Ally Financial Inc. (ALLY) Q1 2017 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Ally Financial First Quarter 2017 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session with instructions following at that time. [Operator Instructions] As a reminder, today's conference is being recorded. And now I turn the conference over to your host Michael Brown, Executive Director of Investor Relations. Please begin.

Thanks operator and thank you everyone for joining us as we review Ally Financial's first quarter 2017 results. You can find the presentation we'll reference during the call on the Investor Relations section of our website, ally.com. I’d 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’d also like to note the Slides 3 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 accepted to 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'll have some time set aside for Q&A at the end. Our Chief Risk Officer, Dave Shevsky is here for Q&A as well Now, I’d like to turn the call over to Jeff Brown.

Thanks, Michael. Good morning and I appreciate you join in the call. Let me ask you to turn to Slide 4 which contains highlights from 1Q. From a financial perspective, we had a decent quarter, but fell short of expectations of delivering year-over-year earnings growth due primarily to two or three factors which we will cover in detail this morning. Specifically, weather related losses, used vehicle prices and credit trends all combined for a challenging quarter. We’re not satisfied with the financial results, but also known we won’t be on a straight line every quarter. Importantly, we don’t see anything thing that causes a reset on long-term guidance. From an operating perspective, good fundamentals from all of the businesses, including fantastic customer growth, record deposit growth, improving risk adjusted returns on new retail originations, profitable growth in the commercial auto and corporate finance portfolios and we expect the official integration and launch of the Ally Invest over the next several weeks. Ally Invest is a huge strategic opportunity for Ally as we take another step in diversifying the company and diving deeper in this rapidly evolving world of digital financial services. So we see quality fundamentals that position us well for the future and keeps us on track to deliver on our financial and strategic plan. The $0.48 of adjusted EPS is down from last year, and I'll reiterate that's not what we expect for our financial trajectory, so that was a disappointment. Many aspects of the business are performing well, but comps year-over-year were hit by incremental weather losses and as you know we have a big headwind this year with the lease portfolio declining. The lease book performance is still solid in general, but giving a declining balance in yield, there is a challenge that we have to work through in this transition year. On the bright side, GM residual exposure continues to come down at a healthy quip every quarter. Overall, you should fully expect more earnings improvement later this year and in 2018 and 2019. On the auto environment, I would say our tone remains cautious, but constructive. We continue to see good risk return opportunities as the team set on the financial outlook call last month were able to keep our loss content pretty steady on new originations and we’re booking significantly higher yielding loans. Some of that due to higher rates, but more so from certain competitors dialing back. Auto lending there is a core competency for Ally and while we won’t chase market share, we believe these are the times when you can drive higher risk adjusted profitability. We also believe shifting our book more towards loans from leases isn’t a bad thing during the time of following used vehicle prices and lower residuals. Origination yields are up to 6.1% in first quarter and I expect that to drift higher in 2Q and in fact we’re already seeing much higher yielding loans than April. That benefit will obviously expand NIM overtime. Our lease yield came in lower that we would have expected six months ago, but a bit better than we guided on the March call as we saw used vehicle prices improve late in the quarter. The April market has also recovered closer to our expectations, but we continue to carefully monitor. Bottom line is, we're eyes wide open with perspective for the backdrop of auto lending. New vehicles sales pleating, used vehicle prices declining and credit can’t get much better. We got mitigating factors within auto, that I'll touch on it in a minute, and then outside of auto which is where we’re focused growing strategically repositioning the company, I continue to see tremendous opportunities for long-term earnings. Self-help drivers of liability and capital management will propel earnings as well as expanding our other businesses. For example, our corporate finance assets are up 23% year-over-year and pretax income doubled for that segment. We launched our Clearlane, online marketplace to push more into digital and direct lending within Auto. We're aligning with emerging digital and consumer trends, and while relatively small today, it could be a very different model in the future. Ally Invest, which is being rebranded from TradeKing, will be a fully integrated launch this quarter and you'll see a lot of our marketing efforts support the launch. I see Wealth Management is a hug fit with our deposit customer base and influx of millennials into our brand. So we continue to move down our strategic path, grow customers, align with digital trends, diversify the revenue stream and strengthen the franchise. This positions us very well for the future to drive long-term shareholder value. Let's look at Slide 5 and a few of the current hot topics. First used vehicle prices. We've been saying for a few years that we expect used vehicle prices to come down, the supply of off-lease vehicles continues to increase, inventory levels have increased, OEM levels of leasing and incentives have increased. As a result, we saw used vehicle values decline around 7% year-over-year. We've been adjusting our residuals for several years, so that isn’t unexpected relative to where we set residuals three years ago. That's why we're still experiencing nice yields in this 5.6% to 6% range. We're also becoming much less exposed to lease residual value volatility as our portfolio declines. It's an earnings offset with a significant derisking of the balance sheet. Don't get me wrong, we like the leasing product given proper industry fundamentals, but it can cause some variability at times and frankly, this is one of those times. It's also important to keep in mind that we detailed a path to get an extra $1 billion of net financing revenue by 2019. An extra 1% decline in used vehicle values beyond our expectations is worth around $25 million or $30 million in 2019. Obviously, that matters, but it's very manageable. To provide even more context, in a couple of years, the retail loan portfolio should be 9 to 10 times larger than lease portfolio. So a 10 bases point of loan margin expansion is equal to about 100 basis points of lease yield variability. So we watch values, they can cause some variability in any given quarter that we have to adjust for, but relative to other long-term financial drivers, not one of the more important ones. Next topic, credit. We spent a lot of time on this on the financial outlook call. There is really no significant update beyond what the team had already said. We're seeing losses continue to increase on a year-over-year basis, and we’ve some deterioration in the lower credit years. We typically see some improvement in the spring, and we are starting to see that the seasonal improvement now plus the fact with tax refunds finally caught up to prior years. We continue to expect the year-over-year loss increases to decline throughout the year. We're offsetting these higher losses through higher yields, very focused on pricing for risk and you've seen that steadily come through on a portfolio level, but from an origination perspective, we're starting to see more significant improvement on new vintages. That sets us up for well for the future as older vintages roll off and newer vintages are added. We’ve also continued to adjust underwriting strategies on some underperforming pockets of the portfolio, which has resulted in some modest absolute risk reduction and should also reduce volatility. The markets are very focused on subprime or non-prime auto, but for context our non-prime auto loans represents less than 8% of the total loan portfolio. We have a large commercial auto portfolio, we have a growing mortgage portfolio, growing corporate finance business and a large prime auto loan portfolio. These areas have very low losses and are generally pretty stable. So we continue to see good opportunities in full credit spectrum retail auto, but we’re focused on reducing potential volatility to demonstrate we’re going to stay profitable through to the cycle. Last main topic on the slide, weather losses. Relative to what we said on the financial outlook call, this was one area of un-favorability given the late March hailstorms that hit some of our dealer customers. Weather losses were the worst we’ve seen in 20 years, 16 million higher than last year and 30 million higher relative to the average over the last seven years. So, it cost us between $0.02 and $0.04 depending how we look at it. We also took a hit in 2016 that was worse than expected and worse than the seven year average we planned against. This is another area where we like to reduce volatility, so we entered into a reinsurance agreement, its effective April 1, for a 12 month and limits our losses on a quarterly basis. That should give some increased confidence around our noninterest expense numbers for the rest of the year. We want to do want can to focus on the core strategy and financial upside in this company and eliminating volatility caused by weather losses should help. The insurance business is still expected to be profitable with the reinsurance cost and we’ll look to bring dealer premiums higher to help offset. And with that, let me hand it to Chris for a more details on the quarter.

