"It Just Gets Worse And Worse": A Record 32% Of Used Car Trade-Ins Are Underwater

We have frequently written about the unsustainable trends in new car sales in the United States created by the combination of lower rates, easing underwriting standards and voracious demand for new securitizations by wall street and pension funds that will do just about anything for an extra 20bps of yield. 

This week we find that according to the latest Edmunds' data, many of the same problems also afflict the used auto market.  The most startling takeaway from the report is that the percentage of used cars being traded in with negative equity values - which means that dealers lenders are willing to accept an immediate loss for new transactions - continues to rise and currently stands at an all-time high 32.4%, up from under 20% in 2009.  Moreover, the average balance of the negative equity also continues to rise and stood at a record $5,130 last year, up over a quarter from $4,075 a decade earlier.

This confirms that banks and finance companies are making riskier loans to keep up revenue as vehicle sales slow. and here's why.

The record percentage of underwater loans on trade-ins suggests that car owners are trading in their vehicles sooner than they had previously. According to Bloomberg, "a consumer is often the most underwater on his or her auto loan in the first few years of ownership, because the value of the vehicle drops fastest over that time. By the fourth year, for example, the borrower has paid down a big chunk of the loan, catching up to the depreciation they took in the first few years."

As Bloomberg explains, for borrowers who do trade in their underwater cars, lenders are essentially giving them the money to pay down their loan. The dealer sells the used car, and whatever balance remains on the old loan is folded into the new loan. The borrower might get a longer-term loan than he or she had before to help keep monthly payments manageable. That means that loan balances are getting bigger relative to the value of the new car, and the debt will be paid off slower.

Confirming this, Moody's analyst Jason Grohotolski notes that the growing proportion of underwater trade-ins means that at least some borrowers are getting deeper and deeper in debt with every car they buy. This will - eventually - translate to bigger and bigger losses on loans for finance companies whenever the economy heads south, the same way lower down payments slammed mortgage lenders after the credit and housing bubbles burst.

"It’s this cycle that just continually gets worse and worse," Grohotolski said. "It has to stop, and it doesn’t have a favorable outcome."

Meanwhile, the average used car price continues to rise and stood at $19,400 as of Q3 2017. This suggests that, since most people simply roll their negative equity into their new loans, many used car buyers are likely sitting on loans where ~15-20% of their outstanding balance simply reflects their negative equity from their previous car.

But wait, there's more.

Despite rising average used car prices and rising negative equity, average monthly payments for used cars have managed to stay pretty much flat since Q3 2011.  Obviously, monthly payments are determined by 3 variables: beginning loan balance, interest rate and term.  While interest rates have (at least until recently) come down since 2011, they haven't declined nearly enough to offset a $2,800 increase in starting principal balance which indicates that, like new car loans, used car loan terms are getting stretched out further and further to manage monthly payments.

* * *

Record "underwater" trade-ins are just one of the many facets of the deteriorating US auto market, which has been slowing down in the past year, and in 2017 new vehicle sales fell 1.8% to 17.2 million in 2017, the first decline since 2009...

... even as loan volumes for new and used car purchases was on track to be higher than ever. Suggesting more trouble lies ahead, Moody's said that the growth in the average amount financed for a new car outpaced median income growth between 2013 and 2016, suggesting borrowers are getting more strained.

This can be quantified directly by observing surging delinquency and default rates for subprime auto loans. With few ways to keep the business flowing as demand slows, one staple remains which, of course, is to reach out to less creditworthy borrowers. As a result, delinquencies are soaring for subprime auto loans and in the third quarter reached the highest rate in more than seven years, according to New York Fed data from November.

While few deny that the US auto segment, and especially its financing subset is in a bubble, there is broad consensus that unlike subprime mortgages, the bursting of the auto loan bubble will not have dire consequences. In fact, according to a surprisingly rosy take by Bloomberg, "any pain from car-loan trouble will likely be just a shadow of the housing bubble collapse, because the auto debt market is much smaller." There were around $9 trillion of mortgages outstanding at the end of the third quarter, compared with $1.2 trillion of auto debt, the New York Fed said.

And so far, many of the bonds backed by subprime auto loans are performing well thanks to built-in protections for investors. Wells Fargo analysts said in a note Wednesday that bonds issued by two of the biggest subprime auto lenders -- Santander Consumer USA Holdings Inc. and General Motors Co.’s finance arm -- have room to reach prices not seen since before the financial crisis.

Of course, where this analysis falls short is assuming a linear deterioration once the bubble pops; as the last financial crisis demonstrated, once the waterfall effect of bursting asset bubbles is in play, the fallout quickly turns exponential, and no rational assessment will do the ensuing collapse justice. As such, the real question is whether auto loans will be the trigger for the bursting of the next consumer debt bubble, or just one of the many dominoes to fall.

