STRATEGIES

[Pages:8]STRATEGIES

TO HELP MAINTAIN PROFITABLE LEASES IN YOUR PORTFOLIO

BLACK BOOK WHITE PAPER

FEBRUARY 15, 2016

Black Book Lender Solutions White Paper

Strategies To Help Maintain Profitable Leases In Your Portfolio

Ever since late 2009 the lease market for cars and trucks has made a steady climb out of the recession and has been a strong sales tool for the automotive industry over the last few years. Leasing hit a record 3.7 million units at its peak in 1999, and dropped all the way down to just over one million units in 2009 as a result of the economic recession and credit freeze. In 2014, that number climbed all the way back to nearly 3.5 million units and industry observers expect leasing to break a record in 2015, where overall lease penetration rang just shy of 27% according to Experian1.

2016 is expected to see even more overall sales growth, with experts targeting an end-of-year SAAR of more than 17.5 million unit sales. While leasing will most certainly continue to grow as well, one catalyst for this may come in the form of incentives. Historical collateral insight from Black Book shows that retention values reached their peak of strength in 2012 and have continued to stay strong since, despite additional growth in leasing.

Higher Incentives In 2016

With annual sales now cresting above 17 million, the used vehicle market has satisfied much of its pent-up demand, meaning depreciation rates are starting to increase. This trend, combined with rising transaction prices that have outpaced personal income growth, means it will become more challenging to keep monthly payments near the $400 mark for new cars. As a result, manufacturers and dealers are likely to begin adding more incentives for car shoppers. In fact, this past November already saw rising incentives, where carmakers spent an average of $3,066 per vehicle on discounts, a 6% increase compared with the previous November2.

Leasing's Impact On The Industry

The success of leasing could also add further pressure on rising depreciation rates. Industry observers believe the number of offlease vehicles could rise from 2.5 million annually in 2015 up to 4 million3 by 2018. And while the current Certified Pre-Owned (CPO) market remains healthy today, that could change in a year or two depending on other factors such as rising interest rates and the overall health of the economy and labor markets. Additionally, rising levels of CPO in the luxury and near-luxury market could impact new car sales by drawing the buyer away from new and placing further pressure on those segments in particular.

Today, though, as a way to keep payments desirable for consumers looking to finance, manufacturers and lenders have been extending loan terms even further. Terms for new vehicle loans reached an average of 67 months at the end of the third quarter, while terms for used vehicles reached an average of 63 months4.

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Strategies To Help Maintain Profitable Leases In Your Portfolio

February 15, 2016

Longer Leases Rather Than Incentives

Lenders concerned about the impact lease incentives may have on deteriorating residuals and their portfolios may instead want to consider longer terms on certain lease deals. Access to timely collateral insight can help lenders determine which vehicles and segments would be ideal targets for extended lease terms beyond standard 36- or 39-month ranges. These longer terms seem counter intuitive to the lease product but do have merit. Two immediate benefits are the ability to reach the payment affordability target desired by consumers without the need for as much incentive; also, longer terms can spread out off-lease return schedules and mitigate losses. Lastly, return rate may even decrease from today's percentages.

The Role Collateral Data Plays

In order to manage risk levels for leases appropriately and confidently, as well as facilitate the ability to identify continued pockets of profitability, lenders are increasingly relying on collateral insight and residuals as an underwriting tool particularly for longer-term loans. While this is a mainstay for financed loan environments, it can be extremely useful for leases as well. This practice will only grow as interest rates begin to rise and lenders need better visibility in determining the position of equity for their portfolio.

Especially in environments where lease terms are stretched out beyond 39 months, access to collateral insight and residual data can help identify the right vehicle or segments. As seen in the below examples, some vehicles have stronger residual value on longer terms compared with others that excel at 24 or 36 month environments. What's more, collateral and residual data can team together to help lenders identify their tolerable inequity levels and set terms accordingly in order to minimize risk and accelerate profit potential.

Collateral Insight For Leases

Collateral and residual data can help bring the right lease vehicle decision into focus. Data can help manage the amount of Cap Cost reduction needed to reach consumer payment goals, the historical depreciation patterns and the projected residual forecast based on the desired time frame for the lease term. This is critical since not all vehicles depreciate alike, even within the first 36-48 months.

While residuals are important as an underwriting tool, it's important to note that the accuracy of the data is paramount to setting and achieving targeted profit levels for the portfolio. It is necessary to have the best, most accurate value of the collateral for the lifecycle of the lease. The level of accuracy is critical during the origination process, and this can impact portfolio profitability that includes not only the remarketing of the vehicle on the back end of its lifecycle, but even will guide a lessor to the optimum lease end strategy. For instance, a lease on a vehicle is due to end in six months but the collateral data show that in three months the vehicle will significantly depreciate based on historical patterns; it would be the best time to work with the lessee to trade or terminate the lease early. This becomes especially critical in lease environments, where the majority of matured leases are positioned for CPO opportunities.

