Bread Financial Stock: Upside Potential Beyond 52 Week High (NYSE:BFH)

Bread Financial (NYSE:BFH) is a depositor bank that specializes in consumer loans. The bank is different from some consumer lenders like OneMain Financial (OMF) who source their funds from external debt versus depositors. The lender has experienced a strong appreciation in share price over the last six months and currently sits near a 52-week high. Based on Bread’s current financial performance, I believe that further upside in share price is likely.

BFH’s First Quarter Earnings Performance

Bread Financial is dealing with many of the same challenges as other banks with higher interest rates hurting the expense side of funding and lower loan demand hurting the income side. Interest income declined slightly in the first quarter compared to the same period a year ago and interest expenses rose by nearly 15%. Ultimately, net interest income (interest income less interest expense) fell by $65 million to $1.05 billion. When it comes to noninterest income and expenses, noninterest expenses did decline year over year as the company managed to control its labor and overhead expenses very well, but the variance created by the gain on the sale of assets a year ago led to net income being more than $300 million lower at $134 million.

Bread Financial’s balance sheet highlights the lender’s capital structure and what makes it unique. The lender sources more than $13 billion of its $19 billion in liabilities from depositors, which is a cheaper source of funds than external debt, which accounts for $4.6 billion (down from $5.2 billion at the end of 2023). Bread Financial has seen its total loan portfolio drop by $1.1 billion but has built its cash balance up to $3.8 billion and has over $2.2 billion in credit loss allowances. Shareholder equity inched up in the first quarter to over $3 billion.

The cash flow statement highlights the company’s use of its cash in the first quarter. For the quarter, Bread generated nearly $1.2 billion from a combination of operations and principal payments on personal credit loans. Of that $1.2 billion, Bread used $600 million to pay down debt, $300 million to cover the reduction in deposits, and $300 million to build its cash balance. While many investors may become concerned when a bank has a drop in lending and deposits, Bread is demonstrating that it can manage these shifts in liquidity with ease.

Navigating the Interest Rate Environment

Bread Financial is in a rather unique position within the banking industry. The company can procure low interest expense funds through depositors and make high interest loans using credit cards and personal loans. Despite the drop in deposits, Bread has managed to be competitive with the interest rates it offers to depositors and control its overall liability costs, which remain under 5.5%.

Despite the increase in interest rates, Bread Financial has managed to lend at steady rates to its customers with loan yields rising modestly over the past two years. Consequently, the lender has managed to keep its net interest margin stable through the same period. Analysts are not concerned about higher interest rates potentially affecting earnings as they are projecting Bread Financial’s earnings to rise to $6.47 per share in 2025.

Delinquencies and Losses Are the Main Risk

The biggest risk to Bread Financial’s earnings outlook is delinquencies and losses on their loans. Should the economy cool off and unemployment rise, credit cards and consumer loans tend to be the first and hardest hit areas of lending. Bread Financial has had earnings success despite a slow climb in delinquencies to 6.5% at the end of 2023, which pulled back in the first quarter. Net loss rates continue to rise above their 15-year average but remain 150 basis points below their 2009 levels.

One indicator that gives some comfort to the growing concern of the nonperforming loans is the analysis of borrowers by credit score. Currently, 56% of Bread Financial’s loans are to customers with a credit rating above 660, which is considered healthy. Only 17% of the lender’s loans are to customers with a credit rating below 600.

Two Ways To Take a Long Position

While many investors may be fine jumping straight in and buying shares near their 52-week high, others may be a little more hesitant and want to wait for a pullback. One way to wait and still collect income would be to sell cash secured put options. For Bread Financial, cash secured puts are currently being sold at the $35 per share strike price.

While the June and September options have little to no liquidity, there is some volume in the December options, with a recent trade of $2.38 per share. This isn’t bad considering it represents a return of 5.68% of current share price in less than seven months or 12% annualized return based on the cash securing the trade.

Conclusion

Bread Financial has been unfazed by the volatility of interest rates over the past two years. The company has been able to generate solid earnings and cash flows while not having to borrow excessively or significantly raise its lending rates. The lender managed easily through a drop in deposits and loans in the first quarter by paying down debt and increasing its cash position. The options market also offers an opportunity to reserve a spot at a lower price while simultaneously generating income. Whichever option investors go with, Bread Financial offers them a good opportunity for returns over the long haul.