Ally Financial Inc. (ALLY) Earnings Call Transcript & Summary

Good morning, everyone. Thanks for joining us. I'm Moshe Orenbuch. I cover the specialty finance sector here at Crédit Suisse. My colleagues, Susan Katzke informed me last night that I'm the only person who's actually been at all 21 of these or the 20 that actually happened. I'm not sure what that says about me, but certainly it's a little factoid for you. We're very pleased to have the management of Ally with us this morning. Jenn LaClair, the CFO. She's been CFO for just about 2 years now, I guess, this coming week. Prior to that, Jenn had spent 10 years at PNC in a number of roles, including both heading business banking at one point and also the CFO of business units. And so we've got the fireside chat format. We'll be asking some questions, and if there's time at the end, maybe we'll take some from the room.

Jenn, I guess, before we get into the real specifics, maybe could you give us some general thoughts about where you see -- where Ally is right now in your strategic direction?

Yes, sure. Thank you, Moshe, and good morning, everyone. It's a pleasure to be here and have an opportunity to share the Ally story, and I'll start first with just a view of our strategic evolution. We've really been focused on 3 main areas over the last several years. One is the customer. Continuing to create value for our customers and so our customer base has been paramount to our strategy. Second, delivering a compelling financial trajectory, and I'll talk you through some of the metrics around that. And then last but not least, executing through an outstanding culture, and this is a very big focus of our CEO down to the [ EC ] in entire company. But maybe starting first on customer, we've been playing some aggressive offense. I think most of you have probably seen our announcement just over this last week. And we've really been focused on 2 things with respect to the customers. The first is growing our customer base. You see that in every one of our businesses. We hit record across auto, insurance, deposits, Ally Home in 2019, and we want to continue that trajectory of customer growth. At the end of this year, we will have about 11 million consumer customers. We're incredibly proud of that growth, and we want to continue to have a trajectory. In addition to growing customers, we've been playing a bit of catch-up on product, platform and capabilities. If you think about Ally Financial, we are a pretty young company in the grand scheme of things and across the industry. We've been a bank for just over 10 years. And so many regards, we've had to invest in platforms. We've had to build out an approach to Ally Home, for example, and our mortgage space. It's a complicated market. We think we've landed on the right approach to mortgage. We've just acquired a point-of-sale product. We're confident in our ability to lead in that space, but it was an investment we had to make. And then just even this past week, we made probably -- well, it is our largest investment in CardWorks. We're really pleased, at this point in time, with the platform of products and services we're able to offer. We've got deposits covered with industry-leading products. We've got auto covered, insurance, mortgage, all the major asset classes. We are positioned well on the invest side. And at this point, we're pivoting from building capabilities to really harvesting, growing, scaling and growing organically. And so if I can just hit on each one of those areas maybe real quick, but if you look at our automotive space, where we are the top retail lender in both loan and lease as well as insurance, we've continued to optimize our returns in that space. In fact, our returns have improved every single year over the last 5 years, and we don't see any sign of that stopping here in 2020. Deposits, today, we are the largest online-only deposit bank. We continue to see a strong customer growth there as well as balanced growth, and we are focused now on optimization. And then in our newer products and capabilities, we're seeing those ramp up nicely as well. We had $1 billion in mortgage originations in Q4, seeing steady growth here in 2020. Ally Invest continuing to see some nice synergies across our deposit platform, and Ally Lending is off to just a terrific start here. We'll probably hit about $0.5 billion in originations in our point-of-sale product. So that's really the story around the customer, I think a very important one, and I think it's positioned us incredibly well to do -- to really generate a financial trajectory and a compelling financial story for us both revenue and earnings. And if I shift it, our second priority around really growing returns. If you look at our company over the last 5 years, we've grown EPS at a 17% CAGR. We've quadrupled our return profile. Back right before we IPO-ed, we had a 3% ROTCE. We're now at 12% to 13%. We are well on our way to get to a mid-teens and beyond. And the whole story around the customer fits in nicely in terms of creating platforms for growing revenue as well as growing returns. And so we'll continue to execute in that regard. We've got a lot of, I think, really robust opportunities for growth in 2020. We're driving positive operating leverage, something we did in 2019, accelerating here in 2020. And we don't see any signs of our financial trajectories going down at this point. And then last but not least, on culture. This is not just a tagline. It's not just something that we say we do. We actually live it every day. It's something that our CEO is very passionate about. If you look at our employee engagement scores, they're actually in the top 20 across every company that we benchmark across industries. We are leaders, by far, if you look at just financial services. And we continue to receive a lot of positive feedback across a number of different assessments. And in fact, there's a human rights campaign assessment, where we've got a perfect score on just over this last month. So we're incredibly proud of the progress we've made on culture. And so if you wrap it all up, if you focus on your customer, you can create outside value, you lead the businesses where you're focused, you deliver a compelling financial trajectory, and you do that through an industry-leading culture that you're committed to. We feel great about the future of Ally.

