Bread Financial Holdings, Inc.

Good morning and welcome to Alliance Data's first quarter 2020 earnings conference call. At this time, all parties have been placed on a listen-only mode. Following today's presentation, the floor will be open for your questions. To ask a question during the Q&A session, you will need to press star 1 on your telephone. In order to view the company's presentation on the website, please remember to turn off the pop-up blocker on your computer. It is now my pleasure to introduce your host, Ms. Vicky Nakla of Advisory Partners. Ma'am, the floor is yours.

Thank you, Carol. By now, you should have received a copy of the company's first quarter 2020 earnings release. If you haven't, please call Advisory Partners at 212-750-5800. On the call today, we have Ralph Andretta, President and Chief Executive Officer of Alliance Data, and Tim King, Executive Vice President and Chief Financial Officer of Alliance Data. 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 subject to the risks and uncertainty described in the company's earnings release and other filings with the SEC. Alliance Data has no obligation to update the information presented on the call. 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 will be posted on the Investor Relations website at alliancedata.com. With that, I would like to turn the call over to Ralph Andretta. Ralph?

Thank you. Good morning. Thank you for joining this morning's call to discuss our first quarter results. We are in unprecedented times, but our organization has responded immediately and effectively to the pandemic challenge. We've moved swiftly during the month of March to activate business continuity plans and implement work-from-home protocols. I am proud of our associates and the global leadership team at Alliance Data, who have completely rose to the challenge. We are fully operational and performing well throughout this crisis. Today, I will discuss our immediate response to COVID-19, review our first quarter results, and update you on the steps we have taken to improve our operating model with an eye towards investing in our future. On slide four, you can see a summary of the actions we have taken to support our associates, card members and consumers, brand partners and clients, and of course, our communities. First and foremost, we have taken a number of steps to protect the health and safety of our workforce. Currently, 95% of our associates worldwide are working from home. We have instituted paid leave where appropriate, as well as other health and welfare accommodations to support our associates during this difficult time. For the small number of associates who must still come to the worksite, We are paying bonuses, practicing social distancing, and staggering shifts. For our card members and consumers, we are proactively introducing a number of forbearance options, including the option of skipping the next payment without a late fee rather than enrolling in a formal hardship program. We are also waiving late fees where appropriate. For our brand partners and clients, we have maintained a regular dialogue to understand both their current and future needs and to support them as they too adjust their business operations. At Card Services, we are working with our brand partners to optimize their budgets and marketing support and shifting resources to areas that have become more relevant, like e-commerce. At Airmiles, we have added merchandise reward options to increase engagement as collectors' interest shifts from aspirational items, such as travel, to more practical domestic merchandise and stay-at-home essentials. At Brand Loyalty, we are extending the length of certain short-term loyalty programs, allowing consumers a better opportunity to collect and redeem points prior to program expiration. The goal is to increase in-store traffic for our grocer clients. Additionally, we immediately responded to community emergency relief needs in virtually all of our key locations, including contributing to food banks and mental health services organizations for youth. We allowed collectors in our air miles program to donate miles to charitable organizations for relief efforts. We also accelerated corporate charitable donations planned for later in the year to support immediate emergency relief efforts and continue to match our associates' charitable donations dollar for dollar. These actions exemplify Alliance State's commitment to responsible business practices and demonstrate our sustainability strategy in action as we respond to the needs of our key stakeholders during this time. I am proud of these efforts and our culture of partnership, perseverance, and resolve in navigating this difficult period. Now, let me talk about the first quarter. It is best to break down this break this down between the first two months and then March, when COVID-19 began to have the impact on our retail partners and customers. Our business was tracking well in January and February, with revenue up mid-single digits and profitability increasing by double digits as we benefited from higher yields, lower operating expenses, and cost reductions made last year. As retail partners closed and traveled slow during March, we began to experience consumer spending declines, which continues today. In card services, our credit sales declined more than 50% as brick and mortar retail essentially stopped, partially offset by shift to e-commerce. At Loyalty One, we saw a similar story with business holding strong through mid-March, but falling off sharply as travel-related redemptions declined 90%. The combination of strength in January and February and softness in March led to a 4% consolidated revenue growth for this quarter. Trends at the end of March for card services