Earnings Call Transcript - ALLY Q3 2023

Operator, Operator

Good day and thank you for your patience. Welcome to Ally Financial’s Third Quarter 2023 Earnings Call. Currently, all participants are in a listen-only mode. After the presentations, there will be a question-and-answer session. Please note that today's conference is being recorded. I will now turn the call over to Sean Leary, Head of Investor Relations. Please proceed.

Sean Leary, Head of Investor Relations

Thank you, Carmen. Good morning and welcome to Ally Financial's third quarter 2023 earnings call. This morning, our CEO, Jeff Brown; and our CFO, Russ Hutchinson will review Ally's results before taking questions. The presentation we will reference can be found on the Investor Relations section of our website, ally.com. Forward-looking statements and risk factor language governing today's call are on Slide 2. GAAP and non-GAAP measures pertaining to our operating performance and capital results are on Slide 3. As a reminder, non-GAAP or core metrics are supplemental to and not a substitute for U.S. GAAP measures. Definitions and reconciliations can be found in the appendix. And with that, I'll turn the call over to J.B.

Jeffrey J. Brown, CEO

Thank you Sean, good morning. We appreciate you joining us to review our third quarter results. I will begin on Slide number 4. Before we get into the quarter, I would like to spend a couple of minutes talking about last week’s announcement that I will be leaving Ally in the next few months. Let me start by restating my confidence in the strategic, operational, and financial positioning of the company as well as my deep trust in the leadership team to flawlessly execute during and after this transition period. Ally has delivered a remarkable transformation, built an incredibly strong foundation, and is positioned to thrive. I'm honored to have led our company and my teammates through some of the incredible things we've accomplished during these nearly nine years as CEO. I came to legacy GMAC to help with the financial restructuring, that I thought would take three to four years. Nearly 15 years later, we transformed the captive finance company, funded in the capital markets into a leading automotive franchise, the largest all digital bank in the country, and a very special brand. We successfully navigated the Great Financial Crisis, returned $20 billion to the U.S. Treasury coming out of Tarp, and became an investment grade publicly traded company. Starting from basically zero, we've grown to $140 billion of deposits, serving 3 million customers. Our auto and insurance teams serve more than 22,000 dealers across the country, offering them a comprehensive set of products and services that help them grow their businesses. And we've consistently given back to the communities in which we work and live, including the launch of the Ally Charitable Foundation in 2020. But as I've said many times on these calls, what I'm most proud of is the culture we built along the way. It's this team and this culture that will drive Ally to continue to disrupt, innovate, and deliver value for all of our stakeholders going forward. As we'll cover on today's call, the company is stronger than ever and positioned for substantial earnings growth over the next several years. Leaving Ally is a difficult thing to do, but I'm excited to see the next chapter of evolution and innovation, this time from the perspective of a customer. I think it's very important to state there was no disagreement with our Board or regulatory, financial, or operational concern. This was really the only call that could have pulled me away from leading Ally. My relationship with Rick Hendrick, his family and the Hendrick Automotive Group excites me as I transition for my final chapter over the next 20 plus years. Ally in my entire time in the banking industry has blessed me in ways I never dreamed. It has truly been an honor for me. I won't say goodbye quite yet, as I suspect I'll be with you again in January but thank you for the support all of these years. And with that, let's turn to Slide Number 5 to get into the quarter. Adjusted EPS of $0.83, core ROTCE of 13% and revenues of $2 billion reflect another solid quarter of execution in a dynamic environment. I do want to highlight a few notable items impacting the quarter. We recorded a $30 million restructuring charge associated with a workforce reduction. We expect the actions we've taken will drive $80 million in annualized savings heading into next year, as we manage towards meeting our expense target. Additionally, we continue to evaluate ways to monetize certain tax credits, and we're able to realize some of those benefits this quarter with the release of valuation allowance. We also realized benefits from certain state law changes. While we don't expect these items to occur every quarter, the tax team has done an excellent job over the years identifying ways to drive book value and capital accretion. In aggregate, non-recurring tax items provided a $94 million benefit worth $0.31 per share. These items are included in GAAP results, but we've excluded them from adjusted EPS in core ROTCE. Moving to operational performance, we continue to see solid results across the company. Within auto finance, we have generated record application volume of 3.7 million, which resulted in $10.6 billion of originations and attractive risk adjusted returns. Originating yields for the quarter were 10.7%, while 40% of our volume came from within our highest credit quality tier as we continue to capitalize on strong returns within this segment. In total, we've now achieved a cumulative pricing beta of 95% in retail auto, which reflects our consistent approach to dealer engagement and positions us well for yield expansion from here. Net charge offs on the quarter were 185 basis points, which was in line with guidance and up quarter-over-quarter given typical seasonality. Russ will go into more details on credit shortly, but we feel good about what we're seeing in terms of delinquencies, flow to loss rates, and vintage performance. Within insurance. We continue to successfully grow and deepen dealer relationships, as $324 million of earned premiums was our highest figure since 2009. Turning to Ally Bank. Total deposits of $153 billion are up $7.1 billion year-over-year. We added 95,000 customers in the quarter, which results in 307,000 on a year-to-date basis, an Ally record. We're now serving 3 million retail deposit customers, providing another proof point that our brand is resonating with consumers. 