Monday 24 October 2016

Motor trade's bet on solid second-hand values boosting sale of new cars looks riskier in the wake of Brexit

The industry here is banking on cars keeping their second-hand values to boost hire purchase sales. But will cheaper sterling lead to a flood of UK imports - and hefty losses on this bet

Published 07/08/2016 | 02:30

Car dealers are enjoying a bumper year, with 150,000 new cars set to be sold in 2016
Car dealers are enjoying a bumper year, with 150,000 new cars set to be sold in 2016

Ireland's motor showrooms are buzzing. This year is shaping up to be the best year for distributors since 2007 - with 150,000 new cars registered for the first time.

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With the possible exception of the construction industry, no sector was hit harder by the economic downturn than the motor trade. Sales of new cars, which peaked at almost 181,000 in 2007 dropped to just over 54,000 two years later, a fall of 70pc.

The collapse in sales had a devastating impact on the motor trade with many established dealers closing and an estimated 12,800 jobs being lost, a quarter of all jobs in the sector, according to the Society of the Irish Motor Industry (SIMI).

Even as sales nosedived the number of private cars on the road continued to increase, from 1.66 million in 2005, to 1.87 million in 2010 and to 1.98 million at the end of 2015. This combination of a continuing increase in the number of private cars on the road and a massive reduction in sales had two main consequences.

With so few new cars being sold between 2009 and 2013 a severe shortage of Irish-registered, second-hand cars developed. This in turn pushed up the value of three and four-year old, Irish-registered, second-hand cars.

Secondly, the average age of the national car fleet increased dramatically. We went from having one of the youngest fleets in Europe with an average car age of six years in 2008 to a situation where the average car age is now nine years.

It was only in 2014 that the permafrost began to thaw with new cars sales increasing by 30pc to more than 92,000. New car sales jumped by a further 31pc in 2015 to more than 121,000 and SIMI is predicting a near-24pc increase to 150,000 this year.

However, this may be as good as it gets for the time being. Buying a new or second-hand car is very much a confidence decision. A person feeling positive about the future will take the plunge, someone who isn't, won't.

In the wake of last June's UK vote in favour of Brexit, the Central Bank has already reduced its 2016 and 2017 Irish economic growth forecasts - while the latest KBC/ESRI index figures show that consumer confidence fell by almost 4pc in July following the referendum result.

Last week's July Exchequer returns (which showed July VAT revenue running €61m behind target and excise duty €25m behind target) certainly point to weakening consumer sentiment.

With consumer confidence noticeably weaker, SIMI has reined back its forecasts for 2017 new car sales from over 160,000 to a repeat of this year's likely outcome of 150,000.

As car sales revved up in 2014 most of the major distributors wheeled out new finance offers to entice purchasers. The most important of these was the Personal Contract Plan (PCP), a form of hire purchase contract, which was first introduced into the Irish market by Volkswagen in 2012.

New car purchasers using a PCP to finance the purchase of a new VW must stump up a deposit of between 10pc and 30pc with the "optimal" deposit being 22pc, says Paul O'Sullivan, VW's head of marketing. Volkswagen Bank underwrites the future guaranteed minimum value (FGMV) of the car after three years, usually 40pc. This leaves the buyer to pay off the remaining proportion of the purchase price, about 38pc, in equal instalments over the following 36 months. At the end of the three-year PCP period the buyer has three options: she can hand back the car, use the difference between the FGMV and the trade-value as the down-payment on a new car, or pay off the FGMV and drive away.

While precise figures are impossible to come by, PCPs have been hugely successful in helping motor dealers shift more metal. O'Sullivan says that about 70pc of his marque's private (that is, non-fleet) purchases are credit-funded with about 75pc of these purchases (that's about 50pc-52pc of the total number of sales), being financed by PCPs.

However, PCPs aren't for everybody. The mileage buyers can drive in their cars is restricted, 20,000 kilometres a year in the case of most VW PCPs. If this mileage is exceeded then buyers are penalised.

The key to all of this is second-hand car values. While guaranteeing the value of a car after three years allows monthly payments to be kept attractively low, PCP providers are essentially betting that, come the end of the contract, the second-hand value of the car will exceed the FGMV.

But what if it doesn't?

The shortage of Irish-registered, three and four-year old cars began to bite from 2013 onwards. Under normal circumstances this would have led to a sharp increase in the number of second-hand cars being imported from the UK.

That didn't happen. While second-hand imports jumped by 29pc to almost 50,000 in 2013 and by a further 6pc to almost 53,000 in 2014, they fell by over 20pc to just over 42,000 in 2015. So while new car sales rose by almost 60pc between 2012 and 2015 used car imports rose by only 10pc over the same period.

The major explanation for this apparent disparity is almost certainly the sharp increase the value of sterling against the euro, from a low of €1.14 in August 2013 to a high of €1.44 in July 2015. Even as late as November 2015 sterling was still trading over €1.40.

Since then as first the prospect and then the reality of a UK vote to leave the EU dawned, sterling has gone into freefall. It was trading at just €1.18 on Friday. Will cheaper sterling lead to a flood of second-hand imports and a collapse in the second-hand car values that have been underpinning PCPs?

Brian Cooke, deputy director general of SIMI points out that sterling was at €1.25 as recently as two years ago. Average new car prices have also fallen 3pc over the past year.

"At the current exchange rate there is plenty of room for both new cars and second-hand imports," he says.

But will sterling stay at its current rate? "Our big concern would be if it got close to parity," says Cooke. That may well come to pass with employers' body Ibec predicting sterling/euro parity within three years.

If that happened who would be at risk? For motorists with a PCP the risk of a collapse in second-hand values is that the difference between the FGMV and the trade-in value which they had been relying upon to fund the purchase of their next car at the end of their contract would either shrink or disappear altogether.

For the providers of finance, the potential risks are even greater. Having underwritten second-hand values, they would be on the hook for any shortfall. With most FMGVs set at about 40pc of the new price, they will be hoping they have built in sufficient room to accommodate any fall in second-hand values.

So who is potentially exposed? VW, which apart from its eponymous brand, also owns the Audi, Skoda and Seat marques, is very much the 800lb gorilla of the Irish motor trade with its own in-house bank and a combined 22pc share of the new car market. It pioneered the PCP in the Irish market.

Others possibly in the firing line include Bank of Ireland, which provides finance to Hyundai, Ford, Toyota, Opel and Kia buyers, and Renault's in-house bank RCI Banque which finances new Renault and Dacia cars.

However, VWs O'Sullivan points out that when Britain finally exits from the EU there may well be tariffs imposed on second-hand imports into Ireland, depending on the deal negotiated by both sides.

In the four years his company has offered PCPs, it has never had to take back a car. In the meantime he advises buyers to shop around.

"The onus is on the consumer to decide on the best form of financing. Our interest rates are lower than those of the banks. Most buyers aren't aware of the interest rates. This can have a huge impact on the cost of ownership and their equity in the car".

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