It is February and I am writing this one day back from the 2013 NADA convention, which is one of three times each year I get to spend significant quality time with a large number of the top executives in the auto finance companies that support the Special Finance industry. In years past I have used NADA as the time to gauge the barometer of the lending industry, specifically in most recent years, trying to determine their appetite for the coming year in the subprime market along with the supply of capital to support it. (It wasn’t all that long ago when even if their appetite was strong, the capital just wasn’t available.)

This year’s talks were framed much differently. It would take someone that really hasn’t been paying attention to not realize the SF market is running wide open with gobs of money behind it, and has been for at least a year. Just before our annual SF Conference in Las Vegas last September I surveyed all the execs in the SF industry and learned their collective fear was that with capital running so freely that many companies had become overly aggressive and that someone (not themselves, of course) would push what I call the “Stupid Button,” which others would then follow, and ultimately cause a correction in the market, otherwise known as a downturn.

As always, I wanted to know how their respective companies were doing, and if they had seen anyone push the button yet. I also presented them with my own opinion of when I felt we would see the next downturn, and I wanted to get their take on it.

Basically, the collective story was all good news. While I can never divulge any confidential information disclosed to me, from a profitability and capital perspective, everyone is smiling. Every company that I spoke with was extremely happy with their books of business written in 2009, 2010 and 2011, which have performed at extraordinary levels. Meanwhile, the cost of money has been dirt cheap. Those that have long been established as banks have money that they are paying virtually no interest on to their depositors, while those that use securitizations and other methods to raise capital have found their costs to be very low. Combine excellent portfolio performance with cheap capital and you have phenomenal margins.

As a quick sidebar, many of these companies are also very big in the prime and near prime space. There the margins are razor thin. Even though the cost of funds is still very low, in prime, where many loans are being written in excess of 78 months, and to be competitive, interest rates must be in the mid to high 1% range, by the time you factor in loan servicing, the additional costs of CFPB compliance and any defaults at all, the margins are microscopic.

Add all this together and it is no wonder that everyone that I talked with was very, very bullish on the Special Finance market, and expects it to be strong through 2013.

That leads me to the other side, the “dark” side. When is it going to turn the other direction?

I have formulated my opinion on the following assumptions:

1) The cost of money is virtually nothing. It can only go one way. Up, and I am sure it will.
2) Underwriting, which tightened immensely in 2009 due to the lack of capital, produced phenomenal credit results from the 2009, 2010, and 2011 portfolios. We don’t know yet about 2012, but all execs admit they were very aggressive in their underwriting in 2012 and 2013.
3) Discounts/fees charged by finance companies have dropped significantly. Good for dealers, not so good for finance companies.
3) The supply of used cars since 2009’s Cash for Clunkers and a host of other reasons remained very tight from 2009 to mid-2012. This produced high used car values and helped minimize losses from defaults. Used car levels are increasing and this past fall we saw used car prices soften for the first time since 2008.
4) Historically, since I became involved with SF in 1989, there have been industry corrections (downturns) every five to six years.

Given those assumptions, I feel that by mid-2014 there will be an increase in the cost of money. I believe that the aggressiveness exhibited by many of the companies will result in the deterioration of portfolio performance, significantly in some cases. I believe that the supply of used vehicles will normalize back to pre-2009 and the prices will soften even more. I believe that a few of the companies will have a significant hiccup when all of these factors come together and I believe that will be in mid-2014. When that happens, we will experience the first correction/downturn we would have had in about 5 ½ years, but it won’t be anywhere near what happened in mid-2008 and more like what happened in 2002-2003. This is what I put forth to all the execs that I spoke with. My question then was, am I nuts.

It seems like I may not be that far off course. While a couple really acted like they hadn’t thought about it, their reaction was that it would not surprise them. One said, definitely not, then backed up and said, well, “Certainly not us, but you know, I could see it for a couple of the others.” Overall, the consensus was that it certainly seems plausible. Finally, to a person, no exec feels like when the inevitable correction does occur that it will come anywhere close to approximating what we saw in 2008.

All of this certainly makes me feel very, very bullish about Special Finance for the balance of 2013 and through the first quarter (tax season) of 2014. What that means is that not only is the SF business back, it is as strong as ever. Finally, remembering that the average credit score for a consumer financing a used vehicle is 659, or at least 21 points below prime credit, any dealer not participating in the subprime credit market right now might as well be walking their customers across or down the street straight to their competition.

The good news is that if you have read this article all the way to this point, you are probably one of the 20% that are active in the SF market. If you don’t feel like you are hitting on all cylinders just yet, there are many ways to remedy it. Remember there are years of my “how-tos” detailed in the archives of Auto Dealer Monthly online. If you’re interested in attending one of our monthly one-day SF training schools, click here. Whichever your choice, as I always say, “Make hay while the sun is shining,” and let me assure you that right now, you really need your sunscreen!

Until next month,
Great selling!
GG