The money game

May 31, 2023

Rising interest rates have created trends and changes in financing for dealers and consumers

As the automotive industry starts to rebound following the disruption of COVID and the subsequent chip shortage, supply chain backlogs are slowly easing, which has led to increased inventory that dealers are selling because of strong consumer demand.

But what has changed for dealers and consumers is the cost of borrowing because of the three percent interest rate jump from March 2022 to January 2023.

This has resulted in changes for banks and financial lenders because of the fluctuation in interest rates and concerns about the economy.

“For sure we’re starting to see consumers beginning to return to showrooms, particularly as the replenishment cycle and new inventory becomes available,” said Gino Caputo, Senior Vice President and Head, TD Auto Finance Canada at TD Bank Group.

“The flipside to that is the rising rate environment over the last 12-18 months has obviously had an impact on higher interest rates that are impacting everything from floorplan financing and terminal financing for consumers.”

This impacts many aspects of dealer operations, including the costs of acquiring new stores. “When you think about the dealer, it’s the floorplan that has gotten more expensive as well as making acquisitions,” said Caputo. “Over the last 18 to 24 months, there’s been a fair bit of consolidation amongst dealership groups getting bigger, so acquisitions go to a dealership with high inventory because (dealers) have to move it quickly. It costs more for dealers to acquire inventory and fill up their lots.”

Caputo said in general the balance sheets of dealerships are significantly better going into this potential downturn or softening cycle than they would have been prior to it. He said because of that it has made the ability for banks to finance dealerships, even on floor plans, in a better position.

“When you think about longer-term interest rates and the impact that has had on valuation, particularly on acquisition of real estate and acquisition of other dealerships which a lot of times includes goodwill financing, I would say we have seen a softening in demand to acquire,” said Caputo.” We’ve seen peak multiples on top of peak earnings because dealerships have seen the best profitability in a generation over the last 18-24 months. But from our perspective it hasn’t been so much that we’re less interested in financing acquisition because we will.”

Grant Simons, Head of Automotive Sales at Royal Bank Canada, said his company is “extremely bullish” as it relates to the automotive industry and the financing of dealerships and acquisition of other dealerships.

“The dealer community in Canada is very strong, they are very resilient and are professional operators,” said Simons. “Interest rates are one input into that, but we are also seeing shorter inventory turn times. Yes interest rates are up, but vehicles are not sitting on the lots for a particularly long period of time. Manufacturers are providing the right mix of vehicles that the dealers and the customers are looking for. There’s a lot of throughput through the system right now that generates economics for everyone.”

On the flipside is the consumer and the availability of loans. Jill Hadfield, President Dealertrack Canada, said the “credit worthiness” of consumers increased in 2022 from 2021.

“Not surprisingly, as car prices go up, consumers need better credit scores to get approved,” said Hadfield. “As such, the prime and super prime bands both saw significant increases in consumer credit scores versus 2021. However, the total number of consumers buying vehicles within those score bands remained flat year over year. There was also a slight increase in the number of subprime and deep subprime consumers year over year. As rates are going up, lenders are broadening their risk profile, leading to more lenders to compete over a larger cross section of subprime and near prime consumers.”

Caputo said the higher-interest cycle has made it harder, though not impossible, to provide loans for customers who have credit problems.

“With every downturn comes greater need for us to consider how we finance the non-prime and near-prime,” said Caputo. “At TD Finance Canada, we see ourselves as the only full-spectrum lender in Canada offering full range from prime, near-prime and non-prime, both for new and used vehicles. We also look at the opportunity on an individual basis, particularly near the non-prime area, for customers to re-establish their credit. Higher interest rates are going to have an impact on non-prime, near-prime and, to a lesser extent, the prime segment, but (banks) have to make individual decisions based on the individual situation to those borrowers and consumers. Particularly in the non-prime and near-prime, we consider the whole profile of the consumer when making those decisions. We’ve been doing it for a long time. We’ve been in that space and know what to look for, and of course we want to be as stable as we possibly can throughout the credit cycle in providing financing to customers.”

For Simons, from RBC, there are always situations in which individual credit isn’t strong enough to warrant purchasing a specific vehicle. He added in those situations his bank looks for strategies to provide some options for the consumers, such as changing amortization or changing down payments.

“Even at the best of times there are credit applications that don’t work,” said Simons.

“We work very closely with consumers who are experiencing financial hardships. We’ll look for ways to help them find a workout scenario that meets their needs and the bank’s as well.”

One evolving trend is consumers going online to determine their credit rating rather than going into a dealership to buy a car and going through the whole sales process before meeting with a finance and insurance manager and finding out they don’t qualify for a loan.

There are many financial companies that provide pre-loan car loans and there is also an increase in technology to do it. Get Auto Finance started last July with an online program to help consumers in the subprime category to get pre-approved for cars and understand the interest rates.

“The biggest thing we’ve seen now is a lot of newcomers to the country (with no credit),” said Daniel Stein, Chief Executive Officer of Get Auto Finance. “Our finance managers specialize in educating the customer and spending time with them so they understand. The finance managers take the customer all the way from the beginning to the end and get them pre-qualified. If the interest rate is a little bit higher, they explain why and how (customers) can build their credit as well, and if it’s a bad credit how to rebuild their credit. There’s lots of lenders out there that do bad credit, no credit and near prime as well, but the customers end up seeking more online after the fact because they’ve spent so much time at the dealership without actually knowing they couldn’t get that car that they went and chose.”

Related Articles
Share via
Copy link