The Flawless Storm Hits Used-Car Values: The Foundation Of The Auto Industry Is Faltering
The following topics all have their part in fueling the storm to come:
Used car values determine in large the velocity of fresh car sales. Most fresh car transactions involve a trade. The level of equity in the trade oftentimes determines whether a fresh vehicle transaction will be successful or not. Inclining used car values lead to swifter trade cycles while declining used car values lead to slower trade cycles. Dismal fresh car sales volume during our last recession created a shortage of used cars. This created a large supply and request imbalance that made used car values soar from two thousand nine till two thousand fourteen as seen on this chart.
This time period was enormously favorable for fresh car sales because consumers found themselves in an equitable position on their vehicles in a very brief period of time. To illustrate this, consider this chart of a 60-month loan.
The black line represents the principal balance owed. An optimal trade cycle occurs when the principal balance owed on a loan intersects with the market value of the vehicle. The bullish used car cycle for passenger cars ended in two thousand fourteen as a result of extreme pricing pressure from fresh car leases. Since 2014, used passenger car values have corrected and proceed to underperform. This underperformance is largely due to the effects that falling used car values have had on fresh car sales velocity. A longer trade cycle results in a slower velocity of fresh car sales. Today, we`ve seen data suggesting that used car values can drop as much as 50% from current levels. Refer to the above loan chart and consider what a drop that large would mean for fresh car sales velocity in terms of trade cycles.
Two) Enhanced Dependency on Leasing
Used car values also determine the effectiveness of leasing. The most significant component of a lease is the gap inbetween the residual value and the sale price of the vehicle. A residual value is little more than a guess at the future value of a vehicle. Manufacturers and third party companies like ALG use current and historic used car value data to establish residuals. Because of this process, residual values tend to lag used car values. As residuals rise, the gap inbetween the residual value and the sales price gets smaller leading to lower payments. As residuals fall, the gap becomes larger leading to higher payments.
There are many benefits to leasing, but the most significant is affordability. Affordability is most often measured in terms of monthly payments. As leases become more affordable, they become more appealing to consumers and penetrate at a higher percentage of total sales. The bullish cycle in used car values from two thousand nine till two thousand fourteen led to some of the lowest lease payments I`ve seen in my career. Consumers noticed and took advantage of the savings.
Residual values lag used car values. When used car values outperform residual values, lessees can trade early and utilize the equity in their lease as a down payment towards a fresh purchase or lease expanding the fresh car business. When used car values underperform residual values, fresh car business contracts as lessees are coerced to go the utter term of the lease and are left without equity in the end. As I mentioned earlier, used car values for passenger vehicles have been falling significantly since 2014. Aside from the negative effects that used car values underperforming residual values have on fresh car sales velocity, the lagging effect discussed earlier leaves captive banks open to a considerable amount of residual risk. Please use this link and read through the entire thread for a number of examples using BMW leases.
As used car values proceed to decline, residual values will proceed to adjust downward. Lower residuals will lead to higher payments, and leasing will produce fewer sales.
Leasing is responsible for a significant portion of total light vehicle retail sales. Here`s a look at the invasion rates by manufacturer.
The average fresh vehicle price has inflated by 20% since 2008. Leasing has become the best and/or only way for consumers to afford fresh vehicles while prices proceed to rise. This is evident when you see manufacturers relying on leasing for most of their sales volume. What happens to the sales volume for individual car companies and for the auto industry as a entire when residuals are adjusted lower and the affordability that leases provide is lost?
Trio) Credit Risk
While conventional auto loans only carry default risk, leasing adds residual risk. Leases do not have to default to become a problem; they can become a problem at maturity. Most of the outstanding leases have been securitized bringing us back to two thousand seven levels. The appetite for auto related Six pack makes flawless sense since leases haven`t produced negative equity for years. This adds a layer of complexity that needs to be considered.
The gap inbetween residuals, principle balanced owed for all auto loans and the recovery value for vehicles will grow as used car prices proceed to fall. The larger the gap inbetween balances owed and used car vales, the larger the risk and potential losses for the banks holding these loans.
Four) What`s Holding It All Up?
The light truck and SUV segment is at a different stage in its` cycle compared to passenger cars. The majority of US consumers choose light trucks and SUVs instead of passenger cars. However, the spectacle of the light truck and SUV segment is very dependent on the price of fuel. Years of low fuel prices have kept the request for light trucks and SUV very high. So what do you do when one segment (Light Pickups and SUVs) is outperforming the other (Passenger Cars)? Well, you build less of what`s underperforming (Passenger Cars) and more of what`s outperforming (Pickup Trucks and SUVs). Much like a stock market index where money can flow into big names like FANG while market breadth is lost and still stir up, manufacturers have shifted their concentrate toward the more profitable light pickup truck and SUV market. This has experts very focused on oil to gauge the overall health of the automotive sector.
Five) Think Fuel Prices Are Your Leading Indicator? Guess Again…
The same thing that caused the correction in used passenger car values is now affecting light pickup trucks and SUVs – ultra low lease payments. Note how lease volume is now favoring SUVs instead of passenger cars. (Residuals are correcting in passenger cars, which translates into higher payments.)
Consumers purchase used cars because they are typically more affordable than fresh vehicles. Affordability is most often measured in terms of monthly payments. What happens to used car values when a fresh vehicle becomes more affordable than its` 1, two or 3-year-old version?
6) Supply and Request
Rate of sale calculations from a record setting year followed by four months of year-over-year misses, has left us with a high-day supply of fresh vehicles.
When sales velocity slows down, the expected reaction from manufacturers is more incentives, and enhanced incentives are exactly what we received. To illustrate this, let`s take a look at General Motors. GM had a 98-day supply of vehicles at the end March (2017). Ninety-Eight days is very high, but GM stated that it`s part of a strategic build in their inventory. Even if that is the case, the Malibu had a 124-day supply and the Silverado had a 115-day supply. The response to the day-supply problem in Silverado and Malibu was a very aggressive lease and 20% off MSRP respectively.
