Consumer Leasing

FEDERAL RESERVE SYSTEM

12 CFR Part 213

[Regulation M; Docket No. R-0892]

Consumer Leasing

AGENCY: Board of Governors of the Federal Reserve System.

ACTION: Final rule.

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SUMMARY: The Board is publishing a final rule to amend Regulation M,

which implements the Consumer Leasing Act. The Act requires lessors to

provide uniform cost and other disclosures about consumer lease

transactions. The Board has reviewed Regulation M, pursuant to its

policy of periodically reviewing its regulations, and has revised the

regulation to carry out more effectively the purposes of the Act. The

final rule adds disclosures, primarily in connection with motor vehicle

leasing, including, for example, disclosures about early termination

charges and how scheduled payments are derived (which requires

disclosure of such items as the gross capitalized cost of a lease, the

vehicle's residual value, the rent charge, and depreciation). General

changes in the format of the disclosures require that certain leasing

disclosures be segregated from other information. Revisions to the

advertising provisions implement a statutory amendment, allowing a

toll-free number to substitute for certain disclosures in radio and

television advertisements, and make other changes to the advertising

rules. A lessor is not required to disclose the cost of a lease

expressed as a percentage rate; however, if a rate is disclosed or

advertised, a special notice must accompany the rate. Further, a rate

in an advertisement cannot be more prominent than any other Regulation

M disclosure.

DATES: Effective date. October 31, 1996. Compliance date. Compliance is

optional until October 1, 1997.

FOR FURTHER INFORMATION CONTACT: Kyung H. Cho-Miller, Obrea O.

Poindexter, or W. Kurt Schumacher, Staff Attorneys, Division of

Consumer and Community Affairs, Board of Governors of the Federal

Reserve System, Washington, DC 20551, at (202) 452-2412 or 452-3667.

For matters concerning the Regulatory Flexibility Analysis, in appendix

I, contact Thomas A. Durkin, Office of the Secretary, Board of

Governors of the Federal Reserve System, Washington, DC 20551, at (202)

452-2326. Users of Telecommunications Device for the Deaf only may

contact Dorothea Thompson, at (202) 452-3544.

SUPPLEMENTARY INFORMATION:

I. Background on the Consumer Leasing Act and Regulation M

The Consumer Leasing Act (CLA), 15 U.S.C. 1667-1667e, was enacted

into law in 1976 as an amendment to the Truth in Lending Act (TILA), 15

U.S.C. 1601 et seq. The Board was given rulewriting authority, and its

Regulation M (12 CFR Part 213) implements the CLA. An official staff

commentary interprets the regulation. (Supplement I to 12 CFR 213).

The CLA generally applies to consumer leases of personal property

in which the contractual obligation does not exceed $25,000 and has a

term of more than four months. An automobile lease is the most common

type of consumer lease covered by the act. Leases accounted for about

one-third of all passenger car deliveries to consumers in 1995. Leasing

in the luxury-car market is estimated to account for more than 70

percent for some models. Used cars are also now being leased, although

to date they account for a relatively small segment of the market.

Under the statute, prior to entering into a lease agreement,

lessors must give consumers 15 to 20 disclosures, including the amount

of initial, end-of-lease, and other charges to be paid by the consumer

(such as security deposits, insurance premiums, disposition fees, and

taxes); an identification of the leased property; a payment schedule;

the responsibilities for maintaining the leased property; and the

liability for terminating a lease early. Special provisions apply to

open-end leases. These provisions regulate balloon payments by limiting

liability at the end of a lease term to no more than three times the

monthly payment, and also require several disclosures unique to open-

end leases (in Secs. 213.4 (k) and (m)).

Open-end leases are a very small segment of the consumer leasing

market. In open-end leases, the consumer's liability at the end of the

lease term is based on the difference between the residual value of the

leased property and its realized value. The consumer--not the lessor--

assumes the risk that the realized value may be less than what was

initially estimated. Closed-end leases are the most common type of

lease covered under the CLA and Regulation M. These leases are

sometimes referred to as ``walk-away'' leases because the consumer is

not liable for the difference between the residual and the realized

values at the end of the lease term.

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II. The Review of Regulation M

The Board's Regulatory Planning and Review Program calls for the

periodic review of a regulation with four goals in mind: to clarify and

simplify regulatory language; to determine whether regulatory

amendments are needed to address technological and other developments;

to reduce undue regulatory burden on the industry; and to delete

obsolete provisions.

Advance Notice of Proposed Rulemaking. The Board began its review

of Regulation M--the first substantial review of the regulation since

it was issued in 1976--by publishing an advance notice of proposed

rulemaking on November 19, 1993 (58 FR 61035). Although comment was

solicited generally on all provisions of the regulation, the Board

specifically sought comment on three issues: disclosure of early

termination charges, broadcast media advertising of leases, and

segregation of leasing disclosures from other information. Most of the

70 comment letters that were received commented only on the three

issues addressed in the advance notice. The comment letters were

received mostly from automobile lessors or their representatives, but

also from federal and state government agencies and from consumer

representatives. Most of the commenters supported revisions to the

disclosures about early termination charges either to better alert

consumers about such charges or to address concerns about lender

liability associated with providing extremely complex disclosures about

these charges. Some commenters supported more flexibility in the

advertising rules, while others expressed concern about the manner in

which leases are advertised. Many supported segregation of leasing

disclosures from other information. In addition, many commenters urged

the Board to mandate the disclosure of the ``capitalized cost'' of a

lease, meaning the value of the leased vehicle and other items that are

capitalized by agreement between the lessor and lessee.

The Proposed Rule to Revise Regulation M. The Board published a

proposed rule to substantially revise Regulation M on September 20,

1995 (60 FR 48752) and an extension of comment period notice was

published on December 6, 1995 (60 FR 62349). The proposal offered a new

disclosure format for model forms and some substantive changes to the

regulation. New disclosures were proposed pursuant to the Board's

authority under Sec. 105(a) of the TILA. Section 105(a) of the TILA

provides that the Board's regulations ``may contain such

classifications, differentiations, or other provisions, and may provide

for such adjustments and exceptions for any class of transactions, as

in the judgment of the Board are necessary or proper to effectuate the

purposes of [the CLA], to prevent circumvention or evasion thereof, or

to facilitate compliance therewith.''

The proposal contained the following proposed amendments to

Regulation M:

Segregation of certain leasing disclosures. (Leasing disclosures

were dispersed throughout a leasing contract.) Additionally, a

statement would remind consumers to read their contracts for other

important consumer leasing disclosures not included in the segregated

disclosures.

Revision of the disclosure of upfront fees to make it easier for a

consumer to understand the amounts to be paid and how they are

allocated, including the amount of any trade-in allowance.

Disclosure of the ``gross cost'' (the agreed upon acquisition value

of leased property) and the ``residual value'' (the estimated value at

the end of the lease term).

Disclosure of an ``estimated lease charge,'' a figure similar in

purpose to the finance charge in a credit transaction.

Disclosures about early termination charges--including a

transaction-specific example of such a charge at an assumed termination

point after one year--and about charges for excessive wear of leased

property.

Changes to the advertising rules to implement a statutory

amendment, simplify disclosure requirements, and deter misleading

advertising.

About 150 comment letters were received on the Board's proposed

rule, from consumer representatives involved in leasing issues and a

large segment of the consumer leasing industry. A majority of the

commenters generally supported the requirement that certain disclosures

be segregated from the remaining disclosures and other information.

Major industry representatives expressed concern, however, about the

overall disclosure format and offered an alternative that presented

some disclosures in a mathematical progression. Commenters generally

supported additional disclosures but many of them suggested

modifications to the Board's proposed definition of the estimated lease

charge and the gross cost. While many commenters favored an early

termination warning about charges for terminating a lease early, a

large majority of them opposed the requirement of a transaction-

specific numerical example for early termination.

To get direct feedback from individual consumers, in January 1996

the Board conducted four focus groups, two in the Washington, D.C. area

and two in Los Angeles, California. Participants gave their opinions on

various disclosure formats, including the Board's proposed model form,

an alternative form showing a mathematical progression of how periodic

payments are derived, and a format in which a few disclosures would be

highlighted in boxes. There were a total of 32 participants (evenly

representing men and women), about a quarter of whom had previously

leased automobiles.

While focus group participants had some concerns about the layout

and language in the disclosure statements presented, they responded

more favorably to the mathematical progression format than to the

Board's proposal. Some participants liked the payment calculation

disclosure because it ``walked you through the process.'' Many of them

were generally familiar with the highlighting of certain disclosures in

credit transactions. For lease transactions, they expressed an interest

in seeing the value of the car, the total due at lease signing, and the

monthly payments highlighted.

The Final Rule Amending Regulation M. The final rule includes most

of the disclosures to supplement the act that were contained in the

proposed rule. The major changes primarily affect motor vehicle

leasing. They include a mathematical progression on how the periodic

payment is derived (using figures such as the gross capitalized cost,

residual value, amount of depreciation and amortized amounts) and a

warning statement about charges for terminating a lease early. Certain

leasing disclosures must be segregated from other information.

The final rule contains revisions to the advertising provisions,

including the implementation of a statutory amendment. The statute

allows a toll-free number or a print advertisement to substitute for

certain lease disclosures in radio commercials, and the final rule

expands the application of this provision to television.

The Board had expressly solicited comment in the proposal about

whether the regulation should require the disclosure of a lease rate.

Under the final rule, a lessor is not required to disclose the cost of

a lease expressed as a percentage rate. If a rate is disclosed or

advertised, a notice must accompany the rate stating that the

percentage may not measure the overall cost of financing the lease

transaction. Also, in the case

[[Page 52248]]

of advertising, a rate cannot be more prominent than any other

Regulation M disclosure.

Other changes have been made to clarify and update the regulation.

Obsolete provisions have been deleted, and generally footnotes have

been moved to the regulatory text or to the Official Staff Commentary

to Regulation M.

The final rule contains the following major amendments to

Regulation M:

A revised disclosure format.

A total of payments disclosure.

An itemization that shows the mathematical progression used to

derive the periodic payment.

A strong narrative warning about the possibility of substantial

charges for early termination.

A notice to accompany any percentage rate (to indicate the

limitations of rate information).

Implementation of a statutory amendment for certain broadcast

advertisements and other changes to the advertising rules.

Official Staff Commentary. When the Board published the proposed

revisions to Regulation M for public comment, it also published

proposed revisions to the Official Staff Commentary on September 20,

1995 (60 FR 48769). The Board will publish an updated proposal to the

commentary in mid-November 1996. The proposal will include material

that was published for comment in September 1995, incorporate guidance

contained in the section-by-section discussion that accompanies this

final rule, and address other questions that may be brought to the

Board's attention following the public's review of the final rule.

III. Recommendations for Legislative Changes

In addition to seeking comment on the proposed regulatory changes,

the Board's September 1995 notice solicited views on whether specific

legislative revisions to the CLA may also be warranted. A few

commenters suggested that CLA coverage be expanded to cover leases that

exceed the current $25,000 cap, given the higher cost of automobiles.

IV. Effective Date

This final rule is effective October 31, 1996, but compliance is

optional until October 1, 1997. The mandatory effective date is

designated by section 105(d) of the act, which states that any

regulation promulgated by the Board is effective October 1 of a given

year, provided the rule was published at least six months in advance.

V. Section-by-Section Discussion of the Final Rule

The following discussion covers the revisions section-by-section.

Changes that are self-evident, and text that has been simplified or

clarified without substantive change, are generally not discussed.

Captions have been added to each paragraph, to conform with current

Board style; the addition or wording of captions alone is not meant as

a substantive change in the meaning of the paragraph itself.

Section 213.1 Authority, Scope, Purpose, and Enforcement

Former paragraph 1(d) on the issuance of staff interpretations has

been moved to appendix C.

1(b) Scope and Purpose

An introductory sentence has been added to state the scope of the

law. This paragraph has been revised to more closely parallel the

purpose clauses in Sec. 102 of the TILA.

Section 213.2 Definitions

Certain definitions are redesignated or added as indicated below.

Former section 213.2(b)--the rules of construction--has been deleted

except that former paragraph 2(b)(1) has been moved to paragraph

2(e)(1) of this section. Former Sec. 213.3--exempt transactions--has

been moved to paragraph 2(e)(3) of this section.

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Definition Final rule

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``Act'' in former 213.2(a)(1)............. 213.2(a).

``Advertisement'' in former 213.2(a)(2)... 213.2(b); examples moved to

commentary.

``Agricultural purpose'' in former Moved to commentary.

213.2(a)(3).

``Arrange for lease of personal Moved to commentary.

property''. in former 213.2(a)(4).

``Board'' in former 213.2(a)(5)........... 213.2(c).

``Closed-end lease''...................... 213.2(d) new.

``Consumer lease'' in former 213.2(a)(6).. 213.2(e).

``Gross capitalized cost''................ 213.2(f) new.

``Lessee'' in former 213.2(a)(7).......... 213.2(g).

``Lessor'' in former 213.2(a)(8).......... 213.2(h).

``Open-end lease''........................ 213.2(i) new.

``Organization'' in former 213.2(a)(9).... 213.2(j).

``Period'' in former 213.2(a)(10)......... Deleted as unnecessary.

``Person'' in former 213.2(a)(11)......... 213.2(k).

``Personal property'' in former 213.2(l).

213.2(a)(12).

``Real property'' in former 213.2(a)(13).. Deleted as unnecessary.

``Realized value'' in former 213.2(a)(14). 213.2(m).

``Residual value''........................ 213.2(n) new.

``Security interest'' in former 213.2(o); examples of

213.2(a)(15). security interests moved to

the commentary.

``State'' in former 213.2(a)(16).......... 213.2(p).

``Total lease obligation'' in former Deleted as unnecessary; open-

213.2(a)(17). end and closed-end

terminology conformed.

``Value at consummation'' in former Deleted as unnecessary; open-

213.2(a)(18). end and closed-end

terminology conformed.

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2(b) Advertisement.

The definition of advertisement is simplified and the examples have

been moved to the commentary. The definition of advertisement is broad,

covering commercial messages in any medium, including electronic media

such as the Internet, that directly or indirectly promote a lease

transaction.

2(d) Closed-end lease.

A definition of a closed-end lease has been added, modeled after

the definition of closed-end credit in Regulation Z (12 CFR

Sec. 226.2(a)(10)). The term covers any lease that does not fall within

the definition of an open-end lease. Commenters generally favored

having definitions of open- and closed-end leases.

2(e) Consumer lease.

The paragraph has been reorganized. The rule of construction in

former Sec. 213.2(b)(1) has been moved to paragraph (e)(1).

Transactions not included in the definition of consumer lease are now

in paragraph (e)(2). Former section Sec. 213.3 on exempt transactions

is now paragraph (e)(3). The term contractual obligation excludes

refundable and ``pass-through'' amounts a lessee is obligated to pay.

For example, the total contractual obligation does not include license

and registration fees and taxes. It also does not include the residual

value.

2(f) Gross capitalized cost.

A definition of gross capitalized cost has been added to this

section. Only items capitalized or amortized by the lessor are included

in this figure. The Board's proposal had contained a broader definition

using the term gross cost. Commenters favored a narrower definition.

