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

Moving right along, I'm very pleased to have Ally Financial with us with from the company, Russ Hutchinson, Chief Financial Officer, Russ, welcome.

Thanks, Jason. Glad to be here.

Maybe the best place to start is just big picture. I think when you were here 2 years ago in the third quarter, Ally put up a 5% ROTCE consensus for this quarter, 13%, 14%. Obviously, a big improvement if that proves right, which we'll get to. Let me talk a bit about kind of what's gotten you here and speak to kind of what work remains.

Great. Thanks, Jason. I'm glad you mentioned the improvement we've seen in profitability over the course of the last 2 years. I think it's really strong evidence that the power focused -- our focused strategy is working. We're doing 2 things simultaneously. We're growing our core franchises. We're increasing our profitability, and we're managing our risk. And that improvement in terms of our performance is anchored in real improvement in our franchises. We have a customer-obsessed culture and that's delivering for us in terms of the traction we get. So if I look at our dealer financial services business, you can see that traction in terms of our Appalachian volume. When I look at our corporate finance business, it's in our investment portfolio there. When I look at our deposit business, it's had strong customer growth that we see year-over-year, -- so I'd say across all of our franchises, we're really delivering, and we're seeing the benefits of that delivery in terms of traction with our customers across all 3 franchises. I think we're pleased with our results so far to date. We expect to be on track with respect to the guidance that we delivered back in January. We're on track with respect to our medium-term targets. And I'm sure as we talk through this, we'll talk about -- we'll talk a lot about net interest margin. We're dealing with pressure along with the lentis relationship from the recalls. Obviously, we've seen the interest rate outlook change, but I'm glad to say we continue to be on track in terms of the guidance that we delivered. We're managing through those. When you look at retail auto and retail auto NCOs I'm sure we'll talk a lot about retail auto credit as we go through this. Again, we continue to be on track. We delivered guidance at the beginning of the year with the expectation that the midpoint was a pretty good guess of where we land within that guidance and that continues to be our assumption today. And so I know we'll talk a lot. We'll probably talk about vintage curves and we'll talk about just some of the headwinds we've seen this year with oil prices, et cetera. But again, we've managed through that, and we continue to be very much on track. And longer term, it's our expectation that we'll see retail audio NCOs drift lower towards our originated target range of 16% to 18% as we move forward. So we feel pretty good about how credit is developing in terms of the trajectory. In terms of operating expenses and capital efficiency. Again, we feel good about how things are progressing there. First half of the year, you've seen our operating expenses flat to slightly down. We've always talked about a low single digits range going forward. And we entered this year with guidance that we expected OpEx up about 1% over the year. So you'll start to see that lower single digits materialize over the back half of this year. But again, in our view, that reflects really strong discipline on operating expenses, our commitment to delivering positive operating leverage. And then on the capital side, we continue to deliver on the story of and not or. The heavy lifting is behind us in terms of building up our capital ratios, looking at it on an RSA fully phased-in view. And as we look forward, we think the first half of this year provides a pretty good template for how we think about capital. That is having capital on hand to invest in the growth of our core franchises, prioritizing growth in our highest profitability products. In retail auto loans and corporate finance and at the same time, returning capital to shareholders with our share repurchase program. So we look across the board, and we feel pretty good about the trajectory that we've established and the track record over the course of the last couple of years since we launched focus forward.

So a lot in there. I'm hoping we can unpack that. I guess the 2 areas I get most asked about as NIM and retail auto charge-offs. So let's maybe start with NIM. You've guided for the full year 3.6% to 3.7%, which it sounds like you still feel good about. You talked about maybe the potential to exit this year above the high end of that range. Maybe talk to the ability to do that. You talked about kind of high 3s over time. The Fed I'm told is hiking tomorrow, how does that potentially impact your outlook? And just talk about the potential hedging strategies to maybe reduce some of that NIM variability going forward?

