Auto Manifesto

August 15, 2008

Auto Leasing Losses

A number of auto manufacturers are cutting back on leasing. The reason is because they are losing money, in some cases a lot of money on previous lease deals that were, at the very least, optimistic in the projected resale or residual values of the leased vehicles. Chrysler has left the leasing business entirely. GM, Ford, and Toyota are scaling back somewhat. All took big hits.

The Wall Street Journal reported that Ford lost $2.1 billion in the second quarter of 2008 on leasing, GM lost $2 billion, while Toyota has set aside reserves for a “large” write down for leasing.

At the heart of the issue is excess capacity. The manufacturers used leasing as a way to keep the factories running. It is often less costly to keep making the vehicles and selling them at break even or at a small loss than to idle a factory and still pay the overhead. Thus they had to find customers for all these extra cars.

What do you do to find customers (notice I didn't say "buyers") for extra cars without lowering retail prices? You lease them at very attractive rates, in some cases at ridiculously low rates. That preserves the retail price of the new car for the time being.

The problem with that, aside from attracting customers who often could not afford to buy the product and thus not enhancing the value of the brand by creating future buyers, is the manufacturers took on a lot more risk.

When a company sells a product it eliminates price risk. The item sold for X dollars and it's a done deal. When a company leases it is projecting what the car will be worth used when the lease runs out. It is also projecting the customer will not default.

Any time projections are made there is risk. The bottom line is the manufacturers bet wrong. The auto market has tanked and now those cars coming off lease, especially the less fuel efficient ones, are worth a lot less than projected. On top of that they have suffered higher default rates due, in part, to the collapse of the credit/mortgage markets.

Leasing, on the scale that it was done, was a bad idea. Not only did it artificially inflate the market size, the additional units "moved" were the riskiest transactions for the manufacturers. In summary, the manufacturers sold off tomorrow for reprieve today. Except that was a couple of years ago. Tomorrow has arrived and it's time to pay. Hence the losses.

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