MARCH 2006
From the Principals
Ronald S. Loshin Randall R. McCathren	Welcome to the new electronic Auto Financing Update. We hope that our new format will be more convenient for our readers and allow us to be more timely in our reporting and analysis of auto industry events and trends that affect financing and leasing.
The rebound of the used car market in 2005, up 4.6% according to the Manheim Used Car Index and 5.0% according to the Used Car Consumer Price Index, has been a boon to both lenders and lessors. Included in this addition are two articles analyzing used car market trends in detail: ALG Forecasts 1.5% Increase for 2006 Used Car Prices   RVI Bullish on Used Car Market Although the two industry experts, Rene Abdalah of RVI Insurance and Raj Sundaram of ALG, agree on many observations and predictions, their views diverge on the expected performance of the used car market in 2006. RVI predicts a 4.2% increase in used car wholesale values while ALG expects less than half as much of an increase (1.5%). The difference is based primarily on their views of new vehicle sales. ALG is forecasting 17.4 million units based on manufacturer plans, and thus assumes that new vehicle incentives will increase as necessary to achieve that sales volume. RVI is more bearish on new vehicle sales, forecasting only 16.8 million, which is closer to the consensus of industry analysts. Only time will tell which view is closer to reality. We are also including a critique of the analysis of vehicle leasing just published by Tom Webb in the Manheim 2006 Used Car Market Report. Please give us your feedback on our comments to the issues he raises. We’ll be posting the responses of our readers on the BLC website for all to see! Ronald Loshin Randall McCathren

Following a strong (although volatile) recovery in 2005, Automotive Lease Guide projects a further 1.5% overall gain for used car prices in 2006. Citing R. L. Polk registration data (which tends to underestimate the percentage of retail leases in some states), ALG projects that 2006 will experience an increase in lease penetration of 1.4 percentage points from 15.4% to 16.8%.

ALG projects 12.4% increase in lease volume. Based on ALG’s assumptions that vehicle sales will increase to 17.4 million units (1) and fleet sales will decline to 16.0% of new vehicle sales, new retail leases are predicted by ALG to increase 271,000 (about $8 billion) from 2.19 million to 2.45 million vehicles. “We think there is a growth opportunity in leasing for new entrants as well as established lessors due to higher interest costs, less loan rate subvention and more attractive lease payments due to stabilizing residual values,” explains Raj Sundaram, President of ALG. “We expect lease penetration to grow 2-4 ppts (2) over the next few years and may approach 20%.

ALG carefully tracks fleet penetration rates. One key in picking the strongest brands in terms of value retention is the percentage of fleet sales. Exhibit 1 shows that overall fleet penetration has a fairly narrow range in recent years from a low of 14.6% in 1999 to a high of 16.5% in 2004. However, four of the highest selling domestic nameplates (Dodge, Chevrolet, Pontiac and Ford) exceeded 35% for the first 9 months of 2005, more than double the industry rate. (See Exhibit 2.) The only import on the top ten list was Mitsubishi, which actually reduced its fleet sales 12 percentage points from 2004.

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(1) While many analysts are projecting between 16.7 and 17.0 million new units in 2006, ALG’s forecast is supply-based and reflects the outlook and plans that have been shared by the manufacturers. Thus, ALG expects manufacturers to use incentives as needed to reach the 17.4 million sales level.
(2) Percentage points of retail sales.
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RVI Bullish on Used Car Market

RVI Group (RVI) is predicting a 4.2% increase in the Used Car Consumer Price Index (CPI) for 2006, building on the strong showing of the 5.0% increase in 2005. “We believe that used vehicle prices will continue to improve in 2006 primarily due to low levels of used car supply,” notes Rene Abdalah of RVI Analytical Services. “Following 24 consecutive months of year-over-year (1) declines in used vehicle supply (as measured by RVI’s Used Stock Index), we expect the first 6 months of the year continue to behave just as well for the industry. For 2006, on average, we expect used car prices to increase by 4.2% on a year-over-year basis.”

RVI’s Used Stock Index is inversely correlated with changes in used car prices. RVI Analytical Services developed its own “Used Vehicle Stock Index” in an attempt to capture changes in used vehicle supply relative to demand in a specific segment. By comparing current and expected future sales by segment to historical sales of that segment, RVI can get a reliable indication of which used vehicles will be in short vs. excess supply relative to demand, since used car demand by segment tracks new car demand closely.

The index represents the ratio between historical sales and recent sales (as a proxy for current demand for that segment) in each segment. Thus, if current demand exceeds historical sales, the index for that segment will be less than “1” and prices will be “strong” by historical standards.

“After experimenting with a number of measures of supply and demand that we thought might be good predictors of future used car prices, we derived the RVI Used Vehicle Stock Index,” notes Mr. Abdalah. Exhibit 7 shows the strong correlation we have found. The relationship between our Used Vehicle Stock Index and Used Vehicle Prices is quite remarkable. When our Used Vehicle Stock Index increases, Used Vehicle Prices decrease; which intuitively makes sense, i.e. when supply goes up, prices go down.

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(1) Because of seasonal variations, the most accurate way to track changes in the used car market is to make comparisons to the same month of the prior year, i.e., “year-over-year,” rather than comparing to the prior month.

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What’s the Verdict on Subvented Leasing? Guilty as Charged?

The Manheim 2006 Used Car Report is one of the essential references that industry professionals and analysts rely upon for definitive data and analysis on the automotive industry. It contains information of the used car market and the four automotive activities that most directly affect auction volumes and used car values:

		Leasing
		Rental
		Fleet
		Repossessions

Tom Webb, Chief Economist for Manheim, has forgotten more about the used car market than most of us will ever know! However, this year, AFU takes exception with some of Tom’s critique of leasing in the 2006 Used Car Report. In particular, we call to your attention the following points:

#1. 2006 Used Car Report: “Use of overly aggressive lease subvention to simply ‘push metal’ often forced the lessor to offset the artificially low monthly payments with unrealistic mileage limits, large mileage penalties, or excessive early termination fees.” [p. 17]

AFU: We don’t know of ANY major lessor that did those things. Captives and banks may have enforced wear and tear more carefully than in past years, but virtually all major lessors use an actuarial early termination formula and we are unaware of any higher, let alone excessive early termination fees. Thus, while the early termination deficiency may be greater because of lower used car values, there are no “excessive early termination fees”
With respect to excess mileage, more than 50% of consumers have chosen mileage limits of 12,000/yr or less for 10 years. This is not a recent change from the standard 15,000 miles per year.

It is true that some manufacturers have advertised especially low annual mileage such as 10,000 miles/year, to gain lower lease payments. Lessees who drive substantially above the lease allowance do then face large excess mileage charges at lease end that may not have been fully weighed at lease inception. However, for many consumers, a 12,000 or 15,000 annual mileage allowance exceeds their expected usage so having flexibility in the mileage allowance is beneficial to consumers. While dealers can alert consumers to the end-of-term charges, ultimately it’s the responsibility of the consumer to choose a realistic mileage allowance. Many people forget that the protection against excess depreciation is independent of any excess miles they may drive and that their trade-in value would also be less if they owned the higher mileage vehicle.

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