This script triggers a series of events that places a lot of negative pressure on used car values.
This fresh car problem precedes a supply glut of lease comes back. Supply will soon overwhelm request as the record setting leases of the last three years mature. Here is a look at a maturity chart for Ford.
Lease maturities don`t necessarily turn into inventory problems. When used car values are outperforming residual values, most clients elect to buy the vehicle from the captive banks or utilize the equity as a down payment toward a fresh purchase or lease. A smaller amount of vehicles reaching wholesale auctions thresholds supply and supports higher used car values. However, when used car values underperform residual values, clients will exercise their right to comeback the keys to the vehicle and use the protection that the residual value provides. A growing come back rate shown here on this slide from Ford`s Q1 earnings call is proof that this is happening today.
Dealers will also reject maturing leases at the residual value thus leaving the transfer of ownership from captive banks to the fresh holder at wholesale auctions. This will lead to higher auction volumes resulting in lower used car values.
7) The Competition Does Not Wait
Competitors will not sacrifice market share while another manufacturer manages a day-supply problem. As I expected, competitors responded quickly to the aggressive lease on Silverado:
These aggressive leases are exactly what triggered the correction in used passenger cars. Will it be different this time?
8) Manufacturers Commence The Problem And Dealers Supercharge It
Fresh car dealerships are being built in vast quantities. With request slowing, more dealers have to fight for fewer sales. This supercharges the already large discounting effect created by the manufacturers. The unintended collateral harm becomes used car values. What market is left for used cars when fresh cars are less expensive?
9) two thousand sixteen Leftovers in May of 2017
A quick scan using your dearest auto search engine will expose a staggering amount of fresh two thousand sixteen leftovers. On May Ten, 2017, a plain internet search returned 145,763 leftover units nationally.
This is concerning for many reasons. Dealers place very mighty emphasis on getting rid of prior model year vehicles before the end of each year. At a certain time of the year (already past), manufacturers will give dealers a lump-sum payment per unit of unsold prior model year vehicles and eliminate incentive support in terms of special leases, incentivized rates and rebates. Dealers do not want to have any leftover vehicles when this happens, as those vehicles are utterly difficult to sell against the newest models that have manufacturer incentive support.
The amount of leftover fresh car inventory is also a sign of slowing request. These vehicles represent the most intense discounted portion of fresh car inventory at dealerships. The two thousand sixteen leftover models have not sold yet and we already have two thousand eighteen models at a showroom floor near you.
Ten) How Significant is the Health of the Rental Car Market?
The problems facing rental car companies today are very serious. It`s significant to understand how their monthly per-unit expense relates to profitability.
There is a direct correlation inbetween used car values and the car rental company`s monthly per-unit fleet cost. The rise in per-unit cost has a direct effect on profit margins. You can see this very clearly if you overlay the NADA used car value index over a stock chart during the same time period.
The monthly per-unit cost at Hertz is presently $348. Consider what happened to sales into rental (below chart) in two thousand nine with a similar per-unit cost.
11) Expected Results Versus Reality
Many respected sources are projecting plane retail sales for two thousand seventeen and a modest 1% decline in 2018. I respectfully disagree. We are simply too far along in a used vehicle value correction that presently includes light pickup trucks and SUVs. Leases will become less affordable as residuals rise. Without leases, we simply will not have the volume needed to meet those projections. I also believe that sales to rental car agencies will significantly decline moving forward. At this rhythm, the possibility of a major rental car agency going out of business in the next year is not out of the question.
12) Not Simply a Retail Sales Problem
It is not only retail sales that we need to worry about, but also manufacturing – an significant part of our economy. A 10% reduction in the automotive SAAR can trigger a nasty set of events. The possibility of losing the affordability of leases, signifying a growing number of retail sales, and fewer orders from rental car companies are enough to make a 10% correction a considerable and respected threat.
13) What Comes Next
I have a hypersensitivity to both switches in inventory and catalysts that influence used car values. Stable used car values are an absolute necessity for a healthy fresh car sales environment. As manufacturers proceed to discount fresh vehicles strongly, they are at the same time ruining the value of the used vehicle that potential customers need to trade in for the purchase of a fresh vehicle. The destruction of used car values offsets the effect of intense discounting, lowers lease offers and shoves trade cycles out further. I view the manufacturers` day-supply problem as a catalyst for the next gam down in used car values. Take a look at this chart from Morgan Stanley Research.
The very first time I eyed this, I did not believe that a 50% correction would be possible. I asked myself, Do they know the influence that a 50% correction in used car values would have on the automotive industry and the banks that service the loans?
Well, I stand here today as witness to a ideal storm that could make a 50% reduction in used car values a very real possibility. I have already witnessed signs that the truck and SUV market have corrected. The manufacturer’s` incentive response to a growing day-supply problem along with the supercharged discounting effect of more dealers fighting over fewer sales is the equivalent of pulling down the MOAB on used car values. This set of events has made fresh cars, in some cases, more affordable than used cars.
Used car values will fall as a result but not instantaneously. Inventory at wholesale auctions will begin to backup as request from dealers dwindles and sellers unwilling to accept acute losses reject offers. This can only proceed for so long as a tsunami wave of lease comes back starts this year (2017) and will provide an unrelenting amount of inventory until the end of 2019. If inventory backs up at auctions, the drop in used car values will be unexpected and unexpected, as sellers will have no choice but to unload the vehicles to the highest bidder. The effects will ripple through the entire automotive sector. Trade cycles will be shoved out further, leases will penetrate at lower percentages as residuals adjust, retail sales will slow, dealers will reject inventory, rental car companies will shrink their inventory levels as per-unit cost resumes to rise, and ultimately manufacturing will slow or stop for a period of time while the rate of sale is adjusted.
The auto industry despairingly needs a YOY hit in retail sales to relieve some of the pricing pressure from a growing day-supply problem. Another miss in May would be a detrimental event that could bring a slowdown or stop to auto manufacturing sooner than expected.
