Used-vehicle pricing has to give. That’s the consensus among market observers who believe the current supply-and-demand dynamic in the new-vehicle market is set to trigger a long-overdue correction in used-vehicle pricing. While the prospect has raised concerns about the health of the U.S. auto cycle, not everyone is convinced a softening in used-vehicle pricing is a bad thing.
That’s where most F&I product providers and agents stand. They have spent the last five years preparing for this eventuality, and they say the inventory management systems and strategies dealers have embraced since the downturn won’t be enough in the years ahead.
“Inventory management systems are terrific, but a quick turn of those vehicles with a strategy for profit is going to be key by 2017, ’18 and ’19. I’m convinced of it,” says Glen Tuscan, president of Dealer Commitment Services and owner and CEO of Triple Protection Auto Care (Tri-Pac).
Used-vehicle pricing has served as a barometer for consumer demand. So when publicly traded dealer groups reported lower profits on used-vehicle sales due to narrowing margins during fourth-quarter earnings calls in late-January and early-February, Wall Street analysts and investors peppered their executives with questions about market conditions that look eerily similar to the run-up to the Great Recession.
Rob Glander, who spent 20 years with General Motors Acceptance Corp. (GMAC) and Chase Auto Finance before joining GWC Warranty in 2009, says those concerns are misplaced. “When you’re seeing the Manheim Index at 120, 125 … it’s a little bit perverse because the headlines on automotive sites will be, ‘Hey, used-vehicle prices are falling. This is terrible. Demand is falling,’” he says. “No, no, no. [An index reading of] 100 is not a bad place to be. That’s normal speed.”
Ally CEO Jeffrey Brown also defended the strength of the market during the finance source’s Feb. 2 quarterly earnings call. Asked how Ally’s current used-vehicle portfolio compared to the last credit cycle, he told investors Ally’s book of business would remain profitable even if losses jumped 50%. He added that the finance source is planning for a 10- to 15-basis point increase in charge-offs and a 5% drop in used-vehicle prices this year.
With most industry forecasters putting 2016 new-vehicle sales at or slightly above last year’s record 17.5 million-unit total, Tim Russi disagrees with the notion that current market dynamics mirror that pre-recession period between 2002 and 2006. Ally’s president of auto finance acknowledges, however, that industry data does point to a plateauing market.
The fear among dealers is that automakers will attempt to steal market share by producing more vehicles and increasing incentive spending. At the Automotive News World Congress in January, AutoNation’s chief executive, Mike Jackson, warned that dealer profits will suffer if that happens. Used-vehicle prices will also feel the pressure, Russi notes.
“So we’ve gone public about the fact that, with increasing supply and the levels that we’re anticipating in terms of demand, we should see a little bit of softening of 5% per year over the next couple of years,” Russi says. “That’s still a pretty good price. This is not Armageddon.”
Russi believes the used-car market’s “pressure point” can be found downstream, in the independent dealer channel. Quality used units from new-car dealers, he adds, will still be in demand.
“Cars that are not well taken care of or don’t have the technology that has been coming into cars lately … potentially become part of the 14 million that go to salvage [each year].”
This isn’t the first time a normalization in used-vehicle pricing has been predicted. There was the summer of 2014, when inventories reached their highest level since August 2009 and used-vehicle prices slipped three straight months due, in part, to the flood of off-lease vehicles that returned to the market that year. Market observers believed then that the stage was set for a steep dip in used-vehicle prices in 2015.
But dealers responded, selling a record 2.55 million certified pre-owned vehicles last year, according to Manheim’s Used Car Report. It was the fifth consecutive year in which CPO sales reached a new high. And despite narrowing gross margins that year, used-vehicle operations at franchised dealerships slashed selling expenses and turned inventory quicker on their way to record profits in 2015. F&I was also a key driver, Manheim’s report noted.
Dealer group executives also lauded their F&I operations during fourth quarter earnings calls for offsetting increased margin compression. AutoNation’s Jackson noted during his company’s Jan. 28 earnings call that the group is taking steps “to align our cost, inventory and pricing strategy to the current market.”
