OneMain Holdings, Inc. (OMF) Q4 2020 Earnings Report, Transcript and Summary

Welcome to OneMain Financial's Fourth Quarter and Fiscal Year-End 2020 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. At this time, all participants have been placed in a listen-only mode and the floor will be open for your questions following the presentation. [Operator Instructions]. It is now my pleasure to turn the floor over to Rohit Dewan. You may begin.

Thank you, Kristo. Good morning and thank you for joining us. Let me begin by directing you to Pages 2 and 3 of the fourth quarter 2020 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 and include the effects of the COVID-19 pandemic on our business, our customers, and the economy in general. 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 9 and have not been updated subsequent to this call. Our call this morning will include formal remarks from Doug Shulman, our Chairman and Chief Executive Officer; and Micah Conrad, our Chief Financial Officer. After the conclusion of our formal remarks, we will conduct a question-and-answer session. So now let me turn the call over to Doug.

Thanks, Rohit, and good morning everyone. We appreciate all of you joining us today. Let me start by discussing 2020. This past year, more than any other, highlighted the importance of being intensely focused on the wellbeing of our customers. Our team members demonstrated our value by connecting with the vast majority of our customers during the year to check in and make sure they know we want to be there for them to offer assistance when they need it. We also worked diligently throughout the year to ensure the safety of our customers and our team members across the country. I'm very proud of our team, who pulled together in a difficult year to support our customers and each other. 2020 was the year of strong financial performance, as we generated $1.1 billion of capital, $81 million more than 2019, and drove net charge-offs to an all-time low of 5.5%. This significant capital generation allowed us to simultaneously originate attractive loans, reinvest in growth initiatives, and distribute meaningful capital to shareholders. We returned $6.27 per share to our shareholders in 2020. And this capital return is continuing into the first quarter with the declared dividend of $3.95 per share. We've now declared almost $13 in dividends since we started paying a regular dividend in February 2019, two years ago. In 2020, we increased our investments to accelerate key strategic initiatives, drive future growth, and deepen our relationships with our customers. We enhanced our underwriting models with next-generation artificial intelligence technology that uses 1,400 pieces of data, and is constantly improving through machine learning. We continued to invest in our digital capabilities, thereby significantly improving our customer experience. This enabled over 40% of our customers to close their loans digitally in the fourth quarter. Offering a digital option increases our application pull-through rates and the early delinquency metrics on digital loans look as strong as our branch originated loans. Our unique hybrid capabilities provide customers the flexibility to originate and service their loans; however they choose through our nationwide branch network, our call centers, or our new digital customer experience. We also launched new products, including smaller dollar loans and new optional product offerings, and initiated the build of a credit card business. We're also testing loan pricing for customers with higher credit scores. These expanded products and initiatives allow us to broaden and deepen our customer relationships. Our customers have a strong loyalty and appreciation for OneMain, and they've given us feedback that they'd like to do more with us. Let me spend a minute to provide additional detail on our new credit card business. We'll provide further detail as the year goes on. But I want to take this opportunity to share our thinking and our strategic rationale. We believe credit cards are highly synergistic with our installment loan business, and that OneMain is uniquely positioned to succeed in this market by leveraging our core competencies. First, credit cards represents a large market with $430 billion of near prime balances, five times the size of the installment loan market. Our average customer has about five cards in their wallet. Second, they're highly synergistic. A credit card deepens our relationship with our customers, enhancing our existing offerings and improves our ability to underwrite by incorporating transactional data on an everyday spend. In addition, it allows us to bring in new and different customers into the OneMain ecosystem. Over time, we also anticipate developing new combination products merging the best feature of cards and loans into one. Our customers have a strong loyalty to OneMain and this card will engage our customer base, enhance customer lifetime value, and enable us to bring more customers into the fold. Third, we're developing a differentiated product focused on a unique value proposition to customers. A digitally focused card that rewards consistent payment habits and reinforces credit building behaviors, providing responsible credit, which improves our customers' financial well-being, is a foundational principle of OneMain. This card product will be designed with unique features consistent with that objective. We're building a new team focused exclusively on the card product led by Nick Clements, a great entrepreneurial executive with deep experience in credit card risk management, and digital first businesses. He joined us from LendingTree which he joined after founding and running MagnifyMoney, a financial education and comparison website and marketplace that was purchased by LendingTree. Prior to that, he ran the largest consumer business at Barclaycard in the United Kingdom. We expect to be in market in the second half of the year. We're very excited by this opportunity, which we anticipate will be a multi-billion dollar receivable product for OneMain over the coming years. Throughout 2020, we invested $50 million into these various initiatives and our technology to position OneMain for future growth. We plan to invest another $100 million into these initiatives in 2021. We remain committed to investing in our business to develop new capabilities, while leveraging our core competencies: customer focus, credit expertise and discipline, distribution and a bullet proof balance sheet. OneMain is uniquely positioned given these foundational strengths to broaden and deepen our customer relationships in a dynamic and growing market. We look forward to providing more information on these initiatives throughout 2021. I think we all know that the near-term future remains uncertain, with COVID impacting every business and every person across the globe. And while we need to continue to navigate these continued uncertain times, we feel very good about the fundamentals of our core business, and the strategic pivots we have made to position us to serve our customers and grow our business as we emerge from the pandemic. With that, let me turn it over to Micah to take you through the financial details of the fourth quarter and the full-year.

