Bread Financial Holdings, Inc. Q3 FY2024 Earnings Call

Good morning, and welcome to Bread Financial’s Third Quarter 2024 Earnings Conference Call. My name is Michelle, and I’ll be coordinating your call today. At this time, all parties have been placed on a listen-only mode. Following today’s presentation, the floor will be 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 at breadfinancial.com. On the call today, we have Ralph Andretta, President and Chief Executive Officer; and Perry Beberman, Executive Vice President and Chief Financial Officer. Before we begin, I would like to remind you that some of the comments made on today's call and some of the responses to your 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. Before I begin, I wanted to start by sending our thoughts to those impacted by the recent hurricanes. To underscore our commitment to the customers and communities we serve, we are increasing this year's financial support to the American Red Cross for emergency relief efforts. Additionally, we are providing payment accommodations to support customers impacted in the affected regions. We wish our customers and everyone affected continued safety during the recovery efforts. Now to our presentation. Starting with key highlights from the third quarter on slide 2. Our third quarter results demonstrated our commitment to growing our business responsibly and allocating capital to reduce risk and improve our balance sheet. We continue to execute on our strategic objectives on strengthening our balance sheet by using cash on hand to repurchase $262 million of our convertible notes. The repurchase impacted our GAAP results for the quarter, including expenses, net income and earnings per share. Accordingly, we provided reconciliations in our earnings materials to our adjusted or non-GAAP results, which we believe will help stakeholders more clearly evaluate the ongoing operations of the company. Additionally, our overall funding mix continued to improve with strong direct-to-consumer deposit growth and reduced wholesale deposit funding. For the quarter, we generated adjusted net income of $93 million and adjusted diluted earnings per share of $1.83, both adjusted to exclude the $91 million post-tax impact from the premium paid on our repurchased convertible notes. Tangible book value per share of $47.48 increased 12% year-over-year, while our common equity Tier 1 capital ratio increased 40 basis points year-over-year to 13.3%. During the quarter, we completed the portfolio acquisition and launch of the Saks Fifth Avenue credit card. Also in October, we launched the Hard Rock credit card program. We are excited to share our cross-channel expertise with these partners, enabling us to deliver strong value propositions to our customers. Turning to the consumer, spending patterns have remained consistent with the second quarter as consumers made more frequent shopping trips with lower transaction sizes. Spending continues to be more heavily weighted towards non-discretionary purchases, which are enabled by our expanded co-brand and proprietary products, along with back-to-school items at apparel and discount stores. While inflation continues to normalize, gas prices declining, growth in real wages and a stable labor market, we are starting to see signs of stabilization in credit sales and still expect a gradual economic recovery. To offset the potential impact of the CFPB's final rule on credit card late fees, we continue to execute on our mitigation strategy in close coordination with our brand partners. We have various pricing changes in the market, including increased APRs and statement fees. While uncertainty remains surrounding the timing and the outcome of ongoing litigation related to the rule, we remain confident in our ability to generate strong returns and achieve our long-term strategic objectives and financial targets regardless of the litigation outcome. As discussed at our Investor Day, we are in a position of strength with increased capital flexibility and financial resilience and are well equipped to address market volatility and uncertainty, enabling us to generate sustainable long-term value for our shareholders. Slide 3 depicts the results of our disciplined capital allocation strategy, which focuses on funding responsible, profitable growth, improving our capital metrics, reducing parent debt, and driving long-term shareholder value. Our common equity Tier 1 capital ratio increased 270 basis points since 2021 to 13.3%, showing meaningful progress towards our medium-term target of approximately 14%. Our efforts to optimize our capital and debt stacks are ongoing. Over the last three years, we have reduced parent debt by 62%. Our double leverage ratio is now well below our target of less than 115%, and we anticipate that this will remain below our target going forward. Finally, our tangible book value of more than $47 per share has grown at a 15% compounded annual rate since the third quarter of 2021. Supported by our strong cash flow generation, we expect our tangible book value to continue to grow. Turning to Slide 4, the chart on the left reflects the diversification of our product suite. Our fully integrated suite of products consists of private label, co-brand, proprietary and Bread Pay, which is our installment lending and buy now, pay later platform. Together, these products have improved our loan portfolio and our credit risk profile. Our expanded product suite has led to gains in consumers' wallet share and more non-discretionary spend, particularly as consumers have shifted their spending patterns given macroeconomic pressures. Co-brand and proprietary represent more than 50% of our total credit card sales, and we expect this ongoing shift to continue in light of the current economic outlook and potential regulatory changes. Shifting to the chart on the right, we are well diversified across our approximately 100 brand partners with several recent partner additions in electronics and travel and entertainment. As a result, travel and entertainment is now our largest vertical from a sales perspective at 32% of total credit sales. We are confident that our product and industry vertical diversification provides stability and will help us reach our long-term financial targets while delivering strong, sustainable shareholder returns. Turning to Slide 5. Throughout the year, we have focused on growing responsibly, managing the macroeconomic and regulatory environment, accelerating digital and technology capabilities and driving operational excellence. Our product and portfolio diversification, along with our proactive credit management and disciplined capital allocation are key to growing responsibly. We closely monitor trends in consumer sentiment and spending and payment behavior. In turn, we can then adjust credit and marketing plans to meet our partners' and customers' needs while delivering strong risk-adjusted returns. As you have heard me say, we will continue to invest in our digital and technology capabilities and deliver operational excellence to improve the customer experience, enhance enterprise-wide efficiency, reduce risk and create value. In summary, our experienced leadership team remains focused on generating strong returns through prudent capital and risk management. We have an unwavering commitment to drive sustainable, profitable growth, building long-term value for our shareholders throughout an ever-changing economic and regulatory environment. Now I'll turn it over to Perry to review the quarter's financials and to discuss our outlook.

