Chit Chat Stocks - Ally Financial: A Share Cannibal With a Growing Deposit Base (Ticker: ALLY) with Jacob Franklin

Episode Date: September 29, 2022

Ally Financial offers various digital financial products and services to consumer, commercial, and corporate customers. The company operates through four segments: Automotive Finance Operations, Insurance Operations, Mortgage Finance Operations, and Corporate Finance Operations. Listen as Brett and Ryan ask Jacob questions about the company, its business model, and valuation. Enjoy the show! ***************************** This episode is sponsored by Quartr, the new way of doing company research. Access conference calls, presentations, transcripts, and more for FREE on your mobile device. Download Quartr on the App Store here: https://apps.apple.com/us/app/quartr-investor-relations/id1552412128 Download Quartr on the Google Play Store here: https://play.google.com/store/apps/details?id=se.quartr.android ***************************** This episode is sponsored by Stream by AlphaSense, the highest quality expert network library. Sign-up here and get a 14-day free trial:  https://streamrg.co/CCM ****************************** Access our “Not So Deep Dive” episodes by signing up for CCM+. Sign-up directly through Spotify or Apple Podcasts. If you listen on another podcast player, use this link and create a private RSS feed: https://anchor.fm/chitchatmoney/subscribe Need more information? Check-out our launch newsletter: https://chitchatmoney.substack.com/p/welcome-to-chit-chat-money-plus ****************************** Want updates on future shows and projects? Follow us on Twitter: https://twitter.com/chitchatmoney Interested to see more of Strat's work? Follow him on Seeking Alpha here: https://seekingalpha.com/author/jacob-franklin Contact us: [e-mail] Timestamps Ally Financial | (3:50) Auto Lending | (13:47) Bear Case | (30:04) Disclosure: Chit Chat Money hosts and guests are not financial advisors, and nothing they say on this show is formal advice or a recommendation. Brett Schafer and Ryan Henderson are general partners and portfolio managers at Arch Capital. Arch Capital and its partners may hold securities discussed on this show. Learn more about your ad choices. Visit megaphone.fm/adchoices

Today's episode is brought to you by our friends at Quarter. Quarter is an all-in-one investor relations app that provides frictionless access to conference calls, investor presentations, transcripts, and more, with Quarter investors can keep up to date with all their companies while on the move. I personally use it every earning season so that I can keep up with my portfolio companies while I'm on my commute to the office. They also just released a cool new feature that allows users to search across all transcripts. That means you can search and see how many companies mention terms like inflation or

cost pressure or recession or even metaverse, you name it. And the best part of all, the app's 100% free and it's on both iOS and Android. So go find it on your app store by searching quarter. That's Q-U-A-R-T-R, no E. That's quarter, Q-U-A-R-T-R. Welcome to Chit Chat Money. This is our Thursday deep dive episode where we have on an analyst to discuss a single stock in depth. And today we're talking about Ally Financial, which is a pretty, I guess we should say popular investing stock or popular financial stock in the investment community right now. It screens really cheap. A lot of value investors have taken a hold. There's been a lot of write-ups out there. And Jacob Franklin, I don't know why I had to say

his last name, has written up something on Seeking Alpha. He reached out. We read his piece. It was great. So we're like, hey, come on the show. And we talked to Ally Financial for what, about 45 minutes to 50 minutes there. Yeah. And to give a little tease, Berkshire Hathaway does own a sizable stake relative to allies market cap, not to Berkshire Hathaway. So that has, I think, sparked the interest from a lot of value investors. And so this gives a pretty thorough rundown of the business and not only the potential, but the potential downsides as well, and kind of the risks that Jacob's monitoring. Anything else that we should talk about before? Yeah, I think highlighting the downsides and stuff was great. I mean, people are worried about used car prices because they have a lot of exposure to the automotive market and the used car lending market, really. And we go through all of that. We go through how to value the company, why the buybacks and dividends have been so aggressive, and they should continue, but might not be as strong. When you look at it, you're like, wow, they are reducing share count by an insane amount right now.

