Editor's note: This article has been updated to clarify when lenders may be less willing to work with dealerships.
After the Great Recession, many floorplan lenders tightened dealers' loan agreements in a bid to detect early signs of trouble.
The warning bells are now ringing as a number of dealership groups have defaulted on floorplan repayments in recent months, and many more have approached, and even tripped, the stricter lending covenants now in place in those agreements.
The rigorous oversight raises the bar for dealers. While it can give them an internal jump-start to fix problems if they're paying close attention to the numbers, it can also mean the beginning of the end. Failing to repay a floorplan loan — selling out of trust — typically drives a dealership into an irreversible spiral, and tougher financing agreements have made these situations more common.
"More lenders seem to have a zero-tolerance approach, and they're quick to tighten the screws on dealers," said Christian Scali, managing partner at law firm Scali Rasmussen in Los Angeles. "The effect of this in some cases was a cascading chain of events that can have devastating effects on the dealer and from which it becomes impossible to recover."
Violations of loan covenants — the conditions under which the financing agreement is granted — can be an indicator that a dealership could sell out of trust. Many lenders have set stricter covenants around criteria such as debt-to-equity ratio and working-capital requirements, dealer advisers said.
Several prominent auto lenders — among them, Ford Motor Credit Co., Nissan Motor Acceptance Corp., Hyundai Capital America, Toyota Motor Credit, Volkswagen Credit, BBVA Compass Bank, BMO Harris Bank — have sued dealers and dealership groups over the past 18 months accusing them of selling vehicles out of trust.
For Ford Credit, which is a floorplan lender in at least two high-profile cases, out-of-trust dealerships make up a tiny slice of the lender's portfolio, Ford Credit spokeswoman Margaret Mellott told Automotive News in an email. Ford Credit uses a proprietary model to assess dealer risk, she added.
"We regularly perform dealer credit reviews, as well as regularly audit dealer inventory and sales records," Mellott said. "Audits may be done more often for dealers with a higher risk rating."
Nissan Motor Acceptance Corp. has been the floorplan lender in at least six high-profile cases. Nissan Motor Co. spokesman Brian Brockman declined to talk about specific dealerships but told Automotive News that each Nissan dealer is responsible for capitalizing his or her operations and preparing dealerships for a changing auto retail market. "Ultimately Nissan will continue to support and work with its dealer network to provide the best sales and service experiences, and choices in store locations, for Nissan customers," Brockman wrote in an email.
When lenders anticipate a recession, they may be less willing to work with a dealership that shows signs it could breach its agreement, said Marguerite Watanabe, president of lender consulting firm Connections Insights.
Given that loans are for amounts in the millions or hundreds of millions of dollars, "you've got to take everything into consideration when you talk about floorplan lending," she said.
Lenders also want to stay ahead of the storm clouds when they see their peers taking a hit. When out-of-trust situations happen, "it hurts the whole industry because it raises the visibility of the potential of a downturn," said Watanabe.
The lessons of the last recession are still strong for lenders.
Some of them may be "a little bit more fearful of letting things go too far with a debtor because things got so out of hand" back then, Scali said.