The large digital consumer bank Ally Financial (ALLY 0.86%), which specializes in auto lending, has seen its annual dividend yield climb from around 2% prior to the pandemic to now approaching 4%, which is a very strong yield.
But as a dividend investor, it's always good to be on high alert when you start to see the dividend yield move up quickly. The goal is to invest in companies that can sustain their dividend and raise it regularly. With that said, let's take a look at whether or not Ally's dividend yield is sustainable.
A strong dividend story
Ally has been paying a dividend successfully since 2016 and managed to raise its dividend every year as well. The bank's two most aggressive hikes to its quarterly dividend yield came in 2021 and 2022. Since 2016, Ally has hiked its quarterly dividend by 275%.
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Ally also has a very reasonable dividend payout ratio that was at about 28% at the end of 2022. Most large banks have a payout ratio between 30% and 40%, so this leaves room for growth. As Ally has grown its dividend its share price is now lower today than it was prior to the pandemic, which explains the nice yield.
Ally benefited from the pandemic because supply chain issues led to a chip shortage, which ultimately led to an inventory shortage among new and used cars, driving more demand and elevated car prices. Ally has taken advantage of this and originated billions of retail auto loans since the pandemic. Additionally, as the Federal Reserve has hiked interest rates Ally has seen loan yields surge. All of this has greatly boosted profits in recent years.
While Ally expects earnings to come down this year, largely due to higher funding costs and the normalization of credit quality in its loan book, Ally expects a nice rebound in earnings in 2024. Additionally, at the end of 2022, Ally had roughly $3.6 billion of excess capital over its regulatory requirements, so it has the ability to return capital to shareholders and has also been a big buyer of its own stock over the years.
The market is clearly worried about how high losses in the retail auto loan book could get because the higher the losses the more capital Ally would have to use to cover them. While loan losses accelerate, Ally is maintaining a healthy base of reserves for future losses. Furthermore, Ally's management team at its last earnings call projected that used-car prices would fall another 13% this year but so far used-car prices are up this year. That's not to say things couldn't change and I do expect used car prices to eventually fall but there is now a higher margin for error.
Is the dividend sustainable?
Looking at everything just mentioned including the company's dividend history, payout ratio, excess capital, and earnings trajectory, Ally's nearly 4% dividend yield looks more than sustainable. Barring any major disasters, I would expect the dividend to continue to grow. The big uncertainty is the economy and how that may impact loan losses and capital but I think Ally can navigate a modest recession fairly well, so overall I feel very good about where things stand.
