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Edited Transcript of ALLY earnings conference call or presentation 27-Apr-17 1:00pm GMT

Thomson Reuters StreetEvents

Q1 2017 Ally Financial Inc Earnings Call

Detroit May 9, 2017 (Thomson StreetEvents) -- Edited Transcript of Ally Financial Inc earnings conference call or presentation Thursday, April 27, 2017 at 1:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Christopher A. Halmy

Ally Financial Inc. - CFO

* David P. Shevsky

Ally Financial Inc. - Chief Risk Officer

* Jeffrey J. Brown

Ally Financial Inc. - CEO and Director

* Michael Brown

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Conference Call Participants

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* Betsy Lynn Graseck

Morgan Stanley, Research Division - MD

* Christopher Roy Donat

Sandler O'Neill + Partners, L.P., Research Division - MD of Equity Research

* Donald Fandetti

Citigroup Inc, Research Division - Director and Consumer and Specialty Finance Analyst

* Eric Edmund Wasserstrom

Guggenheim Securities, LLC, Research Division - MD and Senior Equity Analyst

* Jack Micenko

Susquehanna Financial Group, LLLP, Research Division - Deputy Director of Research

* John Hecht

Jefferies LLC, Research Division - Equity Analyst

* Kenneth Matthew Bruce

BofA Merrill Lynch, Research Division - MD

* Moshe Ari Orenbuch

Credit Suisse AG, Research Division - MD and Equity Research Analyst

* Richard Barry Shane

JP Morgan Chase & Co, Research Division - Senior Equity Analyst

* Sanjay Harkishin Sakhrani

Keefe, Bruyette, & Woods, Inc., Research Division - MD

* Shih-Wei Ho

Deutsche Bank AG, Research Division - Senior Research Analyst

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Presentation

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Operator [1]

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Good day, ladies and gentlemen, and welcome to the Ally Financial First Quarter 2017 Earnings Conference Call. (Operator Instructions) And as a reminder, this conference is being recorded.

Now I'll turn the conference over to your host, Michael Brown, Executive Director of Investor Relations. Please begin.

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Michael Brown, [2]

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Thanks, operator. And thank you, everyone, for joining us as we review Ally Financial's first quarter 2017 results. You can find the presentation we'll reference during the call on the Investor Relations section of our website, ally.com.

I'd like to direct your attention to the second slide of today's presentation regarding forward-looking statements and risk factors. The content of our conference call will be governed by this language.

I'd also like to note Slide 3 of today's presentation, where we've disclosed some of our key GAAP and non-GAAP, or core, measures. These and other core measures are used by management, and we believe they are useful to investors in assessing the company's operating performance and capital measures, but they are supplemental to and not a substitute for U.S. GAAP measures. Please refer to the supplemental slides at the end for full definitions and reconciliations.

This morning, our CEO, Jeff Brown; and our CFO, Chris Halmy, will cover the financial results. We'll have some time set aside for Q&A at the end. Our Chief Risk Officer, Dave Shevsky, is here for Q&A well.

Now I'd like to turn the call over to Jeff Brown

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Jeffrey J. Brown, Ally Financial Inc. - CEO and Director [3]

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Thanks, Michael. Good morning, everyone. I appreciate you joining the call. Let me ask you to turn to Slide #4, which contains highlights from 1Q. From a financial perspective, we had a decent quarter but fell short of expectations of delivering year-over-year earnings growth due primarily to 2 or 3 factors, which we will cover in detail this morning. Specifically, weather-related losses, used vehicle prices and credit trends all combined for a challenging quarter. We're not satisfied with the financial results, but also know we won't be on a straight line every quarter. Importantly, we don't see anything that causes a reset on long-term guidance.

From an operating perspective, good fundamentals from all the businesses, including fantastic customer growth, record deposit growth, improving risk-adjusted returns on new retail originations, profitable growth in the commercial auto and Corporate Finance portfolios, and we expect the official integration and launch of the Ally Invest over the next several weeks. Ally Invest is a huge strategic opportunity for Ally as we take another step in diversifying the company and diving deeper in this rapidly evolving world of digital financial services. So we see quality fundamentals that position us well for the future and keeps us on track to deliver on our financial and strategic plan.

The $0.48 of adjusted EPS is down from last year, and I'll reiterate: That's not what we expect for our financial trajectory. So that was a disappointment. Many aspects of the business are performing well. The comps year-over-year were hit by incremental weather losses, and as you know, we have a big headwind this year with the lease portfolio declining.

The lease book performance is still solid in general. But given a declining balance and yield, there is a challenge that we have to work through in this transition year. On the bright side, GM residual exposure continues to come down at a healthy clip every quarter. Overall, you should fully expect more earnings improvement later this year and in 2018 and 2019.

On the auto environment, I would say our tone remains cautious but constructive. We continue to see good risk return opportunities. As the team said on the financial outlook call last month, we're able to keep our loss content pretty steady on new originations, and we're booking significantly higher-yielding loans. Some of that due to higher rates, but more so from certain competitors dialing back. Auto lending is a core competency for Ally. And while we won't chase market share, we believe these are the times when you can drive higher risk-adjusted profitability. We also believe shifting our book more towards loans from leases isn't a bad thing during a time of falling used vehicle prices and lower residuals.

Origination yields are up to 6.1% in first quarter, and I expect that to drift higher in 2Q, and in fact, we're already seeing much higher yielding loans in April. That benefit will obviously expand NIM over time.

Our lease yield came in lower than we would have expected 6 months ago, but a bit better than we guided on the March call as we saw used vehicle prices improve late in the quarter. The April market has also recovered closer to our expectations, but we continue to carefully monitor.

