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

Thanks, everybody, for joining us this morning. I have a quick disclosure to read. For important disclosures, please see Morgan Stanley research disclosure website at www.morganstanley.com/researchdisclosures. And if you have any questions, please reach out to your Morgan Stanley sales representative. With that out of the way, we are very pleased to have with us today Doug Timmerman, President of Ally Auto Finance. Doug, thanks for joining us today.

Absolutely, Betsy. Thanks for having me. Greatly appreciate it.

So Doug has been with Ally for more than 30 years, in addition to developing strategy and driving performance for Ally's Auto business. Doug is charged with leading the effort to diversify and strengthen Ally's dealer relationships and drive digital innovation.

So we're excited for the conversation we're going to have here. First, let's kick off with a question on the evolution of your auto business, Doug. Ally has been in business for over 100 years. And the business has been fundamentally transformed over the last 5 to 10. Can you share the strategic priorities that supported this evolution and what you're expecting ahead?

Yes. I would say when we think about our priorities, it's kind of a pretty simple kind of perspective. It's been a focus of focusing on our core business, focus on where we know we can win in the marketplace, obviously, focus on where we can leverage our strengths in the marketplace. And then relative to how do we optimize the business, it's really a focus around the blocking and tackling associated with the business. And then very importantly, relative to the evolution of the business, it's about partnering well, with those that are really driving the evolution of the business. So think Carvana, think large publics, the privates partnering well with them, which obviously is one of our positions in the marketplace, one of our advantages in the marketplace. Really, we think that's our best way to participate in the evolution. And then if you think about our evolution and how it's come about here most recently, I view it as kind of taking our game to balance the marketplace, leverage our independents, which we've found to be a huge asset and then be opportunistic along the way, which I think a case in point in that regard is leading towards the used segment of the business. And then relative to optimizing around the blocking and tackling of the business obviously, your relationships critically important. We've been able to grow our dealer relationships up to 19,000 dealers. We focus on application flow, so driving the throughput through those dealership relationships. We had record application flow in the first quarter. We'll have another record here in the second quarter, focusing on pricing relative to the business. So looking at those segments of the business where we can capture more originations and potentially improve our yields. We're obviously a very sophisticated underwriter as well. So the leverage of alternative data, alternative data that allows us to find those applicants that maybe previously, we wouldn't be approved because of that alternative data to be able to say, yes, to some of those applicants. And then also the alternative data leverage, allowing us to identify some applications that maybe we don't want on our balance sheet. Another area of focus is speed of decision. So the industry is obviously challenged with making the consumer experience the best it possibly can be when buying a car or truck. And so focusing on how can we speed our decisions. And so if you look at the percent of our approvals that are automated, today, 70% of our approvals are automated. So that also helps our dealers deliver on that better experience for consumers. And then the last area relative to optimization, it's the collection side of the business. I would say, if you look at the industry, probably 90% to 95% of the industry, the collection activity is via telephone. I can say that because that's where we used to be. Today, we're very diverse in our collection method. So think about communication methods relative to tax and email, push notifications, and very importantly, self-service. So it's all those things that have really helped us adapt and evolve our business and exciting thing is relative to optimization. We've made a lot of progress, but there's also a lot of opportunity for us as we go forward.

That's a great overview. Thanks, Doug. I guess just digging in a little bit, what do you think matters most to dealers and consumers? And I'm wondering, especially as you've got these emerging players in financing and on the dealer side of the equation, can you speak to what you're delivering that's differentiated?

