Bread Financial Holdings, Inc. (BFH) Q4 2022 Earnings Report, Transcript and Summary

Good morning, and welcome to Bread Financials’ Fourth Quarter Earnings Conference Call My name is Charlie, and I'll be coordinating your call today. [Operator Instructions] It's now my pleasure to introduce Mr. Brian Vereb, Head of Investor Relations at Bread Financial. The floor is yours.

Thank you. Copy of the slides we will be reviewing and the earnings release can be found on the Investor Relations section of our website. On the call today, we have Ralph Andretta, President and Chief Executive Officer of Bread Financial; and Perry Beberman, Executive Vice President and Chief Financial Officer of Bread Financial. Before we begin, I would like to remind you that some of the comments made on today's call and some of the responses to your questions may contain forward-looking statements. These statements are based on management's current expectations and assumptions and are subject to the risks and uncertainties described in the company's earnings release and other filings with the SEC. Also on today's call, our speakers will reference certain non-GAAP financial measures, which we believe will provide useful information for investors. Reconciliation of those measures to GAAP are included in our quarterly earnings materials posted on our Investor Relations website at breadfinancial.com. With that, I would like to turn the call over to Ralph Andretta.

Thank you, Brian, and good morning to everyone joining the call. We set ambitious goals in 2022, and I'm extremely proud of our associates for moving our company forward by executing on our initiatives to achieve these goals. I'll begin on slide three, which highlights several major accomplishments achieved in 2022, as part of our ongoing business transformation. To begin, we rebranded from Alliance Data Systems to Bread Financial. A tech forward financial services company providing simple personalized payment, lending and saving solutions to consumers. Following our multiyear corporate transformation, Bread Financial has emerged as a more modern, nimble and streamlined company backed by leading technology and custom platform solutions that empower today's consumer. Coinciding with our rebrand, we launched our direct-to-consumer, Bread Cashback American Express credit card and we branded our buy now, pay later platform to Bread Pay, which offers installment lending and split pay solutions to an omnichannel approach. We also rebranded our retail deposit platform to Bread Savings. These enhanced products provide industry-leading benefits and complement our existing suite of financial offerings, ensuring our customers across generational segments have access to payment and saving solutions. We continue to sign new iconic brand partners, including AAA and the NFL, while renewing valued long-term relationships like Victoria's Secret. We have secured renewals with brand partners representing approximately 85% of our year-end 2022 credit card balances through 2025, after adjusting for the anticipated sale of the BJ's portfolio. We also saw success with de novo program launches in 2022 such as B&H photo, which exceeded our initial performance and growth projections for the year. We look forward to working with our new and existing brand partners to drive incremental sales growth and customer loyalty through our sophisticated data and analytics capabilities, enhanced value propositions and comprehensive product suite. In 2022, we invested more than $125 million in technology modernization, digital advancement, marketing and product innovation. Major achievements included transitioning our credit card processing services to Fiserv, converting to the cloud and integrating Alberia, a state-of-the-art solution and enhances the productivity of our customer care and collections efforts. Our digital advancement continued to progress, as well as we expanded mobile and web-based customer servicing capabilities and launched a virtual card with web to wallet provisioning to provide our customers a more simplified user experience These upgrades supported our transformation, enhanced our strategic differentiation and are essential to driving operating efficiencies and innovation. We remain committed to ongoing technology investment with a focus on further digital advancement. As part of our investments, we increased our marketing investment in 2022 to bolster spend through joint marketing campaigns with our brand partners. Developing strong collaborative relationships with our partners has underpinned our decades of successful growth as these investments build loyalty with both our partners and their customers, as well as expand sales opportunities. Additionally, by leveraging our sophisticated data and analytics capabilities and efficient targeting channels, we were successful in driving new acquisition and engagement with our Bread Cashback American Express Credit Card, Bread Pay and Bread Savings offerings. We will continue to invest for the future to deliver value for our brand partners, customers and shareholders. Finally, I'm proud to announce that Bread Financial was recognized for a prioritization of environmental, social and governance across our entire business earning a spot-on Newsweek's 2023 list of America's most responsible companies. Our commitment to advancing our ESG strategy, objectives and accountability is evident with the organization and remains core to our sustainable business practices. Turning to slide four, we are pleased to have achieved our 2022 financial targets, driven by organic growth from our existing brand partners, as well as addition of our new brand partners and product offerings. Average loans grew 13%, compared to 2021 revenue growth exceeded average loan growth at 17% year-over-year. Pretax pre-provision earnings increased 19% versus 2021, highlighting the quality of the growth we are generating and the underlying value we are creating. We remain disciplined generating more than 200 basis points of positive operating leverage for the year as we managed our expenses in alignment with our revenue and growth outlook, while continuing to invest in our future. Our net loss rate of 5.4% remain within our full-year guidance range and below our historic average of approximately 6%. Along with accomplishing our 2022 targets, we significantly strengthened our balance sheet and bolstered of financial resilience through greater product and funding diversification. We increased loss absorption capacity and growth in capital and tangible book value. Retail deposits on our Bread Savings platform increased to $5.5 billion or 72% year-over-year. We plan to build on these achievements in 2023 through continued execution of our long-term strategy. Moving to slide five, I'll highlight some of our most recent business development success. I am pleased to announce that we have signed a new long-term credit card relationship with Hard Rock International, a well-recognized hotel, casino and restaurant operator. Hard Rock attracts a broad demographic given its diverse offerings, further expanding our reach across generations. We will offer Hard Rock customers a new way to pay, while incenting loyalty and brand affinity through our co-brand credit card. During the quarter, we announced a new agreement with the New York Yankees. This exciting relationship reward’s Yankee fans for their purchase and provides enhanced benefits to our New York Yankee's co-brand credit card, while further diversifying our brand partner base. Also during the fourth quarter, we signed a multi-year renewal with long-term partner Helzberg Diamonds underscoring our strong market share position in the jewelry space. Helzberg Diamonds has more than 100 years of diamonds expertise and operates online at over 200 stores nationwide -- and 200 stores nationwide. We will continue to leverage our advanced data and analytics to enhance the shopping experience to Helzberg's customers. Turning to Bread Pay, we continue to add new brand partners to our platform and importantly, we have now extended nearly 50% of our current loan origination volume with new long-term renewals. Because these contracts historically have been short-term in nature, having long-term extensions will reduce volatility and promote long-term sustainable growth. Additionally, our strategic relationship with CECL continued to outpace our expectations with now more than 200 live merchants and installment loan origination volume exceeding our initial goal. We are pleased with our many accomplishments in 2022 and plan to build on this momentum in 2023. Our business development pipeline remains strong and we are confident in our ability to grow responsibly in 2023, despite a more challenging macroeconomic landscape. As always, we remain vigilant and responsibly driving sustainable profitable growth. Perry will outline our specific 2023 financial targets, which include continued strategic investments aligned with quality and revenue -- quality loan and revenue growth. Our 2023 outlook assumes continued inflationary pressures and gradually rising unemployment levels. Headwinds that we expect will result in a full-year net loss rate above our long-term historic average of approximately 6%. This corresponds with our expectations that net loss rate will hover above our historic average during more challenging economic periods and drop below our historic average during more favorable economic periods. With three decades of experience, our differentiated and tested underwriting and credit risk modeling is purposely structured to navigate the full range of economic scenarios, focused on producing positive annual earnings and a strong risk reward margins even during periods of economic stress. With the changes we have made over the past three years to strengthen our credit profile, we remain confident in our long-term guidance of a through-the-cycle average net loss rate below our historic average of 6%. Our seasoned leadership team is experienced in managing through credit cycles and every cycle is different. Some factors like inflation are impacting all consumers and cannot be fully controlled or mitigated. We will manage what we can control. In these instances, we run our business with a long-term focus as we have done effectively in previous downturns. We have and will continue to proactively adjust our underwriting and credit line management to account for the anticipated challenges faced by consumers. We manage our business with strong governance and controls intact and remain aligned and confident on our objective to deliver long-term value for our stakeholders. With that, I will turn it over to Perry Beberman, our CFO to review the financials.

