Ally Financial Inc

NYSE:ALLY

Earnings Call Transcript 2022-Q1

[Operator]

Good day, ladies and gentlemen. Thank you for standing by and welcome to the Ally Financial First Quarter 2022 Earnings Conference Call. [Operator Instructions] I would now like to turn the conference over to your speaker host today, Mr. Sean Leary, Head of Investor Relations. Please go ahead.

[Sean Leary, Head, Investor Relations]

Thank you, Olivia. Good morning and welcome to Ally Financial’s first quarter 2022 earnings call. This morning, our CEO, Jeff Brown; and our CFO, Jen LaClair, will review Ally’s results before taking questions.

The presentation we will reference on today’s call can be found on the Investor Relations section of our website, ally.com. Forward-looking statements and risk factor language governing today’s call are on Slide 2. GAAP and non-GAAP measures pertaining to our operating performance and capital results are on Slide 3. As a reminder, non-GAAP or core metrics are supplemental to and not a substitute for U.S. GAAP measures. Definitions and reconciliations can be found in the appendix.

And with that, I will turn the call over to J.B.

[Jeff Brown, Chief Executive Officer]

Thank you, Sean and welcome to your first earnings call in your expanded role as the Head of Investor Relations. I have worked directly with Sean for over 13 years at Ally and he will be a terrific liaison with the analyst and investor community. He is a great asset for our company and welcome to the role, Sean.

We do appreciate everyone joining us this morning to review our first quarter results. I am going to begin on Slide #4. Performance this quarter remained very strong and our results underscore the scale and durability of our growing businesses. We have been operating in a rapidly evolving environment for several years now and the start to 2022 certainly continues that trend. In addition to lingering pandemic uncertainties, geopolitical unrest and more pronounced signs of inflation are being met with rising interest rates and the expected normalization of the Federal Reserve balance sheet.

Before getting into our results, I also want to acknowledge and express our deep empathy for those impacted by the war in Ukraine. The stories and images are tragic and our thoughts are with all of those suffering through this terrible humanitarian crisis. We are certainly hopeful for a rapid resolution, but recognize the ramifications could be long lasting. This operating environment has driven market volatility that will continue in the near term. However, I remain confident in Ally’s outlook given the strength of our businesses and consistent focus on disciplined, long-term execution.

The U.S. consumer remains healthy with historically low debt servicing levels, significantly elevated household savings and a tight labor market that’s coming with strong wage growth. These trends are driving increased consumer spending reflected in robust originations, pricing and loan growth across Ally. Our industry leading auto and insurance businesses have deep mutually beneficial relationships with their dealer customers and have proven ability to drive growth and significant value through multiple economic cycles. Across Ally Bank, we continue to see solid customer momentum and engagement.

The integration of Fair Square now Ally Credit Card, our newest bank capability remains on schedule and the business delivered a great first quarter. We remain confident in the differentiated value proposition provided by all of our digital consumer banking businesses and expect meaningful accretive growth over the next several years. Ally’s success has always been defined by our relentless customer focus and the strength of our culture. Our deliberate actions for all stakeholders remain rooted in our do-it-right philosophy. In January, we announced our new cover draft capability, which provides Ally checking account customers protection against accidental overdrafts at no cost. This follows our announcement to fully eliminate overdraft fees in 2021, the first in the industry and a testament to our commitment to delivering a customer-centric banking experience. It has been great to see other banks follow as well.

In February, we hosted our second Annual Supplier Diversity and Sustainability Symposium created to build and expand relationships with minority-owned businesses and we are well underway with the celebration of Financial Literacy Month in April, a key part of our continuous efforts to support economic mobility across our communities. I am proud of our nearly 11,000 Ally teammates for their relentless execution and living our values in meaningful ways everyday.

Let’s turn to Slide #5, where I will touch on a few highlights from 1Q. First quarter adjusted EPS of $2.03, core ROTCE of 23.6% and revenues of $2.2 billion reflected continued momentum and a great start to the year across our diversified platforms. The backdrop across consumer and auto markets remained strong during the quarter and we are well positioned to sustain robust operating and financial results this year and beyond. This positioning reflects years of disciplined execution of building adaptable platforms that will allow us to grow and capitalize on market opportunities in a wide variety of operating environments.

More specifically, we remain confident and our long-term outlook for a sustainable ROTCE profile of 16% to 18% plus with the potential for outperformance in 2022 as the environment normalizes. Our earnings trajectory has positioned us to execute a $2 billion buyback program for the second consecutive year and yesterday, we announced our second quarter dividend of $0.30 per share, up nearly 60% from a year ago.

Our nimble customer-centric businesses provide us the ability to capitalize on emerging trends evident in our results across the past several years and in our sustainable outlook. Within auto, consumer originations of $11.6 billion represented our highest first quarter in 11 years, sourced from 3.2 million decision applications with originated yields once again exceeding 7%.

Despite low levels of inventory and new unit sales, consumer originations were up 14% year-over-year demonstrating the agility and scale of our auto business, allowing us to consistently generate volume at attractive risk adjusted returns. Credit normalization through the first quarter has been in line with expectations and retail NCOs of 58 basis points remained well below pre-pandemic levels. We continue monitoring broader market indicators of consumer health, including wage and price inflation, employment conditions and overall payment trends. While the current inflationary environment will add some pressure to households, consumers are generally well-positioned with healthy balance sheets.

