Auto dealers that sell new vehicles nationwide rely on their Finance and Insurance (“F&I”) departments as an important source of earnings. While top-line revenue from the F&I department is typically a small portion of a new car dealership’s total revenue mix, these departments have much more favorable margins than their counterparts in the selling division. For used dealers without subsidiary captive finance operations, third-party lenders take a larger role in the financing process, and the economics tend to be different from their new vehicle-selling counterparts.

Last June, we released a 2023 Overview of Auto Finance. In this year’s 2024 State of Auto Finance, we review these themes and lay out new developments and changes in auto finance since this time last year.

Layout of the Auto Finance Industry

The auto finance industry includes establishments that provide financing for both sales and leasing of automobiles. Sales financing establishments primarily lend money to provide vehicles through a contractual installment sales agreement, either directly from or through arrangements with auto dealers. Industry participants generate revenue through the interest and fees included in borrowers’ installment payments.

There are two major types of auto finance operators: captive finance companies and third-party lenders.

There are two major types of auto finance operators: captive finance companies and third-party lenders.

Some examples of captive finance companies are Toyota Financial Services, General Motors Financial Company, Honda Financial Services, and BMW Group Financial Services. These companies are “captive” to the larger OEM’s leadership and have less decision-making autonomy. The purpose of these captives is to provide the parent company with a substantial profit source and not lose this income stream to outside parties. It also helps boost the sales of their vehicles by making them more attainable for the average consumer. Captive finance lender loans are typically exclusive to new vehicles.

Third-party lenders like Ally Bank, Capital One, Chase, Wells Fargo, and Truist provide insurance and financing to dealerships, and their dealer partners primarily sell used vehicles or new vehicle dealerships without access to a captive. Consumers can also decide to use a third-party lender in place of a captive finance company on new vehicle purchases. Banks are not the only entities that participate in the auto lending industry. Credit unions, specialty finance companies, and “buy here, pay here” (BHPH) companies also lend to car buyers. It is important to note that BHPH companies may hold the consumer’s loan on their balance sheet or sell the loan in the open market. Thus, these companies have attributes of captive finance subsidiaries and third-party lenders.

See the graphic below (source: Piper Sandler) featuring auto finance lenders in different industry classifications.

It is easy to see how the different classes of lenders outlined in the graphic above might have different risk tolerances and return targets. For example, the BHPH companies are more likely to lend to subprime borrowers. While these companies have taken scrutiny for charging higher interest rates on said borrowers, they are undoubtedly taking on more risk while demanding a higher return in response. Additionally, the cost of repossessing vehicles is endemic to their operations, not a “normalization” adjustment that one might consider in the valuation of a new vehicle dealership.

State of the Auto Finance Industry

Experian releases a “State of the Automotive Finance Market” webinar every quarter. The information in the most recently released webinar outlines origination, portfolio balances, and delinquency trends observed in the first quarter of 2024. A summary of these trends follows.

How are consumers purchasing their vehicles?

Total financing has fallen for the third straight year. In the first quarter of 2024, the percentage of new vehicles purchased with financing was roughly flat from Q1 2023 (80.2% of purchases), while the percentage of used vehicles purchased with financing (37.3%) was down three percentage points from last year. Consumers’ persistent trend toward cash purchases during the previous two years has had an inverse relationship with rising interest rates to avoid pricey debt that brings a higher monthly payment. The magnitude of this year’s drop illustrates this relationship well.

Who is financing these purchases?

Captives maintained the largest share of total financing. Captive lenders took the top spot from banks in early 2023 as the largest provider of auto financing, and this trend has continued as captives gained more share during the last year.  In the first quarter of 2024, captives comprised 31.4% of total financing, beating out banks (25.0%) for the top spot. Banks tightening their position in consumer auto lending aligns with a similar retreat from the floor plan lending space during the past few years. Other than captives and banks, credit unions’ share of the auto lending market has fallen to 20.1%, compared to 25.1% last year and 22.7% in 2022.

Captive lenders took the top spot from banks

Captives dominate new vehicle financing. Captives make up 61.8% of the market share for new vehicles, which is a notable increase in share from 54.2% last year. While captives remain at the top of the ladder and have kept climbing, banks have reduced their position in the new vehicle lending space. Banks’ share has decreased to just 20.7% of new vehicle loans from 23.4% last year and 29.3% in Q1 2022. The increase in captives is likely due to two reasons: they are incentivized to offer better financing to consumers and have a greater ability to handle delinquent loans and recoup more from repossessed vehicles.

