VW's Uphill Battle: Can the Captive Overcome the Emissions Scandal? | Auto Finance News | Auto Finance News

VW’s Uphill Battle: Can the Captive Overcome the Emissions Scandal?

One of the many considerations Eithne Higgins weighed when purchasing her 2010 Volkswagen Seat Leon was its resale value. Yet, after the multi-billion dollar emissions scandal broke in 2015, Higgins claims she went to several dealers to try and sell her car. But no one would bite once they found out it was one of the diesel vehicles affected by the scandal.

She filed a lawsuit in the district court of Castlebar, Ireland, arguing that the value of her car plunged because the automaker installed software designed to cheat emissions tests. Volkswagen Group is arguing this case, and others like it, claiming that the European recall is enough to fix the software problem and, therefore, doesn’t lessen the value of the car — a fix that was not possible in the U.S. due to stricter regulations on nitrogen oxide.

The manufacturer has already paid some $22 billion in consumer paybacks and government fines in the U.S. alone. Settlements are still being decided in Europe, but because diesel sales are so much greater in the European Union — 8.5 million affected units versus 600,000 in the U.S — estimates vary. If the company was forced to pay the same figure per car in Europe as it did in the U.S., it would cost $300 billion — likely enough to put the company out of business.

However, because the EU’s consumer protections are more lenient than in the U.S., analysts think a worst-case scenario would involve a few thousand Euros paid per car, compared with the guaranteed buyback program and $5,000 to $10,000 cash payout per vehicle to U.S. owners.

No matter what the company has to pay in settlements, it brings into question VW’s ability to invest in the future of electric vehicles, autonomous fleets, the future of mobility, and finance arm VW Credit Inc.

“From the public perspective, it’s not yet clear what their strategy is,” Eric Ibara, director of residual value at Kelley Blue Book, told Auto Finance News. “I think the emissions scandal has hit them so hard that it’s going to take them a while to reset.”

Recoveries on the Decline

One of the finance company’s concerns is likely residual values and offlease volume, Ibara said. Used-car values have been depreciating across the industry as the supply of off-lease vehicles grow. This is good for consumers, but bad for manufacturers that want to sell new vehicles, as well as for finance arms, which are underwriting a car’s future resale value.

“If you want to get nervous about one particular aspect” of the auto finance industry, it’s used-car values, William Strauss, senior economist and economic advisor for the Federal Reserve Bank of Chicago, said during a presentation at the recent AFRCS. “I think we’re seeing some missteps and challenges here, where vehicles coming off lease have pushed down used-car values.”

VW Credit, in particular, is vulnerable to this trend. The captive leads the industry in non-luxury lease penetration with a rate of 44.6% in February year-to-date, compared with the industry average of 28.5%, according to Experian data. The captive continues to lead the industry in lease penetration, despite dropping 13 basis points year over year, for the largest decrease in lease penetration among non-luxury brands.

Not only will VW have some of the greatest number of off-lease returns in the industry, but the passenger vehicles the manufacturer specializes in are particularly unpopular right now, Ibara said.

Last year, truck sales were up 7.3%, while passenger car sales were down 7.9%, which means trucks and SUVs made up 63% of all vehicle sales last year, Strauss said.

The majority of vehicles coming off lease this year were new in 2014. During that year, Volkswagen didn’t offer any consumer trucks and sold just two SUVs: the Tiguan and Touareg — which placed 10th in Kelley Blue Book’s top 10 consumer-rated SUVs of 2014.

“Volkswagen is especially vulnerable now, because their lineup skews heavily toward cars,” Ibara said. “They are coming out with a new SUV this year, but that doesn’t help with the off-lease vehicles coming over the next few years.”

However, Volkswagen’s average residual values haven’t dropped as much as it would seem on the surface, Ibara explained.

“When you compare residual values for Volkswagen prior to the announcement, to valuations today — it’s down 6%,” he said. “But, it’s not as bad as it sounds, because when you compare it to the market in total, the overall market is down 5%. So, from that perspective, Volkswagen doesn’t seem all that impacted.”

VW’s diesel vehicles definitely took a hit in values following the scandal, but once the U.S. settlement went through earlier this year, values came back up, he said. In fact, the entire 1% difference between VW’s residual values and the industry average could be attributed to the company halting new-vehicle production of its turbocharged directinjection diesel vehicles in 2015, which have historically held higher values, he said.

Ultimately, analysts believe VW will weather the storm, despite the billions of dollars it owes in settlements and the impact that will have on its used market. But the question that remains is how the company will perform moving forward.

“You could say, ‘Volkswagen has survived this crisis, and they can rebuild the brand going forward,’” Ibara said. “Our worry would be that they have paid such huge financial penalties, that we’re concerned with their ability to invest in future product.”

Driving Forward

Volkswagen has actually topped PwC Global’s list of top 20 research and development spenders every year since 2012; spending more than tech companies such as Apple and Google’s parent company Alphabet. Last year, Volkswagen spent $13.2 billion on R&D, outspending auto manufacturers Toyota Motor Corp. (10th on the list at $8.8 billion) and General Motors Co. (13th, at $7.5 billion).

“They have been, for a number of years, an outlier in terms of spending more than most of their industry peers on R&D,” said Philippe Houchois, head of auto research for Jefferies LLC. “If anything, we think 2017 and 2018 is an opportunity to bring the investment ratios down closer to their peers.”

Volkswagen has spent about 14% of its revenue on R&D for the past two or three years, whereas most industry peers spend between 10% and 12% of their revenue, he added. If the captive were to reduce spending to its competitors’ levels, VW could be more efficient without falling behind, Houchois said.

However, Volkswagen does not appear to be letting up on its R&D spending. Earlier this year, the company announced a $10 billion investment in electric vehicles over five years.

“The main focus is on the development of more environmentally friendly vehicles, the shift toward electrified powertrains — especially electric architecture — in addition to the rollout of new models,” Frank Witter, Volkswagen’s finance chief and former chief executive of VW Credit, said on the company’s latest earnings call. “It is our goal to improve the engine efficiencies, whether it’s diesel or other engine technologies with other new model generation, regardless of whether it’s a combustion engine hybrid, plug-in hybrid, pure electric, or fuel-save vehicle.”

Volkswagen and VW Credit declined AFN’s requests for an interview.

To date, EVs and hybrids remain a niche market, peaking at 4% marketshare when gas prices hit $4 to $5 a gallon, Strauss said. Furthermore, residual values for those vehicles have been poor.

“A lot of what you’re seeing in terms of the EV residual values — and people are going to tell you they aren’t great — is reflective of the fact that they are having difficulty obtaining a price premium for those models,” Alain Nana-Sinkam, senior director of industry solutions at ALG, said at AFRCS. “The fundamental thing we observe about the EV market is that consumers refuse to grade those vehicles on a curve. They expect those vehicles to compete in terms of range, drivability, the ability to fit into their lives, and they expect them to compete on price.”

Volkswagen believes that by 2025 three out of four VW cars will still run on diesel or regular gas, but CEO Matthias Müller admitted during this year’s Vienna Auto Show that “the future of driving is electric.”

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