Leasing Fades With Credit Crunch, but It Won't Disappear

Leasing Fades With Credit Crunch, but It Won't Disappear

By Michelle Krebs September 17, 2008

By Dale Buss

The bloody purge of the U.S. financial industry and its millions of shaky real-estate loans already have forced most automakers to cut way back on lease deals for their customers, an unavoidable blow given the importance of credit to the new-vehicle market.

But auto-company executives aren't giving up on the practice for the long term, believing that today's shakeout will help set the stage for a healthier leasing market in the future. Some of them actually are moving preemptively to ramp up leasing even in the short term instead of cut back.

Meantime, enormous pain is being inflicted on the many automakers that have grown dependent on leasing, the other part of a whopping double whammy that also includes the overall sales slide in the U.S. market.

"There were an awful lot of aggressive tactics out there to push volume -- an overaggressiveness into leasing -- and I think what you're seeing is normalcy coming into the marketplace," said Scott Keogh, chief marketing officer of Audi of America, in Troy, Michigan. The company retailed only about 31 percent of its vehicles as captive leases in August compared with 52 percent in the first quarter, according to data compiled by Edmunds.com.

"Inexpensive money in the marketplace led to some figures that weren't good," Keogh continued. "Extremely low incentivized-lease deals, when you come back with residuals, will be the issue."

Chrysler's Vacuum

Chrysler, of course, made the most spectacular departure from leasing in August, announcing in late July that it would no longer offer auto leases through its lending arm. During the first quarter, 18 percent of Chrysler's retail sales were captive leases, according to Edmunds.com data. But in August, Chrysler Financial leased only 2,000 vehicles nationwide, compared with 24,000 in August 2007. The company's total sales last month plunged 34 percent, exacerbating Chrysler's position as the direst in the industry.

Audi's August sales declined by 16 percent. Meanwhile, BMW also was caught by the rather sudden necessity to reduce leasing, on which German makers rely for as much as two-thirds or three-fourths of U.S. sales -- compared with about 50 percent to 60 percent for Cadillac, for instance.

Leasing accounts for about half of the near-luxury and luxury market, according to fHyundai Motor America.

"If consumers are used to leasing," said David Tompkins, executive director of industry solutions for Santa Monica, Calif.-based Edmunds.com, "they're probably going to go somewhere else rather than come up with a down payment and become buyers."

But automakers hit hard by the necessity to ratchet down leasing haven't been restricted to the flailing Chrysler or to big German players. Other brands have become participants in the leasing shakeout as well, and they also tend to be ones that have taken the hardest overall hits in sales this summer, according to Edmunds.com research.

(Of course, banks and other credit institutions also write leases for auto buyers. But the OEMs' captive finance arms make the bulk of lease transactions.)
 
Less Leasing, Fewer Sales

For example, according to Edmunds.com data, General Motors' Saab division posted the biggest percentage-point reduction in reliance on captive leases in August compared with the first quarter, down to just 8 percent of retail sales from 41 percent during January through March. Saab's overall sales were down 53 percent in August, the third-worst plunge among GM brands in the American market. Saab's sales have declined 32 percent for the year-to-date.

Similarly, Land Rover leased only 8 percent of its retail sales in August, compared with 30 percent during the first quarter; its sales dropped by more than 30 percent for the year-to-date. Beleaguered GM (outside Saab), Mercedes-Benz, Acura and BMW each also did captive leasing in August at rates of more than 10 percentage points less than during the first quarter, according to Edmunds.com calculations; of them, only Mercedes-Benz has posted a sales gain for the year-to-date, and that a mere 0.5%.

In hindsight, this was inevitable. "Lease payments became a main area of competition between luxury manufacturers in many respects," said John Howell, Cadillac's global product director. "It wasn't around brand image and features and content as it should have been. This induced many people to stretch into a luxury car. And with the tightening of credit options going forward, you'll see that augment - the general effect of people not being able to stretch financially the way they used to - and you'll see a reduction in overall volume as a result."

Unfortunate Metaphors

And whether the leasing drought reflects chickens coming home to roost, a house of cards or the legacy of a chain of fools - choose your metaphor - it certainly has involved a domino effect that began late last year.

First, the industry's leasing boom over the last few years had set itself up for an unusually large number of vehicles coming off lease in the last quarter of 2007 and early in 2008 -- which on its own would tend to depress residual values when OEMs sold the off-lease vehicles, according to Joe Spina, senior remarketing manager for Edmunds.com and a former manager at an automotive captive-finance concern.

At the same time, the new-vehicle market last fall began cooling substantially from levels earlier in 2007, meaning there were fewer customers overall for leases or retail sales. At the same time, gasoline prices were rising at an accelerating rate, so the residual values of gas guzzlers - the industry's most expensive and profitable vehicles -- were hurt the most.

New stresses began visiting the automotive-lease market several months ago when the subprime-mortgage crisis began infecting every aspect of the U.S. credit system. Enfeebled consumers who were especially dependent on suddenly shakier credit, especially home-equity loans, proliferated at the same time that the economy's overall troubles turned some of captive finance arms' own loans bad.

