VW, BMW are paying much higher rates for debt

Europe’s car-financing businesses are trading in their cheap bonds for more expensive debt -- which means higher car loan rates for customers.

BMW, Mercedes-Benz and others sold 8.45 billion euros ($9 billion) in bonds in European markets last month, marking the biggest month for auto debt issuance in six years, according to data compiled by Bloomberg.

They are paying dramatically higher rates for debt, and analysts say it will trickle down to consumers, who will face more costly vehicle financing.

“Higher bond yields for auto companies means the cost of car leasing will go up,” said Antoine Lesne, head of ETF strategy and research at State Street Global Advisors.

That means “more pain for the consumer,” he said.

Debt is the lifeblood of the financing arms of Europe’s biggest automakers, which tap public bond markets and other sources of cash to offer consumer financing. To be sure, not all of the bond proceeds are used for in-house lending and automakers also use debt to finance general operations.

Even so, some analysts say that the rates are an early indication of where consumer financing costs are headed.

The average yield on European automaker bonds has climbed to 4.15 percent, essentially a measure of how much it would cost the industry to sell new notes, according to a Bloomberg index.

That is about twice the interest rate that companies are paying on existing debt, currently at 2.14 percent, the data show.

BMW’s lending arm, BMW Finance, recently issued 2 billion euros of bonds with coupons of between 3.25 percent and 3.625 percent. That compares with fixed-rate euro bonds coming due this year with coupons of at least 3 percentage points less than the new ones, implying an extra 50 million euros cost per year, according to Bloomberg calculations.

The broader question for the industry is whether consumers will be able to afford costlier car loans with inflation already eroding incomes, or if they will opt to drive older vehicles for longer and delay new purchases.

Some analysts have speculated that automakers may choose to keep interest rates low, even if it erodes the profitability of their financing units, in hopes of making up the difference with higher sales.

So far, consumers have been resilient despite faster inflation.

The backlog of orders that automakers built up during the pandemic has made for solid quarterly results as supply chains normalize, with auto sales in Europe rising for nine months straight.

But demand has shown signs of waning in the region’s economic powerhouse - domestic orders at German automakers fell 30 percent in the first four months of the year - and analysts say companies are bound to lose some of their pricing power.

“Higher funding costs absolutely impact profitability at auto companies’ financial arms,” said Bloomberg Intelligence credit analyst Joel Levington.

“Auto manufacturers will need to decide how to work around affordability. Do they give up pricing, add incentives or offer cheap rates as mechanisms for purchasing a vehicle?”

In-house lending is a key part of the business model for European automakers, with analysts at Bernstein estimating that it accounts for up to 30 percent of overall earnings.

Rising rates will be a headwind to captive finance companies that have had record results in recent years.

Operating profit for Volkswagen Financial Services plunged in the first quarter after two years of exceptional earnings that were linked to cheap borrowing costs and supply shortages that drove up used-car values.

A VW spokesperson said the automaker will make financing terms as attractive as possible, but it would have to pass on some of the costs to customers. It has also announced a new corporate structure for its financial units that would give it other means of accessing funding such as taking deposits from savers.

Automakers tend to be popular among investors, given their safe debt profile, which gives them the ability to sell bonds at rates lower than other companies.

Almost all of Europe’s major automakers have investment-grade ratings, and recent bond sales from BMW Finance and Volkswagen International Finance saw strong demand.