Used car market is getting messy... here's what no one is talking about

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Today's topics:

🎅 Don’t get on the naughty list: Consumer Financial Protection Bureau is watching
🤑 What’s happening in auto finance: How the f*ck can consumers finance cars?
🙏 Hanging at the mercy of lenders: tough times ahead for used car dealers
🚙 Would you buy this 4Runner?: Trending topics from our private community:

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🎅 Don’t get on the naughty list: CFPB is watching

The Consumer Financial Protection Bureau’s (CFPB or Bureau) issued a report that highlights a few trends, which in the view of the Bureau, represent unfair practices. Let me be clear: most dealers and lenders don’t do these things, but it is good to know which offenses caught CFPB’s attention:

Some add-on products, such as GAP insurance, benefit consumers only for a limited time (until the loan is paid off). However, in some cases, these services are tacked on as a lump sum and are financed through the entire life of the loan. If a consumer pays off a loan earlier, there’s no refund issued to the consumer.
Consumers who were delinquent on their loans requested payment assistance. Lenders “preliminarily approved” them for loan modifications but asked to make just one more payment to finalize loan modifications. However, after the payment has been made by consumers, loan modifications have been denied, which was perceived as misleading by borrowers.
Some consumers were charged for collateral protection insurance that was purchased on their behalf, even when they did not need additional coverage. Consumers have not been refunded when errors have been identified.
In some cases, lenders activated vehicle disabling devices when consumers were not past due on their payments due to errors in their systems. These devices prevented consumers from starting their vehicles or delivered annoying notifications about late payments.

Shoppers, be aware of these unfair practices. Dealers and lenders, please play nice and stay off Santa's naughty list.

🏦 What’s happening in auto finance: How the f*ck can consumers finance cars?

Overall auto loan balances grew 7.6% in Q3. While the loan volume is down, this increase is driven by year over year increases in loan amounts.

With climbing interest rates, Credit Unions are now financing over 30% of all auto loans according to Experian - the all time high. Not surprising because auto-financing through traditional banks had gotten stupidly expensive. So, dealers are adding credit unions to their F&I menus, and consumers are getting savvier and are pre-arranging their financing at credit unions, the only source of reasonable interest rates.

We just had an 820 credit score get quoted 8% from Capital One and 10% from Ally for a CAR LOAN. Have never seen that before.
— CarDealershipGuy (@GuyDealership)
Dec 12, 2022

Note that longer-term loans (73-84 months) are now representing 29% of all loans in Q3. Combined with straight 3 month declines in wholesale car prices, longer loan terms means that many consumers will be underwater, owing more than the value of their cars and paying for repairs in addition to making monthly payments when their cars are out of warranty.

Used car financing loan terms distribution

Experian

As a result, auto lenders are already experiencing an increase in loan defaults. All large auto lenders are consistent in reporting the increase in charge-offs. For example, Ally Financial reported that charge-offs for retail auto loans quadrupled in the third quarter.

Wells Fargo, Fifth Third, Ally, Capital One, and others are shrinking their auto loan portfolios, increasing provisions for credit losses, and are tightening their lending standards. The percentages of auto loans to less risky prime and near-prime borrowers have grown, while riskier loans to lower-credit-score borrowers have shrunk.

All of our national lending partners have become SUPER conservative.
The deal flow we're sending some is down as much as 75% y/y (!)
In contrast, feels like smaller lenders are being pretty aggressive.
Lower APRs, better terms, etc. Time will tell how this plays out...
— CarDealershipGuy (@GuyDealership)
Dec 14, 2022

Overall, auto loan originations for the entire industry dropped by a whopping 40% during the third quarter from the same period the previous year.

But there’s more…

There are second order effects of the credit tightening and decreasing vehicle values. Most consumers start looking into financing about a month before a purchase, as the online part of their shopping journey. That’s why big lenders have been getting prominent placement on dealer websites, inside digital retailing tools, and on vehicle display pages (VDPs) of online classifieds. Consumer-facing F & I menus have become intertwined into the conversion funnel: strategically positioned call-to-actions invite consumers to apply for financing with the promise of a seamless checkout experience.

Making financing arrangements is a savvy move, except when you cannot get approved. What happens when a shopper goes through the credit application flow only to face a denial? What if the quoted payment is ridiculously high? That shopper is gone! She leaves the funnel, the VDP conversion rate drops, and all customer acquisition costs go to waste. As big banks are playing the conservative game, more and more consumers are experiencing this.

Today’s only source for reasonable interest rates, credit unions, do not regularly show up on digital shopping tools because they lack the clout and technical abilities to get integrated.

