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Credit Crunch Slows Ford Credit

April 29, 2008

Ford Credit, the lending arm of Ford Motor Co., pre-tax earnings dropped more than 87 percent to $36 million in the first three months of the year, down from $293 million in the first quarter of 2007.

Ford says it consumer lending arm will remain profitable this year, but what was once a reliable source of revenue for the parent company has dried up in the face of a broader credit crisis.

The decline in Ford’s Credit earnings is due to increases in repossessions and delinquencies, the increase in cost of capital and the decline in demand for used cars, which undermines residual values for leased vehicles.

But the fundamental problems at Ford Credit are the same ones dogging its parent company. Ford is selling fewer cars, which means fewer car loans are needed. And Ford's poor credit rating has raised Ford Credit's borrowing costs dramatically.

Ford’s chief financial officer Don Leclair insists the credit company can make a turnaround. He believes the biggest challenge facing Ford Credit today is the weak used-car auction market, which is damaging residual values on leased vehicles.

"The most important thing for us to do is fix the auto company. If we do that, our credit ratings will improve, our access to capital will improve and our credit company will improve," he said.

The capital markets are not closed to Ford Credit, but they have become more expensive. Last month the company did a bond issue at 12 percent interest. The company, however, typically lends money at about 7 percent.

The decline in lending, however, is good news for bond holders. As a finance company gets smaller, its liquidity improves because it has more capital coming in from existing loans than it has going out in the form of new ones.

That has been happening for the past several years at Ford Credit, which prompted credit analyst Eric Selle of JPMorgan to upgrade Ford Credit's bonds earlier this month.

"(Ford Credit's) reduced size and improved quality of its receivables portfolio should help it weather the downturn better than its peers," he wrote in his note.

The decrease in lending has forced Ford Credit to suspend dividend payments to its parent company. In 2004, those payments were worth about $4 billion to Ford -- more than the parent company lost last year.

Ford also has a profit maintenance agreement with its finance subsidiary that requires it to make cash payments to Ford Credit if the lender's net income falls below $274 million annually. Ford said it does not expect to have to do that this year, but Ford Credit's first-quarter performance was bad enough that the company set aside more than $100 million just in case.

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