For all the talk of a soft landing in the US, there’s one corner of the economy where the hazard lights are flashing: the $1.6 trillion motor-vehicle lending market, which accounts for around a quarter of non-mortgage consumer credit. For the past three years, bad debts have been rising. As of June this year, loans 30 days or more past due were back at levels not seen since the country was recovering from the Great Recession in 2010. Among subprime borrowers, delinquency rates are now even higher than during those times. Is that a sign of deeper stress, or will it be contained?
To answer the question, we need to dig into individual lender portfolios. One of the first to highlight the risk was Credit Acceptance Corp., a specialist auto financier headquartered near Detroit. On its earnings call in July, Chief Executive Officer Ken Booth warned that loans originated in 2022 were performing below expectations and that the company’s 2023 vintage was slipping as well. The company’s stock price fell 15%.
Credit Acceptance caters mostly to the nonprime segment of the market, where delinquency rates can be volatile. But in September, Ally Financial Inc. flagged that it, too, was seeing credit deterioration, and that it was getting worse. Its stock fell 18%.
“On the retail auto side, our credit challenges have intensified over the course of the quarter,” Chief Financial Officer Russell Hutchinson told an investor conference. “In July and August, we saw delinquencies up about 20 basis points versus our expectations … We’re clearly dealing with a cohort of borrowers who have been struggling with cost of living and now are struggling with an employment picture that’s worsened.”
At both lenders, credit approved in 2022 and 2023 is the source of the stress. Higher vehicle prices in the aftermath of the pandemic meant borrowers took bigger loans. Between January 2020 and September 2023, average car prices rose 30%, inflating the cost of servicing a loan. While average monthly payments increased by only $40 in the three years to January 2020, in the three years after, they increased by $130, to $600 per month, according to data from the Federal Reserve Bank of New York.
Eighteen months on, loans originated in the first quarter of 2023 have gone delinquent at a cumulative rate of 7.3%, compared with average delinquency between 2011 and 2019 of around 6.5% at the same point in time. Given that auto-delinquency rates historically top out at around 14%, ultimate losses are likely to be higher.
The problem is that many lenders approved a lot of loans in 2022 and 2023. Over $160 billion of auto credit was extended across the two years, according to the Federal Reserve, twice the volume extended in the 24 months prior to the pandemic.
Not all lenders are equally exposed. Ally Financial leaned into the rising demand. Although it reduced its approval rate in 2023 to 30% from 34% in 2019, it still extended more volume than in the last full year before the pandemic to retain its leading market position. Credit Acceptance pulled back in 2021 and the first half of 2022 but put its foot back on the gas too soon, originating record volume in 2023. Traditional banks, meanwhile, steered away, ceding market share.
One such bank is Capital One Financial Corp. “Credit performance is a function of choices you’ve made over the course of multiple years,” CFO Andrew Young told investors at the same September conference where Ally Financial warned. “And we really like the choices that we’ve made.” The bank reduced origination in auto lending to an average $6.7 billion a quarter in 2023 compared with an average of $7.3 billion in 2019.
Now that others are struggling, Capital One is dialing it back up. “We remain cautiously optimistic and are leaning a little bit into volumes at this point,” said Young. So far, the episode looks more like a classic underwriting cycle than anything more systemic. But given that car loans are often the last debt a borrower will default on, economists will be hoping auto lenders don't cause a pileup.
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