DBRS Confirms Ally Financial Inc. at BB (low) Following 2010 Results, Trend Revised to Positive

DBRS Inc. (DBRS) has today confirmed the ratings of Ally Financial Inc. (Ally or the Company) and certain related subsidiaries, including its Issuer and Long-Term Debt rating of BB (low). The trend on the Issuer and Long-Term Debt ratings has been revised to Positive from Stable. The trend on the short-term rating remains Stable. Today’s rating action does not impact the AAA rating of the Senior Notes Guaranteed by the FDIC. Today’s action follows the Company’s announcement of 4Q10 results indicating net income of $79 million and $1.1 billion for full-year 2010.

The ratings confirmation considers the substantial strength of Ally’s core Auto Finance franchise, its reduced risk profile and the improved quality of the capital stack. In confirming the ratings and revising the trend, DBRS recognizes the positive trajectory in financial performance and acknowledges the Company’s success in transforming the business model. Finally, the ratings consider Ally’s funding and liquidity profile, which, while improved, still includes a sizable amount of higher cost wholesale funding, which adds to ongoing margin pressure.

After a transformational year in 2010, during which Ally converted to a more market-focused model, the Global Auto Finance business remains strong. Indeed, despite still depressed U.S. auto industry sales, Ally increased U.S. originations 72% year-on-year to $32 billion, including $9.3 billion in 4Q10, the highest quarterly level since the beginning of 2008. Demonstrating the strength of the franchise and Ally’s ability to defend its market share, only 28% of 4Q10 origination volume was related to subvented business from GM and Chrysler. Ally’s large dealer network and the Company’s ability to leverage these relationships through its product offerings underpins the franchise and is a key competitive advantage.

Ally has made significant progress in restoring its earnings generation ability. For 4Q10 and full-year 2010, the Company reported core pre-tax income, defined as income from continuing operations before taxes and original issue discount (OID), of $533 million and $2.5 billion, respectively. The substantial improvement in earnings was driven by a 20% increase, year-on-year, in total net revenue to $9.2 billion due to the higher balance in the loan book and a marked decrease in the amount of non-performing loans. The larger loan book offset the decline in net interest income, as margins moved lower reflecting the ongoing shift to higher quality, lower yielding assets. Profitability also benefited from a significant reduction in provision for loans losses, as credit performance continues to improve. Indeed, Ally’s provision for loan losses in 2010 declined an impressive 92% to $442 million from $5.6 billion. Importantly, all four operating segments were profitable in each of the four quarters in 2010. DBRS sees the quarterly and full year results as evidence of good momentum across the franchise.

DBRS views the overall credit risk profile as significantly improved. Credit trends in the Global Auto Finance business were quite favorable. Losses on the retail book continue to improve, with loss frequency declining and severity improving, as the market for used vehicles remains healthy. Further, the positive trajectory in delinquencies indicates credit trends will likely remain healthy for the near term. Importantly, Ally’s risk profile has benefited from management actions taken to de-risk the mortgage business. To this end, Ally reached “rep and warranty” settlements with both Fannie Mae in 4Q10 and Freddie Mac in 1Q10, and also sold its European mortgage business, which included approximately $11 billion of assets and contingent liabilities. While a significant amount of repurchase risk has been removed, uncertainty over the repurchase risk for non-agency loans lingers.

The recent conversion of $5.5 billion of Mandatory Convertible Preferred Shares (MCPs) by the U.S. Government into common equity has improved the quality of Ally’s capital base. However, there are still $5.9 billion of high cost MCPs remaining. Nonetheless, DBRS views the conversion positively, because it improves the loss absorption ability of the capital structure and removes approximately $500 million in annual dividend payments, which should support internal capital generation. As a result of the conversion the Company’s Tier 1 common equity ratio increased to 8.6% from 5.3% at the end of 3Q10.

During 2010, the Company made noteworthy progress in diversifying its funding profile. Net deposits grew by $7.3 billion, or an impressive 23%, year-on-year to $39.0 billion, on strong CD retention rates of 85%. Total deposits now account for 29% of total funding. Importantly, Ally continues to demonstrate good access to the capital markets generating $36.0 billion of funding during 2010. With $23.8 billion of available corporate liquidity, Ally has essentially pre-funded a large part of the Company’s unsecured debt maturities coming due over the next two years. However, funding costs remain elevated and when combined with the shift to lower yielding assets, are resulting in weakening margins. DBRS anticipates the Company making additional progress in 2011 towards addressing its high funding costs.

In revising the trend to Positive, DBRS recognizes the significant achievements discussed above, and the substantial reduction in the risk profile of ResCap. DBRS notes that concurrent with this rating action, the ratings of ResCap were placed Under Review with Positive Implications. Importantly, however, DBRS notes that an upgrade in ResCap’s rating does not necessarily equate to an upgrade at Ally. In assigning the BB (low) rating in January 2010, DBRS had a high level of confidence in the management and its ability to execute on many of their key objectives. As such, DBRS still sees the rating as well placed. However, continuation of the positive momentum, transforming the franchise, strengthening the balance sheet and advancing the track record of solid earnings could lead to upward rating pressure. Moreover, although the quality of the capital stack has improved, DBRS would view positively further reduction in high cost capital.

As noted in the rating table below, DBRS has changed the name of several subsidiaries of Ally to reflect their current legal names.

Note:
All figures are in U.S. dollars unless otherwise noted.

The applicable methodology is Rating Auto Finance Companies Operating in the United States, which can be found on the DBRS website under Methodologies.

The sources of information used for this rating include the issuer. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

Lead Analyst: Steve Picarillo
Rating Committee Chair: Alan G. Reid

Initial Rating Date: 16 May 2001
Most Recent Rating Update: 19 January 2010

For additional information on this rating, please refer to the linking document below.