Last year, the chatter amongst lenders in the auto finance industry pointed toward expectations of a recession. Yet, as the months fell off the calendar, worries were replaced by a cautious optimism that the longest economic expansion in history would continue. In fact, as October came to a close, top executives from Consumer Portfolio Services, Huntington Auto Finance, GM Financial, and Westlake Financial expressed expectations that originations would remain flat heading into the new decade.
Analysts and economists agree that despite being at the end of the credit cycle, used-vehicle values should hold steady, consumer sentiment will remain high, and the unemployment rate will hover around its now-historic low — all signs that point to a healthy auto market and recession-free economy.
“It’s very unlikely [for the economy] to hit a recession in the next 12 months — chances are virtually nil,” said economic consultant Elliot Eisenberg during a webinar presented by CU Direct.
Supplement that expectation with the Federal Reserve’s cuts to the benchmark interest rate — to a target range of 1.5% to 1.75%, which lowers the cost of borrowing money — and lenders are able to offer more attractive rates to consumers looking to purchase vehicles. Eisenberg expects an additional 25-basis-point cut by the Fed in 2020. However, the Federal Open Market Committee signaled after its December 2019 meeting that rates could remain unchanged for the year if the economy continues on its current trajectory.
With that said, lenders should be wary of the increasing price of new vehicles, lengthening loan terms, and trade-in frequency, all of which contribute to rising delinquency rates — especially in the subprime space. “A lot of auto loans are going bad because SUVs and crossovers are the majority — and those are expensive [vehicles],” Eisenberg said. “A lot of [borrowers] are upside-down on their loans from trade-ins [too],” he added, noting that consumers are trading up in models and rolling previous balances into new loans. “A $35,000 vehicle suddenly turns into a $40,000 loan,” he explained.
“Longer loan terms are also contributing to [borrowers being underwater on their car loans],” Eisenberg said, pointing to 90-plus day delinquency balances, which surpassed $60 billion in the fourth quarter of 2019, according to the Federal Reserve Bank of New York.
Delinquency data from Equifax echoes similar concerns in the subprime space. Accounts that were “severely delinquent” — those 60-plus days past due — reached 5.38% of total volume in November 2019, the highest rate recorded since January 2009. Data provided by TransUnion predicts that the share of nonprime originations should continue to hover around 34% of the market in 2020, mostly flat year over year but down from 41% at the start of the recession.
Steady as she goes
Despite back-to-back, year-over-year declines in Manheim’s Used-Vehicle Value Index for October and November, Cox Automotive Chief Economist Jonathan Smoke expects the index to tick up perhaps 1% in 2020, which would “be a little bit weaker than average in terms of how the index has performed since 1995,” he said.
“Based on that we’ve been seeing in 2019 — even down to weekly trends — we think we’re ending the year with values stabilizing,” Smoke said. “Basically, the declines that we’ve seen in the Manheim Index in the fall should be viewed as a bit of a correction. Meaning, if you take a step back and look at the trajectory we’ve been on for used vehicle values for the last couple of years, we had abnormal strength in used-vehicle values starting in the summer of 2017 and continuing throughout 2018. Then we started to see values correcting for much of , especially in the first quarter and again in the fall.”
Looking to the first couple of months in 2020, Smoke anticipates used-vehicle values to remain fairly stable since retail demand slows in winter. Starting in March, though, the “usual spring bounce” is expected, Smoke said, which should last about six weeks and be “pretty similar to 2019.” That momentum should carry into the summer after the tax refund season wanes off. “We’re expecting the summer to be good, but not as good as some of the past years,” he added.
“It would take a slowing economy — and one that would likely turn into a recession — to see negative values [in the index],” Smoke explained.
Muted concerns about a bubble of off-lease vehicles returning to the market are also buoying used-vehicle values, said Eric Ibara, director of residual value consulting at Kelley Blue Book. “The large increase in [off-lease] volume really occurred over the last two or three years, so any increase we see from here is going to be relatively small compared to what we’ve been through,” Ibara said. “I think the market has absorbed the larger, off-lease volume quite well — there’s been little of the values really dropping precipitously.”
However, off-lease supply of SUVs and trucks could over-saturate the market. “Volume in these segments has increased dramatically over the last three years,” Ibara said. “What we saw [in 2019] was used-car values in these segments decline.”
“There’s this temptation to point to one thing and say, ‘This is why prices are moving the way they are,’ but what I think is happening is manufacturers have reduced the incentive levels in cars, and that’s helped used-car values remain strong for the car segments,” Ibara noted. “That’s not happening for SUVs.”
Predicting OEM incentive activity is “notoriously difficult,” Ibara explained. “We’ve seen a slight pullback in incentives [in 2019],” he said, adding that the industry would benefit if that trend continued.
“From a residual value perspective, lower incentives are good,” Ibara said. “It maximizes the chance that the vehicle won’t be upside-down when it returns off-lease. But incentives are used to hit sales targets and manage inventory that rises above acceptable levels — and it’s very difficult to predict when either of those scenarios could happen.”
“The SUV segment is getting quite crowded these days,” Ibara noted. “If I had to guess, I would think that if incentive spending were to go up, it would be there.”
A little less new-car smell
Light-vehicle sales volume in late 2019 was on pace to reach 17.1 million units for the fifth straight year, but analysts expect that trend to end in 2020. The SAAR is expected to decline 2% to 16.7 million units this year, according to JPMorgan’s 2020 Outlook for the High Yield Markets.
This decline is attributed to concerns about affordability issues spurred by rising vehicle prices, tariff threats, increasing gas prices, and consumers keeping their cars longer, said Satyan Merchant, senior vice president and auto line of business leader at TransUnion. Average loan balances are expected to grow 1.6% year over year by the fourth quarter.
Yet, prime customers will still dominate marketshare, accounting for 66.5% of new originations, Merchant said. Meanwhile, consumers will likely attempt to curb rising costs by opting for used-vehicle purchases and longer loan terms. “The auto industry is going to continue to move along in a sort of steady and healthy fashion it has been over the last few years,” he noted.
Despite these headwinds, consumer attitudes remain positive, according to the University of Michigan’s Consumer Sentiment Index, which clocked in at 99.2 in December 2019, an increase of 0.2% year over year.
“Consumer sentiment rose to the upper end of the favorable range it has traveled since the start of 2017,” wrote Richard Curtin, chief economist of the University of Michigan’s Survey of Consumers. “The Sentiment Index has averaged 97.0 in the past three years, the highest sustained level since the all-time record in the Clinton administration.”
Further, sentiment is buoyed by low unemployment rates, which sit at 3.5% and match a historic low unseen since 1969, according to the U.S. Bureau of Labor Statistics. In fact, the number of job openings continues to outpace the number of unemployed workers, according to Kroll Bond Rating Agency’s ABS 2020 Outlook.
“Historically tight labor markets and low interest rates have provided a sturdy base to add debt,” said Brian Ford, senior director of structured finance at KBRA, noting that growth in household auto debt has increased 63% above pre-crisis peaks. “Everything is indicating — at least through the first half of 2020 — that the consumer is going to stay extremely healthy, and I think that really bodes well.”
Editor’s note: This article first appeared in the January issue of Auto Finance News, available now.