Bridget McCrea looks at some of the most important developments that are emerging right now in the US auto financing market
The auto lending market in the US continues to gain momentum, with the total volume of newly financed loan amounts and payments reaching an all-time high of $932bn (£596.7bn) during the second quarter of this year. This represents the largest dollar volume growth in the market since 2006, according to Schaumberg, Illinois-based Experian’s latest State of the Automotive Finance Market report, and a significant increase over the $840bn of new financing distributed during the second quarter of 2014.
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In addition to rapid growth and record-setting dollar volumes, the US automotive loan market showed increased stability, according to Experian, as consumers continued to make timely payments. In the second quarter of 2015, for example, the 30-day delinquency rate dropped to the lowest level for that period in the past five years at 2.32%, down from 2.37% in the second quarter of 2014.
Melinda Zabritski, Experian’s senior director of automotive finance, says two key trends she’s seeing in the US market right now include increased interest in leasing and the use of longer loan terms. On the leasing side, she says the US has traditionally lagged behind the UK, but is slowly warming up to the option based on higher auto prices and the desire for lower monthly payments. Pre-recession, for example, she says leasing was used on about 24% of new car transactions; today that number is reaching 27%.
"With cars costing $4,000 to $5,000 more than they did a few years ago, one way consumers are lowering their payments is via leasing," says Zabritski, who points to the Honda Civic as the most-leased car. For that model, leasing versus buying can mean the different of about $100 a month for the average consumer. "Leasing makes the purchase more affordable."
Spotting the key trends
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By GlobalDataRight now, several trends are emerging within the US auto lending market, some of them positive and some of them troubling. Self-driving and connected cars are taking centre stage right now as auto makers scramble to come up with the safest and most reliable vehicles in the market; industry consolidation is ramping up as firms strive to offer that ‘one-stop shop’ to both dealers and consumers; off-lease vehicle volumes are high; and low interest rates continue to push sales volumes up. Concurrently, loan terms are extending to previously unthinkable lengths; government regulators are examining auto dealer compensation practices; and there’s concern that a growing number of consumers could find themselves ‘upside down’ in their auto loans (i.e. owing more than their cars are actually worth).
From his vantage point as executive vice-president and chief economist at Adesa Analytical Services in Carmel, Indiana, Tom Kontos sees the growing volume of available off-lease vehicles as a positive sign for that sector of the market. The trend can be traced back to a growth in consumer leasing, which has increased from 9.49% (total new and used purchases) in 2010 to 14.34% this year, according to Experian."Leasing has picked up steam and become more mainstream here," Kontos says. "That, in turn, has driven off-lease vehicle availability, some of which – but not all – has been absorbed by the market with relatively little impact on overall used car values."
For purchase loans, longer terms are becoming the norm in the US, where the average term is now 62 months for a used car and 67 months for a new vehicle. Consumers are now seeing options that range from 72 to 84 months on their loans – a trend that some industry experts are concerned about. Right now, Zabritski says the most commonly used financing loan term is 72 months for both used and new vehicles. "Time was, lenders thought 60-month terms were long, but now we’re seeing more cars being financed at 75-76 months, and even into the next bucket up (84 months)," says Zabritski, who credits higher car costs with driving the longer loan term trend. "Consumers are monthly payment buyers, so as loan amounts rise, terms get adjusted."
According to Kontos, those longer terms may keep buyers out of the new car market for a longer period of time as those consumers remain ‘upside down’ on their loans. "It also takes them a lot longer to get equity in their vehicles that they can turn around and use at trade-in time," Kontos says. "It basically dissuades someone from shopping for another car." Kontos sees this emerging trend as a possible limiter of new car sales in the future.
Consider the fact that vehicles that were on 36-month leases are now coming back on the market and putting downward pressure on the used car market. Couple that with the longer loan terms that have been handed out over the last few years, says Kontos, and consumers could find themselves in the precarious position of having to take a ‘wait and see’ approach to buying a new vehicle. This, in turn, could negatively impact auto sales just at a time when volumes are rising quarter over quarter.
So far, 2015’s sales numbers are impressive and on track to hit record highs by the time the year closes. According to the most recent statistics from the National Automobile Dealers Association (NADA), through the first six months of 2015, used vehicle sales were up 1.3% over the same period in 2014. In June 2015, US car dealers sold nearly 1.48 million new cars and light trucks, or 3.9% more new vehicles than in the same month a year ago, according to JD Power. During the same period, the NADA reported used vehicle sales of just under 4.4 million across all retail channels, a 1.3% increase over the same period in 2014.
That momentum may not continue for long, particularly on the new vehicle sales front. Kontos expects the use of lengthier terms to continue, mainly because the trend itself is driven by the price of a car relative to an individual’s income.
He says: "Vehicle affordability is difficult, especially for Millennials, many of whom have student loans and other financial obligations to take care of. In many cases, the only way they can get their car payments down to a manageable level is by taking on a longer-term loan."