Thanks, J.B. I'll start on Slide 6. In general, results were mostly in line with our guidance from last month. Provision of $271 million was a touch better given some late quarter favorability in our legacy mortgage book and auto losses came in towards the lower end of our expectations. Noninterest expense of $778 million was about 15 million to 20 million worse than expected given the weather losses that came up late in the quarter. Take a step back and look at the overall year-over-year trajectory. Total revenues were up about 50 million given growth in the auto loan portfolio as well as additional wealth management and corporate finance revenue, that’s despite the big headwind and lower leasing revenue which should normalize next year. That’s being currently offset by about 50 million in higher provision given the portfolio of mix shifts since 2015. And noninterest expense is up as we continue to invest from the long run across our businesses that includes the auto business, technology, wealth management, mortgage, deposits and the Ally brand. As J.B. mentioned, this is a transition year, as we get into the second half of the year and even some in the second quarter, you should expect to see revenue accelerate beyond any increases in provision and expenses to drive strong EPS growth. Much of that is the self-help path of the deposit growth and bringing down both unsecured and secured wholesale funding, plus we’ll get the benefit from buying back the stock. As we’ve been saying the medium and long-term financial path remains intact. Looking at the longer-term trend on Slide 7. These are key financial results since we went public in 2014. In general, we’re headed in the right direction across these metrics. EPS decline in this quarter is not in line with our expectations, but that is expected to rebound nicely as we progress throughout the year, given some of the self-help drivers I just mentioned. Revenues are trending up, deposit growth has been great and adjusted tangible book value continues to drive higher, finishing the quarter at around $26.60 per share, which is up around 30% since our IPO. Let’s look at net interest margin on Slide 8. NIM was up slightly from the prior year and up 4 basis points from 4Q. As we've been discussing, the least headwind continues to be offset by higher retail and commercial auto yields. Retail auto yields are up 35 basis points year-over-year to 5.66%, and we expect that increase to continue. In the first quarter, we booked $8 billion of loans with an average yield of 6.1%, which will obviously drive the portfolio yields higher. While there has been a lot of discussion around lease gains which were almost $60 million [ph] lower in the first quarter of '17 versus '16, the lease yields still remains strong at 5.7%. On the liability side, strong deposit growth continues to be the key factor as we bring down higher cost debt and fuel modest balance sheet growth. The combination of higher yields on retail auto and more efficient funding will drive NIM higher as we move forward regardless of the interest rate curve. On Slide 9, we posted record deposit growth this quarter of $5.5 billion, taking total deposits over $84 billion. Around $1 billion came from the suite deposits that we mentioned from TradeKing, which is being rebranded Ally Invest. On the rate side, we were down two basis points year-over-year. More recently, we made some minor adjustments to some of our rates to make sure we stay in the competitive set and continue to drive customer growth, but clearly deposit rates are lagging what's happening with benchmarks. Additionally, we have really begun to see the expansion in asset yields that is outpacing any rise in deposit rates. Customer growth was very strong, and we ended the quarter with $0.5 million millennial customers. Capital ratios on Slide 10 have been fairly consistent for some time as we generate earnings and distribute capital to common shareholders. Risk-weighted assets have picked up a few billion dollars over the last years, mainly from higher dealer inventories, increasing the commercial floorplan balances. This is now the third quarter of our approved 2016 CCAR capital plan and we continue to buy back stock at a solid pace. And as others have mentioned, you'll notice some compensation-related share issuance this quarter. The DTA also continues to come down at a nice pace and we'd expect to fully utilize that sometime in mid-2018. Let's look at asset quality on Slide 11. The consolidated charge-offs came in at 86 basis points this quarter, up from 64 basis points last year. Coverage remained flat at 97 basis points as an increase in retail auto coverage have been offset by a decrease in mortgage coverage. Moving forward, we do expect retail auto coverage to increase with higher expected charge offs. We guided you to loss rate in the 1.4% to 1.6% range, so obviously coverage will need to keep pace. Provision for the quarter was $271 million. We were slightly below our recent guidance driven by a reserve release on our legacy mortgage portfolio, which continues to perform well. And as a reminder, our legacy mortgage book has a balance of $2.6 billion and sits in our corporate and other segment. On retail auto, our 30-plus day delinquencies came down almost 30% from 4Q levels. Remember, this is a point-in-time metric, so you can't read too much into this one data point, but it supports our view that losses and delinquencies are moving higher based on our mixed shift, but it's going to be very manageable, particularly given the additional yield we’re picking up. Retail auto net charge-offs were 1.54%, up 46 basis points year-over-year, but we continue to expect the magnitude of year-over-year increases to decline throughout the year. On Slide 12, Auto finance reported $288 million