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

Good morning, everybody. Before we get started, I'm just going to read some disclosures. For important disclosures, see the Morgan Stanley research disclosure website at 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 with that, we're kicking off the second day of our 16th Annual Financials Conference with Ally Financial. This morning, we'll be showcasing 2 businesses at the center of Ally's recent power of focus strategy, specifically dealer financial services and corporate finance. Now while these 2 businesses today are different, today, we'll be digging into the common strategy between them, specifically the emphasis on helping commercial customers win as well as how they're helping Ally achieve its medium-term targets. So joining me on stage this morning is Doug Timmerman. Welcome back, Doug. President of Ally Dealer Financial Services since 2021. He's been in the auto finance business at Ally for more of the -- or almost 40 years, making his inaugural appearance at our conference and I think any conference is Bill Hall, President of Ally's Corporate Finance business since 2006. Bill also cofounded the Structured Finance division in 1999 and has spent his entire career in middle market lending. Welcome, Bill.

Thank you.

And then finally, Someone who investors know already pretty well, it's Sean Leary, Chief Financial Planning and Investor Relations Officer, who leads all line of business and Corporate Financial Planning in addition to Investor Relations. Welcome back, Sean.

Good morning, Jeff.

So let's get into it. Doug, let's start with you. Dealer Financial Services. The business has clearly evolved over time. You were GM's captive finance provider. You're now an independent competing in the dealer F&I office, along with some changes to origination mix over that time period. Can you talk about the evolution of the business and your competitive advantage today at Ally?

Sure. Yes. And I think our evolution is a great story. I think it's a testament to the franchise. It's a testament to the team executing against our priorities for sure. As we like to say -- if you think about our momentum and the power of focus, but we also know that our future is bright. And so from my standpoint, if you think about what differentiates us, it has simply a lot to do with who we are and what we do. So we're very unique in our size and scale, we're the largest, we're also very unique if you look at the products and services we provide. Most of our competitors provide 1 or 2, we provide a full spectrum of products and services arguably across all the dealers' needs. We also think that we're very unique relative to subject matter expertise and our relationships and confident that we're very unique in our approach. And so if you look at the consumer side of our business, for example, where we're obviously highly automated, we're digital, we're also high touch. So our sales teams are very active on the dealer showroom floor, essentially working the day to help the dealers solve problems. And again, they have the subject matter expertise and the full suite of products and services to touch every aspect of the dealers' business. Our consumer underwriters are arguably our secret sauce. And so consumer underwriters, their day is focused with inbound calls and outbound calls helping dealers structure deals to help them sell more cars and trucks. And from a dealer's perspective, job #1 is selling cars and trucks. And so we align perfectly there. If you think about our suite of products, we've got a full suite of commercial lending products. If you ask the broker community, who's most active in buysells, Ally Financial is going to be top of the list. Our remarketing services are in high demand. SmartAuction is a great asset to us as well as our dealers. Our insurance business is aligned to what's really important to the dealer. If you look at the profitability of a dealership, F&I is critically important. And so we provide not only the products, F&I products for the dealer, we also provide the training and the consulting associated with those products and of course, property and casualty insurance on top of that. And then we have what we call a pass-through business, which also helps dealers sell cars and trucks. But if you add it all up, obviously, we're very unique. And because we're unique, it gives us an opportunity to gain unique commitments from the dealer. And so case in point from that is our focus on gaining the dealers' commitment to sending us all of their applications. And by doing so, that's helped us grow our consumer business. It's helped us significantly improve the returns of our consumer business. And it allows us to be selective, it allows us to concentrate our volumes in the segments that have the very best risk-adjusted returns. It also allows us to be nimble when competition ebbs and flows, and it also allows us to adjust as macros change. Very, very importantly and oftentimes missed is the fact that also allows us to hold incremental rates above the competition. So punchline is we're very, very unique. We're much different than all of the competition in a big, big way. We're very difficult to replicate. And arguably, I don't know if there's really a competitor out there that's even attempting to replicate what we do for our dealer customers.

That's great. And as we think about the power of focus, one thing Ally has talked more about is diversifying within those focus areas. So can you talk about how you've been able to diversify your origination channel and how you've been able to drive some nice growth in the fee revenue component. You touched upon some of the aspects there already. Those are more less rate credit, capital sensitive.

