Ally Financial Inc. (ALLY) Q2 2021 Earnings Report, Transcript and Summary

Good day, and thank you for standing by. Welcome to the Ally Financial Second Quarter 2021 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. [Operator Instructions]. Please be advised that today's conference is being recorded. [Operator Instructions]. I would now like to hand the conference over to your speaker today, Daniel Eller, Head of Investor Relations. Please go ahead.

Thank you, operator. We appreciate everyone joining us to review Ally Financial's second quarter 2021 results. This morning, we have our CEO, Jeff Brown; and our CFO, Jenn LaClair, on the call to review results and to take questions. Before beginning, I'll note the presentation we'll reference on today's call can be found on the Ally Investor Relations website. Forward-looking statements and risk factor language governing today's call is on Slide 2. And on Slide 3, we've included several GAAP and non-GAAP or core measures pertaining to Ally's operating performance and capital results. These metrics are supplemental to and not a substitute for U.S. GAAP measures. Definitions and reconciliations can be found in the appendix. With that, I'll hand the call over to J.B.

Thank you, Daniel. Good morning. We appreciate everyone joining us on the call today. Performance this quarter was exceptionally strong. And our results underscore the power of our vibrant and growing businesses. Despite the rapidly changing operating environment over the past 18 months or so, we've executed against our strategic goals, expanding our market-leading capabilities and driving momentum across all areas of the company. Do It Right serves as our mantra and provides great clarity to our actions inside and outside the walls of Ally. I'm tremendously proud of how our Ally teammates uphold our values in meaningful ways every day. Since Ally Bank launched 12 years ago, you've seen us constantly challenge the status quo through innovative, seamless, and differentiated consumer bank products, services, and experiences. In June, we were the first major bank to announce the elimination of overdraft fees for all customers. While eliminating the revenue stream was viewed by many as unprecedented and by some as controversial, this was a logical step for us in continuing to redefine traditional bank norms in advancing our mission to create a better and more equitable banking relationship for everyone. The success of our all-digital banking platform is reflected in the accelerating growth across several measures, including sustained, rapid expansion of engaged customers, industry-leading retention of balances and account holders, and steady growth over the past 5 years among customers who use multiple Ally Bank products. Our model will continue to evolve to meet the increasing demand among consumers for frictionless and simplified experiences enhancing our ability to further unlock additional franchise value in the years ahead. For our Ally teammates, we remain relentlessly focused on fostering an engaged, equitable, and inclusive culture while prioritizing their well-being. We're encouraged by the reduction in COVID cases and growth of vaccinated populations across the nation, but obviously mindful of variants like Delta that are still presenting risks. At Ally, we recently announced our intention to begin welcoming our workforce back to the office after Labor Day but pilot programs already underway today show that teammates were ready and excited to get back together. Our teammates across the company have gone to considerable lengths to balance the complexities involved in this environment, demonstrating a Do It Right approach in their thoughtful planning. I am incredibly proud again of how we have balanced doing right for our teammates and doing right for our company. On top of the great financial and operational results, this morning, I'm pleased to announce a $50 million contribution to the Ally Charitable Foundation, a significant financial commitment toward driving lasting and positive change. Our Foundation was active in the quarter, partnering with Habitat for Humanity of Charlotte to launch one of the largest affordable housing efforts to date, addressing a critical shortage in housing within historically black neighborhoods. We also increased our partnership with the University Growth Fund as they expanded in Atlanta. These efforts help college students from underrepresented groups gain real-world investment experience, including in areas like private equity. We're thrilled to support these and many other organizations and the important work that they do to advance social and educational causes. The measurable progress we've made for our customers, employees, and communities is another source of pride for me, and I'm confident in the significant role these efforts have played in building a stronger company. Let's turn to Slide #5, where I'll touch on a few highlights from 2Q. Second quarter adjusted EPS of $2.33, core ROTCE of 26.7%, and revenues of $2.1 billion, each represented record-setting levels for Ally driven by organic revenue expansion and strong credit trends. While a favorable backdrop across consumer and auto markets accentuated financial results during the quarter, it's important to recognize the underlying drivers of Ally's broader performance. First, as you've heard from us on several occasions, results of this magnitude reflect years of disciplined execution and our adaptability and creativity has enhanced our ability to capitalize on market opportunities in real time. Second, and