🔮 Auto finance is changing: tightening, abandoning and ABS
✒️ Shoppers corner: deals are in the details
🎤 Full transcript from my podcast with Alex Vetter, CEO of Cars.com: Acquiring the domain, the first 100 dealers, pulse on the car market, EVs, DTC & more…
Reading time: ~3 min
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🔮 Auto finance is ch-ch-changing
The auto lending business is changing rapidly in response to rising interest rates and high prices. Many lenders who were traditionally strong in auto lending are either tightening their credit policies or are abandoning the auto lending business altogether.
I wrote that lenders are also having a hard time adjusting to unreliable book values that are slow to react to the volatile market. They are also worrying about growing delinquency rates that have exceeded pre-COVID levels according to the latest report from Experian.
In the last 60 days, Capital One shut off all dealer floor plans (aka inventory lines of credit), US Auto Sales shut down 39 dealerships, Wells Fargo laid-off all its junior auto loan underwriters and capped future loans, PenFed Credit Union started cutting dealers from indirect auto lending, Citizens Financial Group stopped lending in several states. The ones that stay are tightening their lending standards.
Tightening means they are doing the opposite of what they were doing just a few short months ago: they demand larger down payments, reduce the maximum allowed length of loans, increase credit scores threshold, make fewer exceptions to stipulations, and increase fees charged to dealerships. Everyone and their mother can’t get approved for an auto loan anymore, but can lenders react fast enough to stay in business?
A worrisome trend is that the subprime delinquency index has been steadily climbing.
Subprime borrowers are facing serious headwinds from higher cost of living, higher interest rates, dwindling personal savings, and no government stimulus on the horizon.
Reflecting rapidly increasing vehicle prices and interest rates, average loan balance for subprime borrowers doubled between 2010 and 2023 while household incomes increased only by 40% during the same period.
Borrowers with lower credit scores have been forced into financing at higher interest rates and for longer loan terms, ending up with more negative equity, even when used car prices have been climbing.
There have been plenty of cases where loans were given to people with a virtual guarantee of default. Relaxed lending standards and other shenanigans that I wrote about earlier this year are now causing ripples in the asset backed securities market.
Chasing higher profits, subprime lenders of dealers who specialize in subprime wrote bad loans then securitized them into Asset Backed Securities (ABS). Securities were snatched by investors, such as pension funds, enticed by earning higher yields during the times of low interest rates.
Now, with increased interest rates and increasing delinquencies, these securities are becoming worthless. American Car Center and U.S. Auto Sales are two subprime securitizations that are at risk of default.
As long as interest rates remain high, subprime auto loans will not be performing well. Without excess savings, consumers are more susceptible to missing payments.
Speaking of Asset Backed Securities, the industry is starting to notice the inherent risks associated with future values of internal combustion engine (ICE) vehicles. Ben Scott, a senior analyst with Carbon Tracker wrote on this topic.
There is a lot of uncertainty with the industry transition to battery electric vehicles (BEV). Some experts estimate the penetration of EVs to reach 30-35% by 2030, others see it at 90%.
Here’s the EV adoption chart from UK (which is certainly different from US in many ways), but general trends are indicative of how things may play out here:
Souce: Carbon Tracker
In any case, there is a concern that residual values of ICE vehicles will decline faster than expected. Scott lists a few factors:
Supply shortages are keeping used car prices artificially high, masking real differences in residual values by powertrain.
New government regulations may erode consumer confidence in investing into ICE vehicles
Potential overproduction of ICE vehicles by manufacturers who miss the shift in consumer demand
Improved charging infrastructure and rising gasoline prices could make consumers increasingly positive towards BEVs and regret the ICE purchases.
If residual value of securities collateralized by loans written for ICE vehicles is lower than expected, investors will earn lower or negative returns across the securitized tranches. As we get closer to 2030, residual value risks will become more acute.
Automakers’ financing divisions are typically more profitable than their industrial operations, so OEMs will want to protect this important revenue source. They can try to incentivize dealers and customers to lean towards ICEs, but if investors want to be compensated for the higher risk associated with ICE-based portfolios, it will push OEMs towards more profitable BEV financing.
The advice to investors is to start paying more attention to the proportion of ICE/BEV in auto loan ABS contracts.
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✒️ Shoppers’ Corner
When getting quotes from dealerships, pay close attention to details and make sure you understand each line item. When in doubt, ask the dealership for clarifications.
Here’s a real deal sheet shared with me by a friend:
The deal is for a new Honda CR-V advertised at the MSRP or $35,195. The dealership offered a generous discount of $2,485, which is a sweet deal in today’s market. What is wrong with this deal? Let’s take a closer look:
When putting the numbers on paper, the dealership introduced a market adjustment of $1,995 and included a mandatory Dealer Appearance Package for $995. Add it all up and the purchase price ends up at $500 over MSRP.
Is this still a good deal? It is really not bad given the low supply and the high demand for the brand new, freshly redesigned Honda CR-V. However, stepping into car shoppers’ shoes, I’d much rather appreciate the dealership clearly stating the price at $500 over MSRP, without taking me on the rollercoaster ride of first giving the discount, and then taking it back.
The bottom line: read the transaction line by line and make sure you understand and agree with every number.
🎤 Podcast Transcript with Alex Vetter, CEO of Cars.com
Acquiring the domain, the first 100 dealers, pulse on the car market, EVs, DTC & more…
01:25 - Acquiring the domain
02:44 - 25th year anniversary
05:13 - Company background
09:08 - Keeping up with the pace of tech
12:03 - Tailwinds & headwinds
13:24 - Where are we headed as an industry
18:38 - EV search share
21:38 - Direct-to-Consumer
26:07 - Wholesale and Retail
36:31 - Leaning into AI
40:13 - The Future of cars.com
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