Ally Financial - Q3 2023

Transcript

Operator (participant)

Good day, and thank you for standing by. Welcome to the Ally Financial's third quarter 2023 earnings call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question-and-answer session. To ask the question during the session, you will need to press star one one on your telephone. You will then hear an automated message advising your hand is raised. To withdraw the question, simply press star one one again. Please be advised that today's conference is being recorded. I would now like to hand the conference over to Sean Leary, Head of Investor Relations. Please go ahead.

Sean Leary (Chief Financial Planning and Investor Relations Officer)

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'll 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.

Jeff Brown (CEO)

Thank you, Sean. Good morning. We appreciate you joining us to review our third quarter results. I'll begin on slide number 4. Before we get into the quarter, I'd 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 9 years as CEO. I came to Legacy GMAC to help with the financial restructuring that I thought would take 3-4 years.

Nearly 15 years later, we transformed a 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+ 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 dollar 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 realize 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 and core ROTCE....Moving to operational performance, we continue to see solid results across the company.

Within auto finance, we generated record application volume of 3.7 million, which resulted in $10.6 billion of originations and attractive risk-adjusted returns. Originated 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 in 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're 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 this 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 for margin expansion when rates stabilize. Actively managing credit risk remains a top priority. We've refined our buy box 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 NCOs of 1.8% for the full year, which is in line with the range we 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 guides, 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 staying in their cars.

Given the near-term revenue pressure, we further heightened our focus on expenses. Looking to 2024, we'll continue making prudent investments, but 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 held steady 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.... 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 2 times 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 8, we've 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 e-contracts at the discount window for the first time, and are appreciative for 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 being 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 Endgame proposal is the phase-in of OCI.

As a reminder, we have not reinvested in the AFS portfolio in over a year and expect natural OCI 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 weight 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 things like FDIC fees and 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 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.

Russ Hutchinson (CFO)

Thank you, J.B. 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 costs, 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 SmartAuction and pass-through initiatives in auto finance, which we highlighted last quarter.

Despite modest investment gains, we're 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 build to support asset growth. Retail NCOs were in line with prior guidance. I'll provide a more granular update on retail auto credit shortly. Non-interest expense of $1.2 billion reflects higher costs 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 position 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. Commercial portfolio yields expanded alongside benchmark rates given their floating rate nature. Turning to liabilities, cost of funds continued to increase, but the rate of change on both a quarter-over-quarter and year-over-year basis slowed relative to 2Q, 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 OCI 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%-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 assume 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 demonstrates 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 volume 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 loans and 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, mutually beneficial relationships with our dealer customers. 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 to 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 yield 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 NCOs 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, which result in 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 floor plan 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. Pre-tax income of $377 million reflected pricing momentum alongside higher provision and non-interest 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 is 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 pre-tax 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 when faced are the violent hail and windstorms 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 remain 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 for 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. We continue to see strong growth in multi-product 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 deepen 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. Ally Lending balances were relatively flat, given our disciplined approach to underwriting and capital allocation. Corporate finance results are on Slide 25. Core pre-tax 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 pre-tax 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 the forward curve from quarter end, peak Fed funds is unchanged versus 2Q guidance of 5.5%, but cuts have been pushed out considerably. Continued competition for deposits has put incremental pressure on portfolio yield, which could tick up to 4.2% in the fourth quarter. 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, as we covered previously, retail auto portfolio yield is still projected around 9% in the fourth quarter, with continued expansion thereafter.

Retail NCOs are expected to be at 1.8% for the full year, unchanged from prior guidance. 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 unpack it and also realize his love for cars and the Hendrick Group, this was simply the right next step for him. We are going to miss JB dearly, and at the same time, we're excited for him. JB's news in no way changes how I feel about the opportunity or Ally. I am excited for all that we have to accomplish, my fantastic teammates and Ally's attractive financial outlook. The scale businesses are in an enviable position. I remember talking to JB about, and the team about the moat positions, and it's clear that those have been established today. With that, I'll turn it back to JB.

Jeff 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, and we can head into Q&A.

Sean Leary (Chief Financial Planning and Investor Relations Officer)

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 (participant)

Thanks, Sean. And as a reminder, to get in the queue, simply press star one, one, and to remove yourself, repeat the process, star one, one. One moment while we compile the Q&A roster. All right, one moment for our first question. It comes from the line of Ryan Nash with Goldman Sachs. Please proceed.

