China's securitization market continues to struggle amid challenges in the property sector and weaker economic activity. S&P Global Ratings therefore expects new issuance to remain soft over this year. Issuance declined in 2Q 2022 in a market that has been subdued since the second half of 2021.

The asset performance of securitized pools is likely to be under pressure, given a resurgence in local COVID-19 cases and ensuing lockdowns in various regions in China. Recent mortgage strikes are adding to the stress. Volatility in delinquency rates should increase for the next few quarters. Also, the credit quality of securitized pools could weaken further if lockdowns are more widespread and prolonged.

Regulatory Update

New regulatory guidelines for issuing domestic covered bonds

• On May 26, 2022, National Association of Financial Market Institutional Investors (NAFMII) announced a pilot program for covered bonds. The main goal of the notice is to support projects relating to affordable housing and low-rent homes.
• NAFMII set out requirements for the registration of covered bond programs, use of proceeds, and information disclosure. Eligible underlying assets include property and land-use rights; chattels and intangible assets may also be designated as eligible asset classes in the future.
• Compared with auto ABS and RMBS, the deal structure of domestic covered bonds is more flexible. Asset segregation can be achieved either through the true sale of assets to a special purpose vehicle or pledge of covered assets.
• Following the rollout of the guidelines, the first domestic covered bond was issued in the interbank market in late-June, backed by the operating income of a hotel property. In our view, there are still legal and structural hurdles to overcome before covered bonds are issued in China in line with international practices.

Shanghai Stock Exchange supports issuance of corporate ABS

• On June 30, 2022, Shanghai Stock Exchange (SSE) released a notice supporting the asset securitization of key sectors, regions, and enterprises. The sectors include transportation, infrastructure, state-subsidized housing, utility, and environment protection. The key regions refer to the Beijing-Tianjin-Hebei region, the Yangtze River Delta, the Greater Bay Area, and Hainan Free Trade Port.
• The notice aims to implement the State Council's push to further revitalize existing assets and expand effective investments. Asset securitization is mentioned as an effective way to revitalize existing assets.
• SSE has also indicated its goal of optimizing and strengthening the procedure of asset securitization in the notice. A specialized team will be established to address corporate financing needs and enhance product structures.
• The announcement was positive signal on the issuance of corporate ABS, with a more efficient listing process. The impact remains to be seen.

Yield Trend

Ample liquidity drove down auto loan ABS coupons

• Following a cut in the loan prime rate (LPR) in January and reserve requirement ratio (RRR) in mid-April, key policy rates remained unchanged in May and June. However, the monetary easing measures implemented earlier this year have led to abundant liquidity. This was indicated by the RMB21 trillion increase in aggregate financing to the real economy and a reduction of 34 basis points (bps) in the interest rate on newly issued corporate loans, compared with the first half of 2021.
• With increasing availability of liquidity, the six-month Shanghai Interbank Offered rate (SHIBOR) continued to move downwards during the second quarter of 2022. By the end of July, the six-month SHIBOR fell to about 1.99%, the lowest level since June 2020.
• Coupons on the most senior tranches of auto loan ABS also mimicked the trend. Repeated issuances were priced 12 bps-36 bps lower in June than notes issued in the first quarter of 2022.

Chart 2

New Issuance Trends

Another quarter with a decline in issuance amid slowing economic growth

• New securitization issuance decreased 30% yoy to RMB549 billion (US$82 billion) in 2Q 2022. Total issuance in the first half of 2022 dropped 33% yoy to around RMB950 billion (US$142 billion).
• The slump in issuance largely stems from plummeted RMBS issuance, and the decline in supply-chain ABS and account receivables ABS.
• We estimate annual issuance in 2022 will fall by about 10% to RMB2.8 trillion (US$430 billion) compared with the level in 2021--which was the country's first annual drop in issuance. This is because of a sharper economic slowdown than the market expected and the likelihood of issuance levels remaining weak.

Chart 3

Issuance trend varied among asset classes

• Auto loan ABS issuance was stable in 2Q compared with a year ago. This was in line with our forecast early this year of flat-to-modest growth.
• There was no RMBS issuance in 2Q, so the total so far this year stood at RMB24.5 billion, down 91% from RMB264 billion in the first half of 2021.
• Issuance via a scheme managed by the China Securities Regulatory Commission (CSRC) declined to RMB310 billion, 26% lower than in 2Q 2021. The property market downturn and sluggish economic activity continued to drag the issuance of corporate-related ABS. Account receivables-backed transactions and supply-chain ABS fell 20% and 41%, respectively, in the first six months of 2022.
• For centrally regulated consumer loan ABS, the issuance volume was RMB7.5 billion in 2Q, similar to that last year. On the other hand, issuance of consumer finance ABS under the CSRC scheme has been active again since May; some frequent originators returned and issued under this scheme. This was likely a finetuning from the government scrutiny imposed earlier this year.
• Leasing receivables ABS is another sector worth watching, with growth of 17% to RMB79 billion in 2Q. This was partly supported by the broadening financial leasing market and incentive to diversify funding sources.

