S&P Global Ratings expects the assets underlying residential mortgage-backed securities (RMBS), asset-backed securities (ABS), and commercial mortgage-backed securities (CMBS)--the asset classes we consider to be representative of Japan's securitization market--to continue performing steadily in 2019. In this report, we discuss our views on the performance outlooks for Japanese RMBS, ABS, and CMBS deals in 2019.

Table 1

Japan Macroeconomic Scenario

Continued moderate growth in 2019

Growth in Japan's economy is one of the key factors shaping our performance outlook for Japanese securitizations in 2019. We forecast Japan's real GDP will grow 1.1% in 2019 (see Credit Conditions Asia-Pacific: Cold Wind Blowing, Nov. 29, 2018). We expect Japan's economy to continue growing moderately in 2019 despite the decline in real GDP logged in the July-September quarter of 2018, which was attributable in part to natural disasters. Although we consider U.S.-China trade friction a potential risk factor for 2019, we expect major macroeconomic indicators, including policy interest rates, foreign exchange rates, and the unemployment rate to remain at levels seen in 2018.

Chart 1

Table 2

October consumption tax hike likely to have a limited impact

Employment and income conditions affect the performance of loans extended to individuals, such as those for owner-occupied housing and autos. Japan's unemployment rate has been improving since 2010, and has recently been trending at the 2% level (see chart 2). We forecast that the rate will trend at around 2.6% in 2019, similar to its current rate (see table 3). The active jobs-to-openings ratio has been rising since exceeding 1.0x at the end of 2013 and was about 1.6x in 2018, its highest since 1974. In addition, total wages have increased in recent years, albeit at a snail's pace. We have seen a moderate improvement in macroeconomic indicators related to Japan's employment and wage conditions. We expect these changes in the employment and income environment for obligors will have a positive impact on structured finance transactions. Meanwhile, we expect Japan's consumer price index (CPI) to rise 1.2% in 2019. In our view, inflation will again miss the Bank of Japan's 2% target, but this is unlikely to have a major effect on the creditworthiness of individual consumers.

Chart 2

Table 3

A hike in Japan's consumption tax rate is scheduled for October 2019. The last hike was in 2014. However, we expect the increase in October to have a limited impact on structured finance transactions.

As chart 1 shows, Japan's real GDP growth rate was volatile before and after the 2014 hike in the consumption tax because of last-minute demand before its implementation and the subsequent reactionary decline. However, GDP has since 2016 been on a general improvement track. In addition, the 2014 tax hike did not substantially change the performances of the Japan Housing Finance Agency (JHF) regular monthly RMBS notes nor transactions backed by auto loan receivables we rate: All we observed were moderate increases that were in line with assumptions in auto loan credit loss ratios over time (see chart 3).

The planned sales tax hike this time entails a 2 percentage point rise from the current 8% to 10%, smaller than the previous 3 percentage point hike. The tax hike could prove to be a further financial burden for households, but we do not expect it will lead to credit losses. According to the 2017 Family Income and Expenditure Survey, average monthly spending for households with two or more persons was about ¥280,000. Assuming this amount remains unchanged, the tax hike will place an additional burden of about ¥5,000-¥6,000 (or roughly 2% of ¥280,000) on each household. We therefore believe--after taking into account that household budgets prioritize payments of mortgages and auto loans, and considering obligor income levels--that the likelihood of the tax hike leading to a significant increase in credit losses or delinquencies is limited. In addition, household spending on food increased after the 2014 tax hike, but overall spending decreased amid restrained spending on everything else (see chart 4). Alongside the upcoming consumption tax hike, the government is considering economic measures including reductions in certain areas of the tax rate system and consumer reward programs are also under consideration. These measures should ease concerns surrounding the performance of structured finance transactions, in our view.

Chart 3

Chart 4

We view the total number of corporate bankruptcies as a key indicator in forecasting the performance of structured finance transactions backed by corporate receivables. The number of bankruptcies has trended at a low level since the end of the global financial crisis and continued to do so in 2018. We don't expect drastic changes in transaction performance for corporate receivables because we think the number of corporate bankruptcies will likely trend around the same level again in 2019.

