Last year was a study in contrasts for the auto finance industry. The unemployment picture failed to improve, slowing the drive toward normalcy, but few would disagree that gains were made. At September’s F&I Conference, executives from five of the top auto finance sources met for a panel discussion, and the tone of their comments reflected that duality. The executives believe business will continue to grow in 2012, but they also hinted at making concessions if the economic picture doesn’t improve.
The executives covered a host of issues during their hour-long discussion, from used-car values to today’s subprime customer. Moderated by Connections Insights’ Marguerite Watanabe, the panel included Toyota Financial Service’s Pete Carey, GM Financial’s Craig Hewitt, TD Auto Finance’s Kelly Mankin, Bank of America’s Walter Masnyj, and Wells Fargo Dealer Services’ Adam Pope. The following is an abridged version of their exchange.
Watanabe: How are used-car values impacting your business these days?
Pope: Used-car values have benefited all lenders over the last couple of years due to the shortages in supply. I think we’re reaching a point where supply is finally catching up to the demand, which is why our outlook for used-car values over the next 12 months is flat.
Mankin: We see things similarly. However, late-model cars are getting to a point where they are starting to bump up against new cars in terms of payments and values and things like that. So there has to be a shift, because it can’t go much further or you’ll see people transfer over to the new-car side.
Watanabe: The credit crisis brought a lot of change to our business. Some banks chose to exit the business, while others pulled back. We also saw the emergence of the “hybrid” captive. What do you see happening over the next couple of years?
Mankin: You always see cyclicality in a recession. That was the case in 2007 and 2008, when lots of folks folded up the tent and left. Fundamental to that, too, was the inability to get capital. Now we’re on the other side of that mess. Funding is available and there is a lot of liquidity out in the marketplace.
In fact, TD bought [Chrysler Financial], in part, because they had an incredible amount of excess assets that they needed to employ. You have to keep in mind that this asset class has performed and continues perform better than any other asset class during this period. Combined with more opportunity through the increased SAAR and used-car sales, those economic factors are going to drive more lenders into the industry.
Carey: Kelly is right about the asset class being attractive. I think what’s really fueling that is the mortgage vertical. Banks traditionally use that to invest their money and they’re struggling with that. Until that dynamic changes, I think we’re going to see more players coming back to the market. For instance, we’re starting to see more competition with regard to leasing, which is driven by the fact that the consumer is looking for that low payment option. So, I think that’s going to continue.
Watanabe: How do you make sure some of the recent changes in regulatory activity get conveyed to dealers?
Pope: First, it’s focusing on your operational risk program that you have in place, making sure all of your team members are properly trained. With regard to the Consumer Financial Protection Bureau, well, there’s still a lot we don’t know. So, the only thing we can do now is focus on all the rules we do know about and make sure we’re compliant with all of them. That will allow us to gear up for anything that comes down the pike from the CFPB.
Carey: The advent of some of the e-contracting initiatives that are being rolled out across the industry is certainly going to help on both sides of the fence. Dealers are going to be forced into a level of compliance that maybe they don’t have today. I think it’s going to mitigate a lot of the risk, and it certainly helps our internal controls.[PAGEBREAK]
Watanabe: How have subprime profiles changed?
Hewitt: I think there is some regionality to that assessment of the subprime customer. In states with high mortgage foreclosures, such as Florida and California, we’re seeing legacy prime customers that are now falling into the subprime category. They’re good on all of their credit except for mortgage. We think there are still some valid credit opportunities in that space, but we are seeing a bigger concentration of subprime credit customers in the dealerships. However, I think it will flatten out over the next 12 months.
Masnyj: The situation has stabilized, but I also think certain mortgage programs are actually prompting customers to go into default before they can modify some of those mortgages. What’s happening is consumers are selectively placing themselves in the delinquent status in order to benefit from some of those modification programs, so we have to be aware of that as well.
But we’re going to have to get more creative, because the cars on the road today are eventually going to need to be replaced. And if that unemployment picture doesn’t improve in time to catch up with that, we’re going to have to find ways to work around it and make some concessions that we normally would not have done in a different environment.
Hewitt: I think there has been a small shift between 2005 and 2011 — in the positive direction — for underwriting subprime credits. There are less credit offerings for subprime consumers than there were in 2005, which means the customer you take onto your books in that credit spectrum isn’t going to be taking on additional debt. So, they may turn out to be a better credit risk today than just a few years ago.
Watanabe: How do you see monthly terms, loan-to-value
ratios and amount financed evolving over the next year and a half?
Hewitt: I think there is a good opportunity for amount financed to increase based upon the potential of our new-to-used mix shifting more toward new. I don’t expect LTVs to increase dramatically, and I think terms will remain flat. I don’t see us going anywhere above 70 months. And I don’t see a whole lot of exotic loans being offered in the near future.
