Risk Factors for a Growing Industry

© Can Stock Photo Inc. / barsikThe auto industry is headed for a record-breaking year in 2015, according to Joe Derkos, an analyst with J.D. Power & Associates. New vehicle spending is forecast to hit $407 billion in 2014, equal to the GDP of Austria, and exceed that in 2015. The average transaction price is also expected to exceed $30,000 on the year, and retail sales (excluding fleet sales) are set to hit 13.8 million vehicles in 2015, matching a record set in 2004.

But lenders should remain cautious even in the face of such strong numbers, as numerous risks threaten that growth. Here they are, as Derkos described them:

  1. Manufacturer incentives are on the rise. In 2014 they may reach an average of $2,975, close to 2008’s figure of $3,018 — but since transaction prices have also grown, the newer number represents a smaller percentage of the MSRP.
  2. Interest rates are due to rise over the next several years. While there are upsides for lenders, a rise in interest rates of 100 b.p. could mean as many as 300,000 lost sales or $8 billion in lost revenue.
  3. Longer loan terms allow buyers to finance more expensive cars for the same payments as a shorter loan on a less expensive vehicle. Monthly payments have held steady since 2008, while transaction prices have steadily risen. Longer loans to less capable buyers means risky loans stay on the books longer.
  4. Leasing is on the rise, and residual values are falling. Leasing is set to cross the 26% mark on the year, ensuring a steady supply of used vehicles. Used prices, as a result of increased supply, are softening.
  5. OEMs must maintain production discipline to keep supplies of vehicles at a rational level, but market volatility can make production discipline difficult.
  6. Gen Y or Millennial buyers are growing in importance in the market — but they are a difficult group for lenders to predict. They tend to fall into the subprime category, and prefer longer loans. Will their behavior change as they age, or is the industry stuck with this group as it stands?

The future is impossible to predict, but “cautious optimism” is the watchword for the industry at the moment.

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