Description

I recommend a long in OneMain Financial, an under-appreciated, high-quality and well-managed subprime consumer lender that earns ~25%+ ROEs, has compounded EPS at ~20% over the past 10 years, generates profits even in the most severe of recessionary scenarios, and is returning excess capital to shareholders (repurchased ~13% of shares outstanding since 2019; ~8% dividend yield). 

The Company operates in a growing market at an inflection in competitive intensity, with key fintech competitors retrenching, and is accelerating its growth and diversification with a multi-product strategy expanding into auto loans and credit card products for non-prime borrowers. 

Shares tend to trade around the consumer credit cycle, but at current prices, I believe OneMain effectively already prices in a consumer recession, while trading at just ~3.5x normalized EPS potential in a few years (and ~2x EPS factoring in a recovery of one’s cost basis through interim dividends). 

Overview

OneMain is a leading non-bank lender primarily focused on providing personal loans to non-prime consumers, with ~20% national market share of the US non-prime personal loan market. 

OneMain focuses on consumers with a FICO score of ~500-700 (average FICO score of ~630), a segment underserved by large financial institutions who largely withdrew from the market after the GFC due to regulatory, risk and capital treatment constraints. 

OneMain typically provides ~$5-15k size unsecured and secured personal loans (~50% secured / ~50% unsecured) on a two-year tenor that borrowers use to fund episodic personal needs, unexpected expenses, and debt consolidation.   

The Company operates an omni-channel model with both a nationwide branch network and an online platform. OneMain has one of the largest branch-based distribution networks in the industry, with ~90% of the US population living within 30 miles of one of its 1,400 branches, which are generally small formats with low real estate costs. A typical branch is staffed with ~4-5 employees, who generally spend ~75% of time on originations, sales and administration and ~25% on collections. Underwriting is performed centrally on an automated basis, while verification and loan closing and servicing and collections of early stage delinquencies are handled at the branch level. The business continues to invest in its digital capabilities, with meaningful investments over recent years in digital products, digital marketing and customer engagement channels, and underwriting models. 

The Company’s competitive advantages stem from a few areas:

1. Distribution: A superior physical branch network drives better distribution and cheaper customer acquisition while also serving to lower default rates and enhance collections 

2. Data moat / capabilities: Proprietary data spanning multiple economic cycles ($195B of cumulative originations since 2006) and deep expertise in the non-prime credit category leads to better credit underwriting and decisioning 

3. Funding: Seasoned issuer in the capital markets with better funding access versus fintech competitors

4. Scale: Scale economics on a national basis resulting in a lower cost-to-serve versus regional bank and credit union competitors 

While the predecessor entities to the business trace their history back to the early 1900s, the present manifestation of OneMain was formed in the aftermath of the Great Financial Crisis as large banks exited the subprime consumer category. Fortress Investment Group acquired Springleaf Financial from AIG in 2010 and then combined Springleaf with Citigroup’s OneMain Financial in 2015, creating what is today one of the largest non-prime consumer lenders in the country. Apollo and Varde acquired 41% of the business in 2018 from Fortress Investment Group at $26 per share before exiting in 2021. 

Attractive Economic Model 

While non-prime consumer lending is typically perceived as risky, OneMain actually operates a highly resilient business model due to its high loan yields (~25%) and high pre-loss profit margins (~13% of receivables) that provide ample cushion against charge-offs, even at levels seen during the GFC.  Loans are generally short tenor and can be re-priced fairly quickly to adjust to changing interest rate and credit conditions. 

The Company expects to be profitable in a repeat of the GFC and is even better positioned for a recession today than it was in 2008 / 2009 due to a significant increase in its secured mix (~50% of loans today are secured vs. <10% during the GFC) and lower leverage (net debt / capital is ~5.5x vs. ~10x+ in the past). Additionally, the company operates with significant liquidity and has 24+ months of runway in the event capital markets are shut to them. 

OneMain has been proactive about tightening its credit box starting in the second half of 2021 in anticipation of a weaker economy, with better charge-off performance relative to peers. ~60% of OneMain’s current loan book are from “front book” loans originated after its credit tightening actions. 