The Flawless Storm Hits Used-Car Values: The Foundation Of The Auto Industry Is Faltering, Zero Hedge
The Ideal Storm Hits Used-Car Values: The Foundation Of The Auto Industry Is Faltering
The following topics all have their part in fueling the storm to come:
Used car values determine in large the velocity of fresh car sales. Most fresh car transactions involve a trade. The level of equity in the trade oftentimes determines whether a fresh vehicle transaction will be successful or not. Inclining used car values lead to swifter trade cycles while declining used car values lead to slower trade cycles. Dismal fresh car sales volume during our last recession created a shortage of used cars. This created a large supply and request imbalance that made used car values soar from two thousand nine till two thousand fourteen as seen on this chart.
This time period was utterly favorable for fresh car sales because consumers found themselves in an equitable position on their vehicles in a very brief period of time. To illustrate this, consider this chart of a 60-month loan.
The black line represents the principal balance owed. An optimal trade cycle occurs when the principal balance owed on a loan intersects with the market value of the vehicle. The bullish used car cycle for passenger cars ended in two thousand fourteen as a result of extreme pricing pressure from fresh car leases. Since 2014, used passenger car values have corrected and proceed to underperform. This underperformance is largely due to the effects that falling used car values have had on fresh car sales velocity. A longer trade cycle results in a slower velocity of fresh car sales. Today, we`ve seen data suggesting that used car values can drop as much as 50% from current levels. Refer to the above loan chart and consider what a drop that large would mean for fresh car sales velocity in terms of trade cycles.
Two) Enlargened Dependency on Leasing
Used car values also determine the effectiveness of leasing. The most significant component of a lease is the gap inbetween the residual value and the sale price of the vehicle. A residual value is little more than a guess at the future value of a vehicle. Manufacturers and third party companies like ALG use current and historic used car value data to establish residuals. Because of this process, residual values tend to lag used car values. As residuals rise, the gap inbetween the residual value and the sales price gets smaller leading to lower payments. As residuals fall, the gap becomes larger leading to higher payments.
There are many benefits to leasing, but the most significant is affordability. Affordability is most often measured in terms of monthly payments. As leases become more affordable, they become more appealing to consumers and penetrate at a higher percentage of total sales. The bullish cycle in used car values from two thousand nine till two thousand fourteen led to some of the lowest lease payments I`ve seen in my career. Consumers noticed and took advantage of the savings.
Residual values lag used car values. When used car values outperform residual values, lessees can trade early and utilize the equity in their lease as a down payment towards a fresh purchase or lease expanding the fresh car business. When used car values underperform residual values, fresh car business contracts as lessees are compelled to go the utter term of the lease and are left without equity in the end. As I mentioned earlier, used car values for passenger vehicles have been falling significantly since 2014. Aside from the negative effects that used car values underperforming residual values have on fresh car sales velocity, the lagging effect discussed earlier leaves captive banks open to a considerable amount of residual risk. Please use this link and read through the entire thread for a number of examples using BMW leases.
As used car values proceed to decline, residual values will proceed to adjust downward. Lower residuals will lead to higher payments, and leasing will produce fewer sales.
Leasing is responsible for a significant portion of total light vehicle retail sales. Here`s a look at the invasion rates by manufacturer.
The average fresh vehicle price has inflated by 20% since 2008. Leasing has become the best and/or only way for consumers to afford fresh vehicles while prices proceed to rise. This is evident when you see manufacturers relying on leasing for most of their sales volume. What happens to the sales volume for individual car companies and for the auto industry as a entire when residuals are adjusted lower and the affordability that leases provide is lost?
Three) Credit Risk
While conventional auto loans only carry default risk, leasing adds residual risk. Leases do not have to default to become a problem; they can become a problem at maturity. Most of the outstanding leases have been securitized bringing us back to two thousand seven levels. The appetite for auto related Six pack makes flawless sense since leases haven`t produced negative equity for years. This adds a layer of complexity that needs to be considered.
The gap inbetween residuals, principle balanced owed for all auto loans and the recovery value for vehicles will grow as used car prices proceed to fall. The larger the gap inbetween balances owed and used car vales, the larger the risk and potential losses for the banks holding these loans.
Four) What`s Holding It All Up?
The light truck and SUV segment is at a different stage in its` cycle compared to passenger cars. The majority of US consumers choose light trucks and SUVs instead of passenger cars. However, the spectacle of the light truck and SUV segment is very dependent on the price of fuel. Years of low fuel prices have kept the request for light trucks and SUV very high. So what do you do when one segment (Light Pickups and SUVs) is outperforming the other (Passenger Cars)? Well, you build less of what`s underperforming (Passenger Cars) and more of what`s outperforming (Pickup Trucks and SUVs). Much like a stock market index where money can flow into big names like FANG while market breadth is lost and still budge up, manufacturers have shifted their concentrate toward the more profitable light pickup truck and SUV market. This has experts very focused on oil to gauge the overall health of the automotive sector.
Five) Think Fuel Prices Are Your Leading Indicator? Guess Again…
The same thing that caused the correction in used passenger car values is now affecting light pickup trucks and SUVs – ultra low lease payments. Note how lease volume is now favoring SUVs instead of passenger cars. (Residuals are correcting in passenger cars, which translates into higher payments.)
Consumers purchase used cars because they are typically more affordable than fresh vehicles. Affordability is most often measured in terms of monthly payments. What happens to used car values when a fresh vehicle becomes more affordable than its` 1, two or 3-year-old version?
6) Supply and Request
Rate of sale calculations from a record setting year followed by four months of year-over-year misses, has left us with a high-day supply of fresh vehicles.
When sales velocity slows down, the expected reaction from manufacturers is more incentives, and enlargened incentives are exactly what we received. To illustrate this, let`s take a look at General Motors. GM had a 98-day supply of vehicles at the end March (2017). Ninety-Eight days is very high, but GM stated that it`s part of a strategic build in their inventory. Even if that is the case, the Malibu had a 124-day supply and the Silverado had a 115-day supply. The response to the day-supply problem in Silverado and Malibu was a very aggressive lease and 20% off MSRP respectively.
