ECONOMY: DESPITE SLOW APRIL, FUNDAMENTALS ARE IMPROVING

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1 May 2009 ECONOMY: DESPITE SLOW APRIL, FUNDAMENTALS ARE IMPROVING page 1 RETAIL AND WHOLESALE VEHICLE MARKETS page 3 Q&A WITH TOM WEBB page 5 The Auto Industry Brief is published monthly by Manheim Consulting. About Manheim Consulting. Manheim Consulting is a business arm of Manheim, the world s leading provider of used vehicle services. Manheim Consulting comprises a team of automotive strategic consultants who work with clients to solve business challenges. With access to the most comprehensive used vehicle database in the industry, Manheim Consulting creates highlycustomized solutions for its customers to help them achieve greater success. Manheim Consulting is dedicated to helping its customers drive business results and maximize their profit potential through a broad scope of services, including custom analytics, business optimization, macroeconomic analysis, data services, strategic development, research and more. For more information, visit or call. SUMMARY Economic statistics for April and early May were generally weaker than expected. They did not, however, violate (indeed, they comported with) our scenario of a recession ending shortly and then followed by a weak recovery. The major depressionary forces in this cycle have always been uniquely concentrated within the financial markets. First, it was their freezing up, and, then, it was their threat of collapse. Both of those negatives have been greatly reduced over the past several months. Recent statistics on the vehicle side have been more of a mixed bag. Retail used vehicle sales have risen and wholesale pricing continues strong. And, importantly, financial statements suggest dealers are not sacrificing gross to maintain used vehicle inventory turn. However, on the new vehicle side in April, we saw both a lowering of sales and a narrowing of gross. ECONOMY: DESPITE SLOW APRIL, FUNDAMENTALS ARE IMPROVING Credit markets: not normal, but better. In the financial markets, rates are low and the yield curve is steep. That s a prescription for better credit flows, and, indeed, lending has picked up. Additionally, secondary stock offerings (such as Ford s) raised $34 billion in the first two weeks of May. Despite this thawing in the credit markets, many businesses and consumers feel left out in the cold. The Federal Reserve Board s survey of lending officers shows a further tightening in auto loans just less dramatically so than in recent quarters. The TALF program has enabled several large auto securitization deals to get done, but, of course, that remains just for prime paper. Subprime lenders continue to shrink their loan portfolios. Annual Subscription: $495

2 It remains to be seen whether the combined GMAC/Chrysler Financial will be a looser lender or a tighter one. It depends, of course, on future capital standards, loss ratios, and the degree of government backstopping. Given the significant reduction in the dealer network that will occur, there is certain to be a period of turmoil and the cutting of credit lines for many dealerships. Although GMAC retail loan originations picked up in the first quarter of 2009, it was relative to the exceptionally low level of lending that was done during the fourth quarter of GMAC provided the retail financing for just 17% of its North American sales during the first quarter of 2009, down from a 49% financing share in the first quarter of last year. In contrast, Ford Motor Credit s share of retail financing only eased from 37% to 31%. Additionally, GMAC financed only 33,000 used vehicle retail contracts in the first quarter of 2009, down from 133,000 contracts in the year-ago period. Although credit unions and regional banks have picked up some of the slack left by the pullback by the domestic captives, that shift appears to have played out. Of particular concern will be the regional banks that, in addition to auto loans, rely on commercial real estate lending. Losses on commercial mortgages are destined to rise sharply over the next year. That will put a restraint on the other lending done by the regional banks. Job losses: is the worst over? April s job loss of 539,000 represented the 16th consecutive decline in non-farm payrolls and brought the cumulative loss since December of 2007 to 5.7 million. From its peak, the percentage loss in employment now equals 4.2%, a bigger decline than any of the other postwar recessions. Amidst that dire news, there were signs that we may be at the trough. Certainly monthly job losses are unlikely to jump back into the 600,000 to 700,000 range, as was the case from November to March. There are some reports that small business, the engine of job growth, has started adding workers. Having access to capital will be the key in keeping that trend alive. Additionally, the impact of the large stimulus package (as well as the hiring of Census workers) will be felt more strongly in the back half of Initial jobless claims, which we noted last month were a reliable indicator of economic turning points, moved higher in early May. Still, we have not yet breached the previous peak and the recent rise in claims was driven, in large part, by the auto industry, where, with plants already shut down, the seasonal loss this year will be smaller than normal. page 2 Auto Industry Brief May 2009

