Bread Financial Holdings, Inc.

Good morning and welcome to Bread Financial's second quarter earnings conference call. My name is Emily and I'll be coordinating your call today. 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 register a question, please press start followed by one. It is now my pleasure to introduce Mr. Brian Verab, Head of Investor Relations at Bread Financial. The floor is yours.

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

Thank you, Brian. Good morning to everyone joining the call. I'd like to start the call today by welcoming Joyce St. Clair, a veteran financial services senior executive to our board of directors. Joyce most recently completed a successful 30-year tenure with Northern Trust. We are thrilled to have her serve as a member of our board, as well as on our board's compensation and human capital and risk committees. We look forward to the value she brings to the board through her extensive insights, perspectives, and experience. Starting with the key highlights for the quarter on slide three, we achieved another major milestone towards our long-term financial goals in the second quarter, refinancing and reducing our parent unsecured debt by more than $500 million. Our management team has made it a priority to reduce our leverage and the company took another meaningful step forward this quarter in that regard. Tangible book value per share exceeded $38 at quarter end. Importantly, we continue to deliver improved tangible book value for our shareholders with growth of 23% versus the same period a year ago. Earlier today, we announced we will provide a private label credit program for Dell Technologies a leading technology provider with the industry's broadest technology and services portfolio. The definitive agreement to acquire Dell's consumer portfolio is expected to close in the fourth quarter of this year. The Dell Pay program will include a broad suite of payment solutions and expands our position in the consumer technology market. We will continue to leverage our deep financial services industry expertise, upgraded technology, and sophisticated data analytics capabilities to drive value for our partners. Moving to the economy. Numerous macroeconomic headwinds, including prolonged high inflation, rapidly rising interest rates, and a tightening job market have weighed on our consumers and influenced a slowdown in credit sales. These headwinds tend to disproportionately impact moderate to low income Americans, including our customers' spending decisions. In certain areas like beauty and travel and entertainment, we are seeing continued strong year-over-year growth. However, in other areas like specialty apparel, spending has softened, declining year-over-year. Given the ongoing macroeconomic pressures facing consumers, we continue to proactively and responsibly tighten our underwriting and credit line management. Even prior to the pandemic, we proactively managed our exposure by tightening approval rates, pausing line increases, and implementing line decreases where prudent. We will continue to closely monitor consumer health and spending behaviors and adjust to changing economic conditions. Turning to slide four, our current focus areas for 2023 are growing responsibly, strengthening our balance sheet, optimizing data and technology, and strategically investing in our business. Our management team is committed to driving sustainable, profitable growth that will deliver long-term shareholder value. We continue to selectively pursue new partnership opportunities that will be accretive to our business, considering both de novo and partners with existing portfolios. Enhancing our balance sheet remains a top priority and is integral to our long-term strategy. As I mentioned, we have made additional progress building capital and reducing our parent unsecured debt in the second quarter. Coupled with strong free cash flow generation, our balance sheet management actions further enhance our financial resilience, and provide additional flexibility for capital utilization, including supporting continued business growth, debt reduction, and future capital distribution. We will continue to build our capital position, refine and improve our funding structure, and proactively manage our credit, liquidity, and interest rate risk to build our balance sheet strength. On the data and technology front, we continue to leverage innovative capabilities gained from our platform conversion, system enhancements, and expanded product portfolio. We have successfully utilized machine learning for many years to build strong credit risk models to enhance underwriting, line management, and collections. We will continue to invest in a range of technology innovations from data and customer analytics to self-service and digital capabilities as we continually strive to deliver exceptional value and experiences for our customers. Our goal is to continuously generate expense efficiency to reinvest in our business to support responsible growth and achieve our targeted returns. Slide five includes financial highlights resulting from the prudent balance sheet management actions over the past three years since I've joined the company. Starting with funding, we have diversified our base with direct to consumer deposits growth of $4.8 billion since the first quarter of 2020, as we have reached $6 billion in consumer deposits at quarter end. We remain confident in our ability to efficiently fund our long-term growth objectives and further broaden our funding base with continued growth from direct to consumer deposits going forward. As mentioned previously, We have made great progress executing our parent debt plan in the second quarter. Steps included successfully refinancing our term loan and revolving line of credit, completing our convertible notes offering, executing our tender offer, and receiving bank board approval for a $500 million dividend to the parent company to facilitate debt reduction. As a result, since 2020, we have reduced our parent level debt by 55%. paying down more than $1.7 billion. Additionally, since the first quarter of 2020, we have more than tripled our TCE to TA ratio. Finally, while our reserve rate remained steady till the last quarter, we expanded our credit loss absorption capacity with a reserve rate 300 basis points higher than our CECL day one rate in 2020. These significant accounts over the past three years demonstrate our success and strengthening our balance sheet and managing our business responsibly to deliver long-term value for shareholders. Overall, we are pleased with our second quarter results and the progress we have achieved. Our associates continue to navigate through a changing environment with confidence and tenacity in achieving our goals, winning new partners, strengthening our balance sheet, gaining efficiencies, and providing a positive customer experience. Our leadership team appreciates their hard work and their dedication on behalf of our many stakeholders. Together, we remain focused on driving our performance to achieve sustainable, profitable growth that builds shareholder value over time. Now I'll turn it over to Perry to discuss the financials for the quarter.

