By Mike Antich
GM, Ford, and Chrysler will testify Dec. 5 before the House Financial Services Committee in an effort to secure a $25 billion emergency bridge loan. It is imperative that this emergency funding be approved. Failure to do so will have negative repercussions to the fleet management industry.
The root cause of today’s crisis in the auto industry is the difficulty to finance customers. More than 90 percent of new vehicles sold in the U.S. are financed with credit. The average FICO credit score on a loan originated in October by GMAC was 740. This is bad news since 60 percent of the U.S. population has a FICO score below 740.
The business model for the major automakers requires annual sales of 14 million units to be profitable. If volume slips below this, the industry will start hemorrhaging money. The overall industry is on pace for a SAAR of 10.6 million unit year, down from 16 million in 2007. It is impossible to sell 14 million new vehicles a year if 60 percent of your customers can’t be financed.
Mike Jackson, CEO and president of AutoNation, the largest dealership in the country, likewise believes the auto industry’s problems are directly tied to the financial crisis on Wall Street. “It would be a travesty for the irresponsible behavior of Wall Street to, as collateral damage, sweep away the American auto industry.”
Harder to Get a Loan
A Federal Reserve survey of lenders, released the week of Nov. 9, and conducted in October, found that 50 percent of lenders had raised their minimum required credit scores over the past three months. The most creditworthy customer a year ago was someone with a 700 FICO score. Now it’s more like 730. The Federal Reserve survey reported that 20 percent of domestic banks reduced credit limits for existing prime, or creditworthy, borrowers. About 60 percent of the domestic banks said they have cut limits for existing nonprime borrowers. A growing number of banks won’t loan to an individual below a 580 FICO score. The floor used to be a 520 FICO. This is a dramatic increase. A FICO score measures the likelihood that a borrower will make a payment 90 days late or even later in the next two years. The higher the FICO score, the more creditworthy an individual. A lower FICO score reflects less creditworthiness and a higher interest rate. According to Experian, the average FICO score in the U.S. is 678.
The automakers need $25 billion as a bridge loan to help them survive until 2010. Advocates for the bridge loan argue that if the Detroit Three can survive until 2010, they will be better positioned for long-term viability. In 2010, billions of dollars in annual savings negotiated in the 2007 labor agreement with the United Auto Workers (UAW) will begin. Also in 2010, the responsibility for retiree health care costs will shift to UAW-controlled trust funds.
The auto industry is a cyclical business -- vehicles don’t last forever. Pent-up consumer demand will cause new-vehicle sales to pick up again by 2010. In addition, anticipated plant closings will bring the auto industry’s production capacity in line with buyer demand in calendar-year 2010.
The ultimate hope, to both the auto industry and the overall U.S. economy, is that credit begins flowing again to consumers and businesses in the next 12 months. If this happens, many of the problems facing the auto industry will self-correct.
Thinking the Unthinkable
Many leading Congressional Republicans have suggested that Chapter 11 bankruptcy is a better option than a bridge loan. They argue that Chapter 11 bankruptcy will enable the Detroit Three to restructure and ultimately emerge as leaner and more viable businesses. It is interesting to take notice of the home states of the most vocal Republican senators opposed to a $25 billion bridge loan. Republicans who have criticized the requested financial aid for GM, Ford, and Chrysler include those from states where import automakers have transplant factories. For instance, Republican Senators Richard Shelby and Jeff Sessions represent Alabama – home to Honda, Toyota, Mercedes, and Hyundai assembly plants. Senator John Cornyn represents Texas, which has a massive brand-new, state-of-the-art Toyota truck assembly plant in San Antonio. Senator Bob Corker represents Tennessee, which has two Nissan plants — in Smyrna and Dechard — and the recently relocated Nissan’s U.S. headquarters in Franklin. In addition, Chattanooga, Tenn., will be the future site of an all-new VW assembly plant. Would these same senators oppose protecting the U.S. operations of Honda, Toyota, Nissan, VW, Mercedes, Hyundai, etc., if their viability in their home states were at risk? By the way, I never heard Senator Shelby state during the congressional hearings that he helped Alabama come up with $650 million in tax incentives for transplant automakers. An interesting omission.
