A better-than-expected economic revival may have moderated any possible damage to China securitization transactions from the COVID-19 outbreak. But an about turn is unlikely. Issuance volume fell in the second quarter (2Q) of the year, and defaults increased--albeit marginally. S&P Global Ratings expects issuance volume to continue to decline over the next few quarters. Asset performance will remain under pressure, but to a lesser degree than in the previous quarters. The outbreak is bringing about changes in how the market operates. The effects of some of these changes will play out over the next few quarters.

COVID-19 Impact

What we learnt from the pandemic

• Originators will strive for contactless origination where allowed. Some auto finance companies (AFCs) that sponsor auto loan ABS transactions rated by us have taken steps to enhance their origination process by promoting online processing to significantly lower in-person contact. Such measures will moderate the potential impact on loan origination should lockdown measures follow in case of a COVID-19 resurgence.
• In-person workout of severe delinquent loans is most susceptible to lockdown measures. Chinese originators tend to outsource workout of severe delinquency to third party agencies, which follow up with delinquent obligors mainly through in-person interactions. For the transactions we rate, the potential risk is largely addressed by our low recovery assumption for auto loans and long recovery period for mortgage loans.
• Arrears reporting practices associated with an extended grace period vary from originator to originator. For example, if an extended grace period is approved and offered, some originators may report overdue payments based upon pre-extended due date while other originators may report based upon new due date. Potential difference in reporting arrears is likely to result in opaqueness at least in the 1-30 days past due bucket. The potential implications of such opaqueness and variance in reporting practices largely depend on the number and the amount of extended grace period cases should such financial relief be offered again.
• In the auto loan sector, some AFCs have offered more variety in their loan products to both support vehicle sales campaigns and cope with borrowers' repayment capability post the outbreak. Products with riskier features as such more flexible repayment will test AFCs underwriting capability.

Yield Trend

Auto loan ABS coupons started to climb

• Market rates showed a U-shaped turn in 2Q. The six-month SHIBOR hit a record-low of 1.48% in April, after another targeted required reserve ratio cut (for smaller banks) as further monetary easing to support the economy.
• The six-month SHIBOR moved up to 2.17% as of end June. This reflects some withdrawal of exceptional and temporary liquidity rather than policy tightening.
• Coupons on the most senior tranches of auto loan asset-backed securities (ABS) followed suit, picking up in June, after falling to less than 2% in May.
• Coupons will remain low over the next several months but should be stable as the economy recovers.

Chart 1

New Issuance Trends

Auto loan ABS growth stood out while total issuance dropped

• New securitization issuance in China fell a steep 10.6% to Chinese renminbi (RMB) 514 billion in 2Q 2020 as the COVID-19 impact became more apparent.
• The drop can be largely attributed to the lackluster issuance from banks and originators regulated by the China Banking And Insurance Regulatory Commission (i.e., transactions issued under the credit assets securitization scheme).
• Issuance of residential-mortgage backed securities (RMBS) has remained weak since the second half of 2019.
• Auto loan ABS issuance remains strong.
• Consumer and corporate loan ABS declined in the face of weaker consumption capacity and lower industrial activity.
• So far no credit card ABS was issued this year.
• We expect new issuance to drop by 10%-15% in 2020, mainly due to weak RMBS issuance. The broad consumer finance sector is also likely to remain soft throughout the year, although credit card ABS issuance will likely resume in the second half.
• In the global context, during 1H 2020, issuance growth in China, Japan, and Latin America was relatively flat, while the U.S. (-30%), Europe (-25%), Canada (-28%), and Australia (-42%) all experienced considerable declines.

Chart 2

Chart 3

Auto Loan ABS Issuance

Momentum stayed strong

• A total issuance of RMB58.4 billion by captive AFCs across 10 transactions translates to 24% YoY growth in 2Q 2020.
• We believe low interest rates have been one of the key factors that attracted AFCs for repeat issuance. The majority of the repeat originators have already issued a couple of transactions in the first half of the year.
• Auto sales improved materially from April and auto loan origination volume also recovered, which are positive for auto loan ABS issuance.
• Some AFCs have offered more variety of their loan products to cope with borrowers' repayment capability post the outbreak. However, AFCs with auto loan ABS that we rate are likely to adopt consistent loan underwriting criteria. In addition, loan products with more flexible payment terms may not be eligible for securitization.
• We estimate that issuance will be flat for the full year.

Chart 4

RMBS Issuance

The decline continues

• Five RMBS transactions were issued in 2Q, totalling RMB33.2 billion.
• Number of issuances plunged by 64% YoY, with a total of nine transactions in the first half, from 25 in the same period in 2019.
• The falling issuance reflects the decelerated mortgage loan growth earlier this year due to COVID-19 and the subdued need for balance sheet management amid an economic downturn.
• Falling mortgage rates and easing pandemic restrictions revived property sales growth in 2Q.
• Despite some positive signals in the property market and consequently active mortgage origination in the quarter, we expect RMBS issuance to remain sluggish. That's given limited need for balance sheet management from originators and the government's continuing strict control to curb housing speculation.
• Nevertheless, we acknowledge that the regulators keep a close watch on monthly loan origination growth. We would not be surprised if the active mortgage loan origination in 2Q continues into the second half of the year, leading to an increasing need for banks to offload mortgage loans from their balance sheet.

