The Future of Leasing

If there’s one component of finance that’s gotten hammered hard in the past year, it’s leasing. Like lenders, lessors have tightened underwriting across the board. What makes things more difficult is the fact that so many lessors have curtailed their businesses or exited the market altogether. In a nutshell: Fewer providers are offering leases, and of those that remain, qualification standards are tough.

Technically, it would seem that leasing would be a popular option these days, with car buyers seeking the lowest possible monthly payments. But because lessors have reined in residual value estimates, monthly payments are not that much cheaper than loan payments. Put simply: Leasing has lost its edge.

In its heyday, leasing commanded about a third of the financing market. These days, I wouldn’t be surprised if the ratio were closer to 10%.

Will leasing ever rebound? Sure, when the memory of residual value losses fades. For now, though, with financiers scrambling to survive the current new-vehicle-sales nosedive, leasing will remain elusive.

Tags: lease, leasing, lessor, loan, sales

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Comment by Thomas B. Hudson on June 24, 2009 at 12:55pm: Until fairly recently, leasing was mostly limited to the new car market. We have seen a lot of interest lately from buy-here, pay-here dealers who are contemplating lease-here, pay-here as an alternative. The residuals issue is, I think, less of a problem in this market, and there can be some significant operational advantages as well, such as (in some states) the imposition of sales or use taxes on the monthly payments rather than up front. Anyone considering leasing needs to consult legal and accounting folks, though - it isn't just another form of financing.

Comment by Brian Reed on June 24, 2009 at 1:06pm: It is clear that most of the captives and independent leasing companies have backed out of leasing. This was driven by residual losses, increased credit losses, and funding constraints. Relative to anytime in the past 5 years, I would say that this would be the time to be in leasing if you feel that you can manage residual values. Used car values have tanked and are reflected in lower ALG residuals, competition is minimal, so you can "pick and choose" the cars that you want to lease with residual at or below ALG. In addition, if you have access to funding, margins are better than straight retail financing. The OEM risk can be a challenge but there are ways to stay away from cars you think are too risky and only lease cars that have minimal risk. In my opinion, the significant resetting of the market conditions have resulted in the "risk vs reward" of leasing is at a point where if you know what you are doing to manage residual risk, and you can build a diversified portfolio, that leasing could make good financial sense.

Comment by Marcie Belles on June 24, 2009 at 1:11pm: Tom -- The lease-here, pay-here idea is pretty interesting. I can understand that residual values would be much less of a potential pitfall than with new-car leasing, but how much would a lessee really save? It seems that the residual value of a used car (and I'm not sure what age car we're talking about here) would be so small that a lease payment would be only minimally less than a loan payment.

Comment by Jim Finnegan on June 24, 2009 at 1:54pm: The interest in leasing among BHPH lenders may be spurred by the law changes that have taken much of contingent liability risk off of the lessor, and because a leased vehicle is titled in the name of the leasing company there is no need to re-title the vehicle after repo: The vehicle can just be put quickly into the hands of new lessee. Turning around repoed vehicles quickly is part of doing business in this credit sector.
My guess is these BHPH leases are structured like operational leases (no residual value amount); just a nomimal buy-out cost at the end of the lease term.

Comment by Marcie Belles on June 24, 2009 at 2:06pm: Neat. Thanks, Jim.

Comment by Valerie Torphy on June 24, 2009 at 2:11pm: All good comments, but don't forget: three years ago when leasing was subvented by the manufacturers, you could have a $400 monthly payment on a vehicle with a Cap Cost of $45,000. When that lessee goes into a dealership to lease the new version of the same car, the residual drop and lack of subvention causes the new monthly payment to be $700. So the leasing industry is taking a double whammy: lessors tired of losing big bucks and lessees incredulous over current monthly payments, and unwilling to pay them. A real driver (no pun intended) of the 72 and 84 month loan deal.

Comment by Marcie Belles on June 24, 2009 at 2:44pm: Right, Valerie. The ability to afford leases -- i.e., the attractiveness of lease payments -- is significantly diminished these days from what it was a few years ago. And with a lot of lenders cracking down on 72- and 84-month loans, the days of abnormally low monthly payments on new vehicles are a thing of the past. Any thoughts on how long it might be before leasing recovers?

Comment by Frank Rauscher on June 24, 2009 at 2:55pm: Leasing should be only for the cream of the customers. Buy here- lease here-pay here is an oxymoron. Those customers do not belong in a lease unless the dealer simply wants to gouge the customer as much as possible and then the dealer should install the GPS and ignitiion demobilizer because they are going to need them.

To the degree that losses are occuring (other than residual value changes caused by exogenous forces such as the price of gas) it usually reflects poor underwriting and that is what most of those lessors did to get sales.

Leases should be as stringent a credit criteria as any collateralized products.

Unfortunately, Americans are having to face the new reality that many no longer qualify for "their dreams". They will have to settle for basic transportation needs until they can "afford" that "dream". "Afford" does not mean 60, 72, or 84 month financing.

Comment by David Ruggles on June 25, 2009 at 5:44pm: Marcie,

When I get home I'll send over some info re: Lease Here Pay Here. Some big advantages are that when the title is in the name of the lessor, it is easier to make a repossession in many states. In addition, sales/use tax is on the payment. With BHPH, the sales/use tax paid up front is forfeit when a vehicle is repossessed, which is a third of the time in BHPH. Instead of a down payment, a security deposit is posted, which adds flexibility to the deal and an extra incentive to complete the contract for the lessee.

Randall McAthren is the expert on this. The whole concept trumps BHPH in my view.

Comment by David Ruggles on June 25, 2009 at 8:12pm: Regarding conventional leasing, I certainly agree with Valerie. Rene, Valerie and the other folks at RVI have their finger on the pulse of leasing as much as anyone.

With the government getting involved in so many aspects of the domestic auto business its no wonder there haven't been any programs designed to lessen payment and reduce term. As long as resale values (residuals) stabilize, and rebates and incentives are part of the selling equation, subsidized short term leases make sense to shorten the trading cycle and reduce monthly payment. After all, a rebate is a know quantity and comes off the OEM's books immediately. The residual subsidy is somewhat of an unknown and is realized at end of term, deferring the cost to lease termination and providing an actual figure for projected residual and realized residual. This gives a balance sheet a boost short term. It also gives brand managers an incentive to put a new subsidized lease program on the books when an old one is terminating, to offset residual losses with new lease "profits."

The driving force is the fact that capital reduction/rebate/lease incentive/trade equity on a short term lease has a dramatic impact on monthly payment, about $50./mo per thousand on a 24 month lease. A $1000. on a 72 month contract lowers monthly payment less than $20. And short term leases mean more potential volume and better control of the buyer's next purchase/lease.

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