OneMain Holdings, Inc. (OMF) Earnings Call Transcript & Summary

I'm very pleased to have team from OneMain joining us. CEO, Doug Shulman; and CFO, Micah Conrad. This is going to be a fireside chat format. So I have a number of prepared questions. We'll take a break in the middle to ask some questions of you, the audience for your views, and I'll open it up for any questions that you might have.

But just starting off, I wanted to lead off with credit. It's been top of mind for investors. You increased the full year kind of net charge-off guidance by 50 bps last quarter. Can you recap for investors what happened and what you saw that kind of makes a change there?

Sure. First of all, good to be here. fun to be back in person. So it's nice to see a full room of people after a couple of years of strangeness. So yes, look, if you go back, I think the context is 2020, we really cut our credit box and consumers, including our consumers, we're given a lot of government stimulus. In 2021, the government stimulus continued March 2021 was the last big infusion of stimulus, especially checks going out to people. And then you add on top of that a number forbearance that was given to different industries, some government mandate, some not. We saw from kind of, call it, second quarter 2021 through first quarter of this year, pretty what we thought was an orderly path of normalization of our credit and that was how we based our loss guidance for the year. In May, we saw a pretty significant uptick in early-stage delinquencies -- it was heavily concentrated in lower credit quality. We don't underwrite to FICO, but the characteristics of where we saw an increase were lower FICO, lower income, heavier debt loads. And we also saw more stress in renters versus homeowners, which actually makes sense because homeowners had mortgages, although some of them were variable rate, they had much more stable payment of monthly housing expense, renters, I think, saw a pretty big increase. And so that happened in May, in June and July, we saw that continue. The delinquencies didn't go up significantly. They generally delinquencies go upwards from our low point is April and seasonally, they increased kind of after tax season, but enough for us to change our guidance. Our guidance, we increased it by 50 basis points, still within our long-term targets. And we adjusted some other things in our guidance as well.

Okay. Great. You kind of alluded to this, but it seems like inflation is really eating into the disposable income of non-prime borrowers more than we anticipated initially. Is that generally true across all nonprime? Or are there certain cohorts that are more susceptible here?

Yes. Look, we track as many of you, and I know you do, all the industry data that's out there. And I think if you look across the board, the nonprime consumer kind of middle class, working class, lower-income consumers are much more stressed than prime consumers. The ABS data, almost everyone who's got non-prime data that's out there. We've seen it go up. A lot of folks have gone up even more than we have access to other public data. And then within our own book, it is the lower income borrower. It makes perfect sense, right? If you don't have as much cushion and you have an increase in basic living expenses, gas, housing, utilities, food, those kinds of things, you start to have to triage and some people are having trouble paying we underwrite to 20% return on equity, right? So we don't have a broad -- people are always often asking kind of like what's happening you cut in your box, you're expanding your box. We don't think about it that way. We think about it in a very granular way. And so we have stressed the assumptions for losses in our box. We also have taken a little bit of pricing action as we had some room for pricing action, and we're managing through it. We also did activate borrowers assistance for people who either lost jobs, showed proof of decreased income, those kinds of things. A hallmark of our business is trying to work with our customers and put them in alone, they afford, give them access to capital, if they're struggling, try to help them through if it's a temporary home.

Okay. One related question I had on that. I mean, as you alluded to, one of the populations where you saw more stress was on renters. And anecdotally, we've heard -- I've read a lot about some very significant rental inflation, it's uneven, right? Because it just depends on when your rental agreement comes up. How do you guys factor in the fact that this could be -- you could have kind of a wave over the next year or so of borrowers whose rents have not increased yet but are due in the next month or a quarter to go up meaningfully?