1.2 million active credit card holders continue to represent long-term opportunities for the business, and the launch of a One Ally experience will be completed in the coming months. Corporate finance continues to deliver accretive, disciplined growth as nearly 100% of the $10.6 billion portfolio is in a first lien position. On Slide Number 6, we wanted to directly address some of the critical items that we are navigating and what's top of mind for investors. From an interest rate perspective we've talked for multiple quarters about the near-term challenges of a rapidly rising rate environment. Operationally throughout the cycle, the businesses have been disciplined in managing pricing on both sides of the balance sheet. We've also leveraged our strong ALCO processes, including an active hedging program, to soften the financial impact from higher for longer rate scenarios. Beyond the near-term pressure, the momentum we have on the asset side of the balance sheet positions us well from margin expansion when rates stabilize. Actively managing credit risk remains a top priority. We've refined our buybacks to eliminate underperforming segments and added significant price, particularly in riskier segments, to compensate for potential volatility. Based on where we see things today, we'd expect retail auto net charge-offs of 1.8% for the full year, which is in line with the range we have provided in January. This is a unique environment where unemployment remains historically low, however, persistent inflation is a challenge for many consumers. Delinquencies remain a watch item, but we saw another quarter of shallowing in terms of year-over-year change and flow to loss rates remain strong. And consistent with prior guidance, we assume a meaningful step down in used vehicle values for the remainder of the year. The investments in data science and technology we've made within our collections and servicing teams will drive solid performance, even in a challenging environment. We have a much deeper understanding of consumer payment patterns and more options to get consumers current and stay in their cars. Given the near-term revenue pressure, we further heightened our focus on expenses. Looking to 2024 we will continue making prudent investments that see a path for less than 1% controllable expense growth and roughly 2% on a total expense basis. I'll share more details in a few pages. On the regulatory front, we continue to evaluate the proposals released in recent months and are preparing for increased capital and liquidity across the industry. However, we believe that regulators should fully study the implications of these proposals and we are working closely with BPI and other advocacy partners. We will continue to be disciplined in allocating capital across our various businesses to optimize risk adjusted returns. Slide Number 7 shows the success we've had creating scale across Ally Bank and deepening relationships with engaged customers. As mentioned, year-to-date customer growth of 307,000 is an Ally record, and we now have 3 million retail deposit customers who hold $140 billion in balances. The portfolio is granular, diversified, and 92% of balances are FDIC insured. Customer retention has helped study at 96%, reflecting our industry leading ability to maintain relationships once customers experience Ally. The bottom half of the page highlights how our offerings have led to an engaged customer base and the key benefits of that engagement. We've steadily grown our checking, or what we call our spending product, to more than 1 million customers. Across that population, 77% also have a liquid savings account. More than 1 million deposit customers either leverage our smart savings tools, utilize direct deposit, and/or have an Ally Invest relationship. We're approaching 300,000 multi-product customers across the consumer bank as we've seen consistent adoption from deposit customers across Invest, Home, and Card. The benefit of engagement is meaningful. As an example, deposit customers who also have an Invest relationship have a balance two times of those who don't. Our brand, digital offerings, and customer experience continues to hit the mark, and we remain optimistic about the growth potential within the consumer bank moving forward. Moving to Slide Number 8, we have provided a snapshot of our current funding stack and available liquidity. We're core funded with deposits as they account for 87% of our funding, but importantly, we have multiple sources of liquidity beyond deposits. On the right side, we show total available liquidity of $64.2 billion representing 5.6 times uninsured deposit balances. We meaningfully increased our capacity at the discount window within the quarter to further strengthen the quality of our contingent liquidity. We pledged auto finance key contracts at the discount window for the first time and are appreciative of the engagement with the Federal Reserve as we work together through that process. The events of March emphasized, again, the importance of contingency planning and ensuring multiple avenues of liquidity are available at all times. The foundation of our funding profile is a mature consumer deposits franchise, and we maintain access to multiple other sources of liquidity, including a solid and stable relationship with the home loan bank. Slide Number 9 provides a summary of how we're thinking about recently proposed changes to the regulatory environment. For Ally, the most meaningful impact of the Basel III end-game proposal is the phase-in of AOCI. As a reminder, we have not reinvested in the AFS portfolio in over a year and expect natural AOCI accretion of around $500 million after tax annually, assuming the forward curve plays out. In terms of the proposed changes to RWA, our net impact is not material as the addition of operational risk RWA is effectively offset by a lower risk rate on retail exposures, including our retail auto portfolio. I'm confident we can naturally build capital to meet increased requirements in advance of the proposed implementation periods. The proposed requirements for long-term debt would result in incremental issuance for Ally, given all our long-term debt sits at the parent company. The amount of issuance will depend on several factors as we optimize parent and bank-level liquidity positions. On all these issues, we are actively engaged in our industry response, including coordination with peer banks and the Bank Policy Institute. We will continue to evaluate the regulatory landscape and adapt as needed, but feel comfortable in our ability to navigate the changes given our strong liquidity and capital position. Let's turn to Slide Number 10 to talk about our expense outlook. As we previewed on the second quarter earnings call, we are committed to 1% growth for the expenses we can control. When factoring in things like FDIC fees, insurance commissions, and losses, we expect total operating expense growth of around 2%. We have taken specific actions over the past year to reduce expense growth, including a hiring freeze in mid-2022 and a reduction in workforce in recent weeks. It's also important to keep in mind that expense growth this year was impacted by the normalization of weather losses and consumer credit losses. In total, we still anticipate 2023 expenses to be a little over $4.9 billion, and given the actions we've taken to date, we expect 2024 to be right around $5 billion. So around $100 million of growth with 80% of that coming in the form of non-controllable items. We will continue to make the right investments to fuel the company for the long term, but the specific actions we've taken and continued focus on efficiency are driving us to very modest growth in total. With that, I'll turn it over to Russ to go through the detailed financial results.