Owner-Occupied RMBS And Condominium Investment RMBS

Performance outlook for underlying assets is somewhat positive

We expect the performance of the assets underlying RMBS transactions backed by loans for purchasing owner-occupied houses (owner-occupied RMBS) and RMBS transactions backed by loans for investments in condominiums (condominium investment RMBS) to remain favorable in 2019. Our performance outlook for these assets is somewhat positive.

Major risk factors for housing loans are:

• Increased repayment burdens for obligors as interest rates rise;
• Deteriorating employment conditions, because of factors such as a rise in unemployment rates, occurring in tandem with an economic slowdown; and
• Asset values deteriorating because of a decline in real estate prices.

From a longer-term perspective, the low birth rate and aging society is likely to cause a decline in housing demand, which could weigh on real estate prices and damage the performance of housing loans. Meanwhile, moderate growth for the Japanese economy and extremely low and stable interest rates are likely to continue supporting the favorable performance of housing loans, in our view.

The upcoming consumption tax hike in October 2019 would inevitably hurt households. However, we believe its impact on the performance of housing loans, which have a higher priority in payment than most expenses for obligors, is likely to be minimal.

Rating trend will likely be somewhat positive

We expect the overall rating trend of owner-occupied RMBS and condominium investment RMBS for 2019 to be somewhat positive.

We expect the ratings on owner-occupied RMBS to remain stable in 2019, reflecting our view that Japan's economy will likely see favorable employment conditions and its real estate market perform strongly. The underlying assets backing Japanese owner-occupied RMBS transactions are largely housing loans with fixed interest rates for their entire loan periods. They therefore face extremely limited risk from rate hikes, which is another factor supporting their ratings.

Meanwhile, the majority of the underlying assets backing Japanese condominium investment RMBS transactions are located in metropolitan areas where demand for leasing is strong. These assets have also benefited from rising real estate prices in recent years. We have observed a material increase in prepayment ratios among condominium investment RMBS transactions with increased seasoning (time elapsed since transaction closing), because some obligors reaching compulsory retirement age have repaid their loans using retirement payouts. Credit enhancements in line with progress in redemption of senior classes provide a buffer sufficient to offset future shocks such as a rise in unemployment or an increase in interest rates.

Apartment Loan RMBS

Performance outlook for underlying assets is stable

The assets underlying rated RMBS transactions typically backed by loans to landowners who build rental apartment buildings (apartment loan RMBS) performed very well in 2018, with few delinquencies and defaults. We attribute the strong performance of these assets to the factors below.

• Developers of the collateral apartment buildings frequently enter into master lease contracts with the borrowers of the underlying loans. These contracts allow the borrowers to receive stable rent income regardless of actual occupancy rates or apartment rent levels.
• Apartment loans generally use floating interest rates, and these remained low in 2018. As a result, repayment burdens for borrowers did not rise.
• Master lease contracts remain effective, even though we assume they will be terminated when we assess RMBS transactions. This allows borrowers to repay apartment loans mostly with income from the master lease contracts.

Periodic reviews of rent levels for apartments leased under master lease contracts pose a major risk for apartment loan RMBS transactions. Rents for apartments with high vacancy rates and low profitability may fall. In addition, borrowers may struggle to pay back apartment loans with stable rent income if interest rate hikes push up the floating interest rates on apartment loans.

However, we believe the performance of the assets underlying apartment loan RMBS transactions will be stable in 2019, based on the following factors:

• As well as the originally-owned land serving as capital injections on the loans, equity makes up an increasing portion of the loans as repayments are made.
• We expect interest rates to remain very low and stable in 2019 and therefore believe the repayment burden on borrowers is unlikely to grow.

Leopalace21 Corp., a major apartment builder in Japan, disclosed in April 2018 that there were defects in some of the apartment buildings it constructed. The company continues to examine the issues surrounding these defects. The company said it will shoulder the expenses for any repair work and also assumes some tenants will need to move out when repair work proceeds. Although we believe the building issues are unlikely to have an immediate impact on the performance of apartment loan RMBS, we will monitor the progress Leopalace21 makes in checking all of its buildings and repairing defects.

