US consumer finance: Ally Financial shows how a soft landing offers a springboard

A soft-landing for the US economy would allow consumer lenders to bounce back from concerns about a slowdown. Investors are not waiting for confirmation.

Shares of Ally Financial, best known for its auto lending business, have rallied by a third this month alone. Last year its stock price halved, after Ally was wrongfooted by a steep rise in US interest rates as well as a cooling auto market. Since the global financial crisis, Americans have learned some lessons about holding excessive debt.

Still, Ally feels good about its situation and said so in its earnings results last week. It is originating new auto loans at a yield around 10 per cent. Worries about its loan losses in its existing portfolio have been mitigated by a surprisingly steady US economy and jobs market.

Speaking of bouncy, between its shares bottoming near the pandemic’s outset and then peaking in June 2021, Ally’s stock price rose five fold, reaching a market capitalisation of $20bn. In the fourth quarter of 2019, it originated $8bn of consumer auto loans. That figure had reached more than $13bn in mid 2022.

Ally has in recent years increasingly relied, sensibly, on consumer deposits to fund its lending. To do so it offered high saving rates. Last year, to remain competitive, Ally had to boost savers’ yields even as its loan book returns were locked in. Net interest margins have since waned, towards 3.5 per cent, a figure the company believes will mark the bottom.

Ally says net charge offs — at historical lows in early 2022 — will spike to more than 2.2 per cent in the fourth quarter of this year. The lender sees unemployment jumping to 5 per cent and used auto prices falling a third from peak. It noted that loan originations from late 2021 and early 2022, when auto valuations peaked, form the weakest parts of its loan book.

Ally says earnings per share will fall from $6 in 2022 to $4 this year. But by 2024, EPS could rebound to $6 again, according to the lender’s forecasts. But even with this year’s rally, the company trades at just under six times those 2024 earnings.

Ally very much offers a role model for what Goldman Sachs wanted in consumer finance. With sufficient scale in lending, plus some good fortune on the economy, Ally’s return on shareholder equity can easily bounce back into double-digit percentages again.