Sunday, 13 September 2009

How Do You Measure Quality in the Auto Business?

Am I presumptuous enough to lecture J.D. Power on how to measure quality? Not really. My point is that there is more than one way to calculate vehicle quality. General Motors and Ford are sporting some gaudy J. D. Power rankings these days. Some of their products are ranked as equal to the leading imports. I’m sorry to have to leave Chrysler out of this discussion. It is anyone’s guess where Chrysler’s future quality numbers will end up, given that many important decisions are being made by Fiat. Fiat’s hallmark has not been quality in the past and many dealers, including myself, still have a bitter taste in their mouth from Fiat’s last foray into the U.S. market. But Chrysler/Fiat will be a subject for another day.
So what might be a better measure of quality than J.D. Power and other quality surveys? I submit that resale value is the most important measure of quality as perceived by consumers and the market in general. Quality is more than fit and finish. Quality includes how well an OEM’s vehicles hold their customer’s money together. In this regard Honda and Toyota have set the mark. Other than their traditionally high fit, finish, and NVH (Noise, Vibration, and Harshness) achievements, they have eschewed large volume fleet sales. They have also disdained direct to consumer rebates. As a consequence, their CPO (Certified Pre-Owned) programs serve to strengthen their strong resale values whereas the Domestics are desperately trying to rehabilitate themselves. Consumers do not appreciate the OEM, with whom they just did business, undermining the value of their new vehicle. They might appreciate the rebate they just received that helped motivate them to buy, but they certainly resent waking up one day and discovering they are thousands of dollars “upside down” in their recently purchased vehicles. Many owners of Domestic vehicles don’t find out how bad their financial situation is when they try to trade their vehicle 36 months or sooner into their finance contract. There is no doubt the resale value issue has a strong impact on whether a consumer is a repeat buyer frm an OEM.

Ubiquity is the Enemy of Cachet
So how do Toyota Camry and Honda Accord, two of the best selling vehicles in the U.S. auto market, maintain their cachet in the face of their large sales volumes? In my mind, its boils down to the fact that you rarely see those vehicles in fleet and rental service. In addition, you don’t see consumer rebates advertised. Just as I was becoming sold on the J. D. Power rating on the Chevy Malibu and the good things said about the car in the press, I observed a couple hundred Malibus decked out as taxis at McCarran Airport here in Las Vegas. At the taxi cab pick up station there was Malibu after Malibu rolling up to pick up passengers. It left a bad taste in my mouth. While there are many Toyotas and Hondas coming back into the market as pre-owned vehicles, they are mostly three year old lease turn ins and natural trade ins, whereas there is a much higher number of Domestics recycling in a year or less. Many of these are daily rental turn ins. This, coupled with direct to consumer rebates outweighs any J. D. Power quality ratings in the mind of consumers..

Resale Value, Residuals, and Leasing
Leasing is in the news again. GM and Chrysler have both announced recently they will re-enter leasing. I still can’t get used to the idea that Chrysler finances and leases through GMAC. Chrysler has been out of leasing since last July when lenders forced them to give up leasing as a condition of granting essential financing. GM’s lack of capital and huge residual losses forced GM to scale back leasing last fall. GM will be leasing through U.S. Bank in 5 northeastern states. Other OEMs have continued to lease through their captive finance arms and independent banks. GM and Chrysler have lost substantial market share as a consequence of their not being in the leasing business for the last months.
What is the lure of leasing to an OEM? They can offer lower monthly payments for shorter terms and achieve a higher degree of repeat business through leasing. In addition, there are depreciation credits available as the title of a lease vehicle is held in the name of the OEM. These depreciation credits come in handy if the OEM is profitable. In addition, trade equity and cash down payment lowers the monthly payment a lot more on short term lease contracts than on long term finance contracts. Cycling the consumer more often leads to increased market share when your competition can’t compete. Lower resale value (residuals) means it costs Domestics to subvent their residuals and money factors to be competitive with Toyota and Honda.
And now we see Ford is pushing their new world class Taurus, bi turbo, direct injection, AWD, etc. as a police cruiser. They already devalued the name Taurus in past years by making it the most common fleet vehicle in history. It appears Detroit has not learned their lesson.