Yes. No, there's a lot in that question. And maybe -- and maybe where I'll start is we're pleased with the NIM expansion that we've delivered so far. And so you dial it back a couple of years, ex cards, our NIM hit about 3% second quarter, we were about 3.6%. And so that expansion is something that we're pleased to have delivered and gives us confidence as we think about the forward -- and I'd say, look, the NIM story is very much anchored in that customer obsession, that traction that I described with customers beforehand. And we see it on both sides of our balance sheet. And so we exercise a lot of pricing discipline on both sides. Within retail auto, that application volume that we talked about, it gives us the ability to look at a lot of applications to really assess credit and then to manage our book a quarter-to-quarter basis in terms of maximizing our risk-adjusted returns. On the deposit side, that strong deposit growth at strong deposit customer growth that we have provides a nice anchor for us to be disciplined in of how we price deposits going forward. And that's anchored in real things that we're doing with our customers. Our commitment to our dealers, our consistency over a long period of time. I was at the Ally challenge a few weeks ago just outside of Detroit. And I'll tell you, dealer after dealer thanked us for our consistency our reliability in the market. And I think that pays dividends in terms of the traction we have with our dealers. We've made a lot of changes to our business to help them sell more cars. One of the changes we've asked our dealers to send us all their applications and they're doing that and that gives us more looks and more opportunity to manage towards risk-adjusted return and to be disciplined on the asset side of the balance sheet in terms of pricing. Similarly, when you look at the deposit side, we've made real investments in our deposit platform, providing a digital experience that's second to none, a nationally recognized brand that resonates with our customers, a long track record built on trust and doing things the right way for our customers. And that's paid dividends for us in terms of 7% year-on-year growth in customer accounts in the first half of this year, and it's something that we expect to continue building upon. And so that NIM expansion that we've seen over the last couple of years is really anchored in things that we've done in the business. Now as I think about kind of more current terms, if you look over the course of this year, we started the year back in January, we gave a guide of $3.6 billion to $3.7 billion. Yes, a lot of things have changed. Obviously, the interest rate outlook has changed. We've seen some headwinds in terms of gains or more appropriately losses on lease terminations. Some of you will remember at the start of the year, we talked about PHEV, plug-in hybrid electric vehicles and some of the challenges we had there as a result of recalls and other changes in the industry. It's I think it's well known that our lease terminations this year are somewhat over concentrated in Stan. Lantus recalls on gin hybrids kind of hit us hard towards the beginning of this year and the end of last year. And now they've extended recalls to a broader swath of their vehicles, including internal combustion engine vehicles. And so we're seeing the impact of that. We now expect to take about $20 million of lease losses in the third quarter. And so where previously I would have expected net interest margin to be up quarter-over-quarter on the back of some of the deposit pricing changes we made in the second quarter. We now expect it to be more or less flattish. And that's a headwind, obviously, we didn't anticipate in January, but I'm pleased to say that it's still our expectation that will be in the range of 3.6% to 3.7%. And it's still my expectation that we'll exit the year at the high end or above that 3.7%. And so we feel pretty good about our ability to manage a changing rate outlook and other bumps in the business and still deliver on the guidance that we gave back in January. The rate outlook has obviously changed. You mentioned that in your question as well. We're now expecting 1 or 2 rate increases. The first 1 we expect tomorrow, and then we'll expect another 1 early in 2027. Interestingly, the effect of a rate increase in terms of the current quarter is positive. We do have a significant floating rate portfolio between our commercial auto, corporate finance as well as our hedging portfolio and effectively, those yields adjust real time right away. And then on the deposit side, we're going to be disciplined on deposit pricing. So you saw us when rates were coming down, we were disciplined. We got to a 69% beta on the way down, and we're going to be disciplined on the way up. And so we'll manage our deposit pricing on the way up to hold on to some of the benefits of those rising rates on the floating rate side of our business. So again, we've dealt with some headwinds here and some changes in terms of the rate outlook and in terms of lease residual performance. But again, we're managing through that. Our guidance remains intact and nothing has changed from that perspective. Similarly, a lot of the same factors that have been driving our overall expansion in NIM for the last couple of years remain intact. The biggest driver will be the remixing of the balance sheet. So as we continue to put on higher-yielding retail auto loans and corporate finance loans while running off lower-yielding mortgage loans and legacy mortgage securities. We have a natural gravitational pull upwards in terms of our net interest margin over time. And we continue to believe we have a strong trajectory towards our high 3s medium-term objective.

A lot in there.