Bottom line is we're eyes wide open with respect to the backdrop of auto lending. New vehicle sales plateauing, used vehicle prices declining and credit can't get much better. We've got mitigating factors within auto that I'll touch on in a minute. And then outside of auto, which is where we're focused growing strategically, repositioning the company, I continue to see tremendous opportunities for long-term earnings.

Self-help drivers of liability and capital management will propel earnings as well as expanding other products. For example, our Corporate Finance assets are up 23% year-over-year, and pretax income doubled for that segment. We launched our Clearlane online marketplace to push more into digital and direct lending within auto. We're aligning with emerging digital and consumer trends and, while relatively small today, could be a very different model in the future.

Ally Invest, which is being rebranded from TradeKing, will be fully integrated and launched this quarter, and you'll see a lot of our marketing efforts support the launch. I see Wealth Management as a huge fit with our deposit customer base and influx of millennials into our brand. So we continue to move down our strategic path, grow customers, align with digital trends, diversify the revenue stream and strengthen the franchise. This positions us very well for the future to drive long-term shareholder value.

Let's look at Slide #5 and a few of the current hot topics. First, used vehicle prices. We've been saying for a few years that we expect used vehicle prices to come down. The supply of off-lease vehicles continues to increase. Inventory levels have increased. OEM levels of leasing and incentives have increased. As a result, we saw used vehicle values decline around 7% year-over-year. We've been adjusting our residuals for several years. So this isn't unexpected relative to where we set residuals 3 years ago. That's why we're still experiencing nice yields in this 5.6% to 6% range.

We're also becoming much less exposed to lease residual value volatility as our portfolio declines. It's an earnings offset, but a significant de-risking of the balance sheet. Don't get me wrong, we like the leasing product, given the proper industry fundamentals, but it can cause some variability at times and, frankly, this is one of those times.

It's also important to keep in mind that we detailed a path to get an extra $1 billion of net financing revenue by 2019. An extra 1% decline in used vehicle values beyond our expectations is worth around $25 million or $30 million in 2019. Obviously, that matters, but it's very manageable. To provide even more context, in a couple of years, the retail loan portfolio should be 9 to 10x larger than the lease portfolio. So a 10 basis points of loan margin expansion is equal to about 100 basis points of lease yield variability. So we watch values. They can cause some variability in any given quarter that we have to adjust for, but relative to other long-term financial drivers, not one of the more important ones.

Next topic, credit. We spent a lot of time on this on the financial outlook call. There's really no significant update beyond what the team had already said. We're seeing losses continue to increase on a year-over-year basis, and we've seen some deterioration in the lower credit tiers. You typically see some improvement in the spring, and we are starting to see that seasonal improvement now plus the fact with tax refunds finally caught up to prior years. We continue to expect the year-over-year loss increases to decline throughout the year. We're offsetting these higher losses through higher yields, very focused on pricing for risk. You're seeing that steadily come through on a portfolio level, but from an origination perspective, we're starting to see more significant improvement on newer vintages. That sets us up well for the future as older vintages roll off and newer vintages are added.

We've also continued to adjust underwriting strategies on some of the underperforming pockets of the portfolio, which has resulted in some modest absolute risk reduction and should also reduce volatility. The markets are very focused on subprime or nonprime auto, but for context, our nonprime auto loans represent less than 8% of the total loan portfolio. We have a large commercial auto portfolio. We have a growing mortgage portfolio, growing Corporate Finance business and a large prime auto loan portfolio. These areas have very low losses and are generally pretty stable. So we continue to see good opportunities in full credit spectrum retail auto, but we're focused on reducing potential volatility to demonstrate we're going to stay profitable through the cycle.

Last main topic on the slide, weather losses. Relative to what we said on the financial outlook call, this was one area of unfavorability given the late March hailstorms that hit some of our dealer customers. Weather losses were the worst we've seen in 20 years, $16 million higher than last year and $30 million higher relative to the average over the last 7 years. So it cost us between $0.02 and $0.04 depending how you look at it. We also took a hit in 2016 that was worse than expected and worse than the 7-year average we plan against. This is another area where we'd like to reduce volatility. So we entered into a reinsurance agreement. It's effective April 1 for a 12-month period and limits our losses on a quarterly basis. That should give some increased confidence around our noninterest expense numbers for the rest of the year.

We want to do what we can to focus on the core strategy and financial upside in this company, and eliminating volatility caused by weather losses should help. The insurance business is still expected to be profitable with the reinsurance costs, and we'll look to boost dealer premiums higher to help offset.

And with that, let me hand it to Chris for more details on the quarter.

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Christopher A. Halmy, Ally Financial Inc. - CFO [4]

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Thanks, J.B. I'll start on Slide 6. In general, results were mostly in line with our guidance from last month. Provision of $271 million was a touch better given some late quarter favorability in our legacy mortgage book and auto losses came in towards the lower end of our expectations. Noninterest expense of $778 million was about $15 million to $20 million worse than expected given the weather losses that came up late in the quarter.

Let's take a step back and look at the overall year-over-year trajectory. Total revenues were up about $50 million given growth in the auto loan portfolio as well as additional Wealth Management and Corporate Finance revenue. That's despite the big headwind in lower leasing revenue, which should normalize next year. That's being currently offset by about $50 million in higher provision given the portfolio of mix shifts since 2015. And noninterest expense is up as we continue to invest for the long run across our businesses. That includes the auto business, technology, wealth management, mortgage, deposits and the Ally brand.

As J.B. mentioned, this is a transition year. But as you get into the second half of the year and even some in the second quarter, you should expect to see revenue accelerate beyond any increases in provision and expenses to drive strong EPS growth. Much of that is the self-help path of deposit growth and bringing down both unsecured and secured wholesale funding. Plus, you'll get the benefit from buying back the stock. As we've been saying, the medium and long-term financial path remains intact.

