Riding the Waves

Last year, I said that the waive of credit defaults was just beginning. First to go were those subprime loans which should never have been done in the first place, many a result of fraud and/or greed in the mortgage and real estate business. It was obvious that these loans would default. Debt and payment ratios were out of whack, in both mortgages and auto loans, and it was inevitable that these loans would go bad sooner or later.

The second waves of defaults were people who initially could afford their loans, but severe income reductions or unemployment left them unable to pay their bills. No one expected the economy to turn around so badly or abruptly, and people making good money suddenly found themselves in the situation where their payments exceeded their income. This group probably includes those newbie investors, who bought investment properties with little or no down payments, and found themselves unable to pay the mortgage or sell the property. Buyers were scarce, and mortgage money dried up. Values crashed, and many of these folks walked away from their investment properties, trying to save their primary homes.

Now we come to the third wave - folks who can still pay their mortgages or car payments, but owed so much more than the collateral is worth that they are simply walking away. Credit scores are getting trashed, but what's worse is that these folks don't understand how to deal with their newly damaged credit. People with 700+ credit scores are finding themselves faced with the prospect of trying to secure credit with a score, in some cases in the low 50o's or even lower.

For the most part, the customers care little about the consequences of their actions. Many are still under the assumption that, because “everyone is doing it”, defaulting on their loans shouldn’t matter, and they should still be entitled to low interest rates and no stip loans. They balked at providing proof of income, or phone bills and references, figuring the lender shouldn’t require and documentation for their loan. However, lenders I deal with are now asking even good credit customers for POI and POR.

Many dealers I talk to have cut back their subprime departments, finding it too difficult to do these deals anymore. Prime deals are getting tougher, and F&I profits are shrinking. But faced with the new waive of subprime customers; maybe dealerships shouldn’t completely abandon special finance. Now is the time to put your ace in the game, the special finance expert you hired to help get through these tough times. Lender relationships, knowing what deals to send to what lenders, will help dealers sell more cars, make more money, and earn new customers who appreciate a true professional, who can guide them through this newly uncharted territory they face.

I’d like to think we’re starting to see the light at the end of the credit tunnel. I just hope it’s not the headlight from the oncoming train!

Auto Loan Applicants Face Tougher Scrutiny

Dealers Must Heed Lenders’ Demands for Proof of Income, Residency, Phone Bill

By Donna Harris
dharris@crain.com
Automotive News 10/12/09

Dealer consultant Frank Martin has come to expect auto lenders to call a customer's cell phone to confirm the customer's credit information – right in the middle of the finance transaction. It is just a sign of the times.

“Even customers with high Beacon scores get calls," says Martin, who works in Boca Raton, Fla., and sometimes fills in for absent F&I managers in the stores he serves in the Southeast.

In many markets, major lenders are requiring proof of income and sometimes proof of residence even from customers with excellent credit.

Although lenders have stepped up standards during the credit crisis, finance experts also attribute this intense scrutiny to additional factors:
- Some banks report an increase in fraudulent credit applications related to the credit squeeze,
- Identity theft continues to rise.
- Lenders are subject to greater government regulation requiring them to confirm the accuracy of customer information.

Like A Mortgage
"We have seen credit restrictions the rise in each of our regions throughout the last eight to nine months even on high-prime customers," says Jeff Dyke, executive vice president of Sonic Automotive Inc., the nation's fourth-largest dealership group based on new-vehicle unit sales last year. "That includes both proof of income and proof of residence."

Chuck Butler, owner of Butler Automotive Group, says that over the past year, applying for a car loan has become almost as complicated as applying for a home mortgage.

Butler says lenders require that total debt be no more than 50 percent of income, giving them a huge cushion, "They used to allow as high as 70 percent debt," says Butler, whose dealership group encompasses four import and domestic stores in Medford and Astrland, Ore.

Julie Westermann, a spokeswoman for Bank of America, says the bank has adjusted its underwriting model to require proof of income but typically just for customers with credit scores at the lower end of prime. Experian defines prime customers as those having credit scores between 680 and 739.

