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Edited Transcript of OMF earnings conference call or presentation 29-Oct-19 12:00pm GMT

Q3 2019 OneMain Holdings Inc Earnings Call

Evansville Nov 16, 2019 (Thomson StreetEvents) -- Edited Transcript of Onemain Holdings Inc earnings conference call or presentation Tuesday, October 29, 2019 at 12:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Douglas H. Shulman

OneMain Holdings, Inc. - President, CEO & Director

* Douglas Shulman

* Kathryn Harmon Miller

OneMain Holdings, Inc. - Head of IR

* Micah R. Conrad

OneMain Holdings, Inc. - Executive VP & CFO

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Conference Call Participants

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* Arren Saul Cyganovich

Citigroup Inc, Research Division - VP & Senior Analyst

* Eric Edmund Wasserstrom

UBS Investment Bank, Research Division - MD & Consumer Finance Analyst

* Eric J. Hagen

Keefe, Bruyette, & Woods, Inc., Research Division - Analyst

* Henry Joseph Coffey

Wedbush Securities Inc., Research Division - MD of Equities Research

* John Hecht

Jefferies LLC, Research Division - Equity Analyst

* John J. Rowan

Janney Montgomery Scott LLC, Research Division - Director of Specialty Finance

* Kevin James Barker

Piper Jaffray Companies, Research Division - Principal & Senior Research Analyst

* Michael John Grondahl

Northland Capital Markets, Research Division - Head of Equity Research & Senior Research Analyst

* Michael Robert Kaye

Wells Fargo Securities, LLC, Research Division - Senior Analyst

* Moshe Ari Orenbuch

Crédit Suisse AG, Research Division - MD and Equity Research Analyst

* Richard Barry Shane

JP Morgan Chase & Co, Research Division - Senior Equity Analyst

* Vincent Albert Caintic

Stephens Inc., Research Division - MD & Senior Specialty Finance Analyst

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Presentation

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Operator [1]

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Welcome to the OneMain Financial's Third Quarter 2019 Earnings Conference Call and Webcast. Hosting the call today from OneMain is Kathryn Miller, Head of Investor Relations. Today's call is being recorded. (Operator Instructions) It is now my pleasure to turn the floor over to Kathryn Miller. You may begin.

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Kathryn Harmon Miller, OneMain Holdings, Inc. - Head of IR [2]

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Thank you, Maria. Good morning, and thank you for joining us. Let me begin by directing you to Pages 2 and 3 of the third quarter 2019 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. 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, October 29, and have not been updated subsequent to this call. Our call this morning will include formal remarks from Doug Shulman, our President and CEO; and Micah Conrad, our Chief Financial Officer. After the conclusion of our formal remarks, we'll conduct a Q&A session.

So now let me turn the call over to Doug.

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Douglas Shulman, [3]

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Thanks, Kathryn, and good morning, everyone. I'm pleased to be with you today. We produced significant earnings growth during the third quarter, driven by the continued execution of our strategic priorities for the year and our ongoing commitment to enhance our customer experience. We generated C&I adjusted earnings growth of 35% year-over-year and drove a 90 basis point improvement in our return on receivables, which reached 5.5% for the quarter.

Credit performance continued to be strong. Our net charge-off rate was 5.2%, about 60 basis points better than last year's third quarter. Our 30- to 89-day delinquency ratio was flat year-over-year, and our 90-day ratio came in about 10 basis points better than last year. We're also continuing to exercise expense discipline in driving operating leverage in our business. Our third quarter operating expense ratio declined by about 60 basis points year-over-year even as we continued to invest in the business.

From a funding perspective, we issued a total of $1.7 billion of 7-year revolving secured debt at a blended interest rate of about 3.5%. This was an important milestone for our funding program, as we became the first-ever personal lender to complete a 7-year revolving securitization. We are very committed to maintaining a conservative balance sheet and significant liquidity cushion. Overall, the core drivers of our business are performing very well and reflecting the benefit of the initiatives we have undertaken to enhance our customer experience and the profitability of the platform.

We are using advanced analytics to optimize our marketing strategy and drive our credit model. Our streamlined application, our expanded after-hour support and our build-out of analytics tools all -- are all improving our customer pull-through. And our investment in technology is driving greater productivity across our branch and central operations teams. Simply put, we are attracting, converting and serving more of the customers that we want to serve. This has contributed to the strong originations growth we have achieved over the last 2 quarters, in particular.

We're excited to talk about these and other initiatives at our upcoming Investor Day. We'll provide an overview of our longer-term plans for the company, including enhanced digital capabilities and a number of opportunities we see to further optimize our business, better serve our customers and enhance profitability.

We will also provide insight into the resilience of our business regardless of the economic environment and discuss our reinvestment and capital return priorities. We look forward to seeing you all there. With that, let me turn the call over to Micah.

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Micah R. Conrad, OneMain Holdings, Inc. - Executive VP & CFO [4]

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Thanks, Doug, and good morning, everyone. I'll start by reviewing the core drivers of our third quarter results, followed with some comments on CECL and its expected impact. We earned $248 million of net income in the third quarter or $1.82 per diluted share, primarily driven by our strong C&I performance. Our income for the quarter included the benefit of $22 million of nonrecurring discrete tax items. As a result of these tax items, we now expect non-C&I impacts to be about $70 million for the full year 2019 down from the $90 million I guided to during our First Quarter Conference Call.

Our C&I segment earned $241 million on an adjusted net income basis or $1.77 per diluted share. This was up 35% from $179 million or $1.31 in the third quarter of 2018.