Used vehicle financing usually takes a different shape. For franchised dealers that sell used vehicles, 36.1% of total used vehicle loans came from banks, while 34.3% came from credit unions during Q1 2024. The remaining purchases were financed by other means like captives and specialty finance companies. Captives lend for used vehicle purchases at franchised dealerships (14.2%) but at a much lower rate than for new vehicle purchases (52.4%).

Credit scores and credit quality

Auto consumers’ credit scores have continued to improve. Over the last five years, the average new vehicle purchaser’s credit score rose 18 points, and the average used vehicle score rose 31 points. Specifically, the average credit score for a new vehicle purchase was 755 in Q1 2024 compared to 752 and 747 over the previous two Q1s. For used vehicles, the average credit score has also risen. For the last three years, first-quarter averages were 686, 682, and 678, respectively.

New vehicle financing continues to boast superior credit quality. For new vehicle financing, the prime and super prime segments have remained relatively stable in the total share of loans. In Q1 2024, 83.9% of total new vehicle loans were prime+, compared to 84.1% last year and 83.6% in 2022. These loans have cemented themselves as premier products, with the most growth occurring in the super prime segment year after year.

Used vehicle credit quality is improving. Used vehicle financing has also experienced an increase in credit quality. Subprime loans were recorded near record lows in the first quarter of 2024 and have remained below 4.0% of total loans for four years. Furthermore, the prime and super prime segments grew to 58.9% of total used vehicle loans compared to 56.6% last year and 55.4% in Q1 2022.

Interest rates and term lengths

Rates remain elevated for both new and used vehicle loans. For new vehicle loans, the average interest rate was 6.7% in Q1 2024, up from 6.6% in Q1 2023 and 4.1% in Q1 2022. The large jump in rates from 2022 to 2023 aligns with the broad market trend set in motion by the Federal Reserve during 2022 and 2023. Similarly, the average interest rate on used vehicles purchased was 11.9%, modestly higher than last year (11.4%) and much higher than the first quarter of 2022 (8.6%).

The average new vehicle loan term decreased for the second straight year. The average loan term on new vehicles was 67.6 months, which marks the second straight year of decrements in the metric. The average loan term was 68.6 months in Q1 2023 and 69.5 months in Q1 2022. Consumers typically get more favorable interest rates on lower-term loans. Perhaps consumers are responding to the market’s higher rates by shortening the terms on their loans.

The average loan term on new vehicles was 67.6 months

Used terms increased. Similar to new vehicle loans, the average loan term for used vehicles has averaged 67.4 months over the last three years. However, unlike new vehicle loans, there was no pronounced increase in shorter-term loans, which kept the average term relatively stable. This observation is compatible with the idea that younger, lower-income consumers would be more likely to avoid higher monthly payments.

Portfolio Balances and Delinquency

Growth in loan balances slowed over the last year. Overall loan balances grew 2.8% over the previous year from $1.43 trillion to $1.47 trillion. Compared to last year’s growth rate of 8.3%, the data suggests that overall loan activity has slowed down.

The auto loan balance by credit band has not changed much in the previous five years, but growth areas include the super prime (31% of total loans) and deep subprime (2.8% of total loans) segments.

Delinquencies are up across the board. 30-day delinquencies grew to 2.7% in Q1 2024 from 2.3% this time last year.  While this increase isn’t particularly great news, 30-day delinquency rates have finally returned to pre-COVID levels.

On the other hand, 60-day delinquencies are up modestly to 1.0% from 0.9% during the same period. 60-day delinquencies surpassed pre-COVID levels last year and have continued to grow this year. We believe that rising delinquencies will persist into the near term.

Conclusions

As dealers across the country navigate an environment where more vehicles are available, many sticker prices are returning to below MSRP, and the level of consumer demand is uncertain, all of the dealership’s profit centers will be very important to the overall profitability of the dealership. Perhaps it could benefit dealers nationwide to look at their finance and insurance departments as an area of opportunity instead of uncertainty.

Mercer Capital provides business valuation and financial advisory services, and our auto team helps dealers, their partners, and family members understand the value of their business. Contact a member of the Mercer Capital auto dealer team today to learn more about the value of your dealership.