A global microchip shortage is bad news for carmakers but a potential boon for auto lenders, which have largely benefited from the topsy-turvy events of the last 12 months.
The recent logjam in chip production figures to further constrain the production of new cars, which, for lenders, is driving up the values of used vehicles and enabling larger recoveries when loans go bad. Throughout the pandemic, margins in auto lending have widened amid tight vehicle supply and strong consumer demand.
Still, questions are emerging about how long the flush times can last. Auto lenders are benefiting from transitory factors that have juiced consumers’ spending power. The sector’s strong recent financial results have also led to intensified competition, which figures to bite into profits over time.
“We have noticed that when competition is fierce, even in strong economic environments, the losses tend to rise a year or two later,” said Amy Martin, an analyst at Standard & Poor’s.
When America went into lockdown last March, car showrooms closed, and auto lenders braced for hard times. Across the industry, loan originations fell by 13% in the second quarter of 2020 compared with the same period a year earlier.
But several unexpected factors soon converged to spark a revival for lenders. Low interest rates made borrowing more affordable. Fears about the virus led some commuters to avoid public transit. Interruptions in the supply of new vehicles — manufacturers curtailed their production last spring — drove up the value of lenders’ collateral.
The rise in used-vehicle prices also resulted in bigger loans for lenders that serve the pre-owned car market. “Volumes are benefiting from sales but also prices,” Brian Foran, an analyst at Autonomous, said in an email.
All the while, Americans have been receiving stimulus checks, expanded unemployment benefits and forbearance on their mortgages at a time when their ability to spend on travel, dining and entertainment has been constrained. The result has been an unusual kind of economic downturn, one in which many consumers are flush with cash.
“Never in a recession are incomes up,” commented Warren Kornfeld, a senior vice president at Moody’s Investors Service.
More stimulus payments are likely on the way soon. Congress is working to finalize a plan that is expected to provide $1,400 checks to more than 100 million Americans, in addition to additional jobless aid.
Meanwhile,
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 to the chip shortage as contributing to car supply trends that have benefited the Detroit-based company. Ally reported record net income of $687 million in the fourth quarter.
“The supply constraints have led to margin expansion and high pricing on the used-vehicle side,” LaClair said.
Companies with large auto leasing businesses, especially the financing arms of the auto manufacturers, are particularly well-positioned to gain. That’s because the resale value of vehicles when leases end is likely to be higher than initially anticipated.
The shortage in new cars is likely to persist in the first half of 2021, according to Inna Bodeck, an analyst at Moody’s. “And that problem will abate 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 unusually strong over the past year, as the high level of household liquidity has enabled most borrowers to make their payments, and forbearance programs have kicked problems down the road for many borrowers who have lost their jobs.
Dallas-based Santander Consumer USA, which specializes in loans to borrowers with subprime credit scores, reported an all-time low net charge-off rate in 2020.
“Accounts that have not received a modification since the pandemic continued to perform well,” Chief Financial Officer Fahmi Karam said during the company’s most recent earnings call, “as consumers continue to behave rationally, controlling spending and increasing savings.”
Santander Consumer reported that 697,000 of its customers received a payment deferral between the start of the pandemic and the end of 2020. Of that total, 8% of the customers paid off their loans, and Santander Consumer charged off the debt owed by another 6%.
But the vast majority of the firm’s pandemic-affected customers remained in limbo. Some 63% of them were classified as less than 30 days past due, another 15% were categorized as more than 30 days late, and 8% were still in a forbearance plan.
The strength of the U.S. economic recovery in 2021, which hinges largely on the effectiveness of vaccination efforts, will go a long way toward determining how many cash-strapped borrowers start making their loan payments again.
“I don’t think we’ve seen the full impact in terms of defaults, credit losses,” said Daniel Chu, the CEO of Tricolor Holdings, a subprime auto lender that focuses on Hispanic consumers.
Borrowers with low credit scores are causing more consternation among lenders than those with more pristine payment histories. Blue-collar workers have been disproportionately likely to lose their jobs during the pandemic.
While loans to borrowers with credit scores below 700 comprised only about 25% of active loans in prime auto securitization pools at the end of last year, they accounted for 53% of the loans in those same pools that had been granted extensions during the pandemic, according to S&P data.
“We do expect nonprime performance to show a little bit more deterioration than prime,” said David Laterza, a senior vice president at DBRS Morningstar.
The high margins on loans during the last year may be tempting some lenders to loosen their underwriting standards. In a recent survey by the Federal Reserve Board, 18% of banks that responded said that they expect to ease their auto lending standards somewhat in 2021, and none said that they plan to tighten those standards.
At big banks, 43% of the respondents said that they plan to ease their auto lending standards somewhat, and none expected to tighten them.
Competitive pressures in auto lending have been increasing, particularly in the subprime segment, Capital One Financial Chairman and CEO Richard Fairbank said at an industry conference last week. “So that could impact how big the growth opportunity is,” he added.
