Why you can't get a car loan

NEW YORK (Fortune) -- Auto dealers are using rebates, discounts, and other incentives to lure buyers back into their showrooms. But once they get customers through the door, dealers are still battling an issue that has troubled the industry for months: a lack of financing.

Brandon Schaefer, the owner of Nationwide, a string of dealerships in Timonium, Maryland, says foot traffic has improved, but lending has not. "About twice as many people as before are getting turned down for loans," he says. "The guidelines continue to get stricter."

Some lenders have said in recent months that they would try to cut more deals. After GMAC received TARP money in December, the auto lender -- reborn as a bank -- announced plans to set aside $5 billion for new contracts and promised to consider applicants with credit scores as low as 621. But despite having lower standards, GMAC still originated just $3.4 billion worth of loans for new vehicles in the first quarter, down from $13.1 billion in the same period last year.

Spokesperson Michael Stoller says the bank lowered its bar again this spring. "We want dealers to send business our way," he says. "We're looking at applications from customers with scores below 620."

Of course, looking isn't approving. Jeffrey Knott, a Florida based dealership consultant, says one of his customers received a rejection from GMAC a few days ago despite having a FICO score of 652. Though Knott says GMAC is "working harder than other banks" to improve the situation, situations like these persist: "Getting loans is still the number one problem for auto dealers right now," he says.

The financing environment for auto buyers has been difficult since 2007, when the credit crunch spread from the housing market to other sectors of the economy. Lenders struggled to sell their asset-backed securities, and delinquencies among cash-strapped customers shot up.

In order to steel themselves against future losses, auto lenders slammed the brakes on new contracts. From the beginning of 2007 to the end of 2008, loan approval rates for prime applicants, who have credit scores above 750, fell from 95% to 84%, according to CNW Research. Subprime applicants were far worse off -- just 17% of them were approved last December, down from 66% in 2007.

Good credit, no loan. There has been a slight uptick in approvals this year, with 89% of prime applications and 20% of subprime borrowers receiving loans in May. But that still pales in comparison to the pre-credit crunch market, says Greg McBride, a senior financial analyst at Bankrate.com. "The days of showing up with nothing but a smile on your face are over," he says. "Today, stories are legion of people who have great credit and still can't get car loans."

Some dealers are having more luck. Tony Pordon, a senior VP at Penske Automotive, says his company's 300 dealerships have seen an improvement in financing. "The freeze hit its peak in the fourth quarter of 2008, but it's much better now," he says. "[The lack of] foot traffic is hurting sales more than financing at this point."

Penske may have an advantage because it mainly processes loans through the captive financing units of foreign automakers like Toyota (TM), Honda (HMC), and BMW, which are in better financial health than their American counterparts. While GMAC's originations were down by about 75% last quarter, BMW Financial Services only produced 20% fewer contracts than it did last year. (Penske recently purchased former General Motors brand Saturn, but isn't commenting on how it will finance the vehicles).

No cash. Pordon also says these captive units, which are tied to their manufacturers, may be more invested in accomplishing deals. But even if lenders want to help their manufacturers "move metal," many of them still lack the means to boost loans, says J.D. Power & Associates financial services analyst David Lo. "There's a conservatism around lending right now that supercedes everything," he says. "If the lenders have difficulty securitizing loans, they simply don't have the cash to make them."

Until recently, auto financing was a growing industry, expanding beyond carmakers' captive branches to banks and subprime lenders. In addition to the captive branches of carmakers, banks and subprime lenders were also getting in the game. Since the credit crunch, however, many new entries have dropped out. For instance, HSBC stopped writing loans last year, and several subprime auto lenders have gone out of business.

One of the largest subprime lenders, Fort Worth-based AmeriCredit (ACF), has to cut back on its loan originations to about $200 million per quarter, down from $2 billion in 2007. Defaults amongst lenders are at 13%, up from 11% in March. "We've had to tighten our credit policies dramatically," says CFO Chris Choate. "We've lowered our tolerances for loan-to-value ratios and lifted our minimum credit scores."

As banks and subprime lenders pull back, one group of lenders has expanded its share over the last year. Nick Connors, an analyst at industry research firm Callahan & Associates, says credit unions now command more than 20% of the auto financing market, up from 13% in 2002. "A lot of lenders out there have stepped back or tightened standards," he says. "By staying in, credit unions have captured more of their volume."

Lo says the upheaval in the financing landscape has dramatically changed the dynamic between dealers and lenders. "Dealers used to say, I have a number of financing sources to help customers. Now, there's been a power shift -- the lenders are turning down deals."

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