In addition to being America's largest online-only bank, Ally Financial is also the nation's largest auto lender and one of the top 25 banks by assets. The company makes the vast majority of its pre-tax profit (more than 90%, in fact) through its "prime" auto lending business, meaning that Ally Financial is the only bank in the U.S. to offer auto loans to its customers. prime", i.e. Ally does not do "subprime" (more profitable but more risky) unlike for example Santander, Carvana or Credit Acceptance. As a reminder, a subprime loan is a loan that differs from others in that it is granted to people whose income suggests that repayment will be more complicated. The lending bank therefore takes risks and asks for financial compensation in return by applying a higher rate.
It has $131 billion in deposits and 10 million customers. The continued growth of Ally's retail deposit base is appreciated. It leads the market in prime auto lending. Some 85% is funded through customer deposits. As an online-only bank, Ally has a lower cost structure than its peers with large branch networks. As a result, Ally has averaged an adjusted efficiency ratio of 47% (excluding insurance operations) over the past five years, compared to an average of 55-60% for its peers.
The bank is well capitalized and estimates that it currently retains $4 billion in excess capital. However, this could be a handy cushion in the event of stress in the auto credit market. However, the fundamentals of the automotive market remain strong, with high trade-in values for used vehicles and strong demand for auto loans.
In addition, Ally continues to grow its relationships with dealerships, which has led to a substantial increase in auto loan applications over time.
For now, the rate of defaulted or non-performing loans remains under control. Typically, it explodes during recessions. This may be reflected in Ally's stock price, but then again Ally is well managed and focused on the less exposed prime segment.
The bank is trading below the value of its equity (0.9 times to be exact), despite an excellent profitability track record and an average ROE of 10% over the last cycle, as well as a low interest rate environment and reasonable leverage
Source: Ally Financial
The last fiscal year (2021) was exceptional with a profit per share of 8.22 dollars against an average of 2.9 dollars per year over the previous five years. At 35 dollars a share, Ally is priced at 4 times the profit per share of 2021 and 12 times the annual profit smoothed over the last five years. We should expect a return to normal over the next few years and this is exactly what the market is asking for.
In any case, we can see that management has been clever. It already carried out significant share buybacks between 2016 and 2019, when the stock was trading at less than ten times earnings. In 2021, it will also have spent the absolutely uncommon profit on massive share buybacks. In total, the number of outstanding shares has decreased by 37% since 2016, which is quite impressive. At the same time, the dividend payout has increased fourfold over the period 2016-2022, from 8 to 30 cents per share. Despite these two metrics, book value increases from $40 to $52 per share over the period.
Simply put, Ally has returned its market capitalization ($10 billion) to shareholders over the past five years ($7.5 billion via share buybacks and $2.5 billion via dividend payments). In short, management is really focused on shareholder remuneration rather than growth at all costs, which is quite good in the banking sector where growth necessarily comes with a higher risk.
We can envisage two positive scenarios for shareholders:
The first one sees the bank maintaining its historical profitability and pursuing its policy of returning capital to shareholders (which will be richly remunerated).The second scenario is that the auto market collapses, causing many defaults and insolvencies among lenders, especially subprime lenders, and this will provide a unique consolidation opportunity for Ally, which will be able to buy back good loan books and grow at a good price.
It is understandable that Warren Buffett (or one of his two lieutenants) set its sights on the stock since Berkshire Hathaway now owns 10% of Ally's capital. It is known that Berkshire does not like to exceed 10% of the capital on its banking investments because it causes regulatory difficulties. Warren Buffett likes to hunt for quality companies at a reasonable price and especially those that offer a significant return on investment to shareholders, the big strength of Ally Financial. He should also appreciate Ally's ability to offer a superior product to its customers in the form of competitive deposit rates, lower fees, and a better overall user experience. This stock must certainly remind him of his famous bet on Geico in auto insurance. He surely expects Ally to continue to gain share in the U.S. retail deposit market, while maintaining a more efficient business model than its competitors.