Bread Financial Holdings, Inc. Q3 FY2022 Earnings Call

Good morning, and welcome to Bread Financial's Third Quarter Earnings Conference Call. My name is Drew, and I will be coordinating your call today. It’s now my pleasure to introduce Mr. Brian Vereb, Head of Investor Relations at Bread Financial. 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. On the call today, we have Ralph Andretta, President and Chief Executive Officer of Bread Financial; and Perry Beberman, Executive Vice President and Chief Financial Officer of Bread Financial. Before we begin, I would like to remind you that some of the comments made on today's call and some of the responses to your questions may contain forward-looking statements. These statements are based on management's current expectations and assumptions and are subject to the risks and uncertainties described in the company's earnings release and other filings with the SEC. Also on today's call, our speakers will reference certain non-GAAP financial measures, which we believe will provide useful information for investors. Reconciliation of those measures to GAAP are included in our quarterly earnings materials posted on our Investor Relations website at breadfinancial.com. With that, I would like to turn the call over to Ralph Andretta.

Good morning. Thank you, Brian, and thank you to everyone for joining the call this morning. I will start on Slide 3 by highlighting a few key updates from the quarter. We continue to make strong progress towards our 2022 financial goals. We are pleased with the continued acceleration of our loan growth with end-of-period loans up 16% on a year-over-year basis, leading to revenue growth of 15% for the quarter. Credit sales growth remained positive for the quarter despite pressure on discretionary spending in July, when fuel prices temporarily spiked and consumer confidence declined. Notably, year-over-year sales growth rates improved in both August and September from the July low as consumer confidence and in-store traffic gradually recovered, and we are seeing that trend continue in October. Also, in anticipation of the transition of our credit card processing services, we shifted promotions and incentives with our brand partners and direct-to-consumer offerings from the third quarter to the fourth quarter, which impacted sales growth. The outlook for credit sales growth in the fourth quarter looks strong driven by new partner additions and holiday spending. We are already seeing brand partners ramp up their promotions and incentives in preparation for the holiday season. Pretax pre-provision earnings growth improved at a double-digit rate from the prior year periods for the sixth consecutive quarter, highlighting the quality growth we are focused on consistently delivering over the long term. We improved our funding mix and made significant progress again in the third quarter with retail deposits growth of over 70% year-over-year and 24% sequentially. Retail deposit balances exceeded $5 billion, benefiting both our funding diversification and cost of funds relative to other funding sources. Earlier this month, we successfully converted a AAA portfolio of over 1 million active accounts and approximately $1.5 billion in loan balances. We are confident that the new and improved cardholder value proposition on our AAA products will drive further engagement with AAA's more than 56 million U.S. members driving increased sales and accounts. By leveraging our full product suite, we remain well positioned to continue to add quality partners that further strengthen our diverse portfolio. We also continue to invest in our technology modernization and business transformation efforts. We have made major upgrades in the last year, including transitioning our credit card processing system, converting to the cloud and integrating Alberia, a state-of-the-art collection software that helps enhance the productivity of our collectors. While we experienced some temporary disruptions during our transition, these upgrades support our long-term plan, enhance our strategic differentiation and are essential to further driving operating efficiencies and innovation. From a macroeconomic perspective, while labor markets remain resilient, lower-end middle-income households feel the pressure of persistently high inflation and increased cost of overall consumer debt. According to an internal study, over 90% of Americans have changed their spending habits due to inflation. We have taken targeted actions to protect inflation-vulnerable segments when prudent. We consistently and proactively adjust our underwriting and credit management to account for changes in inflation and other factors present to consumers. We will continue to closely monitor consumer health indicators, including how consumers are navigating an increasingly challenging economic environment. Our seasoned leadership team has extensive credit card lending experience and has successfully navigated the full range of economic cycles. We remain focused on reasonable risk management and proactive recession readiness planning. We are confident in our outlook and financial resilience. Moving to Slide 4, I will highlight some of our business development success. This morning, we announced a new long-term credit card relationship with WORLD MARKET, a specialty retailer of home furniture, decor, apparel and international food products with over 240 locations across the U.S. and a vast online assortment at worldmarket.com. We will leverage our deep expertise in serving specialty retailers, coupled with our sophisticated data and analytics capabilities to offer World Market customers and their 6.5 million reward members a new payment product with valuable rewards and an enhanced shopping experience. Also during the quarter, we signed a multi-year renewal with our valued partner Buckle. Buckle operates over 440 retail stores in 42 states as well as its buckle.com e-commerce site and has grown to become one of America's favorite denim destinations with a strong millennial customer base. This partnership will focus on providing Buckle guests with lending solutions and a customer loyalty program tailored to evolving guests' wants and needs. Turning to Bread Pay. We are pleased to have signed WaterRower among dozens of other new small- and medium-sized partners in the third quarter. We have grown our total Bread Pay merchant base by over 50% this year, while developing incremental platform capabilities and enhancements, including ensuring our products are regulatory compliant. Finally, our strategic relationship with Sezzle has experienced faster-than-expected new merchant additions with over 125 merchants enrolled and now able to access Bread Pay's long-term lending solutions since launching in the first quarter. We look forward to building on our business development momentum in the coming quarters. Moving to the bottom half of the page. We remain committed to continuously enhancing our customer experience through technology. Through relationships with MARQETA and VERSATILE CREDIT, we are making it easier for consumers and merchants to access our broad suite of consumer payment products. The program we have developed with MARQETA brings access to our Bread Pay installment lending and split pay products in store, ensuring consumers can access their preferred payment option and the channel of their choice. The virtual card solution we've developed with MARQETA enables customers to seamlessly apply for provision in the digital wallet and purchase in store. We took an innovative approach to the virtual card and worked with MARQETA and two of the largest digital wallet providers to develop a smoother and faster process that does not require a mobile app download to complete the sale, a market first. This improved virtual card process is accessible in-store through a QR code scan. By eliminating the app download step, it does not disrupt the merchant checkout flow, which improves customer conversion rates. Bread Pay puts brand partners first with a simple white label ready, web-to-wallet-based solution. This offering is a prime example of how our technology investments improve the customer experience and enhance the payment products that our brand partners provide. Bread will continue to expand its presence into home improvement, elective medical, and furniture verticals by integrating into Versatile Credit's simple, flexible, and diversified sales finance lending platform. With the addition of these two relationships, Bread Pay delivers split pay or pay in 4 at point-of-sale installment loan products both online and in store. We continue to transform our company through the successful execution of our strategy. We have positioned Bread Financial to drive sustainable, profitable growth through continuous improvement, innovation, operating efficiencies, and the appropriate risk management balance. I'll now turn it over to our CFO, Perry Beberman, to review the financials.

