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The Coming Auto-Financing Gold Rush

Here's what you need to know about the car business: It's not about selling cars so much as it's about selling car loans. That business has been in the toilet for the past few years, but as the market recovers, it's about to come roaring back. And a bevy of players are positioning themselves to grab the consumers' money.

The marquee bout will feature General Motors (GM) and Ally Financial, which interestingly used to be known as General Motors Acceptance Corp. GMAC was the jewel in the crown of the old GM, but when times got tough in the mid-2000s, GM sold most of the business to fund a failed pre-bankruptcy restructuring. Rebranded as Ally, the new bank continued to handle GM (and Chrysler) lending. But now GM is rebuilding its captive financing business. And Ally isn't happy.

The name of the game is financing, and GM wants a piece of it
As Bloomberg recently reported, this is because Ally wants to launch an IPO this year. Kind hard to justify that if it loses all of GM's lending. For its part, GM has to have been gnashing teeth over its inability to originate high-quality loans during its dark period. The silver lining, of course, is that the auto market has been so bad since 2008 that GM hasn't missed out on all that much.

But auto sales could more than double in 2011, which would lead to a gold rush in financing. Ally isn't just under pressure from a resurgent GM -- other big financial institutions also want to grow their auto lending business. Much of this is cynical: banks can see a deep reserve of buyers out there with aging vehicles and reduced FICO scores. It's a magic formula for small down payments and hefty interest rates, which translates into tidy profits on long-term loans.

The auto industry runs on credit
The major automakers may be trying to shed debt and fuel their growth with operating profits, but at the consumer and dealer level, credit still rules. Very few people are capable of paying all cash for a new car (especially one priced high enough to be profitable for the automaker). And car dealers depend on the car companies' finance arms and other lenders to help them buy inventory with borrowed money.

You don't have to be a genius to see that there are spreads all over the place here. If you want to be in the car business, it's advisable to find ways to lend money that both support continued profits and a kind of endless cycle of consumer debt-loyalty.

If you finance one car with Ally, there's a good chance you'll finance another one. Dealers also like having a captive finance arm available to them, so that they can get more loans approved. Cars historically haven't been like houses; you haven't needed superb credit to obtain a loan.

Millions more loans in 2011, millions more to come
Most analysts expect the auto market to recover to 12-13 million vehicles sold this year. By 2012, the total could be up to 14-16 million. A general economic recovery also means that consumers may return to the typical cycle of buying a new car every two years or so. That's serious loan volume.

It's also the time to grab money while the grabbing is good. Another recession is inevitably coming -- and it may arrive sooner than everyone expects, due to the duration of the current downturn. Five-year loans originated in this period will allow the carmakers who are running financing operations to have a source of cash flow to get them through the next rough patch.

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Photo: Wikimedia Commons
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