Fitch Affirms Ally Financial at 'BB+'; Outlook Remains Positive.
Today's rating actions have been taken as part of Fitch's periodic peer review of U.S. consumer finance companies, which comprises four publicly rated firms.
KEY RATING DRIVERS - IDRs, VRs, AND SENIOR DEBT
The rating affirmation reflects Ally's strong franchise, leading market position in the U.S. auto finance industry, solid credit quality, diverse funding base, ample liquidity, adequate risk-adjusted capitalization and seasoned management team. Primary rating constraints include weaker profitability and higher usage of wholesale funding sources relative to more highly rated bank peers. Additional rating constraints include Ally's concentrated and cyclical business model and higher pricing sensitivity on internet-sourced deposits during a sustained period of rising interest rates.
The Positive Rating Outlook reflects Fitch's expectations for a continued funding mix shift toward retail deposits relative to less stable and higher cost funding sources, improved loan yields as the company repositions its retail auto portfolio toward more used vehicles and non-subvented channels, manageable increases in deposit pricing relative to Fed interest rate hikes, stable credit performance as higher loss vintages amortize, and continued measured expansion of Ally's non-auto business segments over the medium term. Fitch also views Ally's moderate asset growth favorably given heightened competition in the auto finance sector.
While Ally experienced an improvement in net income and EPS growth over the past year, this was primarily driven by a lower tax rate stemming from corporate tax reform legislation passed in December 2017 and a reduced share count from an increase in share repurchase activity. On a pre-tax basis, core ROA has remained fairly stable over the past few years at roughly 1%. However, risk-adjusted yields in its retail auto segment have gradually improved as pricing has increased on new loans and credit losses have stabilized. Funding cost improvement will be a key input into future profitability as Ally has over $5.9 billion of unsecured debt maturities through 2020 that have a weighted average coupon significantly above the company's current cost of retail deposits. Fitch expects the company will continue to refinance a significant portion of its unsecured maturities with retail deposits. However, rising interest rates and recent competitive intensity for online deposits in particular, may cause the funding cost differential between Ally's unsecured debt and retail deposits to narrow.
Consumer auto originations in 1H18 grew roughly 9% from the same period a year ago, as the company expanded into new dealership channels, while continuing to originate more loans for used vehicles. Loan originations for used vehicles increased to 51% of Ally's retail auto origination mix in 2Q18, compared to 47% in 2Q17 and 43% in 2Q16. Management believes that used vehicle financings provide the best risk-adjusted returns in the current environment. While the credit scores of borrowers on used vehicles are typically lower than those of new vehicle borrowers, Fitch believes the higher risk is potentially mitigated by lower loss severities and higher yields given a slightly less competitive environment in the used vehicle market relative to new vehicles.
With a meaningful shift in Ally's loan origination mix occurring over a relatively short period of time, the underlying credit performance of more recent vintages remains an important driver of Ally's ratings. Credit losses on Ally's 2015 and 2016 loan vintages, while weaker than previous years, have been within a reasonable range thus far. Further, while the portfolio mix shift has yielded higher credit losses, Fitch views the reduction in Ally's lease exposure favorably given Fitch's expectations for further softness in used vehicle prices.
In June 2018, Fiat Chrysler Automobiles N.V. (FCA) announced plans to establish or acquire a captive finance company by 2022. Ally derived 27% of its retail auto originations and 30% of its commercial wholesale volume from Chrysler dealers in 1H18. Although it is unclear at this stage what implications the establishment of a captive by FCA would have on Ally's competitive positioning in the Chrysler dealer channel longer term, Fitch believes it is unlikely to be financially impactful to Ally's business over the Outlook horizon.
