How VW Recall Puts Dealer Floorplan Securitization At Risk

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Volkswagen’s decision to halt sales of diesel cars in the United States that are involved in a recall puts bonds backed by dealer floorplan financing at risk.

The stop sale, which was announced Sunday, leaves Volkswagen dealers “saddled with unsalable product, at least for the time being,” Barclays said in a report published today.  

The decision came after the U.S. Environmental Protection Agency issued Volkswagen a notice of violation of the Clean Air Act Friday. The EPA alleges that certain Volkswagen and Audi vehicles with four-cylinder diesel engines contain software that detects when the car is undergoing official emissions testing; the software turns full emissions controls on only during these tests.

Volkswagen, like other automakers, extends revolving lines of credit to dealers to finance their inventory. This financing gets repackaged as collateral for bonds. The most securitization, the $1.25 billion Volkswagen Credit Auto Master Owner Trust 2014-1, closed in August of last year.  Moody’s Investors Service and Standard & Poor’s both rated the bonds triple-A.

A stop sale could trigger early repayment on these bonds, according to Barclays. The bank noted that a shortfall in the monthly payment rate would trigger an early repayment of the bond, but only if, over a three-month period, the payment rate is 27.5% or lower.

Barclays expects the monthly payment rate in September for VWMT 2014-1 to fall by 25% from August’s rate. The drop would still keep collections within historical norm. More importantly, even if the stop sale persists into October, and the payment rate dropped to 0%, the three-month average payment rate would be 31%, according to Barclays.

“It should be noted that a 0% MPR for the October collection period is a very low probability event, given that approximately 75% of the inventory financed through VWMT likely remains salable,” the report states.

Some 11 million vehicles worldwide may be impacted, according to Volkswagen and around 482,000 of those cars have been sold in the U.S. since 2008.   Diesel engine models accounted for 22.9% of Volkswagen’s U.S. sales in August, which, said Barclays “by extension indicates approximately three-quarters of the total Volkswagen inventory at dealers is still salable.”

The impact of the sales stop on collateral performance in Volkswagen’s retail loan and lease securitizations is limited to the fallout regarding consumers’ perception of Volkswagen. There are currently $1.82 billion outstanding of VW auto ABS backed by VW leases and $2.57 billion of ABS backed by auto loans, according to figures reported by Deutsche Bank.

“In the unlikely event that the company is slow to respond or provides an ineffectual solution, there remains a risk of lingering bad will toward Volkswagen vehicles,” said Barclays. “Such bad will could have spillover implications for recovery/residual values, as well as new vehicle sales.”

Moody’s Investors Service, Standard & Poor’s and Fitch Ratings, which all rate Volkswagen’s dealer floorplan securitization, have yet to comment on the implications of the recall or stop sale order.  Fitch did say on Monday that Volkswagen's 'A'/Stable corporate rating could come under pressure if the group’s brand image is damaged, particularly in the U.S., where Volkswagen "is already struggling to increase its market share". On Thursday, S&P placed VW's 'A/A-1'  corporate credit ratings on CreditWatch with negative implications. 

Volkswagen said in a press release today that it plans to set aside approximately $7.2 billion “to cover the necessary service measures and other efforts to win back the trust of our customers.”

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