OneMain Holdings Inc (OMF) 2018 Q4 法說會逐字稿

Welcome to the OneMain Financial Fourth Quarter and Full Year 2018 Earnings Conference Call and Webcast. Hosting the call today from OneMain is Rohit Dewan, interim Head of Investor Relations. Today's call is being recorded. (Operator Instructions)

It is now my pleasure to turn the floor over to Rohit Dewan. You may begin, sir.

Thank you, Maria. Good morning, and thank you for joining us. Let me begin by directing you to Pages 2 or 3 of the fourth quarter 2018 investor presentation, which contain important disclosures concerning forward-looking statements and the use of non-GAAP measures. The presentation can be found in the Investor Relations section of our website.

Our discussion today will contain certain forward-looking statements reflecting management's current beliefs about the company's future financial performance and business prospects and these forward-looking statements are subject to inherent risks and uncertainties and speak only as of today. Factors that could cause actual results to differ materially from these forward-looking statements are set forth in our earnings press release. We caution you not to place undue reliance on forward-looking statements.

If you may be listening to this via replay at some point after today, we remind you that the remarks made herein are as of today, February 12, and have not been updated subsequent to this call.

Our call this morning will include formal remarks from Doug Shulman, our President and CEO; and Scott Parker, our Chief Financial Officer. After the conclusion of our formal remarks, we'll conduct the Q&A session.

So now let me turn the call over to Doug.

Thanks, Rohit, and good morning, everyone. I'm really pleased to be with you today. Let me start with a review of the highlights for the year and then I want to share some high-level thoughts on our future direction.

We had a great fourth quarter and full year in 2018 with some important milestones for the company. We earned over $5 a share in our Consumer & Insurance segment and ended the year with over $16 billion in receivables.

During the course of the year, we executed on our strategic priorities, including shifting our portfolio towards more secured lending, delivering strong credit performance, strengthening our balance sheet and executing expense discipline.

Going into a little more detail. Portfolio yields remained stable at nearly 24% through the year. We continued to focus on efficiency and expense discipline, reducing our operating expense ratio by 50 basis points for the full year. On credit, a larger secured lending portfolio and increased collections effectiveness helped us drive a 50 basis point reduction in net charge-offs for the full year. All of these factors, along with the impact of corporate tax reform, helped us to expand our return on receivables by 100 basis points in 2018, reaching 4.5% for the full year.

We also continued to strengthen the balance sheet through further reducing our adjusted tangible leverage ratio to 6.9x at year-end. That was down from 9.4x at the end of last year.

Looking forward to 2019, I expect continued positive momentum on credit performance, deleveraging, operating efficiency, which will further support capital generation. In addition, we will continue to invest in data analytics and technology to drive increased efficiency and profitability in our business. We'll talk more about our 2019 outlook and our capital policy later in the call.

I want to make a few observations about the strength and resiliency of our business. I want to note and emphasize that we are focusing on managing our business for the long run. We're not currently seeing any signs or leading indicators of strain in our customer base. Nonetheless, regardless of economic cycles, we are in a great position, given our secured loan portfolio and conservative balance sheet. We've executed a significant portfolio transformation over the past couple of years.

Since the end of 2016, all, let me repeat, all of our net portfolio growth has been secured by collateral, improving the overall credit profile of the business. In addition, we have significantly enhanced our funding, capital markets access and liquidity.

In 2018, we reached our near-term goal of 50% unsecured funding through the issuance of nearly $3 billion of unsecured bonds at attractive rates. We've also continued to develop our ABS program, becoming the first issuer with the AAA rating in the personal loan space. At the end of 2018, we also had $6 billion in committed conduits, up from $5.1 billion a year ago. And we had $7.6 billion of unencumbered assets, up from $5 billion a year ago. This gives us over 24 months of liquidity runway, even if we had no access to capital markets, which puts us in a very, very strong position.

Overall, from a portfolio positioning, liquidity and capital perspective, the business is in fantastic shape. And yesterday, as I'm sure you all have seen, our board approved a dividend, which I will discuss later in the call.

So with that, let me turn it over to Scott.