Part of the problem was low fuel prices, which spurred a surge in demand for large trucks and SUVs. Problem was, the cars consumers traded in didn’t sell for the prices dealers hoped for when they pushed them to the retail market, causing used-vehicle profits to fall in the fourth quarter of 2015 for most publicly traded dealer groups.
“So you look at the categories of pre-owned, and no question fuel prices right now are fueling a surge in larger SUVs and larger trucks right now,” Dealer Commitment Services’ Tuscan notes. “But where is it going to be at the end of 2016 and into 2017? That’s what we need to concentrate on now and prepare for.”
Eye on F&I
F&I has always been critical to dealer profitability, but it has become more so since dealers emerged from the rubble of the Great Recession. One of the reasons is individuals like Dale Pollak, founder of vAuto. He and others ushered in a new approach to the used-vehicle market, where wholesale values were determined by the retail market instead of what dealers paid for vehicles at auction. And these agents of change did so behind inventory management systems that allowed dealers to see just how much a pre-owned vehicle would fetch in the subprime, retail and wholesale markets.
“One of the reasons why the auctions were valuable to dealers historically is that they’ve been a source of liquidity. Anytime a dealer needed cash, which is generally where much of their cash is tied up — their used-car inventory — the auctions were there. Now that source of liquidity is better in the retail market,” Pollak says, noting that the emergence of the Internet shopper changed things even more.
“Because of the Internet, you can sell any car any day you want if you price it right,” he adds. “You may not like the result, but you might not like the result if you took your car to auction. But given the choice, you’re almost better off doing it in the retail market, because then you have an F&I opportunity.”
And that’s why F&I product providers and agents have been champing at the bit since 2014, when market observers began warning that the flood of off-lease vehicles coming back to market might overwhelm dealers. And with lease maturities expected to grow another 800,000 units this year from last year’s 2.3 million and CPO sales expected to surpass last year’s record-setting total, the prospects for dealer reinsurance programs look bright once again.
But what really has service contract providers excited is the fact that they’ve been able to extend mileage eligibility and coverage terms thanks to improved vehicle quality. That’s what allowed Ally Insurance to add two years and 50,000 miles of additional coverage to its Ally Premiere Protection product, which was released last June to replace the former captive’s General Motors Protection Plan. And according to Doug Timmerman, president of Ally Insurance, the product accounted for 52% of the former captive’s contract volume in the fourth quarter — a third of which were sold on used vehicles.
“I think the timing was arguably perfect,” Timmerman says. “One of the things is, not only is the used-car market expanding, but the segment of higher mileage used cars is also expanding. So I think it’s important we’ve moved to 12 years and 150,000 miles, which is a pretty significant step.”
Located 30 miles north of Atlanta in Cumming, Ga., Troncalli Chrysler Dodge Jeep Ram sits in what James Ayers describes as “trade-in heaven.” The business manager, who is among 110 F&I pros across the country to earn the Chrysler Service Contract Inner Circle designation, says his dealership often takes in trade-ins that have hardly left the customer’s garage — two- to three-year-old vehicles with 30,000 miles on the clock. Then there’s the store’s elderly customer base, which will only trade in their prized Town & Countries when the repair bills get too expensive.
Through Chrysler Capital, Ayers has a solution for both customers. There’s Chrysler’s exclusionary lifetime wear-and-tear policy, which can be sold on vehicles within 48 months or 48,000 miles of the in-service date. The product covers everything but maintenance, Ayers notes, adding that customers must maintain their vehicle according to the manual. He also discloses to buyers that Chrysler Capital will cut them a check for the Kelley Blue Book retail value if repairs exceed what the vehicle information site shows for their vehicle.
Also available is Chrysler’s unlimited mile, two-year extension product, which Troncalli offers in the service lanes. Ayers says the product also works as a great service-contract option for customers who purchase a low-mileage trade-in but don’t plan on keeping the vehicle long.