And then lastly, I think what gets me excited about looking at Ally Financial is the best financials investor ever, Warren Buffett, is looking at the company and either him or his protégés have said, we want to own as much of this as possible. So I think that's an indicator that I want to learn more about this company. All right. Well, without further ado, here's your interview with Jacob Franklin. Welcome to Chit Chat Money. On this show, hosts Ryan Henderson and Brett Schaefer interview industry experts and riff

on the world of investing. As a quick reminder, Chit Chat Money is a CCM Media Group podcast. Ryan and Brett are also general partners at Arch Capital, and Arch Capital may have positions in the securities discussed in this podcast. Anything discussed on Chit Chat Money by Ryan or Brett or any other podcast guests is not formal advice or a recommendation. Now, please enjoy this episode. Welcome in. Today, we are joined by Jacob Franklin. He is a writer at Seeking Alpha

and an individual investor. And he's written about Ally Financial, which is a company that Brett and I have been interested in for a while. There are obviously some well-known investors that own the company, including Warren Buffett. So it definitely piqued our interest and uh, Jacob's done work on them before. So first of all, welcome to the show. Um, do you kind of want to talk about how you came across Ally Financial? Uh, and then maybe, I guess, talk a little bit about what it is. Uh, sure. Yeah. And first I just wanted to say, thanks for having me, uh, excited to talk about this and appreciate the chance to be on your show. Um, so I originally came across Ally, uh, kind of in my every day-to-day life.

Um, I work as a software engineer and it's a pretty highly recommended bank, uh, in the circles that I, you know, travel in as a software engineer. Um, when people are looking for new banks, it often gets recommended by current clients and I kind of in the Peter Lynch style, I thought, you know, these are the exact kind of clients a bank should want. So I thought it was really interesting from that perspective. And that's kind of how it originally got on my radar. And then, as you guys mentioned, eventually some other kind of high super investors got involved in it. And that kind of re triggered my interest in the name. Okay. And it is it's a financials company. So sometimes that

it's not always like the most intuitive in terms of how they generate revenue. So do you want to kind of talk about who they are, what they do and how they actually make money? Yeah, sure. So I think you kind of get this a lot when you talk about banks, like there's lots of, I guess, formulas or screeners people use. And they're like, I don't want any bank stocks in there because they don't play by the same rules. So kind of like banking 101, the way a bank makes money is uh it borrows money and then it lends it back out at a higher price uh now normally you think about this like a bank takes in customer deposits um so if you you know have you have an ally account uh you leave your money there uh and they pay an interest on that and then they lend it

out at a higher interest rate um so that's kind of the you know 101 of banking all right and i I mean, specifically, like what, I guess we'll move on to specifically what Ally does in some of their different segments. But what are some metrics that say, I know banking stocks can be a mystery to people. What are some metrics that you're following with Ally Financial and what are some that you specifically want to track? I know there's return on equity, but we're not looking at like a typical company, you know, with an operating business. So just for anyone that has no experience with banking stocks, maybe give an overview before we get specifically into Ally Financial. Yeah. So I think from a valuation perspective, like the two that most people look at are price to tangible book value, financial stocks, mark to market every quarter. So their book value tends to be more, especially their tangible book value, it tends to be a lot more useful than your non-financial stock.

and then the other is just the basic price to earnings generally does a pretty good job of capturing their normalized earnings uh the thing you have to be careful with there is uh they banks will add provisions for loan losses which basically means they gave out a loan and then they're expecting some percentage of those loans they won't be able to collect on and they just basically write that off when they originate the loan or when something bad happens. So like recently at the start of COVID, almost all banks, just immediately when COVID happened, Q2 2020, they wrote off a bunch of their loans with loss provisions. And that factors into the P2E. And the reason you need to be careful about it is because especially in 2021, Q2,

a year later a lot of banks realized like hey this wasn't as bad as we thought at 2020 q1 and they released a lot of those loss provisions um so basically that got factored back into their earnings even though like you know they wrote off the loans and then re-added them back to their books that's all non-cash um so that's kind of the thing that i would watch out for especially in the past few years with the covid that happened to almost every bank and let's keep going sorry yeah so those are kind of the two valuation ones um and then really important for banks is kind of their efficiency uh it's a very commoditized business you know your money isn't really worth more than anyone else's money obviously it's like the definition of a commodity

And so you want to be really careful with your expenses. There's a lot of ratios that bank investors will follow like the overhead ratio, which is your non-interest expenses divided by the total assets on your book, or the efficiency ratio, which is the non-interest expenses divided by the operating income. And those are both just basically meant to say how well the people you're paying, the real estate you're paying for, how well is that actually translating into real income? And I think that those are both really important for banks just because it's a mature industry, commoditized industry. And then the last one I want to mention is the net interest margin. So I talked about banking 101, you lend out at a certain rate and then you borrow