Gil Rabani, finance manager for Vacaville Pontiac-Buick-GMC in Vacaville, Calif., says the lenders he works with are focusing on customers' phone numbers. "If the name and number don't match with the name, phone number and address listed in their records, customers not only have to prove income but provide a phone bill," Rabani says.

Ken Basdeo, finance manager for Star Auto Group in Queens Village, N.Y., says some major lenders are requiring proof of income on customers with A+ rating. "For 75 to B0 percent of the deals, we're required to provide proof of income and proof of residence," Basdeo says.
.
Some banks report an increase in fraudulent credit applications. Dealership employees and their customers are sometimes inflating income on the credit application to boost the chances of obtaining financing.

Identity Theft Rises
Identity theft also is rising. Such theft affected almost l0 million victims in the United States in 2008, the latest data available from the Javelin Strategy and Research Center, up 22 percent from 2007.

"Fraud has been increasing as the economy continued to sour," said Nicholas Stanutz, senior executive vice president of dealer sales for Huntington National Bank. Stanutz estimates credit fraud is up l0 to 15 percent.

Martin's firm provides temporary help to dealerships when the F&I manager is out sick or on vacation. The Florida consultant says lately, dealers have called on his firm to fill the job because they fired the finance manager.

"Many dealerships have become more seriously proactive in preventing fraud," Martin says. "What used to be a slap on the wrist has now become cause for termination."

Red Flags
All financial institutions must comply with the federal Red Flags rules requiring them to create a written plan to protect consumers from identity theft. Although enforcement of the rules was postponed a year to Nov. 1, many lenders already have stepped up their efforts to confirm customers' identities.

"No one wants to be the clerk that overlooked inconsistent proof of income or the credit manager that approved a deal with something missing," says Charles Ognibene, a Boston attorney who represents major banks and finance companies.

While Ognibene says regulation has prompted closer scrutiny of every deal, competition also comes into play: "Before the credit crisis hit, if a finance company pushed back an application because something was inconsistent and asked for more information, the dealer might have gone to another finance source. Now, with limited finance buyers, the dealer must heed when his finance buyer demands that i's be dotted and t's be crossed."

Consultant Martin agrees: "No one can afford to be cut off by a lender who is actively buying their paper. "

Sub Prime Car Buyers Still Can Find Credit

Customers Face Larger Down Payment, Shorter Loan Terms

By Arlena Sawyers – asawyers@crain.com
Automotive News 10/12/09

Even though credit is tight and captive finance companies are focused on prime customers, sub prime customers still can find credit, say dealers, lenders and other financial experts.

Melinda Zabritski, director of automotive credit at Experian Automotive, says lenders are requiring larger down payments and shorter loan terms from all consumers – especially those with sub prime credit - in an effort to manage the lenders, risk.

"It makes sense," Zabritski says. ,,As banks better manage that risk, it helps them offer better loan products to the general market."

Willing To Lend

John Cavanaugh, CFO of Automotive Credit Corp, in suburban Detroit, says many lenders have either reduced their sub prime lending or pulled out of it altogether. But Cavanaugh's company is in it for the
Long haul.

Ln late September, Automotive Credit announced that it had secured a $50 million line of credit from Wells Fargo Preferred Capital, a subsidiary of Wells Fargo & Co.

Automotive Credit purchases the loans of auto buyers with credit scores of 500 and below. About 60
Percent of its customers are franchised dealers.

"Our portfolio is performing well, and we continue to have good access to capital that allows us to grow our business and do what we’ve done successfully for a long time,', Cavanaugh says.

Jonathan Neubauer, CEO of Vehicle Acceptance Corp., of Dallas, provides financial services for dealers who operate buy-here, pay-here operations. Neubauer says his company provides dealers cash advances that when coupled with a customer’s down payment, can cover the dealer's investment in the vehicle. Vehicle Acceptance charges dealers a flat fee to service and collect loan payments.

A small number of the dealers that do business with the company also have new-car franchises, Neubauer says. "We're trying to get the word out that we are lending money,,, he sa1n. "We are willing and able to lend money to buy-here, pay-here dealerships."

The Right Vehicle

Experian Automotives Zabritski says 12 percent of people who purchased vehicles in the first half of
2009 had sub prime credit scores of 550 to 619, down from almost 15 percent in the first half of 2008.

