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

All right, if everyone can get seated. Up next, we are excited to have Ally Financial joining us once again. Ally has continued to execute on its strategy of being a leading direct bank and has done a good job managing through the most rapid rate rising cycle in 40 years. It's leveraged its leading position in the auto market to put significant price into the market and should be well positioned to see significant return improvement over the next few years. Please join me in welcoming Ally's new CFO, Russ Hutchinson, someone who may be new to many of you, but is certainly not new to me as we were colleagues at our firm for many years. Today's presentation is going to be a fireside chat. Welcome, Russ.

Great. Thanks, Ryan. It's great to be here, and thanks for having me. It's great to be back at Goldman.

It's probably our first conversation with no chaperone in 15 years.

Yes.

So maybe to kick it off for us, just starting high level. You've been in your seat at Ally for almost 6 months. Can you maybe just walk us through what your top priorities are as the newly appointed CFO?

Yes, sure. Absolutely. First, I'd say, having spent the last 6 months with a number of our business leaders, yes, I'm just delighted by the momentum I'm seeing across all of our businesses. I think I'm focused on exactly kind of what you'd expect based on our prior discussions. Just very focused on the core franchises, the scale franchises across auto finance, across our retail bank, our corporate finance business. The customer obsession at Ally, as everyone knows, runs very deep, and we're just focused on delivering for our customers and kind of really using the scale and the value of those franchises to drive the NIM expansion story that we've talked about extensively. We're also, as you would expect, very focused on managing credit and analyzing credit across all of our businesses and across the various vintages that we're looking at. You've seen we've taken some very proactive actions around expense management, and we continue to be laser-focused on delivering our promise to get to 1% controllable expense growth, 2% overall expense growth over the course of 2024. And again, as we've talked about before, we're very focused on capital optimization. We're in an environment where capital is a scarce commodity, and we are managing it dearly, really optimizing for the best returns across our businesses.

Great. So Ally has transformed both sides of the balance sheet over the years with the optimization of the Dealer Financial Services business and as well as the growth of the deposit franchise. More recently, you've been focused in growth in your highest returning businesses. Can you maybe just discuss expectations for growth across each of your major asset classes?

Yes. Great. I think that's an excellent question. I think, overall, yes, we expect a balance sheet that is kind of flattish over the next couple of years. But within that, there are a lot of moving parts. Within the auto business, we continue to see kind of modest increase in retail auto assets, continued normalization of dealer floor plan as dealer inventory levels recover from the pandemic lows, offset by lease where we continue to see kind of declines in the size of our lease asset portfolio, translating into kind of flattish to modestly up asset portfolio on the asset -- on the auto side overall. As many of you know, we've taken curtailment actions across our unsecured lending book. And so growth there has moderated. We've got steady but moderated growth across Corporate Finance. And then when you kind of turn to our mortgage portfolio and our investment portfolio, we're really not reinvesting in those businesses. And so those assets just kind of continue to decline over time. We've also taken our cash balances down slightly from the elevated levels we saw during the bank volatility earlier this year. And so overall, it translates into kind of a roughly flattish balance sheet over the course of the near term.

So maybe digging into auto, where Ally has managed to maintain strong marginal returns while shifting up the credit spectrum over the last couple of quarters. Can you maybe just talk about what you are seeing in the marketplace and your strategy to continue to generate attractive risk-adjusted returns?

