Bread Earnings: Continued Progress on Deleveraging, While Wide Net Interest Margins Support Results

No-moat-rated Bread Financial BFH reported solid third-quarter results that came in better than we had expected, as the company benefited from a surprisingly high net interest margin. The bank’s net interest income rose 5% from last year to $1.03 billion despite the sale of the BJ’s Wholesale portfolio earlier this year. Meanwhile, Bread’s net income rose 29% to $173 million, which translates to a return on average equity of 28.7%. As we incorporate these results, we do not plan to change our $50 fair value estimate for Bread, and we see the shares as materially undervalued.

The increase in net interest income was primarily driven by margin expansion, as Bread’s average credit card receivables was flat at $17.5 billion. While much of Bread’s stagnant loan levels can be attributed to the sale of the BJ’s Wholesale portfolio, difficult economic conditions for many of Bread’s cardholders is also likely playing a role. Credit sales decreased 13% year over year and 5.5% from last quarter as inflationary pressure squeezes the spending power of many of Bread’s lower-income cardholders. Low spending on Bread’s cards will impede loan growth, which we expect to remain weak in the short to medium term.

Low loan growth was offset by Bread’s net interest margin expanding to 20.6% from 18.7% last quarter to 19.9%, which was the primary reason behind Bread’s strong quarter. That said, the third quarter tends to be a seasonal peak for the bank’s NIM, and the metric did benefit from there being less transactional activity on its cards. We do expect Bread’s NIM to fall sequentially, though it should stay in the 19%-20% range.

On a more positive note, Bread has made impressive progress in improving its balance sheet. The bank now has a firmwide common equity Tier 1 ratio of 12.9%, up from 11.5% last year. The bank continues to reduce parent company-level debt, which is now down to $1.4 billion from $2 billion last year and nearly $3 billion in 2021.