Ally says auto market remains attractive since others are pulling back

July 19, 2023 4:00 PM

Ally reported making $10.4 billion in auto loans during the second quarter, up from $9.5 billion in the first quarter, while being pickier in the loans it selected and charging higher interest rates to compensate for greater risks.

Adobe Stock

Ally Financial continues to see the U.S. auto market as quite healthy overall, even as some lenders pull back and more consumers fall behind on their car payments.

Executives at the Detroit-based auto lender said Wednesday that they are well aware of the tougher environment, which has led Ally to offer fewer loans to riskier customers and more to super-prime borrowers whose likelihood to repay is much higher.

Some credit unions and banks have retreated from the sector, but Ally CEO Jeffrey Brown said that void leaves opportunities for Ally and other lenders that have maintained a large presence in auto lending, including JPMorgan Chase and Capital One Financial.

Auto lending remains a "really attractive market for us," Brown said on the company's second-quarter earnings call. The company made some $10.4 billion in auto loans during the second quarter, up from $9.5 billion in the first quarter. Executives said that it did so while being pickier in the loans it selected and charging higher interest rates to compensate for greater risks.

"For people that are in and committed like Chase, like Cap One, like ourselves, it's still a very attractive market opportunity at very aggressive returns right now," Brown said. "So we recognize credit may be a little bumpier than expected, but the [returns] that we're putting on are pretty much at lifetime highs for the company."

Below are five takeaways from the company's earnings call.

Consumer charge-offs remain a challenge

Credit has gotten bumpier for Ally over the past year, as borrowers are having more trouble paying back their loans following exceedingly healthy metrics during the pandemic.

Net charge-offs in Ally's retail auto division rose to $277 million in the second quarter, up from $108 million a year earlier and a bit higher than Ally's prior guidance. The increase reflects continued deterioration in credit quality, as consumers' finances return to more normal levels of strain.

Customers with late payments of 30 or more days rose to 3.6% of retail loans outstanding, up from 3.24% last quarter.

Bradley Brown, Ally's corporate treasurer, said the company's tighter underwriting and improvements in its communications with at-risk borrowers should "mitigate losses." He also pointed to the higher pricing Ally has implemented, emphasizing that "we can't lose sight of the fact that risk-adjusted returns are, again, higher than ever."

"We feel pretty balanced about how we're teed up to navigate the rest of this year and certainly '24," Bradley Brown said.

Most auto dealers are in good shape

Ally executives were also relatively upbeat about the health of the dealers they lend to.

Jeffrey Brown, Ally's CEO, said the auto market is still "very much supply-constrained," with manufacturers generally continuing to deal with backlogs in production. Shortages in new vehicles provide "support to the used-car market," where Ally has traditionally focused, he said.

Ally did charge off a couple of loans from dealers whose health the company had been monitoring, but "overall dealer health is still really good," Brown said.

"Generally speaking, the big dealers that we tend to do business with — that are our largest relationships — are still seeing really strong profitability, really strong results, really strong consumer demand," Brown said. "So things are really supportive there."

Carvana seeks to dig out of a hole

One online auto dealer that borrows from Ally has had a rockier time: Carvana.

The company boomed during the pandemic, but more recently it has struggled to repay the massive debts it shouldered. On Wednesday, however, Carvana announced a debt restructuring agreement that will wipe out some of its debt and reduce its interest payments.

Carvana's stock was up 32% after the announcement, which Brown noted was accompanied by positive earnings news.

"Net-net, we see the industry overall still being very healthy and, I think, very supportive for where we play," Brown said.

Deposit costs continue to rise

Ally, which operates a digital bank, has raked in deposits as many consumers realize that high-yield savings accounts will pay them more than traditional bank accounts.

Total deposits at Ally rose to $154 billion during the second quarter, up sharply from $140 billion in the same period last year. The company added 86,000 new customers during the quarter, with much of the growth coming from millennials and younger customers.

The downside is that deposits have gotten more expensive for Ally as the Federal Reserve keeps hiking short-term interest rates. While online banks have gotten accustomed to competing with each other, competition from the traditional banks has also picked up.

"We've seen a pretty big pivot in terms of aggression really across the industry on rates paid on deposits," Bradley Brown said.

All eyes on the Fed

Ally's interest expenses jumped to $1.68 billion during the second quarter, up sharply from $467 million a year earlier, when rates were significantly lower. That trend weighed on the company's net interest margin, which fell to 3.38% from 4.04% a year ago.

Though Fed officials have penciled in a couple more rate increases, futures markets suggest that investors believe the central bank may be done for good after a likely hike next week. Ally's CEO said a Fed pause should keep the company's net interest margin stable.

And margins should start to expand again some time after the Fed is done with rate hikes, Jeffrey Brown said. If the Fed were to start easing policy and opt for rate cuts, margins would benefit more, he said.

"I think a quarter or two after the Fed is done — and we can all guess when that's going to be — you'll start to see pretty rapid margin expansion," Brown said. "And then to the extent you get eases, that really starts to accelerate."