Financial Impact of Defaulted Car Loans in Automotive Industry Essay Sample
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Financial Impact of Defaulted Car Loans in Automotive Industry Essay Sample
Car loan is one of the consumer’s credits that are applied for personal use of a vehicle. This is usually unsecured and it is based on the borrower’s ability to pay. Most consumers need financing or leasing to acquire a vehicle. This paper explores how the defaulted consumer car loan affects the Philippines Automotive Industry. Base on Esquire Financing Incorporation, they seek the five C’s of credit from their borrowers which are character, capacity, capital, conditions and collateral. EFI seek into character – the individual’s credibility and reputation, as can be determined through their credit reports and personal references, and capacity – or one’s ability to repay the loan. A healthy starting capital (which may include the owner’s personal assets) and financial conditions also help make for a favorable case for the business. Car loan default is generally not good for either the borrower or the lender. As soon as a loan has been identified as default, the lender can pursue car repossession and charge off. The lender will typically take back the vehicle, may take with repossession, resell it, and charge the borrower for the balance.
The lender may take this unpaid amount, place it in collections, and consider it a charge off the tax purposes. That means it is an amount of money that the lender expects to lose. Because the negative impact of a dealership closure is network wide, how manufacturers respond today is now more important than ever. This paper outlines the relationship of consumer’s financial distress against their specific impact on the automotive industry such as delayed research and development, and bankruptcy of common dealership. While the number of people who use bank financing to buy cars has gone up, the number of borrowers who have gone into default has also increased. Figures on credit cards are better, but not too rosy – with the receivables to total loan portfolio (TLP) ratio so far just slightly lower at 4.5 percent than last year’s 4.8 percent.* This is in glaring but promising contrast with Esquire’s default rate: just a little over 1 percent of its total loan portfolio (Defaults on car loans up, but borrowing to grow your business still a good idea by Esquirec).
Currently, the automotive industry is experiencing a dramatic decline since 2008 but regained its strength in 2010 being considered as the landmark year for the auto industry based on its auto sales performance according to CAMPI (Chamber of Automotive Manufacturers of the Philippines, Inc.) in new car sales and dealerships. The decline in sales created negative publicity, dissatisfied customers, limited or shuttered operations, and declining wholesale vehicle orders on the side of the manufacturer. But automotive industry is giving back its image through the years. Although these financing companies are maximizing the efforts to qualify their potential customers for financing, such as basing their decisions on analyzed loan performance and third party credit bureaus such as BAP, Trans-union, etc., there is still a possibility that a car borrower gets behind his payments.
Background of the Study
A car loan default is the failure to make an agreed upon payment to the finance company that lent the money for the auto purchase. There are always reasons for non-payment but after a certain point in time, the finance company will report the loan in arrears. It will then become part of your credit history and will affect how your credit score will be calculated (Defaulting on a Car Loan: The Effects of a Car Loan Default http://www.carsdirect.com). There are a lot of individuals who are dreaming of having their own car. But not everyone can pay a car outright cash so some people are applying for a car loans (Why car loans are crucial, http://www.capitalife.ph) to different dealership financing or Auto Company( e.g. Toyota, Mitsubishi, Honda and etc.) in order for them to acquire a car (e.g. BPI Auto Loan). But it is not that easy to get a car loan, investigation about the background of consumer is important. This will allow the dealer to know the ability of the loaner to pay. Consumers should also account their budget before the sale under the dealership financing. (Raining Pesos: The easiest way to get a loan in the Philippines https://www.rainingpesos.com.ph)
Furthermore, while in negotiations with the finance company, no negative reports should be presented by the borrower to any reporting agencies. This should help keep his credit score intact. The only time the credit score will become affected is when a default has officially been posted to his credit history. Although deferments will be posted, potential lenders see this as a proactive sign that the borrower, as a consumer, is willing to accept responsibility and make arrangements to satisfy his loan. Sign of a default only indicates greater financial problems (Defaulting on a Car Loan: The Effects of a Car Loan Default http://www.carsdirect.com ). Since our country’s automotive industry continues to boom from the past few years, there are still problems (e.g. fuel price hike, job loss, supply shortage, calamities and unexpected health care bill) that would possibly bring down the booming industry of our auto sectors. The researchers decided to gather information that will affect the financial status of this industry, for this will help the auto companies to find out the reasons behind the defaulted car loans.