Thanks, Ralph. Slide 6 provides our third quarter financial highlights. Before I review the financials, I will provide details on the impacts from the repurchases of a large portion of our convertible notes in the quarter. As you can see, our third quarter financial results were impacted by our strategic decision to repurchase $262 million, or 83% in principal amount of our convertible notes. The transactions resulted in $96 million of additional pre-tax expense, partly offset by a $5 million favorable tax impact and a $67 million reduction to equity in the quarter. To facilitate the repurchase, our bank boards approved a $400 million dividend to the parent company. As a result of our actions, $54 million in principal value of our convertible notes remain outstanding. Additionally, when we issued our convertible notes in the second quarter of 2023, we also entered into capped call transactions, which are designed to reduce potential dilution to our common stock and/or offset certain cash payments we may be required to make in excess of the principal amount of the convertible notes. We strategically chose to leave 100% of the capped calls outstanding, and they, therefore, remain available to potentially offset certain of the dilution impacts of the remaining convertible notes. Effectively, we have potential share dilution protection up to a share price of nearly $135 at maturity. I also wanted to point out that this quarter, the dilution impact of the remaining convertible notes on our diluted EPS was negligible. So we did not provide adjusted diluted EPS reflecting the offsetting value of the cap costs this quarter. However, as I mentioned, this offset remains in place. Now shifting to the financial highlights. During the quarter, credit sales of $6.5 billion decreased 3% year-over-year, reflecting moderating consumer spend and our ongoing strategic credit tightening, partially offset by new partner growth. Average loans of $17.8 billion in the third quarter increased 1% year-over-year, benefiting from new partner growth. Revenue was $1.0 billion in the quarter, down 5% year-over-year, primarily due to lower late fees resulting from our gradual shift in product mix, leading to a lower proportion of private label accounts. Additionally, we had lower merchant discount fees driven by lower big ticket credit sales as consumers pulled back on large discretionary purchases. Total non-interest expenses, net income, income from continuing operations and diluted EPS have all been adjusted for the impact from our repurchased convertible notes, which primarily represented a premium paid. All adjusted figures are non-GAAP financial measures and a reconciliation table can be found at the bottom of the slide as well as in the appendix, along with our non-GAAP financial measures. Adjusted total non-interest expenses decreased 5%, excluding the $96 million pre-tax impact from our repurchased convertible notes. The decline was driven by a reduction in card and processing expenses, which was primarily due to lower fraud losses. Adjusted income from continuing operations was $94 million and adjusted diluted EPS was $1.84, excluding the $91 million after-tax impact from our repurchased convertible notes, both impacted by a higher provision for credit losses in the quarter. Looking at the financials in more detail on slide 7, total net interest income for the quarter decreased 4% year-over-year, driven by lower late fees, while non-interest income is down $3 million, primarily the result of lower merchant discount fees. Total non-interest expenses increased $72 million or 14% year-over-year, driven by the $96 million pre-tax impact from the premium paid on our repurchased convertible notes, partly offset by a 26% reduction in card and processing expenses of $27 million. Excluding the impact from our repurchased convertible notes, total expenses decreased 5%. Additional details on expense drivers can be found in the appendix of the slide deck posted on our website. Pre-tax pre-provision earnings or PPNR, decreased $120 million or 23%, primarily driven by the $96 million pre-tax impact from our repurchased convertible notes. Excluding gains on portfolio sales and the impact from our repurchased convertible notes, PPNR decreased 5% for the quarter and increased 1% on a year-to-date basis. Turning to slide 8, loan yield decreased 120 basis points year-over-year, primarily due to our continued shift in product mix, leading to lower billed late fees in addition to higher reversal of interest and fees due to higher gross credit losses in the quarter. Both loan yield of 27.4% and net interest margin of 18.8% were higher sequentially following typical seasonal trends. On the funding side, we are seeing our funding cost rate moderate as savings accounts and new term CDs have begun to decline with the recent Fed rate cut and lower US Treasury rates. Additionally, as you can see on the bottom right chart, our funding mix continues to improve, fueled by growth in direct-to-consumer deposits, which increased to $7.5 billion at quarter end, while we continue to reduce wholesale deposits. Direct-to-consumer deposits accounted for 41% of our average funding, up from 35% a year ago. Concurrently, wholesale deposits decreased from 40% to 32%. While we anticipate that direct-to-consumer deposits will continue to grow steadily, we will maintain the flexibility provided by our diversified funding sources, including secured and wholesale funding to efficiently fund and manage our long-term growth objectives. I'll also note that in October, we extended the maturity of our $700 million senior unsecured revolving credit facility to October 2028 with improved terms. These improved terms include updated covenants that provide additional future capital action flexibility, further evidence and recognition of the positive actions that we have taken to strengthen our balance sheet and our commitment to disciplined capital management. Moving on to Slide 9. Our delinquency rate for the third quarter was 6.4%, up 40 basis points seasonally from the second quarter. From