Russell Hutchinson, CFO

Thank you, JB. Good morning, everyone. I'll begin on Slide 11. Net financing revenue of $1.5 billion was down year-over-year, driven by the continued pressure on funding cost, given increased short-term rates as the majority of our consumer deposit portfolio is comprised of liquid products. While the strong pricing momentum we've demonstrated on the asset side of the balance sheet partially mitigates the near-term compression and sets us up for strong NIM expansion. We'll come back to NIM expansion in a few slides. Adjusted other revenue of $491 million increased year-over-year and quarter-over-quarter, reflecting momentum within our insurance business as well as our smart auction and pass-through initiatives in auto finance, which we highlighted last quarter. Despite modest investment gains we are effectively at the $500 million quarterly run rate we've previously alluded to and continue to see opportunities for expansion ahead. Provision expense of $508 million was up quarter-over-quarter, reflecting seasonal trends and a modest reserve bill to support asset growth. Retail net charge-offs were in line with prior guidance. I'll provide a more granular update on retail auto credit shortly. Noninterest expense of $1.2 billion reflects higher cost within auto finance relating to application volume and higher repo costs seen across the industry. Record application volume drove higher variable costs within auto finance, but has enabled us to achieve a nearly 95% pricing beta throughout the tightening cycle. The incremental revenue driven by the strength of our pricing significantly exceeds the marginal expense of increased application flow. We've also seen higher pricing from third-party vendors when vehicles go to repossession. We remain focused on minimizing net credit losses and bottom line impacts to Ally. Despite these headwinds, the year-over-year growth in expenses slowed again this quarter as our efficiency initiatives begin to take hold. As JB covered, our recent actions to reduce costs positioned us for $80 million in annualized savings next year, and the anticipated year-over-year growth reflects our ability to navigate the near-term revenue headwinds brought on by the higher interest rate environment. We've called out the $30 million of restructuring costs which have been excluded from core pre-tax results. GAAP and adjusted EPS for the quarter were $0.88 and $0.83 respectively. We've excluded the benefit of certain tax planning strategies from adjusted EPS to better reflect underlying recurring results, but these tax benefits are a nice boost to capital generation. Moving to Slide 12, net interest margin of 3.26% was down 15 basis points quarter-over-quarter. Momentum within earning asset yields continued in the quarter, but was offset by deposit costs as the OSA rate moved up within the quarter. Total average loans and leases of $149 billion were up $8 billion year-over-year, driven by growth within commercial and retail auto balances. Quarter-over-quarter growth of $1.5 billion reflects our disciplined capital deployment as we focus on accretive risk-adjusted returns when originating. Earning asset yield of 7.14% increased 15 basis points quarter-over-quarter and more than 150 basis points year-over-year given the cumulative impact of trends we've discussed previously, including retail auto portfolio yield expansion, the increasing contribution from higher yielding assets, and over $50 billion of floating rate exposure across our commercial loan and hedging portfolios. Retail portfolio yield continued to expand this quarter as recent vintages comprise a larger portion of the portfolio. I'll talk more about retail auto portfolio yield dynamics later. Turning to liabilities, cost of funds continue to increase, but the rate of change on both a quarter-over-quarter and year-over-year basis slowed relative to Q2 as we approach the end of the tightening cycle. Competition for deposits remains intense and market pricing increased within the quarter, but we have remained disciplined on pricing. The themes of our NIM trajectory are largely unchanged. We expect NIM to trough a couple of quarters after rates stabilize, followed by gradual expansion each quarter, even without the benefit of rate cuts. Moving to Slide 13, our CET1 ratio increased quarter-over-quarter to 9.3% given our disciplined approach to capital allocation. Our TCE ratio of 4.9% includes unrealized losses within our AFS securities portfolio, which increased this quarter given the shift in long-term rates. Based on the current forward curve, we expect around $500 million per year of after-tax AOCI accretion as we allow the portfolio to roll off. We announced another quarterly common dividend of $0.30 for the fourth quarter, and as mentioned earlier, the outlook for loan growth is modest and will be primarily comprised of auto assets at attractive risk-adjusted levels. At current levels, we exceed our 7% regulatory minimum for CET1 by $3.7 billion. Let's turn to Slide 14 to review asset quality trends. Consolidated net charge-offs of 131 basis points increased quarter-over-quarter given typical seasonal trends. Retail Auto net charge-offs of 185 basis points were in line with prior guidance of 1.8% to 1.9%. We continue to see modestly offsetting impacts of slightly elevated delinquencies and favorable flow-to-loss trends. Severity levels were elevated early in the quarter, reflecting softer used values that strengthened in September. In the bottom right, 30-day delinquencies increased seasonally, but the year-over-year change continues to decline. Delinquencies will increase seasonally in the fourth quarter, and we continue to assess the impacts of inflation, but remain comfortable with our full year NCO guidance. I'll cover Retail Auto credit in more detail shortly. Slide 15 shows that consolidated coverage increased 1 basis point to 2.73%. The total reserve balance of $3.8 billion was relatively flat quarter-over-quarter and is $1.2 billion higher than CECL day one. Our macro assumptions predict worsening employment conditions with unemployment reaching 4.3% next year before increasing beyond 6% under our reversion to historical mean methodology. Retail Auto coverage was flat at 3.62% and remains well above the 3.34% on CECL day one. The remaining weighted average life of our Retail Auto