Auto Manufacturers Come to Their Senses

Includes: F, GM
by: Vernon Hill

Chrysler announced last week that  it’s exiting the auto lease business following recognition of soaring residual losses. The news comes a day after Ford (NYSE:F) said it took a $2.1 billion charge at its credit unit—largely related to overstated residuals. Can G.M. (NYSE:GM) be far behind?

All this is great news for banks. For years, they’ve been shut out of the auto finance business as automakers fooled themselves (and their shareholders) into thinking they were making money offering auto buyers financing via long-term lease agreements.

Only now we know they weren’t. To lenders, the auto lease may be the most tempting, dangerous of consumer finance product of all. Its profit or loss depends hugely on the lender’s estimate of the vehicle’s value when the lease expires four or five years down the road. Who can accurately forecast that? Nobody, it turns out. So, too often, the automakers’ finance units would come up with overly optimistic residual guesstimates in order to get transactions done—and cars sold—here and now. The bogus residual values wouldn’t become apparent for years, and would be somebody else’s problem. And they’d cost billions.

Thankfully, that game seems to be over. The automakers at last seem to be realizing that their leasing schemes (and 0% financing plans, for that matter) are unsustainable and only add to eventual losses.

If, as, and when sanity does return to the auto finance business, the banks will have a huge opportunity make money by underwriting well and offering fair rates. If the automakers would just stick to making cars, everyone would be better off.