September 2001
| A publication of the European offices of Mayer, Brown & Platt
www.mayerbrown.com www.securitization.net
Auto Finance Securitisation in the UK
By Steven P. Janes | Partner, Mayer, Brown & Platt, London
Consumer Finance Securitisation in the UK
When the UK market for securitisation was in its infancy, in the late 1980’s/early ‘90s, there were some observers who considered the prospects for securitising any UK consumer-based receivables to be very questionable. The impact of UK consumer credit laws, together with laws and regulation concerning sale of goods, unfair contract terms, data protection and more was felt to pose too great a threat to the predictability of income streams. A decade or so later, there is a thriving sector of the UK securitisation market focussed on consumer receivables, of which auto finance is just one - albeit one of the more significant constituents. The market has learned to assess the true effects of UK conditions, such as consumer protection legislation, and the historic data from many successful transactions has allowed these, along with other risk factors, to be deal with in the most effective ways in terms of deal structure and pricing. The legal systems in Scotland and Northern Ireland are based on different principles to those applicable in England and Wales and in some areas of economic and social activity have unique statutory rules or case law precedents. However, in the context of the aim of this note to provide a general guide only, and not to be a substitute for specific legal advice, it should be assumed - unless otherwise stated - that the legal issues affecting auto securitisations are substantially the same, and/or the locallyadapted structural solutions produce similar outcomes, in each part of the UK. Indeed, UK auto securitisations commonly include assets from all the constituent parts of the UK (though not the Channel Islands or the Isle of Man).
1. The Auto Finance Market in the UK
1.1 Size/value
UK new motor vehicle sales have averaged around 2.2 million units for the past 2 years (2000, 1999) - in addition to which there is a large market for used vehicles. According to the UK Finance and Leasing Association around 57% of all new car registered in the UK is achieved through various finance arrangements, with consumer credit for car finance worth around £20 billion. The
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figures for 2000 suggest that “point of sale” consumer finance (that is, taken out at a car dealership) for new and used cars is worth around £9.5 billion. Personal (unsecured) loans comprise the majority of the remainder, with this form of finance being especially suited to small business customers. The UK has probably the most developed business fleet market in Europe, with many employees receiving a “company car” as a feature of their total salary and benefits package. Vehicles coming out of company car schemes also impact the size of the UK used car market and residual value levels.
Under HP and Lease Agreements as well as Conditional Sales, the finance provider retains legal title in the car until full payout of the financing, thus giving collateral backing for the payment obligations. The HP contract involves a nominal final payment to acquire title, whereas the lease purchase may have a more substantial final instalment. The “personal contract purchase” (PCP) arrangement is a popular hybrid form of a lease purchase contract (see Sections 1.4 and 3.3). • contract hire agreements - these are similar to an “operating lease” concept, although customarily the lease company also includes a vehicle maintenance service in the “package”. The customer normally has no right to acquire title, unless a separate option has been negotiated.
1.2 Providers
UK car/motor vehicle finance is provided through a variety of sources, but the most significant are: • manufacturer-tied finance units - most, if not all the car ‘majors’ have their own financing division; • banks - a number of retail banks offer loan products specifically targeted at consumer car finance; • specialist finance houses - these institutions often target particular sectors of the consumer/small business vehicle finance market, such as employees exiting company car schemes or “sub-prime” customers; • “contract hire”/business leasing - these are specialist providers of new vehicles, with service/maintenance packages, to (mainly) business users.
1.4 Trends/Future Changes
The key trend in car finance market in the UK in recent years has been the growth of “low-cost” consumer finance products from the finance departments of car manufacturer groups based upon expected future values i.e. the value of the vehicle that remains at the end of the finance period. These financing programs initially assumed a fairly high level of residual value, with lower monthly payments, and therefore a more attractive deal for the consumer. The socalled “personal contract purchase” (“PCP”) arrangement has become a highly popular mode of consumer car financing: some estimates suggest over a third of new cars are now sold under some form of PCP arrangement. The UK’s relatively high level of new car sales - including those sold via business fleets and resold “used” within a year - has to some extent flooded the market. This has meant that residual values have tended to fall, which has posed problems for car financing operations, whether manufacturer, bank-owned or independent. Some finance providers have had to make write-downs or augment their reserves to handle the problem. The phenomenon of lower guaranteed residual values under PCP contracts has also
1.3 Products
The main financing products available in the UK market are: • personal loans - these consist of unsecured monetary obligations of the relevant customers. No security has normally been given by a customer for any such obligations and therefore the finance provider will have no interest (and therefore cannot transfer the benefit of any interest) in any property acquired by a customer with the proceeds of any loan made to him pursuant to a Personal Loan Agreement. • title retention products - these comprise hire purchase (“HP”) contracts, lease purchase and conditional sales contracts.
