Auto leasing given health warning

Following an exceptional performance in 2015 with strong sales and record average price per vehicle sold, the US automobile market must adopt a more disciplined approach to maintain long term health for the industry, according to analysis by J.D. Power which highlights potential problems in auto leasing.

The research consultancy warns that incentive spending on new vehicles has risen rapidly in the past year and is trending toward recession-era levels for the industry as a whole and has already exceeded recession-era levels on cars.

The analysis finds that while overall industry retail sales are expected to grow by 300,000 to 14.5 million units in 2016, the growth is being delivered through actions that pose what the agency calls “meaningful risks to the long-term health of the industry.”

Those actions include elevated incentive spending, increased use of extended loan terms, rising loan-to-value ratios and record levels of leasing.

“Overall, auto sales figures continue to post strong results, but when you peel back just one layer beneath the surface, some worrisome trends are taking hold,” said Thomas King, vice president of Power Information Network at J.D. Power. “Chief among the trends is the fact that first quarter sales incentives averaged 9.6% of MSRP, a 70 basis-point increase from last year and are trending toward levels observed at the height of the recession.”

King said the increased spending, which was due primarily to manufacturers trying to offset a shift in demand from cars to trucks and SUVs, has the potential to reduce future resale value.

“Significant declines in the value of used cars would disrupt consumers’ ability to buy new vehicles (due to lower trade-in values), while vehicle manufacturers and lenders would have to deal with exposure on their lease portfolios (if off-lease vehicles fail to achieve their expected resale value),” he pointed out.

King noted that an immediate and significant reduction of incentives on new cars is required, but that means manufacturers will have to reduce car production levels. While many manufacturers have already made significant adjustments to their production schedules, the scale of the shift away from cars toward trucks and SUVs is such that further, more significant changes are required.

According to J.D. Power’s analysis, in 2015, 14.2 million retail sales were achieved. That figure is projected to grow to 14.5 million in 2016 and 14.7 million in 2017.

The company says the proportion of long-term loans and leases on the rise. The percentage of loans in the 84 months and longer range is now 5.4% of total sales, up 140 basis points from 2015. Likewise, the percentage of vehicles that are leased is now 31.4%, up 360 basis points from 2015.

In addition, buyer credit scores appear to be declining. The proportion of new-vehicle buyers with FICO scores below 650, which would place them in the sub-prime category, has increased 40 basis points from 2015, with a total of 17.6% of all buyers now falling into that category.