Thanks, Ralph. Slide 5 provides our third quarter financial highlights. Bread Financial credit sales were up 4% year-over-year to $7.7 billion and average loans were up 14% with end-of-period loans up 16%, driven by growth from our existing partners as well as our new product and brand partner additions. Revenue for the quarter was $979 million. Revenue increased 15% versus the third quarter of 2021, while total noninterest expenses increased 13%. Income from continuing operations was $134 million, and diluted EPS was $2.69 in the quarter. Looking at the third quarter financials in more detail on Slide 6. Total interest income was up 23% from the third quarter of 2021, resulting from 14% higher average loan balances, coupled with improved loan yields. Noninterest income, which primarily includes merchant discount fees and interchange revenue, net of the impact from our retailer share agreements and customer awards, was negative $106 million. This included an $11 million write-down in the carrying value of our equity method investment in loyalty ventures. The carrying value of our investment in loyalty ventures was $6 million as of September 30, 2022. Total noninterest expenses increased 13% from the third quarter of 2021 due to increased employee compensation and benefit costs and increased information processing and communication expenses as a result of the transition of our credit card processing services. The third quarter expenses were lower than anticipated as some of the expenses were shifted to the fourth quarter, and we received payment network expense credits that were projected in the fourth quarter. Additional details on expense drivers can be found in the appendix of the slide deck. Overall, income from continuing operations was down $72 million for the quarter versus the third quarter of 2021 as improvement in pretax pre-provision earnings, or PPNR, was offset by a higher provision for credit losses in the quarter. Taking out the provision and tax impacts, we are pleased that our PPNR improved 17% year-over-year, marking the sixth consecutive quarter that we have generated year-over-year double-digit growth in PPNR. As we have said, our focus continues to be on making the right decisions to produce quality earnings. Turning to Slide 7. The left side of the slide highlights our earning asset yields and balances. Third quarter loan yields increased 160 basis points year-over-year and improved 220 basis points sequentially, driven by the increases in the prime rate as well as increased delinquencies resulting in higher late fee contributions to yield in the quarter. Note, the third quarter is typically the high point for loan yields each year, and we expect the loan yield to drop in the fourth quarter following normal seasonal trends. Net interest margin improved approximately 100 basis points year-over-year as the increase in earning asset yield outpaced the increase in the cost of funds. On the liability side, we saw funding costs increase in the third quarter in line with our expectations given the Fed interest rate increases to date. As you can see from the stacked bars on the bottom right, our direct-to-consumer deposits continue to grow and now represent 27% of our total interest-bearing liabilities. We expect that our retail deposit balances will continue to increase, providing a stable funding base as it becomes an even more meaningful portion of our funds over time. Moving to Slide 8, and starting in the upper left with the delinquency rate. The third quarter is our normal seasonal high point for delinquency with a rate of 5.7%, which remains 20 basis points below our pre-pandemic third quarter of 2019 performance. We experienced temporary impacts from the credit card processing services transition that influenced both our delinquency and loss rates in the quarter. In addition, both rates were impacted by continued payment rate normalization. We expect the delinquency rate to move meaningfully lower in the fourth quarter given that we are seeing improvements in early-stage delinquency buckets. In the upper right, the net loss rate was 5% for the quarter. As previously disclosed, our losses would have been higher had we not completed customer-friendly accommodations in July around our credit card processing services transition. Historic seasonality, along with normalization, would have suggested a mid-5% net loss rate for the third quarter. Moving to the bottom left. The reserve rate increased 20 basis points from the second quarter to 11.4%, consistent with our previous comments and the continued economic uncertainty. While the conversion of the AAA portfolio and seasonal growth will be key factors moving into the holiday season, our intention is to maintain a conservative weighting of economic scenarios in our credit reserve model and recognition of the