Originations for the third quarter was $3.7 billion, of which 55% was secured, up from $2.9 billion and 54% secured last year. These strong originations led to ending net receivables growth of $2 billion year-over-year. Our secured portfolio grew by $1.9 billion or 26% over the same period, reflecting our continued focus on building a resilient portfolio that will continue to perform in all economic conditions.

Given the growth we've achieved thus far, we are now expecting ending net receivables growth for the year to be between 12% and 14%.

Interest income was $1.1 billion, up 13% from last year. The increase primarily reflected higher-average receivables and higher yield, which was 24.1% in the third quarter. The year-over-year increase in yield reflected improvement in our 90-day delinquencies and continued strength in origination APRs. These positive dynamics continue to provide stability in our yields despite continued growth in our secured portfolio mix.

Total other revenue was $154 million in the third quarter, up 10% versus last year, consistent with our originations and receivables growth. Let's move on to credit, which continued to be stable. Our 30-to-89 delinquency rate of 2.3% remained consistent with last year's third quarter.

Our 90-plus delinquency rate was 1.9%, down about 10 basis points from last year. And our net charge-off ratio was 5.2%, an approximate 60 basis point improvement compared to last year. Keep in mind, this was driven by a particularly strong 30-to-89 delinquency rate in the first quarter of this year. We do not expect year-over-year improvements of this same magnitude in future quarters given the portfolios moderating growth of secured lending.

Our loan loss reserves increased sequentially by $50 million or by 10 basis points to 4.6% of receivables. This increase was in line with expectations and reflected seasonally higher delinquency. Our reserve rate was down 20 basis points year-over-year driven by the lower loss profile of our portfolio compared to last year.

Third quarter operating expenses were $335 million, about 5% higher than last year. On a year-to-date basis, expenses were $963 million, up 3% versus 2018. This increase reflected continued investment in technology, customer experience and customer acquisition, which has been partially offset by continued operating efficiency in our branches and our central operations. Year-to-date, our operating expense ratio was 7.7%, down about 50 basis points from the comparable period last year.

And lastly, interest expense was $238 million in the third quarter, up from $218 million a year ago. Consistent with prior quarters, the increase reflected higher-average debt balances to support our portfolio growth as well as a greater proportion of unsecured debt.

Let's move on to our balance sheet. As you know, our priority is to maintain a conservative balance sheet and a long liquidity runway, both of which we continued to enhance during the quarter. As Doug mentioned, we issued $1.7 billion of secured debt through two 7-year revolving securitizations at a blended rate of 3.5%. As a result of this longer issuance, the average tenor of our secured debt maturities is now about 3 years, up from 2 years at the end of 2016.

Our third quarter tangible leverage ratio was 6.8x. And we are well positioned to deliver on our target of 6x by year-end. As you all know, we are a wholesale-funded business that regularly accesses the Capital Markets to pre-fund upcoming maturities and growth. As a result, our cash levels fluctuate from quarter-to-quarter reflecting the timing differences between debt issuance, receivables growth and debt reductions. At the end of the third quarter, we had roughly $1.2 billion of available in excess cash. Net of this available cash, our leverage ratio was about 6.3x for the quarter.

In terms of liquidity, during the quarter, we expanded our undrawn capacity to $6.9 billion. In addition to the $1.2 billion of available cash on our balance sheet, we also had $8.5 billion of unencumbered assets at quarter end. These liquidity sources, along with our balanced and longer maturities, provide an extended runway to operate our business without access to the Capital Markets.

Now let's move on to CECL. As you all know, CECL requires us to move away from our current incurred-loss reserving to a lifetime projected loss methodology. Keep in mind, this is simply an accounting change and does not affect the cash flow or fundamental economics of the business. Accordingly, when we adopt CECL on January 1, 2020, we expect our reserve ratio to increase from the current 4.6% to between 10% and 11%. This estimate is reflective of the portfolio attributes and economic outlook as of September 30. The ultimate amount that will be recorded on January 1 will be dependent on our portfolio composition and economic outlook at that time. Reserved bills will be accompanied by an increase to our deferred tax asset of approximately 24%, the net of these 2 resulting in an offsetting reduction to retained earnings. As we've highlighted in the past, we've always viewed reserves and tangible equity as the combined loss absorption capacity for the business. CECL simply moved this capital from one account to the other with the aggregate amount remaining the same.

Unlike a bank, regulatory agencies do not govern our capital levels. We see our balance sheet as very well capitalized regardless of the CECL accounting change and do not anticipate it having any impact on our capital adequacy or our ability to invest in the business or return capital to shareholders.

Let me finish by saying this, CECL is purely an accounting change. It does not impact fundamental drivers or underlying economics of our business. Our business generates very attractive returns and a considerable amount of capital for reinvestment and shareholder returns. And we remain well capitalized with significant liquidity to run the business through all economic conditions.

With that, I'll turn the call back to Doug.

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Douglas Shulman, [5]

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Thanks, Micah. As you can see, we continue to drive very strong results. Our key metrics, whether it be earnings, return on receivables, losses or liquidity, are great. What really excites me is the underlying fundamentals of the business and initiatives that are gaining momentum and driving these great financial results. We have a world-class executive team that is working extremely well together and are totally aligned against the company's priorities. We are hyper-focused on our customers and recently surpassed 2.4 million customer accounts for the first time in the company's history. This is a result of a number of factors, including a finely tuned credit box that allows us to better target customers that meet our risk returned profile. Marketing optimization that is starting to pay off with more customers applying, who meet our risk-return criteria. And the operational and customer experience improvements that have more customers, who we approve for a loan, booking those loans with us once they start the process and interact with us. I look forward to discussing these and other initiatives and plans with you at our upcoming Investor Day. With that, let me thank all of you for joining us, and I'll turn the call over to the operator for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question coming from the line of Kevin Barker of Piper Jaffray.

