GM Lending Arm Pumped Up

General Motors' (GM Quote) lending business is the only thing keeping America's largest automaker from falling into the abyss. So it's unnerving to see this finance arm, called GMAC, report low-quality first-quarter earnings.

In the first quarter, GMAC -- short for General Motors Acceptance Corp. -- earned $729 million, while GM's auto business lost $1.83 billion. On a consolidated basis, then, GM lost $1.1 billion, or $1.95 per share.

The company had warned investors that the loss was coming, but not until mid-March. Up to that time, it was telling investors to expect earnings of $4-$5 per share in 2005. Now the company says it expects to make just $1-$2 per share.

The reduction in earnings guidance, along with fears that rating agencies will downgrade GM's debt to junk and news that GM's unions aren't likely to bow to cost-cutting measures, has crushed GM's stock. It closed down a dime at $26.09 Tuesday. That's nearly 50% below the stock's 52-week high.

Detox first took a bearish stance on GM three years ago, greeting with skepticism the company's prediction back then that it would make $10 per share in 2005.

Sticky Wicket

To assess just how dangerous a slowdown at GMAC would be, one must understand the gamble that GM made after the 9/11 attacks. Automakers have a notoriously sticky cost base, which means any slowdown in sales can tip a carmaker into a loss very easily, as can be seen with the recent reductions in earnings forecasts.

GM feared the terrorist attacks would reduce demand for car purchases, so it had GMAC unleash a tidal wave of cheap credit to motivate people to buy cars. Car sales did respond, and GMAC also made money from its large mortgage operations during the easy-money boom that took over the entire U.S. financial sector.

However, this strategy always threatened to come undone if interest rates rose or if demand for GM's products dropped off, due to saturation or competition. Surely enough, these factors are hurting GM now, forcing the company's managers to try a deep restructuring.

However, a full-blown crisis could occur if GMAC started to show real signs of stress. Clearly, anyone looking at GM's stock simply has to watch GMAC for any signs of weakness. And the unit's first-quarter results, as well as management comments, do raise some uncomfortable questions. The big fear is that GMAC used hard-to-repeat gains to boost earnings at its mortgage operations.