“Big Short” 2017: When the Auto Industry Implodes

The first line of The Wall Street Journal’s March 21 story sums up the trend:

The auto finance sector has taken a bad turn.”

“The auto finance sector just ran a red light and is about to T-bone a minivan” would’ve been more accurate.

We first wrote about the coming carnage in U.S. auto finance in December.

Now the story’s catching on. There’s big trouble in the U.S. auto market.

That means there are also huge profit chances ahead, if you know what to do.

According to the WSJ, Ally Financial, one of the biggest auto finance companies, said defaults on auto loans for low-credit borrowers are still increasing.

As I wrote in December, Experian’s market tracking shows that up to 40% of all auto debt in America today is “nonprime” or worse.

Let’s take a closer look at what that means.

The more nonprime auto debt out there floating around, the higher the likelihood of defaults.

That means more car repos.

More repos cause massive used car inventory coming back onto lots.

Which results in huge losses for automakers. More used car inventory means less fewer car sales. It also means lower prices for used cars.

Mike Shedlock hit a home run on this idea on March 20, in a post at MishTalk.

He wrote that used car prices in February fell the most in any month since 2008. It was only the second February decline in used car prices in 20 years.

Mish didn’t have to twist any arms to find those data. The WSJ quoted it too. It came from the National Automobile Dealers Association February report.

Everyone knows there’s huge used car inventory. But nobody wants to admit what’s causing it.

This would all be part of a normal market cycle if lenders were pulling back on subprime loans.

But just like during the early days of the housing crisis, lenders would rather keep doing what they’re doing than pay attention to the storm clouds ahead.

In the fourth quarter of 2016, according to Ally’s own data, about a third of loans the company originated were to buyers with FICO scores below 660.

Credit Acceptance Corp., like Ally, also does big business in the subprime borrower space.

And in case you think it’s just the “shady lenders,” major automakers also have exposure through their captive finance divisions.

Ford’s a great example.

According to a recent Morgan Stanley research note, Ford as a percentage of market cap has the most financing debt among major carmakers.

That Morgan Stanley note went on to add, “We believe a decline in used car values may occur a bit later than consensus, but could also prove to be far more severe.”

Since we first started covering this story, we’ve targeted mid-2017 for a meltdown in the U.S. auto market.

In December, our analysis was early. Now it looks right on the money.

We predict that by July, the combination of subprime auto finance, rising defaults, falling used car prices and cratering new car sales will threaten not only the entire auto industry but the broad economy as well.

If you have the appetite and the risk capital, put options on Ally Financial, Credit Acceptance Corp. and Ford could turn into your score of the year.

I’ll have more on this story as it develops…


Amanda Stiltner
for The Daily Reckoning

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