And as you have heard from us before, we made significant investments in our ability to engage our auto customers through expanded digital channels, coupled with enhanced analytics within our servicing teams. From an industry production perspective, we are still seeing low levels of inventory, driven by persistent supply chain challenges and strong consumer demand. These dynamics continue to result in lower floor plan balances and structural support for used originations and values. We saw modest normalization in the first quarter, but expect floor plan balances to remain low for quite some time. Within insurance, written premiums of $265 million reflected lower overall inventory levels. Investment portfolio performance remained strong, while weather claims benefited from lower exposure.

Turning to Ally Bank, organic and accelerating growth trends continued. Retail deposit customers now exceed 2.5 million, expanding 8% year-over-year and representing our 52nd consecutive quarter of growth. Retail balances grew to $136 billion and account for nearly 90% of our funding profile. Our consumer engagement and product adoption trends remain robust. Ally Home originated $1.7 billion in the quarter despite the headwind from higher mortgage rates and slowing refinance volume. Ally Invest customer assets grew to $16.8 billion, a 10% year-over-year increase, while accounts expanded 7% and Ally Lending volume of $442 million more than doubled year-over-year as we expanded merchant relationships and volume in the healthcare and home improvement verticals.

Ally Credit Card surpassed $1 billion in loan balances in the quarter and now has over 800,000 active cardholders, up 73% from prior year. I was in Wilmington about a week ago with our new teammates and we celebrated 1 million account openings, nice milestones for this business. Corporate Finance posted another steady and solid quarter with the held-for-investment portfolio exceeding $8 billion in credit performance remaining very strong. Performance across our businesses reinforces our broad customer reach, adaptable platforms, years of disciplined execution and ability to meet our financial and operational goals. I remain incredibly proud of all of our teammates and highly confident in their ability to continue to execute in a rapidly changing environment.

And with that, Jen, over to you.

[Jen LaClair, Chief Financial Officer]

Thank you, J.B., and good morning everyone. I’ll begin on Slide 6. The strength of our financial performance again this quarter reflects our disciplined operating approach and the continued execution against our long-term strategic priorities. Despite ongoing shifts in the broader market, the strength of Ally’s auto and digital bank platforms is reflected in our ability to protect and improve our market share, grow and diversify our income sources and generate a solid sustainable return. Our comprehensive product offerings now serve more than 10.5 million customers with a clear path to ongoing expansion.

On Slide 7, we have provided a few metrics we are watching closely relative to consumer health with over 10.5 million total customers, including over 2.5 million depositors and over 1 million monthly consumer loan applications we have unique data and insight into ongoing consumer trends and performance. The average savings account balance at Ally has increased 20% to 30%, including a 23% increase in the lower balance accounts. And while inflation, in particular, gas prices impact, spending levels and real wage growth, our retail auto portfolio has virtually no exposure to consumers most sensitive to higher gas prices. We have also included a delinquency snapshot across our loan portfolios. Increases of the 2021 lows remain gradual and overall levels remain well below 2019. While key consumer health indicators reflect a strong starting point, we expect normalization in the months ahead and will leverage our proprietary data to inform prudent underwriting and servicing strategies.

Let’s turn to Slide 8, where we’ve included a snapshot of key measures, demonstrating the strength of our balance sheet. Our funding, capital and liquidity remain robust and above pre-pandemic level. Our stable cost-efficient deposit portfolio has increased to 88% of total funding, up from 64% in Q1 2018, positioning us well in this rising rate cycle. And while wholesale funding balances have materially declined, we maintain access to multiple efficient funding alternatives and improved execution levels as we’ve earned an investment-grade rating in recent years. Allowance for loan losses of 2.63% or $3.3 billion represents over 2.5x our reserve level in 2018 and approximately $700 million higher than our CECL day 1 requirement. Our CET1 level remains elevated at 10% which results in approximately $1.5 billion of excess capital relative to our internal operating target and nearly $3 billion above our SCB requirement positioning us well to support accretive customer growth and capital returns.

Detailed results for the quarter are on Slide 9. Net financing revenue, excluding OID of $1.7 billion grew roughly 23% year-over-year. This represents the seventh consecutive quarter of expanding net financing revenue. Performance in the quarter was driven by strength in auto pricing and origination volumes, growth in accretive consumer products, including our credit card and point-of-sale offerings, normalization of excess liquidity and proactive hedging activity partially mitigating impacts from short-term rate increases. Adjusted other revenue of $508 million reflected strong investment gains and diversified revenues from SmartAuction insurance and our consumer businesses, while our financial outlook assumes mid-$400 million per quarter, we remain opportunistic capturing upside from favorable market conditions. Provision expense of $167 million reflects robust origination activity and the anticipated gradual normalization of credit performance, although trends remain favorable as we’ll cover in a few moments.

Non-interest expense of $1.1 billion includes seasonal compensation items, the first full quarter of credit card operations and investments in business growth, brand and technology. We expect the year-over-year expense increase to moderate over the remainder of 2022 as the quarter was impacted by certain nonrecurring items. Excluding the acquisition of Fair Square we expect full year operating expense growth consistent with prior years. And as a reminder, Fair Square is projected to be EPS accretive by the end of 2022 and to drive positive operating leverage in 2023. GAAP and adjusted EPS for the quarter were $1.86 and $2.03 respectively.