from other people at another rate. The net interest margin is just the difference between those two rates. So if you went out at 7% and you pay 2% on the deposits in your bank, your net interest margin is 5%. Right. You're just looking at the spread, I guess. Yeah, exactly. And you mentioned on some of those efficiency ratios, kind of how efficient are they with either the people they employ or the real estate they have for Ally specifically, there isn't a whole lot of real estate seen as it is an online bank. So can you talk a little bit about Ally specifically? What do they do? And then what are the various segments of its business? Yeah. So I'll start with like, there's two really important segments

and then there's a lot of other smaller segments. So I'm just going to spend a little bit more time on the two really important ones. The first one is kind of general auto lending. They're, I believe, the second biggest auto lender in the US and the largest prime auto lender. um so that means a few different things one it's like if you're buying a car uh and you need a loan of money to finance the car they do that uh if you're leasing a vehicle um where you're just gonna you know have a new vehicle for three years and pay make a lease payment and then return the vehicle uh they do that uh they finance that they also finance um like dealer floor plans so when car dealerships take inventory. They don't want to have to have all of that working capital in

their business. So they'll generally borrow in order to finance the cars that are held at the dealership. And Ally lends them the money to do that. And then finally, they also do some auto insurance, which is pretty atypical for a bank. But it kind of plays into their, I guess, market position in having all of the dealer relationships which we'll probably talk more about later so that's one side the other side is the consumer banking and specifically the thing that's really important to them into the thesis is their deposit base they have a very large deposit base they're the largest all digital bank by customer deposit um and so uh the the kind of selling point there is they don't pay for all these things like branch

locations or uh you know a bunch of like people at the branch locations to collect customer deposits instead they do everything through their uh you know the web and their app and because of that they're able to pay out a higher interest rate on their deposits and they have a lot of other kind of digital friendly features, like they'll refund you ATM fees and they don't charge overdraft fees. And I think those are the things that make Ally really popular with kind of the, you know, my friends, the developers that, you know, they don't really care about having a physical branch.

They just want a good deal on their savings account. Do you use Ally? I do not. So actually, we'll probably talk more about this later. But the big selling point of moving your stuff to Ally is the higher interest rate. And for the past two years, the Ally interest rate has been around like half a percentage, which is the lowest it's been since the bank, since they started the bank. um and so when you think about like what i use my money like what i use my bank for it's basically kind of like the working capital of my life like i don't keep a whole lot there other than what i need just kind of to like lubricate my life on a month-to-month basis and so like i actually did think about switching but it's like i kind of did the math it's like you know i'm gonna make fifty dollars a year or something like that versus my current bank um but when the interest rates go

up, it starts getting more interesting. And generally, people don't like switching their bank. But when you start the gap between the interest you're getting at your traditional bank, iBank, and Chase, and Ally goes up, I think it starts getting more tempting. And I've actually been thinking about it more now because their interest rate just went up to 2% pretty recently. This episode is brought to you by Stream by AlphaSats. Stream is an expert interview transcript library with more than 10,000 interviews spanning across all industries, including tech, media, consumer goods, and plenty more. Not to mention 70% of these experts can be found only exclusively on stream. Thanks to many of the interviews that I've read on stream,

I feel like I've gained a much more intimate understanding of the companies that I cover. And at this point, it has become an integral piece of my research process. So if you want to check out some of their transcripts for yourself, you can go to streamrg.co slash CCM and sign up for a free 14-day trial using the promo code CCM. Again, that's streamrg.co slash CCM, S-T-R-E-A-M-R-G.co slash CCM. All right. Yeah, that is interesting. I want to talk about deposit growth, but one more follow-up on what they do. The automotive lending part, I know that is a vital part of this business. How are they funding that? Is it with the deposits now? Because I know the deposits have really grown the last decade. Or is it another source? I don't

know. Are they getting that finance from somewhere else and just earning a spread? How does that work? Yeah. So originally, they were just borrowing money from other people and earning a spread. And the improvement they've really seen over the last decade is replacing their funding stack from secured and unsecured loans with this deposit base. They do still have some loans. I think they're like about 90% deposit funded now. So that's the majority of their funding at this point. Gotcha. That does sound like an advantage and why they've gotten more profitable. But let's talk about the retail deposit growth. You mentioned the basics of why people are going there, but maybe could you give some numbers around that? And why has it

been so consistent the last decade why are they you know i don't know i i guess you'll have the numbers and do you think this can continue are is there even you know an opportunity to continue this growth um and then we'll have a follow-up we'll talk about the the stagnation that has happened this year as well yeah so i so i actually kind of break it into two parts um and if you just look at the raw numbers you can kind of see like continuous deposit growth from uh like you know 2012 all the way to the beginning of this year 2022 like they've grown deposits a lot but actually probably the more impressive section was 2012 to 2019 they grew their market share of the overall deposit base in the us uh really rapidly they almost doubled it they had 44 basis

points of the overall deposit market in 2012 and in 2019 they had 83 basis points of the overall market. But actually, from the beginning of 2020 until today, they've lost market share. They've gone from about 83 basis points back down to 71 basis points. This was kind of masked by the fact that overall deposits in the US exploded when COVID happened. Basically, people got a lot of money in stimulus and didn't have stuff to spend it on. And a lot of it just went into their bank account. And so if you look at a growth of deposits at all US banks over time, it's generally very slow moving. But right around 2020, Q2, Q3, there is a big increase in that. And we're starting to see some deflation in the first half of this year back towards a more normalized level.

