Negative equity. Amid the global financial crisis, it spelled misery for millions of U.S. homeowners as the outstanding balance on mortgages exceeded resale prices.
Now, it's shifting to another credit-addicted sector: the car market. Almost one-third of U.S. vehicles traded in this year were in negative equity, according to JD Power data. That puts a heavy burden on consumers and it's an unhappy signal for auto-maker profit.
Thanks to ultra-low interest rates, car-buyers have in recent years been able to afford the kind of prestige models they'd once only dreamed of. New car sales rose to a record in the U.S. last year and average transaction prices also hit a high.
But sale prices aren't strong because consumers are flush with cash. On the contrary, U.S. wage growth has been tepid. One reason negative equity is rising is that lenders have extended the duration of car loans to keep monthly payments affordable. If a customer pays a loan slowly, he's likely to owe more than the vehicle is worth for a longer period and won't rush out to purchase a new one.
"Equity is like a down-payment sitting in the driveway. Rising negative equity could therefore pull people out of the market," says Jonathan Banks, analyst for the NADA Used Car Guide.
Of course, an increasing number of new car "buyers" don't purchase the vehicle, they lease it. That's a worry too. Under a leasing contract, the finance company -- often a captive of the carmaker -- typically guarantees the trade-in value when it's returned after three years. Negative equity in this instance is the carmaker's problem, not the consumer's.
Until now, carmakers haven't really suffered from negative equity when leasing vehicles because residual values have been buoyant. But that's expected to change as leasing's ubiquity leads to a flood of nearly-new cars hitting the market at the end of their contracts. Carmakers who've made optimistic assumptions about residual values risk finding themselves sitting on negative equity. This affects the U.K. too.
It will force carmakers to assume greater depreciation when working out leasing contracts with customers, meaning monthly charges will probably have to rise. So people will either trade down to cheaper vehicles or dealers will offer incentives -- an already established U.S. trend. Either way, margins will probably suffer.
So who's going to come off worst? Negative equity is particularly high among mass-market sedans, according to an analysis of JD Power data by Exane's Stuart Pearson. Some 42 percent of sedans (we Brits call them "saloons") have negative equity on trade-in, compared to 28 per cent for SUVs or trucks.
That stands to reason because cheap fuel has spurred demand for gas-guzzling SUVs, supporting prices. But most cars coming off-lease are humdrum sedans for which consumers aren't willing to pay top dollar. Cox Automotive estimates that the average wholesale used price for a large sedan car fell 15 percent year-on-year in April.
In Europe, BMW could be vulnerable because U.S. sedan sales account for about one in 10 of its sales. It relies heavily on leasing and in-house finance. Other non-U.S. carmakers also look exposed.
It's true that negative equity on a car loan is hardly the same as being underwater on your mortgage. As long as monthly repayments stay low, people can keep driving without trading in. Even so, the trend suggests U.S. car-buyers might not be kings of the road much longer. That's bad news for the industry.
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
Second-hand cars were in comparatively short supply in the years following the financial crisis because fewer people had purchased new cars during the recession.
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