Bread Financial Holdings, Inc.

Good morning and welcome to AlliantStata's second 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 via the audio, you will need to press star 1 on your telephone. Please be advised that today's call is being recorded. In order to view the company's presentation on the website, Please remember to turn off your pop-up blocker on your computer. It is now my pleasure to introduce your host, Ms. Vicki Nakula of Advisory Partners. Ma'am, the floor is yours.

Thank you, Sylvia. By now, you should have received a copy of the company's second 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 uncertainties 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 card. 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 and good morning. Thank you for joining us to review our second quarter results. Since our last earnings report in April, which came merely weeks after COVID-9 was declared a global pandemic, our associates have continued to navigate exceptionally challenging conditions and rise to the occasion across every facet of our business. I continue to be inspired by the dedication of our leadership team and resilience of our associates, all of whom have successfully adjusted to new and different working environments while maintaining required client service levels, supporting each other, and doing what we can in our communities to show our support to people and organizations in need during this time. Likewise, we have done our part to support our card members, our collectors, and our retail partners. For our card members, we introduced a number of forbearance programs, which used by card members approximately 10% of our accounts receivable to relieve financial pressure during this difficult time. For our air miles collectors, as travel slowed, we pivoted our reward options to at-home and delivery, and service options and launched a digital redemption program. For our retail partners, we worked to support e-commerce and direct to consumer engagement. Brand Loyalty has used this time to support its retailers by leveraging digital channels for loyalty programs and increased engagement. In summary, for the second quarter, we are managing well in the COVID-19 environment, remaining profitable, and we believe we will have adequate liquidity to manage through this period of significant stress. Sales and credit were better than we anticipated. People are spending and meeting their credit obligations. They are engaged with us and our brand partners. And we are investing in our future with people, process, and technology. Turning to slide four, let's discuss the key takeaways from our second quarter results. On a consolidated basis, our results reflected the challenging environment. Revenue was down 27% year over year, and adjusted EBITDA net was down 50%. Loyalty One results were mixed. Air Miles benefited from a shift in focus to items that are more relevant for time at home. This combined with expense reduction led to 5% improvement over last year's constant currency adjusted EBITDA. Brand loyalty results were less favorable. With revenue and adjusted EBITDA both down, as clients in the grocery business deferred loyalty spending to later in the year. For card services, our second quarter sales activity progressively improved throughout the period as stores reopened. Sales ended 14% down as we exited June compared to last year. However, sales were down 36% to Q2 of last year. Although sales were down considerably, our products and offerings remain attractive. Within this challenging environment, our focus has been on managing what is within our control, our service levels, and our costs. In the second quarter, our cost reduction programs resulted in approximately $50 million of additional savings. Consistent with what we announced previously, we are on track to deliver $240 million of savings for 2020, meaning we expect to reduce expenses by another $100 million in the second half of this year. primarily attributable to additional procurement and operating efficiencies. We are positioning the business to be far leaner and more profitable once top line growth returns. Our credit metrics and payment activity were better than expected. I will highlight some of those metrics after Tim discusses our financial results. The majority of our card members continue to shop across all channels. Our card members, including those currently in forbearance programs, continued to make payments indicating continued engagement and responsiveness in managing their payment obligations. The positive performance together with lower sales volume led to lower accounts receivable and resulted in a modest reserve release this quarter. However, given the uncertainty around the macroeconomic environment for the remainder of the year, we are maintaining a robust allowance for loan loss exceeding 13% of our period end receivables. which is an increase of over 110 basis points from the previous quarter. Our loan loss reserve reflects a more conservative economic outlook than the first quarter, with a further reduction in GDP and a further increase in unemployment. Finally, we will continue to invest in our business. Technology and talent are at the top of our list. I will now turn the call over to Tim to cover the financials.

