By Richard Coe, managing director of Albany Business Consulting

Currently, residual value (RV) guidance from the current data suppliers is based on a similar methodology to internal combustion engine (ICE) vehicles.

This includes: manufacturer perceived quality, including design/appearance; cost; historic value comparison and auction/trade prices; period, calenderisation, annual, plate change periods and mileage; functionality and economy; driver infotainment; and warranty.

In earlier times the cost and availability of parts also played a part.

Electric vehicles (EVs) have features which are very different and require a more basic approach which possibly is less subjective and very much more financially driven.

The main points to be accounted for are:

1. Cost. It is certain that EV pricing will fall in the near future and the volume will centre on cars being smaller and generally cheaper. This points to funders needing to take a much more bearish view on larger luxurious models.
2. The life and warranty period of the batteries.
3. Battery range indicated by the capacity (kWh).
4. Cost of replacement batteries. Production costs currently are said to be about $100 (£76) per kWh, naturally the replacement charges will be much higher.
5. Mileage, this sensitivity is reduced but with regard to the battery warranty it is more important.
6. Reduced complexity of drive train, no gears less usage of brakes (more tyre wear).
7. Driver infotainment

In considering the differences the major points are the cost of acquisition, currently considerably higher than ICE models and the finite life of the battery.

The replacement costs of batteries is currently prohibitive with, potentially, a cost of disposal at end of useful life. An added cost complication most to likely occur is in the used market. A ‘Battery Condition’ certificate maybe required or advisable for the buyer this costing about £500.

The process of forecasting the future values of ICE and EV vehicles must differ due the length of the usable life of the asset dictated by the battery life and the warranty conditions.

Looking back at the early days of vehicle leasing and contract hire the provider of the lease took the responsibility for the future value simply based on time and mileage. This reflecting average usage and vehicle second hand values.

Leases of plant and machinery had an asset life more easily recognised and that period was funded with a terminal value readily determined.

Some assets had difficult end of life situations and their disposal costs were so high that this was factored into the lease payments.

These leases had negative residual values, something which could perhaps happen with the disposal of large battery packs.

Where a lease could possibly end with more value in the asset, as its life was far from completed, the lessor would offer a lease continuation at a peppercorn rental.

When cars entered the leasing world the desire for a driver to want to change to the latest model rather spoiled the lease extension as a way of managing residual losses.

Any loss for the funder would only be crystallised upon disposal and therefore a second lease could give the lessor more time to write down the asset and avoid a loss.

The extension or re-contracting a lease is very dependent on the vehicle having sufficient useful life to be operated economically.

The main funders for contract hire and lease providers had guidelines copied from the early asset leasing of plant and machinery; this was crudely based upon the residual value of the asset being a percentage of the cost upon acquisition.

While some had complex tables the main commonly used numbers were on two years, 50% of cost, and three years 40% of cost.

In the management of risk over the years these simple numbers have proved themselves to be a useful indicator.

The argument is that EV’s are more akin to plant and machinery. They have a very expensive component, the battery, which potentially creates a finite useful life.

Moreover the battery is generally only warranted for eight years and while it probably lasts for longer it will have lost 25% of its efficiency in that time. Some OEMs such as Kia have lower warranty periods.

So the value of a vehicle that has a range of 200 miles when new will, at eight years old, be capable of about 150 miles and should there be any problems with the battery the vehicle will be worthless.

Therefore the second hand buyer is going to approach the eight-year-old vehicle with caution and will not want to risk any substantial amount in the purchase. At this stage will these vehicles be financeable?

As the cost of the EV is more than the ICE vehicle they replace this is an added burden on the consumer and the finance house providing the funding.

Currently, the average car in the UK is about 12 years old, there are about 24 million used cars over seven years old. It is difficult to envisage the same numbers as EVs become the only replacements of the old ICE, certainly with the present level of technology.

Battery warranty is generally for eight years/100,000 miles whichever is soonest.

