HONG KONG (S&P Global Ratings) Oct. 7, 2021--The residential mortgage-backed securities (RMBS) we rate in China will not be affected by the likely default of China Evergrande Group, S&P Global Ratings said today. This is mainly because our rated deals are backed by existing homes, and therefore face no construction risk.
Mortgage loans exposed to construction risk related to property developers are common in China. Residential properties still under construction are routinely sold to the public. Regulation stipulates that if the top of a residential property is sealed, that property can be offered as collateral by a home buyer to take a mortgage loan from a bank. If the associated developer is unable to complete the construction of the property, the home buyer (also the mortgage borrower) faces the risk of not receiving a completed home. The mortgage loan then is exposed to construction risk. This increases the risk that the mortgage borrower may not pay off the mortgage loan.
In our view, potential implications arising from construction risk are very limited for China's RMBS sector. The underlying mortgage loans backing RMBS deals that we do not rate exposed to construction risk can vary a lot from deal to deal. A range of between 30% to 40% of an underlying mortgage pool is common. The full recourse characteristic of mortgage loans in China and rising awareness of the importance of individual credit records would prompt affected borrowers to exhaust other measures before considering intentional default on their mortgage loans.
We also believe local governments will play a coordinating role, ensuring that prepayments from home buyers are protected and monitoring unfinished projects should these be negatively affected by property developers in distress. Increasing seasoning of the underlying loans over time also helps reduce potential construction risk.
Property prices are one of the pillars of asset performance in the RMBS sector. They would take a manageable direct hit from the Evergrande contagion. Property sales are slowing in China as policy tightening has taken hold in recent months. Room for further fire-sale prices is limited given Evergrande has already drastically cut prices, sometimes selling units at a loss. The Chinese property market is very fragmented. And while Evergrande is one of the country's largest developers, its market share remains relatively low. We anticipate Evergrande's direct negative effects on other major players' projects would be manageable, even in a default scenario.
There will still be pressure on pricing and volume from the overall property market downturn in the country, but that is not triggered by Evergrande's downfall. Most Chinese RMBS exhibited a weighted average current loan to initial value (LTV) of less than 50%. We believe this can largely mitigate volatility in property prices.
Another important factor and a tail risk is borrowers' repayment capability, which typically tracks the unemployment rate. Our forecast unemployment rate for China in 2021 and 2022 is slightly over 5%.
The low LTV we observed in Chinese RMBS and the country's largely stable unemployment rate support our expectation of steady collateral performance of our rated RMBS transactions.
RELATED RESEARCH
- China's Local Governments Will Address Evergrande--Quietly, Behind The Scenes, Oct. 5, 2021
- China Auto ABS And RMBS Tracker: August 2021, Sept. 28, 2021
- Credit FAQ: Evergrande Default Contagion Risk--Ripple Or Wave?, Sept. 20, 2021
This report does not constitute a rating action.
S&P Global Ratings, part of S&P Global Inc. (NYSE: SPGI), is the world's leading provider of independent credit risk research. We publish more than a million credit ratings on debt issued by sovereign, municipal, corporate and financial sector entities. With over 1,400 credit analysts in 26 countries, and more than 150 years' experience of assessing credit risk, we offer a unique combination of global coverage and local insight. Our research and opinions about relative credit risk provide market participants with information that helps to support the growth of transparent, liquid debt markets worldwide.
| Primary Credit Analyst: | Annie Wu, Hong Kong + 852 2532 8077; annie.wu@spglobal.com |
| Secondary Contact: | Jerry Fang, Hong Kong + 852 2533 3518; jerry.fang@spglobal.com |
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