(Archived Content)
TG-563
Good morning.
Chair Warren, and members of the Congressional Oversight Panel, thank you for the opportunity to testify before you today. We are here to report on the state of the capital markets for financing the purchases of cars and light trucks by dealers and consumers, and in particular the relationship between one of the nation's largest sources of such financing – GMAC [1] – and the Treasury's investments in General Motors and Chrysler.
Background on Auto Industry Investments
Over the past year, the Obama Administration has been working to manage an historic crisis in the American automobile industry. President Obama inherited a situation in which the industry had lost 50% of its sales volume and over 400,000 jobs in the year before he took office. GM and Chrysler had received substantial loans from the prior Administration and were requesting additional assistance. Without such assistance, both companies faced almost certain liquidations, which would have caused an enormous disruption to the entire American automotive industry and posed a significant risk to the overall economy. GM and Chrysler's outright failure would have resulted in the loss of hundreds of thousands of jobs across multiple industries and further damage to the financial system, as auto financing accounts for a material portion of overall financial activity.
Working with their stakeholders and the President's Auto Task Force, both GM and Chrysler underwent fair and open bankruptcies and have emerged as stronger global companies. This process required deep and painful sacrifices from all stakeholders – including workers, retirees, suppliers, dealers, creditors, and the countless communities that rely on a vibrant American auto industry. Anytime a company as large and interconnected as GM or Chrysler becomes insolvent, the collateral damage is enormous. However, the steps that the President took not only avoided a potentially catastrophic collapse and brought needed stability to the entire auto industry, they also kept hundreds of thousands of Americans working and gave GM and Chrysler a chance to become viable, competitive American businesses.
Background on Auto Finance Market
A viable auto industry requires financing for both dealers and consumers. The vast majority of automobile purchases in the U.S. are financed, including an estimated 80%-90% of consumer purchases and substantially all dealer inventory purchases.
Both this Administration and the prior Administration have recognized that preventing a collapse of the auto industry required stabilizing the auto finance industry as well. Therefore, from the early days of this Administration, Treasury identified addressing the problems in this market as a priority of our financial stability plan.
For the last 80 years, the auto industry has largely relied upon dedicated financing providers. Most dealer inventories have historically been financed by the captive finance companies (e.g., Ford Motor Credit financed 77% of their U.S. dealer inventories in 2008). [2] Captives have also been the largest source of financing for consumers, financing approximately 47% of consumer units between 2006 and 2008 (30% through loans and 17% through leases). Banks, third-party finance companies, and credit unions financed an additional 30%-40% of consumer purchases. [3] Since at least the 1970s, these financing options supported consumer demand by helping to dramatically lower the total cost of owning a car, from an average monthly payment of 9.1% of household income in the 1970s to 5.7% recently. [4] The improvement in the affordability of owning an automobile coincided with an increase in cars per driver from 0.93 in the 1970s to 1.16 in the 2000s, and likewise supported increases in the size and quality of cars purchased. [5]
Specialized automotive finance companies have unique resources, infrastructure, and long term experience underwriting automotive credit, and for the foreseeable future they will continue to be the largest sources of credit for both consumers and dealers.
GMAC
Founded as GM's captive finance subsidiary in 1919, GMAC has been the primary source of financing for GM's dealers and consumers for over 90 years. At the time of Treasury's initial investment in GMAC, in December 2008, GMAC provided: wholesale financing for 75% of GM's dealers representing 85% of total dealer inventories; "in-transit" [6] financing for 95% of the GM dealers financed by GMAC; and consumer financing for 25% of GM's retail sales. In turn, GM represented 96% of GMAC's wholesale financing volumes and 84% of new vehicle retail financing volumes in 2008.