critically important is that meaningful expansion opportunities remain ahead for Ally as we continue to grow our company and unlock incremental value within auto, insurance, and Ally Bank. These dynamics serve as the cornerstones of our long-term operational and financial expansion, which we steadily delivered against over the past several years. Jenn will provide more detail that we expect full year 2021 performance to exceed normalized returns, while our long-term outlook for sustainable ROTCE profile in the solid mid-teens represents our strongest level as a publicly traded company. Performance will be driven by ongoing core earnings expansion fueled by robust dealer engagement and deepened customer relationships across our digital bank offerings. Our continued progress allowed us to announce a 25% expansion to our share buyback program and increased our dividend for the sixth time in as many years. Disciplined capital management in accordance with the SCB regulatory framework is a continuous part of our focus. Turning to our business performance. Within auto, consumer originations of $12.9 billion represented our highest level in 15 years at a solid 7.15% yield. We focus on being the preeminent dealer partner, evidenced in the record 3.5 million applications we decisioned this quarter and with a pathway for further expansion as we deepen relationships across our 19,700 dealers. For the first time in our history, credit for the quarter was a net recovery reflecting the resilience of the auto asset class, including strong consumer demand, broad strength and health among consumers, including the benefits of meaningful fiscal and monetary actions and our focused and modernized approach to underwriting and collections. Credit trends remain encouraging reducing the likelihood of protracted, elevated losses as a gradual migration back to more normalized levels becomes more likely over the next 12 to 18 months. Importantly, we used this time to further enhance our ability to reach our auto customers through expanded digital channels, coupled with enhanced analytics within our servicing teams. We constantly monitor broader market indicators of consumer health, including wage and price inflation, employment conditions, and productivity measures. While there are several cross currents today, I remain of the view that consumers are well positioned with healthy balance sheets, increasing their willingness and ability to borrow and pay. Auto sector competition remained intense but balanced overall as vehicle sales were robust, particularly for non-fleet retail sales. Strong demand continued to outpace OEM production, pushing industry inventories to multi-decade lows, which in turn is providing structural providing structural support for used values. We expect floorplan balances to remain low and used values elevated for some time before beginning to steadily migrate towards more normalized levels. Based on what we see today and in conversations we have with the dealer community, this will take us into next year. Within insurance, written premiums of $301 million reflected our highest second quarter of consumer volume driven by increased market share and strong vehicle sales. Investment portfolio performance remains solid, while weather claims were the lowest 2Q in over a decade. Turning to Ally Bank, organic and accelerating growth trends continued. Retail deposit customers ended at nearly 2.4 million, expanding 12% year-over-year and representing our 49th consecutive quarter of growth. Retail balances grew to $129 billion, even as seasonally higher customer tax payments increased about 70% year-over-year. Our consumer product adoption trends remained exceptional. Ally Home originations of $2.2 billion increased more than 80% compared to the prior year period. Ally Invest, self-directed customer assets grew to $15.6 billion, a 62% year-over-year increase while accounts expanded 11%. And Ally Lending volume of $299 million increased nearly fourfold year-over-year as we expanded merchant relationships and volume across health care, home improvement and retail verticals. Corporate Finance posted another steady and solid quarter with combined held for investment and unfunded commitments exceeding $10 billion for the third consecutive quarter, including $6.2 billion of HFI balances. Performance across all of our businesses reinforces our broad customer reach, years of disciplined execution, adaptability of our businesses and ability to meet our financial and operational goals. On Slide S6, our ongoing financial trajectory is evident across each of these key metrics, with trends having accelerated following widespread impacts experienced at the onset of the pandemic. In the upper right, we've included PPNR, which we know many of you look to as a measure of core earnings power and is a key metric used by the Fed during CCAR exercises. We surpassed $1 billion this quarter and expect to generate annual growth in the years ahead, though this may not always occur in a perfectly linear manner from quarter to quarter. On the bottom right of the page, tangible book value per share reached an all-time high of $38.83, reiterating the growth and intrinsic value of our company as our return profile has sustainably improved. As you've heard from me in the past, values, culture and disciplined execution remains central to our operating mindset, and we're excited to build upon our momentum in the years ahead as we continue to drive an improved earnings and return profile. With that, Jenn, I'll hand it to you to review the detailed financial results.

