OneMain Holdings, Inc. Q3 FY2022 Earnings Call

Welcome to the OneMain Financial Third Quarter 2022 Earnings Conference Call and Webcast. Hosting the call today from OneMain is Peter Poillon, Head of Investor Relations. It is now my pleasure to turn the floor over to Peter Poillon. Sir, you may begin.

Thank you, Chelsea. Good morning, everyone, and thank you for joining us. Let me begin by directing you to Page 2 of the third quarter 2022 investor presentation, which contains important disclosures concerning forward-looking statements and the use of non-GAAP measures. The presentation can be found in the Investor Relations section of our website. Our discussion today will contain certain forward-looking statements reflecting management's current beliefs about the company's future financial performance and business prospects, and these forward-looking statements are subject to inherent risks and uncertainties and speak only as of today. Factors that could cause actual results to differ materially from these forward-looking statements are set forth in our earnings press release. We caution you not to place undue reliance on forward-looking statements. If you are listening to this via replay at some point after today, we remind you that the remarks made herein are as of today, October 27, 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 Mike Conrad, our Chief Financial Officer. After the conclusion of our formal remarks, we will conduct a question-and-answer session. Let me turn the call over to Doug.

Thanks, Pete, and good morning, everyone. Thanks for joining us today. This morning, I'll take some time to review our quarterly performance, the current credit and macroeconomic environment, and provide an update on our key strategic initiatives. Our capital generation remains strong, coming in at $283 million for the quarter. As I touched on last quarter, demand remains strong, and we've seen improvements in the competitive environment, which has led to an increase in attracting higher credit quality business. Originations were $3.6 billion for the quarter, down 8% from the third quarter last year, but relatively strong given our cautious underwriting posture. Originations this year have also been supported by our expanded products and distribution channels, which made a meaningful contribution to our 7% year-over-year receivables growth. Our 30 to 89 delinquency finished at 2.81%. This is in line with or slightly better than normal seasonal trends. We're encouraged by the stabilization of delinquency this quarter given the worsening we saw in the second quarter. Net charge-offs in the quarter were 5.9%, supported by continued positive performance in our later stage delinquency and also in post charge-off recoveries. I'm also really pleased that we continue to demonstrate one of our core strengths, our balance sheet and funding capabilities by raising $1 billion in a difficult funding market. Regarding the nonprime consumer overall, while unemployment rates remain at historically low levels, it is clear that inflation has presented challenges to some consumers, especially those at the lower end of the credit spectrum. We've reflected this in our tighter underwriting. We started to see inflation become a challenge for consumers across the entire industry in the second quarter. However, from the data we see, which we provided on Page 9 of our presentation, our book is performing quite well in comparison to other nonprime lenders. This is due to the competitive advantages we have developed in our business model. These include our branch-based network, which enables us to work closely with our customers. The relationship that our community-based team members have with their customers is especially valuable during challenging times. We also have a long history of serving the nonprime consumer, during which we have developed a suite of tools and techniques to help customers stay on track. We tailor collections and assistance treatments based on sophisticated analytics. This increases the likelihood that we will be repaid even when a customer hits a rough patch. This is a result that is both good for our customers and good for our business. We stayed very disciplined in our underwriting and have been tightening our credit box for almost a year now. We were early to selectively cut our credit box in late 2021 and early 2022 and have followed on with very meaningful tightening this summer. Our current credit posture is conservative given the uncertainty associated with the persistent elevated inflation and the weakened macroeconomic outlook. As you may recall, we underwrite each loan to meet an expected return hurdle. Embedded in the return hurdle calculation are many assumptions, including pricing, acquisition costs, funding costs, and charge-off assumptions just to name a few of them. Our current underwriting is set so that even if the macro environment deteriorates meaningfully further, beyond the delinquency levels we are seeing today, the loans we are booking today will meet our return hurdles. We see this as a no-regrets move given the current environment. If we have a significant economic downturn, we are ready for it and the business we are booking today will be quite profitable. But we have the ability to dynamically adjust our box so we can make changes in the future as the economic picture evolves. The net effect of this posture is a moderation