z-FINANCING THE AUTOMOTIVE CONSUMER
GeneralAuthor :
Direct Sellers Association 
Since 1954, the DSA has been our nation's trade association for direct selling companies that manufacture and distribute goods and services away from a fixed retail location – through independent sales contractors (ISCs).
There is a lot of noise in the market about financing the automotive consumer. Most believe that there is a credit crisis and that consumers are not able to finance a vehicle. Our research shows different. It isn't that there isn't credit available ... it is. There are a number of other credit related problems but credit availability for consumers to acquire a vehicle isn't necessarily one of them. If it is a problem it is a manageable problem. Other issues cloud this whole area and create a fair amount of misinformation.
The first problem is that lending practices have come back to reality and most lending is now at market rates rather than subsidized rates. The captive finance companies have over the last decade plus offered subsidized interest rates as an incentive for consumers to buy their vehicles. In essence losing money on these finance instruments. They would do this by buying down the interest rate to below par and get away with it because the profit in the new vehicle sale was enough to off-set these lower interest rates. But in today's very lean auto world the OEMs are struggling to find the money to subsidize vehicle loans and or leases and therefore have had to cut back on these prime minus loans and leases. When they are forced to pay market rates some consumers are priced out of the market and therefore complain that they can't get financing. This however is a misrepresentation. It isn't that they can't get financing ... they just can't get financing at below prime rates. Criticizing the financial industry for using sound lending practices would seem to be misplaced.
The second problem is a tightening of credit scoring. But this is also not well understood. For many years less credit worthy customers could get credit especially with captive finance companies and especially with leases because of the willingness of these financial institutions to lower credit scores. Indeed some captive finance companies were very guilty of this practice and used it quite extensively to build sales volumes. The credit market has come back to proper and therefore tighter credit scoring and this has resulting in a cut back in vehicle lending. But can you blame any financial institution for being prudent with their credit scoring? Indeed a strong case can be made that it is in the best interest of most consumers to be put on a tight leash. Look what happened in the US housing market with subprime mortgages and the use of 'liar' loans.
So it isn't a credit availability issue at all. There is plenty of credit available but consumers have to pay market rates and be credit worthy. Two very good lending principles that should be encouraged not criticized.
The third is the problems in the leasing market. Leasing rates have fallen off dramatically in Canada the last six months. By the summer leasing was about 45 percent of the market and this has fallen to about 15 percent of the market. But this also is not an availability of credit issue. It is a collapse of the market for 'securitizing' leases ( and loans to a degree ). For those who don't understand 'securitization' a substitute word for 'securitization' would be 'monetization' .. essentially converting a lease or loan portfolio into cash by selling these portfolios to investors. The issue here is the Asset Backed Commercial Paper (ABCP) market. You have read a lot about the trillions that have been lost globally due to the collapse of the subprime mortgage market. These subprime mortgages were an integral part of the ABCP market and when they cratered the entire ABCP market cratered. Leases are asset backed securities and most leasing companies today have little to no ability to securitize their lease portfolios and therefore have to cut back on leasing and in the process force consumers into the CFC market ( ie: a loan) and then the previous issues become a problem.
Let me explain why securitization is an issue. An OEM might lease 10,000 vehicles at an average cost of $35K to create a $350 million dollar portfolio. They have to borrow this money in order to commit to these leases. They then would lever off this portfolio by securitizing it and in the process create another pool of money in which to do additional leasing. They don't have to borrow any more money to get this levering effect. It does cost them money to sell these portfolios but they are then able to book more leases and access the profits from these leases and these vehicle sales. But if you can securitize the portfolio an OEM would have to borrow another $350 million to lease another 10,000 vehicles. In the current market this is difficult to do. So they can't find the financing to do more leasing and they can't securitize their leasing portfolio so they are restricted to how much more leasing they can do. They have some cash flow from consumers repaying leases booked over the previous years so they can do some leasing but minimal. This backing up of the ABCP market therefore reduces leasing in Canada from the mid 40 percent level to the mid teens level where it is at today.
