Good day, ladies and gentlemen, and welcome to the Q4 2018 Ally Financial Inc. Earnings Conference Call. [Operator Instructions]. As a reminder, this conference call may be recorded. I would now like to introduce your host for today's conference, Mr. Daniel Eller, Executive Director of Investor Relations. Sir, you may begin.

Thank you, Operator. We appreciate everyone joining us this morning as we review Ally Financial's fourth quarter 2018 results. You'll find the presentation we'll reference throughout the call on the Investor Relations section of our website, ally.com. On Page 2 of the presentation, I'd like to direct your attention to our forward-looking statements and risk factors. The contents of our call will be governed by this language. On slides 3 and 4 of the presentation, we've included some of our GAAP and non-GAAP or core measures. These and other core measures are used by the management team, 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. Today, we have our CEO, Jeff Brown; and our CFO, Jenn LaClair, on the call to review our operating and financial results. We do have time set aside after the prepared remarks for Q&A. And with that, I'll turn the call over to Jeff Brown.

Thank you, Daniel. Good morning, everyone, and thank you for joining our call. Let's begin with a recap of 2018 on Slide #5. 2018 was a year of disciplined execution and measurable progress for Ally. The foundation for success we built over the past several years is evident in our operating metrics and financial results. Adjusted EPS of $3.34 for full year 2018 was an increase of 39% year-over-year. Core ROTCE of 12.3% was up over 250 basis points compared to last year. And our adjusted total net revenue exceeded $6 billion in 2018. These reflects reflect: number one, the impressive and growing earnings power of our dominant franchises and market positions we continue to optimize; number two, the ongoing momentum in our new product areas and overall success of Ally Bank in the direct banking space; and number three, the continued focus to optimize the capital structure and drive long-term value to our shareholders. In Auto, we originated $35.4 billion of loans and leases in 2018, maintaining our industry-leading position while expanding risk-adjusted margins. Auto continues to be a great business for us, fueled by deep relationships with our dealer customers and our consistent focus to make them and the OEMs even better. Through mix and pricing, we drove estimated originated retail auto yields over 7% in 2018 compared to 6.2% in 2017 while the credit profile of originations remained consistent. Our dealer base and application volumes have grown every year since 2014. In 2018, we decisioned a record 11.6 million applications sourced from nearly 18,000 dealers, which drove our increase in full year origination volumes. We've had steady progress in our diversification efforts where the Growth Channel in used volumes increased consistently in 2018. I also want to point out that within the Growth Channel, over 1/3 of…

Thanks, J.B. Let's turn to Slide 8 to review our detailed results. Q4 results were solid and trended in line with our expectations across every line item. Net financing revenue, excluding OID, was $1.163 billion in the quarter, up $34 million linked quarter and up $50 million year-over-year. We grew net interest income every quarter this year and grew earning assets 3% and 8% on a linked and year-over-year basis. Adjusted other revenue of $393 million was up modestly compared to Q3 and the prior year period. Provision expense of $266 million increased by $33 million quarter-over-quarter, reflecting the expected seasonally higher net charge-off activity while declining $28 million versus the prior year. Throughout 2018, and again this quarter, the year-over-year trends reflect our improved loss experience in the retail auto portfolio, driven by disciplined underwriting and collection activities, along with a favorable consumer and macroeconomic backdrop. Hurricane-related activity has largely run its course through the numbers with no meaningful impact in Q4 results and about $10 million remaining in reserves. We'll provide some more detail on our credit metrics in a moment. Noninterest expense was down on a linked-quarter basis and up compared to the prior year quarter. Drivers of higher year-over-year expense consisted of items we've discussed in the past, including: growth in volume and revenue-based activities; continued investment in our brands and core businesses, including the ongoing enhancements to our digital and tech capabilities; and the build-out of adjacent product offerings, where we have invested prudently, and we remain focused on driving scale over time. Looking at key metrics for the quarter: GAAP and adjusted EPS of $0.70 and $0.92 per share, respectively; core ROTCE of 13.4%; and adjusted efficiency ratio of 46.9%. Our tax rate was 21.5% this quarter, resulting in a full year tax rate…

