Why Americans Are Falling Behind on Auto Loans At Their Highest Level Ever

23:35There are a lot of rural communities. So if you look at the state where there's the biggest difference between scorable people with the new score, it's actually West Virginia. And so those economies could certainly do really well from a change to more people having home ownership. And then the second thing, too, is obviously RMBS is really important. I had some challenges back in 2008, 2009, right? And so having a better performing model. Challenges is a very modest way of putting it. I've heard about those challenges. I think they came up a couple of times. I was educated in the UK. Pardon me.

24:07We have a tendency to understate things. But so, you know, having a newer, more proven model, one that's, you know, worked so well in credit card and other things for the past eight years, it's become the most used model in many other segments. So having a proven model that's newer and more predictive should help as well with reducing the systemic risk in the RMBS market. Just to go back very quickly because I don't know if it sounded important. Can you just clarify a little bit more? What is this rule change such that could unlock additional source of demand here? Okay. So when a bank before wanted to submit loans to Fannie Mae and Freddie Mac, they could only submit those loans using the FICO Classic score.

24:48Okay. Which is actually two, three different scores. We'll go into that another point. But anyway, and there used to be like a cutoff that if you didn't have 620, then you couldn't be able to submit it. You could go to an FHA loan, but those are more expensive. Right. But you couldn't necessarily get a normal conforming loan that goes to finding me a Freddie Mac. So that's not changed. First of all, that minimum limit of FICO has been removed. And now they are just updating all the pipes to allow them to use Vonage score as a choice. So now there'll be a choice. Lenders can choose which score they want to use.

25:16And they can make their own evaluations about which one performs better. Okay. So let's go back to starting at the end of last year. And you saw that increase in delinquencies among people with decent incomes. Maybe they didn't have as much wealth. Talk to us about the numbers. How big were these numbers? How much did they catch people by surprise? And what is the story there about why there was this delinquency pressure? Well, so the good thing is it's evolved a little bit since the end of last year. But when we're looking at this data then, again, look, high-income earners, not surprisingly, have lower delinquency rates than middle-income earners and that had themselves lower delinquency rates than the lower income, right?

25:54But not a lot of people were looking at that kind of year-over-year trend and the momentum, right? I'm always looking at momentum because I'm trying to get an early read on kind of how things are developing. And so at the time, actually, let's go back a little bit because I think it can explain a little bit more about what's going on in the economy. Is that all right? So when the pandemic happens, right, a lot of stimulus comes in, a lot of forbearance programs are put in place. As a result of that, so many people's credit health and the way that they appear on the credit files improved dramatically.

26:25They were paying down their credit cards. They were building up their savings. It was a good situation, temporary, but good. But then 2021, 22 starts creeping in and we start seeing that, okay, this is not a persistent situation. This was a one-off, right? And we started seeing delinquency rates starting to come up again, right? What we saw, which shouldn't be too surprising, particularly given that that was when inflation was kicking in in a big way, was that those that were initially impacted and who were showing the biggest rises were the lower income households, right? So for the first sort of, you know, six months, nine months, that was the group that was seeing the biggest year-over-year increases.

27:05But then what we started seeing was that come 2023 forward, we actually started seeing that then the middle and higher income households were starting being impacted too. And that's probably related to the fact that lower income households had less disposable income, but they also had less savings put away so that, you know, they're the first to feel the pain. But then when there's this consistent imbalance between your inflows and your outflows, right, even if you have, you know,$30 ,000 or$50 ,000 that's put away, that's going to start depleting. And that's what we started seeing happening, even with these higher income households, because at the same time, you know, they were hit by so many pressures, right?

27:46Biggest rent increases I think we'd ever scene came into effect those few years after COVID, right? We saw things on, you know, car prices, costs of auto financing going up through the roof, and then various other costs also went up substantially. And so it's not that higher income people were immune from this, right? Also, as an economist, a lot of people always talk about, hey, when inflation kicks in, it disproportionately impacts lower income households because the cost of bread, the cost of milk, etc. You know, it's not like high-income people buy milk that's 100 times more expensive, right?