The fourth issue relates to tying all these issues together. When a consumer can't get a lease they are forced to get a loan. But these loans are now are market rates and a consumer has to be credit worthy. Loans are actually cheaper ( less cheaper ) for a consumer but they do require a higher monthly payment. In this respect one could argue that the forcing of consumers into a loan versus a lease is actually better for the consumer from a sound financial planning perspective.
How can a loan be cheaper when the monthly payment is higher? Well the rule of thumb I use is that interest carrying costs on a lease are about a $100 a month ( $35 K vehicle) higher than on a loan. Think about the last month payment on a loan versus a lease. With a loan interest is charged on few hundred dollars. On a lease interest is charged on the remaining residual value which is usually about 30 to 40 percent of the original MSRP of the vehicle. Obviously the interest on the last payment of a lease would be radically higher than on a loan. Calculate this across all 48 months and it averages about a hundred dollars a month. The lease's monthly payment is lower because with a lease you don't have to pay back all of the principal owed on the vehicle which saves the consumer about $200 per month. Factor in the higher interest payments and the consumer pays about $100 a month less on a lease than a loan. But they don't own the vehicle at the end of the lease which is a huge disadvantage and they pay much higher interest payments through the life of a lease.
I attach our preliminary estimates for the automotive consumer and fleet lending market for 2008. Total loans and leases booked fell to $61.6 billion in 2008. A number of reasons behind this. First the market was down slightly with about 1 percent fewer vehicles purchase new and about 0.4 percent used vehicle purchases. Second with all the incentive money and lower msrp's in the market the average transaction price was about 2 to 3 percent lower. Third the market moved further down scale with entry level vehicles accounting for almost 60 percent of retail consumer purchases and this pushes down the average transaction price. And Fourth we found that consumer have migrated back slight to more cash versus borrowing or leasing. This is likely because of all the stuff I just talked about.
The new vehicle leasing market fell from $18.8 billion to only $13.7 billion a massive decline which as discussed is because of the freezing of the ABCP markets. New vehicle loans picked up most but not all of this decline increasing to $23.6 billion from $19.9 billion. Use vehicle financing also declined to $18.3 billion but almost all of this was due to lower prices as residual values were very lean through most of 2008. And finally fleet financing declined to $6.0 billion and this was all due to the decline in fleet sales which dropped to their lowest level in two decades. The bad economy really hurt fleet sales as most companies extended ownership of their fleet vehicles and in this way reduced their needs for additional fleet vehicles.
The first problem is that lending practices have come back to reality and most lending is now at market rates rather than subsidized rates. The captive finance companies have over the last decade plus offered subsidized interest rates as an incentive for consumers to buy their vehicles. In essence losing money on these finance instruments. They would do this by buying down the interest rate to below par and get away with it because the profit in the new vehicle sale was enough to off-set these lower interest rates. But in today's very lean auto world the OEMs are struggling to find the money to subsidize vehicle loans and or leases and therefore have had to cut back on these prime minus loans and leases. When they are forced to pay market rates some consumers are priced out of the market and therefore complain that they can't get financing. This however is a misrepresentation. It isn't that they can't get financing ... they just can't get financing at below prime rates. Criticizing the financial industry for using sound lending practices would seem to be misplaced.
The second problem is a tightening of credit scoring. But this is also not well understood. For many years less credit worthy customers could get credit especially with captive finance companies and especially with leases because of the willingness of these financial institutions to lower credit scores. Indeed some captive finance companies were very guilty of this practice and used it quite extensively to build sales volumes. The credit market has come back to proper and therefore tighter credit scoring and this has resulting in a cut back in vehicle lending. But can you blame any financial institution for being prudent with their credit scoring? Indeed a strong case can be made that it is in the best interest of most consumers to be put on a tight leash. Look what happened in the US housing market with subprime mortgages and the use of 'liar' loans.
So it isn't a credit availability issue at all. There is plenty of credit available but consumers have to pay market rates and be credit worthy. Two very good lending principles that should be encouraged not criticized.
