Leveraging Liquidity: Lenders brace for the coronavirus recession [Feature]

Auto financiers are bracing for the rocky road ahead as vehicle sales plummet, consumer demand tanks and expected credit losses climb due to the COVID-19 economic crisis. During the last couple of years, the auto industry has balked at the thought of a major economic recession battering the sector. Quarter after quarter, automakers and lenders expressed confidence that the industry had learned from the Great Recession and would be prepared to face another downturn. Jim Hackett , chief executive of Ford Motor Co. , said just over a year ago in his opening remarks at a Detroit Economic Club luncheon that Ford would be prepared for a recession. But the current downturn is shaping up to be a whole new beast. The industry was not ready for a recession spurred by a global pandemic that shut down the economy and froze the car business. Most economists define a recession as two consecutive quarters of economic contraction. Already, gross domestic product for the first quarter slipped 4.8% annualized, mostly due to the largest drop in consumer spending since 1980, according to the U.S. Bureau of Economic Analysis . On top of that, second-quarter GDP is expected to take a hit not seen since the beginning of World War II. As a result, the projected 2020 new-vehicle SAAR, which has been revised three times since mid-March, is expected to come in between 11.3 million and 12.6 million units, according to ALG TrueCar . Origination volume, too, will likely plunge 40% in tandem with retail sales this year to $375 billion among the nation’s top 100 financiers, according to Big Wheels Auto Finance Data 2020 . The coronavirus pandemic has pummeled the U.S. automotive industry since the outbreak forced shelter-in-place orders across the country. Now, the liquidity of automakers and their captives are all the more important to the long-term financial health of the sector in order to prevent a repeat of the Great Recession. Combating a different beast The nation first looks to two Detroit automakers — Ford Motor Co. and General Motors Co. — as a benchmark for how the industry can sustain itself throughout the ongoing downturn. Both automakers rely on U.S. vehicle sales to make up the lion’s share of their profits, and both OEMs are scrambling to hoard cash, hoping to ride out the pandemic. At the end of the first quarter, Ford Motor and Ford Motor Credit had $35.1 billion and $28 billion in liquidity, respectively, according to first-quarter earnings. This liquidity is expected to sustain the automaker through yearend. Ford Credit alone holds $9.6 billion in cash and cash equivalents. What’s important to note, Chief Financial Officer Tim Stone said during the earnings call, is Ford Credit’s funding structure is self-liquidating. Basically, Ford Credit generates its own liquidity as the balance sheet shrinks with lower automotive sales, which reduces its funding requirements, he explained. Ford Credit’s originations dropped 3.2% year over year to $12.2 billion as its total portfolio hit $54.9 billion. To further bolster its cash and financial flexibility, Ford drew more than $15 billion from existing credit lines, issued $8 billion of unsecured junk bonds, suspended dividend payments and its share repurchase program, lowered its operating costs, cut executives’ salaries and reigned in two mobility initiatives. General Motors, meanwhile, has also doubled down on its liquidity standing. The OEM tapped a $16 billion credit facility and subsequently renewed another $2 billion, 364-day revolving credit facility for the “exclusive” use of its captive. Not a week later, the auto manufacturer extended a $3.6 billion revolving credit line to April 2022. GM Financial has about $24 billion of liquidity, according to a JP Morgan Chase research note. Following Ford, GM announced last month it has suspended the quarterly cash dividend on its common stock, suspended its share repurchase program and has taken other significant austerity measures to preserve near-term available cash. While Ford Credit and GM Financial likely have substantial liquidity to weather the pandemic, other captives rely heavily on capital markets for funding and liquidity, which could spell trouble if the COVID-19 economic crisis continues to dampen investors’ appetite for ABS bonds. American Honda Finance Corp. , for one, secures nearly half of its liquidity from capital markets. In fact, the captive accessed funds through the auto ABS market six times last year totaling upward of $7.5 billion. AHFC’s first deal of 2020 brought $1.75 billion of prime auto loans to market in January, according to Moody’s Investors Service . This latest ABS deal has not experienced a widening in spreads yet. Moreover, AHFC’s liquidity includes $7 billion in syndicated bank credit facilities and an additional $1 billion in committed bilateral lines of credit as of September 2019. The captive also notes $7 billion of commercial paper as a part of its funding program, but it is not clear if commercial paper is a part of its available liquidity, according to a September 2019 investor relations presentation. AHFC did not respond to requests for clarification. AHFC originated about $30 billion of loans and leases last year and closed out its fiscal year with $1.4 billion in cash or cash equivalents as of March 31, 2019, according to 10-K filings with the Securities and Exchange Commission . By comparison, Nissan Motor Acceptance Corp. ’s liquidity clocks in at $15.9 billion as of December 31, 2019, and includes a $7 billion revolving credit facility that remains undrawn. NMAC securitized three deals last year totaling $3.7 billion and brought its first 2020 deal to