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

Great. So welcome, everybody. I'm Moshe Orenbuch, same as last session. I'm the consumer finance, specialty finance analyst here at Credit Suisse, and we welcome you to our conference. We're very pleased to have with us OneMain. OneMain is a leading a nonprime lender, large robust branch network and a strong online presence that it's really enhanced over the last several years. Company has expanded carefully, I would say, which is not necessarily the way everyone expands, and that's been both in credit cards and has moved also somewhat upmarket as it's seen some of its competitors tighten credit standards. We've got -- very happy to have with us Doug Shulman and Micah Conrad. Doug, CEO, joined OneMain in 2018 and had many, many jobs before that. Most notably, he was the commissioner of the IRS. And Micah came to OneMain -- actually from OneMain when Springleaf acquired, OneMain from Citigroup, where he had been the CFO and had a number of positions also. So we're going to do a fireside chat. And so maybe just to kind of open it up at -- with a little bit of an open-ended question. Maybe just talk a little bit about the current environment from a competitive standpoint, consumer demand for credit and what you're seeing and how that's influenced your thoughts about 2023 and 2024?

Sure. Thanks, Moshe. Hello, everybody. Let me start with the consumer. I'm not going to tell you anything everybody doesn't know, which is we serve non-prime consumer, not deep subprime, but think about someone with a $60,000 income, a couple of kids. We found that in May of last year, kind of spring of the last year, the consumer we serve, especially the ones kind of at the lower end of the credit spectrum that had less cushion started to feel pinched by inflation. And we started to see an uptick in delinquency. The rest of the industry started to see that as well. If you think about the economy, there's a bunch of crosscurrents. Employment is great. It's super constructive. We're in the credit and lending business. And so generally, there's basic laws of physics. We lend to people who have a job. If they have a job, they can pay us. We're quite good at underwriting. If they lose their job, they have a harder time paying us. And that's how it usually works. We found though, even people who had a job, who didn't have much cushion, we're starting to struggle to make ends meet. And so we have these crosscurrents of employment numbers are great, inflation was tight. From a competitive environment, we've got a very strong balance sheet. We built it with long liquidity runway, staggered maturities. So last year and this year, the rising interest rates really didn't affect us much. That contrasts with a number of our competitors who had shorter-term funding, had a hard time accessing the market. And so what we did was any consumer who were struggling, we try to help them and work with them to bridge the gap. And over the last 9 months, our back book, so people who are on the book with our old credit box before this summer, they're doing much better. It's stabilized. And there's a phenomenon that while some people got behind, a lot of them have caught up, some of them are going to move to write-off this year. The people who didn't get behind figured out how to manage their bills and prioritize to us, and we feel very good. So that back book has stabilized. And then we've done a very aggressive cut to our credit box, where we're basically underwriting now assuming all of that stress that we saw with the consumer plus we're assuming the economy is going to deteriorate further for our underwriting box. Like we have no idea whether it will or not. But if it does, we're still going to meet our return hurdles. Demand remains quite high, and it's a little counterintuitive. I think most people think, when consumers are pinched, they're going to borrow more. It's not actually how it happens. Usually, people are only going to borrow if they feel confident they can repay. So we're seeing more demand in our higher FICO range. Think about above 660, getting close to prime kind of the lower end of prime. And so now 60% of what we are booking in loans is that very much higher FICO, and that's performing really well. So I think tricky economy some consumers struggling. Those consumers are kind of rolling through our book, but still very good demand and there's a lot of people in a very healthy position, and we're still lending to them.

Got it. And It's obviously still early in the year, but the macroeconomic results thus far have been probably on the better side from an employment possibly not worse on inflation. Can you talk about what it would take to get you to think about accelerating growth or perhaps even in the other direction, taking your -- tightening your credit box further? Like what kind of things what do you need to see to have either of those things happen?

