Bubble on Wheels

The car business has been rockin’ since the financial crash.  The headline on Automotive News just a few days ago screamed “GM’s Q1 profits surge 34% on North American Strength.”  It was the best quarter Government Motors has posted since emerging from bankruptcy in 2009. “It was the eighth consecutive quarter in which GM’s results topped expectations on Wall Street,” writes Nick Bunkley. Meanwhile, Ford posted a 35% decline in Q1 profits.

The website Jalopnik.com points out “For a couple years, the Morning Shift story at the beginning of every month was ‘Another month of record sales!’”  But, as Kristen Lee writes, the party seems to be over. “New Car Sales Are In The Longest Losing Streak since 2009” her daily missive is entitled. Ford sales were down 7.2% in April while GM sales volume was down 5.8%.

These reported declines in sales run counter to a story I heard recently from a diesel mechanic, who is especially talented at undoing the Gordian Knots that stymied engines and damaged trailers can be. It so happens the bulk of his business is working on car carriers.

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He has seen a steady increase in business since 2009, but now, car haulers are so busy he said, the owners of one particular company are having to get behind the wheel themselves to satisfy the car manufacturers’ demanding delivery schedules.

So while carriers are hauling, consumers making car payments are stalling. Benjamin A. Smith writes for the Lombardi Letter,  “over one million Americans are overdue on their auto loan payments. Coupled with the fact that U.S. auto loan debt is at a record high of $1.16 trillion and delinquency rates are at their highest levels since 2009 (the Great Recession).”

So while interest rates and unemployment are low, “the Federal Reserve Bank of New York has found that 3.8% of all auto loan payments are more than 90 days in arrears. Delinquent loans have increased an amazing 38% from Q1 2016 to Q4 2016 alone. That $23.27 billion in delinquent loans is the highest such figure since the U.S. Housing crisis in 2008–2009.”

Mr. Smith points out that the average encumbered auto is carrying $18,400 in debt, while coincidently, the average used car value is $18,600. But how long will used car prices hold up? Bloomberg reported last month there are “signs that used-vehicle prices are dropping twice as much as expected. That’s bad news for companies that collectively have to dispose of about 400,000 vehicles a year, and especially for Hertz, whose junk-rated debt is teetering close to a downgrade.”

With car prices falling faster than normal, Morgan Stanley analysts told Grant’s Interest Rate Observer, “Our bear-case scenario sees used-car prices falling 50% over five years (-13% per year), representing as much as a trillion dollars in value erosion applied to the entire used [vehicle fleet] in the U.S. market alone.”

This value erosion has investors holding securitized auto loan pools worried. “The percentage of subprime auto-loan securitizations considered deep subprime has risen to 32.5 percent from 5.1 percent since 2010,” Morgan Stanley explained in a recent report. “Auto loan fundamental performance, especially within ABS pools, continues to deteriorate.”

TransUnion figures subprime auto lending balances total $179 billion, making up 16 percent of total auto loan balances.  Some people like the analysts at Evercor ISI Research take a rosier view of the used auto space. “We continue to believe that auto as an asset class is extremely robust. Not only are contracts underwritten in the knowledge that the asset’s value will depreciate but also vehicles are easy to repossess and have an intrinsic tangible value.”

A certain Florida repo man might differ with that “easy to repossess” comment.  A DeFuniak Springs, Florida woman named Doris Jones took offense when the repo man arrived at 2:30am to take her Pontiac G8.  The Dothan Eagle reports the 44-year old Jones “came to the front door with a handgun, pointed it toward him and fired one round, despite him telling Jones who he was.”

If research from UBS is correct, repo men should tread lightly. “As of Q4’16, 18 percent of US consumers indicated they were likely to default on one loan payment over the next 12 months vs. 13 percent in Q3’16. This cohort of at-risk consumers reported being about 4x as likely to embark on a major durable goods purchase (e.g. house, car) in the next year.”

So while car haulers are going full blast, some dealerships are having to find extra space to store unsold vehicles. “For the first time in his 37 years working at New Jersey car dealerships, Larry Kull had to rent extra space to store unsold new Honda vehicles,” writes Gabrielle Coppola for Bloomberg.

“Dealers had about 85 days worth of cars and trucks on hand at the beginning of February — about 22 days more than at the beginning of 2017 and eight days more than a year earlier, according to Automotive News Data Center. “

Thomas King, an analyst with J.D. Power, told Ms. Coppola by phone. “We’ve got a lot of cars on the ground when the market is moving away from cars.”

As usual this all started with lender memory loss and a loosening of standards to chase returns. “Emboldened, lenders shed bust-era inhibitions,” writes Grant’s Interest Rate Observer. “By 2016, 31% of loans financing new-vehicle sales involved negative equity from a trade-in, up from 25.6% in 2013.”

Auto lenders, like those who made mortgages before them, fired up their creative juices to get more money out the door. In hindsight it doesn’t look so smart. John Hecht, an analyst for Jefferies told Grant’s, “It’s not that credit deteriorated, but underwriting got aggressive and now lenders are realizing that they are not going to have suitable rates of return because of the terms of the loans being too loose, so they are tightening and so capital is flowing out.”

It’s a story as old as time and easy money.  This time it’s on wheels.