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

Thank you, Operator. We appreciate everyone joining us this morning as we review Ally Financial's fourth quarter 2018 results. You'll find the presentation we'll reference throughout the call on the Investor Relations section of our website, ally.com.

On Page 2 of the presentation, I'd like to direct your attention to our forward-looking statements and risk factors. The contents of our call will be governed by this language. On slides 3 and 4 of the presentation, we've included some of our GAAP and non-GAAP or core measures.

These and other core measures are used by the management team, and we believe they are useful to investors in assessing the company's operating performance and capital measures, but they are supplemental to and not a substitute for U.S. GAAP measures. Please refer to the supplemental slides at the end for full definitions and reconciliations.

Today, we have our CEO, Jeff Brown; and our CFO, Jenn LaClair, on the call to review our operating and financial results. We do have time set aside after the prepared remarks for Q&A. And with that, I'll turn the call over to Jeff Brown..

number one, the impressive and growing earnings power of our dominant franchises and market positions we continue to optimize; number two, the ongoing momentum in our new product areas and overall success of Ally Bank in the direct banking space; and number three, the continued focus to optimize the capital structure and drive long-term value to our shareholders.

In Auto, we originated $35.4 billion of loans and leases in 2018, maintaining our industry-leading position while expanding risk-adjusted margins. Auto continues to be a great business for us, fueled by deep relationships with our dealer customers and our consistent focus to make them and the OEMs even better.

Through mix and pricing, we drove estimated originated retail auto yields over 7% in 2018 compared to 6.2% in 2017 while the credit profile of originations remained consistent. Our dealer base and application volumes have grown every year since 2014.

In 2018, we decisioned a record 11.6 million applications sourced from nearly 18,000 dealers, which drove our increase in full year origination volumes. We've had steady progress in our diversification efforts where the Growth Channel in used volumes increased consistently in 2018.

I also want to point out that within the Growth Channel, over 1/3 of the originations are sourced from specialty and direct dealers. The auto and insurance businesses have proven their long-term resiliency. We've consistently adapted to the needs of our customers and changing market conditions.

This may be a 100-year-old business for us, but we adapt, innovate, and take care of the customer each and every day. The market position we've established within auto today has never been stronger in the history of the company. Credit performance in our portfolio remained solid throughout 2018.

On a full year basis, the retail auto loss rate declined while the portfolio yield increased versus the prior year. Net charge-offs for full year 2018 of 133 basis points were down 15 basis points year-over-year against the portfolio yield increase of 34 basis points.

We know there's a lot of focus on the state of the economy and the health of the consumer. Everything we see across our portfolios reinforces that consumer remains healthy. Employment conditions are strong across the country. Wage growth is accelerating. Tax reform and falling gas prices have been incrementally beneficial.

All of this leads to a strong consumer balance sheet. We'll continue to monitor trends, but our data remains favorable. Turning to deposits. We ended the year at $106.2 billion in balances, up $12.9 billion year-over-year, driven by our leading online deposit franchise.

Deposits remain a powerful product for us as we reduce high-cost debt and efficiently grow and diversify our earning asset base. Our 14% year-over-year retail balance growth compares to an industry-wide retail growth of around 2%, an indicator of our strong value proposition and momentum in direct digitally based banking.

We were in line with our data expectations throughout 2018 and, in 4Q, experienced the largest quarterly growth ever in both retail balances and new customers. For the year, we added another 230,000 deposit customers, ending at 1.65 million.

Millennial customers accounted for 55% of new account openings during the year, an attractive future prospect considering the generational wealth transfer of $30 trillion that will occur over the next 3 to 4 decades. The growth in customers is strategically aligned with our approach to adjacent products and capabilities.

Our invest and mortgage products provides us with access to large, addressable markets, representing attractive growth opportunities for us moving forward.

Multiproduct customers across our business lines continue to grow, where over 90% of our card customers, nearly half of our direct-to-consumer mortgage customers, and roughly 1/3 of our incoming invest customers are existing deposit account holders.

In Corporate Finance, pretax income was up 26% year-over-year while held-for-investment asset levels increased 19%. We've driven steady, measured portfolio growth in this book while remaining disciplined in our credit approach. In looking at capital management, we remain diligent in returning capital to shareholders in 2018.

We increased common distributions 26% year-over-year as we repurchased shares at attractive levels and continued to increase the dividend, resulting in a 2018 payout of 94%. In total, these results demonstrate the strength of Ally and the meaningful progress we've made along our strategic path. Let's turn to Slide #6.

