Item 2. Management’s Discussion and Analysis
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
The following discussion should be read in conjunction with the unaudited condensed consolidated financial statements and related notes thereto presented in this quarterly report and the consolidated financial statements and related notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2020, filed with the Securities and Exchange Commission, or SEC, on February 26, 2021.
2021 Recent Developments
● For the nine months ended September 30, 2021, as compared to the nine months ended September 30, 2020:
● Revenue decreased $215.0 million, or 6%, to $3,196.5 million.
● Provision for loan loss decreased $933.4 million, or 84%, to $180.3 million.
● Income before income taxes increased $808.5 million, or 326%, to $1,056.8 million.
● Net income increased $581.7 million, or 288%, to $783.4 million.
● Effective July 6, 2021, Perry Beberman joined the Company as Executive Vice President and Chief Financial Officer.
Planned Spinoff of our LoyaltyOne Segment
On October 13, 2021, the Board of Directors of Alliance Data Systems Corporation, or ADSC, approved the previously announced separation (the “Separation”) of its LoyaltyOne segment, consisting of its Canadian AIR MILES® Reward Program and Netherlands-based BrandLoyalty businesses, into an independent, publicly traded company, Loyalty Ventures Inc. listed on Nasdaq under the symbol “LYLT” (“Loyalty Ventures”). The Separation will be completed through the pro rata distribution of 81% of the outstanding shares of Loyalty Ventures to holders of ADSC’s common stock at the close of business on the record date of October 27, 2021, with ADSC retaining the remaining 19% of the outstanding shares of Loyalty Ventures. ADSC stockholders of record at the close of business on October 27, 2021 will receive one share of Loyalty Ventures common stock for every two and one-half (2.5) shares of ADSC common stock.
The distribution is expected to qualify as a tax-free reorganization and a tax-free distribution to ADSC and its stockholders for U.S. federal income tax purposes and is expected to be completed on November 5, 2021.
The completion of the distribution is subject to a number of customary conditions, including ADSC’s receipt of an opinion from its tax advisor confirming that the distribution qualifies as tax-free for U.S. federal income tax purposes for ADSC and its stockholders (except for cash received in lieu of fractional shares). ADSC has received a private letter ruling from the Internal Revenue Service to this effect. The ADSC Board reserves the right in its discretion to delay the distribution, change any of the terms relating to the distribution, or abandon the distribution.
COVID-19 Update
Following the declaration by the WHO in the first quarter of 2020 of COVID-19 as a global pandemic and the rapid spread of COVID-19, international, provincial, federal, state and local government or other authorities have imposed varying degrees of restrictions on social and commercial activity in an effort to improve health and safety. As the global COVID-19 pandemic has continued to evolve, our priority has been and continues to be, the health and safety of our employees, with the vast majority of our employees continuing to work from home.
We continue to see sequential improvement in business conditions. Credit performance remained strong, attributable to our prudent risk management strategy changes, deliberate underwriting actions, and direct consumer stimulus payments resulting in greater customer liquidity and ability to pay. For the three months ended September 30, 2021, our net loss rate was 3.9%, with a delinquency rate of 3.8% for the period ended September 30, 2021. For the three months ended September 30, 2020, our net loss rate was 5.8%, with a delinquency rate of 4.7% for the period ended September 30, 2020. For the year ended December 31, 2021, we expect our credit sales to increase at a double-digit growth rate, and we expect a net loss rate in the high 4% range for the year. We expect credit metrics and payment rates to continue to moderate into 2022 as government stimulus programs expire.
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Index
AIR MILES Reward Program issuances and redemptions for the third quarter of 2021 increased 1% and 12%, respectively, as compared to the second quarter of 2021, while issuance declined 7% but redemptions increased 30%, respectively, as compared to the third quarter of 2020. The increase in redemptions can be attributed to the improvement in our travel-related categories. Issuance for the third quarter of 2021 was down due to timing of promotional activity. At BrandLoyalty, new program activity is increasing with consumers actively engaged in loyalty campaigns. However, both the varying degrees of restrictions impacting the U.K. and many Asian and European countries, as well as recent disruptions to port services in southern China amid COVID-19 resurgences exacerbating already challenged global supply chain conditions, have impacted our third quarter results and could negatively impact our results of operations in the fourth quarter of 2021.
Despite the availability of vaccines, surges in COVID-19 cases, including variants of the strain, may adversely impact the economic recovery and our industry outlook. We continue to evaluate the nature and extent of changes to the market and economic conditions related to the COVID-19 pandemic and current and potential impact on our business and financial position. However, given the dynamic nature of this situation, we cannot reasonably estimate the impacts of COVID-19 on our future results of operations or cash flows at this time.