Yes. I think, one, we've got momentum in arguably every aspect of our business. But just like every business, you're trying to find competitive advantage. And so I lined out our competitive advantage that ties to the consumer side of the business and really our business overall. But some -- a good examples are our SmartAuction business, we've really been focusing on, call it, the large consignor segments. Our leverage point for that segment as we offer up our SmartAuction technology to those large consignors. We make a commitment to modify that to their wants and needs, in some cases, even put their name on that technology. Every time a transaction is done, obviously, there's economics associated with it, where we could participate in those economics. If those deals do not transact on their platform, spills over to SmartAuction, so we get more volume that way. And it's just a great leverage point relative to SmartAuction back to our technology. If you think about our Insurance business, it's about leveraging our relationships. So 22,000 dealer relationships. Essentially, the effort in simple terms is coordinating the auto finance team and the insurance teams, getting the auto finance team really good at prospecting their dealer customers, getting the insurance team really good at proving out to those prospects that we're a better provider. We've had tremendous amount of success in that regard, and there's still a lot of opportunity in that regard. And then our pass-through business is a leverage of our application flow. And so again, we gained the dealers' commitment to sending us all of their applications. Some of those applications don't fit our risk appetite. We pass those applications on to 2 others. Essentially helping dealers connect with finance sources that they normally wouldn't have access to, again, hits the point that's most important to a dealer, and that is helping them sell more cars and trucks. And again, we get an opportunity to participate in the economics but without taking any credit risk. So there's leverage points in everything we do. We obviously focus on those leverage points, great momentum and great opportunity as we think forward as well.

And if we step back from Ally and look more at other players and the competition, we've been hearing a lot more about competition reentering the space of late. Are you seeing this? Has it caused you to make changes in how you're approaching the market? And how is it impacting pricing and spreads maybe as we think about that 9.8% you put on last quarter?

I mean the businesses is -- and the industry is always competitive. I'd say competition is generally pretty balanced. If you look at the very top end of the super prime segment, rate competition is probably a little bit more aggressive than it was 3 months ago, 6 months ago. If you look at the deep subprime business, so some of the traditional lenders are starting to reenter into that segment. Where we play, which is in the middle credit segments, I'd say it's been more consistent. And again, we focus on the middle credit segment because we feel that's where the best risk-adjusted returns are. It requires a certain level of sophistication to play in that segment. So it's a little bit difficult to enter. You have to be consistent. You can't come in and out. And very importantly, that's the most profitable segment for our dealers as well. So playing into the segments that's most important to them, obviously, is a critical value prop as well.

Okay. Great. So maybe like slightly less focused on the S tier as you see more competition or maybe...

Yes. S tier is very broad. So when I say the top end of the super prime segment, that's S tier, but it's a portion that we really don't play in.

Got it. Okay. Great. Let's talk about tariffs, multipart question here, so bear with me. But let's discuss the current environment and how you're positioned to navigate this uncertainty. Is this pressuring affordability on new and used vehicles? And what are the potential impacts to your vintage losses if auto prices increase further. You've taken steps to curtail your risk post 2022. But is there anything else you're doing incrementally today to position for that uncertainty or volatility? And then maybe you can then just touch upon consumer demand with pull-forward dynamics that you're seeing today?

Sure. Yes. Well, there's obviously still a lot of uncertainty relative to tariffs. And so we're monitoring very closely. I think it's kind of important to think about our position to today. And so I would say, if you look at our purchase policy, if you will, our purchase policy is relatively conservative versus a historical perspective. But despite the fact that it's conservative, if you look at our yields, our risk-adjusted returns and our volumes, they're all very, very, very healthy. If you look at our vintages for example, 2023, every quarter of 2023, the vintages are very healthy and they're high returning. Our 2024 vintage, also healthy, high returning, even a little bit better credit performance in the '24 vintages. And then the first half of 2025 is going to look very much like to '24. So we feel like we're well positioned relative to credits and how we're underwriting the business today. I think what's also important is to recognize that essentially 2/3 of our origination flow is used. So on a relative basis, that's a good place to be. And then if you line out all the OEMs, we're really heavily skewed towards those OEMs and those franchises that will probably be impacted less because of tariffs. So a lot of things position us well. So sometimes I get a question of, is this going to be similar to the pandemic or what we would say the hang over the pandemic. I don't see tariffs having near the impact as it relates to inflation, volatility or affordability challenges. But we're watching. We're going to obviously be very measured, very balanced as we think through it. hopefully, we'll learn more in the next 60 to 90 days and of course, play accordingly.

And just real quick, have you noticed that uptick in pricing in May or April, May. And then maybe is it...

Very much on the margin. We watch transaction prices across all makes, all models and very much on the margin. Consumer demand is still very healthy. Yes.

