Ally Financial Inc. (ALLY) Q4 2016 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Ally Financial Incorporated Q4, 2016 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions] As a reminder, today's conference is being recorded. I would now like to introduce your host for today's conference call, Mr. Michael Brown, Executive Director of Investor Relations. You may begin.

Thanks operator and thank you everyone for joining us as we review Ally Financial's fourth quarter and full-year 2016 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 slide of today's presentation regarding forward-looking statements and risk factors. The contents of our conference call will be governed by this language. I would also like to note the Slides 3 and four of today's presentation where we have disclosed some of our key GAAP and non-GAAP or core measures. These and other core measures are used by management and we believe they are useful to investors in assessing the company's operating performance and capital measures, but they are supplemental to, and not a substitute for, U.S. GAAP measures. Please refer to the supplemental slides at the end for full definitions and reconciliations. This morning our CEO, Jeff Brown and our CFO, Chris Halmy will cover the financial results. We will have some time set aside for Q&A at the end. Now, I would like to turn the call over to Jeff Brown.

Thanks, Michael. Good morning, everyone thank you for joining our call. Before we cover the details on the numbers, which were in-line to favorable versus expectations. Let me spend a couple of minutes reflecting on the year as a whole. 2016 was another solid year for the company, as we continue to build and position Ally as the leading digital financial services company. From an earnings perspective, full-year adjusted EPS was up 8% from 2015, you should expect EPS growth to accelerate over the next few years to result in the 15% EPS CAGR that we talked a lot about. That’s a type of growth potential that is embedded in the strength of the opportunities before us and the power of the franchise and foundation we've built. A few primary components of our earnings growth trajectory; first, optimizing returns on the auto finance business, our retail auto lending market was up a 141 million last year and we see that accelerating to offset remaining decline and lease portfolio. Second, deposit growth is very powerful as we've reduced high cost debt and efficiently grow our earning asset base, we posted rapid deposit growth in 2016 with balances up 12.5 billion for the year and we see that accelerating going forward giving a compounding effect that we're getting from both new and existing customer expansion. Deposit growth will be further supported by the new product introductions and expanding our brand presence in the marketplace. Third, capital management, we're buying back a lot of stock at a discount, which is very accretive. And fourth, we've laid the groundwork for product expansion and diversification initiatives. On the auto finance side, we're introducing new segments in relationships outside our traditional channels. We acquired TradeKing, which provides a wealth management platform we can significantly grow for many years to come; within the next couple of months, you should expect the official customer day one launch. We introduced a direct mortgage offering towards the end of the year, a long runway for growth in a massive addressable market and we introduced an Ally cash back credit card, another key consumer-lending product. We've discussed our strategy for a while now, expand our customer offerings and diversify to not only grow earnings, but to strengthen the overall franchise to drive shareholder value. Deposits and customer growth are credible underpinnings. So, we've made a great progress on the strategic path in 2016 and those efforts set us up well to deliver our targeted results and eventually get multiple expansion. Now we lay out the targeted result from Slide 6 in-line with what we provided at an Industry Conference in December. Chris will get into the dynamics across the line items, but the punch line is we expect strong earnings growth in 2017 and see that really accelerating in 2018 and 2019. Should we get a 15% growth rate in 2017? It's possible; there could be a stretch in the lease book transition that’s still in progress. As that dynamics stabilizes in 2018 along with the shallower trajectory on provision, EPS growth should accelerate above 15% and again result in around 15% CAGR over the next three years. Key drivers again, improving returns in retail auto, as well as deposit growth driving top-line net financing revenue to around 5 billion in 2019. Another very important point, none of my guidance assumes any changes in the regulatory backdrop or tax structure, which could potentially provide the meaningful upside. We think some of the regulatory changes being evaluated are likely to take time, but could eventually bring relief and a better balance for banks, corporate and consumers. On the tax side, whether we're talking about corporate tax reform, which would be very meaningful to Ally or the house plans calling for reduction in the marginal tax rates, the U.S. households been considered; these are all favorable factors for strengthening the economy and frankly the outlook on consumer spending in durable goods. Further, our new President and the administration are clearly focused on the preservation of U.S. based jobs and actually to have very positive implications for our auto, insurance and banking business. Employment is already running close to full strength, so all this sets up very favorably on our thoughts and outlook for the next few years. And with that, I'll turn it over to Chris to walk you through the financials.

