The Subprime Swing

Many of the industry professionals’ describe the subprime auto finance industry as a pendulum constantly swinging back and forth. At one peak, the dealer has the significant advantage; at the opposite peak, the advantage is the finance companies’. Eventually, the pendulum will rest in the center until another chain of events sends it swinging wildly again.

Until late 2007, that pendulum had been at the dealer peak for quite some time, but it has begun to swing back rather quickly. The reason for the abrupt swing was due to many factors outside the automotive industry, but several inside the industry were certainly contributing factors. The competition among subprime finance companies became so fierce that underwriting standards diminished considerably. Industry professionals had to know this relaxed subprime financing climate couldn’t last forever.
As you could’ve guessed, the pendulum currently is closer to the finance company peak, but rest assured, it will gravitate back towards equilibrium.

The trouble with this pendulum analogy is that one can calculate exactly how long it will take an actual pendulum to sway from side to side, as well as when it’ll reach equilibrium. It’s quite a bit tougher to forecast the subprime auto finance industry. While gravity dictates the motion a pendulum, the market dictates the terms of subprime financing, and the market is not as predictable as gravity.

Many dealers and finance managers are having trouble keeping up with the opposite position of the pendulum. Recently, five major subprime finance companies shared information on their programs to help dealers understand the pendulum shift.

Chase Custom Finance
Chase Auto Finance’s Custom program has been serving the subprime market consistently for years, as proven by the company’s inclusion in the inaugural group of inductees to the Special Finance Hall of Fame [see page XX].

Mary Kay Bean, spokeswoman for Chase Auto Finance, said, “Chase works closely with dealers to match up the loan that works best for both the customer and the dealer.” Approvals are based on “customer stability, income and equity.” The company also continues to manage consumer affordability and equity, which she called, “critical in today’s market.”

Bean added that Chase has never exceeded a 72-month term on custom loans and is asking customers for larger down payments. She also said the program guidelines make particular types of vehicles ineligible, “including those for public or livery conveyance or commercial use.”

Dealers wanting specific information on Chase’s programs can find flyers and rate sheets on DealerTrack and RouteOne. Also, dealers can find more information on Chase’s new Web site www.ChaseDealer.com.

CitiFinancial Auto
As a national finance company and a member of Citigroup, CitiFinancial Auto does “business with 10,000 and 11,000 dealers in any particular quarter,” according to Kim Pulliam, senior vice president of marketing and business development for CitiFinancial Auto.

With a focus on subprime coupled with current economic conditions, CitiFinancial Auto has had to shift “focus a little bit to profitability and not just volume … which helps us weather this period of time, so that we can be as strong a lender as we can be today and then be there longer term for dealers,” said Pulliam.

“In the last 12 months, we’ve made some decisions that required us to discontinue doing business with some dealers, but it was a small percentage.” Many of the dealers Citi discontinued business with were signed up with the company, but CitiFinancial Auto really wasn’t “booking any material business them,” said Pulliam.

“Oftentimes, when economic environments worsen, so many lenders tighten up and dealers think that all the lenders just want the good deals—good deal being defined as clean credit. CitiFinancial Auto is still very focused [on the subprime sector] and we want to make sure dealers understand. We’ve made some recent minor adjustments to reinforce that we really want to see that subprime customer.” She added Citifinancial Auto’s “sweet spot” is in the middle of the low-600 to 500 FICO score range.

Pulliam feels that dealers value the fact that CitiFinancial Auto wants to take those mid- to lower-500 scores. While earlier in the year the company tightened up in that range, she said, “We have recently opened that back up allowing our underwriters and buyers to really take a look at those deals again because I think that’s really where we can add some value to dealers.”

Mind you, the company doesn’t focus on FICO scores alone; they also review potential dealers for payment-to-income ratio, but those are somewhat flexible. When setting advances for deals, the company considers the vehicle chosen and how it’s performing in today’s market. Some programs at Citi will allow for loan-to-values of up to about 140 percent, but that’s dependant on the credit quality of the customer and the collateral. “We do focus on being a lender that will be very competitive on loan-to-value, so dealers can sell the products they have and make an appropriate profit on the deals,” added Pulliam.