Thanks, Doug. We achieved strong results in the fourth quarter. We earned $168 million of net income or $1.24 per diluted share. This compared to net income of $39 million or $0.29 in the last year's fourth quarter. As a reminder, fourth quarter 2017 GAAP income included a onetime tax reform-related charge of $81 million or about $0.60 per share.

Our Consumer & Insurance segment earned $189 million on an adjusted net income basis or $1.39 per diluted share compared to $144 million or $1.06 in the fourth quarter of 2017. As we've highlighted before, our GAAP and C&I earnings continue to converge, reflecting the strength of our business performance and the defining impact of acquisition-related charges. We expect this trend to continue.

Now let's discuss the key drivers of our C&I financial performance for the quarter. Ending net receivables grew $1.4 billion versus last year. All of that growth was secured, highlighting the quality of our portfolio growth. Originations grew 4% to $3.3 billion; and we're 53% secured, up from 44% a year ago.

Interest income was $959 million, up 10% from last year's levels, reflecting higher average assets. Yield remained stable at 23.8%, as the pricing actions from mid-2017 continue to offset the yield pressure from our transformation to a more secured book.

Our credit performance in the quarter improved. Net charge-offs were 6.3%, a 10 basis point improvement from a year ago. Both our early and late-stage delinquencies were stable year-over-year.

Our reserves increased sequentially by $20 million, reflecting asset growth for the fourth quarter. Our loan loss reserve declined by 10 basis points compared to last year and was stable with the third quarter at 4.8%.

Fourth quarter operating expenses were $312 million, up about 4% versus last year and down $8 million compared to the third quarter. The year-over-year increase reflects the continued investment in our business. Despite this investment, our fourth quarter OpEx ratio improved by 40 basis points versus last year, demonstrating the inherent operating leverage in our business.

Now moving to funding and liquidity. As we've discussed on previous calls, we've been focused on mitigating interest rate risk and enhancing liquidity. We've done this by increasing our mix of unsecured debt and extending the duration of our liabilities. As Doug mentioned, we issued $2.9 billion of unsecured debt in 2018 at attractive rates. And in the new year, we have continued to diversify our funding by issuing $600 million of personal loan ABS in January.

Our liquidity position, as Doug touched on, is strong. At year-end, we had $6 billion of undrawn conduits, $7.6 billion of unencumbered assets and nearly $700 million of cash. This liquidity allows us to fund our expected cash outlays, originations, scheduled debt maturities and operating expenses for more than 24 months with no access to the capital markets.

Lastly, we reduced our tangible leverage ratio to 6.9x at year-end, down from 7.8x in the third quarter. The reduction was driven by strength in our business performance and continued capital generation.

I'm pleased that Moody's recognized our continued progress yesterday with an upgrade of our ratings to Ba3.

With that, I'll turn the call back to Doug for his closing remarks.

Thanks, Scott. Looking back on 2018, we delivered on our strategic priorities. We came in near the top of the range on receivables growth, while maintaining a stable yield. Credit performed very well with a 6.5% net charge-off rate, coming in at the low end of the range for the year. We maintained operating expense discipline while effectively investing in our business. We achieved our near-term goal of having a balanced capital structure by driving our ratio of secured funding to around 50% through the issuance of unsecured debt. And finally, we reduced our tangible leverage to less than 7x.

As we move forward in 2019, we expect to drive continued momentum across our strategic priorities. That includes receivables growth of 5% to 10%, stable yield, further improvements in net charge-offs and modest operating expense growth of 3% reflecting continued investment in the business.

And lastly, the board has approved a 2019 capital program. We considered where our capital can best be deployed in the coming year, and we're going to allocate it in 3 ways. First, we will continue to invest in the business. We have a great return profile, generating a 4.5% return on receivables. So we plan to continue to use our capital to fund growth and to fund investments to position us for the long term.

Second, we believe it is prudent to continue to strengthen our balance sheet. So we will continue to use excess capital to reduce our tangible leverage. We are targeting around 6x by the end of the year.

