FRANKFURT, Aug 3 (Reuters) - Banning diesel vehicles in European cities could threaten the way automakers help to finance car sales with loans, rating agency Moody's warned on Thursday, undermining a technique used to help sell billions of euros worth of cars.
A court ruling last week to pursue bans on diesel cars in the city of Stuttgart could trigger a fall in the second-hand vehicle market used to underpin a system of cheap credit finance, Moody's said.
Car sales have received a fillip in the past decade thanks to financing contracts that enabled customers to make only small monthly payments for cars costing tens of thousands of euros.
At the same time, carmakers shifted the risk of default on these loans to debt investors using asset backed securities (ABS) in a process known as securitisation.
In addition to monthly instalments, most of these car loans include a final "balloon" payment worth up to 60 percent of the vehicle's purchase price.
Car buyers have not been forced to find cash to cover the balloon instalment when a loan matures because they could instead trade in their car to cover the cost.
This system has relied on the value of the vehicle being equivalent to the outstanding amount in payments due.
But the Germany court ruling last week raised the prospect of diesel bans, a step which could lead customers to shun diesel powered vehicles and lead second-hand car values to deteriorate, Moody's warned on Thursday.
Environmentalists have vowed to press ahead with legal action aimed at banning polluting vehicles despite a clean-up plan agreed by German politicians and car bosses.
"If residual values decline, dealers will have difficulty covering residual value losses," Moody's said.
"Consequently, they might not have the financial capacity to fulfil their repurchase obligations and borrowers would be more likely to default on the unexpected obligation to cover the balloon payment themselves."
The warning from Moody's echoes comments from the Bank of England and Britain's financial watchdog about "personal contract purchase" agreements made to fund the buying of cars.
The residual value of a car is also used as a basis for calculating monthly leasing payment rates. A lower residual value would force carmakers to push up monthly instalments, potentially slowing sales and increasing defaults.
"Concrete measures to ban diesel cars in urban areas would significantly cut the cars' attractiveness, leading to declining residual values that would adversely affect the credit quality of German auto ABS," Moody's said in the note.
German auto ABS have shown average cumulative losses of 0.1 percent over the life of the currently outstanding transactions, Moody's explained.
With 15.6 million new car registrations in the past five years in Germany, and 4.1 million auto finance contracts currently securitised, a significant part of the German fleet is affected, the credit rating agency said.
This week German car sales data showed demand for diesel cars fell 12.7 percent in July. Now diesel makes up only 40.5 percent of new car sales in Europe's largest car market, down from 46 percent at the end last year.
Registration figures for 2016 show that Renault sold 45 percent of its new cars with diesel engines, while Daimler's global share of diesel cars was 38 percent.
BMW's overall share of diesel cars was 35 percent and Volkswagen's was 26 percent. (Reporting by Edward Taylor)