Thanks, Jenn. It has certainly been terrific progress and results during your first year in the CFO chair. On Slide #24, I'll walk through our strategic priorities for 2019, which represent the how in achieving the financial outlook Jenn just covered. This year, we'll continue to build upon the momentum we have established as our strategic efforts are now in full swing. We are a comprehensive [Technical Difficulty] commercial finance provider with dominant franchises well positioned for the long term. Across the financial services landscape, it's clear that secular trends are increasingly migrating to digitally based products and services. Consumers expect simplicity and transparency and, more than ever, a focus on convenience and strong customer service. These have been cornerstones to our approach from the beginning. The customer remains at the center of our Do It Right mentality. 2019 will be our 100th year in auto and the 10th year since Ally Bank was launched, milestones that reflect our deep industry experience, the resiliency of franchises and true ability to take advantage of market opportunities. Within Auto Finance and Insurance, we'll continue optimizing risk-adjusted returns while maintaining a strong focus on credit discipline and future growth opportunities. On the deposit side and within our digital product offerings, you should expect that we'll continue to focus on customer growth and improvements in operating leverage, and we'll continue to be efficient in our capital deployment. Our culture is critical to our long-term success, and I'm particularly proud of what my teammates have accomplished across the company in 2018 and over the past several years. We'll keep our relentless focus on our customers, communities and shareholders as we move forward from here. So as we've entered 2019, I thought I'd share 5 simplistic reasons why Ally should have your support. One, we excel at managing credit. It's a key core competency established over the past 100 years and over a variety of economic environments. Two, we're adaptable. We've proven we thrive when a challenge comes our way. This adaptability has led to extraordinary and resilient franchises inside of Ally. Number three, we take care of our customers, new ones and existing ones. We don't take the strong retention levels and brand awareness lightly. This is deeply embedded in our beliefs. Four, we're using and investing in technology to our advantage. We see our digital strategy and capabilities as a critical component of our competitive strength and market position. And number five, financially, we're poised to continue a very positive trend. This is a credible team. We deliver what we say we will deliver, and we have 8,000 teammates focused on continuous advancement and improvement. We will continue to win by keeping our heads down and executing the plan. I am very proud and honored to lead our great company, especially as we embark on the next 100 years. Thank you, and I think we can now, Daniel, head to Q&A.

Yes. Thanks, J.B. [Operator Instructions]. IR will be here afterwards if you want to reach out with further questions. So operator, with that, let's begin the Q&A.

[Operator Instructions]. And our first question comes from Rick Shane from JPMorgan.

When we go back and look at the slide on the unsecured maturities, the '19 maturities are actually relatively low cost, but you have 7.5s and 8s maturing in 2020. Is there any opportunity to call those sooner and take advantage of the arbitrage between the deposit costs and refinancing those notes?

Rick, thank you for the question. Certainly, we look at liability management all the time as part of our routine ALCO process and appreciate your perspective here. As we look at other options to generate returns, it's definitely on the list where our stock is trading today at a discount to book value. We've been leaning heavily into share repurchases. Certainly, you saw that in Q3 when we increased our share repurchase about 3% and 16% since the inception of our buyback program. We just -- we really like the returns we're seeing from buybacks. Now we'll continue to look at liability management. And as you mentioned, through 2020, we've got about $3.7 billion coming due at a coupon over 5%. And with our very strong deposit performance exiting 2018 and entering 2019, we'll continue to accrete that value over time.

Got it, okay. And then just one follow-up question related to deposits. When we compare your deposit costs on sort of the digital banking model versus the brokered model of other consumer finance companies, it appears that there's about a 30 basis point advantage in terms of deposit costs. When you think about the operating and marketing expenses associated with operating that digital bank, does that actually net out to a positive return?

Yes. I mean, we're very conservative and prudent in terms of how we deploy our branding expense. We did have a promotion in Q4. I think we garnered multiples of what we were expecting in terms of balance sheet growth, and we're seeing strong retention on that investment as we've come into Q1. So I would say net-net, our strategy around deposits has been largely to lag some of the leaders in the space and to be prudent with our expenses around branding. And I think we're well positioned, and certainly, we feel very good about the trade-off between total cost to deposits and the volume we brought in, in 2018 and heading into 2019.