Looking at the longer-term trend on Slide 7. These are key financial results since we went public in 2014. In general, we're headed in the right direction across these metrics. EPS declining this quarter is not in line with our expectations, but that is expected to rebound nicely as we progress throughout the year, given some of the self-help drivers I just mentioned.

Revenues are trending up. Deposit growth has been great, and adjusted tangible book value continues to drive higher, finishing the quarter at around $26.60 per share, which is up around 30% since our IPO.

Let's look at net interest margin on Slide 8. NIM was up slightly from the prior year and up 4 basis points from 4Q. As we've been discussing, the lease headwind continues to be offset by higher retail and commercial auto yields. Retail auto yields are up 35 basis points year-over-year to 5.66%, and we expect that increase to continue.

In the first quarter, we booked $8 billion of loans with an average yield of 6.1%, which will obviously drive the portfolio of yields higher. While there's been a lot of discussion around these gains, which were around $60 million lower in the first quarter of '17 versus '16, the lease yields still remain strong at 5.7%.

On the liability side, strong deposit growth continues to be the key factor as we bring down higher cost debt and fuel modest balance sheet growth. The combination of higher yields on retail auto and more efficient funding will drive NIM higher as we move forward, regardless of the interest rate curve.

On Slide 9, we posted record deposit growth this quarter of $5.5 billion, taking total deposits over $84 billion. Around $1 billion came from the sweep deposits we mentioned from TradeKing, which is being rebranded Ally Invest.

On the rate side, we were down 2 basis points year-over-year. More recently, we made some minor adjustments to some of our rates to make sure we stay in the competitive set and continue to drive customer growth, but clearly deposit rates are lagging what's happening with benchmarks. Additionally, we have really begun to see the expansion in asset yields that is outpacing any rise in deposit rates. Customer growth was very strong, and we ended the quarter with 0.5 million millennial customers.

Our capital ratios on Slide 10 have been fairly consistent for some time as we generate earnings and distribute capital to common shareholders. Risk-weighted assets have ticked up a few billion dollars over the last year, mainly from higher dealer inventories increasing the commercial floor plan balances. This is now the third quarter of our approved 2016 CCAR capital plan, and we continue to buy back stock at a solid pace. And as others have mentioned, you'll notice some compensation-related share issuance this quarter. The DTA also continues to come down at a nice pace, and we'd expect to fully utilize that sometime in mid-2018.

Let's look at asset quality on Slide 11. Consolidated charge-offs came in at 86 basis points this quarter, up from 64 basis points last year. Coverage remains flat at 97 basis points as an increase in retail auto coverage has been offset by a decrease in mortgage coverage. Moving forward, we do expect retail auto coverage to increase with higher expected charge-offs. We've guided due to loss rate in the 1.4% to 1.6% range, so obviously coverage will need to keep pace.

Provision for the quarter was $271 million. We were slightly below our recent guidance driven by a reserve release on our legacy mortgage portfolio, which continues to perform well. And as a reminder, our legacy mortgage book has a balance of $2.6 billion and sits in our Corporate and Other segment.

On retail auto, our 30-plus day delinquencies came down almost 30% from 4Q levels. Remember, this is a point-in-time metric. So you can't read too much into this one data point, but it supports our view that losses and delinquencies are moving higher based on our mix shift, but it's going to be very manageable, particularly given the additional yield we're picking up.

Retail auto net charge-offs were 1.54%, up 46 basis points year-over-year, but we continue to expect the magnitude of year-over-year increases to decline throughout the year.

On Slide 12. Auto Finance reported $288 million of pretax income, down $49 million from last year. The lease headwind we've been discussing drove over $100 million lower net lease revenue, but the higher yields and balances on retail loans and the yield pickup from commercial help keep net financing revenue relatively flat. Other revenue was up, driven by some additional loan sales we executed, which we do from time to time.

Our provision expense was up versus the prior year driven by higher charge-offs from the mix shift and seasoning of older vintages. So from an origination perspective, we had robust used volume, which made up nearly half of our originations this quarter. It's important to keep in mind that the used opportunity is significant. Used SAAR is running over 40 million units and generally trending up. The increase in off-lease vehicles has gotten a lot of attention, but a 3-year-old vehicle hitting a dealer lot is a great financing opportunity for us. Our used book has been very profitable.

Leasing and used vehicle prices are a hot topic, and J.B. hit the key themes, so I'll just mention a few points. The pressure from used vehicle prices impacting our auction proceeds improved mid-March to April, which you can see on the bottom right of the slide, where we had losses in February but are now getting a few hundred dollars of gain per vehicle.

As a reminder of our process on accounting for residuals, we initially set them at the time of origination, which is typically 3 years ago, and then we make depreciation adjustments over time to get close to a 0 gain at the end. We've missed our expectation to the upside for the last few years, and in 1Q got pretty close to that 0 gain level and a 5.7% yield. That's a little below where we would have expected, but it's still solid.

We continue to watch manufacturer production levels and are encouraged given some of the recent statements by manufacturers about cutting production to manage days of inventory. And we're also watching incentive levels. Those fundamentals are important to the industry backdrop and overall health of the auto ecosystem.

We show our key auto metrics on Slide 13. We had a solid quarter of auto originations and landed around $9 billion, basically flat versus last year as we continue to optimize the portfolio. From a channel perspective, GM was 32% of originations, the lowest it's been in our history as the manufacturer has pushed more incentives through its captive. The Growth Channel, which is non-GM Chrysler, we built out a few years ago, is really paying dividends and was 40% of our originations this quarter.

