Will car loans be the canary for UK unsecured credit?

Yesterday the news hounds clustered around one piece of economic news as they caught up at least tangentially with something we have been looking at for some time. From the Society of Motor Manufacturers and Traders.

UK new car market falls for sixth consecutive month in September – down -9.3% to 426,170 units. First time the important September market has fallen in six years.

This will have had an impact in various areas as for example if you happened to be an unreliable boyfriend style central banker looking for a reason to cancel a proposed Bank Rate rise for the third time you might think you have struck gold. However we were expecting trouble because as I pointed out on the 22nd of August there had to be a reason why manufacturers were offering what they call incentives but we call price cuts?

Ford is the latest car company to launch an incentive for UK consumers to trade in cars over seven years old, by offering £2,000 off some new models.

Unlike schemes by BMW and Mercedes, which are only for diesels, Ford will also accept petrol cars.

That issue has been added to by the uncertainty over what is going to happen to older diesels of the sort I have.

Confusion surrounding air quality plans has inevitably led to a drop in consumer and business demand for diesel vehicles, which is undermining the roll out of the latest low emissions models and thwarting the ambitions of both industry and government to meet challenging CO2 targets.

Back in the day I was told my Astra was efficient and low emission but let us move on whilst noting that official credibility in this area is very low. Registrations had been falling for 6 months compared to the year before so that we now find we have stepped back in time to 2014.

Year-to-date, new car registrations have fallen -3.9%. But, overall, the market remains at a historically high levels with over 2 million vehicles hitting UK roads so far this year.

What does this mean?

This is more of a consumption issue for the UK economy than a production or manufacturing one. You see in the year to August some 78.4% of UK car production was for export so whilst there is a downwards impact it is more minor than might otherwise be assumed. Ironically a fall in UK demand affects producers abroad much more as this from the European body indicates.

The other way round, the EU represents 81% of the UK’s motor vehicle import volume, worth €44.7 billion.

For example Germany exported 809,853 cars to the UK in 2015 according to its trade body. Actually it may not be the best of times to be a German car manufacturer. From Automotive News Europe.

FRANKFURT — New-car registrations in Germany fell 3.3 percent in September as continued uncertainty over the future of diesel-powered cars hit demand.

The issue is complex as much manufacturing these days is of parts rather than complete cars. For example the UK engine industry has had a good 2017 but it is more domestic based so it will need more months like August if it is to carry on in such a manner.

Engine production rises 11.9% in August with more than 150,000 made for export and home markets. Overseas demand drives growth in the month, up nearly 20% compared with last year.

So we advance on knowing that there will be an effect on consumption and a likely smaller one on manufacturing although the latter is more unpredictable. What we will see is a reduction in imports which will boost GDP in an almost faustian fashion as the other factors lower it.

Car loans

So far there is nothing to particularly worry a central banker as after all it is not as if manufacturing or consumption are as important as banking is to them. However there is a catch and maybe the car manufacturers have been brighter than you might otherwise think. From the 18th of August.

That is partly because car manufacturers and their finance houses are increasingly stimulating private demand by offering cheaper (and new) forms of car finance. As amounts of consumer credit increase, so do the risks to the finance providers. Most car finance is provided by non-banks, which are not subject to prudential regulation in the way that banks are. These developments make the industry increasingly vulnerable  to shocks.

Now if we return to the real world the concept of prudential regulation is of course very different as after all it was not that long ago that so many banks needed large bailouts. But have the car manufacturers been very cunning in making themselves look like “the precious” as in the banks?

So much of the car market has gone this way that you could question what registration actually means? It used to mean a car was bought but these days is vastly more likely to mean it has been leased.

The FLA is the leading trade association for the motor finance sector in the UK. In 2016, members provided £41 billion of new finance to help households and businesses purchase cars. Over 86% of all private new car registrations in the UK were financed by FLA members.

Today we were updated on how this is going?

New figures released today by the Finance & Leasing Association (FLA) show that new business volumes in the point of sale (POS) consumer new car finance market fell by 8% in August, compared with the same month in 2016, while the value of new business was up by 2% over the same period.