Thanks, Ralph. Slide six provides our fourth quarter financial highlights. Bread Financials’ credit sales were up 16% year-over-year and $10.2 billion. Average and end of period loans were each up 23%, driven by our new program additions, as well as new products and organic growth from existing brand partners. Revenue for the quarter was $1 billion, increasing 21% versus the fourth quarter of 2021, resulting from higher average loan balances and improved loan yields. While total non-interest expenses increased 28% as anticipated. As we signaled previously, EPS was materially impacted this quarter by the higher provision for credit losses, reflecting seasonal loan growth in the quarter, coupled with the required upfront CECL reserve build from the acquisition of the approximately $1.5 billion AAA loan portfolio. Turning to slide seven, I'll review our full-year 2022 financial highlights. Bread financial credit sales were up 11% year-over-year to $32.9 billion and average loans increased 13%. Revenue for the year was $3.8 billion, an increase of 17%, compared to 2021, while total non-interest expenses increased 15%, driven by portfolio growth, inflation and ongoing investments in technology modernization, digital advancement, marketing and product innovation as Ralph had discussed earlier. Income from continuing operations was $224 million and diluted EPS from continuing operations was $4.47 for the year, both of which were materially impacted by the higher provision for credit losses in the year as a result of our strong loan growth, portfolio acquisitions and a higher reserve rate. Looking at the financials in more detail on slide eight. Total interest income was up 30% from the fourth quarter of 2021 resulting from 23% higher average loan balances, coupled with improved loan yields. Non-interest income, which primarily includes merchant discount fees and interchange revenue net of the impact from our retailer share agreements and customer awards was negative $97 million. Total non-interest expenses increased 28% from fourth quarter of 2021, driven by three primary factors: First, card and processing expenses related to incremental card issuance volume; second, information processing and communication as a result of the transition of our credit card processing services and other software licensing expenses; and third, higher employee compensation and benefit costs. Additional details on expense drivers can be found in the appendix of the slide deck. Overall, income from continuing operations was down $195 million for the quarter versus the fourth quarter of 2021 as the improvement in pre-tax, pre-provision earnings or PPNR was offset by a higher provision for credit losses in the quarter. Including the previously discussed upfront CECL reserve impact from the AAA portfolio acquisition in the quarter. Taking out the tax and provision impacts, we are pleased to report that our PPNR improved 13% year-over-year making the -- marking the seventh consecutive quarter that we have generated year-over-year double-digit growth in PPNR. As we have said, we remain focused on making responsible decisions to produce quality earnings. Turn to slide nine. The left side of the slide highlights our earning asset yields and balances. The fourth quarter loan yield increased 80 basis points year-over-year, driven by the increases in the prime rate, but decreased 120 points sequentially, due to seasonally higher balances in the quarter the addition of the lower and yield, higher quality AAA portfolio and an increase in reversals of interest and fees revenues from higher gross losses. Net interest margin increased 30 basis points to 19.1% year-over-year as the benefit from loan yields more than offset the increase in funding costs. On the liability side, we saw funding costs increase in the fourth quarter in line with our expectations given the Fed interest rate increases through December of 2022. As you can see from the stacked bars on the bottom right, our direct-to-consumer deposits continue to grow and now represent $5.5 billion or 26% of our total interest-bearing liabilities. We expect that our retail deposit balances will continue to increase providing a stable funding base as retail consumer deposits become even more meaningful portion of our funding over time. Moving to slide 10, and starting in the upper left with delinquency rate. The fourth quarter rate of 5.5% was slightly below the third quarter rate, following typical seasonality. On the upper right, the net loss rate was 6.3% for the quarter slightly better than our earlier projection, due to lower-than-expected losses in November. The loss rate in December of 6.7% was more in line with our expectations given continued payment rate pressure. If we think about where the consumer is today, we have to look at how we got it. Earlier in 2022, we still saw some of the benefits from the late 2021 stimulus aid coming through in terms of both spend and very strong payment rates. If you look at a trend line from our low point in 3Q ’21 to today, you could see the upward movement or normalization of loss rates from both the wind down of stimulus, which has largely run its course and the influence of elevated inflation. We saw lower scoring and lower income cohorts normalized first. However, given the broad impact of inflation, we're seeing impacts across the full credit spectrum and all income groups. As you would expect, we continue to proactively manage risk reward decisions at the margins for both new account underwriting and existing account line management. This is an ongoing and evolving as the macroeconomic environment unfolds. Moving to the bottom left, the reserve rate increased 10 basis points sequentially from the third quarter to 11.5% as a result of continued elevated inflation increasing consumer debt levels and weakening macroeconomic indicators pulling down the base case scenario outlook. This was modestly offset by the addition of the higher quality AAA portfolio and seasonal transactor balance growth in the fourth quarter. Our intention is to maintain a conservative weighting of economic scenarios in our credit reserve model in anticipation of the increase in macroeconomic challenges and the expected potential impact on our credit performance metrics. We estimate that our reserve rate could increase up to approximately 100 basis points, due to the continued macroeconomic trends, seasonality and the impact from the anticipated sale of the better credit quality BJ's portfolio. In nominal dollar terms, we would expect a