Well, I think it's -- again, our thought is, is focus on the core business. And quite frankly, that's what's most important to our dealer customers. Obviously, the relationship aspect of the business is critically important. Many of our relationships go back multi decades. And an example of what we do differently relative to competition and towards our focus relative to application flow is we tell dealers just to send us all of their applications. We're willing to do the work. We don't want them to miss out an opportunity to sell a vehicle, and we don't want to miss out an opportunity for us to be able to originate that application. In doing that, what we also do is for those applications that don't meet our risk appetite, we pass on to other lenders. And those other lenders potentially say yes to those applications. So allows the dealer to sell a vehicle that potentially they wouldn't otherwise. And the benefit to us is obviously we build through that relationship with the dealer by helping them deliver more units, but we also generate a fee by doing so. There's a lot of examples. I think it's all the things that I talked around optimization. But I think that's a good example of something that we do different versus our competition.

Got it. Okay. I do want to touch on insurance because I think your insurance offering is a bit unique. Maybe you could give us a sense as to how important insurance is to the dealer and the consumer decisioning here.

Well, we have a full array of products and services that we offer our dealers. It's one of the differentiators that we have versus the competition, for sure. Insurance is one of those. If we had dealers on today's panel and ask them where their focus point would be, probably within the top 2 or 3 focus points for our dealers would be F&I, the F&I portion of their business. So very important part of the dealer business, which obviously is very important to us as well. We don't just offer the products and services relative to F&I., we also provide the training, we provide the consulting there. But a very important part of the dealer business. And of course, that makes it very important to us as well.

You ran insurance for many years, I believe, is that right?

Yes, indeed. Close to the heart, for sure, yes.

When we think about the progress of Ally's auto business, you've clearly demonstrated significant progress here in both operating and financial results over the past several years. And COVID, it feels like gave you an even accelerated bump up. What's your expectation from here on continuing or even improving the momentum you've been generating?

Well, we feel very good, obviously, as to how we were able to navigate the pandemic. Obviously, the industry has done very well. We feel very good about this year. But we're also very optimistic as we think 2, 3, 4, 5 years out. And again, it gets back to our optimization efforts around the blocking and tackling. There's no finish line in any of that stuff. We made great progress, but there's opportunity for us to do more. Again, we feel very good about the partnerships that we have with the players that are really leading the evolution of the auto industry. So we're very bullish about our business, very bullish about the future of the business as well.

Okay. Before we get into current auto trends, I wanted to see if you could discuss what makes auto strategically attractive. I mean, the reason I ask this question is, sometimes you get investors saying, this is cyclical business, I don't want to invest because it's not structural, but it feels like you might have a different point of view on that. What would you say to get to your point on why it's strategically attractive?

Well, I think the -- if you compare asset classes, I think auto consistently outperformed. So I think that's first and foremost. So if you go back through the cycles, auto has always outperformed. Obviously, the pandemic is another case in point. I think a lot of that is resilient to the dealer body. And we saw that resiliency during the pandemic. And I think what we've also found is the importance of the automobile to the consumer. And so I think if you tie all those things together, I think that substantiates why auto in the asset class is differentiated and much better than others.

And why do you think it's outperforming over time?

I think it gets back to the resiliency of the industry and I think that the consumers desire relative to auto and the focus point relative to their automobile relative to their needs.

So then when we think about the other question that we get frequently from investors. And I do want to remind people, if they do have a question, you can pop it into the browser in the webcast. But the other question I get is how do you think Ally -- so now that we have you in front of us we'll ask you, Doug, how do you prepare yourself for the inevitable decline in used car prices? People think it's inevitable because we're going to have supply chain normalization at some point. And as supply chains normalize, shouldn't used car prices normalize, i.e., begin to come down. So maybe you can give us a sense as to how you prepare yourself for that?

Yes. I think, again, it gets back to focusing on the core business and focusing around the blocking and tackling associated with the business. I mean, we're very fortunate. And in fact, the business is performing extremely well today. Relative to used vehicle valuations, obviously, they're at historic highs. Our perspective relative to valuations going forward is they're probably going to the trend toward normalization over extended period of time. And I think they'll follow the trend towards normalization right in line with how production starts coming back and starts to normalize. So it's not just a question of production, meeting consumer demand, we really have to get to the point where production exceeds demand, exceeds demand for extended period of time, so that inventories on dealers lots can grow to the point that there's good selection for consumers out there. So as we think about it, I think it's going to happen over an extended period of time. Obviously, as we talked about, we've given guidance, a net charge-off rate of 1.4% to 1.6%. We've thought through kind of all the scenarios relative to how things could unfold. We feel very good about that guidance. We price our business according to that guidance. And we're hopeful that we'll be able to outperform that guidance.

