Are Cars Loans Our Next Problem?

Chrysler has announced that it will stop offering leases through its leading facility (see WSJ article). The move comes as Chrysler and other car companies are seeing their borrowing cost rise (typically Libor plus a spread of 1% or more for Chrysler - with Libor around 2.8%). Higher borrowing cost make it more difficult for the car companies to make money on low interest rate loans, or absorb write-offs for 0% loans that are often used to increase sales of higher-margin or low selling vehicles.

The old joke of "we lose money on every sale, but make it up in volume" may not even apply here. The first part still holds true, but volume may not increase unless they can find ways to help customers purchase their vehicles. Customers have basically quit buying the higher margin vehicles, such as trucks and SUVs. To make matters worse, even if customers do purchase these vehicles, and the car companies finance or lease them, the car company may be stuck with a bad loan which has an asset that has depreciated below the current loan value.

Issues such as these have led to the recent decision by Chrysler to quit offering leases. But does this solve the problem, or simply make things worse? Sure, by eliminating poorly performing loans and leases, as well as reducing the company's dependency on higher borrowing cost, the company can scale back poor performing assets, which is good. Unfortunately, they may also be scaling back sales in the process, in what amounts to shooting themselves in the foot.

Typically, buyers will utilize the dealer credit facilities if they are unable to get a better deal at a bank or local credit union (most likely due to weak credit). Even with good credit, they may still decide to take the loan or lease with the car credit facility when it is tied with incentives, such as rebates or low financing. By eliminate this line of credit for customers, you are essentially preventing the weaker credit customers that need the facility from purchasing your vehicles. For those with good credit who can obtain low interest loans elsewhere, you now lose another carrot that might help get them in the door to buy the higher-margin vehicles that make you the most money. In a sense, you have reduced credit risk by introducing sales risk, resulting in lower revenues and lower valuation.

Of course, this is not to say that Chrysler made the wrong move. The company may have had no other choice given the credit markets, and car loans themselves may be the next shoe to drop, bringing down not only the car makers, but the banks underwriting the credit as well. Nonetheless, it does tell you how serious Chrysler's problems are, and another reason its competitors, such as Ford (F) and General Motors (GM), and even Toyota Motors (TM) to some extent, are getting marked down in the stock market. They are in a bind, and there are not really any easy answers. I am just not sure that making it harder for your customers to buy your product is the answer.

Comments

[Augustus:]

Sure, all of the auto finance / lease operations will see the effects of a weaker consumer. However, the real reason for Chrysler getting out is the crash of the residual values of the vehicles comming back off of lease. A three or four year old vehicle that gets 15 mpg has really taken a beating. The lease is a put option at lease end. Chrysler and the other auto lease providers will really take a beating as these vechicles come back to them over the next couple of years.

2008 Jul 27 09:25 AM

[CaptBob:]

They're getting the double whammy:
1. All this time and they still haven't learned you must build cars people want, not just cars with a big profit margin that you want.

That said in todays market, if it's not hybrid you've got no chance. Even Toyota sales are down.
2. When the debt ridden consumer goes under on one he goes down on all. Does anyone think he'll let his house go to buy a new car or clothes??

2008 Jul 27 09:30 AM

[jackh:]

Very few of the vehicles on lease get 15mpg......

You have a cash strapped consumer with negative home equity and high gas prices.... a perfect storm for ALL car manufacturers. (even Toyota is down).

The consumer who has been buying the SUV for the last 5 or 6 years is still out there and will still buy a large vehicle....... he just can't afford it in the near future.

2008 Jul 27 09:54 AM

[Paul Killinger:]

The REAL problem in selling more vehicles is trade-in values. The skyrocketing cost of gasoline has effectively "stranded" a large portion of our nation's vehicle fleet. How can you trade a truck or SUV when its value is $8,000-$12,000 below the amount left on its loan?

Incidentally, this is another reason to adopt the Pickens Plan. It would enable the owners of large vehicles to convert them to use CNG as their fuel, which currently costs anywhere from 70 cents to $2.50 a gallon right now, and can even be refueled at home at an average price of $1.50 per gallon. Also, if we used less gasoline, the cost would come down.

