Blame Sales Woes on Crushed Confidence, Not Crunched Credit
By Michelle Krebs October 30, 2008By Dale Buss
As automakers dig for the bottom of the industry's dire situation, they're trying to answer a fundamental question: Is this increasingly steep nosedive in sales mainly the result of consumers' lack of confidence in the economy and in their own financial future? Or is the squeeze on credit availability -- by defeating willing auto buyers -- largely to blame?
An Edmunds.com analysis has arrived at the answer: The crushed economic expectations and heightened financial fears of most Americans are causing the preponderance of the damage. And it's only going to get worse, judging by the announcement Tuesday that a leading measure of U.S. consumer sentiment, the Conference Board's consumer confidence index, plunged to 38 in October, its lowest level on record -- a 41-year record.
Loan terms are getting tougher for many borrowers, but the credit squeeze has played only a subsidiary role in bringing the U.S. auto industry to this precipice -- which will be precisely quantified in ghastly October sales numbers to be reported one day before Election Day.
And actually, the biggest damage being done by the deterioration in credit availability is that it helps make consumers afraid to visit dealer showrooms -- rendering it as much a matter of confidence as credit.
Confidence Game
Among the other conclusions of our analysis, shared in this story and others in our package on the confidence-vs.-credit issue:
* Many Americans with the best credit ratings are the most constrained in their auto-purchase decisions because they have the soundest financial judgment -- and are most worried about the economic future.
* Subprime borrowers can still obtain car loans but generally must settle for "less vehicle" than before.
* Automotive lenders typically are requiring 10 percent bigger down payments in the loans they grant and, even for the best borrowers, are trimming terms by six to 12 months.
* While some big captive-finance arms have greatly constricted credit, other lenders are picking up the slack.
* Credit unions may emerge as the biggest market-share winners in the new auto-loan derby.
Edmunds.com's conclusions are based on interviews with dozens of executives in the auto and financial industries, dealership owners and managers, experts on consumer sentiment, and credit, consultants and market analysts.
"Many people who want and are willing to buy are blocked by lack of credit, but we record many fewer people wanting to buy now because of uncertainty about job and income prospects," said Richard Curtin, director of surveys of consumers for the Institute for Social Research of the University of Michigan, which in partnership with Reuters calculates the most closely watched monthly index of U.S. consumer confidence.
Curtin's conclusions were echoed today by the latest Conference Board report on its own index, which plunged to its lowest level since the New York-based organization began tracking consumer sentiment in 1967. In September, the index was at 61.4; a year ago, it stood at 95.2.
Rich Apicella, a leading consultant to the auto-lending industry, also maintained that "it's a consumer-confidence issue. Certain lenders have pulled out of certain markets, but there is still money to be lent out there." While "credit is a problem with some people," said the practice executive with BenchMark Consulting International, "there are still enough players in the market, and people are still lending money, so that the consumer who wants to buy a car and is reasonably qualified will be able to find someone to lend them the money."
Anxiety Moves Online
Queries to TrueCredit.com make it apparent that "consumer confidence is definitely a bigger issue than credit specifically," said Lucy Duni, vice president of consumer education for the unit of Chicago-based TransUnion, one of the Big Three credit-reporting services. "People are overextended and hearing the same thing from friends and family and considering big purchases more carefully than in the past. But they're also pulling back across the board, even with small non-credit purchases."
The president of Bank of America Dealer Financial Services agreed. "Consumer confidence is a driving factor right now as it relates to buying any product -- an auto, a TV set or a new home," said Ellsworth "Ellie" Clarke. "If people don't need to spend it, they're not spending it. But if you have good credit, your ability to buy a car hasn't been diminished at all."
OEM executives echo that conclusion. "There are likely many customers sitting on the sidelines now -- not wanting to make a big-ticket purchase," said Mike Groff, group vice president of sales and marketing for Toyota Financial Services. "But we have the means to support credit-worthy individuals."
Chrysler chairman Jim Press said that the current market is "really, really tough" for its dealers, in part because of consumer fears that car loans aren't available. "Actually, I think there are a lot of sources of financing that local dealers can use. And we've got half a billion dollars of incentive money in the market," he told the Detroit Free Press last week, referring to Chrysler's fourth-quarter incentive-spending budget.
Hyundai just announced a series of very aggressive finance offers that include loans with interest rates as low as zero percent as well as cash incentives. "The issue for us is rising cost of capital, which is frustrating," said Mike Buckingham, president and CEO of Hyundai Motor Finance. "But we're taking thinner margins because we're putting competitive [loan] offers out there."