The same scenario happens when shoppers go through an online trade-in valuation process, which is now a common offering across online shopping tools. Gone are the days of gleaning over your car’s increasing value. What happens when shoppers see a low trade-in valuation? They leave the funnel and abandon their shopping journey.

Dealerships and online classifieds, take note and adjust your funnels to present creative options that are most likely to move a consumer towards a purchase rather than being hostage to big banks underwriting models and vehicle valuation tools.

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🙏 Hanging at the mercy of lenders: tough times ahead for used car dealers

More than ever, used car dealers are at the mercy of auto financing companies. Here's why:

In the past decade, the low-interest-rates environment favored used car dealers. Lithia, Asbury, Autonation, and many others aggressively pursued the used cars business. Now, when the rates are climbing and the recession is on the horizon, used car biz is starting to lose its appeal. Unlike franchised dealers, independents are not sufficiently diversified, having only one main profit center.

Did you know that many independent dealers live and die by their lending partners’ underwriting model? Now, big lenders are becoming conservative and are either dropping independent dealers or are simply lending less against used vehicles. Increasing rates and decreasing values brew a perfect storm. Prime borrowers are quoted insanely high rates which hurts affordability. Subprime borrowers present another problem: the max APR that can be charged is regulated by states. With APR capped, unable to compensate for risk, lenders charge dealers fees, sometimes up to $3,000, to lower their collateralized position. There goes the dealer’s margin.

Another problem that is not commonly known is that dealers live and die by book values and this is what lenders lend them on. NADA, Black Book, you name it. In the past few months car prices have been changing so quickly that books could not keep up. Books have been adjusting values left and right, sometimes more aggressively than the market, and frankly, nobody knows how they do it.

Manheim used vehicle value index

On top of that, dealers have been blindsided by prices that are declining faster than historical norms. They simply cannot keep up. To be proactive, smart dealers are tightly managing their inventory and even doing inventory “write downs” (we fall into this bucket). Typically they are done at the end of the year, but we had to do it early, in the beginning of Q4, to reflect the market situation. Market values in the last 30 days are still dropping (except for extra luxury and exotics), and the demand at our stores has cooled, trending 20% behind forecast, which is uncomfortable because you can only sustain your overhead so much.

Looking at 2023, I expect it to be a tough year for used car dealers. Some dealers will struggle, some will close, and some will be bought out by the big guys. Survivors will be the ones with the most fortified balance sheet, driven by variable expenses.

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🚙 Trending topics from our community

Should I buy this car? It looks good but has a salvage title…

My private community of 1,200+ is buzzing with questions from active car shoppers who are leveraging my expertise. A couple of weeks ago we got a few questions on vehicles with salvage titles. Here’s one example. A group member, let’s call him Jim, found a 2020 Toyota 4Runner with 25K miles for $33K. The car had a salvage title, but looked sweet on photos:

The dealer was firm on the price, but the price is really good. Well below the market.

Jim did the right thing and had the car inspected by a mechanic, who told him that no welding was done on the frame, and only side panels and the tailgate had been replaced. Sounds great, doesn’t it? Why not buy an almost new, reliable, 4Runner for $8-$10K less than the market value?

I’m glad you asked, Jim, because I googled the VIN of the car, and the first page of results shows the page from Copart auction - the site where salvaged cars are sold to be rebuilt.

This is a great find because it shows the pictures of the damage. The site also says that Estimated Retail Value: $41,228 with the Estimated Repair Cost ≈ $31,704. Here are some photos. Would you still buy this car?

What do I see here?

A powerful hit in the rear driver’s side.
Additional damage on the right side that likely happened after the initial collision.
All side airbags have been deployed.
Judging by deformations of the doors, there’s likely some frame damage
Damage to the rear suspension, which could have been proparaged well into the front of the car affecting transaxle and other parts.

Let’s admire the labor people put in to fix this 4Runner to the “almost brand new” condition. Let’s wish it many miles driven on safe and happy roads, serving its future owners.

As a consumer, I would not buy it though, because I don’t have the confidence that the car’s structural integrity has been preserved to sustain another bad collision. Nor do I have confidence in the suspension and drivetrain reliability.

Generally speaking, there are gems to be found in salvage yards. Some cars have been written off with very superficial damage that will not affect the long-time driveability. However, buying cars with salvage or restored titles is not for everyone. You need to be an expert or have one on your side. It is next to impossible to assess the extent of the damage after repairs have been done or by looking at the photos of damages.

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-CarDealershipGuy

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