BFH - NYSE

Good morning, and welcome to Bread Financial's Third Quarter Earnings Conference Call. My name is Bruno 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 open for your questions. [Operator Instructions] It is now my pleasure to introduce Mr. Brian Vereb. Head of Investor Relations at Bread financial. The floor is yours.

Thank you, Bruno. 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, some of the responses to your questions may contain forward-looking statements. These statements are based on management's current expectations and assumptions and are subject to the risks and uncertainties described in the company's earnings release and other filings with the SEC. Also on today's call, our speakers will reference certain non-GAAP financial measures, which we believe will provide useful information for investors. Reconciliation of those measures to GAAP are included in our quarterly earnings materials posted on our Investor Relations website at breadfinancial.com With that, I would like to turn the call over to Ralph Andretta.

Thank you, Brian and good morning to everyone joining the call. Starting with Slide three. Bread Financials business model, which features and industry leading risk adjusted yield, conservative reserves, strong capital positioning is built to consistently performed well through the full cycle. Our third quarter results which include net income of $171 million and a 25% return on equity demonstrate our continued financial resilience despite losses above or through the cycle average in this current more challenging macroeconomic environment. Funded by strong cash flows for operations we completed our authorized $35 million share repurchase in the quarter, which represented 935,000 shares. Additionally, we continue to deliver on our commitment to build long-term shareholder value as tangible book value per share exceeded $42 nearly triple the level compared to the fourth quarter of 2020, when I joined the company. During the quarter we launched Ross Dress for Less, the largest off price apparel and home furnishing chain in the U.S. Also at the beginning of October we successfully closed on Dell Technologies consumer credit portfolio, purchase of approximately $400 million and simultaneously launched the Dell program, which includes a broad suite of payment solutions and expands opposition in a consumer electronics market. Through our industry expertise, technology and data and analytic capabilities, we are well positioned to drive value for both our new and existing partners. The economic environment, remains challenging and consumers contend with numerous headwinds including the compounding effect of persistent inflation relative to wage growth, high interest rates, the resumption of student loan payments, and gas volatility. Broadly speaking, these factors are weighing on consumers and in part led to the reduction in our credit sales in the third quarter, particularly within our retail and home industry verticals. For moderate to low income Americans, who have depleted much of their excess pandemic era savings, we noted a reduction in travel and entertainment spending, as these consumers focus more on non-discretionary purchases. By contrast, higher income consumers have continued to spend on health, beauty and experiences. Prime and Super Prime cardholders remain resilient and are spending approximately the same amount as they did last year. However, as evidenced by many retailers updated financial outlooks, economic pressures are expected to continue to manifest in terms of softer sales in the fourth quarter. Given the ongoing macroeconomic stresses faced by many consumers, we have continued to responsibly tighten our underwriting and credit line management. We proactively manage our exposure by tightening approval rates, pausing, line increases, and implementing line decreases were prudent. While these adjustment limits sales and loan growth, we see these as the right actions to support improved credit performance over time, where we make focused on responsible growth and we'll continue to manage underwriting to meet our risk return thresholds. From a regulatory perspective, we are developing mitigation strategies in anticipation of the CFPB’s final rule on credit card late fees, which would have significant impact on our business if unmitigated, we actively engaged with our brand partners regarding possible outcomes and strategies. Having effectively managed through significant regulatory changes and vary credit cycles in the past, our seasoned leadership