Ally Financial (ALLY) Q2 2023 Earnings Call Transcript

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Ally Financial (ALLY 5.40%)
Q2 2023 Earnings Call
Jul 19, 2023, 9:00 a.m. ET

Prepared Remarks:

Operator

Good day, and thank you for standing by. Welcome to the second-quarter 2023 Ally Financial 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] And be advised that today’s conference is being recorded. I would now like to hand the conference over to your speaker, Sean Leary, head of investor relations. Please proceed.

Sean Leary — Head of Investor Relations

Thank you, Carmen. Good morning, and welcome to Ally Financial’s second-quarter 2023 earnings call. This morning, our CEO, Jeff Brown; and our corporate treasurer, Brad Brown, will review Ally’s results before taking questions; CFO Russ Hutchinson has also joined for today’s call. The presentation will reference can be found on the Investor Relations section of our website, ally.com.

Forward-looking statements and risk-factor language governing today’s call are on Slide 2. GAAP and non-GAAP measures pertaining to our operating performance and capital results are on Slide 3. As a reminder, non-GAAP or core metrics are supplemental to and not a substitute for U.S. GAAP measures.

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Definitions and reconciliations can be found in the appendix. And with that, I’ll turn the call over to J.B.

Jeff Brown — Chief Executive Officer

Thank you, Sean. Good morning, and thank you for joining the call. Before I start into details on the quarter, I’d like to take a moment to officially welcome our new CFO, Russ Hutchinson, to Ally. I’ve known Russ for nearly 15 years, and he’s been one of my most reliable and trusted advisors during my time as CEO.

He’s a terrific addition to our team and a great partner to the investment community, many of whom have relationships with Russ already. Russ, welcome. And why don’t I turn to you to see if there’s any comments you’d like to add.

Russ Hutchinson — Chief Financial Officer

Thanks, J.B. As J.B. mentioned, I have first had knowledge of Ally’s excellent culture from working with this leadership team over many years. I’m thrilled to be joining the company now at Ally’s day to day as a particularly rich set of opportunities across its auto finance and Ally Bank businesses.

Jeff Brown — Chief Executive Officer

Thank you, Russ. And again, welcome. And with that, I’m going to begin on Slide number 4. Adjusted EPS of $0.96, core ROTCE of 14%, and revenues of 2.1 billion demonstrate our ability to execute in a dynamic operating environment.

Net interest margin of 3.4% was generally in line with our expectations as we continue to absorb the impacts of rapidly rising short-term interest rates. Given the continued changes in market interest rates, margin pressures are more severe from a few months ago. We’ll discuss that in detail as we navigate the presentation deck. While the bank funding market has been relatively stable since the events of mid-March, we continue to hold a conservative liquidity posture anchored by our leading deposits franchise.

Retail deposits were up nearly 0.5 billion despite seasonal headwinds related to tax payments and a host of other factors pressuring deposit flows. Insured balances increased 1.3 billion in the quarter and now represent 92% of the portfolio. Total available liquidity of 42.5 billion was effectively flat quarter over quarter and is equivalent to 3.8 times our uninsured deposit balances. CET1 ended the quarter at 9.3% and exceeds our regulatory minimum by 3.7 billion.

Operational performance in the quarter was steady across the company. Within auto finance, 3.5 million applications powered us to generate 10.4 billion of originations at attractive risk-adjusted returns. We highlighted this last quarter, but I want to reiterate that we see around 100 billion of potential originations in any given quarter, allowing us to be selective in what we book to the balance sheet. Net charge-offs in the quarter were 132 basis points, which was down from prior quarter but was slightly elevated relative to expectations.

Brad will talk more about the second-quarter loss performance and our outlook for the rest of the year. Within insurance, we continue to successfully grow and deepen dealer relationships as 299 million of written premiums were up 14% year over year. Turning to Ally Bank. Total deposits of 154 billion are up 13.9 billion year over year as we continue to grow our deposit customer base, now approaching 3 million.

We have over 1 million active credit card holders and remain excited about long-term opportunities for this business. We’ve launched our One Ally digital experience and expect to complete the full rebranding of Allied credit card later this year. Corporate finance continues to deliver accretive disciplined growth is nearly 100% of the 10.1 billion portfolio is in a first lien position. Turning to Slide number 5.

I remain incredibly proud of the culture we’ve established, and it’s critical to our success as we navigate periods of uncertainty. Culture has always been a top priority for me, and we continue to see tangible impacts from our efforts. Our 11,700 teammates provide diverse perspectives and contributions and our leadership team is focused on maintaining strong engagement across every level of the organization. We recently completed another company engagement survey, and I’m proud that we remained in the top 10% of global companies and were eight points higher than the financial services benchmark.

We remain focused on being a source of strength for consumer, commercial, and dealer customers. Year to date, customer obsession has resulted in satisfaction scores of nearly 90% and customer retention of 96%. Stronger communities mean a stronger ally, and we were thrilled to recently announce nearly 1 billion in giving and lending support for affordable housing initiatives. I’m proud of Ally’s ability to make a difference in home affordability, which remains a key challenge in many communities.

Our culture is authentic, unique, and a key differentiator in delivering long-term results. On Slide number 6, we wanted to directly address some of the critical items we’re navigating today. This is a unique time in the industry and our company, and I’m confident in our leadership team and teammates who have successfully navigated numerous challenging environments before. From an interest rate perspective, we’ve talked for multiple quarters about the near-term challenges of a rapidly rising interest rate environment.

