Vehicle Depreciation Continues to be Low – Good News for Sub-prime Lenders

For all the talk of trucks and SUVs, used compact and mid-size sedans have performed really well in the last 18 months in value retention. After several years of declining prices, mainstream sedan segments bounced up from the lows in the used market. With lagging growth in real income levels, affordability remained front and center driving demand higher for used cars. At the same time, franchise dealers embraced the marketing and selling of used cars, with some creating separately branded rooftops to make the most of higher margins associated with selling used vehicles. This has enhanced awareness of used vehicles, particularly off-lease returns, and has contributed to keeping used vehicle values high.

Auto manufacturers have been disciplined in keeping new vehicle incentives in check. As a result, new vehicle prices have edged up, and used vehicles look increasingly attractive. It will be interesting to see if this trend on incentives continues as new vehicle sales decline.

2018 depreciation trends
The annual depreciation rate on two-to-six-year old vehicles dropped to 12.4 percent in 2018, which was the lowest in four years. The average depreciation over the last eight years is 12.5 percent, with 2011 and 2012 registering the lowest due to strong pent-up demand right after the recession. Prior to the Great Recession, annual depreciation of 16 percent was the norm. The demand for used vehicles peaked in 2018 due to a confluence of favorable factors: low interest rates, excellent credit availability with lower delinquencies, extremely high job growth, tax cuts enabling both consumers and commercial buyers to upgrade, increased marketing of off-lease vehicles, and disciplined incentives on new vehicles with rising transaction prices.

The overall market looked quite strong, but when you dig deeper you find there were significant differences in segment performance. Luxury sedan segments, namely Near Luxury Car, Luxury Car, and Prestige Luxury Car segments performed relatively poorly in depreciation rates, with 16 percent or worse. Typically, luxury vehicles tend to have higher depreciation. However, the depreciation gap between mainstream brands and luxury brands was particularly high last year. Mid-size cars depreciated at a 10.2 percent rate, whereas Luxury Cars had a 18.5 percent depreciation. That’s an 8-percentage-point gap. Usually, luxury cars depreciate about 3 to 5 percentage points more than mainstream mid-size cars. This highlights the affordability concern that was front and center for used vehicles in 2018.

What’s ahead in 2019
Access to credit is a key driver in auto sales and valuations. We expect credit availability to remain generally strong in 2019 as losses remaining low. The ongoing implementation of the new accounting regulation CECL will raise loss reserves, particularly in sub-prime. Rising loan terms are also a concern, particularly for used vehicles. Over 60 percent of the used vehicle loan originations now have loan terms in excess of 60 months. Higher depreciation of the underlying asset combined with longer loan term results in higher levels of negative equity. It is increasingly important for lenders to monitor equity levels as loss severity could be higher later in 2019.

For demand factors, Black Book relies upon reasonable economic forecasts. Currently, Black Book’s base residual value models assume a GDP growth of 2.2 percent, and jobs growth at an average of 160,000 per month in 2019. We are projecting good demand, but not as strong as in 2018, which was unusually high spurred by tax cuts. Weakness in home sales, volatility in the stock market and tariff threats could pose additional headwinds for the auto market. With growing uncertainty, it is important to consider the impact of alternative economic scenarios. Black Book’s Scenario-Based Residuals, under Federal Reserve’s Severely Adverse economic stress test, show a substantial drop of between 12 to 24 percent in used vehicle values, depending on the vehicle segment.
Precise data more important in uncertain times

Given the increase in younger vehicles returning to the used market, it has become very important to leverage precise, VIN-specific data to value vehicles. With advanced analytics solutions available, a full 17-digit VIN can now provide a precise valuation for a vehicle. This includes using Vehicle History Report information to automatically calculate a History-Adjusted Value, accounting for all the positive and negative events in a vehicle’s history. In addition, advanced capabilities now decode the trim and options of a vehicle better than before. Precise data reduces risk and maximizes profitability.

 

Anil Goyal
Anil Goyal is executive vice president, Operations, at Black Book, a leading provider of timely, independent, and precise vehicle pricing information. Through its Lender Solutions division, Black Book offers innovative data solutions and analytics to help lenders find profitable vehicle opportunities for their portfolio. To view the latest Used Vehicle Retention Index from Black Book, visit www.blackbook.com/black-book-index.