Ally Financial fails the qualitative test because of mismanagement of its retained earnings

The company has lost more than 53% of its value since the beginning of this year

• Ally Financial has been buying back shares at a higher price than its fair value

• The CEO of the company has received excessive cash and stock awards which are 23.5 times his annual base salary in 2021

• The directors and executives of the company receive stocks as PSUs and RSUS as compensation

Ally Financial Inc. is a U.S. based financial and holding company of Ally bank, a subsidiary providing online financial products and services, primarily to automotive dealers and their customers. The company which was spun off from General Motors in 2006, operates through its Dealer Financial Services which comprises Automotive Finance and Insurance segments and Mortgage Finance. Ally bank provides substantial cost savings relative to traditional brick-and-mortar banks.

Ally Financial has lost about 53% of its value in the last year with its share price closing at $23.93 as of December 23, 2022. Investors are dumping the company shares because of compensation program for its management and directors. Otherwise, there is no reason for the stock to lose its value considering that its is trading below its book value of 0.58 (price-to-book value) and pays a higher dividend. Because of its attractive valuations and share buyback program, even Warren Buffett was attracted to the stock who first bought $8.9 million shares in Q1, 2022 at an average price of $47.34 (the price ranged between $40.81-$52.76). In Q2, 2022, he increased his position by buying another 21 million shares which makes up 0.23% of his portfolio.

Ally Financial’s Earnings per share (EPS) since 2016 has increased 3-fold from $2.04 to $8.22. It could be argued that the reason for this increase was the share buybacks what is evident from their 10-K filings with Security and Exchange Commission (SEC). Since the beginning of this program in 2016, the company has thus far returned $6.5 billion of excess capital to shareholders through buybacks and dividends. In January 2022, the company announced a second consecutive buyback program of up to $2 billion and increased its dividends by 20% to $0.30 per share for all its common stockholders which was the seventh increase in as many years.

However, now when the auto industry and the mortgage market started slowing down due to the Federal Reserve, raising interest rates to control inflation, Ally Financials’ revenues and profits started to decline. Its EPS for the twelve months period ending September 30, 2022, was $5.95, which is a 27.79% decline year-over-year. This is something that has not just affected Ally Financial but even its competitors like Capital One Financial Corp. (COF) and Discover Financial Services (DFS). However, surprisingly enough, these competitors despite being in the same boat have not lost as much as Ally did in value.

The stock price of Ally suffered more than its competitors is attributed to the compensation program of its management and its directors which is why the investors are losing confidence in the company. It pays compensation to its directors in the form of directors deferred stock units (DSUs). Each unit vests immediately and represents the right to receive one share of common stock upon the director’s departure from the Board. The amount is prorated for directors who join the Board after an annual meeting of stockholders.

In October 2021, on the recommendation of the Compensation, Nominating, and Governance Committee (CNGC), the Board approved an increase in the annual equity retainer from $135,000 to $145,000 which was effective as of the Annual Meeting of that year. The directors also received an annual cash retainer of $130,000 on average which is paid in quarterly installments. Therefore, each director received compensation of about $275K in cash and in stocks on average.

Security Ownership of Directors, Nominees, and Executive Officers

Source: Ally Financial’s 2021 Annual Report

Besides this performance-based cash, the Executives also received Restricted Stock Units (RSUs) as compensation. These are awarded annually and vest one-third on each of the first, second, and third anniversaries of the grant date. The payouts are settled in shares of Ally common stocks which have a performance period of three years with a clawback condition. The management also received an additional annual Performance Stock Unit (PSU) of up to 150% of the target based on a performance period of three years which also has a clawback clause. PSUs are linked to Return on Tangible Common Equity (ROTCE) and Total Stockholder Value (TSV) and determined by the value of Ally’s common stock and are paid in cash.

(a)    This is a non-GAAP financial measure.

Source: Ally Financial’s 2021 Annual Report

Therefore, the CEO of the company Jeffrey Brown and other executives have received 30% to 35% of PSUs and RSUs as compensation in 2021.  The CEO has received the compensation for achieving an adjusted total net revenue of $8.4 billion, core ROTCE of 24.3%, and a full-year adjusted Earnings per share of $8.61. The Earnings per share, in this case, was obviously manipulated because the company had spent $2.0 billion buying back 40 million shares in 2021. It paid a higher price to reduce the number of shares outstanding by about 30% since 2016.

Ally’s revenue and profits have declined despite an expansion in the dealership network which now stands at 21,100 dealers. This has led to an increase in total consumer auto origination of $46.3 billion and mortgage originations of $10.4 billion in 2021. Yet despite this increase in its assets which stand at a total of $182 billion, the Return on Assets (ROA) declined from 1.60% to 1.10 in the first nine months of 2022.

This clearly reflects poorly on part of the CEO because ROA is a key metric for financial institutions and banks. There was also an increase of 10% in retail customer deposits reaching a total of $141.6 billion in 2021. But because Ally has a non-conventional way of sourcing its deposits using its online platforms, it pays a higher interest rate which is why it lagged in its performance falling behind its competitors.

Despite this abysmal performance delivered by the CEO, the value of his total compensation (cash incentive, PSUs, and RSUs) in 2021 had reached 23.5 times his annual (base) salary. It is evident that the management is milking its common shareholders by buying back and retiring existing shares to issue new shares as PSUs and RSUs to compensate its directors and executives.

Some of the largest corporations have recently tried this strategy of buying back a massive number of shares to issue PSUs and RSUs have in fact failed in reviving their depressed stock price and regaining shareholder’s confidence. The management of Ally has clearly adopted this failed strategy to disillusion its shareholders. The cash retained by the business is owed to its shareholders and not its directors or its management. Despite an increase in free cash flows year-on-year and a cash position of 5 billion plus a year ago, Ally today has a deficit in its retained earnings. This is mainly because of share buybacks to excessively compensate its directors and management.

META has recently spent $45 billion of its cash and bought back 158 million shares at an average price of $330 to issue RSUs. It lost about 75% of its market value with its stock declining from $384 to $100 a share in three years using this strategy. Therefore, buying back own shares makes more sense only when the stock of the company is trading at a reasonable level. For example, Berkshire Hathaway (BRK.B) has a policy of buying back its shares only if the stock is trading below its intrinsic value or at 1.2 times its book value.

It is not surprising to see why the insiders and the executives of Ally, in particular, have been selling their stocks which were awarded to them as part of their compensation package. The common shareholders are, therefore, losing confidence in the company because of these accounting gimmicks and mismanagement of its surplus capital to excessively compensate its executives. The company is using share buybacks as a tool to manipulate its financials for its valuations to look good on paper. Despite these efforts, the shareholders are still dumping its stock which has lost more than 53% of its value this year alone.

We have to wait and see if Warren Buffett follows the suit and starts selling the stock in Q4, 2022 when Berkshire Hathaway (BRK.B) files its 13F with SEC. This is because Ally’s compensation policy is clearly in contradiction with Berkshire’s policy that does not award any stock options to its directors.

Disclaimer: I wrote this article myself and have a long position in Ally Financial (ALLY). I do not have any position in any other stocks mentioned in this article. The views and opinions expressed in this article are my own. This article must not be construed as an endorsement or investment advice in Ally Financial or any other stocks mentioned in this article.  

Additional Disclaimer: I am not receiving any compensation for this article (other than my Substack readers and followers). I have no business relationship with any company whose stock is mentioned in this article.