And finally, we're initiating a $0.25 per share quarterly dividend. Now this is a milestone for OneMain as it's the first capital return to shareholders, and it illustrates our conviction in the stability and earnings-generation power of the business. On an annualized basis, this $1 per share dividend provides a compelling yield, over 3% based on yesterday's closing price and will serve as the catalyst to expand our shareholder base over time. We are pleased to start legging in the capital returns with this dividend.

Let me end by just saying that I'm incredibly excited about our business and the opportunities ahead of us. Our market-leading branch network, differentiated customer experience and underwriting, strong credit discipline and conservative balance sheet is a very powerful model that positions us well for the future. I'm confident that we will build tremendous shareholder value over the long term.

So with that, let me turn it back over to the operator for questions.

(Operator Instructions) Our first question is coming from Michael Kaye of Wells Fargo.

First, I was hoping you could provide some color around your preference for dividends over share buybacks. I was wondering -- does the low flow just make it structurally more difficult to do a share buyback?

I'll take this. This is Doug. Look, we think that the dividend is, first of all, going to provide recurring return of capital to our shareholders. We also think it will open the shareholder base up to us. There's a number of shareholders who will only invest in stocks with a dividend. So we think it's going to be good for all shareholders. As I said, we looked at our capital policy for the year. And we're going to invest in the business. We think it's very prudent to keep delevering. And then we started with a -- what we consider a healthy dividend, which has a real compelling yield. So we considered all options, and we looked at it. We feel really great about this option.

Okay. Second question. Just wondering what you're currently seeing on the loan demand side of the equation from customers? Also, I've been reading some research that suggests that lower income consumers could see an outsized benefit from the tax refund this year, from the tax cuts last year. So I'm wondering, how do you see that playing out for your loan demand and credit during tax refund season?

Let me not touch on -- I'll mention tax refunds in a minute. But look, we think there's a large and underserved market. So there's always demand for credit. We're really focused on booking the loans that meet our risk-return profile, where we can provide value to a customer and it fits within our credit box. And so we're not seeing signs of strain in our customer base. Labor markets are healthy. And so -- we have plenty of applicants that we turn away. And we're as focused or more focused on credit and making sure we only book the loans we want to book, and we think that's a prudent way to run the business. I think on tax returns, there's a lot of speculation out there. I think it's too early to say. We're just getting into the tax return season. We're not seeing any impact on our book, but we'll see over time.

Our next question comes from the line of Moshe Orenbuch of Crédit Suisse.

Great. Doug and Scott, really terrific that you guys instituted the dividend. As you outlined kind of the 3 pieces of your capital plan, assuming that business continues to generate capital at the current levels, it probably will provide excess relative to that. How -- I mean, how do you think about which of those areas is going to get incremental capital towards them as you kind of go through 2019 and '20?

Yes, look, like I said, this is a real milestone for the company. We're in a position of strength and stability and feel great about initiating our first capital return. This is a 2019 plan that we kind of debated and came to where we are. We're going to allocate it to the 3 areas we talked about. And we'll let you know in the future, if there's any changes to the capital policy. But where we are now, we feel really great about laying it out, and it's a really good use of capital to invest in our business to delever and to do a dividend. And when we get to any future state, we'll talk to you about it.

Got it. And I would certainly agree that a dividend at that level certainly is a very strong statement about the company's belief in the operating and the strength in the operating earnings. When you look at funding, you did a lot of unsecured in 2018, how do you think about the plan for '19? Is it going to be a little more heavily weighted towards the secured side? You've noted you did one deal already in Q1.

Moshe, it's Scott. I think as we talked about on the last call, we still want to stay in that balance of where we are plus or minus that 50-50. We do have, I think, as you know, have some of the current ABS deals are amortizing. So we will be issuing ABS, not only just to offset that amortization but also to maintain the balance between our funding as we grow the portfolio. But I wouldn't say that we're going to do anything radically different. It's just normal routine accessing both the unsecured and the secured markets throughout 2019.

Our next question comes from the line of Sanjay Sakhrani of KBW.

Doug, you mentioned the 6x leverage by the end of the year. I guess, just a follow-up on the previous question. As we look ahead, how should we think about that ratio? And how it could trend in the future?

