Some investors are still surprised when they find out that the financial divisions of Ford Motor Co. (NYSE: F) and General Motors (NYSE: GM) are among the most profitable parts of the automakers' operations.
As long as they dish out loans responsibly, and residual values on their off-lease cars remain stable, those financing arms are quite lucrative. But if they start signing riskier loans, or used car prices decline (or both) those units can turn from huge profit centers into equally huge money losers -- which is just how it played out during the Great Recession. For that reason, it's important to keep an eye on how automakers' lending units are doing.
Ford Credit generated $641 million of the company's $2.19 billion in adjusted-EBIT for the first quarter. That's a tremendous result when you consider that, outside of North America, the only region where Ford turned a Q1 profit was Europe, and that was a mere $119 million.
In its South America, Middle East & Africa, and Asia Pacific markets, the automaker lost a combined $322 million. Ford Credit's $641 million EBT was a massive 33% jump over the prior year's result, with a broad range of driving forces, as you can see below.
Image source: Ford Credit's 1Q April 25, 2018 presentation.
Other than derivatives market valuation, all factors affecting the business were positive. Most importantly, the auction values it garnered for off-lease vehicles were higher than expected, which drove lease residual value higher. Ford remains disciplined in its underwriting; the percentage of higher-risk loans in the mix is only about 6%, and it has largely been at that level for at least the past couple of years. The average FICO scores of its borrowers have also been pretty steady around the mid-740s; Q1's average checked in at 743. Delinquencies and repossessions remain low, though the latter's 1.22% rate in the quarter reflected its third sequential increase.
At the moment, Ford Credit remains a huge part of the automaker's success and bottom line, and there don't appear to be many red flags in any of its metrics. That said, the risk that the used car market could be flooded with newly off-lease vehicles in the next few years remains a concern.
GMF still growing
During the Great Recession, when GM was in Chapter 11 bankruptcy, it was forced to spin off its financial arm, GMAC, so that the unit (now called Ally Financial) could receive TARP funds. GM later launched a new financial division, General Motors Financial, which is quickly catching up to Ford Credit's profitability. GMF posted an incredible jump in earnings before taxes to $443 million during Q1 2018, up from Q1 2017's $229 million.
Image source: General Motors.
GMF continues to improve the credit rating of its U.S. assets, with 81% attributable to prime and near-prime loans (FICO scores greater than 620), up from the prior year's 76% mix. GMF as a percentage of GM's retail sales checked in at 40.6% which was a sequential improvement from Q4's 30.4%, but a decline from Q1 2017's 50.4%. GMF would obviously like to increase its penetration of GM sales as long as lease terms remain favorable, but that's a volatile metric that can swing significantly depending on what vehicles GM offers incentives such as down payment assistance on.
Looking forward, Ford investors should dial back their expectations slightly, as management said it expects its results to be flat or slightly lower than 2017 for the remainder of this year. Ford is also planning to maintain its managed receivables at current levels for the foreseeable future. It's possible that management thinks the used car market could soften, which would put pressure on auction and residual values. That will remain a factor investors should keep an eye on.
Ford Credit and GMF are excellent strategic assets that support both sales and profits, but they can become liabilities if residual values on leased vehicles decline more rapidly than the companies anticipate -- so keep an eye on the direction of those earnings trends, especially around residual values, each quarter.
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