led some UK consumers away from this product and back to more traditional hire purchase agreements. Loan finance deals have also become more commonplace, including some which seek to ‘mimic’ PCP cash flows by including a large final loan instalment. In Europe in general and the UK in particular, there is uncertainty for the car industry as to what effect, if any, the change in European Union’s “block exemption” from the EU’s normal competition rules will have. This allows manufacturers to sell their cars only through exclusive licensed dealers. Once the exemption expires, new sales channels will open up, and it is difficult to determine what the effect on residual values will be. One predicted effect of this change will be carmakers wanting to exercise greater control over their new and used car sales, and therefore, their residual values. Whether through the introduction of buyback deals or other finance incentives, the aim will be to stabilize used car values and give peace of mind about new car depreciation. Not least among those concerned about exposure to residual value risks will be participants in UK consumer auto finance securitisation deals.
with transferring title to vehicles, or creating other interests in a vehicle, such as a right of possession (i.e., lease) or a security interest (e.g. a mortgage). Among the consequences of this are: • A lease over a vehicle does not give the lessee a legal interest in the vehicle, so if the vehicle were to be sold by the owner/lessor before being delivered to the lessee, the lessee could sue the lessor for breach of contract, but could not compel the new owner to recognise the lease; • A mortgage of a vehicle is only possible by the transfer of legal title to the mortgagee, leaving the original owner with a right to recover title through the “equity of redemption”. It is, however, perfectly possible to create a charge or equitable mortgage over a vehicle, which will be enforceable subject to the risks mentioned in the next paragraph; • In the absence of special protection of vehicle ownership (e.g. through a title registration system) there will always be a risk of rights of ownership or security being diluted, postponed or lost through the wrongful actions of the owner or person in possession of the vehicle. For practical purposes, all motor vehicles in the UK are required to be registered under a government maintained, national vehicle registration/licensing regime. This is essentially an administrative and tax (known as “Vehicle Excise Duty”) collection system. A vehicle is identified by a registration number, and a person is recorded as its “registered keeper”. Confusingly, in some of the relevant legislation, the registered keeper is occasionally referred to as the “owner” of the vehicle. However, the register is neither a record nor proof of title or ownership in the legal sense. In particular, the registration system aims to identify the person who has actual or constructive possession or control of the vehicle, not who may have legal ownership. Thus a finance company which owns a car that is hired to a customer under an HP contract will not appear as the registered keeper/owner; the customer will.
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2. UK Laws on Motor Vehicles
2.1 Vehicle Ownership/Registration
An English law definition of a motor vehicle is any “mechanically propelled vehicle intended or adapted for use on roads to which the public has access” (Hire Purchase Act 1964 s. 29(1)). However, given the importance of the motor vehicle in a modern economy and society, it is surprising - but true - that there is almost no special body of law [in the UK] dealing with their ownership or how they are financed. Cars, trucks, motor-cycles and other motor vehicles are treated in the same way as any other moveable physical asset: that is, as a “chattel” in legal parlance. There is no equivalent of any system of registration of title to vehicles in the UK. This means that there are no special rules for proving ownership of a vehicle, nor dealing
2.2 Recognition of Financing Interests
The UK vehicle registration regime has no facility to register (or even “note” on an informal basis) the legal interests of finance parties, whether owners (under a lease or HP contract) or secured lenders. It is standard practice for finance providers who operate through products that leave them as legal owner (HP contracts, leases, conditional sales) but otherwise unprotected by registration of their interest to file a note of their status with a private company, HPI Group Limited, which maintains an industry-recognised database of vehicle financing interests. The organizations that provide information to HPI include the DVLA, Police, Vehicle Inspectorate, Independent Mileage Verification Association and RMI, many of the UK’s local authorities and the majority of UK finance and insurance companies, motor manufacturers, motor dealers and auction houses. HPI was established in 1938 to prevent financing fraud in the motor industry. HPI has evolved into the preeminent UK source of information for manufacturers, dealers, auction houses, finance and insurance companies who buy, sell, finance and insure motor vehicles. It is also common practice among motor traders, dealerships and finance providers to carry out a search with HPI against any vehicle they propose to acquire (e.g. through “trade-in”) or finance to reveal any outstanding finance. The HPI check reduces risk by giving information on the current status of over 57 million UK registered vehicles. The HPI register does not, however, have any formal legal status, and details of a financing interest recorded with HPI are not deemed to be notified to the public at large.