Thank you, J.B., and good morning, everyone. The strength of our financial performance again this quarter reflects our disciplined operating approach and the continued execution of our long-term strategic priorities. Before I review the details, I'd like to thank our Ally teammates for their ongoing commitment, which underpins our strong performance and accelerating trajectory. We've built deeply integrated auto and digital banking experiences for dealers and consumers, enhancing Ally's franchise value and affording us the opportunity to protect and improve our market share, grow our loan portfolios and diversify income sources and generate a solid mid-teens return profile in the years ahead. We're well aware of the debate on whether prevailing market trends represent peak performance for companies. And while we acknowledge used car values and credit trends will migrate toward normalized levels over time, we continue to focus on expanding our industry-leading businesses, delivering a sustainable core earnings trajectory that is structurally higher than pre-pandemic levels and prudent management of capital and liquidity. On Slide 7, net financing revenue, excluding OID, of $1.56 billion reached the highest level on record for Ally, growing 13% linked quarter and 46% year-over-year. Performance was fueled by ongoing strength in auto pricing and origination volumes, elevated used car values, optimization among funding sources and benefits from redeployment of excess liquidity. Adjusted other revenue of $588 million reflected another solid quarter of investment gains and continued growth among our SmartAuction, mortgage, invest and insurance operations. We repositioned $70 million of OID expense associated with the retirement of $2.4 billion trust preferred securities. In Q3, we expect to reposition around $50 million, aligned with the July closing of the second redemption. We opportunistically replaced this floating rate instrument with 5- and 7-year fixed rate perpetual preferred securities, which improves the quality of our Tier 1 capital and positions us favorably in rising rate environments. Negative provision expense this quarter reflects the benefits of robust consumer dynamics that led to a net recovery in retail auto. Noninterest expense, included $90 million of significant items detailed below related to the contribution to the Ally Foundation and modifications to our retirement eligibility benefits. We remain focused on essentialism in generating positive operating leverage even while we continue to make prudent investments in innovation to enhance dealer and customer experiences, technology, security and brand. Core pretax earnings exceeded $1 billion for the second consecutive quarter, driving GAAP and adjusted EPS of $2.41 and $2.33, respectively. Within GAAP tax expense, we recognized a discrete tax item that lowered our quarterly tax rate. Moving to Slide 8. Net interest margin, excluding OID, of 3.57% expanded 39 basis points quarter-over-quarter and 115 basis points year-over-year reflecting significant and sustained improvement. Earning asset yield of 4.69% grew 25 basis points quarter-over-quarter where average earning assets of nearly $175 billion reflected steady retail auto expansion sourced through strong originations at accretive pricing levels, growth in lease balances and yields aided by elevated used car values, ongoing redeployment of excess liquidity and higher Ally Lending balances at attractive yields. These dynamics largely offset prepayment activity in mortgage and lower floorplan balances stemming from robust consumer demand and continued supply chain constraints. We expect full year retail auto origination yields in the 7% range and now expect used car values to rise in the mid to upper 20% range year-over-year and the mid-30% rise during the first half of 2021, an outlook that contemplates more normalized pricing and the substantial rise in car values that began in the latter part of last year. Impacts from elevated used car values have been partly offset by higher liquidity levels and premium amortization trends we expect to normalize over time. Turning to liabilities, cost of funds improved 15 basis points, the eighth consecutive quarter-over-quarter decline. As you've heard from us before, our interest rate risk position is relatively neutral, and we remain confident in our ability to thrive in both higher and lower rate environments given our balance sheet positioning. While we continue to prefer a steeper curve, we are not overly dependent on rates to drive margin improvement. Ally's liability, transformation, asset growth and pricing tailwinds on both sides of the balance sheet will drive ongoing NIM and NII expansion. Our margin performance has been meaningfully enhanced through years of transformation in organic growth. Since 2014, consumer auto assets have grown $10 billion as we partner with more dealers, decisioned more applications and developed deep expertise to drive improved risk-adjusted returns. Corporate Finance, Ally Lending and mortgage assets, including Ally Home, have expanded by over $11 billion, doubling the 2014 ending levels as we diversify our growing Ally Bank customers and clients. We've transformed our liability stack, reducing reliance on high-cost, 100% beta wholesale funding as we have built stable, sticky deposits. We are now 89% deposit funded, double the 2014 level, and we've retired $24 billion of unsecured over this time frame at a weighted average coupon in excess of 5%. These structural improvements position our balance sheet for a sustainable 3% plus NIM moving forward versus low to mid-2% levels in years past. Turning to Slide 9, CET1 increased to 11.3% in Q2, representing $3.2 billion of excess capital above our 9% internal target. Last week, we increased our Q3 dividend to $0.25 per share and expanded our 2021 buyback program by $400 million, reflective of Ally's strong capital levels, earnings profile and outlook. On the bottom of this slide, outstanding shares have declined 25% since the inception of the buyback program, and we repurchased [$719 million] during the first half of this year. Our approach to capital deployment remains centered around prioritizing opportunities for long-term value enhancement. On Slide 10, asset quality reflected historically strong performance across our consumer and commercial portfolios. Consolidated net charge-offs were negative 2 basis points, the lowest level in our 102-year history. Retail auto portfolio performance reflected solid consumer payment trends and improved loss given default rates. In the bottom right, early and late-stage delinquencies ended meaningfully below prior year levels. These are encouraging trends supporting our expectation for losses to migrate toward a normalized 1.4% to 1.6% NCO level over the medium term, which is contemplated in our reserve and pricing approaches and included in our return projections. On Slide 11, consolidated coverage was stable at 2.79% as retail auto and Ally Lending balances grew and floorplan, which carries