goeasy Ltd. (EHMEF) Q1 2023 Earnings Call Transcript
Good morning, and thank you for standing by. Welcome to goeasy’s First Quarter 2023 Financial Results. [Operator Instructions]
I would now like to hand the conference over to your host today, Farhan Ali Khan.
Farhan Ali Khan
Thank you, operator, and good morning, everyone. My name is Farhan Ali Khan, the company’s Senior Vice President and Chief Corporate Development Officer, and thank you for joining us to discuss goeasy Ltd.’s results for the first quarter ended March 31, 2023. The news release, which was issued yesterday after the close of market, is available on GlobeNewswire and on the goeasy website.
Today, Jason Mullins, goeasy’s President and CEO, will review the results for the first quarter and provide an outlook for the business. Hal Khouri, the company’s Chief Financial Officer, will also provide an overview of our capital and liquidity position; and Jason Appel, the company’s Chief Risk Officer is also on the call. After the prepared remarks, we will then open the lines for questions from investors. Before we begin, I remind you that this conference call is open to all investors and is being webcast through the company’s investor website and supplemented by a quarterly earnings presentation. For those dialing in directly by phone, the presentation can also be found directly on our investor site.
All shareholders, analysts and portfolio managers are welcome to ask questions over the phone after management has finished the prepared remarks. The operator will poll for questions and will provide instructions at the appropriate time. Business media are welcome to listen to this call and to use management’s comments and responses to questions and any coverage. However, we would ask that they do not quote callers unless that individual has granted their consent. Today’s discussion may contain forward-looking statements. I’m not going to read the full statement, but will direct you to the caution regarding forward-looking statements included in the MD&A.
I will now turn the call over to Jason Mullins.
Thanks, Farhan. Good morning, everyone, and thank you for joining the call today.
2023 is off to a great start, driven by record first quarter loan growth, stable credit performance and record earnings. In the first quarter, we received a record number of applications for credit at $435,000, up 31% year-over-year. General consumer demand remains healthy and the broader macroeconomic conditions continue to favor those with scale. The elevated level of applications led to originations in the quarter of $616 million, up 29% over the first quarter of 2022.
Organic loan growth was a record for the first quarter of any year at $196 million, an increase of 58% over the same period last year. At quarter end, our portfolio finished at $2.99 billion, up 39% from the prior year.
Growth in the quarter was driven by strong new customer acquisition with 67% of the credit advanced in the quarter being issued to new borrowers, the highest level in over five years. Net customer growth was also up 26% year-over-year, with our core unsecured loan product continuing to produce the greatest share of lending volume in the quarter.
We also continued to expand our automotive financing program with 250 new dealerships added to our network, helping drive originations in this product up 129% year-over-year. Home equity lending continued to remain strong with originations up 35% year-over-year, and point-of-sale financing continues to scale, with originations up 36% year-over-year, led by powersports.
We are also producing great traction in earlier-stage verticals such as retail and health care, which combined produced originations at nearly three times their levels from the first quarter of last year.
We also remain committed to our strategy to reduce the overall weighted average interest rate charged to our customers, which declined to 30.2%, down from 32.7% at the end of the first quarter last year. Combined with ancillary revenue sources, the total portfolio of yield finished within our forecasted range at 35.6%. Total revenue in the quarter was a record $287 million, up 24% over the same period in 2022.
We continue to experience high credit quality loan originations at attractive risk levels. The credit scores on new originations remained consistently above 600, while the loan-to-value ratios on our home equity lending program run below 67%, inclusive of our loan, and the proportion of our portfolio now secured by hard assets exceeds 40%, up from 34% one year ago. We have been monitoring vintage-level delinquency and loss rate trends very closely and they continue to perform in line with expectations. The tight labor market has continued to keep unemployment at record low levels, providing job and income stability for our customers.
The combination of proactive credit enhancements to higher-quality loan originations, overall shift in our product mix towards secure loans and improved operational execution has contributed to strong credit performance and helped to shelter our portfolio against weakness in the economic environment. The annualized net charge-off rate in the quarter declined from the fourth quarter to 8.9%, consistent with last year. Our loan loss provision rate also reduced to 7.48% compared to 7.62% in the fourth quarter of 2022, reflecting the improved portfolio mix and loss rate performance.