Yes. Look, the main thing we need to see is continued stability in the loans we booked and them performing as expected. So the deep credit cut we did and kind of what I think about as our front book or our new book that started about in August, that's performing very much in line with like pre-pandemic levels. And so we'd want to see several more months of that before we got comfortable that things have normalized. And then our back book where we see some elevated delinquencies, but not getting worse. They're just moving with seasonal trends. We'd want to see that continued. And then I think we need to see unemployment remain low or move up modestly, but not have a very quick hike. I think we're going to look to signals macro signals in the market about is the Fed look like it's tapering off. The way I think about it is we are probably leaving some money on the table now, meaning we're probably being conservative, but that's how we operate. I mean our philosophy is very conservative with our balance sheet and funding, make sure we have a lot of liquidity, so there's never issues. Very conservative with our credit box. So we have cushion to meet our return on equity thresholds and then be aggressive and innovative with our digital presence, with our product innovation, with our marketing. So we bring in as many good customers as we can, but we underwrite them in a conservative way. I think the other important thing, Moshe, is it's not like one day we're going to say, coast is clear. Let's open the box. I mean the way we do this is we've got 6 different credit bands [ SP, ABC ]. And inside of those, we've got 10 deciles in each. And there's different performance. So that's the credit, then we've got our different products. We've got a secured product, which performs very different than our unsecured product, which performs different than our credit card product. We then have levers around pricing and there are certain states we can take more risk because we can price higher. And then we do some analysis around geography. So when it comes time to open, it's going to be in very specific places. It's going to be risk grade S in the seventh decile for secured lending in California. And so it's not going to be a big bang. The other thing we always do, we've got the advantage of scale. We're nationwide. We have 2.6 million customers. We're always booking loans right below our credit threshold. So think of it as 500 loans a month, 250 in the different pockets where we think we might open next, you'd never see that in our public markets, but it's important just to be in the market testing. So whenever the time comes, we'll have data about how a small sample of loans have actually performed. So it will just add to our confidence of opening up. I think on the tightening, if we see things deteriorate, we can always tighten up.

A good segue to the next topic I want to talk about a little bit. I mentioned in my intro credit card. You've also talked about kind of testing both higher end where you said you're seeing better demand and even lower end. Maybe just talk about how -- what you are seeing in those tests and how they might be part of the growth story at some point in the future? And you obviously have got public kind of guideposts for the credit card business. So maybe just talk a little bit about that process.

Sure. So, forgive me if I'm repeating, you've heard this, Moshe, but I'm not sure everyone has, I mean, we decided to go into credit card because we looked at the landscape. We've got a lot of customer loyalty. We've got a very good brand in the market for the non-prime consumer. We have -- our installment loan was a large episodic product that people took a loan, they paid it down. They came to us I would say, occasionally. And most customers, our best customers don't interact with us a lot. They book a loan, they get their money. They put it on auto pay and it kind of goes through. We did a lot of research. We talked to a lot of customers, and they said, we all -- most of our customers have 4 or 5 credit cards. Instead of a large episodic product, it's a daily transactional product that they use for everyday spending. And we thought we had a lot of synergies around decreased marketing costs, fixed infrastructure, credit expertise, customer loyalty and brand. And so we decided to launch a credit card. We went into it very carefully. So we tested in the fourth quarter 2022. We put about 60,000 cards out into the market, and we tested uptake different product variations, line usage and most importantly, we let those cards season, and we saw what was happening with credit. This summer, there were pockets that we felt very comfortable that even if the economy deteriorates significantly, would still be very good business. So we started in those pockets leaning into it. Installment loan market is about $100 billion for nonprime, credit card market is about $400 billion. And so you can think of us as a challenger in that market even though we're a big player with this customer. And so we think this is going to be a big growth engine. We like the results we've seen. We have high utilization rates. People are using the card. They're using it on what we had hoped for, which is groceries, gas, clothing, kind of everyday purpose. So we have a different utility in our customers' lives. And we have about $100 million, a little over $100 million of balances now. We think that will grow to $400 million, $500 million this year, grow it conservatively. We think this could be a $2 billion book by 2025 and grow from there, and the profitability is pretty similar to ours. So we're excited about it so far, so good. But we're going to do it very carefully and make sure we're only booking loans that, again, even in this tricky environment and even if it gets worse, that those card customers will still be profitable for us.

Got it. Micah, Doug alluded to the funding benefit that you've got with -- by having both stable sources of funding and relatively fixed cost. Just talk a little bit about what you're seeing out there in the market today? what your plan is for 2023 and how that folds into the view for OneMain overall?

