Published in Motor Finance, October 2008

When I am writing this column I know I’m talking to the industry rather to its clients. Every so often a topic comes up that is best aired within the industry and would not go down too well if read by the industry’s clients. My subject this month fits squarely into that category.

I was chatting today to an industry insider who said something that stunned me. “You know Colin”, he said, “a few contract hire companies are now technically insolvent, they just haven’t recognised it yet”.

Can that be true?

I have seen evidence of declining margins as contract hire companies have struggled to keep up their market shares, and many players are experiencing reduced order levels. The downturn has lasted more than a year so it is having an effect on current reported profitability – but surely not by enough to make any business insolvent.

After an 11% decline in the last year (though I have seen conflicting figures) used vehicle prices may be stabilising. These price reductions have had a direct impact on contract hire companies’ bottom lines. Assuming an average contract hire company is geared 10:1, (though in many cases they are geared up much more than this by their bank parent companies,) an 11% decline in used vehicle values will certainly dent a company’s share capital and reserves but will not of itself make it insolvent.

That leaves us looking at the rest of the portfolio, and whether the residuals have been set correctly. Around a third of the industry’s fleet will have come off lease since the credit crunch started, and these vehicles will have suffered the 11% reduction referred to above. The remaining two thirds of the portfolio that existed 12 months ago is yet to come off lease. For many companies we are moving into the time of year when the auditors will be looking at the assets on the balance sheet and deciding whether they are valued correctly. Most contract hire companies will have to make provisions for RV losses. However, whilst an 11% write-down would cause most contract hire companies’ results to go into the red, this would still not make them insolvent. To do that the number would need to be nearer 30%.

Looking at business written in the last year or so, if a player had taken a particularly aggressive position on RVs in 2007, or had not moved its RVs down significantly in 2008, this could require very large provisions now that would wipe out a sizeable chunk of the company’s equity. But not all of it.

So no, I don’t know of any contract hire companies that are insolvent or are likely to become so in the foreseeable future. What I do know, however, is that the situation is uncomfortable for many players (losses, provisions, and fierce competition as mentioned above, tightening of credit lines, etc). And things could get a whole lost worse if used vehicle prices decline sharply.

Professor Colin Tourick




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