meaningful decrease in our allowance balance and therefore a provision for credit losses released in early 2023, again due to the anticipated sale of the BJ's portfolio, as well as projected seasonal decline in loan balances from year end. Our credit distribution improved from the third quarter with economic consumer headwinds offset by the benefit from the AAA portfolio acquisition, we would expect our overall portfolio or overall proportion of 660 plus advantage score customers to move down when we exit the BJ's portfolio. A fundamental element built into our business model includes having controls in place to manage our risk tolerance with the objective of ensuring that we are properly compensated for the risk we take to underwrite and manage our portfolio. We closely monitor our projected returns with the expectation that we generate strong risk adjusted margin above fewer levels. As Ralph alluded to previously, we remain confident as a management team in our ability to manage for credit risk and drive sustainable profitable growth through the full economic cycle. Slide 11 provides our financial outlook for the full-year 2023. For the full-year, average loans are expected to grow in the mid-single-digit range relative to 2022. Our expectation includes projected new and renewed business announcements, visibility into our pipeline, the anticipated sale of the BJ's portfolio and our current economic outlook. The range is contingent on credit strategy actions that will lever on macroeconomic conditions. We expect revenue growth to be consistent with average loan growth in 2023. Excluding the anticipated gain on sale, with a full-year net interest margin similar to 2022 full-year rate of 19.2%. The first quarter NIM is expected to be below our full-year guidance given the inclusion of the lower loan yield BJ's portfolio and a larger headwind from the reversal of build interest and fees related to expected elevated first quarter credit losses. Our outlook assumes additional interest rate increase by the Federal Reserve will result in a nominal benefit to total net interest income. We expect to deliver nominal positive operating leverage in 2023, excluding anticipated gain on sale. As Ralph highlighted, we will continue to strategically invest in our business to fuel growth opportunities and create operating efficiencies, while balancing these investments with responsible revenue growth in order to achieve sustainable profitable growth. First quarter 2023 total expenses are projected to be sequentially down from the fourth quarter of 2022 benefiting from seasonally lower transaction volume and lower marketing expenses. At this time from a dollar perspective, we expect the second half 2023 total expense to be flat to down from the first half of the year, driven by lower intangible amortization expenses and improved operating efficiencies related to our technology modernization efforts. We anticipate the full-year 2023 net loss rate will be approximately 7%. As you can imagine, there's a broad range of outcomes for net charge-offs for the year based on potential economic scenarios. Given persistent inflation and rising interest rates, borrowers are making decisions to pull back on discretionary spend and drawing down on savings, pressuring their ability to pay. Despite low unemployment, moderate income households are increasingly noting payment difficulties during the collections process. Our outlook assumes inflation remains elevated and that these pressures will persist throughout 2023. At the same time, our outlook contemplates a gradual increase in the unemployment rate in 2023. We will continue to closely monitor macroeconomic indicators as we gain clarity on the Fed's efforts to tamp down inflation. We'll update our expectations accordingly. We expect the first half 2023 loss rates to trend upward given the current inflationary pressures, as well as the impact of the sale of the BJ's portfolio. Our first half net loss rate is projected to be above 7% inclusive of the impacts from the previously discussed customer combinations we made in the second half of 2022 in connection with the transition of our credit card processing services. Finally, we expect our full-year normalized effective tax rate to remain in the range of 25% to 26% with quarter-over-quarter variability to timing of certain discrete items. Looking forward, we intend to host an analyst event later this year, we will further highlight what we believe are the strategic differentiators and competitive advantages of our business model, including the capital generation potential to create. At that time, we plan to provide new long-term financial targets, as well as more detail around our capital priorities and capital allocation going forward. Regarding current parent capital levels, our TCE to TA ratio temporarily dropped in the fourth quarter of 2022, due to the timing of the acquisition of the AAA portfolio. Given the anticipated sale of the BJ's portfolio, our TCE to TA ratio is projected to increase to a level above the 3Q ‘22 figure of 8% after the sale. In keeping with our business transformation over the past three years, we made strategic decisions to enhance our financial resilience as indicated on slide 12. We improved our credit quality, product and funding diversification, loss absorption capacity through our loan loss reserve and capital positioning and increased our tangible book value. Our tangible book -- tangible equity plus credit reserve ratio as a percent of loans is up nearly 200 basis points since 2020. Our parent level debt is downward in 33% over the same time period. These enhancements and improvements to our underlying credit portfolio mix strengthen our confidence in our ability to sustain more challenging economic outcomes and outperform our historical results through entire economic cycle. Our experienced team will continue to manage our portfolio proactively. We're utilizing our recession readiness playbook for both new and existing accounts with a heightened focus on open to buy authorizations and helping consumers manage their credit lines and balances in a healthy manner. We believe that our improved risk profile coupled with our more diverse portfolio in brand partner base make us better positioned than ever to manage through a recessionary period. We look forward to building upon our successes from 2022 and we'll continue to make strategic decisions to create long-term sustainable value for all our stakeholders. Operator, we are now ready to open the lines for questions.

