After a year that saw tabloids filled to the brim with anxiety over car finance, with varying levels of justification, it can be tempting to view new warnings as ‘the boy who cried wolf’. However, the release of the PRA’s statement on consumer credit in July has crystallised the situation and clear causes for concern have emerged, writes Blue Motor Finance’s Chris Jones
While the media furore over potential mis-selling is not entirely without basis – few would argue that transparency in the dealer finance needs no attention – the pressing issue is one which industry commentators have been quietly discussing since long before motor finance hit the headlines: the systemic fragility of PCP portfolios to a price shock in the used car market.
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The Prudential Regulation Authority (PRA) estimates that the UK’s total guaranteed future value (GFV) exposure stands at around £23bn, with the vast majority of GFV figures set at 85-95% of the expected final value. Given that used car prices fell by around 20% in the financial crisis – admittedly with a fairly rapid recovery – the regulator is concerned that a similar shock could knock a sizeable hole in many balance sheets.
What is more, a price shock could come sooner than we think. At present, the data seems to show residual values tracking in line with expectations, but many lenders are quietly concerned about rising levels of voluntary terminations, and anecdotal evidence suggests that the large number of used vehicles being bought by Irish consumers looking to take advantage of the weak pound may be artificially strengthening values. Once the Irish market is satiated, we may see a rapid correction.
This in itself is no doomsday scenario – even in the event of a price crash, the maturity range on most lenders’ portfolios would cushion them from too much of their GFV risk crystallising at once. Nevertheless, what is worth bearing in mind is the long-term effect of these changes on the viability of the PCP product.
We have already seen lenders who were setting GFVs at 95% revise 15 percentage points downward virtually overnight, and by the year’s end it would seem reasonable to assume that most will be playing within the PRA’s “safe zone” of circa 80%.
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By GlobalDataBut when this is viewed in the light of new IFRS9 accounting rules, with all provisions taken up front, PCP suddenly looks like a hugely capital-intensive product. For independent lenders in particular, this will mean a severe restriction in the product – and naturally, the market will need alternatives in place if we are to keep dealers’ stock moving.
At Blue, we were evaluating product diversification last year, at exactly the time when the GFV question began to develop traction. We had strongly considered a PCP offering ourselves, but after much analysis, decided not to participate.
Seeing where the provisioning situation might lead, we opted instead to launch the Extended Contract Plan (ECP), a hybrid six-to-seven-year HP product with settlement possible at any point in the agreement.
Blue believes this product is more affordable because of the lower monthly payments, and in our experience there is a direct correlation between lower payments and lower levels of default. Hence, ECP – which bears the same securities as an HP agreement – is a ‘best of both worlds’ product, providing consumers with a low monthly payment while securing the lender against future default risk.
Clearly, none of us can predict the future, but when looking at product strategy over the coming months, we would be wise to look at where the wind appears to be blowing.
