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Just like housing, financial magic drove auto sales to a height that they never should have reached

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August 01, 2008 – Comments (4) | RELATED TICKERS: F , GM

Just like housing, financial magic drove auto sales to a height that they never should have reached

Leasing is dead and that means that the auto industry is in BIG trouble

For years, leasing has been the engine that has driven the auto industry.  Manufacturers know that someone who is leasing will likely re-enter the market for a new vehicle every three years or so.  Furthermore, leases provide consumers with low monthly payments than enable them to drive much more expensive vehicles than they would normally had been able to get into.  For years manufacturers' captive finance companies (banks that are owned by automakers) have been magnifying this increased affordability by artificially inflating vehicles residual values to provide hidden support on vehicles and make their monthly payments even lower than they should be.  Now the chickens are coming home to roost.  The vehicles that automakers have leased with artificially high residuals are coming back off lease and they are worth thousands of dollars less than what they are on the hook for.

Just like in the housing industry, financial magic drove auto sales in the United States to a height that they never should have reached.  Leasing currently accounts for 20% of auto sales in the U.S., down from the 30% range several years ago.  I expect that number to continue to fall.  Leasing won't completely disappear, but it will stop or significantly slow for a number of brands.  Starting today, Chrysler has pulled the plug on leasing in the U.S. and GM has stopped leasing vehicles in Canada in Canada.  Companies that have traditionally had high lease penetration rates, like BMW and Mercedes-Benz can't afford to hop off of the leasing merry-go-round, but in many cases leasing will become much more expensive in the future.

Without the turbo boost that leasing, has provided to sales, I expect auto sales in the United States to remain lackluster for a looooong time.  That means that many manufacturers that have build factories based upon unsustainable sales assumptions will eventually be forced to idle or completely close even more plants.  This is bad news for all auto manufacturers, not just domestic ones.  The effects of the new lower sales level that auto sales will likely sit at for a long time is bad news for all companies with major exposure to the U.S. auto market, including suppliers, banks that have leased tons of vehicles over the past several years (particularly Wells Fargo and Chase), and of course the manufacturers themselves.

This is a serious situation that could have a significant negative impact upon the economy that the mainstream media has just starting to pick up on this week.  Make sure to check out my blog post from earlier this month, Liquidity is drying up in the auto industry, and the following recent WSJ article, Detroit Prods Drivers to Buy Instead of Lease, for more information on this subject.

This particular passage from my 7/15 post is particularly relevant:

"The major problem that I see coming down the road that I don't hear many people talking about is captive finance companies' huge residual value exposure.  I don't have any specific data handy on how much exposure to leasing GMAC and Ford Credit currently have on their books, but I can assure you that they are getting hammered as the vehicles that they leased to consumers several years ago come back and aren't worth anywhere near what they had "estimated" they would be.  I use the word estimated very loosely because most manufacturers have their captive finance companies artificially boost the residual values of the vehicles that they lease in order to provide consumers with attractive monthly payments and move more iron for their parent company.

For those of you who aren't familiar with how leasing works, lease payments are made up of two main parts: the depreciation portion and the interest portion.  Banks publish a list of residual values, usually in percentage form, that dealers use to calculate the depreciation portion of lease payments.  These percentages vary by model, term (the length of the lease), and mileage allowance (the number of miles per year the lessee is allowed to drive).  The higher a vehicle's residual value percentage is, the lower its monthly payment will be.  So for years, either out of ignorance of what the market is / will be like in the future or more likely in an effort to hide support, manufacturers have been making their captive finance companies artificially inflate vehicles' residual values.  Now that the market, particularly for pickup trucks and SUVs, is such a disaster the vehicles that these companies are getting back at lease-end are worth thousands of dollars less than they had estimated they would be.  Unless they have some sort of residual value insurance, and even if they do I doubt that it is enough, these companies are probably going to get hit with big charges as a result of this." 

Deej

No position in any automaker

4 Comments – Post Your Own

#1) On August 01, 2008 at 12:19 PM, kdakota630 (29.62) wrote:

Another excellent blog, Deej.

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#2) On August 01, 2008 at 12:26 PM, TMFDeej (99.40) wrote:

Thanks kdakota.

Deej

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#3) On August 01, 2008 at 2:02 PM, Gemini846 (58.70) wrote:

"Now the chickens are coming home to roost.  The vehicles that automakers have leased with artificially high residuals are coming back off lease and they are worth thousands of dollars less than what they are on the hook for."

When I used to work as a salesperson for Nissan they brought in one of those sales coaches to teach us to make more money on each sale. The two things that the guy really pushed was leasing and extended warrenty plans.

They taught us to tell the customer that a lease was basically a guarenteed value option. They could pay a bit more up front w/ good credit and guarentee the value of thier investment.

Guess it worked out well for the buyers after all. On the other hand if you tore up your car expect them to slam you with fees to take it back.

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#4) On August 01, 2008 at 6:12 PM, GS751 (27.40) wrote:

"in Canada in Canada." lol I do it all the time.

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