This script triggers a series of events that places a lot of negative pressure on used car values.
This fresh car problem precedes a supply glut of lease comes back. Supply will soon overwhelm request as the record setting leases of the last three years mature. Here is a look at a maturity chart for Ford.
Lease maturities don`t necessarily turn into inventory problems. When used car values are outperforming residual values, most clients elect to buy the vehicle from the captive banks or utilize the equity as a down payment toward a fresh purchase or lease. A smaller amount of vehicles reaching wholesale auctions thresholds supply and supports higher used car values. However, when used car values underperform residual values, clients will exercise their right to comeback the keys to the vehicle and use the protection that the residual value provides. A growing comeback rate shown here on this slide from Ford`s Q1 earnings call is proof that this is happening today.
Dealers will also reject maturing leases at the residual value thus leaving the transfer of ownership from captive banks to the fresh proprietor at wholesale auctions. This will lead to higher auction volumes resulting in lower used car values.
7) The Competition Does Not Wait
Competitors will not sacrifice market share while another manufacturer manages a day-supply problem. As I expected, competitors responded quickly to the aggressive lease on Silverado:
These aggressive leases are exactly what triggered the correction in used passenger cars. Will it be different this time?
8) Manufacturers Commence The Problem And Dealers Supercharge It
Fresh car dealerships are being built in vast quantities. With request slowing, more dealers have to fight for fewer sales. This supercharges the already large discounting effect created by the manufacturers. The unintended collateral harm becomes used car values. What market is left for used cars when fresh cars are less expensive?
9) two thousand sixteen Leftovers in May of 2017
A quick scan using your dearest auto search engine will expose a staggering amount of fresh two thousand sixteen leftovers. On May Ten, 2017, a elementary internet search returned 145,763 leftover units nationally.
This is concerning for many reasons. Dealers place very strenuous emphasis on getting rid of prior model year vehicles before the end of each year. At a certain time of the year (already past), manufacturers will give dealers a lump-sum payment per unit of unsold prior model year vehicles and eliminate incentive support in terms of special leases, incentivized rates and rebates. Dealers do not want to have any leftover vehicles when this happens, as those vehicles are enormously difficult to sell against the newest models that have manufacturer incentive support.
The amount of leftover fresh car inventory is also a sign of slowing request. These vehicles represent the most powerful discounted portion of fresh car inventory at dealerships. The two thousand sixteen leftover models have not sold yet and we already have two thousand eighteen models at a showroom floor near you.
Ten) How Significant is the Health of the Rental Car Market?
The problems facing rental car companies today are very serious. It`s significant to understand how their monthly per-unit expense relates to profitability.
There is a direct correlation inbetween used car values and the car rental company`s monthly per-unit fleet cost. The rise in per-unit cost has a direct effect on profit margins. You can see this very clearly if you overlay the NADA used car value index over a stock chart during the same time period.
The monthly per-unit cost at Hertz is presently $348. Consider what happened to sales into rental (below chart) in two thousand nine with a similar per-unit cost.
11) Expected Results Versus Reality
Many respected sources are projecting vapid retail sales for two thousand seventeen and a modest 1% decline in 2018. I respectfully disagree. We are simply too far along in a used vehicle value correction that presently includes light pickup trucks and SUVs. Leases will become less affordable as residuals rise. Without leases, we simply will not have the volume needed to meet those projections. I also believe that sales to rental car agencies will significantly decline moving forward. At this tempo, the possibility of a major rental car agency going out of business in the next year is not out of the question.
12) Not Simply a Retail Sales Problem
It is not only retail sales that we need to worry about, but also manufacturing – an significant part of our economy. A 10% reduction in the automotive SAAR can trigger a nasty set of events. The possibility of losing the affordability of leases, indicating a growing number of retail sales, and fewer orders from rental car companies are enough to make a 10% correction a considerable and respected threat.
13) What Comes Next
I have a hypersensitivity to both switches in inventory and catalysts that influence used car values. Stable used car values are an absolute necessity for a healthy fresh car sales environment. As manufacturers proceed to discount fresh vehicles intensely, they are at the same time demolishing the value of the used vehicle that potential customers need to trade in for the purchase of a fresh vehicle. The destruction of used car values offsets the effect of strenuous discounting, lowers lease offers and shoves trade cycles out further. I view the manufacturers` day-supply problem as a catalyst for the next gam down in used car values. Take a look at this chart from Morgan Stanley Research.
The very first time I witnessed this, I did not believe that a 50% correction would be possible. I asked myself, Do they know the influence that a 50% correction in used car values would have on the automotive industry and the banks that service the loans?
Well, I stand here today as witness to a flawless storm that could make a 50% reduction in used car values a very real possibility. I have already witnessed signs that the truck and SUV market have corrected. The manufacturer’s` incentive response to a growing day-supply problem along with the supercharged discounting effect of more dealers fighting over fewer sales is the equivalent of ripping off the MOAB on used car values. This set of events has made fresh cars, in some cases, more affordable than used cars.
Used car values will fall as a result but not instantly. Inventory at wholesale auctions will begin to backup as request from dealers dwindles and sellers unwilling to accept acute losses reject offers. This can only proceed for so long as a tsunami wave of lease comebacks starts this year (2017) and will provide an unrelenting amount of inventory until the end of 2019. If inventory backs up at auctions, the drop in used car values will be unexpected and unexpected, as sellers will have no choice but to unload the vehicles to the highest bidder. The effects will ripple through the entire automotive sector. Trade cycles will be shoved out further, leases will penetrate at lower percentages as residuals adjust, retail sales will slow, dealers will reject inventory, rental car companies will shrink their inventory levels as per-unit cost resumes to rise, and ultimately manufacturing will slow or stop for a period of time while the rate of sale is adjusted.
The auto industry despairingly needs a YOY strike in retail sales to relieve some of the pricing pressure from a growing day-supply problem. Another miss in May would be a detrimental event that could bring a slowdown or stop to auto manufacturing sooner than expected.
