The COVID-19 pandemic and virus containment measures has led to stress that could reach Japan's structured finance market. The crisis put an additional stress on the Japanese economy, which was already shrinking after a sales tax hike implemented last year. S&P Global Ratings has in light of the pandemic revised down its 2020 real GDP growth forecast for Japan to -1.2% (See "Asia-Pacific Economic Forecasts: The Cost Of Coronavirus Is Now US$620 Billion," published March 22, 2020). In this report, we address frequently asked questions about the influence of the ongoing crisis on Japanese securitization transactions we rate.

In order to avoid the further spread of COVID-19, the Japanese government declared a month-long state of emergency for Tokyo, Osaka, and five other prefectures on April 7. At the same time, the government announced a package of economic measures to mitigate the negative impact of the pandemic. This report is based on our most recent macroeconomic forecasts. However, we will revise our assessment of the pandemic's impact on Japanese structured finance transactions in line with changes in our forecasts and other matters.

S&P Global Ratings acknowledges a high degree of uncertainty about the rate of spread and peak of the coronavirus outbreak. Some government authorities estimate the pandemic will peak about midyear, and we are using this assumption in assessing the economic and credit implications. We believe the measures adopted to contain COVID-19 have pushed the global economy into recession (see our macroeconomic and credit updates here: www.spglobal.com/ratings). As the situation evolves, we will update our assumptions and estimates accordingly.

Frequently Asked Questions

Which types of securitizations are directly impacted by the outbreak?

We view transactions with underlying assets concentrated in industries that are vulnerable to the outbreak and those located in seriously affected regions as likely to suffer a direct impact from COVID-19. However, we believe the risk associated with the outbreak is generally limited for most of Japanese residential mortgage-backed securities (RMBS) and asset-backed securities (ABS) transactions we rate. These transactions are backed by highly diversified pools of individual loans, including housing loans and auto loans.

Meanwhile, we view transactions backed by less diversified loan pools with fewer underlying loans to more likely be affected by deteriorations in specific industries and regional economies. Additionally, in these transactions, a deterioration in the performance of some underlying loans is more likely to hurt the entire loan pool. We assessed the performance outlook and expected rating trend of apartment loan receivables to be somewhat negative in "Japan Structured Finance 2020 Outlook: Potential Apartment Loan RMBS Woes Amid General Tranquility," published Jan. 8, 2020. We believe COVID-19 could pile further downward pressure on this asset class.

Chart 1

Generally, in a stressed macroeconomic situation, such as the ongoing coronavirus outbreak, lower-rated tranches are more likely to be downgraded than higher-rated tranches. This tendency is more evident for tranches rated 'BB' category or lower. However, at the start of 2020, as much as 92% of securitization tranches were rated 'AAA' and all but two tranches were investment-grade (rated 'BBB' category or higher). This indicates that most of the transactions we rate in Japan have higher resistance to macroeconomic deterioration.

Chart 2

How have the attributes of housing loans backing Japanese RMBS changed since the 2008 global financial crisis?

The proportion of housing loans with over 90% loan to value (LTV) ratios at drawdown is higher in Japan than other countries. Obligors in Japan are motivated to borrow as much as they can, in part because most Japanese lending institutions allow lending of up to 100% in LTV. In addition, obligors of housing loans get tax relief based on their year-end loan balances.

Additionally, interest rates on housing loans in Japan have declined since the Bank of Japan's implementation of a negative interest rate policy in early 2016. This is accelerating the increase in loans with high LTV ratios. In the case of monthly RMBS issued by Japan Housing Finance Agency (JHF; A+/Positive/A-1), the proportion of underlying loans with 90% or higher LTV ratios rose to about 60% in 2019 from about 10% in 2008.

High LTVs put stress on the performance of assets backing RMBS. However, official residential land prices have been rising across Japan since 2017. We believe this partially mitigates risks associated with high LTV loans. However, the performance of housing loans may deteriorate if the pandemic puts stress on land prices.

What are the effects of COVID-19 on the performance of housing loans backing Japanese RMBS?

We assume COVID-19 will lead to a limited deterioration in the performance of housing loans backing Japanese RMBS. This is despite the likely downward pressure from economic fallout arising from the outbreak and consequent containment measures. The performance of housing loans backing Japanese RMBS has mostly been stable, even during the 2008 global financial crisis. We recognize a strong correlation between unemployment and housing loan performance. However, we continue to expect Japan's unemployment rate to remain below 3%, at 2.7% in 2020 and 2.6% in 2021.

Additionally, JHF and other major financial institutions are prepared to discuss possible modifications of loan terms and conditions with borrowers facing difficulty repaying loans because of the pandemic. Modifications could include the temporary reduction of repayment amounts and the extension of maturity dates. Although negative to credits, in many securitization transactions, originators have to repurchase loans if repayment terms are modified. This essentially entails the same effect as the loan being prepaid. Therefore, in practice, the impact of modifying repayment terms on securitization transactions is limited, in our view.

Chart 3

Would the outbreak adversely affect interest payments on securitization transactions?

In our view, there is a fairly low likelihood of a sudden increase in defaults and delinquencies adversely affecting interest payments on securitization issues. Private-sector RMBS and ABS transactions we rate in Japan generally pay interest on issued instruments using both interest and principal collections from underlying assets, in accordance with predetermined payment waterfalls.

Additionally, we have confirmed that cash reserve accounts for all of our rated private-sector RMBS and ABS have sufficient funds to cover at least three monthly interest payments and maintenance costs, although the actual amount varies among transactions. We believe this should further allay concerns.

For JHF RMBS, we also consider it unlikely that a performance deterioration caused by a sudden increase in defaults and delinquencies will affect their payment of interests. This is because they are structured so that JHF will make interest payments, although a cash reserve is funded only on the occurrence of a trigger event.

Do you expect longer collection/liquidation periods for housing loans and other underlying loans?

Collections for current receivables are generally made automatically through bank deductions. We therefore see little risk of extended collection periods. However, in the case of defaulted and delinquent receivables, a worsening of the coronavirus situation may make it difficult to negotiate with obligors on the sale of property. This may slow down auctions and voluntary sale processes.

Liquidation periods for defaulted receivables are a factor in our cash flow analysis. We assume 18 months for owner-occupied housing and condominium investment loan receivables and 24 months for apartment loan receivables. At the time of writing, there was no slowdown in collections that would materially impact our transaction analysis. We will continue closely monitoring the coronavirus situation, given its fluidity.

Do you expect securities backed by undiversified pool of assets to be affected?

Our ratings on repackaged securities are not based on the analysis of diversified pool of assets, but linked with the credit risk of specific instruments backing the securities and related counterparties. The ratings on repackaged securities may be revised, if ratings on the underlying instruments or the related counterparties are revised due to factors such as pandemic effects.

Related Research

• Asia-Pacific Economic Forecasts: The Cost Of Coronavirus Is Now US$620 Billion, March 22, 2020
• Japan Structured Finance 2020 Outlook: Potential Apartment Loan RMBS Woes Amid General Tranquility, Jan. 8, 2020