Auto Industry

Chrysler dropped a bombshell late last week, part of the ongoing fallout from the high price of gas, and the fact that with falling demand, used pickups and SUVs are worth a lot less than they were just a few months ago.

In turn, that means Chrysler takes a beating on trucks that come back at the end of a lease, and are re-sold at auction. Accordingly, its consumer finance company pulled the plug on leasing in an announcement late Friday, July 25, effective Aug. 1.

That means Chrysler’s in-house finance company will stop offering leases. As reported here, Ford last week wrote off $2 billion on the value of its lease portfolio, for the same reason. GM is facing a similar set of circumstances, but it hasn’t announced its second-quarter earnings yet.

Chrysler dealers are predictably shocked. They’re probably mad as hell, too, but the ones who spoke with Automotive News late last week managed to confine themselves to “shocked,” including one dealer who said leasing accounts for 70 percent of his business.

In a written statement, Chrysler allowed that “Chrysler’s dealers can still pursue lease financing arrangements through other institutions.” Those “other institutions” are big banks, which are likely to beat a hasty retreat out of leasing even faster than the car companies, so that’s not very helpful advice to the dealers.

Chrysler also suggests that its deals on loans will be just as good as lease deals. That might be true in a limited number of examples, but day in and day out, all other things being equal, the monthly payment on a lease is always going to beat the monthly payment on a loan.

That’s because in leasing, the customer only borrows the difference between the upfront cost of the vehicle, minus what it’s worth at the end of the lease. To explain the concept, lease companies used to advertise “half a car,” because in leasing, you only have to borrow enough money to pay for roughly half of the car’s value. A special deal on a loan would have to be awfully special to make up the difference.

The down side to leasing is that you always have a car payment. With a loan, eventually you can pay it all off, and your monthly payment goes to zero. If you keep a car long enough, it’s probably a better deal than a lease in the long run, assuming the car holds up.

The upside to leasing nowadays is that at the end of the lease, the car company takes the hit on the depreciation, not the customer. Apparently, Chrysler was feeling too much of that heat, and decided to get out of the kitchen.

The declining value of vehicles coming off leases, especially pickups and SUVs, came back to bite Ford in the second quarter as expected, to the tune of a $2 billion write-down in the value of off-lease vehicles.

Next: GM and Chrysler. They have yet to report second-quarter earnings, but they are in a similar bind.

As I reported here back in April and again in June, the car companies and their in-house “captive” finance companies have real money riding on the resale value of vehicles coming back after a lease, usually called the residual value.

In Ford’s case, the company reported on July 24 that it had assigned a “carrying value” to its lease portfolio of $11.5 billion, but re-assessed the “fair value” at $9.4 billion. The upshot was Ford had to write off $2.086 billion.

For the second quarter, including a $7.4 billion smorgasbord of “special items” like the lease write-off, Ford had an operating loss of $1.3 billion and a net loss of $8.7 billion.
In leasing, the customer in effect borrows the difference between the up-front cost of the vehicle, minus what it’s worth at the end of the lease, the residual value.

At the end of the lease, the customer can opt to buy the vehicle; extend their lease; or the dealer may buy the vehicle from Ford Credit and re-sell it. But most likely, the customer and the dealer pass it up, and vehicle ends up back at the lender – at Ford, 87 percent of off-lease vehicles came back, in the second quarter.

Ford Credit takes the vehicle back and re-sells it at auction. Not only does it cost the lender money to pick up and transport the vehicle, plus any costs to recondition it, wholesale auction prices for used-car dealers are guaranteed rock-bottom prices.

If the car or truck is worth exactly what the lender predicted it would be worth at the end of the lease, that’s the end of it. Where the lender can get in trouble is if it artificially inflates the residual value, to offer the customer a lower monthly payment. A higher residual means the customer has to borrow less.

The way it works is, the lender says in the lease contract that the car will be worth, say, 45 percent of the sticker price, instead of a more realistic 40 percent. The difference could be a couple thousand dollars per vehicle. It may be worth it, in order to get the customer’s business. Inflated residuals are also seen in the industry as less damaging to a brand’s reputation than a cash rebate.

Even with an inflated residual, the lender still may not be in trouble, because it is obliged by accounting rules to set aside reserves to pay for the expected loss. The real trouble comes if the vehicle is worth even less than expected.

According to auction companies like ADESA Inc., some big pickups and SUVs have lost as much as 30 percent of their resale value this year, as consumers get out of gas-guzzlers and into more fuel-efficient cars.

Hence, the $2 billion write-off at Ford Credit.

In what’s getting to be the “Death of 1,000 Cuts” in the auto industry, Chrysler was widely reported today to be cutting 1,000 white-collar jobs, on top of previously announced production cuts, layoffs and job cuts.

