GM Financial

presentation delivered at the 2021 Auto Conference on Thursday, August 12, 2021 at 12:00 PM


Jonathan Rau: Good afternoon, and thanks for joining us today at the J.P. Morgan Auto Conference. My name is Jon Rau, and along with my associate, Jordan Sabourin, we cover the investment-grade auto sector here at J.P. Morgan.

Excited to have with us today the leadership team from GM Financial, including President and CEO Dan Berce. As I mention every year, Dan has been an executive in the auto finance industry for about as long as I've been alive. I appreciate him joining. It's always great to get his insights.

To our listeners, we're going to leave some room for Q&A towards the end of the session. Feel free to submit questions through the conference website using the "Ask a question" button on the screen.

As a reminder to folks listening, this is a GM Financial presentation with a focus on the captive side of things. Please try to keep questions focused on the finance side of things as opposed to the auto business.

With that, I wanted to get started broader, bigger-picture question here. To kick things off, Dan, you filed earnings last week and it was a record quarter. What drove the results, and how should we be thinking about the rest of the year?

Daniel Berce: Jon, we had an exceptional first half of the year at GM Financial. Three main drivers, those being residual value gains, which were a result of the strong used market we're in today, good consumer credit, and then finally, lower cost of debt, which expanded our margins.

Drilling down on each of those a bit, everyone knows what's happening in the used car market. It's widely publicized. The prices were up through the end of June, let's say from the beginning of the year, some 30-ish percent. We were a beneficiary of that.

We have a large amount of coming off of lease terminations every month. We were able to participate in that strong market through residual gains. In fact, our gains were up about 900 million in the first half of 2021 versus the first half of 2020.

It's interesting that we didn't even participate in that market backdrop as much as we could, because our customers, increasingly, are purchasing their vehicles at the end of the lease.

In fact, 89 percent purchased their at the end of the lease in the second quarter. You contrast that to maybe 20 percent a couple years ago when the market was more stable for used car values.

When customers purchase the vehicle at contract residual, we still recognize gains, but not to the extent the market would allow if we sold the in the market. What's happened with the prices here in the third quarter?

We've seen a bit of a drop-off, but prices are still up about 10 percent year-over-year from this time in 2020. This time in 2020 was about the peak of pricing in 2020, so we're still experiencing a strong market.

Nevertheless, we don't expect our gains in the second half of 2021 to be as much as the first half, mainly because our lease terminations are going to be considerably less. Two reasons.

We did a lot less leasing three years ago in the second half of 2018 versus the first half, and then we also have sold down our available off-lease inventory quite a bit.

We started the calendar year with about 40,000 units, ended the month of June with about 10,000. We drew our inventory down about 30,000, recognizing gains.

Second half of the year, all in all, we've guided to, overall, about a billion to a billion and a half less pre-tax earnings. A big part of that is termination gains, mostly volume-related, a bit price-related.

The second factor in our exceptional first half results was credit. Consumer credit has performed extremely well in auto since the pandemic. We've seen record payment rates across credit spectrums, from super-prime all the way down to subprime.

Our delinquencies are at all-time lows. Charge-offs are extremely low. The consumer continues to benefit from the savings patterns, the savings that they've built up over the pandemic period. It's trillions of dollars of excess savings that consumers are using to make their auto payments, and in some cases, paying ahead their auto loans.

We're also continuing to benefit from the government stimulus programs, even though those are waning. On the charge-off side, of course, used car values are leading to higher recoveries. Second half of the year, we expect consumer credit to remain quite strong, albeit begin the normalizing process.

The thing that won't repeat from the first half as far as consumer credit is that we reduced our reserves. We had built significant reserves in the first half of 2020. We drew down our reserves first half of '21, which won't happen again in the second half.

Jon, the final point I won't hit very hard is we're experiencing robust capital markets and really low spreads. We're realizing our debt raises, whether it's ABS or unsecured.

We haven't had to pass that along to the consumer in terms of pricing, and so our margins have seen expansion, which benefited the first half and should benefit the second half as well.

Jonathan: That's a great overview, a great place to start. Thank you for that, Dan. Maybe shifting gears a little bit, has been making a very large push into vehicle electrification, large investments on that front.

From a captive financial side of things, how are you thinking about managing residual value risk for EVs that are coming down the pike here against the backdrop of this continually improving technology and battery density?

