Car loan delinquencies may be canaries in the coal mine

Automotive industry observers were set ablaze late last week by the Federal Reserve Bank of New York’s latest report on household credit.

The report stated that, at the end of 2018, over 7 million Americans were 90 days or more delinquent on their monthly auto loan payments. Even worse: That number represents 1 million more delinquencies than at the height of the recession in 2010.

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Consumer financing metrics like these are certainly alarming and make great, attention-grabbing headlines. But should we really be concerned? Are rising delinquencies a signal of an underlying weakness in the U.S. economy?

There are reasons to remain calm. The amount of automotive credit has grown significantly since the Great Recession, and although delinquencies volumes are high, the delinquency rate remains relatively modest.

Last year, $584 billion of auto loans were originated, taking the total auto loans issued since 2011 to nearly $4 trillion, a massive influx of credit. Of auto loans outstanding, the 90-day delinquency rate in the fourth quarter (Q4) of 2018 was 4.47 percent — the highest since 2012, but also well below the recession peak of 5.27 percent in Q4 2010.

Still, the delinquency trend is rising across all auto loans. Part of the recent rise is driven by more credit being extended to subprime borrowers. In 2018, nearly $120 billion, or 1 in 5 loan originations went to subprime borrowers, people considered high borrowing risk.

Generally, borrowers with credit scores below 620 are the most economically vulnerable, with unstable income and greater exposure to costs due to their poor credit rating. As a result, the interest rates they pay for auto loans are often three-to-four-times higher than what a better credit buyer would pay, making monthly payments an even greater challenge.

With interest rates rising in the U.S. economy since 2015, the affordability of monthly payments for car loans, and all other debts, is under pressure. Subprime households are the first to suffer. 

The Federal Reserve Bank’s report last week may be revealing an even bigger issue for the automotive industry: The robust U.S. economy is not growing fast enough — or broad enough — for consumers to keep up with monthly automotive expenses.

The bank’s report details loans by borrower’s age, and for young millennials, ages 18-29, delinquency rates are much higher than all other age groups. Student debt, weak wage growth, cell phone costs and other expenses are squeezing younger households hardest, and car payments often go unpaid when ends don’t meet.

Looking back at recent history, it was the 18-29 age group that had the fastest growth in delinquencies as the last recession approached, so monitoring their finances is warranted. However, the current report also reveals that auto loans delinquencies, across all age groups, are at their highest levels since early 2011, during the early stages of the economic recovery.

With the U.S. economy posting record employment levels, strong corporate profits and 10 years of economic growth, elevated delinquencies in this environment suggests vehicle affordability is a growing concern.

Vehicle prices have been rising significantly since the Great Recession. Based on Kelley Blue Book data, average Manufacturer Suggested Retail Price (MSRP) for a new vehicle in the market has risen from $32,665 in 2012 to over $39,003 in 2018, a 19-percent increase.

In the U.S. market, the share of vehicles with a price point under $30,000 has fallen from 55 percent in 2012 to below 36 percent today. Similar increases are appearing in the used market as well.

From high demand for off-lease vehicles and limited older model year supply, conditions are keeping vehicle prices elevated. According to data from Dealertrack, monthly payments for a new vehicle have risen to $533, up roughly $40 a month for a loan and $70 a month for a lease in the past five year, with used payments also rising.

These rising costs, coupled with other cost increases from tightening monetary policy, are putting vehicle buyers under greater financial difficulties. 

Vehicle prices have been rising due in large part to consumer demand for more content and capability. Buyers have shifted toward a preference for utility vehicles, away from generally more affordable passenger cars.

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Automakers have been quick to capitalize on this shift in consumer demand as well, with many cutting smaller, lower-profit vehicles from their lineup. Car share of the new vehicle market over the last five years has fallen from 50 percent to nearly 30 percent, helping drive the upward trend in prices.

Expensive technology content has also been increasing. Components and capabilities such as touchscreens, Bluetooth connectivity, remote start, parking sensors and power-assist features have become increasingly common, and new advanced-cruise-control systems and other driver-assist features will continually be adding cost in coming years. 

Although the U.S. economy remains strong today, there are many signals and indicators pointing to a downturn sometime in the near future. Historically, changes in auto sales tend to proceed changes in the economy, and elevated delinquencies could be an early canary in the coal mine. 

With consumer finances already stretched and auto loan delinquencies piling up, a slowdown in the economy will likely result in even more defaults — as the affordability of monthly payments finally reaches its limit. 

Charles Chesbrough is senior economist for Cox Automotive, which owns both Kelley Blue Book and Dealertrack.