OneMain Holdings, Inc. (OMF) Q4 2017 Earnings Report, Transcript and Summary

Welcome to the OneMain Financial Fourth Quarter and Full Year 2017 Earnings Conference Call and Webcast. Hosting the call today from OneMain is Catherine Miller, Vice President, Investor Relations. Today’s call is being recorded. At this time, all participants have been placed in a listen-only mode. [Operator Instructions] It is now my pleasure to turn the floor over to Catherine Miller. You may begin.

Thank you, Maria. Good morning and thanks for joining us. Let me begin by directing you to Pages 2 and 3 of the fourth quarter 2017 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 and we will be referencing that presentation during this morning’s call. Our discussion today will contain 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 maybe listening to this via replay at some point after today, we remind you that the remarks made herein are as of today, February 15, 2018 and have not been updated subsequent to this call. Our call this morning will include formal remarks from Jay Levine, our President and CEO and Scott Parker, our Chief Financial Officer. After the conclusion of the formal remarks, we will conduct a Q&A period. So, now let me turn the call over to Jay.

Thanks, Catherine and good morning everyone. We achieved our key operating objectives and had a great fourth quarter. Credit losses were in line with our expectations, our portfolio yields stabilized and loan receivables grew by almost $500 million in the quarter. We also further strengthened our balance sheet, reduced our adjustable tangible leverage and issued debt at a meaningfully lower cost of funds. All-in, our consumer and insurance segment generated a $1.06 of adjusted earnings per diluted share in the fourth quarter. This was a great way to close out 2017. As we look back at the past year, I am proud of all that we accomplished. Full year net charge-offs improved versus last year. We drove continued growth on our secured lending, which reached 43% of the total portfolio at year end reflecting the steady growth of our direct auto product and loan receivables grew by more than $1.4 billion, which together with our cost synergies drove the 130 basis point reduction in our operating expense ratio. So, when looking back, it’s safe to say we made considerable progress across all our key strategic priorities in 2017 and we are excited to continue that 2018 in fact with a healthy economic environment and the benefit of recent tax reform serving as the backdrop, we see a number of opportunities to drive shareholder value and it all starts with our customer. Historically, additional income in our customers’ pockets has been beneficial for everyone whether it manifests itself through a boost in loan demand or improvements in credit trends we are focused on making sure that we remain our customers’ first choice for their financial needs. So, while we had already planned to invest in our business this year, the recent tax reform presents a compelling opportunity to augment those plans and invest further in our core foundation, namely our platform and our people. We are focused on providing our customers with the most efficient and rewarding experience and certainly the ways in which we attract, serve and retain our customers are key differentiating factors. To that end, we have identified a number of initiatives to improve customer engagement, including raising brand awareness and refining our technology. Now, that we are operating as one cohesive company, we are ready to invest in our brand elevating the awareness of who we are and how we help our customers’ everyday. And as we become more front of mind and our customers time of needs, we want to make sure that we are providing the best possible customer experience. So, we are investing in the technology that supports both our branches and our online capabilities. We also plan to invest in our post charge-off strategies. We believe we can improve future recoveries by collecting a larger portion of charged off accounts internally. And finally, our team members’ dedication to providing best-in-class personalized service sets OneMain apart from the rest. So, we are sharing the benefit of tax reform by raising our minimum wage and issuing a special bonus to our team members. We are also further investing in training programs and showing that our people are well equipped with tools and resources they need to best serve our customers. So we expect 2018 to be a year in which OneMain drives our momentum and strategic priorities forward. We will stick to what we do best, providing our customers with the right products to improve their financial standing and flexibility. As we continue to build value for our customers, we will enhance the fundamental trends in our businesses that drive the long-term value creation for all shareholders. With that, I will turn the call over to Scott.