Chart 5

Auto Loan ABS Performance

Stabilized delinquency rates as the COVID-19 impact faded indicates the worst is over

• Delinquency rates stabilized as most of the loan servicing and collection operations returned to normal after the COVID-19-related shutdown in February and March.
• The M1 ratio (1-30 days past due) has been largely flat since April.
• The M2 (31-60 days past due) and M3 (61-90 days past due) ratios gradually decreased. The weighted average M2 and M3 ratio in the overall sector declined to 0.12% and 0.07%, respectively.
• The auto transactions we rate maintained low delinquencies. The weighted average M2 and M3 ratios of these rated transactions came down to 0.04% and 0.03% in June.

Chart 6

Resilient performance, with the cumulative default rate remaining low despite inching up

• The cumulative default rate increased moderately in 2Q as defaulted loans caused by COVID-19 kicked in.
• The cumulative default rate of 2018 and 2019 vintages as of end of 2Q increased by around 10bps, compared to six months ago, which posed minimal stress to most of the transactions.
• Asset performance has been resilient during COVID-19.The pressure has subsided but will persist, given the uncertainties in the magnitude of economy recovery and evolving situation of the pandemic.

Chart 7

RMBS Performance

Stabilized early delinquency rates as the COVID-19 impact faded indicates the worst has passed

• M1 restored to pre-COVID level. Delinquencies of 1-30 days improved in 2Q for our rated RMBS transactions, to around 0.3% in June from the February peak of nearly 0.8% amid the height of the epidemic and lockdowns in China.
• The M2 and M3 ratios also declined.
• Nevertheless, M4+ ratio (90+ days past due) is headed higher. The delinquent loans due to COVID-19 staying within the overdue buckets without write-off has led to a higher M4+ ratio of 0.43%.
• We expect the M4+ ratio to continue to inch up in light of continued carryover from earlier delinquency buckets. It takes one to two years or even longer for mortgage servicers to work out severe delinquent and defaulted loans.

Chart 8

Asset performance has been more resilient than we expected

• The increase in the cumulative default rate of most of the vintages only came at 6bps-10bps as of the end of 2Q. The ultimate impact of COVID-19 on collateral performance measured by cumulative default could fall at the lower end of the 30bps-60bps we had estimated in 1Q.
• We attribute the better performance to the relative diversity of the underlying pools of RMBS and restrictive government policies in mortgage lending.

Chart 9

Prepayment became steady during 2Q

• The constant prepayment rate (CPR) for bank-issued RMBS transactions remained about 11% in 2Q, after the rebound in March.
• We expect the CPR to fluctuate between 8% and 12% in the medium term.

Chart 10

New Issuances In 1H 2020

• Bavarian Sky China 2020-1, Feb. 25, 2020
• Rongteng 2020-1 Retail Auto Loan Securitization, March 12, 2020
• Generation 2020-1 Retail Auto Mortgage Loan Securitization, March 13, 2020
• Autopia China 2020-1 Retail Auto Mortgage Loan Securitization Trust, March 17, 2020
• Silver Arrow China 2020-1 Retail Auto Loan Asset Backed Notes Trust, March 24, 2020
• Driver China ten Trust, March 27, 2020
• Bavarian Sky China Leasing 2020-1 Trust, April 17, 2020
• Generation 2020-2 Retail Auto Mortgage Loan Securitization, May 19, 2020
• VINZ 2020-1 Retail Auto Loan Asset-Backed Securities, June 19, 2020
• Jianyuan 2020-2 Residential Mortgage Backed Securities, June 24, 2020

Related Research

• Economic Research: China's Deflating Recovery Still Needs Stimulus, July 21, 2020
• Credit Conditions Asia-Pacific: China First To Recover, June 30, 2020
• Economic Research: Asia-Pacific Losses Near $3 Trillion As Balance Sheet Recession Looms, June 26, 2020
• Economic Research: The China Confidence Game, June 17, 2020
• A Primer On China's Residential Mortgage Backed Securities Market, June 24, 2020
• Credit FAQ: What Do The First Performance Reports Reveal About COVID-19's Effects On China Auto ABS And RMBS?, March 26, 2020
• Credit FAQ: How S&P Global Ratings Factors In The Potential Effects Of The COVID-19 Outbreak When Analyzing China Auto ABS and RMBS, March 4, 2020
• China Structured Finance Outlook 2020: Performance To Diverge Amid Flat-To-Modest Issuance Growth, Feb. 6, 2020
• China Auto ABS And RMBS Must Brace For Coronavirus Impact, Feb. 3, 2020
• An Overview Of China's Auto Finance Market And Auto Loan Securitization, March 12, 2019