Europe’s Car-Leasing Boom Sets Off Alarm Bells
Europe’s Car-Leasing Boom Sets Off Alarm Bells
A shift in how Europeans finance their cars is menacing to expose bondholders in the region to the same risk that’s been building in the U.S. for decades.
Buyers of notes backed by auto debt are increasingly vulnerable to drops in used-vehicle prices because more and more drivers in Europe are leasing cars and trading them in for fresh ones. The U.S. is already predominated by leasing contracts, which consist of low monthly payments for several years followed by a large lump sum or comeback of the car, unlike traditional loans of equal installments.
The shift in Europe reflects broader switches in consumer attitudes about buying everything from mobile phones to entertainment, said Adrian Dally, head of motor finance at the Finance & Leasing Association. Motorists like leasing because they can drive more expensive cars and upgrade more regularly. Manufacturers like that it fosters customer loyalty and spurs greater turnover.
“If there’s a steeper decline in car values, then borrowers will be incentivized to come back their vehicles and it will be bondholders who bear any losses,” said Aaron Baker, a London-based credit analyst at Banco Bilbao Vizcaya Argentaria SA. “This exposure to used-car prices could be catastrophic.”
While residual values have been securitized in the U.S. since at least the 1990s, Europe is now catching up. The number of transactions backed by residual values in the region rose to fourteen in two thousand sixteen from just one in 2009, according to UniCredit SpA.
Almost eighty percent of the 6.Two billion euros ($7.1 billion) of auto-debt securitizations sold in Europe this year included cash flows from residual car values, up from forty seven percent in 2012, according to data compiled by JPMorgan Pursue & Co. In the U.K., deal exposure last year rose to as much as fifty five percent from less than twenty percent in 2015, UniCredit data showcase.
The trend toward securitizing residual car values is also being fueled by a rapid expansion of consumer credit. More than  eighty five percent of fresh cars in the U.K. are now financed, up from just over half in 2009, according to data from the FLA trade group. Most of that debt consists of so-called individual contract purchase agreements, which are similar to short-term leases and encourage buyers to comeback cars at the end of the contract.
That’s putting downward pressure on second-hand car prices, according to Moody’s Investors Service. It’s also enhancing household borrowing, making automakers and consumers more vulnerable to any increase in interest rates.
“There’s no ensure that actual residual value cash flows will match the expectation,” Moody’s warned in its rating of a Volkswagen AG deal in March.
The German carmaker sold 368.Five million pounds ($479 million) of bonds backed by U.K. auto lease agreements, with about half of the cash flows coming from residual values stipulated at the beginning of the contracts. Late last year, such cash flows made up about sixty percent of BMW AG’s four hundred fifty two million-euro securitization of French auto leases and of Societe Generale SA’s transaction secured by German collateral.
“Leasing-style agreements such as PCP create churn and increase the supply of used cars,” said Anthony Parry, a senior vice president in the structured finance group at Moody’s in London. “The growth in lease-style agreements means a decline in residual values is in the post for Europe.”
Low Rates
To be sure, investors are willing to take the risk for the right price. Low interest rates in Europe and extra protections in some deals can make the notes appealing, said Matthias Wildhaber, a Zurich-based money manager at GAM, which oversees 126.9 billion Swiss francs ($132 billion).
Calvin Davies, the Hague-based head of Six pack and covered bonds at NN Investment Fucking partners, which oversees one hundred ninety four billion euros, said he’s being selective with residual-value deals rather than avoiding them entirely. He chooses transactions in Europe that are backed by prime quality collateral.
“If it’s decently priced and calculated I would be blessed to take the risk,” Wildhaber said. “Because of strong request from end investors for higher-yielding bonds, it’s likely lighter to place this risk than it used to be.”
Compensation, however, is falling. The average extra yield senior-ranking notes of auto securitizations suggest compared with benchmark rates in Europe fell to a 10-year low of fifteen basis points this month, JPMorgan data display. The average yield premium for European securities backed by mortgages and credit card debt is forty six basis points, according to Bloomberg Barclays index data.
“Investors only used to be exposed to the resale value of a car if a borrower defaulted, but now they’re also exposed if a borrower elects to give back the car at the end of the lease,” said BBVA’s Baker. “If there’s a difference inbetween the depreciation stated in the lease contract and the real price decline, that’ll be written off and bond investors will take the hit.”