So in nominal terms they are doing okay so far but the real numbers are down. The response has been the normal “extend and pretend” of the finance industry where trouble is on the horizon.

finance providers have responded by lengthening loan terms and increasing balloon payments rather than upping monthly repayments.

So as the Bank of England Financial Policy Committee Minutes observed earlier this week if we look back there has been quite a party.

Growth in UK consumer credit had slowed a little in recent months but remained rapid at 9.8% in the year to July 2017. This reflected strong growth of dealership car finance, credit card debt and other borrowing, such as personal loans. Growth of consumer credit remained well above the rate of growth in household disposable income.

So that is now slowing and likely will be accompanied by falling used car prices as time progresses. Whether the price cuts for new models have been picked up by the inflation numbers I am not sure as I wonder if the scrappage schemes are treated separately but the truth is prices are lower. Ironically this could easily be the sort of deflation scenario that central bankers are so afraid of as we note the risk of both falling volumes and prices. That is bad for debt which of course the car companies are carrying plenty of.

Term Funding Scheme

The problem is that the bubble in car finance has been fed by the easy credit policies of the Bank of England. Last August it gave all this another push with its Bank Rate cut and extra QE. But personally I think the real push came from the Funding for Lending Scheme of the summer of 2013 which is now the larger Term Funding Scheme. It went into the mortgage market and some washed into the car market and here we are. Unless we were all going to have 2 cars each there had to be a limit.

Comment

So we see issues in the real economy of a nudge lower to consumption and a smaller impact on production with ironically a fall in imports. However as we see lower prices and lower volumes the real issue is how the credit market which has built up copes. We are of course told it is “resilient” and that the Bank of England is “vigilant” and the latter may for once be true as after all it hardly wants word to get around that it was there 3/4 years ago with some matches and a can of petrol! How about QE for car production? Oh and a government scrappage scheme for diesels as well…….

 

 

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What is the state of play in the UK car loan market?

One of the features of the last few years has been the boom in car finance in the UK. This has led to a subsequent rise in car sales leading to something of a boom for the UK automotive sector.  the rate of annual UK car registrations dipped to below 2 million in 2011 and much of 2012 but then accelerated such that the SMMT ( Society of Motor Manufacturers and Traders) reported this in January last year.

UK new car registrations for 2015 beat 2.6 million units for the first time, sealing four years of consecutive growth. The market has posted increases in all bar one of the past 46 months ………Overall, the market rose 6.3% in 2015 to 2,633,503 units – exceeding forecast and outperforming the last record year in 2003 when 2,579,050 new cars left the UK’s showrooms.

So volumes surged as we note the official explanation of why.

Buyers took advantage of attractive finance deals and low inflation to secure some of the most innovative, high tech and fuel efficient vehicles ever produced.

The “attractive finance deals” attracts my attention as it feeds into one of my themes. This is that the Bank of England loosened up credit availability with its Funding for Lending Scheme in the summer of 2013. This flowed into the mortgage market but increasingly looks as if it flowed into the car finance market as well leading to what are described as “attractive finance deals”. This was added to by the Term Funding Scheme ( £80.4 billion and rising) of last August when the Bank of England wanted a “Sledgehammer” of support for lending. We know from past experience that such actions lead to the funds going to all sorts of places that no doubt will be officially denied, or disintermediation. But the car finance industry has exploded to now be 86% of the new car market. Of course the Bank will also describe itself as being “vigilant” about credit risks.

Bank Underground

This is the blog of the staff of the Bank of England rather than the London Underground station to which I commuted for quite a few years. They point out that the car market is now slowing.

Private demand for new cars slowed in 2016 (Chart 2). New car registrations spiked higher in 2017 Q1 — mostly due to changes in vehicle excise duty — but fell back sharply thereafter. The Society for Motor Manufacturers and Traders (SMMT) forecasts registrations declining by 2½% in 2017 and by a further 4% in 2018.

I know that this is being described as a consequence of the EU leave vote but whilst the fall in real wages may have added to it a fall was on its way for a saturated market. How many cars can we all drive on what are often very congested roads? Also the bit about “high-tech” I quoted from the SMMT last January has not worn the passage of time well. Although to be fair the emissions cheating software on many diesels was indeed high-tech. The consequence of that episode has also affected the market as I am sure some are waiting to see if the diesel scrappage scheme that was promised actually appears.

