Chart 1

In most markets across Europe, residual values for EVs--expressed as a percentage of the list price--are generally worse than those for ICE vehicles. This exposes auto ABS transactions backed by EV receivables to heightened residual value risk, where applicable, and lower recovery prospects.

Why it matters:  As the 2035 deadline for phaseout of CO2-emitting vehicles approaches, the shift to EVs in Europe is expected to accelerate. However, significant challenges to widespread adoption remain, including manufacturers continuing to grapple with critical battery raw materials, technological advancements, expansion of the charging infrastructure, and fierce international competition. This can lead to price wars, technological obsolescence, and other ramifications which could drive down secondhand prices and increase residual value risk.

What we think and why:   Because EV residual values are generally worse than those for ICE vehicles, we reflect this in our analysis of auto ABS where we deem EV exposure to be material. Despite an eventual inflection point where we expect ICE vehicle demand will drop, causing their residual values to fall lower than those for EVs, we believe the short tenors of our rated European auto ABS transactions will mitigate any resulting risk for ICE vehicle receivables.

Zero-Emission Transition Gears Up

The green energy transition is gaining traction, but the EU still has a long way to go to achieve its climate goal of reducing emissions by at least 55% by 2030 and achieve climate neutrality by 2050. Given that road transport accounts for approximately 20% of total greenhouse gas emissions (GHG) in Europe (European Environment Agency estimates), and is the only sector where GHG emissions have increased in the past three decades, this area has been a key focus for lawmakers. In fact, legislation implemented in April 2023 will prohibit the sale of any new CO2-emitting vehicles by 2035, with most manufacturers favoring battery electric vehicles (BEVs) as the means to achieve emissions targets. This has resulted in significant research and development costs for incumbent manufacturers to establish their BEV platforms and has also paved the way for new manufacturers to enter the market.

On the demand side of the equation, governments have implemented subsidies, tax incentives, and other policies such as net zero driving zones to encourage BEV ownership, while charging infrastructure and vehicle range is also improving over time. Coupled with more vehicle choices for consumers across varying segments/price points and concerns on EV ownership abating, the penetration of new BEV and plug-in hybrid electric vehicles (PHEVs) has significantly accelerated across Europe (see charts 2 and 3), with manufacturers generally using PHEVs as an interim measure to meet shorter-term emission reduction targets.

Chart 2

Chart 3

Countries such as Norway started this adoption earlier and have a more ambitious goal of phasing out new ICE vehicles' registrations and shifting to zero-emissions mobility by 2025. This has been supported by government policy including tax incentives, the vast majority of the energy supply coming from renewable sources (hydropower), and the expansion of the charging infrastructure.

Access to charging points is often cited as a key barrier to EV adoption by consumers. While charging infrastructure has grown significantly over the past five years (see chart 4), more charging points will be needed to support increasing EV registrations. Several countries across Europe and the U.K. have announced infrastructure investments and incentives for continued charging network expansion. Direct current (DC) charging stations are more popular with individuals who travel long distances given they offer the best range to charging time ratio. However, the growth of DC charging stations is slower compared to alternating current (AC) charging stations.

Chart 4

Government incentives can also significantly affect EV demand. For example, Q4 2022 saw EV demand growing significantly in the German automotive market (see chart 5), attributed to pulling forward sales before the phase-out or reduction of some BEV and PHEV incentives from January 2023. Demand for ICE vehicles then rebounded, suggesting customers remain very price conscious when considering a shift to EVs. Similar behavior was observed in Sweden and Denmark when governments announced curbs on incentives.

Chart 5

We understand current incentive schemes have favored EVs for fleet lessees in some countries. While this has supported new EV registrations, oversupply in secondhand markets may persist as those vehicles come off lease given current low used EV demand from private consumers.

