Ally Financial Inc. Q4 FY2020 Earnings Call

Ladies and gentlemen, thank you for standing by. And welcome to Ally Financial's Fourth Quarter and Full Year 2020 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. Please be advised that today's conference is being recorded. I would now like to hand the conference to your speaker today, Daniel Eller of Investor Relations. Please go ahead, sir.

Thank you, operator. We appreciate everyone joining us to review Ally Financial's fourth quarter and full year 2020 results this morning. We have JB, Jeff Brown; our CEO, and Jenn LaClair, our CFO on the call to review results and take questions. Before beginning, I'll note that the presentation we'll reference throughout the call can be found on the Ally Investor Relations website. On slide 2, you'll find the forward-looking statements and risk factor language that will govern today's call, and on slides 3 and 4 we've included several GAAP or non-GAAP core measures pertaining to Ally's operating performance and capital results. These metrics are supplemental to, and not a substitute for US GAAP measures; definitions and reconciliations can be found in the appendix. With that, I'll turn the call over to JB.

Right. Thank you, Daniel. Good morning, everyone. And thank you for joining the call today to review our fourth quarter and full year 2020 results. I'm going to start on slide 5. I'm incredibly proud of the way our company and teammates responded during these challenging times. This past year presented one of the most complex operating environments in our company's history as COVID cases accelerated across all 50 states, and that led to considerable uncertainty about the health and welfare of millions of people and businesses. The fiscal and monetary response from the government, combined with the private sector actions providing relief to those impacted was necessary and still remains critically important to the recovery. Across our country, we also confronted the harsh realities of social injustices and racial disparity, requiring difficult but necessary dialogue and an intensified call to action for everyone. Sadly, COVID appears to be further accelerating these disparities. As I shared across our company and with our board, the only ways we can permanently disrupt the flaws in our system is by each individual making the commitment to change now and after the headlines are less frequent. And candidly, that's part of the reason I share it again today. While the year was full of challenges, signs of hope have emerged as we are now taking a meaningful step forward in the fight against the virus with the rollout of vaccines. And I am proud of how companies and people are responding and recognizing the need for real and lasting social change. I hope America can unite, heal, and strengthen together. Further, the sacrifices and work with healthcare, service industry, and community-focused leaders and organizations is reason for optimism moving forward. At Ally, we build a culture based on doing it right, rooted in an authentic set of values, and inclusivity. I believe we all have the opportunity to emerge from this difficult period with a greater appreciation for each other, for life, and with an emboldened focus on equality and inclusion. These elements of our cultural DNA serve as a huge source of strength and continuity across our stakeholders. Actions reinforcing our values, including moving and maintaining 99% of our workforce to work from home, with outstanding health, family and financial benefits, and utilizing our employee resource groups during critical moments to listen, share and connect on a personal level. For our customers, we proudly lead the industry with comprehensive COVID relief with post-deferral performance remaining strong. We continue to expand our digital products, technologies, and services aimed at meeting customer needs in new and innovative ways, something our modern, nimble, direct platform is well positioned for moving forward. And within our communities, we established the Ally Charitable Foundation, strengthening our ability to make lasting and meaningful change well into the future. And I'm proud of how we demonstrated our humanity more than anything else. And as you'll see, that bettered our results. Across all of our businesses, we demonstrated our leading capabilities and growing momentum, which is reflected in our financial results and outlook. During a year of constant change, we maintained our long-term focus, something we've done for years as we position the company for ongoing success. Turning to slide 6, full year 2020 adjusted EPS of $3.03 and core ROTCE of 9.1% demonstrated our ability to absorb a significant allowance build early in the year, while still driving impressive business results and strong momentum. Revenues of $6.7 billion represented our highest annual result growing 6% year-over-year while credit performance exceeded expectations. Jenn will provide more detail on the quarter in a few moments. The pricing, flows and credit all ended the year on solid footing, and we feel really good about the exit rate into the New Year. Turning