Jenn provided an updated 2018 outlook on our call last quarter. I'm pleased to say that we delivered across every metric as we closed out the year.

And as I detailed a moment ago, drivers centered around our performance in our dominant franchises, including our auto optimization efforts and stable credit performance, along with the continued momentum in our deposit platform and growth products.

These improvements include investments we made across the company that position us to increase returns over the long term and evolve with consumer preferences and trends across financial services. Jenn will provide you with our 2019 outlook, but in short, we expect the financial progress to continue as we deliver along our strategic path.

I'll go over a few key metrics we monitor on Slide #7. We saw record results across each metric again this quarter. In the upper left, adjusted EPS was $0.92 per share in the fourth quarter, up 32% compared to the prior year quarter. Adjusted total net revenue grew to nearly $1.56 billion in the quarter, and net financing revenue expanded.

In the bottom left, deposits increased to $106.2 billion, which now represents about 66% of our funding base. Tangible book value on the bottom right leaped higher on a linked and year-over-year basis to just under $30 per share, a strong indicator of the inherent value we built.

I'm encouraged by these results, and you should expect improvements across each of these metrics as we move through 2019. And with that, Jenn will take you through the detailed financials..

optimization of our leading Auto Finance business, which highlights our execution as a national, full-spectrum, full-product suite lender; strong credit performance, driven by our disciplined underwriting practices and enhanced collection strategies; the growth of our deposit portfolio, allowing us to reduce our reliance on high-cost capital market funding and grow our customer base; benefits associated with our capital management strategy, including consistent share repurchase activity, along with tax reform and a favorable macro-economic environment.

Let's turn to Slide 10 to review adjusted total net revenue.

2018 results continued a trend of steady growth every year since going public, exceeding $6 billion for the full year, an increase of over $1 billion since 2014, driven by growth in earning assets, including capital-efficient asset classes and beta discipline on both sides of the balance sheet with expanding auto yields and growth in stable, efficient deposits that have replaced $10 billion of unsecured maturities.

Keep in mind, we've expanded net financing revenue during this time frame while our lease portfolio declined by over 50%, including a $680 million decline in lease net revenue. This momentum keeps us on track to achieving $5 billion in annualized net financing revenue over time.

We continue to be relatively neutral to rate and feel confident about the strong risk profile across our balance sheet categories. Adjusted other revenue in 2018 was $1.535 billion, an increase of $97 million since 2014.

Over time, we've offset lower investment gains and reduced fee income from the decline in lease terminations with higher insurance and Ally Invest revenues. Moving forward, we'll continue to generate fee income growth through our insurance, smart option, invest and Ally Home offerings. Moving to Slide 11.

Period-end balances in 2018 of $170.8 billion represent earning asset growth of over $27 billion since 2014 while RWA has increased by $16 billion. The balance sheet is comprised primarily of secured assets and new origination volumes coming on at yields in excess of current portfolio levels.

In Auto, the growth in retail and commercial assets more than offset the lease balance decline of $11.1 billion as we reduced our residual exposure. We've been clear about our intention to thoughtfully grow less capital-intensive assets that carry a marginally lower asset yield, including securities and wealth mortgage.

The investment securities portfolio represents around 17% of earning assets today, and we continue to expect this to migrate towards 20% over time. Since late 2017, when our capital requirements at Ally Bank normalized, we have steadily grown our liquidity portfolio, which is accretive to income and carries a strong credit and return profile.

On Slide 12, we have a snapshot of our loan and lease portfolio, which demonstrates the strong credit profile across each line item in consumer and commercial portfolios. Our focus on risk-adjusted returns remained central to our strategy and long-term financial trajectory.

Our commercial auto floor plan portfolio is a floating rate, well-collateralized asset that has performed exceptionally well over many cycles. Annual losses have averaged around 8 basis points over the past 4 decades and under 2 basis points since 2012.

You can also see the year-over-year improvement in losses with consolidated net charge-offs declining 10 basis points. Noninterest expense and efficiency ratio trends are on Slide 13.

Adjusted efficiency ratio for full year 2018 was 47.6%, and expenses were $3.26 billion, up compared to the prior year for reasons we have talked about in the past, including volume-driven growth in our core business lines, the ongoing enhancements of our digital capabilities and increased spend related to marketing and brand recognition, along with the build-out of new product offerings where we're focused on driving operating leverage over time.

Under 5% of the expense base is attributed to these initiatives, and we are seeing strong customer and revenue trends that continue to gain momentum. Over time, we expect revenue growth to outpace expense growth, an obvious component of driving improvement to the efficiency ratio.

