LONDON/FRANKFURT (Reuters) - A plunge in sales of diesel cars in Europe's two biggest markets is helping to drive down the value of used vehicles, posing a risk to the lucrative financing plans used by major automakers to sell millions of cars. Graphic: tmsnrt.rs/2qzZUEz

FILE PHOTO: A diesel pump is seen at a privately operated fuel station in Gasse near Lake Tegernsee, January 9, 2015. REUTERS/Michael Dalder/File Photo

After Volkswagen's VOWG_p.DE emissions test cheating scandal, authorities across Europe are looking to raise taxes on diesel vehicles that are more polluting than originally thought, and ban or restrict their use in some cities.

That is starting to hit demand hard, with new diesel car registrations in April dropping 19 percent in Germany and 27 percent in Britain, according to data this week. This is turn is beginning to weigh on used car prices.

With regulators also looking to encourage a shift to cleaner vehicles, there seems little prospect of a recovery soon.

The outlook is particularly uncertain in Britain, where car sales hit a record high last year fueled by finance packages that now account for nearly 90 percent of sales versus around a half ten years ago, according to Exane BNP Paribas analysts.

Under the “personal contract plans,” customers pay a small deposit toward a new car and then make monthly payments for two to three years. After that, they can either buy the car outright or return it to be sold second hand and use the equity to take on a new car, beginning the cycle of monthly payments again.

How much they can borrow depends on what the finance company believes the vehicle will be worth after the 24 or 36-month period. If residual values fall more than expected, customers will have less money to buy a new car - potentially hitting demand for all new vehicles, petrol as well as diesel.

“It’s a big potential problem if that carries on because it reduces the affordability of vehicles potentially quite significantly,” said Exane BNP Paribas analyst Stuart Pearson.

“The question is how fast those residuals go down. In the U.S. we’ve seen them come down almost 20 percent now, so the UK may have only just begun.”

SLIDING VALUES

The United States has seen a sharp fall in residual values in recent years as demand - which recovered much more quickly than in Europe in the wake of the financial crisis - has stalled and automakers have slashed prices to try to shore it up.

A similar fall in Europe would hit carmakers that have become increasingly reliant on their financing businesses. Operating profit at Volkswagen Financial Services leapt 10 percent to 2.1 billion euros ($2.3 billion) last year, compared with group underlying operating profit of 14.6 billion euros.

Residual values in Britain have fallen around 3 percent over the past two years, with diesel vehicles particularly affected, and the trend has been seen in other European countries too, according to some analysts.

Leasing and finance contracts are both generally priced using an assumption of stable residual values. A sharp fall in used car prices could trigger a spike in leasing prices, which could further dampen demand and increase defaults.

According to Evercore ISI analysts, the cost for eight major European and U.S. carmakers of a 5 percent cut in residual values in Europe could reach a combined 1.6 billion euros.

The big three German carmakers would suffer the most, with Volkswagen taking a hit of more than 500 million euros to earnings, followed by BMW BMWG.DE and Daimler DAIGn.DE.

BMW said on Wednesday it expected a small fall in return on equity in its financial services business this year, although it would remain above its target of 18 percent.

Concerns about the way finance packages are sold have also prompted Britain’s Financial Conduct Authority to conduct a review, warning there may be a “lack of transparency, potential conflicts of interest and irresponsible lending.”

British consumer borrowing late last year expanded at its fastest annual rate in 11 years.

But Graham Hill, car finance expert at the National Association of Commercial Finance Brokers, said firms were able to adjust to falling residual values and many would have factored in a potential big fall.

A car with an expected final payment of 10,000 pounds ($12,900) from the customer might, for example, be put into the finance provider’s books at 9,000 pounds, he said.

“They’re not naive enough to think that there are things which are going to happen from time to time.”