Ally Financial Inc. — Q2 2016 Form 10-Q
Business context and reporting period. Ally is a digital financial-services and bank holding company, with automotive finance, insurance, mortgage finance, and corporate finance operations. This unaudited filing covers the three and six months ended June 30, 2016; income comparisons are to 2015, while balance-sheet comparisons are primarily to December 31, 2015. Amounts below are in millions of dollars unless stated otherwise.
Financial performance and position
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Total net revenue | $1,358 | $1,127 | $2,685 | $2,220 |
| Net financing revenue | $984 | $916 | $1,935 | $1,766 |
| Provision for loan losses | $172 | $140 | $392 | $256 |
| Income from continuing operations before tax | $413 | $263 | $810 | $545 |
| Net income from continuing operations | $357 | $169 | $604 | $348 |
| Net income, including discontinued operations | $360 | $182 | $610 | $758 |
| Diluted earnings per common share | $0.71 | $(2.22) | $1.19 | $(1.16) |
- Q2 total net revenue increased 20% year over year; six-month revenue increased 21%. Net financing revenue rose 7% and 10%, respectively. Net interest spread was 2.57% in Q2 versus 2.43% a year earlier; net yield on interest-earning assets was 2.68% versus 2.55%.
- Net income from continuing operations rose 111% in Q2 and 74% for the first half. Results benefited from higher net financing revenue and the absence of 2015 debt-tender losses. Q2 tax expense included a $175 million benefit from release of a prior-year U.S. tax reserve, partly offset by other tax expense. Thus reported earnings include a significant tax-related unusual item.
- Six-month net income was lower than in 2015 despite stronger continuing results, principally because 2015 included a roughly $400 million after-tax gain from selling a China automotive-finance joint-venture interest. 2015 also included substantial preferred-stock redemption-related dividends that affected common-share EPS.
- Loan-loss provision increased 23% in Q2 and 53% for the first half. Management attributed the increase mainly to a broader-risk-spectrum automotive portfolio, portfolio growth, and the absence of prior-year commercial reserve releases. Six-month net charge-offs were $331 million versus $250 million; the total annualized net charge-off ratio was 0.6% versus 0.5%.
- Insurance results weakened: Q2 pretax loss was $18 million versus income of $15 million, and the six-month income fell to $32 million from $93 million. Severe hailstorms drove higher claims; the combined ratio rose to 122.8% for Q2 and 108.7% for the first half, compared with 112.2% and 99.1%.
Balance sheet, funding, and capital at June 30, 2016
- Total assets were $157.9 billion, down from $158.6 billion at year-end. Finance receivables and loans, net, were $111.6 billion; operating lease assets were $13.8 billion, down from $16.3 billion.
- Cash and cash equivalents were $5.7 billion, down $649 million since year-end. Six-month operating cash flow was $2.4 billion, investing cash outflow was $1.3 billion, and financing cash outflow was $1.8 billion.
- Deposits increased to $72.8 billion from $66.5 billion, while short-term borrowings fell to $6.0 billion from $8.1 billion and long-term debt fell to $61.0 billion from $66.2 billion. Total equity was $13.6 billion; preferred stock had been fully redeemed.
- Management reported total available liquidity of $17.6 billion, split between Ally Bank ($10.7 billion) and the parent/nonbank company ($6.8 billion). It estimated this liquidity could fund planned originations and obligations for approximately 36 months under a long-term capital-markets stress, assuming no unsecured-debt issuance or term securitizations. The Modified Liquidity Coverage Ratio exceeded 100%.
- Ally Financial’s Basel III Common Equity Tier 1, Tier 1, and total capital ratios were 9.59%, 11.18%, and 12.83%; Ally Bank’s were 17.64%, 17.64%, and 18.15%. Both were reported well-capitalized and compliant with applicable requirements. Ally Bank had committed to maintain a Tier 1 leverage ratio of at least 15%; its reported ratio was 15.31%.
