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

Good morning, everybody. My name is Jeff Adelson, I'm the Consumer Finance Analyst here at Morgan Stanley. Before we get started, I'm just going to read some quick disclosures. For important disclosures, please see the Morgan Stanley Research Disclosure website at www.morganstanley.com/researchdisclosures. The taking of photographs and use of recording devices is also not allowed. If you have any questions, please reach out to your Morgan Stanley sales representative. So this morning, excited to welcome Russ Hutchinson, CFO at Ally, to our conference. Russ, I think it's your first time here. Welcome.

Thanks, Jeff. Happy to be here. Thanks, everyone.

So maybe getting into it here, starting high level. We're approaching your 1-year anniversary here at Ally. Can you discuss the first year you've had as CFO? And what do you think investors want to see from you and Ally going forward?

Yes, absolutely. I've had a wonderful year. As many of you know, I had the good fortune of working with Ally for many years before I joined as an adviser to the company. So I had a lot of strong relationships with many members of the management team. I had a really strong appreciation for the culture at Ally and for the transformation that's taken place, particularly over the course of the last decade or so that we've been a public company. Yes, and I'd say after a year into the job, I'd say my conviction for the company, my appreciation of the culture, everything has just grown stronger. It's been a really fantastic year. My appreciation, in particular, for the strength of the core franchises is really strong. I think our Auto franchise is the strongest out there. Our relationships with dealers are unparalleled. Our depth in the industry and the runway we've got in that business just on the basis of the strength of the franchise is amazing. I couldn't be happier with our Deposit franchise. We are a relentless Ally now to over 3 million customers. And I think that franchise has shown incredible resilience, particularly over some of the trials and tribulations we've seen in the industry over the last 18 months. We've continued to grow the franchise. And again, I feel really great about how that sets us up for the future. In terms of what I think investors expect to see from us over the next few years, I think they expect us to -- to see us make good on the trajectory that we've promised. And I think we are uniquely positioned with an earnings ramp powered by kind of NIM expansion from the efforts that we're making on both sides of our balance sheet. I think they expect us to continue to aggressively manage our expense base, to manage our risk, and to grow our other revenue. And those are the things we're absolutely focused on. We're very focused on investing, again, in our valuable franchises.

One other area of focus for Ally of late has been the balance sheet. You've emphasized optimizing the balance sheet with a focus on your highest returning businesses. Can you expand on the mix dynamics and how that drives increased profitability over time? And maybe what the biggest areas of opportunity are for you to maybe lean into, deemphasize, where do you see the balance sheet in the next 5 years?

Yes, absolutely. Look, I think as you look over the next few years, you can expect our balance sheet to be kind of somewhat flattish. But within that, we're growing in the areas you'd want us to grow in. So our retail loan portfolio -- our Retail Auto loan portfolio is growing. Our Corporate Finance and Credit Card portfolios will grow, albeit in a controlled way. And at the same time, our mortgage portfolio and our securities portfolios are both shrinking. And so you can see, effectively, kind of shrinkage among some of the longer duration, lower-yielding assets that are kind of not kind of linked strictly to our core franchises. And you'll see growth in the areas where we're strong, that are tied to our franchise customers, that Retail Auto loan, the Credit Card, the Corporate Finance business. And those are all areas where we have attractive risk-adjusted return assets, kind of more yield than in areas where we've got a really great track record in terms of kind of managing through the risk. And so as you think about our balance sheet going forward, look to us -- look for us to kind of support that expansion in net interest margin by moving our asset base towards our higher returning assets and away from some of the lower returning assets.

And the balance sheet strategy, obviously, has some implications on NIM. You've called out a NIM trough in the first quarter. You're confident in NIM expansion happening this quarter. Is that playing out? And how meaningful is the expansion you're going to see this quarter? And then maybe beyond this quarter, you can speak to the drivers of the variability in that kind of 5 to 15 basis point linked-quarter expansion you talked about over the rest of the year.