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Kevin James Barker, Piper Jaffray Companies, Research Division - Principal & Senior Research Analyst [2]

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Just a follow-up on your comments about the net charge-off rate and the stabilization of that going forward. At what point do you think the portfolio will be basically stabilized between secured and unsecured? And at what point do you feel like the net charge-offs will start to stabilize in the range given the balance between secured and unsecured?

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Micah R. Conrad, OneMain Holdings, Inc. - Executive VP & CFO [3]

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Good morning, Kevin, this is Micah. As we called out in the script, we can see our portfolio has started to level off a little bit, I mean it's going up by about 1 percentage point per quarter if you look over the last few quarters. With originations at around 55% and that portfolio at 51% as you could imagine mathematically that is going to converge. And I'll remind everyone over the last few years the secured mix has really moved from 36% at the end of 2016 to where it is today at 51%, so it's been a pretty market shift and losses over that point of time have declined from 7% in 2017 down to our current range of 6.1% to 6.3%, which we still feel good about. But secured mix is moderating, so we would expect a loss improvement will also moderate. So we are not ready to call out anything for 2020 yet. But you can see in the delinquency trends, if you look over the last couple of quarters, 30-to-89 delinquency rate has been flat to the prior year. So the portfolio remains really strong. We really feel good about it, but the secured mix is moderating and as such will the losses.

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Kevin James Barker, Piper Jaffray Companies, Research Division - Principal & Senior Research Analyst [4]

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Okay. And then at what point do you feel like you're going to hit that stabilized rate? Do you think it's probably sometime in mid-2020 or later in 2020? Just given that mix shift.

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Micah R. Conrad, OneMain Holdings, Inc. - Executive VP & CFO [5]

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Yes. Hard to say it now, right? We are not calling out 2020 yet, but I would direct you back to the delinquency trends.

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Operator [6]

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Our next question comes from the line of Michael Kaye of Wells Fargo.

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Michael Robert Kaye, Wells Fargo Securities, LLC, Research Division - Senior Analyst [7]

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On CECL, how should we think about the provision expense post CECL versus under the current GAAP accounting? Any thoughts on that? And also in your role, your thoughts on if you plan to get some additional pro forma EPS metrics post CECL. Just to normalize some of the noise around the provision expense?

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Micah R. Conrad, OneMain Holdings, Inc. - Executive VP & CFO [8]

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So just to back up on CECL and our day 1 reserve bill that we called out, again, it's -- we are going to -- we are expecting at this point our current reserving to go from 4.6% as a ratio of receivables upwards to a range of between 10% and 11%. We are running about 40 models under CECL. We incorporate up to 20 loan-level attributes and a variety of macroeconomic variables. I would caution you that our current estimate is reflective of our portfolio attributes and the macroeconomic outlook as of today or September 30. Ultimately, what we record on January 1 will be dependent on portfolio composition and macro use at that time. With respect to the Day 2 or earnings impact going forward, one of the things about CECL that it's different from our current reserving methodology, it's really the sensitivity of that model and how it reacts to the different things that are going on in the portfolio. So in general, reserve changes under CECL will be more sensitive to portfolio growth and less sensitive to seasonal delinquency than our current reserving methodology. And there is a few drivers under CECL that will impact the quarterly provision; first in a growing portfolio, there will be an increased level of reserving versus the methodology we have today just by virtue of having that 10% to 11% versus 4.6%. Second, again, the composition and attributes of the portfolio are very important at any given quarter. They will have a larger impact on the provision when projecting losses on a life-of-loan basis. And third, of course, as we mentioned, the macroeconomic conditions will drive future loss forecast as that can create fluctuation in the reserves. Again, this is accounting change only, as we've mentioned and talked about a lot. The fundamental economics of the business don't change. And in terms of the future, we've got a few quarters of parallel testing on our bill to feel really good about where we are with CECL. It's a little premature for us to guide around that expected earnings impact quite yet. But in future calls, we will provide more clarity on this as well as the non-GAAP metrics to allow for year-over-year comparisons with '19 financials.

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Michael Robert Kaye, Wells Fargo Securities, LLC, Research Division - Senior Analyst [9]

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Okay. Just given you're carrying a lot of that excess cash, is there anything you could say about potentially using that to pay down that $1 billion of unsecured due in December 2020. I think it has a 8 1/4% coupon. I wasn't sure if you're waiting for a specific date to pay that down or if that's the plan?

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Micah R. Conrad, OneMain Holdings, Inc. - Executive VP & CFO [10]

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Yes, I don't have any specific comments on that, Michael. I mean the $1 billion that we have on the balance sheet was really a result of our $1.7 billion of very, very successful ABS issuance, as we mentioned that is about 3.5%, which is very, very attractive funding for us. We will tend to access the markets when they are supportive. And as you know, we raised about $4 billion a year just to run the business, grow and satisfy our maturities, but nothing specific on next year's maturity at the end of December.

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Operator [11]

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Our next question comes from the line from John Hecht of Jefferies.

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John Hecht, Jefferies LLC, Research Division - Equity Analyst [12]

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I guess, first one is -- I think the first one is, what do you guys think is driving the incremental growth? Is it market share gains, is it your borrowers? They more willing to take on more credit? Is it just overall macroeconomic trends?

