Dr Roger Gewolb, one of the founders of
the non-prime and sub-prime motor finance industry in the UK, gives
an overview of recent changes to the market, and indications as to
its future development
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In the almost 15 years since I bought
British Credit Trust from Bank of Ireland, I’ve never seen a
situation such as exists today, where there is effectively no
subprime or even non-prime finance capacity.
Welcome Financial Services is gone. But it would
appear from press reports that its listed parent company Cattles
was heading in that direction for a long time anyway, and its
demise was only hastened by the credit crunch and the consequent
funding crisis.
All the other major players have disappeared, their
funding lines having been ceased as part of the overall systemic
deleveraging by wholesale bankers that was the first stage in
confronting the effects of the credit crunch. The crisis of
confidence that pervaded the market, when motor finance lines for
all but the most prime funders were stopped or drastically reduced,
as an adjunct to the much larger non-prime mortgage lines that were
pulled.
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By GlobalDataBut history shows that the British car owner is
always pretty good about making car payments – recognising that the
car is an essential tool. For more on how the finance providers
threw out the motor finance baby with the subprime mortgage
bathwater, see my article in Motor Finance’s April 2009 issue.
There now exists, therefore, a huge market gap and
a consequent opportunity in near-, non- and subprime motor finance
such as we have not witnessed before.
I received a number of approaches from both equity
sponsors and debt providers from here and abroad who see the
tremendous opportunity in the market, where anyone with any kind of
credit impairment cannot easily get finance for a car, and where
the credit bar overall has been raised.
Securitisation is already starting up again, with
recent issues from Volkswagen, Ford Credit and Lloyds TSB as well
as other issues, and it is clearly the intention of all government
regulators to get the securitisation market moving again.
So when the non-prime motor finance market does
revive, what will it look like? Who will fill the gap in the
market? Will the prime lenders look into providing non-prime? No:
they’re not equipped for it, in terms of corporate ethos, staffing,
systems or even clientele. Looking at a parallel market, a big
effort has been made to get prime mortgage lenders to fill the
subprime mortgage gap, but none has apparently been willing to do
so, and I do not think motor finance will be any different.
Will past players be brought back to life through
acquisitions? Again, I get regular approaches on this topic but
nothing concrete has materialised as yet.
Outsourcing of processes
How will possible new entrants into the
subprime zone operate? Will they outsource processes?
I have been in the industry since the
beginning and it has been proved time and again that outsourcing
processes or using ‘virtual’ financial services companies does not
work for non-prime and subprime.
You cannot ‘farm out’ underwriting,
payouts, arrears management and collections for anything below
near-prime. These processes all have to be controlled in-house in
an open-plan trading floor, with highly experienced managers right
in the thick of it.
A subprime point of sale business can
very quickly spin out of control once things start to go wrong, so
managers must be aware of everything that happens in order to nip
problems in the bud every day. (Hey, that’s why you get the big
bucks – for example big margins.)
I was recently interviewed by a bond rating agency,
which said that its biggest concern is that when things go wrong,
there is a big question as to whether standby servicers can cope as
well as they should.
Funding lines, and loan criteria and conditions,
will initially be much tighter than before, even for those lenders
which are currently lending out small amounts of the rentals coming
in every month, in order to keep business ticking over.
Having said all the above, I think the current
moribund state of the market is a shame, as despite some players
having made mistakes with loan-to-value ratios, commissions, and so
on, the UK subprime motor finance market is filled with
exceptionally talented people, capable of serving the needs of a
huge number of customers.
In 2006, Datamonitor said that more than 15 percent
of the population fell into the subprime category (9 million out of
a population of 61 million). That was two years before the credit
crunch, when the economic outlook was decidedly rosier.
I have read recent projections that at least
one-third of the UK population is now non-standard. That’s an
extraordinary chunk of the UK population, and we have more than
enough talented people from this grossly shrunken industry to serve
it.
The smaller players, especially if they are
acquired, may be able to raise additional capital and debt and
increase their market share. We may also see the appearance of
speciality motor finance companies, serving a variety of niches –
dealing with certain types of car, for example, or particular
localities and so on.
