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

All right. We'll get started. So I'm very pleased to have OneMain Holdings on stage with me. And we have Jenny Osterhout, the Chief Financial Officer. So welcome, Jenny.

Thank you. Thank you for having me.

So let's jump right into it. Maybe just beginning with consumer. There's been renewed concerns around household budgets just given higher gas prices and some signs of inflation pressure. How would you characterize the health of the nonprime consumer today?

It's interesting. You can read the papers, you can look at all the stats out there. But frankly, when we look at our customer base, it doesn't match up with what we're seeing. Let me just talk a little bit about who our customers are. So we don't use FICO to underwrite, but our average customer has about a 630 FICO, just to give you a sense. They have been at their jobs for -- about half of them have been at their jobs for over 5 years. Really, you're seeing 40% homeowners. So a really good -- we call them hard-working Americans, $80,000 a year in annual income. So sort of your average American. And when we look at payment behaviors, we're seeing really good payment behaviors where you can then look at sentiment and you can spend time in the branches and you can feel that folks are trying to make things work. But I think what you're seeing right now is that they're able to sort of move things around and make their family budgets work. So at the end of the day, right now, we're still seeing everyone work through it. I would say the pieces we'll be watching are obviously the 2 things you watch. You watch for employment, which right now, we're seeing generally very good employment numbers. And then you also watch inflation. And there on inflation, fuel prices. We've seen very modest change on our card that we have. We now have some spend data. And so we're seeing a move that's pretty minor, 7.5% of our average spend was on gas, and that's moved to about 8% of average spend. So you're not seeing major shifts, but we'll watch gas prices. And we'll also watch for other pieces like electricity bills. I think place like insurance -- places where you can see major shifts very quickly are things that we would watch. But right now, really seeing good payment behavior.

Got it. That's helpful. Maybe we just jump right into credit performance. That's been the focus this year. Net charge-offs were 8.3% in the first half. That compares to your guide of 7.4% to 7.9%. What gives you confidence in achieving your guide? And what would bring you to the high or low end?

Right. So that guide of 7.4% to 7.9%, I think we're feeling very good about that guide. We saw really, really good year-on-year improvement. If I look at the second quarter -- first quarter, we were about 1 basis point year-over-year in our 30 to 89 delinquency improvement. And then if you look at that second quarter, we were 7 basis points in terms of that improvement. So we like that sort of that movement. And if we look at to be at the low end of our guide, we talked a little bit about roll rates, but we've seen a little bit higher roll rates. If those were to continue, you would see us at the high end of our guide. You'd have to see the economy stay rather like it has been. To be at the low end, you'd have to see improvements in those roll rates. We're really at that point of the year when that's going to be what affects our losses and maybe some improvement in the economy. But overall, I think we're feeling very good about the guide, very good about the long-term trajectory of losses.

Got it. And if I just take the midpoint of your guide, that implies net charge-offs are flat year-over-year. Just over the next few years, how confident are you in migrating back to your target 6% to 7% net charge-off range? And if we think about how card and auto kind of impact that, maybe just any color around that.

Yes. So if I look in 2019, we were a personal loans company. That's what we did. It was a different economy, but -- and we were in the 6% to 7% guide. And I think that relates to why you asked the question about the different products. If you look at us today, I would think you look at our consumer loan book, that's personal loans and auto, and I would compare that back to that 2019 number. And then we'll talk about cards in a minute, but cards obviously comes with a different loss rate. Last year, we saw this massive improvement. We went from 8.2% losses to 7.65% losses. We really -- it was outsized improvement. This year, you mentioned it's been rather flat. I think as we look forward, you're not always going to see an exactly linear path, but we feel pretty confident in that consumer loan loss level coming in below 7% over time. So I think you're going to see that get there. And then cards, which is included in our overall C&I, so it's consumer loans plus cards, depending on the growth of cards and its percentage of the book, you're going to then see that impact our overall C&I loss number.

Got it. Okay. That's helpful. Maybe we'll just talk about the recovery side of the net charge-off equation a little bit. Recovery rates in the last 2 quarters have been materially better, up by about 30 basis points year-over-year on average. What's the driver of that? And can you touch upon the sustainability of that going forward?