Our initiatives to improve efficiency and increase productivity to produce operating leverage continue to render results. During the quarter, our efficiency ratio, specifically operating expenses as a percentage of revenue declined to 33.1%, an improvement of over 250 basis points from 35.7% in the first quarter of the prior year. We believe that we can concurrently continue to invest in the critical components of our business platform and our culture while also driving cost efficiencies in the future.
After adjusting for the nonrecurring items, we reported record adjusted operating income of $106.4 million, an increase of 23.7% over the $86 million in the first quarter of 2022. Adjusted operating margin for the first quarter was 37.1%, flat to the prior year despite the meaningful increase in loan loss provisions related to much higher loan book growth.
During the quarter, we also recognized net investment income of $2 million due to unrealized fair value changes in our strategic minority investments related to increases in Affirm Holdings and Brim Financials, partially offset by a decrease in the value of our Canada Drives investment that has now been marked down to the appropriate level.
After adjusting for these nonrecurring and unusual items on an after-tax basis, adjusted net income for the quarter was a record $52.9 million, up 15.6% from the same period of 2022, and adjusted diluted earnings per share was $3.10, up 14% from $2.72 in the first quarter of 2022. As highlighted earlier, we experienced another quarter of accelerated organic growth at $196 million or $72 million above the same quarter last year. As such, we incurred an additional loan loss provision expense related to the growth in our receivables.
At a provision rate of 7.48%, the additional $72 million in growth year-over-year resulted in approximately $0.23 of incremental provision expense on an after-tax per share basis. However, as we have clarified before, the incremental growth is highly accretive to the long-term earnings of the business.
With that, I’ll now pass it over to Hal to discuss our balance sheet and capital position before providing some comments on our outlook.
During the first quarter, we continue to make enhancements to our balance sheet to ensure we have the capital available to fund our growth plans at the lowest cost possible. During the quarter, we exercised the accordion feature of our senior secured revolving credit facility, increasing the size of facility from $270 million to $370 million, while holding pricing at Prime plus 75 basis points or Bankers’ Acceptance plus 225 basis points.
This increase further signifies confidence from our syndicate of banks that we continue to grow profitably and manage credit performance through a macroeconomic cycle. In May, we also increased our securitization facility structured by SLC Management, the institutional asset management business of Sun Life Financial Inc. by $150 million.
The facility will incur interest on advances payable at the rate of interpolated Government of Canada yield plus an initial spread of 310 basis points. The interpolated rate is determined using the remaining maturity of each loan sold into the facility and the rate remains fixed through the life of the loan.
The securitization facility complements the company’s existing $1.6 billion revolving securitization warehouse facilities and will be used for funding growth of the consumer loan portfolio. While we continue to implement interest rate swaps on draws taken on our securitization facilities, incremental draws bear a higher rate of interest today than in the recent past.
As such, at quarter end, our weighted average cost of borrowing was 5.4%, while the fully drawn weighted average cost of borrowing was 5.7%. Free cash flow from operations before the net growth in the loan portfolio in the quarter was $82.1 million, up 106% from $39.9 million in the first quarter of 2022, showcasing the growing capacity of the business to generate strong cash flows.
Based on the cash at hand at the end of the quarter and the borrowing capacity under our existing revolving credit facilities, we had approximately $917 million at total debt capacity as of March 31, 2023. With an exciting growth plan in front of us, we remain focused on continuing to diversify our sources of funding and strengthening the partnerships with our bank and lending partners. As such, we remain confident that the capacity available under our existing funding facilities, combined with our ability to raise additional debt financing is sufficient to fund our exciting updated growth forecast.
I’ll now pass it back over to Jason to talk about our outlook and new forecast.
In connection with our earnings release yesterday evening, we were pleased to publish a new three-year commercial forecast for 2023 through 2025. As we previously communicated, during the first quarter, the federal government announced its intention to reduce the maximum allowable interest rate to an annual percentage rate of 35%. While this change will unfortunately reduce access to credit, which the Canadian Lenders Association estimates could affect as many as 4.7 million Canadians, we believe it will benefit goeasy and those with scale in the long term.
