The UAE’s “auto ownership mania” has made the country a prime international market for carmakers – a business opportunity which has not escaped the local retail bankers. With a plethora of auto financing packages currently available in the marketplace, are car buyers getting a good deal?
So you want to buy a car It all seems so easy. You pick the one you want, and before long, you have signed on the dotted line and made the ultimate commitment. Absolutely nothing could be simpler.
Two years later, however, the story may start to change, and the horror sinks in of the long-term financial cost of your empetious decision. Even worse, you realize that little of the capital amount of your five-year car loan has been paid off over the past 24 months with nearly all of the fixed rate monthly payments having gone to cover upfront interest charges.
Sound familiar? With between 60% to 70% of financed auto purchases in the UAE being made through banks represented on the showrooms of car dealerships, even the most discerning vehicle buyers can be influenced by the excitement of the moment to make an impulsive decision overlooking the fine-print of the financing contract. Financing the purchase of a car with your eyes “less than wide open” is a fraught venture in the UAE where the auto financing marketplace has burgeoned overnight with headline interest rates promoted by many of the banks being potentially misleading to expatriates used to APR (annual percentage rate) loans calculated on a reduced balance basis. While gaining finance in the UAE for the purchase of a personal vehicle is easy enough, the structure and final cost of auto loan packages is less than a clear-cut deal.
Money’s advice to readers looking to finance the purchase of a car is that, while there are presently many competitive bank loan options available offering good value, do not forego the fine-print. Below details some of the auto financing options available and the many snags to avoid.
Government import/export data suggests that the volume of vehicles arriving and remaining in the UAE over 2005 rose year-on-year by 60% to more than 250,000 units at an estimated value of around US$2.9bn. Business Monitor International (BMI) estimates the UAE’s total vehicle population for 2005 at about 1.4 million, with Dubai accounting for roughly half of all vehicles on the road. Abu Dhabi is also experiencing strong growth in its vehicle population, with the number of registered vehicles having risen seven-fold to 212,686 units at the beginning of 2006 compared with the 27,338 units registered at the beginning of 2001, according to the Abu Dhabi Police Directorate. Government data suggests that private vehicles account for approximately 70% of the new vehicles on the road today. Indeed, feedback from auto dealers and auto financiers is that the high per capita private vehicle ownership in the UAE makes the market one of the most robust in the world, with many individuals owning more than one car at a time.
And, with car owners looking to replace their existing vehicles every 18 months – according to Standard Chartered Bank, UAE, - the demand for new and used private vehicles has presented the banking industry with a lucrative new business source in auto financing. The auto market is growing nicely at between 8%-10% a year,” says Atif Bazwa, head of the retail banking group at Mashreqbank, which in turns feeds through to the auto financing side due to the high volume of financed vehicles. There is a constant increase in buyer demand for cars in Dubai, he notes, and all indicators suggest that vehicle sales will remain strong for years to come.
Ashwani Shiv, sales manager at the automotive division of Swaidan Trading Co. LLC, notes that the strong demand for private vehicles in Dubai is largely being driven by the Emirate’s surge in economic activity and the high influx of foreigners. “Dubai’s public transport system is under strain because of the increase in population as well as increased tourist numbers. This is a significant factor pushing demand for private vehicles,” he adds.
While still regarded in its infancy in product development, the UAE’s auto finance market has grown over the past 10 years from almost zero-base to an estimated US$2.1bn today, with nearly two-thirds of all vehicles sold being financed. There are currently at least 40 financial institutions competing in the UAE’s auto financing market, says Shiv.
And, observes Roger Ghosn, marketing manager at Al Habtoor Motors Co. LLC, at least every calendar quarter a bank will launch a new variation on the auto financing product. “The most recent market competition has come from the Islamic banks,” he adds in referring to Islamic Shariah-compliant financing under a “Murabaha” structure. In such arrangements, the capital provider (the bank) acquires an asset and resells it to the final purchaser at a premium which constitutes a “fee” instead of non-compliant “Riba” or interest-based transacting. “Many non-Muslims are now benefiting from the Islamic banking rules,” Ghosn says.
Coupled with the robust local demand for private vehicles, the UAE – Dubai specific – has experienced phenomenal growth in foreign workers with the number of expatriates arriving having increased 17% over 2005 to reach a total of around 2.738 million individuals, all of which has further driven the frenzy for auto financing.
Notably, auto financing growth in the UAE forms part of a broader drive by the retail banks over recent years to grow their loan books (some banks even imply that the market’s competitive pricing pressure on auto financing has eliminated any profit on the line and that auto loans are now only an enticement to bring the customer in, whereupon other more profitable products are “cross-sold”). In fact, most of the retail banks have established “relations” with UAE companies hiring large numbers of expatriates with the view of establishing immediate personal contact with the newly arrived individuals before another bank has the opportunity to claim this fresh turf. Having a bursting package of banking goodies thrust before you – such as credit cards, Diners’ Card, personal loans, a “rent loan” and a “zero down” auto financing loan (which often comes bundled with yet another credit card) – can make it seem that your birthday has come around early this year and the immediate impulse is to avail oneself of these seemingly attractive options. But, beware!
