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

Good morning, and thanks for joining us at Morgan Stanley's Virtual Financials Conference. I'm pleased to have with me Jenn LaClair, CFO of Ally Financial. Jenn, thanks for joining.

Good morning, Betsy. Thank you for having me. Terrific to be here this morning.

So I do have a quick disclosure to read. For important disclosures, please see Morgan Stanley research disclosure website at morganstanley.com/researchdisclosures. And if you have any questions, please reach out to your Morgan Stanley sales representative.

So Jenn, thanks again for joining us. Wanted to talk a little bit first off about the current environment and opening up. Can you provide some perspective on how Ally is approaching this environment today?

Sure. And thank you again, Betsy, for having me. And I hope everyone is staying healthy and safe right now. But we all know this current operating environment is unprecedented in many ways, and there really isn't a perfect playbook in managing any crisis. But we've stayed true to our values and really stayed focused on a few key areas since March that we think will serve us well in the near term as we navigate these challenging times, and eventually as we emerge from the crisis. The first is really continuing to stay laser-focused on our customers as well as our employees. From a customer perspective as the leading lender in auto and leading market position as well as being the largest digital-only bank, we think that we're really well positioned to navigate the challenges ahead. We also acted with speed and decisiveness out of the gates. We rolled out a number of comprehensive forbearance programs. We made our programs open to everybody. We acted with ease and speed and created digital interfaces that were conducive to large take rates across all of our consumer and commercial products and are just really proud of the work that we've done around supporting the consumer. And I'd say on the employee side, this has been a huge priority for us. We acted quickly to move to 100% work from home. Since then, we've seen an incredible amount of productivity, which I think is reflective of our digital model. And we're not in a hurry to move people back to the office. We're in a position where we can focus on safety. And even as some of the racial injustices and riots have emerged, we've been able to be proactive with our employees and, again, focus on their well-being, which is one of our #1 priorities right now. And then I'd say from a business perspective, we're not slowing down at all. We've been on a multiyear transformation in our servicing and collection areas, investing in technology and in talent. We've rightsized staffing levels, knowing that we're going to have a large number of accounts coming off of forbearance in Q2 and Q3. Continue to see just a terrific amount of engagement with our forbearance customers with the new digital tools and the staffing levels that we've created. And then potentially, you've seen the announcement. We just announced a partnership to be in the point-of-sale from lending -- or I mean -- sorry, home improvement sector, which we think is an added capability we're excited about. So across all of our businesses, still looking for opportunities to evolve, build capabilities and support our customers and add value to Ally. And then Betsy, I'd say last, but certainly not least, from a CFO perspective, acting smartly and decisively to protect our balance sheet and our financial performance. We entered this crisis with high levels of capital and liquidity that have only improved. As we've come through the first half of 2020, we'll hit some of the highest capital and liquidity levels we've seen in recent history here at Ally. We built prudent reserves in the first quarter. We have some of the highest reserve, [ 2% ] of the really adverse projected loss levels. And liquidity is looking terrific. We had 2 successful unsecured issuances that have preserved and built parent company liquidity. So we feel great about the strength of our balance sheet. We know we're going to have some near-term earnings headwinds hit us over the next couple of quarters, but that should be short term. We know with our focus on our customers, our employees, the loyalty we're building, the strong balance sheet that we're going to emerge from this crisis with strength, get back to growing per share metrics and expanding returns over time.

Okay. Well, that's a great intro. A lot of things in there that I think we're going to be hitting in some of the other questions. So the next theme I just wanted to talk about is a little bit on the credit and the consumer side of that. So we've heard and seen signs of improvement across consumer segments. Can you give us a sense of what you're seeing in your business?