Thanks Jay. We continued our momentum across the key drivers of our business, which led to a strong fourth quarter results. We are in $39 million or $0.29 per diluted share in the fourth quarter on a GAAP basis versus $27 million or $0.20 per share in the fourth quarter of 2016. This quarter’s results included $81 million of estimated charges related to tax reform. Further detail on this impact can be found on Slide 13 in our earnings presentation. Our Consumer and Insurance segment earned $144 million this quarter on an adjusted net income basis or $1.06 per diluted share compared to $108 million or $0.80 per share in the fourth quarter of 2016. Let’s move on to the key drivers of our financial performance. Originations in the fourth quarter were $3.1 billion, up 34% from last year and reflected a secured mix of 44%. Ending net receivables grew by almost $1.4 billion versus last year. Our strategic focus on secured lending supported this growth and reached 43% of the total portfolio by year end. Direct Auto receivables were 20% of the portfolio, up from 15% a year ago. As a reminder this product generates the most attractive risk adjusted returns in our portfolio. We will continue to prioritize disciplined receivable in 2018 reflecting our focus on credit quality, secured lending and pricing. As a reminder, originations have historically exhibited seasonal trends with slower growth in the first quarter. Interest income was $875 million in the fourth quarter, up almost 7% from last year’s levels and about 5% higher from third quarter. The year-over-year income growth primarily reflected higher average assets while the sequential increase reflected growth in our average assets and higher portfolio yield. For 2018, we expect yield to remain relatively stable around fourth quarter levels, modest fluctuations may occur from quarter-to-quarter depending on product mix, pricing and day count. Fourth quarter other revenue was $138 million. This was down 5% compared to last year, primarily reflecting lower capital gains. We expect this declining trend to continue in 2018, largely due to lower returns on our investment portfolio. Fourth quarter credit performance was in line with our expectations. 30-day to 89-day delinquencies were 2.4%, 90 plus delinquencies were 2.3% and net charge-offs were 6.4% for the quarter and 7% for the year. Total reserves increased by $9 million to $724 million, which represented 4.9% of receivables compared to $715 million or 5% in the prior quarter. The decline in the ratio reflects the continued improvement in our loss outlook. On that note, we expect 2018 credit losses to come in below 7% for the full year. This reflects the benefits of our secured lending focus and disciplined underwriting. That said, our loan loss reserve should increase reflecting asset growth. Also recall we tend to have seasonal releases in the first quarter and builds 0409 bills in the third quarter, in line with our reserving processes. Fourth quarter operating expenses were $299 million, $26 million lower than last year, our OpEx ratio improved by 140 basis points compared to the prior year reflecting the leverage benefits of our cost savings plan and asset growth. Going forward, we expect to achieve continued operating leverage, although to a lesser degree given our planned reinvestments Jay mentioned earlier. These investments combined with modest compensation and benefit increases should lead to around 5% operating expense growth from 2017 levels. Moving on to our funding and liquidity, we were very active in the debt markets in the fourth quarter. We issued $875 million of 5-year unsecured debt at 5.6% as well as $600 million of 1-year revolving direct auto ABS at 2.6%. In addition shortly after the quarter end, we retired $700 million of our 6.75 2019 unsecured debt maturities. On the liquidity side, we continue to be in a very strong position. We had $5 billion of unencumbered consumer loans and over $5 billion of undrawn conduit capacity. Excluding the impact of tax reform, we achieved our target tangible leverage ratio of 9x. We remain on track to achieve 7x by the end of 2018. Looking back over the last year or so, we have been able to achieve ratings improvements in our secured and unsecured programs. Specifically, we issued our first direct auto deal with a AAA tranche. In addition, we had certain tranches of our personal loan programs upgraded to AAA. We also received multiple upgrades on our corporate ratings. We plan to build on this momentum in 2018 and increase our mix of unsecured debt. Doing so will enhance our strong liquidity profile even further by freeing up assets and extending the duration of our maturities. We believe these efforts will lead to continued improvement in our credit rating. Overall, we made significant progress on our strategic priorities that we laid out for the year and we look forward to building on the strong foundation in 2018. With that, I will turn the call back to Jay for his closing remarks.

Thanks, Scott. I just like to say that although the transaction hasn’t officially closed, we are grateful to put risk for all the support they provided and we are very excited about our future shareholders, Apollo and Värde. Together, we are aligned in what will drive shareholder value over the years to come, which is very much a continuation of the strategic objectives we have laid out, disciplined growth, appropriate risk-adjusted returns, strong credit and an even stronger balance sheet. As we execute on these priorities, we will build a more resilient and profitable business. And with that, I will turn the call over to the operator to begin the Q&A.

Thank you. [Operator Instructions] Our first question comes from the line of John Hecht of Jefferies.

Hey, guys. Thanks very much for taking my questions and good morning. First about the auto secured, you gave the composition of the overall of receivables base, I am wondering where are they as a percentage of total originations and is that mix balance out in 2018 to a point where it doesn’t change much or should we consider I think that the auto origin, because the auto secured portfolio will continue to grow as a portion of receivables this year?