Consolidated Results of Operations
Three Months Ended September 30,
Nine Months Ended September 30,
2021
2020
% Change
2021
2020
% Change
(in millions, except percentages)
Revenues
Services
$
10.5
$
24.7
(58)
%
$
70.4
$
109.2
(36)
%
Redemption, net
97.1
113.1
(14)
280.8
318.6
(12)
Finance charges, net
991.7
912.7
9
2,845.3
2,983.7
(5)
Total revenue
1,099.3
1,050.5
5
3,196.5
3,411.5
(6)
Operating expenses
Cost of operations (exclusive of depreciation and amortization disclosed separately below)
489.2
482.7
1
1,481.1
1,474.7
—
Provision for loan loss
161.1
207.7
(22)
180.3
1,113.7
(84)
General and administrative
34.5
29.0
19
78.6
73.2
7
Depreciation and other amortization
18.9
18.4
3
61.7
56.2
10
Amortization of purchased intangibles
12.8
21.7
(41)
35.5
64.1
(45)
Total operating expenses
716.5
759.5
(6)
1,837.2
2,781.9
(34)
Operating income
382.8
291.0
32
1,359.3
629.6
116
Interest expense
Securitization funding costs
26.0
37.5
(31)
89.9
130.1
(31)
Interest expense on deposits
37.3
52.9
(29)
124.7
172.1
(28)
Interest expense on long-term and other debt, net
28.8
24.7
16
87.9
79.1
11
Total interest expense, net
92.1
115.1
(20)
302.5
381.3
(21)
Income before income taxes
290.7
175.9
65
1,056.8
248.3
326
Provision for income taxes
67.0
42.6
57
273.4
46.6
487
Net income
$
223.7
$
133.3
68
%
$
783.4
$
201.7
288
%
Key Operating Metrics:
Credit sales
$
7,380.4
$
6,151.7
20
%
$
20,825.0
$
17,050.1
22
%
Average credit card and loan receivables
$
15,470.5
$
15,299.6
1
%
$
15,512.4
$
16,570.1
(6)
%
AIR MILES reward miles issued
1,155.2
1,239.7
(7)
%
3,406.1
3,608.6
(6)
%
AIR MILES reward miles redeemed
895.8
687.2
30
%
2,435.5
2,289.4
6
%
Three months ended September 30, 2021 compared to the three months ended September 30, 2020
Revenue . Total revenue increased $48.8 million, or 5%, to $1,099.3 million for the three months ended September 30, 2021 from $1,050.5 million for the three months ended September 30, 2020. The net increase was due to the following:
● Services . Revenue decreased $14.2 million, or 58%, to $10.5 million for the three months ended September 30 , 2021 due to a $9.2 million decrease in merchant fee revenue resulting from increased payments to our retailers as volumes increased from the prior year quarter. Additionally, revenue associated with servicing certain third-
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Index
party credit card receivables decreased $4.4 million for the three months ended September 30, 2021 as compared to the prior year quarter due to lower volumes of these third-party credit card receivables.
● Redemption, net . Revenue decreased $16.0 million, or 14%, to $97.1 million for the three months ended September 30, 2021, as redemption revenue from our short-term loyalty programs decreased $18.8 million due to the number and timing of programs in market due to the continuing impact of COVID-19.
● Finance charges, net . Revenue increased $79.0 million, or 9%, to $991.7 million for the three months ended September 30, 2021 due to the increase in finance charge yield of approximately 190 basis points, which increased revenue by $72.3 million, resulting from higher late fees as revenue in 2020 was impacted by consumer relief programs, and a decline in charge-offs for unpaid interest and fees of $51.6 million. Additionally, a 1% increase in average credit card and loan receivables including held for sale receivables, increased revenue $6.7 million.
Cost of operations . Cost of operations increased $6.5 million, or 1%, to $489.2 million for the three months ended September 30, 2021 as compared to $482.7 million for the three months ended September 30, 2020. The net increase was due to the following:
● Within the LoyaltyOne segment, cost of operations decreased $26.5 million (net of a gain on sale of an investment to an affiliate of the Company which was eliminated upon consolidation) due to a $22.7 million decrease in cost of redemptions resulting from the decline in redemption revenue discussed above and a $2.0 million decrease in payroll and benefits expense.
● Within the Card Services segment, cost of operations increased $33.1 million due to a $21.2 million increase in professional services expenses related to strategic initiatives, a $10.9 million increase in marketing expense as the prior year quarter was impacted by COVID-19 and an $8.2 million increase in data processing expense due to the processing platform migration. These increases were offset in part by a $10.2 million gain recognized on the sale of a credit card portfolio in August 2021.
Provision for loan loss . Provision for loan loss decreased $46.6 million, or 22%, to $161.1 million for the three months ended September 30, 2021 as compared to $207.7 million for the three months ended September 30, 2020. The decrease in the provision for loan loss in the current year quarter was due to improved credit performance and lower net charge-offs.
