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

Good morning, everybody. My name is Jeff Adelson, consumer finance analyst here at Morgan Stanley. I appreciate you all being with us today. Before we get started, just going to read some quick disclosures. For important disclosures, please see the Morgan Stanley research disclosure website at www.morganstanley.com research disclosures. The taking of photographs and use of recording devices is also not allowed. If you have any questions, please reach out to your Morgan Stanley sales representative. So very happy to welcome back Perry to our conference. Perry, thanks for coming in today, CFO of Bread Financial.

Glad to be here. Thank you.

So Perry, you come with some good news today. Thank you for saving it for our conference. Why don't we get right into it? Two big updates this morning. Maybe we'll start with the Saks portfolio you announced this morning. What can you tell us about that? What brought you to them? Why they pick you and talk about some of the characteristics of that relationship and portfolio?

Yes. We're very excited to welcome Saks to the Bread Financial family, and they chose us to partner with. I think one of the things that resonated with them during the process was our focus on partnerships. We don't have a big branded portfolio. We're not about promoting the Bread Financial brand the same way some of these competitors are promoting their brands. And I think that really attracted Saks. You'd have to ask them exactly, but I think it was the personalization, the attention that they can see they were going to get the way we use analytics to help grow their portfolio and the track record when they spoke to some of our existing partners, where some partners who have switched from other issuers to us saw a lot of success in their first year with us in terms of the number of new accounts that came on and what they will we see in terms of stimulation with their portfolio. So not to say they were unhappy with where they were, but clearly made the choice to come to us and we're thrilled to have them.

And is that in the midrange of your sweet spot you talked about, I think you talked about like $100 million to $500 million sweet spot.

Yes. It's definitely in the sweet spot. I would say it's in that $300 million to $400 million range. We'll know where the portfolio settles out when it converts later this year, exactly what the amount will be.

And that's probably more in the co-branded higher credit quality, higher spend type portfolio.

Exactly. I mean, Saks is a luxury brand retailer and you would expect the consumers have a better-than-average credit quality and with some higher spend in there. But it will be a combination of co-brand for the higher-end consumers. And for those that are newer to credit or a little bit riskier credit would be offer the private label.

So what else should we expect here? What else is in the pipeline? I mean are you now focused on trying to go after more of these higher-quality opportunities or what else?

Each deal that comes through is unique in and of itself. So we're focused on making sure we get the right return for our shareholders. You can think about it as a differentiating capital that gets assigned based on risk, operational risk, credit risk and the like. And so if there's a path to finding something that's good for our shareholders, we'll pursue it. The pipeline is robust right now. It's good as what it has been. There hasn't been a big pullback in the opportunities. It's just being selective and leaning in on the ones where you say it's a good fit for us based on the diversification aspirations, but also one where we're always ensuring that we're taking care of the returns that we require.

Okay. Great. That all sounds great. And the other big thing you put out this morning was the credit update for May. It looks like the delinquency formation trends look pretty positive this month. You also saw a pretty nice step down in the charge-off formation rate and maybe came in a little bit better versus the 9% you were talking about peaking out here. That peak playing out and talk about maybe what you're seeing there?

Yes. So when we published the loss rate this morning, it was a little lower than what we had previously guided with but not a lot lower, but it was definitely it's a tad lower. So where we had said it was going to peak. I think now we can say the second quarter is the expected peak for the year. And if you do -- anyone can do the math, it may now the peak at 8.8%, that means the quarter will come in slightly under 8.8% and then that should bode well for the rest of the year. As you mentioned, the delinquency formation came in positively. Now I do expect some seasonal movement and really the back end of the year is going to be macro dependent. So the degree to which it improves from here is really going to be defended as inflation come down, we've got some decent numbers this morning, while it's still what it came in like 3.3% CPI below 3.4% last month. It's still high due to as a compounding impact. But we're optimistic and I do think you're going to be in this period of time where you have higher rates for longer. Inflation will seem a little stickier. And so -- but so long as unemployment stays benign, I think the second half of the year will continue to show some signs of improvement. It's just -- I'm not expecting dramatic step down on the back part of the year.

