Why Auto Companies Can't Win For Leasing

In the market for a new car? Driving off in one has gotten a lot cheaper lately, thanks to an auto-industry gimmick: cut-rate leases. A customer shopping for, say, a Honda Accord, America's best-selling model last year, can now cop one for nothing down and $199 per month on a five-year lease--not bad next to the car's $15,375 sticker price. A hot deal for consumers, though, isn't necessarily good for the auto companies and banks that handle the leases. In fact, some are losing big money on them.

Once common mainly for luxury cars, leasing these days is being used to pump sagging sales of even the most prosaic models. Detroit's Big Three, the Europeans, Korea's Hyundai, and Japanese producers all are playing the game. Cadillac now leases its plush Sedan de Ville, which sells for about $33,000, for three years at nothing down and $469 a month, vs. $650 a month just a year ago. Such bargains are one reason the leasing business at General Motors Acceptance Corp. (GMAC), the world's biggest auto-finance company, more than doubled in the first quarter, to $794 million.

LOSING PROPOSITION. The problem is that all this leasing also helped the Big Three lose a record $4 billion in the last two quarters. The car companies' lending companies have remained fairly conservative. But to lure customers, their parents pay subsidies to the finance units to keep monthly payments low. F. Joseph McPartlin, GMAC's director of retail leasing, says these can be "$2,000 or even more" for a pricey car--rivaling rebates as a contributor to Detroit's losses. Overseas makers have also suffered losses or crimped profits.

The $18 billion leasing business is even more of a quagmire for inexperienced players, such as some of the banks that have jumped into it. Since lease customers don't have much money tied up in their vehicles, they're more likely than buyers to walk away if their finances get tight. And in a sour economy such as today's, the problems worsen. Unscrupulous dealers lure customers into leases they can't afford (box). And lessors sometimes lower credit standards to drum up business. "It's pretty easy to make marginal customers look better than they are," says Timothy Hinkin, a University of Virginia professor who surveys lessors for the Consumer Bankers Assn.

The upshot: Auto-lease repossessions doubled last year, to 2% of all leases, according to the CBA. That costs banks and finance companies a bundle: Those answering a recent CBA survey lost an average of $4,500 per repossessed car. Since last fall, such banks as Citicorp and Marine Midland Bank have largely abandoned auto leasing.

The other problem for lessors is in predicting a car's worth by lease's end. A high estimate can produce a loss if the car resells for less than projected at the end of the lease. Resale value also can plummet if customers don't take care of their cars. "We've seen them come back a total wreck," says Steven R. Murphy, a former Marine Midland Bank executive who resells lease vehicles in California. Dealers often don't make a stink, because 80% of those returning vehicles lease another. But the lessor loses if the beat-up car doesn't sell for much.

RED INK. The problem is compounded by lessors who overestimate a car's projected value to keep deals moving. Marine Midland, which once ran lease programs for Porsche and Jaguar, often projected that cars would be worth 60% of the sticker price when 40% was realistic, says Murphy. Devon M. Cohen, Marine Midland's senior vice-president for automotive financial services, concedes that the bank was aggressive "to keep up with the pack" of rival lessors, though he blames slumping used-car prices for some of Marine Midland's losses. Its auto-finance operation was awash in red ink last December, when Ford Motor Credit Co. acquired its network. Marine Midland still holds the leases and is reselling luxury cars in Germany and elsewhere to get the highest price.

Up to a point, carmakers would rather risk losing money than market share. So, Audi inflates the residual value of its Audi 100 sedan, and its parent, Volkswagen of America Inc., picks up the difference, about $3,200, as part of the model's marketing expense, says an Audi official. And when Nissan Motor Co. leases Infiniti Q45 luxury sedans through its finance arm, it figures the car's worth after three years at about $25,000. By contrast, National Auto Research, a Gainesville (Ga.) company, whose Black Book is a standard industry reference, estimates the car's worth at about $17,500. Such rosy projections are largely why two-thirds of the banks and finance companies surveyed by Hinkin lost $563 on average last year per resold lease car.

A few car companies are trying to mitigate some of leasing's biggest risks. Audi now pays for routine maintenance on leased cars. And BMW spends $800 to $1,200 to recondition some 7-series sedans after they come off lease. The cost is more than offset by the higher resale value of the cars, BMW says, so it plans to expand the program.

Auto companies can't afford to slow the leasing boom now, despite its drawbacks. U. S. car and light-truck sales are off 17.3% so far this year--and companies fear sales would fall more without leasing. In the auto industry, though, promotional pricing is like a drug--hard to kick, even when times get better. Now, on top of rebates and dealer incentives, cut-rate leasing is one more pill Detroit may have trouble giving up.

Before it's here, it's on the Bloomberg Terminal.