but yeah so i think that kind of like masked the fact that they were actually losing deposit growth during covid um so yeah and there's kind of like two theories i have on like why they started losing market share one is what i just talked about with the interest rates they were paying i don't remember exactly what off the top of my head but like one point something percent on interest rates in 2019. And then COVID happened, they slashed their deposit rates to the lowest it's been, like 0.5%. And I just don't think the incentive is as strong to switch. Because basically, for the whole 10-year period, banks like Chase never paid any interest, or they paid like 0.001%, effectively zero. So that's who they're competing against. And the motivation

to switch went down a lot um the other i think kind of theory is that ally was one of like the really early movers in like a digital first banking um so in the early years they had a lot less competition from you know other kind of digital first banks um over the past year to three years like that's really exploded there's been a lot of other competitors both from traditional banks opening digital first banks and kind of like fintechs that are positioning themselves as like neobanks okay it makes sense um i have kind of a question on uh we didn't jot this one down for you but the uh it makes sense on its advantages over legacy banks so it you know it doesn't have the real estate and it doesn't have to it doesn't require as much labor does it have

Are there any disadvantages to banking with Ally as opposed or even maybe other predominantly online ones as opposed to one that has a physical footprint? I mean, I think for a lot of older people like that aren't digital first, like good luck convincing my dad that he should be in a digital bank and the apartment check, the one apartment check you got to send over there. that's that's the big advantage when you can go to the bank of america office right there when they only allow you to do a whatever uh cashier's check but sorry continue yeah or like i mean i bought my i bought a house a number of years ago and like when i did that i went into a physical chase location and they helped me with stuff so like that was great but that was i think the only time that i really used a physical chase location the last six years um i will say like this isn't necessarily a physical banking thing but this is more like a mega bank like chase bank of america

kind of a lot more of them have they have a lot more um i don't know the right word for this is kind of like services that you may not always need but you uh you might need like they i think have a much better ability to get like wiring from international accounts into them than something like ally um but i think for a lot of people that's not super important it's just like you know they they kind of do everything so they're going to be able to help you out with anything where allies bank is kind of like a smaller consumer you know footprint of what they do okay and i guess going back to the growth before we move on to some of the other parts of allies business any other questions we have is part of the thesis that say for digitally native people

maybe the maximum age, say like 35, that will continue to the maximum age on say digitally native people will grow over the next few decades. And that will give Ally a nice little tailwind where them and then the other neobanks will see deposit growth for the people that don't feel that tie to the physical locations or the old style banks with all the ATMs everywhere and all the classic services they had. Yeah, I think that's part of it. If you look at allies investor presentations they give breakdowns of like their the generations of the people opening their deposit deposit accounts and it's very shaded towards millennial and younger generations interesting um so like that's definitely part of the thesis um i would also

say that like i mean i think that like you know bank of america and chase they have really good banking product like like mobile first online banking products but when you go to some of like the smaller players like regional players a lot of them are still trying to get their act together when it comes to like digital first banking and and they are kind of going to be in this tough position where they have to fund both the like physical locations and they're gonna have to fund the technology to make that work for them like chase can amortize the technology expenses over so many customers that it's not as material to them but if you're a smaller you know community regional bank or credit union i think that's going to be tougher for you as it becomes more

of an expectation yeah i mean speaking of that we've discussed that ourselves we're with one of those um smaller banks that you mentioned and we've been a bit disappointed with their right right with some of their mobile products and some of how clunky it is and we're like where should we switch and i think what do we say maybe ally huh and we're like i hear they have high interest rates i think that i think the anecdotes but we haven't switched yet that's that's the big thing there's a lot of there's a lot of switching costs which you can you can weigh that as a positive or a negative like you can say well maybe the tailwind's still there but also some of the legacy banks are you know there's a ton of friction to switching your financial institution

