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

All right. Good afternoon, everybody. We have Bread Financial with us here today. Before we get started, I'm going to read some quick disclosures for important disclosures, please see Morgan Stanley's research disclosure website at morgansilly.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. I think I get faster every time I do that. So with us today, we have Perry Beberman, CFO of Bread Financial. Perry, welcome back. I think this is now your fourth year seasoned vet of the conference.

I think that sounds all right.

So welcome. Why don't we get right into it? So before we dive into some of the bigger picture questions, could we get a quick update on what you're seeing on the consumer quarter-to-date -- last quarter, you did note some evidence of a pull forward, you think and spend ahead of tariffs. Are you seeing that continue? Has your view shifted? Can you also talk about what you've seen in your credit sales and how that's evolved so far this quarter?

Yes. So speaking of the quarter, a few things. One, on the credit stats that came out this morning that came in pretty good. Pleased with the progress we're making and you think about where we are now through May, the trends are coming a little better than we expected when we set up the outlook to start the year. So encouraging signs there. I do want to remind everyone that we still anticipate a $13 million impact in the quarter or about 30 basis points of impact in the quarter for the NCL rate for second quarter. And that is related to the hurricane-related accommodations that we have put in place for consumers, who are impacted by these storms late in 2024, and that will be the end of it. As you get through June. June's impact will be a little higher than what it was in May. But in aggregate, $13 million or 30 basis points of the loss rate. As it relates to credit sales, credit sales continue to be pretty good. We're seeing some improvement year-over-year comp wise and expect to see an increase in second quarter versus first quarter. And to remind folks that when that occurs, you're going to have a little more drag on the RSA in the second quarter, so impacting noninterest income accordingly. And so the best correlation is to look at origination trends and then make sure that there's -- you factor in that RSA drag. And it's really -- you pay that upfront, but then the loans are on the books that roll in your interest on going forward.

Any sort of way to think about that impact sizing wise? Or...

No.

Okay. And just on the Meta June dynamic, so lots of an impact in May, but even with that impact, still a pretty good outcome for the month in the credit data, but more to come in June for the hurricane impact?

More impact will be in June. So I would expect a slight tick up in the NCL loss rate in June compared to May as a result of that. But other than that, you look at year-over-year comp for May being down 83 basis points, even with the hurricane impact in there. So I think we're encouraged by the trends that we're seeing.

Okay. And since we're on the topic, does that have any impact on how you're thinking about the full year guide 8% to 8.2%?

It does in that where we are right now, it had you told me at the beginning of the year, that liberation day wouldn't have occurred and there wasn't pressure on tariffs and what that might mean to consumer payment behavior in the second half of the year, I would have told you that we're probably going to be maybe below that low end of the guide. Right now, I'd say I feel very confident in the low end of the guide at the 8% level. I want to see June come in. I want to see a little bit more in terms of this tariff resolution. Today was an encouraging day, right, where it sounds like the high end, the top end of tariffs is starting to pull down. The question is how does it play through the economy, consumer sentiment, spend, payment, any uptick in unemployment. The back half of the year is not necessarily playing out as optimistically as what I think we thought at the beginning of the year, where you're going to have that soft landing with continuing improvement in inflation, lower interest rates. It feels like the improvement is slowing. But again, I think we'll be able to guide a little tighter on that after we see the June data because then you have your delinquency formation that will play through the rest of the year. And then really what you're talking about, do you continue to see the improvement in roll rates that ultimately manifests itself into the ultimate losses for the year. But as of right now, things are -- I'm encouraged by the trends that we've seen stability, and that's been a good thing.

Okay. So it sounds like near term shaping up positively, but maybe a little bit more uncertainty in the back half of the year, more to come there. Another near-term item to address the bond tender you recently did. May you announced a cash tender to purchase up to $150 million of your 9.75% senior notes maturing in 2029. It looks like we got the results last week, some good demand there. Can you talk about why you pursue this, what your plans are from here?