— With assistance by Neil Denslow
Europe’s Car-Leasing Boom Sets Off Alarm Bells
Europe’s Car-Leasing Boom Sets Off Alarm Bells
A shift in how Europeans finance their cars is menacing to expose bondholders in the region to the same risk that’s been building in the U.S. for decades.
Buyers of notes backed by auto debt are increasingly vulnerable to drops in used-vehicle prices because more and more drivers in Europe are leasing cars and trading them in for fresh ones. The U.S. is already predominated by leasing contracts, which consist of low monthly payments for several years followed by a large lump sum or come back of the car, unlike traditional loans of equal installments.
The shift in Europe reflects broader switches in consumer attitudes about buying everything from mobile phones to entertainment, said Adrian Dally, head of motor finance at the Finance & Leasing Association. Motorists like leasing because they can drive more expensive cars and upgrade more regularly. Manufacturers like that it fosters customer loyalty and spurs greater turnover.
“If there’s a steeper decline in car values, then borrowers will be incentivized to comeback their vehicles and it will be bondholders who bear any losses,” said Aaron Baker, a London-based credit analyst at Banco Bilbao Vizcaya Argentaria SA. “This exposure to used-car prices could be catastrophic.”
While residual values have been securitized in the U.S. since at least the 1990s, Europe is now catching up. The number of transactions backed by residual values in the region rose to fourteen in two thousand sixteen from just one in 2009, according to UniCredit SpA.
Almost eighty percent of the 6.Two billion euros ($7.1 billion) of auto-debt securitizations sold in Europe this year included cash flows from residual car values, up from forty seven percent in 2012, according to data compiled by JPMorgan Pursue & Co. In the U.K., deal exposure last year rose to as much as fifty five percent from less than twenty percent in 2015, UniCredit data display.
The trend toward securitizing residual car values is also being fueled by a rapid expansion of consumer credit. More than  eighty five percent of fresh cars in the U.K. are now financed, up from just over half in 2009, according to data from the FLA trade group. Most of that debt consists of so-called private contract purchase agreements, which are similar to short-term leases and encourage buyers to comeback cars at the end of the contract.
That’s putting downward pressure on second-hand car prices, according to Moody’s Investors Service. It’s also enhancing household borrowing, making automakers and consumers more vulnerable to any increase in interest rates.
“There’s no ensure that actual residual value cash flows will match the expectation,” Moody’s warned in its rating of a Volkswagen AG deal in March.
The German carmaker sold 368.Five million pounds ($479 million) of bonds backed by U.K. auto lease agreements, with about half of the cash flows coming from residual values stipulated at the beginning of the contracts. Late last year, such cash flows made up about sixty percent of BMW AG’s four hundred fifty two million-euro securitization of French auto leases and of Societe Generale SA’s transaction secured by German collateral.
“Leasing-style agreements such as PCP create churn and increase the supply of used cars,” said Anthony Parry, a senior vice president in the structured finance group at Moody’s in London. “The growth in lease-style agreements means a decline in residual values is in the post for Europe.”
Low Rates
To be sure, investors are willing to take the risk for the right price. Low interest rates in Europe and extra protections in some deals can make the notes appealing, said Matthias Wildhaber, a Zurich-based money manager at GAM, which oversees 126.9 billion Swiss francs ($132 billion).
Calvin Davies, the Hague-based head of Six pack and covered bonds at NN Investment Playmates, which oversees one hundred ninety four billion euros, said he’s being selective with residual-value deals rather than avoiding them entirely. He chooses transactions in Europe that are backed by prime quality collateral.
“If it’s decently priced and calculated I would be blessed to take the risk,” Wildhaber said. “Because of strong request from end investors for higher-yielding bonds, it’s likely lighter to place this risk than it used to be.”
Compensation, however, is falling. The average extra yield senior-ranking notes of auto securitizations suggest compared with benchmark rates in Europe fell to a 10-year low of fifteen basis points this month, JPMorgan data demonstrate. The average yield premium for European securities backed by mortgages and credit card debt is forty six basis points, according to Bloomberg Barclays index data.
“Investors only used to be exposed to the resale value of a car if a borrower defaulted, but now they’re also exposed if a borrower elects to give back the car at the end of the lease,” said BBVA’s Baker. “If there’s a difference inbetween the depreciation stated in the lease contract and the real price decline, that’ll be written off and bond investors will take the hit.”
— With assistance by Neil Denslow