Let me touch on some balance sheet dynamics you'll see on the bottom 2 charts. First, on consumer assets. We expect lease balances to decline at a similar pace until that stabilizes in the $7 billion to $8 billion range. Second, commercial auto balances are almost $39 billion. We expect this to decrease later this year as you've heard manufacturers mention inventory levels need to be managed down, which overall is a good thing for us and the industry.

On Slide 14, insurance reported pretax income of $40 million. As we've mentioned earlier, the driver was severe weather-related losses we experienced in late March. On March 26th and 27th alone, hailstorms caused nearly $19 million of weather-related losses. The reinsurance agreement we now have in place allows us to continue to offer this product to our customers, but also reduces volatility for our earnings profile. To be clear, we will still experience weather losses, but the reinsurance will limit these losses to our planned historical 7-year average.

Written premiums were $240 million this quarter, up 8% from last year as we increased vehicle inventory rates and dealer floor plan balances remain elevated.

Moving to Slide 15. Our Corporate Finance business continues to perform very well and contributed $25 million of pretax income, up $14 million from the prior year. The portfolio continues to grow and was up 23% from last year, driving higher net financing revenue this quarter. Other revenue increased as we continue to generate strong loan syndication and fee income and we realized an investment gain on an equity stake we held in one of our investments.

Asset quality remained strong, and provision was up from the prior quarter due to asset growth and some recoveries experienced in the fourth quarter. This business has an average annual net charge-off rate of less than 10 basis points over the past decade, with a peak loss rate of 32 basis points during the last recession. We expect to continue to grow this business and hired an experienced team in the health care real estate space this quarter to support our growth initiatives. J.B. continues to emphasize the company's diversification efforts, and Corporate Finance is a perfect example of a business that we expect to double over the next few years. Given our experienced management team, solid business relationships and declining cost of funds, we expect this business to be a major contributor to earnings growth as we move forward.

On Slide 16, our mortgage business earned $9 million of pretax earnings, up $7 million from last year. Asset balances were up from prime jumbo bulk purchase activity, driving net financing revenue 25% higher from last year, while credit performance remained strong. Bulk purchase activity in the quarter slowed a bit, given some competitive market dynamics, but we see a decent pipeline and expect that to pick up in the second half of the year.

Noninterest expense was up from the prior year as asset balances grew, and we invested in Ally Home, our direct-to-consumer product offering. Volume in the direct channel is expected to ramp up over time as we test and refine the operations and increase marketing throughout the year.

And with that, I'll turn it back to J.B. to wrap up.

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Jeffrey J. Brown, Ally Financial Inc. - CEO and Director [5]

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Great. Thanks, Chris. So overall, it was a decent quarter, but we can do better as we focus on our plan for driving strong shareholder returns. The ingredients of our plan remain consistent. We've been optimizing the mix in our retail auto lending to successfully offset the lease decline. And you can't just look at losses; you have to look at yields, and we're positioned to be solidly profitable in Auto Finance even as certain cyclical dynamics play out.

We also know we need to demonstrate that our loss metrics are contained within a range. We don't want to run our long-term business by managing one metric, but we're operating with the knowledge that the market is very sensitive to anything credit related.

Taking care of customers, growing the customer base, solidifying relationships, adapting to what they're looking for in their banking relationships, investing in technology, this will ensure we thrive over the long term.

We're also committed to delivering our medium-term financial targets of 15% EPS CAGR and a 12% core ROTCE. It's not going to be straight line, but those are the kind of the metrics embedded in this franchise and the opportunities that we have. Deposit growth, paying down high cost debt and buying back lots of stock remain key components in getting there.

Protect and grow book value per share. We've increased book value per share by $6 since the IPO, and we expect to see that trajectory continue. We've got hard assets too and no contingent liabilities, so I'm confident that with disciplined financial and operational execution, and relentless focus on the customer, the stock will perform and multiple expansion will be realized.

Strategically, we need to realize more value from this fantastic brand we developed. Deposits and customer growth have been phenomenal, and that's a key long-term driver. We're doing more with this brand, and we'll use it to further diversify and strengthen the franchise.

Over the next couple of years, we expect to demonstrate our ability to grow and diversify in a responsible, capital efficient way to further improve profitability. And we remain committed to appropriate capital allocation. We're building this company for the long-term, making some investments in the franchise, but we're going to continue to lean heavily into share buy backs, particularly with the stock as cheap as it is.

And with that, let me hand it back to Michael Brown, and we'll start some Q&A.

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Michael Brown, [6]

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Thanks, J.B. As we move into Q&A, we request that you please limit yourself to 1 question plus a single follow-up. If you additional follow-ups, after the Q&A session, the IR team will be available. Operator, if you could please start the Q&A session?

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question is from Don Fandetti of Citigroup.

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Donald Fandetti, Citigroup Inc, Research Division - Director and Consumer and Specialty Finance Analyst [2]

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Yes. Jeff, can you talk a little bit about on used car pricing, I think you've baked in a 5% decline in your assumptions? I think you noted that on the credit call. And can you also talk about sort of the used car pricing outlook for next year? I think GM is saying maybe you get 7% down this year and then down only 2% to 3%. Can you talk about your view?

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Christopher A. Halmy, Ally Financial Inc. - CFO [3]

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Yes, this is Chris. Let me take that one. We think of 2017 as a bit of a transition year here, where the off-lease vehicles are much higher this year than they were last year. And because of that, we saw somewhere in the 6% to 7% decline in the first quarter, and we expect that magnitude of decline to really persist through 2017. As we think about 2018 and 2019, we think cumulatively it's probably another 6% to 7% for those 2 years. Now there's a lot of variability in that, in particular, manufacturer production levels and how they manage the inventory on the lots. But right now, we think that 6% to 7% persists throughout this year, and then we think we get another 6% to 7% over the next 2 years.

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Operator [4]

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Our next question is from Chris Donat of Sandler O'Neill.