“According to Dan Berce, Chief Executive of AmeriCredit Corporation, one of the America’s largest subprime auto lenders, Auto loan defaults tend to be event-driven, like job loss, unexpected health care bill or divorce. They watch quite closely economic indicators like unemployment rate, weekly job claims or hours worked.”
Figure 2: Auto Loan Risks
“According to Marvin M. Smith, Ph. D., Community Development Research Adviser, lenders in the automobile market face two main risks. The foremost risk is “default – that is, the person who took out a loan to buy a car or truck fails to pay it back. While a second important risk is prepayment, where the car or truck purchaser pays off the loan early, reducing the lender’s stream of interest payments.”
1. Non- banking Institutions
2. Banking Institution
Car Loan DEFAULT
Unexpected health care Bill
Fuel price hike
There are factors that are considered the reason of a car loans default. According to Dan Berce, divorce, job loss and unexpected health care bill is one of the reason in America’s car loan default, but if we consider the Philippine car loan default factor we could include the fuel price hike in the country, because this usually happens every year. Car loan defaults may affect the non-banking institution by means of the increase of repossessed cars or second hand cars. Banking Institutions can be affected financially because default car loans means the borrower can no longer pay the loan because of certain reasons.
Statement of the Problem
This study will seek to identify the impact of consumer’s financial distress in regards to their automotive against their specific impact on their Automotive Industries.? 1. What are the factors that contribute to consumers default loans? 2. What are the impacts of defaulted car loans in Banking Institutions? 3. What are the effects of dealership closure to the manufacturers?
H0: Defaulted car loans will not affect the Banking Institutions. H0: The risks faced by the automotive industry due to consumer’s default loan will not be solved to lessen these risks.
H0: There is no impact of dealership closure to the manufacturers.
Significance of the Study
This study is significant to the following:
To the banks that offers auto loans who always encounter failure of consumers to continue paying for the applied loans.
To the car manufacturers who will use the research to know the reasons why there are a lot of defaulted car loans.
To the lenders who will use this paper in order to know how to cope up with automotive problems.
To the borrowers who will use this research as a guide when it comes to applying for a car loan.
To the readers who has a lot of interest when it comes to Automotive
Industry and the possible problems that may come up when you are applying for auto loans.
To the individuals who are interested in applying for a car loan in the future.
Scope and Delimitation of the Study
This study covers the financial impact of defaulted car loans in Automotive Industry in selected Banking Institutions (Eastwest Bank, Security Bank, and BDO) and Car Manufacturers (Toyota, Mitsubishi, Hyundai), its negative impact in Automotive Industry, the reasons behind consumers defaulted car loans and how manufacturers respond to this problem. This will not cover other factors that may affect the said industry in our country such as oil price hike, competition and other that can affect the automotive industry.
Definition of Terms
1) Unsecured loan – There is no guarantee of payment or having no security in a specific asset 2) Defaulted – failure to perform or fulfill an obligation especially on financial obligations. 3) Demand – ask for urgent action or things
4) Repossession – to regain possession because of failure to pay installment due 5) Distress – to hold the property of a person against unpaid debts 6) Credit – terms governing such an arrangement or agreement 7) Dealership – a business which is authorized to sell goods and services 8) Wholesale – selling goods in large quantities
9) Direct Lending – this is the process of lending money from one person directly to another without third party in the arrangement. 10) Dealership Financing – this e auto dealers, many car dealers mark up the finance company’s interest rate and keep the difference as additional profit. 11) Defaulted Loans – A default on a loan occurs when the borrower does not make required payments on in some other way does not comply with the terms of a loan. 12) Massive Retrenchment – heavy forced lay-off of employees. 13) Drawback Arrangement – the arranged negative process or features of thing or event. 14) Subcontractors – it is a company that assigns a prior obligation of the contract to another. 15) Small Scale Vehicles – a transportation which occur limited scope. 16) Automobile Credit Market – financial market includes buy and sell of road vehicles. 17) Third Party Loans – it is also known as an indirect loan. 18) Fraudulent – dishonest claim of a particular qualities or accomplishment. 19) Automotive Industry – industry that includes designing, marketing, selling, developing and manufacturing motor vehicles all over the world. 20) Downturn – a loss in economy or any other activity.
Review of Related Literature and Studies
Local Literature and Studies
According to Quiamba and Rosellon (2011), despite the relatively small size and lackluster performance of the automotive industry, the Philippine Government has constantly issued policies aimed at improving the performance and increasing the size of the sector. The most recent of these policies would be the New Motor Vehicle Development Plan which provides incentives like tax breaks offered in free trade zone areas, income tax holidays, duty drawback arrangements and other benefit in order to encourage them to continue business in the Philippines.