Is there a risk here that the next-generation electric vehicles are going to make the prior models or the current models obsolete?

Daniel: It's certainly a new frontier for us and anybody that's doing EV leasing. By the same token, GM has had electrified vehicles in the market for quite a while now. The Volt first and finally the Bolt. We did a fair amount of leasing on both of those vehicles.

It's fair to say that the residual values that were set at origination were fairly conservative. We use ALG as our guide to setting residuals. Just like ICE, ALG is looking out what's going to happen in three or four years when these leases terminate.

They're considering all the normal factors like supply and demand incentives, pricing, product refresh. On EVs, they're also considering technology. We have done pretty well on both returns remarketing above contract residual.

We'd expect, as we go further and further and deeper and deeper into EVs, that at least, the outset for mass-market products, the residual values will be set fairly conservative upfront. The OEMs certainly have the decision to make to enhance residuals as a marketing spend to help drive EV sales.

From a captive standpoint, our starting point will be comfortable.

Jonathan: Maybe as a follow-on there, with this powertrain transition in the works, how are you thinking about residuals for internal combustion vehicles? Is there going to be maybe a shift there as well?

Daniel: This transition to EV has got a pretty long runway. I know we've come out and said we're going to have all electric by 2035, but that's 14 years from now. Even then, ICE vehicles will still exist.

The average age of a vehicle on the US road today is about 12 years. Yet, if you look at a new vehicle, the technology is so much better, whether it's features, assisted driving features, the informatics in the car. Yet, people are still driving 12-year-old cars.

ICE vehicles aren't going to go away anytime soon. I like to look at the example of sedans, which were, at one point, well over 50 percent of the new car market. Now, they're less than 30. Residual values for sedans have held up extremely well, because there's people who need a less expensive or a certain type of product.

EVs are expensive, and people are going to still want a five-year-old ICE vehicle that they can get cheaper.

Jonathan: That's a great point. That's interesting to think about. One more question along the lines of electric vehicles and the investment there is one I get often is green bonds and sustainable financing.

Any thoughts that you have, in terms of as you think about funding needs for the next couple of years as more of these models come through? What are your thoughts on issuing green bonds or some sort of sustainable finance?

Daniel: Green bonds are aligned with GM's vision for a sustainable future, and so green bonds will be part of our funding plan here as we go forward.

As we generate more EV-related assets, either through loan or lease, we'll accumulate enough mass to do a green bond, whether it's unsecured or secured. That's absolutely part of our funding plans in the future, Jon.

Jonathan: Makes sense. Good. Listening to presentations yesterday and also this morning, one of the themes coming out of the conference is this discussion around the consumer, and also in terms of vehicle affordability.

From your vantage point, how are you thinking about the state of the US consumer at the present? Something we've spoken about in the past is with the onset of the pandemic, there was this big shift in consumer preferences in terms of consumer behavior that prioritized the car as an asset.

As a follow-on, wanted to see if you think that shift is more of a permanent one, more a temporary one. Any concern, if it's a temporary one, that as the country eventually reopens, people start to travel again, start to dine out again, is there less room in the budget for making car payments?

Daniel: That's obviously a multifaceted question there. I'll go back to my remarks at the start is that the consumer right now is in tremendous shape, with all the excess savings that they've accumulated. They're using that now to pay off, pay down their auto loans and other debt, for that matter.

With the job market coming back, and jobs being plentiful, and potential for income increases, the consumer is healthy. I don't see that changing anytime soon. Yes, we will get back to as they spend more, they'll take on more debt, but that horizon is a ways off.

The auto has incrementally become an even more important asset to the consumer, and I don't think that goes away anytime soon either. With remote work, the country has seen a lot of consumers move to rural places outside urban centers.

The need for transportation, that personal transportation has only increased as a result of geographic shifts from the pandemic. That bodes well for auto demand and auto finance going forward.

Jonathan: Thanks. The other big topic to talk about is used vehicles. Of course, prices have benefited from a general lack of availability of new vehicles, given the chip shortage among other factors.

Wanted to pick your brain there about how you think about the direction of used vehicles, the potential downside to used prices as new vehicle inventories are rebuilt or eventually rebuilt and your thoughts on that side of things heading into the back half of the year.