And that 1.4% to 1.6% is normalized over time?

That's correct, yes.

Right. Because I would expect that -- I know we're not going to talk specifically about the 2Q, but that you would be running below that at this stage, given the very strong used car prices that we've got right now.

No doubt about it. We're seeing some of the stronger trends that we've ever seen, both from a repo frequency standpoint and also from used valuations, [ you're correct ].

Okay. Let's talk a little bit about the NIM story here. The NIM story has been impressive at Ally, driven in part by the 7% plus originated yields that you were getting in auto. The question here is how is Ally generating that sustained strong yield, especially while you've been maintaining your credit profile because there's been a question as to, well, why hasn't that yield been coming down?

Yes, yes. So a great question. And obviously, consumer demand has been very strong. So obviously, that's helping. We play in what we call the belly of the curve or the prime segment of the business. So that is not quite as sensitive relative to rate as, say, the super prime segment of the business. And then it seems like I keep going back to the same point, but everything goes back to those same points of what we're doing on relative to optimizing the business. So growing the number of dealer relationships, being able to increase our throughput, our application flow, again, record in the first quarter relative to application flow, will be even better here in the second quarter. Good news is even more opportunity in that regard. All that we're continually doing on the pricing front, so testing and learning to defining those segments where we can capture at a higher rates. And also, in some cases, be able to hold more yield. Again, we're a very sophisticated lender. So the use of alternative data gives us insight as to applications that we can say yes to that previously maybe we would not have. And then very, very importantly is, again, speed of decision, the faster that we can say, yes, obviously, helps the consumer experience. It helps our dealers deliver on that consumer experience. But it also allows us to capture at a higher rate, so pushes origination flow. And at the same time, also allows us to hold more yield. So it's all of those things coming together.

Okay. So when I did highlight and remind people they could ask a question in the browser, my inbox did explode with a couple of questions, all around the same topic, but the question really has to do with the floorplan. And as you were indicating, you would expect that used car prices will normalize over a longer period of time or a reasonable -- I'm not sure exactly what you said, extended period of time? Is that...

Extended period of time, there you go.

Okay, extended period of time, as the SARs increase to not only meet current demand, but also meet sufficient demand that dealers have for floorplan. Why we got these questions in has to do with a couple of things. One, given the fast throughput that we've been seeing, do you think we return to a time when floorplan gets to pre-COVID levels? That's 1 question we got here.

Yes. I think that's a long way it's out. And again, I think if you kind of look back in time and you kind of think through what it takes in order to get to those levels. Again, you've got to have production exceeding demand, exceeding demand for an extended period of time to get to that levels. And no surprise, I mean you've heard OEMs say they're focused relative to being more disciplined, seeing the benefits of running at lower day supply. Our dealer body sees the same thing. So I think there will also be another driver that pushes inventory levels a little bit lower than maybe we had pre pandemic just because of the desire, the OEM and the dealer to have a lower, more efficient days supply. With that said, there's a lot of dealers that have big lots. And a lot of -- the advantage of the marketing effort can be selection on a dealer's lot. So if you think in a particular city, if someone has 700 cars on a lot, and someone has 50 cars on a lot, the dealer with 700 cars on the lot, is going to have an advantage in the marketplace. So you're always going to have that dynamic I think to say we'll never go back to the same-day supply as the past, I think some point in time, we'll get back there, but I think it's going to be a long, long time out.

