Bread Financial Holdings, Inc. Q4 FY2023 Earnings Call

Good morning. And welcome to Bread Financial’s Fourth Quarter Earnings Conference Call. My name is Emily, 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 opened for your questions. It is 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. 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 slide three. I will highlight our major accomplishments for 2023. We continue to execute on our strategic initiatives by growing responsibly and strengthening our balance sheet. Additionally, we continue to optimize data and technology while investing to capture future growth opportunities, inclusive of the sale of the BJs portfolio in February of 2023 and our strategic credit tightening. Loans grew at a low-to-mid single digit rate compared to 2022 as forecasted. PPNR or profitless tax and loan loss provisions grew for the full year, as well as for each quarter in 2023, demonstrating our ability to deliver sustainable profitable growth. During 2023, we launched and renewed several key brand partner relationships. New partners included iconic brands such as Dell Technologies and the New York Yankees, and we were pleased to renew multiple partners including our longstanding business relationship with Signet. Importantly, our top five partners are currently secured through 2028 and more than 85% of our current loan portfolio has contracted through 2025. Our continued success reflects the dedication of our associates, our nimble customer-first approach, and our enhanced technology capabilities. We achieved significant progress in reducing our parent-level debt during the year while refinancing both our term loan and revolving line of credit. We also obtained our inaugural holding company issuer credit rating in November. Following, we completed a $600 million senior unsecured note offering in December that was opportunistically upscaled to $900 million earlier this month. With a portion of this new financing, we paid off our term loan early in December of 2023. Consistent with our parent level debt reduction plan, we paid down approximately $500 million of parent unsecured debt in 2023 and an additional $100 million in January of 2024. Additionally, we strengthened our balance sheet highlighted by 18% year-over-year growth in our direct-to-consumer deposits of $6.5 billion at year-end. These actions, coupled with our strong cash flow generation and disciplined capital allocation, improve the company’s financial flexibility and capital ratios further fortifying our balance sheet. Investments in technology and driving innovation are paramount to our success. In 2023, we hired more than 100 new engineers with cloud expertise and optimized our data and technology by adding new systems capabilities. These included API enhancements, enriched software development kits, unified Salesforce integration, virtual card commercialization, as well as the launch of the Bread Financial mobile app. We also successfully converted a majority of our Comenity Mastercard portfolio to the new Bread Rewards American Express program for everyday spending, achieving strong activation and balanced build post conversion. Finally, we strengthened our relationship with our brand partners by delivering enhanced value propositions that helped drive sales and meet the evolving needs of our customers. We are pleased with the progress we achieved in 2023 and remain focused on driving continued success throughout 2024 and beyond. Moving to the highlights for the fourth quarter on slide four. The fourth quarter marked our 11th consecutive quarter of year-over-year PPNR growth, further demonstrating our ability to deliver sustainable profitable growth. Net income was $43 million despite credit losses above our through-the-cycle average in the current challenging macroeconomic environment. Additionally, we continue to deliver on our commitment to build long-term shareholder value as our tangible book value per share approached $44, representing a 49% year-over-year increase. We are proud of the progress we have made in executing on our debt plan, strengthening our balance sheet, and enhancing our financial resilience. The economy continued to be impacted by macroeconomic headwinds, including persistent inflation, high interest rates, and the resumption of student loan repayments. These factors led to a moderation in consumer spending and pressured consumers’ ability to pay. As we enter 2024, we maintain disciplined credit risk management, given continued economic pressures that affect consumer spending and ability to pay. Our ongoing prudent credit tightening is driven by both the current environment and uncertainty around future economic conditions, persistent inflation pressure, and the impact of elevated interest rates. We have continued to responsibly manage our underwriting and credit line management, while proactively eliminating our exposure by tightening approval rates, pausing line increases, and prudently implementing credit line decreases. Although these actions impacted our 2023 sales and loan growth, our credit distribution has stabilized above pre-pandemic levels. In anticipation of the CFPB’s final rule on credit card late fees, we are proactively implementing our plans intended to address the change in regulation, which, if left unmitigated, would have a significant impact on our business. We are engaged with our brand partners regarding necessary mitigating actions and expect to implement many of these actions prior to the final rule becoming effective. Additionally, we continue to strategically diversify our business to be less reliant on late fees, with continued growth in our co-brand and proprietary products, and our improved credit profile. We expect the rule to be challenged in court and will monitor the situation closely. Having successfully managed through significant regulatory changes and varied credit cycles in the past, our seasoned leadership team is focused on addressing the impact on our business while continuing to generate strong returns through prudent capital and risk management. Turning to slide five, as we have highlighted previously, our disciplined capital allocation strategy, which focuses on profitable growth, improving metrics, and reducing parent-level debt, has driven substantial growth in tangible book value over the past several years. Looking at the first chart, you can see that since the first quarter of 2020, we have more than tripled our TCE to TA ratio. We aim to further enhance our total company capital metrics from where we are today. Additionally, we will balance achieving these targets with continued investment in our business and long-term growth, consistent with our capital priorities. Later this year, we plan to host an Investor Day, where we will further discuss our capital targets and allocation strategies. Moving to the second chart, I will again highlight the progress we have made with respect to debt reduction. In just over three years, we have reduced parent-level debt by 54%, paying down more than $1.7 billion, and we paid down an additional $100 million this week, which is not included in that figure. Finally, the improvement in our tangible book value per share has grown at a 38% compounded annual rate since the first quarter of 2020. Supported by our strong cash flow generation, we expect to continue to grow our tangible book value. We believe this growth, combined with our meaningfully improved financial resilience and strengthened balance sheet, should yield a company valuation that is a multiple of our tangible book value. We remain confident in our strategy and are focused on managing our business responsibly to build long-term value for our stakeholders. Turning to slide six, let’s review our key focus areas for 2024. Our initiatives build on the momentum we generated in 2023 while enabling us to proactively adapt to evolving macroeconomic conditions. Our key focus areas for 2024 include growing responsibly, managing the macroeconomic and regulatory environment, accelerating digital and technology offerings, and driving operational excellence. We remain committed to generating responsible growth while further scaling into refining our product offerings to align with a challenging economic landscape. In doing so, we will optimize brand partner growth and revenue opportunities. Although our sales and loan growth may moderate in 2024, our responsible decisions are focused on creating long-term value for shareholders. Managing the macroeconomic and regulatory environment effectively is fundamental to our success, with the proposed CFPB credit card late fee rule coupled with persistent macroeconomic headwinds pressuring consumers; we are executing several mitigation strategies intended to help offset the anticipated financial impact. Perry will provide more details in his remarks. Accelerating our digital and technology capabilities remains a top priority, and I am pleased to welcome Allegra Driscoll to our organization as our new Executive Vice President and Chief Technology Officer. Allegra’s proven track record as an innovative leader, combined with our deep understanding of financial services, will be essential as we advance our tech innovation and modernization. Throughout 2024, we will focus on further building our capabilities to enhance customer experience and satisfaction. Finally, we will intensify our focus on operational excellence to accelerate continuous improvement gains that drive improved customer experience, enterprise-wide efficiency, reduced risk, and value creation. Our goal is to consistently generate expense efficiencies that enable reinvestment in our business, support responsible growth, and achieve our targeted returns. Before I turn it over to Perry, I want to thank our associates for their continued dedication and hard work. Our seasoned leadership team remains committed to generating strong returns through prudent capital and risk management as we move forward. I will now turn it over to Perry.

