New Warnings Car Buyers Need to Hear

Rising interest rates make auto loans and monthly payments more expensive.

The health of the economy is something to worry about.

It may be one of the dominant issues on the minds of voters when they go to the polls in the coming weeks to vote in the midterm elections, according to opinion polls.

The health of the economy is also a major topic of conversation among investors. The question is whether the current economic downturn will turn into a nightmare.

According to economists, the fault lies with the monetary policy of the Federal Reserve. Economists feel that the Fed waited too long before raising interest rates, after numerous stimulus programs aimed to prevent the covid-19 pandemic from crushing the economy were enacted by the government, leading to higher inflation.

The Fed continues raising interest rates, which risks causing a so-called hard landing for the economy, aka a recession

This downturn is likely to translate into waves of job cuts and the freezing of business investment. Above all, it risks forcing consumers to curb their spending. Consumption is the engine of American growth. Investors are therefore looking for any signal that would show that consumers are showing a little more caution.

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Red Flags

But there is also another indicator which could signal that things are not going well: outstanding payments. Do consumers still manage to make their credit payments, given that the rise in interest rates has made credit expensive?

The banks, which are in the best position to provide an answer to this question, have just raised red flags which are particularly concerning. These warnings involve car loans which, along with real estate loans, are an important barometer for assessing the confidence of households.

Falling used vehicle prices may create a ticking time bomb in the coming months, as owners find themselves with high credit obligations while the value of their cars has fallen sharply.

“Total consumer net charge-offs increased $72 million from the second quarter to 40 basis points on average loans driven by an increase in net charge-offs in the auto portfolio,” Wells Fargo’s  (WFC) – Get Wells Fargo & Company Report Chief Financial Officer Mike Santomassimo, said during the third quarter earnings’ call on Oct. 14. “Higher loss rates on certain auto loans, originated primarily in the latter part of 2021, contributed to the linked quarter increase in charge-offs and delinquent loans in the auto portfolio.”

Revenues generated by car loan activities have thus decreased by 5% over one year, and by 3% compared to the second quarter. 

One of the most worrying signals came from Fifth Third Bancorp  (FITB) – Get Fifth Third Bancorp Report, which decided to pullback of loan originations.

“There has been a real tightening in margins on new auto production, on one hand, and on the other, there’s been a decline in used-car prices,” Fifth Third CEO, Tim Spence, told Bloomberg News. “That has caused us to throttle a bit back on production” of loans.

Used Car Prices Are Falling

The fear is that vehicle owners will no longer repay the loan on a vehicle that is not really worth much anymore. The banks may thus find themselves seizing goods that are worth much less than what is owed to them.

The prices of used vehicles jumped by more than 50% at the time of the pandemic, when consumers wanted to avoid public transport. But since then, we have witnessed a decline in prices.

According to the Manheim Used Vehicle Value Index, in the first half of October, wholesale used vehicle prices fell 2% from the month before.

“Financial results were partially depressed this quarter as a result of an impairment on a non-marketable equity investment related to our mortgage business (..) and higher provisions as a result of loan growth in auto finance and a larger coverage build to ensure the company remains protected as recessionary conditions feel more likely to occur in the coming months,” said Ally Financial’s  (ALLY) – Get Ally Financial Inc. Report CEO, Jeffrey Brown. 

Provision for credit losses was 19.3% higher in the third quarter year over year. The retail auto net charge-off rate was 1.05%, up 78 bps year over year, and it could jump to 1.6% in 2023.

The CEO said, however, that Ally Financial, which has one of the largest car loan portfolios in the U.S., does not intend to change its strategy.

“Industry vehicle sales remain pressured but our ability to generate strong consumer originations shows the scale of our auto finance business and depth of application flow,” Brown told analysts during the earnings’ call on Oct. 19.

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Union Capital Financial Group Ltd, registered in the British Virgin Islands, does not provide investment services inside the United States. The company only provides consulting, advisory and educational services.