yeah i mean go ahead go for it oh yeah i mean i don't necessarily think like i don't think the story is like they're going to take over the world and they're going to displace like chase as you know the king of deposits but like i think it's more like they can just steadily slowly increase their market share of deposits uh along with the fact that they've um been you know they're basically fully deposit funded now like they've already made that journey and so i think if they can just keep collecting and slowly increasing their market share i think it's going to be a lot more of a slow thing like if you think about i don't know if you guys have ever like looked at progressive um but they have this competitive advantage over other insurers where they don't

like have the the offices that people have to go talk to and so they can offer more competitive rates as compared to something like a state farm or like a more traditional insurer and like that switch from like the more traditional model to like the um you know not having a local office like that's taken a hundred years you know it's not it's not a quick thing it's kind of a relationship and people don't like change. Right. Makes sense. How do you think interest rates will affect ally? And then what are your thoughts on what happens to this business if credit conditions deteriorate? Yeah. So on the interest rates I mean, I think we just talked about it, but like the people who are using ally as depositors care a lot about the interest rate.

that's like why they're with Ally. So I think that they have a very interest rate sensitive deposit base. Like if, if there's better interest rates out there, substantially better ones, the people who bank with them may leave. So as interest rates go up, they're going to have to keep raising their interest rates. I think, you know, Chase probably doesn't because that's not what their, their clients care about. And the other half of that is like, while the interest rates go up on their deposits, the interest rates on their auto loans are also going up. The problem is that the auto loans generally have a maturity of about six years of origination. So if interest rates go up really fast, like they are now, you're going to see compression

of the net interest margin because they're going to have to re-rate their deposits faster than they re-rate their loans. It's a little bit better than the six years because generally people tend to pay off their car loans a little bit early and if you go look at their kind of stack of car loans usually it's very weighted towards the like you know three most recent years uh but that's still time to have those deposits flow off your books all right and okay we talked about automotive right you mentioned a bit they have big exposure to that market anything else you want to mention with the automotive stuff i know people talk about a little bit doom and gloom with that um you know

deteriorating credit conditions with you know people paying back those loans although i know you wrote about um how people pay off their loans i think the quote was from an ally executive right people pay off their car loan before their house loan um and they also might have exposure to carvana and there's also the the used car prices that have soared how could you know that affect allies business any risks there that people should be worried about yeah i think there's a few things to unpack there one is just general like credit risk um bank stocks generally aren't where you want to be when there's a recession like it's pretty well studied they underperform the market when there's a recession a lot of people think we're in a recession or on the verge of a recession

So that's one thing. I think that one of the things that I like is after the great financial crisis, there got to be a lot more regulation around ensuring the capital adequacy of banks. So they actually run a federal stress test on every large major bank, which includes Ally every year, and they basically mock out what would happen if there was a severe three-year recession. and they're going to lose a lot of money if that happens, but they're going to be solvent and not need to raise additional capital. So I think that one, if we're actually going into a major recession right now, you probably shouldn't really be buying any stock, but Ally's not going to do well. I'm not trying to time that sort of thing, but I want the stocks I buy to be able to at least survive the recession, and I feel like Ally is in that category. was it your other question was kind of about like the used car prices yeah used car prices

people mention i don't know the exact details about the exposure to carvana but maybe those two combinations about how that could be a risk specifically for ally compared to other banks yeah so i think the the really big bear case here is ally does a lot of used car landing um since 2019 used car prices are up like 60 percent um and so the the really worst case scenario for ally is used car prices fall off a fall off a cliff they go back to where they were in 2019 and at the same time customers can't pay for their auto loans so uh you know these are collateralized loans ally gets the car back and generally how they you know uh make up for their loss of the loan is they resell the car. Well, if you're repossessing a bunch of

cars that are worth 50% less than when you loaned out against them, that's going to be really bad. And if you listen to the CEO talk, they claim that they're underwriting these loans with the expectation that the car prices will come down substantially. But that's just, as an investor, you're kind of putting some trust in the ceo there it's kind of hard to actually say they give you some details on underwriting standards but it's it's hard to know what the size of their book um so i think that's the ultimate like kind of bear case on used car prices coming down in terms of like carvana exposure i guess it's not something i'm terribly worried about it's that like i know they have exposure to carvana there they have a big partnership there but

they have such a large loan book that i don't think the carvana exposure is like a material part of um their loans and i mean once once carvana gives the loan to the customer and sells the car it's really like any other used car so i would think they're underwriting those cars with the same standards they are any other dealership relationship they have and i actually kind of like that you know i mean i don't have a big take on carvana but like i like that they're going out there and partnering with kind of, you know, potential disruptors. If you're listening to this ad right now, we know you're already a listener to our show, but for our avid listeners, we've also started a paid membership service called Chitchat Money Plus that extends beyond