28:20But the reality is, is if you look at people's big outlays, many of those actually scale with income. Rent, for instance, people that earn more tend to rent higher. Other big outlays such as childcare, education, and other things, they also have been scaling more with income. Now, obviously, there's a level of income that, you know, that does not apply to. But if we still talk about that cohort, 150 to 250 or so of household income, they're definitely seeing that they felt the pain too. It took them longer before it started impacting their delinquencies, but they did start feeling the pain. The good news though is that as we started looking at the second half of this year, right?

28:59So we still saw those delinquencies and high incomes rising very heavily at the beginning of the first half of this year. But since July, and I've got data from October, so three of the four months since July, we've seen that higher income households came down. So that's a good sign. And the reason I say that's a good sign is not because I'm a fan of making the case-shaped economy even more so, but the fact that so much of the US economy is driven by spending. You mentioned earlier that high income households disproportionately impact that. And so if that dries up, that has a knock-on effect on the whole economy.

29:32So to the fact that we're seeing that cohort, that those delinquencies are starting to come down, I think there's some light at the end of the tunnel.

29:54Hello and welcome. This is the Michelle Hussain Show. I'm Michelle Hussain. I speak with people like Elon Musk. I think I've done enough. And Shonda Rhimes. That's so cute. This will be a place where every weekend you can count on one essential conversation to help make sense of the world. So please join me, listen and subscribe to The Mishal Hussain Show from Bloomberg Weekend, wherever you get your podcasts. You certainly ask interesting questions. I always wondered how useful are big shopping events like Black Friday or Christmas in terms of gauging consumer sentiment? So you always see the headlines.

30:36You certainly saw them this year, you know, record Black Friday spending. But then you also see people break down that spending and say, well, actually, it's because everyone is so pressured. They really need the low prices. So they're buying everything now. How useful is something like that to you? You can always see trends, right? And so from one perspective, it's always good to look at a number of different things, such as spending on Black Friday, Cyber Monday, etc. Because there are nuances into how people have been spending for those weekends over 20 years. But still, if you look at the last three years, you can start to see things that are happening.

31:10But the thing that I haven't been able to get my head around is how much of that year-over-year increase in spending on the holidays is driven by the prices of the goods going up versus people buying things that would have traditionally been more expensive or splurging more. That, for me, isn't obvious. And I think that, again, when trying to understand how the economy is going, it's so important, if you're looking at it from a spending perspective, to actually look at the different merchants, right? So how's McDonald's doing? What are the trends there? what's happening in high end? How is LVMH doing versus Walmart, et cetera?

31:45Because again, even though I said that there's a silver lining in the high income consumers are seeing declines, middle income have come down, but they're still increasing. And low income are staying persistently high, around 8 % year over year increases in their delinquency rates. And so we're probably next you're going to see more households struggling to make ends meet than we saw this year. I still don't think that there is, just looking at the trends, going to be any kind of major break point. But the thing to bear in mind with that, though, is that if you look at here, this situation, and you look at, for instance, JP Morgan published that the amount of cash people have in their checking accounts is coming down.

32:30So it just means that there's more of a challenge if there's a big shock to the system at some point. Not that I can foresee any shock to the system, but it's always something to be a little bit wary of. Before we go on, I want to go back to something you said very quickly. You said, okay, intuitively, people with higher incomes are going to have delinquencies at a lower rate than people with middle incomes, and they're going to have delinquencies at a lower rate than people with lower incomes. That's not intuitive to me, actually, because I would also imagine that underwriting is very different, etc.

33:02It's not obvious to me why higher income people default less than lower income people because I would imagine lenders know their income and they're going to scrutinize the loan of a lower income person much more intensely, etc. So why should this trend exist given that they don't get the same loan terms or same loan availability? No, they don't. And a high income household will buy typically more expensive than a car than a low income household will. But higher income households tend to have more of an ability to squirrel some money away or they tend to have other assets that they can – But the lender knows that.

