Miguel Fernandez remembers the day well. It was three years ago and two months after he had returned from a trip to Hawaii, a reward from his lender for leading his sector in funded deals over a three-month period. On that day, however, that same lender sent a rep to tell Fernandez that his dealership was being cut off because the bank was no longer doing business with independents — the first sign of things to come for his 15-year-old dealership.

“It hasn’t loosened up,” says Fernandez, whose Miami-based Tech Auto Sales store claims an “A+” rating with the Better Business Bureau. “There are players out there, but not all of them let us [independents] play in the game.”

Gus Camacho, president of Camacho Auto Sales, has read the headlines about lenders loosening up. But like Fernandez, he has yet to benefit. Five years ago, his Lancaster, Calif.-based dealer group was doing 100 special finance deals a month. Today, the dealership is only rolling 30 deals a month. The bulk of the business is now being handled by Camacho’s buy-here, pay-here operation, a business model he got serious about six years ago.

“We did it for a couple of reasons,” he says. “For one, there were fewer subprime lenders, so it was difficult to get deals done. Second, we had always done BHPH, but it was a small part of our business. Six years ago I joined a buy-here, pay-here 20 Group, and that’s when I decided we needed to do more of it.

“I guess the timing happened to be right,” he adds.

Danny Reyes, a buyer for a Florida subprime lender, has noticed a steady increase in his DealerTrack and RouteOne bills through the first quarter of the year. To Reyes, that’s a clear indication that there are more and more outside-of-prime customers walking into dealerships these days. Based on conversations with the independent dealers he works with, he has also noticed that many franchised dealers are turning away credit-challenged customers.

“A lot of these franchised dealers are used to doing the prime, captive and nonprime deals. They’re so used to that money,” he says. “Unfortunately, they’re living their days from four or five years ago.”

Dealers Still Feeling the Subprime Pinch

Despite continuing a four-month upswing in March, approvals for subprime auto loans remained at their lowest levels since CNW Research began tracking the stat in January 2002. Approvals for prime and nearprime auto loans, however, reached levels not seen since March 2008, further fueling the perception that nonprime and subprime lending hasn’t loosened up.

Through direct marketing efforts and television advertising, Camacho says his dealership has established a solid reputation for handling credit-challenged customers in California’s Antelope Valley. He says traffic isn’t down, but he’s noticed that more nonprime customers are visiting his dealership these days.

“We do see some customers who have recently become subprime,” says Camacho. “By recently, I mean within the last 24 months. And usually it’s associated with the loss of a job or a cut in pay.”

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In South Florida, where the effects of the mortgage meltdown are still fresh, Tech Auto’s Fernandez has also seen more customers who have recently fallen into the subprime tier. Unfortunately, even customers with 700 credit scores are difficult to finance these days.

In one instance, Fernandez had to turn away a customer who listed himself as a lawyer on his credit application. The customer was current on his personal bills, but had a foreclosure on his record — an investment property he got upside down on and couldn’t rent. He came to the dealership looking for basic transportation because his previous vehicle was totaled in an accident, but the subprime bank Fernandez works with turned the deal down. In the end, he had to send the customer to a local credit union to get financing.

“I used to spend $18,000 to $20,000 a month on advertising. Now I’m down to $6,000 to $7,000 because I can’t get people done. And that’s because I’m in South Florida,” he says. “Recently, I called a bank and they asked me for my area code and ZIP code and they told me they don’t do business here.”

Five years ago, Camacho’s inventory was filled with vehicles he purchased from neighboring dealers. That’s no longer the case, as the dealer has noticed that more new-car stores are holding onto their trade-ins rather than wholesaling them. Camacho, however, doesn’t think the change is related to the influx of subprime customers.

“They’re keeping some of their older units as cash cars they can use as advertising pieces,” says Camacho, who estimates that 30 percent of his customers started out at one of the 10 new-car lots in his area. “I don’t think they’re doing it because they’re seeing more subprime customers. It has more to do with the cash customers.”

Finding the right vehicles for his operation isn’t a problem for Fernandez. He just can’t get the advances he needs to cover the higher auction prices. It’s a dilemma he thinks most franchised dealers don’t face.

“I don’t have proof, but I think they have more sources,” he says. “I even think they get more advances than we do.”

What’s happened is that lenders have gone back to the fundamentals of subprime lending, which they loosely followed between 2003 and 2005. Sources say lenders are operating in all credit spectrums, but that full-spectrum lenders might be the most aggressive of the bunch. Prime lenders are said to be operating in a traditional way, while nonprime lenders are believed to be staying within themselves and tending to their niche. It’s one of the reasons why the outside-of-prime segments remain so fragmented.

In January, the top 10 subprime lenders, according to Experian Automotive, represented only 30.71 percent of the market, with no lender outside of the top 10 having more than 1.27 percent share of the market.

Pace Good for Lenders

Chase Custom’s Bill Jensen remembers when things started to go bad. It was around the second half of 2007. That’s when his business unit began to notice unemployment trends that didn’t look too good.

“We started reacting to that market-by-market, being very diligent about the basics that we go through to approve subprime-loan customers,” he says.

Jensen’s business unit, ranked by Experian Automotive as the fourth most active subprime lender in January, recently opened new offices in Des Moines, Iowa, Richmond, Va. and Pittsburgh. Jensen says dealers should not view the openings as a sign of guidelines loosening. They’re an indication that the bank wants its underwriters directly connected to their communities so they can work more closely with dealers.

