Creeping Auto Loans

Strada iQMarch 2016

Back in the Day

A 24 or 36 month loan term on a vehicle was the standard of the industry for many years. While most folks had equity in the vehicle they were driving, basically the vehicle was worth more than the amount owed.

Situations with negative equity unless a customer had additional cash to put down, it was extremely challenging to close such a deal and find a financial service provider to fund the deal.

Those were the days of "vehicle ownership", equity in the trade in, and by today's standards positively short loan terms.

Fast Forward

In the early years of the 21st Century the Canadian dollar was in the dumpster similar to today, most manufacturers had conveniently raised their prices to compensate for the lower value of the CDN dollar.

While CMS (Citizen Main Street) enjoyed the benefits of leasing which quickly camouflaged the rise in prices while forcing manufacturers and captive financial service providers to have skin in the game by assuming the residual value risk on a ton of leased vehicles.

The Unthinkable

Suddenly GM is in trouble, Chrysler too, residual risks on leases are a billion dollar concern, the value of the CDN dollar is rising, social media is empowering CMS to influence manufacturers to lower the prices of vehicles.

Everyone is very discreet, nobody wants to talk about it, until Strada, yes...us at Strada mention that the residual risk is scaring a ton of folks, while CMS wants to pay a fair Canadian price for a vehicle.

In the meantime it was "We are out or lets get out of leasing, lets extend the loan terms, while disposing of the residual risk on CMS with  finance terms instead of leasing".

Marching Towards 96

Here is an industry that functions best on a 36 month cycle, embarked on a mission to reach a 96 month loan term. For several years it was a stable voyage with a slow, steady, inexorably creep towards longer loan terms.

"We are not leasing, we do not have a residual risk"

"We do need to run on a 36 month cycle to stay in business, and make money"

"By now CMS is closing deals on monthly payments, with a ton of software churning around in showrooms“

Reality Check

A lease is a monthly payment to use a vehicle, its the same with the extended loan terms, its a monthly payment to use a vehicle...forget ownership...its mobility.

Similar to the residual risk being out there, now the negative equity is out there. The best part is that to deal with negative equity everyone has to put skin in the game (manufacturer-dealer-CMS) which perhaps creates a sense of comfort.

Agreed...some manufacturers never stopped leasing, and are in a dramatically different position to deal with their customers.

CMS will shop around as to who will best deal with the negative equity, and remain at a constant monthly payment. Although CMS only wants to visit 1.7892 dealers to make a deal, current reality is that he visits more to package the negative equity.

The Pull Ahead

The auto business working best on a 36 month cycle is on a mission to "pull ahead" abbreviating the finance terms.

Although vehicles are financed for 60-72-84-96 months. The magical time frame is the 36 month mark.

Everyone is pulling ahead exploring the possibility of doing another deal at close to the same monthly payment. 

Obvious that CMS is in an advantageous position in the pull ahead powered by low rates.

Churning

The pull head strategy generates an increased level of "churning" in the showroom.

With deals being more challenging to close, terms getting longer to compensate for increased prices and negative equity. While the monthly payment is inexorably creeping up.

The old school (by now) mantra that customers visit less than 2 dealers, not so much in 2016.

Loan Terms

Its almost scary, and makes for a ton of pundit fodder regarding auto loans.

Prices of new vehicles have escalated powered by the lower Canadian dollar.

New vehicle inventories are up at dealers, which creates pressure to move iron.

To compensate loan terms have increased in length to uphold (or try) a constant monthly paymentChart from JD Power PIN

Powered by Data

Many forget that using big data permits getting closer to a threshold or edge. What seems scary, becomes normal.

Manufacturers use big data to calibrate incentives to generate higher sales results.

Dealers use big data to finely focus the “pull ahead”.

Financial service providers use data to calibrate their appetite for risk, and at times risk sharing.

Risk

Pundits want you to believe that the loan risk rests on CMS. That longer terms, are supported by longer lasting vehicles. That CMS is buying more vehicle than needed.

The auto industry in Canada is fully engaged with the risk of upholding a 36 month cycle. While abbreviating to initial loan terms.

The risk for the industry is no longer a lease residual, its evolved to survival.

While CMS has evolved from ownership to mobility for a monthly payment to replace the longer term ownership risk.

Rolling Over the Risk

CMS with a long term loan cannot afford the maintenance risk of a vehicle especially after the warranty expires during the term of the loan.

The industry call ill afford to let loans run the length of the term.

The industry enables/empowers CMS to trade in a vehicle and roll over a risk (deficiency).

It’s the new mobility business model.

Record Sales

Reinforce the fact that mobility is the new Canadian model. While rolling over the risk generates higher sales.

The wider choice in financial service providers has increased sales.

CMS has a limited appetite, and budget for vehicle maintenance or repairs.

Low interest rates are an additional contributing factor.

Agreed…new vehicle sales are through the roof.

Advantage

Who has an advantage?

Manufacturers who never abandoned leasing in Canada, have a clear and distinct advantage.

Manufacturers who have a strong certified pre owned program can further sustain their advantage.

Financial service providers lend the same money over and over to the same customer.

The Winner

Who wins?

CMS, the customer is the big winner.

CMS is the mobility user.

The auto industry is the mobility provider.

Canada is on the leading edge of the mobility model.

The Wall

Where is the wall?

When are we going to hit the wall?

It’s a moving target making its way further down the road.

The mobility providers will continue pushing the wall down the road.

The mobility users will take advantage of all the options, offers, incentives.

The pundits, analysts will continue trying to pull the wall back.