Captive finance entities offer automakers an efficient means of offering potential buyers competitive financing options. In some cases, they come under the supervision of local banking regulators. Indeed, the recent reorganization of Volkswagen AG's (VW's) captive finance entities brought more of the group's captive finance entities under the regulatory supervision of the European Central Bank (ECB). Following the reorganization, S&P Global Ratings affirmed its 'BBB+' ratings on the group's European captive finance entities (see "VW's Captive Finance Entities Affirmed At 'BBB+/A-2' After Reorganization; New Entity Rated; Outlook Stable," published July 1, 2024).

Here, S&P Global Ratings answers frequently asked questions from investors about how bank regulation affects the creditworthiness of captive finance entities that are part of automaker groups.

Frequently Asked Questions

Why and how did VW reorganize its captive finance entities, and what were the rating consequences?

VW reorganized its financial services entities in Europe to streamline its regulated and nonregulated captive finance operations. A new nonoperating holding company, Volkswagen Financial Services AG (VWFS Europe), now hosts its European captive finance business and is directly subject to prudential supervision by the ECB on a consolidated basis. Within VWFS Europe, Volkswagen Bank GmbH (VW Bank) is the largest subsidiary and, in turn, owns Volkswagen Leasing GmbH (VW Leasing). VW Bank is also subject to prudential requirements on a consolidated basis.

Our affirmation of the ratings on these entities was based on our view that VW, one of the world's largest auto manufacturers, would support its captive finance entities under any foreseeable circumstances, if needed, particularly considering the size and strategic importance of the markets covered for the VW group.

Do you always equalize the rating on a captive finance entity with that on its parent?

In our view, many, but not all, captive finance entities owned by automakers are core subsidiaries. Where we do consider them to be core to the group, the issuer credit rating (ICR) on the parent provides a floor, but not a cap, to the ICR on the captive finance entity.

Under our group rating methodology, captives typically possess a high degree of strategic importance for automaker groups because they provide financing for the purchase of the group's products. Noncaptive banks often curb the volume of their lending activity when market conditions are volatile, so having access to a closely affiliated provider of customer financing is particularly important at these times. The provision of customer financing through a captive helps to bolster car sales and improve customer loyalty while generating additional earnings at the group level. It also gives the parent strong economic incentives to support the captive and often makes the captive integral to the group's strategy. In many cases, we therefore view the automaker as highly likely to support the captive in any foreseeable circumstances.

In the case of VW Bank, for example, its ability to provide financial services and generate income through related services helps to promote the sale of VW's products, supports VW dealers, and strengthens customer relationships. We expect VW Bank's strategic role to be reinforced over time by the need to promote sales of electric vehicles, which are a clear focus for VW group.

Rating a captive above the ICR on its parent depends on the captive's stand-alone credit profile (SACP), its degree of insulation from parental stress, and whether it is a joint venture that could receive support from higher-rated investors. When a captive is supervised by a banking regulator that requires resolution planning, this can also support a captive being rated above its parent.

Are bank-regulated captives safer?

VW Bank, RCI Banque, Banque Stellantis France (BSF), and FCE Bank PLC are all bank-regulated captives. For each, regulation as a bank limits parental influence by setting minimum capital requirements, funding and liquidity ratios, and limiting direct credit exposure to the parent. The overall effect is usually to increase the degree of insulation from parental stress--that is, a default at the automaker parent would not directly lead to a default at the captive. In addition, most national insolvency laws limit creditors' ability to extend bankruptcy proceedings to a bank-regulated subsidiary from the parent.

We may rate a regulated captive entity above its parent, if we consider that it has a strong enough SACP and that the banking regulations to which it is subject support sufficient insulation from the parent. For example, we rate RCI Banque (BBB-/Stable/A-3) one notch above Renault (BB+/Stable/B). Our rating on FCE Bank PLC (BBB-/Stable) was one notch above that on Ford Motor Co. until October 2023, when we upgraded Ford.