Definitions of the related terms capitalized cost reduction and

[[Page 52249]]

adjusted capitalized cost have also been added to this section. The

supplementary information to Sec. 213.4(f)(1) provides a discussion of

these terms and further discussion about the gross capitalized cost,

including the disclosure of the agreed upon value.

2(h) Lessor.

The definition of lessor incorporates a numerical test similar to

the test in Regulation Z for defining a creditor (see footnote 3 to 12

CFR 226.2(a)(17)). Commenters generally supported the revision. The

phrase ``in the ordinary course of business'' has been omitted as

unnecessary.

2(i) Open-end lease.

A definition of an open-end lease has been added. Disclosures in

Secs. 213.4(k) and (m) and Sec. 213.7(d)(2)(vi) are only relevant to

open-end leases.

2(n) Residual value.

A definition of residual value has been added. Many commenters

urged the Board to clarify that the residual value is the lessor's

assigned value of the vehicle used to calculate the lessee's monthly

payments, and not necessarily a projection of the value of the car.

Several lessors noted that often a value is assigned to accommodate

promotional campaigns of a manufacturer. The final rule has a revised

definition in accordance with these comments.

Section 213.3 General disclosure requirements.

The following sections are redesignated or added as indicated

below:

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Former Final rule

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213.4(a)(1)............................... 213.3(a)(1).

213.4(a)(2)............................... 213.3(a)(1); 3(a)(3).

213.3(a)(2) new.

213.4(a)(3)............................... 213.3(a)(1).

213.4(a)(4)............................... 213.3(a)(4).

213.4(b).................................. 213.3(b).

213.4(c).................................. 213.3(c).

213.4(d).................................. 213.3(d).

213.4(e).................................. 213.3(e).

213.4(f).................................. 213.3(f).

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Paragraph 3(a) contains general rules about the disclosures

required under Sec. 213.4, including the form, content, and timing of

disclosures. Paragraph 3(f) on minor variations includes former comment

4(a)-2. The major revision to this section, discussed under paragraph

3(a)(2), is the requirement to segregate certain disclosures from other

information. Clear and conspicuous lease disclosures must be given

prior to consummation of a lease on a dated written statement that

identifies the lessor and lessee.

3(a) General requirements.

Based on comments and to provide a standard consistent with that of

other consumer regulations, the Board has added language requiring that

disclosures be given in a form the consumer may keep.

3(a)(1) Form of disclosures.

Former Secs. 213.4(a)(1) and 4(a)(2) required that all disclosures

be made together on a separate statement or in the lease contract

``above the place for the lessee's signature.'' The Board has deleted

this requirement along with the meaningful sequence, same-page, and

type-size disclosure requirements, replacing them with the requirement

that disclosures be segregated. Most commenters generally supported the

proposed segregation requirement, although some commenters opposed the

deletion of the other requirements. They believed that the signature

requirement ensured that lessors would give disclosures before the

consumer becomes obligated on the lease and discouraged lessors from

putting important information on the back of a lease document. The

Board believes that a segregation requirement and the clear and

conspicuous standard provide the same level of protection as the

previous rules.

The segregated disclosures and other CLA disclosures must be given

to a consumer at the same time. Lessors must continue to ensure that

the disclosures are given to lessees before the lessee becomes

obligated on the lease transaction. For example, by placing disclosures

that are included in the lease documents above the lessee's signature,

or by including instructions alerting a lessee to read the disclosures

prior to signing the lease.

Nonsegregated disclosures need not all be on the same page, but

should be presented in a way that does not obscure the relationship of

the terms to each other.

3(a)(2) Segregation of certain disclosures.

Most commenters--representing both the industry and consumer

groups--generally supported some form of segregation of leasing

disclosures. Many commenters believed that consumers would be more

likely to read and understand the disclosures if key items were

segregated from other disclosures and contract terms. Pursuant to its

authority under section 105(a) of the TILA, the Board has adopted the

requirement that certain consumer leasing disclosures be segregated

from other required disclosures and from general contract terms to

assure clear, conspicuous, and meaningful disclosure of lease terms.

Some commenters, including trade groups that represent a large

portion of the motor vehicle leasing industry, suggested that the more

important disclosures be further highlighted in a manner similar to the

Board's Regulation Z. The Board believes that the segregation

requirement and the requirement that disclosures be in a form

substantially similar to the applicable model form in appendix A

adequately focuses the consumer's attention on key information.

Lessors may provide the segregated disclosures on a separate

document or may include them in their lease contracts, apart from other

information. The general content, format, and headings for these

disclosures should be substantially similar to those contained in the

model forms in appendix A. Lessors may continue to provide the

remaining disclosures required by Regulation M and the CLA in a

nonsegregated format.

The model forms in Appendix A for open-end leases, closed-end

leases, and furniture leases have been revised.

3(a)(4) Language of disclosures.

Under former Sec. 213.4(a)(4), lease disclosures had to be provided

in English, except in the Commonwealth of Puerto Rico, where they could

be given in Spanish. The final rule revises this position. Lessors are

permitted to give disclosures in another language as long as

disclosures in English are given upon request. The Board believes that

a more permissive rule promotes a more meaningful delivery of

disclosures to consumers.

3(b) Additional information; nonsegregated disclosures.

Former Sec. 213.4(b) permitted additional information to be

included with any disclosures required by the regulation. The Board

proposed to permit additional information only with the nonsegregated

disclosures. Some commenters believed that the Board should permit the

inclusion of state-required disclosures among the federally-required

segregated disclosures. The Board believes that the purpose of

segregating disclosures could be diluted if additional information is

permitted among them. The final rule permits additional information

only with the nonsegregated CLA leasing disclosures.

Former Secs. 213.4(b)(1) and 4(b)(2) on inconsistent disclosures

have been

[[Page 52250]]

deleted. Pursuant to Sec. 186(a) of the CLA, Sec. 213.9 addresses the

preemption of state law if information required by state law is

inconsistent with the requirements of the act or regulation.

3(c) Multiple lessors or lessees.

Paragraph 3(c) provides that when a transaction involves multiple

lessors, one lessor may make the disclosures on behalf of all of them.

The phrase ``and the one that discloses shall be the one chosen by the

lessors'' has been deleted as unnecessary. No substantive change is

intended.

3(d) Use of estimates.

Former Sec. 213.4(d) on the use of estimated disclosures has been

redesignated and simplified as paragraph 3(d). The last sentence of the

former paragraph has been deleted as unnecessary.

3(e) Effect of subsequent occurrence.

The rule in paragraph 3(e), previously stated in former

Sec. 213.4(e), has been revised to add a reference to consummation, to

clarify that this rule is limited to events occurring after

consummation of a lease. Footnote 1 of the former regulation,

containing a specific example of a subsequent occurrence, has been

moved to the commentary except for the second sentence, which has been

deleted as unnecessary.

3(f) Minor variations.

Paragraph 3(f) incorporates into the regulation the rules on minor

variations that may be disregarded in making disclosures, including

provisions formerly contained in comment 4(a)-2 of the staff

commentary.

Section 213.4 Content of disclosures.

Although the regulation applies to leases of all types of personal

property such as furniture, much of the focus of the Board's review

under the Regulatory Planning and Review Program has been on motor

vehicle leasing. Because the regulatory issues have arisen in this

context, the final rule limits some of the new disclosure, formatting,

and advertising requirements to leases for motor vehicles. This section

has been reorganized essentially to follow the progression of

disclosures in the model forms as follows:

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Former Final rule

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213.4(g)(1)............................... 213.4(a).

213.4(g)(2)............................... 213.4(b).

213.4(g)(3)............................... 213.4(c).

213.4(g)(4)............................... 213.4(n).

213.4(g)(5)............................... 213.4(d).

213.4(g)(6)............................... 213.4(o).

213.4(g)(7)............................... 213.4(p).

213.4(g)(8)............................... 213.4(h); 4(h)(3) new.

213.4(g)(9)............................... 213.4(r).

213.4(g)(10).............................. 213.4(q).

213.4(g)(11).............................. 213.4(i).

213.4(g)(12).............................. 213.4(g); 4(g)(2) new.

213.4(g)(13).............................. 213.4(k).

213.4(g)(14).............................. 213.4(l).

213.4(g)(15).............................. 213.4(m).

213.4(e) new.

213.4(f) new.

213.4(j) new.

213.4(s) new.

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4(b) Amount due at lease signing.

Paragraph 4(b) requires lessors to disclose to consumers the total

amount of any payment due at lease signing (consummation of the lease).

The Board has adopted several revisions to this paragraph. The revised

language provides that the total amount of payments due at lease

signing must be itemized by amount as well as by type and included

among the segregated disclosures under the heading ``amount due at

lease signing.'' Previously, the lessor was required to itemize these

charges by type but not by amount. Also, to enhance consumer

understanding of the transaction, the lessor is required to itemize by

type and amount ``how the amount due at lease signing will be paid,''

which typically includes any net trade-in allowance, rebate, noncash

credits, and payments in cash. (See the model forms in appendix A for

format.) The Board believes that the standardization of terminology and

the full itemization of the amounts due and means of payment provide

consumer benefit without imposing substantial compliance costs on

lessors.

Commenters supported the proposal in substance. Most of the

commenters supporting the proposal believed that the proposed side-by-

side format would discourage unscrupulous lessors from failing to

credit a lessee's downpayment or trade-in. Some industry

representatives offered an alternative format using only one column to

present the disclosure, in place of the ``balance sheet'' approach.

Upon further analysis, the Board believes that the balance sheet

approach, in which the two columns equal one another, is appropriate to

ensure that the amounts of trade-ins, rebates, and cash payments are

used to reduce the total amount due at lease signing.

Some commenters asked whether a rebate that is subtracted from the

value of the vehicle in arriving at the gross capitalized cost needs to

be disclosed and itemized under this paragraph. They also inquired

about ``negative trade-ins.'' A rebate would be included in the

itemization under this section only when it is applied against the

amount due at lease signing. Also, where the amount owed on a prior

loan or lease exceeds an agreed-upon trade-in value, the difference is

reflected in the gross capitalized cost, and no trade in allowance

would be reflected under the column ``how the amount due at lease

signing is paid.''

4(d) Other Charges

In addition to the periodic payment, the regulation requires

disclosure of a total of other charges and an itemization by type and

amount, payable during and at the end of the lease term. The model

forms include examples of such fees--for example, an annual tax and a

disposition fee at the end of the lease term.

4(e) Total of payments

The Board adopted this disclosure to serve as a tool for comparing

leases that involve the same or similar types of leased properties for

the same lease duration. As the disclosure includes all payments the

consumer is obligated to make under the lease, it is not meant to

reflect the cost of financing the lease transaction.

This disclosure, accompanied by the statement ``the amount you will

have paid by the end of the lease,'' is the net sum of the amount due

at lease signing (excluding refundable amounts such as the security

deposit), the total of periodic payments (excluding the first periodic

payment, if paid at lease signing), and other charges are not part of

the periodic payments (such as a disposition fee). An additional

disclosure is required for open-end leases because, with some

limitations, consumers are liable for the difference between the

residual and realized values of the leased property.

4(f) Payment calculation

Many commenters on the Board's proposed rule expressed concern that

the revised format of the Board's model disclosure form did not present

information in a manner that would allow consumers to understand the

relationship of lease terms such as the ``gross cost'' and the

``residual value'' of a lease. Representatives of major automobile

leasing companies offered an alternative format, one that shows how the

periodic payments are derived. They said that such a disclosure scheme

would result in better consumer understanding of a lease transaction

and would enable consumers to verify their periodic payment. These

commenters

[[Page 52251]]

also noted that the disclosure would impose little additional

compliance burden as lessors make this calculation in setting up a

lease transaction.

The Board believes that a mathematical progression itemizing the

components of the periodic payment is valuable to consumers. It enables

consumers to see several of the newly required disclosures in the

context of the calculation, thereby enhancing the consumer's

understanding of the particular disclosures. Also, it allows consumers

to verify their periodic payment amount.

The CLA does not call for a payment calculation, but based on the

comments and on further analysis, the Board is exercising its

rulemaking authority under Sec. 105(a) of the TILA to require the

disclosure of the amounts comprising the periodic payment, in motor

vehicle leases, in a manner substantially similar to the model leasing

forms in appendix A. The payment calculation utilizes several

disclosures from the proposal; it requires the modification of others

that were proposed, and adds new ones, as discussed below.

4(f)(1) Gross capitalized cost

In the past, federal law has not required disclosure of information

on the base price of the leased property in closed-end leases. Because

this figure has not typically been given, consumers often have assumed

that the lease is based on the manufacturer's suggested retail price

(MSRP), or on a sales price negotiated by the consumer (who might have

initially contemplated financing or paying cash for the vehicle). If

the lessor uses a different starting price in the lease payment

computation, one that is higher than either the MSRP or the negotiated

figure, the consumer would be unaware of that fact, and thus would not

be aware that perhaps the periodic payment could be lower.

The Board's proposal would have required disclosure of the ``gross

cost'' among the segregated disclosures. This disclosure would have

been applicable only to closed-end leases, given that the regulation

already required the disclosure of a comparable term--the ``value at

consummation (the initial value)''--in open-end leases. Under the

proposal, the Board would have defined the gross cost as ``the total

dollar amount of all items included in the value of a lease at

consummation.''

A large majority of the commenters supported the disclosure of the

base price of the leased property in closed-end leases, in one form or

another. However, many of the industry commenters strongly objected to

using the term ``gross cost'' and objected also to the items that would

be included in the definition. Most of these commenters recommended

that the term be changed from ``gross cost'' to either ``gross

capitalized cost'' or ``capitalized cost'' to conform with state law

(as several states now require the disclosure of this figure) and also

to conform with industry practice. Trade associations that represent a

large segment of the industry have encouraged their members to

voluntarily disclose the ``capitalized cost,'' and some lessors have

been doing so. Industry commenters suggested that the term

``capitalized cost'' has gained a certain amount of acceptance from

consumers. Finally, both leasing representatives and consumer interest

groups believed that the disclosed figure should reflect only the

amounts that are capitalized by the lessor (such as the price of the

leased property on which the lease is based); and, in particular,

believed that it should not include amounts that are paid at lease

signing by the consumer.

In response to the comments and upon further analysis, the Board

has modified the final rule to require the disclosure of the ``gross

capitalized cost,'' using that term, in both closed-end and open-end

motor vehicle leases. Only items capitalized or amortized by the lessor

are to be included. The gross capitalized cost is readily available to

lessors from worksheets they use in setting the terms and conditions of

the lease, and hence the Board believes that this disclosure

requirement will not be unduly burdensome for lessors.

Some commenters representing consumer interests asked that the

capitalized cost figure be itemized to give the consumer a clear

picture of the base price of the leased automobile and other amounts

being financed, such as an outstanding balance from a prior loan or

lease. They suggested that without a breakdown, consumers could easily

misunderstand what is included or excluded from the capitalized cost

disclosure. A few industry commenters believed that disclosing an

itemization would be burdensome for lessors; they also believed an

itemization would have to be quite detailed to provide adequate

guidance to lessees concerning the treatment of specific costs.

