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Car Trouble

Finance firms liable for millions of pounds in compensation if regulators decide their products have been mis-sold

Britain’s £40bn car finance market could be heading for a crash. Harry Wilson (London Times) reports growing concerns about the reliance on debt to buy vehicles, and fears a mis-selling scandal.

Until a few years ago, most people would go to a bank to get a car loan, or else take out a Hire Purchase (HP) contract, paying for their car over several years.

But now, nearly 90% of new cars are sold – or ‘rented’ as many consumers allegedly understand the deals – through personal contract plans (PCPs) in which the buyer leases a vehicle rather than buying it outright.

The result has been what the BBC calls ‘a car-buying boom the likes of which the UK has never seen’. is a leading independent regulatory consultancy. Director Steve Bailey said: “The Bank of England and the Financial Conduct Authority (FCA) are already concerned at the record figure consumers borrowed to buy cars last year and now it appears the FCA is going to investigate what it calls “a lack of transparency, potential conflicts of interest and irresponsible lending” in the motor finance industry.

The deals were originally developed in America and were little known in Britain until the past decade. But, according to Wilson, some financial analysts now fear that often the terms aren’t properly explained, leaving finance firms liable for millions of pounds in compensation if regulators decide their products have been mis-sold.

“Imagine the sub-prime crisis, but this time the banks not only lent money to poor people to help them to buy houses but were building the houses as well,” is how one senior money manager at a leading American bank described the modern car finance market to Mr Wilson.

When a manufacturers’ financial services divisions and other lenders create personal contract plans — the leasing agreements used in most car sales today – the customer effectively pays for the cost of the expected loss in value of their vehicle over the life of the contract. Thus ‘residual value’ – the estimate of what the car will be worth at the end of the agreement – is key since the lender effectively banks on this as its guaranteed asset value when the personal contract plan expires.

As well as the risk of drivers defaulting on their payments leaving dealers with a glut of used cars to sell on, there’s the danger from residual value manipulation. If a company wants to encourage sales it will use an optimistic residual value to reduce the amount the purchaser pays over the term, while a more cautious approach will inevitably load the payments, making the contract more expensive but reducing the risk of a loss at the end of the term.

Analysts at Sanford Bernstein quoted one unnamed German executive describing how “the finance guys constantly ask us to support higher residual values, as it makes their offers more competitive. But since we are underwriting these values, it is often a difficult conversation.”

Sanford Bernstein reported widely varying leasing calculations, finding differences of £1,777 to £4,794 between the residual price offered by one lender and the likely resale value of the cars at the end of the contracts.

Multiply this by hundreds of thousands of cars and several lenders and you have the prospect of big losses down the line, says Harry Wilson.

The chief executive of one British bank told The Times he believes that the car finance industry is playing a dangerous game, having used personal contract plans to boost customer demand for their products in the years after the financial crisis. “There is a huge risk here, particularly if the cars depreciate faster than expected,” he is reported to have said.

Sanford Bernstein calculate that the cost of writedowns on diesel cars alone resulting from new regulation could reach €1.7 billion.

“Like everything in the debt-driven world, the manufacturers have brought forward future consumption and inflated demand,” a money manager at the US bank said. “At some point, this is going to unwind and they will be on the wrong end of the trade.”

Has the fallout already started? According to The Times, lender The Car Finance Company appears to be in financial trouble. Six directors have quit since the beginning of March and its accounts are listed by Companies House as overdue. There is no suggestion of any wrongdoing by the Car Finance Company.


Sanford Bernstein believes that car manufacturers’ reliance on motor financing could leave them with heavy losses 

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