Okay. Great. And then just one more for you, Doug, before we switch over to Bill. There's a lot being thrown at the consumer right now. We just talked about tariffs, but there's a resumption of student loan payments, got DOGE impacts on government workers, stock market volatile, et cetera. How would you say the consumer is handling all this at this point? And any read into your portfolio as a result of that?

Sure. Yes. Well, a lot of things to monitor, and I think that's one of the things that we're really good at for sure. So relative to the consumer and health, certainly, where we play, we see the consumer being very healthy. Again, we like those vintages performances that I spoke to. Those are very healthy. So I think that fits well. I think if you look at delinquencies, net charge-offs, flow rates, we like the trends that we're seeing. Flow-to-loss rates are running at historic lows. We've done a lot on the collection side of our business. We brought in some really good talent. We've invested big in our digital technologies, essentially better connecting with consumers at the right time in the time of stress, helping them bridge to better places. So overall, the trends feel good and the consumer feels healthy from our standpoint relative to the segments that we play in.

Okay. Great. Thanks for that, Doug. Bill, let's move over to you now. So Corporate Finance, that's the other piece of Ally's commercial portfolio in addition to floor plan. So you've seen some really strong asset growth there. It's grown from $2 billion in 2014 to $10 billion today. You have really strong ROEs, low losses. Starting high level, can you just talk about the business, how it fits into Ally's ecosystem, who your customers are? And how do you go to market and compete?

Sure. Good morning, everyone. I'm delighted to be here. Ally has about $35 billion of commercial assets on its balance sheet and Corporate Finance represents about $11 billion of that. Fundamentally, we're middle market leveraged lenders, a lender. We have multiple verticals and lines of business, but our core product is senior secured first out floating rate loans to companies or entities that are owned by leading private equity firms or private credit firms. We serve as agent for virtually all of the loans that we do. And we think that's critically important because it allows us proprietary access to proprietary due diligence. We control the documentation. To the extent there's a hiccup, we control really the workout of the credit. And fundamentally, it's also critically important because it allows us to develop relationships that we've enjoyed for over decades now. If you look at our revenue, we're thrilled with the fact that virtually all of our revenue, the vast majority of our revenue comes from deep relationships that we've had for many, many years. Also by serving as agent in all of our deals, it affords us an opportunity to recognize a lot of fee income. And in fact, about 20% of our gross revenue comes from fee income. A great example of that is syndication income. Over the last 3 or 4 years, we've syndicated over $8 billion of loans to other lenders, mostly other regional banks and in the process, generated over $100 million of syndication income. It's funny that Doug's -- you'd think peripherally Doug's business and the Corporate Finance business don't have a lot in common, but the value proposition is virtually identical. Doug's team and the business has been around for over 100 years. Our business has been around for over 25 years. We think we're among the longest tenured players in the middle market leverage lending space that's had the same leadership team backed by the same source of capital, and we're very, very proud of that. Our value proposition to our clients mimics what Doug is, what Doug does for his dealer community. And that is through thick and thin, we have been a consistent provider of speed, certainty and creative solutions for our customers. We're not in the market and out. We have always been a consistent source of financing and ideas for them. And as a result, we believe we benefit from some of the strongest relationships in the private equity or the leveraged finance industry. As I said, we've been at it for 25 years. For anyone that's interested, we're very easy to diligence because all the information is out there, and you don't have to do a lot of guesswork to validate our success over a couple of decades now.

And you're just right up the road.

Right up the road.

Feel free to stop by if you want to chat with Bill. So you also provided a new disclosure in the first quarter earnings deck talking about your vertical loan balances by vertical. You also recently announced a new one focused on infrastructure and energy. Can you talk more about these different verticals and the products you offer across those verticals and how you're able to drive those strong yields and healthy fee income growth we see?