General and administrative . General and administrative expenses increased $5.5 million, or 19%, to $34.5 million for the three months ended September 30, 2021 as compared to $29.0 million for the three months ended September 30, 2020, due to a $3.3 million increase in payroll and benefits expense for higher medical claims and an increase in professional services expenses associated with the planned spinoff.
Depreciation and other amortization . Depreciation and other amortization increased $0.5 million, or 3%, to $18.9 million for the three months ended September 30, 2021 as compared to $18.4 million for the three months ended September 30, 2020, primarily due to an increase in amortization related to capitalized software, offset in part by a decrease in depreciation and amortization at our Card Services segment from the Company’s real estate optimization in 2020.
Amortization of purchased intangibles . Amortization of purchased intangibles decreased $8.9 million, or 41%, to $12.8 million for the three months ended September 30, 2021, as compared to $21.7 million for the three months ended September 30, 2020, primarily due to certain fully amortized intangible assets, including BrandLoyalty customer contracts, offset in part by $5.4 million in amortization of purchased intangibles associated with the acquisition of Bread in December 2020.
Interest expense, net . Total interest expense, net decreased $23.0 million, or 20%, to $92.1 million for the three months ended September 30, 2021 as compared to $115.1 million for the three months ended September 30, 2020. The net decrease was due to the following:
● Securitization funding costs . Securitization funding costs decreased $11.5 million due to lower average borrowings, which decreased funding costs by approximately $11.6 million, offset in part by higher average interest rates, which increased funding costs by approximately $0.1 million.
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Index
● Interest expense on deposits . Interest expense on deposits decreased $15.6 million due to lower average interest rates, which decreased funding costs by approximately $10.3 million, and lower average balances outstanding, which decreased funding costs by approximately $5.3 million.
● Interest expense on long-term and other debt, net . Interest expense on long-term and other debt, net increased $4.1 million primarily due to an $7.9 million increase in interest expense driven by the issuance of senior notes in September 2020, offset in part by a $2.7 million decrease in interest expense on term debt and a $1.9 million decrease in interest expense on the revolving line of credit due to lower average borrowings.
Taxes. Provision for income taxes increased $24.4 million to $67.0 million for the three months ended September 30, 2021 from $42.6 million for the three months ended September 30, 2020 due to an increase in income before income taxes. The effective tax rate for the three months ended September 30, 2021 was 23.0% as compared to 24.2% for the prior year quarter. The decrease in the effective tax rate for the three months ended September 30, 2021 as compared to the three months ended September 30, 2020 was primarily due to a discrete tax benefit related to a favorable settlement with a state tax authority in the third quarter of 2021.
Nine months ended September 30, 2021 compared to the nine months ended September 30, 2020
Revenue . Total revenue decreased $215.0 million, or 6%, to $3,196.5 million for the nine months ended September 30, 2021 from $3,411.5 million for the nine months ended September 30, 2020. The decrease was due to the following:
● Services . Revenue decreased $38.8 million, or 36%, to $70.4 million for the nine months ended September 30 , 2021 due to a $17.6 million decrease in merchant fee revenue due to increased payments to our retailers as volumes increased from the prior year and a $14.7 million decrease in other servicing fees charged to cardholders resulting from a decline in revenue from certain payment protection products.
● Redemption, net . Revenue decreased $37.8 million, or 12%, to $280.8 million for the nine months ended September 30, 2021 as redemption revenue from our short-term loyalty programs decreased $38.3 million due to the number and timing of programs in market that continued to be impacted by COVID-19, offset in part by favorability in foreign currency exchange rates.
● Finance charges, net . Revenue decreased $138.4 million, or 5%, to $2,845.3 million for the nine months ended September 30, 2021. The decline was due to a 7% decrease in average credit card and loan receivables including held for sale receivables, as payment rates continue to benefit from consumer economic stimulus, that decreased revenue by $212.9 million. This decrease was offset in part by the increase in finance charge yield of approximately 60 basis points, which increased revenue by $74.5 million.
Cost of operations . Cost of operations increased $6.4 million to $1,481.1 million for the nine months ended September 30, 2021 as compared to $1,474.7 million for the nine months ended September 30, 2020. The net increase was due to the following:
● Within the LoyaltyOne segment, cost of operations decreased $15.8 million (net of a gain on sale of an investment to an affiliate of the Company which was eliminated upon consolidation) due to a $35.3 million decrease in cost of redemptions due to the decline in redemption revenue discussed above. This decrease was offset in part by the gain on the sale of Precima in January 2020 that did not recur in the current year and a $3.9 million increase in payroll and benefits expense related to higher incentive compensation.
● Within the Card Services segment, cost of operations increased $22.3 million due to a $47.6 million increase in professional services expenses related to strategic initiatives, a $38.8 million increase in payroll and benefits expense due to our Bread acquisition in December 2020 and an increase in incentive compensation, a $27.3 million increase in marketing expense as the prior year was impacted by COVID-19 and a $16.0 million increase in data processing expense due to the Fiserv core processing platform migration. These increases were offset in part by a $71.2 million reduction in fraud losses and $34.2 million in asset impairment charges recorded in the second quarter of 2020 that did not recur in the current year.
