 100 basis points in a year. And now my reserve has to be at 4% of coverage for the next 12 months or wherever a longer number of months coverage. So it's just a different dynamic. That one you're chasing it and then you can't bring down your reserve rate under the old method until you see lower incurred losses. Here, it's about you can stabilize the reserve rate as losses grow into it because if your outlook then is like, hey, it's peaked, and you expect it to come down, then you can actually start to reduce your reserve rate and reduce those risk overly. So it's a different way of modeling it. But this is definitely a far more -- CECL is a far more conservative approach. And it goes to loss absorption capacity. Loss absorption under the old way was far narrower than what it is today. Today, take us as an example, use a round number, say, 9% capital rate plus over 11% CECL rate. That's 20% of total loss absorption capacity. That's pretty sizable. And that's the idea though, we're trying to build a fortress balance sheet.

That's very helpful. I think we're -- that leaves us out of time. Perry, thank you for joining us. We really appreciate it.

Thank you.