The Ideal Storm Hits Used-Car Values: The Foundation Of The Auto Industry Is Faltering, Zero Hedge
The Ideal Storm Hits Used-Car Values: The Foundation Of The Auto Industry Is Faltering
The following topics all have their part in fueling the storm to come:
Used car values determine in large the velocity of fresh car sales. Most fresh car transactions involve a trade. The level of equity in the trade oftentimes determines whether a fresh vehicle transaction will be successful or not. Inclining used car values lead to quicker trade cycles while declining used car values lead to slower trade cycles. Dismal fresh car sales volume during our last recession created a shortage of used cars. This created a large supply and request imbalance that made used car values soar from two thousand nine till two thousand fourteen as seen on this chart.
This time period was enormously favorable for fresh car sales because consumers found themselves in an equitable position on their vehicles in a very brief period of time. To illustrate this, consider this chart of a 60-month loan.
The black line represents the principal balance owed. An optimal trade cycle occurs when the principal balance owed on a loan intersects with the market value of the vehicle. The bullish used car cycle for passenger cars ended in two thousand fourteen as a result of extreme pricing pressure from fresh car leases. Since 2014, used passenger car values have corrected and proceed to underperform. This underperformance is largely due to the effects that falling used car values have had on fresh car sales velocity. A longer trade cycle results in a slower velocity of fresh car sales. Today, we`ve seen data suggesting that used car values can drop as much as 50% from current levels. Refer to the above loan chart and consider what a drop that large would mean for fresh car sales velocity in terms of trade cycles.
Two) Enlargened Dependency on Leasing
Used car values also determine the effectiveness of leasing. The most significant component of a lease is the gap inbetween the residual value and the sale price of the vehicle. A residual value is little more than a guess at the future value of a vehicle. Manufacturers and third party companies like ALG use current and historic used car value data to establish residuals. Because of this process, residual values tend to lag used car values. As residuals rise, the gap inbetween the residual value and the sales price gets smaller leading to lower payments. As residuals fall, the gap becomes larger leading to higher payments.
There are many benefits to leasing, but the most significant is affordability. Affordability is most often measured in terms of monthly payments. As leases become more affordable, they become more appealing to consumers and penetrate at a higher percentage of total sales. The bullish cycle in used car values from two thousand nine till two thousand fourteen led to some of the lowest lease payments I`ve seen in my career. Consumers noticed and took advantage of the savings.
Residual values lag used car values. When used car values outperform residual values, lessees can trade early and utilize the equity in their lease as a down payment towards a fresh purchase or lease expanding the fresh car business. When used car values underperform residual values, fresh car business contracts as lessees are coerced to go the utter term of the lease and are left without equity in the end. As I mentioned earlier, used car values for passenger vehicles have been falling significantly since 2014. Aside from the negative effects that used car values underperforming residual values have on fresh car sales velocity, the lagging effect discussed earlier leaves captive banks open to a considerable amount of residual risk. Please use this link and read through the entire thread for a number of examples using BMW leases.
As used car values proceed to decline, residual values will proceed to adjust downward. Lower residuals will lead to higher payments, and leasing will produce fewer sales.
Leasing is responsible for a significant portion of total light vehicle retail sales. Here`s a look at the invasion rates by manufacturer.
The average fresh vehicle price has inflated by 20% since 2008. Leasing has become the best and/or only way for consumers to afford fresh vehicles while prices proceed to rise. This is evident when you see manufacturers relying on leasing for most of their sales volume. What happens to the sales volume for individual car companies and for the auto industry as a entire when residuals are adjusted lower and the affordability that leases provide is lost?
Trio) Credit Risk
While conventional auto loans only carry default risk, leasing adds residual risk. Leases do not have to default to become a problem; they can become a problem at maturity. Most of the outstanding leases have been securitized bringing us back to two thousand seven levels. The appetite for auto related Six pack makes flawless sense since leases haven`t produced negative equity for years. This adds a layer of complexity that needs to be considered.
The gap inbetween residuals, principle balanced owed for all auto loans and the recovery value for vehicles will grow as used car prices proceed to fall. The larger the gap inbetween balances owed and used car vales, the larger the risk and potential losses for the banks holding these loans.
Four) What`s Holding It All Up?
The light truck and SUV segment is at a different stage in its` cycle compared to passenger cars. The majority of US consumers choose light trucks and SUVs instead of passenger cars. However, the spectacle of the light truck and SUV segment is very dependent on the price of fuel. Years of low fuel prices have kept the request for light trucks and SUV very high. So what do you do when one segment (Light Pickups and SUVs) is outperforming the other (Passenger Cars)? Well, you build less of what`s underperforming (Passenger Cars) and more of what`s outperforming (Pickup Trucks and SUVs). Much like a stock market index where money can flow into big names like FANG while market breadth is lost and still budge up, manufacturers have shifted their concentrate toward the more profitable light pickup truck and SUV market. This has experts very focused on oil to gauge the overall health of the automotive sector.
Five) Think Fuel Prices Are Your Leading Indicator? Guess Again…
The same thing that caused the correction in used passenger car values is now affecting light pickup trucks and SUVs – ultra low lease payments. Note how lease volume is now favoring SUVs instead of passenger cars. (Residuals are correcting in passenger cars, which translates into higher payments.)
Consumers purchase used cars because they are typically more affordable than fresh vehicles. Affordability is most often measured in terms of monthly payments. What happens to used car values when a fresh vehicle becomes more affordable than its` 1, two or 3-year-old version?
6) Supply and Request
Rate of sale calculations from a record setting year followed by four months of year-over-year misses, has left us with a high-day supply of fresh vehicles.
When sales velocity slows down, the expected reaction from manufacturers is more incentives, and enlargened incentives are exactly what we received. To illustrate this, let`s take a look at General Motors. GM had a 98-day supply of vehicles at the end March (2017). Ninety-Eight days is very high, but GM stated that it`s part of a strategic build in their inventory. Even if that is the case, the Malibu had a 124-day supply and the Silverado had a 115-day supply. The response to the day-supply problem in Silverado and Malibu was a very aggressive lease and 20% off MSRP respectively.
