A pullback in lending by banks and credit unions is giving some the green light to lend, even amid signs of borrower stress
By guest author Telis Demos from the Wall Street Journal.
July 23, 2023
Fewer auto lenders may be on the road, improving the drive for everyone else. That isn’t a license to speed like crazy, though.
Among subprime auto borrowers, delinquency rates that were quite low during the pandemic have moved well past normal. Executives at Equifax on Thursday told analysts that delinquency rates for subprime auto borrowers aren’t only above prepandemic levels, they are above the levels reached after the 2008 financial crisis in 2009 and 2010.
The biggest auto lenders will steer clear of this, because they have portfolios tilted much more toward more reliable borrowers. Even so, delinquency rates and losses are rising for higher-quality portfolios, too. Ally Financial this past week said it is now predicting a retail auto net charge-off rate of 1.8% this year, which was at the top end of its previously given range. This is versus a historical average for 2017 to 2019 of around 1.4%. Capital One Financial’s COF 0.50%increase; green up pointing triangle auto net charge-off rate was 1.4% in the second quarter, up 0.79 percentage point from a year earlier.
Amid all that, some lenders are pulling over. This has opened up more of an opportunity to profitably lend in auto—even by picking off only the best borrowers. Ally told analysts on Wednesday that potential returns on super-prime loans were “significantly higher than normal.” Capital One Financial said on Thursday that though it had its “foot on the brake” in auto for a while, “in the very recent months, we’ve seen the opportunity to lean in a little bit more.”
This comes as banks such as Fifth Third and U.S. Bancorp this past week said they have been selling or scaling back auto loans. There has also been a sharp contraction among credit unions, whose aggressive pricing had previously been making things harder for bank lenders. Cox Automotive’s Dealertrack Auto Credit Availability Index in June showed a nearly 17 % decrease year-over-year by credit unions, versus just a 7.5 % pullback among banks.
The best customers default less often. But they also command lower interest rates, pressuring lending yields. Ally told analysts that its “originated yield declined in the quarter as we’ve increased the superprime proportion of our volume.” Those yields will need to stay relatively high to prevent rising funding costs from squeezing profitability further. It also puts the onus on credit performance to help keep returns as high as possible.
Plus, credit risk even for better borrowers may be hard to predict right now. For one, there is the risk that used-car prices decline more than anticipated, making it harder to recover as much on a loan when selling a repossessed car. That is on top of other unprecedented developments in the auto market, like the number of borrowers who now have monthly car payments above $1,000, due to a combination of higher car prices and rising interest rates. Even the well-heeled may balk at this kind of spending.
More broadly, Capital One Chief Executive Richard Fairbank on Thursday described what he called a “deferred charge-off effect.” Because credit performance over the past three years was so unprecedented across consumer credit, he said that there is likely “some catching up that happens on the other side of that, especially for consumers who might otherwise have charged-off over the past three years.” That includes the question of who exactly is a prime borrower, with Fairbank noting that rising savings rates meant a lot more subprime customers had moved into prime in recent years, possibly creating misleading data for credit models.
Lending to wealthier borrowers can help avoid credit risk, especially if it is well-priced. But it isn’t a cheat code.