team is focused on addressing potential impacts to our business, and committed to generating strong returns through prudent capital risk management. Turning to Slide four, our key focus areas for 2023 remain unchanged. They are growing responsibly, strengthening our balance sheet, optimizing data and technology and strategically investing in our business. As I mentioned on the last slide, our management team is committed to driving responsible growth that will deliver long term shareholder value. We continue to expand and renew our partnerships with an emphasis on sustainable profitable growth. Strengthening our balance sheet remains a top priority and is integral to our long term strategy. Our ongoing disciplined balance sheet management actions enhance our financial resilience and provide additional flexibility for capital utilization, including supporting business growth, and further reducing debt. On the data and technology front, we are leveraging innovative capabilities gained from our platform conversion, system enhancements and expanded product portfolio. In addition, machine learning remains one of the many tools we have utilized for many years to bring stronger credit risk models to continually enhance our underwriting line management and collections. We continue to invest in a range of technology innovations from data and customer analytics, to self-service and digital capabilities. We strive to deliver exceptional value and experiences for our cardholders. Our goal is to continuously generate expense efficiencies that enable reinvestment in our business, support responsible growth and achieve our targeted returns. Moving to Slide five, 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. Co-brand spend now comprises approximately 50% of our credit sales enabling us to capture incremental sales as consumer spending patterns shift and responsible evolving economic conditions. Additionally, our broader product suite increased our total addressable market opportunity and diversifies our spend. We have generated significant growth in our direct-to-consumer deposits, which reached $6.1 billion in the third quarter. This additional source of funding has strengthened our balance sheet and enhanced our financial flexibility. We have also strengthened our balance sheet by reducing debt and building capital while maintaining conservative loan loss reserve of 12.3%, for the last three quarters. Our loan loss reserve rate is 300 basis points higher than our CECL day one rate in 2020. Our quarter end total absorption capacity, which we defined as our allowance for credit losses plus tier 1 capital divided by the total end of period loans was 24%, providing a strong margin of protection should more adverse economic conditions arise. We remain confident in our discipline credit risk management and our ability to drive sustainable value through the full economic cycle. We are committed to delivering responsible profitable growth, which may entail responsibly slowing growth during more uncertain economic periods. Turning to Slide six. Our disciplined capital allocation strategy, which focuses on profitable growth and proving capital metrics and reducing debt has driven substantial growth and tangible book value over the past several years. Looking at the first chart, you can see that since the quarter first quarter of 2020, we have more than tripled our TCE to TA ratio. Moving to the second chart, we are proud of the progress we have made with respect to debt reduction. And just over three years, we have reduced parent level debt by 55%, paying down more than $1.7 billion. We aim to further enhance our total company, our total company capital metrics. From where we are today, we will balance achieving these targets with continued investment in our business and growth aligned with our capital priorities. Before I turn it over to Perry, I will again highlight the improvement in our tangible book value per share, shown on the last graph, which has grown at 37% 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 meaningful improved financial resilience and a strengthened balance sheet should yield a company valuation that is multiple of tangible book value. Our significant accomplishments over the past three years demonstrate our focus and the success of managing our business responsibly to build long term value for our stakeholders. We remain confident in our strategic direction, and our commitment to drive long term value creation. Now I'll turn it over to Perry to discuss the financials for the quarter.

