Leasing Risks Scare Lenders

For lenders, leasing is not the most expensive form of auto financing, but it is one of the riskiest.

So says financial expert Himanshu Patel, explaining why most banks have stepped away from leasing, leaving it mainly to auto makers' captive financing arms. But even some of them limit their activity or stay away altogether.

Leasing gives financial institutions pause because it poses a double risk, Patel, a senior auto analyst for JP Morgan Securities, says at the Society of Automotive Analysts' 2009 Strategic Planning Summit in Troy, MI.

“Not only are you taking the risk with the customer's credit, but there also is the risk of the used-car values,” he says.

Monthly leasing rates are determined largely by what a lessor expects a vehicle's value will be when it comes off lease years later and enters the used-car market.

In the late 1999s, many lenders lost millions of dollars because of inaccurate residual-value predictions that turned out to be far too optimistic.

Lenders subsequently became more disciplined, and leasing, which had fallen out of favor among lessors, regained some popularity.

But in mid-2008, it suffered another blow as some auto makers, notably the former Chrysler LLC, ended leasing completely, scared off by watching big-vehicle residuals plunge as fuel prices soared.

Today's rising used-car prices may stimulate leasing activity “a little,” Patel says. “Expect leasing to come back, but not at full force.”

Leasing will reach only 1.2 million units this year in the U.S., predicts Tom Webb, chief economist of Manheim Consulting, a branch of a major auto auction firm.

That's 2.5 million fewer units compared with leasing's peak in 1999.

Here's a Quick History of Vehicle Leasing, Where It Is Now and Where It's Going

David Ruggles has been involved in auto leasing for 38 years, first as a dealer and now as president of Advanced Concepts & Techniques. He has developed software to help lease lenders identify their areas of vulnerability and for dealers to identify opportunities.

Here is his take on the advent of leasing, as well as the reasons some lessors got in trouble:

“Auto makers became sold on leasing when Eustice Wolfington developed the ‘Half a Car’ concept and sold it to Ford, which marketed it as Red Carpet Lease and Customer Option Plan for their balloon program. It worked better in states where the sales tax was charged upfront.

“The idea of cycling customers more often through short-term leases made sense. So did the depreciation credits Ford received because the title stayed in the auto maker's name.

“These depreciation credits helped when an auto maker was profitable, not so much in extended loss periods. There is a limit to “loss carry forwards.” The IRS disallowed substantial loss carry forwards for General Motors a few years ago and it posted a huge loss as a result.

“After Ford's initial success, all the auto makers sprang to get involved in short-term leasing to realize the inherent advantages.

“Unfortunately, the domestic OEMs also were working at the same time to dismantle their own residuals through huge fleet and daily rental sales. The residual losses they took overwhelmed their depreciation credits and caused them to become more conservative on residuals and extend the lease terms from 24 months to 30 and then 36.

“Import-brand auto makers had much better results, with their residuals staying high because they managed their overall business better. The domestics tried to keep things going but were double whammied by residual losses when fuel prices spiked and the Asset Backed Securities market dissolved almost overnight.

“I never understood why independent banks would try to compete with the OEMs with new-vehicle leasing when the domestic manufacturers seemingly had their own death wish going on.

“It made more sense for independent banks to engage in pre-owned leasing, but instead they tried to carve out a niche by offering programs for longer terms. But the same factors caused the independent banks to bail out.

“US Bank has stayed in the game though. It will now handle leasing for GM in five Eastern states. Many credit unions still leases, but they are doing mostly balloon financing. They can be conservative with residuals these days and pick their spots.

“Domestic OEMs look at the market share they lose to imports' continued short-term leasing success. The subject is academic at this point, as the domestic OEMs don't have the money to get back in the leasing game, anyway.

“Limitations have been put on Chrysler and GM by the U.S. Automotive Task Force and provisions of the TALF money those auto makers have received. But the allure to get back in and protect market share is strong. We'll see what happens.”