The lending landscape has certainly become more challenging over the last few months in the Special Finance industry, with lenders’ programs tightening and discounts growing. At the same time, the market of applicants with sub-500s Beacon scores seems to have grown exponentially. What is going on? Is the sky really finally falling on the Special Finance industry?

In my opinion, and in a word—no. An emphatic NO! Then you ask, “What is going on if the sky isn’t falling?”

Fair question. I feel it is as Yogi Berra would say, “It’s déjà vu all over again.”

First, I will set some things straight. Yes, the lenders have cumulatively tightened up, and are discounting heavier. Does that mean that it is going to take twice as many applications to sell the same amount of vehicles? No. It does not. Does it mean that grosses are going to shrink? Not necessarily. They could, but not to the extent that some would predict. It is about working smarter, not harder.

The situation in the market today has been caused by unusual circumstances taking place with what I call the “big three” lenders. In addition, to a degree they have been predictable.

In the past, AmeriCredit, Capital One and Household (noted alphabetically, not by size or strength)—have taken turns having to correct poor performances in areas of their portfolios. It started with AmeriCredit in late 2001. Then Household had their challenges in early 2002. Capital One, which had been rapidly growing in size, took their lumps in mid-2002, followed by the most significant occurrence, AmeriCredit having to reclassify the way they account for earnings in September 2002.

With the exception of the last development noted, the other three were predictable. As someone whose dealerships spent 12 years heavily focused in this market niche, I am aware when a lender is buying “too deep,” or seems to be playing in a different league with regards to discounting or interest rates. Anyone that has worked in the industry for any length of time knows it. The “train” is rolling, and sooner or later it has to derail, as the customer pool in relation to repaying any specific lender isn’t significantly better for one than another.

In late 2001 and until the fall of 2002, the “big three” were making the adjustments that had to take place sooner or later. At the same time, other lenders were either exiting the business, or altering growth plans. Ford Motor Company suddenly became cash-poor, on the heels of some questionable lease residual predictions, the infamous Explorer-Firestone debacle and escalating consumer incentives. Suddenly, their appetite for something out of their primary market core diminished. They terminated their Fairlane project, and repositioned Triad, the other sub-prime company they had acquired. Fairlane also had served a pass-through lender for other smaller sub-prime companies. Consequently, this sent them scurrying for funding. All in all, it has had a significant impact, but one that was not necessarily based on poor operations alone.

I tell dealers all the time it is like looking at the sea. Sometimes, the tide is in, and sometimes it is out. Sometimes you are sitting at the peak of a wave, and sometimes in a trough. It is certainly always moving. Right now, the tide is out, and we are in a trough. It will flow the other way again.

As I see it, the Special Finance industry is certainly a supply and demand industry. As the big lenders tighten up, their slow-downs or cutbacks have a big impact. As I write this article, AmeriCredit has everyone’s attention. Their involvement with the SEC has been well chronicled. Their stock has plummeted from a high of over $46 per share to under $2. That is significant.

Their stockholders are not happy, and the company must react. Disregarding the one-time charge to reclassify earnings, they are still profitable. Regardless of whether you personally like them or not (which is very polarized based on which branch you did business with), you certainly can’t want them to leave the industry, as losing the largest lender in this market sector would make it that much more difficult for other lenders to find financing. I do not believe they will go away. I have met with the upper echelon of their management, and I believe they have structured a solid plan to continue to profit—albeit at a lower volume for now.

Back to the supply-demand issue. When any company states that they are going to reduce their quarterly volume goals by as much as $1.5 billion, that is a lot of loans. That would equate to $500,000,000 per month. My simple math tells me that is about 30,000 loans per month, or 600 per state. Even if it is half that much, that is a very significant amount of business. There are a number of smaller finance companies that don’t fund even 600 deals per month!

At the same time you must factor in the acquisition of Household, which will be finalized about the time this magazine reaches your desk. This transaction has been going on for some time now, and I am sure it has promulgated an air of conservatism in their offices as well. Household is still solid as a rock.

Lost in the headlines was Capital One’s tightening and re-tightening of their credit policies, which many felt were very loose for awhile.

With the three biggest lenders suddenly hitting the brakes simultaneously, over differing issues, the rest of the lenders get their plates full very quickly. Additionally, anyone needing to securitize loans may find it a more challenging climate to raise money. What does it all mean? It means that suddenly lenders can buy all the loans they want, on better terms than they have been. Factor this in with it occurring during peak season for Special Finance departments, and suddenly the sky does seem to be falling.

Without a doubt it is tougher to get approvals for customers at the bottom end of the credit spectrum, and those that are approved are not anywhere near what they were being approved for in the past. On the flip side of the coin, my best barometer, my Special Finance 20 Group, has many of its members enjoying record months in 2003, with delivery rates up 20 percent over their final 2002 results. Yes, their grosses have gone up, too.

How can that happen, you ask? They are working smarter. Most have moved a significant portion of their marketing efforts to the Internet. They are looking for customers with a higher credit score. They are making sure that their inventory is on the money. Most of all, they all continue to foster solid relationships with their lender-partners.

In closing, I feel that what you are seeing in the market is the culmination of some poor timing (for the dealers). Money costs are still much lower than they were five to six years ago when the industry last went through a “low tide.” The lenders are more sophisticated than they were at that time, when many were fledgling start-ups. The pool of credit-impaired customers is certainly not shrinking. Finally, investors have had a very tough time in a bear market finding anything to provide them a sufficient return on their capital, and we are likely entering a time of war. They will return to reap the benefits of sub-prime paper.

The tide will come in, and you will again rise to the top of the wave. It just takes time. How long? Likely six months. But there are already signs of good things on the horizon with new lenders aggressively trying to take advantage of the current market conditions to grow. Keep the faith. Work smart. Inventory well. Maintain relationships. While others may make excuses, you can still make money!