With Perry Beberman, the CFO of Bread Financial. Perry has over 30 years of experience. Most of that time has been spent at Bank of America and MBNA before Bread . Great to be sitting down with you, Perry.
Good to sit down with you.
Maybe, you can start off by telling us a little bit about what you're seeing in the quarter in the aftermath of what's happened with SVB. Do you have any financial outlook updates that you'd like to share with us?
Sure. The first quarter for us at Bread Financial has a few moving parts in it. First, in the quarter, everyone's aware that we have sold the BJ's portfolio, and that's called, you know, nearly $2.5 billion. That comes out of the portfolio in the first quarter. You'll start to see that impact spend and things of that nature in the future. Even with that, you know, I think we're seeing the trends of decelerating consumer spend, which is expected in this period of high inflation. Associated with the conversion, you'll see a gain on sale that we've disclosed in our 10-K, over $200 million. That'll go straight to the bottom line to retained earnings to improve our capital ratios.
You'll also have that there'll be a net provision release. I say net because also as I've signaled before, expect in the first quarter that we'll be increasing our reserve rate, which is really driven by two factors. One is seasonality, and two is the BJ's portfolio going out that had a lower reserve rate. Then, you know, throughout the year, we'll just continue to monitor the economic conditions to see if we need to increase a little further or not. Then as it relates to the lost dollars in the quarter, we are impacted in the month of February, and that came out this morning. We had told everyone that you should expect over 100 basis points of impact from the conversion-related issues from when we had taken customer-friendly accommodations back in July.
Now, you know, so we had suppressed loss rates in July, and now it's elevated in the month of February. That was about 100 basis points for that. Then, so I'd expect in March, it comes back down to more of what we would expect to see. Then we'll see further impacts of transition accommodations hitting in the second quarter with a peak rate over 8% in the month of May. Then as we look at the other thing I'd comment is expenses, just making sure if people are looking at this, that we expect expenses to be roughly flat to the fourth quarter in the first quarter, and then start to come down after that. Hold on, one second.
Are we good? I'll try to give the short, the shortcut, the short version again. Key points for the quarter, expenses flat to the fourth quarter. Expected the loss rate to be a little elevated in this quarter due to the transition impacts from the conversion impacting the month of February, coming back down in March, elevated again in the second quarter with the peak rate of over 8% likely in the month of May, but the other two shoulder months also being a little elevated from customer friendly accommodations.
Okay. All right. Helpful. If we kind of stick at an industry level, can you talk about how you'd characterize the health of the private label card to card industry today? How has it changed since the pandemic and some of the more, most recent events?
Yeah. I, you know, as it relates to private label, it's something that, you know, I was not as familiar with, you know, before coming to Bread Financial as obviously I've become much more so. Really what I've come to appreciate about it is the stickiness of the relationships and the consumers. While sure, you know, you had a period of time where you introduce a little bit of the retailer risk in terms of, you know, are they viable, will they remain in business? Largely, you know, mall-based retailers have moved to omni-channel where, you know, they're taking on digital sales and the like. What you're able to do a lot of these private label partners is morph them into co-brand partners.
You have the private label that really cares for the customer, I'll say, on the lower end of the credit spectrum, and they can graduate them up to the co-brand product where you then capture more of their general purpose spend. You know, overall, I've been real pleased with that. You know, the growth in that is, will remain important to Bread Financial, but also diversification into more of the co-brand aspects of those relationships and other relationships like NFL, and AAA and partners like that to continue to diversify.
Okay. If we can stick with one more macro question here before digging into some more company specific questions. Can you talk a little bit about what your house view is on whether the Fed's gonna ultimately need to drive unemployment higher to temper inflation and how that's filtering through the management of credit and everything else, underwriting, et cetera?
Yeah. There's a lot in there, obviously, macro and a ton of opinions. And I think as any of you who followed my comments for the past year, I thought the economists were getting it wrong in terms of their expectations of inflation, what the Fed increases were going to look like. You know, this inflationary environment is challenging all of Middle America, right? You think about the, they call it the K-shaped economy, where the people at the high end are all tackling, you know, higher food costs, you know, up over 10%, energy costs, meaning their utility bills are up. Okay. For the middle Americans, that's challenging. If it's another $100 a month or whatever it is, they're making trade-offs and choices.