As for expected originations for the remainder of the year, CitiFinancial Auto is “looking to grow a little bit in the back half of 2008 as compared to where we were in the first half of the year because we see more opportunity in the environment … It’ll still be below 2007 levels,” said Pulliam. She cited the economic environment and slow vehicles sales as contributing factors to the company’s lower than anticipated originations in ‘08.

Auto decisioning is not a staple of CitiFinancial Auto’s program, but rehashing deals is. Pullium pointed out that only a very small percentage of the finance company’s decisions are automated and that dealers have the ability to negotiate on almost every transaction. “We really have an underwriter looking at almost every deal and a buyer negotiating almost every deal with the dealer.”

Currently, CitiFinancial Auto is signing new dealers up, but very selectively. Pulliam said it “makes sense” from an efficiency standpoint to sign up dealers, both independent and franchise, that move an appropriate amount of volume and have a subprime customer base with the right credit quality. For more information on CitiFinancial Auto, visit www.CitiFinancialAuto.com/dealer.asp.

Credit Acceptance
 “We believe we continue to be the only national provider of Guaranteed Credit Approval, and our program is becoming even more valuable to our dealer-partners as other subprime sources are exiting the market or sharply cutting origination levels,” said Brett Roberts, CEO of Credit Acceptance.

All deals are submitted through the company’s Credit Approval Processing Systems (CAPS), which provides a written credit approval in 30 seconds or less for the customer on every vehicle in the dealer's inventory, sorted by gross profit. Credit Acceptance offers dealers the ability to select from three programs—Portfolio, Purchase and Collections Only. It’s up to the dealer to choose which program to use with each customer, so the deal can be structured to be both affordable for the customer and profitable for the dealer.

Roberts said, “We approve a wide range of [loan-to-values] depending on the price point of the vehicle.” Additionally, while Credit Acceptance does not set a maximum or minimum amount to finance or require certain look-to-book or approved-to-funded ratios, it does limit payment-to-income at 25 percent.

While many companies are reducing 2008 origination expectations, Credit Acceptance experienced strong origination growth in the first quarter of 2008, according to Roberts, “due to a more favorable competitive environment, which we expect to continue during the latter part of 2008.”

Credit Acceptance is currently signing up new dealers—both franchise and independents. Roberts said, “We are looking for dealers that will be committed to our program, their partnership with our company and changing people’s lives by providing them an opportunity to re-establish their credit.” For more information on Credit Acceptance, visit www.CreditAcceptance.com.
 
Regional Acceptance Corporation
As a freestanding affiliate of BB&T Corporation (a financial holding company headquartered in Winston-Salem, N.C.), Regional Acceptance currently works with dealers in the subprime market in 26 states.

While the company, according to President Bill Jones, is “always proactively adjusting our score cutoffs in dealing with shifting default curves,” it has also become more “make and model specific with regard to what we’re willing to advance” in the last year.

“While the industry has generally used FICO scores under the 660 range to classify subprime customers, this approach is usually not comprehensive enough in general terms. There really isn’t an effective metric dealers may use in attempting to classify subprime applicants beyond the obvious policy decline areas that each specific lender typically employs. To improve upon this, we’ve developed proprietary scoring tools to help us identify more specific levels of subprime risk for subprime applicant profiles,” said Jones.

While FICO scores do factor into Regional’s underwriting decisions, the range of scores “depends on several other factors,” said Jones. Targeted loan-to-value also varies, depending on vehicle make and model. Regional Acceptance classifies collateral into three primary tiers, Premier, Select and Standard. There’s also an ineligible collateral category. Jones said, “Out overall LTV before back-end products averages around 100 percent of average wholesale value in the aggregate … Averages on our higher risk collateral classes run in the lower 90-percent range.”