were similar to what we are experiencing today. Retail brick and mortar sales were down more than 80%, while e-commerce was down in low single digits. As for the first quarter profitability, we benefited from approximately $50 million of the $150 million of cost savings we expected for this year. Operating expenses were down $90 million in the first quarter, adjusting for one-time benefits. Tim will discuss our savings in greater detail from the actions we took in 2019. Considering our adoption of CECL effective January 1 and the impact of COVID-19, we increased our loan loss reserve by $404 million, resulting in first quarter earnings before taxes of $25 million. Based on what we know today with April nearly over and our current economic assessment, we believe this is the appropriate level of reserves for the economic slowdown and related loan losses. It puts us at a reserve percentage of 12%. Of course, we continue to monitor the economic outlook, which remains fluid, and we'll adjust further if necessary. Looking at losses in the COVID-19 environment, We are likely to see increased pressure on loan losses in the back half of 2020, consistent with the reserve actions taken this quarter. We are also seeing increased delinquencies and requests for forbearance, which we would expect to continue given increasing unemployment. We do expect some mitigation from the government relief programs, including additional unemployment benefits and other stimulus programs. We also expect to see a benefit when the states begin to relax stay-at-home restrictions and begin a stage reopening. Given the uncertain climate and the limited visibility into the duration of this health crisis and its impact on the economy and consumer spending, and consistent with other companies, we are suspending our guidance for 2020. Our priorities are to protect our liquidity, to work proactively with our customers and partners, and to be ready for a phased reopening of the economy. We continue to proactively manage the business with an eye toward enhanced liquidity and competitive positioning. We are not taking our eye off the ball on strategic repositioning and continue to look for operational efficiencies, cost management improvement through the eyes of a fresh CEO. We are taking prudent steps today to strengthen our financial position and mitigate risks we may face during this next several months. To that end, we announced a reduction of our quarterly dividend to 21 cents from 63 cents, which will reduce our annual dividend by approximately $80 million. Further, and like many other publicly traded companies, we have suspended our share buyback program. We also have a number of other levers we can pull as needed to add to our liquidity and reduce our expense base. Tim will speak more fully regarding our liquidity, but I want to remind you of what I said last month. We have over $1 billion of liquidity at the parent level with no near-term maturities on our approximately $3 billion of debt. We continue to rigorously stress test the business, prudently using more aggressive cases than we modeled even a month ago. Based on our underlying assumptions of large reductions in GDP, increased unemployment, less disposable income, and lower retail spend, the outcome is the same. We are cash flow and EBIT positive under some fairly dire economic scenarios. To navigate through the current period, we are focused on prudent credit and risk management, near-term expense reduction, and investing in our business strategically. For credit and risk management, we have put our recession readiness plan into action and continue to move through its stages. Compared to 2009, we believe our portfolio is better positioned today as it is more diversified and we have enhanced our scoring model, which stratifies risk via dozens of different metrics. We also skew towards a higher percentage of prime card members today. We have proactively implemented our forbearance programs, which are being actively embraced by our card members. Since the middle of March, nearly 3% of accounts and 4% of balances have engaged in this program. It's still early days, but we expect this program to continue to grow. As part of our recession readiness plan, we are managing towards higher credit scores and have tightened our customer credit. Consequently, our credit exposures are down by 25% from the start of the year. We also closed inactive accounts to further limit credit exposure. We have taken a disciplined approach to expense management and operations. Actions already have been taken as evidenced by the $150 million of savings we expect for 2020, and we have identified and begun to execute on over $100 million of additional cost savings. These savings will come from adjustments in marketing spend, renegotiation of contracts, and operating expenses, all while maintaining our service levels. Finally, as we focus on our future, we continue to explore strategic investments for our business. Areas of interest include digital and information management, new customer-facing products and services, and continuing to enhance our recession readiness capabilities. To sum up, we are pleased with the early progress made on repositioning Alliance data and generating cost savings, which was evident in strong performance we had in the first two months of this year. Our business continuity plan is functioning well. We have taken actions to further manage our risks, strengthen our liquidity to improve our resilience, and identify additional opportunities to reduce our cost structure. Importantly, we continue to thoughtfully evaluate strategic investments that would enhance our business in a post-pandemic environment. Now we'll turn the call over to Tim for a more detailed review of our financials. Tim?

