The impending auto loan debacle could hurt businesses and consumers

By Sam Korus, Analyst for ARK’s Autonomous Technology and Robotics Strategy

Based on ridesharing networks and the shift from gasoline-powered to electric vehicles, ARK believes that the risks associated with auto loans, the asset-backed securities that support them, and their underlying collateral are not well understood and could impact on the global automotive market. ecosystem.

The percentage of auto loans in arrears of 90 days or more has been increasing for almost four years and is approaching levels last seen during the global financial crisis (GFC) in 2009, as shown below. During the GFC, most consumers and businesses prioritized servicing auto loans over their mortgages because, in the absence of carpooling, they relied on vehicles to maintain their jobs and businesses. Now, working from home, they seem to be prioritizing mortgages and home equity (HE) loans over car and credit card debt.

Source: ARK Investment Management LLC, data from New York Fed Consumer Credit Panel/Equifax

Interestingly, it appears the coronavirus crisis has also caused a surge in used car sales as people forgo public transport. ARK believes that this short-term spike in demand is not a harbinger of a long-term trend, especially now that carpooling offers an alternative to owning a car. Soon, self-driving carpooling should further strengthen the negative case for used cars.

Due to their performance during the GFC, the industry seems to have been lulled into the belief that auto loan delinquencies would reach around 5%. In our opinion, however, they could double or more, approaching the level of mortgage loans or even credit cards in 2009-2010.

To make matters worse, investors may overestimate the value of the collateral underlying car loans. While most used vehicles today are gas-powered and human-driven, the shift to electric and, eventually, autonomous vehicles is likely to drive down the residual value of used vehicles. vehicles significantly.

What amount of guarantee is at stake?

ARK values ​​the roughly 260 million U.S. registered vehicles at around $2.6 trillion, including $1.2 trillion securitized or secured by loans, and the remaining $1.4 trillion on consumer “balance sheets,” as shown below. ARK predicts that consumers and lenders exposed to auto loans will have to write them down, casting a veil over self-backed securities.

Source: ARK Investment Management LLC, 2020

A rise in loan-to-value ratios could prevent traditional automakers from offering low-interest financing and other incentives to buy new cars, while a $1.4 trillion discount on their own balance sheets could reduce consumers’ auto buying power because trade-ins facilitate nearly half of new car sales.

If our analysis is correct, car dealerships are in danger. Service, finance and insurance make up around 70% of their gross profit, as shown below. Given much lower maintenance than gas-powered cars, we believe EVs are likely to hurt dealership service businesses as default rates hit their financing businesses. Suddenly, in early June, Wells Fargo ended new loans for independent car dealerships.

Source: ARK Investment Management LLC, 2020

Traditional automakers have significant auto balance sheet exposure and have provided auto dealerships with inexpensive financing to encourage sales. If delinquencies and defaults on auto loans continue to rise, we believe not only will dealerships go bankrupt, but automakers will lose both their distribution networks and the ability to drive sales with financing. cheap.

Despite these risks, investors focused more on the near-term rebound in demand for automobiles from the COVID-19 crisis as consumers shifted to personal transportation over public transportation. According to ARK, over the next year or so, secular risks will return, threatening the entire auto loan ecosystem.

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