Sure. We have 3 principal lines of business. One is sponsor finance, another is private credit finance and the third line is what we call specialty finance. I'll start with sponsor finance because that's really what our roots are. We have a client list of leading middle market private equity sponsors where we're generalists, but we finance their investment activities. We're generally at about 50% of the enterprise value when we make a loan, which we think is very conservative on average, actually, our stats would show about 40%. We have had a terrific loss record over the year. One of the most important things we learned is to choose your partners very, very carefully, and we're proud of our roster of clients. We have a couple of defined niches like defense and aerospace. But generally, it's our reputation in the market as a consistent provider of thoughtful creative capital that's been a differentiator for us. I'll speak more about the private credit finance business because it's been getting a lot of airplay recently in the press. We basically provide wholesale financing to leading asset managers, private credit providers that allow them to leverage and scale their business. And we have a portfolio of about $4 billion in loans that we've made to the leading private credit providers, and we're collateralized by a diversified pool of about 1,300 different loans. So it shows to me the resiliency of that portfolio and the strength of that portfolio. We also have an ability -- those are mostly asset-based loans, all revolving credits. And we have an ability to the extent there's a deterioration in the collateral pool of the loans that are collateralizing our facility, we can give haircuts to how much we're lending against that collateral. So we think it's a very, very safe, thoughtful way to participate in the growth of the private credit market, and it's something that we've done very, very successfully. And we think we have an outstanding roster of the leading private credit providers. And then lastly, we have something called Specialty Finance, which has 3 businesses at the moment. But one is it's basically health care real estate financing technology, venture capital financing and something that we're just about to launch, which is energy and infrastructure. Our health care real estate business is about $2 billion in outstandings, and we finance assisted living facilities, medical office buildings, skilled nursing facilities. Again, we're teaming with leading institutional investors that are backing their assessment of value with significant risk capital in a deal. Our average loan-to-value is somewhere probably around 65% or 60%. So we feel very, very confident in our exposure there. The performance of the portfolio even through COVID was exceptional. We have a technology finance business, which has done extraordinarily well. It's a smaller business, $500 million, $600 million of loans. And there, again, we're backing leading venture capital private equity firms that are backing their assessment of value with significant risk capital and those deals were 15% to 20%, 25% of the enterprise value. And lastly, I won't say too much about it because we just onboarded the team. We haven't done our first deal yet, but we're going to get involved in project financing for basically electricity generation. The investment thesis is there is an insatiable demand in the country for electricity generation, and we're going to do everything we can to participate in a very, very thoughtful way. So it's a diversified pool of businesses, but the core tenet is the same. We're backing sophisticated institutional investors that have significant risk capital below our senior secured position. And all of the businesses individually and collectively have what I think is very, very significant growth potential.

Okay. Great. That's electric stuff. So middle market leverage lending seems pretty competitive, though. What's your secret sauce? How are you able to compete with these large banks and private equity firms given the scale that they have?

I think Doug mentioned that throughout your career, it's always been competitive. The competitors come and go. There's constant competitive threats and our business is the same. The first thing I want to say is Ally has been a perfect platform for us to develop and grow the Corporate Finance business over 25 years. We started at de novo. And now we're over $11 billion. And Ally has a unique deposit platform, which serves as the oxygen for our business. it's viewed in the market as extraordinarily stable. As many of you know, over 90% of our deposits are FDI insured. So that gives us an aura of tremendous stability. So we have a cost of capital that's competitive, particularly relative to the other nonbanks that we compete against. So Ally itself has been a terrific platform. But really, the secret sauce, as Doug alluded to, it comes down to the team and the reputation that the team has developed in the market for so long. We are not going to win deals because of the quantum of funds that we're lending to people. People want us to be their counterparty because they know if their company hits a speed bump or there's opportunity or there's threats that we are a deliberative, thoughtful partner through thick and thin that's going to help them be successful. So it's the team and our reputation that's carried the day.

And as we all start paying more attention to this business from here, can you talk a little bit more about your philosophy on credit risk. How have you been able to navigate multiple cycles through periods of growth with such low levels of average losses? And do you think you need to take on more risk to grow here?

Our business is pretty simple. You can get 99% of the stuff right. But the one thing that matters, the critical success factor for a lending business is your core competency has got to be the ability to assess and manage secured commercial credit risk, and that's what we do. We are very, very conservative. The entire culture of our organization is culture center -- credit-centric, and everything that we do is under the lens of how do we make the smartest credit decisions that we possibly can. And I would say our track record over many, many business and credit cycles has validated our approach to credit. But it's the single most important success factor if you're evaluating a credit platform in my humble opinion, how have they done through a cycle, and we're proud of our results and how we've done.

And then just last one for you, Bill. Under Ally's more focused strategy, it's clear you view the business as an important driver to reaching mid-teens returns here. How do you think this business. How big do you think this business can get under Ally? Do you have any thoughts on medium-term or long-term projections from here?

Well, if you look back, I won't make any predictions, but if you look back over the past 4 or 5 years, we've doubled the size of the business, tripled the profitability. And as I said earlier, if you look at the individual components that make up the entire entity of Corporate Finance, each one of those businesses has a very, very compelling growth story for it, attendant to that. And we're convinced we can do that without altering our very, very conservative risk profile because something we'll never do is chase growth at the expense of loosening credit standards. That's not us, never will be.

