The surprisingly good times for auto lenders will come to an end. But when?
A global microchip shortage is bad news for automakers, but a potential boon for auto lenders, who have profited greatly from the reverse events of the past 12 months.
The recent freeze in chip production numbers further restricts the production of new cars, which lenders see in the value of used vehicles soaring and allowing for greater recoveries when loans deteriorate.
However, questions arise about the duration of the flushing times. Auto lenders benefit from transitional factors that have increased the purchasing power of consumers. The industry’s recent strong financial results have also led to increased competition, which is expected to bite into profits over time.
“We have noticed that when the competition is fierce, even in strong economic environments, losses tend to increase a year or two later,” said Amy Martin, analyst at Standard & Poor’s.
When America went into lockdown last March, car showrooms closed and auto lenders braced for tough times. Industry-wide, loan approvals fell 13% in the second quarter of 2020 compared to the same period a year earlier.
But several unexpected factors quickly converged to spark a revival for lenders. Low interest rates have made borrowing more affordable. Fears about the virus have led some commuters to avoid public transport. Interruptions in the supply of new vehicles – automakers cut production last spring – have pushed up the value of lender guarantees.
Rising used vehicle prices have also translated into larger loans for lenders serving the used car market. “Volumes benefit not only sales but also prices,” Autonomous analyst Brian Foran said in an email.
All the while, Americans received stimulus checks, increased unemployment benefits, and mortgage forbearance at a time when their ability to spend on travel, meals and entertainment was limited. The result has been an unusual kind of economic downturn, in which many consumers are to the brim.
“Never in a recession does income increase,” said Warren Kornfeld, senior vice president of Moody’s Investors Service.
More stimulus payments are expected to arrive soon. Congress is working to finalize a plan that should provide 1,400 checks to more than 100 million Americans, in addition to additional unemployment assistance.
Meanwhile, rarity of the type of microchips used in automobiles, a situation that resulted from the shutdowns of auto factories last year, is again hampering the production of new vehicles. General Motors discussed the idling of three factories in Mexico, Canada and the United States. Ford, Toyota, Honda, Nissan and Volkswagen have also announced production cuts around the world.
While a shortage of new vehicles is a negative development for automakers, it is likely to prove beneficial for lenders.
At an industry conference last week, Ally Financial chief financial officer Jennifer LaClair pointed out that the chip shortage is contributing to car supply trends that have benefited the Detroit-based company. Ally reported a record fourth quarter net income of $ 687 million.
“Supply constraints have led to expanding margins and high prices on the used vehicle side,” said LaClair.
Firms with large auto leasing businesses, particularly the finance branches of auto manufacturers, are uniquely positioned to win. Indeed, the resale value of vehicles at the end of the leases is likely to be higher than initially expected.
The shortage of new cars is expected to persist in the first half of 2021, according to Inna Bodeck, analyst at Moody’s. “And that problem will subside in the second half,” she predicted.
The question for the auto finance industry is what happens when market conditions finally normalize. Loan performance has been exceptionally good over the past year, as high household liquidity has enabled most borrowers to make their payments and forbearance programs have ended problems for many borrowers who have lost their jobs.
Dallas-based Santander Consumer USA, which specializes in lending to borrowers with subprime credit ratings, said a historically low net deduction rate in 2020.
“Accounts that have not received any changes since the pandemic have continued to perform well,” CFO Fahmi Karam said in the company’s latest earnings call, “as consumers continue to behave. rational, controlling expenses and increasing their savings.
Santander Consumer reported that 697,000 of its customers received a deferral of payment between the start of the pandemic and the end of 2020. Of this total, 8% of customers have repaid their loans and Santander Consumer has repaid the debt owed by 6 additional%. .
But the vast majority of customers affected by the company’s pandemic have remained in limbo. Some 63% of them were classified as less than 30 days past due, another 15% were classified as over 30 days overdue and 8% were still on a forbearance plan.
The strength of the economic recovery in the United States in 2021, which depends in large part on the effectiveness of vaccination efforts, will go a long way in determining how many cash-strapped borrowers will start repaying their loans again.
“I don’t think we’ve seen the full impact in terms of defaults, credit losses,” said Daniel Chu, CEO of Tricolor Holdings, a subprime auto lender that focuses on Hispanic consumers.
Borrowers with low credit scores cause more consternation among lenders than those with more intact payment histories. Blue-collar workers are disproportionately at risk of losing their jobs during the pandemic.
While loans to borrowers with a credit score below 700 made up only about 25% of active loans from blue chip auto securitization pools at the end of last year, they accounted for 53% of loans from these banks. same pools that had been granted extensions during the pandemic, according to S&P data.
“We expect nonprime performance to show a bit more deterioration than premium performance,” said David Laterza, senior vice president of DBRS Morningstar.
The high margins on loans over the past year may cause some lenders to relax their underwriting standards. In a recent Federal Reserve Board survey, 18% of responding banks said they plan to relax their auto lending standards somewhat in 2021, and none said they plan to tighten those standards. .
At the big banks, 43% of respondents said they plan to relax their auto credit standards somewhat, and none expect to tighten them.
Competitive pressures in auto loans have intensified, particularly in the subprime segment, Capital One Financial President and CEO Richard Fairbank said at an industry conference last week. “So that could have an impact on the magnitude of the growth opportunity,” he added.