S&P Plances Volkswagen AG (VLKAY) Ratings on CreditWatch Negative

(Updated - September 24, 2015 8:29 AM EDT)

Standard & Poor's Ratings Services said it placed its 'A/A-1' long- and short-term corporate credit ratings on Germany-based auto manufacturer Volkswagen AG (VW)(OTC: VLKAY) on CreditWatch with negative implications. We also placed our long-and short-term ratings on VW's debt instruments on CreditWatch with negative implications.

In addition, we placed our 'A/A-1' long- and short-term ratings on Volkswagen's "core" subsidiaries, captive finance entity Volkswagen Financial Services AG (VW FS), its subsidiary Volkswagen Bank GmbH, and finance subsidiary Volkswagen Group Services S.A. We also placed on CreditWatch with negative implications our 'A' long-term issuer credit and financial strength ratings on captive insurer Volkswagen Insurance Co. Ltd.

The CreditWatch placement follow's VW's announcement that it will take a €6.5 billion charge to third-quarter results to cover the costs of a global recall of 11 million vehicles which show discrepancies between diesel test results and actual road use. This follows an announcement by the U.S. Environmental Protection Agency (EPA) that VW had violated U.S. environmental laws in relation to 482,000 diesel cars sold in the U.S. during 2009-2015.

VW appears to have installed software designed to manipulate the level of emissions and, at least in the U.S., circumvent emissions regulations.

We expect VW to incur substantial remediation costs to correct the engines of the cars affected and potentially face material fines from regulators. Criminal charges in the U.S. may also follow. We expect the group's leverage metrics to be constrained by this charge, and for cash flow to reduce as these expenses are incurred. Although VW's adjusted credit metrics currently have a degree of headroom to accommodate such remediation costs, we see the risk that fines from regulators and other authorities, could lead to costs exceeding the €6.5 billion charge the company currently has in place. We will also assess the impact on VW's liquidity, which stood at €27.7 billion of cash and marketable securities on June 30, 2015.

There is a risk that this recall may significantly affect VW's reputation, thus weakening the group's operational performance, due to lower volumes or additional costs. The resignation of the CEO indicates that there could be a weaker management, governance and risk framework than we had expected. We note positively that the company is taking further steps and is cooperating with the relevant authorities.

This incident could also indicate a wider industry problem, if other manufacturers have followed similar practices, and it may lead to tougher industry-wide regulations and requirements for diesel engines.

As of June 30, 2015, our figure for adjusted debt was €32.3 billion. The ratios of funds from operations to adjusted debt and debt to EBITDA for the 12 months ended June 30, 2015 were about 59% and 1.4x, respectively.

We will resolve the CreditWatch within 90 days, once we have assessed the potential impact on the group's leverage metrics, future profitability, cash flow, business prospects and governance.

We may lower the ratings by one notch, if we expect leverage metrics to weaken below adjusted funds from operations to debt of 45% and adjusted debt to EBITDA of 2.0x. We may lower the ratings by more than one notch, if we conclude that VW's business prospects have also weakened.

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