Kia have only a seven-year time period warranty (definitely an argument to reduce the FRV).

A number of the manufacturers consider it not claimable if the battery has 70% of its original efficiency.

Dacia have a 63% level before it is unacceptable. This would reduce the range from 200 miles to just 120 miles.

Toyota on the other hand have a 10-year/620,000 miles showing confidence in their product.

BYD claim that their ‘Blade Battery’ (Lithium Iron Phosphate) has superior life but again the warranty period is only eight years/100,000 miles.

Consideration by the manufacturer should or could be made to having a ‘buy back’ number at the end of the warranty period. This would provide the funder with some certainty albeit within limits of usage.

Mileage and the warranty impact 

A vehicle doing high mileage in its first lease period has little warranty left for future owner/users.

As most have 100,000 miles limit within the warranty period it is very possible to have this mileage reached well before the end of eight yeares.

In creating the lease contract having a FRV based on the customers projected usage the ‘Excess Mileage’ charge becomes very important. The charge needs to ensure that the loss of period under warranty is covered.

How residual values on EVs could be calculated

A table of percentages based upon range which is reflected in the battery’s rated capacity in kWh. This table applying a higher percentage to the higher kWh rating thereby increasing the residual value for vehicles with the greatest usable range.

This could start with very low capacity batteries being given say a 30% of cost FRV at three years and a banded table increasing this percentage on the highest kWh ratings to say 40%.

The term ‘Cost’ would be the list price issued by the manufacturer. Should the manufacturer offer a discount or incentive in order to reduce the transaction price (a form of price reduction) then the percentage reduction should also be applied to the RV.

Manufacturer pricing is going to be important. For instance the Abarth 500e is priced at almost £39,000 which ensures an extremely high rate of depreciation.

The seasonality or calenderisation currently used should not change any forecasts on future values calculated using the above method.

Insurance

Whilst not directly impacting the financial risk to funders the insurance rates for EV’s are above ICE equivalents.

The lack of ability to repair accident damaged cars leads to a much greater percentage of ‘write offs’.

This is in part due to the heavier weight of the car but also the inability of repairers to handle the construction differences.

It is interesting to reflect that in the 1990’s Royal Insurance the insurers for the Motability account introduced an excess for accident repairs of £150 which was not payable if the car was subject to being ‘written off’.

Not surprisingly the number of ‘write offs’ increased sharply as the user ensured the damage was sufficient for them to avoid paying the excess. Could an EV owner facing financial loss be tempted to create the same situation?

Summary

EV funding is going to be a major factor in the switch from ICE vehicles.

The average customer will find the added cost and the uncertain second hand values drives them into a lease of some description.

PCP, PCH, subscription or contract hire so that they avoid the residual value risk.

Whilst ICE vehicles are a known asset class and have extensive historical data regarding valuations EV’s present a different problem.

ICE vehicles’ usable life span with multiple options in extending these lives give finance providers security in the funding offers they make as this longer ‘actual life’ supports the higher future values.

Vehicle funding is a massive business and with a seismic shift upwards in acquisition costs of EV’s the amounts that are required to fund the switch will also be increased significantly.                                                                

Having a vehicle with a finite life due to the degeneration of the efficiency of batteries is going to require serious financial planning by funders. 

A recognisable methodology in calculating future residual values similar to that described above is surely required to reduce the very real danger of financial damage to the funding providers.

The danger of leaving the RV risk to be subject to the impact of ‘competition’, subjectivity and indiscipline will undoubtedly lead to financial problems.

The current situation with technology and user perception will over time change with batteries that either have extended life cycles or are ‘maintained and repaired’.

The cost of EV’s will without doubt fall over the next two to three years. This will then create an asset life similar to the ICE vehicles and the danger to funders regarding future values will decrease.

However, we are not at this stage yet and caution is needed and amongst the funding industry, the debate is seriously required.