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Ally Financial Inc
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Good day, ladies and gentlemen, and welcome to the Q1 2018 Ally Financial, Inc. Earnings Conference Call. As a reminder, this conference is being recorded.
I would now like to introduce your host for today, Mr. Michael Brown, Executive Director of Investor Relations. Please go ahead, sir.
Great. Thanks, operator, and thank you, everyone, for joining us as we review Ally Financial's first quarter 2018 results. You can find the presentation we'll reference during the call on the Investor Relations section of our website, ally.com.
I'd like to direct your attention to the second slide of today's presentation regarding forward-looking statements and risk factors. The content of our conference call will be governed by this language. I'd also like to note slide 3 of today's presentation, where we disclose some of our key GAAP and non-GAAP or core measures. These and other core measures are used by management, and we believe they are useful to investors in assessing the company's operating performance and capital measures, but they are supplemental to and not a substitute for U.S. GAAP measures. Please refer to the supplemental slides at the end for full definition and reconciliations.
This morning, our CEO, Jeff Brown; and our CFO, Jen LaClair, will cover the financial results. We'll have some time set aside for Q&A at the end.
Now, I'd like to turn the call over to Jeff Brown.
Great. Thanks, Michael. Good morning, everyone, and thanks for joining our call. I'll start by covering highlights from the quarter on slide number 4. We reported adjusted EPS of $0.68, up 42% year-over-year. Importantly, all line items are fully tracking what our team discussed on the financial outlook call last month.
Year-over-year earnings and EPS growth were driven by a combination of 5% top line revenue growth, lower share count and a reduced tax rate. On the operations side, the auto finance business performed very well to start the year. Consumer auto originations of $9.5 billion were up 7% year-over-year with strong risk-adjusted profitability. We're holding the line on credit, and yields continue to increase. And for the first time in a quarter, used originations represented over 50% of our volume.
We've deliberately focused on growing our used originations. We like the characteristics of the paper. It tends to be more predictable performance, better yielding. It's sourced from a diversified base of dealers and the market is much larger in size and new. The retail origination trends are now materializing at the portfolio level as the book has normalized.
For the first time in a while, our portfolio yield was up year-over-year, while our loss rate was down. We continue to expect retail auto charge-offs in the 1.4% to 1.6% range, while yields see further upward momentum. And I know Jen will cover more on that in just a minute.
Overall, credit conditions are pretty benign, and macroeconomic variables appear strong. This could be a nice earnings tailwind as we navigate the year. On the retail deposit side, we grew $3.7 billion. That is our strongest first quarter ever. Deposit growth and customer growth continue to fuel both our earnings growth path as well as our strategic path in building the leading digital bank.
2Q deposit growth tends to be a bit softer, given the impact of consumer tax payments. But we are well positioned to deliver retail growth, generally consistent with what you've seen over the past couple of years. From an earnings perspective, we continue to benefit from the structural roll-down of debt into deposit funding. This is very strategic for us.
Looking at our key financial metrics on slide number 5. We'll reiterate it's not always going to be a straight line, but we see these metrics meaningfully higher on a year-over-year basis, and that will fully continue over the medium term. Adjusted EPS of $0.68, again up 42% year-over-year, was down quarter-over-quarter largely driven by the very strong lease performance we saw in 4Q, as well as lower day count this quarter. That dynamic can also be seen on the revenue side, where we were much higher year-over-year, but down a touch from 4Q.
Deposits in the bottom left are a great story. I know there's a lot of focus on deposit rates and betas, considering the higher rate environment. We feel good about our rate path, and we think it's critical to look at not only rate, but also value-added growth. Our deposit growth enables us to bring down capital markets funding and fuel asset growth.
Tangible book value on the bottom right was down this quarter. As you've seen from many other banks, with rates moving higher, our OCI was impacted during the quarter. So, overall, a solid, clean quarter and I'm encouraged by our business performance and market backdrop on both the lending and deposit side.
With that, I'll turn it over to Jen to walk through more details on the quarter.
Thanks, JB, and good morning. I'll start first with our income statement on slide 6. Net financing revenue ex-OID of $1.069 billion was up $73 million, driven by asset and deposit growth. Despite the movement in deposit rate this quarter, the benefit from bringing down expensive funding sources and asset growth more than offset this impact.
Quarter-over-quarter, net financing revenue was down $44 million, primarily due to three factors: one, lower lease gains as a result of lower termination volumes and less benefit from hurricane replacement; two, lower day count; and, three, hedges we put in place to reduce exposure to increases in short-term rates.
The core year-over-year net interest income growth path continues. We expect to see acceleration in this line item in Q2 and throughout the rest of 2018. Adjusted other revenue of $394 million was flat year-over-year and up a bit from Q4.
I'll note that, starting this quarter, we have earnings impact from a new accounting standard, requiring us to recognize changes in the unrealized value of equity investments through the income statement. Those investments are largely held within the insurance business. We plan to adjust for this item and believing normalized view is consistent with prior periods and more reflective of core operating results.
