Primed for Subprime

Subprime isn't anymore. Nor is it all that in today's economy. Subprime lending, also called special financing, is riding a wave that has become a high dealer delivery and profits priority in nearly all markets, experts say. In the largest population areas, says AmeriCredit's Chief Operating Officer, S. Mark Floyd, it's advisable that franchised dealers set up dedicated special-finance centers surrounded

Subprime isn't “sub” anymore. Nor is it all that “special” in today's economy.

Subprime lending, also called special financing, is riding a wave that has become a high dealer delivery and profits priority in nearly all markets, experts say.

In the largest population areas, says AmeriCredit's Chief Operating Officer, S. Mark Floyd, “it's advisable that franchised dealers set up dedicated special-finance centers surrounded by vehicles for shoppers unable to qualify for prime loans.”

He explains, “These lots perform better in closing rates, profitability and sales than those where nonprime customers are co-mingled with prime shoppers at the dealerships.”

Such a center is operated by Brown Pontiac-Hyundai, a three-generation store in Toledo, OH, which has pioneered in setting up not only a special finance center but also a buy-here-pay-here lot across the street from its Pontiac-Hyundai and Mazda dealerships.

The Brown Pontiac Credit Center is described by its manager of the past five years, Rob Parish, as the “model of the future” for urban dealerships in manufacturing cities like Toledo.

He says, “Special finance has become a ‘must’ for dealerships. More and more of our longtime customers have fallen into non-prime credit ties through no fault of their own.

“There has to be a place to buy vehicles for loan rates they can qualify for, or the dealership will lose that shopper.”

His boss, Robb Brown, saw this coming six years ago and has now become the largest special-finance dealer in northwestern Ohio.

Addressing the credit outlook in late June, Ford Credit Chairman and CEO Michael Bannister asks, “What happens if interest rates rise and credit scores decline because of increasing adjustable rate mortgage payments?”

With 35% of home mortgages based on adjustable rates, Bannister implies the result could be a new wave of credit scores below the 640 score that separates nonprime from mid-prime and high prime.

AmeriCredit is positioned to handle the uptrend in nonprime applications, says Floyd, having emerged from a 2002-04 downspin that forced it to limit its loan originations to $750 million a year, reduce its staff and its dealer customer portfolio from 16,000-18,000 mostly franchised dealers to about 12,000 now.

“Half of our dealer customers run dedicated centers,” Floyd tells Ward's Dealer Business. “The number is going up steadily as dealers realize they need to treat even shoppers with credit issues as “prime” customers — good people with good incomes who've fallen on rough times because of divorce, layoff, recall to military service by the household breadwinner, past bankruptcy, whatever.”

AmeriCredit expected to post $1 billion in loan originations for the summer quarter, in line with the end of its self-imposed recovery ceiling and the rise in nonprime loan demand. It also has started to bolster its dealer customers, adding about 100 in the spring quarter.

At the Brown Pontiac Credit Center, 32-year-old Parish manages five salespeople who staff a six-day-a-week operation. About 90% of the center's inventory comes from Michigan and Ohio auto auctions.

“Trade-ins across the street are sold by the dealerships' used-car lots,” says Parish. “We cover all the bases, with the buy-here/pay-here store and running loans through the Brown-owned self-financing company a block away.”

Profits on special-finance cars are intentionally as high as possible. “We sell only 2001-2004 models,” he says. “No junkers, because most of the nonprime customers want newer wheels like they're used to.”

A 2001 Ford Taurus sedan with 27,000 miles and in decent shape, valued in the Black Book at $8,900 wholesale and the NADA book at $10,300, was purchased by Brown's buyer at auction for $8,500. It was priced for sale at $12,845 and financed at a special finance rate for $11,845 with $1,000 down.

Parish says, “That's a spread of $4,000. We specialize in special finance and always seek out the cars that will bring the highest profits — often higher than the per-vehicle yields across the street.

“Which means that a special-finance center can be a maximum profit producer at a stand-alone location with a dedicated inventory. I think we're on the cutting edge, because Toledo has experienced a lot of layoffs and shrinking businesses as a major auto supplier town to the Big Three.”

Like Brown's new-car stores, which also include Honda at a distant site and Mazda next to the Pontiac-Hyundai dealership point, F&I products are sold through a central F&I staff to special finance and buy-here/pay-here customers.

Average F&I selling prices for pre-owned vehicle buyers at Brown range from $1,200 to $1,800 for an extended service contract and average $495 for GAP (guaranteed auto protection) policies. Also available is credit life and health insurance, at $300 to $800 a year, and window etching at $300 to $500.

The last time Ward's visited the Brown's subprime lot, in 2001, it was selling 20-25 vehicles a month. That rate has doubled this year, says Parish, “thanks to a closing ratio of 80%, far above the average of 18%.”

Reasons for that impressive closing rate include a pre-approved credit acceptance for everyone with $1,000 down, Internet ads on the Brown website, a lot of direct mail and radio commercials and — bottom line — the fact that more buyers than ever before in the bi-state market need vehicles and can't get them any other way but through nonprime financing.

Another of Brown's loan sources, which have doubled from 10 to 20, is San Diego-based Household Auto Finance. Household has initiated three products for near-prime customers — “premier,” “standard,” and “BK” for recently-discharged bankruptcy participants.

Household has introduced a subprime-to-prime program, also used by several captive lenders, in which customers who meet their special-finance loan obligations over a specified period of time can be elevated to prime status and consequently get sharply reduced loan rates without the need for an additional application.