into our business and product offerings; across our growing base of nearly 9 million Ally customers; we focus on our relentless pursuit to provide differentiated, innovative products, services, and experiences. Within auto finance, consumer volume of $35.1 billion was sourced from 12.1 million applications, results that were only modestly impacted by the COVID environment. As we move into 2021, we're well positioned for an outlook that indicates driving new and used auto sales as demand persists. OEM production let you gradually replenish depleted inventories on dealer lots and some normalization of used values from the record-setting levels we saw in the third quarter. Our retail origination yields remained solid, exceeding 7% for the full year, which reflects our dynamic underwriting approach. I can't emphasize how strong this performance is, and exceeds margin expansion well into the future. From a credit perspective, net charge-offs of 96 basis points reinforced a resilient and disciplined consumer despite elevated unemployment in a challenging backdrop. Simply put, the combined impact of fiscal stimulus, digital collection tools, and proactive actions implemented this year have kept losses low. In our insurance business, we generated $1.2 billion in written premium in 2020, while our $6.3 billion investment portfolio produced over $200 million of investment income. The counter-cyclical aspects of this business are a powerful reminder of our ability to drive strong results in a variety of environments. Ally Bank was an early disrupter, and we built the largest direct bank in the US by truly focusing on growth and retention of the customer. Our growing, scalable platform has generated over 10 years of customer and balance expansion, and experienced record-setting growth in 2020. We ended the year with over $124 billion in retail balances, and 2.25 million active customers, a six-fold increase over the past decade. Deposit growth continues to lower our cost of funds and serves as the gateway to Ally Bank in the expanded suite of all digital consumer finance products we offer. Trends accelerated this year across each of these products as depositors with a home or invest product grew to 8%, our fourth consecutive year of growth. Ally Home originations of $4.7 billion increased 74% year-over-year, as we continue to expand and enhance our customer experience and take advantage of a strong refinance market. Ally Invest self-directed accounts of 406,000 expanded 17% year-over-year, while customer assets of $13.4 billion increased 70%. Ally Lending volume of $503 million grew 75%, while entering home improvement and retail verticals complementing our established healthcare offering. We now have over 1,800 provider relationships, a 60% increase from 2019. The opportunity across each of these digitally driven products to grow and deepen customer relationships provides us with a long-term organic growth runway. Our Corporate Finance segment generated strong results driven by experienced teams, focused execution, and prudent underwriting. Our $6 billion held for investment portfolio grew 6% year-over-year, while credit performance remains stable against a shifting backdrop. Over the past several years, we've generated steady growth while maintaining a disciplined underwriting approach. The outlook for each of these businesses continues to accelerate, reflecting years of steady, disciplined, and consistent execution. I'm fully confident in our ability to keep driving meaningful value for our customers, communities, and stakeholders in the years ahead. Turning to slide 7, we highlighted some of the competitive advantages last quarter, and it bears repeating again on the strength and position of the company's core businesses. Within auto, we're a full-service partner to 18,700 dealers, that's the highest level in the history of our company, reflecting growth from both established and emerging players. Scale of this magnitude provides us with broad market insights, and allows us to generate impressive volumes with attractive returns. Our industry-leading field teams, strong service levels, and expanding use of modernized tools and technology will continue to set us apart from the competition. Throughout the year, we streamlined user experiences and enhanced digital capabilities across our servicing, underwriting, and smart auction platforms. We continue to employ the use of advanced data analytics in 2020, leading to our fifth consecutive year of improved auto decision levels and reduced response times. Within insurance, our comprehensive protection products continue to enhance value for over 4,200 dealers and 2.6 million customers in the US. Within our consumer banking products, we differentiated through frictionless experiences built on data intelligence, innovative technologies, and mobile investments. New savings tools rolled out this year have been hugely popular, and we've crossed over 1 million consumer savings goals. We've made significant progress against our long-term strategic objectives in 2020 as ongoing consumer demand for digitally based experiences accelerated.