Thanks, Doug, and good morning everyone. We had a strong fourth quarter as originations improved, credit performance remained healthy, and our operating expense continue to track below prior-year levels, an improving macro outlook also allowed us to moderately reduce our loan loss reserve coverage. We earned $359 million of net income or $2.67 per diluted share in the quarter. On an adjusted C&I basis, we earned $373 million, or $2.77 per diluted share. Capital generation, or C&I earnings excluding the impact of changes in loan loss reserves, was $329 million in the fourth quarter. Ending receivables for the quarter were $18.1 billion, up from $17.8 billion in the third quarter, and down just 2% from 4Q 2019. Interest income was $1.1 billion in the fourth quarter, essentially flat with prior-year as slightly higher yield offset moderately lower receivables. Interest expense was $242 million, down $5 million or 2% versus the prior-year and down $8 million sequentially. We continue to benefit from proactive liability management that has provided a material benefit to our cost of funds, while extending our maturities. We expect this trend to continue. During the quarter, we again took advantage of a favorable credit market in issuing an $850 million 10-year bond at 4%. In early January, we used proceeds from that bond to redeem $650 million of 7.75% bonds that were originally scheduled to mature in October of this year. Our next bond maturity is now May of 2022. Other revenue was $137 million in the fourth quarter; $21 million lower than the prior-year quarter, driven by lower optional product-related revenue, which generally tracks our receivables and originations. Benefits and claims expense was $41 million in the fourth quarter, down $3 million year-over-year and down $2 million sequentially. As a reminder, this expense includes both claims payments and changes to claims reserves related to our insurance products, including involuntary unemployment insurance. IUI claims have moderated throughout the year with new claims in December down by more than 80% from April's peak. Our fourth quarter expense of $41 million included a positive reserve adjustment related to favorable experience in our IUI portfolio. As the year has gone by, our IUI customers have been going back to work sooner than we originally anticipated, and our reserves have been adjusted accordingly. Let's turn to Slide 9 to review our receivables and originations trends. We originated $3.2 billion in the fourth quarter, down 13% from fourth quarter 2019, but up 11% from the prior-quarter. This is a trend we saw throughout the year. As the economic recovery drove an increase in demand, our targeted initiatives enhanced our ability to serve our customers and loan production improved. While government relief measures have been incredibly helpful for our customers during this challenging year, as reflected in our strong credit performance, we've seen an inverse correlation between relief and consumer demand, with direct payments perhaps having the most significant impact. This is evident in our lower second quarter 2020 originations after the passing of the CARES Act, which provided $3,400 to the average family of four. Looking ahead, we have historically experienced seasonally lower demand in the first quarter due to tax refunds and lower discretionary spending by consumers. This is followed by a significant increase in demand and receivables growth in the second quarter, as you can see happened in 2019. We expect these seasonal trends to continue in the first quarter, with additional demand pressure from stimulus checks in our loan sale agreement that I'll discuss shortly. As we progress into the second quarter and through the year we expect the effective stimulus payments to wear-off, demand to return to normal levels and receivables growth to resume. Let's now turn to Page 10 and walk through our recent credit trends. Fourth quarter net charge-offs were 4.2%, a 153 basis point reduction from last year's fourth quarter. Our full-year net charge-offs came in at 5.5%, slightly lower than our expectation of around 5.6% and 48 basis points lower than full-year 2019. 30 to 89 delinquency in December was 2.28%, down 19 basis points year-over-year, 90 plus delinquency was 1.75%, down 36 basis points year-over-year. You can see from these charts that government stimulus; along with our decisive credit tightening in March has had a very positive effect on delinquency and losses in 2020. Our delinquency levels give us confidence that we'll continue to see strong net charge-off performance through 2021, and while there are a number of unknowns in the macro environment, we feel good about the outlook for credit and expect full-year 2021 net charge-offs to come in below 6%. Our loan loss reserve trends are shown on Page 11. We began the year pre-COVID with just under $2 billion of reserves, and a reserve ratio of 10.7% under the CECL methodology. We added $374 million to our reserves over the next two quarters, incorporating future macro conditions that were forecasting unemployment rates as high as 8% to 10% in 2021. This brought our reserve ratio to 13.2% in the second quarter, and remained at that level in 3Q. In the fourth quarter, we grow our receivables by $265 million, which under CECL, brings an addition to the reserves of around $26 million. Our credit performance and lower expectations for future unemployment contributed to a reduction in the reserve ratio of 50 basis points or $85 million to 12.6% and led to an overall reduction of $59 million. While macro expectations have improved throughout the year, uncertainty remains and we continue to take a prudent approach with our reserves. I remain confident in the resilience of our portfolio and the adequacy of our reserves, which remain nearly 200 basis points higher than pre-COVID levels. Fourth quarter operating expense was $319 million, 2% lower than last year's fourth quarter and 7.1% of receivables. You can see on Page 12, the impact of cost reductions we took in reaction to the emergence of the pandemic in 2Q, and our expense growth has generally tracked an increase in customer demand and loan volume since April. In the fourth quarter, we continue to accelerate investment in our operating platform and our technology, which contributed to the sequential increase in our operating expense. For the full-year, our expenses were $40 million, or 3% below 2019 levels, including our continued investment in the business. We expect that with improvements in demand, and acceleration of our investments, expenses will grow in 2021. With that, let's move on to the balance sheet. As I mentioned earlier, we issued an $850 million, 10-year bond during the quarter at 4% coupon. We also executed our first ever loan sale flow agreement that provides committed liquidity for two years. We're always looking for ways to further diversify our funding sources and create flexibility for the business. And while we remain committed to keeping the vast majority of our loan production on balance sheet, this initial sale at a price well above par validates the market for our loans and creates a whole new dimension to our funding program. Over time, we see the potential to use this strategy to expand the range of customers we can effectively serve and to position the business for long-term growth. We continue to maintain significant sources of liquidity with $2.1 billion of available cash, $7.2 billion in undrawn conduit capacity, and $9.2 billion of unencumbered receivables. Our leverage ratio was 4.3 times. We finished 2020 at the lower-end of our leverage guidance, and our longer-term target range of 4 to 6. We anticipate future quarters will be closer to the mid-point of this range, in line with our leverage level going into the COVID crisis. In the fourth quarter, we have $329 million of capital generation, up 14% from the fourth quarter of 2019. And for the full-year despite the pandemic and ongoing economic challenges, we generated nearly $1.1 billion of capital compared to just under $1 billion in 2019. Our total adjusted capital which includes after-tax reserves, and adjusted tangible equity was $3.6 billion at the end of the quarter, 6.5% higher than a year-ago, and approximately 4.7 times our 2019 net charge-offs. The strong performance we have achieved this year has allowed us to return to portfolio growth in a disciplined manner, invest in our business, enhance our capital position and continue to return considerable capital to our shareholders. Consistent with this, we maintained our minimum quarterly dividend of $0.45 per share, and declared an enhanced dividend of $3.50 for a total of $3.95 per share to be paid in February. We'll continue to evaluate capital returns above our minimum commitment every first and third quarter consistent with the previous cadence and guidance. With that, I'll turn the call back to Doug.