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Christopher Roy Donat, Sandler O'Neill + Partners, L.P., Research Division - MD of Equity Research [5]

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Just in terms of your -- the origination mix and the increasing part of used, is that something that -- I don't know, is there cap to how you think about the mix of originations in used? Or would you prefer, given your growth channels, to, say, go above 50% even to 60% used, if the opportunity looks that way or the dynamics of the new market look different?

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Christopher A. Halmy, Ally Financial Inc. - CFO [6]

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Yes, there's no cap. We're just shy of 50% today. The used book has performed extremely well. It's a very profitable book. So we're very comfortable in that space. It obviously helps drive the Growth Channel. Our dealer relationships is really where the dealers make most of their money. So we're fine seeing that drift up over 50% and get into the 50% to 60% range. So no cap on that.

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Christopher Roy Donat, Sandler O'Neill + Partners, L.P., Research Division - MD of Equity Research [7]

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Okay. And then just -- since you mentioned dealers here, historically, there's been very little risk to the dealer financing part of it, but we are seeing these rising inventories and I know there is -- the manufacturers are talking about cutting production at some point, but do you have any heightened concern around risk associated with lending to dealers at this point? Or is that -- do you feel pretty comfortable there?

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David P. Shevsky, Ally Financial Inc. - Chief Risk Officer [8]

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Chris, it's Dave Shevsky. We still feel really, really comfortable there. Each year, we have a pocket full of dealers on our watchlist. We got a very robust risk management framework data around that. So we haven't really seen any real jump. But yes, because of what you outlined. I mean, it's certainly a focus of ours to make sure that we have good performance in that. And then commercial is very different than the retailer we're talking about. Because with commercial, you have so much bootstrap collateral and other protections that even if something goes bad, you generally don't take a loss because you're overly collateralized.

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Operator [9]

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Our next question is from Moshe Orenbuch of Credit Suisse.

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Moshe Ari Orenbuch, Credit Suisse AG, Research Division - MD and Equity Research Analyst [10]

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So there's been a fair number of reports of banks, several medium sized, some even large ones pulling back in auto lending. And I guess, how much of that are you seeing? Is that a contributor to what you've already seen in yield? Will we see it in volumes? Like, how do you foresee that affecting your business?

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Christopher A. Halmy, Ally Financial Inc. - CFO [11]

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Yes, we're seeing it, but I just want to reiterate it's still a competitive market out there. You still have some big players who are across this spectrum that are playing in this space. I think there's a more cautious tone across the industry. You've seen some others' originations come down this quarter. I think it help us -- helped us take a little price. We are not focused on market share at this point. We're focused really on improving our overall returns. So I think you'll see it -- from our book's perspective, you're going to see it more on the margin than you'll see it on the originations.

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Moshe Ari Orenbuch, Credit Suisse AG, Research Division - MD and Equity Research Analyst [12]

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Right. And then just, Chris, to your comments about the fact that credit losses should be increasing at smaller kind of year-over-year increments, could you maybe just kind of flesh that out a little bit? What's the driver there and how should we kind of think about what (inaudible)?

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Christopher A. Halmy, Ally Financial Inc. - CFO [13]

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Yes, one of the ways to think about that is, when we made the change in our originations back to '15, a vast majority of our originations or our portfolio are now being made up of '15, 16, and '17 vintages as we go through '17. So pre-'15 vintages are really starting to fall off. So the overall book has a very similar kind of loss content. So as we gave that guidance of the 1.4% to 1.6% range, we expect that to kind of start flattening out. So we think as you get into the 2Q, you're still going to see an increase, but I think it's going to be more dramatic as you get later on in the year.

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David P. Shevsky, Ally Financial Inc. - Chief Risk Officer [14]

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Yes, I'll just add to that, that as we get into '18 and '19, you'll see it really flatten out.

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Operator [15]

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Our next question is from Rick Shane of JPMorgan.

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Richard Barry Shane, JP Morgan Chase & Co, Research Division - Senior Equity Analyst [16]

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I'd like to talk a little bit about the NCO rate and how we should be thinking about that. Roughly a month ago, you guys provided guidance of 140 to 160 basis points of losses and -- on the auto book, in this quarter, by your numbers, 154 basis points. Historically, Q1 has been a quarter that was slightly below the year number, suggesting the number for the year towards the high end of that range. The other thing I would observe is that the year-over-year increases in loss rate has actually been accelerating essentially over the last 4 quarters. Curious to think about the trajectory in 2017 and what are the factors that could put you above that high end of 1.6% or what might mitigate this as we move through the year when you look into book.

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Christopher A. Halmy, Ally Financial Inc. - CFO [17]

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Yes, as we look out, 2Q will obviously be seasonally lower. So we expect to see that drop off -- the magnitude of that drop off to really happen in 1Q to 2Q. And then like we said, a lot of this has to do with our expectations that the loss rate will start to really flatten as we get into the second half of the year. You're just not going to see as big of a year-over-year increase. That's why we give a range of 1.4% to 1.6%. We think we're somewhere in the middle of that range, but there's variability. And, Rick, we talk a lot about this internally as well what can change that. The biggest factor is probably on the severity, right, which is where our recovery rates -- what we are experiencing in the recovery rates for some of our repoed vehicles. So we watch that closely. And as we look at and we think about this 6% to 7% decline in used car prices, we're comfortable within that range. But if for some reason we're off on that either to the positive or the negative, we think it will sway within that range.

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Richard Barry Shane, JP Morgan Chase & Co, Research Division - Senior Equity Analyst [18]

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Yes, look, I mean, you guys have a conference call and a week later weather rolls through that you can't predict. So we understand there's some variability there. I guess the one question or the follow-up question would be, you didn't see in Q1 the magnitude of seasonal improvement that you normally get from Q4? Should we be thinking about Q2 not getting the normal seasonal improvement as well and then the second half doing a little bit better versus what you would expect seasonally?