You're starting to see that come through in their payment patterns and how it's impacting their ability to pay. Leverage is coming back up, and you're starting to see a rise in delinquencies. That is not surprising to me. Just talk about what does it mean for later in the year. You know, again, I like to be optimistic and think that inflation will taper down. I'm becoming, I'd say, a little less optimistic at the pace it may come down. I think it's gonna... There's a lot of macro considerations out there that are kinda working against it, meaning the consumer is so healthy, the jobs are still out there, you know, wages are going up. Then businesses are passing those higher prices, higher wages on to consumers and their price of goods, and consumers are paying for it.
There's really not a pull-down in prices yet. I think we're still a little ways off before the Fed accomplishes their goal. I don't see a path where at this point that it can be avoided where unemployment won't increase to some extent. My base case, and that we're operating on at Bread is, you know, hitting probably mid to high 4% unemployment rate probably by the end of the year. While I don't think that's gonna impact losses this year, I think it's gonna more so be a leading indicator for losses next year. For us, what that would mean is think about inflation as what's driving our losses above or through the cycle 6% target this year. That is gonna get replaced.
As inflation comes under control, the portfolio's gonna cure a bit on that front, but then, you know, that unemployment element will replace that to keep losses perhaps a little higher. You know, we'll know more obviously as the year goes on, but that's just forward-looking. I expect probably the rate increases to continue throughout this year and then hold steady probably midway through next year before they start to come down. Again, I don't have a crystal ball. I wish I did. You know, again, if we were having this conversation a week ago, I don't think we'd probably be talking about the SVB stuff and what that's meant to the deposit markets and everything else. I mean, the world changes pretty quick sometimes.
That's for sure. Maybe if we could dig a little bit more into the credit theme. Some issuers are still saying they expect their delinquencies to flatten out and get back to 2019 levels while you have others, including Bread, that have seen delinquencies now surpass 2019 levels. Could you parse out for us how much of the increase we've seen so far has been a function of just normalization versus that stress that is being caused by inflation?
Yeah. Sure. Going back to the K-shaped economy theory, right? You've got super prime customers, high prime customers that are still normalizing back to their pre-pandemic levels of borrowing. That means their ability to pay has remained very strong. There's still additional savings from the stimulus that is sitting in their bank accounts at the high end of the credit spectrum. You know, middle America to the moderate-income folks like I talked about earlier are already seeing, you know, the bottom part of the K are feeling that strain. You know, as it relates to credit, yes, some of the, I'll call it the Big Four who try not to have their loss rates breach 3% are still normalizing back to those pre-pandemic levels, and maybe they'll level out, presuming unemployment remains moderate.
Again, inflation's not impacting that population that much. For the rest of America, inflation is the primary driver of what's causing that strain, which is why we're above our 6% through the cycle expectation in a period of low unemployment. It's because of inflation. That is the number one concern of the Fed, is getting inflation under control because of regressive tax on all Americans. It impacts the more moderate-income Americans far more than it does, you know, the more affluent.
Are you seeing any notable differences between early and late-stage delinquencies? Once customers that do enter late stage are maybe a color on cure rates?
You know, I say unfortunate for us is we had this confluence of a couple things happening at once, and we had our conversion actions that we took to consumer accommodations that were throughout the second half of last year, putting noise into our numbers this year. That is affecting, like when I talk about second quarter losses being higher because of the actions that were taken in the fourth quarter, it means the late stages are a little elevated because they're gonna be coming, the losses are becoming due in a few months. Right now we're seeing good signs in early-stage delinquency coming down.
Okay. You've talked about how your portfolio today is about 50% co-brand. Does this increase your risk exposure in a downturn versus traditionally pure private label credit cards, which have historically been viewed as, you know, being sort of beneficial in a downturn because there's more limited utility versus general purpose cards?
That's a fair question. I mean, I think about it as, you know, you're talking about diversifying risk. When you think about product diversification, spend diversification, merchant partner diversification, what you try to do is not be over-concentrated in any particular place. I think for us, the diversification into more general purpose spend has actually been beneficial because as people start to pull back on soft goods like clothing, because they're buying, you know, they have to get gas that's higher or food that's higher. Being able to capture some of that general purpose spend has been good for the business overall.
