Stop the Presses!

July 19th dawned a sunny and splendid morning for my wife and me. We were enjoying a long weekend on Captiva Island, Fla. We started the day with a bicycle trip to Starbucks, where I picked up a copy of my least favorite newspaper, The New York Times. My mood immediately soured. On the front page, a headline blared, “In a Subprime Bubble for Used Cars, Borrowers Pay Sky-High Rates.” I nearly spit my coffee across the room.

The article, if you haven’t read it, is loosely woven around some distorted facts and likens today’s special finance industry to the mortgage industry during the buildup to the crash in 2008. It singles out five of the top subprime auto finance companies, Capital One, Exeter, Prestige Financial, Santander and Wells Fargo, as crosses between Bernie Madoff and 19th-century robber barons.

The article also paints a picture of the auto industry — and independent dealers in particular — as maniacal thieves with customers at their mercy. There is no doubt that special finance, along with the entire auto retail and finance industry, is in growth mode. That is something to be proud of. It has been a long road back.

Like any industry, fraud and other wrongdoing occasionally comes to light. From my perspective, the overwhelming majority of dealers and dealership staff are doing their best to comply with the endless maze of laws and regulations — despite the fact that many are so poorly written that even the agencies that must enforce them can’t easily define them.

Bad business is bad for the industry and it should be exposed. My main concern regarding the NYT story — aside from the inaccuracies and exclusions, which we will cover in a moment — is that it was published in Wall Street’s backyard. For the past three years, I have predicted that the next downturn in subprime would come in the fourth quarter of 2014 or 2015. To the uneducated or uninformed, this story of alleged fraud, reckless lending, and unbridled growth could look like a flashpoint igniting the next depression.

Any news of deteriorating earnings from the auto finance companies listed in the article could cause an elevated and unnecessary concern by those investors whose very capital has helped fuel the auto industry’s comeback. Our industry is very cyclical, especially the subprime segment. We may be due for the next subprime turndown, but we don’t need it fueled by some “War of the Worlds”-style panic.

Blurring the Facts

For those who have not read the article, let me give you some of the totally twisted “facts” the authors put forward, as well some of the ridiculous conclusions drawn from them: 

• Wall Street is again taking on very risky investments just six years after the financial crisis.
• The actions of the auto finance companies “resemble the frenzied mortgage market before its implosion set off the 2008 financial crisis.”
• “… Loans increased to subprime by 130% in five years …” (including a 35% increase in market penetration).
• A “wave of money” pouring into subprime is the cause. 
• “Standard & Poor’s recently issued a report cautioning investors to expect ‘higher losses.’”
• “Despite such warnings, the volume of total subprime auto loans increased roughly 15% … in the first three months of this year from a year earlier.”

I have known and worked with CEOs and other executives at many auto finance companies, some of them for nearly 15 years. They are very bright people. Each of their companies has more data than you can imagine to gauge the performance of their loan portfolios. They hire some of the best engineers, mathematicians and analysts to evaluate risk. Certainly their subprime customers carry more risk, but they calculate appropriate and fair fees and interest rates to offset that risk.

Furthermore, the risk level on this paper is far less today than it was a decade or two ago. The article implies that fraud among dealers is rampant. It doesn’t mention the technology used to detect fraud at the finance company level or how advanced it has become in recent years.

Regarding the growth, I scoffed at their implications — and that was before I got to the bar graph that belies their own points. Mind you, they didn’t blame the economy’s crash in 2008 on the subprime auto industry. In fact, they show that subprime auto loan originations constituted a bigger piece of the pie at that time than they do today. In September 2013, Standard & Poor’s reported that subprime originations peaked in 2005 at $110.3 billion, reached as high as $102.4 billion in 2001 and fell to $96.3 billion in 2007. All represented a far greater share of the originations market than today. And in 2008, when capital dried up in the last four months of the year, $72 billion in subprime loans was booked.

Let’s think this through. The U.S. new-car market shrank by 37% after the crash. We know that the demand was still there, but consumer credit was largely unavailable. In six years, sales have finally recovered and could reach pre-Recession levels by the end of 2014.

So the Times authors focus on the window in which no capital was available, then indicate the slow pace of growth since has been “frenzied”? Don’t they realize the housing market crash created more credit-challenged customers? We are serving more people with fewer loans per capita in that segment. There is no frenzy.

Finally, in 2009 and 2010, the same auto finance companies that are mentioned in the article had some of the best (or “tightest”) underwriting dealers have ever seen. Now that more capital is available and at attractive spreads, more loans are being booked. And, yes, due to competition, they are looser than they were — but nowhere near the gunslinging days of the mid-2000s. Losses are higher than they were in 2009 and 2010, but the better comparison would be to the eight-year period from 2000 to 2007, when annual originations averaged $100 billion.

Crushing the Consumer

The authors interviewed several car buyers who felt swindled. One gentleman bought a 2010 Mitsubishi Galant and quit making payments five months in. Wells Fargo repossessed the car. The article then slams Wells Fargo for pursuing the deficiency. “Borrowers are haunted by this debt, and it can crater their credit scores, prevent them from getting other loans and thrust them even further onto the financial margins,” stated a consumer attorney.

I wonder whether the authors have ever tried to finance a car. They certainly have never worked for an auto finance company or in the box at a dealership. Every finance company that I am aware of uses a valuation guide to set limits on the amount financed. NADA Clean Trade Value, Kelly Blue Book Wholesale Value or the Black Book Clean Trade Values generally set the market. Theoretically, they list the wholesale (resale) value of the vehicle, and 120% of “book” is a common amount to finance. Some offer more to allow for the sale of service contracts and GAP, which is referred to as “unusual insurance” in the article.

