Auto loans: rising delinquency means investors should buckle up

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Americans splurged on cars in a big way during the pandemic. Auto-loan originations in the US hit a record $747bn last year following a brisk 2021, according to data from the Federal Reserve Bank of New York. Total outstanding debt in the sector stood at $1.6tn at the end of September, or $260bn higher than at the start of 2020.

Four banks dominate vehicle lending in the US — Ally Financial, Capital One, Wells Fargo and JPMorgan Chase. Auto loans have been a bright spot for them amid a sluggish recovery in broader loan growth. 

But cracks are appearing. Loan delinquency is rising and used-car prices are falling. Investors in auto lenders and low-rated bonds backed by car loans should buckle up.

High inflation and interest rates are squeezing the finances of American households, particularly lower-income ones. The percentage of auto borrowers at least 90 days past due on their loans hit 2.53 per cent during the third quarter. That is the highest level in over 13 years, according to Fed data.

Softening used car prices mean many motorists who took out big loans during the car-buying frenzy of the past two years now owe far more than their vehicles are worth. ​​The Manheim US Used Vehicle Value index is down 23 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 credit report group TransUnion and market researcher JD Power. 

Lenders repossess the cars of borrowers in default. Falling used vehicle prices means they are less likely to make enough selling the cars of defaulted borrowers to cover unpaid loan balances. The problem is acute for loans made at a peak in used car prices in 2021 and 2022.

Underscoring this point, auto loan charge-offs at the biggest consumer banks are now well above 2019 levels, according to Moody’s Investors Service.

Shares of Ally Financial and Capital One are up 7 per cent and 14 per cent respectively this year. Time for investors to step on the brakes.

Lex is the FT’s concise daily investment column. Expert writers in four global financial centres provide informed, timely opinions on capital trends and big businesses. Click to explore