Yes. No, Jeff, that's a great point, and I'm glad you raised the 5 to 15 basis points quarter-over-quarter NIM expansion. We've talked a lot about our net interest margin expansion trajectory. We've talked about it not being a straight line, but we've talked about this range of kind of getting 5 to 15 basis points each quarter on a linked-quarter basis through the remainder of the year. And I think you're exactly right. We troughed in the first quarter. I think second quarter will be towards the high end of that 5 to 15 basis points in terms of quarter-over-quarter NIM expansion. And that's on the back of continued momentum in terms of pricing on the auto side of the business as well as some of the recent moves we've made on the deposit side of the business. So once again kind of taking advantage of both sides of the balance sheet to drive that NIM expansion. And I'd say, look, on the back of a relatively strong NIM quarter, as we think about how that plays out over the course of the rest of the year, we've talked about exiting the year at 3.4% to 3.5% NIM, we'll be towards the high end of that range as well. And I think as you think about our trajectory through the medium term, our path to 4% NIM is still very much intact. We're still looking at getting to that 4% NIM towards the end of 2025.

And so towards the 15 basis points this quarter, you're also going to exit this year towards the high end of the 3.4% to 3.5%. Does that change the timing of getting to the 4%? I know you just said you expect to get there by late '25. I mean what would have to happen to maybe not get there? Or what could even bring it more towards the mid part of...

Yes. I'm glad you kind of doubled down on that question, because one thing I should talk about is, we've talked about this before, we think we've taken a lot of the interest rate risk, the risk around the Fed funds and kind of whether they cut, when they cut. We've taken a lot of the risk to our NIM trajectory for 2024 off the table through our hedging strategy. And so we feel really great about our exit rate under a range of different Fed scenarios. We are not reliant on the Fed to cut to get to the exit rate that we've talked about. The path of cutting certainly affects the timing to kind of getting to that 4% at the end of 2025. But again, we've taken steps through kind of both sides of the balance sheet as well as our hedging program to try and mitigate that risk. I'd say we feel pretty good about kind of where we are in terms of getting to 4% at the end of 2025. We've run a few different scenarios internally, just around kind of different combinations of kind of cuts and timing over the course of the next 18 months. We feel good across a range of scenarios about that timing and getting to that 4%.

And just the hedging strategy, like what does that look like over the next couple of quarters? Are you thinking about taking the risk off the table with a Fed cut?

Yes. So we haven't really made any major changes, certainly, over the last several months. And we don't anticipate making any changes. I think we feel pretty good about where we are and we feel pretty good about the protection that it's afforded us, even as we've seen the rates trajectory move considerably from where we were at the very end of '23 to where we are today.

And one important component of what you just talked about is the deposit side. You saw $3 billion of deposit growth in the first quarter. You've taken some proactive actions ahead of Fed easing, potentially Fed easing, both on your OSA and your CD rates. What are the deposit trends you're seeing this quarter? You tend to see a seasonal outflow in taxes. And what are your expectations for growth in 2024 or the rest of the year, as well as maybe the pricing strategy going forward?

Yes. So we've been absolutely delighted with the progress of our deposit franchise. As many of you know, it's been a 15-year journey. And we're absolutely delighted by just kind of where we are, the traction we have with customers, the resilience we have. We are fully funded by deposits at this point. And as I said earlier, our balance sheet outlook is flattish over the next couple of years. And so you kind of put those 2 things together and we're really -- really, our deposit franchise really positions us to think more in terms of optimization rather than growth. And so we touched on this in April when we reported first quarter earnings, but our expectation is, quarter-over-quarter, our deposit balances will be down due to seasonal tax outflows. And again, we're happy with that. Our expectation is, over the course of 2024, our deposit balances will be kind of rather flattish. And as you recall, we came off of the first quarter with a kind of up $3 billion. And so over the course of the year, our deposit growth aspirations are pretty modest. And again, that's just a reflection of the fact that we're fully funded on deposits and our balance sheet isn't growing. And so we feel really good about where we are from a funding perspective.

And if we do look at that other side of the balance sheet, in auto, we are starting to hear some rumblings of increased competition. Are you noticing this yet as you're out there in the field in the market? And what are you seeing from your competitors? How can Ally also differentiate itself from the competition and maintain that recent market share you've been able to see as well as the pricing momentum you've been able to see in that more prime S tier?

