Ally Financial Inc (ALLY) 2013 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the third-quarter 2013 Ally Financial Inc. earnings conference call. (Operator Instructions) As a reminder, this conference is being recorded for replay purposes.

I would now like to turn the conference over to your host for today, Mr. Michael Brown, Executive Director of Investor Relations. Please proceed, sir.

Thank you and thanks, everyone, for joining us as we review Ally Financial's third-quarter 2013 results. You can find the presentation we will reference during the call on the Investor Relations section of our website, ally.com.

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

This morning our CEO, Michael Carpenter; Senior Executive Vice President of Finance and Corporate Planning, Jeff Brown; and our incoming CFO, Chris Halmy, will cover the third-quarter results. We will also have some time set aside at the end for Q&A and to help in answering your questions we also have with us Bill Muir, who runs our auto business.

Now I would like to turn the call over to Michael Carpenter.

Thank you, Michael. Good morning, everybody. Thanks for joining us.

First of all, I am pleased to report a positive quarter characterized by improved pretax core income of $271 million, up 30% from the second quarter; strong performance in our core franchises; strategic moves that clear away the underbrush and set the stage for the future.

In a very competitive environment our consumer auto originations were flat at $9.6 billion, but overall our auto earning assets were up 8% year over year. Ally Bank goes from strength to strength. Our deposits are up 30% year over year to $41.7 billion. And we were voted for the third year in a row Best Online Bank by MONEY Magazine, which I think is very indicative of the strength of this tremendous franchise.

Our financial profile continues to strengthen. Our cost of funds is down 57 basis points year over year. Our NIM is up 74 basis points as a result of liability management, deposit growth, and other factors.

We have strong capital ratios with pro forma Tier 1 common at 9.3%. And on a strategic basis, we continue to put mortgage in the rearview mirror with settlements with the FHFA and FDIC in the last few weeks.

The ResCap bankruptcy is proceeding well except for a skirmish between the third liens and the estate. Confirmation hearing is scheduled for November 19 and we believe that will occur. In addition, the $1 billion private placement of common equity with a group of investors will accelerate our ability to repay the American taxpayer and position the Company for the future.

I would like to touch on the common equity raise briefly. I am sure you are all familiar with it.

During a few weeks of August we signed definitive agreements with a dozen institutional investors to raise $1 billion of common equity at $6,000 a share. Half of those investors were new; half of them were pre-existing investors to the Company.

The transaction is contingent on three elements. One is the non-objection by the Federal Reserve to our CCAR plan; and, secondly, is the repurchase of the Series F-2 MCP from U.S. Treasury; and, thirdly, the elimination of the share adjustment provision. The latter two have been negotiated with U.S. Treasury for a price of $6.025 billion together and we are awaiting CCAR results which should happen in the next couple of weeks.

The transaction is scheduled to settle on or before November 30, and if successfully completed, will bring our payment back to the American taxpayer to in excess of $12 billion.

On the next page this is a little bit of history. And why are we talking about history? For a very simple reason, we are approaching a moment in time when the focus of the Company will shift dramatically from -- back in 2009, in all honesty, it was initially survival. Preservation of liquidity became an issue; massive restructuring of the Company, cultural transformation, and dealing with numerous amounts of historical baggage were our priorities in the early days.

We are now in a position where, as we look to the future, all of those issues are behind us and the focus shifts to repaying the American taxpayer in full and a single-minded focus on shareholder value creation. But just to pause for a moment, what has been going on here since 2009 a couple of things worth talking about.

Sorry, JB just passed me a note. I did my math wrong. I meant to say $5.925 billion not $6.025 billion. That must have been an earlier negotiation.

In any case, as we look back over time the strategy of the Company has been very consistent during this period. Importantly, our auto finance business has transitioned from being a captive to being very much a market driven company, fully competitive in the marketplace with all the cultural and operational implications of that. It has massively diversified its business so that its dependency on OEMs is such that subvented business is now only 16% of what we do and we have originated $158 billion of consumer origination since 2009.