Moving to Slide 10, net interest margin, excluding OID, of 3.95%, expanded 13 basis points quarter-over-quarter and 77 basis points year-over-year, reflecting significant and sustained improvement. Overall margin expansion reflects the structurally enhanced balance sheet we have built over several years. Earning asset yield of 4.86% grew 11 basis points quarter-over-quarter and 42 basis points year-over-year, reflecting the same NII drivers I just mentioned. Due to strong auto demand, we continue to see elevated prepayment activity in retail auto, driving a linked quarter decline in the portfolio yield. The originated yield exceeded 7% again this quarter, and we still expect the portfolio to move closer to originated yield over time especially as prepayment activity normalizes with used car pricing. While prepayment activity presents a headwind to retail portfolio yields, we have natural offsets as higher vehicle value benefit lease residuals and loss severity. Looking forward, we expect earning asset yield expansion driven by the strength of our market position, disciplined pricing, especially as rates increase and organic growth across our newer consumer portfolio.

Turning to liabilities, cost of funds declined 4 basis points, the 11th consecutive quarter-over-quarter decline and 39 basis points year-over-year, reflecting the multiyear transformation of our funding profile. The differentiated value proposition of Ally Bank is evident in the growth of our deposit portfolio and the stickiness of our customer base over a wide variety of interest rate and operating environment. And while we constantly evaluate competitive dynamics, we expect overall deposit rate paid relative to Fed funds will be favorable to the prior tightening cycle. The growth and strength of our businesses on both sides of the balance sheet will support a strong net interest margin and net interest income expansion from here.

Turning to Slide 11, our CET1 ratio declined modestly to 10% as strong earnings supported robust loan growth and nearly $600 million in share repurchases. Yesterday, we announced a dividend of $0.30 per share and we remain on track to execute our $2 billion buyback program reflected of Ally’s strong capital levels and earnings trajectory. We recently submitted our 2022 CCAR results which we believe confirms the strength of our capital position in a severe stress and support our 9% CET1 internal target. On the bottom of the slide, shares outstanding have declined 13% since we resumed share repurchases in 2021 and 32% since the inception of our buyback program in 2016. Capital deployment priorities remain centered around investing in the growth of our businesses, delivering innovative and differentiated products and driving long-term shareholder value.

On Slide 12, asset quality remains strong. Results reflect the gradual and expected normalization across our consumer portfolios and continuation of historically low losses in our commercial portfolios. Consolidated net charge-offs of 43 basis points moved up by 2 basis points year-over-year. Retail auto portfolio performance reflected solid consumer payment trends and favorable loss given default rates supported by strong vehicle collateral values. In the bottom right, delinquencies have increased as expected, which will drive higher net charge-off activity over time. We continue to expect gradual normalization to a 1.4% to 1.6% NCO level in the medium term with the expectation of 1% or less in 2022.

On Slide 13, consolidated coverage declined 4 basis points to 2.63%. Retail auto coverage of 3.49% declined 5 basis points but remains 15 basis points higher than CECL day 1 levels. Our baseline forecast assumes gradually improving unemployment, ending the year at approximately 3.5% before reverting to a historical mean of 6.5% under our CECL methodology. As part of our reserving process, we consider a range of potential scenarios, including recession, stagflation and protracted geopolitical conflicts. As discussed, we evaluate consumer health real-time, including rapidly rising inflationary impacts and real wage growth. We remain confident our reserves are appropriate for a variety of economic environments including potential but unexpected downside scenarios.

On Slide 14, total deposits remained at $142 billion as retail balance growth offset the roll down of broker deposits. Retail balances increased $1.3 billion quarter-over-quarter even as seasonal tax payment activity was elevated in March. Our portfolio includes significant balances from affluent depositors generally more susceptible to tax liability outflows. Due to the financial strength of our customers, we would expect tax payment outflows to be elevated in Q2, temporarily pressuring deposit growth. We added another 42,000 customers, our 52nd consecutive quarter of customer growth, exceeding 2.5 million overall, our customer loyalty and engagement are reflected in industry-leading and consistent retention of 96% and multi-relationship expansion for the 17th consecutive quarter, ending at 9%.

On Slide 15, we have included a chart that shows the stable nature of our growing deposit portfolio since the launch of Ally Bank in 2009 every single annual vintage of deposit customers has grown their balances over time, reflecting more than 13 years of continuous growth. Over this time, we’ve made substantial investments in the Ally brand and product capabilities, the powerful combination of industry-leading customer service, expanding digital products and tools and competitive rates differentiates us from our competition and gives us confidence in our ability to remain disciplined as we navigate a rising interest rate environment.

Turning to Slide 16, we continue to drive scale and diversification across all our digital bank platforms. Deposits serve as a gateway to our other banking products, including Ally Lending, Card, Invest and Mortgage, which enhance brand loyalty, drive engagement and deepened customer relationships. A significant portion of Ally Invest account openings and Ally Home direct-to-consumer volume is sourced from existing depositors, lowering acquisition costs and accelerating organic growth and balance sheet diversification. We also see a clear path for expansion among our newer point-of-sale lending and credit card products. Our focus on delivering digital-first integrated capabilities supports our outlook for growth and accretive returns in the years ahead.

Let’s turn to Slide 17 to review Auto segment highlights. Pretax income of $725 million was driven by expanded net financing revenue source from strong originations and solid credit performance. Starting at the bottom left, the originated yield again exceeded 7%, which we expect for the 5th consecutive year in 2022 and Consumer demand for auto remains robust, reflecting the high utility of the auto asset class and driving strong used vehicle values. With low inventory and robust used car pricing, consumers are accelerating trade-ins, resulting in elevated prepayment expense impacting the portfolio yield by approximately 30 basis points. As inventory grows over time, we expect this activity to normalize, driving yields above 7% before any benefit from rate increases.

