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What Are the Advantages of DE’s Captive Financing Entity?

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May. 24 2016, Updated 12:04 p.m. ET

Advantages in recovering bad loans

Unlike major banks, which have access to low-cost bank deposits, Deere & Company’s (DE) funding costs are higher. Deere’s advantage lies in the strong integration of its captive financing unit with its dealer network.

If a customer defaults on an equipment loan, Deere has the advantage of selling the agriculture (DBA) or construction (XHB) equipment through its entrenched dealer network. A bank, on the other hand, relies on third-party auctions to sell recovered assets. Equipment fetches far less value at an auction than at a dealer. In this manner, Deere’s losses on defaults are reduced.

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Accounting for loss reserves

A unique aspect of Deere’s business is the way in which the company accounts for its loss reserves. Deere deposits 1% of customers’ financing repayments into dealers’ forbearance accounts. Forbearance is the procedure of allowing additional time for a borrower to pay delinquent loans.

If a customer were to delay his loan payment temporarily, the local dealer would allocate funds from the forbearance account to help reduce the loan balance. This creates strong goodwill among the local community for the dealer. Given how important this practice could be to drive sales for dealers during upturns, we believe DE has a significant advantage over its competitors.

Among DE’s competitors, AGCO (AGCO) has a joint venture with Rabobank for financing its customers. AGCO’s 49% stake in the entity is slightly limiting, as it needs Rabobank’s compliance to tweak underwriting terms.

Caterpillar’s (CAT) financial products unit is comparable to Deere in terms of profitability, but its exposure to industries such as marine and mining have led to additional write-offs in recent years.

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