Ally Financial Inc

NYSE:ALLY

Earnings Call Transcript 2022-Q4

[Operator]

Good day and thank you for standing by. Welcome to the Fourth Quarter Ally Financial Inc. Earnings Conference Call. [Operator Instructions] Please be advised that today’s conference is being recorded. I would now like to hand the conference over to Mr. Sean Leary, Head of Investor Relations. Please go ahead.

[Sean Leary, Head, Investor Relations]

Thank you, Carmen. Good morning and welcome to Ally Financial’s fourth quarter and full year 2022 earnings call. This morning, our CEO, Jeff Brown; and our Interim CFO, Brad Brown, will review Ally’s results before taking questions. The presentation we will reference 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 Slides 3 and 4. 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. Good morning. We appreciate you joining us to review our fourth quarter and full year results. I will start on Page #5.

Full year adjusted EPS of $6.06, core ROTCE of 20.5%, and revenues of $8.7 billion reflected another year of solid financial results. ROTCE was approximately 16%, excluding the impact of OCI. We completed $1.7 billion of share repurchases over the course of the year, and this week, our Board approved a first quarter 2023 common dividend of $0.30 per share.

We built businesses that are nimble and able to pivot against the fluid backdrop. We maintain healthy levels of capital, reserves and liquidity, which position us well for this dynamic environment. Within auto finance, consumer originations of $46 billion were sourced from 12.5 million applications across more than 23,000 dealer relationships. The average originated yield of 824 basis points expanded 114 basis points on a full year basis. In total, we put nearly 400 basis points of price into the market, largely in line with changes in the Fed Funds rate.

Industry vehicle sales remain below pre-pandemic levels, but our ability to generate strong originations shows the benefits of our scale and depth of application flow. Net charge-offs in retail auto were 97 basis points for the year. In the fourth quarter, net charge-offs increased to 166 basis points as we saw accelerated normalization within the quarter. Brad will cover losses in more detail as well as our current thinking for this year.

Within insurance, written premiums again exceeded $1 billion, driven by strong relationships with 4,600 dealers. Our insurance team remains focused on leveraging synergies with the auto finance sales team and we remain optimistic about the organic growth opportunities for this business going forward.

Turning to Ally Bank, retail deposit balances increased $3 billion year-over-year, ending at nearly $138 billion. We generated $7 billion in retail deposit growth in the second half of the year while maintaining a very balanced approach to pricing. We continue to see strong momentum in retail deposit customer growth and ended the year with 2.7 million customers, up 8% year-over-year. We have seen increased consumer engagement and adoption trends across other Ally Bank product offerings.

Ally Home originations of $3.3 billion were down year-over-year, reflecting broader mortgage market conditions. Equity market trends resulted in a decline in Ally Invest assets while active accounts increased to 518,000. Ally Lending generated origination volume of $2.1 billion as we added merchant relationships across home improvement and healthcare verticals. Ally Credit Card reached $1.6 billion of loan balances from more than 1 million active cardholders. The card team also reached a key milestone in the fourth quarter as we rolled out a lineup of Ally-branded credit cards. I am proud of what we have accomplished on the integration over the past 12 months and excited about the continued opportunities which lie ahead. Corporate Finance continues to generate steady loan growth with the held-for-investment portfolio reaching $10 billion with growth coming primarily from asset-based lending.

Turning to Slide #6, our long-term strategic priorities remain unchanged, even as we navigate this dynamic environment. Our teammates are well prepared to handle near-term challenges while remaining focused on driving long-term value. Our culture is the driving force behind everything we do as a company and I will share more on that on the next page. Since the launch of Ally Bank, we have challenged ourselves to provide differentiated and frictionless products in the market. Consumer preferences have evolved over the past decade and we have always strived to deliver leading digital experiences allowing us to be an ally for our customers. Our dominant positions in auto and deposits continue to fuel consolidated earnings today and we see growth opportunities across the company which will drive continued asset and revenue diversification as we further scale our newer businesses. Central to all our lending products is a disciplined approach to credit risk and we view [Technical Difficulty] ability to underwrite and manage risk as our most critical core competency. And lastly, disciplined capital deployment is a foundational aspect of our strategy to deliver strong returns and add value for all stakeholders.

Turning to Slide #7, the building, caring and nurturing of our culture is what has given me the greatest joy in leading our company over the past 8 years, and it remains a huge priority for me. Our culture is not about the CEO’s culture. It’s a culture that harnesses the true power of over 11,500 teammates and empowers everyone to make a difference. I firmly believe a strong culture is essential to delivering for our customers, communities and stakeholders and that all starts with taking care of our employees.

We have consistently prioritized investment in our people and culture and our actions in 2022 reflect that commitment. In the past 12 months, we have increased our minimum wage by 15% to $23 an hour, which makes a meaningful difference for thousands of our teammates. We recently announced another year of our OwnIt Grant Program, which provides every employee 100 shares of Ally’s stock and empowers them to act as owners of the company. We have expanded mental health benefits for employees and their families this year and expanded upon our benefits for new parents.

The investments that we have made and our deliberate focus on culture has resulted in a highly engaged workforce. We are in the top 10% of companies when it comes to employee engagement and well above industry averages. Our employee resource groups, or ERGs, were launched 5 years ago as we expanded our DE&I initiatives and I am proud to say over 50% of our workforce volunteers and is active in at least one ERG. Creating an engaged workforce that embraces our Do It Right approach improves every aspect of our business as we serve our growing customer base now 11 million strong.