On the bottom right, we have included lease gain trends. Lease gains were robust in the quarter, driven by used vehicle dynamics. But as we’ve discussed for some time, the upside remains muted as approximately 85% of the units terminated were purchased by lessees and dealers. This is another trend that will gradually normalize. As inventory levels increased and used values decline, we expect fewer lessee and dealer buyouts which should be another positive for Ally over the medium term. So while strong used car values have been a benefit to results to date, there is a natural hedge to normalization, including higher retail auto yields, favorable off-lease vehicle dynamics and increased floor plan balances.

Turning to Slide 18, our leading agile platform is built to adapt to dealer and customer needs in a comprehensive and innovative manner reflected in our performance in the multiyear growth of our dealers. Our focus continues to migrate towards deepening these relationships, driving strong application trends, which we expect to exceed 13 million again this year. In the upper right, ended consumer assets expanded to $90 billion, up 7% on a year-over-year basis. We expect to see a robust market that is supportive of our outlook for $40 billion to $45 billion of consumer originations in 2022. Commercial balances ended at $17.3 billion, reflecting a gradual and modest normalization of inventories.

Turning to origination trends, on the bottom half of the page, auto volume of $11.6 billion, up 14% from prior year, represents our highest first quarter in over a decade. We provide a broad access to credit for consumers utilizing our full spectrum underwriting capabilities while maintaining consistent FICO and non-prime trends.

Turning to insurance results on Slide 19, core pre-tax income of $74 million decreased year-over-year driven by the impact of lower industry sales, dealer inventories and record investment gains in the prior year period. Robust investment income of $64 million reflected our ability to drive gains opportunistically in volatile markets. On a year-over-year basis, underwriting income declined $18 million as favorable loss performance was offset by lower P&C premiums. Total written premiums of $265 million reflected lower unit sales and inventory levels across the industry. Within Ally, we see significant opportunity to improve dealer penetration and grow this highly accretive business, and we are excited to have Daniel Eller our former Investor Relations executive in his new role leading this business.

Turning to corporate finance on Slide 20, core income of $68 million reflected expanding net financing revenue driven by disciplined growth in the portfolio, strong other revenue from investment gains, syndication income and growth in unused commitment fees and stable credit trends. The loan portfolio remains diversified across industries and its floating rate, which positions us well for expected rate increases. The quality of our portfolio is evident in our consistent credit performance and asset-based loans comprising 54% of the portfolio. Our $8 billion HFI balance is up 28% year-over-year, reflecting our strong expertise and disciplined growth within a highly competitive market.

Mortgage details are on Slide 21. Mortgage generated pre-tax income of $11 million reflecting tighter margins on conforming production and reduced demand for refinancing activity. Ally Home DTC originations of $1.7 billion was relatively flat on a year-over-year basis but down linked quarter given the contraction in the overall mortgage market. Mortgage remains a critical product for our customers who value a modernized and seamless digital platform. We added four new states to our platform this quarter, now active in 46 plus DC. We are prioritizing a strong experience for our bank customers and enhanced risk-adjusted returns which may lead to changing origination levels in any given quarter for a year.

On Slide 22, we have again included our financial outlook considering the rapidly evolving operating environment. Since we provided guidance in January, we’ve seen accelerating geopolitical conflict, increased inflationary pressure and a significant move in rates as the market expectation for Fed funds has increased over 100 basis points since our January update, a key watch item as we manage pricing on both sides of the balance sheet. Despite that volatility, we’re confident in Ally’s ability to generate a 16% to 18% plus return over the medium term with the expectation, 2022 will be at the high end of that range. Performance will be fueled by strong revenue growth, annual PPNR expansion and normalizing used vehicle value and credit performance. Our outlook embeds balanced, competitive and operating environment assumptions, specifically in auto and deposits. The earnings and return profile of the company has structurally improved and we remain focused on driving near and long-term benefits for all of our stakeholders.

And with that, I’ll turn it back to J.B.

[Jeff Brown, Chief Executive Officer]

Thank you, Jen. I’ll close with a few comments on Slide #23. First, I remain deeply grateful and proud to lead our company. Our results this quarter are impressive, our broader objective to serve our teammates, our customers, our communities and our stockholders is what defines our company’s long-term success. We built a structurally enhanced more profitable company through strategic execution across our business lines, balance sheet optimization over many years and differentiated products for our customers, all of which positions us for a very strong long-term outlook. We will continue to execute with a focus on the same values and priorities that have served us well over several years.

And with that, Jen, Sean, back to you and any Q&A.

[Sean Leary, Head, Investor Relations]

Thank you, J.B. [Operator Instructions] Olivia, please begin the Q&A.

[Operator]

[Operator Instructions] Our first question coming from the line of Bill Carcache from Wolfe Research. Your line is open.

[Bill Carcache, Wolfe Research]

Thank you. Good morning, J.B and Jen.

[Jeff Brown, Chief Executive Officer]

Hey, good morning, Bill.

[Jen LaClair, Chief Financial Officer]

Good morning, Bill.

[Bill Carcache, Wolfe Research]

Good morning. Hi, I wanted to dig into the impact of used car prices a bit more in your outlook you’ve said that you’re assuming 15% to 20% decrease between ‘21 and the end of 2023. But that’s an average, correct? And just to clarify, where do you expect used car prices to be at the end of ‘23 relative to 2019 levels?

