NEW YORK--(BUSINESS WIRE)--Link to Fitch Ratings' Report: Captive Finance Companies
While the captive finance arms of major U.S. industrial firms are currently enjoying strong business conditions, the potential for rising interest rates, normalizing asset performance, heightened competition and increased use of short-term funding are among the challenges that captive finance companies and their parents will need to navigate going forward, according to a special report published today by Fitch Ratings.
The rating levels of all Fitch-rated captives are currently equalized with their parent ratings, reflecting business importance, operating linkages, shared branding and implicit and explicit support. Positive Rating Outlooks at General Motors Financial and Ford Motor Credit reflect the improving credit profile of these captives' parents.
Captives delivered a second consecutive year of strong profits in 2013, reflecting mostly recovered purchasing flows of autos, planes and large-ticket capital equipment. Growth rates are manageable and delinquencies are near cyclical bests, although modest weakening in asset quality measures is expected given easing credit terms. In our view, average managed portfolio growth was comfortably under control at 5.3% for 12 major captives measured through year-end 2013, up from 2.6% in 2012.
Interest rate risk, in form of either gradual increases or spikes, could weaken pretax margins or slow portfolio growth, particularly for those captives more reliant on short-term funding. Currently, the pretax margins of captives average over 30%, about in line with averages from 2012, which leaves a cushion for gradually rising rates. Rate spikes would likely dampen portfolio growth, which could tempt captives to attract customers by easing credit standards.
The captive landscape is also likely become more competitive as banks increase their focus in auto finance and equipment finance, which may also pressure pricing and margins, and could become another factor that leads to a loosening of lending standards.
Short-term debt as a percentage of total debt is typically running in the 15%-20% range for most Fitch-rated captives, and in some cases is nearing levels seen pre-2008. Maintaining short-term funding at modest levels relative to average lease lives and available liquidity is important to our views of funding and liquidity risk management. Third-party committed backup liquidity that can support at least one year of maturities is viewed favorably.
Captive financing provides large industrials such as Caterpillar, Ford, General Motors, Honda, Harley-Davidson, John Deere and Toyota, with expanded opportunities to capture customers. Under most conditions, captives are important to the parent's revenue strength, profitability and capacity for self-generating capital.
For a full analysis of captive finance company credit profiles, see the Fitch special report, "Captive Finance Companies: 2013 Review," dated May 23, 2014, at www.fitchratings.com.
The above article originally appeared as a post on the Fitch Wire credit market commentary page. The original article can be accessed at www.fitchratings.com. All opinions expressed are those of Fitch Ratings.
Applicable Criteria and Related Research: Captive Finance Companies: 2013 Review (Strong Performance Faces Emerging Headwinds)