33:40The lender knows that the higher income household is going to have likely more savings and the lender knows that the household that's in a very tight income probably has very little cushion in the form of what we call wealth. And so why doesn't that just get baked into the underwriting standards? Well, in ways it does, right? And so when you're underwriting a loan for, let's say, somebody who is high income and has a good credit history, your expectation of their default is going to be incredibly low, right? So that's built into the pricing and that's built into... And you obviously don't just look at a credit score.

34:15You look at what their income is and various other important metrics to be able to determine the appropriate amount that you will lend them, et cetera, right? But high income consumers may not need to take on as much debt as a proportion to their income as lower income households to get through what they need to do, right? And so if you look at, for instance, a high income household, how much of their, even though, for instance, probably housing and car costs are some of the biggest outlays they have, proportionately, they're probably less than for lower income households, right? And so, you know, a lot of it has to do with that proportionality, but then also just that, again, they will tend to have a bit more reserves so that they can ride through situations.

34:55Talk to us about auto delinquencies. Those have been rising and obviously there's a lot of lending going on. Again, Tracy mentioned the sort of 2020 to 2022 vintage car prices themselves are going up. So not only have the rates gone up, but we've seen a tremendous amount of auto inflation. So sort of stress at every level, we see the numbers going up. What do those tell us? It's a fascinating story. There's been a lot of interest that was paid attention to auto loans because suddenly in 2022, we started seeing these auto loan delinquencies going up much faster than other types of loan delinquencies.

35:29And it was having a profound effect, obviously, on auto lenders and the economy as a whole. And everybody was trying to explain, well, you see, we got a bit too loose during the period of COVID and other things. And they started adjusting their lending criteria, right? So they did adjust their criteria around 2023 for most of them. But then we still saw that despite that, the delinquency rates kept persistently increasing. And then when we looked at the data, we actually saw that, but they had actually had an impact by adjusting their lending criteria. We saw that the delinquency rates among subprime auto loans reduced quite dramatically after that.

36:05So they did have that effect. But we saw that the delinquency rates on near prime and prime continued to go up. And that was what drove that increase. And so we realized there's something more going on here. And also, why is it it's so different? So we went back a long time. We went back to 2010 to try to understand kind of what's been going on because not many people look at it from that timescale, but it's actually quite fascinating because back in 2010, auto had the best performance of any loan product at the time. It was the least risky loan product. This was always the narrative that Americans will never give up their cars.

36:36Even if they lose their job, they can sleep in their car and live in the car, which is very dystopian. But I remember hearing that story literally from a banker, A banker who was actually working on bundling phone loans. And he was like, no one will ever give up their phone. No one will give up their phone. So at that time, it performed well, right? And people did not default as much on that as on other products. But then we've seen it has transitioned over that 15-year period to now the first quarter of this year, it was the riskiest credit product out there. And it then subsequently student loans started coming in.

37:11And that's another story. Those delinquency rates are at historic levels. But on the auto loan side, we then try to understand what's causing this, right? And so what we've seen was that there's a number of factors, some of them obvious, some of them a little bit more subtle, right? The average cost of a car has gone up an incredible amount. And what we've seen is then the average loan value for auto loans has increased more than any other loan value. And that may sound like, okay, but if you think about it, mortgages tend to be the one that grows the most because house prices have appreciated so much over time.

37:41So the fact that the average auto loan has grown more than the average mortgage has over that 15-year period is telling, okay? Secondly, obviously, there is this double whammy. So not only is the car more expensive, but then more recently, interest rates have been higher, right? And so, you know, then I'm going to have to pay more, not just for the principal, but also the interest. But I think one of the things that has caught many consumers off guard is, okay, so they're in the dealership, they're being shown some numbers, some people get it, and they go like, okay, yes, we can still do that.