Thanks, Ralph. Slide seven provides our third quarter financial results. Bread Financials credit sales were down 13% year-over-year to $6.7 billion, reflecting the sale of the BJs Wholesale Club portfolio in late February 2023, strategic credit tightening and moderating consumer spending, partially offset by new partner growth. As Ralph highlighted, we have been proactive in tightening our credit, underwriting and credit line assignments for both new and existing customers, given the economic uncertainties and pressures affecting a portion of our customer base. Average loans were flat year over year driven by the addition new partners and a lower consumer payment rate offset by the sale of the BJs portfolio in February and softening credit sales. Revenue for the quarter was $1.0 billion up 5%, while total non-interest expenses increased 3% year-over-year, income from continuing operations was $173 million up 29% and diluted EPS from continuing operations was $3.46. Looking at financials in more detail, on Slide eight. Total net interest income was flat year-over-year. Total 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 expenses increased 3% from the third quarter of 2022, yet declined $28 million or 5% sequentially. The year-over-year increase was primarily an increase in card and processing costs, including fraud, and higher employee compensation and benefit costs. This was partially offset by reduction in marketing expenses and depreciation amortization costs. The sequential decline in expense has largely reflected lower fraud expenses, lower depreciation, amortization costs and our continued focus on driving efficiency through our prior and ongoing investment in technology. Additional details on expense drivers can be found in the appendix of the slide deck. Income from continuing operations was up $39 million for the quarter versus the third quarter of 2022, while pretax pre-provision earnings or PPNR grew for the 10th consecutive quarter, increasing by 7% year-over-year. Turning to Slide nine. Loan yields continue to increase, up 140 basis points year-over-year. Loan yields benefited from an upward trend in the prime rate, causing our variable price loans to move higher in tandem. Net interest margin was seasonally elevated in the third quarter at 20.6%. Looking at the sequential change from the second quarter, both loan yield and net interest margin benefited from a decrease in the reversal and interest in fees related to reduced sequential credit losses. Also, funding costs continue to rise and remain in line with our expectations. We would expect net interest margin to move lower sequentially in the fourth quarter following typical seasonality and due to an increase in the reversal of interest in fees related to expected in a sequential increase in gross losses. As you can see on the bottom right graph, we continue to improve our funding mix through our actions to grow our direct to consumer deposits, which increased to $6.1 billion in the third quarter. While we anticipate that direct-to-consumer deposits will continue to grow steadily, we will maintain the flexibility of our diversified funding sources, including secured and wholesale funding to efficiently fund our long-term growth objectives. Moving to credit on Slide 10. Our delinquency rate for the third quarter was 6.3%, up from second quarter as expected, driven by continued macroeconomic pressures. The net loss rate was 6.9% for the quarter compared to 5.0% in the third quarter of 2022 and 8.0% in the second quarter of 2023. The third quarter net loss rate was elevated compared to last year's level due to more challenging macroeconomic conditions, pressuring the consumer’s payment rate as well as actions taken to the transition of our credit card processing services in June of 2022. That benefited the loss rate in that quarter. The net loss rate declined sequentially from the second quarter as the final impact from the transition of our credit card processing services was reflected in our July credit metrics. The reserve rate remained flat sequentially at 12.3%. We intend to maintain a conservative weighting of economic scenarios in our credit reserve model in anticipation of ongoing macroeconomic challenges and the consequential impact on our future credit losses. As macroeconomic headwinds persisted during the quarter, our credit risk score distribution deteriorated slightly compared to the second quarter, driven by downward score migration from existing customers, despite new account risk scores by distribution being well above the portfolio blend. Even so, our percentage of card holders with a 660 plus credit score remained above pre pandemic levels, given our prudent credit, tightening actions and our more diversified product mix. As Ralph touched on, 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. Finally, Slide 11 provides our financial outlook for the full year of 2023. Our financial outlook is updated to reflect slowing sales growth as a result of both our strategic and targeted credit tightening as well as an expected continued moderation in consumer spending. For the full year average loans are expected to grow in the low to mid-single digit range relative to 2022, based on the latest economic outlook. We anticipate year end period loans to be around $19.3 billion inclusive of the recently acquired Dell portfolio of approximately $400. We expect revenue growth to be slightly above our average loan growth in 2023, excluding the gain on sale from BJs with a full year net interest margin similar to the 2022 full year rate. Full year total non-interest expenses are expected to be up 8% to 9% compared to 2022 with fourth quarter total expenses slightly higher than the third quarter driven by increased seasonal marketing and employee benefits costs. We updated our net loss rate outlook as we now anticipate the full year 2023 rate will be in the mid-7% range, including impact from the transition of our credit card processing services in June 2022. While our tighter underwriting and credit line management should benefit future loss performance, these actions raise the loss rate in the near term by lowering our projected loan balance, which forms the denominator in the net loss rate equation. We now expect the fourth quarter net loss rate to be approximately 8%, driven by normal seasonal trends, continued consumer payment pressure and the denominator effect from lower loan growth. In addition, we expect fourth quarter delinquency rate to be relatively consistent with the third quarter. Sticking with credit, with the addition of the Dell portfolio in early October and the fourth quarter anticipated seasonal increase in transactor balances, it is likely the reserve dollars will increase, but the reserve rate could decline slightly at year-end. The increase in transactor balances will also temporarily reduce our capital metrics in the fourth quarter as is typical each year-end. Our full year normalized effective tax rate is expected to remain in the range of 25% to 26% with quarter-over-quarter variability due to timing of certain discrete items. One final item before wrapping up, as you can see in the financial tables provided in the Appendix, we are now reporting total company regulatory capital ratios and our double leverage ratio. As Ralph highlighted, you can see the disciplined management decisions and successful execution of our plans over the past three years. Briefly looking ahead to 2024, we will stay true to pursuing responsible, profitable growth. We expect consumer macroeconomic pressures to continue to drive softer consumer spending, which, coupled with our continued tighter credit underwriting and line management actions, will likely lead to loan growth remaining below our longer-term targets next year. Also, we currently project that our net loss rate will peak in 2024, subject to economic conditions. We will provide specific guidance for 2024 during our fourth quarter earnings call in January and more details around our intended mitigation strategies after a final CFPB rule is released. In closing, we are effectively managing risk return trade-offs through an ongoing challenging macroeconomic environment while continuing to strategically invest and drive long-term value for our stakeholders. Operator, we are now ready to open up the lines for questions.