Thank you, Ralph, and good morning, everyone. Let's turn to slide five, where I'll start with an overview of our consolidated results. Revenue grew 4% in the first quarter, driven by higher yields in our card services business and consistent with our expectations. We also saw increases in our Loyalty One segment when adjusted for currency fluctuations and the sale of Pressima. We benefited from large expense savings across all areas of our business, including corporate, card, and Loyalty One. All the expense initiatives we undertook last year generated approximately $90 million in direct operating savings. As Ralph discussed, we made significant improvements in our payroll, facilities, and marketing costs. However, income from continuing operation was down 83% year-over-year. The driver of the decline was our provision expense of $404 million as we stepped up our reserves considerably for potential future losses. Looking at the business pre-provision demonstrates the underlying business benefited nicely from the revenue and decreased expenses. Pre-provision earnings before taxes was up $216 million or 46%. Net income and net income for diluted share were down 80% and 70% respectively, consistent with our increase in provision expense. Let's turn to slide six where I'll discuss loyalty one. Revenue for this line of business was down 3% to $198 million and adjusted EBITDA Net increased 5% to $58 million. Adjusting for PRESMA, which was sold in January of 2020, and the effects of the currency fluctuation, revenue increased 7% and adjusted EBITDA increased 6%. Breaking the results down further, air miles revenue excluding PRESMA increased 1% on a constant currency basis, primarily due to an increase in brand revenue associated with strong issuance growth. Air miles issued increased 5% in the first quarter, with strong increases in January and February prior to the fall in March due to COVID-19. Rand loyalties and revenue increased 11% on a constant currency basis due to a strong performance in our grocery clients. A strong start to 2020 was tempered in March as clients reduced promotional efforts due to an already strong store traffic and redirected focus on sourcing. Moving to slide seven, I will review the underlying card metrics. Credit sales were down 3% on the first quarter. As Ralph mentioned, heading into March, we are trending towards high single-digit growth. In the month of March, we saw clear downward pressure on our sales. As we sit today, activity remains down almost 50% year to year. Normalized card receivables, which include held-for-sale receivables, were down 1% on the quarter to $18.6 billion. We saw pressure from the sales tail off late in the quarter prior to this. We were trending towards low-digit growth. At the end of the period, our end-of-period receivables of $17.7 billion were up 5% year-over-year, and as expected, this was due to the ramping up of our 19 vintage. Gross yield was 25.5%. up 140 basis points due to the slowing growth and the ramping up of new receivables. Operating expense as a percent of receivable, excluding mark-to-market adjustments, was 8.2% down to 130 basis points year-over-year, benefiting from the cost reductions we have discussed. Our principal loss rate was 7% of 60 basis points and consistent with our expectations at the start of the year. Our delinquency rates of 6% was up 80 basis points. We do expect both our principal loss rate and our delinquency rate to increase as we are seeing deterioration only to the effects of COVID-19 and the lower denominator due to lighter sales. We would expect related charge-offs to be evident in the second half of the year. Finally, our ROE of 18% was down from 32% a year ago. This also is solely a function of the significant increase in allowance during the first quarter. Turning to slide eight, overview card services financial results. Card services revenue increased 5%, but earnings before taxes and adjusted EBITDA were down 88% and 84% respectively, entirely due to the increase in provision for loan losses. Our first quarter provision was $656 million, up 160% for $404 million from last year. This led to an adjusted EBITDA net of $47 million and earnings before taxes of $32 million. Operating expenses of $385 million were down 24% year-to-year, embedded in the savings in the cost reduction for marketing, payroll, facilities, and consulting expenses. Adjusting For the mark-to-market gain on sale, our operating expenses would have been $401 million, which would be $44 million or 10% better than last year. Moving to provision expense, there are a couple of call-outs. First, as we expected, charge-offs were up year-over-year. However, the big increase on our provision expense was the allowance bill. For the quarter, For the quarter, we added $336 million to our allowance through the P&L and another $644 million through the CECL adoption for a total increase in our allowance of $989. Our quarter end allowance is now 184% of where it ended at the end of 2019. In total, we now have $2.15 billion in allowances, which is over 12% for end-of-period receivables of $17.7 billion. The last item of worth note on this page is our funding costs. There was a slight increase year over year, the 4%. This is driven by a modest increase in our cost of funds. Our cost of funds increased to 2.4% this quarter from 2.3% one year ago. Let's turn to slide nine, and I'll give you an overview of our liquidity. Starting with the company, at the end of the March, we had $1.1 billion of billable liquidity. which was a combination of $588 million of cash on hand and $500 million available on our revolver. In addition to the healthy liquidity position, out of abundance of caution, we have taken additional steps to strengthen our balance sheet. Consistent with others, we have suspended our share repurchase programs and we have reduced our dividends. As Ralph mentioned, we are looking at a number of other avenues to further reduce our costs, which would improve our income and cash positions. Turning to the banks, there too we are well positioned. Cash of the banks is $3.9 billion. They have $2.5 billion in equity, a very strong capital ratios even after paying a $75 million dividend to the parent. We've not encountered any issues raising deposits where we have been active in both the retail and broker markets. We have also been successful in the securitization market where we recently renewed $2 billion of capacity. To summarize, we feel the core businesses, while hurt by the pandemic, are still functioning well and making money. We have provided for a substantial increase in charge-off through our provision for loan losses. Our banks are well capitalized and have large cash positions. At the parent level, we have plenty of cash and liquidity. We've taken further steps to manage expenses and do not have any refinancing risk for almost three years. I'll now turn it back over to Ralph.

