Out of Trust, Out of Business
Dealers needn't be on auto maker's hit list to be at risk
By Steve Finlay Ward's Dealer Business, Jun 1, 2009 12:00 PM

Orlando — A car dealer needn't be on an auto maker's hit list in order to become an ex-dealer. Being persona non-grata with a lender will do the job, too.

The fastest way to get on a lender's bad side these days is to become what's known as “out of trust.”

That happens when a dealer borrows money to buy inventory (a lending practice called floorplan financing), sells the cars but holds off on paying the loan.

A dealer also goes out of trust by taking a customer's trade-in but failing to pay off any remaining loan balance on the vehicle forthwith.

Such irregularities usually occur when a desperate dealer faces cash-flow problems, not a rarity in light of today's economy.

But if lenders discover those dubious practices — and they're on a heightened state of alert — they are apt to deliver a death blow to the offender by cutting off financing. Then the lender gets ready to tally the inevitable losses.

“By the time a lender figures out what's going on, it's too late,” says an attendee of the Consumer Bankers Assn. automobile finance conference here. “It's not a question of if there are going to be losses, but how much.”

Out-of-trust dealers are destined to go out of business, says Paul Melville, a principal with Grant Thornton LLP consultancy.

“Dealers with too much credit on their books will go first,” he says. “We've seen it with dealers in the U.K. The ones that failed had out-of-trust problems.”

Auto makers' captive finance firms and other lenders are on the lookout for dealers with such woes, says Michael Jackson, CEO of AutoNation Inc., the largest dealership chain in the U.S. “They are watching like a hawk.”

With credit tight, financial institutions have implemented stricter lending standards and become less tolerant of funny business.

Before, if a captive yanked floorplan financing, a dealer usually could find another lender. “Now they can't,” Jackson says.

“We're watching dealer (financial) health more closely,” says a CBA conference participant. “We have people in the field watching. If a dealership was not well run before, it probably isn't well run now. But we've gotten better at connecting the dots.”

She says warning signs of an at-risk dealer include outstanding titles, non-sufficient funds and failing to pay off floorplan debts.

But suspicious lenders worried about getting burned should not think the worst of all dealers, says Randy Dye, who owns Daytona Dodge Chrysler in Daytona Beach, FL.

“If you've got a dealer you believe is not doing something right, watch him,” he says. “But that doesn't mean all dealers aren't doing things right.”

Lenders should stay true to their best customers, says dealer Russ Darrow, head of the Russ Darrow Group, based in Menomonee Falls, WI. “Your good dealers need you, and you need your good dealers.”

While General Motors Corp. and Chrysler LLC plan to eliminate thousands of dealers, “in theory, lenders could accelerate the decline of the dealership base,” says Adam Goldfein, a former dealership manager who hosts an auto talk show on CBS radio.

Lenders could do that by withholding credit. Conversely, they could “prop dealers up” by extending financing, he says.

Neither proposition appeals to conference attendees.

Being part of a de facto movement to cut dealer ranks is inappropriate, says Marc Sheinbaum, CEO of auto finance and student loans for JPMorgan Chase.

“It's not our place to solve that problem,” he says. “I'd rather see it done by GM and Chrysler. I'm concerned that suddenly you see dealerships closing, and the headline is: ‘I closed because I couldn't get floorplanning from a bank.’”

Nor do lenders seem anxious to help ailing dealers stay in business.

“You do not do floorplan lending because it will help the economy,” says another banker. “Some dealers say, ‘I've been in business 40 years.’ That's not enough. That's not an indication of a low risk.

“But it's tough when you've got a veteran dealer like that who all of a sudden is without liquidity and has nowhere to go to get it,” he says.