portfolio remains under two years, reflecting the coverage we have for expected lifetime losses of this portfolio. Turning to Slide 16, we remain focused on leveraging our differentiated go-to-market approach, coupling high tech and high touch, which has generated significant scale and a competitive advantage. Record application flow enables us to be dynamic and selective in what we originate and continues to drive strong risk-adjusted returns. Ending assets in the top right were up slightly quarter-over-quarter as commercial balances gradually increased alongside modest growth in Retail Auto. Originations of $10.6 billion on the bottom of the page demonstrate the scale of our franchise and the compelling volume we're able to generate given application volume despite tighter underwriting criteria. Given year-to-date volumes slightly above $30 billion, we remain on track to originate around $40 billion this year in total consumer originations. Additionally, used comprised 66% of originations, which was up modestly quarter-over-quarter and highlights our ability to navigate industry disruptions in new vehicle production. Non-prime again represents less than 10% of retail originations in the quarter. Let's move to Slide 17 to talk about the scale of our auto franchise. Put simply, our goal is to help our dealers sell as many cars and trucks as possible. We encourage them to send us all of their application volume. Increased application volume means increased incremental work and cost on our side, but enables us to be selective on what we choose to originate in terms of credit criteria and pricing. This year, we will decision 13.5 million applications or $400 billion in potential loan volume. By optimizing within that application volume, we are on track to book around $40 billion in consumer volume, $37 billion in Retail Auto loans at an estimated 10.7% yield with approximately 37% of the volume in our highest credit tier. Accessing 13.5 million applications is a result of unique scale and strong and mutually beneficial relationships with our dealer customers. And that scale allows us to adapt quickly to changing market conditions, like we did when returns and super prime volume became more attractive earlier this year. Our ability to pivot up and down the credit mix should also give you more confidence in our ability to continue booking very strong yields. Going forward, we'll continue to leverage our platform to optimize our capital allocation within the auto business. Let's move to Slide 18, which highlights the tailwinds embedded in our Retail Auto portfolio. Throughout this tightening cycle, we've demonstrated strong pricing on both sides of our balance sheet, with Retail Auto beta around 95% and a deposits beta around 70%. While origination pricing has been strong, the majority of the portfolio is yielding 8% or less. Only 38% of the portfolio was originated this year. As we continue to originate loans at today's pricing, the runoff of lower-yielding vintages being replaced by current originations drives natural yield expansion on our largest asset class. Assuming stable originated yields, turnover is projected to drive the portfolio to 9.5% in 2024 and a 10% in 2025. On an $85 billion portfolio, that yield expansion drives meaningful revenue growth over the medium term. Obviously, the path of interest rates and the credit mix of our originations will impact the eventual yield migration but we remain confident retail portfolio yields will meaningfully increase over the next couple of years. On Slide 19, we provide context around Retail Auto credit trends to date as well as our outlook for the fourth quarter. As noted previously, we ended the quarter with net charge-offs of 1.85%, in line with expectations. Additionally, the full year outlook remains on track for losses of 1.8%. The drivers of performance are consistent with what we've shared on recent earnings calls. We continue to monitor delinquency levels which have been elevated this year, but importantly, flow-to-loss rates remain well below pre-pandemic levels and have been consistent throughout the year, and vintage performance trends have been encouraging. Loans originated last year show improving trends as they season and our strategic shift into higher credit quality loans will ultimately reduce portfolio loss content. On the bottom left, we've again provided quarterly loss expectations results and a full year loss of around 1.8%. We've lowered the bottom end of our fourth quarter loss rate expectation given the support in used values we expect from the UAW strike, which I'll cover on the next page. On the bottom right, we show the year-over-year change in 30-day delinquency rates, which has declined again for the third quarter in a row. Slide 20 provides our latest view of used vehicle values given performance year-to-date, which has resulted in values flat relative to year-end 2022 following a 4% decline in the third quarter. We continue to embed a conservative outlook for used values and maintain our longer-term outlook for further declines, but the UAW strike is expected to provide support near term. We are currently forecasting a 4% decline in the fourth quarter and, thereby, on a full year basis as well. An elongated strike could create a near-term support for used vehicle values, but would also pressure our client balances and our insurance business. So the net P&L impact is immaterial overall. Let's move to Slide 21 to cover auto segment results. Pretax income of $377 million reflected pricing momentum alongside higher provision and noninterest expense. Provision reflected typical seasonality while expenses were the result of elevated repo costs across the industry and requisite spend to support the strength and scale we just highlighted. On the bottom left, we've highlighted the consistent progression in portfolio yield, up more than 160 basis points year-over-year. Despite the progression to date, the portfolio was still well below recent originated yields, once again highlighting the prospective tailwinds to earning assets. The bottom right chart summarizes lease portfolio trends. Gains declined quarter-over-quarter, but were favorable year-over-year, given the decline in dealer and lessee buyouts. And we continue to assess the near-term net impact from the UAW strike as used values are supported, but tighter supply