2008 Jul 27 11:35 AM

[car_guy:]

Once again a Seeking Alpha commentator displays their complete lack of knowledge about this industry. Chrysler Financial dropped leases because this form of financing results in Chrysler Financial agreeing to "purchase" the vehicle at the end of the lease for a pre-determined value. This means Chrysler Financial is responsible to sell this vehicle, presumably for more than what it payed for it (the residual value on the lease).

This has introduced a high level of variable risk into the financial arm of the company if they cannot resell the vehicles for more than the residual. As others have noted, they are taking a pounding on SUV resale right now at a time when they cannot afford it.

Loans, even 0% loans, establish all of the risk up front. Even with a significant spread between the Chrysler Financial rate & the loan rate, the company can define the cost with no hidden surprises. The auto companies have not followed the reckless practices of the mortgage banking industry and offered loans to anyone with a pulse (with the exception of Mitsubishi), because they actually have to hold on to them for the long term.

Captbob - 1) The Auto companies were building the vehicles people wanted up until gas hit $4, trucks and SUVs. Until gas hit $4, the only hybrid with any sales volume was the Prius. Even Toyota's Camry hybrid was not selling well. 2) Because mortgage companies allowed people to finance a house with little or none of their own $, many people are walking away from their homes before they walk away from their other large purchases. If you have $0 invested in your house and it is worth less than you owe, you should dump the house and keep the car which most people need to get to/from work. The financial motivation for keeping the house is the risk of losing the capital in the house from appreciation or your original investment.

2008 Jul 27 12:10 PM

[CLH:]

user---I dont always agree with you but you are totally right. A person may walk from his house but not his car.

2008 Jul 27 01:47 PM

[CaptBob:]

Long before $4 gas Toyota was eating into GM market share, year after year. GM saw it happening, but coulden't figure out why.

TOKYO, Japan — Toyota Motor beat General Motors in global vehicle sales in the first half of 2008 — and now is expected to knock GM from the No. 1 slot for the full year, despite cutting its own internal sales projections by around 350,000 units.

Anyone who walks from his home is not a viable candidate for a new car sale even though he may be living in it.

As we speak the Vultures are picking the bones of the American Consumer. All I can say is --what a shame!

2008 Jul 27 02:10 PM

[kurt walter:]

Home loans, car loans, credit card debt. The excess is over the top.

2008 Jul 27 04:36 PM

[rhj123:]

Advertising has pushed many people into buying beyond their means. Now it is beginning to come back to haunt them...and the really bad part is that we tax payers are being forced to pay them out.

2008 Jul 27 07:22 PM

[billp37:]

Auction-rate securities may be a problem too.

www.prosefights.org/th...

2008 Jul 27 10:28 PM

[AnotherGuy:]

The key point here is that Chrysler Financial is getting out of Leasing, not Loans, due to the difficulty in managing the additional risk from residual values. A number of banks got out of the car leasing business entirely in 1999/2000 for this reason, particularly SUVs which were leased with very aggressive residuals in the mid/late-90s (and Chrysler's Jeep models were particularly bad).

2008 Jul 27 11:20 PM

[DavidR:]

Nobody here seems to understand what makes a lease senario bad. Cars, trucks, and SUVs are traditionally worth about 50% of their new car value at the end of 3 years (some a little more, some a little less). But since MSRP is no longer the TRUE new car value, ie the true value is MSRP less rebates and discounts, the residual (resale) value of every used car suffers. There are Dodge dealers RIGHT NOW advertising new Ram trucks at 50% off MSRP. How can you guarantee a 3 year residual of 50%, if you are selling them new for 50% off??? YOU CAN'T. The next big storm IS that you can't trade in a used truck you paid $35000 for two years ago if you still owe $29000 and the new one is selling for $25000. Honda WILL take a hit on Pilots when they come off lease, and Toyota WILL take a hit on Sequoias when they come off lease. The next three years should be very interesting. If you want a preview of the US auto industry, just research BRITISH LEYLAND. Same problems, different decade.

2008 Jul 27 11:45 PM

[User 346052:]

Hi,
I like your forum.

Snoreta


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