Operationally, throughout the cycle, the businesses have been disciplined in managing pricing on both sides of the balance sheet. We’ve also utilized our strong ALCO processes, including an active hedging program to protect the company from higher-for-longer rate scenarios. Beyond the near-term pressure, the momentum we have on the asset side of the balance sheet positions us well for margin expansion when rates stabilize. Inflation data we saw last week shows the policy may be working to slow pressures.

And obviously, that will be a significant positive for us going forward. Managing credit risk continues to remain a top priority. We’ve refined our buy box to eliminate underperforming segments and add significant price particularly in riskier segments to compensate for potential volatility. Based on where we see things today, we’d expect retail auto NCOs of 1.8% for the full year, which is in line with the range we provided in January.

This is a unique environment where unemployment remains historically low. However, persistent inflation is a challenge for many consumers. Delinquencies remain a watch item and remain elevated entering the second half of the year. And consistent with prior guidance, we assume a meaningful step down in used vehicle values for the remainder of the year.

The team we’ve built and the investments we’ve made in collections and servicing will drive solid performance even in a challenging environment. On the regulatory front, we’re preparing for increased capital and liquidity across the industry and expect Category IV banks are likely to see requirements more like those with the G-SIB at some point in the future. I won’t advocate whether or not that is appropriate as I firmly believe tailoring works, but I think we are being realistic in our thoughts for the future. We’re well positioned from a liquidity standpoint, and we’re building capital to prepare for these expected changes.

We maintain constructive working relationships with the regulatory community and look forward to clarity on potential changes in the [Inaudible] framework. Understandably, though, there’s a lot of focus on near-term pressures and potential for increased regulation. Overall, I feel strongly the company is well positioned to deliver earnings growth over the next several years. And as rates turn, we are more uniquely positioned to benefit than most in the industry.

Let’s turn to Slide number 7, where we’ve highlighted the strength of our market-leading consumer deposit franchise. Since Ally Bank’s inception in 2009, we’ve continued to provide customers, not just another bank offering, but rather a better approach to banking. Our seamless digital customer experience has resonated as we’re now approaching 3 million retail deposit customers. Millennial and younger demographics represent most of our growth, which highlights the opportunity ahead.

Given the construct of our consumer deposit portfolio, 92% of deposits are FDIC insured, among the highest levels in the industry. And customer retention of 96% continues to demonstrate the loyalty of our customers once they’ve opened an Ally account and experienced our customer-centric digital approach. We recently received recognition from The Wall Street Journal for being their favorite online bank, again, another positive recognition to our approach to banking. Moving to Slide number 8.

We provided a snapshot of our current funding stack and available liquidity. We’re core funded with deposits as they comprise 87% of our funding but importantly, we have multiple sources of liquidity beyond deposits. In fact, over the past three months, we’ve accessed every one of our non-deposit funding sources, including public secured and unsecured debt transactions. We were the first Category IV bank to issue unsecured debt since the events of March, and the transaction, which was TLAC eligible, was very well received, demonstrating confidence in our financial profile.

On the right side, we show total available liquidity of 42.5 million, representing 3.8 times uninsured deposit balances. And for context, cash on hand at quarter-end represented over 80% of our uninsured deposit balances. While markets have been mostly calm in recent months, we know that can change quickly, and we felt it was appropriate to highlight the strength and resilience of the liquidity footprint again this quarter. And with that, I’ll turn it over to Brad to cover our detailed financial results.

Brad Brown — Corporate Treasurer

Thank you, J.B. Good morning, everyone. I’ll begin on Slide 9. Net financing revenue, excluding OID, of 1.6 billion was down year over year, driven by higher funding costs given the rapid increase in short-term rates as liquid savings products comprise the majority of our consumer deposits portfolio, partially offset by higher earning asset yields, given strength in auto pricing increased floating rate assets, our hedging program, and growth across unsecured products.

Adjusted other revenue of 481 million increased year over year and quarter over quarter, reflecting momentum across our insurance and SmartAuction businesses. We see a path for expanding other revenue across the back half of 2023, moving toward a 500 million quarterly run rate. Provision expense of 427 million was down quarter over quarter, reflecting seasonal trends and a modest reserve build. I’ll provide more granular commentary on charge-off trends shortly.

Noninterest expense of 1.2 billion reflects the highest second-quarter weather losses realized since 2020, in addition to disciplined investments across technology and variable servicing and collection costs. Despite elevated weather losses, year-over-year growth in total expenses declined relative to the first quarter. We expect favorable year-over-year expense trends as we progress through the second half of 2023. GAAP and adjusted EPS for the quarter were $0.99 and $0.96, respectively.

Moving to Slide 10. Net interest margin, excluding OID, of 3.41% was generally in line with expectations, down 13 basis points quarter over quarter. We see momentum within earning asset yields, but the increase in short-term rates will continue to pressure cost to funds, as we’ve discussed previously. We continue to maintain a conservative liquidity position, including elevated cash balances.

All of this pressured margin by a few basis points in the quarter, we believe this is a prudent trade-off in the current environment. Our longer-term view of NIM trajectory is largely unchanged, but given the rate environment, we currently see full-year 2023 NIM around 3.4%. I’ll share more detail on NIM dynamics and outlook shortly. Our approach to underwriting and focus on risk-adjusted returns slightly lowered our retail-originated yield this quarter.

As we continue to originate loans in the mid-10% range, we see significant tailwinds in future periods as more recent originations comprised a growing share of the overall portfolio. Total average loans and leases of 148 billion are up 11 billion year over year, driven by growth within retail auto and a gradual normalization of commercial auto balances. Quarter-over-quarter growth of less than 1 billion reflects our focus on disciplined capital deployment. Earning asset yield of 6.99% increased 28 basis points quarter over quarter and nearly 200 basis points year over year given the cumulative impact of trends we’ve discussed previously including retail auto portfolio yield expansion, the increasing contribution from higher-yielding assets, and over 60 billion of floating rate exposure across our commercial loan and hedging portfolios, partially offset by our maintenance of elevated cash levels mentioned previously.

