Modest economic growth should support the performance of Japan's securitization market in 2023.

S&P Global Ratings expects the underlying assets for owner-occupied residential mortgage-backed securities (RMBS) and condominium investment RMBS to perform stably. The same goes for consumer loan and corporate asset-backed securities (ABS). Assets backing apartment loan RMBS and commercial mortgage-backed securities (CMBS) will likely somewhat underperform, in our view.

We consider RMBS, ABS, and CMBS to be representative asset classes of Japan's securitization market. In this report, we discuss our views on the performance outlooks for securitizations of these asset classes in Japan in 2023.

Table 1

Japan Macroeconomic Scenario

In our view, Japan's economy will likely decelerate amid a global recession but continue to grow moderately in 2023. A recovery in inbound travel should contribute to the recovery in domestic demand. At the same time, factors such as fears of a global recession, high inflation, and monetary tightening by central banks will likely weigh on growth. We project Japan's real GDP to grow 1.2% in 2023 and 1.1% in 2024 and 2025 (see table 2).

Table 2

We forecast Japan's unemployment rate to be 2.5% for 2023 and remain at similar levels in the following one to two years (see table 3). Employment indicators, including the unemployment rate, help us forecast the performance of loans extended to individuals that underlie RMBS and ABS. Fears of a coming recession have spurred a wave of job cuts and hiring freezes at leading firms in the U.S., such as at tech giants Amazon and Meta. However, Japan has not seen such moves, as labor contracts generally impose strict rules on layoffs. We do not see significant change in Japan's labor conditions as likely, despite slowing GDP growth in 2023.

We believe new jobs are returning to pre-pandemic levels. Generally, the active jobs-to-applicants ratio is regarded as a coincident indicator because labor supply and demand are generally tied to economic performance. The number of new job offers is regarded as a leading indicator because companies increase job offers during phases of economic recovery. The active jobs-to-applicants ratio declined substantially at the beginning of the pandemic in 2020; but it has been rising gradually. The ratio was 1.35x as of October 2022 (see table 1), on par with pre-pandemic levels. Similarly, the number of new job offers plummeted in 2020. However, it recovered slowly in 2021 and remained slightly below pre-pandemic levels in 2022, suggesting the pandemic's effects on Japan's employment have peaked.

Table 3

Chart 1

We believe buoyed prices in Japan will gradually subside in 2023 and onward before stabilizing around 1%-2%. We forecast Japan's inflation rate to be 1.5% for 2023 (see table 4). Major economies saw sharp price hikes in 2022--over 9% in the U.S. and the U.K. (see chart 2). Although increases in Japan have not been this dramatic, we consider it a meaningful shift for the country, given years of chronic deflation.

An increase in prices can stress household finances if it is unaccompanied by wage growth. According to the International Labor Organization, real wage growth, which incorporates price fluctuations, was negative 3.2% in 2022 in the U.S. This suggests the country's wage growth has not kept pace with inflation (see chart 3). On the other hand, real wage growth in Japan was negative 0.7% in the same period, not as significant as in the U.S. However, with the exception of 2021, Japan's real wage growth has been negative since 2017--an extended period of strain for households. Some companies and industries in Japan have implemented or are considering implementing pay rises. However, we believe it will take time for such measures to take effect nationwide.

As of November 2022, we project Japan's policy rate to rise to about 0.1% for 2023 (see table 4). In the meantime, the Bank of Japan (BOJ) announced on Dec. 20, 2022, that it would raise the cap on 10-year government bond yields, the benchmark for long-term interest rates, to about 0.5% from about 0.25%. Although less volatile than in other countries, we are closely watching the impact of rising interest rates on macroeconomic trends and the performance of securitization deals in Japan, where interest rates have been very low for many years.

Table 4

Chart 2

Chart 3

Owner-Occupied RMBS And Condominium Investment RMBS

Performance outlook for underlying assets is stable

The outlook is stable in 2023 for 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).

Performance was solid in 2022 for such mortgage loans despite various uncertainties. Adverse factors in 2022 included inflation, a weakening yen, soaring energy prices, supply chain disruptions, and a resurgence of the COVID-19 pandemic. At the same time, domestic and global travel began to return to normal. In Japan, the government had imposed only limited restrictions on economic activity.

