In view of the steady increase in investor inquiries regarding Hong Kong's consumer finance asset-backed securities (ABS) market, S&P Global Ratings is providing a market overview to address some common queries.

1. Overview Of Hong Kong's Personal Loan Market

1.1. Originators of unsecured personal loans

Providers of unsecured personal loans in Hong Kong generally consist of licensed money lenders registered at the Companies Registry and authorized institutions regulated by the Hong Kong Monetary Authority. These include banks, restricted-license banks, and deposit-taking companies (see chart 1).

The number of lenders has been decreasing over the past two years. The drop in registered money lenders is more noticeable, at 3%-6% annually since 2021. A series of challenges have hit their business, such as COVID-19, Hong Kong's technical recession in 2022, along with pressure from lower interest rate caps.

Chart 1

By mid-2024, unsecured personal loans in the market totaled HK$108.85 billion, while unsecured revolving loans amounted to HK$16.3 billion.

This S&P Global Ratings commentary will focus more on unsecured amortizing personal loans in the money lending sector--the origin of our rated deals' underlying assets.

1.2. Typical features of loans originated by money lenders

Fast and simple application process  

Money lenders often promote fast and easy applications via mobile apps or websites, without the need to show up in person at branches. They also offer a highly flexible approval and drawdown process, such as loan approval seven days a week and instant cash delivery.

Certain product types only require minimal information, such as a Hong Kong identity card, phone number, and bank account information. When the loan amount exceeds a certain threshold, lenders may require income proof and may check borrowers' credit scores with one of the credit reference agencies (CRAs). These consist of TransUnion Credit Information Services Ltd. and PingAn OneConnect Credit Reference Services Agency (HK) Ltd.

Borrowers and loan products  

Money lenders often focus on higher-risk borrowers than banks, and act as an alternative funding source. Such borrowers include those facing difficulty in obtaining bank funding, mostly due to a weaker credit profile or lack of income proof. TransUnion has a five-tier risk definition, which categorizes borrowers as super prime, prime plus, prime, near prime, and subprime. Money lenders' exposure to subprime borrowers in terms of origination was 45% in the first quarter of 2024, much higher than banks' exposure of 4% in the same period.

For local borrowers, personal loans typically include amortizing loans and revolving loans. Money lenders offer various types of products to meet a borrower's loan needs, including generic personal loans, tax loans, home renovation loans, and debt consolidation loans.

Money lenders also offer unsecured property-owner loans to borrowers that own property in Hong Kong. The title deed is not required as collateral. Compared with general personal loans, property-owner loans usually offer larger loan amounts, longer tenor, and lower interest rates.

Apart from local borrowers, some money lenders also target certain non-local borrowers working in Hong Kong, such as domestic helpers.

Loan tenor varies by product  

The tenor of local loans mostly ranges from three to 84 months, while that of domestic helper loans is much shorter, at 24 months or fewer, in consideration of the fixed term of their work contracts and visa validity.

Interest rates are generally higher than what banks offer 

Money lenders typically charge higher interest rates than banks. This considers money lenders' lower underwriting requirements, the higher-risk profiles of borrowers, higher cost of funds, and the highly flexible application and drawdown process. This is also due to the constraint from Money Lenders Ordinance (MLO) (Cap. 163) that prohibits money lenders from charging costs or expenses relating to the negotiations or granting of loans.

Effective Dec. 30, 2022, the statutory interest rate cap for lending stipulated in MLO section 24(1) was lowered to 48% per annum from 60%, while the presumed definition of extortionate rate under section 25(3) was lowered to 36% per annum from 48%.

1.3. Performance trend

Origination growth trending low as arrears remain elevated 

The origination of personal loans had shown sensitivity to Hong Kong's response to COVID-19 over the past few years. Origination growth slowed during the onset and resurgence of the pandemic in 2020 and 2022, respectively. Consumer spending sentiment and lenders' risk appetite were likely strained during such stressful times, hindering the market's willingness and ability to extend credit.

