Paul Smith, Director at Traka Automotive has been investigating the potential perils of the ubiquitous Personal Contract Purchase (PCP). He suggested continued dillegance on affordability, insurance underwriting practises, and appropriately matching products to consumers could help the market avoid a collapse.
Total car borrowing has ballooned over the last eight years from £11bn in 2009 to £31.6bn in 2016. 82% of car finance, nearly £26bn of that total car borrowing, was via PCP arrangements in 2016.
At a consumer level, Paul Smith sees potential problems with the Guaranteed Future Value (GFV) aspect of the tradition PCP contract: “For a start, most PCPs are now set up for three or even four years, making end of term GFV valuations trickier. Secondly, in their quest for the lowest possible monthly payments, many consumers are guilty of under-stating their average annual mileage usage.”
This underestimation can result in hefty penalties at the end of the contract when thresholds have been exceeded. Added to this there is the fact that if PCP cars start being returned in large numbers, due to delinquency, prior to the end of contract, residual values will be increasingly difficult to estimate. This danger will only be increased by the medium term phenomenon of wages failing to keep pace with price inflation. Paul Smith found that all of the above factors have the potential to bring about a GFV led problem for the new car market.
On the side of the regulators, and underwriters Paul cautions complacency: “One article, by a learned economist that I read, calculated that the US sub-prime car loan market has now swollen to $38bn per quarter (that was the Q2 2015 number) when just before the last crash in 2007 they had $44bn per quarter. So, our American cousins are not far off the last sub-prime car credit bubble’s peak 10-years ago…and we all know what happened next!”
UK consumers have behaved responsibly with regard to keeping up with payments, Paul sees some ominous data from overseas: “In the UK, the delinquency rate for PCPs is still very low at roughly 0.08% – partly because we are rigorous about checking affordability and insurers’ underwriting standards remain high. However, in the US, where delinquency levels for car loans fell through much of the Great Recession, bad loans began rising again in 2015 and now stand at 3.8%. Car loan delinquency was actually lower, at 3.2%, just before the Great Recession really hit us in Q1 2008.”
Paul sees the growth the take up of alternatives to PCPs as a possible source of balance: “One DP I spoke to recently said that he’s seen a major upswing in Personal Contract Hire-based (PCH) new car sales. The Leasing Broker Federation verifies this and new figures from the BVRLA showed the PCH-based leasing market for new cars and vans accounted for half the growth in the total fleet car and van leasing last year. In Q4 2016, the BVRLA’s leasing broker members had 26% more vehicles on PCH leases than they did in Q4 2015, with vans showing 30% growth over the same period.”
Paul concluded: “So, is a switch to PCH or at least a healthier mix of PCH, PCP and Hire Purchase (HP)-based car sales a good idea? Like all these things, it should be led by customer need. So, it’s crucial that customer fact-find and product suitability work has been done rigorously to ensure customers are being fitted to the leasing product that best suits their needs and pockets. That said, PCPs might not command quite such a large a slice of the new car leasing market going forward.
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