If we move to seasoning, some issuers have said that they're not seeing significant seasoning effects because their origination growth has been pretty stable. You have others that are seeing more pronounced growth and more pronounced seasoning effects because they've added a lot of new accounts. Can you talk about how seasoning is impacting Bread?
Yeah. I get that there's mixed commentary, and it will vary by business, by product that they're in and who they serve. As you think about the season and dynamic, you're really talking about month on book and when do they hit their peak losses. For the more affluent customer or prime customers, you're probably looking at month 24 or so when they hit their peak losses. When you start wedging in these large vintages, yeah, they're gonna start to season and stack it so you get the delayed effect of the seasoning. When you look at our client base, we typically hit that peak loss rate in month on book 12. We have less of that seasoning effect because we're always a lot closer to the peak rate of a particular vintage than other issuers.
It really depends on who they're serving and you know, who they're bringing into their portfolio.
Maybe if you could take us inside the business from a risk management perspective and give us a little bit more color on whether you look at the performance of customers who have multiple accounts across your different partners. For example, would a customer facing stress at retail partner A inform how you think about the credit that you're extending to them at retail partner B?
100%, yes. When you think about credit management and risk management, that is one of the key things you look at. You look at the on-us behavior and not just within the one card, but you're looking at the total customer and what that means. If you see stress on one of the accounts, and you take a credit action to, you call it risk detection, where you may restrict line increases or access, you do that across the entirety of the customer. Similarly, you're also looking at off-us behaviors, so constantly looking at the different bureau attributes, change in leverage, ability to pay, and you try to consume as much information as you can real-time, and you're making decisions in customer cohorts to actively manage credit. It's living, breathing. Even in good times, you're doing that.
Certainly in times like this, you know, all the monitoring controls are in place. You know, we've pulled back on our, on our growth targets for this year to be mid-single digits versus where we had been in tandem with consumers reducing their spend. We're not leaning in as much on, you know, growing lines and doing more line, you know, risk detection and being a little tighter with, you know, the buy box as appropriate. As you expect through a period like this, risk scores are going to start to migrate down. You need to be able to look around the corner and anticipate that.
Okay. One more on credit. Of course, no discussion on credit would be complete without talking about CECL. maybe from where we sit, there's this interesting bull-bear debate among investors around CECL. On one side, there's a group that thinks CECL's done its job because reserves already contemplate elevated levels of unemployment. That suggests that there isn't gonna be a need for as much reserve building from here. On the other side, you've got a group that argues it's crazy to think we're not gonna see additional reserve building in a scenario where unemployment goes to 5%. Can you talk about how you'd respond to both of those views?
I think there's certainly philosophical approaches to CECL. Look, none of these models are perfect, and there's always a degree of judgmental overlays and risk overlays that you take based on what you believe your outlook is for the economy. You know, you and I have been connecting now for a bit, and you know I lean in a little bit more on the conservative side, you know, 'cause these loss models, these CECL models are all built and conditioned on historical change in unemployment and those cycles. None of these models are built on periods of elevated inflation. For me, took the approach, look, I'm gonna lean in a little bit on the S3, S4 scenarios that had unemployment, you know, nearly approaching 8% in pretty short order.
Weighted those a little more heavily because the models didn't care for this inflationary period. There's no scenario, I believe, we get to 8% unemployment in a 12-month period. You know, that aside, you still lean in. Where others may be taking the approach, "Oh, I don't view those as highly probable at all," but they're not caring for inflation because their consumers aren't as impacted by inflation. Again, it goes back to their portfolio, it goes back to their philosophy, and some may be fine chasing, you know, that rate up as unemployment goes up. Again, it is different philosophies across the different firms. I think we all try to take a prudent approach.