Chris Kukla, senior vice-president at the Center for Responsible Lending in Durham, North Carolina, says longer loan terms now could result in average loans that never come to term down the road. "It basically means that consumers could be underwater longer on their loans, or – if they start out underwater at the outset – they may never get above water," says Kukla. "That’s disturbing."
With auto makers adding more sophisticated safety equipment (under government requirements in many cases) such as automatic braking, backup cameras, and driver-assist options to their vehicles, loan terms could start extending out further.
"Average transaction prices continue to rise in the US," states Joe Phillippi, president at Auto Trends Consulting in Andover, New Jersey. "Auto makers that add expensive content to their cars have to spread development costs over an increasing number of units to make the options more affordable. Otherwise, these features would only wind up on cars costing $100,000-plus."
Like Kontos and Kukla, Phillippi also finds the expanding loan terms worrying, particularly if sales volumes level off right when the typical car owner still has three-to-four years to go before loan payoff time comes.
"The auto market has had some pretty good years since the recessionary period in 2008-09," says Phillippi, "but I’m concerned that we’re potentially starting to reach a saturation level where sales volumes may start to level off, if not trend downward."
Regulatory burdens
American auto makers and their dealer networks are grappling with increased regulatory burdens that are having both trickle-down and direct impacts on the lending environment.
"We’re seeing some very assertive, if not aggressive, efforts on the part of the Consumer Financial Protection Bureau to regulate auto lending," says Kontos, who’s concerned about the growing regulatory costs associated with auto lending in the US "These activities could inflate costs on the lending side and/or choke fund availability for subprime financing."
Based on the fact that there’s been "very little in the way of consumer protection in auto lending in the US", Kukla says better regulations are in order for both auto dealers and auto lenders, particularly in areas that don’t concern passenger safety (which the government is "paying a lot of attention to right now", he notes). "There’s a lack of transparency in lending; it’s complicated in a way that people don’t always understand."
Specifically, Kukla points to auto dealer compensation as an area that’s ripe for scrutiny. He defines the practice as the signing of a financial contract with an auto dealer (not with the lender itself, as many consumers would assume), who winds up acting as the dealer, the lender, and the term-setter for the loan. "This entity has an incredible amount of responsibility and ability to play with the loan terms and with the proposal that it makes to the consumer," says Kukla. "It also has the discretion to increase interest rates (from a 4% commanded by the actual lender to, say, the 6% that a consumer is willing to pay) and then take the remaining percentage as compensation."
Kukla points out that dealers do use short disclosures that state that "We may be getting paid through the interest rate and you have the right to negotiate your interest rate", but adds that there really is no distinct basis for figuring out what a "fair price" is.
In another example, Kukla says American car buyers are getting hit with a growing number of "add-on" costs when they take out auto loans. Everything from credit insurance to extended warranties, or rust-proofing to security systems, can be folded into the total loan cost with the payments spread over time.
"These products may or may not be useful," says Kukla, who expects this practice to increase as government scrutiny over interest rate-based dealer compensation picks up.
"Dealers are moving away from relying so much on the ability to hike the interest rate for compensation, and instead are focusing on trying to sell people on these products."
On the regulatory front, Kukla says the road ahead could be long for the US auto lending industry, where both auto makers and dealers are powerful forces.
"It’s going to take time because there’s resistance to change in this area," says Kukla, "but the positive news is that regulators are paying more attention. We could see more changes take place going forward."
On a lighter note…
Not all of the US current and emerging auto lending trends are controversial or numbers-oriented. Some are just downright fun, and others paint the picture of an industry that’s ripe for consolidation and growth. Companies like Google and Tesla Motors, for example, have taken to the streets to test out the latest versions of their autonomous vehicles. Other auto makers are following suit and expected to introduce their own renditions of the self-driving car in the near future.
"All of the car companies are committed to building self-driving capabilities into their vehicle architectures," says Phillippi, who points to Audi’s recent experiment with its RS7, which drove around Germany’s Hockenheimring F1 track at race pace without a driver in the seat, as proof of the autonomous vehicle concept.
"The car basically got better and better on every lap as it learned the track." Autonomous cars will be "here before you know it", Phillippi concludes.
"It’s just a question of whether people are willing to make that mental leap of turning the driver function over to a computer."
Consolidation
The US market is also seeing some signs of consolidation and growth, with companies like Cox Enterprise purchasing Dealertrack Technologies Inc, in June. Cox’s automotive unit plans to integrate Dealertrack’s vehicle loan software and dealer website services into its existing collection of used car market-focused businesses (i.e. Kelley Blue Book, Auto Trader, and auto auction firm Manheim).
"The bundling of services is sort of a natural move for a lot of us," says Kontos, whose firm (a car dealer auction specialising in used cars) recently partnered with TradeRev, a real time trade-in valuation tool for cars.
"We’re offering this service as a way to build more value by packaging services that dealers can use in their daily operations. It’s part of a larger trend we’re seeing to package new services that dealers can use in their daily operations," Kontos concludes.