Thanks, JB. I'll start on Slide 7; let's look at 4Q results in the middle of the page. Overall, a good clean quarter as core trends remains solid and we experience some favorability across the businesses. Net financing revenue excluding OID was 991 million, which was slightly favorable to December guidance as commercial auto balances remains stronger going into year-end. Relative to last quarter net financing revenue was impacted by seasonally lower lease revenue. Other revenue of 392 million was positively supported by both equity gains and syndication income in our corporate finance business. Provision expense was 267 million for the quarter. Retail auto losses came in-line with prior guidance and we had the small reserve release on the mortgage portfolio given favorable loss performance. Non-interest expense of 721 million was a bit better than expected due to our continued expense focus across the company, as well as some lower state and local non-income taxes. Our effective tax rate was around 35% and for the second quarter now, we had no preferred dividends. That resulted in $0.54 of EPS for the quarter when you adjust for OID. On the next several slides, I would like to pull the length back and look at the annual results over the last three years. We can see some seasonal impacts on a quarterly basis, but looking at the annual results, [we see] (Ph) a good sense for the progress we've made as well as the forward trajectory. Let's start on Slide 8, with adjusted EBITDA EPS growth. Earnings per share grew 19% in 2015 and 8% in 2016 for a 13% CAGR over the past two years. Keep in mind that our EPS growth would have been more pronounced in 2016 if it wasn’t for the severe weather losses we experienced earlier in the year. Over the past two years, our self-help story of deposit growth, NIM expansion and lower preferred dividends have been key drivers. Going forward deposit growth and NIM expansion will continue to be important and will also benefit from share repurchases and incremental income from new products. Looking at total revenue on Slide 9, which combines net financing revenue and other revenue. Top line revenue was up about 500 million over the last two years. That's notable given our expenses were flat to 2014 and were returning lots of capital, so getting there is lot of leverage from the capital and expense base. Looking at the net financing revenue components on Slide 10. The main story here is that growth in the retail auto-loans is being funded by deposits and is more than offsetting declines in the lease book. The lease NII decline will be a headwind again in 2017, as balances comes down and used vehicle values decline. But we still expect net financing revenue growth to accelerate in 2017 and even more so in 2018, as margins expand and our balance sheet grows. Again, deposit growth is key, as we have attracted uses particularly with the lot of high cost unsecured debt rolling off over the next few years. On Slide 11, we have the other revenue component broken out by several of the revenue streams. This has been pretty consistent over the last few years with some ups and downs across the different components. We expect other revenue to be flat to slightly higher in 2017, but we would expect more material growth in 2018 and beyond, due to the mortgage origination platform and wealth management expansion. Obviously very important as we seek to strengthen and diversify the company. On Slide 12, provision has been increasing in conjunction with our delivered strategy to capture better profitability on our retail auto loans as well as growth in that portfolio. All though net loss is increased, we also have to book provision to compensate for loan growth as well as in increases in our coverage ratio. Provision will be up in 2017 and 2018 to a lesser extent given a similar dynamic. But over the next few years, we would expect provision to start a level out, given the impact from growth and mix shift should normalize. The non-interest expense is detailed on Slide 13, we achieved our targeted mid 40's efficiency ratio last year and we're at 45% again this year. We’ve made some investments in new product initiatives, technology projects and continue to support loan servicing and deposit marketing. As we've discussed at the December conference, we expect expenses to be up around a 150 million next year as we ramp up marketing efforts and continue to grow wealth management, mortgage and deposits. All critical to our strategic path to diversify and expand revenues. You can think about that is a run rate of around 760 million per quarter, with an additional 50 million in the second quarter due to higher weather losses. Switching the balance sheet on Slide 14, we continue to see modest but steady earning asset growth, there is a shift within consumer auto with leases is being replaced by retail loans that will stabilize in 2018. Commercial auto has been running fairly strong, given the higher mix of SUV's and Trucks, which have higher unit prices as well as growth in dealer inventories. We also expect to eventually grow the securities and mortgage portfolios, which are efficient from a capital prospective. Getting a normal capital requirement at Ally Bank will be important to efficiently grow these portfolios. Clearly, deposit growth underpins a lot of what happens to the balance sheet. So let's look at deposits on Slide 15. Deposits have grown steadily over the past seven years, but really accelerated nicely in 2016. The secular shift continues to favor direct banks as they grew faster than traditional banks and Ally continues to pick up market share among the direct bank competitors. We're getting the compound benefit of growth from new customer's as we've seen historically, but also getting increased growth from existing customers as they transfer more of their savings to Ally. This is such a critical driver of our earnings path and we expect to accelerate deposit growth over the coming years, giving the compound growth effect as well as favorable demographic trends. Turning to Slide 16, another driver of deposit growth is our brand awareness and market presence. Awareness pick up nicely in 2016, given some of our efforts with the Do It Right marketing campaign and Ally Lucky Penny contest was a big success. Introducing new products is also part of the sales reinforcing cycle; more products increase our market presence, which drives more customers. Those customers are then prime look at expanding their product relationships or increasing their deposits with Ally, all important factors strategically to grow, diversify and strengthen the franchise to drive shareholder value. Switching gears to net interest margin on Slide 17, NIM can move around a bit due to seasonal factors. So let's focus a minute on the full-year results. NIM was up six basis points year-over-year to 2.67% when we back out OID, a lot of the same themes continue that we previously discussed. Retail auto loan yields continue to claim higher and average balances were up 3 billion in 2016. Leases are higher yielding, but those balances are declining. Commercial auto balances were a bit elevated and the yield is floating higher with the increase in benchmark [rigs] (Ph). The mortgage and securities portfolios have drifted higher, but that should also accelerate over the next few years given the higher expected interest rates. If you combined all of that and asset yields were up around 14 basis points for the full-year. On the liability side, unsecured debt did declined last year due to refinancing our costly preferred securities, but we expect the footprint to decline dramatically over the next few years to be a key driver of NIM expansion. Secured debt yields have moved higher, but the balances continue to decline given the strong deposit growth. Deposit yields have held pretty steady about a 150 basis points. We haven't moved our rate at all since December's tightening, but we’ll continue to watch the competitive dynamics here that’s key for us and really all banks. Optimized deposit pricing relative to growth to benefit as much as possible from a rising rate environment. We have some pre-balance assumptions incorporated into our forecast and interest rate sensitivities and expect to continue to see NIM drive higher from here. On Slide 18, capital ratios have been pretty steady as we generate earnings and distribute more to shareholders. In the