Good day, and thank you for standing by. Welcome to the Ally Financial Second Quarter 2021 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. [Operator Instructions]. Please be advised that today's conference is being recorded. [Operator Instructions]. I would now like to hand the conference over to your speaker today, Daniel Eller, Head of Investor Relations. Please go ahead.

Thank you, operator. We appreciate everyone joining us to review Ally Financial's second quarter 2021 results. This morning, we have our CEO, Jeff Brown; and our CFO, Jenn LaClair, on the call to review results and to take questions. Before beginning, I'll note the presentation we'll reference on today's call can be found on the Ally Investor Relations website. Forward-looking statements and risk factor language governing today's call is on Slide 2. And on Slide 3, we've included several GAAP and non-GAAP or core measures pertaining to Ally's operating performance and capital results. These metrics are supplemental to and not a substitute for U.S. GAAP measures. Definitions and reconciliations can be found in the appendix. With that, I'll hand the call over to J.B.

Thank you, Daniel. Good morning. We appreciate everyone joining us on the call today. Performance this quarter was exceptionally strong. And our results underscore the power of our vibrant and growing businesses. Despite the rapidly changing operating environment over the past 18 months or so, we've executed against our strategic goals, expanding our market-leading capabilities and driving momentum across all areas of the company. Do It Right serves as our mantra and provides great clarity to our actions inside and outside the walls of Ally. I'm tremendously proud of how our Ally teammates uphold our values in meaningful ways every day. Since Ally Bank launched 12 years ago, you've seen us constantly challenge the status quo through innovative, seamless, and differentiated consumer bank products, services, and experiences. In June, we were the first major bank to announce the elimination of overdraft fees for all customers. While eliminating the revenue stream was viewed by many as unprecedented and by some as controversial, this was a logical step for us in continuing to redefine traditional bank norms in advancing our mission to create a better and more equitable banking relationship for everyone. The success of our all-digital banking platform is reflected in the accelerating growth across several measures, including sustained, rapid expansion of engaged customers, industry-leading retention of balances and account holders, and steady growth over the past 5 years among customers who use multiple Ally Bank products. Our model will continue to evolve to meet the increasing demand among consumers for frictionless and simplified experiences enhancing our ability to further unlock additional franchise value in the years ahead. For our Ally teammates, we remain relentlessly focused on fostering an engaged, equitable, and inclusive culture while prioritizing their well-being. We're encouraged by the reduction in COVID cases and growth of vaccinated populations…

Thank you, J.B., and good morning, everyone. The strength of our financial performance again this quarter reflects our disciplined operating approach and the continued execution of our long-term strategic priorities. Before I review the details, I'd like to thank our Ally teammates for their ongoing commitment, which underpins our strong performance and accelerating trajectory. We've built deeply integrated auto and digital banking experiences for dealers and consumers, enhancing Ally's franchise value and affording us the opportunity to protect and improve our market share, grow our loan portfolios and diversify income sources and generate a solid mid-teens return profile in the years ahead. We're well aware of the debate on whether prevailing market trends represent peak performance for companies. And while we acknowledge used car values and credit trends will migrate toward normalized levels over time, we continue to focus on expanding our industry-leading businesses, delivering a sustainable core earnings trajectory that is structurally higher than pre-pandemic levels and prudent management of capital and liquidity. On Slide 7, net financing revenue, excluding OID, of $1.56 billion reached the highest level on record for Ally, growing 13% linked quarter and 46% year-over-year. Performance was fueled by ongoing strength in auto pricing and origination volumes, elevated used car values, optimization among funding sources and benefits from redeployment of excess liquidity. Adjusted other revenue of $588 million reflected another solid quarter of investment gains and continued growth among our SmartAuction, mortgage, invest and insurance operations. We repositioned $70 million of OID expense associated with the retirement of $2.4 billion trust preferred securities. In Q3, we expect to reposition around $50 million, aligned with the July closing of the second redemption. We opportunistically replaced this floating rate instrument with 5- and 7-year fixed rate perpetual preferred securities, which improves the quality of our Tier 1…