38:12We can make it work. We can just about mix and stretch. Because also I think people are trying to buy either the same that they had before or slightly better. I know many people like downgrading. And so they think, well, it's the same car. And yes, it's a little bit more, but we can make ends meet by looking at these numbers. But what they often forget about is that insurance has gone up significantly, as have just the cost of ownership, repair costs have also gone up substantially. And so when all those things then hit them, they can be in a situation where we just can't make it work. And so that's not good.

38:44And the key piece of this too is, look, the good thing is of all the loan products, mortgages are performing pretty well. Okay. They are increasing, but they're still much, much lower than they were back in 2010 and obviously much lower than 28, 29. So, but if you default on a mortgage, it takes some time before anything really happens, right? With an auto loan, they will come and they will take that car away from you. And given that, you know, so many people rely on that car to go to their job, to make their income, to do other tasks that are important, like their shopping or taking their children to the school or other things that they need to do, people don't willingly just default on these auto loans.

39:21And so I think it is a sign that correlates with the fact that, you know, more households are struggling to make ends meet. How much insight do you have into leverage? And the reason I ask is because we've seen an explosion in buy now, pay later programs. Virtually every site you go to now has three different options for getting a loan for a small amount. And only a few of those, my understanding is, are actually reporting to the credit bureaus. And I can also imagine if you're a lower income person who is perhaps more pressured, you're probably going to turn to a family member and say something like, hey, can you loan me, I don't know, 500 bucks to make it to the end of the month?

40:02And there's no way that credit scoring bureaus are going to have insight into things like that, informal loans. The credit data that comes from the credit bureaus is still incredibly predictive and useful, but it doesn't capture everything. Alex was on, I think, recently a firm is starting to provision data to the credit file, which is great, but not all of them are there. And so, you know, I think there is still a lot that's not visible, and that is definitely a concern to lenders. We've been hearing their concerns about stacking and things of that nature. Obviously, these companies haven't got to where they are without having some understanding of risk themselves, right?

40:36So they're not going to necessarily just let someone who's not performing a loan take out another five BNPL loans, right? And the ability of a consumer to go to all different BNPL providers and use that, there's a level of effort and sophistication required to do that. Certainly, I'm sure there are going to be some, but I don't know how many people fall into that category. Nevertheless, it is a concern that more isn't visible. And that's why I think being able to pull in more than credit file data, such as cash flow data, becomes really important. And so what we're seeing is that there are more and more that are looking to incorporate cash flow into the process because then they can have a better understanding of the ins and outs, right?

41:13Is their checking balance going up or declining over time? Does their income look like it's stable? Does it look like it's more sporadic? And so we have started building now credit scores that also incorporate that type of data. and that I think is going to become even more important as we go forward because there are going to be more and more ways that consumers can borrow. So that's probably the better way to get that holistic view. Sure. Quickly, auto delinquencies, are they at their highest level ever right now or close? Yep. I mean, they are, yes. And they're continuing to go up. So what we have seen though is that credit cards, for instance, they went up a lot.

41:47So they went up - Delinquencies. Yeah, delinquencies. Credit card delinquencies went up a lot in 23, 24, but they've started coming down. And we started seeing personal loans coming down as well. So it's a very nuanced picture. So we've seen the unsecuritized delinquencies that have started coming down this year, year over year, but we're still seeing mortgage and auto loans continue to increase. Which is pretty topsy-turvy when you kind of think about it. But anyway, so the other thing happening now is insurance rates going up because of the, I guess, non-extension of previous subsidies. And one thing you're seeing all over social media is people posting their new insurance rates for 2026.

42:25And I've seen some crazy ones, you know, something going from $600 to like$1 ,800 a month. How much pressure would you expect something like that to exert on the consumer for next year? You know, for many, it's going to be the straw that could break the camel's back, right? It's just, particularly if it's like car insurance can be a very significant an outlay for many households. But there's other insurance for homeowners, homeowner insurance is going up. And particularly if they're in areas like California or Florida, where natural disasters have led to an increase in premiums above the national average.