this point forward, we expect future quarters to largely follow historical seasonal trends subject to continued broad macroeconomic improvements and gradual benefits from our strategic credit tightening. The net loss rate was 7.8% for the quarter compared to 6.9% in the third quarter of 2023 and 8.6% in the second quarter of 2024. The third quarter net loss rate is expected to be the low point for the year, although the fourth quarter will see some timing benefit from the customer-friendly actions we have taken for customers impacted by the recent hurricanes, as Ralph mentioned. These actions will result in a reduction to fourth quarter 2024 losses and an increase in the second quarter of 2025 losses, simply reflecting timing as we support our affected customers. Overall, our baseline outlook assumes a slow gradual improvement in the macroeconomic environment as it will take time for the effects of a prolonged period of elevated inflation to be fully absorbed by our consumers. As expected, the reserve rate of 12.2% remained within the range we have seen over the past seven quarters. In this challenging macroeconomic environment and uncertain outlook, our conservative economic scenario weightings remained unchanged in our credit reserve modeling, and we believe our loan loss reserve provides an appropriate margin of protection. Compared to year-end 2023, we expect the year-end 2024 reserve rate to be flat to slightly lower, reflecting stability in delinquencies and the overall credit quality in the portfolio. Further, our total loss absorption capacity comprised of total company tangible common equity plus credit reserve rate ended the quarter at 25% of total loans, an increase of 140 basis points from a year ago, demonstrating a strong margin of protection should more adverse economic conditions arise. Looking at our credit risk mix distribution, the percentage of cardholders with a 660-plus credit score remained relatively flat over the past seven quarters and above pre-pandemic levels, despite continued inflationary pressures. This is primarily a result of our ongoing prudent credit tightening actions as well as our more diversified product mix. We continue to proactively manage our credit risk to protect our balance sheet and ensure we are appropriately compensated for the risk we take. Moving to Slide 10, adjusting for the expense impact from our repurchasing of convertible notes, our 2024 financial outlook remains unchanged from the second quarter of 2024. We continue to expect 2024 average loans to be down low single digits on a percentage basis relative to 2023 based on economic impacts on consumer spending, proactive credit tightening actions and higher gross credit losses. Total revenue for 2024, excluding gains on portfolio sales, is expected to be down low to mid-single digits with a full-year net interest margin lower than 2023, reflecting higher reversals of interest and fees due to higher gross credit losses, declining interest rates and a continued shift in product mix to co-brand and proprietary products. This guidance includes the impact of early CFPB mitigation pricing changes, which are not material to the full-year 2024 guidance. However, specifically for the fourth quarter, we expect net interest margin to benefit from our proactive CFPB actions as well as a lower cash position, offsetting normal seasonal pressures from higher reversals of interest and fees from higher gross credit losses and the typical fourth quarter loan balance increase from more transactional holiday spend. Note that as we remain slightly asset sensitive, we expect net interest margin pressure from lower Fed and prime rates as our variable rate assets reprice faster than our liabilities. As a result of efficiencies gained from our focus on operational excellence, including ongoing investments in technology modernization and digital advancement, along with reduced fraud, we expect adjusted expenses, excluding the impact from repurchased convertible notes, to be down mid-single digits relative to 2023. We would expect fourth quarter expenses to be higher than the adjusted third quarter figure based on seasonally higher sales volumes and further increased marketing expenses. As I mentioned earlier, the third quarter net loss rate is expected to be the low point for the year, and we continue to expect a full-year net loss rate in the low 8% range for 2024 or around 8.3%. Given the recent devastation the hurricanes have caused to the communities in which a number of our cardholders live, we have proactively frozen delinquency buckets in FEMA identified impact zones designed to provide some near-term payment relief until we have the opportunity to engage them for longer-term solutions as needed. These actions will result in a modest shift of approximately $10 million in losses from the fourth quarter of 2024 to the second quarter of 2025. This will slightly lower the net loss rate in the fourth quarter and increase the net loss rate in the second quarter of 2025. That modest accommodation aside, our outlook continues to assume a gradual modest improvement in economic conditions aligned with economist consensus. Finally, our full-year normalized effective tax rate is expected to be in the range of 25% to 26%, excluding the impacts from our repurchase of convertible notes. As expected, the tax deduction allowed on the repurchase premium paid was limited. Looking at the bigger picture, we continue to make meaningful progress towards the financial targets we provided at our Investor Day in June. We are well on our way to achieving our near-term targets with additional progress made on implementing CFPB mitigation strategies this quarter, a double leverage ratio of 103%, well below our 115% target, a stable risk mix given our proactive credit actions, and a strong CET1 ratio at 13.3%. We will look to continue to build capital to achieve our capital targets and grow our tangible book value. As Ralph already highlighted, we are well-positioned to deliver responsible growth, strong returns, and increased shareholder value.