Daniel: I believe that used car prices are going to be strong for some time to come. You cited the fact that new car inventories are quite short right now.

I know an hour or two ago, Steve Carlisle was on and mentioned that GM dealer inventory was in the teens, a far cry from where it was and pretty far from optimum levels, which would be, in Steve's parlance, 30 to 60 days of inventory.

With the chip shortage affecting things today expected to get better through the end of the year into 2022, there's a lot of new car demand to feed first before inventories can even be rebuilt. We're on a pretty slow ramp for used car prices to normalize.

I believe they'll be strong well into 2022. I don't believe there's much risk of an abrupt change in used car values, primarily because of what's happening with new car supply.

Jonathan: Thanks. Maybe going back to the EV side of things briefly here, this, I don't know if you'd call it a shifting go-to-market strategy, but the introduction of new vehicles where consumers put down a deposit and there's more of a direct link from the manufacturer to the consumer.

I'm wondering, the reintroduction of new models in this way, does this offer your business as a captive any unique advantage relative to competitors on the finance side who would otherwise step in?

Daniel: I would say, Jon, at the margin, it does. To the extent there is a order list for any vehicle, such as the , for instance, that provides us built-in leads where we can get ahead of the delivery and get in front of the consumer, through the dealer, of course.

The vehicles will still be delivered through the dealer. In conjunction with the dealer, get ahead of the delivery, and offer financing, and get things set up by the time they take delivery. At the margin, I'd say it's helpful.

Jonathan: Maybe bigger picture, GM Financial has been in growth mode for the past many years or so since the General Motors acquisition of AmeriCredit. If I look at the balance sheet now, your earning assets are currently wrapped around 100 billion.

Maybe remind us of the target size of where you want to grow to and maybe how many years away you are from reaching that steady state.

Daniel: We have probably till mid-decade ahead of us to get to steady state. Steady state we consider to be somewhere in the neighborhood of 125 to 130 billion of assets.

For us to get to steady state, we would need to penetrate GM retail sales by, say, 45 to 50 percent continually for the next few years. If we do that through mid-decade, we'll get to that steady state number, after which our growth will be subject more to the level of GM sales and industry sales.

I'll point out that the 125 to 130 billion may be a bit high, if, in fact, dealer floor plan assets don't get back to where they were traditionally, which I don't think they will. That probably is a little hole in that number. The growth will be mainly on the retail loan and lease side, Jon.

Jonathan: Great. One follow-up there, you mentioned the dealer and the floor plan side of things. I wanted to dig into that a little bit deeper.

If that doesn't get back to where it once was, is that a function of running with lower inventories going forward, or is there also an element of maybe this shifting go-to-market strategy, with automakers introducing products and customers putting down deposits ahead of delivery? Are those two maybe interrelated?

Daniel: They're interrelated. Everybody's benefited -- OEMs, dealers, and captives -- from running with less inventory. I think everyone's learned to sell with less inventory and sell it at pretty good price points and margins. The idea of getting back to normal or traditional inventory levels probably isn't ideal.

That'll be a situation where our floor plan assets probably won't get to where we thought they might. The whole pre-order situation may lead to lesser inventory as well. We're going to be in the middle of it as a captive no matter what.

Whether the inventory is carried in a national footprint by the OEM, or whether it's carried at the dealer level, we're still going to be financing it and be the funding source. They are interrelated.

Jonathan: Interesting. When you get to steady state, you've said this in the past, the idea that once you reach that steady state level, the distributions to GM Co could match the company's earnings.

I suppose we're in a very strong year for the company right now, where if you think back, what you earned in the second quarter of the first half of the year was probably more than what the business was earning for a full year going a couple of years back, but...


Daniel: in the first half this year than we did in all of last year, which we thought was a great year.

Jonathan: Is the plan still that when you reach that steady state, that the vast majority of GM Financial's earnings can be dividended to the motor Co?

Daniel: Absolutely. At those steady state numbers I referenced, we'll be earning somewhere in the range of two and a half to three billion pre-tax.

You can put a tax rate, whatever that might be on it, 25 percent, and we'll be paying dividends in the 1.8 to 2.5 billion-dollar range to GM, which would basically be all of our earnings.

Again, that doesn't happen until steady state, because as we grow from our current 103 billion of assets to that steady state range, we'll need to accumulate and keep some of the capital we earn.