Of course. [Operator Instructions] Our first question comes from Sanjay Sakhrani of KBW. Sanjay, your line is open. Please go ahead.

Thanks. Good morning. I guess, I have some questions on the loss assumptions in reserve rate. Perry, you talked about the reserve rate possibly going up another 100 basis points in 2023. So I'm just making sure I got this right. So you think by the end of this year we're probably closer to 12.5% and then the 7% charge-off rate for the year. Can you maybe just separate what the processing, conversion impacts are versus sort of the deterioration you're seeing as a result of normalization? Thanks.

Sure. Thanks, Sanjay. So let me start with the reserve rate first. We're always trying to give our best thinking based on our current visibility into our portfolio and the economic landscape. As I mentioned earlier, we expect the rate to increase in 2023 given the sale of the BJ's portfolio and potentially continued economic weakness. So when BJ's exit, that's going to cause a step up in our reserve rate, because today that's on the portfolio at a lower than the current average that we have. And then you look at the -- I would say that a lot is going to happen in the first quarter, plus then you've got seasonal impacts that can also affect the first quarter. Specifically regarding the risk overlays, I think you guys could see that we are proactive in getting ahead of what we've seen to be future potential weakness, which is what the CECL economic risk overlays help us to achieve. And one thing we recognized early on was that all industry loss models have been calibrated historically on changes in unemployment and those unemployment led recessions. This elevated inflation environment that's currently creating strain on consumers is not what these models are calibrated. So it requires a different degree of judgmental overlays, which is when you hear us talking about, hey, we're leaning into more of those more severe scenarios, which update -- for our severe scenarios. The severe has a -- reaches an unemployment rate of 7.8% over the next 24-months that we’re at peaks. And then the severe reverse adverse peaks at 8.9%, but I don't think those are realistic outcomes of what's going to happen, but we leaned into those for weightings to care for that inflation component. So you can decouple, let's say, there's a judgmental piece, but then there's also the unemployment. So this is kind of a new environment for these models to care for. So when we get to the end of this year, we're thinking that we're going to exit the year with a mid to high 4 % range for unemployment. So that's kind of the -- sorry, I gave you probably a lot more on that with the reserve rate. And then I'll answer the second -- the first part or second part of the 70% loss outlook, that's an increase of 150 basis points to 175 basis points year-over-year. And there's three components that are in that, right? There's the macroeconomic pressure that we're seeing in the consumers and we expect throughout the year there'll be the continued impact of inflation that maybe in the back half of the year that starts to abate, but then you start to pick up some elevated unemployment. Then you also have the second piece in there that's contributing to the increase of 150 basis points to 170 basis points is BJ's, which has a lower NCL rate than the rest of the portfolio, that's going to cause over the lift. And then the third piece for us is we do have some trailing conversion relating -- related items that from customer accommodations that was simply the timing of credit losses that would have been in 2022 that are pushing into the first half of ’23.

Are those equally weighted or unequal? Like is there a more prominent impact from one over the other or?

I'd say macro is definitely the -- more than half.

Okay. And just maybe one follow-up question for Ralph. Just on the processing conversion, I'm just curious, are all the residual impacts over at this point, all the kinks ironed out. I'm just wondering if we should think about anything else? Thanks.

Hey, Sanjay. How are you? I think a lot of the growing pains are in the rearview mirror. And now we're going to reap the benefits of the -- of why we moved quicker to market, better capabilities, less expensive to operate. So unfortunately, we have these kinks, but I think a lot of that is an overview mirror. And we're focused on continuing to stabilize the system and then take use of all of the capabilities that we signed up for.

Okay. Thank you very much.

Thank you. Our next question comes from Robert Napoli of William Blair. Robert, your line is open. Please proceed.

Thank you. Question on your target capital ratio. What do you -- what is -- do you have a formal target? And when do you expect to -- when do you target reaching that target?

Yes. So what we've been communicating is that we're striving to get to a 9% TCE to TA ratio is a good low-end mark. The first priorities of our capital has remained to provide in support profitable growth. And then the second priority is to pay down debt. And we will provide more information about our capital priorities and plans at the Investor events later this year.