She attributes the decline to a number of factors, including lenders that didn't provide financing or consumers who could not qualify for loans.

Consumers qualifying for deep sub prime loans - scores under 550 - made up about 16 percent of vehicle buyers through June, up from l5 percent in the same period last year

Anthony Stalworth, vice president of sales and marketing at Automotive Credit, says sub prime financing works best when dealers provide customers the right vehicles. He ,says those vehicles typically are 2 to 7 years old, a domestic brand and in good condition.

"That is where the biggest amount' of depreciation is already off the cost of the vehicle and allows our customer to get in at a reasonable payment;" Stalworth says.

"lf they do a good job putting the 'customer in a nice car and treat the customer right, we have a much better job of collecting”

No Cash, No Car

Bill Perkins, owner of two Chevrolet dealerships and a Buick-Pontiac-GMC store in suburban Detroit, promises customers he will find them financing - no matter their credit history- with one caveat 'they have to have $1,995 down; you can't buy a car without cash now, says Perkins, who sells about 140 used vehicles a month at his three dealerships. About 40 percent of the used vehicles he sells are to customers with sub prime credit.

Tony Testo, sub prime finance manager at Landers Automotive Group- in Little Rock, Ark., which handles nine new-car franchises, says he works with five financial institutions to finance his sub prime customers.

Testo says he spends an hour or i more with each customer explaining that he can get them into a good 3- to 6-year-old vehicle, but they will have to pay higher interest rates because they are high-risk customers' Testo also tells customers they need to have a down payment, typically $500 to $2,500. Testo says he empathizes with customers who find themselves in a financial bind, but he wants them to be realistic about their vehicle purchase.

"most of these people have been banged around, treated badly and told no over and over again," he says' "i tell them yes, but we have to do this together

Thank Goodness He Didn't Try To Finance A Car!

Michael Jackson’s credit score: 564

by Karen Datko

TMZ, the news source for all things Michael Jackson, expressed amazement that MJ had terrible FICO scores.

"Here's a shocker -- Michael Jackson had an abysmally low credit score," said a story at the Web site. In 2007, TMZ says it has learned, Jackson's scores from the three major credit bureaus were 592, 524 and 575, averaging out to just under 564.

It's really no surprise, considering his well-documented ultra-extravagant spending and financial woes, including the fact that Neverland Ranch nearly slid into foreclosure. But there's a lesson for everyday people in the specifics that caused the King of Pop to have poor scores.

Here are the reasons given in the TMZ report:
- A derogatory public record or collection filed.
- The amount owed on delinquent accounts.
- Number of accounts with delinquency.
- Too many inquiries in the last 12 months.

To put this in perspective, FICO scores have a range of 300 to 850. A score under 620 puts you in the subprime market. (Experian offers a state-by-state look at average scores and debt.)

Michael Jackson may have made a mess of his finances, but he did prepare a solid estate plan, including a will, a living trust, and trustees and executors who are experienced and knowledgeable.
All told, Jackson's estate is worth hundreds of millions -- a number that's still being figured out. The total is expected to be considerably larger than his estimated $435 million of debt. Plus, the size of the estate has grown by $100 million since he died on June 25, and is expected to make $50 million to $100 million a year, The New York Times says. Compare that with the $55 million Elvis Presley's estate earned last year. The NYT also said:

In life, Mr. Jackson faced a precarious financial future, as he piled on debts to finance his tastes in art, to travel on private jets and to keep up Neverland. In death, his estate may enjoy the financial security he never had.

Jackson will be buried on Sept. 3, according to the Glendale News Press

Will the real FICO score please stand up?

by Karen Datko

This post comes from partner blog The Dough Roller.

Earlier this week we took a look at how to get your free FICO credit score from myFICO.com. Operated by the Fair Isaac Corp., creator of the FICO credit score, it offers consumers a free credit report and FICO credit score when they sign up for a 30-day trial of Score Watch. The FICO credit score myFICO.com provides is from Equifax, one of the three major credit bureaus.
And that's where some confusion can creep in.