Rating trend will likely be stable

We expect a stable rating trend for apartment loan RMBS in 2019. The interest rate is unlikely to rise materially in 2019 and therefore, the repayment burden on borrowers is unlikely to grow. Accordingly, borrowers are likely to be able to continue repaying housing loans with stable income from master lease contracts. Conversely, ratings could be constrained at a later date by the decline in competitiveness of aging apartments and a fall in demand for leasing as Japan's population shrinks and gets grayer.

In addition, the number of assets under some apartment loan RMBS has declined because loans have been prepaid in full. This also has the potential to constrain ratings in the future because it increases the concentration in large-lot loans to total underlying assets.

ABS Backed By Consumer Receivables

Performance outlook for consumer receivables is stable

We expect the performance of consumer receivables--auto loan receivables, shopping credit receivables, credit card receivables (shopping and cashing receivables), and consumer loan receivables--backing ABS transactions to remain stable in 2019.

The performance of consumer receivables hinges on the ability of borrowers to repay debt, which in turn is sensitive to shifts in labor market conditions, income levels, and consumer prices. Because employment and income conditions will likely be steady in 2019, we expect default rates of consumer receivables to remain stable and low.

Meanwhile, the performance of auto loan receivables is not very sensitive to changes in labor market conditions or the income status of borrowers. This is because the borrowers of auto loans in Japan generally have strong creditworthiness relative to borrowers of other types of loans backing ABS. As a result, auto loan receivables have traditionally performed stably relative to other classes of receivables. Indeed, defaults by borrowers of auto loans underlying rated transactions did not surge even when employment conditions and workers' wages plummeted in 2008 and 2009. In addition, originators have tightened their screening criteria since the global financial crisis, which has improved the performance of auto loans. Default rates for auto loan receivables have remained stable and low since 2012.

The default rate of Japanese auto loans has strong correlation with the unemployment rate, according to our analysis of auto loan ABS transactions we rated in the past. Japan's unemployment rate rose about 1 percentage point in 2009 from a year earlier, but has been slowly declining since then. During 2009, the default rate remained low. In terms of attributes of the asset pool, we believe that the performance of pools of assets with obligors of lower creditworthiness (mainly pools of auto loans for used vehicles) is more susceptible to changes in economic conditions. However, we expect auto loans to perform steadily in 2019, because we do not foresee economic downturn.

Rating trend will likely be stable

S&P Global Ratings expects its ratings on ABS transactions backed by consumer receivables to remain stable in 2019, based on the following:

• We expect consumer receivables to perform steadily.
• There are currently no scheduled legal or regulatory changes that could impair the performance of these receivables.
• Credit enhancements for ABS transactions backed by the receivables that also employ sequential pay structures have risen, reflecting increased seasoning.

ABS Backed By Corporate Receivables

Performance outlook for corporate receivables is stable

We expect the performance of corporate receivables (equipment lease and auto lease receivables) backing ABS transactions to remain stable in 2019.

The default rates of pools of corporate receivables generally trend in line with corporate bankruptcies in Japan. Accordingly, for auto lease receivables, we focus on changes in bankruptcy numbers in the trucking industry, because the asset pools generally have a high percentage of leases extended to small and midsize trucking companies. The number of bankruptcies rose on a year-on-year basis in the second and fourth quarters of 2017, showing signs of bottoming out after several years of decline. However, the number remained low in 2018. According to data from Teikoku Databank Ltd., the total number of corporate bankruptcies in Japan in the first half of 2018 declined year-on-year for the first time in two years. The data showed Japan also logged the lowest number of bankruptcies on a half-year basis in a decade. In addition, data from Tokyo Shoko Research Ltd. indicate that the number of bankruptcies in the first half of 2018 declined for a ninth consecutive year, and was at its lowest level since 1990. However, the number of bankruptcies varied by region. Meanwhile, the trucking industry also remained solid in the first half of 2018; the number of bankruptcies dropped year on year for a fifth consecutive year. In the second half of 2018, the number of bankruptcies has generally remained on a downward trend.

