Are Car Loans The Next Problem For the Auto Makers And Dealers?

Implications: With Chrysler's announcement on Friday that it was going to stop offering leases through its lending facility, every domestic car dealer felt the tremors.

Analysis:  Leasing has been an important part of the North American auto dealers profit portfolio for decades. At times less profitable than others, but always an important option for many buyers and sellers

Domestic car dealers, already in the middle  of the worst sales years in decades, have seen a dramatic dropoff in sales of their most profitable models, floor traffic is off dramatically, lenders are tightening their policies on a daily basis.

When Chrysler announced last week that it will not accept leases from its dealers after August 1, many car dealers began the countdown for the other shoe(s) to fall. Most anticipate the other captive lenders to follow suit.

The move comes at a time when 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 costs make it more difficult for the captives to make money on low interest rate loans, or absorb write-offs for 0% loans that are used to increase sales of higher-margin or slow selling models.

The old joke of "we lose money on every sale, but make it up in volume" may not apply here. The first part holds true, but volume will not increase unless the car makers and their captive lenders can find ways to help customers purchase or lease their vehicles.

Leasing has always been a tricky part of the car business, going through cycles when it was every ones favorite flavor to others where the captives and the banks got burned badly with large losses on cars coming off lease. Some of the same customers who got easy home mortgages also found leasing to be easy way to get a new car every few years. In the case of vehicle leases, they simply walked away from the vehicle at lease end.

Lease payments are calculated according to how much of its value a vehicle is expected to lose during the length of the lease, and often have little correlation to the cars actual price. Until the past year, the lenders did ok, values on used cars continued to rise, so they could dispose of the trade-ins at a profit.

For the last eighteen months  resale values on the previously hot-selling pick-ups and large SUVs plummeted, leaving the lenders with residual losses in the billions.

Typically, buyers will utilize the dealer credit facilities if they are unable to get a better deal at a bank or credit union. Even with good credit they may they may still opt to use the dealers captive lender when it is tied in with incentives such as rebates or low APR financing.

Chrysler's losses from leasing are its own fault, not the consumer's, because Honda and Toyota aren't' having this problem even when consumers use leases to spend up. The key to profitability on a captive's leasing arm is to build vehicles with high resale value.

That criticism aside, I like this move by Chrysler because it indicates they're deciding to chose to make profitable sales over sales at any cost. It will be interesting to see how this shakes out as far as impact on profitability, if/when the other Detroit captives follow suit and if additional similar moves are made in the future.