Yes, we would expect the auto originations to continue at the kind of increasing. It just won’t increase at the same rate that it has over the last year or so John. And so we do expect the percentage of direct auto to continue and increase.

Okay, thanks. And then Jay, you talked about we are leveraged to be at the end of the year in your guidance, you talked about, I guess the ratings increases and so forth. Can you give us an update in your thoughts about capital returns? I know they are not in the near future, but they might be coming next year, what’s your thought on the capital base and what you might do with excess capital over time?

Sure. We have tried to be pretty clear that our key priorities are getting our leverage to where we think it needs to be, which is at least 7x. And as we approach that, I’d say we remain exactly where we are is the board, it will still actively discuss what makes the most sense to the extent there is excess capital in the business, but at this point, we are more than pleased with the way the rating agencies have looked at our trajectory and we will continue that. And as we approach the end of 2018, I suspect we will have active conversations at the board level, which we will share with all shareholders appropriately.

Great, guys. Thanks very much.

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

Thanks. The tax reform is putting a little bit of more money in the consumer’s pockets and was wondering if you could discuss if you are seeing any indications yet from customer activity if that’s impacting the first quarter and what your expectations are whether or not this will cause more pay-downs or because of the increased income that will actually give them some capacity to borrow more?

I would say a couple of things, one it’s still early, so it’s hard to tell any immediate impact, so that’s the first thing. And really on your second one it’s probably yes and yes. There will be some people that probably like to take the savings and retire debt and all the others who have the confidence based on free cash flow to take on some additional debt. So with the exact balances are detailed, but I am sure we will get a little bit of both as we do most tax seasons when refunds come.

Okay, fair enough. And in terms of the outlook on the yield, when you say there would be – expect to be relatively stable, I am wondering why it wouldn’t be rising if you are starting to get an inflection in terms of new originations coming on higher than what your book is rolling off?

Yes, this is Scott. So as you know you have seen the increase in secured, so we expect a secure percentage of the portfolio to increase. John just asked the question about Direct Auto, so the way we kind of think about it is the pricing actions we are able to do is offsetting, kind of the lower pricing on the Direct Auto product.

Got it, okay. Thank you.

Our next question comes from Mark Hammond of Bank of America. Please go ahead.

Good morning. Two questions, so first on the tax savings, I get about $100 million delta, when you change the tax rates, would you bucket between tech marketing and employees if that number is off just probably 5%?

Bucket, what – our reinvestments you mean, Mark?

Right. That additional savings from the tax rate going lower and I see that tech marketing and employees are listed?

Yes.

Just specifics on where that’s going to go?

Yes. I don’t think we need to give a specific. I think the – I think that expectation is we were looking for normal kind of inflationary increases in expenses, I have mentioned that before. And as part of the tax reform, it does give us the opportunity as Jay mentioned, to really reinvest in our customer – how we engage with our customers and making it easier by investing in technology as well as our employees to continue to evolve as an overall business.

Okay. And then switching to financing, so I was wondering, if you could elaborate on your business or ABS structures or in the rating agencies minds change to prompt them to sign a AAA rating to your most senior tranche in that latest deal?

I think it’s a continuation of kind of the credit performance on the portfolio. So we are happy that that was recognized by the rating agencies and it gives us additional access to new investors, because of the new structures that we can kind of put out in the marketplace.

Alright. Jay and Scott, thank you.

Sure.

Our next question comes from the line of Michael Tarkan of Compass Point.

Thanks for taking the question. Just on a mix basis for it sort of 43%, 44% now, just long-term where do you that level is off from secured, unsecured mix?

Yes. I think we are going to kind of have on the near-term we would feel good if we can continue to increase the secured mixed to 50-50. A lot of that is dependent on the customer base and the overall kind of trajectory, when we get there, but I think that’s kind of where we would like to get to that level. As you remember the prior spring leaf was kind of more 55 and so it doesn’t – for us the secured products are one of our more profitable product lines. So it would be a good both from overall credit performance as well as overall profitability to continue to grow that secured mix.

Okay. I guess competitively as you grow that secured mix, like are you seeing any sort of different dynamics, is it still sort of pretty stable from that perspective?

I would say yes. There is certainly, the indirect of market is a weekly competitive one. The direct market where we are providing customers choices sort of on the spot in the office, there is not as much competition. So we are continuing to see that as a very viable option we can put in front of customers.

Okay. And then last from me and any updated thoughts on new accounting around CSO, I know it’s a little ways away, but I am just curious how you are thinking about it now? Thank you.