Yes. So thank you for bringing that up. So we did have good demand. We had over $500 million in opportunity to -- through the tender offer. And we only took $150 million of it, right? We're looking at the cash position we had and when we have excess cash, keeping a solid liquidity buffer, putting into the Fed at 4% to 5% interest rate when you can take out some bonds that were at 9.75%, which is good interest rate management there. So we did that. Going forward, we're going to continue to see what kind of growth is in front of us. And we'll -- maybe if there's time to be opportunistic. Again, to remind you on those -- those bonds that were -- senior notes, $900 million were outstanding down to $750 million. We have a first call option that is in, I think, May 15 of next year, [ 104.78% ], so we were able to do it at [ 107.8% ], a little bit of premium. That premium will hit in the quarter to the amount of $13 million as a onetime nonrecurring item. I don't know if it will end up in nonrecurring or not, but bottom line is it was $13 million onetime hit. That will become into NIM positive for us going forward. So it's a pretty quick payback on that. The spread between treasuries and taking down the 9.75%. As we look into next year, you -- and for the rest of this year, you have the interplay between making sure we get to our capital levels. And then do you -- how to use that cash, make sure you keep the right amount of liquidity buffers hitting capital levels, supporting growth. And so the interplay of all those will come to play into what we do with the remaining senior notes. And -- but knowing that March of next year, we have the option to do some refinancing of it.

Okay. Great. Now that we've gotten some of the near-term items out of the way. I think -- are we good on the near term? Anything else...

I am good on the near term.

Okay. Great. Let's maybe shift back to the big picture for a bit, Perry. You're coming up on 4 years with Bread. The company has gone through quite a transformation in that time. Talk about how Bread changed and why investors should care about that. And what maybe don't they appreciate about Bread now?

Well, I hope folks appreciate what we've done. I mean we have been on this journey. And when you say 4 years, it's crazy that it's already been 4 years. The amount of transformation that this company has gone through has been pretty remarkable. When it started with the board having the vision, I'll say, almost 5 years ago to simplify this company, right, to shed all non-related businesses that -- and really focus on the 2 banks and the financial services component of this, brought in a CEO in Ralph Andretta, seasoned financial services executive, who then formed the management team of the likes of Val Greer, who came in with a lot of financial service experience, myself and others and then elevating people from within the company, who were in a lot of those bank roles, the financial services. So we are really trying to operate with the financial discipline, capital discipline, and you can see it in the results. I mean this doesn't -- didn't happen overnight, but 4 years seems like a short period of time, but it's been budgeted by a maniacal focus on being disciplined and building out better enterprise risk management processes, which takes years to get that type of the uplift in that. The focus on -- you've seen it through the financial results, the capital levels the capital discipline, the capital policy, liquidity risk management, things that matter to regulators with the FDIC matter to rating agencies where we were able to get our -- the first time we had a rated bond back in the end of last year. So all the things that we've been working towards is starting to play out, and you're starting to see that inflection point. And what matters is we're hitting the markers, right? You saw the first material buyback, stock buyback in the first quarter as a result of that when we introduce subordinated debt, and we're really close to hitting the targets that we've laid out there. So the discipline, the capabilities, hiring the new Chief Technology Officer, who's upskilling the team and modernizing how we deliver tech, all these things are helping us hit our stride. So for us, the economy is what it is, you got to navigate it and we have a seasoned team to do that. But the transformation of this company from what it was 4 to 5 years ago to where it is today is pretty remarkable.

And you've also shifted the business mix towards quality, co-brand. Talk about how you've been able to win deals or -- win the deals that are actually driving this outcome and the continued path there. What strategic goals and KPIs are your partners most focused on as you engage with them in those conversations, sorry?

