On July 28, 2023, S&P Global Ratings assigned its 'AAA (sf)' rating to the class A notes of Anyihua 2023 Phase III Personal Consumption Loan Asset Backed Securities (Anyihua 2023-3). It was the first 'AAA' rating assigned by an international ratings agency to a securitization transaction in China backed by consumer finance assets. The notes issued are backed by a pool of unsecured consumer loans originated by Mashang Consumer Finance Co. Ltd. (Mashang CFC).

This report addresses questions from investors in China's consumer finance asset-backed securities (ABS) sector as well as our rating process and methodology.

Frequently Asked Questions

What are the prospects and key characteristics of China's consumer market and consumer finance industry?

China's consumer market has soared over the past nine years. Total retail sales of consumer goods have jumped 7.4% in terms of compound annual growth. In the first quarter of 2023, total retail sales of consumer goods increased 5.8% year on year to Chinese renminbi (RMB) 11.5 trillion.

Key underlying drivers for this rapid growth include increasing GDP per capita, rapid urbanization, growth in the middle class, and the proliferation of e-commerce. The vast scale of China's private consumption has cemented its status as the world's second-largest consumer market (by country).

The consumer finance market has displayed robustness since 2013--widely recognized as Year One of China's internet finance era. With the rising penetration of internet finance and online payments, consumer loans have gained sizable momentum, mainly due to business originated through online channels.

During 2013-2019, China's outstanding consumer loans recorded annual growth of 15%-62%. However, the onset of the pandemic in 2020 slowed growth. As of the end of 2022, consumer loans outstanding total around RMB17.25 trillion, up 4.1% year on year. After China's reopening, consumption loan volumes rose 11% in the first quarter of 2023, compared with the same period of 2022 (see "A Primer On China's Consumer Loan ABS Market," published on June 9, 2023).

Consumer loans can be securitized through three schemes: credit ABS, under the credit asset securitization (CAS) scheme; corporate ABS, under the Asset-Backed Specific Plan (also known as Exchange ABS); and the asset-backed notes (ABN) scheme managed by China's National Association of Financial Market Institutional Investors (NAFMII). Given that this FAQ is related to the transaction set up under the CAS scheme and the availability of data, we will focus on credit ABS in this report when referring to sector or in case of cross-sector comparison.

What are the key characteristics of the rated transaction?

Below are select key characteristics (see "New Issue: Anyihua 2023 Phase III Personal Consumption Loan Asset Backed Securities" published on July 28, 2023):

• Regulatory regime: This transaction is constructed as per China's CAS scheme, set up by the National Administration of Financial Regulation and People's Bank of China.
• At deal close: Mashang CFC sold a pool of consumer loan receivables to a special-purpose trust (SPT). To fund such receivables purchase, the trustee issued, on behalf of the SPT, class A, class B, and subordinated notes. We rated the class A notes 'AAA (sf)'. The class B and subordinated notes are not rated by S&P Global Ratings.
• Securitized pool: The collateralized assets are consumer loans extended to retail borrowers. The borrowers draw personal lines of credit to purchase goods and services and pay later through monthly instalments. As of the initial cut-off date, the pool consisted of more than 400,000 contracts, with a weighted-average loan balance of RMB4500, weighted-average interest rate of 23.83%, and weighted-average remaining tenor of about nine months.
• Revolving period: The asset pool will be revolving for seven months. During the revolving period, principal collections and residual interests defined by the transaction documents will be used to purchase additional receivables from Mashang CFC.
• Sequential pay: When the amortization period begins, the asset pool will become static. Thereafter, principal collections, after application of principal draws, will be used to pay down the class A, class B, and subordinated notes sequentially. Excess income, if any, will be diverted to the principal waterfall for note principal payment.
• Cash liquidity reserve: A cash liquidity reserve equivalent to RMB20 million has been funded by the issuance proceeds upon transaction closing to provide liquidity support to the transaction. During the transaction life, the liquidity reserve will be maintained at a required amount defined by the transaction documents (roughly two times senior fees and expenses, and note coupon).
• Servicer: The originator is the transaction's servicer to collect borrowers' payments and to manage arrears.