Yes. We've continued to originate Retail Auto loans at an originated yield north of 10.5%. We've continued to originate more than 40% of our paper in our highest credit tier, the S tier, which again is just reflecting the fact that we've been able to take both price and move up credit in the conditions that we have in the market. I'd say, Jeff, you're right, we have seen some competitors start to come back. It's been primarily in very super prime area where we don't compete as much. And so we really haven't seen any pressure in the areas where we compete. Again, I think we've taken this opportunity, where a number of our competitors have either scaled back or exited, we've really taken this opportunity to deepen the moat around our businesses, to really just -- yes, to really, quite frankly, just focus on our dealers, continue to deliver consistency, continue to be there for them, and to strengthen our relationships with them. We think that gives us a durable and sustainable advantage in the market. We also think a lot of what's been driving our competitors to either scale back or exit, these are not transient factors. It's, predominantly, it's capital changes and the capital diets that many of our peers are under. And while the time line around those capital changes will kind of ebb and flow based on what's going on in D.C., it's our expectation that those constraints are durable and we'll keep a lid on competition for quite some time. And so we're happy to take advantage of this period, again, to continue to deepen that moat, continue to strengthen our relationships with dealers, continue to build on a multi-decade trajectory of supporting our dealers through good times and skinny times. And again, we feel pretty good about where we are from a competitive perspective.

And just one point of clarification, the 10.5% plus, 40% of originations, is that continuing through quarter-to-date or is that more of a first quarter comment?

No, that's continuing through the quarter.

Okay. And one thing you've also talked about in maybe supporting the yield going forward is, if the competition comes back, leaning a little bit back in towards the belly of the curve. Can you talk about what you think the time line, the path is there, and what could drive some of that shift? Does the credit outlook also have an impact there as well?

Yes. No, that's a great point. It's something we've talked about before. We're not doing that right now. We really don't feel the need to in the market. But you're right, it's one of the levers that we have that gives us a lot of comfort around maintaining our yield, is the fact that we are currently originating kind of north of 40% in that upper S tier. If you kind of -- we think of kind of a normal market, we do 25% to 30% in the S tier. And so, yes, there's an opportunity when we think the time is right to scale back some of the curtailments that we've made over the course of the last 18 months and bring our mix kind of more in line with that norm. And that has the ability of essentially giving us the opportunity to capture yield in order to preserve the margins that we're currently seeing in the business. And so we think that just speaks to the sustainability of our 4% NIM target and our ability to maintain attractive margins going forward.

And related to that question on credit, you have seen Retail Auto losses tick up in the first quarter, but your delinquency performance on a formation year-over-year basis, as well as a vintage basis, continues to improve. What delinquency trends are you observing today? And how will those trends translate into the charge-off progression over the remainder of the year? Do you still see that charge-off peaking in the first half of the year?

Yes. It's a great question, and you kind of dig in on credit. What I'd say is, as we look at credit on a vintage basis, a lot of the trends that we've talked about before, so seeing that 2023 vintage diverge from the 2022 vintage in a favorable way, we are continuing to see that when we look at delinquencies and NCOs on a vintage basis. That being said, the back book, predominantly the 2022 vintage, continues to be challenging. And so moving from first quarter to second quarter, just on the basis of seasonality, we would have normally expected to see a 50 to 60 basis point decrease in our NCO level, just again, seasonality going from first quarter to second quarter. We're probably looking at the shallow end of that just based on some of these challenges that we've seen in the 2022 vintage in particular. And I'd say that is a more challenging environment than I think we anticipated when we last spoke to the market back in April. All that being said, we've talked about a consolidated NCO rate for the year of 1.4% to 1.5%. We think we're still within that range, but towards the higher end of that range as you think about our annual kind of consolidated NCO rate. And so again, I'd say that we see very encouraging signs in the 2023 vintage as that continues to diverge from 2022. But that '22 vintage continues to be a challenge. I'd say as we think about the forward, we're right now, we're kind of sitting at a point where, just given the age and the kind of the seasonal development of that 2022 vintage, the majority of our losses right now are coming from 2022. As we make our way through the year, that shifts, as we start to kind of exhaust the loss content in that vintage and more of the loss contribution comes from '23 and ultimately from newer vintages. And so we think we're making our way through that. But it's clearly -- it's something, again, that kind of impacts the quarter. But again, on a consolidated basis, we think we're still within our range, towards the higher end of that 1.4% to 1.5% range. We'll obviously come back after we see the close of the quarter and provide a very detailed summary of kind of what we're seeing in terms of credit. So we'll come back to you in July with that.