Yes. Look, it's a good question. The way we do our underwriting, we have hundreds of factors that go into it. And it -- one factor is geography, both what's happening in a metropolitan area or in the state, and we have rural borrowers. We're nationwide. We run a nationwide portfolio risk we have urban borrowers. But we also operate under state laws. And so some states for an unsecured borrower or any borrower, we can charge 36%. We voluntarily cap at 36%. In some states like Ohio, we have to cap out at 27%. So we can actually calculate pretty precisely how much cushion we have to meet our 20% return thresholds. And so we monitor it quite closely. And then every month, our data scientists are updating our models. So what they can see is by state, by MSA, what's happening to renters versus homeowners, the models adjust and so they're tracking that. We -- I'll talk about credit in a minute, but we've actually now just added stress to be careful. I mean our basic posture right now is it's very uncertain economy. We saw some things. We saw certain cohorts. We didn't like the way they were performing. We've cut those out. And right now, we're operating with caution and preserving our shareholders' capital, making sure we're careful with what we learned. We're still doing plenty of what we think is really good lending and especially to higher credit quality. But look, there's it's not going to be perfect, right? I'm sure there'll be people who have a big increase in rent. And all of a sudden, they've got a problem, but we think our models have captured it. And the people who have a lot less cushion, we've kind of -- already cut out the underwriting.

Okay. Great. You've hit on some of this already, but you've talked about you have tightened your credit buys. Can you give us some more color on the type of underwriting adjustments you'll be making? And is it more around pricing or just cutting off certain borrower types for FICO bands...

Yes. So look, we have decades of both experience, and we've got a great team of data scientists, credit experts analysts. We're looking at this very closely in benign and in tricky environments. We -- and like I said, we do monthly scoring the model just automatically -- it doesn't automatically update, but we've got people looking at it, and we're constantly updating the model. Late last year, we did some trimming around the edges. And I -- we had talked about it, Mike and I publicly. We actually saw when people funded a loan through neobanks, we were having some not as good credit quality, so we put some extra stress in there. thin-file customers, ones that have less than 3 credit lines. We did some trimming there, certain channels. So we also underwrite the channel. If you come to us directly or you've done business with us before and you walk into a branch, there's usually a different pattern than if you come through an affiliate like Credit Karma or somewhere else. -- some smaller affiliates who maybe were chasing growth, advertising, who knows what was happening. We didn't like the results. And so we did some trimming around them. And then we also judgmentally just decreased our assumption of what cars were worth because with the jump in car prices, we took a big trim of collateral value anywhere from 15% up to 45% depending on the car. And then we do have our lending is secured lending. So that was all late 2021. And -- this year, after we saw the big increase in May, we've made 2 significant credit cuts and very aggressive. Just to give you a sense of our credit box, like I said, geography, what's the yield, we can charge what's the product secured versus unsecured, size of loan, industry, length of time and job, there's a whole number of factors. And so we don't have just a broad credit box. We have each customer comes in, get scored. Yes, no, if yes, do they get a secured or unsecured loan. And the way the model works is about 15% of every loan we make, is equity. And so we look for a 20% return on equity. And the factors -- and we know we've modeled out what the lifetime return is. The core factors in that are the yield or the APR, So how much can you charge, the losses, all the expenses, marketing, OpEx, tax, branch, expense, et cetera, we can talk about digital channels a little less and then cost of funds. I mean there's a bunch more into that, but those are the 4 basic. What we did now is every loan we book needs to meet that 20% threshold. A, we've already cut out all of the cohorts that wouldn't meet that threshold based on what's been happening since May. So that was a pretty significant cut. And then this is important. We took a judgmental cut over the top assumed in '01, '02 type recession, which took -- put about 30% more stress into our loss assumptions for that model. Now we're not calling a recession, but our view is, given the current environment, we should just be taking a conservative stance. At the result of all that is a pretty significantly tightened credit box it ended up cutting out unsecured loans to the riskier customers, some secured loan to riskier customers. Some people used to be able to get an unsecured loan. Now they can only get a loan if they give us title to the car, and we have collateral. And we always model what do we think that will do to originations. The good news is we're now booking a decent amount of business, not as much as we were before, but much higher credit quality. Just to give you a sense, our top 2 risk grades, which are very much kind of very near prime or prime are now 55% of our bookings this last month versus 40% before we made all these cuts. And so we're actually moving our book to higher ground. I think there's a lot of good loans we can book. strength of our balance sheet allows us to keep doing business with people who come and want a loan, and we think are a good credit risk in this environment.

Okay. And then you hit on at least what's happened to mix. But overall, what's the impact been on growth so far from these changes? And when should we expect an impact on credit...

