Motor finance has been one of the star performers of the UK consumer credit sector in recent years, but the rapid rate of growth has led to fears that lenders may find themselves overexposed in the event of a downturn.
The new car market is in the midst of a prolonged boom, with sales having risen every year since 2011. New car registrations reached a record high of 2.69 million in 2016, and registrations in Q1 2017 were 6.2% higher than during the same period in 2016.
This growth has been fueled by the widespread availability of cheap car finance deals, with car manufacturers using personal contract purchase plans (PCPs) as a way to attract and retain customers. Under these deals, consumers typically pay an upfront deposit followed by monthly repayments over a three-year period. At the end of the term, they have the option of returning the car to the dealer at no cost, paying a final sum to take assume full ownership, or rolling over onto a another deal for a new vehicle.
Around half of PCP users opt for a new deal with the same manufacturer, thus demonstrating the effectiveness of these finance products in promoting loyalty and, thanks to the short terms, demand for new vehicles. The attractiveness of PCP plans has led to an explosion in borrowing, with the Finance & Leasing Association reporting that point-of-sale new car motor finance has almost tripled over the last five years, with advances rising from £6.86bn in 2011 to £18.09bn in 2016.
Policymakers have expressed increasing concern about market conditions, with the Bank of England’s Financial Policy Committee (FPC) noting the rapid growth in borrowing and easing of lending conditions. In its March 2017 meeting, the FPC stated that stressed impairments on consumer credit exposures were higher than those for mortgages, even though outstanding balances on the former were far smaller than on the latter. The FPC also believes that the credit quality of such loans is vulnerable, given their short maturity, and that weaker underwriting standards could magnify potential losses.
The PCP market is also susceptible to its dependence upon secondhand car prices. Should prices fall, consumers will return their cars at the end of the term rather than make a final payment that exceeds the market value of the car. Factors such as probable restrictions and financial penalties on diesel cars, a glut of secondhand cars from expiring PCP deals, and an economic downturn, could all depress prices, leaving manufacturers lumbered with low-value, unwanted stock.
These factors – the inherent vulnerabilities of PCP financing, the rapid growth of lending in recent years, and laxer underwriting standards – place motor finance providers in a precarious position. Should macroeconomic conditions deteriorate, they could face big losses.
By Daoud Fakhri, Prinicipal Retail Banking Analyst