Ally Financial Inc

NYSE:ALLY

Earnings Call Transcript 2019-Q3

[Operator]

Ladies and gentlemen, thank you for standing by and welcome to the Q3 2019 Ally Financial Earnings Conference Call. At this time, all participants are in a listen-only mode.

I would now like to hand the conference over to your speaker, Mr. Daniel Eller, Head of Investor Relations. Please go ahead sir.

[Daniel Eller, Lead, IR]

Thank you, operator, and we appreciate everyone joining us to review Ally Financial's third quarter 2019 results. This morning, we have our CEO, Jeff Brown; and our CFO, Jenn LaClair on the call to review our results and to take your questions following prepared remarks. You can find the presentation we'll reference during today's call on the Investor Relations section of our website ally.com.

I'll direct your attention to Slide 2 of the presentation, where we have our forward-looking statements and risk factors. The contents of today's call will be governed by this language on Slide 3, we've included some of our 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 results. Please keep in mind, these are supplemental to and not a substitute for US GAAP measures. The supplemental slides at the end include full definitions and reconciliations.

With that, I'll turn the call over to our CEO, Jeff Brown.

[Jeff Brown, CEO]

Thank you, Daniel. Good morning everyone and thank you for joining our call. On slide number 4, I will cover highlights from third quarter. Let me begin by saying that in the midst of continued market volatility, Ally's financial results were solid again this quarter, reflecting the ongoing execution of our long-term strategy.

We remain pleased with performance across our auto and deposit franchises, where customer growth persisted, flows remain robust, and pricing trends were accretive to results. Progress in our Ally Home and Ally Invest offerings continued, where trends affirm, we are meeting the preferences and needs of our customers.

Adjusted EPS of $1.01 increased a 11% year-over-year, our highest quarterly result since going public. Core ROTCE of 12.3% remained solid. Revenues exceeded $1.6 billion, up 7% compared to the prior year, while our risk profile remained steady.

In auto, we originated $9.3 billion of loans and leases in the quarter, a 14% increase versus 3Q '18 and we decisioned 3.2 million applications. Despite some slowdown in new light vehicle sales, used vehicle sales remain robust. The shifting dynamic at the consumer level, our auto finance platform is well positioned to capture, evidenced by the higher year-over-year originated volume across all of our major lending categories.

Our originated yield on new retail loans was 7.51%, essentially flat year-over-year, while average benchmarks declined a 135 basis points. Competition continued to ebb and flow in the in the space, but we remain -- we see rational behavior, where underwriting standards remain thoughtful and balanced overall. Within our book, trends remain steady and healthy when looking at indicators of a consumers' ability to pay, including term, FICO, LTV, DTI and PTI.

We stay diligent in managing our risk profile, and as you would expect, have priced accordingly. With two Fed rate cuts behind us and continued easing actions forecasted, we would expect retail origination yields to trend lower over time, but it bade us well below the 100% level we observed as rates rose. Ally's scale and broad reach remains unparalleled across the industry, evidenced by our market-leading position.

Over 90% of franchise dealers in the U.S. now interact with Ally, providing us with the added benefit of real-time insights into consumer behavior and market trends. Our dealer count has consistently grown over the past five years, leading to a record 3.2 million decisioned applications in 3Q, supportive of healthy volumes and continued expansion of risk adjusted returns.

Credit performance remained in line with our expectations this quarter, as a retail auto net charge-offs of 138 basis points moved modestly higher by 6 basis points compared to the prior year. We continue to see a healthy U.S. consumer. Jobs are prevalent, unemployment is at a 50-year low, wage growth continues to outpace inflation, and debt service levels remain well managed. While consumer confidence recently moderated a bit, overall levels are near the highest they've been over the past two decades.

Beyond the consumer, we're monitoring business and manufacturing trends, including trade developments, but remain constructive on the GDP outlook, which continues to expand, although at a slower pace.

In our Insurance segment, written premiums were $357 million in 3Q, our highest level in five years, fueled by sustained growth channel increases, and ongoing expansion in our retail and wholesale product offerings.

Turning to deposits; we surpassed a $100 billion in retail deposits this quarter, ending the period with $119 billion in total balances and adding 72,000 net new customers this quarter, surpassing the 1.9 million mark. With another quarter to go this year, we've already exceeded full year 2018 growth in balances and customers, growing by $12.2 billion and over 290,000 respectively.

Over the past decade, Ally has averaged 19% annualized retail deposit growth; nearly 7.5 times the retail deposit industry growth rate. We've done this by relentlessly focusing on the customer and being true to our brand, with high value, straightforward innovative digital offerings. Customer loyalty is evidenced by our strong retention levels and consistent vintage performance, which Jenn will provide more details on in a few minutes.

Two-thirds of our customer balances are from mass affluent, high net worth individuals, while 60% of account openings are from the millennial cohort, establishing a banking relationship with us at an early stage in their financial journey.

This presents us with the opportunity to continue deepening the relationship over time. The increasing desire for convenience, seamless products, and exceptional customer service, go hand in hand with the core tenets of our philosophy. We're applying the same framework to the broadening array of consumer products we offer, and look to offer in the future.

Corporate Finance posted another solid quarter, with HFI balances ending at $5 billion, a 16% increase year-over-year. The team remains focused on responsible growth, and cultivating a diversified portfolio, with compelling returns, while prioritizing credit and operational risk.

Ally Home DTC originations were $800 million during the quarter, 4.5 times higher than what we originated in the prior year period. Our partnership with better.com has accelerated our ability to deliver a best-in-class digital experience for our customers.

During the third quarter, Ally Invest accounts grew 21% year-over-year, ending at 346,000. In early September, we rolled out new product offerings, including a managed portfolio, with zero advisory fees along with over 500 commission free ETFs, and we recently announced commission free trading and industry trend we have increasingly been anticipating.