Ryan Nash (Managing Director of Regional Banks and Consumer Finance)

Hey, good morning, guys.

Jeff Brown (CEO)

Morning.

Ryan Nash (Managing Director of Regional Banks and Consumer Finance)

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

Jeff Brown (CEO)

Yeah, Ryan, thanks for the question. No, financial outlook did not change or drive my decision in any way, shape, or form. I feel even more confident in the financial profile of the company going forward. I think obviously, rates, as you know, Russ and I both alluded to, have been a big factor in kind of driving some of the margin squeeze that we faced. But as you start to roll the balance sheet forward, and I think, you know, we tried to include 3 or 4 new slides this time that really hit those points. As you start to roll the balance sheet forward, I mean, you're going to be 4% plus type and then, and easily into the mid-teen. So, you know, this was not driven at all about any change in confidence in the strategic outlook, the financial outlook.

I think as, you know, as you heard me say, this is, you know, it's been an honor leading Ally for nine years. I had no real intentions to go, but this was one call that I had talked to my board about for really the past two years, that if this call ever came, that would be the one call I'd probably take and at least listen to. And, and obviously, life sometimes throws you curve balls, and, and, and that's what happened in this scenario. But, you know, Mr. Hendrick and the Hendrick Automotive Group, they're unbelievable people and partners. Obviously, we touch so many thousands of dealers day in and day out, and this is really, the premier franchise that's out there.

I mean, I'm respectful of all of our dealer partners, but this was really a dream opportunity for me to go work with a man, a family, a company that I have got to know for a number of years, that I deeply love and admire. I mean, it's a big business, you know, north of $12 billion in annual revenues. They sell 200,000 cars, big parts player, big work in the defense industry as well. So it just was, you know, it fit in so many reasons for me to make this personal decision. It is hard to leave Ally, a lot of great teammates, and certainly that weighed on me as I, as I made this decision, but nothing about the financial outlook, the strategic outlook.

Frankly, I think the next CEO that comes is going to have a financial profile that's pretty damn attractive going forward. So sorry for the long-winded response, Ryan, but that's really what drove this. No, no change in my view or my degree of confidence, and it's going to be fun being an awfully big Ally customer now, too.

Ryan Nash (Managing Director of Regional Banks and Consumer Finance)

... Got it. No, I appreciate all the color on that, J.B. So, Russ, I hope all is well, and maybe you can dig in on the net interest margin. I know you noted that, you know, NIM will trough a couple of quarters after rates stabilize, and I think you said around, you know, 3.35 for the full year, which I think implies a couple of basis points decline in the fourth quarter. So can you maybe just, Russ, maybe just flesh out a little bit of the near-term margin dynamics. Do you think 4Q is the trough? And then can you maybe just unpack some of the numbers in the trajectory of the NIM under either higher for longer, or the forward curve, which obviously seems to be implying 2-3 cuts for next year?

Russ Hutchinson (CFO)

Sure. Thanks, Ryan. Look, I think you're spot on in terms of thinking about 2023. You know, 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, you know, to the extent that we're already there, I think we could see rates start to expand through the first half of next year. Sorry, you could see NIM start to expand in the first half of next year.

You know, to the extent that we're not quite there, but close, you know, that expansion could be delayed. You know, all that being said, I think as J.B. pointed out, as I pointed out earlier, you know, 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 ifs. And I, you know, would say, and you know, 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 5-10 basis points per quarter of NIM expansion.

Obviously, as you say, to the extent that we see cuts on the short end, we could see that expansion expedited.

Ryan Nash (Managing Director of Regional Banks and Consumer Finance)

Got it. I appreciate all the color.

Jeff Brown (CEO)

Thanks, Ryan.

Operator (participant)

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

Sanjay Sakhrani (Managing Director and Senior Analyst, Consumer Finance and Payments)

Thanks. Good morning, J.B. Congrats on your new role.

Jeff Brown (CEO)

Good morning, Sanjay. Thank you.

