OneMain Holdings, Inc. Q4 FY2020 Earnings Call

Welcome to OneMain Financial's Fourth Quarter and Fiscal Year-End 2020 Earnings Conference Call and Webcast. Hosting the call today is Rohit Dewan, Interim Head of Investor Relations. This call is being recorded, and all participants are currently in listen-only mode. After the presentation, the floor will be open for your questions. Now, I will turn it over to Rohit Dewan. You may begin.

Thank you. 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 represent 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 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 bulletproof 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 expenses continued 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 Q4 2019. Interest income was $1.1 billion in the fourth quarter, essentially flat with the prior year as slightly higher yields 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, and 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 Q3. In the fourth quarter, we grew 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 Q2, and our expense growth has generally tracked an increase in customer demand and loan volume since April. In the fourth quarter, we continued 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 a 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 had $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.

Thanks, Micah. While 2020 was a challenging year, due to the pandemic, OneMain performed well. The core fundamentals of our business remain 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. Your first question comes from the line of Michael Kaye with Wells Fargo.

Hi, good morning. I wanted to see if you could provide more color on customer demand trends and where you see it coming back the 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 address most of that; there's a lot to unpack. First, in the fourth quarter, we saw some recovery in demand, but not significantly; demand dropped about 23% in the third quarter and improved by approximately 5% in the fourth quarter, which means it was down about 15% to 20%. There are a few factors contributing to the reduced demand. One is that the strong government stimulus led to increased savings among consumers, including those with near-prime credit. Additionally, many people have been unable to travel, eat out, or spend as they normally would; they have more money available, but their spending is down. We believe there is still short-term uncertainty. However, as vaccinations increase and economic activity rises, we anticipate a demand uptick, likely in the second and third quarters, though it's difficult to predict the exact timing. Our loan production has actually increased more than demand because our digital processes have a higher conversion rate, enabling customers to secure loans without visiting a branch. We've introduced features like co-browsing on computers with customers to clarify their options, as well as chat and video capabilities. Our new initiatives focus on smaller dollar loans and pricing adjustments, which have helped mitigate the decline in demand. We have also been optimizing our business over the past few years, whether it's through improved underwriting with new data sources that allow us to book more loans without adding risk, or operational enhancements like dynamic routing. Overall, the demand impact has been fairly uniform geographically, with no significant differences. There may be slight variations during immediate shutdowns in certain areas, but demand has generally been down nationwide for the last six months.

Okay, thank you for that. I wonder there's plenty more for Micah. But I wondered to get any color on 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. I would say our asset yields have remained quite stable over the past few years, even with an increase in secured lending, which tends to have a lower coupon. We've discussed small dollar loans and the price testing we're implementing. I believe these factors balance each other out, with one slightly raising the yield and the other slightly reducing it. As you mentioned, the 90-plus accounts have significantly contributed to our yield support this year. Based on our credit outlook, I anticipate that we will maintain strong 90-plus yields. Our 30 to 89 accounts from the fourth quarter are still lower than 2019 levels, meaning these will transition into 90-plus in the first quarter. Therefore, I expect to 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?

Thank you for the questions, Mark. This is Micah. When we discuss required returns, we are considering the entire lifetime of a customer. We acquire new customers and incur acquisition costs, which we factor into our calculations. We also include our expectations for customer losses, yields, and renewal activities, considering that about half of our customers eventually renew their loans. These elements contribute to the lifetime value. We then discount these anticipated flows to evaluate whether they meet our return hurdle, specifically the 20% return on equity. This return provides us with a buffer in case actual outcomes differ from our expectations, allowing us to maintain a healthy return for our business. Regarding how we account for incremental losses, we adjust the expected losses for a given customer according to their risk profile, identifying whether the loan is secured or unsecured. We incorporate our expectations for increased losses, which we mentioned when we tightened our credit criteria earlier this year. Throughout the year, we have made adjustments as necessary, considering geographic and industry factors in our underwriting process. For higher risk industries, we apply a heavier stress factor, while for lower risk industries, we apply a lighter one. To contextualize this in relation to downturns similar to 2008/2009, we anticipate losses to be about 1.5 to 1.6 times our normal annual loss rate, which would place that in the range of 6 to 6.5. I hope this provides clarity.

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. 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 rates, 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 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? 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?

We believe this product will appeal to a wide range of customers and naturally extends our business. It strategically combines our ongoing daily transaction relationships with our existing large episodic loan transactions. Overall, we anticipate being able to serve our current customers who have cards, which might lead to some displacement or prompt them to seek their next line of credit with us. Additionally, we expect to attract new customers who may not qualify for an $8,000 loan but will be eligible for a credit card, fostering deeper engagement with both current and future customers and enhancing the customer lifetime value over time. Regarding the specifics, Moshe, we will provide more details later this year about the size, pricing, and lines as we get closer to the launch.

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 work out 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 million, 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 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 $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, I mentioned the middle part of the range, not the higher end. If you review the page in our earnings deck regarding when we pay enhanced dividends, you'll see that leverage will increase next quarter due to our strong capital generation. The leverage levels will decrease; we were operating towards the lower end of our target range, and I want to convey that we expect to be closer to the middle of that range on average over time in 2021 and beyond.