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Index
Provision for loan loss . Provision for loan loss decreased $933.4 million, or 84%, to $180.3 million for the nine months ended September 30, 2021 as compared to $1,113.7 million for the nine months ended September 30, 2020. The decrease in the provision for loan loss in the current year was due to improved credit performance, lower net charge-offs and improving macroeconomic variables. For the nine months ended September 30, 2020, there was a significant increase in the provision due to a reserve build in the allowance for loan loss associated with the deterioration of the global macroeconomic outlook as a result of the onset of COVID-19.
General and administrative . General and administrative expenses increased $5.4 million, or 7%, to $78.6 million for the nine months ended September 30, 2021 as compared to $73.2 million for the nine months ended September 30, 2020, due to higher data processing expenses and an increase in professional services expenses associated with the planned spinoff.
Depreciation and other amortization . Depreciation and other amortization increased $5.5 million, or 10%, to $61.7 million for the nine months ended September 30, 2021 as compared to $56.2 million for the nine months ended September 30, 2020, primarily due to an increase in depreciation and amortization of $5.5 million in our LoyaltyOne segment driven by previous investments in digital technology.
Amortization of purchased intangibles . Amortization of purchased intangibles decreased $28.6 million, or 45%, to $35.5 million for the nine months ended September 30, 2021, as compared to $64.1 million for the nine months ended September 30, 2020, primarily due to certain fully amortized intangible assets, including BrandLoyalty customer contracts, offset in part by $16.2 million in amortization of purchased intangibles associated with the acquisition of Bread in December 2020.
Interest expense, net . Total interest expense, net decreased $78.8 million, or 21%, to $302.5 million for the nine months ended September 30, 2021 as compared to $381.3 million for the nine months ended September 30, 2020. The net decrease was due to the following:
● Securitization funding costs . Securitization funding costs decreased $40.2 million due to lower average borrowings, which decreased funding costs by approximately $39.0 million, and lower average interest rates, which decreased funding costs by approximately $1.2 million.
● Interest expense on deposits . Interest expense on deposits decreased $47.4 million due to lower average balances outstanding, which decreased funding costs by approximately $25.3 million, and lower average interest rates, which decreased funding costs by approximately $22.1 million.
● Interest expense on long-term and other debt, net . Interest expense on long-term and other debt, net increased $8.8 million primarily due to a $25.4 million increase in interest expense associated with the issuance of senior notes in September 2020, offset in part by a $16.2 million decrease in interest expense on term debt due to lower average borrowings.
Taxes. Provision for income taxes increased $226.8 million to $273.4 million for the nine months ended September 30, 2021 from $46.6 million for the nine months ended September 30, 2020 due to an increase in income before income taxes. The effective tax rate for the nine months ended September 30, 2021 was 25.9% as compared to 18.8% for the prior year. The increase in the effective tax rate for the nine months ended September 30, 2021 as compared to the nine months ended September 30, 2020 was primarily due to greater discrete tax benefits recorded in the prior year, which included the expiration of statutes of limitation related to certain foreign tax matters, a favorable state tax settlement and a benefit related to the issuance of final regulations on the Global Intangible Low-Taxed Income, or GILTI, high tax exception.
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Index
Segment Revenue and Income (Loss) Before Income Taxes
Three Months Ended September 30,
Nine Months Ended September 30,
2021
2020
% Change
2021
2020
% Change
(in millions, except percentages)
Revenue:
LoyaltyOne
$
169.3
$
184.8
(8)
%
$
496.7
$
533.9
(7)
%
Card Services
930.0
865.7
7
2,699.8
2,877.5
(6)
Corporate/Other
—
—
—
—
0.1
nm
*
Total
$
1,099.3
$
1,050.5
5
%
$
3,196.5
$
3,411.5
(6)
%
Income (Loss) Before Income Taxes
LoyaltyOne
$
44.5
$
18.3
143
%
$
100.7
$
88.9
13
%
Card Services
314.2
212.1
48
1,128.5
314.5
259
Corporate/Other
(63.9)
(54.5)
17
(168.3)
(155.1)
9
Eliminations
(4.1)
—
nm
*
(4.1)
—
nm
*
Total
$
290.7
$
175.9
65
%
$
1,056.8
$
248.3
326
%
*
not meaningful
Three months ended September 30, 2021 compared to the three months ended September 30, 2020
Revenue . Total revenue increased $48.8 million, or 5%, to $1,099.3 million for the three months ended September 30, 2021 from $1,050.5 million for the three months ended September 30, 2020. The net increase was due to the following:
● LoyaltyOne . Revenue decreased $15.5 million, or 8%, to $169.3 million for the three months ended September 30, 2021, as revenue from our short-term loyalty programs decreased $21.2 million due to the continued impact of the pandemic, offset in part by a $5.7 million increase in revenue from our coalition program driven by a 30% increase in AIR MILES reward miles redeemed.
