Up next, we're excited to have Ally Financial joining us once again. Ally has continued to execute on its strategy of being a leading direct bank and the premier auto lender in the market, and they should be positioned well to improve returns over the next few years. Joining us for the first time, please welcome me and join Ally's relatively new CEO, Michael Rhodes. Today's discussion is going to be a fireside chat. Welcome, Michael.
All right. Great to be here. Thanks.
So, Michael, now that you've been in the role for approximately seven months, can you maybe just share some of your views on the company?
Absolutely. So it's been seven or eight months now in the role, and maybe I'll start out by saying that I've actually followed Ally for quite some time. I've always admired what the organization was doing, the spaces they played in. And so when you're new, you go on a listening tour and try to understand what's going on in the organization, where your strengths are, where your opportunities are. And what's very apparent to me, really from the beginning, and I still believe this very much today, is we have some very strong core franchises. And I think about our dealer financial services. We've been in business for over 100 years. We have our deposit business, which, albeit newer, say 15 years. We've gone from basically a startup, if you will, to the country's largest digital-only bank.
And then on top of that, you add our corporate finance business, which is 25 years old, but it's had very stable and steady and attractive returns through all sorts of business cycles. And so you look at those core franchises where we have a reason to win, we're differentiated, and in our own way, we're meaningful in the spaces that we play. You feel really, really good about that. A couple on top of that, I was aware of and have a great appreciation for the brand of the organization. In fact, just yesterday, the publication Fast Company, they have an award for brands that matter on a global basis. For the third time in a third year in a row, we were listed as a brand that matters by Fast Company, only financial service company ever to receive that consecutive distinction. That was great.
But probably most importantly, on top of all this stuff, is really the culture of the organization. As an outsider, you hear a lot about the culture. When you get inside, you really get the sense that this is a company from the C-suite to the front line. The customer centricity is really, really intense and very meaningful and purposeful. And so I've seen that. And on top of that, some great talent. And look, I feel really, really good about this organization, and I feel very pleased to be part of the company.
Thanks for that. So can you maybe just touch on what you think some of the strengths are and where do you actually see some opportunities to improve the performance of the company?
Yeah. Strengths. If I go to strengths, I'll go back to kind of these strong franchises that we have, and you have to start with our dealer financial services, where, again, as I said, we've been in the business for 100-plus years. We have 22,000 dealers that we work with, and some of these relationships go back literally decades, and so we're there able to serve our dealers in very meaningful and purposeful ways with a complete suite of products, and we're there throughout all sorts of cycles for them, and so that business is clearly a source of strength. If I look at the depository side, our ability to attract customers and who become very loyal and engaged customers is really quite remarkable. We have a 95% customer retention rate, 90%-plus type satisfaction rate for our deposit business.
And we're actually in an interesting part in the cycle where we've actually been able to demonstrate that we can actually create more engagement with our customers. And so this franchise is really performing very well now. In fact, I'd argue that the franchise is probably performing as well now as it ever has. And then maybe we talk about our corporate finance business every once in a while. Look, here's a place where we have some very specific relationships, very long-standing sponsor relationships that we've had for many, many years. And we know where we play, and we compete in very specific places, and we've done so in a very attractive, risk-adjusted way. And so those businesses, I think, really are sources of strength. In terms of opportunities, so look, I'm new in the job.
And so when you're new in the job, you always take an opportunity to see what would you do differently and where are the opportunities. One place is clearly on the expense line. If you look for the past five or six years, our expense growth rate has been around 5%-10% or plus per year. This year has been different. Our controllable expenses, we got it to less than a 1% increase on a year-over-year basis, and we're going to achieve that. To be fair, the team before me came up with that objective, but they've been executing, and we've been executing this year. So that's an opportunity. In terms of capital allocation, opportunities really to just focus our capital on where we have the best opportunities. And so you've seen that we've actually been investing in some places and actually pulling back in others.
And so you'll see we'll be very good stewards of our capital on an ongoing basis. And so I see that very much as an opportunity. But you kind of pull this all together, and you look at our strengths and we have opportunities, then recognizing the macro environment we're in, the regulatory environment we're in, we have a lot of conviction. We talk a lot about delivering a mid-teens ROE, and we very much believe we can do this when we step back from it all.
