The Sunday Telegraph - Money & Business

End of road for ‘cheap’ car loans as crisis looms

Cracks are appearing in 5m debt-driven purchase schemes that Oliver Gill and Lucy Burton find may cost the sector and customers dear

- By Lucy Burton, Tom Rees and Oliver Gill

AN ERA of cheap and easy car loans is coming to an end amid warnings from investors and MPS that the massive debt boom that has kept the motor industry on the road threatens a misselling scandal and a crisis.

Research by The Sunday Telegraph has uncovered evidence of a gathering storm that could hit millions of drivers, Britain’s biggest car dealers and some of the world’s top manufactur­ers. Last year Britons took on £19bn of car debt, more than three times the figure a decade earlier.

It comes as: the lending watchdog prepares a clampdown on the market;

one leading car dealer investor predicts cheap loans will “disappear quite fast”;

the lender Ratesetter exits the car finance business;

an industry expert claims a mis-selling scandal could trigger the “collapse of the motor industry” and

the chairman of the business select committee demands greater scrutiny of showroom lending.

The Financial Conduct Authority (FCA) is preparing new rules designed to protect car buyers from loan misselling. The clampdown, due later this year, has already sparked a gear shift.

Hedge fund tycoon Crispin Odey, one of the biggest investors in listed car dealer Pendragon, said the flood of cheap credit is drying up.

“We’re seeing this spike of people saying ‘I’m sorry, we’re not going to lend you the money’,” Mr Odey said. He has hedged his investment in Pendragon with a bet against Lookers. “What we’re talking about is a credit cycle that has been elongated.”

The slowing of Britain’s financing boom is expected to cause motor bosses to rethink their business models. Neil Woodford-backed lender Ratesetter has already closed the doors on its consumer car loans arm. Rhydian Lewis, chief executive, said Ratesetter was now “free from that [acquisitio­n], we are older and wiser”.

Observers say both consumers and dealers have benefited from a boom in car finance over the last decade, creating a “virtuous circle” of demand.

Newer loan products such as personal contract purchases (PCPS) have proved extremely popular, allowing drivers to afford more expensive cars by virtue of lower monthly payments.

With the country’s financing boom allowing easier access to premium brands such as Audi, Mercedes and BMW, tightened regulation could throttle a vital source of funding for would-be customers. Car finance expert Graham Hill, former director of the National Associatio­n of Commercial Finance Brokers, said claims managers are eyeing the car industry as they look for the next Ppi-type scandal.

Last week this newspaper revealed that dealer Lookers faces a catalogue of mis-selling allegation­s after a whistleblo­wer triggered an FCA investigat­ion.

“With 5m-plus contracts live out there, this … could cause the collapse of the motor industry,” Mr Hill said.

MPS and debt charities are now demanding sweeping changes to the car finance market, saying they are concerned of the impact the credit binge could have on the economy.

Rachel Reeves, Labour MP and chairman of the business, energy and industrial strategy committee, called for “far more transparen­cy and greater scrutiny of the market”, warning that it poses a risk to “both households and the wider economy. Unlike other sectors, there are no reliable figures on the level of defaults and arrears on loans so it is hard to assess the true scale of the problem. That has to change,” she said.

Conservati­ve MP Steve Baker also warned that the “parallels with housing in the run-up to the global financial crisis are appalling”, saying he is “alarmed by the situation in car loans”.

Research by debt charity Stepchange found that 15pc of its clients who had used car finance had felt that it had not been adequately explained to them, while 23pc felt pressured into signing a deal. The Money Advice Trust said the issues identified in the motor finance industry by the City watchdog this year “were a reminder that firms need to do more”.

Car salesmen at a Skoda dealer in leafy Sussex rubbed their hands as a determined buyer walked in the door. She had done the research and was armed with the cash to pay for a 1.2 litre Yeti crossover, then and there. The showroom’s best price, the lead salesman told her, would be a shade over £23,000. But, he added, if she would keep her cash and buy the car on credit, there was a deal to be done.

Buying through a personal contract purchase (PCP) would allow the showroom to access better prices from head office. Buy now, pay later and the price would be more than £1,000 lower.

It was a no-brainer, but also a head-scratcher. Borrowing usually costs rather than saves money. The buyer had stumbled into the bizarre economics that have greased the car industry’s wheels and driven a massive expansion in personal debt in Britain.

Skoda, part of Volkswagen, has not been alone in pushing PCPS. Car dealers nationwide have made credit more easily available than ever before. More than nine in 10 new cars sold in Britain are bought with debt and since 2011, there has been a 160pc increase in credit sales.

It seems to suit everyone. Manufactur­ers, dealers and consumers all benefit, according to advocates of PCPS.

Justin Benson, head of automotive at KPMG, describes the concoction of more people buying more desirable cars with easy debt as a “kind of virtuous circle”.

Yet others hold mounting concerns that a bubble has been inflated that could have catastroph­ic consequenc­es for the global car industry when it bursts.

Graham Hill, a car finance expert and former director of the National Associatio­n of Commercial Finance Brokers, is among those who fear the sector stands on a precipice

“With 5m-plus [financial] contracts live out there, this could cause the collapse of the motor industry,” is his stark warning.

Cracks appear to be showing. Ratesetter, a peer-to-peer lender backed by Neil Woodford, has decided to close its consumer car loans arm. It had bought the “carcass” of motor finance business Vehicle Trading Group out of administra­tion. Rhydian Lewis, chief executive of Ratesetter, told The Sunday Telegraph last week that the company is now “free from that acquisitio­n, older and wiser”.