Competitive Inflection 

OMF operates in a growing end market and has organically grown its receivables book by ~6-7% per annum over the past seven years. In 2023, receivables are expected to grow another ~7%. 

A lot of industry growth in recent years has been driven by the expansion of various fintech lenders (Upstart, etc.), who are now retrenching due to poor credit performance and tightened access to capital. Transunion estimates that the Fintech share of personal loan debt has shrunk from 33% to 27% in the past year, primarily benefiting banks and finance companies like OneMain. 

New products

OneMain is embarking on the next leg of its growth strategy by diversifying into additional product lines that serve its core non-prime customer. OneMain has a growing credit card business called Brightway with a fairly unique customer proposition (customers are rewarded for credit-building behaviors) that has now scaled to 340k accounts and $230M of receivables from launch two years ago. The Company expects to achieve ~$100M of capital generation from credit cards within the next few years. 

OneMain is also accelerating its penetration into the auto loan market with the recent acquisition of Foursight Capital from Jefferies in November 2023. Foursight provides auto loans to near-prime borrowers at the point of purchase through a network of franchise dealers. 

The multi-product expansion makes sense on several levels. It adds new profit streams in attractive categories with attractive risk-adjusted yields, where OMF has a right to win due to its distribution, data / underwriting, and operational infrastructure advantages within non-prime segments. It also increases customer stickiness and lifetime values, while expanding OneMain’s TAM and growth runway (personal loans is a $100B market vs. $550B for credit cards and $600B for auto finance). 

Valuation

I use capital generation per share as the primary measure of economic EPS, which normalizes for GAAP reserving by adding back GAAP loan loss provisions and deducting net charge offs. This is also the primary metric that OMF manages its business to. 

OneMain has historically had a great track record of compounding earnings, growing its EPS from ~$1.30 per share in 2014 to ~$6.60 in 2023, or a ~20% CAGR over the past nine years. 2023 EPS is currently depressed due to elevated charge-offs (~7.5% of receivables vs. historical levels of ~6%-7%) reflecting a more stressed consumer macro environment. 

As receivables grow, OMF will continue to benefit from significant scalability and operating leverage. Total receivables per branch has grown from ~$2M per branch in 2010, to ~$4M per branch in 2013, to now ~$15M per branch in 2023. Operating expenses as a % of receivables has declined from ~8.6% in 2017 to ~7% in 2023, highlighting the inherent operating leverage of the business. 

I believe receivables can continue to grow at ~6% CAGR over the next 5 years. Assuming ~20% pre-provision net yields (in-line with historical levels), charge-offs revert back to historical levels of ~6.5%, the business continues to scale with operating leverage (opex % of receivables declines from ~7% to ~6.5%), and ongoing share buybacks of post-dividend excess capital, I believe OneMain can do ~$13 of EPS in 2028, consistent with OMF’s mid-term target of $12.50 EPS in 3-5 years. 

While the macro environment is uncertain, history provides reasonable bookends for where charge-offs could go. In 2001-2002 (a mild recession), charge-offs peaked at ~7.5%-8% of receivables, implying $6 of recessionary EPS. In 2008-2009 (a severe recession), charge-offs peaked at ~9.5%-10%, implying ~$3.50 of recessionary EPS. At some point, charge-offs should normalize as macro stabilizes and as the older vintages turn over fairly quickly. 

The stock is cheap any way you look at it. ~7x 2023 currently depressed EPS, ~5x 2023 EPS normalized for losses, ~8x mild recession EPS, ~13x severe recession, and <4x ~2028E EPS. 

The business has historically traded at ~7x P/E multiple. Including interim dividends, this would imply $108 per share of value in 2027 (vs. $48 today). As investors come to appreciate the quality and resiliency of the business, I believe OneMain can re-rate closer to the historical multiples of consumer lending peers at ~9-10x EPS, implying $141 per share of value, or a 3x MOIC. 

Catalyst

• Normalization of charge-offs 
• Buybacks and dividends