So we had a monetary effort to create a Keynesian effect which is that what was badged as “credit easing” did what it says on the tin. Car manufacturers and others used it to offer loans and contracts which shifted car demand forwards. But the catch is what happened next? The future is supposed to be ready for us to pick up that poor battered can which was kicked forwards but increasingly it does not turn out like that.

What about the finance market?

According to the Bank of England it has responded and below is one of the changes.

Providers are increasingly retailing contracts where consumers have no option to purchase the car at the end.  This avoids some risks associated with voluntary terminations, but it creates new risks around resale value.

Are they avoiding a problem now being creating one at the end of the contract? Anyway that issue is added to by the familiar response of a credit market to signs of trouble which can be described as “extend and pretend”

finance providers have responded by lengthening loan terms and increasing balloon payments rather than upping monthly repayments.

Actually there are a variety of efforts going on in addition to lengthening the loan term.

Manufacturers typically set the GMFV ( Guaranteed Minimum Future Value) at around 90% of the projected second-hand value at the end of the contract, in order to build a safety margin into their calculations. Tweaking the proportion can have a material impact on the cost of car finance. Switching the GMFV from 90% to 95% would likely reduce the consumer’s monthly payment.

Reducing the safety margin at the first sign of trouble is of course covered by one of the Nutty Boys biggest hits.

Madness, they call it Madness

Also there is a switch to PCH or Personal Contract Hire finance where the consumer does not have the option to buy the car. This is presumably to avoid what for them will be a worrying development.

So-called voluntary terminations are increasing, and usually result in losses to the finance houses.

However this comes with quite a price.

Greater use of PCH has certain risks attached for car finance houses. The primary risk inherent in PCP finance (ie the car’s uncertain market value when returned at the end of the contract) is at least as great under PCH. And a business model of increasingly relying on volatile and lower-margin wholesale markets to sell cars adds to the risk.

Oh and when all else fails there is of course ouvert price cuts.

Manufacturers often vary the amount of cash support to car dealers in order to meet sales targets — sometimes referred to as variable marketing programmes….. Our intelligence suggests that dealership incentives have increased over the past year.

So my financial lexicon for these times needs to add “cash support” and “dealership incentives” to its definition of price cuts. As it happens an advert for SEAT came on the radio as I was typing this I looked up the details. This is for an Ibiza SE.

One year’s Free Insurance (from 18 yrs)^

  • £1,500 deposit contribution**
  • 5.9% APR Representative**
  • Plus an extra £500 off when you take a test drive*

Comment

It is hard not to look across the Atlantic and see increasingly worrying signs about the car loans market. There are differences as for example the falling car prices seen in the consumer inflation data are not really being repeated in the UK so far. I checked the July data earlier this week and whilst used car prices fell by 1.1% new car prices rose by 1.3% although of course we wonder if the new offers are reflected in that? However the move towards “extend and pretend” and the use of the word “innovative” is troubling as we know where that mostly ends up. Or if you prefer here is it via the Bank of England private coded language.

That is partly because car manufacturers and their finance houses are increasingly stimulating private demand by offering cheaper (and new) forms of car finance. As amounts of consumer credit increase, so do the risks to the finance providers. Most car finance is provided by non-banks, which are not subject to prudential regulation in the way that banks are. These developments make the industry increasingly vulnerable  to shocks.

Barca

My deepest sympathies go out to those caught up in the terrorist attacks in and around Barcelona yesterday.

 

 

 

Of UK Austerity and the Queen’s Speech

Today in a happy coincidence we get both the future plans of the current government in the Queen’s Speech as well as the latest public finances data. It looks as though the atmosphere is for this at least according to the Financial Times.

But he (the Chancellor) is coming under growing pressure from some Tory MPs — who are reeling from the loss of the party’s majority in the House of Commons at the June 8 election — to learn lessons and increase public spending.

Why? Well this happened.

The opposition Labour party pulled off surprise gains in the UK general election by offering voters a vision of higher public spending funded by increased taxes on companies and the rich.

So there is likely to be pressure on this front especially as we will have a government that at best will only have a small majority.

Mansion House

The Chancellor Phillip Hammond also spoke at Mansion House yesterday and told us this.