The way it often works in Detroit is that when blue-collar jobs are cut, white-collar job cuts aren’t far behind. The car companies are sensitive to any suggestion that salaried workers, who are not represented by the UAW, aren’t sharing the pain with the hourly workers, who are.

It also makes you wonder whether things continue to go “according to plan,” as Chrysler’s Jim Press said earlier this month.

According to Bloomberg, Chrysler since February 2007 has announced 28,500 job cuts, including today’s announcement. Last month, Chrysler said it will indefinitely idle one of two plants that make its redesigned 2008 minivans, starting Oct. 31; cut from two shifts to one, at one of three plants that build the Dodge Ram pickup; and cut 2,400 hourly jobs.

Most of the cuts will be reached through attrition and buy-outs, but if all else fails, involuntary terminations are an option.

To be fair, Chrysler’s rivals General Motors and Ford are taking similar actions, as $4 gas has torpedoed sales of the Detroit 3’s bread-and-butter pickups and SUVs this year. (Even Toyota, Honda and Nissan have cut back, some.)

Last week, at the same time GM announced measures to raise $15 billion, including possible asset sales, the company said it was eliminating health care benefits for white-collar retirees over 65, and eliminating annual executive cash bonuses.

“For the company’s top executive officers, (that) represents a reduction in their cash compensation opportunity of 75 to 84 percent,” the company said. That can’t be pleasant. And stock-based compensation for executives probably isn’t worth what it used to be, either. But you sort of assume the top executive officers are not hurting too badly financially.

This isn’t as big a deal as Ford postponing the all-new F-Series pickup (which I characterized earlier as “hell freezing over“), or Chrysler cutting back its new minivans, but Honda confirmed this week it’s cutting back slightly on production of its all-new 2009 Honda Pilot SUV, and the Honda Odyssey minivan.

Pilot sales were down 29.8 percent in June, versus the year-ago month, according to AutoData. The new Honda Pilot was introduced in late May. The Pilot is an established model for a well-respected brand. That illustrates what a tough market Kia faces with its new SUV, the Kia Borrego, since Kia is a lesser-known and less prestigious brand.

Meanwhile, Odyssey sales were down 18.8 percent in June.

At the same time, Honda said it is increasing production of the Honda Civic small car. In keeping with the trend toward fuel efficiency, Ford earlier said it would hike production of its Ford Focus model.

“Business is soft on the truck side, but cars like our Civic are selling extremely well,” said Honda spokesman David Iida.

Similarly, Toyota announced earlier this month it is cutting back production of its Tundra fullsize pickup and the closely related Sequoia fullsize SUV, and hiking production of the Prius hybrid sedan.

Honda’s Iida said the production cuts for the Pilot and the Odyssey will not cause any layoffs.

Kia is sailing into a perfect storm as it launches the all-new 2009 Borrego SUV this month in the U.S. market, just in time for the SUV market to sink.

The Borrego, with a starting price of $26,995, is a midsize SUV, powered by a six-cylinder engine or an optional V-8. It’s based on a traditional body-on-frame truck platform, as opposed to a “unibody” that’s all one piece. That’s how cars and crossovers are built. A unibody is less sturdy for towing or offroading, but offers a smoother ride on the pavement.

Borrego competitors include the Ford Explorer, Chevrolet TrailBlazer, Nissan Pathfinder, Toyota 4Runner, Honda Pilot, and the Jeep Grand Cherokee. In total, U.S. sales in that segment were about 425,000 in the first half of 2008, a steep drop of 26.3 percent from the year-ago period, according to AutoData.

In a press conference, Kia executives tried to make the best of choices that were taken regarding the Borrego four or five years ago, when the SUV market was peaking, and before $4-a-gallon gas. The trend in today’s market is toward cars and crossovers, plus thrifty four-cylinder engines.

I spoke with Tom Loveless, vice president of sales for Kia Motors America, and Tim Chaney, director, marketing communications, in a question-and-answer session following a July 18 press conference. The following are edited excerpts:

BNET: You said that the Borrego will conquer buyers from other brands, but I haven’t heard you say you will also keep existing Kia owners from leaving. I assume you just didn’t get around to mentioning it, as opposed to having a target of 100 percent conquests, right?

Loveless: Obviously we’re interested in our own owner base. The Borrego gives them another place for people to migrate to. In direct-mail, we are targeting Sorento (SUV) and Sedona (minivan) owners. We have been promoting to the owner base through our owner database. We have over one million people in our database. It’s definitely an opportunity for us.

BNET: The Borrego is aimed at people with a household income in the mid-$80,000 range, which you said was high compared with the rest of the Kia product range. How much higher? What does the least affluent model look like? How about the average for the brand?

Chaney: It’s a range. For the Rio (an entry-level car), the household income is probably half of what we talked about before (for the Borrego). The average for the brand is probably $50,000 to $60,000.