Problem in Microcosm
To be sure, auto and banking executives alike have a vested interest in portraying woeful sales as a consequence of broad causes beyond their control rather than as a result of their mishandling of the consumer-credit spigot.
And in fact, both factors are contributing mightily: A slump this bad requires both consumer confidence and credit availability to be plunging in overdrive. "About 20 percent of all new-car sales, historically, have been to people with subprime credit," observed Bank of America's Clarke. "It's sort of interesting that auto sales have been down by about 20 percent."
Clearly, a market that seems on its way to sales of only about 13 million units this year, compared with 16 million last year, wouldn't be nearly as bad if only one of these two dynamics was prevalent. "The reality is that it's a combination of the two factors," said Jesse Toprak, executive director of industry analysis for Edmunds.com.
A few interviewees made one basic observation that illustrates the complex reality. They said that would-be buyers with sound credit and the likelihood of easily arranging loans are refraining from purchasing vehicles because of their frayed confidence, but many oblivious subprime consumers are still attempting to purchase vehicles -- only to be turned down or handed tougher terms than last time.
"The customers who can buy cars are the ones who aren't coming into the dealership," said John Garcia, general sales manager of Kia and Chrysler outlets for the Russ Darrow Group in Madison, Wisconsin. He knows, Garcia said, that's in part because dealership revenues for parts and service are down as well.
On the other hand, he maintained, middle- and lower-income customers "who work at coffee shops and ice-cream parlors and Wal-Mart still want to buy cars and aren't aware of their credit situations. So they're still coming in like a year or two or three years ago; but the banks aren't approving them for their cars."
Jacksonville, Florida-based Clarke seconded that observation. "Showroom traffic is down because people with personal financial restraint, who have the capacity to pay cash or get financing, aren't going," he said. "The ones with poor credit are still going and getting turned down, but they could have gotten a loan two years ago."
A Great Time To Buy?
Dealers nationwide, of all makes, have been testifying to huge new drop-offs this month in showroom traffic, the most telling sales barometer.
"We're not getting people coming in through the doors," said Bert Boeckmann, owner of Galpin Motors in Los Angeles, the largest Ford dealer in the world. "Our showroom traffic is less than half the level it was a year ago. It's close to only half of what we had even two months ago. And this month there's about a 20 percent drop-off from just last month."
Even Honda dealers, the brand that has been the most resilient among the U.S. industry's Big Six OEMs through most of this year, are finding their sales floors largely depopulated these days. "People just aren't coming in," said American Honda spokesman Chris Martin.
As a result, there are only grim projections for November 3 reports of October sales results. Toprak predicted that full-month sales will come in about 15 percent below year-earlier levels. Purchase-intent data for the first week of October versus the first week of September, compiled by Santa Monica, California-based Edmunds.com, showed a 20 percent decline -- double the typical seasonal drop of 10 percent between those weeks.
Ironically, now is a great time to buy a vehicle for Americans who have the resources and intestinal fortitude to take the plunge.
Toyota is offering record across-the-board incentives. The Detroit Three have just increased their already-huge cash-on-the-hood deals for their largest vehicles. There are still plenty of fast-aging 2008-model vehicles that dealers are attempting to clear off their lots to make way for 2009 versions.
"If someone needs a car, they know the market is down, and this is a great buying opportunity," said Edmunds.com's Toprak. The National Auto Dealers Association added that "for many people this may be the best time to buy a car in years. There are plenty of incentives to lower costs."
And a handful of recent reports have suggested that Americans may not be as fearful or pessimistic as had been assumed; for example, U.S. consumer confidence rose unexpectedly for the third straight month in September, according to the Consumer Confidence Index compiled by the New York-based Conference Board.
Shock and Awe
So why aren't more Americans taking the bait? Well, because they are shaking in their boots unlike any time in recent memory, rivaled perhaps only by the period of collective national shock experienced during the weeks immediately following the 9/11 terrorist attacks in 2001.
It seems clear by now, for example, that any expressions of underlying consumer optimism, even from September, represented only a vestigial holdout against the vast forces of economic pessimism that began sweeping the nation and the globe in late September. That period marked the climax of the drama on Wall Street and in Washington, where policymakers and financial executives blamed a freeze in global credit markets for the near-meltdown of Western-style capitalism -- and then cobbled together the $700-billion federal rescue plan.
