Challenge Consulting managing director Chris Cooper and Gavin Wraith-Carter, general manager at Hitachi Capital Business Finance, talk to Brian Cantwell about market issues.

The vehicle sector is storing up problems for the future, because of the huge volume of vehicles being sold on PCP, according to Chris Cooper, managing director of Challenge Consulting.

"There are two issues – one with the volume of stock coming back. There’s always the risk that if there’s a bit of a downturn then values start to drop," says Cooper.

"In many PCP contracts, you can return the vehicle once you’ve repaid half the debt but not completed the contract, with no penalties – it’s the rule of halves.

"And that was a big feature of the chaos in the mid to late-nineties, when PCP was popular," warns Cooper.

"A lot of people realised that a lot of their cars were not going to be worth what they thought they were going to be, and dealers in the main were obliged to take them back while taking a hit on the gap in the finance as well as the car which wasn’t worth very much. I think leasing businesses are softening their residual values, but the PCP issue will have a big impact."

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Business is good at the moment in the consumer motor finance industry, as is the case with commercial asset finance. Cooper is agnostic about it continuing.

"We have had three or four client engagements in the equipment finance sector in the last four months, and the enthusiasm still continues to be positive," says Cooper.

"It’s really hard to predict whether the market will turn. Last November, everyone was very sure that there would be interest rate increases. People started to make greater forecasts on incomes lines, on the basis of that, and by February, it was clear the rate rise was not going to happen – the great certainty and forecast was turned on its head.

"Across the wider sector, it’s very hard to predict what’s going to happen yet. Is the credit cycle going to turn? Will there be increasing levels of bad debt or failure, or delinquency or otherwise? We’ve sort of been waiting for that for the last seven years. It’s not impossible to conceive but people have been confidently forecasting it."

According to Gavin Wraith-Carter, general manager at Hitachi Capital Business Finance, provision for stability through a credit correction is set by concerted growth and adequate risk provision.

"Hitachi set out a five-year plan to make the book grow three-fold, and the portfolio is still keeping pace with where we want to be," says Wraith-Carter. "We wanted to make sure that it was good growth, and sustainable. So the last 12 months have been good. It’s mainly broker-led business, and the progress has supported that five-year plan.

It’s a strong achievement considering that competition is picking up in the UK market, and Wraith-Carter thinks the continued competition, and pressure on pricing is leading to the sort of suppression of risk weighting that caused market exits in 2008.
"It’s a bit dangerous I think at the minute, as people have forgotten what happened in 2005 and 2006.

"I think the FLA released some stats about the fact that SMEs didn’t feel supported by financial services during the tough times. When you think that 100 funders went down to 20 in the wake of the 2008 crash, it’s understandable. Market exits post-recession are not good for the reputation of the market, especially for the SMEs that survive through it but lose their funders. Having funders there through the thick and thin is what SMEs need."

And new entrants need to assess whether gaining volume as market share as a primary strategy allows other risks to creep in without adequate controls.

"Quite a few of the new entrants are looking to be in the industry for the long term, with long-term growth. That’s fine. They’ll do things sensibly. Some of the new entrants are looking for a quick entrance and exit, with the quickest route.

"Look at the economic cycle, which is five to seven years. Those businesses with aggressive growth could be at risk; those with an agenda for getting scale quickly are at risk."

The broker/funder hybrids will be undergoing a change in culture, and might have to navigate cross purposes.

"It’ll be interesting to see where the brokers that have been bought end up in a few years, from a cultural aspect," says Wraith-Carter.
"Whereas they have been masters of their own destiny, doing what they want, when they want, they will have different expectations placed on them of a different kind.

"All the people that bought businesses, they might seek out a mixed model. If they’re going to build scale then I’m not sure how sustainable it is, funding direct and through a broker."

As for general market flexibility, Wraith-Carter is more upbeat.

"Liquidity seems a bit better, but I don’t know about the next couple of years. I think you’ll see some consolidation, and the challenger banks are all in play, which because of their size will be attractive to somebody, at the right price."

Hitachi’s strength as a manufacturer captive that offers wider finance is a structural benefit to the market, says Wraith-Carter.

"Technically we are a captive as well. It works for us because what we learn in the commercial world benefits our captive offering.
Otherwise I think we’d be very insular, we would be less efficient, have less scale, be more expensive, and sub-optimal. We think it’s a good combination to be a captive and a wider player."