General Motors Case Study: GM\'s

General Motors Case Study: GM's relationship with Cerberus Capital Management

The automotive industry is uniquely dependant on lines of credit. Consumers usually do not have the ability to buy cars with cash 'up front,' and the availability of credit enables consumers to buy more expensive cars and pay for them over time. The practice encourages greater consumption of costly vehicles, and a higher rate of turn-over for vehicles on lots. The greater the availability of credit, the greater the health of the automotive industry as a whole, provided these automotive loans are sound. However, although automotive loans were not as beleaguered by defaults as home loans in recent years, the financial insolvency of consumers has forced many individuals to default on their automotive loans. This has made banks wary of extending lines of credit to all but the least risky of borrowers. Consumer wariness about making new purchases combined with tightened credit has been a disaster for all major car companies. 70% of all banks this year have tightened lending standards regarding automotive loans (Welch 2008).

While all automotive companies have been hard-hit by the current financial crisis, General Motors was already in serious jeopardy because of tumbling sales, skyrocketing fuel prices, and the drain of the costly pensions and health insurance plans it had to provide for retired workers. GM is facing a serious liquidity crisis today. "The credit rating agency Standard & Poor's said Monday that it was keeping GM on a negative watch because of concerns about its declining cash reserves" (Vlasic 2008). GM's United States sales alone dropped 17.8% over the course of 2008 and the company is even less popular abroad, as most international consumers prefer more fuel-efficient Japanese vehicles than GM's usual output of SUVs (Vlasic 2008).

To increase consumer demand, GM has offered a variety of incentives, such as employee discounts and dealer flexibility. There has been a stress on offering consumers special agreements regarding cars sold on GM lots to stimulate demand. But GM's attempt to rehabilitate its fortunes has met a roadblock regarding its complicated relationship with the financial corporation that extends credit to most GM car buyers. The finance company known as the General Motors Acceptance Corporation (GMAC), of which GM was once the sole owner but which is 51%-owned by Cerberus Capital Management "sent a letter to GM dealers on Oct. 13 saying that the company won't loan money to car buyers with credit scores lower than 700. Consumers with credit scores above 680 are considered prime-credit borrowers. That means even some would-be car buyers whose credit is considered sterling would be nixed by GMAC" (Welch 2008).

In short, although it is GM's desire, and in the car company's interest to facilitate the process of extending loans to consumers, because GM's primary financing company is partially owned by Cerberus, GMAC is tightening its extension of credit to consumers to bolster the long-term interests of Cerberus and is thus acting against the desires of GM. Cerberus said it has become concerned about its fortunes in the wake of today's economic downturn. Before GMAC started tightening standards in recent months, half of GM's buyers obtained loans through GMAC (Welch 2008). "Most customers of GM's largest brand, Chevy, reportedly sport scores in the 600 range...Additionally, GMAC funded 43% of all GM sales in the second quarter, but only 20% of funding in September" (Wurtzel 2008). Now GM dealers have to go to banks to get loans for their consumers -- banks which are also tightening their requirements for extending credit to borrowers. GM has prepared a campaign to help its customers locate financing from different sources, but because GMAC's decision came so quickly and dealers and customers are used to working directly with GMAC, this has proven difficult (Wurtzel 2008). GM now finds itself in the worst of all possible situations regarding GMAC -- because the financing company has extended loans to homeowners through its non-automotive loan program, GM has a 49% share in the company, but it is enjoying none of the benefits of a special relationship regarding car loans that its association with GMAC is supposed to convey.

When GM gave up control to Cerberus, they got in a pickle...It [Cerberus through GMAC] has taken away flexibility from dealers" (Welch 2008). "GMAC also said it will suspend bonuses to dealers who earned the lender's Platinum designation for bringing the firm strong buyer volume" (Welch 2008). This essentially discourages dealers who engage in hard-sell tactics, and encourages consumers to take on 'more car' than they can afford. But the belt-tightening comes at a time when GM desperately needs to raise its sales: "GM is burning through at least $1 billion a month. It had access to about $21 billion cash and $5 billion in available credit at the end of June but an analyst Friday said the automaker will probably need $10.3 billion in fresh cash through next year to maintain a minimum liquidity of $14 billion (Snell & Tierney 2008)

Cerberus is likely to play an increasingly critical role in GM's future as merger talks are continuing between General Motors and Chrysler. Chrysler is owned by Cerberus Capital Management. As part of a merger deal, GM might contribute some or all of its equity in the finance company to Cerberus (Vlasic 2008). "But people close to the merger talks said that Cerberus had proposed to contribute cash to GM-Chrysler in addition to the estimated $11 billion in reserves that Chrysler has on its books. In return, Cerberus would receive equity in the combined company and become a large shareholder" (Vlasic 2008). Cerberus, industry analysts speculate, would actually like total, 100% control over the GMAC mortgage and auto loan unit and to sell Chrysler to GM entirely (Snell & Tierney 2008).