Organizations with less scale, higher credit losses and higher funding costs will inevitably find it very difficult to compete within a lower rate environment. Moreover, it will prove to be incredibly challenging for new entrants, ultimately raising the barrier to entry. The net result is expected to lead to a greater share of market for goeasy, reduce the future regulatory risk, and produce a portfolio with lower APRs and credit losses, characteristics that have proven to be appealing for investors and creditors alike. After years of future-proofing the business, we are well prepared to adapt.
A key element of our strategy has been to reduce the overall weighted average interest rate charge to our customers over time, whether as a result of gradually lowering the price of credit as a reward for on-time payments or qualifying a customer for a lower-priced loan product, the weighted average interest rate charge to our borrowers has reduced from 45% five years ago to 30% today.
At the core of our strategy has been the long-term benefits of reducing pricing for consumers, which in turn provides them access to larger loans, longer terms, lowers credit risk and extends the life of our customer relationships.
As a result, only 36% of our loan portfolio is currently priced above the future unallowable rate. In response, we are deploying a suite of business initiatives designed to mitigate the impact from the reduced maximum allowable rates so that we can continue to serve as many non-prime Canadians as possible and deliver comparable results to our previous plan.
These include adjusting pricing, seeking ways to accelerate growth and productivity initiatives to increase operating efficiency, all of which are possible in a less competitive environment. In the month of April, for example, we were able to increase the average APR on consumer loans priced below 35% by approximately 200 basis points.
Together, we are confident we will continue to grow annual earnings to record levels and be better off in the future. In our new commercial forecast, we have incorporated the effect of the new lower maximum allowable rate under the assumption that it does not take effect prior to the end of this year.
Though the date remains unknown, we think this is a very reasonable assumption. We remain confident we can scale the loan portfolio to approximately $5 billion in 2025. Total portfolio yields will moderate slightly, reducing by approximately 50 basis points in 2024 and 100 basis points in 2025 when compared to our prior forecast.
With a slightly larger loan portfolio being anticipated, revenues remained similar to the last forecast despite the declining yields. In addition, we have now reduced our loan loss expectations for 2023, reducing to 8% to 10% for the full year. Then in 2025, we expect losses to further improve to a range of 7.5% to 9.5%.
We also continue to benefit from scale and operating leverage. Despite declining risk-adjusted margins, we anticipate the operating margin to gradually expand by approximately 100 basis points each year while also producing a return on equity above 21%. With a total non-prime consumer credit market of nearly $200 billion, we remain at the early stages of our growth journey in Canada.
Despite the macroeconomic conditions and pending legislative changes, we remain confident in our ability to thrive during this period. As we have proven during cycles before, our business model and our customers are highly resilient, and we have a team capable of navigating through adversity.
To achieve this forecast, we will continue to execute on the same 4-pillar strategy that has driven our business priorities since 2017, including building a wide range of products that meet all the credit needs of our customers, expanding our channel network to make it easier to find and access us, expanding our geographic reach across Canada and helping our customers improve their financial health. 2023 is already off to a great start. During the upcoming second quarter, we expect the loan portfolio to grow between $175 million and $200 million.
We expect the total yield generated on the consumer loan portfolio to remain flat at between 34.75% and 35.75% in the quarter. We also continue to expect stable credit performance with an annualized net charge-off rate of between 8.75% and 9.75% in the quarter. In closing, I want to thank the entire team for their unwavering commitment to our vision.
The 2,400 team members across goeasy are smart, hungry and humble. They care deeply about providing an exceptional experience for our customers and improving their financial health. They work tirelessly to make our organization successful and to ensure the 8.5 million non-prime Canadians have access to a trusted and reliable source of credit to finance their life. Together, we are on a mission to be the largest and best-performing non-prime consumer lender in Canada.
We are truly just getting started. With those comments complete, we will now open the call for questions.
Our first question this morning comes from Etienne Ricard with BMO Capital Markets. Your line is open. Please go ahead.
Thank you and good morning. On. So on the 35% rate cap, I’d like to get your thoughts on the longer-term implications of this change for the industry. So for loans currently priced above 35%, clearly, pricing is brought down, but expected credit losses should not change. So please correct me if I’m wrong, but if the industry wants to maintain its historical return on equity profile, there are essentially two options.
The first is stop underwriting loans that do not meet return thresholds and as a result, maybe losing customers? Or the second option is to reprice all of the non-prime loans, including those below 35%, but maybe at the risk of losing market share to competitors. So how do you anticipate the industry will adjust to this new environment and balance those two dynamics I just mentioned?