Thanks, Ralph. Slide six provides our second quarter financial highlights. Fred Financial's credit sales were down 13% year over year to $7.1 billion driven by the sale of the BJ's portfolio in the first quarter, coupled with moderating consumer spending. This was partially offset by our continued new partner growth. Additionally, we have taken action over the past year to responsibly tighten our underwriting and credit line assignments for both new and existing customers, given the economic uncertainties and the economic pressures affecting a larger portion of our customer base. Average and end of period loans increased 4% and 1% respectively year over year. These increases were driven by the addition of new partners as well as further moderation in the consumer payment rate, mostly offset by the sale of the BJ's portfolio. Revenue for the quarter was $1 billion, up 7% resulting from higher average credit card balances and non-interest income, partially offset by increased reversals of interest and fees resulting from higher gross losses in the quarter. Total non-interest expenses increased 12% year over year. Looking at the financials in more detail on slide seven, total net interest income was up 1% from the second quarter of 2022 and with NIM nearly flat year over year. Total non-interest expenses increased 12% from the second quarter of 2022, yet declined 3% sequentially. The year-over-year increase was partially the result of higher employee compensation and benefits costs due to increased hiring to support our investment in both technology and digital capabilities. We also incurred elevated collection costs as well as higher card and processing costs, including fraud. The sequential decline in expenses was driven by lower variable costs from lower sales and strategic credit tightening and expense efficiencies. We expect certain expense efficiencies to continue in the third quarter, resulting in lower sequential expenses in the third quarter, including an approximately $12 million sequential decline in depreciation and amortization costs. Additional details on expense drivers can be found in the appendix of the slide deck. Income from continuing operations was up $52 million for the quarter versus the second quarter of 2022, reflecting a lower provision for credit losses while PPNR marginally increased year over year. Turning to slide eight, loan yields continued to increase, up 110 basis points year over year. Loan yields benefited from an upward trend in the prime rate, causing our variable price loans to move higher in tandem. Both loan yield and net interest margin were pressured by an increase in the reversal of interest and fees related to elevated credit losses. Funding costs continue to rise and remain in line with our expectations. As you can see on the bottom right graph, we continue to improve our funding mix through our actions to grow our direct consumer deposits while maintaining the flexibility of secured and wholesale funding. The reduction in secured borrowings this quarter is a result of the sale of the BJ's portfolio in February. As Ralph discussed, we are pleased with the progress we made during the quarter in executing our parent debt plan including refinancing our term loan and revolving line of credit, extending certain of our debt maturities, and reducing our unsecured debt. Turning to slide nine, we are proud of the success and funding diversification we have achieved from growth in our direct-to-consumer deposits. Our direct-to-consumer average deposits grew 51% year-over-year to $5.8 billion for the quarter, with current balances standing at over $6 billion. These deposits, which are over 90% FDIC insured, represented 33% of our total funding mix versus 22% a year ago. Notably, we experienced net positive inflows of direct-to-consumer deposit balances during each week of the second quarter. As expected, we are seeing more competition in the online deposit space. We will remain opportunistic yet prudent as we continue to grow our direct-to-consumer funding. Given the repricing characteristics of our credit card portfolio and low deposit gathering costs, we are able to offer very competitive rates to drive growth and maintain balance stability. Moving to credit on slide 10. Our delinquency rate for the second quarter was 5.5%, down slightly from the first quarter as expected, with the impact from the transition of our credit card processing services abating. The net loss rate was 8.0% for the quarter. We estimate the second quarter rate was elevated by approximately 100 basis points from the customer accommodations made last year related to the transition of our credit card processing services. The reserve rate remained flat sequentially at 12.3% as key forward-looking macroeconomic indicators began showing signs of stability. We intend to maintain a conservative weighting of economic scenarios in our credit reserve model in anticipation of ongoing macroeconomic challenges and the consequential impact on our credit reserves. From what we see now, both in terms of the internal credit quality characteristics of our loan portfolio and the macro outlook, we believe the reserve rate may have peaked and will now hold steady for a period of time. Additionally, our credit risk score distribution mix improved modestly from the first quarter. Our percentage of cardholders with 660 plus credit score remains materially above pre-pandemic levels given our prudent credit tightening mix and a more diversified product mix with