Since the collapse of SVB Financial and Signature Bank, a lot of bank stocks have been sold off significantly. One of those is the large digital consumer bank and auto lender Ally Financial (ALLY 0.70%), which is down about 18% since SVB started struggling earlier this month.
Investors have had their doubts about Ally for many months now, as the company's large retail auto-lending portfolio looms large heading into what could be a much tougher economy for consumers. Given everything that has just happened, let's look at how Ally is positioned following the SVB collapse and whether investors have overreacted by selling its stock.
Stacking Ally up against SVB
What brought SVB down was a combination of unrealized bond losses, heavy deposit concentration among a few industries, and lots of uninsured deposits. So in this uncertain time, the first thing to do when looking at any bank stock is to check these metrics.
Image source: Getty Images.
At the end of 2022, Ally had tangible common equity of $9.6 billion. Unrealized bond losses in its available-for-sale (AFS) bond portfolio -- the bonds the company intends to sell prior to maturity -- totaled about $5.3 billion.
This portfolio, however, is marked to market, so Ally has already subtracted them from its equity, although the losses will be recouped if the bank doesn't need to sell these bonds while they trade at a loss.
Meanwhile, unrealized bond losses in Ally's held-to-maturity (HTM) portfolio were about $178 million. These have not been factored into equity but are very manageable given Ally's tangible common equity.
Most of Ally's funding profile consists of retail deposits that the bank offers for a competitive rate. These aren't exactly sticky, per se, but the high rate Ally is paying for them is already accounted for in the business model.
Nearly 69% of Ally's more than $156 billion in deposits are insured by the Federal Deposit Insurance Corporation (FDIC). Bank accounts with less than $250,000 at Ally exceed 4.7 million.
So, given the manageable HTM bond losses and heavily insured deposit base, I don't view a deposit run or the destruction of significant equity during a deposit run to be a huge threat. Ally is a digital bank, and the danger in being a digital bank with strong mobile banking is that depositors can pull their funds quicker than if they had to go to a bank branch in person.
But Ally also has a lot of deposits in certificates of deposit (CDs), which are locked up for certain time periods. At the end of 2022, 20% of deposits came from CDs, with an average maturity of 19.4 months.
Ironically, banks with a large number of CDs and money market accounts are viewed to have weaker deposit bases because they are paying up for these, and the customer is only there for the higher rate. While I don't think this will change in the long term, banks that are already paying up for deposits, like Ally, might actually find a bit more stability in the near term given the current environment, although deposit costs may rise more than expected.
A big focus on credit
Even before the collapse of SVB, the big focus for Ally has been on credit. Thanks to the chip shortage, which created a lack of vehicles, prices of new and used cars surged since the pandemic began in 2020, and Ally has built up its retail auto loan portfolio in recent years.
But as used-car prices eventually fall and consumers spend down their savings and enter a tougher economy, investors have focused very carefully on Ally's retail auto loans.
At the end of 2022, charge-offs (or debt unlikely to be collected, and a good indicator of loan losses) rose from 1.05% to 1.66% of total retail auto loans. Meanwhile, the 30-day-plus delinquency rate in the portfolio rose from 2.93% to 3.56%.
Management expects the rate for retail auto net charge-offs to top out somewhere in the 1.6% to 1.8% range this year. Ally has also set aside reserves to cover auto loan losses as high as 3.6% of the portfolio, so management is building in a decent buffer.
Its expectations for this year are that the U.S. economy experiences a modest recession and used car prices fall 13%. So far, used car prices, despite showing volatility, have held up pretty well.
Image source: Manheim.
Management also said on its last earnings call that it was tightening credit and continuing to add new retail loans with 10% yields in order to price risk in the environment appropriately. Car loans are also getting more difficult to obtain, which might allow Ally to be more choosy about whom it lends to.
But there are still a lot of questions about the economy. The Fed might finally be nearing the end of its rate hikes, but the full impact of all the previous hikes are unknown. And now banks are expected to slow lending, which will also slow the economy. It's hard to know if there will be a recession and how severe it might be, as well as its impact on consumers.
Wrestling with uncertainty
The good news is that Ally looks pretty well-insulated from some of the issues that put several banks out of business recently.
It does not have too many unrealized bond losses that are unaccounted for, and with bond yields falling, that should help lessen some of the unrealized losses in its AFS portfolio. I'm sure Ally will see higher deposit costs that could cut into earnings in the first quarter, but a lot of this was expected because the bank already gets a lot of its customers by paying a competitive rate.
The big question in my mind is still credit. So far, with used-car prices staying high and the Fed contemplating a rate cut, Ally seems decently positioned, especially with a healthy level of reserves built up.
The problem is that we just don't know how severe economic conditions could get and how high loan losses could go. Still, Ally trades at just 75% of its tangible book value (or net worth), so I think some of this fear is being priced into the stock. I definitely think that starting to accumulate some shares at these levels is warranted. But given the uncertainty, I also think adding them gradually and not going in too heavily also makes sense.
