After a difficult 2022, stocks have gone on a tear this year. However, one industry that has lagged behind is bank stocks. Despite the recent stock run-up, the SPDR S&P 500 Bank ETF is up just 2.6% on the year, well below the SPDR S&P 500 ETF's return of 24.2%.
With the Federal Reserve potentially pivoting away from its tighter monetary policies, now could be an excellent opportunity to get in on bank stocks.
Ally Financial (ALLY 0.41%) is one bank stock investors may want to consider. The stock is priced right around book value and could be a solid buy for investors looking for a rebound in banking stocks. However, before you hit that buy button, here are four things you should know about Ally Financial.
1. Ally's automotive-heavy lending business makes it vulnerable to market conditions
Ally Financial provides customers with financial products and services ranging from banking, brokerage, loans, and credit cards. However, the company's bread and butter is in extending auto loans to customers. The company started as the General Motors Acceptance Corp., or GMAC, in 1919. In 2010, it was rebranded as Ally Financial and became publicly traded in 2014.
While Ally has tried to diversify its business across financial services, auto lending still makes up a considerable chunk of it. Through the third quarter, auto loans and leases make up $115.5 billion of its $149.2 billion loan and lease portfolio.
Ally's business is therefore sensitive to market conditions in the automotive market. For example, during the early days of the pandemic, supply chain disruptions impacted everything from inventory levels to automotive production. As a result, there was a shortage of vehicles for sale while the demand for vehicles shot up. Ally benefited in 2021, with revenue and net income jumping 22% and 163%.
However, interest rates have risen substantially since March 2022, which has put pressure on all kinds of lending products, including auto loans. Through three quarters of this year, Ally's automotive financing segment income from operations has fallen 27% year over year to $1.3 billion.
2. Ally's deposit base held steady amid this year's bank turmoil
Several regional banks struggled earlier this year, and we witnessed the most significant bank failures since the Great Recession nearly 15 years ago. While several factors contributed to the failure of those banks, the root of it was a mix of deposit outflows coming at a time when the banks were strapped for cash.
Image source: Getty Images.
For example, Silicon Valley Bank (a subsidiary of SVB Financial) saw its start-up community clients strapped for cash for much of 2022. On top of that, more than 85% of Silicon Valley Bank's deposits were over the $250,000 Federal Deposit Insurance Corp. (FDIC) insurance limits, which further fueled the outflows.
Ally doesn't face this deposit risk. Over 92% of its deposits are FDIC insured. And, since the Fed started hiking interest rates, its deposits have increased. Ally's deposit base was nearly $153 billion in the third quarter, up from $142 billion when the Fed first started raising interest rates in the first quarter of 2022.
3. Keep an eye on Ally's loan portfolio
One area of Ally's business that investors will want to keep close tabs on is the bank's loan portfolio. According to The Wall Street Journal, auto debt has surpassed student loan debt, totaling $1.58 trillion through the second quarter.
Auto loans grew significantly during the pandemic due to the rise in auto prices from supply chain disruptions noted above. Not only that, but rising interest rates have put an added burden on consumers looking to buy a car. Edmunds, an information provider for the automotive industry, says the average new car payment is $736 per month, up 4.6% from last year.
Consumers could be feeling the pinch. According to the Federal Reserve Bank of New York, consumer credit card debt is over $1 trillion for the first time, and delinquencies are ticking up. As reported by Cox Automotive, 1.89% of auto loans were severely delinquent (60-plus days past due) in September, the highest for that month going back to 2006.
Ally's loans are holding up well in comparison. The company noted that 1.03% of its loans were severely delinquent in the third quarter. To account for potential future losses, Ally has built up $3.1 billion in reserves, providing a coverage ratio of 3.62%. The bank has also tightened lending standards, approving a small portion of applications compared to last year.
Image source: Ally Financial.
Investors will want to closely monitor Ally's loan portfolio in the coming quarters. The bank expects net charge-offs of 2.2% to 2.4% in the fourth quarter this year, which is roughly in line with the total charge-offs on all consumer loans in the third quarter, according to the Federal Reserve.
4. Ally stock is relatively cheap and could benefit from interest rate cuts
Ally Financial has been relatively cheap for most of this year. Today, its price-to-earnings ratio of 9.67 and price-to-sales ratio of 1.15 are below its 10-year averages. The stock also trades right around its book value, although it was at a 20% discount to book value just a few months ago.
ALLY PE Ratio data by YCharts
While there is the risk of delinquencies, Ally's portfolio has held up well compared to others. Not only that, but the prospect of the Federal Reserve lowering interest rates could be a tailwind for its business in 2024.
According to CME Group's FedWatch Tool, market participants are pricing in five interest rate cuts, bringing the federal funds rate from around 5.25% to 3.75% by the end of next year. Lower rates could spur more demand for auto loans as the financing costs come down. It could also help provide relief to consumers struggling with growing debt burdens alongside the higher interest rates.
Investor takeaway
Ally Financial has built up a fair amount of reserves to account for credit losses, which should help it ride out further delinquencies. Still, you'll want to closely monitor the bank's loan portfolio, net charge-offs, and delinquency trends over the coming quarters.
The stock is up 56% from its low in October, so it's not quite the deal it was just a few months ago. However, if the stock does dip from here, perhaps to a 10% or 20% discount to book value, it could be a good opportunity to scoop up shares ahead of a potential Fed pivot.
