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Feeling The Pressure

June 2007, F&I and Showroom - Feature

by Gregory Arroyo - Also by this author

Like many dealerships out there today, Bob Fenton, CEO and senior manager of the Colorado-based Phil Long dealership chain, touts his finance offices as becoming stronger and better profit centers. When asked about current challenges, he’ll talk about the need for discipline and focus. When asked about his industry outlook, he says he’s “personally optimistic.” But his tone changes when asked about GM losing its No. 1 spot to Toyota in the first quarter for the first time in 76 years.

“It broke my heart,” he said. “Toyota is a great company, but it’s a shame.”

In April, U.S. auto sales fell 8 percent, with even Toyota — which reported a record 235 million vehicles sold in the first quarter — caught in the slide. Most analysts are predicting that auto sales will reach 16.2 million rather than the 16.5 million predicted earlier this year due to gas prices, a slumping housing market, rising consumer debt and no pent-up demand for vehicles.

The situation has created an intensely competitive environment in the marketplace, especially in the F&I office. Dan McKay, senior director of auto finance and insurance at J.D. Power and Associates, says the current pressure on automakers and retailers to meet sales objectives has generated a number of industry-wide trends that appear to encourage subprime business, with automakers and dealers tailoring financial terms to meet their customers’ financial limitations.

“It’s a very diverse market. There are patches of real challenge, but finance companies have shown an incredible level of inventiveness on the auto side,” McKay points out. “However, we have to look at the subprime mortgage side as a caution not to get too inventive. I think there are opportunities in this market, and I don’t have a doom-and-gloom feeling at all.”

Discipline is a word being used by many market watchers, as well as dealers.

According to a preliminary survey released by the Consumer Bankers Association (CBA) in March, 61 percent of new-vehicle loans are longer than 60 months, up from 55 percent last year and 45 percent in 2005. Even more worrisome is that new-vehicle loans of more than 72 months account for 17 percent, up from 9 percent last year and 7 percent in 2005.

“One of the factors creating extended terms is competition, both on price and term,” says

Walter Cunningham, president of Benchmark Consulting International. “Another factor contributing to extended terms has to do with the severe negative equity situations present in today’s market.”

Cunningham says the real proof of how extended terms is effecting the industry will be known once delinquency rates are tabulated in CBA’s complete study, which was not available at press time. Preliminary results showed a slight uptick, rising from1.08 percent in 2006 to 1.14 percent this year.

The Move to Subprime

Auto loan performance has been strong to date, with Standard & Poor (S&P)’s reporting in March that low losses and efficient structures prompted a record number of upgrades in the last year. Despite its strength, S&P analysts wonder if the increases in delinquency rates and loss numbers they’re seeing in the nonprime and subprime auto sectors were a sign of a trickle-down effect on subprime mortgage borrowers, or a willingness of lenders to take on riskier borrowers.

The same report noted that over the last few years, several banks, such as Capital One Financial Corp., Wachovia and Wells Fargo, have expanded their customer bases into lower parts of the credit spectrum to gain yield and sustain growth. In that time, analysts said, long-term loans increased 108 percent. Dealers say the situation is being driven by today’s consumer.

“We’re not seeing any adverse effect from the subprime market,” says Charlie Robinson, vice president of finance for Asbury Automotive, in response to whether there are parallels between the subprime mortgage market and the auto industry. “In fact, what’s carrying us is an emphasis on subprime.”

According to its quarterly report, Asbury Automotive’s gross profit margin rose 15.8 percent, the highest in company history — with sales of all four of its business lines and four U.S. regions showing growth from 2006 through the first quarter of this year. And like many dealers, Robinson says used-car sales and F&I have offset flat or declining new-car sales. He adds that subprime loans represent 30 percent of used-car volume.

“We’ve got to always strive for improvements while we’re there,” says Robinson, who adds that F&I yield grew in the first quarter to $1,045 per vehicle retailed, with F&I income up 13 percent. “You just keep preaching disciplined processes.”

Last year, 1.85 million of the 9.6 million customers in 2006 who leased or financed a new vehicle through the dealership were in the subprime category, with automotive dealerships initiating nearly $50 million in subprime new-vehicle loans in 2006, according to data from Power Information Network, a division of J.D. Power and Associates.

And despite the economy growing at an anemic 1.3-percent pace in the first quarter, consumer credit increased at a brisk annual rate of 6.7 percent, the Federal Reserve reported in March. Demand for nonrevolving credit used to finance items such as cars rose at a 5.2-percent pace in March, compared with a 2.7-percent growth rate in February.

The increase, however, pushed total consumer debt up $13.46 billion to a record $2.43 trillion — a much larger rise than economists were forecasting.

“What’s going on in the industry is it’s moved from a credit-driven to a credit-dependent economy,” says David Robertson, executive director of the Association of Finance and Insurance Professionals. “There seems to be a wiliness to incur debt regardless of the dynamics of that process. And you cannot finance on 60-plus terms and trade on two-to-three-year cycles.”

Will it Continue?

The question is if the trend will continue, with the unemployment rate edging up to 4.5 percent in April, resulting in just 88,000 new jobs created — the fewest in more than two years. Energy prices could also stunt spending, as they surged in April to a record nationwide average of $3.07 per gallon.

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