The final rule requires a disclosure of the gross capitalized cost

with a description such as ``the agreed upon value of the vehicle

[state the amount] and any items you pay over the lease term (such as

service contracts, insurance, and any outstanding prior loan or lease

balance).'' The ``agreed upon value'' of the motor vehicle means the

amount for the vehicle agreed upon by the lessor and the lessee for

purposes of the lease. This would include capitalized items such as the

following: charges for vehicle accessories and options, delivery or

destination charges, and rustproofing. The lessor could also include

taxes and fees for license, title, and registration. The ``value''

would not include charges for service or maintenance contracts,

insurance products, gap waivers, or an outstanding balance on a prior

lease or loan.

Based on comments and upon further analysis, the Board believes

that disclosure of the gross capitalized cost (including the agreed

upon value) may aid consumers in better understanding lease pricing.

The final rule also allows the consumer to obtain an itemization of the

gross capitalized cost upon request. (See the model form in appendix

A.) As in the case of Regulation Z, the itemization must be given

separately, not within the segregated disclosures.

The Board solicited comment on whether the gross cost--the first

item on the proposed model form--should be de-emphasized or removed

from the required disclosures to avoid potential manipulation of the

figure by lessors to mislead consumers. The few commenters that

addressed the issue thought that the potential risk is negligible.

4(f)(2) Capitalized cost reduction.

The Board's proposed rule required the disclosure of any

``capitalized cost reduction'' in the disclosure of the total amount

due at lease signing. Like a downpayment in the case of a credit

transaction, the capitalized cost reduction reduces the capitalized

cost and thus the periodic payments. In response to comments, the final

rule requires that any capitalized cost reduction be reflected both in

the disclosure of the amount due at lease signing and in the

mathematical progression of the periodic payment amount.

4(f)(3) Adjusted capitalized cost.

In response to the comments, the final rule requires the disclosure

of the ``adjusted capitalized cost,'' which equals the gross

capitalized cost less any capitalized cost reduction. This net figure

is the starting point for determining the periodic payment of the

lease.

4(f)(4) Residual value.

The Board proposed to make the residual value of the leased

property a required disclosure in closed-end leases. (A disclosure

called the ``estimated value of the vehicle at the end of the lease''

was already required by Regulation M in an open-end lease.)

[[Page 52252]]

Many commenters, including both industry and consumer representatives,

favored the disclosure of this term. The residual value is the amount

estimated or assigned at consummation as the value of the lease

property at the end of the lease term. In motor vehicle leases, this

figure is frequently but not always obtained by reference to accepted

guides used by lessors, such as the ``ALG Residual Percentage Guide.''

In the payment calculation, the residual value is accompanied by the

statement: ``the value of the vehicle at the end of the lease used in

calculating your base [periodic] payment.''

4(f)(5) Depreciation and any amortized amounts.

The disclosure of the ``depreciation and any amortized amounts''

was not included in the Board's proposed rule but is a necessary part

of the payment calculation. The depreciation represents the difference

between the adjusted capitalized cost and the residual value. This is

the amount that the lessee pays for the vehicle's decline in value

attributable to normal use and for other items paid over the lease

term.

4(f)(6) Rent charge.

This figure, added in the final rule in response to comments,

represents the lessor's ``rent'' or ``interest.'' The rent charge is an

essential component in the payment calculation.

4(f) (7)-(10) Total of base periodic payments, lease term, base

periodic payment, itemization of other charges, and total periodic

payment.

Several other items are used in the payment calculation. The

``lease term'' and the ``total periodic payment'' are already required

disclosures under the CLA, and appear both in the payment calculation

and in the payment schedule disclosures. The ``total of base periodic

payments'' is not required by the CLA, but was used in open-end lease

disclosures and is necessary in the payment calculation. Itemization of

the periodic payment (the base monthly payment and other charges that

are part of the periodic payment) is also not currently required,

although over the years many lessors have routinely provided an

itemization. The periodic payment typically consists of an amount for

depreciation and a rent charge; there may also be state tax and other

fees.

4(g) Early termination.

The CLA requires lessors to disclose the conditions under which the

lessee or lessor may terminate the lease before the end of the lease

term and the amount or method of determining a penalty or other charge

for early termination. Lessors typically disclose the method of

determining an early termination charge, a disclosure which is often

complex.

The proposed rule noted that a U.S. Court of Appeals case,

Lundquist v. Security Pacific Automotive Financial Services Corp., 993

F.2d 11 (2d Cir.), cert. denied, 510 U.S. 959 (1993), caused lessors

concern in determining the requirements for disclosing their early

termination provisions. In that case, the court held a lessor liable

for violating the ``reasonably understandable'' standard for disclosure

under Regulation M; the lessor had an early termination formula that

the court found to be overly complex and beyond the understanding of

the average consumer. Many lessors believe that, given the complexity

of modern automobile lease transactions, it is difficult to describe

every part of an early termination formula in terms clearly

understandable to consumers. In particular, lessors believe that the

various methods used to determine the ``unamortized capitalized cost''

portion of their early termination formulas are inherently complex and

cannot be reduced to a disclosure that is easily understandable.

In response to the Board's proposal, many commenters (mostly those

representing the leasing industry) favored allowing a reference to the

name of the method employed to determine the unamortized capitalized

cost portion of the early termination formula instead of requiring a

detailed description of that method. Opponents believed that merely

providing the name of the method would not be useful and would make it

difficult or impossible for consumers to compute the amount of an early

termination charge. Some consumer advocates believed that in using

complex methods and highly complicated descriptions for determining

early termination charges, lessors preclude consumers from determining

whether the charges themselves are reasonable. (The CLA specifies that

charges for early termination must be ``reasonable.'') Other

commenters, including some lessors and many consumer representatives,

favored a full description of all aspects of a lessor's early

termination method, along with an example of how that method would

work.

Based on the comments and upon further analysis, the Board

continues to believe that the CLA mandates full disclosure of a

lessor's method of determining an early termination charge, even if it

is complex. Therefore, a full description of the complete early

termination method must be disclosed. Given the complexity of the

methods involved, however, a lessor is permitted--in giving the full

description of its early termination method--to refer by name to a

generally accepted method of computing the adjusted lease balance (also

known as the unamortized capitalized cost) for purposes of the early

termination charge. For example, a lessor may state that the ``constant

yield'' method will be utilized in determining the unamortized portion

of the gross capitalized cost, but the lessor would have to specify how

that figure--and any other term or figure--is used in computing the

total early termination charge that would be imposed upon the consumer.

Additionally, if a lessor refers to a named method in this manner, the

lessor will have to provide a written explanation of that method if

requested by the consumer. Lessors should provide clear and

understandable explanations of their early termination provisions to

consumers. Explanations that are full, accurate, and not intended to be

misleading are in compliance with CLA and Regulation M disclosure

requirements even if such explanations are complex.

The Board proposed new disclosure requirements in addition to

requiring this basic statutory information about charges for

terminating a lease early. The proposed rule added a statement alerting

consumers about charges for terminating a lease early, and also would

have required an example of an early termination charge based on an

assumed termination of the lease at the end of the first year. In

general, most commenters supported the Board's requiring a general

statement warning the consumer of the possibility of substantial

charges for early termination.

Many of the commenters representing the leasing industry objected

to the Board's proposed requirement of an early termination example.

They believed that a transaction-specific example would substantially

increase compliance burdens. They said the figure would be difficult to

calculate because published residual values at the end of one year are

not available; the tables typically start at 24 months. Also, the

figure would be imprecise, since charges for early termination are

typically determined based on the realized, not the residual, value of

the leased property at the time of early termination. The realized

value, these commenters pointed out, can vary widely from the residual

value based on factors such as the demand for a

[[Page 52253]]

particular model and the condition of the vehicle at the time of early

termination. Moreover, the example would not be representative of an

actual charge because few leases terminate at the end of the first

year. It is more typical for termination to occur nearer to the end of

the lease.

Industry commenters expressed concern about the compliance burden

attached to a transaction-specific mathematical calculation, as well as

concern about possible consumer misunderstanding of a numerical example

that might be out of line with the amount a consumer would have to pay

if, in fact, the lease is terminated early. Some commenters suggested,

as an alternative, an enhanced general warning to the effect that

charges for early termination could be substantial and ``may be several

thousand dollars.'' They also suggested adding a statement that the

actual charge will depend on when the lease is terminated, and the

earlier the consumer ends the lease, the greater this amount is likely

to be.

Commenters representing consumer interests believed that an example

is needed to give consumers a concrete idea of just how substantial an

early termination charge could be. Some of these commenters suggested

that the early termination example could be rephrased to make clear

that the early termination charge shown in any example is contingent

upon the realized value of the property at the time of termination.

They suggested using language such as ``if you terminate this lease at

the end of the first year, you may owe the lessor the difference

between your adjusted lease balance of [stated amount] and the realized

value at that time.''

While there have been very few consumer complaints about consumer

leasing at the federal level, one of the more frequent issues raised

involves early termination charges. At the state level, authorities

report that early terminations are a major source of consumer

complaints about leasing. Lessees often are surprised that an early

termination charge can be several thousand dollars. Many consumers

apparently think that as long as they are current in their monthly

payments, upon early termination they can merely return the car owing

nothing more or at most a nominal termination fee. The transaction-

specific example proposed by the Board was intended to show just how

substantial a charge could be. Based on the comments and further

analysis, the Board has dropped the requirement of an example and has

instead strengthened the warning to consumers. The final rule requires

the following revised statement among the segregated disclosures:

Early Termination. You may have to pay a substantial charge if you

end this lease early. The charge may be up to several thousand dollars.

The actual charge will depend on when the lease is terminated. The

earlier you end the lease, the greater this charge is likely to be.

The Board believes that a strong narrative statement, even without

the proposed example, will serve to apprise consumers that charges for

early termination may indeed be quite substantial.

4(h) Maintenance responsibilities.

To heighten a consumer's awareness about maintenance

responsibilities without imposing substantial compliance costs on

lessors, the Board proposed to add a disclosure requirement, among the

segregated disclosures, that ``you may be charged for excessive wear

and use based on the lessor's standard for normal use.'' Any applicable

charge for excessive mileage must also be included. In the final rule,

this requirement is limited to motor vehicle leases.

Several commenters requested guidance on disclosing the notice in

paragraph 4(h)(3) when a specific figure for excess mileage is not

available. They suggested that a description of the method for

assessing charges for excess mileage should be allowed in place of a

specific amount. The final rule allows a lessor to disclose a

description of the method used for calculating excess mileage charges

in place of a specific amount, when disclosing an amount is not

feasible.

4(i) Purchase option.

An association representing automobile lessors sought clarification

on whether reference to the fair market value based on an automobile

publication such as N.A.D.A. (published by the National Automobile

Dealers Association) could be disclosed in place of a sum certain, as

the purchase-option price. The Board clarifies that lessors may commit

to a sum certain as the purchase-option price at a future date by

reference to an independent source. The reference should provide

sufficient information so that the lessee will be able to determine the

actual price at the time the option becomes available. Statements of a

lease end price such as ``negotiated price'' or ``fair market value''

do not comply with the requirement of this paragraph. For a purchase

option during the lease term, the Board recognizes that the price may

vary depending on when the lessee exercises this option, and therefore

under the final rule, lessors are allowed to describe a method for

determining the price as an alternative to providing the price.

4(j) Statement referencing nonsegregated disclosures.

To alert consumers to the nonsegregated CLA disclosures, the final

rule requires a statement among the segregated disclosures to direct

consumers to other CLA-required disclosures in the lease documents. The

nonsegregated disclosures include information on early termination,

purchase options and maintenance responsibilities, warranties, late and

default charges, insurance, and any security interest.

4(k) Liability between residual and realized values.

This provision is substantially unchanged from the provision found

under former Sec. 213.5(g)(13); minor edits have been made.

4(l) Right of appraisal.

Paragraph 4(l) requires disclosure of the right to an appraisal of

leased property. This language has been adopted as proposed, with a few

changes for clarity and accuracy; for example, the term ``realized

value'' replaces ``estimated value.'' No substantive change is

intended. This provision is applicable both to open-end and to closed-

end leases.

4(m) Liability at end of lease term based on residual value.

Except as discussed below, editorial changes have been made to this

section without substantive change.

4(m)(1) Rent and other charges.

Former Secs. 213.2(a)(17) and 2(a)(18) defined the terms ``total

lease obligation'' and ``value at consummation,'' that were applicable

to open-end leases. The Congressional intent regarding these

definitions, as set forth in a committee report, was that the lessee

would have a readily understandable method for comparing the cost of

one lease with another or with the cost of buying the same property for

cash or on credit (Senate Committee on Banking, Housing and Urban

Affairs, Consumer Leasing Act of 1976, S. Rep. No. 94-590 (1976)). The

report stated, in pertinent part:

Under subsection 182[(10)][of the CLA], in addition the lessor

must calculate and disclose the difference between the total lease

obligation and the market value of the goods at the inception of the

lease. These figures then will provide an easy comparison

[[Page 52254]]

between the cost of the lease and the cost of an outright cash

purchase, and the differential figure provides a rough comparison to

the amount of finance charge which would be involved in a credit

purchase. The consumer lessee therefore will have at hand the

essential data to compare leases, and to evaluate alternatives to

leasing.

Commenters noted that the value at consummation, defined as ``the

cost to the lessor of the leased property including, if applicable, any

increase or markup by the lessor prior to consummation,'' is

essentially the same as the capitalized cost.

The Board believes that the purpose of the disclosure of the total

lease obligation, the value at consummation, and the differential

between these two figures is served by requiring lessors in open-end

leases to disclose the ``rent and other charges'' described as ``the

total amount of rent and other charges imposed in connection with your

lease [state the amount].'' Because of the new comprehensive disclosure

scheme, including a required disclosure of the gross capitalized cost

(including the agreed upon value) of leased property, the ``total lease

obligation'' disclosure (as defined in former Sec. 213.2(a)(17)), and

the ``value at consummation'' disclosure (as defined in former

Sec. 213.2(a)(18)) have been deleted as unnecessary. The final rule has

been revised accordingly.

4(o) Insurance.

Along with the amount paid to the lessor, this disclosure provides

information on the type and amount of coverage of insurance, whether

voluntary or required, as well as the cost. Several commenters pointed

out that unlike collision and comprehensive liability policies, the

lessor could not furnish the amount of coverage for mechanical

breakdown protection contracts (in states where these contracts are

treated as insurance). For mechanical breakdown protection insurance

contracts not capped by a dollar amount, lessors may describe coverage

by referring to a limitation by mileage or time period. For example,

the mechanical breakdown contract insures parts of the automobile for

up to 100,000 miles.

4(p) Warranties or guarantees.

The Board was asked to clarify whether warranties were limited to

maintenance warranties, or included UCC warranties such as warranty of

title, and whether disclosure is required if certain warranties do not

apply to the lessee. Whether warranties under the UCC should be treated

as warranties under this section is to be determined by state or other

applicable law. If a lessor provides a comprehensive list of warranties

to a consumer, the lessor must indicate which warranties apply or,

alternatively, which do not apply.

4(q) Penalties and other charges for delinquency

As proposed, the final rule adds that any penalty or charge shall

be reasonable, to reflect the requirement found in Sec. 183(b) of the

CLA. No substantive change is intended.

4(r) Security interest

This section has been adopted as proposed without substantive

change. The phrase ``in connection with the lease'' has been deleted as

unnecessary.