significantly lower coverage declined. Retail auto coverage of 3.7% declined by 10 basis points from favorable consumer behavior and improved macroeconomic indicators. Our forecast assumes gradually improving unemployment ending the year between 4% and 5%. Signs of economic improvement continue to emerge, evidenced in rising confidence levels, widespread employment opportunities and ongoing gains in productivity and manufacturing. We continually monitor wage and price inflation trends and assess consumer debt dynamics in real time but remain confident our reserves are well positioned for a variety of economic environments, including downside scenarios. On Slide 12, total deposits grew to $139 billion. Retail balances expanded by nearly $900 million quarter-over-quarter even as seasonal tax outflows were significantly higher than previous years, and we continue to lower brokered deposits. Underlying retail trends remained robust, including inflows from both new and existing customers. We added another 60,000 customers during the quarter, with nearly 70% representing digitally savvy, younger generations early in their financial journey. Looking deeper into portfolio dynamics, every annual vintage since 2009 has grown or remained stable, a testament to our brand value and the stability of balances across rate cycles and rapidly evolving competition. Customer loyalty and engagement are reflected in industry-leading retention of 96% and multi-relationship expansion for the 17th consecutive quarter, ending at 9%. Turning to Slide 13. As the largest all-digital bank in the U.S., Ally Bank is uniquely positioned to benefit from ongoing consumer shift to all things digital. This is evident in our robust customer growth, expanding at a 19% CAGR since 2010. Deposits serve as the gateway to our rapidly expanding bank, which continues to drive loyalty and deepen customer relationships through Ally save, invest, pay and mortgage lending capabilities. The significant portion of Ally Invest account openings and Ally Home direct-to-consumer volume continues to be sourced from existing depositors, accelerating organic growth and diversification in the years ahead. Let's turn to Slide 14 to review auto segment highlights. Pretax income of $917 million was driven by net financing revenue growth from ongoing optimization in the consumer portfolio and strong used values, expansion of SmartAuction and ClearPath activities and solid credit performance. Retail portfolio trends shown on the bottom right, highlight our strong risk-adjusted margin trends, fueled by solid origination yields and credit performance. Turning to Slide 15. And our leading agile platform is built to meet dealer and customer needs in a comprehensive and innovative manner, reflected in our performance and multiyear growth of dealer relationships. Our focus continues to migrate towards deepening these relationships, driving strong application trends which we expect to approach $13 million this year. In the upper right, ending consumer assets expanded to $86.5 billion, both retail and lease growth demonstrates the resilience of the auto asset class in a challenged loan growth environment as we expanded volume and units. Average commercial balances ended at $16.3 billion as industry inventories reached a 36-year low. The floorplan contraction has been driven by strong consumer demand and supply chain dynamics that have improved dealer profitability by lowering inventory carry costs and enhancing used vehicle values. Turning to origination trends. On the bottom half of the page, auto volume of $12.9 billion represented our highest quarterly level since 2006. We've continued to provide broad access to credit for consumers, utilizing our full spectrum of underwriting capabilities while maintaining consistent FICO and nonprime trends. Turning to insurance results on Slide 16. Core pretax income of $67 million increased year-over-year from underwriting income growth and notably lower weather losses. While investment activity declined quarter-over-quarter, realized gains still ranked as a top 10 quarter over the past decade. In the bottom left, the investment balances grew to $6.4 billion providing a diversified, stable revenue stream and enhanced returns. Total written premiums of $301 million reflects consumer F&I strength, where we generated $274 million in volume leading to our highest number of total consumer policies. P&C volume reflected lower industry inventories, though newly onboarded dealers and rate changes mitigated the overall decline. Turning to Slide 17. Core income of $96 million was the highest quarterly result on record for Corporate Finance, reflecting stable net financing revenue, strong other revenue from investment gains, syndication income and growth in unused commitment fees and favorable credit trends, which allowed us to modestly reduce coverage. The loan portfolio remains high quality, comprised of 52% asset-based lending, up from 25% in 2014. Our $6.2 billion HFI portfolio and $4.3 billion unfunded commitments position us for ongoing revenue expansion. While client utilization levels remain low and competition is fierce, we remain confident in the outlook for growth. Mortgage details are on Slide 18. The breakeven income reflects a shift from HFS to HFI originations and impacts from elevated prepayment activity over the past several quarters. Ally Home DTC originations of $2.2 billion represented our highest quarterly level since launching in 2016. The Customer engagement remains strong with nearly 40% of our originations sourced from existing depositors, further underscoring the significance of our growing multiproduct relationships. The path to $10 billion in annual DTC volume over the next couple of years remains within reach, even as the broader market is expected to decline as we build scale through existing and new customers. On Slide 19, we have refreshed the financial outlook given our strong results. We now expect ROTCE in the 20% range for this year excluding the impact of reserve release activity. Performance will be fueled by 20% plus year-over-year total revenue growth and operating leverage gains in the mid-teens range. The chart also demonstrates the significant long-term momentum we've generated across the company, evidenced in the sustainable 15% plus return profile. Ongoing results will be fueled by revenue-driven PPNR expansion. NII will reflect loan growth and net interest margin in the mid- to upper 3% range. Steadily expanding other revenues will reflect organic growth from our established and broadened consumer offerings. And as a reminder, we assume modest investment gain activity, but we'll remain opportunistic in the years ahead. Our outlook in the balanced, competitive and operating environment assumptions, including normalized trends across used car prices, credit activity and deposit market growth. We are confident in the value we're generating across our businesses, driving near- and long-term benefits for all our stakeholders. And with that, I'll turn it back to J.B.

