How loan-hungry Ally is preparing for the Fed's upcoming speed limit

Adobe Stock

Ally Financial's consumer auto loans are staying mostly healthy and earning the company a nice
chunk of income, while borrower demand remains strong. Which raises the question: Why not make more loans? 

Investors clearly aren't worrying too much about the auto lender's current approach, as the company's stock shot up 6.7% after its first-quarter earnings report on Thursday. But analysts did pepper Ally executives with questions about whether there's more juice to squeeze.

The questions come as Ally and other banks with more than $100 billion of assets prepare for tougher rules from the Federal Reserve. Regulators may ultimately soften the rules after facing massive pushback from the industry. Still, the revisions will likely increase the size of the cushion that bigger banks must maintain to guard against the risk that their loans don't get paid back.

There are easy ways for banks to transfer that risk to investors, whose appetite for buying banks' loans seems insatiable. Ally fed them a bit last quarter, bundling up some $1.1 billion of auto loans into securities and selling them to investors. But analysts wondered whether Ally can start bringing out bigger plates.

"It feels like … there's opportunity to do more," Moshe Orenbuch, an analyst at TD Cowen, said on the company's earnings call.

Russell Hutchinson, Ally's chief financial officer, said the company will "continue to look at opportunities." The $1.1 billion in auto loan securitizations last quarter came on top of $1.7 billion a quarter earlier. The sales show that investors have a "strong appetite" for Ally loans, said Hutchinson.

In response to another analyst's question, Hutchinson said the auto lender won't necessarily package loans for sale "every quarter."

"We've been pretty opportunistic, and so we haven't committed to any volume," Hutchinson said.

The Detroit-based company is also evaluating other ways of lightening the capital burden of making loans, including a relatively new vehicle known as a "credit risk transfer," according to Hutchinson. Those arrangements, much like an insurance policy, involve investors taking on the brunt of the risk in loans. Banks, in turn, can hold less capital against the loans they make, freeing up room on their balance sheets to make even more loans.

"We think this is an important tool for us to have as we look at managing capital and positioning ourselves to take advantage of the opportunities that are in the market today," Hutchinson said.

Some investors have been shunning loans tied to riskier consumers, worried that high interest rates will make it harder for them to repay their obligations. But demand has stayed strong for consumer loans from traditional bank lenders, which typically have relatively conservative underwriting standards.

Ally has been facing some credit deterioration, part of a broader return to normal as consumers' pandemic-era cash buffers decline and inflation eats into their budgets. Ally charged off $477 million in retail auto loans last quarter, or 2.27% of its portfolio, up from $351 million, or 1.68%, a year ago.

Ally's auto loan losses will remain "elevated" for a bit longer, since the loans it made in 2022 are running into more trouble than originally anticipated, Hutchinson said. But the company tightened its underwriting significantly in 2023, when a tougher environment for consumers made the company a bit pickier about the types of loans it was willing to make.

The company's more recent loans "continue to show favorable" trends, which should keep a lid on loan losses, according to Hutchinson. 

RBC Capital Markets analyst Jon Arfstrom wrote in a note to clients that the auto lender's "disciplined origination behavior can support improvement" in loan losses.

"We see results as meeting our expectations with a stable balance sheet, stronger fee income, and manageable asset quality trends," Arfstrom wrote.

Consumer demand for auto loans remains strong, with Ally making decisions on some 3.8 million auto loans in the first quarter, up from about 3.3 million in the same quarter of 2023 and 3.2 million in the first quarter of 2022. But the lender's approval rate has decreased, with Ally approving some 29% of loan applications last quarter, down from about 35% in 2022.

In another sign of Ally's tighter underwriting, the average FICO score of its customers has risen to 704, up from 691 last year. 

Despite taking on less-risky borrowers — whose loans often generate lower returns — Ally has been able to keep the yields it makes on auto loans high. The yield on originated loans in the first quarter was 10.92%, almost the same as last year and up from 7.07% in the first quarter of 2022.

Commercial banking

Are credit-linked notes a good way for regional banks to offload risk?

February 1, 2024 5:18 PM

Higher yields on its auto loans are expected to pave the way for an expansion in Ally's net interest margin, which measures the difference between what it makes in interest versus what it pays depositors. The company's NIM has come under pressure amid high interest rates, as Ally has boosted the rates it pays to customers with high-yield savings accounts and certificates of deposit.

Ally's net interest margin fell to 3.13% last quarter, down from 3.51% a year earlier. But executives are eyeing some recovery, with a company presentation projecting that the full-year NIM might be 3.25% to 3.3% in 2024.

Ally and some competitors that offer high-yield accounts have recently started to lower the rates they pay ahead of any rate cuts by the Fed.

On Thursday morning, Hutchinson said that Ally lowered the rate it pays for savings accounts by five basis points. Rate cuts should help the bank's NIM recover, he noted, adding that the company continues to see "strong deposit flows" even though it's paying depositors a bit less.

"We feel great about the franchise and about the stickiness of our customers and about just the overall competitive environment for deposits," Hutchinson said. 

Michael Rhodes, a former TD Bank executive, will become Ally's new CEO on July 29. Rhodes most recently had a brief stint as CEO at the credit card company Discover Financial Services. He left soon after Capital One Financial announced a deal to buy Discover.

Rhodes will replace Ally's longtime CEO, Jeffrey Brown, who left the company earlier this year to become president of a major auto dealership group. Douglas Timmerman, a longtime Ally executive and president of its dealer financial services division, has been serving as interim CEO in the meantime.