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Used Prices Boost Leasing

leaseU.S. auto leasing companies are poised to benefit from another generally healthy used vehicle market in 2013, extending some gains realized as a result of robust residual values for leased cars and trucks seen over the last three years.

Fitch Ratings expects lessors to continue to report meaningful gains on sales and to manage residual risk, even as the secondary market begins to normalize and used vehicle prices continue to soften from historical highs reached in 2011.

After 2008-2009, when U.S. new vehicle demand collapsed during the financial crisis, used car inventories tightened considerably and prices rose. This provided opportunities for lessors to book gains on resale values as fleet depreciation rates fell.

For U.S. commercial auto fleet lessors, residual risk remains mitigated by the fact that portfolios are predominantly open-end leases, which subjects the lessee to any residual value loss or gain. However, lessors may be exposed to the lessee for the repayment of any residual losses in times of stress, which effectively converts residual risk to credit risk. To mitigate this risk, commercial fleet lessors have targeted large corporations with strong credit quality or sufficiently set reserves to help limit the probability of losses.

In the case of both truck leasing and daily car rentals, depreciation rates have fallen since 2009 as a result of increased used vehicle prices, better residual values, and longer holding periods. As supply pressures begin to build in the used vehicle market, depreciation rates are likely to return to more normal levels in 2014 and 2015. Vehicle gains are expected to moderate from recent peaks, but are expected to remain strong in 2013 as off-lease vehicle inventories and prices remain in check and as truck buyers continue to avoid the more expensive post-2010 engines.

Manheim Consulting's Used Vehicle Value Index increased modestly in the fourth quarter of 2012, due in part to supply disruptions related to Hurricane Sandy. However, the index fell by 1 percent on an annualized basis last year, as used vehicle prices softened modestly from their 2011 peak. Seasonal trends in the Manheim index last year closely tracked broader U.S. economic indicators, with notable weakness in the second and third quarters, and a rebound late in the year.

Fitch's Auto Lease Residual Value Loss Index largely mirrored the Manheim index in 2012, as residuals declined somewhat from 2011 highs. Still, the index remained strong through November 2012, showing gains of 10.29 percent for returned residuals. Fitch expects continued normalization in auto lease ABS residual realizations to occur through 2013 as rising new vehicle sales and retail lease volumes begin to increase used vehicle inventories and drive prices down in the secondary market.

Fitch expects annualized North American car and light truck sales to grow by 4 percent to approximately 15 million vehicles in 2013. This level falls well short of the peak sales period between 1999 and 2006, when average annual sales topped 17 million vehicles. Still, as supply pressure builds and inventories of late-model used vehicles begin to increase over the next year, some additional easing in used car prices is likely.

The expected pick up in new vehicle production, together with the impact of higher retail lease penetration, which began to emerge in 2010, should begin to put significant pressure on inventories as soon as the latter half of 2013. Therefore, Fitch expects a more typical supply-demand balance to develop moving into 2014, likely limiting the ability of lessors to realize continuing benefits beyond this year.