“The UAE is an extremely ‘interest rate sensitive’ market,” observes Owen Belman, head of Standard Chartered’s consumer banking in the UAE and Oman. Increased competition from a growing pool of players in the auto finance arena has compelled the banks to reduce interest rates to the current range of 4.75%-4.5% fixed “headline” rates. The level of interest charged probably determines the outcome of about 50% of auto financing deals, says Ghosn, with the remainder purchases influenced by the broader aspects of the auto financing package, he adds: “For instance, some of the more astute car buyers look to whether there is a cost on early settlement on the loan.”
To further sweeten the deal, all of the banks competing in the auto loan marketplace have attached a host of “bells and whistles” features such as extended vehicle warranties, free breakdown service, extended payment periods for up to six years, deferred first payment, discounted/free insurance coverage for the first year, pre-paid petrol cards, credit cards and so forth…In this regard, each bank has its own unique incentive pitch, which the car buyer should ensure that such trinkets do not distract from the real attributes of the loan such as rate and the terms of the finance agreement. “In the absence of any [market] differentiation, banks are offering lowered rates and have increased their focus on services as a response to the intense competition,” remarks Belman.
“Auto finance is pretty much a ‘commodity product’, which typically becomes a thin [profit] margin market,” comments Bazwa. “This, of course, is good for the customer.” The larger banks have the necessary scale
of operations to moderate unit costs on auto financing, he notes, which
means they are able to achieve a modest profit. The main advantage for the bank in auto financing is the cross-selling opportunities that arise from the relationship, he says. Plus, there is very little risk volatility in the auto financing segment, so losses incurred through defaulted payments are low, he adds.
Many of the banks require the individual seeking auto financing to transfer their salary payments to that bank, which further reduces the risk of non-payment. In some instances, banks will offer zero-down financing if salary payments are transferred, or alternatively require up to a 15% value of the vehicle as a down payment. In some instances, banks offer a discounted or “preferred” interest rate on auto loans when the individual’s salary is transferred to a current account with the bank in question.
Louis Scotto, general manager of retail banking at Emirates Bank, says the extent of the financing also depends on the type/quality of the company employing the loan applicant. For instance, he says banks have their own lists of “A-companies” and “B-companies”, and where a person applying is employed by a company not on the list, the down payment requirement can be as high as 40%. Furthermore, some auto financiers, such as Emirates Bank, apply a “minimum stay” requirement for recent arrivals to the UAE. Scotto concurs that competition among the banks has placed pressure on auto financing margins. “Many banks use the car loan as a ‘loss leader’ to develop the client relationship,” he adds.
None of the banks currently offer a zero-down option for used cars and tend to charge a higher rate of interest over a shorter loan period (typically, four years on used cars versus five to six years on new vehicles). Bazwa confirms that used vehicles are usually subject to a shorter financing period: “For instance, with Mashreqbank, the typical loan period on a used vehicle is four years while new vehicles carry five years. It’s really about the retained value of the car - some vehicles will hold their value longer.” Another factor the vehicle buyer needs to take into account is that certain cars carry higher than average capital depreciation (average auto depreciation is around 15% a year) which would attract higher down payment requirements, observes Scotto (notably, exotic sports cars, despite a blue-chip price tag, tend to suffer from steeper value loss).
Several of the banks have attempted to further develop the basic auto financing product, but have met with little success. RAKBANK (The National Bank of Ras Al Khaimah PSC)
attempted to introduce a private vehicle lease-like auto financing plan after having aggressively pursued a campaign to grow its retail loan book. The bank was eventually forced to withdraw writing new auto financing business allegedly due to incurring losses on its “50-50” lease-like scheme. Repeated attempts by Money to gain comment from RAKBANK regarding its auto financing arrangements were ignored. However, Bazwa believes that variable rate pricing (currently all auto loans are structured on a flat rate) and more sophisticated personal vehicle lease arrangements available in Western markets will eventually make their entry into the UAE.
Lack of transparency in the marketing of auto finance products by several banks is a cause for concern as the financing industry moves forward, says Steve Williams, chief operating officer, Middle East at Lloyds TSB Group. “The banks are tinkering with the pricing and how they present the pricing,” he adds.
Williams is at odds with the low ‘flat rate” of financing promoted by several players in the auto financing field. Under such flat rate agreements, the interest rate in question, say 4%, is calculated against the capital value of the vehicle and levied in equal payments over the duration of the loan period (in some instances, the interest and transaction costs are charged on the front-end of the loan, hence little of the capital portion of the loan is repaid in the early stages). In the event the vehicle buyer decides to settle the loan ahead of the repayment schedule, the bank will apply a penalty fee (which normally equates to the “lost interest” that would otherwise have been earned, although some banks will waive this cost if the individual is willing to finance a new vehicle purchase).