Yes. Well, first of all, I would say the competitive environment continues to be favorable. Given how dear capital is across the industry, a number of our competitors have either pulled back or, in many cases, pulled out entirely. And by the way, we think this favorable competitive environment that we're in is probably has some durability to it, in that, certainly for people who have pulled out entirely, it's hard getting back in. And we've really taken this opportunity to deepen the moat around our businesses to really deepen our dealer relationships because I do think that dealers pay attention to providers who are there and they're consistently -- and delivering for them. And so I think the competitive environment will continue to be favorable. We go to our dealers, and our priority is to help them sell more cars. And that's how we've organized our businesses. We encourage them to send us all of their applications. And having done that, I think our application volumes are at highs. They're up significantly year-over-year. And that's allowed us to be really selective around both credit and pricing. And so we've simultaneously, as you pointed out, moved up in pricing and also up in credit. We've really taken advantage of the competitive environment to capture more volume within what we call the S Tier, our highest credit quality tier, which is an area historically where we haven't liked the pricing and the return levels. But given where we are and what we've been able to do on pricing, we like it now, we like it today. And so I'd say we expect this competitive environment to persist, and so we expect that to continue to be a tailwind for us in terms of our originated yield levels. And I'd say where we sit today, where we've got north of 40% of our originations in the S Tier, that is elevated relative to history, right? If you looked at us historically pre-pandemic, we're at more like 25% to 30% in that S Tier. And so that gives us an extra lever, extra flexibility as we watch how the environment evolves, as we watch credit within our own portfolio and across the industry. It gives us flexibility to be able to move, to manage our yield on a risk-adjusted basis and to really optimize across the portfolio. That gives us a lot of comfort in our ability to continue to operate at the yields that we're seeing today.

You mentioned it gives the ability to optimize. So I think for the year, we're targeting about $40 billion of originations, which is down where you ran the last 2 years. You talked about over 40% in the S Tier. Maybe just talk about are you further tightening underwriting at this point? Or is it more just about where the opportunity set is? And how is the dialogue with dealers evolving given your focus on optimizing returns and improving capital?

Yes. So maybe I'll start with the first question on further tightening. Look, I think our credit mix for the fourth quarter will come up very much in line with what you saw in the third quarter. Marginally, there have been actions on the pricing side kind of within our micro segments. But in general, I think it's very much consistent. So I don't anticipate any significant changes in our credit outlook certainly this quarter or next or in the near term. But I did want to point to that flexibility we have over the medium term to kind of manage where we play in the credit spectrum in order to optimize yield on a risk-adjusted basis. I think that's an important lever that we have and certainly gives us a lot of confidence in being able to run at these kind of higher-yielding levels for a while.

Makes sense. So we've seen pricing in the auto market improve a ton, and it's led to even pricing loans for a couple of quarters well above 10%. Maybe just talk about your ability to price loans at these levels above 10%. How do you think about mix dynamics? We already talked about moving up into the S Tier. How do you see that moving over the next several quarters? And how should we think about your ability to sustain price once the Fed does inevitably start bringing down rate as forward curves are indicating?

Yes. Look, as I said before, though, I think the changes in the competitive environment, there's some durability to it. People who have exited entirely, certainly, I think will have a tough time getting in. I think we have taken advantage of this opportunity to really deepen our relationships with the dealers. And so I think all of that is helpful to us. But I think it's also important to point out that we do have this lever in terms of we've moved up in credit. We have the ability to normalize our mix gradually over time to the extent we see the opportunity to do that. The way we've positioned our business with dealers where we're getting all of their apps, I think that positions us really well. I think we've got a much broader and better data set that we can draw upon now as we look at where in the credit spectrum we want to play in order to optimize the yield for the risk that we're taking across different economic environment. So I think we're positioned well in terms of being able to maintain -- be able to maintain the yields at these 10%-plus levels. You asked the question earlier about the dealer relationships. I think -- I'm still relatively new at Ally, and I'd say I've just been interacting with dealers at various events. I'd say every dealer event I go to, the dealers still feel compelled to come up to me and tell me their Ally story. And the story is usually about how Ally served their parents or their grandparents, how Ally was there for them whether it was through the pandemic or through the financial crisis, how Ally helped them grow their businesses at very key times. The importance of that dealer relationship, I mean that's -- it's a big deal and it's a real competitive environment for us. And I do think the dealers pay attention to who's there to support their businesses through various economic environments, and Ally has consistently been there. And I think that's important. And dealer after dealer has told me that. I'd also say just the way that we position ourselves in terms of really helping dealers build their businesses, encouraging them to send us all their applications, making sure that we're there for them, that extends across how we run the business. We often talk about our model as being both high technology and high touch. On the technology side, we use it to get to about a 70% approval rate on applications. That means those applications are auto-approved almost instantaneously. So it's just a really quick response time. On the remaining applications, our underwriters are willing to get on the phone with our dealers and help them get their customers into the right car and get them a successful transaction. I think that's really important to our dealers, and it's a big differentiator in terms of how we approach the business versus others. We really position ourselves as the dealers' partner to help them grow their businesses. And I think that's important.