fourth quarter, risk weighted assets kicked up seasonally with commercial auto balances, which brought the ratios down touch. Our DTA was up slightly this quarter driven by the OCI impacts as you have seen at other banks given the recent rate move. We bought back another 8.7 million shares in the open market this quarter for a total of 17 million in CCAR. In total, we used 326 million of capital on share buybacks in the second half of the year. Combined with dividends, we distributed around 400 million to shareholder in the last six months. We expect to utilize in additional 450 million in the first half of this year, based on last year's CCAR approval. Shares outstanding are coming down nicely as shown in the bottom left. Moving to asset quality on Slide 19, consolidated net charge offs were up seasonally to 88 basis points, while the coverage rate came down a few basis points from the prior quarter, due to a higher mix of commercial auto. Provision expense for the fourth quarter was 267 million, up from the prior year driven by retail auto loan growth and the deliberate origination strategies we’ve discussed. The bottom right shows the retail auto portfolio net charge offs were up 35 basis points year-over-year to 1.56%. You can see the full-year 2016 net charge off rate in a call out table of 1.24%, up 29 basis points from 2015. We broke out the impact of all loans sell activity on the portfolio, which was about 8 basis points for the year. Overall, we continue to feel good about the U.S. economy and the performance of our loan book. Let's move to the segment starting on Slide 20 with Auto Finance. A big driver we keep discussing is the lease portfolio declining. In the table in the middle right, you could see net-leased revenue was down about $100 million this quarter versus last year. In 4Q, 2015, used vehicle prices held up better than expected and our leased yield was around 6.5%. This year it was 5.75% not bad just not as favorable as 2015. So the lease portfolio is declining that’s a headwind for earnings, but obviously brings down our exposure to volatility and residual risk. The good news is we’re largely offsetting that headwind with success on the retail and commercial lending side as well as other dynamic outside of world finance. If you look at the profitability from our retail auto loans in the bottom right, our net financing revenue was up 321 million for the full-year driven by higher balances and higher yields. That’s partially offset with an increase of $180 million of provision expense. We’re net up a 141 million and risk adjusted margins for the year. So a great job by the business of optimizing returns and shareholder capital. As far as future positioning, a lot of the same theme should be expected on the traditional business, but we’re expanding outside the traditional channels as JB the discussed. Carvana is an online lender that we’ve teamed up with to provide financing and we’ll be purchasing a modest amount of loans from them. Carvana has a great team and we’re happy to partner with them. Our transportation and equipment finance team that joined us last quarter, continues to make progress and has started booking loans. And the Blue Yield acquisition we announced last quarter, gives us some capabilities on the direct side, which we will leverage going forward. All these new specialty areas aren't going to be huge over the near-term, but they provide incremental diversification, avenues for attractively deploying capital and could be more meaningful over the long run, as we continually adapt to an evolving marketplace. Consumer auto originations on Slide 21 were solid at 8.2 billion this quarter, bringing the full-year to 36 billion supported by record application volume as we prioritized risk-adjusted returns over volume. Our origination mix was similar to prior quarter and we’ve consistently been in the low 40s range on used volume over the past year. Yields on originations in 4Q were around 5.7% with [indiscernible] expected losses still around 1.2%, so we continue to feel good about margin expansion on the portfolio. The bottom chart summarize the balance sheet, on the consumer side, lease balance declines are being offset with retail auto loan growth. Commercial auto average balances were up 3.3 billion from the prior year due to higher inventory levels and mix as consumer preference shifts towards SUVs and trucks. There continues to be a lot of focused on used vehicle prices, so let me provide a quick update on Slide 22. Used car values continue to decline in the fourth quarter in a similar magnitude to just the third quarter and well within our expectations. There are various public used vehicle industries in the marketplace such as Manheim and NAVA that calculate changes and proceed differently. The NAVA index came down approximately 6% in the current quarter versus the prior year, the NAVA index is more consistent with Ally's performance, but keep in mind, different methodologies such as vehicle age do create differences. The Ally index saw average used price decline of 5.5% in the current quarter from a year ago. Obviously used car values have the largest impact on our lease portfolio. So even with the year-over-year average price decline, we still saw a healthy 5.7% auto lease yield in the quarter with the fourth quarter typically the weakest of the year. As a reminder we still expect a roughly 5% annual price decline in 2017, which would still put our annual lease yields at approximately 6% for the year. On Slide 23, the insurance business reported a pre-tax income of 69 million; this is up 13 million from the prior quarter due to seasonally lower weather losses. Written premiums were strong at 237 million up 15 million from the prior year driven by increased vehicle inventory insurance rates and higher dealer floor plan balances. Operationally the business continues to deliver steady results and is positioned to continue momentum as we completed the national rollout of Ally premier protection last year and look to further develop our growth channel in 2017. The business has been transitioning over the past few years and we expect to grow steadily from here. On Slide 24, the mortgage finance segment contributes 15 million in the quarter, up 6 million from the prior year. Asset balance growth from 3.8 billion of bulk purchase activity executed over the last year drove higher net financing revenue while credit performance remains strong with minimal losses in 2016. Non-interest expansion is up versus the prior year due to asset growth and the build out of our direct-to-consumer offering Ally Home, which we launched in December. We did a lot of R&D in this area over the last 18 months and we expect to demonstrate a nice growth path in this business particularly as you get into the second half of the year. On Slide 25, our corporate finance business reported pre-tax income of 31 million up 22 million from the prior year. The held for investment portfolio is up 24% to 3.2 billion driving higher net financing revenue. Other revenue benefitted from approximately 5 million of gains on equity investments in the quarter, as well as some higher syndication income. Credit performance remain strong and provision expense was down in the quarter due to some small recoveries and lower reserve built. Our corporate finance business provides solid returns and we feel good about the opportunities to continue to grow the business going forward. So, just to wrap up before turning back to JB; the auto finance business is doing well, optimizing returns, reducing residual risk and positioning for continued incremental diversification. We expect auto finance profitability to grow over time. Insurance is a solid business with expansion coming from our growth channel, which would increase written premiums moving forward. Mortgage is fairly small right now but we expect that to really expand over the next few years given the market opportunity. Corporate finance has been growing as expected and is a nice business with excellent profitability. We'll likely introduce a separate wealth management segment overtime that will provide some meaningful income particularly in 2018 and 2019. The earnings growth foundation has been set with deposits and lower cost to funds fueling our businesses and we're now in a great position to build on it for many years to come. And with that, I'll turn it back to J B to wrap up.