just our podcast. Every Tuesday, subscribers get access to one not-so-deep-dive research episode that covers everything you need to know about a company. You also get an email newsletter with our written show notes, important charts, a transcript of each show, and access to our Chit Chat Money research files. Chit Chat Money Plus costs $5 a month. You can subscribe directly through Spotify or Apple Podcasts, or if you listen on another platform, click the link in the show notes to go through the simple steps of signing up. If you're a regular listener to the show, we think the membership will provide tons of additional value. On top of the stock research episodes, members will get one Arch Capital Fund episode a month where we outline why we bought,

sold, or continue to hold a stock in the Arch Capital Investment Fund, along with shows on our broader investment strategy. Sign up and become a Chit Chat Money Plus subscriber today. We can't wait for you to join our community. No, it totally makes sense. And Carvana can feed that demand a little bit. If you know Carvana, I know people are pretty bearish on the company right now, but if they survive or they stick around, it doesn't matter if Carvana stocked as well, if they're still getting tons of demand for used cars, I mean, they can benefit Adelaide. But sorry, Ryan, did you have anything? So on that, I guess, worst case scenario that you mentioned where uh used car prices decline and they end up repossessing a lot of uh the cars

they lent on how would you first of all does that concern you and then how would you know that that is happening like how would you know okay this is a big problem maybe this is potentially uh detrimental to my thesis yeah i mean so i think am i worried about it happening uh yeah i don't think the likelihood of that happening is very high um like if you go back to the great financial crisis the the asset that was in a bubble houses you know they they went down a lot in general across the u.s but like i think it was only like 20 percent peak to trough um and that was like a a huge speculative bubble i i just don't think cars are in that kind of speculative bubble right now like i think the people who are getting car loans are they need the cars to get to work they're

not you know they're not buying the car hoping it appreciates and they can resell it right um and then what was the second part of your question just how would how would you know if if those if that yeah what they are like what metrics should people track if they're interested in ally you know to make sure either this is not happening or is happening i assume ally doesn't report repossessed cars every quarter so they actually do so they report they report a few different things which are like they report their 30-day and 90-day delinquency on loans which is usually a leading and then they also report their net charge-offs which is basically like loans that they've they don't think they're getting back um and that is kind of they report it as a percentage

of their overall book um right now it's at like i mean since the start of the pandemic those net charge f numbers have been at historic lows um and i mean partially because uh people a lot of money and partially because they can offset like when ally goes and repossesses a car they resell it on the used market and for a while they were actually like making money on that so like when people defaulted on their loans, they were reselling the cars and making money on the resale of the car. That's kind of come back down a little bit, but their net charge off rate is still really low right now. Okay. It makes sense. I guess moving to maybe some of the other parts of the business, what do you think about the growth of maybe the multi-product customers? I know there's

a lot of- Investing product, you know, the ads. Yeah. You mentioned in at least one of your articles that i read that they they've got a few different features on there um how does that help how does that benefit the the ally and then how do you think they can what's it going to take for them to steal share from some of the legacy players yeah i i think that if you listen to them it's what they're trying to do is they want to move from just like a place where people put their deposits to a more fully featured relationship with the customer because that increases the switching costs. Once you have a bank, you have a credit card there, you have your home loan there, you have your investments there, you don't want to switch. And I mean, on top of

that, it's kind of like a win-win for them because they also make money off of these products. They make money off the invest, they make money off the credit card. So I think that it's kind of a win-win from them to be able to cross-sell to deepen their relationship and also make money off of that customer relationship more. They also do mortgage origination. To be honest, I think mortgage origination is a pretty crappy business as far as banking businesses go. But I think they do that more just to deepen their relationship with the customers than as a primary uh a primary you know way to make money um i guess my so we've kind of talked about some of their advantages over incumbents but

what makes them better than the other digital only banks or some of i know they're trying to move towards maybe like the sort of the all-in-one app where you can do a lot with your money so more the neobank route what gives them an advantage versus those competitors i mean i think it's a little bit the other side of the coin which is they they already have that sticky deposit base um and a lot of what you're we'll actually see a lot of the neocompetitors are doing is they're not really banks. They're kind of like facades in front of banks. And then they give those deposits out to other institutions. This is starting to change. I think SoFi bought a banking charter recently, so they're becoming an actual bank. But I know Chime, they have partner

