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Hopeful Signs

September 2009, F&I and Showroom - Feature

by Jim Bass - Also by this author

Here I am at the coffee shop again, contemplating the state of the subprime/nonprime auto finance industry. The last time I commented on this was in an article published in F&I magazine’s September 2008 issue. At the time, I said that I really didn’t have a clue what it was going to take to revive the industry. I’m not sure that I’m any more enlightened now, but there are a few hopeful signs.

One must always consider what AmeriCredit is up to, as it really does serve as the bellwether of the subprime finance industry. Well, another earnings call is scheduled in a couple of weeks, but, alas, the deadline for this article will not allow me to wait for that call (See sidebar on page 24 for results). However, it must mean good things when the stock price has risen by 100 percent since November 2008. It now stands at more than $14 — albeit with a dip in March 2009 to just over $3. The stock value is far from the heady days of 2001, but it’s still a great comeback from last fall. And AmeriCredit’s current stock price is pretty well in line with percentage gains in the major indices. That’s encouraging. On an annualized basis, the company’s originations have decreased from $10 billion in 2007 to about $850 million in 2009. But that decrease in originations may tell us something.

I do agree there is some correlation between large growth trends and failure to perform. However, I’m not convinced that the credit crisis is due solely to origination volume. I also don’t think that higher delinquency and losses in the auto finance arena can be blamed on the mortgage crisis.

First Signs of a Crisis

Back in the spring of 2007, it was becoming clear that the competitive pressures of seeking higher earnings, becoming full-spectrum finance companies, and, in the case of depository institutions, having practically unlimited funding available (while securitizations were fueling the rest), were going to cause the rims to start flying off the wagon wheels.

My take on the market at that time was this:

• Dealers were demanding looser buying guidelines and higher advances — and the finance industry responded with hearty approval!

• Risk management tools indicated that anything or anybody could be financed given the right credit “price.” Unfortunately, the price was more often APR and dealer discount than down payment.

• Terms were extended into the realm of the utterly ridiculous by the finance companies. I mean, really, 84 months for a subprime borrower on a non-highline used car!

• Many finance company sales reps were being paid on some sort of volume basis — practically all of them earned six figures or more. (“Let’s see, do I look after my pocketbook or the company’s?”)

• Finance companies tolerated and even encouraged dealer average gross profits of $5,000 per vehicle and higher.

Lest you think I am on the dealers’ cases, I have to admit that they are true capitalists who are in the car business to make a profit. However, any excesses were being happily funded by the auto finance companies that were in search of earnings, bragging rights, etc. Some — or actually lots — of management and board-level personnel were either asleep at the switch, didn’t ask enough questions or were just not as smart as they thought they were.

I do have some positive observations about today’s finance situation. The finance companies that are still out there are doing things in a saner manner. Underwriting guidelines have been tightened and advances have been reduced, which I think is probably just as important. It’s really hard to reduce write-offs when you start with a loan-to-value ratio of 140 percent or more, and the bulk of the defaults occur in the first 18 months.

If you get the chance, sit down with an auction price book, such as the Auto Lease Guide. Pick practically any car and follow its value for 60 months. To better envision the curve, put the monthly or quarterly values on a line graph. On that same graph, plot the declining monthly or quarterly balance of a finance contract. You will find that any loan can be upside down for many months. However, a longer term will keep it upside down for a longer period. But with even a 60-month amortization, the principal balance of the finance contract will significantly exceed the residual value for at least 30 to 36 months.

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