And shallower end of the seasonal decline, is that like a 20 to 30 decline? Is that how to think about it?

So yes, we, normally, we would see 50 to 60 basis points. So I think we'll be towards the shallower end of that 50 to 60 basis point range.

So less than 50 or 50? Okay. All right. So then higher end of the 1.4% to 1.5%, till the 2%, for the auto NCO rate, still about ballpark or?

We'll give a much more detailed update when we come back in July. I think we want to see how June -- we want to see how things look with the data on June.

Okay. Understood. I mean if it were 50, that still seems like a pretty positive result, I would -- okay.

Yes. I think, yes, 50 feels like a positive result. But look, if we were sitting here in July, we would have told you to expect 60.

Okay. Got it. Understood. Okay. And any sort of early reads into how you're thinking about 2025 at this point? You've got that worst performing vintage rolling off. Has the trajectory for that shifted '25 at all?

No. I'd say we continue to expect kind of continued improvement in NCO levels as you go through '25 and '26. Again, it's basically as you kind of progress through the vintages. And just looking at the amount of curtailment and the performance of the '23s and the early read on the '24s, we still feel pretty good about that continued improvement in NCO rates as you move through '25 and '26.

Okay. And I just want to remind folks in the room, if you have any questions, feel free to raise your hand and someone will come by with a mic at any time. So just feel free to raise your hand. Maybe just pivoting towards the other revenue side. That's been a really nice tailwind for you guys. You increased the guide there from 5% to 10% up to 9% to 12% for 2024. Can you just discuss really quickly the drivers behind that increase and how we should be thinking about the trajectory of that beyond 2024?

Yes. No, look, as we kind of look to deepen our relationships with dealers, we continue to get great traction with our Insurance business, our SmartAuction business, our pass-through business. These are all areas that add a tremendous amount of value for our dealers, helps them make their businesses better and more resilient. And they're also great businesses for us in that they drive other revenue at attractive margins. Some of that growth, the growth in the Insurance business, comes with expenses. In Insurance, the Insurance revenues and expenses are very much tied together. And so we encourage our Insurance colleagues to really lean into the opportunity. We like the trade-off. When we look at the revenues versus the expenses, it's a positive contribution. On the basis of the strong traction that we've got, we raised the guidance when we spoke to everyone back in April. I'm happy to say, when you think about the quarter and for the year, we're towards the high end of that revised guidance. So again, continue to see really strong momentum across all of the fee-based businesses. On the expense side, I kind of touched on this with Insurance, and maybe I'll just hit that here quickly. Yes, I'd say we're very much on track for the full year in terms of our original expense guidance. I'd say as you kind of think about the quarter, we expect kind of 3% up this quarter. A lot of that driven by the Insurance business, to a lesser extent, the FDIC charges. Those are both what we consider to be kind of not within the controllable. So on a controllable basis for the quarter, we still expect to be down. And when we think about the full year, our expectation is we'll be, on a total expense basis, up less than 2%; on a controllable basis, down more than 1%. And so we continue to exercise our discipline around our controllable expenses. Really kind of modeling to kind of down this year on a controllable basis and kind of flattish as we think about the next few years. And at the same time, we continue to invest, in particular, in our Insurance business, and we'll see that reflected as you look at kind of that total -- the total expense basis as those expenses kind of reflect that Insurance investment.

So up 3% linked quarter, but down on the controllable this quarter?

That's right, yes. But very much on track for our full year guidance.

Right. Okay. Anything else you want to maybe get out of the way on the quarter before we lose time at the end?

No, look, I think I've kind of hit at -- NIM kind of for the quarter and for the exit rate for this year will be towards the high end of our guidance. Other revenue, towards the high end. Expenses, very much on track. Credit, we'll come back with the quarter with a more detailed review, but we're still within that 1.4% to 1.5% range that we've talked about before, albeit towards the high end. So I think we kind of hit all the quarterly and kind of full year points.

