NEW YORK — Auto-finance companies are issuing record amounts of bonds backed by leases as used cars retain their value like never before. With the supply of second-hand vehicles now poised to rise, it’s raising concern that risks are building.
Sales of securities backed by car leases have surpassed $6 billion this year after a record $16.4 billion were issued in 2014, data compiled by Bloomberg and Wells Fargo show. As many, from automakers to mutual funds, wager on how much cars will be worth when the leases expire, the size of the market has more than tripled since 2008.
The concern is that the expansion is underpinned by a shortage of used cars that a widely followed forecaster says will begin to reverse this year. That would threaten to depress car values and increase the risk of losses for lessors including Ford, General Motors and Ally Financial should they fall more than estimated.
“It’s going to put pressure on the used-car market, which creates a knock-on effect,” John Mendel, an executive vice president at Honda’s U.S. unit, said. “I don’t think anybody is predicting a crash but I think you could see a correction over the next couple of years.”
After the U.S. recession seven years ago triggered a slump in new-car sales and the federal government’s “Cash for Clunkers” program took vehicles off the road, the supply of used cars plummeted. That boosted the value of previously owned autos, allowing lenders to write leases with higher residual values — industry lingo for how much they projected they could get for the cars after the leases expired.
The lenders could then offer lower monthly payments to customers, stoking more leasing and profiting by selling cars for more than forecast when they’re turned in.
New leases last year exceeded 3.5 million, more than tripling from 2009, according to Cox Enterprises Inc.’s Manheim unit, which provides vehicle-remarketing services. More than 25 percent of all new cars driven off dealer lots in the last three months of 2014 were leased, up from 14.9 percent in 2008, according to Experian’s automotive unit.
The growth came at the same time that debt investors, faced with near-zero interest rates, increasingly turned to riskier or more complex securities to boost yields. That helped auto- finance companies to bundle the leases they wrote into bonds, retaining the exposure to initial losses on the contracts while selling the rest to investors such as mutual funds. Since 2008, the amount of securities backed by auto leases has soared by more than $16 billion to exceed $24 billion, according to the Securities Industry & Financial Markets Association.
So far, used-car prices remain elevated. In February, a closely watched index created by a Manheim unit was 12 percent higher than the average over the decade through 2007 and just 2 percent below the record high reached in 2011.
But the tide is turning.
For 2015 models, TrueCar’s ALG unit is predicting cars will retain 48.9 percent of their values after three years. While still relatively high, it is eight-tenths of a percentage point less than its forecast for last year’s models.
After used-vehicle supply fell 25 percent between 2007 and 2013 to 9.3 million, the lowest in at least 15 years, it ticked up to 9.4 million last year, ALG data show. Over each of the next three years, its forecasting supply will rise by a range of 800,000 to 1 million.
History shows how losses on leasing can pile up. Ford and GM reported more than $4 billion of write-downs on vehicle leases in the second quarter of 2008 alone as the U.S. economy was mired in the worst recession since the Great Depression.
Industry-wide losses in 2000 and 2001 totaled more than $10 billion, according to data cited in a research paper by Lamar Pierce, a professor of strategy at Washington University in St. Louis.
“There’s this long history in car leasing, just like home mortgages, where there’s some sort of disaster and everybody is like, ‘This won’t ever happen again.’ But then we go through the cycle again,” Pierce said.
Slumping used-car prices may weaken the value of securities backed by leases even without being big enough to actually cause bondholder losses, according to John McElravey, an analyst for Wells Fargo.
Automakers that issue the debt retain the risk on initial losses in those securities, cushioning investors. Bondholders also rely on ALG’s forecasts instead of the automakers’ to determine the size of the buffers. Even if all of the cars were turned in and sold for prices 30 percent less than predicted, the top-rated portions would get repaid, according to Fitch Ratings.