co-branded proprietary cards representing a larger portion of the portfolio. Turning to slide 11. We've continued to enhance our financial resilience by taking a number of actions. As Ralph mentioned in his remarks, we continue to proactively manage our credit risk to protect our balance sheet in the face of more challenging economic conditions. Consistently managing our risk tolerance ensures we are appropriately compensated for the risk we take. We closely monitor our projected returns with the goal of generating strong risk-adjusted margins above our peers. Additionally, we continue to responsibly manage risk-return tradeoff by tightening credit which includes pausing credit line increases and implementing credit line decreases when necessary. We remain confident in our disciplined credit risk management and our ability to drive sustainable value through the full economic cycle. We are committed to delivering responsible, profitable growth, even if it means slowing growth during more uncertain economic periods. Moving to slide 12, Ralph already touched on the notable improvements we've achieved in our capital metrics and debt levels. While we have made substantial improvements to strengthen our balance sheet since 2020, we still have some additional opportunities ahead. Specifically, we aim to build our total company capital metrics closer to those of our peers while reducing our double leverage ratio from where we are today. We will balance achieving these targets with continued investments in our business and responsible growth aligned with our capital priorities. Our actions over the past three years provide greater financial flexibility to support our long-term growth plans, which we will detail during our investor day in 2024. Before moving to our 2023 outlook, I would highlight the improvement in our tangible book value per share as shown on the graph on the right side of slide 12. We have generated a 33% compound annual growth rate in our tangible book value per common share since the first quarter of 2020. and given our strong cash flow generation, we expect to continue to further grow our tangible book value over time. This growth combined with our meaningfully improved financial resilience and a strengthened balance sheet should yield a company valuation that is a multiple of tangible book value. We remain confident in our strategic direction and will continue to execute on our initiatives to build long-term value. Finally, Slide 13 provides our financial outlook for the full year 2023. Our financial outlook has been updated to reflect slowing sales growth as a result of both self-moderated consumer spending and our targeted credit tightening. For the full year, average loans are expected to grow in the low to mid single digit range relative to 2022 based on the latest economic outlook impacted consumer spend our credit strategies and current new partner pipeline, including the announcement of the Dell consumer credit portfolio acquisition, which is expected to be, which is expected to close in the fourth quarter of this year. The Dell acquired portfolio is expected to be less than $500 million, which is in our historical sweet spot for portfolio acquisitions and is projected to drive strong risk adjusted returns. We expect revenue growth to be slightly above our average loan growth in 2023, excluding the gain on sale from the portfolio sale, with a full year net interest margin similar to the 2022 full year rate of 19.2%. We continue to expect second half 2023 total expenses to be lower than the first half of the year. with third quarter expenses to be lower than the second quarter driven by improved operating efficiencies related to our technology modernization efforts and lower intangible amortization expense. With a previously capitalized software development project reaching the end of its useful life in the second quarter, we forecast depreciation and amortization expense to decline in the third quarter to a run rate below $25 million per quarter. We have refined our net loss rate outlook as we now anticipate the full year 2023 rate will be in the low to mid 7% range, including impacts from the transition of our credit card processing services. While our tighter underwriting and credit line management should benefit future loss performance, these actions create a near-term headwind for the remainder of 2023's loss rate by lowering our projected loan balance, which forms the denominator in the net loss rate equation. Our economic outlook assumes inflation remains elevated but moderates with a gradual increase in the unemployment rate for the remainder of 2023. We expect the third quarter net loss rate to be around 7%, with July representing the last month that is anticipated to reflect an impact from the transition of our credit card processing services. Our full-year normalized effective tax rate is expected to remain in the range of 25% to 26%, with quarter over quarter variability to timing of certain discrete items. Finally, this morning we announced that the board approved a share repurchase authorization intended to offset share count dilution in 2023, bringing our weighted average diluted share count back closer to 50 million shares for the second half of 2023. In closing, we are prudently managing risk return trade-offs through a challenging macroeconomic environment while continuing to strategically invest and drive long-term value for our stakeholders. Operator, we are now ready to open up the lines for questions.