Our next question comes from Arren Cyganovich from Citi.

On retail auto, just curious what your outlook would be for 2019. You had moderate growth in 2018, and just curious as to the value you're seeing the momentum into next year.

Yes. Sure, Arren. Our strategy in auto is really not to chase volume but just focus on risk-adjusted returns. And certainly, here in 2018, we originated $35.4 billion, which is spot on with where we were targeting kind of -- to bring in volumes. And we're very pleased with new origination yields coming on at over 700 basis points, which is up over 80 basis points on a year-over-year basis, so very pleased with performance here in 2018. As we look ahead into 2019, still seeing a lot of opportunities to continue to have success with the strategy. Used continues to be a very strong strategy for us. We ticked up from 45% of our net used in 2017, up over 52% in 2018, and we'll plan to continue to focus on used and certainly focus on the Growth Channel, so seeing a lot of opportunity as we head into '19 and no change in our strategy. And certainly, you couple that with stable credit. We've been originating consistent mix of credit over the last couple of years, and we feel really good about positioning, both on volume and quality, heading into 2019.

And I guess just following up on your last comment on credit. You got it to the low end of the 1.4% to 1.6% in retail auto. What gives you the confidence there? I would think that the outlook for used car prices might be a little bit more negative than it has been recently.

Yes, sure. And certainly, we've been guiding towards deteriorating used car prices for some time now. In 2018, it outperformed. I think spot were up about 4%, average up about 1% in used vehicle prices. We've been anticipating that to trend down. We're supply-driven versus demand-driven, and that is incorporated into our guidance around hitting that low 1.4% to 1.6% range. So we agree with you, and we've thoughtfully considered that as part of our guidance heading into '19. Now you have to couple that with a lot of dynamics around the health of the consumer, J.B. mentioned, still performing very strong, credit rounding up. Fourth quarter was exceptionally strong, the net charge-offs down 26 basis points year-over-year, and we're seeing some strong trends as we head into 2019 as well.

Arren, the only thing I might add, just I spent time with a lot of auto dealers last week, is -- I mean, they are seeing pressure just how expensive new car prices have become, and you've seen the OEMs pull back to some degree on incentives that are out there. So part of that factors into us thinking that the used car market is going to hold up. I mean, Jenn alluded to, we continue to model for about a 4%, 5% decline in prices. But our outlook right now is that used is going to continue to have pretty strong demand, just given how expensive new car prices have become.

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

Jenn, want to ask one on deposit pricing as it looks like the Fed might not be likely to raise rates here, but I'm just wondering what was sort of embedded in your guidance as far as what you do with deposits. Should we expect kind of no change from here or does it really depend on what's going on in the competitive landscape or if you're able to generate solid yields off loans, does that also affect what you're -- how you're thinking about deposit? Just trying to get what factors are in play.

Yes, Chris. And I think you nailed it. Essentially, we don't have any additional rate hikes built into our forecast at this time. And assuming a pause from the Fed, we would expect to see some easing on deposit pricing coming into 2019. Now you got to take that in the context of the competitive landscape. We still have a desire to grow balances, and we've got a lot of liability management and optimization opportunities that are unique to Ally. So we're going to continue to lean in on deposits. We're expecting that there'll be some easing on pricing, but it's going to largely depend on the competitive landscape. Now certainly, we manage beta on both sides of the balance sheet, so love where you're headed with the yield question. We have our portfolio. Our retail auto portfolio is at 614 -- 6.14%. We put on new origination yields over 7%. So as you think about the natural tailwind, even if we don't get any incremental rate increases, we'll have a natural 40 to 50 basis point increase per year in the next couple of years on the retail auto side. So all of those dynamics, we feel play out favorably for us as we head into 2019.

Okay. And then just for benchmarking where you're putting on new loans. Should we think about like using a -- like looking 2 to 3 years out on the yield curve to -- is where you're typically targeting your pricing. So if we see it like -- looks like average yields were kind of flat in the fourth quarter versus the third quarter. But the -- we're exiting -- exited the fourth quarter down a bit. I just wonder if that puts downward pressure on that 7% number or not.

