You should be concerned about falling car prices and Ally’s profit warning

Yesterday, Ally Financial warned that profits would underperform expectations. Now, they dd not say that profits would fall or that they were taking credit writedowns. Neverthless, the warning is an important marker and should be of grave concern. Here’s why.

Three weeks ago I wrote about consumer demand, questioning whether it would continue to hold. And I talked specifically about an inventory problem in the auto sector. First of all, the last report I saw showed 85 days’ sales inventory on car lots. That is a huge amount of inventory. And carmakers are now cutting back on production.

But now, the NADA, the car dealer’s association, says their used car index dropped 3.8% in February, marking the eighth decline on the trot and the steepest fall since November 2008 when the US was in the middle of a recession.

So with Ally, what we are seeing is that these problems have created enough discounting to induce a profit warning at one of the major auto finance companies. Ally is really the former GMAC, the engine of a huge amount of profit for General Motors, as are all of the finance arms of the automakers in the US. So what happens at Ally will definitely pass through to GM and the other carmakers unless the impact is arrested quickly.

And then the question becomes whether this is a sign of a consumer slowdown.

Remember, the automakers have moved heavily into the subprime market, just as the housing industry did in the last cycle. So the question on sales is not about reaching untapped consumer pools. Moreover, these auto deals are highly leveraged – LTVs well over 100%. In an environment in which used car prices are falling, were we to see more defaults, that would be negative for loan recovery values and the associated asset-backed securities.

Why this maters: Autos is one of the three horsemen of new debt markets which replaced housing and boosted GDP growth this cycle. We’re talking about energy investment, student loan, and auto loans. Those are three huge areas. Energy has seen a bust and revival. But autos have not seen a hiccup yet. If this market’s price hiccup is accompanied by a broader slowing in consumer spending, that is going to definitely translate into higher loan losses – and then we would see a auto market hiccup. We’re not there yet. But this is the first sign.

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