Yes. I mean in the business of partnerships, it's a partnership business, we have a retail partner or a co-brand partner, a lot of it comes down to relationships. When you're pursuing a new partner, you're meeting with them many times, and we meet with them at all different levels and across different functions. So before it might have just been the person, who is the relationship or the business development person out there. Now our CEO will go meet with them. I'll meet with them. We'll bring our Chief Technology meet with their Chief Technology Officer for how can we integrate. So you're having multiple functions come to the table to bring the capabilities, to have and understand and to build the report relationship. Again, it's a partnership model, which means you are partnering together for the greater good of both entities. And so when it comes to what they're looking for, they will look you in the eye and believe that you're going to be able to deliver on the promise of helping them better understand their data, analytics, marketing opportunities, helping them construct a value proposition that will resonate with their customer to, again, unlock more sales or more engagement, more loyalty and then have an appropriate set of economics. It's very easy for 2 finance guys in the room we can hash out what economics might look like. But it's way more than that. And that's what they're looking for. Is who can help them unlock the sales, but also retain loyalty and engagement with their customers.

Okay. Makes sense. And one other question I get is whether the retail card industry faces some secular growth challenges as Buy Now Pay Later and other fintechs are competing with you. What's your pushback there? What do you think folks are getting wrong with that assumption?

I think there's always going to be competition for lending. And when I think about Buy Now Pay Later, and I've said this before, they're probably only about 30% of the people, who get Buy Now Pay Later would qualify for private label cards or the low-end credit cards. A lot of people are displacing debit card usage with Buy Now Pay Later. Before they would swipe their debit card now, okay, they maybe can't afford it right away. They want to get it paid out of the next paycheck, so they're doing some more of that split pay, Buy Now Pay Later. And that's just a different cohort. Buy Now Pay Later tilts a little more subprime than prime where credit card, there we can be near, prime and up. So there is some crossover. There could be some pressure on the lower end, but I don't think it's something that's pressuring your prime plus customer, maybe put some more pressure on the near prime.

And we talked about the Bread's evolution on shifting to quality in co-brand, but another key aspect of that evolution is your credit and your underwriting. So you've improved that subprime mix from about half of the book in 2020, now down to the low 40% today. Considering that ship, is there maybe a case for you to outperform your through-the-cycle loss target of about 6%? And how do you think about the risk return for your business as that mix shift continues on from here?

Yes, so -- yes, I think it's a really good question. And I'd like to say, yes, we could outperform it, if the risk mix continues and the overall credit environment improves. The challenge is, you mentioned we're close to that 43% of subprime. And -- but given where we are with the macro and how we got here in that very large portion of Americans are feeling the pressure from what's been the past 4-plus years of elevated inflation, that persistent impact to their, I'll say, the average basket of goods they're purchasing, wage growth has started to improve there, but it's going to take a while to get back down to that 6% through the cycle just because it needs to work its way through. It's not like typical unemployment-driven credit cycles where a stripe of customers go bad up and down the risk score and then everyone is left, the 98% that are left are the call good, meaning they have good credit and it actually end up with a cleaner portfolio. Here, everybody is still working their way through it. But as you go through the cycle and you get out there, it's possible that with the different types of partners that come online, a little bit higher credit scores, it's possible to come below that the 6%, but it's really going to, as you said, be dependent on risk mix. At the same time, because of our underwriting approach, we don't target a loss rate, when we are underwriting a particular customer cohort, we are targeting a return on capital, and we assign a different type of -- different economic capital depending on your 2% loss, its expectation cohort or you might be 15% loss cohort, which can still be very profitable if you have 35% interest rate and 15% losses. And lately, as you can imagine, there's still money made there. So it's -- when you underwrite deeper how does it -- how do you end up? No matter whether it's co-brand or not, it's -- we're underwriting for return less than rate less than loss rate, if that makes sense.

Partner dependent, their goals and everything else, right?

Yes.

So what about the credit action stance? You've taken some tightening actions in recent years. Where are you on that today? Are you continuing to tighten? Are you largely done -- are you thinking about lifting? What would you need to do to start lifting your foot off the pedal. You don't target a loss rate, but is there maybe like a loss rate you want to get down to before you think about doing that? Or...