Yes. CSO kind of goes in place in 2020, so I think we are doing our internal analysis and evaluation of the new accounting standards. And I think as we get into later ‘18, early ‘19 as we form that and we see kind of how the rest of the industry is forming that, I think we can give a little bit better clarity around the impacts of that new accounting standard going forward.

Understood. Thank you.

Our next question comes from the line of Henry Coffey with Wedbush Securities.

Good morning everyone and thank you for taking my question. Now that you sort of finished your process with Fortress and can you sort of focus both on the business inside, but also on the environment outside more what’s likely on the unit growth front either in terms of acquisitions, new store openings, new products or is it just going to be nursing the basic business and maximizing same-store sales growth and profitability of those units?

Look, it’s a good question. Overall, I would say we are very focused on our overall branches in efficiency and productivity and making sure that they continue to grow. We think we have got a great suite of products today that we are able to put in front of customers. But I have said there is no immediate plan to add to the product base, but we are always looking at things that are helpful to our customers that can be overall additive without sort of being dilutive. We continue – the good news is we continue to have more than adequate loan demand we see that is really a matter of sorting through and getting through that. So I would say for the most part expect business as there is as she goes. We will look at markets where we think there is loan demand, we maybe under-penetrated, we may open a few branches here and there, but for the most part I think you can probably expect the branch count to be pretty flattish over time.

Do you have any thoughts on competition, I mean your business has got great access to capital, seeing great credit, obviously that’s happening with some other parties as well, but there were companies like Avant that pulled the way back from the market, you have got the payday lenders getting into installment lending though with a much higher rate and then of course you have at the other end you have Lending Club offering loans that to supposedly good credits at your rate, so what are you seeing?

I mean look those are all things we pay lot of attention to. I think you identified a few that thought this was an easy customer base to lend, so you give money and they will just naturally pay it back. And I think people found out that pricing this customer and getting the right returns and trying to do all that without collateral and without that in person experience is not the easiest thing. So overall, we continue to see ourselves in a pretty good place. But we are always sensitive to what’s out there, I would say, more than necessarily just the online players you mentioned, there is all kinds of local credit unions, things in the local communities and we just want to make sure we are front of mind and we provide the best experience and maintain those relationships as long as we can and certainly great to start with the base as we do with almost 2.5 million customers and 8 million to 10 million former customers where we are front of mind when they need something.

Great. Well, thank you and a great quarter.

Thanks so much Henry.

Our next question comes from the line of David Scharf of JMP.

Hi, good morning. Most of my questions have been answered, but just a couple of follow-ups Jay, I believe you mentioned part of your tax savings investment or reinvestment was going to be focused on the recovery side and building up more in-house collections, can you remind us I mean at this point how much of your post charge-off recoveries are actually either outsourced or sold whether this is a material development we should be thinking about or more just around the edges?

It’s just around the edges. We thought before that as we transition, kind of OneMain portfolio that was a higher proportion of their activities, now as we have gone through integration, we see the opportunity to reduce that even further. We will continue to leverage third-parties, but we think there is a good investment to bring more of that in-house based on our collection effectiveness in our servicing model. But it’s on the edges, it’s a material item.

Okay, that’s helpful. And then just lastly maybe as a follow-up to the last question on competition, I think it was about maybe a year ago or so, Jay you would in response to questions about competition highlighted specifically around the edges, some more competition from sub-prime credit card. Is that something that you are still feeling or is that backing off as we think about other sources of capital?

I’d say one we don’t think of it is complication, to the extent there are sub-prime cards both of them are sort of sub $500 for the few of the brand name ones that are out there and it’s just a different product and not one that we compete with, which is our typical loan of $6,000 to $7,000 and use much more to refinance a fair amount of debt. Those cards are much more, I’d say for general purpose to allow people the flexibility in life. So, I think what I mentioned a year ago and certainly was one that wasn’t my find it in terms of providing clarity, which is much more that it’s on the landscape and something that was in a customer’s wallet. We look a lot of what’s in our customers’ wallet without referring to anyone else’s advertising. And I would say we have seen a very stable mix of customer’s use of credit cards, other installment debt, other auto debt and it’s really been very stable in the last year in terms of how much debt our customer has, the number of line items etcetera. And particularly for the customers we have proven put on the book. So, my reference was much more too, it was out there than it’s competition, but I’d say as we look over the last year, since I made the comment, it really has been very stable in terms of the use of debt by our customers.