And then can you give us a sense as to what you're seeing in floorplan right now today. There's some industry signs that suggest there's been another step function decline in floorplan recently. Is that something in line with what you've been seeing?

Yes, strong demand has definitely brought inventory levels down. So they're down from where they were in the first quarter. We think that they start to probably hit the bottoms, probably somewhere in the third quarter, is what we're saying.

And then the trend back up towards pre pandemic levels, is that extended period of time something that you would care to share a time frame on? Are we talking quarters? Are we talking months? Are we talking years?

No. I think that you'll see levels be certainly down the rest of [ this ] year, certainly down in 2022. And I think you're thinking more further into '23.

Okay, thanks. All right. Let's shift on to -- well, and then the one final question that's come up here on that. As you shift back up into 2023, the time frame you're talking about is to get back to pre pandemic level of floorplan dealers. Where do you think the [indiscernible] is in floorplan? Is that a '21 type of time frame, or you think that's into '22?

Yes, I think, again, relative to inventories getting back to pre pandemic, I think even once you get through the, call it, the production cycle where production exceeds demand for extended period of time, I think when you get to the end of that, I think you're going to see, and you're hearing it in the press, and you're seeing it in the comments from OEMs, a desire to run at lower days supply than they did before and I think the majority of the dealers. So when we get back to pre pandemic, I think it's even further out than [indiscernible].

Okay. And so I suppose one of the things you're suggesting to us is the indicator to watch really is the [ SARs ]. Is that a key indicator for us?

Yes. Obviously, that's a -- that gives you a perspective of demand and obviously sales volume. But on the other side of that, it's the production, right? So again, production has to exceed demand for an extended period of time, that's the big question. I think that's going to happen over an extended period of time. And again, that's why we think that used vehicle valuations normalize over extended period of time. [indiscernible] '22 and '23, you also have some things that are going to help support used vehicle valuations. I think you'll see less off-lease vehicles at auction than we have today. Obviously, the daily rental dynamics are going to support as well. Daily rental business is very good. OEMs have been preferencing retail over fleets, so they're getting their units later. When they do start to get units, they'll start building out their fleets to an appropriate level, something higher than what they have today. And then by the time that they get to replacing units, those units are going to have a lot of [indiscernible] on them. So those are things that are going to help support used valuations in '22 and '23 as well.

And how do you navigate all of that with your dealers?

Well, the good news is, is our dealers are very resilient. And it's -- like everything, it's focusing on individual dealer problems and strategies and seeing how we can best support them. So in some cases, dealers are looking to build out their used vehicle inventories floorplans to levels that they didn't have before. Part of how we can support them in that regard is obviously providing that additional floorplan for their needs relative to additional sales volume.

Because you've got quite a comprehensive product suite. The investors are familiar with the consumer lending and the floorplan like we just discussed. But I think there's other capabilities and products that you do offer to dealers to try to drive [indiscernible] for yourself as well as stickiness for them. Can you talk through that a little bit?

Yes. I would say that, well, there's a number of examples. So many people think of us as a retail lender. Obviously, we do a lot of -- we also do a lot of lease business. So we actually had our second best lease month in April of this year since our IPO relative to volume. We broke that number in May. So our lease business has been very good. Another area that we've been able to be opportunistic, obviously, with supply and demand being what it is. OEMs have not incentivized lease to the same degree. So that's been an opportunity for us to kind of lean in on the lease segment. We also don't just provide floorplan, we provide real estate loans, we provide working capital loans, we provide acquisition lines of products. And so when I talk about aligning to those dealers that are really leading the evolution of the business, there's acquisition lines of credit tied to those dealers that are growing and part of the either the buyer side or [ buyer-seller ] equations. And then very importantly, is our SmartAuction business. SmartAuction is a unique business that we have that others don't, allows dealers to both buy and sell vehicles and also allows us to dispose of our off-lease vehicles and repossessions, which is a very efficient way for us to dispose of those vehicles. And at the same time, it gives us a lot of market intel. So not just transaction information, but we get all the bid-ask information relative to what's happening on the auction. So that's a unique differentiator as well. And of course, our people are a big differentiator as well. Many of people with a lot of experience and again relationships that go back multi generations.