of pretax income, down $49 million from last year. The lease headwind we’ve been discussing drove over a $100 million lower net lease revenue, but the higher yields and balances on retail loans and the yield pick up from commercial helped keep net financing revenue relatively flat. Other revenue was up driven by some additional loans sales we executed, which we do from time-to-time. Our provision expense was up versus the prior year driven by higher charge-offs from the mix shift and seasoning of older vintages. From an origination perspective, we had robust used volume which made up nearly half of our originations this quarter. It's important to keep in mind that the used opportunity is significant. Used car is running over 40 million units and generally trending up. The increase in off-leased vehicles has gotten a lot of attention, but a three-year-old vehicle hitting a dealer is a great financing opportunity for us. Our used book has been very profitable. Leasing and used vehicle prices are hot topic and J.B. hit the key themes, so I'll just mention a few points. The pressure from used vehicle prices impacting our auction proceed improved mid-March to April, which you can see on the bottom right of the slide, where we had losses in February, but are now getting a few hundred dollars of gain per vehicle. As a reminder of our process on accounting for residuals, we initially set them at the time of origination, which is typically three years ago, and then we make depreciation adjustments over time to get close to a zero gain at the end. We missed our expectation to the upside for the last few years and in 1Q got pretty close to that zero gain level and a 5.7% yield. That's a little below where we would have expected, but it's still solid. We continue to watch manufacturer production levels and are encouraged given some of the recent statements by manufacturers about cutting production to manage days of inventory, and we're also watching incentive levels. Those fundamentals are important to the industry backdrop and overall health of the auto ecosystem. We show our key auto metrics on Slide 13. We had a solid quarter of auto originations and landed around $9 billion, basically flat versus last year, as we continue to optimize the portfolio. From a channel perspective, GM was 32% of originations, the lowest it's been in our history as the manufacturer has pushed more incentives through its captive. The Growth Channel, which is non-GM Chrysler, we built-out a few years ago, is really paying dividends and was 40% of our originations this quarter. Let me touch on some balance sheet dynamics you'll see on the bottom two charts. First, on consumer assets, we expect lease balances to decline at a similar pace until that stabilizes in the $7 billion to $8 billion range. Second, commercial auto balances are on the $39 billion. We expect this to decrease later this year as you've heard manufacturers mention inventory levels need to be managed down which overall is a good thing for us and the industry. On Slide 14, insurance reported pretax income of $40 million. As we've mentioned earlier, the driver was severe weather-related losses we experienced in late March. On March 26th and 27th alone, hailstorms caused nearly $19 million of weather-related losses. The reinsurance agreement we now have in place allows us to continue to offer this product to our customers but also reduces volatility for our earnings profile. To be clear, we will still experience weather losses, but the reinsurance will limit these losses to our planned historical seven year average. Written premiums were $240 million this quarter, up 8% from last year as we increased vehicle inventory rates and dealer floorplan balances remain elevated. Moving to Slide 15, our Corporate Finance business continues to perform very well and contributed $25 million of pretax income up $14 million from the prior year. The portfolio continues to grow and was up 23% from last year driving higher net financing revenue this quarter. Other revenue increased as we continue to generate strong loan syndication and fee income and we realized an investment gain on equity stake we held in one of our investments. Asset quality remains strong, and provision was up from the prior quarter due to asset growth and some recoveries experienced in the fourth quarter. This business has an average annual net charge-off rate of less than 10 basis points over the past decade with a peak loss rate of 32 basis points during the last recession. We expect to continue to grow this business and hired an experienced team in the healthcare real estate space this quarter to support our growth initiatives. J.B. continues to emphasize the company's diversification efforts, and Corporate Finance is a perfect example of the business that we expect to double over the next few years. Given our experienced management team, solid business relationships and declining cost of funds, we expect this business to be a major contributor to earnings growth as we move forward. On Slide 16, our mortgage business earned $9 million of pretax earnings, up $7 million from last year. Asset balances were up from prime jumbo bulk purchase activity, driving net financing revenue 25% higher from last year while credit performance remains strong. Bulk purchase activity in the quarter slowed a bit given some competitive market dynamics, but we see a decent pipeline and expect that too pickup in the second half of the year. Non-interest expense was up from the prior year as asset balances grew and we invested in Ally Home, our direct-to-consumer product offering. Volume in the direct channel is expected to ramp up overtime as we test and refine the operations and increase marketing through the year. And with that, I'll turn it over to J.B. to wrap up

