CAPTIVE FINANCE COMPANIES: CURSE OR BLESSING?

 

 

So, what do captive finance companies do and why do I think they are bad-ass companies to invest? Let’s get into it. So, captive finance companies are an arm of a parent automobile company through which you can borrow money to finance your car. Basically, if you want to buy a car, you can approach these companies for loans to buy a car. Now, one would ask, why should I approach them when we already have established banks to finance our vehicles? Well, captive finance companies possess pricing power and hence they are able to provide loans at lower interest rates as compared to established banks. And normal banks lend money for all sorts of things, like buying house, car, educational loans, small business loans, etc., but captive finance companies specialize in writing loans for automobiles only. If market rate for car loan is say 8% then captive finance companies can offer you loans at 6%-6.5%, saving those extra 1.5-2% of your money. Being subsidiary of a parent company, they can also offer you special offers besides lower interest rates.

These companies help reduce the risk of parent companies. This also allows the parent company to increase their sales. These companies finance their own products. When a captive arm finances a customer loan, and let’s say the borrower defaults, they still are in the position to repositioning of car. Now, let me take time to explain the above statement which put’s captive finance companies in a better position than normal lender.

What do I mean when I say, “they are in a position to repositioning a car’?

I’ll tell you with an actual example. We have a captive finance company named Mahindra Finance, which obviously is a subsidiary of Mahindra & Mahindra. So, when say Mahindra finances a car, let’s say 3,5- or 7-years finance deal and let’s say that the borrower defaults, Captive finance companies can repossess the car, and when the car comes back to them, they are in a very privileged position as compared to a typical lender. The problem with these typical finance banks is that when someone defaults car payment, and when car comes to them, as said earlier, they already have so many assets in terms of home loan, education loan, small business loan that dealing with defaulted car loan, is like a headache and they have no idea what to do with this. They have no mastery in one particular asset which these captive finance companies do. They can either sell it or give it to scrap ward. They would just try to get rid of it quickly to get some money back and get the company moving. Now on the other hand what Mahindra can do is that after refurbishing, they can introduce the car in Mahindra pre-owned and get good price for it. Their ability to work with these assets is very different than a typical loan company. Here the borrowers default rate is low comparatively. This was the reason that why Ford did not went bankruptcy in 2008 as when GM did.

One thing that can only happen with captive finance companies is that they can offer Certified Preowned cars (CPO) to their customers. These are preowned cars which have been inspected and refurbished to perfection by the experts. Buying a second-hand car from, say your friend or relative puts you in no advantage because nothing is guaranteed. They can offer you a car that had experienced an accident and makes a lot of noise when you run it. Only captive finance can offer certified pre-owned cars with various guarantees. These pre-owned cars are accident free, low run cars and only a few years old. The biggest benefits of owning CPO cars are a comprehensive warranty to protect buyers from unforeseen repairs and maintenance costs.

Now you see, what just happened. Normal lenders try to get rid of the car as fast as possible, but captive finance companies can rebuild the car and re-launch it under their certified pre-owned car segment with maintenance and servicing guarantee plus a brand protection.

Other advantage which captive finance companies have is they act like savior in times of destress. Let’s say Maruti and HDFC have a contract which states that whenever someone buys car from Maruti and if they need loan, HDFC would finance it. But let’s say that in the future, there is a major crisis. No chips available, increase in crude oil prices, increase in commodities like rubber, metal and steel at the same time. In this case Maruti is going to face heavy losses and HDFC is not going to save them. The same situation that took place during 2020 crisis. Their contract is limited up to financing. On the other hand, if tomorrow Mahindra and Mahindra faces the same crisis, they have their captive finance arm to protect them because they are their subsidiary. Now either captive arm faces losses or the main company, the effects are same. Hence captive finance companies are also willing to bear a loss in order to earn a profit for their main company. These captive finance companies are cash cows and can produce loads of cash which, in times of crisis, puts them in a beneficial position. Almost every established car brand has a captive finance arm. Lexus has one, Mercedes has one, Mahindra has one. And lastly, if you think I am joking, I challenge you, go and check balance sheet of these captive finance companies and have a look at their cash flows.

I hope I was successful in making you understand their business -models and why they are bad-as companies to invest.