XLY - Ally Financial: Buy Ahead Of Warren Buffett

2023-03-21 09:59:20 ET

Summary

• Berkshire Hathaway CEO Warren Buffett is reportedly in talks about investing in regional banks, reviving shattered buying sentiments.
• Berkshire is Ally Financial Inc.'s second-largest shareholder. A research firm speculated that Ally Financial could be a takeover target by Buffett.
• Given its recent battering, we delve into why Ally is poised for a potential reversal, with or without Warren Buffett's investment. Investors should consider this promising opportunity.
• We cautioned investors to be fearful in February, as greedy investors rushed into ALLY after its previous earnings release.
• However, we discuss why it's appropriate for investors to consider being greedy now and buy into the malaise.

Ally Financial Inc. ( ALLY ) has not been spared from the recent furor over the banking sector, as investors fret over whether a broader financial contagion could be stymied.

JPMorgan Chase & Co. ( JPM ) CEO Jamie Dimon upped the ante of further intervention in First Republic Bank ( FRC ), which includes a potential capital infusion into the troubled private banking-focused bank.

It came just a few days from the short-term $30B deposit infusion led by Treasury Secretary Janet Yellen. The Fed, the U.S. government, and the leading Wall Street banks united to prevent a deeper contagion.

However, it remains to be seen whether the efforts are adequate to stem the worrying outflow of uninsured deposits from the regional banks, giving them time to rebuild their deposit base to prevent insolvency risks.

The FDIC is working hard and trying to be ahead of the curve this time. Accordingly, the FDIC was reportedly discussing " temporarily expanding FDIC coverage to all deposits," stemming the carnage from a significant loss of depositors' confidence.

Following the unprecedented social media bank run of Silicon Valley Bank ("SVB") of SVB Financial Group ( SIVB ), we believe "desperate times call for desperate measures."

The fallout over a global systemically important bank or G-SIB such as Credit Suisse Group AG ( CS ) demonstrated how quickly the depositors' confidence could unravel in the social media age. As such, " when things move fast , liquidity and solvency become hard to tell apart," leading to a "self-fulfilling prophecy."

Ally was in the news recently, as it was speculated that Berkshire Hathaway Inc. ( BRK.A , BRK.B ) CEO Warren Buffett could be interested in a takeover of Ally Financial. Gordon Haskett Research indicated that " if Buffett were to do a deal in the banking sector he would likely stick to a name that he already owns."

Bloomberg reported over the weekend that Buffett was in touch with the Biden Administration over the banking crisis, including a potential investment in the regional banks.

Moreover, " large numbers of planes have been observed flying from regional bank HQs to Omaha," fueling bets that Buffett could make his move soon.

Buffett is the second-largest investor in Ally Financial, holding a 9.9% stake as of 31 December 2022. Despite that, ALLY accounted for just 0.2% of Berkshire's holdings.

We believe it's still too early to tell whether Buffett would consider adding to his stake in ALLY or a takeover. However, we discuss why Ally Financial Inc. remains a viable proposition to survive the fallout amid the banking crisis at the appropriate valuation.

Investors following the news should be keenly aware that SVB and Signature Bank (SBNY) were infamously brought down by fleeing depositors worried about their uninsured deposits.

However, Ally has a highly stable deposit base at the end of 2022. In addition, the company highlighted that 80% of its deposits are retail-focused, providing Ally Bank with " stable, low-cost funding."

Moreover, the company reported a 7.6% YoY increase in total deposits in FY22. Hence, it didn't experience the outflows of deposits seen in SVB and SBNY, as depositors sought higher yields.

Furthermore, retail depositors had good reason to increase their holdings with Ally Bank, as it paid out an average deposit rate of 1.39% in FY22. Notably, Ally Financial's uninsured deposits accounted for just $15.2B of its total deposits of $152.3B, or about 10% of total deposits.

Hence, we believe the company is likely not facing any imminent threat of a liquidity crisis that could lead to insolvency that it could not resolve expeditiously.

Notwithstanding, it has a pretty sizeable portfolio of available-for-sale or AFS and held-to-maturity, or HTM, securities worth about $35.9B, or 19% of its total assets. Combined unrealized losses on the AFS and HTM portfolio amounted to about $5.5B.

However, with Ally not likely saving an impending liquidity crisis, we don't think the company will be under significant pressure to realize those losses. As such, Ally's solvency shouldn't be under threat in the near term.

Despite that, the Fed's rate hikes have caused increasing concern to management, given their largely fixed-rate consumer automotive and mortgage portfolio.

Management highlighted in its 10-K that:

The Federal Reserve increased the federal funds target range to 4.25-4.50% in 2022 to address elevated inflation levels, and further increases are expected in 2023. Liability sensitivity remains a concern, and increasing interest rates are expected to have a negative impact on net interest income in the near term. ( Ally 10-K ).

As such, we believe investors will need to watch the developments closely, with the Fed Chair scheduled to speak on March 22 at the conclusion of the two-day FOMC meeting.

Notwithstanding, the used car market has been showing signs of life lately, continuing its recovery from February. The Manheim Used Vehicle Value Index " increased 1.8% from February in the first 15 days of March."

As such, we believe that Ally Financial Inc. could have bottomed in late December, similar to our observation in the economically-sensitive Consumer Discretionary ( XLY ) sector.

However, the recent risk-off move to batter ALLY back toward its December lows is justified given the higher risks of a recession due to potential higher funding costs and tighter lending standards.

Notwithstanding, given the hammering over the past few weeks, is an entry point possible for investors waiting to add?

In our previous article in early February, we cautioned investors to "be fearful when others are greedy."

ALLY formed its top soon after before dropping nearly 40% toward last week's lows and could potentially form a bullish reversal this week (still pending validation).

If validated (reminder: it's not validated yet), it could form a robust bullish reversal predicated against a bear trap or false downside breakdown.

With its valuation (NTM adjusted P/E: 6.2x) dropping well below its 10Y average of 8.6x, we parsed that the reward/risk proposition of buying the panic selloff is reasonable.

However, given the recent volatility, investors should consider a validated bullish reversal before adding new/more positions. Aggressive investors could consider "front-running" the market, but they also need to be aware of the risks.

Rating: Buy (Revised from Hold).

Note: Investors are reminded to do their own due diligence and not rely on the information provided as financial advice.

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