EVEN IN A downturn, western economies are driven by cars. In the US especially, many people will forgo payments on a mortgage before sacrificing their personal transport. After all, the car might be the only way they can get to work. Consequently, successful car companies and their finance arms have often proved fairly robust in the face of souring economic climates. But there are signs that the turmoil might tell upon them this time around.
The overall US market is at its lowest level in 10 years, and ratings agency Standard & Poor’s has put General Motors, Ford and Chrysler on ratings watch negative. Net charge-offs on auto loans were up 86% year on year in the first quarter of 2008.
In Europe, there is not yet the same cause for concern. But it might well be on its way, and sooner rather than later. Europe’s usual lag on the US economy could be diminished in this instance by lower reliance on cars. "In Europe, many people now consider a car to be a luxury item they are better off without," says Eric Spielrein, corporate secretary at RCI Banque, the finance arm of Renault. "A lot of private consumers rent or use public transport, and devote their purchasing power to housing, entertainment, education and so forth."
This will obviously have big implications for the finance arms of the European motor industry. In the past, smaller car companies might have had links with local banks in order to help customers finance the purchase of their vehicles but these days the vast majority of auto manufactures have captive finance units. Captives have two purposes: to help sell cars and to provide an added revenue line, between which each must strike a balance. For the latter, a captive will look to return about 15% on its parent company’s investment. Generally they operate in whichever way sells the most cars, and development or growth beyond that is hard, as most car manufacturers are of the opinion that capital is best employed developing their core businesses. So captives still need the banks for funding, and rely heavily on securitization. Spreads have widened in this market, although to nowhere near the extent they have in other ABS markets, such as credit cards. But should the downturn become more prolonged than has been widely assumed, as many are now saying and have been for some months, the auto loan market could be in line for a greater share of the financial crisis. "The primary source of funding for banks is deposits but captive finance units have no access to this type of funding, or very little," says Stéphanie Herrault, autos analyst at Société Générale. "They have to pay up for funding from the markets or the banks, which puts them at a competitive disadvantage."
Certainly, there are captives that offer banking services. Most of these are in Germany, where many captives have banking status. BMW, Daimler and Volkswagen are the biggest, offering such services as savings plans, funds, credit cards and deposits. It is a big business. Daimler’s finance arm made €630 million before tax last year, while VW’s surpassed €1 billion. VW has one of the country’s largest direct banks, contributing 20% of the captive finance unit’s funding needs. And VW has already been working to increase funding levels away from the capital markets, chiefly from deposits. At the end of 2007, the volume of deposits in the VW bank stood at €9.6 billion, with the number of customers up 6.9% on 2006 to 685,000. But despite a 12.5 % increase in new financing contracts, a 15.7% rise in new leasing deals and a 33.9% leap in wholesale financing for dealerships, the company embarked earlier this year on two campaigns to collect new deposits, which now total about €11.8 billion. However, even with this increasing use of deposits, VW’s captive, and those of other car-makers, are also increasing their reliance on securitization (see chart).
Rising pressure
Even with 20% of VW’s funding covered by its bank, that still leaves 80% that isn’t, and that figure is obviously much higher at captives outside Germany that do not have such large banking businesses, or any at all. As the economic climate continues to worsen, funding will become more and more difficult, and expensive. As with most other things financial, Europe tends to lag behind the US: problems there are usually replicated in Europe, normally within a few months. A recent report from ratings agency Fitch found that in the US, typical BBB-rated securities could withstand an unemployment rate of 8% to 10% before there were significant losses for auto transactions. The US unemployment rate has been gradually rising over the past 12 months. Recently, it has jumped to 5.5% but that figure is closer to 7% in the worst-affected states, such as California. Fitch expects corresponding increases in auto loan losses. In fact, several auto transactions from the late 2006 and early 2007 vintages have already seen their subordinate bonds placed on rating watch negative by the agency.
In Europe, unemployment figures are also creeping up, which will have a similar effect on auto loan ABS markets. If these markets are to worsen further, many captives could be facing serious trouble.
But things are not that dire just yet, and there have been several successful deals recently. In June, VW Bank launched a €500 million, two-year deal at 48 basis points over mid-swaps, its first fixed-rate issue. The deal was almost twice oversubscribed in just two hours of book-building, and was priced down from its initial guidance in the mid-50s. Then, in July, Daimler issued a SFr240 million ($232.2 million) deal, which was increased from an originally planned SFr150 million; and PSA Banque, captive of the makers of Peugeot and Citroën cars, launched a €1 billion ABS of German auto loans at 90bp over Libor. Although all these deals were considered successful, there are those that have not been. BMW Finance’s $300 million, three-year Eurodollar in June, which was 175bp over treasuries at re-offer, was criticized as having the wrong timing and being in the wrong currency. As in so many other markets since the credit crunch, it is now much easier to get it wrong.