[Operator Instructions] We do have our first question. It comes from Sanjay Sakhrani from KBW. Sanjay your line is now open. Please go ahead.

Thank you, good morning. Ralph, I appreciate that this CFPB rules are fluid from a timing perspective, but it seems like we're going to get something by the end of the year, and it's probably going to be close to that $8. I'm just curious if you've started to think about like and implemented any mitigation efforts or tested to see what you might be able to do? And how comfortable are you with mitigation?

Yes, Sanjay, thanks for the question. We're waiting like everybody else for the final ruling from the CFPB. We'd like it to come sooner than later so we can just get focused on it even more. But we're testing different APRs in the marketplace and a variety of other type of fees to close gaps. We're working with our partners diligently. They understand what the issue is and the impact it could have on their business as it could have in our business. And we continue to collaborate with them on mitigations. In terms of how long it will take, what the mitigations will be closing the gaps, we'll know more when the final ruling comes out. But rest assured, we're focused on it. We're testing different strategies and working very collaboratively and diligently with our partners.

And I would just add to what Ralph said there, right? Some of this, it's hard to implement some of the changes that you have teed up before the final rule comes about. And so that's what we are waiting on. And I would say that I think we all believe and know that this is going to get litigated in court. And the question is how long before we actually have to implement. And one other thing I'd share is -- and we'll share more when and if the rule becomes final. But we expect the initial impact as a percent of total revenue will be more impactful to Bread Financial and will be higher than peers, given our higher proportion of private label credit card accounts and our deeper underwriting.

Yes. Absolutely. Perry, maybe just a question for you on like credit. You talked a little bit towards the end about the reserve rate, and I know it's going to go down sort of in the third quarter because you had the -- I'm sorry, in the fourth quarter because you had the transactor build. But I'm just curious, as we look out to next year, maybe you could just speak to how you're seeing delinquency migration, obviously choppy backdrop who knows where things go, but seems stable-ish at this point. But just how the reserve rate would migrate if there's stability? Thanks.

Thanks, Sanjay. Yes. So as we think about the reserve rate, I think it is dependent on what you say. It's what happens with the economy next year. And as we signaled, and I think it's playing out pretty much as we expected. I think we were foreseeing things that perhaps a lot of the economic forecasts were in seeing in terms of what was happening with the consumers we serve, the pressure that this elevated environment of inflation puts into the consumer base and what that means for future delinquency and losses. We were caring for that when we increased our reserve rate to 12.3%. Like I said previously, we did not expect unemployment to be the driver of this. It was more about the pressure from this compounding effect of inflation. So the degree to which the Fed is able to get, I'll say, inflation under control, whether it's the back half of next year, you start to see inflation coming down, a lot of this is you could tell with what the Fed's view on rates are. Now you start to see economists thinking the Fed's going to maybe increase the rate one more time or so or keep rates higher longer, that aligns to our view that rates were going to remain higher longer, which implies inflation is going to remain a little higher longer before hitting that 2% target rate. So we said we expect our losses to peak next year, whether it's mid-year or remains a little elevated throughout the year. Is hard to know. That's really going to be macro dependent. But I would expect that as we think about the reserve rate, the reserve rate should remain pretty steady throughout next year, and it's going to be macro dependent upon when that rate can come down. So we start to have a brighter outlook, and that might be -- if we see a brighter outlook in 2025. That means towards the end of next year, the reserve rate comes down. If the outlook does not improve, you expect the reserve rate to hold kind of where it is.

Okay, that’s great. Thank you so much.

Our next question comes from Robert Napoli from William Blair. Robert, your line is now open, please go ahead.

Thank you. Good morning. Maybe just following up, I guess that's the biggest question. As you looked at -- I'm sure you have all types of models for mitigation and what affects. What do you have a confidence level in being able to generate attractive returns post the adjustments, if assuming we go to the lowest level in late fees? What is your confidence level being able to drive reasonably attractive returns, I guess, at Bread under any scenario?

Thanks for the question. I mean, that's -- first of all, we don't know what the final rule is. And so to your point, if we go to the current $8 fee, you should expect that we said in the past and it's continued to be true that APRs will have to go up across the board for all customers. You'll start to see some fees for credit where it means upfront origination fees, promotional -- fees on promotional bonds like for big ticket or annual or monthly fees. That would be true. Then you're going to have some restructuring of partner contracts. I mean, so as Ralph talked about earlier, we're very engaged with our partners. Look, we're in this together and trying to protect their economics as well as ours, but we've got to underwrite, as you said, to protect returns for shareholders. And we're running through a bank, so we have a responsibility to make sure from a safety and soundness standpoint that we're doing that as well. So you're going to see some tightening of credit standards, which means we'll see -- which will result in fewer customers being extended credit. So you might -- we might grow a little less than what we otherwise might have in, I'll say, private label, but then that will free up capital to deploy into other product adjacencies. So there's a lot to sort through. But yes, there's a full expectation that we will be able to run a business delivering strong returns in the future. It might be a little bit of a burn-in period with the APR changes. But when you look to get to the other side of it, we have full expectation to be able to deliver strong returns.

And then I guess, given that your confidence there and given that your stock is so far below book value, tangible book value right now. What are your thoughts on capital, on capital return and balancing that with the new potential regulatory changes coming up as well? But it seems like a good opportunity for confidence level, is that high to increase tangible book value by reducing the share count even?

