Auto loans extended to buy battery electric vehicles will continue account for a small proportion of underlying loans backing Japanese auto loan asset-backed securities for now.

An increase in the ratio of loans to be included in underlying assets could occur if sales of battery electric vehicles increase. If this happens, we will take into account the impact on the creditworthiness of residual-value loans and changes in obligors' attributes in our loan-loss assumptions.

Why it matters:   We would expect more battery electric vehicle loans in underlying pools of asset-backed securities (ABS) could affect creditworthiness. The residual value of battery electric vehicles declines faster than internal combustion engine vehicles and hybrids. Plug-in hybrid vehicles' residual value moves mostly in tandem with internal combustion engines and other hybrids. Battery electric vehicles' residual value is lower and falls faster because of:

• The limited number of battery electric vehicles in the used car market,
• Uncertainties over battery life and obsolescence,
• Ineligibility for subsidies for used cars, and
• A lack of charging stations and other infrastructure for electric vehicles (EVs).

Here, we consider EVs to be both battery electric vehicles and plug-in hybrids. Such vehicles account for about 3% of new car sales in Japan (see chart 1). There is still a long way to go to achieve the government's target of 20%-30% of all new car sales by 2030. EVs have become more widespread under targets set by governments in various countries. However, this may not last. We have seen some signs in Europe, for example, of decreasing sales as subsidies are discontinued leading major automakers to rethink EV sales forecasts and consider factory closures.

Chart 1

EV Sales Running Cold In Japan

There is still a long way to go to realize the government's target for 2030 of EVs comprising 20%-30% of all new car sales. EVs in Japan account for about 3% of all new sales, an increase of 1 percentage point over five years. The Japanese government has set a target for 2035 of 100% of new car sales to be hybrid, plug-in hybrid, EVs, or fuel cell vehicles. Sales of hybrids have been steadily growing, exceeding 100,000 units per month since 2023, and accounting for 50%-60% of all new car sales.

Although the global shift to EVs is ongoing, signs of change are afoot.   Governments in the major EV markets of China, the EU, and the U.S. have targets for EV sales growth (see table 1). Their targets differ from Japan's as they do not include hybrids. Many major overseas countries aim to increase the proportion of battery electric vehicles, plug-in hybrids, and fuel cell vehicles in new car sales to over 50% by 2035.

Table 1

Automakers and governments are accelerating popularization of EVs for the sake of achieving targets.   They are doing so, for example, by enhancing production systems and through government support measures, such as subsidies. However, we have observed some changes, mainly in the EU. Discontinuation of subsidies for the purchase of battery electric vehicles has weakened sales. Some major automakers have announced modifications in their production systems, revisions of sales targets for battery electric vehicles and possible closures of factories.

We expect the global shift to EVs to continue, even though there will be some ups and downs.   We assume that EVs will occupy 19%-20% of new car sales in 2025, and 45%-50% in 2030 (see table 2).

Table 2

The Price And Charging Stations Are Hurdles

Japanese consumers are being driven away from battery electric vehicles by high prices and scarcity of charging stations. However, people are becoming more aware of them. We believe charging stations will likely remain a high hurdle: The number of chargers needs to quintuple in about five years.

According to the Japan Automobile Manufacturers Assn. Inc.'s survey on passenger vehicle market trends for fiscal 2023 (ended March 31, 2024), more than 60% of respondents have an awareness of battery electric vehicles. This recognition rate is on par with that of hybrids. But the proportion of respondents with at least some aim to buy a battery electric vehicle was 28%, compared with 45% for hybrids. This figure for battery electric vehicles has remained mostly unchanged since 2019. Survey results indicate why consumers don't have much of a yen for next-generation vehicles. The most common concern is that EVs are too expensive, according to 59% of respondents. This is followed by the short mileage per charge and the long time required for charging.

Consumers are willing to pay more, but not enough to drive EV proliferation, in our view.   The survey also found consumers would be willing to pay an average of an additional ¥250,000 for a next-generation vehicle. Central and local government subsidies mitigate payment burdens for buying new battery electric vehicles. Even with subsidies, the added costs of buying a battery electric vehicle are highly likely to exceed the amount would-be buyers can tolerate compared with purchasing a car with an internal combustion engine. We consider this additional expense interrupts the spread of EVs.

Chargers rolling out, but need to spread faster, in our view.  The number of chargers increased to about 31,800 as of July 31, 2024. There are about 21,400 regular chargers and about 10,400 fast chargers (see chart 2). The government targets installing 150,000 chargers by 2030, including 30,000 fast chargers for public use. The number of chargers needs to be increased fivefold in about five years to make the target. Survey results also showed increasing power output to reduce charging time and installing efficient chargers by applying subsidies are key to increasing EV sales.

Chart 2

Battery Electric Vehicles Lose Value Faster

The residual value of battery electric vehicles is drastically lower than vehicles with internal combustion engines, in our view.   Using the price of a new car as 100%, battery electric vehicles have a residual value about 20 percentage points lower than internal combustion engine cars. Hybrids, though, are basically on par with traditionally fueled vehicles.

We expect prices of used battery electric vehicles to remain less stable.   With conventional vehicles, consumers have the option of buying a used car if a new one is too expensive. They can also consider future value. The limited variety of models, small number of cars in the market, uncertain degree of battery obsolescence, and possible deterioration of functionality due to technological innovation mean this is not the case for battery electric vehicles.