Thanks, Ralph. Slide seven provides our 2023 financial highlights. Bread Financial’s credit sales of $28.9 billion decreased 12% year-over-year reflecting the sale of the BJs portfolio in February 2023, moderating consumer spending, and our ongoing strategic credit tightening, partially offset by new partner growth. Average loans of $18.2 billion increased 3% year-over-year driven by the addition of new partners. As Ralph noted, we have proactively tightened our credit underwriting and credit line assignments for both new and existing customers given the economic uncertainties and pressures affecting a large portion of our customer base. Revenue increased by $463 million or 12% year-over-year, driven by higher finance charge yields and non-interest income including the gain on the portfolio sale, partially offset by higher interest expense and reversals of interest and fees resulting from higher gross credit losses. Income from continuing operations increased by $513 million to $737 million driven by a lower provision for credit losses and a gain on portfolio sale, partially offset by higher income taxes. Moving to our fourth quarter financial highlights on slide eight. Similar to our full year drivers, fourth quarter credit sales and average loans were down year-over-year due to the sale of BJs portfolio, moderating consumer spending, and credit tightening. Revenue reached $1.0 billion in the quarter, down 2% year-over-year due to lower late fee revenue, higher interest expense, and higher reversal of interest and fees resulting from higher gross credit losses, partially offset by higher finance charge yield in non-interest income. Total non-interest expenses decreased 6% year-over-year, as we continue to gain operational efficiencies and better align our expenses with a more moderate growth outlook. Income from continuing operations increased by $179 million driven primarily by a lower reserve build. Looking at the financials in more detail on slide nine. Total interest income for the quarter decreased 5% year-over-year but increased 2% for the full year compared to 2023. Fourth quarter and full year non-interest income benefited from three factors: higher cardholder and brand partner engagement initiatives in the prior year post our conversion, higher merchant discount fees, and interchange revenue earned in the current year, and lower payments under our retailer share agreements due to lower credit sales and higher losses. Total non-interest expense decreased 6% from the fourth quarter of 2022, yet was up on an annual basis as anticipated. The year-over-year decrease in the fourth quarter was primarily driven by a decrease in card and processing costs, including fraud, and a reduction in marketing expenses and depreciation amortization costs, partially offset by higher employee compensation and benefits costs. For the full year, investments in talent, technology, and marketing primarily drove the increase. Additional details on expense drivers can be found in the appendix of the slide deck. As Ralph mentioned, pre-tax pre-provision earnings or PPNR grew for the 11th consecutive quarter, increasing 3% year-over-year in the fourth quarter. Turning to slide 10, loan yields increased 170 basis points year-over-year, benefiting from the upward trend in the prime rate causing our variable price loans to move higher in tandem. Both loan yield of 27.7% and net interest margin of 19.6% were pressured sequentially from a seasonal increase in the reversal of interest and fees related to higher sequential gross credit losses. We expect this pressure to continue and lead to a sequential reduction in the net interest margin in the first quarter of 2024. Also, funding costs continue to rise but remained in line with our expectations. 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 $6.5 billion in the fourth quarter, as well as meaningful reductions in our unsecured debt over time. While we anticipate that direct-to-consumer deposits will continue to grow steadily, we will maintain flexibility in our diversified funding sources, including secured and wholesale funding to efficiently fund our long-term growth objectives. Moving to slide 11, our delinquency rate for the fourth quarter was 6.5%, up from the third quarter as expected, driven by continued macroeconomic pressures. We expect the delinquency rate to continue to move slightly higher this month, before stabilizing and moving lower in 2024. The net loss rate was 8.0% for the quarter, compared to 6.3% in the fourth quarter of 2022 and 6.9% in the third quarter of 2023. The fourth quarter net loss rate was elevated compared to last year’s level due to more challenging macroeconomic conditions, pressuring the consumer payment rate that I mentioned, as well as ongoing credit tightening and slower responsible growth impacting the denominator. The reserve rate decreased sequentially to 12.0% as transactor balances increased seasonally in the fourth quarter. We expect the first quarter 2024 reserve rate to return to approximately third quarter 2023 levels as transactor balances are paid down. We intend to maintain a conservative weighting of economic scenarios in our credit reserve model in anticipation of continuing macroeconomic challenges and uncertainty and the consequential impact on our future credit losses. Despite these headwinds, our credit risk score distribution mix remained flat to the third quarter as our percentage of cardholders with a 660 or above credit score remained above pre-pandemic levels due to our prudent credit tightening actions and a more diversified product mix. These dynamics reinforce our confidence that our credit metrics will show improvement in the second half of 2024. We continue to proactively manage our credit risk to protect our balance sheet and ensure we are appropriately compensated for the risk we take. We closely monitor our projected returns with the goal of generating risk-adjusted margins above our peers. Moving to slide 12, we have significantly enhanced our financial resilience, strengthening our balance sheet and funding mix while effectively managing credit risk. Over the past few years, we have diversified our product