The COVID-19 crisis has been tough on most financiers, with the exception of mortgage bankers. Banks have reported significant credit write-downs, while the real estate investment trust industry has seen a decline in the number of tenants paying rent. The crisis has increased credit losses and social distancing has put the brakes on lending as a whole.
Allied financial (NYSE: ALLY) is a consumer finance company formerly known as General Motors Acceptance Corp (GMAC). As such, its bread and butter are the car loan. Below we will see how the crisis is affecting the automotive industry and Ally’s performance.
COVID-19 reduced demand for auto loans
Social distancing policies have meant auto sales are far behind, which has also reduced demand for auto loans. In the second quarter, Ally reported net financing revenue down 9% year-over-year, from $ 1.15 billion to $ 1.05 billion. Net income fell 56% from $ 1.46 per share to $ 0.64 due to higher provisions for credit losses and higher non-interest expenses. Deposits overall increased 13% to $ 131 billion. COVID is expected to be more supportive of internet banking than walk-in branches, but the effect is likely marginal at best.
Working from home has reduced the number of drivers, with an estimate suggesting that kilometers driven have fallen by 40%. As a result, auto sales fell 24% in the first half of 2020 and stocks are tight, although vehicles are quickly leaving dealer lots. Lower interest rates should help increase demand for auto financing, but economic uncertainty will weigh on sales overall.
Ally’s mortgage branch is only average
Ally also has a mortgage branch, and the mortgage origination business is growing. middle of a feast. In the last quarter, the company made $ 1.2 billion in direct loans to consumers. It’s right above the Mortgage Bankers Association average origination volume for the quarter of $ 1 billion. To put this number in perspective, Rocket mortgage (NYSE: RKT), better known as Quicken, made $ 72.3 billion last quarter. Thus, mortgage origination remains a potential area for future growth, depending on how quickly it can increase. At present, Ally’s mortgage activity is only average.
Ally doesn’t have to be cheap
Ally’s price-to-book ratio stands at 68%, which is well above its April low of 32%, but below the historical three-year average of around 80%. So there is probably a catching up of the book value in the share price. However, Ally’s price-to-earnings ratio is at the very top of the range. Admittedly, the post-containment assessment discount has disappeared. The title largely matched the performance of FINANCE Select Sector SPDR ETF (NYSEMKT: XLF) since the start of the year, which is down about 17%.
There are better opportunities in the financial sector
All financial sector has struggled over the past six months, although the economy appears to be recovering. Auto loan business is expected to improve with the economy; however, the mortgage industry is too small to have an effect. In many ways, Ally falls short of its weight in this line of business. If the stock was more exposed to this sector, it would be more attractive. Ally is trading at 23 times expected earnings for 2020, while mortgage giant Rocket is trading at eight times expected earnings for 2020.
Ultimately, if a stock is in an underprivileged industry, it should at least be cheap. This is not the case. Rocket is cheaper, grows faster, and operates in a much more attractive industry with a much better macro image. I can’t seem to get excited about Ally.
This article represents the opinion of the author, who may disagree with the “official” recommendation position of a premium Motley Fool consulting service. We are motley! Challenging an investment thesis – even one of our own – helps us all to think critically about investing and make decisions that help us become smarter, happier, and richer.