The deal structure is similar to Chinese auto loan ABS that we rate. The underlying pool exhibits a shorter remaining tenor, higher interest rate, and smaller average loan size than a typical securitized auto loan pool in China.

How do you rate a Chinese consumer finance ABS transaction?

We apply our relevant criteria to analyze a transaction, using five main risk perspectives: credit, cash flow, operational, counterparty, and legal. Ratings above the sovereign are an additional consideration in our analysis.

Credit risk: We take into consideration historical performance data related to the securitized portfolio, and other qualitative factors such as an originator's track record, business and underwriting strategies, risk-management practices, and data sufficiency and reliability. We determine our base-case assumptions in line with our "Global Consumer ABS Methodology And Assumptions," published on March 31, 2022. We also consider the potential industry and macroeconomic dynamics that could affect loan performance.

Cash-flow analysis: We apply our "Global Framework For Payment Structure And Cash Flow Analysis Of Structured Finance Securities," published on Dec. 22, 2020, in cash flow analysis. We run cash flow scenarios with a combination of stress assumptions, including default timing, prepayment speed, and interest-rate stresses (if needed), to see if the proposed transaction structure supports the timely payment of interest and principal on the notes under relevant rating stress scenarios. We also consider the possibility of servicer transition and the resulting implications for collections commingling and liquidity.

Operational risk: The servicer is generally the key transaction party from an operational risk perspective in Chinese consumer ABS. We analyze the likely effect of a disruption to the servicer's performance under our "Global Framework For Assessing Operational Risk In Structured Finance Transactions" operational risk criteria, published on Oct. 9, 2014. In some cases, our criteria might limit the transaction's maximum potential rating. In addition, if a rating of 'AA (sf)' or higher is sought, then we would apply our servicer risk criteria to determine if an additional safeguard regarding collections is needed (see "Methodology For Servicer Risk Assessment," criteria published on May 28, 2009).

Counterparty risk: We analyze the type of counterparty risk to which the proposed transaction could be exposed. We review if the proposed replacement arrangement or other mitigants are in line with our "Counterparty Risk Framework: Methodology And Assumptions," published on March 8, 2019. Among the common counterparty considerations for Chinese consumer ABS are minimum ratings and replacement provisions surrounding bank account providers to the transaction, and whether there are mitigants in place to address servicer commingling risk.

Legal risk: We undertake a review of the legal structure of the transaction and asset transfer mechanism from a true sale and bankruptcy remoteness perspective to determine whether the special-purpose entity established to issue the notes meets our "Structured Finance: Asset Isolation And Special-Purpose Entity Methodology" legal criteria, published on March 29, 2017.

Ratings above sovereign: Our 'AAA (sf)' rating on the Anyihua 2023-3 class A notes is higher than our sovereign rating on China. Our "Incorporating Sovereign Risk In Rating Structured Finance Securities: Methodology And Assumptions" criteria, published on Jan. 30, 2019, require us to carry out a separate sovereign stress test due to our 'A+' rating on China. These criteria also designate the sensitivity of ABS as "low" in terms of the sensitivity to a sovereign default scenario. With the low sensitivity and our view that the rated notes can fully sustain the hypothetical sovereign default scenario and still meet the senior notes' obligations, the maximum rating allowed on the notes is six notches above our sovereign rating on China of 'A+'. A rating of 'AAA (sf)' therefore is the highest we could assign to a Chinese consumer finance ABS, based on our criteria.

How do you analyze credit risk in this transaction?

We have applied our "Global Consumer ABS Methodology And Assumptions" criteria, published March 31, 2022, to the credit risk analyses in this transaction.

In our credit risk analysis, we assumed all loans that have been delinquent for more than 90 days would default, and used this classification to determine the base-case default frequency for the securitized pool. This assumption is supported by the low historical cure rates--returning from delinquency to current--of loans overdue for more than 90 days.

