Ok look, if you didn’t see Monday’s auto sales apocalypse moment coming then you haven’t been reading Heisenberg.
As we wrote last Friday, we’ve been pounding the table on subprime auto and the extent to which that odious debt has been embedded in the system via Wall Street’s securitization machine for as long as this site has been around.
For instance, in “As Subprime Auto Bubble Bursts, Lenders Use GPS To Hunt Deadbeat Borrowers,” we drew your attention to “DriveTime” and “Credit Acceptance,” highlighting the rather unnerving fact that both companies “have been using technology like ignition kill switches, which allow debt collectors to remotely disable a vehicle’s starter, and GPS devices, which can allow them to track down an automobile or truck,” to quote a Bloomberg piece out last month.
More recently, we flagged the surge in off-lease supply as a possible catalyst for further declines in used car prices which in turn could end up triggering a deflationary spiral as depressed trade-in values weigh on new car sales and force automakers like GM to adopt aggressive discounting.
For anyone who missed all of this, here are some of the relevant posts:
- There’s Trouble In Used Car Land
- More Trouble In Used Car Land: Prices Drop Most Since Crisis Sparking Deflation Worries
- Auto Deflation Arrives: GM “Aggressive Discounting” Raises “Clear Cyclical Concerns”
- “Big Short” Redux? Steve Eisman Is Worried About Subprime Auto
And those are just from the last three weeks.
Well on Monday, the chickens came home to roost:
And cue everyone losing their minds as though this wasn’t telegraphed from (several) miles away. Here’s Bloomberg:
U.S. auto sales trailed estimates, with Kia Motors Corp. and Ford Motor Co. reporting some of the biggest declines, as heavy incentive spending failed to contain plunging demand for sedan and compact models. Carmakers’ shares fell.
Combined deliveries for Kia and its affiliate Hyundai Motor Co. slumped 11 percent, and Ford’s dropped 7.2 percent last month, bigger decreases than analysts estimated. General Motors Co., Fiat Chrysler Automobiles NV and Toyota Motor Corp. also fell short of expectations.
March was supposed to be the month U.S. auto sales rebounded from decreases in January and February. Instead, ample discounts were unable to spur demand for models like GM’s Chevrolet Malibu and Ford Fusion, which are being surpassed by crossovers as the new American family vehicle of choice. Deliveries of those models each plunged by more than 35 percent in March.
Gosh, who could have seen that coming? Put simply: we were incredulous at everyone else’s incredulity.
Well anyway, fast forward to Tuesday and everyone is trying to kind of pick up the pieces and see what exactly went wrong. On that score, Deutsche Bank was out with some good commentary, excerpts from which can be found below.
Via Deutsche Bank
Unfortunately, we are currently observing patterns that resemble those that we described in a Feb 20, 2004 report entitled “U.S. Autos: A Triple Threat”: Rising Rates, Rising Negative Equity in Vehicle Loans, and Used Vehicle Price Deflation.
At this point the primary negative observations are: 1) Pent up demand in the new car market has been moderating, as evidenced by rising incentives and declining elasticity of demand (U.S. LV SAAR 16.6 MM in March and retail demand was roughly flat, while incentives were up $450 per vehicle), and; 2) Used vehicle prices are declining at an accelerating pace, driven in part by increases in off lease supply (and perhaps even more importantly, there is evidence that new vehicle sales has been well above “sustainable”, or “trend” levels). There are a number of negative implications from what we’re observing, including rising negative equity in new car loans, lengthening ownership cycles, tightening credit, and potential for deteriorating mix/pricing (And we see risk of continued deterioration as used vehicle prices remain under pressure, and new vehicle inventories remain elevated).
Implications of falling used prices. NADA’s used vehicle price index started to decline modestly early last year, averaging -3.5% between Jan and Sept. 2016. But the declines have since accelerated, to -6% in Nov-Jan and -7.7% in Feb.
While the February drop might have been influenced by unusual factors (e.g. de-fleeting from rental car companies, delayed in tax refunds), the trend is still directionally concerning. And it seems unlikely to stop. Implications include:
1. This is a negative for new vehicle affordability (most new car purchases involve a trade-in). To illustrate, the average used car sold for roughly $19,000 in 2016, according to Experian. If we assume that used pricing falls 7% yoy in 2017, on average, this would represent a more than $1,330 increase in the average amount borrowed, which equates to an additional ~$22 per month over the average 68 month loan. This could represent a 0.7MM unit reduction in ST demand assuming a 1.0 near-term demand elasticity factor, and 0.3MM unit impact longer-term using a 0.39 long-term elasticity factor. Other market factors to consider include potential for shorter loan terms, higher rates, or a reduction in leasing.
2. It has potential to affect trade-in cycles, since it will take longer for consumers to build positive equity in their current vehicles. This will likely be exacerbated by the fact that consumers are taking longer term loans–avg. is now 68 months vs. 62 months in 2010. This phenomenon is already a factor in the Auto market. According to Edmunds ~32% of new vehicle purchasers with trade-ins had negative equity in 3Q16, and the average was at an all-time-high of $4,832;
3. New vehicle demand could also be impacted by consumers shifting to Used (this phenomenon has already been identified by Experian).
4. It could impact on credit, as lenders become more cautious on collateral risk (e.g. long term loans, leases) when loss severity (and frequency) increases. This phenomenon is also already underway, as evidenced by the past several Fed Senior Loan Officers Surveys (see figure 7)