Let's Talk Loans - Vol. 92
Welcome back to another week of Let's Talk Loans. If you're looking to dive deeper into the world of banking and lending, you've come to the right place. While we cover all lending products from mortgages to credit cards or commercial real estate to unsecured lending - this particular week will be a deep dive into the state of auto lending. These topics come from the chatter we enjoy from the whole loan desk here at Raymond James. I hope you enjoy the content and please share / subscribe with a peer!
Another week, more surprising economic news. Several clients have expressed confusion as to how the bond market can see yields rise when GDP and the US economy shows weakness. Expectations for Q1 GDP were 2.5% but they came in well under the mark at 1.6%. The arguably more important news was that PCE (Powell's inflation favorite) was expected to be 3.4% and popped off at 3.7%. Right now the direction of rates through inflation is more important to traders / investors than the strength of the economy. That may change if we get more data pointing to a weakening consumer, but today, all eyes are on the stickiness of inflation. Higher inflation means any chance at a rate cut gets pushed further out and yields move higher as a result.
We had a wonderful conversation this week on the state of auto lending. Forgive me for feeling validated here. I know many of our credit union clients get tired of me saying, "Raise your rates and lower your dealer premiums" but to have someone like Melinda Zabritski drop truth bombs was helpful. The header to this slide was really powerful for me:
"Credit Union rates average 1.08% lower than banks"
For the entire market, the 2023 average used car rate is 11.59% and new car rate is 6.92%. As always, the devil is in the details. A typical credit union portfolio is roughly 70/30 used to new. Banks tend to slant a little more to new, let's call it 60/40 used to new. The super prime credit bucket (760+) is a much tighter spread as you would expect. Banks have a coupon of 8.12% vs a credit union coupon of 7.46% - only 66bps apart. Looking solely at used car rates, those who have utilized our portfolio analysis will hear my words as I write this. That B+ tier of paper is where you can earn an outsized return. That 680-719 band of credit jumps nearly 220bps in coupon for banks (10.31%) and only 135bps for credit unions (8.81%). Credit unions often misprice deeper FICO loans because of their mission driven effort. That's brought into focus as you get into deep subprime. Credit unions only raise their rates 171bps between the 300-599 and 600-639 tiers (12.80% vs 11.09%). Banks on the other hand jump over 275bps (16.62% vs 13.84%). Admittedly, credit union origination volumes fall off pretty significantly around the less than 660 FICO range. They typically are more heavily slanted to prime lending.
I found it interesting the trends Melinda presented on loan terms. In our analysis, we often see credit unions issuing much longer terms and also a small but growing share of 96 month lending. You can see it below in new lending (43% vs 32%). However, banks and credit unions appear neck and neck on the used size of originations (32% vs 31%). I'm curious readers' thoughts on this. Lenders have a few levers to pull as it relates to payment. Affordability is an issue in the current market. We are experiencing higher balances due to higher car prices. To keep payments low you have rate or term to manage. Raise your rates and shorten your terms - payment goes up. Raise your rates and lengthen your terms, payment goes down. In our analysis, we've felt credit unions try not to raise rates as quickly (to benefit their members) and lengthen terms to keep payments down. That's counter to Melinda's numbers below.
Furthering the above talk track about affordability. The average new car payment is $735 a month. The average used car payment is $532 a month. You'd need to earn $88k and $64k respectively to afford those payments.
This stat continues to amaze me - 16% of new payments are over $1k a month now. That used to be a mortgage.
Closing the auto chat with performance. Experian has tracked DQs back through the previous great recession. A few interesting stats that we spoke about on the webinar. The below chart shows 60 day DQs by both number of units and balance. Balances are a bit unfair because loan amounts today are much higher than they were over a decade ago. Still, you can see what many of you have felt in your own portfolio. By count we are 2bps higher than the great recession, but by balance we are nearly 25bps higher. Performance in the auto sector has continued to worsen, particularly in the 2022 vintage. That's a combination of:
COVID savings have been spent
LTVs, specifically to used cars, were inflated due to COVID
Persistent inflation of goods and services are squeezing the lower end of credit and younger borrowers being impacted the most
From a trading aspect, autos remain incredibly hot. In the last decade, 2023 was the 2nd best year we've had in trading autos. Looking at the first quarter of 2024, trading volumes are up 26% YoY in this sector. Spreads have tightened in and premiums have risen as new coupons have come online. Specific to pricing, the average pool in Q1 of 2023 was trading at light discounts just south of PAR. Today, premiums have risen roughly 200bps since last year. This continues to be one of the lending sectors you can get an improving gain on sale and is in demand. Autos are a sellers market.
I hope this gives you a great glimpse into the land of auto loans. Have a great weekend! (M24-482219)