Ally Financial (NYSE:ALLY) is one of my absolute favorite investments at current prices. This is a fabulously run bank with a reputation for doing what they say they will do. If I could own 100% of the company at current prices, I’d absolutely buy it, as I think the odds of success and growth potential would be enormous, given the bargain valuation. Market participants seem focused on the potential for a recession and used car prices declining and are missing the bigger picture that in any of these scenarios, ALLY is still going to be printing money, and the stock is trading right around tangible book value.
ALLY has over 10.5MM customers and is the largest all-digital bank, along with being the leading prime auto lender with over 22K dealer relationships. The bank has a huge opportunity to cross-sell its multitude of products to its customers, with new businesses such as credit cards, enhancing its return potential. Cross-selling additional products to existing customers is much cheaper than acquiring totally new customers, and multi-product customers have two times more money on average than one-product customers. ALLY is very popular with younger demographics such as millennials that almost never see a need to visit a bank branch.
On July 19th, ALLY reported another excellent quarter of operating performance, with core net income attributable to common shareholders of $570MM, resulting in adjusted EPS of $1.76. These figures were down YoY from $868MM and $2.33, respectively. ALLY’s provision for credit losses was $304MM, including a $151MM provision build, up from a release of $32MM last year, which accounted for much of the decline in earnings. The core ROTCE was 23.2% and the adjusted efficiency ratio was 43.9%, compared to 26.7% and 44.5%, respectively, last year. Adjusted total revenue was $2.222B, up from $2.145B at the same time last year. Net financing revenue grew by 14% YoY to $1.754B, and NIM of 4.04% was up from 3.93% in Q1, and up from 3.55% at the same time last year. Total loans and leases were up nearly $15B YoY, and the earnings asset yield of 5.11% grew by 25 bps QoQ, and 42 bps YoY. Cost of funds grew by 13 basis points QoQ but was down 11 bps YoY. Because of the rapid increase in benchmark rates, NIM is likely to contract in the next few quarters as deposit cost growth exceeds earnings asset yield growth in the short-term. This was likely the primary reason the stock fell on Tuesday in a very positive day for the market and banks, but I won’t be surprised if Ally outperforms in their projections of an upper 3% NIM, which would still generate robust profitability.
Consumer auto originations were an extremely impressive $13.3B, sourced from 3.3MM applications, which was the highest quarterly origination volume since 2006. This occurred despite industry vehicle sales being down 21% and 17% for new and used, respectively. Clearly, some capital has left the vehicle financing market with less securitizations occurring, which opens the door for established giants such as ALLY to scoop up market share and yield. The estimated retail auto originated yield was up a healthy 75bps sequentially to 7.8%, while credit stayed very healthy with only 54bps of retail auto net-charge offs. Banks must increase reserves to account for loan growth, which is a big part of the provision this quarter. Noninterest expense of $1.138B, was up from $1.075B, as ALLY continues to invest in its newer product lines and technology. Insurance written premiums were $262MM in the quarter and the investment management portfolio stood at $5.8B. Insurance pre-tax loss was $122MM due to mostly to investment losses, as expected given the terrible market conditions for both stocks and bonds, and core pre-tax income was $14MM.
Retail deposits of $131.2B were down 4% QoQ due to elevated tax payments, which is common for a 2nd quarter, especially as we didn’t have the recurring stimulus payments that made the last two years atypical. ALLY has 2.5MM retail depositors, which is up 6% YoY and deposits should grow the rest of the year, as ALLY reprices more quickly than big banks when rates increase. Ally Home originations of $.9B were down 60% YoY, as the refinancing market contracted dramatically due to higher rates. On the plus side, the held-for-investment mortgage portfolio grew 39% YoY to $18.9B, as there were less prepayments from refinancings. While mortgages yield less than retail auto loans, they tie up less capital and provide diversification, which is important with regulators. Ally Invest saw net customer assets drop 18% YoY to $13.5B on stock market weakness, but active accounts were up 5% YoY to 518k. Ally Lending had $591MM of gross originations, up 98% YoY, growing its presence in the healthcare and home improvement verticals. This newer point of sale business saw active borrowers increase 78% YoY to 382K. Active merchants were up 26% YoY to 3.2K. Ally Credit Card ended the quarter with $1.2B in credit card loan balances, which is up 93% YoY. There are now 908K active customers, which is up 58% YoY. Credit cards are a huge long-term opportunity for ALLY, and it is good that they are starting small, especially if we indeed are in or are going into a recession. The Corporate Finance held-for-investment portfolio stood at $8.5B, up 38% YoY.