All that was enough to stun would-be American car buyers, along with everyone else, into stagnation. So naturally, the most very recent soundings of consumer sentiment are vastly pessimistic: For example, only 59 percent of a group of Americans who have been surveyed for nearly a year by an AP-Yahoo News poll now are happy about how things are going in their own lives -- down from 70 percent last month.
The presidential election -- reflecting a highly polarized electorate and characterized by increasingly heated rhetoric -- has added another layer of uncertainty and anxiety for Americans to cope with.
"Everyone wants to buy, but they're afraid to buy," concluded Lincoln Merrihew, analyst for the automotive arm of TNS, the Boston-based research outfit that gathers the raw data for the Conference Board's consumer-confidence index. "They're petrified because of what's happening in the financial markets, because of the price of gas, because of their job security. That's an emotional hurdle that the car companies can't overcome.
"Those feelings speak to driving purchase consideration. And people need to at least feel comfortable enough, if not compelled, to buy a car. That's just not happening right now."
Even if Americans aren't active investors, "the stock-market volatility has got to get their attention. It's thin ice and it's warm, so who wants to step out onto the ice?"
The Last Straw
It's also true that many Americans have been treading thin financial ice already. The U.S. savings rate is essentially zero now, compared with 7 percent in the early '90s and 10 percent for much of the '80s. Debt is equal to about 130 percent of take-home pay, including mortgages, these days -- double what it was about 20 years ago.
Bank of America's Clarke said that the auto market's current problems result from a credit crunch only to the extent that personal finances already have been stung. "We've borrowed home equity and leveraged credit cards and overextended payments because the economy was cooking along just fine and supporting that," he said. "But the tightening of credit markets has eliminated a good portion of consumers from living on credit." And these Americans drop out as candidates for buying new vehicles.
The mostly downward lurch in stock markets alone has swept millions of Americans to the sidelines when it comes to considering new-car purchases. "Most people with a 401k have felt a lot of pain in the last few weeks," said Hyundai's Buckingham. The crash in home-equity markets, especially in large states including California and Florida, also has drastically reduced the pool of would-be car buyers.
"So you've got this picture where a lot of people don't have a safety net or a rainy-day fund, but they have really large debt obligations, so their enthusiasm for assuming more debt obligations is fairly low," said Michael Schenk, senior economist with the Credit Union National Association, in Madison, Wisconsin.
One sign that overextended auto consumers, in particular, have been pulling in their horns: The average visitor to LeaseTrader.com is trying to find a lease that has only 17 months remaining. Last year, the service that matches vehicle-lease holders with consumers seeking to take over lease remainders found the average visitor willing to search for a contract that still had 22 months to run.
"That solidifies the fact that people want shorter terms for their financial commitments," said John Sternal, vice president of marketing communications for the Miami-based company.
Even the recent headlong plunge in gasoline prices toward an average of just $2.50 a gallon -- after they spiked in July at more than $4 a gallon -- hasn't noticeably enhanced consumer confidence.
"Consumers expect gas prices to continue to fall this year," said Professor Curtin of the University of Michigan. "But if you ask them, over the next five years they don't expect gas prices to fall -- and you don't buy a car depending on what gas prices will be next week."
Laying It Out There
Yet into the teeth of these stiff economic headwinds, the auto industry and its allied lenders insist that they are making enough credit available for would-be buyers.
Just last week, both GM and Toyota launched new marketing campaigns aimed at reassuring consumers that, if they want to purchase a new vehicle, either the company or dealers will find financing for most of them. While GMAC recently hiked minimum credit scores for its loans, most dealers have relationships with dozens of other lenders that aren't erecting such warning signs.
Similarly, most lenders insist that they're making plenty of money available to car buyers. This notably includes the nation's credit unions, which are conservative lenders whose business is about half auto loans. About 90 million Americans are members of credit unions.
"There are still enough players in the market, and people are still lending enough money, that the consumer who wants to buy a car and is reasonably qualified will be able to find someone to lend them the money," said Apicella, of Atlanta-based BenchMark Consulting.
This fits Merrihew's picture of the root cause of the crisis. "Car companies can overcome the credit crunch," said the executive of TNS Automotive. "For consumers who can't get credit, the companies can solve it. It's not cheap, but they can solve it."
Honda's customers typically are a well-educated and well-off demographic, and the U.S. arm never financed subprime buyers as some of its competitors have. So, said the company's Martin, Honda Finance "hasn't changed anything. And dealers aren't having any difficulty financing people. For the majority of people who have a job that pays them, and they want to buy a Honda, they can probably get financed."