mix through partner co-brand growth, the introduction of two proprietary cards, and the launch and expansion of Bread Pay for installment lending. Our co-brand and proprietary products now comprise approximately 50% of our credit sales, enabling us to capture incremental general purpose sales as consumer spending patterns shift to more non-discretionary spend in response to evolving economic conditions. Additionally, our broader product suite has increased our total addressable market and diversified our spend. Direct-to-consumer deposits, which have continued to grow steadily, provide an additional source of funding that has strengthened our balance sheet and enhanced our financial flexibility. We have strengthened our balance sheet further by reducing debt and building capital while maintaining a conservative loan loss reserve. Our loan loss reserve rate is nearly 300 basis points higher than our CECL day one rate in 2020. Our quarter-end total loss absorption capacity, which we define as our allowance for credit losses plus Tier 1 capital divided by total end of period loans, was 23%, providing a strong margin of protection should more adverse economic conditions arise. We remain confident in our disciplined credit risk management and ability to drive sustainable value through the full economic cycle; delivering responsible profitable growth remains a top priority, even if doing so requires a disciplined slower rate of growth during extended economic uncertainty. Finally, slide 13 provides our 2024 financial outlook. Our 2024 outlook factors in an expected slower rate of credit sales growth as a result of continued moderation in consumer spending and ongoing strategic credit tightening. Both of which will pressure loan growth and the net loss rate. In addition, our 2024 outlook assumes multiple interest rate decreases by the Federal Reserve in the second half of the year, which will pressure total net interest income. At this time, our outlook does not factor in the potential impacts of the proposed CFPB late fee rule. Based on our current economic outlook, executed and expected proactive credit tightening actions, higher gross credit losses, and the visibility into new business pipeline, we expect 2024 average credit card and other loans to be down low-single digits relative to 2023. Excluding the BJs portfolio, which was sold in 2023, we expect 2024 average loans would be up low-single digits. Total revenue growth for 2024 excluding gains on portfolio sales is anticipated to be down low-to-mid single digits, driven by both lower average loans and net interest margin. Note, that the BJs portfolio exit in 2023 reduced our 2024 year-over-year revenue growth guidance by 1% to 2%. We expect our full year net interest margin to be below the full year of 2023 due to higher reversal of interest and fees given higher gross credit losses, declining interest rates, and a continued shift in product mix to co-brand and proprietary products. Consistent with our prior commentary, the potential initial impact of the CFPB credit card late fee rule is significant to our business given our mix of private label accounts and deeper underwriting. For context, while not included in our 2024 outlook, assuming a hypothetical October 1, 2024 effective date, if the rule were to be implemented as proposed, our current estimate is that the rule would reduce fourth quarter 2024 total revenue by approximately 25% relative to the fourth quarter of 2023. This estimate is net of certain mitigation actions that we will proactively implement this year. It should be noted that the estimated revenue impact does not yet include any contractual changes to the retailer share arrangements with partners. Once the final rule is published, we will take further mitigating actions in coordination with our brand partners to preserve program profitability over the long term. We expect the financial impact to be increasingly mitigated over time as our actions take effect, with substantial progress expected within the first four quarters post-implementation. As I discussed in December at an Industry Conference, certain mitigation actions will require a longer timeframe to reach full mitigation value, such as APR changes. Therefore, we will proactively implement certain actions in advance of the final rule implementation, inclusive of fee and policy changes. Additionally, we expect there will be impacts on future loan growth due to the necessary underwriting changes to ensure we maintain profitability thresholds, which, unfortunately, will restrict access to credit for some consumers. All that said, given that a final rule has not yet been published and industry litigation is expected, the timing of the rule implementation and resulting financial impact will vary. In fact, it is possible there is no financial impact in 2024. Shifting to operating leverage, as a result of efficiencies gained from ongoing investments in technology modernization and digital advancement, along with disciplined expense management, we aim to deliver nominal positive operating leverage for 2024, despite net interest margin headwinds. With our focus on expense discipline and operational excellence, we expect total expenses will be lower in 2024 than in 2023, assuming our current economic outlook remains intact. We expect a net loss rate in the low 8% range for 2024, peaking in the first half of the year with each of the first two quarters of the year in the mid-to-high 8% range as inflation continues to pressure consumers’ ability to pay and moderate their spend. Our outlook is inclusive of our ongoing credit tightening actions and expected slower loan growth impacting the net loss rate. Finally, our full year normalized effective tax rate is expected to be in the range of 25% to 26% with quarter-over-quarter variability due to the timing of certain discrete items. In closing, the executive leadership team and I are confident in our ability to successfully manage risk-return tradeoffs in this challenging economic environment, while continuing to make strategic investments that drive long-term value for our stakeholders. Operator, we are now ready to open up the lines for questions.