[Jen LaClair, Chief Financial Officer]

Yes, sure. Thank you, Bill. Very important question as we’ve seen very elevated used car prices even coming into 2022. The guide that we have provided is a minus 10% to 15% on average for 2023. So if you think about the point-to-point decline from first quarter of 2022 to fourth quarter of ‘23, is obviously significantly larger than that. So keep that in mind, it’s sequential, and it’s a steep drop off. Now I do think the dynamics around used car pricing is really important as you look at the total earning asset yield and income statement for Ally. And as we would see used car pricing come down, we would expect to see tailwinds in our retail loan portfolio yield. As I mentioned, elevated prepayment activity has created about a 30 basis point drag on retail auto portfolio yields even within the lease business as we’d expect used vehicle values to come down, LBO and DBO should normalize, and that should give us access to more gains just even within lease. And then last but not least, we are expecting inventory to come up as used vehicle values come down and that should create more growth in a floating rate asset as we head into a rising rate environment. So a lot of just natural hedges around used vehicle values. And I think Ally really wins either way. If used vehicle values remain robust, we will see elevated contract value, strong originations, strong lease yields, lower LGD. If it moderates down, you’re going to see a lot of tailwind in commercial floor plan as well as retail auto yields. And I think from a credit perspective, we’ve been pricing appropriately for LGD. We have reserved qualitatively and quantitatively to cover, and it’s certainly included in our 1.4% to 1.6% guide as well. So hopefully, that gives you some color, Bill. It’s really important to look at this holistically across Ally.

[Bill Carcache, Wolfe Research]

Understood. Maybe just following up on that. So is it reasonable to conclude based on everything that as you explained it, Jen, that 1.4% to 1.6% NCO rate in your outlook for ‘23 to ‘24, is – it reflects – and all the other moving parts associated with used vehicle prices, if they were to decline to 2019 levels that you have confidence that the outlook that you laid out contemplates the achievability of the numbers that you’ve laid out, if used vehicle prices were to normalize back to 2019 levels?

[Jen LaClair, Chief Financial Officer]

Yes. I mean in the guide, just to be really clear, we have that 10% to 15% average annual decrease, and that would flow through all of our yields as well as into our assumptions around NCOs. And just keep in mind, we also have qualitative factors, and we’ve been very mindful of the uncertainty in the operating environment, the elevated contract values that we’re originating against. And like I said, we’re pricing sufficiently for that and guiding towards it in that NCO guide as well as establishing qualitative and quantitative reserves around that. So I think we’re very well suffered in the guide.

[Bill Carcache, Wolfe Research]

Okay. It’s just that there is, I think, the lack of confidence that the improvement that Ally has seen in its earnings growth in ROTCE post-COVID is sustainable. And you’ve laid out clearly that there are structural reasons for the improvement. But I think that just helps get at the sustainability question even if you did have sharper normalization in used car prices. Thanks for taking my questions.

[Jen LaClair, Chief Financial Officer]

Of course. Thank you, Bill. And I think that’s a really important point. And also, as J.B. always tells us, there is a bull case around used vehicle pricing, if you think about inventory levels and continued supply chain constraints. I think the guide that we’ve provided is pretty conservative relative to what we’re actually experiencing across our dealers today.

[Jeff Brown, Chief Executive Officer]

Yes. And I mean, to that point, even we talked to some of our big dealers, I mean there – again, they continue to be another quarter end, and they are presold 4, 5, 6 months out of everything they have coming in on production. So it’s a pretty fascinating dynamic that we’re seeing right now. Great questions, Bill. Obviously, you’re seeing us lay into the sustainability story here. We feel really confident that we’ve got a great outlook and really strong position for the future.

[Operator]

And our next question coming from the line of Ryan Nash with Goldman Sachs. Your line is open.

[Ryan Nash, Goldman Sachs]

Hey, good morning, J.B. Good morning, Jen.

[Jen LaClair, Chief Financial Officer]

Good morning, Ryan.

[Jeff Brown, Chief Executive Officer]

Hi, Ryan.

[Ryan Nash, Goldman Sachs]

So maybe just to start on the net interest margin, so Jen, you reiterated in upper 3s NIM, which also factoring additional 100 basis points of rate hikes. Can you maybe just unpack for us what’s included in there in terms of asset repricing and more importantly, deposit betas? And then second, can you maybe just talk about how you expect betas to progress over, let’s say, the first 100 to 150 basis points relative to the second 150? And how are you expecting the pricing strategy to differ? And what gives you the confidence that it’s going to be favorable relative to last time? And then I have a follow-up.

[Jen LaClair, Chief Financial Officer]

Yes, sure. So let me start first, Ryan, on the asset yield. And I just hit on some of the dynamics there. But – starting with retail loans, we’re continuing to see robust origination. We will have our 5th year of putting new originations on the books at over 7%. And as we would expect to use vehicle values to come down, we’d expect a really nice tailwind on lower prepayments in our retail loan portfolio. And then even in lease, as inventory returns, we should see growth there and just it’s important that we have this natural hedge with used vehicle values coming down, LBO and DBO dynamics should shift with that and help to neutralize some of the decrease from lower vehicle values. And then, of course, we would see inventory levels coming up. I mentioned floor plan, 100% floating rate as rates come up, we will be growing that portfolio at the right time. We also have a mix – a better mix dynamic as we’ve run off excess cash. We’re also growing our unsecured products. So think about Ally Lending and Ally Card at very healthy yields. So – all in, Ryan, we would expect our earning asset yield to continue to expand well into the 5%, and that’s with a rising rate environment, but even absent that with the favorable mix that we will have. And noteworthy is – and we talk about this a lot, the originated yield on retail auto relative to the portfolio. Just even through April, year-to-date, we’ve been able to put pricing in the market – in fact, we’ve added about 40 basis points of price so far, and that’s, as you know, way out ahead of Fed fund increases. So I feel really good about the earning asset yield expansion and the growth attached to that as well.