4(s) Limitation on rate information

Until recently, lessors did not disclose rate information to

consumers, although they have commonly used an implicit interest rate

for internal purposes. Now some automobile lessors disclose rate

information in contracts, or advertise lease rates, or orally provide

rate information to consumers who lease or express an interest in

leasing. Typically these rates are based on the lessor's ``money

factor''--representing only the ``rent'' or the ``interest'' charge--

and are sometimes labelled as an ``annual percentage rate.''

In the proposed rule, the Board solicited comment on whether

Regulation M should require a rate disclosure, and whether (and how)

the rate should be made comparable to the annual percentage rate (APR)

in a credit transaction. Many commenters addressed this issue. For the

most part, commenters representing consumer constituencies advocated

the disclosure of a uniformly calculated lease rate. Those representing

industry interests generally opposed a lease rate disclosure, although

some supported further consideration of the issue.

Those commenters who supported a rate disclosure believed that a

federally-mandated annual lease rate is needed to assure uniform

disclosure of lease-cost information. They expressed particular concern

that rates currently disclosed by some lessors in advertisements and in

contracts may mislead consumers about lease costs, given the lack of

any calculation standards. Commenters also argued that if the

capitalized cost, the residual value of leased property, and other

lease terms are disclosed to a consumer, the lease rate is the only

missing component necessary to fully demonstrate the cost of the lease.

They generally believed that a rate disclosure would be an effective

tool for comparison shopping.

Those commenters opposed to a rate disclosure requirement believed

that such a disclosure would be meaningless and perhaps even misleading

to consumers. They argued that there is no effective way to calculate a

lease rate that will be meaningful to consumers, absent rules

constraining lease terms. Many expressed concern that consumers would

inappropriately compare credit and lease transactions by comparing the

APR with the lease rate. A few commenters, mostly representing

independent lessors, suggested that the Board would be exceeding its

rulemaking authority under the CLA if it were to mandate a rate

disclosure, given that the statute does not impose this requirement.

Commenters also suggested that a rate disclosure presents the

opportunity for unscrupulous lessors to purposely manipulate the lease

rate (to make it look more attractive) by adjusting the residual value.

These commenters suggested that, to quote a low lease rate, such

lessors might use a residual value lower than the figure the lessor

actually expects to realize from the sale of the vehicle at the

scheduled termination of the lease. Reducing the residual value

increases the portion of the periodic payment attributable to

depreciation, thus lowering the amount imputed to the rent charge in

each payment. Indeed, for lease transactions in which the adjusted

capitalized cost, lease term, and periodic payments remain constant,

adjustments in the residual value can produce significantly different

lease rates.

Consideration of alternative approaches. The Board considered

several approaches to address the lease rate issue: it considered

requiring, permitting, or prohibiting a disclosure. In principle, the

disclosure of a lease cost expressed as an annual rate, rather than

solely as a dollar amount, could have value to consumers in negotiating

lease terms and in comparing one lease to another. In practice,

however, there are problems associated both with the computation of the

lease rate and with what the figure represents.

The major problem with a rate computation is that it is subject to

variations in the residual value, whether the variation is narrow or

wide and whether it results from unscrupulous manipulation or from

legitimate, good-faith differences about estimates of value. As to some

of the comparisons that consumers might attempt to make, it is arguable

that comparing the costs incurred in leasing and in financing based

primarily on rate information may never be totally appropriate because

the comparison overlooks legal and

[[Page 52255]]

economic distinctions between the two transactions--in a lease the

consumer accumulates no equity in the property. Given these

limitations, and the fact that the legislative history provides little

support for requiring a lease rate disclosure, the Board decided not to

mandate a lease rate disclosure.

The Board considered prescribing a method for calculating a rate so

that consumers could be assured of uniformity in any rate disclosures

they received. The calculation could use an ``actuarial method''

formula similar to that used for the APR under the Board's Regulation

Z. This formula would analyze the present value of all advances made to

the lessee or on the lessee's behalf against the present value of all

payments received by the lessor.

To address rate manipulation, the Board considered placing certain

general constraints on the use of the residual value, such as requiring

that the residual value used to calculate the rate be the same one on

which the periodic payments are based, and requiring also that the

residual value be a reasonable approximation of the value of the leased

property at the end of the lease term. While this approach would

promote more uniformity in rate disclosure than currently exists, it

would not make the rates quoted to a consumer completely reliable given

the legitimate range of residual values. Alternatively, the Board

considered requiring that lessors use the purchase-option price instead

of the residual value in calculating a rate when the option price is

higher. However, basing a lease rate on a purchase-option price

assumes, often incorrectly, that the consumer will purchase the leased

property at the end of the lease term. Moreover, because only about 60

percent of leases have an option price, this restraint on possible

manipulation would not be available in all instances.

Given the limitations under any of these approaches, the Board

believes that in specifying a rate calculation method, it would be

endorsing the use of an imperfect tool--one whose accurate use for

comparison shopping is questionable in many cases.

As an alternative, the Board considered whether to prohibit the

disclosure of lease rates. However, a regulatory prohibition would

essentially require a determination by the Board that a rate disclosure

is inherently deceptive or misleading to consumers. In light of the

wide support for a uniform lease rate disclosure among consumer

advocates and others, the Board believes it would be difficult to

support such a determination in all cases.

Still, the Board believes that the concerns about variations in

lease rates cannot be ignored. These concerns exist whether variations

result from a lessor's manipulation of the residual value to show a

lower lease rate, or occur despite a lessor's use of different good-

faith estimates of the residual value. Accordingly, the final rule

imposes constraints on the disclosure of rate information to deter--as

much as possible--inappropriate comparisons of leases by consumers

based on rate information offered by different lessors, and mistaken

comparisons between the distinct transactions of financing and leasing.

The final rule requires that where rate information is provided in an

advertisement or in lease documents, a notice must accompany the rate

disclosure stating that ``this percentage may not measure the overall

cost of financing this lease.''

Under the final rule, a lessor advertising or disclosing a lease

rate is also precluded from calling the rate an ``annual percentage

rate'' or any equivalent term to avoid the inference that the rate is

directly comparable to the APR. Moreover, the rate may not be placed

among Regulation M's segregated disclosures. The final rule in

Sec. 213.7(b)(2) also provides that the disclosure of a lease rate in

an advertisement cannot be more prominent than disclosures in the

advertisement required by Regulation M, except for the disclosure that

must accompany the rate.

The estimated lease charge. In its proposed rule, the Board

solicited comment on a new disclosure, called the estimated lease

charge, to show the total ``financing'' costs that would be charged to

the consumer over the lease term, including ``rent'' or ``interest.''

In name, the proposed figure was similar to the finance charge

disclosed in credit transactions subject to the TILA. In concept,

however, it was quite different in that it included fees that the

consumer would pay in a comparable cash transaction and fees paid to

third parties (such as automobile registration fees, insurance

premiums, and state taxes). These are items that in the credit context

would be excluded from the finance charge in most cases.

Commenters representing consumer interests, who generally supported

the proposed ``all-inclusive'' definition of the estimated lease

charge, believed that such a disclosure meets the goal of the CLA to

provide meaningful and full disclosure to consumers of the ``true''

cost of leasing. They thought it could facilitate shopping among

comparable lease transactions, and would not be burdensome for lessors

to disclose. A majority of commenters--all representing the leasing

industry--either opposed the estimated lease charge disclosure in

general or as it was defined in the proposal. They believed that any

lease charge should ideally reflect only that portion of each lease

payment representing the ``rent'' or ``interest'' charged by the

lessor. Also, they believed an all-inclusive lease charge disclosure

could mislead consumers to view leasing as more expensive in comparison

with financing, when that may not be the case. Most of these commenters

believed that if a lease charge were to be disclosed, the rules should

at least be more comparable to Regulation Z regarding the type of fees

included, based on their concern that consumers might attempt to

compare a lease charge to the finance charge in a credit transaction.

Although virtually all costs associated with a lease transaction

are itemized and disclosed under the final rule, there could be some

value in bringing together in one figure the various interest and

noninterest charges that may be split among those due at lease signing,

in the periodic payments, and at lease end. The Board considered that a

lease charge, redefined to more closely parallel the finance charge

disclosed in a credit transaction, could have utility in some

instances. For example, it might assist a consumer in comparing the

cost of leasing a vehicle offered by different lessors, such as when

shopping to lease a particular make and model with the same lease

duration. It would not be very useful in comparing the leasing of cars

with different values or different lease durations, or in comparing a

lease transaction to a credit transaction. For purposes of Regulation

M, a lease charge disclosure is related primarily to the calculation of

a lease rate (as lessors would need to know what fees to include in the

calculation) and to verify compliance with the prescribed formula.

Given that there is no federally-mandated lease rate disclosure, there

is little need for a lease charge disclosure (in a closed-end lease).

Based on the comments and upon further analysis, the final rule does

not require the disclosure of a lease charge.

Section 213.5 Renegotiations, extensions, and assumptions.

Section 213.5 is adopted as proposed with some editorial changes.

No substantive change is intended. This section contains all the

redisclosure rules governing leases that are renegotiated, extended, or

assumed, which were generally contained in

[[Page 52256]]

former Sec. 213.4(h). Paragraphs have been rearranged and revised for

clarity. Rules on assumptions have been moved from the commentary.

Section 213.5(d) retains the substance of the exceptions found in the

former regulation as well as the exceptions previously located in the

commentary for renegotiations, court proceedings, and deferrals under

former comments 4(h)-3, 7, and 8, respectively.

Section 213.6 [Reserved]

Section 213.7 Advertising.

Former Sec. 213.5 is redesignated as indicated below:

------------------------------------------------------------------------

Former Final rule

------------------------------------------------------------------------

213.5(a).................................. 213.7(a).

213.7(b) new, incorporating

standard in one place.

213.7(b)(1) new.

213.7(b)(2) new.

213.5(b).................................. 213.7(c).

213.5(c).................................. 213.7(d).

213.5(d).................................. 213.7(e).

213.7(f) new.

------------------------------------------------------------------------

The final rule contains several substantive additions to the

advertising rules as discussed below. Some of the language of existing

provisions has been revised for simplicity.

7(b) Clear and conspicuous standard.

In response to commenters' request for guidance on the clear and

conspicuous standard for advertisements, the Board clarifies that an

advertisement must be understandable and readable. For example, very

fine print in a television advertisement or detailed and rapidly stated

information in a radio advertisement does not meet the clear and

conspicuous requirement if consumers cannot see and read or comprehend

all of the information required to be disclosed. Further, in the

official commentary, the Board proposed to require that lease

disclosures appear on a television screen at a minimum of five seconds

to meet the clear and conspicuous standard. Upon further analysis, the

Board believes that this ``five second'' rule, which was referred to in

a case by the Federal Trade Commission, is inadequate as a test for the

clear and conspicuous standard. Therefore, the Board is withdrawing the

``five second'' rule as a standard to be used for television

advertisements.

7(b)(1) Amount due at lease signing.

The proposal sought to address misleading advertisements primarily

in which a lessor refers to a low or no capitalized cost reduction

(downpayment) and, in small print lists other upfront charges such as

an acquisition fee, a security deposit, the first monthly lease

payment. The Board proposed that a reference in an advertisement to any

component of the total amount due at lease signing may not be more

prominently displayed than the required disclosure of the total amount

of payments due at lease signing.

The majority of commenters supported the proposed requirement,

stating that it would minimize deceptive practices and that it provided

clarity to the clear and conspicuous standard. However, a number of

commenters opposed the adoption of an equal prominence rule. They

believed the proposed rule was overbroad, and suggested that the final

rule should ensure that the prominence rule is not triggered when the

only payment due at lease inception is the first scheduled periodic

payment. Several commenters sought further clarification on the clear

and conspicuous standard.

The final rule provides an exception to the prominence test for the

periodic payment. Stating the amount of any periodic payment will not

trigger the prominence rule. The rule is triggered by oral or written

references (which includes electronic media such as the Internet) to

any other component of the total amount due at lease signing. The Board

believes the final rule addresses some of the concerns about lease

advertisements without adding significant burden on lessors or

interfering with the effective marketing of their products. The final

rule does not specify what terms are to be advertised, but only that

components of the total amount due at lease signing cannot be

emphasized without giving equal prominence to the disclosure of the

total amount due itself. Lessors can advertise lease transactions

without including any CLA disclosures. Disclosures are only required

when certain ``trigger'' terms are included in the advertisement. The

CLA requires only disclosure of the total due, not an itemization of

its component parts, in advertisements. Such an itemization is provided

in the transaction-specific disclosures.

7(b)(2) Advertisement of a lease rate.

As discussed in the supplementary information to Sec. 213.4(s), if

a percentage rate is stated in an advertisement, a notice must

accompany the rate. The notice must be placed next to the rate without

any other intervening language or symbols. For example, a lessor may

not state a rate with an asterisk and make the disclosure in a

different location in the advertisement or lease document. The notice

states that this percentage may not measure the overall cost of

financing the lease. In addition, with the exception of the notice

required by Sec. 213.4(s), the rate cannot be more prominent than the

disclosures in the advertisement required by Sec. 213.4.

7(c) Catalogs and multi-page advertisements.

Section 7(c) is adopted as substantially proposed, with no

substantive change from the former rule.

7(d) Advertisement of terms that require additional disclosure.

In paragraph 7(d)(2)(iii), the word ``such'' prior to ``payments

under the lease,'' inadvertently omitted in the proposal, is inserted

back in the paragraph.

In complying with paragraph 7(d)(2)(iv), lessors are required to

provide a sum certain if the purchase option is available at the end of

the term. Referring to a source for determining a sum certain in the

future complies with this requirement. Statements of a lease-end price

such as ``negotiated price'' or ``fair market value'' do not comply

with the requirement of this paragraph.

7(e) Alternative disclosures--merchandise tags.

The substance of this section is unchanged from the former

provision in Sec. 213.5(d); editorial changes have been made.

7(f) Alternative disclosures--telephone or radio advertisements.

Section 336 of the Riegle Community Development and Regulatory

Improvement Act of 1994 (Pub. L. 103-325, 108 Stat. 2160) amends

Sec. 184 of the CLA to provide an alternative disclosure scheme for

radio lease advertisements. In radio advertisements, lessors are

permitted to substitute a reference to a toll-free telephone number or

to a print advertisement for the disclosures about the purchase option

and the end-of-term liability. When calling an advertised toll-free

number, if a consumer obtains a recording that provides several dialing

options--such as providing directions to the lessor's place of

business--the option allowing the consumer to request lease disclosures

should be provided early in the phone message to ensure that disclosure

information is not obscured by other information.

In keeping with the purpose of the statutory amendment, the final

rule requires language to accompany the telephone number indicating

that all required disclosures are available by

[[Page 52257]]

calling the toll-free number. Without language such as, ``call 1-800-

000-0000 for details about costs and terms,'' consumers are not put on

notice that disclosures may be obtained by calling the toll-free

number. A specific reference to disclosures in print advertisements is

also required.

The Board proposed to extend the alternate disclosure provision to

television advertisements. The majority of commenters supported this

proposal. They agreed that television has the same time and space

constraints as radio and that the alternate disclosure provision allows

consumers the opportunity to obtain lease information in a format that

can be retained and studied at a convenient time.

