July 29, 2021

Chip shortage a plus for captives’ profits

Inventory constraints prompted by the semiconductor shortage benefit captive auto lenders because the scarcity of new cars boosts used-vehicle valuations, according to industry research.

Four automakers said last month that production cuts were necessary as chipmakers pivoted capital to support larger deals outside the automotive sector. Consumer electronics companies such as Apple Inc. have tied up the available chips for gaming consoles and computers. Insufficient semiconductor supplies are likely to last for the first half of the year, making car dealerships more reliant on used vehicles to stay afloat.

Moody’s Investors Service said in a Feb. 24 report that the resulting valuation surge would help auto lenders by “raising residual value estimations and the captives’ profitability.”

Ford Motor Credit Co. and GM Financial, for instance, estimate the residual values of used cars in their portfolios on a quarterly basis. If used-vehicle sales and prices are stronger than the lenders’ estimates, “depreciation will be lower and profitability will improve,” the report said.

Additionally, Ford Credit and GM Financial reported lower lease return rates for 2020, which will reduce volatility in their lease portfolios this year, Moody’s said.

The surge in used-car valuation benefits major auto lenders even outside the captive space.

Jagdeep Dayal, head of partnerships for Chase Auto, said any lender with auto leases on its books saw a boost in profitability when those values surged last year.

“It is a net positive for institutions,” he told Automotive News. “The entire industry saw that, and we were no exception to the rule.”

Multiple recessions have demonstrated the profit boost auto lenders experience when the supply of new vehicles dips below consumer demand, he said. This includes the pandemic time frame.

“As the OEMs started shutting down factories for obvious reasons, the supply of new cars was starting to shrink,” Dayal said. “What we saw in the second half of 2020, collectively as an industry and definitely also with our brand partners, was a material increase in the valuations of used cars.”

Still, Moody’s anticipates inventory constraints on the new-vehicle side may be enough to harm captive profitability in the long term. Increased incentive activity could offset those challenges until the chip bottleneck is resolved, the company suggests, although it could eat into future residual value profits when those vehicles return to market.

And the auto finance landscape has shifted somewhat since the initial shock of the pandemic. Competition from banks, which ceded market share to captive lenders in the early days of the pandemic, might be another challenge.

“Competition might be fiercer than in 2020, as banks are also more aggressively seeking loan growth in 2021, as evident from the loosening in bank auto loan underwriting standards during” the fourth quarter, the report said. In fact, Moody’s called it “the largest easing in auto loan standards since 2015.”