A lot in there. Now you asked about hedging as well which is an important part of our risk management strategy, and we continue to hedge very dynamically. But I'd also point out that we have made real structural changes to the business to reduce that interest rate risk volatility exiting a discontinuing mortgage originations running off that portfolio. The way that we've changed our approach to our investment portfolio where we're taking the runoff of that portfolio, we're reinvesting it in shorter duration securities. A case in point is the securities repositioning we did last year in 2025 where we took a large chunk of that legacy portfolio and repositioned it into shorter-duration securities. We're making real changes to our business to help manage that asset liability in a better way.

Okay. A couple of quick follow-ups. You talked about the $20 million lease reuse loss in the third quarter. Is that just entirely tied to Stellantis and we'd expect that to kind of not reoccur in the fourth quarter? I guess how should we frame that?

Yes. It's tied to Slants. It's vehicles that have been impacted as a result of their recalls. And I'd say I'm glad you doubled down on that one. We're overexposed on the Lantus lease terminations this year, but that changes over time. So many of you guys who have been following us for a while know that I think it was the first quarter of 2024, we entered into an arrangement with an EV manufacturer. And a lot of our lease volume actually pivoted towards that relationship. That relationship has residual value protection built into it. So those leases are going to start coming off at the beginning of 2027, so beginning of next year. At the same time, we diversified the remainder of our lease origination more away from Stellantis and towards a more diversified mix of OEMs. And so once again, that takes effect as well. And so I think the Stellantis pressure will certainly be an issue through the remainder of 2026 but as we get into 2027, we'll see that Stellantis lease termination concentration abate. And by the time we get through the end of 2027, that pressure is gone.

And I guess on deposit pricing, I think the cumulative beta on liquid savings has been around 70%. One of the things we've seen is kind of CD rates drift higher in front of this Fed hike. Just how do we -- how should we think about that looking out.

Yes. I think we've seen a lot of competitors use the CD product as a way of offering rate to their customers. We're coming in in a relatively strong position in terms of the strength of our brand and that underlying growth in customer accounts. And so we've been able to be a little bit more disciplined. Now we've put some rate increases on the CD side as well. But we've been more disciplined relative to the rest of the market. Also, when you look at our overall concentration of CDs, that's come down over the course of the last couple of years. And so again, we have a few benefits built into our business to help us manage through that.

Yes. So maybe shifting to the other side of the balance sheet. But Q1 originations skewed richer and 2Q adjacent skewed towards kind of maybe higher credit quality. Just how are you thinking about the STR mix and just the impact to originated yields and portfolio yields rest of this year into next year?

Yes. Look, I think it's easy to get caught up in the quarter-to-quarter dynamics -- but I really caution you against reading too much into any 1 quarter's originations. As you pointed out, Q1 was rich in terms of yield and with the lower STR concentration Q2 swung the other way in terms of higher STR concentration, lower yield. And interesting in Q2 kind of buried in that improving STR mix -- we put a lot of price into the market. And so if you looked at Q2, if you looked at Q2 cohorts on a like-for-like basis in terms of credit, we actually put a significant amount of price increases through the market. Now as I look at Q3, our expectation is we'll see a good improvement in originated yield. And that will come primarily from putting price into the market. We've talked about the STR mix settling in long term in the low to mid-40s. I think for the third quarter, we'll probably be more like mid-40s. So maybe a little bit of progress there in terms of bringing that STR concentration down. But most of that yield improvement that you're going to see is going to be driven by the pricing actions we took in the second quarter, basically continuing through the full of this quarter and pricing actions that we've been able to put into the market over the course of the third quarter as well. So we continue to feel pretty good about the competitive environment, and we feel great about the traction that we have with our dealers, that's really driving the application volume, which is giving us the ability to be able to manage for the best risk-adjusted yield possible in our portfolio. So again, we continue to feel good about where we are in the pricing side on the auto business. And we think it's supportive to our high margins over time.

Helpful. Maybe shifting gears to credit quality. I guess, this morning kind of reiterated the midpoint of the $1.8 billion to $2 billion guide for retail auto NCOs. I guess that's 1 9. Just maybe just talk to just how to think about the progression in the back half of the year. And just how you think looking out further kind of normalization towards price expectations over time? I think you should talk about 1.6 to 1.8 for cargo.