The third is the problems in the leasing market. Leasing rates have fallen off dramatically in Canada the last six months. By the summer leasing was about 45 percent of the market and this has fallen to about 15 percent of the market. But this also is not an availability of credit issue. It is a collapse of the market for 'securitizing' leases ( and loans to a degree ). For those who don't understand 'securitization' a substitute word for 'securitization' would be 'monetization' .. essentially converting a lease or loan portfolio into cash by selling these portfolios to investors. The issue here is the Asset Backed Commercial Paper (ABCP) market. You have read a lot about the trillions that have been lost globally due to the collapse of the subprime mortgage market. These subprime mortgages were an integral part of the ABCP market and when they cratered the entire ABCP market cratered. Leases are asset backed securities and most leasing companies today have little to no ability to securitize their lease portfolios and therefore have to cut back on leasing and in the process force consumers into the CFC market ( ie: a loan) and then the previous issues become a problem.
Let me explain why securitization is an issue. An OEM might lease 10,000 vehicles at an average cost of $35K to create a $350 million dollar portfolio. They have to borrow this money in order to commit to these leases. They then would lever off this portfolio by securitizing it and in the process create another pool of money in which to do additional leasing. They don't have to borrow any more money to get this levering effect. It does cost them money to sell these portfolios but they are then able to book more leases and access the profits from these leases and these vehicle sales. But if you can securitize the portfolio an OEM would have to borrow another $350 million to lease another 10,000 vehicles. In the current market this is difficult to do. So they can't find the financing to do more leasing and they can't securitize their leasing portfolio so they are restricted to how much more leasing they can do. They have some cash flow from consumers repaying leases booked over the previous years so they can do some leasing but minimal. This backing up of the ABCP market therefore reduces leasing in Canada from the mid 40 percent level to the mid teens level where it is at today.
The fourth issue relates to tying all these issues together. When a consumer can't get a lease they are forced to get a loan. But these loans are now are market rates and a consumer has to be credit worthy. Loans are actually cheaper ( less cheaper ) for a consumer but they do require a higher monthly payment. In this respect one could argue that the forcing of consumers into a loan versus a lease is actually better for the consumer from a sound financial planning perspective.
How can a loan be cheaper when the monthly payment is higher? Well the rule of thumb I use is that interest carrying costs on a lease are about a $100 a month ( $35 K vehicle) higher than on a loan. Think about the last month payment on a loan versus a lease. With a loan interest is charged on few hundred dollars. On a lease interest is charged on the remaining residual value which is usually about 30 to 40 percent of the original MSRP of the vehicle. Obviously the interest on the last payment of a lease would be radically higher than on a loan. Calculate this across all 48 months and it averages about a hundred dollars a month. The lease's monthly payment is lower because with a lease you don't have to pay back all of the principal owed on the vehicle which saves the consumer about $200 per month. Factor in the higher interest payments and the consumer pays about $100 a month less on a lease than a loan. But they don't own the vehicle at the end of the lease which is a huge disadvantage and they pay much higher interest payments through the life of a lease.
I attach our preliminary estimates for the automotive consumer and fleet lending market for 2008. Total loans and leases booked fell to $61.6 billion in 2008. A number of reasons behind this. First the market was down slightly with about 1 percent fewer vehicles purchase new and about 0.4 percent used vehicle purchases. Second with all the incentive money and lower msrp's in the market the average transaction price was about 2 to 3 percent lower. Third the market moved further down scale with entry level vehicles accounting for almost 60 percent of retail consumer purchases and this pushes down the average transaction price. And Fourth we found that consumer have migrated back slight to more cash versus borrowing or leasing. This is likely because of all the stuff I just talked about.
The new vehicle leasing market fell from $18.8 billion to only $13.7 billion a massive decline which as discussed is because of the freezing of the ABCP markets. New vehicle loans picked up most but not all of this decline increasing to $23.6 billion from $19.9 billion. Use vehicle financing also declined to $18.3 billion but almost all of this was due to lower prices as residual values were very lean through most of 2008. And finally fleet financing declined to $6.0 billion and this was all due to the decline in fleet sales which dropped to their lowest level in two decades. The bad economy really hurt fleet sales as most companies extended ownership of their fleet vehicles and in this way reduced their needs for additional fleet vehicles.