Auto Financing Gets Creative : Cut-Rate Deals Put Pressure on Banks, Other Lenders

If anyone had asked Alan Baker one month ago whether he intended to buy a new car, he “would’ve smiled and said, ‘No way.”’ But when General Motors began offering 2.9% financing late last month, the Hacienda Heights food-company executive couldn’t resist. He rushed out and bought a new Cadillac.

“I probably accelerated my purchase by at least a year and maybe longer,” he said, noting that this was the first time he bought a car using financing provided by an auto manufacturer. In the past he bought cars using cash or bank loans.

Baker’s purchase helps illustrate major changes that are transforming the $220-billion auto-loan market.

Cut-rate loans by the finance arms of General Motors, Ford and Chrysler have stimulated sales and allowed them to gain a greater share of the auto-loan market. Banks, which a decade ago held three times as many auto loans as finance companies, could lose their No. 1 position by the end of this year, some experts predict.

But the finance companies’ gains have not come without hitches. Car buyers today are increasingly accustomed to low-rate financing or other forms of incentives, industry experts say. Sales fall off sharply when such programs are discontinued.

“It’s like borrowing from Peter to pay Paul,” said Alan Dietor, sales manager of University Ford & Chrysler in San Diego, noting that stronger purchases today may come at the expense of weaker buying later.

Meanwhile, the advent of these low-rate deals--coming amid growing variety in price and style of autos, increased consumer sophistication and other factors--has prompted auto-loan providers to offer a much larger, and often confusing, array of financing options.

Long gone are the days of the standard 20% down, 36-month car loan. Buying a car these days is becoming more like buying a house. Lenders offer no-money-down loans, loans with maturities ranging from two to eight years, variable-rate loans and balloon-payment loans.

“We’re doing things that 10 or 15 years ago we wouldn’t have ever dreamed about,” William E. Odom, president of Ford Motor Credit Co., Ford’s finance arm, said in a telephone interview. “Consumers are much more informed . . . and (loan providers) are much more concerned about what consumers want.”

Charles Newcomer, spokesman for General Motors Acceptance Corp., General Motors’ auto-finance subsidiary, said, “All the traditional assumptions about the auto-finance market are not necessarily true today.” He noted that just as home buyers are increasingly picking 15-year mortgages over 30-year loans--despite the fact that shorter maturities require larger monthly payments--some customers are also asking for shorter-term auto loans, possibly reversing the trend of recent years toward longer terms.

The competition for the auto-loan business--and the need to churn out more low-rate financing deals--is likely to continue, some analysts predict. Car production in the next few years is expected to outgrow demand, as domestic and foreign auto makers add new manufacturing plants in the United States while imports, including those from South Korea and other Third World nations, increasingly flood the market.

The resulting glut of cars could put continued pressure on manufacturers to offer low-rate deals or other incentives to move merchandise. Importers such as Toyota, Nissan and Honda, who have largely refrained from the low-rate wars initiated primarily by General Motors, may be forced to join the fray, some analysts say.

That and other trends could further erode banks’ market share, bankers fear. “There’s no way we can compete with the domestic manufacturers’ captive finance companies when they offer 2.9% programs” like General Motors’, said Patrick W. Harrison, chairman of the consumer credit division of the American Bankers Assn.

The increased need to use computers and other factors are hurting smaller banks and “driving the market to fewer and fewer lenders,” said Robert Monteith, a Security Pacific National Bank official who is chairman of the Consumer Bankers Assn. The association, seeking to stop banks’ market share from sliding, has asked the attorneys general of 13 states, including California, to investigate whether auto-financing firms’ practice of low-rate financing violates state laws regulating credit competition.

The Stakes Are Huge

The stakes in the battle for the auto-loan dollar are huge. Auto loans represent the nation’s largest single category of non-mortgage consumer borrowing, accounting for about two-fifths of the $570 billion in non-mortgage installment debt. At many banks, auto loans account for 10% or more of total loans and other assets, and 50% or more of consumer loans.

To be sure, banks and credit unions are expected to continue to be major players in auto lending, even with manufacturers’ low-rate deals. They are expected to remain strong in “direct” lending, where potential car buyers get loans directly from banks and then take the cash to dealers to buy cars.

But incentive deals by auto firms’ financing arms clearly have hurt banks, particularly in “indirect” lending, where shoppers arrange for financing through dealers, who in turn sell the loans to banks or to auto firms’ finance companies.

In January, 1977, banks held 59.8% of the $82.9 billion in auto loans outstanding, according to Federal Reserve Board data. Financial services companies such as GMAC or Ford Motor Credit took only 18.4%, while credit unions held 21.8%.

But by June of this year, banks’ share had tumbled to 41.9%, while financial services companies’ share grew to 38.9%. Credit unions also slumped, to 14.4%. Other types of lenders accounted for the remaining loans.

“By the end of the summer, I wouldn’t be at all surprised if finance companies became the primary lenders for cars,” Howard Cosgrove, spokesman for the Credit Union National Assn., said.

Trying to Compete

Banks and credit unions, however, are not giving up. They are trying to compete by, among other things, offering their own versions of “creative financing” deals to lure customers.

One of the newest and fastest growing types of loan is the balloon-payment note. Similar to an auto lease, it gives a customer lower monthly payments for a set initial period, such as three years, with the option then of paying off the note with a lump sum, refinancing it or giving the car back to the lender. Such deals may become more popular under tax reform, which will phase out tax deductions for interest on car loans and most other non-mortgage consumer debt.

Banks and credit unions also hope to capitalize by calling attention to what they say are pitfalls in the auto-finance firms’ low-rate deals. They say that low dealer financing rates come at the expense of higher car prices and that consumers may end up buying cars or features they do not really want.