Thank you, JB, and good morning, everyone. I'd like to begin by thanking our Ally teammates for their consistent operating and financial performance throughout the many challenges of 2020. Their commitment to our values, hard work, and perseverance is reflected in our strong and accelerating financial trajectory. Let's turn now to slide 9; net revenue of $6.7 billion for full year 2020 expanded for this six consecutive year, representing a 5% CAGR over this timeframe. The sustained top line trajectory reflects margin improvement across both sides of the balance sheet, driven by over a decade of customer growth and relationship deepening. Our balance sheet positioning and revenue momentum this year demonstrate our ability to navigate challenging environments and drive improved financial results in the years ahead. Turning to slide 10; we've included details on our balance sheet reflecting three primary dynamics. First, asset expansion and diversification. We ended 2020 at $176 billion in assets, a $33 billion increase since 2014. Retail auto loan growth has outpaced the decline in lease exposure, reflecting our strategy to broaden our capabilities in distribution. Corporate Finance has tripled in size to $6 billion through prudent entry into additional verticals. And we've grown capital-efficient mortgage and investments securities portfolios and added Ally Lending. We expect continued organic loan growth and return optimization moving forward. The second driver has been the transformation of our funding profile shown in the bottom left, where deposit growth and retention have increased stability and reduced cost of funds. Since 2014, our deposit portfolio has nearly doubled to $137 billion, now representing 85% of overall funding. As a result, higher-cost legacy unsecured debt has declined by 60%, and we've reduced reliance on other wholesale funding, including securitization, facilities, and other borrowings. And third, optimization of retail auto portfolio yields, where we've consistently generated improved risk-adjusted returns through expanding dealer relationships and increased application flow. Full-year new origination yields exceeded 7% for the third consecutive year, even as benchmark rates have declined 150 to 200 basis points over the past two years. Our consistent pricing reflects the strength of the retail auto asset class and our leading competitive position. Across those parts of our balance sheet, we've reduced NIM volatility by managing to a relatively neutral interest rate risk management position, which is evidenced in stable full-year net interest margin. From here, we expect sustained revenue and margin expansion to be a key differentiator for Ally. Let's turn to slide 11 to review detailed results. I'll begin with significant items on the bottom of the page. Other revenue, including impacts related to an early pay down of FHLB debt where again this quarter we utilized surplus liquidity to accelerate cost of funds benefits. And gains related to corporate investments and a legacy mortgage portfolio sale executed in Q4. Non-interest expense included our contribution to the Ally Charitable Foundation and an auto legal settlement that's subject to court approval that will fully resolve an outstanding class action case described in our 10-K and 10-Q filings. Moving to the top of the page, Q4 net financing revenue excluding OID was $1.312 billion, our highest quarterly results to date, increasing 9% linked quarter and 13% year-over-year, powered by steady loan and lease growth, stable earning asset yields, declining cost of funds, and proactive liability management as we reduce excess cash. Adjusted other revenue of $567 million reflected strong realized investment gains, robust mortgage fee income, and the significant items mentioned earlier. While we remain opportunistic generating investment gains, ongoing other revenue expansion will be sourced from steady growth across insurance, mortgage investment, and our smart auction platform. Provision expense of $102 million declined linked quarter and year-over-year as consumer commercial performance remains solid, and reserves declined due to macroeconomic favorability. Non-interest expense trends, excluding the one-time items mentioned earlier, reflect ongoing business investments to drive long-term customer and revenue expansion. Q4 GAAP and adjusted EPS of $1.82 and $1.60 respectively reflect a strong finish to a challenging year, and are in direct reflection of our talented workforce, loyal customer relationships, and several years of diligent focus and execution transforming our balance sheet. Before moving on, I'll address full year 2020 non-interest expenses of $3.8 billion. The year-over-year increase reflects nearly $80 million of insurance business expansion; its variable conditions and weather-related increases reflecting growing written premium volume from prior years. $150 million of investments supporting business growth, customer capabilities, technology enhancements, and our growing brand; and $173 million of significant one-time items covered earlier, and a goodwill impairment in Q2. Importantly, we will deliver positive operating leverage and efficiency improvement in 2021. Let's turn to slide 12. Net interest margin excluding OID of 2.92% improved 25 basis points linked quarter and 26 basis points year-over-year. Earning asset yield of 4.34% remains stable quarter-over-quarter, a trend we expect to persist as we patiently redeploy excess liquidity towards organic growth and balance sheet management. Our outlooks for 2021 embed assumptions for retail auto origination yields in the mid-6% range, and a declining used car values of 3% on a full year basis. Average earning assets of $178.5 million expanded quarter-over-quarter among all loan and lease portfolios, except mortgage where prepayment activity reflected persistently low rates. Notably, average commercial auto balances rose $1.2 billion quarter-over-quarter, an 11% increase from the trough in July, as auto inventory levels continue to build. Cost of funds improved 27 basis points, the sixth consecutive quarter-over-quarter decline, reflecting improved deposit costs and ongoing wholesale funding optimization. $2.2 billion of unsecured debt matures in 2020 with a weighted average coupon of 6.6% as we opportunistically issued $2.8 billion in new bonds at a blended rate of 3.1%, less than half the cost of the maturing debt. Given strong deposit flows, we did not access ABS markets and reduced broker's deposits and FHLB borrowing levels. Stable asset yields, declining cost of funds, and liability management will contribute to ongoing NIM expansion in 2021 and beyond. Detailed deposit trends are on slide 13. Total deposits grew to $137 billion, powered by $20.6 billion of retail growth, our highest annual growth ever. Existing customers drove over 50% of balance growth while retention of 96% remains industry-leading. Our 2.25 million customers grew 14% year-over-year while deposit customers with an Ally Home or Ally Invest account expanded for the 15th consecutive quarter. The momentum generated by our customer-centric approach is reinforced in the accelerating trends across all of our digital offerings. Over half our brokerage account openings and mortgage volumes are sourced from existing customers, reflecting the organic growth opportunities within Ally Bank. Throughout the year, we rolled out new innovative digital tools aimed at helping customers set and achieve their