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 already use some off-the-shelf fraud tools for our digital underwriting, and our work in digital positions us well to incorporate other products that differ from our traditional methods. We'll provide more details on the credit card product throughout the year, but it's likely that we'll start with some off-the-shelf fraud products.

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 regulatory 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, 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, it's 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. 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 a 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 the 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 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, that's very helpful context. For my second question, your reserve level is around 13%, and you're discussing charge-offs at 6% or lower this year. You're not providing guidance for 2022, but if you expect charge-offs to be at 6%, what is the long-term reserve requirement from a seasonal perspective? I am trying to understand how much excess allowance might still remain.

Yes, John, let me take a moment to discuss the CECL methodology. It's been in use for nearly a year, but it differs from the previous method of reserving based on incurred loss. Under CECL, we need to consider economic inputs, apply expectations for losses related to those inputs, and our current reserves are based on an assumption of around 6% to 7% unemployment in 2021. We have not accounted for direct impacts from government stimulus. When we established our reserves at the end of December, the influence of stimulus on delinquency and future losses was still unclear. In the fourth quarter, we observed a normalization of delinquency levels approaching those of 2019, moving away from the very low rates observed in the second quarter due to the CARES Act. Given the ongoing uncertainty in the environment, we are maintaining a cautious approach to reserving. As we entered January, we noticed stronger delinquency trends, likely influenced by stimulus measures. We are confident in our loss expectations for 2021, but the CECL methodology involves a different approach. As I mentioned in my prepared remarks, reserves reached 13.2% by the summer of last year during a period of uncertainty. While there is more clarity now, some uncertainty remains. Therefore, at 12.6%, we believe we are sufficiently and prudently reserved. These reserve levels are approximately 18% higher than pre-COVID levels. On a sustained basis, the pre-COVID annual loss rate of 6% to 6.5% corresponds to a reserve rate of about 10.5% to 11% under CECL.

Your next question comes from the line of Kenneth Lee with RBC.

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.

Thank you for the question, Ken. When we consider these factors, we are closely examining the losses reflected in our current accounts. A significant factor is the delinquencies from the second half of the year. As we reach the end of December, we can fairly accurately predict our charge-offs 180 days ahead. I have strong confidence in the first half of the year. If you review our charge data, particularly the 90-plus delinquent accounts, and compare the charge-off ratios to those from the previous quarter, you will observe consistent stability within the range of 2.8 to 3 times. The same analysis can be applied to the 30 to 89-day delinquencies from two quarters ago, which will also shed light on our charge-off expectations. We feel assured about the first half, though there remains some uncertainty. However, the normalization we experienced in the latter half of 2020 and the positive trends we've seen in January provide us with further reassurance. I'm quite comfortable with accounts performing below 6%, but how much they perform under that threshold will largely depend on the pace of economic recovery, the growth of our portfolio, which affects the charge-off ratios, and any additional government support that may assist 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 adjusted 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 pricey right now, but again, never say never, but 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 have 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 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?

We've shared a lot of our strategy during Investor Day, and I believe we've been quite consistent. Our business and core franchise are strong, supported by various core competencies. We have a loyal customer base, robust marketing and distribution capabilities, and superior underwriting in the near-prime sector, along with solid funding capabilities and a strong funding program. Over the past few years, we've built the necessary infrastructure to maintain the strength of our core product and platform. We remain disciplined in our approach to underwriting, ensuring it aligns with our risk-return goals. Overall, our company is conservative with a strong balance sheet. As we've mentioned before, we've always planned to expand the platform in various ways. For better credit customers, we've been developing the technology and analytics that support more dynamic pricing, which remains central to our core product. We have traditionally served a small segment of customers with FICO scores above 700, and now we aim to be competitive in that market and increase volume by expanding our digital capabilities. For smaller loans, I view that as an extension of our platform; it offers a similar product but at a different size to attract customers who may not qualify for larger loans. The card offering is also something we’ve been discussing for some time. It's a natural expansion of our business, creating synergies by linking ongoing daily transactions with larger loan transactions, which strengthens our customer relationships over time. This allows us to develop products that combine the best features of both loans and cards, leveraging our core competencies. We've made intentional investments in our business's foundation over the last couple of years without slowing down. I believe that great businesses adapt to external events and conditions but should stay focused on the long term. All these long-term initiatives are designed to add significant value to our franchise. Some have started earlier, while others are just beginning, including the card launch planned for the second half of the year.

It's helpful. At the end of the day, sometimes timing is just coincidental. One last follow-up on a different topic. The investment community has been hearing a lot recently in the software space, and more specifically in consumer lending, about AI. You mentioned it in your slides and also in your previous response. Could you provide more specifics on how you're defining AI, not just in relation to underwriting models, but also in terms of technology that you consider to fall under that definition? I believe this is the first time the company has highlighted this.

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 into 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 anonymous 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 advances 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 perform 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 stat 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, this is Micah. We haven't made significant underwriting adjustments to loan values. There has been a small, moderate increase in size across our auto and secured portfolio, but it hasn't been substantial. I've noticed this correlates with a somewhat larger loan size, but again it remains moderate. Loan to value ratios have been consistent throughout the year, and it's important to remember these are not purchase money loans. We consider them personal loans secured by collateral, so they undergo additional underwriting, including our standard risk grade process and assessments of loss, as well as our ability to pay, just like with any other loan. The vehicle's value is just one aspect of this evaluation.

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.