Markets

Lisa Abramowicz is a Bloomberg Gadfly columnist covering the debt markets. She has written about debt markets for Bloomberg News since 2010.

(Corrected )

For the past few months, clouds over the $1.2 trillion market for U.S. auto debt have grown darker.

The latest round of investor hand-wringing came last week when Ally Financial warned its profit would grow less than expected because of falling used-car values. That built on angst triggered by Ford Motor Co.'s decision in November to cut $300 million from its credit arm’s profit forecast for 2017.

It’s no secret that auto-loan borrowers are struggling to repay their debt and that some firms are starting to experience the consequences. Delinquency rates have been soaring to some of the highest levels since the financial crisis. Loan losses are greater than expected.

Each new wave of worse-than-expected news from companies in the auto industry has come as a negative surprise to markets. Ally shares, for example, fell in response to the disappointing forecast last week, and prompted declines in values of auto-related companies, from Hertz to Santander Consumer USA.

Sympathy Declines
After Ally's disappointing profit forecast, its shares and those of Hertz declined
Source: Bloomberg

Going forward, all signs point to accelerating declines in auto-loan creditworthiness this year and into next. Investors should just expect to see millions of dollars of auto-related credit losses, steadily falling resale values and some large challenges for big auto manufacturers.

The problem stems in part from a phenomenon highlighted by my Gadfly colleague Chris Bryant in December: Consumers are leasing many more cars and trucks than they used to. After about three years, when the lease term is up, dealers often try to resell the returned vehicles. Because a lot of leased vehicles are due back in the coming months, resale values are going to decline.

Under the Hood
A record number of leases has been a chief driver behind recent new vehicle sales
Source: Edmunds.com

But that's not the only issue. Some financing firms were much looser with their lending standards than they had been in the past, resulting in more subprime and so-called deep subprime loans. About a third of the risky car loans that are bundled into bonds are considered “deep subprime,” up from about 5.1 percent in 2010, according to Morgan Stanley research reported by Matt Scully of Bloomberg News in an article this week.

This all leads to the question of just how widespread the pain will be. Asset managers are exposed to auto-related credit in multiple ways. They fueled a rapid expansion in the market for auto-debt backed bonds, which has nearly doubled since 2010 to $195 billion outstanding. 

Bond Boom
The volume of auto-related asset-backed securities has surged since the crisis
Source: Securities Industry and Financial Markets Association

Wells Fargo analysts are recommending that investors in U.S. subprime auto debt should "take some risk off the table" but are generally protected from losses, Scully wrote on Thursday.

Less-creditworthy auto-loan borrowers will most likely keep struggling to repay their debts, even if the U.S. economy continues to chug along. Fitch Ratings expects losses on securitized subprime auto loans to rise to 12 percent by the end of 2017 from 10.41 percent in December.

While most of these securitizations are performing fine so far, some issued by smaller companies, including GO Financial and Skopos Financial, have shown signs of weakness. There will likely be consolidation or even insolvencies among some of these less-established financing firms.

Climbing Losses
The pace of losses on newer subprime auto ABS has accelerated
Source: UBS, S&P

Investment firms have also been buying up billions of dollars of unsecured bonds of auto-related companies, including rental companies Hertz and Avis. Even Ford bonds have underperformed as investors start pricing in lower resale values for the fleets of cars they buy, as Bloomberg Intelligence's Joel Levington highlighted in research this week. Hertz, in particular, has failed to assuage investor jitters and has suffered the consequence with both declining bond and stock prices.

Growing Gap
Investors are demanding more to own Ford bonds relative to other corporate debt
Source: Bloomberg Barclays U.S. Aggregate 10+ Year Bond Index, Finra's Trace

And then there's the question of whether the consumer credit weakness in the auto market challenges the consensus idea of a steadily growing U.S. economy. UBS analysts Matthew Mish and Stephen Caprio summarized it well in a report on Thursday when they said that these losses probably won't result in imminent doom but that it's "evidence that a growth rebound may be weaker than expected."

The auto market is pocked with signs. Almost all of them point to potentially treacherous road ahead. 

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

(An earlier version referred to the incorrect month in the second paragraph of when Ford lowered its 2017 profit forecast.)

To contact the author of this story:
Lisa Abramowicz in New York at labramowicz@bloomberg.net

To contact the editor responsible for this story:
Daniel Niemi at dniemi1@bloomberg.net