Our base-case default assumption for the collateral pool is 3.0%, based on the historical performance observed in the static pool and dynamic pool data. It also reflects China's macroeconomic conditions and our forward-looking view on asset performance trends. The overall loan portfolio's delinquency ratio was relatively high before 2019. The originator's management has attributed this to the small origination volume and less-comprehensive risk management when Mashang CFC launched operations. Asset performance has improved notably and stabilized since 2019, after the company tightened customer sourcing and loan underwriting and enhanced risk-management measures.

We formed our base-case default assumption by putting more weight on the asset performance of the originator's portfolio since 2019. We also considered the temporary volatility in the originator's asset performance due to the effects of the pandemic as well as the originator's subsequent remedial actions to enhance its asset quality.

We applied a stress multiple to the base-case default percentage in the 'AAA' rating category for the class A notes. The magnitude of the stress multiple that we applied reflects the rating level of the notes and the underlying pool's revolving nature that could render a portfolio profile different from the initial pool. We also considered the relatively short development history of consumer loan securitization in China and limited experience of macroeconomic stress in the past decade. We therefore applied a relatively high stress multiple within the criteria range.

Due to the unsecured nature of the loans in the portfolio, we assumed the whole amount of defaulted loans will become a loss (i.e., zero recovery).

How do you analyze cash flow in this transaction?

We analyzed the capacity of the transaction's cash flows to support the rated notes--i.e., timely interest payments and repayment of principal by the legal maturity date--by running several different scenarios correlated with a 'AAA' rating level for the class A notes. Our cash-flow analysis included various scenarios that reflect different combinations of the following factors:

• Level of defaults commensurate with the rating level and zero recoveries.
• Three different default curves: front-loaded, back-loaded, and normal. The curves we employed primarily reflect the default timing that we observed in Mashang CFC's static default curves.
• Different prepayment rates: high (constant prepayment rate [CPR] of 35% per year at year one, stepping up to 60% over the transaction's life), normal (35% per year), and low (5% per year). We observed a prepayment trend based upon the aggregate loan book, in which prepayments in the first two months after loan disbursement are relatively high compared with the remaining tenor. Given the minimum loan seasoning of one month in weighted-average terms for additional loan purchases, we construct the normal prepayment curve based on historical prepayment rates from the second month onward. We assume a CPR further stresses the prepayment rate to historically high levels, while the low CPR assumption stresses the effect of prolonged deal amortization.
• Stressed fees and expenses upon servicer transition and unexpected expense increase.
• The loss of one month of collections due to potential commingling risk.
• Minimum pool yield required by the asset eligibility criteria.

How do you analyze counterparty risks in this transaction?

There are three types of potential counterparty risks, namely the risk exposed to the bank account provider, servicer commingling risk, and set-off risk.

Bank account provider  Issuer accounts for Anyihua 2023-3 are held with Bank of China Ltd., pursuant to the account bank agreement. Among other transaction arrangements, the bank will be replaced within 90 calendar days if the rating on it is lower than 'A'. This arrangement meets our counterparty criteria to support a 'AAA' rated transaction, considering the transaction's cash flow arrangement.

Servicer commingling risk  Our counterparty criteria consider a transaction's commingling risk through the rating on the servicer, the amount of funds likely to be held in a servicer account at any given time, and the potential effect of a delay in receipt of those funds on the supported securities. In our opinion, there is potential commingling risk in this transaction if the servicer defaults. This is because Mashang CFC, acting as the servicer in this transaction, can hold the collections for a period of one month before remittance to the SPT account.

Collections could be redirected to the SPT accounts if the rating on the servicer is lowered to certain levels, based on local rating agencies' scale. In our view, the current transaction arrangement does not sufficiently mitigate commingling risk in accordance with our counterparty criteria. For this reason, we have assumed that one full month of collections may be lost due to commingling risk, before the payment redirections kick in. We have considered a one-month collection loss that roughly reflects the average monthly exposure for the early period in the transaction life in our cash flow analysis of the transaction.

