Ford Takes a $2B Hit on Off-Lease Vehicles
The declining value of vehicles coming off leases, especially pickups and SUVs, came back to bite Ford in the second quarter as expected, to the tune of a $2 billion write-down in the value of off-lease vehicles.
Next: GM and Chrysler. They have yet to report second-quarter earnings, but they are in a similar bind.
As I reported here back in April and again in June, the car companies and their in-house "captive" finance companies have real money riding on the resale value of vehicles coming back after a lease, usually called the residual value.
In Ford's case, the company reported on July 24 that it had assigned a "carrying value" to its lease portfolio of $11.5 billion, but re-assessed the "fair value" at $9.4 billion. The upshot was Ford had to write off $2.086 billion.
For the second quarter, including a $7.4 billion smorgasbord of "special items" like the lease write-off, Ford had an operating loss of $1.3 billion and a net loss of $8.7 billion. In leasing, the customer in effect borrows the difference between the up-front cost of the vehicle, minus what it's worth at the end of the lease, the residual value.
At the end of the lease, the customer can opt to buy the vehicle; extend their lease; or the dealer may buy the vehicle from Ford Credit and re-sell it. But most likely, the customer and the dealer pass it up, and vehicle ends up back at the lender â€" at Ford, 87 percent of off-lease vehicles came back, in the second quarter.
Ford Credit takes the vehicle back and re-sells it at auction. Not only does it cost the lender money to pick up and transport the vehicle, plus any costs to recondition it, wholesale auction prices for used-car dealers are guaranteed rock-bottom prices.
If the car or truck is worth exactly what the lender predicted it would be worth at the end of the lease, that's the end of it. Where the lender can get in trouble is if it artificially inflates the residual value, to offer the customer a lower monthly payment. A higher residual means the customer has to borrow less.
The way it works is, the lender says in the lease contract that the car will be worth, say, 45 percent of the sticker price, instead of a more realistic 40 percent. The difference could be a couple thousand dollars per vehicle. It may be worth it, in order to get the customer's business. Inflated residuals are also seen in the industry as less damaging to a brand's reputation than a cash rebate.
Even with an inflated residual, the lender still may not be in trouble, because it is obliged by accounting rules to set aside reserves to pay for the expected loss. The real trouble comes if the vehicle is worth even less than expected.
According to auction companies like ADESA Inc., some big pickups and SUVs have lost as much as 30 percent of their resale value this year, as consumers get out of gas-guzzlers and into more fuel-efficient cars.
Hence, the $2 billion write-off at Ford Credit.