One customer received a $12,473 loan in 2012 to buy a 2004 Buick LeSabre, which was later repossessed, after the salesperson falsified her income. The sticking point is the value of the loan versus the value of the vehicle, for which the authors consulted the July 2014 Kelley Blue Book. If only I could have projected values two years into the future when I was appraising cars for trade.

The authors complain of interest rates as high as 24%. First, the states set the maximum rate that can be charged to a borrower. The states feel that the risk of lending money to people who have had multiple repossessions, foreclosures and bankruptcies in the past warrants the auto finance companies being able to charge that. Second, the interest rates and fees are necessary to balance the risk of the losses taken by the finance companies when giving second, third or fourth chances to credit-challenged borrowers who need dependable transportation to be able to live their lives.

The article makes it sound like the interest rate was the only barrier between these customers and timely payments. Would they have made every payment on a zero-interest loan? People of all types of credit and all types of backgrounds — even reporters — are responsible for their choices in life. Someone who truly earns just $1,200 a month should not ever think they can afford a $400 monthly payment for a vehicle, along with everything else that comes with it.

Real Numbers

We collect data from our dealer clients, franchised and independent, on a daily basis. To be fair, our dealers are more proficient in SF than the average dealer, but their subprime business represents just 52% of their total transactions.

From the last nearly 10,000 transactions, the average vehicle traded in has less than $200 of true equity, meaning the actual cash value exceeds what is owed on the vehicle. In all, the average consumer put down an average of $1,035 in cash. On an average sales price of just $25,000, the sales tax at 7% (in Florida) would be $1,750. That means that the trade equity and the cash down wouldn’t even cover the sales tax on this transaction.

The article indicates that subprime consumers leave the dealership owing more on their vehicle that it is worth. Of course they do. Nearly everyone does, and has, for years.

The same is true of other credit tiers. In transactions involving credit scores of at least 680, the average customer put just $1,126 down and had only $727 in trade equity — an insignificant sum for more expensive vehicles.

Let’s say a typical prime credit customer buys a $200,000 home in today’s ultra-tough mortgage environment. They take out a 95% mortgage and, with the accompanying fees for items such as the home inspection, appraisal, title insurance, government fees and taxes, private mortgage insurance, and loan origination fees, the borrower will likely pay another 5% minimum over the price of the home and be left with a mortgage of $200,000.

If the buyer were to then sell the home for what they paid, they would be responsible for the realtor’s commission (typically 7%) and all the associated seller closing costs, which would likely be at least 1%. The $200,000 sales price would net out at $184,000. In this case the seller would have a payoff on the mortgage (plus one month’s interest) of roughly $200,900, leaving them with a $16,900 deficiency.

Tell me again how the auto finance companies — or dealers — are crushing the subprime customer?

Getting Personal

The article’s next target was, naturally, the dealers themselves. And why not? After all, they “wield tremendous power” and force buyers to sit through an “interminable wait” while they seek financing. Then they hit them with loans that far exceed the retail value and may have negative equity rolled in. The bigger the size and rate of the loan, the bigger the dealer’s profit, right?

The article singled out a particular salesperson who worked for an independent dealer in Queens. He was indicted on grand larceny charges after he allegedly defrauded 23 car buyers on refinancing schemes. As I said in the beginning, yes, there are bad apples in our industry, just as there are bad doctors, lawyers, engineers and journalists.
Regarding the other statements … Huh?

Let’s assume the authors gathered their data from lawsuits filed against dealers. Lawsuits filed by dealers are much harder to come by. In my 18 years as a dealer principal, we seldom brought action against a customer. We only called the lawyer when a customer refused to pay a debt, and only as a last resort.

Anyone can pore through court records and find suits and judgments against dealers. That doesn’t mean they were all guilty or that the rest of us are guilty by association. What about the millions of very happy subprime customers who make their payments every month and refer their friends and family to their dealer?

As for the interminable waits and the wielding of tremendous power, spare me. As a dealer and a trainer, along with everyone else working SF deals, we know that subprime deals are not quick work. The typical submittal subprime auto finance companies requires stips to prove who the people are, where they live, what they earn and so on. More often than not, they don’t show up with all those documents in hand.

Also, the proliferation of websites such as FakePayStubOnline.com means that dealers and managers must be increasingly thorough in verifying every document. And most transactions take place in the evening and on weekends, so their places of business are often closed, making verification that much more difficult.

Then comes the “unusual insurance.” Well, GAP is hardly “unusual,” so let’s move that out of that column. Credit life and disability appears on few subprime loans these days, but if I were borrowing, it would be a great product. The cost is based on someone almost half my age and in average health. With cancer, cervical fusion and cardiac arrest on my record, it would be a steal.

The authors may also have been referring to vendors single interest coverage. This is a limited policy that protects the lienholder in case the vehicle is damaged or destroyed and the borrower’s insurance has lapsed or falls short. Some very, very deep subprime finance companies occasionally require this coverage, and some might describe it as “unusual,” despite its utility. So let’s give the authors the benefit of the doubt here, despite the fact that they didn’t see fit to extend the same courtesy to us.

Had this article appeared on the Times’ op-ed page — or even the cover of the National Enquirer — I wouldn’t be so sensitive. But to give placement and credence to this piece with the plain intention of rattling the cage of the money markets and financial institutions on Wall Street is just plain wrong. It isn’t criminal, but it is dangerous, at least in my opinion.

Let’s discuss it at Industry Summit in Las Vegas. If you are there, be sure to stop me and say hello. Until then, great selling!

Greg Goebel is the CEO of DealerStrong and the industry’s leading special finance trainer since 1989. He is an 18-year former dealer principal and a highly sought-after speaker, author and consultant. [email protected]