HOW TO - Black Book

HOW TO

GROW A PROFITABLE USED LEASING PORTFOLIO

B L AC K B O O K W H I TE PA P E R

SEPTEMBER 2016

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How to Grow a Profitable Used Leasing Portfolio

Black Book Lender Solutions White Paper

How to Grow a Profitable Used Leasing Portfolio

Once viewed as a way to drive a luxury vehicle at a lower monthly price, leasing today is an alternate form of financing available

on just about every car and truck at retail. Lease deals have exploded in popularity and have been a part of the fuel that has

helped the automotive industry lead the American economy ever since the recession.

Since 2008 especially, leasing as a finance option has grown by 76% according to Experian Automotive1. Leasing popularity

as a share of total sales has grown over this time, but it also means more three-year-old vehicles have come back into the market.

In fact, more than 3.1 million vehicles will return to the market by the end of this year alone, and this is expected to increase the

number of off-lease vehicles by 20% from the previous year2. Incentives have been on the rise to offset declining residual value

forecasts and thereby keep lease payment amounts low on new vehicle leases.

The following paper will help auto lenders identify when and where used leasing makes sense for a portfolio based on incentive

information, depreciation trends, residual forecast data, and how to leverage residual data to find profitable used lease

candidates, given a variety of vehicle collateral insight.

Popularity of Leasing

Besides luxury vehicles, leasing has become increasingly popular

for non-luxury vehicles as well. The top leased vehicles returning to

the market are popular cars by volume, such as the Toyota Camry,

Honda Civic, Honda Accord, Toyota Corolla, Honda CR-V, Ford

Escape, Nissan Altima, Ford Fusion, Lexus RX 350, and Toyota

RAV4. The aforementioned vehicles make up 28% of all leased

vehicles that will be returning to the marketplace.

That list is indicative of just how widespread interest in leasing has

become. The most popular vehicles to lease have been entry-level

CUVs, mid-size cars, compact cars, near-luxury/upscale vehicles,

and utilities of nearly every size.

2015 was a record year for new auto sales, with more than 17

million sold. Of these sales, about 85% were financed or leased.

Leasing has grown faster than financing. In 2016 Q1, there were

more than 31% of retail sales leased, a significant growth from two

years prior at 25%. Due to the high amount of financed and leased

vehicles, the total outstanding balance on car loans in the U.S. is

now more than $1 trillion dollars3.

September 2016

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Used Leasing Trends

Even though new lease volume has increased substantially, used leasing remains small. Used leases, as a percentage of lease

market, have stayed relatively flat, 3.90% in Q1 2015 versus 3.98% in Q1 2016, according to Experian.

Used lease options are not only beneficial for consumers¡¯ wallets, but they also aid in retaining customers for the dealership and

the manufacturer. The loyalty rate for leasing is 71.5%, but only 60.6% for loans4. Now, dealerships like Toyota, Scion, and

Lexus are offering certified leases on used cars. Infiniti is rumored to also be working on a certified lease program, but has not

announced formal plans just yet. Ally Financial recently announced that they will be offering financing on used leases5.

How Used Leasing Impacts Remarketers & Dealers

When someone buys a vehicle, it¡¯s not known when the car comes back into the market as a trade-in. However, in a lease

scenario, the vehicle does come back on the maturity date. With the increase in new leasing, the supply of those late-model used

vehicles will continue to increase in the next few years. As that supply increases, used leasing offers another alternative to remarket

the vehicle. If done right, the used-car leasing portion of the market can expect to see moderate growth. With the amount of

used cars entering back into the market, any improvements that can be made to the used-car supply issue will be celebrated by

consumers and dealers alike.

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How to Grow a Profitable Used Leasing Portfolio

Monthly Lease Payment

Calculation

NEW

$4,000

Rebates

$10,000

MSRP:

$35,000

$31,000

Capitalized

cost after

incentives

60% of MSRP

Retail Price

Highly

subvented

residual after

36 months

Residual

Subvented

finance charge

$52

Depreciation

Depreciation change

$278

New Monthly Lease Payment:

$330

Example A

USED

Markup

and CPO

costs

Wholesale

Price

$3,500

$17,500

Capitalized

cost:

$21,000

Retail Price

Finance

charge

$67

$9,100

Depreciation

$11,900

Residual after

36 months

Residual

Depreciation change

$253

Used Monthly Lease Payment:

$320

September 2016

Example A

At a high level, the following steps determine the

calculation of monthly lease payment amounts. The

majority of the monthly payment is due to the depreciation

charge, but finance charges and mileage charges can

make a difference as well.

1. Start with the retail price of the vehicle. For new

vehicles, rebates are subtracted from MSRP. For

used, adding markup, CPO costs, and other costs to

wholesale price determines the retail selling price of

the vehicle. This is the capitalized cost of the vehicle.

2. Determine the contract residual value of the vehicle

at end of term (assuming 36 months). For new, it¡¯s

common to have subvented residuals which, in some

cases, may be substantially higher than the projected

residual.

3. The difference between the capitalized cost and

the contract residual value is the Depreciation Cost

(assuming no down payment) which, when divided

by the number of months in the term (say 36 months),

gives the depreciation charge per month.

4. Add Finance Charge per month determined using

money factor, which is typically lower for a new lease

due to subvention.

5. Add any additional mileage charges over the

allowed mileage per year.

Where Used Leasing Does Not

Make Sense

Example A represents the same vehicle offered as a new

lease, as well as a used lease option (at 36 months of

age). Based on the comparative financing options, you

can see where the monthly payment calculations come

out to very little difference between new and used. In this

case, the residuals on a new lease are highly subvented,

resulting in a lower depreciation assessment. Demand

would be soft for this vehicle as a used lease option, since

most people would opt to pay just a few dollars more for

the new lease.

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