The low and stable unemployment rate should underpin the performance of mortgage loans. We consider the unemployment rate to be a convincing indicator for the future performance of mortgage loans.

Prices for daily goods continue to climb. Inflation without higher wages could stress borrowers' ability to repay, hurting the performance of mortgage loans. However, we think the likelihood of this risk materializing is limited because we expect the annual inflation rate to hover in a range of 1%-2% into 2025 (see table 4).

Rating trend will likely be stable

We expect rating trends for owner-occupied RMBS and condominium investment RMBS for 2023 to be stable.

Property prices are rising for some property types in certain areas, such as for condominiums in the greater Tokyo area. An increase in property prices is a positive factor in our rating analysis because, for existing transactions, it provides obligors with weaker repayment capacity an option to pay off their loans by disposing of properties. It also leads to higher recovery from defaulted loans. In the case of new transactions where collateral assets are mostly condominiums in favorable locations, we examine and incorporate in our analysis the likelihood of a rise in property prices leading to a higher risk of collateral value declining in the future.

Most housing loans in Japan are floating-rate based. Accordingly, a rise in interest rates directly results in an increase in repayment amounts for borrowers, and therefore would be a risk factor for the performance of housing loans. However, higher interest rates would have only a limited effect on our ratings on owner-occupied RMBS and condominium investment RMBS, because more than 90% of underlying loans backing these securities have fixed interest rates. We also view the risk of a rate hike to be limited in the medium term even for RMBS transactions backed by loans with floating interest rates or convertible interest rates. This is based on our November 2022 assumption that Japan's policy rate will remain at about 0.1% through 2025.

Apartment Loan RMBS

Performance outlook for underlying assets is somewhat negative

We expect the performance outlook of assets underlying RMBS transactions typically backed by loans to landowners who build rental apartment buildings (apartment loan RMBS) to be somewhat negative in 2023.

The performance of assets underlying apartment loan RMBS transactions that we rate was favorable in 2022; both delinquencies and defaults remained low. In rated transactions, developers of the collateral apartment buildings typically have in place long-term master lease contracts with the borrowers of the underlying loans. These contracts allow the borrowers to receive stable master lease rent, regardless of vacancy rates or apartment rent levels. We believe this mechanism supports the favorable performance of apartment loans.

Declining profitability of apartment properties is a stress factor for the performance of underlying assets. More than 15 years, on average, have passed since the inception of transactions we rate; and the underlying apartment properties backing the rated transactions are about 20 years old. The competitiveness of apartment properties generally weakens over time as new competing apartments are built, weighing on their rent levels and vacancy rates. Long-term master lease contracts typically have a clause to review master lease rent levels regularly. In recent years, we have seen a reduction in master lease rents to reflect the weaker profitability of some older apartments. Our rating analysis incorporates a scenario in which long-term master lease contracts terminate.

Leopalace21 Corp., a major apartment builder in Japan, has not totally resolved issues related to defects uncovered in 2018 at some apartment buildings it constructed. Although the builder has maintained long-term master lease contracts, this long unresolved problem has hurt the profitability of related apartment buildings and constrained the performance of the underlying apartment loans.

In the medium to long term, a decline in rental housing needs arising from Japan's decreasing population could also stress underlying apartment loans. Aged apartment properties will only remain competitive if periodic major renovations take place and adequate daily maintenance is ensured.

Rating trend will likely be somewhat negative

We expect the overall rating trend of apartment loan RMBS for 2023 to be somewhat negative. This reflects challenges including erosion of competitiveness over time of apartment buildings backing rated transactions, persistent problems with defects at Leopalace21's apartment buildings, and demographic changes in Japan.

Apartment loans typically have floating interest rates. Our main scenario does not assume a huge hike in Japan's policy rate in the medium term. However, apartment loans greatly outnumber residential loans. In our view, an interest rate rise will likely have a greater effect on the ability of borrowers to repay apartment loans than those of residential loans and thus affect our ratings on apartment loan RMBS more negatively.

