German Automaker Volkswagen Ratings Lowered To ‘A-/A-2’

Volkswagen AG (VW) is facing wide-ranging negative credit consequences following its admission that it installed software designed to manipulate diesel engine exhaust emissions in 11 million vehicles

Standard & Poor’s Ratings Services said that it lowered to ‘A-/A-2’ from ‘A/A-1’ its long- and short-term corporate credit ratings on Germany-based auto manufacturer Volkswagen AG (VW or parent). We also lowered our long- and short-term ratings on VW’s debt instruments.

In addition, we lowered to ‘A-/A-2’ from ‘A/A-1’ our long- and short-term ratings on Volkswagen’s “core” subsidiaries, including captive finance entity Volkswagen Financial Services AG (VW FS) and its subsidiary Volkswagen Bank GmbH (VW Bank). (See “Volkswagen Financial Services Ratings Lowered To ‘A-/A-2’; Still On CreditWatch Negative” and “Volkswagen Bank Ratings Lowered To ‘A-/A-2’; Outlook Negative”.) We also lowered to ‘A-‘ from ‘A’ our long-term issuer credit and financial strength ratings on captive insurer Volkswagen Insurance Co. Ltd.

The long-term ratings on VW remain on CreditWatch with negative implications, where they were placed on Sept. 24, 2015. We have removed all short-term ratings from CreditWatch negative, with the exception of Canada national scale short-term ratings of A-1 (Low) in respect of Volkswagen Canada Inc. and VW Credit Canada Inc., which remain on CreditWatch with negative implications.

The downgrade and continued CreditWatch placement reflect our view that VW continues to face wide-ranging negative credit consequences following its admission that it installed software designed to manipulate diesel engine exhaust emissions in 11 million passenger cars and commercial vehicles and the related global recall of these vehicles.

The downgrade reflects our assessment that VW has demonstrated material deficiencies in its management and governance and general risk management framework. We believe VW’s internal controls have been shown to be inadequate in preventing or identifying alleged illegal behavior in the U.S. and misconduct in other regions. We understand the software was installed in VW vehicles over a period of several years, in a number of vehicle brands and models, and appears to have been intended to deliberately mislead regulators, governments, and consumers. Our assessment of VW’s risk management framework includes our view of VW’s management of its material environmental and social risks. We believe that VW’s breach of U.S. environmental law and potential other laws outside the U.S. represents a significant reputational and financial risk to VW over the medium term. We have revised down our overall assessment of VW’s management and governance to “fair” from “satisfactory”, as such terms are defined in our criteria, which leads us to include a one-notch negative adjustment to our initial analytical assessment (anchor) of VW’s creditworthiness of ‘a’, which is currently unchanged.

We have not yet concluded our full assessment of the potential impact on VW from its actions. We have therefore maintained our negative CreditWatch placement to indicate the possibility that we may lower the long-term ratings on VW by up to two more notches.

Factors that could lead to a downgrade include whether we regard VW’s business prospects or competitive position to have weakened further; and if we expect cash flow generation and leverage metrics to sustainably weaken below adjusted funds from operations to debt of 45% or above adjusted debt to EBITDA of 2.0x.
We recognize, however, that the full facts and consequences of VW’s emissions manipulation may not be known for months, even years.

We expect VW to experience a negative impact on its sales volumes, prices, and margins. We also anticipate that equity accounted profits and dividends from joint-ventures in China will be lower, due to weaker market conditions. VW continues to have substantial capital expenditures, though we anticipate that it will review its spending levels.

Our assessment of VW’s business risk profile is currently unchanged at “strong,” supported by its leading market positions in passenger cars and trucks, with broad product and geographic diversity mainly in Europe and Asia.
VW has well-known brands covering volume, premium, and luxury segments.

Our assessment of VW’s financial risk profile is currently unchanged at “modest,” as we see a degree of headroom in accommodating VW’s announced €6.5 billion provision, with respect to this matter. The costs of remediation, compensation, litigation, and potential fines could, however, be substantial and well in excess of this level. This would constrain VW’s cash flow generation and leverage, albeit likely spread over a number of years.

As of June 30, 2015, our figure for adjusted debt was €32.3 billion. The ratios of funds from operations to adjusted debt and debt to EBITDA for the 12 months ended June 30, 2015 were about 59% and 1.4x, respectively.

We regard the default risk of VW’s captive finance entity VW FS and its subsidiary, VW Bank, as indistinguishable from that of the parent, and as “core” entities under our criteria, such that the parent would support them under any foreseeable circumstances.

We aim to resolve the CreditWatch within 90 days, as indicated in our original placement on Sept. 24, 2015.

We expect that, all other things being equal, we could lower the long-term ratings by up to two more notches. Factors that could lead to a downgrade include whether we regard VW’s business prospects or competitive position to have weakened further; and if we expect cash flow generation and leverage metrics to sustainably weaken below adjusted funds from operations to debt of 45% or above adjusted debt to EBITDA of 2.0x.