Retail portfolio yield expanded 32 basis points from the prior quarter as recent vintages comprised a larger portion of the portfolio. At quarter-end, nearly 60% of the portfolio consisted of loans originated since 2022 when the tightening cycle commenced. Concurrently, we’ve added 460 basis points of price, which will provide significant tailwinds in future periods, and our hedging program continues to provide incremental benefit to the retail auto portfolio yield. Commercial portfolio yields expanded alongside benchmark rates given their floating rate nature.

Turning to liabilities. Cost of funds increased 45 basis points quarter over quarter and 273 basis points year over year. The increase in deposit costs reflects continued increases in short-term rates and a highly competitive market for deposits. On Slide 11, we provide an updated view of our expectations for retail auto and deposit pricing, the two largest drivers of our margin trajectory.

Our current expectation for full year NIM of around 3.4% is based on the forward curve, which now assumes peak Fed funds of 5.5% and no rate cuts until 2024. Despite this pressure, we remain confident in the underlying momentum, which will lead to NIM expansion in future periods. Retail auto portfolio yield expanded again this quarter as we continue to originate well above the overall portfolio yield. Originated yield declined in the quarter as we’ve increased the super prime proportion of our volume.

Disruption in the market has enabled us to capture super prime share with minimal change in price. Returns in this segment are significantly higher than normal, and we’ve taken the opportunity to optimize risk-adjusted returns. This shift demonstrates the benefit of our scale and ability to adapt to market conditions. Current originations are still well above portfolio yields, which will drive portfolio yield to 9% by year-end.

Deposit pricing reflects dynamic environment with banks competing with each other and investment alternatives to capture deposits. We expect the retail deposit portfolio yield to continue migrating toward current liquid savings rates. Clearly, there are a range of possible outcomes given the current backdrop but we remain confident in our balance sheet positioning and corresponding NIM trajectory. And while we’ve seen pressure to our full-year NIM outlook, we see a steady migration up to 4% over time even without the benefit of rate cuts.

Moving to Slide 12. Our CET1 ratio increased quarter over quarter to 9.3% given our disciplined approach to capital allocation. We announced another quarterly common dividend of $0.30 for the third quarter, and loan growth will be modest and focused on attractive risk-adjusted returns. At current levels, we exceed our 7% regulatory minimum for CET1 by 3.7 billion.

While Ally was not subject to this year’s DFAST exercise, our stress capital buffer remains unchanged at the minimum 2.5%. The bottom right provides our current TCE ratio and a pro forma view of CET1 in the unlikely scenario where the AOCI filter is fully removed. Even without the expected benefit of a gradual phase-in, pro forma CET1 of 6.9% is in line with our 7% regulatory minimum and is expected to increase naturally. As a reminder, nearly all of our securities portfolio is held in AFS, meaning we don’t have a large unrealized loss sitting and held to maturity.

And we have continued to allow the securities portfolio to roll down with minimal reinvestment over the past 12 months. Let’s turn to Slide 13 to review asset quality trends. Consolidated net charge-offs of 116 basis points were down quarter over quarter as we saw typical seasonal trends, partially offset by a specific charge-off within corporate finance. The charge-off within corporate finance added 16 basis points to the consolidated rate.

This exposure was fully reserved for previously and did not impact provision expense in the quarter. Retail auto net charge-offs 132 basis points were down versus the prior quarter but slightly higher than prior guidance. We continue to see mostly offsetting impact of elevated loss frequency and favorable severity benefiting from higher used values. I’ll cover retail auto charge-offs in more detail shortly.

In the bottom right, 30-day delinquencies increased 36 basis points quarter over quarter. More specifically, the 30-day delinquency rate rose less than we typically see in a normalized environment. Delinquencies will increase seasonally throughout the second half of 2023, and we continue to assess the impact of inflation. But the investments we’ve made will support our ability to communicate with consumers and mitigate losses.

Slide 14 shows that consolidated coverage declined two basis points to 2.72%, given the release of specific reserves related to the corporate finance charge-off mentioned previously. The total reserve balance of 3.8 billion was flat quarter over quarter and is 1.2 billion higher than CECL day 1. Our macro assumptions assumed worsening employment conditions with unemployment reaching 4.6% next year before increasing to approximately 6.2% under our reversion to historical mean methodology. Retail auto coverage increased 2 basis points to 3.62% and remains well above the 3.34% on CECL day 1.

The remaining weighted average life of our retail auto portfolio remains under two years, demonstrating the coverage we have for expected lifetime losses of this portfolio. On Slide 15, we share credit trends we’ve seen so far through June and our outlook for the year. As noted previously, we ended the quarter with NCOs of 1.3%, which were slightly elevated versus expectations. The drivers of this increase are consistent with the themes we’ve talked about today and on our prior earnings call.

Delinquencies entering the quarter were elevated as we did not see the typical seasonal decline coming out of tax refund season earlier this year. Flow to loss rates remained stable and favorable to pre-pandemic levels, but we did see elevated loss frequency late in the quarter. Those losses occurred at the same time the industry saw several weeks of declining wholesale vehicle values, which further added to the pressure through the end of the quarter. While delinquencies remain a watch item, we saw the smallest second-quarter increase in 30-day delinquencies since the pandemic, and year-over-year increases continue to decline.