I was saying this earlier today to someone, but recoveries are such a core piece of what we do regularly and just in the normal course of business. We, a little while back, invested more in our internal recovery capabilities. And to talk about what some of those things are, I mean, that can be looking at the tools that you use and the models that you use to determine who you're going to contact, how you're going to contact them? And let me -- just to give you some examples. I mean, it used to be you call the next person on your queue at the time that worked for you. Think about in today's day and age, you've got to think about, well, what -- how can we predict what's the best time to call a customer? How can we predict what's the best method to reach them? Should we call them? Should we chat with them? Should we text with them? Should we send them a notification in the app? Should we e-mail them so they can see it later. So you have so many more channels to determine what's the best way to reach them. And then you can also determine who on your -- what's the right? Should we put this in the -- where -- who should contact them? So I think there's so much that we did around investing in those analytics, and it also comes with making sure you have the right data sources to figure out some of those pieces. And I think that's an ongoing effort. I mean the world is changing. We're moving into folks who are much more digitally native. So that's going to change the way that you're doing recoveries. And we also have had since the sort of '21, '22 inflation, if you want to call this an inflation cycle, more inventory. And so as we've looked, you have more opportunity to go and look at externally what you -- the value of that inventory and what somebody else can do with it. So I think it's just given us a little boost there as well in terms of recoveries. But if I look at the second half of the year, I think you'll see an average of what we've seen over the past few quarters. And it's obviously been great to see the improvements that we've seen there.

Got it. That's helpful. Maybe just a follow-up on the inventory piece, any sense on when that excess inventory normalizes?

I think you've seen some others talk about it, too. I think it's sort of a phenomenon that's not just a OneMain phenomenon. I think over time, if you see the trajectory of losses improve, you're going to start to see less inventory. But I think through the end of the year, you still have a little bit more inventory, and then we'll look at it again next year.

Okay. Got it. That's helpful. Maybe just to switch gears a little bit. So OneMain has one of the largest branch networks in the nation. Can you just talk about how that fits with OneMain's strategy? And are the branches primarily customer acquisition advantage, the servicing advantage or something else?

Capital A advantage. I really -- I love talking about our branches. I think they're -- I just talked about changing customer behaviors and how folks' behaviors are changing, but I also still think there's so much value in talking to a person face-to-face. We have 1,300 branches across 44 states. We have the seventh -- if we were a bank, we have the seventh largest branch network in the United States. It's core to our model, and I think it will be core to our model for a long time. And let me explain why. I mean, it builds trust. I think when you know that there is a OneMain branch, you've seen it on your way to work or you've seen it to drop off your kid at soccer, it gives you this sense of comfort and trust. I think trust is so important in the industry. You also have this -- in this moment, and I would just say we always talk about this, but it's a pretty stressful moment. I mean if you live in Texas and your HVAC goes out and you need a new air conditioning system and you don't know where you're going to get $10,000. When you go in, you are stressed when you have that conversation. It is helpful to have somebody who has seen many of these conversations sit and have -- and talk to you about your options. So it's a consultative process where we also guide you. And our branch managers, on average, have over 14 years of experience. So they've sat with many customers who have been in a position just like you. And I really think there's so much value in that. And you're also, at the same time, always looking to help put the customer into a loan that you think they're going to be able to pay back. And remember, you have this dual model where you're both at the upfront in the initial acquisition process, but you also have your branch team members there if -- for the minority of our customers who do need help in figuring out how to make a payment, just having had that conversation at the beginning, you may not even be talking to the exact same person, but to know that they know Sally or that they sit in a branch with Sally, and it's the same person that you talk to. It really builds trust, and we think it drives better outcomes. I have to say that a lot of what we're doing and investing in, in terms of the digital capabilities that we have are also to help make those team members more productive. How can I take the branch manager and make it so that we really have the -- make the most value out of their time, out of their workday. And so this isn't just about, okay, you've got this branch network and you're doing -- we're doing things the way we've always done them. I'd say this is really about how can you look and make sure you're making the most of the human connection, making the most of the experience that, that person has while simultaneously leveraging your central sites, so where you have your central sites and capabilities and self-service. Maybe for certain activities, we'd rather just allow the customer to do it themselves. So it's really figuring all of this out is a major effort of what we're doing at the company, and it's exciting. I mean it's really exciting. You can sort of feel that it's pretty powerful.

Got it. And OneMain applied for a bank charter last year. Any updates that you can share on the status of the application? And then maybe also just to take a step back, just remind us why OneMain applied for a bank charter.

Great. I wish I had more of an update. I don't. Obviously, we think it's a really strong application. We think we've been doing this for over 100 years, and we're a great -- we would be a great applicant for an FDIC charter. Just as a reminder of why we did this because I do think it is helpful for our strategy. I would say, if we don't get it, we have a great strategy and we would be fine. I think of it as the word we've been using is an amplifier. It allows us to reach more customers in more states. I think that's the first and foremost piece of this. It also reduces some of the complexity. Just to give you an example, in North Carolina, if you lend to a customer, if you lend them $4,000, you have a certain rate. If you lend them $4,000 to $8,000, you have a different rate. If you lend them $8,000 to $12,000, you have a different rate. So all of that drives complexity and then you compare that in each state, you have different complexity. It could be complexity on the collection side, it can be complexity on the underwriting side. So all of that -- there's a simplification of what's happening in the back and sort of the bowels of OneMain. We also today use a credit card bank for our credit card. We would be able to do that ourselves. And then there is some funding flexibility that it would allow us over time, and I think that could be a long-term benefit for us. So it's exciting if it happens, but we'll see.