Disciplined expense management will remain a focus area for us across the enterprise. I'll turn back to a review of quarterly results on Slide 14 with balance sheet and NIM. Net interest margin, excluding OID, was flat quarter-over-quarter at 272 -- or 2.72%, in line with our expectations.

On the asset side, overall yields increased 12 basis points linked quarter and 45 basis points compared to the prior year. Earning asset balances increased, driven by seasonally higher dealer floor plan balances and investment security purchases.

Retail auto portfolio yields moved up 19 basis points quarter-over-quarter as new originations were above 7% again this quarter while lower-yielding vintages continued to pay down. This resulted in a full year retail auto portfolio yield of 6.14%, an increase of 34 basis points year-over-year and on the upper end of our 6% to 6.2% expectation.

Commercial auto yields increased 15 basis points quarter-over-quarter, the third consecutive quarter with an increase of this magnitude as short-end rates continued to rise. Lease portfolio yields increased to 5.82% due in part to strong used car value that performed above expectations.

We continue to embed a supply-driven decline in used car values in our financial projections. Moving to the right-hand slide of the balance sheet. The ongoing optimization of our liability stack continued again this quarter. Retail deposits grew during the period while the unsecured footprint declined.

Over the past 5 quarters, over $5 billion of institutional unsecured debt has matured with a weighted average coupon of 4.5%, and we have another $3.7 billion scheduled to mature through the end of 2020 carrying an average coupon of 5.3%. Deposit details are on Slide 15.

Q4 was an exceptionally strong quarter for us with customers and balance growing at record levels. In the top right, we ended the year with $106.2 billion in total deposits, driven by Q4 retail deposit growth of $4.5 billion. Average deposit balances also demonstrated consistent growth trend.

Customer retention rates remained solid at 96%, a testament to Ally's strong value proposition and the high brand loyalty of our customers. In the bottom left, you can see that retail deposit rates increased 15 basis points linked quarter.

This resulted in a cumulative portfolio beta of 35% since the beginning of the tightening cycle, in line with our medium-term expectations relative to fed funds. And over in the bottom right, you can see the steady growth of customers and balances we've experienced since 2016.

Nearly 70% to 80% of our balance growth comes from new customers and the remainder from existing customers. In total, these metrics demonstrate that our 1.6 million customers stay with us and consistently grow their balances over time. Moving to capital on Slide 16. Q4 CET1 was 9.1%.

Keep in mind, elevated year-end floor plan balances drove higher RWA, and we also had higher share repurchase activity in the quarter. Outstanding shares are now down 16.3% over the past 2.5 years since the inception of the buyback program at an average price of $23.39, well below tangible book value.

2018 total capital distributions of $1.2 billion were 26% higher than 2017, and we recently announced an increase to our dividend, the fourth increase since mid-2016. Let's look at asset quality details on Slide 17.

Consolidated charge-offs were 85 basis points, down 16 basis points year-over-year as credit performance remained on solid footing across our portfolios. The consolidated provision expense was $266 million in Q4, down from $294 million in the prior year.

Retail auto coverage remained flat quarter-over-quarter at 1.49%, reflecting the stable credit performance and consistent underwriting practices we've executed over the past few years. Compared to the prior year, reserve levels normalized as a result of hurricane-specific reserve activity.

Retail auto net charge-offs in the bottom left declined 26 basis points year-over-year, continuing the trend of lower year-over-year quarterly loss rate. Looking at delinquency trends in the bottom right. 60-plus and 30-plus delinquencies increased year-over-year.

As we've previously discussed, the increase in 30-plus delinquency rate is mainly due to the increased used origination volume in 2018.

And while 60-plus delinquencies are higher year-over-year, the drivers are related to the increased use of collection strategies we put in place midyear that resulted in slightly higher delinquencies but measurable improved flow-to-loss trends.

Delinquencies remained in line with our expectations and are consistent with being on the low end of our 1.4% to 1.6% net charge-off range. On Slide 18, Auto Finance pretax income of $335 million was down $48 million versus prior quarter and increased $50 million versus the prior year period.

Retail net financing revenue grew, and provision expense declined year-over-year, more than offsetting $15 million lower net lease revenue. Used car values have remained strong, exceeding our expectations and driving higher gains per vehicle in Q4.

Compared to Q3, lower pretax income was driven by seasonally higher net charge-offs in a prior quarter loan sale gain that did not repeat, offset by higher net financing revenue.

In the bottom right, you can see the meaningful progress we've made over the past few years expanding the retail auto portfolio yield while maintaining stable-to-improving losses, driving improved risk-adjusted spreads in auto. Let's turn to Slide 19 to review origination and balance trends.