Thank you, Jenn. I'll close with a few comments on Slide #20. First, I remain deeply grateful and proud to lead our company. Our results this quarter are really impressive, but our broader purpose and calls to serve our teammates, our customers, our communities and our stockholders is what defines the long-term success, but still remains ahead for Ally. We built a structurally enhanced, fundamentally stronger company through strategic execution across our business lines and balance sheet optimization. This positions us for a long-term outlook that is brighter now than at any other point in our company's history. We will continue to execute with a focus on the same values and priorities that have served us well. And the future is bright for All Things Ally. So Daniel, with that, turn it back to you, and we can head into Q&A.

Great. Thanks, J.B. So as we head into the Q&A session, I’ll remind participants to please limit yourself to one question and one follow-up. Operator, you may now tee up the Q&A session.

[Operator Instructions]. Our first question comes from the line of Ryan Nash from Goldman Sachs.

So J.B., Jenn, can you maybe talk about how you can manage through the normalization of used car prices by underwriting? And maybe just talk about what assumptions are baked into your intermediate-term net interest margin guidance. And secondly, maybe can you just talk about what you're seeing in SmartAuction in terms of lease gains? Are you starting to see any signs of normalization? And what are your expectations as you look out over the next 6 to 18 months?

Sure. Good, morning, Ryan. So just a couple of comments on where we are with used car prices. We can get into some of the dynamics on SmartAuction. But clearly, first half of this year, used SmartAuction. But clearly, first half of this year, used vehicle pricing is up kind of over 30%; in second quarter, up over 40%. We are expecting, Ryan, for used car pricing to start to normalize in the back half of this year. Now, I think the question is around the pacing of that. We do think we've kind of passed the peak and we would migrate down to more normalized levels at a minimum by 2023. And that's what is embedded in our kind of medium-term guidance around ’22, ’23 , 15-plus percent ROTCE. I think a lot of dynamics there, and we hit on this in the prepared remarks, but we're continuing to see incredibly strong demand for personal vehicle ownership. We actually think some of that could be pushed out simply because of availability of new and used vehicles. Coupled with on the supply side, we think the chip shortage is going to continue to pressure inventory levels. And so, while we're expecting the normalization, I think the big question, Ryan, is quite frankly, when will that happen? I think you know us, we tend to be pretty conservative in how we've modeled this, and we are expecting it to come down at least in our modeled numbers through '22 and '23. On your question on underwriting, look, we never change underwriting for pockets of abnormal activity. And so, we have embedded normalized used vehicle pricing in LGD and off lease as well in our underwriting for both lease and lending. So we feel really good about our pricing approach. Obviously, our reserves include much more normalized levels. And then on SmartAuction, not quite as many cars as we would have liked. We are seeing kind of dealer buyouts increase simply because of the demand for inventory on lots and their appetite to sell metal. So we're not seeing quite the activity we'd like to on SmartAuction, but the gains are coming in just huge as you saw in Q2 and then we will be modest in terms of assumptions there on out.

Got it. And maybe if I can ask 1 follow-up. I mean the business is obviously generating outstanding returns right now. You're talking about 20% plus this year, you're benefiting from elevated used car prices. So J.B., can you maybe just talk about prioritization in terms of how you think about accelerating investments in some of the new businesses that can drive revenue growth versus potentially accelerating capital repatriation. You've obviously increased the dividend by a decent chunk and you're going to be buying back $2 billion of stock versus over the next year. But I'm just curious how you think about that relative trade-off of accelerating some investments given the outsized profits versus continuing to return a lot of capital to shareholders.