EV Growth Increases Credit Risk For Related Auto Financing Contracts

If we compare stickier prices between new EV and ICE vehicles, generally the latter continue to be cheaper. All else being equal, this may increase financing costs and notwithstanding EVs' lower potential running costs, the greater depreciation is one of the key considerations when comparing the total cost of ownership with ICE vehicles. Concerns around EV battery health, charging infrastructure, and the range of older EV models has hampered consumer demand for used EVs. Secondhand prices may continue to face pressure in the near term from the following factors:

New manufacturers and fierce competition   European car manufacturers are facing fierce competition from international manufacturers who historically have not exported large volumes to Europe. In particular, Chinese manufacturers are set to ramp up exports to Europe as their production exceeds local demand, and these manufacturers may benefit from state subsidies or have relative cost advantages compared to European original equipment manufacturers (OEMs). They have also entered partnerships to increase brand awareness with European consumers, such as a partnership agreement entered into between China's BYD and rental car company Sixt.

The limited historical EV data that we have, reflect limited diversification across models, and probably at the higher cost end (premium segment vehicles). Now that most manufacturers have an EV offering across segments and given the pipeline of new models, we believe that EV residual value data quality will improve over time and that we may see a different trend.

Chart 6

Chart 7

Chart 8

EV prices initially commanded a premium given high production costs, limited competition, and low demand elasticity for early adopters. With more manufacturers now offering EV models across various segments for the mass market, competition has led some manufacturers to significantly reduce new vehicle prices to maintain market share. We understand that this in turn, can cause secondhand EV prices to fall.

Economies of scale, supply chain improvements, and technological progress OEMs are reducing production costs and improving the quality of their EV offering, such as through increased range. Manufacturers have invested significantly in battery production as they seek lower costs and diversify their supply chains, which currently rely heavily on battery imports from China. The EU is following ambitious targets to develop more "made in Europe" goods, aiming to manufacture at least 40% of the products it needs for net-zero technologies by 2030. If production costs decline, this may be reflected in cheaper new vehicle prices, which in turn may lower the value of secondhand models.

Batteries represent about 30%-50% of the EV price, making them one of the most expensive components. Battery health--which may be significantly affected by charging behavior--remains a concern for used EVs, although proposals such as third-party battery health certificates, extended manufacturer battery warranties, and some studies suggesting slower degradation rates than manufacturers initially forecast may alleviate some concerns.

Chart 9

An independent third-party evaluation associated with the health of each secondhand EV battery could potentially increase the vehicle's price given the associated rise in consumer confidence.

Residual Value Performance Varies By Jurisdiction

EV residual value performance, when compared to ICE vehicles, differs significantly across European jurisdictions with secondhand EV values generally trailing ICE vehicle values by 5%-10%, when expressed as a percentage of the initial purchase price (see chart 10).

Chart 10

In our view, used car price evolution over the past three years reflects:

• Supply chain constraints caused new vehicle registrations to fall significantly and used vehicle demand is meeting reduced supply, thus leading to higher residual values for all fuel types.
• All-electric residual value curves are more volatile and may be biased by limited manufacturers/models in historical datasets. We expect this will improve as more EV models enter the market.

Charts 11 to 15 show the monthly residual value performance of the different fuel types by country.

Chart 11

Chart 12

Chart 13

Chart 14

Chart 15

On average, a low supply of used EVs may have supported historic residual values. However, when supply starts to increase, demand may be insufficient, so secondhand prices start to decrease. In the U.K., in particular, the volume of used EVs may be increasing as a result of previously leased new EVs (linked to purchase incentive schemes) entering the secondhand market. This has caused supply to exceed demand given the lack of mass EV adoption, with common concerns cited by private individuals for not purchasing EVs including range anxiety, charging infrastructure, fast depreciation, and higher prices than ICE vehicles.

We expect this trend to change in the coming years as more EV models enter the market and the shift from ICE to EVs gathers greater momentum. Higher consumer confidence would reduce the gap between EV and ICE residual values, and eventually, EVs may have higher residual values than ICE vehicles.