Okay. Great. And I just want to pause and see if there's any questions from the audience, feel free to chime in at any point. Otherwise, we can continue. Doug, I mean -- sorry, Sean, too many of you up here. Let's wrap up with you. So you've laid out the journey to mid-teens returns. That's underpinned by NIM expansion, normalizing credit losses, disciplined on expense management. Can you talk about your journey in a little bit more detail here? And then maybe we could talk about the quarterly trends from here?

Sure. Thanks, Jeff. I'll actually -- I'll hit your question in reverse order, if that's all right. In terms of near-term results, I'd start by saying that the operational momentum and strength that we saw in the first quarter has really continued all the way through the month of May. So if you look at the Auto business, Doug talked a little bit about strong application flow. This has the potential to be a second consecutive all-time record from application volume specifically. That's led to really strong origination volumes. We expect to be up double-digit percent year-over-year in terms of consumer auto originations with yields that are pretty consistent with the strong yields we saw in the first quarter. From a deposit standpoint, we've talked about tax season in particular. We're now through the tax season for this year. And while we will have a sequential decline in deposit balances, just like we did last year, feel really good about the momentum of the business and frankly, deposit gathering for the full year is ahead of our own expectations, largely driven by strong balance retention throughout the year. On net interest margin, look, we've said it before, but just to reiterate, we expect to fully offset the 20 basis point headwind associated with the sale of card on April 1. Drivers, of course, are -- we made a couple of OSA moves pretty late in the quarter in 1Q. So you're seeing a full quarter of benefit there. And then we have a nice CD repricing tailwind that we highlighted in the disclosure in April. But even beyond that, just the continued roll-on, roll-off of 3% yielding mortgage and securities being replaced by the auto assets and corporate finance assets that Bill and Doug are generating creates a nice tug on margin upward over time. Look, a lot of focus on the back half of the year. And I would say in the near term, our trajectory is going to be influenced by rates. We've spent a lot of time with investors talking about how we are near term asset sensitive. And so to the extent we get into an easing cycle in the back half of the year, particularly an aggressive easing cycle, that is going to be a bit of a headwind to margin compression or margin expansion in the near term. But from our perspective, the direction in travel is incredibly clear and so too is the destination. Look, on credit, Michael hit this at a conference pretty recently, but I would say we remain very encouraged by what we're seeing in our portfolio, and that continued through the month of May, but remaining appropriately cautious of everything that's going on in the macro that Doug talked about. But generally speaking, losses right in line with our expectation for the quarter. So overall, 2 months into the quarter, I feel really good about results, but more importantly, we feel really good about the momentum in the businesses the guys have talked about today. Look, as it relates to mid-teens, we can appreciate that this is a show-me story, but we are very confident in the direction that we're headed. And that confidence comes from all the actions we've taken in recent years. If you just sort of step back over the past 18 to 24 months specifically, we've reduced interest rate risk. We've reduced credit risk. We've simplified the organization. We've exited noncore businesses, and we've driven the CET1 level quite a bit higher than it was 2 or 3 years ago, all while maintaining what we think is a uniquely strong deposit institution with 92% FDIC insurance. But even more encouraging than the actions is we're starting to see the inflection point in earnings, which is really a testament to the steps that we've taken. It can get really easy to get caught up in any individual quarter, but I would just reiterate that our earnings expansion story is actually quite simple. In terms of margin, Doug's business is putting loans on the balance sheet of 500 basis points over Fed funds. In Bill's business, we're more like 200 to 400 basis points over SOFR. Of course, it comes with less credit risk than the consumer side of the house. And as you know, Jeff, liquid deposits priced well below Fed funds. So we're going to continue to invest capital in those businesses, again, all while running off 3% mortgage and securities balances over time. That's -- when you put all that together, that's kind of how you get to that upper 3% NIM. On credit, Doug talked about what we're seeing on the front book, remain really comfortable with the credit position of the loans we're putting on to the balance sheet and that roll on, roll-off dynamic. Again, mindful of macro, but feel really good we're going to move below 2% over time. And then lastly, on cost, it's been 18 months straight of controllable expenses being flat to down. You can expect that discipline to continue. Total expenses will drift up a little bit higher, but frankly, that's a good thing because it comes along with fee income in the insurance business. So upper 3s NIM, normalizing credit, and a lot of focus on capital and expenses is sort of the path to get us to mid-teens. And like I said, we can appreciate this is a show-me story, which is why from our perspective, we're more focused on execution than ever.

Okay. Great. Anything else you want to leave with investors today before we depart here?

I don't think so, Jeff.

Okay. Great. I think we'll put an end to it here, and thank you guys so much for attending our conference, and we look forward to talking further.

Thank you.

Thank you.