The Philippine government has recognized the importance of the sector of its deep forward and backward linkages. The backward linkages are composed of the first tier industries that directly supply needs of the local automotive industry, and the second and third tier industry that are subcontractors of the first tier as well as providers of the raw materials that are needed by the first tier. The forward linkage includes shippers, forwarders, dealers and other upstream services.
According to Ecumenical Institute for labor Education and Research, Inc. Philippines (2011), the global automotive industry was one of the most severely affected sectors in the real economy by the global economic and financial crisis in 2008. Due to the exposure of the major players in the automotive industry to various financial derivatives, the industry immediately initiated massive retrenchments of autoworkers worldwide, from vehicle assembly line workers to parts manufacturers and retailers; the entire supply chain was affected. To prevent a total collapse of the industry in the US, the auto giants immediately received bailout funds from the U.S. governments.
According to EILER Philippines (2011), the current status of Philippine automotive industry is no different from the general characteristics of the manufacturing sector in the country. It is generally characterized by small-scale vehicles assembly plants, the manufacturing of low value-added components of the local content auto parts, high production costs relative to international levels, and a high rate of importation of raw materials, components and completely built up units (CBUs). On the demand side, the industry servest a small and slow growing domestic market.
The small-scale production and high production costs in the Philippine automotive industry reflects the overall underdevelopment of the Philippine economy. The auto parts and components sectors are dominated by small and medium enterprises. They have limited access to capital and technology. The auto parts and components sectors is also highly imported-dependent, as raw materials to the auto parts and components manufacturers. Due to these factors, production costs in the industry remained high and it failed to establish its comparative advantage in the automotive global supply chain. Foreign Literature
According to KPMG automotive professionals (2008), they observed that 25 percent of auto suppliers were in some sort of financial trouble, and now that figure has increased with the severe tightening of credit. Since approximately 80 percent of an automobile is manufactured by suppliers, the financial pressures on suppliers will affect the entire supply chain.
Dealers face equally serious issues. Shares for Inchcape, the international car dealership, plummeted when the company outlined plans for job cuts and warned that 2009 profits would be “significantly lower” than expectations. In the U.S., the combination of the credit crisis and high gasoline prices has discouraged sales of heavy trucks and sports utility vehicles (SUVs), thereby forcing many automotive dealers in the U.S. to close down. Lower loan approval rates – form 83 percent last year to 63 percent this year – further aggravate the crisis.]
In Europe, September car sales decreased by 8.2 percent, despite two extra working days during what is usually a strong buying season. The steepest declines were noted in the U.K. and Spain. During October, sales in Spain fell another 40 percent. Global automotive sales, even in traditionally strong markets such as China, have seen showing growth rates or even declines.
According to Aizcorbe, Kennickell, and Moore (2003), automobiles are the most commonly held nonfinancial asset. For example, in 2001, over 84 percent of American households owned an automobile. In contrast, approximately 68 percent of American households owned their primary residence. Furthermore, loans related to automobile purchases are one of the most common forms of household borrowing (Aizcorbe and Starr-McCluer 1997; Aizcorbe, Starr, and Hickman, 2003). Consistent with the high penetration of automobile ownership among households and the average automobile purchase price, Dasgupta, Siddarth, and Silva-Risso (2003) note that the vast majority of auto purchases are financed. In fact, Aizcorbe, Starr, and Hickman (2003) report that in 2001 over 80 percent of new vehicle transactions were financed or leased. As a result, given the size of the U.S. automotive market, it is not surprising that automobile credit represents a sizeable portion of the fixed-income market. For example, in 2002, debt outstanding on automobile loans was over $700 billion, and a growing percentage of this debt is held in “asset backed securities.”
Financing for automobile purchases comes from three primary sources: dealer financing, leasing, and third-party loans. Based on a sample of auto sales in Southern California between September 1999 and October 2000, Dasgupta, Siddarth, and Silva-Risso (2003) report that 24 percent of the transactions were leased, 35 percent of the sales were dealer-financed, and the remaining 40 percent of the cash transactions were most likely financed from third-party lenders (credit unions or banks). Furthermore, using a national sample of 654 households that purchased new vehicles, Mannering, Winston, and Starkey (2002) find that 51.6 percent financed, 28.1 percent paid cash, and 20.3 percent leased. Based on these surveys, clearly third-party financing represents a sizable portion of the automobile credit market.