There are three major credit bureaus: Equifax, TransUnion, and Experian. And each of these credit bureaus calculates a consumer's FICO credit score, which can be and usually is different for each credit bureau. In other words, you likely have a different FICO credit score from each of the three major credit bureaus. And to add to the confusion, each of the credit bureaus calls its version of the FICO credit score by a different name.

So let's quickly sort all this out:

FICO credit score. FICO stands for the Fair Isaac Corp., the company that created the formula for the FICO credit score. Fair Isaac was founded in 1956 by engineer Bill Fair and mathematician Earl Isaac.

Fair Isaac does not calculate credit scores. While Fair Isaac created the FICO formula, it does not actually use it to calculate a consumer's FICO credit score. To use the formula, one needs credit information about the consumer, and that's where the credit bureaus come in.

Three credit bureaus. The three major credit bureaus in the United States use the FICO credit score formula to calculate a consumer's FICO credit score.

Three different scores. Because each of the three major credit bureaus has slightly different information on each consumer, the FICO credit score it calculates is usually different from the others. As a result, most consumers have three different FICO credit scores.

Three scores and three names. Each of the three credit bureaus has branded its FICO credit score with a different name. Equifax calls its score the Beacon score; Experian calls its score the Experian/Fair Isaac Risk Model or Score Power; and TransUnion calls its version of the FICO credit score Empirica.

VantageScore: You may have heard of VantageScore, which is a credit score formulation created in 2006 by the three credit bureaus in an effort to compete with the official FICO credit score. VantageScore has not been widely adopted by lenders and creditors.

Clear as mud, right? Now, how do you get your credit scores? As you may know, consumers can get a free copy of their credit reports from AnnualCreditReport.com. But if you want your FICO credit score, myFICO.com is the place to go, while FreeCreditReport.com offers its own version of a credit score. Here are the details:

MyFICO.com. MyFICO.com is run by Fair Isaac and offers consumers a credit-monitoring service called Score Watch. When you sign up for a free 30-day trial of Score Watch, myFICO.com gives you a free copy of your credit report and FICO credit score as reported by Equifax. You can also purchase from myFICO.com your credit report and FICO credit score as reported by TransUnion for $15.95.

FreeCreditReport.com: Known for its snappy commercials, FreeCreditReport.com is run by Experian. It offers a credit-monitoring service called Triple Advantage Credit Monitoring. In exchange for signing up for a seven-day free trial, you'll receive a copy of your Experian credit report and a credit score from Experian that is not a FICO score.

Stop The Madness!

Insanity reigns these days, or so it seems. Customers continue to make ridiculous offers or expect miraculous finance options, regardless of circumstances.

I am bombarded daily by customers who view our inventory on our website, and offer to purchase a vehicle for thousands less than we have it listed at, with the caveat that “I’m paying cash!” It seems that many consumers believe that we are so cash strapped that we will take any offer, so long as it’s in “dead presidents”. They are amazed when I graciously decline their offer, explaining that when we advertise a vehicle on our website, we list it at the lowest price we can sell it for. After all, why spend money to advertise something if you can sell it cheaper than you advertise it for?

It makes sense to me to advertise on the Internet the lowest sale price for a vehicle. The Internet allows us to reach well beyond our local marketing area, and although many of our local customers find us through our website, we sell to customers all over the US as well as the world. In the last thirty days, we sent vehicles to Tennessee, Mississippi, Maryland, and South Carolina, as well as Nigeria and the Caribbean. Our advertised prices are typically among the lowest on the web, and our out of town clients appreciate the fact that we sell vehicles at reasonable prices.

Our local clientele are the ones who tend to make ridiculous offers. I’ve had customers offer cash deals, but then not have the cash. Finance customers who can’t, or better yet, won’t prove their income. And out of state or even out of the country customers who want BHPH on a $23000 vehicle with $1000 down!

The biggest obstacle these days seems to be first time buyers with overzealous expectations. Trying to convince these customers to consider a more reasonable vehicle than a $17000 or $18000 vehicle is an obstacle we consistently have to overcome, albeit with less success than we would like to be enjoying. The “you’ll do anything to make a deal” mentality still permeates our marketplace, especially since we are the foreclosure capital of the nation! Many of our customers are past due on their mortgage, or in foreclosure, and think that lenders should overlook this fact. After all, isn't everybody in the same boat?

