A tidal wave of used SUVs coming off leases will cost auto lenders as much as an estimated $4.9 billion this year, and similar amounts again in 2009 and 2010.
"Three and four years ago, SUVs remained a viable lease vehicle at moderately solid residual values. The sudden and virtual overnight collapse in both the new and used-car marketplace has caught the industry off guard," CNW said in a June 16 newsletter.
In leasing, the consumer in effect borrows the difference between the up-front cost of the vehicle, called the capitalized cost, versus its estimated value at the end of the lease, called the residual value. A high residual value shrinks that difference, and lowers monthly payments.
At the end of the lease, the consumer typically walks away from the vehicle. Unless the dealer can sell it used, the car probably ends up back in possession of the auto lender. Those include so-called "captive" finance companies, like Ford Credit, plus banks, credit unions, and independent leasing companies, all of which typically resell the off-lease vehicles at wholesale auctions. Ford Credit reported 86 percent of Ford and Lincoln Mercury leased vehicles were returned in the first quarter of 2008.
If the actual resale value of the vehicle is the same as the projected residual value, there's no harm done. But if the actual resale value is less than the estimated residual, that can result in a loss for the auto lender.
Meanwhile, auto lenders often artificially inflate residual values in order to achieve a lower monthly payment. Under accounting rules, they also reserve money to pay for the anticipated loss at the end of the lease. But if the loss is worse than anticipated, the auto lender has to make up the difference.
According to CNW, close to 800,000 SUV leases will expire this year. They were written at an average residual value of 51% of the original capitalized cost, CNW said. In the interim, the bottom has fallen out of the market for new SUVs, as buyers have switched to more fuel-efficient smaller cars and crossovers. That also depresses values for used SUVs.
Therefore, the actual auction price for SUVs today is more like 34 percent of the original capitalized cost, CNW said. The difference between an estimated 51 percent residual and an actual 34 percent value translates into a loss of around $6,000 per vehicle, for a total of about $4.9 billion, CNW said.
It's likely not all of that amount will be pure loss, depending on how much the auto lenders reserved for future losses, but it's likely the off-lease vehicles will generate substantial losses, on top of the other problems the industry is suffering.
The way that works is that the automakers typically subsidize their captive finance companies to make the losses good. In the case of banks, with less of a vested interest in auto sales, some banks may take their losses and bail out of leasing SUVs, or maybe out of auto leasing altogether. Several banks have already curtailed leasing in the last few years, but more could join them.
If there's a silver lining, it's that used-truck buyers may save enough to make up for the high cost of gas.
Image by Flickr user Tracy O, CC 2.0