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Christopher A. Halmy, Ally Financial Inc. - CFO [19]

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We're early in the quarter, but we still expect to see the seasonal drop-off in 2Q that would be significant. And we think the magnitude of 2Q charge-offs on a year-over-year basis will be considerably less than what you saw in 1Q.

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Operator [20]

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Our next question is from Sanjay Sakhrani of KBW.

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Sanjay Harkishin Sakhrani, Keefe, Bruyette, & Woods, Inc., Research Division - MD [21]

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Just a quick question on the lease yields. Obviously, it's been a little bit of a moving target, and we've had to recalibrate again on the range. Could you just talk about what gives you the comfort this time around that you guys have tightened that range and that used car prices actually won't decline more than what you guys are expecting? And then when we look at the remarketing gains and the movement of those remarketing gains versus used car, I mean, obviously, there's been a big disparity between the 2. Does that narrow now?

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Christopher A. Halmy, Ally Financial Inc. - CFO [22]

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Yes. I mean, thinking about the lease yields, the portfolio is getting smaller. We've seen a pretty dramatic drop in used car prices in the first quarter. So it's providing us a little bit more comfort that we're understanding what's happening in the marketplace to adjust to this increase in off-lease vehicle supply. So we're gathering more comfort, but there's still variability there. And like I said, we're encouraged by what the manufacturers said about production levels, but we obviously have to see that come through, and that could obviously affect what we really see on used car prices. So right now, it's our best estimate, but there's variability there really based on the OEMs. So moving forward, we feel pretty good. Now we've showed you a little bit in the earnings presentation how we've seen things firm up already in April. It's something we were expecting when we did the financial outlook call last month. So it's coming to fruition. So I'm feeling better about 2Q lease yields and where gains will be and, therefore, following through the yields, but there's still obviously variability in the second half of the year.

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Sanjay Harkishin Sakhrani, Keefe, Bruyette, & Woods, Inc., Research Division - MD [23]

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And I guess, just the actual residual value assumptions you guys have made, I mean, are they much closer to where the actually experience is today?

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Christopher A. Halmy, Ally Financial Inc. - CFO [24]

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It's actually -- if you go back 3 years ago, we were obviously predicting used car prices to come down. So we have gotten more conservative in the way we have set residuals for the cars that are coming off this year than they were coming off in '16. So I think that's a very important factor. Keep in mind, though, we moved depreciation rates around, and we did that a bit in '15 and '16 when we saw the used car prices better than expected. So we took some of that already into income. But overall, we feel pretty good about coming closer to this kind of 0% gain.

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Sanjay Harkishin Sakhrani, Keefe, Bruyette, & Woods, Inc., Research Division - MD [25]

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Okay. And then just one quick follow-up, sorry. The gain on sales of vehicles, I mean that was a pretty strong number relative to even the number you had all year. Could you just talk about the sustainability of that number as we move through the rest of the year?

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Christopher A. Halmy, Ally Financial Inc. - CFO [26]

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Yes, thanks, Sanjay. And the way I think about that is whether it's through securities or the sale of loans, we tend to have somewhere around $40 million to $50 million of gain on sale in our other revenue number on a quarterly basis. We did a little bit -- we experienced a little bit more of a gain on sale on the loan sale this quarter, a little less on the securities sale. I think, well, going forward, a good rule of thumb is $40 million to $50 million of gains whether it's through securities or through the loans. So I think of that as a pretty consistent number this quarter.

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Operator [27]

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Our next question is from Betsy Graseck of Morgan Stanley.

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Betsy Lynn Graseck, Morgan Stanley, Research Division - MD [28]

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A couple of questions on couple of different topics. One, on the deposit growth that you got, I know you're looking to pay down some of the higher cost debt. Could you give us a sense of the cadence throughout the year of that debt paydown that you're looking to do? I know you put the total in your slide deck, but just wondering when -- what quarters that's going to hit in?

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Christopher A. Halmy, Ally Financial Inc. - CFO [29]

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Yes, we had a pretty significant -- I'm sorry, maturities in the first quarter. You didn't see that fully effective in NIM because most of it was already -- happened throughout the quarter. So you're going to see that really hit our cost of funds as you get into the second quarter, which we think is a real positive to net financing revenue. But then as you lookout throughout the year, most of it is back ended. So as, an example, we have a very big 6.25% coupon billion dollar deal that comes off in December. So it's -- our maturity schedule is public. You can get it out there. But most of the paydown is in the back half of the year and the rest of it.

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Betsy Lynn Graseck, Morgan Stanley, Research Division - MD [30]

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Okay. And then when you talked about acquiring the new contracts for -- reinsurance contracts to reduce the volatility of the insurance claims, could you give us a sense as to how material that's going to be?

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Christopher A. Halmy, Ally Financial Inc. - CFO [31]

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From an earnings perspective, we don't think it's going to be overly material. We've obviously experienced some weather losses over the last, what I would say, 6 or 7 quarters that have been worse than our 7- or 10-year average. So we felt that it made sense to pretty much cap that and just make our earnings a bit more predictable as we move forward. We also think that some of the cost of that reinsurance will get passed on through just increases in our premium store dealers.

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David P. Shevsky, Ally Financial Inc. - Chief Risk Officer [32]

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Betsy, I'd just say on that last part, I mean, we were pretty aggressive in premium increases last year impacting accounts this year. We'll obviously go back and do even more, but that's really -- that offset will come more in 2018 than it will this year. But I think as Chris pointed out, I mean, it's pretty manageable in the context of overall earnings here. And I think the design was we just got tired of all the costs involved. And obviously, weather, the past several years, several quarters continues to be more and more unpredictable. So it was time that we just put reinsurance back in place.