So you just referenced the mid-teens return. I think you reiterated that on the earnings call. What gives you the confidence in the medium-term financial outlook? And based on the current operating environment, over what time frame do you think you can actually deliver this?
Yeah. Okay. Great question, and this came up on our earnings call recently, and the path to get to mid-teens ROE or returns on capital is pretty straightforward. Three things need to be true. First of all, your net interest margin has to look something around 4%, and that's up from where we are today. Second is on the credit side, and really the auto credit. We're looking for auto credit losses to be 2% or lower, and then we have to manage expenses well. Now, on the expense line, we've done that well this year. You can assume that we're going to keep on doing that well, and so I'm not going to say that's a layup, but that's something that we're very committed to doing and demonstrating that we will do.
On the interest margin and loss side, the factors set up for us to be successful, and of course, we now have to just drive those and give everyone the confidence that we will do those. On the net interest margin line, we actually have benefits on both sides of the balance sheet, both on the asset side, being a fixed-rate portfolio in a falling-rate environment is a good thing, and we have some mix shifts going on with our assets, which are also positive, and then clearly being depository funded, look, we anticipate betas will retrace in one way or the other from where they were before, and we're looking at something like about a 70%-type beta, and so you pull that together, and you see visibility into the NIM expansion.
And the credit losses, the story, I could spend a lot of time on the credit losses or I could spend a little time on the credit losses. It's a really run-off story. The nice thing about auto finance is a relatively short-duration asset. Some of the 2022 vintages, a little earlier in 2023, there was some pressure on that. But as they go through peak loss and we look at our last 18 months or so of underwriting, and that comes through and reaches peak loss, we expect to see some benefits there. And of course, you asked me the timing, and that's the big question. And I'm going to say, I'm not going to be really precise about the timing because there are lots of factors that come into play. But the table is set.
The table is set on the expense side, on the NIM side, and certainly the credit loss side.
Great, so maybe to dig in on some of those things, Ally historically was a 3% NIM company. You changed the asset mix, repricing. Now you believe you're a 4%, so a couple of part questions. What are underlying trends or shifts, give you the confidence this will be sustainable? Have you considered other alternatives to accelerate the NIM, such as restructuring the securities, and since the last time we heard from you, we've seen a couple of cuts come out of the forward curve, the rate curve steepening? You guys have been aggressive in reducing OSA. What does all this mean for your confidence level in terms of reaching it?
That was a many-part question.
That absolutely was.
So in terms of net interest margin and the NIM, maybe I'll double-click a little bit on some mechanics and then get to your secondary and tertiary questions. In terms of the mechanics, look, we've got mix impacts and margin impacts that are actually working our way. On the mix impacts, if you look from 2019 to today, you can actually see that we've actually been burning off some of the lower margin businesses, mortgage, securities, some of the commercial auto business has actually burnt off. And in their place, we're putting higher-yielding assets, i.e., consumer auto and some of our corporate finance. So you have some mix benefits that are actually working our way. Then you also have margin benefits. And the margin benefits come from a couple of places. One is in the auto business itself.
If we have this shift to what I call our sweet spot, which is prime and used, and that's actually a more attractive margin, and so the on-off dynamic, again, with the auto loans and the margin is actually a favorable mix impact that we're seeing now, and then on the depository side, again, we're actually seeing some, I think, very strong behavior here, and in fact, if you compare the size of our deposit book in 2019 to today, it's $40 billion higher on a roughly $200 billion balance sheet, and that's a favorable funding dynamic really almost in any rate environment, and so that actually comes into play, so those factors, I think, play quite well, and so you kind of put those together, and the Fed can move lots of different directions, and that can impact us in the near term.
But we think the trajectory is going to get us to the right place. When it comes to, I think you referenced some of the securities and.
Changing curve.
Yeah. Clearly, as we think about our capital base overall and to the extent we have excess capital, how we deploy it, we have lots of opportunities in terms of what we would do. This is something that we recognize others have done. I'm not saying that we are. I'm not saying that we're not. We recognize it's an alternative. And so it's on the table. But that's all I'll say about that right now.
Gotcha. Maybe on the back of those thoughts, we're two months into the fourth quarter. When Russ spoke at BAAB, he said we'd seen some positive developments in credit. Is there anything that you wanted to share about how the fourth quarter is shaping up relative to expectations and how it translates into your expectations for next year, particularly on credit?
