US auto finance Industry, the cut-throat world of captive OEM financiers

The auto sales in the US grew at a CAGR of 7% between Sep. 2011 to Sep. 2016. In the same period, auto loan balance grew at a CAGR of 7.7%.

The captive OEMs increased their share of retail loans on the back of subvention programs supported by their parent companies. The captive OEMs had the second highest share of total loan balance amounting nearly $250 billion in 2015. Televisory analysed few of the captive OEM financiers, which have the majority market share in new car financing and are a major participant in lease financing such as Toyota Motor Credit Corporation (TMCC), Ford Motor Credit Company LLC (FMCC), American Honda Finance Corporation (AHFC). 

The captive OEMs are generally more inclined towards lease financing due to greater technical know-how in comparison to other categories of auto financiers. The AHFC has a higher proportion of lease financing followed by TMCC and FMCC.

A higher share of lease financing impacts financing margin owing to increased charges towards depreciation on operating leases. A combination of portfolio mix, average revenue per vehicle financed, interest rates charged on auto loans and lease finance, gross asset yield, the cost of debt and delinquency ratio impacts the bottom line of captive OEM financiers. The below charts show how each of these factors impacted EBT margin of TMCC, FMCC and AHFC.

TMCC had the highest revenue per vehicle financed due to the range of products offered. Toyota Motors mostly serve elite consumers, while Ford and Honda target middle-class consumers. Additionally, despite the lowest revenue per vehicle financed, AHFC enjoyed higher yield on earning assets and higher financing margin than its peers. This can be directly attributed to higher APR (Annual Percentage Rate) charged by these companies. The APR offered by TMCC, FMCC and AHFC for lease financing was 2.97%, 3.10% and 3.13% respectively in Sept. 2016. The retail financing APR was recorded at 0% for Ford and Toyota and 1.99% for American Honda Finance during the same period. 

A higher APR charged by AHFC led to greater yield on earning assets and higher financing margin. However, higher interest expense (in the case of TMCC and FMCC) and greater depreciation expense (in the case of AHFC) also impacted financing margin. TMCC had a higher share of operating leases in its portfolio leading to more depreciation expense as compared to FMCC, this, in turn, led to low financing margin for TMCC. On the other hand, TMCC had higher revenue and earning assets, this generated better yield on earning assets as compared to Ford. These factors led to a minor difference in financing margin among the three companies. Furthermore, the increasing share of operating lease contracts and rise in interest expense for the three firms resulted in declining financing margin over the years. A low yield and low financing margin translated into low EBT margins.

Although, the above factors are revenue drivers, controlling cost metrics is also significant to generate better EBT margins. 

In addition, as consumer debt levels increased in the US, the companies were forced to lend to subprime borrowers impacting their delinquency ratio negatively. Thus, all the three companies recorded a slight increase in default frequency percentage. Subsequently, as the default frequency rises, the allowances for credit losses also increases along with loss severity per unit, thereby raising the costs and impacting the EBT margins negatively. However, captive OEM financiers are more inclined to cater to super prime and prime borrowers and consequently had a very minimal impact on their delinquency ratio and margins. Therefore, it can be stated that a slight increase in delinquencies leads to a higher difference in EBT margin. Toyota Motors had the highest default frequency as compared to FMCC and AHFC. While AHFC and FMCC had the same level of delinquency, FMCC was also burdened with the highest interest expenses, thereby adding to downward pressure on its EBT margin.  

Thus to summarise, the reasons behind low EBT margin of TMCC, despite the highest revenue per vehicle financed was the low gross yield on earning assets, higher delinquency ratio and high depreciation expense. However, Ford’s lower EBT margin was mainly due to high-interest expense coupled with the low gross yield on earning assets, this may have been a result of its lower inclination towards lease financing. A better gross yield on earning assets, lower delinquencies and lower cost of debt were reasons because of which AHFC had the highest EBT margin among all its competitors.

The minor differences in the KPIs of these three major captive auto financiers had a cascading effect and led to major differences in their bottom line profitability. Hence, maintaining consistently higher EBT margin, lower interest expense and delinquencies is essential to survive in the environment of cut-throat competition.