Soaring car prices might not pose depreciation threat

Buying a used 2019 Toyota Camry in the second quarter required a loan of $10,000 more than what was needed to purchase a 2018 model last year, LendingTree reported. In fact, the online lending marketplace saw the average loan request for 2-year-old vehicles rise $5,176, or 28 percent, over 2020.

Experian said its average used-vehicle purchase in the second quarter carried a $23,365 loan, up more than $2,000 from 2020 and $3,000 from the pre-pandemic second quarter of 2019. The average new model carried about $1,000 less in financing than in 2020, but the $35,163 financed still represented a nearly $3,000 increase from 2019.

The rise in prices means customers have more equity in trade-ins and leases, boosting profit-per-vehicle and F&I sales, according to Elliot Schor, JM&A Group vice president for sales operations. But the booming vehicle values today raise the specter of negative equity hindering dealer opportunities down the road, Schor said.

"I think that is a universal concern throughout the industry," he said.

But dealers might not need to worry.

National Automobile Dealers Association Chief Economist Patrick Manzi said Thursday that the association didn't foresee a negative-equity issue.

"We expect that once new-vehicle inventory levels have stabilized closer to historical levels, that prices will return to depreciating at a normal and manageable rate," Manzi said in a statement. "We do not expect that there will be a sudden cratering of used-vehicle values back to pre-COVID levels. We expect that there will be a new floor for used-vehicle prices above the floor seen before the pandemic."

Manzi said the new-vehicle market has underproduced for almost two years, a main factor driving up used-vehicle values.

"Given the current situation with continuing COVID outbreaks throughout the global automotive supply chain as well as the microchip shortage there is a chance that we continue to underproduce well into 2022 as well," he said. "We believe that there is currently, and will continue to be, strong demand for new and used vehicles in the market from both retail and fleet customers and because of that, we don't expect to see a massive cratering of used-vehicle values."

Experian doubts elevated prices pose a significant risk to lenders.

Melinda Zabritski, Experian's senior director of automotive financial solutions, noted Aug. 20 that Black Book had just reported another week-over-week decline in wholesale prices. She said she expected values would begin to level out.

However, loan-to-value ratios had demonstrated a "pretty big reduction" in the second quarter, Zabritski said.

New-vehicle loans stood at 111 percent of sticker prices, down from 115 percent in the second quarter of 2020, but higher than the 109 percent in 2019. Used-car loans had a loan-to-value ratio of 108.43 percent, compared with 121 percent in 2019 and 2020.

Thus, if a lender had to repossess a vehicle bought at today's elevated prices down the road, it's not likely to be significantly underwater, according to Zabritski. "The severity shouldn't be as much," she said.

Customers could balance additional loan expense with longer terms, Zabritski said. The average used-vehicle loan term grew by a month between the second quarter of 2019 and 2020, and increased by another 0.36 month since to 65.88 months this year.

LendingTree questioned the extent vehicle prices would fall in the first place.

Jenn Jones, an autos expert and writer for LendingTree, doubted that depreciation represented a significant threat.

Supply chain issues drove up new-vehicle prices and sent consumers to the used-vehicle market, Jones said. However, prices are elevated to the point that current owners don't want to give up their used vehicles, she said.

Meanwhile, America is reopening — for now.

"They probably need to resume commuting," Jones said.

Yet public health concerns remain and make public transportation less attractive, she said.

Regardless of all of that, vehicle prices have already increased faster than the national median wage, according to Jones.

"I don't see this trend reversing entirely," she said.

Jones also highlighted the potential for elevated emissions standards in 2023 and President Joe Biden's desire to have half of vehicle sales be electric by 2030.

"EV models tend to be thousands more," Jones said.

While automakers are trying to cut technology costs, it's possible new-vehicle prices could rise even further, driving further used-vehicle demand, she said.

"I see car prices staying elevated, even if not quite this elevated, for years to come," Jones said. She doubted a "sharp drop" would occur.

Even if depreciation slashes auto values, the lender would only be stuck with a loss and underwater asset if the consumer defaults. The auto loan default rate stood at 0.31 percent in July, according to the S&P/Experian Consumer Default Indices. This represented a 0.01 percentage point increase from June but a decline from the 0.47 percent seen in July 2020. It's also down from the 1 percent rate defaults have hovered around between 2012 and 2020.

American Financial Services Association Communications Director Dan Bucherer said Aug. 18 that Americans tend to prioritize paying auto loans over other bills when money gets tight. "They need to go to work," he said.

Customers also don't seem concerned about underwater loans. JM&A has observed greater adoption of GAP insurance, but this has been "consistent with general increases in other F&I products," according to Schor.

"Based on the data, we don't see significant evidence that would indicate that GAP sales are attributing to used-car prices," he said in a statement. "GAP remains a very popular product with consumers with one of the highest penetrations of any F&I products."

Schor said GAP insurers are doing well in the current pricing environment, but he said retailers "should ensure that their GAP providers consider continued reserve adjustments in anticipation of higher claims severity in two to three years."