The lessor of evils It's been a great, but costly, lesson

LAS VEGAS — How bad are lease residual losses these days? Deadly. So say participants in the 2001 Conference of Automotive Remarketing, trying to make sense of the worst residual losses in the last seven years and bracing for more of the same this year.

Bill Jensen of Banc One Credit Co. likens it to an “illness.” He calls his analysis of what went wrong “an autopsy.”

The not-so-good good news?

“You can't fall down if you're lying on the floor,” says Stuart Angert, CEO of Remarketing Services of America Inc.

People who set those inaccurate residual predictions, and lessors who lost money relying on them, say they've learned something.

“It's been a great, but costly, lesson,” says Raj Sundarem, a vice president and residual setter for Automotive Lease Guide.

Leasing industry leaders are taking steps so it doesn't happen again — or at least not so drastically. But some of the factors are beyond their control. Those include manufacturers' incentives on new vehicles and overproduction, both of which can hurt the used-car market.

Lessors lost money on 84% of off-lease vehicles returned to them in 1999, says the Consumer Bankers Association.

It didn't get any better after that. It's probably going to be worse before it gets better as 1998 models start coming off their three-year leases.

Last year, the average loss reached $1,365 per vehicle. This year it's forecasted to hit $1,450 per unit on the 3.3 million vehicles that are coming off lease, says CNW Marketing/Research Inc.

In some respects, residual losses are part of the game. But how much is too much? That's what banks and lessors are asking themselves.

“You cannot be in this industry without making a lot of mistakes,” says Ron Loshin, vice president of Bank Lease Consultants Inc. “But you need to learn from your mistakes or you'll pay the price.”

Mr. Sundarem cites four reasons forecasted residuals turned out to be so off. The losses reflect a difference between a residual prediction and actual value when a car comes off lease three or four years after the forecast.

“It's been a tough two years to put it mildly,” says Mr. Sundarem. “So what went wrong?”

First, the overestimated residuals of the late 1990s are a reaction to underestimated residuals in the early ’90s, a time when leasing was gaining in popularity.

“In 1993-94, vehicles were coming off-lease with actual values greater than their predicted residual values,” he says.

“You can't fall down if you're lying on the floor.”
— Stuart Angert
CEO of Remarketing Services of America Inc.

So the residual setters took corrective action by setting residuals higher. But they over-corrected, says Mr. Sundarem.

Second, he says, increasing manufacturer incentives on new cars “did a lot of damage to the used-car side by pulling used-car customers away.” He says incentives doubled from 1997 to 2000 on a unit basis.

The higher the incentives, the lower the ultimate residual value, says Mr. Sundarem.

Third, residual setters overdid it in estimating the residual value of options and dealer-added accessories, he says. A new-car owner may think that sunroof is spiffy. But the option retains only about 10% of its value at a used-car auction.

“Twenty to 40% of residual losses have something to do with not preventing accessories such as chrome wheels from being residualized,” he says.

The fourth culprit in the residual mess is a market saturation of SUVs. Their popularity led many leasing companies' vehicle portfolios to clog up with SUVs — 60% in some cases.

Their popularity also led to many manufacturers getting into the SUV segment, increasing the product offerings and decreasing the residual values of old faithfuls such as the Ford Explorer and Jeep Grand Cherokee.

The projected loss on a 1999 Explorer coming off lease next year is $3,100, says John Eckenrode, senior vice president for the underwriter firm of Lee & Mason of Maryland Inc.

He adds, “We've had good times and bad times. These are the bad times. We're losing lots of money and fighting for survival.”

Even some of yesterday's darlings are looking like tomorrow's problem children.

“For the last eight years we never lost money on pickup trucks,” says Mr. Eckenrode. “Now they could be our next problem because the segment is being saturated. Two million pickups were built in 1991. That went to three million in 2000.”

Even some former sure bets are losing money in today's residual game.

Says Mr. Eckenrode, “We're expecting a loss for a 1999 Honda Accord two-door with a two-year lease. That's a first for Honda. We're estimating a $624 loss. I wish they were all like that, though.”

Lessees and dealers are keeping arm's length from overresidualized cars coming off-lease. Consequently, those vehicles are reverting to the lessors for remarketing, says Banc One's Mr. Jensen, vice president of dealer affairs.

He says, “When you have $4,000-$5,000 losses, it increases returns. We've had eight of 10 cars come back to us. We had some as high as 10 of 10. It makes you wonder, doesn't anyone have a collision anymore?”

More of those returned cars end up at auctions for remarketing, says Mr. Eckenrode.

“There's job security at auctions,” he says. “I'm not so sure of myself. But what the heck, I'm 55.”

Mr. Jensen says leasing companies got caught up in the competitiveness of it all. Indeed, Mr. Angert says a lot of leasing companies “followed the competition over the cliff.”

Yet, if residuals are set too low, it drives the monthly leasing payments up — and drives customers away.

“Since 1997 we haven't had the nerve to tell the consumer what the real payment is,” says Mr. Jensen. “We continue to see $299 and $399 monthly lease payments when we should be seeing $499. The problem won't be cured unless we stop using leasing as an incentive program.”

Adds Mr. Angert, “You've got to price it realistically. You've got to be competitive, but you don't mark down the whole store.”

Mr. Eckenrode reveals that two more banks will soon follow others out of the leasing business.

“They can't afford the charge-offs,” he says. “It's a shame because of the excesses. We've got to show corrections are being made or it's over.”