banks that actually take the deposits and pay interest on them. So I think by being an actual bank, you have an advantage. You can pay a higher deposit rate because you're the one who's actually getting the advantage. And I mean, I don't think there's necessarily anything stopping those other people from being able to kind of go along the same journey that Ally's going along. I just think Ally's a lot farther along in that process. Okay. That makes sense. Yeah. Well, I want to talk about the buybacks and the dividends because that's a huge part of the story. I mean, I don't have the math in front of me, but I think they bought back 24% or the run rate was like 24% of their shares outstanding. So absolutely huge. But first, we've been a bit, I think,

skewed towards the pessimistic side of Ally talking about the downside risk here. And we forgot to really include a question about the upside, like what could go right here over the next decade? I mean, as someone who's looking at the stock, what do you see as the upside scenario here? Could deposits double? I mean, what's sort of the growth that you're looking for this to be a successful investment? Yeah. I mean, so I think that the, you kind of touched on it in the beginning of this question, which is like, they don't need to grow their business much for this to be a successful investment there. I think they have like about a $10 billion market cap. They returned $3 billion or almost $3 billion on the trailing 12 months to investors

via dividends and share buybacks. So, you know, you're just betting that their earnings don't collapse basically you're not but to get to the tailwind question i do think that like we kind of talked about it but i personally think that like banking is going to keep moving more digital um i think that banks like chase and bank of america are going to be fine but like i do think it's going to be even more pressure on some of these like smaller regional community type banks um and eventually like if the interest rates go up i think there'll be more and more pressure on other banks to pay interest, and then they'll have the double of needing to pay interest and having to support their legacy footprint. So I think Ally has a little bit of a cost

advantage there. But it's not really a stock that I'm expecting explosive growth from. I think it's more like they're cheap. I think the CEO is a good capital allocator. Their earnings are clearly real because they've been returning cash to shareholders for several years um and like i think in the car lending side of the business um i think they're like a clear leader and generally in banking kind of having that specialization and market leadership position gives you advantages because you can kind of like the the overhead ratios and stuff we talked about at the beginning you can kind of amortize the people you have to hire and pay to do stuff over more and more loans. So you're just in a more competitive position from that aspect.

So you think, yeah, there is some economies of scale here, you think. And on the fast-growing side, I was going to mention the fast-growing financials can be kind of a red flag, I think, from some of the famous short sellers that have pointed that out with companies like Wirecard and all those good ones. But one more quick follow-up on the buybacks. What are your thoughts just generally on that strategy. They've really ramped that up. And you mentioned that you think the CEO is a great capital allocator. I know that combines with the buybacks. Why do you think that is the timing of the buybacks part of that good indicator for you? So I think the reason that I think they're doing the buybacks and dividends is one of the things that banks get judged on, we talked

about is return on tangible equity. So if you make a bunch of money and you just leave it on your balance sheet, that will hurt your tangible equity because you're basically having equity and you're not getting more loans. So you're going to start looking worse. And return on tangible equity is probably one of the... That's what bank investors look at. And so you're really strongly incentivized as a bank to return access capital you don't need to your shareholders. So I don't see it so much as they're being really aggressive in their buybacks. It's just like they're returning capital to shareholders in the way they promised and the share price is low. so they're buying back a lot of shares um i can't go wrong with that like i mean you hear that

scenario i think i look at every software company i'm like hey that's a three-step process why we implement that one time huh but uh sorry go red run okay so you mentioned they returned what was it roughly three billion dollars to shareholders and the market caps like 10 billion dollars today yeah that was that like is that sustainable yeah i guess that's on everyone's mind do they doesn't seem like they can are going to keep doing that so i think the current like the current economic or the the economic situation over the past 12 months has basically been as good as you can get for ally um used car prices have gone up meaning that they're like you know net charge us we talked about have been really low interest rates have been low so they've been

paying their depositors less. There's been a big increase in auto loans because the price of cars is higher. So they've been able to write a bunch of loans. So all those things are really good for Ally. I think that the earnings are almost unquestionably going to come down. The question is around how much they come down um because like like you said it's if they're not going to keep buying back they're not going to keep returning three billion to shareholders in a year but like if they're returning a billion to shareholders in a year two billion to shareholders in a year that's still pretty cheap for what i think is a quality business um that i do think i know i kind of downplayed the growth a little bit but um one

of the things like you look at for growth and financials is just the growth of their of their tangible book value um allies done a good job of growing their tangible book value over the past five years and so um i do think it's a it's a story that will grow um faster than your average bank and uh so even if we're looking at you know a price to earnings of like seven or eight instead of five i still think that's pretty compelling yeah i mean their deposit growth chart i know it's been stagnating recently but i over the last decade just quite impressive um i know there's some good charts out there that they give out but sorry ryan we have one final question yeah i feel like we've kind of been dancing around this question during the whole interview but what