Thank you, Jenn. I'll close with a few comments on Slide #20. First, I remain deeply grateful and proud to lead our company. Our results this quarter are really impressive, but our broader purpose and calls to serve our teammates, our customers, our communities and our stockholders is what defines the long-term success, but still remains ahead for Ally. We built a structurally enhanced, fundamentally stronger company through strategic execution across our business lines and balance sheet optimization. This positions us for a long-term outlook that is brighter now than at any other point in our company's history. We will continue to execute with a focus on the same values and priorities that have served us well. And the future is bright for All Things Ally. So Daniel, with that, turn it back to you, and we can head into Q&A.

Great. Thanks, J.B. So as we head into the Q&A session, I’ll remind participants to please limit yourself to one question and one follow-up. Operator, you may now tee up the Q&A session.

[Operator Instructions]. Our first question comes from the line of Ryan Nash from Goldman Sachs.

So J.B., Jenn, can you maybe talk about how you can manage through the normalization of used car prices by underwriting? And maybe just talk about what assumptions are baked into your intermediate-term net interest margin guidance. And secondly, maybe can you just talk about what you're seeing in SmartAuction in terms of lease gains? Are you starting to see any signs of normalization? And what are your expectations as you look out over the next 6 to 18 months?

Sure. Good, morning, Ryan. So just a couple of comments on where we are with used car prices. We can get into some of the dynamics on SmartAuction. But clearly, first half of this year, used SmartAuction. But clearly, first half of this year, used vehicle pricing is up kind of over 30%; in second quarter, up over 40%. We are expecting, Ryan, for used car pricing to start to normalize in the back half of this year. Now, I think the question is around the pacing of that. We do think we've kind of passed the peak and we would migrate down to more normalized levels at a minimum by 2023. And that's what is embedded in our kind of medium-term guidance around ’22, ’23 , 15-plus percent ROTCE. I think a lot of dynamics there, and we hit on this in the prepared remarks, but we're continuing to see incredibly strong demand for personal vehicle ownership. We actually think some of that could be pushed out simply because of availability of new and used vehicles. Coupled with on the supply side, we think the chip shortage is going to continue to pressure inventory levels. And so, while we're expecting the normalization, I think the big question, Ryan, is quite frankly, when will that happen? I think you know us, we tend to be pretty conservative in how we've modeled this, and we are expecting it to come down at least in our modeled numbers through '22 and '23. On your question on underwriting, look, we never change underwriting for pockets of abnormal activity. And so, we have embedded normalized used vehicle pricing in LGD and off lease as well in our underwriting for both lease and lending. So we feel really good about our pricing approach. Obviously, our reserves include much more normalized levels. And then on SmartAuction, not quite as many cars as we would have liked. We are seeing kind of dealer buyouts increase simply because of the demand for inventory on lots and their appetite to sell metal. So we're not seeing quite the activity we'd like to on SmartAuction, but the gains are coming in just huge as you saw in Q2 and then we will be modest in terms of assumptions there on out.

Got it. And maybe if I can ask 1 follow-up. I mean the business is obviously generating outstanding returns right now. You're talking about 20% plus this year, you're benefiting from elevated used car prices. So J.B., can you maybe just talk about prioritization in terms of how you think about accelerating investments in some of the new businesses that can drive revenue growth versus potentially accelerating capital repatriation. You've obviously increased the dividend by a decent chunk and you're going to be buying back $2 billion of stock versus over the next year. But I'm just curious how you think about that relative trade-off of accelerating some investments given the outsized profits versus continuing to return a lot of capital to shareholders.

Yes, it's a great question, Ryan. And I guess it's a blend of both for us right now. So as you pointed out, we were really happy to be able to announce higher capital returns via the dividend and buybacks and even having said that, we're still running elevated levels of capital. I think the 11.3 CET1 is still 230 basis points higher and that's a real amount of dollars than our internal target that we want to run. So, going into this year's planning process, Jenn and I are really working with our business leaders on trying to think through what we're calling kind of unconstrained growth. So what are the higher growth scenarios that we could deploy to drive better organic levels both in terms of balance sheet and revenue opportunities. I think we continue to be very tactical in what we're doing on the technology side, the digital side, the cyber investment side. Those are some of the near-term investments like Jenn and I have greenlighted to accelerate. And then also the same thing on the brand side. Well, Ally Bank brand and the Ally brand overall continues to resonate extremely well. I think relative to some of our competitors, we are underspent there and we are underinvested there, and we think there's broader opportunities in promoting the brand, doing more in digital acceleration with the brand. We have a great Chief Marketing Officer in Andrea Brimmer, and she’s got some world-class teammates that are trying to really push forward what we do in the digital analytics side there. So we're super excited, and I think it's going to be a fun year. I think the Board is on board with us and kind of pushing the company forward. So, we're proud of the foundation that's been established, but I think now it's really about pushing for even higher levels than we've achieved to date. So hopefully, that's helpful, Ryan.