We have also built, as I said a moment ago, the leading direct bank brand; $25 million in retail deposit growth since that period of time. And these were two very, very high priorities for us.

We resolved the wall of debt maturities that we saw in 2010 and 2011 that were pretty overwhelming at the time and today have a very strong liquidity profile. Our cost of funds has declined over 180 basis points since 2009. We have exited or sold 37 businesses with over $50 billion in assets over that period of time, mostly in mortgage, but also our international auto business and some other impermissible insurance and other activities.

We have resolved our legacy mortgage risk. Mortgage assets have declined from $135 billion at the peak in 2006 to less than $9 billion. We have a comprehensive ResCap bankruptcy settlement, which is subject to final plan confirmation that seems to be very well on track, and the recent settlements with FHFA and FDIC really put the major issues behind us.

We have worked very hard to improve our standing with bank regulators. That was a weak spot back in 2009. I think today we are a credible factor. We always have issues in the regulatory world. Today, obviously, we are waiting to hear on CCAR.

The other development is the new CFPB agency, which is looking in-depth across the auto finance industry, not just at Ally, and has taken the new position that the finance providers have responsibility for the actions of dealers, even though we are a purchaser of installment contracts. I have always vehemently disagreed with that, but those of us have to deal on a day-to-day basis are very sensitive to these issues and want to make sure that we are absolutely on the right track.

I don't know where this will lead. I would encourage you to read the Q where we have some additional disclosure, and that will be coming out later today.

Moving on to the next page. As I said a moment ago, we are approaching a pivotal point for Ally. We are on very solid ground with two great franchises and the baggage of the past has really left behind with the ability to repay the American taxpayer in full very clearly possible.

Our intention then is going to shift to a singular focus on creating shareholder value. We know that our return on equity is unacceptable, given the strength of our franchise, and we have a three-point plan to address it.

The first one is under the heading of margin expansion. We have begun this year an aggressive program of liability management to retire high-cost unsecured debt, and we will continue to do that. We have continued to grow our deposit base, and as we look to the future, those two things together will significantly improve our NIM and reduce our cost of funds.

Secondly, we have a cost structure today which is really more reflective of a multinational, multi-business company. Today we are much more domestic and we are only really in two business lines. We need to simplify our company and the expense reduction that will result from that is also substantial.

Then, thirdly, on the regulatory front we would look to use Ally Bank increasingly to fund our businesses, which is more cost efficient. And longer term we would hope to be on a regulatory level playing field and be able to rationalize our capital base over time.

So these are the three legs of the stool to a double-digit return on equity that we are very focused on at this stage of the game. So with those introductory remarks let me hand over to JB to get you into the next level of detail.

Great. Thanks, Mike, and good morning, everyone. On slide seven let's take a closer look at the financial results for the quarter. Let's start at the top with net financing revenue for the quarter of $801 million, which was up $112 million quarter over quarter and $253 million year over year, primarily driven by lower cost of funds as well as growth in our lease portfolio.

This top line is a major focus of ours and you can expect to see additional improvement in net financing revenue over the next several quarters as we expand our NIM and take out additional callable high-cost legacy debt.

Now if you look at total other revenue of $367 million this quarter, you will note the significant decline from a year ago of over $400 million, which is a result of exiting the mortgage business. And I would just say you have to keep that in context of what third-quarter 2012 meant in the mortgage market. It was historically probably the best time to be in mortgages with HARP 2.0 and other initiatives, so it makes the comp a tough one on a year-over-year basis.

Provision expense was up from the quarter as we had seasonally higher charge-offs in our retail auto portfolio and as our portfolio mix continues to normalize. Chris will cover more on the asset quality trends in a minute, but I just want to mention that our loan performance and charge-offs are well within expectations. As I mentioned on our last earnings call, we fully expected provision to be up from 2Q.

You can see both controllable and other noninterest expenses decrease quarter over quarter and year over year. With our strategic transformation nearing completion, we are better able to fully focus on efficiencies within our auto and deposit businesses. This is an area where we have additional opportunity to take expenses out longer term, and you can expect steady and gradual improvement over the next couple of years.

