The Irish car trade is becoming increasingly nervous that its reliance on cheap, subsidised PCP (Personal Contract Purchase) finance is building a castle of debt on the sand of a falling market.
PCPs, which defray a significant chunk of the cost of buying a new car by using the expected residual value to reduce the amount borrowed, have gone way beyond popular and have become a driving force within the industry. Some dealers are reporting that as many as 70 per cent of their new car sales are based on PCP.
The Society of the Irish Motor Industry (SIMI) has commissioned a report on PCPs by analysts Grant Thornton. That report, originally intended to be presented to a meeting of franchised dealers last week, has slipped and will likely not now be published in full before the middle of June.
Tom Cullen of SIMI told The Irish Times that "we're trying to benchmark PCP, where it is now, where it's come from and where it ultimately might go. No one has raised any particular concerns, just the usual ones. But all dealers are very keen to see the report." SIMI is known to be trying to get the report finished before the July 1st changeover to the new 172 registration plates, and the concomitant spike in new car sales and finance agreements.
Subprime
Those ‘usual’ concerns revolve around two particular issues - sub-prime lending and the fact that, for the most part, dealers must underwrite the costs of buying back the cars from customers at the end of a PCP deal.
These very worries are exercising legislators both in the UK and the US markets. The US market is becoming increasingly concerned about sub-prime practices in the car loan market, which has now spiked above USD$1.1-trillion in value. Late payments and defaults on this massive loan pile are increasing, leading some analysts to fret that a collapse in car loan repayments could precipitate a second financial crisis.
In the UK, the Bank of England is worried about the STG£40-billion car loan industry, both for similar sub-prime reasons as the US market, and also because of concerns over mis-selling of loans, similar to the recent travails of payment protection insurance. PCP and car hire purchase plans are almost unique in the financial world because they’re sold not by financial professionals, but by car dealers. While the industry claims that all sales personnel are trained to deal with these issues, the fact is that many are under increasing pressure to meet lofty monthly sales targets, and the generally accepted wisdom is that if the bank or finance house says OK to the loan, then all must be well.
Regulation
In Ireland, PCPs are not licenced as a specific product, but comer under general financial conduct rules. The Bank of England seems to be looking at changing its status on PCPs, and regulating them specifically, but the Central Bank when asked said that PCPs are a form of hire purchase and are therefore not really within the remit of the Central Bank. They are provided by "financial intermediaries" such as a car dealer and the credit agreements drawn up under a PCP are normally looked after by the Competition and Consumer Protection Commission (CCPC).
As of yet, the CCPC is not looking at making PCP or any form of car hire purchase a specifically licenced product. A spokesperson for the CCPC told The Irish Times that “the Central Bank’s Consumer Protection Code, in particular, chapter five, requires regulated financial services providers to ‘know their customer’ in terms of assessing affordability and suitability of the product. However, the Code does not apply to certain categories of financial products including hire purchase and PCP. We believe the market, particularly the business practices of certain providers in the UK, is quite different to that in Ireland and that some of the practices of concern to the Bank of England may not be relevant in the Irish market.”
However, the CCPC is showing come concern that people are getting into credit agreements that they can either not fully afford, or do not fully understand (the old ‘I don’t know what a tracker mortgage is’ ad comes to mind…). “In the Irish context; we are of the strong view that there are certain characteristics of car finance products that mean that some consumers could take out a product which may not be affordable or in their best interests in the long term.
Used cars
For example, with PCPs, a sudden decrease in second hand cars value as a result of Brexit, exchange rate changes or other factors could impact on many consumers’ options at the end of a PCP agreement” said the spokesperson.
“Decisions around regulation of this area cannot be made by the CCPC. For that reason we have raised the issue of further regulation with the Department of Finance and the Central Bank. To assist consumers in their decision making we have conducted research into the car market and car finance, and conducted numerous public awareness campaigns on the issue of car finance. Our next campaign is due to coincide with the release of 172 registration cars, will commence in late May.”