Yes, sure. Thanks, Moshe. We feel great about our balance sheet. We think our access to funding is quite significant. I mean we've built a program over the years that I think is viewed as best-in-class both from a performance perspective, but also investor transparency and reporting. We will -- we tend to monitor -- we monitor the markets very closely. We'll issue 3 to 5 times a year. I think what you've seen from us over the last few years is discipline around our funding. So even in a period of 2021, we were able to issue ABS at 1%. We really went deeper into the unsecured market, which was more expensive, very attractive at the time at about 3.5% but we wanted to make sure we had that discipline to take advantage of a market when it was good, put on long-duration assets that has served us well now because in 2022, with the high-yield market kind of disrupted a bit, we were able to lean back into the very efficient ABS market. And that market has been very good for us. We've raised about $3 billion last year through 4 transactions at an average cost of about 5%. We're actually in the market today with an auto deal that seems to be going very well. The ABS market was efficient, but it's spreads definitely went up in the fourth quarter. It was misbehaving a little bit, and things have tightened now so spreads have come in quite a bit, and I think that remains a really good market for us. And we've seen success with both new issue -- with new investors coming in, but also just return investors. I think on the other hand, high yield was pretty difficult in 2022. And obviously, we stayed away from that market until it's found some better footing. The average high-yield index was in the mid-6s in the first half of the year and then in the mid-8s in the second half. It was as high as almost 10% by the time -- the end of September. That market has -- spreads have come in about 140, 150 basis points or so since the September high level. So it's starting to get interesting to us. I would say our issuance cadence will be opportunistic as it always is. The great part of our balance sheet is we have access to this really deep ABS market. We're sensitive to our secured funding mix. As you probably know, we've kind of had a target of about 50-50 on our secured and unsecured. That creates a balance between the cheaper ABS funding, but also going into the unsecured where we extend duration and free up unencumbered assets that serve as a source of liquidity. So we always try to keep that balanced but when we were really focused on unsecured, we shifted that secured mix down to about 40% in the third quarter of '21. Even with all the issuance we did last year, in the ABS market, we still ended the year at just 51%. So we feel really, really comfortable with continue to issue ABS if we need to. We also have $7.5 billion of committed bank lines that we can draw. So our funding situation is very strong. If the unsecured market is there, we'll certainly -- I think you could see us issuing there at some point this year.

I think you talked a little bit on the conference call -- in the earnings call about the cost of that funding into '23 and '24. Maybe you could kind of elaborate on that a little bit.

I think just because of the staggered nature of our maturities and all that work I just talked about that we did in 2021, it takes some time for changes in rates to move through our debt structure. So what we said on the call was 90 -- on average, our average debt in 2023, about 90% of it is already on the books. And so if you flush that out to 2024, it's about 80%. So even if we're -- even if rates at elevated levels, it takes some time to move through the income statement because of the fact that we've gone relatively long on our duration. That certainly has served us well from that regard as well.

And maybe to take that back, Doug, you made some comments about pricing that varies a little bit kind of state by state. But I'm assuming that there are products certainly, some of your secured products and the like that probably have room if over time, it doesn't -- I mean, it doesn't appear the current market forecast is for this rate environment to persist forever, but you do have probably some room in pockets of your portfolio to improve pricing if that were to happen?

Yes. Look, one of the things we've done is diversify our product set over the last 3 or 4 years. So we used to have a roughly $12,000 secured loan, and $8,000 unsecured loan, there were variations on that theme. But what we've done is we added a smaller dollar, it's not a small dollar because when people think about small value loans, they think about a couple of hundred bucks, it's -- think about $2,500, $3,000 loan unsecured for somebody. We've then got our different secured lending, and now we've added the credit card. And so we've always maintained price discipline. One of the things that happened in 2021 is we'd make somebody a 19% loan offer and other people were making it at 10%. Those loans, the 10% loans are way underwater now. And so -- during that time, we found ourselves getting picked off, especially in things like Credit Karma or LendingTree where people are very price sensitive. And you have a conversation. We monitor everybody else's pricing, and we say, okay, what do we think about market share and things. And we run the company for long-term sustainability and profitability. What we've seen is others have had to come back up to where we are. And when we go head-to-head with pricing, with competition, we've got a strong branch network, a community presence. A lot of people have borrowed from us before. We treat our customers really well. We work with them if they have an issue. And so we're finding without lowering price and without needing to raise price, we've maintained our profit thresholds, and we're winning a lot more business. We do have some room to move price. So some of our secured lending and through some of our distribution channels like Dealertrack, which go out to auto dealers. Others have moved their prices up 500, 600 basis points. We've moved them a little bit. So overall, we've moved pricing, but 50 basis points. We're not making these wild gyrations partially because we were pretty steady in the market. We do have some room to go up a little more if we need to. But the good news is what Micah said is our debt stack as such. It's not -- our interest rates actually went down in 2022. Our overall cost of funds because of the way we issue. So we don't have a lot of pressure on our NIM from -- that others are having right now.