A growing player in the nonprime market, Household Auto Finance was integrated with the global investment bank, HSBC Holdings last year. Household has surpassed the 5,000 mark in the number of U.S. dealers handling its loans. Household is an issuer of the GM credit card and has initiated a special credit card for nonprime customers.

Household Auto Finance says it is one of the three largest independent providers of nonprime vehicle loans in the U.S.

Nuvell Credit President Tom Pritchard says the GM nonprime subsidiary, reflecting growth in applications for special-finance loans, has more than doubled it target for the number of GM vehicles it finances.

“While not lessening our focus on used vehicles,” Pritchard said, “we felt additional value could be provided to our GM dealers if we focused on assisting our dealers in their efforts to deliver more GM vehicles.”

Pritchard says minimal impact on the nonprime marketplace is anticipated by Nuvell as a result of any interest-rate increase.

A volatile segment of the financing business with a history of “ins and outs,” nonprime now is experiencing a rush of “ins.” The list includes, as posted on the Brown center's bulletin board: AmeriCredit, CapitalOne, Centrix, DRIVE, Household Auto Finance, Nicholas Friendly, Nuvell Credit, Regional Finance, Trans South, Triad, WFS, plus local banks and credit unions.

Brown's newest salesman, Chris Belanga, says that, if he has to, he'll call them all to arrange special financing for a customer.

“Some of them won't finance Oldsmobiles or Plymouths,” he says of the lenders. “But we'll try them all before losing a customer.”

Who is the subprime borrower?

There's no widely accepted definition of that person, say researchers Erik Heitfield of the Federal Reserve Board and Tarun Sabarwal of the University of Texas at Austin.

But in a study they say that generally subprime borrowers display a range of credit risk characteristics that may include one or more of the following:

  • Two or more 30-day delinquencies in the last 12 months, or one or more 60 day delinquencies in the past 24 months.
  • Judgment, foreclosure, repossession or charge off in the prior 24 months.
  • Bankruptcy in the last five years.
  • Relatively high default probability as evidenced by, for example, a credit bureau risk score (FICO) of 660 or below.
  • Debt service-to-income ratio of 50% or greater, or otherwise limited ability to cover family living expenses after deducting total monthly debt-service requirements from monthly income.

The researchers say: “Even when loans are priced fairly, subprime borrowers, who by and large have lower and more volatile income and fewer assets than prime borrowers, may have particular difficulty making regular debt payments during times of economic stress.”

They say increases in unemployment rates precede increases in default rates, indicating that default rates on subprime auto loans “are particularly sensitive to shocks to household liquidity.”

Their study indicates that lenders who charge the highest interest rates also experience the highest default rates.
with Steve Finlay

Ford Credit Ends Its Aggressive Days

By Steve Finlay

Ford Motor Credit Co. will continue to “buy a spread of the market,” says CEO Michael Bannister, explaining that the company will assume some non-prime credit risk in an effort to benefit its dealers and vehicle buyers.

But the Ford Motor Co. subsidiary's era of aggressive lending — which peaked in the late 1990s and early 2000 — is over.

“We bought too deeply before,” says Bannister, referring to the captive finance firm's losses because it bankrolled too many auto loans to people with risky credit. “We learned quickly not to do that.”

Bannister says Ford Credit will approve a loan to a vehicle buyer with a Fair Isaac and Co. (FICO) score of at least 620.

“But we're not going to get into the 550 business,” he says, referring to sub-prime levels.

A FICO score, which can range from 400 to more than 700 points for a sterling credit rating, is a snapshot of a consumer's credit worthiness based on various factors, including payment history, debt level and length of established credit.

“Our goal is to lend to people with the capacity to repay,” says Bannister, speaking at a J.D. Power & Associates' automotive roundtable in Dearborn, MI. “The other way is not a practice to replicate.”

A customer with a FICO score of 550 is a candidate for a buy-here, pay-here dealership, in which the dealer assumes the financial liability while maintaining “close control of the customer,” says Bannister.

Also addressing the roundtable audience, Tim Russi, president of Bank of America's Auto Group, describes his division as a prime non-captive lender with no “strategic need to buy below” a 620 FICO score.

“Subprime is a volatile business,” he says. “We don't want to enter markets we can't be in long-term or need to exit when the economy takes a down turn.”

Meanwhile, Russi says his group is striving to provide dealer clients and borrowers with a “customer experience” a la Starbucks, in part, to avoid the pitfalls of an industry trend towards commoditization.

“Clearly, we should be concerned with that because no one wants to be in a commodity market, competing just on price,” Russi says.

Bannister says challenges facing Ford Credit include lowering costs and increasing value, tougher lending regulations and mixed consumer confidence.

25% Credit Challenged

Special financing represents about 25% of U.S. credit customers. It's the fastest growing segment of the auto loan industry. It's a $200 billion industry.

Today's typical sub-prime customers are not reckless spendthrifts who run up debts through self-indulgent purchases of high-ticket items they don't really need.

It doesn't take much for regular people to suddenly become credit challenged.

Divorce drills down the most,” says Jim Hancock, vice president-marketing at Centrix Financial, a firm specializing in special finance.

Hancock cites another modern-day trend that can affect credit ratings: Bill collectors representing hospitals and assorted medical facilities, have become most aggressive. Their efforts can quickly push many people without medical insurance into sub-prime levels.

Hancock says Centrix recognizes such circumstances that are often beyond some people's control, no matter how financially responsible they try to be.

“We let people know that we'll work with them if they work with us,” he says.

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