BMW’s decision to write-off €236 million is a brave decision to acknowledge the weakness of its U.S leasing book which clears the decks and puts the business to rights, or a display of weakness in the face of the credit crunch, which heralds even more financial problems coming soon.

These are the conflicting verdicts from investors after BMW’s statement in late April that it would take this huge charge against its bottom line to cover possible defaults on loans for leased vehicles.

But investors are sure of one thing. Mercedes, Porsche, and Audi will have to take similar action. The scale of these other write-offs by the big German premium car makers is the only subject of conjecture.

BMW, and the German premium car makers, have based their U.S. business on aggressive use of leasing, cashing in on high expectations for strong residual values on its vehicles.

BMW said a steep drop in second-hand car prices in the U.S. driven by the credit crunch has devastated the revenue obtainable when cars are sold at end of leasing contracts. At least 70 per cent of BMW’s sales in the U.S. are based on leasing, and analysts believe there are about 450,000 leased vehicles on its balance sheet. The U.S. is BMW’s biggest market, accounting for about 23 per cent of sales in 2007.

When BMW made its statement, it added that its profit forecast for  2008 remains unchanged; pre-tax earnings this year will be in excess of 2007’s €3.8 billion.

Unsustainable business model
Investment banker Morgan Stanley is not so sure, and worries that the U.S. business model might not be sustainable.

“The provision covers the financial impact of one year of depressed residual values, but we are more concerned with the impact on the ability of the company to price leases to the end consumer. Over the years, BMW has monetised strong residuals to lower monthly car payments, attracting new customers to the brand to buy more cars or higher-mix cars,” Morgan Stanley’s Adam Jonas said in a report.

“We wouldn’t have expected BMW to make a provision like this unless the situation was very serious. For investors, we are concerned that the risks of owning BMW shares, enters a new dimension,” Jonas said.

Merrill Lynch said it is not surprised by BMW’s action, and expressed “amazement” that it was able to maintain its profit forecast for 2008.

Resilient
“(The extent of the write-off) is much less bad than we had feared it might be. We continue to believe that BMW’s earnings will prove more resilient than peers. We reiterate our “Buy” (the shares) rating,” Merrill Lynch said in a statement headed “BMW: Bad news is not so bad”.

Citigroup Financial Markets was in the doubter’s camp, saying it couldn’t be sure this write-down would be the last, with a material risk of further “adjustments” and more cash being locked into the Financial Services book.  

Deutsche Bank breathed a sigh of relief that the write-off was only $236 million, saying some investors had worried the figure might be closer to €1 billion.

“The ongoing risk remains hard to quantify, but we would continue to see no material impact on the business,” Deutsche Bank said.

Morgan Stanley’s Jonas though needs to be convinced the worst is over.

“While the write-down may not come as a seismic shock to the market, in the current environment, we would expect the risk premium applied to BMW earnings and targets to rise materially. What’s more, this may not be the end of it. There is ongoing risk for vehicles coming off lease in 2009 and beyond,” he said.