It’s been a tough year for the car lender and online banking specialist Allied Financial (ALLY 1.95%). Rising interest rates continue to squeeze its margins and now credit concerns in a declining economy are adding to its financial pressures.
With a 44% decline this year, buying Ally Financial stock might not seem like a smart move. But if you refocus the lens to get the bigger picture, buying this stock today might actually be a smart move. Here’s why.
Short term problems
Ally Financial recently released its third quarter results, and the results fell short on all fronts. For starters, high interest rates reduce its net interest margin (NIM), the spread it earns on the difference between the interest it earns on its loans and the interest rate it pays to depositors. Its NIM shrank by 0.23 percentage points in the third quarter and the company expects a further compression of 0.30 points by 2023.
NIM compression is far from ideal, but it’s something a lot banking stocks are facing today. The biggest concern is the number of net write-offs it is experiencing for its auto loans. The third quarter of 2022 saw an 80% increase in the value of auto loans that are unlikely to be collected. This exceeds the pre-pandemic levels of the third quarter of 2019, and deterioration in credit conditions for its borrowers could mean more delinquencies and charge-offs in the future.
Look at the big picture
It is certainly disappointing to see such lackluster earnings, but investors should remember that the challenges Ally faces are temporary. Although the United States is not officially in recession, two quarters of negative gross domestic product growth in the first half of 2022 and higher loan losses are sure signs of significant economic weakness.
Economic downturns are tough on banks. Higher unemployment rates mean people have to spend their savings, which reduces deposits. Banking institutions rely on deposits to make new loans, so less money in banking tends to limit the ability to fund new loans. Economic weakness also tends to lead to increased defaults on credit cards, car loans and home loans, which the company is already seeing.
It’s not all bad news, however. Ally Financial has several things for that to help him overcome the difficult circumstances of today. The first is that it has increased its reserve to $3.6 billion to help it combat future loan losses. The second is that online banking is also gaining momentum and has low overhead thanks to the absence of physical branches.
In addition, Ally’s consumer banking business is booming. Retail deposits were up $2.7 billion from the second quarter and retail spending is still above pre-pandemic levels. Higher interest rates will help boost yields on retail auto loans, which the bank expects to increase to around 8% by the fourth quarter of 2023.
Tough economic times don’t last forever. Many banks have been crushed in the Great Recession. But financial conditions are different today and banks like Ally Financial are in a much better position to weather the storm. The company’s aggressive moves to increase its reserves in light of what might come mean it is taking short-term problems seriously and preparing for long-term success.
Ally’s stock is trading well below book value and at around 4.5x earnings per share, making today’s valuation a great entry point for long-term investors. .