One of the big topics related to credit, but is how the reserve develops and you've got a reserve that's been very healthy, large and you built it modestly in the last quarter or 2. Just talk a little bit about how you see that reserve development during '23, particularly if credit tracks what your current expectations are?

Yes. So I mean, our reserves for sure, are very much aligned with our credit outlook. So we feel we've got -- we've got that covered. We feel like our provisioning is very adequate for what our near-term loss outlook is and over the horizon of our reserves. And we also have some room in those reserves for some worsening in the macro environment as generally folks do with CECL, we've assumed about a 4.5% to 5% unemployment rate in our reserve assumptions. I would make sure to note that, that also -- it's kind of a lever to move the reserves, but it also gives us some room if we weren't to see unemployment, we see continued elevated inflation instead both of those things could actually be covered by the reserve levels we have. Just in terms of process, our reserves every quarter will reverse all of the reserves we have against current period charge-offs, so we're fully reserved for that period. And then we build them back based on our loss outlook at the time and what we think the future macro environment. So we're always stepping forward each quarter and looking out on the horizon as to what we think based on external data and sources of data that we use from macro projections, what things will look like and where we think we should be reserved for. And so all else being equal, given we've got this portfolio transition that Doug talked about a little bit with our front book, which is that post originations tightening that's performing in line with 2019 pre-pandemic kind of levels. To the extent that continues to grow, and it was about 30% at the end of December 2022. We expect that front book, absent any other changes to our originations appetite that would grow to about 70% by the end of 2023. And so given that performance is better than what we are seeing for some of the back book cohorts, all else being equal in the macro environment that could lead to a reduction in reserves as we get to the back half of the year, and we're looking forward to 2024. Of course, a lot of that is really highly dependent on what the macro state looks like at that time. So that's a dynamic that's very different under CECL than the old incurred reserves method.

Right. Although now it seems to be, given where we are, both in the economic cycle and how much you've got in reserves, it seems to be acting more defensively perhaps than one might have thought. I know what I might have thought.

Sure while -- It does push you in some ways to get ahead of it. You want to take -- I think that was the design that FASB had in mind when they put it there.

Another big topic, capital return, you've kind of -- that's evolved over some time. You had a large shareholder that had wanted periodic dividends. You've now established a high regular dividend that you just recently increased and are also in doing, I don't know if you call them opportunistic or it may be more like almost a steady stock buyback. Just talk about your -- I guess what that says about your thoughts about the returns of the company and how you see that going as we move forward?

Yes. Look, anyone in the lending business, but especially in the nonprime lending business, it's a cyclical business. And we feel really good, even right now, we're in a down cycle because delinquencies went up that even in a down cycle, we still generate a lot of capital that we can use for our priorities. And our priority order is, first, we're going to book every loan or every credit card and use that capital for a high-returning asset. We have, on average, 4% to 6% return on assets, very healthy, again, even in a down economy. We're then investing in the business. We're investing in credit card, which has a capital drag on the business last year and this year, which should turn positive by the end of this year. We're investing in distribution channels. We've been investing in our omnichannel capabilities. And then we decided to have a very robust dividend that people could count on regularly. We got a lot of feedback from the market that episodic dividends were great and people like the cash, but they'd rather put it into the regular so now it's a predictable stream. We just increased it even in a year where we put out our strategic priorities or guidance where we're going to make a little less this year than we did last year, just the math of this, and we think we'll bounce right back. We've got plenty of coverage even in a severe economic stress. And so I mean, I think what you should take from our increase in dividend is even if things get a lot worse, we feel very comfortable that our dividend sacrosanct, and we can return this kind of capital to investors. I think buyback, we have a steady buyback program. We're in the market every day. We're not day traders. We think the company is undervalued. Last year, we did about $300 million in buyback, but we ramped that down as the year went on. This year, we've said we're probably going to do less than that. And it's a lever we can use depending on how much capital we're generating. I think over time, we feel very comfortable that whenever we get through this economic cycle, and even if we don't get through it with the current book we have, our capital generation and earnings will go right back up in 2024 unless the economy takes a serious dive that will give us more capital to distribute. The most flexible lever is buybacks. So we'll think about a steady dividend that will likely increase over time. Investment in the business and excess capital we can use for buybacks.