Alliance Data Systems(BFH) - 2021 Q4 - Annual Report

Part I Business Alliance Data Systems operates as a single segment, providing tech-forward payment and lending solutions in North America, following the LoyaltyOne spinoff - The company is a leading provider of tech-forward payment and lending solutions, including credit card products and Bread® digital payment solutions, serving over 600 companies and online merchants[9][10] - On November 5, 2021, the company completed the spinoff of its LoyaltyOne® segment into an independent, publicly traded company, Loyalty Ventures Inc. (NASDAQ: LYLT), retaining a 19% ownership stake[11] - Following the spinoff, the company now operates as a single reportable segment, focusing on continuing operations and excluding the discontinued LoyaltyOne segment from its results[12] - The business strategy involves simplifying the business model, reducing debt, and making strategic investments in technology, digital capabilities, and expanding its product suite[13][14][15] Key Loan Portfolio Statistics (as of Dec 31, 2021) | Metric | Value | | :--- | :--- | | Principal Loans | $16.6 billion | | Active Accounts | ~36 million | | Average Balance (for accounts with balances) | ~$828 | Products and Services The company offers private label/co-brand credit cards, BNPL options, and digital payment solutions, transitioning processing to Fiserv - Core offerings include private label and co-brand credit card programs, Buy Now, Pay Later (BNPL) options, and direct-to-consumer products[16][17] - The company is transitioning credit card processing services to Fiserv to improve speed to market, add new products, and enhance operational efficiencies[19] - Through its Enhanced Digital Suite and Bread platform, the company offers omnichannel digital payment solutions, expanding its market to include small- and medium-sized businesses[22][23] Competition The company operates in a highly competitive market against diverse financial institutions, fintechs, and payment networks - The company competes in a highly competitive market against a wide range of businesses, including financial institutions, fintechs, and payment networks, some with greater resources[26] - Competition for brand partners is based on factors like program financials, underwriting standards, marketing expertise, service levels, and technological capabilities[27][28] - In the payments space, products compete with cash, checks, debit cards, general-purpose credit cards, BNPL products, and emerging digital/mobile payment solutions, some with less regulatory scrutiny[28] Supervision and Regulation The company operates through two regulated bank subsidiaries subject to extensive federal and state banking regulations - The company operates primarily through its two insured depository institution subsidiaries: Comenity Bank (Delaware-chartered) and Comenity Capital Bank (Utah-chartered)[29] - Both banks are subject to prudential regulation and supervision by their respective state chartering authorities and the FDIC as their primary federal regulator[31][32][34] - The banks are subject to risk-based capital and leverage ratio requirements under U.S. Basel III rules, with regulatory capital ratios above "well-capitalized" standards as of December 31, 2021[37][43] - The company is subject to a wide range of consumer protection regulations, including those related to privacy, data protection, anti-money laundering, and fair lending[58][62][64][67] Human Capital The company employed approximately 6,000 associates worldwide as of December 31, 2021, focusing on talent attraction, development, and retention - As of December 31, 2021, the company employed approximately 6,000 associates worldwide, with key human capital objectives to attract, develop, and retain top talent[74] - In 2021, approximately 95% of the workforce continued to work from home, with a focus on associate wellbeing, including mental health support and flexible time off policies[75][76] 2021 Workforce Metrics | Metric | 2021 Rate | 2020 Rate | | :--- | :--- | :--- | | New Associate Acquisition | ~21% | 10% | | Voluntary Turnover | ~17% | 13% | Workforce Diversity (as of Dec 31, 2021) | Category | Total Workforce | Senior Leaders | | :--- | :--- | :--- | | Female | ~60% | 43% | | Minorities | ~41% | 17% | Risk Factors The company faces a wide range of strategic, financial, regulatory, and operational risks that could materially affect its business Strategic, Business and Competitive Risks The company faces risks from the ongoing pandemic, partner concentration, and susceptibility to U.S. economic fluctuations - The ongoing COVID-19 pandemic continues to pose risks, including potential impacts on retail partners, consumer spending, credit losses, and operational challenges