Auto-debt risk reaches Europe as leases create a used-car glut

Bloomberg

A shift in how Europeans finance their cars is threatening to expose bondholders in the region to the same risk that’s been building in the US 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 new ones. The US is already dominated by leasing contracts, which consist of low monthly payments for several years followed by a large lump sum or return of the car, unlike traditional loans of equal installments.
The shift in Europe reflects broader changes 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 return 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 US since at least the 1990s, Europe is now catching up. The number of transactions backed by residual values in the region rose to 14 in 2016 from just one in 2009, according to UniCredit SpA.
Almost 80 percent of the 6.2 billion euros ($7.1 billion) of auto-debt securitizations sold in Europe this year included cash flows from residual car values, up from 47 percent in 2012, according to data compiled by JPMorgan Chase & Co. In the UK, deal exposure last year rose to as much as 55 percent from less than 20 percent in 2015, UniCredit data show.
The trend toward securitizing residual car values is also being fueled by a rapid expansion of consumer credit. More than 85 percent of new cars in the UK 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 personal contract purchase agreements, which are similar to short-term leases and encourage buyers to return cars at the end of the contract.
That’s putting downward pressure on second-hand car prices, according to Moody’s Investors Service.