Yes. I think when we think about our capital structure, I'll first start by saying our priorities remain unchanged, right, supporting responsible, profitable growth, make sure we're investing in our technology and digital capabilities to serve our brand partners and customers. We're still not where we want to be on that front. Ralph talked about earlier, we're paying down our debt. We need to pay down our debt to get below 115% double leverage ratio. We want to continue to build our capital ratios to fortify this balance sheet and then we could think about things like you mentioned around further returns to shareholders. But in this environment, with the uncertainty around the macro side of things, and as you noted on the regulatory front, it would not be responsible to take, say, a strong action like that. We did do our good hygiene share repurchase. As Ralph noted, we bought back $35 million shares. If it weren't for those uncertain environments that we're right now, it certainly be a lot more attractive, but I think that would not be the responsible thing for us to do at this time.

Thank you. Appreciated.

Our next question comes from Mihir Bhatia from Bank of America. Your line is now open. Please go ahead.

Good morning. Thank for taking my question. I wanted to start with the delinquency trends, and I think your comments about 2024 right at the end. Delinquencies right now at like 15-year highs, I think they saw in your trend like [ph]. And I understand some of the pressures on the consumer. But I was curious, like -- I think it sounds like you expect this to obviously drive NCOs higher next year. And in hindsight, do you think Bread or the industry got too aggressive with growth coming out of COVID? Like what's driving this? Just talk a little bit about the tightening you're doing to get back to your expected or long-term guidance of loss rates. Any more color you can give on that tightening?

Yes. Let me talk a little -- you've got a number of things in there, and I'll -- Ralph will talk about the credit strategy tightening. But in terms of did we grow too fast? No, I'd say we've remained very disciplined in the growth. And compared to others who maybe you heard where they've had these large vintages and these vintages seasoning, you can look at our lag loss rates and things of that nature. We have not -- that is not our issue. Really, what we're -- what you're seeing is the economy and the effect it has on moderate and lower-income households and where their wage growth is not keeping up with the compounding effect of inflation. So it's an unfortunate element of this type of environment, and our customers are doing the best they can to make ends meet. They're rotating spend categories to try to make it happen. They're picking up second jobs. It's a job full environment. So your question, though, around the hitting delinquency and a 15-year peak, and I'm sure if you link that to the great financial crisis when the losses really peaked up much higher, it was a very different environment, right? The great financial crisis was driven by rapid and high unemployment. People are upside down, and their mortgage are eating the -- they had negative equity. And that drove a lot of consumers to file bankruptcy. And so that was a very different macro environment versus the one we're in right now where consumers are employed. If that's not the issue, it's more so inflation, and inflation should come under control. It's just -- it's not a matter of if, it's just a matter of when. So I think you're going to see continued pressure on delinquency for a bit. It's going to result in some higher losses, but I don't think you're going to see the breakthrough type of losses like you had last time. And so Ralph will talk about the credit management.

Yes. We have a very robust and proactive risk management process. And it's across the life cycle of a borrower. So we think from acquisition to line management to collections and account closures. We manage that very carefully. Our view is to make sure that we are not putting anybody in harm's way, and we're managing their debt appropriate. So for example, now that student loans have come back on track, we monitor those customers that have student loans, where we've included those student loans in their obligation and ability to pay even when they weren't paying them. So as we step through this uncertain time, we continue to focus on this across the life cycle of individual in terms of their credit underwriting and their ability to manage credit. So I feel very good about that. We were focused on this pre my arrival in 2019. We were very diligent and thoughtful through the pandemic when everybody was kind of opening the box a little bit. We were very conservative and make sure that we were very diligent in terms of underwriting and line management, and we'll continue to do that as we move forward. Now as we said, some of that impacts our growth in the near term. But from a loss perspective long term, we believe it's the right thing to do, and we'll continue to manage very thoughtfully through the process.

And I'll add one last comment to what Ralph just said. We are seeing the benefits of those credit strategies and that we're seeing a little bit lower early-stage delinquency, which demonstrates that the credit actions are taking hold. The challenge is that once consumers get into delinquency, even though they're employed, they're struggling to get back to current. And so what that means is that your later-stage roll rates are higher than historically they've been, and that's what's driving the higher losses. So we're going to continue to do what we can to drive down the early stage and, again, work with customers as they enter those later stages.

Got it. Thank you for that. Maybe switching gears just to spending, but related to some of this tightening. Can you just talk about some of the changes you saw intra-quarter in consumer spending? Do you see like slowdown month over month over month and maybe give us a glimpse of what you've seen months-to-date? I really want to try to understand how much more can spending slowdown from here into the fourth quarter and as we think about the first quarter next year?

