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.


F&I offices are at the center of this intense competition, with many feeling if they can’t get a deal done, someone else will. The Internet is also playing a role, allowing consumers to find dealers that can meet their needs, regardless of their credit situation.

“You don’t have a choice,” says Jesse Toprak, senior analyst for, who said terms have stretched out to 64 months, their longest point in 10 years. “If you don’t find a way with some creative thinking, either lease or extended term, the next dealership will do it for sure.”

The question is how this situation will effect the trade cycle. Toprak says 27.4 percent of customers who traded in a vehicle to purchase a new vehicle were upside down, up from 26 percent last year. The average amount of negative equity has also gone from $3,270 a year ago to $3,930 this year.

“It’s very diverse,” Toprak adds. “Because of changes in bankruptcy laws last year, we saw two million additional families going into ‘C’ and ‘D’ paper. The quality of applicants is really all over the place, and requires from the F&I office a vast variety of sources to work with, sources that will cater to a customer all the way to ‘D.’”

In Cincinnati, where home foreclosures jumped 24 percent last year to 79,000 — the largest gain in the city’s recent history — F&I Manager Steve Wirtz shook his head at the type of customers entering his Borcherding Buick Pontiac GMAC dealership. Located in Kings Automall, the Midwest’s largest automall, he says gas prices are really impacting the dealership.

“We’re in a well-to-do area and I’m seeing a lot of bad credit, a lot of negative equity,” he says. “Some of the lower scores I’m looking at right now are people wanting to buy way out of their means, people looking for trade-ins because gas prices are so high.”

Balancing on a Razor’s Edge

According to the Bandon, Ore.-based CNW, the auto industry so far this year is perhaps at its most fragile state in at least a decade. Stats showed that the first half of April started strong, with floor traffic up and all signs pointing toward a positive month. The second half of the month, however, saw a 60-percent drop in floor traffic.

It also saw in April the first signs of fallout from the subprime mortgage market, with closing ratios at new-vehicle dealerships dipping below 20 percent for the first time since 2000. The average FICO of those approved for an auto loan rose 4 percent to 719 vs. 691 a year ago.

CNW also reported that incentives increased dramatically this year, despite what the industry has reported. Lease subsidies are at their highest level since 1998, with residual value projections in lease contracts climbing. Basically, CNW said, everything from demonstration-vehicle incentives and looser credit criteria to lower-interest loans are on the table.

Borcherding Buick Pontiac GMAC’s Wirtz says March was strong, but that the April tax-return rush he was waiting for never materialized. He says the dealership is just now looking at addressing the number of credit-challenged customers it’s seeing with a dedicated subprime center — a move he hoped would have come sooner. The saving grace, however, was the dealership’s emphasis on the used-car market.

As for F&I revenue, Wirtz says the dealership has been doing more GM service contracts and GM’s Smart Care prepaid oil change program. The dealership is also jumping heavily into aftermarket accessories, loading vehicles with rearview cameras and navigation systems.

Over at Phil Long, Fenton says the company is really focused on selling wrap coverage. He adds that credit life and health and accident are two of the products that are really suffering, and says consumers are looking for more personal protection, such as prepaid maintenance, tire and wheel, road hazard protection, GAP and Secure Guard.

“Those are becoming the products of choice,” he says. “We’re running over 100 percent product penetration on those products (Secure Guard and Road Hazard).”

Still, with the focus turning toward used-car sales, Fenton and Wirtz say it’s difficult increasing F&I revenue per vehicle.

The Year of the Used Car

For dealerships experiencing a major uptick in used-car sales, Melinda Zabritski, an analyst for Experian, says dealerships will have to get used to it.

“I hear from a lot of analysts that there is a lot of speculation that 2008 is going to be the year of the used car,” she says. “I think dealers need to be more responsive to what’s happening in the used-car market. They also need to think about stocking the right cars … that’s going to be huge.”

Zabritski says dealers need to understand who is lending in the used-car space, and what type of spectrum lending they’re doing. As for current trends, she still sees that prime represents 50 to 55 percent of the market, and says lenders are definitely looking to buy lower to tap into the remaining 46 percent. However, she says that with the upper and lower tiers growing, she is also noticing a “squishing” of the middle tier.

“It’s more of our hour-glass progression at this point,” she notes. “Consumers on the low-end seem to be sinking even further.”

She adds: “I personally, from the data I see, don’t see the consumer out there really falling into this doom-and-gloom perspective. Yes, you do have a squeezing of credit quality, and all credit does appear to be going down some, but I have yet to see the impact across the board.”

Thomas Quintana, who purchased the Texas-based Grapevine Chrysler Jeep Dodge in Texas last year, says his dealerships has been operating just fine. Through the first four months of 2007, he says the dealership is up 200 units. Much of it has to do with the highly affluent community his dealership is located in, where customers typically write checks rather than finance.

However, Quintana believes that recent training at the dealership to tighten up menu presentations and other policies at the store has helped. Mainly, he says, it comes down to mindset.

“We’re going to have a challenge every single day, every single month,” he says. “We can either latch on to the challenge and use it as an excuse for failure, or figure out how to overcome it. And that’s what we focus on.”