Absolutely. Maybe switching to the liability side of the balance sheet, it looks like we are getting closer to the end of the tightening cycle. Your cumulative beta seems to be tracking in line to slightly better than peers. Maybe to just kind of think about the road ahead, if we were to be in a period where the Fed is on hold, what are your expectations for deposit pricing? And second, once the Fed does start to ease, forward curve is pricing in, 3 cuts, it was as many as 4 or 5 a couple of days ago, how aggressively do you think you can reduce price? And what are the factors that you think will drive it?

Yes. No, it's a great question. And as you can imagine, it's a tremendous amount of focus within Ally around how we price our deposit product and how we think about our interest rates. I guess, first, I'd say in a steady rate environment, we're watching our deposit flows on a daily basis. We're watching what competitors do, including 1 competitor who moved as recently as this morning. So we're watching all that carefully. I wouldn't rule out another increase in our deposit rate, but I do think -- to your point, I do think that we are either at the end or near the end in terms of increases in deposit pricing. I'd say I've been delighted by the way that our franchise has performed both through the rising rate environment in terms of being very much kind of on track in terms of our deposit beta, but then also just through the overall kind of bank volatility that we saw earlier this year. We're on track to add a record number of customers to our franchise. And we've done that in an environment where we're not the highest payer in terms of deposit rates. And I think a big part of that is just the level of customer engagement we see across our platform. We deliver to our customers an attractive rate, a rate that's very competitive in the market, but it's not the highest. And we pair that with a value proposition that includes really just a top-tier technology interface, incredible customer service and just a variety of products to help people engage, whether it's our spend or checking product or whether it's our savings toolkits, the ease of which people can work with our Ally Invest platform versus our deposit platform, our credit cards, our mortgage, which are very much geared towards our deposit customer. And we see real engagement. We've got now about a million customers in our checking or spend product. We got about a million customers who interact with us across our savings toolkits through direct deposit in our Ally Invest platforms. We see real benefits, and it pays in terms of when you look at the types of customers we're attracting. If you take a customer who has both a deposit account and an Ally Invest account, they typically have 2x the average balance with us versus a customer who's just a deposit customer. So we think they're real benefits, and we think the value proposition that we have surrounding our rate is one of the things that's allowed us to continue to grow our franchise in terms of customers and in terms of deposit balances, even while the industry overall has seen, in general, more of a net outflow of deposits. So we think that's important. But again, to summarize, I wouldn't rule out another increase to our pricing, but we're watching it carefully, and we'll be responsive to the competitive environment.

So piercing together both sides of the balance sheet, how do you think about the trajectory of Ally's NIM over 2024? When does it drop? When can we expect to see this 4% NIM? And maybe if we assume no change in rates, how does it accelerate if the Fed does cut, which is what the forward curve seems to be indicating?

Yes. I think great question. Yes, I think previously, we've said we expect our NIM to trough, call it, 2 quarters following the Fed stopping on increasing rates. So I think we're kind of there or close to there in terms of when you kind of see what our fourth quarter NIM looks like. And I think we're poised for expansion early next year. We've talked about a 5 to 10 basis point kind of quarter-over-quarter rate of expansion. I think that's still our best view. And I think kind of looking at the math that gets you kind of end of 2025, exiting 2025 around the 4% NIM area. As you pointed out, to the extent that we see the Fed cutting -- and by the way, markets are volatile, this is -- the last couple of weeks have been great, but they're volatile. And to the extent you see the Fed cutting, that could accelerate that path to the 4% NIM. But again, we're not banking on that. The passive rates to us affects the timing, but it doesn't change the destination in terms of a 4% NIM and a mid-teens ROE for the company.

So sticking with the revenue side of the equation, you guys have been talking about a $500 million other revenue run rate when it comes to some of the growth-oriented businesses. Can you maybe just talk about the key drivers and what areas do you expect higher growth from here?