could aside from anything we've mentioned already is there anything that could make ally turn into a poor investment uh yeah i mean i think that the biggest one is what what i i when we already touched on uh which is like the rapid decline in used car prices coupled with compute with consumers beginning to default on their loans um i think that's like the ultimate nightmare scenario for them where they you know could be going out of business um i think some of the other ones like i think about are i've maybe actually gotten better over the past year like a year ago i was a little bit more worried about like irrational market participants in that there were a bunch of fintechs kind of like so far that like so far is basically just trying to

build a bank but they're generally banks are very i guess rational in that they're very like returns driven so far is willing to spend a lot on advertising and other stuff uh because they kind of have that more you know tech growth at any cost mentality um so i was a little bit worried about that just from the perspective of there being a lot of cheap money out there. But I think that's kind of started to slow down. We talked about if there's a big recession, the price is definitely going to go lower. If there's actually a recession, you'll probably be able to buy the stock for 30% to 40% cheaper. But timing the market's pretty hard to impossible. And also, a lot of people are worried about stagflation. The last time the US had stagflation, that was

really bad for most bank stocks um uh and then some other things uh they're getting into a lot of these new businesses uh like we didn't even touch on all of them they're they're doing some uh point of sale loan origination for uh um like home good or home renovation and medical devices where they'll like loan people money to renovate their houses um and it's growing really fast but you like you said a lot of bank investors actually kind of see rapid growth as a warning sign because a lot of times that can be coupled with bad underwriting standards especially when you're getting into a new line of business so like a new line of business growing too large in that line of business having bad underwriting standards um now probably the last one is like just like

one of i would say their competitive advantages is their relationship with dealerships uh they have grown their dealership relationships by, I think, 20% a year. And that's really impressive considering the dealerships in the US have actually been declining. And the dealerships is how they source their auto loans. It's how they source basically all of their auto finance. So if dealerships get totally displaced and Ally isn't hooked into whatever the new lending system is, that could be bad for them. That's one of the reasons I like that they're doing the partnership with Carvana because that's the kind of thing that I think could potentially displace a lot of used dealerships.

Right. Yeah, I guess there's that risk. Companies like Tesla go D2C-ish. Do they have, I mean, does the D2C part, does that pose a risk to them on top of that? Or would they be able to hopefully have that partnership as well, similar to a Carvana? So this is a little bit of ally history, but they were actually originally the captive finance unit of GM. And so for a long time, they had this special relationship with GM dealerships where they were the only one who could do financing. That ended like 10 years ago, I think. And at the time it ended, people were really worried that their business was going to be non-feasible. But they did a lot of nice going out there and expanding their business. And over time,

their business has moved more and more towards used cars over new cars because a lot of the new car a lot of the you know gm and ford toyota they have their own captive finance um so they're competing against captive finance but even though you know gm went away from them 10 years ago they still do a lot of gm finance things so i think that kind of speaks to you know the strength of their business that even though they're competing against they're kind of you know playing at a disadvantage against GM's captive financial service, they're still originating loans there 10 plus years later. Right. Well, I think that's all the questions we have yet. Got any more? No, we had a ton of follow-ups for you. So I hope they weren't too many, but there's a lot

of nitty gritty with the financial stock you had to get to. Where can listeners keep up with you? Yeah. So I write on Seeking Alpha. I wrote an article about Ally maybe six or seven months ago. I'm planning on writing a follow-up article that I will hopefully be publishing in the next few days. So if you're more of a visual person and you want to see some of the charts and read stuff, I'll be publishing that on Seeking Alpha. I also have a Twitter account, I guess, that I made just to get in contact with you guys. Maybe you could follow me on Twitter. I've been poking around the FinTwit space since getting on there, since that's kind of compelling. So maybe I'll start tweeting.

yeah the uh listeners comment on jacob's uh cdl articles and tell them to get on fintwit because it is fun and uh it is you know plenty of discussions on there but we'll definitely link to the new article since it'll be out after you published it so it'll be in the show notes and anyone that wants to read that it'll be a great combination with this episode all right well that is going to do it we want to remind listeners that brett and i are not financial advisors anything we say or discuss here on chit chat money it's not formal advice or recommendation we are however general partners at Arch Capital so clients may have positions in the securities discussed in this podcast. Thank you all for listening. Thank you, Jacob, for coming on the show.

We will see you guys next time.