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The US Used-Car Price Bubble Burst: What Does it Mean for Mexico?

By Daniel Esponda - Odetta
Founder and CEO

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By Daniel Esponda | Founder and CEO - Mon, 10/31/2022 - 13:00

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The semiconductor shortage created scarcity in the supply of new cars and customers flocked to used cars as a mobility alternative. This migration was coupled with easier and cheaper access to capital as US citizens received COVID-19 economic relief packages and low-cost auto loans, as fed rates remained close to zero. 

Consequently, we saw a meteoric rise in used car prices for more than a year, given that the supply of used cars remained stable (used cars cannot be produced at will) or even decreased as users held their cars for longer in response to the shortage. The Manheim Market Report (MMR) tracks wholesale used car prices through its Used Vehicle Value Index. After the initial shock of the global pandemic, it reported a rise in used car prices, showing a whopping 69 percent growth in used car prices from January 2020 to January 2022.

Since then, however, MMR has reported a steady decline in prices and has prompted multiple analysts to call it: the bubble finally burst . For context, during the 2008 mortgage crisis, car prices declined about 15 percent in 24 months from January 2007 to December 2008. Likewise, Manheim has reported a similar 15 percent decline in used car prices in just nine months.

What caused this accelerated price decrease? First, there is less demand for vehicles, as inflation has constrained overall consumer spending, especially in what could be considered luxury items like cars. Second, increasing interest rates also reduced demand; 37 percent of used car sales in the US are sold with financing, and dealers sell more than 60 percent of their volume with loans — as loans get more expensive, consumers are less incentivized to acquire vehicles. Finally, it is relevant to mention that, unlike in Mexico, where loans have fixed interest rates, in the US, most loans have variable interest rates, so a fed interest rate hike increases monthly payments, making it difficult for consumers to pay off their loans. Repossessions in the US are increasing and these cars flow back into the market through auctions, increasing supply and creating further downward pressure on used car prices.

The impact of such a price bubble bursting can be massive for used-car market incumbents. While car prices are not the only reason why the stock prices of companies like Carvana have been falling dramatically, it adds significant pressure to their profitability prospects. Dealers need to keep buying cars despite rising prices to keep their business going, and established dealers find it easier to do so because of floor plan financing and they typically hold them for 60-90 days before they can sell them. So prices falling, especially when dropping rapidly, can significantly impact profitability per unit. For the past quarter, the monthly price drop has been 3.5 percent. 

A colloquial saying in Mexico goes like this: “When the US gets a cold, Mexico gets pneumonia.” So, should we expect a similar negative outlook for the Mexican used car market? 

The consulting firm J.D. Power estimates that used car prices in Mexico increased only 14.8 percent over the past year. This increase is significantly lower than the 45 percent increase in used car prices in the US from 2021 to 2022. However, comparing these price increments to inflation rates of 7.5 percent and 7.1 percent for the US and Mexico respectively, we can observe that the real magnitude of the increase in the US is massively higher than in Mexico. 

Prices did not increase in Mexico as much as they did in the US because the purchasing power of Mexican consumers did not increase as dramatically as it did for Americans. Mexico did not issue stimulus packages for individuals throughout the pandemic, the cost of financing is much higher, and access to auto financing is not as widespread as in the US, as described below.

The average APR of a used car loan in Mexico is 16 percent (with almost no access for subprime buyers), while prices for used car loans in the US are lower than 5 percent in most instances. In addition, financial institutions in Mexico often structure auto loans with fixed interest rates. As a result, used car interest rates in Mexico have barely budged despite changes in the Central Bank interest rates fluctuating from 7 percent before the pandemic to a low of 4 percent last year and to a record high of 9.25 percent announced at the end of September. Furthermore, used car financing penetration in Mexico is considerably lower than in the US  — less than 1 percent of total used car transactions are completed with a loan. This last factor derives from a lack of certainty on the legal and mechanical conditions of used cars, exacerbated by the fact that 85 percent of used car transactions are P2P and do not have access to financing products for this same reason.

The corresponding price fall is also likely to be less dramatic. However, it will disproportionately affect established dealers, who already purchased inventory at all-time-high prices and will have to take low margins, or even losses, a situation which has never been seen in the used car market, where assets depreciate by nature. Banks have already hinted at increasing interest rates, which will hurt consumer spending. But as mentioned before, financing penetration is so low that it is unlikely to affect used car prices in the broader market. 

Auto financing in Mexico has little risk and has traditionally enjoyed lower delinquency rates than mortgages. Even if we saw an increase in delinquency, given that Mexico's used car wholesale industry is considerably less developed than its US counterpart, it is harder to sell any repossessions at an attractive recovery value. This prompts banks to usually restructure such loans before attempting aggressive repos. Therefore, little financing penetration and a remarketing industry full of barriers prevent an important volume of repossessed cars from flowing back quickly into the market, mitigating a sudden increase in supply.

In conclusion, the market dynamics that created a bubble and its corresponding bursting in the US are not the same in the Mexican used car industry. While prices have also increased atypically in the last two years, we do not expect a massive fall in prices. Of course, prices will be adjusted as markets return to normal, and established dealers will be constrained, but the magnitude of these effects will be more moderate. It is interesting that the local market inefficiencies also make the market more resilient in contrast with that of our northern counterparts. 

However, the turmoil in the market presents an excellent opportunity for asset-light innovators to grow, as consumers will be more price-sensitive and compare prices for the best selling or buying alternatives. Asset-light business models like Odetta are not subject to the volatility of market prices, which increases the overall risk and translates into higher costs for consumers. Additionally, such players’ business models allow for increased flexibility as market conditions shift, generating an even lower beta than the already resilient used car market.

Photo by:   Daniel Esponda

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