Provision expense was down, as we're seeing loss rates stabilize and less of a credit impact from the hurricanes. Noninterest expense moved higher. Expense growth is largely driven by both business growth, as well as our product diversification initiative.
This quarter, we also had an $8 million impact from the one-time tax reform bonuses to our associates. Increases from the fourth quarter were largely driven by typical compensation seasonality we see each year. So that gets us to GAAP EPS of $0.57. And after backing out OID and the changes in the equity valuation, we had adjusted EPS of $0.68.
Core ROTCE of 10.6% this quarter was up from 8.2% last year. And the adjusted efficiency ratio was 50%, given the seasonal expense impact. We'd expect that to fall below 50% for the remainder of the year. The effective tax rate was in line with our prior guidance at 23%. So a solid quarter overall and consistent with the guidance we provided in March.
Turning to slide 7 to look more at net financing revenue. I already mentioned some of the key themes, but looking in more detail on a couple of line items. Our retail auto loan yield was flat linked-quarter at 5.9%. We had another strong quarter of production with originated yield of around 6.5%, which drove a 4 to 5 basis points increase in the underlying portfolio yield over prior quarter. This increase was offset by the impact of hedges we put in place early January to enhance our position relative to short-term LIBOR rates.
Based on our origination yields in the hedges, you will see an increase in retail auto yields in Q2 and throughout the rest of the year in line with the 6% to 6.2% portfolio yield, the outlook we provided in March.
I'll also mention the lease yield. We're seeing a transition in the lease portfolio as gains moderate and the legacy GM book has largely run off at this point. Termination volumes have declined significantly. This quarter, our yield was around 5.1%. Typically, in Q1 and Q4, you see the lowest seasonal yields and would expect to be up modestly in Q2. This is a headwind we continue to face with a lower lease balance and a lower yield relative to prior years, but we have offsets in other areas.
In commercial auto, we're seeing a benefit, given these are floating rate assets where yields have moved up with LIBOR. But those higher commercial yields as well as higher retail auto yield drove overall asset yields up 23 basis points year-over-year. On the liability side, deposit rates have increased, as discussed on the March outlook call, and were trending in line with our expectations on deposit beta.
Overall, managing deposit rates in a rising rate cycle is a critical focus. We continue to have a significant structural benefit from growing deposits, while we bring down more expensive funding sources and fuel accretive asset growth. This would drive net financing revenue significantly higher over time and drive expanded return on shareholder capital, which is our primary focus.
Looking at deposits on slide 8. The secular trend towards digital banking remains strong and we have the wind at our back. $3.7 billion of quarterly growth was a record for a first quarter, as JB mentioned, and drove retail deposits up $11.7 billion year-over-year, which is a great annual pace. The total deposit base is now over $97 billion, and we expect to push that to over $100 billion later this year.
Customer growth was also strong this quarter with a net growth of 59,000 customers, our highest total in five years. We're maintaining strong customer retention levels of over 90%, and every deposit vintage has remained stable or grown, back 10 years.
Our loyal and growing customer base is strategically important, as we look to drive cost-efficient deposit growth, as well as offer an extended retail customer product suite, particularly, Ally Invest and Ally Home.
On the rate side, the portfolio average moved up 15 basis points this quarter. There was an acceleration of deposit beta, as we've been expecting. We look at the longer-term trends here, and cumulative beta is up 21% relative to Fed funds since the start of the tightening cycle, well in line with our expectations and keeps us on our path for delivering our financial targets.
Turning to capital ratios on slide 9. CET1 was down a bit this quarter, driven by risk-weighted asset growth and adoption of new accounting rules. While we have grown our RWA, earning assets have grown at double that pace, given the increase in more capital-efficient assets to increase ROE. As we generate capital, we're deploying a significant amount towards share repurchases. That's driving down our outstanding share count at a good pace, as shown on the bottom right.
In total, we have repurchased around 11% of our shares since the second quarter of 2016 at an average price of $22 per share. We just went through the CCAR process and have submitted our capital plan. We're generating more income now than in past years and expect to continue to deploy the large majority of what we're earning.
We still see share buybacks as an attractive capital deployment alternative. So, we'll continue to lean in there. And clearly, there are changes on the horizon in terms of the CCAR process and stress modeling. Overall, we are encouraged by the potential changes. We plan to participate in the comment process and are supportive of efforts to make capital management more practical, flexible and efficient. Briefly, on our deferred tax asset, we saw a slight increase this quarter, as the decline in OCI driven by rates more than offset the impact of core earnings.
Looking at asset quality on slide 10. One key takeaway is, for the first time in a while, we're now seeing the net charge-off rates really flatten out on a year-over-year basis and were actually down somewhat particularly in the retail auto portfolio. Our retail auto coverage ratio came down a few basis points based on the performance we're seeing in the portfolio.