Our Analytical Approach To Stressing EV Values

In our view, the higher potential depreciation of EVs--classified as both PHEVs and BEVs--in our rating analysis, increases credit risk in auto ABS transactions in the short term from a recovery or residual value perspective, if applicable.

When a securitized pool has a material portion of EV assets above the 10% threshold outlined in our criteria, we would typically apply additional stresses in our recovery and residual value analysis.

Some of the key analytical considerations made in our analysis of residual value risk and EV recoveries in European auto ABS include:

• Does the lender differentiate its residual value setting by fuel type (EVs and ICE)?
• How accurate has historical residual value performance been across different fuel types compared to the forecast?
• How do recoveries compare between EV and ICE assets?

Chart 16 outlines our approach for assessing residual value risk in auto ABS transactions.

Chart 16

We incorporate a haircut on the excess EV assets in the pool in step 3 (see chart 16), to cover for the residual values that are subject to market-value risk. In particular, when the portfolio contains more EV assets than what is outlined as the pool concentration limit in our criteria, currently at 10%, we apply a rating-specific haircut to the residual value.

This will also depend on the originators' strategies and residual value setting policies. We need to understand if originators are considering residual value performance in their residual value forecasts, whether they differentiate between ICE and EV assets, and on what basis.

We also analyze recoveries for defaulted receivables. The rates and timings across jurisdictions and originators differ, as these variables depend on factors such as legal rights, financing terms, servicing intensity, liquidity of the used vehicle market, and idiosyncratic risks related to the vehicle brand and type. When analyzing recoveries for portfolios with a material portion of EV assets, we will consider this last factor.

Overall, in Europe, residual value performance for EV assets is worse than for ICE vehicles, with Autovista forecasting this trend to prevail over the next couple of years. This does not strictly depend on a country's specific EV adoption rate (see chart 10). Given the worse performance of EV assets, we stress our base-case recovery rates accordingly.

If a portfolio contains a material portion of EV assets, exceeding the concentration limit stated in the sector and industry variables associated with our global auto ABS criteria, and we believe that the originator is not distinguishing between the different fuel types, we will typically apply the following adjustments:

Table 1

Table 2

We may further adjust our residual value assumptions in step two or six from chart 16 if we believe that the penalty is insufficient to capture the total residual value risk in the securitized pool.

Auto ABS EV residual value risk: The road ahead

As new EV registrations increase, more manufacturers and models enter the market, and a longer time series of residual value performance becomes available, there will be better data to support our analytical assumptions. We believe current consumer EV adoption concerns will gradually be overcome. In the long term, it is likely EV residual values will perform in line with historical ICE vehicles. However, in the near term, we believe that EV assets represent an increased credit risk in auto ABS transactions, particularly when residual value risk is present.

Furthermore, despite the 2035 phaseout of CO2-emitting vehicles, there is currently no proposal to ban driving existing ICE vehicles after 2035. Combined with the short weighted-average life of auto ABS transactions, we consider for currently rated transactions, the risk of secondhand ICE car prices declining in the longer term to be mitigated. Therefore, we do not believe any adjustments to our residual value and recovery stresses for ICE vehicles are currently warranted.

Editor: Claire Ellis.

Related Criteria And Research

• Industry Top Trends Update Europe: Autos, July 18, 2023
• Global Auto Sales Forecasts: Macro Risks Demand Pricing And Production Discipline, April 18, 2023
• Industry Top Trends 2023: Autos, Jan. 23, 2023
• Asset Price Risks: European Auto ABS Appear Resilient To A Potential Fall In Used Car Prices, Nov. 29, 2022
• How Will The Electric Revolution Impact The Credit Quality For The Global Auto Industry?, Oct. 20, 2022
• Global Auto ABS Methodology And Assumptions, March 31, 2022
• What's It Worth? The Rise Of Electric Vehicles In European Auto ABS, Nov. 30, 2021