● Card Services . Revenue increased $64.3 million, or 7%, to $930.0 million for the three months ended September 30, 2021 , driven by a $79.0 million increase in finance charges, net primarily due to the increase in finance charge yield resulting from higher late fees as revenue in 2020 was impacted by consumer relief programs, and the decline in charge-offs for unpaid interest and fees by $51.6 million. The increase in Card Services revenue was offset in part by a $9.2 million decrease in merchant fee revenue resulting from increased payments to our retailers as both credit sales and volumes increased from the prior year quarter.
Income Before Income Taxes . Income before income taxes increased $114.8 million, or 65%, to $290.7 million for the three months ended September 30, 2021 from $175.9 million for the three months ended September 30, 2020. The net increase was due to the following:
● LoyaltyOne . Income before income taxes increased $26.2 million, or 143%, to $44.5 million for the three months ended September 30, 2021. The increase in income before income taxes was due to a $12.1 million decrease in amortization of purchased intangibles due to certain fully amortized intangible assets, a $4.1 million gain on sale of an investment to an affiliate of the Company that was eliminated upon consolidation and net margin improvement from our short-term loyalty programs, offset in part by the decrease in revenue discussed above.
● Card Services . Income before income taxes increased $102.1 million, or 48%, to $314.2 million for the three months ended September 30, 2021 resulting from a $46.6 million decrease in the provision for loan loss due to improved credit performance, a $27.1 million decrease in interest expense, net due to lower average balances and the increase in revenue discussed above.
● Corporate/Other . Loss before income taxes increased $9.4 million for the three months ended September 30, 2021 due to an increase in payroll and benefits expense for higher medical claims and an increase in interest expense associated with the issuance of senior notes in September 2020.
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Index
Nine months ended September 30, 2021 compared to the nine months ended September 30, 2020
Revenue . Total revenue decreased $215.0 million, or 6%, to $3,196.5 million for the nine months ended September 30, 2021 from $3,411.5 million for the nine months ended September 30, 2020. The decrease was due to the following:
● LoyaltyOne . Revenue decreased $37.2 million, or 7%, to $496.7 million for the nine months ended September 30, 2021 as revenue from our short-term loyalty programs decreased $44.0 million due to a decline in programs in market across most regions with the impact of COVID-19. This decrease was offset in part by an increase of $6.8 million in revenue from our coalition program driven by a 6% increase in AIR MILES reward miles redeemed and favorability in foreign currency exchange rates.
● Card Services . Revenue decreased $177.7 million, or 6%, to $2,699.8 million for the nine months ended September 30, 2021 , driven by a $138.4 million decrease in finance charges, net due to a decline in credit card and loan receivables as payment rates continue to benefit from consumer economic stimulus, a $17.6 million decrease in merchant fee revenue due to increased payments to our retailers and a $14.7 million decrease in other servicing fees charged to cardholders, resulting from a decline in revenue from certain payment protection products.
Income Before Income Taxes . Income before income taxes increased $808.5 million, or 326%, to $1,056.8 million for the nine months ended September 30, 2021 from $248.3 million for the nine months ended September 30, 2020. The net increase was due to the following:
● LoyaltyOne . Income before income taxes increased $11.8 million, or 13%, to $100.7 million for the nine months ended September 30, 2021. The increase in income before income taxes was due to a $34.9 million decrease in amortization of purchased intangibles due to certain fully amortized intangible assets, a $4.1 million gain on sale of an investment to an affiliate of the Company that was eliminated upon consolidation and net margin improvement from our short-term loyalty programs, offset in part by the decrease in revenue discussed above.
● Card Services . Income before income taxes increased $814.0 million, or 259%, to $1,128.5 million for the nine months ended September 30, 2021 due to a $933.4 million decrease in the provision for loan loss from improved credit performance, improvement in the macroeconomic environment and a decline in credit card and loan receivables. Income before income taxes also benefitted from an $87.6 million decrease in interest expense, net from lower average balances, the effect of which was offset in part by lower revenue as discussed above.
● Corporate/Other . Loss before income taxes increased $13.2 million for the nine months ended September 30, 2021 due to an increase in interest expense associated with the issuance of senior notes in September 2020.
Asset Quality
Our delinquency and net charge-off rates reflect, among other factors, the credit risk of our credit card and loan receivables, the success of our collection and recovery efforts, and general economic conditions.
