Why Shrinking Auto Inventories Are No Problem for Ally Bank

The coronavirus pandemic and related shutdowns have had far-reaching impacts. Not only has it affected us on a personal level, but businesses have seen disruptions in their supply chains — throwing off manufacturing and production processes. One area that has felt the effects from disruptions is the auto industry.

Vehicle inventory levels have hit record lows. Issues with semiconductor chips, trucking shortages, and other problems have affected auto production levels. This shrinking supply of new vehicles coincides with demand for vehicles ramping up as we emerge from the pandemic. As a result, used car values have been on the rise.

Falling inventories are generally bad for a bank like Ally Financial (NYSE:ALLY), a leading provider of automotive loans and other consumer loans. However, the bank performed quite well in the first quarter this year, helped by rising used car values. Strong demand pushed originations in its auto finance segment to the highest level in nearly five years, leading to strong revenue growth in the first quarter.

Keys sit on top of auto loan application.

Image source: Getty Images.

Record quarter and strong auto lending demand

Ally posted a strong first quarter, with net financing revenue of $1.4 billion in the quarter, up 20% from the prior year and up 5.3% from the prior quarter. This helped the bank post earnings per share of $2.11, up from a loss of $0.85 last year and up 16% from the prior quarter.

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Improving economic conditions allowed Ally to reduce its provision for credit losses. Last year, it built up $903 million in loss reserves as it braced for the pandemic. The bank released reserves in the first quarter, and this provision gave it a $13 million benefit on its income statement.

More importantly, the bank was boosted by strong demand for vehicles during the quarter. Application volume was the highest in the history of the bank. Its auto finance segment saw consumer originations up $1.1 billion to $10.2 billion — the highest level in five years and the highest first quarter in nearly a decade. The bank also saw yields on auto loans increase 24 basis points, to 7.2%.

High demand plus production issues will boost used auto values

Demand for vehicles was robust. However, Ally’s management noted that inventory levels in the auto industry have reached multi-decade lows, due to strong sales trends and production issues.

CFO Jenn LaClair noted that while pandemic-related shutdowns of factories were the first disruption, other disruptions like semiconductor chip shortages, trucking shortages, and extreme weather events in Texas have thrown off supply chains and production. While production is improving, it will still take some time to normalize.

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As a result, used vehicle values have steadily risen. According to Manheim Consulting, wholesale prices on used vehicles increased 6.8% in the first two weeks of April compared to the month of March. This brought the Manheim Used Vehicle Value Index — a measurement of used vehicle prices — to 191.4, a 52.2% increase from April of last year and the highest reading ever.

Chart shows increase in Manheim Used vehicle Value Index.

Image source: Manheim Consulting.

Strong car values, decreasing funding costs, and deployment of excess liquidity all boosted Ally Financial in the first quarter. Its auto finance segment posted a net income of $803 million, up from $563 million in the prior quarter.

The current inventory crunch is a “win-win” according to LaClair. That’s because lower inventory levels will be offset by higher-priced used vehicles, and the company generates 50% of its originations from these products. As inventory levels pick up, the bank can then shift its focus on putting cash to work and growing its net interest income with new vehicle sales.

Growth in other consumer lending segments, too

Ally Financial has been working toward being more than an auto lender. Eighty-five percent of its net income comes from its auto segment, but the bank has been diversifying its revenue sources. Growth in mortgage, investment, and point-of-sale products in recent years has helped the bank grow retail balances for 48 consecutive quarters.

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Retail deposits were $128.4 billion at the end of the quarter, up 21% from the same quarter last year. The bank’s Ally Lending product generated another $211 million in volume, nearly a threefold increase from last year. Additionally, its mortgages segment saw its highest quarterly volume since the segment launched in 2016. In the next couple of years, the bank hopes to push mortgage originations to $10 billion.

Positioned for growth

Ally has done a good job of growing its product offerings for customers with its mortgage and investment products, while continuing to crush it in its auto lending segment.

Despite production issues, the increase in used car values has more than offset declining inventories. Consumer demand in the auto segment remains strong. As production normalizes, Ally will be positioned to put its capital to work, which could give the bank a boost in the second half of the year and into 2022.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

View more information: https://www.fool.com/investing/2021/04/28/why-shrinking-auto-inventories-are-no-problem-for/

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