Credit rating agency puts VW Group on notice

ONE of the world’s leading credit rating agencies has placed Volkswagen Group on notice, as the German auto giant reels under the complexity and breadth of the EA189 diesel emissions scandal.

Fitch currently rates the group as investment grade A, its third-highest ranking, but has applied what it calls a Ratings Watch Negative to the grade, with the car-maker staring down the barrel of a compensation package that could, according to some estimates, blow out past €50 billion ($A81b).

In a statement, Fitch explained that the ratings watch reflects “the reputational damage on the group's brands following alleged manipulation of emission tests in the US and the expected multi-billion Euros financial impact from potential fines, recall costs, lawsuits and legal claims”.

The US-based ratings agency believes that while the car-maker can absorb several billion Euro’s worth of extraordinary cash outflow without impact to its credit rating, it expects the brand’s image and reputation to be “seriously undermined” by the crisis, which involves 11 million cars sold into markets around the globe.

Volkswagen has already earmarked €6.5 billion ($A10b) from its projected quarter three earnings to counter the mounting costs of the scandal, which will include as a minimum a hefty fine from the US government, reparations to dealers and customers and covering the rectification work or recall of affected vehicles.

Up to 44 per cent of Volkswagen AG is comprised of Volkswagen Financial Services, an entity that, by itself, is said to have doubled in value in the last decade, and is said to be worth more than €114 billion ($A184b).

This financial arm underwrites the stock held on dealer lots, as well as providing leasing finance to customers it is estimated that 30 per cent of VWs sold in Europe in 2014 alone were under lease arrangements.

With affected cars in the US and Europe quarantined from sale, dealers are unable to pay down debt to the parent company, while residual values from leased vehicles already in the field will be lower than predicted.

Volkswagen Financial Services, which also provides traditional banking services to customers and is holding €25 billion ($40b) in deposits, holds more than 10 million financial contracts and contributed 14 per cent of the Group’s profit in the first half of 2015.

This additional pressure on VW’s bottom line may see an increase in the cost of borrowing for the German giant going forward. These increased costs may see the development cycle across the entire group curtailed in an effort to contain the damage.

While the Group is reliant on its modular MQB platform for many of its passenger car lines, the platform itself is approaching its mid-life, and its replacement is a key plank in the company’s passenger car portfolio.

The sale of key assets – including Porsche, which recently snapped up part of the VW AG shares recently unloaded by Japanese company Suzuki – could also provide a war chest for the beleaguered brand.

A recently mooted – and well-developed – plan to enter Formula 1 as an engine manufacturing partner to Red Bull Racing in 2018 has reportedly been axed, while the Group’s world endurance championship racing activities – centred around a diesel-electric hybrid-powered racer – may also be collateral damage as the group seeks to restore its reputation.