Invest brings enhanced value to our customers and increases deposit stickiness. Year-to-date, around 40% of account openings have been from existing customers, and retention levels for these multi-product customers is higher overall.

We closed the HCS transaction earlier this month, and we welcome 85 Charlotte based teammates to Ally. We look forward to building upon momentum the team has established, leveraging the growing desire of consumers to use alternative digital payment sources in a seamless manner. And we were pleased during 3Q, to receive an investment grade rating from Fitch, an acknowledgment of the significant progress we've made in the strength of our enterprise.

Let's turn to slide number five to recap some of our quarterly metrics. Across each of the four measures shown here, we continued our strong progression in 3Q, while not always linear, the long-term trends of improvement have been consistent. Adjusted EPS on the upper left of $1.01 per share, increased from $0.91 a year ago. In the upper right, adjusted total net revenue increased by nearly $100 million year-over-year, while deposits grew 18% to $119 billion, compared to 3Q 2018.

On the bottom right. We continue building tangible book value, increasing to $34.74 per share, up 21% versus prior year. I'm confident we have the right business strategy and the right people to continue building on our momentum, while remaining mindful of potential risks on the horizon.

With that, I'll turn it over to Jenn, to walk through the details on the quarter.

[Jenn LaClair, CFO]

Thank you and good morning everyone. Our strong results in Q3 continue to reflect the consistent progress of our business models, grounded in a relentless customer focus and operating discipline.

Let's begin a review of our detailed financial results on slide 6. Net financing revenue excluding OID of $1.195 billion increased $31 million linked quarter, and $67 million year-over-year. The steady expansion of NII was driven by auto optimization, where portfolio yields continue to move higher and new origination pricing remained above 7.5% and the dual benefit of growing the deposit book where rates moved lower, and continuing to replace higher cost wholesale funding.

Despite the volatile rate environment, we expect NII to grow on a year-over-year basis over the next several quarters, though seasonality will drive some linked quarter fluctuations, which we expect in Q4.

Adjusted other revenue of $424 million grew $31 million quarter-over-quarter and $32 million year-over-year, driven by solid investment gains and revenue growth from insurance. Provision expense of $263 million increased $86 million quarter-over-quarter reflecting normal seasonal trends and $30 million year-over-year, as asset levels grew, and net charge-offs moved modestly higher.

Auto net charge-offs increased by 6 basis points year-over-year, remaining consistent with our expectations. As we've discussed in the past, we have been originating and pricing to 1.4% to 1.6% net charge-off range. We expect to outperform this range for full year 2019, due to strong used vehicle prices and macroeconomic factors at or near historically strong levels.

We remain confident in the overall performance of the portfolio and our outlook remains the same. Losses will continue trending toward the stated range of 1.4% to 1.6% over time, which is fully accounted for in our underwriting, pricing and collection approaches. Non-interest expense declined $43 million linked quarter, reflecting the seasonally lower weather losses, and increased $31 million compared to the prior year.

We generated positive operating leverage again this quarter, something we've done every quarter this year, as year-over-year revenue growth of 7% outpaced expense growth of 4%. Efficiency gains are a direct result of leveraging our scale and the investments we've made over the past few years in opportunities, aligned with our long-term strategy. We expect to continue to prudently investing for the future, which will result in expense growth with the parallel objective of driving improved efficiency over time.

Looking at our key metrics for the quarter, GAAP and adjusted EPS were $0.97 and $1.01 per share. Core ROTCE was 12.3% including elevated OCI reflecting declining rates since year-end. Adjusted efficiency ratio of 45.3% improved 70 basis points year-over-year. Given our progress year-to-date, we remain on track to achieve the full year 2019 guidance we provided in January. This is despite the significant shift in rates and expected Q4 impacts related to the HCS acquisition of $25 million to $30 million not included in our original outlook.

Turning to slide 7; I'll review balance sheet and margin. We generated revenue expansion again this quarter, through continued balance sheet growth and optimization. Like most banks, we prefer a steeper curve, but we are positioned to deliver expanded net financing revenue over the near term, as we are not overly dependent on rates.

Average earning assets grew 6% year-over-year, primarily in capital efficient categories. We expect earning assets to modestly grow moving forward, the remeasured auto expansion and consumer loans, ongoing diversification and capital efficient mortgage assets, prudent corporate finance growth, and continued but slower investment portfolio, growth as we've neared our 20% objective.

On the funding side, average deposits grew nearly $18 billion year-over-year, financing earning asset growth of $10 billion, the roll-down of $2 billion in unsecured and $9 billion lower secured funding . Net interest margin excluding OID of 2.72% increased five basis points linked quarter and was essentially flat year-over-year. As we've said for some time now, we expect NIM to stay relatively stable for full year 2019 compared to 2018, but as we move into 2020, we expect balance sheet dynamics to drive NIM expansion.

The retail auto portfolio yield of 6.66% increased 8 basis points quarter-over-quarter and 46 basis points year-over-year, resulting in another quarter of improving portfolio yield. As JB touched on earlier, we are monitoring competitive dynamics and benchmark activity, but continue to expect increasing portfolio yields as around 10% of our retail auto book reprices each quarter. Keep in mind, we've generated six consecutive quarters of new retail origination yields above 7%.

The lease portfolio yield was 6.24% for the quarter. Our used car index remains essentially flat year-to-date, outperforming our 3% to 5% expected decline for the year. While industry off lease volume of 4 million plus units is at the highest level in 20 years, the consumer has continued to exhibit strong demand for used vehicles.