So it's still early in the year and you've set out kind of financial goals and talked about it a little bit, but investors are understandably concerned given the turmoil in the markets, the concerns -- talk a little bit about the -- your expected performance this year in light of what's been going on and any kind of thoughts you have about that current environment?

Yes, sure. And this is where I think Ally really stands out as a company if you look at our 2020 guidance. And I've had a lot of chance to talk about that on our fourth quarter earnings call just this last week, but the headline here is we are very much on track to deliver our 2020 guidance. In Ally stand-alone, we were guiding towards the 6% to 9% revenue growth rate driven largely by net interest margin expansion. I think we're one of the few financial services companies out there that are delivering NIM growth this year, and that's due to the kind of the nice dynamics we have on both sides of the balance sheet, and we're expecting our NIM to hit about a 15 basis point improvement over the course of this year. You had CardWorks on top of that. We're expecting NIM to hit 30-plus basis points. We'll get over 3% on our NIM this year. That's driving just outstanding revenue that, again, I think, really stands out in the industry. We're one of the few banks in this kind of volatile rate environment that's able to deliver this kind of NIM expansion and revenue growth. That is driving EPS up 10% to 15% this year. And that's not just revenue, but that's driving positive operating leverage that's been a big focus of ours. We're continuing to invest aggressively as we just talked about in our customers in growth, but we're driving revenue at a faster pace. And then on credit, not only are we focused on returns, but we're really focused on managing risk against those returns. And if you look at how we've run our auto business, we've been in that business for 100 years. We've got full spectrum servicing capabilities. We're able to very quickly identify if there's any stress in the portfolio because of the servicing capabilities we've built over decades. We continue to perform on credit. We were at -- our retail auto net charge-off rate was about 1.33% 2 years ago, 1.29% last year. We're guiding towards to 1.4% to 1.6% retail auto net charge-off ratio. The increase is largely due to just mix and seasoning of our used portfolio, well in line with our expectations there. Delinquencies will likely be up a bit, again, all within expectations. Corporate Finance segment. So if you look at that business over the 2 decades that we have really been growing, that business has generated less than 20 basis points of losses, and that's positioned well -- us well. So everything is really coming in line. You think about top line growth, industry-leading, driven by NIM expansion, positive operating leverage, strong credit risk management. We're incredibly well positioned across the company.

You mentioned this 15 basis points improvement in Ally stand-alone, and you also mentioned that it's being driven by both sides of the balance sheet. So maybe you could just spend a moment on that because I think that one of the things that's been most interesting through the portion of the cycle where rates are going up is that lots of financial companies didn't quite have the asset sensitivity that they were -- that was advertised. And yet you were able to maintain your auto yields and, at the same time, you've been a leader driving the deposit costs down. So as you look at that into a potentially even lower rate environment, can you talk about -- through that and...

