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Guest opinion: Brexit from an automotive finance perspective

Tarun Mistry

The events of Friday, June 24and their immediate impact on the UK political scene came as a shock to many industry commentators.

The impact on markets had been widely predicted as we entered a period of volatility and instability.

What happens next, and the implications for businesses in the UK is unclear and so we continue to engage with our clients stressing the importance of staying calm, reviewing contingency plans and assessing the possible implications for your business and the risks and opportunities this creates.

In terms of impact on the motor and equipment finance sector we see a number of key considerations.

Basics

The basics are different from the financial crisis of 2008.

It is important to understand that, although we have seen a significant run on bank share prices, the fundamentals are very different to the pre-Lehman Brothers days.

Banks are now more robustly stress-tested for capital adequacy and should hopefully be strong enough to absorb this type of shock.

However, it will impact on their ability to raise funding in the short term and could lead to a more conservative view on credit and pricing risk.

The UK economy is likewise in a more robust shape.

Volume

New business finance volumes are highly likely to fall.

By how much will depend on customer confidence that the economy will look to grow in the short/medium term.

In 2008/9 we saw the deferral of capex for a number of years and if the Government, supported by the Bank of England, does not look to quickly build confidence (various actions have already been taken) we could easily see a decline in capex both from corporates and individuals.

Leasing volumes have already shown some signs of a slowdown especially in construction and agriculture, and Brexit and the uncertainties it unleashes, could easily lead to further contraction.

UK business has however only recently gained the confidence to start investing after years of underinvestment, and business should continue to do so. 

Shorter term flexible leasing and rental could be impacted by reductions in demand. 

However, some parts of this sector have developed products and increased penetration into their customer fleet base and therefore become a more critical part of their customers’ transport needs.

Transaction pricing

For the last couple of years we have seen a downward pressure on rates and a race to the bottom often with poorer credits.

We suspect this trend will start to reverse as funders are possibly faced with higher funding costs.

This will be positive for the market as long as some of the major players, who are already at the cheapest end of the spectrum, don’t hold to their current pricing strategy.

Credit risk

We expect to see a kneejerk reaction on credit risk.

This is common with major changes in market conditions and a tightening of credit criteria until the period of uncertainty is clearer.

Once the direction of exit is clearer, credit policies will gradually become looser, but if we look at the credit conditions in 2007/8 we still haven’t got back to these heady days.

Residual values

Reductions in the price of the pound will have a significant impact on sterling commodity prices for raw materials.

If manufacturers need to hold prices to remain competitive this will possibly reduce their ability to support residual values.

If prices rise to reflect the increased price of raw materials residual values could remain fairly constant.

In 2008 we saw a blood bath in car residual values as customers returned vehicles or looked to renew on reduced rates but this strong fall was corrected quite quickly by the market.

As a result of a weakening pound we believe that new car subsidies from manufacturers will be restricted leading to an increase in new car prices which in turn will hold used vehicle prices up. 

Clearly this is dependent upon the overall level of demand and therefore the state of the overall economy.

Direct and indirect tax

The chancellor has announced plans to reduce UK corporation tax rates to the lowest levels across developed western countries in an attempt to retain the attractiveness of the UK market for investment.

How he attempts to fill this gap in the Treasury’s funds is unsure, however, other tax rate rises and further public spending cuts are likely.

Challenger banks and private equity

Some challengers or niche banks have significant exposures in the property market with asset finance almost as a ‘side line’.

These banks saw the most significant of share falls post the referendum.  

Generally, these banks are well capitalised and therefore should be able to absorb any additional capital requirements associated with this part of their asset base. 

The need to diversify their lending activities should continue to drive strategic growth in other lending activities.

It will be interesting to follow the PRA’s decision on the various banking licence applications in process, especially where the business plan is for a relatively small lending activity and focused lending products.

It is likely that the private equity market will pause to re-consider their investment plans.

However, they may also see the recent turbulence as an opportunity to secure attractively priced investment opportunities, leveraging their capital base to acquire attractive platforms.

Captive finance companies

These companies could face substantial issues especially if they provide pan-European finance with issues ranging from indirect tax, tariffs, residual values to free movement of labour. 

The nature of the final deal between the Britain and the EU will be key in determining the extent of these matters.

M&A activities

Common sense would dictate that there will be a slowdown or if not a slowdown that pricing multiples could calm down.

In 2008 we saw a significant reduction in activities but the fundamentals this time around are not the same and certainly the appetite for lending platforms and associated routes to market remain high. 

The demand appears to be currently driven by a need to diversify lending activities, especially in asset backed funding. 

We are probably likely to see some slow-down in activity over the summer period whilst clarity on the UK political front is achieved followed by a return in activity in Q4 2016 and Q1 2017.

With so much of the motor finance market predicated on consumer confidence, softening of demand in the short term is to be expected and it is vital that we see clarity at the earliest opportunity around the shape of the government and our future relationship with the EU.

Needless to say, so much of European OEM’s increased investment in the UK motor market has been due to the stability of the regulatory environment and the robustness of our financial systems which we have worked hard to rebuild following the global financial crisis.

It will be some time before we realise the full impact of that dislocation.

Grant Thornton’s broader views on the impact of Brexit can be found at http://www.grantthornton.co.uk/brexit

Author: Tarun Mistry (pictured), partner and head of financial services corporate finance at Grant Thornton

 

 

 



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