Lessors bail out on the thirsty trucks

By Brendan Moore

07.30.2008

Chrysler has already stopped leasing any vehicles through Chrysler Credit, GMAC LLC, GM’s leasing arm, has halted leasing in Canada and is scaling back leasing in the U.S. and Ford has announced that they intend to make the lease terms on trucks and SUVs so onerous that no one will want to lease one.

Chase Auto Finance told Chrysler dealers that Chase will not be leasing any Chrysler vehicles in the near future, and Wells Fargo said they’re out of the vehicle leasing business as of July 9.

The culprit here is the fact that the value of used SUVs and pickup trucks has plummeted as gasoline has gotten more expensive.

This isn’t a problem for a lender but it is a HUGE problem for a lessor, the company that does the leasing. It’s a problem because the lessors get a large percentage of those SUVs and pickups back when the lease is up, and instead of, say, the 45% residual they calculated at the beginning of the lease, now the vehicle in question might be worth only 25%. They take it to auction, it goes across the block for the 25%, which is perhaps a few thousand dollars less than they expected when they wrote the lease, and now they’ve lost a lot money on the lease. Multiply that by a million vehicles and you see how you would have some problems.

Let me explain it just a little bit more.

Everyone started to figure out pretty quick in the last few months that the residuals on SUVs were way too high. Unfortunately, for the lessors, this was two years into a lease they already written for a term of 3 or 4 or 5 years. Consumers that had the leases have figured out the same thing about the residual values, and are not exercising the option to purchase their leased vehicle at the end of the lease term, and instead, are just giving back the car to the lessor when their lease is up. Suddenly the lessors are getting swamped with end-of-lease vehicles, which all have to be sold by them somehow. Since the banks and finance companies don’t have huge used-car lots (and the requisite dealer’s license) scattered all of the United States, those returned cars, which by this time are mostly SUVs and pickups, have to go to auction. So many of the same thing showing up at the wholesale auto auctions just depresses the values of those used vehicles even further, and causes huge shortfalls from the original stated residuals on these vehicles, which in turn, wiped out any profit the lessors had made on the front end. Lessors, whether they are banks or finance companies, are sustaining massive losses, and they are now getting out of the leasing business as quickly as possible.

This problem was further compounded by the prevalence of subsidized leasing, which is called subvented leasing in the retail auto finance business.

What is subvention, you might ask quizzically? When lessors subvent a lease, they typically artificially bump up the residual value of the vehicle leased, or, lower the lease finance rates, or, lower the FICO credit scores needed by the lessee in order to be approved for the lease. There was a lot of this activity going on in the past few years, and none of this subvention activity is helpful when the secondary market has already collapsed for the vehicle in question. But this is the situation that the lessors find themselves in; not only has the used car market collapsed for SUVs and pickups, the heavy subvention of these leases in the past is making things even worse for the lessors from a financial perspective.

Paradoxically, the same market factors that have made lessors of SUVs and pickups trucks very unhappy have made the lessors that have leased small, fuel-efficient cars to consumers the last few years deliriously happy. A car they might have calculated to be worth 45% after three years when they leased is now worth 60%. Of course, that’s if the lessee doesn’t exercise the purchase option at the end of the lease and the lessor gets it back. But if the lessor does get it back, they will have made much more money than they originally projected on the lease because the car is worth so much more money than originally forecasted.

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Autosavant was also interviewed on NPR’s Marketplace on this same subject – the interview was fairly substantial but the audio clips they used are brief. Nonetheless, if you want to hear those clips, go here and then here.