Fitch Ratings-London/Frankfurt am Main-10 September 2021: The latest European Court of Justice (ECJ) ruling on consumer rights in German loan agreements heightens legal uncertainty regarding information that needs to be included in contracts, Fitch Ratings says. Implications for Fitch-rated German auto ABS transactions have been limited so far, but it remains important to monitor the impact on borrower behaviour and how far this increases exposure to originator creditworthiness, as well as developments in deal documentation.
Several, sometimes conflicting ECJ and German court rulings have led to legal uncertainty on how auto loan contracts should be drawn up to comply with applicable consumer protection legislation. On 9 September the ECJ found mandatory information to be missing from applicable German loan documentation. It also found limitations in arguments used by lenders to counter borrowers’ attempts to revoke contracts.
Earlier ECJ rulings had established that a consumer’s right to withdraw from a credit agreement is only limited to the 14 days following conclusion of the agreement if they were given “clear and concise” information on when and how they could withdraw, and that the applicability of the Consumer Credit Directive meant that auto loan agreements referencing the German civil code did not do this. Where loan agreements are found not to have met this standard, the borrower can exercise revocation rights at any point in the lifetime of the loan.
In practice, risks to ABS deals arising from this persistent uncertainty have been limited, with no significant impact on transaction performance or cash flows. If a borrower chooses to revoke the loan, the purchase agreement is also unwound and the vehicle must be returned. However, relatively few borrowers have taken advantage of this provision (some owners of diesel vehicles that do not comply with emissions regulations have done so).
Moreover, in many cases losses in the car value have been largely offset by the requirement that the borrower pays the originator for the use of the vehicle before revocation. There is an ongoing legal debate on the scope of such payments, highlighted in the ECJ’s 9 September judgment, which found that it is for the national courts to determine the applicable law and for member states to take steps “to ensure credit suppliers do not suffer a financial loss”. If enforceability of these payments became uncertain, losses could substantially increase, as would the borrowers’ incentive to revoke as they would have used the car for free.
Where revocation does cause a loss to the ABS transaction, the seller/originator usually has to reimburse the issuing SPV. This negates any impact on the transaction, but could increase credit risk from exposure to the originator if revocation became much more widespread.
Legal uncertainty also has implications for asset eligibility, as ABS documentation typically states that no loans with active revocation rights can be included in transactions. If revocation rights were shown unambiguously to persist over the life of a loan agreement, originators could have to repurchase entire portfolios at considerable cost.
Some originators have been adapting their documentation in both new and existing transactions in anticipation of this eventuality, to narrow the scope of their repurchase obligations, for example saying these would only apply in cases of “successful revocation”. While this should limit the risk to the originator, the potential for changes in transaction documentation that might allow originators to sidestep loan repurchase or other obligations to the issuing SPV will be important to monitor.
Fitch will remain alert to trends in rulings, borrower behaviour and developments in transaction documentation, and originators’ adaptation of loan contracts to evolving regulation as part of its German auto ABS analysis.
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Markus Papenroth, CFA
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