Yes, sure. And I appreciate those nice comments, Moshe. I mean we are incredibly proud of the way in which we've managed pricing dynamics on both sides of the balance sheet as well as manage interest rate risk at Ally. And there's lot of skepticism as rates were rising, "Are you going to be able to grow revenue?" We grow revenue every single year as rates were rising. And now as rates are falling, we are also positioned to grow revenue, which is very unique in the industry. And it's driven in large part because of the position that we have in our retail auto segment. We are, as I mentioned, leaders in this space. We've been able to continue to put price in the market. We're going on our eighth consecutive quarter of putting new origination yields in the market over 7%. If you think about our book last year, our retail auto origination portfolio was at 6 -- our retail auto portfolio was at 6.60%. We ended the year at 6.68%. As we continue to put new originations on the books over 7%, you just naturally have this migration up from a yield perspective, and that's irrespective of the rate environment. It's largely built into our run rate, and we're just hitting a roll forward on that, so a low execution risk. And then on the liability side, we just had a tremendous story growing deposits, and then we've hit records every single year. Last year, we grew over $16 billion in deposits. We grew our customer base over 20%. And as we've grown deposits, we've been able to take down the overall cost of funds of the company. In fact, over the last 10 years, we've reduced cost of funds by 1 percentage point. Now as rates are falling, that gives us an opportunity to optimize within the deposit business. Last year, at this time, our retail deposits were at 2.20%. Right now, they're at 1.60%. And so you think of that go forward on the cost of funds side, it's largely driving that NIM expansion. And then I also mentioned we've got high-cost unsecured debt that's rolling down. We've got a pretty big maturity coming up at the end of March at a coupon of 8%. And so if you think about that coming down, the nice tailwinds you get from a cost of funds perspective. I do want to remind everybody that while we've got this great guidance, we've got all this NIM trajectory, it's not always on a linear path, and some of this is lumpy and back-end loaded. If you think about the first couple of quarters of the year, we will see less growth than we'll have back half of the year, so that's something to keep in mind. And then just if I could mention one more thing with respect to the volatile interest rate that are occurring last year and this year as well. Because of the hedging activities and the foreign -- kind of sophisticated balance sheet management we've had across Ally, we are still positioned fairly neutral from an interest rate shock position, so the ups and downs 100 basis point shock really only generates about a 1% to 2% impact on our net interest income annually. So great position to grow revenue as well as to manage risk across our balance sheet.

Let's move to the acquisition of CardWorks, as you mentioned, the largest investment that the company has made. It's -- obviously, investors had a strong reaction. Maybe could you talk through both why this was the right deal for Ally, why it the right deal now? And kind of help us understand your strategic thinking behind it.

Yes, sure. I'll go back to maybe how we started, which is our strategic priorities around customers, financial returns; and related to financial returns, a focus on long-term shareholder value. But if you look at the CardWorks platform, that allowed us to enter a very critical consumer asset class, credit card. This is a capability that we've been interested in for years, and our CEO has been pretty vocal in terms of wanting to have an unsecured product. And we had an incredibly robust search process around all the different opportunities in the marketplace to acquire or to partner around credit card. And after an extensive and exhaustive kind of set of analysis, we've identified CardWorks as the best opportunity for Ally. What it gives us, it rounds out our platform. It's an incredibly high-return business. If you think about it bringing CardWorks into Ally, it generates a 40-plus percent ROTCE. We don't have anything within the 4 walls of Ally that can generate that kind of return. We have tremendous confidence in the management team. This is a business that was built starting with servicing. They understand credit risk management. They understand how to win through cycles, and they understand how to generate consistent ROA and ROTCE. And in that regard, we thought that this was a really great opportunity for us. A couple of things. So the, "Why now?" So the question that we ask ourselves and that you've also asked us is, "Why would you buy kind of at the peak of the market?" And the short answer is, that's when this company became available, right? You have to be opportunistic. You can't just say, "Okay, well, I'm going to wait until this happens, and I can get it at a discount." And if anyone thinks he can buy a company like CardWorks in a crisis, that is an absolute fallacy. Well-run companies do not sell their companies at 0x multiple, right? They're going in to play through a cycle, be successful for a -- through a cycle and wait till they can get a multiple that reflects the quality of the platform they have, the quality of the management team that they have. The cultural alignment is something that cannot be underestimated here. Don Berman, the CEO of CardWorks; our CEO have known each other for a long time. They have a shared vision around how these 2 companies can come together and really generate something that's unique and special. We think the non-prime market is a terrific market. It's underserved. These are customers who need liquidity, they need access to credit. There's not a lot of players who can do this well. If you can believe they've got NPS scores that are in the 60s, very hard to find that in any asset class in any customer segment in the industry. And so you combine a consumer market that -- where we think and we know we can win with a company that's been built over decades that have strong risk management and you modernize that with the digital platform at Ally. We think there's just a terrific opportunity to grow this together as a combined company. But I do want to say we get the dilution. We are not changing our capital allocation strategy. We are still very much interested in per share metrics. Book value per share is important to us. If you look at since 2016 until today, we've repurchased almost 1/4 of our company, right? We get distributing capital to shareholders. We've actually delivered $3.8 billion or so in capital over the last couple of years to our shareholders. That is absolutely front and center from a capital allocation strategy, but we have to balance our desire to grow strategically, invest in our consumers, our desire to have a long-term robust financial trajectory that's not just about buybacks; it's about revenue, and it's about earnings. And I'm confident that we will get to the per share metrics over time.

