It’s natural for lenders and investors to anticipate the end of the current used-vehicle boom, and the valuations of banks with large auto finance businesses seem to partly reflect that. Lenders such as Ally and Capital One Financial are trading at relatively low forward price-earnings valuations from where they normally trade compared to S&P 500 banks as a whole, according to FactSet data.

But investors shouldn’t overcorrect either. Industry monitor Cox Automotive has projected the Manheim Used Car Price Index to be just 3% lower by December than it was in December 2021. Perhaps a drop prices could accelerate rapidly the following year. For now, though, things like supply chain grunts for chips that make new cars take longer to build still seem to be a factor. Ally said that, while making a cautious forecast, “recent trends point to continued resilience” in second-hand stocks.

One of the drivers of high used car prices and demand has been tight inventories at car dealerships. Both Ally and Huntington Bancshares noted increases in the use of dealer credit in their quarterly updates, indicating a need to finance inventory that does not instantly leave the showroom floor. . More new cars on the lots could lead to fewer buyers in the used car market.

However, even new-car makers could still see usage as a way to meet demand. General Motors and Ford Motor are beginning to enter the used car market through online platforms. Used vehicles may continue to be the best option for many entry-level buyers, given the general upward trend in sticker prices for new vehicles. And the Wall Street Journal just reported that Ford had to halt orders for a more affordable pickup truck.

Even if floors start to have more vehicles, it would also indicate current market compensation for lenders: more financing for dealership inventory. These commercial loans are often variable rate and would benefit from higher rates in the future, unlike the fixed rate loans currently given to consumers.

This same trend of inventory scarcity has also likely played a role in more vehicles being bought back at the end of leases, meaning a leasing finance provider is unable to take a car off leasing and selling it on the booming market. Ally said 62% of leases were repurchased in 2021, compared to a figure generally closer to 30%, which to some extent reduced lenders’ advantage on the rise in second-hand values. Falling used car prices would reduce gains on car sales, but it could also lead to more cars ending up in the hands of lenders in the first place.

The relationship between used car prices and loan size is not strictly one-sided either. Lenders have said they consider the impact of high prices when underwriting, which can then be reflected in lower loan-to-value ratios. So even if the value of cars increases, the size of loans does not necessarily increase as much and vice versa and could help cushion some of the future normalization of credit risk and defaults.

Most banks are facing a settling of scores due to a normalization in pandemic trends, whether in savings habits or mortgage refinancing. Investors could navigate these waters by heading to the relative value of auto lenders.

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