of balance sheet growth and a migration of our originations to better credit quality loans. For instance, we have significantly decreased unsecured loans to new customers and our top two risk rates, those with the best credit quality and lowest risk customers, make up 60% of our new originations today versus 37% a year ago. We're seeing strong application flow in higher credit quality segments partly driven by competitive dynamics as competitors without our stable funding and strong balance sheet have reduced their originations. We're seeing a lot of opportunity to write profitable new business even with our more conservative credit box. And while we are beginning to see the benefits of our tighter underwriting in recent vintages, these changes will take some time to fully materialize in our $20 billion portfolio. We expect to maintain a conservative underwriting posture until we have more clarity about how the environment will evolve. Let me now spend a few minutes on our strategic initiatives. Our focus right now is on credit and balance sheet management, given the uncertain macroeconomic environment. However, it is also critical to continue to drive our longer-term strategic initiatives that will fuel future growth and profitability. We continue to invest in customer experience, technology, and data analytics. I've spoken at length in the past about how our digital investments have helped us maintain our competitive position in loan originations. Let me talk for a moment about how newer digital and analytics tools are also generating positive results in servicing and collections. We risk score our entire portfolio on a monthly basis. The scores are generated using machine learning models that leverage internal and external credit payment and behavioral data. We then optimize who we reach out to, when to reach out, and how to reach out. Based on payment patterns, responsiveness, and demonstrated changes in circumstances, we will dynamically evolve our interactions with customers, whether it be through phone calls, texts, or e-mails. We've developed these techniques over a number of years, and you can see the positive results in the back-end delinquency performance of the last several quarters. Said another way, our digital tools and advanced analytics, combined with our locally-based team members are resulting in fewer customers moving to charge-off even if they fall behind on a payment at some point in time. We continue to make excellent progress on our Brightway credit card. Our customers are excited about the reciprocity value proposition. Our commitment to reward them for their positive payment behavior. At quarter end, we had 104,000 cards issued and $79 million of card receivables, up from 79,000 cards and $64 million of receivables as of June 30. We've been very disciplined in the rollout of our credit card. We ended 2021 with approximately 66,000 accounts across a range of test cells. And throughout 2022, we've been monitoring the performance of these test accounts across a range of metrics, including spend, balance build, revolve rates, and credit. This quarter, we began our targeted rollout into select segments identified from our test cells. We've taken a conservative credit card underwriting posture, similar to the very tight credit box we have in our personal loans, which gives us plenty of cushion and a high level of confidence that the cards we are booking today will be profitable regardless of the economic picture. In addition to credit performance, we're seeing positive signs in spend patterns and digital engagement. Our customers are engaging and paying us in our Brightway mobile app as well as giving us very high ratings in customer experience across this mainly digital channel. We also continue to see growth and strong credit performance from our expanded distribution channels. These include partnerships such as Dealertrack, which allow us to use our core capabilities and expertise to expand our secured lending. Let me touch on capital allocation. As always, our first and highest priority is investing in our business to generate strong returns. As discussed earlier, we're focusing on underwriting higher credit quality loans while continuing to invest in important growth initiatives that will drive strong capital generation in the future. We also continue to return excess capital to shareholders through our regular dividend and share repurchases. Our current $3.80 annual dividend provides a very healthy yield of approximately 12% at the current share price. We also repurchased another 1.2 million shares this quarter. Year-to-date, we've repurchased approximately 5.6 million shares or about 4.5% of shares outstanding at the beginning of the year. Let me finish by saying we really like our competitive positioning, especially in turbulent economic times. We have built our business with a fortress balance sheet, which allows us to keep making every loan that meets our return hurdles. We are strategically investing in the business to put us in a position of strength for the long run. And we have decades of experience lending to non-prime consumers, including in difficult environments, which gives us great confidence that we can adjust our credit box and work with our customers as needed, whatever the future may bring. With that, let me turn the call over to Micah to take you through the financial results of the third quarter.