Pope: The dealers are looking for higher LTVs, higher amount financed and longer terms because the customer’s disposable income is really driven off of that monthly payment. And we as lenders have all been burned the last couple of years, so we’re very hesitant about increasing those terms and the amount financed. On the other side, manufacturers are still announcing price increases on their vehicles, which has caused a natural uptick in the market. If you look at LTVs based on invoice or something like that, then, yes, you’re not really going to see an increase.
Mankin: Just to clarify, and I realize that this varies substantially by region of the country, but 72-month loans, at least in our book, are pretty prevalent. We’re starting to see some 75-month loans on the West Coast and, because the market demands it, we’re seeing some 84-month loans as well. We’re managing that very carefully, but we don’t see those things increasing dramatically.
Watanabe: Where are we in terms of e-contracting, on a scale of one to 10?
Pope: We’re at about a one. With us, it’s been driven by resource-availability issues. I think a lot of other lenders have faced that as well. It’s certainly something that we all want to do. It’s a green initiative, but it also will reduce errors in the dealership, at the funding table and at the lenders desk.
Mankin: I agree with the one out of 10, but I’m a little more optimistic. There are too many fundamental things that I think are going to drive it there. It is, without a doubt, the most effective way to ensure compliance in the store. I also think there’s always pressure in terms of cost and drives for efficiencies. And then you have the credit aggregators. Somebody is going to crack the code. In fact, I think you’re going to see it over the next 12-18 months, not en masse, but you’re going to see it start to take hold.
Carey: Toyota is in the midst of a rollout, but we also see this as a fairly significant change to the management process. I think once dealers fully comprehend it, they will see that it drives cost out of the equation. They will have funding that turns around faster and all of those things. But I don’t want to shortchange the amount of work that’s required, because it really is a dealer-by-dealer rollout.[PAGEBREAK]
Watanabe: How can you work more closely with the dealers in helping them build a more profitable business?
Carey: I think it’s twofold. The first thing is your pricing, your advance and your reserve split policies. Those have to be designed to allow the dealer to maximize profitability, or you’re not going to win in that store. The second part is understanding what the profit drivers are across the dealership as a whole.
I would add that the field sales rep needs to be more than someone who comes to the store and hands off a rate sheet, or worse, calls you and says, “Check DealerTrack or RouteOne.” To really add value, the field sales rep has to act as a consultant to dealers.
Watanabe: Do you allow dealers to bureau shop?
Hewitt: We do periodic studies on what is the primary credit bureau for specific regions. I can’t define that process, but it’s fairly intense and, therefore, we do have a primary bureau based on region.
Masnyj: There’s a specific bureau that we prefer, but there might be a certain region in the country where Transunion provides a better profile of consumers in that area, Experian in another and Equifax in another. The main driver for us is what source provides the best information to help [assess] risk.
Pope: We’re in a similar situation, and we don’t allow the dealers to bureau shop. We look at which bureau our dealers have historically used. We also conduct our own analysis, based on ZIP code, to determine which bureaus show the best results in different areas of the country. We also have a preferred bureau that we use internally, but it’s really based on what the dealer uses in a particular area.
Watanabe: Why isn’t subprime leasing big?
Hewitt: We introduced subprime leasing. I don’t think we’re anywhere we want to be with that, but we’re not looking to dominate the market. We just want to be relevant at the dealer level. And in my part of the country, leasing has been out of the dealership for a while, so, to some extent, the knowledge of how to set up a lease on the sales floor in the Southeast isn’t there. The easier path to go is retail [financing], especially in the nonprime and subprime space.
Mankin: We’re not currently doing subprime leasing, but we’re exploring it as a product. Some of the challenges we see with subprime leasing, in particular, is that most leasing today is, to some degree, subsidized. And when the manufacturer has to look at the math of paying the subsidy cost on a subprime customer, where the effecting rate is 17, 18 percent, the cost to do that from an incentive point of view becomes astronomical. At Chrysler Financial, we did a lot of subprime leases and it was very bad business for us. It requires a whole lot of understanding of the credit to make it work.
Watanabe: Where do you see rates going?
Masnyj: We’ve stabilized and I think it’s going to remain stable in the near future. If the rate environment changes in the opposite direction, I think it throws a lot of other variables out of whack. It makes it a much more difficult environment to operate in.
Carey: You’re not going to see rates change until consumer confidence changes. That’s my view.
Pope: Part of it is supply and demand. The rates are so low right now because there is a lot of idle capital out there and we’re sitting around waiting to lend it, but nobody is coming through the door to borrow it.