Got it. So, the main takeaway is overall household leverage is pretty stable in terms of what you are seeing in new underwriting – in new applications?

For our customer base, yes.

Yes, for the loans that we are booking, for the loans we are booking.

Right. Perfect. Thanks so much. Congratulations.

Thanks.

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

Great, thanks. Most of my questions also have been asked and answered. But I guess maybe to just talk about some of the investments that you are making and how they will factor into loan growth and what things could kind of get you to between that range of 5% to 10%, what would get you kind of towards the lower end, what would get you towards the higher end and over what timeframe will those investments kind of benefit loan growth?

Look, when we think about the range, I will sort of separate into two questions, one high-level growth. First thing, we are most focused on is maintaining our risk adjusted returns and maintaining the credit box that we have had out there. So, we are not at any point going to chase growth for the sake of chasing growth and I want to be really clear on that. So to the extent the market allows us to grow at the upper end and we can maintain our credit box and credit standards. And as Scott talked about, moving the book closer to a 50% mix of secured, which is where we would ultimately like to be, we will see the higher end. To the extent, we don’t see the loans we want to book. It may wind up at the lower end, but as we sit here today, the good news – the customer is in reasonably good shape. As we all know, the vast majority of our customers are paycheck to paycheck, but when we look at their overall debt loads, their income capacity and their ability to support it, the good news is its pretty darn solid. As I say when we think about the investments we are making, I would say they are all things on the margin, I don’t see any of them materially driving short-term growth, I say the mall helping long-term value of what we are providing to our people and our customer base. So, I don’t think any of them will necessarily be meaningful in 2018, but I would say the most important message you will probably hear from and it would be any one of us is we will take the growth that comes our way, but we are going to do it with the loans we want to do it with.

Got it. It makes sense. And then Scott, could you talk just flush out a little bit just the plans, the financing plans obviously the rates that you are getting on both secured and unsecured are kind of a lot better than what’s rolling off. So, maybe could you kind of talk through what we are likely to see in 2018?

Yes, Moshe, I kind of talked a little bit about that. I think we are going to continue to access both markets and assuming the markets there we would like to kind of do a little bit more on the unsecured side as I mentioned to kind of continue to increase – or move our durations and continued to get a nice ladder of future maturities that will help us on our liquidity as well as less encumbered balance sheet. So, I don’t think there is a material change in kind of what we have been doing. We just would like to make sure that we have the continued balance between both types of funding.

Do you have the approximate cost of the debt that’s either maturing or that you can pay off in ‘18 the unsecured?

Well, the unsecured that we have no maturities in 2018. I mentioned that the $700 million we paid off in January was a 2019 maturity and the coupon on that was $675 million. So, as we keep going that took our 2019 maturity stack down to $700 million. So as we kind of get there, now you are kind of looking into really kind of 2020 2021s, where we have a mix of different coupons on that debt. So, as Jay mentioned, we are in a position right now, which in the given current markets, our funding cost of new originations versus that expiring has been beneficial to us. I am not going to make a forecast, whether that’s continue to at that point, but the overall strategy is continue to balance the funding going forward.

Great. Thanks so much.

Our next question comes from the line of John Rowan of Janney.

Good morning, guys. Two quick questions. Have you guys had to change anything on the auto side for, maybe there is a recent adjustment to the Military Lending Act and whether or not which we will call it ancillary products are counted against usury under the MLA, just have you had to make any changes because of that?

Look, we pay a lot of attention to the MLA we understand sort of the implications of what can and can’t be offered and we sort of probably made those bifurcations about a year ago.

Okay. But I believe there is a recent change regarding GAAP contracts to service members and their family very recently just a matter of fact.

The second question just can you guys over just the guidance that you gave Scott, you just said that there was going to be some reserve releases without first quarter or first half and then reserve building later in the year. Can you just repeat what you said I think it is down?

Yes. So as you know if you look back over the lot couple of years, first quarter is seasonally a reserve release, because it’s our highest loss quarter and then in the third quarter which is seasonally our lowest loss we have a reserve build.

Okay, thank you very much.

Our final question today comes from the line of Ken Bruce of Bank of America.

Thanks. Good morning. My questions have been answered. So I will leave it at that. Thank you very much. Good quarter.

Thanks, Ken.

Thanks, Ken.

Thank you ladies and gentlemen. That was our final question. This does conclude today’s conference call. You can disconnect your lines at this time and have a wonderful day.