Sure. And absolutely, we are seeing some early signs of positive customer momentum, and I'd say, in particular, in the retail auto space. I will caveat that significantly with just the warp speed of changes in the macroeconomic environment and capital markets. I mean we're seeing macroeconomics change weekly if not daily. And so I want to put a large caveat around anything I say in terms of trends that they could reverse on us fairly quickly and materially. But just starting with retail auto, if we dial back to late March, early April when we announced first quarter, as a reminder, we had seen apps and origination volume fall precipitously. We were down about 50% to 60% at that time. We have seen since then really an improvement. We kind of hit the trough. We've seen application flow actually hit last year's levels that were kind of neutral on a year-over-year basis on app flow. Originations will come in a bit under that. And we're looking at about $6 billion in retail auto originations this quarter, which, in total, will be around negative 25% to 30% from prior year and what we were expecting. But the interim month trends are definitely showing a lot of improved momentum, especially as we've come into the early part of June here. And then we talk a lot about retail and auto yields. We've been originating above 7% for several quarters. We have dipped down a bit below that as we've headed into second quarter. But definitely still performing very strongly relative to underlying benchmark movement. Where we have seen pretty material declines, Betsy, is really on the floorplan side. If you recall, early in the crisis, the plants had shut down largely across the U.S. And since then, we've seen pretty precipitous drops in terms of floorplan levels declining about $1 billion a week, in line with inventory levels across the market. And we're expecting about a $4 billion to $5 billion drop on average on floorplan and probably a $12 billion to $13 billion end-of-period drop linked quarter. So seeing some pretty precipitous sharp declines on floorplan. Obviously, that will be temporary. We do see OEMs opening back up and production ramping up and that will likely occur as we enter the last half of 2020, but are still seeing some declines there as we've headed through the back half of the second quarter here. And then just as we look across our banking products, just seeing robust activity pretty consistently across deposits. Really strong customer growth. We're flush with flows on deposits hitting daily, weekly, monthly, now quarterly records across deposits. And even in home lending, Invest, Corporate Finance, still seeing really strong activity levels and performance. And I think this environment, because we are a digital bank, I think we've got an opportunity to scale some of those newer businesses at a quicker pace than even prior to the crisis. So we're cautiously optimistic. Still a lot of things to navigate relative to this crisis.

So when we're thinking about the credit performance and reserve levels, how should we be thinking about that as we move into 2Q and the rest of the year?

Yes. Let me hit on some highlights. So I talked about the operating improvements we've made. We took strong decisive action on reserves in the first quarter. We took almost a year's worth of provision in Q1. So we do feel that we were set up with strength as we head into second quarter from a reserve perspective. Keep in mind, a couple of dynamics here. We're not seeing any credit deterioration at this time. I think the deferral program, obviously, is a help. Stimulus, unemployment, it's just too early to see any breakdowns in terms of underlying credit quality. We have seen about 10% of our forbearance population roll off of forbearance. And so far, performance has been strong. It's exceeded our expectations. And the forbearance roll off in terms of flow to loss, flow to better are actually outperforming the population that did not go into forbearance. So some green shoots there, but still, I think, a little bit too early to tell. And as we look at reserve building this quarter, there's a lot of ins and outs. We're still working through that. Certainly, macros have deteriorated a bit as we've come into second quarter. We had modeled kind of a 10% drop in unemployment. That's heading towards somewhere between 10% and 15% at this time. So there could be some reserve build relative to macro changes. But I'll remind everyone, we have not built in an underlay from stimulus or forbearance. We're seeing our asset levels drop a bit. So there are some positives in terms of those trends as well. I would say, kind of bottom line here, we're expecting provision expense to be materially lower in the second quarter relative to the first quarter.

Right. Okay. When you say the 10% of the forbearance roll off that happened over the past quarter, are you saying that your deferral rates on auto are going from 25% to 15%? Is that how I should read that? Or 25% to 23%?

Sorry. Let me clarify. Our overall take rate on deferral, Betsy, that was about 25% as we ended the first quarter. That has migrated up to about 29%. I will say new requests for deferrals have come to pretty much a screeching halt. We're at BAU levels, and we're looking to sunset new entrants into the forbearance programs this month. So that overall take rate has continued to increase. What I was referring to in that 10% is those that have started to roll out of the deferral program. So you've got those that roll in and that's the 29%. But of that 29%, we're seeing 10% that are exiting the program. We'll see about 90% exit the program as we get into the back half of second quarter -- of third quarter.

Got it. Okay. And that's because it's a 90-day forbearance period?

Yes, some. And we didn't require a level. We had some come in at 60 days, some at 90 and some at 120 -- with up to 120, but we do have some that are rolling off this quarter.

Got it. Okay. All right. No. That's helpful.

Yes. Just on the deferral program, I mean, a couple of other points that I'd make. We get that our take rates were much higher than the industry. We do think, overall, this positions our customers very well. We think what's right for our customers will ultimately be right for Ally. And as I mentioned, we've invested pretty much significantly in staffing levels as well as digital communication tools, and we're seeing really high engagement across this population. We do -- it's a high-quality segment. A vast majority have never been delinquent. A vast majority has never had an extension before. And early signs of the roll off have been positive to date.

