Chris Sutton, managing director of Black Horse and
chairman of the Finance and Leasing Association, demystifies the
cost of lending.
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As any finance provider will, I’m sure, agree,
charging the right price for the money they lend is a balancing
act.
It has to take into account the
margin and overheads the finance house has to make to stay in
business. It also has to allow the dealer or intermediary to make
money from the deal and, of course, the price must also be one
which is fair and favourable to end-user customers.
The method which is used to arrive
at the actual price, however, can sometimes be a difficult one to
convey, as there is often confusion about the relationship between
funding rates and short-term changes in the base rate or other
market rates.
There’s an important distinction to
be made here, which is crucial to understanding how most banks and
finance houses fund their lending requirements.
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By GlobalDataBank base rate (BBR) only provides
an indication of short-term variable interest rates and actually
has very little to do with the price the customer sees, although it
is the rate most quoted in the press when interest rates are being
discussed.
Lending a fixed amount over a fixed
term is generally funded by a fixed funding mechanism (more
commonly known as a SWAP rate), relevant to the term of the loan.
This removes the volatility inherent with variable funding options
(like BBR and LIBOR) and provides certainty to the lender, the
dealer and the end-consumer that the rate for a loan won’t
change.
SWAP rate prices are determined
within the money markets and reflect the expected cost of money
over the SWAP rate term. And, just like the risk premium applied to
consumers within risk-based pricing schemes to offset the chance of
default, the money markets apply a risk premium to lenders for
exactly the same reason.
Therefore, borrowing and lending
funds over a period of three to five years has a very different
funding cost associated to it than doing the same over much shorter
periods.
Funding cost is only one factor
that is considered when setting pricing levels. Overheads and, in
particular, impairments (credit risk), are also included.
In today’s age of technology and
automation, the former is relatively low.
Impairment cost, on the other hand,
needs to factor in economic changes over an extended period. Hence,
one of the key success factors for any lender is its impairment
forecasting (or credit risk management) capability.
At Black Horse, we are very
conscious about the current uncertainty and volatility that exists
within the economy.
We attempt to take a longer-term
view of changes in market rates and impairments, so that we create
a business that is sustainable over the long term and one that is
still supporting the motor industry in many years to come.
SWAP rates have increased gradually
over the past two years and will undoubtedly continue to rise.
Most economists are agreed that we
will also see BBR go the same way – the big question is when and
how quickly?
Consumer spending will play a part
in this progression and it’s also interesting to note the
increasing confidence which seems to be emerging among businesses,
so research conducted recently provides some crumbs of comfort.
A Lloyds Banking Group survey of
200 businesses, which was widely reported in last month’s press,
revealed the first increase in business confidence this year. It
found a majority of businesses were confident the economy would
rebound, the highest margin since May 2009.
Some 54%
of businesses said they were more optimistic than three months ago,
up from 45% in March, compared to a quarter of businesses that were
less optimistic.
While it’s too early to predict
what impact this might have, if it’s sustained it would point to an
improvement in the economy in the second half of the year. However,
it’s still highly likely that we will see base rate hikes before
the year-end.
But, while economists generally are
agreed that BBR will rise, they are split when it comes to
forecasting exactly when – crystal ball anyone?
Black Horse, the biggest lender
in the UK motor finance market, provides point of sale finance to
more than 5,000 UK new and used car dealers, as well as motorbike
and caravan dealers, and also offers dealers new and used car stock
funding