It is, of course, a universal requirement of motor finance contracts to place upon the customer the obligation to obtain not only statutory third-party insurance but also cover against damage to or theft of the vehicle. Thus, there is not in the UK at present the same degree of exposure as exists in the US to vicarious tort liability for falling upon finance providers for harm caused by the vehicle.
3. Structural Issues for UK Auto Securitisations
3.1 Asset Types/Limits
The categories of finance product commonly offered in the UK auto finance market have been outlined at Section 1.3. Receivables deriving from Hire Purchase Agreements, PCP Agreements, Personal Loan Agreements and Lease Agreements that have been generated for the finance of new or used vehicles for consumers and small businesses are all capable of being securitised. Special conditions in some transactions place limits on some categories - for example: • The percentage of Receivables which relate to the finance of used, as opposed to, new vehicles will not exceed [x] per cent; • Personal Loan Receivables will not represent more than [y] per cent. of total acquired receivables; and • Lease Receivables will not represent more than [z] per cent. of acquired Receivables. These limits normally apply at closing or (in a revolving deal) immediately following any further substitution.
2.3 Liability Issues
Under UK law, any person using a motor vehicle on-road must have, as a minimum, a valid insurance in place against third-party liability. It is a criminal offence - and may be the basis of a claim for damages by an injured party - to “cause or permit” another person to use a vehicle without the statutory minimum insurance. However, under UK case law a finance provider will not normally run a risk of liability for “permitting” an uninsured driver unless it has specific knowledge of its customer’s affairs.
3.2 Transfer of Assets
The originator will normally transfer to a special purpose entity (SPE), commonly but not universally located in a low-tax jurisdiction: • The benefit of the Receivables, which will generally consist of unsecured monetary obligations of customers under the Receivables Agreements;
• Proceeds of related credit protection insurance policies; and • The proceeds (net of associated expenses) of contracts for the sale (or lease, hire purchase, use or other disposition) of any vehicles following their repossession. In more limited circumstances, the title in the vehicles which are the subject of the Receivables Agreements may be transferred to the SPE, or the SPE (or the servicer on its behalf) may have a direct right to repossess a vehicle if a customer defaults under a Receivables Agreement. There will normally be little practical credit/collateral value for the SPE in acquiring title to vehicles. It may in practice, be difficult to trace and repossess any individual vehicle, and any proceeds arising on the disposal of a vehicle may be less than the total amount outstanding under the relevant Receivables Agreement. A car may be subject to an existing possessory lien or similar right, for example, in respect of repairs carried out for which no payment has yet been made.
• Deal arrangers will become more sophisticated in analysing an originator’s residual value loss experience, and in imposing receivables criteria and operational requirements that maintain a strong management incentive on the originator to minimize such losses. There remains some uncertainty about the way that PCP receivables should be treated for accounting purposes, especially if they are to be acquired by a SPE which is subject to US GAAP (and FAS 140 in particular).
4. Legal Issues for UK Auto Securitisations
4.1 Consumer Credit legislation
The Consumer Credit Act 1974 (“CCA”) will apply in relation to any Receivables Agreement where the debtor is not a body corporate and which is for an amount less than (in most cases) £25,000. This will have several consequences, including the following:
3.3 Issues Relating to PCP Contracts/Residual Value Risk
The inclusion in a securitisation of PCP Receivables - or more specifically, the final “future value” instalment under a PCP contract, poses a number of additional difficulties. As a result, it is believed that to date no public/term ABS deals based on UK car finance products have included PCP contract final payments. However as PCP contracts come to be a standard feature of the consumer car finance market, and come to represent a significant portion of their portfolio for many finance providers, there is increasing probability that solutions will be found to the main issues. • Support from the manufacturer may be offered, through residual value loss protection or some form of buy-back for returned vehicles inevitably, the finance divisions of the more “upmarket” model manufacturers will find it easier to place PCP contracts into securitisation, provided that the future values are set conservatively. • Finance providers may have to become more expert - or arrange access to agents with this expertise - in the management of vehicles returned from PCP contracts.
