It’s been a tough year for auto lenders and online banking specialists ally finance (NYSE: CONNECTED). Rising interest rates continue to weigh on its margins, and now credit worries are increasing financial pressures in a sluggish economy.
With the stock down 44% this year, buying Ally Financial stock may not look like a wise decision. But if you’re refocusing the lens to get a broader view, buying this stock today could actually be a smart move. Here’s why.
Ally Financial recently released its third-quarter results, and results fell short of expectations on all fronts. First, high interest rates shrink 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 decreased 0.23 percentage points in the third quarter and the company expects another 0.30 point decline through 2023.
NIM compression is far from ideal, but many bank stocks are facing it today. The bigger concern is the number of net charge-offs it’s experiencing on its auto loans. In the third quarter of 2022, the value of auto loans that are unlikely to be collected increased by 80%. This is above pre-pandemic levels from the third quarter of 2019, and worsening credit conditions for borrowers could lead to more delinquencies and write-offs going forward.
Look at the big picture
It’s certainly disappointing to see such lackluster earnings, but investors should keep in mind that the challenges Ally faces are temporary. While the US is not officially in a recession, two quarters of negative GDP growth in the first half of 2022 and higher loan losses are surefire signs of significant economic weakness.
Economic slowdowns are affecting the 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 banks tends to limit their ability to fund new loans. Economic weakness also tends to drive higher defaults on credit card, auto, and home loans — something the company is already seeing.
It’s not all bad news, however. Ally Financial has a lot to offer to get through today’s challenging circumstances. The first is that it has increased its reserve to $3.6 billion to combat future loan losses. Secondly, online banking is also picking up speed and has a low overhead thanks to the lack of physical branches.
Ally’s private banking business is also booming. Retail deposits increased $2.7 billion from the second quarter and retail spending still exceeds pre-pandemic levels. Higher interest rates will help boost retail auto loan yields, which the bank expects to rise to the mid-8 percent range by Q4 2023.
Difficult economic times don’t last forever. Many banks were destroyed 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 the face of what could come means it is taking near-term concerns seriously and preparing for long-term success.
Ally’s stock is trading well below book value and about 4.5 times earnings per share, making today’s valuation a great entry point for long-term investors.
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