Our next question comes from the line of Sanjay Sakhrani from KBW.

Good quarter. Things are really solid. Just a quick question on the originations. Obviously, a very strong quarter of originations. Could you just speak to how you see that unfolding for the remainder of the year?

Yes, sure. Good morning, Sanjay, and thank you for the questions too. Our originations approached $13 billion this quarter, and it sets us up really nicely for full year originations. We're expecting strong flows through Q3 and Q4 and likely will exceed $40 billion. We always talk about our strategy is not to chase volume, but we'll be opportunistic when we see it, and we are certainly seeing it this year evidenced in kind of the strongest originations we've seen in 15 years, and we continue to see opportunities to hit that kind of 7% retail auto origination yield in 2021 as well. So think about kind of Sanjay, a number in the $40 billion to $45 billion, and then we'll continue to see how things unfold into '22 and '23, again no volume target. But with the rapidly expanding distribution, J.B. mentioned, it's our 29th quarter consecutively of growing dealers. And then the team is all over relationship deepening right now, so we hit record application flows. We're not seeing any sign of that stopping based on the operating environment, but more specifically just our strategic positioning across our dealer base and our product set right now.

Great. And then I guess a follow-up question to Ryan's question on capital. I guess when we think about the excess capital, some of it could be used towards M&A. Are there any opportunities out there that you're seeing? Is there a pipeline of things you're contemplating?

Sanjay, I'd say, we always try to stay opportunistic and open. I think the position we find ourselves in today though is we've got dominant franchises in auto, in the bank. And we're seeing all these new businesses really start to grow and scale on top of what auto continues to do. So we're in this fortunate position where we don't feel forced to have to do anything. And I think that's probably different than some of our banking competitors. And so we'll always stay open. The Ally Lending business is obviously new. We're impressed with leadership there, the way they've integrated into Ally and the scalability of that business. But -- and that's an entree into this universe of unsecured consumer lending. I think there's still a broader question, is there something bigger? Should we accelerate what we're doing there that we have a broader opportunity. But we're just -- we find ourselves in a really great position today. The business -- the business model has been validated. So we're not in a rush or a race to do anything.

Our next question comes from the line of Bill Carcache for Wolfe Research.

Can you give a bit more color on your discussions with your dealers around floorplan levels and the possibility that they'll be able to run with less inventory? And also if you could remind us what kind of impact smaller dealer floorplan balances will have on Ally's profitability?

Yes, sure. Good morning, Bill. Maybe I'll start with the dealer floorplans impact, and we can circle back to the dealer question. But on floorplan, I mean, obviously, that's impacting our balance sheet. And we've continued to see loans in the commercial space dip down. And we think we've hit the trough here in the second quarter. We could kind of bounce around at these levels for another couple of months. But we do expect kind of back half of this year to see a commercial start to grow again and normalize kind of through '22, '23. It is going to take some time, no doubt, especially with continued strong consumer demand and then supply chain shortages, just from chips as well as other constraints. So expecting to see that turn around a bit towards back half of this year, but it's going to be a slow kind of and steady recovery. I think what's great for Ally is that we have natural hedges. And with the lighter floorplan, you're seeing used vehicle values continue to climb. We hit kind of 40-plus percent in the second quarter. We're expecting 25% to 30% increase in used vehicle values, that's obviously showing up in our lease yields through lower depreciation as well as lease gains. And it's also showing up in our loss given default. From a loss perspective, we're in a net recovery position this quarter as you've seen. So the natural hedges offset the balance sheet decreases that we've seen on the floorplan side and net-net set us up to generate really robust returns and earnings. And it's -- quite frankly, it's the same for our dealers. They're seeing margin expansion. We're hitting kind of record numbers of dealers that are profitable right now due to some of these dynamics on the inventory side, lower carry costs, high vehicle values. In terms of kind of their views on where we are, I think the sentiment -- and J.B. can add on, but the sentiment is this is going to take some time. And I think because dealer profitability is so high, there's no rush to kind of -- to increase inventory, increase carry costs. I think there's been some smart learnings that have come out of this and it always makes sense to build for demand as opposed to build supply and hopefully, the demand comes. And so we're hopeful that the OEMs as well as the dealers we'll continue to take some of these lessons learned into future operational practices. But J.B., anything you add to that?

You covered it incredibly well, Jenn.

As a follow-up, I wanted to ask about branding. You guys have had tremendous success with the build-out of the deposit franchise. But is there an active focus on doing more to continue to develop the Ally brand inside the organization with the goal of just ultimately being seen as more than beyond the provider of a balance sheet.