In the top left, originations were $8.2 billion in Q4, bringing full year 2018 to $35.4 billion with improved risk-adjusted returns. Growth in used volume during the quarter accounted for 47% and 52% of origination, highlighting our continued diversification and optimization momentum. In the upper right, our non-prime volume was consistent at 10%.

In the bottom left, consumer assets grew $2.1 billion year-over-year to $78.9 billion, where retail auto increases more than offset lease portfolio declines. And looking at commercial assets, average balances increased quarter-over-quarter to $36.6 billion due to seasonally elevated inventory levels and higher vehicle value.

Let's turn to Insurance segment results on Slide 20. Core pretax income of $78 million this quarter increased $30 million linked quarter and was down slightly from the prior year. The year-over-year variance was driven by marginally lower investment income. Written premiums of $298 million during Q4 increased $33 million versus the prior year.

We've seen increased volume every quarter throughout 2018. This trend has been fueled by strong vehicle service contract volumes and increased rates on dealer inventory products. The Insurance business continues to deliver steady results for us and is well positioned with our national Ally Premier Protection product and progress in our Growth Channel.

Turning to Slide 21. We have our Corporate Finance segment results. Core pretax income of $25 million in Q4 was down on a linked and prior year basis. The decline was driven by nonrecurring fee income and lower investment gains in prior period.

This was partially offset by higher net financing revenue as new origination activity drove higher asset level. Ending HFI asset levels grew over $200 million during the quarter. Competition was intense throughout 2018 in this space, but we remain focused on prioritizing credit and risk-adjusted returns in our originations.

We have experienced teams, a highly diversified portfolio and deal structures that are well aligned with our risk appetite. Corporate Finance provides attractive returns, and we are constructive on the opportunity this business provides us going forward. Looking at mortgage on Slide 22.

Pretax income of $15 million this quarter was up $7 million linked quarter and up $13 million from the prior year. Net financing revenue increased as asset levels grew, primarily in bulk mortgage purchase activity and direct-to-consumer volume. Growth in these products drove higher noninterest expense.

Let me wrap up on Slide 23 with our full year expectations for 2019. We are replacing the medium-term outlook we provided early last year as we're entering into the latter part of the original time frame.

Combined with actual performance through year-end 2018, we've achieved but remain consistent with each metric in the medium-term guidance, including an EPS CAGR that will be at or above 18%, improved core ROTCE in the 13% range and ongoing efforts to drive an improved efficiency ratio through positive operating leverage.

Building upon our momentum, we expect to see continued expansion of EPS and ROTCE in 2019.

Steady top line revenue growth of 4% to 6% will be fueled by ongoing execution in our business lines, including the ongoing optimization within our auto portfolio; the structural benefits associated with growing deposits, which allows us to roll down high-cost unsecured debt; and measured growth in capital-efficient assets.

We remain focused on disciplined expense management and driving improvement in our efficiency ratio in 2019 and beyond. You've heard us talk repeatedly about generating positive operating leverage in our new product offerings over time, and we have seen positive trends and revenue momentum throughout 2018 that we expect to continue in 2019. As J.B.

mentioned earlier, we continue to see increased multiproduct customer levels providing a future growth platform. Looking at retail auto net charge-offs. We expect to be on the low end of our stated 1.4% to 1.6% net charge-off range, driven by our consistent underwriting trends and a healthy consumer backdrop.

I close by saying Q4 continued a trend of improved financial performance across 2018 and the past several years. We generated record EPS, ROTCE, deposit levels and auto applications in 2018. We expanded risk-adjusted returns while investing in our businesses and future growth prospects.

Asset quality was excellent, and our balance sheet remained strong and well positioned. Well, capital returns to our shareholders increased to their highest level as we opportunistically repurchased shares. Looking into 2019.

We expect to continue our strong trajectory as we focus on executing for our customers and delivering long-term value for our shareholders. And with that, I'll turn it back to J.B..

Thanks, Jenn. It has certainly been terrific progress and results during your first year in the CFO chair. On Slide #24, I'll walk through our strategic priorities for 2019, which represent the how in achieving the financial outlook Jenn just covered.

This year, we'll continue to build upon the momentum we have established as our strategic efforts are now in full swing. We are a comprehensive [Technical Difficulty] commercial finance provider with dominant franchises well positioned for the long term.

Across the financial services landscape, it's clear that secular trends are increasingly migrating to digitally based products and services. Consumers expect simplicity and transparency and, more than ever, a focus on convenience and strong customer service. These have been cornerstones to our approach from the beginning.

