A changed landscape in Canadian auto finance

The 2008 financial crisis sharply reshaped Canadian auto finance. Automaker captive finance companies that once dominated the auto loan and lease market lost nearly half their share within four years. Captives have since regained some share, but their hold is still significantly lower than it was in 2008.

Market share numbers from J.D. Power tell the story:

• In 2008, captives had 82 per cent of the auto loan and lease market, leaving 14 per cent to banks and four per cent to finance companies and credit unions.

• Just four years later, captives’ share shrunk to 45 per cent and banks’ rose to 50.

• Through the middle of June 2017, the captives have regained some share, getting back to 54 per cent, but banks remained at a strong 42 per cent — three times their share pre-crisis.

Captives have gradually bounced back from the financial crisis because of leasing’s comeback, but experts agree that banks’ auto lending prowess is here to stay. Rising lease penetration and evolving auto finance market solutions (see related story on Page 22) suggest that there is room for banks and captives alike. But the market is unlikely to return to a 14/82 mix.

In 2008, many captives significantly decreased their roles. Banks were ready to take on more business, said Grant Simons, vice-president and head of Royal Bank of Canada Automotive Finance.

“Banks were happy to step into that void and find ways of funding the end consumer or the commercial enterprise,” he said. “There was a natural synergy there, in that banks had capital, and they largely knew how to do [auto] lending.”

Still, it was a change for the industry, especially dealers.

Hugh Brennan, president of Brennan’s Dixie Chrysler in Brampton, Ont., leased 65 to 70 per cent of the dealership’s vehicles 10 years ago, so he said he had never worked with a bank other than for a short stint. But his relationship with the banks “morphed into a similarity I wasn’t expecting,” he said.

By law, banks are prohibited from leasing, and a large percentage of captives’ 82 per cent share in 2008 would have been leasing, said Kevin Teslyk, senior vice president of automotive finance for Scotiabank.

 “Leasing ultimately dried up during the financial crisis. The captives were either not there or less able to offer it to the same extent that they had,” he said. 

The subsequent rebound of captive financing reflects an increase in leasing, Teslyk adds:

“We’re at that part of the cycle, and we’re expecting to see more of that.”

There has never been anything wrong with leasing, but bad leases exacerbated the problem during the recession, said Alan Bird of SCI Marketview, a leasing and dealership technology company.

“Leasing has been a standalone good product,” he said. “What has happened with leasing over the last several decades is that people or organizations really abused the residual in order to try to help support moving product.”

Brennan now only leases five per cent of his sales, though he said he might begin to increase his store’s lease penetration.

“I think we were leasing too many cars back in the day, but it became the easiest way to sell a car,” he said. But it was troublesome. Customers often returned vehicles over their kilometre limit, meaning that dealerships had to handle penalties, as well as wear-and-tear fees.

He sees 25-30 per cent as a healthy lease penetration for the customer, the dealership and a lease company.

Through the middle of June, the lease penetration in Canada was 26.8 per cent, according to J.D. Power. It has grown  steadily over the past few years. In 2014, it was 23.1 per cent.

“That’s a very significant increase from where we were post-crisis when [leasing effectively] went away,” said Teslyk. “It has already helped moderate the growth and lengthening of loan terms further.”

Most lease transactions are in Toronto, Vancouver and Montreal, according to J.D. Power.

Of the captives, Toyota Credit Canada does the most leasing in Canada, making up 62 per cent of its portfolio. Honda Finance’s business is 48 per cent lease. Hyundai has 14 per cent. FCA has two per cent. GM Financial has 25 per cent.

Aside from providing an opening for banks, the decline of leasing helped contribute to longer loan terms. Even though many captives stopped leasing, consumers still wanted a low monthly payment.

“So with the departure and shrinking of the lease market came the emergence of ... the longer amortization loan,” stretching the loan term 72, 84 or 96 months, Teslyk said. Pre-crisis, the average loan term was in the 60s, he said.

Now Canada’s average loan term has stretched to 75 months, said Mike Buckingham, senior director of the automotive finance practice at J.D. Power.

“Banks are competing for that business and trying to aid afford-ability, so they stretch the loan term,” he said.

Loans of 84 and 96 months are also common, driven by market competition with incentive programs. Those incentives sometimes prompt consumers who don’t necessarily need a long-term loan to take one anyway.

“They could support a 48- or 60-month car loan, but the programs are on certain terms, categories, vehicles, that cause people that have greater financial means ... to be involved in those longer amortization loans,” Teslyk said.

“Cash buyers are as much attracted to that segment as are people who need a slightly longer term to be more affordable or to act as a proxy for a lease-type solution,” he said.

Loan terms probably won’t extend out much further as lease penetration revives, said Simons of RBC. The longest terms have been in the 84-96 month range for the last few years, he said.