Did Subprime Auto Loans Just Claim Their First Victim In Ally Financial?

Auto lender Ally Financial Inc ALLY on Tuesday let out a hint that exposure to subprime loans could be hurting it, as used car prices continue southward.

Toned Down Adjusted EPS Expectation For 2017

In its financial outlook update issued Tuesday, the company lowered its 2017 adjusted earnings per share growth outlook to 5–15 percent. This represents a scale back from the guidance it issued on its fourth-quarter earnings call, when it suggested that 2017 earnings per share growth may be shy of 15 percent but still very solid, with acceleration expected in 2018 and 2019.

The shares fell 2.9 percent on Tuesday in reaction to the tempered outlook.

The medium-term adjusted earnings per share growth forecast is at a 15+ percent CAGR.

Sequentially Flattish Near-Term Revenue Outlook

Concerning its near-term revenue outlook, Ally Financial said it expects net financing revenue to remain fairly flat sequentially, given the lease yield of about 5.5 percent due to lower vehicle prices. The company, however, expects this metric to improve seasonally in the second quarter.

Other revenues are also expected to be flat, although the company expects more benefit from new products in the second half of 2017. The company sees about $9 billion in auto originations.

Headwinds The Industry Faces

Giving an update on the auto lending market, Ally Financial said rising interest rates, and interest rate expectations would pressure the auto lending market.

The company also noted that consumer credit losses continue to migrate higher, particularly in lower credit tiers. Apart from these, the industry is also facing headwinds — such as declining used vehicle prices, increasing manufacturer incentive levels and many captive arms of manufacturers continuing to increase their leasing presence.

When vehicles come off leases, it floods the market with used cars, and this further depresses used car prices.

In 2016, used business accounted for 42 percent of Ally Financial's originations of $36 billion. New retail standard accounted for $17 billion and leases $3.4 billion.

How Lower Used Car Prices Hurt?

A decline in used car prices means a decline in the value of the collateral on the loan extended. This results in companies increasing provisions against future losses. Additionally, lower car prices suggest that finance companies can recover only less amount on repossessed cars.

Ally said on Tuesday that it expects a 5-percent drop in used car prices in 2017, although thus far in the first quarter, used car prices fell 7 percent, resulting in a $15 million to $20 million expense.

A Déjà Vu Feeling With Subprime Loans

A Bloomberg report, quoting S&P Global Ratings, said losses on auto loans of lenders were an annualized 9.1 percent in January, up from 7.9 percent in the year-ago period, marking the worst since January 2010. Recoveries on subprime loans also fell to 34.8 percent in January.

The subprime loans are packaged into bonds and sold to investors, who now seek higher returns from them due to the risk involved. Consequently, the borrowing costs of the lending companies increase.

Meanwhile, non-prime loans' share of Ally Financial's total originations had dipped to 11.4 percent in 2016 from $14.4 percent in 2015.

Other auto lenders such as Credit Acceptance Corp. CACC, Santander Consumer USA Holdings Inc SC and Capital One Financial Corp. COF, which have significant exposure to subprime loans may also see their financial performance hit by these headwinds. Are these companies hurtling toward a Lehman Brothers-like disaster? The first quarter earnings release and the ensuing conference call may have more answers.

Related Links:

Meet The Companies Most Exposed To Subprime Auto Risk

Fallout Of Record High Gap Between New, Used Car Loans For Auto Lenders