“Frankly, this whole concept of whether credit is loosening up or tightening up is an industry term,” he says. “That’s not something we use internally.”

Jensen says the perception that outside-of-prime lending remains tight has to do more with consumers than lender guidelines. “If you had a car with a 72-month loan and three years later you’re still $3,000 to $4,000 negative equity, back in ’04 or ’05, there was a home for that type of transaction,” he says. “Today, there’s really not.”

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Unfortunately, that reality is what’s kept many consumers on the sidelines. What could change everything is a better job market.

For instance, when auto sales slowed in February and consumer borrowing fell by $11.5 billion — about $2 billion for nonrevolving credit (includes auto loans), according to the Federal Reserve — the U.S. Department of Labor reported that the economy lost 14,000 jobs. In March, when the economy reportedly added 162,000 jobs, auto sales surged almost 25 percent to a seven-month high.

“The one thing that would cause lenders to be more cautious is unemployment, which is still pretty high,” says Jack Tracey, executive director of the National Automotive Finance (NAF) Association. “If it were to drop, then maybe they’d become more aggressive.”

In talking to his members, Tracey says the feeling among lenders is that there has been a gradual increase in activity for nonprime and subprime lending, but nothing dramatic. Fueling the better outlook these days, he adds, is that investors are returning to the asset-backed securities (ABS) market, where finance sources sell pools of loans as investment instruments to gain funding.

“They collectively feel the ABS market is going to come back, and that’s because they no longer have the fear of the mortgage meltdown looking over their shoulder,” he says. “But even during that period, there were only three downgrades of ABS instruments, and all were tied to Chrysler coming apart and not portfolio performance.”

Lenders, however, are happy with the modest pace so far and say a market that grows too fast could once again send things out of whack. As Tracey puts it, too much capital would bring more lenders into the market, but the additional competition could force lenders to become overly aggressive.

“The nonprime market over the last 10 years has been predictable. You can forecast it and the credit models lenders have created do work,” Tracey says. “But when market conditions make you have to take exception to your guidelines or models, or readjust your risk appetite, that’s when it gets out of whack.”

But with the market coming back, Chase Custom’s Jensen wonders if dealers are ready to take on today’s new subprime customer.

“One of the casualties of these last couple of years is the number of dealers who established dedicated departments specifically to handle subprime,” he says. “What we saw as the market wore on was that dealers disbanded these departments. So, what you have now are F&I shops that are more attuned to handling the prime and nearprime business trying to handle the subprime business that’s showing up.”

Franchised Dealers Missing Out

Breaking down recent data from Experian Automotive and the National Alliance of Buy Here, Pay Here Dealers (NABD), Jack Lintol, chief operating officer of the Auburn Hills, Mich.-based Auto Credit Express, estimates that more than 46 percent of the buying public has fallen into the subprime segment. He predicts that percentage will rise to 50 percent within the next couple of years, and believes franchised dealers could have the advantage.

“It’s definitely right for franchised dealers, and in talking to lenders, these guys would love to have more great dealers on,” Lintol says. “Lending might not be where it used to be, but it is out there. Last week, Consumer Portfolio Services got another $50 million. Automotive Credit Corp. also raised $50 million. Credit Acceptance has strong borrowing capabilities and had been aggressive through the whole downturn. The problem is most dealers aren’t prepared to handle the subprime customer.”

AmeriCredit is another company Lintol points to. The subprime lender says originations during the March quarter totaled $245 million more than the year-end quarter last year. “As with other economic cycles that we have weathered, the optimal period for new loan originations is at the inflection point where economic conditions begin to stabilize and improve,” says Dan Berce, the company’s chief executive. “We believe we are at the inflection point.”

Lintol believes the new environment for the outside-of-prime segment may no longer require special finance gurus or dedicated departments, and says that all F&I managers need to be trained in handling this consumer segment. He adds that dealers will also need to adjust pay plans to encourage F&I managers to service subprime customers.

Processes also need to change, Lintol says. For one, F&I managers should only be working with their lenders to advise salespeople on what needs to happen. Packaging deals and verifying stips should be handled by the back office, he adds. Book out and managing the subprime inventory database also needs to be handled by administrative personnel.

“I’m telling you right now, if people think nobody is doing subprime business, they’re crazy,” he says. “There are guys who are cleaning up right now and eating people’s lunches. They are taking customers right out of dealers’ backyards.”

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Sidebar: BHPH Sales Could Top Two Million

Recent data from BANDON, Ore.-based CNW Research indicates that 2010 could turn out to be a big year for buy-here, pay-here (BHPH). The research firm is projecting sales of more than 2.3 million BHPH units before the year is out.

CNW’s report noted that demand for nontraditional credit and average values for BHPH units both have increased, a clear indicator that more stores — including franchised dealerships — are responding to the demand. In 2000, according to CNW’s figures, 1.32 million of the 29.7 million used vehicles sold by dealers were BHPH units. Those figures didn’t change much for several years until the global economic downturn put BHPH in the spotlight. Last year ended with 1.84 million BHPH sales on the books and no immediate change to credit availability on the horizon.

The report further noted that high gross profit margins — ranging from 32 percent for franchised stores up to 43 percent for some independents — have also helped to make the prospect more attractive to dealers. But BHPH, like any other segment, also faces an inevitable market correction.

“As credit loosens, BHPH sales may well decline somewhat, but will remain both significant and profitable,” the report stated, in part. — By Tariq Kamal

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