Thank you. And our first question comes from Mihir Bhatia with Bank of America. Your line is open.

Hi. Thank you for taking my questions. Maybe to start, I just wanted to get big picture. Look, you made some comments on losses and expecting seasonality from here. But I think you also mentioned that you expect your credit actions to get better. So I guess the big question everyone is trying to answer is, are you close to peak losses right now? And will 2025 losses be better than 2024 losses if the macro stays stable?

Hi, Mihir. Thank you for the question. I think it's really going to come down to the macro environment. We'll give guidance, obviously, in our January call. Right now, what we're seeing is stability in our delinquency. So what I'm expecting is the, I'll say, future quarters to follow historical seasonality with a little bit of inflation from some of the customer-friendly things we did to support our customers through the hurricanes, and that will pass through into Q2. So you got a little bit of noise in there. But the rates in general are going to be – I expect to be stable to improving, but it's really going to come down to the macroeconomic landscape. And that would encourage consumer spend that will help with our loans. But again, beyond that, I'm expecting slow gradual improvements in consumer behavior over a prolonged number of quarters, given that these consumers are still trying to dig out from nearly three years of persistent high inflation, high-interest rates on cards, autos, and home loans. And then that's just going to take time to unwind. So there's no fast fix for, say, the typical American household. So it really is going to come down to, I think, a gradual easing through next year. I mean, I'd say is our baseline hypothesis, but that is more of what it is on the macro sentiment. And I could give more views on the economy, but it's really going to be economic dependent.

Got it. Okay. And then just, I guess, as a follow-up, maybe I can just talk about the late fee situation. What I'm trying to understand is what mitigants of yours are already in the market? How much of a benefit are you getting from them right now? And are you – like is the delay going to help from the standpoint of if it gets implemented at some point next year, should the headwinds be less because some of the mitigants who are in the market already, particularly, I guess, higher interest rates?

No, it's an excellent question, right? I mean, so we have been working diligently with our brand partners. You've seen we put some actions in the market already. What I want to make sure it's clear, we do not have an intent to over-earned prior to the effective date. Our commitment remains to providing our customers a valuable product to meet their borrowing needs and then fair economics and investments in our partner programs. We have had very meaningful discussions with our brand partners with actions that have already been put into the market and when. And then I'd say, we're probably over 95% have contractual understanding of strategies required to be executed. And to your point, in the back end of 2023, we took some early actions where we took some partial steps to increase APRs in anticipation of the rule. Since then, we've implemented a number of changes that are in the market, including APR increases and paper statement fees. APR increases just take a lot of time to, I'll say, burn in to build an effect. And so that's where my comment in the fourth quarter, we'll start to see some of that benefit, but it will offset other seasonal things happening in the quarter. And then as you start to go into next year, some of that will build. And we'll give more color on that, Mihir, as we get into next year. And some of that is shared back with partners. So it's again, the goal here is not – this is an unintended consequence of this, we deem as a flawed CFPB late fee rule.

Thank you. Our next question comes from Sanjay Sakhrani with KBW. Your line is open.

Thank you. Good morning. Hey, Perry, just to go back on the credit stats. I guess when we look at that second derivative of the year-over-year change in delinquency, that does steadily continue to improve. I guess based on your comments, do you expect that to just stabilize as we move forward? I know there were some comments on like the late-stage delinquencies, not necessarily seeing a lot of improvement. Has that changed in any way? I'm just trying to think about any tightening that you guys would have done and how that sort of impacted the credit metrics. Shouldn't that positively help your credit metrics as we look into next year? Thanks.