Ruggles in Wards, reprinted with permission

Ta-Ta Clunkers; Now What?
Let's hope a dead spot won't follow successful program
By David Ruggles, Ward's Dealer Business, Sep 1, 2009 12:00 PM

Cash for Clunkers has been a surprise success to many, including government.

Hopefully, we won't have a serious dead spot now that Clunkers is kaput. We all know how rebates can be like getting on drugs.

Training consumers not to buy until the next program contributes to a “whip saw” market that makes good consumer satisfaction impossible. It also makes marketing dependent on loading up dealers' inventories and then introducing a program to sell them.

Still, Clunkers was worth it. In my 38 years in the business, this has been only the second time I have seen a federal initiative spark so much sales activity in the new-vehicle business. The first time was when the Nixon administration repealed the excise tax on cars in 1971.

There have been other government initiatives that stimulated sales, but mostly through tax policy. Most recently, the Bush administration provided a substantial tax credit for those purchasing a vehicle over a particular GVW rating.

This was meant to spur the purchase of trucks by ranchers, farmers, plumbers, and other small business people. It also spurred the purchase or lease of Navigators, Escalades, Suburbans, etc. to doctors, consultants, and anyone who could take of advantage of the business write off.

But the tax policy measures didn't have the broad appeal of Cash for Clunkers.

As a consequence, about 707,000 old vehicles have been designated for the crusher. Engines have been destroyed to ensure the clunkers do not find their way back into the system. Initially, this is having an impact on the Buy Here, Pay Here dealers. What the Feds call “clunkers,” they call inventory. Any revival of the program will exacerbate their plight.

Clunkers is not the only factor impacting the pre-owned market. The low seasonably adjusted annual sales rate has generated fewer sales. This means fewer pre-owned vehicles will be available down the road.

A lot fewer rental vehicles have been placed in service. There's a dearth of new leases put on the books. As pre-owned values strengthen, fueled by the inevitable shortage, there will be more people in an equity position than before.

I expect this trend will be tempered by people keeping their vehicles longer. We all know that above-average miles have a major impact on true resale value at auction. But the trend is certainly toward higher pre-owned prices down the road.

Despite the recent rise in pre-owned prices we hear complaints from dealers that some guidebooks' loan values are not reflective of what is really going on in the pre-owned marketplace, so owners who should show equity are shorted by lenders who use those guides in their finance advance calculation.

Another interesting by-product of the strengthening pre-owned market might be the impact of current lease returns to the OEM captives and independent bank lessors.

I am told many lenders took write offs for current and anticipated residual losses. Some of those previously stated losses may turn out to be profits in the current marketplace, which is driven by the pre-owned shortage and low fuel prices.

Pre-owned values can only go so high, but perhaps we have not yet hit the ceiling. Just imagine a world where new vehicles can be sold without rebates or dealer “trunk money.”

A true pull market scenario would strengthen pre-owned values even more and provide even more trade equity for would-be buyers. Might we be able to return to the pre-Joe Garagiola days when the baseball player turned Chrysler TV pitchman said, “Buy a car, get a check” in 1975? My guess is probably not.

The domestic auto makers have trained an entire generation not to purchase unless there is a rebate. In addition, there are just too many competitors all vying for sales. Where will it end up? Nobody knows. Here's hoping those guidebook loan values will catch up with the market. Dealers and consumers need all the legitimate help they can get!

Former auto dealer David Ruggles is president of Advanced Concepts & Techniques. He is at Ruggles@msn.com and 312-925-1863.