Thank you. And I would expect that we wouldn't see buybacks until you hit that or share -- capital return until you hit that target. Is that there?

I don't want to give specifics, but again our priorities are to support our growth, get our capital levels up and then start to pay down our debt.

Thank you. And then can you give any color on the competitive environment? There has been a lot of portfolios. Obviously, that have changed hands? Are you guys have resigned a lot? You've added a lot? What's going on with the competitive environment and the returns that you and your competitors are requiring for deals?

I think no matter what the economy is in competitive environment is always, always hot and that never changes. So that never changes. But when we look at things, we look at things saying, can we grow the portfolio for the partner? Can we do it profitably and does it contribute to growth for us in a right -- correct way? That's how we look at portfolio. So portfolios changed hands, the portfolios we signed and acquired, we have a lot of confidence that we'll grow those portfolios. We'll grow them responsibly and we'll have good consistent growth.

Great. Thank you.

Thank you. Our next question comes from Moshe Orenbuch of Credit Suisse. Moshe, your line is open. Please go ahead.

Yes. Great, thanks. And one of the things you talked about a little bit in the prepared remarks was the idea of consumer spending. Could you talk a little bit about how you, kind of, formed your expectations for receivables growth in terms of what you're seeing in consumer spending and payment rates and how those two interact over the course of ‘23? And I've got a follow-up.

Yes. When I started that, I'll ask Perry to chime in. So we saw a good consumer spending in the -- we're seeing good consumer spending in January. But given the environment, there is pressure on sales that will offset some of the payment rate improvements. Just the reality of the macro environment we're going into.

Yes. And I'll add into -- on to what Ralph just said. With that context of decelerating spend, consumers making choices within category to deal with the inflation. And then there's a rising cost of debt overall for them. They're pulling back on spend too. So we do contemplate that coupled with -- if you think about elevated losses -- credit losses through the year, that also dampens your growth speed as it drops 1.5% for you -- were the prior year that's in peach growth by 1.5%. And then on top of that, we're being more thoughtful about credit strategies and when you pull back online and underwriting, so that affects that and then as well it may throttle what we do with marketing, because the marketing returns look a little different for certain cohorts now. So there's a combination of things that go into our receivables outlook and all those things are contemplated.

And the last thing I'll say is our book is changing and with the spend shift to non-discretionary to essential. Years ago, we would have been able to catch that, because we didn't have the products. We now have the products and co-brands and buy now, pay later and other things that are and direct-to-consumer, we're catching just general spend that we wouldn't have bought that before. Brand launches and new products are going to also help us drive sales growth over the course of the next year.

Great. And as a follow-up, you mentioned kind of an unemployment outlook of 4.5% to upper 4s. How do you think about the variability around that if unemployment is either better or worse than that? And as we sort of think about the economic performance over the -- just beyond ‘23 as well?

Yes, you know, unemployment is always a leading indicator of credit worthiness. So if the rate is better, we would expect credit to perform a little bit better. Obviously, if the rate is worse, we would expect it to perform worse. But we don't expect a spike in 2023. I think we're feeling what we've forecasted, we feel that is where it would be -- that's an exit rate for ‘23 that will impact ’24.

Okay. Thank you.

Thank you. Our next question comes from Vincent Caintic of Stephens. Vincent, your line is open. Please go ahead.

Thank you for taking my question. I wanted to ask about late fees, so two-part question. The main one being just your overall thoughts about that given potential regulation that might challenge late fees. So just your thoughts on what the potential impact is and how you can maybe around that? And then a follow-up question is, so saw that this quarter, part of the yield decline quarter-over-quarter was from the reversals of interest and fees. So just wondering if you might be able to quantify that and what are your thoughts on that for 2023? Thank you.

Yes. It wouldn't be an analyst call without the question about lease fees. So I'm happy to address it. I look at this as no different than Card Act. The industry was able to adjust. We adjust it accordingly, and we'll read into any regulation that is out there and we adjust accordingly around this. So we’ll say that as we think about late fees and any other regulatory changes, we have the ability to work with our brand partners to negotiate -- renegotiate terms if that's appropriate. So -- and there's other levers to pull, so that's -- we'll adjust accordingly just as we do with Card Act. Perry, you want to take the second?

Yes. So as it relates to net interest margin, which is where late fees reside for us. When we see some delinquency increasing, you see the late fees materialize in net interest margin early and then when the delinquency manifests itself into elevated charge-offs, the reversal of some of those interest and fees occur in that period. So if you have a period where you're going to be above 7%, which is what we've indicated for the first half, you should expect that you're going to have some more reversal of interest and fees impacting that quarter relative to the prior quarter where losses were lower and you had less interest and fee reversal, so you actually had a little bit higher net interest margin. So that's going to be the dynamic throughout the year, and that's normal when you're going through periods of rising and falling delinquent the charge-off follow-up.

Okay, that’s great. Very helpful. Thank you.

[Operator Instructions] Our next question comes from Jeff Adelson of Morgan Stanley. Jeff, your line is open. Please go ahead.

Hi, thanks for taking my question. Perry, I just wanted to dig into the new loss guide. I think a lot of your competitors are still at or below their cycle averages and you're not guiding to something that's above that. I know we've got the noise coming through the portfolio, but you talked about some of the changes you've made over the past three years. How you've kind of enhanced the credit profile of that book. Just wondering what gives you confidence that that's going to drop back down to a below 6% level by the end of this year after this year?