Thanks, Chris. I'll conclude with quick recap of our priorities for the year, which are likely familiar to most of you. You've heard us talk a lot about deposit and customer growth and that's a real key driver from so many perspectives. So we have to keep the strong momentum going there. We introduced several new products and plan exceeds in 2016, in 2017, we want to demonstrate the next stage growth path for these products. We're doing this in gradual and prudent way so won't be massive out of the gates, but you should start to see the growth opportunity emerge particularly in the second half of the year. In Auto, we've done a great job of optimizing the returns on that business and managing the risk return profile, the originations and we expect the risk adjusted margins to expand again in 2017. On the credit and expense side, we’re focused on maintaining a disciplined approach to risk management and expenses to maintain efficiency and drive operating leverage. As most of you know, we continue to have some inefficiency in our bank operating structure, particularly the leverage ratio requirement. We hope to see that normalize this year to get on a level plain fields to other banks in the industry to fully optimize our funding construct. It's important and I can assure you, we keep working our way at it. On the capital side, we were happy to get share buybacks going in 2016 and we expect to buy even more in 2017. It's early in the CCAR process, but we're making more money now than before and will continue to lien in the capital returns given the current market valuation. The combination of these factors should drive accelerated EPS growth and expand the returns going forward. As we've mentioned, 2017 growth maybe shy of 15% but still very solid and then really accelerate in 2018 and 2019. We've got the right opportunities with continued balance sheet management and the right operational ingredients to deliver in these results. So thanks for your time today, hopefully you will hear a very optimistic tone it's intended. And with that, let me turn it back to Michael.