Used vehicle values are a driver of loss severity, and we feel our assumed decline in the second half of the year is appropriately conservative. On the bottom left, we’ve again provided quarterly loss expectations, which result in a full-year loss rate of around 1.8%. On the right side, we’ve included a summary of some of the key underwriting decisions we’ve made as we leverage detailed segmentation and analytics to optimize risk-adjusted returns. Slide 16 provides our latest view for used vehicle values given performance year to date, which saw values increase 5%.

We are currently forecasting a 12% decline in values across the back half of 2023, which would result in a full-year decline of 8%, roughly in line with what we shared last quarter. Beyond 2023, we expect elevated values relative to pre-pandemic levels given the constraint on used vehicle supply. Turning to Slide 17. Retail deposits, 139 billion increased 486 million quarter over quarter and 7.8 billion year over year, demonstrating the strength and resilience of our leading franchise.

Importantly, insured balances were up 1.3 billion this quarter and represent 92% of total balances. Total deposits of 154 billion are up 14 billion year over year. Following record customer growth in the first quarter, we added another 86,000 new customers, our 57th consecutive quarter of growth. More than 10% of deposit customers now have a relationship with Ally Invest, Home, or credit card.

And we see opportunities across Ally’s growing customer base as we expand and deepen relationships as consumer preferences continue to migrate toward digital offerings. Moving to Slide 18. Our digital bank platforms provide diversification and deepen consumer relationships. Ally Invest complements the deposit franchise well as 85% of new accounts were from existing customers as they leverage the ease of money movement between accounts within Ally.

Ally credit card added 49,000 new cardholders in the quarter, now 1.1 million strong. Balances increased a modest 100 million, reflecting our discipline given the current backdrop. Going forward, we’ll continue to look for opportunities to prudently market to the existing Ally customer base. Ally lending is focused on deepening merchant relationships within home improvement and healthcare verticals.

Like the Ally credit card, our disciplined approach to underwriting and capital allocation results in a modest growth quarter over quarter. Let’s move to Slide 19 to cover auto segment results. Pretax income of 501 million reflected pricing momentum along that higher provision expense. On the bottom left, we highlight the intentional shift we made in our origination profile over the past several months.

Uncertainty in the market has caused a number of lenders to reduce or exit their position in the marketplace, creating an opportunity for Ally to win incremental business. Our strategy to drive overall application volume and increase the top of the funnel enables us to see the entire market and focus on risk-adjusted returns. The bottom right chart summarizes lease termination trends. While used values declined from March to June, average auction proceeds were slightly favorable quarter over quarter.

A higher number of lease terminations in the period also led to an increase in remarketing gains versus the prior quarter. Slide 20 highlights a few ways in which the auto business continues to evolve and develop in order to serve our dealer customers even better while driving attractive economics for Ally. SmartAuction is our web-based auction platform that enables dealer-to-dealer transactions, generating fee revenue for Ally while providing real-time data on market pricing and trends. Despite a meaningful reduction in industry volume, SmartAuction revenue is projected to be up more than 60% versus 2019 and unit volume up more than 50% since just last year.

We see tremendous opportunity to leverage our platform for additional white label relationships, providing efficient incremental revenue. On the right side of the slide, we highlight Passthrough Program Revenue. Given our strategy to drive increased application volume mentioned above, we now see more than 1 million applications per month, allowing us to be selective and maximize risk-adjusted returns. For certain loans that do not meet our underwriting criteria, we route those applications to relationship partners.

Ally receives the fee for the origination and services of loan, allowing us to generate efficient revenue while leveraging the scale of our servicing platform. Both initiatives represent opportunity to further expand Ally’s other revenue and demonstrate the strength and breadth of the auto finance franchise. Turning to Slide 21. Our unique scale and deep dealer relationships allow Ally to engage in and support EV adoption as the market develops.

Originations of 347 million are up 42% year over year and represent our single highest quarter of EV originations, demonstrating our reach in the marketplace. Consumer EV portfolio balance of 1.5 billion is diversified across lease and retail and OEMs and consists of plug-in hybrid and battery electric vehicles. As we’ve highlighted previously, the synergies between auto and insurance are a competitive advantage for Ally and benefit our dealer and consumer customers. In October of last year, we introduced a new insurance product designed specifically to cover plug-in hybrids and battery electric vehicles.

Our approach to EVs is consistent with our overall auto strategy to adapt to changing environments, focus on our core strengths and drive accretive returns. Ally’s history of finance and EVs goes back more than 20 years, and we remain well positioned to support dealers and customers as consumer preferences evolve and EV adoption grows. Turning to Slide 22. We remain focused on leveraging our differentiated go-to-market approach coupling high tech and high touch, which has generated significant scale and a competitive advantage.

Application volume of 3.5 million and 29% approval rate reflects the selective way in which we deploy capital. Ending assets in the top right were up slightly quarter over quarter as commercial balances gradually increased alongside modest growth in retail auto. Originations of 10.4 billion on the bottom of the page displays the scale of our franchise and the compelling volume we’re able to generate despite tighter underwriting criteria. Year to date, nearly 20 billion of origination volume puts us on track to originate around 40 billion this year.

Additionally, used comprised 64% of originations, which was flat quarter over quarter as we progress through the typical used vehicle selling season and down 5 percentage points year over year, given the underwriting actions we’ve taken in recent quarters. Nonprime represented just under 10% of retail originations in the quarter. Turning to insurance on Slide 23, a core pre-tax loss of 16 million was a result of seasonally higher weather losses along with normalization of GAAP losses given decline in used car values. Keep in mind, we do have reinsurance in place for weather losses to limit our total exposure, but following several years of favorability, we saw weather activity more in line with historical averages.

