Two major studies indicate the automobile finance industry is in the midst of a major disruption.
The auto finance industry is in the midst of a major disruption, rocked by a confluence of shifting consumer preferences, rising popularity of electric vehicles, entrance into the market by creative fintech companies and automaker efforts to find new revenue streams according to two prominent reports.
The reports from data analytics and consumer credit reporting company Experian and management consulting company McKinsey and Co. also reveal a strengthening challenge to the dominance of automaker captive finance companies as lending leaders and a continuation of rising loan balances.
Ben Ellencweig, Senior Partner with McKinsey, leader of Americas Auto Financing service line
“If there's one takeaway to take from this whole conversation, yes, I think it's important to understand that auto financing is no longer a separate silo. It is a core part of go to market of the entire buying experience. Today, I think you and I don't really differentiate, this is the financing, this is the selection of the car, this is the delivery. It's one experience, it has to be consistent and easy to use,” observed Ben Ellencweig, Senior Partner with McKinsey, leader of Americas Auto Financing service line and co-author with Abhilash Sridharan of the report, “Disruption and innovation in U.S. auto financing.”
It all starts with the reality that average loan amounts are escalating along with strong consumer preferences for costly SUVs and pickup trucks driving up average transaction prices.
Melinda Zabritski, senior director, of automotive financing at Experian.
“Larger vehicles like SUVs comprised more than 60% of new vehicle financing, with no signs of slowing down, so average monthly payments continue to reach new highs. This continues to be compounded by supply and demand challenges, which has also caused spikes in average loan amounts and monthly payments,” noted Melinda Zabritski, Experian’s senior director of automotive financing and author of the report, “State of the Automotive Finance Market Q4 2022.” in emailed responses to our questions.
During the final three months of 2022, total average outstanding automotive loan balances stood at $1.147 billion up from $1.305 billion during the fourth quarter of 2021, according to the Experian report.
Experian graphic showing growth of auto loan balances.
A combination of new and traditional players is shaking up the way consumers are handling the ballooning cost of swinging a new car or truck.
Online financing and re-financing websites such as AutoFi and Caribou are competing with traditional banks and automakers' captive finance companies to make the process more convenient, quicker and less expensive.
In some cases they are actually working alongside dealer finance departments to offer customers more choices.
As that trend takes hold, McKinsey's Ellencweig observes dealers are catching on to not only retain the revenue but create new opportunities.
“If you think about the auto retailers, whether it's dealers, or we're seeing some of the newer OEMs selling direct today, it's actually an opportunity for them to create a much more of a personal relationship from a CRM perspective, just like the Amazon experience,” Ellencweig said. “They can collect data, they understand preferences, etc. and there's actually a lot of information can be gathered, about purchasing behaviors through that.”
When the Federal Reserve raised interest rates to cool inflation, an increasing number of consumers turned to an old standby for relief—credit unions.
Experian graphic showing growth of credit unions for auto financing.
While captives still retain the highest marketshare for new auto finance loans, during Q4 2022, credit unions have seen the biggest growth originating nearly 30% of all car loans and just shy of 25% of loans for new vehicles according to the Experian report.
“Lower interest rates were the main driver in the growth of credit union market share. In many cases, credit unions were offering interest rates a full percentage point lower than other lenders,” said Zabritski. “For new vehicles, credit unions offered an average interest rate of 5.49% this quarter, not far behind captives at 5.45%, but much lower than banks at 7%. Credit unions also had the lowest average interest rates for used vehicles, coming in at 7.03% this quarter, with captives offering 9.25% and banks at 9.34%.
Indeed, consumers financing their vehicles could use a break with average monthly payments hitting record highs in Q4 2022—more than $700 for new vehicles and $500 for used, according to Zabritski.
With new vehicle production still not up to pre-Covid levels dealer inventories are improving, but remain thin, meaning there's no incentive for automakers to offer rebates or other cut-rate financing, leaving consumers shopping around for the best interest rates.
McKinsey and Co. graphic showing projected rapid growth of electric vehicle sales.
The rising popularity of electric vehicles is also creating a disruption in the auto finance space, with the McKinsey report pointing out sales are growing at about 70% annually with a predicted marketshare reaching almost 50% by 2030.
What it all means, says Ellencweig, is the advanced technology associated with EVs presents fertile new revenue ground for automakers and finance companies.
SAN FRANCISCO, CALIFORNIA - Rising popularity of electric vehicles opens new opportunities for auto ... [+]
“So imagine, can I sign up for financing in order to pay off for an upgrade or my software so that's an interesting angle which we never had before,” said Ellencweig. “Second thing, those electric vehicles need to be charged and those chargers are highly expensive. Is it a question of can I get financing for a supercharger at my home? I drive a lot. High speed charging is still expensive, and there's financing there for you and me but also financing for dealers or your corner street grocery shop might decide to have a charger and they need the financing for that.”
A display lists Silicon Valley Bank (SVB) achievements as customers gather to withdraw money at SVBs ... [+]
Although not part of either study, the recent failings of Silicon Valley Bank in California and Signature Bank in New York are causing some concern, but not panic, observed Ellencweig who noted, “I think there's questions all of us consumers are kind of in a wait and see mode, what is happening with the entire finance system. The good news is I think we're seeing some very strong reactions from the Fed and bringing back confidence.”
With only two weeks left in the first quarter of this year, both Ellencweig and Zabritski are looking ahead to the remaining nine months of 2023 and what's ahead for the auto finance industry.
“There’s a few things we’re keeping an eye on, such as rising delinquency levels, and average loan amounts beginning to level out as inventory challenges ease,” noted Zabritski. “Additionally, if there continues to be more interest rate increases, we’ll likely continue to see average payment amounts increase, and terms extend.”
From Ellencweig's point of view, things are looking up for consumers, concluding, “for consumers, it's a great time to watch and see how the market evolves. I think for the big players, it's great time to innovate and I do think we'll be probably talking about it, probably earlier than we think, and we'll see the market changing and faster. So you could probably be very excited about the space. I think it's going to be quite interesting.”