Great. Thanks JB. As we move into Q&A, we request that you do please limit yourself to one question plus a single follow-up. If you have additional follow-up questions after the Q&A session, the IR team will be available after the call. So operator, with that if you could please start the Q&A.

[Operator Instructions] Our first question comes from Betsy Grasek with Morgan Stanley.

HI good morning. How are you? A couple of questions on the outlook for NIM and how you mentioned that you expect to see some improvements still going forward and I know part of that is a function of the deposit data and the question is two things. One, give us the sense of growth and deposits you are expecting over the next 12 months, as well as how you expect that deposit data to reject. Because I know what you put in your queue and it doesn’t seem like that's happening yet. Just wanted to know when you think that flex point is?

Yes, so let me start with the NIM expansion. Okay, the biggest piece of the NIM expansion on the cost of funds side will be really just the absolute growth in deposits versus the unsecured debt coming down. And that's important, because it has less to do with the data than it has to do with the sheer turnover of the light over these sides. So deposits will really replace the unsecured debt, as well as replaced some of the secured debt, which the cost of that has moved up just with benchmark rigs. As you look at the growth in deposits, we grew retail deposit over 11 billion this year, total deposits over 12.5 million. We expect that to accelerate to somewhat in 2017. So we think the retail deposits will grow in excess of what they grew in 2016. To a nice extent, we also think we may take advantage of some brokerage CDs particularly as our TradeKing acquisition brings in some incremental deposits. So that will also be a bit of a tailwind for us. When I think about deposit basis going forward, obviously there was a very muted reaction to the last two rate moves, nobody has really moved much at all, particularly in the online savings or in the money market accounts, there has been some movements on the CDs, but it's pretty small. We don’t think we’re going to see any real dramatic change in the stance of rates, although at least in the next few months. We are watching it closely, as the Fed continues to raise interest rates, there is going to be appoint obviously where there is going to be some reaction out of the banks. But we still think it’s going to be fairly small. We have been pretty transparent that we modeled most of it; most of our pass through rates around 75% to 80%. But our expectation at least for us is it will be somewhere at 50% or less and obviously we haven’t seen it move at all yet.

Okay, and then maybe if you could have a comment on the used car price declines that you are looking for, I mean you highlighted that 5% price decline, which is what you have been kind of modeling to or managing to over time. Any pressures on that? I know you said 2017 looking for the same kind of decline, but given the mix and the desire for different kinds of autos, I'm wondering adjusting any shift in that as you go through the year?

Yes. We really saw the shift start at the end of the third quarter, where cars have been particularly poor performers and honestly there has been some specific cars even within the GM fleet that have not done very well. That has kind of dragged the overall cars down. Having said that, the trucks you know particularly the pickup trucks have done fairly well and have held in there, since we've had a continued expectation of price declines, when we set our leases three years ago, we set residuals lower for car that would come off at least in 2017. So while we continue to expect that 5% decline, we still expect the lease yields to be somewhere around 6% and we still expect to have some level of gains. I also always want to caution people that when you look at the leases and you look at cars coming off of lease its very seasonal. Meaning fourth quarter is always the worse; the second quarter is always the best. So try to look at it on an annualize basis, so I would expect lease yields to be little higher in the second quarter and a little worse in the first quarter.

Okay. Thank you.

Thanks Betsy. Next question.

Our next question comes from Chris Donat with Sandler O'Neill.

