Bread Financial Holdings, Inc.

Good morning, and welcome to Bred Financial's second quarter 2024 earnings conference call. My name is Tawanda, and I will 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 star 11 on your telephone keypad. It is now my pleasure to introduce Mr. Brian Farub, head of investor relations at Bread Financial. Sir, the floor is yours.

Thank you. Copies of the slides we will be reviewing and the earnings release can be found on the investor relations section of our website at breadfinancial.com. On the call today, we have Ralph Andretta, President and Chief Executive Officer, and Perry Beiberman, Executive Vice President and Chief Financial Officer. 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 question may contain forward-looking statements. These statements are based on management's current expectations and assumptions and are subject to the risk 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 provide useful information for investors. Reconciliation of those measures to GAAP are included in our quarterly earnings materials posted on our investor relations website. With that, I would like to turn the call over to Ralph Andretta. Thank you, Brian, and good morning to everyone joining the call. Starting with the highlights from the second quarter on slide two, I am pleased to report another quarter of solid results as we continue to navigate a challenging consumer and regulatory environment. Our strong results include net income of $133 million and earnings per diluted share of $2.66, or adjusted diluted EPS of $2.67, after adjusting for the anti-dilutive impact of our capped call transactions, which are related to the 2023 issuance of convertible notes which Perry will discuss more fully. Notably, our balance sheet continued to improve as we increased our tangible book value by 25% year over year to nearly $49 per share, improved our common equity tier one capital ratio by 170 basis points year over year to 13.8%, and reduced our double leverage ratio to 110% achieving our target of less than 115%. Additionally, direct-to-consumer deposits increased 20% year over year to $7.2 billion, representing 14 consecutive quarters of growth. During our investor day in June, we highlighted the company's transformation and our energized culture, the strong returns and capital generation that our business model can deliver, and how our responsible capital allocation will build sustainable long-term value for our shareholders. We also announced our newest partnership with SACS Fifth Avenue. In the third quarter of this year, we expect to complete the conversion of the existing SACS portfolio and launch the new and enhanced program. In the second quarter, we made further progress implementing more of our mitigation strategies in response to the CFPB's rule on credit card late fees. Our ongoing discussions with brand partners have been productive, and we now have various pricing changes in market, including increased APRs and statement fees. We are closely monitoring the ongoing litigation related to the rule and will continue to implement our mitigation strategies given the uncertainty surrounding the timing and outcome. Regardless of the litigation outcome, We are confident in our ability to generate strong results and achieve our long-term strategic objectives and financial targets. From a macroeconomic perspective, consumer spending continues to moderate, reflecting persistent inflation and higher interest rates. As a result, second quarter trends reflected lower transaction sizes accompanied by more frequent shopping trips, as well as reduced discretionary and big ticket spending. Credit sales were also impacted by our proactive credit tightening as we remain disciplined given economic pressures affecting payment capacity. Our credit actions have proven effective as delinquencies have trended lower and the net loss rate is expected to have peaked in the second quarter. Our second quarter results reflect our position of strength with increased capital flexibility and financial resilience. We are better equipped to address uncertainty than ever before. positioning us well to generate long-term value for our shareholders. Turning to slide three, our disciplined capital allocation strategy focuses on funding responsible, profitable growth, improving our capital metrics, reducing parent debt, and driving long-term shareholder value. Indicative of the success of this strategy is the 410 basis point improvement in our common equity tier one capital ratio over the last three years as shown in the chart on the left. As I mentioned previously, we have also made progress on our debt reduction as shown in the second chart. Over the last three years, we have reduced parent level debt by 53% and this quarter we achieved our long-term double leverage ratio target of less than 115%. This is an impressive achievement given where we were just four years ago when I joined the company. Finally, our tangible book value of $49 per share has grown at a 22% compound annual rate since the second quarter of 2021. Supported by our strong cash flow, we expect to continue to grow our tangible book value over time. Turning to slide four, our key focus remains on growing responsibly. managing the macroeconomic and regulatory environment, accelerating digital and technology offerings, and driving operational excellence. As we highlighted during our investor day in June, our decisions are focused on creating sustainable value over the long term by effectively managing our credit risk while scaling and diversifying our product offerings, we can grow responsibly. Managing the macroeconomic and regulatory environment effectively is fundamental to our success. Although litigation is ongoing and timing and outcome unknown, we will continue to take actions to mitigate the potential financial impact of the CFPB late fee rule. We are confident in our strategy and have an experienced leadership team that has successfully navigated through regulatory changes in