This Is The Worst Auto Loan To Hold As Delinquencies Rise

New and used vehicle affordability has improved over the last few months, but there’s still a slow motion lending crisis in the United States, with auto loan delinquencies reaching a record high. In particular, economic conditions have seriously impacted people who made loans or took out loans during the pandemic.

Also this morning, we’ll talk a little about the impact the strike will have on other companies, Toyota’s plan to win the EV war, and Volvo’s plan to cut out all diesels in the next year.

The Conundrum Of Buying A Car In The Pandemic

I’ll continue to talk a lot about vehicle affordability in this space because, as I see it, it’s one of the three key automotive stories of the next three years (along with labor and the transition to electrification). The car market between early 2020 and late 2022 was simultaneously impacted by: government spending that gave money to consumers, vehicle scarcity caused by production issues, high prices caused by that scarcity, and lower-than-normal interest rates followed by quickly rising rates.

This means that, because fewer cars were sold during the pandemic, those cars were generally more expensive. Additionally, buyers with pandemic cash and access to historically low interest rates meant we continued to see a ballooning of car payment terms out to 72 and even 84 months. The pandemic period was also a field day for predatory lenders who knew that there was money to be made, even with loans that would inevitably default. And then, to top it all off, inflation hit and the Federal Reserve started raising interest rates.

There’s new data out from Cox Automotive pointing to historic delinquency rates:

Auto loan performance deteriorated in August as delinquencies and defaults both increased. Sixty-plus day delinquencies increased for the fourth month in a row in August; the subprime loan delinquency in August was the highest for the month dating back to at least 2006.

A delinquent loan is one that hasn’t been paid on time — a default is when the bank determines the loan isn’t going to be repaid. This distinction is important, and I’ll get to that in a second.

First, though, another term: vintage. The vintage of a loan, like the vintage of a wine, refers to a specific time a loan was made (e.g. Q1 2021 is a loan made in Q1 of 2021 — quite straightforward), and there are institutions that track these vintages. One of those institutions is Standard & Poor’s, which puts out a regular report on the auto loan market. No surprise, the worst vintage right now? Subprime loans made in 2022.

What’s going on? From S&P (CNL stands for Cumulative Net Loss, FYI), here’s why:

We expected subprime CNLs to rise from the unsustainably low levels on the 2019-2021 vintages, but rather unexpectedly (given low unemployment levels), the 2022 vintage is reporting worse-than-historical loss levels with 2.60% in CNL as of month seven compared to 1.99% for 2008 and 2.02% for 2016 at the same month (see chart 9). The deterioration started with the 2022 second-quarter cohort. At month 13, its CNLs are 6.03%, which exceeds the 5.73% for 2008 and 5.21% and 5.28% for 2016 and 2017, respectively, at the same month. The subsequent 2022 quarterly vintages are also showing deterioration relative to historical levels, but not to the same extent. Higher CNLs have been due to greater defaults (chart 11), a precipitous drop in recoveries (chart 12), and, in our opinion, either a liberalization of credit standards among some lenders and/or the inability of their underwriting methods to account for pandemic-related “inflated” credit bureau scores.

This makes sense. If you had to buy a car in 2022, you were hit by the double whammy of super high prices and interest rates that were suddenly climbing. If you’re one of these borrowers you probably didn’t benefit from a super low interest rate, you paid at the top of the market, and the value of your car has now dropped as depreciation returns.

Should we all panic?

“If anything, the market is normalizing in key metrics like defaults and repossessions, and we’re not even back to 2019 levels in those activities,” said Cox Automotive chief economist Jonathan Smoke on the Car Dealership Guy Podcast.

It’s true, and he goes on to add that the default rate (i.e. the loans that the bank assumes aren’t getting paid back) is not rising to the same historical level. But the news isn’t rosy for everyone. The New York Federal Reserve Bank tracks automobile loans by vintage in granular detail, including by age:

Before Autopian commenter rootwrym yells at me, you can see here how, for younger buyers especially, there’s been a long period of time where the affordability of vehicles, predatory financing, and other conditions have resulted in an unfriendly market only made worse by the pandemic.