Credit union spokesman Cosgrove noted that buyers using a credit union can get just as good a deal as taking a low-rate offer from an auto-finance firm. For example, he said, a customer financing a $10,000 car with a 36-month loan at 2.9% from GMAC or Ford Motor Credit will pay $290.37 a month. But if the customer took a $1,000 rebate instead of the low rate and got a 10% loan from a credit union or bank for the same 36-month period, the monthly payment would be $290.41--only 4 cents more per month.

Banks and credit unions are also arranging for discounts on cars. Joe Perkowski, chairman of the Credit Union National Assn. and also president of the Minneapolis Federal Employees Credit Union, noted that his credit union has joined with others to offer special sales of used Hertz and Avis rental cars. They also have arranged with local dealers to offer new cars to credit union members at only $150 above the factory invoice price, or at discounts of as much as $600.

Offer Fleet Prices

Other credit unions in California, Texas and elsewhere are arranging for members to buy new cars at fleet, or wholesale, prices. Some credit unions have also offered to match low rates offered by auto-financing companies, although such deals may have ended for now with 2.9% or lower financing available from auto-finance firms, Perkowski said.

Banks and credit unions also have another source of sustenance. While losing share in financing of domestic new autos, they still provide loans for imported and used cars. Some clearly have benefited from the rising share of U.S. sales by Japanese and other foreign manufacturers. The importers, unlike domestic auto makers, generally include banks in their low-rate financing deals by paying the banks to compensate them for funding the below-market-rate loans.

For example, at Security Pacific Credit Co., the consumer-finance arm of Security Pacific National Bank, between 60% and 65% of its auto loans now are for imported vehicles, compared to between 20% and 25% in the 1970s, said Monteith of the Consumer Bankers Assn., who heads an auto-finance consulting unit at the bank.

“If it weren’t for the import and used car business, we’d have no growth,” Harrison of the American Bankers Assn. said. Harrison, who also is executive vice president of Nashville-based Commerce Union Bank, said his bank is not making any loans for U.S.-built autos while the American auto makers’ current low-rate financing deals are in effect. Instead the bank is relying totally on making loans for imported and used cars.

But banks’ reliance on lending for imports may soon be threatened, too, some industry experts say. Japanese and other importers may increasingly use their own in-house financing arms to make auto loans. For example, Toyota Motor Credit Corp., started only three years ago, now covers 30 states and plans to go totally nationwide by the end of next year, said John McLaughlin, administration manager for the finance unit.

Once they set up nationwide financing networks, Toyota and Nissan would probably exclude banks from participating in low-rate incentive deals, Ford Motor Credit’s Odom suggested.

Banks, particularly smaller ones, also face other threats that could make it more difficult for them to compete in the auto-loan business.

Freeze Out Small Banks

One such threat is the growing concentration of dealerships into larger “mega-dealers,” spurred partly by auto makers’ desire to exert more control over their distribution networks, to stress higher volume of sales and to reduce overhead. These fewer and larger dealerships are likely to prefer dealing with larger financial institutions, freezing out smaller banks, Security Pacific’s Monteith said.

Another threat is the growing use of computers placed in showrooms to help customers arrange financing--a practice also growing in the mortgage business. Ford Motor Credit’s Odom noted that his firm is experimenting with computers placed at more than 50 dealerships. The computers can quickly check customers’ credit records and give credit approvals much faster than conventional methods, he said. Banks, too, are expected to link their computers with dealers’ computers for the same reasons.

“Small banks can’t put in place the computer systems we have,” Odom said. “The costs will be too high.”

Another threat to smaller banks is the new and growing practice of selling auto loans on the secondary market to investors or other banks--a practice that has transformed the mortgage market. New York-based Marine Midland Bank was one of the first to try this practice of “securitization” when it sold $23 million in auto loans to the investment banking firm of Salomon Bros., which in turn repackaged them into “certificates for automobile receivables” (CARS) and sold them to investors.

General Motors Acceptance has packaged $4 billion worth of auto loans since December, while Ford Motor Credit is selling loans through private auctions.

May Purchase Loans

While this practice may increase funds available for auto loans and make loans cheaper for consumers, it could also make it more difficult for smaller banks to compete, some experts say, since they cannot generate enough volume of loans at low-enough cost to effectively sell to other buyers. Instead, smaller banks may instead end up buying these packaged loans from auto-finance firms or larger banks.

The next major battlefield between banks and auto-finance firms is likely to be in home mortgages and other financial services. General Motors, Ford and Chrysler are all increasing their involvement in other forms of consumer lending, seeing their car buyers as prime customers for home loans, insurance and other financial products.

GM, for example, literally overnight has become the nation’s largest mortgage-servicing firm and one of the nation’s top five mortgage originators since its acquisitions last year of Colonial Group and Norwest Mortgage, two mortgage-service companies. GM now has 60 mortgage offices in more than 40 states that write mortgages for sale to the secondary market, GMAC spokesman Newcomer said.

Ford, meanwhile, last year acquired a savings and loan firm, San Francisco-based First Nationwide Bank, and is considering offering the S&L;’s Visa credit cards to Ford Credit’s 3.5 million customers. Through First Nationwide, Ford may also offer home-equity loans to Ford buyers. That practice, although insignificant now, could grow if tax reform phases out car-loan interest deductions while keeping mortgage deductions.

But some experts say banks need not worry too much yet about the threat posed by S&Ls; linking up with auto firms. “Marketing to each other’s customers is not that easy,” said Anthony M. Frank, First Nationwide’s chairman and chief executive. Ford car buyers, he said, “aren’t sitting at home wishing First Nationwide will call to offer them a home loan. There isn’t any shortage of home loans.”

Times Staff Writer Greg Johnson in San Diego contributed to this story.