Once upon a time, people with bad credit felt some remorse over their situation. “Bad things happen to good people” we used to say, and customers with credit issues understood their options were limited. Many realized that there were dealerships out there that were willing and able to help them get a car, although some used tactics and techniques that were less than honorable.

Ultimately, many of the unscrupulous dealerships and there people were caught and punished, and in many instances, those folks responsible for abuses and fraud ended up in jail. Of course, the local news shows love nothing more than a car dealer or his employees getting taken away in handcuffs in front of the camera!

I wish the media would stop telling people that we dealerships are in dire straights, that we are all facing bankruptcy or about to go out of business. While some independents down here in south Florida have closed their doors, most of us are still in business and doing pretty good, if not flourishing. Is traffic down? Yes! Is it harder to get inventory? Absolutely! Are lenders tightening their standards? Without a doubt! But regardless of all these issues, we’re still selling cars and making money. And isn’t that what it’s all about?

Coming: A 3rd Wave of Foreclosures

The next group of Americans to lose their homes seemed to have good credit and affordable loans. But those families have been walloped by the recession.

By Michael Brush -MSN Money

There's a simple reason you shouldn't get too excited about the "green shoots" of an economic turnaround.

In the housing market, a lot of prime mortgages are becoming subprime as a new wave of foreclosures begins to hit. Mainstream homeowners -- those previously "safe" borrowers with sound credit who have conservative, fixed-rate mortgages -- are getting into trouble at an alarming rate.

In the first quarter, the percentage of these borrowers who were behind on their mortgages or in foreclosure had doubled from a year earlier, to nearly 6%. For the first time in the housing crisis, these homeowners accounted for the largest share of new foreclosures.

Job losses are a major reason once-safe borrowers are falling into trouble. With unemployment likely to rise, the problem will only get worse. So the core challenge at the heart of our economic crunch -- a poor housing market that infects banks and the whole credit system -- is not going away soon. That's bad news for the stock market and the economy in general.

"A couple of months ago, a lot of people had hoped that the housing collapse was about over," says money manager and forecaster Gary Shilling, a well-known bear who called the housing problems early in the cycle. "But it was more hope than reality."

The 3rd wave of woe

Economists call rising delinquencies and foreclosures among prime borrowers the third wave of trouble. The first two waves were housing speculators going bust and subprime borrowers -- those with poor credit histories and some version of no-down or low-down adjustable-rate mortgages -- getting into trouble.

Mark Zandi, the chief economist for Moody's Economy.com, calls the third wave a "significant threat" to the economy. "It is gathering momentum," he says. "The problem is now well beyond subprime and deep into prime."

It will cause at least three problems that could shrivel the "green shoots":
-Mounting foreclosures among prime borrowers will destroy their credit ratings, making it tough for them to contribute to growth by spending on credit.
-Rising foreclosures will add to an already high level of housing inventory on the market, pushing down home prices even more. That will make people feel poorer, so they'll spend less. It also will tempt more people to walk away from mortgages, adding to the problem.
-Foreclosures will mean more loan losses at banks, deepening the problems in the financial system.

Investment opportunities?
How do you play this as an investor? Well, if you missed the 30%-plus move off the bottom since early March but you're still confident enough to tiptoe back in, don't do anything more than that. Average in on down days.

Better yet, wait for the market pullback that this third wave makes more likely. Shilling has a bearish forecast of a trip down to 600 for the S&P 500 Index, more than a 30% decline from recent levels of 940.
Investors confident and daring enough to short stocks -- selling borrowed stock with the hope of buying it back later at a lower price -- may find profitable targets in the housing sector and among the regional banks. Homebuilder stocks look particularly tempting; they have risen more than 50% off their March lows on hopes for a quick recovery.

Whitney Tilson, a co-portfolio manager of the Tilson Focus Fund who also spotted the housing crisis early on, was recently short KB Home, Lennar and Toll Bros. in housing. He also has bearish bets against regional banks Regions Financial, First Horizon National, Zions Bancorp and New York Community Bancorp.