Written premiums of 299 million increased 14% year over year as we remain focused on increasing dealer relationships and benefit from normalizing inventory levels. As a result of the momentum in written premiums, earned premiums were up 27 million year over year, with further expansion ahead. Our focus remains on leveraging the scale we’ve established within auto finance and highlighting our full spectrum product suite to dealers, driving further integration of insurance across our auto dealer base. Corporate finance results are on Slide 24.

Core pre-tax income of 71 million reflected disciplined portfolio growth and the benefit of higher interest rates, given the entire portfolio is floating rate. The charge-off referenced earlier resulted from a vertical we no longer originate and didn’t impact second-quarter results given specific reserves posted in prior periods. The portfolio remains high quality with roughly 60% asset-based, and effectively 100% of loans are in a first lien position. HFI portfolio balance of 10.1 billion has remained relatively flat year to date with modest growth expected to the rest of the year, reflecting the team’s discipline and focus on maximizing risk-adjusted returns.

Slide 25 includes details for mortgage. Mortgage generated pre-tax income of 21 million and 267 million of DTC originations. We’re not tied in any specific origination target and instead remain focused on a great experience for customers and have considerably reduced the expense load of the business in light of market conditions. Slide 26 contains our financial outlook for 2023.

The operating environment remains dynamic, and despite the difficulty in providing granular guidance, we’ve continued the transparent approach we’ve taken over the past several quarters. As we’ve highlighted previously, our guidance is based on expectations for interest rates, specifically Fed funds, which continue to change rapidly. At the end of the first quarter, the market was expecting a peak Fed funds of 5.25%, followed quickly by rate cuts with Fed funds ending the year at 4.5%. At the end of the second quarter, the market expected Fed funds to 5.5% through year-end, a full 100 basis points higher than previously expected.

Given the nationally liability-sensitive nature of our balance sheet, that will put incremental pressure on NIM and see full-year NIM of around 3.4% or 10 basis points lower than our previous expectations. Our expectation for full year 2023 other revenue is closer to 1.9 billion, mainly due to some of the one-time items we recorded earlier this year, but we remain confident in our ability to get to that 2 billion annual figure. As we covered previously, retail auto portfolio yield is still projected around 9%, while funding costs have moved up given the changes in benchmark rates and the intense competition for deposits. Retail NCOs are expected to be at 1.8% for the full year and no change to operating expense as we limit spend to nondiscretionary costs or essential investments.

We see the tax rate closer to 18% for the year as we’ve had solid momentum in generating EV tax credits and expect that trend to continue. While elevated and increasing interest rates are a headwind, we expect most of the tightening cycle is behind us and have positioned the balance sheet for margin and earnings growth over the medium term and remain confident in our ability to continue to execute and drive long-term profitability. And with that, I’ll turn it back to J.B.

Jeff Brown — Chief Executive Officer

Thank you, Brad. The strategic priorities, which guide everything we do are unwavering and essential for our long-term success. First and foremost is ensuring we maintain strong alignment between our culture and our stakeholders. We’re focused on highlighting the differentiated offerings across our businesses for both consumer and commercial customers.

We’ll continue finding ways to disrupt the industry and remove friction for customers by delivering leading digital experiences. And even more important in this dynamic environment is our disciplined approach to risk management and capital allocation. I remain incredibly proud to lead our company. And over time, I’m confident these priorities will help us deliver value for all stakeholders.

Before I close, I want to take a minute to thank Brad for the exceptional job he has done serving as both the Interim CFO and corporate treasurer over the past nine months. That would have been a huge task in a normal operating environment, and the last nine months have been anything but that. Brad seamlessly expanded his responsibility to lead the entire finance organization, and the team continued to excel in everything they do. Brad, thank you on behalf of the entire company.

And with that, Sean, I’ll turn it back to you and head into Q&A.

Sean Leary — Head of Investor Relations

Thank you, J.B. As we head into Q&A, we do ask that participants limit yourself to one question and one follow-up. Carmen, please begin the Q&A.

Questions & Answers:

Operator

Thank you. [Operator instructions] One moment while we compile the Q&A roster. Our first question comes from Sanjay Sakhrani with KBW. Please proceed.

Sanjay Sakhrani — Keefe, Bruyette and Woods — Analyst

Thanks. Good morning. Appreciate all the commentary. Maybe we could just dive into the NIM migration next year.

I think, Brad, you mentioned you see a path to the 4%. Could you just talk about timing of how we get there? Obviously, it sounds like you guys are able to go upmarket. And I assume that that has an impact on the yield, but it also should have a better impact on provisions. So, maybe you can just talk about those moving dynamics there and maybe risk-adjusted margins as well.

Brad Brown — Corporate Treasurer

Sure, yes. Good morning, Sanjay. So, a couple of things. As we called out, the two biggest drivers of that trajectory being the retail auto portfolio yield, which you highlighted, as well as really cost of funds pressure that we’ve experienced given the continued volatility and certainly increase we’ve seen in short-term rates.

All of that to say that those dynamics have really led us to get down to that sort of 3.4% for full year 2023. And then, a couple of things I would mention just around — you highlighted it as well around what we’ve been able to really pass through from a retail auto yield perspective, they’re balancing risk-adjusted returns, which, again, are at historical highs in terms of what we continue to see there and the balanced approach we’ve taken around maintaining those risk-adjusted yields and certainly loss content or expected loss content as well. And then, on the cost of funds side, again, just continued volatility in short-term rates. From an overall deposit pricing perspective, which is the biggest driver there, we feel like when you look at the performance that we’ve had over the first half of the year, we’re very pleased with overall when you consider a number of things.