increase in macroeconomic concerns and the potential impact on our credit performance metrics. If current economic trends continue, it is quite possible that the reserve rate will remain closer to the third quarter rate of 11.4% at year-end. On that note, a fundamental element of our business model, managing risk tolerance and being properly compensated for the risk we take, along with the impact on credit performance metrics, the normalization of payment rates has also positively impacted our net interest margin, which has improved nearly 100 basis points year-over-year as well as loan growth, which is up 16%. We remain confident as a management team in our ability to manage our credit risk and drive sustainable, profitable growth through the full economic cycle. Slide 9 provides our financial outlook for the full year of 2022. Our full year average loans are expected to grow in the low double-digit range relative to 2021 with the addition of approximately $1.5 billion of AAA portfolio in the fourth quarter. We expect year-end loans to be between $21 billion and $22 billion before dropping in the first quarter of 2023 as we exit the BJ's portfolio and seasonal balances run off. As a result, this is a significant impact on the dollar balance of our allowance for credit losses with a large build in the fourth quarter and then a likely release in dollar terms in the first quarter of 2023, all else being equal. We expect revenue growth to be consistent with average loan growth in 2022 with upside from improved full year net interest margin of around 19%. The fourth quarter net interest margin is expected to be down over 100 basis points, consistent with both pre-pandemic seasonality and the reversing of billed interest and fees related to expected elevated fourth quarter credit losses. We continue to remain on track for full year positive operating leverage in 2022. We expect expenses to increase sequentially in the fourth quarter. As we've previously discussed, our 2022 spend includes incremental strategic investments of over $125 million in technology modernization, digital advancement, marketing and product innovation to fuel growth opportunities and future operating efficiencies. We also anticipate higher marketing expenses in the fourth quarter associated with higher sales and brand partner joint marketing campaigns as well as on expanding our new brand product and direct-to-consumer offerings. Regarding our net loss rate outlook, we anticipate the full year 2022 loss rate to be at the high end of our low to mid-5% range. Fourth quarter losses are expected to be above that range, aligned with higher mid- to late-stage delinquency rates we are seeing this quarter and the normal seasonal trend of a higher loss rate in the fourth quarter. Note that the normal historic seasonality would result in the October net loss rate being up nearly 100 basis points from September in addition to the impact from continued normalization trends. Over the next two quarters, expect elevated losses due to the impact from the transition of our credit card processing system and continued payment rate normalization. We see this elevation as temporary and remain confident in our through-the-cycle average net loss rate remaining below our historic average of 6%. As I mentioned, we are seeing good improvement in early-stage delinquency performance, which should lead to a meaningful reduction in the delinquency rate in the fourth quarter and bodes well for our performance post the transition impacts. Finally, we expect our full year normalized effective tax rate to be in the range of 25% to 26%, with quarter-over-quarter variability due to timing of various discrete items. Slide 10 highlights our strengthened financial resilience and ongoing financial transformation. The improvement in our balance sheet, including higher parent and bank capital levels, a significantly higher reserve for credit losses and improved funding mix as well as an enhanced underlying credit mix distribution, PPNR margin and diversification of brand partner products, provide marked evidence of our continued financial transformation. These enhancements offer increased confidence in our ability to sustain more challenging economic outcomes and outperform our historic results. We will continue to manage our portfolio proactively. We have a recession-ready playbook in place for both new and existing accounts with a focus on managing open-to-buy authorizations and helping consumers manage their credit lines and balances in a healthy manner. We continue to further strengthen the financial resilience of our company and are confident in our ability to deliver sustainable, profitable growth with an expectation to outperform historic loss levels through a full economic cycle. Operator, we are now ready to open the lines for questions.