So all this results in core pretax income, excluding repositioning items, of $271 million, which is up about $60 million from 2Q.

If you look at the discontinued operations line item, you will see this quarter we had a net loss of $86 million, which was driven by an after-tax charge of $107 million related to the FHFA and FDIC mortgage settlements. I should note that cash payments to both these counterparties have already been delivered and the dismissals of all the pending lawsuits against Ally are in the process of being filed. And both FHFA and FDIC will file their support for the ResCap claim confirmation.

This resulted in net income of $91 million for the quarter, which was up significantly quarter over quarter due to the ResCap settlement charge that we took last quarter in the disc ops line. So while we had some noise this quarter and last quarter from what we believe to be the last material legacy mortgage charges, you can finally start seeing some of the core underlying trends driving both earnings and ROE expansion.

Net financing revenue is increasing as cost of funds declined and we expect noninterest expense to decline as we rationalize our expense base. Those will be critical themes for us going forward as we drive our shareholder returns to more acceptable levels as Mike discussed.

Now turning to slide number eight, where we breakout results by segment, I will just highlight briefly the year-over-year variances. Here you see a significant decline in mortgage due to the exit from the origination and servicing business. That decline is largely being offset by steady performance in our auto business and progress made in our corporate and other segment where you see a meaningful improvement due to our cost of funds reduction. And I'm going to touch on those more in a minute.

So while core income was down somewhat year over year, we are improving on a quarterly basis and we view these earnings as much higher quality, more predictable, and more stable in nature.

Now let's take a look at NIM, which is broken out in more detail on slide nine. We reported net interest margin of 2.34% this quarter, which translates into 30 basis points of NIM expansion quarter over quarter and 74 basis points year over year. We have been able to hold our earning asset yields pretty steady, so our NIM expansion is simply driven by our cost of funds, which is down 34 basis points quarter over quarter and 57 basis points year over year due to the redemption of some of our callable, high-cost legacy debt.

We expect to see NIM further expand driven by this liability management process, which you can see better on the next slide so I will turn there.

We highlight here on slide 10 the progress made quarter over quarter in reducing our cost of funds. Similar to last quarter, we thought it would be helpful to show a breakdown of the components of our funding profile so you can see the true drivers. If you take a look at the table, you can see that our long-term unsecured debt continues to carry a pretty heavy interest expense load of over $500 million a quarter, with an average cost of funds around 6%. This continues to represent the most significant and highly visible opportunity to drive profitability improvement.

Near term we have been addressing cost of funds through callable debt. During the third quarter we called $5.8 billion of the $10 billion of par, but since this happened in increasing increments throughout the quarter you can see on average we still had about $7 billion of callable debt outstanding throughout the quarter. But in the fourth quarter you can expect to see this amount come down dramatically.

In addition to the $10 billion of total callable debt, we also have over $11 billion of non-callable debt that matures over the next two years. So you're looking at over $21 billion, or about two-thirds, of our unsecured debt that will turn over in the near future.

Some of that will be refinanced with lower costs of unsecured debt, but some of it we will just use existing liquidity or alternative sources of funding in the future. So you can expect to see our overall unsecured footprint come down over time.

You can also see that this quarter we had a benefit from unwinding derivatives on the callable debt which helped accelerate our cost of funds decline, but you can expect to see a continued drop in the fourth quarter from the 2.38% we show here.

And with that I will turn it over to Chris.

Thanks, JB. So let's look at funding and liquidity on slide 11. If you look at the top right you can see here that with $22 billion of parent company liquidity we continue to maintain a very strong level of cushion relative to our unsecured debt maturities.

It is important to note, however, that we have been building up excess liquidity throughout the year and we are now putting that to work by calling legacy debt. We also plan to use some of the excess liquidity to repurchase the MCP in the fourth quarter. So you can expect that our absolute levels of liquidity will come down to a more normal level over the next few quarters, but we will continue to maintain very robust liquidity levels to cover over two years of unsecured bond maturities.