Thank you, Ralph, and good morning, Debbie. Let's turn to slide five to discuss our consolidated results for the quarter. During the second quarter, revenue was down 27% versus last year's $979 million, as the company and each of the segments were impacted by the pandemic. At Card Services, many of our retail partners were essentially closed at the beginning of the quarter and began to reopen as the quarter progressed. As you may recall, during the last two weeks of March, credit sales were down 50%. This improved approximately down 14% at the end of June. For our loyalty one segment, air miles travel redemption decreased dramatically. And at brand loyalty, grocers did not need programs offering to drive traffic. Income for continuing operations was $38 million, down 73%. And our earnings per share from continuing operations were down 70% at 81 cents per share. Pre-provisioned earnings before taxes of $297 million were down 34%, which was impacted by a 27% revenue decline and an asset impairment charge taken in the quarter. I will discuss the asset impairment charge in more detail in a few slides. Net income declined at 72% year-over-year, and net income per diluted share was down 69%, reflecting a lower share count. While all income measures were down, we offset some of the COVID-19 impact with substantial cost savings. including volume-related savings and operational efficiencies. Specifically, in the second quarter of 2020, we took out approximately $50 million of non-volume direct operating expenses. This follows $90 million of realized savings in the first quarter for an approximate total of $140 million of benefit cost initiatives here today. As we mentioned in past earnings calls, we expect that we will continue to see cost efficiencies. For the remainder of the year, we expect approximately $100 million of additional cost savings or approximately $50 million for each of the next two quarters. Let's turn to slide six, and we'll discuss the results of loyalty one, which includes the Air Miles reward program in Canada and the Netherlands-based brand loyalty. Revenue for the quarter was $150 million, or down 40% versus the prior year. Excluding PRESMA, which was divested in the first quarter of the year, revenue decreased by 35%. On a constant currency basis, revenue was down 38%, but adjusted EBITDA was down only 11%, reflecting expense reductions and continuing emphasis on prudent cost management. Turning to air miles, revenue was down 28% on a constant currency basis, primarily the result of the press sum up. Air miles issued declined 26% as a result of softer consumer discretionary spend, especially in our credit card programs. Redemptions were down 42%, primarily as a result of reduced travel-related redemption, offset somewhat by stronger merchandise redemption activity. However, due to strong expense management and margin improvements in air miles, as Ralph mentioned, the EBITDA net improved 5% on a constant currency basis. Brand loyalty revenue declined 44% on a constant currency basis, due primarily to fewer short-term growth-treated loyalty programs. in market and delay of major sporting events such as the Euro championship and the Olympics. So now let's move on to slide seven and we'll discuss card services. Card services revenue was down 24% and adjusted EBITDA was down 56% versus the prior quarter. Operating expenses declined 14% benefiting from cost reduction efforts and volume related savings. Including an expense for the quarter was a $34 million non-cash impairment charge related to the underperformance of certain client programs and the consolidation of an office location. As for provision, $350 million of charge-offs were offset by the release of $55 million from our allowance. This release was largely a function of the $1.9 billion end-of-period accounts receivable decrease from March 2020. On a sequential quarter basis, our end-of-period receivables were down approximately 11% versus our allowance down 2.6%. So the release was really all volume-driven. Even after the release, our reserves of $2.1 billion increased as a percentage of our end-of-period accounts receivables to 13.3% from 12.1%. This higher reserve rate is driven by a worse economic outlook, including a deterioration outlook for both our GDP and our unemployment rates. Moving to funding costs, they were $102 million, down 3% year-over-year. Lower normalized average receivables were offset by higher cost of funds as our short-term data liabilities pay down, increasing the average duration of our funding. On slide eight, I'm going to review some of the card service metrics, starting with credit sales, which were down 36%, as Ralph mentioned. This is a sharp decline, but this marks a progressive recovery from the low point in April. As you may recall, again, the end of April, our sales were down 50%. Ralph's got a slide. He'll talk about that in more detail later. Normalized card receivables, which include held-for-sale receivables, were down 12% year-over-year at $16.2 billion, and end-of-period receivables were down 10% at $15.8 billion. While the forbearance programs have resulted in positive consumer behavior, the programs have had an offsetting effect on yields. Overall, yields decreased 350 basis points, mostly due to lower late-fee yields. There's also been some pressure on our finance charges due to the Federal Reserve discount rate cuts. On a positive note, because of our cost management success, operating expenses and as a percent of receivables, excluding marked marks, and asset impairments, was 9.1%, down 30 basis points year over year, even after a significant decline in receivables. Principal loss rate was 7.6%, up 150 basis points, and delinquency rate was 4.3% down 90 basis points over year. Now let's move on to slide nine, and we'll talk a little bit about our liquidity. In April, we suspended our share repurchase programs and reduced our dividend, consistent with actions taken by others in the industry. This is obviously we're brilliantly managing our cash flow and our balance sheet. This resulted in a very stable cash position at the parent of $1.2 billion, which is consistent with the cash we had on the balance sheet and liquidity we had on the balance sheet at the end of Q1. Our long-term debt maturity profile has not changed, with $2 billion of term debt not coming due until December 2022. Moving to the banks, we have seen a sequential increase in the collective cash position of $300 million for a total of $1.2 billion in cash. Further, the capital ratios have improved, with our total risk-based capital on the combined bank now sitting at 19.7%. Funding also continues to be strong with availability both in securitization and deposit markets. Our retail deposits continue to grow as a funding source and now represents over 11% of our bank funding. I'll now turn it back over to Ralph.

