Alliance Data Systems(BFH) - 2022 Q4 - Annual Report

PART I Business Bread Financial is a tech-forward financial services company specializing in personalized payment, lending, and saving solutions - The company operates as a single segment after completing the spinoff of its former LoyaltyOne segment in November 2021, simplifying its business model to focus on tech-forward financial services[374][395][396] - Key strategic initiatives include rebranding as Bread Financial, expanding its product suite with BNPL and direct-to-consumer offerings, and investing over $125 million in technology, digital capabilities, and marketing[396][425] Credit Sales and End-of-Period Loans Breakdown (2022) | Category | Private Label | Co-Brand | Bread Pay | Other | | :--- | :--- | :--- | :--- | :--- | | Full Year Credit Sales | 47% | 49% | 4% | - | | End-of-Period Loans | 39% | 56% | 1% | 4% | - The company's primary product offerings include private label credit cards (exclusive to a partner), co-brand credit cards (usable on major networks like MasterCard and Visa), Bread Pay™ (installment and split-pay loans), and Bread Savings™ (direct-to-consumer deposits)[382][401][404][406] - In 2022, the company completed the transition of its credit card processing services to Fiserv to enhance speed to market, improve digital integration, and increase operational efficiencies[408] Risk Factors The company faces significant risks primarily from macroeconomic instability, including inflation and potential recession Macroeconomic, Strategic, Business and Competitive Risks The company's performance is highly sensitive to macroeconomic conditions such as inflation, rising interest rates, and recession risk - Adverse macroeconomic conditions directly impact loan volumes and revenues; a recession or prolonged economic weakness could significantly increase delinquencies and charge-offs, with the delinquency rate at 5.5% and the full-year net loss rate at 5.4% as of December 31, 2022[1][547] Revenue and Loan Concentration (2022) | Metric | Five Largest Programs | Ulta Beauty Program | Victoria's Secret Program | BJ's Wholesale Club Program | | :--- | :--- | :--- | :--- | :--- | | % of Total Net Interest & Non-Interest Income | ~47% | >10% | >10% | ~10% | | % of End-of-Period Loans | ~41% | - | - | ~11% | - The company relies extensively on complex models for managing credit risk, pricing, and reserving; inaccurate assumptions or model errors, especially regarding macroeconomic conditions, could lead to sub-optimal decisions and have a material adverse effect on results[528] - The amount of the Allowance for Credit Losses is a critical estimate; the CECL accounting standard requires reserving for lifetime expected losses, which can create volatility, and an underestimation could result in insufficient coverage of actual losses[529][558][589] Liquidity, Market and Credit Risks The company's primary funding sources include customer deposits, securitization of credit card loans, and unsecured borrowings - The company relies on securitizing credit card loans as a significant funding source; an early amortization event, triggered by deteriorating asset performance or partner bankruptcies, could significantly limit the ability to securitize additional loans and adversely affect liquidity[10][578] - Customer deposits are an increasingly important source of funds, growing 72% to $5.5 billion in 2022; intense competition for deposits and regulatory restrictions could affect the availability and cost of this funding[12][611] - The company's level of indebtedness requires substantial interest and principal payments; covenants in debt agreements restrict the ability to incur additional debt, pay dividends, and make certain investments, which could limit operational flexibility and growth[14][647] - Profitability is sensitive to changes in market interest rates; while recent Federal Reserve rate increases have had a nominal benefit, a scenario where funding costs rise faster than asset yields could adversely affect net interest income[16][616][649] Legal, Regulatory and Compliance Risks The business operates in a highly regulated environment, subject to oversight from the FDIC, CFPB, and various state authorities - The business is subject to extensive and evolving government regulation, which can be costly and limit product offerings; a key risk is the CFPB's February 2023 proposed rule to reduce the credit card late fee safe harbor amount to $8, a significant decrease from current inflation-adjusted levels of $30 for an initial fee and $41 for subsequent fees[23][621][622] - The company is exposed to litigation, including class action lawsuits; while arbitration clauses have historically limited this exposure, their future enforceability is not guaranteed, and mass arbitrations could present a significant risk[25] - The company's banks must maintain minimum regulatory capital levels; failure to meet these requirements could trigger corrective actions by regulators, restrict the banks' ability to pay dividends to the parent company, and potentially require capital injections from the parent[27][626] - Compliance with privacy and data protection laws (e.g., GLBA, CCPA) and anti-money laundering regulations (e.g., Bank Secrecy Act) is critical; noncompliance can lead to significant fines, sanctions, and reputational harm[31][64][630] Cybersecurity, Technology and Vendor Risks The company faces significant risks related to cybersecurity, technology infrastructure, and reliance on third-party vendors - The transition of credit card processing services to Fiserv in June 2022 led to unanticipated platform stability issues, causing outages in call centers and online customer service platforms, resulting in customer complaints, reputational damage, and regulatory scrutiny[635][698] - Failure to protect customer data and privacy from unauthorized access or cyberattacks could damage the company's reputation, expose it to legal claims from partners and customers, and result in regulatory enforcement actions[36][699] - The business relies on numerous third-party vendors for a range of products and services; the failure of a significant vendor to meet contractual requirements, comply with regulations, or prevent a security breach could cause economic and reputational harm[69] - The financial services industry is subject to rapid technological change; if the company cannot successfully invest in and compete with new technologies, its revenue and profitability could be adversely affected[71][637] Properties As of December 31, 2022, the company leases 14 general office properties totaling approximately 1 million square feet Principal Leased Facilities | Location | Square Footage | Lease Expiration Date | | :--- | :--- | :--- | | Coeur D'Alene, Idaho | 114,000 | July 31, 2038 | | Columbus, Ohio | 326,354 | September 12, 2032 | | Columbus, Ohio | 103,161 | June 30, 2024 | PART II Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities The company's common stock is listed on the New York Stock Exchange under the ticker symbol "BFH" - The company's common stock trades on the NYSE under the ticker "BFH", which changed from "ADS" on April 4, 2022, following the corporate name change to Bread Financial Holdings, Inc[92][684] - On January 26, 2023, the Board of Directors declared a quarterly cash dividend of $0.21 per share; the company expects to continue paying quarterly dividends, subject to Board approval and other factors[120][685] Issuer Purchases of Equity Securities (Q4 2022) | Period | Total Number of Shares Purchased | Average Price Paid per Share | | :--- | :--- | :--- | | October 1-31 | 4,076 | $30.61 | | November 1-30 | 3,651 | $36.75 | | December 1-31 | 3,816 | $38.22 | | Total | 11,543 | $35.07 | Stock Performance Comparison (Value of $100 Invested on 12/31/2017) | Date | Bread Financial Holdings, Inc. | S&P 500 Index | S&P Financial Index | Peer Group Index | | :--- | :--- | :--- | :--- | :--- | | 12/31/2017 | $100.00 | $100.00 | $100.00 | $100.00 | | 12/31/2018 | $59.98 | $95.62 | $86.97 | $98.31 | | 12/31/2019 | $45.92 | $125.72 | $114.91 | $141.60 | | 12/31/2020 | $31.08 | $148.85 | $112.96 | $184.87 | | 12/31/2021 | $35.39 | $191.58 | $152.54 | $196.11 | | 12/31/2022 | $20.37 | $156.89 | $136.48 | $145.48 | Management's Discussion and Analysis of Financial Condition and Results of Operations (MD&A) In 2022, Bread Financial saw strong top-line growth, with total net interest and non-interest income increasing 17% to $3.8 billion Business Environment and 2023 Outlook The company's 2023 financial outlook anticipates mid-single-digit growth in average credit card and other loans - The company's 2023 financial outlook anticipates mid-single-digit growth in average credit card and other loans, with total net interest and non-interest income growth aligned with this rate[63] - The full-year 2023 Net Interest Margin is expected to be consistent