Yes, look, we want to make sure that we have a conservative balance sheet. We think it's a prudent way to run a consumer lending business. The team has made real significant strides in delevering. We feel very good that we got down to just under 7 this year. We looked at kind of the economic backdrop where we are. We are not seeing any signs of strain in our customer, and we monitor a lot of different variables. With that said, we're mindful that we're 10 years into an economic expansion. And so we think a good way to position the business for the long run is to get to 6 this year. That's our target. We're going to work throughout the year and take advantage of capital markets, and we'll reassess it a year from now depending on kind of market conditions where we are, opportunities in the business.

Okay. And I'm sorry, I should have added to that. As far as like CECL is concerned, Scott, I mean, how should we think about how that plays into that 6x as we exit this year into next?

Yes, so you can imagine that we had a lot of conversation with the stakeholders around the current business when we set these targets. On CECL, there has been a lot of discussions around the implementation of CECL, but we believe that all the things that we've laid out in our capital policy will continue regardless of the impact of CECL.

Okay. And then just one final follow-up. As far -- and congrats on the Moody's upgrade. I guess, as we think about the economic benefit over time as a result of this, could you maybe just walk us through how we should conceptualize the economic benefit of the upgrade?

Well, I think, one is we like the fact that we kind of moved to the next level out of single B. And what that does, as you know, provides expansion of the investor base. So this year, we've been able to grow our unsecured investor account by over 50%, which is a good thing. As we get the upgrade, it also brings in other players that can look at our debt. Technically, being in the BB range should help us on unsecured issuance -- on the issuance cost, but I'd say that's a marginal benefit from kind of where we were trading at. But I think the bigger piece is access to more investors, a deeper market to allow us to continue to have the success we've had in the unsecured market.

Our next question comes from the line of Rick Shane of JPMorgan.

Looking at the charge-off guidance for 2019, the expectation is for modest improvement versus a good number in 2018. One thing we noticed is that the delinquency trends are starting to flatten out on a year-over-year basis. Is the assumption that loss severities will go down modestly, as you continue to shift the portfolio, is that what drives the favorable trend, given flat delinquencies?

Yes, so when you kind of think about that Rick, I also say that it's the continued mix shift. So one of the reasons why things are kind of moderating is that we've been on a significant increase over the last couple of years of pushing secured. It's starting to kind of tail off as we come into 2019, but it's really more the mix of our secured losses or about half of our unsecured losses. So as you get there, it's actually a frequency, as we talked on different calls. The frequency of loss on the direct auto and hard secured is much lower than that of our unsecured, which drives the continued improvement that we expect in 2019.

Got it. So it's actually a roll rate issue from the delinquencies to the charge-offs?

Well, it's not -- you say an issue. I think we've seen improvement. Part of the improvement we had in 2018 is both a combination of the mix shift as well as improved collection effectiveness in the late-stage collection area as we continued to kind of bring in a lot of the policies and practices through the integration. And that piece has kind of stabilized. And so now you really -- the focus for '19 is really just the mix shift.

Got it. Yes, don't read into the word issue; explanation would have been a more accurate description. Second question related to operating leverage. Obviously the guidance for 2019 in terms of OpEx versus loan growth is very favorable. I'm curious, is that realization of the synergies of main the Springleaf-OneMain merger? Or is that really a function of that mix shift driving larger loan sizes?

Well, on this one, it's kind of the absolute number, Rick, not the percentage. So we will continue to drive down the percentage because of kind of loan growth relative to operating expenses. But I think, we invested in 2018. Some of those investments will pan out in 2019. But as Doug mentioned, the philosophy is to continue to invest in the business but find cost efficiencies in the platform to fund those. And so at 3% operating expenses it's kind of think about it as around kind of inflationary growth rate. And we look at all the time trying to figure out how to get as much operating leverage out of the platform as we can.

Yes, I'll just add. I have a strong belief that one of the jobs of the management team is to just continually drive improvements and efficiency. So we're looking across the platform, and we're saying how do we optimize our branch network, how can we use technology to automate things that are manual now, if they're back office functions, where might we have extra weights and layers of people or spans. And so you should expect us to continually be driving to make the company more efficient. That's also going to include investment dollars to invest in things that are going to make us better like data, like analytics, like our credit and underwriting, like our technology so we can serve our customers well and give our employees great tools. So I would think most of the integration is behind us, and this is now us just running the business in a more efficient way, and our plan is to do it year after year.

