In our earlier video titled “The Deleveraging
Myth and The Revival Of U.S. Real Estate Concerns” we brought up the issue of household debt
and, in particular, how this may affect the U.S. real estate market. However, if household
debt is to become a key issue, there are other industries that may also suffer. One major
area of concern for the U.S. is the increase in car related debt and the deterioration
of its quality. In a similar fashion to the real estate industry,
the current situation with car loans leaves the automotive industry extremely vulnerable
to any possible downturn or catalytic event which would leave companies and individuals
exposed to unmanageable levels of risk. Unfortunately, the idea that equity markets
are due a correction has been gaining traction, as can be observed in recent financial media.
Could the knock-on effects of a market reversal cause unwelcome pressure on this area of fragility?
Taking ‘vanity’ metrics on face value, the auto industry appears to be in a healthy situation
with vehicle sales currently higher than pre-financial crisis levels. This mirrors the situation
we found with the housing industry, where new home sales had been steadily increasing
and looking in great shape. Even when we consider the potentially concerning
levels of credit linked with vehicle purchases, our initial reaction is not necessarily one
of alarm. The parallels with the housing industry continue in this area since consumers tend
to satisfy these financial payments ahead of any other obligations. The dependence on
these purchases for managing aspects of everyday life, including the ability to generate an
income, means the prospect of repossession is not a realistic option. In this regard,
it is a relatively safe issuance of credit. Of course, this assumes that the current data
is being presented in a situation that is stable. However, deeper analysis shows that
this may not actually be the case. In fact, the Office of the Comptroller of the Currency
in its ‘Semi-annual Risk Perspectives’ stated “auto lending risk has been increasing for
several quarters because of notable and unprecedented growth across all types of lenders”.
As you would expect when you consider an increasing percentage of financing on an increasing level
of sales, the overall outstanding securitised loans has dramatically increased since 2010.
The situation depicted thus far shows an industry enjoying positive demand, resulting in increased
credit issuance to facilitate the increased demand. These surface level metrics certainly
appear positive, but unfortunately it is often the figures buried deeper that unveil the
reality. If there are vast quantities of loans being
issued, this does not necessarily represent a problem. If the loans are being serviced
adequately, it is simply enabling the purchase of more vehicles without necessarily creating
a cause for concern. The more important question is regarding the
quality of the loans being issued. We do not need to cast our minds far back to observe
how the deterioration in the quality of lending can not only create fragility in an industry,
but can also cause its demise. In the case of the automotive industry, a
worrying picture unfolds as you begin to delve into the details of the financing taking place.
To give this some context we want to focus on the loan amount, the duration of the loans
and the distribution of the risk. As we can see from the chart on screen, the
average loan amount is increasing across all purchase types. This obviously means that
capital repayments will be higher, but also that interest payments will increase too.
Fortunately, the finance rate on consumer instalment loans have been in a decreasing
trend since the financial crisis, which has allowed these interest payments to be more
affordable. The actual rate to be paid by a borrower will
depend largely on their credit score. Although the financial institutions will receive larger
incomes from clients on the lower end of the scale, they are also increasing their risk
exposure and will therefore want to keep their distribution in balance. This does not appear
to be the case with car loans, with the current risk distribution showing around 45% being
made to non-prime borrowers. Since the end of 2009, auto loans to non-prime
borrowers have tripled to $60 billion. In 2016, approximately $30 billion per quarter
was going to borrowers with a credit score below 620, which is sub-prime.
The balances of sub-prime borrowers are now above the pre-recession level.
In addition to this, the exposure to these high-risk borrowers is extended, due to the
higher average term length. Experian reports that the average payback period for prime
borrowers is 66 months, while non-prime and sub-prime both have an average of 72 months.
Despite the low finance rates we have seen since the financial crisis, these term lengths
still ensure that the money owed by borrowers will outweigh the value of the car as the
loan matures. One method borrowers adopt to avoid any negative
situations is to ‘trade in’ their vehicle. This involves agreeing with the car dealership
for any residual amounts owed on the trade-in vehicle to be rolled over onto the new car’s
loan. The amount of trades with negative equity
(car loan higher than the value of the vehicle) has increased to 30%. With these factors in mind, one must determine
whether the current situation is sustainable. On paper, it clearly does not appear to be
a trend that can continue ad infinitum and there will surely need to be a reversal; either
positively or negatively. In other words, either deleveraging or defaults.
Looking at the latter scenario, there are statistics that we can already start to monitor
for key indications of a potential decline. Of particular interest are the delinquency
rates, which appear to be on the rise. 90+ day delinquency rates for auto loans increased
in 2016 to 3.6%. The New York Federal Reserve note that 6 million auto borrowers with low
credit scores are at least 90 days late with their loan payments.
If we separate these figures to their core components, we get a mixed picture. On one
hand, banks and credit unions have seen an improvement in the delinquency rate last year,
but auto finance companies have suffered with an increase of 1%.
Looking at the distribution of overall lending activity across lender type, we can see that
auto finance companies account for over half of all loans. However, more concerning is
their involvement in sub-prime lending, where they account for 75% of loan originations.
This divergence in delinquency rate and lending type shows clear parallels to the situation
discussed in our recent real estate industry research, where non-bank lenders are seen
to be taking large risks. The geographical distribution of the 60-day
delinquency balance suggests there is a heavy concentration in the Sunbelt states.
Interestingly, it appears there may be a correlation of some form with the slowdown in fracking
and shale productions in these areas. This is arguably a minor correlation, but
it certainly shows the breadth of potential catalytic events that could impact the delinquency
rates and add pressure to this fragile situation. Although it is unclear at this point what
the trigger for a reversal will be, it is certain that the industry is in a precarious
situation. We will be paying close attention to the statistics outlined in this video over
the coming quarters, especially as the wider economic and political landscapes evolve. Let’s continue the discussion about this topic
in the comments section. If you liked this video, don’t forget to hit the thumbs up button
and share with any friends who might find it interesting. Subscribe for more videos
like this and to learn more about the financial markets. As always thank you for watching
and see you in the next video.