Yes. I think when we think about -- there's a slowdown basically that we're seeing, certainly in the moderate and lower income cohorts, but you're starting to see that creep up into even some of the prime cohorts as inflation has taken hold. And I think the way you can look at it is when you think about the fourth quarter and what retailers are saying, what our brand partners are saying that they're projecting a softening of sales this holiday season, which is kind of in line with some of the trends they've been seeing over the summer. So what you should expect is that more retailers will be planning to offer discounts, incentives, rewards of -- now unlike last year and maybe the year before where there were supply chain issues, people couldn't get the electronics or whatever what they were looking for, spend got accelerated earlier in the season into really early October even. And now what I think you're going to see is as consumers are more cost conscious and looking for deals, you're going to see the typical seasonal spend of what you saw a few years ago where it's really concentrated into November, December as they're looking for that deal and with the merchants are going to be obviously putting things on sale at that time. So it made look more like past cycles from past years.

Got it. Thank you.

Our next question comes from Jeff Adelson from Morgan Stanley. Jeff, your line is now open, please go ahead.

Hi, guys. Thanks for taking my questions. And good morning. Just wanted to follow up on the credit commentary. And at the risk of beating a dead horse, I just want to make sure we got it right. So I think you're expecting your loss rate to peak out next year. I just want to be sure, should we be thinking about a peak loss rate in the context of -- I think you mentioned this fourth quarter looking more like an 8%. I think maybe we were all accepting a little bit more improvement next year, so I just wanted to square those figures.

No, I appreciate the direct question. You're right, we are definitely expecting fourth quarter to be around 8% and reiterate that's 100 basis points up linked quarter. Some of that is a seasonal increase. And then the other half that, I'll say, is a combination of the macro conditions, effective the consumer's ability to pay and the denominator effect. So when you think about that, yes, you can extrapolate that into next year because while seasonality will move around, I think that pressure on the consumers' ability to pay will continue to play out throughout next year as well as the denominator effect as we will have smaller vintages from this year carrying into next year, and next year's vintage will also be smaller as a result. So that will put pressure on the net loss rate, and I don't think any of us are thinking that inflation is abating that quickly. And the effects of higher interest rates, there's a lagged effect of what that means to the consumers in terms of higher cost of auto loans, home loans, credit card debt. And their debt is rising for them, so they've got more debt to pay with higher interest costs and at the same time, student debt repayment is occurring. So I think there's going to be this play out for the next year, which is definitely going to put it in the higher end of their range.

Okay. Great. And just to circle back on the NIM. I know this was seasonality lower reversals and it's going to trend back down next quarter on seasonality as well. I think we're all pretty surprised by the strength in the NIM though. You've discussed yourself being a little bit more neutral to rates. I know there's a lag effect with the Fed here to the prime rate. But thinking forward, is there a case to be made that maybe you've got a structurally higher NIM or card yield going forward with people maybe revolving more? Or are you still more in the camp of hanging around this low 19% level?

Yes. I'm definitely more in the camp of hanging around the low 19% level. We'll give more guidance on that as we get into next year. But when you think about what's going to happen in the fourth quarter, you're going to get a seasonal drop. And as losses remain elevated -- remember, this quarter, losses were 100 basis points below last quarter. And now next quarter, they're going to go back up. So you're going to have that, the purification or reversal of interest and fees impacting the fourth quarter and of losses remain elevated through next year. That's going to put pressure on there. So -- and then as we bring in smaller vintages, that will also affect higher quality vintages that may have a little bit of less rollover, maybe a lower pricing. So I would not want to speculate that we have a structurally higher net interest margin going forward.

Our next question comes from David Scharf from JMP Securities.

Thank you, taking for my question wanted to circle back to just some of the planned mitigation efforts. And as it relates sort of timing and ability to kind of roll things out, not looking for you to name names. But I'm wondering, as you reflect on maybe your top 20 retailer partners and the discussions you've had thus far, is there sort of an unanimity in their reactions or embracing of certain mitigation efforts or pushback on others? I'm just wondering, is there a wide spectrum of support and resistance to various strategies among your partners? Or do you think that there's a pretty uniform buy-in to what you're thinking and that, therefore, kind of implementation should be pretty smooth?

So let me start, and I'll let Perry finish up. Just a couple of things. So our partners and our interests are aligned to remain profitable during any kind of regulatory change. So that said, they are focused on making sure that we would do the right things for their cardholders, and we can still provide credit that their baskets at the point of sale are as robust as it can be, given the challenges we would have, underwriting a sort of population with just an $8 late fee. So they are aware of it. They understand our challenges. We understand their challenges. And we're working through the impacts of the changes we will need to make to keep them profitable in us as well. And that may vary from partner to partner, but the collaboration and understanding of the challenge is consistent.

Got it. So -- and really, what I was getting at is I didn't know if there was maybe a uniform pushback on origination fees whereas others were more leaning towards promotional and whatnot. But obviously, it sounds like everybody is rowing in the...