Thank you. Ladies and gentlemen, if you would like to ask a question, please press Start followed by 1 on your telephone keypad now. If you change your mind, please press Start followed by 2. When preparing to ask your question, please ensure your phone is unmuted locally. Our first question today comes from the line of Sanjay Sukrani with KBW. Sanjay, please go ahead.

Thanks. Good morning, and good results in a tough backdrop. First question's for Ralph. As it seems we're moving towards this final rule around late fees, pretty much it seems at the same level as the preliminary proposal. Maybe you could just give us an update on the plan to offset the impact and what kind of feedback you're getting from your partners.

Yes, I'll let Perry chime in. We've been anticipating this for a while, and we continue to look at alternative ways to close what gap this may open with our organization. So the themes haven't changed. We're looking at APRs, we're looking at fees for credit, and we're looking at other things such as where do we draw the line on underwriting for credit. Those are all things that we've been looking at since the beginning and will continue to look at as we move forward.

Anything to add, Perry?

No, I was going to say, similar to what you're probably already aware of and you've heard, the rules aren't final. Expecting something possibly in October, expect those rules will likely be challenged in the court by industry associations, and that could result in a lengthy process before any new rules become effective. I think Ralph talked about all the different things, but throughout this, the team is working closely with partners, and our objective is to really try to make sure that our partner economics are not impacted from this. We're in this together. That's why it's called a partnership.

Okay. And then just to follow up for you, Perry, the slower growth, I assume a lot of this slower growth is being driven by your tightening the box a little bit. I'm just curious, Is that the right assumption, or are you actually seeing diminishing demand for loans? And then maybe you could also help us think about the capital return. It's a good positive step, the small capital return, but at what point can you ramp it up in terms of the TCE ratio? Thanks.

Yeah, so related to the outlook we gave on the consumer loan growth, I'd say it's a combination of Two things. One, our own credit tightening, but also when you think about things we've talked about with the K economy and the people who are most impacted by inflation, they're self-moderating their spend. So we are seeing some slowing and moderating spend, and that's built into our outlook. So it's a combination of those two things that are impacting loan growth as well. When you have periods of elevated gross losses, that also tempers the growth by, say, a percentage point at this time. As it relates to the capital returns, I think Ralph has stated very clearly in the past what our capital priorities are. We're going to continue to strengthen our balance sheet, make sure we improve our capital ratios as we set those targets, continue to use capital, pay down debt, support growth in the business. So really, this repurchase is nothing more than what is already in our capital plans, and we'll call it good housekeeping and keeping our share count around that $50 million range.

Great. Thank you.

Our next question comes from Robert Napoli with William Blair. Robert, please go ahead. Your line is open.

Thank you. Good morning. And congratulations on the dramatic improvement in the balance sheet. That's really appreciated. Pretty substantial. So in your presentation, Ralph and Perry, you do kind of reiterate you're comfortable with 6% charge-off rate through the cycle. We're above 6% now. What gives you the confidence in that? It looks to me like your mix from a couple years ago has actually become a little bit more subprime. So I just would like to understand how you have confidence in that type of charge-off rate through a cycle.

Yeah, I think the way to think about it is when you look at through the cycles and when we've evaluated cycles, a cycle can be a 10-year from peak to peak, trough to trough, 10 to 15 years. So you're going to have periods of time. If you say we're going to run through the cycle average of 6%, you're going to have years, quarters in years where you're above 6%, and then you're going to have periods when you're below 6%. Our credit profile continues to improve compared to where we were pre-pandemic. And some of the movement that you just noted when you look back, say, a year ago, was we had BJs in our portfolio, which was a greater mix in there. So that had a better than average credit score. So that coming out, new partners coming in, you know, each partner has a different set of credit profiles, but we are managing this over time to achieve that 6%. So really, in terms of when we come back below 6% is going to be much dependent on when the economy improves and then expect a prolonged period that will be, you know, at or below 6% so you blend back out.

I hear you. I mean, but unemployment's pretty low. So, I mean, that's kind of a challenge. I don't know that we get unemployment much lower than it is today in the future. And just on the Dow win, it's nice. to see that. Does maybe a commentary on the pipeline of potential new business and does Dell come with a portfolio?

Yeah, this is Ralph. Yeah, Dell comes with a portfolio, you know, around our sweet spot. So we're very excited to, you know, to onboard them in the fourth quarter. You know, the pipeline remains, you know, very robust and it's robust up and down the line from DeNovo's to, you know, those partners with portfolios and One of the things that we are really excited about is we can compete up and down that line for the $100 million portfolios and the $500 million portfolios and above because we have an array of products now that can address all consumers' needs. So we're excited about it. We're getting invited to a lot of RFPs, and business development continues to be strong.

I want to follow back up on your point about that unemployment is low right now. That is absolutely a fair point. And the thing that we've talked about for the past year, what's driving our loss rate up right now is the elevated level of inflation and that persistently high inflation that consumers are experiencing, right? I mean, if you think about what consumers have experienced recently, say the average American earns $67,000. Well, their monthly bill is up $250 from a year ago and $750 from two years ago. And that's what's putting pressure on the consumers and their ability to pay. So while unemployment's low, the real problem is inflation and persistent inflation that's impacting moderate and lower income Americans. So, yeah, and that's what we're all so focused on what the fed is doing and are they going to get inflation under control as inflation eases that is able to put, give relief to the consumers. And that's what you would expect then wage growth, outpaced inflation, and then consumers can, uh, you know, feel that relief. So it, You know, these are all different periods when you're in different economic cycles, and this one is really inflation-driven that's causing the pressure. So over time, you know, that's why I said earlier, I expect inflation to come down, which will create some relief for our broader consumers. And then, yes, unemployment may tick up that could replace some of that, but I don't expect it to be a compounding impact.