The automaker finance companies "had to deal with high credit losses because of the economy and also competition, because they were writing some loans that they shouldn't have," said Spina.

Scramble to Re-set Strategies

Financial-market woes "have caused banks to shore up balance sheets, so they're providing less liquidity to the non-financial sector - which has had some impact on auto sales," added Ellen Hughes-Cromwick, Ford's chief economist. "Unfriendly credit scores are getting shut out of the market."

This summer's spike in gasoline prices added the last straw, contributing to generally poor automotive sales in the second and third quarters, which in turn exacerbated the effects on leasing of the credit crunch. Even the higher number of vehicle repossessions have depressed residual values, Spina said.

OEMs have been reacting variously in the short term.

BMW, whose sales were off 4 percent for the year-to-date through August, had pushed leasing rates as high as 70 percent on its 7 Series and to about one-third of retail sales on its 3 Series over the last few years. The latter was a level that Howell of Cadillac nevertheless called risky on a luxury car, "because it can come back to bite you a bit in terms of volumes going forward if the cost of leasing rises dramatically." That, of course, is what has happened.

"We're trying to maintain or even improve our performance in the U.S., and residual values are down," conceded Jan Ehlen, business communications manager for BMW of North America. "One way to limit the possible risks of leasing is to lower the leasing penetration a little bit and offer other possibilities for getting people into our vehicles."

Yet, Ehlen added, "There is a need in the premium market to better understand customers' needs, so we will not switch off leasing like some other companies have done. Leasing is a very important sales tool and will remain an important sales tool in the future because it meets customers' desires and helps make our products available to a very diversified customer base."

German Challenge

BMW's overall lease penetration now is below 50 percent in the United States, Ehlen said, compared with a historical rate of 60 percent that he called "ideal" and "something we will try to maintain."

But to attempt to keep sales trends in the black, BMW has slowly been reeling out cut-rate retail financing, a rarity. The company offered 0.9-percent loans in August on nearly its entire line, "which made a huge impact," Ehlen said. For September, BMW came up with a new plan that became a bit less generous on some products, including 1.9- to 4.9-percent deals. For the biggest-volume product, the 328i, BMW has a 2.9-percent financing offer.

"People are not hooked on leasing," Ehlen said. "If you have the right products and deals in the market, there is a pretty good chance that people are going to take advantage of financing."

Though the cutback in its captive-leasing deals bespoke Audi's participation as a strong promoter of leasing, the company's Keogh maintained that Audi wasn't "hyper-aggressive" about the practice -- so for Audi, he said, it is easier to deal with a decline in leasing than it is for, say, BMW.

Audi, for example, has been trying to boost residual values of leased vehicles by favoring equipment options that used-car customers will value most. "You can put a lot of things in the car that don't have long-term value," Keogh said, without elaborating.

Another Problem

Audi also launched a new arrangement a year ago with its retailers, offering performance incentives and off-lease bonuses to dealers, who then have more slack to market the vehicles to consumers.

"Then you don't have to spend $700 or $800 to send that vehicle to an auction facility and put it through an auction line where someone is going to bid less on it and then truck it somewhere else," Keogh explained. "You're losing value all over the place. If you keep cars out of auctions it keeps residuals up because the car that stays grounded has more value."

Biting the bullet on captive leases was hardly timely for Chrysler, whose sales have taken a pounding over the last several months. But it was a peculiarly necessary step for Chrysler because Chrysler Financial was facing trouble in July trying to renew its own credit facility with banks that were getting wobblier themselves, as well as increasingly worried about Chrysler's woes.

Nevertheless, after shutting off the Chrysler Financial tap, the company and its dealers gamely tried to make the most of August. Last month, Chrysler had "roughly 5,000 [customers] that transitioned from lease to retail, recovering about 30 percent of the lease business that we had last [August]," said Steven Landry, Chrysler's executive vice president of North American sales.

It "shifted a lot of incentive effort from leasing to retail," Landry said. And the company "continued to support leasing from an independent standpoint, so dealers ... always have the opportunity to do leasing through other relationships."

Japanese Approach

GMAC, the captive-finance arm of GM, ended lease incentives in Canada and became extremely stingy in the U.S.

"We did almost no leasing in the month of August," said Mark LaNeve, GM's vice president of North American sales, "probably 2 or 3 percent penetration compared with an average of 18 to 20 percent." The company made that move because "it was cost-prohibitive based on dynamics that we hope aren't permanent." And, he added, "No leasing also helps keep overall incentive spending in check."

In September, GM has retained incentivized lease programs only for Cadillac and one Saab model. Still, said Howell, "We probably have a higher degree of cash buyers, and loyal buyers, than some of our competitors do, so we might have a slight advantage there."

Meanwhile, Mercedes-Benz's leasing rate remains around 50 percent, consistent with its recent average of 40 percent to 50 percent, said Drew Slaven, marketing general manager for Mercedes-Benz USA. "It's still manageable," he said. "We're not taking any actions" right now to reduce leasing. It's at a healthy level."