Delinquencies . An account is contractually delinquent if we do not receive the minimum payment by the specified due date. Our policy is to continue to accrue interest and fee income on all accounts, except in limited circumstances, until the balance and all related interest and other fees are paid or charged-off, typically at 180 days delinquent for credit card receivables and 120 days delinquent for installment loan receivables. After an account becomes 30 days past due, a proprietary collection scoring algorithm automatically scores the risk of the account becoming further delinquent. The collection system then recommends a collection strategy for the past due account based on the collection score and account balance and dictates the contact schedule and collections priority for the account. If we are unable to make a collection after exhausting all in-house collection efforts, we may engage collection agencies and outside attorneys to continue those efforts.
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Index
The following table presents the delinquency trends of our credit card and loan receivables portfolio based on the principal balances of our credit card and loan receivables:
September 30,
% of
December 31,
% of
2021
Total
2020
Total
(in millions, except percentages)
Receivables outstanding ─ principal
$
14,939.9
100.0
%
$
15,963.3
100.0
%
Principal receivables balances contractually delinquent:
31 to 60 days
$
192.9
1.3
%
$
229.9
1.4
%
61 to 90 days
126.0
0.9
162.8
1.0
91 or more days
242.7
1.6
315.2
2.0
Total
$
561.6
3.8
%
$
707.9
4.4
%
Net Charge-Offs . Our net charge-offs include the principal amount of losses that are deemed uncollectible, less recoveries and exclude charged-off interest, fees and fraud losses. Charged-off interest and fees reduce finance charges, net while fraud losses are recorded as an expense. Credit card receivables, including unpaid interest and fees, are charged-off in the month during which an account becomes 180 days contractually past due, except in the case of customer bankruptcies or death. Installment loan receivables, including unpaid interest, are charged-off when a loan is 120 days past due, including in the case of customer bankruptcies or death. Credit card receivables, including unpaid interest and fees, associated with customer bankruptcies or death are charged-off in each month subsequent to 60 days after the receipt of notification of the bankruptcy or death, but in any case, not later than the 180-day contractual time frame.
The net charge-off rate is calculated by dividing net charge-offs of principal receivables for the period by the average credit card and loan receivables for the period. Average credit card and loan receivables represent the average balance of the cardholder receivables at the beginning of each month in the periods indicated. The following table presents our net charge-offs for the periods indicated:
Three Months Ended
Nine Months Ended
September 30,
September 30,
2021
2020
2021
2020
(in millions, except percentages)
Average credit card and loan receivables
$
15,470.5
$
15,299.6
$
15,512.4
$
16,570.1
Net charge-offs of principal receivables
151.5
223.1
543.5
847.9
Net charge-offs as a percentage of average credit card and loan receivables
3.9
%
5.8
%
4.7
%
6.8
%
Liquidity and Capital Resources
Our primary sources of liquidity include cash generated from operating activities, our credit agreements, issuances of debt or equity securities, our credit card securitization program and deposits issued by Comenity Bank and Comenity Capital Bank. In addition to our efforts to renew and expand our current liquidity sources, we continue to seek new funding sources.
Our primary uses of cash are for ongoing business operations, repayments of our debt, capital expenditures, investments or acquisitions, stock repurchases and payments of dividends.
We believe that internally generated funds and other sources of liquidity discussed below will be sufficient to meet working capital needs, capital expenditures and other business requirements, including the expenses associated with the planned spinoff of our LoyaltyOne segment, for at least the next 12 months. However, continued volatility in the financial and capital markets due to COVID-19 may limit our access to, increase our cost of capital or make capital unavailable on terms acceptable to us or at all.
Cash Flow Activity
Operating Activities. We generated cash flow from operating activities of $1,208.0 million and $1,488.6 million for the nine months ended September 30, 2021 and 2020, respectively. The year-over-year decrease in operating cash flows of $280.6 million was primarily due to a decline in profitability after adjusting net income for non-cash charges and an increase in working capital.
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Investing Activities . Cash provided by investing activities was $380.7 million and $3,364.8 million for the nine months ended September 30, 2021 and 2020, respectively. Significant components of investing activities were as follows:
● Credit card and loan receivables. Cash increased $87.9 million for the nine months ended September 30, 2021 due to a decrease in credit card and loan receivables from increases in payment rates that benefitted from government economic stimulus programs. Cash increased $3,107.8 million for the nine months ended September 30, 2020 due to a decrease in credit card and loan receivables as a result of the pandemic-related store closures.
● Proceeds from sale of business. During the nine months ended September 30, 2020, we received cash consideration of $26.7 million from the sale of Precima.
● Proceeds from sale of credit card portfolio. During the nine months ended September 30, 2021 and 2020, we received cash consideration of $512.2 million and $289.5 million, respectively, from the sale of a credit card portfolio in each period.
● Purchase of credit card portfolios. During the nine months ended September 30, 2021, we paid cash consideration of $99.5 million for the purchase of three credit card portfolios. No portfolios were acquired for the nine months ended September 30, 2020.
● Capital expenditures. Cash paid for capital expenditures was $58.8 million and $37.9 million for the nine months ended September 30, 2021 and 2020, respectively. The year-over-year increase was due to additional investments in internally developed software associated with digital tools.