Chart 3

Hybrids have a lower residual value with increasing elapse of time, but the declining pattern is similar to that for vehicles with internal combustion engines.   The residual value of internal combustion engine vehicles falls to 90% after one year, 58% after five years, 31% after 10 years, and to its nadir in about 13 years.

Residual values for other types of vehicle are only for reference at this point, in our opinion.   This is because of the modest number of models and infrastructure, and small sample sizes. Battery engine vehicles have a residual value of 72% after one year, 18 percentage points lower than conventionally fueled vehicles. Residual value falls to 36% after five years and 10% after eight years, which is almost the lowest limit, although it can be regarded as a reference value as the amount of sample data becomes more limited as time elapses. The residual value of plug-in hybrids falls to 89% after one year, and 59% after five years. And the residual value of fuel cell vehicles falls further still.

In analyzing the residual value of battery electric vehicles, we note the number of battery electric vehicles in the used-car market is low.   Even so, we observed a difference in residual values between even newer vehicles when the number of vehicles in the used-car market is relatively sufficient. We consider the reasons and outlook as follows (see table 3).

Table 3

More Battery Electric Vehicles Will Affect Assumptions On ABS Transactions

Greater popularization of battery electric vehicles will affect our assumptions. Lending for battery electric vehicle purchases account for only a small proportion of the auto loan ABS transactions we rate in Japan. If the proportion increases due to the spread of battery electric vehicles, we will consider the impact of residual value loans on creditworthiness and changes in obligors' attributes in our loan loss assumptions.

Residual value of battery electric vehicles

The 'AAA' stress scenarios in auto loan ABS transactions we rate do not incorporate recoveries from defaulted loans. In such transactions, the larger rate of decline in residual value of battery electric vehicles compared with internal combustion engine vehicles does not have a direct impact on our analysis of transactions from the viewpoint of the recovery rate.

Rated auto loan ABS transactions backed by auto loans with balloon payments have a stress scenario that does not incorporate assumptions the auto loans will be repaid by returning automobiles at the final maturity. This means that the 'AAA' stress scenario sees obligors' ability to repay loans with their own funds as an issue of credit risk rather than the risk that the price of vehicle falls below lenders' assumptions (residual risk).

Accordingly, an increase in auto loans for battery electric vehicle purchases is unlikely to affect such transactions directly from a residual value perspective. In making assumptions for credit risk, or more specifically, the default rate of the underlying asset pool, we will consider various factors including whether the residual amount of loans can be repaid by sales proceeds, given the possibility that obligors repay loans using the proceeds of sales of their automobiles in the used car market.

Considering that, when analyzing credit risk, we may incorporate battery electric vehicles' residual values and the remaining amounts of loans at final maturity (the level of residual amount for loans).

Generally, ABS transactions backed by auto lease receivables are based on the assumption that the obligor will return the vehicle when a contract is terminated. Some transactions have structures where returned vehicles are sold in the used car market, and sales proceeds are applied to redemption of the rated ABS transactions. In such cases, a large decline in the prices of vehicles may lead to a loss in the rated transactions.

We incorporate residual risk in our analysis of such transactions. For transactions backed by an asset pool that consists of a large proportion of lease receivables of unstable value of used cars, such as battery electric vehicles, we may additionally trim prices of vehicles based on our auto ABS criteria (see "Global Auto ABS Methodology And Assumptions", July 26, 2024)

Attributes of battery electric vehicle obligors

We may incorporate changes in obligors' attributes in our analysis of transactions if the attributes of buyers of battery electric vehicles are different from those of internal combustion engine vehicles. The Japan Automobile Manufacturers Assn.'s survey on passenger vehicle market trends for fiscal 2023 includes a study on attributes of obligors considering a battery electric vehicle purchase.

We selected respondents (for households with four-wheel vehicles) who would "consider" or "maybe consider" buying a battery electric vehicle when asked if they intended to buy a next-generation vehicle. Then we extracted the attributes of the highest proportion in each category (life stage, gender and age, models they intend to buy next, and prices of vehicles they intend to buy next). We examined how an increase of obligors with each attribute in the underlying asset pool would affect the default rate assumption.

The survey shows the typical respondents considering a battery electric vehicle purchase would "are unmarried or have young family" and "male in their 30's." Regarding the vehicle, they are considering purchases of "station wagons" at a cost of "¥4 million or more." The portion of respondents considering a battery electric vehicle purchase is 28% on average, and respondents with those attributes is about 10 percentage points higher than the average.

We consider the default rate may rise if the proportion of younger obligors increases, based on our assumption wages generally increase with age. In addition, we consider an increase in the amount of auto loans to purchase battery electric vehicles could raise the default rate, given that they are more expensive than internal combustion engine vehicles. Nevertheless, we will make an assumption of the default rate of the underlying asset pool taking into consideration various factors holistically, such as originators' loan strategies and recovery policies and historical loan performance, in addition to changes in obligors' attributes.

Related Criteria

• Global Auto ABS Methodology And Assumptions, July 26, 2024

Related Research

• Global Auto Outlook: More Players, Less Profit, Oct. 9, 2024
• Japan Structured Finance Midyear Outlook: 2024 Issuance Will Likely Rise To ¥7 trillion, July 31, 2024
• Japan Auto Loan ABS Performance Watch: Prepayments Stay Elevated, July 25, 2024