market with a $750 million issuance backed by prime loans. NMAC’s originations totaled $17.9 billion last year. However, NMAC faces a different challenge compared with its fellow captives: a stumbling parent company. In fact, Nissan Motor Co. may need its U.S. captive to funnel additional liquidity to the OEM. Ultimately, Nissan is in a cash crunch. The OEM’s free cash flow was -$6.2 billion before dividend payments for the nine months ended December 2019. Nissan postponed its first quarter earnings filing at the end of April and expects to post a loss in the fiscal year as a result of COVID-19. Hyundai Capital America has a different concern: a lack of diverse funding sources, which limits its financial flexibility as the cost for debt funding rises and the economy continues to deteriorate. In fact, the captive’s significant reliance on commercial paper and a revolving line of credit could squeeze the lender’s access to funds, according to Moody’s. HCA has $6.5 billion in available liquidity, a company spokeswoman confirmed with Auto Finance News. HCA’s total liquidity is calculated by combining its liquid assets and credit line, she said, noting that amount should be enough capital to cover the global captive’s outstanding redemptions over the next six months. Still, the cost of the captive’s debt funding has already increased, according to its latest auto ABS deal. In its first $1 billion prime auto receivables trust of the year, spreads increased 91 basis points to 130 bps, compared with its last auto ABS deal in October 2019. Hyundai, which issued an $894 million securitization backed by auto lease receivables in January, usually securitizes two lease and two loan deals every year. Conversely, Toyota Financial Services ’ diverse funding sources mirror that of its OEM’s product mix, providing “more resilient free cash flow,” according to Fitch Ratings . In fact, TFS, the nation’s largest auto lender by volume, has access to $27 billion in dedicated funding through committed bank credit facilities and average liquidity portfolio at yearend 2019, the captive’s treasury team told AFN . As of Dec. 31, 2019, the credit facilities were not drawn. “For liquidity purposes, we hold cash in excess of our immediate funding needs,” the team stated. “These funds are invested primarily in short-term, highly liquid money market instruments.” Toyota Motor Co. also has an inter-company lending infrastructure similar to its European counterparts, which allows its captive access to a part of Toyota Motor’s $84 billion of available liquidity, if needed. The OEM’s liquidity portfolio is separate from the $27 billion in liquidity dedicated to TFS. Further, TFS is one of the most active prime issuers in the asset-backed securities market, with $5.1 billion in public auto ABS issuances as of yearend 2019. However, the captive does not include funds raised in the capital markets in its available liquidity, as most of the capital raised was used to refinance debt maturities and new business growth, according to the TFS treasury team. Europe's global mindset For European luxury automakers BMW Group , Daimler AG and Volkswagen Group , the OEMs’ global finance structures and diversified funding sources insulate their captives from potential liquidity concerns. For example, a significant portion of the each organization’s liquidity is held at the level of the parent company and dispersed to various segments of the company as needed, including to its global captive. BMW, Daimler and Volkswagen lend in 60, 40 and 48 countries, respectively. As the three captive finance subsidiaries wind down origination volumes, their parent companies are provided with a source of cash until their portfolios swing back to growth mode. For most European OEMs and captives, liquidity is not a concern, according to Moody’s, which provides a “degree of confidence in their ability to manage through the next few quarters of high cash burn.” BMW Group’s total available liquidity, not including loans and leases refinanced on global capital markets, clocked in at $70.4 billion at the end of the fiscal year 2019. After operating expenses — including financing — BMW Group had $18.9 billion of liquidity leftover at the end of the year. BMW Financial Services experienced a 9.9% YoY increase in global originations to $66.5 billion last year. Still, going forward the captive anticipates the number of new contracts to decrease and risk provisioning expenses to increase. Direct competitor Daimler Mobility tightened its origination volume as its parent Daimler AG shifted into full cash-preservation mode, said Harald Wilhelm , who serves on Daimler’s board of management, during an investor relations webcast in early April. He also oversees finance, controlling and Daimler Mobility. In fact, Daimler Mobility's originations decreased by 7% to $17.6 billion in the first quarter, the company noted during an earnings presentation in late April. “In the current situation we take less new business on board, which means less cash out to sort the financing,” Wilhelm said. A reduction in purchased retail contracts or leases will allow the captive to hold onto $3 million in cash and cash equivalents. The Stuttgart, Germany-based automaker reported a decrease in its net liquidity to $10.1 billion at the end of the first quarter, largely due to $2.5 billion in spending related to “upfront investment for future products.” Still, Daimler ramped up its financial flexibility in April with a $13 billion loan facility in addition to its existing $12 billion revolving credit facility, which has not yet been utilized. The additional loan facility can be tapped within a 12-month period with two extension options of six months, the company