Dangerous Road Ahead On Auto Loans?

Insert your own car/road/looming accident analogy here, and then take a look at auto loans. While consumer confidence may be good, the stock market is at new highs and wages in general are up, there are some concerns bubbling up in this crucial sector of credit and lending.

Bloomberg notes that the auto loan market is growing by leaps and bounds and now is, relatively speaking, a bigger slice of household debt than has been seen in nearly a decade-and-a-half. And in the United States, auto loans are growing as a class of consumer credit. Moody’s Analytics and the newswire estimate the loans outstanding at $1.1 trillion, and of that, a subset of 25 percent is in the hands of subprime borrowers.

And it is the subprime borrower who has been having trouble meeting the monthly note. This speaks to a bifurcation: Despite an improving economy, some are not finding it easier to find the money to pay all expenses or are triaging expenses, leaving some that they may deem non-essential for right now.

In a look at how some of those loans are trending and how they may be impacting lenders, consider that Ally Financial reported that pre-tax income slid by 11 percent last year, and the decline stemmed from auto loan losses and delinquencies. In another example proffered by Bloomberg through its Intelligence unit, Capital One had $45 billion of auto loans on its own balance sheet, where a full third of that book has been extended to subprime borrowers. Loan provisions were up 52 percent year over year in that segment, with profit off 40 percent as a result.

Yet the market – as in the stock market – seems largely unfazed. Investors are looking past those metrics and their possibly perilous signals, and perhaps they are eyeing the rollback of financial regulations and stimulus programs to come from Capitol Hill. The duo just mentioned, Capital One and Ally, have seen their common stock gain by double digits, the former by 29 percent as measured in just the past six months.

A few engine warning lights are blinking, notes the newswire (we had to have at least one auto analogy here).  On the one hand, subprime loans pay relatively higher and more attractive yields that do other classes. But if delinquencies start to spread into higher tranches of borrowers as measured by creditworthiness, then margins get squeezed, as do financial results. If net income turns to net losses, investors will dump stocks of lenders. That effect might snowball if economic growth starts to slow in earnest (as might be seen in a rising interest rate environment).