Together with:

Today’s topics:

• 💵 What’s happening in auto lending?

• 🤔 Have you heard of used car leasing

• 🚗 Shoppers Corner: should shoppers care about LTV?

Reading time: ~3.5 min

💵 What’s happening in auto lending?

Let’s take a look at what’s going on in the world of auto finance. I’ve posted a bunch about big players that recently exited (whether fully or partially) the auto lending business:

Some exit just the “floor plan” lending (aka inventory lines of credit), while others exit the retail side as well. Lenders have to deal with increasing delinquencies, used car pricing volatility, higher interest rates and worsening spreads. Most lenders are being cautious across their entire portfolios that include floor plan and consumer loans.

The net result? Fewer auto loan approvals.

Rate of auto loan applications and rejections:

At the same time, the void left by lenders who are leaving the industry is being filled by banks who see opportunities to increase their auto portfolios. Significantly improved vehicle availability means more business for banks, driven by dealers’ need to finance new inventory. These banks offer credit to finance M&A, install EV infrastructure and floorplan inventory.

Speaking of M&A, the consolidation of dealers into larger groups is mirrored by a similar trend in banking. Automotive News recently reported that in the first half of 2023 buy/sell activity increased 26% compared to the first half of 2022, with 418 completed transactions.

The booming M&A activity in car dealerships boosted acquisitions among banks that work in the auto industry.

High interest rates and high prices are leading consumers to search for affordability. More and more shoppers are turning back to leases or finding ways to pay cash to avoid paying interest on their car purchase. Combined, lease and cash deals are approaching 40% of all car deals, up from 30% in early 2022. On the surface, it is a good trend because it enables consumers to purchase cars despite challenges in credit availability...

But as usual, there are multiple forces and second/third order effects:

• First, consumers who are already stretched thin or are getting into short-term contracts are not likely to purchase ancillary products, such as service contracts.

• Second: the cost of labor and parts is up, making it easier for dealerships to sell service contracts… A single visit to the repair shop could pay for the cost of the extended warranty.

• Third: the increased cost of labor and parts increases the cost of warranty claims, and presents challenges in working with underwriting partners that may not be able to pay out claims.

In summary, dealerships’ F&I profit centers are facing headwinds and need to innovate by offering relevant products that boost the PVR (Per Vehicle Retail), one of the important metrics for measuring dealerships’ financial performance. One of such products is CPO programs. CPO sales have been hot lately, as consumers are looking for cost-effective alternatives to sky-high new car prices. Traditionally, CPO programs have been offered only by franchised dealerships, but now independent dealerships are partnering with insurers to offer products that are comparable to manufacturers-backed programs, providing a level of confidence for shoppers.

And let’s not forget…

October is going to bring another surprise: student loan payment resumption. Student loan interest will resume accruing in Sept, and payments will be due starting in October.

Approximately 90%+ of student loans had no scheduled monthly payment as of Q1, 2023, representing about 40 million borrowers.

The Federal Reserve reports that 18% of auto loan borrowers have at least 1 student loan in forbearance. The resumed student loan payment for those consumers could be $245 on average or $160 as a median. This puts further stress on already high consumer monthly obligations that have reached over $2K/month.

This brings us back to the topic of affordability…

🤔 Have you heard of used car leasing?

The “new” trend: used car leases. An ancient proverb says: “Everything new is well-forgotten old”. Here’s some history. Used car lease-like programs, that are actually balloon financing, emerged 20+ years ago as a way for credit unions to compete with captive lenders. Programs were offered on late model used cars, with the payment calculated based on a 2-5 year term, with a large balloon payment due at the end. At the end of the term, consumers had the option to return the vehicle or keep it and pay off the loan. The balloon payment was based on the residual value, which was provided by Automotive Leasing Guide (ALG), the company later acquired by Edmunds. Initially these lease alternative programs had a good adoption by consumers, however most of them failed shortly thereafter.

Here’s why things turned sour: as consumers had started returning vehicles to lenders, lenders had no clue how to dispose of these cars. On top of that, at the time, residual values were not very accurate, and many lenders ended up with overvalued “metal” sitting in their parking lots. They had to take large losses and most programs have been shut down.

Some manufacturers’ finance arms even tried to offer similar programs through the years.

Now, we hear about the return of used car leasing. Why now, you ask? Few reasons.

First, new and used car prices are sky high. Combined with high interest rates, basic reliable transportation has become unaffordable.

Second, today much more precise, market-specific data is available for accurate prediction of residual values.

Third, today there are plenty of seamless vehicle disposal options through a variety of online buyers, with valuation tools, shipping arrangements, inspections, etc.

Lastly, vehicles are becoming more reliable overall and can easily last through two owners (or 6+ years), without major repairs.

So why not lease a 3-year old, loaded, certified Lexus or BMW at a monthly payment that is up to 40% lower than a comparable new vehicle? Why not drive a 3-year-old true luxury car at the same monthly payment as a new base model?

Consumers benefit from lower monthly payments, having options to keep or sell the vehicle at the end of the term, while driving a new car every few years. Dealerships sell more used cars by offering lower payments and an alternative to traditional financing. Financial institutions benefit by writing more loans with higher yields while being protected from the downside by offering safer shorter terms and lower payments that reduce delinquencies.

Is this a true win-win-win scenario?

Together with RunBuggy

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It's not just about transportation; it's about providing a holistic solution that integrates technology, an open transporter network, integrated communication, and easy-to-use digital tools. This results in a seamless, efficient, and modern vehicle transportation experience for shippers and transporters alike.

🚗 Shopper Corner: should shoppers care about Loan to Value (LTV)?

If you want your financing approved at a lower APR, prepare to bring a sizable downpayment. In the times of increasing defaults, lenders are mitigating their risks by tightening their credit policies and most are lowering loan-to-value (LTV) ratios. Reminder: Loan-to-value (LTV) ratio is your vehicle's value in comparison to how much you need to borrow.

For example, a fairly typical LTV ratio of 115% means the maximum amount financed for a $30,000 car would be $34,500.

This seems like enough cushion on the surface, but $30K is not the real out-of-the-door price. You need to budget for taxes and fees, which can add up to 10% to the selling price in some areas of the country.

Then consider the case when a vehicle’s book value – the value banks use to underwrite the loan – is significantly less than the selling price. This happens when dealerships add markup to popular models with limited availability, such as Toyota Sienna.

Another scenario is when a consumer has some negative equity in their current vehicle because they purchased it at the peak of the market and took the long-term financing. LTV limits the negative equity that can be rolled into the new loan, requiring consumers to produce a larger down payment.

Finally, LTV limits how many additional products can be added into the loan, such as extended warranties, service contracts, vehicle accessories, etc.

Bottom line, when shopping for a car, don’t forget to estimate the true out-of-the-door price and budget for taxes and fees to avoid unpleasant surprises at the time of closing the deal.

Thank you for joining me again here on the CarDealershipGuy newsletter. See you soon!

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-CarDealershipGuy