Great. Thanks, Chris. So overall, was a decent quarter, but we can do better as we focus on our plan for driving strong shareholder returns. The ingredients our plan remain consistent. We've been optimizing the mix and our retail auto lending to successfully offset the lease decline. And you can't just look at losses, you have to look at yields and we're positioned to be solidly profitable in auto finance even as certain cyclical dynamics play out. We also know we need to demonstrate that our loss metrics are contained within a range. We don't want to run a long-term business by managing one metric, but we're operating with a knowledge that the market is very sensitive to anything credit related. Taking care of customers, growing the customer base solidifying relationships, adapting to what they're looking for in banking relationships, investing in technology, this will ensure we thrive over the long term. We're also committed to delivering our medium-term financial targets of 15% EPS CAGR and a 12% core ROTCE. It's not going to be a straight line, but those are the kind of the metrics embedded in this franchise and the opportunities that we have. Deposit growth, paying down high cost debt and buying back lots of stock remain key components in getting there. For tax and grow book value per share, we’ve increased book value per share by $6 since the IPO and we expect to see that trajectory continue. We've got hard assets too and no contingent liabilities. So I'm confident that with discipline, financial and operational execution and relentless focus on the customer, the stock will perform and multiple expansions will be realized. Strategically, we need to realize more value from this fantastic brand we developed. Deposit and customer growth have been phenomenal and that's a key long-term driver. We're doing more with this brand, and we'll use it to further diversify and strengthen the franchise. Over the next couple of years, we expect to demonstrate our ability to grow and diversify in a responsible, capital-efficient way to further improve profitability. And we remain committed to appropriate capital allocation. We're building this company for the long-term, making some investments in the franchise, but we're going to continue to lean heavily into share buybacks, particularly with the stock as cheap as it is. And with that, let me hand it back to Michael Brown and we'll start some Q&A.