Yes, I'll take that one, Mark. Certainly, on the changes that we made in late 2021 and early part of '22, we can see those results. We look at basically how is the vintage performing with those cuts and what would performed like without them. And we had a good sense for whether our adjustments have really held. I think on the broader adjustments that Doug mentioned in -- over the summer, still a little early to tell there, where you can see it is in our originations. Doug just started -- just alluded to a little bit with our top 2 tier risk grades. Now being a bigger part of our originations. Those are about 650 plus. We've also basically cut out the bottom half of our new customer unsecured originations. So not doing that business anymore. And then you mentioned renters earlier. Our recent updates to our credit box now tilt a little bit more towards homeowners and away from those riskier sort of rental, particularly on the unsecured product. And so over time, these changes will start to emerge in the book, but on a $20 billion portfolio, it takes some time for move through. We talked a little bit also about our growth expectations for the year. On our last earnings call, we updated that and felt we'd probably be because of these adjustments at the lower end of our 5% to 10% guide for the beginning of the year. So I mean, we're seeing some really good things in our distribution channels. We've seen good performance there. I think the small dollar loan product that we've rolled out has given us yet another lever on credit or it's not necessarily saying we can't give you a loan, but we might want to put you in a smaller loan to start with. So that's just given us a lot more flexibility. The card product has been great, kind of helping to support growth. And I think all of this is really building these different avenues for us to originate and add receivables helps to offset some of the impact from the credit cuts. But we think we'll be at about the lower end That range.

Okay. Great. So what do you need to see before you expand the credit box again, better macro or lower inflation or something else?

Yes. Look, there's certainly uncertainty in the macro. The biggest macro driver historically of credit is employment. You've got a job. We'll give you a loan. You pay us back because you have income, you lose your job, you have a harder time paying us back. The wild card right now has been inflation, which has eaten into lower income, lower credit quality customers. Clearly, if the macro environment became more certain and inflation leveled offer abated, that would change our loss assumptions right now. Again, we put this 30% extra stress into our loss assumptions for our underwriting. And so assuming that there could be an '01, '02 type recession. And so I think we could pull back on that. Again, though, it's not -- we're generally not making macro calls. We've got a very granular surgical box. We're making adjustments as we see things happen. And look, just so you know, our attitude is -- we think, given our data, given our team what distinguishes us is we can react very quickly to what's happening, including going into microsegments, pulling out of microsegments, expanding, contracting, depending what happens. When we made this extra cautious move in July and said, okay, let's just -- let's put an extra level of stress. Let's be cautious. Let's make sure we're good stewards of shareholders' capital. We also said, okay, we're going to go back in and look at very specific things. We're looking at high rate states where collaterals inflated. We're going to keep looking at the collateral inflation. We take notes on that. The next month when we make the choice, we go back and we say, do we still want to be conservative? What are we seeing? What's happening in old vintages is what's happening in new vintages. So it's quite dynamic. And I think we will pull back quickly when we need to, but we'll also lean in because that's our business. We make loans to people, and we think we -- there's still plenty of people who are good credit risks, meet our risk return hurdles that we should be lending to.

Okay. Excellent. Turning to loan loss reserves. Can you remind investors what kind of assumptions or loss expectations are embedded in current reserves?

Yes, sure. So with our reserves under CECL, we obviously first start with the delinquency position of the portfolio at a given point in time. And we run an expectation as to how we think that delinquency will ultimately roll to loss. And over a lifetime period, you can imagine that involves a good degree of assumptions. We use both historical assumptions and an expectation for the future. So we try to, in part, some view on whether we think historical results are reflective of future periods. And over the last few years, as you know, there's been nothing but normal in terms of roll rates coming through pandemic and the support that came out of that. We saw some of the lowest roll rates of our delinquency we've ever seen. And so as we went through that period, you remember day 1 CECL when we put -- we put up our reserves, we had a reserve rate of about 10.7% went through some gyrations in pandemic when unemployment was forecast to be in the 14%, 15% range. But we kind of settled in the middle of 2021 around 11%. So above that 10.7% range, knowing there was still some continued uncertainty in the environment and consumers were just moving away from that last round of stimulus. It's now almost 18 months ago. And so we never got back down to that 10.7% level. We probably had reason to, but we wanted to be cautious. And when we started to see some of the delinquency emerge and some of these, I would say, uncertainties become more certain -- in the second quarter, we were effectively reserved for it already, and we were provisioned for it. And so in terms of the macro, I think the -- it's all related, but the roll rates that we assume are probably the most important assumption we have. And there's also the macro conditions. And we, at the second quarter, assumed a relatively stable macroeconomic environment. Unemployment, roughly 3.5%, 4%. So just slightly above where we were at the time in the second quarter, and this is when we're looking forward to 2023. I think as Doug mentioned, we've continued to see the impacts of inflation in the third quarter, continued uncertain environment. So I think it's likely you'll see us modestly increase those reserves over time, again, in taking a very conservative approach to our balance sheet I'll remind you that we go through this process for GAAP reserving, but we run the business for capital generation. And so we think about our reserves as another form of loss absorption capital where we're moving capital around the balance sheet. We're focused on that capital generation, which is really the actually incurred loss versus what we think is going to happen 1 year, 1.5 years out. So it doesn't really influence our thoughts on capital returns and capital adequacy. But nonetheless, hopefully, that that's a helpful view as to how we're thinking about it.