What about the digitization angle? There's been a big push into digital, as you well know, not only over the past decade, but accelerated significantly during COVID. What role does tech and data play in auto finance and in dealer finance, specifically at Ally?

[Technical Difficulty] I'm sorry, Betsy, I think [indiscernible].

Okay. So the next question here is on digitization and technology, and there's clearly been a big push into digital over the past decade and obviously accelerated significantly during COVID. So could you help us understand what role tech and data play in auto finance, and dealers -- with dealers and how you're delivering that from Ally's perspective?

Sure. Absolutely. Well, obviously, what -- we're a digital company. If you think about everything we do relative to those optimization efforts, it includes data, analytics and technology, from application flow to pricing, to the sophistication of our underwriting model, the speed of decision. And then, again, also very much a part of how we partner well with those dealers that are leading kind of the evolution of the industry. So it's very much part of everything we do. And as I mentioned, not only have we made a lot of progress, but we're really excited about the fact that there's a lot more for us to do in that regard as well.

And then just switching gears to a couple of other investor questions that's come up. One is regarding the variety of direct-to-consumer finance options that we can see out there. How are you thinking about that?

Yes. I think if you -- if we really break down the numbers relative to direct-to-consumer, actually dealers are controlling more of the [ sales ] than they did before. And so I think the trend is actually growing towards greater dealer control. And of course when we describe dealer that includes the [Technical Difficulty] a small portion of the industry. I don't see [ it as being a ] growth area of our industry.

Okay. Sorry, we lost you for about 23 seconds there. So yes, maybe you could repeat your answer, thank you.

See if I say the same thing, right, yes. I would say, actually, if you look at the direct-to-consumer segments, dealers are actually controlling more of the [ sales ] than they did previously. And of course, when we talk about dealers, we're including the Carvanas and Vrooms of the world. And dealers are also controlling more of the financing than they did before. So direct-to-consumer is a small portion of the overall industry, overall business. I think actually, dealers will continue to control more. You see a lot of investment being made by large publics in that respect, call it the Carvanas, the Vrooms. Obviously, when you look at what Sonic is doing with everything that they're doing in their segments with growing out their used car superstores and EchoParks, AutoNation with AutoNation U.S.A., so a lot of focus on used. And I think actually, what we'll find is dealer display some of that.

Okay. [Audio Gap] I want to ask you about the greening of auto and what that means for your dealers and what you can do to help them become more green.

I think everything relative to EV is exciting for the industry. It's obviously exciting to see the investments being made for the OEMs. I think a lot of the OEMs today are going to be the winner to the future. I think there's a good chance that electric vehicles also try to accelerate some of the trade cycle. So it actually could boost sales volume, which is [ a thought ] into everyone in the industry including ourselves. What we're obviously not concerned about figuring out residual values and depreciation curves. We do everything internally. We get the benefit of the third-party data, which is also part of what gives us kind of competitive advantage and opportunity to kind of be opportunistic in those segments. But we're excited about the evolution in the industry. And obviously, our ability to partner well as we demonstrated, I think it's going to be a competitive advantage for us.

One of my colleagues here at Morgan Stanley talks about a cash for clunkers type of program for e-vehicles. Is that anything that you've kind of considered or thought about?

Well, certainly, it gets a lot of buzz in the industry. Whether it actually comes about that way and who knows, obviously, that would probably most likely need to be a government initiative, but it certainly presents an interesting potentiality out there for sure.

So just shifting gears to underwriting. When we look at the senior loan officer survey, it suggests that banks are loosening standard significantly in 1Q in auto. Have you seen this from competitors? And where does Ally sit relative to how you think about the underwriting criteria, especially versus pre COVID time?