Rights of Early Settlement and Termination
Whether under the terms of the agreement or (even if it is silent or purports to prevent this) by exercising his CCA rights, the customer has a right to settle early (or terminate) a Receivables Agreement before its scheduled final payment date. This may occur at any time. If he so elects, the customer can settle by payment of all outstanding amounts in advance of their scheduled payment dates less any statutory rebate of charges to which he may be entitled under the CCA. Early settlement will entitle the customer to exercise his option to acquire title to the relevant vehicle. As an alternative to early settlement the customer has a right to terminate a CCAregulated Receivables Agreement (without acquiring title to the relevant Vehicle) without completing all payments which would otherwise have been due. In those circumstances the originator is entitled to recover: (a) any interest due and unpaid in respect of any arrears of payments due;
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(b) amounts payable by way of damages arising from a failure to take reasonable care of the vehicle; (c) any arrears due immediately before the termination; and (d) where at the date of termination the customer has paid less than one half of the total amount (the “total price”) payable under the Receivables Agreement (including any sum payable on the exercise of an option to purchase, but excluding any damages for breach of the agreement), an amount equal to the difference between (1) one-half of the total price and (ii) the aggregate of the sums paid and the sums due under the agreement immediately before termination.
The vehicle ceases to be protected from a repossession action if the customer terminates the agreement, although this would not preclude him from applying to the court for a “time order” pursuant to which the court can reschedule the outstanding liabilities.
4.2 Data Protection
Consumer Protection legislation and data protection legislation may also be relevant if they proscribe certain methods of dealing with the assets, so that the transaction will need to be structured in such a way as to ensure compliance with the relevant regulations. The Consumer Credit Act 1974 (the “CCA”) and the Data Protection Act 1998 (the “DPA”) are the two most relevant statutes in the UK. It is common practice, therefore, in transactions involving UK assets, for the SPC to obtain a CCA licence and to register itself for the purposes of the DPA. Consideration will also be required as to whether the transaction complies with the requirement for “personal data” to be processed fairly, as laid down within the principles of the DPA.
Liability For Dealer Misrepresentations and Breach of Contract
CCA Agreements: Pursuant to Section 56 of the CCA, the originator may be liable for any misrepresentations, acts, omissions or statements made by a dealer to a customer during negotiations between them prior to the execution of the Receivables Agreement. The customer may make a claim for such misrepresentations against a finance provider as well as the dealer. Under the Supply of Goods (Implied Terms) Act 1973, he may also make a claim for breach of contract against the originator if the vehicle is not of satisfactory quality. For these purposes, the quality of the vehicle includes its state and condition, its fitness for all the purposes for which vehicles of the type in question are commonly supplied and its appearance and finish. Agreements Not Regulated Under the CCA: If the agreement is not regulated, the finance provider, as a term of the agreement, can exclude liability for any misrepresentation by a dealer and any condition or warranty as to the vehicle’s quality, condition, performance or fitness. These exclusions are, however, subject to tests of reasonableness established by statute and by regulations and unfairness and where such tests are not satisfied the originator could suffer the cost of the liability which it sought to exclude. Protected Goods: If, under a CCA-regulated agreement, the customer has paid one third or more of the total price, the vehicle becomes “protected goods” and the finance provider is not entitled to recover possession of the vehicle, except pursuant to an order from the court or with the customer’s consent.
4.3 Tax issues
The tax treatment (e.g. tax depreciation, tax on gains, income, withholding taxes and VAT and stamp duty treatment) of an auto finance securitisation, as regards each of the parties, will need to be explored in depth. For example, it is important to structure the deal so that the transfer of assets by the originator does not give rise to a taxable profit and that all payments routed through the SPC structure can be made without withholding taxes. An important issue in relation to the securitisation of car lease and HP receivables is the tax treatment. It may be necessary to investigate the way in which tax depreciation or capital allowances in relation to the underlying vehicles are calculated and whether, and if so the way in which, the originator uses these capital allowances in the course of its financing business. If HP or conditional sale receivables are sold to an SPC for a price matching the value of the receivables, the effect would be effectively tax neutral. However, if the originator sells to the SPC a pool of lease receivables for a discounted purchase price the whole of the sale proceeds may be characterised as accelerated income from the originator’s financing/leasing trade and recognised in the accounting year of the sale. The consequence
of this is that there may well be a substantial tax charge in the year of sale, making the securitisation unattractive. There are a number of solutions to this problem. One of the methods most frequently used is the sale of both the lease receivables and the underlying vehicle as one asset. This is because unless the purchase price paid exceeds the cost of the vehicle to the originator, the sale proceeds are treated as proceeds for the sale of the vehicle and not as a trading receipt. Depending upon the originator’s overall capital allowance position, this may give rise to a tax charge and an inefficient tax position for the SPC. One solution which has been used in the past is to interpose an intermediate company which pays for and receives vehicles and receivables and then assigns the receivables to the SPC and sells the vehicles to an equipment company. Not only does this have tax advantages, but it also means that there may well be structural advantages in funding of the residual value of the vehicles as well as retaining capital allowance benefits. The impact of the UK trend to aligning tax and accounting treatment means that careful attention will need to be paid to the originator’s accounting methodology specifically how the sale proceeds relating to the leasing receivables are brought into account.