Okay. Great. Turning to the competitive environment. Can you just talk about what you're seeing here? And what kind of impact, if any, kind of higher funding costs and credit normalization is having on supply of credit?

Yes. Look, we've -- we try to stay disciplined and stick with our discipline. I've talked before about we actually don't manage the growth. Growth is an output. We have our credit box. It's very specific and granular. We want to put customers in loans, they can afford and pay us back. That's good business for our customers. It's a good business for us. In 2021, I think there was a lot of supply in the market. There are a lot of people really leaning in. We had good growth, but not as much growth as others because we stayed pretty disciplined and made sure everything met our 20% return hurdles. And then we actually -- our growth slowed down while some of the competition's growth continued to increase because in late 2021, we started trimming our credit box pretty early. I think since May, and you look at all the data that's out there, everyone saw a spike in delinquency. Some of the competition saw a huge spike in delinquency. I think competition has pulled back. Some of it is -- I think everybody has cut their box some and is being prudent. But I think some of the competitors who rely more on flow and whole loan sales and just-in-time funding there's stress in that market, and we built a balance sheet with a lot of long-tenured unsecured debt with a lot of excess liquidity. We've still been able to access the capital markets at higher rates than we were a year ago, but we think quite competitive rates. And so yes, I think we would have predicted a certain decrease in originations for our cuts, and it didn't happen because we got a bunch of the higher credit quality customers, demand coming to us and because of the strength of our balance sheet, we're still able to book them. And so we like this kind of competitive environment. This is what we do for a living is we manage a nationwide portfolio risk. We built this resilient balance sheet. So we're not going to be put on the defense because of some sort of weakness in the balance sheet. We're quite profitable and generate a lot of cash. even in this kind of an environment. And so we think this gives us a good opportunity. As I said, we're still in a conservative credit posture, but we're still booking really good loans. And we've seen competition, I think, doesn't have the balance sheet strength and therefore, is -- puts us at a competitive advantage.

Okay. Excellent. I'm going to pause here. If we could queue up the audience response questions, I would really appreciate it if you in the audience would be willing to participate, grab the controller in front of you and register your response. First question, what factor do you view as most likely to determine whether one may outperforms over the next year? One, accelerating loan growth, 2 stable credit, 3, stable portfolio yield, or other...

I don't think I've done one of these, Mark, with everyone. We should do this on our earnings call. 94% credit. I'm surprised -- next question.

What do you view as the biggest risk to shares? -- decelerating loan growth worsening credit, higher-than-expected OpEx or other...

I Guess -- want to guess 2...

Okay, 95%. Next question, please. Where do you expect net charge-offs to be in 2022 versus the 6.1% to 6.5% guide? 5.75% to 6%, 6.1% to 6.25%, 6.25% to 6.5% and above 6.5%.

All right. So skewed to the high end or above 48%, the high end and 38% above it.

And then last question. Over the next year, would you expect your position in OneMain to one, increase, 2, decrease, 3, remain the same?

Okay. So 57% remain the same.

All right. Well, thank you all for participating in that. I want to open it up to the audience for questions if there are any. If not, I'm happy to continue.