Yes. Another great question. Let's -- maybe I'll focus primarily on the auto side of the house. We continue to grow our insurance business. We have 22,000 dealer relationships, probably only about 10,000 of them are engaged with us through the F&I office for our insurance product. Yes, we think there's a lot of opportunity for us to deepen that penetration and ultimately increase our insurance premium volume and drive more revenue through the other revenue line. We've also been continuing to grow our SmartAuction product. We've added a white label partner, and our expectation is that our smart label volume and revenue will continue to increase. You've also seen us active through our pass-through programs, where it allows us to face our dealers and to speak for volume that we wouldn't -- that wouldn't necessarily meet the underwriting that we use to put on our balance sheet. We love that product. It allows us to serve the dealers and to serve their customers. It also provides a fee stream for us that is also important. And also gives us a look at credit in terms of servicing and performance that we wouldn't otherwise get a look at. So that part of it is important, and that continues to grow as well. So we've got a few different engines of growth on the other revenue side. And as you pointed out, we expect to be just about $500 million for this quarter, and I think that we expect to continue to grow that going forward.

Maybe let's turn to credit, which continues to be a focal point for investors given the backdrop. I know there'll be some puts and takes, but how are you thinking about 2024 losses relative to '23? We're looking ahead, we haven't even gone through '23 yet. But how are you thinking about that? And what do you see as the key drivers for Ally in terms of loss progression?

That is -- I love how you put that. You're talking about '24, we haven't even finished '23 yet. But maybe I'll start with '23 because that is an area where we've previously given guidance. We've talked about 2023 getting to 1.8%. I think we're very much -- continue to be very much on track for that. For the quarter, we've talked about 2.2% to 2.4% for fourth quarter, very much on track to be there. So we feel great about retail auto credit for the fourth quarter and for the guidance that we've provided for the full year. There are both headwinds and tailwinds as we think about retail auto credit going forward. And maybe I'll start with the tailwinds. As you know, we've been analyzing on a vintage-by-vintage and micro segment basis for quite some time now, kind of really digging in on our credit. We've put in place a lot of curtailment through the course of 2023 in response to what we were seeing through some of the 2022 vintages. We see very encouraging signs there. We have continued to see encouraging signs in terms of how the 2023 vintages have been performing. And so we feel great about that. 2022, those vintages, delinquency and loss levels, as everyone knows, have been elevated. That being said, we've seen encouraging signs in terms of how those vintages have performed as they season. And we continue to see that encouragement. And so both of those things, in our view, are tailwinds going into 2024. On the other side of it, our expectation is that unemployment is increasing. We assume unemployment going to 4.4% next year. When you look at how we set our reserves, we assume a reversion to mean of just about 6%. And so unemployment will be what it will be. Also, when you just think about kind of vintages and where they are from a timing perspective, those vintages in the second half of 2022, where we've seen elevated delinquencies, those are going to hit their peak loss periods in the first half of 2024. And so when I think about the inventory of headwinds on the credit side for retail auto, one is just that vintage dynamic, which will hit us in the first half of 2024 and then rising unemployment. And so those -- you have those kind of balancing against some of the tailwinds that I mentioned earlier. I think we'll come back with kind of more precise views on retail auto credit going forward when we report fourth quarter, so call it, mid-January.

Awesome. Maybe a follow-up on credit. So we've seen losses for the company go from 1.3%, 1.4% pre-pandemic to about 1.8%. Can you maybe just talk about what has driven that? Obviously, there's been a lot of shifts within the portfolio. And second, as we think about the risk of a downturn, I get asked this question a lot still. How should investors think about credit performance if we do see an economic downturn, a big slowdown or a modest recession?

Yes. So you point to the 1.3%, 1.4%. I would characterize that the losses that we saw at that level as being kind of below what we would have expected at the time of origination. And obviously, at kind of the 1.8% level, it's above the losses we would have expected at origination. And so the answer in terms of where we kind of underwrite to on a regular basis would be kind of between those 2, right? And so we certainly expect to see that normalization of credit performance certainly over the medium term. As I said, we've got some headwinds that will hit us in the first half of '24, but we should see improvement towards kind of a more normalized level after that. As you think about a slowdown, we agree. And we certainly -- as we underwrite, as we look at our models, as we look at our reserves, as I pointed out, we've anticipated some degree of slowdown in terms of unemployment picking up another 50 basis points on top of the 50 basis points that we've seen. And in our reserves, we assume a reversion to mean. Yes, look, the change in unemployment has historically been a meaningful driver of credit. And so to the extent that we saw unemployment or economic slowdown, that was certainly kind of beyond that. That would certainly impact us from a credit perspective. All that being said, we obviously managed our portfolio on a dynamic basis. We've executed a migration of credit over the course of 2023. And I think the way our franchise is positioned with dealers really gives us a lot of both visibility into credit, but then also optionality in terms of how we manage the portfolio on a risk-adjusted basis. So we can really target those parts of the credit spectrum that make the most sense for us and deliver the best returns to our shareholders.