As for the Japanese luxury brands - Lexus by Toyota, Acura by Honda, and Infiniti by Nissan - historically, they haven't delved heavily into leasing. "They've had low-priced cars in relation to competitors and haven't gotten into aggressive leasing, so it's kept their business relatively sound," observed one competing sales executive. "But now when competitors have been offering aggressive lease deals, they've been responding. We'll see if they go further down the slippery slope."

Said a competing marketing executive: "The Japanese actually did what everyone says they'd like to do: Put out a car with a lot of content and a fair MSRP. That's what gives you relatively good residuals."

Toyota, Honda 'Buying Lots of Business'

Nevertheless, Toyota and Lexus have emerged as the brands most interested in picking up some of the opportunities abandoned in the leasing market by their competitors. Lexus's overall lease rate, for example, lately has risen to about 40 percent from a more typical 30 percent to 25 percent, said spokesman Greg Thome.

"The tough market has led to an increase in [per-vehicle] incentive spending for most of the luxury makes, including our closest competitors," he explained. "For us, this has led to some better lease deals this year as we strategically use leasing to help sales in the most competitive segments."

Thome added that, "unlike our closest competitors, we did not have a new volume product come to market this year, which would have helped our overall sales figures."

Specifically, he said, Lexus stepped up lease promotion for entry-level luxury sedans and volume models including the ES, IS and RX.

As for Toyota, over the summer - even before GM's drastic restriction of leasing in August - it passed GM in lease percentage, "the first time that's ever happened," said GM's LaNeve. Toyota increased its penetration of captive leases to 9 percent of sales in August from an average of 6 percent for all of 2007, according to Edmunds.com data.

"That may not sound like a major increase," said Edmunds.com's Dr. Tompkins, "but that picks up all the Chrysler slack. It's a big untold story."

GM's LaNeve agreed. "We have to keep an eye on that," he said. "Toyota and Honda are buying lots of the business with that."

And, in the short term, competition in general for lease customers certainly continues. "With all this volume [among Germans], you have to move it," said one exec. "Their strongest markets are Los Angeles, New York and Miami - all strong lease markets too - and they're knocking each other dead with [lease] deals."

Boost for Certified Pre-Owned

Another significant effect of the deterioration in the leasing market has been an accompanying rise in the market for "certified pre-owned" vehicles: late-model used cars that the OEM inspects, refurbishes if necessary, then sells with a renewed warranty. Automakers ranging from Mercedes-Benz to GM lately have been expanding their efforts in the "CPO" arena.

"Captive finance arms depend on these programs to absorb off-lease vehicles now," explained Edmunds.com's Spina. "They want to keep customers for the manufacturer, and having CPO vehicles helps support that. It also supports branding and enhancing the customer experience by having a factory-backed warranty and keeping the customer in the family."

Expect CPO programs to continue to grow, because the consensus of OEM executives is that leasing activity won't pick up again anytime soon. There is just too much detritus from the sales downturn and the credit crisis to work through yet.

"The percentage of leasing for the industry will continue to drop for the next few years, just due to cautiousness on the part of finance companies to protect themselves on the back end, given the problems of the credit crunch and liquidity," said LaNeve.

In the meantime, of course, automakers are busy realigning production toward smaller and less-often-leased vehicles. "There's going to be a lower supply of trucks and SUVs three to five years down the road and a much greater supply of smaller vehicles," Spina said, "and residuals on those [smaller] vehicles - while they won't be as strong as they are today - they won't be that bad down the road."

And while leasing won't disappear, it will wax again only with higher rates. Automakers are "lowering residual forecasts," Spina added, "so customers have to pay more depreciation, making lease payments higher. They've got to be careful now because they have to cycle more profitability through leases to help mitigate the losses they've been taking."

"But they're also trying to restrict the supply of vehicles coming off leases in three to five years, so values will be going up. So it will definitely be harder for people to get leases."

Different Basis

Chrysler has about 65,000 customers coming off leases by the end of the year, Landry said. And he seems to be whistling through the graveyard in terms of whether the company would be able to keep all of them in the Chrysler dealership.

"They'll go one of three ways," he said. "They'll stay in their leased vehicle and buy it [off-lease]; or they'll bring it back to the dealership and switch to retail - which is our 'druthers - or they'll go back to one of our dealerships and do a lease with an independent leasing company."

For its part, BMW will try to maintain its current 50-percent leasing level for the "near future," Ehlen said. "We want to maintain our place in the U.S. market and also profitability. That will determine our product strategy. But we have to have the right products and offers at leasing or retail."

LaNeve said that GM "like[s] leasing. It brings customers back into the market on a quicker cycle. Customers like the convenience. Philosophically, it's an essential tool. But there is a higher cost to do that business versus a cash or APR sale; and just like the daily-rental [fleet] business, it always will be a less profitable sale. But we managed to improve our profitability on the daily-rent vehicles, and we would like to do that with leasing over time.

"Despite the temporary disruptions in credit and liquidity and residual values - which actually have firmed up in the last month," LaNeve said, "longer-term, we would like to stay in leasing. But at a more profitable level."

 

Michelle Krebs:  is Editor-in-Chief of AutoObserver.com. Follow @AutoObserver on Twitter.