Are Cars Loans The Next Problem?

Posted by Bull Bear Trader | 7/25/2008 05:03:00 PM | , , | 0 comments »

Chrysler has announced that it will stop offering leases through its leading facility (see WSJ article). The move comes as Chrysler and other car companies are seeing their borrowing cost rise (typically Libor plus a spread of 1% or more for Chrysler - with Libor around 2.8%). Higher borrowing cost make it more difficult for the car companies to make money on low interest rate loans, or absorb write-offs for 0% loans that are often used to increase sales of higher-margin or low selling vehicles. The old joke of "we lose money on every sale, but make it up in volume" may not even apply here. The first part still holds, but volume may not increase unless they can find ways to help customers purchase their vehicles. Customers have basically quit buying the higher margin vehicles, such as trucks and SUVs. To make matters worse, even if customers do purchase these vehicles, and the car companies finance or lease them, the car company may be stuck with a bad loan which has an asset that has depreciated below the current loan value.

Issues such as these have led to the recent decision by Chrysler to quit offering leases. But does this solve the problem, or simply make things worse? Sure, by eliminating poorly performing loans and leases, as well as reducing the company's dependency on higher borrowing cost, the company can scale back poor performing assets, which is good. Unfortunately, they may also be scaling back sales in the process, in what amounts to shooting themselves in the foot. Typically, buyers will utilize the dealer credit facilities if they are unable to get a better deal at a bank or local credit union (most likely due to weak credit). Even with good credit, they may still decide to take the loan or lease with the car credit facility when it is tied with incentives, such as rebates or low financing. By eliminate this line of credit for customers, you are essentially preventing the weaker credit customers that need the facility from purchasing your vehicles. For those with good credit who can obtain low interest loans elsewhere, you now lose another carrot that might help get them in the door to buy the higher-margin vehicles that make you the most money. In a sense, you have reduced credit risk by introducing sales risk, resulting in lower revenues and lower valuation.

Of course, this is not to say that Chrysler made the wrong move. They may have had no other choice given the credit markets, and car loans themselves may be the next shoe to drop, bringing down not only the car makers, but the banks underwriting the credit as well. Nonetheless, it does tell you how serious their problems are, and another reason their competitors, such as Ford (F) and General Motors (GM), and even Toyota Motors (TM) to some extent, are getting marked down in the stock market. They are in a bind, and there are not really any easy answers. I am just not sure that making it harder for your customers to buy your product is the answer.