The customer remains at the center of our Do It Right mentality. 2019 will be our 100th year in auto and the 10th year since Ally Bank was launched, milestones that reflect our deep industry experience, the resiliency of franchises and true ability to take advantage of market opportunities.

Within Auto Finance and Insurance, we'll continue optimizing risk-adjusted returns while maintaining a strong focus on credit discipline and future growth opportunities.

On the deposit side and within our digital product offerings, you should expect that we'll continue to focus on customer growth and improvements in operating leverage, and we'll continue to be efficient in our capital deployment.

Our culture is critical to our long-term success, and I'm particularly proud of what my teammates have accomplished across the company in 2018 and over the past several years. We'll keep our relentless focus on our customers, communities and shareholders as we move forward from here.

So as we've entered 2019, I thought I'd share 5 simplistic reasons why Ally should have your support. One, we excel at managing credit. It's a key core competency established over the past 100 years and over a variety of economic environments. Two, we're adaptable. We've proven we thrive when a challenge comes our way.

This adaptability has led to extraordinary and resilient franchises inside of Ally. Number three, we take care of our customers, new ones and existing ones. We don't take the strong retention levels and brand awareness lightly. This is deeply embedded in our beliefs. Four, we're using and investing in technology to our advantage.

We see our digital strategy and capabilities as a critical component of our competitive strength and market position. And number five, financially, we're poised to continue a very positive trend. This is a credible team. We deliver what we say we will deliver, and we have 8,000 teammates focused on continuous advancement and improvement.

We will continue to win by keeping our heads down and executing the plan. I am very proud and honored to lead our great company, especially as we embark on the next 100 years. Thank you, and I think we can now, Daniel, head to Q&A..

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

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

When we go back and look at the slide on the unsecured maturities, the '19 maturities are actually relatively low cost, but you have 7.5s and 8s maturing in 2020.

Is there any opportunity to call those sooner and take advantage of the arbitrage between the deposit costs and refinancing those notes?.

Rick, thank you for the question. Certainly, we look at liability management all the time as part of our routine ALCO process and appreciate your perspective here. As we look at other options to generate returns, it's definitely on the list where our stock is trading today at a discount to book value. We've been leaning heavily into share repurchases.

Certainly, you saw that in Q3 when we increased our share repurchase about 3% and 16% since the inception of our buyback program. We just -- we really like the returns we're seeing from buybacks. Now we'll continue to look at liability management. And as you mentioned, through 2020, we've got about $3.7 billion coming due at a coupon over 5%.

And with our very strong deposit performance exiting 2018 and entering 2019, we'll continue to accrete that value over time..

Got it, okay. And then just one follow-up question related to deposits. When we compare your deposit costs on sort of the digital banking model versus the brokered model of other consumer finance companies, it appears that there's about a 30 basis point advantage in terms of deposit costs.

When you think about the operating and marketing expenses associated with operating that digital bank, does that actually net out to a positive return?.

Yes. I mean, we're very conservative and prudent in terms of how we deploy our branding expense. We did have a promotion in Q4. I think we garnered multiples of what we were expecting in terms of balance sheet growth, and we're seeing strong retention on that investment as we've come into Q1.

So I would say net-net, our strategy around deposits has been largely to lag some of the leaders in the space and to be prudent with our expenses around branding. And I think we're well positioned, and certainly, we feel very good about the trade-off between total cost to deposits and the volume we brought in, in 2018 and heading into 2019..

Our next question comes from Arren Cyganovich from Citi..

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

Yes. Sure, Arren. Our strategy in auto is really not to chase volume but just focus on risk-adjusted returns. And certainly, here in 2018, we originated $35.4 billion, which is spot on with where we were targeting kind of -- to bring in volumes.

And we're very pleased with new origination yields coming on at over 700 basis points, which is up over 80 basis points on a year-over-year basis, so very pleased with performance here in 2018. As we look ahead into 2019, still seeing a lot of opportunities to continue to have success with the strategy.

Used continues to be a very strong strategy for us. We ticked up from 45% of our net used in 2017, up over 52% in 2018, and we'll plan to continue to focus on used and certainly focus on the Growth Channel, so seeing a lot of opportunity as we head into '19 and no change in our strategy. And certainly, you couple that with stable credit.

We've been originating consistent mix of credit over the last couple of years, and we feel really good about positioning, both on volume and quality, heading into 2019..