Thank you. Just to sneak in one more, student loans, what's your view of your analysis of the effect on your business from the repayment of student loans?

yeah so we have a good line of sight to that you know around student loans you know when we underwrite customers we who have a student loan we can see that we monitor their performance and then we take action as necessary and what I'd say is less than a quarter of our portfolio have a student loan but what I think is going to happen while we expect their you know we know what happened with the the ruling that they can't forgive Debt outright, the administration is working to come up with other ways to give some relief to consumers. And that's something that we're watching. I think you're seeing the Department of Education has within their rights to recalculate how the payment requirements are determined in terms of minimum payment as a percent of discretionary income. So they're able to look at, hey, how do they calculate discretionary income? And then moving from 10% of discretionary income to pay down student debt to 5%. and then making it $0 for people who have minimum wage or waiving the debt entirely for people with 20 to 25 years of it. So, you know, I don't think it's going to have a large impact, but it's something we actively will monitor.

Thank you.

Our next question comes from Mihir Bhatia with Bank of America Merrill Lynch. Please go ahead. Your line is open.

Good morning, and thank you for taking my questions. Maybe I just want to start with the second quarter. And, like, you know, what changed during the second quarter specifically, right? Is there something you're seeing in the data that's giving you pause? Because it sounds like you tightened underwriting further in the quarter, which is leading to slower sales growth. And then, you know, from there you go to slower loan growth. You also upticked your credit guidance. Again, I think there's some, it sounded like partly denominator effect in there. But I guess what changed in the past three months? Did second quarter just come in a little below your expectations? Are you seeing something in the macro, something in your own data? Like just trying to understand what's different today versus, you know, three months ago. Because I think most people, like most investors are talking about soft landing, right? So just what's changing in your data or what you're seeing?

Yeah, it's a really good question. So let me start by talking about what's going on with the economy more broadly and then how that informs the way we think about credit and then how we're seeing that play itself through an actual performance of consumers. So when we think about the economy, look, we think the economy and the consumer is resilient. So we'll start with that. But there's a lot of uncertainty in terms of how they're dealing with the persistent headwinds that are out there. And while some of the signs are steadying and even showing signs of improvement, the economy is starting to slow. I mean, you know, if we look at us retail sales year over year since March, they're only up one to 2%. And that's with inflation north of 3%. So that means real spending is down. Um, that's the lowest level since 2019. And you think back to that point, that's significant because a lot of economists were concerned about a potential recession back then before it was preempted by the pandemic. And so during this period of time, inflation has remained elevated while it's been improving. If you think about shelter and food, they're still significantly up year over year. And you think about the comment I made about that average consumer, you know, make 67,000 and how much more they're paying in their monthly bills today. Uh, we're seeing, you know, some headlines out there. There's more layoffs coming. You see how the impact of higher interest rates are starting to pull through consumer sentiment fell in April and may, but yet, The good news is you're starting to see, okay, we had June sentiment, improved wage growth, outpaced inflation for the first time since February of 2021. But that compounding effect over that period of time is weighing on consumers. So that's the part we're talking about. While the market steady, both in terms of job market and the stock market, that sounds good. So those factors led to improving consumer sentiment in the month of June. That said, we're seeing pressure in sales in July and we hear and listen to our partners. I think that's kind of caused a little bit of a contraction in the third quarter. And this is all about the K-economy we've talked about many times in the past where you think about us as a full-spectrum lender, right? Modern middle-income Americans are more affected by the economic conditions than upper, I'll say, middle-class Americans. So most of these folks have depleted their savings. It's a growing cohort of people out there who are struggling to make their costs every month due to the things I talked about, shelter and food prices that are way up. We're observing consumers are doing the best they can to work through this, but they're feeling the pressure and they're adjusting their spend. The slower spend that we're observing is happening across all the consumer groups, but really exaggerated for lower risk score customers. That's what we're watching. And, you know, then we're doing credit pullbacks along the way. It's not like we're just started this quarter, but it's a compounding effect of those credit pullbacks. And now we're getting more line of sight into consumer demand, pulling back coupled with our actions gives us better line of sight into what the back half of the year is looking like. And honestly, we need a prolonged period where, you know, household wage growth outpaces, you know, this inflation. with employment remaining steady for these customers, I think, to resume the type of robust spending. While they're still spending, we're just saying that it's a little more tempered than what we thought it was going to be. And we're being, you know, we've stated, Ralph and I have said many times, we're focused on responsible growth.

Great. No, no, I appreciate that. And thank you for that, Colin. It was quite helpful for us. I just wanted to follow up quickly on Sanjay's question. In the answer, I think it was you who said something about you're trying to make sure partners' economics are not impacted by the late fee rule. Can you just expand on that some more? I guess maybe take the opportunity to expand on just the discussion with your partners. How are they thinking about the issue? How much attention are they paying to it? How willing are they making... to make changes to the program to account for it. Yeah, thank you.