the past, such as Cardax. Accelerating our digital and technology capabilities remains a top priority. We are committed to fueling innovation, leveraging data and AI, and scaling our platform to enhance satisfaction for our customers, partners, and associates. Finally, our heightened focus on operational excellence to drive improved customer experience, enterprise-wide efficiency, reduced risk, and value creation is embedded in our decision making. Our goal is to consistently generate operational and expense efficiencies that enable reinvestment in our business, support responsible growth, and achieve our targeted returns. Our experienced leadership team remains focused on generating strong returns through prudent capital and risk management, reflecting our unwavering commitment to drive sustainable, profitable growth and build long-term value for our shareholders through challenging economic and regulatory environments. Now, I will turn it over to Perry to review the quarter's financials and to discuss our outlook. Thanks, Ralph, and good morning, everyone. Before I dive into the second quarter financial highlights, I'd like to discuss the financial benefits of the CAT call transactions we entered into when we issued our convertible notes in 2023. The cap call transactions are set up to reduce the potential dilutive impact of the convertible notes up to a stock price of $61.48. Our GAAP diluted share count does not incorporate the anti-dilutive impact of these cap call transactions, which you can see incorporated in our adjusted non-GAAP figures on slide five. More specifically, the share amounts used in calculated calculating adjusted net income per diluted share and adjusted income from continuing operations per diluted share have been adjusted for the anti-dilutive impact of our capped call transactions. Reflecting this, our adjusted net income per diluted share was $2.67, and our adjusted income from continuing operations per diluted share was $2.66 in the second quarter. Moving to slide six, which provides our second quarter financial highlights. During the second quarter, credit sales of $6.6 billion decreased 7% year-over-year, reflecting moderating consumer spend and our strategic credit tightening partially offset by new partner growth. Average loans of $17.9 billion increased 1% year-over-year, driven by growth in co-brand programs highlighting our continued focus on product diversification. Revenue was point nine billion dollars in the quarter, down one percent year over year due to reduced merchant discount fees resulting from lower big ticket credit sales. Income from continuing operations increased sixty nine million dollars due to a higher reserve release and lower non-interest expense compared to the same period last year. Looking at the financials in more detail on slide seven, Total net interest income for the quarter remained essentially flat year over year, while non-interest income is down $8 million, resulting from the previously mentioned lower merchant discount fees on big ticket purchases. Total non-interest expense decreased 12% year over year, primarily driven by a decrease in card and processing costs, including fraud, and a reduction in depreciation and amortization costs and marketing expenses. Additional details on expense drivers can be found in the appendix of the slide deck posted on our website. Pre-tax, pre-provision earnings, or PPNR, increased $48 million, or 11%. Turning to slide eight, loan yield increased 30 basis points year over year, benefiting from the upward trend in the prime rate, which caused our variable price loans to move higher in tandem, along with some small amount of CFPB mitigation-related APR increase impacts. Both loan yield of 26.4% and net interest margin of 18.0% were lower sequentially following typical seasonal trends. We expect a seasonal improvement in the net interest margin in the third quarter of 2024. On the funding side, we are seeing total funding costs moderate as deposit costs are stabilizing. Additionally, as you can see on the bottom right chart, our funding mix continues to improve, fueled by growth in direct-to-consumer deposits, which increased to $7.2 billion at quarter end, while wholesale deposits declined. Direct-to-consumer deposits accounted for 40% of our average total funding, up from 33% a year ago. While we anticipate that direct-to-consumer deposits will continue to grow steadily, we will maintain the flexibility of our diversified funding sources including secured and wholesale funding to opportunistically and efficiently fund and manage our long-term growth objectives. Moving to credit on slide nine. Our delinquency rate for the second quarter was 6.0%, modestly down 20 basis points from the first quarter as a result of our credit tightening actions. From this point forward, we expect future quarters to largely follow historical seasonal trends until we see broader macroeconomic improvements. The net loss rate was 8.6% for the quarter compared to 8.0% in the second quarter of 2023 and 8.5% in the first quarter of 2024. The second quarter net loss rate was elevated compared to last year due to more challenging macroeconomic conditions pressure in consumer payment rates, as well as ongoing credit tightening and our slower responsible loan growth impacting the denominator. As anticipated, the second quarter net loss rate is expected to represent the peak for 2024. We anticipate a reduction in the net loss rate in the third quarter to 8% or slightly below before increasing seasonally in the fourth quarter to the low 8% level. Our outlook assumes a slow, gradual improvement in the macroeconomic environment as it will take time for the lingering effects of a prolonged period of elevated inflation to dissipate. As expected, the reserve rate of 12.2% remained within the range we have seen over the past six quarters. In this challenging macroeconomic environment, our conservative economic scenario weightings remained unchanged in our credit reserve modeling, and we believe