And then on the liability side, look, we are in such a different place today than we were in the past and especially in 2018 in the last rising rate cycle. You think about we’re almost 90% core funded. We’re investment grade. We have access to alternative funding sources. And quite frankly, we’ve continued to invest in a very competitive value proposition around digital tools, brand, the multi-product relationships that we’ve been building, the consistent retention that we’ve driven. And so we feel great from a consumer value perspective as well as from an Ally’s balance sheet perspective that we will be able to hold rate at a lower level relative to Fed funds in this next rising rate cycle. No, I mean, I know, Ryan, we’ve gone back and forth a lot on beta math. And as you know, we’re starting at a significantly lower pricing position this time around. And so beta could – we run scenarios where beta could potentially be a little higher. But I think what’s important is even when we run those scenarios, we’re still seeing a path to that upper 3% NIM that’s supporting our 16% to 18% plus ROTC guide. So hopefully, that gives you a bit of color.

[Ryan Nash, Goldman Sachs]

No, that’s helpful. And maybe if I can ask a follow-up or a two-part question, so J.B., when we met in December, you talked about the franchise being able to generate $6 to $7 a share of earnings. But obviously, the world has changed a bit in the past few months. But – so wondering if you could talk about how you expect earnings to progress as the cycle progresses? Do you still feel comfortable outside of the recession? Can we see those type of earnings? And what are the drivers? And then second Jen, you mentioned on the call that earnings has structurally improved. And when I talk to investors, they do so to understand what took us from kind of 12 to 12.5 pre-pandemic to 16 to 18 post-pandemic. So, can you maybe just talk about what are the main drivers that should make profitability structurally higher and why you think they are sustainable? Thanks.

[Jen LaClair, Chief Financial Officer]

By the way, Ryan, I think you are on question four or five, but that’s alright.

[Jeff Brown, Chief Executive Officer]

Do you want to start, Jen?

[Jen LaClair, Chief Financial Officer]

I think you are very much connected. And the key drivers as we continue to reiterate, it’s just in retail lending, we have changed our focus from sub-vented super prime paper to prime. You have seen our market position and the continued performance we have had in retail auto, and that just generates a higher earnings trajectory as well as a higher return on tangible common equity. So, just the mix shift inside the four walls of auto has been very powerful. And then, I mean look, we have added a lot of new product capabilities, which are accelerating. We shared the numbers around Ally Lending as well as Ally Card. Obviously, Ally Card of 5%, ROA product driving very significant and accretive returns, Ally Lending as well. And so the growth of our newer products is really helping to propel our earnings trajectory and the guide towards the 16% to 18%-plus return on tangible common equity. And then we can’t underestimate the power of our liability stack and you have been out there saying Ally has transformed the liabilities back more so than any other bank out there, and we agree with that. And that is a big part of our structural improvement in our profitability. And hey, if you want to point investors to our track record, look at our 2021 return on tangible common equity hit 24%. We just printed over 23% and I could see, Ryan, this year getting to 20% plus or minus. And then we have a very healthy guide to 16% to 18%-plus. So, we have got a great track record. I think we have a very reasonable set of assumptions going into the future. And 16%, 18% plus return is very healthy because of all those dynamics.

[Ryan Nash, Goldman Sachs]

Thanks, Jen. No follow-up.

[Jen LaClair, Chief Financial Officer]

Thanks, Ryan. I appreciate your good question.

[Jeff Brown, Chief Executive Officer]

I just told you we are not coming off of what I told you in December. So, yes, all good.

[Jen LaClair, Chief Financial Officer]

Thank you, Ryan.

[Operator]

And our next question is coming from the line of Sanjay Sakhrani with KBW. Your line is open.

[Sanjay Sakhrani, KBW]

Hi, good morning. Obviously, you guys alluded to the fact that people are getting generally about consumer credit, and I appreciate the color you provided on Slide 7 on how it’s affecting your portfolio. But I am curious how it’s affecting your underwriting and the decisions that you are making going forward. Do you guys did mention it impact any of your loan growth expectations, especially on the unsecured credit side?

[Jen LaClair, Chief Financial Officer]

Yes. Good morning Sanjay. So, the way that our underwriting strategy is positioned is really to look through the cycle. And so we are not making big shifts based on macroeconomic forecasts that we know will not be perfectly correct or even remotely correct in some circumstances. So, our position on underwriting has always been to look through returns through the cycle. We have largely done that in retail auto. I will say we make some tweaks around the edges. We are seeing elevated contract values, and so we are mindful of potential LGD impacts down the road. And so we put additional pricing in to cover off on LGD. We have also been mindful of that as we have established quantitative and qualitative reserves around the portfolio. So, we do make tweaks around the edges. I think that we are incredibly well positioned as we think about both the pricing and the reserving that we have. And then on the unsecured side, very similar approach that we are taking. And I shared a slide in the presentation just around the data that we are looking at and that will help us to make tweaks as well. Again, it’s not going to be a wholesale change in our underwriting, but we will be mindful of that making tweaks. And then underwriting is important, but servicing as well. And as we see any kind of deterioration or we see delinquencies pick up in pockets, over time, we will be able to be incredibly proactive from a servicing perspective as well. And I just noted in response to Ryan’s question that we have been mindful of this environment, and we have been taking pricing up in retail auto by way of example, we have increased pricing a couple of times and it’s about 40 basis points just year-to-date through April here.