Yes. Yes. Well, I mean, I'm not sure the perspective relative to the first quarter and loosening or not, obviously most everyone made the appropriate decisions are in the pandemics and to make adjustments to their underwriting. And if you think about first quarter compared to fourth quarter, third quarter and second quarter during the pandemic, they've certainly loosened from there. Relative to how we approached it, we obviously made the appropriate adjustments during the pandemic. Once we got into the pandemic a bit, we started methodically leaning back in as we thought -- found it being prudent to do so and be also a little bit opportunistic relative to some of our competition in that regard. Today, our purchase policy is right in line with where we were pre pandemic. And I think the vast majority of lenders have kind of positioned back to the same spot to today. So...

Okay. It's interesting, right? Because consumers are sitting here with a significant amount of liquidity, how do you factor that into your underwriting? Do you give them credit for that liquidity?

Well, it's the general health of the consumer. We're not privy to how much they have in savings. But our underwriting model is obviously taking consideration -- all the credit considerations around a particular consumer. And they've certainly proven them out to be very successful along the way and relative to continuous improvement. We also get the benefit of alternative data that gives us some unique insights relative to the consumer, something that allows us, again, to help dealers sell more vehicles, in some cases, we identify consumers where there's indications that we don't want those applicants on our balance sheet as well.

Okay. But when you are underwriting, you've got kind of this expectation that in a normalized market, you would be willing to live with a 1.4% to 1.6% net charge-off ratio. And so the question we get is, how -- what are you watching as we move forward here? Because to your point, consumer debt is performing at historically phenomenal levels, right, like it's performing extremely well. And you've got that normalized credit risk in your modeling. How long do you think it is before we get to that type of net charge-off outlook?

I think that is anyone's guess. [Technical Difficulty]

I guess, the underlying [Technical Difficulty] okay. So I think we're back now. Thanks, everybody, for holding on for a minute or 2. So yes, Doug, maybe you can just highlight the answer to your question around what's the time frame here to get to the 1.4%, 1.6%?

Yes. I think it's anyone's guess, but we do think it's going to happen over an extended period of time. I think that the good news is as we kind of think through the dynamics and the health of the consumer, that our view is, there isn't a large spike in credit losses as we go forward, we'll see a normalization of credit over extended period of time. Again, outperformance today to normalization. And again, over an extended period of time is probably the best guidance I could give you.

And when used car prices do start to normalize, do you think that will translate into a spike in net charge offs?

No. I think, again, we're -- kind of the same view relative to used vehicle prices. I think that normalizes over time as well. And of course, remember, the biggest component relative to net charge-off is frequency loss versus severity. Obviously, severity is impactful, but frequency is the bigger driver. And actually, frequency is the bigger driver of what we're seeing in our results today as well.

Okay. So then just a final question here as we're looking forward, I think Ally has indicated near $40 billion in originations for 2021. Is that right? And you've got yields hovering around 7% for the fourth consecutive year, can you just give us a sense as to how long you're expecting these types of trends to persist?

Yes, well, from our perspective, we kind of take advantage of the market as it comes about. The consumer demand is very strong. So we're -- but we certainly feel good about the future in that respect. How we think about it and what we do about it is, is again focusing on our core business. But demand is strong, but we do think that [indiscernible] probably be a little bit of pressure relative to price. We think full year will be above 7% relative to yield. But feel very good about today's flow. We feel very good about the balance of the flow. And it's really going to be a function of how strong the industry stays. We're very confident in our ability to continue to get more than our fair share.

All right. Great. Well, Doug, thank you very much for joining us today. You are very happy I'm sure to be in one of the hottest growing sectors in finance right now, in particular with retail auto doing so well. And I can very much say, I'm looking forward to seeing you in-person next year at our conference.

Very good. Thanks for having me, Betsy. Much appreciated.

All right. Take care. Now we move on to...