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There Is No Auto Credit Crisis

Auto sales are down. But it's not because Americans can't get financing. It's because they aren't shopping for cars

I"You have to just about be walking on water to get financed…but even with our prime customers, banks are looking for a reason to say no."—AutoNation CEO Michael Jackson, The Wall Street Journal, October 2008

I have never figured out why the media use AutoNation (AN) Chief Executive Mike Jackson as an authoritative source on anything happening in the automobile industry. Reporters must think that because AutoNation owns hundreds of dealerships, it must be the most successful at automotive retailing. This is a case of confusing quantity with quality. As for Jackson's view that banks are looking for ways to not finance new cars for prime customers, I just can't find that it has any basis in reality.

Consider this: AutoNation's Bankston Ford of Grapevine (in the Dallas-Fort Worth area) sold only 60 new Fords (F) in September. However, a mile up Highway 121 at Tom Durant's Classic Chevrolet, the agency retailed 439 Chevrolets. Far from having to walk on water, Classic's customers found it relatively easy to get financing on a new Chevy. In fact, contrary to the market downturn, Classic Chevrolet sold more new vehicles this September than it did a year ago.

Of course, that's a "Chevy to Ford" comparison, so let's use AutoNation's Bankston Chevrolet, 10 miles from Classic. That store delivered just 85 new Chevys last month. Both Classic and Bankston Chevrolet use GMAC to finance their vehicles and share the same demographic customer, yet AutoNation's store came up 354 sales behind Classic's. That suggests that it was not any "marketwide credit lockup" that determined which dealer did or did not sell cars in September.

As for creditworthiness, Equifax (EFX) gives Dallas-Fort Worth the lowest average credit score of any major metropolitan area in America, a collective Beacon credit rating of 600 (that's worse than Detroit's). Yet this year, Dallas-Fort Worth continues to be one of the best markets for new car sales.

Six Truths

September's new car sales were horrendous, but this wasn't primarily because any credit lockup was keeping people with moderate or better credit ratings from obtaining loans. Here are six truths about what happened to auto sales in September:

1. Truth: Reporters nationwide found many dealerships complaining they had customers they couldn't get financing for but who could have obtained loans earlier this year. Greater truth: If you asked finance managers at the same stores at the end of any month, in years good or bad, they will tell you about the "declined" stack of folders—10 to 25 customers they could not obtain loans for, who they were certain should have been financed. So, suggesting that the inability to get "everyone" a new car loan was the cause of last month's downturn in the market is foolish. Rene Isip, owner of Toyota of Lewisville, Tex., and Tom Ryan of Metroplex Toyota in Dallas both said they obtained loans for people with credit Beacon scores of 610 to 620, or the mid-range of fair credit. Those loans require more money down, as they always have, but are available. Not having flawless credit was not a factor at Toyota, even though that brand's sales fell with the overall market. Meador Chrysler Dodge Jeep of Fort Worth had its best September for sales in almost a decade. General Manager Mike Biggers said he could see no difference in credit approvals for his customers.

2. Truth: In automotive downturns the first buyers to flee are always the most well-read and educated; they show appropriate caution about incurring long-term debt in uncertain financial times. This is a primary reason they tend to have good credit. Every dealer knows that the most creditworthy customers leave the market in slow times, while those of lesser means continue to attempt to buy cars at the same rate, and this is what led to the increased percentage of declined loans.

3. Truth: Subprime lending has tightened up or disappeared. But that happened back in the spring and primarily hit the used-car end of the business.

4. Truth: The downturn in September sales was due solely to a 39% drop-off in showroom traffic in the first half of the month, and a 50% decline in showroom traffic in the last half. These numbers come from CNW Marketing Research, which claimed it was the worst decline in new car shopping since its survey started in 1986. But a figure of 50% less traffic was optimistic, compared with what dealers told me: Some dealers said they had zero showroom traffic on many days in the last third of the month. When asked directly whether the reason for their poor sales was tighter credit or a lack of buyers, all agreed it was lack of buyers. In case you didn't catch it, showroom traffic averaged a 45% decline in September, but car sales fell by only 27%. That means a much higher percentage than usual of shoppers bought, received loans, and took delivery of a new vehicle.