Retention levels at Ally Bank remain industry leading, along with compelling customer satisfaction rates. We have consistently rallied around initiatives that help us better our customers and drive industry change and our teammates continue to invest in the communities we live and work in. We work hard to nurture this culture across the enterprise and I am confident it will be a differentiator for Ally now more than ever.

Let’s turn to Slide #8. Before diving into the fourth quarter details, I’d like to highlight Ally’s multiyear strategic and financial transformation which demonstrates the steady execution and strong performance over a longer lens than a quarter or two. In nearly 10 years as a publicly traded company, we have consistently worked to remain a disruptor and execute against our long-term priorities which has resulted in sustained improvements in operational and financial results.

Within Auto & Insurance, we have transitioned from a captive auto finance company to a market-leading diversified lender with dealer relationships of 23,000, increasing roughly 50%, while application flow of nearly 13 million is up almost 40%. Ally Bank remains the largest all-digital bank in the U.S. While the direct banking industry was largely unproven when we launched Ally Bank, our steady growth to $138 billion of retail deposits and 4 million customers make it clear our model and our brand resonates with consumers.

Our balance sheet has evolved through optimization within auto finance, along with expansion into other consumer lending verticals. Overall, earning assets are up $44 billion since our IPO, which includes $28 billion of non-auto loan growth. This growth has generated $3.7 billion of revenue expansion. This evolution has created a structurally more profitable company. NIM of 3.88% is up 134 basis points from where we were in 2014 and is driven by optimization on both sides of the balance sheet.

Throughout this transformation, we have remained disciplined on capital allocation and ensured we are adequately reserved. Shares outstanding have declined 38%. Book value, excluding the temporary headwind from OCI, has effectively doubled and we maintain a $3.7 billion loan loss reserve. These metrics reflect years of consistent execution and give me confidence in our ability to deliver in the years ahead.

Slide #9 reflects our focus on growing an engaged customer base. We now serve 11 million customers across our businesses, which represents a 58% increase since 2014. Ally Bank customers have more than quadrupled over this timeframe as we have evolved, expanded and enhanced our digital capabilities. Our consumer lending products are resonating and customers want to deepen their relationship with Ally evidenced by the significant growth in multi-product customers shown at the bottom of the page. Across Auto & Insurance, we have added 500,000 customers as we have leveraged our strength and scale in the market as the leading independent full spectrum lender. This product expansion and customer growth have translated into improved balance sheet composition and expanded earnings, which I will cover over the next few pages.

Turning to Slide #10. Since 2014, we have significantly transformed our balance sheet as we have optimized auto and expanded additional consumer offerings. Loans and leases have increased $31 billion or 26% since 2014 through disciplined expansion across all our lending products. Auto assets have been relatively stable as growth in higher yielding retail assets has been offset by a decline in floor plan balances. While not reflected in the charts, the return profile of the auto finance business has dramatically improved as we strategically shifted into the intersection of prime and used. Allied Bank Consumer and Commercial Products have grown 6x since 2014 and now make up $33 billion of balances. And it’s important to keep in mind that while we have recently added point-of-sale lending and credit card capabilities, our balance sheet remains 95% secured.

On Slide #11, you can see we have driven substantially higher net interest margin given the optimization across both sides of our balance sheet. NIM increased 134 basis points from 2014 given expanded earning asset yields and an improved liability construct. The optimization within auto has increased yields, while expanded consumer lending offerings have provided incremental tailwinds.

Our liability stack shows equally meaningful progress. In 2014, we were only 41% deposit funded relative to 88% today. Market-based funding has declined by more than $50 billion. The transformation of our funding profile has driven cost of funds down nearly 30 basis points despite average Fed Funds being 160 basis points higher. While we face near-term pressure on margin, given our liability-sensitive position, this optimization on both sides of the balance sheet positions us with a much improved NIM despite the rapid rise in interest rates. Brad will share more on margin dynamics later.

Turning to Slide #12, total revenue of $8.7 billion represents a 74% increase since 2014. Net financing revenue of $6.9 billion has nearly doubled through balance sheet transformation and the strategic positioning of the auto finance business. Other revenue has also expanded as we have grown fee-generating businesses like insurance and smart auction. Investment gains will fluctuate with market conditions, but we see a path to a $2 billion plus annual other revenue stream. The bottom of the page highlights the significant progress across our Ally Bank businesses. Revenue in 2022 of $1.2 billion has increased more than $1 billion since our IPO and is up 75% in just the last few years.

Moving to Slide #13, we show the consistent credit performance of our largely secured balance sheet and significant reserve coverage relative to losses. On a consolidated basis, net charge-offs of 74 basis points compared to a coverage rate of 2.72%. Within retail auto, net charge-offs of 97 basis points reflect normalization of historical lows. The retail auto reserve of 3.6% remains elevated versus CECL day 1. We feel comfortable our reserves position us well for a variety of environments as we have consistently taken a conservative approach in our reserve methodology.

Slide #14 adds additional perspective on absolute levels of our reserves and excess capital. The $3.7 billion allowance on our balance sheet is roughly $1.1 billion higher than CECL day 1 and positions us well to absorb expected lifetime losses based on the current economic outlook. And our capital position creates significant buffer against unexpected losses and volatility. While we have largely normalized excess capital relative to our internal targets, we continue to maintain $3.6 billion of CET1 above our regulatory minimum under the SCB framework. The ultimate path of the economy over the near-term remains fluid, but we feel very good about the reserve and capital position of the company.

