Warning signs emerge in the UK car loan market

The rapid acceleration of car loan growth in the UK has sparked alarm among regulators, raising fears that car loans could be the source of the next financial crisis.

A sharp rise in the amount borrowed by indebted UK households to buy new cars is fueling fears of an economic crash if borrowers come under pressure from rising interest rates and unemployment.

Auto loan growth has exploded in recent years, spurred by personal contract purchase plans. These plans allow people to acquire a new car for a certain period of time in exchange for a deposit and a monthly fee, before returning the vehicle, trading it in for another, or paying off the rest of the loan and keeping it. .

Some lenders, from automakers to banks, provide loans assuming the resale value of the car will increase from their original estimates. Bankers call this practice “taking a hit on the metal.” The risk is that the value of the car will plummet during this period, leaving lenders to support themselves.

David Oldfield, Head of Retail Banking at Lloyds banking group, says there could be trouble ahead for some parts of the industry after a 30% increase in car sales over the past four years, which could drive down the price of used cars. “We expect there will be an oversupply of used cars in the future given the strong demand for new cars in recent years,” he said.

In the United States, where the auto loan market is larger with a larger share of subprime loans, concerns are heightened as car prices have fallen 10% in the past year, analysts say. from RBC. Borrowers are under strain: Figures from the US Federal Reserve in New York show late car loan repayments have reached levels not seen since the financial crisis.

Although warning signs are emerging in the UK market, analysts wonder to what extent it is following the same path as the US and whether that leaves some lenders dangerously exposed.

The increase in amounts borrowed in the UK was significant. UK households borrowed a record £31.6bn in 2016 to buy cars, up 12% from the previous year, according to the Finance and Leasing Association.

According to the Bank of England, around 85% of new car purchases used dealer car finance in 2016, double the figure for 2009. Within this, the use of PCP plans has grown rapidly.

Robert Noble, analyst at RBC, believes that part of the strong growth in auto loans is due to the slowdown in the mortgage market. “Banks pushed consumer credit growth higher due to the increased regulatory burden on mortgages in the US and UK,” he said. Historically low interest rates have also attracted banks to riskier loans for higher returns.

Although the UK has very few subprime car loans, data from credit rating agency Experian shows households with ‘strained’ finances have seen a 54% increase in PCP applications since then. 2014. Some subprime loans are available for used car purchases.

Andy Wills, director of Experian, says PCPs “have proven to be incredibly popular with car buyers, often enabling them to purchase cars from major brands for the first time. Increasingly, car buyers are exchanging a new car for the duration of the PCP, often accepting a new PCP agreement for the new vehicle”.

Such is the rapid rise of PCP plans as households take on more debt as regulators take action. Last month the Financial Conduct Authority launched a review of the auto finance sector and whether it needs regulatory intervention.

The Bank of England also warned that consumer credit in the broad sense was growing too quickly and ordered banks to set aside larger capital reserves should the market deteriorate.

“The concern that the Bank of England is specifically talking about is car finance as it is the fastest growing part of consumer credit,” said Investec analyst Ian Gordon.

BoE figures show car finance has grown at an average annual rate of around 20% since 2012, growing by more than £30bn in that period and accounting for three-quarters of total market growth. stock of consumer credit.

Mr Gordon says the catalyst for the bursting of the lease bubble and the BoE’s “real concern” is that car values ​​have “deteriorated so sharply” that it is exposing lenders.

But the banks are not leading the pack. In the UK, the largest car finance providers are subsidiaries of global car manufacturers. Banks provide less than half of auto dealer financing, according to the BoE. Indeed, non-banks account for £34bn of the £58bn UK car finance market, with banks providing the rest.

Lloyds is the largest bank operating in car loans in the UK, although its market share is still underweight relative to its size. Lloyds is selling up to 100,000 used cars from its Lex Autolease business, which supplies fleets of vehicles to businesses.

Mr Oldfield argues that Lloyds was prepared for a potential oversupply of used cars, adding: ‘Although there has been a 10% decline in the resale value of used cars since the peak in 2013 , we always make a profit, on average, for every car we sell because our approach is conservative.

He says Lloyds had hedged against a market downturn by pricing its fleet management contracts to make a small profit on reselling the cars it leases rather than taking big risks on future values .

Lloyds’ Black Horse business has also applied a haircut to its expected car resale values ​​in its PCP loans, giving it “a buffer” to absorb any price declines.

Despite growing concerns and similarities with the United States, analysts point to some key differences.

RBC’s Mr Noble said “there is much higher auto loan penetration in the US, which limits growth prospects”, while auto finance companies in Europe are seeing an average growth of 16 % year over year.

Concerns about the US market may also be overstated. Katherine Davidson, global industry specialist at Schroders, says she thinks the deterioration in US subprime lending has less serious implications than the fall in subprime mortgages.

“Despite headline-grabbing comparisons to mortgage-backed securities, subprime auto loans are a fairly small group.” She points out that subprime auto loans, at $270 billion, represent 25% of total auto loans and only 2% of total consumer credit in the United States.

Even though fears of a crash in the auto loan market are overblown, the sector is booming and regulators are expected to step up their scrutiny in the coming months.

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Priscilla C. Carnegie