Thank you, Tim. In closing, I started my tenure with Alliance Data halfway through the first quarter and approximately one month prior to the onset of COVID-19. I am immensely proud of the immediate and successful mobilization of our teams and the response efforts which continue. It is also not lost on me that next to protecting the health and safety of our associates during this time, Earning the trust of our valued investors and analysts is among my top priorities. As such, I have been and will continue to be committed to being accessible and communicating transparently and directly with this important stakeholder group. Lions Data is moving forward on a path to reposition business consistent with our strategic review and to emerge from this crisis in a more efficient competitor. At the same time, we are thoughtfully investing in the future. We are working hard to do all of this while continuing to support our key stakeholders in any way we can and show we are a partner of choice. As I said on the March analyst call, because of prudent and proven actions to responsibly manage all aspects of our operations, Alliance data has come through many tragic and economic events better positioned. I am confident this will be no different. We are managing through the COVID-19 environment. We are implementing a more efficient and effective operating model and thoughtfully investing in the future. Thank you and be happy to open up the line for some questions.

As a reminder, to ask a question, you will need to press star 1 on your telephone. To withdraw your question, please press the pound or hash key. Our first question this morning comes from Sanjay Sakharani from KBW. Please go ahead.

Thanks. Good morning, and I hope you guys are doing well. I wanted to ask about the reserve build assumptions first. If I'm doing my math correctly based on sort of the day one assumptions you made for the CECL build, you're assuming about an 8% charge-off rate under the recessionary view that you have. Do you guys think that that's appropriate? Maybe you could just talk contextually about the macro assumptions you made and sort of where you expect the loss rate to pan out under the scenario. And I think if you hear some of the other issuers and banks that have reported, they've said the macro forecast has actually deteriorated since quarter end. So maybe you could just speak to what that might mean for you guys as we look into the second quarter. Thanks.

Hey, Sanjay. Thanks for the question. Actually, let me start with the end of your question and work my way backward, which is we actually clearly can see the economy as we set that CECL later in the month, and I think some of our competitors.

So we did have a pretty good look into mid-April, thinking about all the economic environments. And, of course, when we set the CECL, it's going to be a variety of economic indicators, but like a lot of our competitors, competitors, we stressed that. We stressed GDP. We stressed unemployment. It pushed our unemployment rates in some of our stressed scenarios north of 10%. Some of our GDP, I guess a contraction to 30% depending on the quarter. So we did stress it a variety of different ways. We felt we had a pretty good look late in the quarter, late meaning as into the first couple of weeks of April to set that. We did not set a specific charge-off numbers. We looked at the economic overlays. We looked at where the delinquencies were to set our CECL level.

Okay. And then are you assuming a recovery inside your macro assumption?

Yes, we are. So we think that we should start coming out of this at a rolling basis at the end of Q2, starting to get back to some type of normalcy towards We did, of course, stress that to make sure that we're being conservative on the CECL side of that, but we did expect recovery by the latter half of the year.

Okay. All right, great. And then I guess second question for Ralph. I know you had embarked on a listening tour, and I know, unfortunately, we've thrown a wrench into sort of what you might have decided at the point that you finished it or concluded it. But, you know, you're pulling guidance. And obviously, a lot of structural change might occur over this situation unfolding. I'm just thinking at a high level, you know, how different ADS might look based on your preliminary review and what you might see unfolding given you've been around in previous recessions. Thanks.

Yes. Yes, Ange, I hope you're well as well. I think a couple of things. I just want to take a step back. I joined ADS because it was a company that had really good bones and had really good reputation that had a couple of bad years. And my view was this was an organization that we could certainly move quickly without a bureaucracy of a larger organization. And I still believe and see that. So for me, obviously my listening and discovery tour got cut a little short. But the way we responded to COVID-19 really gives me a lot of confidence that we can become a more efficient and effective organization going forward. We're able to pivot, reduce our operating costs, and improve our margins as we go forward. But as importantly, really invest where we think the consumer is going to be. So digital and online was investments I will continue to make. I think the evidence that they were even more important is clearly here and will continue to invest there in customer-facing capabilities and continue to move to digital and mobile. So my thesis hasn't changed, and I think this has really put a spotlight on why our investments are important in the near term.

Great. Thank you.

Our next question comes from Darren Peller from Wolf Research. Please go ahead.

Hey, thanks, guys. You know, maybe just to help us understand revisiting the structural opportunity versus risk for someone like yourselves in the sense that, you know, I think you guys have spent a lot of time and investment over the years on being able to help your clients, your merchants with, as you mentioned just a minute ago, Omnichannel and I'd be curious to hear the kind of demand you're getting right now from the end market for that upgrade, what you can do to help them out. And maybe on the other side of all this, maybe any type of new percentages or numbers that give us a sense of what part of your portfolio you think would be really able to survive and benefit from those trends around omnichannel, those technologies that you can help them with versus those that really are relying on just physical brick and mortar without any type of on-demand or omnichannel capabilities.

Yeah, it's Rob. So we are in constant contact with our partners and ensuring that we are assessing what their needs are, assessing how they want to move forward. So the shift of some of our marketing resources to online was clearly evident, and the continued switch to ensuring that we have the right online capabilities is our focus going forward. No matter where the customer shops, whether it's in the mall or in their living room or on their phone in their car, we're going to be there to provide the right capabilities for them to have bigger baskets and have that ability to, you know, get engaged with the brand. So for me, it's about helping our brand partners enhancing their customers' experience with that brand. So, you know, I view this as certainly an opportunity to enhance our digital capabilities. You know, I think in terms of bricks and mortar, you know, 25% of our sales or our portfolio is probably bricks and mortar. But they're also coupled with each of those bricks and mortar organizations certainly have online capabilities. And that's what we're helping our brand partners focus on now, which was online capabilities.