This script triggers a series of events that places a lot of negative pressure on used car values.
This fresh car problem precedes a supply glut of lease comebacks. Supply will soon overwhelm request as the record setting leases of the last three years mature. Here is a look at a maturity chart for Ford.
Lease maturities don`t necessarily turn into inventory problems. When used car values are outperforming residual values, most clients elect to buy the vehicle from the captive banks or utilize the equity as a down payment toward a fresh purchase or lease. A smaller amount of vehicles reaching wholesale auctions thresholds supply and supports higher used car values. However, when used car values underperform residual values, clients will exercise their right to come back the keys to the vehicle and use the protection that the residual value provides. A growing come back rate shown here on this slide from Ford`s Q1 earnings call is proof that this is happening today.
Dealers will also reject maturing leases at the residual value thus leaving the transfer of ownership from captive banks to the fresh holder at wholesale auctions. This will lead to higher auction volumes resulting in lower used car values.
7) The Competition Does Not Wait
Competitors will not sacrifice market share while another manufacturer manages a day-supply problem. As I expected, competitors responded quickly to the aggressive lease on Silverado:
These aggressive leases are exactly what triggered the correction in used passenger cars. Will it be different this time?
8) Manufacturers Embark The Problem And Dealers Supercharge It
Fresh car dealerships are being built in vast quantities. With request slowing, more dealers have to fight for fewer sales. This supercharges the already large discounting effect created by the manufacturers. The unintended collateral harm becomes used car values. What market is left for used cars when fresh cars are less expensive?
9) two thousand sixteen Leftovers in May of 2017
A quick scan using your beloved auto search engine will expose a staggering amount of fresh two thousand sixteen leftovers. On May Ten, 2017, a elementary internet search returned 145,763 leftover units nationally.
This is concerning for many reasons. Dealers place very intense emphasis on getting rid of prior model year vehicles before the end of each year. At a certain time of the year (already past), manufacturers will give dealers a lump-sum payment per unit of unsold prior model year vehicles and liquidate incentive support in terms of special leases, incentivized rates and rebates. Dealers do not want to have any leftover vehicles when this happens, as those vehicles are utterly difficult to sell against the newest models that have manufacturer incentive support.
The amount of leftover fresh car inventory is also a sign of slowing request. These vehicles represent the strongest discounted portion of fresh car inventory at dealerships. The two thousand sixteen leftover models have not sold yet and we already have two thousand eighteen models at a showroom floor near you.
Ten) How Significant is the Health of the Rental Car Market?
The problems facing rental car companies today are very serious. It`s significant to understand how their monthly per-unit expense relates to profitability.
There is a direct correlation inbetween used car values and the car rental company`s monthly per-unit fleet cost. The rise in per-unit cost has a direct effect on profit margins. You can see this very clearly if you overlay the NADA used car value index over a stock chart during the same time period.
The monthly per-unit cost at Hertz is presently $348. Consider what happened to sales into rental (below chart) in two thousand nine with a similar per-unit cost.
11) Expected Results Versus Reality
Many respected sources are projecting plane retail sales for two thousand seventeen and a modest 1% decline in 2018. I respectfully disagree. We are simply too far along in a used vehicle value correction that presently includes light pickup trucks and SUVs. Leases will become less affordable as residuals rise. Without leases, we simply will not have the volume needed to meet those projections. I also believe that sales to rental car agencies will significantly decline moving forward. At this rhythm, the possibility of a major rental car agency going out of business in the next year is not out of the question.
12) Not Simply a Retail Sales Problem
It is not only retail sales that we need to worry about, but also manufacturing – an significant part of our economy. A 10% reduction in the automotive SAAR can trigger a nasty set of events. The possibility of losing the affordability of leases, signifying a growing number of retail sales, and fewer orders from rental car companies are enough to make a 10% correction a considerable and respected threat.
13) What Comes Next
I have a hypersensitivity to both switches in inventory and catalysts that influence used car values. Stable used car values are an absolute necessity for a healthy fresh car sales environment. As manufacturers proceed to discount fresh vehicles strenuously, they are at the same time demolishing the value of the used vehicle that potential customers need to trade in for the purchase of a fresh vehicle. The destruction of used car values offsets the effect of strenuous discounting, lowers lease offers and thrusts trade cycles out further. I view the manufacturers` day-supply problem as a catalyst for the next gam down in used car values. Take a look at this chart from Morgan Stanley Research.
The very first time I spotted this, I did not believe that a 50% correction would be possible. I asked myself, Do they know the influence that a 50% correction in used car values would have on the automotive industry and the banks that service the loans?
Well, I stand here today as witness to a flawless storm that could make a 50% reduction in used car values a very real possibility. I have already witnessed signs that the truck and SUV market have corrected. The manufacturer’s` incentive response to a growing day-supply problem along with the supercharged discounting effect of more dealers fighting over fewer sales is the equivalent of pulling down the MOAB on used car values. This set of events has made fresh cars, in some cases, more affordable than used cars.
Used car values will fall as a result but not instantly. Inventory at wholesale auctions will begin to backup as request from dealers dwindles and sellers unwilling to accept acute losses reject offers. This can only proceed for so long as a tsunami wave of lease comes back starts this year (2017) and will provide an unrelenting amount of inventory until the end of 2019. If inventory backs up at auctions, the drop in used car values will be unexpected and unexpected, as sellers will have no choice but to unload the vehicles to the highest bidder. The effects will ripple through the entire automotive sector. Trade cycles will be shoved out further, leases will penetrate at lower percentages as residuals adjust, retail sales will slow, dealers will reject inventory, rental car companies will shrink their inventory levels as per-unit cost resumes to rise, and ultimately manufacturing will slow or stop for a period of time while the rate of sale is adjusted.
The auto industry despairingly needs a YOY strike in retail sales to relieve some of the pricing pressure from a growing day-supply problem. Another miss in May would be a detrimental event that could bring a slowdown or stop to auto manufacturing sooner than expected.
