to intermediaries is the latest in a series of upheavals in
sub-prime motor finance, Jo Tacon finds.
The decision by British Credit Trust (BCT) to stop paying
commission to its brokers (see News, p5) was broken via a
conference call. After the bombshell had been dropped, there was,
apparently, a long silence, before one brave soul asked: “Well, how
are we expected to stay in business?” The reply from BCT was that
brokers could, perhaps, sell more add-on products (GAP and payment
protection insurance, for example), or could ask dealers to pay
them a commission, in return for arranging finance for a customer.
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It’s not hard to imagine how brokers reacted to that particular
idea; dealers, hard-hit by falling sales and shrinking margins, are
hardly likely to welcome the thought of having to pay for a service
– finding a source of sub-prime funding for a customer – for which,
up until now, they received payment.
But, says one broker, they may have to get used to the idea, and
fast. “Dealers can’t charge a customer for finding sub-prime
finance, as the customer is already paying a doc fee. Times are
changing and brokers and dealers need to renegotiate their
relationships, and dealers may have to accept that they need to
subsidise brokers.” Dealers have no real choice, the broker
continues: “If the alternative is that the dealer is unable to sell
the car, they will have to come around.”
With an estimated one in four potential car buyers now falling
into the sub-prime category, and more and more potential motor
finance customers suffering from an impaired credit rating as the
economic outlook darkens, brokers’ services are needed more than
ever. “Without brokers, dealers will be left with prime funders,
who will increasingly cherry-pick the customers they want and
ignore the rest,” says another intermediary. “For dealers, moving
the metal is paramount. If they don’t want to pin themselves to one
funder, they should allow brokers to use their skills and knowledge
to place non-prime customers with lenders, meaning dealers can
concentrate on selling cars.”
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By GlobalDataLes Spencer, director of brokerage Mann Island Finance,
estimates that during 2008, the non-prime market “lost about 80 per
cent of its funding capacity”. He adds: “There is an inability in
today’s market to satisfy the needs of dealers and finance brokers
actively trading in this area.”
The roll-call of those who have ceased sub-prime lending as the
credit crisis has deepened (Welcome Finance stopped providing hire
purchase through intermediaries in April, while in the same month
Blue Motor Finance ceased lending from its own book and reverted to
pure brokerage activities; Black Horse’s non-prime Deal Assist
programme was stopped in June; BCT cut ties with a number of
“underperforming” brokers in June; Park Finance closed to new
business at the end of August) makes for sobering reading. “When
Welcome ceased doing business through brokers, we didn’t panic,
because Welcome went deeper into sub-prime than other funders and
we thought its problems were caused by the nature of the customers
it was taking on,” a broker comments. “But Park going was a
shock.”
With funders tightening underwriting standards across the board
– with prime lenders moving to ‘super-prime’, sub-prime moving to
near-prime, and so on – there is more demand for sub-prime lending
than there is appetite among lenders to fulfil that demand. One
industry observer comments: “Lenders such as Duncton, Advantage
[see boxes], Marsh Finance and Southern Finance are very selective
about who they deal with, and are turning business away.” Nikki
Cann, associate director at the NACFB observes: “Brokers have noted
that it’s getting more difficult to place deals and that even minor
past financial misdemeanours mean that some clients are being
classified as ‘sub-prime’.
“One broker mentioned a case where a client of theirs had
overlooked a debt of £10, and despite an otherwise impeccable
record this meant they were refused finance. The bar for ‘prime
lending’ is being raised ever higher as funders cherry-pick the
business they want to write,” she recounts.
Filling the gap?
The future for sub-prime finance is unclear. There does not seem
to be an obvious candidate to fill the vacuum left by BCT, with the
specialist players who talked to Motor Finance insisting they would
look to grow conservatively (see boxes), despite noticeable upticks
in application volumes since Park ceased lending, and since BCT
restricted its flow of new business (“We’ll still look to place
some business with BCT, but with the new commission rules they are
right at the bottom of our list,” a broker says).
Could Black Horse fill the gap with its Rate for Risk product,
which places finance applicants on a sliding rate scale depending
on their credit score? A spokesman for Black Horse confirms that
the bank-owned lender intends to grow Rate for Risk next year, and
for dealers looking for a ‘one-stop shop’ finance provider, it
could prove more palatable than paying brokers to place business
with the relatively few funders still willing to consider non-prime
and sub-prime customers. But some brokers are sceptical about the
programme’s benefits. “Because of BCT’s decision [to stop paying
commission], I can see that some larger retail groups may consider
going back to Black Horse – even if they have been unhappy with
them in the past. But with Rate for Risk, you have to trust the
funder to tell you the truth about where the customer sits on the
spectrum, and with a lack of alternatives in the marketplace, it’s
difficult to make a fair comparison,” says one broker.
“What about the captives?” asks another. “Up until now they have
been squeaky-clean in the business they will write. But will
growing numbers of sub-prime customers mean they have to roll up
their sleeves and get their hands dirty? I can see a situation
where the captives enter into joint venture partnerships with third
parties to provide non-prime finance to car buyers, just to keep
the metal moving through the showrooms as alternative forms of
finance dry up.”
“The problem is that funders don’t like this market,” says an
industry expert. “BCT ran out of cash after Merrill Lynch [which
provided the majority of its funds] decreased the proportion of the
risk in the business written by BCT that it was willing to take on,
following Merrill’s rescue by Bank of America. There’s speculation
that Merrill was told to bring its funds back to the US, but in any
case the end result is the same – the days of cheap money for
sub-prime lenders are over.”
