Amid Rising Delinquency Rates, Auto Lenders Seek Safe Growth
Disclosures of worsening delinquencies by Ally Financial caused a noted analyst to ask if the situation was specific to the bank or "a canary in the coal mine." Delinquencies have been increasing among both banks and credit union auto lenders. Interest rate cuts alone will not solve the problem.
By Steve Cocheo, Senior Executive Editor at The Financial Brand
The Federal Reserve may have started lowering interest rates again, cheering many and warming the national mood. But for bank and credit union auto lenders and retail vehicle buyers, it will take some time to feel the effects. And there may yet be a good deal of angst along the way.
The lenders must deal with the issues inherent in the body of loans already made, including rising delinquencies, and the continuing hangover of pandemic economic trends, compounded by inflation and higher interest rates before the Fed’s cut. Unlike many credit cards and mortgages, car loans typically carry fixed rates, so consumers who already have auto loans won’t feel the rate cut directly.
One potential benefit of the cut for lenders seeking volume and market share going forward is the opportunity to refinance existing car loans as rates continue to fall, if the central bank sticks to its plans, suggest Charlie Wise, senior vice president, research and consulting, at TransUnion.
Meanwhile, the outlook for new auto lending by banks and credit unions is partly cloudy. Automakers and their captive finance companies have been providing incentives to move vehicles. At midyear, captives topped the share of outstanding auto loan balances ($544.3 billion), gaining 7.7% over 2023, according to Equifax. Banks, in second place at $516.2 billion, saw a decline of 2.9%. Credit unions, third at $459.9 billion, were nearly flat year to year.
This comes on top of auto sales that continue to be sluggish, according to Jonathan Smoke, chief economist at Cox Automotive, parent of multiple automotive data sources and service companies. He cited a slowing economy and sluggish labor market for the drag. Cox predicts that new vehicle sales will be about even with 2023, at 12.7 million vehicles sold at retail, and that used vehicle sales will finish 2024 up slightly, to 19.9 million from 19.3 million. (Retail refers to consumer purchases, versus vehicles bought for rental or corporate fleets.)
In the Cox Dealer Sentiment Index for the third quarter, the economy, interest rates and the political climate were the top three reasons holding back business. Concerns over credit availability were much further down the list, though this measure was higher than a couple of years ago.
Fed Shift Meets a Challenging Auto Lending Environment
Rate cuts will take time to trickle down to consumers borrowing for both new and used cars, Smoke said during a Cox webinar in late September. He predicted that lower rates would start coming to auto lending before the end of the year. However, he added that "affordability challenges will not be solved by this new path for rates."
For multiple reasons, vehicle prices remain high, even though they have retreated from levels seen during the pandemic.
Wise points out that the average monthly payment for a new car was $740 in the second quarter, down from $743 a year ago, but up nearly 24% over 2021. The average for used cars was $527, down from $535 in 2023, but up 17.6% over 2021. The average amount financed on new vehicles hit $41,324, up nearly 13% from 2021.
"That’s a lot of money," says Wise and those numbers ballooned over only three years. (Price figures come from S&P Global Mobility AutoCreditInsight.)
Auto Loan Trends, Q2 2024
Source: TransUnion1Note: Originations are viewed one quarter in arrears to account for reporting lag
2Data from S&P Global MobilityAutoCreditInsight, Q2 2024 data only for months of April & May.
Multiple factors go into higher prices. Among them is the drying up of leasing during the pandemic, when many stopped traveling. Off-lease vehicles make up a big portion of used-car sales in subsequent years. Likewise, during supply chain disruptions, many cars were never made. Jeremy Robb, senior director of economic and industry insights at Cox, pointed out that those never-built vehicles will never be in the sales chain, somewhat constraining supply.
Cox has found that more consumers are moving towards leasing these days in the quest to lower monthly payments. "The vehicle market is still recovering from the period of high inflation," said Charlie Chesbrough, senior economist at Cox, in the webinar. Another development: Consumers have shifted towards compact cards and subcompact SUVs to bring payments down on new vehicle loans.
Read more: Auto Lenders Shift Gears in a Race to Outrun Covid Aftereffects
Rising Delinquencies Darken the Skies Over Auto Loans
Auto loan delinquencies have hit higher levels than in quite some time, according to Charlie Wise. The credit bureau’s Credit Industry Insights Report for the second quarter noted that the 60+ days past due delinquency rate rose to 1.4% in the second quarter, up from 1.3% a year earlier and double the level for the second quarter of 2021. In an interim report for August, TransUnion said the 60+ delinquency rate on autos had hit 1.6%.
S&P Global Market Intelligence, which ranks delinquency differently, using both nonaccruals and past-due loans, reported in mid-September that bank and credit union auto delinquencies reached their highest point for a second quarter since 2013. The company indicated this was in the wake of year-over-year increases over 10 quarters. The firm reported that 22 of the top 25 bank auto lenders saw rises in their delinquency ratios in the second quarter.