efficiencies of a medium-term note programme with the added advantages of a presence in the asset-backed market. The inaugural issue under the programme, an AAA rated DM1 billion floating rate issue backed by US dollar wholesale auto receivables, closed in October 1997. The second issue, comprising a senior tranche of F490,750,000 AAA rated and a junior tranche of F20,500,000 A rated floating rate notes backed by German retail auto receivables, closed in March 1999. The Globaldrive programme gives FCE Bank plc, the pan-European finance arm for Ford, as well as other Ford Credit affiliates worldwide, a medium through which they may securitise their assets in many different jurisdictions, both in Europe and the rest of the world. The programme offers gains the benefits of a master trust type structure, in that it can securitise assets by means of a vehicle capable of issuing successive series of notes, but with the added advantage of being able to securitise separate portfolios of assets in independent transactions. Rather than creating undivided interests in a revolving pool of assets, “firewalls” in the structure will prevent defaults in one securitised portfolio having an adverse effect on other transactions under the programme. A number of financial institutions in the UK specialise in lending for consumer or business car finance. An example of these specialists is Paragon Car Finance (PCF) which was launched in 1997 and provides car financing solutions to a wide range of car users and buyers. Operating in the motor dealer and corporate markets, PCF offers a range of car finance products, including hire purchase, personal contract purchase, contract hire and leasing, for both new and second hand vehicles and is among the top 5 UK lenders in the car finance market. In 2000 Paragon successfully completed a £195 million securitisation issue, its thirtyfourth public securitisation, involving car finance contracts (and some secured personal loans) through a subsidiary company, Paragon Auto and Secured Finance (No. 1) PLC. The assets forming the security for the notes include the benefit of car hire purchase agreements and car conditional sale agreements entered into by PCF and legal and beneficial ownership of the vehicles that are the subject of the car finance contracts.
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5. Examples of UK Auto Securitisations
The following are examples of recent transactions involving UK auto finance assets. It should not be inferred that Mayer, Brown & Platt represented any parties to such deals - all information has been taken from published sources.
5.1 ABS Public/Term Issuances
A number of European car manufacturers and other non-affiliated, specialist car finance providers have entered the auto finance securitisation market, among them Fiat, Volkswagen and Ford. Ford Credit’s Globaldrive programme was the first pan-European asset-backed programme to be set up by a corporate and seeks to combine the flexibility and
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1.2 “Sub-prime” lenders
In early 2001, SPA Holdings, which trades as Yes! Car Credit (YCC), originated the first UK securitisation structured entirely around UK subprime auto loans. The Royal Bank of Scotland (RBS) arranged the GBP108 million deal,YCC specialises in the non-standard credit market, and supplies customers with both financing and a vehicle. An SPV named Spartacus, rated P-1/A-1 by Moody’s and Standard & Poor’s, bought auto loans from Direct Auto Financial Limited, which is the subsidiary of YCC which provides loans. Spartacus funded the purchase of the loans by means of a private placement. The assets have been put into the TAGS conduit, which will fund the purchase by issuing commercial paper. Spartacus uses collections on the underlying loans to repay the facility. From the originator’s perspective, this type of securitisation provided it with cheaper funds in comparison with straight bank debt, and also provided access to the capital markets to help with future fund raising. It has also been noted that securitisation instils more discipline in the organisation owing to additional reporting requirements and tighter default triggers, so there is more focus on cash control.
The auto finance originator’s credit procedures and systems need to provide a platform on which to structure the deal, allowing the parties to track all loan information in detail.
1.3 ABCP Conduit Securitisation
A range of UK auto finance assets are thought to have been securitised through conduits with asset-backed commercial paper programmes though, of course, such transactions are not normally in the public domain. As well as receivables arising under consumer car finance, conduit securitisations are believed to have included contract-hire/business leasing receivables originated by some of the UK “majors” in the car rental/contract hire sector.
For further information on Auto Finance Securitisation, Mayer Brown & Platt have published a guide to “Equipment and Auto Lease Financing”. If you would like to receive a copy, please contact a member of the MBP European Securitisation Group.
European Securitisation Group
Kevin Hawken +44 (0)20 7246 6218 Dr Ralf Hesdahl +49 (0) 69 7941 0 Steven Janes +44 (0)20 7246 6243
Jean-Pierre Lee +33 1 53 53 43 43
Mark Nicolaides +44 (0)20 7246 6232