We see this as a reflection of their healthy overall financial position, improved quality and durability of used vehicles, and an increasing difference in average transaction price between new and used cars, which recently exceeded $13,000, a 50% increase versus 2011. The commercial auto portfolio yield declined 16 basis points linked quarter, and increased 19 basis points year-over-year. Keep in mind, this is a floating rate asset that closely tracks one month LIBOR trends on a lag.

On the funding side deposits grew to 74% of overall funding, while unsecured balances declined to 8%, While we expect to periodically issue for parent liquidity purposes, overall balances will continue to decline, as another $3 billion is scheduled to mature by the end of 2020, with an average coupon of 5.8%.

On slide 8, we'll cover some deposit highlights. In the upper right, total deposits ended above $119 billion, driven by retail growth of $2.7 billion, while customer retention levels remain strong at 96%. Q3 marks the 39th consecutive quarter of [Technical Issues].

[Daniel Eller, Lead, IR]

Operator, are you there?

[Operator]

Yes, we're here.

[Daniel Eller, Lead, IR]

Okay. We had a technical difficulty, but we're going to pick up where we left off.

[Jenn LaClair, CFO]

So I'll resume on slide 8, where we're recovering deposits highlights. In the upper right, total deposits ended above $119 billion, driven by retail growth of $2.7 billion while customer retention levels remained strong at 96%.

Q3 marks the 39th consecutive quarter of double digit percentage growth in our portfolio on a year-over-year basis. Year-to-date, around two-thirds of balance growth has come from new customers, while the remaining third was sourced from existing customers adding to their balances.

We've seen an increasing array of competitive offerings from both traditional and emerging players in the digital space, but our customers and balances continue to demonstrate strong loyalty to Ally, reinforcing our value proposition and the long-term stability of the platform

From a flow of funds perspective, the majority of net inflows continue to come from traditional banks, where there is around $4 trillion of balances, earning under 50 basis points. In the bottom left, retail deposit rates declined 8 basis points linked quarter, reflecting pricing actions over the past several months.

As the Fed continues to ease, we expect the cumulative beta to be higher than what we observed as rates increased, a positive catalyst for the overall NIM trajectory. But our pricing decisions will remain balanced, as we focus on maintaining the trust and loyalty we've earned with our customers over time.

On the bottom right; we added 72,000 net new deposit customers during the period, which was our strongest third quarter and resulted in 23% year-over-year growth. The strategic value in customer and balanced growth aligns with our strategy, and positions us well, as we remain mindful of our 75% to 80% deposit funding target.

On Slide 9, we've included a chart, demonstrating the stability of our deposit vintages over the past decade. Our customers consistently keep their money with us and grow their balances. Our industry leading growth has been achieved, even as we have widened the gap to top rate payers on our online savings product, which you can see at the bottom of the chart. And the pricing action we took last week, positions us as the lowest among large direct banks, while our rate remains competitive in the broader context of the deposit industry.

Let's move to capital on slide 10; CET1 of 9.6% increased linked quarter and year-over-year, reflecting earnings growth and our disciplined approach to managing risk-weighted assets, which grew by 2% year-over-year, compared to average earning asset growth of 6%. We continued repurchasing shares during the quarter, reducing shares outstanding by 20.7% since mid-2016 and we closed HCS earlier this month and expect an associated capital impact in Q4.

As it pertains to CECL, we currently estimate day one reserves will increase by 105% to 115% driven by consumer auto. We have been proactive in planning for CECL, given the phase-in to the capital position of 25% annually over the next four years. Following CECL implementation, we expect increased volatility in go forward earnings, as we move to life of loan reserving and have potential fluctuations in macroeconomic assumptions

Even as this represents a material increase to our existing reserves, the underlying risk profile of our balance sheet has not changed. We plan to absorb day one and navigate the ongoing impacts of CECL, through prudent balance sheet management, while we continue to prioritize strategic capital deployment, including investment in accretive growth opportunities, share buybacks and dividends.

Let's turn to slide 11 to review asset quality details. Consolidated net charge-offs were 83 basis points this quarter, an increase of 8 basis points year-over-year, primarily driven by retail auto. In the top right, consolidated provision expense was $263 million, an increase of $30 million compared to the prior year, due to higher asset balances and moderately higher auto net charge-offs.

In the bottom left, the retail net charge-off rate increased six basis points year-over-year, to 1.38%, reflecting dynamics I discussed earlier. 30 plus and 60 plus delinquencies in the bottom right increased year-over-year by 26 and 9 basis points respectively. The rise in delinquencies this quarter reflects the increased mix and seasoning of our used portfolio. The purposeful change in our servicing efforts to have increased delinquencies, but consistently resulted in improved flow to loss trends.

In dynamics around closing out the quarter on a Monday, which impacts consumer payment timing; on slide 12, auto finance pre-tax income of $429 million declined $30 million linked quarter, due to seasonally higher provision, and increased $46 million compared to prior year. Net financing revenue growth was driven by retail auto asset growth and increasing portfolio yields.

We experienced the 22nd consecutive quarter of expanding dealer relationships in Q3, leading to our strongest third quarter ever in application volume, decisioning over 3.2 million apps and 11% year-over-year increase, which resulted in $9.3 billion in originated volume in Q3, a 14% increase versus prior year. In the bottom right, our risk adjusted return trends reflect improved new origination yields, even as benchmarks have meaningfully declined.

Turning to Slide 13; we originated $9.3 billion of consumer loans and leases in the quarter. Growth originations of 46% declined as a percentage of our total volume in Q3, though dollar originated volume increased compared to the prior year period. Seasonally higher new and lease volume resulted in used volume in near 50% of total originations, while non-prime of 11% remained consistent. While the percentage of use was lower year-over-year, the dollar amount of originations increased.