Thanks, Doug, and good morning, everyone. The company's focus on supporting our customers through a challenging environment, combined with a more conservative underwriting posture has helped to bend the curve a bit on early-stage credit performance. And our best-in-class balance sheet was further strengthened as we successfully completed a $1 billion ABS transaction in the quarter. In terms of our Q3 financial results, we earned $188 million on a GAAP basis or $1.52 per diluted share in the quarter. Capital generation was $283 million, down $77 million from the third quarter of 2021, reflecting a $128 million increase in net charge-offs from the historic lows we saw in the year-ago period. On an adjusted C&I basis, we earned $187 million or $1.51 per diluted share, down from $2.37 per diluted share in the third quarter of 2021. This difference was also driven by the normalization of charge-offs as well as increases to our loan loss reserves. Our managed receivables reached $20.5 billion this quarter, up $1.3 billion or 7% from a year ago. Net interest income was $895 million, up 2% compared to the prior year quarter, driven by higher average receivables. Net interest margin remained strong at 18.1% in the quarter. Portfolio yield was 22.6%, down 55 basis points sequentially. Importantly, our top line APR on new originations was flat sequentially and up modestly from the third quarter of 2021. We have found recent opportunities to take positive pricing actions, which has offset impacts from our credit tightening. While yield is being temporarily impacted by the current environment, we anticipate that over time, these effects will subside and yield will return to more normal levels. Interest expense was $221 million, down 6% versus the prior year. Interest expense as a percentage of average receivables improved to 4.5% this quarter from 5.0% a year ago. The reduction in our interest expense reflects the proactive management of our balance sheet which has served to shelter us to some degree from the increase in issuance rates that we've seen in 2022. Our debt is largely fixed rate and we intentionally stagger our maturities to manage cash flow but also to absorb periodic volatility in interest rates. As a result, it takes some time for increased rates to have a meaningful impact on our interest expense. Other revenue was $165 million in the third quarter, up 9% from the prior year quarter, reflecting the positive impacts from our loan sale agreements. Policyholder benefits and claims expense for the quarter was $31 million, down from $45 million in the third quarter of 2021. The reduction was driven by current period reserve adjustments relating to continued strength in claims experience across products, but primarily in our credit life book. Let's now turn to Slide 7 to review our originations and receivables trends. Originations were $3.6 billion in the third quarter, down from $3.9 billion in the third quarter of 2021 due to a significantly tighter credit box. The ability to quickly adjust our underwriting as circumstances dictate is a foundational strength of our company. Despite those adjustments, we continue to see strong demand for our core loan product, driven by improved competitive dynamics as well as growth in our credit card and distribution channel partnerships. As a result, we were able to grow receivables by nearly $400 million sequentially. Turning to Slide 8 and our credit performance, 30 to 89 delinquency increased 8 basis points to 2.81% in the third quarter from 2.73% in the second quarter. As we discussed in some detail last quarter, after tracking in line with expectations throughout the first four months of this year, we saw an increase in our early-stage delinquency starting primarily within the lower credit quality, lower FICO customer segments. We've seen some modest improvement in these segments in the third quarter, and as a result, the sequential 30 to 89 performance looked more like a normal seasonal increase. 90-plus delinquency was 2.41%, an increase of 26 basis points sequentially, following the 30 to 89 trend we saw in the second quarter. Loan net charge-offs were $290 million or 5.9%, above the historically low 3.5% we reported in the third quarter of 2021, but in line with the 6% we reported last quarter. Charge-offs were supported by continued strength in post charge-off recoveries. Recoveries in the quarter were 1.2% of average receivables, well above pre-pandemic levels of approximately 0.9%. This performance is the result of a diverse and balanced strategy of internal and external collections and opportunistic sales. In summary, while we maintain a heightened level of focus on our delinquency, we are encouraged by the stabilization we saw in Q3. We continue to closely monitor performance and we will adjust our underwriting and our operations accordingly. Turning to Slide 11. Our third quarter allowance increased by $127 million to $2.3 billion with a coverage ratio of 11.4%. This compares to a second quarter reserve ratio of 11.0%. The $127 million increase included approximately $35 million to $40 million related to growth in our receivables with the remaining increase reflecting the weakened macroeconomic environment. Turning to Slide 12. Third quarter operating expenses were $359 million, up 6% year-over-year as we continue to invest in new products and channels, technology, digital and data science while maintaining expense discipline across our business. Our operating leverage remains on target for the year at 7.1% as compared to 7.3% in 2021. Turning to Slide 13. Let me briefly provide an update on our balance sheet. As I'm sure you all know, the funding markets remain quite challenged and it is during these times that a strong balance sheet and a mature sophisticated funding program become a big advantage. In late August, we initiated a $500 million ABS transaction that was received with strong demand and was subsequently upsized to $1 billion and tightened to an average coupon of 5.17%. We saw strong support from returning investors, and we added some new investors to our program. This year, through one of the most difficult funding environments in recent memory, we've issued $2.2 billion in the ABS market at an average rate of about 4.8% and an average life of just over 3 years. This is just below our portfolio rate of approximately 5%. Our liquidity runway, which we define as the length of time in which we can operate the company under stressed macroeconomic conditions and with no access to the capital markets, remains strong at more than 24 months. A foundation of our liquidity runway is our committed bank capacity, which increased by $400 million in the quarter to $7.4 billion at quarter end. Rounding out the balance sheet, our net leverage at the end of the quarter was 5.6x, flat to the second quarter. On Slide 16, we've provided an update to our full year strategic priorities. We continue to expect managed receivables to grow at the low end of our long-term operating framework, but we are pleased with the volume of loans that we're booking at the higher end of the credit spectrum. Last quarter, we had increased our expectations for net charge-offs by 50 basis points, so in the range of 6.1% to 6.5%. We now expect full year net charge-offs to be at the lower end of that range. As discussed earlier, we are managing our expense base given current market conditions, and we expect our full year operating expense ratio to be approximately 7.1%. Finally, last quarter, we had reduced our capital generation estimate by approximately 12%, which equated to a range of . Given the improved outlook for net charge-offs, we expect full year capital generation to be at the higher end of that range. With that, I'd like to turn the call back over to Doug.

