Another installment in our series:
These Economic Times: The Great Pandemic of 2020.
As part of our ongoing series on the economic fallout from the COVID-19 Pandemic, we focus today on car purchases, car loans, and the overall brewing problems with slightly over $1 trillion in car loans in the United States.
For most of those who paid attention in the last financial crisis or the “Great Recession” as its called, the automotive industry, while partially bailed out by the United States government, was spared massive turmoil by the nature of the crisis. At that time, it was believed that the contagion in the housing market would spill over into the auto loan world. Fortunately, most paid their cars as they needed them to go back and forth to work. So, car loans were not negatively affected or did not have the same outcome that mortgages and other credit products did. This is most likely not going to be the case in this crisis.
Since this crisis is somewhat man-made, there are little to no rules of engagement. Now one knows what the outcome will be and how those events will reshape the industry for the near and longer terms. However, in this crisis we now have people being put out of work as well as being told to shelter in place, or not to do anything other than the bare necessities. As compared to the “Great Recession” the hardest hit sector of this market will be subprime car loans and the lower-income segment of the economy. Those with net worth have staying power until the crisis has averted. Unfortunately, the gap between the haves and the have nots has widened since the last crisis. Those in the lower tier of the economy are most often living paycheck to paycheck. With most furloughed or unemployed, they may get unemployment insurance and the additional government stimulus, but this will not change the fact that their disposable income has basically disappeared. Even worse if they are sick with the virus, their ability to manage day to day expenses related to medical expenses, while out of work is almost impossible.
With the current stay at home orders, and people told to keep inside as much as they can, it is obvious that the last thing people are thinking of is a new car. While car dealerships are open to deliver cars that are purchased, it is also a foregone conclusion that anyone looking at a car will most likely want to sit in it, test drive it, and go through the options available. This current situation is probably the worst-case one can think of for doing everything people do when purchasing a vehicle. That is why it is no surprise that month over month new car inquires are down over 60%, leaving dealerships holding the bag on inventory. With a new model year inventory coming as factories reopen.
Subprime car lending has been teeter-tottering on the verge of issues for many years. The COVID-19 Pandemic may be the straw that breaks subprime car lending’s back. Prime lenders have been able to shore up their portfolios with the record lending the Federal Reserve is doing and infusing into the debt markets. Lenders of automotive loans are being allowed to use the portfolios as collateral. The real test is going to be what occurs when defaults increase and the portfolios themselves start to buckle in the subprime sector. A lot of subprime auto lenders are not banking institutions and do not have access to the same liquidity.
Adding insult to injury (the same as the growing mortgage issue we have reported on) will be as these lenders cannot access capital markets to securitize their auto loans. Without that liquidity, as these asset-backed markets are virtually closed right now, their credit lines are full and can possibly be called due to defaulting loans or forbearances being granted by the lenders. Keep in mind each of these lenders’ original credit line agreements never contemplated a complete economic closure or pandemic.
The longer the stay at home order continues the more chance these lenders have of larger amounts of defaults. Even with government-based market liquidity subprime auto lenders may have a hard time continuing to operate if they are giving forbearances at the same time as losing financing lines to write new loans. Add to that fact the reduction in credit scores that will occur over even a short period of time and the number of customers that fit into the subprime category significantly increases as well. Only the well-capitalized lenders will survive and there will be fewer choices to those with lower credit scores and lesser income.
The way in which we buy and sell automobiles may need to change in the coming future to protect against such inadequacies of the marketplace.