Bread Financial Faces Challenges as It Looks to Resume Growth After Spinning Off Assets

Business Strategy & Outlook

After the sale of Epsilon in 2019 and spinoff of LoyaltyOne in 2021, Bread Financial is now solely a consumer credit company, with its private label credit cards and buy now-pay later businesses being its only two product lines. However, Bread’s retail credit card business is under pressure. The company has historically targeted midsize retailers for its partnerships. This strategy has led to a partnership base that is weighted toward mall-based retailers, which are in decline due to increased online shopping. Many of Bread’s retail partners have already filed for bankruptcy, including the Ascena Retail Group in July 2020 and Forever 21 in 2019. Bread has also suffered defections, losing Wayfair and Meijer to Citi in 2020 and BJ’s Wholesale Club to Capital One at the start of 2022. The retail partner loss is an ongoing threat to Bread as the firm does not have a competitive advantage that would give it an edge in retaining partnerships during contract renewal negotiations.

Bread must also now contend with rising competitive threats from buy now-pay later firms, which are targeting the U.S. retail market and seek to sign agreements with Bread’s partners. These firms are still a relatively small part of U.S. retail, but Bread takes the threat seriously. The company’s acquisition of the original Bread, a buy now pay later company, as well its decision to adopt its name as its own was done with the intent of accelerating the deployment of its own competing offering. As part of the spinoff of LoyaltyOne, Bread used the proceeds from the transaction to reduce its considerable debt load. This strategy favorably as Bread is heavily leveraged, especially when considering the low credit quality of its receivable portfolio, which has historically seen net charge-offs well above industry averages. More needs to be done to put Bread in a good financial position, but the spinoff and the related debt reduction are a material improvement to Bread’s balance sheet. However, this does place Bread in an awkward position should credit conditions deteriorate industry wide, as the bank is among the most credit sensitive firms that cover.

Financial Strengths

When viewed as a single consolidated company, Bread Financial is a heavily leveraged firm. Bread finished 2021 with a tangible asset to tangible equity ratio of 15.1. The company accomplished this leverage by holding its banks as subsidiaries and keeping around $2 billion of its debt at the parent level. With the spinoff of LoyaltyOne now complete there are no longer any revenue-generating assets held at the parent level, and Bread will need to reconsolidate itself as a single entity or have its subsidiary banks make regular distributions up to the parent company to support its debt. The banks themselves are well capitalized with $3.3 billion in equity and a combined common equity Tier 1 ratio of 20.1% as of the end of June 2022. However, the banks are guarantors of the parent company’s debt, and the company will likely have to rely on further distributions from the banks. The degree of leverage also restricts Bread’s flexibility to invest in its businesses and respond to competitive threats. One of the key reasons that Bread sold its Epsilon business was that the firm did not believe it had the ability to make the kind of investments necessary to support the enterprise. There is precious little room for the company to maneuver, and its debt costs have already risen. In late 2020, the company issued 7% unrated debt to do a partial paydown of its credit line, which at the time was costing the company roughly 1.9%. The debt paydown that was a part of the LoyaltyOne spinoff, and in the future, one would like to see the company continue to manage its debt levels, particularly as economic fears intensify.

Bulls Say

Bread Financial’s restructuring efforts have been highly successful at reducing the company’s costs. This has allowed it to adjust effectively for its smaller size and retain profitability.
Many of Bread Financial’s partners rely on it for data collection and loyalty programs. Switching costs protect these partnerships from competitive threats.
The company’s credit card business is well capitalized, which will help protect the firm if credit results deteriorate.

Company Description

Formed by a combination of J.C. Penney’s credit card processing unit and The Limited’s credit card bank business, Bread Financial is a provider of private label and co-branded credit cards, loyalty programs, and marketing services. The company’s most financially significant unit is its credit card business that partners with retailers to jointly market Bread’s credit cards to their customers. The company also retains minority interest in its recently spun off LoyaltyOne division, which operates the largest airline miles loyalty program in Canada and offers marketing services to grocery chains in Europe and Asia.

(Source: Morningstar)

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