In the bottom left, consumer assets grew to $81.5 billion as lease balances increased slightly and retail continued to grow. And on the bottom right, average commercial balances of $33.3 billion declined year-over-year and quarter-over-quarter, as dealer inventories normalized.

On slide 14, Insurance reported core pretax income of $66 million in the quarter, an increase of $70 million linked quarter and $17 million versus prior year. Earned revenue increased $23 million year-over-year, reflecting the strong written premium trends over the past several quarters.

We wrote $357 million of premiums in Q3, the highest level since becoming a publicly traded company, with increased volume and rate across our product offerings. And during the quarter, we were pleased to receive an upgrade to A minus from AM Best, our first upgrade in 10 years at Ally Insurance.

Slide 15 has our Corporate Finance segment results. Core pretax income of $45 million was down $2 million linked quarter and increased $9 million year-over-year. Portfolio credit performance remained strong and in line with our expectations. Collateral based lending increased to nearly 60% of new originations in the period, and compared to prior year, ending HFI assets grew 16%. Our origination activity reflects focus from our experienced, cycle tested teams, who continue to execute through competitive environments.

On slide 16, mortgage pretax income of $11 million was relatively flat versus prior quarter and prior year periods, reflecting increased premium amortization, as rates declined and prepayment activity increased. We originated nearly $800 million of direct-to-consumer loans, the fourth consecutive quarter of increasing origination volume in our highest level since launching Ally Home. We continue to see strong deposit synergies, with 55% of direct-to-consumer originations sourced from existing Ally depositors

Our partnership with better.com, led to a series of best-in-class improvements including after fund turn times declining to approximately 30 days, and industry leading NPS scores. The all digital platform and streamlined customer experience will drive a 40% improvement in the cost-per-funded loan over time.

In closing, we had another successful quarter with solid pre-tax pre-provision income growth, and operating leverage gains, that created ongoing progress against our 2019 full year financial objectives. These results demonstrate the strength of our core businesses and our focus on delivering for our customers and driving sustainable long-term value for our shareholders.

And with that, I'll turn it back to JB.

[Jeff Brown, CEO]

Thank you, Jenn. Wrapping up on slide number 17, are the priorities for our company. The common thread running through each of these objectives is our prioritization of culture at Ally. It's how we ensure we're driving our company in the right direction.

Simply put, we're working to bring increased value through comprehensive and innovative consumer and commercial offerings, and as established leaders in auto, insurance and deposits, we're looking to seize upon untapped opportunities, that will further enhance the way we meet our customers' needs.

Our 8,500 Ally associates are striving to do it right in every interaction with our customers, within the communities we serve, and on behalf of our shareholders. It has been a great three quarters of the year, and we're focused on finishing strong over the months ahead, and well into the coming years.

With that, we can now head into Q&A.

[Operator]

Thanks, JB. Go ahead operator, [Operator Instructions]. Our first question comes from Moshe Orenbuch from Credit Suisse.

[Moshe Orenbuch, Credit Suisse]

Great. Thanks and congrats on really strong results. I wanted to kind of drill down a little on deposit pricing. I mean, you talked a little bit, Jenn, about being able to lead in the downward direction and just talk a little bit about your strategies there and how you think about that, in particular, given you've had such strong results on the asset yield side?

[Jenn LaClair, CFO]

Sure. Good morning Moshe and thank you. So no changes overall to our deposit strategy, I mean as we look across the business, we're really pleased with the customer growth we're seeing, the deposit flows we're seeing. In fact through Q3, we've had the highest levels of customer and deposit growth that we had in any full year in the history of the company. So really pleased there, and we'll continue to have strategic focus on growing customers, as well as deposits.

Now relative to pricing; I mentioned we're getting close to our target funding rate of 75% to 80%, and as we do so, we do feel that we're in a really good position to continue to focus on margin, and to be thoughtful, as we balance competing priorities. We want to continue to grow our business. We also want to optimize the margin. We will just be really thoughtful about that as we go forward.

You've seen over the last couple of months since June, we've dropped OSA rates around 40 basis points, CDs have come down around 35 basis points, and we think that positions us exceptionally well from a financial trajectory, as we go into 2020 and position ourselves for NIM expansion and overall for the customer, relative to the -- most bank rates with $4 trillion out there getting paid under 50 basis points, we think we're really optimizing, not only for Ally's margin, but optimizing for the customer as well.

[Moshe Orenbuch, Credit Suisse]

Got you. And in a somewhat related, I mean you talked about the, the debt you have that comes due by the end of next year, and the impact that would have at 5.8% kind of coupon. I guess the question that I have relates to operating leverage, and how does that make you kind of think about the ability to kind of continue to deliver on the operating leverage, as you go through 2020?

[Jenn LaClair, CFO]

Yes. So, I mean all of this really positions us to continue to grow net interest income and NIM, as we move into 2020, which is going to be a big driver around revenue -- overall revenue growth and operating leverage. Relative to the unsecured debt rolling down, it's a little bit lumpy, but we've got some really high cost debt coming down in the first quarter at an 8% coupon. And so the roll down of the unsecured, we'll just continue to lower overall deposit cost, and again, it's an input into NII and NIM trajectory

[Daniel Eller, Lead, IR]

Operator, you there?

[Operator]

Yes. I'm here.

[Daniel Eller, Lead, IR]

Okay. Moshe, are you still on the line?

[Moshe Orenbuch, Credit Suisse]

I am.

[Daniel Eller, Lead, IR]

Okay. We were getting a sign of more technical difficulty here.

[Moshe Orenbuch, Credit Suisse]

My questions have been answered. Thanks.

[Jenn LaClair, CFO]

Okay, great. Thank you so much, Moshe.

[Operator]

Thank you. Our next question will come from Sanjay Sakhrani with KBW.

