A Calculated Bet on Auto Leasing

When the recession hit a few years ago, President and CEO of Toyota Financial Services George Borst refused to panic when major competitors cut way back on auto leasing or even quit leasing entirely.

“We placed a huge bet on leasing,” which now gives Toyota a real advantage in the marketplace before other automakers begin to catch up.

The payoff: Toyota Financial Services was No. 1 in U.S. leasing volume in the fourth quarter of 2012, up from No. 2 a year earlier, according to Experian Automotive.

Car companies, their finance arms and their dealers all like leasing because lease customers tend to be more loyal than either loan or cash customers, and they come back more often for a new car. “Lease loyalty is by far the biggest,” Borst says.

But a panic in leasing started when Chrysler Financial quit leasing in August 2008. Within the auto industry, it was shocking for a captive finance company to quit a major business line cold turkey. Captive finance companies exist so the parent companies’ dealers and customers always have a lender of last resort.

It would’ve been less shocking if a bank had quit leasing. Banks have other business lines besides autos. Banks have been known to jump in and out of auto finance as auto sales rise and fall. But for a captive to quit, that was really bad news.

Not only that, but the same factors that drove Chrysler Financial out of leasing were hammering other car companies and auto lenders, too. Gas had topped $4 per gallon for the first time in June 2008. Resale values tanked, especially for big pickups and SUVs coming back from leases because customers suddenly wanted better gas mileage.

Perhaps worst of all, as credit got tight, many auto lenders including Chrysler Financial were having trouble borrowing money to make new loans and leases.

In leasing, the customer borrows the difference between the upfront cost of a vehicle and what it is predicted to be worth at the end of the lease—the residual value.

Predicting residual values is risky. When vehicles get returned to the lender at the end of a lease, the lender typically auctions them off to dealers. Some cars never make it back to the lender. Customers can buy them at lease end, or dealers may buy them on the spot at the dealership and resell them.

However, for cars that come back to the lender, the lender stands to lose money if the actual resale value at auction is lower than the predicted residual value. The car companies set aside money in reserve for just that reason, to cover the difference between actual resale values and predicted residual values.

But in late 2008, resale values fell so low that reserves were inadequate to cover losses. Several car companies took billions of dollars in one-time charges to cover the difference.

Instead of hitting the panic button, Borst says he and his team took time to analyze what the lease market would probably look like in a few years instead of how it looked right then. That required taking an educated guess at supply and demand.

The supply side was fairly predictable. After all, today’s new cars are tomorrow’s used cars. With new-vehicle sales falling, Toyota Financial—and everyone else in the auto industry—knew that two or three years down the road there would be a corresponding drop in the supply of 2- and 3-year-old used cars. In turn, that drop in supply would tend to make those late-model cars more valuable.

That left the demand side. Borst said Toyota Financial looked at past recessions and how long they lasted, and decided that the U.S. economy in general and the auto market in particular were bound to start recovering within a few years. “We thought, There’s no way this is going to be a five-year recession,” Borst recalls.

That meant consumer demand would likely recover while late-model used cars were still in relatively short supply—the best possible convergence of supply and demand for leasing. Borst said it became clear to him that Toyota Financial could reasonably expect good resale values for vehicles that were leased new in 2009 and 2010, which would reach the used-car market in 2012 and 2013.

In addition, Toyota Financial had a key advantage over most competitors—an investment-grade credit rating that gave them continued access to capital when other auto lenders were having trouble borrowing money.

Meanwhile, many banks followed Chrysler Financial’s lead and quit leasing in 2008 and 2009. General Motors Acceptance Corp., which is now Ally Financial, and Ford Motor Credit cut back on leasing but didn’t quit entirely. Borst said Honda Financial Services and luxury-import brands also stuck with leasing.

Not only did Toyota Financial keep on leasing, it increased its average residual value. Borst says that on 36-month leases, the average increase was 3 percent of manufacturer’s suggested retail price. For instance, hypothetically, a 60 percent residual on a Toyota Camry after 36 months became 63 percent. Borst said that translated into about $20 off the monthly payment.

In other words, when other auto lenders quit leasing, Toyota Financial purposely increased its risk. Borst says the decision made him swallow hard, but it was driven by the company’s experience with past recessions, by Toyota Financial’s analysis of the supply-and-demand situation, and by Toyota’s financial strength—and not by blind faith alone.

The end result has been similar to what Toyota Financial and Borst predicted. Used-car values are a little below recent historical highs, but they are still high, according to used-vehicle auction firm ADESA Inc. in Carmel, Ind.

U.S. auto sales bottomed out at 10.4 million in 2009 but have gradually increased to 14.5 million in 2012, according to Autodata Corp. in Woodcliff Lake, N.J.

“People always say it’s better to be lucky than smart,” Borst says. “But I like to think in this case it was some of both.”


How Toyota Zigged in a Crisis When Most Others Zagged

1. Don’t panic. Take some time to analyze the big picture.

2. Focus on how your market will look, not how it looks right now.

3. Remember your strengths, too, not just your weaknesses.


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