If you recall, we put up a $50 million reserve for incremental credit losses due to the hurricanes last year. And based on the performance to-date, the hurricane-specific reserves declined in the first quarter, which brought the overall portfolio coverage ratio down 3 basis points to 1.54%. That level is consistent with the 1.4% to 1.6% net loss rate expectations for the overall portfolio.
Looking at delinquencies in the bottom left. We're still seeing some increase on a year-over-year basis. Much of that is driven by dynamics around the new use mix of the portfolio, as well as some collection strategies we're employing. We've been more effective in managing roll rates and flow to loss, and delinquencies are running in line with expectations.
We remain positive about the forward outlook on our credit trends. We've addressed the underlying – underperforming areas from prior vintages and have trimmed some tails on risk, and the consumer is healthy given the continued strong macroeconomic backdrop and tax reform. As always, we'll closely monitor portfolio and market trends and react accordingly to ensure profitability through the cycle.
Turning to the segment, starting with auto finance on slide 11. Year-over-year pre-tax income was down, driven by lower gains on loan sales, partially offset by higher net financing revenue. Sequentially, pre-tax was down due to day count and lower lease revenue, as gains on average vehicles was down around $400 per unit, given seasonal factors and the hurricane effect subsiding. That was partially offset by lower provision expense, given seasonal factors and the lower hurricane reserve, which has declined to $18 million.
On the retail origination side, we thought it would be helpful this quarter to show our quarterly application flow. While this isn't a perfect illustration of what drives the originations, since there are other market forces and not all applications are created equal, there are a few key takeaways.
One, the year-over-year increase in used applications is notable, where we saw 100,000 more this quarter. Two, it demonstrates the deliberate strategic positioning of the business over the past several years to source more apps for more dealers. And, three, there's a lot of focus on industry sales or SAR flattening. But we are seeing a lot of opportunities to originate profitable loans to enable us to optimize our risk-adjusted return and drive earnings growth.
As JB mentioned, we like the profitability on used. And we're also aligning with emerging trends and players in the marketplace. We'll continue to explore alternative channels for attractive incremental growth, where we can leverage our expertise and also position the business for the future.
Looking at the origination and balance sheet numbers on slide 12. Both our growth dealer percentage and used volume percentage were at all-time highs this quarter. That helped drive our originations up to $9.5 billion. And while we're not primarily focused on volume or market share, we were able to generate strong volume at solid profitability levels. That helped propel our consumer asset base higher this quarter up to nearly $78 billion. And as part of that, the lease portfolio has leveled out in the mid-$8 billion range.
On the commercial side, balances were down from the elevated levels we saw early last year and pretty flat sequentially. Dealer inventory levels have been normalized. And overall, that's healthy for the market backdrop.
Looking at insurance on slide 13. Overall, another steady quarter here with core pre-tax income up $22 million year-over-year. As previously mentioned, that excludes the impact of the equity mark-to-market of $35 million, given some gains we realized this quarter along with the performance of the equity market.
Written premiums have moved higher, up $35 million year-over-year, driven by both good volumes on the service contract side, as well as better rates on the floor plan inventory insurance side. And notably, we renewed our reinsurance agreement for this year, which will reduce earnings volatility. Given the adverse weather over the last four quarters, our quarterly attachment points have moved up modestly, but the terms are generally similar to last year.
On slide 14, the corporate finance business continues to perform well with core pre-tax income up $9 million year-over-year and $2 million quarter-over-quarter. Steady loan growth and stable credit are driving the positive trends in this segment. Year-over-year, held-for-investment loan balances are up over $800 million or 25%. We're getting loan growth from both previously existing verticals, as well as new specialized verticals added over the last couple of years, which we break out on the page, like the diversification, returns and growth trajectory that this business provides.
Turning to mortgage finance on slide 15. Net financing revenue was up both year-over-year and quarter-over-quarter, driven by steady portfolio growth. This was somewhat offset by higher non-interest expense. Expense growth is driven by bulk purchase asset growth, higher corporate overhead allocations, as well as expense associated with building out the Ally Home business.
Let me wrap up on the financials and the outlook for the rest of the year on slide 16. Overall, Q1 was a solid quarter and keeps us on the path to delivering our 2018 outlook that we're reiterating on this slide. Year-over-year trends continue along the themes we've been discussing for a while, which we expect to translate into adjusted EPS growth of 20% to 30% for the year.
We expect net financing revenue to move higher, fueled by deposit growth even at higher expected rates, and we still have a bit of a headwind from the transition of the lease book, but this will be more than offset on the loan side. We remain focused on demonstrating that credit is contained and the portfolio trends we are seeing are positive.
On the expense side, we're making prudent investments in technology and product expansion to position the company for the long run, and we're obviously getting the benefit of the lower tax rate. So, overall, we're off to a good start in 2018. We're well-positioned to deliver our overall financial outlook and the path for the year based on trends in the business, the market, our portfolios and the financials.
And with that, I'll turn it back to JB.
