DBRS Upgrades Ally Financial, Inc. to BB (high), Trend Positive

DBRS, Inc. (DBRS) has today upgraded the Issuer and Long-Term debt ratings of Ally Financial Inc. (Ally or the Company) to BB (high) from BB. Concurrently, the Short-Term Instruments rating was confirmed at R-4. The trend on all ratings is Positive. Today’s rating action follows a detailed review of the Company’s operating results, financial fundamentals and future prospects.

The rating action reflects the sustained improvement in profitability achieved by Ally, the strengthening funding profile, and improving capital structure. Moreover, the ratings reflect the Company’s strong franchise, well-managed liquidity and sound risk management and servicing capabilities. However, Ally’s focus on the U.S. auto market and reliance on wholesale funding remain constraints on the ratings over the longer-term.

The Positive trend reflects DBRS’s expectations that over the next 12 to 18 months that Ally’s financial performance will continue to improve supported by sound U.S. auto sales volumes, continued rationalization of the cost base, and additional actions by the Company to address legacy high cost debt. DBRS also sees earnings benefiting from the Company’s continuing shift towards a more bank-centric model with increasing origination volumes financed by Ally Bank’s (the Bank) low-cost deposit base. The Positive trend also considers that Ally’s broad product offering, deep industry knowledge and dealer-focused business model will allow the Company to successfully execute on its strategy of growing non-GM/Chrysler origination volumes. Nevertheless, should the expansion into these growth channels and new products materially alter the risk profile of the balance sheet positive ratings momentum could stall or potentially reverse. Moreover, the resiliency of the retail direct deposit base in a rising rate or otherwise disrupted environment will be a key consideration for the ratings over the near-to-medium-term.

Ally’s leading U.S. auto finance franchise and top-tier direct banking franchise remain key factors underpinning the ratings. The Company’s long operating history in the auto finance space, broad range of products, dealer focus, and seasoned management team contribute to Company’s leading market position. According to Experian, Ally is the number two U.S. retail auto lender by market share supported by a number three position in used vehicle retail lending and number four in new retail lending. DBRS notes that Ally is the leading non-captive new retail lender in the U.S. and is the leading lender in U.S. dealer floor plan.

While replacing the loss of GM subvented leasing volumes (23% of 2014 origination volumes) is a near-term challenge, DBRS sees Ally’s progress to date in diversifying its originations by channel as demonstrating the strength of the franchise. Of significance, DBRS sees good opportunities for Ally to continue to broaden its presence in this channel with only 26% of growth channel dealers selling five or more contracts a month to Ally in 1Q15.

Importantly for the ratings, DBRS sees Ally’s improved earnings generation as sustainable. For 2014, Ally reported net income of $1.15 billion, up from $361 million the year prior. The positive momentum carried into 1Q15 with Ally generating $490 million of core income, up 45% year-on-year. With additional liability management actions expected in 2015 and 2016 as well as lease yields expected to stabilize, DBRS sees NIM as improving through 2015, albeit at a modest pace.

Operating efficiency has benefited from the Company’s efforts to remove costs including those associated with legacy businesses. As a result, the Company’s operating efficiency ratio has improved to 48% in 1Q15. DBRS expects further cost removal actions over the near-term which should continue to support positive operating leverage and profitability.

Expanding revenues and the removal of controllable expenses has underpinned an improvement in Ally’s pre-provision income (DBRS-calculated IBPT) generation that is sustainable, in DBRS’s view, and increases Ally’s ability to absorb losses through earnings. Provisions for loan losses were a modest $457 million in 2014, or 24% of DBRS-calculated IBPT.

Ally continues to advance towards a more bank-centric business model, which is key to funding, and profitability over the medium-to-long-term. As of March 31, 2015, 68% of all Company assets reside at the Bank, up from 11% at YE07. Importantly, with the Company’s exit from TARP complete Ally expects to receive regulatory approval to broaden the credit mix of retail auto loans financed by the Bank. DBRS sees such approval as ultimately providing Ally a key competitive advantage vis a vis other auto finance companies by allowing Ally to utilize deposit funding and a cost of funding advantage.

Asset quality metrics continue to slowly migrate towards more normal levels. DBRS expects credit performance to continue to gradually normalize as the mix of loans shifts and the portfolio seasons.

Ally maintains a diverse funding profile with deposits continuing to expand and becoming the anchor of the funding profile. As of March 31, 2015, deposits accounted for 46% of total funding (23% at YE09), while the quality has improved with 84% comprised of retail deposits. Liquidity is ample with Ally maintaining 24 months of liquidity before required funding.

Regulatory capital remains solid with Ally reporting a fully phased-in Basel III Common Equity Tier 1 ratio of 10.4% at the end of 1Q15. DBRS notes that in March 2015, Ally received a non-objection from the Federal Reserve for its 2015 capital plan submission. Ally’s 2015 capital plan includes the reduction of $2.8 billion of high-cost capital securities and the continuing opportunistic redemptions of high cost debt. Subsequent to quarter end, Ally redeemed $1.3 billion of its Series G preferred securities in April 2015. Pro-forma to the Series G redemption, Ally’s Basel III CET 1 ratio was a solid 9.5% at March 31, 2015.

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

The applicable methodology is Global Methodology for Rating Finance Companies (October 2014). Other applicable methodologies include the Global Methodology for Rating Banks and Banking Organisations (June 2014), DBRS Criteria – Support Assessments for Banks and Banking Organisations (March 2015) and DBRS Criteria: Guarantees and Other Forms of Explicit Support (February 2015), which can be found on our website under Methodologies.

The primary 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
Rating Committee Chair: Roger Lister
Initial Rating Date: 16 May 2001
Most Recent Rating Update: 14 September 2014

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