Most of you reading this are probably aware the U.S. auto market is a train wreck waiting to happen, but a recent report by Moody’s really puts the industry’s insane lending practices into perspective.
As U.S. auto sales have peaked, competition to finance car loans is set to intensify and drive increased credit risk for auto lenders, Moody’s Investors Service said in a report released on Monday.
“The combination of plateauing auto sales, growing negative equity from consumers and lenders’ willingness to offer flexible loan terms is a significant credit risk for lenders,” Jason Grohotolski, a senior credit officer at Moody’s and one of the report’s authors, told Reuters.
Motor vehicle sales have boomed in the years since the Great Recession. U.S. sales of new cars and trucks hit a record annual high of 17.55 million units in 2016.
Industry consultants J.D. Power and LMC Automotive on Friday reiterated their forecast for a 0.2 percent increase in sales in 2017 to 17.6 million vehicles.
But Moody’s says it expects U.S. new vehicle sales to decline slightly to 17.4 million units in 2017.
In the first nine months of 2016, around 32 percent of U.S. vehicle trade-ins carried outstanding loans larger than the worth of the cars, a record high, according to the specialized auto website Edmunds, as cited by Moody’s.
Typically, car dealers tack on an amount equal to the negative equity to a loan for the consumers’ next vehicle. To keep the monthly payments stable, the new credit is for a greater length of time.
Over the course of multiple trade-ins, negative equity accumulates. Moody’s calls this the “trade-in treadmill,” the result of which is “increasing lender risk, with larger and larger loss-severity exposure.”
To ease consumers’ monthly payments, auto manufacturers could subsidize lenders or increase incentives to reduce purchase prices, though either action would reduce their profits, the report said.
Bad loans and reckless behavior generally seems to be already baked into the cake, so the real question is when will it all truly enter the market and create major problems? The cycle is already long in the tooth and a year of negative sales growth could turn out to be a tipping point.