You mentioned some couple of updates to underwriting criteria. I was wondering unemployment rate itself didn't come up until later. And I think what I heard was 3.5% to 4% or a small increase versus where we're at over the summer is where you were at. One question is how sensitive are the assumptions around credit and reserves to increases in the unemployment rate? And how should we think about the beta to that? Should there be a more significant downturn?

Do you want me to take that? Yes, I want to make sure we differentiate reserving from underwriting. So we do take a conservative approach to our reserving, but we also do follow in general, what we see from economists and others who are projecting this. We're not economists ourselves. I think a lot of debate about the unemployment rate. It is a factor in our reserving. It's a factor as much as the absolute level, but also the timing of when you're expecting that because you are reserving for a discrete runoff book at a point in time. So I want to keep that in mind as it relates to CECL. On the underwriting side, Doug mentioned we out of an abundance of caution over the summer, we've incorporated an '01, '02 type downturn on top of the delinquency worsening we've already seen in the portfolio from inflation. '01, '02, unemployment went from, I think, 4% to 6%. So you can think about our underwriting posture as, again, not calling a recession. But anticipating a recession and saying for the book of business we're putting on, does that business still meet our risk-adjusted return hurdles and ROTCE post any post having losses that are equivalent to a '01, '02 downturn. We did a lot of downturn planning back in 2019, taking our existing book and running it through both '08, '09 and '01, '02. -- beauty of being around as long as we have. We actually have data to support that. And '01, '02 would give us roughly on a base loss rate of 6% to 7%, about 30% stress. So you can think about those 2 things together. Hopefully, that answers your question. Welcome.

Could you talk about what factors other than sort of credit losses or if there's a level of credit losses where it might change your capital allocation plans? And you talked about the strength of your balance sheet, but could you see any changes to the leverage target or the makeup of the balance sheet in terms of liabilities if we get in '01, '02 or worse recession.

Yes. Look, we've built the business through the cycle with plenty of cushion. We've been very clear that even in like an '08, '09 severe, severe downturn would not be a capital event for us, it would be an income event. We think we'd still stay profitable. And we've -- given the environment, we've continued to restress it, our Board Risk Committee has done a rigorous dive on this. We use a bunch of outside advisers to help pressure test and make sure we're not talking our own book. Our capital allocation policy again is built to withstand for sure, an '01,'02 downturn in an '08, '09 downturn as well. And so capital allocation, we'll book every loan that we think meets our risk/return hurdle, we will invest in the business. We've invested a lot in digital, analytics, technology and new products. And then we've got a robust capital distribution. We've got, right now, a dividend that yields over 10%. That's quite sacrosanct to us. We don't think in an '01,'02 that anything happens with that. We like our -- we think we have the right amount of cushion. And I think of leverage as a proxy for making sure we're running the balance sheet very prudently. And so I think we were well within our capital range. We're doing buybacks on a programmatic basis. We continue to do the buyback programmatically now. If you're in '08, '09, maybe something happens with that, that's the lever that has some variability, but we really want the dividend to be, like I said, it's quite sacrosanct. We think people should be able to count on it and it's a healthy dividend.

Yes, if I could just add, I think one of the most important things that we talk about a lot with respect to our balance sheet is liquidity. And that's making sure you have the cash and the cash flow to operate the business. We've been operating under a 24-month minimum liquidity runway. And so while that sounds great, it's all sort of in the assumptions that you make. We have very, very conservative assumptions in that runway. So we say we're in an '08, '09 type loss downturn. We're going to hold the balance sheet flat, and we have no access to capital markets whatsoever. And so we can continue to pay the dividend, all of our obligations, our maturities, our expenses, hold the balance sheet flat, which in a business with an average life loan with an average life of 18 months, there's a lot of flexibility there. We can operate this business for 24 months minimum without needing to access the capital markets. And of course, you have to have that to be able to support this comfort level in our dividend and being able to compete and operate the business over the long term. As I said, there's a number of levers we can pull there. The most important being receivables if we ever needed to, to extend that runway, but really, really important part of our balance sheet that I want to make sure we talked about...

Thank you for the great presentation. You talked about how you've been able to increase your credit quality recently. What do you think is happening to borrowers at the lower end of the spectrum than maybe you're not lending as much to anymore? Do you think they're going to your competitors, different challenges? Or do you think there's going to be -- there's a general kind of pullback in credit for those lower end customers right at the time when -- as the point you made, they're facing major inflation and major bills...

