On February 13, the Society of Motor Manufacturers and Traders (SMMT) released data showing a 2.1% year-on-year decline in used car sales in UK in 2018, with an even bigger decline in new car sales.
While many will have expected to see a decline in new car sales, given the perils of impending Brexit, the dip in used car sales speaks of broader forces at work.
More and more research is pointing to a move towards alternative fuel vehicles, particularly electric, and with continued investment in public transport, many borrowers are wondering if investing in carbon belching combustion engines vehicles is worth it.
Moody’s said in February that the “lower demand will lead to declining vehicle prices, resulting in decreased recoveries in underlying auto finance loans, as well as in an increase in voluntary terminations [a borrower's right to end his contract and return the vehicle in question while being liable for half of the financing amount] of the loan contracts.”
The report also said that because of the slump in new car sales across Europe, securitization issuers will turn towards the used car sector as a means of generating higher returns.
More banger for your buck
Securitizing cars is not the same as securitizing mortgages however, as lenders are more likely to voluntarily terminate the contract if economic conditions allow. Voluntary terminations have grown more common in the UK with the increase in balloon loans, those which require one final payment larger than the others, prevalent in recent transactions.
Both these features make UK car loans hairy looking items in a securitization.
A global recession coupled with stringent regulation could leave issuers holding large amounts of outdated auto collateral they are unable to shift. 2008 saw one of the worst crises for the auto sector in the US, while Europe fared little better. And now, the largest car manufacturing country in the world, Germany, has also admitted that its auto industry is in trouble.
One might think that there will be more carbon-emitting vehicles sold as a result as, with lower wage growth, the used car market hosts more borrowers looking to source their rides.
However, a boom in used car sales may not happen if current regulations are anything to go by. Governments may see a new credit cycle as an opportunity to regulate against conventional combustion engines.
Since September 2014 the EU's Euro 6 emission limit has applied for all vehicles. In 2017, more than 95% of all new vehicle registrations were Euro 6-compliant.
But eventually, incentives to switch to used cars will run out, especially if schemes like London's ultra-low emissions zone (ULEZ) spread far enough and the fines for non-compliance stretch high enough.
For the rest of the country, the Climate Change Act 2008 is even stricter than the EU’s regulations.
Under the Act, the UK must cut its carbon emissions by 80% from 1990 levels by 2050.
UK emissions were 44% below 1990 levels in 2018. The first carbon budget, covering 2008-2012, was met, as was the second from 2013-2017 and the UK is on track to outperform the third, 2018-2022.
However, it is not on track to meet the fourth: 2023 to 2027, meaning it will have to be even tougher on its targets.
Regulatory change to the emissions from new cars and investment in electric vehicles is highlighted as a key investment to allow the UK to meet its target.
Securitizations, as financial history has shown in the auto sector and elsewhere, are only as strong as the loans that back them. Those working in UK auto securitizations need to be sure to check under the bonnet.