Thanks, J.B. As we move into Q&A, we request that you please limit yourself to one question, with a single follow-up. If you have additional follow-ups, after the Q&A session the IR team will be available. Operator, if you could please start the Q&A session?

[Operator Instructions] Our first question is from Don Fandetti of Citigroup. Your line is open.

Yes. Jeff, can you talk a little bit, on used car pricing, I think you baked in a 5% decline in your assumptions, I think you noted that on the credit call. And can you also talk about sort of the used car pricing outlook for next year? I think GM is saying, maybe if you get 7% down this year and then down only 2% to 3%. Can you talk about year-over-year?

Yeah. This is Chris. Let me take that one. We think of 2017 as a bit of a transition year where the off-lease vehicles are much higher this year than they were last year. And because of that, we saw somewhere in the 6% to 7% decline in the first quarter and we expect that magnitude of decline to really persist through 2017. As we think about 2018 and 2019, we think cumulatively it's probably another 6% to 7% for those two years. Now there are a lot of variabilities in that, in particular, manufacturer production levels and how they manage the inventory on the lots. But right now, we think that 6% to 7% persists throughout this year, then we think get another 6% to 7% over the next two years.

Our next question is from Christopher Donat of Sandler O'Neill. Your line is open.

Just in terms of your origination mix and the increasing part of used, is that something that -- I don't know, is there a cap to how you think about the mix of originations in used or would you prefer giving your growth channels to go above 50% even to 60% used if the opportunity looks that way or the dynamics in the new market look different?

Yes, there is no cap, we’re just shy of 50% today. The used book has performed extremely well. It's a very predictable loss book, so we're very comfortable in that space. It obviously helps drive the growth channel. Our dealer relationship is really where the dealers make most of their money. So we're fine seeing that drift up over 50% and getting to the 50% to 60% range. So no cap on that.

Okay. And then just since you mentioned dealer share. Historically, there has been very little risk to the dealer. Dealer is financing part of it, but we are seeing these rise in inventories and I know the manufacturers are talking about cut in production at some point, but do you have heightened concern around risk associated with lending to dealers at this point or is that -- do you feel pretty comfortable there?

Hey Chris, it's Dave Shevsky. We still feel really, really comfortable there. Each year, we have a pocketful of dealers on our watch list. We got a very robust risk management framework data, around that. So we haven't really seen any real jump. But yes, because of what you outlined, I mean, it's certainly a focus of ours to make sure that we have good performance in that. And then commercial is very different than the retailer we're talking about because with commercial, you have so much bootstrap collateral and other protections that even if something goes bad, it generally don't take a loss because you're overly collateralized.

Our next question is from Moshe Orenbuch from Crédit Suisse. Your line is open.

There has been a fair number of reports of banks, several medium sized, some even large ones pulling back in auto lending. And I guess, how much of that you're seeing? Is that a contributor to what you have already seen indeed, will we see it in volumes? How do you foresee that affecting your business?

Yeah, we're seeing it, but I just want to reiterate, it’s still competitive market out there. You still have some big players who are across this spectrum that are playing in this space. I think there is a more cautious tone across the industry. You've seen some other originations come down this quarter. I think it helped us take a little price. We are not focused on market share at this point, we’re focused on really on improving our overall returns. So, I think you'll see it -- from our books perspective, you're going to see it more on the margin than you'll see it on the originations.

Right. And then just Chris, to your comments about the fact that credit losses should be increasing at smaller kind of year-over-year increments. Could you maybe just kind of flush that a little bit, what's the driver there and how should we kind of think about what [Multiple Speakers]?

Yeah. One of the ways to think about that is, when we made the change in our originations back to 2015, a vast majority of our originations or our portfolio will now be made up of 2015, 2016, and 2017 vintages as we go through 2017. So pre '15 vintages are really starting to fall off. So, the overall book has a very similar kind of loss content. So, as we give that guidance of the 1.4% to 1.6% range, we expect that to kind of start flattening out. So, we think as you get into the 2Q, you still going to see an increase, but I think it's going to be more dramatic as you get later on in the year.

Thank you.

Yeah. I'll just add to that. As we get into 2018 and 2019, you'll see it really flatten out.

The next question is from Rich Shane of JPMorgan. Your line is open.

I'd like to talk a little bit about the NCO rate and how we should be thinking about that. Roughly a month ago, you guys provided guidance of 140 basis points to 160 basis points of losses on the auto book, in this quarter, by your numbers it was 154 basis points. Historically, Q1 has been a quarter that was slightly below the year number, suggesting the number for the year towards the high end of that range. The other thing I would observe is that the year-over-year increases in loss rate has actually been accelerating essentially over the last four quarters. Curious to think about the trajectory in 2017, and what are the factors that could put you above that high end of 1.6% or what might mitigate this as we move through the year when you looking at the book?

