Reflections on NADA Week 2015, San Francisco

Ruggles based on a column in Wards
minor additions by Smitka

There was a lot going on in San Francisco in January. The week began with the American Financial Services Association (AFSA) conference. Following that, J. D. Power and Automotive News held conferences on the same day, while at the same time, NADA workshops were in session. There was simply no way to take it all in so I’ll only comment on the high points of sessions I attended.

AFSA:

Notably absent from the AFSA conference was the Consumer Financial Protection Bureau. I got the impression they weren’t invited and wouldn’t have come anyway. Last year, CFPB’s Patrice Ficklin addressed a packed room. Since last year’s event, AFSA commissioned a scholarly study, conducted by the highly regarded Charles River Associates, that isn’t kind to CFPB’s suspect methodology called Bayesian Improved Surname Geocoding (BISG) which CFPB uses to “prove” unintentional “disparate impact” discrimination. One gets the impression that zealots at CFPB see discrimination behind every tree and will stop at nothing to “prove” it. According to the Charles River study as summed up in an AFSA bulletin, “BISG estimates race and ethnicity based on an applicant’s name and census data. AFSA’s study calculated BISG probabilities against a test population of mortgage data, where race and ethnicity are known. Among the findings:

• When the proxy uses an 80% probability that a person belongs to an African American group, the proxy correctly identified their race less than 25% of the time.

• Applying BISG on a continuous method overestimates the disparities and the amount of alleged harm and provides no ability to identify which contracts are associated with the allegedly harmed consumers.”

To say that race and ethnicity is “known” in the case of mortgage data is a HUGE stretch as mortgage applicants are asked to “self describe” their race and ethnicity without any objective standard. For example, if a person is ¼ Native American, ¼ Asian, and ½ African American, what objectively is their race? People have a variety of motivations for how they will answer such a question. And with no objective standard, the margin of error is impossible to calculate.

Yet, no lender will stand and fight CFPB in court. CFPB knows they have an immense intimidation element working in their favor, and they leverage it at every turn.

Having said this, CFPB has done a lot of good in some areas. But attempting to prove discrimination where there is none is likely to cause a huge backlash that could overwhelm any good they might do.

MTV:

A highpoint at the NADA conference was a press conference presented by MTV. The attraction for me was that they stated up front that their research debunks the conventional wisdom regarding Millennials, who we are told are taking over the world. There is good reason to be suspect of research undertaken and then repackaged by people who know nothing about auto retail. We know that there are a LOT of Millennials out there. We know they will grow up and as they do, they will become more like the generations who came before them. And their children will complain about how stodgy they are.

One of the excellent points the MTV study makes is that there is a good reason Millennials tend to get their drivers license later than earlier generations. It has more to do with more restrictions imposed these days than in days past, not that Millennials have little interest in vehicles and are reluctant to drive. The study also showed that Millennials with both a drivers license and a vehicle drive a lot, in fact more than previous generations Baby Boomers and Gen Xers. So they'll need to replace their cars more often than other generations, good news for us in the business.

There are many who think Millennials are brats. The MTV study supported this, pointing out that this generation received a trophy for just showing up. “They want what they want when they want it,” said Berj Kazanjian, the Senior Vice President for Ad Sales Research for MTV. He said the study revealed a level of idealism on the part of Millennials. “They want things to be fair. They don’t want anyone to pay more or less for the same product.” I sat there thinking that this wasn’t sounding much different than what my own parents, who were raised during the Great Depression, sounded off about Boomers. Don’t idealism and being young go hand-in-hand?

The Q&A lasted long after the presentation officially ended and eventually turned into a spirited discussion. I mentioned my own “surveys” when I asked roomfuls of Millennials if they think 10% is a fair dealer gross profit on a new car. The consensus answer is that 10% is “fair.” This coincides closely with TrueCar’s survey which shows consumers think 8% is fair. But when I ask the same room if a $3000 profit is “fair,” the tone of the room changes instantly and I hear comments about car dealers being cheats and liars. The MTV presenters thanked us for “keeping them honest.” While I think their research shows interesting results I do think they need to enlist the input of someone who understands automotive retail to frame questions in a way relevant to the industry, and thus translate what customers mean in our context as opposed to the words they utter as general principles.

At least it seems that MTV isn’t interested in selling their advice to dealers on a consulting basis like many who conduct self serving research. They just want to sell some advertising. They may not feel it's worth their trouble to restructure their survey on our behalf, but we benefit from their not trying to spin the data to drum up our business.

