In early 2012, Directions Credit Union ($662.6M, Sylvania, OH) was looking for ways to increase its loan portfolio. It had offered auto leasing through Credit Union Leasing of America (CULA) since 2002, but the credit union could do more to expand its business into the Northwest Ohio market.
“CULA is strategic about partners. Unlike some other programs, it wants just one credit union to manage a program in a certain market,” the credit union’s senior vice president of lending, Tim Crosby, says.
In the years since, Directions has originated just north of 3,300 leases corresponding to $104 million.
The Ins And Outs Of Leasing
Once entering into a partnership with CULA, Directions had to ensure all staff members understood this new component of the auto loan portfolio.
CU QUICK FACTS
Directions credit union
Data as of 03.31.16
HQ: Sylvania, OH
12-MO SHARE GROWTH: 5.94%
12-MO LOAN GROWTH: 8.50%
“Our ongoing relationship with CULA has been excellent,” Crosby says. “They continue to provide the level of expertise which is needed with a leasing program, especially in terms of portfolio management and risk analysis.”
CULA provided on-site training at the credit union and helped Directions establish processes and procedures. CULA also works closely with the credit union to bring dealers into the program, providing advice on how to structure the program in terms of pricing, and helping the credit union establish best practices for marketing and developing the program and dealer relations.
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On the front end, auto leasing mimics an indirect lending operation wherein partner dealerships initiate leases.
Directions accepts leases from between 50 and 60 dealerships with which it has an indirect lending relationship, although most of its lease business comes from just 25 of those dealers. It also sticks with brand-name manufacturers rather than partnering with independent dealers.
When a member or potential member at the dealership inquiries about leasing options for a specific automobile, the salesperson pulls a guide that shows the terms and payments financial institutions will offer based on the make and model of the car. This occurs before the buyer has even submitted an application.
“In an indirect market, the deal is typically bought at the finance desk,” says Nathan Andrews, Directions’ consumer lending manager. “Leasing is a bit different in that before a member even gets to financing, the dealership has an idea of where that lease is going.”
And, according to Andrews, the residual plays a large role in determining where the dealer finances each vehicle.
The Importance Of The Residual
The residual value is a key component of a lease. The residual value is how much a vehicle is worth at the end of a lease. It’s a pre-determined value established at lease inception and has a major impact on a lease’s term and payment; therefore, a properly set value is the difference between attractive or unattractive payments and profitable or unprofitable leases. However, setting residual values too high can have a negative impact when the term of the lease is over.
Leasing companies set residual values differently for each make and model of car. The process of setting residual values is complex, and because of the overall importance of establishing proper residual values — not only from the standpoint of originating new leases, but also its impact on mitigating losses when disposing of a vehicle at the end of lease — the process is best left to experts.
“That’s another reason we value our relationship with CULA,” Crosby says. “They set the residual values for us.”
Leasing By The Numbers
$30,000: The sticker price of an automobile.
$10,000: The residual price — the amount for which a borrow can purchase a vehicle at the end of the lease — set by Company A.
$15,000: The residual price set by Company B.
$20,000: The balance — the cost of the vehicle minus the residual — on which Company A bases its monthly payment.
$15,000: The balance on which Company B bases its monthly payment.
At the end of the lease term, the lessee can purchase the vehicle outright and refinance into a standard auto loan, trade in the unit for another, or turn in the vehicle to the leasing company. For turn-ins, the member will need to pay a disposition fee and can be billed for any excessive wear and tear, mileage overages, or any other fees and taxes stated in the lease agreement.
In the case that the vehicle is turned-in and the sale proceeds of the unit does not pay in full the residual value of the unit, the lessor — in Directions’ case CULA — will access funds from the credit union’s hold-back account to make the lease whole.
You can originate a lot of leases by setting your residual value high because that is going to drive a lower payment. But if you are setting those too high in relation to the vehicle, you are going to have a problem.
“You can originate a lot of leases by setting your residual value high because that is going to drive a lower payment,” Crosby says. “But if you are setting those too high in relation to the vehicle, you are going to have a problem.”
The Beginning And The End
Directions has two business development officers who educate and network with dealers to strengthen the credit union’s leasing network and one internal underwriter who specializes in leases.
According to Crosby, Directions originated $11 million leases in 2014, $23 million in 2015, and $21 million year-to-date in 2016.
And, according to Crosby, the credit quality has been outstanding.
The credit mix for auto leases includes 70% in A+ paper, 20% in A, and 8% in B. The remaining 2% is in C and lower. All told, the credit union has recorded 106 losses for $490,000. In 2015, lease delinquency was 0.06%, compared to 0.17% and 0.15% delinquency in its indirect and direct auto portfolios respectively.
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“Members identify with their car differently with a lease than when they buy it,” Crosby says. “They know it’s short-term. They have to take care of it better, make payments on time, and keep up maintenance.”
Financial institutions that deal in leases must identify differently with those relationships, too. That’s because, at some point, the terms come to an end. And then what?
In 2018, 4 million vehicles are expected to come off lease, compared to 2.5 million in 2015, according to a Cox Automotive report. This could create significant losses in income for both dealers and lenders. However, Directions feels that the conservative nature with which CULA sets residuals, as well as its proven end of lease process, will do a lot to mitigate the risk.
In addition, one of the requirements of the CULA lease program is that a credit union maintain a hold-back (reserve) account for all leases. When a member takes out a lease, they pay an acquisition fee of $780. Directions puts $165 of that fee into a hold-back account. When the lessee turns in the vehicle, if sale proceeds of the unit does not pay in full the residual value of the unit, CULA will use the funds from the hold-back account to make the lease whole.
For Directions, it is better for the member to not turn-in the loan. However, the credit union coaches them on the advantages of all their options when lease terms near their close, including trading in the vehicle or keeping the vehicle, buying out the lease, and entering into a conventional auto loan.
The credit union reaches out to members six months before a lease expires to discuss these options, while CULA does the same four months out. These communications are meant to complement each other and make the overall lease end process run as smoothly as possible.
But since the leasing process is more involved and complicated than a traditional direct or indirect auto lending program, Crosby advises credit unions to prepare for the turn in process as early as possible.
“We have to understand that originating a lease is only half of the battle,” he says. “We have to understand, recognize, and prepare for that time, 36 months down the road, when that lease turns in.”