How Crazy Is The Auto Financing Frenzy?

The auto industry has been on a tear for several years, and this year it’s running white hot. In November, the industry rolled 1.25 million cars and light trucks over the curb, up 8.9% from a year ago. Year to date, sales are up 8.4%. This is going to be the best year since the halcyon bubble days of 2007. November’s Seasonally Adjusted Sales Rate (SAAR) of 16.4 million new units was the highest since February 2007. The industry is happily bobbing up and down in a sea of boundless exuberance. Nothing can possibly go wrong.

So sales in September and October had experienced a sharp downdraft. Inventories on dealer lots going into November were (dreadfully) high with a 76 day supply, highest since 2005. And the sales-miracle is built on cheap, ballooning, and increasingly risky credit.

Average loans for new cars jumped by $756 to $26,719 in the third quarter from a year ago, the highest increase in five years, according to Experian Automotive, which collects registration data from motor vehicle departments and financing data from lenders – an essential cog in the perfect surveillance society. Despite the jump in loan balances, the average monthly payment rose only 1.3% to $458, due to two factors:

  • Magically lower interest rates. Though interest rates elsewhere in the economy rocketed higher in Q3, auto lenders just ignored them, and average rates actually dropped to 4.27% from 4.53% a year earlier.
  • Dizzyingly long terms. The average term grew by one month to 65 months. A stunning 19% of all new-car loans were stretched to over 72 months, up from 16% last year.

Used vehicles saw similar dynamics. The average amount financed rose 1.8% to $17,900, but the average monthly payment remained flat at $350, thanks lower interest rates and longer terms.

Leasing – a fancy word for “long-term renting,” something dealers, lenders, and automakers love because they get to extract more money out of you, and you don’t even know it because the monthly payments are deceptively low – made up 27.2% of all new financing in Q3, up from 24.4% a year ago, up from 14.2% in 2009, and up from the mid-single digits back when I was still in the business (and we loved, loved, loved leases!).

And lenders are closing their eyes. The average new-car loan-to-value rose 1.17 percentage points to 110.6%. That is, the average amount financed exceeds MSRP (full-pop retail) by over 10%! The moment the car drives over the curb – that’s when it becomes a used car – the owner is many thousands of dollars upside down. It will take many years of payments before the owner starts building equity. And for the lender, the loss if the car is repossessed is magnified. How could this happen?

Everything gets plowed into the loan. The dealer might sell the car at “invoice,” so at a steep discount from MSRP, but then essentially refunds cash to the customer to pay for tag and taxes, add-ons, or just cash-back. Often the customer is upside down in the trade-in, and that amount must be plowed into the new loan as well. Anything the lender tolerates. And these days, lenders tolerate anything. Ha, used-car LTV rose by 2.18 percentage points to 133.2%.

So even strung-out consumers who were upside down in their trade-ins, didn’t have the money for tag and taxes, and needed cash-back to go Christmas shopping with kept splurging, and subprime loans kept creeping up: 26.0% of all new cars loans (up from 24.8% a year ago) and a troubling 54.9% of all used car loans (up from 54.4%) were subprime or deep subprime.

People need their cars. If you can’t keep up with mortgage payments, you stop making them and live in your home for free until you get kicked out. Then you rent a home. It’s not a bad deal. But when the repo man tows your car into the sunset, you’re on foot. You might not even be able to go to work. And try financing another car with a fresh repo on your credit! So you try to make payments to hang on to your car, even if things get tough. And that has been happening. Loans that were 30 days delinquent edged down to 2.58% in Q3, from 2.67% a year ago. But….

Signs of problems are piling up. The repossession rate in Q3 jumped 54.4%, to 0.62% of all loans, up from 0.40% – according to an earlier report by Experian Automotive. They were concentrated in the riskiest part of the market, at finance companies that fund subprime loans often for used car. There, repossessions more than doubled to 2.66% in Q3, up from 1.18% a year ago. And the average write-off jumped 10.6% to $7,770, up from $7,026 a year ago – yes, the ballooning loan-to-value ratio.

So how crazy is the auto financing frenzy? Loan balances in Q3 soared by 15% to hit an all-time high of $782.9 billion, according to Experian. That’s $103 billion more in 12 months! Sizzling states: up 29.3% in California, 26.3% in Texas, 26.0% in Nevada. Michigan was at the bottom with an increase of 6.8%, which would be a large uptick in normal times, but during these crazy times of ours, it’s the worst performer!

Experian talked about a “positive spiral effect” – with easy credit handed out by blind lenders leading to ever higher sales, giddy dealers, exuberant automakers, bullish analysts, lenders that take on ever more risk, and consumers who’re ever more upside down in their cars and over their ears in their loans. We’ve been there before. It feels good. It’s a new world. This too is an outgrowth of the biggest credit bubble in history. But the spiral can reverse viciously. All it takes are higher interest rates and – once losses are starting to add up – slightly less reckless lending. Suddenly, the industry runs on fumes.

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