Great. Thanks, Jen. Pretty good time for Jen to come into the chair as CFO, a lot of positives to start the year. I'm going to wrap up on slide number 16. I'd just say, I feel good about the financial path and what the businesses are delivering today and, importantly, how we're positioned for the future; incrementally constructive on the opportunities out there and the strength and resiliency of our business. Still very competitive, but I like the flows we're seeing.
The banking and deposits business continues to demonstrate its strength and really is fuelling the strategic and financial growth path for the company. We're focused on getting our new businesses, namely Ally Invest and Ally Home, scaled up over the next couple of years. Ally Invest is making good progress, and we're excited about some of the improved customer interface and technology we'll be rolling out this year in that business.
We've got some work to do on Ally Home in improving that offering, and I expect us to make a lot of great progress on mortgage overall this year. We're also generating strong capital organically and have attractive ways to deploy that capital by supporting our customers through our lending businesses, as well as significant share repurchases at current valuations. Overall, the right ingredients are there to drive strong shareholder returns for a long time.
So, Michael, I think, with that, we can head back to Q&A.
Great. Thanks, JB. As we move into Q&A, we do request that you please limit yourself to one question plus a single follow-up. If you have additional follow-up questions after the Q&A session, the IR team will be available.
So, operator, if you could please start the Q&A?
And our first question comes from the line of Donald Fandetti with Wells Fargo. Your line is now open.
Good morning. Jeff, clearly, your credit has been trending well and you guys sort of had a good read on that. But as you look at the retail auto delinquencies up, I think it's about 25 basis points year-over-year versus 15 basis points last quarter, will that ultimately sort of bleed into higher charge-offs? As you think about 2019, I think in the past you've talked about 2019 not being too materially different than 2018 on charge-offs. And I guess it sounds like some of that's just mix.
Yeah. Don, I'll start and then let Jen provide some of the details. I mean, I think, overall, we come back to kind of managing charge-offs in that 1.4% to 1.6% range. I think the danger in looking at delinquencies is it's a point-in-time measure. But importantly, I think when we dive into the details, what we're not seeing is delinquencies falling to loss rates. We're just not seeing that trend. So we feel good overall about the state of credit.
Jen, anything you want to...?
Yeah. I mean, I would just add in there. Good morning, Don. The mix really matters here. So as we've shifted to used and you saw we hit record highs this quarter, you tend to get higher frequency, less severity. And coupled with the fact that we've implemented some new collection strategies, we've really stemmed the flow to loss in the portfolio. And that's why you're seeing charge-offs down about 7 basis points year-over-year.
Got it. And then, on CCAR, one of your competitors the other day just talked about the Fed being a little tougher on – including – and subprime auto, I know you're sort of more focused on prime. But have your views changed on CCAR as you've kind of gone through the last six months?
Yeah. And, Don, we just submitted and we can't get into the details. But there were definitely some pluses and minuses in the submission. Certainly, the severely adverse scenario, the macroeconomics were worse than we'd ever seen. However, if you looked at our modeling around PPNR because we're starting from a higher earnings point, as well as we've got lower deferred tax assets. And also, our deposit book is higher and the rates are higher, so we had a bit of a tailwind coming into PPNR and then lastly a steeper yield curve. So there were pluses and minuses in our submission. I think, overall, we feel confident in terms of being able to grow earnings organically and continue to deploy capital against our earnings growth.
Thank you.
Thanks, Don.
Thank you. And our next question comes from the line of Betsy Graseck with Morgan Stanley. Your line is now open.
Betsy, we may have you on mute.
Oh, yes. Yes, I am. Thank you. Good morning.
Hey. Good morning.
Hi. Hey, a couple questions. So, one, just to follow up on the last one. The question I have is regarding the used portfolio that obviously increased this quarter, as you mentioned. Just wondering if you could – I know you mentioned the profitability on used is really good and you like that. Could you just make sure that we understand what your thoughts are on how that higher level of used is going to be impacting the net charge-off line?
Yeah, sure. This is Jen. Good morning, Betsy. Yeah, I mean, we just talked about it a little bit. It does tend to increase the frequency and the delinquency levels and you'll see that. However, I think it's just an easier asset class to predict collateral values, and we're very good at kind of managing collections around used. So we're not anticipating the shift to used in any way to pick up our charge-offs and we'll be well in line with our 1.4% to 1.6% guidance that we've been providing for some time.
Okay. And then, the follow-up is just on, how are you seeing borrowers react to the higher level of interest rates that's been coming through over the past year? I mean, obviously, we're seeing the blended portfolio. But maybe if you could give us some color on any changes that you're seeing in your new loans as borrowers are dealing with the higher rates. And I get the question from investors on how much longer can consumers take on these higher rates, and I just would like to get your sense on that.
Yeah. Betsy, what we're seeing is just overall healthy trends around the consumer. We're very sensitive to unemployment rates, and unemployment rates have been trending favorably over the last – gosh, I forgot how many quarters here. So, we're seeing overall very healthy consumer. We really haven't seen the tick-up in rates impact either demand or our ability to originate in the market. So, it hasn't impacted.