Absolutely. I'd say I'm pleased to say our fourth quarter is shaping up in line with expectations. And so I'll leave that. And then in terms of for next year, I think you might have heard us on the call. We said we would give guidance for next year in January. And so I'll say the same thing. We have guidance for next year in January. That being the case, this quarter is shaping up in line with expectations.
Gotcha. So maybe talk a little bit about the businesses, a little bit about where you play in auto and why you think that's such an attractive asset class for Ally.
So let's start with auto. It's obviously the largest business we have by a fairly substantial margin. I should probably start with the fact that for good or bad, I'm a bit of a car nut. So I love the auto business. It's a business I've been following for a long, long time. So to be part of this team is actually fabulous. But if you look at what we do and how we play, the secret to our success is we have 22,000 dealer partners. And our philosophy and approach is if we can have our partners be more successful, then we can be more successful. And so we do that in many ways. And it starts with credit. We try to be full-spectrum lenders.
And so we try to be there to provide opportunities to underwrite deals from the top to the bottom in terms of how things work. We have a comprehensive suite of opportunities and products and services for our dealers. And that's insurance products, F&I, and P&C insurance. We also provide some commercial support for them, both in terms of floor planning, but other types of capital needs the dealer community might have. We also provide technology solutions. The technology solutions think of things like SmartAuction, which is an ability for dealers on a dealer-dealer basis to move inventory themselves. And so we're there providing a really holistic suite of solutions for our dealers. And we try to be really relevant for them and try to have them be very successful. And when that happens, then generally just kind of more business comes our way.
One, there are a lot of ways you can look and try to judge the effectiveness of how we're doing. One way is you look at our application flow, so this year, we'll probably look at something around 14 million applications. Two years ago, it was 12.5 million applications. 10 years ago, it was nine million applications. We'll probably look at $400 billion worth of deals to book $40 billion worth of volume, so we are in a really privileged position, and the privileged position is anchored on long-standing trusting relationships with our dealer partners. If we can help them be successful, then they will help us be successful, and so just really, really pleased with how that business is shaped up.
How about the deposits platform? It's been a bright spot for the company. Maybe share with us just your thoughts on the overall platform.
Yeah. So the deposits platform is really, again, quite remarkable. What we've actually accomplished here is the largest digital-only bank in the U.S. And we get there for a lot of reasons. We have attractive rates. We're generally not at the top of the tables in terms of rates, but we provide very attractive rates. A great customer experience. And the customer experience really matters in a digital world. It's a digitally-based customer experience. And then, of course, a brand. And the brand also really matters in digital banking because the brand actually is basically your billboard, it's your front door, and it's how people actually find you. And we have a very good recognition. We have good consideration and really strong favorability ratings. That all translates, I think I mentioned earlier, the 95% retention rate, which is absolutely fabulous.
The other thing about the deposit business that you can't lose sight of is we're at the forefront of the shift in consumer behavior, and so consumer behavior, obviously, all sorts of industries is moving very much to be a digitally-centric journey, and Ally was at the beginning of this path, and in fact, if you look at the past few years, the direct banks as a category have been growing about twice the rate of the consumer kind of deposit franchise overall, and so that's our sweet spot. That's where we play. The other thing about the deposit business, which is just really important to know, is that I mentioned we're not the top of the league tables, and we used to be. We've actually moved down in terms of league tables, in terms of pricing, but we still continue to attract customers.
And so we have this mix shift going on in our deposit business, which is very favorable. And the mix shift is less rate attracting customers because of rate, now attracting them because of our brand and our customer experience, lower average balance, less price sensitivity. And we think that actually serves us very, very well going into this environment. And also, I guess the other thing about our deposit business you need to think about is we grow our deposit business in service of our assets. And so right now, we actually see we have this on-off dynamic going in the asset side where our mortgages and securities are coming down and our auto is going up. We don't see aggregate balance sheet growth to be a large growth number. That actually gives us the ability on the deposit side to actually price and get attractive funding costs.
So you talked about the product suite. You've diversified the product suite over the years. Earlier last year, you closed on the sale of Ally Lending. What are your thoughts on the product suite as of today? Are there further opportunities for areas of optimization, areas like card and the like?
