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Captives Feel the Pain, Too

It will cost them, but auto makers' captive financing firms likely will increase consumer incentives to prop up vehicle sales in what has become a rough year for the industry. So says Christopher Wolfe, managing director-financial institutions for Fitch Ratings Ltd. He predicts such initiatives will cut into the profits of the captives, which are feeling the industry's pain just as others involved,

It will cost them, but auto makers' captive financing firms likely will increase consumer incentives to prop up vehicle sales in what has become a rough year for the industry.

So says Christopher Wolfe, managing director-financial institutions for Fitch Ratings Ltd.

He predicts such initiatives will cut into the profits of the captives, which are feeling the industry's pain just as others involved, including auto makers, dealers and suppliers. (“What could be worse than being an auto supplier right now?” he asks.)

Financing arms such as GMAC Financial Services, Ford Credit Co., Chrysler Financial and Toyota Motor Credit Corp. are responding to market pressures — at a price.

Even though incentive spending “remains an industry concern,” it will nevertheless increase in the near term, Wolfe predicts.

Auto makers' incentives averaged $2,356 per vehicle sold in June, up 1.4% from the previous month, according to Edmunds.com.

In June, the industry's aggregate incentive spending was an estimated $2.84 billion, with domestic auto makers accounting for 60.3% of the total; Japanese auto makers, 25%; European manufacturers, 9.8%; and South Korean companies, 4.9%.

During a time of rising pump prices, large SUVs with a thirst for fuel had the highest average incentive of $5,097, followed by large pickup trucks at $4,329.

“The captives are feeling the squeeze, too,” Wolfe says of what is turning out to be a lousy year for the auto industry. “The implications of parent-company issues are significant for the captives.”

Their subvention programs are expected to include an increase in lease residual support in order to lower monthly payments and make leasing more attractive, he says. “There is pressure on lease residuals, particularly for truck and SUVs.”

After suffering widespread residual losses in the 1990s, auto makers curtailed their leasing efforts early this decade.

Now, leasing is making something of a comeback, spurred by captive companies sweetening the deals of late. “There is a view the leasing pullback was too much,” Wolfe says.

Having to subvent vehicle leasing is not just “a problem” for domestic auto makers, he says. “Transplants have become more aggressive.”

This subsidizing expense comes at a time when funding markets are less hospitable, reducing finance firms' access to money. “And what is available is more costly,” Wolfe says. “The biggest worry for the captives is that clearly the market has re-priced.”

Automotive lenders today also face more consumers with weakened credit quality.

It's not as bad as the fallout from the subprime home-mortgage debacle, in part because “not that many people were buying new cars hoping to see them increase 100% in value in a few months,” Wolfe says of some homeowners' great expectations.

Still, the mortgage mess and lower home values are affecting automotive sales and financing.

Reduced home-equity lending has led to rising defaults on other consumer debts, including car loans. In the past, consumers regularly took out home-equity loans to pay off their other debts.

“U.S. consumer-debt burdens are now at historical highs,” Wolfe says.

Another concern is a trend towards longer auto loans, with 72-month terms no longer uncommon and 84-month loans not far behind. The longer the loan, the higher the chances of delinquencies, defaults and lender losses.

Lenders say they are lengthening terms because everyone else is. “That's probably not the best reason,” says Wolfe. “Where does it end?”

Meanwhile, captive finance firms are containing and stabilizing dealer floor-plan losses, with defaults up, but charge offs only at about 0.10%, he says.

As dealership ranks decline — from about 25,500 in 1987 to just over 21,000 last year — “there may be a long-term positive for remaining dealers,” Wolfe says.

But single-franchise dealerships affiliated with an under-performing brand are most vulnerable.

“Dealer profitability is declining,” he says. “An increasing percentage of Detroit Three dealers are not profitable.”

Because of their ties to their respective auto makers, captives are more interested in moving the metal, while non-captive lenders such as banks are more interested in the lending itself.

The differences don't stop there though, presenting challenges to the captives.

For instance, most non-captives are banks with access to federally insured deposit funding, Wolfe says. “Non-captive lenders are more immune to current and ongoing credit-market dislocations.”

Captives' funding constraints present opportunities for non-captive auto lenders, the top 10 of which have picked up market share, he says.

Captives' retail penetration rates may increase with stepped-up subventions, but the cost of those subsidies stands to hurt profitability this year, he says.

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