Ally's stock drops 15% as its credit challenges grow

Ally Financial said Tuesday that more borrowers struggled to repay their auto loans over the summer, prompting a 16% plunge in the company's stock. 

"Our credit challenges have intensified," Chief Financial Officer Russell Hutchinson said at a Barclays conference.

Late payments on Ally's auto loans in July and August rose by 20 basis points more than the company expected, Hutchinson said. And, as more borrowers became seriously delinquent, the company wrote off more loans than it had anticipated. Net charge-offs on auto loans rose by 10 basis points more than Ally had expected.

"We're clearly dealing with a cohort of borrowers who have been struggling with cost of living and now are struggling with an employment picture that's worsened," Hutchinson said. 

The U.S. unemployment rate has risen from 3.7% at the start of 2024 to 4.2% in August. The modest weakening in the labor market is prompting the Federal Reserve to pivot toward cutting interest rates.

Ally, which has long focused on used-car loans, was a darling of stock investors during the COVID-era boom for used vehicles. Investors started souring on Ally as the good times waned, but the company's relatively strong financial performance over the past 18 months won it goodwill.

Given investors' positive expectations, they "will question" whether the negative surprise portends more pain, RBC Capital Markets analyst Jon Arfstrom wrote Tuesday in a note to clients.

"This all seems manageable, but higher credit costs and a lower margin will pressure numbers in the near term and that is a disappointment for the company," Arfstrom wrote.

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Hutchinson, Ally's CFO, said the rapid pace of Fed rate cuts that the market is currently expecting could put pressure on Ally's net interest margin.

The $193-billion asset company has some $60 billion of floating-rate assets that will immediately reprice downward when interest rates fall. The effect should reverse as time passes, Hutchinson said, since Ally can lower the interest rate it pays for deposits without too much trouble.

The Detroit company started taking a more cautious view of the auto market in early 2023, saying it would pull back on its lending and focus more on borrowers with high credit scores.

Hutchinson said Tuesday that the "curtailment" appears to be paying off, since the loans Ally made in 2023 continue to outperform those from 2022. Even so, he noted that the less risky 2023 borrowers are "contending with a different macroeconomic backdrop," and the outperformance compared with the previous year may become harder to maintain.

One upside is that Ally raised its loan pricing during and after the pandemic, as it sought to protect itself against potential troubles ahead. So even though the loans are faring worse than expected, they're "still attractive loans" with "risk-adjusted margins that are higher than what we wrote pre-pandemic," Hutchinson said.

"Quite frankly, even with the credit headwinds … we look at the return on the loans that we're originating, we look at the return on the recent vintages, and they're still attractive," he said.

Ally has taken a series of steps in the last two years to improve its profitability, including selling a point-of-sale loan division to a competitor, cutting expenses, shifting its mortgage business away from its balance sheet and tapping the capital markets to decrease auto-loan risk.

The company has also packaged more of its loans to sell into the securities market, where investors, rather than Ally, can take on the risk of borrowers failing to repay their loans. It recently completed the first of what executives hope are many credit risk transfer deals, a relatively new structure that sheds loan repayment risk to outside investors.

"We acknowledge the road is harder, and we're going to have to do more," Hutchinson said of the path to boosting investor returns.