Ally Financial: Buy, Sell, or Hold?

Ally Financial (ALLY) has been a subject of interest for investors due to its recent performance and the broader market conditions. As a digital-only bank with a focus on auto lending, Ally has navigated various market challenges, including supply chain disruptions and rising interest rates. This article will analyze Ally Financial's current status, its digital-only business model, credit risk management, and provide a recommendation on whether to buy, sell, or hold the stock.

Key Factors Contributing to Ally Financial's Undervalued Status

Ally Financial's current undervalued status can be attributed to several key factors:

1. Volatility following regional bank failures: Ally Financial has been caught up in the volatility that followed the failure of some regional banks earlier in the year. This has contributed to its undervalued status, despite not facing the same deposit risks as the failed banks.
2. High interest rates and consumer stress: The bank is dealing with interest rates that are the highest in decades, which has increased the cost of financing and led to fewer loans and tighter margins. Additionally, consumers are beginning to show signs of financial stress, with credit card loans topping $1 trillion and delinquencies ticking up.
3. Rising delinquencies in auto loans: Ally Financial's bread-and-butter business is auto lending, and the bank is facing rising delinquencies in this sector. According to Fitch Ratings, 6.1% of subprime auto borrowers are at least 60 days past due on their auto loans, the highest percentage since 1994.
4. Cheap valuation: Ally Financial trades at a 20% discount to its tangible book value and a price-to-earnings ratio of 0.85, indicating that it is priced cheaply.



Ally Financial's Digital-Only Business Model: Resilience and Long-Term Benefits

Ally Financial's digital-only business model offers several advantages over traditional banks, particularly in terms of resilience during economic downturns and potential long-term benefits. These advantages include:

1. Lower operating costs: Ally Financial doesn't have to worry about maintaining physical branches, which significantly reduces expenses related to real estate, utilities, and maintenance. This cost advantage allows Ally to maintain profitability even when interest rates are low or economic conditions are challenging.
2. Flexibility in adjusting to market conditions: Ally's digital-only platform enables it to quickly adapt to changing market conditions. For example, during the pandemic, Ally was able to capitalize on the surge in demand for vehicles and the subsequent price increases, leading to a significant boost in its automotive lending business. Conversely, when interest rates rose, Ally could swiftly adjust its lending standards to focus on borrowers with higher credit scores, mitigating risks.
3. Resilience against deposit risks: Unlike traditional banks that rely on deposits for funding, Ally's digital-only model allows it to diversify its funding sources. This resilience was evident when regional banks faced deposit outflows and runs on the bank earlier this year. Ally's deposits remained stable, with a 5% increase from the same quarter last year, and 91% of its retail deposits were FDIC-insured.
4. Potential long-term benefits: Ally's digital-only business model positions it well for the future, as consumers increasingly prefer digital banking services. This trend is likely to continue, even as economic conditions improve. By focusing on digital services, Ally can attract tech-savvy customers, reduce operational costs, and maintain a competitive edge in the market.

Credit Risk Management and Mitigation Strategies

Ally Financial has taken several steps to manage its credit risk effectively, despite the recent rise in delinquencies and charge-offs. Some of these strategies include:

1. Tightening lending standards: Ally has tightened its lending standards, focusing on extending loans to those on the higher end of the FICO credit spectrum. This approach helps reduce the risk of lending to subprime borrowers who are more likely to default on their loans.
2. Building reserves: Ally has set aside funds to account for future losses, with its allowance for loan losses now at $3.8 billion, or 2.73% of all loans. This reserve would cover losses if they were to double from the current level.
3. Monitoring credit quality: Ally is closely monitoring its credit quality and has been transparent about the trends in its loan portfolio. The company reported a net charge-off rate of 1.31% in the third quarter, which has gradually increased over the last several quarters.
4. Diversifying loan portfolio: While Ally's core business is auto lending, the company also offers mortgages, consumer credit cards, and commercial real estate loans. Diversifying its loan portfolio can help Ally mitigate risks associated with a single sector, such as the automotive industry.

To further mitigate credit risks in the future, Ally can consider the following strategies:

1. Improving risk assessment: Ally can invest in advanced analytics and machine learning algorithms to better assess the creditworthiness of borrowers. This can help the company identify potential risks more accurately and make informed lending decisions.
2. Offering credit insurance: Ally can explore partnerships with insurance providers to offer credit insurance products to its borrowers. This can help protect both the borrower and the lender in case of default, reducing the overall risk for Ally.
3. Promoting financial education: Ally can invest in financial education initiatives to help its customers better understand and manage their debt. By empowering borrowers with the tools and knowledge they need to make informed financial decisions, Ally can help reduce the risk of delinquencies and defaults.
4. Expanding into new markets: Ally can explore opportunities to expand its business into new markets, both domestically and internationally. This can help the company diversify its revenue streams and reduce its exposure to risks in any single market.

Recommendation: Hold

Given the current market conditions and Ally Financial's recent performance, a hold recommendation is appropriate. While Ally's digital-only business model offers several advantages, the bank is currently facing challenges related to rising delinquencies, high interest rates, and consumer stress. As the economy improves and consumer credit conditions stabilize, Ally Financial may present a more attractive investment opportunity. Investors should closely monitor the company's credit quality and its ability to manage risks effectively.