Whether you're more a risk-taker or more conservative, you'll, you end up somewhere on the different spectrum. I do think we're in a better position with CECL, although I think I struggle with it because when you're trying to make investment decisions, you're better off doing it on a cash flow basis or, you know, an NPV type thing, not really factoring in CECL. I can tell you, our board members and others who are not as accustomed to it, that growth tax is tough. You know, we think more sophisticated investors see right through that 'cause you're taking all the future losses that you expect could possibly happen on day one, but you're not discounting and bringing forward all the future revenues.
You know, in the past, what would happen is losses would go up 100 or 200 basis points. You compound that with having to increase the reserve at the exact same time for that. Today with CECL, you can get ahead of it a little bit by leaning on the risk factor. As losses rise now throughout, if they were to go up further from here, the CECL rate doesn't necessarily have to move. Then it'll obviously get released as, you know, hopefully, I'm wrong.
If we move on past credit, I wanted to ask a couple questions on the CFPB late fee proposal. Before we do that, I wanted to also ask others, we'll leave a few minutes at the end if you all have any questions you'd like to jump in with please.
You got a lot of four-letter acronyms you wanna talk about. CECL, CFPB.
That's right. Maybe, you know, if we can sort of set aside the deterrence aspect of it, and maybe could you talk a little bit about how the $8 late fee cap that the CFPB is proposing compares to what you would view as the actual incremental cost of collecting on past due accounts? Is there room for that to potentially move higher? Then maybe I'll just rope in the other question here. Could you talk a little bit about any projections you have in terms of timing or potential delays around the proposal?
Yeah, I think... Look, they obviously had data and analysis they got from the big issuers on what appears to be a variable cost to collect. You know, I think about when I started in this space back in the late 80s, people using dialers and Rolodexes, and the cost to collect was pretty high. It was also unsophisticated. Today, I think cost to collect has become more efficient through the analytics and tools that are available to make sure you're optimizing your collection efforts. The cost to collect is just one aspect of the cost to lend and the cost of credit. I think that's the part that they're perhaps missing, is that's a key component. Look, at the end of the day, investors are expecting us to get a return on capital and for the risk you're taking.
Ultimately, it has to come back through higher APRs or fees to the customer in order for us to continue to underwrite those customers. You know, where this ultimately lands, not sure. I do expect that this to be a little bit of a protracted comment period in terms of how they absorb the information. You know, from what I can tell, they don't seem to wanna listen very well, so it'll obviously get taken up in court. Your guess on how that turns out is probably as good as mine. All I can say is from inside Bread Financial, getting a playbook together, making sure we understand by partner, by customer, by risk band, what actions have to be taken to fully recoup the impact of whatever the late fees end up being.
I think about that as higher APRs, probably across the board. It may vary the degree to which it goes up by risk score, introducing perhaps maintenance fees or whatever you want to call them for like the way it was in the early '90s for a lot of accounts, had annual fees. You could end up having to restructure some partner share agreements if they want us to continue to underwrite those certain accounts and ultimately, you know, reducing the number of accounts that you underwrite, where you no longer hurdle and get the return that you're expecting. It will limit access to credit for certain customers.
Maybe if we can kind of link in some of the dynamics there with economic sharing, that comes up frequently in discussions with investors. Can you maybe remind us how common economic sharing arrangements are across your retail partners? Potentially, you know, if that's something that's started to factor into your discussions yet, given like what's happening with the CFPB, or is it still too early for that?
Yeah. For as long as I've been doing this, every contract looks different. It is rare. I mean, for real small deals, you might have more of a standard cookie cutter type deal, but largely, you have deals that have no revenue share, except to the extent they get paid for every new account that gets opened, they get a bounty, and then they get a royalty, you know, on basis points for every dollar spent on the card. It could be each year if the, if the account's still open, you know, they may get another bounty for that. That would be there's no profit share. Others have, you know, we get a certain ROA, they get a share then above our threshold ROA, where they would be very exposed to this. Others have a hybrid of all.
It's hard to quantify. You know, 95% of our contracts allow for us under regulatory change to go in, redo pricing, reopen discussions. You know, what I tell you is these are partnership agreements, and the objective is not for our partner to take it on the chin because of regulatory change. Our goal is to keep them whole and keep ourselves whole. The consumer's paying for this today, the consumer needs to be paying for this tomorrow. If the CFPB's objective was to spread out the late fees among a broader set of customers or through APRs and other fees, that's the what will happen
There's a view that you don't share the cost of higher credit losses across your partnerships, but instead bear the full consequences of credit, whether that's good or bad. Can you speak to that? At a high level, I understand every agreement's different broadly.