Yes, it's a great question, Ryan. And I guess it's a blend of both for us right now. So as you pointed out, we were really happy to be able to announce higher capital returns via the dividend and buybacks and even having said that, we're still running elevated levels of capital. I think the 11.3 CET1 is still 230 basis points higher and that's a real amount of dollars than our internal target that we want to run. So, going into this year's planning process, Jenn and I are really working with our business leaders on trying to think through what we're calling kind of unconstrained growth. So what are the higher growth scenarios that we could deploy to drive better organic levels both in terms of balance sheet and revenue opportunities. I think we continue to be very tactical in what we're doing on the technology side, the digital side, the cyber investment side. Those are some of the near-term investments like Jenn and I have greenlighted to accelerate. And then also the same thing on the brand side. Well, Ally Bank brand and the Ally brand overall continues to resonate extremely well. I think relative to some of our competitors, we are underspent there and we are underinvested there, and we think there's broader opportunities in promoting the brand, doing more in digital acceleration with the brand. We have a great Chief Marketing Officer in Andrea Brimmer, and she’s got some world-class teammates that are trying to really push forward what we do in the digital analytics side there. So we're super excited, and I think it's going to be a fun year. I think the Board is on board with us and kind of pushing the company forward. So, we're proud of the foundation that's been established, but I think now it's really about pushing for even higher levels than we've achieved to date. So hopefully, that's helpful, Ryan.

Our next question comes from the line of Sanjay Sakhrani from KBW.

Good quarter. Things are really solid. Just a quick question on the originations. Obviously, a very strong quarter of originations. Could you just speak to how you see that unfolding for the remainder of the year?

Yes, sure. Good morning, Sanjay, and thank you for the questions too. Our originations approached $13 billion this quarter, and it sets us up really nicely for full year originations. We're expecting strong flows through Q3 and Q4 and likely will exceed $40 billion. We always talk about our strategy is not to chase volume, but we'll be opportunistic when we see it, and we are certainly seeing it this year evidenced in kind of the strongest originations we've seen in 15 years, and we continue to see opportunities to hit that kind of 7% retail auto origination yield in 2021 as well. So think about kind of Sanjay, a number in the $40 billion to $45 billion, and then we'll continue to see how things unfold into '22 and '23, again no volume target. But with the rapidly expanding distribution, J.B. mentioned, it's our 29th quarter consecutively of growing dealers. And then the team is all over relationship deepening right now, so we hit record application flows. We're not seeing any sign of that stopping based on the operating environment, but more specifically just our strategic positioning across our dealer base and our product set right now.

Great. And then I guess a follow-up question to Ryan's question on capital. I guess when we think about the excess capital, some of it could be used towards M&A. Are there any opportunities out there that you're seeing? Is there a pipeline of things you're contemplating?

Sanjay, I'd say, we always try to stay opportunistic and open. I think the position we find ourselves in today though is we've got dominant franchises in auto, in the bank. And we're seeing all these new businesses really start to grow and scale on top of what auto continues to do. So we're in this fortunate position where we don't feel forced to have to do anything. And I think that's probably different than some of our banking competitors. And so we'll always stay open. The Ally Lending business is obviously new. We're impressed with leadership there, the way they've integrated into Ally and the scalability of that business. But -- and that's an entree into this universe of unsecured consumer lending. I think there's still a broader question, is there something bigger? Should we accelerate what we're doing there that we have a broader opportunity. But we're just -- we find ourselves in a really great position today. The business -- the business model has been validated. So we're not in a rush or a race to do anything.

Our next question comes from the line of Bill Carcache for Wolfe Research.

Can you give a bit more color on your discussions with your dealers around floorplan levels and the possibility that they'll be able to run with less inventory? And also if you could remind us what kind of impact smaller dealer floorplan balances will have on Ally's profitability?