Thanks, Micah. While 2020 was a challenging year, due to the pandemic, OneMain performed well. The core fundamentals of our business remains strong and we're investing in our future. We've been building out our customer-facing digital capabilities since late 2018 and clearly this investment paid-off in 2020, with almost half of our customers closing their loans digitally in the fourth quarter. Early results from our digitally closed loans and other new product initiatives are positive and we're excited to continue to offer customers innovations and valuable new products in 2021 and beyond. Overall, we had a strong 2020, where we delivered great credit results, robust financial performance, strengthened and deepened our customer relationships and invested to position OneMain to take advantage of growth opportunities as the country eventually emerges from the pandemic. As we enter 2021, we expect a strong credit environment with growing demand as COVID gets under control. We also believe the investments we've made over the past several years, and that we accelerated in 2020, and into 2021, will position us for growth in the years to come. With that, let me thank you for joining us today, and we're happy to take your questions.

The floor is now open for questions. [Operator Instructions]. Your first question comes from the line of Michael Kaye with Wells Fargo.

Hi, good morning. I wanted to see, if could provide more --

Good morning, Michael.

Hi, good morning. I wanted to see, if you could provide more color on customer demand trends and where you see it coming back to strongest and where it's been lagging in terms of credit profile, products and geography. And how does this match up with your appetite to open up the credit box as you look ahead to 2021? And how does the December stimulus and potentially more stimulus coming impact the outlook on consumer demand?

Hey, Michael, it's Doug. Let me try to cover most of that, it's a lot in there. First, I'd say in the fourth quarter, we saw demand come back some, but not a lot, third quarter demand was down about 23%, fourth quarter, it was down. It improved about 5% from there, so down 15% to 20%. A couple of things driving the decreased demand. One is the robust government stimulus which led to increased savings of really consumers across the board, including near prime consumers. And then second, was a lot of people, just unable to move around decreasing their travel and their eating out and their spending overall, they had more money. The way we think about it is there remains uncertainty in the short-term. But we think that as more people are vaccinated and economic activity picks-up, demand will increase exactly when that is, hard to say, but probably into the second and third quarter. We've been doing a lot, so our loan production is up more than demand because of digital has higher pull-through rate and allows people to book loans not coming into a branch. And we've added things like co-browsing on a computer with customers to make sure they understand their options, chat and video. Our new product initiatives are smaller dollar loan and our pricing have added to us kind of being up not being down as much as demand. And then, we've been doing a lot of just optimizing up the business over the last couple of years. So whether it's in an underwriting and using new data sources and alternative data that allows us to book more loans without taking additional risk or operational enhancements like dynamic routing. As far as across the board, the impact on demand is -- it's really been pretty much geographically across the board, there haven't been huge differences, you can see a little bit of difference sometimes when there's an immediate shutdown in an area, but demand generally has been kind of down across the country for the last call it six months.

Okay, thank you. Thank you for that. I wonder there's plenty more for Micah. But I wondered to get any color, how to think about asset yields in 2021. Most likely, you're going to see some increase in late-stage delinquencies. And you talked about it doing additional, maybe higher credit quality product, customers. How should I think about 2021 versus 2020 for asset yields?

