Update: Ally Financial (ALLY)

July 13, 2022 | Premium Service | For the past several weeks, we have watched as credit default swap (CDS) spreads for Ally Financial (ALLY) have widened out, to the point where the implied CDS is close to 280bp over the curve. While many readers of The Institutional Risk Analyst have been watching crypto fiascos like Silvergate Financial (SI) and Signature Bank (SBNY), the prospect of financial problems for the 23rd largest bank holding company (BHC) and a large ABS issuer is cause for concern. But have any of the US bank regulators noticed?

Back in September 2020, we profiled ALLY (“Bank Profile: Ally Financial Inc”) and focused especially on the bank’s still high funding costs relative to its peers. We also noted that the yield on the loan portfolio is low vs the risk, especially given the large consumer exposures at ALLY.

Since that time, ALLY has improved its financial performance and has evolved into a stand-alone consumer lender operating via an online (aka “wholesale”) funding platform. With earnings expected on July 19th of this month, the market action in the stock, options and related debt is decidedly bearish.

Source: Bloomberg (07/13/22)

The put/call ratio on ALLY is almost 10:1, Bloomberg reports. More, the bank’s debt is trading 250bp over the Treasury curve, roughly 3x the OAS spread for large banks. The 5-year CDS spreads for ALLY were trading 280bp over the swaps curve compared with 120bp for Citigroup (C) and 150bp for CapitalOne Financial (COF). What gives?

We suspect that the large (> 50%) consumer loan exposure of ALLY is the chief reason that the $180 billion bank is attracting the attention of short-sellers. The sharp upward skew in loss rates in Q1 2022, both for COF and ALLY, was not helpful. COF, let us recall, has a gross yield near 10% and a yield on its credit card portfolio in the mid-teens.

Loans to individuals at ALLY accounted for almost 60% of total loans in Q1 2022, making for a decidedly bad position for the bank going into a recession. C&I loans accounted for 20% and real estate loans were just 20%. Indeed, ALLY’s exposure to individuals is among the highest in Peer Group 1, with the bank ranking in the 97th percentile.

Source: FFIEC

While ALLY has tracked the other large banks down in value since June, the change in spreads on the CDS and bonds caught our eye. Simply stated, ALLY is trading more like a nonbank finance company than a bank, a function of the fact that the bank has more loan exposure than its mainstream peers. Yet the funding profile of ALLY is quite solid, with better core deposits than when we looked at them in 2020. Over 90% of the bank’s debt has maturities over five years, among the best in Peer Group 1. But bottom line, ALLY has some of the most expensive funding among large banks even compared to Citi and COF.

Source: FFIEC

On the credit side, ALLY is well-reserved against credit loss, but its loss rate is 4x peer because of the nature of the bank’s consumer lending business. Likewise, part of the reason that ALLY has been able to grow core deposits is because the bank pays up for money, with interest expense at 0.91% of average assets vs 0.2% for Peer Group 1 and less for the money center banks.

ALLY has far more large time deposits than do banks of similar size, a component of the funding equation that regulators view as a red flag. The bank also has lower capital than its peers, another fact that may weigh upon the credit in the context of a deep recession. The spike in the bank’s loss rate in Q1 2022 may have served as a catalyst for negative sentiment.

Source: FFIEC

ALLY had a gross loan yield of 5.7% vs less than 4% for Peer Group 1 and 5.32% for Citigroup. By achieving higher loan yields, ALLY has been able to push next interest income above 4% of average assets vs a bit below 3% for Peer Group 1, a reflection of the higher default rate target for the bank’s business model. The skew in ALLY’s loss rate in Q1 2022, however, suggests a degree of volatility and unpredictability in results that is an obvious concern since most other banks continue to show benign credit performance.

In a recession, some investors clearly believe, the bank will likewise be subject to higher loss rates. We agree. ALLY has adequate but costly funding and liquidity, but too little spread on its loan book. We think that in a recession the bank will come under growing pressure in the equity markets and may need to be sold.

As we've noted in past missives on ALLY and in our testimony before SIGTARP, the ALLY business model is not sufficiently subprime a la COF to generate enough income to offset potential credit losses in a deep recession. We suspect that is why the stock, debt and CDS of ALLY are under growing pressure.

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