financial goals. And we continue to receive several industry awards throughout the year. And we're pleased in Q4 to be named Best Online Bank by Money magazine for the eighth time in the past 10 years. Turning to capital on slide 14. Q4 CET1 of 10.6% reflected strong earnings and lower risk-weighted assets stemming from lower commercial floor plan balances. Last week, we announced the Q1 common dividend of $0.19 per share and a share repurchase program up to $1.6 billion for 2021. We're pleased to be able to resume that. And while we await guidance from the Federal Reserve regarding activities beyond Q1, we remain confident in the positioning of our balance sheet, our proven approach to risk management, and a robust capital position. At these levels, we remain well above our 9% internal target and have $3.7 billion in excess above the 8% SCB requirement. Capital deployment priorities remain centered around investing in the growth of our businesses, delivering innovative and differentiated products, and driving long-term shareholder value. Turning to slide 15, asset quality remains strong. While we observed unexpected linked quarter seasonal uptick across loss metrics, trends improved considerably versus the prior year. Results were driven by broad-based consumer and commercial resilience with consolidated NCOs of 0.67% declined 24 basis points year-over-year. In the upper right, charge-offs of $198 million declined $92 million compared to the prior year driven by retail auto. In the bottom left, the Q4 retail auto net charge-offs rate of 1.01% declined 40 basis points year-over-year, reflecting the combined impact of lower frequency and improved severity as customer payment behavior remains solid and used car values remain elevated. In the bottom right, early and late-stage delinquencies remained strong, ending meaningfully below prior year levels. Taken together, credit trends reflect the high utility of auto, disciplined underwriting, effective servicing strategies and a resilient consumer benefiting from lower discretionary spending and government stimulus. Let's turn to slide 16 to review coverage and reserve detail. Given favorable credit trends and improved macroeconomic indicators, consolidated coverage of 2.78% and retail auto reserves of 3.95% moves modestly lower to end the year. Retail auto reserves of $2.9 billion remain well positioned for elevated pandemic-related NCOs. Retail auto coverage remains 2.5x higher than 2019 ending reserves and nearly 20% higher than CECL day one level. Our baseline forecast assumes unemployment remains elevated throughout 2021, ending above 6%. And consistent with prior quarters, we continue to exclude any stimulus-related impacts. While we are encouraged by the underlying trends of our portfolios and confident in our ample reserves, we recognize the continued uncertainty driven by COVID-19. On slide 17, I'll review auto segment highlights. Net financing revenue expanded year-over-year reflecting growth in the retail margin and strong lease gains. Used car prices shown in the bottom right moderated throughout the quarter, but continued to generate higher year-over-year gains per vehicle. Execution within our auto reflects our diversified full-spectrum capabilities, expanded market reach, experienced underwriting, and growing use of technology across our products. The proven ability to meet and adapt to the needs of our dealers is reflected in our strong application flows, pricing trends, and overall improved risk-adjusted returns. Detailed origination and asset trends are on slide 18. Auto originations of $9.1 billion in the quarter increased $1 billion year-over-year and represented our highest Q4 in three years. We maintained a dynamic, disciplined approach to underwriting this year, evidenced by stable FICO and non-prime trends. In the bottom left, ending consumer assets grew year-over-year and sequentially, ending at $83.1 billion driven by retail and lease expansion. On the bottom right, average commercial assets ended at $22.4 billion, up quarter-over-quarter as inventory levels have gradually improved over the past five months. Turning to insurance results on slide 19. Core pretax income of $72 million increased $7 million linked quarter and declined $13 million year-over-year. Written premiums of $312 million declined seasonally linked quarter, with a year-over-year decline reflecting stable F&I, but lower commercial activity resulting from lower floor plans. Notably, commercial volumes declined by less than half the rate of vehicle inventory reflecting ongoing new business expansion across our growing dealer base. Overall, we were pleased with the resilient and counter-cyclical value of the insurance business throughout 2020, delivering core pretax income growth, fueled by record premiums and strong realized investment gains. Turning to slide 20, corporate finance core income of $63 million grew $4 million quarter-over-quarter and $14 million year-over-year, reflecting expanding assets and steady credit performance. HFI ending balances of $6 billion increased linked quarter and year-over-year, as the base lending now comprises 50% of the portfolio compared to 43% a year ago, and 25% in 2014. Unfunded commitments of $4.1 billion reflect our ability to expand amid a challenging backdrop. Portfolio metrics reinforce our continued prudent underwriting approach and operating execution. Moving to slide 21, mortgage pretax income of $7 million declined quarter-over-quarter but increased year-over-year reflecting strong gain on sale results, partly offset by the ongoing impact of elevated prepayment activity. Direct to consumer originations of $1.4 billion represented our strongest quarter since launching in 2016. The low mortgage rate environment resulted in robust refinancing activity accounting for 70% of Q4 volume. Our digital end-to-end offering continues to resonate with consumers. Over half of originated volume comes from existing depositors. Average cycle times have continuously improved, ending the year in the 40 to 45-day range. While our NPS scores in the upper 50s are industry-leading and reinforce the frictionless experience we're delivering. I'll wrap up on slide 22 with our financial outlook. We've continued to demonstrate the expanding earnings power of our franchise with significant opportunities ahead, assuming our gradually improving economic environment. As I mentioned at the start, our financial trajectory will be driven by embedded balance sheet talent, ongoing pricing optimization within our established businesses, and organic growth across our expanded product offerings. ROTCE will grow to 12% in 2021, before expanding to mid-teen in 2022 and 2023. New expansion of over 3% will drive net financing revenue growth in the mid-teen year-over-year. Adjusting for significant items, other revenue will steadily grow fueled by our broader set of consumer offerings and ongoing insurance expansion. And as a reminder, we embed modest investment gains in our outlook. These factors will drive PPNR expansion and positive operating leverage as revenue growth outpaces expenses. Based on pandemic-related uncertainty reflected in our reserves, we expect NCOs to peak in 2021, before stabilizing in 2022 and 2023. I'll close by reiterating the gratitude and pride I have in our Ally teammates who drove our results and positioned us for success by doing it right for our customers, communities, and our shareholders. And with that, I'll turn it back to JB.