And higher discretionary borrowing to fund current consumption is simply asking the next generation to pay for something that we want to consume, but are not prepared to pay for ourselves, so we will remain committed to the fiscal rules set out at the Autumn Statement which will guide us, via interim targets in 2020, to a balanced budget by the middle of the next decade.

Is that an official denial? Because we know what to do with those! But in fact setting a target of the middle of the next decade (so 2025) gives enormous freedom of movement in practical terms. You could forecast pretty much anything for then and the Office for Budget Responsibility or OBR probably has. If we look back over its lifespan we see that one error which is that forecasting wage inflation now would be 5% per annum as opposed to the current 2% has had enormous implications. Also we only need to look back to the 3rd of October to see the Chancellor giving himself some freedom of manoeuvre.

“As we go into a period where inevitably there will be more uncertainty in the economy, we need the space to be able to support the economy through that period,” he said. “If we don’t do something, if we don’t intervene to counteract that effect, in time it would have an impact on jobs and growth.”

As later today the media will no doubt be using OBR forecasts as if they are some form of Holy Grail lets is remind ourselves of the first rule of OBR club. That is that the OBR is always wrong.

A 100 Year Gilt

You might think that with all the political uncertainty and weakness from the UK Pound that the Gilt market would be under pressure. My favourite comedy series Yes Minister invariably had the two falling together. But nothing is perfect as that relationship is not currently true. It raises a wry smile each time I type it but the UK 10 year Gilt yield is blow 1% ( 0.98%) as I type this. In terms of recent moves the market was boosted yesterday by the words of Bank of England Governor Mark Carney who with his £435 billion of holding’s is by far its largest investor. In essence the likelihood of more purchases of that sort nudged higher yesterday and thus the market rallied and yields fell.

Also we live in a world summarised by this from Lisa Abramowicz of Bloomberg.

Argentina has defaulted on its external debt seven times in the past 200 years. It just sold 100-year bonds.

Actually it was oversubscribed I believe and I will let readers decide if they think a yield of 7.9% was enough. The UK however could borrow much more cheaply than that as according to the Debt Management Office the yield on our longest Gilt (2068) is 1.52%. Actually as we move from the 2040s to the 2060s the yield gets lower but I will not extend that and simply suggest we might be able to borrow for 100 years at 1.5% which seems an opportunity.

Actually quite a historical opportunity and we could go further as this from the Economist from 2005 ( h/t @RSR108 ) hints.

In 1751 Henry Pelham’s Whig government pulled together the lessons learnt on bonds to create the security of the century: the 3% consol. This took its name from the fact that it paid 3% on a £100 par value and consolidated the terms of a variety of previous issues. The consols had no maturity; in theory they would keep paying £3 a year forever.

I have a friend who has always wanted to own a piece of Consols to put the certificate on his wall so he would be pleased. Assuming of course they still do certificates…..

Today’s data

It was almost a type of Groundhog Day.

Public sector net borrowing (excluding public sector banks) decreased by £0.1 billion to £16.1 billion in the current financial year-to-date (April 2017 to May 2017), compared with the same period in 2016; this is the lowest year-to-date net borrowing since 2008.

So the financial year so far looks rather like its predecessor. Although below the surface there were some changes as for example it is hard to put a label of austerity on this.

Over the same period, central government spent £123.5 billion; around 4% more than in the same period in the previous financial year.

In case you were wondering on what? Here it is.

Of this amount, just below two-thirds was spent by central government departments (such as health, education and defence), around one-third on social benefits (such as pensions, unemployment payments, Child Benefit and Maternity Pay)

This meant that tax revenue had to be pretty good.

In the current financial year-to-date, central government received £110.2 billion in income; including £79.1 billion in taxes. This was around 5% more than in the same period in the previous financial year.

In case you are wondering about the gap some £20 billion or so is National Insurance which is not counted as a tax.

How much debt?

The amount of money owed by the public sector to the private sector stood at just above £1.7 trillion at the end of May 2017, which equates to 86.5% of the value of all the goods and services currently produced by the UK economy in a year (or gross domestic product (GDP)).

Actually some of this is due to the Bank of England something which we did not hear about yesterday from Governor Carney.