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Douglas Shulman, [13]

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Yes. Look, it's I think a number of things. First of all, the business is performing well and you're seeing the benefit of a number of initiatives that we started in the fourth quarter and first -- of last year and the first quarter of this year. We have marketing efforts that are driving more customers that we want to apply for loans -- to apply for those loans. We are using advanced analytics to help refine our understanding of the total lifetime value of a customer when they come in the door, which helps us approve customers that have the right risk-adjusted returns. I mentioned on the last call, we have a streamlined application, we have expanded our after-hour central support and we build out a number of analytical tools, which are all helping with the customer pull-through. And our investments in technology are starting to pay off and drive better efficiency and productivity across our branch and central operations. So a piece of the driver is these initiatives that are resolving us attracting and converting more of the customers we want to convert. However, the mix shift that Micah talked about earlier, which is usually, for a larger secured loan than an unsecured loan has also been a driver. And so I think between the 2 of those -- both the trends of us attracting the right customer and doing a good job operationally and with marketing and all throughout our processes together with more customers are choosing a secured loan at this point. Those are the 2 main drivers of the growth.

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John Hecht, Jefferies LLC, Research Division - Equity Analyst [14]

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Okay. That's great color. Second is with respect to the -- you had a fairly high yield this quarter. I know, Micah, you attributed some of that to the road you used, but you also mentioned pricing strength, I believe. Is there any kind of targeted market for your push the pricing up? Or is it just more of a mix shift? Or how do we think about that?

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Micah R. Conrad, OneMain Holdings, Inc. - Executive VP & CFO [15]

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Yes. John, that's been going on for a number of years, as you know. It's -- second quarter '17 is really when we started a lot of our price testing. We ensured all of our markets will remain competitive from a price standpoint. We feel really good about where are APRs have been trending last couple of years. On the trend in yield, that's obviously a function of those APRs, but also a function of 90-plus delinquency, which reverses out of yield when we get to that 90-day-plus point. So to the extent, we continue to have really positive trends on the back end of our collections and our delinquency buckets that's supportive of yield is a function of product mix and also stable payments. And I think all of those have been relatively supportive, which is driving the continued stability in our yields, so we feel really good about.

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Operator [16]

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Our next question comes from the line of Eric Wasserstrom of UBS.

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Eric Edmund Wasserstrom, UBS Investment Bank, Research Division - MD & Consumer Finance Analyst [17]

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Maybe just going back to the investment in the centralized operations, can you just remind us what functions those actually take on and sort of how it manifests itself in terms of the operating or typically, more specifically rather, the cost component of the income statement?

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Douglas Shulman, [18]

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Yes. So we have a large centralized operation that does a number of things. Traditionally, it was focused on collections after 90 days and then recovery activities. Over the last year, we have also increased our central sales and servicing team, and so when I'm referring to some of the things that are happening in central operations, we've been running tests where sometimes we sweep delinquencies earlier than 90 days into central, which helps with both overflow. And it also allows you to do a champion challenger test to seek out what is more effective. We also have after-hours, so when somebody applies online and a branch is closed, rather than waiting until the next day to be contacted by one man they can be contacted immediately, perfect their application, schedule to go into a branch. We also have just overflow calling. So if a branch is busy and there is a lot of people in there and there is more people who want to talk to the branch, they can flip over to our central operation. So we have a whole number of things happening. And I think -- we refer to it as our hybrid model that we have got branch and central that can complement each other. And we have also talked about this before. One of the great things is should we ever end up in a situation where we want to ramp up collections that provides quite a bit of overflow where we can toggle where we've got a lot of branches at central that we are both trained to do servicing and closing of loans, but also to do collection, which gives us a lot of operational flexibility depending on where the focus is.

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Eric Edmund Wasserstrom, UBS Investment Bank, Research Division - MD & Consumer Finance Analyst [19]

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And how do we think about the accretion of this functionality to the operating leverage?

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Micah R. Conrad, OneMain Holdings, Inc. - Executive VP & CFO [20]

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Yes, this is Micah here. It's -- some of what Doug talked about accretes to portfolio growth, right, and being able to get the applications quicker with some of our central operations and just pairing that together with our branches to enhance some of the growth in unit production and receivables growth we are seeing. And then, of course, some of it results in operating efficiency and expense reductions. We have continued to maintain cost discipline within the company and drive these efficiencies. One of the things we will see this year, we are enhancing our branch productivity, which is really a result of what Doug talked about receivables per branch were up 17%. So somewhat of a cost play, but also more adding receivables without adding that extra dollar of our expense. We are also leveraging our scale to reduce third-party vendor costs. And I'd be remiss if I didn't say that we are reinvesting these savings in our core technology to be -- continue to be efficient and invest in our customer experience and enhancements to the business. And you'll hear more about this in our upcoming Investor Day for sure.

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Eric Edmund Wasserstrom, UBS Investment Bank, Research Division - MD & Consumer Finance Analyst [21]

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If I could just sneak in 1 last clarification on CECL. Micah, you gave the DTA impact, but can you just help me with my arithmetic and what TCA level approximately does that suggest?

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Micah R. Conrad, OneMain Holdings, Inc. - Executive VP & CFO [22]

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Yes. So Eric, we've come a long way from our 17x leverage. We feel really good about where we are. I want to remind folks that the economics of the business won't change, our balance sheet remains strong. I'm not ready to give that out at this point.