[Sanjay Sakhrani, KBW]

Okay. Great. And just to follow-up on – some color on the reserve expectations. I know Jen you sort of went through some of the comparisons relative to CECL day one. Just on the qualitative side, if we compare today versus CECL day one, what’s the difference in the qualitative assumptions given how the market or the investment community sort of positioned and the macro is considering deterioration from here? Thanks.

[Jen LaClair, Chief Financial Officer]

Yes. Sure. I mean look, as we came through the pandemic, we had qualitative reserves around COVID. And as we have headed into 2022, we have again, considered qualitative factors, especially relative to inflation, recession probability and in particular, in retail auto have established some qualitative reserve factors there. So overall, from a quantitative and a qualitative perspective, retail auto is up some 15 basis points from day one CECL. So, we think we are in a really good position there. And then as I have continued to note, we essentially have a recession built into our assumptions on our reserves if you think about after year three, unemployment rate at 6.5%. So, for all those reasons, Sanjay, and I think what you are pointing to, we have a really robust reserve and really strong balance sheet as we enter 2022 and continue to navigate an unbelievable amount of uncertainty. Thank you, Sanjay.

[Operator]

And our next question is coming from the line of Betsy Graseck with Morgan Stanley. Your line is open.

[Jeff Adelson, Morgan Stanley]

Hey. Good morning. This is Jeff Adelson on for Betsy.

[Jen LaClair, Chief Financial Officer]

Hi Jeff. Good morning.

[Jeff Brown, Chief Executive Officer]

Good morning.

[Jeff Adelson, Morgan Stanley]

Good morning JB and Jen. It seems like you are perhaps suggesting some NIM upside from here, just given all the benefits you have talked about coming through today on the earning asset yield side over time as used car prices normalize and I know we are already sitting here today at 3.9%, 3.95% NIM and you are sticking to the upper 3% guide. Just want to understand how you are thinking about the probability of going higher from here or how much conservatism is embedded in the guide? And then on the slide, you did mention you are monitoring the shape of the yield curve. Can you just remind us what you are embedding in your expectations right now in the yield curve? And maybe how much of an impact inversion has for your NIM profile?

[Jen LaClair, Chief Financial Officer]

Yes. And let me just start with the assumption around the yield curve. So, we are now expecting Fed funds forward to hit about 2.5% at year-end and then migrating up to about 3% early 2023. And against that, we are expecting kind of through time to continue to hit that upper 3% NIM. I will say it could bounce around a little bit from quarter-to-quarter as we continue to have low deposit pricing and asset yield expansion kind of early 2022. But then as deposit pricing picks up in some of the later quarters, you could have NIM bounce around, quite frankly, over the next kind of six quarters to eight quarters. But I think what’s important is that we still see a clear path to that sustainable higher NIM simply because of the structural improvements we have on both sides of the balance sheet. So hopefully, that helps in terms of just the NIM. From an inversion perspective, that’s something we are watching very carefully, and we are not putting a lot of duration on the books right now. We have been mindful of adding to our securities portfolio. As I talked about in mortgage, we are being really selective about what we put into HFI just to make sure that we do manage duration and potentially ahead of an inversion. And the other watch item, and I mentioned this in my prepared remarks, is simply making sure we are disciplined and diligent around deposit pricing.

[Jeff Adelson, Morgan Stanley]

Got it. That’s helpful. And just as a quick follow-up, I am not sure if I missed this already, but just wanted to understand in the back of the slide deck why the interest sensitivity profile seem to have been more impacted in the 100 basis up scenario for the instantaneous rate scenario?

[Jen LaClair, Chief Financial Officer]

Yes. Well, I mean, you have to look at the underlying assumptions as we move from fourth quarter ‘21 to first quarter ‘22. Keep in mind, our forward assumption also increased 100 basis points. So, this is 100 basis points on a 300 basis point assumption. And so you are talking about a very, very steep shock relative to even where we were in the fourth quarter ‘21. Now, as I have talked about in the past, we have hedging activity that helps to mitigate part of that very steep ramp up in interest rates. But essentially, it’s just the pull forward of 100 basis points on Fed fund forwards.

[Jeff Adelson, Morgan Stanley]

Thanks guys.

[Jen LaClair, Chief Financial Officer]

Thank you.

[Operator]

And our next question is coming from the line of Moshe Orenbuch with Credit Suisse. Your line is open.

[Moshe Orenbuch, Credit Suisse]

Great. Thanks. I think the – I wanted to talk a little bit about the originations level and the yield and the pricing comments that you made. And I guess, pretty remarkable just given that some of the large banks reported have not been nearly as robust. And like what do you see as driving that specifically? Is it a competitive advantage versus some of the competitors that are wholesale funded, like – can you talk a little bit about what has given you that? Is it some of the partnerships? Just talk about that and how it relates to both the volume and pricing?