Moving to Slide #15, we have highlighted our steady growth in book value per share. At year end, book value per share, excluding the impact of OCI was $44, up 92% since 2014. We understand the magnitude of interest rate movements has heightened the focus on AOCI and the mark on our securities book, but we feel the $44 figure is a better representation of the true intrinsic value of our company. The existing mark will fully amortize back to par over time and declines in rates like we saw in the fourth quarter will accelerate book value generation.

The bottom of the page shows the progress we have made in buying back shares at levels below the intrinsic value of the company. Since the inception of our repurchase program in 2016, shares outstanding are down 38% creating significant value for long-term holders. We recognize there is a lot of focus on our earnings trajectory over the next few quarters, but it’s important to consider the tailwinds that have been created by a fundamental transformation over the past several years.

And with that, I will turn it over to Brad to cover our detailed financial results.

[Brad Brown, Interim Chief Financial Officer]

Thank you J.B. Good morning, everyone. I’ll begin on Slide 16. Net financing revenue, excluding OID, of $1.7 billion was up slightly year-over-year, driven by continued strength in origination volumes and auto pricing, higher funding costs given the rapid increase in short-term rates partially offset to our hedging position and growth in unsecured consumer products. Adjusted other revenue of $478 million reflected continued momentum across our insurance, smart auction and consumer banking businesses. Elevated investment gains in 2021 drove the year-over-year decline. Provision expense of $490 million reflected the continued normalization of credit and modest reserve build to support loan growth and to reflect the evolving macro environment. Non-interest expense of $1.2 billion reflects investments in our growing businesses and in technology.

As we mentioned during our last call, the fourth quarter included a $57 million charge consisting of the final impact of the termination of our legacy pension plan. Results also reflect the tax impacts related to that termination, which drove $60 million of tax expense and increased the tax rate in the quarter by approximately 14 percentage points. GAAP and adjusted EPS for the quarter were $0.83 and $1.08 respectively.

Moving to Slide 17, net interest margin, excluding OID, of 3.68% decreased 14 basis points year-over-year and 15 basis points quarter-over-quarter. The impact of rapid increases in short-term rates and the repricing dynamics of our balance sheet creates some near-term margin pressure. We still see NIM troughing around 3.5%, which I will cover in more detail shortly and remain confident in our ability to return to a 4% margin over time.

Fourth quarter NIM benefited from continued increases in retail auto originated yields, declining retail auto prepayment activity and growth within our commercial and unsecured consumer lending segments. Total loans and leases are up nearly $16 billion versus prior year, while declines in cash and securities resulted in total earning asset growth of roughly $9 billion.

Earning asset yield of 6.24% grew 65 basis points quarter-over-quarter and 149 basis points year-over-year reflecting the continuation of trends we’ve highlighted previously, including strong originated yields within retail auto, growth in higher-yielding assets, and more than $40 billion of floating rate exposures across the loan and hedging portfolios.

Retail auto portfolio yields expanded 33 basis points from the prior quarter due to continued increases in originated yields and a decline in prepayments, which have been pressuring yields since mid-2021. Including the hedge – impact of hedges, yields reached 7.98%, up 69 basis points quarter-over-quarter, and we expect yields to migrate towards 9% throughout 2023. Similar to the prior quarter, commercial portfolio yields expanded as their floating nature benefits from higher rates.

Turning to liabilities. Cost of funds increased 84 basis points quarter-over-quarter and 170 basis points year-over-year. The increase in deposit costs was in line with what we shared last quarter and reflects higher benchmark rates and a competitive direct bank market for deposits.

Slide 18 provides incremental detail on our outlook for margin. We continue to expect near-term compression and NIM to trough around 350 basis points, assuming the forward curve and a Fed funds peak of 5%. In retail auto, we added 395 basis points of price into the market in 2022 and are currently originating loans in the 10% range. On the deposit side, our OSA pricing has moved up 280 basis points as of year-end. So prices in retail auto were 115 basis points in excess of what we passed through on OSA.

Despite that pricing momentum, the timing dynamics we’ve highlighted previously will remain a margin headwind until we get through the Fed tightening cycle. So much of this last quarter, the bottom of the page highlights the two largest drivers of our NIM trajectory. Retail originated yields were 9.57% and given the portfolio yield, it’s still more than 150 basis points lower than originated yields, we see meaningful portfolio expansion ahead. By the fourth quarter of 2023, we expect portfolio yield will increase to roughly 9% without assuming any incremental pricing actions on new retail auto originations.

The bottom right shows the evolution of retail deposit pricing. At year-end, our OSA was priced at 330 basis points, while average retail deposit costs in the quarter were just over 240 basis points. Deposit pricing has remained dynamic and competitive and incremental betas were a little higher in the fourth quarter. And while we’re not providing a specific outlook for OSA pricing, we continue to see a 3.5% NIM trough in a scenario where liquid deposits go to 375 basis points. Clearly, there is a range of possible outcomes but we feel very good about our overall NIM trajectory.

