DETROIT Aug 1 The U.S. auto industry hasn't
appeared so healthy for years. Sales hit an eight-year high in
June, there appears to be plenty of pent-up demand, and
discounting is far from getting out of hand. New plants and
production lines are being built, and many auto executives,
dealers and securities analysts are optimistic.
And yet, a minority on Wall Street and in the autos business
are seeing reasons to be wary. They argue that a combination of
cheap loans with extended terms, deep incentives from some
dealers, and unsustainably high values for used cars, is making
it far too easy for many Americans to buy new vehicles.
Demand, they argue, is being artificially pumped up. And, if
the U.S. Federal Reserve raises interest rates next year as
expected, it will raise the costs of buying a car and could
trigger a slowdown in demand.
Among those seeing a glass half empty is Morgan Stanley auto
analyst Adam Jonas who says we may be heading towards what he
terms "peak auto."
Jonas, one of the industry's top analysts based on
Institutional Investor's 2013 annual rankings, says that cheap
and extended loan terms and inflated residual values on leases
are making it far too easy for many Americans to buy new
"We have little doubt that we're in bubble territory," he
said in an interview. "We've blown through prior (sales) peaks
in terms of value, the amount of money people are spending on
automobiles. We're in uncharted territory right now."
When figures for July auto sales are released on Friday,
growth is expected to show a slight dip to a 16.7 million
annualized rate from 17 million in June, according to economists
polled by Thomson Reuters. Full-year sales forecasts are now
ranging from 16.2-16.4 million, compared with 15.6 million in
2013 and are set to hit the highest level for a year since 2006.
Even Jonas doesn't expect a drop off in demand anytime
soon. He sees U.S. sales reaching a record 18 million in 2017,
driven by easy credit. However, by 2019 he sees sales sinking to
just 14 million.
"We are clearly pulling forward demand from the future,"
LOWER CREDIT SCORES
The U.S. Office of the Comptroller of the Currency, which
regulates national banks, said in a June report that "signs of
risk in auto lending are beginning to emerge." The assessment
was based on lenders' willingness to lengthen terms, to chase
borrowers with lower credit scores and to offer loans that
exceed the value of the vehicle.
General Motors Co is among several automakers
recording growth in subprime lending, to borrowers with credit
scores of less than 620. Those buyers now represent 14-15
percent of the mix at GM, compared with the industry average of
just under 13 percent.
"Longer-term loans continue to dominate the market," said
Melinda Zabritski, senior director of credit data firm Experian
Automotive, although she said loan delinquencies are "near
historic lows." The average term of a new-vehicle loan this year
has risen slightly to 66 months, with vehicle manufacturers
routinely offering zero-percent financing for 60-72 months, and
some lenders extending terms to 84 months, or seven years.
Jonas believes easy credit terms are fueling record
transaction prices, which now average more than $30,000. Buyers
are financing about $27,600 on average, according to Zabritski,
nearly $1,000 more than a year ago.
Still, many in the industry say they believe consumer demand
will continue to drive growth.
"We're exiting a very long recession, and that means there
is still pent-up demand," said Steven Szakaly, chief economist
for the National Automobile Dealers Association
Rodney O'Neal, chief executive of auto parts supplier Delphi
Automotive said: "When you look at the replacement needs, the
math says it hasn't reached its peak."
And Jeff Skobin, marketing manager at Los Angeles
mega-dealer Galpin Ford, sees little reason for concern: "We've
had little dips and spikes here and there, but we don't see any
indicators of a major fall-off coming - no red flags, nothing
that points to a big shift in our business."
The incentives being offered by the automakers have been
relatively stable. When the automakers begin to discount
heavily, it is often a sign that there are too many vehicles
being produced and that underlying demand isn't keeping up. The
hit to margins soon hurts their profits.
"Manufacturers are holding back" on rebates and other
incentives, said Charles Chesbrough, senior principal economist
for research firm IHS Automotive. "There is still a lot of
margin to give away if they really want to move sales."
IHS sees U.S. sales peaking at 16.75 million in 2017 and
tapering off slightly to 16.44 million in 2020.
Anil Valsan, lead analyst on Ernst & Young's global auto
team, says manufacturers have been "fairly disciplined" about
applying incentives to boost sales, unlike during the recession
when there were "huge inventories" of unsold vehicles at
dealers, auto plants were operating at well below capacity and
"incentives were the only way to move stock."
Now, says Valsan, inventories are at a healthy and
manageable level and capacity utilization is near peak - about
90-95 percent, according to industry estimates.
What that means, adds Valsan, is that "we will probably not
see a crash, but we will see a cooling in demand, a plateauing
of the market."
While incentives from vehicle manufacturers may seem
relatively modest, a Reuters survey on Thursday of U.S. auto
dealers' websites indicated there is heavy discounting going on
at many dealers across the country. Some of it supported by the
manufacturers but much of it coming out of the dealers' own
For example, discounts run as high as $20,000 on the
Cadillac ELR hybrid sports car. Some Ford and Chevrolet dealers
are advertising massive discounts of $10,000 and more on their
full-size pickup trucks and sport-utility vehicles. At least one
Hyundai dealer is offering $8,000 off the price of a Genesis
luxury sedan, while the discount on a Cadillac XTS sedan ranges
up to $10,000.
Jeff Schuster, senior vice president of forecasting at LMC
Automotive, believes "much of the recovery has taken place" in
the auto industry and sales growth will slow.
But "Detroit is in a much better position to weather such
issues," says Schuster. "The industry's cost structure and
discipline will allow some wiggle room if the market goes
Morgan Stanley's Jonas isn't as relaxed.
Cheap money "is like a drug," says Jonas. "It's an
aphrodisiac" that is artificially inflating demand. The
aftermath won't look pretty, he adds.
"We think the next 10 years" in the auto industry "are going
to be more brutal than the last 10 in almost every way."
(Additional reporting by Peter Rudegeair; Editing by Martin