I wouldn't say there's a loss rate that we have to get down to -- to consider some unwind of the credit actions. In fact, I'd almost argue that if the time we're right and you can unwind some credit actions by increasing credit lines on customers are performing really well. That can bring in some new balances, better balances with better risk profile that could help your loss rate eventually. So it could actually help you work the loss rate down. In terms of credit posture, we've been in a pretty restrictive posture, expecting that summertime, we could have started to unwind some of these things based on what the original hypothesis was or thesis was on macro. Right now, I mean anybody has seen the latest Moody's outlook looks like it's softening now in the second half of the year, makes us a little more cautious as the macro inputs are a variable into the decisioning on expected losses and is now the time to do some of that unwind. So I think we're -- and I think I know we just need to be cautious, prudent. And when I say that, there's still always been little pockets that you're doing some unwind to while you're doing other restrictions in other areas. It's never been binary. It's all for it's all on. It's -- and it's always going to be, as we unwind, it's going to be slow, gradual as you see the credit improvement as you see the on us behaviors look better. It will give us confidence that, coupled with the macro outlook to then strategically do some things to do some more line increase programs, maybe a little higher initial line assignment. But in terms of approval rates, that will still end up being kind of where it's at because we underwrite as deep as it makes sense for the profit that we expect.

Makes sense. I think that was quite clear. So it could have done summer, but maybe that's on positive now until you learn more. Let's talk about one aspect of credit or credit quality, just the recent focus on student borrowers. We've -- you've been quite clear that there's been pressure on the low-income consumer in this key economy. What are you seeing today from this consumer? Is any of this spreading to middle income, particularly student loan payments have started? I mean the middle-income consumer is quite impacted by student loans probably. So anything you're noticing there?

Yes. We have gotten a lot of questions on student lending is something that we've been trying to be transparent about for a while that we do monitor our consumers that have student loans, about 20% of our -- our population has a student loan on their credit bureau. What we've observed is they perform pretty much in line with the rest of the population, whether you had a student loan or not. Again, they were benefiting from not having to make payments on those student loans. Now when we underwrote those customers, we underwrote them with the expectation when you look at their discretionary income that they were going to have to make that payment at a cash flow at the time of underwriting as if they were going to make that -- make the payment. So what we've seen since, now we're able to see customers are you making -- are they making payments on those student loans or not? And what we can see is a bifurcation of customers, who have made payments on their student loans, their delinquency on the credit cards with us have remained stable, consistent with the rest of the portfolio. There's been no material uptick. For those -- and what we've actually seen with those customers is their risk scores have gone up. They're improving. So customers who are resuming payments on their student loans are seeing an improvement in their risk score, which would tell us down the road, that's going to make them more eligible for a future line increase, right? That's shown good payment behavior strength of the customer. We've other customers who have chosen not to make their student loan payment. And they're showing increased delinquency on their student loan on the bureau, we're seeing very stable delinquency with them as well. No separation from those who are making payments on student loans versus those who weren't. But what you're seeing with them, so they've prioritized, continue to make payments on their mortgage, auto, credit cards, because credit cards have utility, so we do a payment hierarchy, they're choosing that credit card payments have more value to them near term than paying on the student loan. But what's happening is now this report on the credit bureau, their risk scores are going down. And so that will make it more -- them more likely to be subject to a future risk action if necessary.

Makes sense. And who knows, if these consumers even know they were supposed to pay in their loans either, right?

That's a good point. And then the other question we get and I'm sure you get it as well is, well, geez, what happens if the government decides to do garnish wages and do those types of things. Look, I don't know the probability of that. There's certainly -- it's out there as a possibility. But when you think about populism or populous type administration, that's pretty punitive to say you're going to put your student loan payment as the first thing the customer has to pay out of every paycheck or social security check before making a mortgage payment or rent payment or anything else, I don't think there's a high probability of that. But that is something that would -- could change delinquency or payment patterns on credit cards, if that were to happen for those cohort of customers who today choosing not to pay.

Yes. Yes. Makes sense. Let's shift gears again. So regulatory side. You've got 2 rules in your favor lately. Late fees and I think the tush-push staying in place last [ Saturday]?

Yes. We'd like to call it the Philly Show, but, yes.

Okay. Well, I think only you call it that. But, alright. Keeping into the business side of things, you said you believe higher pricing changes across the industry can stay in place. Can this provide more of a tailwind to NIM in revenues for you over the next few years? Or do you think your partners want to reinvest this into rewards and other value props?