Our first question today comes from Sanjay Sakhrani from KBW.

A question for Perry and one for Ralph, but maybe start with Perry. Perry, could you just talk about the NIM going forward in the different factors that impact it? Obviously, yields have done really well. But I'm just curious, do you hit a point in passing through some of the rate increases? And then maybe just talk about deposit betas, too.

Sure. Thanks for the question. Yes. With NIM and the trajectory, there are a lot of moving parts, right? A number of things come into equation including product mix, the percent of your portfolio that's revolver, transactor. Obviously, the more transactions in your portfolio, you're going to have more negative NIM. We don't have a lot of that portfolio. We don't target those super high-end spenders. We're looking for good revolve rate. And for us, that's variable rate price. So as rates go up in funding, the APRs go up on that front, too. So during a period like this, you can see in our NIM, we're getting really good performance. And that dynamic, we expect to continue to occur.

Okay. Great. And then, Ralph, obviously, it's a very dynamic market out there. A lot of pain has been felt by the fintech space since we last spoke last quarter. I'm just curious how you think it's impacting Bread. I mean, do you see opportunity out there to be more offensive? Maybe you can just chat through sort of what you're seeing.

Yes, Sanjay. One of the advantages of Bread Financial owning the Bread platform is our understanding of the challenges faced by regulated institutions. We took a proactive approach to ensure our platforms meet regulatory standards. Our team brings extensive experience in underwriting and collections through various market cycles, which many fintechs lack. Additionally, the products we provide are just a portion of what we offer to our consumers and brand partners. We can adapt to market trends, so I’m confident about our position. Our pricing is competitive because we focus on our relationships, which gives us an advantage. I'm confident about our position in terms of regulation, underwriting, and the risks and rewards involved, as well as the stability of our system. We offer a range of products and services to our consumers.

Our next question today comes from Robert Napoli from William Blair.

Ralph, Perry, can you share your confidence in the credit loss rate as we approach 2023? Considering the increase in delinquencies, the introduction of new portfolios, some effective marketing strategies, and the loss of certain portfolios, what supports your confidence in the 6% charge-off rate? Given the volatility in the macro environment, it seems likely that rates could be significantly higher. Have you tightened credit standards? I would appreciate any insights you can provide regarding your confidence in credit.