In principle, the same logic would allow us to rate VW Bank one notch above Volkswagen AG (BBB+/Stable) if VW Bank demonstrated greater stand-alone credit strength than VW. VW Bank's SACP is currently 'bbb+', the same level as our rating on its parent.

We may also allow a rating differential for regulated captives that are joint ventures, if we consider there is sufficient support from the captive's non-automaker owner(s).

How can bank resolution planning affect our ratings on an automaker's captives?

In the EU, captive banks of sufficient size may be subject to the authority of the Single Resolution Board (SRB), in addition to prudential supervision by the ECB. The SRB is the eurozone's central resolution authority; its mandate is to ensure the orderly resolution of failing banks, where it is in the public interest to intervene. The SRB requires banks to take steps that would support such an orderly resolution. In particular, each bank must meet a minimum requirement for own funds and eligible liabilities (MREL) that can be written down at the point of resolution to recapitalize it, if the bank were failing.

As captives increase the scope of their business and expand their deposit franchises, we see a possibility that the SRB could earmark some regulated captive banks for resolution planning, making them subject to MREL requirements. If this occurred, the bank would be required to issue subordinated debt as part of its MREL stock. This would provide senior creditors with extraordinary support that could provide some rating uplift. To date, none of the European automotive captives we rate have met the criteria to benefit from this form of extraordinary support.

The closest example is operating leasing company Ayvens, which has been regulated by the ECB as a mixed financial holding company since its acquisition by Société Générale. It is now part of Société Générale's resolution perimeter and is therefore subject to its single-point-of-entry bail-in-led resolution strategy. Ayvens therefore benefits from material prepositioned resources that could be bailed-in if needed. Our rating on Ayvens ultimately benefits from uplift based on additional loss-absorbing capacity (ALAC) at the level of its parent, Société Générale (A/Stable/A-1).

By contrast, we do not expect BSF to benefit from additional extraordinary support as a result of ALAC at the Banco Santander S.A. level. As a joint venture in car finance, BSF's strategic importance and materiality within the Banco Santander group will remain limited, in our view, especially in a resolution scenario. Therefore, we consider the extent to which bail-inable instruments issued by its ultimate parent could protect BSF's senior debtholders to be less predictable.

What could the bank resolution planning mean for VW Bank?

Given that VW Bank's activities have grown significantly as a result of the reorganization, we understand that the SRB will reassess the potential public interest in preparing the new mixed financial group for resolution. We anticipate that the SRB's reassessment will be concluded by mid-2025.

If SRB opts to make VW Bank subject to resolution planning, the bank would be required to issue additional subordinated debt, in the form of Tier 2 capital and senior nonpreferred debt, to create a buffer of MREL-eligible debt. We would consider the ramp up of this issuance and assess the extent to which it provides sustainable protection to senior preferred creditors. In any case, we would look at both ALAC and group support, to assess which had the stronger capacity to offer extraordinary support, when assigning rating uplift.

How do senior preferred and senior nonpreferred debt instruments differ?

Senior nonpreferred debt is explicitly earmarked to absorb losses as part of a resolution process, without triggering a default of the company. These subordinated debt instruments are eligible to be included in both MREL buffers and our ALAC buffer. We typically rate this debt type one notch below the SACP. If we expect group support to flow before any resolution action, we rate this debt type one notch below the group-supported issuer credit rating.

Senior preferred debt is a pure funding instrument that we rate at the same level as the issuer itself. It is not eligible to be included in MREL or ALAC buffers. Legally, this type of debt can also be bailed-in, but so far we have not observed it being used as part of resolution actions.

Table 1

Related Criteria

• Group Rating Methodology, July 1, 2019
• Financial Institutions Rating Methodology, Dec. 9, 2021

Related Research

• VW's Captive Finance Entities Affirmed At 'BBB+/A-2' After Reorganization; New Entity Rated; Outlook Stable, July 1, 2024
• Credit FAQ: A Closer Look At Insulated Entities In Financial Services, July 18, 2023