Turning to Slide 19. Our CET1 ratio remained at 9.3% as earnings supported $2 billion in RWA growth. In 2022, we executed $1.7 billion of share repurchases as we continue to normalize excess capital. Additionally, we announced a dividend of $0.30 per share for the first quarter. We remain disciplined in our capital allocation and currently maintain $3.6 billion of CET1 in excess of our SCB requirements. Our priorities remain focused on maintaining prudent capital levels amid continued uncertainty while investing in our businesses and supporting our customers.

Let’s turn to Slide 20 to review asset quality trends. Consolidated net charge-offs of 116 basis points reflected the combination of normalization and seasonality. Comparison to the prior year and three pandemic periods are influenced by the addition of unsecured lending, which added 11 basis points. I’ll provide more color on retail auto credit shortly, the trends remain generally in line with our expectations. We are closely monitoring performance trends across the portfolio to inform tactical actions and risk tolerance as we continue to manage through credit normalization.

In the bottom right, 30-day delinquencies increased due to typical seasonality and have normalized back to 2019 levels. 60-day delinquencies are elevated versus 2019, given strategic shift in collection practices, but we continue to see favorable total loss rates. We expect continued increases in delinquencies and are closely monitoring consumer health and the impact of persistent inflation on spending and savings trends. The investments we’ve made within servicing and collections over the past few years will enhance our ability to communicate with and support our customers.

Slide 21 shows that consolidated coverage increased 1 basis point to 2.72%, primarily reflecting growth in our retail auto and unsecured lending portfolios. The total reserve increased to $3.7 billion or $1.1 billion higher than CECL day 1 levels as we accounted for modest loan growth and the current macroeconomic outlook which has the unemployment rate approaching 5% by year end. Retail auto coverage of 3.6% increased 4 basis points quarter-over-quarter and is 26 basis points higher than CECL day 1. Total retail auto reserves of $3 billion are up roughly $600 million or 25% versus CECL day 1.

Slide 22 provides a detailed view of originations dating back to 2016 bucketed into our proprietary credit tiers. As a full spectrum lender with critical scale, we are able to opportunistically focus on market segments where we see the most value while supporting our dealer customers. Since 2016, originations from our top two tiers have remained consistent in the 75% range, while we slightly decreased our exposure to lower credit tiers. Our approach to risk-based pricing is evident on the right side of the page. In total, we added 395 basis points of price in 2022, which was intentionally added across the credit spectrum. Like some other lenders, we weren’t able to add as much price into higher FICO segments, but we aggressively added price to higher risk tranches to buffer returns from losses that may exceed underwritten expectations. The bottom of the page highlights a few originated stats showing our strategic shift towards used, which has largely driven yield expansion despite stable credit origination trends over the past 7 years.

On Slide 23, we show our forecast for used vehicle values, which has remained largely consistent for the past 12 months. In 2022, we saw a 19% decline from peak values most of which was realized during the second half of the year. We are projecting a further decline of 13% from current levels, which will result in a 30% total decline from 4Q ‘21 to the end of 2023 consistent with previous guidance. There are certainly other views on used values out there, most of which are projecting smaller declines in 2023. While we do see the possibility for a smaller decline in 2023 based on the supply and demand dynamics at play, we continue to maintain a conservative stance.

Turning to Slide 24, we have added some details on what we’re seeing within the retail auto portfolio regarding vintage performance. We have continued to see strong performance from vintages originated through mid-2021. These loans have now passed their peak loss period, and we expect lifetime losses to be favorable to price expectations. We are seeing elevated delinquency and loss trends in the vintages originated from late 2021 through mid-2022, consistent with what others have observed in the industry. These vintages currently account for about 38% of the portfolio and are just entering peak losses. Although we expect that cohort to amortize to about 24% of the book by the end of this year, we do expect elevated losses in those vintages to impact our full year 2023 net charge-off rate. As we have discussed previously, we have been taking underwriting and pricing actions to reduce the risk content of new originations. By the end of this year, these latest originations will account for the majority of the portfolio and loss content heading into 2024.

Slide 25 provides an update on retail auto net charge-off expectations. Our 2023 net charge-off outlook assumes a mild recession in 2023, along with a 13% further decline in used values just discussed. Loss performance in December was consistent with what we expect on a normalized basis, and we assume full normalization of the portfolio in first quarter of 2023. Peak losses on the late 2021 and early 2022 vintages and increasing unemployment drive elevated losses late in the year and a full year 2023 net charge-off rate of around 1.7%. The bottom of the slide provides a perspective on how we currently expect losses to materialize throughout 2023. We’ve also included historical references, which have shown similar seasonality. Overall, expected losses are up approximately 30 basis points from those periods and are slightly elevated relative to what we’d expect for the normalized risk profile of our originations. We expect 2023 to continue to be a very dynamic environment and we will continue to be transparent about what we’re seeing and our current expectations for the year.

On Slide 26, we have laid out various actions we’ve taken throughout 2022 to mitigate risk on new originations and how we’re prepared to manage credit through the cycle by focusing on what we can control. Front-end actions, including modifying decision strategy, implementing pricing increments and curtailing risk helps to ensure we’re originating loans at adequate risk-adjusted returns, maintaining appropriate staffing levels through the cycle and investing in digital capabilities proactively positions us to handle normalized credit conditions.

