Regional banks have been in the news once again following New York Community Bancorp's disappointing fourth-quarter results. One regional bank stock that has shaken off the news around bank stocks over the last year is Ally Financial (ALLY 0.41%).
The volatility surrounding regional banks last year has impacted Ally Financial, but the stock has recovered nicely, gaining 77% since its March 2023 low. The bank stands to benefit from a pivot in the Federal Reserve's interest rate policy, but investors must also keep a close eye on its credit quality. Here's what you need to know about Ally Financial and whether it's a stock to buy, hold, or sell.
Ally Financial is a digital-only bank focused on automotive lending
Ally Financial is a digital-only bank providing customers with financial services, including banking, brokerage, loans, and credit cards. Its digital-only business model gives it an advantage because it doesn't have to worry about running a physical branch location and the expenses associated with it.
The bank has made an effort to expand into other financial products, but ultimately, its bread-and-butter business comes from extending auto loans to customers. After all, the company initially started as the General Motors Acceptance Corporation (GMAC) in 1919 and rebranded to Ally Financial in 2010. At the end of 2023, auto loans and leases made up 77% of Ally's $153.6 billion loan and lease portfolio.
Ally's business has experienced wide fluctuations amid supply chain shortages and changing interest rates
Consumer banks are highly cyclical stocks, which means their business and stock prices tend to follow the business cycle, doing well during economic expansions but underperforming during contractions. Ally Financial's business leans heavily on automotive sales, another highly cyclical industry that fluctuates with the economy.
During the pandemic, automakers dealt with significant supply chain disruptions. This drove up the prices of new and used vehicles, and many consumers utilized automotive loans to help finance their purchases. Ally's business boomed.
Image source: Getty Images.
However, supply chain issues began easing as the price of used cars began falling in early 2022. This happened around a similar time when the Federal Reserve aggressively raised its benchmark interest rate.
Rising interest rates put a damper on loan demand, and with automotive prices stabilizing, Ally saw a sizable drop in its earnings. Last year, Ally's automotive financing originations fell 14%. In addition, rising deposit costs put pressure on Ally's net interest income, and its total net income fell 40% year over year.
Why Ally investors will want to keep tabs on rising automotive loan delinquencies
Thus far, the U.S. economy has navigated the high-interest-rate environment, which many believed would cause a recession in 2023. Although the economy is holding up, investors will want to keep tabs on Ally's loan portfolio. That's because automotive debt has grown significantly, and delinquencies and charge-offs are rising across the industry.
According to The Federal Reserve Bank of New York's Household Debt and Credit Report, consumer automotive debt is around $1.6 trillion, and accounts in serious delinquency (90 days or more delinquent) have increased from 2.22% to 2.66% over the past year. Subprime borrowers, in particular, are feeling the pinch. According to Experian, subprime borrowers pay up to 19% in interest rates on used vehicle loans. Cox Automotive reports that 6.11% of subprime borrowers are delinquent by 60 days or more.
In the fourth quarter, Ally Financial saw 4.42% of retail auto loans that were 30 days or more delinquent and 1.23% more than 60 days delinquent. Ally has $3.1 billion in reserves for potential future losses on its retail automotive loan portfolio, providing a coverage ratio of 3.65%. The bank is also tightening lending standards, approving fewer applications than one year ago.
Image source: Ally Financial.
Investors will want to continue monitoring Ally's credit metrics and keep an eye on what is happening in the broader economy. Many market participants expect there to be interest rate cuts in 2024. The CME FedWatch Tool shows the markets are pricing up to five interest rate cuts by the end of this year.
Lower rates could be a welcome sign for consumers, which could reduce interest expenses on variable-rate loans or allow them to refinance loans at potentially lower rates. However, it's important to remember that higher inflation readings could push back rate cuts and keep interest rates higher for longer.
Is Ally a buy?
Ally's loan portfolio is undoubtedly something investors will want to keep a close eye on. The bank has put aside a fair amount of reserves for future charge-offs, and if economic conditions improve and delinquencies fall, it could release reserves, which could be a tailwind for its net income.
Ally Financial stock is relatively cheap, although not as cheap as just a few months ago. The stock is priced at a 5% discount to the bank's tangible book value and 12 times last year's earnings. However, the stock has increased by 62% since November, and the upside may be more limited from here until credit and lending conditions improve. Therefore, I'd wait to add shares and keep a hold rating on the bank right now.
