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Investment thesis
Ally Financial Inc. (NYSE: ALLY) differentiated its business model through mortgages, investments and digital point-of-sale capabilities that position the company to grow and attract robust markets. It added credit card capabilities through the acquisition of the Fair Square Financial platform, bringing strong risk-adjusted returns and increased long-term value play. I’ll explain why I’m bullish with this headline with particular reference to the strong performance out to 2022.
Growth initiative
ALLY has gained more than 34% in the 1-year analysis, outperforming the S&P 500 index by almost 10% over the same period. The price return of market leader Upstart Holdings, Inc. (UPST) increased by 263.7% while Lufax Holding (LU) fell by 61.25% (y-o-y).
Source: YCharts
Auto-sell segment
In the third quarter of 2021, ALLY reached 12and a consecutive year of growth as an automotive financial dealership with a consumption volume of $12.3 billion. During the quarter, the company generated an automotive retail return of 7.10% and insurance premiums written worth $295 million. Investors will note strong credit performance driven by high net charges on retail autos at 27 basis points. 2021 is the 4th consecutive year that ALLY’s retail automotive production exceeded 7%. The company is also optimistic that the value of used cars will exceed 30% (YoY) by 2022.
In my opinion, ALLY has maintained a disciplined and innovative underwriting system that has enabled the company to achieve sustainable investment income from its $6.4 billion portfolio. The quarter also saw customers improving their payment trends with automotive net charges heading towards 30 to 40 basis points by the year 2021. This projection is a reality as the automotive section had already reached revenue of 825 millions of dollars.
The automotive segment’s revenue share in the quarter contributed 39.29% of the total revenue share which stood at $2.10 billion. We can consider the successful digital integration of Internet auction mechanisms SmartAuction and ClearPass which have helped improve the risk-adjusted automotive market. More than 20,000 dealers have been able to purchase automotive products and obtain loan services through Ally’s business services. With the growth of retail auto loans, I agree that originations will reach a range of 30% to 40% by 2023, processing more than 30 million applications.
Acquisition of the place of the fair
For a large financial company like Ally, a cost-benefit analysis was necessary before entering into this transaction. Investors would like to consider whether it was easier to open a credit card company or acquire an existing entity. This question is needed especially after spending $750 million (cash to close the deal).
I think this move was a great show of financial strength since Ally’s current cash position is $10.92 billion. The company still has more than $10 billion in cash to offload in subsequent quarters if needed. Ally is expected to fully close this deal in the first quarter of 2022.
For Fair Square, in addition to its 86 employees, the company has 693,000 cardholders and up to $816 million in loan balances. Since its inception in 2016, Fair Square’s loan balance has grown at a CAGR of 74%.
Source: Ally Financial Inc.
This business is scalable, with a robust customer growth rate. In Q3 2021, Fair Square customers grew at a 4-year CAGR of 66% while revenue jumped at a 4-year CAGR of 109%.
Although not as profitable as notable credit card companies like American Express (AXP) with a market capitalization of $120.75 billion and a cash position of $27.60 billion or Capital One Financial Corp (COF) with a market capitalization of $58.88 billion, Fair Square is still presenting itself as a strategic acquisition. Ally had to deploy approximately 25% of its excess capital to fund this acquisition. This financing exceeded the internal target set.
This transaction reminds me of the acquisition of the credit card segment of HSBC Holdings (HSBC) by Capital One in 2012. At the time, COF’s total cash and investments were $83 billion. It paid $31.3 billion and in return received loans worth $28.2 billion and $600 million in prime assets. Ten years later, COF cash and investments increased by 22.92% to $102.158 billion, while net lending stood at $249.863 billion (+7.18%). Net interest income also nearly doubled to 85.18%, from $12.741 billion to $23.594 billion.
It was after this period that HSBC announced the formation of the HSBC Premier World Elite Mastercard. The bank is targeting growth outside the US and has set its sights on Asia, particularly after seeing total assets rise 16% and total deposits rise 35% on the back of expansion. In the midst of the pandemic in 2020, HSBC recorded a pretax loss of $547 million in its US retail business.
Source: Ally Financial
In my view, the market will appreciate the Ally acquisition in Q1 2022 when it finally closes the deal and completes the acquisition of Fair Square. Its customer-centric benefits are crucial offerings that will increase customer growth. Ally’s revenue could increase 15% in fiscal 2022-23 due to an increase in operating leverage of 100 to 125 basis points.
Mortgage and corporate financing
Ally’s move from held-for-sale (HFS) to held-for-investment (HFI) helped boost its pretax profit to $6 million in the third quarter of 2021. The increase indicated positive growth in direct-to-consumer issuance which is on track to exceed $10 billion by the end of 2021. In Q3 2021, domestic applications were $3.6 billion (the highest level of origination ever recorded for the company – 64% growth (QoQ) and 78% growth (YoY)).
In addition, the transition to purchase from refinancing was possible thanks to the value proposition given to customers for investments. HFI assets in Q3 2021 increased from $11.2 billion to $16.0 billion (+42.86% YoY). True to form, Ally reduced its retail loan balance in the mortgage segment by 11.53% (year-over-year) despite gaining 2.83% from Q2 2021. retail mortgages indicated Ally’s willingness to work on the HFI-HFS business model mix.
From its $6.6 billion loan portfolio, Ally was able to lend $362 million with a 110% (year-over-year) increase in point-of-sale originations. This portfolio showed a 12% increase (year-over-year) in the establishment which employed nearly 3,000 merchants.
Ally leverages the point of sale as an unsecured lending facility to make large purchases for both merchants and fintech companies. The company intends to include low-income people in its portfolio as individuals emerge from the shackles of the pandemic.
How Businesses Are Adopting the POS Financing Option
The pandemic has forced banks to waive certain fees such as overdraft fees after their related revenue fell by 26% (year-on-year). Only banks Ally and Capital One have promised to eliminate overdraft fees in 2021. Meta Platforms (FB) has introduced Novi digital wallet which enables peer-to-peer payment. Facebook or Meta plans to launch the Paxos Dollar to replace the digital crypto Diem likely in 2022 as the social media giant continues to push for better crypto trading.
Apple (AAPL) in conjunction with Goldman Sachs (GS) has also introduced its point-of-sale line of credit – Apple Card to take on the buy now/pay later market dominated by fintechs such as Klarna (KLAR), Affirm (AFRM ), and Afterpay Limited (OTCPK: AFTPF). One thing I noticed with Afterpay is that its revenue jumped 101.7% to $626.9 million in September 2021 compared to June 2020 after introducing this POS model.
Amazon (AMZN) for its part threatened to suspend Visa (V) credit card payments on January 19, 2022 in the United Kingdom due to high payment costs. The e-commerce giant has struck a deal with Affirm to offer buy now/pay later services to help consumers access credit. For users with non-bank payments, Amazon has integrated Venmo as a payment option. It remains to be seen whether AMZN will keep its word and remove Visa from the UK.
Conclusion
Ally Financial Inc. leads the pack in offering point-of-sale loan facilities, mortgages, and digital investment options. It maintained an annual retail return of 7% for the fourth consecutive year and still managed to increase the value of used cars for its dealers. Another addition that advances the scalability of the business is the option to acquire credit company Fair Square. Since its inception in 2016, Fair Square’s loan balance has grown at a CAGR of 74%. We expect growth in fiscal year 2022-23. Ally’s adoption and expansion of the point-of-sale financing system has been adopted by major e-commerce companies like Amazon and Apple. For these reasons, we maintain a bullish position with the stock.
