Business context and reporting period
Ally Financial Inc. filed this unaudited Form 10-Q for the quarter and nine months ended September 30, 2011. Ally provides automotive finance, insurance, and mortgage origination and servicing, and operates Ally Bank. Comparisons below are with the 2010 comparable period or December 31, 2010, as applicable. Dollar amounts are U.S. dollars.
Financial results and position
| Metric | Q3 2011 | Q3 2010 | Nine months 2011 | Nine months 2010 |
|---|---|---|---|---|
| Total net revenue | $1.191bn | $2.047bn | $4.625bn | $5.994bn |
| Net financing revenue | $590m | $590m | $1.838bn | $2.051bn |
| Continuing income (loss) before tax | $(123)m | $325m | $171m | $947m |
| Continuing net income (loss) | $(210)m | $277m | $70m | $830m |
| Net income (loss), including discontinued operations | $(210)m | $269m | $49m | $996m |
| Net income (loss) attributable to common shareholders | $(410)m | $(58)m | $(513)m | $141m |
| Provision for loan losses | $49m | $9m | $213m | $371m |
| Noninterest expense | $1.265bn | $1.713bn | $4.241bn | $4.676bn |
Management’s non-GAAP core pretax income was $102m in Q3 2011 versus $635m a year earlier, and $996m for the first nine months versus $1.946bn. Ally defines this measure as continuing pretax earnings excluding original issue discount amortization; it is not a substitute for GAAP results.
- Margins and returns: Net interest spread was 0.99% in Q3 and 1.04% year to date, versus 1.03% and 1.37%, respectively, in 2010. Excluding original issue discount amortization, the spreads were 1.68% and 1.87%, versus 2.10% and 2.44%. Q3 efficiency ratio rose to 106.21% from 83.68%; year-to-date ratio was 91.70% versus 78.01%.
- Cash flow: For the first nine months, operating cash flow was $5.781bn, investing cash flow $(6.826)bn, and financing cash flow $5.858bn. Cash and cash equivalents ended the period at $16.402bn, up from $11.670bn at year-end 2010. Operating cash flow was below the prior-year $11.540bn.
- Balance sheet and funding: Total assets were $181.956bn, compared with $172.008bn at year-end. Deposits were $44.326bn (up from $39.048bn); short-term borrowings were $5.933bn; long-term debt was $90.546bn. Equity was $19.732bn, down from $20.489bn.
- Liquidity and capital: Management reported $25.9bn of available parent-company liquidity and $13.6bn at Ally Bank, subject to entity-level restrictions and facility collateral requirements. Ally’s Tier 1 risk-based capital ratio was 14.34%, total risk-based capital 15.50%, and Tier 1 common ratio 8.01%. Ally Bank’s Tier 1 leverage ratio was 15.65%, above its 15% maintenance requirement.
Material changes and management commentary
- Q3 net revenue fell 42% year over year. A $471m net loss from servicing asset valuation and hedge activities, compared with a $27m loss in Q3 2010, was a major factor. Management attributed the deterioration principally to lower interest rates and greater market volatility reducing mortgage servicing rights values. The MSR balance declined to $2.663bn from $3.738bn at year-end 2010.
- Mortgage and automotive loan gains fell to $83m in Q3 from $326m; year-to-date gains were $290m versus $863m. Management cited lower mortgage production, sale margins, and whole-loan sales. Insurance premiums and service revenue also declined, partly reflecting prior international business sales.
- Lower noninterest expense, including lower mortgage representation-and-warranty expense, partly offset weaker revenue. Year-to-date loan-loss provisions declined to $213m from $371m, and net charge-offs fell to $433m from $959m. Management cited improving credit quality and runoff of legacy portfolios; Q3 provision nevertheless increased year over year.
- Automotive finance grew: North American consumer originations were $27.745bn for the first nine months, up from $22.618bn. Consumer auto finance receivables increased, while lower lease revenue reflected the smaller lease portfolio. Ally remained cautious about near-term vehicle sales amid economic uncertainty.
- Mortgage production was $40.747bn year to date, down from $47.291bn. On November 2, 2011, Ally announced it would reduce its focus on correspondent lending while continuing consumer and broker channels; correspondent lending represented about 84% of year-to-date mortgage originations.
- ResCap remained a material uncertainty. It met its $250m tangible-net-worth covenant with $331m at September 30, but Ally disclosed substantial doubt about ResCap’s ability to continue as a going concern. ResCap depends heavily on Ally and affiliates for funding and capital, and future support is not assured. Ally had $1.2bn of loans utilized under $1.9bn of secured ResCap financing arrangements.
Outlook, risks, contingencies, and unusual items
- The filing provides no quantified consolidated earnings guidance. Management described continued caution regarding economic growth, auto demand, housing, and mortgage markets.
- Mortgage foreclosure practices were under government investigation, and Ally entities were subject to an FRB/FDIC consent order requiring servicing, compliance, and control improvements. Ally estimated incremental compliance costs of $30m–$40m annually for 2011–2013 and foreclosure-review costs of up to $200m; costs could be higher. The company considered monetary fines probable but could not estimate a range. A $9m liability was recorded for certain probable and estimable fines and penalties.
- Mortgage representation-and-warranty claims, private-label MBS litigation, and monoline insurer disputes remain significant risks. The reserve was $829m; unresolved demands totaled $1.090bn of original unpaid principal balance, including $909m from monolines. Ally said reasonably possible losses beyond reserves could be material but could not estimate a range.
- Ally’s relationship with GM remains important to automotive results; the filing identifies adverse changes in GM’s business or vehicle sales as a risk. Other risks include market and funding disruption, credit-rating changes, interest and foreign-exchange movements, and regulatory capital requirements.
- On October 6, 2011, Ally declared preferred-stock dividends totaling about $201m, payable November 15. Treasury had sold its trust preferred securities in March; Ally received no proceeds from that sale. In March, Ally also amended Series A preferred terms, with a $32m accounting impact to income available to common shareholders for the nine-month period.
Important facts for investors to verify
- How much of the quarterly loss reflects potentially recurring mortgage servicing valuation volatility, and how sensitive are MSR values and hedge results to rates and prepayments?
- What is ResCap’s current liquidity, debt-maturity and covenant position, and what support—if any—will Ally provide?
- Are the $829m representation-and-warranty reserve and foreclosure-related cost estimates adequate given pending claims, litigation, and regulatory reviews?
- How much of reported liquidity is usable at the parent versus regulated or subsidiary entities, and what collateral or renewal conditions apply to committed facilities?
- Can Ally sustain improving auto credit performance and deposit growth while mortgage correspondent production is reduced and preferred dividends remain payable?