Hey, Michael, good morning. Yes, I would say our asset yields have been remarkably stable over the last couple of years, even despite a trend towards a higher mix of secured lending, which as you know, has a lower coupon. We've talked in the past about our -- and today about small dollar loans and also price testing that we're doing. I think those two things sort of offset one another, one being a little bit higher yield, one being a little bit on the lower end. But 90-plus, as you point out, has been a big driver of our and at least support for the yield this year in June 2020. We with our credit outlook that we provided, I think we'll continue to see strong 90-plus yields. You look at our 30 to 89, from fourth quarter is still below 2019 levels, so that 30 to 89 from fourth quarter turns into 90-plus in the first. So I do expect we'll see fairly good stability in our yields, at least in the near-term.

Your next question comes from the line of Mark DeVries with Barclays.

Yes, thank you. I think in the past, you've talked about underwriting new loans, kind of post-pandemic to generate 20% returns on, in more like a global financial crisis loss scenarios. Can you just expand on what this means in terms of loss expectations that are priced in, and then how those loans are actually performing compared to loss expectations presumably much better and kind of what the implications are for the returns, you might actually realize on those loans?

Hey, Mark, thanks for the questions. This is Micah. The -- when we talk about required returns, this is over the lifetime of a customer. So we bring in the customer new, we pay an acquisition cost that goes into the algorithm, we of course, then plug in our expectations for loss on that customer, as well as our yields and our renewal activities and the expectations that come with the business like ours, where half of our customers renew at some point in their loans. So that factors into the lifetime value. We then will discount those flows and look at does this meet the return hurdle that you mentioned this 20% ROE. That 20% ROE gives us a little cushion on perspective, should things turn out to be a little bit different than what we anticipated, we still make a return that we think is healthy and adequate for our business. In terms of how we incorporate incremental losses, we simply increase the losses that we would normally see from that particular customer and we'll look at it by risk rate, is that a secured or unsecured loan? And we'll have an expectation for higher losses, as we talked about when we tighten the credit box back in March and April. So, throughout the year, we've adjusted that a bit in certain places, as you guys know, we underwrite with geography and also industry in mind. So higher risk industries, we applied a little bit higher stress factor, and low risk industries, maybe something a little lower. But just to put it in context of what -- in 2008/2009 type of downturn look like that would be about 1.5x, 1.6x our normal annual loss rate you call somewhere in the 6 to 6.5 context. So that's how we're thinking about it and hope that's helpful.

Yes, that is, thank you. And I think on the last call, you mentioned starting to loosen underwriting in certain segments. Can you just update us on how you're approaching underwriting over the next couple of quarters?

Yes, just a reminder, we had a playbook for a severe 2008/2009 kind of recession. And we made what we called a "no regrets move" in March, just to see how this all played out and did a full pullback and assumed that loans would have 1.6, 1.7 times their normal loss, on average with what Micah just referred to. As from March till now, we continue to look at our data. And we look at it on a very granular basis by state and by industry. And we looked at unemployment rate, we looked at our actual delinquency rate and trends, we looked at use of borrowers' assistance trends, and then a host of other macro data, housing starts, consumer sentiment, et cetera. And so we've very surgically adjusted our underwriting thing. And we took some of those constraints down because, as you've seen, we haven't experienced severe losses, the combination of decreased spending and boosted government stimulus has allowed our consumer to stay strong together with some of the actions we took in the early days, like helping them with paid deferments and those kinds of things. And so we will make very surgical changes, we look at this, we have a team looking at it daily, I spend time with the team weekly. And the combination of state and industry adjustments, together with, are lots of other data points we have from these consumers, having done this for a 100 years, and having booked 15 million customers, over the last 10 years, we've got a lot of data to look at. At this point, what we've done is for lower risk and lower geography, segments of our borrowers, we've decreased the loss assumptions. And so it's very dynamic depending on what government stimulus looks like, and how the economy opens, we're still not back to assuming pre-pandemic stress on our credit, but we've definitely moved in that direction. And at some point this year, we anticipate we'll be back to that.

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

Great, thanks, and thanks for the detail on the credit card effort, maybe could you just expand a little bit on the type of customers that you're looking for, is it -- will you be displacing what they're doing, are there going to be customers new to the credit card business, and just a little bit about maybe the kinds of, the size of balances, and how you might think about the yield and the loss content?

I guess on your first two questions, we think that this product has a lot of appeal to a lot of different customers. We think it's a natural extension of our business. And very synergistic and strategically, I mentioned it's -- it pairs an ongoing daily transaction relationship with our current large episodic loan transaction. And so I think generally, we'll be able to serve current customers who have cards, so there may be some displacement, or maybe as they look for their next line of credit on a card, they'll come for us. We also think we'll be able to bring some new customers to the fold, who we might not give an $8,000 loan to. But we will give a credit card and we think it's going to have really lead to deeper engagement with current and future end customers and increase the customer lifetime value of everyone over time. On the specifics, Moshe, we'll talk more about that later in the year, the size, the pricing, the lines, et cetera. That's something we'll, as we get closer to launch, we'll be ready to talk about it.

Okay, thanks. And maybe just as a follow-up, the loan sale, I mean, I'm a huge fan of that as a tactic, because I think it kind of gives companies an appreciation for how much their loans are actually worth to other people and gives us evidence about it, but maybe could either Doug or Micah talk a little bit about, what your motivations were to start doing this and how might that and any kind of further granularity about the pricing that you're able to get and what it helps you kind of think you can do over time?