There’s a huge opening, I think, for an automaker that can address this market.

Toyota Is Going To Toyota Its Way To Electric Cars

Toyota did not sell the first hybrid in America. It was Honda, with the Insight. Toyota is nothing if not a great fast-follower, a company that sees what others are doing and manages to swoop in and use its expertise to win market share (think iPhone and Blackberry) and did so with the Prius.

Never bet against Toyota, is my point, because the entire world copied their lean production methods and its insight into what people want is historically very good. Of course, electrification has long been the area where Toyota, as a brand, has been slow to follow. Not anymore, says Toyota! If the company can combine its historical trust, lean production model, and some new gigaasting to EVs, perhaps it can catch up with Tesla?

That’s the premise of this Reuters report:

Toyota revolutionised modern manufacturing with its system of lean production, just-in-time delivery and “kanban” workflow organisation. Its methods have since been adopted everywhere from hospitals to software firms and studied widely in business schools and boardrooms around the world.

The relentless focus on continuous improvement and squeezing costs helped fuel Toyota’s ascent from post-war upstart to global giant. But in battery EVs, it has been eclipsed by another tireless innovator, Tesla, which has used efficiencies of its own to build market-leading profitability.

Under new CEO Koji Sato, Toyota in June announced an ambitious plan to ramp up battery EVs, a big shift after years of criticism that the maker of the industry-leading hybrid Prius was slow to embrace fully electric technology.

I mean, if anyone can do it…

Volvo Will Kill All Diesels Next Year

It’s been clear for a while that the first internal combustion engine to disappear in passenger cars isn’t going to be a V8, it’s going to be a diesel. Swedish automaker Volvo is making a big deal out of killing diesels with an announcement today:

By 2030 we plan to sell only fully electric cars and by 2040 we aim to be a climate-neutral company. That clear roadmap towards all-out electrification represents one of the most ambitious transformation plans of any legacy car maker.

To underline our commitment to those ambitions, today at Climate Week NYC we announce the end of production of all diesel-powered Volvo Car models by early 2024. In a few months from now, the last diesel-powered Volvo car will have been built, making Volvo Cars one of the first legacy car makers to take this step.

This milestone follows our decision last year to exit the development of new combustion engines. In November 2022 we sold our stake in Aurobay, the joint venture company that harboured all of our remaining combustion engine assets. We’re no longer spending a single krona of our R&D budget on developing new internal combustion engines.

RIP Volvo diesels.

A UAW Story About Suppliers

With Ford now facing a strike in the United States and Canada and everyone struggling to predict the future, The Detroit Free Press is out with a story about how this might impact suppliers:

Pat Green is nervous. He has spent the past two years trying to hire talented people to fill the two plants in Grand Rapids operated by Cascade Die Casting Group, which makes aluminum and zinc diecasting for the automotive and appliance industries.

“We’ve got a good team now and I don’t want to lose people because it was hard to find good people,” Green, who is CEO of the company, told the Detroit Free Press on Monday.

That’s why on the fourth day of a historic United Auto Workers strike against the Detroit Three automakers, Green was intensely planning for ways to ride it out without having to lay off workers if the strike grows and stretches into weeks. He has good reason for planning. On Monday night UAW President Shawn Fain announced a new strike deadline of this Friday at noon. If Ford Motor Co., General Motors or Stellantis have not made substantial progress toward an agreement with the UAW by that time, Fain will expand the Stand Up Strike to more plants.

It’s a serious concern since these plants exist as part of a vast network of companies in these communities and the labor market, to Pat Green’s credit (not that Pat Green), is fairly constrained. At the same time, rising wages in a community tend to give workers more bargaining power.

The Big Question

Ok rootwrym et al., are we in for more huge disruptions or is this a bad set of loans that need to work themselves through the system?