Thank you, Jenn. I'll wrap up with a few comments on slide 23. I want to thank my teammates for their tremendous efforts during 2020. The resolve they've shown in balancing a myriad of personal and family obligations while working from home and taking care of our customers serves as a testament to our ability to do it right. And that reinforces the pride I have in leading our company. The trust and transparency that exists inside Ally is simply energizing to our customers and communities. Our relentless work will continue as we preserve and build upon the trust and loyalty you continue to show in us. And regardless of challenges we may face in the weeks and months ahead, we will continue to lead with our values and focus on these consistent priorities as we continue to enhance long-term value for all of our stakeholders. Daniel, I think that’s it for the prepared remarks. And we'll turn it to you for Q&A.

Thank you, JB. Operator, please begin the Q&A session.

Our first question comes from Ryan Nash with Goldman Sachs.

Thanks. Good morning, everyone. So maybe to just dig in a little bit more on the ROTCE progression, so JB, Jenn, the bank is clearly benefiting from the environment as well as investments that you've made in the business and bringing down funding costs optimizing on the asset side. So you maybe just dig in a little bit more on the drivers of getting us to 15% returns. And I think more importantly, can you talk about the ability to sustain these returns, particularly as the interest rate environment may evolve over time, and what are some of the drivers to doing that?

Yes, sure. I appreciate the question, Ryan, and I'll jump in and JB may want to add. The progression to the mid-teen ROTCE, I think you described it really well. It will be revenue driven positive operating leverage, I just mentioned the NII trajectory next year, which will progress into the mid-teen, coupled with the fact that we'll continue to see other revenue expand over time, minus some of those one-timers. So when you wrap that all up, we're expecting total revenue next year to be around 9% or so. And so really nice positive operating leverage driven by that revenue growth and coupled with the fact that on the credit side, we do expect that to migrate more towards normalized levels as we exit 2021, and into 2022 and 2023. So those are some of the big dynamics there. And I would absolutely expect that the 15% is sustainable. And I think that's due to all of the drivers that we kind of just described this morning around consistent customer growth, continued value add across every one of our businesses. We don't see any signs of stopping in the auto segment, continuing to grow relationships, deals per relationship, and just our positioning in the market couldn't be any better than it is today. And we don't see any sign of that stopping over the next several years.

Got it. Thanks for all the color and maybe if I can dig in a little bit further on the credit expectations. So, Jenn, a couple of things, I think you mentioned a 3% decline in used car prices, unemployment ending about 6%. And I also think you mentioned that charge-offs are going to peak in 2021. So can you just give us a little bit more color on where you see charge-offs headed? And then second, I think you said that you think losses are returning to more normal levels in 2022 and 2023. What is embedded in the 12% reserve and the 12% plus returns in terms of where the reserves headed? Is there any assumption of reserve releases? And how long would you expect until we actually get back to that pre-COVID level on the reserve front?

Yes. So, Ryan, maybe let me start with some of the assumptions around reserves and then I'll get to the NCO trajectory, but embedded in our reserves, and you're listening really well. You pretty much captured it. We have a pretty adverse macroeconomic scenario embedded in our modeling. So we use a November forecast. We're exiting 2020 at about 8% unemployment rate migrating down to just above 6% at the end of this year. And because we have a short RNS forecast, we revert to a mean that's over 6.5% in unemployment. So yes, there is definitely some adversity built into that macroeconomic forecast. I also remind you that we have not built any stimulus benefits into our reserve trajectory. So you think about stimulus that has already been ruled out but new stimulus potentially on the horizon, as well as the fact that consumer spending has dropped, and we're seeing savings rates that are really at all-time high levels. So embedded in our reserves is a lot of kind of conservative assumptions. And so I do think, depending on macros, depending on the continued performance of the consumer, there could be some upside as we continue to roll through 2021. So that's some context around the reserves. Embedded in those reserves, we have NCOs really starting to accelerate in the first quarter, second quarter of this year, and peaking in Q3 and Q4 before returning to more normalized levels into 2022 and 2023. So bottom line here is we are well reserved. We've taken the pain through the income statement in 2020 and could potentially be some upside as you think about macro performance and consumer outperformance. And then last but not least, we do not model any kind of reserve release within our forecast. The reserve level will migrate down as we run through NCOs assuming that the projections play out as I just described.