could lead to elevated dealer and lessee buyouts. Turning to Insurance on Slide 22. Core pretax income of $30 million was the result of the highest earned premium revenue since 2009, partially offset by elevated loss activity given the highest severe weather activity since 2014. The reinsurance we have in place capped our exposure, but weather was still a headwind given favorability seen in the prior year. Our proactive engagement with dealers to mitigate losses was on display again in the third quarter. Initial estimates for property losses from Hurricane Idalia exceed $2.5 billion. But given our actions, we didn't incur any losses from the storm. Named storms often give dealers the time to move inventory, but this still takes a lot of coordination. The challenges one faced are the violent hail and wind storms with little warning, and that was more what was encountered in the previous quarter. Written premiums of $335 million increased 15% year-over-year as we remained focused on increasing dealer relationships and benefit from normalizing inventory levels. Our focus remains on leveraging the scale we've established within Auto Finance and highlighting our full spectrum product suite to dealers, driving further integration of insurance across our auto dealer base. Turning to Slide 23, retail deposits of $140 billion increased $1.1 billion quarter-over-quarter and $6.2 billion year-over-year, demonstrating the strength and resilience of our leading franchise. Total deposits of $153 billion were up $7 billion year-over-year. 95,000 net new customers was our 58th consecutive quarter of growth and year-to-date customer growth of 307,000 is the highest in Ally Bank's history. 2023 is on track with the highest annual customer growth in Ally Bank's history as customers become increasingly aware of the opportunity to earn more on their savings and the value Ally provides beyond rates. And we continue to see strong growth in multiproduct customers, which has grown by 30% annually over the past several years. The continued evolution in consumer preferences driving the migration towards digital offerings provides a tailwind for continued growth across the entirety of our customer base and product suite. Moving to Slide 24, our digital bank platforms provide diversification and deepened customer relationships. Ally Invest complements the deposit franchise well as we once again saw 85% of new account openings from existing customers as they leverage the ease of money movement between accounts within Ally. Ally Credit Card added 53,000 new cardholders in the quarter, now 1.2 million strong as we prudently grow the portfolio. The continued integration and launch of One Ally in the fourth quarter will accelerate our ability to deepen relationships across Ally's product suite. Corporate Finance results are on Slide 25. Core pretax income of $84 million was up $13 million quarter-over-quarter, benefiting from higher interest rates given the entire portfolio is floating rate. The year-over-year comparison was down slightly as an investment gain in the prior year period did not repeat, but was largely offset by accretive disciplined asset growth. The portfolio remains high quality with 61% asset-based and 100% of loans are in a first lien position. Our HFI portfolio balance of $10.6 billion shows modest growth reflecting the team's discipline and focus on maximizing risk-adjusted returns. Slide 26 includes details for Mortgage Finance. Mortgage generated pretax income of $26 million and $267 million of direct-to-consumer origination. Expenses were down $10 million year-over-year, highlighting the benefits of a variable cost partner model. More than half of our origination volume came from existing deposit customers, highlighting the benefits of our One Ally experience and deepened customer relationships. We remain focused on a great experience for customers rather than a specific origination target. Slide 27 contains our current financial outlook for 2023. The operating environment remains dynamic and interest rate volatility persists, increasing the difficulty in providing granular guidance. But we're committed to maintaining a transparent approach to guidance based on what we know currently. You'll notice the page is largely unchanged versus the outlook we provided in July. Assuming a forward curve from quarter end, peak Fed funds is unchanged versus Q2 guidance at 5.5%, but costs have been pushed out considerably. Continued competition for deposits has put incremental pressure on portfolio yield, which could pick up to 4.2% in the fourth quarter. And we see full-year NIM above 3.3%, likely in the 3.35% area. Our expectation for full-year 2023 other revenue remains $1.9 billion, and importantly, we're achieving the $500 million quarterly run rate we guided to in January. And as we covered previously, Retail Auto portfolio yield is still projected around 9% in the fourth quarter, with continued expansion thereafter. Retail net charge-offs are expected to be at 1.8% for the full year, unchanged from prior guidance. And no change to operating expense guidance as we limit spend to nondiscretionary costs and essential investments. We see the tax rate closer to 9% for the year given some of the tax planning items that hit in Q3. We expect our near-term effective tax rate to return to approximately 18% absent tax planning items as we've had solid momentum in generating EV tax credits and expect that trend to continue. While elevated and increasing interest rates are a headwind, we expect most of the tightening cycle is behind us and have positioned the balance sheet for margin and earnings growth over the medium term and remain confident in our ability to continue to execute and drive long-term profitability. From my perspective, JB’s news last week was a bit of a surprise, but when you consider his passion for cars and the Hendrick Group, it was simply the right next step for him. We will miss JB dearly, but we are also excited for him. JB's announcement does not change how I feel about the opportunities at Ally. I am looking forward to everything we can accomplish together, my fantastic teammates, and Ally's promising financial outlook. The scale businesses are in a strong position. I recall discussing the moat positions with JB and the team, and it is evident that those have been firmly established today.