Thank you. Our first question today comes from the line of Vincent Caintic with Stephens. Please go ahead. Your line is open.

Hi. Good morning. Thank you for answering my questions. I appreciate the CFPB's estimate on late fees and their impact. I would like to delve into that a bit more. Regarding the 25% figure, I want to grasp the level of confidence in that estimate and how much lower it might possibly go. Specifically, I am curious about the mitigating factors that contribute to that 25%. What would that percentage look like without those mitigating factors, and how low do you believe it could go? Additionally, what changes would need to occur to reach that lower percentage? Thank you.

Thanks, Vincent, for the question. I am glad you appreciate us giving some guidance and increasing transparency there. What we have provided is, what I’d say is, a downside scenario, meaning it’s assuming the late fee rule comes out as proposed at $8, a 25% cap with an effective October 1 with no partner adjustment considerations there, there were program considerations. And as we talked about in what I provided at one of the past conferences, some of the mitigating actions are just going to take time, right? APR changes take time to burn through. So there’s a lot more value that will come from mitigating action. So within, you can imagine, if you think about the six months of impact that might be in place if we start to do some pricing changes, if the rule comes out pretty soon, there’s not a ton of mitigation within that number. The value is going to come over time.

Vincent, it’s Ralph. I think the thing to remember is, we have a really seasoned team here that has been through the Card Act and has managed through that and managed to return to profitability. So that’s what we are going to do. We are going to focus on what it takes to return to profitability. It’s going to take a little bit of time. We thought it was important today to kind of put out the worst-case scenario, but we are really focused on closing the gap over time and we have been working on it since February of 2023.

I appreciate it. It seems that the 25% figure only includes six months of elevated APRs. Could you discuss the actions you plan to take once the rule is finalized and the potential impact of those strategies? Also, what are your conversations with the merchants like regarding this? Thank you.