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Operator [23]

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

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Moshe Ari Orenbuch, Crédit Suisse AG, Research Division - MD and Equity Research Analyst [24]

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Given all of those things you talked about with respect to the operating side of their ability to help you grow -- continue to grow loans at a very, very healthy rate. As you get feedback from your customers, are there other products that you can kind of -- maybe not completely different products, but tweaks to this that could kind of keep that going even longer. Are there things that you're learning that will allow that growth to continue?

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Douglas Shulman, [25]

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Yes. Moshe, it's a good question. And it's one we spent quite a bit of time on. Our core products, the installment loan, we'll go through some of this in Investor Day. The market has been growing, and we don't see a reason that it's not going to continue to grow into the future. Because there is a fair amount of our customers that come in for debt consolidation who are looking to get a regular monthly payment that's controllable, that can kind of move them out of the cycle of debt as opposed to have a number of credit cards that they hold. And so there has been a bunch of conversion from credit cards to personal loans, which is a big market that has quite a bit of room to grow. We are always looking and asking, what else can we do to help our customers. Because as we spend time with our customers, we are often there for them in the time of need. And because we have proprietary underwriting that isn't just a credit score, we can help them sometimes when people who just have more simpler models and not 100 years of experience working with the newer prime. Our customer won't take on that risk. And as you see, we have good risk-adjusted returns. So we are looking at both innovations to our current product set as well as new products. What I'd say is, over the last year, since I have been here, our main focus has been on strengthening the current business and optimizing it, because we think there was a lot to be done there. And we have a good runway for growth just within the core. And I think you're seeing some of that producing now. With that said, we're certainly going to continue to evaluate opportunities to expand our product set in the future.

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Moshe Ari Orenbuch, Crédit Suisse AG, Research Division - MD and Equity Research Analyst [26]

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Okay, and just on a slightly different tack, I mean there were some questions about specific debt issues. But maybe Micah, you could just talk a little bit about the philosophy of kind of managing the right hand side of the balance sheet now given the fact that the capital markets have been pretty favorable and both in terms of spreads and rates, what you might be doing over the next several quarters?

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Micah R. Conrad, OneMain Holdings, Inc. - Executive VP & CFO [27]

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Yes. Moshe, we're obviously very, very happy with our Capital Markets program. It has been -- certainly the markets have been favorable, but there has been a lot of effort from the team here at OneMain to really do a lot of outreach with our fixed income base. We spent a lot of time with our rating agencies. And we really built quite the program here. And just from a high-level point of view, we have set up for where our goal is to manage and run a conservative and resilient balance sheet. Long liquidity run rate is very, very important to us. We typically issue about $4 billion a year. It's going to be in a mix of ABS and unsecured. So I think our philosophy is still to have a balanced mix of the 2. ABS has been very, very attractive for us as you see from the $1.7 billion we did at 3.5%. I mean both of those were 7-year revolvers, which gives us about an 8-year life on those securitizations. So we're not only getting great rates from ABS but also getting tenor and that doesn't come without building a program over the years and building relationships with all of our investors. So I think, you will continue to see us using mix of about half and half that's going to be opportunistic as well. So we will issue when the markets are supportive.

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Operator [28]

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Our next question comes from the line of Vincent Caintic of Stephens.

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Vincent Albert Caintic, Stephens Inc., Research Division - MD & Senior Specialty Finance Analyst [29]

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And it's a very strong third quarter and it's impressively across the board. I guess, I'm wondering as we're thinking about 2020, sort of -- are there any particular items in the third quarter, and as we are thinking about the fourth quarter that are more onetime or so. I know you mentioned the losses, maybe a little bit of moderation on the loan growth side, but how should we think about 2020 from the base of third quarter? And then just because you beat so much versus the prior guidance, I was just wondering what sort of changed in the actuals versus what you were thinking earlier this year with prior guidance?

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Micah R. Conrad, OneMain Holdings, Inc. - Executive VP & CFO [30]

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Okay. I'll try to unpack that a little bit. We did call out the losses, as we've talked about. The secured mix and the portfolio is moderating. And very much expectedly so. So we are doing -- expect loss improvement to also moderate. In terms of yields, we feel comfortable with our call out on stable yields for the rest of this year. Not quite ready to give any further guidance on 2020 at this point. We'll certainly do that in the fourth quarter call, as we get into the early part of next year. The 1 item that I did call out in the third quarter was that discrete tax item on a GAAP basis. You will not see that in our C&I results, as we use a statutory rate throughout the year for those results. But that $22 million certainly is something that we don't expect to recur. That was driven by the release of evaluation allowance on some of our state deferred tax assets, which came from a combination of our strong earnings growth and our internal continued efforts to streamline our legal entity structure. Those are the big items for the quarter I'd call out.

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Vincent Albert Caintic, Stephens Inc., Research Division - MD & Senior Specialty Finance Analyst [31]

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Okay. Great. And I guess, when you think about the third quarter, one of the questions I have been getting from investors on the strong third quarter results, it's usually when you have the 3 different things. So very strong loan growth, very strong yields and then lower losses, usually you kind of take 2 and give up the third. So when the yields are strong it's because underwriting to a higher loss rate or when loan growth is strong maybe give up on something else, but just wondering first if I could get a comment on you from that. And then if you could talk about your recent vintage performance, help me do an even deeper underwriting to a different level or things that have been consistent?