Chart 4

Chart 5

Auto ABS Issuance

Stable issuance, more supportive measures rolled out

• A total of RMB60.9 billion was issued by captive auto finance companies (AFCs) across 14 transactions in 2Q 2022. This was largely flat compared with that in the same period last year.
• Stable auto loan ABS issuance was mainly supported by frequent originators.
• Although auto sales declined in the first half of this year under the disruptions from COVID lockdowns, increasing auto loan penetration and auto finance support to auto manufacturers on car sales have been favorable to auto loan growth and ABS issuance.
• Newly introduced auto purchases tax incentives and a notice on vehicle consumption expansion published on July 7 will likely boost consumption in the second half this year.
• The notice also encouraged AFCs to increase auto finance support for car purchases, by adjusting down-payment ratios, interest rates and tenors within regulatory requirements, and risk management. It remains to be seen how the notice will affect AFCs' loan origination and underwriting.
• More auto finance companies are joining or looking to join the "green" frenzy to issue green auto ABS. Four green auto loan ABS were issued during the first half of 2022, which accounted for about 7% of total auto ABS issuance in this period.

Chart 6

RMBS Issuance

No issuance in 2Q, uncertainties heightened amid mortgage strikes

• There has been no RMBS issuance since mid-February 2022. This meant RMBS issuance plummeted 91% yoy to RMB24.5 billion in the first half of 2022.
• This partly reflected the weak mortgage origination volume due to the strained property sector and sliding homebuyer confidence.
• Also, banks had less imminent needs to manage their funding and mortgage loan books via RMBS issuance.
• A similar issuance pause occurred around mid-2021, though it lasted only three months.
• The recent mortgage strikes have further complicated the situation and the sector is now contending with homebuyers' waning confidence. We expect national property sales will fall by a third this year, with home prices set to fall 6%-7%.
• It is unclear when RMBS issuance will resume, but it is likely to depend on mortgage origination momentum and the regulatory stance in the second half.

Chart 7

Auto Loan ABS Performance

Delinquency ratios stayed stable but lagging effects remained to be seen

• Lockdowns in Shanghai led to a slight rise in delinquency ratios during May, while the overall auto loan ABS sector remained largely stable in 2Q.
• The weighted average M2 (31-60 days past due) climbed to 0.11% in May and then returned to 0.09% in June, while M3 (61-90 days past due) ratios for all outstanding auto loan ABS transactions rose slightly to 0.06%.
• The auto transactions we rate have shown some divergence in delinquencies since we started to include transactions with distinct pool attributes. The attributes include vehicles backing the loans not from car makers associated with originators. The increased credit risk has been mitigated by higher credit enhancement.
• We expect the delinquency ratios to remain at a similar level for a few months before leveling off as more transactions with distinct pool features are included in our rated portfolio.
• The resurgence of the pandemic and any strict COVID restrictions may create greater fluctuation in the delinquency ratios, given stability of borrower's income and feasibility of in-person collection will both be hampered.
• That said, the weighted average M2 and M3 ratios of our rated transactions remained low at 0.07% and 0.05%, respectively, in June.

Chart 8

Cumulative default rates stayed low

• Cumulative default rates were largely similar to those in 1Q 2022 and overall stayed below 0.5% for 2016 and later vintages.
• For the 2020 and 2021 vintages, the rates increased marginally by 3 bps-5 bps during 2Q 2022, attributed to the broadly stable collateral performance.
• Although economic conditions remain gloomy under the strict lockdowns and social distancing policy, we expect favorable pool attributes, such as low loan-to-value ratios and higher seasoning relative to the initial loan tenor, to underpin the steady performance of auto loan ABS.

Chart 9

RMBS Performance

Mortgage strikes could hamper RMBS backed by forward delivery houses

• Recent homebuyers' strikes on mortgage payments for delayed residential projects have deepened the liquidity crunch for property developers. With the sliding confidence among homebuyers, we expect property sales will fall 28%-33% this year. (see "China Property Sales Set To Drop By A Third As Mortgage Strikes Break Out," published July 26, 2022)
• The strikes would pose a limited direct threat to Chinese banks and put at risk almost RMB1 trillion of outstanding mortgage loans for delayed projects by distressed developers. (see "China's Mortgage Strike Puts Almost RMB1 Trillion In Bank Loans At Risk," published July 26, 2022)
• We believe the strikes will have knock-on effects for RMBS and corporate risk-related ABS, on top of the already weakened property market.
• In terms of RMBS, mortgage loans backed by forward delivery houses (FDH; residences still under construction) are common among China RMBS, exposing them to the construction risk related to property developers. For details, see "China Securitization: How Strained Property Developers Might Affect Existing RMBS," published Jan. 20, 2022.
• Our rated RMBS transactions are not exposed to risks from property developers strained from the strikes because the underlying pools are backed by existing home mortgage loans, and therefore face no construction risk.
• However, the fallout from the property sector could still cause ripple effects on property sales and price movements, which is worth further observation. The next three to six months would be critical as the impact on RMBS asset performance, if any, would start to kick in and would likely lead to increased volatility in delinquencies.

