Auto lender Ally points to signs that credit erosion will stay in check

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As Ally Financial's longtime CEO prepares to step down, the much-feared downturn in the used auto loan market has yet to take a massive bite out of the company's earnings.

Some Ally borrowers are having a tougher time making their car payments, prompting Ally to charge off roughly 1.85% of its retail auto loans during the third quarter, up from 1.05% in the same period last year.

But the increase was within the auto lender's expectations, and executives said Wednesday that they don't anticipate the rest of the year will be much worse. The company stuck to its earlier projection that its retail net charge-offs will be about 1.8% for all of 2023.

"Early days, but we continue to see positive signs that keep us on track," Ally Chief Financial Officer Russ Hutchinson said during a call with analysts.

Jeffrey Brown, the Ally CEO who announced his departure last week, noted that inflation continues to take a toll on many consumers' pocketbooks. But the job market remains strong, which is helping to ensure that people have enough income to pay back their obligations.

Detroit-based Ally has invested heavily in technology and its collections department, Brown said, which has given the company "a much deeper understanding of consumer payment patterns and more options to get consumers current and staying in their cars."

The auto lender has also taken steps to mitigate risks on its balance sheet. This year, Ally shifted to focus more on loans to consumers with super-prime credit scores. And it started charging higher rates to riskier borrowers to protect itself in a more uncertain environment.

While loans that Ally made in 2022 remain on track, this year's "shift into higher credit quality loans will ultimately reduce portfolio loss content," Hutchinson said.

The company's overall performance was "relatively stable," and its credit metrics came in within expectations, Jefferies analyst John Hecht wrote in a note to clients. He argued that the bigger question facing Ally is its expenses. Given the competitive deposit market, the cost to Ally of offering high-yield savings accounts continues to rise. 

To help lower expenses, Ally said this month that it will lay off some employees and reduce its headcount by less than 5%.

The third quarter had "puts and takes, but reflected a focused execution in an increasingly difficult market," Hecht wrote.

Tougher operating conditions had prompted speculation that Brown's departure might be tied to growing pessimism about the company's outlook. But Brown, who may stay with Ally until the end of January, said that his exit "was not driven at all about any change in confidence" in the company's trajectory.

He will become president of Hendrick Automotive Group, a large privately held dealership group and an Ally customer. Brown described it as a "dream opportunity."

"Life sometimes throws you curveballs, and that's what happened in this scenario," he said.

During the third quarter, more Ally borrowers fell behind on their payments, with roughly 3.85% of Ally's retail auto loan total marked as at least 30 days late. That percentage was up from 2.93% a year earlier.

Hecht, the Jefferies analyst, noted that those delinquencies may turn into higher charge-offs as some borrowers struggle to get back on track.

At several auto lenders, delinquencies rose in September compared with August, suggesting that higher charge-offs may follow early next year as lenders get troubled loans off their balance sheets, according to a note by Stephens analyst Vincent Caintic. The note reviewed delinquency trends at Ally, Capital One Financial, Santander Consumer, CarMax and Carvana.

The worsening trend in delinquencies "still jibes with lender guidance of peak losses" by the first half of next year, Caintic wrote. But "the acceleration in delinquencies makes it difficult for us to know when peak losses will occur," he added.

Ally executives pointed to a positive trend on that front. While delinquencies of at least 30 days rose by more than 90 basis points last quarter, the pace of increase has steadily fallen over the past few quarters. At the end of 2022, delinquencies of at least 30 days rose by 142 basis points.

The company's executives also said that the value of used cars that are recovered during repossessions may not drop by as much as previously thought, limiting the dollar amount that Ally would ultimately have to charge off.

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Investors have long feared the impact of a steep drop in used auto prices on Ally, where used-car loans make up a larger part of the balance sheet than at numerous other auto lenders.

The company's stock price jumped early in the pandemic as a slowdown in new-car production led to a boom in used-auto business and prices. But Ally's share price fell sharply last year as investors worried those trends would unwind.

Used auto prices have fallen from 2021 levels, Ally executives said Wednesday in an earnings presentation, but they've stayed roughly flat so far this year.

A strike by workers at the nation's largest automakers could keep used auto prices elevated, Hutchinson said, though he noted that Ally continues to take a "conservative outlook" and is assuming a large decline in those prices.

The $195 billion-asset bank reported that its profitability stayed roughly flat during the third quarter. Net income dipped slightly to $296 million, down from $299 million a year earlier, as higher deposit costs outweighed increases in its interest revenues.