Maybe just to round out the discussion on credit. Maybe talk about credit expectations in some of your other portfolios, card, Ally Lending, what you've been seeing there, corporate finance, which I know is a very good return business, but has had some lumpy credits over the course of '23.

Yes. No, that's -- I'm glad you went there. Maybe I'll start with Corporate Finance. As you pointed out, the business is lumpy from a credit perspective, just by virtue of the nature of the large loans that it tends to make. Performance of that business across multiple business cycles has been fantastic. I think we continue to be impressed by the performance of the business. All that being said, fourth quarter is going to have some noise in it with Corporate Finance. I'd say, number one, we're going to take some NCOs that we've already reserved for on a couple of credits. They're largely reserved for, so it's not a significant impact on P&L. But at the same time, we're also going to increase provisions on some loans that are already in nonaccrual status. And so that will actually run through the P&L. So you'll see an uptick in provisions on a linked-quarter basis within that business. All that being said, we're not putting any new loans for the nonaccrual status. And yes, when we look at our overall level of nonaccrual loans in that business, it's less than 1%. It's pretty much near record lows. Criticized assets are about half of what they are in a normal environment. And so we feel fantastic about that credit book on a go-forward basis, but we will see some noise there in the fourth quarter. Credit card, as you've heard from others in the industry, recent vintages are showing signs of trouble. And as you know, we're relatively new entrants to the credit card business. So our performance is more heavily weighted by the "front book." And so we're seeing the same challenges that the industry is seeing in credit within our front book. And actually, in fourth quarter, we're seeing NCOs approaching 11%. And our expectation, similar to what others have said, is that the NCO level there continues to tick up into the first half, probably peaking in the first half of '24. And so that's something that's going to hit in terms of our credit costs in the -- certainly in the fourth quarter and on a go-forward basis. All that being said, as many of you know, our credit card book is pretty small. It's about $2 billion of assets by the end of the year. We've actually taken a lot of steps to really curtail growth in that business. If you kind of look at what we had originally planned to originate this year, we've probably pulled back about 40% in terms of new accounts versus what we planned. And a lot of that is just curtailments in order to manage risk. And we'll continue to watch that book closely and watch how it performs, and we'll manage it dynamically in order to make sure that any credit issues there are contained on a go-forward basis.

So Russ, you referenced the fourth quarter a couple of times, auto credit tracking in a lot of expectations, maybe some lumpiness in the other portfolios. Given that we are 2 months into the quarter, I think you guided to a 3.35% NIM, meaning roughly a 3.2% bottom. We just talked about credit. Any changes to what you guided to or any other color in terms of how the quarter is shaping up?

