At a crossroads: European automotive borrowers in the face of change and the effects of events in Ukraine | White & Case srl

Vehicle sales have rebounded strongly from the shutdowns, but European automakers face a period of significant change as governments phase out combustion engines, supply chain constraints bite and the impacts of events in Ukraine are felt

Automotive leveraged finance issuance in Europe has proven robust over the past two years, with issuers finding the market favorable to the industry through lockdowns and keen to fund its post-pandemic recovery.

Automotive leveraged loan issuance in Western and Southern Europe reached its two highest annual totals on record in 2020 and 2021, with the issuance of US$23.9 billion and US$21.7 billion, respectively. High yield activity in the European sector also held up well, with US$12 billion issued in 2020 and US$9.6 billion in 2021representing the second and third best annual totals on By debts disk.

Global issue in value 2015 – 2021

Device type: High yield bonds and leveraged loans Use of profits: All
Location: Western and Southern Europe Sectors: Automotive

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Despite the strong appetite for auto debt over the past 24 months, the industry entered 2022 in a state of flux.

Car sales, which have rebounded as economies around the world reopened, are expected to rise 7.5% in 2022, according to the Economist Intelligence Unit (EIU), topping 2019 levels. supply and a shortage of semiconductors, a critical automotive component, however, has put the industry under extreme pressure to meet this demand. Still, the first two months of 2022 have been better than expected.

Events in Ukraine have significantly affected the automotive industry. Supply chains have been affected as Ukraine is a hub for wire harnesses. This has already had a particular impact on European automakers, some of which have announced temporary production halts. Additionally, sanctions against Russia, an export hub, will most likely lead to higher commodity prices and could even lead to commodity shortages.

In addition to immediate supply chain headwinds and raw material risks, the industry is grappling with ambitious government timetables to phase out combustion engine manufacturing within the next 10 to 15 years and move to electric vehicles.

Electrification: Winners and losers

The general transition will benefit some manufacturers and suppliers more than others. According to the EIU, global electric car sales are expected to significantly outpace overall vehicle sales, with an expected 51% growth.

Manufacturers focused exclusively on electric cars, such as Tesla and startup Rivian, have directly benefited from this increase in sales – at times last year their stock prices exceeded those of much larger incumbent automakers.

However, for automakers that still produce combustion engine vehicles, the transition to producing all-electric cars poses significant challenges.

Speaking at a Reuters Next conference in late 2021, Carlos Tavares, CEO of Stellantis – the European car giant formed in 2021 following a $50 billion merger between PSA, owner of Peugeot and Vauxhall, and Fiat Chrysler – warned that the accelerated switch to electric vehicles would impose significantly higher costs on automakers and jeopardize their financial viability.

Stellantis has already planned 30 billion euros of investment by 2025 to develop its electric vehicle capabilities and expects 70% of European sales and 40% of US sales to be low-emission cars by the end of the year. decade. Despite this activity, however, Tavares warned that the pace and cost of the electric vehicle transition demanded by governments and regulators could be too much for the industry to bear.

Electric vehicles are already more expensive to manufacture, with Tavares pushing the extra costs up to 50%. This additional cost is too great to pass on to consumers and will likely lead automakers to sell fewer more expensive electric cars or cut margins dramatically. Either scenario could result in job losses and cutbacks. The costs of retooling production lines and increasing productivity will push the industry to its limits.

The financial pressures associated with this transition could affect the credit quality of automakers, as well as the cost and availability of debt financing. The impact on automotive supply chains could be felt even more deeply, with the market bifurcating between component suppliers who will benefit or not be affected by the shift to electric cars and those who will suffer its negative effects. Suppliers of chips, batteries and vehicle interiors, for example, should find debt markets open and attractive, but suppliers in areas such as powertrain components used only in gasoline and diesel engines are already finding it more difficult to obtain loan capital.

Events in Ukraine and the sanctions imposed on Russia could significantly affect this forecast, as Russia is an important source of certain raw materials needed for the production of batteries and chips. Sanctions on Russia could worsen the chip shortage crisis and affect the supply chain more generally. With key raw materials appearing more relevant for electric cars and their associated batteries, the transition to electric cars may even slow down. It remains to be seen whether this result is offset by the effect of the rise in oil prices, which makes electric cars more attractive.

Generally, the effects of events in Ukraine are more relevant to the European automotive sector than to US-based companies. Within the European automotive sector, it is likely that suppliers will, in general, be harder hit than OEMs. We expect the resulting uncertainties and risks to be factored into the debt terms of auto companies exposed to these risk areas.

Integration of ESG criteria

Affected supply chains and the transition to electric vehicles are not the only challenges facing the industry. Automakers are also working hard to improve their environmental, social and governance (ESG) status, which adds both opportunities and challenges for the industry.

Over the past 12-24 months, for example, several car manufacturers and suppliers have secured ESG-linked financing that reduces financing costs if pre-agreed ESG criteria are met.

At the end of 2021, German automotive group Volkswagen secured its first-ever sustainability-linked loan, raising a three-year €1.8 billion loan where interest payments will be tied to targets for reducing its carbon emissions. CO2 fleet emissions.

Earlier in 2021, French automotive supplier Valeo became the first European automotive supplier to raise a sustainability bond, securing 700 million euros with a seven-year maturity linked to reducing carbon emissions, while Faurecia, the French automotive technology company, has raised the largest ever ESG-related Schuldschein facilitated by an issuer outside of Germany. Many other issuers, including Volvo and Spanish component supplier CIE, have also successfully tapped ESG-related credit lines.

The industry’s over-eagerness to present ESG credentials to the market and the potential for greenwashing, however, pose risks to the long-term viability of providing ESG-linked debt to auto borrowers.

The reputational risk to borrowers and lenders if ESG targets are not met is significant and there is still work to be done to tighten KPIs for ESG in automotive. ESG KPIs and performance will need to extend beyond vehicle electrification exclusively and incorporate other relevant KPIs to show that automotive ESG claims are credible.

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