“So when I ask the question during my interview, ‘How long do you plan on keeping this car?’ and they say ‘Until the wheels fall off,’ I say, ‘That’s great. I do, too. How about I show you a product that keeps you covered for that long?’” Ayers says, noting that the lifetime product represents a third of the contracts his department sells.
“But if I’m selling a trade-in that’s got 30,000 miles on it, but it’s not a person who keeps a car eight to 10 years, then the two-year extension will give them excellent coverage for less than $1,000,” he adds.
The wave of bundled products that has hit the market in response to the surge in leasing also represents an opportunity for F&I offices, especially plans with no mileage restrictions. Popular combinations typically feature items like windshield and tire-and-wheel repair, key replacement and paintless dent removal.
Complimentary maintenance programs that allow F&I offices to upsell additional years of coverage also help producers increase their product per deal count. That’s been the case for Wisconsin-based Heiser Automotive Group. For the past three years, the group has placed one-year or 15,000 miles of complimentary maintenance on the hoods of its pre-owned inventory. The group also provides buyers with a $250 coupon they can use toward the purchase of a new vehicle if all maintenance is performed at one of its five locations.
Business Manager Lis Arndorfer-Mess, who operates out of the group’s Toyota location, says the goal is to funnel customers to the service department, which is charged $95 for each complimentary plan. Once customers reach her office, she can upsell them on three coverage options: two years or 25,000 miles, three years or 40,000 miles, or up to four years or 55,000 miles.
Licking Their Chops
Where the competition is really brewing, however, is in the high-mileage space. GWC Warranty, for instance, has been charting used-vehicle supplies since pre-owned sales collapsed in ’08 and ’09. And based on his company’s tracking, the industry should see a 6% to 7% increase over the next five years in what Glander calls the sweet spot for used cars: five- to seven-year-old vehicles with between 50,000 and 125,000 miles behind them.
“You saw it in Q4  and again in January — big increases in used-vehicle sales at independent dealers. And that correlates perfectly with the pricing situation that you’re seeing out there, which is exciting to us,” he says. “We play very well in the used-vehicle space, and we are sort of licking our chops at what our dealers are going to be able to do over the next few years.”
The firm has also extended mileage bands on its service contracts — up to 200,000 miles in some cases. It also offers exclusionary coverage that mimics factory warranty coverage, as well as stated component coverage.
But it’s the company’s CPO program Glander is most excited about. He says GWC, which is recognized by Motor Trend as a Recommended Best Buy for Independent Dealers, revamped its program several years ago, adding point-of-sale materials so its independent dealer customers could brand their lots. The program now has five times the number of dealers using it than before the revamp, Glander says.
Jimmy Atkinson, COO of AUL Corp., reported a similar pickup in the company’s CPO program when he spoke to F&I and Showroom in June 2014. “The leader in [CPO programs] is obviously the OEMs, because the BMW dealer or the Lexus dealer wants to have the manufacturer certified program,” he said at the time. “But we’ve seen a lot of dealers who want to do their own or take their non-factory cars and certify them in a different way, and we’ve experienced significant growth over the last few years as a result.”
Atkinson also reported growth in the company’s standard used-vehicle program, which offers terms that go up to five years or 100,000 miles. “It’s a lower price product,” Atkinson said. “It’s got some lower aggregates on it, but it fits a price point where lenders only allow so much on a loan, and it can fit into that spot where you couldn’t sell a more expensive service contract.”
At Industry Summit 2014, executives with The Warranty Group, GSFSGroup and Protective Asset Protection also talked about how improved vehicle quality has allowed them to extend mileage eligibility and coverage of their long-term limited warranty programs. EFG Companies also came out with Power X2 that year, a program that doubles the factory warranty’s powertrain protection and allows dealers to upsell additional coverage.
As an agent, Tuscan’s advice to his dealers is to always look outside of factory CPO programs. He understands that luxury stores don’t have a choice because customers demand the factory program, but he says the costs associated with such programs tend to eat into used-vehicle profits.