for a remote workforce[92][93] - The company has significant partner concentration risk, with the 10 largest partners accounting for 59% of total net interest and non-interest income in 2021, and Victoria's Secret representing 13% of this total[97][98] - The business is heavily concentrated in U.S. consumer credit, making it highly susceptible to fluctuations in the U.S. economy, consumer spending, and targeted regulatory actions[99][100] Historical Net Charge-off and Delinquency Rates | Metric | 2021 | 2020 | 2019 | | :--- | :--- | :--- | :--- | | Net Charge-off Rate | 4.6% | 6.6% | 6.1% | | Delinquency Rate (EOP) | 3.9% | 4.4% | 5.8% | Fraud-Related Operational Losses | Year | Amount (in millions) | | :--- | :--- | | 2021 | $71 | | 2020 | $141 | | 2019 | $195 | Liquidity, Market and Credit Risks The company's funding relies on capital markets, securitization, and deposits, exposing it to market conditions and interest rate fluctuations - The company's primary funding sources are customer collections, deposits, securitized financings, and unsecured borrowings, with adverse financial market conditions potentially limiting access[140][141] - A significant source of funding is the securitization of credit card loans, and the inability to access this market could materially impact operations and profitability[143][144] - Customer deposits are another key funding source, totaling $11.0 billion at year-end 2021, with intense competition and regulatory restrictions potentially impacting availability and cost[151][156] - The company is exposed to interest rate risk, as the prime rate and LIBOR/federal funds rate may not move in tandem, with the planned discontinuance of LIBOR presenting additional risk[161][162][164] Legal, Regulatory and Compliance Risks The company is subject to comprehensive government regulation and supervision, which may impose costs, limitations, and capital requirements - The business is subject to comprehensive government regulation and supervision by federal and state authorities, including the FDIC, with changes in laws potentially leading to additional costs and limitations[174][175] - The company's subsidiary banks are subject to extensive regulation that may restrict their ability to pay dividends to the parent company and may require capital contributions[185][186][187] - As the parent of insured depository institutions, Alliance Data is required to serve as a "source of financial strength" to its banks, potentially requiring financial assistance during times of stress[188] - Regulations related to privacy, data protection, and cybersecurity are evolving and could increase costs, limit business opportunities, and result in significant penalties for noncompliance[197][198] Cybersecurity, Technology and Vendor Risks The company faces risks from reliance on third-party vendors, data protection failures, and the need for continuous technological investment - The company relies on third-party vendors and is transitioning key services to strategic partners, which presents risks such as implementation delays, data loss, and cost overruns[212][214] - Failures in data protection, cybersecurity, and information security could critically impair products and services, with risks increasing due to new technologies and sophisticated threat actors[215][216] - The industry is subject to rapid technological change, and failure to invest successfully in new technologies like AI, machine learning, and alternative payment mechanisms could harm the company's competitive position[219][220][221] Risks Related to the LoyaltyOne Spinoff The company may not achieve anticipated benefits from the spinoff and faces risks related to its retained stake and potential tax liabilities - The company may not achieve all anticipated benefits from the spinoff, and as a smaller, less diversified business, it may be more vulnerable to market and economic changes[224][225] - The company's retained 19% stake in Loyalty Ventures Inc. is subject to the spun-off company's performance, which recently recognized a $50 million non-cash goodwill impairment charge[225] - The spinoff could result in substantial tax liability to the company and its stockholders if determined to be taxable, despite receiving a favorable tax opinion and IRS private letter ruling[226][227] Properties As of December 31, 2021, the company leased 14 general office properties totaling approximately 1 million square feet, deemed suitable for its business needs Principal Leased Facilities | Location | Square Feet | Lease Expiration | | :--- | :--- | :--- | | Columbus, Ohio | 326,354 | Sep 12, 2032 | | Coeur D'Alene, Idaho | 114,000 | Jul 31, 2038 | | Columbus, Ohio | 103,161 | Dec 31, 2027 | | Draper, Utah | 22,869 | Aug 31, 2031 | | Plano, Texas | 27,925 | Jun 