Description

Ally Financial represents a good long term risk reward at current levels following a > 50% decline from peak amidst the CV crisis. The company is clearly in the eye of the storm but has a number of things going for it including a severely discounted valuation vs tangible book, a good capital position, an underappreciated asset/funding source in its large and growing online banking franchise and the nature of auto loans. 

On the negative side, at least for me, is the potential acquisition of Cardworks which the company announced in the first quarter and which was universally panned by investors including myself. Though Cardworks has historically been a solid, niche performer in the credit card space, ALLY paying a big price and incurring significant tangible book value dilution for a an acquisition that offered little medium term earnings accretion seemed highly questionable. 

Since the equity portion of the consideration has lost significant value (and was only subject to a collar 15% below ALLY’s stock price at time of announcement) it is unclear whether the deal will happen on the original terms, at a renegotiated price or not at all. Clearly most shareholders would prefer option number 3 judging by the stock price action when the deal was announced and the potentially more vulnerable nature of Cardworks business vs Ally’s core business in the current environment. In any event, ALLY should work as a long term long from here regardless of whether the deal is consummated. For what worth, Cardworks performed as a break-even business at the nadir of the great financial crisis as discussed in the transaction call.

Valuation: Given that ALLY is trading at less than 50% of tangible book value AFTER taking a $903mm credit provision in the recent quarter (reserves are now 2.5x the level they were at year end) and that it is trading at 5.5x 2021 consensus EPS and < 4x consensus 2022 EPS, i believe the upside from current levels is pretty obvious.

Balance Sheet/Capital/Liquidity/Etc: Clearly the primary determinant of this working is the company’s ability to get to the other side of this mess relatively intact. I believe it is set up to do so given a number of factors. First the company has ample liquidity with over $30bn of cash and “highly liquid securities” as well as a funding sources comprised of 75% deposits. The company noted that it has a $7bn buffer against its minimum CET1 requirement. The company’s recent provision assumes that NPLs will be in the 2.5-3% range for a time and then recover. For context, this figure peaked out around 3% in the great financial crisis and then recovered quickly. So clearly, there’s the potential for the company to have to take another reserve if things get worse than ‘08-’09 levels. But it’s tough to see the company’s tangible book value getting cut in half from here.

No one knows how bad the environment will get on the consumer side but it is important to remember 2 things about ALLY’s loans: 1) the majority of their borrowers are prime credits and the majority of the remainder are “near” prime so most of their customers were on the favorable side of the risk spectrum to start with. To that end, it seems a little disconnected that ALLY is down considerably more YTD than Santander Consumer, a competitor in the auto space which focuses much more on lower FICO customers (potentially an interesting hedge to this).

2) this is a qualitative observation in part but during the GFC, auto loans actually performed relatively well. The reality is that it is extremely difficult for most Americans to retain or pursue employment without access to their car. This is why in many cases people will pay their auto loans prior to their credit card bills (or multiple credit cards). It’s just not practical for most people to default on their auto loan if they have ANY other option. As a result, it is likely that people who lose their jobs (hopefully temporarily) will utilize government stimulus checks in part to maintain their cars.

Ally Bank: Ally bank is a valuable and underappreciated asset. It is the largest online banking franchise with $106bn of retail deposits which has grown consistently over recent years (recently in the HSD/LDD range). In addition the has made a significant effort in recent years to invest in ancillary products to further monetize this base including investment, mortgage and credit cards. To the extent financial mergers were ever en vogue (or allowed by the Fed) this asset could be seen as highly appealing to a larger financial institution looking to bolster its online financial offerings.

Catalyst

easing of the crisis... focus on ultimate tangible book value and earnings power again