When considering pricing actions, some of them require agreement from our partners. Val Greer and her team have been actively engaging with each partner to determine the best solution should the rule be implemented. We need the rule to be finalized with clear parameters before each partner collaborates with our team to establish the appropriate course of action. For some partners, this may involve promotional fees without changing their pricing, while others might prefer to focus on APRs or adjust royalties to maintain deeper underwriting. There will be various credit actions taken, and we will utilize different strategies based on the specific needs of each partner and product. It’s challenging to provide detailed specifics until the rule is finalized and we’ve had a chance to work with each partner to identify the right approach.

Okay. I appreciate it. Very helpful. I will get back in the queue. Thank you.

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

Hi. Thank you for taking my questions and good morning. Just off maybe just staying on the late fee topic, I think, you said the net of the mitigation actions, it will be 25% and we appreciate the specificity of the disclosure. But I was wondering if you could maybe take a step further, what will be the gross impact if you don’t implement the net, the mitigation actions? What I am trying to understand is how much are you mitigating proactively versus what it would be if you didn’t, because it also sounds like, hey, this might not come in. There will be litigation. So just trying to understand what is the I guess, I don’t know if the insurance is the right word, like proactively mitigating you are taking a bit of a revenue hit too, so or maybe getting a revenue boost, I guess? Yeah.

I appreciate your question. What we're providing is a hypothetical downside risk for the fourth quarter of this year. While I don’t typically make predictions, some might argue it's unlikely that this rule will affect this year significantly. We wanted to give you an idea of what the impact could look like if it is enacted as proposed and affects this particular quarter, especially since we just released the results for the fourth quarter of 2023. Looking ahead to the first or second quarter of 2025 complicates the estimation. The extent of mitigation we expect is not substantial compared to the fee change's overall effect. There are various factors at play, and as you noted, if litigation continues and we collaborate with our partners to take early actions in anticipation of potential outcomes, this could yield some short-term advantages. However, I wouldn’t want to imply that there’s a definite boost, since our aim is not to capitalize on what we consider flawed rulemaking.

Thank you for your question. I want to discuss credit performance. First, are you still confident in your longer-term guidance of keeping it below 6% through the cycle? What gives you confidence in achieving that? Specifically, in terms of delinquency, do you think this will be resolved by the end of 2024 or by the end of 2025? I'm trying to understand your thoughts on how to reach that goal. While credit tightening measures are beneficial, I’m looking for clarity on the path forward. Thank you.

I am confident that we will return to below 6%, but the timing will depend on your confidence in the economic outlook, which will influence the process. Historically, during past cycles, there is a period of increased losses. Currently, we are experiencing higher loss rates, but we have provided guidance suggesting a decrease in loans. We are introducing lower new account vintages that offer better credit quality; however, they are not sufficient to offset the higher gross losses and normal attrition we are experiencing. As the cycle improves economically, the riskier customers will be removed from the portfolio, allowing us to introduce larger new vintages. This growth, combined with a lower loss rate, will occur in a better economic climate. Additionally, we are continuing to shift our product mix. Therefore, we are quite confident we will achieve this, though I cannot specify the exact quarter or year, as it is largely contingent on the necessary economic improvements happening alongside this.

Got it. Thank you. Thank you for taking my question.

Sure. Thank you.

Our next question comes from the line of Sanjay Sakhrani with KBW. Please go ahead, Sanjay.

Thanks. Good morning. I don’t know, Perry, Ralph, I guess, when I think about the late fee impact as it stands right now. Could you just talk about maybe, like, what you can do to offset this on expenses, because I understand like the APRs probably take a couple of years, right? So in the absence of some kind of delay or deferment, it seems like next year if everything sort of static, you could actually lose money or please correct me if I am wrong, unless there are some expense offsets and some of the offsets sort of flowed through quicker than what we think. Maybe you could just talk about that plus the fact or the question as to how can you get back to the profitability levels that you were at pre this regulation over time and sort of what the time horizon would be?

Thank you for the question, Sanjay. Your inquiry is quite hypothetical since the rule is not finalized, and we don’t know where it will end up. Regarding expense management, Ralph has been clear, and we have all agreed that we aim to invest in this business for the long term and avoid short-term decisions that could harm our competitiveness and ability to serve our customers and brand partners with necessary digital capabilities. Expense efficiency is in our DNA; our focus on operational excellence is evident in the second half of 2023 results and will continue into 2024. It wouldn’t be appropriate to significantly cut expenses at the risk of sacrificing our future. There are multiple factors to consider, especially with revenue while making tighter underwriting changes. We will enhance our digital capabilities and mobile deployment to help improve expenses, which is a standard practice for us. However, as Ralph mentioned, we need to navigate through this situation. Tighter underwriting may lead to fewer accounts, providing a slight expense boost, but we need to work back through the revenue side. While there may be less risk in the portfolio leading to lower losses and reserve rates, this will all unfold as we await the final rule and collaborate with each partner to determine the mechanics involved. Your comment about returns is valid; it’s possible they may be somewhat lower than they were before the CFPB, but we still anticipate strong returns as the business will be slightly less risky, especially since some consumers will no longer have access to credit on the riskier end of the spectrum.