The Board also solicited comment on whether constraints similar to

those for television and radio advertisements exist for print

advertisements. Although some commenters encouraged imposing the same

standard for both broadcast and print media, the majority of commenters

did not support the application of the alternative disclosure rules to

print media. Much of the oral and written disclosure information in a

broadcast is difficult for lessors to provide and for consumers to

comprehend or retain. The Board believes that lessors have the ability

to more efficiently provide the required disclosures in print format.

And generally, print advertisements are easier to retain for use by

consumers who are shopping for a lease. Therefore, the Board has

extended the alternate disclosure provision to television but not to

print media.

Appendices

To simplify the regulation, the written information contained in

former appendices A and B about the procedures and criteria for

preemption and exemption determinations have been removed. Such

information is available from the Board upon request. The model forms

are in appendix A. The list of federal agencies that enforce the CLA

for particular classes of businesses is moved from former appendix D to

appendix B. Appendix C incorporates former Sec. 213.1(d).

Appendix A--Model Forms

The model forms illustrate the new segregated disclosure scheme

required by Sec. 213.3(a)(2). Instructions have been deleted as

unnecessary.

A-1--Model Open-End or Finance Vehicle Lease Disclosures

A-2--Model Closed-End or Net Vehicle Lease Disclosures

A-3--Model Furniture Lease Disclosures

VI. Regulatory Flexibility Analysis

In accordance with section 3(a) of the Regulatory Flexibility Act

(5 U.S.C 603), the Board's Office of the Secretary has reviewed the

amendments to Regulation M. The text of a detailed analysis appears at

the end of this document as appendix I. The changes to Regulation M

will require a substantial revision to the disclosure format currently

required of lessors. In issuing the final rule, the Board has attempted

to minimize the burden of changing to the new disclosure format by

requiring, wherever possible, disclosures that can be preprinted.

Further, the Board has provided model disclosure forms to facilitate

compliance. Section 105 of the Truth in Lending Act provides that a

lessor that uses the appropriate model forms published by the Board

``shall be deemed to be in compliance with the disclosure provisions of

this title with respect to other than numerical disclosures....'' Thus,

using the model forms properly provides lessors with a safe harbor from

civil liability. Required disclosures will be the same for large and

small lessors, but the Board does not expect that the changes to

Regulation M will have a substantial adverse economic impact on a large

number of small entities. The automobile leasing industry, at which

most of the changes are directed, is highly concentrated in a small

number of large firms. Actual preparation of lease documents will

typically take place in the offices of numerous automobile dealers,

many of which are small entities. However, preparation will take place

through computer terminals and computer programs provided by the

lessors. Because the new forms are provided through the lessors'

computer systems, they will be clearer and easier for dealer personnel

to understand. Explanations and necessary training of personnel should

actually be enhanced and made easier for dealers.

VII. Paperwork Reduction Act

In accordance with the Paperwork Reduction Act of 1995 (44 U.S.C.

Ch. 3506; 5 CFR 1320 Appendix A.1), the Board reviewed the final rule

under the authority delegated to the Board by the Office of Management

and Budget.

The respondents are individuals or businesses that regularly lease,

offer to lease, or arrange for the lease of personal property under a

consumer lease. The purpose of the disclosures associated with

Regulation M is to ensure that lessees of personal property receive

meaningful information that enables them to compare lease terms with

other leases and, where appropriate, with credit transactions. Records,

required in order to evidence compliance with the regulation, must be

retained for twenty-four months. The revisions to the disclosure

requirements in this regulation are found in Secs. 213.3, 213.4, and

213.7.

Regulation M applies to all types of financial institutions, not

just state member banks. Under the Paperwork Reduction Act, however,

the Federal Reserve accounts for the paperwork burden associated with

Regulation M only for state member banks. Any estimate of paperwork

burden for institutions other than state member banks affected by the

amendments is provided by the federal agency or agencies that supervise

those lessors. The Federal Reserve has found that few state member

banks engage in consumer leasing and that while the prevalence of

leasing has increased in recent years, it has not increased

substantially among state member banks. It also has found that among

state member banks that engage in consumer leasing, only a very few

advertise consumer leases.

The estimated burden per response for the disclosures is eighteen

minutes, three minutes more than the estimate of the burden for the

disclosures under the former rule. Under the Board's September 1995

proposal, the estimate was seventeen minutes. The final rule adds two

particular items: an itemized mathematical progression of the periodic

payment and, if an annual lease rate is included, a statement that the

rate may not measure the overall cost of financing the lease. The

estimated burden for advertisement disclosures, twenty-five minutes (a

decrease of five minutes from the former rule), is unchanged since the

proposal. It is estimated that there will be 310 respondents and an

average frequency of 120 responses per respondent each year. The

combined amount of annual burden is estimated to increase from 9,322

hours to 11,179 hours. In addition, start-up costs are estimated to be

$12,000 per respondent, amounting to a total of $3,720,000 for state

member banks.

The Board received no comments that specifically addressed the

burden estimate.

The disclosures made by lessors to consumers under Regulation M are

mandatory (15 USC 1667 et seq.). Because the Federal Reserve does not

collect any information, no issue of confidentiality under the Freedom

of Information Act arises. Consumer lease information in advertisements

is available to the public. Disclosures of the costs, liabilities, and

terms of

[[Page 52258]]

consumer lease transactions relating to specific leases are not

publicly available.

An agency may not conduct or sponsor, and an organization or

individual is not required to respond to, an information collection

unless it displays a currently valid OMB control number. The OMB

control number for Regulation M is 7100-0202.

Comments regarding the burden estimate, or any other aspect of this

collection of information, including suggestions for reducing the

burden, may be sent to: Secretary, Board of Governors of the Federal

Reserve System, 20th and C Streets, N.W., Washington, DC 20551; and to

the Office of Management and Budget, Paperwork Reduction Project (7100-

0202), Washington, DC 20503.

List of Subjects in 12 CFR Part 213

Advertising, Federal Reserve System, Reporting and recordkeeping

requirements, Truth in Lending.

For the reasons set forth in the preamble, the Board amends 12 CFR

Part 213 as follows:

PART 213--CONSUMER LEASING (REGULATION M)

1. The authority citation for part 213 continues to read as

follows:

Authority: 15 U.S.C. 1604.

2. The table of contents to part 213 is revised to read as follows:

Sec.

213.1 Authority, scope, purpose, and enforcement.

213.2 Definitions.

213.3 General disclosure requirements.

213.4 Content of disclosures.

213.5 Renegotiations, extensions, and assumptions.

213.6 [Reserved]

213.7 Advertising.

213.8 Record retention.

213.9 Relation to state laws.

Appendix A to Part 213--Model Forms

Appendix B to Part 213--Federal Enforcement Agencies

Appendix C to Part 213--Issuance of Staff Interpretations

Supplement I to Part 213--Official Staff Commentary to Regulation M

3. Part 213 is amended as follows:

a. Sections 213.1 through 213.5 are revised;

b. Section 213.6 is removed and reserved;

c. Sections 213.7 and 213.8 are revised;

d. Section 213.9 is added;

e. Appendices A through C are revised; and

f. Appendix D is removed.

The revisions and additions read as follows:

Sec. 213.1 Authority, scope, purpose, and enforcement.

(a) Authority. The regulation in this part, known as Regulation M,

is issued by the Board of Governors of the Federal Reserve System to

implement the consumer leasing provisions of the Truth in Lending Act,

which is Title I of the Consumer Credit Protection Act, as amended (15

U.S.C. 1601 et seq.).

(b) Scope and purpose. This part applies to all persons that are

lessors of personal property under consumer leases as those terms are

defined in Sec. 213.2(e)(1) and (h). The purpose of this part is:

(1) To ensure that lessees of personal property receive meaningful

disclosures that enable them to compare lease terms with other leases

and, where appropriate, with credit transactions;

(2) To limit the amount of balloon payments in consumer lease

transactions; and

(3) To provide for the accurate disclosure of lease terms in

advertising.

(c) Enforcement and liability. Section 108 of the act contains the

administrative enforcement provisions. Sections 112, 130, 131, and 185

of the act contain the liability provisions for failing to comply with

the requirements of the act and this part.

Sec. 213.2 Definitions.

For the purposes of this part the following definitions apply:

(a) Act means the Truth in Lending Act (15 U.S.C. 1601 et seq.) and

the Consumer Leasing Act is chapter 5 of the Truth in Lending Act.

(b) Advertisement means a commercial message in any medium that

directly or indirectly promotes a consumer lease transaction.

(c) Board refers to the Board of Governors of the Federal Reserve

System.

(d) Closed-end lease means a consumer lease other than an open-end

lease as defined in this section.

(e)(1) Consumer lease means a contract in the form of a bailment or

lease for the use of personal property by a natural person primarily

for personal, family, or household purposes, for a period exceeding

four months and for a total contractual obligation not exceeding

$25,000, whether or not the lessee has the option to purchase or

otherwise become the owner of the property at the expiration of the

lease. Unless the context indicates otherwise, in this part ``lease''

means ``consumer lease.''

(2) The term does not include a lease that meets the definition of

a credit sale in Regulation Z (12 CFR 226.2(a)). It also does not

include a lease for agricultural, business, or commercial purposes or a

lease made to an organization.

(3) This part does not apply to a lease transaction of personal

property which is incident to the lease of real property and which

provides that:

(i) The lessee has no liability for the value of the personal

property at the end of the lease term except for abnormal wear and

tear; and

(ii) The lessee has no option to purchase the leased property.

(f) Gross capitalized cost means the amount agreed upon by the

lessor and the lessee as the value of the leased property and any items

that are capitalized or amortized during the lease term, including but

not limited to taxes, insurance, service agreements, and any

outstanding balance from a prior loan or lease. Capitalized cost

reduction means the total amount of any rebate, cash payment, net

trade-in allowance, and noncash credit that reduces the gross

capitalized cost. The adjusted capitalized cost equals the gross

capitalized cost less the capitalized cost reduction, and is the amount

used by the lessor in calculating the base periodic payment.

(g) Lessee means a natural person who enters into or is offered a

consumer lease.

(h) Lessor means a person who regularly leases, offers to lease, or

arranges for the lease of personal property under a consumer lease. A

person who has leased, offered, or arranged to lease personal property

more than five times in the preceding calendar year or more than five

times in the current calendar year is subject to the act and this part.

(i) Open-end lease means a consumer lease in which the lessee's

liability at the end of the lease term is based on the difference

between the residual value of the leased property and its realized

value.

(j) Organization means a corporation, trust, estate, partnership,

cooperative, association, or government entity or instrumentality.

(k) Person means a natural person or an organization.

(l) Personal property means any property that is not real property

under the law of the state where the property is located at the time it

is offered or made available for lease.

(m) Realized value means:

(1) The price received by the lessor for the leased property at

disposition;

(2) The highest offer for disposition of the leased property; or

(3) The fair market value of the leased property at the end of the

lease term.

(n) Residual value means the value of the leased property at the

end of the

[[Page 52259]]

lease term, as estimated or assigned at consummation by the lessor,

used in calculating the base periodic payment.

(o) Security interest and security mean any interest in property

that secures the payment or performance of an obligation.

(p) State means any state, the District of Columbia, the

Commonwealth of Puerto Rico, and any territory or possession of the

United States.

Sec. 213.3 General disclosure requirements.

(a) General requirements. A lessor shall make the disclosures

required by Sec. 213.4, as applicable. The disclosures shall be made

clearly and conspicuously in writing in a form the consumer may keep,

in accordance with this section.

(1) Form of disclosures. The disclosures required by Sec. 213.4

shall be given to the lessee together in a dated statement that

identifies the lessor and the lessee; the disclosures may be made

either in a separate statement that identifies the consumer lease

transaction or in the contract or other document evidencing the lease.

Alternatively, the disclosures required to be segregated from other

information under paragraph (a)(2) of this section may be provided in a

separate dated statement that identifies the lease, and the other

required disclosures may be provided in the lease contract or other

document evidencing the lease. In a lease of multiple items, the

property description required by Sec. 213.4(a) may be given in a

separate statement that is incorporated by reference in the disclosure

statement required by this paragraph.

(2) Segregation of certain disclosures. The following disclosures

shall be segregated from other information and shall contain only

directly related information: Secs. 213.4(b) through (f), (g)(2),

(h)(3), (i)(1), (j), and (m)(1). The headings, content, and format for

the disclosures referred to in this paragraph (a)(2) shall be provided

in a manner substantially similar to the applicable model form in

appendix A of this part.

(3) Timing of disclosures. A lessor shall provide the disclosures

to the lessee prior to the consummation of a consumer lease.

(4) Language of disclosures. The disclosures required by Sec. 213.4

may be made in a language other than English provided that they are

made available in English upon the lessee's request.

(b) Additional information; nonsegregated disclosures. Additional

information may be provided with any disclosure not listed in paragraph

(a)(2) of this section, but it shall not be stated, used, or placed so

as to mislead or confuse the lessee or contradict, obscure, or detract

attention from any disclosure required by this part.

(c) Multiple lessors or lessees. When a transaction involves more

than one lessor, the disclosures required by this part may be made by

one lessor on behalf of all the lessors. When a lease involves more

than one lessee, the lessor may provide the disclosures to any lessee

who is primarily liable on the lease.

(d) Use of estimates. If an amount or other item needed to comply

with a required disclosure is unknown or unavailable after reasonable

efforts have been made to ascertain the information, the lessor may use

a reasonable estimate that is based on the best information available

to the lessor, is clearly identified as an estimate, and is not used to

circumvent or evade any disclosures required by this part.

(e) Effect of subsequent occurrence. If a required disclosure

becomes inaccurate because of an event occurring after consummation,

the inaccuracy is not a violation of this part.

(f) Minor variations. A lessor may disregard the effects of the

following in making disclosures:

(1) That payments must be collected in whole cents;

(2) That dates of scheduled payments may be different because a

scheduled date is not a business day;

(3) That months have different numbers of days; and

(4) That February 29 occurs in a leap year.

Sec. 213.4 Content of disclosures.

For any consumer lease subject to this part, the lessor shall

disclose the following information, as applicable:

(a) Description of property. A brief description of the leased

property sufficient to identify the property to the lessee and lessor.

(b) Amount due at lease signing. The total amount to be paid prior

to or at consummation, using the term ``amount due at lease signing.''

The lessor shall itemize each component by type and amount, including

any refundable security deposit, advance monthly or other periodic

payment, and capitalized cost reduction; and in motor-vehicle leases,

shall itemize how the amount due will be paid, by type and amount,

including any net trade-in allowance, rebates, noncash credits, and

cash payments in a format substantially similar to the model forms in

appendix A of this part.

(c) Payment schedule and total amount of periodic payments. The

number, amount, and due dates or periods of payments scheduled under

the lease, and the total amount of the periodic payments.

(d) Other charges. The total amount of other charges payable to the

lessor, itemized by type and amount, that are not included in the

periodic payments. Such charges include the amount of any liability the

lease imposes upon the lessee at the end of the lease term; the

potential difference between the residual and realized values referred

to in paragraph (k) of this section is excluded.