  1. Jay Pal says:

    Great video Nicholas…

  2. cosmin troc says:

    Great idea with subtile. Very useful for non-english viewers

  3. Eisenstein says:

    what are your views on the whole BTOs that are running around the place and whether that is going to shock us once again?

  4. James Jacques says:

    It would be interesting to see how some of these figures stack up against other forms of vehicle possession such as lease or contract hire for example, as it seems to be that the majority of people are slowly converting from ownership of their vehicles to using vehicles on almost what I'd call a tariff based system? I wonder if manufacturers realise to what extent they are essentially making it easier for people to live beyond their means and tie themselves almost subconsciously into things (in this case vehicles, but it seems to apply to many other services, products and industries) that they ultimately cannot afford in an effort to boost sales, and the knock on effect this has on the economy?

    These questions will probably raise more questions than they actually answer. For example, what effect does having such a high level of sales have on production costs? Could there be a peak level production before increasing the number of units manufactured over a set time scale actually starts to show an increase in production costs? What has been the catalyst that has enabled this colossal increase of vehicle debt?

  5. Philip Kane says:

    Tesla is behind it!

  6. Lance Dooley says:

    I think every needs to watch Mike Moloneys video on 7 Stages of Empire. The dollar is nothing but a ponzy scheme and the bankers need to be ……………….. for there crimes.

  7. Jay Pal says:

    What would you invest in if you know this will turn out to be the case?

  8. SEM says:

    I got a car loan of 25k with a low wage job haha although i trade under the table!

  9. Anddres Torres says:

    Stop buying shit you cant afford!!! I have 450k net worth i drive like a 10 year old truck. Life is not that hard dude

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