Yeah. If I look at our product suite, and we have a dollar of expense to spend or a dollar of capital to invest, we're going to go at our core businesses, which is the auto franchise deposits and our corporate finance. We have very attractive margin economics in those businesses, and so that's where our resources are going to go. Look, the card business, I'm a big fan of the card business. We have a great team and a great business, but I look in a world of limited capital and limited expenses where my next dollar goes, it's not going to go there, despite the fact it's a very strong business. It's going to go into other things that we see that we do very, very well.
And with mortgage, I think you know that we stopped originating mortgages to our balance sheet and we're doing mostly originating to sell. That feels like the right model for us. And of course, all this stuff we continue to look at.
Yeah. Given that you're not allocating capital, are those things that you could look to optimize over time?
As I said, we're taking a hard look at everything.
Gotcha. Maybe to talk a little bit about the competition in auto. Over the past few years, we've seen the competition pull back. More recently, it's come back in. How are you thinking about the competitive dynamics in your business, either on the volume or the pricing side?
Yeah. So in the competition of auto, first of all, the auto finance market is a very large market. And as a very large market, it's also very fragmented. And so you have to look at competition in the various segments. Where we play is the intersection of used and prime, where we do quite well. We're number one in terms of origination at the intersection of used and prime. Competition the past couple of years has been quite interesting. And really, starting in 2023, you started seeing people kind of pull back from what was kind of what we call the S Tier, which is the top of where we generally underwrite to. And that actually gave us a good opportunity to actually go up market in terms of the credit profile and still receive attractive returns as we've liked that dynamic.
If you go above that into what I call Super Prime, that's a place where the competition appears to really step back in. And we play there less, to be fair. And there is more competition. But where we play at the intersection of used and prime, again, we feel that we're very, very well positioned.
Gotcha. So maybe let's talk a little bit about the current operating environment. I think Russ had commented that things are stabilizing and then could improve at some point. You talked about needing to get losses below two to hit your objectives. Maybe just talk about what you're seeing in terms of your consumer credit trends in your auto book. And then maybe any updated thoughts on the progression of the problematic vintages, the 2022 and the 2023, and any early thoughts on what you're seeing in the 2024 vintage?
Yes. So obviously, we spend a lot of time looking at consumer credit. And actually, even if you talk about credit for overall book, I have to give the opportunity to say in our commercial business, our loss performance this year has been spectacular.
Excellent.
On the consumer side, our losses have gone higher than our expectations. To be fair, if you kind of step back and take a look at this, I talked about the fact that the auto business has a relatively brief duration of assets. There's kind of on-off dynamic that we think is going to play out very well for us. Also, if you just look at losses across the portfolio, it's impacted by frequency and then severity. Then frequency, you can look at vintages and look at vintage curves to get a sense of frequency. We see 2023 is looking better than 2022. 2024 is early, but it actually looks quite good in terms of how that's performing.
Severity has some interesting dynamics because the 2022 vintage, again, particularly used car prices, all car prices, all vehicle prices were actually quite elevated. So that actually stretched the consumer a bit in terms of what they were paying. Also, as prices have adjusted and reset, it causes more of a severity bump than we probably would have anticipated. So as we work through that vintage and severity levels balance out and we're seeing frequency levels play out, it all tees up to being well positioned on a go-forward basis. Again, I'm being less prescriptive in terms of timing, but the table is set nicely.
Gotcha. Maybe to pivot back to deposits for a second, you talked about launching this brand 15 years ago. How do you think about the future of your deposits business now that your core fund that you referenced earlier that you're not sort of growing? And should that lead to being less rate sensitive during cycles? Maybe just kind of talk through that dynamic.
Absolutely. And as I think about the future of the deposit business, it really is all about this having more engaged savers. And so we have about 3.3 million, give or take, consumer customers. About a million of them we call engaged savers. And that means they have a savings toolkit or direct deposit or using a debit account or different types of factors that go into that. And so we're really looking at the engaged saver population. If I look across the year, we anticipate our deposit business is going to be more or less flat. Our engaged savers will actually be a growth business. And those who are not engaged will actually be contracting a bit. And so the real focus is really digging in and creating that deeper engagement level with our customers. And we don't need to be chasing balances per se.
This gives us, I think, it puts us in a really good position in a falling rate environment to both position ourselves well with our customer base, but also get our funding at the right costs.
