Description

I believe ALLY is a solid bank which operates a simple, understandable business with competitive advantages on both the liability and asset side. I believe ALLY can generate “normalized” high teens returns on tangible equity and yet is trading at ~85% of tangible book value per share (TBVPS), or ~60% if one is willing to exclude AOCI impact of unrealized securities losses from TBVPS. I believe ALLY has $5/share of downside risk and $18/share of upside potential over the next 2-3 years.

ALLY was formed in 1919 as GMAC, the captive finance subsidiary of General Motors (GM). It diversified into mortgage lending and got burnt by subprime mortgages, leading to a US Treasury bail-out during the financial crisis. In 2009 the company was rebranded as ALLY and came public in 2014. Since becoming public, ALLY has built an industry-leading online retail banking franchise and a diversified automotive lending platform (GM was less than <22% of lending volumes in 2022 vs >70% in 2009).

ALLY has grown its deposit base impressively by delivering a good online banking product:  https://www.jdpower.com/business/press-releases/2023-us-direct-banking-satisfaction-study. From 2012 to 2022, ALLY grew its deposit base at a 12% CAGR from $53bn to $152bn and its deposit base is now 88% of total liabilities (up from 37% in 2012). ALLY is now the #1 all-digital bank in the U.S. with 2.8m retail deposit customers. During banking industry turmoil in Q1 23, ALLY grew retail deposits sequentially and had record customer growth (126k net new customers). I believe ALLY was able to grow deposits even in Q1 23 because 91% of its deposit base is FDIC insured and ALLY pays attractive interest rates on deposits.

On the asset side, the only segment that really matters is Automotive Finance. In 2022, this segment generated 88% of total company pre-tax income (before corporate). At year end 2022 the Automotive Finance segment accounted for 59% of total assets. 64% of consolidated total loans + leases were comprised of retail auto loans + leases and another 13% of loans were commercial auto loans. The $10bn of commercial auto loans are primarily floor plan inventory loans used by auto dealers to finance the purchase vehicles on their lots (low risk working capital loans). The retail auto loans + leases are made to consumers who are purchasing cars from the dealers. As of Q1 23 ALLY had $84bn in retail auto loans + $10bn in leases across 4m consumers (implying ~$23k average balance per loan/lease). ALLY has relationships with 23k auto dealers who send consumer loan applications to ALLY. I believe that one of ALLY’s key competitive advantages lays in its strong dealer relationships. Auto dealers get good service when they use ALLY: https://www.autoremarketing.com/subprime/ally-tops-jd-power-dealer-financing-satisfaction-charts-subprime-second-straight-year/. ALLY also offers other services to dealers which deepens their relationships. In addition to floorplan financing, ALLY also offers dealers insurance products and auction services. ALLY “bundles” these products to encourage dealers to use multiple ALLY products. Based on conversations with industry participants, I believe these strong dealer relationships help ALLY from getting adversely selected retail auto loans. If a dealer intentionally sends ALLY bad retail loan applications, it could jeopardize the relationship in other areas of the auto dealer.

I believe the market has two primary concerns with ALLY – the impact on rising rates on net interest margins (NIMs) and risk of rising credit losses in an impending recession. I think one can address and get a level of comfort with each of these concerns.

ALLY’s NIM benefited from a zero-interest-rate environment as its deposit costs fell to ~50bps in Q1 22, driving ALLY NIM to a peak of ~4% in early 2022. With Fed Funds rapidly increasing to 5%, ALLY’s deposit costs rose to 3.2% by Q1 23 which has squeezed ALLY’s NIM down to 3.5% as of Q1 23. The company believes that NIM will bottom in the next couple Qs “slightly below 3.5%” and I believe this is credible as the asset side of the balance sheet is repricing upwards, albeit at a slower pace than deposit costs. ALLY’s new retail auto originations in Q1 23 were at a 10.9% yield vs 7.1% origination yield in Q1 22. Retail auto loans book have an average life of just over two years, so these higher rate loans will replace lower rate loans over the next few quarters. Once we get past peak Fed Funds (ALLY assumes a 5.25% peak), ALLY believes NIM will migrate back towards ~4%. For purposes of discussion, let’s assume NIM ranges between 3.4% and 3.8% over the next 2-3 years.

I think many investors perceive ALLY’s retail auto loans are to be risker than they are. ALLY’s retail auto loans have a weighted avg FICO score of ~690 and only ~10% are sub-prime (<620 FICO). ALLY has guided FY 2023 net charge offs (NCOs) to a range of 1.2-1.4% on a consolidated basis, which is driven by 1.6-1.8% NCOs in retail auto. ALLY’s NCOs were unusually low during the pandemic as consumers were flush with stimulus liquidity and used car prices were rapidly rising. Retail auto NCOs were a record low ~30bps in 2021 after averaging ~100bps during the 10 years from 2010-2019. In 2009 in the depths of the financial crisis, ALLY’s retail auto NCOs were >3% but ALLY had a much different loan book at that time. In 2009, ALLY was still operating as GM’s captive financing subsidiary and >70% of loans were on GM new vehicle sales. So, let’s assume a bad recession case for NCOs is ~2.5% for retail auto and ~2% on a consolidated basis.

Penciling out a downside case of 1.4% NIM and 2% NCOs results in $1.00-1.10 of EPS. Given the current consensus estimate for 2023 EPS of $3.50, ALLY’s stock certainly wouldn’t react well to this, but I don’t think ALLY would erode much of its book value either. ALLY would likely cut its annual $1.20/sh dividend in this scenario. ALLY’s TBVPS was $31.59 as of Q1 23, so at 70% of TBVPS, ALLY’s downside price is ~$22/share (coincidentally this is where stock traded during the SIVB panic).

Assuming 1.8% NIM and 1.4% NCOs (high end of company’s 2023 NCO guide) results in ~$5.70 of EPS in the upside case. Note that ALLY had pointed to ~$6 of 2024 EPS on its Q4 22 conference call but backed off this figure on the Q1 23 call. Using $31.59 of TBVPS implies a ~18% ROTE on the ~$5.70 upside case. ALLY’s TBVPS is after the $12.55/share negative impact from underwater securities (AOCI). Post SIBV, investors naturally have a heighted awareness of the risk of underwater securities, so it’s worth clarifying that ALLY has already taken these marks in their TBVPS and if these securities are allowed to accrete at par, TBVPS will accrete by ~$1/share per year for the next several years. Unlike SIBV, ALLY should not have to sell these securities at a loss because a) they are getting deposit inflows, not outflows and b) these securities are eligible collateral for repos and/or FHLB. Rounding out the upside case, ALLY could grow TBVPS by ~$5/year (earnings + AOCI accretion – dividends), meaning by 2025 TBVPS could be north of $45/share. Thus, in 2-3 years the upside price could be ~$45 (1x forward TBVPS or 7.5x normalized P/E on ~$6 EPS).

Catalyst

Peaking Fed Funds rate leads to NIM expansion over next few quarters

Retail auto NCOs not as bad as feared