Yes, let me give you a little bit on this strategy, Moshe, and Micah might want to add. Look our rationale was pretty simple which is to create strategic optionality and we wanted to start out small, and workout the plumbing of this. It allows us to diversify our balance sheet for our core product. But it also gives us strategic optionality of creating a mechanism where we could utilize our distribution network, in our customer demand, in our brand, in our reputation, to potentially originate products that we don't want to keep on our balance sheet. It comes with some of the core principles is, we'll keep the customer relationship, we've got a healthy servicing fee and while we're not giving the detail on the pricing, we got very good pricing above par. So we do that, it's a very small part of it. Now, it gives us strategic optionality. And we'll look at opportunities as kind of we move forward.

Yes, I mean I think that's well said. And Moshe, I view this less as a transaction more as a relationship agreement. This was done with a strong counterparty and prospective financial institution. As Doug mentioned, it gives us a lot of business optionality in terms of how we grow customers in the future. But just like everything we do around our funding programs, this I would view as an enhancement to our already terrific program. We have no intentions of this being a material portion, or displacing either of our core funding programs, again, just an enhancement and a diversification of the platform, in addition to the strategic benefits that Doug talked about.

Your next question comes from the line of John Rowan with Janney.

Doug, you mentioned $100 million worth of expenses for the credit card business. Can you just kind of break that up of what's operating, what's capital expense and I assume that that goes in with the comment that there'll be higher operating expenses in 2021?

Yes, John, this is Micah. Good morning, I'll take that. Most of this is operating expense, so I would call both out of the 100, about two-thirds of that spend is for the new products and channels, including our digital channel that we talked about in our prepared remarks. And then the other third reflects investments in technology, data and cyber to support these initiatives, as well as our core business. In terms of overall impact to 2021 expenses, if you think about the $100 million versus the $50 million that we spent in 2020, just that incremental investment alone puts us at about 4% higher than prior-year. So, it's early to say at this point, but I think this year, we could end up being at the higher-end of our long-term target of 3% to 5%. I would also consider the fact that we're operating also in starting from a much lower 2020 base, due to some of the aggressive cost cutting actions we took in 2020.

Hey, John, I just also want to clarify because what you stated wasn't accurate. So I want to make sure there's no confusion on the call. We're investing a $100 million, as Micah said, across the business, not $100 million on credit cards, credit cards is a very small part of that.

Okay. And then, Micah, you also mentioned that you would move up to the higher-end of the leverage range. Is there something that gets you there, perhaps an acquisition or moving over 100% payout? I'm just trying to understand, how you get from the bottom of the range to the middle part of the range?

Yes. So John, middle -- middle part of the range, not the higher-end was what I said. I think if you just go back and look at, even looking at the page in our earnings deck about when we pay enhanced dividends, the leverage will move up next quarter because of our strong capital generation, the leverage levels will move down, you can see we were operating towards the lower-end of our target range, and simply just trying to message that we expect in 2021 and beyond we'll probably be closer to the middle of that range, on average over time.

Your next question comes from the line of Rick Shane with JPMorgan.

Hey, guys, thanks. A couple of questions on the card product this morning. Look, as you move from your traditional loan product, which is upfront underwriting and fraud detection, to a card product, which is basically upfront underwriting and real time fraud detection. Are you planning to use off the shelf fraud tools? Are you planning to develop your own?

We're -- we -- first of all, we've got some off the shelf fraud tools that we utilize for our digital underwriting already, which a lot of the work we've done on digital sets us up to be able to add other products that look different from our traditional approach. Like I said, we're going to get more detail on fraud product, or I'm sorry, on the credit card product during the year, but there's a good chance, we'll use some off the shelf fraud products, to start.

Got it. And then the second question, on the regulatory side, for the card product, how are you going to structure this, when you think about it, most card issuers rely on bank charters for raid exportation that's never been your business model, sort of actually and pathetical to your business model in terms of bank model. So curious how you'll structure this from a regulatory perspective?

Yes, all good questions. At this point, we wanted to make sure you knew we were launching a card that we're excited about; that we think is highly synergistic. We think we've got a bunch of core competencies in our business, which will generate efficiencies for us and create an ability to really launch this card efficiently and have it be successful, whether it's our customer base, or corporate cost base, our marketing and distribution, our funding capabilities. We're not getting into the details of the deep structure of this, how we're structuring it from regulatory, et cetera at this point.

Got it. I appreciate that.

Yes, thanks for the question.

Yes, understood. And I realize it's early in the process. Pivoting just slightly tinker, not slightly, but pivoting. Can we talk a little bit about dividend policy? And as you set dividends, particularly the supplemental dividend, how much of that's forward-looking versus how much of that is backward looking? What should we glean from the substantial increase in the first quarter supplemental?

