The two largest purchases by consumers are houses and cars. Cars are starting to look like the prior housing debacle. Some 33% of people who traded in cars to buy new ones in the first nine months of 2019 had negative equity, compared with 28% five years ago and 19% a decade ago, according to car-shopping site Edmunds. Why are autos an important metric for real estate? What does this mean for the economy going forward?
What was in the data?
Owing more than the vehicle’s value on a car loan is known as being “upside down” or “underwater.” The gap between the car’s value and the amount owed is called “negative equity.” Whatever you call it, it is trouble for consumers as the car is worth less than is owed.
Over recent years, we’ve seen a rise in the number of people underwater, as well as the amount of negative equity they have in their cars. In 2012, for example, only about 23 percent of cars traded in were worth less than what was owed on them. Today approximately 33% of people who traded in cars to buy new ones in the first nine months of 2019 had negative equity, compared with 28% five years ago and 19% a decade ago, according to car-shopping site Edmunds.
With negative equity rising quickly, breaking the cycle will become increasingly difficult. The negative equity is trapping consumers in a downward spiral. I’m not sure how consumers ultimately get out of the cycle as incomes are not rising or even able to keep up with increased debt loads. At some point the cycle will ultimately break and lenders will no longer allow the negative equity to keep rising.
Why should we care about auto lending?
The loosened standards are leading to higher charge offs on auto loans both at banks and within securitized pools. Auto delinquencies have hit their highest level in seven years. Furthermore, with 33% of all autos worth less than what is owed will lead to further delinquencies.
According a recent Morgan Stanley report previously owned cars are predicted to decline by 20% over the next 4 years (and they might plunge as much as 50%). Even on the low side of the 20% decline auto loan losses are set to explode.
Who will be left holding the bag when auto loans losses mount?
It is going to be a large bag! The total balance of auto loans outstanding just reached 1 trillion dollars, the highest amount ever recorded. The million-dollar question is who will take the hit?
The easiest suspects to identify are the automakers and banks. For example, in recent SEC filings Ford increased its loan loss reserves to 449 million a 34 percent increase and GM set aside 864 million, a 16% increase. Between these two auto makers the anticipated loan loss reserves is almost 1.3 billion dollars!
Banks will also be hurt. Many banks have built substantial auto lending portfolios in an effort to increase their yields. As defaults increase, banks will no doubt be impacted.
Other than banks/automakers who else will be impacted?
The increased losses will trickle through the economy in unique ways. In the last mortgage crisis, finding out who actually was holding the bag when the **** hit the fan was an interesting question. The same thing is happening with today’s auto loans. They are being bundled into various securities and packaged/resold on wall street. Furthermore, autos are being “stripped” like mortgages where they are bundled into securities and different buyers buy different pieces (tranches) of a security. Each tranche could have a drastically different risk level. It is difficult to know exactly what portfolio these various tranches end up in.
Yields are extremely low by historic standards and therefore there is a huge desire of investors to increase their returns. Many pension funds, hedge funds, retirement accounts, etc.. have invested in auto loans and I would suspect that many individual investors also have exposure in their portfolio that they might not even fully understand just like the last mortgage crisis.
What about real estate and mortgages?
A large group of consumers will be left out of the real estate market. With auto loans taking a larger share of consumer paychecks, there is less money for housing and other items. At some point lenders will take their losses and stop extending negative equity loans due to loss risks. This will crimp consumer spending on housing and other items.
Summary
The looming auto crisis is a good reminder of the risks within the economy. Everyone is chasing yields as treasuries continue to languish which is driving investors into riskier asset classes like auto lending. At some point the risk vs. reward analysis begins to break down as losses occur and lenders will begin pulling back on other types of loans like mortgages. Fortunately, the amount of auto loans is a much smaller part of the economy than the mortgage crisis in 08 so the fallout should be less. Unfortunately, it will still be painful for the holders of the securities when they ultimately take a hit.
Additional reading
- https://www.wsj.com/articles/a-45-000-loan-for-a-27-000-ride-more-borrowers-are-going-underwater-on-car-loans-11573295400?mod=djem10point
- https://www.edmunds.com/car-buying/being-upside-down.html
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Written by Glen Weinberg, COO/ VP Fairview Commercial Lending. Glen has been published as an expert in hard money lending, real estate valuation, financing, and various other real estate topics in the Colorado Real Estate Journal, the CO Biz Magazine, The Denver Post, The Scotsman mortgage broker guide, Mortgage Professional America and various other national publications.
Fairview is a hard money lender specializing in private money loans / non-bank real estate loans in Georgia, Colorado, Illinois, and Florida. They are recognized in the industry as the leader in hard money lending with no upfront fees or any other games. Learn more about Hard Money Lending through our free Hard Money Guide. To get started on a loan all they need is their simple one page application (no upfront fees or other games).