One, short-term rates, of course, and we highlighted the intense competition for deposits, both among banks but with alternative investments as well being so attractive. A dynamic there in banks, I mean, one of our premise has always been that direct banks will have a competitive advantage given the rates that we pay. We’ve seen a pretty big pivot in terms of aggression really across the industry on rates paid on deposits. So, that certainly has put pressure on those rates.

So, when you think about Ally more specifically, when you look at the first half, we’ve grown record customers in the first quarter. We grew another 86,000 this quarter. If that’s not a record for first half, it’s certainly second best ever. At the same time, we’ve grown balances, and retention and engagement remain very high.

All of this and not being really lagging at least certainly the top five payers on the good products. So, all of that to say, once we get past the peak in Fed funds and they pause, we will expand margins from there, maybe a quarter or two later. When you go into the — into full year 2024, that’s when we really expect to see that margin expansion, which will be a primary driver of that long-term trajectory of profitability.

Sanjay Sakhrani — Keefe, Bruyette and Woods — Analyst

OK. Great. And then, maybe you could just help us think about like reserve coverage on a go-forward basis because you do have the higher losses, but the delinquency rate seems to be trending in a positive direction. And then you might have a more favorable mix shift.

Maybe you could just help us think about the reserve coverage going forward.

Brad Brown — Corporate Treasurer

Sure. Yep. And you saw us take that up a little bit in retail auto by a couple of basis points this quarter. And I think that’s really directionally when we think about the activity and the actuals that we saw in the second quarter, we entered the second quarter as we talked about with elevated delinquencies.The seasonal decline that we expected in the first quarter, we didn’t see as much, but we did see an increase less than expected here in the second quarter.

And so, we’re also really navigating that with this backdrop of persistent inflation and just higher demand and financial obligations for customers. And couple that with potential higher loss frequency, we talked every aspect of that and our assumptions there. All of those dynamics together kind of lead us toward that 1.8% for full year 2023. So, when you think about that, we don’t see a significant coverage — anticipated coverage for retail auto certainly as the biggest driver, given those dynamics.

And then again, that is supported through the 12-month reasonable and supportable forecast that we have and then reverse into the historical means from there.

Sanjay Sakhrani — Keefe, Bruyette and Woods — Analyst

OK. Great. Thank you.

Operator

Thank you. One moment for our next question, please. One moment, please. All right.

And it comes from the line of Betsy Graseck with Morgan Stanley. Please proceed.

Jeff Adelson — Morgan Stanley — Analyst

Oh, yeah. This is Jeff Adelson on for Betsy. Good morning.

Brad Brown — Corporate Treasurer

Hi, Jeff. Good morning.

Jeff Adelson — Morgan Stanley — Analyst

Yeah. So, just wanted to dig into the NIM trajectory a little bit more. It seems like you’re looking for the back half of the year NIM to kind of hold steady to maybe a little bit lower from here. Just wanted to maybe dig into the components a little bit more and how we should be thinking about the trajectory of your deposit funding.

I know you have the OSA at about 4% today. You’re on — your CD is about 4.85%. And I realize you’re guiding to an OSA of about 4.1%. But just given that the competition is already above that today, one of your competitors just raised today, just wondering how you’re thinking about offsetting funding costs.

And maybe how we should be thinking about higher for longer rate environment into 2024?

Brad Brown — Corporate Treasurer

Yeah. Sure, Jeff. I’ll take a stab. So, I guess from a deposit pricing perspective, I know I say we are at 4%.

If you kind of look at how we’ve kind of priced through the journey here and the timing cycle, right, we expect that the market does another hike next week. So, when you think about — what I would say is we anticipate that Fed hike in our guidance that we provided, right, we — that certainly is factored in as well. And then, all the other elements that I talked about as well in terms of intense competition, just continued pressure on rates, all of those are embedded in that balance as well. And then importantly, we expect the portfolio yield will migrate toward, as I said, the liquid rates that we’re paying as well.

So, that’s the deposit pricing side, which is a huge driver. Now, to your point, we’ve also been highlighting the fact that this near-term pressure, one of the things that we’ve been doing is really positioning the balance sheet where we can by converting or swapping fixed assets to floating. That really is a significant benefit to us, particularly as the bridge to help mitigate some of this pressure near term. For example, it’s probably 200 million or so just in NII this quarter, which also translates to significant benefit to NIM the sculpting of that notional really does help here until sort of early 2024 or so.

So, to me, that also is embedded in the guidance of us in terms of the longer-term NIM — NIM view as well.

Jeff Brown — Chief Executive Officer

I think you’ve got it ballpark right. I mean, we see sort of trough in NIM approaching some point later this year. And I think as Brad mentioned in his response to Sanjay, I think a quarter or two after the Fed is done, and we can all guess when that’s going to be, you’ll start to see pretty rapid margin expansion. And then, to the extent you get eases, that really starts to accelerate.

But I think your timing around you’re getting closer to sort of the bottom is spot on.

Jeff Adelson — Morgan Stanley — Analyst

Got it. That’s helpful. And if we think about the credit outlook from here, I appreciate the updated color on the trajectory from here. Do you have an update on how you’re maybe thinking about 2024 as we’re sitting here almost six months away.

I know before you talked about getting that back down to a retail auto loss rate of 1.6%. And how are you thinking about that? And maybe relative to the prior update you’ve given us on the second half ’22, early ’23 vintage performing better than the prior to your vintage. Are you still seeing that, or is there an update there?