[Sanjay Sakhrani, KBW]

Thanks. Good morning. So Jenn, I appreciate the commentary on CECL, and sort of the related impacts. But I guess when we're thinking about EPS impacts, you mentioned the variability of volatility it will bring. But is there any rough estimate assuming macroeconomic conditions are stable, what the EPS impact might be?

[Jenn LaClair, CFO]

Yeah. And we'll be providing a bit more guidance, as we finalize our 2020 plan. But I mean essentially, when you look at day two [Phonetic] there is a number of drivers around that volatility, and let me just outline a couple of those.

The first is, if you're growing your portfolios, you're going to see an outsized increase in your reserve levels, because again, you're going from a 12 month incurred loss model to life of loan. So it will depend to some degree on the growth in each of your portfolios.

Second, it's going to be tied to your mix, and that's the mix of your assets across your book, but also just the risk content within each of those asset classes. And then last but not least, it will depend to some extent on your macroeconomic forecast. So we need to settle down our overall forecast, and when we do so, we'll will provide our EPS trajectory overall for the company, and give you some sensitivities around CECL.

[Sanjay Sakhrani, KBW]

Okay, great. And I guess a follow-up related to credit quality, and some of the comments you had on the delinquency rate. Obviously, you guys have had very solid performance on credit quality this year. But when we look at the delinquency rate, that was a little bit higher than normal in the third quarter and there was a pretty decent pick up year-over-year. Was that all related to timing, or is it a little bit indicative of next year being a run rate charge-off level that's more consistent with what you guys have targeted this year. Thanks.

[Jenn LaClair, CFO]

Yeah, sure. So on delinquency, yeah, I'd say overall performance is well in line with our expectations, and kind of three drivers to the increase year-over-year. One is just the normal and expected seasoning of the used portfolio.

We've talked for some time around the fact that used tends to have slightly higher risk content. Keep in mind, we get paid three to four times that in the yields. So we're really pleased with the risk-adjusted returns in that segment.

But it does drive some higher frequency, and we're just seeing that coming through here in Q3, again, well in line with our expectations, and then there is a couple of just, what I would say operational impacts. One is, we launched some new collections and servicing strategies over the last four to eight quarters and some of that's just pushing out repo timing and increasing the delinquency levels.

It's improving flow to loss that we're pleased with, with the overall performance of these strategies, but it does result in some slightly higher delinquencies. And then there is just nuances in terms of the day in which the quarter closes, that can drive some volatility in your delinquencies, and I'd say almost a third of that increase was due just to the fact that the quarter closed on a Monday instead of a Friday.

So overall, in line with expectations, to your question on where we're going, we would expect to -- at some point, migrate up to that 1.4% to 1.6% retail net charge-off ratios, simply because that's where we're originating today.

And so as the used portfolio continues to season, as used vehicle values start to migrate out and we're still expecting that to occur, we'd have some increased severity and so over time, we'd expect to be more in line with that 1.4% to 1.6% range. Keep in mind we're pricing -- that's where we drive risk-adjusted returns in our sweet spot. So we're good with that.

[Sanjay Sakhrani, KBW]

All right, great. Thank you.

[Operator]

Thank you. Our next question comes from Arren Cyganovich with Citi.

[Arren Cyganovich, Citi]

Thanks. I was wondering if you could just comment on the decision to change the commission fee? I guess, the industry is moving in that direction and what the potential impact could be from a revenue perspective for you?

[Jenn LaClair, CFO]

Yeah, sure. Good morning, Arren, and maybe just I'll take the second question first. The impact is extremely small for us, as a percent of overall Ally revenue, it's tiny. So from a financial perspective, it's pretty much a non-event.

From a customer perspective, we still very much like this business, it's capital-light. JB mentioned, it increases the stickiness in the retention levels of our deposit portfolio, and so we see value there. And over time, as we move to more of an advice-centric model, and we're in the process of building that out, we think that this can be accretive from an ROE perspective.

But I mean, the bottom line here is, when the industry moves, you have to move with it, otherwise we lose some valuable customers and we didn't want to put ourselves in that position. JB I don't know if you want to comment on that.

[Jeff Brown, CEO]

Perfectly covered, Jenn. You got it.

[Jenn LaClair, CFO]

Thank you for the question, Arren.

[Arren Cyganovich, Citi]

Sure. And just as a follow-up. There is -- a few weeks ago, there was an article on the Wall Street Journal talking about kind of the middle class not being able to afford a car loan these days, and rolling over kind of underwater loans into new purchases and extending the terms.

Are you seeing anything from a competitive standpoint, where you're concerned about the trends that you're seeing within auto finance? Obviously we're not seeing that in your charge-off rates or anything of that nature, just curious what your comment would be about that?

[Jenn LaClair, CFO]

Yeah look, I mean, there is always going to be attention paid to the fringes, and that's really how we view that commentary on the overall business. As we look at our business, nothing has changed in terms of the way in which we originate and JB mentioned in his comments, that we see extremely consistent FICO scores, payment to income scores, loan to value.

We're not seeing any kind of deterioration in terms of term, etcetera. And if you look at the consumer, I think just right in contrast, the consumer right now is performing extremely well, we've got 50 employment. Debt servicing levels are actually at a 39-year low. They're under 10%, and so ability to pay continues to be strong, and I think you see that in our year-to-date credit performance, as well as just an incredibly robust application flow. We had record applications this quarter, continuing to be able to put price in the market. We're just not seeing it.

[Arren Cyganovich, Citi]

Thank you.

[Jenn LaClair, CFO]

Thank you.

[Operator]

Thank you. Our next question will come from John Hecht with Jefferies.

