Credit crunch hits auto market's weak link

DETROIT (Reuters) - The next shakeout in the American auto industry has started to play out on Main Street as weaker dealerships face closure as the credit crisis worsens and car and truck sales slide to 15-year lows.

Detroit's automakers have been trying to prune their weakest dealers for years with only limited success because each dealership is an independent, franchised business often owned by a family and closure negotiations can prove costly.

But financial market turmoil in recent weeks has put a vice-like squeeze on auto dealers, who face reduced and more expensive credit to finance both their own inventory and consumer purchases, analysts and industry executives say.

"Dealers who have been in this business for decades say they have never seen anything like this before," said Annette Sykora, who chairs the National Automobile Dealers Association, a trade group that represents the over 20,000 franchised car dealers in the United States.

"Dealers can't move product. And they're facing higher rates themselves. So the products they can't move are costing them more money," Sykora said.

Analysts see a Darwinian consolidation ahead. If the shakeout is limited, it could help the Detroit Three by culling lagging and loss-making stores without the ability to put marketing money to work to support the U.S. auto brands.

"There is a silver lining, " said Michelle Krebs, editor of Edmunds-affiliated AutoObserver.com. "This will accelerate the consolidation."

But there is also a risk the credit crunch sets off a wave of auto retail closures, risking further downward pressure on orders from General Motors Corp GM.N, Ford Motor Co (F.N) and Chrysler LLC when they are scrambling to ride out a downturn that has already run deeper and longer than they had expected.

U.S. dealers had been swamped earlier this year by a weak housing market, a slowing U.S. economy and rising gasoline prices that cut demand for SUVs and pickups that had been the most lucrative slice of the new vehicle market.

But truck sales have tumbled. Cash-strapped consumers are holding off purchases of new and used cars -- typically higher margin deals for car retailers.

The result has been a strain on U.S. dealer profits, which are down 25 percent on average, according to auto sales and dealer tracking firm Edmunds.com.

Bill Heard Enterprises Inc, one of the biggest Chevrolet dealerships, filed for bankruptcy last month, citing decreased demand for vehicles and lack of credit. At its peak, Heard's revenue had been about $2.5 billion per year.

The strain is also evident on U.S. automakers. GM shares fell to their lowest level in more than 54 years Tuesday and Ford shares hit a quarter century low, having dropped more than 90 percent since the stock reached a peak in 1999.

GM shares fell 10.85 percent to $7.56 and Ford shares fell 20.87 percent to $2.92.

'A DISASTER' IN THE MAKING

The NADA says the pace of dealership closures accelerated in September, as credit froze. Without an improvement in economic conditions, nearly 700 dealerships were likely to shut their doors this year, the trade group forecasts.

U.S. vehicle sales dropped 26 percent in September, the first monthly sales total below 1 million since 1993. Sales are down 13 percent through the first nine months of the year and are expected to be only flat at best next year.

The drop in demand has been particularly hard for the Detroit Three. GM's sales are down 18 percent so far this year. Ford's sales are off 17 percent and Chrysler sales are off 25 percent.

Ford and Chrysler, controlled by Cerberus Capital Management CBS.UL, have also increased the rates on loans given to dealer to stock new cars from their affiliated finance companies.

That makes cash king for both dealers and consumers.

"The days of zero down payment are rapidly receding," said James Ziegler, an auto dealer consultant based in Atlanta.

Raymond Ciccolo, who owns seven dealerships based in Boston, Massachusetts, including Hyundai, Honda, Nissan, Cadillac and Hummer brand stores said many dealers -- like other businesses -- are now scrambling to conserve cash and stay afloat.

"A lot of dealers are having problems getting capital," Ciccolo said. "Banks don't have the cash for loans even if you have a very good credit rating."

Ciccolo has eliminated overtime, frozen new hiring, and is moving to reduce his inventory of new cars.

"It's a disaster for many dealerships," he said.

Jason Mattia, a former dealer who now leads the AutoEngage consulting firm for dealers and manufacturers in California, said the industry has far too many dealers even at the 16-million unit sales rate of 2007, let alone the 13 million-sales rate of recent months.

GM has too many dealers by a margin of about 30 percent, and the retail overcapacity is 20 percent at Ford and Chrysler, he said.

An orderly reduction in dealerships is not possible as none of the automakers can spare cash to buy out dealers.

GM's decision to eliminate the Oldsmobile brand cost it an estimated $2 billion in dealer payouts, and the No. 1 U.S. automaker has been burning through $1 billion a month in the most recent quarter and struggling to shore up its cash position.

"They are far better off to starve their dealers, kind of a Darwin effect, let the strong survive and the weak go away, than they are to actually go out and try and buy these stores out and close them," Mattia said.

(Additional reporting by Soyoung Kim; Editing by Bernard Orr)