Yes, Sanjay, a very fair point. The credit actions that we've taken certainly have – I'm sorry, here some feedback on the line – is benefiting our – our actions. If you think about the stability that we've seen in the delinquency, despite our credit actions over the past couple of years, this is still where we're at. Now I think you've seen and we've all seen that our delinquency has probably stabilized more than many peers, and that is a result of the credit actions we've taken. I mean the economy is still very challenging for the consumers we serve. But I do believe that a combination of an improving or stabilizing economic outlook in combination with the effects of our mitigations and the continued credit risk mix from the shifting products a bit away from private label towards other products, co-brand and proprietary products will again also aid that continued improvement. But again, I think it's going to be a long road to get back to our through-the-cycle target, but we are fully expecting improvements throughout next year. It's just the degree of improvement is really going to be macro dependent in combination with the effect of our credit actions.

Okay. Did the hurricane actions help the delinquency metrics in September? I'm curious about that. Also, regarding the late fee, can you provide an update on when we might see the impacts from the late fee offset, especially if it was supposed to kick in this year? I'm trying to understand the timing of those effects. Thanks.

Yes. The effects from the hurricane will begin to influence our operations in October, and we expect to observe changes in delinquency rates during that month. We will clarify the specifics of these impacts, as they will become apparent in our credit quality updates and monthly reports. These effects will materialize primarily in October and November, with losses affecting the current quarter and extending into the second quarter of next year due to timing. Regarding mitigation, we anticipate gradual benefits leading up to the potential implementation of the late fee rule. Many of our negotiations and actions are contingent upon this rule taking effect. Our guidance indicates a return to strong performance over time, but the timeline is linked to the rule's implementation and the ongoing adjustments to our APR and related products. This process is not expected to conclude within a 12-month timeframe; as we've previously mentioned, it will take several years.

Thank you. Our next question comes from Vincent Caintic with BTIG. Your line is open.

Hey, good morning. Thanks for taking my questions. First one, I wanted to talk about your perspective on the fourth quarter, particularly the holiday sales season. What's your perspective on, first, how the consumer is feeling and will be doing in terms of the holiday sales? And then additionally, in terms of the merchant engagement you're experiencing perhaps on promotions or other merchant discussions you're having in terms of fourth quarter sales? Thank you.

Yeah. This is Ralph. If I think about it, we've not seen a change in consumer behavior from the second quarter to the third quarter, and I really don't expect a change in consumer behavior in the fourth quarter. I think you'll see consumers self-regulating. There'll be more frequent visits and they probably smaller baskets, but they will be out there. I think our partners are doing what they think they need to do to attract consumers in terms of sales and scrap prices; I think that's appropriate. I think it will be a moderate sales season. I think given the macroeconomics and a little bit of the uncertainty out there, but I'm not anticipating a very robust fourth quarter, just probably fourth quarter that will be in line with the second and third quarter spend that we've seen.

Yeah. And I'll add to that. One of the things that you may have read is that the National Retail Federation anticipates that the nominal retail sales growth for holiday will be in that 2.5% to 3.5% range, lower than recent years and in part due to the shorter time frame between Thanksgiving and Christmas, which is only 26 days, which is five days shorter than I think it was last year. So that's going to possibly put some pressure on the amount of sales that happened in the holiday season. And the other thing that we're in this election cycle that a lot of ads that retailers would normally put on TV are getting squeezed out because of the flood of campaign ads. So again, everything that Ralph said is around the health of the consumer remains stable, but I think these are some other things that will affect industry-wide retail sales.

Okay, that's very helpful. I was considering the day count as well, so I appreciate all that detail. For Perry, thank you for the guidance on the losses and the impact of the hurricanes. I was wondering if you could clarify that further. Previously, we expected fourth quarter charge-off rates to be at 8.3%, so a $10 million benefit would represent a decline of 20 basis points. However, the first quarter has a higher charge-off rate, and you also mentioned the second quarter. Could you provide more precise numbers on how to compare the fourth quarter with your previous guidance and how to view the first quarter rolling into the second quarter? That would be very helpful. Thank you.

Yes. I think the way you just characterized it, it is right. I mean we're expecting a seasonal increase in 4Q to low 8% range and that the fourth quarter will see that $10 million now benefit from the actions that we took to support the customers in the hurricane-impacted zones. But that's not sizable enough to impact our full year guidance. I think you've quantified it in the range of what I would have expected. And then going to first quarter, we did comment that there typically are seasonal increases when you go from fourth quarter to first quarter, and the reason why we thought that was important in the past to make sure we reminded people of that. We actually saw a number of models that had losses going down in the first quarter and didn't want people to be surprised when it actually does follow some seasonal trends. Now, there's lots of credit actions out there. We're taking – doing things that will hopefully mute some of what maybe historical rise has been, but there is going to be an expected increase. And then things should then follow some seasonality from there as well as then it's macro and credit action-dependent upon how much it can improve beyond that point, adjusted beyond – for that then the $10 million hitting into the second quarter. But take that aside, that's the best I can give you at this point. We'll obviously put a finer point on that as we get closer to it and we give you the January guidance in January.