Okay. Maybe just to follow up on credit. I think when we look at the peers. It seems like they are kind of turning the corner on credit. It seems like there’s gradual progress on your front. It just seems like when you qualitatively talk about your loan portfolio, it seems that there is a little bit more pressure on your end customer. Is it fair to say that the inflation and the higher rates really hit them a little bit more disproportionately relative to other issuers in this space or when you parse out the same customers inside those portfolios, they are behaving the same way? And what’s the light at the end of the tunnel, as inflation is receding, are you seeing better behavior? I am just curious just thinking through your credit performance? And then maybe just, sorry, follow-up on that, the reserve progression over the course of this year? Maybe you could just talk about how you are thinking about it? Thanks.

It's interesting that you mention others are improving, as our perspective may differ slightly. We've noticed that competitors are experiencing a faster decline in loss rates and delinquencies compared to us, and we are still facing some pressure. When assessing lagging loss rates, the fourth quarter of this year mirrors the fourth quarter of last year, which challenges that statement. However, I agree with your point regarding the consumers we serve. The top third of consumers driving the economy are experiencing some higher rates, which is inconvenient for them. In contrast, the two-thirds of Americans facing pressure are impacted by rising costs. An EY study indicated that the monthly expenses for consumers have increased by $1,000 compared to 2019, totaling $20,000 annually, while wages have not kept pace. Currently, wage growth is starting to exceed inflation and inflation is decreasing, which will benefit the two-thirds we serve, particularly the middle third. They are feeling the impact of higher interest rates, with reduced savings and increasing debt. This is why the credit actions we are implementing will require some time to show effects, but it gives us confidence as we approach the second half of next year. I hope that addresses your initial question.

Yeah.

And as it relates to reserve rate, let’s see, I think we have been very transparent about what our belief was going to be with the reserve rate and we got ahead a little bit, right? We are looking around the corner. We increased the reserve rate recognizing that a lot of reserve models are geared towards changing unemployment. We took an approach, we said, there’s a lot of things model don’t care for which is a period of rapid inflation, persistently high rapid rise in interest rates. So that conservatism that we had placed in there is playing out and we feel confident that we have sufficiently cared for what’s ahead of us in the first half of the year. And candidly in the guidance that I gave where we said, hey, this reserve rate should remain pretty steady through most of the year, it is possible as you enter the back half, we start to see lower delinquency formation, the roll rate starts to improve and better economic outlooks. I would expect that the reserve rate will start to come down.

Okay. Perfect. Thank you.

Thanks, Sanjay.

Our next question comes from Moshe Orenbuch with Cowen. Please go ahead.

Great. Thanks. Perry and Ralph, could you discuss your expectations for balanced growth in 2024? You mentioned slowing spending and some other actions you’ve taken. Could you provide more detail on those and their implications, particularly regarding your relationships with partners? I have a follow-up question.

Thank you for the question, Moshe. Some of our approach is influenced by the current economic environment, which we've discussed since Ralph became CEO and I joined along with Val and Tammy. Our focus is on responsible growth, especially during challenging economic times. We've tightened credit buybacks, limited new accounts, and as a result, we issued fewer loans last year compared to the previous year. We anticipate a similar trend in 2024. When losses exceed 8%, and gross losses are even higher, the existing portfolio is not being replenished at the same rate due to a smaller influx of new accounts and lower credit lines. Additionally, there is less economic activity as consumers are moderating their spending. However, towards the end of the year, as spending picks up and losses decrease, we expect to see a positive growth trajectory.

I think about it and I'm comfortable with low single-digit loan growth similar to BJs. Considering the current economy and the pressures and uncertainties we're facing, that level of growth seems appropriate. It would be concerning if we reported much higher growth in this environment. From the beginning, we have focused on being conservative and managing our growth responsibly, and we will continue that approach.

Okay. When you think about the mitigating actions post the implementation of the late fee thing. Are there any issues with respect to interest rate caps, either statutory caps or caps that you would impose in terms of the level of rates, particularly given your kind of average balances per account as you think about implementing those actions?

Moshe, that's a good question and one that the industry is currently facing. You've identified a significant issue related to the unintended consequences of the CFPB action, which is likely to result in much higher rates for a larger portion of the population. Essentially, everyone will end up paying for those who are late, and the extent to which rates will increase will largely depend on the market. It's uncomfortable to see rates rise into the mid-to-high 30%, but that is where we are heading.