Yes, Bill, like do you have a direct line to enter. Yes, I mean, in fact, we are -- as J.B. mentioned, we are in active dialogue right now. We're launching our strategic planning process. And we're in active dialogue around how we can continue to be a thoughtful share the Ally story with our customers. We have a terrific product set across both sides of the balance sheet, adding to our wealth management capabilities. So we think there's just a terrific opportunity ahead to accelerate the growth of our new businesses and to continue to dominate across auto and deposits. So absolutely -- and I can kind of hear Andrea cheering from a couple of doors down around this. Now of course, we want to do it smartly and we want to make sure that we position the brand effectively, just being mindful of generating positive operating leverage. But with that said, we would agree.

Yes. I think just to add on a little bit there too. I mean today, we've got ballpark round numbers, 9 million customers. I think the unique thing for us is they're active, they're engaged. We're growing the multiproduct nature of the customer base as well. So it's all about what we're really trying to optimize. If we wanted a higher headline customer number, we could target for that. But I think what's been very important in what's been guiding us is get a customer in the door, grow around them, help them see the holistic nature of the brand. I mean we're very proud using a subset of the customer base, 2.4 million at the bank, I mean, to see a 96% retention rate on our customer base says something about our brand and the quality of our service. But as Jenn pointed out, Andrea, is always looking to grow and optimize. And our new advertisements promote kind of the holistic nature of Ally. So you'll see more from us. Obviously, we continue to grow our sports marketing footprint and what we've done on the Champions Tour with women's soccer with MLS coming and then obviously a really dominant position in NASCAR today. We think sports marketing approach also drives pretty incredible brand value there as well.

Our next question comes from the line of John Hecht from Jefferies.

Congratulations on a solid quarter. The -- most of my questions were around residual values, and you guys have addressed those. So I guess 1 thing is -- I think back in '16 and '17, you kind of gave us an indication of kind of, I think it was like a 5% year-over-year decline in residual values or used car pricing to kind of give us just a sense where your head's at, how you're resetting your -- the depreciation curve and so forth. I mean do you have anything that that's that straightforward for us thinking about '22 and where you might be kind of pinpointing expected residual value declines?

Yes. So good morning, John. So let me start with this year. So we are expecting this year to land kind of up 25% to high 20% range. The first half of this year is up 35% or so above 30%. And so we are expecting the back half to start to normalize. And without getting too specific around kind of '22 and '23 numbers, which a lot to work through to have a clear view. But by '23, what we've modeled in our guide is that we do get back to kind of a much more normalized lease yield. So we always talked about kind of 4.5% to 5% pregains and then add another 1% or so for gains. And so we do expect to get back to that much more normalized yield by 2023. Now as I mentioned, there is definitely a bull case out there just as we look at continued demand for vehicles as well as the supply shortages. But we don't model in any kind of extraordinary results into the guide. We have much more normalized projections.

Okay. That's super helpful. Appreciate that, Jenn. And J.B., thinking about you guys had a lot of applications and thinking about your conversion rate. And maybe just sort of commentary on what you see going on in terms of underwriting quality across the industry as banks may be coming back into the fray and how you guys respond from a competitive perspective?

Yes. So I mean it's been overall a pretty balanced competition. I mean the market, as we've seen for quite some time has been intense. I think as we've probably talked about for a year or so, there's been rumors of players coming back in, but it really hasn't disruptive flow or competition of things that we see are certainly any of the pricing dynamics. I mean if you look at some of our pages in the deck, some of the supplemental financial information, we haven't really changed anything on underwriting standards. We've kind of been running the same type of FICO trend, same type of focus on our S, A tiers of business because we're generating really, really solid returns there. I mean when you think about -- we're now at probably 12 quarters or so of running the 7%-plus yield in a practically 0 rate environment with very low or benign credit costs. I mean this is pretty chunky. So we probably would have expected a little bit more competition that we're seeing. But frankly, we've made it really easy to work with the dealers. The dealers know what our buy box is. They know we're not inconsistent in that. And so part of just having established relationships with 19,700 dealers just leads to really attractive originations overall and really attractive yields for our booking. So I'd just say -- I don't mean to sound boring. It's just -- it's always a competitive market, but there haven't been really any big shifts in the universe in which we play in.

Our next question comes from the line of Betsy Graseck from Morgan Stanley.

I just had a couple of questions. I wanted to ask about the capacity of current balance sheet to add more loans. I know you've been growing loans at a nice steady clip. You've got a lot of capital generation. But I'm just wondering from a liquidity perspective, do you feel like you're optimized for that? Or is there room to kind of burn down some of that liquidity to add incremental lending?