noted. Wolfsburg, Germany-based Volkswagen Group reported a net liquidity of $19.3 billion at the end of the first quarter and a $4.8 billion decrease in spending, mostly due to the spread of coronavirus and a decline in demand, which has minimized the need for additional funding. Global captive Volkswagen Financial Services increased cash and cash equivalents by 1.7% to $8.7 billion since yearend 2019. Banks stockpile reserves While many captives and nonbanking financial institutions rely heavily on operational revenue, credit facilities, and access to capital markets to secure funding and liquidity, banks’ diversified revenue streams, such as deposits, allow a little more leeway when one source of funding — such as the auto ABS market — becomes more difficult or expensive to tap. During the credit crisis in 2008, access to available credit dried up and big banks, such as Bank of America , JP Morgan Chase and Wells Fargo , required government bailouts as the recession deepened. But now the coronavirus economy is squeezing consumers as shelter-in-place orders spur unprecedented unemployment rates and a major pull-back on consumer spending, which accounts for 70% of the nation’s gross domestic product. Simply put, there is not enough consumer demand for big-ticket purchases, such as automobiles or homes, to squeeze banks’ access to liquidity. For others, like Ally Financial and Santander Consumer USA , which have the backing of bank holding companies but focus heavily on auto originations and access to capital markets, liquidity is more of a concern. Ally Financial seemingly learned from the credit crisis. The lender was formerly General Motors Acceptance Corp. before breaking off from General Motors and receiving two rounds of funding from the government’s troubled-asset relief program in 2009. In fact, Ally is in a comfortable liquidity position at $30.1 billion, including cash and cash equivalents and secured and unsecured debt, according to the bank’s first-quarter earnings report. Deposits, which make up 75% of the bank’s funding source, amounted to $122.3 billion. Ally was also able to issue $750 million of unsecured notes last month. The pandemic lockdowns reduced activity at dealerships and lowered application and origination volume by more than 50% by late March, softening cash burn. Ally expects that trend to continue in line with the shelter-in-place orders. Ally’s total originations for the quarter were relatively flat at $9.1 billion. SCUSA, too, put an increased emphasis in its liquidity position, with $50 million available from four diverse funding sources, including private financing, warehouse lines of credit, the ABS market and support from its parent company, Santander Holdings USA . As of April 28, 45% of the subprime lender’s available warehouse capacity syndicated by 13 banking partners remained undrawn. Even though a large majority of Santander’s liquidity is secured through auto ABS, the subprime lender — and largest issuer in automotive capital markets — was able to securitize a total of $2.1 billion in deals this year, including a $965 million nonprime transaction in the second week of April. However, banks are loading up their coffers as they gear up for mounting credit losses, which are expected to increase as payment deferral programs expire in the second quarter. Over 30 million Americans have filed for unemployment since the economy shut down, a record-breaking figure, which puts into perspective how high delinquencies could climb. At Bank of America, for example, approximately 3% of the bank’s outstanding auto portfolio have deferred payments, or $1.53 billion worth, according to first-quarter earnings. To be fair, large financial institutions, such as Bank of America, Capital One , Citizens Bank , Fifth Third Bank , JP Morgan Chase, and Truist Bank — which all have managed auto portfolios exceeding $10 billion — already set aside additional loss reserves Jan.1, under the Financial Accounting Standards Board ’s Current Expected Credit Losses methodology. CECL requires lenders to set aside loss provisions for the entire life of a loan on a quarterly basis in order to protect the bank from mass delinquencies in a stressed economic environment. But still, the full scope of the economic fallout from COVID-19 has yet to be realized, spurring additional loss reserves from banks during the first quarter on top of Day 1 CECL reserves. Some banks, such as Chase Auto and Truist Bank, increased their allowance for credit losses in response to coronavirus by as much as $732 million and $600 million, respectively. Some large financial institutions, such as Ally Financial, Bank of America, Capital One, and SCUSA, have also taken the Federal Reserve up on its March 27 order allowing banks to defer CECL’s effect on regulatory reserves until 2022, which effectively frees up additional working capital on their balance sheets in order to remain agile during the downturn. Seven weeks into what is now being dubbed the “Great Lockdown,” it is unclear how much longer the economy will be shuttered, or how much auto loan performance will deteriorate in the coming months. Some states, such as Texas, reopened in a limited capacity at the end of April in an effort to promote consumer spending. Others, such as Illinois and New York, have stay-at-home orders through mid-May, with additional extensions possible. But as states slowly start to ease restrictions, dealer showrooms reopen, and consumers are ready to purchase cars, lenders have to be ready with cash in hand, while still preparing for the worst. Editors' Note: This article first appeared in the May issue of Auto Finance News, available now.

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