There is no denying that the credit market has changed or that many lenders seem to be tightening their offerings. The question is, "What strategies can lenders and dealers utilize to maintain their volume in this turbulent market?" The answer depends on where you sit in the market. The good news is that options are available and help is coming.
New Vehicle Financing
For new-vehicle sales, the news is much better than for used-vehicle sales. Most manufacturers' finance arms see their mission as unchanged — help consumers buy their brand of car. For dealers who have shunned captive finance systems for being slow, cumbersome or uncompetitive, the time has come to re-evaluate.
At the American Financial Services Association Vehicle Financing Show in February, there was a lot of discussion about maintaining sales volume. Stephen Smith, an executive at American Honda Finance, commented at the show, "We're not going to slow consumers down. We're here to help dealers sell cars." In fact, most captive lenders seem committed to holding their ground through the turbulence, and ensuring that consumers are able to find financing.
Some captive lenders are also working to improve their offerings in the subprime space. George Borst, president and CEO of Toyota Financial Services, noted, "We've added improved analytics at the low end of the credit scale, using more data to make decisions. We've added 84-month financing for tier 1 and 2 consumers, so there is positive news at the high end, not just negative [news]."
A 2007 study by J.D. Power and Associates found that 20 percent of customers leasing or financing new cars had poor credit. Because some captive lenders, such as GMAC Financial Services, Ford Motor Credit, National City and FirstMerit, have long limited their exposure in subprime, financers are unlikely to see much restriction from these lenders since they weren’t heavily exposed to riskier loans.
In response to a question about turmoil, Michael Bannister, CEO of Ford Motor Credit Company, said the company's lending practices have been consistent over the last five years. "We are watching the credit landscape evolve with interest, but don’t plan any changes," he explained.
The news on the used-auto side is less cheery. For years, subprime consumers have found it easier to buy a new vehicle at two to three times the cost. This trend seems to be amplified as lenders pull back support for subprime lending. While captives may be willing to absorb some of the risk in new-vehicle loans, many consumers still need a more affordable vehicle.
Daniel Berce, AmeriCredit's president and CEO, explained that the company began shrinking its subprime business toward the end of 2007, with an eye toward a 30-percent reduction in 2008. Still, he expressed optimism that the market would hold.
"In mortgage, people were buying second homes on speculation," he said. "People don’t buy used cars on speculation."
Lending experts concur that the risk associated with subprime auto is dramatically less than subprime mortgage loans.
By way of contrast, Chase Auto Finance CEO Marc Sheinbaum said he expected a pull back on periphery loans with less down, higher loan-to-value (LTV) ratios and longer terms. This may impact some subprime consumers, but he seemed optimistic about the business. His final comment should encourage every dealer and F&I department to keep Chase on the short list.
"We are seeing paper today that we didn't get before, so someone must be cutting back, but it's not us," he said.
Alternative Data and the Underbanked Consumer
So, what will turn this tightening market around? Alternative data sources appear to be the trend that will help the market. Subprime and underbanked consumers are often lumped together, but the difference to lenders is critical. Subprime consumers have been extended credit and have proven their inability to meet the terms of the agreement. By contrast, underbanked consumers don’t have enough traditional credit experience for traditional scores like FICO to provide an accurate evaluation. Many of the 50 million underbanked consumers are great credit risks, but financers lack the tools to evaluate them.
Fair Isaac Corp., which developed the FICO score, has offered a FICO Expansion score for some time. The Expansion score uses up to 90 nontraditional data sources to rate consumers with limited credit. Although the statistical results look promising, adoption by leading lenders has not kept up with dealer demand.
Link2Credit, offered by Atlanta based L2C Inc., scores consumers with limited traditional credit histories. They claim increases in applicant approvals of 10 to 20 percent while maintaining the lender’s existing customer turnover and default rates. LexisNexis and eFunds also offer alternative credit models that promise to close the underbanked gap.
RentBureau collects rental payment histories and incorporates them into its National Rental Data Exchange. Two factors make rental information particularly appealing as a data source: it is a significant percentage of consumer expenditure, and the majority of underbanked consumers pay rent.
PRBC (Payment Reporting Builds Credit) is a credit bureau that has received much attention as lenders seek alternative data sources. They capture a consumers' history of paying rent, utility and other recurring bills that aren't reported to traditional bureaus. This provides both a tool for consumers to build their credit and a resource for lenders and dealers seeking a way to rate risk. The credit bureau now offers Bill Payment Scores that can be used alone or in conjunction with other scores.
What to Do Today?
In the short term, it's important to remember there are still options for most consumers. Captive lenders are becoming increasingly appealing as the market tightens. Top lenders will still underwrite most loans, even if they are with fewer options, and there are many smaller lenders available. If you aren't receiving the products or acceptances you need, be open to looking for additional providers. If you haven't built a relationship with local credit unions, now may be the time. The lenders which have been successful in subprime for years will continue to offer products and accept paper while others pull away.
Eric Lindeen is director of marketing for Zoot Enterprises. He can be reached at [email protected]