We continue to balance and optimize both the cost and liquidity throughout our diversified funding strategy. Our stable deposit base provides us with a lot of flexibility and now presents us with over 40% of our total funding mix. We remain active in the securitization markets across various asset classes with $1.4 billion of ABS issued in the third quarter.

We also tapped the unsecured debt markets twice in 3Q, raising $2.1 billion at much lower rates relative to the debt we are calling.

Turning to capital on slide 12. You can see our ratios were largely flat quarter on quarter, but increased year over year as a result of the gains and risk-weighted asset reductions associated with our international entities' sales. We show in the chart a pro forma Tier 1 common number of 9.3%, which is really the number we focus on. That is pro forma for the impact of the $1 billion capital raise, as well as the closing of Brazil and China.

I should mention that Brazil closed earlier in the fourth quarter and China continues to move forward, but timing for closing is still yet to be determined. So despite absorbing the meaningful ResCap bankruptcy charge this year, we will have improved our Tier 1 common ratio from 7% to 9.3% and largely normalized our capital base during 2013, which we obviously feel very good about.

Going forward we will be able to generate more capital organically as we repurchase the MCP and eliminate its significant dividend burden.

Let's turn to asset quality on slide 13. What you see here is a continuation of the themes we have been discussing for several quarters now, where quarter-over-quarter results are driven generally by seasonality and year-over-year results are driven by the mix shift in our book. Let's look at these charts in a bit more detail starting on the top left.

The movement you see in aggregate charge-offs is really driven by the retail auto loan book. Our commercial auto charge-offs are low and steady and our mortgage book is improving and relatively small at this point. So let's look at the retail auto portfolio performance on the bottom of the page.

You can see here that losses and delinquencies were up both quarter on quarter and year on year. The point I want to emphasize is that performance is right in line with our expectations. The general trend is driven by a number of factors.

First, as you know, we have been shifting to a more balanced and profitable credit mix, particularly compared to 2009 to 2011 vintages. Second, we have vintages now entering their peak loss period that are larger and have a more balanced credit mix versus the vintages that were entering their peak loss period a year ago.

Third, we have a bit of a denominator effect as the portfolio growth rate has moderated relative to the growth rate a year ago. You should expect to see losses increase modestly on a year-over-year basis from here, in line with these same dynamics. And then you layer on to that from a quarter-over-quarter perspective we had the typical seasonal impact where losses come off their lows in the second quarter and increase throughout the second half of the year.

But, again, this is completely as expected and performance is right in line or better than the assumptions we used to price the lines.

Let's look at the auto finance segment on slide 14. Auto finance pretax income was $339 million, down $43 million quarter on quarter and up $2 million year over year. The general trend here is higher net financing revenue being partially offset with higher provision.

Net financing revenue is up year over year due to a growing portfolio, particularly the lease book, where we have also seen the benefit of termination gains. Provision expense is up quarter over quarter and year over year simply due to the dynamics with our net charge-off rate that we just discussed.

We provided you with some extra information this quarter on the bottom right of the slide. What we are showing you here are some of the dynamics within our consumer auto originations that follows the commentary that we have been describing for a couple of years now.

You will see that in 2009 to 2011 we swung the pendulum a bit too far towards the super prime end of the spectrum. We have been maintaining a much more balanced, profitable, and diverse origination mix since the beginning of 2012.

The current FICO mix is more in line with our pre-crisis levels; however, the very important point is that post 2008 our underwriting policies are dramatically different as a more independent regulated institution. For example, we place a much greater emphasis today on avoiding layered risk such as lower FICO coupled with higher LTVs. We are also focused on getting a first look at application flow and have discontinued programs like the legacy Nuvell subprime platform.

Another dynamic that we will call out in the table is that in the super prime segment we have scaled back somewhat, given the intense competition with respect to the loan product. To be candid, we think some of the super prime loan market is irrationally priced and some of that product could be underwater, particularly if rates rise.

However, with the reemergence of leasing demand we have been able to shift some of our super prime originations into lease, which we like. Lease is less commoditized and we can use our competitive advantage and expertise here to earn a better return.

