DBRS Comments on Ally Financial’s 3Q12 Results, Unchanged at BB (low), UR - Developing

DBRS has today commented on the 3Q12 results of Ally Financial Inc. (Ally or the Company). DBRS rates Ally’s Issuer and Long-Term Debt at BB (low). The ratings remain Under Review – Developing where they were placed on May 15, 2012. For the quarter, Ally reported net income of $384 million compared to a net loss of $898 million in the prior quarter. DBRS notes that 2Q12 results were impacted by a $1.2 billion charge related to the bankruptcy filing of Residential Capital, LLC (ResCap). Core pre-tax income (income from continuing operations before taxes and origination issue discount (OID) amortization expense), excluding ResCap related items totaled $559 million compared to a core pre-tax income of $533 million in 2Q12.

In an increasingly competitive marketplace, DBRS sees Ally’s underlying results as illustrating the strength of the overall franchise underpinned by a strong U.S. auto finance business and a growing direct bank franchise. Results also benefited from solid credit performance and asset yields that reflect a more diversified origination mix. Moreover, DBRS recognizes the progress the Company has achieved in executing on its strategic plan to simplify and streamline the business. To this end, Ally recently agreed to the sale of its Mexican insurance business as well as its Canadian operations (both transactions are subject to regulatory approval), which combined will result in an estimated pre-tax gain on sale of $1.2 billion, further supporting capital and liquidity. Ally expects to announce plans for the remaining international operations in Europe and Latin America in the near-term and is currently evaluating alternatives for Ally Bank’s agency MSR portfolio and mortgage business lending operation.

Results were driven by a solid performance in the core auto services business, improving earnings in Mortgage Operations and good underlying trends in Insurance. The North American Automotive Finance segment reported pre-tax income of $510 million, 19% lower on a linked quarter basis. Results were impacted by normalization in provision for credit losses, which increased QoQ as a reserve release in 2Q12 did not repeat. Other revenue declined on lower gains associated with whole loan sales and off-balance sheet securitizations. Positively, net financing revenue improved on earning asset growth. Net interest margin was 9 basis points (bps) lower QoQ at 2.06% as earning asset yields were lower due to Ally holding higher cash balances ahead of repayment of TLGP debt partially offset by a 4 bps reduction in cost of funds.

In 3Q12, Ally’s North American Auto Finance segment reported U.S. consumer origination volumes of $9.6 billion. Demonstrating Ally’s progress in successfully broadening its origination channels diversified new dealers, used and lease origination accounted for over 50% of total origination volumes, while GM and Chrysler subvented business accounted for just 14%. DBRS considers the solid origination volumes as illustrating the substantial strength of Ally’s core U.S. auto finance franchise. Moreover, DBRS views the loan origination volumes as evidencing the Company’s strong competitive position and the ability of the Company to leverage its strong relationship with auto dealers.

For the quarter, the Mortgage Operations segment reported pre-tax income from continuing operations of $354 million, up from $110 million in 2Q12. Mortgage Operations include the Company’s legacy and originations servicing segments, but exclude ResCap. Results benefited from higher gain on sale revenue due to an increase in refinance activity and a strong MSR hedge performance as the increase in the value of the Company’s hedges outpaced the decline in the MSR asset. Insurance reported pre-tax income of $33 million down from $43 million in 2Q12 due to an other than temporary impairment in the investment portfolio which more than offset lower weather related losses than in the prior quarter. Importantly, the Dealer Products and Service business, (which provides dealer-centric products such as extended service contracts and floor plan insurance, and is a key product line for Ally), wrote $285 million of premiums in 3Q12, the highest level in four years.

Credit metrics were up slightly quarter-on-quarter but remain near historic lows. Within the $121.3 billion loan book, the net charge-offs (NCOs) rate increased 13 basis points (bps) QoQ to a very low 0.42%. The modest increase reflects seasonality, large recoveries in the commercial loan book in 2Q12 which did not repeat, and normalization of loss rates in the retail loan book. Delinquencies in the global auto book were up 16 bps from the prior quarter at 1.39% owing to seasonal trends as delinquencies remained near cyclical lows. Provision for loan losses increased to $116 million from $28 million in 2Q12 as notable reserve releases in the prior quarter did not repeat and earning assets continue to grow. DBRS sees the reserve coverage as solid at 285.3% of NCOs.

Ally’s leading direct bank is the foundation for the solid funding profile. Net deposits grew by 4% QoQ, or $1.7 billion to $42.0 billion. Importantly, CD retention rates remain strong at over 90% and the average number of deposit accounts per customer at 1.95 demonstrates the strength of franchise. At quarter-end the Company’s time to required funding was sound at over two years. DBRS notes that the Company recently repaid $2.9 billion of TLGP debt and intends to repay the remaining $4.5 billion of TLGP before year-end. Upon the repayment of the TLGP debt, the Company’s debt maturity schedule becomes more balanced. During 3Q12, Ally completed nearly $6.3 billion of new secured and unsecured funding, while launching its new Ally Retail Term Note Program demonstrating the Company’s broad and diversified access to capital markets.

Capital remains stable as capital generation from earnings was offset by growth in risk-weighted assets due to the solid growth in auto originations. At September 30, 2012, the Company’s Tier 1 Capital ratio stood at 13.6%, essentially unchanged from 2Q12. Risk weighted assets increased 2% sequentially to $150.3 billion. DBRS notes that should the full sale of the Company’s international operations be completed, RWAs would decline approximately $30 billion, further strengthening regulatory capital ratios. Tangible common equity increased $400 million QoQ to $11.3 billion and as a result, the Company’s tangible common equity-to-tangible asset ratio improved 10 basis points to 6.2%.

The Under Review Developing reflects the ResCap bankruptcy filing and DBRS’s view that while there are medium-to longer-term positives for Ally to this action from ResCap, DBRS is nonetheless concerned that indirect and direct costs may exceed Ally’s estimates. Moreover, DBRS notes that the bankruptcy plan may be altered or delayed in the bankruptcy process. Importantly, DBRS notes that to date, ResCap’s bankruptcy costs to Ally remain within its initial estimates. DBRS expects to conclude its review at the end of the bankruptcy process which is expected by the middle of 2013 at the latest.

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

The principal applicable methodology is the Global Methodology for Rating Banks and Banking Organisations. Other methodologies used include the DBRS Criteria – Intrinsic and Support Assessments. Both can be found on the DBRS website under Methodologies.

The sources of information used for this rating include company documents and SNL Financial. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.

Lead Analyst: David Laterza
Approver: Alan G. Reid
Initial Rating Date: May 16, 2001
Most Recent Rating Update: May 15, 2012

For additional information on this rating, please refer to the linking document under Related Research.