Yes. Look, we still have quite a bit of demand. We're just not approving as much. Again, I mean, I think your point that people are struggling maybe and need some money. Our view is we're very focused on our customers, and we do not want to put them into loans that we think they can't afford. That does not help our customers. Look, I think a lot of people, especially the lower end are used to managing and triaging bills. I think with inflation, there's been a number of people who have just shifted away from all their discretionary expenses. You see in the news, people are going to the dollar store more for food than they are the Kroger high end. Don't take this as commentary on grocery stores. You definitely don't want to follow my investment advice there. So we track all of that. And so I think in this time, it's probably harder to get credit, maybe harder to get responsible lenders like us who have great disclosure, follow all the rules, cap our rates at 36%. Some of them maybe are going to higher rate lenders. But also I think -- remember, some of our lending is an emergency situation. Your car breaks down, your hot water heater breaks, a fair amount is debt consolidation and then some of it is discretionary, where people want to go on a vacation or they want to remodel their kitchen. And so not all of the people who come to us are because they've got a severe need now...

Quick question. On the flip side of that question, you've been growing Prime. Are you seeing traditional prime guys pull away, which is creating opportunity for you to go upscale...

Look... Prime is a pretty big category, right? It's generally thought of a 660 plus. We do a lot of business of 660 to like 720 FICO. There's -- when you say traditional prime, I think of a lot of people who are doing like high 700s is what we think of as super prime. I do think there's a swath of our direct competitors who also just don't have the funding right now to do the 660 plus. And so some people have pulled out, some people, we've kept pricing discipline. So we might make a 21% loan and people are in the market doing unprofitable pricing in the low teens, and they've maybe come up to 20%. And now with our brand and reputation, they're booking with us versus with them. And so people have done some pricing moves, and we've been able to keep some -- keep our discipline. So I think there's a variety of factors, but we are booking more, I'd call it, higher near prime and then some prime customers because those remain excellent loans for us to book.

And a follow-up. Through the years, a lot of times in downturns, companies underestimate collection [ jobs ]. Have you thought about that or framed it out? How do you flex it higher even if we don't have big charge-offs [Technical Difficulty] call center collecting [ charge ]. How do we think about that?

Yes. Look, the beauty of our business model is we've got 6,000 people in branches across the country who both loan, make loans and do collection. It's one of our secret sauce is people are actually responsible in small groups to lend and collect so -- and they get measured on both loan bookings and delinquency, which makes them very prudent stewards of the capital allocated to each of our 1,600 branches. They're able to toggle. So right now, they're doing more collection work, less lending work. And so we have an automatic flexibility or elasticity in our workforce because these people are already trained both ways. We then have a collection team centrally, and so we can flex if there's a branch where there's high delinquency and they can't get to everything. It can flow over into a branch. And then we've been building out digital capabilities. And so 2-way tax, tax to pay. So we feel like we've got, again, a real competitive advantage in collections. We've got plenty of capacity. We have flux capacity so we can move over. We keep some third-party contractors just on retainer in case we need flux capacity, but we haven't needed much of it because we've been able to toggle our teams and our teams are quite good at it.

Great. I think we're going to need to end on that note. But please...

Can i do one more thing? Before we go since we still have 30 seconds... According to my clock, we have... Look, the one thing I would say is in this environment and really in any environment, people get super focused on credit. And I hope you can see we're super focused on credit, like we are all over it. We're conservative, but our business is built, A: through the cycle. And so we'll make a little less when things aren't as good, we'll make a lot more when they're not. We didn't talk at all about we have our hooks into 2 very big growth markets, more kind of auto channel distributions and our credit card, which happy to talk to anybody about. And we've got a lot of levers. We've got pricing, we've got expense, we've got cost of capital and its credit. And we're managing all of those very actively. And so we actually feel quite good about we're cautious. We'd love credit to stay at 4% forever, like it did during the pandemic. But if it did, we wouldn't be taking enough risk and managing our portfolio appropriately. So we feel actually cautious about the near term and quite good about our competitive positioning.

Okay. Great.

Thanks, Mark.

Please join me in thanking them for their time.

Thanks, Mark.

Thank you all, Appreciate you coming.