Okay. Great. And then capital management is another big part of the story here. You did the sale of Ally Lending. You've been doing some loan deconsolidation. You also, I think, suggested some interest in credit risk transfers recently.

Yes.

How do you plan to use CRTs at this point? How meaningful do you think that could be for your capital levels? And then maybe just also touch upon your capital management overall and how you're thinking about the eventual path to turning on the buyback again.

Sure. So maybe -- so starting with credit risk transfer. I'm sure many of you saw, we got approval from the Fed, I guess, a little while ago. We really like the credit risk transfer as a lever to helping us manage capital. As you pointed out, we've pulled some other levers in terms of using the securitization markets to fully deconsolidate loans. And that's been a really useful tool as well. And you'll see some of the stuff we've done in the first quarter, we've obviously done with a positive income effect, just showing the attractiveness of our loans in the market. The credit risk transfer, the CRT, we like that in particular because we don't actually have to sell the loan. So we can take a reference portfolio of loans and execute a CRT and we can continue to hold those loans and benefit from what we believe are the very attractive economics of those loans on our balance sheet. But what we effectively do is we issue a note that kind of reflects the mezzanine risk on that portfolio and we get a considerable amount of RWA relief for that. And so when we look at it in terms of a cost of capital, it's the cost on a mezzanine note, that's, call it, 10-ish percent of the reference portfolio, versus an RWA benefit that's on the order of about 2/3 of the RWA on the reference portfolio. And so when you kind of look at those 2 things together, it becomes a very attractive way for us to reduce RWA and effectively preserve capital that we can kind of deploy in our business and supporting our dealers. So we think this is a really important tool going forward, and we think it complements a number of the other tools that we've been using over the course of the last few quarters. So we're happy with it. We'll kind of test and see and test and learn, and kind of see what the market capacity is for this, but it's certainly something that we want to incorporate in our toolkit on a go-forward basis. And then I think you asked also about share repurchases. Yes, share repurchases, kind of always on our minds. Important tool as we kind of think about capital return. It's something that we spend a lot of time talking about as a team. Our expectation is there are some regulatory changes coming down. The precise details of those are still unclear to us, as well as the timing of any phase-in. And so I think we expect we'll be in capital preservation mode as we kind of see how all that unfolds. But it's certainly top of mind and it's certainly our desire to get back to using share repurchases as a capital return tool. The way that we have in the past, I think Ally, I think we've always been very disciplined around capital management and we've been among the strongest users of share repurchases in the past, and we certainly look forward to getting back to that. But again, I think we do that with kind of more visibility around just kind of the end state in terms of the regulatory capital rules and the timing.

And while we're on the topic, just anything to note on the CCAR process later this month or...

We're -- yes, we made our submission, and I think the results are supposed to come at the end of the month. So we're looking forward to getting our results.

Okay. And as you think about the return profile for the business, hitting your 4% NIM, mid-teens ROTCE, if I look at you, where you sit today, it seems like that's pretty achievable by next year from where I'm standing. How sustainable is this beyond next year? And do you think there's even a potential to over-earn given some of the favorable competitive dynamics you're seeing out there?

Yes. I think that's a great question. We think it's completely sustainable. We talked about some of the levers we have within the Auto business in terms of the ability to dial back some of the curtailment and the move-up that we've made in terms of credit as a way of supporting the yield there. That's certainly on the table. Again, I think we feel absolutely delighted by the strength of our deposit franchise and the opportunity that we have to optimize versus kind of how we've run the business in the past, really prioritizing growth. And so we feel really good about the trajectory and the sustainability of NIM going forward. We think the continued migration of the balance sheet, again, towards our higher-yielding businesses across Retail Auto and Corporate Finance, and ultimately, Credit Card, and the movement away from the lower-yielding long-duration assets, the mortgage portfolio and the securities portfolio, I think all of those things kind of speak to improved profitability. That traction that we have on the other revenue side through the Insurance business, SmartAuction and pass-through, those are all very high-margin, low-capital-intensity businesses for us. And so we think we have a number of levers that are built into the business that give us not just a path to the 4% and the mid-teens ROE, but the ability to sustain that going forward. And obviously, we'd love to overshoot and we'll do everything we possibly can to deliver on that.