Let's turn to slide 15 where I will cover consumer originations in the commercial book. You can see in the top left our consumer originations were pretty consistent year over year and quarter over quarter. We feel very good about this level of originations, particularly given the competitive environment and the loss of the Chrysler subvented business. You can see in the top right that our subvented loan business is down to 11% and we have generally replaced that business with growth in used, lease, and diversified, which is a good risk/return trade-off for us.

In the bottom right we show our commercial balances, which you can see are down both year over year and quarter over quarter. Some of that decline is driven by lower inventories which we expect to see reverse in the fourth quarter, but some of it is just due to the hypercompetitive market right now. As we continue to focus on profitability we have seen our market shares decline somewhat from very high levels and we can see some continued moderation from here.

But we continue to be very well positioned within our core dealer relationships where we maintain what we call our all-in partnership. These relationships remain very strong and that is what is driving the continued high level of consumer originations we have been posting quarter after quarter.

Let's turn to slide 16 and I will talk a little about the insurance business. Our insurance segment recorded pretax income of $83 million this quarter, which is up $45 million last quarter and $13 million a year ago. The quarter-over-quarter increase is driven by seasonally lower weather-related losses offsetting $22 million of lower investment income. The year-over-year increase is driven by a $76 million increase in investment income due primarily to a significant other-than-temporary impairment we booked last year.

We continue to see strong written premiums with $267 million this quarter, and this is down $9 million from last quarter, which was the highest level of written premiums achieved since 2008 and flat to a year ago. The quarter-over-quarter decline is primarily due to seasonally lower wholesale inventory levels.

Now turning to slide 17, let me make a few brief comments on mortgage. We reported a pretax loss of $5 million this quarter, which is $21 million favorable versus the second quarter. Net revenue was higher, driven by a positive mark on our very small remaining HFS portfolio.

With respect to our provisioning, we had an offsetting dynamic this quarter where we released some credit reserves on the loan side and increased our reserves on the repurchase side. If you look at year-over-year results, obviously the driver there is exiting the origination and servicing business earlier this year that JB spoke about.

As we mentioned, originations have seized and we sold our MSR last quarter, so the only material asset left are the held-for-investment loans of just over $8 billion held at our bank. The credit characteristics of the HFI portfolio remain fairly consistent as the balance is steadily declining due to prepayments and amortization. You will see that we experienced lower net charge-offs this quarter due to continued macroeconomic improvements and an improved mix of the remaining loans as lower quality legacy loans continue to run off.

Going forward, we will continue to earn interest income on the HFI portfolio. We expect this to be offset by provision expense and a modest amount of direct and indirect expenses, resulting in a largely breakeven to moderate loss segment.

Let's turn to slide 18 and I will talk a moment about corporate and other. As we mentioned, this is the segment where a lot of the bottom line improvement in cost of funds shows up. You can see we have already made significant progress with our net financing loss declining 88% year on year to $28 million, driven by lower cost of funds. Going forward, we will continue to improve our net financing revenue and chip away at the noninterest expense line item here.

Now turning to deposits on slide 19, our retail deposits grew 5% this quarter to nearly $42 billion with total deposits, including brokered CDs, now over $51 billion. The bottom right chart shows our retail deposit growth of $1.8 billion this quarter, which is essentially flat to third-quarter performance for the past two years.

Third-quarter growth seasonally rebounds from the second-quarter lows attributed to tax payment outflows. And if you look at the average rates we pay, you can see it is actually down 14 basis points year over year, driven primarily by the mix shift from CDs to more liquid products.

We are very focused on providing consistent, attractive rates for our customers, but we are not the top ratepayer and we will look for ways to optimize our deposit rates as we move forward. Our existing customers continue to exhibit strong loyalty evidenced by our CD balance retention that has been over 90% from nine consecutive quarters. And customer satisfaction has been over 90% for the last five consecutive quarters.

We continue to receive great feedback on the brand's value proposition. In this quarter we received a couple of third-party awards, including the Best Online Bank for the third year in a row by MONEY Magazine that Mike mentioned earlier.