3 RETAIL AND WHOLESALE VEHICLE MARKETS New vehicle sales: ever lower. We, and others, expected that the first quarter s 9.5 million seasonally adjusted annual selling rate would represent a trough. On a quarterly basis, it probably still will. But April s new vehicle sales came in at only a 9.3 million annual rate. Large declines were reported for both fleet and retail purchases. New vehicle sales to rental companies fell 10% during the month, commercial fleet purchases were off 43%, government purchases declined 38%, and pure retail sales fell 37%. The rapidity and the magnitude of the new vehicle sales decline has meant that even total plant shutdowns are taking time in whittling down inventories on a days supply basis. The actual new vehicle inventory unit count at the beginning of May was 20% lower than a year ago, but the days supply remained abnormally high at 85 days. Used vehicle sales: a rebound in April. Retail used vehicle sales increased at both franchised and independent dealers in April, according to CNW Marketing Research. On a combined basis sales were up 6.8% for the month, which reduced the year-to-date decline to just 1%. Conversations with dealers suggest that some of the improvement in April was the result of a better retail lending environment. It wasn t so much that lenders eased credit standards, but rather that guidebooks set loan values that were finally beginning to reflect the higher acquisition costs that dealers were paying at auction. Wholesale Prices Continue to Move Up in April. April marked the fourth consecutive monthly increase in wholesale used vehicle prices on a mix, mileage, and seasonally adjusted basis. The Manheim Used Vehicle Value Index now stands at That represents a year-over-year decline of 1.7%, but an increase of 8.8% since the beginning of the year. Wholesale pricing in the first half of May showed an acceleration in the upward movement. This year s rise in wholesale pricing (and the strong conversion rate at auction) was initially driven by the steep falloff in new vehicle sales, which reduced the supply of trade-ins much more than the underlying demand for those units. Now, however, the stability in the used vehicle market appears to be more despite of, rather than because of, the weakness in the new vehicle market. As such, periodic setbacks in pricing may be experienced even though the supply/demand dynamics remain positive for used vehicle values. page 3 Auto Industry Brief May 2009

4 Bankruptcy and residuals. For years, analysts have speculated on the impact that a manufacturer bankruptcy or brand discontinuation would have on residual values. Now, unfortunately, we have case studies. As of mid-may, the impact on residuals (with a couple of minor exceptions) has been very modest. There are several reasons for this. Wholesale pricing overall has been strong and there has been a significant reduction in the wholesale supply of newermodel used vehicles (the segment most likely to be impacted by these events). More important, in addition to being large and liquid, the wholesale market is an arena where the prices of individual models are influenced (both positively and negatively) by the multitude of competing models. Price differentials between competing models generally remain within reasonable bands. In economist-speak, cross-price elasticities are very high. That said, we are likely to see some negative implications in the weeks ahead. Not so much from the stigma of bankruptcy or brand discontinuation per se, but rather from possible turmoil in the dealer network. Dealer access to capital may be severely impaired. Thus, although used vehicles typically offer a safe harbor in an otherwise stormy market, this time the collateral damage may be widespread. For example, as noted earlier, used vehicle operations in April benefited from lenders increasing their loan amounts on many models (reflecting the earlier rise in wholesale prices), but that is a situation that could quickly reverse for the affected models. Wholesale prices for large pickups and SUVs continue to rise. Low gasoline prices and easy year ago comps, made pickups and SUVs the two big winners over the past year. The year-over-year price drop for compact and midsize cars in April reflected more their strength last year than any weakness today. Luxury cars showed some volatility in pricing in April, but held onto their year-over-year gains. Fullsize vans (and, to a lesser extent, compact ones) improved their pricing in April, but remained the weakest segment over the past year. Off-rental program vehicles matched their year ago pricing. Their volume sold in the wholesale market was nearly 33% lower than a year ago. Off-rental risk units also matched their year-ago prices, despite having 32% more miles at time of sale. Pricing for end-of-service fleet units was modestly lower in April. This was also reflected in the trends by price tiers as units in the $6,000-$8,000 wholesale price range were the weakest segment. page 4 Auto Industry Brief May 2009

5 Q & A WITH TOM WEBB Q. I see that dealer consignment volumes are down sharply throughout the auction industry. Is this the result of low new vehicle sales and thus fewer trade-ins or are dealers wholesaling more through non-auction channels? Thomas Webb Chief Economist Manheim Consulting (540) Thomas.Webb@Manheim.com A. It s definitely the former. And, it is has been compounded by the fact that used vehicle sales have stabilized, which means that the trade-ins dealers are receiving are more likely to be kept in hopes of a retail sale. Four of the publicly-traded dealership groups report used vehicle wholesaling percentages on a quarterly basis. As shown below, all four have shown a significant decline in their wholesaling ratios Given the enormous role that dealers play in the wholesale market, if dealers (franchised and independent combined) lower their wholesaling ratio by one percentage point, that means 500,000 fewer vehicles into the wholesale market. Thus, there is no evidence that the auction industry has lost share of the dealer business. In fact, the auction industry s share has likely grown Q. You dismissed March s decline in retail sales as simply the result of a late Easter, but now we see that April sales were down also. Does this cause you to rethink your recovery scenario? A. With respect to retail sales, yes, in hindsight, it might be more logical to consider January and February as the outliers. Those were the only two months out of the past ten in which sales rose, and in each of those months, sales activity benefited greatly from the record high tax refund season.. With respect to the economy, however, note that despite the weak top-line numbers, several retailers (even auto dealers) posted better-than-expected gross margins and profits for the first quarter. All told, retail activity has not been inconsistent with our forecast a recession that ends in the third quarter and is followed by a weak recovery. page 5 Auto Industry Brief May 2009