NADA Used Car Guide gave SubPrime Auto Finance News an exclusive look at its latest white paper that examines a new way of financing in light of lengthening terms and deeper negative equity positions.
During a conversation on Monday, executive analyst Jonathan Banks explained what NADA UCG found in terms of how much negative equity is becoming an issue in auto financing, especially if the contract is attached to a car as opposed to a truck. Banks said his team reviewed data from J.D. Power’s PIN Network, which covers about 35 percent of the total auto finance market. Through the first quarter of last year, Banks indicated about 29 percent of originations included trades that carried negative equity. Through the first quarter of this year, that level ticked up to 31 percent.
While a 2-percent year-over-year rise might not seem overly noteworthy, Banks pointed out how the situation is much more dramatic when cars are involved as opposed to trucks and SUVs, which have not seen their used-vehicle prices decline as much.
Banks noted that about 60 percent of car contracts had an equity position through the first quarter of both last year and this year. However, the amount dropped by 50 percent, sitting at about $1,000 during Q1 of 2015 and $500 at the first quarter of this year.
“Even the people who are trading in with an equity position, that’s declined dramatically,” Banks said. “And arguably $500 as an equity position, likely a lot of time that’s what the dealer is giving to the customer to facilitate the loan. It’s definitely an issue on the cars and we’re seeing that changing pretty quickly.”
For trucks and SUVs, it’s a much different scenario. Banks relayed J.D. Power data that showed about 80 percent of originations for those units during Q1 2011 included trades with equity. This past quarter, the level dropped to 70 percent but Banks pointed out that the amount of equity was much more robust, as trucks and SUVs brought about $4,000 to the table.
“People coming in with a trade-in with trucks, SUVs and even compact SUVs, we think are going to be in a strong equity position in 2016. It’s a much different situation when you’re looking at the car versus the truck segment,” Banks said. “We expect it to continue. A lot of that is the used prices on cars are dropping, and that’s going to continue as the lease maturities for those segments are going to be quite high.”
What’s triggering all this concern about negative equity? It’s a metric finance companies have been watching for some time — lengthening contract terms.
“Roughly when you extend a loan from 60 to 72 months, that pushes back the equity position by about the same amount of time by about 12 months,” Banks said. “When you consider about one-third of the loans represent 72 months or longer, according to PIN data, this is problematic, especially when considering the negative equity trends especially in the car segments.
“Someone in a car loan with a longer term is unlikely to be in an equity position coming back into the market in 2016,” he continued. “We think it’s going to get a bit worse if our forecasts are correct for used-vehicle prices, where we’re anticipating about a 6 percent decline in 2016 and more declines in ’17 and ’18 that probably will be less dramatic than the 6 percent but declines nonetheless.
“Consumers that are in these longer-term loans who want to come back into the market this year or next year or 2018 especially in car loans — truck loans are a little bit better — the chance of more negative equity is greater,” Banks went on to say.
Compounding the matter is the behavior NADA UCG is seeing from automakers. Banks indicated overall incentive levels are up about 10 percent so far this year with a 5-percent rise for lease subventions.
“Manufacturers have been very reliant on lease subvention to keep sales humming,” Banks said. “I don’t believe this is sustainable. When you look at incentive as a percentage of MSRP, they’re reaching close to 10 percent of MSRP. It’s truly a bad signal.
“You do not want to get people into your vehicles through discounting,” he continued. “Our research suggests that when you do that, it tends to make consumers think high discounts means more discounting and they say, ‘I’ll wait on the sidelines until I get that optimal discount.’ That’s not really what you want to do. You want to get consumers buying your product for the attributes of that product.”
What should the industry do instead? NADA UCG recommended in its white paper that will be distributed later this month that finance companies “can mitigate some of the risk associated with lower equity levels by fine-tuning the amount of credit extended on a new automotive loan at origination by complementing current processes with market-based data.”
Banks mentioned during the conversation with SubPrime Auto Finance News that these current trends aren’t necessarily out of left field. He noted that the industry witnessed such developments during the early 2000s as well as during the middle of the 1990s.
“Bottom line: When the customers come back to the market, they’re going to be coming back in a car loan likely with negative equity, coming out of a longer-term loan which likely has a lower payment due to the interest rates,” he said. “They’re going to be expensive to get into a replacement vehicle.
“What we’ve seen already, and likely one of the reasons we’ve seen incentives shoot up in the car segment, is a lot of the consumers might stay on the sidelines and delay their purchase because of their negative equity,” Banks went on to say.