Okay. Thank you.
Thank you. Our next question comes from the line of Chris Donat with Sandler O'Neill. Your line is now open.
Hi. Thanks for taking my questions. I wanted to ask about the accounting standard, the ASU 2016-01. Just as we think about your – the line on the income statement for other gains and losses and, last year, that line averaged about $26 million a quarter, should we just be now expecting because of the fair value changes to equities just more volatility around that line? Or was this a unique quarter just because of the market performance? I mean, just trying to think about...
Yeah...
In the context that you...
Yeah. Going forward – first of all, that line item on gains will always jump around a bit as we see opportunities to sell securities in our portfolio. So, always a bit of volatility there. Our approach on the new accounting standard around the equity valuation was to adjust that out in large part because it will depend on the equity market. It already flows through tangible book value and capital. So, it's already flowing through the balance sheet. And when we adjust it out, it just makes it a much easier comparison for you on an apples-to-apples basis.
Okay. And then...
But going forward, that line item will fluctuate with the equity market performance, as well as our realized gains and our dividends.
Okay. And then, on a somewhat different topic, as you've moved more into used vehicles on originations, does that reflect mostly your strategy? Or is there a part of that that you've seen some opportunity because of some other large competitors pulling back on their activity? I just wonder how the competitive dynamic fits into your strategy.
Yeah. It's a little bit of both. I mean, this has been our strategy for some time now. We want to be a diversified lender, and we see opportunities across new, used, leased. And as we've shifted to a full spectrum lender, we've seen a lot of opportunity in the used space. Certainly, it showed up this quarter with record flows from the growth channel, as well as record used originations. So, we'll continue to focus there.
I think it is a place where we feel the competition is fair. I mean, if you look at some of the tails in the subprime and super prime, and it does get a bit crowded there. With our very diversified, full-spectrum lending as well as our portfolio of products, which really gets across financing as well as insurance and even branching into some new innovation in the auto space, I think we are very well positioned to continue to grow used as well as new and leased.
Thank you. And our next question comes from the line of Moshe Orenbuch with Credit Suisse. Your line is now open.
Great. Thanks. I guess, first, maybe could you just talk a little bit about the competitive environment at the dealer and kind of your thought process in terms of that mix? And obviously, the GM portfolio has been kind of running down for a while. But maybe just talk about that and how you've been able to kind of maintain/increase your volumes.
Yeah, sure. Good morning, Moshe. On the lease side, we've been talking for some time with the transition from GM which has largely run through. I think it's less than 5% of our units now. So, we've really hit that run rate on the balance sheet and leased about $8.5 billion. It could kick up to $9 billion. And on the yield side, we've seen that come down a bit from the fourth quarter primarily because of the inflated used car vehicle values because of the hurricane, and we'll see that running around low-5s going forward.
But besides lease – and we still really like that product and we feel we're well positioned in it. We've got really great disposition around lease, as well as – we're good at establishing the residuals. So we'll continue to stay in the lease business. In addition to that, we're looking to continue our strategy around dealers. We've got over 18,000 dealers that we have very close partnerships with and will continue to be a full spectrum across used and new for our dealers.
Yeah. And, Moshe, I guess, the one other thing maybe to add, you asked about just kind of competitive space and to build on the last question even from Chris. I mean, we've seen some players come in and come out. But it's still pretty fluid out there. But everyone I think particularly in the big bank space has been pretty rational. So, I mean, it's always a competitive market, but not seeing anything outside.
I mean, we may benefit a little bit from some – from a couple of players pulling back in the used space, and that's probably fueling a little bit of our growth. But, net-net, as Jen said, it's just all about working with the dealers, building good relationships there and seeing flow.
Thanks. Just as a follow-up. I guess, you – can you talk a little bit – because I think there's a little bit of confusion equating used car sales with subprime car sales. And I guess, for a given FICO, wouldn't it be true that the actual used car loan to be less risky because severity would be less because of depreciation? And maybe you could kind of talk about that a little bit.
Yeah. What we are able to do in the used space is really lend full spectrum. We don't see a specifically different FICO score in the used space versus a new space. What we do see from time-to-time is a higher frequency. But again, because the collateral is predictable, we're able to manage that flow to loss very well in the used space. But, no, we don't see a very big delta in FICO or credit quality in the new versus used.
Yeah. And I think, Moshe, you're right. I mean, that seems to be maybe the wrong misnomer that used borrowers or all subprime borrowers. And therefore, we must be skewing to a lower credit quality borrowing. You just don't really see it at all. I mean, I think the FICO differences are kind of within around 20 points or so.
So, net-net, they're very much in the same ballpark. And as Jen talked about, you may have a little higher frequency. But severity on used, it's much better. And obviously, the asset has already taken its kind of upfront hit. So, net-net, it's a very clean product for us to get our arms around and it's not all that different from a borrower base.