Yeah as we look out, 2Q will obviously be seasonally lower. So we expect to see that drop off -- the magnitude of that drop off to really happen in 1Q to 2Q, and then like we said, a lot of this has to do with our expectations [ph] that the loss rate was start to really fattening as we get into the second half of the year. You're just not going to see as big of a year-over-year increase. That's why we give a range of 1.4% to 1.6%. We think we’re somewhere in the middle of that range, but there is variability. And Rick, we talk about this internally as well, what can change that. The biggest factor is probably on the severity, right which is where our recovery rates -- what are we experiencing the recovery rates for some of our repo vehicles. So, we watch that closely and as we look at and we think about 6% to 7% decline in used car prices, we're comfortable within that range. But if for some reason, we're on that either to the positive or the negative, we think it will sway within that range.

Yeah, look -- I mean, you guys have conference call a week later weather roles through that you can't predict. So, we understand there is some variability there. I guess, the one question or the follow-up question would be, you didn't see in Q1 the magnitude of seasonal improvement that you normally get from Q4? Should we be thinking about Q2 not getting the normal seasonal improvement as well and then the second half doing a little bit better versus what you would expect seasonally?

We're early in the quarter, but we still expect to see the seasonal drop off in 2Q that would be significant. And we think the magnitude of 2Q charge-offs on a year-over-year basis will be significant less than what we saw in 1Q.

Thank you. Our next question is from Sanjay Sakhrani of KBW. Your line is open.

Just a quick question on the lease yields. Obviously, it's a little bit of moving target and we’ve to recalibrate again on the range. Could you just talk about what gives you the confidence this time around that you guys have tightened that range and at used car prices actually won't declined more than what you guys are expecting? And then when we look at the remarketing gains and the movement of those remarketing gains versus used car, I mean, obviously there is a big disparity between the two, does that narrow now? Thanks.

Yeah, I mean, digging about the lease yields, the portfolio is getting smaller. We've seen a pretty dramatic drop in used car prices in the first quarter. So it's providing us a little bit more comfort that we're understanding what's happening in the marketplace to adjust to this increase in off-leased vehicle supply. So we're gathering more comfort, but there is still variability there and like I said, we're encouraged with what the manufacturers said about production levels, but we obviously have to see that come through and that could obviously effect what we really see on this used car prices. So right now it's our best estimate, but there is variability there really based on the OEMs. So moving forward, we feel pretty good. Now we’ve showed you a little bit in the earnings presentation how we've seen things firm up already in April. It's something we were expecting when we did the financial outlook call last month, so it's coming to fruition. So I'm feeling better about 2Q leasing yields and where gains will be and therefore following through the yields, but there is still obviously variability in the second half of the year.

And I guess, just the actual residual value assumptions you guys have made. I mean are they much closer to where the actually experience is today?

If you go back three years ago, we were obviously predicting used car prices to come down. So we have gotten more conservative in the way we set the residuals for the cars that are coming off this year than they were coming off in '16. So I think that's a very important factor. Keep in mind though, we moved depreciation rates around and we did that a bit in '15 and '16 when we saw the used car prices better than expected, so we took some of that into income. But overall we feel pretty good about coming closure to this kind of 0% gain.

Okay. And then just one quick follow-up, sorry. The gain on sales of vehicles, that was a pretty strong number relative to even the number you had a year. Could you just talk about the sustainability of that number as we move through the rest of the year? Thanks.

Yeah, Thanks, Sanjay. And the way I think about that is, whether it's through securities or the sale of loans, we tend to have somewhere around $40 million to $50 million of gain on sale in our other revenue number on a quarterly basis. We did a little bit -- we experienced a little bit more gain on sale on the loan this quarter, a little less on the security sale. I think while going forward a good rule of thumb is $40 million to $50 million of gains whether it's through securities or through the loans, so I think that is a pretty consistent number this quarter.

Next question is from Betsy Graseck of Morgan Stanley. Your line is open.

A couple of questions on couple of different topics. One, on deposit growth that you got. I know you're looking to pay down some of the higher cost debt. Could you give us sense of the cadence throughout the year of that debt pay down that you're looking to do? I know you put that total in your slide deck, but just wondering what quarters that's going to hit in?

Yes we had a pretty significant depreciation -- sorry, maturities in the first quarter. You didn't see that fully effected in NIM because most of it was already happen throughout the quarter. So, you're going to see that really hit our cost of funds as we get into the second quarter, which we think is a real positive to net financing revenue. But then, as you lookout throughout the year, most of it is back ended. So as an example, we have a very big six in a quarter coupon billion-dollar deal that comes off in December. So, it's our maturity seclude is public, you can get it out there. But most of the pay down is in the back half of the year and the rest of it.