with the 2022 rate of 19.2%[63] - The 2023 outlook assumes a net loss rate of approximately 7%, reflecting continued pressure on consumers' ability to pay due to persistent inflation[97] - The outlook for 2023 is influenced by the sale of the BJ's Wholesale Club portfolio, which in 2022 generated approximately 10% of total net interest and non-interest income and represented 11% of total loans[63] Consolidated Results of Operations For the year ended December 31, 2022, total net interest and non-interest income increased by 17% to $3.8 billion Consolidated Financial Performance Summary (in Millions, except per share data) | Metric | 2022 | 2021 | % Change | | :--- | :--- | :--- | :--- | | Total net interest and non-interest income | $3,826 | $3,272 | 17% | | Provision for credit losses | $1,594 | $544 | 193% | | Total non-interest expenses | $1,932 | $1,684 | 15% | | Income from continuing operations | $224 | $797 | (72)% | | Diluted EPS from continuing operations | $4.47 | $15.95 | (72)% | - The increase in Provision for credit losses was primarily due to a $626 million reserve build, driven by a 23% increase in end-of-period loan balances, higher net principal losses, and a higher reserve rate due to a weaker macroeconomic outlook[96][100] - Total non-interest expenses increased by $248 million (15%), primarily due to higher employee compensation, information processing costs related to the credit card platform transition, and marketing expenses[101][133] Asset Quality The company's asset quality metrics showed signs of normalization from pandemic-era lows Delinquency and Net Loss Rate Trends | Metric | 2022 | 2021 | 2020 | | :--- | :--- | :--- | :--- | | Delinquency Rate (End-of-Period) | 5.5% | 3.9% | 4.4% | | Net Loss Rate (Full Year) | 5.4% | 4.6% | 6.6% | - Both the delinquency rate and net principal loss rate for 2022 were impacted by the transition of the company's credit card processing services[110][140] Consolidated Liquidity and Capital Resources The company's primary liquidity sources are cash from operations, deposits, and securitization programs - Primary sources of liquidity include cash from operations, deposits, securitization programs, and debt issuances; the company believes these sources are adequate to fund current and long-term requirements[142][143] Key Funding Sources (as of Dec 31, 2022) | Funding Source | Amount (Millions) | | :--- | :--- | | Total Deposits | $13,826 | | - Direct-to-consumer (retail) | $5,466 | | - Wholesale | $8,321 | | Debt issued by consolidated VIEs (Securitizations) | $6,115 | | Long-term and other debt | $1,892 | - During 2022, the company increased its private conduit facilities capacity by $2.1 billion to a total of $6.5 billion[115] Combined Banks Capital Ratios (as of Dec 31, 2022) | Ratio | Actual Ratio | Minimum to be Well Capitalized | | :--- | :--- | :--- | | Common Equity Tier 1 capital ratio | 17.0% | 6.5% | | Tier 1 capital ratio | 17.0% | 8.0% | | Total Risk-based capital ratio | 18.3% | 10.0% | | Tier 1 Leverage capital ratio | 15.6% | 5.0% | Critical Accounting Estimates The company's most critical accounting estimates involve the Allowance for Credit Losses and the Provision for Income Taxes - The two most critical accounting estimates are the Allowance for Credit Losses and the Provision for Income Taxes[182] - The Allowance for Credit Losses is estimated using the CECL model, which considers historical loss experience, current conditions, and reasonable forecasts; the estimate is sensitive to assumptions, with a 100 basis point change in the allowance as a percentage of loans resulting in an approximately $210 million change as of December 31, 2022[156][184][746] - Estimating the Provision for Income Taxes is complex and requires judgment regarding the realizability of deferred tax assets and the technical merits of uncertain tax positions; as of December 31, 2022, the company had $282 million in unrecognized tax benefits[158][185][784] Financial Statements and Supplementary Data This section contains the company's audited consolidated financial statements for the fiscal year ended December 31, 2022 Report of Independent Registered Public Accounting Firm The independent auditor, Deloitte & Touche LLP, issued an unqualified opinion on the company's consolidated financial statements as of December 31, 2022 - The auditor, Deloitte & Touche LLP, expressed an unqualified opinion on both the consolidated financial statements and the