Sharply lower residual values are strong medicine for lenders, but they are only a 'quick fix,' said Bill Jensen, dealer retail services manager for Banc One Credit Co.
To prosper in leasing over the long term, Jensen said, lenders must:
Exclude certain options when figuring residual values.
Avoid a high concentration of makes, models, body styles or terms.
Shift to longer-term leases.
'We and the rest of the industry have made the most obvious adjustment - that is, the drop in (residual figures from Automotive Lease Guide). In some cases, we have cut residuals even deeper than they have,' Jensen said March 13 at the Consumer Bankers Association Automobile Finance Conference in Orlando, Fla.
Automotive Lease Guide of Santa Barbara, Calif., a widely used benchmark for residual values, shook up the leasing industry by slashing residual values in its January-February guide. (See story, Page 8i) It expects a glut of off-lease vehicles, combined with incentives on new vehicles, to depress used-car prices even more.
The cuts were the buzz of the convention. 'I've had a lot of people saying, `What did you do to my residuals?' ' said Raj Sundaram, Automotive Lease Guide's vice president. 'But I've also had a lot of people say, `Thank God you did something about this problem.' '
A lower residual value means less risk of residual losses, but it also means higher monthly payments for the customer, which makes leasing less attractive.
A lease customer in effect borrows the difference between the up-front cost and the residual value. Artificially inflated residual values have been the most common form of lease incentive.
That can cause big losses for lenders when cars returned to the lender are sold at wholesale auctions, because auction prices are often far below the predicted residual.
Keith Wilton, Wells Fargo Bank senior vice president, said at the convention that the Financial Accounting Standards Board requires lenders to book anticipated losses on the residual value of leased vehicles the same year they are found. But lenders are not allowed to book any anticipated gains if the lease portfolio should increase in value, he said.
Some of the cuts by Automotive Lease Guide were profound.
For instance, it slashed the predicted residual value on the Ford Expedition/Lincoln Navigator from 56 percent of suggested retail on a 60-month lease, set when the Expedition was introduced four years ago, to only 35 percent of sticker price on a 60-month lease.
At a sticker price of $41,260 for a 2001 four-wheel-drive Eddie Bauer Expedition, a 56 percent residual is $23,106. A 35 percent residual is $14,441. The customer has to finance the extra $8,665.
Sundaram admitted: 'We missed that one really badly.'