ALLY Stock is too risky and too late to the Fintech party

Based on the advertisement, Ally Financial (SNEEZE:ALLY) is a digital-first provider of financial services. But while Ally may position itself as a fintech-like entity, those familiar with ALLY stock are well aware of the company’s true business: car loans.

Ally Financial is the successor to GMAC, the former financial arm of General Motors (SNEEZE:GM). GM sold its remaining stake in Ally in 2013.

Since the GM split, and especially in recent years, Ally’s auto loan segment has been focused primarily on the origination and holding of used auto loans.

This was not a problem in 2021, when pent-up demand for used vehicles resulted in a big jump in profitability. Since last year, however, this high used car exposure has turned negative.

Even worse, despite reporting a big drop in earnings, and experiencing a big share price decline, Ally’s problems have yet to enter the rearview mirror.

Why it is not a Fintech

The line between traditional financial institutions and fintech has become blurred in recent years. For example, with the acquisition of a bank charter, SoFi technologies (NASDAQ:SOPHIE) has become more like a bank than other fintechs such as e.g PayPal (NASDAQ:PYPL) and Block (SNEEZE:SQ).

Conversely, “old school” institutions like Ally are becoming more like fintechs lately. A good example of this is with Ally’s brokerage platform, Ally Invest.

Ally Invest has more in common with retail-friendly brokerages such as Robin Hood (NASDAQ:HOOD) than it does with traditional brokerage houses.

So do these “fintech features” make ALLY a fintech? Not exactly. While Ally’s non-auto businesses have become an increasingly large part of the financial institution’s asset base, auto-related loans and lease financing arrangements still make up a majority of its $181.7 billion balance sheet.

Car loans and related services also continue to make up the lion’s share of Ally’s annual net revenues.

Again, being an auto-focused lender was a good thing for Ally during 2021, as earnings per share nearly tripled, from $2.89 to $8.28 per share, thanks to a favorable environment for the auto industry. However, it has been a different story since 2022.

The worst may not have priced in yet

Deflation of the “used car bubble” has weighed heavily on ALLY stock, with shares down around 44.7% over the past twelve months.

Mainly due to deteriorating results. Although net interest income rose in 2022, rising car loan write-offs and loss provisions offset this.

As a result, earnings last year fell by about 38.9%, to $5.06 per share. Sell-side analysts expect a further decline in EPS this well, with the consensus now coming in at $3.76.

With the stock trading at a single-digit multiple to this forecast, it may look as if it represents the current headwind for ALLY.

However, it is possible that current forecasts may be too conservative. Conditions in the used car area, where Ally accounts for 71% of the loan assignment, are expected to worsen during 2023.

Ally has already admitted that it expects net interest rates to continue to climb, from 1.7% to 2.2%.

Even worse, Ally has a particularly high exposure to one of the used car industry’s riskiest players. As Louis Navellier recently pointed out, Ally is a key source of funding for Carvana (SNEEZE:CVNA), which currently agrees to provide up to $4 billion in financing, under a forward flow agreement.

The bottom line

Already in a tough spot, if the U.S. economy goes into recession this year, and/or unemployment continues to rise, Ally’s loan losses could end up being far larger than expected.

While fears about banking operations from earlier this month may have been an overreaction, worse-than-expected results could also pressure shares. A recovery could play out much more slowly than current forecasts, which call for earnings to decline starting in 2024.

In the long term, Ally’s potential to transform into a fintech may be limited, given competition from up-and-coming names like SoFi.

Unless this auto-focused bank buys/merges with another large to mid-sized financial institution, its fortunes will likely remain tied to the health of the auto market.

Considering the current situation with the used car market, it is best to err on the side of caution and avoid ALLY stock.

On the date of publication, Thomas Niel did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the author, subject to the InvestorPlace.com Publishing Guidelines.