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Residual Values and Risk

As we all look ahead a few years down the road to 2020 there are increasing sound bites that leasing is increasing in Canada, and the risk of residual values.

Here is the deal...

If you have been around leasing for a while (decades) you surely remember there is always a lively debate on residual values, and there will always be a debate.

Leasing in Canada is a great marketing tool. Increasingly CMS (Citizen Main Street) is not interested in owning a vehicle and enduring the aggravations of vehicle ownership/maintenance. The warranty runs out and the wear and tear cycle of any vehicle initiates which is of no interest to CMS.

We could keep on going, and going, and going some more.

But...lets get to residual values.

To lease a vehicle you have to set a residual value at the end of the lease. The residual value is usually a percentage of the retail price (MSRP). Obvious there is a ton of crystal balling that goes on to set residual values. There are a slew of algorithms whirring away to set values, alleviate risk, and also allocate risk to various stakeholders.

Even with all the tools, algorithms, lets be candid the residual risk is a scary thing for a lot of folks.

Canada is a unique and interesting case.

Ten years ago manufacturers were content to assume a residual risk on 50% of the vehicles sold in Canada. At one point manufacturers conveniently got out of leasing and the cloud of residual risk. "If this manufacturer is on unstable financial grounds, and its captive finance company is under a cloud of residual risk from its leasing its really scary".

Especially when leasing was at 50% suddenly the bottom falls out of the leasing model..."Lets offer longer term finance to have a monthly comparable to a lease, and move what was a residual risk to CMS".

"We don't have to crack our heads, run a bunch of algorithms, torture spreadsheets to arrive at residual values and avert finger pointing".

The auto business thrives on a 36 month cycle, the reason leases were usually 36 months. While the strange numbered leases of 39 months, 42 months is to have a units returned at a more opportune time.

In the auto business you can keep a lease cycle going and going and going....reflect on this for a moment.

Converting lease customers to a longer term finance is very easy the outset. "You had a 36 month lease we can put you in a 48 month finance for the same monthly"...."Think about it now you will actually own the vehicle with only your name and the ownership, and you can drive it as much as you want".

The customer returns or is pulled ahead at 36 months, the warranty ran out, and wants a new vehicle "Sadly you owe more than its worth, don't worry about it, we will go to 60 months for the same monthly, but now we suggest you buy gap insurance too".

In Canada the manufacturers that continued to lease (step up to a residual value risk) have grown their business in the past 10 years. The manufacturers that transferred the risk to CMS with extended finance terms are under increasing pressure to accommodate CMS in rolling over deficiencies.

Now you hear sound bites of CPO programs, 60 months leases, residual values plummeting, and leasing is increasing slightly in Canada.

The reality...everyone is stuck in these long finance terms, pulling ahead, rolling over deficiencies.

The individual in the back of the room that did not abandon leasing; has understood that its a powerful tool. Do you think that this individual for a moment will share the leasing knowledge base they acquired in the past 10 years? We don't think so.

Is there a possibility that this individual will support and encourage the current "leasing sound bites"...what do you think?

Which is a bigger risk? Residual values or pulling ahead, rolling over deficiencies on finance terms that are close to the limit...what do you think?