Meanwhile, the default rates of loans underlying rated ABS backed by equipment lease or auto lease receivables remain generally low and stable.

We do not expect the total number of corporate bankruptcy filings to increase significantly in 2019 from 2018. This is because we expect Japan's employment and income to remain steady, although uncertainties such as overseas political and economic troubles, including U.S.-China trade friction, could have a negative effect. Based on these factors, and also taking into account expected extraordinary demand as Tokyo gears up for the 2020 Olympic Games, we do not anticipate any major shifts in the performance of ABS backed by auto lease receivables.

Nevertheless, the performance of pools of equipment lease or auto lease receivables in which borrowers are concentrated in specific industries or geographic areas, as well as pools that include such receivables for large-lot borrowers, could fluctuate in the short term. This is because these pools are more vulnerable to trends affecting specific industries or geographic areas, or to defaults by large borrowers.

Rating trend will likely be stable

We expect our ratings on ABS transactions backed by corporate receivables to remain stable in 2018. This is because:

• We expect stable performance from equipment lease and auto lease receivables;
• No legal or regulatory changes are currently scheduled that could impair the performance of these receivables; and
• Credit enhancement levels have risen for outstanding transactions, reflecting their seasoning.

CMBS

Outlook for commercial real estate prices is generally stable

We expect prices for Japanese commercial real estate backing CMBS--such as office buildings, rental apartment buildings, and distribution and warehouse facilities--to stay nearly flat year on year in 2019.

According to data from Miki Shoji Co. Ltd., the average vacancy rate of office buildings in Tokyo's business districts as of end-October 2018 was 2.20%, down 0.82 percentage point from a year earlier. Meanwhile, average rents for those buildings rose 8.2% over the same period. These figures indicate that both vacancy rates and rent levels have improved significantly. The higher rent levels are attributable in part to rents being higher at newly constructed buildings than they are at existing ones. Meanwhile, according to Mori Building Co. Ltd.'s 2018 Survey of the Large-Scale Office Building Market in Tokyo's 23 Wards, which was released on April 28, 2018, expectations for the average annual supply volume over the five years from 2018 through 2022 are about 1.01 million square meters --almost the same as the historical average of 1.02 million square meters.

We assume average office vacancy rates in 2019 will be nearly flat compared with levels seen a year earlier because:

• In 2019, new office buildings are being built mostly to replace demolished old buildings in highly competitive locations in greater Tokyo, enabling developers to easily find tenants beforehand, in our view.
• There is a strong demand for leasing new offices because business activity and the workforce are expanding.

We expect rents in 2019 to remain virtually flat from 2018 levels because we assume vacancy rates will remain flat and because of the following other factors:

• New office space will mainly be sophisticated in terms of facility grade and construction, and generally located in Tokyo's three central wards, where rent levels are higher than in other wards, factors that could potentially continue pushing up the average rent level.
• In contrast, rents in submarkets outside central Tokyo likely have some downside. But rents are less likely to fall immediately, because of anticipation that there will be moderate growth for Japan's economy.
• Despite the new supply of large office buildings, Japan's office leasing market remained solid in 2018, as demonstrated by factors such as the rise in rent levels. Therefore, the market is likely to continue absorbing new supply at the current rent levels in 2019.

Two factors primarily influence commercial real estate prices: net cash flow generated by the commercial properties and capitalization rates (or cap rate; the expected rate of return on the commercial properties). We expect net cash flows from existing office buildings to stay generally flat in 2019 from 2018, based on our assumption that both vacancy rates and rents in 2019 will stay near 2018 levels. The Japan Real Estate Institute's (JREI) survey on real estate investors shows that cap rates have remained nearly flat from the previous year. Meanwhile, domestic and foreign investors have shown a strong appetite for Japanese real estate, and as there are few commercial properties on the market for sale, acquisition prices have risen. Therefore, actual cap rates on real estate transactions have remained flat or have been edging down. We believe cap rates in 2019 will be almost flat from 2018 because the investment market for commercial properties has tended to overheat when there is a shortage of properties that meet investors' criteria, which has led some to refrain from investing in the current market. Based on our expectations for rent levels, vacancy rates, and cap rates, we therefore believe office building prices will remain virtually flat in 2019.