Martin's conclusion is that Honda's showroom traffic has tanked because of consumers' lack of confidence. "Our buyers are educated enough to know that their income would still allow them to get credit," he said.
The picture is much the same for used-car buyers, maintained CarMax, the Richmond, Virginia-based nation's largest retailer of used cars. "Our ability to finance qualifying customers has not significantly changed," said Tom Folliard, CarMax president and CEO. This includes, he said, a recent reaffirmation by third-party lenders "to provide more financing for CarMax customers."
The Other View
Despite all of that, those who finger the credit crunch as the most important cause of the intensifying auto-sales malaise can be vehement in their argument.
Some of them start by presenting a different view of the state and importance of underlying consumer confidence. The turmoil in financial markets "hasn't affected the vast majority of people," maintained Art Spinella, who, as president of CNW Marketing Research, is continually surveying thousands of consumers for their views and dispositions on vehicles and shopping.
"They're just watching things," said the head of the Bandon, Oregon-based market-research concern. "It's like the Civil War, where people took picnic lunches to the battlefields and watched. People now know their bank accounts are protected. They're jittery about stocks but they don't really have a feeling that they're being impacted terribly. In the grand scheme of things, people are just [watching] the World Series."
The main thing holding back a surge in new-vehicle demand, proponents of this view hold, is credit availability, not consumer confidence. They cited the huge discouragement to auto consumers that was introduced when GMAC announced its new floor for credit scores earlier this month. The move by the nation's largest captive-finance company reflected the unfortunate fact that an extremely cautious Wall Street had decided to reduce its exposure to subprime auto loans and severely restricted GMAC's access to capital.
"While you're going to see the overall aggregate sales numbers down because people are fearful of spending," said Mike Sheridan, whose company finances dealer operations, "it is the credit-application approval reduction across the board that is making it more difficult and is probably the driver" of the sales slowdown.
"Even the people going into showrooms are probably more apt to be real consumers these days than those who are just fiddling around and doing some research," said Sheridan, president of the Global Debt Network, based in Alameda, California. "And those people are having a hard time getting financing."
What's beyond dispute is that most lenders have tightened up significantly. Consumer-finance companies, for example, can't securitize their loans as easily anymore because financial markets now are staying away from all varieties of subprime credit as if it were toxic waste. So they're being far more careful in doling out the capital they do have.
"A number of [these companies] used securitization and the public market to bundle contracts, and that's dried up," said Mark Edelman, partner in McGlinchey Stafford, a Cleveland-based law firm specializing in consumer finance.
Signs of Caution
Her members "are tightening" their lending, confirmed Lynn Strang, vice president of communications for the American Financial Services Association, a Washington, D.C.-based trade group for non-bank finance outfits that make millions of auto loans. "When you have a deterioration of the credit pool underlying the market, fewer people will get approved."
Banks are getting stingier as well. Average loan-to-value requirements have risen by about 10 percent in the last several weeks, said bank lenders including Clarke and other sources such as executives of Informa Research Services, a Calabasas, California-based provider of financial-market data. Some banks, such as Milwaukee-based M&I, are offering rate discounts for better loan-to-value ratios and rising tier requirements, said Toprak of Edmunds.com.
New York-based Chase is the biggest bank-owned auto-finance company in the country. In addition to direct loans to consumers, it acts as a captive-finance arm for Subaru and Mazda and in a "side-by-side" relationship with Saturn dealers, according to bank spokeswoman Mary Kay Bean.
"We have tightened standards and are avoiding high loan-to-value deals," said Detroit-based Bean. "We are asking for more documentation and looking for higher down payments." She said that Chase's curtailment actions go back about a year. "Not much has changed lately," Bean insisted. But she said that "we have been seeing fewer deals presented to us by dealers."
Wells-Fargo, "similar to everyone else, [has] tightened underwriting standards to effectively manage risk in this difficult credit environment," said Steve Carlton, assistant vice president of the auto-finance division of the San Francisco-based banking giant.
At the same time, banks and other lenders have been hiking interest rates very recently. Rates had eased a bit through this year since 2007, in part reflecting the success of automakers' cut-rate loan incentives in keeping the U.S. new-car market from derailing completely. But in August, new-car loan rates at auto-finance companies suddenly spiked, to an average of 5.11 percent, according to Federal Reserve data, from just 3.28 percent in July.
