Investors Worried About Auto Loans Amid Recession Fears

Charge-offs remain below pre-pandemic levels, but the trend remains concerning.

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An increase in auto loan loss rates and uncertainty in the industry has investors concerned, and many of them are unwilling to stick around to find out what happens. The second-largest auto lender in the country, Ally Financial, reported a spike in charge-offs, and while the rate remains below pre-pandemic levels, the trend is worrisome.

Key Takeaways

  • Auto lenders are experiencing a sudden spike in charge-offs as borrowers fail to repay their loans.
  • Loss rates remain lower than they were before the coronavirus pandemic, but there are several other factors giving investors pause.
  • Fears of a looming recession, inflation, Fed interest rates, and other factors have created significant uncertainty in the industry.

The Auto Lending Industry Could Be in Trouble

From the second to third quarter of 2022, the net charge-off rate for Ally Financial nearly doubled, jumping from 0.54% to 1.05%, exceeding the estimate of 0.9%. That figure is below the 1.38% rate for the third quarter of 2019, but Ally expects to exceed that rate in the near term, with guidance from 1.4% to 1.6%.

When considering macro-economic conditions, the trend is especially troubling. It remains unclear how much further the Federal Reserve will go with its interest rate hikes and how quickly inflation rates will respond to that policy. The combination of higher loan payments and inflated everyday expenses, along with a looming recession, could create a perfect storm for auto lenders, leading once again to higher-than-expected losses.

Add in a continued decline in used car values, and borrowers may become increasingly underwater on their loans, giving them less of an incentive to pay off their debt.

On its recent earnings call, Ally Financial's chief executive Jeffrey Brown called the situation for the auto lending industry a "pretty fluid environment." Brown also added that he expects things to stabilize next year, and the bank has adjusted its underwriting standards to limit its risk exposure. It's also increased its pricing and expects the higher resulting yields to more than compensate for rising loss rates.

But there are enough unknowns to spook investors, leading to an 8% drop in Ally's stock on the date of its earnings call. Consumers thinking about applying for an auto loan should shop around and compare multiple top auto lenders to ensure they're getting an affordable monthly payment.

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  1. Wall Street Journal. "Investors Are Wary of Steering Into Auto Loans."

  2. Yahoo Finance. "Ally Financial Inc."