30, 2026 | Legal Proceedings The company is involved in various claims and lawsuits arising in the ordinary course of business, not expected to materially affect its financial condition - The company is periodically involved in various claims and lawsuits arising in the ordinary course of business, which are not expected to have a material effect on its financial condition[259] Part II Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities The company's common stock trades on the NYSE under "ADS," with 49,948,146 shares outstanding as of February 18, 2022, and a quarterly dividend of $0.21 per share declared in January 2022 - Common stock is listed on the NYSE under the symbol "ADS," with 49,948,146 shares outstanding as of February 18, 2022[265] - On January 27, 2022, the Board of Directors declared a quarterly cash dividend of $0.21 per share[267] - No shares were purchased as part of a publicly announced repurchase plan or program during the three months ended December 31, 2021[268][271] Management's Discussion and Analysis of Financial Condition and Results of Operations MD&A reviews 2021 financial performance post-spinoff, highlighting reduced credit losses and outlining the 2022 outlook - Following the November 5, 2021 spinoff of the LoyaltyOne segment, the company adjusted its financial statement presentation to align with bank holding companies and now operates as a single segment[279][280] - The 2022 outlook anticipates high-single- to low-double-digit growth in average Total credit card and other loans, with a net loss rate expected in the low-to-mid 5% range as credit metrics normalize[286][285] - The company plans an incremental strategic investment of over $125 million in 2022 for digital/product innovation, marketing, and technology, expected to increase total non-interest expenses[287] - The company's contract with BJ's Wholesale Club was not renewed, which accounted for approximately 8% of total net interest and non-interest income and 11% of total credit card and other loans in 2021[286] Consolidated Results of Operations In 2021, the company reported $801 million in net income, driven by a significant decrease in the provision for credit losses and moderate reduction in non-interest expenses Financial Performance Summary (in millions, except per share data) | Metric | 2021 | 2020 | 2019 | | :--- | :--- | :--- | :--- | | Total net interest and non-interest income | $3,272 | $3,298 | $4,050 | | Provision for credit losses | $544 | $1,266 | $1,188 | | Total non-interest expenses | $1,684 | $1,731 | $2,200 | | Income from continuing operations | $797 | $208 | $506 | | Net income | $801 | $214 | $278 | | Diluted EPS from continuing operations | $15.95 | $4.35 | $9.94 | - The Provision for credit losses decreased by $722 million (57%) in 2021 compared to 2020, driven by lower net charge-offs and an improved macroeconomic outlook, with 2020 being higher due to COVID-19 reserve build and CECL adoption[303] - Total non-interest expenses decreased by $47 million (3%) in 2021, primarily due to a $73 million reduction in card and processing expenses, partially offset by a $62 million increase in employee compensation[311][312] Asset Quality Asset quality improved in 2021, with total delinquency rates decreasing to 3.9% and net charge-off rates falling to 4.6% Delinquency Trends on Credit Card and Other Loans (Principal Balance) | Delinquency Status | Dec 31, 2021 | Dec 31, 2020 | | :--- | :--- | :--- | | 31 to 60 days | 1.3% | 1.4% | | 61 to 90 days | 0.9% | 1.0% | | 91 or more days | 1.7% | 2.0% | | Total Delinquent | 3.9% | 4.4% | Net Charge-Offs on Credit Card and Other Loans | Metric | 2021 | 2020 | 2019 | | :--- | :--- | :--- | :--- | | Average credit card and other loans (in millions) | $15,656 | $16,367 | $17,298 | | Net charge-offs of principal balances (in millions) | $720 | $1,083 | $1,055 | | Net charge-off rate | 4.6% | 6.6% | 6.1% | - As of December 31, 2021, approximately $86 million in credit card loans were under a COVID-19 related forbearance program, down from $157 million at year-end 2020[328] Consolidated Liquidity and Capital Resources The company's liquidity is supported by operations, credit facilities, securitization, and deposits, with strong capital ratios post-spinoff - Primary sources of liquidity include cash from operations, a credit agreement, debt securities, securitization programs, and deposits, with $1.54 billion cash from operations in 2021[333][337][338] - Following the LoyaltyOne spinoff, the company used $725 million of proceeds to repay term loans, with $658 million remaining outstanding and a $750 million revolving line of credit undrawn as of December 31, 2021[343][344] Funding Sources (as of Dec 31, 2021) | Source | Amount (in billions) | | :--- | :--- | | Total