Financial turmoil at Capital One Financial Corp.’s auto finance business continued last quarter as credit deterioration continued, even as the company scaled back its vehicle financing.
What follows are auto finance-related excerpts from Cap One’s earnings call yesterday, courtesy of SeekingAlpha.com:
Auto finance credit trends continue to show the impact of seasonality, broad economic worsening, the denominator effect of the shrinking auto loan portfolio and the impact of sharply falling used car auction prices. We expect these trends to continue in to 2009.
Our 2008 originations continue to show early but encouraging results in our auto business. As we’ve retrenched and repositioned the business we’ve been able to originate loans with lower LTVs to customers with higher FICO scores. At the same time we’ve been able to improve pricing and margins in the current competitive environment. As a result we expect that the 2008 originations will yield adequate risk adjusted returns.
Early delinquency and loss performance of 2008 originations are consistent with our expectations. While declining loan balances pressure the optics of delinquency rate, charge off rate and other ratios with loans in the denominator we expect that the shrinking auto portfolio and improving credit profitability characteristics of the 2008 vintages will partially offset the negative impacts of the downturn and the continued seasoning of the more challenged 2006 and 2007 vintages. …
Managed loans in the auto finance business declined by approximately $800 million in the quarter as a result of our ongoing repositioning of the business. Originations in the fourth quarter were about $1.5 billion, down more than 50% compared to the fourth quarter of 2007 and relatively flat compared to the third quarter of this year. …
A starting balance of $1.4 billion of goodwill was in the auto sub segment resulting largely from the banks but also from our auto related acquisitions of Summit Acceptance Corporation, People First and Onyx Acceptance Corporation. Our decision to scale back originations volume by some 50% has led to an expectation that our auto business will remain smaller than our previous estimates and therefore its fair value has been reduced. After recognizing the $811 million non-cash impairment, auto now carries $619 million of goodwill.
Default probabilities associated with credit scores are unconditional probabilities, meaning that they are averages. Defaults rates (and vehicle values) are correlated with the state of the economy, which means that your conditional probability of default is greater in bad economies than in good. Duh! In bad economies such as this one your default rates are going to increase due to the correlation effect. That is to be expected. That is also why pricing based on historical experience alone is shear stupidity. Pricing has to be based on the entire probability spectrum.
What is most concerning about their earnings release is the write down of goodwill applicable to their acquisitions. Fair value is the present value of future expected cash flow. If this was just a downturn in the economy followed by an expected return to normalcy then goodwill would probably not be written down. The fact that goodwill was written down my more than 50% may mean that decreased volumes and/or increased credit losses are permanent. That is scarey. However, the bad economy could just be an excuse to get goodwill off of their books.