Okay. And then when you talked about acquiring the new contracts for reinsurance contract volatility of the insurance claims. Could you give us a sense as to how material that's going to be?

From an earnings perspective, we don't think it's going to be overly material. We've obviously experienced some weather losses over the last, what I would say six or seven quarters that had been worse than our 7 or 10 year average. So, we felt that it made sense to pretty much cap that and just make our earnings a bit more predictable as we move forward. We also think that some of the cost of that the reinsurance will get passed on through just increases in our premium store dealers.

I just add to that last part. I mean, we were pretty aggressive in premium increases last year impacting account this year we’ll obviously go back and do even more, but that's really -- that offset will come more in 2018 well this year. But, I think as Chris pointed out, I mean, it's pretty manageable in the context of overall earnings here. And I think the design was we just tired of all the cost involved and obviously, weather, the past several years, several quarters continues to be more and more unpredictable, so it was time that we just put reinsurance back in place.

Got it. Okay. And then just lastly, your mentioned during the prepared remarks about corporate finance and the expectations that this is going to be a growth driver. I seeing a buildup in the cash on the balance sheet not obviously high-yielding. So, wanted to understand your comments and some of the different colors you can give us around the corporate finance business and how you're planning on accelerating growth there?

Sure. We have a very, what I would called, experienced team in that spot, that's been a part of company since 1999 and this is really a relationship type business and this team has got a great reputation for its speed and reliability in the market. And as you've seen over the last year, we've added a couple of small teams to that as well. And when I think about the space because we're a bank and we have really the right cost of capital, we tend to play on really the first lien part of this, so kind of top of the stack, but we're seeing some great business flow and given those relationships, we think we can continue to grow and really play, what I would call more lead agent type roles, that should drive incremental fee revenues as well.

Okay. Just interesting because you know many other institutions are have trouble driving growing that in line item right now, so I'm just wondering is it more of a sale person acquisition model that's driving your growth?

Yeah, I mean Betsy, that's certainly some of it. I mean obviously, there has been some large former competitors that have sold their businesses, and so teams there, therefore look for new home and Ally was a nice bet, particularly that we have this business inside the bank where it can take advantage of very attractive cost of funds. So we've been very tactical and hired several teams over the past year. But I think as Chris points out, our core leadership in this space, you know 30 years plus experience has been around for a while. But now it's really a push in into saying this was a growth business, these can be very attractive market for us. And so you've seen I think an increase of about $600 billion in assets over the past year and I more look at the $3.5 billion balance sheet today there is no reason why that shouldn't be $7 billion, $7.5 billion over the next 2.5 years.

Our next question is from Eric Wasserstrom from Guggenheim Securities. Your line is open.

Chris, can you update us perhaps on where things stand with respect to bank and its capital requirements and any limitations that continue to exist on originations?

Yeah, Eric, it's J.B. I mean, on asset origination limitations those are now completely gone and so we are booking more or less everything at the bank today. So there is one remaining covenant that's in place, that's obviously the maintenance of 15% Tier-1 leverage. And I've been saying for about a year that we remain in active dialogue and discussions with our regulators. I'd say that, that continues certainly to be the case optimistic this will get cleaned up and addressed at some point in the very near future.

And does that leverage constraints influence how you're approaching any of the dynamics around returning some of the upcoming debt?

I mean, it's really the avoidance of having to refinance that debt. I mean, that's a big one. So really for us to take full advantage of the deposit base and be able to retire the unsecured, that's really key ingredient. But I think we speak with pretty high degree of confidence that will come to fruition.

Our next question is from Ken Bruce of Bank of America. Your line is open.

On the cost of benefit line, is that -- do you expect that to be a good run rate or is there anything that's kind of seasonal onetime in nature that in that line item this quarter?

Yeah. There is definitely a seasonal component of that in the first quarter because of just things like FICA taxes and 401Ks [ph] and things like that in the first quarter. So, we do expect that to drop somewhere in the $15 million to $20 million range and that should be more of what I would call steady-state throughout the year.

Great. And then, the improvement in the net gain loss per unit on the lease vehicle, do you think that that is in a sense reflection of the tax issue that obviously kind of created a little bit of stop in the industry in the first quarter or is there something more dramatic just in terms of what you're seeing on the residuals that are already baked into leases? If you can give us little understanding to maybe what's driving, that would be helpful?

Yes, it's -- and I'll let Dave jump in here as well. It's hard to tell, but obviously, the tax refunds catching up we think was a positive. The other thing that we deal is just the seasonal dynamics, meaning coming out of winter months into kind of March and April tends to result in more used car sales and just better pricing and that tends to be a seasonal nature.

Yeah. I mean -- that's exactly. Chris, I would say it's more of a spring selling season than the tax rebates, which had a little effect on it.

