By now, everyone in the industry knows the story. The residuals on full-term lease vehicles are much lower than original estimations made at the beginning of the leases. The number of lease vehicles being returned at a loss is extraordinary.

According to the Consumer Bankers Assoc., 95% of the full-term vehicles returned to lessors lost money in 2000, compared with 84% in 1999 and 71% in 1998. In 2000, the losses averaged $2,342.

CNW Research reports the leasing industry lost $10 billion in 2000 and that number could be even higher in 2001 — $11 billion some analysts predict.

So what happened? Michael Collins of Curomax, tells an Auto Remarketing conference in Denver that several factors converged to create “The Perfect Storm.”

An explosion in leasing during 1996-1999 brought about by high residual forecasts that in turn created the opportunity for low lease payments; record new car sales caused by generous incentives and low lease payments — payments built on the expectations that off-lease residuals would be higher than they turned out to be. Another culprit: manufacturers, wanting to increase market share, kept overproducing and had to provide attractive incentives to move the vehicles.

Lease terms became shorter and therefore, in 1999 and 2000 a record number of vehicles were being returned. An oversupply of used cars hit the market and that helped drive down the residuals for many vehicles by the end of lease term. In short, its simple economics — supply is outdistancing demand, ultimately driving down vehicle values.

The banks, and residual guide books, most notably Automotive Lease Guide, failed to see the coming explosion in new car sales and established very high residual levels in the mid to late '90s. The residuals are lower now — for the SUV market, the residuals are down 21% since 1997 — and that means there is still a lot of pain to endure.

For the short term, the future doesn't look any brighter, says Raj Sundarem of Automotive Leasing Guide.

“There is still a lot of uncertainty — the market is still being driven by incentives rather than being demand based,” he says.

As of June, incentive spending was 13% higher than last year at the same time, according to ALG. Also, the number of vehicles being returned this year will peak in September and October driving prices down even further.

So what is the fallout? First, several independent companies have left the leasing industry because the losses were too great to handle. Those staying in the game, such as Bank One, are changing strategies by focusing more on long-term leases in an effort to correct some of the oversupply. For dealers, that keeps people out of the showrooms longer and that will probably lead to decreased sales over time.

“The market is still being driven by incentives rather than demand.”
Raj Sundarem
Automotive Leasing Guide

With independents abandoning the industry in droves, dealers are going to find fewer leasing companies left to work with. Less competition means those days of cheap monthly payments are over.

The leasing companies are becoming more sophisticated in their end of term management to help reduce residual loss.

Contacting lessees as early as 12 months before termination and working to create an attractive buying option for the vehicle is part of the strategy. Leasing companies have three options — they can sell the vehicle to the lessee, sell it the dealer (who invariably take a pass if the residual predictions turn out to be less than actual market value) or sell it to the auctions. It's generally better for the lessor to sell the car to the lessee before lease term ends; the CBA reports only 22% of the early terminations in 2000 produced a loss for the lessor.

Dealers, especially those in areas dependent on leasing (the Northeast, for example), are changing some strategies, too. Colleen Morrissey, owner of Morrissey Pontiac-GMC in New York, says her Pontiac sales are down 50%. In May of 2000, 70% of her new car sales were leases.

GMAC is not offering the same kind of low lease deals on Pontiac vehicles as they had in the past. It's part of a strategy, outlined to Ward's by GM CEO Richard Wagoner, to step back somewhat from leasing, and instead encourage customers to buy vehicles.

But it makes it difficult when a customer comes in and expect to get the same kind of deal as they had before, says Ms. Morrissey. The Grand Am and the Grand Prix are the only Pontiac vehicles getting the attractive lease deals now, so Ms. Morrissey cut her inventory, keeping only those core vehicles.

She is also concentrating on her truck business because those are selling well. “The customer who can afford a $40,000 Envoy isn't going to be too worried about how much the monthly payment is,” she observes.

Mr. Sundarem expects the conditions to ease in the long term. ALG has set residuals for vehicles leased in 2000 that should be more in tune with market conditions and that should reduce the losses considerably — in about late 2003.

Until then, most people in the industry are holding on because it's going to be a rocky ride.