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Betsy Lynn Graseck, Morgan Stanley, Research Division - MD [33]

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Got it, okay. And then just lastly, you mentioned during the prepared remarks about Corporate Finance and the expectation that this is going to be a growth driver. I see a buildup in the cash on the balance sheet, not obviously high yielding. So wanted to understand your comments and some of the depth of color you could give us around the Corporate Finance business and how you're planning on accelerating the growth there?

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Christopher A. Halmy, Ally Financial Inc. - CFO [34]

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Sure. We have a very, what I would call, experienced team in that spot. That's been a part of the company since 1999. And this is really a relationship-type business. And this team has got a great reputation for its speed and reliability in the market. And as you've seen over the last year, we've added a couple of small teams to that as well. And when I think about the space because we're a bank and we have really the right cost of capital, we tend to play on really the first lien part of this, so kind of top of the stack, but we're seeing some great business flow. And given those relationships, we think we can continue to grow and really play, what I would call, more lead agent-type roles that should drive incremental fee revenues as well.

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Betsy Lynn Graseck, Morgan Stanley, Research Division - MD [35]

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Okay. So essentially because many other institutions are having trouble driving growing in that line item right now, so I'm just wondering is it more of a salesperson acquisition model that's driving your growth?

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Jeffrey J. Brown, Ally Financial Inc. - CEO and Director [36]

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Yes, I mean, Betsy, that's certainly some of it. I mean, obviously, there's been some large former competitors that have sold their businesses, and so teams there, therefore, look for a new home and Ally was a nice fit particularly that we have this business inside the bank, where it can take advantage of very attractive cost of funds. So we've been very tactical and hired several teams over the past year. But I think, as Chris points out, our core leadership in this space, 30-years-plus experience, have been around for a while. But now it's really the push into saying this was a growth business, these can be very attractive markets for us. And so you've seen, I think, an increase of about $600 billion in assets over the past year. And I more look at the $3.5 billion balance sheet today. There's no reason why that shouldn't be $7 billion, $7.5 billion over the next 2.5 years.

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Operator [37]

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Our next question is from Eric Wasserstrom of Guggenheim Securities.

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Eric Edmund Wasserstrom, Guggenheim Securities, LLC, Research Division - MD and Senior Equity Analyst [38]

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Chris, can you update us perhaps on where things stand with respect to the bank and its capital requirements and its -- any limitations that continue to exist on originations?

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Jeffrey J. Brown, Ally Financial Inc. - CEO and Director [39]

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Yes. Eric, it's J.B. So I mean, on asset origination limitations, those are now completely gone. And so we are booking more or less everything at the bank today. So there is one remaining covenant that's in place. That's obviously the maintenance of 15% Tier-1 leverage. And I've been saying for about a year that we remain in active dialogue and discussions with our regulators. I'd say that, that continues certainly to be the case. Optimistic this will get cleaned up and addressed at some point in the very near future.

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Eric Edmund Wasserstrom, Guggenheim Securities, LLC, Research Division - MD and Senior Equity Analyst [40]

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And does that leverage constraint influence how you're approaching the -- any of the dynamics around returning some of the upcoming debt?

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Jeffrey J. Brown, Ally Financial Inc. - CEO and Director [41]

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I mean, that -- it's really the avoidance of having to refinance that debt. I mean, that's a big one. So really for us to take full advantage of the deposit base and be able to retire the unsecureds, that's really a key ingredient. But I think we speak with pretty high degree of confidence that will come to fruition.

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Operator [42]

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Our next question is from Ken Bruce of Bank of America.

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Kenneth Matthew Bruce, BofA Merrill Lynch, Research Division - MD [43]

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On the comp and benefit line, is that -- do you expect that to be a good run rate? Or is there anything that's kind of seasonal or onetime in nature that's in that line item this quarter?

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Christopher A. Halmy, Ally Financial Inc. - CFO [44]

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Yes, there's definitely a seasonal component of that in the first quarter because of just things like FICA taxes and 401(k)s and things like that in the first quarter. So we do expect that to drop somewhere in the $15 million to $20 million range and that should be more of what I would call steady state throughout the year.

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Kenneth Matthew Bruce, BofA Merrill Lynch, Research Division - MD [45]

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Great. And then, the improvement in the net gain loss per unit on the lease vehicle, is -- do you think that, that is in a sense reflection of the tax issue that obviously kind of created a little bit of a stop in the industry in the first quarter? Or is there something more dramatic just in terms of what you're seeing on the residuals that are already baked into those leases? If you could just give us a real understanding of what's driving that, that would be helpful.

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Christopher A. Halmy, Ally Financial Inc. - CFO [46]

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Yes, it's -- and I'll let Dave jump in here as well. It's hard to tell, but obviously the tax refunds catching up with think was a positive. The other thing we really deal with is just the seasonal dynamic, meaning coming out of the winter months into kind of March and April tends to result in more used car sales and just better pricing and that tends to be a seasonal nature.

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David P. Shevsky, Ally Financial Inc. - Chief Risk Officer [47]

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Yes, I mean, that's exactly it, Chris. I would say it's more of a spring selling season than the tax rebates, which had a little effect on it.

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Operator [48]

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Our next question is from Jack Micenko of SIG.

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Jack Micenko, Susquehanna Financial Group, LLLP, Research Division - Deputy Director of Research [49]

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Chris, I think in your prepared comments, you talked about some operating leverage in the back half of the year. I'm wondering if you could maybe put a sharper point on that as it relates to efficiency ratio for either the back half of the year or the year.

