Questioning Mobility: Finance

Since the financial crisis of 2008, economic recovery has returned optimistic sentiments to the auto market, allowing for auto lending practices which give way to easy access to new cars for the average consumer. In a bullish market where economic indicators look healthy, it's much easier for lenders to justify loans which can be over-extended and offered without much verification. On the Wall Street side, these loans can be pooled together then used as assets in packaged financial products to be sold to investors. Buyers of those financial products are also more likely to be attracted to them in this kind of investment landscape. Issuance of sub-prime auto loans have been rising sharply in recent years, and the asset-backed securities which use them have also been sold to investors on the market at a climbing rate.

In the short-term, this appeals to corporate stakeholders, investors interested in securitized debt, and, obviously, drivers looking for new cars- all for different reasons.

Stakeholders in major auto groups enjoy seeing more volume moved to market and improved corporate performance, investors are acquiring over-collateralized asset-backed securities at an unprecedented rate, and it's now possible to acquire new vehicles without strong credit background or income verification. This creates a short-term, self-sustaining financial feedback loop, although each respective short-term benefit listed above has its own potential long-term pitfall which is explored here.

By the way- if this sounds reminiscent of the housing mortgage crisis, it's because it is- but at a much more tempered, smaller scale.

It's important to keep this in perspective; The volume of Wall Street financial products which pool these subprime/deep subprime auto loans is only fraction of the toxic assets sold before the housing crisis. While this does not spell outright disaster in case of a bubble burst, the situation is still worth close examination because of the uncanny parallels to a disaster that took years to recover from.

James Serritella, H. Seiji Newman, and Massimo Giugliano of Davis & Gilbert LLP have put together the "Subprime Auto Loan Crisis Chronometer". This is represented by three gauges which track several major components that may contribute to bring the situation to crisis levels. Each month, these gauges are updated to reflect Lending Practices & Factors, ABS (asset-backed securities) Practices and Factors, and Auto Market Risks. While the first two gauges reflect the lending and finance world, the third gauge (Auto Market Risks) is most important as it would be the catalyst for a crisis.

For the auto groups and their stakeholders

Average auto prices have been rising since the financial crisis and consistent voluminous movement of new cars to market has made global auto groups look impressive to investors. At the same time, the lending practices and incentives to sell new cars has contributed to a drop in used-car prices and this causes a cascade of tertiary effects on the vitality of the automotive market as a whole. This group is most aligned with the Lending Practices & Factors gauge.

The traditional manufacturing-to-market process is cyclical: high volumes of new car models- with annual tweaks- are moved to market by way of financing through auto-lenders who create the loan frameworks with auto-dealers. Using third-party lenders allows auto companies to offload the details of the lower-level financing, and focus on maintaining the cycle of bulk orders sent to market each year.

This is where subprime lending steps in: the retail side of the sales pipeline can incentivize over-extended loans with high interest rates in order to move higher numbers of new cars. Repeating these offers on an annual, cyclical basis at a large scale contributes both to consistent volume and the sense of strong demand for new cars- subsequently raising prices. While this looks impressive to corporations and their stakeholders, these lending deals can result in borrowers coming away upside down on their vehicles, or eventually becoming unable to make payments over the arc of the loan.

Although this does not ultimately help drivers, it does support the cyclical nature of the auto industry and produces interest rates which commercially sustains the lending intermediaries between auto groups and end-users. On Wall Street, investors have access to these asset-backed securities (ABS)- packaged with 'credit enhancements' to mitigate buyer-side risk- which pool together these subprime auto loans.

For investors interested in securitized debt

Asset-backed securities which pool subprime auto loans are being packaged and sold to investors at increasingly high rates. The spike is most notable because it is occurring while delinquencies in the underlying loans are rising and the ability for subprime borrowers to pay back long-term, high-interest loans is falling out. As of February of 2018, subprime auto asset-backed securities topped $3 billion- compared to $1.8 billion sold around the same time in 2017. At the same time, Goldman Sachs has reported a rise from 3% in 2013 to 8% currently in annual loss rates for subprime auto loans.

If a crisis were to occur, however, we would not see effects like 2008 as the sheer volume here is relatively small. Bonds using pooled subprime auto loans as underlying assets hovered around $25 billion in sales in 2017, compared to around $400 billion of bonds pooling subprime home loans sold each year in 2005 and 2006. The ABS Practices & Factors gauge will cover this area of finance and investment products.

For drivers looking for new cars

This is where things could go south for all parties involved in the event of a crisis. This area is reflected in the Auto-Market Effects gauge. New cars are being aggressively pushed with extended lending arrangements which can exceed 100% of the loan-to-value ratio. The lending and sales incentives for new cars are also driving up the new car prices, flooding the market with new autos. While new-car sales are growing, and new-car prices are rising, the used-car market is over-saturated, depressing used-car prices overall.

Here, a driver/borrower can come out 'upside-down' on their new car loan; they've ended up paying more toward a loan than the trade-in value of the now-used car. This is called negative equity, and it hurts the average used-car equity because trade-ins can end up holding this negative equity, which can start a chain-reaction of defaults. One of the gauges in the Crisis Chronometer tracks auto market risks, which is now set the highest out of all gauges and nearing the redline.

Now what?

Even after the 2008 financial crisis, something as simple as acquiring mobility has become similarly financially distorted and each participant in the arrangement is at obvious risk. In the case of the housing bubble- it was a shared vision of infinitely-increasing home values that drove investment into toxic asset classes which pooled subprime mortgages. With automobiles, that doesn't exist. The underlying assets for these financial products immediately begin depreciating after the initial sale. Institutional banks may point to poor loan underwriting practices and a lack of 'shock absorbers' for investors when looking back at the 2008 meltdown, which apparently have been fixed in the subprime auto lending space.

This one component still may not prevent what can happen in the larger auto market, and the smoke signals are coming from used car values. It is at this termination point of the financial chain where a crisis can reverberate back up into financial institutions. Does it make sense to apply these same lending and investing practices to assets which depreciate upon purchase?

Is it also possible that we've passed a point in society where the concept of owned mobility has become obsolete? The simple fact that so much financial artifice is required to keep this industry intact may be a hint.

There are two major components to the problem:

• Traditional business and manufacturing models don't adequately reflect the changing nature of mobility around the world.

• Over-extended financing is positioned against the average consumer to sustain these outdated models while inflating corporate performance for stakeholders- which distorts the reality of mobility.

This raises a series of general questions:

• Will people continue committed financial relationships with global automotive manufacturers?

• Will these relationships change, or dissolve and reconstitute with new industry entrants?

• Is owned mobility still considered a representation of personal freedom and success?

In the Questioning Mobility series, I'll be looking at where things are at now, where they're going and who may be set to shape global mobility in the future. Ride-hailing, autonomous driving, micro-manufacturing and a swath of other topics will be covered.