With the motor finance sector increasingly finding itself under the national spotlight, Motor Finance investigates where these claims are coming from, and whether the industry really should be worried
Motor Finance could be about to cause the second coming of the financial crisis, with millions of subprime customers having been mis-sold PCP over the past five years, leaving both finance houses and consumers – somehow – at risk of a crash in residual values.
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Or at least that might be the impression a consumer reading a number of national papers could be under at the moment, after a series of articles were published in papers including The Times, The Sun, The Telegraph and The Guardian.
While these articles are too varied to sum up all their views and nuances in a single sentence, or even a longer feature, a number have shown some similarities, including some large inaccuracies.
As mentioned in the opening paragraph, one assumption made in the majority of these titles has been that subprime customers have been buying cars using PCP in their droves. Examples include The Guardian, which wrote: “For many people with poor credit records, a PCP is likely to be the only way they can borrow a sizable sum of money,” and The Times, whose front-page article Fears for car market amid loan mis-selling switched between PCP and the potential financial troubles of subprime lender The Car Finance Company (TCFC), without clarifying that TCFC does not, in fact, offer PCP.
Of course, the majority of Motor Finance readers will already know that PCP is traditionally used for new cars, and while prime independent lenders offer PCP, as consumers slip down the credit scale PCP becomes harder and harder to find, until one reaches the subprime sector, where virtually no lender offers it as a product.
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By GlobalDataThis is not the only inaccuracy present in these articles. The Telegraph, for example, says that at the end of a PCP agreement “the majority simply roll over their contract, by trading in their old car for a new model, and their debt continues to grow.” Quite why the debt will continue to grow in this situation is unclear.
While these issues do somewhat harm the credibility of the articles in question, they do highlight a number of concerns which are worth looking at.
The first question that needs to be explored is the timing of these articles. Certain concerns around PCP have existed for a while now – indeed, Motor Finance published a number of articles on the topic half-way through last year – largely focussed on its sheer size, and its importance to the car market. However, 2017 has seen a level of interest outside specialist sources that has been unseen in past years.
Developments
Two key events seem to have ignited interest in the market. Towards the end of 2016, the Bank of England’s (BoE) staff blog published an article suggesting PCP may have made the industry more vulnerable to macroeconomic-scale bumps, and separately released reports that consumer debt was becoming alarmingly high.
This was followed by the Financial Conduct Authority’s (FCA) Business Plan, which was released in April 2017 and included the revelation that it was planning to conduct an “exploratory piece of work” on motor finance. It added it was concerned there may be a lack of transparency, potential conflicts of interest and irresponsible lending in the motor finance sector.
This has created what seems like a perfect storm for the press – the BoE has said it is concerned that consumer debt levels are too high, and that finance might be making the industry more vulnerable to macroeconomic issues, combined with the industry regulator saying there may be problems within the industry in advance of a review.
The FCA review has led to papers publishing headlines suggesting that the industry may be about to go through a mis-selling scandal.
Those in the industry, however, are relatively relaxed about the upcoming FCA investigation. Adrian Dally, for example, tells Motor Finance: “There is a big difference between what the FCA and the BoE are saying and doing, and what is described by others.
“For example, when the FCA announces it’s doing a review, that’s a ‘small r’ review, not a Thematic Review, and not a market study, both of which are much more formal and imply there is something potentially more serious going on.
“This is a review – an exploratory piece of work, as they describe it. It is what we were expecting, and it’s exactly what you would expect a responsible regulator to want to do when it has taken over responsibility over the last couple of years for regulating the second-largest area of consumer lending after mortgages, which it has regulated for over 10 years.”
Andrew Smith, a director at Compliancy Services, was quoted extensively in the Times article previously mentioned.
Asked for his view on the exploratory piece, his views are more closely aligned with Dally’s than one might expect: “At the moment the FCA has just said that as part of its 2018 objectives it will conduct a ‘review’ of the motor finance sector. This may lead to thematic reviews but it depends on what the FCA finds through its work over the next year or so.”
He adds that businesses within the scope of the review also have the opportunity to pre-empt FCA action by reviewing processes and making improvements.
“Motor finance lenders, particularly, should already be aware of their risks and putting mitigation programmes in place to address these,” he notes.
Regardless of the fact that a number of these articles have taken an alarmist slant on proceedings, the reality is that they play an important role in shaping public opinion, and do bring up a number of potential issues when taken in isolation.
Issues around affordability
One of the concerns brought up on a few occasions has been around affordability, with questions about whether lenders are doing enough to ensure consumers are able to repay the loans.
This was an area noticed by Shoosmiths during conversations with Motor Finance. Stephen Dawson, partner at Shoosmiths, said that if the FCA were to look at how lenders considered affordability, they would also need to reflect on themselves: “The FCA is responsible for the rules on affordability and sustainability. We are given the rules by the FCA, and our clients are working very hard to meet and exceed those rules.
