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The Auto-Loan Industry's Warning Light

Delinquencies are on the rise and only expected to get worse.
As of 3:53 PM EDT
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The U.S. auto-loan market is starting to show some strain.

First, delinquencies among lower-rated borrowers have risen to the highest level since 2009.

Second, the amount of auto loans outstanding is growing at the fastest pace on record and now accounts for a bigger proportion of total U.S. household liabilities in at least 14 years.

Cars for Everyone

The volume of U.S. auto loans has risen at a faster pace than other types of consumer credit

Source: Moody's Analytics, Equifax

Third, delinquencies and losses are expected to only get worse.

To be clear, this doesn’t point to an imminent, 2008-style meltdown. After all, the U.S. auto-loan market is about $1.1 trillion, which pales in comparison with the $8.9 trillion U.S. mortgage market and $8.6 trillion of dollar-denominated corporate credit. And only about one-quarter of the outstanding car loans have been extended to subprime borrowers, who are the ones having the problems.

Still, the auto-loan losses are concerning, especially in light of the continuing economic recovery. As more borrowers fail to pay their bills, there will be some significant losers.

Chipping Away

Ally's need to reserve more cash to cover auto-loan losses has eaten into its profits

Source: Bloomberg Intelligence

Ally Financial, for example, reported an 11 percent decline in pretax profit in the fourth quarter as delinquencies and losses rose, according to filings highlighted by Bloomberg Intelligence’s Ryan O’Connell. Even harder hit was Capital One because about one-third of its roughly $45 billion of auto loans are extended to subprime borrowers, as O'Connell pointed out. It reported a 52 percent jump in provisions year-over-year, with pretax profit at its consumer lending unit falling 40 percent

More Losses

Auto lenders have reported a rising proportion of net charge-offs in recent years

Source: Bloomberg Intelligence

So far, investors don’t seem all that worried about auto-loan distress. Capital One’s shares have surged 29 percent since the end of September, while those of Ally have risen 20 percent. After all, these companies are still solidly profitable.

But these two companies will be important to watch as harbingers of broader pain in the auto industry as well as in broader consumer creditworthiness. And they're not alone. The pain will also most likely extend to smaller independent lenders, including Exeter Finance, DriveTime, Flagship Credit Acceptance and Westlake Financial Services, not to mention the captive financing arms at auto companies.

Less-creditworthy borrowers may be having the most trouble right now, but they’re not the biggest concern for auto-loan investors. Subprime loans pay higher yields, which provide investors bigger cushions to absorb defaults and delinquencies. Prime loans, though, have much narrower margins, so if creditworthy borrowers start to have trouble, losses will pile up much faster.

And just think, delinquencies are rising despite the generally strong economy. Should growth slow, more car owners will inevitably struggle to meet their obligations, including those with better credit ratings.

Meanwhile, as rising delinquencies and losses cut into profits, companies may opt to simply underwrite more auto loans, possibly at narrower yields. This shrinks any room for error and will most likely only make the situation worse should growth stall. Meanwhile, used-car values have declined, reducing potential recoveries.

The troubles in the auto-loan market will inevitably cause a lot of headaches and possible insolvencies. If auto lenders get more aggressive with their loans to bolster their profits, the eventual losses will only be worse. 

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

    To contact the author of this story:
    Lisa Abramowicz in New York at

    To contact the editor responsible for this story:
    Daniel Niemi at

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