[John Hecht, Jefferies]

Hey guys. Thanks very much and congratulations on a good quarter. You touched a little bit on this in the last question, but I'm just wondering kind of thinking about incremental loan volume, where are new -- not new, new loan, not new car loan, but new loan terms moving in terms of durations. And yeah, I guess, yield margins, and where do you see the competitive market going?

[Jenn LaClair, CFO]

Yeah. I mean on retail auto, our term has not changed at all. I mean, we've been very consistent year-after-year, at just around 70 months term and that has not changed. So I guess that's answer to question one. Just in terms of yields, really robust yields.

We had our sixth consecutive quarter of putting new origination yields on the books over 7% and with the portfolio yield at 6.66%, we are very well positioned to continue to see portfolio yield migrate up to those new origination yields, and I think that performance this quarter really speaks for itself in terms of ability to generate flows, continue to drive upward expansion on the asset side, from a yield perspective

[Jeff Brown, CEO]

And then, John, on the competitive front, I'd say very consistent. Obviously I'm sure you saw one large bank talked about an increase in share that they took on. But we really didn't see it and didn't feel it in the third quarter. I think our flows were exceptionally strong, added to the point of Jenn covered for six consecutive quarters of where we've been bringing in new loans at, we've been very pleased with the margin we are capturing there.

So I'd say, the competitive environment remains very rational, and we haven't seen any big shifts in structure or appetite lately at all.

[John Hecht, Jefferies]

Okay, appreciate that color. And follow-up question is, you guys have been working on diversification, you've talked a lot about new business lines and had some positive commentary with the better.com partnership. And I think you've also mentioned historically that, you're -- in order for capital management, we might see incremental mix toward mortgage and so forth. I am -- just wondering, what do we think about kind of business mix as we enter next year and your focus on ongoing diversification?

[Jenn LaClair, CFO]

At a high level, we see opportunities to grow all of our portfolios, and that's auto, it's mortgage as you're mentioning as well, and specifically in the mortgage space, the key to that business is managing operating expenses, and with the partnership that we have with better.com, we see an opportunity to be able to accrete ROE over time, because we're able to bring down those operating expenses.

We just closed the transaction with HCS, that's another opportunity we have to drive diversification. It's a $130 billion-ish market growing at 20% a year, drives ROAs in the 3% to 4%, and so we see a really nice opportunity to continue to diversify through point of sale lending, with our HCS acquisition as well.

[John Hecht, Jefferies]

Great, thanks guys.

[Operator]

Thank you. Our next question comes from Betsy Graseck with Morgan Stanley.

[Jeff Adelson, Morgan Stanley]

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

[Jenn LaClair, CFO]

Good morning.

[Jeff Adelson, Morgan Stanley]

Just wanted to dig into the other revenue lines a bit. I think this is the first quarter you've actually seen the adjusted fees exceed $400 million in several years, and in the not-to-distant past, you kind of talked about that being in the range of $375 million to $400 million quarter-to-quarter.

So you're obviously seeing some good results in the insurance business, you've had some good gains the last couple of quarters and you're layering in that Ally Invest business over time. So I guess my question is, is it too early to think about the $400 million plus as kind of a new normal, or how should we think about that going forward?

[Jenn LaClair, CFO]

Yeah, I mean I would say we're absolutely focused on growing our fee income and our non-interest income. I'm not ready to give you guidance quite yet. I mean, we do see a lot of opportunities to continue to grow our fee income.

Insurance, you saw had record levels of written premium, and you're seeing that record levels and continued momentum over time show up in the -- in the earned premium, and we see opportunities across all of our businesses in that space. Inventory insurance, the insurance we provide, which by the way is becoming more and more critical to dealer margins. We're just seeing a lot of opportunity to continue to expand our insurance business, and that's not only the earned premium, it's also gains that we take on the assets in that portfolio.

So insurance is absolutely a growth engine for us. I'd say second, we grew our investment securities portfolio, as rates were rising and so we're in a really strong position, relative to kind of harvesting some gains around our investment securities portfolio as well.

And then as you mentioned, Ally Invest over time, we're still bullish on this business. We think that there's opportunities to grow, especially in the advisory space. It is supported by secular trends to digitization, and we think we're very well positioned to capture those growth opportunities as well.

[Jeff Adelson, Morgan Stanley]

That's all I had.

[Operator]

Thank you. Our next question comes from Kevin Barker with Piper Jaffray.

[Kevin Barker, Piper Jaffray]

Thank you. Your expenses ticked up a little bit in the third quarter compared to the growth that we've seen in the first half. I mean you've mentioned that this could occur. But could you just talk about the trajectory for expenses over the next few quarters and some of the things that are driving the increasing expense growth?

[Jenn LaClair, CFO]

Yeah, sure. And I do want to couple that with the revenue growth that we -- our focus is really around driving positive operating leverage, and we've been driving positive operating leverage every quarter this year, and that is our intention, as we move forward. But relative specifically to the growth in expenses has really been around the same themes that we've been discussing.

One is continuing to invest in our core competencies around marketing and digital technologies and platforms, and continue to see some growth relative to -- continuing to evolve both marketing, and digital and technology capabilities.

Second, there is just some variable costs tied to just the terrific amount of customer growth we've seen across all of our businesses, and so, a big chunk of that is just related to growing our business. And as I mentioned, there is revenue that comes along at an accelerated pace against that variable growth.

And then last but not least, just continuing to look for ways to grow long-term value for the company and for our customers, and the HCS transaction is the perfect example of that, and we will have some expense hit in Q4 relative to the closing of that acquisition. Those are the key themes.

[Kevin Barker, Piper Jaffray]

Okay. So do you expect the year-over-year growth rates in marine consistent with what we saw in the third quarter to persist, or do you think it will accelerate given the HCS transaction and then go forward?

