The bear market of 2022 is taking many victims rightly or wrongly. I’d argue the baby is getting thrown out with the bathwater in the case of Ally Financial (NYSE:ALLY). The company is operating as well as it ever has in its history, and it is poised to continue producing robust results for shareholders. Whenever the economy has a hiccup, bank stocks seem to get treated like they are having a heart attack, ever since the Financial Crisis devastated the sector. It is ridiculous that ALLY is trading at a mid-single digit price to earnings ratio when it is producing a high-teens ROTCE. I can’t tell you when the stock will bottom, but I firmly believe the stock will be considerably higher over the next 24 months.
Ally Financial Inc. is in an extremely strong competitive and strategic position in the U.S. banking sector. The company benefits from a lower cost profile due to being branchless, which greatly reduces the overhead burden of the legacy consumer banking franchises. Ally emerged from GM Financial when that company went into bankruptcy during the Financial Crisis. Auto Finance is still the biggest business for Ally, which is attractive in that the lending is secured, and when defaults do occur, the asset is typically repossessed in a timely manner, reducing losses. Ally appeals to a younger demographic that does most business online. The company has diversified into investments, insurance, mortgages and now credit cards.
Ally’s financial profile became dramatically stronger over the last decade due to its ability to use low-cost retail deposits to fund its business, rather than expensive secured and unsecured debt sources that the company relied on prior to becoming a bank. Since 2014, the bank has doubled low-cost retail deposits, while retiring $24 billion of legacy and secured debt with a weighted average coupon of over 5%. Ally works with over 21,000 dealers and over 4MM auto customers across the country, providing loans, insurance, and investments. Between 40% and 70% of auto customer interactions occurred digitally each month, which increases the speed and effectiveness at which the company operates, leading to strong customer experiences.
Ally reported a very strong 1st quarter of 2022, with GAAP and core net income attributable to shareholders of $627MM and $687MM, respectively, on $2.2B of adjusted total net revenue. On a per share basis, GAAP earnings were $1.86, and the adjusted EPS was $2.03. On a trailing twelve months basis, ALLY has generated $8.54 of adjusted earnings per share. The Core ROTCE was a staggering 23.6% but adjusted tangible book value per share did drop to $35.04, from $38.73 in the prior quarter, largely because of higher interest rates reducing the AOCI. Core pre-provision net revenue was $1.088B, putting the figure over $1B 4 quarters in a row. Pretax income was $846MM, down from $899MM in the prior quarter. Ally has simply been on fire since late 2020 when used car prices started increasing on reduced supply of new vehicles, and higher demand. Ally’s net interest margin expanded to 3.95%, up from 3.18% a year ago, and up from 3.82% sequentially.
Ally ended the quarter with a CET1 Capital Ratio of 10%, which provides ample room to complete its FY 2022 $2.0B share repurchase program, and its $.30 quarterly common dividend. Since 2016, ALLY has reduced its common shares outstanding from 484MM to 327MM, while the dividend has risen from 8 cents a quarter to 30 cents. Consumer auto originations of $11.6B were the highest for a first quarter in 11 years, sourced from 3.2M applications, at an estimated 7.1% retail auto originated yield. Credit has been abnormally exceptional over the last couple of years and that trend continued with 58bps of retail auto net-charge offs. Consumer credit has been bolstered due to the lockdown-driven stimulus, while strong used vehicle values have also been a major boon for Ally. Insurance written premiums of $265MM and a $6.2B investment management portfolio further diversify Ally’s earnings profile.
Ally started on its path for lower funding costs when it became a bank during the Global Financial Crisis. In just the last 4 years, low-cost deposits have surged to 88% of the funding composition, up from 64% in 2018. In Q1, the company had 2.5MM retail depositors, up 8% YoY, and $136B of retail deposits, up 6% YoY. Ally Home originated $1.7B in mortgage originations, which was down as the refinance market slowed down with higher rates. The company has a held-for-investment balance of $18.4B, which is up 48% YoY. Ally Invest ended the quarter with $16.8B in net customer assets, up 10% YoY, and had 517k active self-directed and robo accounts. The company also just announced that they are breaking into wealth management, which can be a lucrative and capital-light foray for them, which I’m excited to learn more about as the year progresses. Ally Lending has $442 million point-of-sale originations up 109% YoY, with 3.2K merchants, up 30% YoY. The newest business prior to Wealth Management, Ally Credit Card, had $1.0B of credit card balances, up 93% YoY, and 844K active customers, up 73% YoY. Corporate Finance has an $8.0B loan portfolio, which expanded by 28% YoY. All these businesses make Ally a capital-efficient earnings juggernaut in the finance world.
Ally has a strong track record in credit underwriting, with delinquency trends consistently industry averages. While the 1.69% 30 days past due number is higher than the 1.28% at the same time last year, it is meaningfully lower than the 2.15% figure in 2019. Banks have been forecasting normalizing credit, which is healthy for the industry and Ally is not a big subprime player. As we’ve seen in the Financial Crisis, auto loans are one of the last things a struggling consumer will give up on, as they need it for so many uses. Repossessions are much quicker than on homes and the used car market remains strong, although prices are thankfully dropping a bit from record-highs. Ally has been conservative in its allowance for loan losses, ending Q1 with a 2.63%, or $3.3B reserve, which is up from 2.03% when CECL first started being used in 2020, despite the amazing credit performance. I don’t think market participants properly appreciate the difference CECL accounting makes in that banks are reserving for all expected future credit losses, incorporating a recessionary scenario into those figures. For instance, ALLY forecasts unemployment to revert back to a historical mean of 6.5%, which is about 3% dramatically worse than the current rate. This should greatly reduce the volatility in reserves over time.
Ally over-earned in 2021 with its Core ROTCE of 24.3%, but the company is targeting 2022 and medium-term goals of 16-18%. The business is fundamentally stronger and more diversified than it has ever been. Normalized earnings based on that guidance is between $5.60 and $6.30, which means the stock trades at less than 7x the low-end of normalized earnings, at its recent price of $38.67. The company should earn close to $7 this year in my opinion, and the 3.1% dividend and $2B buyback, enhance the attractiveness of the stock.
In early 2020, the stock was crushed from lockdown fears and unfortunately, the banks weren’t allowed to buy back stock during that time. This bear market is very different, and ALLY will fully be able to take advantage of Mr. Market’s pessimism in relation to its share price. The stock trades at a slight premium to its tangible book value, despite a normalized ROTCE of 16-18%, which is ridiculous. New businesses like Ally Credit Card and Ally Lending, and now Wealth Management, come with far higher returns on assets. Even if we do indeed get the recession, which is being priced into shares, ALLY will be very profitable and will likely grow its book value per share metrics. I believe ALLY is worth about $52.50, conservatively, which is about 1.5x the current tangible book value per share. I’d expect intrinsic value to compound by at least 10% per annum from there.
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