Yes, sure. Good morning, Bill. Maybe I'll start with the dealer floorplans impact, and we can circle back to the dealer question. But on floorplan, I mean, obviously, that's impacting our balance sheet. And we've continued to see loans in the commercial space dip down. And we think we've hit the trough here in the second quarter. We could kind of bounce around at these levels for another couple of months. But we do expect kind of back half of this year to see a commercial start to grow again and normalize kind of through '22, '23. It is going to take some time, no doubt, especially with continued strong consumer demand and then supply chain shortages, just from chips as well as other constraints. So expecting to see that turn around a bit towards back half of this year, but it's going to be a slow kind of and steady recovery. I think what's great for Ally is that we have natural hedges. And with the lighter floorplan, you're seeing used vehicle values continue to climb. We hit kind of 40-plus percent in the second quarter. We're expecting 25% to 30% increase in used vehicle values, that's obviously showing up in our lease yields through lower depreciation as well as lease gains. And it's also showing up in our loss given default. From a loss perspective, we're in a net recovery position this quarter as you've seen. So the natural hedges offset the balance sheet decreases that we've seen on the floorplan side and net-net set us up to generate really robust returns and earnings. And it's -- quite frankly, it's the same for our dealers. They're seeing margin expansion. We're hitting kind of record numbers of dealers that are profitable right now due to some of these dynamics on the inventory side, lower carry costs, high vehicle values. In terms of kind of their views on where we are, I think the sentiment -- and J.B. can add on, but the sentiment is this is going to take some time. And I think because dealer profitability is so high, there's no rush to kind of -- to increase inventory, increase carry costs. I think there's been some smart learnings that have come out of this and it always makes sense to build for demand as opposed to build supply and hopefully, the demand comes. And so we're hopeful that the OEMs as well as the dealers we'll continue to take some of these lessons learned into future operational practices. But J.B., anything you add to that?

You covered it incredibly well, Jenn.

As a follow-up, I wanted to ask about branding. You guys have had tremendous success with the build-out of the deposit franchise. But is there an active focus on doing more to continue to develop the Ally brand inside the organization with the goal of just ultimately being seen as more than beyond the provider of a balance sheet.

Yes, Bill, like do you have a direct line to enter. Yes, I mean, in fact, we are -- as J.B. mentioned, we are in active dialogue right now. We're launching our strategic planning process. And we're in active dialogue around how we can continue to be a thoughtful share the Ally story with our customers. We have a terrific product set across both sides of the balance sheet, adding to our wealth management capabilities. So we think there's just a terrific opportunity ahead to accelerate the growth of our new businesses and to continue to dominate across auto and deposits. So absolutely -- and I can kind of hear Andrea cheering from a couple of doors down around this. Now of course, we want to do it smartly and we want to make sure that we position the brand effectively, just being mindful of generating positive operating leverage. But with that said, we would agree.

Yes. I think just to add on a little bit there too. I mean today, we've got ballpark round numbers, 9 million customers. I think the unique thing for us is they're active, they're engaged. We're growing the multiproduct nature of the customer base as well. So it's all about what we're really trying to optimize. If we wanted a higher headline customer number, we could target for that. But I think what's been very important in what's been guiding us is get a customer in the door, grow around them, help them see the holistic nature of the brand. I mean we're very proud using a subset of the customer base, 2.4 million at the bank, I mean, to see a 96% retention rate on our customer base says something about our brand and the quality of our service. But as Jenn pointed out, Andrea, is always looking to grow and optimize. And our new advertisements promote kind of the holistic nature of Ally. So you'll see more from us. Obviously, we continue to grow our sports marketing footprint and what we've done on the Champions Tour with women's soccer with MLS coming and then obviously a really dominant position in NASCAR today. We think sports marketing approach also drives pretty incredible brand value there as well.

Our next question comes from the line of John Hecht from Jefferies.

Congratulations on a solid quarter. The -- most of my questions were around residual values, and you guys have addressed those. So I guess 1 thing is -- I think back in '16 and '17, you kind of gave us an indication of kind of, I think it was like a 5% year-over-year decline in residual values or used car pricing to kind of give us just a sense where your head's at, how you're resetting your -- the depreciation curve and so forth. I mean do you have anything that that's that straightforward for us thinking about '22 and where you might be kind of pinpointing expected residual value declines?