Unfortunately, the consequence of this action is that credit will become more expensive for everyone, and those who have access to credit today may not have it tomorrow. This is likely to be part of the outcome.

Got it. Thank you.

Our next question comes from Jeff Adelson with Morgan Stanley. Jeff, please go ahead.

Yes. Hi. Thanks for taking my question. I guess I just wanted to dig in a little bit more again on the late fee impact that you are outlining here with no partner considerations. Could you just clarify what that means, is that more than normal formulaic RSA that offsets or is that already considered, or is it more just what your contracts allow you to do in the event of some adverse versus change to the regulatory environment?

Thank you for the question. The RSA that is already part of the contract is included in that estimate, but since the rule isn't finalized, we haven't completed negotiations with those partners. It would not be appropriate for me to provide an estimate based on what each partner might agree to in a hypothetical scenario. That's why we presented the estimate in this way.

Okay. Got it. And then just the revenue guide, just to make sure it’s crystal clear, I know you are saying no assumed gain on sale. But does the revenue base for 2023 considered in the growth rate include or exclude BJs? I think you mean to include BJs in the base, correct?

Yes. In the base forecast for 2023 that included BJs with the base guidance, I mentioned that excluding it from the prior year would have lessened the reduction.

Okay. Great. Got it. Thanks for taking my question.

Thank you.

The next question comes from Reggie Smith with JPMorgan. Please go ahead, Reggie.

Good morning. Thank you for taking my question. This year, you mentioned efficiency, and I've been looking at your employee headcount. When I compare it to Synchrony and Affirm in relation to credit sales or receivables, it appears significantly higher. My question is, is there something fundamental about your business that necessitates a larger headcount? Perhaps it’s the credit experience you offer. If you were to reimagine this business from the ground up using modern technology and automation, would you need fewer employees? I understand that’s a sensitive topic, but any insights you can provide on this would be appreciated.

Thank you for your question. When considering the factors that determine staffing needs, it's essential to factor in the risk organization and technology. There are certain fundamental elements we need to have in place to support our business, and clearly, having scale is beneficial, especially when comparing ourselves to companies that are significantly larger. Additionally, we service one in seven households in America, which means we manage a considerable number of accounts relative to our asset size compared to larger issuers. It's also important to note that the figures don't fully reflect the level of interactions we have with third-party vendors that may handle servicing differently. Many variables contribute to our operational metrics, and your observation about benchmarking is pertinent. We are focused on achieving operational excellence over time, a goal we've been working towards for decades. Technology plays a crucial role in this; enhancing the skills of our customer representatives and equipping them with better tools, or enabling customers to self-serve via mobile or chat, contributes to improved efficiency. These advancements, which Ralph mentioned in terms of our investments in mobile technology, will continue to evolve over the next couple of years and further enhance our operational effectiveness.

If I could sneak one more in just a point of clarification. I would imagine there’s some seasonality to kind of the late fees and I was curious if it’s 4Q is typically a heavier late fee quarter than maybe others. I am just trying to think about like what that 2025, like how much of that is kind of seasonal and like where it kind of moves?

Yeah, are you referring to the 25% impact from the CFPB rule?

Correct.

Yeah. No, there’s no material movement. I mean it’s more about tracking delinquency, right? So, it’s really, when you think about movement in late fees, delinquent accounts pay late fees, and so we look at delinquency movements, you are going to see movement in that end. Right now you have been seeing some fluctuation, sometimes you have some more sloppy payers. I mean it’s an interesting dynamic. You have people who missed by a few days, and that’s you call, I will say, a sloppy pay versus those that are actually going 30-day, 60-day delinquent. So its variation. Right now it’s more macro-driven than, I’d say, month-to-month seasonality.

Got it. Okay. Thank you.

Thank you.

Your next question comes from Bill Carcache with Wolfe Research. Please go ahead.

Thank you. Thanks, Ralph and Perry for all the proactive disclosures. I guess, maybe first question I had was whether providing so much detail suggests in any way that you view the eventual implementation is likely, it just seems like there’s still this scenario where the rule gets immediately litigated and the industry gets a win in the 5th Circuit, which would likely push the legal process beyond the 2024 election and given Trump’s appointing is an opportunity to overturn the rule. If we assume a Trump win and a Biden versus Trump 2024 rematch, I was just hoping you could speak to that dynamic and your view of what this says about likelihood of implementation?

It’s difficult for us to predict the political climate, but we see significant potential here. We are keen to understand its impact on our business and how we can effectively manage it. If things are delayed, that would be great, but we recognize that hope alone isn't a strategy. We believe this situation is highly probable, and we're prepared to address it with our experienced team.