Rick, its Micah. So, I think the answer, the short answer to your question is we look both ways. Certainly, we're considering where we are at the end of a quarter, when we're setting the expectation for these enhanced dividends. And as we mentioned, in the fourth quarter and our decision on this first quarter dividend, then it gives us evidence of the strong capital generation we had in both the quarter and the year, but also the confidence we have in our portfolio in the business. We set out here and also gave you a little bit of preview into what we thought losses were going to look like in 2021. It's below 6%. So, I think the answer clearly as we look in both the rearview but also looking forward as to how we think about this. We increased our regular last quarter; we finished fourth quarter in the lower part of our range and felt that $3.50 for an enhanced dividend was prudent for our business. And going forward we've shared with you on numerous occasions that our allocation framework which is to put loans on the books that meet our risk adjusted return hurdles, invest in the business, which we've clearly done in 2020, and continue to accelerate that in the future. And then any excess capital that we create will evaluate for these enhanced dividends in the first and third quarter with our board.

Terrific. Thank you for taking all my questions this morning.

Pleasure and thanks.

Thank you.

Your next question comes from line of John Hecht with Jefferies.

Good morning, Doug and Micah and Rohit, thanks very much. I guess it's more of a thematic question initially is that, years ago, or just over the past few years, there's been this discussion point where your digital capabilities and the branch capabilities are very symbiotic, and kind of work-off each other. It sounds like the narrative right now is that you're able to do more digitally with maybe less physical customer interaction. I'm wondering, could you talk about what's happened in your underwriting model? It sounds like you were using things like artificial intelligence and so forth this morning, what's happened to that, that gives you more capabilities to interact more fluidly from a digital perspective going forward?

Yes. I'm not sure; it's the underwriting model, John and let me tell you how we think about this is. We're building out an omnichannel business. So we can and we're very customer first, customer focus, we want to make sure current customers and future customers that we can serve them when and how they want to be served. So if they want to walk into a branch and have a conversation with someone and sit down and look someone in the eye, that's always going to be an option for our customers. If they really just want to do it on a mobile app, that's now an actual option for them. And if they want to do a phone call and talk it through, that's an option for them. Most of our digital closed loans for originations include a hybrid approach. And so they end up on a phone call with our -- with our -- somebody on our team, to talk them through their loan options, product options, and super important, the hallmarks of our business of ability to pay underwriting, doing a budget, doing income verification, we haven't sacrificed any of those. What's happened over the last couple of years is we really didn't have the ability to efficiently close loans digitally and have a great customer experience. And so, 2019, we just had to build a whole bunch of back end things like our systems were built. So you had to walk into a branch. And when you open and closed our ledger, it was always attached to a branch. And so we had to do some back-end things. And we had to make sure everything from our budgeting tools to our disbursement to showing product options were all available and seamless on a screen. So we did a lot of back-end plumbing in 2019, to get ready to do this. In 2020, we rolled out a lot of just very forward-facing customer features like Cobrowse. So some we can get on the same screen that a customer is on to really walk them through the option, make sure they understand exactly what we're getting. We've got chat capabilities, and we've got video capability. So even if you don't walk in, you can replicate that experience. And as far as underwriting that, for sure having a very fluid underwriting system that allows you to make real time decisions that uses a lot of different data points and can crunch the numbers quickly. We've been, I feel good about us staying abreast of everything that's happening in underwriting. And just, as you know, the cost of computing has gone down, and the ability to use either AI algorithms or machine learning algorithms to continually improve your underwriting, we've continued to invest in that and we've got a great modeling team, we've got a lot of data scientists on staff, and that's only enhanced our ability to accelerate digitally, but it's the same underwriting methodology that we use in our branches.

Okay. And then -- that's very helpful, the context there. And then, second question, your reserve level, it's near 13% might be you guys are talking about charge-offs at 6% or below this year, not thinking -- not -- you're not asking for kind of guidance into 2022 or anything like that. But if you're running 6% charge-offs -- what's the -- what's -- from a seasonal perspective what's the long-term reserve requirement? I guess I'm just trying to determine how much excess of allowance might still be in there?

Yes, John let me step back for a minute with the CECL methodology. I mean, it's been around close to a year now, but still it's different from the way that reserving used to be done, which was to look at incurred loss. So under CECL, we've got to look at economic inputs, which we do, we've got to apply some level of expectation, on losses to those economic inputs and our reserves today assume a level of around 6%, 7% unemployment in 2021. We've assumed no direct impacts from government stimulus. When we were setting our reserves at the end of December while there was stimulus out there, it was unclear how that's going to influence our delinquency and future losses. I would say in fourth quarter, we continued to see normalization of our delinquency levels back more towards 2019 levels from the very, very low delinquency that we saw in the second quarter coming off of CARES Act. And I think we just generally, given the great deal of uncertainty that remains in the environment, we're continuing to apply a prudent approach to reserving. As we move into January, we see some stronger delinquency trends, most of that potentially delivered and driven by stimulus. So we feel good about where we were putting out the sort of loss expectations for 2021. But CECL methodology just takes on a little bit different approach. In terms of the overall levels, we -- as I talked about in my prepared remarks we ended up putting up getting up to 13.2% by call it, summer of last year, when things were looking really uncertain, I would say there's a little bit more clarity, but still some uncertainty in the future. So, we feel at 12.6%, we're adequately and prudently reserved. Those reserve levels remain about 18% higher than where we were pre-COVID. And so on sort of a, I would say, on a sustained basis, pre-COVID, 6% to 6.5% annual loss rate is expressed by about a 10.5% to 11% reserve rate under CECL.

