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The cost of protecting against car rental company Hertz defaulting on its debt has shot higher in recent weeks as declining used car prices have ratcheted up concerns across the auto market.
Senior 5-year credit default swaps, which aim to track the creditworthiness of a company, on Hertz have risen from 500 basis points on March 16 to 815 basis points on Tuesday – the highest level since 2011, according to data from Markit. Competitor Avis has also seen a steep increase in the cost of its CDS, rising 160 basis points over the same period.
Car rental companies earn money from the day to day rental of vehicles as well as the re-sale value of their fleet. Used car prices have been declining, with the National Auto Dealers Association’s used car pricing index dropping 7.7 per cent year-over-year for February.
The price pressure is expected to accelerate as a growing number of cars that had been leased out will return to dealerships and need to be re-sold. The increasing supply will in turn push used car prices down further, said Bank of America analysts on Friday.
“We estimate that by 2019-2020, the number of vehicles coming off lease could reach 5m units, significantly higher than the prior peak of 3.4m units in 2002-2003,” the analysts wrote in a note. “In our view, as the number of vehicles coming off lease increases, used vehicle values will continue to fall.”
Ally Financial, a big auto lender, issued a profit warning in March due to the impact from the declines in used car prices.
Declining used car prices could also flow through to investors in bonds backed by junk auto loans, as the re-sale value of a vehicle is a key component of recoveries from defaulted borrowers. Delinquencies on sub-prime bonds are close to post-crisis highs having dipped slightly in the past month due to seasonal payments tied to tax rebates.
Well Fargo analysts said last week that despite investors being well protected from losses due to the way the bonds are structured, now is a good time to “take some risk off the table”, and the Bank of America analysts have called for lenders to tighten standards: “In the retail auto loan market, we think it is time for lenders to pull back or, at least, not continue to expand the credit box,” they said.
The most recent Senior Loan Officer Survey from the Federal reserve showed some respondents tightening lending standards for auto loans, and analysis from Morgan Stanley analysts backs up the shift. But concerns still surround some of the new entrants to the market which have driven competition and declines in the quality of borrowers.
“We still favour the sector but we are being cautious,” said Jennifer Thomas, ABS analyst at Loomis Sayles. “Some still have their foot to the gas. Others have tightened standards. The low to no credit scores is decreasing. It is very lender specific.”
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