Okay. And we heard from another issuer yesterday, card issuer that there's maybe a little bit of an uptick in minimum payers out there. There's maybe some noise and seasonality now with the tax refunds being slower than versus pre-pandemic. I think you've sort of highlighted some of this before. So maybe you could just touch upon your -- what you're seeing there and whether that's something that's change or accelerate it? Or if it's just still kind of in line with your expectations at this point?

Yes. When we made the comment there, you kind of caught me by surprise because there's really not a lot of new news there. We've been seeing that for the past year and calling that out that we were seeing more min-pay folks when they're making payments where we were working with them and our collections team to figure how can we assist them in getting payments in. The period of time that we've been going through with this persistently high inflation for what it feels like the past couple of years, has really impacted Middle American and lower income American. So maybe it's starting to creep up deeper in some other peers portfolios. But I'd say the observation we've been calling for the past year, you see more people once they get delinquent, roll through charge-offs. So you're seeing that is called low rates at peak levels. That really hasn't moderated yet. So that could be a tailwind if that starts to improve. But we're not seeing big shifts in min-pay compared to what we've been seeing.

And as you think about that trajectory, obviously, this is all very macro dependent. Is there anything that you're seeing maybe in like the new vintages you're doing today versus '23, '22, '21, et cetera? That gives you a sense of how the outlook is going to shake out in late '24 or into '25, like improvement or stability or maybe something better or...

So unlike some others in the industry that put on really sizable larger vintages coming out of COVID. We had a playbook in place that had tightened things up and have remained tight and then tighter as we worked through last year. So our vintages have been better risk mix, better credit quality and smaller in size as we've been stepping through this period of time. So we did get caught up in the, I'll call it, risk or migration upward coming out of COVID. And now as they're migrating back down, we've been in a position where we've continued to tighten. And we're going to remain cautious on the credit actions until we find a period of time where there's -- it's really a little brighter outlook, and then we'll ease into those changes that will be a tailwind for growth. But I don't really have anything specific to call out really to any specific event. They've all felt stress, I'll say, similarly, but the newer vintages are certainly a little better credit quality than the ones that from just a couple of years ago.

And then if we just take it to the consumer health and some of the spending trends you see there, you've talked about this pullback in discretionary and big ticket spend for a bit here, and you talked about the K-economy for probably at least a year now, right? We're starting to see some of that show up at the retailers in recent quarters. And I guess what's your response to that? And it doesn't seem like you're seeing any further deterioration at this point than what you've talked about. But maybe just highlight the trends you're seeing, maybe any sort of particular verticals of strength or weakness, too.

Yes, I'd say that the consumer is doing the best they can in this environment, they're remaining resilient. They have, as you mentioned, pulled back on big ticket. And we're starting to see a little bit of, I'll say, moderation there. We're now a little bit of a month-on-month improvement in some categories. Not that it's going to provide for a year-over-year positive comp but it's something where I think we've seen stabilization through self-moderation by the consumer and through our credit actions. And hopefully, that remains stable and then we start to see some improvement as we march on to the exit of the year.

And where are you seeing that slight uptick maybe you're just talking about there some...

It's in -- I'd say, in probably more beauty even some of the apparel. I mean it's -- because some of these have really pulled back. But still, it's the nondiscretionary spend where consumers are continuing to spend. And what you're seeing is consumers are making more frequent trips. So you're seeing lower transaction size, but more transactions, I think more trips to the stores to make their money go further. And candidly, that's what people do when they're going paycheck to paycheck.

And so it sounds like you're basically paying a picture of the consumer getting through, managing. What would get you more concerned about the pullback here? I mean, what are some of the first signs you'd look for?

Well, I think if inflation really went much higher back up towards 5%, that would concern me. If, for some reason, the Fed starts to crank interest rates up, and that drove greater unemployment, those things would concern me. But as I see things today, I think our proactive credit management, the diversification that we've put in place with our product set, the risk mix we have and everything I'm seeing with the economy I think we're going to be in a slow gradual improvement phase as we go through the year and that we should be able to navigate it pretty successfully.

And maybe while we're on the topic of credit sales, is there any sort of quarter-to-date trend you want to point out to? I think there's some noise in there with BJ's from a year ago coming out, but yes, anything.

So the BJ's exit was February of 2023. So the year-over-year comp that should already be out of the noise. So that we should now be in a clean year-over-year comparison as we look to. And so no, I just want not a lot to talk about with the credit sales. It's just more macro of what we're seeing and what the consumer.