Okay. It sounds like you guys have a pretty strong case to get approved for one. But maybe just switching gears again. You've indicated your reserve ratio should trend higher over time as credit card becomes a larger portion of the portfolio. How should investors think about the reserve ratio as the mix evolves? And what could the reserve ratio look like in a more normalized credit environment?

CECL is my favorite topic. So I think you've seen 11.6% was our reserve rate this past quarter. That was sort of a modest increase this past quarter, that really was from the growth in our card book. And cards has a higher loss rate. So we've stated our long-term loss rate in cards is 15% to 17%. It also comes with a great revenue yield. We've got over 33% revenue yield. So overall, it's a great product. We're happy to put it on our books. The goal here is to put profitable book -- profitable growth on our books. And it's still such a small portion of our overall, about $1 billion on our $27 billion portfolio. But even minor increments in the percentage of -- or the portion of cards receivables on our book are going to make changes to CECL, and that's because our CECL reserve for cards is about 2x that of our reserve for consumer loans. And so while it's really good and profitable growth, it's going to inch us up. I'd say 11.7% or 11.8% are visible in the near term. I think towards the end of the year, we could trend in that direction as you see some of that growth in cards.

Got it. Just shifting to loan growth. OneMain has continued to maintain a conservative underwriting box. Most of your current originations today are from your higher credit tiers. What returns are you currently underwriting to today? And what would you need to see before reopening the credit box?

So we underwrite to a 20% minimum ROE hurdle. It's actually -- it's pretty simple. So I start with just if you think about our -- you take your APR and your fees and you take your cost, so your funding costs and then you take your operating costs and then you take your losses. And on the losses, we've had this 30% overlay. So that means if we thought you're a 6% loss rate, you're actually going to be a 7.8% loss rate, really simple, 1.3. You multiply that by 1.3. And then you get to your 20% return hurdle. You've got a hurdle over that for us to underwrite. I'd really say, for us, we're pretty conservative in how we -- like we really think about this as a focus on returns. So we're focused on long-term capital generation. To loosen that, you'd need to see on-us outperformance, I'd say, over time in terms of pockets where you'd see that ROE hurdle perform better than you'd expect. And then we also run something called a weather vane test. And that's basically you take a small slice of customers who are going to perform below your 20% ROE hurdle, and we put just enough on that would allow us to read that group. And if you start to see that population moving upwards and performing above that 20% ROE hurdle, that's when you start to look at, is it time for us to make moves. But unfortunately, it's not going to be something that you see externally in the environment where you're going to say, okay, we now think the future is going to be better. It's going to be something that we're likely to see on-us. But overall, we've seen pretty good growth. So I would also say I don't think there is the need or the pressure to think about credit right now because I think we found so many other ways for us to think about growth.

Got it. Where do you see the greatest opportunities to accelerate growth without taking any incremental risk?

So we have that 6% to 9% managed receivables guide. I think we feel pretty good about that growth. Again, for us, growth is an outcome. Our consumer loan originations this past quarter was at 10% year-over-year. So I think quite good. Accounts was 44%. So really, you're seeing that impact from the credit card from a smaller line having more accounts. And you're also seeing the acceleration of those newer products. In auto, you're seeing just -- we can get very good growth with just new geographies, new dealers, new partnerships. It's very much a -- for those of you who follow other auto, it's very much a grind-it-out business. You're looking -- but there's so much opportunity. I think we're coming off of a smaller base. In cards, it's really about the product mix that you're changing, some of what we're doing in terms of growing with our best customers. It's how we attract and find new customers. I think, again, we're growing off of such a small base that there's just so much more that we have in the pipeline to do to grow. And then in loans, I really think what you're seeing now are the fruits of our labor that we put in back a year ago or 1.5 years ago to do tests. And the 3 things I'd call out are we have this new home fixture-secured product that we're still rolling out. That allows folks who have a home to get the advantage of a secured product. Then you have debt consolidation, which is a product we've had for a long time, but we've really reenvisioned how we market it and how we connect it and how we interact with the folks that we're paying off. So that's become much more digital, and we've seen a lot of success there. And then we're also seeing bank data, which I think folks have been talking about for many years, but we're really seeing it and it allows you to think about the offer that you're making to your customers and to really look at them in a different way. So I think we're feeling very, very good about growth. And it's a good reminder that you always have to invest and I think of it almost like an R&D arm of what we have in the background to make sure that we feel good about the future.

Got it. That's helpful. So with your portfolio, cards have grown meaningfully, and they've become -- that segment has become profitable this year. Auto continues to grow as well. How have these product lines developed compared to your initial expectations, particularly around credit and also return profiles? And then longer term, what are your expectations for each of those?