Thanks, Tim. The next few slides provide insight on sales activity, the credit environment, and how we are managing partner bankruptcies. who also touch upon the way forward and how we are preparing to emerge from the current environment. Excuse me. On slide 10, you can see at the end of June, 92% of our retail partner stores were open. With the stores opening, net credit sales improved from a negative 47% during the shelter-in-place period to a negative 14% in the second half of June. Obviously, store-based sales showed the most dramatic improvement from a low of 78% during shelter in place to down 32% at the end of June. Direct sales returned in May and continued to perform. Lastly, general purpose sales are improving as states reopen. We track sales by region very closely. As you can see on slide 11, sales grew progressively as our retail partners reopened stores. There was a dramatic improvement over April results. Since quarter end, some hotspots have returned to closing stores, but the initial impact has been generally balanced by momentum in other states. That said, we are closely monitoring these trends and believe that our multi-channel credit solutions and particularly digital offerings are even more important to our retail partners during this unusual period. On slide 12, you can see payment behaviors from our card members, both non-enrolled and enrolled in forbearance. As I mentioned earlier, approximately 10% of our accounts receivable was in forbearance at the peak. Payment trends in the environment have remained stable. We are pleased with these trends, which in part reflect the benefit from government stimulus and enhanced unemployment, but also underscore our responsible credit management efforts. Moving from top to bottom, the chart shows zero payers, those who maintained a balance, and those who paid in full. Card members not enrolled in forbearance, representing about 90% of our accounts receivable, demonstrated strong engagement and payment behavior in the early stage of the pandemic. Over 85% of those not enrolled made a payment, which is significantly up over last year. While these types of payments have shifted, it is important to note that these card members are making payments. Those enrolled in forbearance also showed strong engagement. the majority of our forbearance efforts have been shorter-term solutions, such as payment holiday, and more than half of those continue to make payments, even though they were not obligated to do so. These payment behavior trends supported a better-than-expected delinquency rate in the second quarter, and since behavior was supported by stimulus, enhanced unemployment, reduced discretionary spend, and forbearance, a high level of uncertainty remains for the second half of the year and into 2021. This is reflected in our loan loss reserve. The current environment has either caused or accelerated a number of retail bankruptcies, some of which are our partners. On slide 13, we provide some information and context on how bankruptcies affect our business. First, approximately 6% of our current accounts receivable are within retailers, that have bankruptcy filings. As we've mentioned in the past calls, when retailers declare bankruptcy, there is little immediate impact on our economics. We do not lend to the retailer, so the bankruptcy does not affect our accounts receivable. Our customer is the card member. We maintain our relationship with the card members, and the card members continue to make payments on their balances. Without additional purchases at the retailer, remaining card members will maintain balances and pay over time, which proves profitable to us as we no longer incur sales or marketing expenses associated with customer acquisition or sales activities. Most bankruptcies filed by our partners are Chapter 11 proceedings with little change for us. In the worst case, for those who file or shift to Chapter 7 liquidation, We need to replace the sales generated by the retailer to continue to grow our accounts receivable. We maintain an active pipeline of prospects and continue to focus our business development efforts on retailers in growing attractive verticals. The way forward begins with good governance and talent. As you can see on slide 14, our board of directors continues to implement its multi-year refreshment plan. Three of our long-tenured directors completed their board service this year, and we have added two highly qualified directors who bring new skills, views, and experience to our board. The board also elected a new board chair in Roger Ballou. As previously mentioned, we added key talent to Alliance data. Val Greer joined us from Citi, where she was head of co-brands and successfully revitalized their portfolio, car technology infrastructure, and drove strong growth. This is an important role at Alliance Data. Val will lead our efforts to attract and retain brand partners and drive profitable growth. We will continue to invest in data and analytics and customer-facing digital capabilities while we migrate to a more flexible business model, reducing our costs to serve. We continue to renew and sign partners in high-growth verticals, including health and beauty, home improvement, and home furnishings. We recently signed a multi-year private label renewal with The Tile Shop, a specialty retailer of stone and man-made tiles. We also launched a private label commercial card program for small business owners with floor and decor and signed a new private label credit card program for Salon Centric, one of the largest U.S. wholesale distributors of professional salon and beauty supplies. Finally, we remain highly focused on our balance sheet and will continue to work to improve our liquidity and cash flow. In conclusion, for the remainder of the year, we will focus on two key areas. First, on our current near-term performance across the enterprise as we continue to work and deliver for card members, customers, and partners. I'd like to thank our associates across our lines of business for their efforts and hard work during this very challenging an unprecedented time. We continue to evaluate our return to office plans as we monitor the progression of the virus in the U.S. and maintain proper safety work protocols in international markets where infection rates have tempered. The health and safety of our associates always comes first. We will also continue to monitor the accredited environment closely in the second half of the year, manage our risk strategies, and maintain prudent reserve levels. we will continue to employ a disciplined approach to managing our balance sheet and risk profile. Second, while we're managing the present environment, we're also working to shape our future and position ourselves to emerge as a strong competitor. Our go-forward focus will include right-sizing our expense base to reduce our cost to serve, partnering with clients in growing attractive verticals and building to scale, growing with our partners through payment capabilities that integrate with any purchasing channel, providing products and services that are relevant to the consumer to meet their purchasing, borrowing, and saving needs, and managing our balance sheet to improve shareholder returns and reduce risk. As we continue to develop our long-term strategy, we will take advantage of opportunities late this year to share plans through conference calls, future earning calls, and participation in investor conferences. With that, operator, I'd like to open the call to questions.