Our next question comes the line of John Hecht of Jefferies.

I guess, a little bit of a follow-up from the last discussion. One of the surprises has been kind of the expense leverage here. But you also -- it seems one of your priorities is to invest in technology and digital initiatives. I'm wondering if maybe you can give us a little bit more detail on that. The 3%, I'm sure some of it is tied to your wage inflation and so forth, but what component of that is technology initiatives? And what capabilities do you have in terms of goals in that regard?

Yes, look, I think I said on the last call, any financial service company needs to be very focused on technology enablement, having a digital presence for customers and for employees, because it's just the way the world is moving. And people expect a better experience. They expect things faster. And so we -- a lot of our investment is core investment, open branches, where we think there's high demand and potential. We're closing some branches where it doesn't make a lot of sense or we can do branch consolidations. We're investing in people, and we're always going to be looking for the best people to make sure we can drive our company forward. I think from a tech perspective, we're doing a lot of investment in just our core platform to make the branch-based employee more efficient, to make sure we have great tools for customers when they walk into the branch. We're also investing in data and analytics so we can optimize our operations, optimize our marketing, optimize our credit and underwriting. And then we're going to be always looking to have enhancements that we invest in either for the customer experience or for the employee experience. And so we can't really dimensionalize it. I mean, generally, there's an uptick going on in various parts of the business. But at the same time we increase by 3%, we're also cutting in certain places.

And any discussion point around kind of soup to nuts online lending at this point?

No, look, we want to make sure we serve our customers well. And we right now have a lot of digital capabilities and a lot of our customers come in to us and apply online, et cetera. We over time have built up a quite a strong centralized network that can do customer assistance but also takes collection loads off of branches when needed. And then we have in-person. I think over time, we're just going to need to optimize our ability to meet the customers where they want to do business with us. I will say our branch network is a real differentiator. I spend a lot of time in our branches, and the deep relationships we have with people, the ability to talk through product optionality with them, the ability to do ability-to-pay underwriting and real budgeting with them is great. But we also have a lot of those capabilities on the phone, and we have some of them online. And I think we, as a team, are going to work on a strategy that makes sure every customer wants to do business with us that meets our credit box that we think we can provide value to them, we're going to be able to do business with them.

Our next question comes from the line of Vincent Caintic of Stephens.

For the 2019 guidance on credit, so I appreciate that you're guiding lower year-over-year for 2019. Last year's improvement from the mix shift from unsecured to secured, I'm just kind of wondering how much of a benefit that will be going forward? And then if we look at 2018 and separate the mix from unsecured to secured, where credit trends would have gone, so just trying to isolate that benefit there.

Vincent, it's Scott. So we're not going to kind of decompartmentalize it. But as I mentioned between -- in 2018, we had the benefit of the continued mix shift over the last couple of years plus some improvement that I've mentioned to Rick on late-stage collection effectiveness. When you think about 2019, the point we're trying to make is since the mix shift of those '16, '17 and '18, as those vintages kind of season, we expect to see continued improvement, just not at the same trajectory as we experienced between 2017 and 2018.

Okay, understood. Then on to the yields. So it was nice to see in 2018 the pricing improvements. Just wondering how much more pricing improvements are available to you over the course of 2019? And what gives you confidence that the yields stay stable year-over-year?

Yes, as we mentioned, we're continuing to look at ways to optimize kind of our pricing relative to the market and competitive forces. We still believe as we did in 2018 that based on those strategies and how we're optimizing the platform, as Doug mentioned, that we can maintain a stable yield even with the continued mix shift that we're going through. So that's kind of our expectation for 2019.

Our next question comes from the line of Arren Cyganovich of Citi.

Just looking at the competitive environment, was it impacted at all in the fourth quarter whenever you had high-yield spreads widening out, maybe as spreads widening out, did you notice anything from your competitors? I know you have plenty of liquidity and would be able to take advantage of those kind of situations. But was there any impact on the competitive environment from the spread widening we saw last quarter?

