For the first time after the diesel emissions scandal, Volkswagen is putting forward a new issue of Asset backed Securities collateralized by auto lease receivables. Volkswagen Financial Services first started moving off balance sheet its lease receivables in 1996, expanding the range of securitized assets to loan receivables in 2004. Currently the VCL (lease receivables) programs represent the majority of issuances, which have shown sustained growth in the past years (from €9bn in 2010 to €18bn in 2014). Amongst the fastest growing programs, the “UK Driver” has more than doubled in size since 2011 (from approx. €2bn to €4bn.) and is representative of the nature of the ABS issues: over 90% of the 2014 £2.8bn issue consisted of AAA-rated senior tranche with an expected duration of 1.98 years and a Libor+0.4% coupon.

Source: VW Financial Services

Source: VW Financial Services

However, the recent scandal and scrutiny from rating agencies could pose a threat to similar future transactions and to outstanding securities: approximately €2.6bn in credit for cars with the cheating software is currently packaged in existing ABSs. The current issue is expected to pay a premium of 60bps on 1 month Euribor, about three times the level of a very similar deal in April. Until recently, the top ranking notes from securitization were viewed as safe, cash-like assets with short 1-2 year maturities and very low premiums of 15-25bps, while now the pricing of the ABS is closer to similar instruments from budget car manufacturers.

The main risk to the cash flows comes either from clients choosing to return cars and exit the financing agreement, or from the structure of certain ABS deals which require the sale of the car at the end of the lease. In both cases, a depressed second hand value for VW used cars could potentially hinder investors as the issuer is forced to sell the car in an unfriendly market. Lease receivables, which represent the collateral of the majority of ABS issues, are more vulnerable as the client usually has more freedom to decide how long to pay for the car and overall, depending on the flexibility of the original contracts, the securities are exposed to residual value risk. Another factor to consider is the different legislations under which the loans and leases are originated and the ABS are issued. Volkswagen Financial Services operates across European countries, Japan, China and Australia amongst the others, and each legislation grants different rights to customers concerning the right of the customer to return the vehicle and exit the financing agreement.

In our view, given the limited movements in the second hand market, there might be interesting opportunities among outstanding ABS, which are less likely to suffer from declining second hand prices in the short term. As concerns new issues, much will depend on the 11m vehicle recall due in 2016: unsatisfied customers are much more likely to return their car or to sell it, depressing second hand prices and creating a potential risk for ABS investors.

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