Yeah. That is. It goes back to it varies by contract. Some contracts are more exposed to changes in credit losses, others are not so much so. You know, I think when partners have gone through periods of economic stress, they realize pretty quick that, Hey, you know what? I wanna be in the business of selling product. You be in the business of underwriting and taking on the credit risk.
Make sure you get paid for that, but that's, you know, that's our job, and then their job is to market and develop loyalty programs that resonate with their customers. You know, I think it'll be interesting to see the other side of this, and what retail partners want in terms of contracts. You know, when you go through a period of economic stress, and they realize their revenues get suppressed, just economics alone. I mean, with the macro conditions of credit losses, and then you take into something like the CFPB, you may be looking at a different style of contract going forward.
Understood. Maybe last one here on economic sharing. You guys have talked about having late fee exposure that's sort of in the same ballpark as Synchrony. They emphasize this, you know, RSA benefit that, you know, as an offset in a downturn, including the benefit that the RSA would provide if the profitability of the programs were reduced due to lower late fees. Some investors have concluded your exposure is likely greater than Synchrony's. Is that a fair characterization? Maybe could you speak to that?
I have my IR guy here right in front who likes to say that, you know, our you know, we think about late fees for us, you know, you take Synchrony plus because we're more of a full spectrum lender. On that front, that comment I'd say is probably not wrong in that, again, I don't know their book that well, but with the fact that we don't have as much discrete sharing, yes, they have an innate hedge in there.
What I can assure you is that in the name of a partnership, they're not looking for their partner to have reduced revenues as a result of this action. Their partner is gonna be looking for them, and like our partners look to us, is to make sure they stay whole. It sounds good in theory, but if that's the case, the partner's not gonna be very happy, and, you know, Bread Financial will be very happy to help work with them in the future.
We could switch gears to some questions on capital and corporate structure. You've talked about managing Bread as if it were a bank holding company. Internally, maybe could you talk a little bit about how you whether you think about capital at the enterprise level? You know, a lot of issuers will have CET1 targets in the neighborhood of 11%, give or take. Do you look at CET1 at the enterprise level? Maybe more broadly, do you view CET1 as your binding constraint?
Real good question. We are maturing our capital management policy practice and everything else goes in between at Bread. When I joined, there was no enterprise capital policy. There was no capital planning. The banks had, you know, more rigor around it, what they had to do because they were regulated by the FDIC. As a commercial holding company, that didn't exist. What we're putting in place, we've introduced and had approved by our board our capital policy, and with that comes a capital plan. Like you asked about, you know, with all the ratios you would expect. You know, I expect our binding constraint to probably be total capital in the near term. Getting our capital levels up to an appropriate amount.
You know, we put out there a marker of getting to a minimum of 9% TCE to TA was the rudimentary target we put out there. I think when I started, we were closer to 2%. At the end of this quarter, with the gain on sale, some provision release, lower assets, you know, I expect that, you know, we'll be back above the over 8% we were at the end of the third quarter. We dropped in the fourth quarter to seasonal growth and AAA and the big provision build we had to have. We should be, you know, north of the target that we had set. At that point, Like I said, we are maturing this.
We're setting internal operating targets to get more in line with peer levels for the risk we have, the stress models we're putting in place. Again, when it comes to capital priorities, we haven't changed from what we've said. You know, we wanna make sure we have capital to support the responsible growth. That means profitable growth, not growth for anything. You see that to where we pull back on SplitPay. The economics weren't there, we pull back on it. You know, we wanna continue to grow responsibly over time. With that's the first priority. Second priority is paying down debt. You know, we are still working on that capital structure at the enterprise level. That's a piece of refinancing debt, paying it down, and then ultimately, you know, return to shareholder once we feel like we're in a strong position.
The buybacks would start then at that point once you've gotten the capital to the target levels, such as that?
Target levels and having cared for our parent debt.