Thank you. Ladies and gentlemen, if you would like to ask a question, please press star 1 on your telephone keypad. Your first question comes from the line of Sanjay Sakrani from KBW.

Thanks. Good morning, and I'm glad you guys are doing well. I guess if we strip out provisions for a minute, and understanding the returns on the business are quite high and probably not reflected in the stock. I'm just trying to think about pre-provision profitability going forward. Are you guys suggesting that going forward, a combination of some of the expense saves will sort of mitigate the revenue yield weakness? Because the revenue yield is down 500 basis points or so from its peak. Maybe you could just walk us through the profitability of the business going forward.

Sure. Hey, Sanjay. Thanks for the questions, obviously, too. So let's start with the expense portion. Clearly, what we outlined is on a year-over-year basis, about $250 million, $240 million of total operating expense saved. And that is not volume-related. Those are operating expense savings. So obviously... If you look at our P&L, you'll see a much larger number of dollars saved, but pure takeout was about $240 million is what we either realized or are going to realize. Then you work your way back up to the revenue line item, and the effect of our yields are twofold. One is, I'll start with the smaller, is going to be the effect of the discount rate translated into our yields. Those are down 40, 50 basis points. There's a little bit of noise around the charge off, the purification. But the vast majority of that drop then comes from the late fees. So of that 350 basis points, about two-thirds of that is a function of our late fees. So the real wild card is going to be for us, you know, the positivity associated with the credit metrics is obviously then turning back around and having some negative effect on the yield, and that's the wild card for us. you know, if we continue to have very good credit metrics, I'd expect that we continue to have pressure on our late fees. If our credit metrics begin to deteriorate, I'd expect that my credit, my yields, and especially my late fees start to come back into line.

Okay. And then when we think about the provision and the reserves, you know, when I look at that reserve rate and I think about what that implies in terms of a macro, could you just talk about what you're assuming inside for your macro assumption. And then if I'm doing the math correctly, are you suggesting sort of the associated charge off rate for that reserve rate is like 9% annualized? Is that the right way to think about it?

Thanks. We didn't, I'll start with the last question and work my way back to the assumptions. We didn't, we don't necessarily have a charge off rate that we're assigning to that because the way you end up setting allowances, the math is so different. I'm looking at obviously all my receivables on the balance sheet today and look at the total dollars that are gonna charge off over the life of those loans. So I didn't really translate that back into, we don't really translate it back into a charge off rate. But having said that, maybe we talk about how we did set the provision, which is clearly we look at all the math associated with the different buckets. And if you look back on page 14 of our 10Q from last quarter, we basically break out the different segments. And you'll look at how those segments are going to perform over time. And then, of course, we choose a question. We get to choose, boy, what type of economic environment do we think we're going to have? We use Moody's as our economic overlay. We use the most conservative economic overlay from Moody's. Those of you familiar with it would be the S4, which is a probability that we are going to perform at 96% chance we perform better than we overlaid in that and that includes having a double dip on recession that has unemployment rates back into 13%, meaning you have a double dip and employment rates go back to 13% into 2021, then we have at least a 10% decrease in the GDP. So again, the most conservative numbers we're footing to in that off of Moody's S-4.

