Ally shares fall 15% as its credit challenges mount

Ally Financial said on Tuesday that several borrowers struggled to repay their auto loans over the summer, sending the company’s shares tumbling 16%.

“Our credit challenges have intensified,” chief financial officer Russell Hutchinson told a Barclays conference.

Late payments on Ally’s auto loans in July and August rose 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 10 basis points more than Ally had expected.

“We are clearly dealing with a cohort of borrowers who have struggled with the cost of living and are now struggling with an employment picture that has worsened,” Hutchinson said.

The US unemployment rate rose from 3.7% at the start of 2024 to 4.2% in August. The modest weakening of the labor market prompts the Federal Reserve to do so pivot to lower interest rates.

Ally, which has long focused on used car loans, was a darling of stock investors during the COVID-era used vehicle boom. The investors began to sour on Ally as the good times dwindledbut the company’s relatively strong financial performance over the past 18 months has won goodwill.

Given investors’ positive expectations, they will “wonder” if the negative surprise portends more pain, RBC Capital Markets analyst Jon Arfstrom wrote in a note to clients on Tuesday.

“Everything looks manageable, but higher credit costs and a lower margin will pressure the numbers in the near term, and that’s a disappointment for the company,” Arfstrom wrote.

Hutchinson, Ally’s chief financial officer, said the rapid pace of Fed rate cuts the market is currently expecting could put pressure on Ally’s net interest margin.

The $193 billion-asset company has about $60 billion in floating-rate assets that will immediately decline when interest rates fall. The effect should reverse itself over time, Hutchinson said, because Ally can lower the interest rate it pays on deposits without too much trouble.

Detroit company he began to take a more cautious view of the auto market in early 2023, saying it will pull back from loans and focus more on borrowers with high credit scores.

Hutchinson said Tuesday that the “reduction” appears to be paying off, as Ally’s loans in 2023 continue to outpace those in 2022. Even so, he noted that the less risky borrowers in 2023 “face with a different macroeconomic context’ and year-over-year outperformance may become harder to sustain.

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One advantage is that Ally raised the price of its loans during and after the pandemic as it sought to protect itself from potential future problems. So while loans are doing worse than expected, they are “still attractive loans” with “risk-adjusted margins that are higher than what we wrote before the pandemic,” Hutchinson said.

“Quite frankly, even with credit headwinds … we look at the yield on the loans we’re making, we look at the yield on recent crops and they’re still attractive,” he said.

Ally has taken a number of steps over the past two years to improve its profitability, including sale of a credit division at the point of sale to a competitor, cutting expenses, moving its mortgage business off the balance sheet and accessing the capital markets to reduce auto loan risk.

The company also has he packaged his several loans to sell into the securities market, where investors, rather than Ally, can bear the risk of borrowers defaulting on their loans. It recently completed the first of what executives hope will be many credit risk transfer transactions, a relatively new structure which reduces the risk of loan repayment to external investors.

“We recognize that the road is harder and we’re going to have to do more,” Hutchinson said of the path to increasing investor returns.