[Jen LaClair, Chief Financial Officer]

Yes. Sure, Moshe. And I think it relates to just our overall strategy in auto, which is to focus on the prime segment. I think super prime has been impacted simply because of vehicle availability, where we are underwriting in prime and in particular, at the intersection of used and prime there is still a terrific amount of transaction volume and some of that’s driving churn in the portfolio, but there is a terrific amount of demand still in the system that’s driving transactions and driving originations for us. I mean as we take kind of a step back we think there are some 4 million, 5 million customers that are on the sideline right now just because they cannot find a vehicle to purchase. And so not only are we expecting this very strong origination volume to continue. This year, we would expect it in the future. And there could be some mix shift for more new as it becomes available versus just the used and the new. But it’s related to our segment. It’s related to our scale, our relationships. We are at well over 21,000 continues to grow. We are driving outflows through those dealer relationships. And so Moshe, it’s really all of the above. It’s the very important segment we are in prime and used, and it’s obviously the capabilities that we are bringing to that segment that has continued to fuel just very accretive originations for years.

[Moshe Orenbuch, Credit Suisse]

Got it. Thanks. And maybe just kind of a follow-up on one of Ryan’s questions. You talked about the natural hedges in terms of the earnings outlook and things that could help mitigate whatever – whether it’s the normalization of used car values or rising rates and the like. Are there any kind of active steps that you are taking that you would add to that, like things that you are doing kind of – you mentioned obviously pricing, but are there other things that the company is doing to kind of position for the rest of ‘22 and ‘23?

[Jen LaClair, Chief Financial Officer]

Yes. I mean look, we are not complacent on anything. I mean we are very focused on continuing to serve all of our customers starting first with the dealers, making sure we are there to support originations. We have continued to expand not only our traditional dealers, but our newer dealers, Carvana, EchoPark, a number of the newer entrants. And we are not getting complacent at all continuing to drive that engagement and that application flow. We are also mindful of dynamics around consumer health. And so we are monitoring that very closely. I included that extra slide this morning to give you a sense for how closely we are monitoring the data to inform, as you pointed out, Moshe, pricing, but also servicing strategies. I mean we are expecting delinquencies to continue to normalize charge-offs to continue to normalize, and we have continued to invest heavily in human capital, technology and digital capabilities in the servicing side of the house as well. And then I think your point on hedges is really important. And as I pointed out earlier, while there is a lot of headlines around used vehicle pricing coming down, continuing to see offsets to that, whether it’s the LBO or DBO dynamics, whether that’s increase in inventory that we will see in the floor plan book or even continued origination unit opportunities that we would expect it to grow from here if used vehicle values come down. So again, Moshe, it’s continuing to do a lot of what we have been doing in the past, but just monitoring the consumer health and making sure that’s in consideration in originations as well as underwriting strategy. JB, I don’t know if you want to add something? Thank you, Moshe.

[Operator]

Our next question is coming from the line of Rob Wildhack with Autonomous Research. Your line is open.

[Rob Wildhack, Autonomous Research]

Good morning JB. Good morning Jen. Just wanted to ask on expenses quickly. On expenses, you said that this year was going to be consistent with past years in terms of expense growth. If we dig into that at all, do Fair Square and more credit card or Ally Lending business changed the expense profile such that there are some puts and takes within the business lines there?

[Jen LaClair, Chief Financial Officer]

Yes. And Rob, just to clarify, I mentioned Ally’s standalone expense trajectory for full year will be similar to what you have seen in the past. So, that excludes credit card in the Ally’s standalone expenses, you expect a lot of the same themes that you have heard me talk about in the past. So, we are scaling our businesses. There are variable costs attached to that, continuing to invest in technology and marketing brand to fuel that growth, cyber security as well. And then credit card, I think we have been very clear on our performance expectations ROTC accretive day one, EPS accretive by year-end 2022 and operating leverage accretive by 2023. And as JB hit on it and I hit on my prepared remarks, we are well underway to hit that guide and those robust performance expectations from Ally Card. And then just – I think it is important to take the big picture in mind. We do not manage expenses point in time line item-by-line item. We are investing over time for positive operating leverage and accretive returns. And certainly, we have been delivering that. We had a mid-teens plus positive operating leverage in 2021. We would expect to see operating leverage and PPNR expansion over time, but we are not managing line item-by-line item quarter-by-quarter, Rob, just to clarify.

[Rob Wildhack, Autonomous Research]

Got it. Thanks. And then just on the deposit side, looking at the rate tables there, you guys are still at 50 basis points. A lot of your peers haven’t moved either – why do you think that’s the case? Why do you think those haven’t re-priced yet?

[Jen LaClair, Chief Financial Officer]

Yes. Look, I mean there is still a lot of liquidity in the system today. And I think it’s going to take some time for loan growth to catch up to access liquidity available on bank balance sheets. I think that’s number one. I think if you look at the 50 basis points relative to the average across the industry, it’s still competitive. And last but not least, I think just mindful of the continued capabilities that Ally has invested in or in terms of digital, brand, customer service, we do think we offer value above and beyond just rate. But I think it’s going to take some time, Rob, quite frankly, to see pricing come through. We have seen CD prices elevate a bit across the industry. You would expect that early in a rising rate cycle as the industry is trying to lock in lower-cost funding, but not a lot of growth in those products just yet.

[Jeff Brown, Chief Executive Officer]

Thanks Rob.

[Rob Wildhack, Autonomous Research]

Thanks. Very helpful. Thank you.

[Jen LaClair, Chief Financial Officer]

Thank you, Rob.

[Sean Leary, Head, Investor Relations]

So, we are a little past the hour. I think that’s all the time we have for today. If you have any additional questions, please feel free to reach out to Investor Relations. Thank you for joining us this morning. That concludes today’s call.

[Operator]

Ladies and gentlemen, that does conclude our conference for today. Thank you for your participation. You may now disconnect.