The auto finance sector has been pressured from all sides since COVID-19 took root in the U.S.
With vehicle production halted and dealership operations frozen, originations have stalled. Lenders are starting to load up loss reserves in anticipation of rising delinquencies and charge-offs. As the industry shuts down, investment in subprime auto finance stocks has taken a beating.
Since the beginning of March, the stock prices for five subprime auto lenders have lost between 11% and 59% of their values. Consumer Portfolio Services’ stock (NASDAQ: CPSS) suffered the largest decline: 58.8%. The stock price plunged to $1.48 per share on April 13, from $3.59 per share on March 2.
The stock price for Santander Consumer USA (NYSE: SC) dropped 36.3% to $15.32 per share, while those for Credit Acceptance Corp. (NASDAQ: CACC) and Nicholas Financial (NASDAQ: NICK) declined 27% to $288.68 per share and $6.19 per share, respectively.
Carvana’s stock (NYSE: CVNA) fared best, presumably because of the company’s online lending model and a March 24 investment by Ally Financial, doubling the used-car retailer’s line of credit to $2 billion in the next year. From March 2 to April 13, Carvana’s stock fell 11.2% to $73.10 per share.
Combined, the stock losses at those five companies have shaved a total $7 billion off the subprime sector’s market capitalization since the start of March, according to an Auto Finance News analysis.
For Credit Acceptance, more than 200,000 shares have been transacted in recent weeks by those with 10% stakes in the company. Chief Financial Officer Ken Booth bought 5,700 shares of company stock, for prices ranging from $400.75 per share on Feb. 27 to $215 per share on March 23. Meanwhile, founder and former Chairman Donald Foss sold 157,000 shares, and investment firm Prescott General Partners LLC sold 48,000 shares between late February and early April.
The challenge for lenders during a recession hinges on customers’ ability to make payments. While prime lenders’ clientele might have a cushion of cash saved for emergencies, subprime lenders’ customers often live paycheck to paycheck.
That model gets stressed to the limit when borrowers face furloughs or lose their jobs altogether. So far, the effect on subprime delinquency rates has been muted, as many layoffs have come in the past few weeks. Plus, the typical spring seasonal improvement in delinquency rates might offset some of the expected erosion.
“We could begin to see a modest increase in delinquencies due to the current macroeconomic backdrop,” wrote Jefferies analyst John Hecht in an April 14 research note about Santander. “But we believe that it is likely still too early to begin seeing the full effects of a COVID-19 related economic slowdown flow through to credit.” Jefferies expects Santander’s net charge-off rate for March to increase 110 basis points to 8.46%, rather than decline 147 basis points, as it had previously forecasted.
Santander’s credit performance will likely be stretched further in the coming months, since the company has revised its servicing practices to increase the maximum number of permitted monthly payment extensions, grant waivers for late charges, provide lease extensions and continue the suspension of involuntary repossessions.
“Unlike the regional impact of natural disasters, such as hurricanes, the COVID-19 outbreak is impacting obligors nationwide and is expected to have a materially more significant impact on the performance of our auto loan and auto lease portfolio than even the most severe historical natural disaster,” the company wrote in an April 10 SEC filing.
In a nutshell, Santander’s customer-support programs may actually hurt the lender’s financial performance in the near term if they are unable to mitigate the negative effects of COVID-19, according to the filing. Moreover, Santander could see its business “materially and adversely affected” in the long term.
Even prime lenders are preparing for steeper losses. JPMorgan Chase, for one, increased its first-quarter auto finance loss allowance 57% to $732 million, according to earnings released this week.
As the fallout from COVID-related layoffs and shelter-in-place orders ripples through the market, subprime lenders will continue to see further stock pressures. My best guess: Stock prices will drop another 25% or 30% through September and remain there into early 2021. Pricing stabilization will depend on how well these companies weather the storm.
A company like Carvana might have a better chance with its online lending strategy, whereas a company like Nicholas Financial, which relies heavily on a branch network, might face greater challenges.
The stock rebound will be slow, similar to the market’s three-year bounce back after the Great Recession, likely lasting into 2023.