Fitch: European Diesel Restrictions Could Hit Used Car Prices 

The prospect of greater restrictions on diesel-engine cars in Europe has not affected used car prices so far, but this could change if the restrictions caused a rapid and large shift of demand away from diesel cars, Fitch Ratings says. Implications for auto loan and lease ABS are likely to depend on the scope of the restrictions and how quickly they are introduced.

Concerns about NO2 emissions have prompted Stuttgart to announce plans to stop some diesel cars entering the city when air quality is particularly poor. Similar restrictions have been discussed for Dusseldorf and Munich.

Greater restrictions on the use of diesel cars in Germany and elsewhere appear likely. The Stuttgart announcement followed European Commission warnings to Germany, France, Spain, Italy and the UK for failing to cut NO2 levels. Last year, the mayors of Paris, Madrid, and Athens announced plans to ban diesel vehicles from city centres by 2025.

The chief impact of such initiatives on auto ABS transactions would be felt in deals with residual value (RV) exposure (where obligors can return the vehicle in lieu of final payments) if used diesel car prices fell sharply below the price assumed within the contractual RV amount. In such transactions, RV risk often outweighs obligor default risk. Transactions with no RV exposure would only be indirectly affected by lower recovery proceeds from defaulted clients.

There is no evidence so far of any impact on used diesel car prices. Whether this happens will depend on how widespread and severe the eventual restrictions are - both geographically and regarding the types of vehicles affected - and on the response of manufacturers and customers. Diesel remains an important component of manufacturers' attempts to meet carbon emissions targets while the market for electric and hybrid cars develops. High mileage diesel drivers may be less affected by restrictions on driving in urban areas. Scrappage schemes, which press reports say the UK has considered, could place a temporary floor under prices.

However, a declining share of new car sales in Germany, coupled with press reports that it is taking longer to sell used diesel cars due to decreasing demand, bolsters our view that regulatory pressures could eventually hit used diesel car prices. Prices could also suffer due to company-specific environmental agendas (company fleets comprise a high share of diesel cars).

If used diesel car prices fell and the time to sale increased, the impact on ABS transactions would depend on factors such as the proportion of diesel cars in the underlying pool and the RV exposure. There could be an offsetting short-term effect from higher demand for petrol-powered vehicles. We already stress transactions for steep declines in used car prices due to unexpected macroeconomic deterioration and/or changes in consumer preferences.

Transactions backed by diesel cars which comply with the EU's latest 'Euro 6' anti-pollution standard (predominantly sold from late 2015), would probably be less affected (Stuttgart's proposed restriction would not cover these vehicles). Transactions that have amortised will have larger buffers against losses, due to increased credit enhancement (CE). Typically, initial CE increases by at least 2pp-3pp in the first year after closing for senior notes and even faster in years thereafter.

Our assessment of these factors would be reflected in the transaction-specific RV and recovery assumptions that we apply to capture the risk that future sale proceeds fall due to changes in consumer preferences.

In UK transactions, we analyse the RV risk embedded in widely used personal contract purchase (PCP) contracts under the same framework as for auto leases elsewhere. Voluntary termination rights introduce used car value exposure to all contracts governed by applicable consumer legislation, but in today's PCP-dominated ABS portfolios, these are less important from a ratings perspective.