Richard Fairbanks, Capital One Finance Corp.’s CEO, said auto finance stabilized at the bank last quarter. His remarks on auto finance from the company’s earnings call yesterday, courtesy of SeekingAlpha.com:
Our Auto Finance business posted net income of $14.5 million for the quarter. Third quarter profits were driven by solid and stable revenue margin and efficiency as well as lower provision for loan losses as the overall portfolio continues to shrink. These factors more than offset the sharp increase in charge offs and delinquencies that are typical during the third quarter.
We took aggressive steps to retrench and reposition our Auto business at the beginning of the year. We pulled back on originations and we’re shrinking managed loans. We improved the credit characteristics of new originations. We’ve leveraged pricing opportunities in the face of shrinking competitive supply, and we continue to aggressive manage operating costs.
Originations for the second quarter were $1.4 billion, down 56% from the third quarter of 2007. We’re on track for Auto loan originations for the full year of 2008 to be at least 45% lower than 2007 originations. The total Auto loan portfolio shrank by $1.1 billion during the quarter and by $2.8 billion year-to-date.
As we’ve stepped back from our riskiest segments and focused only on our best dealer customers, the credit characteristics of new originations continued to improve, as evidenced by rising average FICO scores, improving loan to value ratios, and encouraging early delinquency performance of our 2008 origination vintages. We’ve been able to maintain pricing power and solid revenue margins while improving the credit characteristics of our new originations.
The overall results of our Auto Finance business are likely to be influenced by sometimes conflicting forces and trends. Expected seasonal increases in chargeoffs will put significant pressure on profitability for the remainder of 2008. The continuing pressure from the seasoning 2006 and 2007 vintages and broader cyclical economic challenges are likely to be a drag on results throughout 2009, and the continuing decline in loan balances will impact the optics of our Auto business.
For example, declining loan balances would reduce the denominator for calculations of metrics like chargeoff rates, delinquency rates and operating expenses as a percentage of loans. This would put upward pressure on these ratios, making them appear more negative than the actual trends in chargeoff, delinquency and operating expense dollars. On the other hand, the expected improvements in the credit performance and profitability of the 2008 origination vintages are likely to gradually improve Auto Finance performance over time. We also expect that Auto Finance performance will be helped by our continuing aggressive actions to improve operating efficiency. And the shrinking loan portfolio will continue to have favorable loan loss allowance impact.
We’ll need to see further progress and improvement in overall results, but we believe the aggressively repositioning of the business and our continued actions to navigate the downturn will result in a substantially smaller Auto business that can deliver above hurdle risk adjusted returns over the cycle. We’re monitoring the business results closely, especially the performance of new originations, and we’ll be prepared to take further appropriate actions based on the results and industry conditions we see over the next few quarters.
Maybe I shouldn’t have left there!
Marty, that’s an interesting way of looking at the customer. If I understand you correctly, you see a consumer who has gone through a recent foreclosure as one who has already deleveraged, right? And if they have already deleveraged, their creditworthiness is inherently better than a customer who has not gone through a restructuring of his personal balance sheet, no matter what the credit score. Is that correct? Perhaps you can elaborate on your underwriting perspectives? Are you underwriting mainly to DTI?
I hear you. How has FFC’s DTI and PTI standards changed over the last, say. 12 months?
Consumers have always wanted the deck stacked in their favor, but the Internet gives them a compelling tool to dictate negotiation. The Saturn business model allows the dealer in the market to set prices. Now the only business model that protects dealer profitability is going away.
Before the Internet, it was difficult to make money on new vehicles unless the demand exceeded supply. The Internet has triggered a “free for all” scenario on readily available vehicles. But the profit on the new vehicle is only the beginning of the dealer’s opportunity. Most dealers know that the most important thing is to get the deal without over appraising the trade to get it. F&I is the real profit center. And the new car franchise adds tremendous credibility to a used vehicle operation.
We should also keep in mind credit issues. Three years ago, approximately 37% of consumers had a car buying credit score over 700. Now the “good credit” threshold seems to have moved up to 720, while the number of consumers who fall in this category is estimated to be in the low 20’s. Many dealers advertise to credit challenged consumers who are glad to pay whatever if the dealer can get them “bought.” We shouldn’t assume that every buyer is “Internet armed” and “fast lane” credit qualified. But determining which customer is a traditional walk in, which is “Internet armed,” and which is “credit challenged” is difficult to do over the telephone or on sight.
In the realm of pre-owned, used vehicles are becoming more and more a commodity, thanks to the Web. To maximize “turn rate” it is essential for dealers to price competitively. The old “cost plus” model has been largely discredited, although some dealers still cling to the old ways. Read Dale Pollak’s excellent book “Velocity” for his take on how the pre-owned business has evolved. His company, vAuto, is predicated on these theories. And it is a thriving concern!
I wish I could predict where all this is going to lead, but we are truly on new ground these days. It seems clear that dealers will be forced to engage on the consumer’s terms or be left out. How to make money on the consumer’s terms is the new challenge.
A dealer who’s costs are too high on a per vehicle basis just can’t compete. Chrysler and GM think that by cutting dealers, the remaining ones can be profitable and build ever larger and more expensive monuments to the factory. The new reality is that the monitor on the consumer’s PC is the new showroom. The big fancy dealership with acres of inventory is a losing proposition. But the OEMs just can’t let go. Of course, it’s not their money.
It becomes apparent to me that cutting dealerships was largely mandated by the government “task force,” who were trying to make GM and Chrysler over based on their nebulous understanding of the Toyota model of high “through put.” I recently saw a piece quoting Mark LaNeve of GM as saying he is worried about losing so many rural dealers. The idea that consumers will drive long distances because of brand loyalty flies in the face of the new realities. Toyota has acknowledged that the lack of sales of its very fine Tundra truck is largely due to the distances consumers have to travel from rural areas to buy them.
Now I see Mr. LaNeve is leaving GM. One of these days LaNeve, Wagoner, Fong, Nardelli, Press, or another exec familiar with what happened with the dealer terminations is going to write a “tell all” book and we’ll know the truth. The idea that they would save appreciable money by closing dealerships is a total laugh. The idea that fewer dealers enables bigger and pricier facilities will go no where. Wringing all possible cost out of each transaction will be essential to success in the future as there will be loads of downward pricing pressure on gross profits.