Thanks, Micah. We feel really good about how OneMain is positioned today. The combination of our incredibly strong balance sheet, superior knowledge of the nonprime consumer, proprietary data through multiple economic cycles, and world-class underwriting and servicing capabilities puts us in a position of strength in this uncertain macroeconomic environment. While we remain cautious, we also feel confident in our ability to navigate this environment and continue to generate advantages for our business over the long run. I want to again thank all of our team members. This month, OneMain was named to Newsweek's list of the top 100 most loved workplaces for 2022. This external recognition is a reflection of what those of us who work at the company already knew that our team members are exceptional. They come to work every day committed to making a difference for our customers, our communities, and each other. It is our team members who make OneMain such a special place to work, and I want to congratulate them on this honor. With that, let me turn it over to the operator, and we're happy to take questions.

Our first question is coming from Moshe Orenbuch with Credit Suisse.

Doug and Micah, I'm hoping that given what you talked about in terms of your ability, tightening of the credit box, the strong funding, could you talk a little bit about how that fits in with the overall competitive environment? Like what are you seeing from competitors? Are there either kind of prime lenders that are tightening that have given you greater opportunities or other sorts of opportunities from a competitive stance?

Yes, thank you for the question, Moshe. It's Doug. We are identifying opportunities in the competitive landscape. In 2021 and early 2022, several players who usually focused on prime began to shift to non-prime. Many of them have since exited the market, resulting in less supply. We have a strong balance sheet that enables us to continue lending to customers as long as the loans meet our return criteria. Additionally, many non-prime lenders have tightened their credit standards in this environment, and we highlighted in our presentation that delinquencies are rising across the non-prime sector. Most lenders have rightly reduced their credit offerings. Those who depend on partnerships and loan flow agreements have noticed that capital suppliers have become much more conservative. Our strategy of adding long-term unsecured debt of 8 to 10 years to our portfolio over the last couple of years, coupled with our strong funding program, ensures we have plenty of available supply. We have significantly reduced our credit box, and if competition had remained at its previous levels, we would be originating fewer loans. Instead, we are acquiring higher quality borrowers and continuing to grow our balances with improved quality. We are pleased with the competitive environment and intentionally structured our business to maintain a strong position during economic downturns or market turmoil.