Sanjay Sakhrani (Managing Director and Senior Analyst, Consumer Finance and Payments)

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

Jeff Brown (CEO)

Yeah, Sanjay, thanks. I'd still say a bit of the early stages, you know, I had obviously talked to my chair of the board when I was considering this. So the board, our, and our search committee had a bit of time to sort of start structuring their own thoughts about what a candidate profile would look like, all those things. So that is underway. Obviously now, you know, and the timing of this was really related. We had our board meeting last week, and at that meeting, that was when I officially submitted my notice to leave the firm at that point in time. And so obviously, you know, we went public last Wednesday with this. But I'd say the board is doing a great job.

I'm excited to be able to say I'll be involved in that process. You know, that's very important to me in finding the right type of leader in partnership with our board to really carry Ally forward for the next, you know, five, 10, 15 years. So, you know, it's obviously easier that things are out in the public domain, that you can conduct an external search. We're working with a leading global search firm, and so that's underway. You know, I think our board is very focused on trying to get somebody that can really carry the culture of the company forward, and also can continue to transform the businesses.

You know, it's. I'm very proud of what's been accomplished over nine years, but as I've said to every one of my leaders, and all our employees and our board, it's never about one person. This has always been. This transformation's been led by an incredible team, and I am fully confident in their ability to continue executing in this next chapter. So I think a new leader will come in recognizing they have an exceptionally strong management team, they have a hungry employee base, and all of us believe, you know, we. Ally's never really fully got the credit for the transformation that's been executed, and I think that's gonna be a neat opportunity for our next leader to go and crack. And so, you know, it's underway.

Sanjay, I've obviously said I would, I would be here through the end of January, if needed. You know, I, I suspect that timing's gonna be right around the mark of, of when we'll bring in a new leader. But obviously, I'm going to be a very close customer of Ally, and it's in my interest to ensure we get a, a great leader, a transformational leader, a culture carrier, a servant leader, all those things. But I think I've tried to be here. We get somebody that's even gonna take that to the next level. So, you know, it's underway, and I would hope, you know, by the end of January, you'll be talking to our next CEO.

Sanjay Sakhrani (Managing Director and Senior Analyst, Consumer Finance and Payments)

Okay, perfect. And then my follow-up question, appreciate slide nine, 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 PNL 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.

Russ Hutchinson (CFO)

Yeah, sure. Thanks, Sanjay. It's a great question. It's obviously one that's complicated by the fact that these are proposals. And as JB mentioned earlier, we're working with BPI and other industry constituents to make sure our feedback is reflected. And as you've heard, the industry has had a reaction to the proposals as they're currently stated. All that being said, and maybe I'll start with Basel III Endgame. The biggest impact for us is in terms of AOCI. And I'll just make it clear, we can manage within the transition time period that has been proposed so far without doing anything unnatural. That is, we can manage it organically. As you can imagine, it's obviously curtailed our share repurchases.

You know, and quite frankly, if you look at our auto business, you're just looking at the attractiveness of the assets that we're seeing from our dealer partners. We have certainly had to be restrained, in terms of our origination volume, and it's also forced us to really make hard decisions around the growth trajectory of some of our growth businesses. All that being said, we can manage within the timeframe that's been provided, and, you know, the only significant real impact for us on the capital line is that AOCI inclusion. When you look at long-term debt, and it's very early, and, you know, as JB laid out on his slide, the binding requirement for us is the 6% of IDI at the bank level.

Because as you can imagine, our unsecured debt is issued at our holding company level. We actually don't have unsecured debt at the bank level today, and so that's gonna require us to, you know, as the proposal is currently stated, it's gonna require us to really look through the liquidity we have at the hold co versus the bank level, and look at our issuance. And that could drive incremental issuance from where we sit today, which would obviously, you know, which would obviously come with additional interest expense.

Sanjay Sakhrani (Managing Director and Senior Analyst, Consumer Finance and Payments)

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?

Russ Hutchinson (CFO)

Yeah, 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 RWA is completely offset by some of the benefits we see in our retail loan portfolio.

Sanjay Sakhrani (Managing Director and Senior Analyst, Consumer Finance and Payments)

Okay, great. Thank you very much.

Operator (participant)

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

John Armstrong (Research Analyst)

Can you hear me all right?

Operator (participant)

Yes, sir.

Russ Hutchinson (CFO)

We can hear you now, John.