Financing Activities . Cash used in financing activities was $1,157.1 million and $5,064.3 million for the nine months ended September 30, 2021 and 2020, respectively. Significant components of financing activities are as follows:
● Debt. Cash decreased $76.1 million and $44.5 million for the nine months ended September 30, 2021 and 2020, respectively, due to net repayments of our term loans. In September 2020, we issued $500.0 million in senior notes and used the net proceeds of $493.8 million to make a prepayment of our term debt under our amended credit agreement.
● Non-recourse borrowings of consolidated securitization entities. Cash decreased $1,123.7 million and $2,945.0 million for the nine months ended September 30, 2021 and 2020, respectively, due to net repayments and maturities under the non-recourse borrowings of consolidated securitization entities and lower borrowings due to declines in credit card and loan receivables.
● Deposits. During the nine months ended September 30, 2021, cash increased $88.4 million due to net issuances of deposits. During the nine months ended September 30, 2020, cash decreased $2,012.0 million due to net maturities of deposits. The volume of deposits as of September 30, 2021 and 2020 was lower as a result of lower liquidity requirements.
● Dividends. Cash paid for quarterly dividends and dividend equivalents was $31.6 million and $50.5 million for the nine months ended September 30, 2021 and 2020, respectively. The quarterly dividend was reduced in the second quarter of 2020 from $0.63 to $0.21 per share in response to COVID-19.
Debt
Credit Agreement
In July 2021, we amended our credit agreement to, among other things, (i) provide consent by the lenders to the spinoff or sale of our LoyaltyOne segment, (ii) extend the maturity date of the revolving loans and approximately 86% of the term loans from December 31, 2022 to July 1, 2024, (iii) revise the method of determining interest rates and commitment fees to be charged in connection with the loans, (iv) modify the financial and operational covenants and certain other provisions in the credit agreement to reflect our business and operations after giving effect to the LoyaltyOne spinoff or sale, (v) require a prepayment of certain of the loans in an amount equal to the net proceeds from the LoyaltyOne spinoff or sale, including any net proceeds from debt that is distributed to us minus, in the case of the first transaction associated with the divestiture of the LoyaltyOne spinoff or sale, $25.0 million and (vi) add Lon Inc. and Lon Operations LLC acquired in our acquisition of Bread as additional guarantors.
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At September 30, 2021, we had $1,408.3 million in term loans outstanding and a $750.0 million revolving line of credit. As of September 30, 2021, we had no amounts outstanding under our revolving line of credit and total availability of $750.0 million. Our total leverage ratio, as defined in our credit agreement, was 1.5 to 1 at September 30, 2021, as compared to the maximum covenant ratio of 4.5 to 1.
As of September 30, 2021, we were in compliance with our debt covenants.
BrandLoyalty Credit Agreement
In the first quarter of 2021, BrandLoyalty and certain of its subsidiaries, as borrowers and guarantors, amended its credit agreement to extend the maturity date by one year from April 3, 2023 to April 3, 2024. As of September 30, 2021, we had no amounts outstanding under our BrandLoyalty Credit Agreement.
Funding Sources
Deposits
We utilize certificates of deposit and money market deposits to finance the operating activities, including funding for our non-securitized credit card receivables, and fund securitization enhancement requirements of our bank subsidiaries, Comenity Bank and Comenity Capital Bank.
As of September 30, 2021, we had $5.0 billion in certificates of deposit outstanding with interest rates ranging from 0.20% to 3.75% and maturities ranging from October 2021 to September 2026. Certificate of deposit borrowings are subject to regulatory capital requirements.
As of September 30, 2021, we had $4.9 billion in money market deposits outstanding with interest rates ranging from 0.37% to 3.50%. Money market deposits are redeemable on demand by the customer and, as such, have no scheduled maturity date.
Securitization Program
We sell a majority of the credit card receivables originated by Comenity Bank and Comenity Capital Bank to certain master trusts. These securitization programs are a principal vehicle through which we finance Comenity Bank’s and Comenity Capital Bank’s credit card receivables. Historically, we have used both public and private term asset-backed securitization transactions as well as private conduit facilities as sources of funding for our securitized credit card receivables. Private conduit facilities have been used to accommodate seasonality needs and to bridge to completion of asset-backed securitization transactions.
During the nine months ended September 30, 2021, $1.8 billion of asset-backed term notes matured and were repaid, of which $265.9 million were retained by us and eliminated from the consolidated balance sheets.
We have access to committed undrawn capacity through three conduit facilities to support the funding of our credit card and loan receivables through the trusts. As of September 30, 2021, total capacity under the conduit facilities was $4.5 billion, of which $2.7 billion had been drawn and was included in non-recourse borrowings of consolidated securitization entities in the consolidated balance sheets.