When the pandemic subsided in 2021 and early 2023, loan origination volumes increased temporarily. During those times, social distancing restrictions were relaxed, and government's stimulus measures, such as the consumption voucher scheme and tax concessions, were rolled out to encourage spending.

Another influencing factor has been money lenders' risk appetite. Origination grew in 2021 when money lenders had a renewed willingness to advance loans. This was indicated by a higher distribution of loans to below-prime consumers, which increased to 95% in the fourth quarter of 2021 from 82% in the same period a year earlier, according to TransUnion data.

In mid-2023, origination declined again and has remained sluggish since then, with lenders adopting a more prudent approach to underwriting to manage credit risk. This was observed from the origination data for higher-risk borrowers, as both traditional lenders and money lenders reduced origination to subprime borrowers by 2-3 percentage points in the first half of 2024. Lenders' risk appetite declined likely because the underlying loan arrears increased around the same period and have remained elevated thereafter.

In contrast to a decrease in unsecured amortizing loans, origination of unsecured revolving loans increased by 22-49 percentage points year on year for the past four consecutive quarters. This could signal increasing consumer demand for more flexible credit options, according to TransUnion.

Chart 2

Delinquency rate remains sensitive to market conditions  

The 60-plus-day delinquency ratio has had some volatility in the past five years due to changing market dynamics. The ratio increased from 0.37% in 2019 (before social unrest), to 0.63% in the first half of 2020, when COVID-19 first struck Hong Kong. Although the ratio leveled off from mid-2020 to 2021, it crept up again in the first half of 2022 due to a surge in COVID-19 cases. Social-distancing restrictions were reintroduced at that time, and GDP contracted for four consecutive quarters in 2022, meaning that Hong Kong was technically in an economic recession.

Delinquencies have remained elevated since then, according to the latest data by TransUnion. Borrowers' repayment ability could be hindered in 2024, in part because the unemployment rate has been inching up moderately again since the beginning of 2024.

Chart 3

Prepayment trend  

Under debt consolidation or refinancing programs, new loans are extended to borrowers, such that they may use part of the proceeds to repay existing loans. Depending on where borrowers' existing loans originated, such practices may result in a higher prepayment rate not only for money lenders, but potentially for banks as well.

1.4. Key drivers for loan performance

Considering the highly fragmented market and divergent underwriting practices, individual lenders' loan performance varies greatly. Nonetheless, some macro factors, including individual bankruptcy petitions and the unemployment rate, have generally been able to explain past loan performance and may indicate future performance.

Bankruptcy petitions  

Bankruptcy petitions and personal loan delinquency have been correlating positively in the past few years (see chart 4). Under Hong Kong's bankruptcy regime, no proceedings can be taken against or continued without the court's approval once a bankruptcy petition is filed or when the court makes a bankruptcy order. This infers that borrowers' payment obligations will be paused once a bankruptcy petition is filed.

As such, bankruptcy petition figures generally trend toward the same direction as the state of debt serviceability.

Chart 4

Unemployment rate  

Hong Kong's unemployment rate and bankruptcy petitions often move alongside each other as well, especially during tough market conditions, as seen throughout macro cycles over the past two decades. This includes the 2002-2003 recession, 2008-2009 recession, and the more recent turbulence in 2019-2020 and 2022 (see chart 5).

Chart 5

We view the unemployment rate as another factor influencing loan performance, since employment status can affect a borrower's income level and repayment ability. Before the stressed period of social unrest and COVID-19, Hong Kong's unemployment rate had been strictly below 3% throughout 2018. The figure began rising after mid-2019, until it more than doubled to 6.7% in the first quarter of 2021. During this period, personal loans' 60-plus-day delinquency ratio also hit a five-year peak of 0.63% in the second quarter of 2020, compared with 0.37% at the start of 2019.

Unemployment has been edging up slightly since the beginning of 2024, with a similar uptick in delinquency rates.