So I'm going to make sure I heard the question correctly. I think there's two parts. One is, why are we guiding higher? I mean, I think our -- the increase in basis points is probably in line with what we're hearing across the board. What we're seeing with our portfolio is we did normalize faster. And it's simply -- every company has a different composition of its portfolio. We're more a full spectrum lender. And as we communicated well over a year ago, we expected normalization to occur faster in our portfolio as consumers use their stimulus early and then that would start -- and they would normalize faster. And that has happened. And then as you mentioned, we do have some noise in our numbers, because of the BJ's departing and then some trailing impacts of timing of losses from customer accommodations that we did. But the -- when we talk about the confidence to get at or below, I think I heard you say at or below 6%. I think the thing is to have a 6% handle back on the back half of the year, it's because we do have front-end of the year noise that with the economic assumptions, I think -- again, there's a range of outcomes for the second half of the year, depending, I mean, if it's a mild year, if inflation starts to abate and then you have a slow increase in unemployment, I think that where things fall, the 6% average that we talk about is through the cycle. So you're going to have periods where you're below 6%, years where you're below 6%, then you're going to have years when you're above 6%. And when you're in a recession environment, you've got to be above 6%, if you're going to have a through-the-cycle average of 6%. And that's where we are. And I think the question that is for all of us is, okay, how long is this recession environment where it gets officially labeled with that or word or not, how deep does it go and how long does it stay right? Because it mild and short, then you get back towards that the reversion to the mean faster.

Yes. I would say the thing to remember is we have improved our portfolio over the last three years. But our portfolio is still a bit riskier than our competitors, because we underwrite deeper. That said, we get paid for that risk and managing that risk as we move forward. So although we've improved our portfolio, we are still casting a wider net than others, and we get paid for the net that we cast.

Got it. Thank you. And then just in terms of the credit sales this quarter, just wondering how much of the boost that you saw at the credit sales was driven by AAA?

Yes. That was a significant amount of the increase. I mean, there was a slight increase in credit sales if you were to exclude AAA.

Thank you. Our next question comes from Bill Carache of Wolfe Research. Bill, your line is open. Please go ahead.

Thank you. Good morning, Ralph and Perry. Perry, I wanted to wanted to follow-up on your comments around legacy credit models having been built around the concept of rising unemployment and not necessarily some of the inflationary pressures that consumers are facing? There's a view that delinquencies are going to continue to rise, but because labor markets remain exceptionally strong, we'll see them flattened out once we get to sort of the “normalized pre-pandemic levels”. Are you expecting given that point that you made that delinquencies could continue to trend higher, sort of, above normalized levels, because of these inflationary dynamics even though labor market conditions could still remain pretty strong. Just want to make sure I understood what you were -- the point you were making correctly?

Yes. The point I was making on the models was more on loss forecasting models, not credit underwriting models. Credit underwriting models take into account think that the consumer level and taking a whole host of attributes of the consumer that do care for things like you've mentioned income, gainful employment, their debt they have on other issuers. So that all goes in on that. But yes, I mean, you raise exactly the -- one of the key points and why inflation is that the thing the Fed is trying to tackle it is a regression type tax, right? And so it’s moderate income to middle income families are feeling the pressure of that. So yes, while they're gainfully employed and yes, while there is wage growth that wage growth is not keeping up with things that are putting pressure on their families. And you see that with some increasing leverage and all of this impacts eventually ability to pay, and that's where customers can fall behind. And if you even think about inflation as what we're seeing today, while it's moderating a little bit, it's -- some of it is -- there's good news in there, but it's really driven, because there's lower fuel prices and lower used in new car prices, which certainly helps people own cars, but not everybody does. But on the flip side, shelter cost, food prices and utility costs are up significantly month-over-month and year-over-year. So while inflation abating, this is still concerning for most American’s even wilder, like you said, it's a job full environment and they're doing their best, but they're making choices on spend. So why I think you're starting to start to see some deceleration in overall spend, and we see some shift from discretionary to nondiscretionary, but all these things put pressure on folks.

Understood. That's super helpful, Perry. Thank you. And separately, Ralph, I wanted to follow-up on your late fee commentary. I appreciate all the color. But I wanted to ask, if I could follow-up on the comment you made last quarter that the safe harbor you thought surrounding late fees was more likely to be reduced rather than eliminated. Is there any way you could give us an update there and maybe frame the potential magnitude of any reduction or impact that you think we could, see?

You know, I know what you know from the CFPB, that was just -- what I would suspect that happen in the third quarter. I don't want to guess on what will happen. Whatever will happen, we're ready for it. We will lean into it, and we will manage accordingly.

Understood. Thanks again for taking my questions.

Thank you. Our next question comes from Mihir Bhatia of Bank of America Merrill Lynch. Mihir, your line is open. Please proceed.

Excuse me. Good morning and thank you for taking my questions. I wanted to go back on to the credit guidance. And following up a little bit on Jeff's question, earlier. I just wanted to better understand the reason you have a high degree of confidence that the back half of ‘23 would be below 7% at least. Right, just given your implied guide of 1H above the 7%. So like given the high unemployment, you have BJs coming out. I understand you have some noise in the first half, but if I recall, that's about a 30, 35 bps impact there. Why would the back half come in below the first half, just given the macroeconomic pressures you are pointing to, right, with unemployment increasing throughout the year? And then relatedly, just in terms of your delinquencies and losses, like when do you expect delinquencies to peak and in terms of losses, given you've normalized faster than peers, do your losses peak before your peers who've all talked about that happening maybe in 2024. Any additional color you can help us with some of that. Thank you.

