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Visitors to Britain are often struck by how many people drive fancy cars. If an Englishperson’s home is their castle, then their ride must be a top of the range BMW or Audi. As the cost of credit rises, maintaining that lifestyle is becoming harder, threatening to put a dent in automakers’ profits.
While real UK incomes have declined since 2008, ultra-low interest rates softened the blow by helping Brits acquire a sparkling new premium motor every few years — one they might otherwise not have been able to afford. Now, rising borrowing costs imperil this happy arrangement by pushing up the monthly cost of the Personal Contract Purchase (PCP) plans that finance the bulk of UK private car purchases.
Premium car manufacturers may have to cut buyers some slack as affordable brands such as Kia, Hyundai, MG and Dacia gain market share. But automakers’ captive finance units likely aren’t facing a calamity, thanks to another remarkable feature of this market: Used car prices, which help determine the cost of PCP plans and the provider’s financial exposure when customers return the vehicle – remain extraordinarily high, for now.
It’s easy to be sniffy about people leveraging up to tool around in oversized SUVs or keep up with the Joneses, but PCPs were a good deal for consumers while the music was still playing, and I don’t blame them for taking advantage.
Briefly, a PCP deal works like this: after putting down a hefty upfront payment, the customer pays a few hundred pounds each month for the duration of the three- or four-year contract, subject to a mileage cap.
At the end of the contract, they can return the car and pay nothing further, as with a lease. Alternatively, they can opt to pay off the balance (known as a balloon payment) and acquire the car outright, or exchange the vehicle for a new one and begin a new PCP deal. Many drivers opt for the latter, which can make PCPs feel like a never-ending financial treadmill. Of the 84% of consumer car sales financed in the 12 months to November 2022 by Finance & Leasing Association members, some 79% were PCP agreements.
Admittedly, the Bank of England hiking rates to 3.5% from 0.25% in the past year won’t impact the bulk of current car loans as PCP rates are fixed. However, 0% annual percentage rates are becoming rarer. It’s a common misconception that PCP customers “only finance the depreciation,” whereas in fact the quoted APR includes the balloon payment. Hence it matters if you now have to pay 8% interest instead of 4%. A study of five popular models in November found that PCP monthly costs are already 23% more expensive compared with 2019 due to a combination of higher vehicle prices and rising borrowing costs.
Another survey in September found the average monthly cost of four-year PCP deals had risen to £538 ($662) from £479 in the past year. Autocar magazine lamented that “finance deals will never be as good as they were in the last decade… We never realized how good we had it.” Quite.
Facing a cost-of-living squeeze and having to dedicate more of their income to servicing their mortgages, Brits may have to lower their sights when picking a new vehicle. “The cost of credit has gone up and consumers are cutting their cloth to fit their new situation, which might mean choosing a smaller car or lower specification model” says Adrian Dally, director of motor finance at the FLA.
This is potentially bad news for German auto manufacturers which until now have relied on the UK market to shift lots of expensive metal; PCP deals motivate customers to buy an expensive new car more frequently, often sticking with the same brand. Indeed, a cynic might wonder if PCP really stands for Posh Car Plan. BMW AG and Audi are among the top-selling marques in the UK and around 30% of UK car sales are premium vehicles, compared to an average of 22% in Germany, France, Spain and Italy, notes Morgan Stanley. The bank lowered its 2023 forecast for UK car sales in October to reflect potential PCP finance pressures.
Manufacturers may have to trim new car prices from the current exorbitant levels or forgo some sales entirely.
It’s not all bad news. Although UK used car prices dropped around 3% last year, this followed a 30% increase in 2021, according to automotive data provider CAP HPI. Hence current PCP customers often find their vehicle is worth a lot more than the finance company predicted at the start of the contract, and they can roll this equity into a new PCP deal or profit by acquiring the car and selling it.
Used electric-vehicle values have come under pressure lately owing to Tesla Inc’s big price cuts, but in general used car prices probably won’t quickly fall back to pre pandemic levels. New car production has been severely curtailed for three years due to parts shortages and manufacturers have prioritized retail customers, so rental and fleet users have fewer vehicles to hand back.
“People say what goes up must come down, but that’s not really the case here,” says Derren Martin, CAP HPI’s director of valuations. “We don’t think used car values will collapse.”
Automaker finance units therefore look fairly well insulated. Their windfall profits from selling leased vehicles will normalize, of course, and BMW made a low treble-digit million euro provision in November to reflect customers’ deteriorating finances. Yet compared with the US there are proportionally fewer subprime car borrowers in the UK. Customers aren’t able to terminate a PCP until near the end of the contract and loan delinquencies remain very low, which bodes well for securitized PCP loans.
The PCP merry-go-round is creaking but hasn’t broken down — yet.
More From Bloomberg Opinion:
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Mortgage Market Is a Bright Spot in UK Cost-of-Living Crisis: Marcus Ashworth
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Tesla’s Skid Leaves Old Auto With a New Quandary: Liam Denning
• Britishvolt Is a Monument to Global Britain’s Empty Hype: Matthew Brooker
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Chris Bryant is a Bloomberg Opinion columnist covering industrial companies in Europe. Previously, he was a reporter for the Financial Times.
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