our loan loss reserve provides an appropriate margin of protection. Consistent with what I said last quarter, and based on our economic outlook, we expect the reserve rate to be lower at year end 2024 versus year end 2023, reflecting an overall improvement in delinquencies, as well as improved credit quality in the portfolio. Our total loss absorption capacity comprised of the total company tangible common equity plus credit reserve rate ended the quarter at 26% of total loans, an increase of 100 basis points from last quarter and 270 basis points from a year ago, demonstrating a strong margin of protection should more adverse economic conditions arise. Looking at our credit risk distribution mix, The percentage of cardholders with a 660-plus credit score improved 200 basis points sequentially and remained above pre-pandemic levels despite continued inflationary pressures. This improvement is primarily a result of our prudent credit tightening actions as well as our more diversified product mix. We continue to proactively manage our credit risk to protect our balance sheet and ensure we are appropriately compensated for the risk we take. Moving to slide 10, which provides our 2024 financial outlook. While there is uncertainty surrounding the timing and outcome of the ongoing CFPB late fee rule litigation, our outlook now assumes no impact from the CFPB late fee rule this year. Considering that a stay is in effect, the number of motions, hearings, and other procedural matters, including appeals, expected to take place in the litigation over the coming months, as well as a presumed implementation period following the final legal ruling, our base case is that the rule does not become effective in 2024. Our full year contemplates a slower credit sales growth rate as a result of moderation in consumer spending and credit tightening, both of which pressure loan and revenue growth and the net loss rate in the near term. In addition, our 2024 outlook assumes two interest rate decreases by the Federal Reserve in the second half of the year, which are expected to slightly pressure total net interest income. Based on our current economic outlook, proactive credit tightening actions, higher gross credit losses, and visibility into our new business pipeline, we expect 2024 average loans to be down low single digits on a percentage basis relative to 2023. Total revenue growth for 2024, excluding gain on portfolio sales, is anticipated to be down low to mid-single digits with a full-year net interest margin lower than 2023, reflecting higher reversals of interest and fees due to expected higher gross credit losses, declining interest rates, and a continued shift in product mix to co-brand and proprietary products. This guidance includes the impact of early CFPB mitigation pricing changes, which are not material to the full year 2024 guidance. As a result of efficiencies gained from ongoing investments in technology modernization and digital advancement, along with disciplined expense management and reduced fraud, we expect expenses to be down mid-single digits relative to 2023. Expenses are projected to increase in the second half of 2024 versus the first half, driven primarily by the addition of Saks Fifth Avenue portfolio and increased sequential marketing expenses of around $10 million in the third quarter. We would expect fourth quarter expenses to be higher than the third quarter based on seasonally higher employee compensation and benefits costs and further increased marketing expenses. As I mentioned earlier, The second quarter net loss rate is expected to be the peak for the year, and we continue to expect a full year net loss rate in the low 8% range for 2024. With the first half loss rate at 8.6% and a projected improved second half loss rate of approximately 8%, that would currently imply a full year net loss rate of around 8.3%. Again, our outlook assumes a gradual modest improvement in economic conditions throughout the year aligned with most economists. Finally, our full year normalized effective tax rate is expected to be in the range of 25 to 26%. Quarter over quarter variability will continue due to timing of certain discrete items. We are confident in our ability to successfully manage risk return trade-offs through this challenging macroeconomic and regulatory environment. while continuing to make strategic investments that drive long-term value for our stakeholders. Before opening the call for your questions, I want to take a moment to reiterate the financial targets that we shared during our investor day in June. You can see these targets on slide 11. Note, this slide assumed an October 1 CFPB late fee rule change effective date. From a debt perspective, as Ralph mentioned earlier, we've already successfully reduced our double leverage ratio to less than 115%. For capital, our goal is to build total risk-based capital to around 16% with an initial CET1 build to approximately 14%. Over the longer term, we plan to optimize our capital mix through additional Tier 1 and Tier 2 capital which will allow us to lower our corresponding CET1 ratio. Overall, we will continue to grow tangible book value with the goal of generating a low to mid 20% ROTCE in the medium term and mid 20% ROTCE in the long term. While there are many scenarios currently in play regarding our timing to achieve our target, given the uncertainty around the economy and potential regulatory changes, We are well positioned to deliver responsible growth, strong returns, and capital distribution opportunities over time. 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 star 11 on your telephone keypad. You would then hear an automated message advising your hand is raised. Then wait to hear your name announced. To withdraw your question, please press star 11 again. When preparing to ask your question, please ensure your phone is unmuted locally. Please stand by while we compile the Q&A roster. Our first question comes from the line of Mihir Bhatia with Bank of America. Your line is open.