“My opinion is to always keep manufacturer involvement in that department out as much as possible,” he says. “But anytime a dealer is going to prepare for decreased or compressed profits, he should really consider doing his own certified program.”
Where Tuscan sees the biggest opportunity is in the affordable pre-owned market — Class One Asian and domestic makes that retail for $8,000 to $12,000. He says most quality franchised dealers keep about 30 to 40 of those vehicles on the lot and average between $1,200 and $1,300 in profit per unit sold. The problem on the F&I side, he says, is that most F&I producers don’t feel comfortable selling $3,000 to $3,500 powertrain plans with limited coverage.
In January, Tri-Pac released “30/30 Affordable,” a service contract offering new-vehicle-like coverage for 30 months or 30,000 miles on vehicles with up to 150,000 miles on the odometer. Covered are items like door handles, door hinges, seals and gaskets, and even sport utility and truck packages. The program also offers additional coverage for enhanced electrical, and includes a $300 to $500 cost share reduction. The retail cost: $2,000.
“We did an actual study of 25 years of performance of these Class One Asians and domestics, and we found a sweet spot: 30 months, 30,000 miles,” he says, noting the plan is being underwritten by AmTrust, with Warrantech servicing as the claims administrator. “And because we eliminated the risk associated with high-end and exotic vehicles, we reduced the exposure to the underwriter to provide comprehensive coverage at an affordable price for both F&I producers and the consumers.
“Yes, the customer is buying a little bit more into the claim with a $300 or $500 cost share reduction, but a consumer’s average deductible on comprehensives and collision is $500 to $750,” he adds.
The Road Ahead
According to the NADA Used Car Guide, incentive spending increased 13.2% from a year ago to $3,035 per unit in February, with the U.S. Big Three, Toyota, Nissan, BMW, Audi and Volkswagen all showing increases. But not all nameplates opened up their wallets, with Honda, Mercedes-Benz and Subaru spending less per unit.
February also saw car trade-in values outpace truck values for the first time in 10 months, with values rising 1% for cars vs. a 0.2% decrease in truck values. The month also saw the NADA Used Car Guide’s seasonally adjusted used-vehicle price index decline by 3% from January to 118.9, the largest decline recorded for any month since 2009.
Citing its new-vehicle sales forecast of 17.6 million units, the resulting high volume of trade activities and the high volume of lease returns, Black Book and Fitch Ratings predicted that overall depreciation in 2016 will crest above 14% for the first time in five years. And while that’s still at the lower end of the pre-recession range of between 15% and 18%, the firms warned that the state of the wholesale vehicle market will bear intense scrutiny in the year ahead.
February also saw the Manheim Used Vehicle Value Index decline 1.4% from a year ago to 123.3, as wholesale used-vehicle prices fell at their fastest pace in more than three years. The firm also reported steady but unspectacular new-vehicle sales in February, noting that, on a three-month moving average basis, the seasonally adjusted annual rate is plateauing despite incentive spending and fleet deliveries increasing at a double-digit clip during the first two months of 2016.
Melinda Zabritski, senior director of automotive credit for Experian Automotive, says the trends are playing right into what she saw in the auto finance arena during 2015’s end-of-year quarter: Credit scores flattened out for new-vehicle financing — a sign that prime consumers are beginning to shift to the used market. In fact, used-vehicle loans accounted for 62.8% of all vehicles financed during the period. And she believes banks and credit unions are especially excited to see prime customers moving to the pre-owned market.
“People shop for vehicles largely based on monthly price, and right now, average dollar amounts for new-vehicle loans are soaring,” she says. “In order to stay within their budget goals, we have seen that more consumers — even those within the prime and superprime risk categories — are turning to leasing and used vehicles as cost-effective alternatives to buying new.”
GWC Warranty’s Glander also doesn’t think demand for used vehicles will be a problem. “I look at what is on independent dealers’ lots,” he says. “And most will tell you they would buy significantly more cars at auction tomorrow, and could sell those cars tomorrow if they were available at a reasonable price. So as the price falls, our dealers will snap those cars up.”