ABS Backed By Consumer Receivables

Performance outlook for consumer receivables is stable

We expect the performance of consumer receivables backing ABS transactions to be stable in 2023. Transactions are backed by auto loan receivables, shopping credit receivables, credit card receivables (shopping and cashing receivables), and consumer loan receivables.

The unemployment rate is a key factor that could affect the creditworthiness of obligors of auto loans backing ABS transactions we rate. We forecast an unemployment rate of 2.5% for 2023, a decline of 0.1 percentage point from the previous year. We therefore think it somewhat unlikely that unemployment would drive a deterioration in obligors' performance, including through delinquencies and defaults.

Meanwhile, macroeconomic factors can also hit the creditworthiness of obligors, and consequently transactions. In particular, an increase in geopolitical risk and changes in economic conditions, such as consumer price inflation and a sharp depreciation of the yen, weighed on the Japanese economy in 2022. We believe such uncertainties will endure in 2023.

Auto loan obligors face challenging conditions due to rising prices for gas and daily necessities. Although consumer prices are rising at a slower pace in Japan than elsewhere, limited growth in wages means inflation is still hurting. Despite this, we do not expect inflation to directly affect obligors' delinquencies and defaults. This is because we consider Japan's inflation transitory, and because monthly repayments of auto loans are generally in the tens of thousands of yen (hundreds of dollars).

Demand for used cars, which affects the performance of auto loan ABS transactions, has been growing. In the used-car market, the main factor at play is a decrease in new car sales caused by shortages of semiconductors and auto parts. The supply of used cars remains low, which has lifted prices at auctions. In addition, overseas dealers have been able to purchase used cars relatively cheaply in Japan thanks to the weak yen. In 2023, we expect the demand for used cars to remain high. The performance of underlying loans is likely to be supported by possible sales of automobiles by obligors to repay loans when they face financial difficulties.

Rating trend will likely be stable

We expect our ratings on ABS transactions backed by consumer receivables to remain stable in 2023. Underlying assets have been stable. This was the case even during the pandemic's darkest phases. Transaction defaults and delinquencies remained low, leading to progress in repayments of rated classes and credit enhancement. We have assigned 'AAA (sf)' ratings to all the auto loan ABS transactions. We see only a limited possibility of a negative rating actions.

ABS Backed By Corporate Receivables

Performance outlook for corporate receivables is stable

We expect the performance of corporate receivables backing ABS transactions to be stable in 2023.

In the case of ABS transactions backed by corporate receivables, the main underlying assets are lease receivables (including auto lease receivables) and trade receivables. According to the Japan Leasing Association, lease transactions decreased 2.1% year on year to ¥1.9 trillion in the first half of fiscal 2022, although the decline was smaller than in 2020 when the market was hit hard by COVID-19. However, we think the market is shrinking over the long term, considering the peak semiannual transaction volume of about ¥4 trillion in the 1990s.

Amid a shrinking domestic market, leasing companies are not only offering conventional leases, but also focusing on providing high-value-added leases aimed at meeting diverse and sophisticated customer needs, expanding in specialty fields such as aircraft leasing, and developing overseas businesses. Leasing companies--originators of corporate receivable ABS--are often group companies of banks or manufacturers. Thus, we consider their business bases to be relatively stable. The impact of changes in the macro business environment on their businesses will likely remain limited in 2023.

The default rates of pools of corporate receivables generally trend in line with corporate bankruptcies in Japan. According to the October 2022 bankruptcy information published by Teikoku Databank Ltd. (TDB), an upward trend for corporate bankruptcies has continued since May 2022. For the full year 2022, TDB expects to see the number of corporate bankruptcies grow for the first time in three years. At the same time, we do not anticipate a sudden increase in the number of corporate bankruptcies that would adversely affect default and delinquency rates of underlying assets, because the number remains lower than pre-pandemic levels. However, the direction of macroeconomic conditions remains uncertain in our view, as a weaker Japanese yen, inflation, and geopolitical risks will likely continue through 2023. If conditions deteriorate more than we expect, the number of corporate bankruptcies may rise, affecting default rates of corporate receivable pools.

CMBS

Outlook for the performance of office buildings is somewhat negative

We expect the value of properties backing Japanese CMBS to either slightly decline or remain unchanged in 2023. By asset class, we expect the value of office buildings will somewhat decline from the previous year. The value of rental apartment buildings will remain nearly unchanged or decline slightly and that of distribution and warehouse facilities will be almost flat.

