Ally Financial Inc. — Q3 2018 Form 10-Q
Business context and period. Ally is a digital financial services and bank holding company focused on automotive finance and insurance, with mortgage finance, corporate finance, deposits, and digital brokerage businesses. This unaudited quarterly filing covers the three and nine months ended September 30, 2018; balance-sheet comparisons are with December 31, 2017 unless noted.
Financial performance and position
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Total net revenue | $1.505 billion | $1.462 billion | $4.366 billion | $4.292 billion |
| Net income from continuing operations | $374 million | $280 million | $974 million | $747 million |
| Diluted EPS | $0.88 | $0.62 | $2.25 | $1.63 |
| Net financing revenue | $1.107 billion | $1.081 billion | $3.250 billion | $3.127 billion |
| Provision for loan losses | $233 million | $314 million | $652 million | $854 million |
| Noninterest expense | $807 million | $753 million | $2.460 billion | $2.341 billion |
- Quarterly revenue rose 3% and continuing-operations net income rose 34%; for the first nine months, revenue rose 2% and continuing-operations net income rose 30%.
- Q3 net interest spread was 2.49% versus 2.59%; net yield on interest-earning assets was 2.67% versus 2.74%. Nine-month measures were 2.50% and 2.67%, versus 2.57% and 2.70%, respectively.
- At September 30, total assets were $173.1 billion, finance receivables and loans net were $125.4 billion, deposits were $101.4 billion, short-term borrowings were $7.3 billion, long-term debt was $45.5 billion, and equity was $13.1 billion. Deposits increased $8.1 billion from year-end; total assets increased $6.0 billion.
- For the first nine months, operating cash flow was $3.3 billion, investing cash flow was negative $8.8 billion, and financing cash flow was positive $4.9 billion. Cash and restricted cash ended at $4.7 billion. Management cautions that cash-flow analysis may be less informative for a lending business than funding and liquidity disclosures.
- Available liquidity was $21.1 billion, including $15.5 billion of unencumbered highly liquid government and agency securities, $3.3 billion of liquid cash and equivalents, and $2.4 billion of unused committed facilities. Ally reported a Modified Liquidity Coverage Ratio above 100% and said available liquidity could fund planned originations and obligations for more than 36 months under a specified long-term capital-markets stress scenario.
- Ally’s CET1, Tier 1, and total capital ratios were 9.41%, 11.12%, and 12.68%; Ally Bank’s were 13.32%, 13.32%, and 14.13%. Both were reported well-capitalized and compliant with applicable requirements.
Material changes and management commentary
- Management attributed improved earnings mainly to lower loan-loss provision, higher lending revenue and yields, portfolio growth in mortgage and corporate finance, and lower taxes. These benefits were partly offset by higher funding costs, operating expenses, and lower net lease revenue.
- Interest expense increased 28% in Q3 and 23% year to date, primarily reflecting rising rates, deposit growth, and funding needs. Deposit costs rose as market rates increased.
- Consumer automotive credit performance improved: nine-month net charge-offs were $668 million versus $692 million, and the consumer auto annualized net charge-off ratio was 1.3% versus 1.4%. Total allowance for loan losses was $1.248 billion, down from $1.286 billion at September 2017.
- Commercial nonperforming loans rose to $184 million from $72 million at year-end 2017; commercial criticized exposures rose $573 million from year-end to $3.7 billion. Management cited more commercial auto problem accounts and downgrades of two Corporate Finance accounts.
- Automotive Finance pretax income rose 28% in Q3, while Insurance pretax income fell 20%, reflecting higher non-weather losses. Insurance combined ratio was 92.6% in Q3 versus 86.0%; year-to-date it improved to 97.2% from 101.5%.
- The legacy GM lease portfolio was substantially wound down by June 30, 2018. Q3 off-lease terminations fell 55% year over year; management expected future terminations to be more consistent with the nine-month trend. Lease residual risk was described as declining with the run-off.
Outlook, risks, contingencies, and unusual items
- No specific earnings or revenue guidance was provided. Management noted continued focus on risk-adjusted returns, consumer and commercial portfolio growth, deposit funding, digital capabilities, and diversification.
- Ally’s interest-rate sensitivity analysis estimated a $59 million decrease in next-12-month net financing revenue if rates remain unchanged versus its baseline. Under instantaneous parallel rate shocks, the estimated impact was negative $70 million at +100 basis points and negative $135 million at +200 basis points; gradual increases of those amounts each showed a negative $3 million impact. Results depend on modeling assumptions, including deposit repricing.
- Ally expects adoption of the current expected credit loss standard (ASU 2016-13) on January 1, 2020 to materially increase its credit-loss allowance and reduce retained earnings; the amount depends on portfolio composition and economic forecasts at adoption.
- Accounting changes adopted in 2018 included revenue recognition, which reduced opening retained earnings by $126 million net of tax, and the equity-security fair-value standard, which reduced opening retained earnings by $20 million net of tax. Fair-value changes on equity securities now flow through earnings. Adoption of the revenue standard reduced Q3 and nine-month 2018 net income by $3 million and $9 million, respectively.
- Management disclosed securities class actions alleging misstatements in connection with Ally’s 2014 IPO and prior SEC, DOJ, and state regulator information requests concerning subprime auto finance and securitizations. Ally said it could not estimate reasonably possible losses or a range for the material legal matters and intends to defend the litigation.
- Key risks include credit deterioration, used-vehicle and housing values, interest-rate and funding-cost changes, market access and ratings, regulatory and capital requirements, cybersecurity and operational disruption, and legal proceedings. Management reported no material change to previously disclosed risk factors; disclosure controls were effective and no material change in internal control over financial reporting was reported.
- The Federal Reserve did not object to Ally’s 2018 capital plan. The Board authorized up to $1.0 billion of repurchases through Q2 2019; $250 million was repurchased in Q3. The Board declared a $0.15-per-share dividend payable November 15, 2018, subject to regulatory and other constraints on future capital distributions.
Most important facts for investors to verify
- Whether lower auto credit losses persist as the portfolio grows, and whether rising commercial nonperforming and criticized exposures require higher provisions.
- Deposit repricing, funding costs, and net interest income sensitivity as rates and competition change.
- Used-car prices, lease returns, remarketing gains, and the earnings effect of the completed legacy GM lease run-off.
- The pace and credit quality of mortgage and Corporate Finance growth, plus the impact of CECL adoption on reserves, retained earnings, and regulatory capital.
- Regulatory approval and capacity for planned dividends and share repurchases, and the availability and terms of committed funding facilities.
- Developments in the securities litigation and regulatory inquiries; the filing provides no clear estimate of potential losses.