The Finance Effect

As the $200 Billion TALF (Term ABS Loan Facility) ether starts to wear off, it is going to be interesting to see what happens to non-prime automotive finance for the remainder of the year. Dealers have endured the credit crisis, rising inventory costs, Cash for Clunkers, unprecedented unemployment rates, and a growing pool of consumers with subprime credit scores. And for many, it’s been two years of hold-on-tight, off-road navigating without a map, but finally, the industry is starting to stabilize.

Like it or not, the automotive finance industry has gone backwards in time as the natural pressures on the market begin to find their equilibrium points. The diminished appetite for non-prime investment risk has sidelined billions of dollars as Wall Street licks its wounds, leaving special finance companies scrambling for dough and market share. Prudent finance companies that have stayed the course and kept their focus on sound underwriting with persistent collection efforts are self-sufficient and profitable with plenty of demand for their services; they will only get stronger. Others that have taken shortcuts or deviated from industry fundamentals have already faded or will quickly fade from prominence. Simply put, there are no shortcuts to success and profitability in finance, and the economic pressures of the recession are emphasizing that very point.

The law of supply and demand determines profitability and success for every industry, but for automobile dealers, the effects of that law on the finance industry determine future sales. The simple reason is that an automobile is a high-ticket purchase. Finance has made it possible for consumers to buy and drive better-quality, more expensive vehicles than they could afford to purchase with cash. As a result, the prices of vehicles have skyrocketed over the past 40 years. The 1970 Buying Guide of Consumer Reports listed the cost of a Volkswagen Beetle at $1,800, and a Toyota Corolla at $1,700. Today, the least expensive new Beetle retails for around $16,000, and a Corolla sells for approximately $15,400. Many people will argue that the prices of cars have increased because of governmental regulations for safety and emissions. But for me, I believe vehicle pricing has increased tenfold because of the evolution of automotive finance, also known as the finance effect. The ability to finance increases the purchasing power of consumers, thus increasing demand.

The mortgage industry is a great example of how the ability to finance effects demand. Just before the mortgage meltdown, practically anyone with a job could finance a home, but once the purchasing power (ability to finance) was reduced, demand decreased, leaving a surplus of newly-constructed homes vacant. Just take a look at several communities in Florida, Nevada, Texas and California that were booming only three years ago, but today are virtual ghost towns. The finance effect has a similar impact on the automobile industry.

People with A-tier purchasing power can get the best deals on automobiles, but if you are a C- or D-tier buyer, your choices are limited because your financing options are limited. Big “duh,” right? But what does that mean to car dealers?

The availability of automobile financing has decreased because the supply of money from Wall Street has decreased, much like the mortgage industry but to a lesser extent. The resulting purchasing power of consumers as a whole has decreased significantly. This has been further compounded by the general deterioration of consumer credit scores due the recession. The impact on supply has lead to a surplus of new vehicle inventory and a shortage of used cars.

What all this means is that competition will continue to be fierce for dealers trying to attract A- and B-tier buyers. It also means that while the lines between near-prime, subprime and buy here pay here were blurry a few years ago, they are much more distinct today. Special finance is still a highly viable option for dealers, but the difference today is having and keeping strong relationships with the right subprime finance companies since many have refocused their approach on quality over quantity.

To do this, the top finance companies have streamlined their sales and management teams and are working toward establishing stronger relationships with their dealer bases to better emphasize underwriting goals and portfolio performance. Dealers can still make lucrative profits on these non-prime deals. But, they have to have the right inventory, sound procedures and the right leader directing the sales team.

According to Experian Automotive, the nation’s highest volume non-prime automotive finance companies for 2009 were:

1. Wachovia Dealer Services
2. Capital One Automotive Finance
3. Toyota Financial Services
4. Chase Custom Automotive Finance
5. GMAC Financial Services
6. Ford Motor Credit
7. American Honda Finance
8. Nissan Infinity Financial Services
9. CitiAuto Financial
10. Credit Acceptance

Since the appetite for subprime risk has basically evaporated from the investment world, traditional BHPH has once again reaffirmed its niche in the market. What we knew as special finance no longer effectively competes for the same customers. Instead, that segment of the market is headed back in the right direction as finance companies more clearly focus on common-sense fundamentals for loan originations.

Vol. 7, Issue 5