Yes. So I want to be more clear, right? When we say the losses could be approximately or around 7%, that does not necessarily imply that the back half of the year will be significantly below the first half of the year. So it could still have a seven handle on it, it could be slightly below, it could be still slightly above or it could be flat. So I want to moderate the expectation that the second half will be materially lower. And I think you said it, there's a lot of economic uncertainty in the back half of the year and what continues to happen with inflation and unemployment. So I think there's a lot of speculation and we'll continue to update those expectations as we march forward. In terms of normalization, will we peak sooner I hope so. I think that -- so normalization of the higher end consumer is lagging. And when you think about the way when you underwrite with where we do the full spectrum, we manage losses very carefully and at a -- in line carefully where they -- you manage a low line with a lot less open to buy, compared to if we were in that super prime space, we have large lines, lots of open to buy. So when unemployment hit’s you're taking for a large line for us, you don't have as much open to buy. So as unemployment comes through, we have less severity risk is the way to think about that. So we may be less volatile.

Okay. Thank you. Thanks for taking my question.

Thank you. Our next question comes from David Scharf of JMP. David, your line is open. Please go ahead.

Hey, good morning. Thanks for taking my questions. Most have been answered. Perry, I guess I just wanted to follow-up a little on the NIM outlook, which is effectively flattish from fourth quarter throughout the year. I mean, I believe, historically, the company has always had, sort of, a net asset-sensitive model. And notwithstanding the reprising rates, I'm wondering, given the fact that deposit funding has continued to increase as a part of the mix, and we've successfully had a number of months past now where we can flatten out that the impact of the abrupt changes, the abrupt Fed rate rises and passing it along to consumers? Why wouldn't throughout this year, especially if we're not looking at any surprise increases from the Fed beyond the current outlook, why wouldn't there be a net positive impact in NIM? Is it primarily related to expectations at late fees first get reversed out with higher losses and maybe tempering, kind of, the late fee modeling as well based on what the CFPB might propose?

What I would say is that the -- our outlook doesn't contemplate anything with the CFPB changes, because, as Ralph said, we can't speculate from what that means. But as it relates to net interest margin, you kind of touched on it, is we have been slightly asset sensitive. Our objective is to be close to neutral. And then as you think about NIM, there's many components from the asset mix, meaning the product mix, risk mix that goes in there and then when you enter a period of rising loss as you kind of said it is that the increase in late keys that you get or rollover is partially dampened when the losses come through because of the reversal of billed interest and fees. So it's all those things together. And then on top of that, we will have a changing funding mix throughout the year as we work through our debt stack and then you continue to shift to more deposits and things. So we're just giving guidance for what we think is a good way to model a base case for it.

Understood. Appreciate the detail. And then just a quick follow-up. I know and I'm sure on the upcoming investor event, what will get updated background on, kind of, the vertical mix and other ways to sort of slice and dice the portfolio profile. But I noticed in the slides on new signings, there was another jewelry vertical retailer involved. Can you update us on kind of what percentage of balances are associated with that vertical, which has always been so prominent for you?

Jewelry specific?

Yes.

Probably for us, the low double-digit in terms of receivables.

Got it. Perfect, thanks so much. That’s all I got.

Thank you.

Thank you. Our next question comes from Dominick Gabriele of Oppenheimer. Dominick, your line is open. Please proceed.

Great. Thank you so much for taking my questions. I want to talk about the spending trajectory throughout 2023. And do you think it would make sense that the consumer would continue to slow their spending given what we're seeing in inflation coming down, because that's going to hurt nominal dollars, right, the grow-over effect of nominal dollars being dampened and really, the fact that would you expect spending to slow down through the period before up until we hit peak unemployment? And then I just have a follow-up. Thanks.

Yes. I think that's -- that is our speculation a little bit as we're starting to see some decelerating spend. So I think when you think about that, that's impacting the individual consumers, as we talked about earlier, if you think that their utilities costs and food costs have gone up $100 in a month, where they've got to slow down spend elsewhere. So I do think that's a factor. For us as a company, we've continued to add new partners in 2022 and increase our marketing. So for us, we continue to see some overall spend growth -- originations growth even with the departure of BJs. But that -- and that is a -- it was a high transactor portfolio. So for us, that will slow our growth a little bit more than what it might have otherwise. But overall, the consumer, again, is still -- I think we said earlier, so gainfully employed, jobs to be had, small businesses are hiring even though you're reading about layoffs of big companies, there's lots of jobs out there. So that's what gives me encouragement that we're going to move through what would be more of a mild economic scenario.

Yes. And I kind of mentioned it before, the shifts in our portfolio help us maintain spend, right? So if they move from discretionary nondiscretionary, we have products and services that the spend will be sticky to us.

Great. Great. I really appreciate that. And if we -- I just want to walk through this formula with you guys. If you think about growth math and the fact that a lot of -- you and your peers have seen some really significant growth over the last few years that puts that kind of growth math seasoning pig-through-the-python dynamic, right? On the front book, but if we have unemployment rising, that would affect the front and back book. And so I feel like that would have almost like a doubling of -- not a pure double, but an increased additive effect on the net charge-off rate, if you have the pig-through-the-python and the back book is getting worse because of unemployment. Does that make sense to you or am I getting something wrong?