Okay. Thank you.

Thanks, Sanjay.

Your next question comes from the line of Andrew Buck from Wolf Research.

Hey, guys. This is Andrew on behalf of Darren. So just thinking about how ADS is going to become more aggressive on the marketing front and those types of things when the economy turns, I guess what are the types of levers that you're thinking about pulling forward? when that turn actually starts to happen? Is it a credit perspective? Is it the investments in data and analytics that you can kind of turn on? Maybe you can give us some higher-level thoughts around that.

Sure. This is Ralph. So a number of things. I think we will continue to invest in data and analytics, and we'll kind of turn that up as we come out of the turn here. We have a good platform. We'll continue to invest in that platform. Digital is key to us, and I think if we've learned anything through this pandemic is, You know, digital is the way forward, and we have made some good digital investments in enhancement, presentment, online, time, real pre-screen, provisioning our co-brand cards and Apple Pay. We'll continue to make those investments to make it seamless for our customers to transact in any channel they choose to.

Got it. Thank you so much.

Your next question comes from the line of Bob Napoli from William Blair.

Thank you, and good morning. Tim, just a quick question. You said 6% in bankruptcy. I'm not sure if that includes Acena. That's been one of your larger clients. And then I have a follow-up for Ralph, just a big-picture question.

Sure, yeah. So that was about 6% at the end of the quarter, so the end of June, so that did not include Acena.

And how much does that, what does that bring the number to on the bankruptcy side?

Oh, I think you're probably a couple more percent, probably two or three more percent. I'm off the top of my head.

Okay, thanks. Then, Ralph, I mean, you've spent a lot of time at American Express and Citigroup, and now you've been at ADS, I think, long enough to get your arms around, obviously, a very difficult situation. But as you look at this business, what do you think, you know, how do you compare it to where you've been, what do you view as the strengths, and then what do you think should be like a normalized credit loss for this type of business, and then kind of a normalized efficiency ratio over the long term for the card business?

Yeah, so I've spent, let's see what it is, about 25 years at City and American Express and six months at ADS. So I will give you my perspective. I think there's strength here. I think the reputation of ADS with retailers of all kinds, not just apparel, but all retailers, really will help us going forward in structuring the right kind of deals in the marketplace. So I'm thrilled about that. I think the nimbleness of ADS has been refreshing to me. We're able to pivot pretty quickly because of the size of our organization. Decision-making is important. is quicker than in organizations I've been in before. So that's all been very refreshing. The leadership team is very focused on what needs to get done. There are no ancillary things we need to worry about. We're focused, particularly in the card services business, on serving customers and on striking deals that are right for both the partner and ADS. So to me, those are things going forward that make good sense for us. In terms of the In terms of the ultimate loss rate, hard to predict. I think the way I look at loss rates, are we getting paid for the risk that we're taking? So is my credit margin increase outpacing my loss rate increase? And that's the way I tend to look at loss rates. Clearly, in a private label business, as opposed to a general-purpose credit card, you're going to get higher loss rates, but you're also going to get higher yields. So one would ask, are you getting paid for the risk? And that's kind of the way I look at the organization. I feel very comfortable with our underwriting process and procedures here and the focus we have working with our card members, not only to get through difficult times, but also to get through business as usual times.

And if I could just sneak in one quick one, what percentage of your sales today is digital online versus what it was prior to the pandemic?

So, Prior to the pandemic, it was hovering around 30%. Now, it's probably hovering a bit above 40%.

Okay. Thank you very much. Appreciate it.

Your next question comes from the line of Eric Wasserstrom from UBS.

Thanks very much for taking my question. I just want to return, if I could, to the PPNR discussion. And could you maybe give us a sense of, you know, where you see the loan portfolio sort of troughing? Is it now, or do you think it will continue to attract over the course of this year? And what will sort of signal inflection? And then I just have a follow-up on the OpEx side.

Sure. So, Eric, PPR, are you talking about the average receivable conversation?

Yes, exactly.