Jeffrey J. Brown, CEO

Thank you, Russ. I will certainly miss you and this entire team as well. The strategic priorities, which guide everything we do are unwavering and essential for our long-term success. First and foremost is ensuring we maintain strong alignment between our culture and our stakeholders. We're focused on highlighting the differentiated offerings across our businesses for both consumer and commercial customers. We'll continue finding ways to disrupt the industry and remove friction for customers by delivering leading digital experiences. And even more important in this dynamic environment is our disciplined approach to risk management and capital allocation. I'm confident these priorities and this management team will help us deliver value for all stakeholders. And with that, Sean, back to you, we can head into Q&A.

Sean Leary, Head of Investor Relations

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

Operator, Operator

Thanks, Sean. One moment for our first question. It comes from the line of Ryan Nash with Goldman Sachs. Please proceed.

Ryan Nash, Analyst

Hey, good morning guys. JB, obviously, you gave a lot of color on the decision to exit the company. Maybe just to dig a tiny bit deeper, did your view of the returns that the company is capable of generating over an intermediate time frame impact the decision at all and if not, do you still believe mid-teens and $6 of EPS over time are still the right levels for this company over time?

Jeffrey J. Brown, CEO

Yes, Ryan, thanks for the question. No, my financial outlook did not change or influence my decision in any way. I'm actually more confident in the company's financial profile moving forward. As Russ and I mentioned, interest rates have been a significant factor affecting our margin base. However, as we project the balance sheet forward, we expect to exceed 4% and easily reach the mid-teens. This decision was not influenced by any shift in confidence regarding the company's strategic or financial outlook. As I've said, it has been an honor to lead Ally for nine years. I had no plans to leave, but I discussed with my Board over the past two years that if this opportunity came up, I would consider it. Life sometimes presents unexpected opportunities, and that was the case here. Mr. Hendrick and the Hendrick Automotive Group are exceptional partners. We engage with thousands of dealers daily, and this represents a fantastic opportunity for me to work with a family and company I greatly admire. They have a substantial business with over $12 billion in annual revenue and sell 200,000 cars. They are also significant players in the parts and defense industries. Many factors contributed to my personal decision to make this move. Leaving Ally is difficult because I have great teammates, and that weighed on me, but my decision was not based on changes in financial or strategic outlook. I believe the next CEO will inherit a very attractive financial profile. Apologies for the lengthy answer, Ryan, but that explains my decision. My confidence in the company's future remains strong, and I'm looking forward to being a major Ally customer.

Ryan Nash, Analyst

Got it. I appreciate all the insights on that, JB. Russ, your input is helpful as well. Could you provide more details on the net interest margin? I understand you mentioned that NIM will reach its lowest point a few quarters after rates stabilize, and you suggested it would be around 3.35 for the full year, indicating a slight decline in the fourth quarter. Could you elaborate on the near-term margin dynamics? Do you believe the fourth quarter will be the lowest point? Additionally, could you explain the numbers concerning the NIM trajectory under either a higher for longer scenario or the forward curve, which seems to suggest two to three rate cuts for next year?