Distress in Credit Markets. As a result of the financial crisis, particularly the events of September 2008 including the collapse of Lehman Brothers, credit availability to auto dealers and consumers became severely impaired. The impact of the contraction of credit was dramatic: loan approval rates dropped, interest rates increased, and financing terms tightened. This was especially true for GM and Chrysler, as uncertainty about the future of the companies impaired the ability of GMAC and Chrysler Financial to access the capital markets. Consumers were immediately impacted: loan approval rates to prime borrowers dropped from the mid-80% to approximately 60%, loan-to-value ratios dropped from 95% to 85%, and interest rates increased from approximately 5.0% to over 8.0%. [7] In addition, GMAC and Chrysler Financial cancelled their vehicle leasing programs and reduced lending to lower income borrowers considerably. Some estimates suggest that the contraction in the auto finance market reduced auto sales by 1.5 – 2.5 million cars per year.[8]
Impact on GMAC and Auto Industry. By late 2008, one of GMAC's primary sources of funding, the securitization market, was in severe distress. This abrupt contraction in funding forced GMAC to dramatically restrict its lending activities to auto consumers in order to preserve capital necessary to support dealers. The asset-backed securitization (ABS) market's fear about the risks of funding GMAC's ongoing operations was magnified by the simultaneous crisis overwhelming the automakers, including the threat of both GM and Chrysler bankruptcies. ABS investors were skittish and required significant credit enhancement, and GMAC was not able to access alternative sources of funding, such as the unsecured bond market. Without government assistance, GMAC would have been forced to suspend financing lines to creditworthy dealerships, leaving them unable to purchase automobile inventory for their lots. Without orders for cars, GM would have been forced to slow or shut down its factories indefinitely to match the drop in demand. Given its significant overhead, a slow-down or stoppage in production of this magnitude would have toppled GM.
When the prior Administration decided to provide assistance to GMAC in December 2008, GMAC managed approximately $26.5 billion of wholesale auto loans, $23.3 billion of which supported GM dealers. Had Treasury allowed GMAC to fail, no single competitor or group of competitors could have stepped in to absorb GMAC's entire loan portfolio. Dealer floor plan financing is a unique and labor-intensive segment of the loan market that has been dominated by captive lenders who are not easily replaced. For example, in December 2008, 75% of GM dealers received their financing from GMAC while the next five lenders made up only 8%. The remaining dealers were serviced by 200 banks, most of which provided financing for only a single dealer. It is also important to remember that when the initial investment decision was being made, many large national banks faced significant threats to their own financial health (e.g., deteriorating legacy asset values, diminished access to capital, mounting losses). Finally, most banks lack the capacity to aggressively grow their auto lending portfolios, given internal and regulatory limits on borrower and industry concentrations. In addition to size and capital constraints, providing new dealers with financing is complex and requires time that was not available. GM estimates that it would have taken a new provider up to six months to create the infrastructure, systems, and human capital necessary to replace GMAC.
Actions Taken. Given this difficult environment, in December 2008, GMAC (which already owned an industrial loan company) applied for and received approval from the Federal Reserve to become a bank holding company (BHC). Shortly thereafter, the prior Administration invested $5.0 billion in GMAC, and GMAC was able to raise an additional $2.0 billion from its existing owners, $884 million of which came from a loan provided by Treasury to GM. [9]
After the Obama Administration took office, Secretary Geithner announced the Financial Stability Plan, a key component of which was the "stress test." The Treasury worked with federal banking supervisors to develop the Supervisory Capital Assessment Program (SCAP) to determine whether the nation's largest BHCs had a capital buffer sufficient to withstand losses and sustain lending in a significantly more adverse economic environment. The supervisors conducted forward-looking assessments to provide the transparency necessary for individuals and markets to judge the strength of the banking system. All domestic BHCs with year-end 2008 assets exceeding $100 billion were required to participate in the SCAP. These 19 firms collectively held two-thirds of the assets and more than one-half of the loans in the U.S. banking system. GMAC, with $173 billion in assets as of year-end 2008, was one of these 19 institutions.
As part of the SCAP, Treasury committed to make capital available for firms that did not meet their SCAP buffer requirement via third party sources.