Volatility in late delinquency rate of our rated RMBS increased as expected

• For our rated RMBS transactions, the M4+ ratio (90+ days past due) increased to 0.68% at the end of 2Q from 0.57% at the end of 1Q 2021. It seems that the increase in the delinquency ratio has slightly accelerated. The increase of the M4+ ratio was in part due to the paydown of the underlying pools and accumulated severe delinquent loans taking time to work out.
• Our view remains that volatility in late delinquency rates could remain elevated due to the uncertainty around the impact of COVID.
• Early delinquency ratios remain largely stable. The delinquencies of M1 ratio stayed low at around 0.26% in 2Q 2022. The M2 and M3 ratios remained at or below 0.1%.

Chart 10

Default rates rose marginally; trajectory depends on certain critical factors

• The increase in the cumulative default rate of most of the vintages was minimal at 3 bps-5 bps as of the end of 2Q 2022.
• The cumulative default rate of most of the vintages stayed below 0.8%.
• A liquidity crunch and the weaker economy have brought further risks to the RMBS sector, and we believe that the down cycle may persist for several quarters.
• Critical factors that will drive asset performance of RMBS, in our assessment, are property price movements, the regulatory stance, and the trajectory of the pandemic, particularly the scale and duration of lockdowns.
• A few RMBS transactions originated in 2020 have shown a jump in cumulative default rates in the past two quarters, partly due to the default of mortgages with larger size and the impact of COVID. We don't rate these transactions. The increase in cumulative default rates of these transactions has slightly leveled off in this quarter. But it remains to be seen if the asset quality will stabilize amid the uncertain environment.

Chart 11

Prepayment may hover at 6%-10% in the next few quarters

• The constant prepayment rate (CPR) for bank-issued RMBS transactions was around 10% in 2Q.
• The CPR largely echoed the momentum of secondary property sales. The prepayment rate usually drops when the secondary market becomes less active.
• The uncertainties in the property sector and recent events will continue to weigh on property sales volumes, and thus CPR could fluctuate at 6%-10% for the next six to 12 months.

Chart 12

Credit Card ABS Performance

Volatility in the delinquency rates of our rated deal could increase

• Our rated credit card ABS, Zhaoyin Hezhi 2021 Phase I Personal Consumer Loan Asset-backed Securities, has demonstrated stable performance in the first seven months since closing.
• The M2 and M3 ratios were at 0.55% and 0.38%, respectively, as of end-June 2022, and they have remained largely flat.
• Prime credit card ABS generally has a higher loss rate on the initial portfolio balance than prime auto loan ABS. This mainly reflects the unsecured nature of credit cards and their relatively weaker arrears performance.
• Sporadic lockdowns across cities and towns in the past few months have hit consumption and economic growth. We believe this could cause some volatilities in delinquencies, but the performance should still be within our expectations.

Chart 13

New Issuances In 1H 2022

• Bavarian Sky China 2022-2, June 16, 2022
• Fuyuan 2022-2 Retail Auto Mortgage Loan Securitization Trust, June 14, 2022
• Autopia China 2022-1 Retail Auto Mortgage Loan Securitization Trust, April 19, 2022
• Silver Arrow China 2022-1 Retail Auto Loan Asset Backed Notes Trust, March 15, 2022
• Bavarian Sky China 2022-1, Jan. 21, 2022

Rating Actions In 1H 2022

• Driver China ten Class A Notes Upgraded To 'AAA (sf)', Feb. 22, 2022
• Driver China eleven Trust Class A Notes Upgraded To 'AAA (sf)', Feb. 17, 2022

Related Research

• China Property Sales Set To Drop By A Third As Mortgage Strikes Break Out, July 26, 2022
• China's Mortgage Strike Puts Almost RMB1 Trillion In Bank Loans At Risk, July 26, 2022
• Inflation And China: Rough Ride Ahead, July 4 2022
• Credit Conditions Asia-Pacific Q3 2022: Costs Heighten, China Growth Tightens, June 28, 2022
• China Structured Finance Midyear Outlook 2022: New Issuance Set For Historic Fall, June 19, 2022
• China Auto: Sales Recovery To Stall, June 13, 2022
• A Primer On China's Residential Mortgage Backed Securities Market, May 24, 2022
• A Primer On China's Auto Loan Asset-Backed Securities Market, April 28, 2022
• How Strained Property Developers Might Affect Existing RMBS, Jan. 20, 2022
• Credit FAQ: What's Behind Our First Rating On Credit Card ABS In China, Nov. 30, 2021