Yes. So you're exactly right. It's a 2 to 3 year price point on the curve, and you can't really look at any quarter because there are seasonal mix changes. I would just look at it full year. We put on about 80 to 80-plus basis points of price. As we head into next year, even if we don't have any incremental uptick on the yield curve, we'd still expect to add in about 40 basis points of pricing.

Our next question comes from Moshe Orenbuch from Crédit Suisse.

Great. Maybe just to expand on that a little bit. I mean, when you think about how you're pricing, is it off the captives? Is it off banks when you're thinking about the yields? Like where is the biggest -- who's the biggest driver of the competitive dynamic for yield pricing?

Yes, Moshe. And I appreciate the question. We're pricing based on a lot of different dynamics. First and foremost, it's the credit profile of our borrowers. Second, we look for opportunities across all sorts of products and across the full spectrum. And so you'll see, we typically lean into the belly of the curve. We're not overly exposed to super prime, and sub-prime's running around 10%, 11% right now. So we feel very comfortable with where we're positioned. Certainly, the OEMs and captives have leaned in heavily on the super prime space, seeing credit unions in there as well. We're not overly exposed to that part of the curve. So we feel good about our positioning. Now we continue to see opportunities in used, continue to see opportunities in the Growth Channel, and that's where we'll continue to focus in 2019. Now our overall pricing and credit management is really, as we've talked about several times, focused on risk-adjusted return. And certainly, you see that in our performance this year with the portfolio yield up 34 basis points and charge-offs coming down 15 basis points. So we'll continue to focus on risk-adjusted returns above all else.

On the other side of the balance sheet, we just heard from one of the other large online banks, they're spending a lot of money to kind of relaunch their brand. And kind of how do you think about that? Obviously, your efficiency is going to be significantly better than theirs. But kind of how do you think about that in terms of the -- any changes that you see in the competitive environment in 2019?

Yes. I mean, it's very competitive. And as a result of that, we've continued to lean in on our core competencies around brands and technology. That's nothing new for us. It's really a continuation of where we've been focused over the last couple of years. I think we're really pleased with the efficiency that we've seen in our marketing spend. We'll continue to focus on refining that. I mean, obviously, we watch every dollar, and we're prudently investing not only in branded technologies but in our core businesses and the new businesses that we see. But net-net, we feel good about where we are in terms of our investments.

Our next question comes from Don Fandetti from Wells Fargo.

Jeff, I'm just curious if you could provide us your latest thoughts on how digital is impacting the dealership business, auto sales in general and then how do you think you're positioned. I know you have this interesting Carvana relationship. Maybe you could provide us the latest on that, what kind of growth that's providing and how you sort of compete with alternative bank or banks that might come in for that type of business as well.

Sure. So thanks for the question, Don. So I mean, I'd start by saying the indirect channel is still really the dominant channel of how consumers access loans. So the vast majority is still through the dealer. Having said that, dealers have dramatically invested in their own technologies and infrastructures to make the process for consumers more efficient. So dealers are evolving, getting more user-friendly, more friendly websites, offering potential for financing through their websites. But still, the reality is, I think, it's 94%, 95% of all auto loans are sourced through the indirect channel. So part of our strategy is to help the dealers to understand capabilities that are out there, who's being more efficient than others and so helping the dealers really evolve into a more user-friendly environment. And I think that will remain a key part of our strength. But one of the stats, and I think it's the first time we've shared it, is within our Growth Channel, which is obviously representing more than 50% of the originations we're putting out right now, about 1/3 or a little over 1/3 within that Growth Channel is coming from what we call our specialty indirect providers. And those would be names like Carvana, CarMax, DriveTime, our CSG group as well. And so we are well positioned there. We're mindful that trends may accelerate in that space today, and it's part of the reason we've established relationships with a number of those names. So hopefully, that covers more or less, Don, what you're after.

Just to clarify, of your Growth Channel, 1/3 or higher of the growth is coming from the sort of specialty, like, Carvana. That's pretty material percentage.