Yes. So we're pleased with the performance that we've seen in the book year-to-date. I'd say in the first half of the year, low to loss rates and used vehicle prices were probably better than we had expected. And we talked pretty openly about our expectation that those things will normalize through the back part of the year. When you look at our guide of 1.8% to 2% and you look in particular at the midpoint, and you look at what we printed in the first and second quarter, it's pretty clear that in order to get to that midpoint 6% to 1.9%, that would imply that NCOs are flat to slightly up in the back part of the year. And again, that was anticipated. That was expected on our part -- that support that we were getting in particular from used vehicle values, we expected some normalization there, and we believe we're seeing that. So we feel pretty good about 2026 being yet another example of our calling credit and pricing risk appropriately. And then longer term, we continue to expect retail auto NCOs to drift towards that originated range of 1.6% to 1.8%. We haven't put a time line on that, but we certainly expect that, that continuing drifting.

All right. So 2 follow-ups. I guess, one, you talked about kind of used vehicle prices. Just how do you think that plays out kind of looking maybe beyond this year into next year?

I think our expectation over the medium term is we expect to see continued support in terms of used vehicle prices, and it's really grounded in the supply of vehicles manufactured over the last 3 to 5 years. Just coming out of the pandemic, manufacturing capacity was constrained. The other part of support is just what we've seen on new vehicle MSRPs, just the price of new vehicles and the used vehicle is really providing the best affordability option for the customer. And so we see those 2 things, the support we're getting from new vehicle MSRs as well as just supply constraints as being helpful to used vehicle prices over the next couple of years.

And then I want to maybe just ask about kind of vintage curves. They've got a lot of attention recently, particularly around kind of 10-Q season. We're kind of looking at 2025, 2026 vintages in particular. Love to get your take on kind of what you're seeing there, any emerging trends in your book that may have contributed to some of these dynamics -- maybe just talk about what you're seeing.

Yes. Again, we continue to be pleased with what we're seeing. We've been talking for a few quarters now about the '24 vintage having outperformed our expectations. And that's not necessarily a goal of ours. And so we expected the '25 vintage to not perform quite as well as '24, and that's what we planned for. It's what we modeled for. And that's what we're seeing. And so nothing in the vintage curve surprises us -- you mentioned '26. I know a lot of people look at the '26 data. In our view, it's too early to read anything from that. But there's nothing there that surprises us as well. And so we continue to feel pretty good about our loss guide for this year, obviously, and about the trajectory going forward. As you can imagine, for us, credit is very dynamic in terms of the way that we underwrite. We simplify everything. We talk about the STR population, but the reality is we're looking at monthly vintages across a number of different cohorts. We divide them into what we call micro segments. And we're looking at multiple characteristics of each of the cohorts to define the micro segment. And we're constantly looking for micro segments that are outperforming our price expectations and micro segments that are underperforming our price expectations. And so as you can imagine, we're dynamically making changes to our pricing to our underwriting threshold to our rules for what gets kicked to manual underwriting in order to address any kind of variances that we're seeing positively or negatively and again, at a very granular level in terms of analyzing all of these different micro segments. So we continue to be dynamic in terms of how we manage credit. As you can imagine, we're always going through periods where we see certain segments that are underperforming and others that are overperforming were dynamic. We're adjusting for that on a real-time basis. But as we look at the vintage curves, '24, '25 and what we've seen in the early days of '26, we continue to be confident in our ability to manage credit moving forward.

So I guess $1.9 million in charge-offs this year, retail auto kind of 1.6% to 1.8% normalized. Is that something we could see next year? How should we think about that?

We'll give guidance in January the way that we typically do. And so that gives us the benefit of looking at how credit performs over the back half of the year. And that's how we do it. And we haven't promised any specific timing on the 1.6 to 1.8. So we'll come back to you in January with a view in terms of 2027 NCOs.

Yes. There's been a lot of finance. Maybe let's go to the operational side of the house. We've seen very strong growth in auto application flow despite the fact that I feel like the market has been competitive -- maybe just share kind of what's behind the strength we've seen and just kind of current expectations for the pipeline and continued growth opportunities.