Simultaneously, the average loan-to-value ratio plunged to 88 percent from 95 percent in July. Yet the average amount financed only eased in August, to $26,920 from $27,582 the month before.
Cleanliness in Vogue
"Most lenders now are setting up their auto-loan programs to encourage dealers to ask for higher down payments," said Edmunds.com's Toprak, based on an analysis of current rate sheets from 15 different automotive lenders. "Banks are willing to lend, but they also want to limit their exposure."
In addition to higher rates and tougher overall standards, that also means lenders increasingly are fly-specking every potential auto loan.
"What they're saying is that we need these deals to be extra clean," said Justin Rawcliffe, Informa's assistant manager for indirect loans. "'We're not going to accept below-prime credit scores or if the person doesn't have the income.' They want the deal to look perfect before they're going to lend them the money. And some lenders are so limited in cash that they're not even accepting new deals until an old one comes off the book."
Edelman, the credit-industry attorney, said, "Blemishes that didn't used to be problems are problems now. Mortgage-payment problems on a credit record, for example, "set off alarms in the underwriting world at auto-finance companies and lenders."
Some observers contend that the auto industry's biggest problem isn't consumers' actual access to credit, but their perceptions of creditworthiness. Many Americans who need or want a new vehicle aren't moving toward purchase now because they're afraid they'll get turned down for loans.
Is that a confidence problem or a credit problem?
Self-Elimination
In any event, the resulting suppression of demand is a real problem. GMAC's move to stiffen its vehicle-lending standards, for one thing, has greatly encouraged consumer self-screening, given that the nation's largest captive auto-finance company also holds millions of home mortgages. That action, of course, followed an earlier cutback by GMAC in auto leasing and last summer's announcement by Chrysler Financial that it no longer would offer leases.
"People are simply not ready to take a risk that could hurt their credit in a time when even mildly weak credit scores will disqualify them from other loans, namely home loans," said Clifton Lambreth, author of the book Ford and the American Dream.
But TrueCredit.com said that 63 percent of Americans don't know their credit scores, based on a 2007 survey -- a phenomenal share, given huge media attention to credit scoring and its importance over the last several years, and the ubiquitous Internet advertising of free credit reports. And TrueCredit.com's Duni said that most of the company's calls these days are from consumers wondering if their credit scores will qualify them for all sorts of loans.
Such ignorance helps explain the growing prevalence of credit self-discouragement. "The loss in [auto] sales includes 90 percent of people who could qualify for credit if they wanted to but don't want to waste their time or embarrass themselves," contended Brett McBrayer, president of the Birmingham (Alabama) Auto Dealers Association. "Pride is a big factor."
Demand or Deflation?
Yet, some observers believe even this specific form of credit-related pullback by consumers is being overwhelmed by their broader lack of confidence.
"At the end, the consumer is less worried about getting rejected for an auto loan that they're applying for than worried about their job and getting a paycheck," said Arthur Shaboul, Informa's manager of loans products.
Of course, more important than how the auto market got here is how it gets out of its profound slump. With that challenge, the question of confidence versus credit will remain important.
Auto lenders generally are still awaiting the thawing of credit that the federal government rescue of financial markets was supposed to achieve. And Strang noted that her organization -- along with every other element of the U.S. economy that is extremely credit-dependent -- is hoping to get its share of the $700 billion to help accelerate the process.
"We're looking for the government to define the 'troubled assets' that they're going to rescue to include specifically non-mortgage assets" such as car loans, said the spokeswoman for the American Financial Services Association. "So we're really paying attention to what's happening in Washington."
Some analysts believe that, as battered as it is, the U.S. auto market is harboring lots of pent-up demand that will be unleashed as soon as credit begins flowing again through the American economic system. This demand -- defined by CNW Research as individuals who are within a month of making a vehicle acquisition who postpone it for any reason -- amounts to about 950,000 people now compared with only 120,000 at the end of last year, the research outfit said.
But in the meantime, the bailout did little to forestall the increasing likelihood that America already is experiencing a recession. That is a huge confidence issue not only for consumers but also for lenders.
"No one knows how severe or deep or long the recession will be," said Keith Leggett, senior economist for the American Bankers Association, in New York. "So institutions naturally are just going to be more cautious. They're not out there pushing their credit aggressively when the economy is weak. It's a good way of losing their shirt."
"In September and October," Leggett said, "you'll see the [auto-lending] data tightening even more. And you'll see lower average amounts being financed."
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Very well done, Dale. Comprehensive, insightful
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