43:00And so again, I don't see that there's any one thing that is going to cause the house to fall down. But at the same time, just there's more and more households where that one unexpected increase puts them in a situation that makes it impossible for them to make their payments that month or for a number of months. Talk to us about the resumption of student loan payments. I mean, you mentioned the importance of not only the stimulus, but all the sort of forbearance. And so all this stuff, nice. The one thing that just kept getting pushed forever was the resumption of student loans. How much, when those numbers turned back on or those payments turned back on?

43:38What kind of impact did that have? And what are we seeing with student loan delinquencies? Yeah, it had a very big impact. And so, you know, if we look back before COVID, the average student loan delinquency rate was around that 10%. It was sort of wavering around between 9%, 11 % in that sort of range. And then obviously, in this five-year period of forbearances and no reporting, because you had a period of a year through 24, where they were starting to need to make payments, but they just weren't being reported. So that's basically a long period of time where people just got used to not having to make that payment.

44:13And also a very substantial part of student loan borrowers who never had ever made a payment because they finished their studies in a period when there was forbearance. And so what then happened was they started trickling back onto the credit file, sort of mid-February of this year. And then I think you got the first batch really kind of come in by May. And at that point, you saw the delinquency rates on the student loans that were not in deferment was over 20%. So they were over double what the historical norm was. Since then - Is that the highest level ever? It is the highest level that we've seen going back a long, long time.

44:49So remember, there's been a lot of changes when it was not federally mandated and privately owned. So I I don't have visibility going back that far, but at least in recent history, it's absolutely the highest by a very substantial amount. And that's not too surprising. But one of the things that we've seen is that we expected that there would be some people who go into delinquency, not because they intended to, right? And so there were some people who they moved and they didn't get their addresses or a lot of people that were confused because there were so many mixed messages like, we're going to be forgiven, but then we're not.

45:17And we're in a certain program, but now that program doesn't exist anymore. So some people have been able to then address that. And so it's come down to this 17, 17.5%, which is a good sign. And so that's improving. But there still are people who are on programs that have been killed, like the SAVE program. And so they are going to next year have to either get onto another forbearance program or start making payments. And so maybe we haven't seen the full effect then, basically, of the resumption of student loans. We've seen the biggest batch come through, but there still are some more cohorts of consumer borrowers that will either have their existing program expire or that aren't being reported yet because the servicers are trying to figure out exactly what's going on before they report to the credit bureau.

46:02So there still is a little bit of lack of visibility there from on the credit servicer side. Ricard, thank you so much for coming on Outlaw. That was great. Thank you. Thank you so much.

46:24Tracy, it always comes back to insurance, doesn't it? That's always like the little fly in the ointment. You know, you buy this car and it's like, okay, here's the car and here's the interest payment. Oh, I think we can make the math work. You can't control what that insurance payment is going to be. You have no idea what it's going to be. This is my theory. Insurers secretly run the world. They run the world. Run the world. They really do. You know, the other thing I was thinking, and we've written about this in the newsletter, but one of the difficulties of our current economic moment is there is so much division and difference built into the aggregate.

46:57If you're just looking at a single number, a total, like if you looked at the average FICO score of an American, it tells you almost nothing now because the individuals are so disparate. Yeah. And it really does come down to, you know, wealth, right? Wealth is just such an important factor in the economy. We always talk about income and income inequality. And of course, that's a real phenomenon. But wealth is such an important predictor or driver of anything. And it also goes to show how important financial markets and asset prices are to the real economy. And it gives me once again an opportunity to say the stock market is the economy because we live in such a wealth driven economy.

47:37You know, someone once wrote into me, I wrote something about pressures on lower income people. And someone wrote into me saying, well, why don't the lower income people own more assets? If they did, they'd be in a better position. Have you tried not being poor? Why haven't you tried just being rich? Why haven't you tried buying NVIDIA 20 years ago? Why haven't you tried buying a house in California in 2009 after the bus? It's that simple. Stop being poor. Seriously. The other thing I was thinking just on auto delinquencies, I also think the trade down story is a big piece here, which is, I mean, a car from 10 years ago now is pretty decent.