Ally's credit performance has stabilized over the past year with retail auto net charge-offs of 1.3% in 1H18, which compared favorably to 1.4% in 1H17, and is thus far below management's full year expectation of 1.4%-1.6%, which it now anticipates will be at the lower end of the range. Ally's retail auto 30+ day delinquencies increased to 2.78% of loans at 2Q18; up 7 bps from the year-ago period. The increase in delinquency rate is partly attributable to the shift in loan mix toward used vehicles, which are expected to result in higher loss frequency but lower severities. Reserve coverage is near the mid-point of the current retail auto charge-off expectation of 1.4%-1.6% for consumer auto loans and 1.5x annualized net charge-offs at June 30, 2018. Fitch believes Ally's improved credit performance has been aided to a large degree by underwriting adjustments made by the company, continued contraction of the higher loss 2015/2016 vintages in relation to the overall portfolio, as well as positive macroeconomic factors including a stabilization in used vehicle prices.
In addition to the stabilization in Ally's credit performance, the company has experienced further declines in lease residual exposure. Ally's net auto lease portfolio has more than halved from $19.5 billion at the end of 2014 to $8.6 billion at the end of 2Q18, although the lease portfolio is expected to stabilize around current levels. Fitch views the reduction in Ally's lease residual exposure favorably given the expectation for further declines in used vehicle prices over the next couple of years despite recent stabilization.
Ally has a diverse mix of funding sources. At June 30, 2018, deposits represented 64% of Ally's total funding, with secured debt accounting for 25% and unsecured debt accounting for 11%. Short-term wholesale funding, including $3.5 billion of unsecured demand notes, represented only 5% of Ally's total funding at June 30, 2018. Ally is targeting for deposits to represent 70%-75% of funding over the medium term. Ally's deposit growth over the past couple of years through a Fed tightening cycle has been stronger than expectations, although the competitive environment for online deposits has become more intense recently, which coupled with competition from higher yielding fixed income and equity products may have, in part, contributed to a flattening of Ally's sequential deposit growth in 2Q18.
Although Ally's deposit beta on a cumulative basis remains within the company's 30%-50% medium-term expectations, we have yet to see a meaningful repricing of brick and mortar banks' retail deposits and have also begun to see digital bank carve-outs by some of the largest U.S. banks, which could further fuel competitive intensity for retail deposits. Stronger competitive responses from traditional banks in terms of offered deposit rates, over a full interest rate and economic cycle, also need to be observed before the durability of Ally's internet deposits can be fully assessed. Nonetheless, Fitch views Ally's diverse funding strategy favorably as it reduces funding concentration risk and provides more flexibility in the event that wholesale funding sources (securitization and public debt markets) dry up or become cost prohibitive, or if the online deposit platform experiences material outflows in a rising interest rate environment.
Ally maintains adequate liquidity with $16.8 billion of total consolidated liquidity (excluding $2.9 billion of undrawn credit facilities) at the end of 2Q18. This compared to unsecured debt maturities of $2.8 billion over the next 12 months. Fitch views unused credit line capacity as an additional liquidity source, but potentially less reliable than cash or high-quality liquid assets, given that it generally requires eligible assets to collateralize incremental funding. However, Ally's loan portfolio is mostly unencumbered reflecting the company's high mix of deposit and unsecured funding, suggesting a higher likelihood the credit facilities could be drawn upon during periods of stress.
Ally remains well capitalized, as reflected by Basel III Transitional Tier I capital and Tier I common ratios of 11.1% and 9.4%, respectively, as of June 30, 2018. The company estimates that the fully phased-in Basel III Tier I common ratio was 9.4% at June 30, 2018, roughly flat with the year ago period. Fitch views the company's capital position as adequate given the risk profile of its balance sheet.
On June 28, 2018, Ally received a non-objection on its capital plan from the Fed as part of the Comprehensive Capital Analysis and Review (CCAR) process. This resulted in Ally increasing its quarterly cash dividend to $0.15 per share from $0.13 per share and authorizing a share repurchase program of up to $1 billion of common stock over the four quarters ended June 30, 2019, a 32% increase from the previous authorization of $760 million. Although this level of shareholder payout relative to net income is consistent with other large banks, Fitch expects this will result in fairly stable regulatory capital ratios for the company over the near term, given expectations for modest asset growth and an improving earnings trajectory.
