Is Special Finance Dead? Don’t Confuse Near-Prime Cutbacks with Special Finance

Subprime auto finance has been significantly impacted, as even prime auto finance has, by first the subprime mortgage market and then the decline of real estate values due to massive foreclosure rates in many U.S. markets. That is an obvious understatement.

I must disagree with the comments that I have read by other industry analysts saying that loans are no longer available to those consumers with subprime credit. That just isn’t so. 

What is missing is the flow of capital from Wall Street investors via subprime securitizations. Finance companies that do not have depositors must use these securitizations to fund their business. Through the first nine months of 2008, the flow of money through securitizations has amounted to less than $1.5 billion; through the first five months of 2007, over $12 billion flowed into subprime finance.

After AmeriCredit’s $750 million securitization in May, many assumed the market had opened back up. Unfortunately, it had not. Save a small $25 million securitization by CPS, nothing else came forth in the following four months. Even banks with depositors must securitize at times. One of the largest players in both prime and subprime had to pull back a prime securitization in the last 60 days. This has created havoc in the industry, as well as the exit of additional SF companies.

The good news that I just learned was that AmeriCredit had successfully placed another $500 million securitization. Cost of funds was higher than in the past, but at least it provided much-needed capital to the market.

One area that has died with many of the “full spectrum” SF companies is near-prime. Top executives from both Capital One and CitiFinancial told me they are exiting that market. Logic would lead one to believe that the near-prime market – often defined by Beacon or FICO scores of 620 to 680 – would be a much safer play for banks and finance companies than subprime. Not so for most. Both Capital One and CitiFinancial have suffered greatly from their near-prime loan portfolios. It seems that those customers feel that they are deserving of prime credit rates but pay like SF customers. Unable to price the loans with rates, advances and fees like SF deals, losses have been heavy. Once I thought about it, that credit demographic is also the most likely to be caught up in a subprime mortgage disaster, as only a relatively small percentage of true SF customers would have real estate loans.

With Capital One and CitiFinancial pulling out of near-prime, HSBC exiting the market, and AmeriCredit and Wells Fargo cutting back, the only finance source that has been serving that segment well is Wachovia. Of course, just days before I wrote this article, Wachovia nearly failed and a sale was arranged to CitiGroup … only to be muddied by Wells Fargo.

My point is that neither of the inevitable buyers is looking to expand that market segment and I assure you this is an instance where one plus one does not equal two. While I have not been able to confirm this with the executives of any of those three institutions, I would not expect under any circumstances that the end product of the sale/merger would produce the same level of SF loans as the sum of what the two were doing individually.

Back to SF, the true subprime loans. There are sources. There is money. Finance companies are still making money on SF loans; in fact, their 2008 portfolios are some of the best paper they have ever written (which should help securitizations in 2009). Capital One’s CEO told me directly that it is their mission to be considered the first choice of dealers they work with when it comes to subprime paper. I feel they are working very hard to do so.

CitiFinancial’s leadership tells me they are working hard to capture the true SF credit market, and that they have money. The same goes with Chase Custom and Santander/Drive Finance. Yes, pricing has changed. Advances have dropped. But the business is still there. Oh, by the way, prime credit customers are turning into subprime credit customers at record rates.

So why can’t you get deals bought? Quit looking for that “unknown” finance company out there that your dealership doesn’t have, but you believe is exists and is making loans with advances and terms like what existed nine months ago. It doesn’t exist. Work on fundamentals instead. If there was ever a time that you must have all 10 Critical Components for success in SF in place, now is it.

I was amazed to learn that for many of those I now call the Big Six – AmeriCredit, Capital One, Chase Custom, CitiFinancial, Drive/Santander and Wells Fargo (yes, Wachovia is still a market leader, but who knows what is going to happen) – payment-to-income ratios are now averaging 10 percent or less. Not that I disagree with the importance of the customer’s ability to pay being critical in the performance of a loan portfolio, but that is about half of what it used to be and what most dealers/SF managers were used to.

What does that mean? As I have been saying for six months, inventory becomes absolutely critical. You have to have inventory that you can structure full gross deals on that provides smaller monthly payments. Don’t tell me it doesn’t exist. I know too many strong SF dealers who are still buying it. Yes, it requires work, but it is out there.

If lower payments and lower payment-to-income ratios are of importance to finance companies right now, then to be able to pick your lost volume you must be able to adjust accordingly. SF deals are still out there, but for the run-of-the-mill SF customer, you are not going to be able to rely on high-priced program cars. If you can put a deal together on those vehicles, it certainly won’t be with much gross profit.

I assure you, if you work smart—and I work with a bunch of smart departments—you will still have success in SF. Yes, grosses are down, but the deals are still there. This is the time to make sure you are on your game, not to fold your cards. It is going to be a bumpy 12 to 18 months in SF until the capital supply comes back around, but the epitaph for the SF industry is quite premature. I very much believe it is going to be around for a long, long time—and you should too.

Until next month, Good Selling

Vol 5, Issue 11