A recent German regional court decision backing an effort to ban diesel-engine vehicles in Stuttgart is a setback for the country’s domestic auto manufacturers – and could produce some backfire on German and European auto asset-backed securitizations, as well.
In a report last week, Moody’s Investors Service said the court decision requiring Stuttgart to sharply improve emission levels in the city – which could involve a diesel-car ban requested by a local environmental group – could eat into the performance of existing ABS deals, many of which have large concentrations of diesel vehicles that could face punitive declines in resale (and recovery) values.
Diesel engine cars from Volkswagen, Opel and Daimler AG have been huge sellers in Germany, having a 46% share of new registrations in the country as recent as 2016. Diesel sales were down to a 40% share of the market according to registration figures published May by the KBA, the German motor transport authority.
“The court decision is the latest and firmest indication of restricting diesel cars in various German cities and possibly elsewhere in Europe, a credit negative for German and European auto asset-backed securities,” the report stated.
A ban on diesel-engine cars could involve approximately 2 million vehicles, based on a proxy estimate by Moody’s between the percentage of diesel-car registrations and the 4.1 million total consumer loan contracts assigned to German ABS deals from Volkswagen, BMW, Opel, Daimler and others.
If bans or restrictions on diesel-engine cars go into effect across the country, a universal decline in their residual values could dramatically reduce cash flows to securitizations derived from either balloon-loan contract payments or resales.
Securitizations could most be impacted by the large percentage (52%) of loans with balloon-payment options. In Germany, a balloon-note borrower usually has a repurchase contract with a dealer that covers the expense of the final installment payment. A loss of resale value would disrupt that arrangement, and “dealers will have difficulty covering residential value losses,” the Moody’s report stated.
“Consequently, they might not have the financial capacity to fulfill their repurchase obligations, and borrowers would be more likely to default on the unexpected obligation to cover the balloon payment themselves.
The Stuttgart court ruling, taking place in the home city of Mercedes-Benz and Porsche, is not the only pressure mounting on manufacturers.
Regulators and government officials across Europe have steadily pushed for cleaner emissions, with the UK and France going so far as to target 2040 for the elimination of all combustible-engine cars on the roads. Manufacturers are in discussions with German government officials looking into measures in which they could meet new standards without banning diesel cars – mostly by retrofitting older vehicles – and preserving the historically popular product segment.
But the Stuttgart ruling said software-based retrofits or upgrades were inadequate, according to reports, putting into place a strong likelihood a ban on diesel-engine cars could emerge in Stuttgart and soon be replicated in cities and regions across the country.
The Stuttgart court ruling comes two years after Volkswagen’s global emissions cheating scandal that forced it recall and refit more than 11 million vehicles. That scandal largely left Volkswagen’s global ABS transactions unscathed, and in fact prompted VW to ramp up its capital-markets activity as its stock price fell and unsecured debt avenues became less attractive.
VW benefited from low default and return rates from owners of the impacted diesel cars who largely kept up payments and kept their cars, and that in turn preserved resale values. In a June report, Moody’s noted that Volkswagen’s residual values of its diesel cars were still higher on average relative to other manufacturers’ diesel-engine vehicles.
But the same report also indicated a bleak future was still ahead for diesel engines, and depending on the national impact of the court ruling, may soon be a reality.
Stricter regulations against the cars were already stacking up prior to the court ruling. The European Commission set the latest emissions standards in 2014 (the “Euro 6” standards) for which many diesel cars, manufactured up through 2015, cannot meet without software-based retrofit upgrades.
Cities such as Madrid, Milan and Paris preceded Stuttgart with threats to ban diesel-engine vehicles. And earlier this year the UK government passed a clean emissions framework that would require diesel engine cars to meet the Euro 6 standards…while regular petrol cars would only need to satisfy the less-extensive “Euro 4” standards.
“We expect 2017 will see a larger decline in the proportion of new diesel vehicles sold and this shift in consumer demand will be echoed in the used car market,” the June Moody’s report stated. “Scrappage schemes may be implemented in various markets to remove older diesel vehicles from the road, but any such schemes are unlikely to fully mitigate negative pressures on diesel used car values caused by stricter regulation.”
