How Will Rate Hike Impact Auto Loans?
I’ve been holding off on this blog for a few weeks because I’m tired of the seemingly endless cycle of predictions about impending Fed moves to nudge up interest rates that never materialize. But this time, baring the financial equivalent of a killer meteor slamming into the earth and ending life as we know it, the Fed will announce its first rate hike in at least ten years when it meets tomorrow.
Readers of this blog don’t have the luxury of debating whether this is good monetary policy. You are faced with the practical challenge of divining what impact, if any, this will have on your business plans.
For credit unions, the canary in the coal mine may well be automobile lending. Auto lending has done more than any other activity to help credit unions emerge from the Great Recession. Vehicle loans accounted for more than 33% of credit union loan volume in the third quarter. Financing for new cars has grown 16.25% over the last year and more than 13% for used cars. (https://www.ncua.gov/analysis/Pages/call-report-data/Reports/Chart-Pack/Chart-Pack-2015-09.pdf)
So, it’s worth speculating about how rate increases will impact this lending. Fortunately for us, the Federal Reserve Bank of New York has done the work for us. Based on modeling, it released a report in November asserting that a 100-basis-point increase in interest rates will cause light vehicle production to fall at an annual rate of 12 percent and sales to fall at an annual rate of 3.25 percent. Don’t expect the car loan gravy train to keep on chugging in the year to come. (http://libertystreeteconomics.newyorkfed.org/2014/08/just-released-looking-under-the-hood-of-the-subprime-auto-lending-market.html#.VnAMulgQXGg).
You may find this prediction a bit more pessimistic than that of other prognosticators. What the researchers tried to account for is not only the impact that higher rates would have on household spending but also what impact higher interest rates would have on auto makers. They point out that higher interest rates raise inventory costs leading to a downturn in production. This, in turn, results in price cuts in the short run but then less production to account for less demand.
I’m in no position to know how accurate this prediction is or if a decrease in new car buyers necessarily will have a corresponding impact on the used – I’m sorry, I mean pre-owned – car market, but it underscores just how important the coming weeks and months are to your credit union’s plans. The Fed has decided that the economy is strong enough to withstand an interest rate increase. Now the question is just how much of a raise does it think is necessary and over how long a period? As this week’s Economist explains: “the consequences of one premature quarter-point rate rise are unlikely to be disastrous. A series of premature increases would be another matter. And that is where the Fed’s apparent plans are worrying.” (http://www.economist.com/news/leaders/21679793-federal-reserve-set-raise-interest-rates-first-time-2006-its-next-step).
Running your credit union about to get even trickier; have fun.