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Strategies To Help Maintain Profitable Leases In Your Portfolio

February 15, 2016

Using Residuals to Determine the Right Lease Vehicle

Collateral and residual data can help auto lenders minimize risk and accelerate profit potential by helping to identify the position of equity for a vehicle or overall portfolio. Based on vehicle depreciation curves, not all vehicles depreciate alike. However, even if one vehicle's position of equity is achieved later than another vehicle in a given lease environment, it does not automatically mean it will produce a lesser profit opportunity. Ultimately, access to accurate collateral data can help lenders determine which vehicles would be more profitable candidates for longer lease terms. Visibility into residual forecasts on a per vehicle basis can then be compared against vehicles with larger incentives and their effect on values over time.

The following examples show two vehicles in different segments, with both achieving a position of equity at different intervals. The lender can use the collateral and residual data to identify the point of equity, and then determine if each individual vehicles would be profitable candidates for longer lease terms.

Intra Segment Strengths Not Always Universal

Among the largest reasons why it's critical to analyze accurate collateral data is the fact that not all vehicles depreciate alike ? even within the same segment. This is particularly important when evaluating the residual forecasts and retention histories of vehicles during their respective 24- versus 36- versus 48-month environments.

Example A shows where Sporty Cars show stronger retention rates compared with Luxury Cars through a typical 36-month lease term. However, when the term is extended out to 48 months, the collateral trend shows a reversal in retention strength. This can be critical when determining which segments to focus on for longer-term leases within a given portfolio.

Luxury Car

Example A

Sporty Car

69%

60% 50% 41% 34%

Term Lease

12 months 24 months 36 months 48 months 60 months

66%

57% 48% 42% 36%

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Strategies To Help Maintain Profitable Leases In Your Portfolio

February 15, 2016

Percent of Retail Value

70.0% 60.0% 50.0% 40.0% 30.0% 20.0%

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Example B

Vehicle #1

Vehicle #2

Lenders need to take a closer look at collateral data, especially since the segment level won't provide the ultimate visibility into determining the right vehicles for each portfolio. Example B shows two specific vehicles in the Mid-Size Car segment. Vehicle 2 shows a stronger retention rate at 36 months (45% vs. 43%). However, Vehicle 1 shows a stronger retention rate when the lease terms are extended out to 48 months (38% vs. 37%).

24

36

48

60

Age (months)

Example C shows a similar pattern, this time for two vehicles in the Near Luxury Car segment. Vehicle 1 shows a stronger retention rate at 36 months (52% vs. 49%). However, Vehicle 2 shows a stronger retention rate when extended out to 48 month terms (44% vs. 43%).

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Percent of ERT

80.0%

Example C

Vehicle #1

Vehicle #2

70.0%

60.0%

50.0%

40.0%

30.0%

20.0%

12

24

36

48

60

Age (months)

Strategies To Help Maintain Profitable Leases In Your Portfolio February 15, 2016

Summary

Leasing has been a major driver of the resurgence of record-breaking auto sales ever since the recession in 2010. With healthy credit availability and a still-hot CPO market, leasing is ripe for continued growth in 2016. However, the significant rise in new sales activity over the past few years, additional incentives offered by dealers and an outlook for rising interest rates means lenders will need to explore new strategies for leases in their portfolios.

One of these strategies may come in the form of longer lease terms, particularly in the 48-month environment. In doing so, lenders will be able to keep monthly payments low for consumers and even mitigate risk from lease return schedules. Collateral data will be a key ingredient for this strategy since not all vehicles depreciate alike, even within the same segment. By leveraging collateral data, lenders will be able to identify the right vehicles that represent strong residual opportunities in longer lease environments.

Black Book collateral data is made possible through access to vehicle insight that is timely, independent and accurate. Black Book's suite of values includes wholesale, trade-in and retail values that are updated on a daily basis. Black Book offers the industry's most innovative portfolio management technology, which lets lenders evaluate different vehicle options to see how each would impact a portfolio in real time. Black Book's data can also help with loss forecasting, which include historical trending and depreciation curves to measure the impending risk of downward or upward movement in specific vehicles and vehicle segments.

Collateral data from Black Book is made available with detailed analytics provided in a variety of file formats, online portals, and on desktop or mobile platforms. For more information, please visit Lender-Solutions or call 855-371-7532.

Appendix

1: "Industry highs set, with a quarter yet to go"; Automotive News; December 2, 2015 2: "Crossover SUV revolution fuels U.S. auto sales in November"; USA Today; December 1, 2015 3: "Extended loan terms pose risk to lenders, finance experts say"; Automotive News; December 16, 2015 4: "5 trends to watch in 2016"; Automotive News; December 30, 2015

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Strategies To Help Maintain Profitable Leases In Your Portfolio

February 15, 2016

Black Book Lender Solutions

Contact Information: (855) 371-7532

LenderSolutions@ Barrett Teague Vice President, Lender Solutions Phone (770) 533-5295 BTeague@

Automotive Valuation and Analytics Anil Goyal Senior VP, Operations Alex Yurchenko Principal Data Scientist

Notes:

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Strategies To Help Maintain Profitable Leases In Your Portfolio

February 15, 2016

1745 N. Brown Rd., Suite 130, Lawrenceville, Ga 30043 Phone (855)371-7532



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