What Drives Auto Buys, Loans in a Recession?

Mike Sheridan   

Mike Sheridan, President of Alamo, CA-based Global Debt Network Incorporated, gives you a state of the union on the auto industry. Topics include the virtues of buying a used car and the fate of overall auto financing.

Transcript

John: I'm your host, John Fischer. Welcome back to the CreditFYI Café. One of the long-standing cornerstones of American business has been the auto industry. With the exception of a home, a car is the number one big-ticket purchase for most of us. Right now, though, the auto industry is in dire straits. Renowned auto makers like General Motors and Ford are barely able to stay afloat right now. In fact, there are serious concerns that GM may not be able to survive the rest of the year.

That's why, today, we're talking with Mike Sheridan, President of Global Debt Network Incorporated, an Alamo, California-based secondary loan provider — an alternative place where both dealers and consumers can get auto loans. For auto dealerships, companies like Global Debt Network Inc. are critical to their success, perhaps even their survival. And for consumers, with banks either unable or reluctant to provide loans to individuals, companies like Global Debt Network Inc. become a viable loan alternative.

Thanks for being with us today, Mike Sheridan. It's good to have you with us.

M. Sheridan: Thanks, John. It's great to be here.

John: Mike, let's get right into a couple of questions. I know there's a lot of people out there who are very interested in what's going on with the auto industry. The auto industry is really one of the cornerstones of American business and American way of life, and I know there are a lot of unanswered questions out there. So we'll get right into a few of them.

M. Sheridan: Great.

John: It's tough times right now, needless to say, Mike, for the auto industry. But do you think that the current state of things may represent rock bottom for the industry? Or do you think that things will get a little worse before they get better?

M. Sheridan: Wow. Unfortunately, with all the bad news out there that we've seen, the one thing that we haven't seen yet that — to, at least, me — that would represent a rock bottom is a clear plan to get out of this. And we don't have that yet. There's certainly a lot of discussion that seems to at least have some smart people out there generating some good ideas, but I really do believe that it gets worse before it gets better. In the auto industry, we are seeing rising delinquency. You're seeing a reduced credit quality of the overall auto buyer, and sales are down, at least on the new-car side, from 15 and a half million units last year, and now we're on pace to do 11 million units. And with fewer loan originators out there, a less-liquid secondary market for these auto loans — where a lot of these banks use the securitization market to offset some of their risks in the auto loans — that's completely disappeared. It's just making it tougher for these companies to lend money to prime, near-prime, and sub-prime consumers. And that's the thing that really drives the auto-buying community, to have that liquid credit, and it just isn't out there, whether it's in the housing or even on the auto side of things right now.

John: Sure, from a consumer standpoint, given all the problems that you just cited, how should people deal with the difference between buying a used or a new car? Would you advise people who are looking to invest to try to start buying used cars right now? Let's say ones that are not particularly old, have limited mileage on them — what's your general stance on that?

M. Sheridan: Yeah, John, this is a question that my wife and I just went through recently. We were just in the market for a car, and we really battled between a new and a used car. We've always either leased or purchased a new car. But walking on the lots these days, it just became clear to me that the deals out there on the used car right now — for a low mileage, maybe it's a 2007, 2006 or 2005 coming off lease — are really just too good to be true. Especially on the SUV side of things, with gas prices falling significantly. And that's why people were really moving away from the SUVs pretty significantly over the last six, eight, 10 months. We actually purchased a used 2006 SUV and got a great deal on it.

Now there's definitely some pros of buying new. The pros of buying new: You have that whole factory warranty; a lot of places are offering six years and 100,000 miles. You've got a longer-lasting car, right? You're doing a low mileage — maybe 1,000 miles, or if it's a demo, 500 miles, or no miles. The cons are it's a big cost. It's the second-largest expense that any consumer makes outside of their home — ever. And right now, making that expenditure is just a really difficult step for people to make.

On the used car side, the definite pro, and the one that really convinced us is — as you know — a significant portion of the value of a car is lost right when it's driven off the lot. So that used car has that really taken out of it. And it makes it much more affordable for the consumer. And that was really the driver decision for us; the con there is that you're really not sure how that previous owner took care of that car, and you do have a reduced warrantee protection on it.

From my standpoint, with the certified car market really having exploded over the last five, six years, that offsets a lot of that risk. It certainly doesn't cover all of that risk, but it does take care of a lot of the warranty risk in making sure that that car was serviced. And that you have that dealership that's going to support you if you buy a used car, and it doesn't perform as you hoped.