Okay. All right. Now, that's helpful. So, I mean, look, segmenting a portfolio for us, we're all trying to figure out. I think most investors are kind of looking through the second quarter right now and probably even 2020 or some degree. You mentioned your liquidity is in a sound position to take advantage and kind of weather the storm. So we're trying to figure out structurally, you know, A, what size someone like ADS can be on the other side of all this. And then structurally, if you're going to be able to win in market share by helping these merchants or maybe others out. And it sounds like has demand been coming in already in these conversations already having to help along this process?

Yeah, I mean, good times or bad, we're always in conversations on merchants and partners to, you know, enhance their sales, enhance their market share. You know, now it's a matter of talking to them to, you know, plan their emergence from this, how they're going to emerge from this, when, you know, making sure we're coordinated with the timing, making sure we're there where they need us most. And right now where they need us most is the capabilities are online, but we are working with them on a – on a pretty regular basis to talk about age reopening during the course of this year.

Yeah. All right. And just last question. I know Sanjay touched on this, but with regard to credit quality, look, I mean, you mentioned in the prior cycles, I remember also just seeing peak charge offs at around 10%. I'd be curious, you know, what's the, you know, dynamic in this environment that would give you confidence and what kind of rate should we be thinking about? I mean, is it, potentially something that could be 12% to 14% or any thought process on that? Thanks, guys.

So if I just think going forward, we've stressed our business to the last recession. And I think that's a, you know, it's a good barometer for us. And through every stress test, through every dire scenario, we are cash flow positive and EBIT positive as we exit 2020. That said, there are certain things that are available to our consumers now that weren't available during the Great Recession. The economic stimulus to the consumer wasn't available during the Great Recession. It's available now. At early days, we've seen some good pickup when those stimulus checks came out in terms of our customers and card members reaching out proactively to make payments. It gave us a bit of confidence in early days, but certainly people are certainly meeting their obligations.

Okay. Thanks, guys.

Our next question comes from Andrew Jeffrey from SunTrust. Please go ahead.

Hey, Andrew, you're breaking up a little on us. Hey, Vicki, go to the next question, and we'll see if we can't get Andrew back in.

Next today is Bob Napoli from William Blair. Please go ahead.

Thank you, and good morning, and also hope everybody's well. If I recall, going back to the last recession with charge-offs peaking at 10%, I think the market, the stock market, grossly underestimated the profitability at higher charge-off levels, and I think, you know, that the company was able to stay profitable at even, you know, materially higher charge-offs. You know, what is the maximum charge-off rate that this company can withstand for, say, a period of a year, you know, without having, you know, significant losses and liquidity challenges?

Yeah, look, so... Clearly, we test our banks at a variety of different stress tests. It's going to depend on how long. We tested it back to the last recession. We remained profitable and cash flow positive. It's going to be a combination of both that charge-off rate as well as what happens with our receivables for liquidity and cash positions. We tested it for a variety of different scenarios, including the peak charge-off we saw in the recession. Decreases in receivables, receivables staying flat, and in all those cases, we stay cash flow and income positive.

Okay. What are you seeing so far in April from a payments perspective? What should we expect out of the payment rate? I mean, have you seen, I mean, you have due dates throughout the month. I mean, have you seen any significant, what type of change have you seen in payment rates, delinquencies as we've gone through April?

Ralph, so in terms of payment rates, if I look at payment rates year over year, our payment rates have not gone down. So, payment rates are essentially stable. We're seeing people proactively reach out to us to make payments. Now, people are proactively also looking at forbearance programs. But that said, the forbearance programs people are taking advantage of are shorter in duration, 30 or 60 days, as opposed to a 12-month forbearance program. So we're seeing people actively want to get a little relief, but also engage in terms of paying their obligations.

Thank you. That's helpful. And the 50% decline in spend volume that you've seen in April, what percentage of your spend is currently e-commerce and online? And have you seen... You know, did that trend, is it continuing to decelerate or has it bottomed out?

Well, you know, I talked about in my opening comments, we've seen a 50% decline in bricks and mortar. But in the beginning, we did see an uptick in e-commerce. Our e-commerce spend is about 30% to 40%. You know, that's where we see, that's where we pretty much land on e-commerce spend. Now, that will fluctuate, but we've seen that increase a bit during the crisis.

And I guess, again, through the month of April, so the 50% was bricks and mortar, so it's a combination e-commerce. So overall, blended, you're down 40-ish. And, again, can you give any color on the trend over the month?

Yeah, so what we've been seeing is similar to the end of March, we've seen our collective sales down 50%. Bricks and mortar are down almost to nothing, 90% being 10%, 20%. And we're making the rest of that up on our e-commerce group. And our e-commerce is actually down slightly but doing pretty well.

Okay. And I guess last question, just a follow-up, I guess, on the customer base and Is there any, I mean, what is your confidence level that, I mean, obviously this is an unprecedented environment that your customer base, you know, I mean, what percentage of your customer base do you think is at risk? So, I mean, is this company 30% smaller coming out of, you know, potentially, like in the worst case scenario, a 30% smaller company, you know, coming out of this before you, and you have to grow on top of that, or? Just any feel for what percentage of your customer base is at risk. Is it more than 30%?

