Could car loans be problematic for downstream banks?

The coronavirus pandemic has likely resulted in hundreds of billions of dollars in total loan deferrals, in which lenders allow borrowers to skip certain payments and move them to the end of a deferral period or perhaps the end of of the term of the loan. These deferrals have become a big mystery to anyone watching the banking industry, as investors and bankers themselves try to figure out how many of these borrowers will get back to good financial shape and how many loans will turn into losses.

There’s been a lot of talk about business sector issues, and credit card loans typically see higher loss rates during a recession. Many of the nation’s top auto lenders are also experiencing high deferral rates. There had already been signs of trouble in the auto loan segment before the onset of the pandemic, which raises the question of whether banks will see problems in this portfolio in the future.

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Posting levels

Some of the largest auto-lending banks in the country are Capital one ( COF 1.90% ), JPMorgan Chase (JPM 1.83% ), Wells Fargo (WFC 2.07% ), Allied Financial ( ALLY 1.61% )and Santander Consumer USA Holdings ( SC ).

Bank Reports in the automotive portfolio*
JPMorgan Chase 7.4%
Wells Fargo ten%
Capital one 3.4%
Allied Financial 21%
Santander Consumer USA Holdings 17.7%

* As of June 30, 2020. Source: Bank Earnings Documents and SEC Filings.

As you can see above, most of these companies and banks had high deferral rates as of June 30, and I think what stands out is that deferral rates in auto portfolios were up compared to other loan segments. At JPMorgan, a higher percentage of the auto portfolio was on backorder than in the home loan and consumer card and business card portfolios. At Wells Fargo, automatic deferrals were at the same or slightly lower levels than residential mortgage categories, but higher than credit cards and other revolving and installment loans. And at Ally, the auto deferral percentages were much higher than in the company’s mortgage or personal lending businesses.

Another interesting stat offered by some of these banks was the number of customers who made a loan repayment while enrolled in the deferral program. At JPMorgan, 34% of customers made a payment during deferral, which was a much lower percentage compared to the home loan and business and consumer card categories. At Wells Fargo, only 24% of auto customers made a payment during deferral, compared to 34%, 48% and 62% in the bank’s residential mortgage, credit card and junior lien categories, respectively. Capital One seems to have performed better; the company has seen 14.1% of auto accounts go into rollover since the start of the pandemic, but 10.7% of those accounts are no longer enrolled.

Asked by an analyst on the company’s recent earnings call whether higher automatic deferrals mean anything for future ‘credit trends’, JPMorgan CEO Jamie Dimon replied with a ‘no’. very simple. Capital One co-founder and CEO Richard Fairbank also addressed the increased use by auto borrowers of the company’s deferral program. He said auto and mortgage customers are more likely to use the programs because those loan repayments are much higher than, say, a credit card payment, and the company was seeing a correlation between using the deferral program and higher loan repayment sizes. Additionally, he said “the stakes are higher for the customer” to keep their cars.

Capital One Chief Financial Officer Scott Blackley pointed out that actual losses in the card book are generally higher than those in the auto portfolio, mainly because it is easier to collect collateral on auto loans if needed.

The problem was brewing

Trouble was already brewing in the auto loan segment before the coronavirus pandemic hit. Americans have racked up auto debt at record levels. In mid-2010, the total volume of auto loans in the United States was less than $700 billion. By the end of the second quarter of this year, it had reached nearly $1.2 trillion.

Drivers also take out larger loans. According to NPR, at the end of 2019, drivers were paying an average of nearly $38,000 for new cars, up 26% over the past decade. However, during the same period, the value of these vehicles had not increased as much.

Americans also took out longer car loans. In the first quarter of 2019, 70% of new and used car loans ranged from 61 to 84 months (five to seven years), according to a study conducted by Experian in 2019. The problem is that the car will depreciate sharply and even may collapse before the loan is repaid.

Cracks in the car loan market were already beginning to appear before the coronavirus hit. About 5% of outstanding auto loans were more than 90 days past due at the end of the first quarter of 2020, the highest rate since 2012, according to the Federal Reserve Bank of New York.

Watch it carefully

Car loans are an asset class that is a bit like home loans during the Great Recession. People are taking out larger loans, and as loan periods have gotten longer, it can happen that the outstanding balance is more than the actual value of the car.

It’s similar to the Great Recession, when homeowners made the same monthly mortgage payments they always had — or more if they had a variable-rate mortgage — even as their homes fell in value.

Although a car loan is much smaller than a home loan, I think the high deferral rates in car portfolios show us that the car borrower can be very sensitive to economic conditions, so it’s a segment of loan which must be monitored carefully.

This article represents the opinion of the author, who may disagree with the “official” recommendation position of a high-end advice service Motley Fool. We are heterogeneous! Challenging an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and wealthier.