effectiveness of internal control over financial reporting as of December 31, 2022[199][220] - The Allowance for Credit Losses was identified as a Critical Audit Matter due to the significant and subjective judgments made by management in its estimation, particularly regarding the CECL model, forecasted economic conditions, and qualitative adjustments[191][192][196] Consolidated Financial Statements The consolidated financial statements detail the company's financial performance and position Consolidated Statement of Income Highlights (in Millions) | Line Item | 2022 | 2021 | 2020 | | :--- | :--- | :--- | :--- | | Net interest income | $4,181 | $3,485 | $3,453 | | Provision for credit losses | $1,594 | $544 | $1,266 | | Total non-interest expenses | $1,932 | $1,684 | $1,731 | | Net income | $223 | $801 | $214 | Consolidated Balance Sheet Highlights (in Millions) | Line Item | Dec 31, 2022 | Dec 31, 2021 | | :--- | :--- | :--- | | Credit card and other loans, net | $18,901 | $15,567 | | Total assets | $25,407 | $21,746 | | Deposits | $13,826 | $11,027 | | Total liabilities | $23,142 | $19,660 | | Total stockholders' equity | $2,265 | $2,086 | Consolidated Statement of Cash Flows Highlights (in Millions) | Cash Flow Activity | 2022 | 2021 | 2020 | | :--- | :--- | :--- | :--- | | Net cash provided by operating activities | $1,848 | $1,543 | $1,883 | | Net cash (used in) provided by investing activities | $(5,111) | $(1,691) | $1,774 | | Net cash provided by (used in) financing activities | $3,267 | $608 | $(4,167) | Notes to Consolidated Financial Statements The notes provide detailed explanations of the accounting policies and financial figures presented in the consolidated statements - The company's five largest credit card programs accounted for approximately 47% of total net interest and non-interest income and 41% of end-of-period loans in 2022; the Ulta Beauty and Victoria's Secret programs each accounted for more than 10% of income[296] Allowance for Credit Losses Rollforward (in Millions) | Description | 2022 | 2021 | 2020 | | :--- | :--- | :--- | :--- | | Beginning balance | $1,832 | $2,008 | $1,815 | | Provision for credit losses | $1,594 | $544 | $1,266 | | Net principal losses | $(972) | $(720) | $(1,083) | | Ending balance | $2,464 | $1,832 | $2,008 | - The company regularly securitizes its credit card loans through trusts, which are consolidated VIEs; as of Dec 31, 2022, total securitized credit card loans were $15.4 billion[824][846] - As of Dec 31, 2022, total borrowings were $8.0 billion, consisting of $1.9 billion in long-term and other debt (including senior notes) and $6.1 billion in debt issued by consolidated VIEs (securitizations)[862][879] Controls and Procedures Management, including the CEO and CFO, evaluated the company's disclosure controls and procedures and concluded they were effective as of December 31, 2022 - Management, including the CEO and CFO, concluded that the company's disclosure controls and procedures were effective as of the end of the period covered by the report[189] - Management assessed the effectiveness of internal control over financial reporting using the COSO framework and concluded that it was effective as of December 31, 2022[791] - The independent auditor, Deloitte & Touche LLP, also audited and provided an unqualified opinion on the effectiveness of the company's internal control over financial reporting as of December 31, 2022[199][792] PART III Directors, Executive Officers, Corporate Governance, Compensation, and Related Party Transactions Information required for Part III, covering directors, executive officers, corporate governance, executive compensation, security ownership - The information for Items 10, 11, 12, 13, and 14 is incorporated by reference from the Proxy Statement for the 2023 Annual Meeting of Stockholders[223][224][274] PART IV Exhibits, Financial Statement Schedules This section lists all exhibits filed as part of the Form 10-K, including corporate governance documents, material contracts, and certifications - This section contains a list of all exhibits filed with the Form 10-K, including key agreements like the Amended and Restated Credit Agreement and various Indentures for senior notes[5][227] - Certifications from the Chief Executive Officer and Chief Financial Officer pursuant to SEC rules are filed as exhibits 31.1, 31.2, 32.1, and 32.2[5] - Financial information formatted in Inline XBRL is included as Exhibit 101[6]