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Despite the heightened risks, the practice of setting residuals, or
predicting the estimated worth

 of vehicles at the end of the lease term, remains a
cornerstone of leasing, much to the consternation of some top
industry executives.

 “No one can tell you what that car is going to be worth,”
said Bruce Harris, vice president and chief financial officer of VW
Credit Inc., during a session at the recent Auto Finance Summit. If
a company gets it right, “it’s just stupid luck,” he added.

 Miscalculated residual values are what got lessors into hot
water a decade ago, sparking hundreds of millions of dollars in
writedowns and a handful of exits by players sector-wide.

 Residual value- setting has evolved from the once-common
practice of just extrapolating vehicle values based on auction
prices to predicting the competition’s vehicle inventory several
years into the future, as well. 

 “You have to figure out not just what an Audi or a VW will be
worth in three years, but what all the substitution cars are
worth,” Harris said.

 For non-captives, the challenge is even greater, said Mike
Buckingham, president and chief executive of Hyundai Motor Finance
Corp., and another panellist at the Auto Finance Summit. Banks, for
instance, have to set residual values on a much broader range of
vehicle, not just certain nameplates. To that end, leasing has
become a tool used almost exclusively by manufacturers, Harris
said. The reason: For automakers, leasing serves as another channel
to boost sales of the vehicles it manufactures. Hyundai Finance is
a perfect example, having entered the space two years ago for that
precise reason.

 As a relatively new entrant to the sector, Hyundai Finance is
just starting to bring some cars in-house now, Buckingham said. The
company calls lessees 90 days in advance to inform them of
end-of-term procedures and to remind them of mileage caps. Hyundai,
like others, also uses the call to get customers into new
vehicles.
 Though leasing may boost origination volume, financiers
should keep in mind that it is “far riskier than lending,” Harris
said. And his advice for companies considering entry into the
market: “psychiatric treatment,” he joked.

SUBPRIME LENDING

Will auto finance be immune from the mortgage
meltdown?

Riley McDermid

Though nonprime lending continues to weigh on auto executives’
minds, fallout from the mortgage sector is unlikely to cause more
than a ripple. That was the message from panellists during a
nonprime lending session at the Auto Finance Summit in
October.

 Essentially, nonprime auto lending differs significantly from
the traditional subprime mortgage product, panellists said. Vehicle
loans are exponentially smaller than home loans, and their terms
are shorter. Besides, underwriting guidelines did not loosen nearly
as much in the auto sector, they said.

 Still, because of consumers’ credit issues, the face of
nonprime auto lending will change to a degree. For some lenders,
that shift will translate to a move into lower credit score
bands.

 “We’re going to have to go from being a prime player to being
a nonprime player,” said Joe Pendergast, a group vice president at
Chevy Chase Bank. Chevy Chase made an unsuccessful foray into
subprime lending in the 1990s. The bank has since set up a
pass-through programme with a nonprime player, which Pendergast
declined to name.

 Even so, the nonprime partner will avoid certain borrowers,
like first-time buyers, Pendergast said.
 Other lenders, though, seek out borrowers with minimal credit
histories. “We love the thin-files and first-time buyers,” said
Jonathon Levin, president and chief executive of Chicago-based
Turner Acceptance Corp.

 Drive Financial, the auto finance unit of Banco Santander,
takes a similar approach to nonprime lending. “Nothing really
scares us,” said Alex Keechle, the lender’s senior vice president
of originations. “If you anticipate the risk and price for it, you
are ready for anything that comes your way.”

 Still, auto lenders maintain a distinct advantage over their
mortgage counterparts: “When you get right down to it, you are just
more likely to get paid when it comes to dealing with people’s
cars,” Levin said. “As I like to tell investors, people can’t drive
their houses to work. And it is our interest to make sure they get
to work.”

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