ALLY ended the quarter with a CET1 ratio of 9.6% or $14.7B, which is about $4.0B in excess of its 7% required minimum plus preliminary SCB, and $1B more than ALLY’s internal operating target of 9%. ALLY grew its loan loss reserves by 5 basis points sequentially to 2.68%, or $3.5B, which is up quite substantially to the day one CECL reserve of 2.03%. Retail auto coverage is now 3.51%, or $2.9B. 30-day retail auto delinquencies grew to 2.52% from 1.6% last year, but were down from 2.9% in the 2nd quarter of 2019, prior to the stimulus impacted numbers. Credit is still very healthy and used car prices are still strong, assisting with recovery values. Retail NCOs of .54%, were up from a net recovery rate of -.03% a year ago but is down from .95% in Q2 2019. This is expected credit normalization and ALLY underwrites for much higher loss ratios than we are seeing now. Remember that CECL accounting frontloads loan losses, as banks are supposed to project total losses over the life of the loans, and most banks including ALLY, have over weighted downside scenarios since Covid.
Many bears are focused on used vehicle values dropping, which they well may do, but ALLY’s management put out some helpful info in thinking about that. In Q2, retail NCOs benefited by $50MM, and net lease revenue benefited by $45MM on higher recovery levels. However, this was contrasted by far lower commercial floorplan assets due to supply chain issues, hurting results by $45MM, on low inventory. Also, prepayments hurt results in the retail portfolio yield by $50MM. I’ve mentioned this many times before, but bank analysts are often very myopic and they get obsessed with one data point such as used vehicle values or net interest margins, and then they miss the other ten most important factors.
ALLY has $28.3B of liquidity and has grown its deposit funding to 85%, up from 64% in the 2nd quarter of 2018. This has greatly reduced ALLY’s cost of capital and enhanced net interest margins. While it is possible that NIM peaked this quarter, ALLY’s management did indicate also that they expect to originate retail auto loans at an over 8% rates this quarter, after putting more than 150 basis points for price into the market. By being mostly funded by deposits, ALLY isn’t reliant on access to capital markets via securitizations or expensive unsecured debt, which has plagued competitors. They see a clear path to originate over $45B of consumer loans this year. Used loans were 69% of originations this quarter, so the company is not reliant on new vehicles where supply is so constrained. In Q2, ALLY repurchased $600MM for stock, and has now bought $1.2B YTD. The quarterly dividend is now $.30 per share, which puts the current yield at 3.6%.
At a recent price of $33.33, ALLY trades at around 4x times 2021 earnings, and under 5x projected 2022 earnings. Common shares outstanding has dropped from 484MM in Q2 2016, to 313MM, so the current market capitalization is roughly $10.432B. The company has over-earned over the last year, but is targeting an ROTCE of 16-18%, which seems quite realistic. Management expects NCOS to be under 1% this year and gradually migrate back to normal over time to 1.4-1.6%, so it is very difficult to see credit being a major issue even in a mild recession. ALLY is modeling a 30% point-to-point reduction in used vehicle values from the end of 2021 to 2023, so it isn’t like we are dealing with a company in fantasyland in terms of the potential risks. Medium-term earnings power on the low-end of the 16-18% targets, would be around $5.20, with upside far beyond that as we saw last year, and will likely see again this year. Owning a business that can produce a sustainable 16-18% ROTCE at a valuation right around tangible book value, is something I simply can’t pass up. If I could buy the whole business at this price and take the company private, I would do so, as it is an absolute no-brainer in my opinion. I believe ALLY is worth at least $50 per share and that intrinsic value will grow materially over time. Stock buybacks at current prices are enormously accretive so I hope that management really leans in with the stock at current levels.