These Republican politicians need a reality check. The U.S.-headquartered auto industry is not an expendable enterprise. The auto industry is so large that its growth or contraction results in changes in the U.S. gross domestic product. In fact, almost 4 percent of the U.S. GDP is automotive-related. It is irresponsible of these politicians to flippantly advocate Chapter 11 bankruptcy, while ignoring the dire consequences of such an action to the U.S. economy.
While these politicians argue the automakers should file Chapter 11 bankruptcy, Jackson of AutoNation doesn’t believe the auto industry would survive bankruptcy. “Eighty percent of customers say they are going to buy something else if a carmaker is in bankruptcy,” Jackson said. “Chapter 11 reorganization is not a choice, because it would quickly become a Chapter 7 liquidation.” As a result of the credit crunch, it is questionable whether automakers in Chapter 11 would be able to get necessary financing from lenders to help them during the reorganization process. Consumers will not buy new vehicles from a bankrupt automaker due to concerns about resale value and future warranty coverage. An automaker in Chapter 11 would most likely have to idle its assembly plants for a significant period of time while renegotiating new contracts with thousands of individual suppliers. If you're not producing vehicles, you can't sell vehicles. In short, an automaker that files for Chapter 11 will quickly devolve into a nonviable enterprise that will ultimately be forced to go out of business. The consequences are that millions of jobs, either directly or indirectly, would be eliminated as the result of the collapse of the U.S. auto industry. GM has about 120,000 U.S. employees. Ford has about 80,000, and Chrysler has about 66,000. In addition, the three automakers have about 14,000 U.S. franchised dealers that among them employ another 740,000 employees. Suppliers selling components to the Detroit Three employ more than 600,000 workers. Suppliers typically do business with multiple OEMs. For instance, 96 of Chrysler's top 100 suppliers also do business with Ford and GM. A failure of just one of the Detroit Three places enormous pressure on the supply chain. It mostly likely would trigger a string of supplier bankruptcies and component shortages at surviving automakers. Altogether, more than 1.6 million jobs in the auto industry and related industries are in potential jeopardy.
Click on the below video, which illustrates the economic ripple effect of a collapsed auto industry.
If the auto industry collapses, it would also result in a loss of local, state, and federal tax revenues of $60 billion in 2009. In 2010, the estimated tax loss is $54 billion and $42 billion in 2011. Cumulatively, it would represent a total government tax loss of more than $156 billion over three years. In addition, there would be a decline in Social Security receipts paid by auto industry employees. This would represent a decrease of Social Security proceeds of $21.1 billion in 2009, $19.3 billion in 2010, and $15 billion in 2011. What about the 700,000-plus retirees who depend on pensions from GM, Ford, and Chrysler?
Despite all this, I am amazed at politicians who want to “roll the dice” and ignore these highly likely consequences. They continue to argue that Chapter 11 bankruptcy protection will allow a company to continue to operate as it restructures debts and revises contracts. They argue that bankruptcy judges will be able to force the automakers to eliminate brands and terminate dealer franchise agreements, as well as get the Detroit Three out of unaffordable labor contracts. Furthermore, they cite other U.S. industries, such as steel manufacturers and airlines, which have used bankruptcy in the past to return to profitability without putting federal dollars at risk. However, this off-mark analogy is the equivalent of comparing tangerines and oranges. The reality is that a collapse of the auto industry will significantly impact the automotive supplier base and, ultimately, the overall industrial manufacturing base of the United States, which has serious national security implications. The U.S. government would never have allowed the airline industry to enter into Chapter 11 bankruptcy if there had been a possibility it would push the aviation manufacturing sector into insolvency.
Second, the notion that the labor agreement with the UAW can be torn up and salaries reduced dramatically ignores the history of the union. I predict there would be a spontaneous rank-and-file strike, irrespective of what the UAW leadership advocates. If the automakers attempted to get scab workers to cross the union picket lines, the Michigan National Guard would have to be mobilized to restore the peace.