Set-off risk  We believe the obligors' set-off risk in this transaction is remote because Mashang CFC is not a deposit-taking institution in China. In addition, according to the asset eligibility criteria, none of the obligors is an employee of Mashang CFC. Hence, no set-off risk arises specifically for employees.

Is sovereign risk a rating constraint for this transaction?

No, there is no rating cap from a sovereign risk perspective.

Our rating on the class A notes is higher than our sovereign rating on China. We applied our "Incorporating Sovereign Risk In Rating Structured Finance Securities: Methodology And Assumptions" criteria, published Jan. 30, 2019, and determined that the highest rating that can be considered for this transaction is 'AAA'.

To address sovereign default tail risk, our criteria employ a notching framework that caps the maximum achievable rating. The maximum differential of the number of notches above the sovereign rating for Anyihua 2023-3 is driven by our view of the sensitivity of the transaction's assets and structure to a sovereign default, our sovereign credit rating on China (A+/Stable/A-1), and our assessment that the rated notes can withstand a sovereign default stress. We use asset-class-specific assumptions from our typical 'A' rating stress scenario for cash flow analysis to replicate the impact of a sovereign default scenario, as per our criteria.

What is your view on the originator? How do you consider an originator's credit profile when assigning a rating to ABS?

Please refer to the "Originator/Servicer Overview" section of our rating report (see "Anyihua 2023 Phase III Personal Consumption Loan Asset Backed Securities," published July 28, 2023). The section summarizes what we learned from an in-depth operational review meeting with the originator and other data available to S&P Global Ratings.

We analyzed the risks associated with the originator/servicer from an ABS transaction perspective, such as operational risk and servicer commingling risk, based upon the information and transaction documents, as per our relevant criteria. Our rating committee is of the opinion that the ABS can be assigned a 'AAA (sf)' rating, delinked from the risk exposed to the originator/servicer. This is because either the risks are remote from a rating perspective or they have mitigants compatible with our applicable criteria.

Related Criteria And Research

Related Criteria

• Criteria | Structured Finance | ABS: Global Consumer ABS Methodology And Assumptions, March 31, 2022
• General Criteria: Environmental, Social, And Governance Principles In Credit Ratings, Oct. 10, 2021
• Criteria | Structured Finance | General: Global Framework For Payment Structure And Cash Flow Analysis Of Structured Finance Securities, Dec. 22, 2020
• Criteria | Structured Finance | General: Counterparty Risk Framework: Methodology And Assumptions, March 8, 2019
• Criteria | Structured Finance | General: Incorporating Sovereign Risk In Rating Structured Finance Securities: Methodology And Assumptions, Jan. 30, 2019
• Legal Criteria: Structured Finance: Asset Isolation And Special-Purpose Entity Methodology, March 29, 2017
• Criteria | Structured Finance | General: Global Framework For Assessing Operational Risk In Structured Finance Transactions, Oct. 9, 2014
• General Criteria: Global Investment Criteria For Temporary Investments In Transaction Accounts, May 31, 2012
• General Criteria: Principles Of Credit Ratings, Feb. 16, 2011
• Criteria | Structured Finance | General: Methodology For Servicer Risk Assessment, May 28, 2009

Related Research

• China Securitization Performance Watch 2Q 2023: Issuance Continues At A Slow Pace, Aug. 11, 2023
• New Issue: Anyihua 2023 Phase III Personal Consumption Loan Asset Backed Securities, July 28, 2023
• China Securitization: Auto ABS And RMBS Tracker May 2023, June 27, 2023
• A Primer On China's Consumer Loan ABS Market, June 9, 2023
• Credit FAQ: What's Behind Our First Rating On Credit Card ABS In China, Nov. 30, 2021
• Credit FAQ: A Closer Look At The First 'AAA (sf)' Rating Assigned To Chinese Auto Loan ABS, April 6, 2017