Yes. Thanks for the question. So as I think about our portfolio, and I'll start with speaking to credit risk mix, which we've improved that from pre-pandemic levels where we're 600 basis points better in our 660-plus rate than what we were back then. So that credit mix will continue to be a favorable, I'll say, tailwind for us as we move into the next cycle. And with that as well, as Ralph talked about and I've talked about, where we have a very active recession readiness playbook, it's dynamic, it's living and breathing. I mean, we've got people focused on it every day, all day, as you would imagine. And leadership is focused on it, weekly routine. So it's you're not going in and making a wholesale change at any point, but being very surgical and deliberate and its dynamic, taking into all the data we have about our customers. That's an important point. Currently, we anticipate some increased losses in the fourth quarter and the first quarter of next year primarily due to the transition of our card processing platform. However, we are optimistic about the indicators we're seeing. The early stage delinquency is showing positive trends, which suggests that our strategies have had an impact. The mid- to late-stage delinquency we encountered was a result of the measures we implemented while accommodating customers and transitioning our platform.

What are your thoughts on loan growth for 2023? Also, what do you consider to be the appropriate return on equity for this business over time?

Yes Bob, we established our targets two years ago, and we intend to stay committed to them. We expect average receivables in 2023 to be around $20 billion, a mid-20s return on equity, and a loss rate through the cycle of 6%. However, the macroeconomic environment will affect these projections. We will not increase loans merely for the sake of growth; instead, we will expand them responsibly with the appropriate return. But for now, that's our target for 2023.

Yes. And Rob, if I could add, what I'd say is exactly what Ralph said, as the economy deteriorates a little bit, and we need to do more credit pullbacks, we won't hesitate to do that. And like Ralph said, we're not going to chase that number just to hit $20 billion. If the economy slows a little bit, it could be a $19 billion handle. If things really turn around, it could grab a $20 billion handle.

Our next question today comes from Mihir Bhatia from Bank of America.

I want to revisit the topic of credit losses. You mentioned an increase in credit losses for the fourth quarter. My analysis suggests that your guidance indicates a level around 6.2%. There's also the effect from the actions you took in the first quarter. I understand your guidance is based on a full-year and through-the-cycle perspective, but considering your current observations regarding early-stage delinquencies, do you anticipate remaining above the 6% mark for an extended period? Or do you believe that by the end of the first quarter, you'll drop back below that 6% threshold?

Yes. I mean, look, I think when you think about where we are in the economic cycle, you're starting to see a little bit of softness out there with the consumer. We have payment normalization occurring. And I think we're going to be around the 6% level up and down when we talk about through the cycle, you do expect some quarters to be above it, others will be below it. Every economic cycle is different. And we'll see where we go. But we are taking actions proactively making sure that we are caring for the customers who we think may experience more strain in that period. But I think as you think about the overall through-the-cycle guidance of 6%, I'm not expecting it to be materially above that, but it can be up and down around that as we march through next year based on what we know now. We're hoping, for us, a more of a soft landing as we move through next year. But again, every recession looks a little different.

Could you clarify how much of the increase in loan yields this quarter was due to interest rates versus the benefit from payment normalization?

Yes. When I consider the expansion in net interest margin, there are a few factors at play. We are seeing some growth in net interest margin because the interest rates on our assets are increasing at a faster pace than the rates on our funding costs. Additionally, the rise in our delinquency rate also leads to an increase in late fees, which contribute to our yields. Both of these factors are occurring simultaneously during this period. It’s also important to note that this time of year typically has higher figures, while the fourth quarter tends to be lower.

Our next question comes from Bill Carcache from Wolfe Research.

Can you give a little bit more detail behind why NCO rates and DQ rates were impacted by the transition of credit card processing services? And maybe along similar lines, if you could also discuss what level of unemployment you would say is implicit in your outlook?