Moving now to Ally Bank on Slide 27, retail deposits of $138 billion increased $3.8 billion quarter-over-quarter reflecting continued growth and solid inflows from traditional banks. Total deposit balances $152 billion increased $6 billion quarter-over-quarter, driven by incremental growth from broker deposits. Given the continued momentum across the deposit franchise, we’re currently 88% deposit funded. We delivered our strongest quarter of customer growth since the second quarter of 2020, adding 85,000 new customers in the fourth quarter, our 55th consecutive quarter of growth. Since we founded Ally Bank, balanced growth and retention have been foundational aspects of our retail deposit strategy. We continue to lead the industry with a 96% customer retention rate. Customer acquisition, especially within the younger generations is noteworthy. The customer demographics in the bottom right highlights the long-term opportunity we have to deepen relationships by being part of our customers’ financial journey from the other stages.

Turning to Slide 28, we continue to drive scale and diversification across our digital bank platforms. Deposits continue to serve as the primary gateway to our other banking products, which enhanced brand loyalty, drive engagement and deepen customer relationships. The strength of our brand allows us to build on current momentum across our newer consumer lending products.

Ally Invest continues to increase depth and strength of customer relationships at Ally Bank. The percentage of new accounts opened by existing customers remains above 70%. Card balances of $1.6 million are derived from 1 million active customers reflecting our strategy of low and grow credit lines. Ally lending balances of $2 billion highlights the momentum across healthcare and home improvement verticals. And we continue to see balanced opportunity for accretive growth in these portfolios as they currently comprise less than 5% of our earning assets.

Let’s turn to Slide 29 to review auto segment highlights. Pre-tax income of $437 million was a result of continuing actions, pricing actions as well as balanced growth within the retail and commercial auto, offset by higher provision. The increase in provision expense versus the prior year reflects historically lost performance in 2021. Looking at the bottom left, originated retail auto yield of 9.57% and was up 82 basis points from the prior quarter, reflecting significant pricing actions. As mentioned previously, we put nearly 400 basis points of price into the market in 2022 and are continuing to see solid flows with originated yields above 10%. This drove further expansion of the portfolio yield, and we expect this to continue over the medium term, given the strength and scale of our franchise. The bottom right shows lease portfolio trends. Despite the decline in used values, gain per unit was up quarter-over-quarter given the decline in lessee and dealer buyouts.

Turning to Slide 30, we continue to realize the benefits of our leading Agile platform underpinned by a high-tech and high-touch model. Consistent application flow shown in the top left, enables us to be selective in what we approve and ultimately originate. Applications and approvals have been relatively stable over the past couple of years, but we did target a tick down in approval rate as we proactively manage risk through detailed micro segment analysis. In the upper right, ending consumer assets of $94 billion are up 6% on a year-over-year basis. Commercial balances ended at $18.8 billion as new vehicle supply remains pressured, but has shown some signs of normalization.

Turning to origination trends on the bottom half of the page, consumer auto volume of $9.2 billion demonstrates our ability to add price in the market and maintain solid origination volume. This culminated in full year originations of $46 billion. We remain nimble and are not tied to any target, but we would expect to generate originations in the low $40 billion range in 2023. Lastly, use accounted for 60% of originations in the quarter, while non-prime declined to 7% of volume given ongoing risk management and seasonal trends.

Turning to insurance results on Slide 31, core pre-tax income of $52 million decreased year-over-year from the low – from the impact of lower investment gains, given the market backdrop. Total written premiums of $285 million increased year-over-year but still reflects headwinds from lower unit sales and inventory levels across the industry. Last quarter, we shared some context on how our proactive approach and dealer relationships were able to limit losses related to Hurricane Ian. We continue to see favorable results and expect minimal loss content as shown in the bottom left chart. Going forward, we remain focused on leveraging our significant dealer network and holistic offerings to drive further integration of insurance across auto finance.

Turning to Corporate Finance on Slide 32, core income of $67 million reflected disciplined growth in the portfolio and stable credit trends. Net financing revenue was driven by higher asset balances as well as higher benchmarks as the entire portfolio is floating rate. The loan portfolio is diversified across industries with asset-based loans comprising 55% of the portfolio and a first lien position in virtually 100% of exposures. Our $10.1 billion HFI portfolio is up 31% year-over-year reflecting our expertise and disciplined growth within a highly competitive market.

Mortgage details are on Slide 33. Mortgage generated pre-tax income of $19 million and $170 million of DTC originations, reflecting tighter margins on conforming production and effectively zero demand for refinancing activity. Mortgage is an important product for our customers who value a modern and seamless digital platform. We’re focused on a great experience for our customers, but refrain from any specific volume targets.

Before closing, I’ll share a few thoughts on the outlook for 2023. On Slide 34, we show key drivers of expected 2023 expense growth while headline expenses are projected to grow roughly 6%, it’s important to look a little closer at the details. Roughly half of the year-over-year growth is comprised of non-discretionary items including an industry-wide increase in FDIC fees and insurance expenses, primarily commissions, which have a direct offset in revenue and weather losses.

Growth also includes increased costs to ensure we are able to provide leading service to our customers, support continued credit normalization and manage loss exposure. The remaining increases in expenses consist of variable costs directly tied to revenue growth, like servicing and acquisition costs in auto and card and long-term investments across the enterprise like cyber. So what you traditionally think of as discretionary expenses are driving approximately 1% to 2% of expense growth in 2023. We acknowledge the revenue headwinds present this year and remain very focused on efficient expense deployment.

