Ally Financial Inc. has few upside growth drivers in the near term as the auto lender and retail digital bank faces higher delinquencies in auto loans and rising costs on deposits, according to analysts.
Ally missed analysts' earnings estimates in the third quarter and lowered fourth-quarter net interest margin guidance to about 3.50% from its previous guidance just a month prior of modestly below 3.70%. This was to "reflect near-term pressure," CEO Jeffrey Brown said during the company's Oct. 19 earnings call. After reporting third-quarter earnings, equity analysts are bearish on the company's growth catalysts.
"[Third-quarter] results were weaker than expected, and there's not enough clarity on the macro to make their planned December update a positive catalyst, in our view," Wells Fargo analysts wrote in an Oct. 20 note.
Negative catalysts
Piper Sandler analyst Kevin Barker labeled the company's net charge-off and NIM guidance, and the potential slowing of loan growth as funding costs rise, as "negative catalysts" that will "likely prevent the stock from re-rating to a higher valuation."
"We have limited visibility on the earnings capacity of Ally on the other side of this cycle, especially if rates continue to move higher," Barker wrote in an Oct. 20 note.
Following the company's third-quarter results, Wells Fargo downgraded Ally to underweight while Morgan Stanley downgraded the company to equal-weight.
The Street also reacted to the company's third-quarter results, as the company's stock price fell and closed down 7.94% on the day it reported earnings.
Ally's delinquency rates in the third quarter elevated to pre-pandemic levels, driven by deterioration in retail auto loans. Still, management targeted $48 billion in full-year auto originations, up from $46.3 billion in 2021.
"Why not pull back? I mean part of this is we see still these markets being very attractive," Brown said during the earnings call in response to an analyst's question about moderating originations amid the economic uncertainties.
Higher yields
While Ally believes its retail auto origination yields, which expanded 19 basis points from the prior quarter to 7.04%, are attractive, analysts expressed concern that higher yields are usually tied to higher risks.
"Yields have indeed expanded rapidly with new originations, but this surprises us since other lenders are not seeing nearly as much, if any, yield expansion," Stephens analyst Vincent Caintic wrote in an Oct. 19 note. "We think Ally may be shifting toward non-prime credit which, while perhaps expanding risk adjusted yields, would add more losses than investors in prime credit might desire."
Interim CFO Bradley Brown acknowledged during the earnings call that Ally's loan portfolio has slightly more risk content relative to 2019 since it began making the strategic shift several years ago to focus more on used car borrowers and reduced concentration in super prime, which generally has lower returns.
But not all analysts were bearish on the company's risk exposure. While absolute upside catalysts at Ally are limited, it still has an edge compared to unsecured card issuers with outsized exposure to low-end consumers, such as Capital One Financial Corp., Synchrony Financial and Bread Financial Holdings Inc., Wolfe Research analyst Bill Carcache wrote.
As pandemic tailwinds subside, Ally expects normalized delinquencies of between 3.4% to 3.8%, above the 3.1% seen in 2019. Net charge-offs are projected to migrate toward 1.60% — on the higher end of the prior guidance, Raymond James analyst David Long noted.
Piper Sandler's Barker believes auto credit losses could tick higher than the 1.6% guidance as "declining used vehicle prices combined with higher unemployment [could] be greater headwinds to credit performance."
Stephens analyst Caintic echoed that "there may be some additional deterioration beyond what's implied in [fourth-quarter] guidance."
Deposit competition
During the third quarter, Ally's cost of funds increased 77 basis points quarter over quarter due to higher benchmark rates and a competitive direct bank market for deposits, the interim CFO said. Deposits currently represent 86% of Ally's funding.
"You're seeing a lot of competitors and a lot of competitive pressures being out there. It's been sort of interesting to see some of the behaviors we've observed in the fourth quarter in the direct banks and a couple of folks now paying in excess of 3%," Brown said during the call. Ally Bank's online savings account currently pays a 2.35% annual percentage yield.
Given that online banks tend to pay a significant premium for savings accounts over most branch banks, deposit betas will likely level off later in the rate cycle as online banks gain deposits, Credit Suisse analyst Moshe Orenbuch wrote.