Declaring Chapter 11 bankruptcy is not an option, except to initiate a one-way corporate death spiral that has no return.
Support from Other OEMs
A collapse of GM, Ford, or Chrysler would create more problems than opportunities for the U.S. operations of automakers headquartered overseas. Some executives from these companies worry that a collapse of GM, Ford, and/or Chrysler would have a chilling impact on new-vehicle sales, financially destabilize already fragile suppliers, and trigger a possible public (perhaps political) backlash against import brands. Nissan-Renault CEO Carlos Ghosn and Honda CEO Takeo Fukui have indicated they back financial aid. “Countries face massive job losses unless they move quickly to provide financial assistance to their carmakers,” said Ghosn on Dec. 1. “Job destruction will be massive in those countries that do not rapidly help the auto sector to finance itself.”
Earlier, Fukui said on Nov. 6 that he isn’t opposed to the U.S. government helping automakers as long as fair competition is maintained.
In South Korea, the idea of a bridge loan is also supported. President Lee Myung Bak told reporters on Nov. 16 that a financial aid package is vital because of links between the U.S. auto industry and the South Korean economy. “I’m in favor of the efforts to rescue the U.S. auto industry,” South Korean newspapers reported Lee saying.
Hyundai, South Korea’s largest carmaker, “recognizes there may be extraordinary situations [which] may require unprecedented actions to assure [the auto industry’s] long-term viability and a healthy American economy,” said Hyundai spokesman Oles Gadacz. Similarly, Daewoo in South Korea is responsible for GM’s small-car output and would experience a significant loss if GM were to enter into Chapter 11 bankruptcy. South Korea is home to GM’s small-car design and production and GM Daewoo Auto and Technology made about a quarter of the 4 million cars built in Korea in 2007. “GM’s collapse would not only be a disaster for the U.S. economy, but also a major blow to the Korean auto industry,” says Kim Jun Kyu, research manager at Korea Automobile Manufacturers Association. In addition, hundreds of South Korean component manufacturers and suppliers also depend on GM for sales.
In addition to job losses, bankruptcy for any of the Detroit Three would mean a dramatic decrease in automotive research. Without the billions of dollars the Detroit Three spend on R&D in North America, Europe, and Asia, the pace of automotive technological advancements will slow significantly. Combined, GM and Ford alone spent $15.6 billion in R&D in 2007. This total does not include Chrysler, which is privately held and doesn’t publish its R&D budget.
A Viable U.S. Auto Industry is Essential
While critics would have us believe nobody is interested in vehicles built by GM, Ford, and Chrysler, the fact remains that the Detroit Three sells millions of new vehicles each year in North America. They are also the primary supplier of fleet vehicles in the U.S.
Both the Automotive Fleet & Leasing Association (AFLA) and NAFA voiced their support of a congressionally funded bridge loan. In a letter to congressional leaders, AFLA wrote: “We urge Congress to come to the assistance of the U.S. automobile industry. We fear that failure to do so will have dire consequences to the overall U.S. economy, resulting in the unemployment of millions of American. Congressional financial assistance in the form of a bridge loan is critical since the credit lines normally available to the automobile industry are now frozen.”
In both the short-term and the long-term, the health of the fleet industry and the U.S. economy are linked to a viable domestic automotive industry. In its letter to congressional leaders, AFLA stressed the urgency of swift action. “AFLA urges you to implement immediate assistance to the U.S. automotive industry for the well-being of the commercial fleet management industry and the greater well-being of the U.S. economy.”
Time is of the essence. GM risks running out of money by year-end 2008 without financial aid. GM “burned” through $6.9 billion during the third quarter, leaving it with only $16 billion on hand as of Sept. 30. But it needs $11-$14 billion to continue normal operations. Ford and Chrysler have more cash relative to their needs, mostly from money they borrowed prior to the current credit crunch. However, each of those automakers could also run out of cash during 2009-2010 without federal assistance.
If you are in favor of Congress appropriating a bridge loan to GM, Ford, and Chrysler, please send an e-mail today to:
Let them know what you think.