During a media briefing about second quarter credit union performance, National Credit Union Administration Chairman Todd Harper noted a 16-basis-point rise in auto delinquencies year over year and said the regulatory agency was watching it closely.
Speaking about auto lenders in general, TransUnion’s Wise recounts that at the outset of the pandemic, in the days of lockdown, they generally tightened up across the board. The days of forbearance and federal stimulus payments created an atmosphere of low delinquencies, and this encouraged many to start aggressive auto lending beginning in the second quarter of 2021. This included making more car loans to subprime borrowers. Some have described this phenomenon, and its lingering effects, as "credit score inflation."
In 2022, many lenders saw delinquencies rise, and as the Federal Reserve began raising interest rates to fight inflation in March of that year, banking lenders began shifting away from higher-risk loan prospects.
Read more: How Auto Lenders Can Help the Growing Ranks of Troubled Borrowers
Ally Financial Discusses Rising Delinquencies with Analysts
Ally Financial, the nation’s second-largest bank auto lender, disclosed during a September analyst briefing that its delinquency level and chargeoff rates had both increased over levels announced with second quarter earnings, and would likely become worse. The comments by CFO Ross Hutchinson resulted in a fall in the company’s stock price from which it has not completely recovered. (The remarks, made on Sept. 10, caused an immediate fall from $39.66 to $32.67. The stock closed at $34.82 on Sept. 26.)
Regarding the CFO’s statements and more he said about credit card performance, Sanjay Sakhrani of Keefe, Bruyette & Woods wrote that the news "begs the question if this is ALLY-specific or a canary in the coal mine."
In his fireside chat at the Barclays Annual Global Financial Services Conference, Ally’s Hutchinson noted the differing performance of each year’s vintage of auto loans, in terms of conditions at the time the credit was granted and current circumstances. Loans made in 2023, for example, continue to outperform 2022 loans, in part because of tightening done in 2023. Hutchinson said this gives Ally some confidence for the future, as 2022 loans continue to roll off the bank’s books.
However, 2023 loans face challenges, Hutchinson said, and that vintage’s outperformance of 2022 auto credits at Ally may not last. He pointed out that those loans were made in an environment of a 3.5% unemployment rate. In the government’s most recent report, unemployment had reached 4.2%. Hutchinson said those loans would face an increasingly challenging macroeconomic environment and promised more detail in the company’s third quarter earnings briefing.
Hutchinson also emphasized that while the auto portfolio has been underperforming in credit terms, "they are still attractive loans. They were written to risk-adjusted margins that are higher than what we wrote pre-pandemic — even with elevated credit costs. They are overall accretive to the enterprise."
Read more: Even as Financial Worries Grow, U.S. Consumers Keep Using Credit Cards
Capital One CFO Reviews Its Evolving Auto Lending Strategy
"Credit performance is the function of choices you’ve made over the course of multiple years," said Andrew Young, CFO at Capital One, at the same Barclays conference. "And we really like the choices we’ve made."
Capital One is the nation’s largest bank auto lender. Young said the bank’s delinquency rates remain below where they were pre-pandemic. He traced how the company’s credit strategy evolved over the last few years.
Prior to the pandemic, he said, Capital One aimed for origination of $7 to $8 billion in auto loans per quarter. In 2021, he continued, the bank saw the combination of forbearance, stimulus and more as creating an attractive opportunity "to lean into growth," according to Young.
As a result, over 2021 and into the first half of 2022, the bank’s quarterly originations varied between $10 billion and a peak of $12.9 billion, he said.
"But as we got into the middle of 2022, though, there were some warning signals," said Young. Among them: The level of vehicle pricing had risen so high that the bank didn’t think it was sustainable. Credit score inflation became a concern as the government assistance programs seemed to be skewing those numbers. That, and proprietary analyses, convinced management it was time to damp down. This tack was taken even while other lenders were still pursuing loans aggressively.
"So, you saw us pull back on the origination side quite dramatically," said Young. Originations fell below pre-pandemic levels, to $6-$7 billion per quarter.
"That’s down 30% year over year," said Young, "because we were cautious." That skepticism continued through 2022 and into 2023.
"It’s only been recently that those originations have begun to tick back up," said Young. In the second quarter of 2024 the bank made $8.5 billion in auto loans, a bit above pre-Covid levels.
He said loss rates are up, but that that is a result of vehicle values coming down, impacting recoveries, among other factors. Delinquencies have been stable, he said.
"Where it goes from here is going to be a function of the macroeconomic backdrop," said Young. "What we’re seeing makes us remain cautiously optimistic, and we are leaning a little bit into volumes at this point."