I understand that it's an attractive business to add, and they are a leader in the space. And during the call, talking about this, you didn't really want to go too far in terms of thinking about how broad it could impact and help Ally's customer base in the future. But maybe you could just talk a little bit about that, not in 2021, but in years out. I mean do you see this as a way to kind of complement and add to the growth of what would then be your current portfolio?

Yes. And you're asking about overall Ally. But if I can just reiterate one thing that I think is really important is we are investing in products and services and markets where we think we can lead, okay? So we -- so CardWorks today is in non-prime. We see that there's tremendous opportunity in that space to continue to grow. And you couple what they've built from a credit risk management perspective and a platform with our ability to leverage our brand, leverage our digital capabilities, we think that, that in and of itself is a very compelling opportunity for us. Second, on the broader opportunities. We'll have 11 million customers at the end of this year. We absolutely think that there's an opportunity to leverage our core competency in prime lending. Our average FICO on the auto side's about 690. The average FICO inside CardWorks is 630. We understand the prime customer segment, and we absolutely think that there's an opportunity. And it's much easier, quite frankly, to go upmarket than going downmarket in this space. And so we'll continue to look at those opportunities and didn't want the deal economics to be dependent on it because, quite frankly, we've got some more work to do to really build out the capabilities outside of the current kind of credit box at CardWorks, but we absolutely think that there's an opportunity there. Now keep in mind, we've got data that suggests that typical bank cross-sell rates are in the 20%, even over 30%. Ally today is that 1%. But we don't need heroic improvements in cross-sell. They have an incredibly meaningful opportunity ahead. And if you think about each area where we're delivering exceptional customer value, whether that's our retail auto loan at least, our insurance products, which we -- which are our top of the market, this is a $1 billion business. In insurance, we have our savings and checking opportunities. We have, on the deposit side, combined with the unique capabilities we're building out in every one of our consumer markets. Again, we're not looking for heroic growth opportunity, but we absolutely think we can close the gap from 1% to a number in the 20% to 30%. And this is just the unique opportunity we have because we are a relatively new bank and a younger bank, and it's just going to get to the next stage in our evolution to take advantage of those organic growth opportunities.

Okay. Jenn, you'd mentioned that you expect it to still continue to deliver efficiency improvement in 2020. If you could talk a little bit about the steps you're taking, what's happening on the expense front? Where, within that, are you spending more money and where are you able to kind of find those efficiencies?

Sure. So at Ally, we don't have specific expense targets. We do, however, align around generating positive operating leverage. And if I can just share a little bit of our history on efficiency ratio, we -- pre-IPO, we were at a 60% efficiency ratio. We dropped that down to 50%. We've been running about the mid-40s. And with the positive operating leverage that we have, Ally stand-alone is looking to take that down another 1% or 2%. And then you add CardWorks, which is a 30% efficiency ratio business, we're going to get down into the low 40%. So I just want to share that as kind of a bit of a backdrop. We know how to drive positive operating leverage, and that is absolutely in our line of sight. Now we still want to invest in our business, and we talk about some of the platform builds, but in addition to that, building out our leading brand. We've added some sponsorships over the last 2 years that have been very meaningful for us. We're continuing to invest in technology, and that's our digital capabilities, but it's also shoring up our infrastructure and cybersecurity. In the fourth quarter earnings call, I talked about our new auto servicing platform, which was a pretty sizable investment that we've made to really shore up our operational capabilities, and we'll continue to invest in that business as well. But the headline here is really driving positive operating leverage. I will mention just on the noninterest expense line item. Our insurance business, which we've continued to grow, we hit a record in 2019 in terms of written premium and earned premium. Keep in mind, we adjust that out of our efficiency ratio, but there's a pretty sizable increase in expenses as we scale that business from dealer margin as well as dealer commissions. And about 1/3 of that 5% growth that we had in 2019 expenses came from our insurance business. And again, in 2020, as we scale up that business, we'll see about 30% to 40% of our expense growth coming from the insurance segment. And then one other unique item we've got in 2020 is we purchased HCS in the third quarter of 2019. As that business rolls forward to a full run rate, we do have a little bit of expense increase in the first half of 2020, simply a reflection of that investment. And because that is also growing from a revenue perspective, it's largely offset in revenue.

You mentioned HCS. And I think you mentioned before a target of $0.5 billion of originations. Can you talk a little bit about what verticals you're seeing that there's potential to enter like talk through how you see the expansion of that business in 2020?