Russell Hutchinson, CFO

Sure. Thanks, Ryan. Look, I think you're spot on in terms of thinking about 2023. And I think you're spot on with the commentary in terms of rates troughing within a couple of quarters. I think the key question there is where do rates go from here and I think we are under the view that we are towards the end of the tightening cycle. And so to the extent that we're already there, I think we could see rates start to expand through the first half of next year. So you could see NIM start to expand in the first half of next year. To the extent that we're not quite there, but close that expansion could be delayed. All that being said, I think, as JB pointed out, as I pointed out earlier, the dynamics of our portfolio and that replacement effect that we pointed out in some of the pages earlier, is strong and it's real. And in our view, it is a question of timing in terms of rate expansion as opposed to a question of if. And I would say, and we like to think about things here in terms of a stable rate environment, so a higher for longer scenario. And in that context, we'd expect 5 to 10 basis points per quarter of NIM expansion, and obviously, as you said, to the extent that we see cuts on the short end, we could see that expansion expedited.

Ryan Nash, Analyst

Got it, appreciate all the color.

Jeffrey J. Brown, CEO

Thanks Ryan.

Operator, Operator

Thank you. One moment for our next question, please. And it comes from the line of Sanjay Sakhrani with KBW. Please proceed.

Sanjay Sakhrani, Analyst

Thanks, good morning. JB, congrats on your new role.

Jeffrey J. Brown, CEO

Thank you.

Sanjay Sakhrani, Analyst

Yes. It's been quite a ride. Maybe you guys can talk about where we are with the CEO search and what the criteria might be. Is it internal, external, any leaning in terms of that?

Jeffrey J. Brown, CEO

Thank you, Sanjay. I would say we are still in the early stages of the search. I've spoken with the Chair of the Board about my considerations, so the Board and our search committee have had some time to start defining what the ideal candidate profile might look like. This process is already in motion. The timing aligns with our recent Board meeting, where I officially gave my notice to leave the firm. We announced this publicly last Wednesday. The Board is doing an excellent job, and I am pleased to be involved in this process, which is very important to me. We aim to find the right leader to guide Ally over the next 5, 10, or even 15 years. It's beneficial that this information is public, allowing for an external search. We are collaborating with a prominent global search firm, and the Board is keen on finding someone who will advance the company culture and further transform our businesses. I take great pride in what we've achieved over the past nine years, but as I've noted to my leaders, employees, and the Board, this transformation has never depended on just one person. It has been driven by an exceptional team, and I am confident they will continue to execute effectively in the next chapter. The new leader will inherit a strong management team and a motivated workforce, and we all believe Ally has not received the recognition it deserves for the transformation we've accomplished. This presents a unique opportunity for our next leader. I have indicated that I will remain until the end of January if needed, and I expect that to be around the time we will have a new leader in place. I will stay closely connected to Ally and am committed to ensuring we find a strong transformational leader who embodies our culture and values. My goal is to help find someone who can elevate our success even further. The process is moving forward, and I anticipate that by the end of January, you will be speaking with our next CEO.

Sanjay Sakhrani, Analyst

Okay. Perfect. And then my follow-up question, appreciate Slide 9 that sort of goes through all the implications of the proposed regulation. But maybe if we take a step back, Russ, could you just maybe over the next two years, how should we practically think it flows through the P&L and the balance sheet, like what specific lines does it impact, I mean maybe there's debt issuance, obviously, capital return, maybe you could just talk about how we should think about that over the next couple of years? Thanks.

Russell Hutchinson, CFO

Yes, thank you, Sanjay. That's a great question. It's complicated since these are proposals. As JB mentioned earlier, we're collaborating with BPI and other industry participants to ensure our feedback is considered. The industry has reacted to the proposals as they currently stand. Regarding Basel III endgame, the most significant impact for us is in terms of AOCI. I want to clarify that we can operate within the proposed transition period without any drastic measures; we can manage it organically. As you might expect, this has limited our share repurchases. Looking at our Auto business, the attractiveness of assets from our dealer partners has compelled us to be cautious with our origination volume. Additionally, it's made us reevaluate the growth potential of some of our growth businesses. However, we can operate within the given timeframe, and the only notable impact on the capital side for us relates to AOCI inclusion. Concerning long-term debt, it's still early, but as JB noted in his slide, our key requirement is 6% of IDI at the bank level. Since our unsecured debt is issued at the holding company level, we currently have no unsecured debt at the bank level. Therefore, as the proposal stands, we will need to assess our liquidity at both the holding company and bank level for our issuance, which may lead to increased issuance from our current position, resulting in additional interest expenses.

Sanjay Sakhrani, Analyst

Okay. And then, I mean, just in terms of like you could take that liquidity and invest it too, so it wouldn't be the full impact, right?

