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Slashing lease prices could be a risky move for Toyota

The carmaker bets that its vehicles will be worth more than its competitors' models three years down the road, but some industry analysts are skeptical.

July 30, 2010|By Jerry Hirsch, Los Angeles Times

It's an enticing offer: Lease a well-equipped Toyota Corolla for just $189 a month for three years.

For Toyota Motor Corp., the deal could be a financial disaster.

To keep customers coming to its showrooms amid a series of large and embarrassing recalls, Toyota has been offering some of its best leasing terms in years.

But the generous come-on could "haunt them three years from now," depending on how the market turns, said B. Craig Hutson, an analyst with Gimme Credit, a corporate credit research firm.

By offering such low monthly payment options, Hutson explained, Toyota is essentially betting that the vehicles will have superior resale value when they are returned after the lease ends. If their value sinks, it could cost the finance arm of the Japanese automaker hundreds of millions of dollars.

To make the numbers on the special lease deals work, Toyota has been setting a vehicle's so-called residual value at about 60% of the vehicle's sale price. That can be up to several thousand dollars higher than the estimates of independent analysts, depending on the model.

Although its hard to project what the auto market will look like in three years, current data indicate that Toyota's used car prices aren't holding up as well as other makes'.

According to auto pricing information company, the average transaction price of a used Toyota fell 1% in June to $15,073 compared with an industry average gain of 9%.

Meanwhile, the average price of a used Chevrolet rose 12% to $15,452. The average for a used Ford rose 14% to $14,716. Used Honda prices were up 5% to $14,530.

Toyota is one of the more aggressive companies in setting residuals for its vehicles, but the strategy was less important in previous years, when leases accounted for only 21% of its new car sales and the brand had strong resale value.

But leases now account for 30% of Toyota's business, according to the automaker. The numbers don't include the automaker's Lexus and Scion brands.

And now it's offering leases to customers who are greater credit risks. CNW Research noted in a recent report that one Toyota program requires a credit score of "only 660 to qualify." That's considered the dividing line between good and poor credit. CNW said that cut-rate lease deals "with puffed-up residuals" is a "dark shadow" on the industry.

"Toyota was in a corner. They had the recalls and their inventory was climbing," said Matt Traylen, chief economist for Automotive Lease Group, or ALG, which analyzes auto residual and depreciation data.

Traylen gives the automaker credit for using a mix of attractive lease pricing and cut-rate financing rather than cash discounts as incentives. Such a strategy preserves sticker prices and helps prevent customers from always expecting big cash discounts when they buy a Toyota.

But he said Toyota's resale price estimates were surprisingly high, and that it would have to carefully manage the inventory of cars that will come off lease in 2013.

"Even if ALG's residuals are conservative it is still a big difference. It is a risk," Traylen said.

For example, ALG estimates that a well-equipped 2010 Corolla leased in a typical 36-month transaction that allows it to be driven 12,000 miles a year will be worth about 53% of its sale price when its lease term is up. Toyota pegs that number at 63%. That amounts to an $1,800 difference in the resale value of the car, which sells new for about $18,000.

The higher resale value that Toyota assigns to the Corolla shaves the customer's monthly payment by $40 to $50 a month, depending on other terms of the lease contract.

ALG sometimes gets its estimates wrong, said Tom Webb, chief economist for Manheim Consulting, a large used vehicle auction company, but the 10-point gap between ALG's projections and Toyota's is "big" compared with previous misfires.

When an automaker overestimates the resale value of its leased vehicles, lease holders won't be inclined to buy them back at the end of the contract. "The cars go to auction and you find what the real value of that vehicle is," Webb said.

Toyota is confident it can extract the values it expects for the cars when they are returned.

"We believe strongly that our residual numbers are the most accurate, in large part, because we use more refined data than perhaps other sources," said Justin Leach, spokesman for Toyota Financial Services, the automaker's financing unit.

"We see there will be a smaller pool of used vehicles available in three years, especially quality used off-lease vehicles, so we are very confident that our values are the most accurate," Leach said.

Some auto industry trends are working in Toyota's favor.

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