Got you. From a financial perspective, you mentioned an improved outlook for capital generation, with revenues, expenses, and credit losses all showing slight improvements. The reserve has increased again and now stands at 11.4%. I would point out that at the end of the first quarter of 2020, the reserve was at 12%. Can you clarify how you view this level? It seems to me that economic uncertainty was likely greater back then than it is now. Could you discuss how we should interpret the reserve trends moving forward?

Yes, it's Micah. Thanks for the question. If you look back at the first quarter, it was around 12%. By the second quarter of that same year, it increased to 13.2%. At that time, we were facing forecasts of unemployment in the mid to low teens, which influenced expectations. However, that scenario did not materialize, and many of us, including our team, had to adjust our reserves downward as the macro economy improved. Currently, reserves are assessed quarterly. We aim to maintain accurate and appropriate reserves at all times. Our reserving process involves projecting lifetime gross loss assumptions for delinquent receivables. Under CECL, we are required to make assumptions and establish reserves for our nondelinquent receivables, which comprise 95% of our portfolio. This accounting approach is quite different. We also take into account our recovery expectations after charge-offs, not only for loans going to loss but also for recoveries related to past losses. There are numerous factors considered in our reserves. It’s essential to factor in the future macro environment and its effects on potential losses. We evaluate various sources to create these assumptions. This quarter's macro outlook incorporates multiple economic scenarios, leading to moderately elevated unemployment assumptions for 2023, a rise from the second quarter. Additionally, we take into account the effects of credit performance along with broader economic factors such as ongoing inflation. I mention all this to convey that there are many variables in how we operate our CECL reserve models. We adjust outputs against different loss projections to ensure our reserves are appropriate at any time. Naturally, we continuously refine our estimates based on actual outcomes and the evolving situation in the coming quarters.

We'll take the next question from Kevin Barker. One moment, please. Our next question will come from Kevin Barker with Piper Sandler.

Sorry, I was talking a little bit there.

We didn't hear you, Kevin. We didn't hear anything though.

Could you provide details on what you are observing in the credit portfolio that suggests net charge-offs are at the lower end? Specifically, what exit rate do you anticipate for net charge-offs in 2022? Additionally, what do you forecast for year-over-year growth rates in net charge-offs and delinquency rates as we approach the fourth quarter and into the first quarter?

Okay. Kevin, this is Micah. I'll try to unpack that a little bit for you. Obviously, it's kind of an uncertain environment, which played into certainly how we were setting what we felt was a reasonable assumption when we last talked to you in late July of 6.1% to 6.5%. I think built into that estimate was a range of potential outcomes, mostly with respect to our recoveries and our late-stage flows. By the time we get to this point in the year, any early-stage delinquency we're booking today, call it, our September results will really impact first quarter just because of the way things roll through the buckets to charge off at 180 days. If you go back and look at all of our historical data of 30 to 89, two quarters later to charge-offs and 90 plus one quarter later to charge-offs, those ratios give you a pretty good sense for how to think about losses over the next couple of quarters. We're tightening our guidance today to be at the lower end of that range. It's really a function of our being very disciplined with our underwriting. We've been tightening for a while, so we are starting to see some benefits of the tightening we did before the summer. The summer significant tightening we've done is still taking hold, and we will see some of those tailwinds coming in the future. Our back-end roll rates, our performance continues to be strong; I think this is a function of our business model. We talked earlier about the algorithms and the data we use to rescore our portfolio on a monthly basis and provide those tools to our central operations so they know who to call and where to prioritize, what tools to offer when they're on the phone with folks. We're just seeing continued strength in the back end. A lot of that's just our business model. We're able to now tighten that range as we get one quarter closer to the end of the year. Recoveries also remained strong. We had a strategy change in 2018 where we started to do a lot more internal collections. Our current recovery rates are well above '19 levels; I think there's now more confidence that there's some stickiness to that. We'll see as time unfolds, but that's really a balanced strategy of both internal and external collections and then doing some opportunistic sales. In terms of going forward, I think the 90 plus in this quarter will give you a pretty good sense for what fourth quarter looks like, plus we gave you that full-year guidance. Take the 30 to 89, which we saw some stabilization in this quarter that should help inform your first quarter expectations for loss. I think beyond that is really a function of where the macro environment unfolds.

