Slumping Used Car Prices Spell Disaster For Subprime Auto Securitizations

It will come as no surprise to our readers that sales of automobiles in the U.S. have bubbled over in recent years and stood at a SAAR of 17.7mm units at the end of September.  To put that number in context, an assumed 15-year useful life for vehicles would imply that's more than 1 car for every driving age person in the United States.  Obviously that's likely not sustainable which is probably why Ford executives admitted on a recent conference call that U.S. auto sales have reached a "plateau."

As we've argued in the past, the main reason auto sales have bubbled over is due to the continuous degradation of lending standards over the past 6 years fueled by the Wall Street securitization machine.  Of course, the problem with "rigging" new car sales in this way is that eventually all of those vehicles come back to flood the used car market with excessive supply resulting in lower used car prices and higher securitization losses...and that's when the whole ponzi starts to unravel.  Which, as the Wall Street Journal points out, is exactly what is starting to happen right now.

Several large companies have warned that prices of used vehicles are likely to weaken, potentially leading to higher losses on loans on which cars are the collateral. That, combined with looser terms for loans and the growth of loans going to subprime borrowers, is sounding a warning for the long credit boom that has spurred auto sales.

 

Auto-loan balances topped $1 trillion for the first time ever this year. Actual default rates remain low, but losses are starting to tick up, leading some big lenders to scale back. That has the credit underpinnings of the auto boom looking shakier.

 

“Losses are going to go higher—there’s no question about that,” said Hylton Heard, senior director at Fitch Ratings.

 

Earlier this year, J.P. Morgan chief James Dimon warned about a weakening auto market and the potential for used-car prices to drop. Indeed, prices of used cars that are up to eight years old are down 3.6% in 2016 through September versus the same period a year earlier, according to the NADA Used Car Guide, a division of J.D. Power.

 

“It is the first time since 2008 that prices have fallen by any material amount,” said Larry Dixon, director of market intelligence at the NADA Used Car Guide. The firm is projecting prices will finish the year down by an average of 4% compared with 2015.

While data from Manheim suggests that overall nominal used car prices have not yet collapsed, they have certainly stalled in recent months...

Manheim

 

...while used car pricing as a percentage of new car pricing has been on the decline.

Manheim

 

As we recently pointed out, rising delinquencies are already apparent in GM's subprime securitizations where 31-60 day delinquencies have been on the rise since 2012 and now stand at over 8% of outstanding loans.

Subprime Auto

 

Meanwhile, the year-over-year change in 61+ day delinquencies for GM securitizations have been growing at double-digit rates for several months now.

Subprime Auto

 

Finally, just like in 2008, wall street is starting to bet against the bubble they created as S&P warns that downgrades of certain subprime securitizations are imminent in the face of mounting delinquencies and write-offs.

"The auto industry has also become intensely competitive, which has led to price competition, loosening of credit standards, and higher charge-offs," S&P said. U.S. car sales have been growing for six years, but the growth rate is showing signs of slowing after a record 2015.

 

The ratings firm said it may have to downgrade some subprime auto loan securities that have high-yield grades because of the increased delinquencies and loan losses, a statement it first made last month.

 

Some investors believe that subprime auto loans will continue to deteriorate, and have looked for ways to bet against them. After the financial crisis, mortgage lenders have been required by law to verify that applicants can repay their debt, but car lenders do not have that obligation. In the 12 months ended in June, only 5.2 percent of car loan applications were rejected, down from 11.1 percent in the 12 months ended in October 2015, according to research from the Federal Reserve Bank of New York. Lenders are making longer-term loans than before, and used car prices have fallen, which also could hurt loan recoveries, S&P said on Tuesday.

With used car prices coming under pressure just as delinquencies and charge-offs start to mount, it's just a matter of time before the subprime auto bubble bursts.  Just another sign of the Obama "economic recovery."

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