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Christopher A. Halmy, Ally Financial Inc. - CFO [50]

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Yes, we do expect ratio the efficiency ratio to start trending back down 45% or even under. I think I guided last call that we would have expenses somewhere around $760 million per quarter with an additional $50 million in the second quarter because of weather losses. So I still think that's a pretty good run rate. But as we get into the second half of the year, what you're really going to start to see is the expansion in net financing revenue, and that expansion will come on a pretty consistent expense base.

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Jack Micenko, Susquehanna Financial Group, LLLP, Research Division - Deputy Director of Research [51]

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Okay. And then it looks like the broker deposit mix ticked up both quarter-on-quarter, year-on-year. Is there any strategic shift there? Or what's driving some of that about-average growth?

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Christopher A. Halmy, Ally Financial Inc. - CFO [52]

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One of the pieces of that is our TradeKing, our Ally Invest, deposits. So they are considered somewhat broker deposits. So you have to take that kind of $1 billion or $1.2 billion out of that. We did take advantage of some incremental broker this quarter as well. One of the reasons we did that is just because of the elevated dealer floor plan balances that we expect to come down. So sometimes we use brokered as well, call it a little bit of temporary funding joy and kind of higher floor plan months.

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Operator [53]

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Our next question is from David Ho of Deutsche Bank.

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Shih-Wei Ho, Deutsche Bank AG, Research Division - Senior Research Analyst [54]

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Just wanted to follow up on the flexibility you have now at the bank to originate full spectrum at the bank. And I think you mentioned at the last call that you were going to, in the short term, do a little more lower FICO and you saw a little bit of a tick-up in near prime and maybe a little below. Is that still the plan, given your comments earlier about kind of tightening underwriting standards on the margin and structure on the margin as well?

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David P. Shevsky, Ally Financial Inc. - Chief Risk Officer [55]

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David, it's Dave Shevsky. I mean, we have the ability to book those assets in the bank, but we've actually been taking as a percentage nonprime actually down from right around 14.5% to it's trending at around 11% today. And I would say that our position on credit is caution. And nonprime, especially nonprime new vehicles that have high advance rates, we're cautious on those. I would say we're not going to be increasing that segment.

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Christopher A. Halmy, Ally Financial Inc. - CFO [56]

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And our ability to fund in the bank really has no decision on that.

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David P. Shevsky, Ally Financial Inc. - Chief Risk Officer [57]

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Yes. And again, I think the other important thing is the yields we're getting on these assets today are substantially higher than just the last couple of years.

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Shih-Wei Ho, Deutsche Bank AG, Research Division - Senior Research Analyst [58]

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Got it. And switching over to the commercial floor plan growth trajectory, I know you'd mentioned that potentially lower inventory levels at the OEM translating to dealer inventories coming down a little bit. Obviously, it's been a very good growth year-over-year the last few quarters here. But how do you expect that to trend if some of these either your projections or opinions on the dealers play out?

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Christopher A. Halmy, Ally Financial Inc. - CFO [59]

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Yes, it's obviously elevated because of the dealer floor plan balances just elevated on dealers lots today. Our expectations is it'll come down a couple of billion dollars as we get into the middle of the year. And we are, obviously, hoping that the OEMs stick to what they've said and close down some of their production plans for retooling, which we think will be the right thing to do and really help the overall dealer lots and bring their days of inventory down. So we expect a couple of billion to come down.

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Shih-Wei Ho, Deutsche Bank AG, Research Division - Senior Research Analyst [60]

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And just one more, if I may, just really quickly on the 2015 vintages or so. How big are they as a percentage of losses? I'm not sure if you've disclosed that before, but one of your competitors [sized it].

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David P. Shevsky, Ally Financial Inc. - Chief Risk Officer [61]

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Yes, David, I think based on the last update call, we said it's probably right around 2/3, maybe 75% of the loss content coming through. And it's going to start declining because as we move out into the year, you're going to see '16 then coming in as well. The loss content on '16 and '17 -- or '16 and '15 are pretty close. The big difference, though, is the yield on '16 is dramatically higher than '15.

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Operator [62]

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Our next question is from John Hecht of Jefferies.

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John Hecht, Jefferies LLC, Research Division - Equity Analyst [63]

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Most of my questions have been asked and answered. I guess, one question just in terms of modeling is on the reserve build. I think you said the reserve build should track the increase in charge-off guidance. And just specifically, what does that mean? Does that mean reserves as a percentage of ALL should be up similar to the trajectory of charge-offs? Or we should more model this towards forward 4 quarters coverage or something of that nature?

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Christopher A. Halmy, Ally Financial Inc. - CFO [64]

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Yes, I mean, we look out a year. And if we think our losses are going to settle in this 1.4% to 1.6% range, and we think it will settle in there and start to flatten as you get into '18, then obviously, we need coverage that's going to be greater kind of than that level. So depending on where we fall, we're going to have to continue to kind of increase coverage along with this. Our coverage today is 1.43%. So it's obviously on the lower end of that range. So we're going to have to move that up. And you'll see that really get done on a quarterly basis.

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John Hecht, Jefferies LLC, Research Division - Equity Analyst [65]

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Okay, that's very helpful. And second question is -- forgive me if you've mentioned this. Where do you see your lease book? I know you gave some ratios that were leases to loans in a couple of years, but where do you see the lease book at the end of this year?

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Christopher A. Halmy, Ally Financial Inc. - CFO [66]

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We see it around $8 billion, I think just a little north of it.

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Operator [67]

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Thank you. This ends the Q&A portion of today's conference. I'd like to turn the call over to Michael Brown for any closing remarks.

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Michael Brown, [68]

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Great, thanks. If you have additional questions, please feel free to reach out to Investor Relations. Thanks for joining us this morning. Thanks, operator.

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Operator [69]

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Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program. You may now disconnect. Have a wonderful day.