BNET: In your consumer clinics for the Borrego, people said they like the styling, and they like the fact that it has so many features. But what about “avoiders?” To borrow a term from J.D. Power and Associates, avoiders are people who don’t consider your brand at all (as opposed to rejectors, another widely used term in the auto industry, for people who consider a brand but buy something else). Are they worried about quality, or is that an outdated impression?

Chaney: We do have avoiders who have concerns about the Kia brand… That’s why it’s important to take the product out to people (and let them test-drive the Borrego). We’re not going to reach everybody through TV.

Photo by Greg Jarem

General Motors might not quite fit my earlier definition of “desperate,” but they’re doing a good imitation. One editor pointed out that GM is sharing plenty of detail about the Chevy Volt, which is still a few years off. Spilling the beans on future product was one of my criteria for defining “truly desperate.”

Be that as it may, GM’s latest round of cost-cutting, announced on July 15, is spreading more than a whiff of panic. Poor GM. The more it reassures people, the worse it gets, because it’s scary to think that GM thinks it needs to reassure people. Got that?

In an editorial following GM’s latest cuts, The Detroit News insisted that this time it’s different: ”Tuesday’s news should not be taken as just one more step down a long downsizing stairway for the auto industry,” the paper said.

“General Motors acted because the financial markets were rapidly losing confidence in its ability to survive,” the newspaper said. The paper criticized Wall Street for applauding GM for cutting jobs; the Michigan state government for not doing enough to attract business; and the federal government for choosing now of all times (several months ago, actually) to raise gas mileage standards.

As far as I can tell, ”just one more step down a long downsizing stairway for the auto industry,” is a perfect description. What makes it a crisis is that there have been so many downward steps before now.

The paper suggests that government regulators should go easy on the auto industry, until it can regain its “footing.” No word how long that might take.

In a July 15 announcement, GM said it expects to save an extra $15 billion, on top of years of cost-cutting. The latest announcement includes harsh measures like eliminating healthcare benefits for retirees over 65 years old, cutting additional white-collar jobs, delaying the introduction of a new truck platform, and further cutting production of existing trucks.

In short, “the auto industry is at DefCon 4. It’s time to panic,” said Art Spinella, president of CNW Marketing Research, in a July 16 note.

Meanwhile, Lehman Brothers analyst Brian Johnson seems to suggest in a July 15 note that if anything, GM isn’t panicking enough: “[T]he announcements offered little sense of a ‘new’ GM strategy or shift in organizational culture that might set the stage for a more dramatic reinvention.”

If GM’s latest announcement can be seen as “business as usual,” maybe it really is time to panic.

Fisker Automotive named Valmet Automotive in Finland the manufacturer for its $80,000 Karma plug-in hybrid sports car.

The question of who would build the Karma has been hanging over the project since CEO Henrik Fisker, a former designer for BMW, unveiled the Karma at the Detroit auto show in January 2008. The immediate question now becomes what looks like a next-to-impossible target for starting retail deliveries — before the end of 2009.

Valmet is well-known within the auto industry as a contract manufacturer for premium specialty cars. Valmet has been manufacturing Porsche Boxsters since 1997 and Porsche Caymans since 2005. Before that, it built convertibles for Saab for many years. Earlier this month, Valmet celebrated building its 200,000th Porsche.

But on June 26, Porsche announced it will not renew its current manufacturing agreement with Valmet beyond 2012. Porsche will switch to Magna Steyr in Graz, Austria. Losing Porsche may have made Valmet more eager to take on the Karma project. Fisker, with a target of 15,000 cars a year, will replace some of the lost Porsche business, and the high-tech nature of the Karma potentially makes it a feather in Valmet’s cap.

Fisker says the Karma will be the first plug-in hybrid sports car. A plug-in hybrid can be recharged at home overnight or in a parking garage during the day, which increases the range over today’s hybrids like the Toyota Prius, which recharge themselves with the onboard gasoline engine and regenerative brakes, which recaptures some energy while braking.

Fisker claims a range of more than 350 miles on a single charge, using both the battery and the internal combustion engine, fuel economy of more than 100 mpg, and a top speed of 125 mph.

Fisker’s rival Tesla Motors is also building a battery-powered sports car and has plans for a plug-in hybrid. The latter is now the subject of a lawsuit between Tesla and Fisker.

Domestic automakers have been compelled to state in recent days that they’re not planning to file for bankruptcy — which unfortunately for them only serves to keep the word “bankruptcy” appearing in the same headlines as Ford, GM and Chrysler.

Spokesmen like Chrysler’s Jim Press and GM’s Rick Wagoner used terms like, “without merit” and “inaccurate” to describe speculation that the automakers are burning through so much cash in the present sales downturn, they would be better off filing for bankruptcy.