Yes, so it is a good question. So I think, first of all, I would say that in order to accommodate and adapt to the lower rate cap environment, it’s much easier done and perhaps only possible for those companies that have meaningful scale because if your cost of capital is in double digits, like where many new entrants are or where we were when we began lending, and your loss ratios are in double digits, again, also, where many new entrants, particularly in unsecured lending are and also where we were at our beginning, it makes it very difficult to operate and make a sufficient return.
Those companies like goeasy with scale, that have single-digit cost of capital and single-digit OpEx ratios relative to receivables can manage through, and through the ongoing improvements in operating leverage begin to absorb the compression in the risk-adjusted margin and still grow earnings at an attractive ROE level, which, for us, as we noted, it is 21% plus.
The net effect of all of that is that we do believe it will reduce competition in the marketplace, and there will likely be fewer number of companies able to operate and there will likely be a higher barrier to entry that reduces the number of new entrants and it will shift the market closer toward where many other industries in Canada are, which is, most of the business concentrated in the hands of a smaller number or a fewer number of companies.
So the result of that is, while the maximum allowable rate then reduces, to your point, it does expose the industry to pricing increases on the remaining subset of borrowers that are priced below because the lending industry, like the insurance industry, for example, is one in which the price charged to the pool of individuals needs to cover the associated credit losses and the cost of running the operations. So I think where the industry heads in working towards accommodating this change is frankly similar to where many other industries that are highly regulated to Canada are as well.
Understood. On operating leverage, you’ve kept your forecasts for 100 basis points of margin expansion annually. How do you think about the pace of operating expense growth over the remainder of 2023 as you work through the rate cap change?
So we are anticipating a continued gradual improvement in our efficiency ratio. You should expect to see that efficiency ratio in those OpEx expenses proportionate to revenue gradually decline.
Obviously, the OpEx dollars will continue to gradually rise in accordance with funding our growing operation, but the expense ratio will continue to slightly improve. Part of the reason for that is that the categories of lending that we have to moderate due to the rate count are the categories of lending that are typically higher yielding, higher loss but also higher OpEx ratio categories.
The remaining business that then will be growing more quickly to replace some of that velocity will come from categories where you have lower OpEx ratios. That’s why we are able to still sustain similar levels of operating margins is because although your risk-adjusted margin compresses, it’s shifting business into categories that also have lower OpEx ratios and, therefore, can still sustain similar levels of operating margins.
But you should expect a continually gradually declining efficiency ratio and gradually improving operating margins from both the shift in business and the general benefits of growth and scale.
Our next question comes from the line of Gary Ho with Desjardins Capital Markets. Your line is open. Please go ahead.
Jason, just going back to your comments in April that you’ve raised some of the products with APR below 35% by 200 basis points. So when you increase those, what did you see in the corresponding decline in, I guess, in terms of application to loans funded basis? And any other color that you can provide on that?
Yes, so very minimal. Very minimal impact on application volume or origination volume. Look, we always said that there was some level of price elasticity in this market, but it’s not an extreme level. It’s not as though small pricing adjustments translate into meaningful velocity impact. There always is for every category, for every credit segment, a point at which the pricing shifts start to produce unproductive levels of velocity reduction, but there is room before that inflection point for us.
Because the competitive environment is already coping with higher cost of capital due to rising interest rates, higher OpEx due to inflation and now layered on this regulatory matter. It already has made, gradually over the last year, the price in the market of most loans have to go up to accommodate the higher funding costs and has already resulted in less competitive tension because those companies that don’t have enough margin have had to scale back on marketing dollars and origination velocity.
Some are even struggling just to get the appropriate amount of debt capital. So that creates the capacity over time for us to be able to do some of that repricing and manage to a limited impact. So it’s like any optimization exercise that we’ve always done, which is you’re trying to find the right balance between velocity, yield and credit risk and figure out where is the ultimate sort of combination of those data points. That’s the journey we’ve been on, and we’ve got a lot of great data on the relationship between price and velocity at each customer segment level. So it’s not as though our confidence in the pricing opportunities is riddled with guesses and assumptions.
We are leaning on historical experience and data over the last six years, where we run a significant number of trials and tests to figure out what is that price and elasticity relationship in each product and each credit segment. So we know where we can toggle and adjust and find that right middle ground.