The last piece of that, though, I just want to talk about, John, is the leasing aspect of things. The last ten years, leasing has been one of the major ways that car companies have put consumers in cars they couldn't normally afford. Leasing was used to get them into a car that they just couldn't afford to purchase. But over the last year now, what's happened is that the residual market for cars — that's the value of the car to that dealership, or what they can sell that car for when the leasee turns it back in after three or four years and their lease is up — has just dropped out of the market. And the value of those cars has been reduced significantly. So that loss for a dealership or a bank or a lender has just made it so that they just can't even do leasing anymore. And most lenders — especially in the U.S., on the car side of things — are just not doing lease deals right now. And they've slashed or eliminated that program entirely. So it's just not an option out there for most consumers.

John: Not to belabor the point too much, Mike, but I think everybody who reads, or is even informed in the least, knows that we're in a significant amount of trouble on a lot of different fronts these days. But given how the auto industry has suffered, and obviously you mentioned the homebuying market earlier — how they've both suffered — are there any concerns about a wave of car repossessions, similar to the foreclosure wave that's affected real estate so heavily in really the last year-plus now?

M. Sheridan: Sure, sure. So most of the auto lenders that we deal with on a day-to-day basis — and banks — have seen a rise in delinquencies. But these delinquencies — and even the repossessions — are still within the historical or acceptable low range for these lenders. Again, that being said, most investors, banks, and finance companies that are making these auto loans right now do expect that you're going to see a further rise in delinquencies and repossessions. And what they've done, and the way you can tell that, is that they've begun to do a lot of hiring on the servicing and collection side of things to be able to handle expected repossessions. And I'll certainly tell you that that hiring and the customer service people that they're trying to get into their staffing plans right now is hopefully going to make it easier, as far as whether it's — one word you've heard in the mortgages a lot is "loan remodifications." That's something that a lot of people are talking about even on the auto side of things right now, because it's really in the best interest of these banks and finance companies, with these auto loans on their books, to work with that end borrower and make sure that they continue to pay their loans, because there is no market for their car if they have to repossess it right now. They're going to take a big loss if they do that. So there has been a lot of talk on the loan remodification side of things, but that's going to be a way to help the consumer and try to keep them in the car — like people are trying to do right now on the home mortgage side of things.

John: Sure, that certainly makes sense. And as elemental as it seems, I would imagine that staying positive — especially in your business — is a key right now.

M. Sheridan: Exactly.

John: With that in mind, and we try our best on this show to try to keep a positive outlook on things, what signs should consumers look for that the tide might be turning in the auto industry?

M. Sheridan: The car business has been battling for a couple of years. There have been a lot of regime changes at the top of the big-three auto makers in the U.S., and they've been battling the Toyota and Honda car manufacturers for a couple of years now over the quality of their products at the price points they put out there. One of the problems that have really strangled the car business is their current labor costs. They're 52 percent higher on a per-hour basis than their competition. It's just really difficult to overcome any sort of the problems that you have when you've got labor costs that are strangling you like that. And it's my belief — or at least the belief across most of the people who I talk to right now — is that the step that you're going to see here is a clear plan: somebody to say, "This is what we're going to do." You've heard General Motors (GM) recently talk about the fact that they don't want to go into Chapter 11 bankruptcy. And the reason they don’t want to do that is that they've done a lot of studies over the past three years, because they've talked about bankruptcy several times as a way to reorganize their business. They're worried that car buyers will completely abandon their brand. The figures that recently came out from CNW Research said that 80 percent of new car buyers would not buy from a brand that was in bankruptcy. And the thought of that from an automaker right now — if they're trying to reorganize their business and restructure their labor costs and restructure their capacity issues, the thought of losing 80 percent of your top-line revenue or people that would think of buying from a sales aspect is just going to make that completely impossible. And pretty soon, what you would see is not a Chapter 11 but more like a Chapter 7 liquidation. The thing here, though, truly the turning sign is just going to be somebody to come up with a plan. And whether that's the future administration of President-elect Obama or it's the Senate taking control, or the House of Representatives putting a clear plan on the plate, and also from the auto manufacturers themselves saying, "This is what we do, and this is how we think we're going to be able to get ourselves out of this — step 1, step 2, step 3, step 4." That lack of clarity is just killing the GM stock and bonds right now.

John: That makes perfect sense, and obviously with the American economy being so much a consumer-driven economy, I tend to agree with you that something has to be done — and probably soon. To that point, you mentioned President-elect Obama's desire — it's been in the news recently — to try to reach out to President Bush to see if, in fact, the government would be willing to provide some direct relief to the auto industry. Can you offer a definite opinion about that?