Yeah, what I would say is that we're having productive discussions with the partners. Yeah, I think they appreciate the fact that we have to make some contractual changes, pricing changes, and the ones that Ralph mentioned. And without some of those adjustments, there's going to, or perhaps even with some of their own contracts, we may have to reduce the people were able to underwrite and and that would mean restricting credit which then could also impact their ability to you know I'll say enable the sale so those are conversations they probably look different for each partner some partners are going to be more impacted by this proposed rule change than others and that's something that so again it looks different for each partner I mean I don't think Trust me, none of us like the proposed rule change, partners included, but I think they're all starting to better understand it and working jointly to figure out how do we mitigate it so we're able to continue to lend to the customers who they serve.

Okay.

Thank you for taking my question.

The next question comes from the line of Jeff Adelson with Morgan Stanley. Jeff, please go ahead. Your line is open.

Hey, good morning, guys. Appreciate you taking my question here. Just wanted to understand a little bit better what you're seeing under the hood in your portfolio. I think there has been a bit of a narrative that the lowest quality, lowest income credits are maybe starting to stabilize a little bit. Are you guys seeing that? I know, Perry, you just alluded to some pressure on the low, mid-income consumer. Maybe just an update on the internals there. And then maybe more specifically, can you give us an update on what percentage of your borrowers are maybe doing a min pay now versus last quarter or a year ago?

Yeah, I think when you look at our, the best thing to look at for us is look at our delinquency rates where we're seeing stabilization. which is why I feel confident in being able to guide the second quarter loss rate should be about a hundred basis points below. I mean, third quarter loss ratio, we've got a hundred base points below the second quarter loss rate because of our line of sight into delinquency formation. Uh, you know, payment rates still continue to come down when you look at where we are this quarter compared to the first quarter. Uh, again, I think these are things that we just continue to monitor. And when we're looking at it, we're seeing some stabilization in part because of the credit actions that we've taken. But it is something that you just continue to watch. And hopefully some of the inflation improvement or moderation is going to give a little bit of relief. But when you do look at certain categories, they do remain elevated. So we're just very watchful of this.

Okay. And then just in terms of spending, I know BJ's is kind of distorting the year-over-year noise with that 30% decline. But Any way to think about kind of the ex-BJs growth you're seeing and how July is trending so far in the consumer spending front? I know you're commenting about some weakness in the retail sales for July. I guess just trying to get a better sense of how consumers are spending within your book and whether they're still continuing to kind of trade down like you've said before.

Yeah, this is Ralph. I think, you know, let's put BJs in perspective. It was a high-spend, a high-transactor book, and that's, you know, that's So those are the effects that you're seeing. We have new partners coming on. We're seeing growth with some new partners as they came on the books. So you'll see accelerated growth with those partners as they move forward. So spending in July was a little softer than June. We've turned the corner in June. Spending was a little softer. What I see is that consumers are still spending, but they're self-regulating. So they're spending thoughtfully instead of... spending in a different way, which I think is a good thing. So they're managing their budget in a period of time when they have to, with high inflation and high interest rates. So I expect that will continue for some period of time, but as we bring on new partners, we see a growing spend.

Thank you.

Our next question comes from the line of Bill Koresh with Wolf Research. Bill, please go ahead.

Thank you. Good morning, Ralph and Perry. I wanted to follow up on your commentary around building capital closer to your peers. The growth in your tangible common equity has been impressive, but most of your peers tend to have CET1 targets in the 11% range at the enterprise level. Is there a comparable enterprise level CET1 metric that you think about internally? Seems like you guys are getting close, but it'd be great to hear from you how close you think you are.

Yeah, I mean, look, we're closing in on it, right? But for us, our total risk-based capital is our binding constraint. And so that's something that we're continuing to evaluate what's the right target for us. And for, you know, like we say, getting closer to peers. Remember, every company has a slightly different target rate. based on their internal stress models and the profile of their, of their business. So it's something where we're, you know, look, we've made tremendous progress as you've noted, and we're getting close, but we still have more room to go. And, uh, as well as, um, you know, continue to improve that double leverage ratio, which means, you know, paying down debt a little bit further.

Right. And it seems like it just puts more meat on the, uh, the, the kind of, the restart of the buyback once we have kind of greater clarity that you're at peer levels. And so certainly, you know, just some back of the envelope math suggests that you're close. But it'd be great if there's any way that you guys might be able to try to provide something like that going forward. That would be much appreciated. That was it for me. Thank you. Thank you.

Our next question comes from the line of Dominic Gabriel with Oppenheimer. Please go ahead, Dominic. Your line is open.