So I'll take the first half, and I'll ask Perry to kind of chime in on the unemployment rate. So when you make a magnitude of change that we've made in our technology from going from an aging legacy system to a state-of-the-art system and going to the cloud, there are bound to be issues and concerns as you go along the way. Our focus was to make sure that consumers and our brand partners were not harmed. So because of that, we've done a couple of things. We kept a payment window open longer to help our consumers make payments. We delayed the aging of accounts to ensure that consumers weren't harmed, that they could make a payment because of technology disruption. And we then extended promotional plans that were expiring around the time of the conversion to give consumers more time again to make those payments. So a combination of all those kind of, well, impacted the rates during the time of conversion. That will all work itself out over the next kind of couple of quarters. So it's a timing issue. We still feel confident in that 6% rate. We feel confident in our guidance in 2022. But our focus was to ensure that the consumer may have been disrupted for a period of time but was not harmed. And we did everything we could to ensure that consumers have the ability to make payments, and that extended the payment window and some aging of accounts. That's how it impacted us.

Yes. To follow up on your question regarding the CECL reserve rate, I would say that we have kept a conservative economic scenario in mind. When we do our modeling at the end of the third quarter, we consider these factors. Over the past 90 days, the macroeconomic variables we use in our model, including both the baseline and the risk weighting for other scenarios, have shown some deterioration compared to 90 days ago. This indicates an increased probability of a recession. In our baseline views, there are signs of potentially higher unemployment, among other variables. While that's just one factor, it's the combination of all scenarios as we consider the impact of persistent high inflation leading to an increase in consumer debt. Therefore, we believe it is prudent to maintain a conservative stance for the time being until we navigate through what we anticipate will be the peak and move to the other side.

Ralph and Perry, that's super helpful. If I may, as a follow-up. Can you give us an update on your current thinking around the CFPB late fee issue? Rather than engaging in a legal dispute over the safe harbor provision around late fees, some concerns have surfaced more recently that the CFPB may eliminate the safe harbor altogether. Just curious if you guys have engaged in any discussions with your retail partners about potential changes to the economics of the private label business model. If so, how would you characterize their responses? Anything that you can give around that would be super helpful.

I don't think our answer has changed. Since we're supportive of regulations that provide the appropriate consumer protections, and we continue to have a good relationship with our regulators. I think our mantra is fair and responsible lending. We'll continue to do that. We've not engaged actively with our brand partners on this subject. As it evolves, we'll continue to do that. But I think it's appropriate that we continue to lean into the regulators as we move forward. Rule making is probable, but I can't predict what they'll do. But we think it will be more likely the safe harbor would be reduced rather than eliminated.

Our next question comes from Jeff Adelson from Morgan Stanley.

Just wondering if you could give us a little color on the removal of the recent Master Trust ABS securitization funding and just your thinking around funding from here, whether you may be coming back to the market on that.

Yes. So thanks for the question. Yes. So our last outstanding asset-backed security that you noted matured in September. And so that was the only public ABS deal that we had. It's about $685 million of securitized balances. We have over $5 billion, and a lot of that is syndicated through conduit facilities with bank lenders which has about $4 billion outstanding. And so I think what you're talking about is that one, we let mature. And then what you should expect is, I'd say, we'll be in the market multiple times per year going forward being opportunistic at the right time back in the public ABS market. So that will remain an important funding instrument for us as part of our diversified funding. And again, we've mentioned numerous times, our goal is to get direct-to-consumer deposits to over 50% of our funding. So that will be a critical funding element of our future growth.

Understood. And then just, Perry, going back to the comment around the 100 bps of seasonality in October on the net loss rate down. It seems like quick math is that September also saw like a roughly 100 basis point benefit. So we should probably be thinking about layering in that removal as well, if I understand it correctly.

What we're sharing with you is that we expect October to jump up in the fourth quarter when you do the math and we say that we're going to be in the high mid-5% range for the full year, the fourth quarter in total, I'm not going to do the math for you on the call, but we'll say what it is. And the loss rate for the quarter was 5%. So it's going to elevate as those, I'll say, the customer-friendly accommodation that we did start to work its way through, that will be seen in the next two quarters. And then after that, should come back down.

Our next question comes from David Scharf from JMP Securities.

Ralph, I wanted to follow up on one of the comments you made in your prepared remarks. You made reference to sort of targeted actions to protect inflation-sensitive segments. And it actually raised kind of the broader question in my mind, given all the kind of new business activity in the portfolio. It's been a while since we've gotten sort of a portfolio mix and breakdown. And I'm wondering, particularly with AAA coming onboard, BJ's Wholesale rolling off. As we think about 2023 or the end of the year, is there an update on a rough mix for both in-store and digital as well as traditional apparel and nonapparel? Maybe just to kind of bring us current since it's been a while since we've discussed that.