£86.8 billion is attributable to debt accumulated within the Bank of England, nearly all of it in the Asset Purchase Facility. Of this £86.8 billion, £63.3 billion relates to the Term Funding Scheme (TFS).

Comment

There is much to consider about austerity UK style. Ironically in the circumstances we would qualify under one part of the Euro area rules as our deficit is less than 3% of GDP. But of course that is a long way short of the horizon of surpluses we were promised back in the day. Please remember that later today as all sorts of forecasts appear, as the George Osborne surplus remained 3/4 years away regardless of what point in time you were at. As we have run consistent deficits is that austerity? For quite a few people the answer is yes as some have lost jobs or seen very low pay rises as we note it represented a switch. The switch concept starts to get awkward if we look at the Triple Lock for the basic state pension for example.

Moving onto other matters it was only yesterday that Governor Carney was boasting about the credit boom and I pointed out the unsecured portion. Well already the news has not gone well for him.

Provident Financial said recent collections performance had “deteriorated”, particularly in May. ( New York Times)

Presumably they mean the month and not Theresa. Also there was this in the Agents Report about the car market.

Increases in the sterling cost of new cars and decreases in the expected future residual values of many used cars had put some upward pressure on monthly finance payments on Personal Contract Purchase (PCP) plans.

If there was a canary in this coal mine well look at this.

Car companies had sought to offset this in a
number of ways, including increasing the length of PCP
contracts.

As the can gets solidly kicked yet again we wait to see if finance in this area is as “secured” as Governor Carney has assured us.

The Longest Day

The good news for us in the Northern Hemisphere is that this is the longest day although the sweltering heat in London it felt like a long night! So enjoy as for us it is all downhill now if not for those reading this Down Under. I gather it is also the Day of Rage apparently which may be evidenced when the Donald spots this.

Ford Motor Co (F.N) said on Tuesday it will move some production of its Focus small car to China and import the vehicles to the United States ( Reuters )

Both UK unsecured credit and car loans surge

After looking at US auto-loans yesterday attention shifts today to the consequences of the easy monetary policy of the Bank of England. This was where Bank of England Governor Mark Carney regularly gave Forward Guidance about interest-rate rises and then ended up cutting them to 0.25% in Bank Rate terms. We also got an extra £60 billion of UK Gilt (government bond) QE and £10 billion of corporate bond QE of which the former is complete but the latter continues. As ever a subsidy for the banking sector or “The Precious” was tucked away in it and now amounts to some £47.25 billion of cheap funding called the Term Funding Scheme. All this was based on the Bank of England’s grim economic forecasts post the EU Leave vote. How have they gone?

BANK OF ENGLAND MPC’S MCCAFFERTY SAYS DOES NOT EXPECT UNCERTAINTY TO DISSIPATE SOON, BUT HAVING LESS IMPACT THAN PREVIOUSLY FEARED ( @hartswellcap )

BoE’s McCafferty says “We did get it wrong last August” on the forecasts for downturn made after Brexit vote ( @KatieAllenGdn )

In other words they got it wrong again but will he respond to rising inflation with an interest-rate rise?

“I don’t know if I will vote for a rate hike… hahahaha. It will depend on how I feel at the next meeting” ( @SigmaSquawk )

In spite of admitting to being wrong he appears unwilling to put right his mistake and as he was one of those considered to be most likely to be willing to do so the UK Pound £ fell below US $1.25.

Unsecured Lending

If we look for a consequence of easy monetary policy we would expect to find it here and regular readers will be aware that I have been warning about this since late summer last year. I warned about unsecured credit growth back on the 29th of September in particular.

The three-month annualised and twelve-month growth rates were 10.4% and 10.3% respectively.

How is that going? From this morning’s update.

The net flow of consumer credit was £1.4 billion in February. The twelve-month growth rate remained at 10.5%

So as you can see the UK consumer continues to borrow at what frankly is an alarming rate if you look at the growth in the economy or even worse real wages. Each month we get a hint of slowing ( this month in personal loans) but there were hints of that in January which have just been revised upwards!

Car Loans

Some of the increases above are from the car loan sector so let me hand you over to the Bank Underground blog from last August.

This article examines a fairly recent development in the industry, namely that new car purchases nowadays are mostly financed by manufacturers’ own finance houses.