[Jenn LaClair, CFO]

Yeah, I mean Q4, we have some seasonality in expenses relative to tech, marketing and HCS will close, which is kind of about half of that $25 million to $30 million in pre-tax impact in Q4. And for overall 2019, we're expecting to be well within our guidance of kind of flat to down a percent on efficiency ratio.

[Kevin Barker, Piper Jaffray]

Okay. Thank you for taking my question.

[Jenn LaClair, CFO]

Thank you, Kevin.

[Operator]

Thank you. Our next question will come from Chris Donat with Sandler O'Neill.

[Chris Donat, Sandler O'Neill]

Good morning and thanks for taking my question. Jenn, I wanted to ask about the full year guidance -- you made the comment in your prepared remarks that you're on track to meet it. I just want to flush out sort of the other piece of that with the -- because it seems like you've got some -- based on the prior three quarters, there should be some upside bias to the EPS part of the guidance.

But your commentary around the Health Credit Services acquisition in the $25 million to $30 million, is that one-time in nature related to the closing the transaction or is there -- are there losses with that acquisition that will persist into 2020?

[Jenn LaClair, CFO]

Yeah so good morning Chris. A couple of things. So first of all on Q4, there is some seasonality in the quarter, and I just mentioned some of the expense impacts there. We do have some impacts from an NII perspective, lease gains can be a little bit lumpy and we're still expecting used vehicle prices to come down a bit, so little bit of pressure in terms of the sequential quarterly impact to NII. I mean, year-over-year, we will be up on NII, but it’s not always a linear path.

And then on provision, we tend to have seasonality there, no different than we've had in any fourth quarter in kind of the history of the company. So just keep in mind, there's the seasonal element which is putting us back on track with our overall EPS guidance.

And then relative to HCS, we closed the transaction in first quarter. We've got some operating expenses obviously that are part of that transaction. They are not one-time in nature. We would expect that expense roll forward into 2020. And then second, as we acquire the portfolio, we've got about $250 million in balances that we will build in Q4, and then as we continue to grow that portfolio, there is some provision expense around it.

Those are really the two big drivers. But taking a long-term view, really pleased again with the opportunity to drive earnings and accretive ROA and ROE assets over time. But I do want to keep -- I do want to emphasize one more point here, and that's the fact that we are sticking with our original guidance for this year, that's in spite of an incredibly volatile interest rate environment, and in spite of that, we have grown NII in line with expectations.

We're hitting that flattening number that we've been guiding towards, and now taking a longer-term view. We're incredibly well positioned to have continued NII growth and NIM expansion, as we head into 2020.

[Chris Donat, Sandler O'Neill]

Okay. And then I had one question too about the insurance business and the written premiums, that if I'm looking at the trend correctly, they tend to be -- you have higher written premium in the third quarter of each year. If you just explain what's going on there, I understand that earned premium component of it, but just want to understand why written is stronger, what's seasonally going on there?

[Jenn LaClair, CFO]

Yeah, I mean, there isn't really any key driver of growth there. I will say, as you look at both written and earned premiums, Chris, there is some lumpiness just related to reinsurance costs. And so we mirror the reinsurance expenses with when we have weather losses, and so you typically do see some higher reinsurance costs in the high weather quarters. But other than that, it's been a pretty linear growth trajectory from a written and an earned premium perspective.

[Chris Donat, Sandler O'Neill]

Okay. Thanks very much.

[Jenn LaClair, CFO]

Thank you, Chris.

[Operator]

Thank you. Our next question comes from Eric Wasserstrom with UBS.

[Eric Wasserstrom, UBS]

Thanks very much. Jenn, I'm just trying to think through the capital lock on CET1 into next year, but maybe the preface to my main question is, I think I saw you guys did a little bit of securitization in the period, is that correct? And what was the CET1 benefit of that?

[Jenn LaClair, CFO]

So short answer is yes, we did have some securitization activity, just business as usual. There is not any big CET1 impacts related to that.

[Eric Wasserstrom, UBS]

Okay.

[Jenn LaClair, CFO]

And just on your CET1 question, I mean we are being very thoughtful, just in terms of continuing to grow CET1 and we are up about 50 basis points since fourth quarter, and that's really to position us well to absorb the day one impact from CECL. So again, 25% of the capital impact hitting in 2020, we're very well positioned to absorb that.

In addition to that, we have the HCS transaction that closed here in Q1, so that'll be a Q4 event. And then above and beyond that, we are positioning ourselves very well to continue to look for strategic opportunities to deploy capital. We've done all of that, in spite of distributing over $900 million in capital, year-to-date in the form of repurchases and dividends.

And so we'll just continue to organically accrete capital, be very thoughtful in terms of RWA growth and balance sheet management to position ourselves, not only to absorb CECL, but also to make sure that we can stay focused on our strategic priorities.

[Eric Wasserstrom, UBS]

Great. And so, if I can just maybe just follow up on that. My quick arithmetic on the day one CECL impact is about 90 bps with the phase -- well and then -- I guess a quarter of that phased in pro rata. Is that ballpark correct?

[Jenn LaClair, CFO]

Yeah, I mean, think about it kind of in that 80% range overall and then you take 15% to 20% of that kind of in any given year. Take a quarter of that in any given year. So kind of tax effect, the reserve impact, take 25% of that over the next four years.

[Eric Wasserstrom, UBS]

Got it. And so then it sounds like the other dynamics, so just the accretion which is typically about 30 to 40 basis points and then a little bit of impact from HCS, is that basically right?

[Jenn LaClair, CFO]

Yes. Well done.

[Eric Wasserstrom, UBS]

Okay. All right, thanks very much. I appreciate it.