Okay. And you also have a new CEO in place, Michael Rhodes. Anything you can share about his first month and see anything, his views on the go-forward strategy and the financial algorithm you've put out there?

Yes. Look, I mean, I don't want to speak for Michael. You will all hear from Michael when we report our second quarter in July. So you'll get a chance to meet him and get to know him. He's met with a couple of our large investors already, and so we're starting to bring him out. I'd say it's been fantastic the last 30 days. Michael, just he's got 30 years of banking experience, and it absolutely shows. Just the depth of his knowledge across the business is actually really amazing and really refreshing. He also comes to us with a really healthy respect for the Ally culture. And I think he's going to be a really, really positive contribution to the team. I think we're all just looking forward to working with Michael to do even better as we like to say at Ally. But yes, we're all really excited. We've spent a lot of time as a management team with Michael. I spent a bunch of time just kind of walking him through the financial plan. He's got a tremendous amount of respect for our core franchises, for the plan that we have in place, and for the earnings ramp and the trajectory and the story that we've been talking about for the course of the last year. So I think it's -- I think we're going to focus on execution. Again, I don't want to speak for Michael because all of you guys are going to get a chance to spend time with him over the coming quarters starting with our second quarter.

Just if we could go back really quick to the credit guide for the year. How has used car prices factored into that? And they've been moderating recently. Has that been according to your expectations? I know they did rebound a little bit last quarter, which you highlighted. And is there anything else that's maybe factoring into why you think the late '22 vintage is performing a little bit worse at this point outside of used car prices?

Yes. So used car prices are interesting. They've been more kind of volatile over the course of the last 12 months. As you pointed out, they're kind of weak in the first quarter, recovered through the second quarter. I'd say we kind of -- we came into this year expecting, between December of '23 and December of '24, we'd see, call it, 5 percentage points of decline throughout the year. I'd say right now, where we sit, used car prices are probably a couple of percentage points ahead of where we expected them to be at this point in the year. Again, our anticipation is that they'd be declining throughout the year. And so we've seen some favorability in the second quarter that's been helpful to us. But again, it's still our expectation that we'll see that 5 percentage points of used car price decrease between December of last year and December next -- December of this year. Yes, that would take us to about, we call it a 1.20 on the Ally Used Vehicle Index. What that basically means is basically a kind of 20% premium to kind of where we would have seen used car prices pre-pandemic. And again, that view is a long-term view and it's informed by just what we see in terms of the dynamic between supply and demand of used vehicles, just kind of as we kind of forecast forward based on kind of lease returns and what was produced and kind of where the demand is. So again, probably a percentage point or 2 favorable to where we thought we'd be, but that's on the -- with the backdrop of our expectation that used car prices through the year will decline by about 5 percentage points.

And there's been some recent reporting on consumers abandoning new car purchases. Not sure if that's overblown. But does that maybe support some of the dynamic in your used car price strategy as well?

Yes. Look, as you know, our -- when you look at our origination business, it's kind of heavily skewed towards kind of used, like prime kind of used customer. And so we certainly appreciate the strength that we're seeing as we look at dealer lots, and you can kind of see it when you kind of look at month-over-month trends in terms of inventory levels, there's definitely some strength in the used cars. I don't recall the specific stories, but it's probably a little bit exaggerated and overblown. But we certainly appreciate just the strength in the used car market, and being able to support our dealers for a product that's really important to their business right now.

And just maybe in the last minute, anything you want to leave investors here with today to wrap up or -- about the Ally story, anything you think that's misunderstood about the company at this point?

No, I think we got a lot of it out -- of it out. We, as a management team, we're very much -- we're focused on executing, we're focused on executing within our core franchises. And we have as much conviction as we've ever had around our 4% NIM trajectory and our mid-teens ROE. And yes, I'd say that's about all I got.

All right. Great. Well, I think we'll end it there. Thanks, Russ, for coming to our conference this year, and looking forward to having you in the future.

Awesome. Thanks, Jeff. Thank you.