Auto lending might be a safer bet than it seems

I have never owned a new car and I never will. My first car was a 1993 Nissan coupe that was already almost 10 years old when I got ahold of it, and as with many first loves I doted on it, lovingly washed and waxed it, and overall gave it more attention than any 1993 Nissan ever deserved. Like most other 1993 Nissan coupes, it's long since been melted down or is being salvaged in a scrapyard somewhere. As with many first loves, that car taught me a lesson: Never pay top dollar for something that will eventually be worth nothing.

But the used-car market of the last couple of years has turned the reasoning behind my uncool miserliness on its head. Used cars, new cars, any and all cars became increasingly scarce because of a confluence of factors that many have written about extensively: a global shortage of computer chips and COVID hampering supply, stimulus money driving up demand, fewer people taking public transportation, etc. All those forces combined have created a price surge for cars that has endured for the last two years — and that, in turn, has made auto lending a hot business for banks and credit unions.

But the curmudgeonly conventional wisdom about the value of cars is staging something of a comeback. The New York Times proclaimed that the used-car boom is abruptly over, citing rising inventories, falling prices and dramatic contractions among some used-car sales startups like Carvana as evidence. 

Bloomberg News

What is more, interest rates have famously gone up quite a lot over the past year, which has made buying and financing cars more expensive, and as a result thwarted consumer demand. And on top of all that, the Consumer Financial Protection Bureau and the New York attorney general have filed suit against the subprime auto lender Consumer Acceptance Corp. for what they describe as deceptive sales practices, a move that could make banks and other lenders less willing to get into subprime auto lending. What goes up, it seems, must come down.

Or so it would seem. I suspect that the tumult in the auto sales and lending businesses of the last few years may be symptomatic of a fundamental realignment in the nature of those markets than a temporary blip driven by idiosyncratic macroeconomic variables — and the banks and credit unions that understand that broader shift can stand to benefit from it.

First, take a look at a chart of total auto inventory in the United States — the total number of cars made in a year versus the number of cars taken off the road. That number is ticking up slightly, but the overall trend since the mid-'90s has been a dramatic and secular decline. Overall auto sales have been somewhat more steady over that time — notwithstanding the unpleasantness of 2008 — but since the pandemic have largely gone down and stayed down.

CFPB lawsuit seen as warning shot to subprime auto lenders

Now let's consider who's doing the buying. Millennials like myself are the new "it" consumers, the ones in the prime of their careers and spending power and whose money retailers — and banks, for that matter — would very much like to get a hold of. A cursory Google search will tell you that millennials' attitudes toward spending are somewhat different than older generations in a few important respects: we are shrewd when it comes to finding deals, we care about value and corporate ethics, and we tend to be loyal to brands we identify with. We also tend to effectively have less money than our parents and their parents had at our age — all the more reason to be careful with it — and we tend to be decidedly less enthusiastic than our parents or grandparents were about buying and owning cars.

All that seems to paint a picture of what auto sales and auto lending might look like in the near future. Fewer cars will be bought, but those cars that are bought will be "held to maturity" — that is, until the wheels fall off — and will increasingly be electric. That could make both new- and used-car values secularly higher than they have been in the past, though the value retention of electric cars will likely require some time before it can be fully understood.

What that means — at least what I think it means — is that banks in the auto lending business can't necessarily rely on volume, should be choosy in their underwriting and should think carefully about the collateral value of gasoline-powered cars as EVs increase their market share. But transitions like these can be nonlinear and distorted, so in the meantime, buckle up — it could be a bumpy ride.