Yes. So good morning, John. So let me start with this year. So we are expecting this year to land kind of up 25% to high 20% range. The first half of this year is up 35% or so above 30%. And so we are expecting the back half to start to normalize. And without getting too specific around kind of '22 and '23 numbers, which a lot to work through to have a clear view. But by '23, what we've modeled in our guide is that we do get back to kind of a much more normalized lease yield. So we always talked about kind of 4.5% to 5% pregains and then add another 1% or so for gains. And so we do expect to get back to that much more normalized yield by 2023. Now as I mentioned, there is definitely a bull case out there just as we look at continued demand for vehicles as well as the supply shortages. But we don't model in any kind of extraordinary results into the guide. We have much more normalized projections.

Okay. That's super helpful. Appreciate that, Jenn. And J.B., thinking about you guys had a lot of applications and thinking about your conversion rate. And maybe just sort of commentary on what you see going on in terms of underwriting quality across the industry as banks may be coming back into the fray and how you guys respond from a competitive perspective?

Yes. So I mean it's been overall a pretty balanced competition. I mean the market, as we've seen for quite some time has been intense. I think as we've probably talked about for a year or so, there's been rumors of players coming back in, but it really hasn't disruptive flow or competition of things that we see are certainly any of the pricing dynamics. I mean if you look at some of our pages in the deck, some of the supplemental financial information, we haven't really changed anything on underwriting standards. We've kind of been running the same type of FICO trend, same type of focus on our S, A tiers of business because we're generating really, really solid returns there. I mean when you think about -- we're now at probably 12 quarters or so of running the 7%-plus yield in a practically 0 rate environment with very low or benign credit costs. I mean this is pretty chunky. So we probably would have expected a little bit more competition that we're seeing. But frankly, we've made it really easy to work with the dealers. The dealers know what our buy box is. They know we're not inconsistent in that. And so part of just having established relationships with 19,700 dealers just leads to really attractive originations overall and really attractive yields for our booking. So I'd just say -- I don't mean to sound boring. It's just -- it's always a competitive market, but there haven't been really any big shifts in the universe in which we play in.

Our next question comes from the line of Betsy Graseck from Morgan Stanley.

I just had a couple of questions. I wanted to ask about the capacity of current balance sheet to add more loans. I know you've been growing loans at a nice steady clip. You've got a lot of capital generation. But I'm just wondering from a liquidity perspective, do you feel like you're optimized for that? Or is there room to kind of burn down some of that liquidity to add incremental lending?

Yes. Hey, Betsy. So on your first question, resounding yes and really across all of our lending categories that you've seen us grow consumer retail auto kind of sequentially for the last several quarters, and you see the robust outflow, origination flow, and we're absolutely focused on continuing to grow our retail auto lending. Lease as well continues to be a strong point, and we don't see any sign of that stopping. Ally Lending is really just getting started. So you saw we almost hit $300 million in originations. We're well on our way to get to a couple of billion in that business in short order. We hit our highest level of originations in our direct-to-consumer mortgage portfolio. So we're well on our way, kind of hit $8 billion or so in originations this year and climb up to $10 billion from here on out. Corporate Finance continues to be a steady growth engine. We'd expect that to get to about $8 billion. So I mean, across the board, we see opportunities to grow every one of our loan portfolios, and that's part of the NII guide. It's NIM expansion, but it's also growth in the balance sheet and growth across all of our businesses. And then on liquidity, the short answer there is yes as well. There's still room to optimize. We are sitting with excess cash that we plan to burn through the growth of our loan portfolio, but also through liability management, you've seen us continue to be proactive. We're at 89% deposit funded, but we think that can go higher, and we're naturally running down our brokered deposits as well as FHLB and some unsecured and secured debt. So just continuing to take down that cash over time, which will help with that NIM trajectory as well. So Daniel's just clarifying, Ally Lending is $2 billion is annual. So sorry about that, annual is $2 billion, not quarterly.

