An Overview of Auto Finance

Credit Risk, Trends, Used vs. New Vehicle Sales

Valuation Issues

Auto dealers that sell new vehicles around the country rely on their Finance and Insurance (F&I) departments as an important source of earnings. While top-line revenue in these departments 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 tends to be different than their new vehicle-selling counterparts.

In this blog post, we examine the layout and current state of the auto finance industry as well as quotes from public auto executives pertaining to the current financing environment.

What Is the 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 are primarily engaged in lending money for the purpose of providing 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 that are included in the installment payments of borrowers.

The auto finance industry includes establishments that provide financing for both sales and leasing of automobiles.

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 source of profit and also limit the company’s risk exposure. 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 customers that primarily sell used vehicles or new vehicle dealerships without a captive finance subsidiary. Consumers can also decide to use a third-party lender in place of a captive finance company on purchases of new vehicles as well. 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 as well as 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 “Buy Here, Pay Here” 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 on a quarterly basis. The information in the most recently released webinar outlines origination, portfolio balances, and delinquency trends observed in the first quarter of 2022. A summary of these trends follows.

Origination Trends

  • Over the last three Q1’s, around 60% of total vehicles financed were used vehicles.
  • Retail volume is down in 2022. Using January as an example, 3.48 million units were financed in 2022 compared to 4.22 million and 3.89 million units in 2020 and 2021 respectively.
  • The market share of total financing has shifted a bit in the past year, with banks and credit unions capturing bigger pieces of the auto finance pie when compared to captives and Buy Here, Pay Here operators. Captives gained some market share following the onset of the Covid-19 pandemic as banks tightened underwriting standards, but banks have recently regained their position.
  • The average credit score by vehicle type has been consistently increasing since the first quarter of 2017 for both new and used vehicles. (Q1 2022: 736 for New and 669 for Used) These scores compare to Q1 2017’s 725 and 644.
  • Prime borrowers (buyers with credit scores between 661-780) made up just over 64% of total financing, while subprime borrowers made up around 17%. The most substantial growth in originations over the past quarter has been with prime borrowers.
  • Despite rising trade-in values, the average amount financed has also been on the rise. The average amount financed and the average monthly payment were $39,450 and $648, respectively in Q1 2022.

Portfolio Balances and Delinquency

  • Overall loan balances grew to $1.37 billion in Q1 2022.
  • Delinquencies have ticked up over the past year. Auto loans that are 30 days delinquent grew from 1.46% of total loans to 1.55%. Auto loans that are 60 days delinquent grew from 0.51% of total loans to 0.59%.
  • Independent, used dealers are seeing the highest rates of delinquency. As discussed above, this is part of the normal course of business for BHPH operators.

As prime borrowers are flocking to new car loans and delinquencies on these loans remain low, subprime used car buyers are beginning to show signs of financial stress. Rising sticker prices and monthly payments are the most likely cause of an uptick in delinquencies.

Public Auto Executives Chime In – Sonic Automotive

In our Q1 Earnings Calls blog, we touched on a theme that came up throughout this quarter’s public auto exec interviews: affordability. Many of the franchised, new vehicle-selling dealers downplayed affordability concerns, which is consistent with what we have seen in the trends outlined above.

Heath Byrd, CFO for Sonic Automotive, when asked about new vehicle affordability concerns, said that:

“What we’re seeing from a macro perspective is there’s not any material impact to the prime and near prime consumers. […..] Are you starting to see a little bit of degradation in credit and portal in the lower income brackets, which is a very small part of both our franchise as well as our EchoPark consumers? So, what you’re starting to see [is] a little bit on the lower income, but on the upper tier we’re not seeing anything material.”

Jeff Dyke, President at Sonic Automotive, echoed these concerns around used vehicle affordability:

“The problem is, is that we’re pushing $500 a month payments, and we used to pay $400 a month payments, and it’s too close to the new car pricing. […] You really want your average used vehicle selling price to be one half that of your new vehicle selling price. And in my whole career, it’s always run 50% to 55%, somewhere in there. It’s at 70%. It’s too close to the new vehicle pricing and prices are too high, $500 whatever, $525 a month payment. That’s just not — that’s out of the norm.”

With a lack of new vehicle affordability, buyers are increasingly bidding up used vehicles. The explosion of companies like Carvana, Shift, Vroom, etc. has exacerbated used vehicle demand, lifting prices above historical norms, further squeezing subprime buyers.


Rising rates and record levels of inflation may put auto purchases out of reach for some lower income consumers and create hardships for those trying to pay down existing floating rate notes that weren’t locked when interest rates were low. Facing the possibility of a recession and deteriorating credit quality, auto lenders will likely adopt more conservative lending practices and credit portfolios linked to auto loans may trade at steeper discounts to par to recognize the increased risk. While this could impact vehicle sales in the case that would-be buyers are unable to obtain the financing they need, as we’ve seen in the past two years, vehicle demand tends to be pretty inelastic. Ultimately, those focused on prime borrowers seem to be on solid footing for now while lenders with more exposure to subprime borrowers may start to experience more difficulty.

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.