Oil Economics:

It is always interesting to hear economists provide their SAAR predictions for the coming year. There was a lot of talk about oil economics and how the current low price of fuel at the pump will impact the mix of vehicles sold. It seems apparent that small vehicles will need to be heavily incentivized to keep the assembly lines running and to minimize CAFE fines. This will reduce residual values on those vehicles. There were some estimates on how long the moderate fuel prices will last, up to 24 months. As someone who was raised in the oil patch to an oil company family I have watched OPEC curtail its own production to maintain price equilibrium. In fact, they produce about the same amount of oil today as they did 40 years ago when the population of the earth was half what it is today and consumption much less than today. This is despite the fact that OPEC had 5 members then, and 12 today. However, OPEC has on occasion allowed the global market price of oil drop to drive out high cost competitors. They are the low cost producer and Saudi Arabia is sitting on around $700 billion in dollar reserves. I recall distinctly the oil glut of the mid 1980s. The economies in oil patch states took major hits. There were huge numbers laid off from various oil companies during that era. Just last week Schlumberger announced a layoff of 9000 workers.

It is hardly a surprise when a cartel acts like a cartel. Frackers, sand and shale producers, ethanol producers, EV car manufacturers, battery makers, etc. will take a hit. With the world market price of oil below the cost of production where would Keystone get the traffic it needs to pay its debt service?

The issue in the U.S. has NEVER been our dependence on foreign oil. The issue is our dependence on the global market price of oil as controlled, or at least heavily influenced, by OPEC. Does anyone think an American oil company would sell its oil to American consumers for less than the global market price? In fact we know the answer, because when we tried price caps in the 1970s, the response of the industry was to leave oil in the ground.

Oil is a fungible commodity. It makes little difference from a price standpoint if the fuel we put in our cars came from a foreign country. Yes, it is always nice to keep money at home, and with all things being equal, the transportation advantages means a lot of domestic oil stays home. But that doesn’t have a major bearing on the price.

Saudi Arabia finds itself in an interesting position. The Sunni Saudis aren’t fond of their Shiite Iranian OPEC partners. Through their policies they cooperate – though that is likely not their primary motive – with the U.S. Government in its sanctions against Iran for its nuclear program as well as its financial support of terrorist groups in the region. Their policies likewise support the Administration in its desire to curtail the oil revenue of ISIS. Their policies, intentionally or otherwise, reinforce our sanctions on Russia over its Ukrainian incursion. The low price of oil doesn’t help Venezuela either, something that might please the Administration. Low fuel prices will give the U.S. economy a real shot in the arm and it could carry through the next election cycle. The EU may avoid another recession, which also helps the U.S. At the same time, the Saudis are accomplishing what they wanted to accomplish all along, which is to force high cost producers to fall by the wayside. As production wanes, the global market price will rise on its own. It will take time for it to come back online. During previous periods of “glut, many ethanol plants went bankrupt. It may well happen again.

The Administration will have to bite its tongue as their alternative fuel initiatives will become less interesting. There will be less conservation. CAFE might have to be revisited. There are rumors of EV inventory piling up. Of course we find an emphasis on fuel efficiency in the policies of Europe, Japan and China. That leaves pressure on American producers, from Toyota to GM, to engineer and make fuel efficient, and hence often small, cars and light trucks. They would really like to add US volume to spread their cost base. So there are lots of tensions building.

My best guess is we will see moderate oil prices for 24 months or longer barring anything unforeseen.

Auto Finance Sub Prime Bubble?

I don't think so. For some reason, the New York times jumped on an Equifax report, cherry picked data to suit a sensationalistic agenda, and published the piece on Dealbook (link). Many have weighed in since, including myself – see below! Other examples are Marketwatch and a NYT Op-Ed

Written for Auto Finance News

By David Ruggles

A recent report from Equifax Inc., which noted that originations and total outstanding balances for subprime auto loans have hit recent highs, triggered an alarmist article on subprime lending in The New York Times. In the July 19 piece, authors Jessica Silver-Greenburg and Michael Corkery cited anecdotes that leave the impression that fraudulent practices are widespread. They castigate the “high” interest rates on subprime loans without mentioning the high rate and expense of default and repossession. Repos can reach a third of originations, and collection practices ― which are expensive to begin with ― are a challenge on these loans.

Through April, 2.6 million subprime loans were originated, representing 32% of all auto loan originations, according to Equifax. The outstanding balance of those subprime loans totaled $46.2 billion, an eight-year high. Equifax defines “subprime” as loans to customers with credit scores of 640 or below. As a matter of record, though, in some circles, a loan is deemed subprime when the credit score drops to 580.

The American Financial Services Association and other industry professionals have since weighed in on the NYT article, noting that it enflames already-riled regulators. And Derek Kreindler, managing editor of TheTruthAboutCars.com blog, writes: “Don’t expect that 32% figure to let up anytime soon. The glut of credit available for auto financing ― driven by securitized subprime auto loans being sold as investment-grade instruments ― is going to keep the auto financing business alive and kicking for the foreseeable future.”

I have seen many articles trumpeting the danger of the expansion of subprime without proper context. It is one thing to have data, but quite another to interpret it properly. In the Equifax report, Deputy Chief Economist Dennis Carlson called the increase in subprime lending “good news,” adding that “a fully functioning second-chance market is essential for a healthy economy.”

I would be pleased if people would stop acting like subprime auto financing had a damn thing to do with the global economic meltdown in 2008. It didn’t. Subprime auto financing is nothing like the subprime home lending issues of the past decade, and $46 billion of total outstanding balances on all subprime loans is miniscule compared with the size of the overall economy and a drop in the bucket compared with the mortgage market.