(e) Total of payments. The total of payments, with a description

such as ``the amount you will have paid by the end of the lease.'' This

amount is the sum of the amount due at lease signing (less any

refundable amounts), the total amount of periodic payments (less any

portion of the periodic payment paid at lease signing), and other

charges under paragraphs (b), (c), and (d) of this section. In an open-

end lease, a description such as ``you will owe an additional amount if

the actual value of the vehicle is less than the residual value'' shall

accompany the disclosure.

(f) Payment calculation. In a motor-vehicle lease, a mathematical

progression of how the scheduled periodic payment is derived, in a

format substantially similar to the applicable model form in appendix A

of this part, which shall contain the following:

(1) Gross capitalized cost. The gross capitalized cost, including a

disclosure of the agreed upon value of the vehicle, a description such

as ``the agreed upon value of the vehicle [state the amount] and any

items you pay for over the lease term (such as service contracts,

insurance, and any outstanding prior loan or lease balance),'' and a

statement of the lessee's option to receive a separate written

itemization of the gross capitalized cost. If requested by the lessee,

the itemization shall be provided before consummation.

(2) Capitalized cost reduction. The capitalized cost reduction,

with a description such as ``the amount of any net trade-in allowance,

rebate, noncash credit, or cash you pay that reduces the gross

capitalized cost.''

(3) Adjusted capitalized cost. The adjusted capitalized cost, with

a description such as ``the amount used in calculating your base

[periodic] payment.''

(4) Residual value. The residual value, with a description such as

``the value of the vehicle at the end of the lease used in calculating

your base [periodic] payment.''

(5) Depreciation and any amortized amounts. The depreciation and

any amortized amounts, which is the difference between the adjusted

[[Page 52260]]

capitalized cost and the residual value, with a description such as

``the amount charged for the vehicle's decline in value through normal

use and for any other items paid over the lease term.''

(6) Rent charge. The rent charge, with a description such as ``the

amount charged in addition to the depreciation and any amortized

amounts.'' This amount is the difference between the total of the base

periodic payments over the lease term minus the depreciation and any

amortized amounts.

(7) Total of base periodic payments. The total of base periodic

payments with a description such as ``depreciation and any amortized

amounts plus the rent charge.''

(8) Lease term. The lease term with a description such as ``the

number of [periods of repayment] in your lease.''

(9) Base periodic payment. The total of the base periodic payments

divided by the number of payment periods in the lease.

(10) Itemization of other charges. An itemization of any other

charges that are part of the periodic payment.

(11) Total periodic payment. The sum of the base periodic payment

and any other charges that are part of the periodic payment.

(g) Early termination--(1) Conditions and disclosure of charges. A

statement of the conditions under which the lessee or lessor may

terminate the lease prior to the end of the lease term; and the amount

or a description of the method for determining the amount of any

penalty or other charge for early termination, which must be

reasonable.

(2) Early-termination notice. In a motor-vehicle lease, a notice

substantially similar to the following: ``Early Termination. You may

have to pay a substantial charge if you end this lease early. The

charge may be up to several thousand dollars. The actual charge will

depend on when the lease is terminated. The earlier you end the lease,

the greater this charge is likely to be.''

(h) Maintenance responsibilities. The following provisions are

required:

(1) Statement of responsibilities. A statement specifying whether

the lessor or the lessee is responsible for maintaining or servicing

the leased property, together with a brief description of the

responsibility;

(2) Wear and use standard. A statement of the lessor's standards

for wear and use (if any), which must be reasonable; and

(3) Notice of wear and use standard. In a motor-vehicle lease, a

notice regarding wear and use substantially similar to the following:

``Excessive Wear and Use. You may be charged for excessive wear based

on our standards for normal use.'' The notice shall also specify the

amount or method for determining any charge for excess mileage.

(i) Purchase option. A statement of whether or not the lessee has

the option to purchase the leased property, and:

(1) End of lease term. If at the end of the lease term, the

purchase price; and

(2) During lease term. If prior to the end of the lease term, the

purchase price or the method for determining the price and when the

lessee may exercise this option.

(j) Statement referencing nonsegregated disclosures. A statement

that the lessee should refer to the lease documents for additional

information on early termination, purchase options and maintenance

responsibilities, warranties, late and default charges, insurance, and

any security interests, if applicable.

(k) Liability between residual and realized values. A statement of

the lessee's liability, if any, at early termination or at the end of

the lease term for the difference between the residual value of the

leased property and its realized value.

(l) Right of appraisal. If the lessee's liability at early

termination or at the end of the lease term is based on the realized

value of the leased property, a statement that the lessee may obtain,

at the lessee's expense, a professional appraisal by an independent

third party (agreed to by the lessee and the lessor) of the value that

could be realized at sale of the leased property. The appraisal shall

be final and binding on the parties.

(m) Liability at end of lease term based on residual value. If the

lessee is liable at the end of the lease term for the difference

between the residual value of the leased property and its realized

value:

(1) Rent and other charges. The rent and other charges, paid by the

lessee and required by the lessor as an incident to the lease

transaction, with a description such as ``the total amount of rent and

other charges imposed in connection with your lease [state the

amount].''

(2) Excess liability. A statement about a rebuttable presumption

that, at the end of the lease term, the residual value of the leased

property is unreasonable and not in good faith to the extent that the

residual value exceeds the realized value by more than three times the

base monthly payment (or more than three times the average payment

allocable to a monthly period, if the lease calls for periodic payments

other than monthly); and that the lessor cannot collect the excess

amount unless the lessor brings a successful court action and pays the

lessee's reasonable attorney's fees, or unless the excess of the

residual value over the realized value is due to unreasonable or

excessive wear or use of the leased property (in which case the

rebuttable presumption does not apply).

(3) Mutually agreeable final adjustment. A statement that the

lessee and lessor are permitted, after termination of the lease, to

make any mutually agreeable final adjustment regarding excess

liability.

(n) Fees and taxes. The total dollar amount for all official and

license fees, registration, title, or taxes required to be paid to the

lessor in connection with the lease.

(o) Insurance. A brief identification of insurance in connection

with the lease including:

(1) Voluntary insurance. If the insurance is provided by or paid

through the lessor, the types and amounts of coverage and the cost to

the lessee; or

(2) Required insurance. If the lessee must obtain the insurance,

the types and amounts of coverage required of the lessee.

(p) Warranties or guarantees. A statement identifying all express

warranties and guarantees from the manufacturer or lessor with respect

to the leased property that apply to the lessee.

(q) Penalties and other charges for delinquency. The amount or the

method of determining the amount of any penalty or other charge for

delinquency, default, or late payments, which must be reasonable.

(r) Security interest. A description of any security interest,

other than a security deposit disclosed under paragraph (b) of this

section, held or to be retained by the lessor; and a clear

identification of the property to which the security interest relates.

(s) Limitations on rate information. If a lessor provides a

percentage rate in an advertisement or in documents evidencing the

lease transaction, a notice stating that ``this percentage may not

measure the overall cost of financing this lease'' shall accompany the

rate disclosure. The lessor shall not use the term ``annual percentage

rate,'' ``annual lease rate,'' or any equivalent term.

Sec. 213.5 Renegotiations, extensions, and assumptions.

(a) Renegotiation. A renegotiation occurs when a consumer lease

subject to this part is satisfied and replaced by a new lease

undertaken by the same consumer. A renegotiation requires new

[[Page 52261]]

disclosures, except as provided in paragraph (d) of this section.

(b) Extension. An extension is a continuation, agreed to by the

lessor and the lessee, of an existing consumer lease beyond the

originally scheduled end of the lease term, except when the

continuation is the result of a renegotiation. An extension that

exceeds six months requires new disclosures, except as provided in

paragraph (d) of this section.

(c) Assumption. New disclosures are not required when a consumer

lease is assumed by another person, whether or not the lessor charges

an assumption fee.

(d) Exceptions. New disclosures are not required for the following,

even if they meet the definition of a renegotiation or an extension:

(1) A reduction in the lease charge;

(2) The deferment of one or more payments, whether or not a fee is

charged;

(3) The extension of a lease for not more than six months on a

month-to-month basis or otherwise;

(4) A substitution of leased property with property that has a

substantially equivalent or greater economic value, provided no other

lease terms are changed;

(5) The addition, deletion, or substitution of leased property in a

multiple-item lease, provided the average periodic payment does not

change by more than 25 percent; or

(6) An agreement resulting from a court proceeding.

Sec. 213.6 [Reserved]

Sec. 213.7 Advertising.

(a) General rule. An advertisement for a consumer lease may state

that a specific lease of property at specific amounts or terms is

available only if the lessor usually and customarily leases or will

lease the property at those amounts or terms.

(b) Clear and conspicuous standard. Disclosures required by this

section shall be made clearly and conspicuously.

(1) Amount due at lease signing. Except for the statement of a

periodic payment, any affirmative or negative reference to a charge

that is a part of the total amount due at lease signing under paragraph

(d)(2)(ii) of this section, such as the amount of any capitalized cost

reduction (or no capitalized cost reduction is required), shall not be

more prominent than the disclosure of the total amount due at lease

signing.

(2) Advertisement of a lease rate. If a lessor provides a

percentage rate in an advertisement, the rate shall not be more

prominent than any of the disclosures in Sec. 213.4, with the exception

of the notice in Sec. 213.4(s) required to accompany the rate; and the

lessor shall not use the term ``annual percentage rate,'' ``annual

lease rate,'' or equivalent term.

(c) Catalogs and multipage advertisements. A catalog or other

multipage advertisement that provides a table or schedule of the

required disclosures shall be considered a single advertisement if, for

lease terms that appear without all the required disclosures, the

advertisement refers to the page or pages on which the table or

schedule appears.

(d) Advertisement of terms that require additional disclosure.--(1)

Triggering terms. An advertisement that states any of the following

items shall contain the disclosures required by paragraph (d)(2) of

this section, except as provided in paragraphs (e) and (f) of this

section:

(i) The amount of any payment;

(ii) The number of required payments; or

(iii) A statement of any capitalized cost reduction or other

payment required prior to or at consummation, or that no payment is

required.

(2) Additional terms. An advertisement stating any item listed in

paragraph (d)(1) of this section shall also state the following items:

(i) That the transaction advertised is a lease;

(ii) The total amount due at lease signing, or that no payment is

required;

(iii) The number, amounts, due dates or periods of scheduled

payments, and total of such payments under the lease;

(iv) A statement of whether or not the lessee has the option to

purchase the leased property, and where the lessee has the option to

purchase at the end of the lease term, the purchase-option price. The

method of determining the purchase-option price may be substituted in

disclosing the lessee's option to purchase the leased property prior to

the end of the lease term;

(v) A statement of the amount, or the method for determining the

amount, of the lessee's liability (if any) at the end of the lease

term; and

(vi) A statement of the lessee's liability (if any) for the

difference between the residual value of the leased property and its

realized value at the end of the lease term.

(e) Alternative disclosures--merchandise tags. A merchandise tag

stating any item listed in paragraph (d)(1) of this section may comply

with paragraph (d)(2) of this section by referring to a sign or display

prominently posted in the lessor's place of business that contains a

table or schedule of the required disclosures.

(f) Alternative disclosures--television or radio advertisements.--

(1) Toll-free number or print advertisement. An advertisement made

through television or radio stating any item listed in paragraph (d)(1)

of this section complies with paragraph (d)(2) of this section if the

advertisement states the items listed in paragraphs (d)(2)(i) through

(iii) of this section, and:

(i) Lists a toll-free telephone number along with a reference that

such number may be used by consumers to obtain the information required

by paragraph (d)(2) of this section; or

(ii) Directs the consumer to a written advertisement in a

publication of general circulation in the community served by the media

station, including the name and the date of the publication, with a

statement that information required by paragraph (d)(2) of this section

is included in the advertisement. The written advertisement shall be

published beginning at least three days before and ending at least ten

days after the broadcast.

(2) Establishment of toll-free number. (i) The toll-free telephone

number shall be available for no fewer than ten days, beginning on the

date of the broadcast.

(ii) The lessor shall provide the information required by paragraph

(d)(2) of this section orally, or in writing upon request.

Sec. 213.8 Record retention.

A lessor shall retain evidence of compliance with the requirements

imposed by this part, other than the advertising requirements under

Sec. 213.7, for a period of not less than two years after the date the

disclosures are required to be made or an action is required to be

taken.

Sec. 213.9 Relation to state laws.

(a) Inconsistent state law. A state law that is inconsistent with

the requirements of the act and this part is preempted to the extent of

the inconsistency. If a lessor cannot comply with a state law without

violating a provision of this part, the state law is inconsistent

within the meaning of section 186(a) of the act and is preempted,

unless the state law gives greater protection and benefit to the

consumer. A state, through an official having primary enforcement or

interpretative responsibilities for the state consumer leasing law, may

apply to the Board for a preemption determination.

(b) Exemptions.--(1) Application. A state may apply to the Board

for an

[[Page 52262]]

exemption from the requirements of the act and this part for any class

of lease transactions within the state. The Board will grant such an

exemption if the Board determines that:

(i) The class of leasing transactions is subject to state law

requirements substantially similar to the act and this part or that

lessees are afforded greater protection under state law; and

(ii) There is adequate provision for state enforcement.

(2) Enforcement and liability. After an exemption has been granted,

the requirements of the applicable state law (except for additional

requirements not imposed by federal law) will constitute the

requirements of the act and this part. No exemption will extend to the

civil liability provisions of sections 130, 131, and 185 of the act.

Appendix A to Part 213--Model Forms

A-1 Model Open-End or Finance Vehicle Lease Disclosures

A-2 Model Closed-End or Net Vehicle Lease Disclosures

A-3 Model Furniture Lease Disclosures

BILLING CODE 6210-01-P

[[Page 52263]]

[GRAPHIC] [TIFF OMITTED] TR07OC96.006

[[Page 52264]]

[GRAPHIC] [TIFF OMITTED] TR07OC96.007

[[Page 52265]]

[GRAPHIC] [TIFF OMITTED] TR07OC96.008

[[Page 52266]]

[GRAPHIC] [TIFF OMITTED] TR07OC96.009

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[GRAPHIC] [TIFF OMITTED] TR07OC96.010

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[GRAPHIC] [TIFF OMITTED] TR07OC96.011

BILLING CODE 6210-01-C

[[Page 52269]]

Appendix B to Part 213--Federal Enforcement Agencies

The following list indicates which federal agency enforces

Regulation M (12 CFR Part 213) for particular classes of business.

Any questions concerning compliance by a particular business should

be directed to the appropriate enforcement agency. Terms that are

not defined in the Federal Deposit Insurance Act (12 U.S.C. 1813(s))

shall have the meaning given to them in the International Banking

Act of 1978 (12 U.S.C. 3101).

1. National banks and federal branches and federal agencies of

foreign banks

District office of the Office of the Comptroller of the Currency

for the district in which the institution is located.

2. State member banks, branches and agencies of foreign banks (other

than federal branches, federal agencies, and insured state branches

of foreign banks), commercial lending companies owned or controlled

by foreign banks, and organizations operating under section 25 or

25A of the Federal Reserve Act

Federal Reserve Bank serving the District in which the

institution is located.

3. Nonmember insured banks and insured state branches of foreign

banks

Federal Deposit Insurance Corporation Regional Director for the

region in which the institution is located.