Mike, thank you for the detailed answer. And regardless of the year-over-year growth rates, it seems like your guidance would imply that the year-over-year growth has plateaued on the charge-off rate? Likely, it will decline into the early part of '23. Am I thinking about that correctly just given your guidance and the growth rates?

Yes. I think maybe on a long-term trend, that's potentially possible. You have to start with the 30 to 89. Against 2019 we were about 60 basis points higher in June than 2019 levels. We were about 50 basis points higher when we got to the third quarter. I would say modest improvement. We were still very mindful of the environment, but we'll have to track where 30 to 89 goes from here. That should really start to inform you when we see a trend in that early-stage delinquency where things are headed. I would caution you on the first quarter and second quarter of 2022; the year-over-year compare is going to be a little bit difficult because of the fact that we still had some of the tailwinds from stimulus and think about where the 30 to 89 was in the third quarter; it was still pretty low coming off that massive stimulus we saw in March of '21. You're always kind of two quarters behind, if you will, on the charge-offs into where that turn is. I encourage you to keep watching the 30 to 89, and of course, we'll keep updating you as we go.

Our next question will come from Michael Kaye with Wells Fargo.

This quarter, we saw a pretty substantial reduction in asset yields, and you mentioned the crude interest reversals. I suspect there's probably a heavy amount of borrower assistance programs implemented. But then you noted that origination APRs were flat quarter-on-quarter. Could you just talk a little bit more about the near-term outlook on asset yield? Should they begin to stabilize a bit next quarter at these levels or even head up a bit as delinquent stabilize?

Yes. For the fourth quarter, I expect asset yield to be slightly below what we experienced in the third quarter. We are closely monitoring APRs as new originations come in, as they indicate future yield trends. However, we often operate with a lag because the assets we add today, which are consistent with the second quarter and show modest growth compared to last year, will take time to stabilize in a $20 billion portfolio. This serves as a good reference point for where yields might settle once we navigate through some of the current macro challenges. The yield this quarter has been affected by the increase in delinquencies, particularly the rise in accounts over 90 days past due. As you know, we reverse accrued interest on these receivables and stop accruing, which significantly impacts yield. Additionally, the payment assistance we provide to some customers delays yield recognition on accrued interest for those accounts. We believe these measures lead to better outcomes, and we anticipate that yield will normalize as the macro environment improves.

Second question is I wanted to just talk about your funding needs for the rest of this year and into 2023. How long can you go without raising unsecured debt? And how high would you let that secured funding mix go?

Yes, that's a great question. Let me first discuss how issuance rates impact our interest expense. It's important to note that we've structured our balance sheet with staggered maturities and fixed rates to mitigate the effects of issuance rates. We have issued aggressively in the unsecured market, including some 8- and 10-year debt during that time. Additionally, we reduced our secured debt to about 40%, reaching down to 39% in the third quarter of 2021. We capitalized on that market, positioning ourselves to return to ABS when the opportunity arose, which has come in 2022. We have only issued ABS debt. Considering the impact on our interest expense, the issuance from ABS remains slightly below our average portfolio rate for our debt. Looking ahead, if we engage in issuance over the next month, it will account for 6% to 7% of our average debt in 2023. Issuance over the following 24 months will represent just 22% of our average debt in 2024. Changes in issuance rates and our balance sheet composition take some time to affect our interest expense. With ABS, starting from a position of 39%, we are now roughly even between ABS and other debt, and we feel confident that we could issue solely ABS in 2023 if necessary. While we hope to issue some unsecured debt, it is not essential at this moment; we’ve positioned ourselves well for this. We will continue to be opportunistic and manage this for the long term.

