OREANDA-NEWS. General Motors' (GM) higher emphasis on offering its customers lease options through its captive General Motors Financial (GMF) subsidiary poses another challenge for Ally Financial (Ally) and could pressure the bank to weigh other potentially higher risk avenues to support its growth, says Fitch Ratings. That said, the loss of the GM contract will reduce Ally's exposure to residual value risk which Fitch views positively given the current environment, which is characterized by elevated used vehicle pricing and intense competition.

Ratings assigned to Ally ('BB+', Outlook Stable) and GMF ('BB+', Outlook Positive) are unaffected by the development at this time, as Fitch had anticipated this possibility for some time, given GM's stated objective to grow GMF. That said, longer-term rating implications will be influenced by Ally's response to the forgone business.

Ally confirmed last week that GM would offer subvented leases on several of its popular brands exclusively through GMF. This development adds to a number of headwinds facing Ally and the auto finance industry more broadly, including normalizing credit performance, intense competition and pricing pressure, as well as elevated regulatory and litigation risk.

Ally's total lease origination volume for the three brands affected, GMC, Buick and Cadillac, accounted for 12.7%, or \$5.2 billion of Ally's \$41 billion in total originations in 2014. Fitch believes Ally's remaining GM subvented products, which include leasing for Chevy vehicles and loans on GM vehicles, remain at risk. Combined, these remaining products accounted for \$8.1 billion or 20% of Ally's total 2014 originations.

Despite the loss of GM subvented lease volume, Ally remains confident that it will achieve origination volume in the high \$30 billion range in 2015. Fitch believes the target is potentially achievable but reaching it will pose challenges and may lead to growth in potentially higher risk areas to meet shareholder expectations.

The loss of the GM lease contracts comes as Michael Carpenter, Ally's CEO since 2009 and the chief architect of the bank's turnaround, has stepped down. Ally executive Jeffrey Brown assumed the helm as the new CEO on Feb. 2, having served in several leadership positions at the bank since joining the firm several years ago from Bank of America, where he last served as the corporate Treasurer.

Fitch recognizes that Ally has successfully overcome multiple significant challenges over the last few years as the company transitioned from a captive finance company to an independent diversified auto finance company. GM's internalizing of leasing presents yet another challenge for the company and places a greater emphasis on Ally's 'growth' channel, which the company defines as originations from non-GM and non-Chrysler dealers. Originations within this channel have grown at a 61% CAGR since 2010 and represented \$8.3 billion in 2014 (or 20% of total 2014 originations). Fitch continues to believe that Ally remains well positioned as a market leader in the growing U.S. automotive finance market, an industry that should provide ample opportunities for the company to prudently grow its core auto finance business in the future.

Ratings assigned to GMF and its affiliates' are equalized with the GM parent. Fitch considers GMF to be a 'core' subsidiary of GM based on actual and potential support provided to GMF from GM, the increasing percentage of GMF's earning assets related to GM, and the strong financial and operational linkages between the companies.

The rationale for GM's lease internalization in Fitch's view is largely driven by the strategy to sustain strong unit sales and earn an attractive net lease yield. GM specifically noted that it believes the company could better control its options for retaining customers at the end of leases through its own financing arm. Fitch agrees that leasing is an important strategy for auto firms to build brand loyalty as lessees are more likely to lease or buy with the same manufacturer. However, leasing does introduce residual value risk, which requires careful residual value and depreciation policy setting, particularly in the current market where used car values remain high but are expected to moderate.

Fitch will monitor GMF's growth and expansion in leasing, paying particular attention to underwriting standards, residual value management, profitability, funding and leverage.

GM's strategy of increasing its dependence on GMF is in line with other global auto manufacturers. However, a larger GMF increases the likelihood that GM could need to provide extraordinary financial assistance in the case of a liquidity event at the subsidiary. Such an event would have the potential to place downward rating pressure on GM.