Yes. Back some question on -- we're obviously pleased that we -- the regulatory environment regulatory but the -- the environment change on the CFB late fee rule. As it relates to pricing, I think I've been pretty clear on this over time that my expectation is long term, it gets competed away. Near term, it can provide a little bit of a tailwind or it at least can help buffer the impact of what we're seeing right now, where we have elevated losses. It creates the appropriate margin to care for this period of elevated losses. In time, you expect that some of this will get reinvested into a value or value proposition for the customer. Some of it gets shared with a partner. And then in time, 5 years out or more, these things tend to work themselves out through different economic sharing when renewals or RFPs come to market. There's always somebody in newer entrants that wants to -- is willing to have a certain return. But again, it goes back to just rational pricing. There could be some rolling back. Some of the things in place are surprisingly not having any, I'll say, statistical impact to credit sales. So that's a good thing, which means we can work with the partner to maintain some of that's a positive.

And what about the promo fees ad? I mean, we heard from someone else that they're planning to probably take those off. So is that something on the...

I think it's probably a partner-by-partner decision. I mean if they're sharing in that, both parties are impacted. And if you can demonstrate and show them the statistical data that says sales are not being suppressed from that. I mean somebody can get a 12-month financing, same as cash 0% interest. And if you pay upfront 2% fee, that's a pretty good deal. So again, we're not seeing suppression. I think some of it might be psychological for the partner, not looking at the data. So I think it depends on the motivation often of the partner.

And how many of these conversations have you had? Like I'm assuming you've not yet unwound anything or reinvested yet, but like what's the cadence of conversations looking like at this point? Is it still too early? Or...

We have an amazing client partnership team. They're talking to partners every day. So some may become more front and center, if they're feeling sales pressure, maybe they want to believe that it's because of the higher APR on new accounts or a promotional fee and you try to show them data. A lot of times, if you're a private label card, -- and the pricing is at 33% or 34%, 35% or even 30%. Is the customer really going to make a different choice about whether it take the card to make the purchase. It's still somebody who's newer to credit, maybe a little damage credit, and it's still a square pricing value proposition for them.

Okay. Is there any way to maybe think about the benefits of route to your ROE from all these pricing changes? Or...

I think the best way to maybe articulate is probably what the impact has been to net interest margin for the year and let that translate a little. So for this year, when you think about the effects of the interest rate, the prime reductions, the Fed funds reductions from the back part of last year, a couple more maybe expected this year. For us being asset sensitive, that would have given us some net interest margin compression. We have had elevated losses in the first part of the year. Again, there's higher reversal of interest and fees, which is a drag. You continue to have a risk mix improving, which better risk mix, lower APRs that's a little bit of a drag. And then you also have lower build late fees, because delinquency is improving. So as delinquency improves, you get less late fees built. These things would have actually all else being equal. We would have said net interest margin would likely be down year-over-year. Our guide is now that net interest margin will be slightly up, like nominally up. So the pricing actions that we put in place are helping to maintain or slightly increase net interest margin in the near term.

Got it. Makes sense. And shifting to capital. You established medium-term capital targets of 16%, total risk based last year, 14% CET1 and then a longer-term CET1 of 12% to 13%. You've talked about being more opportunistic on the buybacks. It looks like you did that more recently. You did the $150 million buyback authorization, execute on the full amount last quarter or also through April, I believe. You also did the sub-debt issuance. We touched on the bond tender, so a lot happening, obviously. But with your CET1 now at 12%, what do you think about the trade-off of buybacks versus dividends versus growth from here? Is there a valuation framework you would employ. So first...

