Credit: Shutterstock.com Aerial view new cars parking for sale stock lot row.

Fitch Ratings has highlighted increased market value risk in UK auto loan agreements due to over-inflated contractual residual values (RVs).

According to a new report, these RVs were inflated during high used car prices, leaving them exposed as prices correct rapidly.

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The agency’s analysis of 15 UK auto asset-backed securities (ABS) transactions reveals a significant rise in RVs as a percentage of purchase prices since 2020. Higher sale prices during this period led to a substantial increase in the cash balance of contractual RVs.

However, used car prices in the UK are now adjusting more swiftly than anticipated. A three-year-old used car currently holds about 51.7% of its list price on average, a decline of almost 15 percentage points from a year ago.

This sharp drop heightens the risk of borrowers entering negative equity if their loan agreements included over-inflated RVs. This situation could result in more RV and voluntary termination (VT) handbacks and lower sale proceeds from returned vehicles.

The report notes that used electric vehicle (EV) prices have decreased more rapidly than the broader market. This is due to fleet demand for new EVs outstripping private demand for used EVs, making loans financing EVs more susceptible to RV and VT losses. Contractual RVs often do not fully account for these additional risks.

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Despite these challenges, Fitch has not significantly altered its recovery rate assumptions for rated UK ABS transactions. The agency expects the trend of declining recoveries to be temporary and believes that lower original loan-to-values (OLTVs) from the peak period of car prices should provide some buffer against reduced sales proceeds.

Fitch continues to review recovery assumptions for new ratings and monitors existing deals. The agency assesses the concentration of loans with RVs considered inflated relative to medium-term used car price expectations.