Reality is finally setting in for auto financiers: The vehicle sales market is shrinking and losses are climbing — a serious combination with which lenders must grapple.
Manufacturers continue to take steps to reduce headcount and limit output, particularly of gas-guzzling SUVs and pickup trucks. Lenders, meanwhile, face lower origination volume and higher delinquency and chargeoff levels.
So where are things headed? For one thing, I think the lease product is on its way out the door. For years, lessors recorded losses on incorrectly calculated residual values. Truth is, in some cases, it wasn’t their fault. Inherently, the practice of residual-value setting requires lessors to accurately predict the value of vehicles two, three, four, or five years out — essentially an impossible task.
Banks learned that lesson in the late 1990s, when they took $100-million-plus chargeoffs to correct their miscalculations. Most exited the sector. But manufacturers were in a different boat, forced to offer the product in order to move vehicles. Based on today’s second-quarter earnings announcement from Ford Motor Co., the scenario may be changing.
Ford lost $8.67 billion last quarter, in part because of incorrect residual value estimates at captive Ford Motor Credit. How steep was the miscalculation? $2.1 billion. Ford Credit had booked its lease portfolio expecting to recover $11.5 billion when the vehicles were remarketed at the end of the lease period; instead, it recouped $9.4 billion. Sure, severe softness in the SUV and light-truck market is largely to blame but, ultimately, the shortfall remains.
A look at Ford Credit’s fixed-income presentation this morning puts things into perspective: Loss severity on remarketed vehicles last quarter hit $10,000. You read that right. That’s up from $7,000 in the prior-year period. And, according to the Federal Reserve, the average amount financed for new vehicles in May (the latest month for which data were available) was $24,911. Those are some serious losses.
I think other manufacturers and captives will finally begin to take notice. For one thing, Ford doesn’t operate in a vacuum, and the others are probably taking similar losses. It seems the lease product may finally have met its demise.
