Stormy Seas in Special Finance

Oh, my! What a first quarter it has been in the special finance industry! To be certain, the strong SF dealers are still hitting their stride and while it may not be business as usual, it is certainly business nearly-as-profitable. For most, it has been a sea of constant change – mostly for the worse.

I have always said that the bank and finance company climate is like looking at the sea: you have high tides and low tides; sometimes you are on top of the wave and sometimes you are in its trough. I guess I never mentioned a tsunami?

The faltering U.S. economy, led by the meltdown in subprime mortgages, has sent forth what seems to be a relentless barrage of bad news, creating more volatility than I think I have ever seen in the special finance sector in the 18-plus years I have been involved in the industry. The climate seems to change daily as many of the traditional market leaders appear to be reluctant to hold that title. As I write this, the April issue of our sister publication, Auto Dealer Monthly, has just made it to dealerships. In it were the 2008 Dealers’ Choice Awards. Dealer sentiment concerning subprime finance sources has changed so markedly that if ballots were cast today the results would look nothing like those just released in print.

Whether due to the inability to raise capital on Wall Street, faltering collections spurred on by doubling mortgage rates, or layoffs created by the economic slowdown, many of the “big dogs” have crept back onto the porch. Dealers are receiving termination notices in record numbers. Finance companies are changing their financing terms by increasing interest rates and fees and lowering advances. Additionally, opportunities for the lower-tier credit spectrum customers – those ranging from 475 to 520 credit scores – have been reduced substantially.

The market has been so volatile that one finance company which was aware of a strong competitor looking to Wall Street for a $300 million securitization in order to raise capital to loan out - and was openly rooting for them to succeed. They felt that a successful securitization of that amount would bolster everyone’s confidence in the SF market and thus bring about some stability. Of course if it went the other direction, it would certainly portend signals of even more cuts and corrections.

What does the landscape look like today? Based on the massive number of responses to a questionnaire I sent to my network of 4000-plus SF dealer contacts, the overwhelming majority have received a termination letter or, at minimum, a warning letter from at least one finance company stating that the dealer may no longer submit business to them.

Which finance companies are involved with the terminations? By the responses, the three companies that have had the most significant impact are CPS, HSBC and Capital One, all apparently for different reasons.

I had reported in months past that CPS had become very focused on company efficiency. Without depositors, CPS must look outside for capital, which most often means securitization. With the word “subprime” being synonymous with “plague” on Wall Street, their operations must be able to stand up under the most stringent scrutiny. With significant costs being assigned to every application, Look-to-Book (LTB) or Approve-to-Fund (ATF) for non-computer scored paper has once again become key.

While at the NADA convention, CPS officials stated that they were indeed terminating dealers for LTB; however, in cases where an appeal merited closer look, they were reinstating some dealers, but those dealers would not be able to submit applications over DealerTrack (which also brings additional cost).

On a side note, in the same questionnaire that I mentioned above, dealers singled out CPS as the one finance company with which it has become significantly more difficult to get deal packages funded timely.

It appears that CPS has been the most active with selected nationwide dealer terminations. While not having been able to verify it, I have heard from multiple sources that as many as one-third of CPS’s dealer body has been terminated. They certainly do not have that honor cornered, however, as dealers reported having received termination notices from 15 different finance companies or banks (a few prime) in the past 90 days.

HSBC has also been very active in terminating dealer relationships. On Monday, March 17, dealers in 10 states and the HSBC employees who served them began receiving notices of termination. (See accompanying article on page 7) This move appears to have been made to fortify operations and was seemingly based on how loan portfolios within entire states were performing, combined with particular economic issues driving business within those states. Business in the other 37 states appears to be unaffected.

Another widespread termination was to take effect on April 1 as Capital One apparently notified its entire independent dealer base that it would discontinue serving that market. This was particularly disappointing for the strong independent dealers who had lobbied for so long to be able to do business with one of the major market leaders. No official word was given, but it can be assumed that portfolio performance had to be the factor.

Where does it all shake out? I, for one, feel you must be very proactive. Strong relationships count (usually) and they aren’t always measured by deal volume. If I am a dealer who wants to stay ahead of the curve and not be surprised by a Dear John letter, I would make it a point to talk with the finance company representatives, and likely their bosses and their bosses’ bosses. I would maintain a dialogue around what the finance companies and banks are currently looking for in a relationship (and with many companies, only the regional managers or higher may really know that). I would also want to know how my book of business is performing in relation to state and national averages. What are my LTB- or ATF-to-funding ratios like? How do they compare to what the companies are looking for? Additionally, I would want to make sure that my SF manager fully understands what type of deals the finance companies are looking for – and what they aren’t – so they don’t needlessly waste a company’s time and money.

This is also a time to be nimble in your inventory. This is not something that you can change overnight. If you are carrying more than a 30-day supply of SF inventory, you will likely pay the price. As finance company programs and terms change, so does the inventory needed to put deals together. I would err on the side of having too little inventory (as you can always purchase it easier than you can get rid of it) and would buy less expensive vehicles rather than more expensive ones. Nothing helps make car deals like inventory owned below average trade – way below. As the credit grade drops – which it has and will likely keep doing – inventory will either make or break your ability to put car deals together.

Finally, don’t assume the market is dead. That absolutely is not the case. Dealers are widely reporting that for some finance companies, while rates or fees may have ticked up a bit, the same deals that have always been deals, still are. Dealer comments to me about Chase Custom and Wachovia were very favorable. Banco Santandere, the 12th largest bank in the world by market capitalization, now owns Drive Financial and has stated that they are determined to grow their U.S. market share. Westlake Financial’s president Don Hankey, in discussing their position, communicated to me in an e-mail, “…as a matter of fact, we are adding to our sales force and looking for more business.”

Special finance isn’t dead. It’s not even dying. It is going to be an increased challenge in 2008, and likely for part of 2009. As I told one dealer just this morning, as dark as the clouds are now, there will be a brighter future. Unfortunately, for the citizens of this fine nation, the mortgage mess is creating a whole new niche of sub-prime credit customers that will need to be serviced. Eventually the finance institutions will stabilize and the pendulum will swing the other direction. Now is the time to have a solid plan and the patience and discipline to see it through.

Until next month,
Good Selling!