Car sales are a great indicator of the state of the economy and an especially strong proxy for consumer confidence. Outside of their home, an automobile is the most expensive item a consumer owns. If more cars are being consumed, the greater confidence consumers must have in the stability and growth of their future income. Over the last several quarters, we have seen a decline in automobile sales.
It appears the culprit of this decline in auto sales is a combination of increasing financing rates and increasing standards for auto loans. These increases join forces to suppress demand and reduce consumption. Increasing the interest rate at which auto loans are bonded decreases the demand for auto loans by increasing the amount of consumers who see buying a car as cost prohibitive. In addition, we see the increase in standards for auto loans reducing the amount consumption through reducing the consumers who qualify for auto loans.
Since the third quarter of 2016, domestic banks have been tightening their requirements for auto loans. This decline, when only viewed on its own, could be seen as problematic. If banks are tightening the requirements for receiving an auto loan, they must be skittish, right?
Not necessarily, while some investors may want to take this information and take a bearish look at the banking sector and they have all the right to, we’re going to discuss what this tightening of lending requirements has done to the economic indicators of the automobile sector. Furthermore, we’ll have a picture of how to frame the expectations of earning reports from the major auto manufacturers.
We begin the analysis with the overarching data series, the Net Percentage of Domestic Banks Tightening Standards for Auto Loans, coming to us from the same place every data series we’ll talk about will come from, Federal Economic Research Database (NASDAQ:FRED). This information is based on a survey sent to dozens of large banks asking how their lending practices, involving auto loans and business lending in general, are expected to change. The Federal Reserve then compares these answers over the past years, at quarterly intervals, and we get one of the most interesting macro economic indicators. (If you’re interested in reading more about the methodology, here’s the link to the summary and tables of the survey)
As the chart shows, banks have increased their standards for auto loans consistently over the past year. With the last 5 quarters seeing an average increase of 8.5% of banks tightening their standards. This escalation of requirements for auto loans has had a ripple effect through out the economy.
This rise in standards is producing some pretty pronounced impacts on auto sales and auto financing. One of the most interesting impacts we have seen in major economic indicators is in the total retail sales of domestic and foreign autos. Since the second quarter of 2016, we have seen a steep decline in auto sales. In the second quarter of 2017, U.S. consumers purchased 540,000 autos, that is the second lowest quarterly sales since the fourth quarter of 2011, and a decline of 11.8% from the second quarter of 2016. The lowest auto sales since the fourth quarter of 2011, was in the first quarter of this year.
As we can see, motor vehicle sales began their steepest decline since the recession at the same time that banks began tightening their standards on auto loans. This clamping has stifled auto sales. Dragging auto sales are usually a favorite indicator of predicting economic upturns and downturns, but it is important we realize that we are not comparing apples to apples. As banks increase the difficulty to borrow, we must include that in how we metabolize these sales numbers. These declining auto numbers appear to driven not by consumers not wanting to buy automobiles, but by banks being able to be more selective in who they can lend to. That discretion carries large economic meaning. The current decline in vehicle sales is not being caused by a looming economic contraction, but by selective banking practices.
If banks can operate profitably and sustainably while increasing standards and selectivity that shows banks are healthy. When banks must decrease their standards to remain operational in auto lending, that spells trouble. When we consider general banking economic indicators, we can see that banks are healthy. With the knowledge that banks are healthy, we can conclude that this increase in standards for auto loans is the result of banks being able to be more selective in loans, and maintain profitable operations; this is a phenomenal sign of health in banking. Though, what does this mean for auto buyers?
Unfortunately for General Motors (NYSE: GM), Toyota (NYSE: TM), and the all the other car manufacturers in the world, buying a car is becoming more expensive in the U.S. economy. If we look at the Finance Rate on Consumer Installment Loans at Commercial Banks, New Autos 48 Month Loan, we see that the rate for four-year auto loans has been climbing steadily since the second quarter of 2016. This increase coincides with the dip in auto sales in the U.S. economy.
In May of this year, the last month reported in this series, the average interest rate on a 48-month auto loan was 4.67%. That is up from 4.33% in May of 2016. This is 7.9% change in just 12 months. A near 8% increase in a year’s time is quite the steep climb; which is why we saw light weight vehicle sales fall by 373,000 over the same timeframe, which is a slide of 6% from the same time in 2016.
Light weight vehicle sales include not just automobiles, but also light trucks. This difference is important because it allows us to look at vehicle sales on an even larger scale, and see how consumption has changed based on these rate changes. In fact, the U.S. economy has seen the worst decline in auto sales since the last quarter of 2009. The first and second quarter of 2017 mark the first time since the recession that light vehicle sales fell below their previous year’s level for two consecutive quarters.
This decline in auto sales is also the product of a chronic reduction in new lease growth. Between May of 2016 and May of 2017, the value of outstanding motor vehicle leases increased by $8.04 billion, which is positive growth; though, between May of 2015 and May of 2016, new leases were recorded at $24.7 billion. Since August of 2012, there have been 10 months where the U.S. economy saw new leases growing by no less than $20 billion when compared to the same month in the previous year; the last nine months represent nine of those ten. When auto loans rates and lending standards increase, we should expect consumers to move to auto leases, but we are simply not seeing the same growth that would suggest that this is happening. The economic indicators are showing us that automobile consumption is falling the fastest it has since the end of the recession. While this decline seems to be caused by banks being able to be more selective, it still bodes poorly for car manufacturers.
The economic indicators are showing us that automobile consumption is falling the fastest it has since the end of the recession. While this decline seems to be caused by banks being able to be more selective, it still bodes poorly for car manufacturers. While no market watchers want to see car sales stall, this decline is isolated in the auto sector and does not appear to be foreshadowing a gloomy market outlook for the economy in general.
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