Credit bubble in the making in used cars market 

When her office shifted locations, Roma was faced with a daunting daily commute from her Vashi residence in Navi Mumbai to Bandra Kurla Complex in Mumbai. Unwilling to depend on unreliable autorickshaws in BKC, she decided to buy a car.

Given her immediate need, Roma opted for a used vehicle, and some quick online searches led her to one of the many wholesale markets in Mumbai. Before Roma could put her bargaining skills to use, the dealer presented her with papers for the sale of a car, financing options for near complete value of the vehicle, and third-party motor insurance for her to sign.

What caught her by surprise is that a second-hand car was being sold at nearabout a new car’s price. After several more online searches and visits to multiple second-hand car dealers, she gave up and returned to the first dealer who’d kept everything ready for her. The same evening, a down payment of ₹55,000 allowed her to drive home in a shining blue three-year-old Hyundai i20.

The next morning Roma drove to office and realised that many of her colleagues had recently opted for second-hand cars, at price points very similar to Roma’s. This got her thinking to the time her sister had purchased a used car, about five years ago, when used cars weren’t as expensive and largely the domain of non-banks while banks stayed away from the segment.

Today, the fight to finance used cars — whether from non-banks or banks — is outrageous.

Exploding market

As Shruti Saboo, Director, India Ratings & Research, reasons: “The demand for used car has been increasing continuously amid consumers’ desire to upgrade their lifestyle, on account of growing middle-class population and increasing disposable income. With the widening demand-supply gap, prices of used car vehicles have been inching up.” She adds that prices of new cars have increased post Covid, and is one of the factors leading to higher prices of used cars, which are “expected to stay on higher side in the near future”.

Shortage of new vehicles, sustained demand led by rising incomes, desire to upgrade from two-wheelers to four-wheelers, customer awareness, digitisation and easier access to finance have helped open up the market; pricing in the segment has also increased in line with the around 20 per cent rise in demand.

“Typically, the first holding period is around 3-5 years. At that time, during Covid, new car sales de-grew, which means that availability of used vehicles coming to the market now is lower and creating a demand-supply gap,” says Aniket Dani, Director-Research, CRISIL Market Intelligence & Analytics. To top it, eagerness of financiers to lend to retail consumers, especially credit worthy borrowers, has helped sustain demand, creating a vicious cycle of stretched valuations and higher loan amounts.

In short, with demand far exceeding supply, used cars have turned into an intermediaries market, and pricing is also influenced by how the intermediaries value the cars. Deep-pocketed private equity backed online sellers such as Spinny, CarDekho, CarWale and Cars24 dominating the market (accounting for 20–24 per cent of sales in the used car market), seems to have added a layer of irrational exuberance, particularly with respect to pricing, even if at the cost of their own profitability.

Pricing is key

Let’s go back to Roma’s case. Assuming the car would have costed ₹6.5 lakh three years ago, it’s depreciated value should be in the ballpark of ₹4 lakh. Top it up with a dealer margin, the car should have cost her ₹4.25-4.50 lakh at most, whereas Roma’s purchase price is ₹5.5 lakh. Today’s cost of Hyundai i20 that Roma purchased is about ₹8.5 lakh. In 3–4 years, about 40 per cent of the car’s value could be considered as depreciation. Consequently, the car’s price would work out to ₹5.1 lakh, clearly throwing up the pricing mismatch.

Old-timers in the used car financing space say that the spurt in demand and the consequent need for funding meant fewer on-ground checks by financiers and more reliance on third-party valuers, which in some cases, is leading to compromised underwriting. In cases where higher loan to value may not be possible, ecosystem players have reported instances of lenders encouraging partner third-party valuers to stretch the pricing of the vehicles to enable higher loan disbursement amounts.

A senior analyst with an automobiles research outfit agrees. “Unlike a few years ago, today cars in the second hand market are being priced based on demand for similar variants in the new cars segment. Certain important considerations like life of the car or kilometres run aren’t being considered adequately, and this is particularly prevalent for cars above the entry hatchback segment. This poses a systemic risk, given how the used cars space is exploding,” he said.

What’s more, the increased pricing across the board over the past 2–3 years and aggressive financing have led to a surge in demand for even older vehicles, including those that are closer to the 15-year limit on re-registration. This has had a rub-off on the price of relatively newer second-hand vehicles as well, especially the 2020–21 model SUVs, now being sold at up to 80 per cent of the new car value, according to multi brand dealers.

Bubble in the making

Is a credit bubble brewing in this segment? According to a Crisil report, the share of used-vehicle financing rose to 40 per cent from 33 per cent in the past four years. Finance Industry Development Council (FIDC) suggests that NBFC lending for used vehicles has grown 154 per cent in the last two years, whereas the pricing differential for loans between used and new vehicles has shrunk to 250 bps from 400 bps earlier.

The used car market is poised to touch $31.62 billion in 2024 and compound to $63.87 billion by 2029. It is 1.3x bigger than the new car segment. Credit penetration in the used cars segment has increased to 15 per cent from low-single digits about five years ago. At a time when the RBI is cautioning lenders against accelerated consumer lending, this poses the question of whether the used vehicle ecosystem is a credit bubble in the waiting.

It certainly seems so with the present credit underwriting framework very different from the past, and lenders — particularly smaller banks and NBFCs — riding on the demand wave. Hope the pedal is pressed to avert an accident.