Our next question will come from Rick Shane with JPMorgan.

Two questions. Earlier in the quarter at the conference, you talked about sort of a divergence in the portfolio in terms of credit performance between customers who rent and customers who own their homes. I'm curious if you can provide some context on what the mix within the customer base is.

Yes, Rick, we're seeing that inflation is eating into the cushion of renters more than homeowners. It's pretty obvious. There are a lot of homeowners, especially working Americans who have 30-year fixed-rate debt; they can choose not to move, and their expenses don't go up that much. I mean, gas, food, and other essentials are going up, but their housing isn't going up that much. In some metro regions, especially in certain parts of the country, rents have increased significantly. We've adjusted our credit models. The result is we usually had a little bit less than 50% of our customers were homeowners. We've now decreased the number of renters just by definition of the way we have our credit box, where we're assuming a higher cost of living and therefore, less net disposable income, resulting in either a reduction in the size of the loan or our willingness to spend or whether you have secured or unsecured loan offered from us. We've definitely seen more stress from renters, and we've adjusted the box appropriately.

Got it. Yes, I agree with you. It was a very interesting comment at the conference because it struck me as a stickier source of inflationary pressure for your consumer. So 50-50 is probably sounds like a reasonable place to assume. That actually dovetails with my next question, which is you also made a comment on this call about high-grading the portfolio in terms of the credit buckets going from mid-30s to 60% in your highest two credit buckets. All things being equal, given the duration of the portfolio, how long would it take in terms of number of quarters if you stuck with that to really see the portfolio converge towards that 60% level? I realize that's not going to happen but just from a hypothetical perspective, so we understand how quickly the portfolio recast.

Yes, Rick, this is Micah. Thank you for your question. It's difficult to predict exactly what will happen in the future with the portfolio. However, I expect that the originations from our stricter underwriting, which took shape post-August, will reach around 35 million by March, and then somewhere in the 45% to 50% range by the second quarter of next year. Considering this, we could start to see some positive credit trends over the next three to four quarters, assuming a stable macroeconomic environment. If we maintain this approach throughout the period, by the end of next year, we should fully see the trends I mentioned integrated. However, we will need to see how the environment evolves next year. I hope this provides some insight into the timeline.

Our next question will come from John Hecht with Jefferies.

Can you quantify or characterize the impacts of inflation on disposable income? Additionally, how does that influence the average loan size in the current timeframe?

Yes. I'll take a shot at it, John. I think in terms of the inflation impact on our consumers, we've talked a lot about the lower sort of credit quality. We tend to see in our scoring that those customers of the highest risk that are having some challenges have much lower average income per month than, say, our average borrower, certainly our lowest risk cohort. We’ve seen some wage growth over the last couple of years, particularly in this sort of consumer base, but inflation has just continued to outpace wage growth. If you look at a lot of the economic data, real incomes have been down for several months. That's what leads to the credit performance of these folks. In terms of loan size, loan size is really a function of your risk scoring. A lot of these customers that are not fitting our box anymore aren't getting a loan size at all because they are just not getting an offer or they're getting a secured offer only where we feel that's a good trade-off and a good return for us. We've seen stability in our loan sizes across risk grade. We're just seeing less of that higher risk customer coming into the book. In secured loans, we’ve made a couple of adjustments specifically over the last year to ensure that we are not riding up the curve on collateral values. We've cut them a couple of times, probably netting to about a 30% overall reduction. We're moderating loan sizes there. Loan size is part of the equation along with just who we’re underwriting on a new customer basis.

And John, I would just add that one of the things we've done over the last couple of years is diversify our product offerings. We had already established a solid smaller dollar loan program for $2,500. So if you consider someone who, before we tightened our criteria, might have qualified for a $7,000 unsecured loan, now we might only provide them with a $7,000 secured loan or a $2,500 smaller dollar loan, which results in a significantly lower monthly payment. As Micah mentioned, there are several customers whose risk profile leads us to believe it's not advisable to extend a loan to them, as we don't think they would be able to repay it.