So are you referring to our retail partners or our consumers in the cart? The retail partners?

Retail partners, yes.

Good question. We're obviously watching that very closely. It's tough for us to tell at this point. because we don't know what type of government support any of our retailer partners will get, what type of, you know, forbearance on their rent payments. Certainly we expect it to be smaller. We've run some stress, but it's too early for us to tell because we just don't know how it's going to affect our retailers post the type of help they're going to get from the government and some of their forbearance programs, debt, rent, et cetera.

And you can, under a smaller business, you can maintain... You can hit targeted returns. Obviously, you have work to do on the organization.

Sure. Yeah, you know, one thing, clearly, Ralph and I have a very, very sharp focus on is going to be the expenses and making sure we have the expenses. Luckily, this doesn't snap overnight, so when they start seeing the sales start dropping or receivables start dropping, if that were to ever happen, we can adjust our cost basis to that. So, relatively low fixed overhead is going to be the variable associated with, you know, the attrition we might have to have in the call center, you know, natural attrition to match if the receivables drop. But a smaller base, yes, we could be profitable and we would be profitable.

Thank you. Appreciate it.

Our next question comes from Andrew Jeffrey from SunTrust. Please go ahead.

Is this better, guys? We'll try again.

Andrew, much better.

Okay, excellent. Appreciate your patience with me. I wonder, Ralph, if you could elaborate a little bit on underwriting standards. I know you mentioned curtailing some credit lines, and this is a dynamic environment. You heard at least one credit bureau this week talk about the challenges of trying to ascertain employment and income in given furloughs and compensation cuts and things like that. I know historically Alliance hasn't used FICO scores necessarily to underwrite. Are there specific changes and assumptions you're making in your underwriting criteria that try to account for sort of the dynamic environment today where people may be out of work for a little while and come back and have variable incomes and things like that? How are you going to think about risk management in that kind of world?

Yeah, so I'll just talk about our underwriting strategy and how it's evolved. So today our card members look much different than they did in the past, and we believe our portfolio is more resilient than it was during the recession. The changes have been driven by both our product diversification. We started several years ago underwriting changes. We started making about a year ago, which indicates a potential economic slowdown. So we constantly look. It's not that we have a knee-jerk reaction to what happened. We constantly look to enhance our model's our scoring models by upgrading to a newer version of Tribural Score and continuing to find add-on scores focused on fraud prevention, synthetic identities, and credit file customers and other elements. In 2009, our underwriting changes were focused on finalizing scoring enhancements, raising minimum due scores for new applicants, and reducing contingent liability by closing inactive accounts or scaling back That said, we're certainly very diligent on – we've tightened our underlying criteria, but also we're a responsible lender. We're not going to go out there and offer credit lines or product to those that do not have the capacity to pay.

Okay. Well, good to hear you're proactive. I think that is good foresight. And then – With regard to forbearance, and I know it's early days and encouraging perhaps that you're not seeing some of your borrowers really want to stretch out to 12 months, for example, I'm just thinking back to the experience with Harvey and the sort of bubble it created in delinquencies that lasted, I think, a lot longer than maybe you expected at the time, recognizing you weren't at the company. Is there a risk that we're still talking about COVID-19 elevated delinquencies and or losses a year from now, 18 months from now, I guess. How do you probability weight the outcome of this just drags on for a protracted period?

You know, again, nobody could predict what's going to happen over a protracted period, particularly, you know, with something we've never really faced before. But my view is, There are more resources today than there have been with past crises, whether it was hurricanes or other economic crises. The assistance to the general public, our ability to react quickly, offering programs that are more flexible than they've been before, I think will certainly curtail that bubble long term.

Appreciate it. Thank you.

Our next question comes from Ryan Carey from Bank of America. Please go ahead.

Good morning. I hope you're all well, and thank you for taking my questions. I just wanted to build on Andrew's question a little bit. I think on the update call, you mentioned the majority of customers applying for forbearance. Up to that point, it opted for shorter-term programs, and that these customers are more likely to end up current on their loan. And so how has that changed since late March? And if it has, how do you think about the inferences as a result from that and the impact on the business?

You know, it hasn't changed. So we're seeing customers proactively want a shorter forbearance program and, in fact, wanting to just skip a month's payment rather than going to a forbearance program. So that's what we're seeing. It's early days. These programs are just getting up and running. As I said, right now they're in the low single digits, but we expect them to probably settle in the low double digits as we move forward. And so it really hasn't changed yet a little bit too early to tell what we're seeing though, in the month of March of our, uh, you know, our payment rates are, are, are holding, uh, to what we have predicted. And we're seeing based on the first wave of stimulus checks, customers have a willingness to, to make payments.

Got it. Okay. It sounded like before you were expecting to see pent up demand and a potential bounce back once the COVID situation was under control. And I would feel like there's a little bit more wait and see. Is this just due to the duration and severity of the slowdown? Or have you seen anything else change over the past month that would lead you to think the recovery might take a little longer?

