The Auto Loan Madness Coming To An End

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Includes: F, GM, TM
by: Macro Analyst

Summary

Low interest rates have fueled strong sales in the U.S. auto market and pushed it to a record high.

The amount of U.S. auto debt has never been greater than now - a huge increase in used car supply is probable.

Auto lenders start getting aggressive in their pricing - signifying worries about the creditworthiness of borrowers.

In 2015, we have seen several headlines about new record highs in auto sales and auto loans - they reached $1.06 trillion in total (the high in 2007 was $0.82 trillion). Fueled by low interest rates and increasingly risky underwriting practices, this trend has not slowed down yet. Similar to the housing bubble in 2008, still increasing prices for new and used cars seem to limit the losses for lenders in the case of a default. Although housing debt amounts to a much bigger $8.74 trillion, it grew by $20 billion compared to $101 billion in new car loans last year. The percentage of vehicles with financing is 87% for new cars and 55% for used ones.

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With such a huge amount of auto loan debt outstanding, auto lenders will have to slow loan growth and increase the costs and barriers for an auto loan. Auto lenders already start to be more aggressive in their pricing - which signifies worries about the creditworthiness of borrowers. With more auto loan debt per borrower than ever before I expect a slowing loan growth. Just a slow-down or flat numbers won't hurt the automobile industry that much. As long as the consumers can pay back their debt in time, everything seems to be fine. But the bigger problem is that we have a bubble here which will have its sudden negative impact once it bursts.

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That would start a self-reinforcing trend with more and more barriers for new auto loans. With increasing defaults in auto debt, the used car supply will be flooded. As prices for used cars drop massively, the salvage value for cars financed by loans will deteriorate and generate losses for the lenders. Cheap used cars mean less demand for new cars and a huge increase in automotive inventories-to-sales - look at what we have seen in 2008.

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What could be the trigger for the end of this auto loan boom? Obviously, further tightening by the fed takes away the main driver for cheap auto loans. A higher price of oil wouldn't just make less money available for the consumer to pay back debt. The low price of oil has fueled demand for trucks and cars with higher gas-consumption. An increase in used car supply is coming - not just from defaults on debt - which will have its own effect. I believe there are serious reasons why we are at the end of this boom and I expect the U.S. auto sector to be a good short.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.