Deposits | $11.0 | | Securitized Credit Card Loans | $11.2 | | Debt issued by consolidated VIEs | $5.5 | | Long-term and other debt | $2.0 | Combined Banks Capital Ratios (as of Dec 31, 2021) | Ratio | Actual Ratio | Minimum to be Well Capitalized | | :--- | :--- | :--- | | Tier 1 capital to average assets | 18.6% | 5.0% | | Common Equity Tier 1 capital to risk-weighted assets | 20.0% | 6.5% | | Tier 1 capital to risk-weighted assets | 20.0% | 8.0% | | Total capital to risk-weighted assets | 21.3% | 10.0% | Discussion of Critical Accounting Estimates The Allowance for Credit Losses is the most critical accounting estimate, significantly influenced by the CECL model, economic forecasts, and qualitative adjustments - The most critical accounting estimate is the Allowance for Credit Losses, determined using the Current Expected Credit Loss (CECL) model, influenced by portfolio characteristics, economic forecasts, and qualitative adjustments[371][372] - The CECL model utilizes historical data and macroeconomic variables, with management incorporating qualitative overlays to address uncaptured risks, particularly related to the macroeconomic environment and the COVID-19 pandemic[372][373] - A hypothetical 100 basis point (1.0%) increase in the Allowance as a percentage of loans would have resulted in a change of approximately $171 million in the Allowance for Credit Losses at December 31, 2021[374] Controls and Procedures Management concluded that disclosure controls and internal control over financial reporting were effective as of December 31, 2021, with an unqualified auditor opinion - Management, including the CEO and CFO, evaluated and concluded that the company's disclosure controls and procedures were effective as of December 31, 2021[380][381] - Management assessed internal control over financial reporting using the COSO framework and concluded that it was effective as of December 31, 2021[385] - The independent registered public accounting firm, Deloitte & Touche LLP, provided an unqualified attestation report on the effectiveness of the company's internal control over financial reporting[386] Part III Items 10-14 Information required for Part III, Items 10 through 14, is incorporated by reference from the company's forthcoming 2022 Proxy Statement - Information for Item 10 (Directors, Executive Officers and Corporate Governance), Item 11 (Executive Compensation), Item 12 (Security Ownership), Item 13 (Certain Relationships and Related Transactions), and Item 14 (Principal Accounting Fees and Services) is incorporated by reference from the forthcoming 2022 Proxy Statement[388][389][390][391] Part IV Exhibits, Financial Statement Schedules This section lists the financial statements, financial statement schedules, and exhibits filed as part of the Form 10-K, with schedules omitted if not applicable or included elsewhere - This section contains the list of financial statements and exhibits filed with the Form 10-K, with financial statement schedules omitted if not applicable or included in the consolidated financial statements[392][393] Financial Statements and Notes Reports of Independent Registered Public Accounting Firm Deloitte & Touche LLP issued an unqualified opinion on the consolidated financial statements and internal control over financial reporting, highlighting the CECL adoption and LoyaltyOne spinoff - The auditor, Deloitte & Touche LLP, issued an unqualified opinion on the financial statements, confirming they are presented fairly in conformity with U.S. GAAP[413] - The audit report includes an Emphasis of Matter paragraph noting the classification of the LoyaltyOne segment as a discontinued operation and the change in financial statement presentation to the bank holding company format (Article 9)[416] - The critical audit matter identified was the Allowance for Credit Losses, due to the significant and subjective management judgments required for its estimation under the CECL model, particularly regarding economic forecasts and qualitative adjustments[419][421][422] - The auditor also issued an unqualified opinion on the effectiveness of the Company's internal control over financial reporting as of December 31, 2021[424] Consolidated Financial Statements For 2021, the company reported $3.485 billion in net interest income, $797 million in income from continuing operations, and $21.7 billion in total assets Consolidated Statement of Income Highlights (2021, in millions) | Line Item | Amount | | :--- | :--- | | Net Interest Income | $3,485 | | Provision for credit losses | $544 | | Total non-interest expenses | $1,684 | | Income from continuing operations | $797 | | Net Income | $801 | Consolidated Balance Sheet Highlights (Dec 31, 2021, in millions) | Line Item | Amount | | :--- | :--- | | Assets | | | Cash and cash equivalents | $3,046 | | Credit card and other loans, net | $15,567 | | Total Assets | $21,746 | | Liabilities & Equity | | | Deposits | $11,027 | | Total Debt | $7,439 | | Total Liabilities | $19,660 | | Total Stockholders' Equity | $2,086 | Notes to Consolidated Financial Statements The notes provide detailed disclosures on accounting policies, including the LoyaltyOne spinoff, Bread acquisition, credit loan portfolio, CECL allowance, and regulatory capital Note 2. Acquisitions On December 3, 2020, the company acquired Lon Inc. (Bread) for $491 million net of cash, recognizing significant goodwill and developed technology - On December 3, 2020, the company acquired 100% of Lon Inc. (Bread) for total consideration of $491 million (net of cash acquired), consisting of cash, equity, and deferred cash[472][473] Bread Acquisition - Fair Value of Net Assets Acquired (in millions) | Assets/Liabilities | Fair Value | | :--- | :--- | | Goodwill | $370 | | Developed technology | $91 | | Installment loans | $112 | | Intangible assets | $11 | | Total liabilities assumed | ($104) | | Other net assets | $11 | | Net assets acquired | $491 | Note 3. Credit Card and Other Loans Net credit card and other loans increased to $15,567 million in 2021, with 62% of the portfolio having a Vantage Score of 661 or higher Credit Card and Other Loans, Net (as of Dec 31, in millions) | Component | 2021 | 2020 | | :--- | :--- | :--- | | Credit card loans | $17,217 | $16,666 | | Installment loans | $182 | $118 | | Total loans | $17,399 | $16,784 | | Less: Allowance for credit losses | ($1,832) | ($2,008) | | Credit card and other loans, net | $15,567 | $14,776 | Credit Quality by Vantage Score (as of Dec 31) | Vantage Score | 2021 % of Portfolio | 2020 % of Portfolio | | :--- | :--- | :--- | | 661 or Higher | 62% | 60% | | 601 to 660 | 26% | 28% | | 600 or Less | 12% | 12% | - Unused credit card lines available to cardholders totaled approximately $112 billion at December 31, 2021, up from $108 billion at year-end 2020[492] Note 4. Allowance for Credit Losses The allowance for credit losses, estimated using a CECL model, decreased in 2021 due to improved credit performance and macroeconomic variables - The allowance for credit losses is estimated using a CECL model, which considers historical experience, current conditions, and reasonable forecasts of future economic conditions over the estimated life of the loans[496][497] Allowance for Credit Losses Rollforward (in millions) | Description | 2021 | 2020 | | :--- | :--- | :--- | | Beginning balance | $2,008 | $1,171 | | CECL adoption impact | - | $644 | | Provision for credit losses | $544 | $1,266 | | Net principal charge-offs | ($720) | ($1,083) | | Other | - | $10 | | Ending balance | $1,832 | $2,008 | - The decrease in the allowance in 2021 was due to improved credit performance, lower net charge-offs, and improving macroeconomic variables, while the 2020 increase was driven by CECL adoption and COVID-19 economic outlook[504] Note 11. Borrowings of Long-term and Other Debt Total borrowings were $18.466 billion as of December 31, 2021, primarily from deposits and debt issued by consolidated VIEs, with credit agreement maturity extended to July 2024 Total Borrowings Summary (as of Dec 31, in millions) | Category | 2021 | 2020 | | :--- | :--- | :--- | | Long-term and other debt | $1,986 | $2,806 | | Deposits | $11,027 | $9,793 | | Debt issued by consolidated VIEs | $5,453 | $5,710 | | Total Borrowings | $18,466 | $18,309 | - In July 2021, the company amended its credit agreement, extending the maturity of most of its term loans and its revolving credit facility to July 2024[542] - As of December 31, 2021, the company had two series of senior notes outstanding: $850 million of 4.750% notes due 2024 and $500 million of 7.000% notes due 2026[543][544][545] Note 22. Discontinued Operations and Bank Holding Company Financial Presentation On November 5, 2021, the company completed the spinoff of its LoyaltyOne segment, distributing 81% of shares and retaining 19%, and adjusted its financial presentation to a bank holding company format - On November 5, 2021, the company completed the spinoff of its LoyaltyOne segment into Loyalty Ventures Inc., distributing 81% of shares to stockholders and retaining a 19% stake accounted for using the equity method[623] - In connection with the spinoff, Alliance Data received a $750 million distribution from Loyalty Ventures, which was used to repay term loans[623] - The note provides a detailed reconciliation of the company's historical financial statement presentation (Article 5) to the new bank holding company presentation (Article 9) for 2020 and 2019, showing discontinued operations removal and reclassifications[638][639]