Material changes and management commentary
- Automotive Finance pretax income increased to $426 million in Q2 from $373 million and to $763 million for the first half from $679 million. Higher consumer yields and commercial floorplan balances helped, while increased credit provision and lower net lease revenue partly offset gains. Consumer originations declined, reflecting lower GM volume and Ally’s focus on risk-adjusted returns; Growth and Chrysler channel volumes expanded.
- Management said lease termination volumes should increase in the second half of 2016. Average remarketing gain per vehicle fell to $1,126 in Q2 from $1,686 a year earlier, and management expected the lower-gain trend to continue in the near term. It also expects lease volumes and residual exposure to decline materially from 2018 onward as GM lease originations run off.
- Ally acquired online brokerage and digital wealth-management company TradeKing on June 1 for $298 million cash. The acquisition added $193 million of goodwill; June results were included in Corporate and Other. Ally also launched the Ally CashBack Credit Card during Q2, with fee revenue and no direct credit-risk exposure under the co-brand structure.
- Mortgage Finance continued bulk purchases of higher-quality jumbo and low-to-moderate-income mortgage loans, totaling $2.4 billion in the first half. Corporate Finance loans grew 42% year over year, with $2.98 billion outstanding at quarter-end.
- The Federal Reserve did not object to Ally’s 2016 capital plan. In July, the board declared a quarterly common dividend of $0.08 per share and authorized up to $700 million of common-stock repurchases through Q2 2017. Redemption of $500 million of trust preferred securities, previously approved as part of an earlier capital plan, was indefinitely deferred in support of the TradeKing acquisition.
Risks, contingencies, and other matters
- Key sensitivities include consumer and commercial credit performance, used-vehicle and housing values, lease residuals, interest rates, funding-market access, deposit behavior, and regulatory requirements. The filing notes that the company’s sensitivity to interest rates depends materially on assumptions about the repricing of non-maturity deposits.
- Ally and its subsidiaries disclosed ongoing DOJ and SEC mortgage-related inquiries, including matters involving legacy Residential Capital mortgage-backed securities and potential claims; separate DOJ, SEC, and New York regulator inquiries concerning subprime automotive finance and securitizations; and CFPB/DOJ consent-order obligations relating to alleged disparate impact in automotive lending. The company stated that these matters could result in material adverse consequences, while noting its view that currently known legal matters would not materially harm consolidated results overall; an unfavorable resolution could nevertheless be material in a particular period.
- Management highlighted severe-weather claims as a current unusual operating pressure. The filing also identifies the allowance for loan losses, lease-asset valuation, financial-instrument fair value, legal and regulatory reserves, and income taxes as critical accounting estimates.
- No formal earnings guidance is presented. The filing provides scenario-based interest-rate sensitivity, rather than an earnings forecast: under its stated forward-curve assumptions, a 100-basis-point instantaneous rise reduced projected 12-month pretax net financing revenue by $18 million, and a 200-basis-point rise reduced it by $128 million.
- Management reported effective disclosure controls and procedures and no material change in internal control over financial reporting during the quarter. The filing states there were no material changes to previously disclosed risk factors.
Important facts for investors to verify
- Whether the $175 million tax-reserve release and associated valuation allowance materially distort comparisons of Q2 tax expense and continuing earnings.
- Whether rising automotive provision and net charge-offs reflect expected portfolio mix changes or indicate further deterioration in consumer credit quality.
- Whether hail-related insurance losses, combined-ratio performance, and investment income normalize in subsequent quarters.
- How lease return volumes, used-vehicle prices, and lower remarketing gains affect future lease profitability and residual exposure.
- Whether deposit growth and committed funding capacity remain durable, and whether liquidity held at Ally Bank is available to support parent-company obligations.
- Progress and potential financial exposure from the disclosed DOJ, SEC, New York regulator, CFPB, and consent-order matters; also verify the execution and regulatory constraints on planned dividends and share repurchases.