Leasing is a major component of the automobile business. Customers like it because they know in advance when they will be getting a new car and won’t have to haggle over the trade-in value when the time comes. Dealers like it because they can often get customers into a new car for a lower monthly payment than a conventional auto loan. Manufacturers like it because their in-house financing companies can generate enormous profits for the companies.
The magic dust that makes leasing work is something called “residual value.” Basically, it’s an educated guess based on past experience of what a car will be worth at the end of the lease period. Cars with higher residual values have lower monthly lease payments and vice versa. But what happens when those carefully calculated residual values aren’t what they were expected to be? Boom! The dam breaks and a tide of red ink washes over the industry.
The coronavirus is the factor that no one anticipated, and it is kicking the stuffing out of used car values. Off-lease cars are pouring in but no one is buying them. They are pilling up at auto auctions across the country as buyers — typically used car dealers — are snapping their wallets shut and waiting to see where all this chaos will lead. The conveyor belt of off-lease cars to used car showrooms has come to a grinding halt.
Any novice economist can tell you what happens when supply exceeds demand. Prices drop, and that is precisely what is happening to used car prices in the US during the coronavirus crisis. Manheim is one of the largest auction houses in America. It reports prices were down 11.8% during the first 15 days of April, according to a report by Automotive News. Soon car rental companies like Hertz and Avis are expected to add more cars to the auction stream as they try to cash out before prices crash completely. That will put even more downward pressure on used car prices.
JPMorgan analyst Ryan Brinkman wrote in a recent research note, “The real losers of the development are likely the captive-finance subsidiaries of automakers like GM and Ford, and the rental-car companies,” Brinkman wrote. If prices finish the second quarter 10% lower than envisioned, he estimates losses could total $3 billion at GM Financial and $2.8 billion at Ford Credit.
The real economic impact of the pandemic is that it has disrupted the “business as usual” economic model. What business craves more than anything is predictability. Without it, markets become chaotic crap shoots and losers abound. Ford and GM rely on their financing divisions for much of their cash flow and profitability. There are stormy seas ahead for both as the coronavirus upends all markets great and small.
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