So you talked a little bit earlier about expenses, and you pointed to expenses as something that could be an opportunity. You referenced that you guys were running at 5%-10% expense growth this year. You've had much lower controllable costs. Given that you view this as an opportunity, what should we expect in expenses going forward, and particularly as revenues ramp, which is expected given the trajectory of the margin?
Absolutely. So again, I said, I think a couple of times, taking a hard look at everything we do, including how we spend our expense dollars. This year, to be fair, our controllable expenses will be down about 1% on a year-over-year basis. So that's attractive. But on a go-forward basis, look, you should expect us to have a lot of diligence and a lot of focus around ensuring that our expenses are well managed. And so don't expect us to return to the expense growth levels that we've seen in the past kind of three to five years at a much more moderate pace.
Got it, so let's maybe pivot to capital. Can you remind us where you are today in terms of CET1, how you're thinking about managing the capital ratio, and how are you thinking about the potential for capital return at some point in time, given that you've been building the capital ratios? Some of the AOCI marks have come back. What does that mean for overall capital?
Yeah. Well, great question. So to remind everyone, at the end of the third quarter, our CET1 ratio was 9.8% against a target of 9%, internal target of 9%. Relative to the stress capital buffer, we're about $4 billion of excess capital. And so that's where we are today. Now, to think about return of capital, you have to think about sort of sources and uses of capital in the near term. So let me first talk about the uses and the sources. So the uses, there are probably three primary areas. One is the AOCI phase-in. Look, we anticipate that the AOCI phase-in will occur in some way, shape, or form. We don't have a lot of specifics around that. And there's a bit of a regulatory question around that that we're kind of still waiting on. And so that's the anticipated use of capital.
We also have the CECL phase-in, and that'll happen in the first quarter. And so that's coming in. And then we also have the potential to change our accounting on our EV leases to the deferral method, which is a short-term use of capital, gets feathered back in over time. And so we have three uses of capital coming up in the near term. Our sources of capital are, first of all, there's our earnings ramp and our earnings trajectory. And so if you put together the math of the credit loss performance, the NIM, and the expenses, you see a more attractive earnings ramp. And so that's obviously a source of capital. But also this year, we've had some good success, some very good success with some of these capital market transactions to create capital. We've done one this quarter, which generated about 15 basis points of capital.
It was these credit risk transfers. It was actually very well subscribed. We were really pleased with the result on that, so kind of add that all together, the good news is that we can meet our capital needs through our earnings growth, and some of these capital market transactions will, of course, be helpful. In the normal course of business, even with the AOCI phase-ins, we feel good about that. In terms of share repurchases, I recognize share repurchases have been part of our shareholder value proposition for quite some time. We're quite committed to doing share repurchases. We've really got to get more clarity on the kind of regulatory picture before we can be too declarative about when and how that'll look like and what the quantums will be.
I know that's probably a story we've been giving for a while, but it keeps on being the case that we're still kind of looking for certainty.
Absolutely. So you referenced a couple of different things in the uses of capital. I know you recently highlighted some of the success you're having in EV leasing. And you noted that you're evaluating an accounting change. So two-part question. Can you maybe just discuss the EV trends that you guys are seeing, what you're expecting? And are you still evaluating an accounting change given the recent news that the EV tax might go away under the new administration?
Yeah, so in terms of the EV volumes in general, look, we don't set explicit goals around EVs versus internal combustion engines, and we're sort of a taker of what the market's going to offer for us in EVs. We, of course, like the business. It's an attractive business, and you've probably seen recently that our volumes have actually been higher than they were last year, and so that's good business. We like the business. It has an attractive return. In terms of the accounting, look, we are looking at that, and we still have work to do on this, but it's quite probable that we'd actually make the accounting change at the end of the year. Still work to be done. The accounting in the deferral methodology, it reflects the economics of the business, and that's why we like it.
So you're likely to make it at the year-end, provided the work that you need to get through.
Yes. There's still work to be done.
A couple of items that, excuse me, that I wanted to touch upon. So you talked earlier about the originations that you've been doing, that a lot of the competition had come back in Super Prime, which is an area that you don't play as much. However, you have certainly moved up tier, right? I think over 40% of your production has been in the S Tier, which is your highest, which has helped credit in some of the recent vintages. How do you think about the trade-off between yield and credit? And what are you guys waiting to see to potentially start to unwind some of these curtails?