And is there anything else you'd want to talk about for the quarter. We discussed charge-offs. I think you talked about more like an 8.8%. You talked about some weakness in NIM on the reversal dynamic. Maybe slightly less so because of the charge-off picture, but not too much. And then anything on expenses maybe?

Yes. So net interest margin will be lower than the first quarter. You got a little seasonal movement, but also we're still a higher peak loss rate in the second quarter, so that will drag net interest margin down further as a result. Well, yes, a little less than what it would have been. Should have been a 9% loss rate, but it will still be more than what would have been the effect on the first quarter. Expenses were continuing to remain very disciplined on expenses. You're in a period where we're not growing a lot. So you point to pull back and make sure we talked about the second half of the year that we're well positioned for the second half of the year. But I would tell you that when we look at the trends, right, the first part of last year, the whole industry got impacted by some elevated fraud. That got under control in the back part of the year and has continued to maintain good control across us and I believe the industry at this point. We benefited from the -- completing the amortization of some software and system stuff at the first half of last year and that benefited us on the second half and obviously continues to benefit us now. And then with the volumes where they are, we're maintaining strict discipline. We've focused on operational excellence, what we call, which is finding ways to automate, simplify, find efficiencies, invest in the business. And so even through this, we are not letting up on our investment in technology and digital investments that are required to serve our customers and drive further efficiency automation and that will continue. So we're right now, I think things look good and we'll continue to look opportunistically for appropriate investments. But right now, it's pretty stable on expenses.

And is that dynamic you highlighted of the lower ticket -- big ticket spend impacting some of the unit change or the other revenue, is that still kind of flowing...

It does, right? So when you have less big ticket, you have less merchant discount fees, a little bit less fee income.

Yes. Maybe we'll switch to late fees. I guess last quarter, you lowered your estimate of that impact in the October 1st implementation scenario of 20% versus the prior 25%. Can you just remind us why you decided to lower that? Was that a result of better-than-expected progress with your conversations with retailers? And how has that trend sort of continued into this quarter as you start to work through those changes in terms and so forth?

Great question. I mean, really, there are 2 factors that had us revised the 25% down to 20%. The first is the final rule came out. And so the original rule had some caps in there around what fees could be relative to [indiscernible] and then they came out with the hard $8. There were other things that were not included. So it was part the fact that the final rule came out in its, I'll say, simplified fashion of $8 and then rules around how to calculate cost to collect and then the continued progress we've made with partners and things that we had confidence we would have in market by that point in time. And we do continue to have progress with partners, but I would not say that there's a revision to the guide that we have previously put out there.

And for the larger offsets you're maybe holding off on at this point or maybe haven't fully rolled through, how meaningful do you think those could be versus what you've done already? And is there a path to Bread eventually offsetting this and becoming ROA, ROE neutral in all these changes? And what's the time line like to get there?

So consistent with what we said, I mean, the biggest impact is going to be APRs, right, getting pricing up. And due to CARD Act, that takes time. So it's really the degree to which your existing portfolio churns and the payment rate moves and cycles that through. And for us, we have a lower payment rate because of the consumers that we serve, and it's going to take some time for the existing portfolio to reprice to the higher APRs. We started putting higher APRs in the market in the back half of '23, took a step up. Then when the final rule came out, you're seeing us take another step up. But that's going to take some time, and that's to -- we've talked about to take a few years for that to fully, I'll say, burn into the portfolio. Other things are shorter term, like you saw us go out with a $2.99 statement fee. Again, that will be for many partners that will continue to roll out throughout this year. That I almost think is temporary because if I'm signing up for a credit card and there's a fee for that, I'm going to go paperless and digital, which has been one of our objectives anyways to get more of our consumers to adopt digital interaction with the consumer -- with us as a company because that lowers our cost to serve. They can self-serve themselves. It gives an opportunity for cross-sell. So we see great opportunity there, and this is an accelerant to that. But it's more of a near-time benefit and with some of these actions that we're taking near term, we're sharing some of that back with partners who agreed to, I'd say, allow us to work with them to put these things in place sooner. Others want to wait until the late fee change actually goes into effect. Meanwhile there's an agreement in place, they just want to time it a little differently. So again, when you're serving over 100 partners, they all have different timing of the strategies. But to your last point, we said it before, we fully expect to get back to strong returns. These strong returns will be a combination of continued focus on the new business we put on, getting the pricing in place for the existing business has been impacted as well as a focus on operational excellence that will continue to drive benefits to this firm going forward. And there's lots of opportunity across all of it, but we'll definitely get back to strong returns, and we'll talk more about that next week at our Investor Day.