I think the other thing to remember too is most of our -- partnership contracts have a material change in law and provides us to make -- allows us to make adjustments. So -- and that's what we're working through with them.

Yes. And I'll add to what Ralph just said. If you think about top 20 partners, they're all different, whether they're a big ticket partner where they're, I'll say, a little less impacted by the late fee, but still impacting a way and then so you can pull levers on things like promotional fees, or others that are more private label concentrated and the soft goods who are more impacted. Those require different things. So each partner, because each of them are different in terms of their business model, the size of the average balance, the customer they're attracting, they all require nuanced and different approaches. And the team is doing a really good job of partnering with them. As Ralph said, it's a partnership we're trying to protect their economics, protect our economics and really trying to figure out how to underwrite as many customers as we can and still provide the right return for our shareholders.

Yes. I think one of the -- as you look at what's facing us in terms of the cost to collect, it's really a cost to lend. And the unintended consequence here is we may not be able to lend in the population we lend to today. So that I believe is going to be casualty of this late fee legislation, and that's unfortunate because people will not be able to borrow as they do today because the legislation has made it riskier for people to borrow.

Right. Quick follow-up. I think you mentioned about 50% of credit sales are co-branded now. And can you just remind us what the mix is in terms of balances at the end of the quarter, private label versus co-brand?

We are about a third of our portfolio average balances are co-brand.

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

Thanks. Good morning, Ralph and Perry. It's great to see the total company CET1 ratio disclosure. By our math, that metric was actually negative when you took over, Ralph, which is real testament to the significant capital that you've all accreted since taking over from the prior management team. But what's the right level of CET1 to target as you look forward from here? And then if you could layer into your response how you're thinking about the RWA inflation associated with Basel III endgame, which many of your peers are working through, but it'd be great to hear whether that's impacting how you think about capital.

Yes. Thanks for the question, and thank you for acknowledging the great work that Ralph has done under his leadership.

Bill, I've heard today.

When you think -- let's start with the Basel III endgame and the implications, that only impacts the bank's over $100 billion in assets, and we are well below that. So for us, it could be opportunistic as a number of the big players where they look at new opportunities, new deals to sign with partners. We'll have a different degree of capital requirements. So that for us is not an impact. As it relates to our ongoing targets, that's something that we continue to develop. We're not all the way home yet. We think about the stress models that go into figuring out what the right target is, look at your risk ID factors that go into target. If you think about what traditional disciplined banks do, that is how we're going to approach this. And in the environment we're in right now, we're certainly not all the way to where we want to go, and then we will communicate more in 2024, probably during our investor event to give longer-term targets around where we will be and what our buying and constraint is.

Understood. That's helpful. And separately, as you prepare for the potential late fee changes that you've given some details on, are there any costs associated with that you'd call out, whether they be onetime or recurring? And I guess how dependent are those costs on the rule getting litigated and whatever path that could take? Any thoughts around that would be helpful.

Yes. I mean that some of the issue is and some -- I think some of the comments that have been provided to the CFPB. And we're encouraged that we understand that they've been looking at the comments and hopefully, they contemplate the comments, as Ralph said, the cost to lend. But there are going to be some costs depending on what the rule comes out to implement those costs. If they put in certain things that require percent, the late fee can be max of 8% of balance or change in grades versus their system cost to making those changes. But then more so, when you think about the investment to pivot into other product adjacencies if we start to pull back in certain products that maybe are no longer as viable in a post CFPB rule change, there could be some cost to develop capabilities on that front.

Got it. Thank you for taking my questions.

Our next question comes from Dominick Gabriele from Oppenheimer. Dominick, your line is open. Please proceed.

Yes, good morning everybody. Thanks for taking for my question. Just following up on the last line of questioning. The CET1 total company target, I do appreciate that as well. Is it fair to say that your target would likely be slightly above the industry average for credit card issuers just given the profile of the credit profile of the company? That's the follow-up.

I'll answer that directly. Yes, that is a fair expectation.

Okay. Perfect. I thought that was an easy one. And Yes. When you think about -- Perry, you've had some really good spending comments on this call. I know this is a huge focus for many investors on the trajectory of spend. Could you try to isolate for us the spending slowdown, specifically at partners only, not Bread spending in the fourth quarter, but what the partners that you have, that you're talking to, what that year-over-year spend expectation is? For instance, is it 1%, 2%, 3% slowdown versus last year? How are they thinking about the magnitude of that spending slowdown?

Yes. I think I don't want to speak to any one particular partner because I think it's going to be varied by partner, by product category. So it's really mixed by vertical. So I think as we commented you're seeing some slowdown in some retail categories, some home furnishings year-over-year. So it's really going to be interesting to watch consumers as they play into this fourth quarter and how they direct their holiday spend. I wish I can give you more context on that, but it probably wouldn't be appropriate to comment at one particular partner.