Got it. Thanks so much.
Thank you. And our next question comes from the line of Arren Cyganovich with Citi. Your line is now open.
Thanks. If you could just talk a little bit about the hedging costs for the quarter and the duration of those hedges and what the ultimate impact of your pricing. Is it just kind of kicking the can down the road to some extent or just eventually get to market, but I am just trying to better understand the hedging strategy on the short-term rates.
Yeah, sure. Good morning, Arren. We put the hedges on kind of late fourth quarter or early January timeframe and we have a very comprehensive capital market approach to our balance sheet. And essentially, the goal was just to reduce any kind of volatility. The short-term rate increases, and you certainly saw that in the auto portfolios, roughly about $17 million – under $20 million in impact this quarter on a year-over-year basis.
And as we go into the second quarter because we essentially swapped fixed for floating. And if you saw what happened in three months with rates increasing, we should see a nice benefit already, nice carry going into the second quarter there.
Now, I made – in my prepared remarks, I made some comments around the lease yield being flat. That was in large part because of the hedge that we put on it and some of the lease gain reduction that we had. But going into the second quarter and beyond, those hedges will be accretive, and we should see yields continue to increase and net interest income increase every quarter for the rest of 2018.
Okay. And then, if you could touch on the duration of those. And then, also, maybe just remind me what the beta assumptions are on your retail deposits on the intermediate term and then the EPS benefit that you're expecting from that trade-off into deposits from your high-cost fund.
Yeah. Sure. On the duration, it's about one or two years. And then, on the retail deposit beta, it's something that we look at daily, looking at the competitive environment, looking at our options to grow assets, as well as take out high-cost capital markets funding. So, it's really something that changes day-to-day. I'd say, overall, we are very pleased with the flows we're seeing in our deposit book relative to our betas. And there are a lot of comments this morning already – record growth for our first quarter. And our cumulative deposit beta is around 21%.
We've been, I think, pretty transparent that we model a 30% to 50% beta in the medium term. We'd look to outperform that if we can, but it's going to be dependent on competition, dependent on asset growth opportunities, as well as what we can do on the liability side.
And that EPS benefit that you've modeled out for those trade-off of high cost deposits?
Yeah. All of that is built into our net interest income trajectory and our EPS forecast. Yes, exactly.
Great. Thank you.
Thank you. And our next question comes from the line of Sanjay Sakhrani with KBW. Your line is now open.
Thanks. Good morning. I just wanted to follow up on some of the questions that were asked around mix and yield. I was just hoping if maybe you could just break down what's driving the loan yields higher. Is it a specific mix or demographic? I'm just trying to get a sense of what's driving – is it because of the competition? Maybe you could just talk through what's driving the yield higher – outside of just the general rate environment going higher.
Yeah, sure. So, it's been our strategy over some time to be a full-spectrum lender and that's what you see with us moving into used. And certainly, used has allowed us to continue to take up the yield. And as we have been putting price in the market, we continue to see really positive flows. I think it comes back to our competitive advantage. We have a very diverse product set. We've got over 18,000 dealers that we're working with across the country, and we're positioned as a full-spectrum lender. And I think that's showing up in the yield.
I mean it is tied to the benchmarks. I mean, as rates are increasing, we're obviously looking at that very closely because our net interest income growth is going to be very sensitive both to the beta on the loan side, as well as managing down beta on the deposit side.
And, Sanjay, obviously, we're trying to put as much price on the market here as we can and still see the right types of flows. And so, I mean, we're pretty happy. I think you've heard Jen and the team talk about new originated yields are well north of 6.5% at this point, approaching 7%. So we're putting a lot of price in the market right now, and we're still seeing the flows hold up. I think we are all very pleased with the $9.5 billion dollar top line origination number. And so, obviously, we're pushing there.
And then, as Jen pointed out, we're being as disciplined as we can be in kind of what we're doing on the deposit side and we come back to those basic fundamentals on how we price deposits, what are market rates or what are the benchmarks doing, what our competitors doing and then obviously what are flows doing. But, fortunately, for the first quarter we saw really good trends on both sides. The origination numbers are strong. And then, obviously, a record deposit growth story as well. So we feel pretty good about the way we're handling the ALCO strategy today.
All right. Appreciate that. And my follow-up is on the origination mix. Obviously, you guys have done a good job of keeping your share at GM and Chrysler, if not growing on it. But as we look at towards the diversification efforts, I mean has the traction among newer OEMs are stalled or is that continuing at a pretty nice rate?
Yeah. I mean, obviously, given our relationships with 18,500-plus dealers, we see and we finance every nameplate what's out there. So we still say the vast majority of the business directed to us comes through the individual dealers, and that's where we've got our strong footing. We are still active with OEMs. We engage in a lot of conversations with OEMs about strategic partnerships, but often those are hard to crack into.