Slide 35 contains our financial outlook as we see it today. Clearly, the dynamic environment makes it harder than ever to provide granular guidance, but we remain committed to transparency. Based on what we know today, we see adjusted EPS of approximately $4 in 2023, the main drivers of which include NIM of 3.5%, which we’ve covered previously, other revenue expanding to roughly $500 million per quarter, modest earning asset growth, mid-single-digit expense growth, retail auto net charge-offs of 1.6% to 1.8% and consolidated net charge-offs of 1.2% to 1.4%, and finally, a tax rate in the 21% to 22% range, slightly favorable versus our historic average given ongoing tax planning strategies.

We have also provided our thoughts on earnings trajectory beyond 2023. We expect earnings expansion over the next several years as NIM moves past the trough and migrates path towards 4%. Based on what we know today, we can see a path to that $6 as early as 2024, but obviously, several variables will ultimately dictate the pace of EPS expansion. We continue to view mid-teens as a return profile of the company based on all the structural enhancements we have made over the past several years. We acknowledged 2023 will be a very dynamic year given macroeconomic headwinds and volatility, but we are confident in our ability to continue to execute and drive long-term profitability.

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

[Jeff Brown, Chief Executive Officer]

Thank you, Brad. I thought I would close by highlighting several of my near-term priorities. First and foremost is credit risk, as I have said before, our ability to underwrite and manage credit risk is our core competency. I am confident the investments we have continued to make in risk management positioned us well to navigate this fluid environment. The bar on cybersecurity risk management continues to move higher, and we are committed to protecting our customers from external threats. I am thankful for the talent of our CIO and CSO and the broad cyber teams that exist at Ally.

Taking care of our people and maintaining a purpose-driven culture is even more important during periods of heightened uncertainty. Our continued emphasis on essentialism will drive operating efficiencies over time. While we are focused on actively navigating this dynamic environment in the near-term, we are committed to continuing to execute on our long-term priorities. And finally, we must live our name and be an Ally now more than ever. We are going to support our dealer, corporate finance and consumer bank customers, staying true to our name and promise has driven our unique growth and retention of customers. I remain incredibly proud to lead our company. And over time, I am confident these priorities will serve us well and deliver value for all stakeholders.

I know the deck today was longer than normal, but we thought it was important to really give that longer term view and focus on the trends that we have executed on since we went public and also hit the things that are top of mind for all of you and top of mind for investors, things like credit and margins. So, we tried to evolve the deck this time. We know we added several pages, but we thought that transparency was very important.

And with that, Sean, back to you, and we can head into Q&A.

[Sean Leary, Head, Investor Relations]

Thank you, J.B. As we head into Q&A, we do ask that participants limit yourself to one question and one follow-up. Carmen, please begin the Q&A.

[Operator]

[Operator Instructions] One moment for our first question, it comes from the line of Moshe Orenbuch with Credit Suisse. Please go ahead.

[Moshe Orenbuch, Credit Suisse]

Great. Thanks for that extra disclosure. So, just drill in a little bit on the credit loss outlook and how we should think about it. Can you talk a little bit about the impact of frequency versus severity, the period that you saw from the middle of ‘21 to ‘22, those originations, what are you seeing that’s driving that higher loss? And how does that inform us as to the path in ‘23 and ‘24 for the overall loss rate?

[Brad Brown, Interim Chief Financial Officer]

Hey. Good morning Moshe. It’s Brad. I will start on that one, and J.B. can certainly add in. As you mentioned, we did highlight that kind of late 2021, early 2022 vintage. From a frequency perspective, we did see that kind of normalization pace accelerate in the fourth quarter and a couple of variables to that are important. One, as customers really get to that stage earlier in the cycles alone, that is typically a higher balance, a charge-off with certainly impactful. And then as well, as noted, we did see some acceleration and used car values in the late part of the year, which were also impactful. As we think forward drilling into 2023 here, as I mentioned, that vintage was about almost 40% of the book at the end of the year. As that continues to normalize, we will work that through the system here in 2023. And I think that, that will, as we mentioned, be impactful to the 1.7 rate that we highlighted as well. But then at the same time, we have taken, as noted, significant actions tactically around risk management and trimming some of the risks that we see, particularly around micro segmentation which will also – which has really reduced the loss expectations on that more recent book. And then couple that with the really strong outperforming back book really kind of gives us comfort there in terms of that range. And then ultimately, the macro environment is certainly impactful. As mentioned, this does assume – we are assuming a mild recession in 2023. That’s really led by contraction in GDP for the first couple of quarters and then ultimately unemployment getting near 5% by the end of 2023.

[Moshe Orenbuch, Credit Suisse]

Great. Thanks. And the margin outlook is roughly consistent with where you had been, although rates have moved up a little bit more. What has countered that? Has it been the yield on auto? I mean I think the – your performance this quarter was a little better than we had been expecting. Talk a little bit about what drove what you – how we should think about what’s happened on the yields side, I guess?

[Brad Brown, Interim Chief Financial Officer]

Yes. Sure. Well, I would go back to all the enhancements that J.B. highlighted at the beginning, structurally, that is continuing to be a significant part of the expansion just generally from an overall company and balance sheet perspective. I would say that retail portfolio yield continues to expand. I think that – those levels, I think have been a little bit underestimated as well. And I think again, putting on good solid business at 10% yields, high-9s during the fourth quarter was also impactful. And then you think about things like the hedges that we have, which really do provide a nice bridge for us. As you think about the increase in Fed funds in the fourth quarter, 125 basis points was dramatic. So, that did re-price the OSA portfolio as we also highlighted. But the hedges really do kind of help us bridge the 4Q through really most of 2023 to kind of give time for the retail auto portfolio to really overwhelm the increase in liability costs.

