Why the FT is Wrong About Ally Financial

January 30, 2023 | Premium Service | On January 23, 2023, the Lex column of the Financial Times carried a shameless public endorsement of the stock of Ally Financial (ALLY), a $200 billion asset wholesale funded bank that focuses on auto lending. Suffice to say this is one of those instances when we wonder why journalists that make specific stock recommendations to retail investors are not subject to FINRA regulation.

Now a century old, ALLY was the captive finance unit of General Motors (GM) and over the decades mutated into a mortgage issuer within GM, ultimately leading to the spinoff of what is today Ally Bank in 2010 and the bankruptcy and liquidation of Residential Capital in 2012. Some twelve years later, ALLY is still more finance company than bank and really has no core deposit base worthy of the name. If you acquired ALLY tomorrow, a discriminating buyer would pay no deposit premium and might even ask for a discount.

We last wrote about ALLY in July (“Update: Ally Financial (ALLY)”), when we noted that the bank has a yield on its loan book that is too low and a cost of funds that is too high. ALLY is forced to compete for funding with some of the largest market facing banks including CapitalOne (COF), Goldman Sachs (GS) and Barclays Bank (BCS). Notice that all of these banks are paying at least 3.3% for funding compared with SOFR closing in on 4.5%. Meanwhile, the average interest expense for the largest US banks is still below 1%

None of these public facts prevented the FT from engaging in hyperbole that really begs the question as to why they wrote this column at all. Could the team of reporters that so courageously tracked down the Wirecard AG fraud really get a simple analysis of a $200 billion consumer bank so badly wrong? Yes they can. Consider this perfect regurgitation of ALLY’s IR twaddle:

Consumer deposits? Not only is this statement factually incorrect, but it suggests erroneously that ALLY actually has a retail deposit base like JPMorgan (JPM) or Bank of America (BAC). In fact, ALLY is exactly comparable to GS, which has a base of “core deposits” that are very yield sensitive and will walk out the door if the bank does not keep pace with the bulletin boards for brokered deposits. But then the FT concludes their little stock pitch with the following drivel:

No, actually GS has done a better job building its admittedly flawed Marcus than ALLY has done building its online bank. We have some significant issues with the GS business model, but the ALLY model is clearly a monoline consumer finance business with no real reason to exist. There is no competitive advantage for ALLY occupying the funding killing field between the large banks, on the one hand, and the more aggressive bank and nonbank consumer lenders on the other.

Let’s take a look at some quantitative comparisons between ALLY and its peers in the world of narrow banks using the data from federal regulators. Notice that we choose as our comparable firms the usual suspects – GS/C/COF and have also added the $180 billion asset US unit of Barclays Bank PLC (BCS), Barclays US LLC, which is a monoline issuer of credit cards. All of this FFIEC data is public and has a consistent accounting taxonomy in terms of presentation, but few members of the media or Buy Side analyst ratpack ever bother to look. They are too busy.

First let’s take a look at net loss rates, the proof of the pudding for any bank. We’ve commented in the past about the relatively high loss rate of GS compared to the other large banks. The net loss rates in Q4 were up across the board for these consumer facing lenders. Somehow the folks at the FT did not notice that ALLY’s net charge-offs are up 270% YOY, more than any of the other comps in our group.

Source: FFIEC

Notice that ALLY’s loss rate is below that of Barclay’s US business, Citi and COF, but well above that of Peer Group 1. We’ve already noted the brisk increase in net charge offs (Page 15 of the ALLY Supplement).

Next let’s take a look at the gross spread on the loan book, which is a key component of the analysis. The first thing to notice is that the spread for ALLY’s loan book is pretty stable compared with other consumer facing banks such as COF and Barclays. But at the same time, ALLY’s gross yield on its loan book is far lower than these other lenders.

Source: FFIEC

At the end of 2022, ALLY reported a net margin of almost 8% for auto loans, but then there is a lot of the book that is in mid-single digits. The best yielding assets for ALLY are unsecured consumer via Ally lending (11%) and Ally credit card (22%), but these loan categories are relatively small. Yet the bank’s exposure to individual consumers at 40% of total loans puts ALLY in the 96th percentile of Peer Group 1.

Of note, ALLY is about 70% loans to assets, with the remainder in securities. At the end of 2022, ALLY had a negative balance of accumulated other comprehensive income (AOCI) of $4.1 billion or roughly 1/3 of total capital, a far larger percentage of capital impaired by unrealized losses than larger banks. This fact is due to ALLY having $136 billion of loans and finance receivables held available for sale at December 31, 2022, one big reason for the large negative AOCI balance. Also, the fact the ALLY has no retained portfolio is significant and speaks to the question of funding costs.

ALLY really is more of a finance company than a bank, with virtually no loans held to maturity in portfolio. Next on the list is funding costs, an important piece of the puzzle that illustrates the fundamental weakness of the ALLY business model. ALLY has made progress reducing the funding differential with other banks during QE, but that is not really notable. What is important is the rate of change in ALLY’s funding costs profile as interest rates rise.

Source: FFIEC

Notice that ALLY’s funding costs are galloping higher, above all of the other members of our group except Barclays US. And do please notice where funding costs were for Barclays in December 2018, when the FOMC almost ran the US financial system aground. Ally was right behind Barclays and 1.5x the funding costs for Citi, COF and GS. In Q4 2022, ALLY’s Interest Expense/Average Assets was 2.5%.

Below we decompose the gross yield and interest expense of the group as a percentage of average assets. As you can see, COF, Barclays and Citi are the best performers, but ALLY actually outperforms Goldman Sachs. Readers will recall that we have consistently called out GS for poor credit portfolio performance, both in terms of the loan yield and net credit expenses. Keep in mind that the Net Spread shown below is before SG&A and taxes.

Source: FFIEC

More important than the relative distribution of the net spread among our comps, note that ALLY is just a point above the average for Peer Group 1, arguably too little spread given the risks on the book. At 300bp of gross charge offs (vs < 1% for large banks), ALLY’s production is basically “BB” bond equivalent, not hideous but not prime. If net losses revert to the pre-COVID mean ~1%, then ALLY will have a hard time expanding earnings.

How does ALLY survive given our view? First, they benefit from the relatively cheaper funding costs of being a bank, even if they must pay brokered deposits spreads for cash. ALLY basically uses deposit funding as a replacement for warehouse finance for an originate-to-sell nonbank finance model.

Second, the bank has kept operating efficiency tight, with an efficiency ratio in the high 50s. Pushing operating costs down to get closer to 50% efficiency would be among the few ways the bank can grow earnings.

More significant, over the past decade ALLY has not demonstrated any ability to grow its loan spread – contrary to what you read in the Financial Times. Simple fact is that ALLY cannot expand its loan spread without sacrificing volumes, hardly a strong position. IOHO, the Financial Times owes their readers an apology for misstating the financial situation of a publicly traded bank.

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