Hi thanks for taking my question. Chris just wanted to explore again on the deposit price and sort of how you are thinking about it, because you said you are going to watch the comparative environment closely. I'm just wondering what are your trigger points is it, when you see competitors raise or do you actually wait to see if you are seeing action in your own deposit book, if either you are seeing less growth or outflows. I'm trying to understand where you are going - at what times are you likely to make a move if it went under…

We look at full dynamics, but keep in mind there is growth today in deposits and that growth has been strong, particularly the growth rate in online deposits is strong as well. So long as we continue to see the increase in our overall deposits and the growth in our book, both from deposits as well as customers, we will be pretty consistent with our deposit rates. Now, that can obviously change given the market dynamic. But what I’ll tell is that we would - we are the biggest online depositor today. So we are a little bit off a bellwether and we have no intension of leading rates up. So we will see.

Got it. And then Chris, just to go back to something else in your slide deck from your Investor Day in February. At that point, relative to used car prices, there was a comment about 1% change in used car market value equates to about 50 million in revenue on an annual basis in 2016 and 2017. Has anything in your mixed shift changed that sensitivity or does that still basically hold?

No, like 1% move worst in our expectation, so let's say instead of going down 5%, used car values went down 6%. The biggest sensitivity obviously on the lease side. So a 1% move would be about 50 million in 2017 that drops to somewhere 25 million to 30 million as you get to 2018, just because the portfolio is significantly reduced.

Got it. Okay, thanks very much.

Thanks Chris.

Our next question comes from Sanjay Sakhrani with KBW.

This is actually Steven Clark filling in for Sanjay. My question is around credit. Well when we look at the year-to-date results, it's up about 35 basis points on both the delinquencies and charge offs side, can you talk about your expectations for 2017 and also around your reserve methodology?

Yes, I do expect charge offs to go up again in 2017 and it's a bit of what I would call the continued seasoning of the book, particularly as you get in 2015 vintages starting to really hit their peak loss periods in some of the early 2016 vintages. I do not expect it to go up to the same magnitude as we saw from 2015 to 2016, so that 29 basis points. I do expect it to rise however, particularly in the first half of the year. I think you will see more of the leveling off happen in the back half of the year given that’s where we saw some of the increase in kind of the quarterly charge off rates. Now on the provisioning side, our provision was up about $200 million from 2015 to 2016. So once again, I expect the provision to be up driven by charge off as well as some increase in the coverage ratio. I do not expect the coverage ratio to go up as much as the overall charge off rate, but we do expect that coverage ratio to really start to flow up. It was 142 in the retail auto portfolio for the fourth quarter, but you should expect that. And were running kind of a couple of basis points a quarter this year and I would expect that to continue in 2017.

Great that’s very helpful. And then my second question is around the CCAR process. The Fed released some new methodology around perhaps eliminating to qualitative exam for Ally; can you talk about the potential impact for you?

Yes, I mean the rule came out, I think some people might have seen that last night. The rule came out; it was very similar to the NPR that they put out in the fourth quarter. So not a lot of changes. For a bank like Ally below the $250 billion mark, the qualitative really moves out of the annual CCAR process and really goes into what they call the - like routine monitoring by the Fed. So, our expectation is to look at it in the third quarter and it will be just kind of routine. So, our actual capital distribution will be based on the quantitative assessment that happens within the second quarter. So, I don’t think there is a big change; we’ve obviously done very well on the qualitative side in the last few years. So, I don’t think it has a much of an impact to what we expected to do on the capital side, but obviously takes a little pressure off some of the operations.

Great. Thanks for taking my questions.

Thanks.

Our next question comes from Eric Wasserstrom with Guggenheim Securities.

Thanks very much. Chris, could you just talk about your balance sheet growth expectations relative to what you are thinking about with respect to SAR please?

Yes. I mean we expect SAR to be somewhat flat, as we look at 2017. I mean we think it will kind of go sideways a bit and whether it goes up or down, we said this a lot, whether SAR goes up or down let's call it a million units, it's not really going to have a big effect on us. Particularly given that our used volume is somewhere at 40% to 45% and the used sales are pretty steady over the last few years as well. So, when I think about the balance sheet growth, we expect the auto balance sheet to remain pretty flat, the leases will continue to come down, our retail auto loans will go up. So, you can think about the leases will come down about $1 billion a quarter and retail auto loans will go up above a $1 billion a quarter. So, it will keep pretty flat. I think where we were surprised a little bit at the end of the year and we expect to run a little hard I think in the first half of the year on our commercial balances. So, commercial balances are up, it’s a great business in the sense that it has no losses in that business, but the yields tend to be a little lower than the overall portfolio. So it put some pressure on NIM, but it’s a good kind of low loss business and its all LIBOR type based. So, if rates do go up, we do have a little leverage there.

Great. Thanks. And then just within the auto growth, can you just talk about sort of what the FICO composition will look like relative to where you were let say in the second half of this past year. And how that relates to the nearer expectation?