Sunday, 6 September 2009

No Smoking Gun? -- Financial Innovation

Mike Smitka

The appellation "luddite" rings nasty, at least to this economist. I am after all an erstwhile student of the history of innovation and am steeped in "IO", the economics of "Industrial Organization." But look as I may, I cannot find evidence—far less make a compelling case—that the recent spate of acclaimed financial innovation is beneficial.
Let me accept at face value the claims of innovation. Now securitization goes back decades, if not more. Bank letters of credit and bill discounting are both forms of credit insurance, and they go back centuries. So I'm skeptical that Wall Street has innovated rather than merely created an impenetrable smoke-screen of complexity.
Mind you, my skepticism is tempered by my own experience in finance, working on Eurodollar syndicate loans to Latin America in the late 1970s, in the first heady days of large-scale international finance since the collapse of such markets in 1914. For those too young to remember, every single one of those loans went bad, taking the economies of a continent with it—and giving regulators the option, which they failed to exercise, to shut down Citibank. Instead forbearance was the game of the day. But at the time they were marketed as safe. First, syndication allowed banks to diversify their risk, since the organizers could sell off the bulk of what were for the time very large loans, while those purchasing it were doing so in bite-sized chunks from different borrowers and different countries. Second, banks could hedge their funding and maturity risk, because while these were long-term loans (one I worked on to a "greenfield" Brazilian steel venture carried a 12-year term) the interest rate was reset every 6 months against LIBOR (the London Interbank Offer Rate). If interest rates bumped up a bit, banks wouldn't face the potential disintermediation that was at the time plaguing savings and loan banks. (Remember your history?—the plague is typically fatal. It's an appropriate adjective.) Banks didn't even need to boost their deposit base, but could borrow in the very same London market, arbitraging their good credit ratings (LIBOR) to lend on to Brazil (LIBOR+25bp at the peak of the bubble). Sound familiar?
Anyway, what are the claims made for securitization, credit default insurance and the like? The fall into two main camps, that these innovations lowered the cost of finance, and that they provided finance to borrowers who for one reason or another lacked access.
If we look at the macroeconomy, did firms go on an investment boom? No, to the extent that we'd label the last decade of growth "robust" (which requires ignoring what happened to wages), then the sources were consumption and exports. If all of these new products lowered the cost to borrowers, it's not there in the data, or at least not enough to show up without resorting to fancy econometrics.
How about access? Well, sure, lots of new borrowers got money up front, but we have incontrovertible evidence that those who received sub-prime "mortgages" couldn't handle the payments. (Not that a "3/27" ever made sense as a loan; such "mortgages" were never anything more than a bet that real estate prices would continue to appreciate). Now we're starting to see other sorts of borrowers. The most prominent right now is credit card debt, but commercial real estate loans are starting to go bad. Losses on local and state government debt, another area of innovation, will surely follow. So improved access turned out to be a short-run illusion. And this shouldn't be a surprise: back in antiquity, in the 1990s, it wasn't as though banks enjoyed zero rates of default on their portfolios. They took their chances, but generally were able to pay for their mistakes, rather than needing bailouts.
Innovation in finance ought instead to be looked upon as fool's gold, which can only be sold to the naive. (And remember the age of those "in the game"—na├»ve was apropos.) The essence of banking, and of finance in general, is the proper measurement of risks. We've had claims of a "new world" in finance since the days of the South Sea Bubble. But underlying cash flow analysis isn't a matter of rocket science, it's a matter of wisdom. Who knows what the risk characteristics are of a new product?—initially, no one. And how do you regulate it? Too little and too late. New products arise in the shadows, because finance is a very mature product, and there just isn't anything new under the sun.
To conclude: there is a smoking gun. It's too soon to tell, however, whether a conviction of involuntary manslaughter will follow. For those wielding the gun committed crimes against multiple economies, killed their employers and robbed the wealth of millions of unsophisticated citizens. But the outcome will likely be a mistrial: the defendant has bought off a lot of potential judges and jurors and remains able to buy expert witnesses sufficient to shout down the prosecution.