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Douglas Shulman, [32]

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Yes, let me start, and then Micah might add in. I said it before on these calls, which we think of growth as an output of running the business, where we are going to market to the customers we want, we are going to underwrite to have loans that meet our risk-adjusted return and we're going to try to get people a great customer experience. So once they start interacting with us they want to book loans with us. And so I think you're seeing us hitting across a number of variables, which is running. I think of it as we run a disciplined analytical set of processes to manage a nationwide portfolio of risk. And this quarter you're seeing the output of around both risk and the price that we have for risk and the losses that come out of that being the very good and the result of us putting it together, an attractive powerful platform. My goal is to continue with that. And we don't necessarily say, hey, let's do one and not the other. We try to hit on all cylinders. And we have been doing well the last bunch of quarters. And our intention as management is to keep driving that and hit around. Again, book the right loans with the right risk-adjusted returns, and growth will be whatever growth is based on us hitting on all those levers.

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Operator [33]

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Our next question comes from the line of Rich Shane of JPMorgan.

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Richard Barry Shane, JP Morgan Chase & Co, Research Division - Senior Equity Analyst [34]

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As we get into 2020, and look, you guys are demonstrating strong growth and very high returns on capital, obviously it sets you up for potential return of capital. I'd love to go sort of through the thought process, dividend versus repurchase, and wondering, specifically two factors, one, does CECL impact that calculus in any way. For example, does it change the characteristic of a potential dividend from a qualified dividend to a return of capital? And also curious if the concentrated position of a sponsor influences that decision at all as well?

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Douglas Shulman, [35]

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Yes. We've talked before about our capital return priorities. And they remain the same that we've talked about before, which is, we have a business that generates excess capital. Our first priority is going to be to invest in the business to ensure we're serving our customers well, innovating and positioning the platform for long-term profitability. We'll also invest in growth as long as we see loans that meet our risk return profile and we think have a good return for our investors. We are going to prioritize the conservative balance sheet with a long liquidity runway and capital that gets generated in excess of that, as you see in this year, we've started to return it to shareholders. And we plan to continue. Regarding CECL, I'll just repeat what Micah said, and especially CECL vis-a-vis capital returns. We have a very strong conservative balance sheet. We're going to run the company based on the fundamental economics of the business, not on the accounting treatment of the business. And so, CECL is not going to change the way that we think about our capital adequacy, it's not going to change the way that we think about how we are going to invest in the business, and it's not going to change our ability to return capital to shareholders.

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Micah R. Conrad, OneMain Holdings, Inc. - Executive VP & CFO [36]

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Rick, I will just -- I can add to that a little bit, just to get a little bit more granular. We've said before we do -- we always viewed the combination of our reserves and our tangible equity as our total loss absorption capital or capacity for business. So CECL doesn't change that because we are just moving from one account to the other effectively. Post CECL implementation though, as a result of this will begin including reserves, net of tax in our leverage calculation, which is consistent with this thought process and methodology. It's actually a very similar methodology for leverage that's used today by S&P.

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Richard Barry Shane, JP Morgan Chase & Co, Research Division - Senior Equity Analyst [37]

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Got it. Okay, and I -- and by the way I agree with you. Look, I think this is just balance sheet geography more than anything else. I don't think it changes the ability of the company to absorb losses, but what I'm curious about is, for example, it does change the optics in terms of things like book multiple. And so in a post-CECL environment buying back stock is more dilutive to book because of the geography. I'm curious if that type of consideration influences how you think about repurchase versus dividend.

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Micah R. Conrad, OneMain Holdings, Inc. - Executive VP & CFO [38]

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I think I have to go back to the statement that we don't see CECL as changing any of the way we think about capital adequacy. And we will be including reserves in our leverage calculation. As I mentioned in the prepared remarks, we aren't a bank. Regulatory agencies don't govern our capital level. So what we need to be mindful of is the rating agencies and how they are thinking about it. We've had extensive conversations with the rating agencies about CECL. And, of course, as I've said before, while we can't speak for them directly, we are confident that they understand this is an accounting and not an economic event. And we don't expect any changes in our ratings as a result. As I mentioned, S&P sort of specifically already addresses this with the addition of general reserves. So they're already there. And as Doug mentioned as always, we are going to continue to prioritize the conservative balance sheet with prudent levels of leverage.

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Operator [39]

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Our next question comes from the line of Eric Hagen of KBW.

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Eric J. Hagen, Keefe, Bruyette, & Woods, Inc., Research Division - Analyst [40]

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I'm filling in for Sanjay today. Just a clarification on the leverage, is that the target for 6x by the end of the year? Is that coming down from 6.8 or 6.3 net of cash?

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Micah R. Conrad, OneMain Holdings, Inc. - Executive VP & CFO [41]

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Target for 6x is our reported metric. So what the 6.3 does is try to give you a little context around what the impact of prefunding for growth does to the reported leverage metric, but our 6x is based on our reported number.

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Eric J. Hagen, Keefe, Bruyette, & Woods, Inc., Research Division - Analyst [42]

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Okay. Got it. Okay. So the liquidity position really should remain strong, it's not necessarily coming down dramatically like almost a full turn? It's kind of what we are hearing, is it?

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Micah R. Conrad, OneMain Holdings, Inc. - Executive VP & CFO [43]

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We feel good about where we are. We feel comfortable with our year-end target for capital. Liquidity being a little different, we continue to enhance our liquidity, so as we increase our conduit capacity in the quarter, we do count that cash as liquidity until it's used, and also our unencumbered receivables remain strong at over $8 billion.

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Eric J. Hagen, Keefe, Bruyette, & Woods, Inc., Research Division - Analyst [44]

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Got it, okay. Great. I'm going to follow up on the funding side. Hoping you can give just a little bit more color on the feedback that you're actually getting from fixed income investors and their risk appetite to take on longer-term assets, especially just considering the stage of the cycle that we're in. I realize that your ability to price 7-year deal is probably at least largely based on the fact that the mix shift it is changing toward more secured. But in the end, I mean, do you think your ability to get that kind of deal done is really a function of the fixed income environment that we are in and the level of credit spreads? Or are you guys structuring deals differently and there is some enhancement in the deal structure that investors are drawn to?