John Armstrong (Research Analyst)

All right. Thank you. Appreciate that. Question for you on slide 19. Just curious what the big picture message is on auto credit performance. On one hand, it sounds simple, but on the other hand, the delinquencies are going down. What's the message that you're trying to send? And as we look past the fourth quarter into 2024, with the delinquency numbers, it feels like credit should actually be getting better. Is that too simple?

Russ Hutchinson (CFO)

Yeah, I mean, maybe I'll start, you know, just to try and be as clear as possible about it. We very much see ourselves on track towards the 1.8% NCO rate that we advertised last quarter. That being said, there's seasonality in terms of our delinquency trends. And so what you see in the bottom left on page 19 is you see that seasonality expressed through the NCO trajectory as we go from second quarter to third quarter to fourth quarter. And so fourth quarter is typically when we see our highest level of NCO activity, and so we show the 2.2-2.4. That 2.2%-2.4% for the fourth quarter is consistent with a full year 1.8% NCO rate.

So that's an expression of the seasonality in our portfolio. On the bottom right, what we're doing is we're showing year-over-year change to get through some of that seasonality issue. So the comparisons that you're seeing as you look at each of those quarters is 3Q 2023 versus 3Q 2022, 2Q 2023 versus 2Q 2022. And so when you look at it on a year-on-year basis, you can see that the those elevated delinquency levels that we're currently seeing, you can see they're actually coming down. That year-over-year change is coming down each quarter sequentially, and it has been for the last three quarters straight. And we think that's a reflection of a couple of things.

You know, one, we implemented through curtailments and pricing, a lot of changes to our, to our portfolio recently, and we are seeing that, in terms of the performance of our recent vintages. It's early to tell. We're very early in those vintages, but we are seeing real impact to our, curtailment and pricing actions. On the other side of that, when you look at our 2022 vintages, we are seeing improvement in those vintages with respect to our original expectations as well. And so again, early days, but we continue to see positive signs that keep us on track to that 1.8% NCO rate.

John Armstrong (Research Analyst)

... Yeah. 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 the deposit costs? Thanks.

Russ Hutchinson (CFO)

No, it's also a great question. So, you know, we raised during early in the quarter, and so you'll see the full impact of our latest OSA raise over the course of fourth quarter. And look, it's our expectation that because of the competition, and we've always expected this, we continue to see deposit competition even after the last raise. And so where we are now, we've, you know, and you probably noticed in the presentation, when we talked about our outlook, you know, we've changed our guidance. You know, we were at a 4.1% overall deposit yield for fourth quarter. We've moved that up now to say it's 4.1%-4.2%.

So we're not ruling out the possibility of continued pressure on deposits and the possibility of increased pricing going forward.

Kevin Barker (Stock Analyst)

Okay. All right. Thank you.

Operator (participant)

Thank you. One moment for our next question, please. All right, and our next question comes from the line of Bill Carca with Wolfe Research Securities. Please proceed.

Bill Carcache (Senior Financials Analyst)

Thank you. Good morning, and good luck, JB. Wish you the best.

Russ Hutchinson (CFO)

Thank you very much, Bill. Appreciate that.

Bill Carcache (Senior Financials Analyst)

Yeah, absolutely. I wanted to follow up on the commentary and all the color you've already given on the NIM guidance, and in particular, your outlook for OSA rates. There's been a debate around the possibility that your OSA rates may continue to face upward pressure and ultimately have to converge with the Fed funds rate. Historically, in a ZIRP environment, you know, how I offered rates above Fed funds, and, you know, I guess there's just concern that that upward pressure on deposit beta could persist as long as, you know, Fed funds continues to exceed the rates that you're offering. You know, just, I guess, your thoughts around that and the potential for further offsets from betas on asset yields would be great.

Russ Hutchinson (CFO)

Great. Look, we think we're at the end of the tightening cycle. Assuming that's true, we do think there's a possibility that our OSA rates tick up slightly from here, but I do say it's a possibility. I'd say the trends that we're seeing in our deposit book have actually been quite favorable. You know, as JB pointed out, and as I mentioned during the presentation, you know, we've had a really great quarter in terms of attracting new customers. We're about to have a record year, in fact, in terms of attracting new customers to our platform. You know, we are not the highest payer right now, when you look at our liquid deposit rates. But again, we continue to have incredible momentum with our customer base.

