A UK auto ABS market in flux

The UK auto finance market, long considered a strong performer, has been grappling with uncertainty for the past year, a trend that is, sadly, only expected to continue for the foreseeable.

With a high proportion of Personal Contract Purchase (PCP) uptake driving new car sales, the UK has historically been a leading player in the global automotive market, boasting robust auto ABS issuance and relatively healthy auto-finance company performance.

While used car prices have been subject to ongoing volatility and the market remained sensitive to consumer confidence, the UK's competitive lending environment and increasing focus on technological advancements—particularly for EVs—pointed towards continued growth and innovation.

However, the unfolding regulatory challenges from the FCA’s review into DCAs and the subsequent court cases that have broadened the scope of investigation have rocked this period of relative strength.

Consequently, many lenders have taken significant provisions in their accounts and share prices among public lenders have suffered sudden and severe fluctuations. In some cases, such as in the case of Metro Bank, lenders have ceased any new lending until matters are resolved.

Consumer market challenges

Depending on which analyst prediction you put most weight on, the potential compensation bill resulting from consumer claims of miss-sold commission could be anywhere in the range of £17bn - £44bn. With millions of consumers potential eligible for a payout.

The Court of Appeal ruling in October 2024 is likely to only have stoked the compensation fire, triggering increased customer complaints and potential contract rescissions. Consequently, creating stress on portfolios.

It is anticipated that larger lenders are likely to feel the impacts of consumer challenge more so than non-bank lenders, given they are more likely to have such commission arrangements in place. While smaller lenders may be more vulnerable to insolvency owing to a lack of resources available to offset the risks of reduced demand, potential compensation payouts, and the need to respond to changes resulting from the Supreme Court hearing.

While new car sales across Europe have slowed over recent years, the UK market faces the additional hurdle of rebuilding consumer trust amidst the commission controversy.

Impact on funders and auto ABS transactions

Given the structure of ABS deals and certain protections, such as back up servicing, that are essential components of deal structures, the UK auto ABS market is reasonably protected from the fallout from the commission rulings. Trade structures ensure continuity of payments to investors even if the originator faces financial difficulties.

However, during the course of 2024 a certain level of caution was certainly in the air. The ongoing commissions case was initially announced in January 2024, and recent data has shown a decrease in issuance volumes and increased scrutiny on new deals since that time. It is thought that the decrease in issuance is likely driven by an unfavourable environment for issuers to price transactions.

According to a recent DBRS report, there is also the chance that some securitisations could be on the hook for some of the indemnities - if a significant number of loans are deemed mis-sold, the originators may be required to repurchase those loans from the ABS pool, potentially affecting the performance of the securitisation. 

Furthermore, European markets have also experienced a rise in delinquencies and defaults during 2024, with the UK feeling this rise more than other European territories. Likely creating further hesitancy in the auto ABS market.  

That said, ABS structures are characterised by sturdy support mechanisms that create resilience in the market. Therefore, there is a reasonable expectation that confidence and resulting issuance volumes will recover once the outcomes of the Supreme Court hearing are concluded. In fact, in the early months of 2025 we have started to see a small number of securitisations announced and funded, indicating a cautious increase in optimism that we hope will continue.

This gradual recovery is creating interesting market dynamics for the future. Deals that were initially slated for 2024 are now gaining traction for completion in 2025, suggesting a shift in timing rather than an outright abandonment of plans. This delay may prove advantageous, as it coincides with a potential influx of new investors into the space.

We anticipate that some investors, previously hesitant to back auto finance deals, may view the market's emergence from uncertainty as an opportune moment to diversify their portfolios. This confluence of delayed deals and fresh capital could inject renewed vitality into the sector.

Furthermore, the evolving landscape may accelerate strategic moves among market players. For instance, we may witness an uptick in M&A activity as companies seek to consolidate their positions, potentially leading to a more concentrated but robust market structure.

These emerging trends paint a picture of a market not just recovering but actively reconfiguring itself for future growth. As the old adage goes, out of adversity comes opportunity.

Nevertheless, the overall speed of recovery will, in large, be determined by motor finance providers’ agility in responding to any regulatory and operational changes that result from the hearing, and the FCA’s concluding judgements.

Our hope, and the hopes of the entire industry, is that these conclusions come swiftly to be able to capitalise on the aforementioned opportunities.

For existing ABS trades, if the current challenges faced by originators are prolonged further, we may still see more players leave the market and the risk of lender default may be heightened. Consequently, investors may face reduced liquidity, lower returns, or increased risk of credit losses if the performance of underlying loans deteriorates. If originator financial performance is significantly impacted, it may reduce overall confidence in ABS structures.

The broader picture

Outside of the commission’s controversy, auto-ABS continued to be a crucial component of European ABS markets in 2024. According to DBRS, auto-ABS issuance was expected to account for 50% of total European ABS issuance last year, emphasising the sector’s significance in global capital markets.

Moving through 2025, the recent interest rate cuts and easing monetary policies are expected to lower the cost of capital for auto-ABS deals. Additionally, interest rates on lease loans and pre-payment rates is expected to remain high. If combined with a favourable outcome from the Supreme Court hearing, there is further cause for optimism in recovering issuance volumes for the UK.

However, it's crucial to acknowledge some counterbalancing trends. While new car sales growth may be modest, EV sales decelerated in H1 2024 due to decreasing subsidies and purchase incentives across several jurisdictions. The long-term impact of this deceleration on green auto ABS issuance remains to be seen but overall, the expectation from DBRS was that green auto ABS issuance has yet to materialise.

Furthermore, borrower performance deteriorated across all EU countries in H1 2024 (most notably in the UK), as used car prices dropped in most EU jurisdictions, though the UK market felt these drops significantly. These elements will be something to keep an eye on as the year progresses.

Concluding thoughts

The UK auto finance industry is in a state of flux. Unfortunately, where capital markets are concerned, uncertainty spreads. The current conditions are destabilising an otherwise resilient and well-performing auto ABS market in the UK.

In the lead up to 1 April 2025, some participants are adopting a ‘wait-and-see’ approach, while others are temporarily reducing their exposure to mitigate risk. The situation has arisen following a period of significant turbulence for global markets, including the UK, after the onset of the COVID-19 pandemic.

This issue, which strikes at the heart of the UK automotive ecosystem, requires resolution that addresses the needs of consumers, lenders, and investors alike.