Motor Finance Market 2018: FCA Update

Last year the newspapers were full of headlines on how the motor finance market was the next toxic shock set to hit banks and carmaker finance houses.

The narrative went something like this. Dealers and finance houses were selling high value cars on Personal Contract Purchases (PCPs) using dodgy sales tactics and taking little or no account of the consumer’s ability to repay the loan. The spectre was also raised of a crash in residual values similar to that experienced in 2009.

As a result the Financial Conduct Authority (FCA) had to wade in. As the new regulator replacing the old FSA, it had a duty to look at markets which may or may not be experiencing problems. So, in July last year it announced a review of the motor finance sector. It wanted to understand the use of motor finance products and assess the sales tactics employed by finance houses and dealers and whether the products could cause consumers harm.

It had two key questions.  Were finance houses sufficiently covered  if used cars were to fall as they did in 2008? And its conclusion? “We found that the asset valuations and risk management processes at these firms appear to be robust. Stress tests showed that the financial impact of a fall in residual values would not materially affect their overall financial soundness.

“The firms were able to show that they had appropriate strategic plans in place in the event of a fall in vehicle prices and their approach to managing credit risk appears to be appropriate. We have concluded that the largest FCA solo-regulated lenders are adequately managing the risk of a severe fall in used car prices, such that this would not materially affect their overall financial soundness.” So far so good.

The second question it asked was whether firms are taking the right steps to make sure that they are lending responsibly. The bottom line was whether they were assessing that the customers could afford the car they were leasing? One of the leading daily newspapers had already sent reporters out to see how dealers were selling finance. To get its evidence the FCA looked at credit rating agency files to see whether more high risk consumers were being sold motor finance. If there was a big increase, that would be a cause for concern.

“Consumers with higher credit risk account for a relatively small share of motor finance lending. For example, consumers in the lowest 30% of credit score range accounted for only 2% of outstanding motor finance lending in December 2014 and 3% in December 2016. Furthermore, motor finance lending to consumers with lower credit risk has grown more than lending to consumers with higher credit risk.”

The FCA moved on to look at whether the growth in motor finance was leading to more customers being unable to afford repayments, looking at arrears, severe arrears and defaults. Here, again, it did not find cause for undue concern.

“We found that in aggregate, these measures are generally low. For example, 2.4% of accounts in our data had one or two missed payments and 0.4% of accounts had between three and five missed payments in the 12 months to December 2016. By comparison, 1.6% of mortgage accounts were in arrears in the fourth quarter of 2016,” it said.

It also looked at whether arrears, severe arrears and defaults had increased for specific consumer segments and found generally there had been “modest increases” between 2014 and 2016. That said for high risk customers, effectively sub-prime customers who account for 3% of the motor finance market, the increases were “relatively high” and had increased more than prime customers. This is a cause of concern. In the next phase of its inquiry the FCA will be looking at whether lenders are adequately assessing consumers’ ability to repay motor finance.

“We are seeking information from a sample of lenders on how they assess affordability in motor finance and what information or data they take into account. We are focusing on assessments for higher credit risk consumers,” it said.

There is also more work to do on commission arrangements and dealers. The FCA asked whether there were conflicts of interest arising from commission arrangements between lenders and dealers and if so are these appropriately managed to avoid harm to consumers? In the next phase of its investigations it is planning to test the effectiveness of lenders’ systems and controls.

“We will undertake a lender survey to assess systems and risk controls with respect to commission structures and dealer incentives. This will include the extent to which lenders comply with relevant requirements and take steps to make sure that brokers acting on their behalf comply with consumer credit provisions such as disclosure of status, remuneration and commissions. We are collecting data on motor finance contracts to assess whether commission arrangements have led to higher finance costs as a result of the incentives they create for the brokers,” it said.

The FCA also asked whether the information provided to potential customers was transparent enough. So for example it looked at dealers’ websites to see how they fare.

“We have reviewed the websites of a sample of lenders and dealers. Our initial analysis suggests that terminology and language in general appear to be clear and consistent. However, we have seen cases where information is not sufficiently prominent and may not meet our requirements. We will continue to review further websites and address issues as part of our normal supervisory processes,” it said.

And, significantly for dealers, it is also going on a mystery shopping exercise to see whether consumers have access to clear, timely and transparent information at the point of sale.

“This will develop our understanding of current practices and whether consumers are aware of the risks and benefits of different motor finance options, including the cost implications. The mystery shopping exercise will allow us to test compliance with relevant regulatory requirements.”

Looking to the future the FCA is going to look more closely at commissions. “We are doing further work in relation to commission arrangements. In particular, some commission structures create a strong link between the dealer commission and the interest rate charged to consumers. This can create incentives for dealers to arrange motor finance at higher interest rates. Without adequate systems and controls, this could lead to consumer harm,” it said.

The FCA completes its review by the end of September this year and will publish its findings setting out areas of concern and how it plans to tackle them.