Ally Earnings: Lower Net Interest Margins Pressure Results While Credit Costs Are Expected to Rise

No-moat Ally Financial ALLY reported decent second-quarter results that were in line with our expectations as lower net interest margins and higher credit costs continue to place downward pressure on results. Net revenue increased 0.7% from last year but was down 0.4% from last quarter to $2.1 billion. Meanwhile, earnings per share fell 29% from last year to $0.99, which translates to a return on tangible equity of 11.8%. The decline in profitability was primarily due to higher provisioning expenses as Ally transitions from a period of unusually low credit costs last year. As we incorporate these results, we do not expect to materially alter our $39 fair value estimate. We see the shares as undervalued at current prices on a full-cycle basis.

Net financing revenue fell 11% from last year and 2% from last quarter to $1.57 billion, despite period-end loans and leases increasing 8% year over year. The culprit was the bank’s net interest margin, which fell to 3.38% from 4.04% last year. Rising interest rates have driven the bank’s funding costs up faster than its asset yield, creating a meaningful headwind to interest income. As more of Ally’s loans roll off into new higher-yielding receivables, we expect this downward pressure to improve. In the meantime, competition for deposits means that further interest rate hikes will likely be to Ally’s detriment.

On a positive note, despite tighter auto lending underwriting, which saw Ally’s approval rate fall to 29% from 31% last quarter and 35% last year, the bank’s origination volume improved $0.9 billion sequentially to $10.4 billion. Many of Ally’s competitors have pulled back from the auto lending space, allowing the firm to maintain decent loan origination despite weaker auto market conditions, while also increasing the credit quality of its accepted applicants, with its weighted average FICO score rising to 701 from 685 last year.