One of the main reasons for the current downturn is an industry – wide credit crunch. Loan defaults are increasing, and many banks and finance companies, especially in the U.S. and Europe, are becoming much more rigorous in approving car loans.
According to the Wall Street Journal, auto loan default rates are increasing rapidly. Standard & Poor’s reported that 2.01% of car loans made in 2006 were already past due in November of last year. This figure is reportedly higher than it’s ever been, and stats are already looking worse for 2008.
A CBS News affiliate notes that the practice of reporting “stated income” to qualify for car loans has become prevalent. This practice, of course, is fraudulent, since stated income reflects a figure larger than actual income, and is sometimes inflated by tens of thousands of dollars.
By reporting a falsely elevated income level, some borrowers illegally qualify for bigger car loans and can buy or lease nicer cars. Of course, as happened in the housing market, most borrowers end up defaulting on such loans, since they cannot really afford them. So why has the credit crunch started pinching the auto industry as well? Theories abound. According to the Denver Post, vehicle repossessions in some areas have nearly doubled since this time last year. And one repo man evidently blames two main factors: gas prices and other loans. This makes sense, considering that energy and fuel costs have been creeping upward for some time now.
And, with rising levels of credit card debt and more and more homeowners defaulting on mortgages, and/or seeking the protection of bankruptcy, people are certainly juggling debts these days. It seems some Americans are forced to choose the lesser of two evils, and let the car payments go in order to keep the house.
Plus, when the housing market was booming, many people took out loans against their houses, and some bought cars with those loans. Now, with housing values plummeting and second mortgages demanding payments, those cars might not look so affordable. Unfortunately, increasing car defaults mean more bad news for the economy. CHAPTER III
This chapter deals with the research methodology, data gathering procedure, method critique, design of questionnaire; research instrument and data analysis.
There is a need to obtain specific information about a case or problem being studied. This information may then be used to assist the study or aid with the solution to the problem. Descriptive method perfectly matches this query for elements involved in a case are gathered to specifically describe the population to result in a factual interpretation. This study used descriptive analysis method. The study is generally concern if there will be an impact of defaulted car loans in the automotive industry and how manufacturers and banking institution respond to it. The research are developed by the literatures that we gathered related to defaulted car loans and its effect to the automotive industry. The sources of the information of this research study are based on secondary data. The researchers used data from journals, news and other data that seen from the internet that is related to the research topic.
Data Gathering Procedure
The researchers will conduct wide literature review from primary data to secondary data for the defaulted car loans and its effect to the automotive industry. This study will be acquired from the researcher’s respondents. For this matter, having one-by-one interview techniques to the respondents will be conducted to gather primary data and to discuss more about the research topic. Conducting interview to the respondents will lead to the researchers to have more valuable information related to the research topic. Primary data will be collected from the chosen banking institution of the researchers. The interview is a more flexible form than the questionnaire and, if intelligently used, can generally be used to gather information of greater depth and can be more sensitive to contextual variations in meaning. http://www.sagepub.com/upm-data/47370_Seale_Chapter_11.pdf. For this study, the researcher are going to use the General Interview Guide Approach which is intended to ensure that the same general areas of information are collected from each interviewee; this provides more focus than the conversational approach, but still allows a degree of freedom and adaptability in getting the information from the interviewee. http://en.wikipedia.org/wiki/Interview
Different information of Financial Impact of Defaulted Car Loans to Automotive Industry in the Philippines were gathered from the journals, news, books, internet and articles that were seen and visited by the researchers. The keywords for the topics are defaulted car loans, negative impact of default car loans to automotive industry, automotive industry.
The research is relied on primary and secondary data gathered from three auto-financing banks and three car companies financing automobile loans. The secondary data are based on the information gathered in relation to the Financial Impact of Defaulted Car Loans in the Philippines’ Automotive Industry.
Design of Questionnaire
Above-mentioned, the researchers are going to conduct one-on-one interview with their respondents. A prepared questionnaire provides help to keep the flow of interview on right track and it also ensures that interview does not miss any important question due to complexity of topic, number of variables involved, pressure of time, or simply because of human forgetfulness. With the problem stated beforehand, the researchers are guided on how they are going to construct questions to their chosen interviewees. The questions are presented in the form that they can conduct the interview well. Major points are presented and sub-questions are used to get all the information needed in this study.