The benefit of a PCP is supposedly double-sided - car buyers enjoy reduced monthly repayments and are effectively guaranteed that the residual value of their car will, at the end of the finance period, cover the remaining cost of the loan. Car dealers enjoy the increased sales that come with more affordable credit, receive bonuses from financial houses for encouraging people to take out loans, and further benefit from customers returning to ‘roll-over’ their PCP into a new agreement for a new car. Renewal rates for PCP buyers are running as high as 60 per cent, depending on the brand in question, a customer loyalty rating for which most car makers would give their eye-teeth.
Report due
So what’s the problem? In spite of assurances that the Grant Thornton report has not been commissioned on foot of any specific concerns, there are apparently worries within the dealer community that the underwriting of used car values, inherent to the PCP deal, could be just waiting to bite both dealers and consumers.
Although the terms and conditions of each loan differ from brand to brand and between finance houses, the way it works is this. The Guaranteed Minimum Future Value of the car (GMFV) is built into the PCP agreement at the beginning. Generally speaking, it’s under-estimated, to allow for potential market fluctuations and to allow owners to build up equity in their car - value over and above the GMFV which will then act as a deposit on their next purchase. For the most part, those values are underwritten by the dealers, meaning that they are exposed to any collapse in second hand values. Consumers are at risk too - if second hand values fall, their car will cover the final cost of the loan, but there may be nothing left in its value to act as a deposit for a new car if they chose to roll-over, or worse; they may have to pay a final loan amount that will be more than the effective value of the car.
One dealer, speaking anonymously, told The Irish Times that "more regulation is probably a good thing, depending on how the regulations come. You can go too far with these things. PCPs are good, especially in that they have allowed a car park of buyers with older cars, who wouldn't have had much equity in their cars, to buy into new models, which are both safer and more eco-friendly. If it [THE MARKET]goes wrong, it will be because of a flood of UK imports, most likely. The biggest damage to dealers would not really be the underwriting, but the fact that people would not be able to trade-up as easily because they would have less equity at the end of the deal." Interestingly, the same dealer told The Irish Times that while they don't see much downward pressure on second hand prices yet, PCPs, because of their apparent value, are reducing demand for one-year old cars, because the repayments on a new car can be cheaper.
Legislation needed
Toyota Ireland, one of the major car brands which does not have its own ‘captive’ in-house finance arm agrees that more legislation is probably needed, but that in the meantime, the simplest form of protection for all is old-fashioned prudence. “We’ve set realistic Guaranteed Minimum Future Value which our dealers are happy to guarantee” Ian Corbett, marketing manager for Toyota Ireland told The Irish Times. “Our GMFVs are conservative and to properly sell a PCP your GMFV should not be inflated and customer deposit should be less than 20 per cent. If this is done then the customer should be able to roll into a new car in three years’ time without any surprises. Unfortunately many brands don’t follow this practice and, yes, we would welcome any regulation into market.”
Is the Irish consumer in danger, then? For now, probably not. The fact is that as long as residual values stay high, then the PCP train can continue chugging happily along. But, the Irish car market is experiencing some severe wobbles so far this year. New car sales are down by ten per cent, and that is itself a figure boosted by rampant pre-registering. According to figures from Motorcheck, more than 15,000 cars have been registered across the last sales days of the first four months of the year, indicating that they have been either pre-registered as ‘demos’ or sold in bulk to hire-drive or fleet deals. Those cars will place a downward drag on second hand prices, as will 31,000 cars imported from the UK, a 50 per cent increase on last year.
Then there’s the concern over potential changes to the car tax system. The Government is increasingly joining in with international concerns over the effect of diesel exhaust fumes on air quality and public health, and it is likely that we will shortly see proposals to begin moving drivers away from diesel power and towards hybrid and electric models. Such moves could severely undermine the residual values of the many thousands of diesel cars sold here since the introduction of the Co2-based taxation system in 2008, a move which dramatically reduced the values of petrol-powered cars at the time.