Although amount-to-finance has no set restrictions at Regional Acceptance, Jones added, “Our average amount financed runs around $18,000 and we fund very few deals in excess of $30,000 or under $8,500.”
Additionally, Regional Acceptance does not require dealers to maintain certain look-to-book and/or approved-to-funded ratios, but the company does monitor look-to-book ratios.

When it comes to automation, approvals are never automated, but declines are. Jones said, “In general, we auto-decline more applications than are being reviewed manually by underwriters. This is simply a function of the higher risk nature of the business.”

For dealers looking for additional finance sources, Jones said Regional Acceptance “is always looking to establish new relationships with successful and reputable automobile dealers” (both independent and franchise). For more information on Regional Acceptance Corporation, visit www.RegionalAcceptance.com.

Westlake Financial Services
Los Angeles-based Westlake Financial Services hasn’t changed their programs too drastically in the past year. According to Ian Anderson, senior vice president of production, business strategy and analytics at Westlake, the company tightened up slightly in October 2007 and began paying more attention in the areas of advance and loan-to-value.

The company, which has been serving auto dealers and the subprime market for more than 20 years, has four programs available—Platinum, Preferred, Standard and Profit Builder. Through Westlake, dealers can serve a wide range of subprime customers—from near-prime to those who would normally have to go to a BHPH lot.

Anderson said, “We consider a subprime customer somewhere around 580 FICO and below.” The Platinum Program, which is for those customers who are near-prime, has a minimum FICO score of 635.

While Westlake doesn’t have set minimum FICO scores for the Preferred and Standard programs, there are some other parameters Westlake defines for its subprime programs. The Preferred Program has a minimum monthly payment of $225, requires at least 10 percent down, doesn’t allow for any open derogs, sets a minimum income of $1,500 per month, and requires two years on bureau or for customers to be a homeowner. The Standard Program only has one definitive requirement—a minimum payment of $170 per month. Car, income, credit and FICO scores are not set. The Profit Builder program is for those customers with severe credit issues who’d normally need BHPH financing.

Currently, Westlake’s targeted loan-to-value is “around 105 to 110 percent” according to Anderson, and the company’s highest LTV is 140 percent. In order to get 140 percent LTV on a deal, the vehicle selected is very important and the customer needs to have relatively good credit. Anderson gave the example of putting a good customer in a Camry as a deal that could warrant 140 percent LTV.

The maximum amount Westlake will finance is $25,000. While there is no minimum amount, Anderson offered, “Let’s say a guy wants to make three payments, financing only three grand. We’ll do it, but we won’t do $3,000 for 36 months.” It depends on the structure of the deal. The company also keeps an eye on payment-to-income ratios. Anderson said they like to keep customers’ payments between 12 and 15 percent of their income.

Ratios like look-to-book and approved-to-funded aren’t focused on by Westlake, which utilizes automated decisioning 100 percent of the time. Anderson did say that Westlake does keep an eye on turndown percentages; “We try to keep that around 20 to 25 percent, meaning if it goes too high, we’re doing something wrong.” He added that the company is currently receiving about 80,000 applications per month.

Lately, business has been good at Westlake. Anderson said it could possibly be a combination of other companies tightening up coupled with an increased subprime borrowing base. While many companies expect significantly lower origination totals in 2008 as compared to 2007, Westlake is not in that group. Anderson estimated the company’s total originations for 2008 to be about 5 percent more than its total originations in 2007.

Also on the rise at Westlake is dealer signups. Anderson said the company, which does business in 31 states, is signing up substantially more dealers than last year. For more information on Westlake Financial Services, visit www.WestlakeFinancial.com.

The Pendulum’s Return
While the industry may not know when the pendulum will swing back in the favor of the dealer (or at least hit equilibrium), that day will undoubtedly come. It’s all a matter of surviving until the next market shift.

The upside to all this—those finance companies and dealers that persevere through these tough times and ride that pendulum back to productivity will come out stronger and more stable than ever. Plus, the relationships between finance company and dealer will be stronger as well. With any luck, it won’t be too long before we’re talking about the latest pendulum swing in hindsight.