48:15And I say that as someone who owns, I think it's a Toyota RAV from like 2011 or something like that. Like it's pretty dependable. And I don't really feel the need to get like a fancy new car. And I imagine if you're under pressure on your car loan, it's probably like not that difficult necessarily to find an older car that is somewhat reliable. I don't know. You know, the one thing, though, so I have a car that I bought in 2015. It runs perfectly well. I would not be surprised if it continued, like, no issues at all. It doesn't have CarPlay integration. Oh, yeah. The one difference between older cars and newer cars is that it's very nice, like, having that, no, that interface where you have, like, a nice map.

49:01You can get a little speaker or something. Yeah, but what it doesn't have is that, like, really nice interface with the map. Like, and I know that's minor, but it's like. But do you have a map? It's a Subaru for those curious. And it's like, you know, it's like they're in-house. It's a crappy map. It's not that really nice at Google Maps where it's like really clear and it doesn't have turn by turn navigation. I know this sounds like kind of minor, but it is very annoying. And like when I am in a car that has like a modern, I'm going to have a little tangent here. But when I am in a car that has like a really nice interface with a nice Google Maps or Apple Maps and the Spotify integration, it's very nice.

49:39And apparently we've taken it to the dealer. They just cannot. It is un-upgradable. Yeah, it's un-upgradable. There's no, for some reason, there is no way to put in a new dash. Oh, sorry. I thought you meant un-upgradable in terms of trading it in for a newer car. No, it's un-upgradable. It's like we cannot like this. We could never install CarPlay or whatever in this car. You know, my husband and I rented one of those like big fancy trucks, pickup trucks. And I was amazed by the amenities that are actually in there, including like the heated seats. I have a heated seat. Personalized heated seats.

50:12I have a heated seat. What? Yeah. That's fancy. No, it is very nice. In the winter, heated seats. Can we just talk about cars for a while longer? But the thing is, like, even for a car like that, I just I cannot imagine spending like$100 ,000 plus whatever the interest rate actually is on something like that. I remember that meme from like 2010. It was like, oh, no one will ever default on. That was a big thing. And the phone. It really was. The two things that people always find a way to make a payment for, the car and the phone. I forget. Which is why I think you have to look at something structural that's shifted.

50:49And I suspect maybe it's the availability of, you know, lots of older cars. But just just one last point. It's I thought it was very interesting. Ricardo is saying it's like there's no obvious catalyst for class cataclysm. There's not obvious like, oh, here is something we're on the verge of consumer credit collapse. But it is a story of just like steadily building pressure. Right. Such that if there is some sort of spark or something, there is a lot of stress. not to the resumption of student loans after five years, the fact that the total loan price of the car has gotten so high relative to people's income, all of these different things.

51:28So you have all these upward stresses on prices. You have all of this reliance, obviously, on accumulated wealth, most notably stock market and home equity. So you have a lot of things come together that are not necessarily disaster or anything like that. But the alignment of pressures is there where things could potentially get bad. The consumer is much more fragile than they used to be. Than they might have been a few years ago. Yeah. All right. Shall we leave it there? Let's leave it there. OK. This has been another episode of the Odd Lots podcast. I'm Tracy Alloway. You can follow me at Tracy Alloway.

51:59And I'm Jill Weisenthal. You can follow me at The Stalwart. Follow our producers, Carmen Rodriguez at CarmenArmand, Dashiell Bennett at Dashbot, and Kale Brooks at Kale Brooks. For more Odd Lots content, go to Bloomberg.com slash Odd Lots. We have a daily newsletter and all of our episodes. And you can chat about all of these topics 24-7 in our Discord, discord.gg slash oddlots. And if you enjoy Oddlots, if you want me and Joe to just review cars in the future, then please leave us a positive review on your favorite podcast platform. And remember, if you are a Bloomberg subscriber, you can listen to all of our episodes absolutely ad-free.

52:34All you need to do is find the Bloomberg channel on Apple Podcasts and follow the instructions there. Thanks for listening.

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