For months we've been talking about the massive lending bubble propping up the U.S. auto market. Now, noting many of the same concerns that we've highlighted repeatedly, Morgan Stanley's auto team, led by Adam Jonas, has just issued a report detailing why they think used car prices could crash by up to 50% over the next 4-5 years.
Here's the summary (flood of supply, poor lending standards and desperate OEMs who need to keep new car sales elevated at all costs):
- Off-lease supply: This has already more than doubled since 2012 and is set to rise another 25% over the next 2 years.
- Extended credit terms: Auto loans are at record lengths and lease assumptions (residuals, money factor) are at record levels of accommodation.
- Rising rates: Starting from record low levels in auto loans.
- Overdependency on auto ABS: The outstanding balance of auto securitizations has surpassed last cycle's peak.
- Record high deep subprime participation: 32% of subprime auto ABS deals were deep subprime (weighted average FICO < 550) in 2016 vs. 5% in 2010.
- Record high units of new car inventory: 2016YE unit inventory levels were near 10% higher than 2015YE, and are continuing to trend higher in 2017.
- OEM price competition: Car manufacturers have capacitized to a 19mm or 20mm SAAR. At this point in the cycle we start seeing more money 'on the hood' to move the metal. As new car prices fall, used prices look relatively more expensive, which necessitates a decline in used prices to equilibrate the supply/demand imbalance.
- Increased ADAS penetration: We expect auto firms to achieve nearly 100% active safety penetration by 2020, creating an unprecedented safety gap between new and used vehicles, accelerating obsolescence of the used stock. Rising insurance premiums on older cars could accelerate this shift.
- Trouble in the car rental market: Due to a number of secular shifts, including how consumers access transportation options (e.g. ride sharing), car rental firms are facing stagnant growth, weak pricing and over-fleeted conditions. As these cars hit the auction, the impact on prices could be significant.
All of which Morgan Stanley thinks could spark a 50% decline in used car prices over the next couple of years. So, for all of you pension funds out there scooping up all of the AAA-rated slugs of the latest auto ABS deals for the 'juicy yield', now might be a good time to review what happened to the investment grade tranches of MBS structures back in 2009 when home prices crashed by similar amounts.
And here are the stats...
Off-lease volumes have already doubled since 2012 and are only expected to get worse...meanwhile, lending standards have gradually gotten worse and worse...
...as further revealed by the growing share of 'deep subprime' loans in auto ABS deals.
Of course, so far negative equity hasn't been a problem for car buyers because lenders have been all too willing to roll those debt balances into new loans. And, courtesy of low rates and stretched out terms, consumers haven't really cared that their debt balances are ballooning so long as their monthly payments remain low.
Meanwhile, none of the warnings about a flood of used car volumes about to hit the market has impacted new car volumes being pushed on to dealer lots.
All of which results in this fairly brutal outlook for used car prices:
Dear OEMs, the first step is admitting you have a problem.
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