On May 7, 2009, the Federal Reserve released the initial results of the stress test, which required GMAC to raise $13.1 billion of new capital. The SCAP analysis included loss assumptions for certain discrete events, the most significant of which were the then-pending GM and Chrysler restructurings. SCAP participants were given until November 9 to meet their capital requirements. Aside from GMAC, 18 of the 19 participants were shown to have no additional capital need, or were able to raise the necessary capital in the private market. In consultation with the banking supervisors, Treasury agreed to help meet GMAC's SCAP requirement by investing additional capital in two stages. The first investment of $7.5 billion was made on May 21 to address GMAC's immediate capital needs. Days before the November 9 deadline, GMAC's Board of Directors informed Treasury that it would replace the company's CEO with one of its Board members, Michael Carpenter. With the banking supervisors' consent, GMAC and Treasury agreed to delay the second investment to allow GMAC's new management to review the company plans. In December, Mr. Carpenter presented to Treasury a proposed recapitalization plan to bring GMAC into compliance with its SCAP requirements by year-end. Treasury ultimately invested an additional $3.8 billion on December 30. This amount was $1.8 billion less than the initially projected $5.6 billion in May due to variety of factors, including less disruption than anticipated from the GM and Chrysler bankruptcies. Completion of the SCAP process by year-end was an integral part of preparing GMAC to re-enter the public debt markets, and thereby, protecting the taxpayers' existing investment in GMAC. [10]
Concurrent with the May transaction, GMAC received regulatory approvals that enabled it to enhance its liquidity. The FDIC approved GMAC's application to issue guaranteed debt under the Temporary Liquidity Guarantee Program and also increased the amount of brokered deposits that GMAC's bank subsidiary (Ally Bank) could raise. In addition, the Federal Reserve Board granted a waiver of Section 23A of the Federal Reserve Act, expanding Ally Bank's ability to fund consumer and dealer finance loans for GM and Chrysler with deposits.
Chrysler Financial
Like GMAC, Chrysler Financial also faced a severe liquidity crisis last year, as credit market deterioration and the threat of a Chrysler bankruptcy constrained its access to funding throughout the first half of 2009.
Necessary for Successful Restructuring of Chrysler. As the conditions in the auto industry continued to worsen throughout the spring of 2009, it became clear that a Chrysler bankruptcy could well be required to effectuate a restructuring of the company. Chrysler Financial, Chrysler's affiliated finance arm providing retail and wholesale loans to Chrysler customers and dealers, [11] had approximately $20.4 billion of conduit financing that was slated to expire by July 30, 2009, some of it immediately upon the occurrence of a Chrysler bankruptcy. The loss of these conduits would have had an immediate and acute impact on Chrysler's dealers: Chrysler Financial would have been forced to discontinue financing any new inventory for Chrysler dealers, the dealers would have been unlikely to find alternative financing, and the purchase of new vehicles from Chrysler by dealers through Chrysler Financial would have ceased entirely. Since Chrysler Financial financed approximately 60% of dealer purchases from Chrysler, this would have resulted in a near-total collapse of Chrysler revenues. The portion of the conduits backing its dealer financing would have terminated immediately upon a bankruptcy of Chrysler, and those providing Chrysler Financial its retail and lease financing facilities would have foreclosed on the underlying collateral, starving Chrysler and its retail customers and dealers of needed capital. Given the state of the credit markets and the threat of a Chrysler bankruptcy, Chrysler Financial looked for but found no refinancing alternative.
As it became clear that a Chrysler bankruptcy was imminent, the situation rapidly became more acute, and we were forced to act. Without a viable financing source for its customers and dealers, a successful restructuring of Chrysler would not have been possible. Fiat, who played a critical role in the restructuring, insisted as a condition to its alliance that such a viable funding alternative be in place before it agreed to any deal.
Actions Taken. Given the lack of funding options for Chrysler Financial and the ramifications its failure would have had on Chrysler, several options were reviewed. Chrysler Financial solicited bids for its platform from potential third-party non-captive finance providers, but was unable to successfully complete a sale.
Taking into account the circumstances at that time, it was determined that the most effective method to provide financing to Chrysler's dealers and customers was to capitalize GMAC's existing auto origination platform to a level adequate for GMAC to assume these financing responsibilities. GMAC had advantages that Chrysler Financial did not, such as the ability to use its bank deposits to fund its automotive finance originations and to apply for support under the FDIC's Temporary Liquidity Guarantee Program (TLGP).
As part of the stress test results in May 2009, t he Federal Reserve determined that GMAC required $4.0 billion in addition to the SCAP buffer requirement in order to assume Chrysler's dealer and customer loan originations. Today, the transition is nearly complete as GMAC has become the preferred financing source for Chrysler dealers and customers. As of December, GMAC has completed its final underwriting and provides wholesale financing for 77% of Chrysler's U.S. dealership inventory , and is the top provider of consumer financing for Chrysler vehicles in the U.S.
