DBRS Comments on Ally Financial’s 2Q13 Results, Senior Unchanged at BB, Trend Stable

DBRS, Inc. (DBRS) has today commented on the 2Q13 financial results of Ally Financial Inc. (Ally or the Company). DBRS rates Ally’s Issuer and Long-Term Debt at BB. The trend on all ratings is Stable. For the quarter, Ally reported a net loss of $927 million compared to net income of $1.1 billion in the prior quarter and a net loss of $898 million a year ago. The quarter’s results were impacted by a $1.6 billion charge related to the Company’s previously announced comprehensive settlement agreement with the Residential Capital, LLC (ResCap) bankruptcy estate and ResCap’s major creditors. The charge was partially offset by $600 million of tax benefits related to the settlement and the sale of certain international operations. While the size of the loss is notable, the loss was within DBRS’s expectations. Excluding repositioning items, core pre-tax income (income from continuing operations before taxes and origination issue discount (OID) amortization expense), totaled $211 million, up marginally on a linked quarter basis, but 20% lower YoY.

During the quarter, Ally made further progress in the strategic transformation of its business model. To this end, Ally completed the sale of its Mexican insurance business, as well as its remaining European operations, primarily in France. Meanwhile, the deals to sell the auto finance operations in Brazil, as well as the joint venture stake in China remain in process. Further, along with the comprehensive ResCap settlement, Ally completed the sale Ally Bank’s (the Bank) agency MSR portfolio and ceased new mortgage originations during the quarter effectively exiting the residential mortgage origination and servicing business. At quarter end, Ally’s only exposure to residential mortgages is the $8.8 billion of mortgages held for investment at the Bank. These actions are designed to simplify and streamline Ally’s business, which DBRS views favorably, as it allows management to focus on growing its leading dealer focused U.S. auto finance business and direct bank franchise.

On an operating basis, the Company’s auto finance business reported solid results in a highly competitive marketplace. Consumer origination volumes were $9.8 billion across a broad range of origination channels. Earning assets were 10% higher YoY reflecting originations outpacing portfolio amortization. Commercial loans were down modestly, primarily due to lower dealer inventory levels as a result of strong retail sales. DBRS considers the solid origination volumes and growth in earning assets in the current environment as demonstrating the Company’s ability to leverage its strong relationship with auto dealers.

For the quarter, the Auto Finance segment generated pre-tax income of $382 million, an 11% improvement from the prior quarter, but 13% lower YoY. Importantly, while results were lower compared to the comparable period a year ago due to the absence of reserve releases and several other one-time items that benefited results a year ago, net financing revenue was higher both sequentially and YoY. Specifically, net financing revenue increased 1% QoQ and 12% YoY to $777 million. The positive trajectory in net financing revenue was underpinned by growth in earning assets and improving margins. While the net interest margin (NIM) was modestly lower QoQ largely due to one-time items, the NIM was 37 basis points (bps) higher YoY at 2.04% primarily reflecting reduced funding costs. To this end, Ally’s cost of funds stood at 2.72% in 2Q13, which was 18 bps lower YoY.

The Insurance segment reported pre-tax income of $45 million, down from $61 million in 1Q13 reflecting seasonally higher weather-related losses that was partially mitigated by higher investment income. Positively, the Dealer Products and Services business, (which provides dealer-centric products such as extended service contracts and floor plan insurance), wrote $276 million of premiums in 2Q13, the highest level since 2008. Moreover, wholesale insurance penetration levels remain high with 82% of U.S. dealers with Ally floorplan financing also utilizing floorplan insurance.

Within the U.S. Retail Auto Finance portfolio, net charge-offs (NCO) continue to be near cyclical lows at 0.57%, a 12 bps improvement QoQ reflecting seasonal factors. While NCOs remain at low levels, NCOs were 23 bps higher YoY driven by a more balanced mix in originations, the seasoning of some larger vintages that are entering their peak loss periods, and a slight decline in used vehicle values during the quarter to more normalized levels. DBRS notes that the Company expects these trends to continue over the coming quarters leading to normalization in loss rates. Non-performing loans (NPL) were stable on a sequential basis at $1.0 billion. Company-wide provision for loan losses were 32% lower QoQ at $89 million due to lower losses primarily in the mortgage held for investment portfolio. Nevertheless, DBRS sees the reserve coverage as acceptable at 117.6% of NPLs.

Ally’s leading direct bank anchors the solid funding profile accounting for 40% of total funding with total deposits of $49.4 billion at June 30, 2013. During the quarter, retail deposit growth was solid expanding $1.1 billion and accounting for 81% of total deposits. For the eighth consecutive quarter, CD retention rates were strong at over 90%. At quarter-end, the Company’s time to required funding was sound at over two years. DBRS notes that a priority of Ally going forward will be to reduce the presence of high cost debt in its capital structure, which should improve earnings. To this end, the Company recently issued $1.4 billion of unsecured senior debt using the proceeds to repay higher coupon SmartNotes.

Capital ratios increased sequentially reflecting the benefits of the sale of the international operations, which more than offset the impact of the ResCap settlement. At June 20, 2013, the Company’s Basel I Tier 1 Capital ratio was 15.4%, an 80 bps improvement from 1Q13. Risk-weighted assets were 11% lower QoQ at $127.2 billion reflecting the sale of certain international operations partially offset by earning asset growth. Ally’s Tier 1 Common ratio was 8.0%, and pro-forma to the completion of the remaining international operation divestures was 8.9%. Regarding forthcoming regulatory capital requirements, Ally expects the impact of the recently finalized Basel III rules to have a minimal impact on its regulatory capital levels. Indeed, the Company estimates that the Basel III rules would have lowered its Tier 1 common ratio by only 20 to 40 bps at quarter-end.

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

[Amended on May the 23rd, 2014 to remove unnecessary disclosures.]