Thanks so much for taking my question, and good morning, everybody. So I guess a peer of yours talked about recouping some of the late fee revenue through offsets would take quote-unquote years. I was wondering how you think about that timing. Do you think that if you got a head start on this, It's more of a two to three-quarter impact, or is this really measured in years to fully recoup the offset late fees coming down? And I just have a follow-up. Thank you.

Thanks, Dominic. Yeah, I think it really goes to the dynamic of the lever which you pull, right? So as we think about the levers... if we do across the board APR increases that you think would happen. Yes. As soon as you think, or as soon as we hear the announcement, you may start to increase APRs for new accounts and existing customers, and then say the effect goes in 12 months later. But the way card act has the payment hierarchy rules, it pays off the highest APR first and then the low. So it's going to take a bit of a burn in period for that to happen for us to realize the benefits of the higher APRs, on existing account balances new accounts you get that benefit as soon as you book the new account so for those they look a little different so really determine what determines the the phase-in of this is the amount of new volume that comes on through new accounts and the churn in your portfolio uh and that existing account base is really i think what they're speaking to is how long it would take to fully mitigate. Now, obviously, transaction fees, annual fees, things like that, partner agreements, all those things will have a much faster burden, but I think they're speaking to, you know, to be 100% mitigated, just the card act aspect could take a longer period of time on existing balances. So it's really the degree to which the last dollar is, fully mitigated. Maybe it does take years. It just depends on, I think, the profile of the portfolio.

So it sounds like more of, if we were to calculate the turnover of the total portfolio, that's almost what I'm hearing right there. Does that sound right?

That is an element that goes into the factor at the pace at which it gets offset.

Okay, cool. I really appreciate that. And then If we just think about the processing expenses as a percentage of credit sales, I believe that was about 1.6% this quarter and it was last quarter, but it's up from 1% the previous year. I'm just trying to think about some of the efficiencies that you're targeting. I know you've talked about modest efficiency gains and we've seen some real progress over the last few years, but maybe you could just talk about What may have changed to elevate that percentage and where you think that percentage should trend out and some of the factors? Thanks.

Yeah, I think what I would say is over time, I would expect us to continue to be able to see that rate come back down. It was elevated in the first half of this year in part because of the conversion-related expense carryover. I haven't driven out those efficiencies yet, coupled with elevated fraud that's been seen across the industry. Again, that's something the industry always has to grapple with. It's been a little elevated across the entire industry in the first half of the year, and expect that to get back in line over time.

Thank you.

Our next question comes from Reggie Smith with JP Morgan. Reggie, please go ahead. Your line is open.

Hey, good morning. Thanks for taking the question. Most of mine have been hit, but I wanted to kind of dig into, I know you guys have talked about, and everybody's talking about, you know, tightening credit bands and standards. My question is, are there any contractual limits to how high you can set APRs on new accounts? I'm just curious that obviously you guys are in the business of pricing risk, and I was just wondering if there was a way to accept more people or open more accounts, maybe at a higher APR, or are you at that limit?

There are not limits, but we want to be responsible and competitive in the environments that we work in. While there are not limits, you know, our view is we've got to be reasonable and respectful and, you know, be competitive.

Got it. Thank you. That's all I have.

Our next question comes from David Scarf with JMP. David, please go ahead.

Yeah, good morning. Thanks for taking my question as well. Just to return to the spending outlook discussion and observations. I'm wondering, it was helpful you provided very early in your prepared remarks some talk of the verticals that you were seeing changes to. And specifically specialty apparel it sounded like was where you were seeing a fair amount of the moderation I'm wondering, I guess it's a two-part question. One is maybe just an update on some of the vertical exposure, sort of the mix. And secondly, as you think about your historical exposure to very discretionary verticals like jewelry, I think you highlighted travel as holding in there, whether that's something that, you know, may be next in line for moderation. Can you just talk about whether this slowdown is kind of likely to be more broad-based and whether there are discretionary verticals, you know, that are now representing a considerable mix of the portfolio?

Yeah, I think, you know, since 2020, you know, we've really diversified into your risk-off portfolio. If you remember back in 2020, you know, the rap was, You know, soft goods, retail, mall-based. And if you look at the verticals now, you know, just take our announcement today with Dell. You know, we've got a technology vertical. We've got AAA and tech travel entertainment, automotive. We've got a number of verticals, beauty as well. All those verticals, you know, we no longer have that concentration risk. So as we think about it, travel and entertainment and beauty are really holding extremely well and actually growing. While we see a little bit of decline in soft goods, we see an increase in those areas. And remember, our portfolio is very different than it was. We now have a lot of general spend and discretionary spend because we've moved, we've migrated to co-brand cards. That's 50% of our, you know, really 50% of our spend, and those sales and categories are up.