Yeah, obviously it's going to be very dependent on what happens with those sales. We saw a fairly significant drop for us sequentially from the end of March to the end of June when we actually dropped 50%, finishing at 14%. If we continue to have that type of drop in sales, we're going to continue to have that type of drop in receivables. What we're obviously showing is that as we're coming out of the pandemic and people are learning to shop again, you know, down 10, down 15% that we saw at the end of June, then we would expect our receivables to start to stabilize. So it's really going to depend if, you know, we start having California, Texas, Florida, you know, New York start to lose steam from the pandemic. It starts coming back up again. People stop shopping. Of course, we'll lose receivables. But if it does stabilize it down 10, down 15, we should stabilize our receivables.

And then just on the OPEX, the 240 that's not volume related, is the appropriate way to think about that Relative to the year-end figure from 19, so in other words, it's like roughly a quarter of a billion dollar lower run rate as we move into 2021. Is that the appropriate way to think about it?

Correct. Yep. So if you had exactly the same receivables, exactly the same air miles redeemed, exactly the same program numbers in brand loyalty, if I looked at all those and that was all flat, then I would be taking $240, $250 million out on a straight run rate.

Thanks very much for the response.

Thanks, Eric.

Your next question comes from the line of David Scharf from JMP Securities.

Hi, good morning. Thanks for taking my questions as well. You know, first, just a more of a near-term sort of financial cadence question for you, Tim. On the... On the yield outlook, as we think about the second half, you know, how should that cadence work as forbearance eases up and the payment holidays ease and we start, you know, recognizing late fees again? Can you give us a little sense for whether, you know, the 20.4% likely represents a bottom and how that might trend near term?

Yeah, I'll never say bottom, but I certainly would say pretty darn close to the bottom. given what's happened the last three or four months. And let's break it down a little. I'll take the easier portion. The yield, the one-third of that, that's a function of the Fed discount rate. That's going to stick with us for the rest of the year. But as we get back to the forbearance effect and the payment effect on the two-thirds of that 350 basis point drop, I think as people start coming out of the forbearance programs, and we saw the forbearance down dramatically by the end of the quarter, you're going to see people start paying those late fees again. So I could see that mitigating down to half to a quarter of where it was before, meaning that 230, 240 could be 80 basis points. We have not modeled that out, so I'm just looking at matching my forbearance to my late fees. And again, it's going to be dependent. People go back into forbearance. We'll give up the late fees. We'll obviously deal with the charge off, have the benefit of the charge off. But if people come back out, forbearance programs are no longer there. They come out and skip the pays. We'll start getting those late fees again.

Right, right. Got it. No, that's helpful. And then as a follow-up, I guess, for Ralph, you know, maybe bigger picture sort of product mix question. You know, given Ms. Greer's background, you know, with kind of co-brand and working with partners and with, I guess, with Acena, you know, 8%, 9% of the portfolio with retailers and BK, do you have any thoughts about sort of the mix of pure private label versus co-brand that you might think is optimal going forward? Is there any desire to perhaps become a little less tethered to the fortunes of specific programs, or is the profitability of the PLCC programs such that you actually want to stay away from the price competitiveness of co-branded products?

I think a couple of things. I think some of it's going to be opportunistic, what comes into the marketplace. That's always clearly part of the equation. But the way I look at it is you do want a balanced portfolio. You want a a fair amount of PLCC in your portfolio, but you also want a balance of co-brand. Now, each portfolio does a different job for you. So, for example, PLCC, the private label portfolios, have higher yield and higher losses, where in the co-brand portfolio, you'll have higher spend, you'll have less losses, and your yields are a little less. All that balances out so you can take the right amount of risk in each portfolio to drive overall profitability. So I'm not looking for each portfolio to do the same job. I'm looking for each portfolio to do a specific job and how that all fits together. So like I said, some of it's opportunistic on what's in the marketplace. I think in PLCC, our concentration was apparel. We're moving our concentration to other types of private label, home and beauty, home design, home improvement. all of which have proved stable throughout this pandemic. So we're not only diversifying our portfolio between co-brand and private label, but we're diversifying that private label portfolio as well.

Got it. Thank you very much.

Your next question comes from the line of Rafael Posadas from Oppenheimer.

Rafael, your line is up. Rafael?

Hey, can you guys hear me?

Yeah, now we can hear you.

Hey, this is Dominic Gabriel. I think they must have mixed my associate and my name up. So I was just wondering if you guys can talk a little bit more about the new commercial card and the opportunity there and why now and you know, what that revenue opportunity could look like for earnings, say, a year from now. Could that be a needle mover? Is this a penetration within your current customer base? Or are you looking for new partners you could expand to on that commercial card? If you could discuss more on the commercial card, it seems really interesting. I'd love to hear about it. Thanks so much.