You know, I think people are optimistically looking at the recovery of May 1st. But, you know, as you can tell publicly, the recovery is going to be a staged recovery over a period of months. So it's going to be a ramp up rather than a, you know, a big bang. And certainly we've You know, we've stressed our business model for that. And under those scenarios, our business model is still EBIT and cash positive for the year.

Got it. And just to make sure, just a clarifying question on that. I know before you were talking about the stress scenarios as retail sales down kind of 25% extended for 12 months. Is that still the same zip code in these most recent stress examples?

Yeah, we've stressed it down 25% for the year to go. So that's actually more like 25% on the full year, which is more like 33% on the year to go. So that was one of the stress scenarios we ran.

Great. Thank you for taking my questions.

Yep. Our next question comes from Dan Perlin from RBC Capital Markets. Please go ahead.

Thanks. Can you guys just remind us, a little bit about the customer concentration risk that's embedded in the current portfolio today. I mean, we're really just trying to handicap, you know, what is going to happen to the extent that we have more retail failures. So maybe you can just walk through the puts and takes that we need to be thinking about modeling in that environment.

Yeah, so, you know, I'll do it in terms of high level, in terms of percentage of receivables. I think our portfolio has changed. It's a great recession. If you recall, probably during that time, we were 95% private label. We've evolved to something less than that. So 50% of our portfolio is, you know, retail goods or private label. 25% of our portfolio is big ticket items where you tend to get better credit quality. And then 25% of our portfolio is co-brands where you tend to get better credit quality and general purpose plastics. That's how I dimensionalize the portfolio now. So certainly stronger than we were in the Great Recession and a bit more diversified than we were.

Okay, that's helpful. And then to the extent that we have to brace for additional failures for your retail partners over the coming months and quarters, can you just talk through the puts and takes that we need to be thinking about in the model? I know you talk about these stress tests, but, you know, what are the actual – you know, outcomes or optics that we need to be thinking about, and how long of duration are you able to kind of send off those?

Yeah, so I'll use the most egregious, the worst scenario. We get a private label retail partner who files for Chapter 7 and goes out of business. It takes, you know, call it six to nine months for you to get a half of those receivables, and then you continue with that type of half-life. So it's a call we lend to the consumer, not the retailer. What happens is, of course, we stop getting new sales from that retailer if they go out of business. And then we, of course, make a lot of money as they unwind. And we just start losing the receivables. We lose about half of it in six to nine months. We lose another half six to nine months. And so quickly it trites away. After two to three years, we don't have that receivable. So our real risk is that we make less money. On a volume basis, we make a higher percent on those receivables. And then, of course, it's up to us as an organization to replace those receivables with a new partnership.

Okay. That's super helpful. There's one other one if I could sneak it in. Just for cadence of the provision expense, I know, I mean, you had this huge reserve bill. I'm just trying to think about what are we jumping off into in kind of the second quarter as you are framing it from, you know, a plus or minus range for the provision expense in that quarter? Of course.

Yeah, so obviously we'll take into consideration everything we know at the time we set that provision expense. We clearly were able to do that as we saw April unfold in the first couple weeks of April. There's always risk that the economy continues to deteriorate or people don't come back as quickly as we'd expect. At this point, you know, we looked at it. We felt very good that we'd factored into everything. We took a nice, solid, conservative look at the balance sheet and what we needed for the reserves at the end of Q1.

All right. Thank you, guys.

Our next question comes from Eric Wasserstrom from UBS. Please go ahead.

Thanks very much for taking my question. Can you hear me all right?

Yeah, we can.

Okay, great. Thank you. So thank you for going through some details of the liquidity and capital position. I think in my recent experience with the stock, I think that is, in fact, probably the more of a woman can serve, even relative to credit quality in the current environment. So could you just maybe talk about how you're thinking about the overall company's leverage position at this point and whether these circumstances has caused any rethinking about that relative to, let's say, even a month or two ago?

Sure. Obviously, the leverage ratio, when you take that big an equity hit, the setup CISO is going to cause the leverage ratio to go up. And you'll see that we also took a drawdown on our line of credit. Having said that, we are concerned about the leverage ratio. We are not tossing and turning about it. We have enough cash flow to cover that. We are comfortable with that. It's clearly something Ralph and I will need to adjust, address, excuse me, long term. But at this point, the leverage ratio from our perspective is, you know, first and foremost, we feel comfortable that we can pay our debt service. We feel very comfortable that we can.

Great. And just to follow up on the – in terms of the – the subsidiary bank position. Do you anticipate any challenge to continuing to upstream dividends to the hold code based on the near-term operating outlook at the subsidiary level?