5. Truth: Many but not all automotive lenders tightened their standards for loans. Greater truth: GMAC raised its "buy" rates for new car loans on A and B Tier credit customers on Aug. 1. True, GM's sales fell by 18.3% that month, but they fell less last month. In reality, finance companies change their buying standards constantly, in good years and bad. In 1995, Honda Finance decided that its 1% delinquency rate was too high, and it ordered its credit buyers to tighten up on the buying standards: Honda (HMC) wanted its past-due rate at one-half of 1%. That same year, Honda refused to finance "credit ghosts"—people listed with credit bureaus but not showing any previous credit and repayment. Honda dealers can tell stories of 22-to-25-year-olds, careful never to have used any credit, who had saved half down on a Honda Civic (, 6/7/06) and could not obtain credit from Honda without a co-signer. So in good years and bad, finance companies alter their standards for car loans regularly, based on rising percentages of late payments or losses on repossessions. Nothing new here.

6. Truth: Houston is one of the most dynamic car markets in America, but Hurricane Ike and the consequent loss of electricity across that region had most dealerships shut down for a week—some up to 10 days. One of the most ultra-reliable car markets failed last month because of an act of God, not credit problems. Furthermore, hurricanes Gustav and Ike had Gulf Coast refineries running at just 66% of capacity two weeks ago, causing gas shortages from Georgia to North Carolina. The evidence of two national energy crises shows that when motorists are sitting in line for gasoline for an hour, car sales fall in those regions.

Closing Dealerships

On dealerships closing their doors for lack of available credit, such as Bill Heard's 14-store General Motors (GM) chain in Georgia and many other local dealers, the media led the public to believe that, if only more credit had been available, those dealers might have remained in business. Wrong! It's time for a lesson in Automotive Retailing 101.

For a manufacturer to cancel the wholesale finance floor plan—the financing the dealer uses to pay the automaker for its cars—of any dealer is the culmination of a long process. It starts with a check of the dealer's inventory to make sure the store is paying off the lender for vehicles sold. If vehicles are found sold and not paid off, the dealer must pay them off immediately, and the investigation of that dealer is accelerated. That means more frequent floor plan checks.

If the dealer gets to the point where he can't immediately write a check for vehicles already sold, typically the lending source picks up the dealer's MSOs (manufacturer's statement of origin), and the dealer must present a cashier's check to the lender to get the MSO when the car is sold to complete the titling to the customer. (If the customer is financed with that lender, the lender will handle the car's titling; no cashier's check is needed.) When a dealer's working capital is so depleted that he can't even sell and deliver cars, pay them off with the lender, and forward the collected taxes to the state, that dealer is considered insolvent, or "out of trust." By this point the dealer typically owes millions he can't pay. Only then does the manufacturer cancel the store's wholesale floor plan financing.

Therefore, if a manufacturer takes the most drastic step of canceling a dealer's financing, there's not a banker in America who doesn't understand that this dealer is now the worst of all credit risks: He has no money.

Yes, the credit crunch did hurt sales last month, just not in the way the media portrayed it: When news organizations started reporting on the potential for the next Great Depression, along with the political battle over the $700 billion Wall Street bailout plan, a great many A Tier customers quit going into car dealerships.

Lenders tightened their standards, but not to the point that most people couldn't get car loans. Dealers who have their floor plans canceled are extremely bad credit risks and most often close down. Again, this happens in the best of times, just not as often.

Right now, contrary to what you have been told, if you have perfect or even decent credit, you don't have to walk on water to get a new car loan. Just ask 20,000 car dealers in America. They'll grant you one in minutes. What they can't do is restore confidence in the economy. So the downturn will probably continue.

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