And what about the deferrals on the dealer side? What percentage are you at now? I think you were at 73%, is that right, at the end of 1Q?

Yes. We're still around that 72-ish, 73% or so. Betsy, you're absolutely right. Yes.

Okay. What about just talking a little bit about the health of the auto dealers. Can you give us a sense as to what strong dealers are doing in this environment? And any kinds of stress you're seeing in that footprint?

Yes, I mean, a lot of moving pieces and parts. I mean the good news story here is the dealers did enter 2020 from a position of strength, still having pretty high profit margins. That being said, COVID-19 hit them very hard. Over 40 days of shut down and significantly curtailed application and origination flow, as I mentioned. Kind of late March, early April, we hit the trough. I think what's been encouraging is just the level of kind of resiliency and business model changes that have occurred across the industry. That's cost-cutting related. Obviously, with LIBOR coming down, interest expense has come down for dealers. And they've been creative in finding ways to continue to originate through COVID. You think about contactless sales strategies, concierge delivery services as people need repairs on their auto vehicles. And those that have moved quickly, the Carvanas, the Vrooms of the world are definitely in a position to continue to win and take share. And I'd say with some of the inventory pressures we're seeing, those that are positioned and used segment and have just more access to diverse revenue from a variety of different channels are the ones that are going to win in this environment. I think if we look at the largest kind of stress ahead for dealers as well as Ally is just thinking about the inventory levels and where inventory levels are going right now. We did see kind of the sharpest month-to-month contraction in inventory since 2009. We're at the lowest level since 2012. And it's a bit uncertain around when inventory levels come back, and so that could put some pressure on new car sales and -- revenue from new car sales. The flip side of that is, hopefully, it does bode well for used vehicle values and demand for used vehicles. So a lot more to play out here. I have been impressed by how resilient our dealers have been through this. We did talk about the positive momentum we're seeing overall from a demand side. We have continued to support our dealers with the forbearance program, PPP program, which we kind of became an SBA lender within 48 hours, and we were able to respond to 100% of the requests for PPP lending. So we feel great about our position with the dealers, continuing to be able to support them. We're seeing some positive trends so far. And we are impressed by how quickly they've -- many of them have navigated the crisis and been creative even in a very stressful environment.

And then those deferrals on the dealers, do they have a time frame associated with them, like the 30, 60 -- or the 60, 90, 120 of the consumer deferrals?

Yes. 60 and 90 days.

60 and 90. Okay. And then let's talk a little bit about used car prices. There's a lot of movement here, some positive trends following a steep decline. And just relative to your 5% to 6% embedded declines that you typically have and you had coming into 2020, what are you now expecting in used car prices given COVID and rental car bankruptcies, et cetera?

Yes. So the 5% to 6% we are anticipating this year was very much on the supply side if you just look at the number of off-lease vehicles coming into the market. Clearly, with COVID-19 impact, there could be both demand side pressures as well. And it's hard to say exactly where this is going to land. We've modeled out kind of another 3% to 5% potential deterioration. But again, a lot of unknowns, I think, that we're navigating. We are expecting Q2 to see the largest precipitous drop in used vehicle pricing, especially here in June. So we'll know more as we close out the quarter. I think on the positive here, we have seen auction volumes come back materially. We hit that trough early April. Auction activity was down about 70%, 75%. Now here in May and early June, it's down about 25%, 30%. So we are seeing an improvement in auction activities. Values have kind of followed the activity. So we hit a trough of negative 10% in April. It's come back about halfway here in May and continuing to see some positives here in June as well. I think from an Ally perspective, we've been just smart in mitigating some of the impacts. We've delayed repossessions. We've also had leased program extensions, which are helping to shield us from the negative impacts of the market declines that we've seen. But a lot to navigate, I'd say. Pluses and minuses here, if I were just kind of sum it up quickly. Positives are: lower new vehicle inventory could be a net positive. We are still seeing unit values have better affordability. And especially in a crisis with unemployment levels and consumer stress, affordability is going to continue to matter. We are seeing millennials and others prefer personal vehicle ownership. Even with work from home, there is a fear around mass transit. So there are some exogenous market changes that are helping to bolster used vehicle values as well. And then last but not least, I'll remind everybody, our $9 billion in leases is predominantly Chrysler. SUVs is about half. The trucks is another 1/3. And with low gas prices and with a lot of the off-fleet vehicles really in the sedan category, we think that we're still positioned well from a make-and-model perspective.