So April was really an opportunity for us to, following the change in the announcement, to make some changes to really further prove out and validate that historical history and then to be able to also share that data point so that it could help those confidence in the types of offsetting tools that we have available.
Great answer to that, and then my next question, I think in prior discussions, you mentioned they target ROA to meet your 22% ROE. I guess in the set of new three-year outlook, can you remind me what your target ROA has changed, too, just in terms of the new business that you’ll be thinking about putting on?
Yes, so if you just use the simple math, if we fund the business with 30% equity and 70% debt, the very floor would be — and you need after-tax ROAs of at least 6%. So that’s sort of the floor or the minimum hurdle rate for anything we do, is can it confidently deliver greater than 6% after-tax ROAs? Because receivables make up the majority of our assets, if you were measuring a return on average receivables, you would look for a number a little higher than that, 6.5% or 7% to account for that net income again, so half that base would be a slightly lower ROA number.
But we’re building the whole business on the basis that we need to deliver for each product, each business initiative, each investment, ROE is above 20%. That means for those investments, we need to deliver after-tax ROAs in that 6% to 7% level. Everything is built on the basis that, that becomes the minimum hurdle rate. There are inherited products that generate higher returns than others.
So you still want to prioritize and allocate capital ideally into the categories where you generate the highest ROAs, but you’re, of course, trying to balance a diversified business where you’re looking to get incremental growth from multiple categories. So you do that in tandem, but there is a minimum hurdle we use for all of our measurement of profitability at a 20% plus ROE, which will get you to a minimum after-tax ROA of 6% to 7%.
So does that 6% to 7%, did that change with the new three-year outlook given that’s the lower ROE that you’re targeting?
Not really. I mean, only on the margin, like it might move the ROA or the return on average receivables marginally because the categories that you are reducing such as the higher APR unsecured loans do have slightly higher ROAs than say, the secured lending products that are going to make up and shift and do some of the heavy lifting, but it’s marginal. Like you saw our ROE guidance went from 22% to 21%.
So that’s the kind of marginal nature that we’re talking about. That would be — and then at the ROA level, it would be an even smaller degree of change. So yes, it’s a small degree, but nothing that changes the fundamental economics of the business.
Then if I can just sneak one more in, just a numbers question. Just in terms of the corporate segment, the other operating expense of $24 million. If I remember correctly, that line used to be like $15 million to $18 million the last few quarters. Was there some onetime in there that would have skewed that higher? Then how should we think about that on a run rate looking out?
Yes, it’s Hal here. There’s definitely some onetime implications in those numbers. Particularly, we had a onetime termination fee on a contract that we had — that we had previously cited. That was roughly $1 million pre-tax. We also had some onetime adjustments to our short-term incentive plan that materialized and crystallized in Q1 in addition to, based on the performance to date, higher-than-expected incentive costs in the first quarter.
So you should see, as you look at balance of the year, certainly going into Q2 more of a normalization of that run rate cost on our corporate expense lines. As Jason had alluded to previously, with the continued growth in the overall book, we should continue to drive efficiencies on a marginal basis.
So if you back out those onetime costs and think about that corporate bucket on a go-forward basis, it’s probably more in the 2021 level versus the ’24 that has some of these one timers in there.
In the $20 million to $21 million range?
Our next question comes from Jeff Fenwick with Cormark Securities. Your line is open. Please go ahead.
Jason, I just want to talk about product mix a little bit. We’ve seen the balance of the secured loans going higher in terms of total of the portfolio. Can you just discuss a little bit of your thinking on mix here going forward and what that balance will be? Obviously, unsecured rolls off a little more quickly and allows you to, of course, adjust a bit on your underwriting as a result, but the longer — or the secure tend to be a little longer duration, which is obviously helpful for building that loan book out? Like how do you think balancing across those broad categories going forward?
Yes, I think we had previously said that in our three-year outlook that, that secured bucket would rise from the 40% to more like 50% as you get to the outer period of the last three-year cycle. I think that this regulatory shift may mean that, that number moved up a little bit. The unsecured proportion may come down a little and secured may go up a little. I don’t think it’s going to be material.
We’re not talking about it from 50% to 70%. Maybe it goes up from 50% to 55% or something along those kinds of lines. That’s because as we look at the product mix, even in the lower rate environment, a very healthy proportion is still going to come from unsecured lending. It’s likely it continues to be still our largest single product category in our business.