Yes. We expect it to be pretty steady. I mean I would tell you that our FICO has drifted up a bit in the fourth quarter. And the reason for that a little bit is seasonality meaning the fourth quarter tends to be the quarter you see mostly new cars, you see a lot of incentives from the manufactures around the holidays. So, you tend to have a higher credit quality customers in the fourth quarter. But I think our credit quality - the way we look at the competitive environment today, our credit quality and our nailer should be pretty consistent going forward, which is one of the reasons as we saw looking out to 2018, we start seeing what I would call a flattening of our provision, because we think the overall credit quality of the book will be pretty similar.

Okay. Thanks very much.

Our next question comes from [indiscernible].

Hey good morning. With the Ally Home origination, just curious how you are thinking about the volume, are you going to flow the 30 years through and keep arms and what is your target there? And then is there any servicing escrow balance assumption in your deposit/rate outlook?

Yes, there is no servicing deposits or escrow deposits in any of our assumptions. When we think about Ally Home and we've pretty modest assumptions of originations and most of those originations, will be conforming whether they are fixed or floating, most of that stuff will go off to the GSEs. The only production we expect to keep is the jumbo production. When we think about it over the next couple of years, our assumptions are somewhere around $5 billion of originations, we probably keep a 1 billion or 1.5 billion of those originations on the balance sheet. We continue to buy some bulk mortgages as well to bring that; overall balance sheet in mortgage up, but we get some nice fee income associated with those conforming originations.

Okay and then your investment securities balance grew nicely in the quarter, but it’s kind of flat on the year. How do we think about 2017 securities growth with the loan portfolio sort of balancing out between auto lease and auto loan. Kind of a flattish top line on the securities book. Is that net growth from here, how should we think about that?

Yes. We have relative to size of our balance sheet when you think of our peers across the banking industry, our investment portfolio is pretty small, its somewhere at 13% somewhere in that type range. We would like to move the investment portfolio higher; we think it's good for strength of our liquidity ratios. The think that's preventing us from doing that at the moment is the leverage ratio requirement that we have at Ally Bank and because of that we've really held back from growing it. Our expectation is that leverage ratio will be lifted at some point this year and once that happens, our expectations will grow the securities portfolio bit higher. So hopefully in the second half of the year you will see real growth there and most of that growth will be in liquid products.

All right. Great, thank you.

Our next question comes from David Ho with Deutsche Bank.

Goo morning. Just want to talk about the expenses just real quick, the 150 million that you highlighted just want to make sure what base you are going that off of potentially and how much flexibility you have there?

Well we wanted to make sure that we were pretty transparent to the overall market that expenses are going up and when we look at the overall expenses, they were just shy of 3 billion in total non-interest expenses; I think it was 2.94 billion. So, we expect the 150 to kind of grow off of that. A lot of that growth is really going to come from the marketing side and really driving some of the new products, and things like wealth management JB mentioned in his prepared comments. Over the next couple of months we're going to rebrand that and we will have a Customer Day One and once we have that Customer Day One we're marketing behind that to really grow the wealth management segment. Likewise we just started Ally Home and we're looking at it and very kind of moderate way and making sure operationally we have everything handled, but once we start feeling good about the operation you will start to see it but some more marketing dollars behind that with that it will also comes just variable expenses as that portfolio really grows. We've also in that corporate finance group we've hired some specific teams within that group to help to grow that portfolio as well. So all of these it's just some incremental expenses really driving some of the new products and new businesses and we're really going to focused on operating leverage though. So while expenses are going up, we expect to really see revenues rise as well, and as we start getting out of couple of years 2018, 2019, we start to seeing that mid-40s efficiency ratio really come down.

Got it, and then as it relates to some of that business expansion it seems like it’s a little more backend loaded in terms of the timing in 2017 and obviously if rates rise, you would have probably a little more pressure on the investment gains before you kind of recruit that towards back half of the year is that the right way to think about it?

Yes, that's a good point. Meaning higher rates will give us less opportunity to harvest gains as of the investment portfolio. We did have some real success in 2016, during that particularly in the first half of the year, given rates were lower than people expected. So to the extent that we see rates continues to rise, we will have less gains to harvest. But the offset obviously is just higher balances and higher NII, which we would obviously like to see. The rate bar is just going to move around there, so will see how to gain that interim.

Got it. Great, thank you.

Our next question comes from Moshe Orenbuch with Credit Suisse.

