This is a personal reflection on the similarities and differences between the two recent crises, both of which I have lived through; the 2008/9 crisis as a senior VP for Toyota Financial Services and the recent crisis as an entrepreneur with stakes in various businesses and a content advisor to the IAFN.
I think that everyone will remember the Lehman Brothers bankruptcy and the global impact that followed; for example, the TV pictures of queues on the street outside the Northern Rock!
In a way 2008 was all about banks (sub-prime mortgages etc) funding and risk concentration in the financial markets generally. This time around it feels to me more like a classic recession, (created by a health crisis) with the added variable of fighting against an invisible enemy.
My memory of the 2008/9 crisis was going straight into a board meeting when we took the decision to increase provisions against bad debt and RV losses to a level that virtually wiped out the profits for the year. I also recall that just six months later I was in discussions with the auditor about how and by how much we should reduce the provisions!
So last time there was an over-reaction by the automotive financial services industry (notwithstanding what happened and RBS et al) it begs the question:
Has there been an over-reaction this time?
Before we went into this crisis the business wasn’t broken. OK, the auto industry was still managing decades of over-capacity, exacerbated by the move to BEV’s. However, at the same time, the overall financial system is much stronger than it was 11 years ago with significantly stronger reserves and also having enjoyed the longest period of economic expansion in history. Auto finance captives have done very well during this period helped by stable interest rates, high employment rates and the insatiable desire of the OEM’s to use subsidised personal contract purchase (PCP) as the preferred route to market.
However, with interest rates at zero or below, central banks have less room to manoeuvre leading to global governments having to step in with employment support schemes and business loans and grants. This is a key difference. Some countries have managed this transition better than the UK. Germany is a good example. Using the basic structures that were set up during the last crisis the German government was able to quickly turn them on, whereas the UK government had to develop new ones almost from scratch and therefore lost valuable weeks in tackling the pandemic.
Bringing my thoughts closer to home, I have some comments about the UK auto finance industry. One big difference this time is that the car factories have been closed now for over two months but in 2008/9 the factories were still open with manufacturers trying desperately to right-size production to demand and in many cases failing.
I recall joining Jaguar Land Rover at the very end of 2009 when it was in the process of recovering from having almost 12 months inventory on the ground when Lehman Brothers went under.
Therefore, there is less stock of new cars and this should mean that from 1 June most of the deliveries that have been frustrated by the lockdown can be completed and with fewer new cars being built this should ensure that new car marketing is not overly disorderly for the foreseeable future, even though overall demand will be hit by unfortunately increased unemployment.
The market for used cars is even more interesting. There can be no doubt that there will be a spike in supply as customers return overdue PCP cars, company car and salary sacrifice drivers return their cars and fleet operators dispose of excess capacity. However, with the government message to avoid public transport then there could be an increase in demand?
Against that there is a strong message (and desire from those who have had the opportunity of sampling it) to work from home and hence less reliance on personal mobility.
All these (and other) factors need to be taken into account when forecasting RV’s of the existing portfolio and setting guaranteed minimum future values (GMFV) for new PCP contracts. My personal view is that many of the factors will balance out and that there will be a reduction in RV’s in the order of 2-3% during the remainder of 2020.
Captives will exercise greater caution
However, I would also expect that captives (and independents) will exercise greater caution when setting GMFV’s for new contract which will have the effect of increasing monthly payments and therefore heightening the stress between the OEM’s and their captives. How I fondly (not) remember those RV setting meetings with the various OEM’s I have worked with!
During the last crisis I served the industry as the chairman of the UK Finance & Leasing Association (2007-2010) when I worked with Stephen Sklaroff the director general at the time. Stephen spoke about those times most eloquently when he gave the keynote speech for the IAFN webinar on the 5 May.
I think that it is fair to say that Stephen and I burnt a lot of midnight oil then preparing for meetings with The Bank of England and the regulator. I’m pleased to say that far fewer lenders went to the wall than expected and the industry came through, crucially with its reputation for helping customers enhanced, indeed relative to other parts of the financial services sector.
I’d like to touch on a couple of specifics that face the industry, then and now.
First, a major impact for auto finance companies 11 years ago was that wholesale funding lines in many cases dried up almost overnight; asset backed securities (ABS) disappeared and those companies that had pursued a model of borrowing short and lending long to increase margins found themselves in a great deal of trouble
Exit strategy in doubt
A second issue to consider is the role that the regulator plays. The FCA has, quite rightly laid out the guidelines that companies should follow to provide customer forbearance and the industry has complied fully. However, there has not been enough thought put into the exit strategy, as often happens. Simply extending a car loan is different to a mortgage, the asset subject of the former depreciates rapidly whereas the asset subject of the latter is stable/ increasing in value (over time).
So, the regulator needs now to engage with the industry on managing the exit strategy. Moreover, the regulator needs to react to the lessons learned about the inflexibility of the current auto lending landscape, still regulated by the 1974 CCA. Modifying agreements have been a painful problem, so looking forward the FCA needs to review what products are needed to provide customers with what they want to buy.
Post crisis, consumers will wish to avoid long term fixed commitments and move to shorter term more flexible products. The industry needs help from the regulator to approve these types of products quickly.
I’d like to add that those skills developed by the industry to navigate the turbulence in 2008/9 will be needed again this time around as many of the government sponsored schemes don’t easily reach the smaller independents.
I know that the current chairman and DG of the FLA are working very hard to address the funding and regulatory issues and on behalf of us all we send them our very best wishes for a successful outcome.
David Betteley is an automotive industry professional