[Jeff Brown, Chief Executive Officer]

Yes. The only thing, Moshe, maybe I would add just a couple of things on – it’s really Slide 30. We didn’t spend a ton of time drilling into what we did in the quarter, but you will see auto originations. We pared back fairly considerably in the fourth quarter from where we had been running. And I would say that was probably driven two-fold. One, just being ever more deliberate on credit management and as Brad talked about trimming some of those micro segments and things like that. But you also saw a decent pop in what we are doing in the new space. And part of this, we just think it’s a function, and I talked about it at one of the industry conferences in December as you get to kind of a 10% type of yield on new consumer originations, you hit a bit of a saturation point with the consumer. So, part of that – all those factors sort of drove into kind of lower volumes and maybe a little less risk appetite in the fourth quarter as well.

[Operator]

Thank you. One moment for our next question and it comes from Ryan Nash with Goldman Sachs. Please proceed.

[Ryan Nash, Goldman Sachs]

Hey. Good morning guys and thanks for all the additional disclosure. Brad, to Moshe’s question, you outlined what you expect to drive credit losses in the near-term. Can you maybe just expand upon what’s included in the allowance from a macro perspective? I know you said 5% unemployment by the end of the year. And just how are you thinking about future reserve build here given the fact that you are expecting a modest recession in the near-term? Thanks.

[Brad Brown, Interim Chief Financial Officer]

Hi. Good morning Ryan. Sure. So, I guess I would start by saying we did mention the macroeconomic. It certainly has evolved since third quarter, right. And we pointed that out, you did as well, GDP contraction as well as higher unemployment by the end of the year, approaching 5%. I would start with by saying we – and J.B. pointed this out, right. We continue to be really generally conservative in our overall reserving methodology that includes the assumptions that we make in our CECL framework as well when you think about our 12-month supportable and then the 24-month reversion as well and the look back there, which includes the Great Recession, to kind of get into that kind of reversion mean of 6.3% in unemployment. So, when we kind of think about 3.6% coverage versus that range of 1.6% to 1.8%, and my kind of simple broad mass when you think about even the high end of that range, if you allocate that annualized number over our weighted average life of auto, which is 22 months or so, you will see that we are really well covered even at the higher end of that range.

[Ryan Nash, Goldman Sachs]

Got it. Thanks for the color. And then J.B., maybe a question for you on capital, so, the slides note that you don’t expect to repurchase any shares here. And given slower than last year’s balance sheet growth, I think it’s pretty clear you are going to build capital this year. So, maybe you could just talk about, given the uncertainty in the environment where you would like to run capital ratios at? And then maybe what would it take for you to turn repurchases for the company back on? Thanks.

[Jeff Brown, Chief Executive Officer]

Yes. Sure, Ryan. So, as kind of we alluded to, we are close to sort of running at our internal target, which is 9%-ish. And so we have been aggressive buyers of the shares. Got ourselves paying a reasonable dividend today. I think just in light of what a fluid environment, dynamic environment challenging, whatever you want to call it, we think the prudent thing right now is not to plan for incremental buybacks. But to the extent we get clarity, the extent – whatever we head into and it becomes a mild recession, and we start generating incremental capital, I think we would look to restart the buyback program at some point in the future. And so that was using that word currently was very much by design. I mean I think what we see today, the prudent things do not plan for it. But look, we – I think we have shown we are aggressive buyers of our shares when we feel they are undervalued, and we certainly would say that today. And so to the extent we get more and better clarity, it would not be unreasonable to assume we begin again.

[Operator]

Thank you. One moment for our next question please. And it comes from the line of Bill Carcache with Wolfe Research. Please proceed.

[Bill Carcache, Wolfe Research]

Thanks. Good morning. Your presentation materials go a long way towards addressing some of the major debates on your stock. So, let me add my thanks. I wanted to follow-up on your credit comments. Based on what you see today, would you expect NCOs to peak in 2023, or could we see peak NCOs going on until 2024? And when should we expect the reserve rate to start to drift floor in relation to those peak losses?

[Jeff Brown, Chief Executive Officer]

Yes. Hey. Good morning Bill. Sure. So, I think the slide that we added that shows sort of that expected trajectory in 2023 is a great reference point. And you will see kind of at most, the biggest delta and sort of our normalized view versus 2023 expectations really is in the fourth quarter. And so that’s where the unemployment rate, as I have said, is peaking and cresting as well as working through some of the other dynamics we mentioned in terms of just when you think about the content of new originations as well, the vintage, the dynamic that I mentioned, which is really working through that late ‘21, early 2022 cohort where we expect that to be down to less than a quarter of the book by the fourth quarter. So, I think that, that – and also kind of continuing what we have guided to previously around our decline in used vehicle values, they will kind of get us to that high point of the 4Q 2023. Now, if things worsen or things change from here, I mean variables, as I mentioned, are moving quickly and certainly hard to predict. But we would see that there could be some of that elevation going into 2024, but really feel like given all of those dynamics that, that should be around the top...

