Automakers Face Ugly And Bumpy Road Full Of Potholes!

The road ahead looks very challenging for automakers with problems building and lurking around every corner. The major reason the automobile industry took a beating during the 2008 downturn was that the world was mired in overcapacity. When this occurs companies are forced to cut prices and are faced with reduced profit margins. The combination of overcapacity coupled with high consumer debt and higher interest rates paint an ugly picture going forward. When you add in the fact millions of vehicles are coming off leases the challenge facing automakers becomes formidable. Manufacturers can only push iron out the door for so long by massively discounting their products before margins evaporate completely. The current growing level of incentives poses the significant risk of long-term damage to the industry. Other risks include an increase in loans with terms as long as 84 months and a big jump in the number of riskier subprime loans to customers with credit scores below 620.

Everybody Is Chasing That Short-Term Fix

At the start of 2014, John Murphy, lead U.S. auto analyst in equity research with Bank of America Merrill Lynch, predicted during his presentation to the Automotive News World Congress that the auto industry would sell over 17 million vehicles in 2015 and could reach 20 million in 2018, but said we should expect a sharp downturn after that. Murphy also spoke about how older cars are more likely to get scrapped, as they became more obsolete because of changing technology and fuel economy improvements. His feelings this would reduce the need for aggressive incentives or price cutting may have been too optimistic. For the first quarter of 2017, the average new-vehicle incentive was $3,900, up from $3,400 a year ago. In 2017, J.D. Power predicted the average incentive per new unit to top $4,000 for all of 2017.

Of course, all this is being pushed by automakers continuing to add production facilities and higher inventory levels as they fight to gain market share. This means dealers want and need to get the iron off their lot to make room for more. Basically, everybody is chasing any short-term fix they can use but sooner or later they must face the fact that too many cars are chasing too few customers. Up to now they have those lusting for a new ride and cheap credit to thank for keeping sales moving. Unfortunately, delinquencies on subprime loans made by non-bank lenders are soaring toward crisis levels. Fresh investment has dried up and some of the big banks long friendly to this sector have pulled back from the auto lending business. To top it off, state regulators are circling the industry and looking at whether it preyed on borrowers and put them in cars they couldn’t afford.

Bad Loan Write-Offs Are Mounting In The Subprime Sector

In the years after the financial crisis, buyout firms, hedge funds, and other private investors poured billions of dollars into auto finance in search of the big profits that flow from offering high-interest loans to buyers with the weakest credit. Among PE firms, everyone from Blackstone and KKR & Co. to Lee Equity Partners, Altamont Capital, and CIVC Partners waded in.  At rates of 11 percent or more, there was plenty to be made as sales boomed. But now, with new car demand waning and intense competition causing lax underwriting standards, bad loan write-offs are mounting and the sector has lost its shine.

This means that private-equity firms that plunged headlong into subprime auto lending are discovering just how hard exiting this market might be. Near the end of 2017, it was reported that Almost 9.7 percent of subprime car loans made by non-bank lenders and private-equity backed firms catering to car dealers became 90 or more days past due in the third quarter. The delinquency rate is back near recession levels for these lenders according to the New York Fed’s quarterly report on household debt and pushing seven-year highs.

Millions Of Cars Coming Off Lease Now Flooding Market

There’s $1.2 trillion in auto loans outstanding in the U.S., up $23 billion from the previous quarter. About 20 percent of new car loan originations are for borrowers that have a credit score below 620. Bloomberg reports this poor quality debt and the risk it poses is reaching crisis levels. While the impact on the larger financial sector may be muted the same may not be said for many of the more than 23 million consumers who hold subprime auto loans. After falling behind on payments or having their car repossessed.many of these consumers may find their credit reports further damaged or encounter further financial difficulties. Other negative ramifications of these loans turning sour are that it will result in more used vehicles being retendered to the market pressuring prices ever lower at the same time that future buyers find getting credit more difficult.

The recent decline in automobile sales while largely ignored is already an indication of the future consumer debt crisis starting to emerge. The main areas where household credit still growing are student loans, which are essentially government guaranteed entitlements and auto loans which are collateralized by the car. Issuing billions of debt to subprime borrowers for housing proved to be a disaster and going forward we should expect the same trend to reveal itself in autos. For a long time, I have had a problem with those pointing to the auto industry as proof that the American economy is on the road to health. The auto market continues to face the issues of oversupply and this means lower prices. Until now this has been lessened by wave after wave of subprime auto loans that have allowed a buyer to purchase a car even when it makes no sense financially.

It is hard to deny, auto sales and low monthly lease payments have been driven by artificially low interest rates. While we hear claims that the auto market is hitting on all cylinders we also hear of far too many unemployed students living off their student loans buying new cars. Unnoticed by many is following Trump’s victory small businesses in a wave of optimism leased trucks and cars to position themselves for growth, however, this wave of new sales has begun to wane. The final Failure to focus on where the sales are coming from or the amount of profit per car sold is a mistake and does not bode well for the smaller players in this industry that constantly demands a company invest huge sums of money to stay competitive. To those investing in companies such as Tesla, it is logical a difficult sales environment will only make the company’s mission more challenging.

H/T: Bruce Wilds

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