Okay. That’s very helpful. Thanks so much.

Thank you. Our next question comes from Jeff Adelson with Morgan Stanley. Your line is open.

Hey good morning, Perry and Ralph. Perry, you talked about the persistent impact of higher prices and you now have real wage growth here. But you've highlighted that dynamic as part of a reason why your late-stage roll rates have been more elevated. I was wondering if you could just maybe give us a quick update on how the late-stage dynamic has been evolving. And I guess as we think about the rest of 2025, should the seasonality cadence for charge-offs be similar to delinquencies? Or is there any sort of dynamic in the roll rates that might be impacting that seasonality?

Yes. So, great question. Let me give you a little bit on the thought on the economy because I think this is an important point as we have seen some stable signs and stable economy with some signs of improvement. So, you would expect that to start to assist some of the roll rates and delinquency, like we're seeing improvements in early-stage delinquency. If things play out better, then that should improve. But it is too early to declare victory right now in the economy and inflation. I think that's something the Fed acknowledged themselves. So, we still see areas of concern regarding the consumer and the economy overall. Inflation still remains above the Fed 2% target, and it's especially true for stickier categories like shelter, medical and insurance, all still above 4%. And so that still concerns us with the, I'll say, the general consumer. And this has been a problem. If you think about small business sentiment, they're pessimistic about the future, which means it brings to question their ability to grow, invest and hire, and that can affect employment down the road. Household debt is still very high, well above pre-COVID levels. And you think about what higher rates have done to mortgages, auto loans, credit card, personal loans, all that's eroded spending power, and that's increasing their monthly cost. So what this has done is creating an affordability gap. If you think about who we serve, it's lower middle-income Americans. So while the top, I'll say, 20% to 30% of Americans, the higher inflation in this environment is, I'll say, a nuisance, but these people are still driving the broader economy, and they're not showing a lot of signs of stress; there’s sure some delinquencies creeping up the prime ladder when you look at other issuers. But it doesn't tell the issue for two-thirds of Americans who are still struggling to balance their budget. But all that said, those are our concerns. But we are seeing those encouraging signs that more positive trends could materialize, right? And that's the piece of this where we're encouraged that, okay, this quarter, wage growth did outpace inflation. That should start to help the two-thirds of the customers that we talk about who have been, say, struggling the most with this. And so inflation is moving towards the Fed's 2% target, and that obviously resulted in a 50 basis point cut. People are expecting some more cuts throughout the end of this year into next year. That should be good for employment, again, employment, labor unemployment. So everything is trending well, and it's definitely showing its signs. But the bottom line is the cumulative impact of what has happened over the past three years and the economy has not proven sufficient yet for many of our customers to fully, I'll say, adjust to this higher bit of inflation. So any amount of unemployment tickups and a re-pickup in inflation for some reason, depends on what happens with the elected administration, it could create some strain. So we're, I'll say, cautiously optimistic for 2025 and really encouraged that the debate and sentiment with economists and others have gone from, is it going to be a recession or a soft landing, it's really shifted to a soft landing or no landing. And if that's the case, that should bode well for our consumers and start to help with those back-end roll rates. And that's really what we're looking for. The front end looks good. It's the back end we want to see some relief into.

Okay. And as my follow-up, as we think about the forward curve here, your asset sensitivity, how should we also quantify the impact to your gross card yields from what could be a higher level of charge-offs into 2025? And when do you think those reversals could start to be a good guide?

Well, while I'm not providing guidance for 2025, if the loss rate decreases next year, that should positively influence our net interest margin. Additionally, if interest rates continue to decline, meaning the Fed cuts, and since we are somewhat asset sensitive, this may reduce the benefits from lower gross losses.

Thank you. Our next question comes from Bill Carcache with Wolfe Research Securities. Your line is open.

Thank you. Good morning, Ralph and Perry. I wanted to start off with a high-level question. When we look across the broader universe of companies extending consumer credit, you guys have relatively higher exposure to customers with lower credit scores than many as you've described. But you don't seem to be experiencing the same credit headwinds. Could you discuss why you think that is, particularly since all lenders are essentially sharing the same population of customers?

Yes. I think it's a combination of things. One, we saw the strain early. When you think about the K economy, we've talked about in the past, that's one reason. So yes, we have a shared universe of customers, but when we tilt a little higher risk our customers felt that risk earlier. They used up their pandemic level savings faster. And at the same time, I'll say two other big reasons is, we understood what a period of elevated inflation was going to mean to our customers. We took credit actions early, and we've continued to take actions through – from the time we sensed this was going to happen a couple of years ago. And at the same time, through those credit actions, and you know the narrative from other issuers, we didn't expand our buy box. You have not heard us talk about the 2022 vintage and 2023 vintage. It's seasoning. They're larger vintages than they should have been, and now we're feeling the pain from that. So I think that's some of the reasons when you go look at loss rate changes year-over-year, ours is on the low end of that compared to many other peers. And that's a credit to our credit risk team and the disciplined management that we have in place.