Okay. And the outlook that you're giving there, that's the time frame around those kind of opportunities that you were citing. Is that a next 12-month kind of outlook? Or is that something longer than that?

Yes. It's over time. I mean we are expecting -- I didn't hit on commercial floorplan, I hit on that earlier in the call, but that's the big question mark for us in terms of how quickly that kind of starts to grow from here. But my comments are really over kind of the next 18, 24 months, Betsy.

Our next question comes from the line of Moshe Orenbuch from Credit Suisse.

Looking at the big increase in originations, the biggest is what you call the growth channel, which went from 50% to 53%. So it kind of accounted for, I don't know, well over $2 billion of growth year-over-year. Can you talk about what's driving that? Is it the partnerships that you've got with some of the newer-type players? Or any other kind of insight that you can give us there?

Yes. Hey, Moshe, it's really all of the above. It's definitely the growing partnerships we have, and we've talked at length about Carvana that continues to be a very robust relationship, but there's many others in that category as well as just focusing on diversified, more traditional dealers that have added to that growth channel as well. That's been a deliberate strategy that we've had to diversify access to applications, diversify our customer base, and we just continue to see really strong success across all types of dealerships.

Great. I'm struck Jenn by a comment that you made earlier in your prepared remarks about kind of the growing partnerships we have, and taking steps, I think, given the strong earnings now. And obviously, some of these things will moderate. And as you pointed out about the dealer floorplan, some of them will get better as you go forward. But could you talk a little bit more -- and you've talked about higher levels of capital return, but can you talk about other steps to optimize, whether it's balance sheet structure or other pieces of the P&L or other types of kind of economies of scale that we could see generating better sustained returns over time.

Yes, sure. I mean I talked a lot about the optimization that we've delivered, and we're not done with that, right? So the conversation we just had on retail auto, we're going to continue to diversify. Our customer base continue to increase access to applications and drive strong originations and risk-adjusted returns. And so the retail auto story is to be continued, and we see a lot more opportunity there in the traditional loan and lease categories, but also in insurance, SmartAuction; our direct lending platform, Clearlane, ClearPath. So a lot of opportunity is to continue to optimize risk-adjusted returns within kind of the 4 walls of auto and insurance. And then outside of that, we talk a lot about liability optimization. That's been just the terrific growth that we've had in deposit customers. We've built loyalty with them, strong retention, and we've been able to take down the cost of funds 8 consecutive quarters, and we've got at least that to come in terms of continuing to take down deposit costs. We have some kind of $20 billion in CDs that are rolling off this year at over 150 basis points, and much of that is rolling into a 50 basis point OSA products. So a lot of room just kind of within the 4 walls of deposits to continue to optimize. And then there's a mix component here as well as we continue to increase the percent of our liabilities coming from deposits. So lot there still to come. And on many of our newer businesses, we're just starting to accelerate up the J curve. We're seeing accretive returns in mortgage. We're getting there quickly in Ally Lending. Invest is going to take some time, but we like the synergies across kind of the savings in Invest platform. So really just getting started in terms of the optimization of our newer businesses. And then, Moshe, last but not least on capital deployment, I think what's great is you can see just the robust trajectory we have ahead from organic growth. And so we don't need to be in a hurry to deploy that capital. We can be patient. We have a great earnings forecast. We'll be opportunistic on M&A. And then under the SCB framework, we can continue to look for ways to optimize our capital and our capital deployment. And with share buybacks, we had a big increase. Based on where I believe our stock price is going, we have an incredibly strong return from those buybacks, and so we'll continue to look for additional ways to deliver value through our buyback program. So hopefully, that gives you some color. But in many ways, Moshe, we are just getting started with optimization efforts. There’s obviously a lot completed, but a lot more to come.

Great. Thank you. And I'll remind folks, if you have additional questions, feel free to reach out to Ally Investor Relations. Thank you for joining us this morning. That concludes today's call.

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