M. Sheridan: Sure, my opinion — at least from President-elect Obama's standpoint — is that the thought of not doing some sort of support for the car manufacturers and having the significant job loss could be a problem. What you have to remember in the car and overall auto industries in general is, if you're "saving," or offering support to Ford, GM, or Chrysler, you're not only offering support for them, but the number of suppliers that they're basically keeping in business. Whether it's Delphi, for example, from the sales and component side of things you use in the car, the number of people employed in the auto industry is significant. I guess the thought right now, and my belief, is that if we had a massive job loss in this economy, that it would take the economy — as you said, the consumer-driven economy that we have — down another level of recession here, when you just don't have people spending. And really, it's just going to drive even more fear out in the marketplace, which is just going to cause a continual spiral downward. I do think that there needs to be some support here on the government side of things. I have not seen or heard all of the details of Obama's plan of what exactly needs to get done there, but I think that he needs to work with the current administration. Because it needs to be done before he's in office by the end of January. And really to take that step forward to get that clear path in place, is something that's going to have to be done — and probably over the next 4-6 weeks — for there to be a real impact in saving some of these auto car manufacturers.

John: Of the loans that are currently being extended, and more to the point, for people who are still out there — and although they may be struggling — are still trying to buy cars. You'd mentioned anecdotally before that you and your wife had made some decisions — based on a used car — because the pros outweighed the cons. Currently, what trends do you see in loaning habits — particularly in your business, where you're an alternative to a bank — as far as both dealers and consumers are concerned?

M. Sheridan: One of the things in the last couple of years, during a more "normal" economic environment, is that you did see a lengthening of loan terms, so that people could buy more expensive cars than they normally could afford, with more reasonable monthly payments. That loan origination — or habit or type of loan — has completely disappeared. What you've seen is a much lower approval rate on the sub-prime, which is now defined as 550 FICO score or lower. Less than one-third of all of those applications are being approved. Even on the prime side of the lending spectrum, where it was almost 90 percent of auto loans being approved, that's gone down to below 80 percent. So you've seen a significant decline there. You're seeing lower approvals, and you're seeing much shorter loan terms. And why that's being done, the problem with longer loans has been, as that loan gets out further in terms of the contract, the car value versus what you own on the car just doesn't make sense, like in the housing market right now, to stay in that car. And what consumers will do is they'll just either abandon that car or stop making payments. Because that car is no longer worth what you're paying for it. So what lenders have done is they've really reduced the length of the loan, and they've also really looked at that borrower: They're making sure that the debt-to-income ratio and the payment-to-income-ratio solidifies the borrower's employment stability. This is really key to their underwriting now, because they want to make sure that this car payment fits into what a person can spend on a monthly basis. And they're really trying to do a good job of working with that borrower, making sure that they put them in a car that's right for them — not necessarily the car that every buyer wants.

John: Understand. How have you had to change gears in your business, given what's happened? Is there a silver lining here, given the fact that you're in a secondary situation to most banks? Has that given you some leverage in this market?

M. Sheridan: The thing for us, because we're a marketplace, where banks and finance companies can trade these loans — like an e-Bay for auto loans — is that there has been a call for more transparency and more liquidity for all consumer loans. And we are just a solution — part of the solution, really — to help facilitate that going forward. So then people can make the loans that they need to make, but also then know that they have buyers on the other side of it after they've made the loans that can reduce some of their liquidity risk, or the risk of the loans that they're taking when they originated. It's been very beneficial for us in some ways because there has been a lot of talk about transparency, and that's the type of thing that we're trying to promote in our business. The problem has been that the buyers of these assets in the secondary market — again, whether that's a national finance company, whether that's a national bank, foreign bank, hedge fund, or private equity firm — have really just dried up. Nobody wants to touch the consumer loan market right now. People are scared when the next shoe might drop here — in the auto markets specifically. And there's been a lot of fear very recently about the credit card market. But we believe, long-term, that we are part of that solution that's going to help people trade these assets and make it easier for them to clean up the balance sheets when they need to.

John: All right, folks. Well, you heard it: Try to stay positive, keep an ear to the ground, keep a close eye on the auto industry — both online and in the news. Mike Sheridan, we thank you very much for your time, and we look forward to picking up this discussion at a later date, because there's obviously a great deal to talk about, and we appreciate having you here today.

M. Sheridan: John, again, thanks so much for having me on CreditFYI. I appreciate it.

John: Have a good day, Mike.

M. Sheridan: Bye.

John: Thanks again to Mike Sheridan, President of Global Debt Network Incorporated for so much useful and timely information about the state of the auto industry. Until next time, this is John Fischer for CreditFYI.com. And remember, the biggest factor in controlling your credit destiny is you.