The Ideal Storm Hits Used-Car Values: The Foundation Of The Auto Industry Is Faltering, Zero Hedge
The Flawless Storm Hits Used-Car Values: The Foundation Of The Auto Industry Is Faltering
The following topics all have their part in fueling the storm to come:
Used car values determine in large the velocity of fresh car sales. Most fresh car transactions involve a trade. The level of equity in the trade oftentimes determines whether a fresh vehicle transaction will be successful or not. Inclining used car values lead to quicker trade cycles while declining used car values lead to slower trade cycles. Dismal fresh car sales volume during our last recession created a shortage of used cars. This created a large supply and request imbalance that made used car values soar from two thousand nine till two thousand fourteen as seen on this chart.
This time period was enormously favorable for fresh car sales because consumers found themselves in an equitable position on their vehicles in a very brief period of time. To illustrate this, consider this chart of a 60-month loan.
The black line represents the principal balance owed. An optimal trade cycle occurs when the principal balance owed on a loan intersects with the market value of the vehicle. The bullish used car cycle for passenger cars ended in two thousand fourteen as a result of extreme pricing pressure from fresh car leases. Since 2014, used passenger car values have corrected and proceed to underperform. This underperformance is largely due to the effects that falling used car values have had on fresh car sales velocity. A longer trade cycle results in a slower velocity of fresh car sales. Today, we`ve seen data suggesting that used car values can drop as much as 50% from current levels. Refer to the above loan chart and consider what a drop that large would mean for fresh car sales velocity in terms of trade cycles.
Two) Enlargened Dependency on Leasing
Used car values also determine the effectiveness of leasing. The most significant component of a lease is the gap inbetween the residual value and the sale price of the vehicle. A residual value is little more than a guess at the future value of a vehicle. Manufacturers and third party companies like ALG use current and historic used car value data to establish residuals. Because of this process, residual values tend to lag used car values. As residuals rise, the gap inbetween the residual value and the sales price gets smaller leading to lower payments. As residuals fall, the gap becomes larger leading to higher payments.
There are many benefits to leasing, but the most significant is affordability. Affordability is most often measured in terms of monthly payments. As leases become more affordable, they become more appealing to consumers and penetrate at a higher percentage of total sales. The bullish cycle in used car values from two thousand nine till two thousand fourteen led to some of the lowest lease payments I`ve seen in my career. Consumers noticed and took advantage of the savings.
Residual values lag used car values. When used car values outperform residual values, lessees can trade early and utilize the equity in their lease as a down payment towards a fresh purchase or lease expanding the fresh car business. When used car values underperform residual values, fresh car business contracts as lessees are coerced to go the total term of the lease and are left without equity in the end. As I mentioned earlier, used car values for passenger vehicles have been falling significantly since 2014. Aside from the negative effects that used car values underperforming residual values have on fresh car sales velocity, the lagging effect discussed earlier leaves captive banks open to a considerable amount of residual risk. Please use this link and read through the entire thread for a number of examples using BMW leases.
As used car values proceed to decline, residual values will proceed to adjust downward. Lower residuals will lead to higher payments, and leasing will produce fewer sales.
Leasing is responsible for a significant portion of total light vehicle retail sales. Here`s a look at the invasion rates by manufacturer.
The average fresh vehicle price has inflated by 20% since 2008. Leasing has become the best and/or only way for consumers to afford fresh vehicles while prices proceed to rise. This is evident when you see manufacturers relying on leasing for most of their sales volume. What happens to the sales volume for individual car companies and for the auto industry as a entire when residuals are adjusted lower and the affordability that leases provide is lost?
Three) Credit Risk
While conventional auto loans only carry default risk, leasing adds residual risk. Leases do not have to default to become a problem; they can become a problem at maturity. Most of the outstanding leases have been securitized bringing us back to two thousand seven levels. The appetite for auto related Six pack makes ideal sense since leases haven`t produced negative equity for years. This adds a layer of complexity that needs to be considered.
The gap inbetween residuals, principle balanced owed for all auto loans and the recovery value for vehicles will grow as used car prices proceed to fall. The larger the gap inbetween balances owed and used car vales, the larger the risk and potential losses for the banks holding these loans.
Four) What`s Holding It All Up?
The light truck and SUV segment is at a different stage in its` cycle compared to passenger cars. The majority of US consumers choose light trucks and SUVs instead of passenger cars. However, the spectacle of the light truck and SUV segment is very dependent on the price of fuel. Years of low fuel prices have kept the request for light trucks and SUV very high. So what do you do when one segment (Light Pickups and SUVs) is outperforming the other (Passenger Cars)? Well, you build less of what`s underperforming (Passenger Cars) and more of what`s outperforming (Pickup Trucks and SUVs). Much like a stock market index where money can flow into big names like FANG while market breadth is lost and still stir up, manufacturers have shifted their concentrate toward the more profitable light pickup truck and SUV market. This has experts very focused on oil to gauge the overall health of the automotive sector.
Five) Think Fuel Prices Are Your Leading Indicator? Guess Again…
The same thing that caused the correction in used passenger car values is now affecting light pickup trucks and SUVs – ultra low lease payments. Note how lease volume is now favoring SUVs instead of passenger cars. (Residuals are correcting in passenger cars, which translates into higher payments.)
Consumers purchase used cars because they are typically more affordable than fresh vehicles. Affordability is most often measured in terms of monthly payments. What happens to used car values when a fresh vehicle becomes more affordable than its` 1, two or 3-year-old version?
6) Supply and Request
Rate of sale calculations from a record setting year followed by four months of year-over-year misses, has left us with a high-day supply of fresh vehicles.
When sales velocity slows down, the expected reaction from manufacturers is more incentives, and enhanced incentives are exactly what we received. To illustrate this, let`s take a look at General Motors. GM had a 98-day supply of vehicles at the end March (2017). Ninety-Eight days is very high, but GM stated that it`s part of a strategic build in their inventory. Even if that is the case, the Malibu had a 124-day supply and the Silverado had a 115-day supply. The response to the day-supply problem in Silverado and Malibu was a very aggressive lease and 20% off MSRP respectively.
