General Motors Financial rolled out its North American vehicle lease program during the second half of 2014 and became the exclusive provider for the parent automaker — assuming captive finance company status — early last year. As a result of those moves, GM Financial determined that leases now make up the largest portion of its earning assets composition, sitting at 38 percent and 9 percent higher than its retail installment contract segment.

So is GM leveraging its captive too much to move new metal via leases? GM Financial chief financial officer Chris Choate addressed that point and more about the OEM’s leasing activity during a special presentation last week.

“I think, and I believe GM would tell you, that leasing has probably gotten to be a higher percentage of their overall sales mix than they would like to see sustained over time. It tends to be a slightly more expensive product for the manufacturer to support in the market,” Choate said in response to the last question posed by Wall Street watchers during a presentation titled “Behind the Charts.”

Choate quickly continued by saying, “Now that comment relates to, that’s a very GM specific comment. Certainly luxury makers are always going to have very high penetration of leasing.”

Experian Automotive revealed through a study released during the National Automobile Dealers Association Convention & Expo back in April that leasing as a financing option for new vehicles has grown 76 percent since the company began publicly tracking the data in 2008.

Additionally, the study determined the upward trend of leasing has resulted in a rising surplus of vehicles coming off lease. In fact, according to the analysis, more than 1.8 million vehicles will come off lease by the end of 2016, looking at projections for April through December.

“With such a large volume of vehicles coming back into the market, consumers, dealers and lenders will want to better understand the options available to them so they are able to take action,” said Melinda Zabritski, senior director of automotive finance for Experian.

Choate emphasized that GM Financial and the parent automaker have plans in place not only to handle off-lease volume but also establish residual values that do not place undue risk on the finance company.

“GM’s actions to predict residual values include, and this has been much discussed over the last several months and quarters, the managing of fleet sales, actively managing new vehicle inventory and maintaining disciplined incentive spending. All of those have a downstream impact on residual values that GMF has to wrestle with as vehicles come off-lease,” Choate said during his prepared presentation.

“GMF has developed a robust end-of-term remarketing process,” he continued, referencing endeavors such as its private label online wholesale marketplace at GMFDealerSource.com. “It’s designed to support the GM dealer base while also maximizing resale values. The more vehicles that we can dispose higher up the food chain to GM dealers either at a local, regional or even national level, keeps those vehicles out of the wholesale auction markets where they will bring less value and, therefore, have a detrimental effect on residual value.”

Choate also touched on the relationship between the captive and the OEM regarding residual values.

“Almost for all leases we do receive some type of lease residual enhancement where GM increases the contracted residual value above the ALG value at origination,” he said. “This subvention payment is based on the difference between those two values.

“ALG, as many of you probably know, is a recognized industry leader in setting residual values which incorporate macro, industry and brand factors. And again that residual enhancement payment results in lower lease depreciation over the life of the loan,” Choate went on to say.

The information GM Financial receives from ALG is a crucial part of its leasing activity, according to Choate, who added that residual values can be adjusted depending on how the wholesale market behaves and how many leases are written.

Industry wide, Experian said franchised dealers finalized 31.11 percent of all new-vehicle transactions during the first quarter as leases.

“We feel very confident at this point that the residual experts are properly bringing into account the supply and the used vehicle values and the gas prices and all the other things that will have a downward impact on residuals over the next three years or so,” Choate said. “So we don’t feel like we've created any extreme amount of exposure for the business. Certainly it’s very cyclical and it’s over time residuals have problems and there’s usually some impairments taken but at this point we don’t really see that that's going to occur over the near-term.

“We can moderate our depreciation rate to slow the depreciation on vehicles that are performing — that are called out by ALG as performing better in the wholesale markets — which is something we're seeing this calendar year relative to trucks and SUVs, for example,” he continued. “We have moderated our depreciation rates a bit on those in order to, again, the goal is to have things kind of come down to what they are really going to be worth at the end of the lease term.”

View of floor plan business

An investment analyst wondered about how GM Financial’s floor-planning business, especially in light of the possibility of an economic downturn and how that portfolio segment helps maintain the relationship between the automaker and the franchised dealer community.

GM Financial indicated that its wholesale dealer penetration level has been on an upward track, sitting at 6.3 percent at the end of the first quarter of 2013 and rising to 10.1 percent a year later. After the first quarter of this year, the penetration level came in at 13.5 percent.

Without mentioning the company by name, GM Financial is competing for floor-plan business that many GM dealers already have with Ally Financial.

“The returns in this business are abnormally low right now because of pricing competition really from everyone. We obviously are dealing with a large legacy provider of floorplan in this product channel, as well,” Choate said.

“We are actively looking to grow the business. We are attempting to stay as price disciplined as possible so that we stay right side up and generate profits from the business. We are OK with where we are now as far as having scale and size and ability to capitalize if and when the next downturn comes,” he continued.

Choate added that he agreed with the inquiry GM Financial needs to absorb the demand if another institution opts to reduce its floor-planning offerings.

“Absolutely agree with your last premise that there may need to be a bit more of a catalyst for us to increase our penetration from kind of the mid-teens upward to 20 percent or even north of that over time. And that may be the economic cycle that we have to see to have that happen,” he said.