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

Yes, sure. And certainly, we've been guiding towards deteriorating used car prices for some time now. In 2018, it outperformed. I think spot were up about 4%, average up about 1% in used vehicle prices. We've been anticipating that to trend down.

We're supply-driven versus demand-driven, and that is incorporated into our guidance around hitting that low 1.4% to 1.6% range. So we agree with you, and we've thoughtfully considered that as part of our guidance heading into '19. Now you have to couple that with a lot of dynamics around the health of the consumer, J.B.

mentioned, still performing very strong, credit rounding up. Fourth quarter was exceptionally strong, the net charge-offs down 26 basis points year-over-year, and we're seeing some strong trends as we head into 2019 as well..

Arren, the only thing I might add, just I spent time with a lot of auto dealers last week, is -- I mean, they are seeing pressure just how expensive new car prices have become, and you've seen the OEMs pull back to some degree on incentives that are out there. So part of that factors into us thinking that the used car market is going to hold up.

I mean, Jenn alluded to, we continue to model for about a 4%, 5% decline in prices. But our outlook right now is that used is going to continue to have pretty strong demand, just given how expensive new car prices have become..

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

Jenn, want to ask one on deposit pricing as it looks like the Fed might not be likely to raise rates here, but I'm just wondering what was sort of embedded in your guidance as far as what you do with deposits.

Should we expect kind of no change from here or does it really depend on what's going on in the competitive landscape or if you're able to generate solid yields off loans, does that also affect what you're -- how you're thinking about deposit? Just trying to get what factors are in play..

Yes, Chris. And I think you nailed it. Essentially, we don't have any additional rate hikes built into our forecast at this time. And assuming a pause from the Fed, we would expect to see some easing on deposit pricing coming into 2019. Now you got to take that in the context of the competitive landscape.

We still have a desire to grow balances, and we've got a lot of liability management and optimization opportunities that are unique to Ally. So we're going to continue to lean in on deposits. We're expecting that there'll be some easing on pricing, but it's going to largely depend on the competitive landscape.

Now certainly, we manage beta on both sides of the balance sheet, so love where you're headed with the yield question. We have our portfolio. Our retail auto portfolio is at 614 -- 6.14%. We put on new origination yields over 7%.

So as you think about the natural tailwind, even if we don't get any incremental rate increases, we'll have a natural 40 to 50 basis point increase per year in the next couple of years on the retail auto side. So all of those dynamics, we feel play out favorably for us as we head into 2019..

Okay. And then just for benchmarking where you're putting on new loans. Should we think about like using a -- like looking 2 to 3 years out on the yield curve to -- is where you're typically targeting your pricing. So if we see it like -- looks like average yields were kind of flat in the fourth quarter versus the third quarter.

But the -- we're exiting -- exited the fourth quarter down a bit. I just wonder if that puts downward pressure on that 7% number or not..

Yes. So you're exactly right. It's a 2 to 3 year price point on the curve, and you can't really look at any quarter because there are seasonal mix changes. I would just look at it full year. We put on about 80 to 80-plus basis points of price.

As we head into next year, even if we don't have any incremental uptick on the yield curve, we'd still expect to add in about 40 basis points of pricing..

Our next question comes from Moshe Orenbuch from Crédit Suisse..

Great. Maybe just to expand on that a little bit.

I mean, when you think about how you're pricing, is it off the captives? Is it off banks when you're thinking about the yields? Like where is the biggest -- who's the biggest driver of the competitive dynamic for yield pricing?.

Yes, Moshe. And I appreciate the question. We're pricing based on a lot of different dynamics. First and foremost, it's the credit profile of our borrowers. Second, we look for opportunities across all sorts of products and across the full spectrum. And so you'll see, we typically lean into the belly of the curve.

We're not overly exposed to super prime, and sub-prime's running around 10%, 11% right now. So we feel very comfortable with where we're positioned. Certainly, the OEMs and captives have leaned in heavily on the super prime space, seeing credit unions in there as well. We're not overly exposed to that part of the curve.

So we feel good about our positioning. Now we continue to see opportunities in used, continue to see opportunities in the Growth Channel, and that's where we'll continue to focus in 2019. Now our overall pricing and credit management is really, as we've talked about several times, focused on risk-adjusted return.

And certainly, you see that in our performance this year with the portfolio yield up 34 basis points and charge-offs coming down 15 basis points. So we'll continue to focus on risk-adjusted returns above all else..

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

But kind of how do you think about that in terms of the -- any changes that you see in the competitive environment in 2019?.