Debt. Understood. Maybe switching gears, do you expect loan growth to continue to outpace spending growth as payment rates and revolve rates continue to normalize? Maybe if you could talk a little bit about how a recession would change that dynamic of that sort of normalization that we're seeing.
Yeah. You know, essentially, I haven't really thought about characterizing it that way. On a macro basis, you know, yeah, as spend per account, let's go with that, would come down. Their payment rate comes down because they're increasing their leverage, the balance increases. Balances are growing even though the rate of spend is coming down. Again, there's still spend growth in the account, but that's a part of it. For us as well, it's also are you putting on new brand partners? Are you putting on more direct, you know, direct-to-consumer brand products? That will vary by business. On a consumer basis, the answer is yes. I think what you're seeing is they're increasing their leverage in total, even while they're slowing their pace of spend growth.
There's still spend growth per customer.
Okay. That's helpful. We have about five minutes left. Are there any questions from the audience? Okay. We'll keep going. On funding, you've talked about direct to consumer deposit funding, having a target of 50% versus 26% today. Within that, can you parse out for us how you're thinking about the relative attractiveness of things like CDs versus other online savings and money market accounts that reprice lower more quickly in a down rate scenario to the extent that we go down that path? There's been a lot of focus also on exposure to uninsured deposits. If you could also speak to that, you know, and sort of in light of the SVB situation. You know, what's Bread's mix of uninsured deposits?
Yeah. We, our mix of insured deposits is well north of 80%. We don't have a lot of uninsured deposits in our direct consumer deposit business. It's something which we do view as a valuable way of funding the business, both in terms of remixing our current funding, but also funding growth that we're seeing. We're not afraid of being towards the, you know, the top of the rate table. It is still a very attractive cost of funds for us. As rates increase, our assets increase. As we've said, and I think for folks who wonder like, you know, how is Bread Financial impacted?
Could it be anything like one of these other firms? You could see it in our NIM expansion. We're, you know, we're slightly asset sensitive in that we've been seeing a slight bit of NIM accretion during periods of rising rates. It goes to show that as rates rise, you know, we're gonna, you know, the top line APRs on our assets are going up.
Okay. This was a bit of a conceptual question. You know, in the world before CECL, most issuers would base their allowance on expected next 12 months of charge-offs. Today in the post-CECL world, a lot of credit card issuers are talking about probability weighting different charge-offs scenarios to arrive at their allowance for lifetime losses as you are. You know, maybe could you talk a little bit from a forecasting perspective, what you would think some of the implications are of those two different approaches? This is sort of our first cycle going through CECL and maybe anything stand out to you from that.
Yeah. It kind of dovetails onto the comment I made earlier. The old approach was, let's just say if you had 3% losses in period, you would then take the next 12 months and assign the fact that what are your loans gonna look like, what's your growth, and make sure you have that same amount of coverage for the loans that you are gonna have in the future and today, but it's more an incurred rate basis. The way you look at it now is you're not just covering for the next 12 - 13, 14 months of coverage. You're covering for the entire life of the loan that's on the books today of losses that you might foresee, and you're then applying a risk overlay for different economic scenarios and doing some weighting in that.
Before, you would be catching up to the cycle because really, if losses went from 3% - 4%, okay, now I'm up 100 basis points in year, and now my reserve has to be at 4% of coverage, you know, for the next 12 months or however long your number of months coverage. It's just a different dynamic. That one you're chasing it, and then you can't bring down your reserve rate under the old method until you see lower incurred losses. Here, it's about, you know, you can stabilize the reserve rate as losses grow into it because if your outlook then is like, "Hey, it's peaked," you expect it to come down, then you can actually start to reduce your reserve rate and reduce those risk overlay.
it's just a, it's a different way of modeling it, but this is definitely a far more, CECL's a far more conservative approach. it goes to loss absorption capacity. Loss absorption under the old way, was far narrower than what it is today. Today, take us as an example. You use a round number, say 9%, you know, capital rate plus, you know, over 11% CECL rate. That's 20% of total loss absorption capacity. That's pretty sizable. That's the idea, though. You're trying to build a fortress balance sheet.
That's very helpful. I think that leaves us out of time. Perry, thank you for joining us. Really appreciate it.
Thank you.