Leasing: How To Expand Your Lending Portfolio
The Pros and Cons to Starting a Leasing Program
Americans are leasing more cars than ever before. It’s easy to see what’s driving this trend; lease payments are often substantially lower than financing payments on the same vehicle. According to Edmonds, lease payments are on average 23 percent lower than financing payments.1 Another advantage to leasing, consumers don’t like the idea of a long-term commitment anymore; they prefer to have a vehicle for its first two, three, or four years while still covered by the full bumper-to-bumper manufacturer’s warranty. By the time the car is out of its warranty period, and costly repairs or purchasing an expensive extended warranty become a reality, the consumer has already moved on to a new leased vehicle.
Leasing can be an important way for both the dealer and the lender to increase business substantially. Teachers Federal Credit Union based in Hauppauge, NY reported originating $264 million in auto leases in 2014 vs. only $100 million for conventional auto financing.2 Leasing gives lenders, car dealers, and consumers an additional option and revenue stream but in doing so the lender has to mitigate their risk to maintain profitability.
Leasing allows car dealers to reach customers who otherwise would be unable to afford the vehicles they want. This is an opportunity for lenders who have a leasing program as they provide the car dealer with more options to close the sale. Drive Time’s director of market strategy reported that leasing made up 20 percent of the retailer/financer’s overall business in 2015.3 According to Automotive News, leases accounted for 47 percent of North American originations for GM Financial in the third quarter 2014.4 Both of these numbers represent a huge share of their respective businesses.
Leasing creates profits beyond just the initial sale/financing as well. Lease returns can be more valuable than regular trade-ins, which come-in in an unknown/unpredictable condition. Leasing comes with mileage and wear and tear restrictions that owning does not. As a result, lessees tend to take better care of their vehicles to avoid any penalties at turn-in. In the event a vehicle does get returned over the mileage allowance or in damaged condition, the lessee must pay the associated costs. If a vehicle gets returned under mileage, the lessee does not receive any credit; rather the leasing company absorbs this benefit. Therefore, a well-crafted leasing program has the potential to make money years down the road on the lease returns as well.
A leasing program also increases the life-time value of a customer and, therefore, increases future profits. In this modern day and age of disposable products and instant gratification, consumers don’t want to hold on to their vehicles for 9 years, 10 years, or longer; they want to drive a new vehicle every few years. Leasing creates an endless cycle of turnover where a customer comes back, turns in their lease and starts a new one. This situation is much more profitable for lenders. Jessica Caldwell, Edmunds executive director of industry analysis had this to say on the topic:
…but it seems many consumers have resigned themselves to the fact that they’ll always have a monthly car payment. Younger car buyers in particular are so conditioned to having monthly fees for things like their smartphone and streaming entertainment services that they don’t necessarily expect monthly payments to result in eventual outright ownership.1
Having what amounts to a subscription service for vehicles is always going to maximize profits for the lender as well as provide a steady and more consistent profit stream.
For financial institutions that offer leasing, there is more work involved with leasing than with financing, and having the right tools is critical. The first consideration should be software. Leasing calculations are more complex and lease originations are much more complicated than their loan counterparts. Both RouteOne and Dealertrack offer options that mimic their loan origination abilities, but these are not complete solutions. An institution that offers leasing should not be without a complete loan origination system that can support every facet of lease origination. Loan origination systems provided by a third-party tend to be more robust and offer more tools designed to help with calculations, risk, and profitability – thus ensuring your leasing program will be set up for success.
The second major consideration when offering leasing is scoring. Scoring lease applications is different from scoring loan applications therefore, it is important to have a proper scoring model in place. A lender not only expects the applicant to make all their payments, but to take good care of the vehicle and to return the vehicle at the end of the lease as well. As responsibility and character are more of a concern, payment history is more heavily scrutinized when underwriting leases. Due to leasing companies retaining ownership of the collateral, employment stability and address stability are also weighed more heavily when considering an application.
The third and most critical concern when establishing any leasing program is setting the correct residuals. Set residuals too low, the calculated lease payments will be too high and the program will not be competitive. Set residuals too high and the leasing company will see significant losses when leased vehicles cannot be liquidated for the amounts that were predicted. The industry standard for residual pricing is ALG, a statistical analysis company in business for over 50 years that uses industry leading propriety modeling to predict what vehicles will be worth at points in the future. Further, a leasing company should review and adjust the ALG numbers based on their own history and geographical area. An additional option lenders have to mitigate the risk of residuals being too low is residual value insurance. Another option is to have a strategic partner, such as a dealer, wholesaler, or marketing company that will guarantee the lender’s residuals. Haan Financial has used car dealerships that guarantee to take their returns and Long Island-based Groove Car performs the same function for all of its local credit union partners.
Leasing gives lenders, dealers, and consumers an additional option and revenue stream, but in doing so the lender has to mitigate their risk to maintain profitability. It’s up to you to decide if opening a lease program will be right for your institution, but after considering the upside and downside, I think it’s an unbelievable way for your institution to expand its portfolio.
1) Edmunds. Press Release. Number of Leased Vehicles Reaches All-Time High in First Half of 2016. Www.edmunds.com. N.p., 28 July 2016. Web. 17 July 2017.
2) Morrison, David. “Auto Leasing a Win-Win for Credit Unions, Members.” Credit Union Times. Credit Union Times Magazine, 30 Aug. 2015. Web. 17 July 2017.
3) Ringle, Hayley. “DriveTime Recognized as Best Place to Work for IT, Plans to Hire 650 This Year.” Bizjournals.com. Phoenix Business Journal, 30 June 2015. Web. 22 July 2017.
4) Unknown Author. “Captives See Big Rise in Leases.” Automotive News. Automotive News, 29 Oct. 2014. Web. 23 July 2017.