Meanwhile, the ratio of subprime auto originations, including the buy-here, pay-here sector, has hovered around the 30%-to-35% mark for more than a decade. After all, more than a third of the population has a credit score below 640. Kind of makes sense, right? People need cars, and those originations include new and used loans, although they are mostly used.

To be clear, despite the sky-is-falling tone of the NYT piece, Equifax said “serious” delinquencies of 60-plus days remained near all-time lows, and represented less than 1% of total outstanding balances.

A quick call to Melinda Zabritski, director of auto finance at credit bureau Experian, revealed the following: First, the Great Recession spurred the average credit score of U.S. consumers to take the hit one would intuitively expect. Second, when credit dried up, many people ― except for the highest credit score consumers ― turned to BHPH or subprime finance, as one might expect. The stat cited in the NYT article compared subprime originations today with the dark days of the credit crisis, when capital for that kind of lending was completely dried up. Why pick a point in time that is obviously an anomaly, if one is trying to tell a story in real context?

Third, lenders are looking at the near-prime and subprime markets in a search for yield unavailable in the highly competitive prime lending space. Fourth, fast-track credit ― the point at which a dealer can send a contract to a lender without first calling it in for formal approval ― is now 720, up from 690. There are more strict debt-to-income and loan-to-value parameters, as well. Fifth, and perhaps most importantly, millions of consumers have been able to rehabilitate their credit through subprime financing ― and there will be millions more. An accurate portrayal of the Sub Prime market would have at least mentioned this.

There are some who equate subprime auto lending to with mortgages made under the Community Reinvestment Act. Nothing could be further from the truth. CRA mortgages are NOT inherently "Sub Prime." According to the Federal Reserve, CRA mortgages have outperformed the mortgage market overall.

Also, as a matter of record, most of the mortgages that soured during the mortgage crisis were not subprime. Many people with excellent credit walked away from mortgages where they were paying off, for example, $450,000 on a $250,000 home. Yes, their credit score took a hit, and they might have had to get a subprime auto loan to buy a car. It will take some time to repair all the damaged credit. This has played its own part in the slow economic recovery.

Despite the NYT piece, clearly fueled by a desire to create controversy where the facts don’t indicate controversy exists, it’s time for everyone to take a deep breath and keep both feet firmly planted on the ground. There is no subprime bubble.

Sparks from Orlando

David Ruggles - Ward's Dealer Business

One of the more interesting occurrences taking place in Orlando during NADA convention week actually happened at the American Financial Services Association (AFSA) conference held at the Peabody Hotel earlier in the week. The conference preceded the J.D. Power conference and the NADA convention. One of the most anticipated presentations was to be given by industry forward thinker and innovator, Dale Pollak. Many of the attendees were curious to see what Dale would have to say to a room full of bankers.

Pollak made the case that technology could better determine retail values by sampling actual prices posted on dealer pre-owned inventory in each market. It then followed, based on Pollak’s reasoning, that wholesale and loan values could then be established by calculating backwards from the market driven retail price. He then asked the room full of bankers, “Wouldn’t it make more sense to lend based on actual market numbers rather than the theoretical numbers provided by the “guide books?”

Of course, this new concept assailed the current and historical practice of lenders and dealers using the guidebook numbers provided by Kelly Blue Book, Black Book, and NADA, which use much different methods from what Pollak proposed to establish their values. Adding to the intrigue is the fact that Pollak’s company, vAuto, is under the same Cox Enterprises/AutoTrader corporate ownership as Kelly Blue Book and Manheim Auctions. Manheim Market Report (MMR) has become a commonly used appraisal tool for dealers these days.

Mike Stanton, VP and COO of NADA Used Car Guide took the microphone when the floor was opened up for Q&A. Clearly irritated at having his business assailed in a public place by a partner of NADA University, Stanton made the assertion that Pollak had misrepresented the methodology used on the sixth floor of NADA headquarters, where the NADA guide book staff crunches the numbers for the iconic values guide. There was an uncomfortable hush in the room as the discussion unfolded.

In a later conversation, Stanton itemized a number of potential problems with Pollak’s new concept, including the fact that all possible vehicles are not necessarily available for sale in a given market at any single point in time to provide consistent retail pricing. In other words, single markets do not always provide enough units of each example to be statistically relevant. Then there is the issue of price sampling inventory with inconsistent mileage. In addition, lenders need a certain “smoothing” in the values they depend on to make lending decisions as value volatility can be unnerving to lenders. To be sure, NADA in particular, has improved its methodology in recent years after dealer margins were pinched when the relationship between actual wholesale values and retail values were not accurately reflected when the used vehicle shortage caused auction prices to skyrocket in 2009.

With retrospect, it is easy to imagine that the participants in the discussion would have preferred that it had unfolded in a different forum. But the genie is now out of the bottle. It will be interesting to see if this discussion has legs. There is a lot at stake.