Dominic, you talked about how we're placing – you know, the current offering was the tile shop and why we think that's a good offering currently? Yeah. We're always looking for opportunities to expand. The tile shop is a strong retailer. It's in the home improvement sector, which we like quite a bit. As you've probably seen some of the statistics out there, you know, what hasn't suffered in this pandemic is, you know, the do-it-yourselfer slash, you know, home improvement area. This will be mostly small commercial programs, you know, a tile guy putting in a new bathroom, et cetera. So we felt it was well positioned with what's happening in the current economic environment.

Yeah, we're anxious to see what it does. It is a, it's new for us. You know, I put this in the test and learn category right now and understand, you know, is it something that we can grow responsibly and thoughtfully and manage manage the yields and manage the credit of a commercial car.

Okay, great. And then maybe you could just go over what you're seeing among the jewelry category in particular. How does that trend line look? Does that mirror travel versus home improvement? How does that trend line look? And then when you think about large average balance accounts versus smaller average balance accounts, what are the differences among the payment behavior given all the stimulus you've seen from the government in particular and just the payment behavior among your customer base? Thanks so much, everyone.

You bet. So as you would imagine, jewelry is down. It's probably not as down as much as travel, but it is down. You know, right now the essentials are up, and even apparel is a bit better than jewelry. In terms of the payment behaviors of balances, really no difference across the board. We've seen the same behavior as whether the balance is high or low, so really no difference there.

Great, thank you.

Your next question comes from the line of William Ryan from CompassPoint.

Good morning, and thanks for taking my questions. A couple of things. A while back ago, I think it was mentioned that The initial expectation was maybe that 50% of accounts that were on deferral or forbearance may ultimately charge off, but you've clearly had a big percentage paying while in forbearance. Is that still the expectation? Do you think that might be a little bit less based on the payment trends that you're seeing from these people while they've been in forbearance? We focused on the yield a lot, but on the funding costs, you know, you've clearly articulated that there is a lag in the repricing of funding costs. You know, sort of what is the cadence of that that you're anticipating over the course of the next, you know, call it two, three quarters? Thanks.

Sure. So we were seeing, based back in the last recession, people who put in a forbearance program, we thought that would be about a 50% cure rate, meaning that they wouldn't go to charge-offs. Actually, we're seeing that more at like 75% now of people coming out of those programs, and that's obviously a function of the large percent of the folks now that are coming into the skip-a-pay, the shorter-term programs. So kind of pretty positive news there. And, William, I'm sorry, I missed your second question. Can you repeat it for me?

Yeah, second question was just on the funding cost side. You know, we focused on the call mostly on yield, but just thinking about you've always articulated that There's a lag in the funding cost repricing and sort of what kind of cadence might we expect over the next two or three quarters?

Yeah, we'd expect by the time we get into the fourth quarter that we should start getting some benefit there. What I hadn't anticipated, what we hadn't anticipated was the quick pay down of the receivables on the liability side. And, of course, what that meant was the short-term liabilities, the money market accounts, The short-term CDs were, of course, what paid off. And given how much the balance sheet shrunk, we needed to keep the long-dated maturities. And hence, actually, our cost of funds went up a little bit this quarter. That should mitigate over the course of the next two quarters. So we think we'll start getting some benefit by the fourth quarter.

Thank you.

Thanks, William.

Your next question comes from the line of Mahir Bahata from Bank of America.

Hi, good morning, and thanks for taking my questions. I just wanted to maybe first just start with, I think previously you'd also articulated about charge-offs. You don't expect them to breach 10%, I think you'd mentioned, because that was the high-water mark of the last crisis. Is that still your expectations based on everything you've seen so far? And just if you could talk a little bit about just what you're seeing in terms of what your expectations are for the trend, at least.

Yeah, I think that's what our expectation would be this year. And, you know, it's hard to predict with the stimulus package now rolling off and the spike in the pandemic. But we, you know, we think we are certainly adequately reserved for the year and going into 2021.

Hey, does your reserve assume the stimulus package rolls off? So a renewal would be a positive, I guess, from the reserve point of view, or?

Yeah, so if you go look at, you know, it's obviously purposeful and call that the Moody's overlay, the S4. So if you go look, there's a very specific write-on if you have access to that. And it does not assume a stimulus and actually assumes that our friends in Washington have some issues in the fourth quarter as far as any ongoing, you know, ability to help the consumer. So it's an ongoing recession with no further stimulus.