Brad Brown — Corporate Treasurer

Sure. So, I’ll start. So, I guess, just as it relates to the expectations around auto NCO. So, you did see us kind of guide up to the 1.8% higher end of the range here for this year.

I think a number of things obviously are dependent there, right, in terms of just obviously, the macros and certainly where they go I think that one of the things that we highlighted in the earnings presentation was this sort of slowing both quarter-over-quarter and year-over-year increase in delinquencies and net charge-off trajectory as well. I think some of that’s factored in as we continue to migrate through ’23 here and into 2024. And then, to your point, those sort of earlier, let’s say, more front book type of vintages have been more of an impact in terms of what we’re seeing both on those elevated delinquencies, as well as ultimate charge-offs. And so, those also are a driver and we kind of spelled out where we see those vintages reaching their peak loss periods.

All of that to say, 2024, given the guide that we’ve given for ’23, we would see some of that most likely bleed into 2024 as well given those dynamics. And then we can’t lose sight of the fact that risk-adjusted returns are again higher than ever. And when you think about the underwriting actions that we’ve taken to tighten and all the dynamics there, coupled with the investments we continue to make in servicing and collections, we feel pretty balanced about how we’re teed up to navigate the rest of this year and into ’24, again, continue on the macro backdrop shifting.

Jeff Brown — Chief Executive Officer

And I think on that pricing power point, the other thing is, look, the competitive environment right now for us is pretty sweet. I mean, you’ve seen a number of players decide they want to exit auto lending. And so, that makes for a pretty rich set for us. I think, obviously, with respect to Chase, I’m sure you looked at their originations last week.

I think quarter over quarter, they were up in the neighborhood of 30%. So, there’s still for people that are in and committed like Chase, like Kaplan, like ourselves, it’s still a very attractive market opportunity at very aggressive returns right now. So, we recognize credit may be a little bumpier than expected, but the ROEs that we’re putting on are pretty much a lifetime highs for the company. And so, we like the business.

You’ve got to have scale. And I think for the players that kind of are consistently there, it’s a really attractive market for us.

Jeff Adelson — Morgan Stanley — Analyst

Great. Thanks for taking my questions.

Operator

Thank you. One moment for our next question, please. All right. And it comes from the line of Ryan Nash with Goldman Sachs.

Please go ahead.

Ryan Nash — Goldman Sachs — Analyst

Hey, good morning, guys.

Jeff Brown — Chief Executive Officer

Hey, good morning, Ryan.

Ryan Nash — Goldman Sachs — Analyst

Maybe I’ll switch gears a little bit. So, the expense guide appears to be a little bit of a step down in the back half of the year. And I think you guys mentioned a little bit more of a harder look at cost. Can you maybe just talk about some of the drivers of the step down ex the weather-related insurance costs? And given potential for slower earning asset growth, could we see expense growth start to flatten out in the coming quarters?

Jeff Brown — Chief Executive Officer

Yeah. Ryan, I think you’re spot on. So, first, the trajectory in the first half of the year is definitely richer than what we see in the back half of the year. And I think the past three months, the entire leadership team has really appropriately responded to a message of clamping down on all fronts.

And in fact, largely outside of kind of new hires and new interns and one-offs here and there, we’ve effectively paused hiring as a corporation. There’s not a hard mandate per se, but I think it’s a very high hurdle rate to bring on new talent into the company right now. And so, we see the back half trajectory this year being much different than what we experienced for the first six months of this year. And so, that starts to get you back in line with the overall expense guide that Brad gave.

And then, I think the message into 2024, which clearly on the analyst community’s minds is going to be a much different trajectory. I mean, we’ve supported a lot of growth. They’ve been in smart areas like technology and brand and continued hiring in the company. I think just recognizing the environment we’re in, it’s going to be a much different story entering 2024.

And yeah, there are uncontrollable things like you alluded to, FDIC piece and things like that, but I think the controllables, the things that are within our power expect a very different expense trajectory out of the company going forward.

Ryan Nash — Goldman Sachs — Analyst

Got it. And maybe as a follow-up, I think Brad highlighted the adjusted capital ratio being around 7% J.B. or Brad, can you maybe just talk about how you expect to manage capital over the medium term, just given the need to get back to the, let’s call it, 9% plus level. And maybe is there any optimization strategies across the balance sheet that you could potentially pursue to get capital back toward your targeted levels? Thanks.

Jeff Brown — Chief Executive Officer

Yeah, Ryan. So, I’ll start. Brad, feel free or, Russ, feel free to dive in. I think one, we showed that kind of fully phased in as just the draconian view.

I think the reality is we’re hearing anywhere from two years to five years as an appropriate phase in. And so, we’re waiting to see. But I think our point was, look, even if you jam this down our throats on day one, we’re already basically at the regulatory minimum. So, there’s not a problem per se.

There’s not a need to go do anything out of line. And I think that important reminder that Brad gave in his prepared remarks is [Inaudible]. I mean, the company has chosen AFS for a reason, and yes, it presents some more volatility and some more pressure. But I think it affords us a lot more flexibility.

And I think you see that when you look at our TCE ratio relative to others that are out there. And so, for us, managing capital is going to be very appropriate, but I think we’re waiting to some degree on regulatory clarity as to how this all times out. I think for now, obviously, dividend is well intact. We announced that, and that’s full speed ahead with buybacks, I think we continue to be in no buyback mode for the moment right now.

We have had conversation around optimizing certain assets on balance sheet. We don’t think that’s necessarily a push to do, but these are things we constantly look at. And we will continue to look at. And so, for now, Ryan, we feel really good about the state of capital, level of capital.