Thank you, Perry. I'd like to follow up on credit. You've indicated that you anticipate your loss rates to gradually align with your longer-term targets. Can you clarify how we should consider the dynamics of frequency and severity moving forward? You mentioned these aspects earlier, but in the context of a potential soft landing for the economy, should we expect some improvement in cure rates as we approach 2025, which would contribute to the later stages of delinquency improvement and ultimately lower loss rates? Would this also support the possibility of a lower reserve rate by 2025?

I believe everything you've mentioned is reasonable. It's all dependent on macroeconomic factors. We are indeed taking credit actions and improving our credit risk mix, but much of the improvement will rely on the consumer's financial health. Are consumers experiencing wage growth that outpaces inflation? That will be crucial. I don’t have much confidence based on current policies from either party regarding potential inflation outcomes and whether it will decrease or rise again. I am cautious, but your argument is sound that if conditions remain stable and continue to improve, I anticipate a modest improvement in back-end roll rates throughout the year. I don’t foresee any sudden negative events, and as I mentioned earlier, a quick fix isn't likely. I want to remain cautiously optimistic. Also, if you'd like me to address the reserve rate, I can do that, as you seem to be looking to connect it to potential loss rates. The reserve rate is currently at 12.2%, which is consistent with where we've been over the last seven quarters. I expect the reserve rate to stay around this level until there is clear evidence of continued credit quality improvement, meaning we want to see fewer back-end roll rates over time and a better economic outlook in both baseline and stress scenarios. At this point, I'm confident in the guidance for the fourth quarter, expecting the reserve rate to slightly decrease or remain flat, which will largely depend on changes in those baseline and stress scenarios we are evaluating. We'll have to see how things unfold. As we gain more confidence in a softer landing scenario in the upcoming quarters, I expect we can adjust our CECL models to reflect a less adverse posture, which would allow the reserve rate to decline. We will keep an eye on that. So far, the scenarios haven't changed much since June of this year. It's crucial to monitor those outlooks in the fourth quarter over the next 60 to 90 days. I want to clarify that the fourth quarter of this year will see a decrease compared to last year, so seasonally, it will go down, then typically rise again in the first quarter.

Understood. That’s very clear. Thank you for taking my questions.

Thank you. Our next question comes from David Rochester with Compass Point Research & Trading. Your line is open.

Hey good morning guys.

Good morning.

On expenses, you mentioned those would be higher in 4Q. And when I look at the expense guide, it seems to imply a pretty sizable step up quarter-over-quarter just to get to the more favorable end of that guidance range. Can you just possibly narrow down that range of an increase you're expecting in the fourth quarter? And I guess that's all coming from higher marketing and sales volume pickup. Is that right?

Yes, that is correct. I mean you go back and look at the past couple of years, and you'll see the step-up from third quarter to fourth quarter, and that's probably your best guide in terms of what to expect in the fourth quarter of this year.

Okay. And on the margin, I appreciate all the comments you made on all the forces that work there in the fourth quarter, the supports and the pressures. Is the net of all that still a net negative? And are you still expecting margin pressure? Or could the mitigants rolling in be enough to drive some stability there or maybe even some upside in the fourth quarter? Thanks.

Yes, I wouldn't say upside in the fourth quarter. I think there's a lot of moving parts. And some of it is, I'll say, yet to be seen. Some of it is the consumer behavior in the quarter, what does, I'll say, loan growth look like with transactors. We've got Fed cuts that are still going to possibly come through. So, there's just a lot of variables. But the reason why we wanted to share the commentary we did is that typically, you see a seasonal decrease in net interest margin of, I'll say, a substantial amount. Here, we're saying that our mitigation actions that we put in place to offset some of the CFPB late fee rule is going to mute some of that.

Okay. So, definitely no expansion, but potentially not much in the way of compression?

Not as much, correct.

Thank you. Our next question comes from John Pancari with Evercore ISI. Your line is open.

Morning. Perry, you had indicated that you expect the loss trajectory to again reflect more of your normal seasonality here. How would you define that normal seasonality? And specifically, when we look at first quarter 2025, I believe you're looking at it maybe your historical seasonal increase may have been around 70 basis points. So could that put your first quarter 2025 loss rate above 9%?