Thanks. You guys had talked a little bit a lot actually about kind of the deposit pass through rates and all that kind of stuff. Can you talk a little bit about kind of the composition of the liabilities? I know you are starting pretty soon to start to see debt mature. If you thought about how you are going to replace that and does it matter, whether you kind of get that relief on the leverage ratio and can you talked about how that will kind of phase in over the next couple of years?

Yes, I mean as I look at overall deposits, we expect overall deposits to obviously continue to grow. I think it was somewhere around 54% of our overall funding. Over the next couple of years, we want that to grow to 75% of overall funding and when you think that could be realistic. With that I expect the unsecured debt to continue to come down; we've got about $12 billion of maturity over the next three years. Our expectation is that we're not going to refinance that. Now, having said that we have this leverage ratio restriction and because of that leverage ratio restriction Ally Bank needs incremental capital, that capital comes from liquidity as a holding company. So to the extent that gets delayed it may cause us to do some additional liquidity raises at the parent where we can push liquidity down. But I think, if I take a longer term view over the next two to three years, our view is that none of that $12 billion will really be needed within the company and we can bring that down. And then I think the other trade off that you will continue to see is we've had some big liquidity facilities at our bank and holding company on the secured side. Most of those are LIBOR based type facilities; we like to bring those down dramatically as well. So you will see overall secured funding come down, I think the convenience here is active in the securitization markets. But I think some of the private facilities that we have will come down.

Got it, just another question I mean, two years in a row of down 5% used car values, it’s a little unfair, I going to ask beyond that but 10% is a pretty hefty move, I mean you think things start to stabilize after that, how do we think about kind of on a longer term basis?

I think as you stock in out to 2018 and 2019, you hopefully will start seeing some real stabilization. So we've seen a pretty dramatic move in 2016, we think that continues with the off lease vehicles, but you are getting steady state with the amount of vehicles that get least by the OEM's on an annualize basis. So they should be able to handle some of that used car volume and it should be a little bit more of a steady state. But some of it depends just on how the OEM's incent the new cars and I always say used car values have more to do with where new car prices are, than anything else. So some of it depends on OEM behavior and we all hoping expect that OEM behavior will be better this time around than it was pre prices.

Got you. Thanks very much.

Our next question comes from John Hecht with Jefferies.

Good morning guys. Thanks. So, you just started touching a little bit on sort of a OEM major, I'm wondering if it give us a rundown of the competitive behavior across the various kind of segments in your business now, is it lightning of certain categories that still tightening and how do you feel about 2017?

This is Chris, may I’ll start and then JB can jump in. It's been pretty public out there that’s on what I would call the super prime. The prime to super prime side, the system, what I would call regional type players back a way a bit. We did see some price increases in the fourth quarter by some of the major competitors and we think that is very healthy for the market, particularly given just the higher interest rates. So the only thing on the - it’s still a competitive market, the only thing what I would call the prime to super prime side, is that the credit unions continue to keep pricing low and they have picked up a little bit of market share. So now they will tend to be a little bit of lager when it comes to raising prices, so I think they are worth watching on the top side. So that’s where you are seeing most of the competitive there. In more of the other into this spectrum, the subscriber prime side, without naming any just a one large player, what I would say step away a bit and go a little bit upstream and you saw another large bank kind of go in and take some of that volume. I think we probably know who that is. But all in a very rational way, so still competitive environment. We starting to see some pricing move up, which we think is a good thing along with benchmarks, but overall rational.

And then John, may be the only other thing I would add obviously Chris listed on the retail component within commercial floor plan still very competitive there, particularly by a large cap that continue to be very aggressive and frankly we have got to maintain our discipline around pricing and ensure we're in appropriate returns, but floor plan is probably where its most competitive today. So we're obviously happy to see what balances continue to be pretty stable to up, but we got to be mindful what that could mean for the longer term.

That’s great color guys. Thanks very much. And second question, I imagine this for Chris, Chris the off lease remarketing, there was a little bit of lower gain this quarter, obviously there is some seasonality and then some expected components to that. How should we think about the next few quarters with that factor?

Yes, gains - well I think we have about $10 million a gains in the fourth quarter, I would expect the first quarter to be somewhere in that ball park, meaning particularly in January and February you don’t tend to get many gains, because of the winter months. It starts to pick up more when you get in March. As we get to the second quarter, however, we do expect it to realize some gains in the portfolio and really associated with just better used car sales in the second quarter. So I really expect first quarter to be pretty similar, second quarter to actually start to move up a bit as you go through the summer months, it's probably pretty similar and then it tails offs again in the fourth quarter.

All right. Thanks very much guys.

Thanks John.

And I’m not showing any further questions at this time. I would like to turn the conference back over to our host.

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