Yes. And maybe I'll dial it back, and I'll start with earning assets as we kind of talked about earlier. We've talked about previously, we're opportunistically kind of optimizing across our asset portfolio. We executed on $1.7 billion of auto loan sales through the securitization markets during the quarter. And so we'll see a slight tick down in terms of retail loans. We will see an increase in floor plan in the quarter just as dealer inventory levels have been normalizing. And so when you cut across it, and we've got kind of rundown across the mortgage book, across the investment portfolio, we've got some of the curtailment we've done across the unsecured book. When you cut through it all, our expectation is for earning assets being down on a linked-quarter basis, call it, $1 billion or $2 billion. You talked about NIM at the 3.35% level. I think on the last earnings call, I said 3.3% plus, and then I kind of clarified to, call it, roughly 3.35%. That is still our expectation. So we expect very much to be on track from a NIM perspective. That being said, fourth quarter NIM, I think, will probably be a shade under 3.20%. And part of that is pressure we've seen from lease gains. We've seen some volatility in used car values over the course of the quarter, where they got some support from the strike. And then as the strike was resolved, that support pulled back. And so we've seen that volatility kind of relative to where we were at the beginning of the quarter. I think our expectation is we'll see some softness in lease gains that will translate into the fourth quarter NIM, but not enough to move us off that 3.35% area for NIM overall. We've talked about credit. We'll see some noise in the corporate finance book. We've talked about what we're seeing in the credit card book. Again, from the retail auto side of things, we're very much on track with the guidance that we've previously stated. We've talked a little bit about other revenue. Other revenue, roughly $500 million, very much on track with what we've discussed previously. In terms of OpEx, we're looking at, call it, 1% to 2% up year-over-year, very consistent with the guidance. And again, I'd reiterate that we're very much on track to deliver on the 1% controllable, 2% overall, looking at 2024 versus 2023. And so yes, I think kind of across all these metrics, I would say that our view is unchanged in terms of our view of certainly 2024 and our view of the forward in terms of a 4% NIM and a mid-teens ROE for the company on a long-term basis. I think kind of what we'll see in the fourth quarter is a little bit of noise here and there on the NIM line and on the non-auto credit line. But again, I'd characterize the story for '24 and beyond as being very much unchanged.

Maybe let's talk a little bit about capital and liquidity. First, maybe you can just touch upon the long-term debt rule and how that will impact Ally. Maybe tying in capital, maybe just talk about the priorities, what are the levers you have. You talked about earlier about optimizing. Given all the regulatory changes that have happened, is 9% still the right level for Ally?

Yes. Great. There's a lot in there. Maybe I'll start with some of the Basel III and long-term debt. As we've previously described, we think we can manage towards Basel III as stated internally by continuing to preserve capital and to manage and optimize across our businesses. The AOCI -- losing the AOCI opt-out is probably the biggest impact. But from an RWA perspective, it's some puts and takes that really kind of don't change the RWA picture for us. Long-term debt, as it's currently stated, is probably more of an impact, but very manageable. The -- as you know, the world calls for 6% of RWA both at the bank holding company level and at the IDI level. The IDI level is the one that's going to be binding for us. It will essentially require us to downstream cash to the IDI in order to meet that 6% IDI unsecured debt requirement. That cash can come from a number of places. It can come from cash that we -- from assets that we currently have at the holdco. It can come from essentially dividends between now and implementation that go from the bank to the holdco, and it can also come from unsecured issuance at the holdco. And so if you were to cut it now, that 6% would translate into about $9 billion, and some portion of that will have to come from incremental unsecured debt issuance at the holdco as currently stated. It's too early to tell what that number is just based on kind of differences in asset and cash levels over the next few years. And also the fact that the legislation, obviously, is finalized. We're working with the industry, and we'll be submitting comment letters within the time line provided. And obviously, we're hopeful we get to a better place in terms of the outcome. But I'd say with respect to both Basel III endgame and long-term debt, they're both very manageable, certainly manageable within the long-term targets that we've provided. You raised the 9% target. The 9% target is a management target. If you look at our CCAR and our regulatory minimum, we're required to hold 7%. So our management target is set at a 2% buffer to the regulatory minimum. As of third quarter, that was about $3.7 billion of additional capital. We still think that's the right management target. And as you know, we manage at a buffer to our management target. So we're typically slightly above that 9%. As we roll the clock forward as we think about some of these upcoming changes, including losing the AOC opt-out, we think we can manage internally. And what you'll see is we'll continue to be very disciplined around how we deploy capital across our businesses. We'll continue to be opportunistic in terms of kind of looking for opportunities to do loan sales and to take other measures to optimize our balance sheet. And we can manage towards Basel III even as it's currently stated through -- effectively through kind of managing our balance sheet carefully.

We're out of time, and I know you gave lots of different pieces. We'll get formal guidance in January. But anything else you wanted to close with in terms of the outlook or anything else you wanted to add?

No, I think we've hit it. Thank you.

Perfect.

Thanks for the time, and thanks for the great questions.

All right. Great.