Well, we look forward to that.

But you unfortunately won't be able to join us that apparently, someone's getting married or...

I'll be there in Spirit.

Okay.

Next time you have to check with my admin on the count.

Yes, I know. Hey, Brian...

[indiscernible].

It's all good. So I guess one other thing that's going on is there's questions about how the consumer behavior is going to be in response. That's the biggest wildcard, obviously, right? Possible to perfectly predict. But how has that reaction function been so far from the consumer? And you've talked a little bit about how you've lifted the soft APR caps. You've obviously had the Fed hiking rates. So the consumers already absorbed a lot of that. But how they reacted to the statement fees? Are there -- is there an increase in complaints or et cetera?

Well, no consumer likes fees, right? When they have late fees, they pay late. They call, complaint about it. If there's any type of overdraft, they didn't have money in their account, they wrote a check, they bounce the check, they get return check fee, they complain about it. So that's going to happen. Now the good news is when it comes to the statement fee, there is a path to free. And obviously, we'll put waivers in place in the beginning to make sure that as consumers adapt. And my expectation is the vast majority of consumers will go paperless. So that's a benefit to our expense plan long term. We had a lot of that built into our plan previously. This helps to accelerate it. So again, we plan for increased calls, get easy path to avoiding that fee. As it relates to the higher APRs, again, consumers are always complain about APRs and interest they pay. But this is an unsecured credit. We do underwrite deeper. There seems to be some inelasticity there in that when you look at what a low balance account is and what that amounts to, if you had a $500 average balance, 300 basis points, was that $15 over the course of the year, divide that by 12, right? It's just not -- it's not a lot of dollars when it really comes down to it. So I think there's a little bit of that inelasticity around the consumer that we're not seeing a pullback right now, and it's hard to isolate it because you've got so much going on with the macro environment and what's happening with overall leverage, their ability to pay that these pricing changes aren't material in the grand scheme of what else they're dealing with.

And speaking of underwriting deeper, you characterized, I think, recently the underwriting change dynamic as -- or response to the late fee rule as a last resort. But how drastically would you need to cut back on your -- or enhance your standards rather than shrink your credit box in response to all of the late fee caps there?

It will be partner dependent, right? So there's a lot of things like we talked about all the pricing changes, fees, trying to make sure we return every cohort -- risk cohort back to profitability. And at the end of the day, the partnership we have with the brands is to unlock sales for them. So it is, as we said, the last resort, the last thing you really want to do. And it may be, in some cases, that the partner will forgo bounties or their partner compensation on these risk cohorts because they want to continue for us to underwrite to unlock the sales for them so they can make their margin on the sales. Where that's not possible, we will need to change the underwriting practice for that population. Where we see it, it's going to be more in probably soft goods. Where it's harder to find this solve with the highest risk customer, the lowest balance. And that's where there may be some more pullback. But when you look at the grand scheme of what it means to total originations, total loan impact, it's not going to be entirely that material and then it allows us to lean in another partnerships and elsewhere into our pipeline of opportunities and to redirect capital.

So I guess what I'm hearing is for those more affected retailers where there's more at risk shoppers that may be a little bit more dependent on that shopper coming in mid-order of the store and giving them credit access. If they want to maintain that, they're going to have to maybe share a little bit of the economics with us on that.

Yes, that's right. And we -- that progress is undergoing. I mean, look, this is something where -- this is -- this regulatory change is happening to us, to them. It's not something we're doing to them, right? It's happening to both of us in this partnership. So we're working together, so we've come up with a successful outcome for both parties.

And one response we've heard from some retailers is they'll launch a co-brand card, try to dilute the impact of late fee by going more upstream in the quality of that consumer and that borrower. But there's only so many co-brand cards that can go around. Again, not everyone can have a top of wall of credit card. So I guess, what's your response to that when you hear that from some retailers?