Yes. If you consider our previous position compared to where we are now, we have adjusted our portfolio significantly. Currently, less than 25% of our sales come from specialty retailers, while about 40% are generated through digital channels. This illustrates the shift in our portfolio. We have successfully diversified our partners, with specialty apparel and department sales constituting 50% of our sales in 2016, and that figure has now dropped to less than 25%. Additionally, a larger portion of our portfolio is now tied to variable pricing. Overall, we are pleased with the new additions and the way we have diversified our approach, covering co-branding, core PLCC, and direct-to-consumer sales.

Got it. Maybe as a follow-up, very maybe overly generalized question and just the competitive environment, maybe it's a derivative of what Sanjay was asking earlier about fintechs. But I'm asking because earlier this week at Money 2020, it's been a few years since I've been there. I was just struck by how many booths there were for companies related to point-of-sale financing, not just BNPL or even lenders but just the whole ecosystem around POS financing. And as you kind of broadly survey competition, is there anything new on the horizon you're seeing, new entrants?

It's interesting. I think there are a lot of companies in the point-of-sale financing space, especially at events like this in Vegas. What stands out to me is the potential for innovation in technology related to point-of-sale systems, which is positive as many consumers want to make purchases in that way. However, it's crucial to responsibly underwrite these customers and provide adequate service. If bad debts occur, you need to be prepared for regulations. Your technology needs to function reliably, not just quickly. We focus on ensuring our funding is handled appropriately, as we are a bank. All these factors give us a competitive edge. The technology available today can be utilized by partnering with others, borrowing, or developing it internally, but the foundation of how we operate as a financial institution remains our key advantage.

Our next question comes from Regi Smith from JPMorgan.

There's a perception that some fintech companies have access to superior data and are more agile in managing their portfolios. Ralph, you mentioned managing open lines, and I'm interested in your recession playbook. What other tools and capabilities do you have to navigate through economic cycles? I feel that you are better positioned and more flexible than the market recognizes. Could you elaborate on that? I have a follow-up question as well.

I appreciate your question. It's quite the opposite of what you might think. We are data-rich, having invested millions in data and analytics technology. We've experienced multiple economic cycles and have a comprehensive data repository from the past two recessions showing how consumers respond. I would argue that others lack that level of sophistication. We have invested in artificial intelligence and machine learning across all our models, applying them to risk, marketing, and servicing. We share partner information regarding industry trends and credit profiles. We take proactive measures with our clients, ensuring appropriate line assignments without putting anyone at risk. All our decisions are based on thorough data and analytics. Additionally, we have a seasoned leadership team that has navigated many cycles. Combined, these factors position us well to handle whatever economic challenges arise. Proactivity and precision in our approach are crucial; we aim to make targeted decisions rather than sweeping changes to our portfolio. I believe we possess a level of information and history that sets us apart from other fintech companies.

Got it. I understand. I believe you have a greater margin for error due to the yield of your portfolio and its size compared to some newer companies. My second question relates to a slide in your presentation that discusses your capital ratios and tangible book value. You mentioned that you're above your regulatory ratios. Given the current stock price and your tangible book value, what is preventing you from being more aggressive with share repurchases?

That's a great question and one we hear often. We've mentioned that we aim to achieve a 9% TCE to TA ratio before considering additional capital actions. This goal serves as a good baseline for our capital ratios. Our primary focus remains on supporting profitable growth and investing in our business. As we approach the 9% target, we can begin discussions on capital allocation with the Board and establish more concrete targets regarding our investments, debt repayments, stock buybacks, and other options. However, we aren't in a hurry to make decisions. We have many factors to consider, including peer capital levels, our growth strategies, and potential opportunities, all of which must be evaluated before making any recommendations on stock buybacks.

Our next question comes from John Pancari from Evercore ISI.

On your expectation for the elevated delinquency and losses related to the card processing platform transition, can you help us quantify that impact and how we should consider its contribution over the next couple of quarters? Additionally, you mentioned some improvement in your underlying early-stage delinquency buckets. Where are you observing that improvement, what is driving it, and could it continue?

