Drive an Expensive Import? You Probably Lease It

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I don't see how they could abandon leasing and expect to do any volumes," he added.

Inflating Residual Values

Setting the residual value is where leasing gets tricky. The residual value, which is set ahead of time and specified in the customer's leasing contract, is an estimate of how much the car or truck will be worth at the end of the lease—say, in 36 or 48 months.

At the end of the lease, a customer has three options. He can extend the lease, purchase the vehicle, or simply turn it in, which is what most people do. At that point, the dealer may opt to buy the off-lease vehicle and resell it as a used car—often as a certified pre-owned car, with a factory-backed warranty.

BMW was a pioneer in promoting leasing starting in the early 1990s. At the same time, BMW was also one of the first brands to promote certified pre-owned cars, to support the value of off-lease cars, and to motivate BMW dealers to take more off-lease vehicles off BMW's hands.

"We almost see leasing as a CRM (customer relationship management) tool, having a customer coming back on a regular basis, the way we work the whole process, from the new car, to the relationship during the lease, to the used car," said DeChristopher of BMW Financial.

Across the industry, most off-lease vehicles end up back at the leasing company. The leasing company resells the off-lease vehicles at a wholesale, used-car auction. If the actual value of the off-lease vehicle is the same as the forecast residual value, that's the end of the story.

But the car companies and auto lenders often artificially inflate the predicted residual value. That lowers the monthly payments, because the customer is financing only the difference between the up-front cost and the residual value. For luxury brands, hiking the residual value is also seen as less damaging to the brand image than Detroit-style customer cash rebates.

The car companies set aside reserves to cover the expected loss from the difference between the inflated residual value and the actual value of the off-lease vehicle. They get into trouble, especially in the cases of Chrysler, Ford and GM, when the actual value of the off-lease vehicle falls substantially. That creates a bigger-than-expected loss on the residual value.

Plunging Resale Values

That's what happened with trucks this year, when gas prices hit $4 per gallon. Auction prices for used, full-size pickups were down 22.9% in July from the year-ago month; full-size SUVs were down 24.4% and luxury SUVs down 13.3%, according to auction firm ADESA of Carmel, Ind.

Those drops forced Ford last month to write down $2 billion from the value of its lease portfolio in the second quarter. GMAC Financial Services took a similar writedown of $716 million for the second quarter. Chrysler is privately held and doesn't disclose its financials, but it's safe to say that big losses on residuals helped motivate Chrysler to drop leasing entirely.

"Ford and Chrysler are pretty much getting out of the leasing business. GM is still in it, and leasing is still available for luxury and midline imports," said Charles Oglesby, CEO of Asbury Automotive Group (ABG), one of the nation's largest dealership chains.

He said resale values are dropping so fast for big trucks that the car companies have started programs to encourage customers to turn in their leased trucks early, before the values get any worse.

"Particularly on the heavier vehicles, there's been such a drop in [residual values], they're being proactive to get people out of them now, rather than wait 15 or 18 months from now," he said.

Looking for Cover

The mass-market shakeout has the luxury brands rethinking leasing, too.

At BMW Financial, more than 70% of off-lease vehicles are returned, according to an October 2007 filing with the Securities & Exchange Commission. In 2006, the last full year for which numbers were available, BMW had close to 100,000 vehicles coming off-lease, the filing said. That's a big potential liability.

GM has said that while it will continue to offer leases, it is not going to put incentives behind them. Of the 10 most leased vehicles in the U.S., the Saab 9-7X is the only GM product, at 82.2% leases, according to PIN.

Kevin Frayne, marketing manager for SUVs and crossovers at Saab Automobile USA, said that as residual values have fallen for traditional truck frame-based SUVs like the 9-7X, it's gotten to be too expensive for GM to support discount leases.

Without incentives, and with lower residual values, he said monthly lease payments would go up "a couple hundred bucks." On the other hand, during the 2008 model year clearance, GM is offering up to $12,000 in incentives to buy a 9-7X.

"Maybe folks were used to going out and leasing for X number of dollars per month, and getting something that was more expensive than they would normally buy. They can still get in for X per month, but it's going to be on a five- or six-year loan, instead of a three-year lease," he said.

Click here to see a slide show of the 10 most leased cars in America.

Henry is a reporter covering the automotive industry and automotive trends in BusinessWeek's New York office.