The ARES Japan Property Index shows that the prices of rental apartment buildings have increased marginally but virtually remained flat on a year-on-year basis in 2018. We expect the vacancy rate and rents for such properties to remain stable in 2019, reflecting moderate economic growth and stable unemployment rates in Japan, and domestic and foreign investors' robust demand for Japanese real estate to keep cap rates for this asset class low. Meanwhile, the JREI Home Price Indices indicate prices for existing condominiums in greater Tokyo are nearing their highest levels since the crisis surrounding the bankruptcy of Lehman Brothers Holdings Inc., and we believe this market is somewhat overheated. The average price of new condominiums has remained on an upward trend, but started to show signs of slowing amid a supply decrease and a declining number of property sales. Given these factors, we expect prices for rental apartment buildings to generally exhibit the same pattern, though there may be price adjustments in some areas.

Vacancy rates for distribution and warehouse facilities rose moderately year on year in greater Tokyo but improved slightly in the Kinki (greater Osaka and nearby prefectures) region in 2018, according to CBRE Inc.'s survey for the third quarter of 2018, which covers large-scale distribution and warehouse facilities in the two regions. We expect vacancy rates for these facilities to remain stable in the Kinki region unless there is a drastic change in economic conditions, because new supply will be limited. On the other hand, given the planned supply of large facilities in greater Tokyo in 2019, demand from tenants may soften further, pushing up vacancy rates and weakening the property price trend. However, we expect prices of distribution and warehouse facilities in 2019 to be almost flat from 2018 levels. This is because:

• An increase in vacancy rates is likely to be limited, as several properties scheduled for completion are already fully occupied, thanks to brisk demand for leasing;
• Demand for space in such facilities from various industries is fundamentally strong, and they generate stable earnings because their rent prices tend to move little;
• As is the case with office buildings and rental apartment buildings, investors have strong appetites for such facilities, especially for large properties of high scarcity, which will likely keep cap rates low; and
• The construction period for distribution and warehouse facilities is shorter than for other property types, allowing developers to adjust supply relatively easily.

Nevertheless, property price adjustments may emerge in some areas, depending on leasing market conditions.

In our article, "Application Of CMBS Global Property Evaluation Methodology In Japanese Transactions," published Jan. 22, 2014, we provide the cap rate assumptions we use in conducting our rating analyses of Japanese CMBS transactions. In principle, we apply cap rates disclosed in this article in our rating analyses.

Related Criteria

• Ratings Above The Sovereign - Structured Finance: Methodology And Assumptions, Aug. 8, 2016
• Global Framework For Assessing Operational Risk In Structured Finance Transactions, Oct. 9, 2014
• Global Framework For Cash Flow Analysis Of Structured Finance Securities, Oct. 9, 2014
• Methodology And Assumptions For Rating Japanese RMBS, Dec. 19, 2014
• Global Methodology And Assumptions For Assessing The Credit Quality Of Securitized Consumer Receivables, Oct. 9, 2014
• Methodology And Assumptions For Rating Japanese Lease Receivables Securitizations, May 11, 2010
• Rating Methodology And Assumptions For Japanese CMBS, Jan. 22, 2014
• Understanding S&P Global Ratings' Rating Definitions, June 3, 2009

Related Research

• Japanese Structured Finance Scenario And Sensitivity Analysis 2017: The Effects Of The Top Five Macroeconomic Factors, Dec. 26, 2017
• Credit Conditions Asia-Pacific: Cold Wind Blowing, Nov. 29, 2018
• New Issuance Of Japanese Securitizations Pulled Down By Slowing Fixed-Rate Housing Loan Demand In 2018 First Half, Aug. 3, 2018
• Default, Transition, and Recovery: 2017 Annual Japanese Structured Finance Default Study And Rating Transitions, March 27, 2018
• Application Of CMBS Global Property Evaluation Methodology In Japanese Transactions, Jan. 22, 2014