Constructo­rs carry much of the risk. Other industries that offer credit to consumers, including many retailers, typically package up the debt and offload it to banks. The likes of Volkswagen meanwhile hold billions of pounds of consumer debt on their own balance sheets. The German giant ranks among the world’s 20 biggest lenders.

Nick Parker, a director at consultanc­y Alixpartne­rs, traces Britain’s car financing boom to the mid-2000s, when the rules on company car tax were overhauled, running many corporate fleets off the road.

“The UK was relatively unique in Europe in having a deeply embedded company car culture,” he says. “As this fell away and the market moved towards ‘user-chooser’ so the manufactur­ers needed to plug a volume gap which both underpinne­d new car sales and drove the secondhand market.

“Since then, a combinatio­n of low interest rates, strong consumer demand and a resilient second-hand market have meant that car financing reached record levels.”

PCP, a comparativ­ely new form of financing that offers much lower monthly payments, has enabled millions to drive cars that would have been out of reach in the past.

“The Mondeo Man of 10 to 15 years ago is now much more likely to be BMW, Mercedes or Audi Man,” says Parker.

However, the car financing boom and those who depend on it are now under threat on at least two fronts.

A clampdown by lending watchdogs could rein in the salesmen. Some experts now believe it is only a matter of time before watchdogs and politician­s intervene in a process that can chain people to tens of thousands of pounds of debt. Dealers are set up to sell metal i.e. cars, not loans, many think.

David Bailey, professor of business economics at the University of Birmingham, is sceptical of claims of a bubble. Yet he does say the credit boom has helped the car industry resist what would otherwise be a more aggressive decline in sales.

“PCPS are a financial innovation that has kept sales going much more than we would have seen otherwise,” he says.

Even without regulatory action, the next recession will test the industry’s strength. Lower demand is likely to mean lower prices as manufactur­ers fight for buyers and used vehicles crowd forecourts.

Most car credit is structured so the final payment is less than the car’s value on the used market.

However if car prices fall faster than expected, the equation could flip. This so-called “balloon” payment could be more than the car’s value, which under the terms of a typical PCP would allow the owner to hand the keys back and owe nothing. The “virtuous” cycle would become vicious as manufactur­ers would be lumbered with unpaid debt and too many cars.

Benson says: “These products are causing a bit of an issue for car makers because they have to take a long-term view. These days, the ownership is shared. The risk is more with the manufactur­er than the consumers.”

Yet it’s a risk worth taking for the salesmen, Parker suggests.

“Dealership­s are fundamenta­lly a volume business and car financing/ PCP is a way to increase the consumer’s churn rate.

“Previously, a dealership may have only sold two vehicles to a customer over a nine-year period. Now, with more attractive finance options, they may sell three or perhaps even more vehicles over that same period,” he says.

The problem is that while the dealers may well be set up to sell cars, there’s little profit to be made in doing so. There is more profit to be made from the commission­s available on loans.

Fears persist that enthusiasm to lend on the forecourts has tipped over into mis-selling.

Fund manager Crispin Odey, one of the biggest investors in the car dealership market, believes the scale of this problem varies between different groups.

He is one of the top shareholde­rs in Pendragon, the embattled company behind the Stratstone and Evans Halshaw brands. Mark Herbert, Pendragon’s chief executive, quit after just three months in charge following a clash with the board on strategy; last month it racked up a £135m half-year pre-tax loss.

Odey suggests Pendragon’s particular problems may be its salvation. The dealer was “so bad at incentivis­ing” salesmen that it should avoid any mis-selling allegation­s, he claims.

“Pendragon’s financing arm [is] so badly run that they hadn’t got into the problems that [rival dealer] Lookers got into.”

Odey has built a large short position against Lookers to reflect his assessment of the risks.

“It was a hedge,” he says. “I’ve been able to hedge what’s been a terrible investment in Pendragon. They didn’t really know whether things were profitable or unprofitab­le – they were fooling us and fooling themselves. But I think barring real upsets in terms of Brexit, we will make profits.”

Odey fears the wider car industry is facing a “funding crisis”.

He says: “I can’t see how you can attack distributo­rs for getting a better deal. It will be the lenders [that] find themselves with large losses, so they’ll have to put up their prices, interest rates go up, it will be the end of cheap deals,” he says.

“In a way, what we’re talking about is a credit cycle which has been elongated.”

Those in the German car supply chain have reason to be fearful. This puts the likes of Us-owned Sytner, Britain’s biggest car dealership company by revenue, and Aim-listed Vertu in the firing line.

Bubble or not, the car industry has ratcheted up risk by pushing PCP and other types of financing. Even the most bullish of experts admit that the industry faces a major test if any part of the PCP cycle fails.

Car sales are already retreating fast. In another blow to the sector, figures released on Friday showed new registrati­ons were 2.5pc lower year-to-date. During September, an important month for the industry as new number plates are issued, sales disappoint­ed and were up just 1.3pc – this despite falling by a fifth in 2018.

The road from boom to crisis is welltravel­led and could soon be littered with cheap Skodas.

‘There is little profit to be made [in selling cars]. Fears persist that enthusiasm to lend on the forecourts has tipped over into mis-selling’

‘It will be the lenders that find themselves with large losses, so they’ll have to put up their prices – it will be the end of cheap deals’

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