[Jenn LaClair, CFO]

Thank you, Eric.

[Operator]

Thank you. Our next question comes from Dominick Gabriele with Oppenheimer.

[Dominick Gabriele, Oppenheimer]

Hi, thanks so much for taking my questions. When we look at the deposit mix and your targets and where we are today, and we saw some nice funding release this quarter, quarter-over-quarter, when you think about the interest rate path going forward that the implieds have, can you talk about if the quarter-over-quarter change in deposit costs and total funding costs could accelerate on a downward trajectory from here? Thanks.

[Jenn LaClair, CFO]

Yes, I mean it's not a perfect formula. We -- well, as I mentioned earlier, we want to balance strategic focus on customer growth, balance growth, But we do feel we're well positioned. We're approaching our target funding level of 75% to 80%.

I mentioned in my comments this morning that as the Fed continues to ease, we could continue to see opportunities to take down rates -- OSA is down already 40 basis points and that beta on the downs will be higher than the beta on the ups, and I think that's probably the best way to think about it.

[Dominick Gabriele, Oppenheimer]

Okay, great, thanks. And then when we think about -- you did mention about the betas on the yield side. Can we talk a little bit more about where you think that may be and the ramp there over time, and on the auto yields in particular? And you actually saw some really nice uplift in the lease yields this quarter. What's, what's going on there, If you don't mind, talking about that. Thanks so much.

[Jenn LaClair, CFO]

Yes, sure. Maybe I'll start with retail auto, and then we can go to lease. But yeah, if you go back to the tightening cycle, we've passed on over 100% of the increase in the underlying benchmark rate, the two to three year swap. And as we passed on that increase in the benchmark rate, that's when we really started to originate above that 7% mark.

Now if you look year-to-date, the underlying two to three year benchmark is down on average 130 basis points and the beta on that has been zero. I mean, because we just continue to put in pricing in the market above that 7% mark.

Now there is a number of dynamics there. One is healthy consumer has sustained car purchases, high demand, as well as the fact that -- while the rate is up compared to a couple of years ago, we are well below the average from a historic time period. And so, the overall interest rate on the car relative to payment income and debt income level continues to be absorbed.

So we're not seeing a lot of overall price sensitivity from the consumer at this point. Now, as we go forward and fed funds is top of mind and we see Fed funds potentially coming down, we could see some pressure on rates. But we're just not seeing that at this point.

And then, relative to lease, we can have some lumpiness there, especially related to lease gains. We had a really strong lease gain quarter, this quarter. That's been sustained by very strong used vehicle prices. We are -- as I've mentioned several times expecting used vehicle value to come down at some point. But overall this quarter, we had a really nice pickup because of lease gains, sustained by used car performance, which continues to be very strong.

[Dominick Gabriele, Oppenheimer]

And then if I may just one more, on the mortgage business, we saw year-over-year loan growth kind of slow a bit. Is that from one of the sales there, of why the growth slowed or is there may be a different strategy taking place, or was this a one-off? And what do you see in the mortgage market today, given the increased mortgage application spike more recently? Thanks so much, I really appreciate it.

[Jenn LaClair, CFO]

Yes, no, sure, maybe I'll separate it DTC versus bulk. On the DTC side, we absolutely see a lot of growth, and I mentioned, we hit $800# million in originations, which is a record quarter for us, and puts us well on the path to originate up to the $3 billion mark that we've set for ourselves.

So on the DTC side, really bullish on the product offering we have, the opportunity to continue to grow originations, especially as refi volume has peaked here. And so we'll continue to grow DTC and with the better.com partnership, we think we can get really great returns on that business as well.

On the bulk side, you're absolutely right. We have brought down the balances and a little bit of a shift in strategy there, just as we have seen early prepayments and amortization expense increase, we have just been really thoughtful about the way in which we grow that book, and we did have a loan sale.

Part of that was just positioning around the LIBOR transition, but part of that was just exiting some of the lower yield and portfolios that were in the money, because of the rate drop. So we'll continue to be incredibly thoughtful as we allocate capital to bulk, just making sure we get the right yields that are accretive to the book.

[Dominick Gabriele, Oppenheimer]

Thanks so much for taking my questions.

[Jenn LaClair, CFO]

Thank you.

[Operator]

Thank you, ladies and gentlemen I'm showing we do have time for one last question. And our last question will come from Rick Shane with JPMorgan.

[Rick Shane, JPMorgan]

Hey guys, thanks for taking my question, this morning. Jenn, I actually had a lease question and I thought you were going to touch on it, but I'm a little bit -- I'd like a little bit of clarification. The lease yields were up nicely year-over-year.

But if you look at the gains from vehicle sales, they were actually flat. So I'm curious if this is a mix shift in terms of the new vintages, is there more pricing power in the lease business, or was there actually a change to the depreciation curves that you guys are using?

[Jenn LaClair, CFO]

Yeah, so I mean, the short answer to all of that is no. We did see strong origination flow this quarter, and we were up about couple of hundred million in terms of the flow. But we've been guiding towards kind of ex-gains of low 5% yield and I think we've been trending kind of right in line with that.

And then anything above that 5% is related to the gains and the trajectory around the gains. But, no real trends, Rick, just in terms of our overall lease portfolio.

[Rick Shane, JPMorgan]

Okay, great, thank you so much.

[Jenn LaClair, CFO]

Thank you, Rick.

[Operator]

Ladies and gentlemen, thank you for participating in today's question-and-answer session. I would now like to hand the call back over to Mr. Daniel Eller for any closing remarks.

[Daniel Eller, Lead, IR]

Thanks operator. All I'll say is that, if you have additional questions, please feel free to reach out to Investor Relations, and we thank you for joining our call this morning.

[Operator]

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.