Additional Auto Finance Programs
Another striking effect of the financial crisis has been the disintegration of the securitization markets. These markets have historically been a critical component of lending in our financial system but were virtually shuttered during the worst period of the crisis. These markets were especially important to the U.S. automotive financing marketplace with nearly $70 billion of securities backed by auto-related receivables issued in 2007. Therefore, the Federal Reserve, with the support of Treasury, launched the Term Asset Backed Securities Loan Facility in November 2008 to jump-start the securitization markets by providing financing to investors to support their purchases of certain AAA-rated asset-backed securities (ABS).
Retail Auto ABS. Through TALF, automotive finance companies have raised over $41.5 billion of securities to date backed by retail auto loans and leases since the program's launch in February 2009. Through the end of January, the Federal Reserve estimates that TALF has supported more than 2.6 million individual auto loans and leases. TALF has stimulated investor demand in asset-backed securities as spreads for ABS backed by retail auto loans and leases have narrowed to pre-crisis levels and liquidity has returned to the market. Today, retail auto loan and lease ABS are able to be successfully issued to investors without TALF assistance.
Dealer Floor Plan ABS. The financing environment has been and continues to remain challenging for ABS backed by dealer floor plan loans, where spreads remain wider than historical averages and investor demand remains limited. The securitization markets were historically the prominent source of funding for captive finance companies, including GMAC, who relied on both public and private securitizations to fund loan originations. As early as 2005, secured funding and whole loan sales represented 90% of GMAC's U.S. automotive term funding in comparison to 46% in 2004. [12] With access to this market effectively closed, finance companies were, and continue to be, severely restricted in their ability to originate loans for auto dealers to purchase inventory.
While dealer floor plan loans are TALF eligible, the rating agencies have been reluctant to rate floor plan securities AAA (a requirement under TALF), regardless of the credit enhancement offered, due to the distress in the auto industry. In fact, issuance for auto dealer floor plan loans remained frozen from 2007 until World Omni's TALF-supported issuance in August 2009 of $225 million. [13] Since that issuance, dealer floor plan ABS spreads have narrowed, but continue to remain above historical levels. In total, only approximately $3.0 billion of auto floor plan ABS to date has been issued with TALF support since the program's launch in February 2009, which can be contrasted to the nearly $6.0 billion issued solely within the first six months of 2007 without TALF support. In the past three months, selected issuers like Ford, Hyundai, and Nissan have successfully completed issuances though investors remain attuned to the specific credit risk associated with each issuer, and the markets remain fragile.
Conclusion
While recognizing the need to avoid past excesses, a viable domestic auto industry cannot be sustained without improving the availability and affordability of credit to a more "normalized" level. Having the capital markets recognize the stability in the value of domestic automobiles as collateral will be the most effective mechanism for improving the provision of credit to automotive dealers and consumers. We believe that the auto industry offers strong credit opportunities: manufacturers have been revitalized and some have already returned to profitability; dealer networks have become healthier; the value of new and used vehicles produced by the domestic automakers is stabilizing; and we believe dealer floor plan loans will prove again to be safe assets. [14]
The Administration's investment in GMAC has been and continues to be a critical component of the effort to stabilize the U.S. auto industry. Providing GM and Chrysler with a viable source of financing enabled Treasury to facilitate the successful restructuring of both of these companies. GMAC was uniquely positioned to provide the personnel and infrastructure to originate and service auto loans and is now the largest provider of retail and wholesale financing to both GM and Chrysler's customers and dealers.
GMAC is now capitalized at levels well-above historical industry averages. At the end of 2009, GMAC had $22.4 billion in Tier 1 Capital (14.1%) and $7.7 billion in Tier 1 Common Equity (4.8%). GMAC is also now able to secure external funding for its ongoing operations, a critical step toward its independence. As of year-end 2009, the company's deposit base at Ally Bank reached $31.0 billion, an important source of stable, low-cost funding. With the support of TALF, GMAC has completed three securitizations in the past six months – two backed by retail loans to consumers and one backed by wholesale floor plan loans to dealers. These represent GMAC's first ABS issuances in over three years. [15] In addition , GMAC raised $2.0 billion of unsecured debt this month, priced at terms comparable to a recent financing completed by Ford Motor Credit. This is the first time that GMAC has been able to raise unsecured debt since 2007, an important step towards financial stability.