Obviously, 9% is our kind of baseline internal target, and we think you’ll gradually get up there. But some of this just depends on the time and pace in which we get a message out of D.C. Fed on how these things are going to pan out.

Ryan Nash — Goldman Sachs — Analyst

Thanks for the color, J.B.

Jeff Brown — Chief Executive Officer

You got it.

Brad Brown — Corporate Treasurer

Thanks, Ryan.

Operator

Thank you. One moment for our next question, please. And it comes from the line of Arren Cyganovich with Citi. Please proceed.

Arren Cyganovich — Citi — Analyst

Thanks. I was wondering if you could talk a little bit about the health of the auto market, and we’re seeing commercial loans start to rise a bit but still below pre-pandemic levels and how the mix of new and used could change over the next couple of years.

Jeff Brown — Chief Executive Officer

Yeah, Arren. Thanks for the question. And I’ll start. Brad, again, feel free to dive in.

Overall, health of the market, it’s pretty solid right now, I mean, a couple of things I’d point out. We’re still very much supply constrained. And while you’ve seen some gradual uptick in inventories, and you’ve seen commercial balances migrate slightly higher. We’re still in a relatively constrained market.

And particularly, it differs by OEM by OEM. But I think overall, we still see things being very constrained. And obviously, that provides support for the used car market, and you see where we continue to be a big player there. I think on the dealer health front, you probably noticed there were a couple of charge-offs in the dealer space today.

I mean, these were dealers that we had on watch. And I think that’s just got to be a trend that we evaluate. We think overall dealer health is still really good. But this is the kind of a newer development.

We had a net recovery last year, and we’ve had effectively no charge-offs there. So, this is just sort of a new dynamic that’s out there. But I think generally speaking, the big dealers that we tend to do business with that are our largest relationships are still seeing really strong profitability, really strong results, really strong consumer demand. So, things are really supportive there.

The online players, obviously, Carvana was out this morning with some announcements on their restructuring and demonstrating good earnings trends there. So, net-net, we see the industry overall still being very healthy and I think very supportive for where we play.

Brad Brown — Corporate Treasurer

And maybe just to add a couple of comments on balance sheet. From an overall earning asset perspective, auto assets of 115 billion or so. We’ve done a little bit of trade as commercial balances have been down a little more retail auto. So, from a capital connection perspective, we really don’t have aspirations to see that change.

And I think we have opportunity between both of those and to J.B.’s point, we’ve seen commercial balances normalize slowly. We don’t expect them to get back to where they were anytime soon pre-pandemic. And so, again, we feel good about our ability to support our customers while also being disciplined on capital allocation.

Arren Cyganovich — Citi — Analyst

Thanks. And on credit card, you’re growing that at a nice pace. It’s still obviously really small relative to your balance sheet. But could you remind us what kind of credit quality customer you’re putting into that book as you grow that?

Brad Brown — Corporate Treasurer

Sure. So, I think it’s really not that different when you think about sort of overall average FICO retail auto being around 700-ish today. Credit card is most likely in that range as well. Again, for us, credit card is a significant opportunity to really expand and deepen relationships as we’ve talked about and certainly white space, right, which is one of the reasons we entered that market back in December of 2021.

So, as J.B. highlighted in his remarks, the journey continues there. There’s a lot of opportunity, right, for us to really expand across Ally’s total 11-plus million customers. And so, I think that opportunity is great.

At the same time, we are very mindful of the unsecured risk and the nature of that book, but also our continued allocation of capital, particularly in an uncertain backdrop. So, very careful and disciplined on that approach as well.

Arren Cyganovich — Citi — Analyst

Thank you.

Brad Brown — Corporate Treasurer

Thanks, Arren.

Operator

Thank you. One moment for our last question, please. And it comes from the line of Rick Shane with JPMorgan.

Rick Shane — JPMorgan Chase and Company — Analyst

Thanks, everybody, for taking my questions. And, Russ, welcome. And, Brad, thank you for all the help over the last year. Just wanted to talk a little bit.

Last quarter, there was commentary that the flow to loss ratios were pretty good. I’m curious in the context of what you’re seeing with loss severities potentially picking up in the second half given your outlook for used car prices if you think that there will sort of be a rational expectations behavior of higher loss frequency as used car prices decline and consumers potentially increasingly strategically default.

Brad Brown — Corporate Treasurer

Hey. Good morning, Rick, and appreciate your comments there. A couple of quick things. I know we’re almost out of time here.

On the flow to loss perspective, two things I would say, stable and still favorable versus pre-pandemic levels. So, that’s certainly a positive. We talked and highlighted a loss severity as well given the used vehicle dynamics. We also highlighted given the year we’ve seen dynamics and values different than we initially expected, but we’re now for the second half of this year, assuming a further kind of 12%, it would have to be a 12% decline.

So, all of that sort of factored into our guidance and expectations when we look at the NCO rate of full year, 1.8%.

Rick Shane — JPMorgan Chase and Company — Analyst

Got it. Yeah. Look, the math for the second half by quarter is very, very helpful as we think about things.

Brad Brown — Corporate Treasurer

Good.

Rick Shane — JPMorgan Chase and Company — Analyst

Thanks, guys.

Jeff Brown — Chief Executive Officer

Thanks, Brad.

Brad Brown — Corporate Treasurer

Yeah. Thanks for your comments, Rick.

Sean Leary — Head of Investor Relations

Thank you, everyone. Showing we’re a little past the hour, that’s all the time we have for today. If you have any additional questions, as always, please feel free to reach out to investor relations. Thank you for joining us this morning.

That concludes today’s call.

Operator

[Operator signoff]

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