FRANKFURT -- Volkswagen Group, Europe’s largest corporate bond issuer, can expect a boost to its vehicle sales when it re-opens a key refinancing channel for its loan and lease business that has remained shut since the start of the automaker's emissions-cheating crisis.
"We expect that the group will once again issue bonds to the capital markets by the middle of the year,” VW said in a statement, adding this would likely happen before the end of June.
Beyond the billions of euros in fines, settlements and recall costs, the diesel emissions scandal has also frozen the automaker’s ties to investment grade bondholders. They serve as an important source of cheap liquidity for Volkswagen’s captive financial services business, VW FS, whose funding is behind nearly every other car the group sells in Europe.
Retail sales of Volkswagen group cars dipped 1.2 percent in the first two months, due to a 4.7 percent decline in the scandal-plagued VW brand. This drop came despite efforts by VW FS to bolster volumes through various incentives such as extended warranties, maintenance and inspection, or special financing conditions.
Volkswagen will need unfettered access in order to ramp up sales and fuel the growth of VW FS, which plans to double in size by 2025. Part of the subsidiary’s new long-term strategy entails growing its portfolio of income-generating assets to 30 million insurance, services and financing contracts from last year’s 16.6 million.
Although less glamorous than the traditional business of developing, building and selling cars, financial services can provide a valuable edge over rivals by putting up the necessary cash to enable a broader group of consumers that cannot afford a lump-sum cash payment the ability to purchase a new car.
One out of every three new cars VW Group sells worldwide is financed by the financial services unit either in the form of a loan or a lease, and in Europe that rate is far higher. The reason why it is so low globally is that only one out of every ten cars sold in China, the group's largest market by far, is financed directly by the company.
Beyond the 18 percent contribution VW FS makes to the automaker's operational profits, Morgan Stanley wrote in a report late last month that “its importance to the other operating divisions cannot be overstated.”
The U.S. investment bank went so far as to tax the value of VW FS at nearly 19 billion euros – more than what the investment bank estimates the group’s equity is worth in its two Chinese joint ventures.
One official at the subsidiary put it bluntly: "Wherever Volkswagen or any of its brands sells cars or trucks, you will find us. Were the group to exit a market entirely, we would be the last ones to turn off the lights."
If managed poorly, however, the financing business can also be a major risk for carmakers - even when excluding notable examples such as GM’s disastrous foray a decade back into the U.S. subprime housing market. A normally cautious BMW ended up sustaining a 2 billion euro hit to earnings in 2008 after the residual value estimates underpinning customer leasing contracts proved overly optimistic.
Volkswagen may not be immune. “VW has grown its FS business more aggressively than other OEMs, particularly in the total number of contracts, as well as penetration,” noted Morgan Stanley in its report.
Before the group may finally return to global bond markets, it must first disclose to investors the risks stemming from the emissions scandal in its mandatory prospectus. Once it can fully comply with various securities laws, it can go back to selling debt priced in euros, pounds and dollars.
The timing couldn’t be more ideal. Aiming to combat deflationary risks in the euro zone, the European Central Bank is now pumping 80 billion euros into the economy every month by purchasing assets like sovereign debt. But the effect hasn’t been as strong as it hoped, so policymakers have expanded the types of securities eligible to include corporate bonds effective this month.
Volkswagen, along with other German carmakers, could become a key beneficiary of the bank’s quantitative easing, as ECB board member Peter Praet explicitly acknowledged last month in an interview with La Repubblica. The automaker issued more bonds globally over the four-year period to 2015 than any other Europe-based corporate.
According to data provided by market research firm Dealogic, it sold a total of $88.8 billion in various denominations across the world. By comparison, Daimler and BMW came in second and third with $62 billion and $44 billion, respectively, while oil giant Royal Dutch Shell only came in fourth.
Ever since Volkswagen was locked out of the corporate bond market a half year ago, it has been forced to rely largely on customer deposits made to its captive banking subsidiary or, more commonly, by bundling cash flows from pools of loan and lease contracts and securitizing them.
The risk however with these so-called ABS notes is that investors may lose their appetite given a portion of the collateral backing some of the existing instruments likely include diesel cars affected by the fraud, which are losing value. Volkswagen’s Financial Services (VW FS) division itself has already booked 286 million euros in impairment charges last year to adjust for the lower resale values of such cars on lease.
For the moment, a goodwill offensive is helping to stabilize these kind of residual value risks on new VW Group cars currently being sold. Protecting resale prices for vehicles coming off-lease is crucial, given VW FS annual accounts list the value of its portfolio assets potentially at risk of further writedowns at 19.7 billion euros.
That may be a reason why VW FS finance chief Frank Fiedler wants to end the division’s current dependence on ABS securities for funding and get back to selling unsecured debt even if it means paying higher interest. "That costs profits, we know, but it's a safeguard since something can always happen elsewhere," he told reporters last month.
In order to dampen the effect of rising rates, VW FS plans to save at least 150 million euros in costs on average over this year and the next. "We won’t be able to avoid making hard cuts. No longer everything that we took for granted in the past as being natural will still be possible," Fiedler said.