Our next question comes from Moshe Orenbuch with Credit Suisse.

Great, thanks. And that set of answers actually answers a lot of the questions, but maybe we could drill down a little bit into on the deposit side or the funding side. I mean, one of the things that we've talked about over the years, is both optimizing your mix of funding overall. And then your kind of deposit pricing and some of the comments that you made sounded like you think that's relatively near given, the liquidity at yourself and some of your peers. Could you just talk about the opportunities there? And what that could mean to your cost of funds?

Yes, sure. Thank you for the question, Moshe. So a couple things just is first on the cost of funds trajectory. I think this quarter is a really nice reflection of what we're expecting to see as we continue to roll through 2021 and 2022, which is that cost of funds will migrate down due to a couple of things, including the full run rate impact of the OSA reduction this year, and the CD repricing that will continue throughout 2021 and 2022. If you think about CDs rolling off at 2% and rolling back on at material levels under 1%. And then to your point on other funding sources, the excess cash we have on the asset side of the balance sheet will be used in part to replace FHLB and our broker deposits. We've terminated our demand notes program, and we haven't been active in the ABS markets either. So we see other sources of funding rolling down at the same time, we continue to see overall deposit growth and pricing move down as well. So hopefully, that gives you a bit of color, Moshe just on what we're expecting, but I think this quarter kind of really summarizes it perfectly, and you'd expect that trajectory to continue.

Got it. And I mean, I think you made a very strong point about the impact of the margin on revenue growth in 2021. But it does sound like there's some of that, that extends kind of beyond and provides further lift, even if there are some elements of current profitability that are kind of better than normal.

Yes, absolutely, Moshe. This is a trend we expect to continue over the next several quarters. In your first question, you hinted at market pricing. We have cash-rich balance sheets across the direct banks, and our liability stacks have been optimized. Therefore, there isn’t much appetite in the industry for price increases in 2021 or beyond. This also affects loan growth. However, we are confident in our pricing and our ability to further reduce funding costs after 2021.

Our next question comes from Betsy Graseck with Morgan Stanley.

Hi, good morning. Okay, one quick follow up and then a separate question, but the rate environment that you're looking for, could you just help us understand just using the forward curve results what is embedded in your outlook? And if rates move higher does that materially change your thoughts around NIM?

Yes, Betsy, I mean a couple of things. So we're not embedding any rate increases into our projections right now. But the interesting thing is if you do consider a rising, more rapidly rising rate environment, we're really confident in continuing to hit these higher NIM levels. And that's all of the dynamics that we have on pricing in auto on the asset side, as well as in deposits, we think will be persistent in almost any rate environment. I mean you never want to say that 100%. But as we look at a variety of different rate forecasts, we continue to see that NIM rolling through just because of the strength of the pricing we have on both sides of the balance sheet.

Okay, so you're saying that if the short end starts moving up, that you can continue to maintain the spread relative to what you're getting on the auto side?

Yes, I mean I think if we do see rates rise, I think it'll be a positive on the asset side. If you think about LIBOR based commercial floor plan. And I think if anything, if you see any interest rate increases across the curve, that's only a net positive for some of our longer duration assets like investment securities, or auto book, mortgage, et cetera.

Okay, and then just separately on loan demand and the portfolio and how it's been migrating. Maybe you can give us some sense on what you're seeing on the ground demand for both used and new asking the question, because one of the pushback I get on the call on Ally is, well eventually everyone's going to have one, two, or three cars, whatever they need. So shouldn't loan demand pullback, so a little color on that. And if you could give us a sense as to how the portfolio has been migrating from a credit perspective, in the various buckets prime, non-prime, sub-prime. I asked that question because the other pushback I get is, hey, used car prices are so strong, that's why credit is doing so well, when used car prices start to stabilize or come down slightly year-on-year, you're going to see the credit quality come through and just wanted to get your sense as to what you're seeing there so we can better address those questions we're getting from investors. Thanks.