The consequent shake-out in the broker sector is likely to be
painful. Already, there are multiple reports of brokers cutting
staff numbers, or closing doors altogether. “There’s a grim
realisation that things are not how they used to be,” says one.
“Those brokers who survive the credit crunch upheavals will be the
larger, more diversified ones, not solely dependent on non-prime
income.”
With all the confusion in the wider economy, it is impossible to
say what will happen in sub-prime motor finance in coming months;
the cost of funds to lenders does not look like it will get much
cheaper any time soon. Still, nature abhors a vacuum, as the saying
goes, and there is definitely room for new entrants in non-prime
lending; whether anyone has the nerve to enter the troubled
sub-prime arena, and whether anyone will back them, is another
matter altogether. “A year ago, everyone wanted our business and
the market was saturated. Now there’s been a total role reversal,
with funders few and far between,” a broker laments. “It’s
definitely not an easy business to be in at the moment.”
PROFILE: DUNCTON
Small beginnings and steady growth
Duncton is one of the dwindling number of motor finance companies
not to have withdrawn from sub-prime lending, and has the funding
secured to stay in the arena, said its managing director Peter
Minter. “We secure the bulk of our funding needs using warehousing
loans rather than securitisations, and have maintained good
relationships with our banking partners. We still have guaranteed
funds – arranged on pre-credit crunch terms,” he explained. Setting
up funding in this manner was “more expensive” than going down the
securitisation route, Minter noted, but has proved the wiser choice
in the long term.
Like its funding, Duncton’s underwriting process – applications
are manually underwritten, with about one in four accepted – is
perhaps more expensive than its competitors’, but has proved its
worth in the current climate. “The proportion of applications that
are accepted has remained fairly stable over the past few years,”
Minter said. Extensive documentation is required, with clients
often visited in their homes. Even so, fraud is still “a worry” for
Minter, with numbers of fraudulent applications “rising
significantly” as the overall economic outlook gets bleaker.
A conservative take on lending has also insulated the company
from the worst of the shocks affecting other sub-prime lenders.
“Our loans are based on a relatively low lend to value ratio –
nothing like the 120 per cent LTV deals that we saw some of our
counterparts write,” Minter said. “We lend less against the asset,
so have far more security,”
There is no upper limit on balances, but a substantial deposit is
required. And the company may benefit from the withdrawal of the
competition, Minter pointed out. “Since the news from BCT, we have
seen an uptick in applications, which allows us to be choosier
about the business we write,” he observed.
Another factor aiding Duncton is its membership of a programme
sponsored by the Office of Fair Trading, called Buy With
Confidence. It is the only vehicle finance company to be accredited
on the programme, Minter said, and membership gives Duncton a
reputational boost. Minter is also a fan of the Finance &
Leasing Association’s Specialist Automotive Finance campaign: “It’s
very worthwhile,” he commented.
PROFILE: ADVANTAGE FINANCE
Prudence is more than a buzzword for sub-prime lender
Grimsby-based Advantage Finance is living up to its name, as its
business model and strong emphasis on back-office systems have
allowed it to prosper during turbulent times for sub-prime
lenders.
Deputy managing director Keith Charlton said: “We have built up
a pretty robust business model which works for us, and have very
experienced directors who have had dealings in sub-prime going back
to the 1980s. We’re not interested in chasing volume for volume’s
sake – and if you go into sub-prime lending without your eyes fully
open in terms of what to expect, you’re probably doomed to
failure.”
At the end of last year, Advantage implemented a back-end
technology upgrade which switched its manual underwriting system
over to a fully automated system, which it developed in-house. “Our
system is based on our own underwriting experiences, from the last
nine years, allowing us to have the advantages of a manual system
with the efficiency of instant automated decisions, which gives a
clear competitive advantage,” Charlton said. Advantage has not
changed its underwriting criteria over the course of the credit
crunch, he added, but the withdrawal of erstwhile rivals has
allowed the lender to improve the quality of the business it
writes. Around 25 per cent of applications are approved, Charlton
reported, with the average advance around £5,000.
Having anticipated at the start of the year that the
availability of funds was likely to shrink, Advantage has been less
affected by spiralling money costs than other sub-prime players,
especially as its funds are channelled via its parent, S & U
plc, which has agreements in place with a number of commercial
banks.
Arrears are “in line with expectations”, Charlton said, with
Advantage “bucking the trend in the market” thanks to its robust
collections process, administered in-house.
Around 70 per cent of new business comes via brokers, with the
rest direct from dealers and the existing customer base. “We value
our relationships with dealers and brokers and are very strong on
the idea of partnership values, with both sides profiting,”
Charlton explained. “When dealing with more difficult-to-place
applications, our partners appreciate the high service levels that
we provide, and we do not therefore compete on just commission
alone,” he added.
Advantage does not, however, claw back commission – so a
dealer’s commission is “safe once paid”. “Our philosophy is that we
take a risk when underwriting but we also expect to make a profit,”
Charlton said. With half-year profits to July 2008 up 30 per cent
year on year to £1.6m, it is a philosophy which has served
Advantage well; as sub-prime point of sale finance becomes scarcer,
Advantage may well be in a position to expand. “There’s a desire to
grow, but always in a prudent and controlled manner,” said
Charlton. “We won’t throw caution to the wind.”