Yeah. And this is Perry. I will add. Bill, thanks for the question. And I also like your thesis, and I am hoping you are right. But as you know from us being together in the past, we get a lot of questions on the potential impact, and in the spirit of transparency and knowing that we are giving guidance for the year and that if you have a catalyst event, it gave us the opportunity to provide some more context to help investors understand what that potential impact would be. Even though there’s a highly likelihood of almost certain litigation and delays, we felt it was appropriate to provide that transparency.

Understood. That’s very helpful. Thanks. And like if I could follow up on the expense guidance. Is the hypothetical sort of, I guess, like, sort of nominal positive operating leverage, it’s like roughly 3% decrease in year-over-year OpEx growth sort of the right zipcode, given your revenue guidance?

It would decrease slightly more than revenue decreases, right? That would kind of place...

Understood. Great. Thank you for taking my questions.

Thanks, Bill.

Our next question comes from Dominick Gabriele with Oppenheimer. Please go ahead.

Great. Excuse me. Thank you so much for taking my questions. If you think about the long-term loan growth expectation that you have had of roughly 10%-ish or so and the fact that you would be paring back from some of the lower FICO bands, most likely given this rule if it comes into effect. How does that affect your long-term loan growth rate and given if it slows it to maybe mid-single digits or whatever it may be, how do you think about that dynamic with your long-term net charge-off expectation? And I just have a follow-up. Thanks.

We will provide more information at Investor Day as we move forward. We have been diversifying our portfolio. If you consider the implications of potential changes, we may not be able to underwrite at the previous levels. We have co-brands and direct-to-consumer proprietary products that will continue to grow in the long term, and we plan to invest heavily in those areas. At this point, I wouldn’t want to change anything until we reach Investor Day, where we can be clearer about our future strategies and outlook.

Thank you for that information, Perry. I wanted to get some examples to understand the effect of late fees on the efficiency ratio. For the fourth quarter, if I follow your guidance on revenue and adjust for a 25% reduction while keeping expenses stable, it seems that could push the efficiency ratio into the high ‘60s. I'm wondering if that estimate is in the right range and whether it would decrease over time as we work towards a more sustainable level of recapture. Does that sound accurate? Thank you.

Yeah. Thanks for the question. I mean, look, everyone is going to plug some numbers into the model with this downside scenario. What I share with you is, the math is going to be the math, right? And whatever that math turns out, I mean, the first quarter of impact is an impact to revenue and then over time that will get mitigated. So you will take a hit to all of your return metrics, inclusive of efficiency ratio in the first quarter of implementation, that should be the worst of it and then it gets better from there to get back to places where we are comfortable.

Yeah. That makes perfect sense. It just feels like to me that, you want to keep your expense base strong because you are looking towards the future and in order to do that, you would have to grow expenses or whatever it may be. I really appreciate it. Thank you so much.

Thank you.

Our final question today comes from John Pancari with Evercore ISI. Please go ahead.

Good morning, and thank you for the information about the late fee. I apologize for bringing it up again, but I would like to confirm a couple of details that may not have been addressed. Specifically, do you know the gross impact from the late fee you estimated compared to the net impact you provided? Additionally, I believe this topic was discussed earlier, but I'm not sure you specified what you believe the net impact of that 25% will be. Could it potentially decrease to around 10%, or how do you see that evolving in the long term? Thank you.

Thank you for the question. We do not provide a grossed up number if the net includes partial in-flight mitigation that we expect to implement before the actual execution of the final rule. The extent of mitigation against the original amount is uncertain, but it will definitely improve over time. Additionally, there will be offsets in other line items due to reduced underwriting, improved loss rates, lower provisions, and decreased expenses. Several factors over the 36 months following the final rule will ultimately shape our outcome. Once the team completes its work with all partners, we will be able to share more information.

I appreciate that you are not providing specific details. However, could you give us an idea of what percentage of overall mitigation you considered as this rule was implemented? Do you think about half of it has been accounted for, with the other half still in progress? How can we conceptualize that?

I would recommend looking back at the slides I prepared and shared during the last conferences. One of the key factors is APR repricing. Because of how cardiac operations work, it takes time for this to take effect. That’s why we mentioned taking some early steps to jumpstart the process. However, it will take time for existing accounts to cycle through their balances and for new accounts to start at the higher APR. Additionally, once we collaborate with our partners, we'll be able to see who is interested in using more promotional rates and who prefers to implement some fees. There's a lot involved in that. I don’t want to speculate on the percentages of mitigation at this point, but there’s definitely more mitigation to come after the rule is enforced and after collaborating with our partners. We are focused on the long-term goals here and are fully committed to ensuring we achieve strong returns on the capital we invest in this business.

Okay. Great. Thank you.

Thank you.

Firstly, I want to thank you all for joining the call and for your interest in Bread Financial and for all your questions today. Everyone have just a wonderful day. Take care now.

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