[Operator Instructions] Our next question comes from Reggie Smith from JPMorgan. Please go ahead

Yes. Good morning, thank for taking a question. I've got a few here. You -- I guess you suggested that loss rates would eat in '24. It sounds like you expect inflation to kind of moderate to the back half of the year. What's your, I guess, embedded unemployment assumption in that view? The loss rates were kind of peak in '24. I guess new employment assumptions were 25 to fully appreciate that, right?

Well, so I've talked about this numerous times in the past, right? When we think about loss rates and where they're at this year, unemployment is low. It's really inflation-driven. And then as we talk about next year and the commentary of losses peaking next year, I'm talking a full year loss rate, but then even within some quarters, I expect the quarterly peak to happen next year. So we're going to end up this quarter, coming quarter 8%. Next year, there could be some quarters like that. When you think about -- it's less about what the unemployment assumption is and more about inflation. Now I expect it to be a rotation of inflation pressure getting replaced by some modest uptick in unemployment. And I think that's the outlook that everybody is looking at. Now when we think about our reserve levels, we have -- we weighed in scenarios, which include unemployment peaking over the next 24 months, an adverse number of 7.7%, severely adverse at 8.7%. That's not what's expected, right? It's more of that baseline view, which does have unemployment getting up into the low 4s next year. And I think -- so that's what I'll say, informing our base loss rate view would be that low to mid-4% unemployment with a -- starting to have some moderation of inflation, but not expecting inflation to, say, fall off a cliff and come back in line that quick. And I think that's the sentiment that's starting to emerge is that inflation is going to be hanging around a little bit longer. But the good news is that means unemployment should stay in a good place for longer. And that's the idea of a soft landing. And I think from all the outlooks that now getting updated, it's just pushing out that view so that we expect that to be the case. So it's just a matter of how long this environment persists.

Understood. That makes sense. You made a comment in regards to the impact of late fees and you guys, you -- I guess, you talked about the impact relative to your peers. And I was curious when you say peers, is that just kind of Synchrony? Or is it the broader credit card issuer space? Because I think you suggested that your proportion of late fees is not materially different than Synchrony. And so I was just trying to square those comments.

We've always said that if somebody is asking about us relative to peers that we have a higher mix of private label and we underwrite deeper, and then -- which means we have more exposure to that. And then if you're asking specifically about Synchrony, what we said it, whatever it is Synchrony. And I say plus, that means more not in line with them more because of the fact that we have a higher mix of private label card and underwrite deeper than they do.

Okay. That's fair. And then last question is kind of a bigger picture question. Your cycle loss rate guidance. I was curious how you arrived at 6%, given your rich NIMs, it doesn't appear to be a level that maximizes profit dollars, but maybe I'm wrong, like how are you thinking about that? And I guess does it does that create unnecessary constraint on the business, if that makes sense.

That's a really good question, and one that we grapple with internally. But I think when you start to think about -- well, let's talk about the cycle, right? The cycle is typically 10 years, it could be 15 years through the cycle is to go peak to peak, trough to trough, average it out. And it's been a good marker for us in terms of guiding in terms of -- we're going to have some periods when we're above that, somewhere we're below it. And you can see right now, it's not like we're closing off these tickets, we are still delivering very strong margins, and I appreciate you commented on that. But there's also an element of capital, right? So you need to stress your book. So you start to be more disciplined at the bank level and total company level and making sure that your capital ratios, capital targets are aligned if we underwrote a lot deeper, so let's go through the cycle of 9% as a new target, well, that means the capital levels that would be at to help would be far in excess of that. And I'm also not sure our regulators would appreciate. So I think we find that sweet spot of profitability, and we want to make sure we're underwriting on the margin, so to be profitable and provide that right return on equity. So that's a real part of the disciplined practice that we have in our credit underwriting shop is every account is a decision around its profitability and making sure as a proper return on capital. So on the margin, we're underwriting deeper than 6%, right? So people coming in -- it could be a 10% loss rate on the margin, but they're giving the right return. So it's -- I don't want to imply that there's a hard cut at 6%. So it's something that is managed very effectively and over time.

Yes. I think the principles we abide by are: one, we get paid for the risk that we take; two, that we're lending responsibly and that we're always aware of the safety and soundness of our banks. Those are the principles we buy by how we arrive at the risk willing to take and the loss rate we're willing endure with the returns we're expecting.

Okay. Thank you.

We currently have no further questions, so I will now pass it back to Rob and Peter for closing remarks.

Well, thank you all. I appreciate your time and your continued interest in Bread Financial. Everybody, have a terrific day.