4. Savings institutions insured under the Savings Association

Insurance Fund of the FDIC and federally chartered savings banks

insured under the Bank Insurance Fund of the FDIC (but not including

state-chartered savings banks insured under the Bank Insurance Fund)

Office of Thrift Supervision regional director for the region in

which the institution is located.

5. Federal credit unions

Regional office of the National Credit Union Administration

serving the area in which the federal credit union is located.

6. Air carriers

Assistant General Counsel for Aviation Enforcement and

Proceedings, Department of Transportation, 400 Seventh Street, S.W.,

Washington, DC 20590

7. Those subject to Packers and Stockyards Act

Nearest Packers and Stockyards Administration area supervisor.

8. Federal Land Banks, Federal Land Bank Associations, Federal

Intermediate Credit Banks, and Production Credit Associations

Farm Credit Administration, 490 L'Enfant Plaza, S.W.,

Washington, DC 20578

9. All other lessors (lessors operating on a local or regional basis

should use the address of the FTC regional office in which they

operate)

Division of Credit Practices, Bureau of Consumer Protection,

Federal Trade Commission, Washington, DC 20580

Appendix C to Part 213--Issuance of Staff Interpretations

Officials in the Board's Division of Consumer and Community

Affairs are authorized to issue official staff interpretations of

this Regulation M (12 CFR Part 213). These interpretations provide

the formal protection afforded under section 130(f) of the act.

Except in unusual circumstances, interpretations will not be issued

separately but will be incorporated in an official commentary to

Regulation M (Supplement I of this part), which will be amended

periodically. No staff interpretations will be issued approving

lessor's forms, statements, or calculation tools or methods.

Supplement I to Part 213--[Amended]

4. The Supplement to part 213 is amended by revising the heading to

read as follows:

Supplement I to Part 213--Official Staff Commentary to Regulation M

Note: Appendix I will not appear in the Code of Federal

Regulations.

Appendix I to the Preamble--Regulatory Flexibility Analysis

I. Introduction

Acquiring and financing a substantial asset through purchase credit

or a lease contract ranks among the most complicated financial

transactions a typical consumer undertakes. In fundamental economic

terms, however, a consumer's decision whether to lease rather than use

more traditional forms of credit is relatively straightforward. Stating

the problem in its simplest form, a consumer should lease an asset

rather than purchase it on credit if the discounted present cost of all

the lease payments and outflows (including down payments and any

deferred payment for a residual value where relevant) is less than the

present cost of all outflows for the credit purchase over a comparable

period of leasing or ownership.

Unfortunately, difficulties arise that make this criterion less

than straightforward for many consumers. One problem is properly

accounting for the streams of outflows--including acquisition charges,

down payments, periodic payments, disposal charges, taxes, insurance

premiums, and other outflows--that can differ in both timing and

amounts under the two financing alternatives. A more basic concern is

that consumers do not typically think in terms of present values,

discount rates, and other elements of financial economics that are

second nature to the financial analyst, even though present value is

the index that brings asset acquisitions under different financing

schemes into the same framework.

To help satisfy concerns that individuals did not have the

necessary information available to make lease versus purchase decisions

wisely, Congress in 1976 mandated consumer disclosures for leases by

passing the Consumer Leasing Act. Structurally, the Consumer Leasing

Act is an amendment to the Truth-in-Lending Act, which Congress

established as a basic consumer protection in 1968. A recurring

question since then is whether the Truth-in-Lending Act generally,

including the Consumer Leasing Act component (which is unchanged since

passage), meets the needs of consumers in today's marketplace.1

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\1\ Congress itself is reviewing this question in the 1995-6

session as members in each house have introduced bills to amend both

Truth in Lending and the Consumer Leasing Act.

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This paper examines current and proposed disclosure requirements

for vehicle leasing, the largest segment of the leasing industry

subject to consumer disclosure requirements, in light of consumers'

information needs--including what is necessary to calculate present

values, the method of comparison that places all financing methods on

the same footing. First, Section II looks briefly at types of

automobile leases commonly available in today's marketplace and notes

some important characteristics. Section III then reviews the cash flows

that arise under the most common form of consumer automobile-leasing

arrangement, the closed-end operating lease, and specifies a present

value equation that consumers might use to analyze their leasing

decisions. Finally, Section IV examines staff proposals to revise the

disclosure requirements in Regulation M, the regulation that implements

the Consumer Leasing Act, in view of consumers' information needs and

the regulatory burdens that the proposed changes would entail.

II. Kinds of Leases

As the leasing market has evolved over the years, the closed-end

operating lease has become typical in consumer transactions, at least

in the big market for automobiles and light trucks. An ``operating

lease'' covers a period of time shorter than the whole economic life of

an asset. There is an expectation that an asset will still have an

economic value (usually called its ``residual value'') at the end of an

operating lease. With an operating lease, an asset user (lessee) agrees

to pay for the expected depreciation of an asset during the lease

period, plus a financing or lease charge to compensate the owner

(lessor) for the use of the lessor's capital, including a

[[Page 52270]]

profit. Common car rentals or apartment leases are examples of short-

term operating leases.

Also increasingly familiar today are longer-term operating leases

(possibly up to 4-5 years) that auto dealers offer consumers through

leasing companies and banks. These operating leases have become

important substitutes for purchase financing for consumers and are

widely advertised by both automobile manufacturers and dealers. Like a

car renter or apartment lessee, a vehicle lessee under these plans uses

the asset for a term but must return it to the lessor at the end of the

lease period (unless the parties make some other arrangement for

disposition). An operating lease always assumes the asset will have

some remaining economic life and value at lease end. Consequently,

transfer of ownership at lease end (to the lessee or another party)

requires additional payment for the residual value.2

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\2\ The alternative to an operating lease is a ``full-payout''

or ``financial'' lease, which finances the whole economic life of an

asset by fully paying for (amortizing) the asset's capitalized cost,

plus financing charges. Financial leases are not common in consumer

leasing; they are more common in commercial leases and sale-

leaseback transactions involving industrial buildings and equipment.

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Among operating leases for consumers, the ``closed-end'' operating

lease, sometimes referred to as a ``walk-away'' lease, has become the

most common form of automobile lease agreement. On a closed-end

operating lease the lessee has no obligation concerning the market

value of the lessor's asset at lease end. The agreement merely requires

the consumer to return the asset at lease end and to pay then for any

excess damage above normal expected wear and tear.3 Common, long-

term, closed-end lease agreements for automobiles and trucks typically

contain an option for consumers to purchase their vehicles at lease end

at a price agreed upon at the outset, but there is no obligation to

purchase.

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\3\ There may be a refundable security deposit to guarantee

payment for damages. For automobiles there may also be a small

``disposition'' or ``drop off'' charge specified in the contract.

The typical automobile lease contract also specifies a yearly

average mileage limit to avoid having charges for excess usage

collected at lease end.

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The closed-end operating lease contrasts with the less common

``open-end'' operating lease where the lessee still does not have a

requirement to purchase but where there is an obligation at lease end

to make up to the lessor any shortfall in the actual market value of

the asset from expectations. In effect, the open-end lessee guarantees

the residual value of the lessor's asset. Under typical open-end

automobile lease contracts, consumer lessees also may purchase their

vehicles at lease end for a purchase price guaranteed at the outset,

but open-end lessees cannot walk away. Rather, if they return their

vehicles, they are liable for any differences between assumed residual

values and actual, realized market values at lease end.4

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\4\ The Consumer Leasing Act limits a consumer's liability for

the difference between expected and actual market value on an open-

end vehicle lease to no more than three times the amount of the

monthly payment. This provision likely has encouraged the use of

closed-end leases by making open-end leases less useful to lessors

as a way of shifting risks to their customers.

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From this description it is easy to see that the embedded fixed-

price purchase options in common, closed-end operating leases for

vehicles present consumers with different risk characteristics on their

transaction than purchase financing. Closed-end lessees do not bear any

risk of decline in the residual value of used assets below expectations

over the lease period, but open-end lessees and purchasers do. If at

lease end the value of the asset is below the deferred purchase price

set at the outset, the closed-end lessee may return the asset and walk

away. If, in contrast, the market value at lease end is greater than

expected, the lessee may keep the asset by paying the deferred purchase

price agreed upon at the signing of the lease and can retain it or sell

it. For the closed-end lessee this amounts to a ``heads I win, tails

you lose'' proposition, at least with respect to the residual value of

the asset. It seems reasonable to suppose that lessors will charge

closed-end lessees for the purchase option feature that transfers the

residual-value risk to the lessor. Purchasers and open-end lessees bear

this risk themselves. Ultimately, it is this difference in risk

bearing, together with differences in the size and timing of cash flows

(discussed in the next section), that characterizes the distinction for

consumers between leasing and purchase financing.

III. Cash Flows

Before examining proposals for disclosures on consumer vehicle

leases, there is some usefulness in examining the cash flows that arise

from lease and purchase-financing contracts. Ultimately, it is

comparison of the present values of the outflows that arise under the

different financing schemes that resolves the question of best choice.

In the long run in a competitive, perfect capital market with full

information and without transaction costs or taxes, the type of

financing arrangement for retail purchase of automobiles by consumers

would be a matter of indifference to both consumers and creditors/

lessors: both costs to consumers and yields to creditors and lessors

would be the same under the two financing alternatives. Clearly,

capital markets are not perfect, however. First of all, there are

transaction costs that may differ between leasing and debt financing.

Also, taxes may differ between consumers and lessors, as well as

between financing schemes, and there may be risk differences among

consumers and among types of transactions. On occasion there also may

be marketing promotions that encourage one transaction form over the

other. Consequently, at different times leasing may be more or less

advantageous than purchase financing to either consumers or creditors/

lessors, and both consumers and creditors/lessors have an interest in

evaluating the alternatives.

Fundamentally, consumers should choose a closed-end operating lease

instead of debt financing only if the present value of all the costs

(outflows) arising from the lease (including any down payment) is less

than the present value of outflows resulting from the credit purchase

over a comparable period of leasing or ownership.5 The present

value of the purchase option embedded in a closed-end operating lease,

which the consumer also pays for as part of the lease payments, must be

subtracted from the present value of the lease payments in order to

maintain comparability between the packages of transportation-related

services purchased. This presents the following decision criterion:

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\5\ Although the discussion here concerns comparing a lease with

a purchase, comparing two leases or two purchases would proceed in

fundamentally the same way.

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If Sum PV (LP)-PV (Option) 0, then lease.

(1)

To analyze the decision, a consumer should discount the leasing

flows at the annual percentage rate available on the credit purchase or

loan. If the discounted present value of the credit flows (which equals

the purchase price) plus the present value of the option is greater

than the discounted present

[[Page 52271]]

value of the leasing flows, then leasing is the better choice and vice

versa.6

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\6\ Because discounting the flows from a financed purchase at

the annual percentage rate paid for the credit equals the price of

the asset, substituting the price of the asset for the discounted

present value of the finance flows produces a standard net advantage

of leasing (NAL) equation (see Myers, Dill, and Bautista [1976]).

Substituting into equation 1 produces the decision criterion:

If NAL = Purchase Price (FP) + PV (Option) - Sum PV (LP) > 0,

then lease.

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Leaving aside the question whether consumers understand present

values and the discounting process, the difficult matter in analyzing

the decision is to specify the flows properly for the two kinds of

arrangements. Typically, they will differ in form, timing, and amount.

Also, valuing the purchase option available on a closed-end lease might

become an important aspect of the decision.7

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\7\ As a practical matter, the value of this option may not be

very great to the extent that lessors are reasonably competent in

predicting values of used assets in the future and set residual

values and optional purchase prices at lease end accordingly.

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Table 1 provides a listing of the four possible patterns of cash

outflows arising from (1) a closed-end lease and (2) a purchase

agreement for an automobile. For the lessee there are two possibilities

at lease end: the lessee may return the vehicle to the dealer or may

exercise the purchase option and buy it. For the credit purchaser there

are also two possibilities at the end of the payment period: the owner

can keep the vehicle or sell it. The table adopts the convention that

outflows are positive and inflows negative; thus, the table expresses

net costs of the transactions.

Initial Flows. Under this convention, the consumer receives from a

lease or a financed purchase an inflow (negative cost) of

transportation and other services from the vehicle during the period

covered by the agreement.8 Over comparable time periods the

transportation services are assumed to be independent of the financing

method (line 1 of Table 1).9

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\8\ Services provided by the vehicle may also include

psychological services such as pride of ownership or opportunity to

drive a new or stylish automobile or truck, and in the past these

psychological services may have varied depending on whether the

transaction was a purchase with financing or was a lease. For

example, it is possible that at least some drivers felt better

thinking they ``owned'' a vehicle rather than they merely leased its

services. Leasing has recently become such a common financing

alternative, however, that it seems reasonable to assume that these

psychological services are similar for purchase financing and

leasing today and that they are of comparable value. Differences

that may have existed formerly may be ignored today.

\9\ Transportation services may differ between the leasing and

the purchase financing cases if the amount of yearly mileage

permitted under a lease without an additional mileage charge

(typically 12,000 or 15,000 miles per year, but with variations)

constrains the potential purchaser. For illustrative purposes this

limitation is assumed not to be binding so that transportation

services provided by the leased and financed vehicles are the same

for this example. If the constraint were binding because the

potential lessee intends to drive more than the yearly maximum, then

another term for the present value of the expected deferred excess

mileage charge due at lease end would be added to column 2 of the

table.

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Some of the initial outflows arising from the two alternative

financing methods will also be the same between the alternatives, but

some will differ. For both types of financing the consumer agrees to a

series of outflows to satisfy the payment obligation. Frequently, the

first of these is a trade-in of a vehicle already owned by the consumer

(line 2 in the table). With the assumption that the consumer trades in

the same vehicle under both financing schemes, the trade-in is the same

under the two alternatives; this is denoted in the table by equal signs

between columns.

Often the trade in is accompanied by a cash down payment (line 3).

(On a lease the down payment and the trade in are often called the

``capitalized cost reduction.'' In Table 1 this term applies to the

cash component.) A lessee typically must also provide a security

deposit, which often approximates one monthly payment on the lease

obligation (line 4). Upon satisfaction of the lease agreement this

security deposit is refunded at lease end (line 5).

Periodic Flows. In addition to these initial outflows, the consumer

is also obligated for a series of further cash payments over the

agreement period, usually monthly (line 6). On a lease the first

payment typically is due at signing, while a credit-purchase agreement

normally defers the first payment for a month. In many jurisdictions

vehicle owners are also subject to personal property taxes on their

vehicles owned or ``garaged'' within tax districts such as counties or

states (line 7). On a lease in some jurisdictions the lessor may be

responsible for these taxes, which it recoups by upping the necessary

periodic payments. Consequently, for lessees the flows for personal

property taxes may not appear as a separate, explicit outflow on a

lease in many tax jurisdictions, even if personal property taxes are

explicit for financed purchases. For comparability with a credit

purchase, therefore, either the taxes in these jurisdictions must be

subtracted from the lease payments or added to the finance

payments.10

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\10\ Identifiable personal property taxes may be deductible from

adjusted gross income for federal and state income tax purposes for

some consumers, which also should be properly taken into account by

those eligible for the deduction. There also may be sales taxes

associated with both the credit purchase and the lease. For

comparing a purchase to a lease, both must be accounted for properly

to avoid erroneous conclusions. For example, on a purchase sales

taxes may be financed as part of the gross purchase price and paid

for through the down payment and periodic payment flows. On a lease

they may be collected monthly as part of the monthly payment, either

explicitly or not. Each of these possibilities requires an

adjustment in the table to account properly for the facts of

individual situations.