You're talking about from a customer point of view or from a funding point of view?

From a funding point of view, so your high-yield bonds have capped out pretty significantly and I imagine most folks' did, but you also had plenty of liquidity available. So I didn't know if the online folks or folks that you would see in the market would have been constrained at all from a lending perspective?

Yes, I think, well, at least from a funding perspective, the fourth quarter was pretty tough, both for -- clearly the unsecured market. There wasn't a lot of ABS transactions. As I mentioned, we were the second deal out in January, which was a strong reinforcement of our program that given some of the disruption and dislocation in the market in the fourth quarter that given what Doug mentioned about our AAA program and the investor base we've been able to cultivate, we were able to get a deal out fairly early into the process. As the market has stabilized in January and February, clearly, others have kind of been able to get out there, Arren. So I think, one of the advantages we have is that we want to continue to have liquidity in the event the markets go through that, which is why it's very important. And we keep kind of mentioning about how long we can run the business, even in the event of capital markets access. So that's, I think, a very big differentiator for us, and we want to continue to maintain that strong liquidity. And then number two is the cost aspect. So I think we paid a little bit more in January. But I think, from a perspective of our overall funding cost, it's marginal, given the fact that we can continue to tap the markets in the good times and the bad.

Okay. And then in the -- for the rate perspective, I know it doesn't really impact your yields or your cost of funds too much, but what are you assuming for rate hikes in your yield assumption this year?

Well, you know our yields are kind of based on state-by-state ranges. So I think, our expectation is that whatever happens in the rate environment, our focus is to try to optimize our yield such that we can manage both kind of customer market dynamics, competitive dynamics as well as our kind of overall return expectations. And then from a funding point of view, clearly, our -- the base rate on the ABS side has already kind of been kind of elevated, and we've been able to offset most of that base rate improvement or increase with our spread improvement. And on the unsecured market, I think, it's really more tied to longer-term rates than it is to shorter-term rates.

Right. I guess, I asked that kind of backwards. But what are you assuming for rate hikes in -- with respect to your expectations for cost of funds for the year?

We kind of used the kind of the forward curve. So the forward curve kind of was predicting modest kind of rate hikes by the Fed.

Our next question comes from the line of Kevin Barker of Piper.

A lot of my questions have been answered, but maybe just a follow up on the expense side. Are there any updates regarding the traction of the ad campaign initiated a few quarters ago? You kind of touched on it, but how do you expect marketing spend overall to come into play versus other things like maybe tax spends or as you mentioned branch improvements?

Look, no real updates. Look, we have an overall marketing program that's quite effective that includes mail, digital, some ads, some branding, some affiliates and partnerships, and we're always looking at that. Like I said, consumer demand for credit is robust. And so really no specific updates on the marketing.

Our final question will come from the line of John Rowan of Janney.

Just one more quick question on CECL. I know you haven't disclosed the impact. But just the way I look at it, I look at your balance sheet. It looks like you're carrying 8-ish months of allowance coverage. My understanding of CECL is that within a lifetime pool, it's important how much of your loss content happens within that 8 months' coverage ratio. Would you guys venture to maybe give us a number handicapping how much of that lifetime loss in any static pool happens within your reserve coverage that you currently have now?

Yes, I think, John, it's kind of -- to kind of do that right now is we're kind of working through kind of the modeling and all the activities around CECL implementation. I think it's probably fair to say that we'll probably provide more updates on that as we get through kind of midyear. But clearly, the difference between us where we -- as you mentioned, we have kind of our loss emergence period is kind of the 7 to 8 months kind of forward. With CECL, it's life of loan. And so you have to take into consideration that fundamental difference between where we are today, us specifically in the industry, and kind of where CECL is kind of going. But what we focus on is to me from an overall balance sheet perspective, reserves and capital are your cushion for losses. And so when we go through that implementation, I think it's just important to understand that from a balance sheet protection around losses, we'll be in the same spot before and after that process. So those are the kind of things that we think about, and then kind of the ongoing impact is also something we'll provide some insight around.

And thank you. This does conclude OneMain Financial's fourth quarter and full year earnings conference call. Please disconnect your lines at this time, and have a wonderful day.