[Bill Carcache, Wolfe Research]

Got it. And separately, I did want to also ask if you could give some color on the decision to provide concrete expense guidance and speak to the concerns that 2024 is a long way away and you may be limiting your flexibility. Why not go with more of an efficiency ratio that gives you the ability to potentially manage expenses for the revenue environment? Just any kind of color on the thought process that you all went through there.

[Jeff Brown, Chief Executive Officer]

Yes. I mean Bill, what I would say is look, we – across the enterprise, we embrace this essentialism mindset, which is disciplined pursuit of less. There is a number of the items let our sort of non-controllable, what I think Brad pointed out, FDIC piece being a big driver. The insurance line item creates a decent-sized pop and your headline expense number. But as Brad mentioned in his prepared remarks, that’s the direct offset in revenues there. And so then when you get into kind of controllable space, you got a number of 1% to 2%, which we think in light of the environment is pretty reasonable. I mean as I talk to other CEOs in financial services, I think everyone is kind of grappling with higher people costs and human capital costs. And so we are trying to manage through that. What I would say is, as an enterprise in the end of the summer last year, we more or less hit the pause on hiring. You have seen other financials do that as well. I would say there are some special exceptions to that new talent, entry-level talent you want to continue to build a pipeline and allow those people to come into the company, that doesn’t end up being a big driver of expenses, but we have added to the headcount there. And then with respect to the technology space and cyber space, things like that, we think these are areas that you have to constantly invest in. And we think it’s kind of interesting what’s going on in the world of technology, more layoff announcements throughout this week more this morning, and that may provide us an opportunity to bring in incremental talent. So, all of these things kind of balance out the way we are thinking through. I mean we recognize revenues, as Brad talked about, are going to be pressured in the near-term. But I think our focus is trying to create that right balance for the long run. And I think what we have done in hiring has been very responsible and very disciplined in what I think our long-term holders would expect us to be doing. But I mean I would start with there is a big essentialism push to drive efficiencies wherever we can.

[Operator]

Thank you. And one moment for our last question. And it comes from the line of Betsy Graseck with Morgan Stanley. Please proceed.

[Betsy Graseck, Morgan Stanley]

Hi. Good morning.

[Jeff Brown, Chief Executive Officer]

Hi Betsy. Good morning.

[Betsy Graseck, Morgan Stanley]

Two questions. One, just wanted to dig in a little bit on the guide for how you are thinking about the OSA rate and the NIM and all that. And I know that you indicated there were several different scenarios in a range of potential outcomes. So, can you help us understand how you are thinking about working through the scenario where perhaps OSA rate becomes a little more competitive than what you are baking into the baseline that you have got here?

[Jeff Brown, Chief Executive Officer]

Yes. Betsy, I will start and Brad, feel free to dive in. So, what I would say, certainly the direct bank market has been hypercompetitive as of late – I think there is a bigger thrust for deposits. So, we take the point. I think where we are priced at right now at 3.3 on OSA is in line with what I would say are other kind of top name direct banks and big banks. And so we are kind of right in line with the pack. There are certain names that are priced higher than us, and we are not seeing big outflows. And so all this ends up being kind of a – a balancing act on the competitive environment and the rate environment. I think the guide that Brad tried to point out is, I mean we – I think most of the universe is starting to think that the Fed is getting closer to being done, maybe there is another 50 basis points to go. And obviously, I mean we are at 3.3 today. Brad is showing you a scenario where you are going up 45 basis points against maybe a 50 basis point move. So, it’s kind of like a 90% beta. That feels pretty darn aggressive to me. So, it is a balancing act. That’s why we try to add the transparency about what you are assuming on the Fed funds rate. Everyone can kind of do their own math if they think it would go higher. But the nice thing, I would say, in talking to our deposit leader, Paula and our bank leader, [indiscernible], they would tell you things have kind of felt a little bit more stable here in the past three weeks, four weeks. So, we think there is more to go, but I don’t think it’s another kind of 100 basis points from here.

[Betsy Graseck, Morgan Stanley]

Okay. Got it. And then separately, same kind of theme, how should we think about the impact on loss rates if used car prices fall more sharply than what you have baked in?

[Jeff Brown, Chief Executive Officer]

Yes. I mean obviously, they would go up to some degree. But I think there are a couple of dynamics at play. First, if you look at other industry experts and big names that are out there, they are more modest than the declines that they have projected. I think we have been pretty consistent saying end of ‘21 to the end of ‘23 would be this 30%-ish type decline. We saw a little more than that last year. But as Brad shown you, you have got probably 13 basis points of decline embedded here. I think that – the other factor that’s out there is there were about 11 million less cars produced over the past sort of 3 years. And so we think that provides some structural support. We always try to take a more conservative view. But I mean the way I would think about the range of risk is maybe it’s another 5% decline in used car prices, and that would represent kind of a couple of basis points of incremental NCO. So, it’s fairly well in there. Yes, could it be worse, but we think that’s probably a little bit unlikely from here.

[Betsy Graseck, Morgan Stanley]

Okay. Thanks so much for the time. Appreciate it.

[Jeff Brown, Chief Executive Officer]

You got it, Betsy. Thanks.

[Sean Leary, Head, Investor Relations]

Great. Thank you everyone. That’s all the time we have for today. If you do have additional questions, as always, please feel free to reach out to Investor Relations. Thank you for joining us this morning. That concludes today’s call.

[Operator]

And thank you, ladies and gentlemen. This concludes today’s conference and thank you for your participation. And you may now disconnect.