Our next question is from Jack Micenko of SIG. Your line is open.

Chris, I think in your prepared comments, you talked about some operating leverage in the back half of the year. I'm wondering if you could maybe put a sharper point on that as it relates to efficiency ratio for either the back half of the year or the year?

Yeah. We do expect the efficiency ratio to start trending back down 45 or even under. I think I guided last call that we would have expenses somewhere around $760 million per quarter with an additional $50 million in the second quarter, because of weather losses. So, I still think that's a pretty good run rate. But as we get into the second half of the year, what you're really going to start to see is the expansion in net financing revenue and that expansion will come on a pretty consistent expense base.

Okay. And then it looks like the broker deposit mix ticked up both quarter-on-quarter and year-on-year. Is there any strategic shift there or what's driving some of that about average growth?

No, one of the pieces of that is our TradeKing, our Ally Invest deposit. So they are considered somewhat brokered deposits. So you have to take that kind of $1 billion or $1.2 billion out of that. We did take advantage of some incremental broker this quarter as well. One of the reasons we did that is just because of the elevated dealer floorplan balances that we expect to come down. So sometimes we use broker as what I would call a temporary funding kind of during higher floorplan months.

Our next question is from David Ho of Deutsche Bank. Your line is open.

Just wanted to follow up on the flexibility have allowed the bank to originate full spectrum at the bank. And I think you mentioned at the last call that you were going to in the short term, do a little more lower FICO and you saw a little bit of pick up in the non-prime and maybe a little below. Is that still the plan, just given your comments earlier about tightening underwriting standards structure on the margin as well?

Hey David, it's Dave Shevsky. We have the ability to book those assets in the bank, but we've actually been taking as a percentage, non-prime actually down from right around 14.5% to spending at around 11% today. I would say that our position in credit is cautioned and non-prime, especially non-prime new vehicles that have high advance rates, we're cautious on those, I would say, we are not going to be increasing that segment.

And our ability to funding the bank really has no decision on that.

Yes. And again I think other important thing is, the yields we're getting on these assets today are substantially higher than just the last couple of years.

Got it. And switching over to the commercial floorplan growth trajectory. I know you mentioned that potentially lower inventory levels at the OEM translate into dealer inventories coming down little bit. Obviously, it's been a very good growth, year-over-year the last few quarters here but how do you expect that to trend if some of these -- you're projections or opinions on the dealers play out?

Yes, it's obviously elevated because of the dealer floorplan balances just elevated on dealers' lots today. Our expectations is it will come down a couple of billion dollars as we get into the middle of the year. And we are obviously hoping that OEMs stick to what they said and close down some of their production plans for retooling, which we think will be the right thing to do and really help the overall dealer lots and bring their days of inventory down. So we expect couple of billion to come down.

And then just one more if I may, just really quickly on the 2015 vintage or so, how big are they as a percentage of losses? I'm not sure if you had disclosed that before, but [Multiple Speakers]?

Yes, David, I think based on the last update call, we said it was probably right around two-thirds to maybe 75% of loss content coming through. And it's going to start declining because as we move out into the year, you're going to see '16 then coming in as well. The loss content in '16 and '17 or '16 and '15 are pretty close. So the big difference though is the yields on '16 is dramatically higher than '15.

Got it thanks.

And operator, I think we got time for one more question?

Thank you. Our next question is from John Hecht from Jefferies. Your line is open.

Most of my questions have been asked and answered. I guess, one question just in terms of modeling is on the reserve build. I think you said the reserve build should track the increase in charge-off guidance. And just specifically, what does that mean? Does that mean reserves as a percentage of ALLs should be up similar to the trajectory of charge-offs or we should more model this towards about four quarters coverage or something of that nature?

We look out a year and if we think our losses are going to settle in this 1.4% to 1.6% range, and we think it will settle in there and start to flatten as you get into '18, Then obviously we need coverage that’s going to be greater kind of that level. So depending on where we fall, we’re going to have to continue to kind of increase coverage a long with this. I'll cover today is 1.43 [ph], so it's obviously lower end of that range, so we’re going to have to move that up and you'll see that really get done on our quarterly basis.

Okay. That’s very helpful. Thanks. And then second question is, forgive me if you have mentioned this, where do you see your lease book? I know you gave some ratios of leases to loans in a couple of years. But where do you see the lease book at the end of this year?

We see it around 8 billion, I think just a little north of it.

Okay. Great. Thanks very much guys.

Okay.

Thank you. This ends the Q&A portion of today's conference. I’d like to turn the call over Michael Brown for any closing remarks.

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

Ladies and gentlemen, that concludes your participation in today's conference. This concludes the program. You may now disconnect. Have a wonderful day.