Even though Personal Contract Hire (PCH) is still on the rise in the UK car leasing market – it accounted for 36% of contracts created in the last year on Quotevine – it has a long way to go before standing a chance of usurping Personal Contract Purchase (PCP) from its throne as the most popular automotive finance option.
According to recent figures from the Finance and Leasing Association (FLA), in the past 12 months 90% of private car purchases were done through PCP – and Experian have told the Guardian that “the number of PCPs overall has increased fivefold over the last five years”.
As car finance is becoming more and more popular in the UK – last year, the nation borrowed £31.6 billion to spend on vehicle purchases and finance products accounted for 81% of new car purchases – so the interest in it, and concerns about it, grows.
The possible risks linked to PCP deals are roughly threefold: we must consider risk to the economy as a whole, risk to manufacturers and lenders, and risk to customers.
As the Bank of England stated in a recent report, “consumer credit has been growing much faster than household incomes in recent years and dealership car finance has seen the fastest expansion”; some have gone as far as comparing the rise of car leasing deals with the sub-prime mortgage crash in the States.
Indeed, the Financial Times warns that the rise of PCP and the trend for consumers to be able to trade up at no extra cost has mostly been thanks to low interest rates and high used car prices – it’s a “fortuitous combination which may not persist for much longer”, and the FT uses Hertz as an example of what may happen for lenders or manufacturers when one of these factors changes. Last November, Hertz had to account for a huge $63 million ‘depreciation adjustment charge’ because of “changing assumptions about the value of the cars in its rental fleet” – in other words, if the residual value of rental vehicles drops, lenders may end up making losses on vehicles returned by PCP customers.
Then there’s the end customer. A Retail and Consumer Specialist at CAP stated that “today’s deals are so strong that a lot of people are driving premium cars who shouldn’t be”. In an age of social mobility, what’s the issue with premium models being available to the masses? The fact that this will no longer be the case in three or four years’ time when the cars have to be returned. CAP’s representative went on to say that car manufacturers have a “responsibility” to think about the future of the market when it’s flooded with used cars after PCP deals are over – if the demand no longer matches the supply, used car prices will drop like they did for Hertz and lenders will need to make up for the shortfall somewhere. Even before we reach this point, the end customer is still at risk when using a PCP agreement to buy their new vehicle; Huntswood recently released an infographic explaining the key risks they face, such as customers accidentally under-quoting their annual mileage and therefore paying out large excess mileage charges at the end of their contract, and the customer not having a chance to consider alternative deals or the implication of long-term agreements (instead being drawn in by the lower monthly cost).
With all this taken into account, it seems like PCP’s rise and the buoyancy of the car finance market might be too good to be true – in the not-too-distant future, it could cause problems from the macro level right down to the micro level.
If the implication is that lenders have a responsibility to mitigate these problems and minimise the risk of them occurring we need to start thinking of ways to do this today. Starting with the largest-scale risk, the FLA actually believe that the risk posed by PCP and car leasing to the economy isn’t as large as it may appear – their Head of Motor Finance called the UK a “world leader in the quality of underwriting and minimising risk”, which is reflected in the relatively low number of defaults and impairments on PCP payments. Parallels with the sub-prime mortgage crash may not be totally justified: financial products are now much more closely monitored because of it, and the debts incurred by PCP customers are usually far smaller than those who took out mortgages. Take the repayment period alone – PCP contracts are paid off in around a tenth of the time it takes to pay off a mortgage.
When it comes to the risk to lenders and manufacturers, again the concerns might not be as troubling as they first appear. In the same Financial Times article that warns about cases like Hertz, the author also concedes that the drop in used car prices would need to be a dramatic one to have any large impact; Guaranteed Minimum Future Values are set quite conservatively in the first place to protect against exactly this issue, and lenders will probably budget for an even lower figure in their accounts to act as an extra buffer. Vehicles which depreciate to a level lower than this amount would cause problems for the lenders but are extremely rare.
That leaves one last risk level to resolve: the risk to end customers. Huntswood released several recommendations with their infographic which largely mirror FCA recommendations for business practice already: train staff well so that they are clear on products, pricing and customer rights, be proactive in identifying people who will not be able to afford future payments and uphold robust responsible lending policies. The FCA Handbook even includes a whole section (CONC 2.10) on vulnerable customers and how to treat those who may not have the mental capacity to “understand, remember and weigh up relevant information” along with its guidance on responsible lending (CONC 5). With motor finance companies already being tightly regulated by the FCA to minimise customer risk, this is another area where concerns can be fairly easily answered.
With institutions like the Bank of England and the FCA keeping a keen eye on PCP, smart industry professionals might want to start exploring alternative products that may better suit their target market.