Credit Crisis Update

Why the Credit Crisis Shakes more than Banks

It's not just companies like Citibank and Merrill that have exposure to the credit markets.
A surprising number of manufacturers have drifted into financial services.

Harley-Davidson has a problem, and it's not only that people are becoming less inclined to spend $15,000 on a pair of wheels. It's that the ones who bought bikes a while ago are having trouble paying.
Harley itself finances half the hogs it sells. This year defaults on its loans have risen nearly half a percentage point to 1.65%.Harley's fortunes largely ride on its skill at selling bikes. But its ability to size up a good credit risk matters a lot, too. Last quarter 13% of its pretax earnings came from loans and leases.

Herein lies a hidden risk in corporate profitability: It's not just the financial sector that will suffer if the subprime crisis spreads to other kinds of lending.A lot of companies that are not classified as financial have financial arms and could suffer along with the banks and the brokers if borrowers stop paying their bills.
General Electric, for example, gets 34% of its pretax earnings from financial services. Deere & Co., Caterpillar and Pitney Bowes each get at least 12% of their earnings by financing things.Quite apart from the very obvious risk that U.S. consumers will throttle back next year is the risk that they won't be able to keep up payments for their past spending sprees.

Now signs are emerging that payback problems are spreading from mortgages to other kinds of loans. In November HSBC said that unsecured loans like credit cards were experiencing "early-stage delinquency." Last quarter Capital One wrote off 4.13% of its credit card receivables, up three-quarters of a percentage point, and warned it expects losses to jump this quarter again. Its auto loan business just slipped into the red, too.

Did you know that Sony owns 60% of a finance company, Sony Financial? The electronics maker sells health, life and car insurance and even runs a bank. With a few clicks on its Web site shoppers can buy a flat-screen TV or PlayStation 3 gaming system with no money down and no interest until 2009.Last year 82% of Sony's $1.1 billion in pretax earnings came from its financial unit--twice what its pictures division made producing films like The Da Vinci Code and Casino Royale. Sony's financial operations are in fine shape--for now. One area to watch: its $2.8 billion in mortgage loans, up 63% annually since 2004.

Businesses selling to other businesses on credit is big, too. That's more or less how GE veered away from lightbulbs and locomotives and into loans and leases. Now GE's financial operations are a business in their own right, largely unconnected with the products it sells. But the original motivation of non-financial companies getting into lending, to move goods off the shelves, remains important in many industries.
Boeing carries $8 billion of customer leases and interest-bearing receivables on its books. Paccar, a maker of tractor-trailer trucks, has $9 billion.
Frederick Hickey, author of newsletter High Tech Strategist, says:Companies tend to make loans to meet sales goals today, and worry about if they picked the right borrowers tomorrow.
During the tech bubble of the 1990s telecom gear makers like Cisco and Lucent extended billions of dollars of loans to phone companies to buy their products--then took billions in writeoffs when telecom crashed.

Circuit City ate losses early this decade when it exited the credit card business.
How big is financing in the economy? One way to measure it: 18% of the $13 trillion market value of S&P 500 companies is for the financial sector.

That bulge is a big part of why the market has been choppy since last summer: Credit problems are dragging down the banks, brokers and insurers.

Another measure is profits. The finance sector accounts for 28% of the index's combined $748 billion in earnings for 2006. Those earnings are likely to be down in 2007 when writeoffs are included. Neither of these percentages for financial services includes the financial activities of companies like Sony and GE.

Here's another way to look at how much is riding on the soundness of borrowers. Debt at U.S. households, governments (state and federal) and non-financial businesses now stands at 217% of gross domestic product, up from 141% a quarter of a century ago. So a small rise in interest rates or in defaults is likely to have a bigger impact than it once would have had on business bottom lines and consumers' ability to spend.

"The debt level is unprecedented, and the acceleration in the growth of the debt hasn't been seen since the 1920s," says Christopher Watling of Longview Economics in London. "Lots of businesses have profited off this, and they're vulnerable."