The Lex Newsletter: US auto loans hit traffic

Dear reader,

Summer is road-trip season in the US. But this year, growing strains in the auto loan sector might make some motorists think twice about hitting the road.

Sky-high prices for used and new cars alike forced buyers to take out bigger loans for their vehicles during the Covid-19 pandemic. Auto-loan originations in the US hit a record $747bn last year following an already brisk 2021, according to data from the Federal Reserve Bank of New York. Total outstanding debt in the sector stood at $1.56tn at the end of March, or $93bn higher compared with the year before. 

Bigger monthly payments were no big deal when interest rates were low and consumers’ finances were padded out by stimulus cheques and deferments for student loans and mortgages. But that has changed as the government rolls back its stimulus packages and stubbornly high inflation strains household budgets.

A growing number of Americans are falling behind on their car payments, according to Moody’s Analytics. The 12-month moving average for total delinquency rates reached 3.08 per cent in April, the highest level since 2011. 

All those with outstanding car loans are suffering. Delinquency rates range from 23 to 49 per cent higher than 2019 levels, points out Moody’s. The worst hit are those with near-prime credit ratings between 660 and 720. Credit scores in the US range from a low of 300 up to 850.

In other words, the biggest increase in delinquency is not coming from subprime borrowers. It is showing up in near-prime borrowers whose credit rating got a bump up during the pandemic.

Softening used car prices also mean many motorists who took out big loans during the car-buying frenzy over the past two years now owe far more than their vehicles are worth. ​​The Manheim US Used Vehicle Value index is down 13 per cent from its peak in December 2021. Negative equity — when the amount of debt owed exceeds the vehicle’s worth — is becoming more commonplace, according to both credit report group TransUnion and market researcher JD Power. 

They found that the used car loan-to-value ratio increased to 125 in the first quarter, compared with 110 a year ago. A ratio of 125 means that the borrower’s loan is worth 125 per cent of the vehicle’s value.

And as we have seen in the US commercial real estate sector, borrowers have no qualms about walking away from their loans when the value of the asset is underwater.

In the event of a default, lenders can repossess the car, sell it and use the money to pay off the unpaid balance. Most of the time, though, the capital recovered is not sufficient.

Fears that lenders will be stuck with losses have hit the share prices of financial groups with high exposure to the auto loan market. Shares in Ally Financial, one of the biggest, have shed about 13 per cent over the past 12 months and it now trades at just 0.8 times book value.

Ally’s net income fell more than 50 per cent during the first quarter as higher funding costs ate into margins. It booked $446mn in provisions. Its annualised net charge-off rate of 1.68 per cent in retail auto lending compares with 0.58 per cent a year earlier.

The worst may still be to come if the US tips into a recession. That means investors should steer away from auto loan financials until more visibility appears on the road ahead.

Other stuff I liked this week

Given the uncertainty about whether a recession is or isn’t coming, I thought this thoughtful piece in The New York Times, exploring how much has changed in the global economy, was interesting.

Have a great rest of the week.

Pan Kwan Yuk
Lex writer