So what I had suggested was that you guys look at the seasonal movement. I'm not giving specific guidance on this, but it was just that, as I mentioned earlier, analysts had reflected a decrease. So the exact opposite of what seasonal movement would naturally do. So again, I'd say we're taking great credit actions. The team is doing a terrific job with collections. It's just whether we're hoping to do better than normal seasonal movement, I just wanted to be sure that there's a recognition that there is seasonal movement. And it will be macro dependent and collection effectiveness dependent and the like.

Thank you. Our next question comes from Reggie Smith with JPM. Your line is open.

Hey, guys. Thanks for taking the question. It's probably a really easy answer to this, but could you remind us of the calculus you guys did internally when deciding to redeem those converts which have a fairly low coupon rate and how you thought about that versus paying down more expensive debt or you want to buy back stock? And then I have a few follow-ups.

Reg, I had a bit of difficulty hearing you, but I believe you were asking about the reasoning behind our decision to repurchase some of the convertible debt compared to other options. Is that correct? Yes. When we took on the convertible debt nearly 18 months ago, it was a necessary step at that time. We have since developed a plan to reduce our parent debt and enhance our capital structure, and we've made significant progress since last year. Our team has focused on strengthening the balance sheet, which led to our first rating in November 2023. Following that, we seized the opportunity to issue a $600 million senior unsecured notes offering in December 2023, which increased to $900 million in January. We also paid down over $500 million of parent debt during that time, and we added another $100 million in the first quarter. This commitment has paid off, allowing us to eliminate the company’s bank term loan. The recent repurchase of $262 million of our convertible debt is a continuation of our strategy to improve our parent level debt situation. As we noted, our double leverage ratio has decreased to 103%, down from 184% at the end of 2022. We view this as a positive step. We shared our numbers during Investor Day and our belief in the potential for tangible book value growth in the coming years. This action allows us to further reduce our leverage, which aligns with our capital priorities, and mitigates future dilution risks associated with convertibles as we anticipate our share price rising significantly. At Investor Day, we indicated that we think our shares deserve to trade at a multiple of tangible book value. As you've seen, we've moved from trading at a huge discount to nearing tangible book value just in the past year. As the macroeconomic environment improves and we show our ability to navigate challenges successfully, we expect our share price to continue to rise alongside our responsible growth and return goals. If we were to wait longer to repurchase the convertible, it could become quite costly. Therefore, we seized the opportunity to reduce leverage and eliminated what I would call future price risk by acting sooner.

I understand. Regarding the mitigation strategies, I believe the APR increases apply only to new purchases. I'm curious about the mechanics; when customers pay down their balances, does it mean that those higher APR balances are paid off first? That's the first part of my question. The second part is about the impact in the fourth quarter; can we assume that most of the benefit will come from the statement fees? If there’s any information you can share about the potential range of those fees, that would be appreciated. Thank you.

You bet. You are correct. CARD Act has prevailing rules around payment allocation. And typically, it is anything above min pay has to go against the highest APR balance first, which is why it takes so long for the higher APRs to have an effect. Now that said, every new account booked throughout the year or from whatever point you have those rates in market are 100% at the higher rate. So that also helps to build as the new vintages come on each quarter, that will continue to be a building benefit. Specific to fourth quarter, because the balance has been building with some of the higher rates and some of the new accounts coming on with some of the waves of APR increases that went out in the second quarter, you start to see that benefit really come through a bit more in the fourth quarter. Specific to statement fees, that would not affect net interest margin. That would be in non-interest income.

Thank you. Our next question comes from Jon Arfstrom with RBC Capital Markets. Your line is open.

Hey. Thanks. Good morning.

Good morning.

Just, yeah, I want to get out of the P&L for a second here. And in your guidance, you talked about visibility into your pipelines. Can you talk a little bit about what you're seeing in the pipelines? And then Ralph, you've been pretty quiet. Perry has been kind of beat up, but can you maybe talk about new business activity, new business win potential for the company and what you're seeing right now?

Our pipeline has always been strong, and it continues to be robust. We recently announced a couple of exciting developments, including our partnership with Saks and the launch of a new program with Hard Rock. Overall, our portfolio looks solid, with 90% of our accounts secure through the end of 2025 and 80% extending into 2026. Most of our top ten programs are set to remain stable through the end of the decade, which gives us a lot of confidence. I appreciate the potential of new opportunities like Hard Rock and the ability to compete for high-quality portfolios such as Saks. Our business development team deserves credit for their excellent reputation and respect in the industry. We are strategically focusing our product offerings across co-brand, private label, and various market segments. We are no longer reliant on any single sector, be it mall-based or soft goods. Our diversified portfolio and product range position us well for future success.

Okay. Thank you. That's all I have.

Thank you. There are no further questions at this time. I'll now pass it back to Ralph Andretta for closing comments.

Well, listen, thank you all for joining the call today and your continued interest in Bread Financial. And we look forward to speaking with you on the next quarter. So everybody, have a terrific day. And thanks again for your time.

This concludes the program. You may now disconnect. Good day.