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End-of-Term Flows. End-of-term outflows also differ between

purchasing and leasing. In the credit purchase case the consumer owns

the vehicle at the end of the financing period and holds the right to

continued transportation services over the additional expected life of

the vehicle; with a lease the consumer does not have this right. To

compare a lease with purchase financing, it is necessary to account for

the remaining transportation services at lease end.

One possibility, of course, is that the consumer purchases the

leased vehicle at the end of the lease period, thereby obtaining the

remaining transportation services. On a typical closed-end lease the

consumer obtains the vehicle and its remaining services by purchasing

it at the optional purchase price disclosed in the original lease

agreement, or at some other price negotiated between the parties. This

price becomes another outflow (line 8), this one deferred until the end

of the lease period.11

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\11\ This purchase price may also be financed, in which case the

price becomes another stream of outflows. The lessor and lessee may

also agree to another lease or to a continuation of the old lease

agreement. The examples in the table do not reflect these

possibilities.

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Because the lessee does not have to make the decision whether or

not to retain the vehicle until the end of the lease period, at the

outset the deferred decision amounts to a call option for the lessee,

and, as noted previously, this option has value because it transfers

risks of residual price fluctuations to the lessor. In effect, when

lessees contract for the services of vehicles, they obtain options to

call the residual values of their vehicles at the end of the leases by

paying at lease end a deferred optional purchase price agreed at the

outset. This differentiates the lessee from the credit purchaser who

owns the vehicle and bears all of the residual price risk. To maintain

comparability with a purchase, the present value of this option must be

subtracted from the present value of the lease costs or added to the

present value of the purchase-finance costs (see equation 1, above).

The other possibility is that the consumer returns the vehicle to

the lessor at lease end, thereby giving up any claim to transportation

services

[[Page 52272]]

remaining in the vehicle. In this case the lessee returns the vehicle

and pays any drop-off or disposition charge in the contract (line 9),

but not any optional purchase price (line 8 is zero in this

case).12

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\12\ The lessee still acquires the purchase option, even if the

ultimate decision is to return the vehicle at lease end, and so the

present value of the option remains a term in equation 1, above.

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Purchasers who sell their vehicles receive a wholesale selling

price upon sale (line 10 in the table). Those who sell them privately

and not to a dealer may receive an amount closer to the retail price

(if the cars are in good condition), less, of course, their costs of

selling, including advertising expenses and the costs of personal time

spent on the sale process (and subjective personal costs of any

accompanying aggravations).

Contingencies. Two contingencies might lead to additional outflows.

First, there is a chance that a vehicle may be worth more or less at

the time of eventual disposition than the consumer expects at the

outset, which may be important to the consumer in some cases. If the

consumer expects to purchase the vehicle at lease end or plans to

retain the vehicle at the end of the purchase finance period, however,

planned disposition likely will take place long enough into the future

that the consumer may well not have at the outset any expectation about

the value many years hence. If so, this contingency probably need not

enter into the present value calculations at the outset of the

transaction (or into columns 1 or 3 of Table 1).13

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\13\ Even if there is a recognized prior probability of deferred

gain or loss, there is no reason to expect a difference if original

acquisition is through a lease or purchase contract. If loss

expectations are equal at the outset, they can be ignored in the

calculations (and the table) when making comparisons.

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In the other situation, that is, if the consumer does not intend to

retain the vehicle at lease end or plans to sell the purchased auto,

the time before expected disposition is shorter and unexpected loss may

become a factor in decision making. For the closed-end lessee the

lessor bears this risk; the value to the consumer of avoiding the loss

is subsumed into the value of the call option on the vehicle's residual

value. Thus, of the four cases only the purchaser who plans to sell the

vehicle upon completion of the payments is subject to this potential

risk (column 4 on line 11 in the table).14

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\14\ For such a purchaser who plans to sell there is the real

possibility of an unexpected loss upon disposition of the vehicle,

but there may also be an unexpected gain. If the likelihood of the

loss or gain is unknown at the outset of the lease arrangement, it

might be argued that the expected value of the distribution of

possibilities may well be zero, arguing for its dismissal from the

calculations and the table. Because the risk of loss exists,

however, an expected value of loss upon disposition is a potential

outflow for a purchaser (column 4, line 11).

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A second contingency is the chance of a loss upon an early

termination of the lease or upon a sale of the vehicle before the end

of the credit-purchase agreement period. A loss on early termination

might occur following theft or an accident not fully covered by

insurance, or because the consumer desires to change vehicles before

the end of the lease or purchase financing agreement. For both lessees

and purchasers this risk is independent of plans to retain the vehicle

or not at the end of the payment period and can be assumed equal for

all lessors or all purchasers (indicated by equal signs on line 12 of

Table 1). Since a loss (outflow) is more likely than an unexpected gain

under these circumstances, however, the expected value is probably

positive. To minimize the size of such losses for lessees in the cases

of accident or theft (and the financial and legal difficulties that

might arise) ``gap insurance'' often is available from lessors,

typically included as part of the leasing transaction and charge. For

most consumers, though, either the prior probability of unexpected

early termination (and, consequently, the expected value of any

associated loss) is probably small enough in the consumer's mind at the

outset of the transaction, or the expectation of a difference in loss

size in this area between leasing and purchase financing is probably

small enough, that expectation of a loss on early termination is

probably not much of a factor in the choice between leasing and

financing.15

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\15\ This is not an argument against required disclosure of the

existence of such a risk, however.

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Now, the quantities in Table 1 can be substituted into equation 1

to derive the net advantage of leasing, first, for the case where the

consumer keeps the vehicle at lease end (equation 2); and, second, for

the situation where the consumer does not retain the vehicle (equation

3).

To ease solution, a few simplifications of the equations are

possible. First, because Transportation Services (line 1 of Table 1)

are assumed to be the same for comparable periods of ownership and

lease holding, they may be ignored and omitted from the equations.

Likewise, since the trade in is the same (line 2), it may also be

dismissed. Third, if the expected value of the loss from an early

termination (line 12) either is not very large or does not differ much

between a financed purchase and a lease, it also can drop from the

equation, since it is the difference between these quantities for a

financed purchase and a lease which would enter the equation anyway.

Thus, with these assumptions and recalling that leases but not

purchases commonly require one monthly payment in advance, this leaves

the following specifications for equations 2 and 3 for finance and

lease periods of N months:

(2), (3): See Equations (2) and (3) at the End of the Analysis

These equations exhibit some features that should receive special

mention. First, as discount rates move higher but other things are

equal, leasing becomes relatively more attractive. Specifically, in the

case where the vehicle is retained (equation 2), higher discount rates

make leasing more attractive because higher discount rates relatively

reduce the discounted future purchase price of the leased vehicle. This

decreases the second (subtracted) term in equation 2 (the term in

square brackets), tending the equation toward a positive value favoring

leasing. In contrast, where the vehicle is not retained at contract end

(equation 3), higher discount rates favor leasing for a different

reason. In this case as the discount rate rises, it relatively

decreases the present value of the sale price of the vehicle in the

future. Since this is a subtracted item in the first part of the

equation, higher discount rates again increase the likelihood that the

equation will be positive, again tending to favor leasing relatively.

Second, the non-retention case (equation 3) requires a term, the

future sale price of the vehicle, that is not known at the outset of

the transaction. Even if an expected used car price some time in the

future is available from some guidebook, there is no certainty

concerning this price, and there is no certainty about advertising,

sales and aggravation costs that properly should reduce the final sales

price. Consequently, equation 3 requires some estimating and cannot

serve as a definitive guide.

Third, both equations 2 and 3 contain a term for the discounted

value of the purchase option available on a closed-end operating lease.

Estimating the value of this option is not a simple matter, although

its value may not be very great to the extent that experienced

automobile dealers are reasonably proficient at estimating the values

of used vehicles some time into the future.

In sum, a consumer's informed choice whether to lease or purchase

an asset like a vehicle depends on the amount and pattern of the stream

of outflows

[[Page 52273]]

and on the discount rate that converts the stream of outflows to

present values. Unfortunately, presence in a closed-end lease of a

purchase option with unknown value and consumer uncertainty about

future used-car prices mean that the single-equation optimal decision

criterion will always contain multiple unknowns and be insoluble

mathematically, even if the discount rate is known. Consequently, the

search is not for the perfect set of disclosures, but rather for the

set that enables most consumers to make good decisions most of the

time.

IV. Required Disclosures

Staff proposals to revise Regulation M would make substantial

changes to the format and content of required disclosures on consumer

leases. In analyzing this (or any) disclosure regime, a few general

principles seem useful:

(1) The goal of a disclosure scheme should be to make available

sufficient information that consumers can make good decisions, not to

require every disclosure that might possibly be useful to someone,

sometime, for some purpose. No disclosure scheme, it seems, will ever

be able to insure that all consumers understand everything or that they

never have to read contracts or make any calculations for themselves.

Required disclosures can be used to compare features of transactions,

but cannot reasonably be specific to individuals whose situations will

differ.

(2) Whenever possible, disclosures should discourage obvious

opportunities for abuses.

(3) Regulatory requirements (and changes in requirements) should

maintain a reasonable balance between costs and benefits.

(4) Transaction-specific disclosures are the most costly and should

demonstrate clear benefits.

Avoiding the issue whether the Consumer Leasing Act itself

satisfies these requirements, it appears that the proposed redrafted

Regulation M does so, within the constraints of the law. The redrafted

regulation mandates that lessors make substantial changes in the format

and content of required disclosures, but it seems that the new approach

will improve the quality and accessibility of useful information to

consumers. Furthermore, much of the leasing industry supports the bulk

of the proposed changes.

It does not seem, however, that any leasing-disclosure scheme can

provide all of the information required for consumers to solve

equations 2 or 3 for the theoretically correct choice between a lease

and a financed purchase. First of all, leasing disclosures cannot

reasonably be expected to provide information about the purchase-

financing alternative to a lease, which is necessary to solve either

equation. Consumers would have to obtain this information themselves by

shopping, even if this merely means obtaining the necessary information

from the same dealer. Second, some information like personal property

taxes and an individual's personal tax situation are idiosyncratic to

each shopper and must be factored into the purchase or lease decision

by that person. Third, as already mentioned, both equations 2 and 3

require some information, such as future prices of used vehicles and

the present value of the purchase option, that is not readily available

to either party to the transaction except by crude estimation.

For these reasons, it does not seem reasonable to expect that any

disclosure scheme will provide all the information that a consumer

might find useful; it simply is not possible. Nonetheless, most of the

information that consumers might need to characterize a lease is

available from the required disclosures. Moreover, the new disclosure

scheme should make this information easier for consumers to comprehend

and use.

The proposed regulation redraft does require disclosures of some

transaction-specific numerical quantities beyond those mandated by the

statute, which is quite detailed. In those cases where the proposed

redraft extends the law it appears, for the most part, to respond to

consensus of both industry and consumerist comments that such

requirements would be useful. Except for the quantity called the

``total of payments,'' all of the new numeric disclosures are amounts

that lessors already calculate and have readily available. For this

reason disclosing most of these additional quantities, even though not

required by statute, may not by itself cause substantial marginal cost

as part of a complete revamping of the disclosure regime. Proposed

major changes to the regulation include the following:

(1) Formatting Changes. The new disclosure plan will require

substantial changes in disclosure format for all lessors. Especially

notable are first, the requirements for segregation of a group of key

disclosures in a highlighted ``federal box''; and second, disclosure of

elements that comprise the monthly payment in a mathematical

progression. Although a segregated ``federal box'' of disclosures and a

mathematical progression are not required by the statute, they follow

the general approach for credit disclosures that became part of

Regulation Z under the Truth-in-Lending Act amendments of 1980. Third,

staff also proposes requiring a new format for itemization of the

amount due from the consumer at inception of the lease, disclosures

already required. Under the proposed format in this area, itemization

of amounts due at signing would be in two columns, one listing amounts

due at signing and the other designating means of paying the itemized

costs.

It appears that the proposed new requirements for formatting in all

three areas could help consumers become aware of important terms

without searching through the contract, as is sometimes necessary

today. At present, Regulation M contains no placement requirement for

the key disclosures except that they be clear, conspicuous, in

meaningful sequence, and that they be on the same page and above the

lessee's signature. Otherwise, lessors may spread the disclosures

through the contract document. For disclosing monthly payments, the

current requirement is disclosure of the total amount required plus

identification of the components; the regulation does not currently

require disclosure of the amounts of the individual components,

although some lessors have disclosed amounts of components and there

has been some confusion concerning exactly what is required.

Presentation of a mathematical progression should help interested

consumers understand the intricacies of their transactions. The new

requirement for placement of disclosures of amounts due at lease

signing should help clarify questions consumers may have about any of

these quantities.

Even though the proposed format of the segregated key disclosures,

the mathematical progression, and the amounts due at lease signing are

not required by the Consumer Leasing Act, comments from the automobile

leasing industry largely support such requirements. The automobile

leasing industry originally proposed both the segregated key

disclosures and the mathematical progression to the monthly payment,

and industry comment letters have strongly favored them since. The new

requirement for a two-column disclosure of amounts due at lease signing

merely calls for a reorganization of current disclosures.

In all three areas the new disclosure placement requirements would

replace the current mandates concerning type size, sequencing, and

placement on the same page as the lessee's signature. In the past these

requirements have, on occasion, caused lessors some difficulties in

form design anyway.

[[Page 52274]]

Sufficient lead time before a mandatory compliance date could minimize

any disruptions caused by the necessity of redesigning and reprinting

disclosure forms and of reprogramming computer systems to print the new

forms. In addition, staff has proposed new model disclosure forms with

segregated disclosures and mathematical progression. Use of these model

forms ensures compliance and provides a safe harbor from liability if

the form is used properly.

(2) New Disclosures Associated with the Mathematical Progression

Leading to the Monthly Payment. As indicated above, the revised

regulation also requires some new disclosures. They include disclosure

of gross capitalized cost, adjusted capitalized cost, residual value,

rent charge, and total of payments. Except for total of payments, these

new disclosures arise as components of a mathematical progression

leading to the monthly payment. There are also requirements for

calculating and disclosing certain subtotals. Gross capitalized cost is

analogous to gross purchase price including lease acquisition charges,

carried-over balances on any previous transactions, initial taxes owed,

registration fees, delivery charges, and any after-market products such

as extended warranties. Adjusted capitalized cost is gross capitalized

cost less ``capitalized cost reductions'' including trade-in

allowances, cash down payments, rebates, and any other reductions. The

residual value of the lease is the estimated value of the asset at

lease end. The rent charge is the lessor's added-on charge to cover

transaction costs and the charge for capital use, including any profit

from financing.

Lessors determine periodic payments by subtracting the capitalized

cost reductions and lease residual from the gross capitalized cost and

adding the rent charge. They then divide the resulting quantity by the

number of periods to determine the size of the base periodic payments,

excluding any added amounts for taxes and insurance. Thus, each of

these new d

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