Got it. Maybe just kind of a related question as you think about maybe the soft goods moderation. And I know the VS portfolio has always been kind of the largest and that has a lower FICO profile, lower age demographic, I believe, historically. Is there any way of getting a sense whether any of the moderation and spend is actually market share attrition at point of sale to maybe other point of sale offerings versus just, you know, more of a macro observation?

Yeah, I think that's a good question. And I think to the point you're making, it's another aspect that influences, you know, our sales growth is the growth of each partner, you know, partners who are growing and capturing more share and, And I'll say in favor of the consumer are clearly going to do better than others who maybe aren't. And we're not going to give any specifics to any one partner in particular, but partner performance is certainly something that factors in. And we have some, as Ralph mentioned, who are doing extraordinarily well, and others in this environment are feeling pressure a little differently. So I think it's, you know, the way you're thinking of it, I'm not saying about a particular partner, But you're right, as you read their own headlines, that will influence into our tender share. Got it.

Great. Thanks so much for taking my questions.

Our final question today comes from the line of Alexander Villalobos with Jefferies. Please go ahead. Your line is open.

Hey guys, thank you for taking my question. Did want to clarify a little bit on just net interest income. Maybe if you could give us like a little bit of, you know, on seasonality, the next few quarters, what should we assume on that? And then also on the Dell portfolio, wanted to ask if that was included already in the guide or if this is on top of that.

Thank you. So,

First, I'll start with the Dell portfolio. That's absolutely within the guide. We were aware of that. When we talk about our guidance, we're including things that are in the pipeline as well as our best view of the economy, so Dell was certainly in our guide. As it relates to net interest margin, we talked about there's lots of moving parts, pluses and minuses, and we expect the full year to be close to the same rate that we had last year. Second quarter, you're going to get variability with each of the quarters. In the second quarter, it was impacted a lot by purifications related to the elevated losses, so that dragged down net interest margin. Then, seasonally, third quarter is normally a high point, and in our case, you're going to also then see an improvement because of the lower loss expectation, which means less of a drag on net interest margins related to those respective losses. The second half of the year is obviously mathematically going to be higher than the first half to get to that average of 19.2. Then you look at the fourth quarter. I talked earlier about losses being sequentially higher than the third quarter by about 50 basis points. That means purification will be a little bit higher. in the reversal of interest and fee impact in net interest margin in the fourth quarter than what it was in the third quarter. So you'll get a little bit of bouncing around of net interest margin. But again, with our line of sight into it, it will be higher than what we saw in the first half of the year.

Perfect, perfect. Thank you so much. And one quick last question. RSA this quarter, what drove the benefit? And should we kind of expect kind of the same levels going forward? Thank you.

Yeah, as it related to RSA this quarter, it's really based on lower sales originations.

Okay. Perfect. Thank you for taking my questions, and congrats on the good quarter. Thank you.

We do have one further question that comes from the line of John Pansari with Evercore ISI. John, please go ahead. Your line is now open.

Morning. The loss on the discontinued operations, the $16 million or $0.32 a share, what did that relate to? Was it a revenue-driven loss or just a traditional operating loss, or is there a reserve charge taken there related to loyalty?

Yeah, what's in discontinued ops this quarter is associated with some small charges that are related to discontinued legacy businesses, including loyalty one and epsilon.

Okay. So has a reserve charge been taken for the, any potential litigation in the loyalty business?

No, this has nothing to do with anything related to the spin. And at this point, we've not been sued by that litigation trust that everybody's been talking about.

Right, right, got it. Okay, thanks. And then separately, can you just comment on your partnership pipeline in terms of potential, you know, maturities of any partnerships in the, just given the competition remains relatively brisk on that front. We'd love to get your updated line of sight in terms of maturing partnerships.

Yeah, I, you know, I think I mentioned it a little earlier before, the pipeline is very robust and You know, one of the things that we're very pleased with is we're being corded on certain initiatives and we're winning more than our share. And, you know, given that we are less reliant on any one partner because of our diversification as we think about it. And as our renewals go, you know, we have nearly 85% of our loans are secured through 2025. And our top five brands have been renewed through 2028. So, you know, we have a good outlook. It's pretty secure. And, you know, we look at renewals now earlier, and we look at our pipeline and determine, you know, what is our percentage of winning? How would we go about it? And we have a basket of products now that we can offer our partners and their customers on how they want to borrow. So we feel very, very good about the pipeline. We feel very good about our results, and we feel very good about our renewals.

Okay, great. Thanks for taking my questions.

Thank you.

We have no further questions, so I'll turn the call back to Ralph and Jessa for closing comments.

Thank you. I want to thank you all for joining the call. As you've seen, we've made really nice progress on our balance sheet and paying down our debt. very focused on that. We'll continue to be focused on that, and we'd like everyone to have a wonderful day, and thank you again for your questions and your interest.

Thank you, everyone, for joining us today. This concludes our call, and you may now disconnect your lines.