Yeah. So the S Tier, you've seen our S Tier numbers have gone up. And look, we like the economics of the S Tier volumes today, without a doubt. And so we're taking that given the economics. In terms of what we need to see, look, there are a number of indicators that we look at. But kind of the stability of the credit environment and the performance of our book will be indicators. And so there's no really bright line this has to happen before we kind of feather back in. I will say that the S Tier volume that we've seen has been attractive volumes. And so you can imagine, given $400 billion worth of volume, we look to constantly optimize the risk-adjusted return and just assume we'll be doing that on an ongoing basis.
A couple of other questions that I want to touch upon. So you noted when you were talking about capital optimizations that you recently completed another CRT transaction. Maybe just talk about how you think about use of these in the future. Obviously, it's been a good tool of building capital in an environment where the industry has been trying to do that. And how do you think about the trade-off between sharing of some economics with the capital relief?
Yeah. Shortly after I came in the role, Russ a nd the team had executed one of the CRTs. And so I said, well, let me look at the math on this. And you kind of look at the math on a with and without doing the transfer and look at returns on capital and how much economics you give up. And when you look at the transactions, you like the optics of what that does for the business. There is some economic give-up, without a doubt. But it's not significant relative to the lift we get on returns on capital. And so we actually think these CRTs, they actually end up allocating risk capital in a way that's more of the economic reality than sometimes the regulatory capital presents itself. So I actually like the transactions.
As long as the markets are there and attractive, you'd expect us to be doing some of these.
Gotcha. Okay. One of the other things you talked about was the AOCI phase-in, and obviously, there's a lot of changes going on down in Washington, D.C., and there's a lot of optimism that we could see a more business-friendly environment. Obviously, we're going to have to see what happens, who gets put in place, but there's generally a view that there's going to be a better regulatory backdrop. Do you in any way see this impacting Ally, either the way you run the company or the way you think about capital allocation, fully recognizing that we're still in early days in this process?
Yeah. Maybe I'll just anchor on your point. We're in the early days of this process, which is a bit of an I don't know. A lot could play out in D.C. As an organization, we're built to operate in all sorts of environments. And whatever environment is served up to us, we'll react, I think, intelligently to that. It could be that there's some things that kind of break the way for the bank industry. But we're just going to run the business today in the best way we know how to do it.
Gotcha. So we're coming up upon the end here. So it sounds like things are progressing as you had articulated. Credit and the margin, you highlighted the fourth quarter, is progressing in line with your expectations. I guess maybe just from a high level, I fully recognize that we'll get guidance as we move into next year. But when you think about the things that you discussed here, the ROTCE goals and the like, what are your financial priorities as we head into 2025? And what message do you want to leave shareholders and potential shareholders with in terms of the desire to invest in Ally?
So I'm going to answer your question about the future by talking about the past first, if you don't mind.
Yep.
And actually, last week, my management team and I had the opportunity to ring the bell at the New York Stock Exchange, 10 years as a public company. And that was a lot of fun to be there and ring the bell. And it causes a moment of reflection. And the moment of reflection is that as soon as we became a public company, a lot has changed about this business. This has been a business that has transformed itself to react to the market in pretty significant ways. We were an OEM-centric model. And now we have 22,000 different dealers. And we deal with just about every single OEM in one way or the other across the country. We were predominantly wholesale funded. And now we're very much depository funded. So those were two very significant shifts that have happened over the past 10 years.
And so the message is this is a business that has actually understood what the times require and has actually been able to pivot in a way that's effective. And so if I were to leave folks with kind of one message about the future, actually, when we ring the bell, they have the opportunity for you to get up and say a couple of words. And I talked a couple, left a couple of words. And we talked about what legacy this team wants to leave behind. And I say the team because it's not my legacy. It's our legacy. And our legacy is one of higher standards and higher standards of everything that we do. The company has done some remarkable things over the past 10 years. I'm quite privileged to be part of this team.
Yet we aspire to better financial performance, better customer experience, better market shares, everything that kind of goes better, risk management. Just leave the aspiration of higher standards. This is the team that's committed to deliver that.
Great. Well, we are out of time. So please join me in thanking the team.