Is the rapid growth in car loans and finance deals a ‘slow motion car crash’ waiting to happen? This is the question being posed by the City regulator – the Financial Conduct Authority (FCA) – as it begins to scrutinise this industry. It emerged this week that the FCA is also in discussions with US authorities about this issue.
The growth of these credit deals also appeared in the Bank of England’s financial stability report – published this week. These noted concerns over the surge in consumer credit over the past five years, pointing out that car finance now makes up almost 30% of this debt. These outstanding car loans are estimated to be worth some £58 billion.
Consumer debt is growing at a rate of 10.3% a year. Within that car finance is growing at 15% a year – this compares to just a 9% growth in credit card debt, and a 7% increase in personal loans.
Much of this growth is fuelled by so-called ‘personal contract plans’ offered by car dealerships. The Bank of England’s figures show that 85% of all new cars were bought through such deals – compared with just 50% of new car sales back in 2009.
It is not hard to see why these personal contract plans are appealing. They only require a low deposit – usually of around £100. Borrowers then make monthly payments, which can be as low as £100. Unlike a conventional hire purchase plan though, these payments are not gradually paying off the cost of the car. Instead they cover the depreciation in the car’s value.
Most of these deals are three-year plans. At the end of the term borrowers have the option of paying a one-off fee to purchase the car outright, or simply handing the car back and upgrading it for a newer model, via a new PCP.
Could PCPs Cause Next Credit Crisis?
Andrew Bailey, chief executive of the Financial Conduct Authority said the FCA wanted to understand what was going on in this car finance market – and whether, structurally, it was now more like a secured lending market (such as mortgages) rather than unsecured personal debt.
Speaking to the British Bankers Association he said: “What’s going on here? Does it mean there are more cars of [has] the form of financing changed.” He said he believed it was the latter, and that his hunch was that the market was now more akin to secured lending markets.
The question for regulators is that whether people would prioritise these loans if – and when – interest rates rise. Or whether they would simply hand back the car keys leaving lenders with huge unpaid debts – with the potential to cause further problems in the credit market.
Mark Carney – governor of the Bank of England – pointed out that unlike many products bought on credit “people need their cars in general” so are more likely to keep up repayments, even if the cost rises.
However, he said that if used car prices fall by 30% - the worst-case scenario modelled by the bank – this could mean hundreds of thousands of motorists handing back vehicles, which could create an issue for the lending industry. At this level, the bank estimated it could knock 0.1% percentage points off the capital ratios of banks.
Downturn In Car Prices “Factored Into” Finance Deals
Adrian Dally, head of motor finance at the Finance and Leasing Association said that that worst-case scenario modelled by the bank was outside any previous fall seen in used car prices – even during previous economic downturns.
George Galliers, an auto industry analyst at Evercore added: “Manufacturers offering PCPs look at what the value of the car is likely to be at the end of the PCP and offer something lower.
“Say they think it will be worth £12,000, then they say it is £10,000. It gives them a ‘buffer’ against a fall in car prices.”
He said he did not believe PCPs would be the cause of the next credit crunch because they are backed by assets – the car themselves – unlike most other forms of consumer lending. However, this does gloss over the fact that it was secured lending – in the form of sub-prime mortgage lending that is seen as the main cause of the last credit crisis.
Rising Number of Auto Loan Defaults In US
Katherine Davidson, a global sector specialist at Schroders says there is no reason yet, for investors to panic. She says: “For several months, speculation has been building that auto loans could be at the hearts of the financial world’s next crisis. Audi credit data in the UK – the world’s most important auto market – has shown a marked deterioration in recent quarters.
“Newly “delinquent”, or overdue, US auto loans reached $23 billion in Q4 2016 and new “seriously delinquent” loans exceeded $8 billion; both are absolute levels not seen since the depths of the global financial crisis.”
However, she added that despite comparison to the problems in the sub-prime mortgage market in the US – which triggered the last global credit crunch – subprime auto lending remains a small pool of the total auto loans in the US. Although the specialist lenders providing these loans may “become unstuck” if the economic condition worsens, she does not predict that larger mainstream lenders will be unduly affected.
She added that while she did not think that a “crash” was imminent, there could be some pot holes ahead to avoid.
“Some of the headline data on auto credit looks alarming, but our analysis suggests there is no reason to panic. The risks to both the auto industry and the wider financial system appear modest at this stage.
“Our more serious concern is wider profitability in the auto industry. Used car prices in the US – which determine the “residual value” of the collateral for a loan or lease – have been falling. This matters, even for high-quality lenders.”
The FCA wants to see whether the problems seen in the US are also present in the UK market.