And when you say the 3% to 5% modeled potential deterioration in used car prices, is that something that's just a scenario analysis for you or is that something you would put through in 2Q?

Yes. So we'll see how actual values come through Q2, and we're expecting June to be a net loss month for us as we hit some of the trough here on used vehicle values. What we're saying is that 3% to 5% is kind of for the full year, so we could hit as high as negative 10% this year. Again, a lot of moving pieces and parts. I think there's an opportunity to outperform that, but still many unknowns at this point.

Got it. Yes. All right. I've always found you guys to be pretty conservative on your outlook for used car prices, so it's helpful to understand. What about deposits? Can we talk a little bit about the deposit trends? You're at or above your core funding target of 75%. So does that open you up to increased price flexibility here? Would you be bringing down maybe your deposit rate a little bit now that you've hit that target?

Yes. So let me provide a little bit more color here. I mentioned at the start that we are seeing really positive deposit trends, customer growth as well as flows. And I think that underscores just our model is winning in a digital environment here in a remote environment. But we hit 75% deposit funding in the first quarter. It's heading towards 80% here in second quarter, and we're about to hit 100% loan-to-deposit ratio because of the strong flows as well as the kind of the temporary decline in terms of floorplan balances. So I think consistent with the rest of the industry, just terrific deposit growth here in the second quarter. On a pricing -- from pricing perspective, we were first movers in 2019. We came down early, kind of led the market. I think we've been a bit more cautious here in 2020 just with all the uncertainties and wanting to preserve liquidity as we know our core businesses are going to come back online, and we want to continue to grow. But that being said, we absolutely think that there's further opportunity to optimize. We'll continue to balance that with the strategic focus on customer growth, wanting to continue to optimize our liability stack from a balance perspective, but we absolutely think that there's opportunity to further optimize pricing. And that will create, Betsy, a nice tailwind for us in '21 and '22 as we see NIM expanding as we get out of 2020.

Yes. As we're on the topic of NIM and NII, can you give us any thoughts as we move into 2Q on what you're expecting there?

Yes. So I talked about some dynamics, but let me just sum it up. So on NII, we are expecting it to come down here in the second quarter and for full year, and a lot of that is reflective of the lease gains I just mentioned, which pretty much hit a trough likely here in June. So that will be one dynamic. Second, the floorplan balance, as I mentioned, that's going to bring NII down. And then with rates where they are, we're seeing prepayment activity pick up, and that's going to impact kind of NII against our mortgage and MBS portfolios. NIM, I think about it kind of on a short-term and a long-term basis. NIM, short term, is going to come down because of excess liquidity, strong deposit flows, lower LIBOR rates that impact floorplan and some of our commercial balances. But over time, we should be positioned really well to see NIM expand again and NII to continue to grow as we exit 2020. So I really think about the short-term dynamics here we're navigating. Longer term, still positioned very well to grow NII and to see NIM expanding. And we always talk about our rate position being relatively neutral. If you exclude the impact from lease gains, our NIM should be fairly flat on a year-over-year basis. So that's a little color.

In 2Q?

Just on full year. If you exclude the impact from lease gains losses, we'll be flat year-over-year.

Got It. Okay. Yes, that's helpful. And then just while we're on the numbers, we had a question come in on the website just regarding how you're thinking about the loss expectation around auto. I think you're running at, what, 1.8 to 2.1 NCO outlook? Is that still hold or is there any changes there?

Yes. That still holds. As I mentioned, we think we have modeled in a good reserve that reflected that 1.8 to 2.1. And so far, we're not seeing any deviation or any credit deterioration beyond that assumption that we built and we modeled in Q1. So still sticking with that 1.8 to 2.1 full year NCOs. Now keep in mind, we're likely to see most of that in the back half of this year, in particular, in Q4, simply because we'll have about 90% of our forbearance participants rolling out of the program in August.