It probably is a preposterous suggestion. But these are preposterous times, starting with $4 gasoline, which would have sounded far-fetched a year ago, even after three years of gasoline price hikes.

The automakers seem mystified — maybe angry, reading between the lines — that the bankruptcy rumors are flying, and frustrated that the rumors don’t stop when the Detroit 3 say so. It’s understandable they’re frustrated, but it’s also understandable that the rumors are out there.

Where the Detroit 3 are already overdrawn is credibility, at least at this high, corporate level. They’ve been declaring for a generation that the latest restructuring plan, merger, acquisition or globalization plan will put things right, if only people will be a little patient. When that fails, another restructuring comes along. Lather, rinse, repeat.

At this point, people can be forgiven for doubting, when the companies declare again that they can see the light at the end of the tunnel.

In a short time, Ford has ditched Aston Martin, Jaguar and Land Rover, which it spent billions to acquire and billions more to try and fix. Daimler divorced Chrysler, undoing the biggest industrial merger in history. GM sold GMAC, which promptly sank in the subprime mortgage mess, and it’s probably dumping Hummer. Not to mention the current production cuts and layoffs for all three domestic automakers.

These are all big-time distress signals. It’s no wonder people are trying to connect the dots to see where all this leads.

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Is Chrysler truly desperate? Or GM, or Ford? Getting there, but not quite yet.

Strike One: Fire-Sale Incentives

All three of the Detroit Three recently resorted to incentive programs to try and sell down stockpiles of unsold cars and trucks.

GM had a “72-Hour Sale” in late June. Ford added “You Pay What We Pay” for the Ford F-150 pickup. Chrysler sweetened and extended its “$2.99 Gas” offer. But so far, no one has touched off a price war like “Employee Prices for Everyone” in 2005, or zero-percent financing, in 2001.

Strike Two: Win One for the Gipper

Chrysler recently invited Lee Iacocca in from the cold. Iacocca got airbrushed out of the picture for opposing the 1998 DaimlerChrysler merger, and when he sided with Kirk Kerkorian, when Kerkorian tried to take over Chrysler.

Take your pick, Iacocca’s June 26 appearance at Chrysler headquarters was A. a heartwarming, overdue tribute, B. a cynical attempt to rally the troops, now that DaimlerChrysler split up and it’s safe to invite him back, or C. both.

Who would serve a similar charismatic role for Ford or GM? That’s a tough one.

Strike Three: Psst! Look What’s Up Our Sleeve

But here’s the best way to tell if a car company is truly desperate, and again Chrysler provides the precedent: A truly desperate car company will throw open the super-secret future-product vault and show people the great products they have in the pipeline.

Chrysler did just that with its LH-platform cars of the early 1990s, many months before they went on sale, also sharing an incredible amount of detail on key decisions that were made in developing the cars. Normally that level of detail, and products that far off, are the ultimate hush-hush secrets.

The unsubtle message is, “Don’t give up on us, just look at the great stuff we have in the pipeline, if you’ll just stick with us until they arrive, everything will be OK.” Some wag at Wikipedia said LH stood for “Last Hope.” I never heard that one, but at the time, it fit.

If you start seeing “authorized” write-ups and photos of cars that don’t go on sale until, say, 2010 or later, you’ll know true desperation has arrived.

Higher demand for fuel efficiency is driving up small-car prices in a couple of ways.

First is simple supply and demand. Toyota said on July 1 it had only a one-day supply of the Toyota Prius hybrid – meaning in effect that it is sold out, and has a waiting list. That kind of demand usually spells what the auto industry calls “gouging,” or charging more than sticker price.

Bob Carter, Toyota Division group vice president and general manager, admitted in a July 1 conference call there are what he called “rare examples” of Toyota dealers charging more than the manufacturer’s suggested retail price for the Prius. But he insisted that data from the Power Information Network shows that on a nationwide average, the actual transaction price is slightly under MSRP.

Second, car company executives said that anecdotal evidence suggests customers who are trading in bigger vehicles for smaller, more fuel-efficient ones are ordering small cars with all the optional bells and whistles, and that also drives up transaction prices.

Third, a couple of the best-selling small cars are newly redesigned, which also helps boost prices. The redesigned 2009 Toyota Corolla went on sale in February. Ford introduced the 2008 Focus last fall.

According to the Power Information Network, a subsidiary of J.D. Power and Associates which gets finance data directly from dealerships, the average transaction price for the Corolla was $17,263 year to date, from Jan. 1 to June 22. That was about $1,500, or 9.5 percent, higher than the first half of 2007. For the same time frame, Ford Focus prices increased $666, or 4.6 percent.

“The direction of the industry is higher prices, and you’re going to lean into the direction of the hot segments, and that’s small cars right now,” said Mark LaNeve, vice president, GM North America vehicle sales, service and marketing.