2. Hong Kong Consumer Loan ABS Sector

2.1. Stable issuance trend at a low level

The transactions we rate are originated by a major money lender in Hong Kong. The number of outstanding rated transactions has been stable at one to two annually since 2017, while issuance or committed amount per transaction averaged HK$1 billion-HK$2 billion.

We observe that market participants have been showing interest in this sector, and view ABS as an alternative source of financing. However, deals are likely to gear towards the private domain. The issuance will also depend on the cost of financing of ABS versus other funding channels at the prevailing market condition.

2.2. Typical deal structure of rated transactions

Transaction comparison  

We compare the two latest rated transactions in table 1.

Table 1

Capital structure  

In the transactions that we rate, typically two to four classes of notes have been issued, comprising senior notes, subordinated notes, and occasionally mezzanine notes. We only assign ratings to the senior notes, which carry floating-rate coupons. The subordinated notes are held by the originator, which also takes up the roles of servicer and transaction administrator.

Apart from the subordination of mezzanine notes and subordinated notes, credit support for the senior notes generally consists of a certain amount of excess spread, because the underlying assets carry high interest rates.

Revolving structure  

The transactions we rate often adopt a revolving structure. This is mainly driven by funding efficiency, and in consideration of the shorter tenors of some loans, such as those to domestic helpers.

During the reinvestment period, which usually lasts for at least two years, receivables are purchased and added to the securitized pool. The newly acquired receivables must meet the documented asset eligibility criteria and portfolio parameters. These include, but are not limited to, the maximum exposure to different loan products, distribution of internally assessed credit scores, and average loan size. Failure to maintain these preset portfolio parameters will lead to transaction amortization.

The transaction will also stop reinvesting in new receivables and enter an amortization period by the end of the revolving period or when any early amortization event occurs. This includes the failure of key third parties, such as the servicer, in carrying out their obligations, breach of preset loan performance measures (including delinquency and default rates), as well as a failure to maintain a minimum excess spread or a set of loan tenor-loan interest combinations.

Borrowers  

The transactions we rate are backed by local loans and domestic helper loans. We observe that the latter often have lower cumulative deemed default rates. This is due to the higher income stability that is secured by fixed-period contracts and faster amortization resulting from their shorter loan tenors.

Underlying assets  

The secured assets are all amortizing loans. The tenor of domestic helper loans is generally much shorter. For instance, in Ocean Funding 2022-1 Ltd., the maximum tenor for such loans is two years, in contrast with local loans' limit of eight years.

Underlying yield  

The current maximum interest rate allowed under the MLO is 48% per annum since December 2022. As expected, the lowered interest rate cap has a limited effect on securitized transactions because eligibility criteria typically filter out defaulted or seriously delinquent loans, and place certain requirements on a borrower's credit score. This means that the proportion of high-risk loans--priced at or close to the maximum interest rate allowed by law--are minimal.

2.3. Asset performance

Rated portfolios generally remained resilient  

The originator of the transactions we rate is a key player in the money-lending market, and it focuses on borrowers with weaker creditworthiness than those served by banks. Nonetheless, it has been performing in line with our base case loss assumptions, which are 5.3% for domestic helper loans and 9% for local loans.

Although Hong Kong's economy has seen some volatility over 2019-2023, the performance of our rated portfolio has been fairly stable. In our view, this demonstrates resilience amid macro challenges. The transactions' high excess spreads, stringent portfolio parameters, and early amortization triggers also help ensure that credit losses are fully covered, and credit enhancements are maintained during the revolving period.

High prepayment rates  

The transactions we rate have seen higher prepayment rates than those of other asset classes. This is because borrowers are incentivized by the underlying loans' high interest rates to repay sooner, while additional proceeds offered by some lenders under debt consolidation or refinancing programs make early repayments feasible. Such high prepayment rates tend to affect the excess spread available to the transactions. We've taken into account such factors in our cash flow modeling.

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