Leases Drive Up Credit Losses in Deere’s Financial Unit
Deere Financial services performance in 3Q16
Deere & Company’s (DE) financial services (IYF) unit represented 10.2% of revenues in 3Q16, which is comparable to levels of 10.4% in 3Q15. However, the net income from the unit attributable to Deere fell 17.7% to $126 million due to lower net interest margins and higher credit loss provisions in the quarter. As prices of used equipment sink to record lows, the company has also suffered losses from lower residual values of used equipment. As a result, the company’s operating margins in the unit have contracted from 37.6% in 3Q15 to 28.6% in 3Q16. Deere’s annualized provision for credit losses currently stands at 24 basis points, which is below the ten-year average of 26 basis points. Deere’s competitors such as CNH Industrials (CNHI) and Caterpillar (CAT) have also reported lower margins of late due to lower net interest margins.
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Why Deere’s credit losses increased
In our company overview on Deere & Company, we discussed how in a depressed agriculture (DBA) economy, farmers were increasingly opting to rent equipment, rather than purchase it, in bids to cut back excess capital tied up in equipment purchases. With an eye on tapping these trends, Deere increased its rental offerings in recent quarters with leases accounting for an estimated 25% of customer-financing deals, as compared to the historical figure of 15%.
However, this decision backfired, as customers walked away from short-term leases. The consequence was that dealers were burdened with used equipment, which had rapidly depreciated in value. In light of these circumstances, the company in the second quarter stated that it would severely restrict short-term leasing activity.
Leasing in 3Q16
Deere stated that although leasing activity increased in the quarter, its actions on short-term leases were effective. Without getting into financials, the company also stated that it had increased residual values across the board on short-term as well as long-term equipment leases in an attempt to reign in the losses from depreciation.