“Affordability is something about which I won’t have a great deal of sympathy for the FCA if it formulates a view on it, because it wrote the rules.”
A separate issue may come from the subprime sector, where questions have been asked on the feasibility of lending to this sector. For example, earlier this year The Guardian wrote Subprime cars: are car loans driving us towards the next financial crash?
Mel Chell, partner at Shoosmiths, says this is a difficult issue due to the target audience; subprime customers, by their nature, will likely have difficult credit histories including, potentially, bankruptcies, defaults and CCJs. However this section of the community still needs credit in order to access a vehicle.
She adds: “Subprime lenders will set APR at a much higher rate because of the risk they’re taking.
“In terms of proving affordability, those lenders go the extra mile with their customers, sitting down with them to try and truly understand their circumstances before they’ll lend to them. This isn’t a market where affordability is ignored: The creditor’s obligations are understood and taken very seriously.”
Issues around PCP
A separate topic often mentioned is some of the worries around PCP. With huge dominance in the new car market, and a growing importance in the used space – albeit weighted heavily towards the prime end of the credit scale – a number of commentators have expressed concerns around the product.
These issues boil down to two separate themes: One is the risk it poses to lenders, given the exposure it leaves them to residual values; the second separate issue is the potential for this product to be mis-sold.
The first issue formed a large part of the initial BoE blog’s argument back in 2016, and is a legitimate concern which has been expressed privately to Motor Finance in the past. With a PCP deal, lenders take the risk on residual values, and will therefore be on the hook if used cars crash.
With large macroeconomic changes such as Brexit and its possible effects looming, the declining popularity of diesel cars, and the rise of newer types of car with less historical data on which to base predictions – such as electric cars – the industry is facing a period of relative uncertainty.
This leads to questions about whether the motor finance industry in the UK is systemically important, and whether a crash here could lead to a wider economic crisis, similar to the effects of the subprime mortgage crash around a decade ago.
There are several differences, however. For a start, the typical PCP deal lasts between two and four years, whereas mortgages tend to last for decades. Secondly, while houses can increase and decrease in value, car values nearly always go down – meaning motor finance will have been underwriting for assets they knew were going to depreciate – in contrast to mortgage lenders. Finally the UK motor finance market is not nearly the size the US mortgage market was in 2007.
Nevertheless, lenders do face a large exposure to used car values thanks to PCP, and need to ensure they take the risk seriously.
The issue of how well sold PCP is something of a thorny issue. The Times has no issue, however, declaring: “There is growing evidence that PCP customers are being badly advised, even misled, on interest rates and whether they will ever actually own their cars.”
The Telegraph agrees, saying: “In the case of the motor finance market, there is an added worry that, in their desperation to get their hands on a new set of wheels, buyers may not have had the complexities of these agreements fully explained to them.
“For example, if you want to exit a deal early, you have to buy yourself out.”
The issue with point-of-sale finance products is that the customer tends to buy their finance at the dealer, as opposed to from the lender, so it can be hard to prove what exactly has been said.
Smith at Compliancy Services says the industry as a whole needs to make sure customers understand how PCP works, adding: “I have seen examples where a customer reaches the end of the term and cannot understand why they do not own the vehicle, having paid monthly into a product called ‘personal contract purchase’ [confusing it with HP or similar].”
More damningly, he says: “I have seen a number of motor dealerships that do not hold any FCA permissions or are not appointed representatives of an authorised firm advertising finance products of certain finance providers, and these introductions proceeding to completion with commission being paid to the introducer.”
Both these issues can be helped by auditing all introducer partners, and especially by maintaining regular contact with them.
Chell, for example, notes that it is important to have open conversations all the time between finance houses and dealer networks to make sure everyone is on the same page, and that dealers keep record of what they say.
She adds: “Time and time again, at the back end we see customers come to us, at the point of trying to recover the vehicle for non-payment, and tell us they’re not paying because the dealer said X, Y and Z – that it would do so much MPG, that it would connect to their phone, and so on.
“It’s more and more important that dealers keep an accurate record of what they’re saying and recommending.”
While the introducer-based nature of motor finance might prove to be a weak point in the sales process from a regulatory perspective, it would be remiss not to mention that at this point there is very little evidence of widespread market abuse and mis-selling in motor finance – certainly not enough to draw the conclusions that some newspapers have done, in claiming the FCA review has all the makings of a mis-selling scandal on the scale of PPI
The Times argued in a comment piece that the FCA must ignore the lobbying of the industry, and concentrate on making sure customers are getting a fair deal.
Conversely, while the FCA should indeed be making sure the industry is giving customers a fair deal, it should also avoid giving in to a witch hunt that could cripple an industry which helps millions of people access cars they might otherwise not have been able to afford.
