This bank stock surged after earnings, but could still be a big buy

There’s a lot of investor pessimism surrounding the lending industry right now, and it certainly makes sense. After all, rising interest rates have reduced the demand for loans, and if a recession hits (as most experts predict), loan defaults are likely to rise.

but, Ally Financial (ally 20.01%) It just showed investors that it could do better than expected. The bank recently reported its year-end 2022 results, and the stock surged as much as 20% on the day after the announcement. Here’s a rundown of Ally’s fourth quarter numbers, why the market reacted so favorably, and why the stock remains a big buy for long-term investors.

Ally easily exceeded expectations in Q4

Let’s start with the headline numbers. Ally has exceeded her expectations both in earnings and earnings. Bank earnings came in at $2.2 billion, beating her expectations by $150 million and earnings per share (EPS) at her $1.08, beating analyst expectations by 8%. And it’s worth noting that expectations were likely even worse just before the report. Discover (DFS 4.16%) reported disappointing results and high amortization rates the day before.

Looking beyond the news headlines, Ally originated $9.2 billion in auto loans at an average yield of 9.57% during the quarter. And impressively, net financial income increased slightly year-on-year, despite the difficult economic conditions.

Ally has also done a great job of returning capital to investors and taking advantage of falling stock prices. In fact, Allie will spend her $1.7 billion in 2022 on buybacks. This represents her 18% of the total market capitalization. And that’s on top of about $350 million that bank stocks paid out in dividends.

Highly Profitable Business Model

In case you’re unfamiliar, Ally spun off from general motors (GM -1.06%) After the financial crisis, it is not surprising that the main business is auto loans. About 77% of the bank’s loan portfolio is automotive in nature.

However, it is important for investors to recognize that the company has evolved into a fully-featured online bank. Large scale deposit platform. In banks, he has $137.7 billion in personal deposits and provides low-cost funding sources for nearly all of his $146 billion in loans.

This is why it matters. Deposit interest rates are much lower than other types of financing, so his average cost of funds for Allies in 2022 was just 1.71%. Meanwhile, the average yield on new auto loans for the full year was 8.24%. Even considering administrative costs and reasonable default rates, it’s not hard to see how this all works together to produce a large profit margin. In fact, Ally’s net interest margin in Q4 was 3.65%, one of his best in the banking industry.

Should investors worry about rising defaults?

Ally secured $480 million in the quarter, more than double the fourth quarter of last year, but it’s still broadly in line with pre-pandemic standards and nothing to be alarmed about.

For the full year, Ally’s auto loan portfolio had an annualized write-off rate of 97 basis points (0.97%), which increased to 166 basis points (1.66%). However, this is not the cause of the warning. This is a little higher than his 1.33% default rate Ally saw in 2018, but the bank has about 3.6% of its loan portfolio in reserves. The situation is certainly noteworthy, but the charge-off rate is still fairly manageable.

Ally could still be a great stock for patient investors

Despite the post-earnings pop, Allie still looks very attractive from a long-term perspective. After all, Ally is trading at just over five times her earnings over the past 12 months, and her book value per share is discounted by 12%. The stock is still 40% below its 52-week high.

Admittedly, Ally is not without risks. However, with its highly profitable business model, excellent history of returning capital to shareholders, and undervalued valuation, Ary is a bank stock that could do very well for patient long-term investors.