Okay. Super helpful color. And then another question. I think you guys referred to Dealertrack in some of your prepared remarks and were talking about new channels. Maybe can you just talk about the store versus digital migration and maybe some of the metrics or trends there?

Yes. Since the pandemic and we created our ability to close loans outside of branches, it's been pretty steady that somewhere between 40% and 45% of our loans are through this channel. A lot of it is present customers who do not have to come into a branch to close it. We built out a set of tools, two-way video, one-way video, and co-browsing, being the most popular tool where we can actually show someone on their device; they'll give us access to their screen. We'll walk them through the loan. Almost every one of those loans has a phone call where we help them work through what they can afford, what's the right loan for them, etc. Our normal channels continue to be a major part of the business, and the credit performance of those is very much in line with the credit performance of our branch-based lending. A lot of them get serviced outside of a branch. If you live in Dayton, Ohio, whether you come to a branch or not, you get contacted by the branch manager, one of the team members; you make a personal contact. If you end up in trouble, you may sometimes walk into a branch or you will end up on the phone. All the hallmarks of our business. We've also built out different distribution partnerships. I mentioned Dealertrack; there's one currency that links us to powersports dealers. That similarity with Dealertrack allows us to diversify our business and gives us a channel that isn't branch-based that we can employ everything that we do with a remote close and all of the hallmarks of our business that have made it so successful over time through those channels. We end up getting on the phone with them, verifying the vehicle, securing the title, taking it through our underwriting process, assigning them usually a team member who will be their point of contact. So we have all the hallmarks of what we do, but it's a different way to get customers in the door as opposed to our normal digital originations or direct mail or affiliates.

Our last question will come from John Rowan with Janney.

I just want to dovetail the conversation on competition with the ABS market. I guess, Micah, maybe give us an update on where spreads would be in the ABS market for you guys today. Obviously, the deal that we saw this quarter was relatively stable relative to the prior deal. But there are definitely pockets in the ABS market where spreads are widening quite a bit. Maybe just an update on how you think your next spread is going to be? How is that relative to other competitors that may be seeing wider spreads and possibly lower liquidity?

Yes. Sure, John. I mean, the ABS market has been, I would say, pretty efficient this year. Over the last couple of weeks, it's gotten a little bit messier. We'll be opportunistic when we can. If you think about where our coupon was on this deal, it was about 5.2%. The previous one, a couple of months prior to that, was at 4.3%. About half of that increase was on the benchmarks and another half was the spread increase. We did see some spread increases in our last deal, but we were opportunistic and did this in August when the time was right. I think that's going to be key to our benefits going forward. If we were to issue in the ABS market today, it's probably in the mid-6s, honestly, where spreads are. We'll be patient. The good news is we upsized that $500 million deal to $1 billion, which meant that we didn't have to issue for the rest of the year. First quarter is typically a quarter in which our balance sheet doesn't grow just with tax season and demand. I think we're set up for a lot of flexibility. We feel like we are issuing at levels well inside what our competition is doing. I won't speak to anyone specifically, but the data is out there. I think we're probably 70 basis points inside of what others can issue at on the top tranche, but that changes from time to time.

Yes, we're at the end of the call. Let me just emphasize a couple of things Mike has said. One is we really have invested in our balance sheet over the last three or four years. We didn't try to pick up every last dollar at the lowest rate; instead, we put a lot of long-term debt on. So we're now, in our view, in a really advantageous position going into an uncertain economic cycle. I think one of the reasons we end up getting better rates than a lot is because we have a long history of serving the customer. We cut our underwriting quickly when we need to; we have a set of servicing tools. A lot of the questions that came across today focusing on the strength of our balance sheet and us being able to dynamically manage our underwriting are on point for how we're managing this business. We’re being conservative, which might leave a little money on the table, but we're protecting the business for the long run as we invest and just position ourselves for the future through the cycle. So with that, thanks, everyone, for joining us. We're happy to take any follow-up questions, and hope everyone has a great day.

Thank you, ladies and gentlemen. This does conclude today's OneMain Financial Third Quarter 2022 Earnings Conference Call. Please disconnect your line at this time, and have a wonderful day.