Your next question comes from the line of Kenneth Lee with RBC. Kenneth Lee, your line is open. Kenneth, you may be on mute.

Hi, sorry about that. Thanks for taking my question. Just wanted to follow-up on the net charge-off expectations. Wondering if you could just share some of the key factors give you the confidence that net charge-offs could be below 6% this year, wondering specifically whether there are any other factors outside of the very strong second half delinquency trends you've seen so far? Thanks.

Yes, thanks, Ken. Appreciate the question. I mean, I think when we think about all these things, we're certainly looking at the contents of loss that's in our books today. So a big driver is the second half delinquencies, as we've talked about before we have 180-day charge-off. When we get to the point in the year where we are, we're at the end of December, we have a pretty good idea 180-days out what our charge-offs are going to look like. So I would say a lot of confidence in the first half. If you go back and look at some of our charge, take 90-plus and then look at what ratio charge-offs are to 90-plus in the prior-quarter, because 90-plus are going to roll the loss. You can see pretty good stability at 2.8 to 3 times. And then you could do the same thing with 30 to 89 two quarters prior and look at the ratio of charge-offs to those 30 to 89 delinquency levels. That gives you a pretty good idea. So we feel comfortable with first half. As I said, there's still a lot of uncertainty out there. But we've seen that normalization we saw in the second half of 2020, we saw some really positive trends in January. So that gives us comfort as well. Of course the degree of performance below 6, I feel very comfortable with 6 and below. But the degree of performance below that will be -- continued to be dependent on the speed of the economic recovery, our portfolio growth, which of course contributes to that ratio for the denominator effect, and any further government support we might get for consumers.

Great, that's very helpful. And just one follow-up if I may, wondering if you could just provide any updated thoughts on potential priorities for excess capital deployment, specifically wondering, what's the outlook for any kind of potential deployment to M&A opportunities out there? Thanks.

Yes. Micah, took you through our framework, and we stayed very disciplined to our framework, it's one we laid out two-years ago, which is first we're going to make loans that meet our risk return hurdles, two is we're going to invest in the business, whether it's technology products, people, analytics, data, we're going to make sure we're world-class and innovative in our business. As far as M&A, we'll be opportunistic. So if we see something that we think is accretive to the business, and adds either a capability or a product, or a platform, we'll consider it, we've got a team who's active. But we're disciplined about that. Our bias would be to do something smaller, and we need to make sure that a) strategically, it makes sense, b) financially it makes sense, c), that it can be executed. And also that it, we've got a regulatory overlay to make sure anything we do makes a lot of sense. And then we'll return capital to our shareholders. And so I'd say we view it as opportunistic, the framework remains what it is. The reality is, a lot of things that could be additive are very pricy right now, but again, never say never, but it's -- that's our framework. And that's how we're going to deploy capital.

Your next question comes from the line of David Scharf with JMP.

Hi, good morning, everyone. Thanks for taking my questions. Listen, all of the specific questions on the quarter and the outlook I had has been answered. But maybe a very general one, Doug, and essentially, I guess the question is why now meaning, it seems like an awful lot of initiatives, card, small dollar loans moving down, the credit throughout the credit spectrum, they all seem to be coming at once. And, I'm curious, were these things that were sort of long in the making? And it's just sort of coincidence, or is there something about the pandemic, or lessons you've learned over the course of the last year, that have perhaps accelerated some of these initiatives, but ultimately, just sort of curious because the profile of the company is expanding quite a bit, and it all seems to be coming together, together right now entering 2021. And maybe if you can talk a little bit about strategically, sort of what has led you to this place currently?

Yes. We've laid out a lot of our strategy at Investor Day. And if you go back to that, I think we've been quite consistent, which is we've got a great business and a great core franchise, and it's a platform that has a number of core competencies. We've got a great set of loyal customers. We've got marketing and distribution capabilities. We've got superior underwriting capabilities in the near prime sector. And we have a deep funding capabilities and a great funding program. And so, we for a couple of years have been building all of the infrastructure to be able to keep our core product and platform strong. And for that core product, we're incredibly disciplined, and we have disciplined underwriting that meets our risk return hurdles, and for the whole company, we're very conservative and have a bulletproof balance sheet. But we were always planning and we've been saying this to expand the platform. I think for each of these, there's different ways to think about it. I think the better credit customers is really we've been building the technology, the analytics, and the AI that allows us to do more dynamic pricing. And so that is still core product, core to what we're doing. We always had a small number of customers in this call it 10%, over 700 FICO. So it's just a matter of being competitive in that market and picking up more volume because we've expanded the platform, including our digital capabilities. For smaller dollar loans again, that's I think of it more as an extension of our platform, it's very similar product just at a different size, which allows you to bring in a different customer who might not qualify for an $8,000 loan. I think card has been a dialogue in the works for a while. And as I've talked about, it's a very natural extension of our business and has a lot of synergies and it pairs an ongoing daily transaction relationship with a large episodic loan transaction, it allows us to lengthen [indiscernible] over time, build products that merge the best of both the loan and the card and takes advantage of those core competencies. And so we've been very deliberate and staged in this. We've been making investments in the backbone of our business over the last couple of years. And, we just didn't slow down. My belief is great businesses, while they're flexible and they respond to external events and conditions, like the pandemic, you stay focused on the long-term. And these are all long-term initiatives that we think are going to add a lot of value to the franchise that are -- that we've been, have been in the works and have been in a staged rollout. And they, some of them started earlier, some of them are just starting, the card will go into market in the second half.