SUBORDINATED DEBT AND OTHER HYBRID SECURITIES
Ally's subordinated debt rating is one notch below Ally's Viability Rating (VR) of 'bb+' in accordance with Fitch's assessment of each instrument's respective non-performance and relative loss severity risk profile. The subordinated note rating includes one notch for loss severity given the subordination of these securities in the capital structure, and zero notches for non-performance given contractual limitations on interest payment deferrals and no mandatory trigger events which could adversely impact performance.
The rating assigned to the trust preferred securities, series 2 issued out of GMAC Capital Trust I is 'b+', three notches below Ally's VR. The rating reflects the subordination of the securities and Ally's option to defer coupon payments, and is in accordance with Fitch's assessment of each instrument's respective non-performance and relative loss severity risk profile.
SUPPORT RATING AND SUPPORT RATING FLOOR
Ally has a Support Rating of '5' and Support Rating Floor of 'NF'. In Fitch's view, Ally is not systemically important, and therefore the probability of sovereign support is unlikely. Ally's IDRs and VRs do not incorporate any support.
Ally's ratings could be upgraded if retail deposit growth continues on a positive trajectory that is consistent with management's medium-term target for deposits representing 70%-75% of overall funding and credit performance on its more recent loan vintages remains stable. A ratings upgrade will also be contingent upon Ally's ability to retain online deposit customers in a cost-effective manner in a rising rate environment, which will be a key consideration in evaluating the strength of its funding profile relative to traditional bank models.
A revision of the Outlook back to Stable from Positive could occur if Ally's deposit growth stalls or if its deposit pricing rises to a level at which it negatively impacts the company's margins and profitability. More meaningful negative ratings actions could be driven by a reversion in profitability, meaningful deterioration in asset quality relative to peers, a sharp reduction in capital and liquidity levels, an inability to access the capital markets for funding on reasonable terms, and/or the issuance of potential new and more onerous regulations that negatively impact Ally's business model.
With respect to Ally's asset quality, Fitch remains focused on the credit performance of the company's consumer auto portfolio following the shift toward alternate origination channels, such as used vehicle loan originations, and away from GM lease subvention during a period when the competitive environment has been intense. Although Ally's exposure to residual value risk has declined sharply with the reduction in subvented lease volume, to the extent that a higher risk profile for Ally's auto loan portfolio is not counterbalanced by higher yields and/or lower residual exposure, Ally's ratings or Outlook could be pressured.
Similarly, Ally's rollout of new product initiatives such as residential mortgages, credit card, and retail brokerage, while viewed as a positive ratings driver from a revenue diversification aspect, also create other risks including increased reliance on third-party execution and reputational risk that could result in ratings and Outlook pressure over time.
SUBORDINATED DEBT AND OTHER HYBRID SECURITIES
The subordinated debt ratings are directly linked to Ally's VR and would be expected to move in tandem with any changes in the VR.
The preferred stock ratings are directly linked to Ally's VR and would be expected to move in tandem with any changes in Ally's credit profile.
SUPPORT RATING AND SUPPORT RATING FLOOR
Since Ally's Support and Support Rating Floors are '5' and 'NF', respectively, there is limited likelihood that these ratings will change over the foreseeable future.
Fitch has affirmed the following ratings:
Ally Financial Inc.
--Long-term IDR at 'BB+';
--Senior unsecured debt at 'BB+';
--Viability Rating at 'bb+';
--Subordinated debt at 'BB';
--Short-term IDR at 'B';
--Short-term debt at 'B';
--Support rating at '5';
--Support Floor at 'NF'.
GMAC Capital Trust I
--Trust preferred securities, series 2 at 'B+'.
The Rating Outlook is Positive.
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|Publication:||Daily the Pak Banker (Lahore, Pakistan)|
|Date:||Dec 4, 2018|
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