Meanwhile, Wall Street is back to its usual antics. Since auto loans performed relatively well during the financial crisis, it encouraged new lenders to step into the space, according to Dan Zwirn, chief investment officer of Arena Investors. Rrisky car loans can be bundled into bonds and sold to yield-starved investors, who are eager to buy them, and as the chart below shows, that's precisely what is going on.

And, according to Zwirn, that also gives cheap funding to finance companies to reach out to riskier borrowers.

"The same sorts of excesses are happening in car loans that happened in residential mortgages,” Zwirn said. "Ultimately, when the overall fixed-income market has an issue, even if this is not the cause, car loan debt will likely suffer greatly."

And since Zwirn's hedge fund had to shutter a decade ago precisely because it did not envision this particular scenario, Zwirn's caution deserves particular attention..

For now, the stable economy and low interest rates are helping keep borrowers afloat for now said Moody's Grohotolski. But once there is a slowdown, and rates start rising aggressively, lenders will face a reckoning.

"We could be in a continued state of risk-building on lenders’ balance sheets," Grohotolski said. "You may not necessarily recognize all of that risk until an unexpected downturn. There could be a meaningful increase in losses."

* * *

For now, besides the modest decline in total sales and surging delinquencies among subprime borrowers, there are few signs of an imminent storm in the new or used auto markets. However, chaos in the used-car market - once it accelerates - will hurt OEMs.

As we pointed out in June, Morgan Stanley recently predicted that the surge in used-car inventory - driven by a flood of off-lease vehicles - would saturate the market, resulting in as much as a 50% crash in used car prices over the next couple of years which would, in turn, put further pressure on the new car market, which has already resorted to record incentive spending to maintain volumes.

Used Car Prices

What can borrowers do when prices inevitably crash? Last year, the New York Times reported that lenders are increasingly taking delinquent borrowers to court, and winning - garnishing their wages for years for cars that were, in many cases, worth far less than the amount they're paying.

For working-class borrowers who are struggling in an economy with stagnant wages, this burden could create serious problems for the household budget, and beyond. It also means that once the current low-rate, credit funded sugar high ends, it will be the middle class that pays for it, as usual.


Giant Meteor Uncertain T Sun, 01/28/2018 - 10:45 Permalink

Holy shite! !

15 years eh, on a hole in the water to throw ones money? ...

There are better ways to sink your gold folks, don't do it !

But seriously, all these debt extended terms on immediate depreciating "assets" are a major tell eh? The system relies, needs, demands DEBT, and that shit has lost, is losing it's mojo .. All the kings horses, all the FED fiat, apparently can't put humpty dumpty back together again!

As one fellow pointed out recently, 600% percent increase on RETURNS , for items purchased over the Holi Daze .. holy shite, peeps are hocking their x mas gifts!

Demographics, broke asses, a lack of greater and greater (or solvent) fools ..

Christ, is it no wonder the constant, incessant lying, fake news, faked statistics, faked metrics, faked "markets" ... hell, fake every fucking thing ..

It does make one wonder tho, the timing of the next great die off event. I suppose we can check in with the planners, the overlords. Major world war, false flag, what the fuck ever ... Looks to be another fabulously interesting year!

Smoke em if ya got em ..



In reply to by Uncertain T

Son of Loki Giant Meteor Sat, 01/27/2018 - 18:15 Permalink

People are buying more stuff they cannot pay for. UPS reports this year they see the BIGGEST number of returns ever after the Christmas Holidays; more then 1 Million items per day processed for stuff being returned to the stores.

And that's just UPS. Add Fed Ex, USPS and physical returns and retail is getting slaughtered with used crap. My friend works in that business and says the number or returns this year is up 600% !!


He said it's extremely expensive since shipping is $$$$$$$$$$$$$ and the item has to be tossed, refurbished or cleaned and re-tagged usually. And most of it has to be marked "Clearance" or marked as "Used."

I am surprised stores don't change their policies of strict 14 day return and a 20% mandatory restocking fee. However, that may hurt the original sale.

In reply to by Giant Meteor

SDShack Automatic Choke Sun, 01/28/2018 - 15:31 Permalink

I wonder if a lot of these "car flippers" actually own their house, or more accurately... own a mortgage on their house that they are currently servicing correctly, but are stagnant in the income versus wealth expectation game. So they look at their appreciated house value, and take out a home equity loan to buy all the toys they think are needed to give the appearance of wealth in their competition with their neighbors, friend and coworkers. The high end new car being just one of those many appearance toys that is being sold to the masses as "gotta have". Of course along with the iphone, rolex, fancy clothes, exotic vacation, gardener, housekeeper, country club membership, private school, etc. It's a nonstop debt culture required to keep the debt ponzi going.

In reply to by Automatic Choke

shovelhead daveO Sat, 01/27/2018 - 22:15 Permalink

Yup. Just bought a couple of heavy duty lift stand Pro 500 Kitchenaid mixers at less than half price 'factory refurbished'. A blog said that almost all of them are returned because the beater paddle isn't adjusted properly at the factory but gives the simple directions to do it in the instructions before using by turning a screw.

