One potentially intriguing opportunity for investors today is Ally Financial (ALLY 0.41%). The consumer-focused bank has gotten caught up in volatility following the failure of some regional banks earlier in the year and trades at a dirt-cheap valuation.
The bank has had its share of ups and downs over recent years as it navigated the COVID-19 pandemic and subsequent supply chain issues. Now, it must deal with interest rates that are the highest in decades and consumers who are beginning to show cracks. Here's what you need to know about Ally Financial and whether it's a stock to buy, hold, or sell.
Ally is a niche bank with a focus on auto lending
Ally Financial is a digital-only bank that provides customers with banking, brokerage, credit cards, and lending services. Its online-only business model is a significant advantage because it doesn't have to worry about traditional branches and the associated expenses, like real estate, utilities, and maintenance.
While Ally focuses on digital-only consumer banking, its bread-and-butter business is in making automotive loans to customers. Of its $140 billion in receivables and loans, $102 billion is in auto loans to consumers and businesses. The remainder is in mortgages, consumer credit cards, and commercial real estate.
The bank has navigated topsy-turvy market conditions in recent years
Pandemic-induced supply chain disruptions impacted every corner of the economy, including automotive production. At the time, a shortage of new and used vehicles occurred, while a simultaneous boost in demand led to higher car prices. Ally benefited in a big way, and in 2021, revenue from its automotive lending business jumped 22% while net income rocketed 163% higher. Conditions have since normalized as economies reopened and supply chains resumed business as usual.
Ally does face some headwinds from some of the highest interest rates we've experienced in decades. Since March 2022, the Federal Reserve has raised its benchmark interest rate by 525 basis points -- the fastest interest-rate-hiking campaign in four decades.
Image source: Statista.
The rise in interest rates has increased the cost of financing everything from auto loans to home loans and credit card debt. While this has helped slow down rising consumer costs, it has also come at the expense of fewer loans and tighter margins for Ally and its banking peers. Through three quarters of the year, Ally's net income is down 34% compared with last year.
It doesn't face the deposit risks that failed regional banks did earlier this year
Ally Financial is on solid footing compared to regional banks that failed earlier this year. That's because the banks that failed earlier this year had a problem with deposit outflows amid a run on the bank.
Ally's deposits at the end of the third quarter were $153 billion, up nearly 5% from the same quarter last year. Also, 91% of its retail deposits are FDIC-insured. In comparison, only 15% of Silicon Valley Bank's deposits were FDIC-insured.
Investors will want to pay attention to its credit quality
While Ally doesn't face deposit risks, it does face credit risks on its loan portfolio due to rising delinquencies. According to data from Fitch Ratings, 6.1% of subprime auto borrowers are at least 60 days past due on their auto loans -- the highest percentage since 1994. Margaret Rowe, senior director at Fitch Ratings, told CBS MoneyWatch, "Persistent inflation, the erosion of real income, and the exhausting of pandemic-related savings are making it harder for subprime borrowers to service their debt."
In the third quarter, Ally saw $456 million in net charge-offs for a net charge-off rate of 1.31%. This rate has gradually increased over the last several quarters and was around 0.85% just one year ago. The company has set aside funds to account for future losses, and its allowance for loan losses is now $3.8 billion, or 2.73% of all loans, and would cover losses if they were to double from here.
Ally trades at a steep discount to its book value
Over 3.85% of Ally Financial's auto loans are 30 days or more delinquent, and the company has tightened lending standards, focusing on extending loans to those on the higher end of the FICO credit spectrum. With these risks lingering, the bank trades at a cheap valuation, priced at a 20% discount to its tangible book value and 0.85 times sales.
ALLY Price to Tangible Book Value data by YCharts.
The stock is priced cheaply, and for good reason. Investors are still concerned about the state of the economy and a potential recession on the horizon. Although experts have predicted a recession for over a year, consumers are beginning to show cracks. Credit card loans topped $1 trillion for the first time, delinquencies are ticking up higher, and excess savings are getting spent down.
I don't think it's wise to sell Ally here at its cheap valuation, but I also believe the upside is limited in the near term as consumers navigate challenging markets. Therefore, I'd give Ally Financial a hold rating until consumer credit conditions improve.