No, I think that's -- for the retail, I think that's a fair thought because if they can -- to your point, it doesn't have to be top of wallet. But if they can capture more everyday spend than just being in store, it means the balance is bigger. There are some points that the customer earns for that particular retailer. And then the better credit quality within the credit spectrum of who you're offering, you can go a little down -- a little further down and offer some co-brand in there. So it is a good approach. I mean, you're still going to risk-based price, right? But it means that the program can be more top of wallet or closer to top of wallet and you get more everyday spend, and that's good for the retailer and for us, clearly, as it helps diversify the spend a little bit more.

And if we think about more of the bull case here, let's just pretend, rule gets blocked, never goes through, how should investors be thinking about the potential upside from maybe some of the offsets you've already put through as we look to '25 and '26? Are you going to maybe leave some of them in or reevaluate, talk to your retailers?

So we have a phased approach to these offsets going in place, the mitigation strategies. They're in flight. As I mentioned earlier, some retailers are holding back a little bit. What I have observed in this industry for the past 30-something years is the competitive forces work really well. And if the -- if there's stickiness in the APRs, they'll hang around, the partner will want to get revenue share around that. If they view that as geez, others are lowering their price, the APRs, the competitive forces will have those APRs coming down. The statement fee is one of which we've introduced that will drive paperless. Again, I think that's transitory in nature. If we start introducing things like promotional fees on big ticket and you don't need it to achieve the return hurdles and the merchant really prefers not to have that, that would unwind. So I think it's going to be a mixed bag of what happens. But at the end of the day, you tend to find in a competitive marketplace that the returns get to a certain point for the banks. We're all rational in that. And then the retailer obviously wants as much of the share they can get from the program as well.

And when you were talking to Saks, and they probably have a little bit less of an impact on late fee given the quality of their shopper. But how did late fee come up in that conversation? Like where -- what was the pain point there? What was the agreement there?

Interesting question because the late fee rule in proposal came about while we're evaluating that partnership. Now this partnership has been for a while. But -- so there is a period of time before you make the announcement. And it was -- I want to say, partway through that, where we had to make sure we were really focused on the profitability constructs that we have protections in there. If this late fee rule went into effect, we had the ability to take certain pricing actions and with the profit share construct that we were going to make sure we got the right returns. And that's true of what you're seeing in all the RFPs in motion right now. And that's where different partners are coming to market. There's definitely a lot of focus on consideration to ensure that the protection are in place for both parties.

And was there anything to that discussion that maybe you're noticing your peers doing differently on late fee with those to the extent you can talk about it?

I don't think so. I think everybody's kind of -- there's always so many levers to pull on. It's...

Right. Okay. And thinking of these retail partner contracts, if we look at your existing partners, I think you have your top 5 locked up through 2028 and then you've got another 85% through 2025, if I have it right, something around that -- Brian suggest...

It sounds about right. I'm looking to Brian for the...

Anything we should be aware of in the 15% that's not locked up? Or anything that's in that 85% that's sitting in the '26, '27 bucket? Or...

No, there's nothing major there, right? This is just normal -- the normal contract cycles renewals. I mean, look, when you have over 100 partners, you're always looking to renew the best partners and some you look at, say, it's not working out and you trim and you prune and that's being responsible. And so I think every year is a couple of years, you prune and that's good for the company and good for the shareholders.

And when the partner chooses you or chooses to stay with you versus the partners that leave, where are you finding the key point of differentiation? Is it economics? Is it...

Well, they all want economics, right? But it's about who can grow their portfolio and are things we can do in using our data analytics, marketing capabilities to give insights back to them and vice versa to help grow the pie. And you've heard our CEO talk about that. It's about growing the pie for both parties, and that's where our team is really good at.

Okay. And if we think about deposits, you've got that goal out there of getting half your funding to the consumer direct deposit base. And I think you're still pretty close to the top of the league tables on deposit rate right now. How do you think about the trajectory of your funding costs at this point given that you still want to grow that book? But the Fed's about the cut and some other -- your peers have started to cut their rates too. Should 2Q maybe be the peak more to go there in terms of your average funding cost?