Look, we are really pleased with the way we executed on the supporting a debt deal and then swiftly being able to execute the stock buyback below tangible book value. That was, again, being opportunistic -- we struck, we got agreement with the Board to do so. And to your point, we ended the quarter at 12.0% CET1. Our target is probably closer to 13% to 13.5% is where we should be living right now with CET1. So we need to get to those spot rates. And again, we do look at a 4 quarter forward role. But we are mindful of the relationship we have with the FDIC, our regulators, rating agencies. We want to make sure we hit these numbers. So the first thing in terms of priority is supporting our business growth. The second thing is hitting those capital ratios. That was more of an opportunistic thing that we did. And then as you roll forward, I mean, you could tell the amount of cash and capital accretion that we're able to generate, I think, to get down to the 12% target we're going to need to better optimize our balance sheet, which include introducing preferreds into the capital stack. And that's something that I would hope to execute against some time into next year and build that over time. And that will drive down the binding constraint to closer to that 12% that you mentioned long term. In terms of priorities, look, the priorities that we've had haven't changed. They really haven't like support growth, it's got good growth, it's got to meet the right capital returns that we're all happy with the expected return on capital. Keep funding the things we need to fund on technology and capabilities, and that helps fund the operational excellence that will continue to drive down our efficiency ratio over time. And then as you mentioned, between dividends and share buybacks, we definitely have more of a bias towards buybacks, particularly while we're trading well below what we believe is an appropriate multiple for us.

Okay. Great. A couple more from me. Any potential thoughts strategically -- strategic question here, any thoughts on potentially expanding outside of other areas -- into other areas outside of retail card? Any ways you can lean more into things like embedded finance, BMPO with the Bread offering or look at some more capital light ways to do lending in your business?

No, that's -- so we do -- we do evaluate different strategic options. And for all the things we just talked about of how to deploy capital, we got to make sure we're doing a way that is the next best use of capital in a place, where we have, I'll say, the right to win, meaning we have the skill set, we have the capability within technology and that we're not putting other technology priorities at risk of not delivering on things we have for our current partners, to go play in a field that maybe we won't be as successful. But you mentioned a number of things where we do believe we can be successful. We've announced a couple of enterprise deals that will come through on our Buy Now Pay Later platform on Bread Pay, where we'll do more of the installment lending. I expect that can grow. We can grow in some personal loans. Again, very much in the wheelhouse of what we do and leveraging the capabilities that we have. There are some capital-light opportunities of some sponsor bank type things we could explore. Again, if that's more about make sure the enterprise risk management framework in place. But again, leaning on core capability. I think that's the important thing. Where it gets a little looser is if you were to say, and I think where we evaluate all different opportunities for adjacent products is not to get into things that are not within that meaning. You start doing small business lending, very different than consumer lending. And we go to auto loans, there's a different type of capital-intensive businesses or mortgage, not so much of interest to us.

Okay. Great. And maybe in the last few minutes, we can wrap up here, Perry, with the strategic question for you. So you talked about Bread's evolution at the beginning. What's the next phase of Bread's evolution? What are your top 3 strategic priorities as we look out the next few years? And maybe you could layer on, on how you think Bread can sustainably reach this medium-term ROCE target of 20% plus.

Yes. I am really excited about the next few years. I mean I was excited about the past for what we've accomplished, and those were in some really challenging times. When I think about the team that's been built and the environment and hitting our stride in terms of generating capital and how we deploy capital, we cleaned up our balance sheet. We took up more than half our debt or hitting the capital ratios, we're going to have lots of options of how to deploy capital, and again, doing it smart. The fact that we are uplifting our technology organization to really be able to deliver things faster for the customer, faster for our brand partners. There's opportunity there. I've been very excited about operational excellence. And I know that's just a term, but the amount of engagement we've had from our employee base, we've taken thousands of ideas on how to improve processes, end-to-end processes, small and big and some transformational work that we have going on and what we are delivering even in year that manifests itself into multiples of values over the coming years. I have a lot of confidence in driving down efficiency ratio, which is an important way to achieving that ROTCE and then further optimizing our balance sheet, which we talked about earlier, I think we've demonstrated the strength of our team in executing against things that we said we were going to do and doing it faster than we believe could be done. And so I think as we look forward to the next year or 2, I expect to have an optimized balance sheet and then really be able to generate those returns that we talked about and then return available capital as appropriate to shareholders.

All right. Great, Perry. I think that's a nice place to end it. So with that, thanks for coming to our conference. Appreciate it, Perry.

Thank you very much for having me.