This market needs to be consolidated – previously,
there were too many small players. We need to see the emergence of
an industry major which serves all segments, not just subprime, as
did Welcome.
Changes in customer
behaviour?
Have subprime customers changed, as a
result of the credit crunch? Previously, good customers were people
with the willingness and the ability to pay; a good subprime
customer had had trouble in the past, and wanted to rebuild his
credit rating, so demonstrated good repayment behaviour.
What the industry needs to ask itself now
is whether the way that the public now seems to hold banks and
lenders in low regard means that customers’ loyalties have changed
– and how, in turn, this will affect their behaviour.
It may well be the case in the area of unsecured
lending that arrears management and collections become more
difficult.
But I believe that in motor finance and first
mortgage lending, the threat of repossession following default
remains unchanged, and may even be stronger, given the sensitivity
to future losses that lenders – many of them bailed-out – may
experience.
“I believe that in motor finance and first
mortgage lending, the threat of repossession following default
remains unchanged, and may even be stronger, given the sensitivity
to future losses that lenders – many of them bailed-out – may
experience”
Furthermore, customer sensitivity to the relative
sparseness of finance options outside the prime world could also
engender better debtor behaviour.
The possibility of a usury ceiling has been raised,
as a result of the credit crunch, the subsequent financial crisis
and other controls introduced on compensation, bonuses, leverage,
proprietary trading and so on, but I do not think one will be
brought in.
First of all, the Consumer Credit Act of 2006 did
not include any rulings on interest rate ceilings in its final
form, and although parliamentary debate on this point has carried
on, there is no serious political appetite to introduce such a
measure.
When the insertion of such a measure was being
introduced, it is notable that even the Citizens’ Advice Bureau,
along with many other consumer protection bodies, argued against
its inclusion in the final bill.
Second, it has long been perceived in the UK that
to introduce a usury ceiling of, say, 20 percent APR, as was the
aim of a three-faith demonstration in the City, would be naïve –
inasmuch as subprime lenders simply cannot make money for the risk
they take on at that level of interest.
Subprime customers would thus be driven into the
arms of unregulated loan sharks. Successive governments have been
well aware of this danger, namely that of leaving
credit-challenged, socially marginalised customers totally
unprotected.
Responsible lending
guidance
The subprime motor finance market perhaps
has less to fear from the Office of Fair Trading (OFT)’s draft
guidelines on irresponsible lending than might be expected.
For example, in non-prime lending, no
finance house makes loans without a statement of income, as the OFT
suggests. Most of the consumer lending protection measures are
already used as self-defence mechanisms by subprime motor finance
companies in any case.
It is undeniable that the very term “subprime” has
had some bad press since the start of the credit crunch. Subprime
motor finance, however, has mostly escaped this bad press – with
the exception of Cattles, although its problems were allegedly
caused by improper provision in any case.
The subprime mortgage industry has had a huge
amount of bad publicity, both here and in the US, but I do not
think that this negative press will affect car buyers, dealers,
brokers or any subprime lender to consumers.
However, it has egregiously affected wholesale
lenders – who fund subprime finance houses – and that is the reason
for the lack of supply of non-prime motor finance.
Those wholesale lenders will return to the market
eventually, albeit softly and gingerly at first, but return they
will – especially as the securitisation market recovers.
Past lessons
Commissions paid to dealers for
introducing subprime customers have almost disappeared from the
market. Will we see a return to the commission wars of the
past?
I think it unlikely, as companies which
return to this market, or which set up new operations, will need
profits to repair their balance sheets, rather than giving money
away in the form of commissions.
Supply will eventually return to the market, and
when it does, we will see whether the industry has learned the
lessons of the recent past regarding loan-to-value ratios, high
commissions, and so on.
It is clear that the subprime motor finance
industry faces many challenges – in my long experience in the
industry, I do not think I have ever seen conditions as tough as
they are at present.
But I believe that the majority of people within
the industry will learn the lessons of the present, and will apply
those lessons in the future.
