Captives may have lending edge as rate hike looms
As federal interest rate hikes loom, banks are lending more conservatively out of fear that with higher interest rates, consumers’ lending risk will go up. Higher rates will also affect automakers’ captive finance arms, but the captives will likely have the ability to keep the rates they charge consumers down through support from their manufacturer parents, industry economists say.
“Higher payments are more difficult for borrowers, so lending risk goes up,” said Charles Chesbrough, senior principal economist for IHS Automotive. Because of that “banks are lending less aggressively.”
The economy is far along it its recovery from the downturn in 2008 and 2009, and banks are concerned about upcoming risk. Banks know that a jump in the federal interest rate is “generally a negative on economic growth,” Chesbrough said. It increases consumers’ monthly payments, and in effect, increases lending risk.
“We’re in that recovery phase,” he said. “Once the banks got comfortable, we saw the flood gates go and availability became more robust. The auto market is back. It just seems to make sense that banks are a little more conservative” now that we are a long way into recovery cycle.
To prepare for the rate increase, banks are tightening their loan approvals, according to quarterly surveys of senior bank lending officers. Each quarter, senior loan officers from up to 80 large domestic banks and 24 U.S. branches and agencies of foreign banks participate in the survey.
Although captives will still be affected by a rate climb, they have more options than other lenders because their automaker parents often subvent deals, say Chesbrough and Dennis Carlson, deputy chief economist at Equifax.
Many consumers go into the dealership with a monthly payment in mind, and often, that monthly payment dictates the interest rate and length of the loan. And the captive is in a position to accommodate them, Carlson said.
Chesbrough agrees. Captives “have more ability to subvene loans,” he said, “because the OEM can give up some profit margin to pay for it. Outside banks make money only on the loan itself.”
When rates do rise, they’re likely to increase very slowly, Carlson says.
“They’re going to take their time, unlike in the past when the Fed moved to increase 50 basis points every time they met,” he said. “This time they will probably increase it 25 basis points once and see how it goes.”
Chesbrough also expects the interest rate to go up 0.25 percent, or 25 basis points, in December, and he expects minor increases each quarter through 2018. By the end of 2016, he expects the rate to be around 1.25 percent, with increases of about 1 percentage point in each of the two next years. That could bring the rate to 3.25 percent by the end of 2018.
“By 2018 we think rates will be high enough that they will choke back” consumer demand, Chesbrough said.
“Transaction prices are rising, loan amounts are rising,” he said. “When we get into the next down cycle, how will customers react? Will they be willing to give up buying exactly what they want, or are they going to pull back entirely from the market? Something is going to have to give because they won’t have the same amount of purchasing power.”
By 2018 or 2019, many consumers will be forced into used-car market or will stick with the vehicle they have, he predicts.
Effect on consumers
Higher rates could significantly affect consumer payments, especially as loan terms lengthen.
If a consumer today has a five-year loan of $27,272 with a 4 percent interest rate, the rate is locked in, Chesbrough said. But if that same person borrowed the same amount over 60 months after the rate has increased 1 percentage point, the consumer would owe $13 more per month or about $800 more over the course of the loan. And with new-vehicle loan terms stretching to 67 months on average, the Fed rate increases may add $2,000 or more to consumers’ payments over the next two to three years, Chesbrough said.
At least for now, he says, the lending market is healthy and a possible December interest rate hike will have minimal effect.
“We’re still very optimistic about the market in the next few years,” Chesbrough said. But with the federal interest rates today at 0 to 0.25 percent, “we’re in uncharted ground and have been for the last several years. Interest rates are getting back to where they should be.”
Send us a letter
Have an opinion about this story? Click here to submit a Letter to the Editor, and we may publish it in print.