Banks and automakers benefited from government bailouts in 2008, but the banking industry also got something else out of the financial crisis: a leg up in the auto lending business.
Today banks hold fewer advantages than they did in the midst of the recession. Credit unions, nonbank lenders and auto manufacturers, whose finance arms are known as captive lenders, are all putting more pressure on the banks' profit margins.
Many banks in the auto lending business have been preparing for this moment by making investments that they hope will give them a more enduring edge.
"We see across the board that the banks are improving at a faster rate than the captives," says Mike Buckingham, senior director of auto finance at market research firm J.D. Power. "We see much stronger infrastructures, much better sales platforms."
Over the last decade or so, banks have made more investments in technology than their auto-lending competitors have, says Liz Jordan, a director at Deloitte & Touche LLP. Those investments have allowed banks to automate more work and provide faster lending decisions to auto dealers. "It gave them an advantage," Jordan adds.
Back in the first quarter of 2008, banks had 31% of the auto lending market, while the financing arms of car manufacturers had 24% market share, according to data from Experian. Five years later, banks' share had risen to 39%, while the automakers' piece was down to 17%.
One big reason behind the shift in market share is Ally Financial's switch from its former role as General Motors' captive finance arm, which was known as GMAC, to its current position as a bank lender that finances more car brands.
When the financial markets seized up in late 2008, GMAC was so uncertain about its ability to raise money that it stopped offering consumer auto loans altogether. The firm soon decided to morph into a full-fledged bank, growing retail deposits from $7.2 billion at the end of 2008 to more than $40 billion today.
Tim Russi, Ally's president of auto finance, says the financial crisis exposed the flaw in the company's strategy of relying entirely on the capital markets for funding. "So becoming a bank gave us a path to solve that systemic flaw," he adds.
During the depths of the recession, many banks saw that their ability to borrow money cheaply offered a decisive edge.
"Because of the funding-cost advantage, because of our capital levels and liquidity, we can originate deposits and borrow at much lower rates than some of the other competitors," says Tim Sloan, chief financial officer at Wells Fargo (WFC), one of the banks that made significant gains.
Another reason that banks saw opportunity in auto loans was that the asset class performed relatively well in a sea of economic uncertainty.
"People need their cars to get back and forth to work," says Tom Wolfe, Wells Fargo's head of consumer credit solutions. He adds that "once you're in a recession," the auto lending business is "always the best-performing book of business."
Wells Fargo's consumer auto loans outstanding grew by 8% between the first quarter of 2012 and the same period this year. Its auto lending business is built on a platform that was developed by nonbank auto lender WFS Financial, which was sold to Wachovia in 2006. Wells bought Wachovia two years later.
Wells Fargo historically focused on used-vehicle loans. But in the last few years the company has made significant investments to compete better in new-car lending, an area that often involves complex financial arrangements between manufacturers and lenders aimed at subsidizing the car buyer's borrowing costs.
Last year, Wells Fargo announced a partnership with General Motors to offer financing on new Chevrolets, Buicks, GMCs and Cadillacs. That was followed by a smaller deal with electric car startup Tesla Motors. Wells executives see an opportunity for more such arrangements with auto manufacturers.
"There are companies that are still looking to import their cars, and bring their cars here. They're looking for who can help support them on the financing side," Wolfe says. "We're pretty well positioned to at least entertain that opportunity."
Wells Fargo's consumer auto lending business, with $46 billion in loans outstanding, is now the nation's third largest just behind Ally and Toyota Financial Services, and one spot ahead of JPMorgan Chase (JPM).
But it's not just the biggest banks that have been investing in auto lending. Fifth Third Bancorp (FITB) has added about 12 states to its lending market in the last few years, according to Peter Kidd, a senior vice president at the regional bank in Cincinnati.
Fifth Third's auto loans are now available in all but five states. "A lot of our growth has come in geographic expansion," Kidd says.
Fifth Third has also spent money on technology that makes it easier and faster for auto dealers to do business. For example, the bank is now able to approve multiple loan structures simultaneously, which can cut down on the amount of time needed to close a sale, according to Kidd.
Credit decisions are another area where Fifth Third has spent money, with the goal of shortening approval times without green-lighting bad applicants. "You automatically decline the terrible ones, you automatically approve the great ones, and you focus on the ones in the middle," Kidd says.
Banks clearly do not have the same advantage over the automakers today that they had a few years ago, when the cost of borrowing in the capital markets soared. "It's really more of a return from an exceptional, once-in-a-lifetime kind of period to something more normal," Richard Fairbank, the chief executive of Capital One Financial (COF), the nation's eighth-largest auto lender, said in a recent conference call.
"I do think that you're seeing margins tighten because you've got more players in the space," adds Bill Himpler, executive vice president of the American Financial Services Association, a trade group whose members include nonbank lenders, auto makers, and some banks.
One potential advantage for the auto manufacturers right now involves regulation. The Consumer Financial Protection Bureau has signaled that a fair-lending crackdown may be coming, which would likely hit banks first, and could make it harder for banks to win auto dealers' business. The consumer agency does not currently have the authority to examine the finance arms of the automakers.
But the auto manufacturers' advantage could be short-lived. The manufacturers' financing arms are expected eventually to be brought under the CFPB's examination umbrella, Himpler says.
In the meantime, banks are likely to enjoy a boost to their existing advantage in funding costs when interest rates begin to rise. In May, the latest month for which data from the Federal Reserve Board was available, a four-year loan for a new car cost an average of just 4.13%, well below the levels seen during the recession.
"When you see a rising rate environment, the gap that the banks have with funding costs is going to be greater," says J.D. Power's Buckingham. "We expect that in the aggregate, they are going to pick up share."