Are auto ABS losing their shine?
Abrupt overnight developments mean that vehicle finance is a riskier asset class to securitise than before
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At first glance, vehicle finance makes for an attractive candidate for securitisation. Financing is secured on vehicles, benign credit conditions have been pushing up demand, and the credit risk assessment process is generally agreed – even by the regulator – to be solid. While issuance activity saw a slump following the financial crisis, auto ABS continue to be an exception to Europe’s lukewarm ABS markets, as well as a major source of refinancing for captives.
Some €272.8bn (£239.7bn) in auto asset-backed securities (ABS) have been issued in Europe since 2000, according to a September 2017 report from Creditreform Rating. For Volkswagen Financial Services, ABS in 2017 were as big a source of refinancing as bonds – around €33bn.
Just like the assets that underlie them, how, auto ABS now face a threat to their once-assured resilience. The ever-looming shadow of Dieselgate means that residual values (RVs) on vehicles could drop abruptly if local and national authorities, especially in finance-intensive markets like the UK and Germany, decide to impose restrictions on diesel vehicles in urban centres. This would in turn have a knock-on effect on securitised contracts, particularly in the case of PCP.
As Eberhard Hackel, senior director EMEA at Fitch Ratings, put it at the 2018 Motor Finance Europe Conference: “Life has been quite easy: we just needed to look into default rate and recovery rates, and that was it. But the recent past has told us that … from one day to another, a new risk factor emerges, and suddenly a certain class might be banned from driving somewhere in Germany, and obviously that has a direct impact into the credit quality.”
On top of Dieselgate, there is a more insidious way auto ABS investors could find themselves with a weaker asset on their hands, at least when it comes to UK-originated contracts. Under the Consumer Credit Act 1974, borrowers in Britain are afforded a voluntary termination (VT) once half the total debt has been repaid. Moody’s warned that an increasing number of customers could take advantage of VT to release themselves of diesel vehicles in the face of anti-diesel rhetoric.
Additionally, DBRS published research showing how VT rates are higher on four-year PCP agreements, which have been growing their share of the market next to the more traditional two- and three-year contracts.
“As four-year PCP agreements have become the norm, DBRS has observed increased cumulative VT rates for UK auto ABS transactions that it rates, DBRS said. “An increase in VTs typically results in a lower recovery rate compared a PCP at maturity, while also denying the transaction additional cashflows and yield.”
Moody’s and other rating agencies say they have not yet seen instability in the motor retail landscape result into a deterioration of ABS quality. But Moody’s said captive finance houses have begun reducing the composition of securities pools away from diesel, as well as introducing residual value guarantees for ABS investors.
“The timely adjustment of RV forecasts is the first level of protection against RV risk for new ABS transactions,” the agency said.
Interestingly, Sixt Leasing, a major player in the German leasing market, has bet on bonds, rather than ABS, to achieve financing independence from parent company Sixt. Earlier in 2018, the lessor had set out an ambitious plan to shed as much diesel-related exposure as possible.
Whether bonds will take a bigger role in refinancing for financing house remains to be seen. But like everything else in the automotive world, ABS are now facing a disruption that will require radical new models to be braved.