Russell Hutchinson, CFO

Yes. Absolutely correct. And just to be clear, when you think about Basel III endgame from an RWA perspective, there are puts and takes, but we don't see any significant change to our RWA. That is the increase in operational RWAs completely offset by some of the benefits we see in our retail loan portfolio.

Sanjay Sakhrani, Analyst

Okay, great. Thank you very much.

Operator, Operator

Thank you. One moment for our next question, please. It's coming from the line of Jon Arfstrom with RBC Capital Markets. Please proceed. Jon, please verify your mute button.

Jon Arfstrom, Analyst

Can you hear me alright?

Operator, Operator

Yes, sir. Go ahead.

Jeffrey J. Brown, CEO

Got you now, Jon.

Jon Arfstrom, Analyst

Thank you. I appreciate that. I have a question regarding Slide 19. I'm interested in the overall message about auto credit performance. It seems straightforward, but on one side, charge-offs are increasing, while on the other side, delinquencies are decreasing. What message are you conveying? Looking ahead to 2024, it seems like credit should actually be improving based on the delinquency numbers; is that too simplistic?

Russell Hutchinson, CFO

Yes, I'll begin by clarifying our position. We remain on track for the 1.8% NCO rate we mentioned last quarter. However, it's important to note the seasonal patterns in our delinquency trends. As illustrated on Page 19, you'll see how this seasonality affects the NCO trajectory from the second to the third and then the fourth quarter. Typically, the fourth quarter experiences the highest NCO activity, and our projections for that period range from 2.2% to 2.4%. This range aligns with our overall annual target of 1.8% NCO, reflecting the seasonal dynamics of our portfolio. On the right side of the page, we present year-over-year changes to address the seasonality issue. The comparisons here show 3Q 2023 against 3Q 2022 and 2Q 2023 against 2Q 2022. When evaluating these on an annual basis, it's evident that while we are experiencing elevated delinquency levels, they are actually decreasing, with the year-over-year changes improving each quarter for the past three quarters. We attribute this trend to several factors. Firstly, we've made numerous adjustments to our portfolio through curtailments and pricing, which are starting to show positive results in the performance of our newer vintages. Although it's still early to draw definitive conclusions, we are observing tangible benefits from these changes. Furthermore, our 2022 vintages are also performing better than initially expected. While we are still in the early stages, the signs are encouraging and keep us aligned with our goal of achieving a 1.8% NCO rate.

Jon Arfstrom, Analyst

Okay. That's helpful, Russ. I appreciate that. And then just one follow-up on Slide 12. The 4.04 deposit rate that you had for the quarterly average you talked about intense pricing competition on deposits. But if the Fed is done, is it as simple as that 4.04 just marches to your 4.25 savings rate or is there something else happening on deposit costs? Thanks.

Russell Hutchinson, CFO

No, it's also a great question. We raised rates early in the quarter, and you'll see the full impact of our latest OSA raise throughout the fourth quarter. Given the competitive landscape, we have always anticipated this, and we continue to see deposit competition even after the last raise. As you may have noticed in the presentation, we discussed our outlook and revised our guidance. We initially projected an overall deposit yield of 4.1% for the fourth quarter, but we've now adjusted that to a range of 4.1% to 4.2%. We are not dismissing the possibility of ongoing pressure on deposits and the potential for increased pricing in the future.

Jon Arfstrom, Analyst

Okay, alright. Thank you.

Operator, Operator

Thank you. One moment please for our next question. Our last question comes from the line of Kevin Barker with Piper Sandler. Please proceed.

Kevin Barker, Analyst

Great, thanks for taking my questions. JB, best of luck at Hendricks. It's a pleasure working with you.

Jeffrey J. Brown, CEO

Likewise, thank you.

Kevin Barker, Analyst

Yes, I just wanted to follow up on the NIM conversation. In particular, the projection for over a 4% NIM at some point, it seems like in 2025. Now in your view, given the current rate environment and the additional rules around debt issuance or potentially different Basel III changes, do you expect to achieve that 4% sometime in a run rate with late 2024 or do you feel like you could achieve it sometime in early or late 2025 just given the current rate environment as you see it today?

Russell Hutchinson, CFO

In a stable rate environment, our expectation remains clear to reach a 4% NIM. We are considering the impact of the portfolio replacement and anticipate being there by 2025. And caveat that with the view that I don't want to be in the business speculating where short-term rates go.

Kevin Barker, Analyst

Got it. Makes sense. And then does that...

Russell Hutchinson, CFO

Caveat that with the view that I don't want to be in the business and speculating in terms of where short-term rates go.

Kevin Barker, Analyst

Thank you Russ.

Sean Leary, Head of Investor Relations

Thank you all. That's all the time we have for today. As always, if you have additional questions, please feel free to reach out to Investor Relations. Thank you for joining us this morning. That concludes today's call.