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Micah R. Conrad, OneMain Holdings, Inc. - Executive VP & CFO [45]

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Okay. So there is no change in the structure of our deals. I mean, we certainly try to advance as much as we can out of our securitization structures and that remains strong. We haven't done anything to soften that at all. In fact, it's -- we've actually gotten more advancement lately over the past couple of years. I think the fixed income markets remain very supportive. As I mentioned earlier, a part of that is just the programs we sell. We have established a level of trust with our fixed income investors and we spent a lot of time on the road telling the story and working with our fixed income investors on what the platform means and what it can deliver. I would say they feel comfortable. The markets are supportive. I think you're seeing a lot of flows into the high-yield sector. I would probably say that those are the issuance and the appetite for risk on that side as leaning a little bit more to the BB credit. So we are in a good position there, and we're obviously, as everyone has figured out on the fixed income side, a very strong platform and one that they're interested in continuing to do. So a lot of investment in and especially on the longer terms.

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Operator [46]

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

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John J. Rowan, Janney Montgomery Scott LLC, Research Division - Director of Specialty Finance [47]

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Micah, you gave the CECL impact on the DTA. I didn't get it written down, can you just repeat that?

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Micah R. Conrad, OneMain Holdings, Inc. - Executive VP & CFO [48]

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On the DTA? The deferred tax asset? Yes, anytime you put up reserves you're going to have an offsetting deferred tax asset just due to the nature of when you can take charges against income and when you can't. So our statutory rate is around 24%. So that's what we are assuming.

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John J. Rowan, Janney Montgomery Scott LLC, Research Division - Director of Specialty Finance [49]

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Okay, and then just to be clear, the Day 1 impact for the reserve built does not go through the P&L, correct?

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Micah R. Conrad, OneMain Holdings, Inc. - Executive VP & CFO [50]

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Correct.

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John J. Rowan, Janney Montgomery Scott LLC, Research Division - Director of Specialty Finance [51]

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Okay. And then lastly, any thoughts on AB 539, whether you'll see incremental volume out of California?

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Douglas H. Shulman, OneMain Holdings, Inc. - President, CEO & Director [52]

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Yes, look, AB 539, the bill in California, that cap lending at 36% was a bill that we publicly supported. And the main reason we publicly supported is because we believe it's the right thing for our customers. We already in California and other states that did not have an interest rate cap, we already voluntarily capped our rate at 36%. So it didn't change our pricing, but we think that's a good responsible thing to do for customers. You may recall that as part of the OneMain-Springleaf merger, we sold a number of our California branches. So we have been generally under-penetrated in California. And we have been opening branches across the state over the last couple of years. So we do think there is some opportunity to gain market share, but it's too early to actually size the opportunity.

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Operator [53]

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

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Arren Saul Cyganovich, Citigroup Inc, Research Division - VP & Senior Analyst [54]

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Just touching on the comments you made about improving the customer pull-through in -- I guess, in combination with the higher growth percentage that you're having. I know you said you don't really manage the growth, but folks that have been through credit cycles when you see higher growth and your -- about customer pull-through immediately makes you a little bit worried about credit. What's -- what gives you comfort that you're not pulling through customers that maybe you shouldn't have?

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Douglas Shulman, [55]

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We are pulling through the same customers we always were. So we run -- I think we have a disciplined analytical process that we run. We continue to make adjustments based on our risk-adjusted hurdle. So we will make adjustments at the edges. Growth in our secured portfolio is a form of credit tightening because it generates lower credit losses and more stable portfolio performance over time. So we feel good that we run a portfolio of risk and return. We know this customer well. We've got world-class underwriting. More of our portfolio has been going to secured over the last couple of years. And so we monitor macro trends, our customers. We've got unique competitive advantage where we actually do polled surveys of our branch managers to see if there's anything happening in the local economy. So, as I said before, we are not targeting growth. We target running our business very well across all the drivers, whether it's marketing, the customer experience, but all of it needs to fit within our credit box. And we feel really good about that we are booking high-quality growth.

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Arren Saul Cyganovich, Citigroup Inc, Research Division - VP & Senior Analyst [56]

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Okay. That's helpful. And then maybe in terms of your employee costs, it's a very tight labor market, and I think historically there's been a decent amount of turnover in some of the industries' employee base. Are you having any challenges in terms of getting employees? Or how are you thinking about the cost of managing the business from that standpoint?

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Douglas Shulman, [57]

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Look, I think any business needs to be obsessed with its employees. It needs to be a great place to work. And all the longitudinal studies show if your employees think you are providing value to customers and they think there is career growth opportunities there and they think the company respects them and pays them a fair wage and gives them opportunity for advancement, that you have lower turnover, you attract more employees, especially we have a 10,000-employee base. So word of mouth is a big and referrals is a big part. And the studies show that you actually have happier customers who are served better in a better-run company over time. So I'm very focused on our employees, our employee value proposition. Our attrition has actually been going down in the last year because we are very focused on that. We think we pay people fairly. We think we have a great culture where people feel like we do the right thing for customers and treat them well. And we are always looking to improve our management, and they feel good about the direction of the company. So glad you asked the question. I have got a lot of passion about focusing on our employees from the senior folks all the way down to the front line folks dealing with our customers. And our attrition actually has been going down because we have been hitting on all cylinders around making sure we are a great place to work.