Okay. Sure thanks, Betsy. A lot in there let me try to tackle it one at a time. I mean, I think on auto what I direct you to is the performance. And our exit run rate in terms of volumes in terms of pricing continues to persist. And we really don't see that stopping and a couple of dynamics there. One is certainly COVID is helping. We've seen a shift from services to durables, and the whole environment around COVID impact on appetite for rideshare, or mass transit has obviously really spurred demand for personal vehicle ownership. So that is a net plus. But I will say just the resiliency of consumer balance sheets, the high savings rate, above and beyond that dynamic, there is demand that has persisted kind of pretty much off the charts. The second thing that I would say is, if you look at just this market, it's a very large and fragmented market, and we have differentiated capabilities. We continue to grow dealer relationships and increase applications per dealer, while maintaining strong performance in originations and pricing across various environments. Our forecasts for 2021 and the following years assume modest growth, with a target of approximately $35 billion in originations and an expectation that pricing will decrease by about 50 basis points. There is strong demand in the current market, and our business model presents ongoing opportunities. Additionally, our guidance is based on conservative assumptions. Regarding credit, the overall performance of our portfolio is exceeding expectations, with broad-based improvements across all segments and no significant issues in specific customer areas. And on your question on used vehicle prices, losses will be reflective of frequency as well as severity as you look at frequency, you will see delinquencies across 30 plus down over a percent, 60 plus continues to come down as well. And so frequency metrics are also trending very strong. And then on the severity we'll see, I mean, we are expecting a decline of about 3% in used vehicle prices in 2021. I think there's a bull case around, outperforming that. Most of it is in the decline is in the back half of 2021. But as I said, if there's persistent demand for new and used, I think we could outperform that. But that 3% is again built into the guide. And as I described, in response to Ryan's question, there's a lot of moving pieces and parts around credit, but I'm not overly worried about the severity side of it.

So then, when we're looking at the net charge-off that should come with what you're baking in for unemployment and a 3% decline in auto, does that get us to kind of a normalized loss rate of one three to one, six, or is that kind of a decent range? Or do you have a different outcome?

Yes, so this year, we're expecting and NCOs, we've modeled NCOs to increase above that level. Our reserve is at 3.95% where, as I mentioned earlier, we're expecting NCOs to really start accelerating, more reflective of frequency versus severity here in the first half, and really peaking in Q3 and Q4 before returning to more normalized levels into 2022 and 2023. And Betsy, with the 3.95% reserve level that, those NCOs are higher than that one, three numbers. Now, as we exit 2021, we would absolutely expect NCOs to migrate back into that more normalized range of kind of 13, or 16 that we've seen historically. But we do have those pandemic-related NCOs accelerating here in 2021, and potentially room to outperform that.

Our next question comes from Sanjay Sakhrani with KBW.

Thanks. Good morning, I wanted to follow up on some of the questions and comments before, maybe just focusing on the auto yields. Those have been pretty resilient, suggesting it could be worse, I guess. Maybe you guys could talk about the competition there and the environment. Is there something different about this environment where you're not seeing a lot of competitive pressure on those yields? And then maybe just broadly, in terms of thinking about the risks to the targets that you guys have provided, taking the economy aside, what are those risks?

Okay, so a couple of things there, just in terms of auto yields and competition. I mean, Sanjay, as you know, this is always a really competitive space. And I think everyone's seeing kind of the performance of this asset class through 2020. And it's been one of the stronger across the consumers. So competition is always strong; I think we could see some more competition heading throughout 2021, but in the belly of the curve, where we're playing, we continue to see a lot of opportunity to grow and to put price in the market. But we are mindful of that. And that's why we have baked in kind of a 50 basis point reduction in retail auto origination pricing this year. When I talked to the team heading into January, I think they’re really pleased with what they saw exiting 2020 and even more pleased with what they're seeing at the outset here in 2021. And then second, just with inventory levels continuing to be pressured and really pressured here starting the first quarter, because of the strong demand I described. I think used vehicle pricing and pricing overall will remain strong. And then sorry, second risk, okay, risks to the forecast. Sanjay, I think if we reflect on 2020, we learned that things can change very rapidly. The big risk for us is to be mindful of this environment. There are many changing factors such as the political landscape, potential changes to the tax rate, regulation, and consumer spending and behavior. We felt that 2020 was quite a rollercoaster ride. However, we believe we are incredibly well positioned to navigate any environment, and our performance this year demonstrated that. Still, we are aware of potential volatility ahead, which would be the biggest risk if anything were to arise. Overall, reflecting on our great performance this year, we feel really well positioned for next year in various rate environments, and we have established a strong reserve. So, I feel quite good about where we are, just wanting to remain aware of the environment.

Yes, I mean, Sanjay, I'd say we really like the position of the existing businesses in the state of the company right now. And obviously, Jenn and I announced with our board the large capital return program. So I think in the short term, we're more kind of hunkered down, focused on scale on our existing businesses and the newer businesses. Longer term, I think, as we've said for quite some time, I mean the unsecured space, we think fits well with the overall consumer position of Ally. We like the asset class. We think it can generate the right types of returns. But we got to be smart on that. And so I think in the near term, it's more kind of head down, focus on what we have in-house today. But you always sort of stay open to the things to counter so nothing imminent.

Our next question comes from Bill Carcache with Wolfe Research.

Thank you. Good morning, everyone. JB, I'm sorry if I missed this; I was on another call. I have a broad question for you regarding Ally's net interest margin performance during the rate hike cycle that began in late 2015. Given what we've seen from you in this reserved environment, along with strong credit performance, positive operating leverage, and the ROTCE trajectory you've outlined, it seems like we're enabling the investment community to feel more comfortable with the through-the-cycle performance of auto as an asset class. The ability for you to meet the guidance you've provided is clearly crucial, but could you describe whether that is achievable or aspirational? Any insights on how confident you are would be appreciated, along with some overall high-level thoughts.