I mean, obviously GM did their strategy and I think that's worked out extremely well for GM, for GMF and for Ally. It's made us a lot stronger and more diversified. And I think with respect to Chrysler, we continue to play a key role there. But we continue to talk to a number of other players. But today a lot of that business is still one at the dealer to dealer level.
Okay. Thank you.
Got it.
Thank you. And our next question comes from the line of Geoffrey Elliott with Autonomous Research. Your line is now open.
Good morning, and thank you for taking the question. Given everything that you now know in terms of macro scenarios, CCAR changes going forward, how do you think about the target CET1 ratio and whether the 9% is still there the right number to be targeting?
Yeah. Good morning, Geoffrey. Certainly, a lot of changes going on in CCAR around stress capital buffer and I'd just make a couple of comments on that. I mean, we're fully supportive of simplification of the process. We like the suggestions around tightening up the forecasting and not requiring nine quarters of capital action to be modeled in. And we'll be very vocal in the common period.
As we think about our capital levels, we have our own very robust, company-wide targeted risk framework. And that's where that 9% is generated. And we'll continue to manage capital based on how our management team thinks we need to, to really manage through a stressed scenario. So I think a lot is still to be determined, as we go through some of these new FRB proposals and consider the impact on our capital level. So, I don't think we have a clear view on that just yet. And, obviously, there's a lot of changes going on with CECL; and all of these different changes, regulatory as well as with the GAAP accounting change around CECL will have to be above that together.
Thank you. And then last time you spoke, you talked about increasing the dollar payout being something you wanted to do, even though the payout ratio might not be able to move up. Now, you've had a little bit more time to digest what the regulators have been saying on auto. Is that still something you think you should be able to do?
We are already distributing the vast majority of our earnings in our capital plan, and we continue to expect to do that going forward. I made some comments earlier around the CCAR modeling. We saw some minuses, but we saw some pluses as well. So we're confident we're going to be able to continue to deploy the vast majority of our organic earnings growth.
Thank you. Thanks very much.
Thank you.
Thank you.
Thank you. And our next question comes from the line of Rick Shane with JPMorgan. Your line is now open.
Hey, guys. Thanks for taking my questions this morning. I think Moshe really touched on an interesting issue here, which is the difference in depreciation curves between new and used. What I'm curious about is two things. One, given that used cars have a flatter depreciation curve, do you actually go in with a different LTV so that when we think about where losses are going to be or loss severities are going to be a year out, do you account for that in your underwriting?
Absolutely. I mean, we look at LTV specifically across every single customer that we have. And we typically are managing to an LTV depending on that underlying customer's attributes. It's not dependent on whether it's a new or used vehicle.
Now, when we're setting our provision estimates and our reserving around that, there's a little bit of difference we see there, but we're not seeing any major difference in how we underwrite for used versus new from an LTV perspective.
Got it. Okay. And then just so we understand with the change in the swap position, what is the NIM hit from that hedge?
Yeah. I mean, I think I've alluded about it. I would say $10 million hit this quarter. So, $10 million to $15 million or so in net interest income this quarter. And again, I mentioned that will already be accretive as we go into the second quarter. So, a bit of a bump down this quarter, but positioning us very well to continue to grow net interest income every quarter throughout the rest of the year, and I think I also mentioned that it was about a 5-basis-point hit on our retail auto yield. So, typically, we would expect to be up from 5.95 to 6 this quarter, and because of that hedge, we were really down at 5 basis points.
Now, as JB mentioned, we're putting loans on it 6.5 from the first quarter, and we're already up to 6.8 here in the second quarter. So, a lot of opportunities to continue to grow our net interest income based on the origination yields we're putting on the books today.
Got it. Very helpful. Thank you, guys.
Thank you.
Thank you.
Thank you. And our next question comes from the line of Jack Micenko with SIG. Your line is now open.
Hi. Good morning. I wanted to ask you about the transition of new money, and it's obviously coming on in north of 6.5. Is the differential there all used mix where you actually able to take some price on the new side as well over the last year?
Yeah. Absolutely. That's not just used. I mean, certainly in the first and second quarter when the used cars given. So, yields tend to be on the new origination is pretty high at this point in the year, but absolutely we're putting on higher yields across the spectrum.
Okay. Thanks. And then, on the deposit growth side, where do you think that deposit growth is coming from, and I guess my point is in traditional banking the wholesale and commercial betas have been pretty, pretty high, but the consumer retail betas have lagged I think probably to a surprising degree for most of us? Are you seeing this deposit inflow is this coming from traditional banks or is it coming from other internet banks? Do you have a sense of maybe where you're seeing accelerated growth on the deposit side?
Yeah. Sure thing. Good morning. Yeah, the deposit growth is primarily coming from traditional banks. When you think about it, the industry has $3 trillion to $4 trillion in deposits getting paid under 25 basis points. And as the rate curve continues to steepen, we're seeing customers continue to wake up to the opportunity to earn more from their deposits. And so, in large part, our growth is coming from the traditional banks.
