FLASH UPDATE: Tradex's Memory is Not Short - Caution Recommended in Auto Suppliers' Corporate Credit

Tradex's Memory is Not Short

Caution Recommended in Auto Suppliers' Corporate Credit

“Subprime auto lenders will likely ease underwriting standards further in 2014 as low interest rates keep profit margins fat enough to offset rising defaults,” said Moody’s Investor Services in a recent report.  Subprime auto loan originations have increased to their highest level since the financial crisis, but as auto sales slow, lenders may cut standards to grab additional market share.  Average credit scores have fallen for three years, while average length of loans have increased.  One of the year’s most highly anticipated IPOs was Santander Consumer USA Holdings Inc., a Dallas-based auto lender, currently valued at $8 Billion.  Fed officials have supposedly recently been focused on “lurking” financial bubbles.  Well, subprime auto loans are not the only asset-class that can rapidly decline, as we know. 

I’ve read five articles over the last month about the “hot” subprime auto lending market, and I’m sure dozens more articles have been written.  The language and tone in the articles remind me of times not so long ago, when borrowing was easy and lending standards were lax.  Low interest rates, persistently high fuel costs, easing underwriting standards, direct government intervention and incentive programs have buoyed the current US auto recovery.  If history is any guide, this easy borrowing environment won’t last and it will not be without consequence.  We expect that the auto suppliers may be indirectly adversely effected by a potential auto-loan burst and directly adversely effected from an already expected cooling of auto sales.  In 2009 there were 27 auto supplier bankruptcies – caution is recommended. 

The notoriously cyclical auto industry is in its 5^th year of near uninterrupted recovery, but momentum is starting to slow.  On February 1^st, the auto industry had an 88-day supply of unsold vehicles, the most since the depths of 2009.  The recently bankrupt Detroit specifically had a supply of more than 100 days (60 days is considered healthy).  The days of big sales increases are likely over, and prices of new cars have been falling month-over-month, which certainly will no doubt build up pressure on suppliers.  US auto sales are expected to grow 2.6% this year, down precipitously from 7.6% in 2013. 

This is a bad sign of things to come for auto suppliers, who tend to be concentrated by client/auto type and need a steady flow of orders to keep revenues healthy.  Already in Q1, three major US auto suppliers saw negative earnings impact from troubles in Europe and lower sales in North America.  These issues, not to mention significant and aggressive legal headwinds (antitrust, corruption, recall issues, etc.) may create a trend that we expect to continue and to be exacerbated by any unexpected auto industry hiccup. 

Richard Travia

Director of Research