By Ben Bartosch
Editor’s note: Written by Ben Bartosch, manager of forecast analytics at J.D. Power. This is one in a series of periodic guest columns by industry thought leaders.
Aggressive advertising, generous financing offers of 0 percent APR for 72 months and surges in employment made the 2018 end-of-year sales season a memorable one. But as we look ahead, a range of risks – including global trade dynamics, customer sentiment and other variables – pose the potential for disruption that will have to be managed in 2019.
Looking at issues that could potentially affect lenders, automakers and consumers, J.D. Power focuses on:
- The cost of borrowing money
- Lenders’ willingness to lend money
- Consumers’ willingness to borrow
While past performance is no guarantee of future returns, we did see some interesting trends last year. Throughout 2018, the Federal Reserve raised its benchmark interest rate 100 basis points, which means the cost to borrow money has increased roughly a full percent.
Financial institutions are maintaining stricter lending policies, which will likely limit the number of buyers – especially among subprime borrowers – who can get a loan.
Borrowers are taking out loans for longer periods of time. Historically, vehicle loans averaged 48 months, but terms then stretched to 60 months; now they are approaching an average of nearly 69 months.
These factors will converge to play an important role in the demand dynamics for the auto industry and how we forecast vehicle valuations in 2019. For instance, we believe that many individuals are migrating away from the new-vehicle market and into the used-vehicle market largely due to affordability. This is because the cost of borrowing money has risen, and new vehicles are becoming increasingly more expensive.
In the new-vehicle market, average transaction prices rose in 2018 to just over $30,000. While crossover and SUV prices rose slightly, car prices jumped over $800 to $22,670, and truck and van prices grew by roughly $500 to $40,750.
Used vehicles compete
To partially offset this tightening of credit and keep buyers in the new-vehicle market, dealers and automakers are offering incentives to lower financing rates for traditional new vehicles. On the used side of the market, dealers are responding by further elevating the profile of certified pre-owned vehicles. While average prices for certified vehicles are higher, educated consumers are enticed by these more affordable, almost-new alternatives that have been gently used.
This has clear implications for new vehicles. It is probable that this segment of the used market will eat into new-vehicle sales. For the short term, this is not entirely unwelcomed by dealers. Although shrinking due to consumers access to pricing information online, the used-car market generally delivers higher margins than new vehicles.
The environment, however, is a bit more complicated for the financial players in this market. The biggest risk rising interest rates present lenders is a potential spike in defaults or lower valued portfolios due to shrinking loans. That said, we’ve seen defaults settle to stable levels, and recent guidance from the Federal Reserve seems to indicate a reluctance to aggressively pursue rate hikes in the foreseeable future. Nevertheless, lenders need to be better prepared to dynamically manage their portfolios as conditions change. Consequently, the automotive financial community is becoming increasingly careful about making risky loans, which is hurting subprime borrowers.
Preparing for Tomorrow
The market dynamics of 2019 will be different than those of 2018. That means all the key players in the market should be prepared to make important adjustments.
On the lending side, it will be critical to pay close attention to market changes that can rapidly affect the quality of loan portfolios. For example, we see some segments of the auto market depreciating at faster rates in 2019 than in 2018. Lenders must focus on how they will improve their ability to monitor future loans across the different segments as valuations and other key variables shift.
While many dealers are trying to be proactive in their responses to the changing financial atmosphere, the fact is that most are still behaving in a reactive manner. Dealers and automakers must continue to actively manage incentive spending to entice buyers, drive sales and maintain their business objectives.
J.D. Power will continue to evaluate the different facets of the financial markets and their implications on new- and used-vehicle pricing, transactions, incentives and other factors that play a role in overall pricing.
We are always watching for any changes in financial markets that can affect new- and used-car prices.
Editor’s note: Ben Bartosch is manager of forecast analytics at J.D. Power. Previously he was an analyst, Public Sector Consulting, for IHS Markit.