Got it, it's helpful, listen at the end of the day, sometimes coincidence in terms of timing is just that. One last follow-up, different broader topic. We -- the investment community has been hearing a lot in recent months, broadly in the software space, and more specifically in consumer lending on AI. And you called it out in your slides, and you just mentioned AI in your previous response to me. I'm wondering, can you just be a little more specific on how you're defining AI, what specifically in your, not just underwriting models, but technology that kind of falls under that definition for you. I think it's the first time I seem to recall the company specifically highlighting that?

Hey, we've been highlighting it for a while. So it's not new to us. Look artificial intelligence and machine learning is just instead of people having to crunch the numbers and look at all of the data, the technology can do it. And the technology learns for itself, recognizes patterns and improves on itself over time. We don't get in publicly into the specific algorithms we use because it's proprietary. What I would say is, as I told you, we have a number of data scientists on staff and we've been adding to that. We've built out the core infrastructure needed to make sure that we can keep using the most up-to-date techniques. We also on a regular basis, send our data out to Fintechs and others to use AI in an unanimous way, to see if they can see patterns that we don't. And so we're always running champion challengers to make sure that we stay up with any new advents in anything that a Fintech is doing. So that's how we define AI. What we have that many Fintechs don't have is a lot of proprietary data over many years with onus behavior of specific customers who have specific characteristics, how long they lived in a home, when they moved, how long they were in a job, what their credit scores were on a very granular basis, over a number of years and how that credit performs. So if you match using best-in-class artificial intelligence and underwriting techniques with our proprietary data, I think it gives us a real advantage. And that's why you see our credit performed so well compared to people, others in the market.

Got it, I appreciate it. Very helpful. Thank you.

Your next question comes from the line of Stephen Varlotta with Piper Sandler.

Yes, good morning. And thank you very much for taking my question. I'm Kevin Barker of Piper Sandler. I was wondering if you could talk a little bit about the implications of the cancellation of student debt pertaining to loan growth and credit.

Sure. I'll say a couple of things. I mean, one is super hypothetical, because there has been no cancellation of debt. And if it happens, we don't know what the size is. But I can say generally, decreased debt is going to be helpful for our borrowers and potential borrowers. It would help their credit; it could mean more people will meet our ability to pay analysis. But it's really hard to say, how much impact it would have and pretty hypothetical at this point until we see what emerges.

Yes, of course, that makes sense. And just a little bit of a follow-up, I was wondering if you guys would be able to give us any numbers as to what percentage of the customers below 30-years old or 40-years old has student debt?

This is Micah. I don't have that step for you offhand, and maybe something we could follow-up on. But it's not generally something we track within the portfolio. Our average customer is several years old. I don't have that for you, right offhand.

Yes, that's great. Thank you very much.

Thanks for the questions.

Your next question comes from the line of Bill Ryan with Compass Point.

Good morning. Thanks for taking my question. Just a question as it relates to the direct auto loan. Obviously, used car prices are up about call it 15%, 16% based on the Manheim data, which is probably giving you guys a little bit of leeway in the sense of potentially making some larger loans. But I'm curious, have you made any adjustments in the underwriting of that particular type of loan, maybe adjusting for some of the inflation that has taken place in used car prices over the last nine months? Thanks.

Yes, Bill, this is Micah. We haven't made a great deal of underwriting adjustments related to loan values. I mean, we certainly seen a small, relatively moderate adjustment or increase in size across all of our auto and secured portfolio and lending, but it hasn't been significant. Now, I would say that's come with a little bit larger loan size, but again fairly moderate, in terms of what you're describing, but certainly that's been somewhat accretive to loan size. I would say in terms of loan to values, they've remained relatively consistent throughout the year and also remind folks that these are not purchase money loans. We also -- we look at them as loan personal loans that are secured by collateral. So they go through additional underwriting, they go through our standard risk grade underwriting and expectations of loss, they go through our ability to pay process just like we would with any other loan and then the value of the vehicle is just a third part of that exercise.

Your last question comes from the line of Mike Grondahl with Northland Securities.

Hey, guys congrats on the quarter.

Thanks Mike.

Just wanted to get your high-level thoughts on the durability of the dividend. You guys have described the framework. But how do you just think about the durability of the dividend and the special dividend looking out a couple of years?

Yes. Look, Mike, at the risk of being redundant, we've got a disciplined framework. So we make loans that meet our risk adjusted return, we invest in the business and we return the rest to shareholders. Every other quarter, we've committed to look at supplemental or enhanced dividend above the minimum dividends. I think given the capital that we generate, we've been clear with shareholders that they should expect this to be, this stock to have significant yield. Our board is going to evaluate it every quarter. And it'll be based on the business performance that we have, I think, Micah, talked about those factors, but I think you can expect a significant yield from OneMain into the future.

Great. Well, I think it's clearly helping rerate the stock too, so congrats on the strategy.

Thank you.

Thank you. Appreciate it.

Thank you. This does conclude today's OneMain Financial's fourth quarter and fiscal year-end 2020 earnings conference call. Please disconnect your line at this time and have a wonderful day.