This year is an exceptional year where we had excess earnings, which created a downdraft on our leverage ratio. We're able to afford a higher dividend this year than we might have otherwise paid to GM.

Jonathan: You mentioned the leverage range, so I'll ask there on the balance sheet. You've disclosed that you have excess capital relative to your support agreement threshold, but where do you target running leverage for the business? Where do you like that ratio to be going forward?

Daniel: Jon, the support agreement threshold is 12 times. Managerial, though, we don't want to see it exceed 10 times, given there's plenty of room between our managerial target and the support agreement level. We're running less than eight now.

Again, that was due to the strong earnings profile we've experienced this year. It's less than eight, even though we've paid a billion two of dividends already this year. The managerial target of 10 times is mostly a function of what our earning assets look like.

For instance, lease and subprime would require less leverage. Things like prime, super-prime, and floor plan, we could leverage more. We look at how that 125 billion is going to look in a few years and calculate backwards to that 10 times.

Jonathan: Thanks. I've got a question in from the audience here. Also, a reminder to folks who are listening, feel free to submit questions using the blue button if you're following along online. The question is in relation to the submission for a bank charter.

GM Financial announced the application for an industrial bank charter earlier in the year. To the extent you could comment on the rationale behind that and what, if approved, that would bring to the business.

Daniel: We did file the application. It was last December, so that was some eight months ago now. The application's in process and it'll be before the FDIC soon. Can't tell you what the time horizon is, because we don't have control over it.

That being said, strategically, the reason we've applied for a charter is to supplement our existing funding platform. It's not going to replace our debt complex, our ABS program, commercial paper, but it's going to add another element of financing. We've got a pretty big capital need.

Even when we get to steady state, we're going to be having to replace a significant amount of debt every year. If we had, let's say, 10 percent of our debt complex ultimately in deposits, that takes that much pressure off the other funding mechanisms. It's a supplemental.

It's also, to some extent, a CRM tool. We've got a significant consumer base here in the US that we could market deposits to and create a deeper link to those customers to drive more loyalty. It's supplemental funding, stable funding, but also a loyalty play as well.

I'll point out that a couple of our peers, BMW and , have ILCs on their own, so it's not a unique strategy for a captive.

Jonathan: Very interesting. I'd say you're in good company there when I look at Toyota's credit ratings and BMW's credit ratings. Very good. Dan, I wanted to ask on the topic of interest rates. I think we're down year-to-date on the five-year Treasury.

With the talks about broader inflation and what that could mean for interest rates, maybe remind us about potential sensitivity to loans for rising rates and at what point, if any, you'd be concerned about higher rates from a consumer perspective.

Daniel: We run our business to be rate-agnostic, so we have very little interest sensitivity in our existing book. That being said, if rates change, we would have to re-price new loans and leases so that we could keep our margin, which we've historically been able to do.

The five-year was three, three and a half percent not too long ago and our business ran quite well from a pricing standpoint. Remind everyone that because of how short an auto loan is, 100 basis points might be only $15 of payment change, which, when you get to multiple 100 basis points, that becomes more meaningful.

We're a long way away from there. There's a lot of other elements of cost to ownership. Gas prices, electrification, there's insurance. The auto loan is just a component and, again, a small move in interest rates. I don't think it's going to affect affordability to the point it's going to change demand.

Jonathan: That's a good way to frame it. Thanks. I know we're running up on time here. Maybe one last question going back to this topic of affordability.

The articles in the press and, of course, the quarterly sales press release, we're talking about average transaction prices north of 40,000. Is there a level at which you start to get worried that consumers can't digest higher transaction prices?

Daniel: Yeah, there is a steady ramp in pricing that makes sense. We've seen pretty significant increases over the last year because of some of these supply factors. I don't think that's sustainable.

Yet, with today's ATPs, we're not seeing waning demand. Consumer is in great shape, interest rates are low, total cost of ownership is pretty reasonable. I don't think we've hit that inflection point yet. Seeing multiple years like we did this year, I don't think it's going to happen.

Jonathan: Fair enough. I'd love to keep going. We're at the half-hour mark here, Dan, so thank you very much. To the entire GM Financial team, great insights as always. Thank you as well to those who listened and participated as well. I hope that next year, we're able to this again in person.

Daniel: Thanks, Jon. My pleasure.



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