One of the reasons for that is that when you think about the fact that you would inevitably need to cease lending to a certain subset of borrowers, presumably on the basis that the maximum allowable rate you could charge has been reduced.
Keep in mind that because we’ve done five sequential quarterly credit tightening adjustments, many of the borrowers who were at the highest risk level within our portfolio, those high-risk customers on the margin, that would have been the ones in a regulatory change on rate cap would have had to have been adjusted for. We’ve already adjusted for different reasons because we were proactively managing the portfolio to prepare for economic headwinds.
So therefore, for us, the remaining number of customers that we now will need to reject and replace with, say, the secured loan category, we believe, is minimal. Again, only because of scale and operating leverage in a business like ours that we think the balance of the industry is probably more proportionally affected. But in our case, that we’ve already made some credit sizing that removed that customer subset. So you can expect, I think, a slightly higher level of secured lending and not a dramatic shift.
That’s helpful commentary. Then I wanted to just talk a little bit about operating leverage. I mean one of the key indicators I watch is the average loan book per store and that continues to decline pretty nicely for you. It’s over $5 million now. Can you just give us a sense of what the — what a mature store’s sort of average loan balance would look like?
Yes, so we continue to believe that those branches at maturity have average loan books around $10 million. That would be consistent with where our largest industry competitor would be. That would be consistent with where Wells Fargo, HSBC Finance and Citi Financial were prior to the 2009 exit from the market. We see well over a dozen locations well in excess of that $10 million level in our portfolio of branches already, some as high as over $15 million in loan book per branch.
So that is just, for us, the ongoing natural maturity cycle that just takes years to gradually accumulate. Keep in mind, we, of course, now have a lot of business coming from other product verticals and channels that fall outside the branch network. But that branch network will still continue to grow and mature. Over the long term, we still believe that, that average branch can double.
Great, and then maybe just one on the funding side of the equation. Obviously, good to see some life added into the mix there for you. I do get some questions about your U.S. notes. You do have — one of them will mature next year. Just remind us maybe what your options are on that front and how you might think approaching that just given there’s obviously a lot of volatility in those markets right now.
Yes, it’s Hal here. So certainly, as we look at that facility, we’ll continue to monitor the markets and would likely not wait until Q4 of next year to restructure and call those notes. So we’ll likely be calling those tail end of this year or early into next year, and we’ll continue to monitor the environment in that respect.
I think, just to add to that, we’ll sort of be in a spot where come this November — as Hal said, there’s no longer a premium to call them, which means that come this November, we have the benefit of a full 12 months to decide when it’s the right time to go to market. That means that if conditions are well, markets receptive, we can choose to exercise early or if we feel it makes sense to wait, we can.
We’ve been following them off the market closely, conversing with investors that are our previous high-yield investors in our portfolio, talking to banks. Everybody feels very good that there is a market there for goeasy to confidently make that — refine that note.
We’ll look at things like should we break it into two separate notes with different maturity levels, should we upsize or increase the note? Those are all the kinds of considerations that we’ll be thinking about when the time comes. But as Hal said, we’ll start to really turn our attention to the right strategy as we get later into this year and think about one great time to go to market.
I think, maybe just to bolt on there, Jeff. As we continue to have strength and support from our bank’s syndicate partners and the broader debt markets, I think that we’ve got options out there, I think, which is a great position to be in, in that respect. So we’ll continue to monitor the space. But certainly, we’re not — don’t have to make decisions without taking that into consideration more broadly.
Okay, great, thanks for that. I’ll requeue.
Our next question comes from Marcel McLean with TD Securities. Your line is open. Please go ahead.
I just have one more question around the regulatory change. So now that we know it is going to apply to only prospective loans. For the book that’s, I guess, call it being grandfathered in — that was probably not the right term, but you know what I mean — where you expect that to naturally roll through, so the upfront impact won’t be that material.
But, in terms of prepayments, could some of these borrowers that currently fall above that rate cap potentially find a loan from another lender and come and prepay their goeasy loan, really accelerating that runoff of the book above 35%? Or is that not the case, there’s penalties and things like that around that?