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Operator [58]

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Our next question comes from the line of Michael Grondahl of Northland Securities.

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Michael John Grondahl, Northland Capital Markets, Research Division - Head of Equity Research & Senior Research Analyst [59]

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Could you kind of describe your incremental marketing efforts that are kind of pushing a little bit better conversion? And maybe what you're doing with data analytics, just so we can understand those better?

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Douglas Shulman, [60]

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Sure. November 20, come to our Investor Day. We will give you a bunch more, but on a call, look, we have got a number of customer acquisition channels. We have got a big direct mail program. We work with a number affiliates and partners. We have got digital efforts. And across all of those, we are making sure that we target the right customers, meaning the customers that meet our risk-return profile, and we are getting to them. We're always running tests, inserts in our mailings, how we do banners online and what advertising we are picking up online, what's the messaging to make sure people understand our value proposition. So there is a lot of things on the outbound that we're spending time on. And analytics drives really all of that. And we have got a lot of, on us, customer data. And as we run tests, we are continually testing and learning and refining the outbound. Once someone hits us, there is a whole set of activities, whether it's on the phone, in person or them going to our website that matters. And I've talked about our streamlined loan application making sure it's easy to apply with us, that the instructions are clear, that you can pre-populate it as much as possible to making it easier on folks. And then to the point of when a customer is sitting in front of us, making sure we have very good technology to allow them to see the options, see the pricing, see how they can work with us and get through the closing process in an efficient yet extremely thorough way. So it's really each of those have analytics behind them and a set of art and science and testing that we're continually doing. That is all we have been spending time and effort on it. And as you see kind of throughout that process starting to pay off. Underpinning all of it, let me remind you is our credit box, which says whether we'll make a loan to you or not and that is not going to -- that continually gets tweaked, but we are making sure that we have high-quality loans when we book them.

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Operator [61]

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

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Henry Joseph Coffey, Wedbush Securities Inc., Research Division - MD of Equities Research [62]

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When we go all the way back -- going all the way back to CECL, is it an oversimplification to sort of say when all the dozens of inputs -- if all the dozens of inputs you have done are perfect and they freeze and they don't change, a small assumption, is the loss reserve on new loans essentially going to be 10% to 11%?

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Micah R. Conrad, OneMain Holdings, Inc. - Executive VP & CFO [63]

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Yes, I mean, what we've put out today for a range, Henry, is really the loss on the portfolio. I have not gotten into the gory details of what the ratio is for new loans versus seasoned versus delinquent, but that overall 10% to 11% is what the embedded lifetime portfolio loss estimate is. Again, given the receivables composition, the portfolio attributes, and the macroeconomic conditions at this point in time.

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Henry Joseph Coffey, Wedbush Securities Inc., Research Division - MD of Equities Research [64]

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But I mean just to be really simplistic when we run our models right now, we just have to say well if loans go up 100, then we add 10% to 11% of that number to the reserve and then back into our provision. That's the way I'm sort of thinking about it.

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Micah R. Conrad, OneMain Holdings, Inc. - Executive VP & CFO [65]

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Yes, the reason we gave you a rate of range as a ratio of receivables was to help you with some of that. So I would look at it as a ratio against the total book.

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Henry Joseph Coffey, Wedbush Securities Inc., Research Division - MD of Equities Research [66]

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And then on the competitive front, you had a big change in California, not for you, but for other parties. You've got -- the banks don't get to just say oh, it's a matter of geography. For the banks, it's a real -- CECL is a real problem whereas with you, the rating agencies have basically been using primary capital for 20 years as the basis for all this analysis. So for you that -- it's not a big change. So are there pockets of competitive opportunities, doors that are opening up either because of the change going on in states like California? And maybe you can tell us if there are any other states moving in this direction? Or on the banks/regulatory capital front where you have some obvious advantages?

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Douglas Shulman, [67]

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Yes, look, we -- I think we stack up very well against our competitors and have a very good value proposition. I told you about California. We have been opening branches there, and we're under-penetrated. So we are going to continue to do that. Hard for me to say on the banks and how it's going to adjust to what they do. I can just tell you we have, as you said, the advantage of not being a bank or not being mandated to build that regulatory capital back up over the next couple of years. And we really are just very focused on running our company based on the economics. So I would just refer back to what I said before, is we're going to provide a great value proposition to our customers with a great employee base. We are going to drive around all the places we can to make sure we bring in the customers we want to book and -- whether it's marketing, operations, making sure we keep a disciplined-type credit box. We feel really good about our prospects vis-a-vis our competitors. Some of our nonbank competitors don't have the kind of funding program and strong balance sheet that we have. So we like our positioning, and we are going to keep playing our game. We are aware of our competitors, but our plan is to keep running the good business and get good risk-adjusted returns for our shareholders.

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Henry Joseph Coffey, Wedbush Securities Inc., Research Division - MD of Equities Research [68]

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Are there any states that you can point to that didn't have some form of restriction rate cap or something that might be putting one in place over the next 12 to 18 months?

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Douglas Shulman, [69]

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Not in particular. Different state legislatures and different governors and administrations have their ideas, but California was the big one that was on the radar.

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Operator [70]

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Our next question comes from the line of Kevin Barker of Piper Jaffray.

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Kevin James Barker, Piper Jaffray Companies, Research Division - Principal & Senior Research Analyst [71]

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My question has been answered.

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Operator [72]

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And thank you, ladies and gentlemen. This does conclude today's OneMain Financial Third Quarter 2019 Earnings Conference Call. Please disconnect your lines at this time, and have a wonderful day.