During Ally Financial's earnings announcement today (transcript here), CFO Chris Halmy revealed that the FDIC has given permission for the bank to start using FDIC insured deposits for auto loans with credit scores as low as 620. Previously, Ally could only use deposits for loans to borrowers with 650 or higher credit scores. With this change, nearly 75% of Ally's lending portfolio can now be funded with deposits. According to Halmy, "we are focused on eventually getting everything funded at the bank."
Why Did The FDIC Have Restrictions On Ally?
Ally Bank was created as a result of General Motors' near collapse and government bailout during the 2008 crisis. GMAC, the auto lending division of General Motors, was spun out as a separate company, capitalized by the government and renamed Ally Bank.
The regulators wanted to make sure that no further taxpayer money would be required to bail out General Motors or Ally. So they put big restrictions on how FDIC-insured deposits, raised by Ally Bank, could be used. The biggest restriction was the minimum credit score for all borrowers. Ally Bank is famous for simple, high interest rate savings accounts available online. Ally savings accounts currently pay 0.99%, compared to the average 0.01% at large, traditional banks. While that interest rate might sound high for savers, it is a very cheap way to raise funds for a bank like Ally.
Ally Bank had to find funding for its large auto loan business. For borrowers with high credit scores, the bank could use its deposits, which cost less than 1%. But for borrowers with low credit scores, it had to raise money from the debt capital markets. Debt investors required high interest rates to fund subprime auto loans. While Ally could receive interest rates below 1% from consumers, it had to pay above 4% to the debt investors. Ally is clearly motivated to reduce debt funding, and increase deposit funding.
The FDIC did not want to Ally to use its low-cost deposits to fund higher risk auto loans. However, as the market improved and the new management team of Ally gained the trust of the FDIC regulators, the restrictions have been relaxed.
What Does This Mean For Consumers?
Ally has a simple business model. The bank looks to raise deposits online and make auto loans. Ally has made good progress building a profitable business with better risk management. In the last three months, Ally generated core earnings of $435 million.
Ally Bank will now be able to reduce its funding costs for consumers with FICO scores between 620-650. The reduction in funding costs can have three potential outcomes:
- Ally reduces its headline interest rate, passing savings along to consumers. The lower rates make the product more competitive, and enables Ally to grow faster.
- Ally expands it credit underwriting policy, approving more borrowers in that score range. Because there is a lower funding cost, Ally has the ability to take more risk.
- Ally makes more money, booking the funding savings as profit.
Based upon indications from management, the focus will be on generating more earnings for Ally, rather than reducing interest rates for consumers or expanding the risk acceptance criteria. However, over time, Ally may use its funding advantage in subprime auto lending to expand market share.
For depositors who enjoy Ally's high interest rates, this is good news. Now that Ally has more places to use its deposits, it will want more of them. Expect the good interest rates to continue.
Should Taxpayers Be Worried?
Ally Bank is a different organization from GMAC. The annualized credit loss rate in Q2 2015 was only 0.39%. This low loss rate is the result of dramatic changes and improvements to the risk management infrastructure and policies. The biggest change is that Ally is no longer a division of an auto lending company whose sole purpose is to help drive auto sales. Instead, Ally is stand-alone bank with an experienced risk management team, who are paid based upon the long-term performance of the bank. In addition, Ally remains highly profitable and has a strong capital cushion. The Tier 1 ratio of Ally Bank is 11.7%.
Ally indicated that it plans on product expansion. We can expect Ally to consider other lending businesses as it finds even more uses for its highly successful deposit-gathering franchise.
Options For Consumers
[Disclosure: LendingTree is the parent company of MagnifyMoney.]Consumers looking to finance a car, can do so directly with Ally Bank on their website. Keep in mind that it is best practice to compare your options. We recommend starting with LendingTree. They have hundreds of lenders on their platform. After you complete an application, you can see real interest rates and approval information. Note, some lenders will do a hard pull on your credit and that this is normal with auto lending. Since multiple hard pulls will only count as one pull, the best strategy is to have all your hard pulls done at one time. You can shop for rates on LendingTree's website.
Barclays Online Savings Account
Synchrony Bank High Yield Savings
Synchrony Bank 12 Month CD
Goldman Sachs Bank USA High-yield 12 Month CD
* All banks listed are a Member FDIC.