The Coming Shift in Leasing Dynamics

© Can Stock Photo Inc. / dencgAs automotive lenders know, leasing is a cyclical business tied to shifting interest rates. For decades, as rates have gone up, so too has consumers’ adoption of leasing.

However, an interesting shift in leasing dynamics may be upon us. In a record year, leases accounted for 23 percent of new car sales in 2013, a figure that is expected to climb higher still by the end of 2014.

Despite interest rates staying relatively low for several years following the economic downturn, leasing has gained traction in the last year or two. Five years ago, leases tended to skew towards a more “traditional” demographic – consumers age 40+ and mostly interested in luxury cars. However, more recently, younger buyers (along with countless others) are choosing to lease cars at a markedly higher pace than historical averages. In fact, in the past year, one of every four new cars was leased. So what is driving this shift?

First, the key attraction for leasing continues to be a lower monthly payment. Millennials were one of the hardest hit demographic segments during the recession. Saddled with student loan debt and facing an uncertain job market, many members of this younger generation are unable to take on a hefty car payment. To them – and any consumer seeking a lower monthly payment – leasing is the perfect option.

Second, today’s consumer is more educated about purchase power than the consumer of 5 or 10 years ago. Auto buyers today have access to troves of information via the Internet, and are especially keen to use those resources when making large, long-term purchases such as a car or house. Through this education, some of the traditional resistances and hesitancies to leasing have diminished significantly. In conjunction with that trend, we are now at the point where leasing has been around for at least two generations. Years ago there was a perceived risk – and even some stigma – regarding leasing, but people now accept the practice as being more commonplace.

Third, consumers are keeping their vehicles longer, and the lease market is following that trend. Given that the average duration of new car ownership is approximately six years, leases now allow buyers to benefit from the reliability of newer vehicles for a longer term – three-year terms constitute the vast majority of all leases, and five-year terms are increasingly becoming available. Consumer confidence about the durability of vehicles helps offset any concerns about these longer-term leases.

There is no reason to believe that this growth trend won’t continue. In fact, leasing is forecasted to become even stronger in the second half of 2014, and any substantial rise in interest rates will only fuel the fire.

So what does this mean for automotive lenders?  Unfortunately, there is a lender Catch-22 when it comes to leasing. Due to its increased popularity, more and more cars are coming off of lease each month, and these cars have a longer shelf life than ever. As the inventory of used cars and trade-ins becomes bigger, the value of cars falls. At the end of the day, the big risk in leasing is the decreased residual value of the car at the end of the term.

2014 is going to continue to be a good year for leasing and a good year for car sales, but there will be a tipping point. When dealers suddenly have this big supply sitting on their lots, overall car values will plummet, forcing used car prices and leasing rates to go up. Increased interest rates will only exacerbate the situation.

How can automotive lenders adapt with as little pain as possible? As all automotive lenders know, it is more complicated to consummate a lease than it is a loan. There are a number of additional factors, such as calculating residual value, and in some cases these calculations are very complex and prone to errors. Many lenders have third parties perform the calculations, which further increases the acquisition cost for the lender. Additionally, there is a regulatory cost that has become more pronounced, including the cost associated with the resulting protective measures instituted for consumers. Automotive lenders are still navigating the required disclosures and the quantity of documents consumers must sign in this new environment.

Technology can significantly alleviate this complicated lease consummation process. For instance, there are automotive loan origination systems that can perform the calculations necessary to execute both loans and leases. Additionally, aggressive remarketing of the vehicle can help alleviate the costs as well. Since one of the best options for a lender in terms of profit is to convince the lessee to buy the vehicle when it comes off lease, look for more aggressive remarketing campaigns in the next year.

As automotive lenders continue to ride the wave of increased car sales and interest in leasing, it is important to understand the trends and be prepared to react. Partnering with a technology provider  that is knowledgeable about the intricacies of leasing and can help with the education of dealer and staff; having the most suitable  technology in place; and being prepared with a remarketing strategy will be key in a lender’s success. By taking these steps, the automotive finance industry will shield itself from the negative side of an otherwise positive trend.

– Pete Radike, director of product management, Lending Solutions, Fiserv

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