Williams points out that Lloyds TSB provides its auto customers with a reducing balance rate of 9.75% which, on the surface, seems unrealistically high relative to the low flat rate auto financing packages available in the marketplace. Williams explains, however, that the same low flat rate and the higher reducing balance rate equate to the same level of interest charged over the typical 48 to 60 month term of an auto loan (see accompanying chart). Unlike a flat rate loan, the reducing balance rate results in declining interest charges as each payment made toward the loan reduces the capital value against which the interest is calculated. The main advantage with the reducing balance rate approach is that the vehicle purchaser is able to reduce the outstanding capital faster and has the option of making an early settlement without incurring penalty costs, he notes.
With roughly two-thirds of financed auto purchases concluded on the dealership showroom, there is intense competition between the banks to gain showroom representation. “Typically, a dealership will have relations with about 10 banks, of which three to four will be ‘active partners’ working with the dealership,” comments Shiv. In turn, the dealerships receive an undisclosed commission from the banks on each auto deal financed (said to be between 1% to 2% of the loan value). And, in instances when several banks are vying for business in the same showroom, it is not uncommon for “special arrangements” to exist between representatives of the banks and the vehicle salespeople where an additional commission of about half a percent of the value is paid under the table.
In total, the dealer and sales commission charges made by the banks looking to grow an auto financing portfolio are ultimately hidden costs to the vehicle buyer, and can significantly add to the repayment value of the loan, observes Williams. “The [auto] dealers have a lot of pull with the banks, as in the UAE some dealers hold exclusive control over the availability of certain makes of vehicle,” he remarks. Lloyds TSB does not operate through the auto dealers and only provides auto financing to its existing customers, he adds.
Williams advises prospective car buyers to consider the following before entering into an auto finance arrangement:
• Rate transparency;
• Whether there are penalty costs for early settlement;
• Flexibility to restructure an auto loan at a future point; and
• Depending on individual circumstances, whether there is the option of a fixed or floating rate of interest.
Both Shiv and Scotto caution car buyers to question the clauses of contracts and examine loan processing fees, which alone can account for 1%-2% of the value. “The clauses of contracts can also vary greatly, with the more established auto financiers likely to provide financing on standard terms,” observes Shiv. “And [car] buyers should look at [loan] foreclosure costs,” he warns.
As mentioned above, Sharia-compliant auto finance schemes are achieving growing popularity outside of the Muslim community. In many instances, the Islamic banks providing vehicle financing offer more attractive “rates” than those available through traditional retail banks. And, as outlined, the car purchaser immediately benefits from capital reductions on the loan from commencement of payments.
Sharia law also affords additional advantages to a car buyer in that the Islamic banks do not pay undisclosed commissions to car dealers, although many do have some form of “incentive arrangement” in place. Additionally, under Sharia law, the bank cannot charge late payment fees.
Dubai Islamic Bank (DIB), which is believed to hold the lion’s share of Dubai’s auto financing market, has literally taken the car from out the dealership and put it into the bank. What is possibly a unique approach to auto financing anywhere in the world, DIB has established four auto showrooms (representing vehicle makes across-the-board) which are attached to the bank’s branches. The showroom staff are employed by the bank and are not influenced by carmaker incentives.
DIB’s success in the auto financing market is a result of the bank’s long-term commitment to the business, says Abdulla Al Shamsi, senior vice president of sales at DIB. While the various banks have developed an appetite for auto financing at various stages of their development, these institutions have not been consistent operators in the marketplace, with many of them using “gimmicky marketing promotions” to catch the attention of consumers. The buying public is aware of who the serious players are, observes Al Shamsi, and tend not to be “hooked” by frivolous promotions that have little value on the underlying auto transaction.
“DIB has also taken auto financing to a new level,” Al Shamsi says, with having created what he calls a “one-stop shop” for auto financing: “By sourcing everything, the customer finds out there is one destination where he can get 90% of what he needs, everything to do with cars, from finance to trade-ins, insurance, warranties and so on...It’s all about adding comfort and ease for customers. That gives you [DIB] a serious advantage in competing against other banks.”
Al Shamsi confirms that, while DIB does have banking representatives on the showroom floors of some auto dealerships, the bank does not offer dealer or dealer salesperson undisclosed commissions. DIB does, however, offer a dealer incentive scheme, but thus far none of the dealerships have availed themselves of this reward, Al Shamsi adds. In addition to its “one-stop shop” facilities, DIB provides ongoing support to its car purchasing clients: “Should there be any kind of defect with the vehicle, the customer comes back to us and we ensure that the dealership rectifies any faults…We want people to know that Islamic banking is for everyone.”