Okay. Thank you.
Okay. And also, maybe, Jack, just to add on, slightly a lot of our existing customers putting more money to work within our bank. So, that's one of the other pieces that we look at, not just the impressive new customer growth we saw this quarter, but even the existing customers in-house have continued to add. And, I think, that's also contributing to the strong retention rates and growth rates that Jen alluded to in her opening comments as well. So, it's a pretty powerful story.
Thank you. And our next question comes from the line of John Hecht with Jefferies. Your line is now open.
Thanks very much, guys. A lot of these questions have been asked, but a couple of follow-ups from some of the other discussion points. Clearly, your credit is stabilizing given year-over-year charge-off levels and so forth, and like-for-like credit stability, but you do refer to an ongoing mix shift impacting things like delinquency trends and overall charge-off levels. I guess the question is do you have kind of an intermediate and long-term mix shift goal? Where should we see the kind of mix of business throughout this year in terms of lease, your new – your prime used and so forth?
Yeah. I'll just – I'll jump in on part of the mix shift. Especially related to credit, it's also an origination mix. So, you'll recall, in 2017, we had a bit of a reserve build because we were reserving around our 2015 and 2016 vintages. As we've been putting on consistent origination mix since late 2016 and 2017, and we're seeing those vintages perform well, we're seeing less of a reserve build as we've come into 2018.
So, part of the credit story is not just the mix in new versus used, but it's also the vintages that have really continued to perform well, and some of the problem vintages especially 2015 is really about less than 20% of our portfolio today.
What about kind of the mix shift trends over time over the course of the next few quarters or is that just you take what you get from the dealers depending on the opportunity at that time?
Yeah. I mean, generically speaking, our strategy has been to continue to diversify. You saw our growth mix at record levels. We'll continue to build out a diversified network of dealers. And we should see used to creep up a bit. I can't say we have a specific target. It's just like I said earlier, we'll originate new and used when we get the right risk-adjusted returns. We're seeing a lot of opportunities in the used space, which is like you saw this quarter, and we'll continue that trajectory to the extent that the market holds up.
Okay. And then, the follow-up is, clearly, you're able to pass pricing along to customers. Any commentary and other factors of loans like the duration, LTD and anything else changing in the market?
Yeah. I mean, for us, no. I mean, as we pointed out, we haven't changed any of our underwriting parameters and things are very consistent in that regard. And, I think, the dynamic you saw this quarter with the portfolio yield up 23 basis points and then charge-off down 7 basis points is really the optimization we've been talking about that came through, materialized really well for us this quarter.
Great. Appreciate that. Thanks.
Thank you.
Thank you. And our next question comes from the line of Eric Wasserstrom with UBS. Your line is now open.
Thanks very much. At the risk of being super tedious, I just want to return to the deposit beta for a moment. I was just calculating what the price was on the marginal deposit inflow and it looks like it was up sequentially about 34 basis points, which was exactly the change in fed funds which would suggest on the marginal deposit the beta is in fact one. So can I just pause there before I follow up and see if you agree with that characterization?
Yeah. I mean, I think you saw. It's hard to just look at beta on a quarterly basis because we were always evaluating it. What kind of growth opportunities do we have, and that's why we really look at beta over a period of time and not just in one quarter. Now, I haven't done the exact calculation that you have. It sounds directionally correct but I think we have to be careful about looking at timing of pricing changes and assuming that's the lowered projections.
And also just the mix of deposits sort of coming in...
Yeah, exactly.
Now, they're skewed between products.
Okay. Great. And so, maybe just then – just stepping back. To what extent – can you just help us on the NII growth trajectory, can you just maybe do some sort of broad level attribution about how much of that you view is coming from balance sheet expansion versus how much of it is coming from changes in net interest margin?
Yeah. Sure. On the net interest margin, we see significant opportunity. I should say, we see NII growth coming from margin expansion from yields beta on the loan side and then managing beta down on the deposit side, and we see a tremendous tailwind on NII as we continue to put price in the market on the loan side and bring in low cost deposits. And keep in mind with the deposit book, we're taking out expensive capital markets funding, which is managing down overall liability cost.
And so, I'd say that probably one of the larger drivers of the net interest income, at the same time, we're growing our balance sheet with a 5% growth in our earning assets. This quarter I think really strong continued growth on the balance sheet, and then continuing to look for diversification opportunities to really grow ROE and you'll see we've been putting on bulk in the mortgage space growing our direct business and mortgage as well. And we're somewhat underweight on the securities portfolio. So, we'll continue to grow the securities book as well.
Okay. Thanks very much.
Thanks, Eric.
Thank you. And I'm showing no further questions. So, with that, I'd like to turn the conference back over to Mr. Michael Brown for closing remarks.
Great. Thanks. If you have additional questions, please feel free to reach out to Investor Relations. Thanks for joining us this morning. Thank you, operator.
Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program, and you may all disconnect. Everyone, have a wonderful day.