Auto Loans Show Consumer Strains

By Ryan Boyle

In the pandemic, my home office was decorated with a banana plant. We knew the lockdown had gone on too long when the plant grew so tall that it stretched beyond the frame on my video calls.

Pressures on household balance sheets have grown in a similar manner: quietly but persistently, liabilities are reaching levels that are challenging some households. Inflation has diminished the real incomes that are necessary to sustain debt service. As a result, we are seeing higher defaults on consumer credit, particularly auto loans.

Lenders understand that not all loans will be repaid. Their task is to set the right size and price for loans that makes them affordable to the borrower while providing compensation for risk. For many years, assessing consumer credit risk had been routine and reliable: Credit score models summarized the behavior in credit files numerically. The scores informed consumers' loan eligibility.

Of late, though, credit performance has been worse than the expected probability of default. Stress has become more common among all consumer strata. In particular, auto loan delinquency rates have approached levels last seen in the Global Financial Crisis (GFC).

Credit scores are calculated only using a consumer's liabilities, not income or assets. However, income and credit scores are correlated: in case of a financial shock, those with greater incomes will tend to have more cushion to make payments. Surprisingly, though, delinquency data shows that consumers with higher ratings are feeling more stretched.