Exactly. And that's part of -- Jenn and I both try to stress some of the adaptability of the franchise. I mean, there's been a number of points really. It's been 4 years for me in the CEO chair, and I've been here 10 years. And I can count on multiple hands a number of times people thought the demise of our Auto Finance business. But part of our strategy is every single day, continue to adapt, continue to be mindful of the future, be mindful of trends. And so that was a core component of our theme today, really, how we've adapted our business model to changing macro conditions and changing environment conditions and competitive conditions.

Yes. And just as follow-up. Are the risk-adjusted returns on that type of origination just as good? I would think by the fall, they'd be a little bit lower just because maybe you have to share some economics, something of that nature.

Yes. It's a good question. No, we don't change our risk-adjusted returns expectation across any channel. We're very consistent how we originate. And we've got retail forward flows with Carvana and all of our partners, and the risk-adjusted returns look favorable there. Now they get the benefit of our balance sheet, and we get the benefit of the increased flows with -- the relationships have worked out really well. So we don't adjust any of our return expectations across our different distribution channels.

Our next question comes from Sanjay Sakhrani from KBW.

With the risk-adjusted yields improving steadily, I assume there's not been a whole lot of change from a competitive standpoint. I mean, I guess have you guys seen any changes? Because it seems it's been in quite a favorable -- you guys have been in a favorable situation for some time now. And then secondly, that improvement in the risk-adjusted yield, how much of it has been driven by mix to used versus new?

Yes. So why don't -- Sanjay, thanks for the questions. I'll take part one. Jenn can take part two. I think with respect to the competitive environment, I'd say, overall, it's pretty stable. We haven't seen any meaningful shifts other than the ones we talked about earlier this year. There's one large player who had migrated more out of the used space. But for the most part, the past 6 months has been stable and pretty rational, still very competitive. I don't want to imply that competition is decreasing. It's still a very competitive market. But I think we've all found in niches where we all can play successfully there. So competitive is still pretty rational. And then Jenn, with...

Yes, sure. Sanjay, as we look at our expansion in risk-adjusted returns, there's kind of three main drivers there. One is just our ability to continue to originate at the -- at high volumes at the prices that we have been, which have largely, at this point, passed on 100% of the rate increase, a little over 100% of the rate increase to date. So that is the leading driver in terms of the expansion on the yield side. And then you couple that with our ability to originate and very consistent credit quality. Those are really the two main drivers. And then to your question, to a lesser extent, it's around the mix of each person. It is a driver, but it's a much smaller driver compared to the other two.

Okay. And my follow-up question's on -- so the residual gains. Obviously, they've trended quite high over the past couple of quarters. I'm just curious where you guys see 2019 shaking out because it seems to be at pretty high level.

Yes, sure. I mean, we've been anticipating kind of a supply-driven decline in used vehicles value. If you look at off-lease vehicles in 2019, it spikes up to its highest level. I think there's about 4 million vehicles coming off-lease. And as a result of that, all else being equal, we'd expect used vehicle values to drop maybe 3 -- about 3% to 5% of what we've modeled into our forecast for 2019. Now there's other dynamics at play there. Obviously, health of the consumers, gas prices. So that's not the only dynamic, and certainly, we outperformed that here in 2018.

Our next question comes from Eric Wasserstrom from UBS.

Just to follow up on a few of the questions that have been asked about pricing, and I realize that there's been many. But Jenn, could you just specify? You've alluded to it in a couple of ways. But how did the marginal price change from third quarter to fourth? Can you just clarify that for me?

Yes. So coming into fourth quarter, origination yield was about 7.33%. And I believe that ticked down just a little bit from third quarter, and that's largely just a reflection of the mix. We tend to move into more of a new vehicle market in the fourth quarter. As we go into 2019, we'll have some seasonality around originations, just depending on mix as well. But net-net, that 7.07% origination yield is up 80 basis points, 80-plus basis points compared to 2016. And so if you kind of look at our book that reprices every 2 to 2.5 years, you'd expect our portfolio to continue to trend up from 6.14% to over 7% over the next 2 years. And we'll continue to see that origination yield go up.