Sure, Bill, thanks for the question. And obviously, Jenn can go through any of the details on it. But I think inside the house we have this kind of pound outperform mentality that exists. So I think Jenn has highlighted what's embedded in the forecast. I think we obviously we put the 12 plus, and that's our focus really continue driving strong disciplined execution. And I think what you're really starting to see come through now and the results is a function of the past several years of work and very disciplined execution; the business is scaling really strong positions. So we feel really good about the state of the company now and the sustainability of earnings. And certainly, as you pointed out, the margin is going to be a big component of that. And Jenn, hit all the highlights of several years of kind of seven-plus percent yields on the asset side, and you're starting to still see the book migrate up to these new origination yields at a time when deposit costs and funding costs overall continue to come down. And Jenn and her team, I just can't say that enough, what our treasury team and Jenn has been doing to continue optimizing the liability structure. I mean we've been very aggressive the past couple quarters, obviously, in trades we've done on the FHLB side, which just further gives us confidence and strength going forward. So I mean, it's been, it's really been fun and energizing to see the company starting to really strut its stuff. And but we've got a high degree of confidence in what we're going to be able to deliver going forward. Jenn, obviously, you've got the details.

Yes, JB, I think you summarized it extremely well. And maybe I just offer two points to add on. One is Bill, on the pricing side, a lot of that, as JB summarize, is already embedded, right, so we've got front book, back book repricing dynamics and retail auto, and there's kind of no stopping that. And similarly on the deposit side, the trajectory to come really reflects that robust positioning that we have across the entire liability stack. So a lot of that is kind of hard-coded into our metrics and our forecast. And then on the reserve, I think I mentioned in prior question just, there's a lot of assumptions in there that are fairly adverse. And so our view today is that we've taken the pain; our reserves have peaked. And so potentially, there could be some upside there. And then to your question around kind of through-the-cycle performance on auto. We're not projecting any change to kind of our day one CECL assumptions as reserves normalize. And so we continue to outperform at this level potentially there could be some kind of just reverse rating of the entire asset class. Again, not embedded in the forecast. But again, based on the information we have today, we feel great about sustainability and performance relative to both our ROE and our reserves and all of our origination dynamics. Our asset class is set up well for downside protection and upside growth.

Got it. Thanks, Jenn. And thanks, JB. That's very helpful. Separately, there's been a lot of focus on dealer floor plan levels, taking longer to return back to historical levels, and I am just hoping that you could comment on how you guys are thinking about the risk that dealers will be running with less inventory than they have historically or do we revert?

Yes. Bill, I guess our base case sort of calls for a slow reversion to more normalized levels. And obviously, you'll see some offset in our cash balances when that starts to happen. But I think the real reality is it's been much slower than the industry expected to see. Now, obviously, that's impacted used car pricing and used car strength and the used car market overall. So while you don't have as many new cars on the lot, the demand by consumers is still remains, it's still very strong. And so they continue to shift in use. So I think our base forecast sort of calls for that slow factory ramp back up more new cars on lot. And that creating a little bit of the more softer use car pricing. So used car prices, as Jenn alluded to, but I mean, we're still a ways away. I mean, while we did see some modest improvement, I think under a $1 billion quarter-over-quarter, we're a long way from kind of the 30-plus billion dollar levels that we would have expected in a normal environment.

Our next question comes from Rick Shane with JPMorgan.

Hey, guys, thanks for taking my question. When we look at the day one reserve level to today, there's essentially a 60 basis point addition, when you think about the duration of the loans, that equates to about 25 basis points a year in annualized charge-off and NCO rate. Given that there has been substantial amortization in the portfolio since we've entered the COVID scenario, cumulative losses are way below original expectations. And at this point, essentially, about 25% of the book has been underwritten in a post-COVID environment. Is there a huge disconnect between the macro assumptions that you guys are using to set the CECL reserve, and the actual sort of bottoms-up experience that you're really seeing in the portfolio?

Yes, Rick, appreciate your very well done summary there. Absolutely. I mean, we are seeing a disconnect across macroeconomic factors and servicing performance, whether you look at 30 plus, 60 plus, or flow to loss metrics. That being said we continue to operate in an environment of uncertainty. And so as I described earlier, we've been prudent and balanced around setting a reserve using historical correlations to the macros and not embedding a lot of stimulus. To your point, I do think there could be some upside, should A; these macros continue to outperform because they have been outperforming and B; if consumers continue to be as resilient as they’ve proven to be through 2020. And that's some of the upside not only on the reserves but also the NCO trajectory, as described earlier.

Thank you, everyone for joining. That concludes the Q&A session. Operator, I'll turn it back over to you.

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