On a Collision Course With Reality

After the torrid pace U.S. automakers set in August, selling a seasonally adjusted annual rate of 16.1 million vehicles -- its best performance since before the recession -- it wasn't unexpected they'd cool off in September. Sales fell 4.2% last month to 1.14 million vehicles, and was the biggest drop recorded in more than two years.

Yet it wasn't an even performance among the automakers. Where General Motors (NYSE: GM  ) recorded sales tumbling 11% in September, Ford (NYSE: F  )  saw sales jump 5.8% on the strength of its F-150 pickup truck, which surged almost 10%. In comparison, GM's Chevy Silverado tumbled 11%. Chrysler sales inched up 1% for the month.

But sales at Japan's automakers also were sent skidding, with Honda (NYSE: HMC  ) dropping 10%, Nissan falling almost 6%, and Toyota (NYSE: TM  ) down 4%. Even Korean car makers Hyundai-Kia felt a reversal of fortune, going from among the best car sellers in August to among the worst in September as sales plunged 14%.

While there are a few plausible reasons behind the overall decline -- including two fewer selling days from the year-ago period, and the Labor Day holiday falling in August, which helped inflate sales that month -- the industry has been whistling past the graveyard, and investors would be wise to take notice.

As I pointed out a week or so ago, Toyota's North America CEO warned that unless the economy started growing much more strongly than it has been, sales would go into reverse. Additionally, used car sales are poised to make a comeback.

New car sellers benefited from the Cash for Clunkers program, which took inventory off the road, raised used car prices, and made them uncompetitive with new cars. But the environment's reverting back to the mean. With all those new car sales, people have been trading in their older cars in greater numbers, raising inventory levels, and pushing prices back down. CarMax (NYSE: KMX  ) , the largest used car dealer, recorded a 17.5% gain in sales last quarter, on top of a 19% gain the quarter before.

Now GM's Canadian boss is sounding a new alarm -- the same warning I raised earlier this year. The president of General Motors of Canada said that the run-up in new car sales has largely been a result of the industry's use of subprime loans to juice sales. In an interview with Canada's The Globe and Mail, he said the car dealers have been extending terms, lowering interest rates, and coming up with financial gimmicks in a bid to keep sales running high. 

Just like the financial house of cards the mortgage and housing industry built, the auto industry is similarly piling up debt to unsustainable heights, and GM's boss fears the wheels are about to come off.

I noted back in May that credit watchers were raising yellow flags about the growth in deteriorating subprime auto loans. I wrote at the time that credit-rating agency Experian saw: "(f)irst quarter 30-day delinquencies rose 1.3% compared to the year-ago period, while 60-day delinquencies shot 12.4% higher. Repossessions surged 16.9%, as finance companies had to reclaim 52% more vehicles, only partially offset by banks experiencing a 15% decline."

While it spun the second-quarter numbers as being better from the year-ago period, and among the lowest since it began monitoring the situation, Experian had to admit that they were worse than the prior quarter. Now, 60-day delinquencies in the second quarter are 16% higher than they were in the first, when the agency said we could expect to see that situation worsen. Today's subprime borrowers may be in somewhat better shape than they were during the recession, as Experian says, but it's clear they're driving down the wrong path, and picking up speed.

GM has good reason to be worried. Experian says a record 84.5% of consumers who acquired a new vehicle in the second quarter took out a loan or leased the vehicle, the highest level since tracking began in 2006. The credit watchers think this is good news, because it suggests that consumers think they can once again lard themselves with debt they can pay off. 

Yet they go on to note that nonprime, subprime, and deep-subprime loans (oh my!) now account for 27.45% of all the loans taken out, up from 25.41% just one year ago. And those three categories also account for more than 57% of used car loans. As GM Canada notes, the increased use of zero-interest loans, nothing-down payment schemes, and seven-year repayment schedules has now pushed the average term of the loan to 65 months. This isn't good news, folks; this is a car wreck waiting to happen.

As the car company's Canadian president said, "The real question is, are you going to run the business the way you ran it in the past in order to drive market share exclusively? The answer is that's not our intent because it [led to] a failed company."

And it's not only GM that's being set up to fai. The entire auto industry is on a crash course with reality.

Two automakers to think about
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