Used-car shortage strains dealers, boosts lenders

An industrywide shortage of newer, more desirable used cars is a hardship for dealers looking for used inventory and for customers looking for a bargain, but it's a windfall for auto lenders, which have stopped losing millions of dollars on depreciated off-lease cars and trucks.

For example, the volume of off-lease vehicles coming back to Ford Motor Credit Co. will fall in 2011, echoing a drop in retail volume in 2008 and 2009.

Ford Credit expects only around 230,000 lease terminations in 2011, down from 400,000 this year, says CFO K.R. Kent. That's a decline of 43 percent.

For dealerships, a shortage of off-lease cars, trade-ins and former rental cars has retailers scrambling to buy newer used vehicles. As a result, those vehicles are more expensive. And dealerships are buying more off-lease units instead of sending them back to the lender to be auctioned off.

“As auction values have improved, we have seen lease return rates decline,” Kent said this month at a conference sponsored by Bank of America Merrill Lynch in New York.

Fewer returns
In the third quarter, 61 percent of Ford Credit lease terminations came back to Ford Credit, down from 70 percent a year ago. Ford Credit's average 3-year-old off-lease vehicle fetched $16,235 at auction in the third quarter, up from $15,615 a year earlier.

The shortage of off-lease units is helping to drive up used-car prices for the whole industry.

Auction firm Adesa Inc. reported that the average wholesale used vehicle was $9,768 in October, up 3.2 percent from a year earlier. Tom Kontos, Adesa executive vice president, said auction prices may vary seasonally, but overall, tight supplies of used vehicles should continue to support used-vehicle prices for the rest of 2010 and into 2011.

Better results
That's generating much better auction results on off-lease units for auto lenders such as Ford Credit. Instead of more or less automatically losing money on lease returns, in some cases auto lenders can actually come out ahead on off-lease cars and trucks that retained their value better than expected.

Adam Berger, vice president of sales for Milwaukee-based Doering Leasing Co., told a recent finance summit that his company's corporate lease clients are recovering up to $5,000 each on off-lease cars because the cars have appreciated so much in value. His clients include big corporations that lease fleets of cars for the use of their employees.

Most leases are closed-ended. That means the lender bears the risk that the car may be worth less than the residual value that is set at the beginning of the lease. Of course, the lender also can reap the reward if the actual value of the off-lease unit turns out to be greater than expected. That rarely happened before this year, but the rise in used-car values has made it happen for several auto lenders.

In contrast, Doering clients have so-called open-ended leases. In their case, the fleet customer bears the residual risk — and reaps the reward, Berger said.

At Ford Credit, improved residual values in the third quarter accounted for an improvement in pretax earnings of about $100 million, the company said last week.