Ally Financial (ALLY 0.41%) is an online-based financial institution with a focus on auto lending, but with a wide variety of banking products. The stock was initially beaten down in 2023, with investors fearing that loan delinquencies would rise and the bank's deposit cost would stay elevated indefinitely, but Ally ended up gaining 43% for the year as inflation started to moderate and a so-called soft landing in the economy is looking far more realistic.
Even with the sharp rally in the stock, Ally could still be a bargain from a long-term perspective. It's one of the few bank stocks still in Berkshire Hathaway's (BRK.B -0.69%) portfolio, with the Warren Buffett-led conglomerate keeping a 9.6% stake despite selling shares of several big banks last year. And a couple of analyst firms, including Goldman Sachs and Barclays, have recently raised their price targets on the bank.
While there are likely several reasons for the optimism from the big investors, here are a couple of things individual investors should keep in mind about Ally.
Ally could be a big winner in 2024 thanks to interest rates
Ally could also be one of the biggest winners if interest rates fall faster than the Federal Reserve predicts they will, which the market seems to expect. Think of it this way -- Ally's loan portfolio currently has an average yield of about 8%, and the company is paying an average of 4.04% on its deposits as of the third quarter of 2023. If rates fall, Ally's deposit yields would likely fall significantly, while the yield from its loan portfolio would stay elevated for several more years.
In fact, thanks to its expected loan and deposit yield dynamics, Ally believes it can expand its net interest margin (NIM) to more than 4%, which would be a big improvement over the 3.26% NIM it reported in the most recent quarter.
Loan losses aren't as bad as feared
There were several factors that led investors to expect a spike in loan losses in Ally's business. Inflation caused strain on many consumers' budgets, pandemic-era stimulus measures expired, and with the Fed rapidly raising rates, there were major recession fears. After all, rising unemployment means more people unable to pay their bills. Plus, auto prices soared during the pandemic years and consumers are borrowing more than ever to buy vehicles.
To be sure, Ally's charge-off rate has risen recently, and is somewhat higher than it was in comparable pre-pandemic times. For example, Ally's retail auto net charge-off rate is 1.85%, compared with a 2017-2019 peak of 1.74%. But it's far from a spike, and it's completely manageable given the company's earnings and reserves. In fact, Ally has enough in reserves to cover a charge-off rate of roughly double where it currently stands.
Better-than-expected delinquencies could be a massive tailwind for the business. Ally has been maintaining relatively high reserves and has been hesitant to use capital to buy back shares and grow its dividend recently. The last dividend increase was at the start of 2022 and the share count has been flat for the past five quarters. However, Ally bought back a staggering 38% of its shares in the six-year period before that time, and a soft landing could help the company get back on track.
Ally could be a bargain for long-term investors
As of this writing, Ally trades for less than 10 times trailing-12-month earnings and just over its book value, even after a strong rally in the final months of 2023. Despite the cheap valuation, Ally remains a highly profitable business with strong asset quality, and it has a lot to gain as interest rates normalize. As we head into 2024, Ally is one of my favorite financial sector stocks, and long-term investors could be handsomely rewarded.