This was discussed in yesterday’s comments section and the blog puts it like this.

First, a growing proportion of finance is now provided by the car manufacturers themselves, often through their own finance houses. Intelligence gathered by the Banks’ Agents suggests that these so-called “captive” finance providers have a market share of about 70% of all private new car finance. Second, households increasingly rent their vehicles using Personal Contract Purchase (PCP) plans.

This is another version of the economic world using the rental model which in truth is a sort of back to the future change and it has happened on a grand scale.

Industry contacts of the Bank’s Agents estimate that around two-thirds of private new car buyers now rent their vehicles using PCPs. Under PCP, the car buyer does not initially take ownership of the vehicle, but instead rents it for an average length of typically three or four years.

There are various changes here and let us start with the monetary and economic one.

This change in buyer behaviour has undoubtedly contributed to the sharp rise in new car registrations and the level of consumer debt in the economy in recent years.

This has fed into the economy and boosted economic output and GDP as more cars are bought.

The popularity of PCPs has thus been associated with a shortening of the replacement cycle for private buyers, thereby boosting the aggregate level of consumer demand for new cars.

So far, so good, although where do the old cars go and what happens to them? Is there some sort of graveyard or perhaps lower prices for older cars? We also get a confirmation of my view that the economic world is increasingly rented these days.

A consumer who might never own the car is likely to view it in the same way they view a mobile phone contract, i.e. just another monthly Direct Debit.

The conclusion is that sooner or later there will be trouble.

Those structural changes have: (a) concentrated financial risk in an industry that is especially sensitive to the economic cycle (in contrast to previous cycles when risk had been shared to a greater degree with the household sector); (b) contributed to increased household borrowing, reflected in the very rapid growth of car finance in recent years and a trend towards premium models; and hence (c) made the car industry more vulnerable to negative shocks, including hikes in interest rates, exogenous falls in market prices of used cars, lengthening of the replacement cycle and changes in consumer tastes.

 

Number Crunching

The UK Finance and Leasing Association or FLA helps out.

New figures released today by the Finance & Leasing Association (FLA) show that new business in the point of sale (POS) consumer car finance market grew 12% by value and 8% by volume in 2016……The percentage of private new car sales financed by FLA members through the POS reached 86.6% in 2016, up from 81.4% in 2015.

Meaning the Bank of England was behind the times again. In terms of amounts there is this.

£88 billion of this was in the form of consumer credit, over a third of total new consumer credit written in the UK in 2016. £41 billion of it supported the purchase of new and used cars,

Here are the most up to date numbers we have.

New figures released today by the Finance & Leasing Association (FLA) show that new business in the point of sale (POS) consumer new car finance market grew 9% by value and 3% by volume in January, compared with the same month in 2016.

On the way we see another hint of inflation in the UK. Oh and should you look at their website I too am unsure why they have a Base Rate at 0.5%.

Business Lending

Back in the summer of 2013 when the Funding for Lending Scheme began we were promised that it was for business lending. In reality we have seen the mortgage market return to positive net lending and for unsecured credit to mimic a hot air balloon. So what about business lending?

Loans to non-financial businesses decreased by £1.8 billion in February, compared to the recent average increase of £0.9 billion . Loans to small and medium-sized enterprises (SMEs) increased by £0.6 billion in February.

If we look for some perspective the annual growth rate is 1.7% overall and 1.2% for SMEs which provides quite a contrast to the household unsecured credit data does it not?

Comment

As you can see the easy monetary policy of the Bank of England has boosted unsecured credit and a lot of it comes from the car loan sector it would appear. So earlier this week it warned about the consequences of its own actions.

UK household indebtedness remains high by historical standards and has begun to rise relative to incomes.  Consumer credit has been growing particularly rapidly.

Is that the same unsecured credit that it has told us is not growing rapidly or a different one? As to the motor industry there are clear worries although so far it assures us there is no problem. From MotorTrader on the 20th of this month.

The used car market is showing “no signs” of cooling down despite the high volume of PCP cars coming back into dealers as part exchanges.

As a last thought has the borrowing been shifted from businesses to the household in the car sector? That fits with the novel below.

Dune

A great novel and are we on the way to its suspensor suitcases?