Should Investors Be Worried About Capital One’s Aggressive Auto Lending Push?

by Trefis Team
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The strong outlook for the U.S. economy, and the ongoing trend of customers choosing SUVs, larger cars and higher-priced models to traditional smaller cars, has had a positive impact on the country’s auto industry for several quarters now. However, this helped auto lending volumes, with the U.S. auto loan industry remaining largely around the $1.1 trillion mark since late 2016. These seemingly contradictory trends can be explained by the fact that the U.S. banking industry as a whole has pulled back from the auto lending market over this period due to the spike in auto loan charge-offs from early 2017. This is evident from the fact that the combined market share of the five largest banking players in the industry (JPMorgan Chase, Ally Financial, Wells Fargo, Capital One and Bank of America) has shrunk from nearly 26% a year ago to below 25% now.

Among these banks, Ally Financial has done well to grow its auto lending business over the period to retain its position as the largest auto lender in the U.S. among the banks. However, Capital One stands out in particular with its unusually high auto loan growth rate figure of almost 8% between Q2 2017 and Q2 2018. This compares to a growth rate of 3% for total U.S. auto loans, and is also considerably ahead of the 5.5% growth achieved by Ally.

Capital One is no stranger to the high-risk, high-return consumer lending industry, as its expertise in the card lending industry over the years has helped it grow to become the 9th largest commercial bank in the country. However, the unbridled growth in an industry which is showing signs of deterioration can potentially trigger losses for Capital One in the near future. As we detail in our interactive valuation dashboard for Capital One, this presents a sizable downside risk to our price estimate of $117 for the bank’s shares.

The figure for each bank is as reported in their latest quarterly earnings disclosures. Bank of America combines its auto lending portfolio with other specialty loans in its quarterly reports, so the figure here is taken from its latest call report as filed with the FDIC here. The total portfolio of auto loans by all commercial banks in the U.S. is from weekly data compiled by the Federal Reserve, accessible here. The total auto loans outstanding in the country are taken from the website of the Federal Reserve Bank of St. Louis here. The yellow-to-green shading across a row helps identify the overall trend in outstanding auto loans for a particular bank over this period.

The auto industry has seen a marked increase in outstanding loans in recent years, with data compiled by the Fed showing that total auto loans jumped by almost 40% between 2012 and 2016. While an important factor behind the growth was the steady improvement in economic conditions since 2011, the growth rate was also propped up by the fact that auto lenders lowered their credit requirements and offered higher loan amounts for used cars at cheaper rates to attract more customers. However, a sharp increase in auto delinquencies since early 2017 led to the total auto loan industry largely stagnating around $1.1 trillion, with the largest U.S. banks in particular trying to curtail their losses by tightening auto loan origination volumes. As seen in the chart above, the total auto loans for the five largest banks in the auto lending industry has decline steadily from $282 billion over most of 2017 to below $277 billion now.

It should be noted that these five banks hold more than 65% of the total auto loan portfolio across all U.S. commercial banks, as banks account for roughly 37% of all auto loans in the country (with the finance arms of the auto makers garnering a larger market share). However, while JPMorgan’s auto loan portfolio has remained largely constant over the last several quarters, Bank of America has shrunk this loan portfolio. Wells Fargo’s almost 18% reduction in auto loans is because of the bank’s decision to reduce focus on the unit while also selling off parts of its auto loan portfolio to ensure that it meets the Fed’s enforcement order restricting its growth.

Capital One continues to resist this industry-wide trend, though, with its above-average growth for yet another quarter. While the aggressive push in the industry can hurt the bank’s profits if economic conditions turn for the worse, it should be noted that the bank reported a sizable reduction in auto charge-off rates from a peak level of 2.12% in Q4 2017 to 1.32% in Q2 2018. The bank’s auto loan delinquency rates have also nudged lower over the last two quarters. While strong economic conditions would partially be responsible for these trends, it would appear that Capital One has also taken measures to tighten its lending requirements in recent months. The strong growth in the portfolio, therefore, doesn’t appear to be a cause for investor concern for now.

Details about how changes to key Loan parameters affect the share price of the largest U.S. commercial banks can be found in our interactive model for JPMorgan Chase | Bank of America | Wells Fargo | Capital One

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