We're seeing it in terms of strong retention. We're seeing it in terms of customers taking advantage of things like our savings toolkit, and we're seeing it in terms of new customer growth. And so while, yeah, we do think that there's a possibility that we could tick up on OSA pricing, we think it's just that it would be marginal, a marginal uptick. And again, at this point, I would characterize it as a possibility, you know, not a certain outcome.

Bill Carcache (Senior Financials Analyst)

Understood. Thank you. That's helpful. If I could just follow up on your commentary on capital and the impact of Basel IV Endgame. Since the inclusion of OCI, AOCI, changes introduces volatility into regulatory capital, there's been some debate around whether this could lead the banks to have to run with a bigger buffer than they have historically. Maybe if you could just speak to, you know, any changes to your long-term capital targets, or, you know, should we continue to expect sort of that 9% range for CET1?

Russ Hutchinson (CFO)

Yeah, look, I think there are a number of kind of puts and takes into the proposals. You know, there's obviously a lot of gold plating around certain asset classes. And I would say, look, when I look at our 9% management target now, that's a full two percentage points north of our regulatory requirement. So right now we're sitting at 9.3% at approximately $3.7 billion of excess capital relative to the regulatory minimum. I feel pretty good about where our capital is, and I don't anticipate any significant changes to how we manage capital going forward.

Bill Carcache (Senior Financials Analyst)

That's very helpful. Thank you for taking my questions.

Operator (participant)

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 (Stock Analyst)

Great. Thanks for taking my questions. JB, best of luck at Hendrick. It was a pleasure working with you.

Russ Hutchinson (CFO)

Yeah, likewise. Thank you.

Kevin Barker (Stock Analyst)

Yeah, 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, you know, debt issuance or potentially different Basel III changes, do you expect to achieve that 4% sometime in a run rate like 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?

Russ Hutchinson (CFO)

Yeah, I'd say, and I'll address your question in a stable rate environment, rather than speculate around the timing of rates. But I'd say in a stable rate environment, our expectation is still crystal clear to get to 4% NIM. You know, I think we're kind of looking at the portfolio replacement impact. I think you could see us there entering 2025.

Kevin Barker (Stock Analyst)

Right. And then does that-

Russ Hutchinson (CFO)

Caveat on that with, you know, with the view that, you know, I don't wanna be in the business of speculating in terms of where short-term rates go.

Kevin Barker (Stock Analyst)

Yeah, that makes sense. Then just to follow up on, you know, your estimated origination yields, do you feel like you can maintain that 10.7% auto origination yields through the next, you know, foreseeable future, just given the competitive environment for auto lending? You know, we've seen quite a few banks pull back from, from the sector in the last year, but seem to be reengaging. Do you feel like that ten point seven is a adequate number or at least a stable competitive environment?

Russ Hutchinson (CFO)

Yeah, I do actually. You know, the pullback in competition this time around, you know, I actually think has more durability to it than what we've seen in past cycles. You know, for a number of folks, this isn't a core business for them, you know? And you know, I think the regulatory capital pressures that other folks are on. It really has forced people to make hard decisions and to really focus on the businesses that they're best at. We've certainly had to think through our capital allocation across various businesses at Ally. But as you know, the auto finance business is absolutely core for us. And so I think the pullback in competition, when you look at players, they haven't just dialed back their originations.

Many have exited the market altogether. And I think that creates a durability to this competitive environment that we're currently seeing. So yeah, I do think we can maintain our rates. And I would just say, just when you kinda unpack our yields, remember, we've increased pricing at the same time that we've been tightening credit. And so we've lifted the credit profile of our originations at the same time that we've increased pricing. If you were to look at it on a same credit basis, our pricing has actually increased significantly more than what we show in terms of this 10.7% yield and the 95% beta that we've printed. So yeah, I think there we have a number of levers in place.

I do think that the competitive environment that we're seeing now is durable and so will give us the ability to maintain that 10.7% yield for a while. And, you know, I don't wanna speculate on rates coming down, but obviously, if rates coming down create a tailwind for us, just in terms of that portfolio replacement effect that's currently causing a headwind.

Kevin Barker (Stock Analyst)

Thank you, Russ.

Sean Leary (Chief Financial Planning and Investor Relations Officer)

Great. 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.

Operator (participant)

Thank you for your participation. You may now disconnect.