No. I think in general terms, sure. But I'll speak specific to us. When you think about the growth that we've taken on over the past year, a good chunk of that was due to two portfolio acquisitions of the NFL and AAA in 2022. Those are already seasoned portfolio. So when you hear others talk about all this growth and they've got vintages, they're going to get peak losses in the next 24-months. That's not the case for us, because there came in season, we were taking losses in the first month, they were on the book. So start with that for us. And then if you think about the product mix, that also influences that growth map seasoning concept, because of the degree that we have private label cards, they start to season and peak in the, say, month 12 to 18-months, whereas many of those co-brands and other things peak 24 to 36-months. So ours within the first 12 to 18-months, we peaked in season. So we season a lot faster.

Yes. I think the other thing I would say, too, is we haven't been sitting still. We've been proactively managing the back book and the front book with the right line assignments, right treatment for card member underwriting for the right vantage score. So we've been managing our recession handbook for the last 2.5 years. And so as I think about it, it puts us in good shift to know what's in the book and know where to focus.

Great. No, that's really, really helpful. Ralph, maybe just really quickly one more for you. Just you have really great co-brand and private label portfolios. How do you see the dynamics playing out between the two? And as far as net charge-off rates and where you may decide to pull back in your underwriting one versus the other in the downturn? Thanks so for everything.

Yes. So it's the private label portfolios have terrific margins, but they also have a little bit more risk in them. While the co-brand portfolios have good margins, but the risk is less. So if you think as you go into the economy, we certainly want to be fair with all our partners. It's important that we work through and make sure that we are doing the right thing by all our partners. But to me, it's really a balanced approach and making sure that we're taking the right risk for the right reward.

Thanks, again.

Thank you. Our next question comes from John Hecht of Jefferies. John, your line is open. Please go ahead.

Good morning, guys. Thanks very much for taking my questions. Just your newer partners, the NFL, the Yankees, the AAA. It's a different, I guess, characteristic relative to some of your older traditional retail counterparts. So I'm wondering, given that they represent slightly different kind of associations -- is there different some characteristics with the usage of the credit cards or the credit relationship with the customers from those different channels?

Yes. So there are -- some of those cards are top of wall of cards. And so if you think about it, right? So I think about AAA, it's a top all of cards. So you kind of make sure you have the right line for the right people. It's higher use. It's discretionary spend, it's non-discretionary spend. That's their product. So make sure that we have the right treatments for those co-brand cards, which may differ a little bit from the treatments you have for the private label card. But diversification for us is key, and we don't treat every card equally. We treat it based on the habits of those people and those products.

Is the general line extension and utilization rate consistent with some of the other platforms or is there anything to point out there?

It depends on the creditworthiness of the individual, right? So, that's how we look at it. We don't look at it on a portfolio basis. We look at it within the portfolio and the performance of the individual and their creditworthiness.

Okay, that's helpful. Thank you. And then a follow-up. We've heard from some of the other card issuers that maybe there's a decline and the pressures ongoing pressures on deposit prices. Are you guys seeing that? Or is there any commentary just over the past few weeks and what you're seeing in the deposit market?

Yes. So for us, deposits remain direct-to-consumer deposit remains a key funding component. The pressures are out there in terms of pricing, yes, it's competitive. And we've been helping to lead the way on that competition because for us, it's a great source of funds. We are variable priced and we have terrific loan yields that can absorb the increases in prime. And as prime goes up, if we want to pass that through our deposit pricing, we get it on topside revenue. So we're good.

Yes. It's a real opportunity for growth for us. We have lower overhead and really helps our funding capabilities.

I guess, the question is as we go into this year, is it similar competition to the last few months or given that the new rate outlook might be changing, are you seeing mitigated -- not mitigated competition, but maybe less aggressive pressure on incremental rates.

It's the same.

Okay. Wonderful, thanks very much, guys.

Thank you. Our final question of the day comes from Regi Smith of JPMorgan Chase. Regi, your line is open. Please go ahead.

Thanks a lot. I know the call is going kind of late. I appreciate you taking the question. A little bit, I guess, on a different subject. A lot of focus has been on credit quality. I was curious -- I was hoping you guys could probably answer this. What proportion of your business today and whether that's spend or revenues, would you say is related to Bread? And that could be, you know, the buy now, pay later, it could be the Amex card. Let me actually expand beyond this. And not just Bread, but anything like modern, so a digital-first card. What I'm trying to get at or understand is it feels like there's probably a story within the story that may be getting missed. And so I was curious if you could share how large that business is and maybe how fast it's growing, because I would imagine that over time, that, that's going to be a bigger piece and an interesting piece of the story.

Well, the cards business, right? Things take time to grow, right? So we've been with both those products a year or last or just about a year. So I could tell you that 40% of our new accounts are digital channels, right? So, and I expect that 40% to grow given our new capabilities, given the capability we're going to put in place. So we expect those digital channels to grow. And we do expect direct-to-consumer to grow. I think that American Express product, 2% cashback is a really good quality product out there. The virtual card was just introduced that will have some traction in 2023, 2024. So while it's not the biggest part of our portfolio today, it is a growing part of our portfolio.

Got it. And if I could sneak 1 more in. Have you guys ever provided, I guess, a longer-term target for efficiency ratio. I know you talked about margin expansion. That's been a theme every year, you kind of mentioned that. But is there a long-term target that you're driving towards?

We talk about it in terms of positive operating leverage for now. As we think about the future potentially. But right now, we talk about positive operating leverage, which also helps our efficiency ratio. We have some internal targets, but primarily, we're looking making sure that our expenses outpaced our revenue outpaces our expense growth.

Understood. Thank you.

Thanks, Regi. Thank you all. I know we ran a bit over, but I think it's time well spent with you. I really appreciate the interest in Bread Financial. I look forward to talking to you all soon. Everybody, have a good day.

Ladies and gentlemen, that concludes today's call. You may now disconnect your lines.