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- Moody’s says the way cars are currently being sold in Europe is "credit negative" for auto finance companies.
- The credit-ratings agency previously changed its outlook on the global auto manufacturing industry from "stable" to "negative."
- Companies in the UK and Germany are offering drivers increasingly generous loans that carry more risks for the lenders, Moody’s says.
- And they’re increasing their exposure to these risky loans in France, too.
- Read more stories on Business Insider’s homepage.
Declining car sales in Europe are pushing auto finance companies into increasingly risky transactions with drivers, according to a new report from Moody’s, the credit ratings agency.
"The response of auto finance originators to faltering new car sales in Europe is credit negative for auto lenders and securitized transactions," Moody’s said.
The problem is that car manufacturers in the UK and Germany have boosted their last few years of sales by offering extremely generous loan terms to drivers. The terms of those loans are so relaxed that car finance companies are now at higher risk of losing money on the loans as new car sales decline, Moody’s said on Tuesday.
Too much easy credit offered to drivers who don’t pay off the loan
Now, Moody’s says, the problem — too much easy credit offered to customers who end up not paying off the full loan — is spreading to lenders in France.
In Britain, 90% of new car financing is offered through "personal contract purchase" loans (PCP). These loans typically offer a driver lease payments spread over a period of two years or more. At the end of the loan period, the driver has three options:
- Make a balloon payment for the remainder of the loan and buy the car outright.
- Get credit for the "residual value" (RV) of the car and roll the loan over into a new deal for a new car.
- Give the car back to the dealership and pay nothing more.
Carmakers have generally prefer drivers to take the second option because that triggers a new car purchase and a new set of interest-bearing payments from the driver.
But a car finance company can still lose money on the deal if the driver chooses either of the second two options. In both cases, the value of the car on the used car market might be less than the residual value estimated in the loan (i.e., the loan isn’t paid off and the value of the car is less than the value of the unpaid portion of the loan).
The new car market and the used car market are tanking at the same time
Governments in the UK and Europe have recently begun legislating against diesel-powered cars, making them unpopular with drivers and tanking their value on the second-hand market. At the same time, sales of new cars have gone into decline.
In March, Moody’s changed its outlook on the global auto manufacturing industry from "stable" to "negative." "Global light vehicle sales will not meaningfully recover in 2019 and 2020 after declining during the latter part of 2018," Moody’s said today. In Europe, total unit sales declined 0.4% in 2018 to 16.2 million, according to data tracked by Moody’s.
The sales declines are pushing car loan companies to offer increasingly risky loan products, Moody’s says.
The longer the loan, the greater the risk
"In Germany and the UK, automakers’ financing companies, known as captives, are expanding into used cars, amid saturation in the new vehicle market," according to Greg Davies, VP-senior research analyst at Moody’s. "We also expect captives to increase origination of products like balloon loans or leases with residual value risk in other European markets, potentially forcing non-captives to riskier origination practices in order to compete."
The longer a loan period is, the lower the monthly payments are, and the more attractive the financing looks to drivers. However, the longer loan periods make it harder to predict the residual value of the car at the end of the loan, increasing the likelihood of companies sustaining losses. In addition, the longer terms increase the chances of drivers returning the cars to dealerships before the loan is up, which also increases the likelihood of losses for the finance companies, Moody’s says.
"Increasing the maturity to 60 months from 36 would almost triple the negative equity built into the contract at the point of VT [voluntary termination]. Importantly, the negative equity effect does not only increase the likelihood that the customer will turn in the car, but also the expected loss for the lessor after selling the vehicle," Moody’s report says today.
This chart shows PCP loans are getting longer. The percentage of PCP loans in the UK for Volkswagen cars that have terms of 48 months or longer is now 70%, up from 55% in 2016.
Now the problem is heading to France
With the market in the UK and Germany for PCP-type loans now at "saturation," according to Moody’s, car finance companies have looked to push into other countries. In France, the equivalent of a PCP loan is the "location avec option d’achat" (LOA), or loan with an option to buy. LOA loans now make up roughly half the French market are on the increase.
Read more about the decline of cars:
- A $70 billion investment manager turned the Milwaukee Bucks into a basketball powerhouse. Now he’s set on improving America’s dismal passenger trains.
- Elon Musk says Tesla’s cars will defy the laws of the auto market and become more valuable over time. Experts say he’s probably wrong.
- Giant companies like Uber and Lyft are getting into the scooter business, but Lime’s CEO is welcoming the new competition with open arms