Turning to slide 20, we provided some additional color here on the direct bank market in general. We continue to think this market has some room to run based on the consumer shift to direct banking, coupled with the advancements in technology and functionality. You can see how that has contributed to very consistent growth in direct bank deposits, which have grown at a 22% CAGR since 2002.

So while there could be fluctuations around the edges based on interest rates and the macro environment, given the growth in the market and our leading brand within this market, we still feel like the wind is at our back and will give us a lot of opportunity and flexibility over the long term.

So just to wrap it up on slide 21, we have got two great franchises in auto finance and deposits which continue to post solid results. Our strategic transformation is nearly complete as we have streamlined the Company, addressed ResCap and legacy mortgage issues, and largely normalized our capital structure. Now we can really focus on improving the profitability of this company and that process is already underway, which positions us well to work with the U.S. Treasury and get them fully repaid in a timely manner.

With that we can move to Q&A.

Great. Thanks, Chris. Operator, we are ready to take calls from investors. If you could just remind everybody how to queue up.

(Operator Instructions) Doug Karson, Bank of America Merrill Lynch.

Good morning, guys. My first question would be around the long-term strategic goals for the Company. I know paying back the government looks like it is going to be taking place in the next few months after equity transaction closes. Do you have any timing of an IPO, thoughts around that? If you could just kind of help refresh us on that.

Yes, this is Mike. Let me respond to that. There are a series of things that have to occur before we complete the monetization of Treasury's investment.

The first step is, assuming that we get the go-ahead from the Federal Reserve, then we will complete the $1 billion equity raise. And that in turn will allow us to get $5.925 billion back to US Treasury in exchange for the two things that I mentioned before.

That is step one. Step two is at that point Treasury will own about 65% of the common equity and then the challenge will be to exit them. And that, by the way, is their decision, not ours. The timing and the exact method of exit is completely under their control, not under our control.

We, obviously, have a frequent dialogue on that subject. I think we all believe that there are certain regulatory things that have to happen in terms of financial holding company status before any of these exit strategies are possible. Assuming that happens, I mean as you well know as well as we do, the market environment right now is very, very responsive. So our advisors are telling us that an IPO is certainly very feasible in the near term.

We also know from the private placement that we did that there might well be enough demand in the private market to take Treasury out in whole. So at least in the current environment we think there are a lot of alternatives. And in terms of timing, I don't think Treasury wants to be a long-term shareholder, so I would imagine they will make a decision, you know, not -- they won't wait for several years to make the decision, let's put it that way.

Right, that was helpful. I guess I just look at on slide 10 you have got some color regarding your interest expense and you analyzed cost of funds. It looks like we had a 57 basis point decline year over year. Am I safe in saying that was a pretty large move and the moves going forward will not be as large?

Doug, this is JB. What I would say, if you -- we don't really know what is going to happen in this interest rate environment, but the simplest way is just to say we took spot rates today and so they were held constant, so you can look at without repricing risk what your liability structure is really doing. We think between now and the end of 2014 you will get another 35 basis points out, and then between 2014 and 2015 you have got another 30 basis points or so to come.

So you add those up and you're looking at a cost of funds target by the end of 2015 of around 1.75%, and that is not us even fully pressing on ways we may be able to better optimize what we do on the deposit book at the Bank. So you have got a decent runway still to go.

Right, that is helpful. Okay, that is it for me. I will turn it over to another caller. Thank you.

At this time there are no additional questions in the queue and I would like to turn the call back over to management for closing remarks.

Great. Thanks, operator. If there is other additional questions out there that you guys didn't dial in and ask your question, feel free to reach out to investor relations. Thanks, everyone, for joining us.

(multiple speakers) I just want to say one thing before we sign off and that is thank Jim Mackey, who has been our CFO until this announcement. Jim decided we were getting entirely too dull, so he is taking over as CFO of Freddie Mac in a couple weeks. We would just like to thank him for everything he did here and wish him well.

Thanks, everyone. Thanks, operator.

You are very welcome. Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Have a wonderful day.