Yes. I mean, it's very competitive. And as a result of that, we've continued to lean in on our core competencies around brands and technology. That's nothing new for us. It's really a continuation of where we've been focused over the last couple of years. I think we're really pleased with the efficiency that we've seen in our marketing spend.

We'll continue to focus on refining that. I mean, obviously, we watch every dollar, and we're prudently investing not only in branded technologies but in our core businesses and the new businesses that we see. But net-net, we feel good about where we are in terms of our investments..

Our next question comes from Don Fandetti from Wells Fargo..

Jeff, I'm just curious if you could provide us your latest thoughts on how digital is impacting the dealership business, auto sales in general and then how do you think you're positioned. I know you have this interesting Carvana relationship.

Maybe you could provide us the latest on that, what kind of growth that's providing and how you sort of compete with alternative bank or banks that might come in for that type of business as well..

Sure. So thanks for the question, Don. So I mean, I'd start by saying the indirect channel is still really the dominant channel of how consumers access loans. So the vast majority is still through the dealer.

Having said that, dealers have dramatically invested in their own technologies and infrastructures to make the process for consumers more efficient. So dealers are evolving, getting more user-friendly, more friendly websites, offering potential for financing through their websites.

But still, the reality is, I think, it's 94%, 95% of all auto loans are sourced through the indirect channel. So part of our strategy is to help the dealers to understand capabilities that are out there, who's being more efficient than others and so helping the dealers really evolve into a more user-friendly environment.

And I think that will remain a key part of our strength.

But one of the stats, and I think it's the first time we've shared it, is within our Growth Channel, which is obviously representing more than 50% of the originations we're putting out right now, about 1/3 or a little over 1/3 within that Growth Channel is coming from what we call our specialty indirect providers.

And those would be names like Carvana, CarMax, DriveTime, our CSG group as well. And so we are well positioned there. We're mindful that trends may accelerate in that space today, and it's part of the reason we've established relationships with a number of those names. So hopefully, that covers more or less, Don, what you're after..

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

Exactly. And that's part of -- Jenn and I both try to stress some of the adaptability of the franchise. I mean, there's been a number of points really. It's been 4 years for me in the CEO chair, and I've been here 10 years. And I can count on multiple hands a number of times people thought the demise of our Auto Finance business.

But part of our strategy is every single day, continue to adapt, continue to be mindful of the future, be mindful of trends. And so that was a core component of our theme today, really, how we've adapted our business model to changing macro conditions and changing environment conditions and competitive conditions..

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

Yes. It's a good question. No, we don't change our risk-adjusted returns expectation across any channel. We're very consistent how we originate. And we've got retail forward flows with Carvana and all of our partners, and the risk-adjusted returns look favorable there.

Now they get the benefit of our balance sheet, and we get the benefit of the increased flows with -- the relationships have worked out really well. So we don't adjust any of our return expectations across our different distribution channels..

Our next question comes from Sanjay Sakhrani from KBW..

With the risk-adjusted yields improving steadily, I assume there's not been a whole lot of change from a competitive standpoint. I mean, I guess have you guys seen any changes? Because it seems it's been in quite a favorable -- you guys have been in a favorable situation for some time now.

And then secondly, that improvement in the risk-adjusted yield, how much of it has been driven by mix to used versus new?.

Yes. So why don't -- Sanjay, thanks for the questions. I'll take part one. Jenn can take part two. I think with respect to the competitive environment, I'd say, overall, it's pretty stable. We haven't seen any meaningful shifts other than the ones we talked about earlier this year. There's one large player who had migrated more out of the used space.

But for the most part, the past 6 months has been stable and pretty rational, still very competitive. I don't want to imply that competition is decreasing. It's still a very competitive market. But I think we've all found in niches where we all can play successfully there. So competitive is still pretty rational. And then Jenn, with....

Yes, sure. Sanjay, as we look at our expansion in risk-adjusted returns, there's kind of three main drivers there. One is just our ability to continue to originate at the -- at high volumes at the prices that we have been, which have largely, at this point, passed on 100% of the rate increase, a little over 100% of the rate increase to date.

So that is the leading driver in terms of the expansion on the yield side. And then you couple that with our ability to originate and very consistent credit quality. Those are really the two main drivers. And then to your question, to a lesser extent, it's around the mix of each person.

It is a driver, but it's a much smaller driver compared to the other two..

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

Yes, sure. I mean, we've been anticipating kind of a supply-driven decline in used vehicles value. If you look at off-lease vehicles in 2019, it spikes up to its highest level. I think there's about 4 million vehicles coming off-lease.

