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Vehicle affordability still a driver of auto finance trends

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Vehicle affordability still a driver of auto finance trends

Strength in used-vehicle pricing in 2018, fueled in part by consumers' desire for lower monthly loan payments, has defied companies' expectations of falling prices for the year.

The Manheim Used Vehicle Value Index in November retreated from a record high set in October, but it remained 3.3% above the year-earlier month. A wide range of interested parties had been bracing for declining used-car values, including auto finance company Ally Financial Inc., which included expectations for declines of between 4% and 5% in both 2018 and 2019 in forward guidance that it issued in March.

But, Ally CEO Jeffrey Brown said during an appearance at a recent investor conference, used car prices "held up extraordinarily well" this year. Brown credited fallout from natural catastrophes such as hurricanes and wildfires for helping to mitigate concerns about "a saturation of supply" in the marketplace. On the demand side, Kroll Bond Rating Agency in a recent report cited a "shift away from new vehicles" as a result of affordability concerns tied to the prospective impact of government tariffs on imports as well as higher interest rates.

Brown echoed that broader sentiment in his remarks, saying that the borrower base had migrated to used cars because they are more affordable to finance on a monthly basis.

"These people need cars to get to work, to take their kids to school," he said. "There is no more magic than that."

Kroll Bond Rating Agency credited higher used-car values for contributing to an improvement in performance for auto loan collateral backing outstanding prime securitizations during 2018 and a considerable slowdown in the pace of deterioration involving nonprime collateral. Capital One Financial Corp. Chairman and CEO Richard Fairbank went further, saying during a recent investor conference that strength in used-car prices represented "probably the biggest single contributor to the exceptionally good credit in auto."

Both Brown and Fairbank expect used-car prices to fall from what the latter executive described as their "celestial heights." Brown foresees a "supply-driven moderation" in used-car prices over the next couple of years.

"I see no reason that this is sustainable," Fairbank said, "and I think all of us should assume that used-car prices are much more likely to go down than up."

Their perspectives are not universally held in the industry, however. KAR Auction Services Inc. CFO Eric Loughmiller, for example, said recently that he anticipates strong demand for the "abundance of three-year-old off-lease cars coming back to the marketplace," particularly in the context of tariffs on new car imports.

Industry data reported by Experian Automotive show some signs of a modest shift in consumer preferences toward used cars. The most creditworthy consumers increasingly opted for loans on used vehicles during the third quarter, the report said, with 59.9% of prime and 42.6% of super-prime borrowers choosing used loans as opposed to penetration rates of 58.4% and 41.8% in the year-earlier period. Used-car loans continued to account for the overwhelming portion of loans by subprime and deep subprime borrowers, according to Experian data.

The same report showed that loans with original terms to maturity of 61 months or longer continued to account for the majority of originations. For new vehicles, loans of that duration had 71.3% share of originations during the third quarter. For used vehicles, they accounted for 60.3% of production. Average payments for both new- and used-car loans nevertheless reached what Experian described as record highs.

Experian data showed increases in interest rates across the auto finance market, but particularly so for new-car loans. The average loan rate across the credit spectrum for new-car financing of 5.73% marked an increase of 63 basis points year over year; rates on used car loans rose only 31 basis points to 9.03%.

From a credit standpoint, Brown remains optimistic that recent strength will continue.

"It's pretty basic: It's all about the ability to pay, and the consumer is in really good shape right now," he said. "Our trends do not signal any slowdown or any weakness in the portfolio."

Kroll Bond Rating Agency issued a similar outlook as it pertains to outstanding auto ABS pools.

"Absent an economic downturn next year, which we view as unlikely, we expect prime and non-prime collateral performance to continue to improve in the year ahead," the rating agency said.

Fairbank, for his part, expects that credit losses will rise. But he admitted that he consistently predicted the same during the recent benign environment. "You might all want to question my credibility," he added.