In June 2021, Master Trust I amended its 2009-VFN conduit facility, increasing the capacity from $1.0 billion to $2.75 billion and extending the maturity to October 2023. In June 2021, Master Trust III amended its 2009-VFC conduit facility, decreasing the capacity from $700.0 million to $225.0 million and extending the maturity to August 2022. In June 2021, the WFC Trust amended its 2009-VFN conduit facility, extending the maturity to August 2022.
As of September 30, 2021, we had approximately $10.1 billion of securitized credit card and loan receivables. Securitizations require credit enhancements in the form of cash, spread deposits, additional receivables and subordinated classes. The credit enhancement is principally based on the outstanding balances of the series issued by the trusts and by the performance of the credit card and loan receivables in the trusts.
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The following table shows the maturities of borrowing commitments as of September 30, 2021 for the trusts by year:
2021
2022
2023
2024
Thereafter
Total
(in millions)
Fixed rate asset-backed term note securities
$
322.3
$
1,571.7
$
—
$
—
$
—
$
1,894.0
Conduit facilities (1)
—
1,725.0
2,750.0
—
—
4,475.0
Total (2)
$
322.3
$
3,296.7
$
2,750.0
$
—
$
—
$
6,369.0
(1) Amount represents borrowing capacity, not outstanding borrowings.
(2) Total amounts do not include $1,061.8 million of debt issued by the trusts, which was retained by us and eliminated in the unaudited condensed consolidated financial statements.
See Note 12, “Debt,” of the Notes to Unaudited Condensed Consolidated Financial Statements for additional information regarding our debt.
Regulatory Matters
Quantitative measures established by regulations to ensure capital adequacy require Comenity Bank and Comenity Capital Bank to maintain minimum amounts and ratios of Common Equity Tier 1, Tier 1 and total capital to risk weighted assets and of Tier 1 capital to average assets. Comenity Bank and Comenity Capital Bank are considered well capitalized. The actual capital ratios and minimum ratios as of September 30, 2021 are as follows:
Minimum Ratio to be
Minimum Ratio for
Well Capitalized under
Actual
Capital Adequacy
Prompt Corrective
Ratio
Purposes
Action Provisions
Comenity Bank
Tier 1 capital to average assets
23.4
%
4.0
%
5.0
%
Common Equity Tier 1 capital to risk-weighted assets
27.8
4.5
6.5
Tier 1 capital to risk-weighted assets
27.8
6.0
8.0
Total capital to risk-weighted assets
29.1
8.0
10.0
Comenity Capital Bank
Tier 1 capital to average assets
15.7
%
4.0
%
5.0
%
Common Equity Tier 1 capital to risk-weighted assets
17.6
4.5
6.5
Tier 1 capital to risk-weighted assets
17.6
6.0
8.0
Total capital to risk-weighted assets
19.0
8.0
10.0
Comenity Bank and Comenity Capital Bank have adopted the option provided by the interim final rule issued by joint federal bank regulatory agencies, which largely delays the effects of CECL on its regulatory capital for two years, after which the effects will be phased-in over a three-year period from January 1, 2022 through December 31, 2024. Under the interim final rule, the amount of adjustments to regulatory capital deferred until the phase-in period includes both the initial impact of our adoption of CECL at January 1, 2020 and 25% of subsequent changes in our allowance for credit losses during each quarter of the two-year period ended December 31, 2021.
Dividends
On January 28, 2021, our board of directors declared a quarterly cash dividend of $0.21 per share on our common stock to stockholders of record at the close of business on February 12, 2021, resulting in an aggregate dividend payment of $10.4 million on March 18, 2021.
On April 29, 2021, our board of directors declared a quarterly cash dividend of $0.21 per share on our common stock to stockholders of record at the close of business on May 14, 2021, resulting in an aggregate dividend payment of $10.4 million on June 18, 2021.
On July 29, 2021, our board of directors declared a quarterly cash dividend of $0.21 per share on our common stock to stockholders of record at the close of business on August 13, 2021, resulting in an aggregate dividend payment of $10.4 million on September 17, 2021.
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Additionally, we paid $0.2 million in cash related to dividend equivalent rights for the nine months ended September 30, 2021.
On October 28, 2021, our board of directors declared a quarterly cash dividend of $0.21 per share on our common stock, payable on December 17, 2021 to stockholders of record at the close of business on November 12, 2021.
Critical Accounting Policies and Estimates
There have been no significant changes to our critical accounting policies and estimates from the information provided in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” included in our Annual Report filed on Form 10-K for the fiscal year ended December 31, 2020.
Recently Issued Pronouncements
See “Recently Issued Accounting Standards” under Note 1, “Summary of Significant Accounting Policies,” of the Notes to Unaudited Condensed Consolidated Financial Statements for a discussion of certain accounting standards recently issued.
Text extracted from the filing as submitted to EDGAR. Formatting, tables and exhibits are simplified for reading; the original document is authoritative for anything you rely on.