Car finance bubble reaches coronavirus bursting point

Covid-19 slammed the brakes on Britain’s £82bn-a-year car industry.

With the lockdown forcing dealers to shut, sales collapsed in April, falling 97pc to just 4,321 vehicles, building on a 44pc plunge the previous month.

The Government has now said that showrooms can open from June 1, recognising these normally spacious operations are able to implement social distancing with measures such as unaccompanied test drives being introduced.

But even if the industry can sell cars, will there be motorists willing to buy them?

The pandemic has caused the greatest economic shock the UK has ever seen and Tim Urquhart, principal automotive analyst at IHS Markit, warns “there’s a very uncertain prognosis for the industry”.

With unemployment expected to spike from the pre-coronavirus level of 3.9pc to a double-digit number because of a recession "on a scale we have not seen before”, according to Chancellor Rishi Sunak, car companies might find buyers few and far between.

Urquhart adds: “Anyone buying a big-ticket item, whether it’s a house or a car, is going to be thinking very hard about whether they are going to commit to it.”

People losing their jobs or suddenly seeing their wages cut as employers battle to survive in a bombed-out economy won’t just be giving up thoughts of buying a new car – they could well be wondering if they can afford their existing one.

According to data from the Finance Leasing Association, since the City regulator ordered lenders to give three-month payment holidays to cash-strapped motorists unable to service loans, there have been 482,000 requests for forbearance.

That’s not just bad news for car manufacturers, it’s bad news for the industry which funds purchases of vehicles, often the finance arms of car companies themselves. The UK’s car loan sector is worth about £75bn, with 6.5 million vehicles on finance deals.

Almost 90pc of these are on personal contract plans (PCPs), where customers effectively rent a car usually for three years. Under these deals, they make monthly payments, effectively covering the depreciation of a new car.

When the term ends, drivers can either hand back the keys and walk away, make a "balloon payment” for the residual value of the car and become its owner, or use any equity built up between the second value and how much they have paid on the existing car to finance a new deal.

Most take the third option and PCPs have fuelled the growth of the car market in the UK. Drivers are now used to the idea of a low monthly fee when compared with a normal loan covering the entire cost of a car, with the added advantage of driving a new vehicle every few years which likely requires less maintenance and is more fuel efficient.

Car companies love PCPs because it creates a regular “churn” of demand as deals end.

Cars coming off PCPs are pushed through into the second-hand market where manufacturers carefully manage supply to ensure prices are stable, as these residual values prop up the system. These cars are being increasingly sold through another PCP, with its presence in the used sector incrementally growing over the last few years.

However, the looming recession could cause the system to collapse. Financial commentator Louise Cooper, of CooperCity, describes the set up as a “house of cards” ready to come crashing down if coronavirus means millions losing their jobs and abandoning finance deals.

“It’s going to be catastrophic, armageddon,” she says. “People are going to prioritise food and their homes.”

If her prediction is correct, there will be a flood of nearly new cars into the used market, forcing prices down and loading up the balance sheets of manufacturers and finance houses with assets which have depreciated heavily as demand evaporates.

Birmingham University’s Professor David Bailey, a car industry expert, agrees, warning automotive financing is “very finely balanced”.

“PCPs have propped up the market for years and depend on no upsets so car companies can manage supply and demand,” he says. “But coronavirus’s impact is unprecedented.”

The Bank of England last looked at the car finance market three years ago. Its financial stability report revealed that automotive loans represented 29pc of the total consumer credit of £198bn.

Of the £58bn of car finance, £24bn was held by the banks and £34bn by automotive companies.  However, Governor Mark Carney gave a guarded thumbs-up to the system.

He pointed out that although consumer credit faced a default rate 10 times higher than mortgages, “people need their cars in general” and were likely to keep making payments on them.

According to the Bank’s model, for there to be trouble with the systems, used car prices would need to fall by about a third, a level that would mean hundreds of thousands of drivers with cars on PCPs handing them back.

Three years ago such a scenario was seen as outlandish. Coronavirus makes it plausible.

Used to uncertainty

An indicator of what’s likely to happen – apart form default rates, which won’t be known for months thanks to forbearance measures – is used car prices.

But with so few transactions because of the lockdown, even these are speculative and skewed as a result of a lack of data.

There are indications used car prices could be rising. However, this may not be the welcome sign it might seem.

Fears over using public transport mean more people are looking to travel by car.

Car sales website Auto Trader reports a surge in interest in the very cheapest used cars on its platform, as financially challenged and safety conscious commuters seek a cut-price alternative.

The company has also conducted research which found more than half of people with a driving licence who don’t have a car are considering buying one to avoid trains and buses.

This might bring some relief to the sector, but it won’t last long.