This screenplay triggers a series of events that places a lot of negative pressure on used car values.
This fresh car problem precedes a supply glut of lease comes back. Supply will soon overwhelm request as the record setting leases of the last three years mature. Here is a look at a maturity chart for Ford.
Lease maturities don`t necessarily turn into inventory problems. When used car values are outperforming residual values, most clients elect to buy the vehicle from the captive banks or utilize the equity as a down payment toward a fresh purchase or lease. A smaller amount of vehicles reaching wholesale auctions boundaries supply and supports higher used car values. However, when used car values underperform residual values, clients will exercise their right to comeback the keys to the vehicle and use the protection that the residual value provides. A growing comeback rate shown here on this slide from Ford`s Q1 earnings call is proof that this is happening today.
Dealers will also reject maturing leases at the residual value thus leaving the transfer of ownership from captive banks to the fresh proprietor at wholesale auctions. This will lead to higher auction volumes resulting in lower used car values.
7) The Competition Does Not Wait
Competitors will not sacrifice market share while another manufacturer manages a day-supply problem. As I expected, competitors responded quickly to the aggressive lease on Silverado:
These aggressive leases are exactly what triggered the correction in used passenger cars. Will it be different this time?
8) Manufacturers Embark The Problem And Dealers Supercharge It
Fresh car dealerships are being built in vast quantities. With request slowing, more dealers have to fight for fewer sales. This supercharges the already large discounting effect created by the manufacturers. The unintended collateral harm becomes used car values. What market is left for used cars when fresh cars are less expensive?
9) two thousand sixteen Leftovers in May of 2017
A quick scan using your dearest auto search engine will expose a staggering amount of fresh two thousand sixteen leftovers. On May Ten, 2017, a ordinary internet search returned 145,763 leftover units nationally.
This is concerning for many reasons. Dealers place very intense emphasis on getting rid of prior model year vehicles before the end of each year. At a certain time of the year (already past), manufacturers will give dealers a lump-sum payment per unit of unsold prior model year vehicles and eliminate incentive support in terms of special leases, incentivized rates and rebates. Dealers do not want to have any leftover vehicles when this happens, as those vehicles are utterly difficult to sell against the newest models that have manufacturer incentive support.
The amount of leftover fresh car inventory is also a sign of slowing request. These vehicles represent the most powerful discounted portion of fresh car inventory at dealerships. The two thousand sixteen leftover models have not sold yet and we already have two thousand eighteen models at a showroom floor near you.
Ten) How Significant is the Health of the Rental Car Market?
The problems facing rental car companies today are very serious. It`s significant to understand how their monthly per-unit expense relates to profitability.
There is a direct correlation inbetween used car values and the car rental company`s monthly per-unit fleet cost. The rise in per-unit cost has a direct effect on profit margins. You can see this very clearly if you overlay the NADA used car value index over a stock chart during the same time period.
The monthly per-unit cost at Hertz is presently $348. Consider what happened to sales into rental (below chart) in two thousand nine with a similar per-unit cost.
11) Expected Results Versus Reality
Many respected sources are projecting plane retail sales for two thousand seventeen and a modest 1% decline in 2018. I respectfully disagree. We are simply too far along in a used vehicle value correction that presently includes light pickup trucks and SUVs. Leases will become less affordable as residuals rise. Without leases, we simply will not have the volume needed to meet those projections. I also believe that sales to rental car agencies will significantly decline moving forward. At this tempo, the possibility of a major rental car agency going out of business in the next year is not out of the question.
12) Not Simply a Retail Sales Problem
It is not only retail sales that we need to worry about, but also manufacturing – an significant part of our economy. A 10% reduction in the automotive SAAR can trigger a nasty set of events. The possibility of losing the affordability of leases, signifying a growing number of retail sales, and fewer orders from rental car companies are enough to make a 10% correction a considerable and respected threat.
13) What Comes Next
I have a hypersensitivity to both switches in inventory and catalysts that influence used car values. Stable used car values are an absolute necessity for a healthy fresh car sales environment. As manufacturers proceed to discount fresh vehicles strongly, they are at the same time ruining the value of the used vehicle that potential customers need to trade in for the purchase of a fresh vehicle. The destruction of used car values offsets the effect of mighty discounting, lowers lease offers and thrusts trade cycles out further. I view the manufacturers` day-supply problem as a catalyst for the next gam down in used car values. Take a look at this chart from Morgan Stanley Research.
The very first time I eyed this, I did not believe that a 50% correction would be possible. I asked myself, Do they know the influence that a 50% correction in used car values would have on the automotive industry and the banks that service the loans?
Well, I stand here today as witness to a ideal storm that could make a 50% reduction in used car values a very real possibility. I have already witnessed signs that the truck and SUV market have corrected. The manufacturer’s` incentive response to a growing day-supply problem along with the supercharged discounting effect of more dealers fighting over fewer sales is the equivalent of pulling down the MOAB on used car values. This set of events has made fresh cars, in some cases, more affordable than used cars.
Used car values will fall as a result but not instantly. Inventory at wholesale auctions will begin to backup as request from dealers dwindles and sellers unwilling to accept acute losses reject offers. This can only proceed for so long as a tsunami wave of lease comes back starts this year (2017) and will provide an unrelenting amount of inventory until the end of 2019. If inventory backs up at auctions, the drop in used car values will be unexpected and unexpected, as sellers will have no choice but to unload the vehicles to the highest bidder. The effects will ripple through the entire automotive sector. Trade cycles will be shoved out further, leases will penetrate at lower percentages as residuals adjust, retail sales will slow, dealers will reject inventory, rental car companies will shrink their inventory levels as per-unit cost proceeds to rise, and ultimately manufacturing will slow or stop for a period of time while the rate of sale is adjusted.
The auto industry despairingly needs a YOY hammer in retail sales to relieve some of the pricing pressure from a growing day-supply problem. Another miss in May would be a detrimental event that could bring a slowdown or stop to auto manufacturing sooner than expected.