As the owner of 56.3% of GMAC's common equity, Treasury has designated two members of GMAC's Board of Directors, and is in the process of selecting two additional members, which it expects to complete in April. The government remains a reluctant shareholder in GMAC and other TARP recipients. As we have noted previously, Treasury intends to dispose of its investments as soon as practicable, with the dual goals of achieving financial stability and protecting the interests of the taxpayers. We have already begun to exit some of our auto-related investments. In July 2009, we terminated the Warranty Commitment Program, and Chrysler Financial fully repaid its loan. The Supplier Support Program will wind down in April this year. GM has made an unconditional commitment to repay its loan by June and continues to work toward an initial public offering. As with GM, Treasury will likely exit its investment in GMAC through a gradual sale of shares following a public offering.
In a better world, the choice to intervene in GMAC would not have had to be made. But amid the worst economic crisis in three-quarters of a century, the Administration's decisions avoided devastating liquidations and provided both GMAC and the automakers with a new lease on life and with a real chance to succeed.
###
[1] Prior to incorporation on June 30, 2009, GMAC Inc. was known as General Motors Acceptance Corp.
[2] Source: GMAC 2008 Form 10-K; Ford Motor Credit 2008 Form 10-K.
[3] Source: JD Power & Associates, AutoNation estimates.
[4] Drivers of improved affordability include (in addition to a reduction in the real cost of cars): (i) lower interest rates, driven by: (a) lower prevailing interest rates (Treasury yields falling from 8.7% in the 1980s to 3.2% in the 2000s), and (b) a decline in the price for market risk resulting in a contraction in auto loan spreads from 440 bps to 200 bps over the same period, and (ii) more favorable financing terms, including (a) maturities increased from an average of 38 months in the 1970s to nearly 60 months in the 2000s, and (b) lower down payments (LTVs increased 86% to 94% over the same period of time). Source: Goldman Sachs Group Inc., Americas: Automobiles, Adjusting Outlook on Affordability and a Deeper Cyclical Downturn, October 17, 2008, citing Ward's Federal Reserve, and BEA.
[6] 12 to 13 days are typically required for delivery of vehicles from manufacturer to dealer.
[7] From March to September 2008. Source: AutoNation, April 2009
[8] Additional estimates of the impact of diminished credit on the Seasonally Adjusted Annualized Rate (SAAR) of auto sales include: 2.6 million units (Barclays), 1 to 1.5 million units (the Fed) and 1.6 million units in 2009 and 3.1 million units in 2010 (AutoNation).
[9] Upon becoming a bank holding company, Treasury invested $5 billion in perpetual preferred stock and obtained warrants for an additional 5% of the initial investment. Upon immediate exercise of these warrants, Treasury received $250 million of perpetual preferred stock. The remaining $2 billion was raised in two ways: (a) GMAC's then-owners (GM and Cerberus) converted $750 million of their existing debt into equity, and (b) GMAC conducted a rights offering, whereby GM and Cerberus collectively purchased $1.25 billion of equity ($884 million and $366 million, respectively). GM funded its purchase with a loan from Treasury. This loan was able to be converted into the purchased shares at the option of Treasury. In May 2009, Treasury converted the loan into a 35.4% equity stake in GMAC.
[10] In December 2009, Treasury converted its existing $5.25 billion of perpetual preferred stock into mandatorily convertible preferred stock (MCP) and converted $3.0 billion of its existing MCP to common stock. These two transactions, combined with the $3.8 billion injection of new capital, resulted in GMAC's compliance with the SCAP buffer requirements. With the conversion of its MCP into common stock, Treasury now holds a 56.3% equity stake in GMAC.
[11] Currently, Chrysler Financial is not an affiliate of Chrysler and is indirectly owned by Cerberus and its co-investors. However, its parent company was the original recipient of the December 2008 financing to Chrysler and as such Treasury has a right to 40% of any distributions from Chrysler Financial received by the parent company with a preference on the first $1.375 billion in distributions.
[12] GMAC 2005 Form 10-K.
[13] World Omni collateralizes Toyota dealers located in the southeast U.S.
[14] Losses on wholesale loans have been less than 2 basis points per annum over the last 15 years. Source: GMAC
[15] Ally Bank raised $983 million in September 2009 and $942 million in November 2009, through the issuance of securities backed by consumer retail loans. These transactions were TALF eligible, but cash investors dominated the order book. Ally Bank also raised $1.4 billion in January 2010, through the issuance of securities backed by floor plan loans. Nearly 50% of the TALF-eligible portion of this issuance was financed through TALF loans.