Understood. And then just maybe a little bit more of a big picture question. I was curious, you know, you've clearly signed up some new programs and it sounds like the pipeline is filling up too. So I was just wondering, can you talk about the competitive environment? Just curious on what you're hearing from retailers. Are you seeing retailers maybe relying a little bit more on their card program because of the economics or to drive sales, revenue, etc.? ? particular features. I think you've talked about ADS maybe needs to build a few capabilities in the past, and you're making those investments, just what those are and how ADS is positioned.

Thank you. Yeah, so I think we're partnering well with our retail partners. We're working with them to determine when we market and enhance sales, what offers we make. So we're working with them really day in and day out, targeting and determining when we'll make those those offers to the card members. I mean, I think we give the consumer the ability to have a bigger basket at the retailer. That's good for the retailer. It's obviously good for the consumer as we move forward. So in terms of enhancements, I think we've done some really nice digital work. I've talked about our enhanced presentment, our real-time prescreen, as well as provisioning our cards in Apple Pay. Those are real good steps forward. We'll continue to make those digital investments. Great.

And then just one last question, if you don't mind. Just on Buy Now, Pay Later, is that a product you can offer to your retail partners? And then just curious on what your thoughts are on that product, how it compares to the card product. If you can offer it, is there thoughts around that? Or do you have first preference with your retailers, et cetera, on that? Or can your retail partners go to someone else for that product? Thanks.

Our goal is to offer our customers a basket of products where they could use to borrow and pay and save. Buy now, pay later is one that clearly we're interested in. We're working towards offering that to our customers in a very expedited way. Our product ties are to the brand loyalty program, but we certainly will, you know, on our roadmap is certainly buy now and pay later.

And generally, you know, for a buy now, pay later, we either have a first right refusal, we have an ability to keep that with our retailer, but I think probably more importantly is that the retailer wants us to have that product as the basket of offerings. It's a whole lot better if they go across the board with a buy now, pay later, a private label, a co-brand. We have that suite and all of them branded with the retailer's name. So regardless of what preference we have before, we have the most important preference, which is the partners would like us to offer that and be part of that total solution for the retail partner.

Thank you.

Your last question comes from the line of John Hecht.

Jeffrey morning guys thanks very much for taking my question I'm you first wanted it I think you talked a little bit about the call but yes it was a moving parts at loyalty one given you and market trends but also some of the marketing plans you guys had you considered originally with you lots of live events that unfortunately have been yeah disrupted so maybe can you just give us a little bit more information about your outlook for loyalty one and your strategic intentions for that division?

John, by virtue of your question, I think you're talking about brand loyalty and the delay in some of those programs?

Correct.

Yeah, so obviously there are two different kind of groups that we'll have there that you end up having, which is the grocery channel, which is fairly ongoing, Those will come back as we need to – as our grocers need us to drive people back into the stores. So in brand loyalty, the grocery stores are going to be very dependent upon, you know, getting out of a pandemic and then getting back to the point where the grocers need our offerings to drive back in. And then the other side of that business is going to be very event-related, the Olympics, any type of event like that. And that clearly is going to be dependent upon, again, the pandemic and once you see those come out. And I think your second question was around, you know, long-term plans with those different divisions.

Yes.

Yeah, so this is Ralph. You know, right now those programs are, both programs are working well for us. They're part of our, you know, of our organization. We'll continue to operate those as we move forward. They throw off good cash flow and we'll continue to operate those as appropriate.

Okay. And then the second question is, you guys talked about a pretty good pipeline of new potential retail partners. I'm wondering, can you characterize that? Is there more of an outreach to digital channel partners, or are they more physical retailers? Maybe just some color on that side.

Yeah, I think it's across the board. The way I look at partnerships, it's location, channel, and resilience. I think those are the three things we look at, and do the partners have that? And Our focus is to help the partner and then help the customer transact in any channel that they wish to, whether it is traditionally a traditional store, whether it's online, whether it's a combination of both. So, you know, that's the way we look at our partnership pipeline.

Okay. Thanks very much, guys.

Thanks, John.

And there are no further questions at this time. Are there any closing remarks?

No, I thank you all for your time, and looking forward in the coming months to talk about our way forward and how we will emerge from this pandemic a stronger competitor. Thank you.

Ladies and gentlemen, this does conclude today's conference. We thank you for your participation and ask that you please disconnect at this time.