After two years of staying largely on track with their auto loans, borrowers are starting to miss payments again.
Deterioration in auto loan quality occurs faster among consumers with non-preferred credit ratings who are hit harder by inflation and have less money to spend on their auto loans each month.
So far, delinquencies on auto loans remain below pre-pandemic levels, thanks in part to the lingering effects of stimulus measures and savings reserves that some customers have accumulated. But the rise in delinquencies may be a sign that the stellar credit environment for lenders is beginning to transform, increasing the possibility of losses on the loans they have made.
Auto loan losses for lenders remain at extremely low levels, but there is “clear stress for unprivileged consumers,” who are more vulnerable to inflation, said Piper Sandler analyst Kevin Barker. Credit quality “holds up better” in banks than in non-banks, which play a bigger role in the subprime auto market, Barker said.
About 7.25% of non-preferred auto loans in May were marked as 30-59 days past due, up from 5.20% a year earlier, according to new data from auto loan indices from ratings firm KBRA. The indices track auto loans that have been securitized and sold to investors.
Delinquencies have been increasing since April 2021, and although tax refunds contributed to a slight improvement earlier this year, the KBRA believes this effect will be temporary.
“We expect these seasonal tailwinds to dissipate next month and inflationary pressures to put upward pressure on casualty and delinquency rates as we approach the summer months,” the report wrote. KBRA analyst Brian Ford in the company’s latest report.
Borrowers with prime credit scores are also seeing delinquencies rise, with 0.82% of loans marked as 30 to 59 days past due in May compared to 0.6% in May 2021, according to KBRA.
Lenders have long expected their extremely strong credit metrics to gradually return to more normal levels, and they are expected to share updates when they report quarterly results from next month.
At Ford Credit, the financial services arm of the U.S. automaker, delinquencies are starting to rise and appear to be “more average-reverting,” Ford chief financial officer John Lawler said last week.
“We’re seeing a bit of a headwind there in terms of delinquencies as maybe a leading indicator,” Lawler told a Deutsche Bank auto industry conference, but delinquencies aren’t ” not yet a concern” given that they have been so low during the pandemic.
These delinquencies could become something more worrisome for auto lenders, who could eventually begin to post more losses on their balance sheets by charging loans they cannot collect.
Net write-offs have remained extraordinarily low for auto lenders over the past two years, partly reflecting the favorable credit environment. But soaring used-car prices also helped limit net charges, said Moody’s analyst Inna Bodeck.
Prices for used cars – which have been in high demand after a shortage of chips hampered production of new cars – rose 16.1% in May from a year earlier, according to the latest report on inflation from the Bureau of Labor Statistics.
Higher used car values mean cars are worth more when traded in, which increases the amount lenders recover and therefore helps offset the amounts charged.
Once prices come back down, net charges will likely become “a bit more pronounced,” Bodeck said.