Tom Webb's Blog (Manheim Consulting)

End-of-Term Residuals: From Big Losses to Big Gains

The following statistics are from the Ford Credit Auto Lease Trust 2011-B prospectus filed with the SEC on October, 26, 2011.  These trends are reflective of the leasing industry as a whole, although Ford certainly had some swings which were greater in magnitude than the industry as a whole.  (The data reflects all Ford Credit leases written since 2002.)

End-of-term residuals: from big losses to big gains.  In 2008, Ford Credit experienced an average loss of $3,390 per end-of-term vehicle returned and sold.  In the first six months of this year, that flipped to its mirrored image – a gain of $3,445 per unit.

And, of course, the percentage of end-of-term units that were being returned was highest when the losses were the worst.  Specifically:

	Return Rate
2007	77.4%
2008	82.2%
2009	75.7%
2010	66.0%
6 mos. 2011	57.5%

The change in the return rate meant that Ford Credit sold 7% fewer end-of-term units in 2010 compared to 2008, even though actual terminations rose by 15%.

Losses were a result of the market, not subvention.  The spread between contract residuals and ALG projected residuals remained fairly constant throughout this period.  It was the ALG projected residuals that proved overly optimistic in 2008 and overly pessimistic in 2011.

Outlook: In 2012 and 2013 we expect that the average dollar gains at end-of-term will be smaller (as contract and ALG residuals move up), but we expect return rates will continue to fall.   

 

Narrowing Gross Margins: Should We Worry?

Now that Penske has reported we can update last week’s posting on the sales-weighted gain in used vehicle retail sales achieved by the seven publicly-traded dealership groups.  It was 4%, not the 3% originally noted, since Penske had a better than expected gain.

Nine consecutive quarterly gains is certainly good news, but some are troubled by the erosion in gross margins.  Depicted here is the trend in the sales-weighted retail gross margin for these groups.  A note of caution in interpreting - since this is a sales-weighted average, a shift in sales volume between the groups will distort the true trend since each company has historically different margins that are dependent on sales mix, geographic mix, and even accounting.

Nevertheless, there is no doubt that industry-wide across all franchised dealers that average retail used vehicle gross margins in the third quarter of 2011 were less than in the second quarter and less than a year-ago.  The question is: how worrisome is this trend?

That depends on your theory as to the cause.  My belief is that most of the margin reduction is the result of rational business decisions – not desperation moves to move metal.

For example, there is no denying that more dealers are willing to retail out at a wholesale price rather than actually wholesale the unit.  The rationale is logical – earn doc fees, generate F&I income, allow salespeople at least some commission, create potential service revenue, and possibly garner a customer for life.  Likewise, more dealers are utilizing auction inventory as their own virtual inventory.  If you have already pre-sold a unit, a lower margin is acceptable since you have eliminated both holding costs and risk.

There is one major downside to this trend.  And dealers should be careful.  As the saying goes “gross is a state of mind”, thus, once you start doing low gross deals, you run the risk of all your deals becoming narrower.