Motor finance bracing for headwinds

Motor finance debt per consumer has significantly increased over the past decade or more. The table below illustrates that in the 13-year period from 2009 to 2022, total motor finance debt increased 263%. To put this into context, average weekly earnings in the same period increased 41%.

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However, new figures released by the Finance & Leasing Association (FLA) show that consumer car finance new business fell by 8% by both value and volume in the first four months of 2023 compared with the same period in 2022. FLA research also suggests the value of consumer car finance new business is likely to contract by 3% in 2023, reflecting the uncertainty of the economic outlook.

Higher default rates expected

For many consumers, servicing high levels of motor finance debt is expected to become increasingly unsustainable as high inflation and rising interest rates are severely squeezing household budgets. This is likely to have an impact on the sector, and we expect motor finance firms to experience higher default rates during H2 2023 and beyond.

Firms must consider the impact of higher default rates combined with a fall in new business on their working capital availability and debt service. As motor finance is generally fixed-rate, lenders may also find themselves borrowing at a higher rate than they're able to pass on to their customers. Stress-testing resilience in different scenarios by having appropriate forecasting models in place can help provide greater clarity on areas that may lead to underperformance. Firms also need to be active in identifying vulnerability, which may be even harder, given how quickly increasing cohorts of customers are experiencing changes in circumstances, contributing to their vulnerability.

Increasing numbers of complaints about motor finance

Against this backdrop, the number of consumer complaints about motor finance has increased materially – up 85% year on year. The Financial Ombudsman Service (FOS) received 11,446 complaints about motor finance in the 2022/23 financial year.

Motor finance has now been in the top five most complained about products for two consecutive years.

Crucially, whereas in the past complaints have focussed on the quality of the car bought, in the reporting year 2022/23 49% of complaints were about commissions, fees, and charges, up from 24% in 2021/22. In March 2023, the regulator issued a letter to the industry:

"We are also focussing attention on whether our ban on discretionary commission models in motor finance and amendments to commission disclosure rules are being complied with by both lenders and credit brokers, including motor dealers."

Firms can expect greater scrutiny from the regulator on this issue.  

Complaints management companies focussing on motor finance

The possibility that regulatory requirements aren't always being followed has led claims management companies (CMCs) to focus on the motor finance sector, which is evidenced by approximately 90% of motor finance complaints in 2022/23 coming from third-party representatives.

Many people will have noticed an uptick in adverts on social media and radio as CMCs engage with consumers to highlight the possibility that people may have been mis-sold car finance and could be eligible for compensation. As complaints are eligible within six years of either the point of purchase or the end of the loan agreement, CMCs have both the potential and the ability to generate a large number of claims in a short period of time, which can put pressure on motor finance firms’ complaint handling resources.

Each complaint to the FOS generates a £750 case fee (under current FOS guidelines), payable by the firm regardless of outcome, in addition to any redress payments that need to be made if the complaint is upheld. This can quickly lead to financial stress and could be a significant issue that motor finance firms need to address.

Dramatic rise in data subject access requests 

Often the first step in the claim process is a data subject access request (DSAR), where motor finance lenders receive a request for all information held on a customer. This can include copies of relevant documentation and confirmation of how much commission was earned on the finance deal. Consumers have the right to make these requests, and firms responding must follow strict procedures and timescales. Not responding to a DSAR risks a complaint to the Information Commissioner’s Office.

There has been a dramatic rise in DSAR requests with a recent study showing that six million adults have considered submitting a DSAR. Dealing with DSARs is often a manual, time-consuming and costly process. It's been estimated that each DSAR may cost upwards of £1,000 for a firm to deal with. Many motor finance firms don't currently have the systems to deal with these requests, and yet they must be processed according to strict timelines which places a significant burden on firm resources.

Deficiencies in statutory notices to customers

Our work in the consumer credit sector has shown us that many firms inadvertently experience issues from time to time when it comes to issuing statutory notices to their customers. The consequences of non-compliance can be severe, including the debt becoming unenforceable. 

Motor finance firms must ensure that they issue all the statutory notices required, in the prescribed form, and at the correct intervals throughout the life of the arrangement with the customer. This may seem simple, but it is an issue that many firms regulated by the Consumer Credit Act 1974 (CCA) fall foul of.

Sections 77A and 86B of the CCA strictly regulates the serving of annual statements and notices of sums in arrears (NOSIA for the first, or SNOSIA for subsequent). A NOSIA must be issued when there have been two missed payments, and within the permitted timeframe of 14 days. Critically, a NOSIA must still be issued even if the borrower has subsequently made a payment to clear the arrears before the NOSIA has been sent.  The consequence of non-compliance of the statutory notice rules are:

• the debt becomes unenforceable
• interest ceases to run
• default sums cease to be payable.

If the timeframe is met, but there's an error in the content, unenforceability remains.

Many errors in issuing statutory notices only come to light when a firm identifies a pattern in complaints or customer contact, issues with backend systems, or when attempting to undertake a debt sale to a third party. This can particularly be the case following extended periods of forbearance (such as those offered during the pandemic or during the current cost-of-living pressures) where automated systems aren't set up to deal with this.

Motor finance firms should undertake regular audit exercises to check that all notices are being issued correctly. Errors in sending statutory notices can often be caused by very minor errors or system glitches. Should a motor finance firm discover a breach, they must self-report to the FCA, outline what steps they propose to rectify the issue and undertake a remediation exercise. Again, this can be a very costly and time-consuming exercise.

As motor finance firms are cognisant of the above macro-issues, or indeed, further micro-issues relevant to each particular firm, early dialogue is vital. This can support resolution of any liquidity issues, or problems around increasing complaints/redress to ensure that the firm is as resilient as possible to weather market forces.

For more insight or guidance, get in touch with Chris Laverty or Jarred Erceg.