Got it. Yes. Okay. And then how are you thinking about just the dealer side of the forbearance piece because a question that came in over the web, you've got the high forbearance rate of 72%, 73%, but then floorplans come down a lot. So just -- is this dealers like looking for max optionality? Do you anticipate that loss trajectory to change much from what you have today? Or is there something going on in the dealers that explain why the forbearance is so high?

Yes. I think the forbearance was high just because this was a great opportunity for our commercial customers and our dealers to really benefit as we navigate a lot of the uncertainties. We have typically, in the commercial book, keep in mind that's a fully secured book, have taken a loss level of 1 to 2 basis points. And during the last great recession, we peaked at annual NCOs of 35 basis points. We built a reserve against that book of over 40 basis points and some 42, 43 basis points. So we are very well reserved for any stress that we can see in the commercial book. And then with floorplan lines coming down as well as forbearance and just the interest rate environment, the cost to the dealer has come down pretty materially, and that should put them in a position of strength as you think about their health and overall economics.

And then the other question that came in just on loan growth generally is around used cars and lending to independent used car dealers. Could you give us a sense as to whether or not Wells' decision to move away from that group is an opportunity for you or not?

Yes. At this point, we -- it could be potentially. We're not seeing it right now. We're already lending into kind of 90% of franchise dealers and a large number of independent dealers. And from what we can tell that these are fairly small independent dealers that Wells is commenting around. So potentially around the edges, but we're not seeing any kind of wholesale changes in the competitive dynamic for us.

And then just kind of last theme here is on capital and capital deployment and how you're thinking about those opportunities. And I ask because people have asked for an update on CardWorks and trying to understand whether or not the new program you announced yesterday is going to be absorbing any capital or is that kind of a capital-light opportunity. And then just rounding it home with how you think about capital post CCAR, which comes up in a few weeks for you now?

Yes. So maybe I'll hit on capital allocation and then CardWorks more broadly. But just as we're thinking about our capital position I mentioned, we entered this crisis in a position of strength. We have a CET1 target of 9%. We've consistently performed above that. And here in the second quarter, we will see some of the highest levels of capital kind of in recent history of the company, potentially eclipsing kind of 10% in CET1. So we're very well capitalized. As we see news from the Fed on the 25th, we like the construct of the SBB. It should give us some more flexibility in terms of timing of capital deployment, to be determined exactly what we learned on the 25th. But by and large, we're hopeful around the SBB giving us some more flexibility. And as we think about kind of short-term capital deployment, we did come out of the market in the first half of this year on share repurchases. We're expecting to pause buybacks for full year 2020 at this point. Just with all of the volatility, we think that's a prudent thing to do. And especially with our floorplan balances coming down and likely coming back up in the back half of this year and wanting to preserve capital for stress as well as for our consumers, we're likely going to pause buybacks in 2020. Obviously, in constant dialogue with our Board of Directors around that. But beyond that, our capital allocation strategy has not changed at all. It's first and foremost, supporting consumers in high-return products and services. We still think repurchasing shares is economical, and we want to improve our per share metrics and plan to continue to improve our per share metrics and our returns. And then we expect to continue to pay the dividend through 2020 and beyond and to have a competitive dividend. So no changes in our long-term strategy. We are rethinking kind of our buybacks for 2020 just in light of COVID, and we'll be in constant dialogue with our Board on that. And then on CardWorks, we've talked about -- CardWorks is kind of light on balance sheet, light on capital. Even if you stress CardWorks, it's a pretty de minimis impact. It's kind of some 25 basis points to our overall capital level. So we're not capital -- we don't see a lot of capital constraints around CardWorks. We're going issue to close the transaction, so we think we're well positioned for CardWorks. We're working through integration right now, waiting for Fed approval. Still really like the transaction. From a strategic perspective, this was a consumer capability gap that we had on card, and we're excited to be able to fill that gap. We like consumer value it offers, the returns and diversification. So everything is proceeding on track with CardWorks. And then, Betsy, I think your last question was just the recent announcement. I think you're getting at the home improvement partnership and the capital there will just grow as we grow balances. So it gives us an opportunity to originate. And as we originate, we'll deploy capital. It should be very, very small since we're just getting started in that -- with that partnership and that opportunity.

Okay. Well, Jenn, that rounds us out. Appreciate the time this morning. Thanks so much for joining us.

Yes. Thank you. Thank you very much. I appreciate the opportunity, Betsy. Take care.

All right. Bye.

Thanks. Bye, everybody.