So it goes back to the mix of what we have, right? So we're taking direct-to-consumer deposits that we view as very attractive with the lower average balance compared to wholesale or brokered CD. And so it's really substituting for that as a funding instrument. And so it's an attractive cost of funds. We'll continue to grow, as you mentioned, getting up to 50% as our target. We're over $7 billion today and made tremendous progress on growing it. I expect the cost of funds to be off the camp, the Fed's going to hold, I'll say, higher for longer. And that's been our position for a long time because we didn't believe inflation was going to come down that fast, and it hasn't come down that fast. So the higher for longer means the cost of funds is going to stay up there a little bit. And we're monitoring every week the deposit pricing team meets and figures what we're going to do with the pricing and make sure we have just steady little inflows coming through, continue to grow our base, not trying to go for outsized funds coming in. And so with the higher for longer, that's good. Now when rates start coming down, we'll get a little bit of NIM compression because the assets will come down a little faster.

I think the market might be disagreeing with a little bit with you today post CPI prints. So we'll have to see if that prediction comes true, but...

Yes, we'll see.

Yes, yes. You touched on expenses a little bit already. But relative to your guidance or specific to your guidance, rather, you're talking about that declining low to mid-single digits this year. You already touched on some of the big drivers, but just maybe talk about that? What's driving it? What the outlook is? How much of that is coming from just slower volumes and changes in underwriting versus actual productivity and efficiency enhancements?

It's a combination. I mentioned earlier we had a couple of nice tailwinds and lower amortization cost this year versus last year. Fraud coming in better, and the team has done an amazing job continuing to tighten up fraud controls. And with that, we continue to evolve and advance our fraud analytics and capabilities because one way to reduce fraud as you really contract originations on the front end. And so you try to really get sophisticated to make sure you're not affecting top line growth, but the fraud activity has been a positive, but something you never take your eye off of. You mentioned that, yes, lower volumes coming through have naturally lower some of the cost base, right, because of all your variable costs. And as I mentioned earlier, staying focused on operational excellence, where we can continue to drive efficiencies that allow us to pour back in money to fund the investments that we're making that fuel more growth, more capabilities and further efficiencies in the future.

And maybe any update next week on your views of efficiency over time or over the next year?

It's better.

Sorry?

It's better.

Okay. How much better?

I don't know. Every year I say we're going to try to deliver positive operating leverage.

Okay. All right. So while we're on that topic, you've got the Investor Day next week. I won't be there but...

We do.

But you will. Maybe you could...

I tell you right now what I was going to say since you're going to miss it.

Yes, you just got to give me exactly everything right now. Brian said he's working on it. So what should we expect or what you're going to talk about...

What's you're going to hear you'll hear from each of our executive leadership team, what's happening in the business. I think we'll highlight a lot of the tremendous progress that we've made over the past 3 to 4 years. And you can see it in our results, and we talk about it every quarter, really proud of the team and how we focus on being disciplined, taking care of the balance sheet the way we have and then we'll -- then I'll share what to expect in terms of financial targets over the medium and long term.

Okay. And maybe something on capital return. I mean I know there's some CET1 seems to have proved a lot, but there's Tier 1, Tier 2 opportunity there as well. Okay. And then anything else in the quarter that we missed so far that?

I don't think so. I think you didn't ask me about our reserve rate in case...

Oh, yes. Let's talk about that. So what's it going to do?

Don't know. So -- but the reality is what we do is that the last month of every quarter, you run your reserve models based on what the portfolio looks like at that time. But I think we hopefully are going to be flat to steady. I don't anticipate a tick up based on what we're seeing with delinquency and expecting that peak. So encouraged by the trends that we're seeing and the fact that it seems like the economic scenarios that we'd be using should remain pretty stable. But I would expect is this delinquency remains stable and losses start to come down throughout the year, that should allow for the reserve rate to drift down over time.

And day 1, that's more of a longer term?

There's so much that goes into that, right? The team that built day 1 is different than the team here today. Say that loud, different models are going to be used and different portfolio mix. So you could be lower, you could be back at it, it can be slightly higher. It just really depends on methodology, composition of the portfolio and the economic outlook. Do you put any weighting into something that's more of a down scenario than up scenarios.

Okay. I think that's all the time we have for today. Thank you, Perry, for joining us. And it sounds like you have some really nice things going for the business right now. So we're looking forward to catching up and good luck with the Investor Day next week.

Well, thank you. We'll have as much fun as you will have next week, but it will be fun.

Yes. I hope so.

Thank you.