Perfectly brand new at less than half price because people are too stupid to read the instructions. My daughter called me up crying because she loves to bake and has always wanted one but couldn't justify $450 for a mixer you don't have to move to the edge of counter to tilt up like the cheaper ones that bog down and break the plastic gears on stiff cookie dough

Dumb people made my wife and daughter happy. Me? I just slap the dough on the counter and knead it or use a dough cutter for really wet dough for French baguettes.

No cure for old school going by feel to get it right.


In reply to by daveO

MK ULTRA Alpha bluecollartrader Sun, 01/28/2018 - 06:19 Permalink

A note on used everything, there is a level of materialism in America that is so great, I find stuff, expensive stuff people threw out, clean it up and sometimes fix it and give it away. I need to start selling it and I have, found a brand new wifi router, found it going to the dumpster to dump the garbage and low an behold, a brand new router.

I try to recycle, never seen it like this, I know a group of programmers who dive dumpsters with eye gear and gloves the whole suit. I'm amazed at their finds. Global over capacity in manufacturing has driven materialism to the highest level in global history.

On the used car pricing issue, all during the Obama era, people held on to their cars. Used parts, junk yards, transmission shops etc were marshaled for the nation's car fleet to hold a new record for the oldest US car fleet in US history.

There is a glut of used cars and they're not holding their value, however inflationary expectation will increase used car valuation over the next economic boom cycle, if a boom cycle in infrastructure, housing and manufacturing materializes as I know it will.


In reply to by bluecollartrader

11b40 JRobby Sun, 01/28/2018 - 16:30 Permalink

The stores charge back the vendor.  Most now have automatic defective allowances of 1 or 2% that either come off each invoice, or get claimed/charged back on a quarterly or semi-annual basis.  Most large retailers close their fiscal year at the end of Jan.  Buyers have been dialing for dollars all month, looking for markdown/margin assistance & collecting adv & defective accruals.  I have been hearing a lot about being “partners” all month.

In reply to by JRobby

swmnguy yogibear Sat, 01/27/2018 - 19:38 Permalink

In September of 2003, I refinanced my little starter home.  My cautious, conservative credit union was willing to lend me 2.5x what I'd paid for it only 7 years before.  I didn't take them up on that, but I did add 20% to the overall size of the mortgage, a new 30 years, and my monthly payment actually went down due to interest rate declines at that time.  I had to get out pencil and paper and do the math to figure that out.  And it struck me that the people who would want my little home hadn't seen a 250% increase in pay in the prior 7 years; how they hell could they afford houses at all?

Well, it took another 4 years for the crash to get going, and 5 years before anybody would admit it was crashing.

America is a huge and astonishingly wealthy nation.  At some point this is going to implode, but it's likely to take far longer than we think possible.

In reply to by yogibear

RafterManFMJ swmnguy Sun, 01/28/2018 - 04:48 Permalink

Quick story. I went into my CU during the boom and wanted an approval letter for 200K as I was interested in a home that listed at 220; wanted a letter in hand to show that I could come up with 200...

I carefully explained to the loan officer what I wanted and why; she came back saying “Good news! We approved you for 600K! Here’s the letter!”

I looked at it, back at her, thanked her and walked out. Didn’t buy the house, and that was a good thing. 

In reply to by swmnguy

Vendetta swmnguy Sun, 01/28/2018 - 11:43 Permalink

Exactly! Housing prices and rents are supposed to based on average wages not interest rates .. but the rentiers increase rent in a gay marriage with housing prices to force potential home buyers to look at buying a home even if its overall price is 4 to 6 times their annual wages... so ass backward in my humble opinion ... just saw a real estate commercial showing some black guy with a new baby looking at home on Zillow for $410,000 ... makes sense if he’s earning $200,000 a year 

In reply to by swmnguy

Vendetta swmnguy Sun, 01/28/2018 - 11:44 Permalink

Exactly! Housing prices and rents are supposed to based on average wages not interest rates .. but the rentiers increase rent in a gay marriage with housing prices to force potential home buyers to look at buying a home even if its overall price is 4 to 6 times their annual wages... so ass backward in my humble opinion ... just saw a real estate commercial showing some black guy with a new baby looking at home on Zillow for $410,000 ... makes sense if he’s earning $200,000 a year 

In reply to by swmnguy

trgfunds JRobby Sat, 01/27/2018 - 18:26 Permalink

And rising rates should only add a little more. Good thing wages are skyrocketing! I mean. Wages are up 2 or maybe even 3 percent!! Oh my god! Everyone is making lots of money and doing great! Didn't you hear? All the call center employees got 1000 dollars! $35k dollar Honda Civics for everyone!!!

In reply to by JRobby