Sure. Obviously, one of the things we're going to watch very carefully is the banks and their capital position. I've said before, and I know Ralph and I have had the conversation before, First and foremost, we want to make sure we have very robust balance sheets for both the parent and the bank, the bank being part of that, part of, of course, the reason we called out the total leverage ratio at the banks of that 16.7%. The banks have been profitable. They were profitable throughout the recession. We expect them to continue to be profitable. then the question becomes a growth versus the income. If this recession plays out one way that we might see it, which is decreased sales lead to decreased receivables, that actually allows us to dividend up more capital, meaning that we don't have as much receivables we have to hold capital against. Again, we're going to be very prudent, make sure our banks are very well positioned, very heavily capital intensive so that we stand shocks like this. So there's a variety of different scenarios we run. In most cases, we feel the banks would be able to upstream some cash to the parent.

And just one last one on this topic. I know that obviously you are understandably sort of in crisis mitigation mode, but over the longer term, Ralph, I'd love to understand your philosophy about earnings growth versus tangible book value accretion and how you think there, you know, if you think that tangible book value accretion is an important role of value creation for ADS.

I think a couple things. So let me just say this. The safety and soundness of our banks influences every decision we make. And I think even through the crisis here where we've taken prudent measures to enhance our capital position, cut expenses, I think those are clearly important things you know, important actions we've taken to ensure the safety and soundness of our institutions. I think from my perspective, predictable, sustained, good growth on top line and bottom line is what we're looking for, you know, long term. And I think that will sustain, you know, that will sustain our safety and soundness and assets in the bank.

Thanks very much for taking my question.

Our next question comes from Ashish Shabhadra from Deutsche Bank. Please go ahead.

Hi, thanks for taking my question. Just a quick question on the March data. Was there any benefit from the forbearance program on the delinquencies in the charge law? Is there a way to quantify that?

Yeah, it's very early, I will tell you. But what we have seen is As I think I mentioned it earlier, the payment rates, if I compared them to last year, were virtually the same. And we're seeing our roll rates are where they thought they would be, probably a little bit better. And we saw when the first stimulus checks came out, we did see incremental phone calls and incremental payments come in. during that period of time. Now, that does not make a trend. We're still managing it very closely. But we did see some improved activity or increased activity.

That's helpful. And maybe just as we think about, again, the charge-off and charge-off trend going through the year, Ralph, as you mentioned, charge-off could potentially go up in the back half as more consumers come out of the forbearance and also as we see a higher unemployment rate. But is there a way to think about all the puts and takes and potentially some impact from any potential retailer bankruptcy? But as we think about going into the back half, is there a way to think about where that could head to and all the puts and takes going into the back half of the year? Thanks.

Yeah, I think, you know, as I think about the backhanded half of the year where you traditionally see you know, loss rates come down, we're going to, I believe, see elevated loss rates. And I think what we've – the actions we've taken in the first quarter to reserve I think are appropriate for what we are – what we are – what we're projecting in the balance of the year. That said, it's a very fluid environment, and if things change, we will certainly adjust accordingly.

That's helpful. Thanks.

Our next question comes from Tim Willow from Wells Fargo. Please go ahead.

Thank you, Anne, and good morning. Just had one question, if we could talk about e-commerce a bit. I understand that probably a fair amount of your retailers are probably in the discretionary bucket, which is going to obviously impact their overall volume, but we're obviously seeing from some retailers stories of exceptionally strong e-commerce and digital, etc., Is there any way that you could just sort of comment or discuss where you think your retailers are with their digital commerce plans? Are they punching at their weights, or do you think that some of these retailers are still reacting and there's still better experiences and better volume to come from them as they really reposition themselves? their businesses for more digital and e-commerce than maybe they otherwise would have expected six months ago or a year ago?

Yeah, I would categorize it probably as a mixed bag. I think we have some good partners out there that have really good retail, you know, really good sites, you know, just sites like Sephora, for example. But, you know, there are, you know, certainly companies This has been an opportunity for them to rethink their strategy and ensure that they have a robust e-commerce channel, which plays right into the investments we've been making and the investments we're going to continue to make to be even more relevant in e-commerce for our partners and our customers.

If I could just ask one quick follow-up, I guess there are some stories and chatter out there about the Victoria's Secret transaction and whether or not that will occur. Is there anything that we should be aware of or think about relative to that deal closing or not closing as it might impact anything with ADS?

You know, it's difficult for me to comment on, you know, what was in the news over the last couple of days. You know, Victoria's Secret has been a partner for a very long time. I think it will continue to be a partner down the road. I think we'll work with them, you know, and we were set to work with them in their current capacity. We were set to work with them in their future capacity, and we'll continue to be a supportive partner.

Okay. Yeah, thanks very much.

This concludes the question and answer portion of our call, and I would like to turn it back to Ralph for final comments.

Well, thank you all for participating this morning. I know this is very difficult circumstances, and we are in many different locations as opposed to Tim and I being in the same room. Thank you for your time, and as I said, this is an important stakeholder and constituency group for me, and I intend to be available and certainly transparent as we communicate going forward. Everybody have a good day, and thanks again.

Ladies and gentlemen, this concludes today's conference call. Thank you once more for participating. You may now disconnect.