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Economic conditions

Auto Industry Faces Threat from Rising Interest Rates and Negative Equity

Strategic Insights

— 2 min read

The American car industry is experiencing record sales levels, boosted by customers trading in their cars before paying off loans and taking out longer and longer loans to keep their monthly payments flat. However, this trend has created a potential timebomb: 28% of drivers looking for a new car have an average of $3,800 of negative equity. Analysts warn that as interest rates rise, the industry will face a sales hangover as consumers decide to pay down debt rather than upgrade their cars.

Key Takeaways:

  • The willingness of drivers to trade in before paying off loans has boosted the American car industry, but has also created a potential timebomb of negative equity.
  • 28% of drivers looking for a new car have an average of $3,800 of negative equity, according to Edmunds.com.
  • The average vehicle selling price in December was $28,835, up from $21,608 five years ago.
  • Customers have been taking out longer and longer loans, with some loans reaching up to seven years.
  • General Motors Acceptance Corporation and Ford Credit, the finance arms of the big carmakers, will face increased risk of default and lower profits as loan periods lengthen.
  • Analysts expect sales of cars and light trucks to drop to 16m from 16.8m vehicles last year, equivalent to a $22bn revenue cut.
  • Rising interest rates will also impact the profits of finance arms, with analysts estimating a 1 percentage point rise in the Fed fund rate will lop $153m from pre-tax profits at Ford Credit and $95m at GMAC.
  • The current economic backdrop is a comfort for carmakers, with rising disposable income and pent-up demand potentially offsetting the extra borrowing cost.
  • Both GM and Ford are hopeful that better economic conditions will slow or even stop the price war that has sapped profits.
  • Rising rates will also help deal with the significant gaps in pension and healthcare funding faced by US manufacturers.

Statistics:

  • 28% of drivers looking for a new car have an average of $3,800 of negative equity (Edmunds.com)
  • The average vehicle selling price in December was $28,835 (FT)
  • Sales of cars and light trucks are expected to drop to 16m from 16.8m vehicles last year, equivalent to a $22bn revenue cut (David Littmann, Comerica Bank)
  • A 1 percentage point rise in the Fed fund rate will lop $153m from pre-tax profits at Ford Credit and $95m at GMAC (Deutsche Bank)
  • Every quarter-point rise in rates adds $1.9bn to the accounting value of GM's pension fund and cuts the $48bn underfunding of post-retirement healthcare by $1.5bn (FT)

Sources:

  • FT.com/autos
  • Edmunds.com
  • Comerica Bank
  • Deutsche Bank
  • GMAC
  • Ford Credit
  • GM

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