No. So that scenario is certainly possible. We, in our model have been very conservative with our expectation as to how long the runoff of that portfolio and those consumers shift to 35% is. So if that were to occur — we don’t think it will in a meaningful way. But if it were to occur, we’ve got plenty of room for that to happen without affecting our portfolio of assumptions. So we just don’t think that it’s likely to occur en masse that the consumers who borrow today above 35% will all of a sudden, post the rate cap, have this plethora of choices to go borrow at lower rates.
I think there is, again, a small number of companies that have scale, that will be able to offer some or the majority of those borrowers, loans at lower rates. But I think the choice step will be more limited, and they may not qualify for a sufficiently large enough loan. One of the things that we and other lenders are likely to do is in response to lending those customers at a lower APR is have to limit the loan size. So there may not be the capacity for them to go get a loan large enough to consolidate that prior loan as well.
So it is possible, and it will happen in some instances, but we don’t think it will be the kind of thing where you’ll have all these borrowers rushing to refinance because they just won’t qualify for the full size loan that they need. In our underlying forecast, we’ve been quite conservative with the time frame that, that book sort of runs off. So if we do see that activity in a more prevalent way, that’s more than accounted for in our portfolio runoff assumptions.
Understood. Then just curious on the proportion that’s above that right now, you said they’re still around that 36% level, but you are taking steps to minimize the impact whenever the effective date is. Just curious if you could put any numbers around that, what proportion do you think it will be if, for example, if the effective date is beginning of next year or any time period that you’re assuming here?
So maybe just — so the way to think about it is right now it’s business as usual. In the sense that the consumer set who are appropriately priced within today’s current rate cap are being priced consistently with past practice. The yield or the average rate on those customers does continue to gradually decline because that is and was our strategy all along. It was always the right strategy for the business.
So really, all we’re doing from a pricing perspective is, as noted earlier, is trying to test and understand where there is pricing opportunity on loans below 35%, which is the exact response any lender, including a major bank would do in this type of environment and with these types of constraints. So there is no material shift in the business or in its pricing.
It’s a case of business as usual until the rate cap takes effect, gradually pricing up the below 35% population as a way to offset some of the price reductions that will be experienced in the future when there’s a new lower rate cap so that we can sufficiently qualify as many customers as possible and generate appropriate and necessary levels of return.
Then our model or our forecast assumes when that date happens, there will be a gradual decline in the portfolio of customers priced above that level. If and when we choose, we will approve and extend them additional credit at the lower price level in due course. So like — and those are all what we believe are quite conservative assumptions and reasonable assumptions and most of them build off historical data in terms of how the customer responds and reacts.
Got it, and if I could sneak in one follow-up to Jeff’s question earlier where you alluded to that split of secured versus unsecured maybe moving up slightly but not materially, maybe something like 55% secured in the next three years. So within three years, that should — pretty much half of these loans that are priced above this rate cap rolled off and you’ll be fully in the new environment or pretty close to it. So just looking out five or 10 years — you mentioned earlier about optimizing the business. Is 55% secured roughly optimized? Or is that a number that would continue to trend up, really thinking longer term here, like five or 10 years?
I think it could still trend up a little bit from there, but I don’t think from that level, you’re going much more. Maybe I could see it getting to like 60% of the business. But I don’t think you get much far beyond that. If you take a look at, for example, OneMain in the U.S. market, it would be a much larger, more mature business that is similar to ours in many respects.
Their secured book is around 50% to 60%, and they have a $20 billion portfolio. So unsecured lending will still be one of the most popular products and a product that people need and rely on a term two. Although categories like home equity, powersports and automotive will still be meaningful contributors of growth, rising the proportion of secured, you’ve also got, as mentioned earlier, new verticals in their early stage of development, like retail point-of-sale and health care point of sale — those are unsecured categories.
So if they perform well, that will continue to keep the portfolio rebalanced. So yes, I think if the old world was secured but from 40% to 50%, maybe now it goes to 55%. Over the longer term, that continues to creep up slowly, but I would anticipate if you’re talking 10 years out, a 60%-40% type secured, unsecured book would not be out of the realm, give or take.
That concludes our Q&A. I would like to now turn it back to the company for closing remarks.
Great, well, thank you, everyone, for taking the time to join the call this morning. We appreciate it, and we look forward to updating you at our next quarter after we close out Q2. Have a fantastic rest of your day. Thank you.
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