Office buildings

We expect the value of office buildings to remain slightly weak in 2023, considering the following:

• Demand for rental offices will moderately weaken as more people work remotely and companies review their office spaces;
• Capitalization rates, almost peaking, may rise partly due to the BOJ's revised monetary easing policy; and
• Japanese REITs have less appetite for property acquisition, amid a decline in public stock offerings.

According to data from Miki Shoji Co. Ltd., the average vacancy rate of office buildings in Tokyo's business districts bottomed at 1.49% in February 2020 and rose substantially through the pandemic. The rate has been stable between 6% and 7% since the latter half of 2021. We attribute this to vacancy rates for newly completed buildings, which increased substantially to about 38% as of October 2022 from 14% a year earlier. In addition, average rents are trending down in tandem with the rise in vacancy rates.

Negative factors for Japan's office building market in 2023 include:

• Weakening of demand due to slower economic growth and expectations for global interest rate hikes;
• A moderate decline in demand as companies revise their office strategies as telecommuting and shared offices become widely accepted; and
• Scheduled new large-scale supply.

Although ample demand remains for high-grade properties in favorable locations, we expect the office building market to remain somewhat weak, particularly in less competitive properties.

Rental apartment buildings

We expect the value of rental apartment buildings to basically remain flat or decline slightly in 2023. We base our view on stable demand, which is counterbalanced by the negative reaction to sentiment in the market that prices are already high.

Rents for leased Condominium in Tokyo, according to data published by Tokyo Kantei Co. Ltd., have been rising in recent years. Rent levels have remained high after hitting a peak in April 2022. Capitalization rates have slightly declined in certain areas in Tokyo. This leads us to believe the demand for rental apartment buildings remain solid.

According to the Real Estate Information Network for East Japan, closing numbers for sales of existing condominiums in the greater Tokyo area have been recording year-on-year decreases since the summer of 2021. Conversely, contracted prices per square meter for condominiums have been moderately increasing. The number of second-hand condominiums available for sale started to decline in the latter half of 2020 and we believe it remains in short supply in 2023. We partially attribute this to a recent downward trend in new condominium supply and relative growth in demand for second-hand condominiums due to rising material prices.

Compared with condominiums for sale and existing condominiums, rental apartment buildings are less liquid and there are fewer of them in the market. However, the value of rental apartment buildings could be affected by high price sentiment. Accordingly, we forecast values will likely weaken, mainly in the greater Tokyo area.

Distribution and warehouse facilities

We expect the value of distribution and warehouse facilities to remain stable in 2023 based on the following:

• Though vacancy rates could rise in the coming year, rental revenue from distribution and warehouse facilities is likely to be stable thanks to robust demand;
• Surveys of real estate investors indicate capitalization rates are declining in all areas; and
• Demand from domestic and overseas investors remains strong.

According to CBRE Inc., vacancy rates in the third quarter of 2022 for distribution and warehouse facilities rose 2.6% year on year to 5.2% in the greater Tokyo area, and remained unchanged and low at 1.7% in 2022 in the Kinki (greater Osaka and nearby prefectures) region. CBRE also reported that there will be large supplies of new distribution and warehouse facilities in the greater Tokyo area and Kinki region in the first quarter of 2023. Demand from e-commerce and distribution companies remains strong. However, we believe that vacancy rates may rise to some extent in the coming year. This is because of significant new supply and stringent screening by tenants in light of uncertainties over future business conditions. However, we expect the value of distribution and warehouse facilities to remain stable in 2023. These properties enjoy strong demand from domestic and overseas investors.

Related Criteria

• Global Methodology And Assumptions: Assessing Pools Of Residential Loans, Jan. 25, 2019
• Global Auto ABS Methodology And Assumptions, March 31, 2022
• Global Consumer ABS Methodology And Assumptions, March 31, 2022
• Global Equipment ABS Methodology And Assumptions, May 31, 2019
• Global Credit Card ABS Methodology And Assumptions, Oct. 9, 2014
• Rating Methodology And Assumptions For Japanese CMBS, Jan. 22, 2014

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