Automotive finance hot topics: Lease residuals

Expected impact: Downward pressure on lease residual values

​With 12 million vehicles expected to reach their end of a lease over the next three years³—and with more lessees returning vehicles in favor of new models—the majority of off-lease vehicles will require a dealer or third party to recondition and remarket the vehicle.

The expected impact? An increase in the used car supply, creating downward pressure on lease residual values—i.e., the expected sales price of an off-lease vehicle at the end of the lease. In turn, vehicles are retaining less market value year over year, and the trend is expected to continue.⁴

Complexity ahead for the automotive finance industry

​Despite record auto sales in seven of the last eight years,⁵ new auto sales are expected to drop by as much as 5 percent in 2018, with a possible drop from 17 million in 2017 to 15 million by 2020.⁶ The expected drop includes a decrease in lease originations for the first time since 2012. Forecasting has been complicated by recent extreme weather events—such as Hurricane Harvey and Hurricane Irma, which damaged hundreds of thousands of vehicles,⁷ leaving lingering questions about used vehicle supply, quality, consumer trust, and pricing.

A way forward for the auto finance industry

To address the unsettled nature of the market and manage residual risk more effectively, automotive finance companies have some clear options—starting with a proactive approach that spans many segments of the business, possibly extending to include original equipment manufacturers.

What does a well-coordinated residual risk approach look like? Consider this example. Model redesigns (engineering), large sales incentives programs, or large production schedules could drive a decrease in residual market values. With this advanced knowledge, finance companies could adjust their pricing and leverage their dealership relationships (both guided by advanced predictive models) to minimize off-lease returns. They also could work with vehicle remarketing team members to maximize the auction price of returned vehicles.

Putting a strategy in gear

How do you activate a proactive residual risk capability? Deloitte has insights that can help—starting with top areas to focus on when seeking to reduce residual risk. Finance companies operating in today's evolving environment have many leading techniques they can use to measure and react to market conditions:

• Enhanced model risk management practices
• Advanced data analytics models
• Dealership incentive programs
• Strategic business planning

Optimally, auto finance companies should focus their energies on improved modeling for better predictions, earlier warning of when market conditions and predictions diverge, and developing a plan to recognize the sale price of returns.

Explore additional Deloitte insights that can help you determine where to start and how to navigate the residual challenges ahead.

Endnotes

¹ Big Wheels Auto Finance Data 2017, Auto Finance News, 2017.
² Big Wheels Auto Finance Data 2017, Auto Finance News, 2017.
³ "U.S. used-car glut is a dealer's dream, automakers' nightmare," Reuters, March 12, 2017.
⁴ Used Vehicle Market Report Q2 2017, Edmunds.com, November 9, 2017.
⁵ Mike Colias and Adrienne Roberts, "Auto Sales Growth Stalls—Annual drop of 1.8% is first in eight years, but pickups and SUVs bolster U.S. results," The Wall Street Journal, January 4, 2018.
⁶ "U.S. Car Sales Will Slip A Bit In 2018, But Things Could Get Grim After That," Forbes, December 28, 2017.
⁷ Steven Wilmot, "Harvey's Destroyed Cars Give Auto Industry Hope" The Wall Street Journal, September 6, 2017.