The 'subprime society'
Shilling suspects many so-called prime borrowers are now going bust because, well, they really weren't so prime to begin with. The same lax standards that created a zoolike atmosphere in subprime lending infected prime mortgage lending to some degree. Many prime borrowers still stretched to qualify, and they lack the financial reserves to sustain any personal setbacks, Shilling says.

A few months of unemployment will throw them into default. The official unemployment rate stood at 8.6% in April, and many economists believe it will top 10% as the recession drags on.

How much worse will the foreclosure crunch get? Credit Suisse analyst Rod Dubitsky predicted last week that 8.1 million mortgages, or 16% of all mortgages, will go into foreclosure over the next four years. A weak economy, continued declines in home prices and rising delinquencies among prime borrowers all but ensure that foreclosures "will march steadily higher," he says.

Dubitsky thinks such a high level of foreclosures could transform the U.S. into a "subprime society." The large number of people unable to borrow because of impaired credit will keep the consumer-spending engine on low idle.

Zandi predicts that a rising number of troubled prime borrowers will keep the number of distressed mortgages aloft for at least 18 more months. He thinks the number of mortgages in default or behind by more than 30 days (the definition of distressed) will rise to 9.2% in the current quarter from 9.1% in the first quarter, then stay above 7% through most of next year.

To put that into context, from 2000 through the end of 2006, 2.7% of mortgages were distressed, on average, at any one time.

Inventory overhang
A big problem stemming from all those foreclosures will be that huge excess inventories of homes for sale will continue to push down prices, Shilling says. "As long as you have those excess inventories, you have downward pressure on prices. It is no more complicated than that," he says.

The combined inventory of new and older homes on the market remained relatively constant at about 2.5 million for many years. Now, it's officially around 4 million, but Shilling thinks it could be higher because of miscounting.

In his bearish scenario, the inventory overhang will push down home prices so much that up to 25 million homeowners will be "underwater," meaning they will owe more than their homes are worth. That would be a huge increase over recent levels of 13.5 million homeowners and bad news for the economy.

Homeowners who are underwater can't borrow against their homes to fuel a rebound. They're reluctant to spend. And they are more tempted to simply walk away from what looks like a losing prospect.

2 more waves
Bad enough? Well, this third wave of prime borrowers going bust will be followed by two more waves of credit-related problems, Tilson says:
In a fourth wave, more homeowners with "jumbo prime" loans will go into default. These are loans to buy high-end homes that once boasted price tags upward of $1 million. "All over the country, the high end is starting to tip over," says Tilson. This wave will also bring more problems with home equity loans and second mortgages on homes.
A fifth wave will carry rising defaults on commercial-real-estate and business loans.

Like Shilling, Tilson believes all of these waves of credit-related problems spell the most trouble for homebuilders and regional banks. "Homebuilders are going to face severe headwinds trying to sell homes at least for a couple of years," he says.

Regional banks will have problems because they got heavily involved in commercial-real-estate loans when they lost so much of their home-mortgage business to upstarts vying for a piece of the subprime action during the boom. Regional banks also lack the income from wealth management and trading that's helping big banks such as JPMorgan Chase earn their way out of trouble.

There are 'green shoots'
There are some glimmers of hope in all this. For one thing, homes are more affordable than ever. Mortgage rates are still extremely low by historical standards despite a recent increase. So the cost of buying a home compared with average income levels is as low as it has been in nearly three decades.

And intriguingly, a housing sector analyst who first started warning of trouble back in 2003, way ahead of most people, now predicts a reversal is at hand. Stuart Feldstein, the president of SMR Research in Hackettstown, N.J., thinks home sales and prices are turning and will be in an uptrend soon.

One problem here is that Feldstein was early -- even if impressively prescient -- the last time around.

And of course, housing affordability doesn't mean much if so many people continue to lose their jobs. Goldman Sachs Group economist Ed McKelvey doesn't expect the jobless rate to peak until after 2010 -- in a sluggish economy that he expects will grow at a paltry 2% in the second half of next year.

With economic conditions like that, no matter how cheap houses get, it'll be tough for anyone to buy them.

At the time of publication, Michael Brush did not own or control shares of any company mentioned in this column.