And as a result of that, all else being equal, we'd expect used vehicle values to drop maybe 3 -- about 3% to 5% of what we've modeled into our forecast for 2019. Now there's other dynamics at play there. Obviously, health of the consumers, gas prices. So that's not the only dynamic, and certainly, we outperformed that here in 2018..

Our next question comes from Eric Wasserstrom from UBS..

Just to follow up on a few of the questions that have been asked about pricing, and I realize that there's been many. But Jenn, could you just specify? You've alluded to it in a couple of ways.

But how did the marginal price change from third quarter to fourth? Can you just clarify that for me?.

Yes. So coming into fourth quarter, origination yield was about 7.33%. And I believe that ticked down just a little bit from third quarter, and that's largely just a reflection of the mix. We tend to move into more of a new vehicle market in the fourth quarter.

As we go into 2019, we'll have some seasonality around originations, just depending on mix as well. But net-net, that 7.07% origination yield is up 80 basis points, 80-plus basis points compared to 2016.

And so if you kind of look at our book that reprices every 2 to 2.5 years, you'd expect our portfolio to continue to trend up from 6.14% to over 7% over the next 2 years. And we'll continue to see that origination yield go up..

And J.B., just to follow up on Sanjay's question for a moment. I think the one large player that you were referring to, I think, recently indicated that it's now they're intent to come back into used in a greater way. And I think historically, they were the number one provider of financing in a still a highly fractionated market.

But can you just maybe relate that expectation maybe to how it's influencing your thoughts on used pricing, if at all?.

Yes. Really not influencing yet today, and we're really -- the reality is we're not seeing it or feeling it. Obviously, we've heard these comments as well. But within the market, within the dealer force, we're just -- we're not seeing any real change right now. And obviously, the results and trends show we're still getting a nice portion of used.

But as you point out, it's a large market. A couple of times, multiple of the new car market, it is very fragmented. So there's opportunity for everyone to play. But I think we've really emerged in the dealer body as a strong partner in booked and used volumes..

Our next question comes from Betsy Graseck from Morgan Stanley..

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

And is there any change in where you think the CET1 could go on a normalized basis?.

Yes, sure. So first, on balance sheet, we're going to continue to grow our asset base, and we've got opportunities across all of our portfolios. You look at auto, we -- we'll continue to find opportunities there at the right risk-adjusted returns. Certainly, we've been leaning in. And Corporate Finance portfolio is about $4.6 billion.

We'll continue to look for opportunities to grow that business. And then we've talked a lot about our capital-efficient assets. We've been leaning in towards securities portfolio. We think we're a bit under-invested there, and we're about 17% of our portfolio in securities. We plan to grow that to about 20%.

And then certainly, seeing opportunities in mortgage, I mean, mortgage, we've been growing the bulk. We see DTC really taking off, and we're getting the right operating model in place around mortgage. So we'll continue to lean in there as well. So we're anticipating kind of mid-single-digit total asset growth coming into 2019.

Now on capital returns, I mean, certainly, that's been a key focus of ours. We've increased our distribution to shareholders in '18 about 26% year-over-year. Certainly, we're mindful as we go throughout 2019, a lot of dynamics around the regulatory environment, CECL. And so we'll be mindful of that.

Now on the CET1 ratio, we did get down a bit this quarter. We had about 9.1%. Some of that was just because of seasonal impact from floor plan on the commercial auto side. We do see that moderating coming into first quarter here. So we're running about historic levels here in terms of our total CET1 ratio.

Now as we go forward, we feel very good about our ability to continue to generate earnings organically. I think we'll be well positioned as we see the different dynamics around CECL and the regulatory environment play out..

Do you feel like the 9% CET1 kind of -- I don't know if target's the right word, but level is appropriate, given all the rules and rigs that changed for a bank your size? Do you think that you would ever bring that down? And maybe if you could talk through a little bit how you see CECL playing out because there's been some mixed messages from regulators.

It's not in their stress tests on a go-forward basis, but maybe the onetime charges. So just let us understand how you're thinking about that..

First of all, we feel very good about the 9% CET1 ratio. If you look at our portfolio, we included a slide in the earnings presentation today. We have a almost fully secured balance sheet. We've done, I think, an exceptional job managing the risk and understanding the risk in our portfolios.

And I'd say kind of point one, we feel really good about the 9%. Now there's a lot of play in terms of the regulatory environment, potentially some relief from a capital perspective, if we look at the SCB, some of the enhanced prudential standards. We'll continue to learn more as we go throughout this year.

But all else being equal, we feel very good about the 9% CET1 target ratio..

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

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

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

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

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