Yes. I believe I’ve provided a solid indication of where our full year results will land at the higher end of our low to mid-5% range, which should help you understand the calculations for the fourth quarter. I won’t provide specific guidance at this moment. We are observing improvements in early-stage delinquency overall. By that, I refer to the higher levels we experienced during this recent transition period, which included some anomalies in the delinquency metrics that we anticipated. As Ralph mentioned, we implemented some customer-friendly accommodations, and we are seeing the positive effects of that. You will notice this improvement when we release our delinquency data in the coming months.

Okay. So that improvement was mainly tied to the elevated impact of the transition.

Well, right now, we're at a 5% loss rate. So I think it's the inverse of it, which is how much of the lower loss rate do we have in this quarter is due to the transition. And so in my prepared remarks, I kind of guided it would have been in the mid-5s. So that tells you roughly what the basis points of betterment was in this quarter that you could then apply to next quarter plus normal seasonality plus some normalization would be the components that would drive the difference in the fourth quarter.

Got it. Okay. All right. And then lastly, regarding the credit sales dynamics, I understand you mentioned a year-over-year improvement in August, September, and October. You believe this trend could continue. As for your outlook, do you anticipate some moderation due to the cooling economic environment and actions by the Federal Reserve? Can you elaborate on how you project this will impact your expectations?

Yes. Like everything we do, it's carefully considered and based on data, as well as historical trends. We maintain ongoing communication with our brand partners to understand their perspectives at the TIL. Using various data points, not just those related to the overall economy, we adjust our approach based on the insights we gather from our brand partners, the macroeconomic landscape, and overall performance.

Our final question comes from Alexander Villalobos from Jefferies.

John Hecht can't be on the call because of other earnings. But he did want to ask a little bit more about the reserve rate and net charge-offs, but going more into next year. You guys were pretty clear about 4Q. But just how should we think about the following year? Obviously, there's a lot of uncertainty, but if there's any guide on that, that would be helpful.

Yes. So again, with the reserve, I gave some dollar-based comments in my prepared remarks, right, in that what you've seen. If the macroeconomic variables continue to, I'll say, soften a bit, that would indicate that the reserve rate could stay elevated until you kind of peak over that and then you get improving outlooks. And then for us in particular, we've got a couple large portfolio moves that are happening between the fourth quarter and the first quarter. So in the fourth quarter, with AAA portfolio coming on for about $1.5 billion, you could do the math at pretty much something close to the exact reserve rate that we have today, we put on a large reserve build in that quarter. And then if you do the same type of math in the first quarter with a large BJ's portfolio going out, you would expect the dollar reserve release in that quarter, plus you've got a normal seasonal movement in the portfolio. So those are two big things that are going to happen in terms of the big dollar swings. In terms of the rate, it will be influenced by several factors, including the core delinquency in the portfolio and the macroeconomic variables we are projecting. If the current trend continues, where we see a slight deterioration in the macroeconomic variables every 90 days when we run the model, I would expect the reserve rate to remain flat in the fourth quarter despite having a higher quality portfolio like AAA. As we head into the first quarter with BJ's leaving, we will need to reassess the reserve rate. Although BJ's has shown a lower loss rate in the entire portfolio, one might assume that the reserve rate could increase while the dollar amounts decrease. We are closely monitoring numerous factors, including internal performance and macro trends. The job market remains strong, and consumers appear to be in good health, indicating that jobs are available for those seeking work. However, there seems to be a divide in the economy; high-end consumers may be better able to manage inflation as they return to travel, though they might face challenges when considering home purchases due to rising mortgage rates, which have doubled in the last six months. Middle America is feeling the pinch of inflation more acutely, particularly for essential items. We are being cautious and deliberate with our credit decisions, maintaining a conservative approach to our reserve rate until we have a clearer outlook.

We have no further questions, so I'll now pass it back to Ralph Andretta for closing remarks.

Thank you all for joining our call today and your continued interest in Bread Financial. Everyone, have a terrific day, and thank you very much.

That concludes today's Q3 2022 Bread Financial Earnings Conference Call.