And J.B., just to follow up on Sanjay's question for a moment. I think the one large player that you were referring to, I think, recently indicated that it's now they're intent to come back into used in a greater way. And I think historically, they were the number one provider of financing in a still a highly fractionated market. But can you just maybe relate that expectation maybe to how it's influencing your thoughts on used pricing, if at all?

Yes. Really not influencing yet today, and we're really -- the reality is we're not seeing it or feeling it. Obviously, we've heard these comments as well. But within the market, within the dealer force, we're just -- we're not seeing any real change right now. And obviously, the results and trends show we're still getting a nice portion of used. But as you point out, it's a large market. A couple of times, multiple of the new car market, it is very fragmented. So there's opportunity for everyone to play. But I think we've really emerged in the dealer body as a strong partner in booked and used volumes.

Our next question comes from Betsy Graseck from Morgan Stanley.

I just had a question on the interplay for expectations for balance sheet growth, increasing capital return and CET1 ratio. I'm just wondering if there's -- you could give us some sense as to where you're thinking you're flexing all those things. And is there any change in where you think the CET1 could go on a normalized basis?

Yes, sure. So first, on balance sheet, we're going to continue to grow our asset base, and we've got opportunities across all of our portfolios. You look at auto, we -- we'll continue to find opportunities there at the right risk-adjusted returns. Certainly, we've been leaning in. And Corporate Finance portfolio is about $4.6 billion. We'll continue to look for opportunities to grow that business. And then we've talked a lot about our capital-efficient assets. We've been leaning in towards securities portfolio. We think we're a bit under-invested there, and we're about 17% of our portfolio in securities. We plan to grow that to about 20%. And then certainly, seeing opportunities in mortgage, I mean, mortgage, we've been growing the bulk. We see DTC really taking off, and we're getting the right operating model in place around mortgage. So we'll continue to lean in there as well. So we're anticipating kind of mid-single-digit total asset growth coming into 2019. Now on capital returns, I mean, certainly, that's been a key focus of ours. We've increased our distribution to shareholders in '18 about 26% year-over-year. Certainly, we're mindful as we go throughout 2019, a lot of dynamics around the regulatory environment, CECL. And so we'll be mindful of that. Now on the CET1 ratio, we did get down a bit this quarter. We had about 9.1%. Some of that was just because of seasonal impact from floor plan on the commercial auto side. We do see that moderating coming into first quarter here. So we're running about historic levels here in terms of our total CET1 ratio. Now as we go forward, we feel very good about our ability to continue to generate earnings organically. I think we'll be well positioned as we see the different dynamics around CECL and the regulatory environment play out.

Do you feel like the 9% CET1 kind of -- I don't know if target's the right word, but level is appropriate, given all the rules and rigs that changed for a bank your size? Do you think that you would ever bring that down? And maybe if you could talk through a little bit how you see CECL playing out because there's been some mixed messages from regulators. It's not in their stress tests on a go-forward basis, but maybe the onetime charges. So just let us understand how you're thinking about that.

First of all, we feel very good about the 9% CET1 ratio. If you look at our portfolio, we included a slide in the earnings presentation today. We have a almost fully secured balance sheet. We've done, I think, an exceptional job managing the risk and understanding the risk in our portfolios. And I'd say kind of point one, we feel really good about the 9%. Now there's a lot of play in terms of the regulatory environment, potentially some relief from a capital perspective, if we look at the SCB, some of the enhanced prudential standards. We'll continue to learn more as we go throughout this year. But all else being equal, we feel very good about the 9% CET1 target ratio.

Would you bring that down? I mean, when you say very good, I'm wondering like maybe it's too high. Is that kind of the message that you're sending? Or...

No. I don't think -- I mean, I think in the current construct that we're operating in today, the 9% is the ratio that we feel very good about. Now I think as we get more detail around CECL, the enhanced prudential standards and, specifically, the SCB, there could be some changes to that, and we will keep communicating as we know more throughout 2019.

And that does conclude our question-and-answer session for today's conference. I'd now like to turn the call back over to Daniel Eller for any closing remarks.

Yes. Thank you, everyone, for joining us this morning and, as always, feel free to reach out to Investor Relations with any additional follow-ups.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program. You may all disconnect. Everyone, have a wonderful day.