Simone Del Rosario: We all remember the collapse of the housing market, which was driven by the subprime mortgage crisis. But could the same thing happen in the vehicle market? We’re starting to see a stark increase in people not paying their car loans. 

Cox Automotive senior economist Charlie Chesbrough is joining me now. Thanks for joining me today, Charlie.

Charlie Chesbrough: Sure, thanks. Thanks for having me.

Simone Del Rosario: Charlie, before we get into all of the data, could you just quickly explain to our listeners, what are subprime loans?

Charlie Chesbrough: Well, subprime loans are loans that are made to borrowers who have questionable credit, they generally have low FICO scores may be in the range of 620 and below. And generally they pay a much higher interest rate because lending to them is thought to be more risky.

Simone Del Rosario: And Cox Automotive research shows that delinquent auto loans have now gone up 26.7% from a year ago, and subprime loans are even worse. What information are you pulling from this?

Charlie Chesbrough: Well, we’re looking at our financial data from Equifax. And what we can see is that subprime is definitely having some trouble out there making those monthly payments on their car loans. The fortunate thing for the automotive market is that the share of the market that is the subprime borrowers is much smaller today than it was back in say the the setback in 2007, 2008. Back then the share of the market that was subprime borrowers was closer to around 30%. Today, it’s half of that.

Simone Del Rosario: That said 7.11% of those subprime loans were severely delinquent in December the highest since you started tracking the data in 2006. Are these turning into defaults?

Charlie Chesbrough: Well, certainly a large portion of them will. And that’ll mean that we’ll have repossessions. But the issue is, is that there’s not going to be quite the devastating impact of these repossessions that we might have had before. Lots of vehicles have gone up in value quite a bit over the last couple of years. So it may be that some of these vehicles that are being repossessed have actually seen some appreciation in value, So that disposing of them isn’t going to cause severe financial hardship to the lender. But that’s just some of the vehicles, certainly there’s going to be {unintelligible}. And it is going to be costly for lenders.

Simone Del Rosario: Do you think this is a crisis or heading that way, seeing this rise in delinquency?

Charlie Chesbrough: Well, I certainly think it’s disconcerting, it’s something to keep an eye on. But we certainly don’t see it turning into a full blown financial crisis, again, in large part because the share of the market that is the subprime borrowers is much, much smaller today, it’s half of what it was before in the last time we went through a major downturn in the economy. So if there is defaults, it’s really, it’s turmoil out there. But the idea that this could bring down the larger economy seems a little bit difficult to imagine at this point.

Simone Del Rosario: Not to mention that if we were comparing the housing market to this, these are much smaller purchases. That said, used vehicles are definitely getting more affordable. We saw the sharpest one year decline in history of the Manheim used vehicle value index, which is very good for people currently looking to buy a car, but I have to imagine that a lot more existing borrowers are now underwater on their loans.

Charlie Chesbrough: There certainly are going to be, but you know, there always are. Anytime anybody buys a new vehicle and they drive it off the dealer lot, it’s worth less than what they just paid for it. And certainly, the volatile vehicle prices that we’ve had over the last two years are going to make more folks that bought certainly over the last year, are probably seeing their vehicles definitely less valuable today. But again, the question is, is this a crisis and it’s hard to see that this becomes a much broader event to spill out into the larger financial markets.

Simone Del Rosario: So what is the appetite for someone who owes so much more on their car than it’s even worth? And what happens then. I know what we saw with the housing market was a lot of foreclosures, you know, neighborhoods filled with foreclosure signs. What does that look like in the car market?

Charlie Chesbrough: Well, certainly, if people walk away from those vehicles, it means that those vehicles are going to get turned back over for repossession. They’ll show up at our auctions and Manheim auctions sites around the country, and then dealers will acquire them again at a much lower price than they had done before. And the cycle begins yet again. There certainly is room for these vehicles in the used market, we have seen that supply in the used market has gone down over the last few months. Much of this was probably intentional as dealers are trying to streamline a bit as they get ready for the selling season, which start once tax returns start going out. And so if we do see a bunch of repossessions, dealers will likely probably grab these because as we enter into the March and April tax season, that is the hot time for the used vehicle market and demand should certainly spike a little bit during that period. So repossessions might be a little bit more welcome then than they would be say at the end of the year when the used market is a little bit quieter.

Simone Del Rosario: And I appreciate you saying that you don’t see this rippling through the financial markets or having such a massive effect, as we have seen with other crises. I’m just wondering what sort of warning signs are you looking for in the automotive sector as a whole to say, we’re tracking these trends, and we’re looking to see that this doesn’t happen. Or if this happens, things could be a little bit more concerning than they are?

Charlie Chesbrough: Well, I think the one thing that we’re really watching for is the unemployment rate. And if we start to see that job losses really start to mount and we see the unemployment go from ticking down to starting to pick up. That’s where we start to get worried about people’s ability to really afford these vehicles. Once people start losing jobs, they’re not going to have income coming in, they’re not going to be able to make monthly payments. And they’re certainly not going to be able to be out shopping for a new or used vehicles. So we have a lot of headwinds that we’re dealing with this year in the vehicle market. Certainly rising interest rates is probably the major known headwind. But whether we slip into a recession and we see unemployment rates rise again, that’s one of the biggest question marks that we’re dealing with this year.

Simone Del Rosario: I imagine with interest rates as high as they are right now that people are probably paying more than ever on their monthly payments.

Charlie Chesbrough: That’s right, the average monthly purchase payment is approaching $800 at this point, and even a lease payment is slowly creeping towards $700. So the affordability question has really been changing over the last couple of years. We’ve seen a big run up in vehicle prices, which means monthly payments have been higher. And then with the Fed raising interest rates here starting last March, that has been icing on the cake in terms of making monthly payments go higher. So it’s definitely something that’s going to be a difficult issue for the market going forward through 2023.

Simone Del Rosario: Charlie Chesbrough from Cox Automotive, thank you so much for talking us through this today.

Charlie Chesbrough: Sure thing, glad to do it.