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David Ruggles

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The automotive world has been jolted in recent months by the pullouts of certain lenders from the leasing business. Wells Fargo has exited leasing altogether, while 5th 3rd Bank and US Bank have exited the pre-owned business. Ford and GMAC announced they will take a much more conservative approach to leasing. On the heels of these announcements, and with the entire industry taking major hits to the wholesale/residual values of vehicles that used to be the “cash cows” of the manufacturers, the announcement of Chrysler leaving the leasing business came as no surprise. After all, Chrysler/Cerberus bought 49% of GMAC’s portfolio of mortgages AND leases, as well as Chrysler credit’s entire finance portfolio. What do these recent events really say?

In this writer’s opinion, it says the domestic manufacturers, Chrysler in particular, are running out of cash fast. Are they really telling us that it is better for them and their customers to put their buyers into of 60 – 72 month retail finance contracts? Toyota and Honda must be licking their chops! And so are certain lease lenders who now find themselves in a marketplace with fewer competitors.

Certified Pre-Owned was supposed to be a plan to bolster the wholesale/residual values of a manufacturer’s pre-owned vehicles. The fact that the Imports could offer much lower lease payment programs because of their higher resale residual values has always chafed the Domestics. And the low resale values of most domestic vehicles, compared to the Imports, means a buyer of an Import will probably have an easier time trading their vehicle earlier in the ownership cycle because they will have to deal with comparatively less negative equity. Now, all the Domestic’s CPO programs can hope to do is bolster their resale values while they promote their new vehicles with more and more rebates, “buy down” interest rate financing, and various give away programs, all financed for longer and longer terms.

The imports have rarely had to advertise public rebates. While they have offered substantial “trunk money”, usually in the form of “stair step” programs and mildly sub-vented short term leasing programs, they have rarely had to cheapen their products with advertising that says “Our cars are so good, we have to pay you to take them off our hands”. This is reflective of the “pull marketing” approach used by the Imports versus “Push Marketing employed by the Domestics. I can remember my Chrysler reps telling me “Inventory Pressure Sells Cars”. But at what long term price?

All the while the Domestics have been trying to bolster their resale values, they have pumped more and more into fleet service. Ford took a wonderful short term leasing program and buried themselves with residual losses because they couldn’t restrain themselves and flooded the market with fleet cars to go along with the short term trades they had planned for. It was like one department didn’t talk to the other, or no one in the executive offices took Econ 101. Only recently have the Domestics tried to get “off the drugs” by somewhat curtailing fleet units. And now they run right into a “wall” caused by an oil crisis, as if this hadn’t happened before. In my memory, when I lived through these crises before, the public lost money trading in their gas guzzlers and paid high prices for a smaller vehicle, which they typically hated. After the oil market stabilized, they took another hit trading in their small vehicle, which were no longer popular, and paid a high price to replace the large vehicle they had only recently traded in. I doubt the script will go exactly the same, but watch and see if we don’t see at least a brief oil glut in the coming months followed by another “whip lash” reaction by the public and the manufacturers.

This oil crisis has affected the Imports as well as the Domestics, but certainly not to the same degree. Toyota will shut down production of Tundras for a while, but in many cases their plants can build more than one type of vehicle. They can stop building what’s not in demand and change the production to what is. The Domestics can not commonly do this. So despite a bump in the road, the Imports press on. They will retain their resale advantage. Their advantage will probably widen! They will be able to offer short term leasing at attractive payments while Chrysler will be left to offer big rebates, cheap interest and long terms finance contracts to get people to take their vehicles off their hands. It makes you wonder how the cost of sub-venting a long term finance contract compares to a short term lease.

As the Domestics credit rating has dropped to near junk status, their money costs aren’t competitive with the Imports. When you factor in the fact that their buyers will not be in a position to trade until quite late into the finance contract, it looks like they are left with a loser strategy. Despite their protestations, I am sure they would prefer to stay in the leasing business but can’t manage their business in such a way as to control their resale/residual risks.

Certain independent banks have also taken some significant residual hits. It makes one wonder why a bank would even take the risk of guaranteeing vehicle values in an uncertain world. Here’s why. Bank/lessors can make profit on the interest/money factor portion of a lease, collect acquisition and disposition fees, and even make money at times on certain residuals. Even now some lessors are experiencing some gain on the more economical off lease turn ins. They can also introduce their lease customers to their bank and perhaps gain a new checking or savings account customer. Because a lease customer tends to be more loyal, there is an increased likelihood that a lessee will lease another vehicle after their current term ends. But a primary value to the bank/lessor is the fact that the vehicle stays in the bank/lessor’s name for the life of the lease, which gives them the advantage of the depreciation calculated into the lease. The savviest banks don’t compete with the OEMs where there is a manufacturer subvention. They pick their spots and spread their risks. For this reason, there are many bank/lessors who are happy to hear the recent announcements of Chrysler and certain lenders who are pulling out.

The pullout from pre-owned leasing by a couple of lessors is somewhat of a surprise. In a recent study it was discovered that the residual for most pre-owned one year old vehicles, after 36 months, is less than it for the same vehicle leased for 48 months from new. This means the risk for lessors is substantially less for pre-owned leasing than for new. Fortunately, there are many players who also realize this and are expanding their operations to pick up the slack left by the other lessors pull back.

Despite the fact that there have been serious losses suffered on trucks and SUVs, this is regarded as a natural cyclical occurrence and does not change the positive fundamentals of the business going forward.

In the meantime, dealers and leasing companies who “get it” are awaiting the beginning of the next ALG book period, which is September 1. It is guaranteed that there will be opportunities. These opportunities might not be quite as compelling as what we have seen over the last ninety days. The last 120 days have truly been an anomaly driven by the precipitous drop in wholesale values, coupled with a residual guide that has stayed steady. This is not to criticize the residual guide, as there is no indication that a spike in oil prices should be reflected in long term residual values. But adjustments have to be taken and these will be reflected in the new guide. There will still be lease arbitrage opportunities to be taken advantage of. Sophisticated lessors, dealers, and leasing companies will be able to take advantage of the voids left by OEM pullbacks and lender exits and put more and more customers into profitable short term late model leases.

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