Yes. Hey, Betsy. So on your first question, resounding yes and really across all of our lending categories that you've seen us grow consumer retail auto kind of sequentially for the last several quarters, and you see the robust outflow, origination flow, and we're absolutely focused on continuing to grow our retail auto lending. Lease as well continues to be a strong point, and we don't see any sign of that stopping. Ally Lending is really just getting started. So you saw we almost hit $300 million in originations. We're well on our way to get to a couple of billion in that business in short order. We hit our highest level of originations in our direct-to-consumer mortgage portfolio. So we're well on our way, kind of hit $8 billion or so in originations this year and climb up to $10 billion from here on out. Corporate Finance continues to be a steady growth engine. We'd expect that to get to about $8 billion. So I mean, across the board, we see opportunities to grow every one of our loan portfolios, and that's part of the NII guide. It's NIM expansion, but it's also growth in the balance sheet and growth across all of our businesses. And then on liquidity, the short answer there is yes as well. There's still room to optimize. We are sitting with excess cash that we plan to burn through the growth of our loan portfolio, but also through liability management, you've seen us continue to be proactive. We're at 89% deposit funded, but we think that can go higher, and we're naturally running down our brokered deposits as well as FHLB and some unsecured and secured debt. So just continuing to take down that cash over time, which will help with that NIM trajectory as well. So Daniel's just clarifying, Ally Lending is $2 billion is annual. So sorry about that, annual is $2 billion, not quarterly.

Okay. And the outlook that you're giving there, that's the time frame around those kind of opportunities that you were citing. Is that a next 12-month kind of outlook? Or is that something longer than that?

Yes. It's over time. I mean we are expecting -- I didn't hit on commercial floorplan, I hit on that earlier in the call, but that's the big question mark for us in terms of how quickly that kind of starts to grow from here. But my comments are really over kind of the next 18, 24 months, Betsy.

Our next question comes from the line of Moshe Orenbuch from Credit Suisse.

Looking at the big increase in originations, the biggest is what you call the growth channel, which went from 50% to 53%. So it kind of accounted for, I don't know, well over $2 billion of growth year-over-year. Can you talk about what's driving that? Is it the partnerships that you've got with some of the newer-type players? Or any other kind of insight that you can give us there?

Yes. Hey, Moshe, it's really all of the above. It's definitely the growing partnerships we have, and we've talked at length about Carvana that continues to be a very robust relationship, but there's many others in that category as well as just focusing on diversified, more traditional dealers that have added to that growth channel as well. That's been a deliberate strategy that we've had to diversify access to applications, diversify our customer base, and we just continue to see really strong success across all types of dealerships.

Great. I'm struck Jenn by a comment that you made earlier in your prepared remarks about kind of the growing partnerships we have, and taking steps, I think, given the strong earnings now. And obviously, some of these things will moderate. And as you pointed out about the dealer floorplan, some of them will get better as you go forward. But could you talk a little bit more -- and you've talked about higher levels of capital return, but can you talk about other steps to optimize, whether it's balance sheet structure or other pieces of the P&L or other types of kind of economies of scale that we could see generating better sustained returns over time.

Yes, sure. I mean I talked a lot about the optimization that we've delivered, and we're not done with that, right? So the conversation we just had on retail auto, we're going to continue to diversify. Our customer base continue to increase access to applications and drive strong originations and risk-adjusted returns. And so the retail auto story is to be continued, and we see a lot more opportunity there in the traditional loan and lease categories, but also in insurance, SmartAuction; our direct lending platform, Clearlane, ClearPath. So a lot of opportunity is to continue to optimize risk-adjusted returns within kind of the 4 walls of auto and insurance. And then outside of that, we talk a lot about liability optimization. That's been just the terrific growth that we've had in deposit customers. We've built loyalty with them, strong retention, and we've been able to take down the cost of funds 8 consecutive quarters, and we've got at least that to come in terms of continuing to take down deposit costs. We have some kind of $20 billion in CDs that are rolling off this year at over 150 basis points, and much of that is rolling into a 50 basis point OSA products. So a lot of room just kind of within the 4 walls of deposits to continue to optimize. And then there's a mix component here as well as we continue to increase the percent of our liabilities coming from deposits. So lot there still to come. And on many of our newer businesses, we're just starting to accelerate up the J curve. We're seeing accretive returns in mortgage. We're getting there quickly in Ally Lending. Invest is going to take some time, but we like the synergies across kind of the savings in Invest platform. So really just getting started in terms of the optimization of our newer businesses. And then, Moshe, last but not least on capital deployment, I think what's great is you can see just the robust trajectory we have ahead from organic growth. And so we don't need to be in a hurry to deploy that capital. We can be patient. We have a great earnings forecast. We'll be opportunistic on M&A. And then under the SCB framework, we can continue to look for ways to optimize our capital and our capital deployment. And with share buybacks, we had a big increase. Based on where I believe our stock price is going, we have an incredibly strong return from those buybacks, and so we'll continue to look for additional ways to deliver value through our buyback program. So hopefully, that gives you some color. But in many ways, Moshe, we are just getting started with optimization efforts. There’s obviously a lot completed, but a lot more to come.

Great. Thank you. And I'll remind folks, if you have additional questions, feel free to reach out to Ally Investor Relations. Thank you for joining us this morning. That concludes today's call.

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